Forged and Missing Check Indorsements: How Some Depository Institutions are Trying to Avoid Liability

The scenario is familiar to financial institutions: A customer writes a check payable to a third party; a fraudster intercepts the check and deposits the check in his account either with no indorsement or with the forged indorsement of the payee; the customer who wrote the check does not learn that the check never reached its intended payee until weeks or months later; when the customer does learn of the missing or forged indorsement, the customer is reimbursed by his financial institution (the “drawee bank”) for the amount of the check; the drawee bank then makes a breach of warranty claim against the financial institution where the check was deposited (the “depository bank”), a claim that should prevail as the New York Uniform Commercial Code (“UCC”) generally places the ultimate liability for a check with a forged or missing endorsement on the depository bank.

However, we have seen an uptick in the assertion of a questionable defense by depository banks to such breach of warranty claims: that the drawee bank has waived its breach of warranty claim against the depository bank if the drawee bank reimburses its customer despite the customer failing to timely report the forged or missing indorsement in accordance with the drawee bank’s deposit agreement.

For instance, say in the scenario described above, the customer who wrote the check does not discover that his check had a forged or missing indorsement for 90 days; however, his deposit agreement with his bank (the drawee bank) requires that any unauthorized or missing indorsement be reported within 60 days. A drawee bank may elect not to enforce this requirement and still reimburse its customer for the check. The institution may do this for customer relations purposes and/or because it believes it has a valid breach of warranty claim against the depository bank. What we are seeing, however, is some depository banks rejecting breach of warranty claims on the basis that the drawee bank was not obligated to reimburse a customer who made their claim of a forged or missing indorsement more than 60 days after the periodic statement containing the check was issued, and that by making such reimbursement the drawee bank waived the breach of warranty claim.

Is such a defense valid? While these cases are very fact-sensitive and the outcome may vary based on the specific circumstances, it is our view that such a defense is generally not valid. We have not found any case law in New York specifically supporting such a defense.

It could be argued that UCC Section 4-406 provides a basis for such defense, but we do not see that section being applicable to this specific scenario. Section 4-406(4) states that if a customer does not report an unauthorized indorsement within three years from the time his account statement showing the item at issue is made available to him, then he is precluded from asserting such unauthorized indorsement against his bank (the drawee bank). Section 4-406(5) then states that if the drawee bank has such a defense to a claim by its customer, the drawee bank may not assert the unauthorized indorsement against the depository institution. However, the protection of Section 4-406(5) only applies to claims made specifically under Section 4-406 (such as the three-year reporting obligation for forged indorsements) and not to any shorter reporting time period contractually imposed by a bank on its customer (usually 60 days or less).

Despite the questionable nature of this defense, we have seen it being relied on by depository banks as a basis to reject a breach of warranty claim. This raises a practical issue for the drawee bank making the claim: Is it worth suing the depository bank to recover the funds? This will usually depend on the amount of the check involved, as the amount will have to be significant enough to justify such a lawsuit from a cost perspective. Attorney’s fees are generally not recoverable in check warranty claims under the UCC, which may factor into the decision on whether to start such a lawsuit.

This advisory is not intended as legal advice. UCC check issues are very fact-sensitive and strategies and outcomes may vary depending upon specific circumstances. If you have any questions about this issue, please feel free to contact Joseph D. Simon at (516) 357-3710 or via email at jsimon@cullenllp.com, Kevin Patterson at (516) 296-9196 or via email at kpatterson@cullenllp.com, Elizabeth A. Murphy at (516) 296-9154, or via email at emurphy@cullenllp.com, or Gabriela Morales at (516) 357-3850 or via email at gmorales@cullenllp.com.