A.C.E., INC. v. INLAND MORTGAGE COMPANY and
West Star Financial Corporation
97-907 ___ S.W.2d ___
Supreme Court of Arkansas
Opinion delivered May 14, 1998
1. Banks & banking -- drawer discharged when draft accepted by
bank -- "check" defined. -- Uniform Commercial Code 3-
414(c), codified in Arkansas at Arkansas Code Annotated
section 4-3-414(c), provides that if a draft is accepted by a
bank, the drawer is discharged regardless of when or by whom
acceptance was obtained; under Ark. Code Ann. 4-3-104(3)(f),
"check" means, in part, a draft, other than a documentary
draft, payable on demand and drawn on a bank.
2. Banks & banking -- case relied upon by appellant inapplicable
-- appellant had possession of check and opportunity to
endorse it. -- Appellant's reliance on a Massachusetts case
was misplaced where the case cited was factually and
significantly distinguishable; there, the appellant sued under
UCC 3-116(b), which requires that, if an instrument is
payable to joint payees, it may be negotiated, discharged, or
enforced only by all of them; the Massachusetts court held
that liability on the instrument or underlying obligation did
not discharge the drawer, because one payee had not indorsed
the check; the decision hinged on UCC 3-116(b), which
expressly prohibits the discharge of an instrument except by
all payees; however in that instance, and unlike the facts
here, the appellant never had possession of the check or the
opportunity to indorse it.
3. Banks & banking -- appellant delivered possession of check to
other joint payee -- under Ark. Code Ann. 4-3-414(c)
appellee's underlying obligation on debt was discharged when
payment was made on the check. -- Where appellant contractor
payee originally possessed the check but delivered it to the
homeowner for whom the repairs had been made, who was the
other joint payee, appellant was not entitled to enforce the
instrument under Ark. Code Ann. 4-3-309(a) (Repl. 1991)
because appellant was in possession of the instrument and
entitled to enforce it when loss of possession occurred, and
the loss of possession was the result of a transfer by the
appellant; accordingly, under 4-3-414(c), appellee's
underlying obligation on the debt was discharged when payment
was made on the check.
4. Banks & banking -- conversion of instrument -- court's
dismissal proper -- conversion could not lie against appellee.
-- Under Arkansas Code Annotated section 4-3-420(a) (Repl.
1997), an instrument is converted if it is taken by transfer
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; here, appellee could not have converted the
instrument since it did not take the check by transfer from
the second joint payee after it came into his possession;
appellee's liability on the check was for the underlying
obligation the check was based upon, which was discharged when
the check was paid.
5. Banks & banking -- negligence alleged against appellee --
appellee's failure to timely stop payment on check did not
inure to appellant's benefit. -- Appellee's alleged negligence
in failing to timely stop payment on the check does not inure
to appellant's benefit in a suit against appellee, but instead
would be a defense the bank might use as a defendant to the
extent appellee's negligence contributed to the loss.
Appeal from Pulaski Circuit Court; Marion Humphrey, Judge;
Griffin Smith, for appellant.
Wilson & Associates, P.A., by: Randall S. Bueter, for
Tom Glaze, Justice.
This case involves the interpretation of statutory provisions
under the Uniform Commercial Code. Because the application of
these Code provisions is in issue, we first address the facts that
led to this litigation and appeal.
Bilal Badar owned a house in Little Rock, Arkansas mortgaged
to West Star, and the mortgage was serviced by Inland Mortgage
Corporation (Inland). The house was damaged by fire, and
afterwards, A.C.E., Inc.(ACE), performed the repairs. Inland
supervised the repairs and distributed the insurance proceeds
required for their payment.
Inland issued its last insurance check in the amount of
$3,800.00 on July 11, 1996, payable to Badar and ACE as joint
payees, and ACE received the check on July 15, 1996. On that
July 15 date, ACE's agent, Sandi Ganus, handed the check to Badar
and asked him to indorse it, since the proceeds were owed to ACE
for repairs. Badar, however, put the check in his pocket, and
refused to return it to Ganus. ACE had not yet indorsed the check.
Ganus has claimed throughout this litigation that she called
Inland on the morning of July 16, 1996, and told Inland's agent,
Laure Eck, what Badar had done. Ganus says she recommended that
Inland stop payment of the check. The record reflects that the
check was paid by the payor bank -- First Commercial Bank -- on
July 18, 1996, and the back of the check reflects "A.C.E., Inc."
and a signature difficult to decipher, but which appears to be
Badar's. John Giuffre, an Inland supervisor in the company's
hazard insurance section, averred Inland's records showed that ACE
contacted it concerning the check on July 19, 1996, but by that
time, the check had already been cashed.
On August 21, 1996, ACE filed suit against Inland and Badar,
and alleged the following: (1) ACE had immediately (on July 15 or
16, 1996) requested Inland to stop payment on the check and Inland
refused to comply; (2) Inland refused ACE's demand for payment; and
(3) Inland's and Badar's actions constituted a conversion of the
check. Alternatively, ACE asserts it had no agency relationship
with Badar, so Inland's delivering the check to ACE as joint payee,
and the bank's cashing the check bearing ACE's forged indorsement,
did not discharge the underlying debt to ACE.
On October 30, 1996, ACE moved for summary judgment on the
basis that the forged indorsement did not discharge the underlying
obligation. In its argument, ACE relied solely on the holding in
a Massachusetts case, General Motors Acceptance Corporation v.
Abington Casualty Insurance Co., 413 Mass. 583, 602 N.E.2d 1085
(1992) (hereafter GMAC).
On March 26, 1997, the trial court denied ACE's motion for
summary judgment, and in doing so, cited Ark. Code Ann. 4-3-
414(c) (Repl. 1991), which provides that, once a draft is accepted
by a bank, the drawer (here Inland) of the instrument is
discharged. The trial court held the decision in GMAC did not
apply because of a factual difference, namely, in GMAC, the drawer
sent the check directly to the wrongdoer co-payee instead of giving
it to GMAC, the co-payee lienholder. Here, Inland, as drawer,
delivered the check first to ACE, which in turn gave the check to
Badar. The trial court further held ACE was not entitled to
summary judgment because a fact issue exists (1) as to whether
Inland had unreasonably delayed in stopping the check after ACE
made the request, and (2) because Badar was a necessary party, who
had not as yet been served with the complaint and summons.
On January 2, 1997, Inland filed a motion to dismiss under
ARCP Rule 12(b)(6), alleging ACE's complaint failed to state a
claim. The trial court granted Inland's motion on April 29, 1997,
by an amended order dated June 11, 1997. ACE appeals from the
amended dismissal order on the following bases: (1) the trial
court overlooked its conversion allegation based on its claim that
Inland failed to timely stop payment on the check; (2) 4-3-414(c)
is inapplicable because the provision refers to a "draft," but this
case involves a check; (3) Badar was not a necessary party under
ARCP Rule 19; and (4) the GMAC case is applicable and the rule
there states that the payment of a check to one co-payee without
the indorsement of the other co-payee does not discharge the drawer
of either his liability on the instrument or the underlying
Inland cites the GMAC holding, but does so for the proposition
that an unpaid co-payee cannot collect from the drawer because,
under 4-3-414(c), the instrument payable to the co-payees is
deemed discharged once it is negotiated by any party. Inland
argues that, when this type of situation occurs, ACE's remedy, if
any, is against the drawer's bank. Inland further argues that,
when a check is issued for an underlying obligation, that
obligation is suspended until the check is presented for payment.
Under the Code, "presentment" means a demand made by or on behalf
of a person entitled to enforce the instrument, Ark. Code Ann. 4-
3-501 (Repl. 1991), and under this definition, Inland contends that
a forger is unable to "present" a check because he is not a person
entitled to enforce it. Inland submits that, because Badar forged
the check, no presentment occurred, and the payee (ACE) was unable
to sue on the suspended obligation.
We hold that Inland's obligation under the check was
discharged at the time of payment. We find the decision in
Mills v. Hurley Hdw. & Furn. Co., 129 Ark. 350, 196 S.W.2d 121
(1917), helpful. There, appellant T. R. Mills lived in Little
Rock, and was the owner of Batesville White Lime Company in
Batesville, Arkansas. A. B. Gowens was Mills's superintendent at
the plant. Gowens was authorized to receive and fill orders, and
to receive checks in payment, but was not authorized to cash
checks; instead, checks were to be turned over to Mills. Appellee
Hurley Hardware & Furniture Company purchased goods through Gowens
and sent its check to Gowens for payment. Gowens forged Mills's
indorsement on the check, cashed it at the First National Bank at
Batesville, and appropriated the proceeds. This court held that,
because the check was sent and received by the proper party, that
ended Hurley's responsibility and constituted payment by Hurley the
moment the check was cashed. Id. at 353.
The early common law rule in Mills is found at UCC 3-414(c),
codified in Arkansas at 4-3-414(c), which provides that, if a
draft is accepted by a bank, the drawer is discharged regardless of
when or by whom acceptance was obtained. Under Ark. Code Ann. 4-
3-104(3)(f), "check" means, in part, a draft, other than a
documentary draft, payable on demand and drawn on a bank. Hence,
Inland's obligation on the check ended when Badar demanded payment
of the check from the First Commercial Bank, and the bank paid it.
While ACE relies on GMAC in making its argument that Inland
had not discharged its obligation, that case is factually and
significantly distinguishable. There, Abington Casualty Insurance
Company had insured Robert A. Azevedo's car, which had sustained
damages. Abington appraised the loss and issued a check payable
jointly to the owner and insured, Azevedo, and the lienholder,
GMAC. Abington mailed the check directly to Azevedo, who forged
GMAC's indorsement and took the funds.
GMAC sued Abington under UCC 3-116(b) [codified in Arkansas
at Ark. Code Ann. 4-3-110(d) (Repl. 1991)], which requires that,
if an instrument is payable to joint payees, it may be negotiated,
discharged, or enforced only by all of them. The Massachusetts
court held that liability on the instrument or underlying
obligation did not discharge the drawer, Abington, because GMAC had
not indorsed the check. The court in GMAC conceded that,
ordinarily, under UCC's 3-802(1)(b) [here, Ark. Code Ann. 4-3-
414(c)], payment of a check discharges the obligation. However,
the decision in GMAC hinged on UCC 3-116(b) [Ark. Code Ann. 4-
3-110(d)], which expressly prohibits the discharge of an instrument
except by all payees. The legal analysis in GMAC ends there,
because GMAC never had possession of the check nor the opportunity
to indorse it.
Here, unlike GMAC, ACE originally possessed the check, but
delivered it to Badar. Under Ark. Code Ann. 4-3-309(a) (Repl.
1991), a person not in possession of an instrument is entitled to
enforce an instrument if: (i) the person was in possession of the
instrument and entitled to enforce it when loss of possession
occurred, (ii) the loss of possession was not the result of a
transfer by the person or a lawful seizure, and (iii) the person
cannot reasonably obtain possession of the instrument because the
instrument was destroyed, its whereabouts cannot be determined, or
it is in the wrongful possession of an unknown person or a person
that cannot be found or is not amenable to service of process.
Since the loss in this case occurred as a result of a transfer by
ACE, ACE cannot enforce the instrument under 4-3-309(a).
Accordingly, under 4-3-414(c), Inland's underlying obligation on
the debt was discharged when payment was made on the check.
Lastly, ACE argues that the court's dismissal was improper
because it did not dispose of ACE's claim against Inland for
conversion based upon Inland's alleged failure to act timely in
stopping payment on the check. No such conversion may lie against
Under Ark. Code Ann. 4-3-420(a) (Repl. 1997), an instrument
is converted if it is taken by transfer 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. Inland could not have converted the
instrument since it did not take the check by transfer from Badar
after it came into Badar's possession. Inland's liability on the
check is for the underlying obligation the check was based upon,
which was discharged when the check was paid.
Inland's alleged negligence in failing to timely stop payment
on the check does not inure to ACE's benefit in a suit against
Inland, but instead would be a defense the bank might use as a
defendant to the extent Inland's negligence contributed to the
loss. See Ark. Code Ann. 4-3-406 (Repl. 1997).