Indemnity and Exculpatory Clauses

1
Indemnity and Exculpatory Clauses

• Richard Warner

2
Patco v. Peoples United Bank

• The eBanking agreement stated that Ocean Bank
  did not assume any responsibilities with
  respect to Patco's use of eBanking, that
  electronic transmission of confidential business
  and sensitive personal information was at
  Patco's risk, and that Ocean Bank was liable only
  for its gross negligence, limited to six months
  of fees.

3
Patco v. Peoples United Bank

• Use of Ocean National Bank's eBanking for
  Business by any one owner of a joint account or
  by an authorized signor on an account, shall be
  deemed an authorized transaction on an account
  unless you provide us with written notice that
  the use of Ocean National Bank's eBanking for
  Business is terminated or that the joint account
  owner or authorized signor has been validly
  removed form sic the account.
• Are these provisions enforceable?

4
Patcos Facts

• Patco used eBanking for weekly payroll.
• A key logger stole passwords and answers to
  security questions.
• Six withdrawals totaling 588,851.26.
• If the banks security procedures were
  commercially reasonable, the bank has no
  liability.
• This is the effect of UCC 4A.

5
Risk Profiling

• Risk Profiling The system entailed the building
  of a risk profile for each customer . . . based
  on a number of different factors, including the
  location from which a user logged in, when/how
  often a user logged in, what a user did while on
  the system, and the size, type, and frequency of
  payment orders normally issued by the customer to
  the bank. The Premium Product noted the IP
  address that the customer typically used to log
  into online banking and added it to the customer
  profile.

6
Precautions Patco Did Not Use

• In May 2009, bank personnel did not monitor the
  risk-scoring reports received as part of the
  Premium Product package, nor did the bank conduct
  any other regular review of transactions that
  generated high risk scores. In May 2009, the bank
  had the capability to conduct manual review of
  high-risk transactions through its
  transaction-profiling and risk-scoring system,
  but did not do so. The bank also had the ability
  to call a customer if it detected fraudulent
  activity, but did not do so.

7
The Withdrawals

• May 7 56,594. The risk-scoring engine
  generated a risk score of 790 for the
  transaction, a significant departure from Patco's
  usual risk scores, which generally ranged from 10
  to 214.
• (1) Very high risk non-authenticated device
  (2) High risk transaction amount (3) IP
  anomaly and (4) Risk score distributor per
  cookie age.
• May 8 115,620.26, from the same IP address.
• May 11 99,068 / 720
• May 12 91,959 / 563
• May 13 113,647 / 785

8
The Holding

• (1) Ocean Bank did substantially increase the
  risk of fraud by asking for security answers for
  every 1 transaction . . . (2) When it had
  warning that such fraud was likely occurring in a
  given transaction, Ocean Bank neither monitored
  that transaction nor provided notice to customers
  . . . (3) Because it had the capacity to do all
  of those things, yet failed to do so, we cannot
  conclude that its security system was
  commercially reasonable. (4) . . . it was these
  collective failures taken as a whole, rather than
  any single failure, which rendered Ocean Bank's
  security system commercially unreasonable.

9
Enforceability of the Provisions

• It is unclear, however, what, if any,
  obligations a commercial customer has when a
  bank's security system is found to be
  commercially unreasonable.
• Why?

10
Types of Clauses

• Exculpatory clause immunizes a person from the
  consequences of his/her negligence.
• The type of clause in Patco.
• Indemnity clause holds the indemnitee harmless
  from liability by requiring the indemnitor to
  bear the cost of any damages for which the
  indemnitee is held liable.
• Waiver of liability protects a beneficiary from
  liability under certain conditions when services
  he or she received are found to be not as
  promised.

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Comment of the Drafters of UCC 4A

• Funds transfers involve competing intereststhose
  of the banks that provide funds transfer services
  and the commercial and financial organizations
  that use the services, as well as the public
  interest. These competing interests were
  represented in the drafting process and they were
  thoroughly considered.

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Comment of the Drafters of UCC 4A

• The rules that emerged represent a careful and
  delicate balancing of those interests and are
  intended to be the exclusive means of determining
  the rights, duties and liabilities of the
  affected parties in any situation covered by
  particular provisions of the Article.
  Consequently, resort to principles of law or
  equity outside of Article 4A is not appropriate
  to create rights, duties and liabilities
  inconsistent with those stated in this Article.

13
The Public Policy Question

• Given the clear public policy behind 4A, should
  the bank be able to avoid liability through the
  exculpatory clause?

14
Damage Waivers

• Consequential (indirect) damages generally may be
  waived.
• Direct damages generally may not be waived.
• Liability for reckless or intentional actions
  cannot be waived.
• Liability for a defective product cannot be
  waived.

15
Exculpatory and Indemnity Clauses

• General rule the clause is enforceable if
  reasonable.
• It must not contravene public policy.
• This is the question in Patco.
• It must be clear and understandable.
• The releasing party must know and understand the
  risk released.
• There must be no unacceptable disparity in
  bargaining power.

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UCC 2-719. Contractual Modification or
Limitation of Remedy.

• (1) . . . (a) the agreement may provide for
  remedies in addition to or in substitution for
  those provided in this Article and may limit or
  alter the measure of damages recoverable under
  this Article, as by limiting the buyer's remedies
  to return of the goods and repayment of the price
  or to repair or replacement of non-conforming
  goods or parts and, (b) resort to a remedy as
  provided is optional unless the remedy is
  expressly agreed to be exclusive, in which case
  it is the sole remedy.

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UCC 2-719

• (2) Where circumstances cause an exclusive or
  limited remedy to fail of its essential purpose,
  remedy may be had as provided in this Act.
• (3) Consequential damages may be limited or
  excluded unless the limitation or exclusion is
  unconscionable. Limitation of consequential
  damages for injury to the person in the case of
  consumer goods is prima facie unconscionable but
  limitation of damages where the loss is
  commercial is not.