RSK.IQ Question of the Week 9/28/15

Liability of Bank for Forged Indorsement


Bank A received a call from Bank B regarding a collection item that Bank B will be returning to Bank A, on the grounds that the indorsement is forged. The check was deposited one year ago. Both banks are located in New Jersey. What is Bank A’s obligation to return the funds to Bank B?

Response Summary

If Bank A is liable to Bank B, it will be under the warranty it gave when it presented the check for payment to Bank B. Under Article 4 of the Uniform Commercial Code, as enacted by the State of New Jersey, a depository bank warrants to the drawee bank that it was entitled to enforce the check at the time of presentment. Bank A may have defenses against a claim of breach of warranty, and if it is required to reimburse Bank B, it can seek recovery from its customer. It will remain liable on its warranty to Bank B, however, whether or not it is able to make such a recovery.

Response Detail

UCC Article 4

Article 4 of the Uniform Commercial Code (the “UCC”), as enacted by the State of New Jersey, defines the rights of parties in matters concerning negotiable instruments, such as warranties for bank deposits and collections.

Statute of Limitations

Under Section 4-111 of the UCC, a claim by Bank B for breach of warranty by Bank A would have to be brought within three years of the accrual of the action. Such an action accrues at the time the check is negotiated; that is, the statute of limitations begins to run at the time the check amount is debited from the maker’s account. Since the check in question was presented for payment less than three years ago, a claim now on a forged endorsement is not barred by the running of the statute of limitations. N.J.S.A. 12A:4-111.

Presentment Warranty

Under Section 4-401(a) of the UCC, a check is properly payable only if it is authorized by the customer and in accordance with any agreement between the bank and the customer. If the drawee bank pays a check bearing a forged indorsement, then it is obligated to credit the customer’s account for the item.

If Bank B, as the drawee bank, is obligated to re-credit its customer’s account, it can turn to Bank A, as the depository bank, for reimbursement. Under Section 4-208(a)(1) of the UCC, the depository bank warrants to the drawee bank that it had the right to enforce payment of the check at the time it was transferred to the drawee bank for collection. This means that Bank A warranted that the indorsements were authorized and had not been forged. If Bank A breached this warranty, it is liable to Bank B for the amount of the item, less any recovery Bank B may have against its customer.

Defenses to Breach of Warranty Claim

Bank A may have defenses to a claim of breach of warranty. For instance, if a fictitious payee or impostor induced Bank B’s customer to issue the check to him, the indorsement of that person may be deemed effective. If the check was fraudulently issued by an employee of Bank B’s customer, an indorsement on behalf of the payee of that check may also be effective, provided that Bank A took the check for value and in good faith, and exercised ordinary care in doing so.

Bank A may also escape liability if it can demonstrate that the drawer is precluded from asserting a claim against Bank B because it failed to exercise ordinary care in issuing the check, and this failure substantially contributed to the making of the forged endorsement. However, if the drawer can prove that Bank B did not act in good faith in paying the check, this exclusion is removed. Bank B, on the other hand, is not precluded from bringing a claim of breach of warranty against Bank A because of its lack of due care in paying the check. N.J.S.A. 12A:4-406(e); 2-208(b).

Course of Action

Bank B’s claim of breach of warranty should be accompanied by the following:

  • The check
  • Affidavit of forgery by the payee
  • A description of the facts substantiating the assertion that the indorsement is forged
  • Documentation that the drawer has been reimbursed and in what amount

This information will allow Bank A to make an initial determination as to whether the claim has merit or whether additional information must be developed. For example, does the affidavit or description indicate that the parties involved have knowledge as to who forged the indorsement? Does this information indicate how the check was issued and to whom? Have criminal charges been filed if the identity of the forger is known?

Bank A should seek to recover the amount of the deposit from the customer who made the deposit. Whether or not it is able to, however, it will remain liable on its warranty to Bank B. Any defense it maintains against the claim of Bank B will depend on the facts of the matter.

This entry was posted on Monday, September 28th, 2015 at 2:00 pm.

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