I. INTRODUCTION
The Federal Reserve Board has issued a final rule, effective July 1, 2006, to amend Regulation CC that defines “remotely created checks” and creates transfer and presentment warranties for such checks. The effect of the rule shifts liability for unauthorized remotely created checks to the depositary bank, which is generally the bank for the person that initially created and deposited the remotely created check. The Federal Reserve Board adopted conforming cross-references to the warranty language in Regulation J.
II. REMOTELY CREATED CHECKS DEFINED
“Remotely created checks” (also known as telechecks, preauthorized drafts and paper drafts) are usually created when the holder of a checking account authorizes a payee to draw a check on that account but does not actually sign the check. As a substitute for the account-holder’s signature, the remotely created check generally bears a statement that the customer authorized the check or bears the customer’s printed or typed name. Remotely created checks are typically used as payment devices (e.g., a debtor authorizes a credit card company to create a remotely created check by telephone, allowing the debtor to pay a credit card bill to avoid late charges; or an individual may purchase an item from a telemarketer by authorizing the seller to create a remotely created check).
Since remotely created checks do not bear the drawer’s signature or other readily verifiable indication of authorization, there have been a great number of consumer and bank complaints identifying cases of alleged fraud or unauthorized creation of such instruments.
For purposes of the final rule, a “remotely created check” is defined as a check authorized by a consumer over the telephone that is not created by the paying bank and bears a legend on the signature line, such as “Authorized by Drawer.” A check that bears the signature applied, or purported to be applied, by the person on whose account the check is drawn is not a remotely created check. A typical forged check, such as a stolen personal check fraudulently signed by a person other than the drawer, is not covered by the definition of a remotely created check. Remotely created checks include remotely created checks that have been reconverted to substitute checks.
III. TRANSFER AND PRESENTMENT WARRANTIES
A bank that transfers or presents a remotely created check and receives a settlement or other consideration warrants that the person on whose account the check is drawn authorized the issuance of the check in the amount stated on the check and to the payee stated on the check. The warranties are only given only by banks and only to subsequent banks in the collection chain. The warranties ultimately shift liability for the loss created by an unauthorized remotely created check to the depositary bank. The depositary bank cannot assert the transfer and presentment warranties against a depositor. However, a depositary bank may, by agreement, allocate liability for such an item to the depositor and also may have a claim under other laws against that person. Nebraska banks should ensure that their account agreements give the bank recourse against a depositor of a remotely created check.
The warranty is for the amount of the check, plus interest and expenses related to the check or return check, if any. A warranty claim may be brought in court up to one year from the date of the violation being claimed.
In a June 6, 2006 letter, the Federal Reserve Bank (FRB) announced implementation of a check adjustment process on behalf of paying, but not depositary, banks in connection with remotely created checks. The claim is described as a warranty/indemnity claim (WIC), the same process used to handle claims made under Check 21 breaches. The claim process is only available on remotely created check items received on or after July 1, 2006.
On or after July 1, 2006, a paying bank may submit an adjustment request for a remotely created check that has been reported as unauthorized by the person or entity on whom the remotely created check is drawn, provided that the following conditions are met:
While no specific form is required, the customer’s written statement must be under oath and must contain the Regulation CC language that serves as the basis for the warranty claim – that the person or entity on whose account the remotely created check is drawn “did not authorize the issuance of the check in the amount stated on the check to the payee stated in the check.”
Upon verification of all requirements, the FRB will provide provisional credit for the paying bank and charge its depositor with the amount of the disputed remotely created check. The FRB will forward copies of the disputed item as well as a copy of the customer’s written statement as supporting documentation for the charge. If the depositary bank believes it has a defense (e.g., “the remotely created check was authorized”, it must deal with the depositor or with the paying bank. The depositary bank cannot use the Federal Reserve to assist its efforts in the adjustment process. FRB operating Circular 3, as well as the Check Adjustments Quick Reference Guide and the standard Check Adjustment Request Form, are available at www.frbservices.org.
IV. EXISTING LAW ON REMOTELY CREATED CHECKS
A remotely created check is subject to Articles 3 and 4 of the Uniform Commercial Code (UCC), which has been adopted in each state. The UCC provides that a bank paying a check drawn on the account of one of its customers may charge the customer’s account for a check only if the check is properly payable and that a bank generally must recredit its customer’s account for the amount of any unauthorized check it pays. Should the paying bank have evidence that the depositor authorized the check and that the customer is seeking to reverse the authorization, the paying bank would not be obligated to recredit its customer for the amount of the check.
A paying bank may, until midnight of the banking day after a check has been presented to the bank, return the check to the bank at which the check was deposited if, among other things, the paying bank believes the check is unauthorized. Once its midnight deadline has passed, the paying bank generally cannot return an unauthorized check to the depositary bank.
The policy behind the law is that the paying bank, rather than the depositary bank, is in the best position to judge whether the signature on a check is the authorized signature of its customer. Since remotely created checks do not bear a handwritten signature of the drawer that can be verified against a signature card, in most cases, the only means by which a paying bank could determine whether a remotely created check is unauthorized and return it in a timely manner would be to contact the customer before the midnight deadline passes, however remotely created checks rarely come to the attention of paying banks until a customer identifies the check as unauthorized and this is typically well after the midnight deadline.
In 2002, in response to problems presented by remotely created checks, the National Conference of Commissioners on Uniform State Laws and the American Law Institute approved revisions to UCC Articles 3 and 4 that define a remotely created check (using the term “remotely-created consumer item”) as “an item drawn on a consumer account, which is not created by the paying bank and does not bear a hand written signature purporting to be the signature of the drawer.” The UCC revisions require a person that transfers a remotely-created consumer item to warrant that the person on whose account the item is drawn authorized the issuance of the item in the amount for which the item is drawn, effectively shifting liability for those items to the transferors.
The policy behind these revisions is that the bank whose customer deposited the remotely created check is in the best position to detect fraud and gives an economic incentive for the depositary bank to monitor customers that deposit remotely created checks .
Arkansas, California, Colorado, Hawaii, Idaho, Iowa, Maine, Missouri, Minnesota, Nebraska, New Hampshire, North Dakota, Oregon, Tennessee, Texas, Utah, Vermont, West Virginia and Wisconsin amended UCC Articles 3 and 4 to include provisions to address remotely created checks, but the definitions and warranties are neither uniform in scope or requirements.
Also, some check clearinghouses adopted warranties that apply to remotely created checks collected through these clearinghouses. The state-by-state approach to the adoption of remotely created check warranties complicates the determination of liability for remotely created checks collected across state lines, because the bank that presents a check may not be subject to the same rules as the paying bank.
The amendments to Regulation CC create a definition of a remotely created check and warranties that apply when a remotely created check is transferred or presented. The amendments require any bank that transfers or presents a remotely created check to warrant that the person on whose account the remotely created check is drawn authorized the issuance of the check in the amount stated on the check and to the payee stated on the check. The purpose of the amendments is to place the liability for an unauthorized remotely created check on the bank that is in the best position to prevent the loss. By shifting the liability to the bank in the best position to prevent the loss caused by the payment of an unauthorized remotely created check, the Board anticipates that the amendments will reduce costs for all banks that handle remotely created checks. Banks seeking to minimize the risk of liability for transferring remotely created checks will likely screen with greater scrutiny customers seeking to deposit remotely created checks. The Board believes that the controls that small institutions will develop and implement to minimize the risk of accepting unauthorized remotely created checks for deposit likely will pose a minimal negative economic impact on those entities. Furthermore, there was unanimous support for transfer and presentment warranties for remotely created checks from the small institutions that commented on the proposal. These institutions noted that the warranties will enable them to reduce losses they currently suffer when they inadvertently pay an unauthorized remotely created check.
V. CURRENT NEBRASKA LAW
Notwithstanding the adoption of the final rule amending Regulation CC with regard to “remotely created checks” the applicable provisions of the Nebraska Uniform Commercial Code remain in effect. These provisions amended the Uniform Commercial Code to address “demand drafts” (i.e., “remotely created checks”) by shifting the burden of loss in demand draft cases from the payor bank to the depositary bank. With specific limitations, the state law was designed to provide protections for financial institutions similar to those resulting from the Regulation CC amendments described immediately above.
A. Shifting the Burden of Loss
Current Nebraska law shifts the burden of loss in certain demand draft fraud cases from the payor bank to the depositary bank. When a payor bank is required to make restitution to a customer’s account because of a fraudulent or “unauthorized” demand draft, it may, in certain cases under the new law, recover its losses from the depositary bank. When the depositary bank presents a draft for payment to the payor bank, it is making a warranty that the draft is authorized. In instances where the draft is not authorized, the payor bank will have a breach of warranty claim against the depositary bank.
NOTE: The provisions of state law establishing additional protections for “payor” banks are limited in that the requirement for the “depositary” bank to make a warranty that a draft is “authorized” only applies to transactions involving a demand draft in connection with which both the “payor” bank and the “depositary” bank are located in states which have adopted UCC provisions that are similar to the provisions of Nebraska law. Currently, states that have adopted a similar form of “demand draft” legislation are California, Colorado, Hawaii, Idaho, Kansas, Maine, Minnesota, New Hampshire, North Dakota, Oregon, Tennessee, Texas, Utah, Vermont, West Virginia and Wisconsin.
Nebraska law also contains “choice of law” or “reciprocity” provisions relating to demand drafts. These provisions ensure that transferees of demand drafts in states where the “payor” bank is liable for payment on an “unauthorized” draft (i.e., such state has not adopted “demand draft” legislation similar to Nebraska) would not be able to pass that responsibility on to a transferor or “depositary” bank in Nebraska.
NOTE: In the vast majority of cases, the provisions of Regulation CC relating to “remotely created checks” will provide greater protections to financial institutions than those provided under state law, due to the limitation on the applicability of these provisions.