Paid-in-Full Checks

BY JAY AND ARTHUR WINSTON, WINSTON & WINSTON, P.C.

A debtor disputes a debt with a creditor and offers a check for a lesser amount in full settlement of the debt. The creditor receives the check and, at that point, must make a decision whether to deposit the check and accept the settlement, or to return the check and continue to prosecute a claim for the full balance due. If the claim is a bona fide disputed claim and the creditor accepts the check, then the creditor is precluded from instituting any further suit for the balance.

The legal terminology for the above transaction would be “an accord and satisfaction,” i.e., a compromise which pays the debt in full. Until recently, this doctrine was almost universally accepted as the majority position throughout the United States. Nevertheless, the “common law” doctrine (“common law” means the law inherited from England, which was not written into statute law but resulted from court decisions and common sense) is no longer the majority view.

Under the common law, the creditor has two options: reject the offer or cash the check. The full settlement check constitutes an offer and when the creditor cashes the “full payment” check concerning a bona fide dispute of an unliquidated or disputed claim, the debtor is released from any further legal obligation under the common law. A creditor cannot avoid an accord and satisfaction by reciting a reservation of rights on the reverse side of the check, or by crossing out the “paid-in-full” language on the check.

Nevertheless, a number of states, including New York, Ohio, South Dakota and West Virginia, had rejected this position. These courts hold that the common law rule places the creditor in a disadvantageous position and permits the debtor to practice extortion. Offering a check for less than the contract amount, but “in full settlement,” allegedly inflicts an exquisite form of commercial torture on the creditor. Thus these state courts have held that Section 1-207 of the Uniform Commercial Code (U.C.C.) permits the creditor to cash a check and avoid an accord of satisfaction, if the creditor makes an explicit reservation of rights by writing on the reverse side of the check such words as “without prejudice,” “under protest” or words of similar import. The courts adopted this theory based upon a literal interpretation of U.C.C. Section 1–207. No meeting of the minds takes place and the result appears to be unfair when the debtor intends merely to offer the check on condition that the creditor accept it as full payment for the disputed debt. In summary, these states allow a creditor to accept the check as part payment of the debt and to proceed with suit for the balance due, notwithstanding the fact that this is not the intent or wish of the debtor. If a letter accompanies the check spelling out the conditions of the offer of settlement, the creditor may still deposit the check and sue for the balance (New York).

When a check for a lesser amount marked “paid-in-full” is submitted to a creditor and the debt is not disputed, deposit of the check by the creditor will not discharge the debt. But what happens if the debtor claims that the account was disputed and someone else in the corporation knew about the dispute? This situation often arises where a debtor mails a check to a large corporation and the department receiving the check is different from the department which charged the debtor.

This dilemma is addressed by U.C.C. section 3-311, which clearly states that a debtor cannot use a paid-in-full check to discharge a claim if:

1. the payee is an organization.

2. if the organization has communicated to the other party that an offer of full payment is to be sent to a particular person, office, or place.

3. the check was not received by the designated person, office, or place.

The “paid-in-full” check is treated as a partial payment and not an offer to settle unless it meets the above requirements. Unfortunately this rule is not absolute, because the debt will be settled if the recipient of the check had knowledge of the dispute.

The purpose of the section is to prevent an accord and satisfaction from taking place when a check is sent to an automated collection center or a large corporation and is cashed without inspection. In the commercial world, hundreds of thousands of checks are processed daily by merchants and corporations. These parties are neither equipped nor is it economical to inspect every check for the purpose of avoiding an inadvertent accord and satisfaction. The section thus prevents a clever debtor from pulling a fast one by slipping a full settlement check through the system to pay less than the full amount on a disputed debt.

One may revoke an accord and satisfaction within 90 days by fully repaying the amount received. A summary of the state laws is contained in Appendix IV. Nevertheless, some of the states have modified section 3–311 and have either excluded certain parts of the statute or have included additional wording.

Section 3-311, a compromise of the common law and the interpretation of UCC 1-207 (subdivision 2), has been adopted in Arkansas, California, Colorado, Connecticut, Florida, Georgia, Idaho, Indiana, Kansas, Louisiana, Massachusetts, Missouri, Nebraska, New Jersey, Pennsylvania, Texas, Utah, Virginia, Wisconsin, Wyoming. Many other states may have also adopted section 3-311 since we have not done a survey of all the states. In most of the states section 3-311 has been proposed as a compromise and is working its way through the legislatures. We do know that New York still follows UCC 1-207 which allows the recipient to deposit a check marked paid in full utilizing the magic words in the UCC and receiving the money and thereafter suing for the balance. For an in depth article on the subject written in 1992, see “Evolution of Accord and Satisfaction” 28 New England Law Review 189, Jay Winston.

1 People v. Percuwitz, 163 California 636; Wright v. The Bank of America, 176 Cal. App, 2d 176, 1 Cal. Rptr. 202 (1959).

2 82 Business Law Journal 347.

3 RPM Pizza Inc. v. Bank One Cambridge, 869 F. Supp. 517 (E.D. Mich. 1994).

4 Sec 1526 California Civil Code; UCC 3–311