IBA Compliance Connection

Your go to source for compliance!

One of our customers lost her checkbook, and checks drawn on our bank were forged. The depositary bank already has cashed the checks. Are we liable for the forgeries?

—

by

admin

In general, your bank (the bank on which the forged checks were drawn) is liable for any forged checks that it did not return before its midnight deadline, but your bank may have a few narrow defenses against liability.

In the context of a forgery, you will need to reimburse the customer for the amount of a forged check if the customer alerts you to the forgery with “reasonable promptness.” Financial institutions may narrow the definition of “reasonable promptness” in account agreements, and an Illinois court has held that a 30-day notification window is reasonable. If the customer notified your bank of the forgeries within the timeframe outlined in your account agreement, the customer has fulfilled their notification obligation.

However, your bank is not obligated to reimburse the customer for the amount of the forged checks if the customer’s own negligence substantially contributed to the making of the forgeries (provided that your bank exercised ordinary care and acted in good faith in paying the checks). For example, an employer that keeps blank checks and a rubber signature stamp in an unlocked desk drawer likely would be treated as substantially contributing to check forgeries. But in less extreme cases, it may be difficult for your bank to prove that your customer’s negligence substantially contributed to the forgeries.

In addition, you may be able to seek recourse from the presenting bank if it violated its presentment warranties, including that it had no knowledge that the signature on the check is forged. However, your bank may face an uphill battle in proving that the presenting bank knew or should have known that the checks were forged.

For resources related to our guidance, please see:

  • UCC, 810 ILCS 5/4-302(a) (“If an item is presented to and received by a payor bank, the bank is accountable for the amount of . . . a demand item . . .  whether properly payable or not, if the bank, in any case in which it is not also the depositary bank, retains the item beyond midnight of the banking day of receipt without settling for it or, whether or not it is also the depositary bank, does not pay or return the item or send notice of dishonor until after its midnight deadline . . . .”)
  • UCC, 810 ILCS 5/3-401 (“A person is not liable on an instrument unless . . . the person signed the instrument . . . .”)
  • UCC, 810 ILCS 5/4-406(c) (“[T]he customer must exercise reasonable promptness in examining the statement . . . . If, based on the statement or items provided, the customer should reasonably have discovered the unauthorized payment, the customer must promptly notify the bank of the relevant facts.”)
  • Napleton v. Great Lakes Bank, N.A., 408 Ill.App.3d 448, 452 (1st Dist. 2011) (Banks may narrow the definition of “reasonable promptness” in a deposit agreement, so that customers have only a thirty-day window in which to report forged checks.)
  • 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, 810 ILCS 5/3-406, 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 that 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.

Case #2. An insurance company draws a check to the order of Sarah Smith in payment of a claim of a policyholder, Sarah Smith, who lives in Alabama. The insurance company also has a policyholder with the same name who lives in Illinois. By mistake, the insurance company mails the check to the Illinois Sarah Smith who indorses the check and obtains payment. Because the payee of the check is the Alabama Sarah Smith, the indorsement by the Illinois Sarah Smith is a forged indorsement. Section 3-110(a). The trier of fact could find that the insurance company failed to exercise ordinary care when it mailed the check to the wrong person and that the failure substantially contributed to the making of the forged indorsement. In that event the insurance company could be precluded from asserting the forged indorsement against the drawee bank that honored the check.

Case #3. A company writes a check for $10. The figure ‘10’ and the word ‘ten’ are typewritten in the appropriate spaces on the check form. A large blank space is left after the figure and the word. The payee of the check, using a typewriter with a typeface similar to that used on the check, writes the word ‘thousand’ after the word ‘ten’ and a comma and three zeros after the figure ‘10’. The drawee bank in good faith pays $10,000 when the check is presented for payment and debits the account of the drawer in that amount. The trier of fact could find that the drawer failed to exercise ordinary care in writing the check and that the failure substantially contributed to the alteration. In that case the drawer is precluded from asserting the alteration against the drawee if the check was paid in good faith.”)

 

  • UCC, 810 ILCS 5/3-406(b) (“Under subsection (a), if the person asserting the preclusion fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss, the loss is allocated between the person precluded and the person asserting the preclusion according to the extent to which the failure of each to exercise ordinary care contributed to the loss.”)
  • UCC, 810 ILCS 5/3-417(a)(1) and 810 ILCS 5/4-208(a)(1) (“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 that pays or accepts 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; (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.”)
     
  • UCC, 810 ILCS 5/3-417, cmt. 2 (“Subsection (a) states three warranties. Subsection (a)(1) in effect is a warranty that there are no unauthorized or missing indorsements. ‘Person entitled to enforce’ is defined in Section 3-301. Subsection (a)(2) is a warranty that there is no alteration. Subsection (a)(3) is a warranty of no knowledge that there is a forged drawer’s signature.”)