We learned that one of our customers had three fraudulent checks drawn on his account after we alerted him that he had overdrawn his account. We believe that the checks are counterfeits and the fraudster forged our customer’s signature on them. The checks all were deposited at different banks. We returned the checks to the Federal Reserve four days after we paid them and received a claim of late return for one of them shortly after. The Federal Reserve says we have twenty days to respond to the claim. What is our best option for responding to the claim of late return?

We believe your bank likely is liable for the check since you returned it after the midnight deadline. Your bank would have a defense to liability for the check only if the depository bank breached a presentment warranty to your bank or your customer’s negligence substantially contributed to the making of the forged check.

Under the Federal Reserve’s rules, a paying bank “may send . . . a returned check that a Reserve Bank did not handle for forward collection only if it sends the returned check within the deadline of Regulation CC and the Uniform Commercial Code” — i.e., the midnight deadline. The midnight deadline provided in the Illinois Uniform Commercial Code (UCC) requires banks to return checks, including forged checks, by midnight of the next banking day after receiving the check (with certain limited extensions permitted under Regulation CC).

The Federal Reserve’s Operating Circular 3 provides that if a depository bank believes that a paying bank has made a late return, it can make a claim of late return, which “must be received by a Reserve Bank within two calendar months after the sender [i.e. the depository bank] was charged for the returned check.” The paying bank then has “twenty banking days after the Reserve Bank charged the bank for the claim of late return” to send a statement stating “that the paying bank returned the check within its deadline under the Uniform Commercial Code . . . and show[ing] the banking day of receipt and the date of return of the check by the paying bank.” Consequently, we do not believe your bank has a valid basis to dispute the claim of late return, as the depository bank’s claim of late return was timely, and you returned the forged check after the midnight deadline.

Your bank may have a claim against the depository bank if it breached one of the Illinois UCC’s presentment warranties. When the depository bank presented the check to your bank, it made three presentment warranties under the Illinois UCC: (1) there are no unauthorized or missing endorsements on the check, (2) the check has not been altered, and (3) the depository bank did not know that the drawer’s signature was forged. It may be unlikely that the depository bank breached any of these warranties unless you can prove that the bank knew the check was forged when it transferred the check to your bank.

Additionally, your bank is not required to reimburse a customer for a forged check if the customer’s own negligence substantially contributed to the making of the forgery (provided that your bank exercised ordinary care and acted in good faith in paying the check). However, except in an extreme case (such as a business that keeps blank checks and a rubber signature stamp in an unlocked desk drawer), it likely would be difficult for your bank to prove that your customer’s negligence substantially contributed to the forgery.

We note that your bank should assess whether a suspicious activity report (SAR) should be filed in relation to the forged checks. The FDIC regulations require you to file a SAR if your loss aggregates more than $5,000 and there is an identified suspect involved in the suspicious activity, or if the total loss aggregates $25,000 or more, regardless of identifiable potential suspects.

For resources related to our guidance, please see:

Federal Reserve, Operating Circular No. 3, 15.1, page 17 (November 15, 2021) (“A paying bank may return a cash item to us for which it has previously made settlement to a Reserve Bank only if it returns the item within the deadline of Section 210.12(a) of Regulation J, Section 229.31(g) of Regulation CC and the Uniform Commercial Code. A paying or returning bank may send to us a returned check that a Reserve Bank did not handle for forward collection only if it sends the returned check within the deadline of Regulation CC and the Uniform Commercial Code.”)

Federal Reserve, Operating Circular No. 3, 20.14, page 30, footnote 9 (November 15, 2021) (“This deadline is generally midnight of the banking day following the banking day of receipt of the check by the paying bank (Uniform Commercial Code Section 4-302 and Regulation J Section 210.12(a)), except as the deadline may be extended under Section 229.31(g) of Regulation CC. This deadline applies to checks returned with entry for any reason, including forged endorsement or forged drawer signature.”)

Illinois UCC, 810 ILCS 5/4-302 (“Payor bank’s responsibility for late return of item.

(a) If an item is presented to and received by a payor bank, the bank is accountable for the amount of: (1) a demand item, other than a documentary draft, whether properly payable or not, if the bank . . . retains the item beyond midnight of the banking day of receipt without settling for it or . . . does not pay or return the item or send notice of dishonor until after its midnight deadline . . .

(b) The liability of a payor bank to pay an item pursuant to subsection (a) is subject to defenses based on breach of a presentment warranty (Section 4-208) or proof that the person seeking enforcement of the liability presented or transferred the item for the purpose of defrauding the payor bank.”)

Illinois UCC, 810 ILCS 5/4-104(10) (“‘Midnight deadline’ with respect to a bank is midnight on its next banking day following the banking day on which it receives the relevant item or notice or from which the time for taking action commences to run, whichever is later.”)

Regulation CC, 12 CFR 229.31(g) (“The deadline for return or notice of dishonor or nonpayment under the UCC or Regulation J (12 CFR part 210), or § 229.36(d)(3) and (4) is extended to the time of dispatch of such return or notice if the depositary bank (or the receiving bank, if the depositary bank is unidentifiable) receives the returned check or notice (1) On or before the depositary bank’s (or receiving bank’s) next banking day following the otherwise applicable deadline by the earlier of the close of that banking day or a cutoff hour of 2 p.m. (local time of the depositary bank or receiving bank) or later set by the depositary bank (or receiving bank) under UCC 4-108. . . .”)

Federal Reserve, Operating Circular No. 3, 20.14, page 30 (November 15, 2021) ( (If a sender believes that the paying bank returned late (after the paying bank's deadline under the Uniform Commercial Code, Regulation J, and Section 229.31(g) of Regulation CC) a check or electronic item in the amount of $100.00 or more, the sender may dispute the return by furnishing us with the returned check (or a legible copy of the front and back of the returned check) and a signed statement that the bank believes that the paying bank returned the check late. This procedure may be used only once for each return, and only if the check or electronic item has been handled by a Reserve Bank for forward collection or return. The statement must be in a format we prescribe and must be received by a Reserve Bank within two calendar months after the sender was charged for the returned check. The sender's Administrative Reserve Bank will provisionally credit the amount of the returned check to the sender's account.”)

Regulation J, 12 CFR 210.2(n) (“Sender means any of the following entities that sends an item to a Reserve Bank for forward collection— (1) A depository institution, as defined in section 19(b) of the Federal Reserve Act (12 U.S.C. 461(b)) . . .”)

Federal Reserve, Operating Circular No. 3, 20.15, page 31 (November 15, 2021) (The sender's Administrative Reserve Bank will revoke the credit provided under paragraph 20.4 given to the sender (and a Reserve Bank will recredit the paying bank) if: . . . b) a Reserve Bank receives the returned check or the copy the paying bank received with the Claim of Late Return and a statement as provided below from the paying bank within twenty banking days after the Reserve Bank charged the bank for the claim of late return. The paying bank's statement must be in a format we prescribe that is signed by an officer of the paying bank and: 1) state that the paying bank returned the check within its deadline under the Uniform Commercial Code and Regulation J or Section 229.31(g) of Regulation CC; and 2) show the banking day of receipt and the date of return of the check by the paying bank.”)

Illinois UCC, 810 ILCS 5/3-417(a)(1) and 810 ILCS 5/4-208(a)(1), Presentment warranties (“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 making payment or accepting 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 (3) the warrantor has no knowledge that the signature of the purported drawer of the draft is unauthorized.”)

Illinois UCC, 810 ILCS 5/3-406(a) (“A person whose failure to exercise ordinary care substantially contributes to an alteration of an instrument or to the making of a forged signature on an instrument is precluded from asserting the alteration or the forgery against a person who, in good faith, pays the instrument or takes it for value or for collection.”)

UCC § 3-406 cmt. 3 (“The following cases illustrate the kind of conduct that can be the basis of a preclusion under Section 3-406(a):

Case #1. Employer signs checks drawn on Employer’s account by use of a rubber stamp of Employer’s signature. Employer keeps the rubber stamp along with Employer’s personalized blank check forms in an unlocked desk drawer. An unauthorized person fraudulently uses the check forms to write checks on Employer’s account. The checks are signed by use of the rubber stamp. If Employer demands the Employer’s account in the drawee bank be recredited because the forged check was not properly payable, the drawee bank may defend by asserting that Employer is precluded from asserting the forgery. The trier of fact could find that Employer failed to exercise ordinary care to safeguard the rubber stamp and the check forms and that the failure substantially contributed to the forgery of Employer’s signature by the unauthorized use of the rubber stamp.”)

FDIC Suspicious Activity Report Rules, 12 CFR 353.3(a) (“An FDIC-supervised institution shall file a suspicious activity report . . . in the following circumstances: . . . (2) Transactions aggregating $5,000 or more where a suspect can be identified. . . . (3) Transactions aggregating $25,000 or more regardless of potential suspects.”)