Chapter 24: Banking in the Digital Age 1
Chapter 24
Banking in the Digital Age
Introduction
Article 3 and Article 4 of the Uniform Commercial Code (UCC) govern checks. The extent to which any party is either charged with or discharged from liability on a check is established according to the provisions of Article 3. Article 4 is a statement of the principles and rules of modern bank deposit-and-collection procedures. It governs the relationship of banks with one another as they process checks for payment, and it establishes a framework for deposit and checking agreements between a bank and its customers. A check can therefore fall within the scope of Article 3 and yet be subject to the provisions of Article 4 while it is in the course of collection. In the case of a conflict between Articles 3 and 4, Article 4 controls [UCC 4–102(1)].
Chapter Outline
I.Checks
A check is a draft drawn on a bank [UCC 3–104(f)]. If any institution other than a bank, as defined in UCC 4–105(l), handles a check for payment or collection, the check is not covered by Article 4.
A.Cashier’s Checks
A cashier’s check is a check drawn by a bank on itself; negotiable on issue [UCC 3–104(g)]. A teller’s check is a draft drawn by a bank on another bank, or if drawn on a nonbank, payable at or through a bank [UCC 3–104(h)].
Additional Cases Addressing this Issue —Cashier’s Checks
Cases in which cashier’s checks or other bank checks were at the center of the dispute include the following.
•Murphy v. National City Bank, 560 F.3d 530 (6th Cir. 2009): (a bank's refusal to cash its teller's check for a payee who was not an accountholder without charging a fee did not violate the bank's obligation under the UCC to pay a dishonored draft—the check was not dishonored because the payee never presented it to the drawee bank for payment).
•Transcontinental Holding Ltd. v. First Banks, Inc., __ S.W.3d __ (Mo.App. E.D. 2009): (a bank established lack of consideration as a defense against liability on a cashier's check, and thus was authorized to stop payment on the check, when its purchaser paid the bank for the cashier’s check with a check drawn on a newly-opened account against a provisional credit that was reversed, leaving no funds with which to pay the check the purchaser wrote).
•Lerner v. First Commerce Bank, __ S.W.3d __ (Tex.App.—Houston [14 Dist.] 2009): (a bank customer’s failure to pursue a claim for breach of contract for more than thirty years after the bank refused to honor a cashier’s check that it had issued effectively time-barred the action under the applicable statute of limitations).
B.Traveler’s Checks
A traveler’s check is a check on which a financial institution is both drawer and drawee. The buyer must sign it twice (buying it and using it) [UCC 3–104(i)].
C.Certified Checks
A certified check is a check accepted by the bank on which it is drawn [UCC 3–409(d)]. When a bank certifies a check, it immediately charges the drawer’s account and transfers those funds to its own account. This discharges the drawer and prior indorsers [UCC 3–414(c), 3–415(d)].
II.The Bank-Customer Relationship
A.Creditor-Debtor Relationship
A creditor-debtor relationship is created between a customer and a bank when, for instance, the customer deposits cash in a checking account or when final payment is received for checks drawn on other banks.
B.Agency Relationship
A principal-agent relationship underlies the check collection process.
C.Contractual Relationship
The rights and duties of a bank and its customer are contractual and depend on the nature of the transaction.
Case Synopsis—Case 24.1: Royal Arcanum Hospital Association of Kings County, Inc. v. Herrnkind
The board of the Royal Arcanum Hospital Association of Kings County, Inc. passed a resolution to require that all corporate checks be signed by two of three officers—Frank Vassallo, Joseph Rugilio, and William Herrnkind. The three were also named as signatories on the firm’s account with Capital One Bank, but the terms of the account did not include the two-signature requirement. After Vassallo and Rugilio died, Herrnkind opened a new account in the corporate name that expressly permitted one-signature transactions. Over the next four years, a series of transactions depleted the account. Royal Arcanum filed a suit in a New York state court against Herrnkind and Capital One to recover the funds, alleging breach. The court dismissed the complaint against the bank. Royal Arcanum appealed.
A state intermediate appellate court affirmed. There was never a two-signature requirement on any of Royal Arcanum’s accounts with Capital One.
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Notes and Questions
Did Royal Arcanum meet the requirements for ratification with respect to Herrnkind’s apparent drawdown of the company’s corporate bank account?No, Royal Arcanum did not satisfy the requirements for ratification with respect to Herrnkind’s apparent drawdown of the company’s corporate bank account. Even if Herrnkind did not have the actual authority to write checks and make withdrawals of the funds in Royal Arcanum’s corporate accounts, it might be said that he had the apparent authority to do so based on the circumstances—his express inclusion as one of three corporate officers authorized to approve the issuing of checks on the accounts, for example.
Ratification occurs when a principal affirms an agent’s unauthorized act, thereby binding the principal to the act. But the requirements for ratification include, among other things, the principal’s full knowledge of all material facts and the principal’s affirmation of the agent’s entire act. Here, it cannot be reasonably concluded that Royal Arcanum had full knowledge of all of the facts with respect to Herrnkind’s opening of a second corporate bank account and apparent withdrawal of corporate funds nor can it be concluded that Royal Arcanum affirmed Herrnkind’s actions.
III.The Bank’s Duty to Honor Checks
When a drawee bank wrongfully fails to honor a check, it is liable to its customer for damages resulting from the refusal [UCC 4–402]. But the bank’s duty is not absolute: if the bank properly dishonors a check for insufficient funds, it has no liability to the customer.
A.Overdrafts
A bank may dishonor a check that, if it were cashed, would create an overdraft in the customer’s account, or the bank may charge the customer’s account for the amount of the check (providing that the customer has agreed in advance) [UCC 4–401(a)]. When a check bounces, the holder can resubmit it (he or she should, however, notify prior indorsers of the dishonor, or they will be discharged). A bank may alternatively agree to honor overdrafts.
B.Postdated Checks
If a bank charges a postdated check against a customer’s account, despite the customer’s timely notice to the bank of the postdating, the bank may be liable for any damages to the customer as a result [UCC 4–401(c)].
Additional Background—Overdrafts
In a bank-customer relationship, the basic interaction occurs when a customer presents an instrument (a check, for instance) to the right bank in a timely manner, so that the instrument can be paid and all parties’ accounts can be adjusted appropriately.
Payment of an instrument creating an overdraft has caused some controversy. The previous (unrevised) Article 4 was not clear about whether a bank can create an overdraft without customer authorization [UCC 4–401]. Revised Article 4 clarifies the issue. First, the revised Article 4 defines an item as properly payable “if it is authorized by the customer and is in accordance with any agreement between the customer and the bank.” Thus, a bank can pay an instrument creating an overdraft if the customer has authorized the payment and it does not violate any agreement between the bank and customer [UCC 4–401(a)]. If there is a joint account from which more than one person can draw, however, the bank cannot hold a joint-account customer liable for payment of an overdraft unless the customer has signed the item or has benefited from the proceeds of the item [UCC 4–401(b)]
C.Stale Checks
A bank is not obligated to pay an uncertified check presented more than six months from its date, but it has that option [UCC 4–404].
D.Stop-Payment Orders
Only a customer can order his or her bank to pay a check, and only a customer can order payment stopped, although there are time limits [UCC 4–403(a)].
1.Reasonable Time and Manner
The customer must issue the stop-payment order within a reasonable time and in a reasonable manner for the bank to act on it [UCC 4–403(a)]. A written order is effective for six months. An oral order is effective for fourteen days.
2.Bank’s Liability for Wrongful Payment
If the bank pays the check over the customer’s order, the bank is liable to the customer for the amount of any actual loss [UCC 4–403(c)].
Enhancing Your Lecture—
How to Use Stop-Payment Orders
For a variety of reasons, a drawer should not misuse stop-payment orders. We look at some of those reasons here.Monetary Costs and Risks
One reason is monetary: banks usually charge between $15 and $25 for a stop-payment order, so stopping payment is not cost-effective for a check written for a small amount. Another reason is the risk attached to the issuing of a stop-payment order for any drawer-customer. The bank is entitled to take a reasonable amount of time to put your stop-payment order into effect before it has liability for improper payment. Hence, the payee or another holder may be able to cash the check despite your stop-payment order if he or she acts quickly. Indeed, you could be writing out a stop-payment order in the bank lobby while the payee or holder cashes the check in the drive-in facility next door. In addition, even if a bank pays over your proper stop-payment order, the bank is liable to the drawer-customer only for the amount of loss the drawer suffers from the improper payment.
When You Can Stop Payment
Remember that, to avoid liability, a drawer must have a legal reason for issuing a stop-payment order. You cannot stop payment on a check simply because you have had a change of heart about the wisdom of your purchase. Generally, you can safely stop payment if you clearly did not get what you paid for or were fraudulently induced to make a purchase. You can also stop payment if a “cooling-off” law governs the transaction—that is, if you legally have a few days in which to change your mind about a purchase. Any wrongful stop order subjects the drawer to liability to the payee or a holder, and this liability may include special damages that resulted from the order. When all is considered, it may be unwise to order a stop payment hastily on a check because of a minor dispute with the payee.
Checklist for Stop-Payment Orders
1.Compare the stop-payment fee with the disputed sum to make sure it is worthwhile to issue a stop-payment order.
2.Make sure that your bank will honor your stop-payment order before the payee cashes the check.
3.Make sure that you have a legal reason for issuing the stop-payment order.
E.Death or Incompetence of a Customer
•If, when a check is issued or its collection has been undertaken, a bank does not know of an adjudication of incompetence, it can pay the check without liability.
•Once a bank knows of a death, for ten days after the date of death, it can pay or certify checks drawn on or before the date of death (unless a person claiming an interest in that account orders the bank to stop) [UCC 4–405].
F.Checks with Forged Drawers’ Signatures
1.The General Rule
•A forged signature on a check has no legal effect as the signature of a drawer [UCC 3–403(a)]. If the bank pays on a forged signature, it must recredit the customer’s account unless the customer’s negligence substantially contributes to the forgery [UCC 3–406(a).
•The bank is responsible for determining whether the signature is genuine. The parties may agree that the customer is responsible for losses related to the forgery of “nonmanual” signatures.
2.Customer Negligence
The customer’s liability may be reduced by any loss caused by negligence on the part of a person paying the instrument or taking it for value (if the negligence substantially contributed to the loss) [UCC 3-406(b)].
a.Timely Examination Required
A customer must examine monthly statements and canceled checks and report any forged signatures promptly [UCC 4–406(a), (b)]. (If a bank does not send the checks, it must keep them, or copies of them, for seven years.) If a customer fails to do this, he or she is liable for any loss to the bank [UCC 4–406(d)].
b.Consequences of Failing to Detect Forgeries
To recover for a series of forgeries of the same signature by the same wrongdoer, a customer must report the first item to the bank within thirty calendar days of receipt of the bank statement [UCC 4–406(d)(2)].
3.When the Bank Is Also Negligent
If the bank is also negligent, the bank is also liable on a comparative negligence basis [UCC 4–406(e)]. It is not negligence to fail to examine every signature on every check [UCC 3–103(a)(7)].
a.One-Year Time Limit
A customer who fails to report his or her forged signature within a year of the date that the statement was available for inspection loses the right to have the bank recredit his or her account [UCC 4–406(f)].
b.Other Parties from Whom the Bank May Recover
•The bank may recover from the forger—a forged signature is effective as the signature of the unauthorized signer [UCC 3–403(a)].
•The bank may also recover from “the person to whom or for whose benefit payment was made” [UCC 4–207(a)(2), 3–418(a)(ii)].
•The bank may not recover from “a person who took the instrument in good faith and for value or who in good faith changed position in reliance on the payment or acceptance” [UCC 3–418(c)].
G.Checks Bearing Forged Indorsements
•A bank that pays a customer’s check bearing a forged indorsement must recredit the customer’s account or be liable to the customer for breach of contract (unless the customer fails to report the forgery within three years after the item with it was available to the customer [UCC 4–111]).
•The bank in turn can recover from the bank that sent it the check, and so on up the line to the first party who took the check with the forgery.
Case Synopsis—Case 24.2: Michigan Basic Property Insurance Association v. Washington
The Michigan Basic Property Insurance Association (MBP) issued a check for $69,559.06 on its account with Fifth Third Bank to Joyce Washington, Countrywide Home Loans, and T&C Federal Credit Union as co-payees. Washington indorsed the check by signing all the payees’ names but did not share the proceeds. Fifth Third notified MBP of the payment through daily and monthly account statements. MBP did not object until it was forced to issue a second check to Countrywide. MBP then sued Fifth Third for the amount. The court held Fifth Third liable.
On appeal, a Michigan state intermediate appellate court reversed. The check was not properly payable because it had two forged indorsements. When a bank pays a check bearing a forgedindorsement, the UCC ordinarily requires the bank to recredit the customer's account. But the UCC allows parties to change their duties by contract. Here, the account agreement obligated MBP to review its statements and notify Fifth Third of any problems within thirty days. Without such notice, MBP was liable for any forged indorsements.
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Notes and Questions
Why should a customer have to report a forged or unauthorized signature on a paid check within a certain time to recover the amount of the payment? The consequence of a customer’s failure to report a forged or unauthorized signature under these circumstances is the opportunity presented to the wrongdoer to repeat his or her misdeeds.Would the situation have been different if MBP had handled its account electronically rather than manually?Electronic banking would have made no difference in the outcome in this instance. The liability rules are essentially the same.
What reasonable steps could MBP have taken to have prevented its loss?MBP might have negotiated different terms in its account agreement with Fifth Third. These terms might have included a different assessment of liability for payment on a forged indorsement or a longer time period to review an account statement and notify the bank of any problems. If different terms were not possible, MBP should have more closely scrutinized its account statements within the prescribed time limits to spot the item with the forged indorsements.
Additional Cases Addressing this Issue—
Bank’s Duty to Honor Checks
Cases involving the bank’s duty to honor checks include the following.
•Afiriyie v. Bank of America, N.A., __ N.J.Super. __, __ A.3d __, 2013 WL 451895 (2013) (bank was liable for wrongful dishonor when it erroneously caused plaintiff to be arrested for attempting to pass a fraudulent check)
•Compass Bank v. Nacim, __ S.W.3d __, 2015 WL 181721 (Tex.App.—El Paso 2015) (bank was required to recredit customer’s account despite notice of unauthorized transaction more thirty days after bank mailed statement on which transaction appeared—duty to report unauthorized transaction does not begin to run until customer receives mailed statement)
H.Altered Checks