If someone can cash a check, they will.
3 Main Points:
1."And" means both parties must sign
2."Or" means either party can sign.
3. Anything in between and either party can sign.
Following an insured loss, an insurance company will often make a check payable to multiple parties. One of those parties will nearly always be the homeowner. Other parties that may appear include the general contractor and the mortgagee. The amount of this check will usually be calculated in the amount of approved work performed by a contractor. The agreement between the contractor and the homeowner may provide that the homeowner assigns all rights to such insurance proceeds to the contractor. However, most insurance companies disregard these attempts at proceeds assignment, and most insurance companies send the check to the named insured on the policy. This is where the legal trouble typically begins.
The form of the "payable to" designation dictates whose indorsements2 are required to deposit the checks. When the check is made payable to the parties in the conjunctive (e.g. "Ms. Homeowner and First Bank and Contractor"), all party’s indorsements are required for the check to be deposited. When the check is made payable to the parties in the disjunctive ( e.g. "Ms. Homeowner or First Bank or Contractor"), only one party’s indorsement is necessary. Scattered in between these two extremes are any number of different levels of ambiguity. Please note that the law on this issue may vary substantially from state to state, so consider the Illinois-based examples herein merely illustrative if you are dealing with jobs outside Illinois.
Harder v. First Capital Bank 3 is illustrative of the problems that may arise due to payee ambiguity. Fire damaged the home of Charles and Marsha Harder.4 The Harders contracted with Emergency Damage Control of Central Illinois (EDC) to repair and restore their home.5 EDC failed to complete the work, and did not return the items it held in storage.6 The Harders’ insurer wrote two checks to cover the damage, one made payable to:
EMERGENCY DAMAGE CONTROL
CHARLES AND MARSHA HARDER
BANK OF PONTIAC7
and the other to:
EMERGENCY DAMAGE CONTROL
CHARLES AND MARSHA HARDER.
EDC came into possession of these checks and deposited both of them with defendant First Capital Bank with only the indorsement of EDC.8 The Harders filed suit against, among other parties, the bank for conversion and negligence in cashing the checks without the appropriate signatures.9 The court found that, as a matter of law, whether the check was payable jointly or in the alternative was ambiguous. 10 Uniform Commercial Code § 3-110(d) further specifies "[i]f an instrument payable to two or more persons is ambiguous as to whether it is payable to the persons alternatively, the instrument is payable to the persons alternatively." Based on this UCC section, the court found enough ambiguity to deny the Harders any relief against the bank. Ambiguity equals "or" for indorsement purposes.
Rather than leaving issues like this up to subtle perturbations in state law as to what is ambiguous, it would make the job of all parties involved, including the bank’s (who has to decide whether or not to accept these checks) a lot easier if the checks were made payable to parties explicitly connected by "and" or "or." However, insurance companies continue to simply stack names together on checks, and this may give the alert contractor an opening to get paid without having to get additional indorsements.11
Indorsements are also interrelated with escrow issues, and this typically surfaces when the contractor is asked to sign before the owner and mortgagee. Owners, even mortgagees, have been known to argue that the prior indorsement of the contractor operates to give up all of the contractor’s rights to the funds, by making the subsequent indorsers or the escrowee into "holders in due course.12" To avoid this result, contractors can sign over the checks to the other payees to go into escrow by using a restrictive indorsement.13 A sample would be as follows:
[Local Restoration Contractor], Pay to the Order of [Mortgage Lender] for the benefit Of [Local Restoration Contractor]
Banks won’t always agree to accept a restrictive indorsement, but the process of dealing with the contractor’s attempt to use the indorsement will give all parties the opportunity of defining escrow terms to fit the particular situation. Unlike title companies holding funds for construction escrows, banks seeking to protect their security interest by requiring reconstruction funds to be escrowed do not seem receptive to signing standard strict joint order escrows. They tend to use letters announcing escrow policies and procedures.
These policies and procedures may not necessarily protect the contractor.14 However, by the time most attorneys learn about the terms of a given escrow, the contractor has usually long since indorsed the check. In the event anyone involved in a loss uses indorsements to filch funds not intended for them, or if escrows go awry15, the adjuster can expect to be pulled in as a necessary party to an escrow interpleader action, or as some form of participant in fraud or fiduciary duty litigation.16
Distilling legal advice down to standard operating procedures and encouraging contractor clients to use restrictive indorsement stamps on multi-payee insurance proceeds checks will help these clients achieve the goal of getting paid for their work. In this role, the business attorney can function "as both a middle-man and an organizing force17" which is important to stress to the client—in case the facts of the client’s first problem in this area turn out to be irredeemably bad. Moreover if a future multi-payee check situation cannot be resolved by using a restrictive indorsement,18 the client will at least understand the risk of proceeding with an unconditional indorsement.
1 The author gratefully acknowledges the writing and research assistance of Nathan Hamstra (B.S. with honors, Univ. of Illinois 2001; J.D. expected 2005, Univ. of Michigan)
2 At first glance, it seems like this should say "Endorsements" but the U.C.C. uses "Indorsements." See, UCC Sec. 3-204.
3 332 Ill. App. 3d 740 (4th Dist. 2002); 775 N.E.2d 610; 2002 Ill. App. LEXIS 654; 266 Ill. Dec. 770; 48 U.C.C. Rep. Serv. 2d (Callaghan) 1069, July 29, 2002, Filed, Released for Publication August 30, 2002.
4 Id 332 Ill.App.3d at 742.
7 Harders’ mortgagee
10 Id at 746.
11 And without risking non-payment by losing possession of the check after the contractor indorses it but before all other co-payees have indorsed it.
12 See, Uniform Commercial Code Sec. 3-302.
13 See, Uniform Commercial Code Sec. 3-206.
14 Many banks will unthinkingly equate reconstruction fund escrows with standard mortgage escrows for things like real estate taxes. However, the reconstruction fund escrow is a completely different animal.
15 This will be the subject of a separate article.
16 When banks take in funds from an insurance proceeds check co-payable to a contractor, they do so with the knowledge that the contractor continues to have an interest in those funds. This is the reason that the bank cannot become the "holder in due course" of the funds, and this gives the contractor the fiduciary duty leverage to use in relation to the bank to the extent the bank takes any action in derogation of the contractor’s interest in those funds.
17 Scott Liebs, "With a Little Help From its Friends: By surrounding itself with IT giants, EDS hopes to win a new audience," CFO-IT (Winter, 2004) at 56. Recurring work from contractor clients ideally becomes standardized and organized for routine enforcement of the client’s right to payment for its work.
18 For example, if the bank flat-out refuses to go along with the indorsement.
Edward N. Tiesenga is a partner in the law firm of Tiesenga & Tiesenga P.C. located at 1200 Harger Road, Ste. 830 Oak Brook, IL 60523.