70 The Alabama Lawyer 279 (2009). A Primer on Applying Articles 3 and 4 to The Ten Most Common Check Disputes.

• Author: BY GREGORY C. COOK and JOHN D. PICKERING

The Alabama Lawyer

2009.

70 The Alabama Lawyer 279 (2009).

A Primer on Applying Articles 3 and 4 to The Ten Most Common Check Disputes

A Primer on Applying Articles 3 and 4 to The Ten Most Common Check DisputesBY GREGORY C. COOK and JOHN D. PICKERINGThis article will provide an overview of the law relating to disputes over payments of checks.(fn1) We focus on what are likely the 10 most common scenarios and the common facts and arguments for those 10. Litigation over checks usually falls into one or more of three categories: (1) unauthorized drawer(fn2) signatures, (2) forged endorsements(fn3) and (3) employee wrongdoing (which might include creating fictitious payees for checks, forging drawer signatures, forging endorsements or altering received checks). Often, the wrongdoer is not solvent and therefore the Uniform Commercial Code ("U.C.C.")(fn4) attempts to allocate the loss by placing it upon the party best able to avoid the loss. This may be the depositary bank(fn5) (the bank that took the check), the payor bank (the customer's bank) or the customer. Often, the liability rules change based upon the due care of the parties and based on the drawer's deposit agreement with its bank. Lawsuits can arise between the drawer and its bank, as well as between the depositary and payor banks.

DISPUTE ONE

(Drawer vs. Its Bank): Drawer's Signature Unauthorized

The starting point for disputes between a drawer and its bank is Ala. Code§ 7-4-401(a), which provides that a bank may only charge a customer's account for an item if it is "properly payable," which means: (1) "authorized by the customer and" (2) "in accordance with [the deposit agreement]."

An unauthorized signature can be either a forgery or simply one made without actual, implied or apparent authority. Ala. Code§ 7-1-201 (43); Ala. Code§ 7-3-402 (signature by representative). In general, a check signed by an unauthorized third person as drawer is not properly payable and the customer's bank may not charge the customer's account and must re-credit the account of the customer. The three most common questions that arise in such circumstances are: (1) whether there were repeated forgeries by the same wrongdoer before notice by the customer to its bank (known as the "repeat wrongdoer" rule), (2) when the customer provided notice to its bank (even if no repeat wrongdoer) and (3) whether the customer was negligent in causing the unauthorized signature. The question of whether the check was signed by a human or by automated or facsimile will usually not change the outcome.(fn6)

Repeat Wrongdoer Rule; Comparative Negligence Standard Unlikely to Help

Section 7-4-406(c) states that if a bank sends its customer a periodic account statement, the customer must (1) "exercise reasonable promptness in examining the statement or the items to determine whether any payment was not authorized" and (2) must promptly notify the bank if a payment was not authorized. Under § 7-4-406(d)(2), if the customer fails to exercise such reasonable promptness, it is precluded from asserting an unauthorized signature by the same wrongdoer on any other items paid in good faith after a reasonable period of time for the customer to examine the previous unauthorized item or a statement listing such item (not exceeding 30 days). Normally, this requirement of good faith will not assist the customer who has failed the repeat wrongdoers test, because Alabama (unlike some states) follows a subjective test for "good faith" for purposes of U.C.C. Articles 3 and 4. Ala. Code§ 7-3-103(a)(4) defines "good faith" as "honesty in fact in the conduct or transaction concerned." Cagle's, Inc. v. Valley National Bank, 153 F. Supp. 2d 1288 (M.D. Ala. 2001); Continental Casualty Co. v. Compass Bank, 2006 WL 644472 (S.D. Ala. March 9, 2006). The defenses in § 7-4-406 must be pled as affirmative defenses. Pinigis v. Regions Bank, 942 So. 2d 841 (Ala. 2006).

This "repeat wrongdoer" rule is often important because it is common for the same wrongdoer to submit multiple checks over several months or even years. E.g., Cagle's Inc. v. Valley National Bank, 153 F. Supp. 2d at 1288 (M.D. Ala. 2001).

Notwithstanding this rule, if the customer can show a lack of "ordinary care" by the bank that substantially contributes to the loss, the liability will be determined comparatively. Ala. Code§ 7-4-406(e). In the case of an unauthorized drawer signature, it is very unlikely that a customer could succeed on such an argument. Section 7-3-103(7) defines "ordinary care" as the observance of reasonable commercial standards prevailing in the area. In the case of a payor bank that processes checks by automated means (which would likely be most banks today), the Code expressly recognizes that reasonable commercial standards would normally not require the bank to examine instruments (a possible exception could exist if the customer's bank was also the bank that accepted the check from the wrongdoer and there is some further indication of negligence). Ala. Code§ 7-3-103(7).

Further, it is becoming more and more common for no physical checks to be transmitted between merchants and banks, and between the depositary and payor bank. Increasingly, physical checks are not transferred for collection (this is known as "check truncation"), rather there are electronic transmissions of instructions or images.(fn7) Under such an electronic system, it will be even less likely that the customer's bank could be found comparatively negligent when there is an unauthorized/forged customer signature.

Late Report by Customer after Receiving Statement

In addition to the repeat wrongdoer rule, Ala. Code§ 7-4-406(d)(1) provides that a customer's failure to comply with its duty under § 7-4-406(c) of reasonable promptness in examining its statement or items and promptly notifying the bank of relevant facts can shift liability to the customer, if the customer's failure causes a loss to its bank because of an unauthorized drawer signature. As with the "repeat wrongdoer" rule, Ala. Code§ 7-4-406(e)'s comparative negligence standard can shift a portion of this liability back to the bank. Because the "repeat wrongdoer" rule often applies in the same circumstances and because it does not require proof of a loss "by reason" of the customer's delay, Ala. Code§ 7-4-406(d)(1) is not often relevant.

Section 7-4-406(f) goes even further and provides that (1) without regard to due care, (2) without regard to repeat wrongdoer and (3) without regard to loss "by reason" of the delay a customer who does not discover and report such unauthorized drawer signatures is precluded from recovery unless the customer provides notice within (1) 180 days after the statement and the items (or a copy or image of the items) are sent to the customer, or (2) within one year after the statement or items are otherwise made available.(fn8) Further, there is no good-faith requirement for the application of this defense. Pinigis v. Regions Bank, 977 So. 2d. 446, 452-55 (Ala. 2007).

However, in virtually every case the customer's bank will have a deposit agreement which shortens both the 180-day and one-year periods, typically to 30 days.(fn9) While some commentators have objected to shortening this period and argued that such a provision may not be enforceable, it is very likely that it would be enforced in Alabama. The customer is clearly in the best position to determine an unauthorized or forged signature and they are unlikely to examine their statement after 30 days if they have not examined it before 30 days - and there are public policy reasons to encourage early reporting.(fn10)

Negligence Substantially Contributes to Making

Section 7-3-406 states that a person whose "failure to exercise ordinary care substantially contributes" to the making of a forged signature (not unauthorized(fn11)) is precluded from asserting such forgery against their bank. The burden of proving this lack of ordinary care is upon the bank. The Official Comments provide an example where an employer uses a rubber stamp to add signatures to a check and leaves the rubber stamp and blank check forms in an unlocked drawer; an unauthorized person then uses the rubber stamp to forge checks.

Conversely, the customer can again argue under § 7-3-406(b) that the bank failed to exercise ordinary care and such failure "substantially contributes to the loss." Under § 7-3-406(c), the...