Civil Procedure-Pero's Steak & Spaghetti House v. Lee: Tennessee Declines to Extend the Discovery Rule to Claims of Converted Negotiable Instruments

On August 29, 1996 Pero's Steak and Spaghetti House and Louis Inn (plaintiffs) filed suit against Elizabeth Hinkle Lee (Lee), First American National Bank, and First Tennessee Bank National Association (First Tennessee) claiming conversion of negotiable instruments.1 The plaintiffs alleged that beginning in 1988, their accountant, Lee, wrongfully cashed or deposited 140 checks and used some of the proceeds for personal needs.2 The checks were intended to be deposited into a First Tennessee account specifically designated to pay federal taxes.3

Beginning in the early 1990s, the plaintiffs were notified numerous times by the Internal Revenue Service (IRS) that they had either underpaid or overpaid their taxes.4 Whenever these notices were brought to the attention of Lee, she would assure the plaintiffs "that the notices were an IRS mistake and that she would take care of them."5 In 1995, the plaintiffs received approximately fifteen notices from the IRS claiming a tax deficiency in addition to a notification that the IRS had imposed a tax levy against the plaintiffs.6 After investigating these claimed deficiencies, the plaintiffs learned in 1996 that 140 checks written to pay taxes through their tax account at First Tennessee had not been credited to the account.7 The plaintiffs filed their claim approximately eight years after the first check had allegedly been converted.8 With respect to First Tennessee, the plaintiffs alleged that the bank "had engaged in joint conversion with Lee by improperly allowing her to cash or deposit [the checks] that were payable to First Tennessee and intended for deposit in the [t]ax [ajccount."9

First Tennessee moved for partial summary judgment on the ground that most of the plaintiffs' claims were barred by the threeyear statute of limitations covering claims of converted checks.10 In response, the plaintiffs argued that the statute of limitations had been tolled by the discovery rule." The trial court granted First Tennessee's motion for partial summary judgment, holding that the discovery rule did not apply, and the court of appeals affirmed the decision of the trial court.12

The Tennessee Supreme Court held, affirmed.11 In claims for conversion of negotiable instruments, the discovery rule does not toll the statute of limitations, and, except in cases of fraudulent concealment, the statute begins to run at the time the instrument is negotiated. Pew's Steak & Spaghetti House v. Lee, 90 S.W.3d 614 (Tenn. 2002).

Statutes of limitations have been an integral part of the law for hundreds of years, providing a time limitation on the right to bring an action.14 justice White of the Tennessee Supreme Court set forth the well-established policy underlying statute of limitations provisions in Hackworth v. Ralston Purina Co. '5

[T]he purpose or object of [a statute of limitations] is to compel the exercise of a right of action within a reasonable time. Such statutes are designed to prevent undue delay in bringing suits on claims, to the surprise of the parties and when the facts have become obscure from the lapse of time, the defective memory[,] or death or absence of witnesses.

The presumption is that one having a well founded claim will not delay enforcing it beyond a reasonable time, if he has the power to sue. Such a statute is remedial and in no manner affects the substantive rights of litigants. Such statutes are now considered wise and beneficent in their purpose and tendency; they are held to be rules of property vital to the welfare of society.16

Considering the importance of statutes of limitations to the administration of justice, courts traditionally construe such statutes narrowly, allowing for few exceptions.17 One historic exception that numerous jurisdictions, including Tennessee, continue to recognize today is applied when a defendant commits a fraud that prevents a claimant from acquiring knowledge of an injury.18 Another traditional common law exception followed by contemporary courts is the doctrine of equitable estoppel, where "the defendant has taken steps to specifically prevent the plaintiff from timely filing his complaint (as where he promises not to plead the statute of limitations)."19 Otherwise, early courts held that in the absence of an established exception, the statutes of limitations began to run when the injury-causing event occurred, regardless of when the plaintiff actually discovered the injury, even if this produced harsh results.20

Although based upon different legal theories, the strict application of the statute of limitations is analogous to statutes of repose that provide for an absolute limitation of an action21 following a specified period of time after the occurrence of an event (often referred to as the "triggering event") regardless of when the actual injury occurred.22 If an action is beyond the statute of repose, the question of when a right accrued under a particular statute of limitations becomes moot, because after the statute of repose has expired, both the remedy and the substantive right to bring an action are extinguished.23

In the latter part of the nineteenth century, courts began to recognize an exception to the occasionally harsh application of statutes of limitations. In cases where an injured party was blamelessly ignorant of a right of action, and the injured party's lack of knowledge was not attributable to actual fraudulent concealment by the defendant, some courts tolled the running of the statute of limitations.24 Although not labeled as such at the time, the doctrine evolved into what is known today as the discovery rule. As applied by contemporary courts, the discovery rule provides for tolling statutes of limitations in instances involving an '"inherently unknowable injury'" where an injured party is '"blamelessly ignorant of the act or omission and injury'" from which a legal right arises.25 When the discovery rule is applicable, the relevant statute of limitations begins to run at the moment an injured party "discovers, or in the exercise of reasonable care and diligence . . . should have discovered" an injury.26

One of the earliest cases recognizing an exception to the statute of limitations in the absence of actual fraud was Lewey v. U.C. Frick Coke Co.,21 decided by the Pennsylvania Supreme Court in 1895. The case involved a coal mining company that inadvertently dug underneath the plaintiff's property and extracted a sizeable quantity of coal therefrom, bringing the coal to the surface on the defendant's property.28 The claimant, "[having] no knowledge of the trespass upon him or the removal of his coal and [having] no means of knowledge within his reach," did not become aware of his injury until seven years after the defendant extracted the coal.29

Within a year after discovering his injury, the plaintiff brought a trespass claim against the mining company and was barred by the lower court on the grounds that the one-year statute of limitations had expired.30 Finding that the case presented an "excellent illustration of ignorance due to the defendant's conduct and without fault on the part of the plaintiff," the court held that "the statute shall run only from discovery, or a time when discovery might have been made."31 Analogizing the defendant's apparently non-malicious extraction of the coal to fraud, the Lewey court stated that the extraction of the coal without compensation to the plaintiff "effect[ed] a fraud upon the injured owner."32 The court reasoned further that if the injured party had "no knowledge of the trespass, and no means of knowledge, such a fraud should protect him from the running of the statute."13 This protection should be extended whether the fraud is labeled as actual or constructive fraud.34

Courts often applied exceptions to the statute of limitations to specific areas of the law.35 For example, certain kinds of medical malpractice suits evolved as another exception to the running of the statute of limitations, usually involving a prototypical "inherently unknowable" injury occurring when instruments and other devices were inadvertently left inside a patient's body following surgery.36 These early cases, while acknowledging the historical reluctance of courts to toll statutes of limitations in the absence of a well-established exception such as fraudulent concealment,37 noted that courts recognized exceptions to timebarring provisions in special circumstances such as subterranean trespass actions and in applying workers' compensation statutes.38 Courts based exceptions to the statute of limitations in medical malpractice cases on the policy that "all statutes, must be read in the light of reason and common sense and that in their applicationf,] they 'must not be made to produce something which [a] [l]egislature, as a reasonably-minded body, could never have intended.'"39

Tennessee followed a similar route as other states in the development of the discovery rule. Like courts in other states, the Tennessee Supreme Court first recognized exceptions to limitations of actions in early workers' compensation decisions.40 Relief from time-barring statutes was also recognized by the Tennessee General Assembly in 1919 with the passage of the Tennessee Workmen's Compensation Act.41 Courts held that under the statute, "reasonable excuse" would provide relief from the requirement that claimants must provide written notice to their employers within thirty days of an accident causing a compensable injury.42 Like other states,43 Tennessee courts interpreted workers' compensation statutes liberally.44

The Tennessee Supreme Court took a narrower approach when applying time limitations to actions falling under the general statute of limitations (i.e., limitations on tort actions for injury to person or property).45 The decision in Albert v. Sherman46 illustrates the sentiment of Tennessee courts at the time regarding exceptions to the statute of limitations.47 Although recognizing that "some conflict in the decisions" existed among jurisdictions and that "hardships may arise in particular cases" by not providing an exception, the Tennessee Supreme Court, in 1934, reasoned that public policy was best served by not allowing exceptions to statutes of limitations, even in cases where an injured party was blamelessly ignorant of the right to a legal remedy.48

The Tennessee General Assembly also created exceptions to the statutes of limitations in specific circumstances. In 1965, the legislature passed an act that tolled the statute of limitations while a defendant was out of the state in order to prevent a statute of limitations from expiring, especially when a defendant deliberately attempted to avoid process.49 The General Assembly also amended the products liability statute of limitations to provide that "the cause of action . . . shall accrue on the date of the personal injury," and not on the date of sale of the product.50

In 1974, after recognizing that the "time has come for us to reexamine the past holdings of our [a]ppellate [c]ourts in the light of contemporary standards of justice and of the holdings of the courts of last resort in other American jurisdictions," the Tennessee Supreme Court, in Teeters v. Currey,51 formally adopted the discovery rule.52 First examining recent trends in Tennessee law, the Teeters court noted the newly-enacted legislation and stated that "the public policy of our state is opposed to requiring that suit be filed when circumstances totally beyond the control of the injured party make it impossible for him to bring suit."53 While recognizing the tradition of past Tennessee courts in refusing to apply exceptions that undermine the policies behind statutes of limitations in preventing "stale claims" and providing stability, the Teeters court stated that such an approach was "harsh and oppressive."54 After noting that the discovery rule had been adopted by a majority of American jurisdictions,55 the Teeters court concluded that adopting such a rule "will be productive of results more nearly consonant with the demands of justice and the dictates of ethics and morality."56

It may be helpful at this point to delineate terminology often used by Tennessee courts in the context of the discovery rule.57 The Tennessee Supreme Court first adopted the discovery rule in Teeters for medical malpractice actions.58 Subsequent decisions have "extended" the discovery rule to "cover" most injuries to persons or property, although there are numerous cases in which courts have declined to extend the discovery rule into a new area of law.59 Courts, in adjudicating claims that are "covered" by the discovery rule, "apply" the rule to determine when an injured party "knew or should have known" that a right of action existed.60

After Teeters, the Tennessee Supreme Court, in McCroskey v. Bryant Air Conditioning Co.,61 effectively extended the discovery rule to cover all injuries under the general statute of limitations for injuries to person or property.62 Subsequent decisions specifically extended or declined to extend the discovery rule to other areas of law.63 In deciding whether to extend the discovery rule, the Tennessee Supreme Court generally considers three factors: whether an existing statute specifically addresses when a particular statute of limitations commences (i.e., if a claim begins to accrue upon the occurrence of a statutorily specified event); the number of other jurisdictions following a similar approach under analogous circumstances; and the general "policies furthered by application of the discovery rule against the legitimate policies upon which statutes of limitations are based."64 In other words, the more specific the language is in an applicable statute as to when a claim begins to accrue, the fewer the number of other jurisdictions following a similar approach to the discovery rule in a particular situation, and the less "inherently unknowable" the injury, the less likely the Tennessee Supreme Court will extend the discovery rule to a new area of law.65

When a statute of limitation specifies when a particular action begins to accrue, courts will likely defer to the legislature's determination of whether or not the discovery rule should cover a particular area of law.66 In other cases, the court may, in effectuating the intent of an existing statute or legislative policy, infer that the legislature intended for the discovery rule to be applicable to a particular area of law.67

Once the discovery rule has been extended to cover a particular area of law, the application of the discovery rule is left for the trier of fact.68 The moment when an injury is "discovered, or when in the exercise of reasonable care and diligence" should have been discovered, thereby commencing the running of the statute of limitations, is usually a question for the jury.69 An injured party is deemed to have discovered or have "knowledge" of a compensable injury even if the claimant is not aware of the full extent or cause of an injury.70

When the Tennessee Supreme Court evaluated whether the discovery rule should be extended to actions for conversion of negotiable instruments, the Pero's court prefaced its analysis by stating the policies articulated in Quality Auto Parts should be considered when deciding whether to extend the discovery rule.71 The court first examined Tennessee Code Annotated section 28-3-105, which was the statute of limitations provision covering claims of converted negotiable instruments effective before 1996, when many of the checks were allegedly converted by the defendant.72

The Tennessee Supreme Court next examined Tennessee Code Annotated section 47-3-118(g), the Uniform Commercial Code (UCC) version of the statute of limitations for negotiable instruments, which became effective in Tennessee on June 1, 1996:73

(g) Unless governed by other law regarding claims for indemnity or contribution, an action (i) for conversion of an instrument, for money had and received, or like action based on conversion, (ii) for breach of warranty, or (iii) to enforce an obligation, duty, or right arising under this chapter and not governed by this section must be commenced within three (3) years after the cause of action accrues.74

In comparing the two statutes and finding that "the critical language was the same," the court stated that "[c]learly, both statutes require that an action for conversion of a negotiable instrument be commenced within three years of the time the cause of action accrues."75 The court then concluded that "nothing in the language suggests that these statutes should be interpreted differently with respect to application of the discovery rule."76 Therefore, the discovery rule should apply to either both section 47-3-118(g) and section 28-3-105 or to neither of them.77

The court declined the plaintiffs' suggestion to follow the unreported opinion in Pacific Properties v. Home Federal Bank,78 where the court of appeals held that an issue of fact existed as to when the plaintiff discovered the conversion of the negotiable instruments at issue in the case.79 In Pero's, the court held that the reasoning used by the court of appeals in Pacific Properties was "not persuasive as to the particular issue in this appeal."80 Specifically, the court reasoned that the lower court in Pacific Properties had erroneously based its decision solely upon medical malpractice and personal injury tort cases, and "failed to consider the authority from other jurisdictions refusing to apply the discovery rule to actions for conversion of negotiable instruments."81

The Pero's court acknowledged that a few other jurisdictions extended the discovery rule to claims for conversion of negotiable instruments,82 but concluded that "the vast majority of courts hold that in the absence of fraudulent concealment . . . the discovery rule does not apply to toll the statute of limitations on an action for conversion of negotiable instruments."83 The court cited two policies underlying the majority rule.84 First, the UCC advocates policies that "militate strongly against open-ended liability on negotiable instruments."85 The supreme court reasoned that in order for negotiable instruments to maintain their utility as a money substitute, transactions via checks must be rapid and predictable, but subjecting claims based upon negotiable instruments to the discovery rule could result in inefficiencies and leave a party open to liability for an indefinite period of time.86

The court noted the second principle underlying the majority rule is that actions "for conversion of negotiable instruments" are not analogous to other situations in which courts have extended the discovery rule.87 As opposed to injuries that do not become apparent until several years after the injury-causing conduct, "the tort of conversion is complete and the injury occurs at the moment the tortfeasor appropriates the plaintiff's property to his or her own use or benefit by exercising dominion over it in violation of the true owner's right."88 Regarding negotiable instruments, the court concluded that "the damage is done, and the tort is complete when the instrument is negotiated, regardless of the plaintiff's ignorance of the conversion."89 Further, because the presumption arises in the law of conversion that owners of property are aware of where their property is located, the law presumes that victims of conversion are not ignorant of their injuries.90 Especially in the case of negotiable instruments, owners "generally should be able to easily and quickly detect the loss and take appropriate action."91 In other words, an injury resulting from conversion of negotiable instruments is not "inherently unknowable."92

In adopting the majority rule approach, the Pero's court followed the reasoning of the Supreme Court of Iowa:

As tempting a choice as that may be in an individual case [applying the discovery rule], we think the public would be poorly served by a rule that effectively shifts the responsibility for careful bookkeeping away from those in the best position to monitor accounts and employees. Strict application of the limitations period, while predictably harsh in some cases, best serves the twin goals of swift resolution of controversies and "certainty of liability" advanced by the [Uniform Commercial Code].93

While acknowledging that refusing to extend the discovery rule may be harsh in certain cases, the court stated it was in the best interest of facilitating commerce through negotiable instruments, "by providing certainty and finality in commercial transactions," that an exception not be permitted.94 Another policy the court cited that is furthered by adopting the majority rule approach is that of uniformity among states, which is a primary objective of the UCC.95

Considering that the injury occurs at the time the instrument is negotiated and a plaintiff is allowed three years after "the instrument is negotiated to discover the [injury] and file a [lawsuit]," the supreme court opined that, except in cases of fraudulent concealment, "three years should be more than ample time for a plaintiff to discover a conversion claim."96 Otherwise, if the discovery rule was allowed to extend the statute of limitations, defendants would be placed "in the untenable position of having to defend against stale claims."97

Turning to the facts of the case, the court noted that "[t]his case presents an excellent example of the difficulties that arise when the discovery rule is applied in this context."98 The plaintiffs filed their complaint approximately eight years after the time the first checks were supposedly converted.99 As a result, records, which had been destroyed in the ordinary course of business or otherwise lost, were no longer available.100 No records were available for some of the first checks that had allegedly been converted, and the defendant was not able to prove that the plaintiffs had or had not actually received any of the proceeds from them.101

After examining the policies underlying the discovery rule and applying them to the facts at issue, the Tennessee Supreme Court concluded that the discovery rule does not prevent the running of the statute of limitations for claims of conversion of negotiable instruments.102 Therefore, under Tennessee Code Annotated section 47-3-118(g), except where fraudulent concealment is present, claims of conversion of negotiable instruments begin to accrue at the time the instrument is negotiated.103

Both the United States Supreme Court and the Tennessee Supreme Court previously stated that exceptions to the statute of limitations have generally been extended only when a particular injury is "unknown and inherently unknowable" until after the limitations period has expired.104 Misappropriated or converted funds, especially in the form of negotiable instruments, which generally produce a traceable paper trail, can be discovered through "careful bookkeeping" as the Pero's court suggested.105 In the event that a conversion is not discovered immediately, it could be discovered through internal audits, which any business should conduct on a regular basis. If claims concerning negotiable instruments are subject to an indefinite statute of limitations, the policies underlying the UCC could be significantly disrupted.106 Even as the number of electronic transactions rapidly increases, negotiable instruments, namely in the form of checks, continue to be a preferred method of payment in conducting business. To allow the stream of commerce to be disturbed by stale claims and lack of finality in transactions could have significant and adverse results.

Those who may be most negatively affected by the court's refusal to extend the discovery rule are individual consumers. Unlike sophisticated businesses, the expectation should not be as great that individuals will audit their personal accounts on a regular basis. Nonetheless, requiring the reasonable person to do simple tasks such as examining cancelled checks and investigating questionable transactions to maintain the integrity of their financial accounts should not pose an onerous burden on individuals. With the proliferation of on-line banking, it is now possible for bank customers at many, if not most, banks to check their accounts on a frequent basis and obtain real-time information on debits and credits to their accounts. Such a slight burden does not outweigh the potential risks to justice and harm to commercial practices if stale claims are permitted to be brought simply because individuals do not maintain their financial affairs in a reasonable manner.

With nearly thirty years of discovery rule jurisprudence in the state of Tennessee, the question naturally arises as to what area of law future courts may choose to apply the discovery rule. As discussed above, the discovery rule has been extended to several areas of the law, providing exceptions in certain situations to avoid seemingly unjust applications of the statutes of limitations.107 One area of law to which a majority of other jurisdictions have extended the discovery rule is civil claims of sexual abuse.108 Often these claims are initiated by child sex abuse victims who do not realize that they have a right of action until many years after the statute of limitations has expired.109 While the Tennessee Supreme Court declined to decide the matter in 1997,110 it is probable that a civil action involving sex abuse may be before the court again in the near future. In light of the fact that the court has traditionally followed the approach of the majority of other jurisdictions whenever the issue of extending the discovery rule to another area of law is raised, the supreme court may extend the discovery rule to cases involving sexual abuse if the Tennessee General Assembly has not acted on the matter.111

Regardless of the issue, however, the Tennessee Supreme Court, when deciding whether to extend the discovery rule in the future, will likely balance the equitable principles of the discovery rule against the policies of stability provided by statutes of limitations "in the light of contemporary standards of justice."112 The supreme court will also be mindful of the aspiration that "the law never requires the impossible"113 by requiring individuals to discover an "unknown and inherently unknowable"114 injury before their rights to relief begin to accrue.

JUSTIN N. JOY*

* Articles Editor, The University of Memphis Law Review; J.D./M.B.A. Candidate, May 2004, University of Memphis, Cecil C. Humphreys School of Law; B.S., 2001, Wake Forest University. The author would like to thank Professor June Entman for her invaluable assistance, guidance, and advice.

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