I. INTRODUCTION
The “Check Clearing for the 21st Century Act” (hereinafter referred to as “Check 21”) took effect October 28, 2004. The much-heralded federal law was designed to promote greater efficiency in the check processing system. Subpart D (Sections 229.51 et seq.) of Regulation CC (12 C.F.R. Part 229) implements Check 21 by setting forth requirements that apply to financial institutions, a model consumer awareness disclosure and other model notices and indorsement and identification requirements for “substitute checks.”
Check 21 allows, but does not require, check truncation. “Check Truncation” means that an image is created from an original paper check and that the original paper check is removed from the check collection or return process. A “truncating” financial institution has two options. Under the first option, in order to make it easier for financial institutions to truncate and electronically clear paper checks, Check 21 creates a new, negotiable document called the “substitute check” (also referred to as “image replacement documents” or “IRDs”). A substitute check has the same legal equivalence and is used as a replacement to the original truncated paper check from which it was created. No agreement is required to exercise this option. It is anticipated that requiring financial institutions to accept “substitute checks” will mean faster collection and return of checks, lower costs for financial institutions and consumers alike (e.g., costs for handling, transport and other requirements) and could result in faster crediting of check deposits. The second option permits data from the MICR line of the original or electronic image of the original check to be sent to a recipient in lieu of the original check, if there is an agreement between the parties to do so. The agreement may be between a number of parties (e.g., clearinghouse rules or other network agreements) and not just between one individual financial institution with another individual financial institution.
Substitute checks allow any financial institution to truncate an electronically presented check, regardless of whether the check-paying institution is equipped to accept electronic “imaged” files. If a paying institution is not equipped to accept truncated check images, the truncating institution need only arrange for an intermediary (e.g., correspondent, processing agent or a facility of its own) in proximity to the paying institution to intercept and convert electronic check files into substitute checks and deliver those items to the paying institution.
By processing checks electronically, the substantial costs of handling, sorting and physically transporting checks are minimized. Moreover, processing items electronically will help depository institutions minimize losses by clearing items faster, allow the use of new technology to identify fraud and create the opportunity for new bank products and services. While Check 21 does not require depository institutions to process electronic images, all depositories will be required to accept substitute checks, educate their customers and comply with the new consumer protections provisions created by the law.
II. DEFINITIONS
As with most major laws, Check 21 utilizes a number of defined terms that have specific meaning. The terms of most significance are defined as follows:
COLLECTING BANK – Any bank handling a check for collection except the paying bank.
DEPOSITARY BANK – (1) The first bank to which a check is transferred even though it is also the paying bank or the payee; or (2) a bank to which a check is transferred for deposit in an account at such bank, even if the check is physically received and indorsed first by another bank.
PAYING BANK – (1) The bank by which a check is payable, unless the check is payable at another bank and is sent to the other bank for payment or collection; or (2) the bank at or through which a check is payable and to which the check is sent for payment or collection.
RETURNING BANK – A bank (other than the paying or depositary bank) handling a returned check or notice in lieu of return.
CHECK – A draft, payable on demand and drawn on or payable through or at an office of a bank, whether or not negotiable, that is handled for forward collection or return, including a substitute check and a travelers check. The term does not include a non-cash item or an item payable in a medium other than United States money.
CONSUMER – A natural person who: (1) with respect to a check handled for forward collection, draws the check on a consumer account; or (2) with respect to a check handled for return, deposits the check into or cashes the check against a consumer account.
FORWARD COLLECTION – Process by which a bank sends a check on a cash basis to the paying bank for payment.
RECONVERTING BANK – (1) The bank that creates a substitute check; or (2) with respect to a substitute check that was created by a person that is not a bank, the first bank that transfers, presents or returns that substitute check or in lieu thereof, the first paper or electronic representation of that substitute check.
SUBSTITUTE CHECK – A paper reproduction of an original check that: (1) contains an image of the front and back of the original check; (2) bears a MICR line that, except as provided under ANSx9.100-140 (unless the Federal Reserve Board by rule or order determines that a different standard applies), contains all the information appearing on the MICR line of the original check, at the time that the original check was issued and any additional information that was encoded on the original check’s MICR line before an image of the original check was captured; (3) conforms in paper stock, dimension, and otherwise with ANSx9.100-140 (unless the Federal Reserve Board by rule or order determines that a different standard applies); and (4) is suitable for automated processing in the same manner as the original check.
TRUNCATE –To remove an original check from the forward collection or return process and send to a recipient, in lieu of such original check, a substitute check or, by agreement, information relating to the original check (including data taken from the MICR line of the original check or an electronic image of the original check), whether with or without subsequent delivery of the original check.
III. IMAGED CHECKS
Check 21 permits a depositary institution to keep any check deposited and create an image of the check that the institution can forward through the check clearing system in order to receive payment. The law does not: (a) require the depositary institution to create an image of the check (imaging remains voluntary); (b) alter the clearing system (the imaged item will be routed according to the bank of first deposit’s preferences); (c) require or even establish electronic image exchange; (d) require or even establish electronic presentment; or (e) turn a paper check into an electronic funds transfer.
An institution is not required to accept imaged items. In order to send an image instead of a paper check, the sending institution must have an agreement with the receiving institution. As the image works its way through the clearing system, its ability to stay in image form depends on a series of agreements. The check could ultimately be presented as an image to the institution which, in turn provides that same image to its customer.
NOTE: If any institution in the chain of presentment, including the paying institution, refuses to accept an imaged item, Check 21 requires that the institution must accept a substitute check.
There are no pre-existing legal or industry standards regarding the quality of images that imaging institutions are required to supply. Images provided must include the front and back of the check to allow any subsequent clearing institution to create a substitute check.
IV. SUBSTITUTE CHECKS
A key provision of Check 21 is the creation of a legal document known as a “substitute check.” By law, a “substitute check” is required to be accepted. A substitute check can be created by an electronic image of an original check and processed by receiving depository institutions just like the original paper check. To ensure the legal equivalent of the original check, achieve uniformity and provide that institutions can process substitute checks using traditional technology, a substitute check must meet specific requirements: (a) contain an image of the front and the back of the original check, with all necessary endorsements and signatures; (b) bear the MICR line of the original check, except as provided under generally applicable industry standards; (c) bear the legend “This is a substitute check. You may use it the same as you would the original check”; (d) conform to industry standards for paper stock, dimension and otherwise; and (e) be suitable for automated processing in the same manner as the original check.
The intention is that a substitute check be used when an original check, converted to an imagefile and transmitted in lieu of physically transporting paper, needs to be reconverted into paper for presentment to the paying institution. The process allows the processing institution to realize the benefits of check truncation while honoring the paying institution’s preference for paper.
A. Legal Equivalence
The substitute check is a paper item and not an imaged item. No agreement is required between sending and receiving institutions. It is the legal equivalent of the original check for all purposes, including any provision of any federal or state law if the substitute check meets all of the requirements for legal equivalence as discussed in the paragraph above. If these requirements are met, any party may use a substitute check for any purpose where an original is required, e.g., for proof of payment or in any court proceeding.
B. Endorsements
A reconverting institution (an institution that creates a substitute check) must ensure that the substitute check bears all endorsements applied by parties that previously handled the check. This does not appear to require a reconverting institution to assume responsibility for missing endorsements, but only to ensure that endorsements appearing on the original check will also appear on the substitute check.
C. Warranties
Check 21 establishes a warranty structure to protect depository institutions against losses associated with the use of substitute checks. An institution that transfers, presents or returns a substitute check, also warrants that the substitute check: (1) meets the requirements for legal equivalence described above; and (2) is not a duplicate of a check that has already been paid. The depository institution that creates a substitute check and each depositary bank that subsequently handles it, whether in paper or electronic form, provides this warranty. Should an item be presented that does not meet this standard, the warranties flow to the recipients of the substitute check. Once a substitute check is created, these warranties flow to subsequent parties regardless of whether the substitute check remains in substitute check form is converted into an electronic form or reconverted from an electronic image back into another substitute check.
D. Indemnification
A reconverting institution and each institution that subsequently transfers, presents or returns a substitute check in any electronic or paper form and receives consideration therefore, agrees to indemnify against any losses incurred by any recipient of a substitute check, if the loss occurred because the substitute check was provided instead of the original check. Indemnification is limited to: (a) up to the amount of the loss (including attorney fees and expenses) incurred if the loss was due to a breach of warranty; or (b) the amount of the check if there was no breach of warranty.
The indemnification provision is intended to put the transferee and all the parties to the check-clearing process in the same position as if they had received the original check, rather than a substitute check. A party will not have an indemnification claim if a loss would have been incurred, even if the original check had been presented.
E. Comparative Negligence
If the loss incurred by an indemnified party was in whole or in part due to that party’s negligence or a failure to act in good faith, then that party’s indemnification can be reduced in proportion.
F. Effect of Producing Original Check or a Copy
If an indemnifying institution produces the original check or a copy of the original check that accurately represents all of the information on the check at the time it was truncated or is otherwise sufficient to determine whether or not a claim is valid, it is liable only for losses covered by the indemnity incurred up to the time that the original is provided.
V. CONSUMER PROTECTION PROVISIONS
Check 21 provides for mandatory time frames in resolving customer disputes when a substitute check is involved. These consumer protection provisions only apply if: (a) the account on which the check is drawn, was deposited or “cashed against” a consumer account (i.e., the account is used for personal, family or household purposes); and (b) the claim relates to a substitute check and not just an imaged check.
NOTE: By refusing to accept imaged items, a paying institution will substantially increase the number of substitute checks that it receives and subject itself more readily to the consumer protection provisions of the law.
A. Expedited Recrediting For Consumers
In order to trigger expedited recrediting, the consumer must make a good faith assertion that the institution incorrectly charged the consumer’s account for a substitute check that was provided to the consumer. The institution may require the consumer to submit the information in writing and may allow the consumer to present the information electronically. The consumer’s claim must: (a) provide a description of the claim, including an explanation of (1) why the substitute check was not properly charged to the consumer’s account or (2) the warranty claim; (b) a statement that the consumer suffered a loss and an estimate of the amount of that loss; (c) the reason why production of the original check or a sufficient copy of the original check is necessary to determine the validity of the charge or the warranty claim; and(d) sufficient information to identify the substitute check and to investigate the claim.
The claim must be submitted before the end of a 40-day period beginning with the later of the date on which the financial institution mails or delivers, by a means agreed to by the consumer: (1) a periodic account statement containing information on the transaction giving rise to the claim; or (2) the substitute check giving rise to the claim.
The institution is required to recredit the consumer’s account if the consumer presents a claim meeting the requirements of the statue and the institution has: (a) not provided an original or copy of the check that accurately represents the information on the front and back of the check; and (b) not demonstrated to the consumer that the check was properly charged to the account.
The institution must recredit the consumer’s account no later than the end of the first business day following the business day on which it determines the claim is valid. If the institution has not made a determination on the validity of the consumer’s claim (1) by the end of the 10th business day after the business day on which the consumer submitted the claim, the bank must recredit the account for the lesser of the amount of the substitute check or $2,500 together with interest if it is an interest bearing account; and (2) on the 45th calendar day after the business day on which the consumer submitted the claim, the institution must recredit the account for the remaining amount of the substitute check together with interest if it is an interest bearing account.
B. Safeguard Exceptions
The institution may delay availability of a recredit until the business day following the business day on which it determines the claim is valid or the 45th calendar day following the business day after the consumer presents a claim if: (1) the account is less than 30 days old; (2) the customer is a frequent overdrafter; or (3) the institution has reasonable cause to believe that the claim is fraudulent.
C. Consumer Notification
The consumer is entitled to written notice of the financial institution’s decision regarding recrediting. If the institution determines that a substitute check was properly charged to the consumer’s account, it must send the consumer, no later than the business day following the business day on which it makes the determination: (1) the original check or a copy which reflects all the information on the front and back of the item; and (2) an explanation of the basis for determining that the check was properly charged. Set forth below are sample Check 21 notices found in Appendix C of Regulation CC that may be used by institutions to notify a consumer of action taken in response to a claim for recrediting.
C-22 – Expedited Recredit Claim, Valid Claim Refund Notice
Notice of Valid Claim and Refund
We have determined that your substitute check claim is valid. We are refunding (amount) [of which [(amount) represents fees] [and] [(amount) represents accrued interest]] to your account. You may withdraw these funds as of (date). [This refund is the amount in excess of the $2,500 [plus interest] that we credited to your account on (date).]
C-23 – Expedited Recredit Claim, Provisional Refund Notice
Notice of Provisional Refund
In response to your substitute check claim, we are refunding (amount) [of which [(amount) represents fees] [and] [(amount) represents accrued interest]] to your account, while we complete our investigation of your claim. You may withdraw these funds as of (date). [Unless we determine that your claim is not valid, we will credit the remaining amount of your refund to your account no later than the 45th calendar day after we received your claim.]
If, based on our investigation, we determine that your claim is not valid, we will reverse the refund by withdrawing the amount of the refund [plus interest that we have paid you on that amount] from your account. We will notify you within one day of any such reversal.
C-24 – Expedited Recredit Claim, Denial Notice
Denial of Claim
Based on our review, we are denying your substitute check claim. As the enclosed (type of document, for example original check or sufficient) shows, (describe reason for denial, for example the check was properly posted, the signature is authentic, there was no warranty breach).
[We have also enclosed a copy of the other information we used to make our decision.] [Upon your request, we will send you a copy of the other information that we used to make our decision.]
C-25 – Expedited Recredit Claim, Reversal Notice
Reversal of Refund
In response to your substitute check claim, we provided a refund of (amount) by crediting your account on (date(s)). We now have determined that your substitute check claim was not valid. As the enclosed (type of document, for example original check or sufficient copy) shows, (describe reason for reversal, for example the check was properly posted, the signature is authentic, there was no warranty breach). As a result, we have reversed the refund to your account [plus interest that we have paid you on that amount] by withdrawing (amount) from your account on (date).
[We have also enclosed a copy of the other information we used to make our decision.] [Upon your request, we will send you a copy of the information we used to make our decision.]
VI. EXPEDITED RECREDITING FOR FINANCIAL INSTITUTIONS
A financial institution may make a claim against an indemnifying institution if: (a) it has received a claim for expedited recredit from a consumer; (b) the claimant has suffered a resulting loss or is obliged to recredit the consumer’s account; and (c) production of the original check, another substitute or a better copy is necessary to determine the validity of the charge or any warranty claim connected with such substitute check. Any claim made by another bank must be submitted before the end of the 120 calendar day period beginning on the date of the transaction that gave rise to the claim.
To make a claim for expedited recredit, the claimant must send to the indemnifying institution:
1. a description of the claim or the warranty claim related to the substitute check, explaining why the substitute check may not be properly charged to the account;
2. a statement that the claimant institution has suffered a loss or is obligated to recredit the consumer’s account together with an estimate of the amount of loss or recredit;
3. the reason why production of the original check or a sufficient copy of the original check is necessary to determine the validity of the charge to the consumer account or the warranty claim; and
4. sufficient information to allow the indemnifying institution to identify the substitute check and investigate the claim.
An indemnifying institution may require the claimant to submit the information in writing and may allow the claimant to present the information electronically if the claimant institution has agreed to communicate with the indemnifying institution in that manner.
No later than 10 business days after receiving a proper claim, the indemnifying institution must provide:
1. the original check or a copy of the original check that
a. accurately presents all of the information on the front and back of the original check at the time of truncation; or
b. is otherwise sufficient to determine that the institution’s claim is not valid; and
2. recredit the claimant institution for the amount of the claim up to the amount of the substitute check, plus interest, if applicable; or
3. provide information as to why the indemnifying institution is not required to comply.
An institution’s delay beyond statutory time limits may be excused it is caused by interruption of communication or computer facilities, suspension of payments by another financial institution, war, emergency conditions, failure of equipment or other circumstances beyond the control of the institution if the institution uses such diligence as the circumstances require. An institution that breaches a warranty or fails to comply with Check 21 or its implementing regulations is liable for:
VII. CONSUMER DISCLOSURE REQUIREMENTS
A financial institution is required to provide a disclosure that is to be distributed to:
An institution must also provide the disclosure to a consumer customer of the institution who requests an original check or a copy of a check and receives a substitute check. If feasible, the institution will provide this disclosure at the time of consumer’s request; otherwise, the institution must provide this disclosure no later than the time at which the institution provides a substitute check in response to the consumer’s request. A financial institution need not give separate disclosures to each customer on a jointly held account. The disclosure must describe:
NOTE: The substitute check policy disclosure (C-5A) reproduced below is taken from Appendix C of Regulation CC. The disclosure does not apply to all copies of checks, but only when a customer is receiving a substitute check. If the customer is receiving an ordinary imaged check, no disclosure is required, but if the customer will not accept an imaged copy, the paying institution may be required to create a substitute check (front and back) meeting the requirements of the law. Like a financial institution, the consumer may not be required to accept the image or a photocopy, but is required to accept the substitute check.
C–5A––Substitute Check Policy Disclosure
Substitute Checks and Your Rights
[IMPORTANT INFORMATION ABOUT YOUR CHECKING ACCOUNT]
What is a substitute check?
To make check processing faster, federal law permits banks to replace original checks with “substitute checks.” These checks are similar in size to original checks with a slightly reduced image of the front and back of the original check. The front of a substitute check states: “This is a legal copy of your check. You can use it the same way you would use the original check.” You may use a substitute check as proof of payment just like the original check.
Some or all of the checks that you receive back from us may be substitute checks. This notice describes rights you have when you receive substitute checks from us. The rights in this notice do not apply to original checks or to electronic debits to your account. However, you have rights under other law with respect to those transactions.
What are my rights regarding substitute checks?
In certain cases, federal law provides a special procedure that allows you to request a refund for losses you suffer if a substitute check is posted to your account (for example, if you think that we withdrew the wrong amount from your account or that we withdrew money from your account more than once for the same check). The losses you may attempt to recover under this procedure may include the amount that was withdrawn from your account and fees that were charged as a result of the withdrawal (for example, bounced check fees).
The amount of your refund under this procedure is limited to the amount of your loss or the amount of the substitute check, whichever is less. You also are entitled to interest on the amount of your refund if your account is an interest-bearing account. If your loss exceeds the amount of the substitute check, you may be able to recover additional amounts under other law.
If you use this procedure, you may receive up to (amount, not lower than $2,500 of your refund (plus interest if your account earns interest) within (number of days, not more than 10) business days after we received your claim and the remainder of your refund (plus interest if your account earns interest) not later than (number of days, not more than 45) calendar days after we received your claim.
We may reverse the refund (including any interest on the refund) if we later are able to demonstrate that the substitute check was correctly posted to your account.
How do I make a claim for a refund?
If you believe that you have suffered a loss relating to a substitute check that you received and that was posted to your account, please contact us at (contact information, for example phone number, mailing address, e-mail address). You must contact us within (number of days, not less than 40) calendar days of the date that we mailed (or otherwise delivered by a means to which you agreed) the substitute check in question or the account statement showing that the substitute check was posted to your account, whichever is later. We will extend this time period if you were not able to make a timely claim because of extraordinary circumstances.
Your claim must include –
VIII. RECORD RETENTION
Check 21 does not include provisions for retaining original checks once they have been “truncated,” however record retention requirements may be included within an image exchange agreement or covered under various state and federal laws.
The record retention requirements for state banks are found in Volume I, under the Records Retention tab of the NBA Compliance Handbook.
IX. DISCLOSING FEES
A financial institution may decide to charge for producing or providing substitute checks, increase existing fees or impose new fees in response to Check 21 or for other reasons. You are reminded that the Truth-in-Savings regulation (Regulation DD) provides that account disclosures must be amended to incorporate any new or revised fees. The addition of new fees is a change that may be adverse to consumer customers and therefore the institution must provide a change in terms notice under Regulation DD not less than 30 calendar days prior to the effective date of the change. Regulation DD disclosures are not applicable to business customers.
X. CONCLUSION
While no financial institution are forced to convert to check imaging, all financial institutions are required to accept substitute checks, educate customers and comply with consumer protection provisions created by Check 21. Customers who receive substitute check items in their return checks or image statements may contact the financial institution to obtain information regarding this new procedure. Front-line personnel interacting with customers should have a basic understanding of substitute checks and be prepared to respond to basic customer questions regarding the Check 21 issues regarding check truncation, substitute checks, consumer notices, copies of checks or information retrieval and, if relevant, fees.