Court of Appeal (Cal.) Finds that While Automobile Merchant Owes a Duty Not to Ignore Red Flags in Purchase of Vehicle, No Red Flags Appeared Simply Because Check Was From a Person Other Than Its Customer

As a general rule, courts have recognized that a person or entity—whether it be a bank or a merchant—engaged in a financial transaction with a person has a duty (1) not to ignore “red flags” or “suspicious” “circumstances” that may indicate that a third party involved in that transaction   is being defrauded, and, in that instance, (2) not to proceed with the transaction without first doing some investigation to dispel those suspicions.   Courts have sorted the circumstances that constitute red flags from those that do not. Red flags include: (1) when a bank’s customer tries to have the proceeds of the third party’s check that was made out to someone else placed in the customer’s own personal account . . . or (2) when a bank’s customer tries to have the proceeds of the third party’s check that was made out to an escrow account placed in the customer’s own personal account in contravention of the escrow notation on the face of the check . .  Red flags do not include: (1) when a check-cashing business’s customer presents a check endorsed by hand (rather than with a stamp). . .  (2) when a check-cashing business’s customer seeks to cash a business-to-business check…; (3) when a brokerage firm’s customer has frequent transactions involving large sums of money …
Because Kader presented two checks payable to The Auto Gallery and bearing Gillam’s valid signature on behalf of DeskSite, this case presents the question: Is it a red flag when a merchant receives payment for merchandise through a check from a person or entity other than its customer, such that the merchant owes the drawer of the check some duty to investigate whether the check is somehow fraudulent and whether the check’s maker wants the merchant to follow special instructions regarding the sale of the merchandise?   We conclude that the answer to this question is “no,” and do so for two reasons.  First, the policy considerations set forth in Biakanja and Rowland counsel against the recognition of such a duty….Here, the primary purpose of a merchant’s sale of merchandise to its customer is (obviously) to sell merchandise; verifying that checks made out to the merchant that on their face appear valid are, in fact, valid and free of any special conditions would seem to be collateral to that primary purpose. No “moral blame” attaches to the merchant’s conduct because the merchant is simply accepting a check validly made payable to it. (Burns, supra, 173 Cal.App.4th at p. 490, 93 Cal.Rptr.3d 130 [noting that “the person deserving of moral blame” is the dishonest customer, “not” the merchant].) And the “policy of preventing future harm” strongly counsels against imposing this duty to investigate upon merchants because the burdens it would impose far outweigh any benefits. Requiring an investigation whenever a check not in the customer’s name is presented means that merchants “would have to stop [their] business every time [they] received such a check in order to make an independent inquiry of the” check’s maker. (Burns, at pp. 489-490, 93 Cal.Rptr.3d 130.) This would “substantially impede[ ]” “the flow of commerce.” (Karen Kane, supra, 67 Cal.App.4th at p. 1199, 79 Cal.Rptr.2d 712.) Burdening the merchant with investigating whether a valid check from someone other than the customer has strings attached and with thereafter enforcing those strings—rather than having the check’s maker make those strings known and enforce those strings itself—also places the burden on the wrong party….Second, Burns has already held, in a similar but slightly different context, that “the fact that an account payment came from a third party is not enough to put [a merchant] on notice of a potential fraud.” (Burns, supra, 173 Cal.App.4th at pp. 486, 488, 93 Cal.Rptr.3d 130.)  Burns‘s logic applies with equal force here, such that a merchant’s customer’s use of a third party check, by itself, also triggers no duty to investigate.