1. What is the difference between a forged indorsement and a missing indorsement in terms of the liability of the parties?

2. What advice would you give to those who cash checks from contractors to subcontractors?

L & T Enterprises issued checks to one of L & T’s subcontractors and one of that subcontractor’s suppliers. Check City cashed the checks but did so with the indorsement of only the subcontractor, not the supplier. The subcontractor had a long, positive history with Check City. Although the reverse side of the checks contained what at cursory glance might appear to be two signatures, even minimal attention to those signatures shows they are the subcontractor’s business name and the signature of a presumably authorized employee, albeit in an order that is the opposite of what is customary. Both entries are in the same handwriting, and a prudent person cashing the checks could not possibly have mistaken the two entries for proper indorsements by both the subcontractor and the subcontractor’s supplier.

Check City filed suit against L & T for negligence. The trial court held that L & T owed Check City a duty and that L & T breached that duty by failing to exercise ordinary care and substantially contributing to an alteration of an instrument or forged signature. L & T appealed.

JUDICIAL OPINION

ORME, Judge … Articles 3 and 4 of the U.C.C. outline a scheme for allocating the loss resulting from an altered [or forged] check among the parties involved in the check processing system… [through] a burden-shifting framework. The UCC differentiates between forged indorsements and missing indorsements.

Here, the district court based its ultimate ruling on UCC 3-406, which precludes a party that substantially contributes to an altered or forged instrument from asserting a claim against a party who accepts the instrument in good faith. However, the checks in this case were not altered or forged, but, instead, the indorsement of one of the joint payees was missing. Thus, the court based L & T’s liability on an inapplicable section of the UCC, even though the action was based on common law negligence.

On the facts of this case, UCC 3-406 simply did not impose any duty in favor of Check City on L & T, and Check City bears the loss for cashing L & T’s checks made payable to two payees when only one payee had indorsed them. The judgment in favor of Check City is reversed.