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From Banking and Finance Law Daily, February 3, 2014

Fed proposes amendments to check processing rules

By Lisa M. Goolik, J.D.

The Federal Reserve Board is proposing amendments to subparts C and D of Regulation CC that would, among other things, encourage depositary banks to receive—and paying banks to send—returned checks electronically. The Fed is seeking comments on two alternative frameworks for return requirements. In addition, the Fed is also requesting comment on applying Regulation CC’s existing check warranties, as well as new warranties and indemnities to checks that are collected electronically.

Background. Regulation CC implements the Expedited Funds Availability Act of 1987 (EFA Act) and the Check Clearing for the 21st Century Act of 2003 (Check 21 Act). The EFA Act was enacted to provide depositors of checks with prompt funds availability and to foster improvements in the check collection and return processes. The Check 21 Act facilitated the electronic collection and return of checks by permitting banks to create a paper “substitute check” from an electronic image of a paper check and authorized banks to provide substitute checks to a bank or a customer that had not agreed to an electronic exchange.

At the end of 2005, the Reserve Banks received about 4 percent of checks deposited for forward collection in electronic form and presented approximately 28 percent of their checks in electronic form. By the end of 2013, the Reserve Banks estimate that more than 99.9 percent of all forward checks, 99.0 percent of FedReturn checks, and 97.0 percent of FedReciept Return checks will be processed in electronic form.

Accordingly, on March 25, 2011, the Fed published a notice of proposed rulemaking intended to facilitate the banking industry’s ongoing transition to fully electronic interbank check collection and return. The Fed is revising its proposed amendments to subparts C and D of Regulation CC based on its analysis of the comments it received in response to the 2011 proposal.

2011 proposal. Under the current expeditious-return provisions of Regulation CC, if a paying bank determines not to pay a check it must return the check in an expeditious manner, as provided under either the “two-day test” or the “forward-collection test”. To meet the two-day test, a paying bank must send a returned check in a manner such that the check would normally be received by the depositary bank not later than 4p.m. (local time of the depositary bank) on the second business day following the banking day on which the check was presented to the paying bank. To meet the forward-collection test, a paying bank must send the returned check in a manner that a similarly situated bank would send a check: (1) of a similar amount as the returned check; (2) drawn on the depositary bank; and (3) deposited for forward collection in the similarly situated bank by noon on the banking day following the banking day on which the check was presented to the paying bank. If a paying bank decides not to pay a check in the amount of $2,500 or more, Regulation CC also requires that it provide a notice of nonpayment to the depositary bank to be received by the depositary bank by 4 p.m. on the second business day following the banking day on which the check was presented to the paying bank.

In 2011, the Fed proposed to retain the two-day test for expeditious return, and to delete the forward-collection test. The Fed also proposed to eliminate the current notice-of-nonpayment requirement because the two-day timeframe for a notice of nonpayment would be the same as the proposed two-day timeframe for expeditious return in situations where the depositary bank has agreed to receive returned checks electronically. As a result, a depositary bank that did not agree to receive returned checks electronically from the paying bank under the 2011 proposal would not have been entitled to expeditious return of the check and also would not have been entitled to a notice of nonpayment.

According to the Fed, almost all of the commenters broadly supported the proposal to eliminate the expeditious return requirement for a paying bank or a returning bank if the depositary bank had not agreed to accept an electronic return directly or indirectly from the paying bank. The commenters, however, expressed concern with its practical implementation. Commenters were split in their support of the elimination of the notice-of-nonpayment requirement. In general, commenters opposing elimination of the notice-of-nonpayment requirement stated that the notice remains an important loss-prevention tool for depositary banks.

Revised proposal. As a result of the comments it received, the Fed is revising its proposal. The Fed is now requesting comment on two alternative frameworks for return requirements. Under Alternative 1, the expeditious-return requirement currently imposed on paying banks and returning banks for returned checks would be eliminated; a paying bank returning a check would be required to provide the depositary bank with a notice of nonpayment of the check—regardless of the amount of the check being returned—only if the paying bank sends the returned check in paper form. Paying banks would continue to be subject to a midnight deadline for returning checks (including checks in electronic form), and returning banks would continue to be required to use ordinary care when returning the item.

Under Alternative 2, the current expeditious-return requirement—using the current two-day test—would be retained for checks being returned to a depositary bank electronically via another bank, but the notice-of-nonpayment requirement would be eliminated. Alternative 2 would require a paying bank that determines not to pay a check return the check in a manner such that the returned check would normally be received by the depositary bank by 2 p.m. on the second business day following the banking day on which the check was presented to the paying bank.

According to the Fed, the alternatives are intended to recognize that requiring the expeditious return of paper checks imposes substantial cost on banks returning checks. The two alternatives also are intended to eliminate some of the concerns that commenters identified with the 2011 proposal.

Warranties. Regulation CC applies to paper checks. Thus, its provisions related to acceptance of returned checks, presentment, and warranties do not apply to electronic images of checks or to electronic information related to checks. Rather, the collection and return of checks in electronic form is governed by agreements between the banks.

In the 2011, the Fed proposed that the existing warranties for paper checks would be made by banks sending and receiving electronic collection items and electronic returns. In addition, the Fed proposed new “Check-21-like” warranties that would apply specifically to electronic collection items and electronic returns. The sending bank would warrant: (1) that the electronic image accurately represents all of the information from the original check; (2) that the electronic information contains an accurate record of all the line information required for a substitute check; and (3) that no person will be charged twice for the same item.

Under the revised proposal, electronic images and electronic information will be treated as checks under subpart C, and Check-21-likewarranties to electronic images and electronic information. The revised proposal would also require a bank sending an electronically-created item to indemnify subsequent transferees for losses caused by the fact the item was not derived from a paper check. It also provides for a new indemnity relating to remote deposit capture services that would cover depositary banks that receive deposit of an original paper check that is returned unpaid because it was previously deposited (and paid) using a remote deposit capture service. The warranties would flow, for electronic checks, to the drawer and, for electronic returned checks, to the owner, in addition to the banks receiving the items. Lastly, the revised proposal would permit a sending and receiving bank to vary by agreement the warranties the sending bank makes to the receiving bank for electronic checks and electronic returned checks.

Simplified definitions. The Fed’s revised proposal also includes proposed simplifications to the applicable definitions and two new definitions for “electronic check” and “electronic returned check.” Unlike the 2011 proposal, the new definitions would permit the sending and receiving banks to agree that an “electronic check” or an “electronic returned check” need not contain both an electronic image and electronic information.

Comments on the revised proposal must be submitted by May 2, 2014.

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