06-1546-cv
J. Walter Thompson U.S.A., Inc. v. Bank of America Corporation



                                 UNITED STATES COURT OF APPEALS
                                    FOR THE SECOND CIRCUIT
                                                 August Term, 2007

  (Argued: November 8, 2007                                               Decided: March 4, 2008)

                                               Docket No. 06-1546-cv

J. WALTER THOMPSON , U.S.A., INC .,

                 Plaintiff-Appellee,

BANK OF AMERICA CORPORATION ,

                 Defendant and Third-Party Plaintiff-Appellee,

                 v.

FIRST BANK AMERICANO ,

                 Third-Party Defendant-Appellant,

THE FEDERAL RESERVE BANK OF ATLANTA ,

                 Third-Party Defendant-Appellant.


Before: MC LAUGHLIN , CABRANES, and SACK , Circuit Judges.


        Drawer of a check, J. Walter Thompson, U.S.A., Inc. (“JWT”), brought an action, arising from a

stolen check that was altered and cashed by a person other than the intended payee, against

drawee/payor bank, Bank of America (“BoA”), for negligence and violations of BoA’s duties pursuant

to the Uniform Commercial Code (“U.C.C.”). BoA filed a third-party complaint against First

BankAmericano and the Federal Reserve Bank of Atlanta, collecting and presenting banks, alleging

breaches of the presentment warranties owed to BoA. The United States District Court for the

Southern District of New York (Denny Chin, Judge) granted summary judgment in favor of JWT against

                                                          1
BoA and, in turn, in favor of BoA against the third-party defendant banks. The third-party presenting

and collecting banks appealed. We hold that (1) the drawer’s alleged failures do not constitute

negligence, pursuant to U.C.C. § 3-406; (2) the drawer’s alleged post-alteration failures will not preclude

recovery for the loss associated with an altered check under the “substantial contribution” test of U.C.C.

§ 3-406; (3) the payor bank acted in good faith and, accordingly, the lack-of-good-faith exception to the

presentment warranty, see id. 4-208(a), did not apply; and (4) the District Court did not err in granting

summary judgment to the payor bank even though the bank had not yet reimbursed the drawer of the

check for the fraud.

         Affirmed.

                                               INA B. SCHER, Davis & Gilbert LLP, New York, NY, for Plaintiff-
                                                       Appellee J. Walter Thompson, U.S.A., Inc.

                                               RONALD M. NEUMANN (David B. Chenkin, on the brief), Zeichner
                                                    Ellman & Krause LLP, New York, NY, for Defendant and
                                                    Third-Party Plaintiff-Appellee, Bank of America Corporation.

                                               WILLIAM D. WALLACH , McCarter & English LLP, Newark, NJ,
                                                     for Third-Party-Defendants-Appellants First BankAmericano,
                                                     Federal Reserve Bank of Atlanta.

JOSÉ A. CABRANES, Circuit Judge:

         This appeal involves the allocation of liability for altered checks outlined in Articles 3 and 4 of

the Uniform Commercial Code (“U.C.C.”)1 and the operation of the check collection system. The

U.C.C. allocates liability for a stolen or altered check among the various parties involved in the check

collection process. Plaintiff-appellee J. Walter Thompson (“JWT”) is the drawer of the check. Bank of

America (“BoA”) is the payor bank and the drawee of the check. The Federal Reserve Bank of Atlanta

(“Atlanta Fed”) is a collecting bank and a presenting bank. First BancoAmericano (“FBA”) is the

depositary bank, a collecting bank, and a presenting bank.


         1
           The parties agree that the applicable law to this dispute is that of New Jersey and Georgia, where the events at
issue occurred. Because both states have adopted the 1990 Revised Uniform Commercial Code, the citations herein
refer to that version of the U.C.C.
                                                               2
        We are asked to determine (1) whether JWT acted negligently in failing to take certain preventive

measures upon learning of prior fraud on its checking account with BoA and, if so, whether that

negligence “substantially contributed” to the check fraud, thereby barring JWT from obtaining a

recovery pursuant to U.C.C. § 3-406(a), post at 6; (2) whether BoA acted in good faith in paying the

altered check and, if BoA did not, whether the lack-of-good-faith exception to the presentment

warranty, see U.C.C. § 4-208, post at 8, bars its claims for breach of the presentment warranty against the

two presenting and collecting banks; and (3) whether a district court may grant summary judgment to a

payor bank for losses associated with a presenting bank’s breach of the presentment warranty before the

payor bank has reimbursed the drawer for the amount of the altered check.

                                            BACKGROUND

A.      The Check Collection Process

        In the normal functioning of the check collection process, the “drawer” of a check issues to the

“payee” a check drawn on an account of the drawer at the “drawee bank.” The check then flows

“downstream” through the banking system, from the drawer to the payee and ultimately to the drawee

bank (also described as the payor bank, see id. § 4-105(3)), which is ordered to make payment, see id. § 4-

104(a)(8). The payment, in turn, “flows upstream” through the various intermediary banks, making its

way from the drawee/payor bank to the payee’s account. See James J. White & Robert S. Summers,

Uniform Commercial Code 544-45 (4th ed. 1995) (“White & Summers”) (describing the flow of check and

payment through the check processing system); U.C.C. § 4-105(4) (defining “intermediary bank”). The

payee’s bank, which is the first to receive the check, is known as the “depositary bank.” Id. § 4-105(2).

The other intermediary banks serve as “collecting banks” or “presenting banks” at various points in the

collection process. A “collecting bank” is a bank, other than the payor bank, that handles a check for

collection. Id. § 4-105(5). A “presenting bank” is a bank, other than the payor bank, that presents an

item for payment. Id. § 4-105(6). An intermediary bank can serve as both a collecting bank and a


                                                     3
presenting bank. The check collection system in a normal, uncomplicated case is depicted graphically in

the appendix to this opinion.

B.       Liability for Stolen and Altered Checks

         Articles 3 and 4 of the U.C.C. outline a scheme for allocating the loss resulting from an altered

check among the parties involved in the check processing system. When a drawer issues an instrument

such as a check, the drawer “set[s] it afloat upon a sea of strangers” and, in so doing, “voluntarily enters

into a relation with later holders which justifies imposition of a duty of care.” Id. § 3-406 cmt. 1

(internal quotation marks omitted). When a check is stolen, altered, and later presented for payment,

losses result. The U.C.C. allocates liability for these losses through what one court has described as a

burden-shifting framework, Putnam Rolling Ladder Co. v. Mfrs. Hanover Trust Co., 74 N.Y.2d 340, 345

(1989), combined with principles of comparative negligence, see U.C.C. § 3-406 cmt. 4; see also White &

Summers, ante, at 566-67.2 We describe that framework briefly below.

(1)      Drawee/payor bank liability

         When a drawer’s account is charged for an altered check, the drawer may assert a claim for

breach of U.C.C. § 4-401 “downstream” against the drawee/payor bank. Section 4-401 of the U.C.C.

states that a bank may charge its customer’s account only when the bank is presented with “an item that

         2
             The U.C.C. determines which of the various parties involved in the check processing system will bear the cost
of fraud based on whether the fraud arises from (1) a forged drawer’s signature, (2) a forged endorsement, or (3) an
alteration to the instrument.

          While liability for payment of either an altered or a forged check lies with the drawee/payor bank pursuant to
U.C.C. § 4-401, the drawee/payor bank may sue “upstream” for a breach of the presentment warranty. In the case of a
forged signature, the presentment warranty is limited to the warranty that the presenting bank has no knowledge the
drawer’s signature is forged. See U.C.C. § 4-208(a)(3). Generally, liability for a check with a forged signature lies with the
drawee/payor bank. In the case of a forged endorsement, losses generally rest with the party who accepted the check from
the forger or the forger himself. See id. § 3-405(b) cmt. 1. The loss associated with an altered check typically rests with the
party who took it from the wrongdoer. The presentment warranties shift the losses for the alteration to the presenting
banks, see U.C.C. § 4-208(a)(2), and ultimately to the depositary bank.

          This allocation reflects the ability of parties to detect the forgery and prevent the loss. Wachovia Bank, N.A. v.
Foster Bancshares, Inc., 457 F.3d 619, 622 (7th Cir. 2006). A forged drawer signature can most readily be detected by the
drawee/payor bank, which is presumed to be familiar with the signature of its customer. Id. A forged endorsement,
however, is more easily detected by the depository bank, which is likewise presumed to know its customer’s signature.
Finally, rules for loss shifting associated with alteration rest on the assumption that alteration can be most easily detected
by the party who receives the check in the first instance. Id.
                                                                 4
is properly payable from the account.”3 A check that is forged or has an altered payee is not “properly

payable.” U.C.C. § 4-401 cmt. 1. In most cases, a drawee/payor bank is strictly liable for charging its

customer’s account for a forged or altered check pursuant to Section 4-401. See, e.g., Travelers Cas. & Sur.

Co. of Am. v. Wells Fargo Bank N.A., 374 F.3d 521, 525 (7th Cir. 2004) (“[O]rdinarily a bank is strictly

liable for charging a customer’s account with an amount that the customer had not authorized the bank

to pay. . . .”); Lor-Mar/Toto, Inc. v. 1st Constitution Bank, 871 A.2d 110, 115 (N.J. Super. Ct. App. Div.

2005) (noting this principle of strict liability as a matter of New Jersey law). After the drawee/payor

bank discovers that an altered check has been charged against the drawer’s account, the drawer is

entitled to have its account credited for the amount of the check. See White & Summers, ante, at 552.

        Section 3-406(a) protects a party who paid a check against suit by any party who contributed to

the alteration. Accordingly, where a drawer’s own negligence contributed to the alteration, the drawer is

precluded from “asserting the alteration” against a drawee/payor bank that “in good faith, pays the

instrument or takes it for value or for collection.” U.C.C. § 3-406(a).4 The U.C.C. defines “good faith,”

generally, as “honesty in fact and the observance of reasonable commercial standards of fair dealing.”

Id. § 3-103(a)(4). When multiple parties are negligent, Section 3-406(b) allocates liability for the loss

associated with an altered check “according to the extent to which the failure of each to exercise

ordinary care contributed to the loss.”5


        3
            Pursuant to U.C.C. § 4-401(a):

                    A bank may charge against the account of a customer an item that is properly payable from that
                    account even though the charge creates an overdraft. An item is properly payable if it is authorized by
                    the customer and is in accordance with any agreement between the customer and bank.

        4
            Section 3-406(a) reads as follows:

                    A person whose failure to exercise ordinary care substantially contributes to an alteration of an
                    instrument or to the making of a forged signature on an instrument is precluded from asserting the
                    alteration or the forgery against a person who, in good faith, pays the instrument or takes it for value
                    or for collection.

        5
            Specifically, Section 3-406(b) provides that:

        if the person asserting . . . preclusion [pursuant to subsection(a)] fails to exercise ordinary care in paying or
                                                                 5
         In order to avoid liability under Section 4-401 for charging its customer’s account for an altered

check, the drawee/payor bank must prove that (1) its customer, the drawer, was negligent; (2) the

drawer’s negligence “substantially contributed” to the alteration; and (3) the drawee/payor bank paid the

check in “good faith.” The drawer may, in turn, assert the drawee/payor bank’s own negligence in

taking an altered check. The drawer must establish that (1) the drawee/payor bank was negligent, and

(2) that the drawee/payor bank’s negligence contributed to the loss. Liability will then be allocated on

the basis of comparative fault. Travelers, 737 A.2d at 694.

(2)      Liability of the depositary bank, presenting banks, and collecting banks

         A drawee/payor bank may also assert claims “upstream” against the presenting bank, a

collecting bank, and the depositary bank for the loss associated with the altered check. In addition, a

drawee/payor bank may bring a breach of warranty action against any party who presented the altered

check for payment. In most cases, “[t]hese warranty actions will continue up the collection chain to the

party who took from the [wrongdoer] or to the [wrongdoer] himself.” Perini Corp. v. First Nat. Bank, 553

F.2d 398, 404 (5th Cir. 1977) (analyzing previous version of the U.C.C.).

         The banks involved in the check collection process extend two types of warranties: presentment

and transfer warranties. Section 4-208 sets out the presentment warranty given by depositary and

collecting banks when presenting a check to the drawee/payor bank for payment. It provides, in

relevant part, that:

         If an unaccepted draft is presented to the drawee for payment or acceptance and the drawee
         pays or accepts the draft, (i) the person obtaining payment or acceptance, at the time of
         presentment, and (ii) a previous transferor of the draft, at the time of transfer, warrant to the drawee


         taking the instrument and that failure substantially contributes to loss, the loss is allocated between the person
         precluded and the person asserting the preclusion according to the extent to which the failure of each to
         exercise ordinary care contributed to the loss.

         U.C.C. § 3-406(c) places the burden of proving negligence on the party asserting preclusion pursuant to
subsection (a) or a failure to exercise ordinary care pursuant to subsection (b).




                                                                6
         that pays or accepts the draft in good faith that . . . . the draft has not been altered.

U.C.C. § 4-208(a) (emphasis added).6 Section 3-417 imposes a nearly identical presentment warranty on

any party presenting a check for collection.

         Section 4-207 outlines the transfer warranty given by customers and collecting banks:

         (a) A customer or collecting bank that transfers an item and receives a settlement or other
         consideration warrants to the transferee and to any subsequent collecting bank that . . . (3) the
         item has not been altered . . . .

         (b) If an item is dishonored, a customer or collecting bank transferring the item and receiving
         settlement or other consideration is obliged to pay the amount due on the item (i) according to
         the terms of the item at the time it was transferred, or (ii) if the transfer was of an incomplete
         item, according to its terms when completed as stated in Sections 3-115 and 3-407. The
         obligation of a transferor is owed to the transferee and to any subsequent collecting bank that
         takes the item in good faith. A transferor cannot disclaim its obligation under this subsection by
         an indorsement stating that it is made “without recourse” or otherwise disclaiming liability.


         6
             The remainder of that provision reads as follows:

                    (b) A drawee making payment may recover from a warrantor damages for breach of warranty equal to
                    the amount paid by the drawee less the amount the drawee received or is entitled to receive from the
                    drawer because of the payment. In addition, the drawee is entitled to compensation for expenses and
                    loss of interest resulting from the breach. The right of the drawee to recover damages under this
                    subsection is not affected by any failure of the drawee to exercise ordinary care in making payment. . .
                    .

                    (c) If a drawee asserts a claim for breach of warranty under subsection (a) based on an unauthorized
                    indorsement of the draft or an alteration of the draft, the warrantor may defend by proving that the
                    indorsement is effective under Section 3-404 or 3-405 or the drawer is precluded under Section 3-406
                    or 4-406 from asserting against the drawee the unauthorized indorsement or alteration.

                    (d) If (i) a dishonored draft is presented for payment to the drawer or an indorser or (ii) any other
                    item is presented for payment to a party obliged to pay the item, and the item is paid, the person
                    obtaining payment and a prior transferor of the item warrant to the person making payment in good
                    faith that the warrantor is, or was, at the time the warrantor transferred the item, a person entitled to
                    enforce the item or authorized to obtain payment on behalf of a person entitled to enforce the item.
                    The person making payment may recover from any warrantor for breach of warranty an amount equal
                    to the amount paid plus expenses and loss of interest resulting from the breach.

                    (e) The warranties stated in subsections (a) and (d) cannot be disclaimed with respect to checks.
                    Unless notice of a claim for breach of warranty is given to the warrantor within 30 days after the
                    claimant has reason to know of the breach and the identity of the warrantor, the warrantor is
                    discharged to the extent of any loss caused by the delay in giving notice of the claim.

                    (f) A cause of action for breach of warranty under this section accrues when the claimant has reason
                    to know of the breach.

U.C.C. § 4-208.

                                                                 7
U.C.C. § 4-207(a)(3), (b).7 The transfer warranty of Section 4-207 is given only by bank customers and

collecting banks, but an identical transfer warranty contained in Section 3-416 applies to any “person

who transfers an instrument for consideration.” Id. § 3-416(a). A drawee/payor bank can bring a

warranty cause of action pursuant to U.C.C. §§ 4-207 and 4-208 against “upstream” banks that

transferred an altered check and presented it for payment. See, e.g., Wachovia Bank, N.A. v. Fed. Reserve

Bank of Richmond, 338 F.3d 318, 321 (4th Cir. 2003).

C.       Factual Background

         On October 31, 2001, plaintiff-appellant JWT, an advertising agency, issued a check in the

amount of $382,210.15 (“Check”) payable to one of its vendors, Outdoor Life Network. The Check

was issued from JWT’s checking account (“Account”) at BoA. At an unknown date, an unknown

person altered the payee on the Check to “Diversified Business Enterpises [sic], Inc”8 and deposited the

Check into an account maintained by Diversified Business Enterprises at First BankAmericano.9 FBA

then presented the Check to the Federal Reserve Bank of New York, which, in turn, presented it to the

Federal Reserve Bank of Atlanta. The Atlanta Fed then presented it to Bank of America via BoA’s



         7
             Section 4-207 further provides:

                    (c) A person to whom the warranties under subsection (a) are made and who took the item in good
                    faith may recover from the warrantor as damages for breach of warranty an amount equal to the loss
                    suffered as a result of the breach, but not more than the amount of the item plus expenses and loss of
                    interest incurred as a result of the breach.

                    (d) The warranties stated in subsection (a) cannot be disclaimed with respect to checks. Unless notice
                    of a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason
                    to know of the breach and the identity of the warrantor, the warrantor is discharged to the extent of
                    any loss caused by the delay in giving notice of the claim.

                    (e) A cause of action for breach of warranty under this section accrues when the claimant has reason
                    to know of the breach.

         8
           In a federal criminal proceeding for criminal check fraud conspiracy, the government alleged in the indictment
that a check for $382,210.15 had been deposited into a business account controlled by a defendant at First
BankAmericano. See Superceding Indictment at 14, United States v. Dedji, No. 03-254 (D. N.J. Oct. 23, 2003) The parties
do not dispute that the check in that case was the Check at issue here.

         9
             FBA is a three-branch bank doing business in New Jersey.

                                                                8
check processing facility in Georgia. BoA debited $382,210.15 from the Account of JWT and

transmitted the payment back “upstream” through the bank collection system to FBA, which,

presumably, deposited the funds into the account held by Diversified Business Enterprises. Later, JWT

discovered that the payee of the Check had been altered, notified BoA the same day of the alteration

and the fact that BoA had made a payment on the altered Check, and sought to have its Account

credited for the amount of the Check. BoA did not credit the Account but, instead, demanded that

FBA remit the proceeds of the Check to BoA. FBA refused to do so.

       At the time of the events at issue, BoA had a program in place to identify potentially fraudulent

checks (the “Positive Pay Program” or “Positive Pay”), and JWT subscribed to this service during the

relevant time period.10 Positive Pay permitted BoA to match check numbers, dates, and amounts on the

checks that were presented to BoA with a list provided by JWT prior to payment of a check. If the

Positive Pay Program identified a discrepancy in any of this information, BoA would not make payment

on the check. At the time of the instant fraud, Positive Pay did not have the capability of matching

payee names (“payee matching”), a capability that arguably would have detected the fraud here.

       Prior to the payment of the Check, ten other instances of check fraud or attempted check fraud

occurred on checks issued from JWT’s Account. At least one of these instances involved the simple

alteration of a payee name. BoA credited the Account for the amount of that altered check, so JWT did

not suffer a loss associated with that earlier payee alteration. Another of the instances involved both the

alteration of a payee name along with the alteration of the amount of the check. BoA’s Positive Pay

system detected this particular fraud and JWT’s account was not charged. The losses suffered by JWT

associated with the remaining prior instances of fraud was less than $9,000.

D.     Procedural History

       After JWT discovered the fraud at issue here and BoA refused to credit its Account for the



       10
            JWT also took certain other general preventive measures we need not discuss for the present purposes.
                                                             9
amount of the Check, JWT brought this action against BoA. JWT alleged that BoA was negligent and

that BoA had violated its duties under U.C.C. §§ 4-10311 and 4-401 (the provision governing when items

are “properly payable”). BoA, in turn, filed a third-party complaint against FBA and the Atlanta Fed for

violations of U.C.C. §§ 3-416 (transfer warranty), 3-417 (presentment warranty), 4-207 (transfer

warranty), and 4-208 (presentment warranty), see ante notes 6, 7 and accompanying text (text of

provisions).

         After the completion of discovery, JWT moved for summary judgment against BoA, and BoA

moved for summary judgment against FBA and the Atlanta Fed. FBA opposed JWT’s motion on the

merits but BoA did not.12 The District Court granted both motions, concluding that BoA was strictly

liable to JWT for charging JWT’s Account for an item not “properly payable,” U.C.C. § 4-401(a). The

Court also concluded that FBA and the Atlanta Fed had breached the presentment warranties they had

extended to BoA under U.C.C. § 4-208.

         The Court rejected FBA’s argument that summary judgment was inappropriate because

questions of fact existed as to whether JWT was negligent within the meaning of U.C.C. § 3-406(a), see,

ante, note 4 and accompanying text, in failing to prevent the check fraud. FBA asserted that JWT had

negligently failed to respond appropriately after learning of previous check fraud on its Account.

         11
              Section 4-103 provides in relevant part:

                     The effect of the provisions of this Article may be varied by agreement, but the parties to the
                     agreement cannot disclaim a bank’s responsibility for its lack of good faith or failure to exercise
                     ordinary care or limit the measure of damages for the lack or failure. However, the parties may
                     determine by agreement the standards by which the bank’s responsibility is to be measured if those
                     standards are not manifestly unreasonable.

U.C.C. § 4-103(a). It is not clear under what theory JWT asserted this Section 4-103 claim against BoA. Neither the
District Court’s order nor the parties’ briefs on appeal address U.C.C. § 4-103.

         12
            Although FBA was not a party to JWT’s action against BoA, FBA opposed the motion based on the theory
that U.C.C. § 4-208(c), see ante, note 8, gave it a “statutory right” to do so. The District Court “assume[d] [without
deciding] that FBA ha[d] that right.”

          FBA also opposed BoA’s motion for summary judgment against FBA and the Atlanta Fed. FBA concedes that
if the Atlanta Fed’s liability is affirmed on appeal, the Atlanta Fed would be entitled to recover from FBA in an action
for a breach of the transfer warranty.

                                                               10
Specifically, FBA faulted JWT for (1) not closing the Account or (2) instituting a payee matching

program to detect future fraud. FBA and Atlanta Fed argue on appeal that a jury could have found that

JWT’s failure to take these preventive measures “substantially contributed” to the alteration of the

Check, and, if so, that JWT would be precluded from recovery against BoA while BoA would be

precluded from recovery against FBA and the Atlanta Fed. See U.C.C. § 3-406(a). The Court

considered the ten prior incidents of check fraud on the Account and determined that none of these

instances “suggest[ed] that the mere act of keeping the account open ‘substantially contributed’ to the

alteration” of the Check. The Court similarly rejected FBA’s suggestions that JWT’s failure to take

remedial measures—such as instituting payee matching, a process unavailable at the time—substantially

contributed to the fraud. Finally, the Court rejected as pure conjecture FBA’s suggestions that JWT or

BoA could have been involved, negligently or otherwise, with the criminal check fraud conspiracy that

obtained and altered the Check.

                                               DISCUSSION

        We review de novo a district court’s grant of summary judgment, drawing all reasonable inferences

in favor of the non-moving parties, see, e.g., Konits v. Valley Stream Cent. High Sch. Dist., 394 F.3d 121, 124

(2d Cir. 2005); Carney v. Philippone, 332 F.3d 163, 167 (2d Cir. 2003), which in this case are FBA and the

Atlanta Fed.

        We conclude that JWT’s alleged failures do not constitute negligence within the meaning of

U.C.C. § 3-406, and that JWT’s alleged post-alteration negligence could not have substantially

contributed to the check alteration, as required to preclude recovery under U.C.C. § 3-406. We also

hold that the standard of “good faith” for a drawee/payor bank under the U.C.C. is one that commands

a “duty of fair dealing” and not a “duty of care.” In light of the applicable standard, we conclude that

BoA did not violate its duty of fair dealing and therefore did not act in bad faith. Finally, we hold that a

drawee/payor bank is not required to reimburse the drawer before proceeding against the collecting


                                                      11
banks for breach of warranty.

A.      Whether allegations of BoA’s and JWT’s negligence are sufficient to defeat summary judgment

        The presentment scheme outlined in the U.C.C. “shifts losses up the collection stream to

presenting and depositary banks.” Fed. Reserve Bank, 338 F.3d at 321. Accordingly, the drawee/payor

bank that pays an altered check in good faith may bring an action for damages against the presenting

banks for breaching the presentment warranty. See U.C.C. § 4-208(b). In a case such as this, in which a

check has been altered, the usual result will be that the presenting banks are strictly liable to the drawer

and the drawee/payor bank for breaching the presentment warranty. The exceptions to this result arise

when either the drawee/payor bank lacked good faith in paying the draft, see id. § 4-208(a), or when the

drawer failed to exercise ordinary care which “substantially contribute[d]” to the alteration of the check,

id. § 3-406(a). Because neither of these exceptions apply in this case, we affirm the District Court’s

summary judgment in favor of JWT and BoA.

(1)     Drawer’s alleged negligence pursuant to U.C.C. § 3-406(a)

        The primary issue on this appeal is whether JWT’s failure to take certain preventive measures

after learning of previous fraud on the Account constituted negligence which “substantially

contribute[d],” id. § 3-406(a), to the alteration of the Check. FBA and Atlanta Fed contend that, upon

learning of the prior instances of fraud, JWT should have (1) closed the Account and (2) instituted a

payee matching system to detect future fraud. They argue that JWT’s failure to take these steps

constituted negligence that substantially contributed to the alteration of the check and JWT should,

therefore, be estopped from asserting the alteration against BoA.

        The Fourth Circuit addressed the issue of drawer negligence in Federal Reserve Bank, a case arising

from the theft and alteration of a check drawn on an account from which six checks had been stolen

previously. 338 F.3d at 324. The defendant in that action contended that the drawer’s failure to

implement certain precautionary measures to prevent check theft—specifically, sending checks via an


                                                     12
electronic funds transfer system or Federal Express rather than through the mail—constituted a failure

to exercise ordinary care that “substantially contributed to the alteration.” Id. at 323. The Fourth

Circuit rejected this argument. Because the prior thefts “constituted a very small percentage” of the

checks issued by the drawer, were relatively remote in time, and were committed by individuals then

believed to be in custody, the drawer’s decision to continue using regular mail to send its checks hardly

amounted to “a failure to exercise ordinary care, much less a failure to exercise ordinary care that

substantially contributed to the alteration.” Id. at 324.

        Here, FBA and the Atlanta Fed contend that, in light of the prior instances of fraud, JWT

should have (1) closed the Account and (2) instituted a payee matching system to detect future fraud.

Based on the facts before us, however, we conclude that ordinary care did not compel JWT to adopt

either of these measures. As the District Court observed, the previous incidents of altered checks

resulted in de minimis losses compared to the significant costs which JWT would have incurred by closing

the Account. In addition, FBA came forward with no evidence showing that had JWT closed the

Account and drawn checks on a different account, the new account would have been less susceptible to

check theft, thereby averting the theft giving rise to this litigation. Under these circumstances, closing

the Account would not have been a reasonable, much less a necessary, exercise of ordinary care. With

respect to FBA’s suggestion that JWT should have implemented payee matching, the record shows that

payee matching was not available to JWT and BoA at the time of the presentment of the Check. JWT

reasonably relied on BoA’s Positive Pay fraud detection service with the technological limitations that

existed at the time. JWT’s failure to utilize an unavailable technology can hardly be said to constitute a

“failure to exercise ordinary care” pursuant to U.C.C. § 3-406.

        We further hold that a defense based on a drawer’s alleged post-alteration negligence is

foreclosed by the plain language of U.C.C. § 3-406. When a drawer’s own negligence “substantially

contributes” to the alteration of a check, the drawer is “precluded from asserting the alteration” against


                                                      13
a collecting or presenting bank, such as FBA, that processes the check in good faith. Id. § 3-406(a); see

ante note 6 and accompanying text. The Official Comments to Section 3-406 define “substantial

contribution” as an action which is “a contributing cause of the alteration . . . and a substantial factor in

bringing it about.” U.C.C. § 3-406 cmt. 2. The Comments also provide certain examples of negligent

conduct that would satisfy this test, including: (a) a drawer who writes the amount of the check in a

manner that makes it easy to alter the amount and (b) a drawer who mails the check to the wrong payee.

Id. § 3-406 cmt. 3. Accordingly, “while the principal cause of the alteration may be the act of a [third-

party wrong-doer], things that make the [wrong-doer’s] job easier” may constitute negligence that

“substantially contributes” to the alteration of a check and therefore precludes a claim based on the

alteration.13 White & Summers, ante, at 571; see also Fed. Reserve Bank, 338 F.3d at 324-25 (“[T]he

unambiguous terms of [Section 3-406] provide a defense to the [presenting bank] only if [the drawer’s]

negligence substantially contributed to the alteration.”); Zambia Nat’l Commercial Bank Ltd. v. Fidelity Int’l

Bank, 855 F. Supp. 1377, 1387 (S.D.N.Y. 1994) (“[U]nder § 3-406 the bank must establish not merely

that the customer was careless, but that the customer’s negligence set the stage for, or in some way

provided the wrongdoer with the opportunity to make the unauthorized signature.”); Fidelity Bank v.

United Nat’l Bank of Wash., 630 F. Supp. 16, 19 (D.D.C. 1985) (noting that a bank’s mishandling of a

check “increased the possibility that an unauthorized person would be able to forge the payee’s name

and pose as the intended payee”).

         The lack of payee matching cannot, as a matter of logic, have “substantially contributed” to the


          13
             It should be noted, however, that the substantial-contribution rule does not conform to the principle that the
party who can best prevent the loss bears the burden for the loss. See ante, note 4. The substantial contribution rule
means that a drawer will never bear the brunt of its own failure to take certain preventive measures or to adopt state-of-
the-art warning techniques for check alterations. The substantial-contribution rule rests on the notion that alteration can
best be detected by the bank which first takes the check from the wrong-doer, see ante note 4 and accompanying text. In
some instances, such as the alteration of the payee name, it may be that the payor bank or drawee would be best suited to
detect the fraud. See Foster Bancshares, 457 F.3d at 622-23 (noting that “modern copying technology” may render the
distinction between forgery and alteration, and its loss allocation rules, obsolete). Although the substantial-contribution
rule may not reflect comparative advantage in preventing losses associated with altered checks, it is the role of the U.C.C.
drafters, not this Court, to determine whether the rule should be reconsidered in light of the changing technological
landscape.
                                                              14
alteration at issue in this litigation. A payee matching mechanism identifies check fraud when an altered

check is presented to the drawee/payor bank for payment, in other words, after the alteration has

already occurred. Because this technology detects alterations after the fact, but does not prevent them

in the first instance, JWT’s alleged failure to adopt payee matching cannot have “contributed” or “set

the stage” for the alteration. We therefore conclude that JWT’s alleged failures to take certain

preventive measures suggested by FBA here did not constitute negligence which substantially

contributed to the alteration of the Check.

(2)      Drawee/payor bank’s alleged lack of good faith pursuant to U.C.C. § 4-208(a)

         U.C.C. § 4-208(a) outlines the presentment warranty owed to a drawee/payor bank that pays an

altered check in good faith. See ante note 6 and text accompanying (text of provision). Good faith, in

turn, is defined as “honesty in fact and the observance of reasonable commercial standards of fair

dealing.” U.C.C. § 3-103(4). Therefore, if a drawee/payor bank pays an altered check in good faith, it

receives the benefit of the presentment warranty and shifts the loss to the presenting banks.

         The good faith requirement incorporates standards of honesty and fair dealing but not of

negligence. In other words, the good faith requirement does not impose a standard of care but, rather, a

standard of fair dealing.14 See Fed. Reserve Bank, 338 F.3d at 322-23; White & Summers, ante, at 573.

Because FBA has not alleged that BoA acted unfairly or dishonestly, this distinction is fatal to FBA’s

argument that BoA did not act in good faith.

         FBA and the Atlanta Fed point to no action or inaction that would suggest, much less establish,


         14
             BoA’s negligence would have been at issue only as part of the comparative fault analysis set forth in U.C.C. §
3-406(a), (b). See ante, notes 4-5 and accompanying text (text of provisions). If JWT had been precluded from asserting
the alteration against BoA as a result of JWT’s own negligence, see U.C.C. § 3-406(a), then JWT could have asserted that
BoA had “fail[ed] to exercise ordinary care in paying or taking the instrument and that failure substantially contribute[d]
to [the] loss,” see id. § 3-406(b). Because we have concluded that JWT was not negligent, the remaining question is one of
BoA’s good faith in paying the check.

          The issue of BoA’s alleged negligence is not a question in its presentment warranty claim against FBA and the
Atlanta Fed. Cf. Id. §4-208(b) (“The right of the drawee to recover damages under this subsection is not affected by any
failure of the drawee to exercise ordinary care in making payment.”).


                                                              15
that BoA did not act with “honesty in fact.” Instead, they suggest that BoA acted negligently because it

should have closed the Account of its own accord or employed more advanced fraud detection

capabilities, such as payee matching. While these alleged failures, if proven, might arguably establish

negligence, they do not demonstrate a lack of “honesty in fact” or a failure to “observ[e] . . . reasonable

commercial standards of fair dealing.” U.C.C. § 3-103(4). Indeed, the Fourth Circuit has held that a

payor bank’s reliance on a Positive Pay system, instead of on other methods of fraud detection,

precluded a finding of a lack of good faith. See Fed. Reserve Bank, 338 F.3d at 323. We conclude,

therefore, that BoA acted in good faith within the meaning of Section 4-207 and can properly claim the

benefit of the presentment warranty.

        In sum, the District Court properly granted summary judgment to JWT and BoA. FBA and the

Atlanta Fed have pointed to no material disputes of fact on the issue of JWT’s alleged negligence or

BoA’s lack of good faith.

B.      Whether the District Court prematurely granted summary judgment in favor of BoA before BoA
        reimbursed JWT for the altered check

        FBA and the Atlanta Fed contend that the District Court erroneously granted summary

judgment to BoA. They question whether BoA has, in fact, incurred a loss associated from the Check in

light of BoA’s decision to delay crediting JWT’s Account for the amount of the loss.

        We find no requirement in the text of U.C.C. § 4-208 suggesting that a drawee/payor bank must

first credit the drawer’s account with the amount of the loss before it can bring a presentment warranty

action against the presenting banks to recover that loss. Section 4-208(b) states that “[i]f the drawee

accepts the draft (i) breach of warranty is a defense to the obligation of the acceptor, and (ii) if the

acceptor makes payment with respect to the draft, the acceptor is entitled to recover from a warrantor

for breach of warranty the amounts stated in this subsection.” Those amounts include both damages

“equal to the amount paid by the drawee less the amount the drawee received or is entitled to receive

from the drawer because of the payment” as well as “compensation for expenses and loss of interest

                                                      16
resulting from the breach.” U.C.C. § 4-208(b).

        Courts have routinely granted summary judgment in favor of a payor bank that had not yet

reimbursed the drawer. See, e.g., First Nat’l Bank of Neednah v. Sec. Nat’l Bank of Springfield, No. 80-0026-f,

1981 U.S. Dist. LEXIS 15495, at *10-11 (D. Mass. Nov. 5, 1981) (granting summary judgment to drawer

against payor bank and, at the same time, granting summary judgment to payor bank against collecting

bank); cf. Foster Bancshares, 457 F.3d at 622 (affirming declaratory judgment that depositary bank was

required to indemnify drawee/payor bank for breach of presentment warranty). The facts of this

litigation do not compel a different result. Judgment has been entered against BoA in favor of JWT;

accordingly, there is nothing premature in finding FBA and the Atlanta Fed liable, in due course, to

BoA. The District Court’s grant of summary judgment was proper.

                                              CONCLUSION

        For the reasons stated above, we conclude that (1) JWT’s alleged failures do not constitute

negligence within the meaning of U.C.C. § 3-406; (2) JWT’s alleged post-alteration negligence could not

have substantially contributed to the check alteration; (3) BoA acted in good faith and, accordingly, was

entitled to pursue a claim for breach of the presentment warranty; and (4) the District Court did not err

in granting summary judgment to BoA before BoA reimbursed JWT for the loss arising from the

alteration of the Check.

        The judgment of the District Court is AFFIRMED.




                                                          17
                                                     Appendix




                                                                Downstream




                                                                                           Presenting               Drawee
                                     Depositary                  Collecting
                                                                                           Bank                     /Payor
                 Payee                 Bank                      Bank
Drawer                                               Present                     Present                 Present     Bank
         Check            Deposit                    Check                                               Check
                                                                                 Check
                          Check



                                                                                                                      Debits
                           Payment                    Payment                       Payment     Presenting           drawer’s
                                                                    Collecting                                     account &
                  Payee                 Depositary                                              Bank
                                                                    Bank
                                          Bank                                                                      transmits
                                                                                                                    payment




                                                              Upstream




                                                         18
