BILL ANALYSIS
SENATE JUDICIARY COMMITTEE S
Charles M. Calderon, Chairman B
1995-96 Regular Session
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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
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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
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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
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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
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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
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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
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