Bank That Accepted Stolen and Forged Checks From Check-Cashing Company Had Duty of Care to Verify Endorsements

Addressing an issue of first impression, the California Fourth Appellate District has decided that a check cashing service is not a bank for purposes of the fraudulent indorsement provisions of Section 3405 of the California Commercial Code.  Therefore, the first bank to receive a check for deposit from a check cashing service is a depositary bank that owes an ordinary duty of care to the payee to make certain that all endorsements on a check are valid. (HH Computer Systems, Inc. v. Pacific City Bank et al. (November 6, 2014, G049028) ___Cal.App.4th ___).


Over a year and one half period, Jennifer Kim ("Kim"), the accounting manager for HH Computer Systems, Inc. ("HH"), stole approximately 300 checks made payable to HH totaling approximately $650,000.  Kim fraudulently endorsed the checks and took them to three separate check cashing services, receiving cash.  The check cashing services then deposited the fraudulently endorsed checks or cashed them at their banks.  When HH discovered Kim's fraud, it fired Kim and referred the matter to the Santa Ana police department.  HH sued the check cashing services and the banks where the check cashing services had deposited or cashed the checks to recover its loss.  The banks demurred to HH's complaint contending that they did not owe HH a duty of care under Section 3405 to validate the endorsements on the checks because they were not the depositary banks.  They contended that the check cashing services were the depositary banks and that the banks were intermediary banks who did not owe a duty of care to HH.  The trial court sustained the banks' demurrers without leave to amend and dismissed them from HH's lawsuit.


The Fourth Appellate District reversed the trial court's dismissal.  It based its decision on its determination that a check cashing service is not a bank for purposes of Section 3405.  Therefore, the banks into which the check cashing services deposited the fraudulently endorsed checks were the "first banks" or "depositary banks" for purposes of Section 3405.  As such, the banks owed HH, as payee of the checks, a duty of ordinary care to validate the endorsements on the checks.  The Fourth Appellate District made a point of noting that under Section 3405, there is a presumption that the loss occasioned by an embezzling employee entrusted with responsibility for checks is placed on the employer, not the bank.  However, the presumption is not conclusive and a bank is subject to a comparative negligence standard.  To the extent a depositary bank fails to exercise ordinary care and its failure contributes to a person's loss, the person may recover from the bank.  The Fourth Appellate District also made a point of noting that it did not hold that an intermediary bank (a collecting bank that is not the first bank or depositary bank) has a duty of ordinary care under Section 3405.  An intermediary bank has a lesser duty of care than a depositary bank. 


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