Scribd Logo
Upload

Welcome to Scribd!

  • SHLG Scan24030819081

    Uploaded by

    Herman Legal Group, LLC
    4 views34 pages

    Original Title

    SHLG_SCAN24030819081

    Copyright

    © © All Rights Reserved

    Available Formats

    PDF or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Report this Document

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    4 views34 pages

    SHLG Scan24030819081

    Uploaded by

    Herman Legal Group, LLC

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Flag for inappropriate content
    of 34
    (CuEck FRAUD AND THE VARIATION OF UCC 4-401: Wry BANK’s SHouLD NoT BE ABLE TO VARY THE UCC’s STANDARD RISK ALLOCATION SCHEME INTRODUCTION Frank Abagnale, one of most prolific check frauds once wrote, “I was a millionaire twice over and half again before I was twenty-one. I stole every nickel of it.”! He had started at 16, in 1964, and within the next five years had managed to bilk banks and companies out of 2.5 million dollars? Abagnale accomplished much of his fraud by producing checks which looked exactly like the payroll checks for Pan Am3 Under the Uniform Commercial Code (“UCC” or the “Code”), Pan Am’s bank had to bear the losses from these fraudulent checks because they were not authorized. Article 4 of the UCC provides a comprehensive set of rules for the check system among banks and for the collection of checks. Article $of the Code governs negotiable instruments, of which checks are a subset Within this system, the Code contains a standard risk allocation scheme that requires that the risk of loss for fraudulent checks be borne by the payment system providers, banks.” Only in the case of user negligence can the bank seck to enforce a fraudulent check on a user of the system. | FRANK W. ABAGNALE, CATCH ME IF YOU CAN 4 (2000) 2d, at 4-6, 21 8d, at 118-19. + U.G.G. § £401 (2002) (providing that checks which are not properly payable cannot bbe charged to a customer's account); Jd. cmt. 1 (providing that unauthorized drawer's signatures cannot be properly payable). 8d, Art. 4. © Id. §§ 3-102, 3-104. 7 Id. § 4401 (providing that banks can only charge their customers for checks that are properly payable). "Id, § 4-406(4) (providing that a customer who fails to exercise reasonable prompt ness in examining the statement will be precluded from asserting against the bank that (1) an unauthorized signature or alteration if the bank proves it suffered a loss by reason of the failure and (2) the unauthorized signature or alteration by the same wrongdoer on an\ item the bank paid in good faith before the bank received notice from the customer of th unauthorized item) 1 lites! Seen corn atstrent D128) 2 Boston College Law Review [Vol. :1 The check system stipulates that the account holder is the drawer of a check on a bank (the drawee) that is made payable to a payee.® The process of collecting a check, governed by Article 4, is that the payee (the person the instrument is made out to) will bring the check to a depositary bank to deposit it for a credit to an account or for cash.0 The depositary bank then either presents the check to the payor bank or transfers it to an intermediary bank (which then presents it to the payor bank).!! The drawee bank (the Article TIT term) is the payor bank (Article IV term meaning the bank on which the check is drawn) and will make the decision to either pay the check or dishonor it! An example demonstrating how the parties interact may prove helpful Frank Abagnale in his book Catch Me if You Can, describes a common scenario which he used to defraud banks: “I made myself, ‘Frank Williams,’ the payee, of course in the amount of 568.10, a sum that seemed reasonable to me. In the lower left hand corner I type in “Chase Manhattan Bank’ and the bank’s address... Below the bank legend, across the bottom left hand corner of the check, I laid down a series of numbers... The numbers purportedly represented the Fed- eral Reserve District of-which Chase Manhattan was a member, the bank’s FRD identification number and Pan Am’s account number... I drove to the nearest bank, walked in jauntily and presented myself at a teller’s booth.... ‘Would you cash this check for me? I think that I have sufficient identification.”” In this case, Frank Williams is the payee, Pan Am is the drawee, and Chase Manhattan Bank becomes the payor bank, where the check would ultimately be presented.?9 When Frank signed the check in order to have the check cashed, that is Frank's indorsement.' #U.G.G. § $-108(4) (2002) (defining drawee as the person ordered to make payment); id. § $103(5) (defining drawer as the person who signs ordering payment). 10 SeeJawes StvEN RoGERs, THE END OF NEGOTIABLE INSTRUMENTS: BRINGING PAY- MENT SysTRMS Law OUT OF THE PAST 125-26 (2011), 1 Seed. 2 U.C.C. § 4402(c) (allowing a payor bank to determine the customer's balance at any time between the time it receives the item and when it returns it as dishonored). ! Abagnale, supranote 1, at 118-20. Mia "See UGC. $§ 3-108 (4), 4-105(3) (2002). °© See id. § $-204(a) (providing that an indorsement is a signature on an instrument ‘meant to negotiate the instrument) Hlectreriinmeny: Nssenconiatstract-2100aD) 1 3 au The teller, of course, cashed the forged check.!” As Abagnale continued, his frauds became more complex and expensive.!8 Frank eventually bought a real Pan Am check from a stewardess which he brought to a check printer, impersonating a Pan Am representative and ordered exact duplicates of Pan Am checks.!® This example demonstrates the importance and potential costs of fraud in the check system and the costs banks are proposing to transfer to their depositors.2° Article 4 of the UCC governs the relationship between a depositary bank and its depositor customer including who is liable for fraudulent and unauthorized checks.2! Section 4-401 provides that a drawee bank can only debit a customer’s account for a check if it is “properly payable.”2 Comment 1 to section 4-401 provides that any check that is not authorized by the drawer (alterations to the check are not authorized) is not “properly payable”. % If the item is not properly payable, then the bank is not entitled to charge the item to the customer’s account. The relationship between the depositor and his bank has always been considered a creditor-debtor relationship. Therefore, the his- tory of the UCC and 4-401 in prior case law has held that it was the bank’s duty to honor proper checks drawn upon it unless the bank had a right to refuse the order by reason of another agreement.2> Banks have attempted over the years to modify the default rules of the UCC in order to pass liability on to their depositors through provisions in their deposit agreements.” This practice has raised the 1 ABAGNaLE, supranote 1, at 119. 3 See id. at 166-70. Hd, ® Seo id at 168-69. 1U.C.G. § 4-401 (2002). 2 Jd, §4-401 (“An item is properly payable if it is authorized by the customer and is in accordance with any agreement between the customer and bank.") 3 Id. § 4401 cmt. 1 (“An item containing a forged drawer's signature or forged indorsement is not properly payable”) 24 James Steven Rogers, The Basic Principle of Loss Allocation for Unauthorized Checks, 39 ‘Wake Forest. LR. 453, 455 (2004), 2 Tex. Commerce Bank-Hurst v. United States, 703 F. Supp. 592, 594 (N.D. Tex. 1988); Caledonia Nat. Bank of Danville v. McPherson, 75 A.2d 685, 687 (Vt. 1950); Mallett v. Tunnicliffe, 186 So. 346, 348 (Fla, 1931). *8 Mallet, 186 So. at 349. ® See eg. Perini Corp. v. First Nat. Bank of Habersham Cnty., 558 F2d 398, 400 (5th Gir. 1977) (attempting to push liability on to the depositor for unauthorized checks which bore the facsimile signature); Cincinatti Ins. Co. v. Wachovia Bank, No. 08-CV-2734, 2010 4 Boston College Law Review [vol.:1 question of whether banks may use these types of provisions to alter the default rules and, if so, to what extent. UCC section 4-103 pro- vides that the UCC’s default rules may be varied by agreement so long as the bank does not disclaim ordinary care.** This provision poses the question of what the duty of ordinary care involves in the setting of a creditor debtor relationship.® Recent developments in the depos- it agreements between banks and their customers have attempted to change the default rules of UCC 4401.2" More recently, in 2010, this issue was presented in Cincinnati Ins. Co. v. Wachovia Bank in the District Court for the district of Minneso- ta® The court held in this case that the provision shifting liability onto the depositor in the deposit agreement was enforceable. At is- sue in the case was whether Wachovia could charge back to their cus- tomer a check that had been altered.‘ Returning to our example, Frank Abagnale was able to reproduce Pan Am checks without any negligence on the part of Pan Am and yet, under the wording of these provisions, the liability would be shifted from the bank to the deposi- tor (Pan Am).5 This Note evaluates whether deposit provisions which vary the properly payable rule in section 4401 are enforceable.* Part I dis- cusses the standard risk allocation scheme provided by Article 4 and the regulation of the relationship between the bank and its deposi- tor.” Part II presents multiple theoretical backdrops to risk allocation, the relationship between the bank and its depositor, and whether sec- tion 4401 can be varied by agreement. Part III provides context to the discussion by providing analogies to other contexts of variability in the regulation of the relationship between the bank and its deposi- WL 2777478, at *1 (D. Minn. July 14, 2010) (attempting to pass fraud losses to depositor if depositor did not pay for positive payment); Mercantile Bank of Ark. v. Vowell, 117 $.W.3d 603, 612 (Ark. Ct. App. 2003) attempting to limit the time depositors have to challenge unauthorized items), 2 Perini, 553 F.2d. at 400, # UGC. § 4103 (2002). ° See id. 8 See Cincinnati Ins., 2010 WL. 2777478, slip op. at *4. Td. 9 Id, Id. at *1 85 ABAGNALE, supranote 1, at 166-70. 56 See infra notes 1-814 and accompanying text. 2” See infra notes 44-105 and accompanying text. * See infra notes 106-162 and accompanying text. J 5 tor. Part IV argues that allowing variation of section 4-401 disclaims the historical and common law duties of the bank to its depositor. Part V compares positive payment and facsimile agreements with time limitation provisions and differentiates them by explaining how time limitation provisions do not affect the substantive rights of deposi- tors! Part VI argues that it is economically efficient not to allow vari- ation of creditor-debtor nature of the relationship between the depos- itor and the bank.? Part VII proposes a solution whereby the courts analyze the provisions regulating the relationship between the bank and its depositor with due regard to the historical common law duties of a bank.#8 1. THe STANDARD Risk ALLOCATION SCHEME OF ARTICLE 4 AND THE RELATIONSHIP BeTWEEN THE DEPOSITOR AND THE BANK A background in the standard risk allocation scheme of Article 4 and the policies behind check fraud loss allocation is necessary to un- derstand whether provisions which vary the default rules of section 4- 401 are enforceable.“ Part A discusses the risk allocation scheme ar- ticulated by Article 4.‘ Part B explains the regulation of the depositor bank relationship provided by Article 4 as well as recent develop- ments in the case law regarding the depositor bank relationship.* Part C discusses the history of the ABA Bank Collection Code and its importance and effect on the formation of Article 4.47 A. Article 4’s Risk Allocation Scheme The standard risk allocation system in the Code provides that the drawee bank is responsible for the loss due to a forged drawer’s signa- ture, whereas the depositary bank will ultimately be held liable for a % See infra notes 163-193 and accompanying text. 4 See infra notes 194-245 and accompanying text. 4 See infra notes 246-278 and accompanying text. © See infra notes 279-296 and accompanying text. * See infra notes 297-314 and accompanying text. + See infranotes 44-105 and accompanying text. Ser infranotes 48-62 and accompanying text. “ See infra notes 63-90 and accompanying text. © See infra notes 91-105 and accompanying text. 6 Boston College Law Review [Vol.:1 forged indorser’s signature Where only the amount of money on the check is altered, the drawee can charge its customer for the amount originally authorized while the depositary bank will bear the risk of loss of the difference between the altered check and the origi- nal payment.” With respect to the example provided above by Frank Abganale, the situation involved an unauthorized drawer’s signature because Frank signed Pan Am’s facsimile signature onto the draft and therefore the payor bank, or Pan Am’s bank Chase Manhattan, would have to bear the loss.*° In contrast, if Frank had stolen a check payable to Pan Am and had indorsed the check as Pan Am, this would consti- tute a forged indorsement in which case the depositary bank would be liable." Banks have defenses against their customers if a customer’s lack of ordinary care caused the loss.*? Article 3, which governs the trans- fer and payment of checks as a subset of negotiable instruments, pro- vides multiple defenses for banks in situations where a customer may bear some of the blame for the loss.'3 Section 3-405 provides that an employer can be responsible for the fraudulent indorsement by one of its own employces.* If the employer entrusted the employee with responsibility with respect to that type of instrument and the employ- ce makes a fraudulent indorsement, the indorsement is effective against the employer.’ If the party that paid value for the instrument failed to exercise ordinary care, then a comparative negligence scheme determines the damages. If a person's failure to exercise ordinary care contributes to the alteration of an instrument or the making of a forged signature, that party is precluded from bringing an action against the bank for re- payment because of that alteration or forged signature.’” If the party 8 U.GG. §§ 4-207, 4208 (2002) (providing that transferring and presenting banks warrant that the instrument has no forged indorsements and that the draft bas not been altered). The result when combined with § 4-401 is that the depositary bank bears the loss for forged indorsements while the payor bank bears the loss for forged drawer’s signatures. See id. $4401. An indorsement is a signature that is made for the purpose of negotiating the instrument. Id. § 3-204. 4 See id. §§ 4-401, 4.208, % See id. §§ $-103(5), 4208. 5 Seeid. §§ 3-204(a), 4207. 5 Id, §§ 3-416, 3405, 3-406. 5 UGC. $§ 3-416, 3-405, 3-406 (2002) 4 Td. § 3-405. Id 5 Id. § 3405(b) 5 Id, § 3406. 1 7 arguing that the item should be precluded also failed to exercise or- dinary care, then there is a comparative negligence scheme to deter- mine the damages." Section 3-417 also provides a warranty for the payor bank for pay- ing over forged instruments.” If the payor bank pays a check that is unauthorized, then the payor bank can recover the damages that re- sulted from the breach of warranty minus the amount that can be re- covered from the drawer. Article 4 of the UCG provides a parallel warranty for payor banks.*! The warrantee has substantially the same provisions and protections as the Article 3 warranty. B. The Relationship Between the Depositor and the Bank and the Issues Posed by Positive Payment Agreements Before the adoption of the UGG, the relationship between the depositor and his bank was considered that of a creditor-debtor.® Ale hough there are differences from a typical creditor-debtor relation- ship, the depositor, as a creditor of the bank, is entitled to repayment as directed. Therefore, prior to the UCC and section 4401, case law had held that it was the bank's duty to honor checks authorized by the drawer unless it had a separate right to not pay the check." The pri- mary right of the creditor-depositor is that the depositor can order the debtor-bank to disburse funds to the benefit of the depositor. The bank cannot deduct funds from the account except with the au- thorization of the creditor-depositor. Returning to the Abganale ex- ample, let us assume that he had a valid payroll check from Pan Am which he deposits into his bank account at Chase National Bank. If %U.GG. § $-406(b) (2002) % Id, § SIT. Section 3-417 provides for a presentment warranty such that any person. who obtains payment for the instrument warrants that the warrantor is a person entitled to enforce the instrument, there have been no alterations and warrantor has no knowledge that the drawer’s signature is unauthorized. Id. @ Id, §3-417(b). Td, § 4-208. See id. § 4.208(a) (1)-(4) © Tex. Commerce Bank-Hurst v. United States, 703 F Supp. 592, 594 (N.D. Tex. 1988); Caledonia Nat. Bank of Danville v. McPherson, 75 A.2d 685, 687 (Vt. 1950); Mallett v. Tumnicliffe, 186 So. 346, 348 (Fla. 1931) See Caledonia, 75 A.24 at 688. © Mallett, 186 So. at 349. Texas Commerce, 703 F. Supp. at 594. © See Cross v. Amoretti, 9 P.2d 147, 148 (Wyo. 1982) & See U.C.C, § 4401 (2002); Cross, 9 P2d at 148. 8 Boston College Law Review [Vol :1 the check is ultimately paid, Frank Abagnale is entitled to repayment from the bank — usually in the form of paying checks that he has writ- ten on his account.® Article 4 of the UCC allows for provisions within the article to be varied by agreement so long as the bank does not disclaim good faith or ordinary care.” Good faith is defined in section 3-103(a) (6) as both honesty in fact and observance of reasonable commercial stand- ards of fair dealing.” Ordinary care is defined as the observance of reasonable commercial standards in the area with respect to the busi- ness in which the party is engaged.” Recent developments in deposit agreements between banks and their customers have attempted to change the default rules of section 4401.” One important change involves the banks’ development of positive payment programs for their customers.”* Positive pay systems help protect both the bank and the customer from fraudulent checks.”* Under positive pay, customers submit the information (in- cluding check number and the amount) of all their checks for the day at the end of business.” For a monthly fee, the bank will then match the checks presented for payment on the customer’s account with the information given by the customer.” If the check presented for pay- ment does not match the information given by the customer, then the bank will promptly dishonor the check as unauthorized.” Following the development of positive payment systems, a bank could stipulate that if a business customer chose to reject the positive payment system, the business customer must accept liability for any forged item.” Following this development, the legal question con- cerning whether the UCC risk allocation scheme could or should be varied by agreement then arose. Positive payment was presented as an issue in the District Court for the district of Minnesota, in 2010, in Cincinnati Insurance Co. v. Wa- © SeeU.C.C. § 4401; Cross, 9 P.2d at 148, UGC. §4108(a). 1 Td. $8-103(a)(6). 7 Ha. - O8-CV-2734, 2010 WI. 2777478, at *4 (D. Minn, 7 Seed, at *1. 7 Ia. 78. Ha. 7 Ta. ” Cincinnati Ins. Co., 2010 WL 2777478, at *1. © Sevid. at 3. J 9 chovia where the court held that the provision in the deposit agree- ment was enforceable.®! Wachovia wanted to charge back to their de- positor, Schultz Foods, a check that had been altered.*? In the deposit agreement, there was a provision stipulating that if the customer re- jected positive payment, then the customer would bear the risk of the loss8 The court ultimately held that this provision was enforceable because it was not manifestly unreasonable under section 4103. There are competing policy objectives on either side of the issue of the variability of what is properly payable. Freedom of contract theory argues that banks and their customers should be able to price and allocate the risk between them as they see fit.8° Proponents of this theory argue that freedom of contract allows business parties to most efficiently allocate the risk.8? On the other hand, the UCC provides a framework which provides certainty for businesses such that both cus- tomers and banks can depend on the same results in different states. Furthermore, clear rules throughout the system serve to minimize litigation between banks and their customers, reducing the costs of doing business for all involved.* One of the main reasons for the last comprehensive update of Article 4, in 1990, was to minimize litiga- tion.” 8 1d at *6, 81d atl "Id. ™ Id, at 7-8, Section 4-103 provides that the provisions of Article 4 can be varied by agreement so long as the bank does not disclaim good faith or ordinary care. UCC. § 4 103 (2002), © Gf Peter A. Alces & Jason M. Hopkins, Carrying A Good Joke Too Far; 88 Cx. Kent L. Rev. 879, 903 (2008) (stating that courts are comfortable assuming sufficient agreement when transactors acted as though they agreed); L. Ali Khan, A Theoretical Anyalysis of Pay- ‘ment Systems, 60 S.C. L. Rev. 425, 485 (2008) (arguing that banks are the best loss avoider and are an unique position to insure society); A. Brooke Overby, Check Fraud in the Courts After the Revisions to U.C.C. Articles 3 and 4, 57 ALA. L. REV. 351, 361 (2005) (stating that the Joss allocation provisions as promoting finality and placing the risk on the banking sys- tem) © Christopher M. Grengs & Edward S, Adams, Contracting Around Finality: Transforming Price v. Neal From Dictate to Default, 89 MINN. L. REV. 163, 202 (2004) (arguing that making Price a default rule would allow parties to contract for the most efficient allocation of risk) 14 8 See U.C.C. §§ 4.207, 4-208, 4-401 © See Overby, supranote 85, at 361 n. 63. % 1d. at 386. 10 Boston College Law Review [Vol.:1 C. The History of Article 4 and its Predecessor the Bank Collection Act Article 4 of the UGG came about primarily as a solution to the problems that existed in a national check collection system.%! Before the creation of Article 4, the law was unclear about the duties of a bank in the collection of checks.% Different states had different standards for the banks.% In some states, the banks were considered agents of the depositor and were ultimately tasked with obtaining payment of the check for the depositor. If the collecting banks were agents of the depositor, then, under agency law, the depositary bank was not liable to the depositor for nonpayment. Other states took the view that collecting banks were agents of the depositary bank and, therefore, provided depositors with more rights if problem in collec- tion resulted in non-payment.* In the 1920s a movement supported by the American Banking Association (“ABA”), began to create a uniform law for check collec- tion procedures which eventually became the ABA Bank Collection Code.” The Bank Collection Code supported the Massachusetts rule, which viewed the collecting banks as agents of the depositor. The ABA Code was ultimately defeated when numerous states refused to pass_it into law because they felt that it was too favorable to, the banks.” A second effort to develop a uniform collection code arose; this effort was included in the movement to create the initial UCC as Article 4 in the early 1950s.1° At the time of the adoption of Article 4, there was significant de- bate revolving around whether the depositary bank should be liable for failure to receive payment due to a problem in collection. Harsh criticism came from a prominent commentator, Frederick Beutel, that % RooERS, supranote 10, at 131 % Td, at 129. 98 I % Td 9 Id % I © RoceRS, supra note 10, at 130. 8 Id % See id. at 131. 01d. 11 See ROGERS, supra note 10, at 131; Frederick K. Beutel, The Proposed Uniform [1] Commercial Code Should Not be Adopted, 61 Yat L. J. 335, 360 (1952) (stating that the pro- posed Article 4 is too bank friendly and that the Article is facta piece of class legislation) ] tt the article gave too much power to the banks by allowing them to avoid liability for non-payment due to a problem in collection. 1° During the process of revising the Bank Collection Code into Ar- ticle 4 of the UCC, the drafters felt that it was necessary to include provisions which governed the relationship between the bank and its customer. Almost as an afterthought, the fourth part of Article 4, governing the depositor-bank relationship was included as part IV of Article 4.1 Therefore, the provisions in part four seem to be lumped into Article 4 without much thought as to the differences between the actions of payor banks on behalf of their depositors and those of col- lecting banks.1° Il. THEortes RELATING TO Risk ALLOCATION IN THE CHECK SysTEM Theories relating to check loss, payment systems, and commercial transactions aid the development of commercial law by helping it provide a beneficial system for the transactions it regulates. Part A discusses the theories of finality as well as banks as payment system providers as support for why banks should not be able to vary the standard risk allocation.” Part B explains how theories of freedom of contract support banks being able to negotiate who bears the risk of loss.108 A. Theories Supporting no Variation: Finality and Banks Bear the Risk of Loss as the Payment System Provider If section 4401 and, by extension, the risk allocation provi sions in Article 4 cannot be varied, then the Uniform Commercial Code (UCC or the “Code”) provides for stability of rules and expecta- tions throughout the country upon which businesses can depend.! Finality is the idea that once a transaction has occurred, there should 12 Beutel, supra note 101, at 359-60. 18 RoceRs, supra note 10, at 143-44. 1 Fa. 108 Ta. 100 See infra notes 106-162 and accompanying text. 107 See infra notes 109-143 and accompanying text. 108 See infra notes 144-162 and accompanying text. 18 Overby, supra note 85, at 361 n. 63. 12 Boston College Law Review [Wol. :1 be minimal debate over it and thus, minimal litigation." Finality promotes easy allocation of the loss without litigation, thereby realiz- ing a main policy goal of the UCC—eliminating or, at least, minimiz- ing litigation." The finality rule draws support from Article 3 of the UCC governing negotiable instruments because people who paid val- ue and took the item in good faith are entitled to payment.1!2 Finality in payment encourages commercial transactions and can provide stability to the commercial system. A traditional justifi- cation for drawee liability was the concept of finality which promotes a positive business environment.!'4 The first edition of the Restate- ment of Restitution expressly supported this view and stated that a rule of finality in negotiable instruments would allow “mercantile in- struments in situations where ordinarily it is reasonably possible for the payor to ascertain the fraud.” For finality to operate properly, liability must be placed squarely on one party or another party in a quasi-strict liability scheme in order to minimize litigation."!° Commentators have argued that banks should bear the risk of loss because, as the payment systems providers, there are significant policy incentives for them to bear the risk."”” Placing the risk of loss on banks provides a strong incentive for the banks to develop new technologies and procedures to minimize potentially avoidable losses that occur due to check fraud." Across different payment systems, the law is relatively uniform in that the risks of unavoidable losses from unauthorized payments are borne by the provider and that these provisions cannot be varied by agreement of the parties.!"8 0 Jd, at 361 1 UGG § 1-103(a) (1) (2002) (stating that the goal of the UCC is clarity and simplici- »). 22 Se id. § 3-418, Section $418(c) provides that there are no remedies against a per- son who took the instrument in good faith and for value or who changed their position in reliance on the payment. Id, § 3-418(c). In this case, the drawee will not have an action against the person paid because there usually is a person who took the check in good faith and for value, See id. 3 RestareMENT (Fixsr) oF Restrrurion § 30 cmt. a (1937), 1 See id, 3 7a, 8 Overby, supra note 85, at 961 n. 63. DT Rogers, supra note 24, at 468-67 (arguing that banks should bear the risk of una- voidable losses due to check fraud) 18 Overby, supranote 85, at 361. 9 Rogers, supra note 24, at 454. 1 13 Placing liability on banks for the unavoidable losses from fraud conforms to all of the other modern payment systems. The main principle of modern payment systems is that payment system providers bear the cost of the unavoidable loss due to fraud.!2! The providers then spread the risk across the system in order to insure against extensive losses for any users of the system.'2* For example, in the credit card system, so long as the user notifies the provider in an adequate amount of time, the user's maximum liability for unauthor- ized fraudulent charges is only fifty dollars.125 Similarly, the debit card system provides a maximum liability scheme with the lowest ceiling of $50 escalating to $500 or more de- pending on the timeliness of the response of the customer.!% In the debit card system, if the customer does not report the unauthorized transfer within sixty days, the bank does not have to reimburse losses that would not have occurred if the customer gave timely notice." As in the credit card system, in the debit card system, if the customer re- ports in a timely manner, the customer's liability is capped at $50.12 This is the only manner in which a customer may be held liable for unauthorized charges on their account.!2” Consumer electronic funds transfers also are governed by the same riules.128 Even the wire transfer system, which is designed primarily for business to business transactions, has rules designed to put the risk of unavoidable loss on the system provider.” Banks bear the risk of loss unless the customer is at fault.1% If a payment order (an order direct- ing a bank to make payment) was not authorized by the customer, the 1 Seri 1h wed, 4 Truth in Lending Act, 15 U.S.C. § 1643 (2006) 44 Electronic Funds Transfer Act ("EFTA"), 15 U.S.C. § 1693g(a)(1) (stating that a ‘consumer's liability for an unauthorized transfer exceed the lesser of $50 or the amount of money obtained in such unauthorized fund transfer prior to notification). 1 Id. see also 12 CER. § 208.6 (1996) 18 12 GER. § 205.6 (providing that if the consumer notifies the bank within two busi- ness days after learning of the loss or theft of access device, then the customer's liability will not exceed $50) 1115 USC. § 1693g(€) 18 Jd. § 1693g(a). EFTA and Regulation E promulgated pursuant to EFTA governs consumer electronic funds transfers of which debit cards are included. 12 GER §205.3(b). 1 U.C.C § 44201-2038 (2002). 290 Jd. § 4-208, uM Boston Callege Law Review [Vol :1 bank is not entitled to enforce the order unless there was an external mistake by the customer.!8! The bank can hold the customer liable for the payment order only if the bank and the customer have agreed to a reasonable security procedure and the bank follows the security pro- cedure in making the following order." These rules are stipulated even though fraud loss presents a massive problem for the wire trans- fer system because, unlike other payment systems, wire transfers han- dle uniquely large amounts of money per order.!88 In fact, due to their reliability and fast finality, wire transfers account for about eighty-five percent of all money passing through payment systems.!34 Article 4A of the UCC, governing wire transfers, ultimately pro- vides that the rules governing the risk of loss cannot be varied by agreement. Section 44-202 which governs the liability of customers on their transfer orders allows only a minimal amount of variation, stating that the provision can only be varied to the extent provided for in section 44-203(a) (1). Section 44-202(b) provides that a bank and customer can agree on a certain security procedure.'8? Section 4A-203(a)(1) provides that a receiving bank can limit the extent to which it is entitled to enforce or retain payment of the payment order by written agreement with the customer. These rules effectively put the emphasis on security and encourage all parties to maintain their security procedures in order to reduce fraud loss in the system.189 There is a strong argument that if payment systems have to bear the risk of unavoidable losses, then the system providers will be incen- tivized to develop new technology and procedures to minimize the risk. The median cost of fraud prevention services for money center banks in 2004 was between $5 and $20 million, not counting the cost "81 Jd. § 44-203. The receiving bank can only enforce the order if the order was made by a person entrusted with a duty for security procedures or payment orders or obtained access to the transmission of the customer from a source controlled by the customer. Id, 12 Jd § 48-202, 9 Td, § 4A prefatory note (stating that the dollar value of payments made by wire transfer far exceeds any other payment method). 14 Rogers, supra note 24, at 476-77. 1% UGC, § 44-202(F) (2002) 198 1d. 197 Td § 4A-202(b). 488 Jd. § 4A-208(a) (1), 199 See id 1 Overby, supra note 85, at 361 1 15 of losses from fraudulent checks." Banks spend a substantial amount of money in an attempt to protect the system against losses.“ There- fore, there is a strong argument that placing the liability for unavoid- able losses on the banks has produced an effort by the banks to step up the prevention of fraud, decreasing costs for everyone.\48 B. Freedom of Contract: A Theory Supporting Varying 4-401 by Agreement Freedom of contract principles support the ability of customers and their banks to vary the provisions of the UCC in order to allocate the risks between the parties as they choose. Commentators argue that allowing parties to allocate the risk of loss as they choose will lead to the burden of the loss falling on the party that can most adequately Dear it. This theory is analogous to Judge Learned Hand’s theory out lined in the 1947 Second Circuit Court of Appeals case, United States v. Carroll Towing: The case involved the question of who should bear the loss in the crash and sinking of a tow boat due to negligence by the defendant. Justice Hand reasoned in the case that whether a duty existed could be determined by an equation that included 1j the probability that that the boat will break away, 2) the seriousness of the possible injury if it did break away and 3) the burden of adequate protections, shown in the formula B

    You might also like