QUESTION: Dan makes a check payable to Paul. Paul places the check on his dresse

Question

QUESTION:

Dan makes a check payable to Paul. Paul places the check on his dresser, and it is stolen during the night by Fred. Fred forges Paul's endorsement and cashes the check at Ralph's retail store. Ralph cashes the check at Dan's bank. Who has liability on the instrument, assuming Fred cannot be found?

NOTES:

Checks are a special form of draft where the drawee is always a bank and the instrument is payable on demand. All of the aspects of chapters 30-32 are applicable. However, in addition checks have some other special incidences under Article 4 of the UCC. 4-201 provides that the bank is an agent of the drawer. They must follow the customer’s instructions. 4-401 provides that if the item is properly authorized, the bank may charge the customers account even if it creates an overdraft. However, they are not obligated to do so and may choose to dishonor the item. The converse of this section would say that a bank cannot charge an improperly payable item to a customers account. The bank is also liable to the customer if they wrongfully dishonor an item (4-402). A check is not an assignment of funds in the drawers account (3-408), therefore, the customer can order the drawee bank to stop payment on the check. Oral stop-payment orders are good for 14 days and must be confirmed in writing within that time period (4-403). Of course, the drawer would have primary liability on this instrument and should only stop payment if they thought they would have a good defense, if sued. Banks are not required to pay “stale” checks that are over 6 months old. 4-406 provides that if a customer wants to recover from the bank for paying a wrongful item, they must examine their bank statement with a reasonable time and notify the bank of any problems. If the bank failed to exercise ordinary care in paying an item, then the customer may be able to recover even if they were delinquent in examining the statement. However, if the issue is not raised within a year, the customer is precluded from raising the issue regardless of the bank’s negligence.

     The liability issues for the drawer and endorsers are the same as covered in Chapter 33. If the drawee bank dishonors a check for insufficient funds, the drawer has primary liability and any endorsers have secondary liability. As a practical matter, when the check is returned to the depository bank, they will take the money out of the endorsers account and leave it up to them to pursue the drawer. This is known as the right of “off-set”. However, there are also liability issues when the instrument is paid improperly. There are 3 situations where this might be the case: a forged drawer’s signature, an altered check and a forged endorser’s signature. The converse of 4-401, would tell us that the drawee/payor bank is liable to the customer/drawer if they pay over a forged drawer’s signature. It is presumed that they know your signature. That is why you sign signature cards. They are also liable for any raised amount of an altered check that they pay (3-407(b)). Payment over a forged endorser’s signature is a different story. The drawee/payor bank does not have to “eat” this loss. Assume a check is written to John Jones, by Henry Smith, for services rendered. John puts the check on his dresser and a thief steals it during the night. The thief cashes it at a retailer, who in turn deposits it in his bank and it is ultimately paid by the drawee bank. John has never been paid for his services. He could seek a new payment from Henry under 3-309. Then Henry would have paid twice, so he could seek recovery from his bank for paying an improperly payable item (the check with the forged endorsement). This is where the difference comes in. The drawee/payor bank can recover from a collecting bank or depository bank (whichever gave them the check) under 4-207 (warranty theory for banks) and the depository bank can go back against the retailer under 3-420 (an endorser warrants that all signature are genuine and authorized). So ultimately, if the forger cannot be found, after all the warranty theory under Articles 3 and 4, the liability will end on the first person or entity that took the instrument after the forgery (the retailer in our example).          

Explanation / Answer

The payor bank has the liability if it honours the check with forged signatures. If the bank manages to detect the forgery, it may dishonour the check, and the losses will be borne by Ralph.

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