U.C.C. -- FICITIOUS PAYEE -- FRAUDULENT INDORSEMENT -- FORGED INSTRUMENT
U.C.C. § 3-405 PROTECTS NON-BANKS PROVIDED THEY DO NOT ENGAGE IN COMMERCIAL
] | [ISSUE & DISPOSITION
| [AUTHORITIES CITED
] | [COMMENTARY
Respondent Getty Petroleum Corporation brought an action to recover $58,541.60
from Petitioner American Express for checks fraudulently submitted by a
supervisor in Respondent's credit department. The supervisor was responsible
for voiding checks payable to Respondent's gasoline dealers to reimburse
them for credit card sales. These checks were not intended for negotiation
and were never delivered to the dealers. Instead, they were supposed to
be credited to the dealers' accounts for future gasoline purchases. From
April 1991 to October 1992, the supervisor stole thirty-one (31) checks,
forged the indorsements of the gasoline dealers and submitted the checks
to Petitioner to be credited to the supervisor's personal credit card account.
Although the checks bore neither the supervisor's nor the Petitioner's
name, Petitioner credited the supervisor's accounts.
Petitioner defended on the grounds that because the checks were drawn
by Respondent with the intent to be voided and not delivered to the dealers,
the checks fell within the scope of Uniform Commercial Code ("U.C.C.")
§ 3-405 (1)(b). This U.C.C. provision allocates the loss to the drawer
if "a person signing as or on behalf of a . . . drawer intends the payee
to have no interest in the instrument." U.C.C.
§ 3-405 (1)(b) (1990). Following a non-jury trial, the Supreme
Court found that the Petitioner's remittance procedures constituted gross
negligence as a matter of law and, in such case, U.C.C. § 3-405 would
not insulate Petitioner from liability. The Appellate Division affirmed,
but on the grounds that U.C.C. § 3-405 could not protect non-bank
depositories such as the Petitioner.
ISSUE & DISPOSITION
Whether the "fictitious payee" rule provided in U.C.C. § 3-405 is
available as an affirmative defense to non-bank depository defendants in
check fraud cases.
Yes. U.C.C. § 3-405 is available as an affirmative defense to non-bank
depository defendants provided that the defendant did not have actual knowledge
of the fraud.
Cases Cited by the Court
Roadworks of Great Neck, Inc., 76 N.Y.2d 975 (N.Y. 1990).
Hartford Accident & Indem. Co. v. American Express Co., 74 N.Y.2d
153 (N.Y. 1989).
Prudential-Bache Sec. v. Citibank, N.A., 73 N.Y.2d 263 (N.Y. 1989).
Speilman v. Manufacturers Hanover Trust Co., 60 N.Y.2d 221 (N.Y.
Merrill Lynch, Pierce, Fenner & Smith v. Chemical Bank, 57 N.Y.2d
439 (N.Y. 1982).
Underpinning & Found. Constructors, Inc. v. Chase Manhattan Bank,
N.A., 46 N.Y.2d 459 (N.Y. 1979).
Tonelli v. Chase Manhattan Bank, N.A., 41 N.Y.2d 667 (N.Y. 1977).
Peck v. Chase Manhattan Bank, N.A., 190 A.D.2d 547 (N.Y. App. Div.
Stockton v. Gristedes Supermarkets, Inc., 177 A.D.2d 425 (N.Y. App.
Aetna Casualty & Sur. Co. v. Bank of New York, 22 U.C.C. Rep.
Serv. 2d (Callaghan) 813 (N.Y. Sup. Ct. 1993).
Other Sources Cited by the Court
2 Ronald Aberdeen Anderson, Uniform Commercial Code § 2-403:4 at 932
(2d ed. 1974).
Robert Baucher, The Legislative History of the Uniform Commercial Code,
58 Colum. L. Rev. 798 (1958).
Alexander C. Black, Annotation, Construction and Effect of "Padded Payroll"
Rule of U.C.C. Section 3-405, 45 A.L.R.5th 389, 431-432, §5 (1995).
2 Crandall, Herbert & Lawrence, Uniform Commercial Code, § 17.12.1,
at 17:160 (1996).
Edward Allen Farnsworth, Insurance Against Check Forgery, 60 Colum.
L. Rev. 284 (1960).
Julian B. McDonnell, Bank Liability for Fraudulent Checks: The Clash
of the Utilitarian and Paternalist Creeds Under the Uniform Commercial
Code, 73 Geo. L.J. 1399 (1985).
2 James J. White & Robert S. Summers, Uniform Commercial Code §
§ 16-7, 18-3, 18-4 (4th ed. 1995).
Note, Section 3-405: Of Imposters, Fictitious Payees, and Padded Payrolls,
47 Fordham L. Rev. 1083 (1979).
§ 3-405 (1)(b), also Cmts.
1, 3, 4 (1990).
§ 3-406 (1990).
State of the Law Before Getty
§ 3-405 (1)(b)
provides, in pertinent part, that "[a]n indorsement
by any person in the name of a named payee is effective if . . . a person
signing as or on behalf of a maker or drawer intends the payee to have
no interest in the instrument." In prior lower court decisions, this provision
of the U.C.C. had been described as a "banker's provision intended to narrow
the liability of banks and broaden the responsibility of their customers."
Stockton v. Gristedes Supermarkets, Inc.
, 177 A.D.2d 425, 426 (N.Y.
App. Div. 1991). See generally
Alexander C. Black, Annotation, Construction
and Effect of "Padded Payroll" Rule of U.C.C. Section 3-405
, 45 A.L.R.5th
389, 431-432, § 5 (1995) (indicating that under New York state law
U.C.C. § 3-405 is not available as a defense to payors that are not
banks); Aetna Cas. & Sur. Co. v. Bank of New York
, 22 U.C.C.
Rep. Serv. 2d 813, 817 (N.Y. Sup. Ct. 1993) (holding that the fictitious
payee rule "should not protect non-bank depositories").
In Stockton, the court indicated that the "fictitious payee"
rule did not apply where a housekeeper stole checks from her employer,
forged the employer's signature, and then cashed the checks at a supermarket
at which the employer maintained check-cashing privileges. The court found
that the fictitious-payee defense was not available to the supermarket
under U.C.C. § 3-405 because the provision applied only to banks.
Additionally, New York has not adopted the 1990 revisions to the U.C.C.
Therefore, the New York U.C.C. § 3-405 has no specific exception language
and is subject to a general "honesty in fact" standard applicable to all
sections of the U.C.C. not explicitly incorporating a different standard.
Effect of Getty on Current Law
§ 3-405 (1)(b)
is available as an affirmative defense to non-bank
depository defendants in check fraud cases was a question of first impression
for the Court of Appeals. In holding that the "fictitious payee" rule extends
to non-bank depositories, the court reasoned that if the legislature wanted
to limit U.C.C. § 3-405 to banks, it would have done so in the plain
language of the statute. In support of its holding, the court noted that
in other U.C.C. sections the drafters explicitly limited those sections
to particular types of banks. Thus, the "fictitious payee" applies to non-bank
depositories provided that there is no showing of commercial bad faith.
Additionally, the court held that the commercial bad faith exception
to the provision does not include gross negligence. Instead, the drawer
must show that the drawee had actual knowledge of the facts and circumstances
of a fraudulent scheme. Because New York did not adopt the 1990 revisions
to U.C.C. § 3-405, the court reasoned the legislature rejected the
comparative negligence standard it set forth. Instead the court determined
that New York's U.C.C. § 3-405 is subject only to the general "honesty
in fact" or "commercial bad faith" exception applicable to all sections
of the U.C.C. not explicitly incorporating a different standard. The court
emphasized that, in either case, the drawer/employer is in a better position
to prevent such loss from occurring in the first instance.
The court's decision in Getty
raises several issues. The first is
whether this is really a U.C.C.
§ 3-405 (1)(b)
"fictitious payee" case and, if so, how broadly
that category is to be applied. The court holds that Respondent Getty did
not intend to deliver or negotiate the forged checks at issue and, therefore,
intended the payees to have no interest in those instruments. This is not
the case. While Getty did not intend to physically deliver the checks to
the payees, it did intend to credit the check amounts towards the payees'
future purchases. Getty, while voiding the checks itself for bookkeeping
purposes, fully intended the payees to receive the amounts the checks represented.
This is unlike the cases contemplated by § 3-405(1)(b), where the
payee's name is used solely as a means to effectuate fraud.
Secondly, assuming that this case is a fictitious payee case, the court
stresses that U.C.C. § 3-405 is meant to allocate loss to the party
in the best position to prevent the loss. Presumably, if a drawer has actual
knowledge of a fraud perpetrated against it, it will act to stop it from
occurring. The court is requiring the same actual knowledge on the part
of a depository bank before imposing liability for improperly paying on
a forged instrument under U.C.C. § 3-405. This means that up to the
point of actual knowledge of the fraud, a transferee (depository bank)
will not incur liability under U.C.C. § 3-405 for paying on a forged
instrument even if they are in a better position to prevent the loss. This
also raises the question of whether there is a distinction between preventing
the loss in the first instance and stopping the loss. While an employer/drawer
may be in the best position to prevent fraud from being initiated by screening
its potential employees, a transferee may in some cases be in a better
position to detect and stop a fraud in progress.
Thirdly, the court concedes that the Petitioner's conduct is likely
grossly negligent, but because the Respondent Getty could not prove that
American Express had actual knowledge of the fraud, American Express is
free of liability. However, the court does not address the possibility
of willful ignorance on the part of American Express. This could be because
Getty raised no such allegations, but the possibility exists that a transferee
could choose to ignore clear evidence of a fraud in progress. The court
does not discuss the outcome in such a situation nor whether the analysis
would change in any way.
Lastly, the question now remains whether all transferees in the case
of a fictitious payee are essentially free of any obligation to attempt
to detect and stop a fraud in progress.
Survey of the Law in Other Jurisdictions
All but four states (New York, Massachusetts, Rhode Island and South Carolina)
have adopted the 1990 revised versions of U.C.C. Articles 3 and 4. In particular,
revised § 3-405(b)
applies to situations where an employee with responsibility makes a fraudulent
indorsement or where a person takes something of value without permission.
The revised section also recognizes contributory negligence thereby replacing
the general "honesty in fact" or "commercial bad faith " exception applicable
to all sections of the U.C.C. not explicitly incorporating a different
It appears that no other state has specifically dealt with the issue
of a fictitious payee rule extending to protect non-bank depositories against
forged indorsements. Several states such as California, Georgia and Kansas,
all of which have adopted the 1990 revised version, have U.C.C. provisions
which allow depository banks to supply the missing endorsements of their
customers in order to facilitate collections on behalf of non-bank depositories.
Special thanks to Jean Braucher, visiting professor of law (1997-98),
Cornell Law School, for her assistance in the preparation of this commentary.
Andrew I. Cohen, 99
Robert D. Falck, 99
Emmy B. Hackett, 98
Anita J. Lee, 98
Armando Pastrana, 98
Charlotte G. Thebaud, 99