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3 Checks and the Risk of Fraud. This chapter discusses the law of negotiable instruments, the application of the legal doctrine of a “holder in due course” to checks, the check system in the United States, how the risk of fraud is allocated to the parties participating in a check transaction | 3 Checks and the Risk of Fraud This chapter discusses the law of negotiable instruments the application of the legal doctrine of a holder in due course to checks the check system in the United States how the risk of fraud is allocated to the parties participating in a check transaction and how to manage that risk. NEGOTIABLE INSTRUMENTS A negotiable instrument is either a promise to pay a fixed sum of money or an order to pay a fixed sum of money. If the negotiable instrument is a promise to pay it is a note which is beyond the scope of this book. If the negotiable instrument is an order to pay it is a draft and if the draft is drawn on a bank it is typically also a check The primary risk associated with checks is the risk of fraud. A principal goal of the law governing a negotiable instrument is to make the negotiable instrument freely transferable in commercial transactions. To further that goal the law generally allows a 23 Checks and the Risk of Fraud person who has taken the negotiable instrument in due course the holder in due course to demand payment from the drawer even if fraud may have been committed by the original payee in the underlying transaction. This chapter considers protection from fraud under the Uniform Commercial Code U.C.C. to the holder in due course of a check. It also considers how the U.C.C. allocates liability for check fraud and check theft among the various parties the bank customer who issued the check subsequent holders of the check and the drawee bank that is instructed to pay the check. Drafts A draft is a three-party instrument. The parties are the drawer the drawee and the payee. When the drawee is a bank the draft is also a check. In a draft the drawer instructs the drawee to pay the payee. What makes the draft unique is that the payee does not have to present the draft to the drawee. Instead the payee may transfer the draft to another party who may either present the draft for payment to the drawee or transfer the draft to yet
