What is our liability for paying or permitting the deposit of unendorsed checks? Our current policy is to return checks that are missing the payee’s endorsement on the back, which upsets some of our customers. We’re considering a new policy of calling customers to ask if we should pay these checks.

While there is some risk in allowing customers to deposit checks that are not endorsed by the payee, there is less risk when paying unendorsed checks that are drawn on customer accounts.

Payment of Unendorsed Checks Drawn on Customer Accounts

When a depositary bank sends your bank a check for collection, the depositary bank has accepted liability for the check being paid to the wrong person — even if the check is not endorsed. Under the Uniform Commercial Code (UCC), when a depositary bank sends a check for collection, it is warranting to your bank (and to your customer) that it has paid the check to the payee, or that it has deposited the check in the payee’s account, whether or not the customer has endorsed the item. 810 ILCS 5/4-205. In addition, the depositary bank is warranting that it is entitled to enforce the check, and this “in effect is a warranty that there are no unauthorized or missing endorsements.” 810 ILCS 5/3-417(a)(1)First Nat. Bank of Chicago v. MidAmerica Federal Sav. Bank, 303 Ill.App.3d 176, 182 (1st Dist. 1999). Therefore, if your customer were to contend that the check was not paid to the correct person based on the missing endorsement, while the customer would be entitled to demand repayment from your bank, your bank in turn would be entitled to demand repayment from the depositary bank.

Because the net effect of your liability in this situation is limited, we believe it would be a reasonable business decision for your bank to honor a check with a missing endorsement (provided the check was deposited in the payee’s account at the depositary bank), particularly if your bank were to call the drawer (your customer) and obtain confirmation of the check. Before changing your policy to follow this practice, however, we would recommend checking your account agreement to see whether your institution has agreed to examine customers’ checks for missing signatures or endorsements.

Customer Deposits of Unendorsed Checks

When your bank’s customer deposits a check without endorsing it, or if the drawer’s signature is missing, your bank is considered to be the depositary bank. If your customer delivers a check to your bank for deposit, you are entitled to enforce the check “whether or not the customer indorses the item.” 810 ILCS 5/4-205(1). On the other hand, the same warranties discussed above will apply to your bank — it will be warranting to the payor bank that the check was paid to the proper payee and that your bank is entitled to enforce the check (meaning that there are no missing or unauthorized endorsements). 810 ILCS 5/4-205(2)810 ILCS 5/3-417(a)(1). If the drawer of the check contends that the check was not paid to the proper payee, you may be liable to the drawer or to the payor bank. For that reason, many banks (such as yours) manage this risk by examining endorsements on deposited checks that are larger than a certain cutoff dollar amount.