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Don't Delay Those Check Returns

By Jon Tavares, JD, LLM, CRCM, NCCO 25 Oct 2017

With all the fuss over the new Prepaid Rule, the changes to the Servicing Rule, TRID, and HMDA, and the bevy of changes coming from the CFPB, it's easy to lose sight of the Federal Reserve Board's (FRB) changes to Regulation CC. Especially since it's a subject that no one is really passionate about; at least, one I am not really passionate about. Typically, I like to write about issues in which I have some interest. But nobody has really addressed this, and I am afraid it can easily slip through the cracks and folks will forget about it until the last minute. If there is anything I dislike more than Reg. CC, it's finding out something at the last minute. Ironically, (or maybe not, since that Alanis Morissette song I was never quite sure what irony really is), the rule is about expediting the return of checks.


Currently, Reg. CC generally requires a paying bank (which includes banks, credit unions and savings associations) that determines not to pay a check to return the check expeditiously, that is it must return the check under either the, "two-day test" or the, "forward-collection test." Under the two-day test, a paying bank must return the checks so that the depositary bank receives it by 4 p.m. local time on the second business day following the banking day on which the check was presented to the paying bank. Under the forward-collection test, a paying bank must return a check in a manner that a similarly situated bank would send a check of a similar amount, drawn on the depositary bank, and 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.


While over 99.99% of all checks are presented electronically, there are still a large number of checks that are not being returned electronically. The FRB believes that electronic returns offer lower costs, faster returns, and fewer errors, and substantially reduces risk to the check system compared to paper returns. Therefore, in an effort to create incentives that encourage electronic check return for those remaining institutions still using paper, the FRB issued a final rule (the Rule) in June that modifies Reg. CC's current check collection and return requirements. The Rule also applies Reg. CC's existing check warranties to checks that are collected electronically, and creates new warranties and indemnities related to checks collected and returned electronically and to electronically-created items. The current same-day settlement rule for paper checks remains unchanged. The Rule is effective July 1, 2018.


The Rule requires that all returned checks, paper and electronic, satisfy a modified version of the "two-day test." All returned checks must be returned so the depository bank receives them by 2 p.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 (i.e. 2 hours shorter than the previous time limit). The Board also has added a new condition for expeditious-return liability, specifically that a paying bank and returning bank may be liable to a depositary bank for failing to return a check in an expeditious manner only if the depositary bank has arrangements in place so the paying or returning bank can return a returned check electronically. The depositary bank has the burden of proof for demonstrating that its arrangements for accepting returned checks electronically are commercially reasonable. The FRB believes that this approach will provide incentives to depositary banks to receive electronic returns in order to preserve their ability to make a claim that a check was not returned expeditiously and that paying banks will have an incentive to send returns electronically because electronic returns are more likely to meet the requirements of the "two-day test" than paper returns.


The Rule increases the threshold on when a paying bank must provide a notice of non-payment and shortens the time in which the paying bank must provide that notice. Under the current rule, Reg. CC requires a paying bank that determines not to pay a check in the amount of $2,500 or more to provide a notice of nonpayment to the depositary bank within the same timeframe as under the "two-day test" i.e. by 4 p.m. local time. Effective July 1, 2018, if a paying bank determines not to pay a check in the amount of $5,000 or more, it must provide a notice of nonpayment such that the notice would normally be received by the depositary bank by 2 p.m. local time on the second business day following the banking day on which the check was presented to the paying bank.


The Rule also establishes a framework for electronic check collection and return. Reg. CC's check collection rules currently apply only to paper checks. Therefore, the provisions related to acceptance of returned checks, presentment, and warranties do not apply to electronic images of checks or to electronic information derived from checks. The collection and return of electronic images and electronic information are governed by agreements between the banks in the form of the FRB's operating circular or a clearinghouse agreement. These agreements often include warranties for electronic checks similar to those made for substitute checks under the Check 21 Act. The Rule creates new definitions for "electronic check," "electronic returned check," and "electronically-created item." An electronic check is an electronic image of and electronic information derived from a check and an electronic returned check is an electronic image of and electronic information derived from a returned check. An electronically-created item is an electronic image that has all the attributes of an electronic check or electronic returned check but was created electronically and not from a paper check.


The Rule applies Reg. CC's check collection provisions to banks that send and receive these items by agreement as if they were checks. The parties may, by agreement, vary the effect of the provisions of Reg. CC as they apply to electronic checks and electronic returned checks. The Rule also applies the existing paper-check warranties and the Check-21-like warranties to electronic checks and electronic returned checks. These include:

  • Returned-check warranties;
  • Notice of nonpayment warranties;
  • Settlement amount, encoding, and offset warranties;
  • Transfer and presentment warranties related to a remotely-created check;
  • Warranties that a bank will not be asked to pay an item twice; and
  • Warranties that the electronic image and electronic information are sufficient to create a substitute check.

The FRB believes that these warranties ensure that a bank that receives a check for collection, presentment, or return receives the same warranties regardless of whether the check is in paper or electronic form.


The Rule added new indemnities for electronically-created items. These electronically-created items items can be difficult to distinguish from electronic images of paper checks. A bank transferring an electronically-created item indemnifies each transferee bank, any subsequent collecting bank, the paying bank, and any subsequent returning bank against any loss, claim, or damage that results from the fact that the image or information was not derived from a paper check. The indemnification, however, is limited to an amount that does not exceed the amount of the loss of the indemnified bank, up to the amount of settlement or other consideration received by the indemnifying bank and interest and expenses of the indemnified bank (including costs and reasonable attorney's fees and other expenses of representation). The indemnities include indemnification for losses caused by the fact that the electronically-created item was not authorized by the account holder and a subsequent bank pays an item that has already been paid. Finally, the Rule adds a new indemnity for remote deposit capture that would indemnify a depositary bank that received a deposit of an original paper check that was returned unpaid because the check was previously deposited using a remote deposit capture service and paid unless it accepted an original check containing a restrictive indorsement that is inconsistent with the means of deposit, such as, "for mobile deposit only."


There's not a lot to do here, but don't delay your implementation of the Reg. CC changes. If you are not already returning and accepting returned checks electronically, you should consider it.

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