- New Oklahoma Regulations Covering Money Transmitters
- Returning Checks for “Breach of Presentment Warranty”
1. New Oklahoma Regulations Covering Money Transmitters
In April 2006, the Legislature passed the Oklahoma Financial Transaction Reporting Act (the Act), which is found in Sections 1512 through 1515 of the Banking Code. These provisions categorize “money transmitters” as money services businesses (MSB’s) for state-law purposes, requiring licensing and examination by the Oklahoma Banking Commissioner. (The provisions are not effective until regulations become final.) The Banking Department has now adopted regulations (Rules 85:15-1-1 through 85:15-11-6) to carry out last year’s “money transmitter” laws, effective May 11, 2007.
These rules will appear in the Banking Code, but can be viewed now by going to the Banking Department’s web page at www.osbd.state.ok.us, clicking on the first headline on the page, and then scrolling down to “Final Rules.” I will discuss several aspects of these provisions, below.
1. Little Direct Impact on Banks
The new rules will have very little direct impact on banks, S & L’s, credit unions, and trust companies—all of which are exempted from regulation as “money transmitters.” However, federal law requires depository institutions to ask questions of any customer that is an MSB, including whether the entity is following federal or state licensing requirements and other required procedures.
Under the new regulations, only a “money-transmitter” company (the main company, not the local money-transfer agents) must be licensed by the Banking Department as a money-transmitter. A bank’s customer, however, is usually just a local agent (called an “authorized delegate”) of a “money-transmitter” company. The rules create a structure whereby every local agent must operate under the authority of a “money-transmitter” company that is licensed, but local agents themselves do not receive a license.
A bank should determine what “money-transmitter” company its customer (the local wire-transfer agent) is affiliated with. It could verify that the “money-transmitter” company is licensed in Oklahoma. Beyond that, I don’t see any increased burden on banks as a result of the new rules.
The regulation could actually make a bank more comfortable with a “money-transmitter” agent as customer. Banking Department authority to investigate and examine local “money-transmitter” agents will “raise the bar” for any agent currently not operating at a minimum level of compliance. Anything that makes a bank uncomfortable about a “money-transmitter” agent’s current operating practices may get straightened out very soon, under the new rules.
2. Money-Transmitter Activity
The most commonly recognized “money transmitter” in Oklahoma is Western Union. If you’re familiar with services available through a Western Union agent, you understand a “money transmitter,” without any definition.
Banks typically wire money in business transactions, but most customers of “money transmitters” are consumers. Money can be sent to relatives in Mexico, to stranded travelers, to children at college, and to convicts in prison. A consumer can wire funds to a mortgage lender or other creditor on a same-day basis, to prevent a loan default or late payment charges. Persons with no bank accounts may have no other way to make electronic payments.
The Banking Department has identified at least 24 separate “money-transmitter” companies operating in Oklahoma, with at least 2,100 total agent locations in the state. Some of these companies may have only a few agents in Oklahoma–in contrast to Western Union, which has many hundreds of agents.
Wiring money may all look the same, but there can be significant differences between “money-transmitter” companies, relating to net worth (a protection for customers); level of training for agents; procedures for recordkeeping and reporting; level of monitoring and auditing of agents’ operations; and other aspects relating to BSA compliance.
3. Need for State Enforcement
The U.S. Treasury Department (through FinCEN and IRS) already has authority to oversee money transmitters and authorized agents (including in Oklahoma); but saying that the feds could step in if a problem comes to their attention is not the same as regular examination of local operations.
“Money-transmitter” agents have been subject to BSA requirements for four years. (Specific federal requirements are discussed below.) But lack of an Oklahoma agency with authority to regulate “money-transmitter” agents at “ground level” (until now) has at least created the possibility of uneven compliance with BSA requirements. Some may be doing everything right, others may not be, but state regulation will ensure uniform compliance.
Oklahoma is one of only a handful of states that have not licensed or examined “money-transmitter” companies and agents. Lack of state regulation has apparently attracted to Oklahoma some individuals who prefer to operate where their money transfers get less scrutiny.
The Oklahoma Bureau of Narcotics has discovered several money transmission operations in Oklahoma that are actively facilitating the drug trafficking industry. Other “money transmitter” agents’ lax procedures may not be effectively deterring money laundering, drug trafficking or terrorist funding.
Criminals actively seek out the “weakest link in the chain.” The new regulations give the Banking Commissioner authority to tighten compliance with BSA requirements, where tightening is needed. The Commissioner also has authority to disclose any apparently illegal or suspicious activity to law enforcement officials in Oklahoma, and can exchange information and coordinate efforts with “money-transmitter” regulators in other states.
4. Equal Standards of Compliance
Without enforcement, no one knows what level of BSA compliance exists at “money-transmitter” offices in Oklahoma. The new rules make “money-transmitter” agents subject to examination and enforcement remedies.
These developments should encourage banks, which incur a lot of cost and effort to comply with BSA requirements, but sometimes wonder if all their efforts just drive criminals away from banks and toward other service providers. (Banks scrutinize their customers like potential criminals or terrorists, but usually turn up only law-abiding individuals after all their effort. Criminals have already been driven out of banks.) If some of the “wire-transmitter” agents in Oklahoma are not as serious about BSA compliance as banks are, regulatory examinations will help to plug any loop-holes and provide greater assurance that the whole wire-transfer industry, across the board, is discouraging criminal activity.
5. License Requirements
The regulations prohibit a “money-transmitter” company from doing business in Oklahoma without a license. (A main company such as Western Union is required to be licensed—not the local agents (called “authorized delegates”) operating under that company’s umbrella.) Individual agents’ locations require no license, but can operate only if affiliated with a “money-transmitter” company that is properly licensed. (Rule 85: 15-3-1.)
There is a 90-day transition period, beginning May 11, 2007, during which all “money-transmitter” companies now operating in Oklahoma must apply for a license. If an application for license is filed within the 90 days, a “money-transmitter” company and its local agents will be deemed to be in compliance until such time as the pending application is either granted or denied. (Rule 85: 15-1-1.) A “money-transmitter” company that decides not to become licensed must cease operations in Oklahoma within the 90 days.
In applying for a license, a “money-transmitter” company must give the name and location of all of its proposed agents in the state. (Rule 85: 15-3-2.) After becoming licensed, a company must provide an updated list of its authorized agents in the state within thirty days following the end of each calendar quarter. (Rule 85: 15-7-3.) The Commissioner can use this list to conduct examinations of local agents—normally by giving ten days’ notice, but without notice if the local agent is suspected of engaging in unsafe or unsound practices or a violation of law. (Rule 85: 15-7-1.)
Entities exempt from licensing as “money transmitters” include the U.S., its departments and agencies; the Post Office; states, counties, cities or other political subdivisions; regulated financial institutions; government-sponsored EFT benefit systems; debit, credit and stored-value card, ACH and similar funds-transfer networks: and securities broker-dealers. (Rule 85: 15-1-3.)
6. Financial Requirements
There are various financial aspects of “money-transmitter” licensing. To apply for a license, the main company (such as Western Union) must pay a nonrefundable application fee of $3,000, a license fee of $2,000, and an additional fee of $50 per authorized agent in Oklahoma. (Rule 85: 15-3-2(c).) The main “money-transmitter” company also must pay annual renewal fees of $2,000, plus an additional $50 per authorized agent. (Rule 85: 15-3-5.)
Most “money-transmitter” companies will pay these fees without thinking twice—probably indirectly passing them on to local agents as increased charges. But a “money-transmitter” company with one or only a few local agents might see a disproportionate cost per agent in maintaining a presence in Oklahoma.
Another financial issue is examination fees. Rule 85: 15-7-1 suggests that the Commissioner may conduct some or most examinations by making written information requests, rather than on-site visits. Clearly, however, the Commissioner has authority to conduct on-site examinations of any “money- transmitter” company or any local agent. Costs of an on-site exam must be paid by the entity under examination. An on-site examination could be a substantial increase in a local agent’s operating costs, compared to present law.
7. Surety Bond Required
Rule 85: 15-3-3 states that an application for a license must be accompanied by a “surety bond, letter of credit, or other similar security acceptable to the Commissioner,” in an amount equal to $50,000 plus $10,000 per agent location in Oklahoma, but not more than a total of $500,000. The security instrument must be payable to and posted with the Banking Department. In some cases the required security can be raised to $1 million.
The security requirement protects the claims that customers have against a “money transmitter.” (If I turn over my money to be wired, I want it to get there. I don’t want it to be ensnared in a bankruptcy, foreclosure on assets, etc.) This security must remain posted for at least five years after the company stops providing money transmission services in Oklahoma (the same time period as the statute of limitations in Oklahoma for suing on a contract). The Commissioner can reduce or increase this time period. (Rule 85: 15-3-3(d).) If a “money transmitter” has only a few proposed agent locations in Oklahoma, the security requirement might deter that company from applying for a license.
However all “money-transmitter” companies continuing to operate in Oklahoma will have security posted for the benefit of customers. This is similar to Section 1004 of Banking Code, which requires trust companies (and bank trust departments) to post up to $500,000 of securities (or letters of credit) with the Banking Department in order to engage in trust business in Oklahoma.
8. Net Worth; Investments
A “money-transmitter” company must have minimum net worth of $275,000 to operate one to fifty agent locations–and minimum net worth of $3 million to operate more than 800 agent locations–with other net worth levels in between. Net worth must be demonstrated annually by audited financials—although the Banking Department can waive the “audit.” (Rule 85: 15-3-6.)
The rules require a “money-transmitter” company to “maintain at all times permissible investments that have a [G.A.A.P.] market value . . . of not less than the aggregate amount of all money transmitted from all states” by that company. (Rule 85: 15-9-1.) (The company’s “temporary money” on hand, belonging to customers, must be held in cash, cash equivalents, high-grade securities, receivables from local agents, money-market funds, etc. (Rule 85: 15-9-2.) A “money-transmitter” company cannot use its continuing “float” (money from customers) to fund other business activities or non-permitted investments.
9. Agent Funds Held “in Trust”
The regulation has no net-worth requirement for local agents. Instead, it treats agents like pass-through entities that are holding “in trust” any money due to the “money-transmitter” company for transferring customers’ funds.
The regulation states, “An authorized delegate holds in trust for the benefit of the licensee [the “money-transmitter” company] all money net of fees received from money transmission.” By imposing a “trust fund” character on any money received by a local agent from customers, such funds (except the agent’s fee) never belong to the agent. If a local agent goes bankrupt, or becomes subject to garnishment, the customers’ money, held “in trust” for the “money- transmitter” company, remains beyond the reach of the agent’s creditors.
Probably every standard contract between a “money-transmitter” company and a local agent requires the local agent to deposit all wire-transmission funds received from customers (or all funds net of the agent’s fees) into a special account to be maintained separately from the local agent’s general business account. The contract does not allow the agent to mix its own funds with funds required to be remitted to the “money-transmitter” company.
(The same business, which often also sells money orders and lottery tickets, will be required by contract with the money order company to place all proceeds from sales of money orders into a separate account “in trust” for the money order company; and proceeds from the sale of lottery tickets must be deposited to a “trust account’ for the Oklahoma Lottery Commission.)
The new regulations require a “money-transmitter” company to provide to the Banking Department “a sample form of contract” that it uses with agents. (Rule 85: 15-3-2(a)(7)). The regulation prohibits an agent from operating outside the scope of what this contract requires. (Rule 85: 15-5-1(c) and (e).) If, for example, the contract requires the local agent to keep customers’ wire funds in a “trust” account, and to remit them promptly, but the agent mixes customers’ wire-transfer funds with its own general business funds and does not pay the “money-transmitter” company when required, the Banking Department could determine that the agent is engaging in an “unsafe and unsound practice,” or suspend or revoke the agent as an authorized agent. (Rule 85: 15-11-2(a)(6).)
Banks with local “money-transmitter” agents as deposit customers probably already know that the local agent is required by contract to put wire funds belonging to its customers into a separate account—which may or may not be happening. But now a regulator (the Commissioner) will be watching whether the local agent is acting properly.
10. BSA Requirements
BSA requirements applicable to “money-transmitter” agents are not changing, but now someone will be checking for compliance. Local agents fully complying with law should have little impact from examinations. However, any “money-transmitter” agents now taking a relaxed approach to BSA requirements could see a major impact on business operations as the result of examinations.
The U.S. Treasury’s “Currency and Foreign Transactions Regulation, 31 C.F.R. Section 103, has various requirements for money-services businesses (MSB’s) generally. (Section 103.11(uu)(5) defines “money-transmitter” companies and local agents as one type of MSB’s.)
A very broad definition of “financial institution” in Section 103.11(n) of the BSA regulation also includes MSB’s. Someone reading BSA requirements applicable to “financial institutions” should remember that the definition is broader than the common meaning, and includes “money transmitters.”
“Suspicious activity reporting” is mandatory at the $2,000 level (and optional below that level) for “money transmitters,” based on Section 103.20. Filed SAR’s must be retained for five years. CTR requirements apply to “money transmitters,” like banks, for cash amounts in excess of $10,000 per day. (Section 103.22.) Provisions for obtaining customer information in connection with CTR-reportable transactions (Section 103.28) and reporting “structuring” by the customer (Section 103.63), also apply.
Section 103.33(f) requires “money transmitters” to make certain records with respect to a transmittal of funds of $3,000 or more. They must retain that information for five years (see Section 103.38(d)) in a manner retrievable by the name of the sending customer.
Based on the definition in Section 103.100(a)(2), and the provisions in Section 103.100(b), FinCEN can require a money transmitter to search its records with respect to the biweekly list of 314(a) names. A money transmission is considered a one-time transaction–not an account–so a “money transmitter” must search the last six months’ worth of (a) records it is legally required to maintain (SAR’s, CTR’s, or wire transfers of $3,000 or more), and (b) any other records that it actually does record and maintain in electronic format.
Section 103.125 requires any MSB (including a “money transmitter”) to maintain an effective anti-money-laundering program. “Effective” means reasonably designed to prevent the business from being used to facilitate money laundering or the financing of terrorist activities. Section 103.125(d)(iii) allows the agent and the “money-transmitter” company to allocate AML requirements between them. For example, the “money-transmitter” company can develop an AML policy that agents comply with, rather than agents developing their own.
However, Section 103.125(d)(2) requires that someone be responsible for day-to-day compliance with the AML program, including making sure that reports are filed, records are retained, and training is provided. Also, someone must do an independent review of the adequacy of the AML program, and this has to be a different individual than the day-to-day compliance person.
11. Additional Recordkeeping
Rule 85: 15-7-5(b) restates the already-existing federal requirement for “money-transmitter” agents to maintain all BSA-required documents (see my list above). Going further, the same provision contains a completely new state requirement not existing under BSA: Local “wire-transmitter” agents must maintain records on money transmissions of $1,000 or more, for three years. This requires recording and maintaining the same 31 C.F.R. Section 103.33(f)-type information required federally for money transmissions of $3,000 or more.
The lower $1,000 state-law threshold for gathering and retaining customer information will probably not affect many household-type wire transfers made through money transmitters. However, by collecting information on wire transactions of $1,000 or more, “money-transmitter” agents in Oklahoma may catch some larger transactions that currently are avoiding scrutiny by being split into separate transactions of under $3,000. (It will be three times harder to divide larger transactions into separate transactions under $1,000, instead of under $3,000.) Alternatively, the $1,000 threshold for gathering information may simply put a stop to questionable wire transfers that currently are being sent in amounts of between $1,000 and $3,000–because the individuals will want to avoid recordkeeping concerning their transactions.
12. Enforcement Authority
The Commissioner can suspend or revoke the license of a “money-transmitter” company. After notice of a suspension or revocation of license of such company, local agents operating under the umbrella of that company’s license must immediately stop providing money transmission services as the company’s agent. (Rule 85:15-5-1(d).) (An innocent local agent is free to become an agent of another company.)
Grounds for suspension or revocation of a “money-transmitter” company’s license include (1) violating the Act, the new rules, or a state or federal anti-money-laundering statute, (2) not cooperating with an examination or investigation by the Commissioner, (3) engaging in fraud, intentional misrepresentation or gross negligence, (4) operating with a level of competence, experience, character, or general fitness (either for the “money-transmitter” company itself, the person in control of its operations, or a local agent) that makes providing money services not in the public interest; (5) engaging in an unsafe or unsound practice; (6) becoming insolvent or suspending payment of creditors; (7) not removing a local agent that the Commissioner finds by final order to have violated the statutes; or (8) making a material misstatement in a license application, or losing its license in another jurisdiction (or being criminally convicted) for fraud or dishonest dealing. (Rule 85: 15-11-1.)
Although a local “money-transmission” agent is not licensed, Rule 85: 15-11-2 allows the Banking Department to suspend or revoke the “money-transmission” company’s designation of that particular agent. Grounds for such action are similar to those stated above for “money-transmission” companies.
The Commissioner may also issue a “cease and desist” order to a “money-transmission” company or local agent, to prevent immediate and irreparable harm before an administrative hearing can be started. (Rule 85: 15-11-3.)
The Banking Department can assess a civil penalty for violating the Act, or any order issued under the Act, up to $100 for each day that the violation is outstanding. The state’s costs and expenses of investigating and prosecuting the matter, including reasonable attorney’s fees, can be assessed to the violator.
Returning Checks for “Breach of Presentment Warranty”
As explained in my April article, a lot of check-return reasons can be used only if the check is returned within the paying bank’s midnight deadline. (Examples are NSF, signature irregular, account closed, and counterfeit item).
After the midnight deadline has passed, a paying bank’s reason for returning a check is going to be limited to a “breach of warranty” claim of some type. (Bankers may not immediately recognize that their familiar return reasons outside of the midnight deadline are all based on breached “warranties” found somewhere in statutes or regulations.)
It’s important for both the paying bank and the depository bank to be familiar with the allowable “breach of warranty” reasons. If an item is returned outside of the midnight deadline, and no stated return reason fits within an available “breach of warranty” category, the return item is a “late return” and should be sent back by the depository bank to the paying bank.
1. Authority for Check Returns
The warranties that permit a check to be returned outside the midnight deadline are mostly found in the following statutes and regulations: (1) the “transfer warranties” and “presentment warranties” in UCC 4-207 and 4-208 (the most useful being warranties against “forged endorsement” or “alteration”); and (2) the warranties in Section 229.34 of Regulation CC, including (a) an “encoding” warranty—that the item has not been encoded with the wrong amount [also see UCC 4-209]; (b) the “Check 21” warranties—for example, that a depository bank will not present both the original check and a substitute check; and (c) the “telephone check” warranty—that the item is actually authorized by the customer, if the check has a printed statement in the lower right hand corner (such as “this item authorized by your customer”) instead of a signature.
Sometimes there is a contractual basis for returning a check outside the midnight deadline, such as a local clearinghouse rule provision, that goes somewhat beyond the regular warranties. (Banks that are members of a clearinghouse have agreed by contract to follow its rules. For checks actually presented through a clearinghouse, it’s worthwhile to understand when the clearinghouse rules might allow a special basis for checks to be returned.)
This discussion will focus on returns based on “presentment warranties.” A future article will cover Regulation CC and other UCC warranties.
2. Presentment Warranties
As suggested above, the most common basis for returning checks outside of the midnight deadline is UCC 4-208 (the “presentment warranties”). These warranties are matters that must be true when a presenting bank wants the paying bank to pay a check. I will review each of the three separate presentment warranties found in UCC 4-208, subsection (a):
(1) “Presenter Entitled to Enforce the Check.” In most cases this warranty roughly means that the presenter of the check, or someone legally linked to the presenter, has appropriate “rights” to the check being presented for payment. (“You’re dealing with someone who can legally deal with you on this item,” is a simplified way to say it. For the moment I will ignore the specifics of what makes this statement true or false.)
What the warranty actually states is that the person presenting the check to the paying bank is either (a) “entitled to enforce the draft” or (b) “authorized to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft.” (See also UCC 3-301.)
The presenter of the check generally must be either (1) the owner of the check, or (2) acting with authority (by statute, agreement, etc.) on behalf of someone who is owner of the check. If either half of this definition is true, the “entitled to enforce” warranty is satisfied. If both of the halves of this definition are false, there is a “breach of warranty,” and the paying bank returns the item.
When a paying bank returns a check for “forged endorsement,” a breach of the “entitled to enforce” warranty actually forms the basis for return. (If the person presenting the check to the paying bank has taken that check through a bad endorsement anywhere in the chain of title, the check has not been properly “negotiated.” The person who is presenting the check lacks legal right to the check, and so is not entitled to endorse it further, or to be paid. If the paying bank pays the check (relying that the presenter has rights, based on UCC 4-208), but the warranty is breached, the paying bank can send the check back when the facts are discovered (such as a bad endorsement)—but not more than three years after the check was presented, at the outside limit. (See UCC 3-118(g).) If it’s a U.S. Treasury check, federal law allows seven years.
The payment system would come to a grinding halt if a paying bank had to verify every prior endorsement before paying a check. Instead, the “presentment warranties” in UCC 4-208 make the presenter liable for prior endorsements, by giving the paying bank the right to send the check back to the person who presented it if a “chain of title” problem exists (such as a bad prior endorsement). In turn, the “transfer warranties” in UCC 4-207 allow the person who presented the check to the paying bank to shift the liability farther up the chain of title, through collecting banks, the depository bank, etc., until the loss ultimately falls on whoever took the check by bad endorsement. (This might be a merchant who unknowingly took the check with a bad endorsement, then deposited it to his bank.)
In the past, you may have looked section-by-section through the UCC, searching for the “forged endorsement” provision, but you found nothing. The words “forged endorsement” do not appear at all in the “presentment warranties” statute. Instead, the statute uses the terminology “not entitled to enforce,” and “breach of warranty” under UCC 4-208.
It’s enough of a return reason to write “breach of warranty” and “UCC 4-208” on the front of a returned check, and to accompany it with an affidavit of forged endorsement. But most banks just write “forged endorsement” on the check, not citing “UCC 4-208”–the actual statute allowing return. There’s no question what is being claimed by stating “forged endorsement,” and no doubt about what section this falls under. It wouldn’t be wrong to write “forged endorsement,” “breach of warranty” and “UCC 4-208” on the front of a check. But it’s more than what’s required.
Technically, the “not entitled to enforce” breach of warranty provision under UCC 4-208 is not limited just to “forged endorsements”–although that may be more than 90% of the cases it applies to. This same provision in UCC 4-208 is also the basis for returning an item as an “unauthorized endorsement.”
A “forged endorsement” occurs when Mary Smith’s name is endorsed on the back of a check in handwriting that does belong to Mary Smith. But what if the payee instead is Smith Trucking Company, Inc.? A legally separate business entity does not possess a particular “handwriting”–unless you mean its rubber stamp—so “forged endorsement” may not be quite the right terminology. A company does have various signers who are authorized to endorse in the company’s name. Anyone not authorized to do this (a different employee of the company, a thief, etc.) would be making an “unauthorized endorsement” by endorsing a check payable to the company.
A “missing endorsement” is also potentially a “breach of warranty” situation, falling under the same “entitled to enforce” warranty in UCC 4-208—if an endorsement by the payee is required at all. (Be very careful before deciding to send a check back for “missing endorsement”–as explained below!)
When a depository bank takes a check that the payee has not endorsed, UCC 4-205 provides an automatic warranty to the paying bank that the depository bank either (a) has paid the payee in cash or (b) has deposited the item to the payee’s account. If either of these two options is true, the payee has received value (in cash or by deposit) and cannot allege “nonpayment” on the check. In this case (full payment), the drawer also cannot argue that the bank paying the check has acted wrongfully. “Missing endorsement” is not a basis for return under these facts, and should not be used.
When the paying bank notices a check that has no endorsement, it can’t really know whether the depository bank has given credit to the payee or not. But the automatic warranty in UCC 4-205 “paints a bull’s-eye” on the depository bank: If (1) there is a missing endorsement on the item, and (2) the payee did not receive credit for the check from the depository bank, the depository bank will be liable on the item to the paying bank. Because a depository bank steps up as “automatic backstop” in this situation, a paying bank is not justified in sending a check back for “missing endorsement, unless the payee is claiming not to have received the funds represented by the check.
When the paying bank later learns that the payee did not receive the check’s value (in cash, or by credit to the payee’s deposit account), the paying bank can send the check back to the depository bank at that time, stating “breach of warranty/UCC 4-205,” with or without adding the words “missing endorsement”; or instead it can fall back on a breach of the more general “entitled to enforce” warranty in UCC 4-208, sending the check back as “missing endorsement,” with or without adding “breach of warranty” and “UCC 4-208.”
(2) “No Alteration.” Another automatic “presentment warranty” in UCC 4-208 states that a check presented to the paying bank “has not been altered.” Usually a paying bank will state “alteration” as the reason for return, without adding “breach of warranty” and “UCC 4-208”—which aren’t wrong, and further explain the same thing, but also aren’t required.
Based on UCC 3-407, an alteration is (1) an “unauthorized change” that attempts to modify the obligation of a party (for example, changing a check to show a different amount, different payee, etc.) or is (2) an unauthorized addition of words or numbers to an incomplete instrument. (If a person writing a check makes some error in the amount, in the payee’s name, etc., and then corrects it, that person should initial the change, so as to eliminate uncertainty by the depository bank and the paying bank as to whether the item was altered “without authorization.”)
Generally, altering a check after it is issued allows a depository bank or paying bank to treat it as void. In this situation, UCC 4-208 would allow the paying bank to return the check to the depository bank, with the technical basis being a breach of the warranty of “no alteration.” Catching it mid-stream, UCC 4-207 would probably entitle a depository bank, after learning the facts, to put the item back to its depositor even before presentment to the paying bank.
Some alterations are carefully done, and difficult or impossible to detect. A check can be chemically washed to remove the payee’s name and the amount. Then a new payee’s name and a much larger amount are typed on the check. The result may look so “real” that the depository bank and paying bank cannot see anything wrong with it.
But even if there’s no way to recognize an alteration (in other words, nothing obviously wrong that the depository bank’s procedures should have discovered), the “breach of warranty” provision in UCC 4-208 will operate to shift the loss on an altered check from the paying bank to the depository bank.
There is some rough logic in this, at least in most cases, because the depository bank is closer to the “thief” than the paying bank is. Maybe the depository bank dealt directly with the thief, and should have been in a position to ask questions and verify the check’s validity if anything appeared suspicious. In other situations, it is the depository bank’s customer (for example, a merchant) who cashed the check for the thief, and who had the best chance to examine the item before cashing it, question the thief, etc. In this case, the presentment warranties in UCC 4-208, combined with the “transfer warranties” in UCC 4-207, will shift the loss on the altered item from the paying bank to the depository bank, and in turn from the depository bank to the customer who deposited the altered item to the depository bank.
I once heard about a check alteration so clumsy that someone had marked out the payee’s name in a different color of ink, writing his own name as payee above the scratched-out name, with obviously very different handwriting. The thief (whose handwriting it was) endorsed the check—so that his name as written above the payee line and on the endorsement looked identical. The convenience store clerk cashed it; and I have to ask, “What was he thinking?” Maybe he simply wasn’t thinking!
In a situation as extreme as this, it’s seems fair that liability for the altered item should fall on the depository bank’s customer—who ought to be more awake. But the UCC is actually concerned with “certainty” of outcome, more than “fairness.” So the loss even on a check with a high-quality alteration will still be pushed back to the depository bank, and then to a deposit customer that took the item, based on “breach of warranty” under UCC 4-208, combined with 4-207.
(3) “No Knowledge of Forged Signature.” This is the last of three “presentment warranties” listed in UCC 4-208. It is also the least used, involving a situation that occurs very rarely. The warranty is this: “The warrantor [the presenting bank, the payee cashing a check, etc.] has no knowledge that the signature of the purported drawer of the draft is unauthorized.” The basis of this warranty is that the person presenting the check for payment should have “clean hands”—should not be in on a trick—should be unaware that the accountholder or other authorized signer did not make the signature on the front of the check.
There are many situations where a paying bank would like to return a check with a forged signature, after the midnight deadline. But I have never seen a single situation where the paying bank learned that the depository bank was aware in advance that the check being presented had a forged or otherwise unauthorized signature.
When an individual payee presents a check for payment, the same UCC 4-208 warranty applies, but the situation may be different. Someone might steal a check, forge the accountholder’s signature, and make the check payable to himself. (This is fairly dumb, because the crook paints a trail directly to himself if he makes himself the payee on a stolen check. But it occasionally happens.) He then comes to the bank on which the check is drawn, to cash or deposit the check. The warranty just described will apply, and is breached, if the payee (the person presenting the check) is the one who made the check out to himself, or is in league with the person who made it out, because either way the payee is fully aware that the signature is forged.
However, a typical forger will not have any money—or may be doing this to buy drugs—reasons why a person could be desperate enough to forge checks without caring about the consequences. A “breach of warranty” claim against the individual as presenter of the check is actually a right by the paying bank to sue the presenter for return of money (where a method of charge-back is not available). What good is such a claim, unless the wrongdoer actually has money that can be reached by a judgment creditor? (Criminal “hot check” charges are more useful in this situation.) This last warranty in UCC 4-208 will probably be helpful only in very limited circumstances.