Legal Definitions - fictitious-payee rule

The fictitious-payee rule (also known as the padded-payroll rule) is a principle in commercial law that addresses situations where a person or entity issues a payment instrument, such as a check, to a payee whom they do not actually intend to receive the funds. If someone then forges the signature of that named payee, the law generally treats that forgery as valid for the purpose of transferring the instrument to subsequent parties, such as banks.

This rule means that the loss resulting from such a fraudulent scheme typically falls on the person or entity who originally issued the check with the intent that the named payee would not receive the money. It aims to place the risk of loss on the party in the best position to prevent the fraud, which is often the issuer who initiated the payment to a "fictitious" or unintended recipient, rather than on innocent banks or other parties who later handled the forged instrument in good faith.

Here are some examples illustrating the fictitious-payee rule:

• Example 1: The Fabricated Vendor

  An accounts payable clerk at "Global Innovations Corp." creates a fake vendor in the company's system called "SupplyLink Solutions." The clerk then generates invoices from "SupplyLink Solutions" for non-existent office supplies. Unaware of the deception, the company's CFO signs a check payable to "SupplyLink Solutions." The clerk then forges the endorsement of "SupplyLink Solutions" and deposits the check into a personal account they control.

  How it illustrates the rule: Global Innovations Corp. (the drawer) issued a check to "SupplyLink Solutions" without intending for a legitimate vendor of that name to receive the funds. The clerk, acting as an agent in preparing the payment, created this fictitious payee. Therefore, the clerk's subsequent forgery of "SupplyLink Solutions'" signature is considered effective under the fictitious-payee rule, and Global Innovations Corp. would bear the loss, not the bank that processed the check in good faith.

• Example 2: The Disgruntled Payroll Employee

  A payroll manager at "City Transit Authority" is upset about a recent bonus cut. To retaliate, the manager creates a check payable to "Jane Doe," a former employee who left the company five years ago and has no outstanding claims. The manager knows Jane Doe will not receive the check. The manager then forges Jane Doe's signature on the back of the check and deposits it into their own bank account.

  How it illustrates the rule: Here, "Jane Doe" is a real person, but the City Transit Authority (the drawer), through its payroll manager, issued the check without intending for the *actual* Jane Doe to receive the funds. The payroll manager's subsequent forgery of Jane Doe's endorsement is considered effective under the fictitious-payee rule. The City Transit Authority, having initiated the payment to a payee not intended to receive the funds, would bear the loss, protecting the bank that processed the forged check in good faith.

• Example 3: The Shell Company Scheme

  A construction company's project manager, responsible for approving subcontractor payments, sets up a shell company called "Apex Services LLC." The project manager then submits fraudulent invoices from "Apex Services LLC" for work that was never performed. The construction company's accounting department issues checks payable to "Apex Services LLC," which the project manager then endorses with the shell company's name and deposits into an account linked to themselves.

  How it illustrates the rule: The construction company (the drawer) issued checks to "Apex Services LLC" based on the project manager's fraudulent submissions, without intending for a legitimate service provider to receive the funds for actual work. The project manager's forgery of "Apex Services LLC's" endorsement is considered effective under the fictitious-payee rule. The construction company, having been duped by its own employee into issuing checks to an entity not intended to receive payment for legitimate services, would bear the financial loss.