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In re Payroll America, Inc.

United States District Court, D. Idaho

August 27, 2013

In re PAYROLL AMERICA, INC., dba Payroll Associates, Debtors.
Greater Rome Bank, a Georgia Financial Institution, Appellee. Jeremy Gugino, Appellant,

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[Copyrighted Material Omitted]

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Thomas J. Angstman, Natasha Nassar Hazlett, Wyatt Benton Johnson, Brian L. Webb, Angstman Johnson & Associates, PLLC, Boise, ID, for Appellant.

Howard R. Foley, Foley Freeman, PLLC, Meridian, ID, for Payroll America, Inc.

James Justin May, May, Browning & May, Boise, ID, for Data Processing Service of Georgia, Inc., Lori Duke, Greater Rome Bank, Appellees.

William G. Pope, Carey Perkins LLP, Boise, ID, Data Processing Service of Georgia, Inc., Lori Duke, Appellees.

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B. LYNN WINMILL, Chief Judge.


The Chapter 7 bankruptcy trustee appeals from the bankruptcy court's decision granting summary judgment in favor of defendant Greater Rome Bank. For the reasons explained below, the Court will affirm.


1. The Parties

Payroll America, Inc. was a local payroll processing company. It collected money from its clients, typically employers, and used that money to pay its clients' employees and taxing authorities. At some point before this litigation, Payroll America misappropriated monies that had been impounded to pay its clients' future tax bills.[1]

In March 2010, Payroll America filed a Chapter 7 bankruptcy petition. Shortly afterward, the Chapter 7 trustee sued Greater Rome Bank. The trustee contends that Payroll America fraudulently transferred over $30 million to Greater Rome Bank before filing for bankruptcy. The trustee seeks to recover those monies for the estate.

Payroll America is not one of Greater Rome Bank's clients. The other defendant in this action— Data Processing Service (DPS)— banked with Greater Rome Bank. Payroll America hired DPS to help process electronic transmissions through the Automated Clearing House (ACH) Network. To understand the claims in this action, it is necessary to understand how these ACH transactions work.

2. ACH Transactions[2]

An automated clearing house is a data hub for financial transactions. The main participants in ACH transactions are originators and receivers. Originators include individuals and others who want to transfer money out of their bank accounts. An easy example is an individual who wishes to pay a telephone bill online rather than with a paper check; the individual is an " originator" and money will be withdrawn from his or her bank account. The individual's bank is an Originating Depository Financial Institution (ODFI). On the other end await the payees, or receivers, as well as their banks, the Receiving Depository Financial Institutions (RDFIs). In the middle of the originating and receiving parties is an ACH operator. The ACH operator is operated by a private organization or a Federal Reserve Bank.

In this case, Greater Rome Bank had an agreement with the Federal Reserve Bank (the " Fed" ) for clearing and settling ACH items. Banks can initiate their own credit and debit entries to the Fed, but they can also use the services of a third-party sender. See ACH Rules, Dkt. 9-26, at 4 (defining " Third-Party Service Provider" ). Greater Rome Bank entered into a third-party sender agreement with DPS, which allowed DPS to directly transmit credit

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and debit entries to the Fed. See id.; ODFI/Third-Party Sender Agmt., Bankr.Dkt. 109-16.

Unlike checks, which are always debit instruments, ACH transactions may be either a credit or a debit entry. ACH credit entries occur when an originator asks that its money move into a receiver's account. In an ACH debit transaction, funds flow the other way, meaning that funds are collected from a receiver's account and transferred to an originator's account.

The advantage of using the ACH system for transferring money is that the transactions are accumulated and made in one large batch, rather than each smaller payment being handled separately. Member banks, such as Greater Rome Bank, submit numerous independent credit and debit transactions to the Fed. The Fed executes the instructions and then settles the net result of credit and debit entries to a reserve account for the member banks. If there are more funds in credit transactions than debit transactions initiated through a particular bank, then funds from that bank's reserve account at the Fed will be withdrawn.

3. The Scheme

As noted above, it was assumed for purposes of Greater Rome Bank's summary judgment motion that Payroll America misappropriated some of its clients' monies that had been earmarked to pay its clients' future tax bills. Payroll America thus found itself in a perpetual game of catch-up, basically using newly collected monies to pay earlier obligations. The scheme would play out as follows:

(a) The ACH Credit Instruction. Payroll America would initiate two ACH instructions (a debit and credit instruction) for the same amount— say $1.5 million each. The $1.5 million credit instruction resulted in $1.5 million being deposited into one of Payroll America's bank accounts. See Am. Opening Br., Dkt. 14, at 10.

(b) The ACH Debit Instruction. At the same time, Payroll America would initiate a $1.5 million debit instruction, which was supposed to result in a debit to another Payroll America account. The debit instruction would fail, however, because Payroll America did not have sufficient funds in the account. Id.

(c) The Cure Wire. Within a day, the Fed would notify Greater Rome Bank of the failed debit instruction. Greater Rome Bank would charge back the $1.5 million to DPS's ...

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