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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