I. GENERAL RULES
The general rule is that if a forged or unauthorized indorsement was a “necessary indorsement” (i.e., a link in the chain of title), the bank cannot charge the drawer’s account but the bank may recover from the person it paid (subsequent transferee not a holder). This is because the UCC provides that a forged indorsement on a check is ineffective and that the person who “looks the forger in the face” usually must “take the hit,” unless the forger is apprehended and forced to pay. In general, the depositary bank is held responsible for accepting a forged indorsement under the theory that the bank is in the best position to control the verification and identity of the person attempting to pass the item. A drawer must report the forged within three years and failure to report timely may result in the drawee’s bank refusal to recredit the account from which the check was drawn.
II. PRESENTMENT WARRANTIES
When a person or bank presents a check for payment, the following presentment warranties are made:
In the case of forged indorsements, presentment warranties (b) and (c) are not applicable since there is no alternation or forged drawer’s signature. Presentment warranty (a) is applicable because a warranty is made that there are no unauthorized or missing indorsements. Each time a party presents a check for payment, it gives a warranty that there are no unauthorized or missing indorsements. With an unauthorized indorsement, each time a check is presented, the party presenting it breaches this warranty.
III. IMPOSTER RULE EXCEPTION
There is important exception to the above-stated rules when the check’s indorsement is forged by an imposter pretending to be the intended payee (e.g., Doe represents that he is Smith and induces Jones to write a check to Smith, subsequently indorsing the check in Smith’s name and taking the cash). The UCC allows such an indorsement to be “effective” with the result that the drawer may end up bearing some or all of the loss for being tricked by the forger into issuing the check to the impostor. The theory here is that the drawer may have been in the best position to prevent the fraud. See, § 3-404(a), UCC. The revised UCC has a comparative negligence standard in which this “imposter defense” does not always shift the entire loss to the drawer. If the depositary bank failed to exercise ordinary care in taking the check for collection and such negligence substantially contributed to the forgery, the loss may be apportioned between the drawer and the depositary bank based on their relative degree of fault.
IV. RECOVERY RIGHTS
When a bank is presented a check, it must decide whether to pay or return the check by the midnight deadline. This does not mean that a bank has no rights of recovery if it pays a check with a forged indorsement, even if the bank misses the midnight deadline. The UCC takes into consideration the fact that most banks would not have the payee’s signature on file and that it would be very unlikely to discover a forged indorsement by the midnight deadline.
The UCC gives the parties a longer time period to enforce their rights. In the case of unauthorized or forged indorsements, there is a three-year statute of limitation.
V. EXCEPTION: U.S. GOVERNMENT DISCOVERY OR REPORT OF UNAUTHORIZED INDORSEMENT OR ALTERED CHECKS
As opposed to the negligence or delay of a private person that discovers or reports an unauthorized indorsement, the U.S. government is not held to the same strict duty. There is a federal law [See, 31 U.S.C. § 3712(a)] that provides for a one year limitation on actions by the U.S. government to recover on a forged or altered government check. The one year limitation begins from the date of payment, and under certain conditions, may be extended an additional 180 days. When a written notice of such a claim is given to an indorsed within the one year period, the period is further extended by three years. This statute will bar a defense of unreasonable delay by the government in discovering and reporting such unauthorized indorsements.