FORGED CHECK DOES NOT COUNT AS BREACHED WARRANTY

July 27, 2004

Steven P. Garmisa
Hoey & Farina Attorney
garmisa@hoeyfarina.com
1-888-425-1212

In deciding whether a bank breached presentment warranties, U.S. District Judge Joan Humphrey Lefkow clarified check-processing procedures and the dense set of rules provided by the Uniform Commercial Code. Firstar Bank N.A. v. Wells Fargo Bank N.A., 2004 WL 1323942 (N.D. Ill.).

Firstar filed a complaint alleging that Wells Fargo Bank and the Federal Reserve Bank of Chicago breached presentment warranties on a forged check. The Illinois version of the Uniform Commercial Code applied. Here are some highlights of Lefkow's opinion (with various omissions not noted in the quoted text):

"A check is written by a drawer and delivered to a payee. The payee typically deposits the check into his or her bank account to obtain the proceeds of the check. The payee's bank (referred to as the depositary bank) sends the check through the bank collection system to obtain payment from the drawer's bank (referred to as the drawee or paying bank).

"The bank collection system is a collection of banks, clearinghouses and Federal Reserve banks governed by Articles 3 and 4 of the UCC and federal regulations.

"Banks process and sort checks automatically using magnetic ink character recognition (MICR) technology. This technology permits the electronic reading and mechanical processing of paper checks. Banks are assigned an identifier called a routing number for processing checks. Checks that are to be processed automatically must have a routing number printed in magnetic ink along the bottom of the check that identifies the paying bank. The routing number tells processing banks to which bank the check for payment should be sent."

The Forgery

"On October 12, 2000," Lefkow recounted, "a check in the amount of $186,587 was deposited into an ATM in Tempe, Ariz. The check was made payable to 'Najam Ali Property,' which had had an account at Wells Fargo since September 2000.

"The drawee of the check was Central National, an entity to which Firstar, by merger, is the successor in interest. The drawer on the check purported to be an entity identified as 'Business Central.' The MICR encoding on the check includes an American Banking Association routing number identifying the drawee bank as 263178478.

"The MICR encoding on the check includes a routing number identifying the drawer as 1981572. The check was not endorsed by either Najam Ali Property or by Orzrenetta Howard, who opened the Najam Ali Property account.

"Wells Fargo accepted the check for deposit into the Najam Ali Property account and processed the check for payment."

After some processing problems, Lefkow continued, "On Oct. 23, 2000, the check was reprocessed by [the Federal Reserve Bank of Jacksonville] and the drawee was now identified as having ABA routing number 071102102, which corresponded with Firstar.

"Based on the routing number on the check and the instruction on file, FRBC's [the Federal Reserve Bank of Chicago's] Peoria office charged the check to Firstar's account on Oct. 23, 2000."
Eventually, Firstar "sent a fax to Wells Fargo informing it that the check was fraudulent and requesting a credit with a cashier's check in the amount of $186,597. Wells Fargo responded on March 8, 2001, stating in a collection letter that it would not accept the charge of $186,597 unless Firstar provided indemnification for the check. Firstar refused this condition," Lefkow noted.

The UCC

"Turning to the merits," she explained, "count 1 alleges that both FRBC and Wells Fargo violated two presentment warranties imposed under the UCC. These warranties are found in UCC section 4-208 (located at 810 ILCS 5/4- 208(a)), which provides as follows:

" '(a) If an unaccepted draft is presented to the drawee for payment or acceptance and the 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:

" '(1) the warrantor is or was, at the time that the warrantor transferred the draft, a person entitled to enforce the draft or authorized to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft;
" '(2) the draft has not been altered; and
" '(3) the warrantor has no knowledge that the signature of the purported drawer of the draft is unauthorized.'

"Based on this statutory section, Firstar maintains that FRBC and Wells Fargo breached presentment warranties (1) and (2) listed above insofar as each was not entitled to enforce the draft and because the draft had in fact been altered," Lefkow noted.

Enforcing an Instrument

"Under the UCC, an 'instrument' means a negotiable instrument. 810 ILCS 5/3- 104(b). A negotiable instrument is a (1) signed, (2) writing that states, (3) an unconditional, (4) promise or order, (5) to pay a fixed amount of money, (6) to order or bearer, (7) on demand or at a definite time, and (8) contains no other undertaking or instruction other than those allowed under the UCC. 810 ILCS 5/3-104(a).

"When a maker or drawer delivers a negotiable instrument to someone for the purpose of giving rights on the instrument to that person he or she 'issues' the instrument. 810 ILCS 5/3-105(a). The holder of an instrument (including a check) is entitled to enforce that instrument. 810 ILCS 5/3-301(i) and (ii).

"A holder is 'the person in possession if the instrument is payable to bearer or, in the case of an instrument payable to an identified person, if the identified person is in possession.' 810 ILCS 5/1-201(20). One becomes a holder of an instrument through negotiation, meaning 'a transfer of possession, whether voluntary or involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder.' 810 ILCS 5/3-201(a).

"A depositary bank, such as Wells Fargo, 'becomes a holder of the item at the time it receives the item for collection if the customer at the time of delivery was a holder of the item, whether or not the customer endorses the item.' 810 ILCS 5/4-205.

"Defendants' position on this motion is that each was entitled to enforce the check because, based on definitions contained in the UCC, they were both 'holders' of the check.

"Firstar, in response, argues (1) that the defendants could not have been holders of this check because the customer who deposited the check was not a holder; (2) there was no 'issue' of the check as that term is defined under the UCC; and (3) the check was neither a 'draft' nor an 'instrument' under applicable UCC definitions.

"Starting with argument (3) first, Firstar is incorrect that the check was required to be a negotiable instrument for defendants to become holders. As 810 ILCS 5/4-205 clearly states, a depositary bank becomes a holder of an 'item' if the customer was a holder of the item. An 'item' is a term specifically defined in the UCC: 'an instrument or a promise or order to pay money handled by a bank for collection or payment.' 810 ILCS 5/4-104.

"Firstar would apparently mean to argue that the check is lacking insofar as it does not contain an order to pay. An order is defined in the UCC as 'a written instruction to pay money signed by the person giving the instruction.' 810 ILCS 5/3-103(a)(6). Firstar theorizes that because the purported drawer is fictional, no instruction to pay was given by any person or entity and that this check is but a worthless piece of paper.

"To accept Firstar's argument, however, this court would have to draw a distinction between a counterfeit check with a drawer that actually does exist and one, as is the case here, where the purported drawer is fictional. Courts dealing with the former situation have never found an issue with whether an order actually exists, instead focusing on the fact that the instrument itself is valid but has been forged.

"Indeed, courts have been persuaded to treated forged and/or counterfeit checks as 'items' under the UCC. The court sees no reason to draw a distinction on grounds that the purported drawer was fictitious. The check itself was a written instruction to pay money.

"This check contained an unauthorized signature, i.e., it was a forgery. Under 810 ILCS 5/1-201(43), ' "unauthorized" signature means one made without actual, implied or apparent authority and includes a forgery.' An 'unauthorized signature is ineffective except as the signature of the unauthorized signer in favor of person who in good faith pays the instrument or takes it for value.' 810 ILCS 5/3-403. Thus, because there was no valid signature by Business Central, whoever signed the check for Business Central (the parties presume it to be Howard) signed it under his or her own name. As such, there was an order to pay or 'a written instruction to pay money signed by the person giving the instruction.' 810 ILCS 5/3-103(a)(6). The check was signed by the person giving the instruction; the unauthorized signature of Business Central served as the signature 'of the unauthorized signer.'

"Firstar's argument (2) -- that there was no 'issue' of the check as that term is defined under the UCC -- is rejected on the same grounds. Under Firstar's theory, there would never be an 'issue' of an instrument when a check is a counterfeit or if there has been a forgery. Nothing in the UCC says as much, and as noted above, cases do not treat a counterfeit different from a forgery.

"As for argument (1), the court also rejects the notion that Wells Fargo and FRB were not holders. The UCC is very clear that possession of an instrument by someone to whom the instrument is made payable creates holder status. 810 ILCS 5/1-201(20).

"The check in this case was made payable to Najam Ali Property and deposited into that entity's account. Najam Ali Property, therefore, was a holder of the check. Since it deposited the check into its account at Wells Fargo, Wells Fargo became a holder because it received the check (which as discussed above was an 'item' under the UCC) for collection and at the time of delivery its customer was a holder of the check. 810 ILCS 5/4-205.

"FRBC subsequently became a holder by negotiation from Wells Fargo. 810 ILCS 5/3- 201. Thus, defendants were holders under the UCC and plaintiff's argument on this ground is also rejected.

"Based on the above, defendants were persons entitled to enforce the check and Firstar's argument that this presentment warranty was breached is rejected.

Alterations

"Under the UCC, an alteration means '(i) an unauthorized change in an instrument that purports to modify in any respect the obligation of a party, or (ii) an unauthorized addition of words or numbers or other change to an incomplete instrument relating to the obligation of a party.' 810 ILCS 5/3- 407.

"The court fails to see Firstar's argument with respect to the check's being altered. There was no unauthorized change or addition to the instrument that changed the obligations of the parties. Instead, the check was a counterfeit item in its entirety. Whatever else may be said about such a situation, it is not an alteration under the UCC.

"Firstar attempts to rely on a statement in First National Bank of Chicago v. MidAmerica Federal Savings Bank, 303 Ill.App.3d 176, 707 N.E.2d 673 (1999), wherein the court noted that '[t]he [UCC rule on presentment warranties] recognizes that while none of the parties may have had reason to suspect a fraud, the one who took from the forger was the closest to the person causing the loss and is presumed to have had the best opportunity to have prevented the loss.'

"The court's ruling in First National should not be surprising given that the factual scenario dealt with a forged or unauthorized endorsement. The Illinois Appellate Court in a subsequent case has correctly distinguished the factual scenario concerning an endorsement with the situation involving a forged drawer's signature.

"In Clean World Engineering Ltd. v. MidAmerica Bank, FSB, the court noted that reliance on First National Bank of Chicago in the forged drawer context was incorrect. 341 Ill.App.3d 992, 1002, 793 N.E.2d 110, 118 (2003). As the court explained, while a collecting bank may be liable for taking a forged endorsement, the UCC directly and separately deals with the situation of a forged drawer's signature. Under such circumstances, no warranty is breached by the depositary bank so long as 'the warrantor has no knowledge that the signature of the purported drawer of the draft is unauthorized.' 810 ILCS 5/4-208(a)(3).

"There is no evidence in the record that Wells Fargo had knowledge that the signature on the check was false and Firstar does not even attempt to argue as much. Accordingly, there was no breach of the presentment warranties under either (a)(2) or (a)(3), and Firstar's claims on these grounds must fail.

"Because defendants violated no presentment warranties under the UCC, their motion for summary judgment is granted."

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