Law in practice: combating employee cheque fraud

Employers should be on their guard against employee fraud and have policies in place to deal with it, writes Steve McCann, who focuses on how to combat a growing menace – cheque fraud.

On this page:
Cheque fraud
Knowledge of the forgery
The extent of employee fraud.

Corporate policies for addressing employee fraud are essential. It damages the viability of commercial entities. If fraud is unchecked because there are no effective policies in place to detect it, recover the proceeds or deter fraudsters, victims’ businesses may fail.

Even though businesses are moving away from using cheques as a means of payment – cheque transaction volumes peaked in 1997 at 1.2 billion and fell to 709 million in 2007 – cheques still account for 40% of all non-cash payments. When making payments to other businesses, companies of all sizes are likely to use a cheque to pay suppliers.

Cheque fraud

APACS, the UK trade association for payments and payment service providers , identifies three types of cheque fraud: forged cheques – a genuine cheque on which the fraudster forges the customer’s signature; fraudulently altered cheques – a genuine cheque that is subsequently altered by the fraudster, for example by changing payee and/or amount to be paid; and counterfeit cheques – used by the fraudster to draw on genuine accounts.

APACS reported that in 2008 cheque fraud losses increased by 25% from £33.5m in 2007 to £41.9m. In the previous year, cheque fraud losses increased by just under 10% after year-on-year falls in 2004-05 of 12.9% and in 2005-06 of 24%. This recent trend is especially troubling given that the volume of cheques being issued is in decline.

A forged signature on a cheque is “wholly inoperative”, according to the Bills of Exchange Act. It renders the cheque a nullity. The bank does not have its customer’s mandate to pay out and in turn is not entitled to debit its customer’s account. A cheque is also a nullity where a fraudster materially alters a cheque a" er it has been genuinely signed.

Therefore, if a bank pays out on a forged cheque, it has to bear the loss. However, it would be entitled to seek recovery of its losses from the fraudster. This is reflected in the Exeter fraud story (see box) reported in the Western Morning News, which said any recoveries from the fraudster would be paid to the bank that had reimbursed the victim company.

It is important to note that the customer is not completely insulated from the effects of cheque fraud – they owe their bank two duties of care. First, they should not write a cheque in a manner that facilitates fraud. Second, they should inform the bank as soon as they become aware of the forgery.

Common sense dictates that blank cheques should never be pre-signed. As Lord Finlay observed: “If a customer signs a cheque in blank, and leaves it to a clerk or other person to fill it in, he is bound by the instrument as filled up by his agent.” So any losses will be borne by the customer, not the bank. However, if the cheque has been properly completed, so that subsequent and fraudulent alteration is clear or easily discoverable, the bank will be liable if it pays out.

In conjunction with Apacs, the Cheque and Credit Clearing Company published Best Practice Guidelines for Business Users of Cheques in March 2009. The guidance includes the advice that when drawing the cheque you should “make sure you write the name of the payee clearly and correctly, starting from the left-hand side of the cheque and write the amount in figures as close to the £ sign as possible.” It adds that “you should draw a line through all unused space so that fraudsters cannot write in extra names, change the amount in words or add extra numbers in the amount box”. This means that drawers of cheques should ensure that a line is also inserted after the payee name. This is important as a cheque will still be valid even if the amount in words commences on the first line of the cheque (rather than the customary practice of writing the amount on the second line of the cheque).

Knowledge of the forgery

The customer’s duty to inform the bank of any forged payment arises where the customer has actual knowledge of the forgery.

While a customer is under no obligation to check their bank statements, if a discrepancy is noted, the customer should inform the bank so that further potential losses can be avoided. In the case of Greenwood v Martins Bank, a wife forged her husband’s signature and secretly cashed cheques. When the husband discovered the forgeries, he did not inform the bank immediately. The court held that the husband’s silence amounted to a representation to the bank that the forged cheques were in order and the bank was therefore entitled to pay out on them.

Be mindful of the duties of care and you should avoid exposure. Nevertheless, if you find yourself the victim of cheque fraud, remember that the bank’s liability should be considered first. Not only is this more attractive commercially (as they should have deeper pockets), it is the proper course of action. It is up to the bank in turn to try to recover its losses from the wrongdoer.