Our customer notified us of four forged checks posted to its account. The checks were purchased from a check printing company and were printed with the name and address of an out-of-state business, as well as our customer’s account number and our routing number. The checks were processed on December 31, and we returned them as “altered/fictitious” on January 13. We obtained an affidavit of forgery from our customer but did not attach it to the return. On February 28, the depository bank sent a claim of late return, and our account was debited for the checks. We have twenty days to contest the depository bank’s claim of late return, and we thought the depository bank only had twenty days to make their claim. Can we contest the depository bank’s claim of late return on the basis that it was untimely? If not, we believe we would be liable for the checks, since our customer reported the fraud within two weeks after the checks were processed. What are our options for recovering these funds?

Mar 12, 2020

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The depository bank had two months to file a claim of late return — not twenty days. Additionally, a paying bank may only dispute a claim of late return with evidence that the return was not late. Consequently, it does not appear that your bank has a valid basis to contest the claim of late return. We agree that your bank likely is liable for these checks since your customer appears to have timely reported the fraud. Whether your bank has any recourse for the checks outside of the check collection process depends on several factors under the Uniform Commercial Code (UCC) warranty rules, as explained below.

Under the Federal Reserve Banks’ (Fed) 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 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 checks returned after the midnight deadline, even if the checks bear a forged drawer signature.

Operating Circular 3 also provides that if a depository bank believes that a paying bank has made a late return, it can make a claim of late return, which “must be received by a Reserve Bank within two calendar months after the sender [i.e. the depository bank] was charged for the returned check.” The paying bank then has “twenty banking days after the Reserve Bank charged the bank for the claim of late return” to send a statement stating “that the paying bank returned the check within its deadline under the Uniform Commercial Code and Regulation J or Section 229.31(g) of Regulation CC . . . and show[ing] the banking day of receipt and the date of return of the check by the paying bank.” Therefore, we believe that the depository bank’s claim of late return was timely, and we do not believe your bank has a valid basis to dispute the claim of late return, since you returned the fraudulent checks well after the midnight deadline.

Additionally, we believe you likely will need to reimburse your customer for the checks (subject to your customer’s negligence as discussed below), since it appears to have alerted you to the fraud with “reasonable promptness.” Under the UCC, your customer must promptly notify your bank of any unauthorized payments that appear on an account statement. Although the UCC provides that a customer must report an unauthorized payment within one year after a statement showing the unauthorized payment is made available to them, banks may narrow this timeframe by the terms of their account agreements. However, since your customer reported the fraudulent checks within two weeks after they were processed — possibly before their account statement was made available to them — we expect the notice was timely, even if your account agreement narrowed the reporting window.

Regarding your ability to recover the lost funds, your bank may have a claim against the depository bank if the checks were indeed altered or if it breached one of other UCC presentment warranties. When the depository bank presented the checks to your bank, it made three presentment warranties under the UCC: (1) there are no unauthorized or missing endorsements on the checks, (2) the checks have 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, since the checks were forgeries and not alterations, 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). However, except in an extreme case (such as a business that keeps blank checks and a rubber signature stamp in an unlocked desk drawer), it likely would be 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 making a claim that your customer’s negligence contributed to the making of these forged checks.

Finally, we note that your bank should assess whether a suspicious activity report (SAR) should be filed in relation to the fraudulent checks. The OCC regulations require you to file a SAR if your 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.”)

FRB Operating Circular No. 3, 20.14, footnote 9 (“This deadline is generally midnight of the banking day following the banking day of receipt of the check by the paying bank (Uniform Commercial Code Section 4-302 and Regulation J Section 210.12(a)), except as the deadline may be extended under Section 229.31(g) of Regulation CC. This deadline applies to checks returned with entry for any reason, including forged endorsement or forged drawer signature.”)

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 . . . retains the item beyond midnight of the banking day of receipt without settling for it or . . . does not pay or return the item or send notice of dishonor until after its midnight deadline.”)

Illinois UCC, 810 ILCS 5/4-104(10) (“‘Midnight deadline’ with respect to a bank is midnight on its next banking day following the banking day on which it receives the relevant item or notice or from which the time for taking action commences to run, whichever is later.”)

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, 20.14 (If a sender believes that the paying bank returned late (after the paying bank's deadline under the Uniform Commercial Code, Regulation J, and Section 229.31(g) of Regulation CC) a check or electronic item in the amount of $100.00 or more, the sender may dispute the return by furnishing us with the returned check (or a legible copy of the front and back of the returned check) and a signed statement that the bank believes that the paying bank returned the check late. This procedure may be used only once for each return, and only if the check or electronic item has been handled by a Reserve Bank for forward collection or return. The statement must be in a format we prescribe and must be received by a Reserve Bank within two calendar months after the sender was charged for the returned check. The sender's Administrative Reserve Bank will provisionally credit the amount of the returned check to the sender's account.”)

Regulation J, 12 CFR 210.2(n) (“Sender means any of the following entities that sends an item to a Reserve Bank for forward collection— (1) A depository institution, as defined in section 19(b) of the Federal Reserve Act (12 U.S.C. 461(b)) . . .”)

FRB Operating Circular No. 3, 20.15(b) (The sender's Administrative Reserve Bank will revoke the credit provided under paragraph 20.4 given to the sender (and a Reserve Bank will recredit the paying bank) if: . . . a Reserve Bank receives the returned check or the copy the paying bank received with the Claim of Late Return and a statement as provided below from the paying bank within twenty banking days after the Reserve Bank charged the bank for the claim of late return. The paying bank's statement must be in a format we prescribe that is signed by an officer of the paying bank and: 1) state that the paying bank returned the check within its deadline under the Uniform Commercial Code and Regulation J or Section 229.31(g) of Regulation CC; and 2) show the banking day of receipt and the date of return of the check by the paying bank.”)

Illinois UCC, 810 ILCS 5/3-401 (“A person is not liable on an instrument unless . . . the person signed the instrument . . . .”)

Illinois 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.”)

Illinois UCC, 810 ILCS 5/4-406(f) (“Without regard to care or lack of care of either the customer or the bank, a customer who does not within one year after the statement or items are made available to the customer. . . . discover and report the customer’s unauthorized signature on or any alteration on the item is precluded from asserting against the bank the unauthorized signature or alteration.”)

Illinois UCC, 810 ILCS 5/4-103(a) (“The effect of the provisions of this Article may be varied by agreement, but the parties to the agreement cannot disclaim a bank’s responsibility for its lack of good faith or failure to exercise ordinary care or limit the measure of damages for the lack or failure. However, the parties may determine by agreement the standards by which the bank's responsibility is to be measured if those standards are not manifestly unreasonable.”)

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.”)

Illinois 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 § 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.”)

OCC Suspicious Activity Report Rules, 12 CFR 21.11(c) (“A national bank shall file a SAR . . . in the following circumstances: . . . (2) Whenever the national bank detects any known or suspected Federal criminal violation, or pattern of criminal violations, committed or attempted against the bank or involving a transaction or transactions conducted through the bank and involving or aggregating $5,000 or more in funds or other assets where the bank believes that it was either an actual or potential victim of a criminal violation, or series of criminal violations or that it was used to facilitate a criminal transaction, and the bank has a substantial basis for identifying a possible suspect or group of suspects. . . . (3) Whenever the national bank detects any known or suspected Federal criminal violation, or pattern of criminal violations, committed or attempted against the bank or involving a transaction or transactions conducted through the bank and involving or aggregating $25,000 or more in funds or other assets where the bank believes that it was either an actual or potential victim of a criminal violation, or series of criminal violations, or that the bank was used to facilitate a criminal transaction, even though there is no substantial basis for identifying a possible suspect or group of suspects.”)