BILL ANALYSIS SENATE JUDICIARY COMMITTEE S Charles M. Calderon, Chairman B 1995-96 Regular Session 1 7 4 2 SB 1742 Senator Maddy As amended on April 18, 1996 Hearing Date: April 23, 1996 Commercial Code GWW/md COMMERCIAL LAW -LIABILITY FOR UNAUTHORIZED DEMAND DRAFTS- HISTORY Source: California Bankers Association Related Pending Legislation: None Known KEY ISSUES 1. AS BETWEEN THE PRESENTING OR DEPOSITORY BANK (COLLECTING ON BEHALF OF THE PAYEE DEPOSITING THE CHECK) AND THE DRAWEE BANK (PAYING ON BEHALF OF THE PAYOR PURPORTEDLY ISSUING THE CHECK), SHOULD THE DEPOSITORY BANK BE LIABLE FOR ANY PAYMENT OF AN UNAUTHORIZED DEMAND DRAFT, AS DEFINED? 2. SHOULD THE PROPOSED DEFINITION OF "DEMAND DRAFT" BE REFINED TO REQUIRE THE CUSTOMER'S NAME AND ACCOUNT NUMBER ON THE DRAFT? PURPOSE The purpose of this bill is to establish rules governing "draft demands" and to specify the liability for unauthorized demand drafts, as between the depository and payor financial institutions. Existing law establishes rules governing the collection by SB 1742 (Maddy) Page 2 banks of checks and other instruments for the payment of money. It also establishes rules governing the relationship of banks with their depositors in connection with the collection and payment of checks and other items. Existing law does not establish a definition or rules governing the collection and payment of "demand drafts." This bill would enact a definition of "demand draft" and include this item within the definition of a check for purposes of the banking law. It would define that term as a writing not signed by a customer that is created by a third party under the purported authority of the customer for the purpose of charging the customer's bank account. It would allocate the liability for wrongful payment of an unauthorized demand draft to the depositor and depository institution by providing that the person presenting the draft for payment warrants that the draft is authorized by the person listed as the drawer/payor. COMMENT 1. Should the depository bank be liable for any payment of an unauthorized demand draft submitted for collection by its customer, rather than the payor bank? According to the California Bankers Association, sponsor of SB 1742, preauthorized payments have grown in popularity since the 1980s as a method for merchants (such as telemarketers) to sell a wide variety of products and services over the phone and for companies to receive regularly scheduled payments. Although credit card debits initially were the most common preauthorized payment method used by telemarketers, checking account debits, also known as demand drafts, increasingly are being used as a means of payment. Bill collectors have also popularized the demand draft as a form of ensuring timely payments. (See Comment 2 for description of a demand draft.) Use of demand drafts grew with the growth of telemarketing. Unfortunately, the use of demand drafts by telemarketing fraud operators have also grown, with the result that the payor bank usually has to bear the costs of the fraudulent instrument. Under current laws, the rights and responsibilities of SB 1742 (Maddy) Page 3 presenting banks, drawee banks, and their respective customers are ambiguous and subject to litigation since demand drafts are not included within the UCC laws governing negotiable instruments. In cases of a fraudulent, .i.e., unauthorized demand draft, the bank customer cannot be held responsible for an unauthorized check paid by the bank. While a payor bank usually has a right to return an improper item to the depository bank, unauthorized demand checks are often not discovered by the bank customer until long after the payor bank has honored the check and lost the opportunity to return the item back to the depository bank. Thus, payor banks by default usually bear the costs of a fraudulent demand draft. The bill would provide that a party presenting a demand draft for payment gives a warranty that the draft is authorized by the named account holder. The bill thus allocates the risk of loss from an unauthorized, unsigned demand draft to the institution that has the banking relationship with the party originating and depositing the demand draft. The CBA contends that this bill would encourage banks to scrupulously screen their customers who use demand drafts; the liability for unpaid drafts would fall upon the bank where the payor bank has rejected the draft and the depositing customer has withdrawn the monies paid by the depository bank. CBA also argues that, as between the depository bank and the payor bank, the depository bank is in the best position to police and control the third parties which issue and deposit the demand drafts. 2. What is a demand draft? Should it be defined with greater specificity? A demand draft is usually a check-like paper item generated by the depositor (such as a telemarketer) which looks like a check and is drawn on the customer's transaction account with the customer's depository institution. Instead of bearing the customer's signature, the customer's name may be typewritten or accompanied by a statement stating that the payee/depositor guarantees that the item is authorized. The unsigned demand draft is deposited with the SB 1742 (Maddy) Page 4 telemarketer's bank like a regular check for presentment to the customer's bank for payment Proposed subdivision (k) to Commercial Code Section 3014 defines "demand draft" to mean: "... a writing not signed by a customer that is created by a third party under the purported authority of the customer for the purpose of charging the customer's account with a bank. A demand draft may contain any or all of the following: (1) The customer's printed or typewritten name or account number. (2) A notation that the customer authorized the draft. (3) The statement "No Signature Required" or words to that effect. A demand draft shall not include a check purportedly drawn by a fiduciary (such an a trustee or an attorney in an attorney-client relationship), as defined in paragraph (1) of subdivision (a) of Section 3307." As drafted, the provision would provide that a demand draft may contain "any or all" of three specified descriptive features. Thus, it does not require that the draft at least contain the customer's account number and depository institution, which would seem to be salient information on any draft. SHOULD THE DEFINITION OF A DEMAND DRAFT BE FURTHER REFINED TO AT LEAST REQUIRE THE CUSTOMER'S NAME AND ACCOUNT NUMBER ON THE DRAFT? 3. Proposed official comment SB 1742 also proposes an "official comment" to the proposed law. Official comments are usually offered to help explain the Legislature's intent in enacting the measure. The proposed comment provides in part: "Section 3104(k) is new. Modern check collection methods have increased the risk on payor banks that items not bearing authorized signatures may be paid against customer accounts. The purpose of this change is to define a new class of payment instrument, drawn on a bank customer's account without an authorized SB 1742 (Maddy) Page 5 signature, and to shift the risk of loss for processing this instrument to the depository-collecting bank which is in the best position to prevent its introduction into the check collection system. "The definition of "demand draft" is intended to identify a payment instrument created to debit a bank customer's account with the bank by a party who is not a signer on the account. This payment instrument is not signed by an authorized signer on the account and does not bear or purport to bear a signature of an authorized signer. This payment instrument is intended to debit the bank customer's account by deposit and collection through the normal check collection system. A demand draft may be created by a third party, such as a telemarketer, with the authorization by the bank customer to obtain payment from the bank customer's account as a means to pay the third party. A demand draft may also be created by a third party such as a home banking service provider, as a means to pay itself or others. The customer's account number and other processing information is encoded on the demand draft and the demand draft is deposited in a bank for collection through normal banking channels and payment by the payor bank. Because checks and other items deposited for collection are processed rapidly and in high volume, payor banks are not able to determine if customers authorize the creation of demand drafts. The depository bank, which is charged with knowing its customer, is in the best position to avoid the introduction into the check collection system of an unauthorized demand draft by scrutinizing the customers allowed to deposit those drafts. This change creates an additional warranty in the case of a demand draft to each transferee that the demand draft was authorized by the bank customer upon whose account it is drawn. This change shifts the risk to the depository bank if its customer deposits an unauthorized demand draft for collection. "Demand drafts do not include instruments that bear forged or unauthorized signatures of SB 1742 (Maddy) Page 6 customers....Instruments bearing forged or unauthorized signatures should be handled under the forgery provisions and unauthorized signature provisions of Divisions 3 and 4 of the Commercial Code, as applicable." The last paragraph of the Comment makes it clear that this legislation does not affect the remedies currently available to bank customers if their bank pays a check bearing a forged or unauthorized signature. Support: State Attorney General Opposition: None Known Prior Legislation: None Known **************