Thursday, October 15, 2015

Restrictive Indorsements & Conversion

The memorandum below is a continuation of last week’s post.  I am reproducing the facts again to put the discussion below into context.

                                                            The Facts

Jerry Zamanski is a salesman at Stephen’s boats. On December 21, 2005 Stephen’s Boats issued an $850 commission check to Jerry. Jerry wrote ‘for deposit only’ on the back of the check and placed it in his desk drawer. Jerry’s identical twin brother Harold stole the check & raised it from $850 to $8,500. Harold took the altered check to East Dade Bank, where Jerry had his account.

Harold explained to the teller, that he had changed his mind on depositing the check and wanted cash for an upcoming vacation. The teller knew Jerry very well, and had done business with him for many years and, believing Harold to be Jerry, allowed him to cross out ‘for deposit only’ followed by his initials. Harold then signed Jerry’s name and was given $8,500 in cash. Two weeks later, the theft, alteration and forgery were discovered.

Stephen’s bank, South Dade, has charged his account $8,500. Jerry has asked Stephen to give him another commission check. Stephen would like an analysis of this situation. Particularly, Stephen wants to know whether he is responsible for the charge to his account, and whether he must reissue the commission check to Jerry.
I would appreciate it very much if you would review these facts in light of the relevant law contained in the Uniform Commercial Code.

Overview: Part II


(A) The Restrictive Indorsement;
(B) Person Entitled to Enforce the Instrument;
(C) The Alteration;
(D) When Payor Bank May Charge Customer’s Account;

A.   The Restrictive Indorsement
You have indicated that when Jerry received the check, he wrote the words “for deposit only” on the back of it. With this language, and accompanying indorsement, this would have been a restrictive indorsement of the check under Section 3-206(c):

If an instrument bears an indorsement ... using the words “for deposit” “for collection,” or other words indicating a purpose of having the instrument collected by a bank for the indorser or for a particular account. . .[it is a restrictive indorsement].
A Depository Bank has strict duties when it receives a check which is restrictively indorsed:

A depository bank that purchases the instrument or takes it for collection when so indorsed converts the instrument unless the amount paid by the bank with respect to the instrument is received by the indorser or applied consistently with the indorsement. Section 3-206(c)(2).
Therefore, any credit given by East Dade for the check should have been “deposited” to Jerry’s account. Harold clearly had no authority to alter the restrictive indorsement. Furthermore, his forged signature of Jerry is ineffective to transfer any rights in the check.[1]

B. Person Entitled to Enforce the Instrument

The only person who was entitled to enforce the instrument as it was originally made out was Jerry:

Person entitled to enforcean instrument means:
i.      the holder of the instrument;
ii.     a nonholder in possession of the instrument who is entitled to enforce the instrument; or
iii.   a person not in possession of the instrument who is entitled to enforce the instrument pursuant to 3-309 [Lost or Stolen Instruments] or 3-418(d) [Payment by Mistake]. Section 3-301(i)(ii)(iii).

Sections 3-301(ii)(iii) are outside the general movement of checks and in any event do not apply here. Under Section 3-301(i), the only person entitled to enforce the instrument would be the holder, which is defined as follows:

Holder means: the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is in possession. Section 1-201(b)(21)(A).

Harold was not a bearer of the check simply because he had possession of it:

A promise or order is payable to bearer if it:

(1) states that it is payable to bearer or to the order of bearer or otherwise indicates that the person in possession of the promise or order is entitled to payment. Section 3-109(a)(1).

The check was payable to an identified person—Jerry. While in possession, he would have been the holder, and the only person who could have that status [unless he indorsed it]. Therefore, Harold was not a holder, and hence not “entitled to enforce” the instrument.

A.   The Alteration
When Harold raised the check to $8,500, he altered the item:

Alteration” means (i) an unauthorized change in an instrument that purports to modify in any respect the obligation of a party ... Section 3-407(a).[2]

Of course, in raising the check, the obligation of the drawer was changed from $850 on the check to $8,500. The unauthorized change in the instrument [the check] purported to modify the contract of the drawer [Stephen’s Boats]. Additionally, the change of the restrictive indorsement purported to modify the obligation of East Dade Bank, and was itself an alteration.
The fact that an alteration occurred in the instant situation, however, does not insure that the drawer’s account may not be charged.

A person whose failure to exercise ordinary care substantially contributes to an alteration of an instrument or to the making of a forged signature on an instrument is precluded from asserting the alteration or the forgery against a person who, in good faith, pays the instrument or takes it for value or for collection. Section 3-406(a).

In the present case, Stephen probably issued the check via customary business practices, and would not be within 3-406(a). If however, he would have written the check in pencil, and such conduct, were deemed ‘a failure to exercise ordinary care [which] substantially contribute[d] to the alteration’ Stephen would be precluded from asserting the alteration against the bank, provided, that the bank paid in accordance with the standard set forth in Section 3-406(a).
Similarly, if Jerry were found somehow to be negligent within Section 3-406, he would be similarly precluded from asserting the alteration against his bank. [For example, would it matter if Harold had a history of theft, forgery, or was known to be in desperate need of money?  These are the types of questions that are activated once you get into the facts of a particular case. Does Harold, being an identical twin, figure into this at all?]

D. When a Payor Bank May Charge
Customer’s Account
Part 4 of Article 4 deals with the relationship between the payor bank and its customer, here, South Dade and Stephen. Section 4-401 states when a bank may charge its customer’s account and reads in relevant part as follows:

A bank may charge against the account of a customer an item that is properly payable from the account even though the charge creates an overdraft. An item is properly payable if it is authorized by the customer and is in accordance with any agreement between the customer and the bank. Section 4-401(a).

In the present situation, Stephen’s Boats did not authorize payment in the amount of $8,500, nor did he authorize payment to Harold. Therefore, the item is not ‘properly
payable’ and Stephen should have his account recredited [unless he fell within Section 3-406].
If on the other hand, Jerry had altered the item and taken it for collection, the indorsement would have been effective, and Stephen’s account could have been charged, although not $8,500:

(d) A bank that in good faith makes payment to a holder may charge the indicated account of its customer according to:
(1)  The original terms of the altered item;
(2)  The terms of the completed item, even though the bank knows the item has been completed unless the bank has notice that the completion was improper.
Section 4-401(d)(1)(2).

If in fact Jerry had altered the item, Section 4-401(d)(1) would control. East Dade would have been a ‘holder’ within 1-201(b)(21)(A) since Jerry would have endorsed the check to its order. South Dade would have made a good faith payment to East Dade, and therefore would be entitled to enforce the instrument according to its original terms.
Among the ‘original terms’ of the altered item was the amount to be paid. That amount was $850 and thus, South Dade would be entitled to charge Stephen’s account at least that amount.[3]


[1] Subsection (a) to Section 3-403 states in pertinent part:
…[A]n unauthorized signature is ineffective except as the signature of the unauthorized signer in favor of a person who in good faith pays the instrument or takes it for value….
Therefore, Harold’s signature was not ‘effective’ as Jerry’s, but in fact operated as Harold’s.
Furthermore, Jerry would not be liable on the instrument since neither he, nor his authorized representative signed it:
A person is not liable on an instrument unless (i) the person signed the instrument, or (ii) the person is represented by an agent or representative who signed the instrument and the signature is binding on the represented person under Section 3-402. Section 3-401(a). 
[2] The obligations of the drawer and endorser are set forth in Sections 3-414 and 3-415 respectively. These sections are discussed in detail later in the book but are reproduced here in case the reader wants to examine the respective obligations of drawer or indorser (in connection with the statement which was the basis for this footnote).
 
[3] Before leaving this case, a few other points should be briefly noted. First, South Dade Bank would have a cause of action against East Dade Bank for breaching warranties under Section 4-207(a)(1)(2)(3):
(a)  A customer or collecting bank that transfers an item and receives a settlement or other consideration warrants to the transferee and to any subsequent collecting bank that:
(1) the warrantor is a person entitled to enforce the instrument;
(2) all signatures on the instrument are genuine and authorized;
(3) the item has not been altered.
It should also be noted that East Dade would have a cause of action against Harold for similar warranties under Section 3-417(a)(1)(2)(3). [See Statutory Supplement for text of these sections.]  Finally, a customer of a bank, such as Stephen, is under a duty to promptly examine his bank statement to discover forgeries or alterations which must be promptly reported to the bank:
If a bank sends or makes available a statement of account or items pursuant to subsection (a), the customer must exercise reasonable promptness in examining the statement or the items to determine whether any payment was not authorized because of an alteration or an item or because a purported signature by or on behalf of the customer was not authorized. If, based on the statement of the items provided, the customer should reasonably have discovered the unauthorized payment, the customer must promptly notify the bank of the relevant facts. Section 4-406(c).
If the bank proves that the customer failed with respect to an item, to comply with the duties imposed on the customer by subsection (c), the customer is precluded from asserting against the bank:
(1) the customer’s unauthorized signature or any alteration on the item, if the bank also proves that it suffered a loss by reason of the failure…. Section 4-406(d)(1).



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