cuna regulatory compliance school law of checks 2017 check...

Law of Checks 2017

Copyright © 2017 Tyler F. Parker. All Rights Reserved.

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Tyler F. Parker 8003 Sand Point WY NE B21

Seattle, Washington 98115 (206) 322-8078

[email protected]

CUNA Regulatory Compliance School

Law of Checks 2017 Check Issues Every Credit Union Employee Must Know to Provide Service and Prevent Losses

I. Introduction to the Uniform Commercial Code’s (UCC) Articles 3 & 4

A. Background

1. American Negotiable Instrument Law

a. Most Checks Get Paid

1) Not All Checks Get Paid - Two Problems

a) Nonpayment (Checks are Dishonored) = Lawsuits against Signers

b) Wrongdoing (Alterations, Forged Indorsemsents, Forged Drawer’s Signatures) = Claims against Presenter and Transferors

b. Law Required to Address the Two Problems = To Encourage the Use of Checks

c. Need Uniform State Law to Address the Problems = UCC Articles 3 & 4

B. Two Versions of UCC Articles 3 & 4 1962 (Did Not Address Changes in Technology (and Key FI Omission)) & 1990

II. Negotiable Instruments in General: What is a Check?

A. Introduction (Safety, Convenience, Control & Proof)

1. Negotiable Instrument - Written Order (or Promise) to Pay Money 3-104(a)

a. Two Key Negotiable Instruments = 1. Notes (Promises to Pay) and 2. Drafts (Orders to

Pay) 3-104(e)

B. The Check (the Most Popular Draft & Negotiable Instrument)

1. A “draft” is an instrument that is an order to pay money. 3-104(e), 4-104(a)(7)

a. A “check” is a draft payable on demand and drawn on a bank 3-104(f), 4-104(c), and

is a written order to pay money 3-103(a)(6), 3-104(e)

1) An “instrument” is only a “check” if it is both 1. drawn on a bank, and 2. payable on demand.

b. “Bank” Defined (the Term “Bank” Includes Credit Unions)

1) Under new Articles 3 and 4, credit unions are banks 4-105(1), 4-102(a), and

share drafts drawn on accounts at banks are checks. 3-104(f), 4-104(a)(1), 4-106

2. Checks: Three Party Instruments - Drawers, Drawees, and Payees

a. Drawers (Hat 1). The person who orders (who signs or is identified in the check as ordering) payment is the DRAWER (e.g., the bank’s customer on his or her checks, and the bank on its cashier’s or teller’s checks). 3-103(a)(3) Drawers order the payment of money in writing. 3-103(a)(6)

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b. Drawees (a.k.a. Payor-Drawees) (Hat 3). The person who the drawer orders to pay the draft is the DRAWEE (a.k.a. PAYOR) (e.g., the bank, the Payor-Drawee). 3- 103(a)(2), 4-105(3)

c. Payees. The person who the DRAWER orders the DRAWEE to pay via the check is

the PAYEE (e.g., the customer’s or bank’s creditors).

3. Types of Checks

a. Customers’ Checks (Members are Customers) 3-104(f), 4-104(a)(1). Where Your Bank is the Payor-Drawee (Hat 3), or the Depositary Bank (Hat 2)

b. Cashier’s Checks (the Bank’s Checks) 3-104(g). Where Your Bank is the Drawer (Hat 1) and the Payor-Drawee (Hat 3). Cashier’s check means a draft with respect to which the drawer and drawee are the same bank or branches of the same bank. 3-104(g)

1) Remitters (Member-Purchasers of Order Cashier’s Check) 3-103(a)(11)

c. Teller’s Checks (the Bank’s Checks) 3-104(h). Where Your Bank is the Drawer (Hat 1), or perhaps (and less likely) the Payor-Drawee (Hat 3). Teller’s Checks means a draft drawn by a bank (i) on another bank, or (ii) payable at or through a bank. 3-104(h)

1) Remitters (Member-Purchasers of Order Teller’s Check) 3-103(a)(11)

C. The Importance of Negotiability: Recourse for Nonpayment and Wrongdoing

1. Provides a Bank with Recourse for Nonpayment and Wrongdoing against by Remote Parties to

the Instrument/Check

2. Warning: Does Not Protect the Bank When it Deals directly with Insolvent or Dishonest Parties, or Against the Bank’s Own Negligence

D. The Stages in the Life Cycle of a Check – Why?

III. Stage 1: The Contract of Deposit = Card & Agreement (Critical to Anticipate Services, Important Information and Preventative & Resolution Issues) IV. Stage 2: Issuance of the Check

A. Issuance Defined = First Delivery of Check by Drawer to Payee (Holder)

1. “Issue” is the first delivery of the check by the drawer (“issuer” 3-105(c)) (whether the check is

issued to a holder or nonholder) for the purpose of giving rights on the check to any person. 3-105(a)

a. When the drawer-customer signs (3-103(a)(3)) and delivers a share draft and gives it to

the payee, the share draft has been issued. 2. General Purpose of Check is to Satisfy Underlying Obligation (Drawer’s Debt with Payee)

B. Check must Meet the Properly Payable Rule

1. Drawer must Sign (3-103(a)(3), 3-401(a), 4-401(b)) and Authorize (4-401(a)) the Payment of the

Check

a. Protects Commerce Against Nonpayment (Drawer Contractually Liable to Pay Check), and Protects the Drawer Against Wrongdoing (Drawer Not Liable to Pay Checks with Alterations, Forged Indorsements, or Forged Drawer’s Signatures)

C. Issuance Creates the First “Holder” of the Check

1. Holder Defined: Test for Holder. A holder is 1. a person in possession of a check that 2. is either a. payable to bearer, or, b. in the case of a check payable to an identified person (i.e., an order check), is the identified person in possession 1-201(20)

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a. Examples: 1. Possession of an Order Check by the Payee = The Payee is a Holder. 2. Possession of a Bearer Check by Anyone = That Person is a Holder

2. Synonym for Holder = Person Entitled to Enforce (PETE) = Person Entitled to Enforce = Holder-PETE

3. Why Care about Holder-PETEs? 1. To Avoid Forged Indorsements (i.e., only Holder-PETEs can properly transfer and present checks). 2. To be able to Sue Drawer for Nonpayment (i.e., only Holder-PETEs can sue the drawer, or indorsers, for nonpayment of the check)

D. How the Code Addresses Problems

1. Non-Payment = Drawer contractually liable for Nonpayment of the Check based on His, Her or

Its Signature

2. Wrongdoing = Drawer Protected Against Alterations, Forged Indorsements, and Forged Drawer’s Signatures by the Properly Payable Rule

V. Stage 3: Negotiation of the Check (Post-Issuance Holders) - Transferring Checks in Commerce

A. Negotiation Defined = Lawful Transfer of the Check

1. A person can only become a Holder-PETE of check after its issuance (i.e., post-issuance) by negotiation. 3-201 Comment 1.

2. “Negotiation” means a transfer of possession, whether voluntary or involuntary, of a check by a

person (other than the issuer (the drawer)) to a person who thereby becomes its holder (Holder-PETE). 3-201(a)

B. Tests for Negotiation: Negotiating Order Checks and Bearer Checks

1. Negotiating Order Checks: Requires Indorsement + Transfer of Possession

a. Negotiation of Checks Made Payable “to Order” of an Identified Person - Indorsement

Required. If a check is payable to an identified person (i.e., is not made payable to bearer or cash (is payable to a specific payee or holder)), negotiation (i.e., “holder status” for the transferee) requires 1. the transfer of possession of the check and 2. the identified person’s (payee’s or holder’s) indorsement. 3-201(b)

b. The Indorsement: Payee’s or Subsequent Holder’s Signature

1) An “Indorsement” is the signature (other than a drawer’s or acceptor’s) that

(alone or accompanied by other words) is made on an check for the purpose of (i) negotiating the check, (ii) restricting payment of the check, or (iii) incurring indorser’s liability on the check. 3-204(a). An “Indorser” is a person who makes an indorsement. 3-204(b)

2) An “Indorser” is a person who makes an indorsement. 3-204(b)

c. Contract Liability - Indorser Liability on Based on Signature 3-415(a)

1) Exceptions 3-415(b),(c),(d) and (e) Example: Qualified Indorsement 3-415(b)

2. Negotiating Bearer Checks: One Requirement = Transfer of Possession Alone

a. Negotiation of Checks Made Payable “to Bearer” - No Indorsement Required. If a

check is payable to bearer, negotiation (holder status for transferee) requires the transfer of possession of the check alone. 3-201(b)

C. How the Code Addresses Problems

1. Non-Payment: Contract Liability = Drawer and Indorser(s) Liable for Nonpayment based on the

Contract (Liability based Signing and Endorsing the Check)

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2. Wrongdoing: Warranty Liability = Transferors Liable to all Parties who take the Check After Them based on the Transfer Warranties of (i.e., Promises made Upon Transfer of the Check that there are) No Alterations, Forged Endorsements and Forged Drawer’s Signatures

a. Transfer Warranties (Warranties Triggered by (Promises Made on) Change in

Possession of Check) 4-207, 3-416

1) A person, customer, or collecting bank (the warrantor), that transfers a check and receives a settlement or other consideration warrants to the transferee (the warrantee) and to any subsequent collecting bank that:

a) The warrantor is a person entitled to enforce (Holder-PETE) the

check 4-207(a)(1), 3-416(a)(1)

b) All signatures on the check are authentic and authorized; 4-207(a)(2), 3-416(a)(2)

c) The check has not been altered 4-207(a)(3), 3-416(a)(3)

VI. Stage 4: Presentment, or Collection and Presentment, of the Check

A. Who Can Properly Present a Check for Payment? Holder-PETE!

1. Presentment Defined. “Presentment” means a demand made by (or on behalf of) a person entitled to enforce (Holder-PETE) a check (i) to pay the check made to the drawee or a party obliged to pay the check or, in the case of an accepted check payable at a bank, to the bank, or (ii) to accept a check made to the drawee. 3-501(a)

2. Who May Make Presentment? The Person (or Representative of a Person) Entitled to Enforce a Check (Holder-PETE) 3-501(a)

3. Why the Complexities of Presentment? People don’t use the same the bank, and banks are

not located in the same geographic region.

B. Two Ways to Present Checks: Over the Counter & Though the Check Collection Process

1. Presentment Over the Counter - for Cash or Deposit

a. Presentment Over the Counter for Cash to Payor-Drawee Bank (Hat 3)

1) Payor-Drawee Bank Must Pay (Honor) or Not Pay (Dishonor) on the Day of Presentment 3-502(b)(2). Payment or Dishonor is Typically Immediate

a) See “Risk Reducing Requirements”

b. Presentment Over the Counter for Deposit in Customer’s Account - “On Us”

Checks . Bank is a Payor Bank (4-105(3)) and is also a Depositary Bank (4-105(2)) because check is being deposited as opposed to cashed.

a) See “Risk Reducing Requirements”

c. Payor-Drawee Bank’s Rights when Presentment is Made - Risk Reducing

Requirements

1) Upon demand of the bank to whom presentment is made, the person making presentment must (i) exhibit the check, (ii) give reasonable identification (which includes thumbprinting) and, if presentment is made on behalf of another person, reasonable evidence of authority to do so, and (iii) sign a receipt on the check for any payment made or surrender the check if full payment is made. 3-501(b)(2)

2) Failure by Presenting Party to Comply with Risk Reducing Requirements =

Presentment Ineffective. 3-501(b)(3)(ii). Return, Not Dishonor 3-501(b)(3)

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2. Presentment Through the Check Collection Process (Downstream)

a. Rationale: People Don’t Use the Same Banks, and those Banks aren’t Located in the Same Geographic Region.

b. Check Collection Process in General

1) Customer-Holder-PETE Deposits Check to Account at Depositary-Collecting

Bank. All Banks in Check Collection Process are Collecting Banks Except Payor-Drawee Bank 4-105(5). Depositary-Collecting Bank Can Refuse Any Item for Deposit

2) Payor-Drawee Bank will Settle and Pay (Failure to Revoke Settlement) or

Dishonor and Return the Check by Midnight of Next Banking Day Following Banking Day of Receipt 4-104(a)(10), 3-502(b)(1). Failure to Revoke Settlement = Final Payment 4-215(a)(3). Result of Final Payment - Payor-Drawee Bank Can Not Recover Money


1. Non-Payment: Contract Liability = Drawer and Indorser(s) Liable for Nonpayment based on the

Contract (Liability based Signing and Endorsing the Check)

2. Wrongdoing: Warranty Liability = Presenters and Transferors Liable to Payor-Drawee based on the Presentment Warranties of (i.e., Promises made Upon Presentment of the Check that there are) No Alterations, Forged Indorsements and No Knowledge that the Drawer’s Signature is Forged 4-208, 3-417

a. Presentment Warranties (Warranties Triggered Upon (Promises Made on)

Presentment and Payment of Check) 4-208, 3-417

1) If a check is presented to the payor-drawee for payment or acceptance and the payor-drawee pays or accepts the draft, (i) the person obtaining payment or acceptance, at the time of presentment, and (ii) a previous transferor of the draft, at the time of transfer, warrant to the drawee that pays or accepts the draft in good faith that:

a) The warrantor is a person entitled to enforce (Holder-PETE) the

check 4-208(a)(1), 3-417(a)(1)

b) The check has not been altered 4-208(a)(2), 3-417(a)(2) and c) The warrantor has no knowledge that the signature of the purported

drawer of the draft is unauthorized. 4-208(a)(3), 3-417(a)(3)

D. Upon Presentment (Stage 4) Only 1 of 2 Events Can Occur - Stage 5 or Stage 6 VII. Stage 5: Payment (Honor) of the Check by Payor-Drawee (Hat 3)

A. Why Pay? Sufficient Funds are Available, and Nothing Looks Wrong with the Check (i.e., Check appears to meet the Properly Payable Rule (Signed and Authorized))!

B. Only Payor-Drawee Bank can Pay Check = Make Final Payment

1. Two General Ways Payor-Drawee Bank Finally Pays Check (Payment Deadlines)

a. When Payor-Drawee Bank Pays Check in Cash 4-215(a)(1) b. When Payor-Drawee Bank Makes Provisional Settlement for Check and Fails to

Revoke the Settlement in Time and Manner Permitted by Statute, Clearing-house Rule, or Agreement 4-215(a)(3). 4-301 is such a Statute - And therefore Failure to Revoke Settlement and Return Check Before the Midnight Deadline is Thus Final Payment - This is How Final Payment Usually Occurs!

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1. Payment. Effect of Final Payment on Contract Liability = Over! = Drawer’s Liability on Check Discharged 3-602(a) = Drawer’s Liability on Underlying Obligation Discharged 3-310(b)(1) = Indorser’s Liability on Check Discharged 3-602(a)

2. Wrongdoing: Warranty Liability = Presenters and Transferors Liable to Payor-Drawee based on

the Presentment Warranties of (i.e., Promises made Upon Presentment of the Check that there are) No Alterations, Forged Endorsements and No Knowledge that the Drawer’s Signature is Forged. Effect of Final Payment on Warranty Liability - None!

VIII. Stage 6: Problem 1 - Dishonor and Return of the Check by Payor-Drawee

A. Dishonor by Payor-Drawee (Hat 3)

1. Primary Reason Checks are Not Paid (and Returned) = 1. Insufficient Funds to Pay the

Check. 2. Secondary Reasons: Checks are Not Paid = Stop Payment Order, Closed Account, No Account, Post Dated Check Notice, Stale Dated Check. etc.

B. Timing for Rightful Dishonor by Payor-Drawee (Hat 3)

1. Dishonor of Check Presented Over the Counter for Cash = Dishonor Occurs if the Check is Not Paid on Day of Presentment for Cash 3-502(b)(2) 2. Dishonor of Check Presented Over the Counter for Deposit - “On Us” Checks = Midnight

Deadline 3-502(b)(1), 4-104(a)(10)

3. Dishonor of Check Presented Through the Check Collection Process (When Check is Not Presented Over the Counter) = Midnight Deadline 4-302. 3-502(b)(1)


1. Dishonor: Contract Liability = Drawer and Indorser(s) Liable for Nonpayment of Check based on

the Contract (Liability based Signing and Endorsing the Check)

a. Problem: Drawers (People or Things) Don’t Pay Their Checks

1) Result: If Drawers Don’t Pay Their Checks, People Won’t Take and Rely On Checks if They Can’t Ultimately Get Paid

b. Problem Resolved by Contract Liability (The Obligation to Pay) (Liability based on

Signing Check) 3-411, 3-412, 3-413, 3-414, 3-415 (Problem Resolved by UCC!) 1) Who is Obligated to Pay? Anyone Who Signs the Check!

a) Drawers (Primary Liability). Bank-Drawers 3-412, Wrongful Refusal to Pay 3-411. Non-Bank Drawers 3-414

b) Indorsers (Secondary Liability) 3-415(a)

2) When are Signers Obligated to Pay? Upon Dishonor of Check!

3) Who can Require (“Enforce” or “Sue for”) Payment against the Indorsers

and Drawer? Holder-PETE (Person Entitled to Enforce) 1-201(20), 3-301

a) Holder in Due Course (HDC) (Super Holders). A HDC is a Holder-

PETE Who Took the Check for Value In Good Faith, and Who is Not Aware that Anything About Either the Check or the Underlying Transaction is Wrong (e.g., that Check is Overdue, been Dishonored,

contains an Unauthorized Signature, has been Altered, is Claimed by Another Person, etc.) 3-302

D. Statutes of Limitation 3-118, 4-111

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IX. Stage 7: Problem 2 - Liability on Checks for Wrongdoing - Claims for Alterations, Forged Endorsements and Forged Drawer’s Signatures

A. Problem: Wrongdoers Alter, or Forge Indorsements or Drawers’ Signatures on Checks and Deprive People of Their Money. Result: People Won’t Take, Rely On or Pay Checks if They Can’t Have Recourse Against Those Who Have Engaged in Wrongdoing. (Problem Resolved by UCC!) 1. Notification by Drawer of Wrongdoing (Q. How does drawer learn of wrongdoing?). Result: Payor-Drawee Must Recredit Drawer’s Account = Properly Payable Rule

a. Exceptions - Alterations & Forged Drawer’s Signatures (Negligence Rule 3-406 & Statement Rule 4-406)

B. Problem Resolved by Warranty Liability (Transfer and Presentment Warranties) (Liability based on Transferring or Presenting Check) 4-207, 3-416, 4-208, 3-417

1. Anyone Who Presents a Check for Payment Promises 1. No Alterations, 2. No Forged

Indorsements, but 3. Only No (Knowledge of) Forged Drawer’s Signatures.

2. Anyone Who Transfers a Check Promises 1. No Alterations, 2. No Forged Indorsements, 3. No Forged Drawer’s Signatures

C. Statutes of Limitation 3-118, 4-111

3-114. Contradictory Terms of Instrument If an instrument contains contradictory terms, typewritten terms prevail over printed terms, handwritten terms prevail over both, and words prevail over numbers.

4-404. Bank Not Obligated to Pay Check More Than Six Months Old A bank is under no obligation to a customer having a checking account to pay a check, other than a certified check, which is presented more than six months after its date, but it may charge its customer’s account for a payment made thereafter in good faith.

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