Shortly after receiving his account statement, our customer notified us that some counterfeit checks had cleared his account. We sent the checks back through the Fed as fraudulent. We have received one of the checks back as a “late return” from the depository bank. Who is liable for these checks under the UCC, and does our bank have any recourse for these checks?

We believe your bank likely is liable for these checks since they were returned after the midnight deadline. Whether your bank has any recourse for the checks depends on whether the depository bank breached a presentment warranty to your bank, or your customer’s negligence substantially contributed to the making of the fraudulent checks.

Under the Fed’s rules, a paying 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” — i.e., the midnight deadline. The midnight deadline provided in the 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). According to its Operating Circular 3, the Fed does not provide an adjustment process for banks that return checks after the midnight deadline even if the checks have been altered or bear a forged endorsement.

However, your bank may have a claim against the depository bank if it breached one of the UCC’s presentment warranties. When the depository bank presented the check to your bank, it made three presentment warranties under the 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 it knew the checks were forged when it transferred them to your bank.

Also, under the UCC, your bank is not required to reimburse a customer for 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. In less extreme cases, it may be more difficult for your bank to prove that your customer’s negligence substantially contributed to the forgeries. Consequently, we recommend reviewing the circumstances surrounding the making of the fraudulent checks and consulting with your bank counsel before deciding whether or not to reimburse your customer or whether to pursue a claim against the depository bank.

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

For resources related to our guidance, please see:

FRB Operating Circular No. 3, 15.1 (“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.”)
Illinois 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: (1) a demand item, other than a documentary draft, 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; . . .”)
Illinois UCC, 810 ILCS 5/4-104(a)(10) (“‘Midnight deadline’ with respect to a bank is midnight on its next banking day following the banking day on which hit receives the relevant item . . . .”)
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. . . .”)

FRB Operating Circular No. 3, 20.11 (“Types of Claims for Which We Do Not Provide an Adjustment Process.

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b) A bank that believes it has a claim for breach of warranty based on an altered check, a forged indorsement, a missing indorsement or an unauthorized indorsement against another bank should deal directly with that other bank. A bank that believes it has such a claim against a Reserve Bank should provide prompt notice of such a claim and also submit the claim to the Reserve Bank together with appropriate documentation, including an affidavit of forged or unauthorized indorsement or alteration.

c) Except as specifically provided by law or regulation, a paying bank may not claim breach of warranty because of a forged or unauthorized drawer signature, or return an item with entry after the return deadline for that or any other reason.”)

FRB Operating Circular No. 3, 20.13 (“A Warranty or Indemnity Claim Does Not Justify Returning an Item After the Return Deadline. A bank must not attempt to recover on a warranty or indemnity claim by including the item in a paper or electronic cash letter or return letter after the return deadline.”)
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.”)
UCC, 810 ILCS 5/4-406(e) (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.

UCC, 810 ILCS 5/3-417(c) (“If a drawee asserts a claim for breach of warranty under subsection (a) based on an unauthorized indorsement of the draft or an alteration of the draft, the warrantor may defend by proving that the indorsement is effective under Section 3-404 or 3-405 or the drawer is precluded under Section 3-406 or 4-406 from asserting against the drawee the unauthorized indorsement or alteration.”)
FDIC Suspicious Activity Report Rules, 12 CFR 353.3(a) (“A bank 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.”)