Checks & Endorsements Guide

Transcription

1 Checks & Endorsements Guide Checks Overview The Laws Related to Check Transactions Check Transaction and Terminology Unauthorized/Forged Maker Signatures General Rules of Liability Exceptions/Defenses to General Rule Ratification of the Signature Untimely Statement or Item Review and Other Timing Limitations Negligence The Drawer Did Not Experience a Loss The "Unauthorized" Signature was Made by the Agent of the Drawer 44 Lack of Ordinary Care by Depositary or Collecting Financial Institutions 44 Facsimile Signatures and Disclaimers Telephone-Authorization of Signatures When an Unauthorized Check Affects Other Checks Unauthorized/Forged Endorsements General Rules of Liability Exceptions/Defenses to General Rules No Forgery Occurred The Payor Financial Instituion Might Not Actually be Liable Drawer Negligence Delayed Claim for Breach of Warranty Ratification Imposter or Fictitious Payee Rules The Responsible Employee Rule The Check was a "Bearer Instrument" Statute of Limitations has Expired for Making the Claim Double Forgeries Front and Back of the Check Missing Endorsements General Rules Joint Payees Altered Checks Material Versus Immaterial Alterations General Rules of Liability Exceptions/Defenses to General Rules Make Negligence Maker Ratifies the Transaction Timing Issues Depositary and Collecting Financial Institution Defenses Untimeley Notice of Breach of Warranty by Payor Institution Credit Union Procedures & Policies Other Relevant Credit Union Policies Education and Training Considerations for Employees When Cashing Checks

2 This guide is intended to provide credit unions with useful information regarding check endorsements, deceased member accounts, the major regulatory changes that occurred in 2011, and a brief summary of report deadlines that apply to credit unions. The material outlined in this guide is intended to provide credit unions with useful information regarding the Minnesota and federal requirements for formulating their credit unions particular policies and procedures. It is distributed with the understanding that the Minnesota Credit Union Network is not engaged in rendering legal, accounting, investment or other professional advice and this information should not be relied upon or substituted for the same. Such advice should be sought from your attorney, certified public accountant or other appropriate professional. 8

3 Minnesota Credit Union Network Checks & Endorsements Guide A Comparison of Rules, Regulations & Laws 37

4 CHECKS OVERVIEW THE LAWS RELATED TO CHECK TRANSACTIONS The law related to checking transactions, check forgery and alterations is primarily based upon the Uniform Commercial Code (UCC). The UCC is essentially a culmination of rules which attempt to make state laws governing commercial transactions as uniform as possible across all states. Once the UCC is adopted by a state, whether as written or with changes specific to that state, the UCC is codified into the state s code of statutes and becomes that state s law. In Minnesota, the UCC is codified and found in Chapter 336 of the Minnesota statutes. Minnesota has adopted its own language in some areas, making some minor changes to the UCC; however, in general the commercial code adopted by Minnesota is the same language as that found in the UCC and a majority of other states. In addition to the language of the UCC and the Minnesota statutes, case law is often needed to interpret the law and apply it to the specific facts of a given situation. While the law is not always black and white, examining how courts have ruled given the facts in various situations is sometimes helpful in predicting how a court might rule given the facts of other situations. It is also common to have courts split on certain issues, meaning that courts in differing jurisdictions might come to two different conclusions based on similar facts. In addition, there may be some situations where courts have not ruled because they have not been faced with the situation before. Check Transactions and Terminology Dealing with issues involving checks and checking transactions is often made more complicated by the terminology that applies to the various parties and institutions. This Guide follows the definitions and terminology of Chapter 336 of the Minnesota statutes based upon the UCC. The table below summarizes some of the common terminology related to the various parties and institutions involved in checking transactions. Check A check is typically a draft that is drawn on a financial institution. However, it would also include a cashier's check, teller's check or money order. 1 Draft A negotiable instrument that is deemed an order. 2 Note A negotiable instrument that is deemed a promise. 3 Order A written instruction to pay money signed by the person giving the instruction. An authorization to pay is not an order unless the person authorized to pay is also instructed to pay. 4 1 Minn. Stat (f). 2 Minn. Stat (e). 3 Id. 4 Minn. Stat (a)(8). 38

5 Promise Negotiable Instrument Maker Drawer Payee Bearer Holder Holder in Due Course Depositary Institution Collecting Institution A written undertaking to pay money signed by the person undertaking to pay. 5 In general, this is a transferable, signed document containing an unconditional promise or order to pay an amount of money, with or without interest or other charges, on demand or at a specified time. 6 Examples can include checks, promissory notes, and bills of exchange. A term used for the financial institution customer or member who writes out their check for payment or purchase (undertaking payment). 7 Technically, the only difference between the maker and drawer is that the person would be the maker when they write out and sign the check, and would become the drawer in terms of ordering their institution to transfer funds from their account to make the payment. The financial institution customer or member who writes out their check for payment or purchase (ordering payment). 8 The party that the drawer makes the check out to, and transfers to, for payment. A person in possession of a check that is payable to them, or blankly endorsed. 9 Someone who is in possession of a check that has been drawn, issued or endorsed to the person, the person s order or the bearer. 10 Someone who accepts a negotiable instrument such as a check, note or other document for payment. The holder must have accepted possession of the instrument in good faith and given something of value for it. On the face of the check there cannot be evidence of fraud, nor can the person accepting the check have knowledge of any fraud related to it. Someone who accepts a third party check can be a holder in due course, as are all subsequent holders of the instrument. 11 The primary distinction between a holder and a holder in due course is that the latter is essentially a holder who has given something of value for the check and taken possession of it in good faith. The institution that first accepts for deposit the check by the payee. This could include the payor institution, but would not include an institution where the check is merely presented for immediate payment. 12 Often referred to as an Intermediary Institution. It is the institution handling an item (check) for collection except when it is the payor institution Minn. Stat (a)(12). 6 Minn. Stat (a). 7 Minn. Stat (a)(7). 8 Minn. Stat (a)(5). 9 Minn. Stat (5). 10 Minn. Stat (20). 11 Minn. Stat Minn. Stat (2). 13 Minn. Stat (5). 39

6 Payor Institution Drawee Institution The financial institution of the drawer/maker of the check. Often referred to as the Drawee Institution. 14 The financial institution of the drawer/maker of the check. Often referred to as the Payor Institution. 14 Minn. Stat (3). 40

7 UNAUTHORIZED/FORGED MAKER SIGNATURES GENERAL RULES OF LIABILITY Minnesota law makes unauthorized signatures, which primarily involve forgeries, unlawful. 15 The general rule is that an item (check) is properly payable if it is authorized by the credit union member on the account and complies with any agreement between the member and the credit union. Therefore, the person whose name is signed without authorization will not be liable for the check. 16 Instead, the individual who makes the unauthorized signature will usually be liable to anyone who in good faith pays the check or takes it for value. In the case of an organization account, if the signature of more than one person is required to constitute the authorized signature of an organization, the signature of the organization is unauthorized if one of the required signatures is lacking. 17 In regard to liability of financial institutions, the general rule is that the payor financial institution will be liable if it pays a check on which the drawer s signature is unauthorized (generally a forged signature on the front of the check) and may not charge the drawer s account for the check. 18 The reasoning behind this rule is that the payor financial institution is paying a check that is not properly payable. 19 In addition, since the payor financial institution maintains the drawer's signature card on file and is held responsible for verifying the drawer s signature, the payor financial institution is considered to be in the best position to confirm and ensure that the drawer s signature is valid. It does not matter whether the forgery is so similar as to be undetectable. However, a credit union being faced with liability for an unauthorized check should to be aware that, although limited, several exceptions do exist that may remove or limit the credit union s responsibility for the amount at issue. EXCEPTIONS/DEFENSES TO GENERAL RULE Ratification of the Signature Minnesota law states that the drawer will be liable for an unauthorized check if they ratify the transaction or are otherwise precluded from denying it. 20 To ratify the transaction for the person whose signature was forged is to adopt the unauthorized signature and choose not to report the forgery and/or to retain the benefit of the transaction. For example, if a member recognizes the unauthorized signature after the fact and chooses not to make a claim because it was their son or daughter that forged their check, the member ratified the transaction. Another example is a situation where the proceeds from the unauthorized check are deposited into an account of the drawer whose signature was forged. Yet another common situation may arise 15 Minn. Stat (a). Although most unauthorized signature claims will be based on forgery, Minnesota law uses the broader unauthorized signatures which would also encompass signatures of agents that do not bind the principal. 16 Id. 17 Minn. Stat (b). 18 Minn. Stat (a). 19 Id. 20 Minn. Stat (a). 41

8 where an unauthorized check is used to pay legitimate debts of the drawer whose signature was forged. Some factors that should be kept in mind when determining whether ratification has occurred are: Did the member accept the benefit of the transaction? Has the member asked the credit union to not file a police report or seek recovery from the forger? Did the member enter into a settlement agreement with the forger? Has the member allowed the forger to complete or write checks in the past? UNTIMELY STATEMENT OR ITEM REVIEW AND OTHER TIMING LIMITATIONS An individual may also be precluded from asserting an alteration when they fail to review statements and returned checks with reasonable promptness and/or notify the payor financial institution promptly. 21 Therefore, if, based on the statement or items provided to the individual, they should have reasonably discovered an unauthorized signature, the member must promptly notify the credit union of the situation. 22 A credit union member also has a limited amount of time to bring legal action against the credit union based on transactions made on their account(s) with unauthorized signatures. What does promptly mean in practical terms? There are three general time-frames a credit union should be aware of in regard to a member claiming the credit union is liable for unauthorized drawer signatures: 30 Days (The Repeat Wrongdoer Rule ) It is often the case that unauthorized checks on a member s account are not onetime incidents, but occur repeatedly against a drawer s account making it potentially very costly for a credit union. However, although a credit union may be liable for an unauthorized check for up to a year as indicated below, it will avoid being liable for any forged check, subsequent to the original forged check, if the forgery is committed by the same wrongdoer and paid by the credit union more than 30 days after the member received the statement or items for review. In other words, if the member has not reviewed, discovered the forgery, and notified the credit union within 30 days of receiving the statement or items, the credit union will still be liable for that first forged check but will not be liable for checks forged by the same person received 30 days after the member has received the information. One Year Upon receiving a statement or items for review, a credit union member has one year to discover and notify the credit union of an unauthorized signature on their check. 23 If one year or more has passed, the member is considered precluded from asserting the unauthorized signature against the credit union. This rule applies whether or not any negligence or bad faith has been determined to exist on 21 Minn. Stat Minn. Stat (c). 23 Minn. Stat (f). 42

9 the part of either the member or the credit union. 24 However, this timeframe can be altered, so it is important to check the member s account agreement to make sure it does not specify a shorter time period. 25 Three Years There is a three year statute of limitations in Minnesota for legal actions arising under the Minnesota Commercial Code. 26 A credit union attempting to determine whether the member failed to reasonably review statements and report a forgery should take the following factors into account: o If a member reports a forgery, do not assume that it is the first forgery on that account. Did any other forgeries exist on the member s accounts preceding the one the member reported? o What was the date of the first forgery? o When was the first statement sent out that included a forged item? o Should something have notified the member that unauthorized transactions could take place? This could include things such as checking the account balance prior to a statement being sent but after the forgery or similar forgeries took place on accounts at other institutions. NEGLIGENCE Another exception to the general rule that the individual whose signature has been forged is not liable for the payment is where the individual has been precluded from asserting the forgery due to negligence. In the context of unauthorized signatures on checks, negligence would be determined if the member s failure to exercise ordinary care contributes to a forged signature for example. Examples of situations where this might be the case include, failing to check the background of an employee who has a record of committing forgery, allowing cancelled checks to be handled by the same individual who signed them, or failing to take reasonable steps to prevent forgeries from an individual known to have forged the drawer s signature in the past. In situations where it is determined that both the individual whose signature was forged and the payor financial institution are both negligent they will ultimately have to share the loss based on their determined proportion of fault. 27 Some factors to consider in determining whether negligence might have been present include: Where did the member store their checks? Did the member discover and report any checks as being missing? Has the member submitted a declaration of loss? Does the member have a history of unauthorized checks being made and failed to take any preventative actions? 24 Id. 25 Minn. Stat (a). The provisions of this article of the commercial code may be altered by agreement of the parties. 26 Minn. Stat Minn. Stat (b). 43

10 Did any other indicators exist that should have tipped the member off, such as large dollar amounts that should have been noticeable or their balance checked at an ATM, etc? If the member maintained a check register, ask to review it. For businesses, did they have written procedures for the security of its checks? If so, were they followed? Did the business fail to conduct an employee background check or knowingly hire an untrustworthy employee? THE DRAWER DID NOT EXPERIENCE A LOSS A credit union is generally not liable for an unauthorized signature if the member whose account the check was drawn upon did not experience a loss. For example, in a situation where the member receives the proceeds from a forged check, or the benefit of the transaction, the credit union would not be liable for the amount of the forged check. 28 Therefore, it is important for a credit union to become aware of what happened to the proceeds of an unauthorized check and whether the member whose name was forged received any benefit. Also, if a credit union discovers that the proceeds from the forged check are on deposit at another financial institution it may be able to freeze those funds by serving an adverse claim form on that institution. THE UNAUTHORIZED SIGNATURE WAS MADE BY THE AGENT OF THE DRAWER There could be situations where a representative, although not listed on the account signature card as an authorized signer, may have authorization to sign checks through an agreement made outside of the credit union s account documentation. This could either be by contract, through a power of attorney, or as shown by a course of conduct such as a member previously allowing someone to sign checks on their behalf. LACK OF ORDINARY CARE BY DEPOSITARY OR COLLECTING FINANCIAL INSTITUTIONS The payor institution will generally have a difficult time shifting liability to depositary and collecting institutions. Depositary and collecting institutions are required only to exercise ordinary care, which means that as long as they have acted reasonably they will not be held liable even in situations where they dealt directly with the wrongdoer. FACSIMILE SIGNATURES AND DISCLAIMERS A credit union may have business members that use facsimile signatures to sign checks. This may make the detection of fraudulently signed checks even more challenging on the part of the credit union. Therefore, a credit union that faces this situation may wish to protect itself by including in its agreement with the member language authorizing the credit union to honor 28 Minn. Stat (e). 44

11 checks with facsimile signatures but absolving it from any loss as a result of unauthorized signatures upon them. TELEPHONE-AUTHORIZATION OF SIGNATURES It is possible that businesses that transact with consumers via the telephone might receive authorization from the consumers to receive payments by check over the telephone. The business representative would ask the consumer information from the check, such as the routing number, the transit number, the account number and the check numbers. The business would then produce a check with that information and use a stamp stating something along the lines of debit authorized by customer in place of a signature. The consumer, in this case the credit union member, might request that the account be credited either because they changed their mind about the payment or they claim the payment was not authorized because they did not sign the check. If this happens, the credit union will need to determine if the check was or was not authorized. The fact that the member did not physically sign the check is most likely not enough to require the credit union to credit the account. 29 This issue will become a circumstance of fact to be determined by the surrounding circumstances. If the member can prove that the check was unauthorized, then the credit union will be required to credit their account. The depositary institution only warrants that it does not have knowledge that a drawer signature is unauthorized. Therefore, the only situation where a credit union could shift liability to the depositary institution is if the credit union could show that the depositary institution had knowledge that the depositor deposited an unauthorized over-the-phone check. WHEN AN UNAUTHORIZED CHECK AFFECTS OTHER CHECKS In some cases the payment of an unauthorized check may cause other, legitimate checks, to be returned. In these situations the payor financial institution may be liable for damages caused by the wrongful dishonor of those checks. 30 A payor financial institution wrongfully dishonors an item if it dishonors an item that is properly payable. 31 Due to this potential liability, it may be wise for a credit union to close the account that has forged drawer signature checks in order to prevent the processing of other forged signature checks and prevent the potential dishonor of future legitimate checks. If this is done, however, it is important to notify the member of the closure and advise them to stop issuing checks against the account See Minn. Stat, (b). A signature may be made (i) manually or by means of a device or machine, and (ii) by the use of any name, including a trade or assumed name, or by a word, mark, or symbol executed or adopted by a person with present intention to authenticate a writing. 30 Minn. Stat (b). 31 Minn. Stat (a). However, a financial institution may dishonor an item that would create an overdraft unless it has agreed to pay the overdraft. 32 Minn. Stat (b). 45

12 Advance notice of account closure should be given if immediate closure of the account might harm the member. Minnesota law generally prohibits a credit union from closing an account unless notice is sent to the member at least 30 days prior to the closure. 33 However, an exception exists to this general rule when the credit union reasonably believes the account is being used in connection with a crime, including check-related fraud, or that funds will not be available to pay items drawn on the account. 34 In those instances, the notice may be sent the same day as the account closure. 35 A federal credit union (FCU) may determine its own contractual obligations when closing a member s share draft account. Minnesota law is not applicable to a FCU regarding matters affecting the closing of share, share draft or share certificate accounts Minn. Stat (b). 34 Id. 35 Id. 36 NCUA Rules & Regulations

13 UNAUTHORIZED/FORGED ENDORSEMENTS GENERAL RULES OF LIABILITY Minnesota law makes payment of a check with an unauthorized endorsement improper. 37 In fact, it is defined as a conversion when a check is paid bearing an unauthorized endorsement. 38 Therefore, when a payor financial institution pays a check with an unauthorized endorsement it creates a cause of action against that institution and makes it liable to its member or customer for that payment. Such a claim is like a customer's breach of contract claim against the financial institution based on the theory that the drawee institution breached the terms of the deposit agreement by paying an item not "properly payable." Financial institutions have an obligation to pursue a remedy against all parties who were in a position to know or should have known of any wrong doing. Therefore, although a payor credit union would be liable to its member in this situation, it is not obligated to check the endorsement and should seek to hold the depositary financial institution liable for the claim. The rationale behind seeking to place blame on the depositary institution is similar to that for unauthorized maker signatures, which is to attempt to place the loss on the institution in the best position to detect the unauthorized signature and prevent the transaction. If a forger attempts to deposit or cash a check at their depositary credit union with a forged endorsement, that credit union has direct contact with the individual presenting the check with the fraudulent endorsement and can verify the signature by checking proper identification or by checking it against the one on file. Furthermore, when the depositary credit union transfers the check to the payor or drawee financial institution, it automatically gives that institution a warranty of good title making the depositary institution liable for a forged endorsement. 39 Once again, however, the obligation to pursue a remedy against all parties who were in a position to know or should have known of any wrongdoing is still present. Therefore, a depositary credit union charged with liability by a payor institution for passing it a check with an unauthorized endorsement should seek to hold its member liable for the claim. A summary of the general rules of liability include: Depositary and collecting financial institutions warrant good title in regard to the authenticity of endorsements when passing them to payor financial institutions for payment. (See Exceptions/Defenses to General Rules for time limitations in making a claim related to this). Payor financial institutions are liable to their customers or members for the unauthorized endorsement of payee checks. The depositary financial institution (instead of the payor institution) will usually be liable for unauthorized endorsements on payee checks. Ultimately the customer or member of the depositary institution will be liable for the deposit of a check with an unauthorized endorsement. 37 Minn. Stat (a). 38 Minn. Stat Minn. Stat and

14 EXCEPTIONS/DEFENSES TO GENERAL RULES No Forgery Occurred The first thing a credit union should do when charged with breach of warranty of good title is to verify that a forgery or otherwise unauthorized endorsed check was actually passed. The specific lines of inquiry to make this determination may depend on the circumstances. However, there are a number of general questions credit unions in this position should consider: Was the endorsement actually forged, or was the check deposited either with no signature or with a different name? Was the endorsement actually authorized? Has the payee allowed others to endorse their checks in the past? Did the payee receive the check? The identity of the payee is not determined by the name written on the check but by the intent of the person (maker) who signs the check. If a signee intends a check to be payable to John Smith but misidentifies him as John Jones on the check the payee is nevertheless John Smith. Did the payee know the forger? Did the payee file a complaint with the police? The Payor Financial Institution Might Not Actually be Liable When a credit union is a depositary institution in a transaction involving an unauthorized endorsement and a payor institution claims the credit union is liable, the credit union should first make certain that the payor institution is in fact liable. A depositary credit union may not be liable for an unauthorized endorsement if the payor institution is not liable to its customer or member. Therefore, if a credit union is faced with a situation where it is the depositary institution and the payor institution asserts a claim based on an unauthorized endorsement, the credit union may defend itself by proving: That the endorsement is effective under the imposter/fictitious payee rules described in more detail in the Imposter or Fictitious Payee Rules section; or That the payor institution s customer or member is precluded from asserting the unauthorized endorsement against the payor institution because the customer or member did not exercise ordinary care or failed to report the issue in a timely manner. 40 The credit union may also wish to inquire whether the other financial institution had any sort of agreement with its customer or member that would preclude them from asserting the claim against the payor institution or otherwise prevent them from recovering. Drawer Negligence Similar to the exception above, an unauthorized endorsement claim may not be valid in circumstances where the maker was negligent. In general, if it can be determined that the maker or the intended payee is shown to be negligent, and that negligence resulted in or could have prevented the unauthorized endorsement and the credit union acted in good faith and in accordance with reasonable commercial standards, the maker or intended payee may be precluded from asserting the unauthorized endorsement. 41 If, however, the credit union 40 Minn. Stat Minn. Stat

15 contributed to the loss by its failure to exercise ordinary care, the loss is allocated between the parties to the extent each contributed to the loss. 42 Factors to consider in determining whether negligence might have been present include: Has the payee made similar claims in the past? Does the member have a history of unauthorized checks being made and failed to take any preventative actions? Did the maker send the check to a person with the same name as the payee? For businesses, did they have written procedures for the security of its checks? If so, were they followed? Did the business fail to do an employee background check or knowingly hire an untrustworthy bookkeeper? Were the business s office procedures careless? Delayed Claim for Breach of Warranty A depositary credit union would be essentially discharged to the extent of any loss caused by a third-party s unreasonable delay in asserting a warranty claim. 43 The third-party could either be the payor institution or its customer or member, and the unreasonable delay is considered to begin upon discovering the unauthorized endorsement. Specifically, a claim against the depositary or collecting institution for breach of warranty must be given within 30 days after the claimant has reason to know of the breach. 44 Whether or not it was an unreasonable delay may depend on certain factors such as: When was the forgery discovered? This may not necessarily be the date the claimant signed the affidavit of forgery, it could have been earlier which may affect the 30-day rule. When should the claimant have first discovered the claim? If the claimant had reported the unauthorized endorsement more quickly, could the financial institution have reduced the amount of the loss? Did the claimant submit a declaration of loss, a police report or an insurance claim? Ratification If the payor institution s customer or member benefitted from, or perhaps did not suffer a loss as a result of the unauthorized endorsement, then the payor institution may not be liable to them. 45 This could occur, for instance, where despite a forgery, the proceeds of the check reached the intended payee. 42 Minn. Stat (c). The burden of proving the customer/member s failure to exercise ordinary care is on the financial institution, and the burden of proving the financial institution s failure to exercise ordinary care is on the customer/member. 43 Minn. Stat (f). If this preclusion applies (e.g., due to the member s failure to report forgeries within the time limits set by MN statute or an account agreement), the payor institution may not recover for breach of warranty with respect to the unauthorized signature or alteration to which the preclusion applies. 44 Minn. Stat and Minn. Stat and

16 The law states that the payee will be liable for an unauthorized check if they ratify the transaction. 46 To ratify the transaction is to basically adopt the unauthorized signature by the person whose signature was forged and choose not to report the forgery and/or to retain the benefit of the transaction. An example may include an instance where a member recognizes the unauthorized signature after the fact and chooses not to make a claim because it was their son or daughter that forged the check. In this instance, the member ratified the transaction. Or perhaps a situation arises where the proceeds from the unauthorized check are deposited into an account of the individual whose signature was forged. Some factors that should be kept in mind when determining whether ratification has occurred are: Did the claimant benefit from the transaction? Has the claimant asked the credit union to not file a police report or seek recovery from the forger? Did the claimant enter into a settlement agreement with the forger? Has the alleged forger been allowed or been given authority to endorse checks in the past? Certain practical considerations should also be looked into by a credit union faced with a forged endorsement situation. Depending on the circumstances surrounding the alleged unauthorized signature, it may be helpful to review account agreements and other account forms in the member s file. For instance, did the person who allegedly signed the checks without authorization have apparent signing authority? In other words, did they have authority to sign for the payee under some capacity? The credit union should verify if the person endorsing the check had apparent signing authority by reviewing any resolutions or authorizations on file. The credit union should also check for any powers of attorney that may exist. Imposter or Fictitious Payee Rules If a payor institution asserts a claim for breach of warranty based on an unauthorized endorsement, a depositary or collecting institution may defend itself by proving that the endorsement is effective under the imposter or fictitious payee rules. When a check is payable to an imposter or fictitious payee, an endorsement by any person in the name of the payee (or in a name substantially similar to the payee) is effective. 47 The instrument s deposit (with or without endorsement) to an account in the name of the payee (or in a name substantially similar to the payee) is effective. 48 Under the imposter rule, a credit union will not be held liable for an unauthorized endorsement if an imposter induces the maker to issue them a check by impersonating the payee or a person authorized to act for the payee. In other words, an endorsement or deposit in the payee s name by anyone is legally effective as the endorsement of the payee if the financial institution acts in good faith and pays the instrument. Under the fictitious payee rule, a person signing as or on behalf of the maker intends the payee to have an interest in the check whether or not the payee is in fact real or fictitious. An 46 Minn. Stat Minn. Stat Id. 50

17 endorsement and/or deposit in the fictitious payee s name by anyone is legally effective as the endorsement of the payee in favor of a person who in good faith pays the check or takes it for value or for collection. The policy behind the fictitious payee rule is that it seeks to ensure that the loss should be placed on the drawer of the check rather than on the depositary institution that took the check for collection because the drawer is in the best position to avoid the fraud that usually sets in motion such fictitious payee scenarios. Since the endorsements are deemed effective in these situations, the negligent financial institution customer or member is typically liable rather than the depositary or collecting institutions. The maker s financial institution may pay the item and the collecting institution has no liability for breach of warranty (absent knowledge of wrongdoing). 49 The Responsible Employee Rule Minnesota law puts the risk of loss for forged endorsements on the wrongdoer s employer if certain conditions are met. 50 If a check is payable to the employer, a forged endorsement alleging to be that of the employer and signed by an employee with responsibility over the checks is effective as the endorsement of the employer if the financial institution pays the check in good faith or takes it for value or for collection. In this scenario, the following five conditions must be met: 1. The checks were the responsibility of the wrongdoer as an employee; 2. The wrongdoer forged the endorsement on the checks; 3. The wrongdoer deposited the checks as an employee; 4. The checks were endorsed in a name substantially similar to the payee s name as shown on the check, and 5. The financial institution takes the check for deposit in good faith. The Check was a Bearer Instrument A bearer instrument in this context would be a check that is payable to the order of "bearer" or "cash" and may be redeemed for payment by the party in possession of it. If a check is payable to bearer or cash and was endorsed in blank by the payee before it was lost or stolen, it is also a bearer instrument and can be presented by anyone. 51 Many financial institutions take the more conservative approach and make it policy to not pay a check presented for payment by anyone other than the named payee. However, if a credit union is presented with a bearer instrument and chooses to accept it, then it should require the depositor to endorse the check. The credit union will likely not be liable to the drawer for a forged endorsement on a bearer instrument. 49 Id. 50 Minn. Stat Minn. Stat &

18 Statute of Limitations Has Expired for Making the Claim A claim is barred if it is not filed within three years after the cause of action accrues. 52 In other words, if the drawer has not discovered and reported an unauthorized endorsement within three years of receiving the cancelled check, then they are barred from making the claim. DOUBLE FORGERIES FRONT AND BACK OF THE CHECK There may be some instances where both the maker and the endorsement signatures on a check are unauthorized. The general rule in this scenario is if it is determined that both the depositary and the payor institutions were both negligent, the loss may be allocated between them based on their determined level of negligence. 53 MISSING ENDORSEMENTS General Rules A credit union should not cash a check with a missing endorsement. However, there may be circumstances where a payee deposits a check at night or via an ATM transaction where the credit union is unable to verify that the check was in fact endorsed. Minnesota law allows a credit union to take a check from a payee for deposit into their account without the payee s endorsement. 54 However, a credit union that does this warrants to other financial institutions that the amount of the check was paid to the payee or deposited into their account. 55 Joint Payees In instances where the check is made payable to joint payees (the check states and between the two parties names as opposed to or ) but endorsed by only one party the general rule is that the credit union should require the endorsements of both payees unless the check is being deposited into a joint account owned by both (or all) parties payable on the check. 52 Minn Stat Minn. Stat (d). 54 Minn. Stat (1). 55 Minn. Stat (2). 52

19 ALTERED CHECKS An altered check is generally one that contains a material unauthorized change. 56 Altered checks are a common fraud that typically occurs after a legitimate maker creates a valid check to pay a debt. The wrongdoer then takes the check and uses chemicals or other means to erase the amount or the name of the payee so that new information can be entered. The new information can be added by typewriter; in handwriting; or with a laser printer, check imprinter, or some other technology. The alteration typically involves either the name(s) of the payee(s) or the amount of the check. Minnesota law also defines an alteration as a change in the number or relations of the parties, completion of an incomplete check in a way that was not authorized, or the removal or addition to any part of the check. 57 MATERIAL VERSUS IMMATERIAL ALTERATIONS: Generally, if the alteration(s) of a check change the obligations of any party to the check, it is considered a material alteration. Some examples of material alterations include: Changing the number of or names of the parties; Changing the payee name; Backdating the date of a postdated check; Deleting restrictive only for deposit endorsements; Completing an incomplete check other than as authorized; and Changing the amount of the check. On the other hand, an immaterial alteration would not change the obligations of any party to the check. Some examples of immaterial alterations include: Conforming the numerical figure to the written amount; Changing an impossible date (e.g. February 30) to the next possible date; Changing the date s year in situations where the calendar year recently changed and use of the previous year is a common error (e.g. changing 2010 to 2011 in January 2011); Altering, adding, or deleting a check s memorandum line; Non-fraudulent reduction of amount to reflect a partial payment; Addition of a date to a check; and Addition of words on the payee line that do not change the payee. GENERAL RULES OF LIABILITY The maker is typically not liable for checks that have been altered. Only in situations where the maker is negligent, ratifies the transaction, or is precluded from asserting a claim, would they be 56 Minn. Stat (a). 57 Minn. Stat

20 liable for an unauthorized material alteration of their check. 58 If no situation such as that applies, then the payor financial institution may only charge the maker s account for the check as it was originally drawn. For instance, if a credit union paid the actual amount of a check and the original amount of the check (prior to the alteration) was less than the amount paid, the credit union could only charge the member the original amount of the check. However, if the alteration is making an incomplete check into an unauthorized completed check, then the payor institution may enforce its right to pay the check according to its terms as completed. 59 Among financial institutions, the maker s financial institution (payor institution) is liable to the maker for payment of the altered check. However, since, as discussed in the previous sections of this guide, the depositary and collecting financial institutions warrant to the payor institution that the check has not been altered, those institutions are generally responsible for the loss. 60 However, if the payor institution unreasonably delays notice of the breach of warranty, the liability of the depositary and collecting institutions is discharged to the extent of any loss caused by the delay. 61 If the depositary and/or collecting institutions are liable to the payor institution for damages for breach of warranty, it is typically equal to the amount paid by the payor institution, less the amount the payor institution is entitled to receive from the drawer because of the payment, plus compensation for expenses and loss of interest resulting from the breach. 62 The right of the payor institution to recover damages under this subsection is not affected by any failure of the payor institution to exercise ordinary care in making payment. 63 Keep in mind also, that a depositary financial institution may be liable for the check as altered if the check showed visible signs of being altered. Therefore, a credit union that encounters a check that appears to have been altered in a way that meets the definition of material alteration should make it a policy to not accept the check. Visible signs of alteration might include: Different colors of ink used; Different handwriting; Different type styles or misalignment. Although a depositor that deposits an altered check is liable to the depositary institution for damages arising from the altered check, 64 finding and/or collecting from them is often difficult. Although not an exhaustive list, to protect itself from fraudulent alterations, when presented with checks credit union employees should: 58 Minn. Stat (b). 59 Minn. Stat and Minn. Stat and Minn. Stat (d) and (e). 62 Minn. Stat (b). 63 Id. 64 Minn. Stat (a)(3). 54

21 Review checks to ensure that the handwriting or print styles are consistent and that there are no signs of erasure or alteration. Compare the signatures on items and the appearance of the presenter with the signature and picture on the identification. Be cautious of a check which shows indications of having been altered, eradicated or erased. Be cautious of an irregular looking signature or one that shows gaps in odd spots. Be cautious if colors on a check smear when rubbed with a moist finger, suggesting it was prepared on a copier. Flag checks with dollar amounts in numbers and in words that do not match. Properly identify members according to credit union procedures. Be cautious of a member who seems to be trying to distract a credit union employee that is reviewing their identification. Refer all questionable transactions to a supervisor. A credit union may delay cashing a check for a reasonable amount of time in order to verify that a signature is genuine and to make sure it has properly identified the person presenting it. The delay may cause a wrongdoer to leave the credit union without the forged or altered check rather than risk being arrested. EXCEPTIONS/DEFENSES TO GENERAL RULES PAYOR FINANCIAL INSTITUTION DEFENSES Maker Negligence If the maker failed to exercise ordinary care, and that failure substantially contributes to the alteration of the check, then the payor institution is not liable. 65 In this situation, the maker would be precluded from asserting the alteration against an institution that, in good faith, pays the instrument. 66 The payor institution is the party that bears the burden of proving the maker failed to exercise ordinary care. 67 If it is determined that both the maker and the payor institution failed to exercise ordinary care, then the liability is shared and allocated according to what degree each party contributed to the loss. 68 Some factors a credit union should consider when faced with possible liability for payment of an altered check (and the credit union believes the maker may have been negligent) include: Did the maker leave a part of the check incomplete? Did the maker leave large spaces before or after the amount? Did the maker leave large spaces before or after the payee s name? Did the maker allow others to insert information on checks? Did the maker use a pencil or an erasable ink pen to write the check? Does the customer or member receive an account reconcilement service? 65 Minn Stat (a). 66 Id. 67 Minn Stat (c). 68 Minn Stat (b). 55

22 Maker Ratifies the Transaction Under Minnesota law, the maker will be liable for an altered check if they ratify the transaction or are otherwise precluded from denying it. 69 To ratify the transaction is to basically adopt the alteration and choose not to report it and/or to retain the benefit of the transaction. For example, where a member recognizes the alteration after the fact and chooses not to make a claim because it was their son or daughter that altered the check, the member has ratified the transaction. Another example could be a situation where the proceeds from the altered check are deposited into an account of the maker whose checks were altered. Yet another common situation may arise where an altered check is used to pay legitimate debts of the drawer whose checks were altered. Some factors that should be considered when determining whether ratification has occurred include: Did the member accept the benefit of the transaction? Has the member asked the credit union to not file a police report or seek recovery from the alterer? Did the member enter into a settlement agreement with the alterer? Has the member allowed the alterer to complete or write checks in the past? Certain practical considerations should also be examined by a credit union faced with a similar situation. Depending on the circumstances surrounding the alleged unauthorized alteration, it may be helpful to review account agreements and other account forms in the member s file. For instance, did the person who allegedly altered the checks have apparent signing authority? In other words, did they have authority to sign for the maker under some capacity? The credit union should verify if the person signing the check had apparent signing authority by reviewing any resolutions and authorizations on file. The credit union should also check for any powers of attorney that may exist. Timing Issues 30 Days (The Repeat Wrongdoer Rule ) A credit union member has a duty to examine their account statements and returned items and to notify the credit union of any alterations. 70 Although a credit union may be liable for an unauthorized check for up to a year as indicated below, it will avoid being liable for any altered check, subsequent to the original altered check, if the alteration is committed by the same wrongdoer and paid by the credit union more than 30 days after the member received the statement or items for review. In other words, if the member has not reviewed, discovered the alteration and notified the credit union within 30 days of receiving the statement or items, the credit union will still be liable for that first altered check. However, it will not be liable for checks altered by the same person received 30 days after the member has received the information. A credit union attempting to determine whether the member failed to reasonably review statements and report an alteration should take the following factors into consideration: 69 Minn. Stat (a). 70 Minn Stat (c). 56