Check Fraud Liability in the Wake of Check 21
By: BEAU J. HURTIG
March 2007
The Check Clearing for the 21st Century Act, better known as Check 21, is revolutionizing check processing. By allowing banks to convert checks into electronic images, Check 21 and the accompanying modifications to Regulation CC have the potential greatly to reduce administrative costs associated with physically transporting and storing checks. In addition, processing times can be reduced, and many banks are even developing various remote capture products that provide merchants the ability to scan check images directly from their stores for deposit in their accounts at the bank. Clearly Check 21 and its implementing regulations can be of great benefit to banks and the check processing system as a whole. However, Check 21 created at least one uncertainty: how would courts resolve evidentiary issues related to check fraud if the original check were destroyed. On July 24, 2006, the Seventh Circuit Court of Appeals decided a case entitled Wachovia Bank, N.A. v. Foster Bancshares, Inc. and Foster Bank that helps shed some light on this issue.
Check fraud was a primary issue commentators raised when banking regulators developed amendments to Regulation CC designed to implement Check 21. Commentators were concerned about whether banks would suffer in check fraud litigation due to the fact that the original check was destroyed, thus eliminating much forensic evidence typically gathered from original checks, such as pen pressure and fingerprints. In response to these concerns, the banking regulators chose not to develop a mandatory retention period for original checks, and instead instructed banks and others to take fraud risks into account when deciding whether to destroy original checks. Considering the advantages of creating electronic images and the relatively infrequent occurrence of fraud, many banks decided to destroy the original checks after a short period of time. However, bankers making this decision were left wondering if the inability to produce the original check would come back to haunt them in litigation.
The Wachovia Case
The Wachovia case involved a classic example of check fraud. The perpetrator deposited a check payable to her in the amount of $133,026 in her account at Foster Bank (Foster). The check was a commercial check drawn on a company’s account at Wachovia Bank, N.A. (Wachovia). After Foster presented the check to Wachovia for payment, Wachovia paid the check and debited the company’s account at Wachovia. It was not until much later, when the intended payee of the check inquired as to why it had not received payment, that the company and Wachovia discovered the fraud. In the ensuing investigation, it was discovered that the perpetrator had substituted her name for that of the actual payee, deposited the check, and skipped town with the proceeds. Since the perpetrator was out of the picture, the company sued Wachovia, and Wachovia in turn sued Foster for breach of presentment warranties.
The Parties’ Arguments under the UCC
Under the Uniform Commercial Code (UCC), presenting depository banks such as Foster make certain presentment warranties when presenting checks for payment, one of which is that the check has not been altered. On the other hand, the bank on which the check is drawn (Wachovia) warranties that the check is genuine and has not been forged. Typically, in schemes where the payee’s name has been changed, the perpetrator simply alters the original check so that the true payee’s name is switched to the perpetrator’s name, so the presenting depository bank (Foster) is liable.
In the Wachovia case, Foster argued that it was plausible that the perpetrator used advanced technology to reproduce an exact replica of the check, including the forgery of the signature of the company’s authorized representative, with the exception that the perpetrator inserted her own name as payee. Under this theory, the perpetrator had forged the check, and Wachovia bank was liable for breach of its UCC warranty that the check was genuine. Therefore, the case hinged on whether the check was altered (in which case Foster would be liable) or forged (in which case Wachovia would be liable). Foster further argued that the only way to resolve this issue was to examine the original check; however, Wachovia had destroyed the original and could not satisfy its evidentiary burden to attain judgment against Foster for breach of presentment warranty and recovery of the $133,026.
The Court’s Analysis
The court recognized that “when checks were inspected by hand, when copying technology was primitive, and when cancelled checks were stored rather than digitized copies alone retained,” the UCC allocation of loss principles based on alteration or forgery were consistent with the principle that liability for loss should rest with the party that could prevent the loss at a lower cost. However, due to technological advancements in copying technology, the presenting depository bank could no longer readily determine whether checks were simply altered or whether they were completely recreated and forged. The court ultimately decided to maintain the status quo by placing liability on Foster, the presenting depository institution. The court reasoned that classic fraud under the circumstances involved check alteration and that is what likely occurred in this case.
Conclusion
The Wachovia case demonstrates that at least one federal jurisdiction is reluctant to ripple the water when it comes to established principles regarding check liability in forgery cases, despite the progression of technology and modification of law. Additionally, the court seemed reluctant to reach a decision making it advantageous from a litigation standpoint for banks to retain original checks, thus eliminating one of the major efficiencies created by Check 21. Although litigation related risks remain in destroying original checks, the Wachovia case should provide banks with some comfort that courts may be reluctant to create an incentive to retain original checks.