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Altered Check or Counterfeit? Who Loses?
John Burnett, Associate Editor
It used to be simple. A presenting bank normally takes the loss if it presents an altered item. The paying bank is liable if the item is counterfeit. But what if it's not possible to readily determine whether the item is counterfeited or altered, and the original item has already been destroyed? Where will the loss fall then?
A decision handed down on July 24, 2006, by the U.S. Court of Appeals for the Seventh Circuit illustrates how two banks found themselves in just such a quandary. In Wachovia Bank, N.A. v. Foster Bancshares, Inc., and Foster Bank, the liability for a $133,026 check is decided, but the court's reasoning took in much more than mundane questions of UCC interpretation. We list some strategies suggested by this case that you can use if your bank is confronted with similar situations.
Summary
The $133,026 check was drawn on Wachovia and deposited with Foster. Wachovia's customer claimed the payee name was altered, and Wachovia sued Foster on its transfer warranty. Foster argued that the check was not altered, but a counterfeit. However, Wachovia had routinely destroyed the check before problems with the check surfaced, making a forensic examination to decide the alteration/counterfeit question impossible.
Wachovia prevailed in both the federal district court case and in the appeal. However, the appeals court made it clear that the case might have had a different outcome had it been pursued differently, or had the banks handled the check differently in the first place.
Key Strategy Issues
The important strategy issues raised in this case fall neatly into lists for the depository (Foster) and paying (Wachovia) banks.
Key Issues for Depository Banks:
Foster Bank argued that the check had been a sophisticated counterfeit, rather than an altered item. Yet it appears Foster failed to adequately present its argument, probably because the original check could not be examined. The court suggested that Foster could have argued that check fraudsters are today more likely to use technology to create counterfeit items than fool around with chemicals to alter actual checks. To be prepared to pursue such an argument, you should --
- Ensure your Security Department keeps current on check fraud techniques and trends.
- Encourage that department to network with check fraud experts to identify potential expert witnesses on this topic.
- Make certain that bank counsel is prepared to raise any such trend as a defense against a warranty claim for alteration, when the circumstances permit.
There are also defensive measures for depository banks that can help them deal more effectively with deposits of large checks. For example --
- Find out if your institution can alert tellers and/or managers when an unexpectedly large deposit (based on prior customer activity) is being processed.
- Determine the cost and benefit of adding such a capability, which can bring special attention to anomalous deposits -- a need for a hold or collection, for example -- as well as flag activity as potentially suspicious from a BSA perspective.
- Consider whether it would be reasonable in such cases to divert larger checks to a direct collection route, removing your bank's exposure to a counterfeit item (this method does not mitigate the risk of handling an altered item, unless the paying bank employs a positive pay system with payee data).
Key Issues for Paying Banks:
Wachovia's decision to destroy paid checks could have left it exposed to a stronger argument from Foster that the check in question was actually a counterfeit. There are also anti-fraud measures available to paying banks that can protect them from falling into Wachovia's position in this case. Some important issues for paying banks include --
- Analyze the risks of being held liable for a counterfeit item in cases similar to Wachovia v. Foster. If a depository bank argues successfully that a check was more likely counterfeited than altered, you could be left with the loss.
- Determine whether current anti-fraud technology deployed by your bank or your customers mitigates the risk of an improper payment. Avoiding any ambiguity by being able to detect and return an altered check on time is always better than a court visit.
- Review any positive pay systems used by your bank, and consider adding payee data to the information available for verification.
- Establish a dollar threshold above which any such payee data will be retrieved and reviewed prior to payment of a check.
- Consider whether you can mitigate risk by establishing a dollar threshold above which original items will be retained for a longer time.
A Side Issue: Your Bank's Website
You normally think of your bank's website as a vehicle to attract business and serve current customers. You probably don't expect that a federal appeals court will be reviewing your site for information to help decide cases unrelated to you. The fact that the court in this case saw fit to look at information on the websites of a mega-bank and a $674 million savings bank should serve as a reminder that what you publish on the internet is truly exposed to the public eye. It can be read not only by your depositors and prospects, but by your regulator, by a Web "surfer" from Minsk, and, yes, by a federal appeals court judge.
Executive Steps:
- Review your bank's website. Does it present the image you want for your bank?
- Enlist the specialists in your organization to help review the content of your website's pages for accuracy, currency, regulatory compliance, and completeness.
On its face, Wachovia Bank v. Foster Bank is a simple UCC case about liability for an altered or counterfeit check. However, advances in technology and in banking practices have surged ahead of both the law and the courts, adding layers of complexity that make outcomes uncertain. The case reflects some of that complexity, and raises several suggestions that you can use to your benefit before or when such an issue confronts your bank.
Read the 7th Circuit decision.
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First published on BankersOnline.com 09/07/06
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