The following scenario has become all too common for community banks in recent years: • A bank customer reports an inaccurate account balance resulting from an unknown check drawn on the customer’s account. • The bank completes a preliminary investigation and determines that the check charged to the customer’s account is fraudulent. • The bank restores the funds to the customer’s account, either because the bank wants to make its customer whole or because it is legally required to do so. • Because the customer report came days or weeks after payment of the fraudulent check, the bank’s “midnight deadline” for returning the check has already passed.1 The bank cannot recover the funds through that channel. • The bank investigates further and determines that the fraudulent check was deposited in an account at a much larger financial institution over 1,000 miles away. The fraudster’s account was opened online shortly before the fraudulent check was deposited into it. • The bank also learns that the fraudster’s account has been closed or drained of funds. Both the fraudster and the money are gone. Modern Check Fraud and a Framework for Recovery Which Bank Takes the Loss? David J. Routh, Partner, and Roger D. Sack Associate, Cline Williams Wright Johnson & Oldfather LLP At this point, the bank whose customer was defrauded will want to recover the funds from the other bank whose customer committed the fraud. Common sense may suggest that the other bank should be responsible because it was the only one that had any contact with the fraudster. Unfortunately, the legal result is not that simple. Uniform Commercial Code Articles 3 and 4 The defrauded bank’s ability to recover from the second bank will depend, in large part, on Articles 3 and 4 of the Uniform Commercial Code (UCC). Specifically, when funds cannot be recovered from the fraudster, the question of “which bank takes the loss” will depend on whether the check was “properly payable” by the customer and the application of the “presentment warranties” for negotiable instruments and bank checks included in Articles 3 and 4 of the UCC. In the scenario described above, the UCC refers to the bank whose customer was defrauded as the “payor bank.”2 The UCC refers to the bank whose customer committed the fraud as the “depositary bank.”3 Potential Recovery: Breach of Presentment Warranties Under the UCC, when the depositary bank introduces the fraudulent check into the payment system as the bank of first deposit, the depositary bank makes the following presentment warranties: • Entitlement to enforce. The depositary bank warrants that it is a person entitled to enforce the check or authorized to obtain payment on behalf of a person entitled to enforce the check.4 • No knowledge of unauthorized drawer signature. The depositary bank warrants that it has no knowledge that the drawer’s signature on the check (the defrauded customer) is unauthorized.5 • No alteration. The depositary bank warrants that the check has not been altered.6 20 NEBRASKA BANKER
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