California Appellate Court Rules on Issue of First Impression: Who Bears the Risk of Loss When a Scammer Misdirects Settlement Funds to the Wrong Recipient?
This is the scenario: The case has been ongoing for months, possibly years. The parties mediate or negotiate informally and finally reach an agreement to settle. Neither party is entirely happy with the result, but they are ready to move on from the litigation. It comes time to make payment. There are wire transfer instructions exchanged. One party makes the transfer and completes the transaction only to find out the other party did not receive payment. Instead, someone else—someone not involved in the dispute or settlement—acquires the funds, potentially through a scam or similar means. What happens to the settlement and the obligation to pay the settlement funds?
The California Court of Appeal, Fourth Appellate District, addressed this scenario this week in Tomas v. Corbyn Restaurant Development Corp.
In that case, after the plaintiff and defendants settled a personal injury lawsuit for $475,000, an unknown third party purporting to be the plaintiff’s attorney sent spoofed emails to the defendants’ attorney that included fraudulent wire instructions for payment of the settlement funds. The defendants wired the settlement funds to the fraudulent account and the third party took off with the funds. Once the fraud was discovered, the plaintiff asked for the settlement funds to be paid and the defendants refused. The plaintiff sought relief from the trial court, which applied federal case law that shifts the risk of loss to the party in the best position to prevent the fraud and concluded the defendants were in that position, without attributing any fault to the plaintiff, and that the defendants were obligated to pay the plaintiff the $475,000 settlement funds notwithstanding the prior payment already issued to the fraudulent account. The defendants appealed.
On appeal, the defendants argued that the trial court chose the correct law to apply but applied it incorrectly by mischaracterizing the evidence that supported shifting the blame to defendants and by failing to consider evidence that supported shifting the blame, at least to some degree, to the plaintiff.
On review, the appellate court agreed that the authority on which the trial court relied was persuasive but disagreed that the court misapplied it, noting that the trial court assessed each party’s role in preventing the fraud and that there was substantial evidence to support its finding that several red flags should have alerted the defendants to the fraud, which was not true for the plaintiff.
Among other facts, the court noted that the imposter’s wire instructions conflicted with the payment procedure established by the parties’ written agreement. The written agreement identified the trust account where payment was to be made, while the wire instructions changed the payee to a different (albeit similar) named account. The imposter’s request to wire the settlement funds also conflicted with the parties’ informal agreement to pay by check. There were similar issues regarding the phone numbers and email addresses provided, along with typographical errors in the requests. The court further rejected the defendants’ arguments that the facts supported an inference that the plaintiff’s attorney’s computer system must have been compromised.
No result in this case would have seemed just. In the end, the bad actor retained the funds and, no matter who bore the greater burden in mitigating the risk, one or more parties would have lost money despite otherwise good faith attempts to resolve a dispute.
While there is no way to guarantee settling parties will be able to entirely avoid the risk of fraud, there are steps that settling parties can take to mitigate the risk. First, as the court noted, they should follow the instructions set forth in the settlement agreement. Second, they should look for inconsistencies and variances from the agreed terms. Third, when making payment through a wire transfer, they should run an initial transfer of a small portion of the funds and confirm with the receiving party that those funds were received before sending the remaining payment.
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