National Check Fraud Center

Forgeries, Forged Endorsement, Alterations,
and other Check Problems

Who can Sue Who?

WHO CAN SUE THE DEPOSITARY BANK ON A FORGED ENDORSEMENT?

  • The intended payee cannot sue if it never had possession of the check or if the check was never issued to it.

  • The drawer cannot sue the depositary bank for conversion. It also cannot sue the depositary bank for breach of warranty.

  • The drawee bank can sue the depositary bank for breach of warranty.

WHO CAN SUE THE DRAWEE BANK FOR FORGED ENDORSEMENT?

  • The payee can only sue the drawee bank if the underlying obligation for which the check is given is extinguished.

  • The drawer of the check can sue the drawee bank if it paid a check that was not properly payable. This includes unauthorized signature (which includes, within its realm, forged signatures), altered checks, and forged endorsement checks.

If the underlying obligation for which the check is given is extinguished, the payee can sue the drawer. The drawer then has recourse for improper payment against the payor bank. The payor bank can then sue collecting banks for the full amount under a breach of warranty theory.

Altered Checks

The general rule is that liability for losses stemming from alterations is a mixed bag, with the drawer of the check sometimes bearing the loss, while at other times it is borne by the drawee and depositary banks.

In order to understand the loss allocation for alterations, it is first necessary to understand what constitutes an alteration for purposes of the Uniform Commercial Code, Article 3. The term "alteration" is specifically defined in Section 3-407. Under that section an alteration is:

  1. an unauthorized change in an instrument that purports to modify in any respect the obligation of a party; or

  2. the unauthorized addition of words or numbers or other change to an incomplete instrument relating to the obligation of a party.

Before a drawee bank agrees to accept a loss in connection with an alteration, it should first examine all the defenses to alteration liability that might be available to it. Those defenses include the following:

  1. Not a material alteration. Many changes made to an instrument are not alterations as that term is defined. In addition, if the alteration does not change the obligation of any party, it is not covered. Thus, it is important to know many other provisions of the UCC as they relate to obligations of the parties. For example, Section 3-114 on contradictory terms of instrument provides that if an instrument contains contradictory terms, typewritten terms prevail over printed terms, handwritten terms prevail over both, and words prevail over numbers. Therefore, if an instrument that contained contradictory terms was changed so that the numbers agreed with the words, there would be no material alteration because the obligation of the parties would not have been changed. Another example is where a date is listed that is impossible (such as June 31) and the check is altered to reflect the next date. Again, that is not legally considered an alteration.

  2. Change was authorized. Because Section 3-407 states that an alteration is an unauthorized change or addition of words or numbers, if it can be proven that the change was authorized, it will not be deemed an alteration.

  3. Customer negligence. As described above. (§3-406.)

  4. Unauthorized completion. If an incomplete instrument is altered by unauthorized completion, a payor bank paying it, or a person taking it for value, in good faith and without notice of the alteration, may enforce rights with respect to the instrument according to its terms as completed. (§3-407(c)(I).)

  5. Original terms. If an instrument has been fraudulently altered, it may still be enforced according to its original terms by one who has paid it or taken it for value in good faith and without notice of the alteration. Thus, if a check was originally written for $400 and altered to $4400, it could be enforced for $400 - its original amount. (§3-407(c)(ii).)

  6. Negligence. If another party (such as the drawer, the payee, or either the drawee bank or depositary bank) was negligent in a manner that substantially contributed to the loss from the alteration they are precluded from asserting the alteration against a person who, in good faith, pays the instrument or takes it for value or for collection. Note that once again the comparative fault rule applies. (§3-406.)

  7. Customer failure to examine and report. If the drawer of the check fails to promptly examine his bank statement and report the alteration within a reasonable time (not to exceed 30 days), the drawer cannot pass the loss on to his bank (which will then be precluded from passing it on to the depositary bank), unless the drawer can show that his bank failed to exercise ordinary care. In such a case, the loss will be allocated among the parties to the extent that the failure of each to exercise ordinary care contributed to the loss. (§4-406.)

  8. One year bar. Notwithstanding the drawee bank's ordinary care or lack thereof, if the customer fails to report the alteration within one year of receiving the item or the statement, the customer is barred from passing on the loss.

  9. Repeat wrongdoer rule. If the alteration was the work of a repeat wrongdoer, the customer is precluded from passing on the loss. (See above under unauthorized signature.) (§4-406).

  10. Statute of limitations. The claim is barred if not filed within the statute of limitations. (§4-111.)

WHO CAN SUE WHOM FOR WHAT?

If an altered check is paid and none of the above defenses apply, the drawer of the check can pass the loss on to his bank. His bank can, in turn, make a claim for breach of presentment warranty to the presenting bank. The payee cannot sue the drawee bank unless the underlying obligation for which the check is given is extinguished. The payee in that instance could also sue the drawer.

Keep in mind: Persons who take checks showing visible evidence of alteration may take with notice of a claim or defense and thus may not be holders in due course. If this is the case, then all the sections that talk about who is precluded from passing a loss on will not apply to the extent the preclusion only extends to those who have taken or paid in good faith for value and without knowledge of a claim or defense.

All About Negligence

Generally, a person who by his negligence substantially contributes to a material alteration or to the making of an unauthorized signature is precluded from asserting the alteration or lack of authority against a holder in due course or a drawee or other payee who pays the item in good faith and in accordance with reasonable commercial standards of the drawee's or payee's business.

Who is protected.
This provision (3-406) protects:

  • the bank that cashes the check
  • the bank that takes it for deposit
  • the payor bank.

Examples of customer negligence:

  • following careless office procedures
  • failing to separate check-writing and statement review functions
  • sending a check to a person with the same name as the payee
  • failing to adopt or follow audit procedures
  • careless handling of facsimile signature devices
  • knowingly hiring an untrustworthy bookkeeper
  • failing to take preventive action after learning of a forgery or alteration
  • negligent hiring practices (such as not checking references)
  • negligently making out a check (for example, leaving large spaces before the amount)

Following reasonable commercial standards:

  • includes following internal bank procedures and generally accepted banking practices
  • includes checking signatures and ID

Bulk filing and the duty of ordinary care

  1. bank used to be out of luck if it didn't examine the check
  2. under new definition of ordinary care under 3-103, the failure of the bank to examine a check will not constitute a lack of ordinary care if the failure to examine was
    1. in accordance with the bank's internal procedure; and
    2. that procedure does not vary unreasonably from general banking usage.


    HAVE A PROCEDURE FOR EXAMINATION OF CHECKS
    AND
    BE SURE YOU ADHERE TO IT!


    Joint Payee Problems

    Checks with joint payees may be made payable:

    • alternatively
    • jointly

    or

    • ambiguously

    Under the revised UCC Section 3-110(d), it states:

    • If an instrument is payable to two or more persons alternatively, it is payable to any of them and may be negotiated, discharged, or enforced by any or all of them in possession of the instrument;

    • If an instrument is payable to two or more persons not alternatively, it is payable to all of them and may be negotiated, discharged, or enforced only by all of them;

    • If an instrument payable to two or more persons is ambiguous as to whether it is payable to the persons alternatively, the instrument is payable alternatively.

    If a joint payee check is payable jointly and all the endorsements of all payees are not on the check, the check is not properly payable and if the bank pays it, it is liable to its customer.

    The UCC Warranties

    There are three sets of UCC warranties that are of particular importance in the area of problem checks. The three sets are the:

    1. transfer warranties (§4-207)
    2. presentment warranties (§4-208) and
    3. encoding warranties (§4-209).

    Transfer Warranties

    There are five separate transfer warranties. They are made by the customer or collecting bank that transfers an item and receives a settlement or other consideration to the transferee and to any subsequent collecting bank.

    The five warranties are that:

    1. The warrantor is a person entitled to enforce the item.[This basically means that there are no forged or missing endorsements.]

    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 [see 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 unaccepted draft, the drawer.

    What happens if the item is dishonored? A customer or collecting bank transferring the item and receiving settlement or other consideration is obliged to pay the amount due on the item.

    1. according to the terms of the item at the time it was transferred, or

    2. if the transfer was of an incomplete item, according to its terms when completed.

    This obligation is owed to the transferee and to any subsequent collecting bank that takes the item in good faith.

    A person to whom the warranties are made and who took the item in good faith can recover as damages for breach an amount equal to the loss suffered as a result of the breach, but not more than the amount of the item plus expenses and loss of interest incurred as a result of the breach.

    SPECIAL NOTE: Unless a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason to know of the breach and the identity of the warrantor, the warrantor is discharged to the extent of any loss caused by any delay in giving notice of the claim.

    Presentment Warranties

    If an unaccepted draft is presented to the drawee for payment or acceptance and the drawee pays or accepts the draft, the person obtaining payment or acceptance, at the time of presentment, and a previous transferor of the draft, at the time of transfer, make the following warranties to the drawee that pays or accepts the draft in good faith:

    1. A warranty that 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. [Again, this basically just means that there are no forged or missing endorsements.]

    2. A warranty that the draft has not been altered; and

    3. A warranty that the warrantor has no knowledge that the signature of the purported drawer is unauthorized.

    Thus, the presentment warranties are fewer and more limited than the transfer warranties. Nevertheless, if a drawee made payment, it may recover from a presentment warrantor damages for breach of warranty equal to the amount paid by the drawee less the amount the drawee received or is entitled to receive from the drawer because of the payment. And, in addition, the drawee is entitled to compensation for expenses and loss of interest resulting from the breach. The right of the drawee to recover damages under these warranties is not affected by any failure of the drawee to exercise ordinary care in making payment.

    Defenses to breach of warranty claim

    The warrantor can raise several defenses, including:

    1. the endorsement is effective due to fictitious payee or impostor;
    2. the responsible employee defense;
    3. the drawer's negligence precludes the loss from being asserted;
    4. drawer failure to examine and report.

    SPECIAL NOTE: Unless a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason to know of the breach and the identity of the warrantor, the warrantor is discharged to the extent of any loss caused by any delay in giving notice of the claim.

    Encoding Warranty

    This warranty is new under the revised UCC. It is found in Section 4-209 and is set forth quite simply, as follows:

    A person who encodes information on or with respect to an item after issue warrants to any subsequent collecting bank and to the payor bank or other payor that the information is correctly encoded.

    Note that the statute says that if the customer of a depository bank encodes, that bank also makes the warranty. In such a case an indemnification agreement from the customer would be essential.

    A person to whom the encoding warranty is made and who took the item in good faith may recover from the warrantor as damages for breach of warranty an amount equal to the loss suffered as a result of the breach, plus expenses and loss of interest incurred as a result of the breach.

    Copyright, 1994, Mary Beth Guard. All rights reserved. Mary Beth Guard is Executive Editor of BankersOnline.com.

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    Copyright Š 1994-2006, Mary Beth Guard
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