Lauren M. Pavlovich v. National City Bank
435 F.3d 560, 2006 U.S. App. LEXIS 2417, 58 U.C.C. Rep. Serv. 2d (West) 695 (2006)
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Rule of Law:
A custodian bank for a non-discretionary account does not breach its contractual or fiduciary duties when it follows the written instructions of a client's authorized agent. The scope of the bank's duties are defined by the contractual agreements, and the client may ratify the agent's actions by having knowledge of the transactions, accepting their benefits, and failing to repudiate the agent's authority in a timely manner.
Facts:
- In 1992, Lauren M. Pavlovich received approximately $2.5 million and hired Cashel Management Company ('Cashel') to invest the funds.
- Pavlovich executed an Investment Management Contract giving Cashel 'complete discretion' over her investments.
- Simultaneously, Pavlovich signed a Custody Agreement with National City Bank ('the Bank') and a Trading Letter granting Cashel 'sole trading authority' over her account, directing the Bank to accept all trades from Cashel.
- Starting in 1995, Cashel directed the Bank to invest Pavlovich's funds in Rx Remedy, Inc., a financially troubled company.
- From 1998 to 2000, Cashel directed monthly wire transfers from Pavlovich's account to Rx Remedy in exchange for promissory notes and stock warrants.
- Cashel engaged in a 'rollover' scheme, wiring funds to Rx Remedy at the start of the month and having Rx Remedy deposit a check for the principal plus 'interest' at the end of the month.
- Pavlovich received monthly statements from the Bank detailing these transactions for several years and reported interest income from the Rx Remedy notes on her tax returns.
- In January 2000, Pavlovich’s husband made a phone call to the Bank complaining about the transfers, but Pavlovich did not provide written notice terminating Cashel's authority until late 2000, by which time Rx Remedy had filed for bankruptcy and she had lost approximately $1.5 million.
Procedural Posture:
- On April 12, 2001, Lauren M. Pavlovich (Plaintiff) sued National City Bank (Defendant) in an Ohio state court.
- The Bank removed the case to the U.S. District Court for the Northern District of Ohio (a federal trial court).
- Pavlovich amended her complaint multiple times, ultimately withdrawing her federal claims and proceeding based on diversity jurisdiction.
- The District Court granted summary judgment in favor of the Bank on all claims and denied Pavlovich's motion for partial summary judgment.
- Pavlovich (Appellant) appealed the District Court's decision to the U.S. Court of Appeals for the Sixth Circuit.
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Issue:
Does a custodian bank breach its contractual and fiduciary duties to a client when it follows the written instructions of the client's authorized investment advisor, even if those instructions result in significant financial loss for the client?
Opinions:
Majority - Merritt
No. A custodian bank does not breach its duties when it adheres to the express terms of its agreements with a client. The Bank's actions were authorized by the Custody Agreement and the Trading Letter, which explicitly granted Cashel authority to direct investments. The wire transfers constituted 'trades' as they were in exchange for promissory notes and warrants. Even if the transactions were unauthorized, Pavlovich ratified them by receiving monthly statements for years without written objection, accepting the benefits by reporting interest income on her taxes, and failing to provide a timely written repudiation as required by the contract. The Bank’s fiduciary duties were limited to its contractual obligation not to make unauthorized distributions, and Ohio's economic-loss rule bars the negligence claim because the Bank owed no tort duty independent of its contractual duties.
Analysis:
This case solidifies the principle that the duties of a custodian bank for a non-discretionary account are narrowly defined by the governing contracts. It provides a strong shield for such financial institutions, placing the burden of monitoring investment advisors squarely on the client. The court's application of the ratification doctrine is significant, demonstrating that a client's inaction and acceptance of benefits in the face of clear account information can waive their right to later claim transactions were unauthorized. The decision also reinforces the economic-loss rule's role in preventing parties from recasting a breach of contract claim as a tort claim to recover purely economic damages.
