Use of Thresholds Below which Drawer's Signatures are Not Verified
by Thomas J. McNamara, Esq.
In these days of automated check processing, most banks do not verify the drawer' s signatures on all checks that they pay. Many banks employ a bulk filing system pursuant to which only checks above a certain threshold dollar amount are selected for visual signature review. Often, use of a threshold is coupled with some variation in which certain checks below the threshold are selected for examination either randomly, or pursuant to certain fraud predictive criteria (checks significantly out of sequence, or disproportionately large amounts in relation to average check amount, etc.)
The largest check fraud losses usually occur when there are multiple forgeries by the same wrongdoer. This wrongdoer is usually the bookkeeper or someone in a similar position. Frequently, these "inside" fraud schemes go undetected for many months, if not years, because there is no segregation of duties. That is, the same person who has responsibility for preparing checks has responsibility to receive and review bank statements and reconcile the checking account. The typical bank defense in such cases is the failure of the customer to review its bank statements and cancelled checks and to discover and report promptly to the bank (within 14 days) any forged checks. N.Y. Uniform Commercial Code 4-406 (1), (2). There is a potential obstacle for a bank to overcome, however, before it can take advantage of this defense. With regard to those checks paid within one year prior to the forgery being reported to the bank, the bank can avail itself of this "failure to look at your bank statements" defense only if the bank itself exercised "ordinary care" in paying the forged checks. The question then becomes whether a bank which has failed to verify any of the drawer's signatures on the forged checks because they fell below the bank's threshold can nonetheless be considered to have exercised "ordinary care" in paying the items. This question has found varying responses in the courts of different states.
Oregon
An Oregon bank instituted a $5,000 threshold below which checks were not selected for "sight review" of signatures. The bank established the threshold after conducting a cost benefit study which revealed that very few actual forgeries are detected by individual review of checks, and the cost of such review far exceeds the benefits. The Court of Appeals of Oregon affirmed judgment in favor of the customer against the bank, finding that the failure to verify any checks below the $5,000 threshold was commercially unreasonable as a matter of law. "While that approach, based on considerations of cost and efficiency, may be a prudent business decision and followed by most banks, it does not meet the bank's responsibility under the statutes." Medford Irrigation District v Western Bank, 66 Or. App. 589, 593, 676 P.2d 329, 332 (1987).
This case points up the importance of factoring in the legal consequences of decisions to integrate technological changes into a bank's check processing system.
New York
In a New York case, the customer's executive secretary forged 155 checks totaling $150,000 over a 22-month period. The bank did not verify any of the signatures because all of the checks fell below the bank's threshold. The bank offered evidence that it paid several million checks per week, employed eight clerks who spent full time verifying check signatures, and that it verified 1.1% of all checks presented for payment. The New York court granted the bank summary judgment, finding that use of a threshold and Verification of 1.1% of all checks was commercially reasonable. The court rejected the opinion testimony of the customer's expert that banks assumed the risk of loss with respect to checks not signature verified, and that ordinary care required at least some random sampling of checks below the threshold. Sterling v Citibank, N.A., Index No. 96-119552, Sup. Ct. N.Y. Co. (10/21/97).
Rhode Island
A Rhode Island bank was found to have exercised ordinary care by verifying all checks above a $1,000 threshold and a random sampling of 1% of those below the threshold. The court said the use of a threshold was justified by the bank's cost-benefit analysis and the fact that few forged signatures are actually detected even when reviewed. Rhode Island Hospital Trust National Bank v Zapata Corp., 848 F.2d 291 (1st Cir. 1988)
California
In a California case, a bank paid more than 100 forged checks. The bank had a threshold of $50,000, above which all checks were signature verified. Certain checks between $10,000 and $50,000 were selected for review depending upon certain other factors, and checks below $10,000 were not signature verified at all. The Court of Appeals of California affirmed summary judgment in favor of the bank. The customer's expert claimed that the bank's check processing system was commercially unreasonable because it resulted in sight review of only one percent of the checks processed and did not require sight review of all out-of-sequence checks. The court pointed out, "However, plaintiff's expert did not provide any evidence that defendant's check processing system was inconsistent with the general practice in the banking industry in the area." Story Road Flea Market, Inv. v Wells Fargo Bank, N.A. , 42 Cal. App. 4th 1733, 1744, 50 Cal. Rptr. 2d 524, 530 (Ct. App. 1996)
Georgia
In Georgia, a customer's comptroller forged 188 checks totaling close to $1 million. The Court of Appeals of Georgia held that an issue of fact was presented as to the commercial reasonableness of the bank's $25,000 threshold for signature verification. The court noted that signature verification procedures for commercial checking accounts at five local banks varied from checking all signatures to checking only those over $40,000. Eason Publications, Inc. v NationsBank of Georgia, 217 Ga. App. 726, 729, 458 S.E.2d 899, 902 (1995).
Illinois
Reversing the decision of a lower court, the Supreme Court of Illinois held that the commercial reasonableness of a bank's $1,000 threshold presented a question of fact to be determined by a jury. Wilder Binding Co. v Oak Park Trust and Savings Bank, 135 Ill.2d 121, 552 N.E.2d 783 (1990).
