CBA Publications >> CBA Regulatory Compliance Bulletin >> Vol 2004 No.13
August 26, 2004

Vol 2004 No. 13 August 26, 2004

Q&As Generated From the Check 21 Final Rules

The following is a compilation, in question and answer format, of new or newly clarified aspects of the Check Clearing for the 21st Century Act ("Check 21" or "Act") as interpreted by the Federal Reserve in its final amendments to Regulation CC issued on July 27, 2004. For an overall review of Check 21, please consult previous CBA Regulatory Compliance Bulletins.

Consumer Awareness Disclosure

To whom must the consumer awareness disclosure be given? The disclosure must be given to consumer customers who receive actual substitute checks, as opposed to paper images or electronic representations of substitute checks. A consumer is an individual who draws a check from a consumer account or who deposits a returned check into (or cashes it against) a consumer account. The final rule includes a model form disclosure, and a bank that uses it is deemed to have complied with the requirement. See section 229.57.

Is the disclosure required where the bank returns not a substitute check but an image statement that contains an image of a substitute check? No. The disclosure is required only if the bank provides the actual substitute check. To avoid confusion and unnecessary inquiries, banks may consider indicating on the image that it is not an actual substitute check, such as by stamping "copy" on the image.

When is the consumer awareness disclosure required to be delivered?

• As to consumers who are customers of the bank as of October 28, 2004 (who regularly receive original cancelled checks with statements), no later than the first regularly scheduled communication with the consumer after that date.
  

• As to customer relationships established after that date, at the time the customer relationship is initiated.
  

• As to customers who receive substitute checks on an occasional basis (such as in the form of a returned check or upon request), at the time of the request, if feasible, or otherwise at the time the bank actually provides the substitute check. See section 229.57 and comments.

Are banks required to provide the consumer awareness disclosure each time a consumer customer receives a substitute check upon request or receives a returned substitute check? What if the consumer had previously received the disclosure with his or her statement? Banks are required to provided the disclosure in each instance that the consumer receives a substitute check upon request or as a returned item. It is irrelevant whether the consumer had previously received the disclosure in a statement. See section 229.57 and accompanying commentary.

Can the required awareness disclosure be included with other information or disclosures?
Yes, there is no requirement to segregate the disclosure. A bank may also include in the disclosure other information relating to substitute checks. See comment 2 to section 229.57(a).

Is the awareness disclosure required if an existing customer, who had received the disclosure with the existing account, opens a new account? No. The requirement is based on the customer relationship rather than the account relationship.

Must separate disclosures be provided to each joint accountholder? No. See section 229.57(b)(3).

May the disclosure be furnished in a language other than English? Yes, as long as the bank makes an English notice available upon request. See comment 3 to section 220.57(a).

Coverage Issues

Is a substitute check created from a check drawn upon a credit card account or home equity line of credit subject to the expedited recredit provisions? No. A claim is available if the bank that holds the consumer's deposit account charged the account for the substitute check. These checks are not drawn upon deposit accounts. However, if such check were deposited into the consumer's account and subsequently returned in the form of a substitute check, then a claim may be available. See comment 1 to Section 229.54(a).

Is an omnibus clearing account (one held by a brokerage firm used for the purpose of allowing the firm to pay checks drawn by consumers) a consumer account subject to the Act? No. Therefore, if a customer deposits such a check, and it is subsequently returned unpaid in the form of a substitute check, the customer is not entitled to the Check 21 warranty, indemnity, or expedited recredit rights.

Warranty

Is the availability of a Check 21 warranty contingent upon receipt of a substitute check?
No, a Check 21 warranty claim is not contingent upon receipt of the actual substitute check. A person may have a warranty claim as long as the person has received a substitute check or a "paper or electronic representation of a substitute check.." By contrast, the Check 21 indemnity and the expedited recredit provisions apply only where the person actually receives the substitute check. See section 229.52(b) and comments to 229.2(xx) (includes examples illustrating the term, "paper or electronic representation of a substitute check").

Does the warranty against duplicative payment apply irrespective of the order of payment? Yes. If both Bank A and Bank B receive an electronic representation of the same check from a nonbank entity that truncated the original check, and both banks present a substitute check (or a paper or electronic representation) to Bank C for payment, both Banks A and B are liable under the warranty. Application of the warranty does not depend on the bank's knowledge or fault, nor on the form in which the item is presented. See comment 5 to Section 229.52(a) and example.

Is a payment made through an ACH debit subject to the Check 21 duplicative payment warranty? No, the warranty applies to charges initiated by check, and ACH debits are not checks.

Reconverting Bank Issues

Is a bank the reconverting bank if, after it receives a substitute check from a nonbank entity, the bank transfers not the substitute check but a paper or electronic representation of that substitute check? Yes. The Act specifies that, where a non-bank creates a substitute check and delivers it to a bank, that bank becomes the reconverting bank when it transfers (or presents or returns) the substitute check. The commentary clarifies that the transferring bank is the reconverting bank even if it transfers a paper or electronic representation of that substitute check. See commentary to section 229.2(zz)

If a bank's nonbank agent creates a substitute check on behalf of the bank and subsequently transfers it directly to another bank, is the first bank the reconverting bank? Yes. The bank would be deemed to be acting through the agent as the producer of the substitute check and therefore is deemed to be the reconverting bank. See section 229.2(zz) and accompanying commentary.

Could a bank become a reconverting bank by taking for deposit a substitute check created by a customer? Yes. Even if the bank, without its knowledge or consent, receives a substitute check for deposit from a customer and transfers it for collection, the bank is the reconverting bank. Banks should address this issue through their account agreements.

Does a bank that is the reconverting bank with respect to a substitute check also warrant the legal equivalence of a subsequent substitute check created from the same item? No, the bank's warranty goes only to the first substitute check. In contrast, the bank that created the second substitute check from an electronic representation of the first substitute check warrants the legal equivalence of both the first and second substitute checks. See comment 4 to Section 229.52(a).

Substitute Checks

What image and quality standards apply to substitute checks? The rule refers to and relies on ANS X9.100-140 as the industry standard for substitute checks, including whether the industry should use black and white or gray scale. The Board reserves to itself the ability to determine by rule or by order any different standard that might apply. See comments and examples to section 229.2(aaa).

Can a check used as a source document to create an ACH debit be used to create a substitute check? It depends on the intent of the drawer of the check. A substitute check can only be created from an original check. Under U.C.C. 3105, a check is "issued" by the drawer if delivered "for the purpose of giving rights on the instrument to any person." A drawer who writes a check for the purpose of initiating an ACH debit does not intend to give rights in the check itself. Therefore, the check is not an original check within the meaning of Regulation CC, and a bank may not create a substitute check from it.

What MICR line variations are permissible on substitute checks? Generally, a substitute check MICR line must have information in each field of the MICR line that was encoded on the original check as of the time the image of the original check was captured. The final rule does not set forth permissible variations, but rather leaves the details to ANS X9.100-140, noting that permitted variations are to be kept to the minimum necessary to facilitate substitute check processing in the same manner as original checks. Also, application of MICR line information to a substitute check is subject to Regulation CC's encoding warranties.

Note that the Board has abandoned the notion of "purported" substitute checks-i.e., a substitute check that, because of encoding variations, is not the legal equivalent of a substitute check but that nevertheless is subject to the liability and consumer protection provisions. Thus, subject to ANS X9.100-140, a substitute check that does not replicate the MICR information on the original check is nevertheless a substitute check for purposes of the liability and consumer protection provisions. See comments and examples to section 229.2(aaa).

May MICR-encoded strips be applied to substitute checks? Yes. Where a document meets the definition of substitute check, a bank may apply MICR-encoded strips to that document as necessary to complete the collection and return process. See comment 9 to section 229.2(aaa).

Is an accurate image of an illegible original check the legal equivalent of the original check, assuming all other requirements for legal equivalence are met? Yes, a substitute check is not held to a higher standard of accuracy than that of the original check.

Does a substitute check that does not faithfully produce features that do not survive the image capturing process (such as watermarks and micro-printing) nevertheless satisfy the legal equivalence requirement, and does it give rise to Check 21 claims? As long as the required "information" from the original check is faithfully produced (i.e., information preprinted on the original check and payment and other required information added to the check), and the other requirements are met, the check is the legal equivalent of the original. See comment 3 to Section 229.51(a). A warranty claim would not be available based on the failure to produce such security features.

However, an indemnity claim (and thus an expedited recredit claim) could be made against the reconverting bank (and transferring and presenting banks) under the argument that a loss occurred because of the receipt of a substitute check rather than the original containing the security features. The indemnity would not apply if the paying bank would not have detected the fraud even if the original check were presented, because then the bank would not have suffered a loss because of receipt of a substitute check instead of the original check. See comment 1 and examples to Section 29.53(a). (Note, however, comment 3 to section 229.51(a) provides an example where the appearance of the word "void" incident to creation of a substitute check could obscure required information and thus give rise to an indemnity and expedited recredit claims).

Is a substitute check (that otherwise meets the legal equivalence requirements) created from a fraudulent check the legal equivalent of that original check? Yes, but it would be treated in the same manner as the original fraudulent check for purposes of other laws. For example, a bank could not properly charge a customer's account for a substitute check that represented a fraudulent original check. See comment 5 to Section 229.51(a).

Is an item that meets the definition of a substitute check but that does not meet the requirements for legal equivalence (e.g., it does not include the required legend) still a check?
Yes, the check would be subject to the U.C.C. and Regulation CC.

Expedited Recredit

Do the expedited recredit provisions apply if the consumer is not provided with a substitute check? No. Despite strong comments supporting the contrary, the Board noted that the condition of receiving a substitute check is explicitly set forth in the Act. The provision is intended to place consumers who receive substitute checks in roughly the same position as if they had received the original check. Thus, for example, image copies of substitute checks (along with copies of original checks) received with statements are not substitute checks that give rise to the expedited recredit right.

Do the expedited recredit provisions apply with respect to a non-Check 21 warranty breach? Yes. A violation of any warranty associated with the use of a substitute check, and not just a violation of the Check 21 warranty, could trigger an expedited recredit right. See comment 2 to section 229.54(a).

In response to an expedited recredit claim, could a bank provide an electronic image of a check as a sufficient copy? Generally, no. A copy must be a paper reproduction of a check. However, if a customer has agreed to receive such information electronically, a bank may satisfy the requirement by providing an electronic image. See section 229.58.

Is a bank under any circumstances required under Check 21 to provide either an original or substitute check upon request? Check 21 does not require any bank to furnish either an original or substitute check, but rather establishes the circumstances under which a substitute check may be used as the legal equivalent of the original check. U.C.C. 4-406, which does not require banks to provide original checks to consumers, still applies. If a bank has agreed to return original cancelled checks to a customer, the bank must honor that agreement by providing original checks or substitute checks.

When is a consumer claim for expedited recredit deemed to be submitted? Upon the bank's receipt of the claim. Therefore, both the expiration of the 40-day period to submit the claim and the commencement of the 10 banking day period to act on a claim are triggered by the bank's receipt of the claim. Section 229.54(b)(1).

When does the 40-day period to file an expedited recredit claim begin? The bank must receive the claim by the end of the 40th calendar day after the later of the calendar day on which the bank mailed or delivered the relevant statement or the substitute check. Section 229.54(b)(1).

What means of delivering the statement or substitute check would trigger the 40-day period? The time period could be triggered by the mailed, in-person, or electronic delivery of the statement or by the mailed in or in-person delivery of a substitute check. (An electronic delivery of a substitute check would not entitle the consumer to an expedited recredit claim because the consumer is not furnished with the actual substitute check). In the case of a mailed statement or substitute check, the period is calculated from the postmark on the envelope. See comment 2 to section 229.54(b).

Can overdraft fees be imposed during the time that the bank delays availability of recredit pursuant to the permitted exceptions (for new accounts, accounts with excessive overdrafts, and suspected fraudulent accounts)? The bank may not impose an overdraft fee with respect to drafts drawn from (delayed) recredited funds until the fifth calendar day after the calendar day on which the bank sent the notice of recredit. Section 229.54(d)(3).

What if the consumer makes an oral claim for expedited recredit? A consumer is permitted to make an oral claim for expedited recredit, but a bank at its option may require a claim to be made in writing, in which instance the bank is required to inform the customer of the requirement at the time the oral request is submitted. The bank that requires written claims must also disclose this requirement in the consumer awareness disclosure. The bank may require the customer to submit the written claim such that the bank receives it within 10 business days of the banking day in which the oral claim was made. Thus, a claim would be timely if the bank received the oral claim within the 40-day period and the written claim up to 10 business days thereafter. The bank would then have 10 banking days after receipt of the written claim to act. See section 229.54 and accompanying comment no. 9.

What if a claim does not include all of the required information? The bank must inform the consumer that the claim is incomplete and identify what information is missing. Neither the rule nor the commentary specifies the manner in which the bank must inform the consumer of the deficiency. See comment 12 to section 229.54(b).

Is there a requirement to retain a copy of expedited recredit claims? No, Check 21 does not include a retention requirement for submitted claims.

Does the E-Sign Act apply to required expedited recredit notices to consumers that are provided electronically? No, such notices may be provided in any manner agreed to by the consumer.

Other Issues

Is a safe harbor associated with use of model disclosures? The final rule includes a model customer awareness disclosure, and a bank that uses the model is deemed to comply with the requirement. No presumption is available when a bank uses other Check 21 model notices.

Can the provisions of Check 21 be varied by agreement? Check 21 explicitly permits the interbank expedited recredit provisions to be varied by agreement. The final rule notes that a bank is permitted to take any actions that are more favorable to the consumer than required by Check 21. See comment 2 and example to Section 229.51(c), which also notes that a law is not inconsistent with Check 21 merely because it allows for the recovery of a greater amount of damages.

What are some of the processing changes Check 21 may require? While one of the central tenets of the Act is that substitute checks can be sorted and processed as original checks, banks may nevertheless face processing challenges. For example, a substitute check contains a reduced image of the original check. Fraud detection programs that scan various fields of a check, such as some positive pay programs, may need to be adjusted to handle substitute checks. Also, the physical size of a substitute check itself may require paying banks to use larger envelopes because substitute checks, with the mandatory legend, are larger than consumer checks. Because of the mandatory use of MICR line designations on position 44 of substitute checks ("4" for forward collection or "5" for returns), banks would be able to identify and segregate substitute checks and handle them differently.

Is a bank required to use magnetic ink on the MICR line of a substitute check if the paid substitute check were produced solely to return to the consumer? No. Generally, magnetic ink must be used for MICR lines on substitute checks because of the requirement that substitute checks are capable of being automatically processed as original checks. However, if a bank prints a paid substitute check solely for the purpose of providing it to the account holder, then magnetic ink would not be required.

If you have any questions, you may direct them to Leland Chan, CBA General Counsel, at lchan@calbankers.com.