Often, an insurance carrier will issue a check to two joint payees — the named insured and either a public adjuster or a mortgagee. What happens when the one payee cashes the check without first obtaining a signature from the other payee? According to recent decisions from the Texas Supreme Court and the Dallas Court of Appeals, in this situation the insurance carrier is still liable to the other payee for the full amount of the payment.

In McAllen Hospitals LP v. State Farm Mutual Insurance Co. of Texas, the hospital had a statutory lien against proceeds of a personal injury settlement. 433 S.W.3d 535, 536 (Tex. 2014). State Farm made the settlement checks payable to both the patients and the hospital. The checks were then delivered to the patients. The patients deposited the checks without obtaining the hospital’s endorsement.

When the hospital filed suit against State Farm to collect the amount of its lien, the Texas Supreme Court noted that payment was made by way of a negotiable instrument and, therefore, was governed by the Uniform Commercial Code. After finding that delivery of the settlement checks to the patients constituted constructive delivery to the hospital, the Texas Supreme Court addressed whether when the patients cashed the checks, State Farm’s obligation to the hospital was discharged. In particular, the court noted:

The UCC instructs that “an instrument is paid to the extent payment is made by or on behalf of a party obliged to pay the instrument, and to a person entitled to enforce the instrument.” [TEX. BUS. & COM.CODE § 3.602(a).] And the UCC explains that, when a draft is issued to nonalternative copayees, one copayee acting alone is not entitled to enforce, and thus may not discharge, the instrument. Specifically, the statute provides: “If 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.” Id. § 3.110(d). The Comment to this section of the Code further clarifies: 

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 .... Thus, ... 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.

433 S.W.2d at 539 (citing TEX. BUS. & COM.CODE § 3.110(d) cmt. 4).

The Texas Supreme Court then concluded that “because payment to one nonalternative copayee without the endorsement of the other is not payment to a ‘holder,’ it does not discharge the drawer of either his liability on the instrument or his underlying obligation.” Accordingly, State Farm was still responsible for satisfying its obligation to the hospital.

Bottom line — State Farm had to pay twice.

In ViewPoint Bank v. Allied Property & Casualty Insurance Co., the Dallas Court of Appeals recently applied the analysis in McAllen Hospitals to a payment by a first-party property insurance carrier. No. 05-12-01370-CV, (Tex.App. Dallas Aug. 7, 2014, no pet. h.) ViewPoint involved a claim for property damage arising from Hurricane Ike. Upon settlement of the claim, the insurer issued checks payable to its insured and the mortgage holder.[1] 2014 WL 3867810, at *1. The insured endorsed the checks and deposited the funds without obtaining the mortgage holder’s endorsement.

Relying on McAllen Hospitals, the Dallas Court of Appeals found that the insurer’s obligation to the mortgage holder was not discharged when the insured deposited the checks. Furthermore, the court found that the mortgage holder was entitled to recover on the checks despite the fact that it did not have possession of those checks. The court specifically rejected the insurer’s argument that the mortgage holder’s only remedy was against the bank that improperly cashed the checks without proper endorsements, noting that the last sentence of UCC § 3.310(b)(4) addresses the issue:

If the payor bank pays a person not entitled to enforce the instrument, as in the hypothetical case, the suspension of the underlying obligation continues because the check has not been paid. Section 3–602(a). The payee's cause of action is against the depositary bank or payor bank in conversion under Section 3–420 or against the drawer under Section 3–309.

Id. at *4 (citing TEX. BUS. & COM.CODE ANN. § 3.310 cmt. 4 (emphasis added by court)).

Under § 3.309, a person seeking to enforce the instrument must prove the terms of the instrument and their right to enforce the instrument. Id. (citing TEX. BUS. & COM.CODE ANN. § 3.309(b)). Once that proof is made, the plaintiff producing the instrument is entitled to enforce the instrument, unless the defendant can prove a defense or claim in recoupment. Id. (citing TEX. BUS. & COM.CODE ANN. §§ 3.308 & 3.309(b).

The court finally noted that the insurer had an adequate remedy for the fact that it would have to make a double payment, with a right to proceed against the bank that improperly paid the checks without proper endorsements. The court noted that “[t]he Uniform Commercial Code envisions this remedy, rather than requiring the innocent loss payee whose endorsement was forged to directly sue the forger or the depositary bank.” Id. (citing State ex rel. N.D. Housing Fin. Agency v. Ctr. Mut. Ins. Co., 720 N.W.2d 425, 432 (N.D. 2006)).

Bottom line — Allied Property had to pay twice.

The outcome in McAllen Hospitals and ViewPoint is clearly unfair to the insurer as it properly included all payees on the claim settlement checks. Nonetheless, the analysis of the issue by the Texas courts is consistent with the UCC. In the end, it is also understandable.

There are two innocent parties when one payee cashes a check without obtaining the endorsement from the other payee — the entity that issued the check and the payee whose endorsement was missing. The UCC has determined that the innocent payee should be made whole, even if that means the entity issuing the check has to make two payments. Of course, the issuing entity can pursue the bank that improperly cashed the check and the other payee to recoup the second payment. It is unclear why in the McAllen Hospitals and ViewPoint cases the insurance carriers issuing the checks did not bring the parties that improperly deposited the checks and the paying banks into the lawsuits. There is no doubt that future lawsuits involving this issue will also include both such parties.

So what is an insurer to do knowing now that under Texas law it bears the risk of improper conduct by its insured in depositing a claim payment without obtaining the proper endorsement of all payees? At a minimum, if an insurer believes there is any risk of improper conduct, the insurer should give advance notice of a forthcoming claim payment to all payees and seek their agreed direction as to where the claim payment should be sent. This will at least inform all payees that a payment is being made and hopefully minimize the likelihood of improper conduct.

[1] The checks were also payable to the insured’s public adjuster, Adjuster's International, who endorsed the checks and delivered them to the insured.