Bazinet v. Kluge: Lawsuit Against Escrow Agent over Depository Bank Failure Proceeds

A New York court has considered whether an attorney could be liable for placing escrow funds into a bank which subsequently collapsed.

Galina Kluge ("Seller") entered into sale contracts for two apartments she owned in Manhattan. The total purchase price for both units was $14,500,000, and ten percent of the purchase price was placed into escrow. The Seller's attorney, Samuel J. Reiser ("Escrowee"), served as the escrow agent and deposited the money into a non-interest bearing IOLA at the New York branch of the Connecticut Bank of Commerce ("Bank"). An "IOLA" (or "interest on lawyer account") is an unsegregated interest-bearing deposit account where lawyers deposit certain client funds, with the interest being used to fund programs like providing legal services to the poor.

A dispute arose between the buyer ("Buyer") and the Seller over what types of alterations could be made to the apartment, and so the transaction never closed. The Buyer filed a lawsuit seeking a determination who was entitled to the deposit.

The Seller then entered into another sale contract with a different buyer. The purchase price for the second contract was $12,800,000, and again ten percent of the purchase was placed into escrow by the Escrowee. However, two days before the closing, the Bank was shut down by bank regulators. Since the Seller was the only party affected by the Bank's failure, the transaction successfully closed.

The Seller made allegations against the Escrowee in the lawsuit brought by the buyer, alleging that the Escrowee committed malpractice by failing to deposit the escrowed funds into an interest bearing account; depositing all of the funds in a bank that failed; and also breaching of his fiduciary duty. The Escrowee filed a motion to dismiss the Seller's allegations.

The Supreme Court, New York County, allowed the Seller's allegations to proceed against the Escrowee. The court first considered whether an exculpatory provision in the escrow agreements protected the Escrowee from liability. Since the Escrowee used an IOLA, the court found that the exculpatory provisions in the escrow agreements were irrelevant.

Next, the court considered whether the Escrowee committed malpractice by depositing almost $2.75 million in a bank that subsequently failed. The Seller alleged that she planned to offer testimony that sharing that it was negligent for a real estate practitioner to leave such a large amount in an account that far exceeded the $100,000 FDIC insurance limit. The Escrowee argued that the Seller may not have any damages, as the Seller could eventually recover all of her money once the Bank's assets were liquidated. The court found that the Seller's allegations were sufficient to survive a motion to dismiss and so allowed these allegations to proceed.

The Seller also alleged that the failure to deposit the escrowed funds in an interest bearing account constituted malpractice. An IOLA in New York state is only supposed to be used for "qualified funds", which is defined as client funds of $150 or less. Here, the deposits totaled almost $2.75 million. Once again, the court found that the Seller's allegations were sufficient to proceed. However, the court dismissed the breach of fiduciary duty allegations, as the court found these allegations were duplicative of the malpractice allegations. Thus, the court allowed, the malpractice allegations against the Escrowee for depositing escrowed funds into an IOLA with a bank that eventually failed to move forward.

Bazinet v. Kluge, No. 110143/01, 2003 WL 21361746 (N.Y. Sup. Ct. May 29, 2003). [This is a citation to a Westlaw document. Westlaw is a subscription, online legal research service. If an official reporter citation should become available for this case, the citation will be updated to reflect this information].