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Check fraud and forgery are two of the biggest security problems faced by banks. In fact, according to a recent Ernst & Young study reported by the National Check Fraud Center, over 500 million checks are forged annually, with losses totaling more than $12 billion, not counting those incurred by other types of document forgery.

Check fraud law is governed by Articles 3 and 4 of the Uniform Commercial Code (UCC). As a result, check fraud law has moved toward reflecting contemporary banking practices.

This memorandum generally addresses check fraud litigation resulting from: (i) alterations to the check, (ii) forgeries of the maker's signature on either the face of the check or the payee's endorsement on the back of the check, or (iii) counterfeit checks created by a dishonest third party. If there is a policy implicit in the UCC's rules for allocation of losses due to fraud, it surely is that the loss be placed on the party in the best position to prevent it.

The revisions to the law will likely result in three significant changes to the causes of action available in check fraud litigation. First, they may provide a new cause of action for contribution based solely on shared culpability. Second, they may expand conversion as a cause of action in check fraud cases. Third, they allow a drawee bank to recover from upstream banks for encoding errors that may result in shifting liability in some counterfeit check cases.

Check Fraud Law

Before addressing the law, it is important to know the relationships between parties typically involved in check fraud litigations. A customer is a person with an account at a bank. A drawer or maker is a person writing a check and is typically a customer of the drawee bank. A drawee is a party, typically a bank, required to pay out money when a check or draft is presented. A payee is the party entitled, by the creation of the check by the drawer, to receive funds from the payor bank, usually the drawee. Presentment is the delivery of a check or draft to the drawee or the drawer for payment .

A check written by the drawer moves downstream from the drawer to the payee, and then moves to the drawee bank that pays the amount shown. Several other parties, however, may enter the stream between the payee and the drawee. Typically, the check moves downstream from the payee to the depository bank. Continuing downstream, the check moves from the depository bank to the collecting bank (most often the Federal Reserve Bank for depository institutions), then perhaps to a presenting bank, and finally to the drawee bank.

The essential element of most check fraud claims is an unauthorized or forged signature or endorsement. The offender may enter the stream at any point in the sequence. Since the person committing the fraud often has disappeared with the money or is judgment proof most check fraud litigation involves a claim by an injured party against a drawee bank that paid over a forged signature, or a depository bank that accepted and processed an item bearing a forged endorsement.

Generally, a drawee bank is liable for claims involving the drawer's signature on the face of a check, and a depository bank is liable for claims involving the payee's endorsement on the back of the check.

A drawee bank's liability for forged signatures of the drawer arises because the drawee bank maintains the drawer's signature card on file and is held responsible for verifying the signature.

The depository bank's liability for forged endorsement of the payee arises because the depository bank has direct contact with the individual presenting the fraudulent endorsement. Thus, the depository bank is in the best position to verify the endorsement. In double forgery situations, when both the drawer's signature and the endorsement are forged or unauthorized, the case is treated as forged check and the drawee bank is generally liable.

Counterfeit items are usually the responsibility of the bank, that pays the item since the check was not authorized by the account holder.

Banks do however 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 (forged endorsement/signature or counterfeit, etc.).

Most State laws say that a bank may only charge a customer's account for checks that are "properly payable." This provision creates a cause of action against a bank that charges its customer's account for a check not properly payable. Such a claim is like a customer's breach of contract claim against the bank based on the theory that the drawee bank breached the terms of the deposit agreement by paying an item not "properly payable."

A bank and its customer may alter the relationship subject to the limitations imposed by the law that provides that the parties cannot disclaim a bank's responsibility for its lack of good faith or failure to exercise ordinary care or limit the measure of damages for the lack or failure.

However, the parties may decide by agreement the standards by which the bank's responsibility is to be measured if those standards are not manifestly unreasonable.

The terms of the deposit agreement between the drawee bank and the drawer may provide the basis for a cause of action under the law. The terms of the agreement may supersede the law as long as the terms do not disclaim a bank's liability for its own lack of good faith or failure to exercise ordinary care not withstanding any such agreement.

Under the law an instrument is converted if it is taken by transfer, other than a negotiation, from a person not entitled to enforce the instrument or a bank makes or obtains payment with respect to the instrument for a person not entitled to enforce the instrument or receive payment. For example, a thief takes A check payable to Mary Dow, forges her endorsement, and pockets the proceeds. Dow may assert a claim for conversion against either the depository bank that cashes the check, or the drawee bank that pays the forged endorsement. The law provides that the measure of damages in a conversation action is presumed to be the face value of the instrument. The payee, however, may only sue for conversion against the drawer if the instrument is a draft payable by the drawer, and not a check payable by the payor bank. A "draft" is a negotiable instrument that is an order. A "check" is a negotiable instrument drawn on a bank and payable on demand.

Generally, a drawer may not sue for conversion, because in many States the courts have ruled that a drawer has not a cause of action for conversion against the depository bank which cashed checks for an individual who forged the payee's endorsement when the check has never been delivered to the payee.

In a check fraud litigation, a plaintiff who maintains an individual account may sue his or her drawee bank or another bank in the collection process under Section 9.

Besides the rights established by the UCC, there are several common law bases to recover losses resulting from check fraud schemes. The most frequently used are conversion, indemnification, negligence, and money had and received. The availability of any common law cause of action for check fraud depends on if the cause of action is displaced by specific provisions of the UCC.

In cases with joint payees, where one payee forges the signature of another payee, the nonforging payee may file a contract claim against the drawer of the check based on the underlying obligation.


The revised UCC continues most defenses to claims based on check fraud, but provides significant changes where an employer of a forger was negligent. The revised UCC shifts liability to the employer where the employer is in the best position to prevent the underlying embezzlement.

One of the most significant changes in the revised UCC is the introduction of comparative negligence concepts. The revised law precludes a party who substantially contributes to the making of a forged signature from asserting an unauthorized signature. Under the old code, a bank is generally liable for the total loss if the bank is negligent in most embezzlement cases. Under the revised law, however, if both the drawer and the bank are negligent, the court will apportion the loss between the two according to their respective fault. The comparative negligence language may also provide the drawer with a new cause of action against the drawee bank. The drawer may assert that, while it contributed to the forged endorsements, it should not be hold liable for the total loss.

The revised law introduces a comparative negligence scheme into the bank/customer relationship.

It provides a bank with a defense to a customer's claim for reimbursement for payment of an item not properly payable, and the revisions introduce comparative negligence as a loss allocation system to the extent each bears responsibility for causing the loss.

The revised law covers situations where an impostor impersonates either a payee or an agent of the payee. Under the old code, this section applied only to cases in which the impostor impersonated the payee and not false agent cases. The revision shifts liability from the bank to the drawer in "bad bookkeeper" cases and other situations in which an impostor-agent endorses a check made out to the principal by the drawer.

The revised law incorporates a comparative negligence standard into impostor and fictitious payee situations. Under it, a bank that fails to exercise ordinary care may be liable for part of the loss from an impostor or fictitious payee situation to the extent that the failure to exercise ordinary care contributed to the loss. It is impossible to predict what the practical result of the comparative negligence standard will be.

Under the revised UCC, double forgery cases will be treated as forged check and not forged endorsement cases. This revision does not result in changes in most States since double forgeries were already generally treated as forged drawer's signature cases.

Under the revised law an employer is liable for theft by an individual with authority to write checks and who draws a check to the order of a payee, intending the payee to have an interest in the check, but who subsequently forms the intent to steal the instrument and does so.

The law provides the drawee bank with several time based defenses stemming from the drawer's failure to comply with a duty to review its statements to discover and report unauthorized signatures or alterations. A drawer who fails to discover and notify the bank of a forged endorsement or alteration within thirty days after the bank makes the statement and items in question available to the customer is precluded from asserting additional forgeries or alterations by the same wrongdoer. If, however, the drawer establishes negligence by the bank paying the item or items in question, then the preclusions are limited.

The customer's duty to inspect statements and discover and report any problems remains largely unchanged from the old code. The subsection defining such duty, however, has been redrafted to help truncation by banks. The revised UCC says that the statement of account provides sufficient information if the item is described by item number, amount, and date of payment. This allows banks to destroy paper checks at some point early in the collection process, retaining instead a photographic or electronic image of the check.

The UCC extends from fourteen to thirty days the time within which a customer must report the unauthorized signature or alteration of a given wrongdoer. The law maintains an absolute bar on the assertion of an unauthorized signature or alteration after one year, mirroring the one year rule under the code.

Under the revised law, the burden of proof shifts back and forth between the party asserting the preclusion and the party asserting the unauthorized signatures. If the bank pays a check over an unauthorized drawer's signature or endorsement, and the customer fails to notify the bank of the error within a reasonable time after the date of the receipt of his bank statement, the burden-shifting begins.

First, the party asserting the preclusion, generally the drawee bank, must prove that the drawer failed to review his statements with "reasonable promptness." If the bank can prove that the drawer failed to satisfy his duty to review statements and notify the bank of any errors, then the liability for the items in question shifts to the customer asserting the unauthorized signatures. The customer will then be precluded from challenging the effectiveness of such signature placed on any other item altered or forged by the same wrongdoer unless he can prove that the bank failed to exercise ordinary care in paying the items in question. If the party asserting the forged signatures can prove that the bank failed to exercise ordinary care in paying the items in question, then liability reverts to the bank on a comparative negligence basis.

A drawer may ratify an unauthorized signature or forgery, thereby foregoing the right to assert the unauthorized signature against another party. Whether a party ratified an unauthorized signature or forgery is a question of fact. Furthermore in order for a court to find that a particular factual pattern is ratification, the facts must not be susceptible to any other interpretation.


The 1990 revisions added an encoding warranty, by which a party who encodes information on the face of a check is held strictly liable for such encoding. Banks have traditionally encoded checks by employing Magnetic Ink Character Recognition technology (MICR), and they are increasingly shifting to Optical Character Recognition (OCR) technology.

The MICR and OCR line on the bottom portion of the check contains three fields. The first field contains the routing number of the payor bank, which tells the depository and collecting banks where to send the check. The second field contains the drawer's account and check numbers, which tells the payor bank which account to debit. The first and second fields are generally encoded by the drawee bank before the preprinted check form is given to its customer. The third field shows the amount of the check. The third field is generally encoded manually by the depository institution.

Definition of Ordinary Care

The definition of negligence standards used in the law were standardized in the revision. Ordinary care with respect to persons engaged in business, such as banks, means the observance of reasonable commercial standards, prevailing in the area in which the person is located, with respect to the business in which the person is engaged. The definition further specifies that in the case of a bank that takes an instrument for processing for collection or payment by automated means, reasonable commercial standards do not require the bank to examine the instrument if the failure to examine does not violate the bank's prescribed procedures and the bank's procedures do not unreasonably vary from general banking usage not disapproved by the law. This endorses the procedure of not verifying signatures on checks below a certain dollar amount (within reasonable limits).


The bottom line from these developments is that employers and businesses are now likely to be responsible for part of the loss incurred in check fraud cases.

They should be put on notice that they need to implement policies under which (1.) banks they deal with are kept current on who is authorized to issue and sign checks, (2.) limit the number of people so authorized and (3.) adequately review canceled checks and statements as quickly as possible after they are received, to ensure they have been properly issued and paid.


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