We have a deposit relationship with a farm LLC that defaulted on its loan with another bank (Creditor Bank). Before the default, Creditor Bank sent a notice of its security interest in the farm’s grain to various crop insurers and grain production facilities, and these companies issued checks for grain payments to the farm LLC and Creditor Bank as joint payees. A co-owner of the farm LLC deposited five of these checks into the LLC’s business checking account at our bank. The co-owner endorsed the checks with a stamp reading “credit to the account of the within named payee.” Creditor Bank did not receive any of the proceeds of these checks and is claiming that we are responsible for a portion of the farm LLC’s debt under Indiana law, since the deposits were made at our Indiana branch. Is this accurate? Isn’t the payor bank responsible for ensuring that both named payees agreed to the deposit?

We believe that your bank may be liable to Creditor Bank for conversion of the checks that were payable to both Creditor Bank and your customer, and your bank also may be liable to the payor banks and the drawers of the checks, since the checks lacked Creditor Bank’s endorsement.

The checks had a missing endorsement, leaving your bank with potential liability to the payor banks and the drawers of the checks. Under the Uniform Commercial Code (UCC), when a check is made payable to two or more persons “not alternatively, it is payable to all of them and may be negotiated, discharged, or enforced only by all of them.” Thus, if the checks were unambiguously made payable to both your customer and Creditor Bank, not alternatively, the checks were not properly endorsed — they are missing Creditor Bank’s endorsement and were deposited into an account solely owned by your customer.

According to the UCC, an instrument has been converted if “a bank makes or obtains payment with respect to an instrument for a person not entitled to enforce the instrument or receive payment.” The official comments to the UCC provide that when “a check [is] payable to John and Jane Doe . . . neither payee acting without the consent of the other, is a person entitled to enforce the instrument. If John indorses the check and Jane does not, the indorsement is not effective to allow negotiation of the check. If Depositary Bank takes the check for deposit to John’s account, Depositary Bank is liable to Jane for conversion of the check if she did not consent to the transaction.” The comment also notes that “[Depositary Bank] did not become holder of the check . . . because John, its customer, was not a holder.”

Consequently, we believe that your bank may be liable to Creditor Bank for conversion of these checks, since Creditor Bank did not consent to the deposits made into your customer’s account, and your customer, acting alone, was not entitled to enforce the checks.

Further, the UCC places the ultimate risk of loss for the payment of a check with a missing or unauthorized endorsement on the depository bank, not the payor bank. Under the UCC, a depository bank warrants to the payor bank and the drawer of the check that the depository bank is entitled to enforce the check (meaning that there are no missing or unauthorized endorsements). Therefore, the payor banks and drawers of the checks may be entitled to demand that your bank repay the checks due to your breach of warranty.

Also, as reflected in the resources below, the Illinois and Indiana versions of the UCC are identical on these points. However, we are not familiar with Indiana law and cannot comment on how these provisions would be interpreted by Indiana courts.

For resources related to our guidance, please see:

Illinois 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.”)

Indiana UCC, IC 26-1-3.1-110(d) (“If an instrument is payable to two (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 two (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 two (2) or more persons is ambiguous as to whether it is payable to the persons alternatively, the instrument is payable to the persons alternatively.”)

Illinois UCC, 810 ILCS 5/3-420(a) (“The law applicable to conversion of personal property applies to instruments. An instrument is also converted if it is taken by transfer, other than a negotiation, from a person not entitled to enforce the instrument or a bank makes or obtains payment with respect to the instrument for a person not entitled to enforce the instrument or receive payment. An action for conversion of an instrument may not be brought by (i) the issuer or acceptor of the instrument or (ii) a payee or indorsee who did not receive delivery of the instrument either directly or through delivery to an agent or a co-payee.”)

Indiana UCC, IC 26-1-3.1-420(a) (“The law applicable to conversion of personal property applies to instruments. An instrument is also converted if it is taken by transfer, other than a negotiation, from a person not entitled to enforce the instrument or a bank makes or obtains payment with respect to the instrument for a person not entitled to enforce the instrument or receive payment. An action for conversion of an instrument may not be brought by: (1) the issuer or acceptor of the instrument; or (2) a payee or endorsee who did not receive delivery of the instrument either directly or through delivery to an agent or a co-payee.

UCC § 3-420 cmt. 1 (“The second sentence of Section 3-420(a) states that an instrument is converted if it is . . . taken for collection or payment from a person not entitled to enforce the instrument or receive payment. This covers cases . . . in which an instrument is payable to two persons and the two persons are not alternative payees, e.g. a check payable to John and Jane Doe. Under Section 3-110(d) the check can be negotiated or enforced only by both persons acting jointly. Thus, neither payee acting without the consent of the other, is a person entitled to enforce the instrument. If John indorses the check and Jane does not, the indorsement is not effective to allow negotiation of the check. If Depositary Bank takes the check for deposit to John’s account, Depositary Bank is liable to Jane for conversion of the check if she did not consent to the transaction. John, acting alone, is not the person entitled to enforce the check because John is not the holder of the check . . . . Depositary Bank does not get any greater rights under Section 4-205(1). If it acted for John as its customer, it did not become holder of the check under that provision because John, its customer, was not a holder.”)

Johnson v. M.B. Financial Bank, N.A., 2016 IL App (1st) 151817-U, ¶¶ 23-24 (“Defendant argues that as the settlement check was made out to both plaintiff and to the Margolis Law Firm, the firm was a ‘holder’ of the check . . . who was entitled to enforce the instrument. See 810 ILCS 5/3-301 (West 2012) (stating that a person entitled to enforce an instrument includes the holder of the instrument). Since the Margolis Law Firm was entitled to enforce the settlement check as a holder, defendant contends it cannot be held liable for conversion under section 3-420 for accepting the deposit of that check. Defendant's contention is without merit, as the comment to section 3-420 states: . . . Under section 3-110(d) the check can be negotiated or enforced only by both persons acting jointly. Thus, neither payee acting without the consent of the other, is a person entitled to enforce the instrument. If John indorses the check and Jane does not, the indorsement is not effective to allow negotiation of the check. If Depositary Bank takes the check for deposit to John's account, Depositary Bank is liable to Jane for conversion of the check if she did not consent to the transaction.”)

Johnson v. M.B. Financial Bank, N.A., 2016 IL App (1st) 151817-U, ¶ 11 (“Comment 3 of the Committee Comments to section 3-420 explains that when section 3-420 was adopted to replace the former section 3-419, it eliminated the defense that had been provided by former section 3-419(3) for a depository bank that acted ‘in good faith and in accordance with the reasonable commercial standards applicable to the business.’ 810 ILCS 5/3-420, Comment 3 (West 2012). For this reason, a depository bank, such as defendant here, is strictly liable for conversion under section 3-420.”)

Illinois 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.”)

Indiana UCC, IC 26-1-3.1-417(a)(1) and IC 26-1-4-208(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 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 or authorized to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft; . . .”)

Illinois UCC, 810 ILCS 5/3-118(g) (An action “(1) for conversion of an instrument, for money had and received, or like action based on conversion [or] (ii) for breach of warranty . . . must be commenced within 3 years after the cause of action accrues.”)

Indiana UCC, IC 26-1-3.1-118(g) (An action “(1) for conversion of an instrument, for money had and received, or like action based on conversion; [or] (2) for breach of warranty . . . must be commenced within three (3) years after the cause of action accrues.”)