An Important Banking Case: A New Mexico Court Gets It Right

"A tragedy is a busload of lawyers going over a cliff with an empty seat".  Author unknown.

I hope you will not think my quote about lawyers in bad taste.  Throughout my legal work in banking, I have enjoyed Pat Dee’s  lawyer jokes.  Since this Blog is mainly about a legal case and all lawyers love to talk about "cases", I thought a joke about lawyers fitting.  I suspect that Pat Dee is really the author of the quote.

The New Mexico Court of Appeals has just decided an important banking case on the duties of banks and their depositors when there are forgeries or alterations in checks negotiated by the customer's  bank.  A bank's operations department should be aware of the case.

 In  Associated Home and RV Sales, Inc. v. Bank of Belen,   the New Mexico Court of Appeals  settled important issues concerning New Mexico Uniform Commercial Code Section 55-4-406 concerning a customer's duty to discover and report forgeries or unauthorized alterations to his bank.  The facts are simple but common.in business.

 Associated Home and RV Sales, Inc.  did  business as Enchantment RV ("Enchantment").  Enchantment’s bookkeeper, with access to Enchantment's checks and accounts, began forging checks on Enchantment’s accounts in February 2003 and this practice continued until October 2004.  The bookkeeper forged or altered 211 checks, making them  payable to "cash" or herself and stole more than $283,546.00 from her employer.  Bank of Belen honored all the forged checks until Enchantment discovered the scheme and notified the Bank of the forgeries in October 2004--about 18 months after the first  forgery.  Bank of Belen refused to reimburse Enchantment for any losses from the forgeries.

Enchantment sued Bank of Belen on several legal common law (ie. non-statutory)  theories, including negligence, breach of contract, misrepresentation and a statutory claim for unfair trade practices. The Bank moved to dismiss all common law claims and the claim for unfair trade practices, leaving Enchantment's claims subject only to Section 4-406. The Bank of Belen also won a summary judgment on another portion of Enchantment’s claims. In its decision the Court of Appeals furnished bankers a road map for the meaning of Section 4-406.

Most importantly, the Court held that the New Mexico Uniform Commercial Code's ("UCC") detailed provisions in Part Four, Relationship Between Payor Bank and Its Customers, was a carefully designed statutory structure that totally superseded and replaced the common law causes of action and the unfair trade practices claim.  Thus, after Associated Home and RV Sales, Inc. v. Bank of Belen, plaintiff customers suing for damages for forgery or unauthorized check alteration must satisfy UCC Section 4-406 in order to recover any damages against a bank honoring forged checks.

Section 4-406 carries significant protections for a bank if the customer does not promptly notify the bank of the forgery scheme.  Under the Associated Home  case the following rules guide the bank and its customers:

1. If the customer notifies the bank of the forgery within 30 days of receipt of the account statement containing  records of the forged or altered checks, the bank is strictly liable to reimburse the customer for the amount of the forged check.

2. The Court of Appeals held that the fact that the forging employee picked up the account statements at the bank did not excuse the customer--delivery of the account statements to the guilty employee is still a valid delivery of the account statement under Section 4-406(d)(1) and starts the 30 day period running.

3. If the customer does not notify the bank of the forged check within 30 days, the bank is not strictly liable, subject to the circumstances in paragraph 5 below,  for the forgeries on the statement delivered to the customer.

4. Each statement of account bearing a forged or altered check starts a new 30 day period running.  For example, if a customer discovers and reports  a forged check in the second 30 day period of the forgery scheme, the bank is not strictly liable for the first 30 day period but is liable for the second 30 day period.

5. The customer can recover from the bank even after the 30 day period has run, by proving the bank's failed to exercise ordinary care--a negligence standard.  Liability is apportioned by comparing the  bank's negligence to the customer's fault in timely discovering the forgery or altered check.

6.  Finally, if the customer does not discover and report the forgery or alternation within one year, the customer has no claim for the forgery or alteration.

Applying the Associated Home rules summar, the Court of Appeals held that the Bank of Belen was not liable for any forgery from February 2003 to October 2003 (the latter date being one year from the discovery and report to the bank in November 2004).  However, since a new 30 day period started with the delivery of each account statement (contrary to the Bank's argument), after October 2003 Enchantment could claim that Bank of Belen did not act with ordinary care.  Enchantment claimed that Bank had cashed checks made to cash contrary to the Bank's promise, did not notice the signatures were false and the checks exceeded teller limits.  The Court of Appeals held that there were material issues of fact that had to be tried by the district court concerning whether Bank of Belen had acted without ordinary care in cashing the checks from October 2003 to November 2004.  This latter ruling while unfortunate for the Bank is in accordance with New Mexico law which does not favor summary judgments.  Enchantment had also alleged fraud without specific facts.  Although fraud is outside of the Court's UCC ruling because it an independent claim, it was lost in a procedural gap in the appellate rules and sent back to the district court without a ruling.

Banks should also avoid special account requirements of the type described in the Associated Home case such as "no cash" checks or two signature requirements.  With the number of transactions in modern banking it is impossible for tellers to police or monitor the requirements.    Banks should also insure that their operations department understands the rules of the Associated Home case.  One powerful motivation is the risk of bad public relations.  In the same week that the Associated Home case was released, the Albuquerque Journal carried a front page story about a bank customer's experience with forgery and her problems with her bank.  Although the facts are not clear, from the story it appeared that the customer caught the forgery within 30 days of  the first occurrence.  She was called on an overdraft and asked to approved a check being negotiating at that time by the forger.  She rushed to the bank, apprehended the forger and informed the bank of the prior forgery.  She was refused reimbursement until a senior bank officer out of state informed her that the bank would "make an exception in her case".  Either the story's  facts are wrong or the bank risked serious legal repercussions. The Albuquerque Journal reporter, apparently not aware of the law, then warned her readers to be careful and read the fine print on their bank's agreements--implying that banks will not honor the law on forgeries or altered checks--which cannot be changed by agreement. 

Sorry for the long Blog.  Mike Comeau, who has significant experience in forgery and altered check cases, contributed to the Blog--but not its length.  Much of my practical knowledge on dealing with Section 4-406 has come from Linda Herrera, formerly head of operations at First Community Bank.  She may be the foremost practical expert on Section 4-406.

The legislature is almost over.  A lot of damage can be done in three or four days. 

Do Good.

Marshall G. Martin
Comeau, Maldegen, Templeman & Indall, LLP
505-982-4611 (office)
505-228-8506 (cell)