978-1285427003 Chapter 22 Lecture Note Part 3

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Additional Case: Wachovia Bank v. Foster Bancshares1

Facts: MediaEdge wrote a check for $133,026 on its account at Wachovia, payable to CMP Media.

Before CMP received the check, someone changed the name of the payee to Sunjin Choi Choi, and

deposited the altered check into Choi’s account at Foster Bancshares. Foster presented the check for

payment to Wachovia; Wachovia paid Foster from MediaEdge’s account. When MediaEdge learned that

CMP never received the check is sued Wachovia for reimbursement. Wachovia then sued Foster.

Issues: Who is liable for paying the stolen check: Wachovia or Foster?

Holding: Foster is liable for paying the stolen check. The check was altered, meaning an unauthorized

change in the check that purports to modify one party’s obligation. The specific warranty made by

Foster when it presented the check to Wachovia for payment was that the check had not been altered.

Because the check had in fact been altered when Foster presented it to Wachovia for payment, Foster

breached its presentment warranty.

General Questions

If students were asked to bring in checks, this would be the appropriate time to look at them. How

much space is usually left on the lines?

Question: Would it be easy or difficult to change the name of the payee on a check? Look

specifically at this case, changing the payee from CMP Media to Sunjin Choi Choi.

Answer: It would probably depend on the name on the line and how much space there was in

between the letters. Although we do not see the actual check in this case, it seems difficult to alter

the names of the payees without being obvious.

Question: If that is the case, why did Foster accept the check?

Answer: Probably because it did not pay close attention to the payee line.

Question: What have students learned about how to write checks?

Example

Frances-Rose Straith received a promotional check in the mail that looked like one of those from a

sweepstakes company. The check was made out to her from the “Office of the Treasurer” in the amount

of $95,093.35. She promptly deposited it. The check said, “Non-negotiable for cash,” but the young

teller who took the check thought that phrase meant Straith could only deposit the check, not cash it.

Before the bank discovered its error, Straith wrote checks to cover the purchase prices of both a car

and a pickup truck. She claims she had no idea the check she deposited was invalid, that she thought it

was either a tax refund or a payment from her father’s estate. Furthermore, she feels that the bank owes

her the money because it cashed the check. Bank officials, on the other hand, feel she has committed

fraud.2

Question: Did Straith violate her presentment warranties when she deposited the check for

$95,093.35?

Answer: Anyone who presents a check for payment warrants that she is a holder, the check has not

Question: Is Straith a holder?

Question: Is the check a negotiable instrument?

Answer: To be negotiable, an instrument must (1) be in writing, (2) be signed by the maker or

1 2005 U.S. Dist. LEXIS 16356, United States District Court for the Northern District of Illinois, 2005.

2 T. L. Henion, “Fake Check for $95,093 Fools Recipient, Bank,” Omaha World-Herald, June 13, 1995, p. 1.

said “Non-negotiable for cash,” which means that it did not contain an unconditional promise or

order to pay. Therefore, it was not negotiable.

Question: Was the check validly negotiated?

Question: So—has Straith violated her presentment warranties?

Question: What is the impact of violating her presentment warranties?

Other Liability Rules

Conversion Liability

Conversion means that (1) someone has stolen an instrument or (2) a bank has paid a check that has a

forged indorsement. The rightful owner of the instrument can recover from either the thief or the bank.

Impostor Rule

If someone issues an instrument to an impostor, then any indorsement in the name of the payee is valid

as long as the person (a bank, say) who pays the instrument does not know of the fraud.

Example

A stranger knocked on Sam Crisp’s door one day to warn him that his lightning rod needed repair.

Crisp, who was in his late 70s, agreed to $12.50 worth of repairs. Hindered by poor eyesight and

arthritis, Crisp allowed the stranger to fill out a check in that amount. He did note, however, that the

payee space was blank and there was a lot of open space preceding the number $12.50. The stranger

promised to fill in the blanks, which he did, with the number $6212.50. When the stranger presented

the check for payment at Crisp’s bank, he used as an ID a Kentucky driver’s license with a black and

white photo and a business address. Valid licenses have color photos and the driver’s home address.

Meanwhile, elderly Mr. Crisp became suspicious and tried to call the bank, only to discover his phone

line had been cut.3

Under the impostor rule, if someone issues an instrument to an impostor, the bank is not liable

unless it knew of the fraud. However, if both the bank and the issuer of the instrument are negligent,

they share the loss according to their negligence.

Question: Who is negligent in this case?

Answer: The bank: The check showed no sign of having been altered, but the check was large and

payable to a stranger, and the Kentucky driver’s license the con artist used as an ID was clearly

Question: Who lost?

Fictitious Payee Rule

3 Sy Ramsey, “The Associated Press File,” Associated Press, Aug. 31, 1979.

If someone issues an instrument to a person who does not exist, then any indorsement in the name

of the payee is valid as long as the person (a bank, say) who pays the instrument does not

know of the fraud.

Employee Indorsement Rule:

If an employee with responsibility for issuing instruments forges a check or other instrument, then

any indorsement in the name of the payee, or a similar name, is valid as long as the person

(a bank, say) who pays the instrument does not know of the fraud.

Example

Mary Anne Nichols, a low-level clerk, embezzled almost $500,000 from the Student Services Division

of the University of California at Santa Cruz. She wrote 202 checks to imaginary speakers for

conducting non-existent workshops and then forged indorsements before depositing the checks in her

own bank account. A teller at her bank finally noticed that the clerk had deposited eight university

checks in a 10-day period. The Student Services Division had never been audited and had no budget or

accounting oversight.4

Question: The embezzler is a “low-level” clerk. Did she have responsibility for issuing checks?

What difference does it make whether or not she had responsibility?

Question: Did Nichols commit single or double forgeries?

Question: Does it matter if the bank was negligent?

Question: Was the bank negligent?

Question: Was the university negligent?

Answer: Yes. The Student Services Division had no budget or accounting oversight and had never

Question: What could Santa Cruz have done to prevent this large loss?

Answer: It is difficult to prevent an employee from being dishonest, but this scheme went on for a

Negligence

Anyone who behaves negligently in creating or paying an unauthorized instrument is liable to an

innocent third party.

Additional Case/You Be the Judge: Gulf States Section, PGA, Inc. v.

Whitney National Bank of New Orleans5

Facts: Adrenetti Collins was a secretary who worked in the PGA office. During a four-month period,

she forged 18 PGA checks totaling $22,699.81. To avoid detection, she intercepted two of the bank

4 Maria Alicia Gaura, “UC Santa Cruz Embezzler Gets 5 Years; Maximum Sentence Imposed on College Clerk,”

San Francisco Chronicle, March 29, 1994, p. A20.

5 689 So. 2d 638, 1997 La. App. LEXIS 167 Court of Appeal of Louisiana, Fourth Circuit, 1997.

statements sent by Whitney National Bank and replaced them with forged statements that left out the

numbers of the checks she had stolen. The usual Whitney statement was printed on vanilla-colored

paper measuring a non-standard 6 ¾  11 inches. The forged statements were on standard 8½  11 inch

white paper. They were not dated but they did contain the Whitney logo. Collins’s boss, Robert Brown,

received two forged statements and then no statements at all for two months.

Whitney’s policy was to verify signatures on checks equal to or greater than $5,000. One of the

forged checks was in the amount of $5,000, but Whitney did not verify Brown’s signature before

paying it. Brown’s signature was a semi-legible letter or two and a long loop. The forged signature on

the check looked very similar to the real one.

Issue: Is Whitney liable to the PGA for the forged checks it paid?

Holding: Judgment for Whitney. The court held that Brown was negligent and that his negligence

substantially contributed to the forgeries. Furthermore, there was no evidence that Whitney had

violated reasonable commercial standards. Other Louisiana banks, for example, only verify checks for

more than $10,000 or even $20,000. Also, the forged signature was so similar to Brown’s real signature

that, even if it had been verified, the forgery would probably not have been detected.

Question: Aren’t banks liable if they pay forged checks?

Question: Was the PGA negligent in this case?

Answer: The court held that it was. The blank checks should have been locked up and Brown

Question: Wasn’t the bank negligent, too? After all, it violated its own policy by cashing a $5,000

check without verifying the signature.

Answer: There is no rule that banks must verify checks over a certain amount. Indeed, a number of

Question: Who would be liable if both the PGA and the bank were negligent?

Multiple Choice Questions

1 Which of the following statements are true?

(a) A draft is always a check.

(b) A check is always a draft.

(d) All of the above.

2 Which of the following standards is required for negotiability:

(a) The instrument must be signed by the payee.

(b) The instrument must be payable on demand.

(d) None of the above.

3 Marla is not a holder in due course if she takes an instrument:

(a) Believing that the underlying contract was honest, although it turned out to be dishonest.

(b) That is a consumer credit contract.

(d) All of the above.

4. CPA QUESTION In order to negotiate bearer paper, one must:

(a) indorse the paper

(b) indorse and deliver the paper with consideration

(d) deliver and indorse the paper

5. What is the difference between a co-maker and an accommodation party?

(a) A co-maker is liable both to the holder and the other co-maker, an accommodation party is

liable only to the holder

(b) A co-maker is liable to subsequent indorsers, an accommodation party is not

holder

(d) A co-maker is not liable once a bank certifies a check, an accommodation party is still liable

even after certification.

Essay Questions

1. Duncan Properties, Inc. agrees to buy a car from Shifty for $25,000. The company issues a

promissory note in payment. The car that Duncan bought is defective. If Shifty still has the note,

does Duncan have to pay it?

2. Shifty sells that note to Honest Abe for $22,000. Does Duncan have to pay Abe?

3. Kay signed a promissory note for $220,000 that was payable to Investments, Inc. The company

then indorsed the note over to its lawyers to pay past and future legal fees. Were the lawyers

holders in due course?

Answer: The lawyers could not be holders in due course unless they had given value for the note.

4. Shelby wrote the following check to Dana. When is it payable and for how much?

5. Railroad issued a check to Parris which, somehow, came to be in Eddy’s possession. Eddy indorsed

the check “Railroad Eddy” and deposited it in his own account at Bank. Parris sued Bank, alleging

that it was liable to him for having paid the check over an unauthorized indorsement. Is Bank liable

to Parris? On what theory?

Answer: An unauthorized indorsement is the same as a forged indorsement. The court held that the

6. Sidney entered into a contract for $35,000 with MacDonald Roofing Co., Inc., to reroof his

building. Sidney made his initial payment by writing a check for $17,500 payable to “MacDonald

Roofing Company, Inc., and Friendly Supply Company.” MacDonald took the check to Friendly

and requested an indorsement, which Friendly provided. When MacDonald failed to complete the

roofing work, Sidney filed suit for damages against Friendly. Sidney argued that Friendly was

liable as an indorser. Do you agree?

Answer: Indorsers are secondarily liable; they must pay if the issuer does not. However, they are

7. Using her company’s check-signing machine, Doris forged $150,000 of checks on the account of

her employer, Winkie, Inc. One of Doris’s jobs at the company was to prepare checks for the

company president, Willie, to sign. He did not (1) look at the sequence of check numbers; (2)

examine the monthly account statements; or (3) reconcile company records with bank statements.

Willie’s bank, as a matter of policy, did not check indorsements on checks with a face value of less

than $1,000. By accident, it paid a forged check that had not even been indorsed. Is the bank liable

to Winkie, Inc., for the forged checks?

Answer: The court found for the bank on the grounds that the owner of the company had been

8. ETHICS When Steven was killed in an automobile accident, he left his wife, Debra a life

insurance policy for $60,000. She decided to move from Bunkie to Sulphur, Louisiana. Debra

executed a document authorizing her mother-in-law, Helen, to sign checks on Debra’s account at

the bank. Debra also signed several blank checks and gave them to Helen with instructions to use

them to pay off the remaining debt on Debra’s trailer. When Helen received the life insurance

checks, she deposited them in Debra’s account. So far so good. But then she immediately withdrew

$50,000 from the account by using one of the blank checks Debra had left her. She did not use these

funds to pay off the trailer debt. When Debra discovered the theft, she sued the bank for having

paid an unauthorized check. How would you rule in this case? Debra has suffered a grievous loss—

her husband died tragically in an automobile accident. She trusted her mother-in-law and counted

on her help. Should the bank show compassion? If the bank made good on the forged checks, how

great would be the injury to the bank’s shareholders compared with the harm to Debra if she loses

this entire sum?

Answer: The court held that Debra had been negligent in leaving blank checks with her

Discussion Questions

1. In the Buckeye case, the court ruled that Buckeye was not a holder in due course and the check was

not valid because Buckeye should have checked with Sheth’s bank before buying the check. Would

this remedy have worked? What could Buckeye have done to protect itself?

Answer: Buckeye bought the check on October 13. At that point, Sheth had not stopped payment.

Even if Buckeye had called Sheth’s bank, it would still not have known about the stop payment

2. In the Antuna case, the Antunas were foolish to sign an agreement with an unlicensed contractor to

install aluminum siding. There is no evidence that TMS was acting in bad faith. Why should it

suffer for the Antunas’ mistake? What could TMS have done to protect itself?

3. Recall the Quimby case. This type of fraud is increasingly common. What could Quimby have done

to protect himself?

Answer: When dealing with strangers, only accept cashier’s checks. In this case, Quimby obtained

a cashier’s check himself, but by then it was too late because the check Quimby had used to pay for

4. Catherine suffered serious physical injuries in an automobile accident and became acutely

depressed as a result. One morning, she received a check for $17,400 in settlement of her claims

arising out of the accident. She indorsed the check and placed it on the kitchen table. She then

called Robert, her long-time roommate, to tell him the check had arrived. That afternoon, she

jumped from the roof of her apartment building, killing herself. The police found the check and a

note from her, stating that she was giving it to Robert. Had Catherine negotiated the check to

Robert?

Answer: The court held that Catherine had negotiated the check to Robert. By indorsing the check

5. Banks are liable for forged checks except in the case of the three rules (Imposter Rule, Fictitious

Payee Rule, and the Employee Indorsement Rule). Do you think this is the proper allocation of

liability? Why should banks be liable for forged checks, in this era of automated check machines?

Alternatively, could you argue that the three rules provide too much protection to banks?