Most vendors have occasionally accepted a business check in payment for a customer’s personal goods or services. This practice is typically common among contractors furnishing residential services (remodeling, roofing, landscaping, painting, etc.) to clients who are also business owners.
Often, the contractor knows the client is an owner or officer of the business and assumes that the client’s business’ and personal funds are essentially interchangeable. The contractor may believe that the client is paying with a business check to gain a tax advantage or rationalizes that the legitimacy of the transaction is the customer’s (or the IRS’) problem – not the contractor’s. Either way, in the past, accepting a company check from an owner, officer or manager of the company in payment for personal goods or services appeared to be a win-win situation: The customer received the goods or services and the vendor/contractor was paid.
If this payment method were ever without risk to a vendor, it no longer is, given recent developments in Wisconsin law. Now, every business should re-evaluate accepting third-party checks from clients for personal goods and services, or risk financial disaster.
Vendors that unknowingly accept from a client a fraudulently issued company check for personal expenditures that was drawn on embezzled company funds can be held 100-percent liable for the embezzled funds paid to it. This is true even though the vendor didn’t know that ill-gotten funds were used for payment. Moreover, this may be true even if the embezzler’s employer contributed to the misconduct by failing to implement internal controls or to otherwise comply with its accountant’s directives, or even to take prompt action when the fiduciaries’ financial irregularities become apparent.
The Uniform Fiduciaries Act (UFA)
Enacted in 1925, Wisconsin’s UFA limited the potential liability of third parties (usually banks) from their dealings with fiduciaries by making companies responsible for hiring honest employees. Before the UFA, third parties bore the brunt of liability for a fiduciary’s breach of duty. They were required to ensure that fiduciary funds were properly applied to the company’s account and to be highly vigilant in detecting fiduciary wrongdoing.
Under the UFA, the standard for imposing liability against a person dealing with a fiduciary is never a lack of due care or negligence: The UFA reasoned that there may be many reasons for “odd and unusual check writing” that third parties would not have any knowledge of.
In many circumstances, the UFA protects banks and other innocent third parties from liability for a fiduciary’s breach of duty to his principal, e.g., the fiduciary’s embezzlement of company funds. However, it also specifically makes an exception to this protection for personal creditors of the fiduciary.
Strategies to protect vendors
So, how can an innocent vendor avoid liability for a customer’s embezzlement actions? Possible strategies include:
- Have customer contracts state that payment for goods and services provided must be in cash, or by check or a credit card in the customer’s name. Although this may discourage some customers from doing business with the vendor, it trumps incurring the expense of a lawsuit from a dishonest customer’s employer and/or turning over monies received for the project to the customer’s employer.
- Adopt a policy requiring that every check accepted for personal or residential services must be drawn on an account where the name on the check matches the customer’s name. If the names do not match, the check must be rejected, and if inadvertently accepted, it may not be processed.
- Train employees to diplomatically reject checks that do not meet these guidelines. Although an employee dealing with high-end customers may fear alienating a customer by questioning his form of payment, such fear is misplaced. Employee embezzlement accounts are typically rare, so these safeguards shouldn’t offend honest residential customers, just as honest bank customers appreciate being asked for identification.
Accepting company checks for goods or services that a vendor or contractor knows will benefit an owner, officer or key manager of the company is risky. If it is discovered that the company fiduciary used embezzled monies, by issuing company checks in payment for goods or services, the vendor/contractor may be left holding an empty bag: After incurring the costs of furnishing the goods or services, it may be compelled to relinquish the monies it received in payment for those services. Although statistically rare, the effects of employee embezzlement can be financially devastating to unwary third parties.
