Gillman v. Chase Manhattan Bank, N. A.
534 N.E.2d 824, 73 N.Y.2d 1, 537 N.Y.S.2d 787 (1988)
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Rule of Law:
A security agreement in a commercial transaction between sophisticated parties is not unconscionable simply because it grants a lender the right to seize the borrower's bank deposits without prior notice if the lender, in good faith, deems itself insecure.
Facts:
- Jamaica Tobacco and Sales Corp. (Jamaica Tobacco), a wholesale tobacco distributor, was required by Aetna Casualty and Surety Company (Aetna) to obtain a $400,000 letter of credit to secure a surety bond needed for purchasing tax stamps on credit.
- Jamaica Tobacco applied for and received the letter of credit from Chase Manhattan Bank, N.A. (Chase).
- As part of the application, Jamaica Tobacco's president, Steven Frohlich, signed a security agreement that pledged all of the company's deposit accounts at Chase as security.
- A clause in the agreement granted Chase a general lien on Jamaica Tobacco's deposit accounts and authorized Chase, if it deemed itself insecure in good faith, to seize the funds in those accounts 'without notice or demand.'
- Over a year later, Chase received information that Jamaica Tobacco was in serious financial difficulty and had violated several other covenants of its agreement with the bank.
- Believing its position to be insecure, Chase, without prior notification to Jamaica Tobacco, transferred $372,920.57 from Jamaica Tobacco's primary checking account to a different account controlled exclusively by Chase.
- As a result of the fund transfer, checks written by Jamaica Tobacco to its creditors were dishonored due to insufficient funds.
- Shortly thereafter, Jamaica Tobacco executed an assignment for the benefit of its creditors.
Procedural Posture:
- The assignee for the benefit of creditors of Jamaica Tobacco sued Chase Manhattan Bank in New York Supreme Court (the trial court) to nullify the transfer of funds and seek damages.
- After a nonjury trial, the trial court found the security agreement unconscionable and awarded compensatory, consequential, and punitive damages to the assignee.
- Chase, as appellant, appealed to the Appellate Division of the Supreme Court (an intermediate appellate court).
- The Appellate Division reversed the trial court's judgment on the law and facts and dismissed the complaint.
- The assignee, as appellant, was granted leave to appeal to the New York Court of Appeals (the state's highest court).
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Issue:
Does a security agreement in a commercial letter of credit transaction, which allows a bank to deem itself insecure and seize the customer's bank account without prior notice, constitute an unconscionable contract unenforceable under the law?
Opinions:
Majority - Hancock, Jr., J.
No. A security agreement that allows a bank, upon deeming itself insecure, to seize a commercial customer's deposits without notice is not unconscionable and is therefore enforceable. To be deemed unconscionable, a contract must generally be both procedurally and substantively unconscionable. Here, there was no procedural unconscionability because the transaction was between sophisticated commercial parties, and the existence of the security agreement was clearly indicated in bold print above the signature line; the failure of Jamaica Tobacco's president to read the contract amounts to gross negligence. The agreement was not substantively unconscionable because the bank's right to act without notice was a commercially reasonable and necessary measure to protect its security interest, which would be defeated if the customer could withdraw the funds after receiving notice. Chase did not act in bad faith, as it had legitimate reasons to deem itself insecure, and the seizure was not a 'voluntary' transfer that could be voided as a preferential transfer under the Debtor and Creditor Law.
Analysis:
This decision reinforces the high threshold for proving unconscionability in contracts between sophisticated commercial entities, emphasizing judicial reluctance to disturb risk allocation agreed upon by the parties. It validates the commercial reasonableness of security agreement clauses that permit a lender to seize a debtor's deposit accounts without prior notice to protect collateral. The case serves as a strong precedent for lenders, confirming their right to enforce such clauses when they have a good faith belief of insecurity, and underscores that business owners are held to a high standard of diligence in reading and understanding the contracts they sign.
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