Check fraud: When are you responsible?
Reprinted from the Leahy Newsletter with permission from Bob Leahy ([email protected]). Contributed articles do not necessarily reflect the viewpoint of ÆGIS. Newsletter recently has received a flurry of phone calls from subscribers— and their lawyers—on the subject of check fraud. All of the subscribers had been the victims of check fraud.
Both bank and corporate subscribers asked the same question, “Are we responsible for check fraud?” Let’s use one of the more complicated cases as an example of where U.S. law places the legal (and financial) responsibility for check fraud. “We are a Canadian corporation with a U.S. subsidiary,” related the subscriber. “Someone intercepted a check mailed by our U.S. subsidiary, typed in an alternate payee, and deposited the check at a Caribbean bank. That Caribbean bank presented it to our U.S. bank. We discovered the forgery within a month of receiving our bank statement and immediately notified our local bank. After several months, our bank still has not removed the debit from our account. Can the bank do this? Are we responsible for the forgery?”
This subscriber’s forgery was very low-tech. The forger took a check that was payable to “John Jones,” and typed “or Mary Smith” after original payee’s name. He didn’t even attempt to match the company’s type style used for the original payee’s name. The Caribbean bank’s teller never noticed the discrepancy, indicating that the forger knew there was no need to bother with such details. We believe that this subscriber is not responsible for this forged check. Section 4-111 of the Uniform Commercial Code (UCC) states that a payor has three years to notify the bank of a forged endorsement on a legitimate check. (Our subscriber’s check falls into this forged endorsement category because the endorsement wasn’t that of the legitimate payee.) Your bank must remove such an item from your account if you notify the bank within this three-year deadline. (Corporates typically discover such frauds quickly. No vendor would wait three years before complaining that it hadn’t been paid.) The legal deadlines for notifying your bank are slightly different when a forger creates the check from his own check stock. The UCC states that you aren’t responsible if you inform your bank of this check within one year.
You will have to absorb the loss if you don’t find the forged check, or if you find it later. Some states have enacted a new UCC Section (4-406 F) that extends this detection period to three years. The UCC absolves you of responsibility for a second similar forged check only if you detect it and notify the bank within one month. The legal theory is that you should be scrutinizing your bank statement more closely after discovering the first forged check. It is possible that these UCC deadlines don’t apply to you. You may have waived your UCC rights by signing your bank’s agreement. Some bank agreements require you to absorb forged-check losses unless you detect forged checks within a very few months. However, it is highly unlikely that this applies to our subscriber’s problem. She discovered the forgeries within a month. We can’t imagine a bank requiring corporates to detect forgeries more quickly than that. (We know of one subscriber whose bank has refused to reverse several forged checks—even though he notified the bank within a day of receiving the bank statement.)
The law is a bit hazy in defining when these time periods begin. If you use your bank’s daily balance reporting service to obtain a list of presented checks, the time clock probably starts ticking again each day. If you obtain the detailed checking account information from your monthly statement, the time clock probably starts ticking when you receive that statement. The law wouldn’t hold our subscriber responsible in this case because she notified her bank within a month of receiving the check statement. This is well within the three years allowed by law. However, if she isn’t responsible, who is? The Caribbean bank probably sent this check to a U.S. correspondent bank, which presented it to the Fed or to the paying bank. The Caribbean bank and the correspondent bank would (should) have signed an agreement stating what they would do about forged checks, and which country’s laws they would use to settle any disputes not covered by their agreement. We can’t imagine that a correspondent bank would agree to settle disputes anywhere but under U.S. state laws, which would hold the Caribbean bank responsible for the fraudulent check. Even if the two banks hadn’t signed an agreement, the correspondent bank could sue under state law, which would hold the Caribbean bank responsible. (In the U.S., international forgery is considered a state—not a federal—criminal offense.) Which country’s laws apply if the Caribbean bank presented a check directly to our subscriber’s U.S. bank? Again, it would depend upon the banks’ written agreement. The agreement probably would require that disputes be settled under U.S. state laws. If this were so, the Caribbean bank again would be responsible for accepting the forged check. If the check value is large enough, we would suspect that the two banks will end up suing one another in U.S. courts—no matter what their agreement states. The reason is that U.S. laws are very kind to parties with weak cases. The losing party rarely must pay the winner’s legal costs. If you won’t have to pay the winner’s legal costs, why not sue and gamble that the court will rule in your favor? Under British law, the losing party must pay the winning party’s legal costs. This significantly raises the cost of losing a lawsuit. As a result, British subjects don’t file lawsuits unless they are very sure that they will win.
Our subscriber’s bank may be reluctant to credit her account because it may be years before it recovers the funds from the Caribbean bank. However, that is the bank’s problem—not our subscriber’s. Since our subscriber is an important customer at her bank, we recommended that she pressure the bank to return her money. All of the subscribers who phoned us complained that their banks were reluctant (or refused) to reverse the transactions. One subscriber’s bank stated that since the 24 hour return period had passed, our subscriber no longer could return the check. Although corporates do have 24 hours in which to return a check for any reason, the bank is mistaken because the law allows corporates to reject fraudulent checks one to three years later. The banks may be reluctant to become involved in a dispute, but the law is clear that the customer is not responsible if it notifies the bank in time.
Corporate Fraud Protection More and more corporations are using Positive Pay bank services (where the bank electronically matches all presented checks against the corporation’s listing of checks issued) to protect themselves against forgeries. This is excellent protection against all types of check forgeries—except a forged endorsement. We know that two banks offer their Positive Pay services at no charge to help decrease check fraud losses. Positive Pay requires that a customer send the bank each day an electronic listing of the check number and dollar value of each check issued. The bank’s computer then confirms that the check number and dollar value of each presented check match information on this listing. The bank’s computer would, for example, note that it was processing check number “101 for $15,000.” The computer would match this check against the corporation’s listing of checks issued to see if the corporation had issued a check 101 for $15,000. If this check number and amount match the information on the corporation’s listing, the bank would accept the check. Otherwise, it would reject the check. Because the system only compares the check’s MICR-line information, Positive Pay never would (or could) realize that someone had altered the payee information. Luckily, most check forgeries do not involve this type of forgery because it is very difficult for a forger to intercept a legitimate check.
The only way to discover a check with a forged endorsement would be to have a corporate employee inspect the payee and endorsement on each check. We know of no corporation that does such an exhaustive reconciliation. The cost soon would exceed the loss from all but the largest forgeries. Our subscriber detected this forgery only because the original payee complained that it hadn’t received the check. Although there is no proof, it is likely that the original payee added the second payee and forged the endorsement. (How could anyone else intercept the check?) Don’t bother switching to expensive check stock that cannot be copied or altered. We have received subscription checks that include a holographic strip that changes color as you move it. In addition, the checks are printed with pastel colors that gradually merge into one another. Our office copy machine makes very poor copies of such checks. In addition, it is almost impossible to obtain such check stock. However, there is nothing to stop a forger from printing a counterfeit check on plain green check stock, and depositing it at his local bank. It is extremely unlikely that his bank would realize that your checks are printed on check stock with a holographic strip.
Without a Positive Pay system, no one would notice the counterfeit check until months later when someone reconciled your checks. By that time the forger would be long gone with the money. Summary The UCC does not hold corporations responsible for check fraud except when corporate employees are involved, or when there has been blatant corporate negligence. We have attended seminars on check fraud where the speakers have stated that corporations can be held responsible for check fraud. However, one corporate lawyer who has researched this problem and the American Bankers Association’s legal counsel have informed us that such statements technically may be true, but are very misleading. With extremely rare exceptions, the UCC holds the bank of deposit responsible for accepting a forged check in the first place. This may not seem fair to that bank, which also is an innocent victim. However, the legal philosophy seems to be that the depositing bank could have prevented the check fraud if it had been more careful whom it accepted as a customer.