National Check Fraud Center
20 UCC Provisions Every Banker Should Know
By Mary Beth Guard
Attorney & Editor
If you are a banker, I urge you to keep abreast of the following UCC provisions.
- Section 3-104: To be a "negotiable instrument" a check must be unconditional. Why do you care if it is a negotiable instrument? Because only if it is will Articles 3 and 4 of the UCC apply. Those laws give you guidelines so that all parties to the instrument know the "rules" that apply to it. If it is not a negotiable instrument, beware! An item that would otherwise be treated as a check can be rendered non-negotiable if it has the words "non-negotiable" printed on it. Don't make the mistake of cashing a non-negotiable item or accepting it for deposit.
- Section 3-104: A draft is an order to pay money. Checks are a type of draft. To be a check, an item must be drawn on a bank. Under the UCC, the term "bank" includes savings and loans and credit unions, as well as commercial banks. When you are trying to determine how the UCC applies to an item, you will need to determine if it is a check or a simple draft. Drafts that are not checks are drawn on nonbank payees.
- Section 3-109: Checks may be payable to Bearer or to Order. The way a check is made payable will affect who must negotiate/indorse it. If it is made payable to bearer, that means the holder of the item can negotiate it (e.g., cash it or deposit it.) Examples of items payable to bearer include items on which the payee line is blank, items that are made payable to cash, items that say they are payable to "bearer", or items that do not indicate they are payable to an identified person. If an item is payable to order, that means it is payable to an identified person and the identified a person must indorse the item or deposit it into his account.
- Section 3-110: If a check is made payable to two or more parties with "and" in the middle, both must indorse it. If a check is made payable to two or more parties with the names separated by "or" or "and/or" or by a virgule (slash) or with one name above the other, either party can indorse it. Losses can occur when a bank accepts an item without the signatures of all parties if the item is payable jointly.
- Section 4-404: If an item is more than six months old, you may pay it from your customer's account if you do so in good faith, but you don't have to. This surprises many people. It means that it's the payor bank who has the discretion to decide whether or not to pay it if the check is more than six months old. Exercise caution, therefore, if you are the depositary bank.
- Section 3-109: If the payee simply signs his name to the back of a check, that is called a blank indorsement and the check then becomes bearer paper, which means that the person who is the holder of it can negotiate it. If a check is made payable to Sally and she wants to give it to Joe, she can either apply a blank indorsement, just signing her name, and give it to him, or she can indorse it "Pay to the order of Joe" and sign it. Either way, Joe becomes entitled to negotiate it. In the first example he would simply become the bearer or a check that, at that point, would be bearer paper; in the second example, he would become the new payee by virtue of the indorsement and would need to affix his own indorsement.
- Section 3-206: If the back of the check says it is For deposit only, then has the signature of the payee, that is a restrictive indorsement and it should be observed, but the person who affixed that indorsement can waive it. If Webster takes a check payable to him and indorses it "For deposit only, Webster", when he comes to the bank he can change his mind and get cash instead. On the other hand, if Webster indorses the check "For deposit only, Webster" and gives it to Ryan to take to the bank, Ryan does not have the authority to waive the indorsement.
- Section 3-114: If there are contradictory terms on a check, typewritten terms prevail over printed terms, handwritten terms prevail over both, and words prevail over numbers. Always be alert to inconsistencies and use this simple set of guidelines to reconcile them.
- Section 3-401: Signature is defined as something which may be made a) manually or by means of a device or machine, and b) by the use of any name, including a trade or assumed name, or by a word, mark, or symbol executed or adopted by a person with present intention to authenticate a writing. Thus, although in order for an item to be payable it should have a signature, the definition makes clear that that doesn't just mean a typical handwritten rendition of the customer's name. It's much broader than that. For example, your customer could talk to a magazine salesman on the phone and agree to allow the salesman to send a paper draft through to debit the customer's account to pay for a new subscription. If the customer authorized it, then the word, mark, or symbol that the salesman puts on the signature line of the draft would arguably be deemed to have been adopted by the customer with the present intention to authenticate the writing.
- Section 3-407: An alteration is an unauthorized change in an instrument that purports to modify in any respect the obligation of a party, or it could be an unauthorized addition of words or numbers or other change to an incomplete instrument relating to the obligation of a party. If your customer, when writing a check, makes a change on it, that would not be an alteration because it would not be unauthorized. Also, if a change made on a check does not modify the obligation of a party, it is not an alteration. Thus, if the date written on the check is April 31, it may be changed by the payee, or someone else, to May 1 without it being an alteration because, since there is no such date as April 31, the change would not modify an obligation of any party.
- Section 4-208: When a check is deposited into a bank and sent through to the bank upon which it is drawn, the depositary bank warrants that the item has not been altered and that it is entitled to enforce the instrument. If there is a problem with the indorsements, or if the check has been altered, the payor bank can bring a claim against the depositary bank for breach of the warranty. This fits right in with the UCC's general scheme which seeks to place the risk of loss on the party in the best position to prevent the loss. Depositary banks, exercise caution when you accept a deposit or when you cash a check! Look it over for any evidence of alteration and be sure you know that the indorsements are all genuine.
- Section 3-307: When a bank is dealing with a fiduciary, it must exercise caution. [The term fiduciary is defined to mean an agent, trustee, partner, corporate officer or director, or other representative owing a fiduciary duty with respect to an instrument.] The bank will be deemed to be on notice of a breach of fiduciary duty (and will thus face potential liability) if there is an instrument payable to the represented person or the fiduciary as such and the instrument is (i) taken in payment of or as security for a debt known by the taker to be the personal debt of the fiduciary, (ii) taken in a transaction known by the taker to be for the personal benefit of the fiduciary, or (iii) deposited to an account other than an account of the fiduciary, as such, or an account of the represented person.
- Section 4-401: It is perfectly proper for a bank to pay a postdated check before its date unless the customer has give the bank notice of the postdating. The notice of postdating is a mechanism through which the customer can place the bank on formal notice that the customer has written a postdated check and does not want it to be paid before its date. It should be given in the same manner as a stop payment, but remember that the two (stop payments v. notice of postdating) are very different. A stop payment orders the bank not to pay the check while the stop payment is in force. The notice of postdating merely orders the bank not to pay the check before the date on the check.
- Section 4-403: Any person authorized to draw on an account can close the account. Many bankers are shocked to learn that this provision means that even if an account is set up in such a way that two signatures are required on checks, either signatory party, acting alone, may close the account! Even an authorized signer or person acting under a pertinent power of attorney can close the account. Keep in mind, however, that there are precautions to protect the account owner. Let's say that ABC Corporation sets up an account and names John Doe and Mary Smith as the authorized signers, with two signatures required. While either John or Mary could come to the bank and close the account, they can't easily escape with the funds -- the check to close the account will be made payable to ABC Corporation. That protects the corporation, who is the account owner. You may then ask, "Well, couldn't John and Mary jointly sign a check on the corporate account, made payable to themselves, that effectively zeroes out the account, and thus make off with the funds?" Yes, they could, but that's not your concern. When the corporation appointed them authorized signers, the corporation took that risk. [On the other hand, be sure you don't allow the agents to take action that would put you on notice of breach of fiduciary duty, as described above.] By the same token, if Mary is an authorized signer on Jimmy's account, she can close Jimmy's account. Again, the check for the balance would be made payable to Jimmy -- the owner of the account -- not to Mary.
- Section 4-302: A payor bank must pay or return an item or send notice of dishonor by its midnight deadline (midnight on its next banking day following the banking day on which it receives the relevant item or notice). Most bankers are familiar with this requirement, but some do not realize that this strict deadline applies even when the check presented for payment is a counterfeit, or is drawn on a closed account. If an item is presented to you for payment, act expeditiously if you intend to return in unpaid. Otherwise, you may lose the legal right to return the item.
- Section 4-205: It is permissible for a depositary bank to send through a check for payment without first obtaining an indorsement. Under Section 4-205, when the depositary bank submits an unindorsed item for payment, it warrants to the payor bank or other payor, and to the drawer that the amount of the item was paid to the customer or deposited to the customer's account. This is a statutory warranty. It does not need to be stamped upon the check; it applies automatically. If it is discovered that the funds were not paid to the customer or deposited to the customer's account, a breach of warranty action can be mounted. Exercise caution, however, when the check has joint payees. If you, as the payor bank, receive a joint payee check that does not bear all the required indorsements, I would consider returning that for missing indorsement.
- Section 4-209: Are you familiar with the encoding warranty? A person who encodes information on or with respect to an item after the item is issued warrants to any subsequent collecting bank and to the payor bank or other payor that the information is correctly encoded. If the customer of a depositary bank encodes, that bank also makes the warranty. Keep this warranty in mind if you are allowing one of your business customers (like a large department store)to encode checks it receives.
Let's look at what could happen with this warranty. John writes a check to Phoebe for $6,000. Phoebe deposits it into her bank. Her bank encodes the amount as $60,000 and credits her account for that much. Phoebe calls the bank's data line and believes that she has found her pot of gold! She doesn't know where the money came from and isn't about to ask any questions. She withdraws all the funds and moves to an exotic island, never to be heard from again. In the meantime, John's checks start bouncing. Upon investigation, he discovers that the check he wrote to Phoebe was paid for the wrong amount. He complains to his bank. Since the check was only properly payable for its actual amount, his bank must recredit his account for the difference between the real amount ($6,000) and the amount wrongly encoded ($60,000). His bank then goes against the encoding bank under a breach of warranty theory. Unfortunately, the encoding bank will have a hard time passing the loss on, since Phoebe is long gone with the money. The moral of the story? Make sure there are plenty of caffeinated beverages in the encoding room!
- Section 4-403: Any person authorized to draw on an account may stop payment of any item on the account, as long as they describe the item with reasonable certainty and give the notice to the bank in time for the bank to act on it before the item is paid. Imagine that Phil and his brother Randolph have a joint account. Phil writes a check to buy a new fishing boat. Randolph thinks it's a stupid purchase. Randolph can put a stop payment order on the check, even though he didn't write it! Remember that this provision, like almost all others in Articles 3 and 4, may be varied by contract. Even authorized signers can impose stop payments.
Don't forget that stop payments don't last forever. A stop payment is effective for 6 months, but lapses after 14 days if not confirmed in writing. If the customer wants the stop payment to be effective for a longer period, he must renew it. If you refuse payment on a check after a stop payment has expired, and return the check marked "Stop Payment", you risk a claim for wrongful dishonor.
- Section 4-401: A bank may charge its customer's account for any item that is properly payable, even if paying the item creates an overdraft. You may have had the kind of customer I've heard about who comes in, ranting and raving, saying, "Why did you pay that check I wrote to John? I didn't want it paid. That's why I made sure I didn't have enough money in the account to cover it!" In that instance, all you have to do is point to Section 4-401 of the UCC, which gives you a clear right to pay the check, even though the customer's balance was not sufficient to cover it.
- Section 4-405: If a customer dies, UCC Section 4-405 provides that you have the authority, as a payor or collecting bank, to accept, pay, or collect an item after the death of the customer. You have that right until your bank knows of the death. Even with knowledge of the death, a bank may, for 10 days after the date of death, pay or certify checks drawn before that date unless the bank is ordered to stop payment by a person claiming an interest in the account. This is a very practical provision. Imagine what chaos would exist if the bank's authority to pay a check was terminated automatically upon the death of the customer, whether the bank knew of the death or not! That obviously would not be a workable situation.
This article was written by Attorney Mary Beth Guard, Editor of BankersOnline.com (www.bankersonline.com). Ms. Guard was formerly general counsel for the Oklahom Banking Department, general counsel and EVP for the Oklahoma Bankers Association, and EVP of Specialized Services for Thomson Financial Publishing. She teaches and speaks all over the country on banking law matters. Copyright, 1994, Mary Beth Guard. All rights reserved.
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