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Ajax then presents the check to ABC Inc. Can ABC Inc., as the drawer of the check, assert its defense to payment against the original payee against Ajax, a subsequent holder of the check? Ajax took the check in good faith and without knowledge of ABC Inc.’s defense to payment against XYZ Corp. Must ABC Inc. pay Ajax?
The answer is yes. When Ajax took the draft in good faith in order to discharge, in part, the debt owed to it by XYZ Corp., it became a “holder in due course.” It is a fundamental principle of draft law that a holder in due course is immune to (not “infected by”) any defense to payment that the drawer of the draft may have against the original payee of the draft.
A check is a draft drawn on a bank. Thus, all of the preceding discussion in regard to the law of drafts applies to checks. All checks are drafts, except that a documentary draft (described earlier) is not a check even when the drawee is a bank.
Drafts and checks are subject to the law of drafts under Article 3 of the U.C.C. and subject to the law of bank deposits and collections under U.C.C. Article 4. The Articles of the U.C.C. are model laws drafted by a national council that sponsors the U.C.C. and presents the models to the state legislatures for adoption, with the goal that the commercial laws in the 50 states be “uniform” and not vary from state to state.
The drawer of the check is the customer of the bank. The drawer writes the check. The drawee is always the bank. The payee of the check is entitled to present the check for payment to the bank and to do so is required to mail or deliver it, or cause it to be delivered, to the drawee bank. Typically, the payee deposits the check at its own bank, which then causes the check to be presented to the drawee bank.
The first bank in the chain of collecting a check is called the depository bank. The depository bank may present the check for payment to the drawee bank or send it for collection to another bank, perhaps a Federal Reserve Bank. Depository banks and other banks in the chain of collection, other than the drawee
Checks and the Risk of Fraud
bank, are called collecting banks. The drawee bank is called the payor bank.
The delivery of a check to a collecting bank for collection— or to any other transferee with the intention that the transferee may receive funds from the payor bank—is a transfer of the check. The delivery of a check to the payor bank for payment is a presentment.
Paid and Accepted (Certified) Checks
As noted earlier, a creditor need not accept a debtor’s check. The creditor may instead demand that the drawer pay in cash, deliver a cashier’s check, deliver a “certified check,” or use some other form of payment. If the creditor accepts the check, however, the debtor’s obligation is “suspended” (deferred), and if the check is paid by the payor bank, the obligation is “discharged” (terminated). The obligation is also discharged if the bank “accepts” the check by “certifying” it—the bank stamps, dates, and signs the check as “certified” and thus guarantees to pay it. (When a bank certifies a check, it usually reserves the funds from the drawer’s bank account.)
What If a Check “Bounces”? If the bank “dishonors” a check— refuses to pay it—the “suspension” of the obligation of the drawer to the payee stops and the holder of the check may then again demand payment from the drawer. If the drawer declines to pay the check, the holder may bring an action against the drawer “on the instrument.” In an action on the instrument, the holder asserts the drawer’s obligation to pay as the drawer of a dishonored check.
The drawer—the person who wrote the check—may be able to avoid liability on the check if the holder demanding payment is the original payee; for example, if the holder is the seller and the goods or services delivered were not as represented. The drawer may not avoid liability, however, if the holder demanding payment is not the original payee but a “holder in due course.”
Any person who endorsed the check is liable to any person to whom the check was subsequently endorsed unless—and this is important—the endorsement was stated to be “without recourse.”
So many checks are routinely endorsed and deposited and paid on presentment that the risks of endorser liability are often not remembered or not clearly understood. Anyone who is asked to endorse or provide a company endorsement on a check is advised to consider using an endorsement “without recourse.”
As noted earlier in respect to drafts, in a blank endorsement, the transferor endorses the check simply by signing the name of the transferor and does not identify the transferee by name. When the transferor delivers possession of the check to the transferee, the check becomes “bearer” paper, and any person in possession of the check is entitled to enforce it by negotiating it to another transferee or presenting it for payment to the drawee. To avoid the risks associated with bearer paper, the payee may use a restrictive or a special endorsement.