December 1, 2000

Subject: Payment-in-Full Check Trap

A UCC provision on "payment in full" checks adopted by many states in the last few years is creating a trop for businesses. You should review your contracts and check-cashing procedures, and take steps to protect yourself from suits over unfair debt-collection practices.

Under UCC section 3-311, cashing any check tendered as "payment in full" is an accord and satisfaction, discharging unpaid portions of a debt balance, even if you strike out the payment-in-full language. This provision has been adopted in every state except New York, Rhode Island and South Carolina.

Debtors frequently attempt to pay less than they owe by sending creditors payment-in-full checks, hoping the creditor does not catch the language and cashes it. This is especially frequent in the construction industry with suppliers who write payment in full checks and try to slip them by.

The common notion has long been that if the creditor simply crosses out the payment in full language or endorses the check with a reservation of rights, the balance of the debt is preserved. But under the law simply cashing the check accepts the debtor's terms.

This can be particularly troublesome for attorneys hired to recover the balance of the debt. It's a trap for the law firm never actually furnished with a copy of the check. When the attorney makes a demand on the balance, he could get hit with a suit under the Fair Debt Collection Practices Act. While he may have a defense, he still has to deal with a lawsuit that costs time and money to get rid of."

There is recourse for creditors. The law allows creditors to:

• Provide in their contracts that payment-in-full checks are invalid unless to a designated recipient, or
• return the money within 90 days of cashing the check.
• Creditors can also add language to their contracts prohibiting payment-in-full checks except pursuant to a separate written agreement.

If a payment-in-full check somehow slips through, the creditor can proceed on the balance if he can successfully argue that:

• The check was tendered in bad faith;
• The debt was liquidated or not subject to a bona fide dispute; or
• The payment in full language was "inconspicuous."

This problem is especially urgent in automated collection settings. There may be many instances where a human being otherwise never even sees or touches a check because it's processed electronically. If there is a situation where every check is dumped in an electronic lockbox, a payment-in-full check will not be caught.

The best way to ensure that you do not inadvertently discharge a debt by cashing a payment-in-full check is to create a mechanism to catch these checks beforehand. There are several ways of doing this, including:

• Designating a special recipient for payment-in-full checks.

This is the method specifically authorized by the law. The creditor can designate a particular person, office or address to receive all payment-in-full checks. If you do this, a check sent anywhere else marked payment in full is defective. Such a provision will be ineffective if it is not conspicuous in the contract. You cannot bury it in boilerplate. You must do it in a typeface or coloration that makes it stand out from the body of the text. There is a tradeoff for businesses that do this. If they designate a recipient, they lose the benefit of the 90-day window to refund cashed checks.

The benefit is having someone who knows the consequences of cashing a payment-in-full check make a decision whether to cash it or send it back. The downside is that if this person makes a mistake, the creditor is out of luck because the 90-day right to change the decision will not apply.

• Designating that no payment-in-full check is valid absent express agreement.

This may prevent the application of the law. The UCC allows its provisions to be varied by agreement unless otherwise prohibited. This section does not prohibit it. For example, a landlord might say in a lease that a check submitted as payment-in-full for a disputed amount is not binding without a separate written agreement executed by both parties. If you are going to require a separate writing, make sure the language in your contract is conspicuous.

If you do cash a payment-in-full check and fail to discover the mistake within the 90 days, there is still recourse. The law allows creditors to collect on the rest of the debt if any of the following has occurred:

• The debtor tendered the payment-in-full check in bad faith.

In every instance this will depend on the facts.

• The debt was liquidated or there was no bona fide dispute over the amount owed.

The law puts the burden on the debtor to prove the debt was disputed, There are things the creditor can do to show the absence of a dispute. Much depends on the debtor's actions before sending the payment-in-full check. Look to see if they ever lodged a complaint about goods or services or whether they made a warranty claim. If they had no contact with the payee before sending the check, it is tough for the creditor to say they are settling a claim the creditor did not know about. It is worth putting in a requirement that all complaints be submitted in writing in the initial contract.

Service providers who cash payment-in-full checks from clients may have a difficult time showing the absence of a dispute. There is a greater propensity for dispute because there is more gray area regarding the value of services. Any professional service is more intangible than a product.

• The payment-in-full language was inconspicuous.

Conspicuous is one of the terms lawsuits are made of. If the language appears in the memo section of the check, it is most likely going to be considered conspicuous under the law. You might make an argument if the language appears in an accompanying cover letter, and not on the check. If the creditor is aware there is an issue when he or she cashes the check, then by definition, the notice is conspicuous.

Despite these issues, it often makes sense to cash the payment-in-full check even if there is outstanding debt. For instance, the check is often more than the creditor will get if he refers it to a collection agency or begins legal proceedings. Another important question is whether the balance is collectible. You can sue a debtor, but if you cannot collect, what difference does it make? This is a reality many creditors face. It might be a wise choice to accept the check.