The use of cheques reached its peak in 1995 but since then has been in decline as we transition to electronic payment alternatives. Despite their decline, cheques are not extinct and are not immune to the potential chain of events that can adversely impact funds that are the subject of the cheque during the period from the time it is drawn by the drawee bank to the time the funds are credited by the collecting bank.
Fraudsters have found fertile soil in exploiting the use of cheques and have been creative in material alterations of the name of the payee and, upon its presentation, the collecting institution proceeds to credit the funds to the (fraudster) incorrect payee.
An interesting defence that is available to the collecting institution is the statutory defence contained in Section 78(2) of the Cheques Act 1986 (Cth) (the Act) in response to any action for damages brought against it. This subsection logically provides that a cheque is discharged if it is fraudulently and materially altered by the holder.
While not much frequent judicial consideration is being given to cheques due to their slow demise it is surprising that there is no reported Australian case law considering Section 78(2) of the Act. However, the UK Court of Appeal in Smith & Anor v Lloyds TSB Bank plc  1 ALL ER 424, considered an analogous defence, under the United Kingdom’s Bills of Exchange Act 1882.
In that case, a cheque was fraudulently altered by inconspicuously substituting the original true payee with a third party. The claimants brought an action in conversion against the collecting bank for the face value of the cheque and a second action against the paying bank in conversion for the face value of the banker’s draft. The Court upheld the bank’s defence under the Bills of Exchange Act 1882 that upon the cheque being materially altered, its status as legal tender ceased and instead it became “a worthless piece of paper.”
The claimants could not bring an action in conversion for the face value of the cheque or the banker’s draft because the cheque or draft that had been materially altered by the fraudster no longer represented a chose in action for that amount because it was rendered a worthless piece of paper upon the material and fraudulent alteration.
Financial institutions should therefore ensure that they have adequate systems in place to detect whether a cheque has been materially altered. However, all is not lost if the fraudster penetrates the system, as there may be an opportunity for Australian Courts to apply the same reasoning of the Court of Appeal in England and Wales to a Section 78(2) defence.
This article was written by Thomas Li, Solicitor and Jonathan Kramersh, Partner.