633
Chapter 27
Checks and Banking in the Digital Age
See Separate Lecture Outline System
INTRODUCTION
Article 3 and Article 4 of the Uniform Commercial Code (UCC) govern checks. The extent to which any party is either
charged with or discharged from liability on a check is established according to the provisions of Article 3. Article 4 is a
statement of the principles and rules of modern bank deposit-and-collection procedures. It governs the relationship of banks
634 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
ADDITIONAL RESOURCES—
VIDEO SUPPLEMENTS
The following video supplements relate to topics discussed in this chapter—
PowerPoint Slides
CHAPTER OUTLINE
I. Checks
A check is a draft drawn on a bank [UCC 3–104(f)]. If any institution other than a bank, as defined in UCC 4–105(l),
handles a check for payment or collection, the check is not covered by Article 4.
A. CASHIER’S CHECK
A cashier’s check is a check drawn by a bank on itself; negotiable on issue [UCC 3–104(g)]. A teller’s check is a draft
drawn by a bank on another bank, or if drawn on a nonbank, payable at or through a bank [UCC 3–104(h)].
CASE SYNOPSIS—
Case 27.1: MidAmerica Bank, FSB v. Charter One Bank, FSB
Mary Christelle bought a $50,000 cashier’s check from Charter One Bank payable to Essential Technologies of
Illinois (ETI)). ETI deposited the check in its account with MidAmerica Bank, FSB. Four days later, Christelle asked
Charter One to stop payment. Charter One agreed and refused to honor the check. MidAmerica returned it to ETI.
Within two weeks, ETI’s account had a negative balance of $52,000. MidAmerica closed the account and filed a suit in
an Illinois state court against Charter One, alleging that the defendant wrongfully stopped payment on the cashier’s
check. Charter One argued that a cashier’s check should be treated as a note subject to the defense of fraud. The court
ruled in MidAmerica’s favor. A state intermediate appellate court reversed. MidAmerica appealed.
items drawn “on the customer’s account.” A cashier’s check is drawn on the issuing bank, not the customer’s account.
As for Charter One’s argument that the check should be treated as a note, the court acceded that the liability of the
CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 635
cannot assert fraud as a defense because it did not know of any fraud when it dishonored the check.
…………………………………………………………..……………………………………………………………………
Notes and Questions
Can the buyer of a cashier’s check cancel the check before it is delivered or negotiated to the payee? Yes. The
party who buys the check retains the right to cancel it before the check enters the stream of commerce by
surrendering it to the issuing bank. In this case, that would have meant that Christelle could have canceled the cashier’s
check payable to ETI before giving it to ETI by returning it to Charter One.
Why might a party buy a cashier’s check and not deliver it to the payee? A party might acquire a cashier’s check to
after it was dishonored..
ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?” IN CASE 27.1
Suppose that the court had accepted Charter One’s argument that a cashier’s check should be treated as a note
and the bank had presented proof of fraud in the procurement of the check. What might have been the result in this
case? Explain. Charter One would most likely contend that it issued the check based on false statements by ETI on
which basis the bank should be able to avoid payment. Because fraud is a personal defense, the contention would have
to include that MidAmerica was an ordinary holder, not a holder in due course. The argument might be that
MidAmerica knew, or should have known, ETI was in a precarious financial situation when it accepted the check. And
Charter One would have to show that it learned of the fraud before it dishonored the check.
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Recent cases in which cashier’s checks or other bank checks were at the center of the dispute include the
following.
dishonored draft—the check was not dishonored because the payee never presented it to the drawee bank for
636 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 637
B. TRAVELER’S CHECK
A traveler’s check is a check on which a financial institution is both drawer and drawee. The buyer must sign it
twice (buying it and using it) [UCC 3–104(i)].
C. CERTIFIED CHECK
A certified check is a check accepted by the bank on which it is drawn [UCC 3–409(d)]. When a bank certifies a
check, it immediately charges the drawer’s account and transfers those funds to its own account. This discharges
the drawer and prior indorsers [UCC 3–414(c), 3–415(d)].
II. The Bank-Customer Relationship
A. CREDITOR-DEBTOR RELATIONSHIP
B. AGENCY RELATIONSHIP
A principal-agent relationship underlies the check collection process.
C. CONTRACTUAL RELATIONSHIP
The rights and duties of a bank and its customer are contractual and depend on the nature of the transaction.
III. The Bank’s Duty to Honor Checks
When a drawee bank wrongfully fails to honor a check, it is liable to its customer for damages resulting from the refusal
[UCC 4–402]. But the bank’s duty is not absolute: if the bank properly dishonors a check for insufficient funds, it has no
liability to the customer.
A. OVERDRAFTS
B. POSTDATED CHECKS
If a bank charges a postdated check against a customer’s account, despite the customer’s timely notice to the
bank of the postdating, the bank may be liable for any damages to the customer as a result [UCC 4–401(c)].
ADDITIONAL BACKGROUND—
Overdrafts
In a bank-customer relationship, the basic interaction occurs when a customer presents an instrument (a check, for
638 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
instance) to the right bank in a timely manner, so that the instrument can be paid and all parties’ accounts can be
adjusted appropriately.
Payment of an instrument creating an overdraft has caused some controversy. Unrevised Article 4 is not clear
about whether a bank can create an overdraft without customer authorization [UCC 4–401]. Revised Article 4 clarifies
C. STALE CHECKS
A bank is not obligated to pay an uncertified check presented more than six months from its date, but it has that
option [UCC 4–404].
D. DEATH OR INCOMPETENCE OF A CUSTOMER
E. STOP-PAYMENT ORDERS
Only a customer can order his or her bank to pay a check, and only a customer can order payment stopped,
although there are time limits, as noted in the text [UCC 4–403(a)].
1. Bank’s Liability for Wrongful Payment
2. Customer’s Liability for Wrongful Stop-Payment Order
The holder can sue the drawer for the amount of the check and consequential damages.
ENHANCING YOUR LECTURE—
HOW TO USE STOP-PAYMENT ORDERS
CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 639
MONETARY COSTS AND RISKS
One reason is monetary: banks usually charge between $15 and $25 for a stop-payment order, so stopping
payment is not cost-effective for a check written for a small amount. Another reason is the risk attached to the issuing
of a stop-payment order for any drawer-customer. The bank is entitled to take a reasonable amount of time to put
WHEN YOU CAN STOP PAYMENT
Remember that, to avoid liability, a drawer must have a legal reason for issuing a stop-payment order. You cannot
stop payment on a check simply because you have had a change of heart about the wisdom of your purchase.
CHECKLIST FOR STOP-PAYMENT ORDERS
2. Make sure that your bank will honor your stop-payment order before the payee cashes the check.
3. Make sure that you have a legal reason for issuing the stop-payment order.
F. FORGED DRAWERS’ SIGNATURES
1. The General Rule
A forged signature on a check has no legal effect as the signature of a drawer [UCC 3–403(a)]. The bank is
responsible for determining whether the signature is genuine. The parties may agree that the customer is
2. Customer’s Liability for Wrongful Stop-Payment Order
If the bank pays on a forged signature, it must recredit the customer’s account unless the customer’s
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or
in part.
Case 27.2: Auto-Owners Insurance Co. v. Bank One
Wulf worked for Auto-Owners Insurance Co. He opened a checking account at Bank One in the name “Auto–
Owners, Kenneth B. Wulf.” Over an eight-year period, he deposited $546,000 in Auto-Owners’ checks that he stole and
endorsed with a stamp that said “Auto–Owners Insurance Deposit Only.” When the scam was discovered, Auto-Owners
filed a suit in an Indiana state court against Bank One, contending that the defendant failed to exercise ordinary care in
in the name of Auto-Owners. The courts ruled in the defendant’s favor. Auto-Owners appealed.
…………………………………………………………..……………………………………………………………………
Notes and Questions
In circumstances such as those in the Auto-Owners case, should a customer have the burden of proving a lack of
ordinary care on the part of its bank, or should the bank have to show that it exercised ordinary care? The burden of
demonstrating lack of ordinary care falls on the person or entity that is asserting the lack. In this case, of course, that
was the plaintiff customer.
Why should a customer have to report a forged or unauthorized signature on a paid check within a certain time to
recover the amount of the payment? The consequence of a customer’s failure to report a forged or unauthorized
ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”
QUESTION IN CASE 27.2
What reasonable steps could Auto-Owners have taken to prevent such internal fraud? Spot audits of the check
handling process would have uncovered the scam. This was not rocket science. It was uncovered, as such things often
are, when Wulf was on vacation and another employee handled some of his files. To allow this to go on for eight years
shows negligence in the design of the audit process at Auto-Owners.
CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 641
ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?” IN CASE 27.2
Would the outcome in this case have been changed if Auto-Owners had never given Wulf (and other staff
members) the authority to deposit checks to its bank account? Why or why not? It would not likely have changed the
court’s holding in this case because the UCC section involved in this case, UCC 3–405(b), does not mention a bank’s
responsibilities when opening an account for a new customer. Instead, that UCC section requires that a bank exercise
642 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
a. Timely Examination of Bank Statements Required
A customer must examine monthly statements and canceled checks and report any forged signatures
promptly [UCC 4–406(a), (b)]. (If a bank does not send the checks, it must keep them, or copies of
them, for seven years.) If a customer fails to do this, he or she is liable for any loss to the bank [UCC 4–
406(d)].
c. Negligence and the Bank’s Duty of Care
If the bank is also negligent, the bank is also liable on a comparative negligence basis [UCC 4–406(e)].
It is not negligence to fail to examine every signature on every check [UCC 3–103(a)(7)].
CASE SYNOPSIS—
Case 27.3: Schultz v. Bank of America, N.A.
Robin Holbrook appeared to be acting as Melvin Schultz’s caregiver when she moved into his home and her name
was added to his account with Bank of America. After Schultz’s death, his son Stephen filed a suit against the bank,
alleging negligence in the adding of Holbrook’s name. He alleged that this violated the bank’s duty of ordinary care
without offering expert testimony as to that duty. The court issued a judgment in Stephen’s favor. On the bank’s
appeal, a state intermediate appellate reversed. Stephen appealed.
…………………………………………………………..……………………………………………………………………
Notes and Questions
In the circumstances of this case, it appears that Stephen filed a suit against the bank on the ground of negligence
because the purported forgeries were not reported timely. Why should a customer have to report a forged or
unauthorized signature on a check within a certain time to recover the amount of the payment? The consequence of a
customer’s failure to report a forged or unauthorized signature under these circumstances is the opportunity
presented to the wrongdoer to repeat his or her misdeeds.
Would the result in this case have been different if the bank had made Schultz’s canceled checks available for
review online? Probably not, because the method by which the bank made customers’ canceled checks available for
CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 643
their review was not a factor in the court’s determination of the bank’s liability in this case. The issue was whether
Stephen should have presented expert testimony to show the bank’s duty of ordinary care. If the checks had been
viewable online, however, and Stephen had had access, this litigation and the events that led to it might have been
prevented.
Does a bank have a duty to protect its customers from their own vulnerability? Why or why not? No. To assert this
duty is to argue that banks should protect their customers from themselves. Under the circumstances of this case, the
bank owed its customer no such duty.
ANSWERS TO QUESTIONS AT THE END OF CASE 27.3
1. “Expert testimony should not be required to inform jurors of what a reasonable standard of care should be in
commonplace banking transactions.” Do you agree with this statement? Why or why not? The Uniform Commercial
Code (UCC) does not specify what degree of care is required in specific banking transactions. Rather, the UCC defines
ordinary care on the part of a bank within the broad framework of commercial reasonableness and the procedures
commonly used by banks in the relevant region. This means that it is up to the courts to determine, on a case–by-case
basis, whether a bank has exercised ordinary care in a particular situation. Not surprisingly, courts—and even judges
within the same court—have disagreed in their conclusions. However you answered this question, you have support
2. Suppose that both Schultz and the bank had been found negligent in the addition of Holbrook’s name to Schultz’s
account. In this situation, which party would be liable for any damages resulting from the negligence? Explain. When
both the bank and the bank’s customer are found to have been negligent, both parties will be liable for any damages
caused by the negligence. Generally, the loss will be allocated between the bank and the customer on the basis of
comparative negligence.
d. One-Year Time Limit
644 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 645
e. Other Parties from Whom the Bank May Recover
The bank may recover from the forger—a forged signature is effective as the signature of the
G. CHECKS BEARING FORGED INDORSEMENTS
A bank that pays a customer’s check bearing a forged indorsement must recredit the customer’s account or be
liable to the customer for breach of contract (unless the customer fails to report the forgery within three years
after the item with it was available to the customer [UCC 4–111]). The bank in turn can recover from the bank
that sent it the check, and so on up the line to the first party who took the check with the forgery.
H. ALTERED CHECKS
If the bank pays an altered check, it is liable to its customer for the difference between the check’s original
amount and the amount paid [UCC 4–401(d)(1)].
1. Customer Negligence
A customer’s negligence can shift the loss (unless the bank was also negligent) [UCC 4–401(d)(2), 4–406].
IV. The Bank’s Duty to Accept Deposits
A. AVAILABILITY SCHEDULE FOR DEPOSITED CHECKS
Essentially, under the Expedited Fund Availability Act of 1987 and Regulation CC, any local check must be cleared
within one business day from the date of deposit. Nonlocal checks must be cleared within five business days.
• Certain checks, including government checks and cashier’s checks, must be cleared before the next day.
• Exceptions include deposits at nonproprietary ATMs, new accounts, deposits over $5,000, and deposits into
accounts with repeated overdrafts.
ANSWER TO CRITICAL ANALYSIS QUESTION IN THE FEATURE—
INSIGHT INTO ETHICS
Why would banks say that they, too, are worse off because of the EFAA? The longer that banks can keep funds
646 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
ADDITIONAL BACKGROUND—
Regulation CC
The following is part of Regulation CC (12 C.F.R. Part 229), which sets out the availability schedule for deposited
checks.
CODE OF FEDERAL REGULATIONS
TITLE 12—BANKS AND BANKING
CHAPTER II—FEDERAL RESERVE SYSTEM
§ 229.12 Permanent availability schedule.
(a) Effective date. The permanent availability schedule contained in this section is effective September 1, 1990.
(2) A check drawn on the Treasury of the United States that is not governed by the availability requirements of §
229.10(c);
(3) A U.S. Postal Service money order that is not governed by the availability requirements of § 229.10(c); and
(4) A check drawn on a Federal Reserve Bank or Federal Home Loan Bank; a check drawn by a state or unit of general
local government; or a cashier’s, certified, or teller’s check; if any check referred to in this paragraph (b)(4) is a local
check that is not governed by the availability requirements of § 229.10(c).
(i) A nonlocal check; and
check that is not governed by the availability requirements of § 229.10(c).
(2) Nonlocal checks specified in Appendix B-2 to this part must be made available for withdrawal not later than the
times prescribed in that Appendix.
(d) Time period adjustment for withdrawal by cash or similar means. A depositary bank may extend by one business
day the time that funds deposited in an account by one or more checks subject to paragraphs (b), (c), or (f) of this
cash or similar means not later than 5:00 p.m. on the business day on which the funds are available under paragraphs
(b), (c), or (f) of this section. This $400 is in addition to the $100 available under s 229.10(c)(1)(vii).
(2) Deposited by a check drawn on or payable at or through a paying bank not located in the same state as the
depositary bank.
(f) Deposits at nonproprietary ATMs. A depositary bank shall make funds deposited in an account at a nonproprietary
ATM by cash or check available for withdrawal not later than the fifth business day following the banking day on which
the funds are deposited.
[55 FR 50818, Dec. 11, 1990; 56 FR 7801, Feb. 26, 1991; 56 FR 66343, Dec. 23, 1991; 57 FR 36601, Aug. 14, 1992]
B. INTEREST-BEARING ACCOUNTS
Banks must pay interest on the full balance of a customer’s interest-bearing account each day. The Truth-in–
Savings Act of 1991 and Regulation DD require that new customers be given certain information, including the
rate of interest, if any, stated in terms of the annual percentage yield on the account, and the amount of fees,
charges, and penalties, and how they are calculated.
ADDITIONAL BACKGROUND—
Regulation DD
The following is part of Regulation DD (12 C.F.R. Part 230), which sets out the methods for the payment of
648 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
interest on the balances in bank accounts.
CODE OF FEDERAL REGULATIONS
TITLE 12—BANKS AND BANKING
§ 230.7 Payment of interest.
(a) Permissible methods—1) Balance on which interest is calculated. Institutions shall calculate interest on the full
(2) Determination of minimum balance to earn interest. An institution shall use the same method to determine any
minimum balance required to earn interest as it uses to determine the balance on which interest is calculated. An
institution may use an additional method that is unequivocally beneficial to the consumer.
(b) Compounding and crediting policies. This section does not require institutions to compound or credit interest at any
particular frequency.
(c) Date interest begins to accrue. Interest shall begin to accrue not later than the business day specified for interest-
bearing accounts in section 606 of the Expedited Funds Availability Act (12 U.S.C. 4005 et seq.) and implementing
Regulation CC (12 CFR part 229). Interest shall accrue until the day funds are withdrawn.
C. THE TRADITIONAL COLLECTION PROCESS
Check collection rules discussed in the text include the following.
1. Designation of Banks
Any bank can be a depositary bank, a collecting bank, a payor bank, and an intermediary bank.
2. Check Collection between Customers of the Same Bank
3. Check Collection between Customers of Different Banks
Each bank in the collection chain must pass a check on before midnight of the next banking day following its
receipt, subject to deferred posting [UCC 4–202(b), 4–302, 4–108].
5. Electronic Check Presentment
Most checks are processed electronically. The text discusses encoding and its warranty.
1. What Is a Substitute Check?
2. Reduced “Float” Time
3. Faster Access to Funds
Banks can exchange checks digitally (which speeds collection). The availability schedule will be revised
accordingly.
V. Electronic Fund Transfers (EFTs)
A. TYPES OF EFT SYSTEMS
There are four principal types of EFT systems—
• Automated teller machines. To initiate a transaction, a consumer uses an access card and a personal identi-
fication number (PIN).
• Point-of-sale systems. These systems also sue access cards.
• Systems handling direct deposits and withdrawals of funds.
• Pay-by-Internet systems.
ENHANCING YOUR LECTURE—
DIGITAL FUNDS PROVIDE
NEW OPPORTUNITIES FOR MONEY LAUNDERING
Money laundering occurs when profits obtained from illegal activities, such as drug trafficking, are processed
through various financial transactions in an effort to conceal their illegal source. This is how criminals make illegitimate
650 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
funds appear legitimate. Money laundering has been going on for many years, but in the past criminals had to
physically transport the cash. The advantages of digital cash—in particular the fact that it can be exchanged
anonymously—have provided an avenue for more effective money laundering (sometimes referred to as
cyberlaundering). Today, terrorist groups and criminal enterprises can use two types of electronic cash to transfer
funds and evade detection by law enforcement: prepaid ATM cards and ATM cards offered by online gaming
companies that convert virtual cash to real cash.
REPORTING REQUIREMENTS FOR CASH TRANSFERS
Federal law requires reporting of any financial transactions or funds transfers that involve more than $10,000.a
According to estimates of the White House Office of National Drug Control Policy, the sales of illicit drugs in the United
States produce more than $65 billion a year in revenue.b Internationally, the amount of proceeds from drug trafficking
that are laundered globally are somewhere between 2 and 5 percent of the world’s gross domestic product (GDP), or
about $600 billion annually.c To avoid detection by the government for transferring amounts in excess of $10,000, drug
wiring funds through Western Union. This limitation also deterred terrorist groups from transferring large amounts of
cash to various locations or cells for the purpose of funding terrorist activities.
ADVANTAGES OF PREPAID ATM CARDS
As discussed in the text, ATM cards normally are issued by banks and connected online to a customer’s account.
Because the government strictly regulates banks, however, this type of ATM card leaves a paper trail that can be
investigated if the customer is suspected of criminal or terrorist activity. Also, as just mentioned, banks and other
regulated financial institutions are required to the report financial transactions involving amounts above the $10,000
threshold.
Prepaid ATM cards, in contrast, are not linked to a bank account like a regular debit or ATM card. They are
essentially a stored-value card (defined later in this chapter) in which the purchaser pays a specific amount and that
amount is loaded onto the card. The user can then access those funds from anywhere in the world. These cards are
convenient for students or travelers because a person does not need to show identification or have a bank account to
MONEY LAUNDERING THROUGH VIRTUAL GAMING CURRENCY
The dramatic increase in virtual gaming also opens the door up for cyberlaundering. Online gaming has become
extremely popular in the United States and elsewhere. For years, gamers who participated in these virtual worlds
(using digital personas, or “Avatars”) have been selling their digital monies, goods, or properties, for real-world
compensation. A number of Avatars have managed to create wealth for the persons controlling them by selling (or
taxing) assets in the virtual world.
CHAPTER 27: CHECKS AND BANKING IN THE DIGITAL AGE 651
In the beginning, players were only able to convert their virtual dollars or credits to real-world cash by selling them
on online auction sites. (Gamers could always do the reverse and use real cash or credit cards to add monies to their
online accounts.) Soon, Web sites developed at which gamers could exchange virtual currency. Then, in 2006, the
makers of Entropia Universe—a giant in the virtual gaming industry that transacted over $165 million of business in
2005—began offering real-world ATM cards.
FOR CRITICAL ANALYSIS
Should only banks and regulated financial institutions be allowed to issue ATM cards? Why or why not? How else
might the government regulate digital funds to reduce the potential for cyberlaundering?
B. CONSUMER FUND TRANSFERS
The Electronic Fund Transfer Act (EFTA) of 1978 governs consumer electronic fund transfers. The Federal Reserve
ADDITIONAL BACKGROUND—
Electronic Fund Transfer
The Electronic Fund Transfer Act (EFTA) of 1978 was passed “to provide a basic framework establishing the rights,
liabilities, and responsibilities of participants in electronic fund transfers.” The EFTA provides the following definition
for electronic fund transfer at 15 U.S.C. Section 1693a(6).
TITLE 15. COMMERCE AND TRADE
CHAPTER 41—CONSUMER CREDIT PROTECTION
SUBCHAPTER VI—ELECTRONIC FUND TRANSFERS
§ 1693a. Definitions
As used in this subchapter—