Thursday, August 1, 2013

FYI: Ill App Ct Rules Mortgagee Must Sue Payor Bank For Conversion When Co-Payee Forges Mortgagee's Indorsement on Hazard Ins Proceeds Check

The Illinois Appellate Court for the First District recently ruled that a mortgagee's only recourse for forged checks for hazard insurance proceeds was to sue the payor bank under the Uniform Commercial Code for conversion for cashing the insurer's checks over the mortgagee's forged indorsements.


In so ruling, the Court noted that:  (1) because the checks had been cashed by the joint co-payee on the checks, the checks had not been lost, destroyed, or stolen, precluding recourse against the insurer as the drawer of the funds; and (2) the insurer's obligation on the underlying insurance policy was suspended, and the suspension continued, because the checks had not been properly "paid" under Section 3-602(a) of the UCC. 



Plaintiff bank ("Bank") extended a mortgage loan to the owners ("Owners") of an apartment building.  Defendant insurance company ("Insurer") issued a hazard insurance policy for the property, identifying Owners as the named insureds under the policy, and Bank as the mortgagee.  After a fire damaged the building, Owners entered into an agreement with a contractor to repair the apartment building pursuant to which Owners assigned their rights to receive payment under the insurance policy.  Insurer issued checks totaling over $250,000, naming Bank, the contractor, and Owners as co-payees, and mailed the checks to the contractor per the Owners' instructions.   


Several months later, Insurer learned that the contractor's agent had forged Bank's indorsement on the checks and that the payor bank had paid the funds to the contractor. 


Bank later demanded payment from Insurer, asserting that it was entitled to the insurance proceeds pursuant to its mortgage agreement with Owners.  Insurer declined to pay the claim, as it asserted it had already done so.  Bank then filed a declaratory judgment action, alleging it was entitled, as the mortgagee, to the insurance proceeds pursuant to the insurance policy.  As an affirmative defense, Insurer argued that it should not be held liable for the tortious and fraudulent act of a third party.  The parties filed cross-motions for summary judgment.  The lower court granted Insurer's motion, but denied Bank's motion.  Bank appealed.


The Appellate Court affirmed, concluding that Bank's sole remedy was to sue the payor bank for conversion under the Uniform Commercial Code ("UCC") for cashing the insurance checks over Bank's  forged indorsement.


As you may recall, the UCC provides that where the drawer (here, Insurer) writes an uncertified check, the underlying obligation is suspended until the check is paid or until the check is dishonored, and that, once the check is paid, the obligation is discharged to the extent of the amount of the check.  See 810 ILCS 5/3-310(b)(1). The UCC further provides that a check is considered "paid" to the extent payment is made by or on behalf of a person obliged to pay the check and to a person entitled to enforce the check.  See 810 ILCS 5/3-602(a). 


Moreover, where a check is made payable jointly to two or more persons, the check may only be enforced by all of them, and a joint payee, acting alone, is not entitled to enforce the check.  See 810 ILCS 5/3-110(d). 


Finally, where a payor bank pays a person not entitled to enforce a check, such as a joint payee who forged the signature of a co-payee, the co-payee may sue the payor bank for conversion, or sue the drawer for enforcement of a lost, destroyed, or stolen instrument, but not on the underlying contract.   See 810 ILCS 5/3-420; 810 ILCS 5/3-309; 810 ILCS Ann. 5/3-310 Comment  4 (providing two potential remedies:  sue drawer of funds under Section 3-309 for enforcement of a lost, destroyed, or stolen instrument; or sue the payor bank under Section 3-420 for conversion).


Noting there was no dispute in this case that the contractor was not entitled to enforce the checks because of the forged indorsements, the Appellate Court concluded that Bank could not sue Insurer on the insurance policy itself but could sue the payor bank for conversion.  In so ruling, the Court agreed with Insurer that Bank could not sue it as the drawer under Section 3-309 for the enforcement of a "lost, destroyed, or stolen instrument" because the checks had been cashed by the contractor rather than lost or stolen.    


Accordingly, pointing out that Bank had not cited any other UCC provisions that allow a payee to sue a drawer of a check, the Court determined that Bank's only remedy was to sue the payor bank for conversion under Section 3-420, thus rejecting Bank's assertion that it should be allowed to sue Insurer on the underlying contract.  As the Court explained, the Illinois Appellate Court decisions on which Bank relied predated the passage of Section 3-310 under which Insurer's obligation on the underlying insurance contract was suspended, and, because the checks were not properly "paid" under Section 3-602(a), "the suspension of the underlying obligation continues . . . ."


The Appellate Court thus affirmed the lower court's grant of summary judgment in favor of Insurer.




Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874


Admitted to practice law in Illinois


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