Legal Tips For Business (1)

Question:

We run a small business in the garment industry. A while ago, we sub-contracted certain work to another business ("Sub"). Sub completed the work satisfactorily, and we issued them a check for $19,536.47, the agreed amount. Four days later, we were contacted by the State Labor Department officials, who told us that Sub had absconded overnight, without paying its employees. The State officials told us that we were liable for those employees' wages to the extent of $19,536.47, the amount for which we had contracted. Very disturbed, we immediately called up our bank and inquired about the check. Finding that the check had not been encashed, we promptly issued a "Stop Payment Order" on that check. We paid the entire sum to the State officials who, presumably, paid Sub's unpaid employees.

Meanwhile, Sub had already encashed the check from a Check Cashing Company ("Check Cashing"). Check Cashing had deposited the check with its bank, and our Stop Payment Order was just in time to prevent that check from being paid.

Check Cashing now seeks the entire amount ($19,536.47) from us, and has threatened a lawsuit. Are we liable to pay this, although we already paid this amount to the State officials on account of Sub's employees' wages?

Also, we notice a slight irregularity in the endorsement on the back of the check: While we had issued the check in the name of "Sub Choice Clothing," the endorsement is only in the name of "Sub Choice." Is this of any consequence?

Answer:

Yes, you are liable to pay Check Cashing, even though you may not be liable to Sub now. And No, the irregularity in endorsement does not matter. I sympathize with you, but here's why.

Check Cashing was a complete stranger to you as well as to Sub. It appears that Check Cashing promptly deposited the check with its bank, and nothing suggests that Check Cashing was aware of anything improper or irregular before it accepted the check and paid Sub. I'm sure you realize that your "Stop Payment Order" four days after issuing the check worked only because the check routing for payment(from Check Cashing to its bank to your bank) took some time, not because of any negligence of Check Cashing.

Check Cashing paid good money for the check, and accepted your check in good faith. Thereby, it became what the law calls a "holder in due course" of the check ("HIDC"). Under the Uniform Commercial Code (a statute which is the same throughout the United States and similar to that in most other countries), an HIDC is a (1) holder (2) of a negotiable instrument (3) who took it for value (4) in good faith and (5) without notice that it is overdue or has been dishonored or of any defense against or claim to it on the part of another. Once these requirements are satisfied, someone who pays on a check, such as Check Cashing, gets the special protection specified by the Code.

This protection is detailed essentially in Section 3-305 of the Code. An HIDC "takes the instrument free from (1) all claims to it on the part of any person; and (2) all defenses of any party to the instrument with whom the holder has not dealt," subject to exceptions that don't help you now.

The reason for this special protection was best explained by New York's highest court, the Court of Appeals, in a dispute between Hartford Accident & Indemnity Co. and American Express Co.:

The holder in due course doctrine--which has particular importance in commercial transactions like those at issue here--has as its objective encouraging and facilitating the ready transaction of negotiable instruments, central to our credit economy; people can rely on the fact that negotiable instruments in the hands of good-faith purchasers will be paid according to their tenor and intent and not paid otherwise. Holder in due course status advances that objective by providing that persons in that category take free of virtually all claims and defenses.

You concede the validity of the check itself, i.e., that you signed it, that it was for the proper amount and to the proper person. The check was not materially altered. And since you have said nothing about the endorser's signature, I assume that too is genuine. So also, since you have no evidence to the contrary, the endorsement is presumed to be authorized by Sub.

True, the endorsement is in the name of "Sub Choice," not "Sub Choice Clothing." But courts have not permitted such minor irregularities in name or endorsement -- even spelling errors and incorrect names -- to defeat the holder in due course. "A signature made by use of any name, including an assumed name, or other symbol, with intention to authenticate a writing, would appear to be sufficient," as one court observed. Indeed, even where a person deposits a check without endorsing it, his bank's stamp placed on the check indicating that it was credited to his account may be sufficient. Thus, the irregularity in endorsement will not help you at all in court.

In sum, Check Cashing acquired the check in good faith, for value, and without notice of any defenses; it became an "HIDC." Hence, you'd be better off talking settlement with Check Cashing instead of wasting your time and money litigating a sure loser. And send those blood hounds out to find Sub, with a hope and a prayer that Sub now has the money to repay you.

Lesson for the future: You should have retained a good lawyer when you got that first phone call from the State officials. Obviously, you didn't, and saved a few dollars then. But that's costing you a bundle. I'm sure you realize now that one has to be filthy rich, with money to throw away, to try to work through business problems without lawyers!

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