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Fraud in the workplace: missing, stolen, and embezzled checks.

Customers pay your bills with checks. These checks find their way through accounting departments, accounts receivable, cash posting, and sometimes, credit departments, for posting, reconciliation, and preparation for deposit. Checks are payable to your company and certainly not your employee(s) in every case. These checks, hopefully, find their way into your bank account.

Old Rules: Depositing Bank Usually Takes Loss

Your trusted employee, such as data processing, accounts receivable, or posting clerk steals a customer check. Who bears this loss? Under these facts we'll apply the "old rules." We have old and new rules, and this article tells you that the old rules don't apply and the new rules do apply.

This typical theft of a customer check usually occurs when an errant, mid-level employee removes receivables checks from your premises, fraudulently endorses these checks (i.e. affixes your name to the back side of the check), and opens a new account in your name at a bank or alternatively, deposits the check in their own bank account. The forgery of your name as an endorsement is probably invalid. Under the old rules, your receivable against the customer remains unpaid. You have claims against any number of parties: the customer, whose check is not deposited in your bank; the bank which takes the check for deposit; even the customer's bank for paying the check on the forged endorsement; and, of course, the errant (and ex) employee, along with your insurance company.

Assuming very prompt discovery of the forgery, in some cases the customer will cause its bank to recredit its account for the check and the bank will return the item to the depositing bank which usually takes the immediate loss. The depositing bank takes legal action (criminal and civil) against the errant employee who either left for different pastures or faces the law enforcement authorities for creative banking. The customer gives you another check to pay the underlying bill. This scenario is fairly illustrative only, and a disgruntled customer might decline a second payment and advise you to pursue the banks and/or errant employee for good legal reasons.

This process penalizes a depositing bank for taking checks on a forged endorsement primarily on the basis that the party receiving the check for deposit (or cashing) had a superior vantage point to avoid a loss. In this case, a depositing bank might have declined the deposit, or declined opening the account, or even demanded identification or authorization. A depositing bank (its shareholder, depositors, and government) bears these losses as a cost of operation. Unbelievably, and even in light of potential for large losses, payment of a check on a forged endorsement is fairly rare and the rate of loss usually modest.

Under the "old rules," the law usually shifts the general risk of loss to the commercial entity who received the check for deposit (or cashing) and afforded protection to the rightful owner, such as yourself.

New Rules: You Might Take the Loss

The "old rules" worked well for employers for many years; but as everywhere, change is here. The new rules, in summary, shift losses from the depositing bank to the employer, such as yourself. These new rules treat customer checks as virtual cash in the hands of certain employees, and possession of the checks and deposit under a forged endorsement by certain employees, is valid against you.

Let's assume that you have an employee who affixes deposits, writes checks, or posts checks to accounts. This employee takes and receives customer checks for deposit, but instead of depositing these items in your bank, goes to their own bank, affixes your name as an endorsement, and deposits the checks. Needless to say, the check is transmitted to your customer's bank, who honors (pays) the check. The credit department finally duns the customer for the bill, who not only claims payment, but presents a cancelled check which shows an endorsement. Needless to say, everybody gets a little excited.

After examining the check and confirming that the check was not deposited in your account, you make demand upon the depositing bank who properly turns you down. You make demand upon the customer's bank who turns you down. You make demand upon your customer, who not surprisingly, turns you down.

The new rule (Commercial Code Section 3-405) exonerates the depositing bank, along with all other parties, from liability. Under the new rules a responsible employee (a person who has the power to endorse your name on the back of check etc.) likewise may have power to both endorse your name and deposit the check in the employee's own account. This employee could turn your checks into his or her private stash of cash. Ultimately the employer, in granting an employee the power to endorse the employer's name, inferentially grants the employee the legal power to take checks and personally deposit them in their own bank account. This is a somewhat over-simplified statement, but accounting managers, data processing managers who handle funds, bookkeepers who handle checks for deposit, and even credit managers are vested virtually as a matter of law with the right to take your customer checks.

These new rules even apply to outgoing vendor checks. The overall impetus of these rules is that the employee's endorsement of a legitimate payee's name is valid on outgoing checks prepared or processed by the employee, or the employee provided information determining the payee's name or address, or simply that disposition is controlled by the employee. For example, the accounts payable (AP) department might issue a check to a legitimate supplier for a bona fide bill. The AP manager, who prepared checks from the employer's records, such as the vendor's invoices, endorses the name of the payee, deposits the check in his or her account, and absconds with the money. Under the new rules, the employer would have very limited recourse against the collecting bank used by the AP manager for deposit, or the employer's own bank for paying the check itself. In effect, vendor checks in the hands of a responsible employee likewise become virtual cash.

Fidelity Bonds Fill the Gap for Liability

The new rules shift the loss from the depositing bank, as a member of the banking community, to the employers as a member of the commercial community. The law imposes a greater burden (much greater) of diligence in this matter, primarily in the screening of employees who will be entrusted with checks, and finally, in the safeguard of checks. Furthermore, an employer can protect themselves with insurance and fidelity bonds, which would ameliorate the losses. In light of these new rules, the premium for fidelity insurance will increase. Buy now and don't pay later. Does this rule apply to all employees who come into possession of checks? No, not all employees, but only employees who sign or endorse the name of the employer for deposit, prepare or process instruments for issue in the name of the employer, supply information as payees to checks, control the disposition of checks to be issued in the name of the employer, or act otherwise in a responsible manner with the checks. This category includes just about anybody at the level of accounting manager, accounts payable and accounts receivable manager, credit manager, and related assistants. Probably excluded employees are low level clerks who simply handle checks for storage, transportation, or mailing.

Comparative Negligence Standards for Careless Depositing Bank

Is all lost to the depositing bank and inferentially your bank, too? If you can prove that the depositing bank was negligent in the handling of the check to the extent of actual negligence. The law incorporates the personal injury standard of comparative negligence in the handling of checks which would shift the loss to the bank if the bank's negligence primarily causes the loss. Needless to say, the depositing bank will also claim that they handled the checks in the ordinary course of business and that the employer is primarily negligent.

Avenue of Escape from Loss

Even with a catastrophic loss by a high level employee, you do have one avenue of recovery. The Commercial Code provides a new section which prohibits a bank or third party from knowingly laundering funds which arise from a theft or more artful terms such as a breach of fiduciary duty. The new law (Section 3-307) provides that the depositing bank is liable if the check is taken with full knowledge that the check is tendered by an unauthorized agent and that the check is deposited in a personal account or used for personal purposes. Knowledge means actual knowledge, which circumvents most commercial deposits through the mails or drop box. The purpose of this section prohibits a bank from knowingly accepting a check, obtained from a breach of fiduciary duty, in which the funds are used for personal purposes. This Code Section would save the employer if the depositing bank knew that the employee had received a stolen account check.

Best Remedy: Increased Vigilance

Any business operates on trust. A newspaper with its literally tens of thousands of accounts receives up to and including 2,000 to 3,000 checks of various sizes on a daily basis. Mail room personnel, clerks, data processing managers, accounts receivable personnel, and credit managers all handle large quantities of checks. The new law shifts the burden of responsibility of loss from the banking systems to the employer and forces the employer to greatly increase vigilance in the handling of checks, as the banking community will no longer insure these losses, absent a showing of negligence. On the other hand, the bank will not serve to launder obviously purloined checks. However, assuming a careful thief who takes great efforts not to arouse the suspicion of a bank, the loss more likely will fall upon the employer, which in this case, is you.

David J. Cook is o partner in the law firm of Cook, Perkiss, & Lew, Son Francisco. [C] David J. Cook, Esq., 1995.
COPYRIGHT 1995 National Association of Credit Management
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1995 Gale, Cengage Learning. All rights reserved.

Article Details
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Author:Cook, David J.
Publication:Business Credit
Article Type:Cover Story
Date:Jun 1, 1995
Words:1659
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