Cash the Check? Maybe not . . .

The Kentucky Court of Appeals recently reminded creditors that, even if the debtor’s check is not in the mail but has actually been delivered, it’s not always a good idea to cash it. Estes v. McKinney, No. 2010-CA-000576-MR (Ky. Ct. App. 2011).

In this case, the creditor had sued the debtor on a $20,000 check, but the debtor asserted various counterclaims and the parties disagreed about the amount of the debt. The debtor’s attorney sent the creditor’s attorney an $18,500 check, with a letter proposing to settle the claim for this amount. The creditor had its attorney deposit the check in the attorney’s escrow account, and responded with a letter rejecting the offer, demanding payment of the entire $20,000 plus attorneys’ fees, and explaining that the check was being held in escrow until the parties reached agreement. The debtor refused and the parties went to trial. The court held that, by taking and keeping the check, even though it had been held in escrow by the attorney, the creditor had accepted the $18,500 in settlement of its claim, and could not continue to argue about it.

The decision was based on a provision of article 3 of the Uniform Commercial Code (“UCC”), as amended in 1990, which is in effect in Kentucky and almost all other states. (New York has not adopted the 1990 amendments to Article 3.) Article 3 covers checks and other negotiable instruments.

The language in the older version of Article 3 was ambiguous, and there were conflicting decisions as to whether a check containing the maker’s “payment in full” notation would automatically bind the payee if the payee endorsed and cashed the check. Some courts found that the payee’s endorsement did act as an acceptance of the maker’s offer, creating an “accord and satisfaction” even if the payee did not intend to accept it. Some courts (including Kentucky courts) recognized this kind of accord and satisfaction, but allowed the payee of a check to avoid an unwanted settlement if it endorsed the check but added language reserving its rights against the maker of the check. Other courts (including the Tennessee Supreme Court) held that, in light of modern commercial practices, an endorsement by itself would not create an accord and satisfaction.

The revised version of UCC Article 3 overrides both the decisions from Kentucky and other states allowing a creditor to have its cake and eat it too, and the cases allowing an unscrupulous debtor to force a settlement on an unwitting creditor.

Revised Article 3 addresses the problem in two steps. Rev. UCC § 3–311(a). First, a conspicuous “payment in full” notation on a check can create an accord and satisfaction but only if:

• the debtor acts in good faith,
• the claim was unliquidated or was subject to a bona fide dispute, and
• the creditor obtains payment of the check.

Second, even if the creditor does accept the check, it can avoid the accord and satisfaction if it reimburses the debtor within 90 days for the amount of the check, as long as the debtor cannot prove that the creditor knew in advance that the check was offered in satisfaction of the entire debt. Rev. UCC § 3–311(c)(2).

In addition, a creditor that is an organization can take extra steps to protect itself against surprise compromises, by giving conspicuous notice in advance to its debtors (or potential debtors, like customers or borrowers) that all communications regarding disputed debts (including “full payment” checks) must be sent to a designated person and place. Rev. UCC § 3–311(c)(1). Then there is no discharge if the designated person does not receive the check. The notice must be given within a “reasonable time” before the check is tendered. Large creditor organizations may want to send such notices to their customers at regular intervals.