Summary
- Courts have held that a counterfeit check, being a complete fabrication, does not fall under the same category as an altered check.
- Presentment warranties and transfer warranties serve distinct purposes in the context of checks.
The ultimate liability for forged, altered, and counterfeit checks is generally governed by Articles 3 and 4 of the Uniform Commercial Code (“UCC”). Checks are negotiable instruments, and the UCC outlines specific responsibilities and liabilities for banks in the check collection and payment process. Article 3 more generally governs the rules related to checks and other negotiable instruments. Article 4 focuses on the banks’ rights and liabilities.
Under the UCC § 4-406, banks are required to send account statements to their customers, who must then promptly examine these statements to identify any unauthorized signatures or alterations. Customers have a duty to notify the bank promptly after discovering any discrepancies. Typically, under the statute, customers have thirty (30) days. Failure to do so within the stipulated time frame can preclude the customer from asserting claims against the bank related to unauthorized signatures or alterations of similar nature occurring after the notice period.
A customer must exercise “reasonable promptness” in examining his or her statement and “promptly notify” the bank of an unauthorized signature or alteration. Failure to do so precludes customer from asserting an unauthorized signature or alteration claim against the bank. If the customer fails to report the first unauthorized signature or alteration within “a reasonable period of time, not exceeding 30 days,” then the customer is precluded from asserting all subsequent unauthorized signatures or alterations “by the same wrongdoer” already paid by the bank. There is absolute preclusion for one-year delays in a customer reporting an unauthorized signature or alteration. These deadlines can be, and frequently are, shortened by contract between the drawee bank and drawer customer.
The distinction between counterfeit and altered checks is significant and well-defined. A counterfeit check is one that is created entirely from scratch and is designed to look like an actual, genuine check. It is a fraudulent imitation of an actual check and involves creating a new document that mimics the appearance of a legitimate check, often using sophisticated technology to replicate the details of a genuine (often stolen) check. On the other hand, an altered check refers to a genuine check that has been modified in some way after it was originally issued. This could involve changing the amount, the payee’s name, or other details on the check to fraudulently redirect the funds or increase the amount.
Courts have held that a counterfeit check, being a complete fabrication, does not fall under the same category as an altered check. The UCC and judicial interpretations of the UCC differentiate between these two types of fraudulent checks in allocation of ultimate liability for the fraudulent item. The depository bank warrants to the drawee bank (the bank on which the check is drawn) that a check has not been altered but does not guarantee against counterfeiting under the UCC. This distinction becomes material when evaluating the application of a presentment warranty under the UCC (discussed below).
Forgery is distinct from counterfeits or alterations in some respects. Forgery is the signing of the name of the someone without authority. That can be on the face of the check (the signature of the drawer of the check) or on the back of the check (the signature or endorsement by the payee or subsequent transferee/holder). A counterfeit is often deemed a forged instrument as the signature of the drawer is not a valid, authorized signature. It is usually an electronic or other reproduction of a valid signature. The legal flaw in a counterfeit check is typically the unauthorized and/or forged signature by the drawer of the check.
In contrast, an alteration does not involve changed signatures, but alterations in the name of the payer or amount of the check. An otherwise valid check with a valid signature actually affixed by the drawer becomes legally flawed because of the unauthorized alteration after the drawer’s signing of the instrument. The intended payee is changed to a fraudster or the amount is changed from the amount authorized and intended by the drawer to a larger sum.
In the context of check forgery, the legal implications differ depending on whether the forgery is the signature of the maker/drawer or the payee/endorser. When the maker/drawer’s signature is forged, it generally means that the entire instrument is invalid from the outset. This is because the drawer’s signature, which authorizes the transaction, is forged, indicating that no valid transaction was ever authorized by the supposed drawer. In such cases, the drawee bank may face liability for honoring a check with a forged drawer’s signature, as there was never any legitimate instruction to pay.
Conversely, when the forgery involves the payee or subsequent endorser, the situation can be more complex. If the payee’s endorsement is forged, the UCC often protects the drawee bank that pays the check in good faith, shifting the liability to the depository bank.
Presentment warranties and transfer warranties serve distinct purposes in the context of checks. Transfer warranties are made to the transferee of an instrument and any subsequent collecting bank by a customer or collecting bank that transfers an item and receives a settlement or other consideration. The UCC states:
a customer or collecting bank that transfers an item and receives a settlement or other consideration warrants to the transferee and to any subsequent collecting bank that: (1) the warrantor is a person entitled to enforce the item; (2) all signatures on the item are authentic and authorized; (3) the item has not been altered; (4) the item is not subject to a defense or claim in recoupment (Section 3-305(a)) of any party that can be asserted against the warrantor; and (5) the warrantor has no knowledge of any insolvency proceeding commenced with respect to the maker or acceptor or, in the case of an unaccepted draft, the drawer; and (6) with respect to any remotely-created consumer item, that the person on whose account the item is drawn authorized the issuance of the item in the amount for which the item is drawn.
Essentially, any person or bank that receives a check for settlement warrants that the check is valid and enforceable to any transferee (except the final drawee bank). It is, practically, strict liability of the transferor to the transferee if the instrument is not enforceable.
Presentment warranties are made at the time of presentment to a drawee bank (the bank on which the check was drawn) by a party obtaining payment. The UCC states:
if an unaccepted draft is presented to the drawee for payment or acceptance and the drawee pays or accepts the draft, (i) the person obtaining payment or acceptance, at the time of presentment, and (ii) a previous transferor of the draft, at the time of transfer, warrant to the drawee that pays or accepts the draft in good faith that: (1) the warrantor is, or was, at the time the warrantor transferred the draft, a person entitled to enforce the draft or authorized to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft; (2) the draft has not been altered; and [sic] (3) the warrantor has no knowledge that the signature of the purported drawer of the draft is unauthorized; and (4) with respect to any remotely-created consumer item, that the person on whose account the item is drawn authorized the issuance of the item in the amount for which the item is drawn.
Presentment warranties primarily protect the drawee bank, ensuring that the draft presented for payment or acceptance is properly endorsed. However, with respect to other defects (i.e., the forgery of the drawer), the presenter only warrants that it is not aware of any such defects.
In cases where the check is defective in some way due to the wrongful actions by individuals entrusted with certain responsibilities by the bank customer/drawer of the check, section 3-405 of the UCC may be implicated. Similarly, under 3-406 of the UCC, the customer/drawer’s own negligence can give rise to a defense for banks who pay the instrument in good faith. Both of these allow a drawer bank to enforce a check that otherwise would be unenforceable against a customer.
Under UCC § 3-405, a bank can shift the loss to the employer/customer if it can demonstrate that the employer entrusted the employee with the responsibility for the instrument in question and that the bank acted in good faith in paying the instrument. This defense is based on the rationale that the employer is in a better position to prevent losses by carefully selecting and supervising employees. Often referred to as the “bookkeeper exception,” this defense requires that the employee actually be entrusted with responsibility. Responsibility is defined as:
“Responsibility” with respect to instruments means authority (i) to sign or indorse instruments on behalf of the employer, (ii) to process instruments received by the employer for bookkeeping purposes, for deposit to an account, or for other disposition, (iii) to prepare or process instruments for issue in the name of the employer, (iv) to supply information determining the names or addresses of payees of instruments to be issued in the name of the employer, (v) to control the disposition of instruments to be issued in the name of the employer, or (vi) to act otherwise with respect to instruments in a responsible capacity. “Responsibility” does not include authority that merely allows an employee to have access to instruments or blank or incomplete instrument forms that are being stored or transported or are part of incoming or outgoing mail, or similar access.
Additionally, UCC § 3-406 provides a defense for banks when an employer’s negligence substantially contributes to a forgery or fraudulent endorsement, thereby precluding the employer from asserting a claim against the bank. The UCC further has a burden shifting and fault allocation mechanism if both parties (i.e., the bank and the customer) fail to exercise ordinary care. In such case, each party would bear responsibility based on their respective allocated fault.
UCC 3-103 defines “ordinary care” as:
”Ordinary care” in the case of a person engaged in business means observance of reasonable commercial standards, prevailing in the area in which the person is located, with respect to the business in which the person is engaged. In the case of a bank that takes an instrument for processing for collection or payment by automated means, reasonable commercial standards do not require the bank to examine the instrument if the failure to examine does not violate the bank’s prescribed procedures and the bank’s procedures do not vary unreasonably from general banking usage not disapproved by [] Article [3] or Article 4.
In other words, the bank can, in theory, have the customer enter into an agreement that removes the bank’s obligation to review checks, detect forgeries, and prevent fraud as long as the procedure does not vary “unreasonably” from generally banking usage and is not disapproved by specific provisions of the UCC. As banks have begun to uniformly move to this type of language in their account agreements, it appears that “general banking usage” is moving toward or has moved to disclaiming any responsibility for the review of fraudulent checks. What the bank did or did not do in a particular case, whether the bank followed its internal procedure, and whether the disclaimer runs afoul of one or more express provision of the UCC are important considerations in evaluating the bank’s responsibility for a forged or altered check.
Banks often utilize and/or provide customers the option of implementing certain fraud prevention procedures or programs to minimize the risk of loss due to unauthorized checks. Positive Pay and Payee Positive Pay are security software programs that banks use to protect against fraudulent checks. These systems work by matching the checks issued by a customer with those presented for payment; any discrepancies found can lead to a check being flagged for review or rejected, thus preventing fraud.
Positive Pay compares the amount of checks by check number to assure that the presented check matches the amount approved by the customer. As fraudsters have recognized this commonly used security feature, they have simply altered the payee, leaving the check number and amount the same to avoid triggering the Positive Pay review. Payee Positive Pay extends this protection by specifically verifying the payee’s name against the list provided by the customer, adding an additional layer of security. This service is particularly effective in identifying and preventing fraud involving altered payee names and counterfeit checks.
Banks often use the existence of a Positive Pay agreement as a defense in claims against them. In an account agreement between the bank and the customer, banks often state that they are absolved of responsibility for a fraudulent check if the bank offers and a customer fails to utilize a security service and the service, if utilized, would have prevented the loss.
Under the UCC 4-103, banks and customers are free to enter into agreements that alter their respective rights and obligations under the UCC, except a bank cannot disclaim its obligation to act in good faith and to exercise ordinary care or to limit the damages resulting from its failure to do so. Banks use this provision, along with their account agreements, to attempt to shift responsibility for fraudulent checks to the customer (and its insurer).
In response, customers may assert that the bank cannot disclaim their responsibility for forged, altered, and other fraudulent items, as doing so, especially for a fee, is disclaiming an obligation to act in good faith and exercise ordinary care. Two cases have evaluated this issue in the context of Positive Pay, reaching somewhat inconsistent, although not fully irreconcilable, outcomes.
First, in Cincinnati Ins. Co. v. Wachovia Bank, Nat. Ass’n, a federal district court in Minnesota granted the bank’s motion for summary judgment based on the deposit agreement’s provision that if the customer failed to implement any of the services the bank offered to prevent payment of unauthorized checks, the customer was precluded from asserting a claim against the bank for improper payment of checks. The check in question had been stolen and its payee altered. The court assessed the cost and feasibility of implementing Positive Pay and determined that the provision was reasonable under UCC § 4–103. It found that Positive Pay would have prevented the unauthorized transaction, and the customer failed to implement Positive Pay although it was offered by the bank. Therefore, the claim asserted against the bank was dismissed.
More recently, in Majestic Building Maintenance, Inc. v. Huntington Bancshares Inc., the Sixth Circuit reversed the lower court’s grant of a motion to dismiss in favor of the bank based on a very similar account agreement provision. The Sixth Circuit held that the plaintiff had adequately alleged that the provision was an effort to disclaim the bank’s duties of good faith and ordinary care barred by UCC § 4-103, which “would be considered manifestly unreasonable.” The court held:
Plaintiff states a plausible claim that it was unreasonable for Defendant to absolve itself from liability for any fraudulent transaction that occurs on a customer’s account when the anti-fraud products cost extra, the nature of the anti-fraud products is not revealed, and when the determination of what unauthorized transactions would have been discovered or prevented is left unexplained.
The court also questioned whether “by charging the customer additional fees for these anti-fraud protection services, Defendant is effectively charging the customer for something it should arguably do at no additional cost—which is to exercise its ordinary duty of care.” The Sixth Circuit indicated that the provision is potentially enforceable, but only if the payor bank can show (1) that the service was known and made available, (2) the customer elected not to utilize the service, and (3) the service would have caught the fraud.
This argument and related defense asserted by banks is completely foreclosed if there is not an enforceable account agreement. Often, banks do not obtain signatures from customers binding them to the account agreement. They use the use of the bank’s services as tacit agreement to the terms of the account agreement. If the account agreement is not binding on the customer or if the terms have changed without agreement by the customer, the bank may have no defense regardless of the other legal issues presented.
If a bank desires to fully disclaim responsibility for fraudulent checks through provisions such as these and assuming courts will follow the Wachovia decision, it would be well advised to (1) have the customer sign the account agreement or documentation binding the customer to the terms of the account agreement and (2) clearly offer and document rejection of the additional security service offered to the insured. If sincerely attempting to prevent fraud rather than simply mitigating its own risk, the bank would make every attempt to educate the customer and encourage the customer to utilize its fraud prevention services. Even if all the other pre-requisites are met, it remains the bank’s burden to prove that if the service had been utilized, it would have actually prevented the fraud.
The issues discussed above are some of the more common issues faced by insurers seeking to recover losses paid in relation to fraudulent, forged, and/or altered checks. These are not all of the issues that may be presented. A careful review of the Uniform Commercial Code as adopted in the jurisdiction at issue and the documents signed by and/or binding on the customer is critical to each analysis.