A customer deposited a large insurance proceeds check made payable to both our customer and his mortgagee bank (together, not alternatively). However, the check was missing the required mortgagee bank’s endorsement, and we are now concerned about fraud. Can we freeze the customer’s account while we investigate?

Your bank may freeze the customer’s account to investigate suspected fraud associated with the account, provided your account agreement includes language effectively authorizing the bank to place a hold on the account’s funds when it is concerned about potential fraud.

In general, your bank’s authority to freeze your customer’s account is governed by your account agreement. Most financial institutions have appropriate language in their deposit account agreements that authorize the placement of a hold on the funds in an account if the bank suspects fraudulent activity with respect to the account. If you do not think that your account agreement contains adequate language for imposing this freeze, we recommend consulting with your bank counsel.

We should note that under the Uniform Commercial Code, your bank warranted that there were no missing indorsements when it forwarded the check to the payor bank for payment. The same presentment warranty also applied when your customer deposited the check at your bank. Consequently, if the mortgagee bank or the insurance company disputes the deposit, the payor bank may bring a claim for breach of presentment warranty against your bank. Your bank, in turn, may then bring a claim against your customer. Due to these potential claims, we believe that freezing the customer’s account to investigate possible check fraud would be prudent, provided this is permitted under your account agreement.

Also keep in mind that when investigating this situation for fraud, your bank also should assess whether to file a Suspicious Activity Report regarding the check transaction.

For resources related to our guidance, please see:

UCC, 810 ILCS 5/3-110(d) (“If an instrument is payable to 2 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 2 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 2 or more persons is ambiguous as to whether it is payable to the persons alternatively, the instrument is payable to the persons alternatively.”)

UCC, 810 ILCS 5/3-417(a)(1) and 810 ILCS 5/4-208(a)(1) (“Presentment warranties. (a) 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. . . .”)

UCC § 3-417 cmt. 2 (“Subsection (a)(1) in effect is a warranty that there are no unauthorized or missing indorsements.”)

Continental Cas. Co., Inc. v. Am. Nat. Bank and Trust Co., 329 Ill.App.3d 686, 698 (1st Dist. 2002) (“[W]hen a bank makes an improper payment . . . the drawer can bring an action for improper payment under section 4-401(a) and have its account recredited.”)

FDIC Suspicious Activity Report Rules, 12 CFR 353.3 (“A bank shall file a suspicious activity report with the appropriate federal law enforcement agencies and the Department of the Treasury, in accordance with the form’s instructions, by sending a completed suspicious activity report to FinCEN in the following circumstances . . . .”)