IBA Compliance Connection

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A business customer wrote a check to one of their vendors that was negotiated and cleared their account. One month later, the customer learned that their vendor did not receive the check. Apparently, a fraudster intercepted the check, created a business with the same name as the payee in another state, and used the check to open an account at another bank. The check was not altered. Who holds the liability for this check, can it still be returned, and do we need to credit our customer for the amount? Our customer notified us of this issue within sixty days of discovering it, as required by our account agreement.

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We believe you will need to credit your customer for the check. However, we believe your bank is entitled to demand repayment for the check from the depository bank, since it appears to have breached its warranty to you that the check did not have a missing or unauthorized endorsement.

Under the Illinois Uniform Commercial Code (UCC), your customer must promptly notify your bank of any unauthorized payments that appear on an account statement. Your customer’s notification within the sixty-day reporting window in your account agreement was timely. As a result, we believe you will need to reimburse your customer for the check, since they alerted you to the fraud with “reasonable promptness.”

Regarding your ability to recover the lost funds, we believe it is too late to return the check since the midnight deadline has passed. However, we believe your bank has a claim against the depository bank since it breached one of the UCC presentment warranties — that the check had no missing or unauthorized endorsements. Here, either the depository bank accepted the check with a missing endorsement or with the fraudster’s endorsement, which was unauthorized.

Under the UCC, notice of a claim for breach of warranty must be asserted within thirty days after the drawee learns of the breach and identity of the warrantor. After this thirty-day period, the depository bank cannot be held liable for any loss caused by the delay in giving notice of the claim. Consequently, we recommend sending notice of the breach of warranty to the depository bank as soon as possible. Additionally, we note that a cause of action for breach of warranty must be commenced within three years after it accrues.

Further, your bank should assess whether a suspicious activity report (SAR) should be filed in relation to the check. The FDIC 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:

  • 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 5/4-302 (“Payor bank’s responsibility for late return of item.

(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 . . .

(b) The liability of a payor bank to pay an item pursuant to subsection (a) is subject to defenses based on breach of a presentment warranty (Section 4-208) or proof that the person seeking enforcement of the liability presented or transferred the item for the purpose of defrauding the payor bank.”)

  • Illinois UCC, 810 ILCS 5/3-417(a) and 810 ILCS 5/4-208(a) (“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
  • Illinois UCC § 3-417 cmt. 2 (“Subsection (a)(1) in effect is a warranty that there are no unauthorized or missing indorsements.”)
  • Illinois UCC § 3-417 cmt. 3 (“Subsection (a)(1) retains the rule that the drawee does not admit the authenticity of indorsements and subsection (a)(3) retains the rule . . . that the drawee takes the risk that the drawer’s signature is unauthorized unless the person presenting the draft has knowledge that the drawer’s signature is unauthorized.”)
  • Illinois UCC, 810 ILCS 5/3-417(b) and 810 ILCS 5/4-208(b) (“A drawee making payment may recover from any warrantor damages for breach of warranty equal to the amount paid by the drawee less the amount the drawee received or is entitled to receive from the drawer because of the payment. In addition the drawee is entitled to compensation for expenses and loss of interest resulting from the breach. The right of the drawee to recover damages under this subsection is not affected by any failure of the drawee to exercise ordinary care in making payment. If the drawee accepts the draft, breach of warranty is a defense to the obligation of the acceptor. If the acceptor makes payment with respect to the draft, the acceptor is entitled to recover from any warrantor for breach of warranty the amounts stated in this subsection.”)
  • Illinois UCC, 810 ILCS 5/3-417(e) and 810 ILCS 5/4-208(e) (“The warranties stated in subsections (a) and (d) cannot be disclaimed with respect to checks. Unless notice of a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason to know of the breach and the identity of the warrantor, the liability of the warrantor under subsection (b) or (d) is discharged to the extent of any loss caused by the delay in giving notice of the claim.”)
  • UCC § 3-417 cmt. 7 (“The first sentence of subsection (e) recognizes that checks are normally paid by automated means and that payor banks rely on warranties in making payment. Thus, it is not appropriate to allow disclaimer of warranties appearing on checks that normally will not be examined by the payor bank. The second sentence requires a breach of warranty claim to be asserted within 30 days after the drawee learns of the breach and identity of the warrantor.”)
  • Illinois UCC, 810 ILCS 5/3-118(g) (“An action . . . (ii) for breach of warranty, or (iii) to enforce an obligation, duty, or right arising under this Article and not governed by this Section must be commenced within 3 years after the cause of action accrues.”)
  • 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.”)