How to Avoid Conversion Claims with Jointly Payable Checks

March 9, 2023

This article is intended to be a “refresher” on how lenders can avoid conversion claims in connection with certain jointly payable negotiable instruments. Certain types of negotiable instruments (e.g., jointly payable checks) can benefit lenders, as demonstrated in the hypothetical below, but these instruments can also cause a lender problems if these instruments are not properly endorsed and negotiated.

For example, if a lender finances a debtor’s farming operation, that lender may sometimes file an Effective Financing (EFS)/Statutory Lien Notice (CNS-1) form1 to get the lender’s name put on checks from the sale(s) of a debtor’s commodities that the debtor sells on the open market. That way, when the debtor sells its livestock or crops to a third party, the third party will make any check(s) for the purchase of the debtor’s livestock or crops payable to “Debtor and Lender.”

This common arrangement ensures that the proceeds from the sale of the debtor’s commodities will be shared with the lender because the lender’s endorsement on these jointly payable checks is required for the jointly payable checks to be lawfully negotiated and deposited into an account or cashed.

However, there has been some recent litigation involving the conversion of checks arising from situations where checks have been issued jointly payable to “Debtor and Lender,” but only the Debtor endorses the checks and thereafter attempts to negotiate and deposit the checks without the Lender’s endorsement. If the jointly payable checks are negotiated and deposited without both of the required endorsements, litigation is likely to arise, and the law is clear that the co-payee on the check who did not endorse the jointly payable check will have conversion claims against both the “payor / drawee” bank (i.e., the bank ordered in the draft to make the payment) and the “depository” bank (i.e., the bank where the jointly payable check is deposited into).

Article 3 of the Uniform Commercial Code applies to the above hypothetical. Specifically, Article 3 expressly provides that “[i]f an instrument is payable to two or more persons not alternatively, it is payable to all of them and may be negotiated, discharged, or enforced only by all of them.” Minn. Stat. § 336.3-110(d) (emphasis added). The above-quoted statutory language means that a check made jointly payable to two payees may not be negotiated for deposit by only one of the payees alone. This conclusion is further emphasized in the “comments” made by the drafters of Article 3 of the Uniform Commercial Code, which provide that:

If an instrument is payable to X and Y, neither X nor Y acting alone is the person to whom the instrument is payable. Neither person, acting alone, can be the holder of the instrument. The instrument is “payable to an identified person.” The “identified person” is X and Y acting jointly. Section 3-109(b) and Section 1-102(5)(a). Thus, under Section 1-201(20) X or Y, acting alone, cannot be the holder or the person entitled to enforce or negotiate the instrument because neither, acting alone, is the identified person stated in the instrument.

Minn. Stat. § 336.3-110, cmt. 4.

Article 3 of the Uniform Commercial Code further provides that “[t]he law applicable to conversion of personal property applies to instruments,” and that “[a]n instrument is also converted if it is taken by transfer, other than a negotiation, from a person not entitled to enforce the instrument or a bank makes or obtains payment with respect to the instrument for a person not entitled to enforce the instrument or receive payment.” Minn. Stat. § 336.3-420(a).

Thus, the “takeaway” from this article is that when lenders are presented with a jointly payable check made payable to “John Doe and Jane Roe,” the “payor / drawee” bank should refuse to make payment on the check unless both “John Doe and Jane Roe” have endorsed the same. In like manner, a lender that would be the “depository” bank for the funds from a jointly payable check should not accept any funds unless both “John Doe and Jane Roe” have endorsed the check. That way, whether your institution is the “payor / drawee” bank and/or the “depository” bank, you will significantly minimize your institution’s liability exposure for any conversion claims that may otherwise be brought by a joint payee of a negotiable instrument.

1 This option is available in Minnesota and other states that have adopted the Central Notification System.

Associated Attorneys