On June 15, 2017, the Federal Reserve Board (FRB) published in the Federal Register final amendments to Regulation CC (Availability of Funds and Collection of Checks). The amendments contain a number of changes that will affect financial institutions, such as modifications to check return requirements, additional warranties, and new indemnities, including a new indemnity for remote deposit capture (RDC). (Spoiler Alert: The indemnity for RDC has significant implications for financial institutions that offer RDC services.) The rule will become effective July 1, 2018.

Regulation CC implements the Expedited Funds Availability Act (EFAA) and the Check Clearing for the 21st Century Act (Check 21 Act). The FRB previously published a notice of proposed rulemaking to amend Regulation CC in February 2014.

The primary purpose of the final rule is to address the current rule’s presumption that financial institutions generally handle checks in paper form, rather than electronic form. The FRB has stated that it now receives over 99.99% of checks electronically, but the current version of Regulation CC does not address the exchange or return of electronic images of paper checks or electronic items not derived from paper checks.

Definitions

The final rule adds new definitions for “electronic check,” “electronic returned check” and “electronically-created item,” and changes a number of existing definitions. Under the new rule, “electronic check” and “electronic returned check” mean “an electronic image of, and electronic information derived from, a paper check or paper 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 derived from a paper check.” Certain definitions, such as “MICR line” and “routing number” are updated to reflect not just paper checks, but also electronic checks.

Check Collection Process

The new check collection provisions include a modified version of the existing “two-day” test for returning checks in an expeditious manner. For a check to be returned in an “expeditious manner” under the new test, the depositary bank (generally, the first bank to take the check) must receive the check not later than 2:00 p.m. local time of the depositary bank on the second business day after the banking day on which the check was presented to the paying bank (generally, the bank the check is drawn on).

Additional changes to the check collection provisions permit a depositary bank to assert a claim against a paying bank or returning bank for failure to return a check in an expeditious manner only if the depositary bank has commercially reasonable means in place for allowing the paying bank or returning bank to return the check to the depositary bank electronically–either directly or indirectly. The burden of proof is on the depositary bank to show that the arrangement is commercially reasonable. This change is intended to incentivize depositary banks who do not currently receive electronic returns to begin doing so.

Also under the new rule, a paying bank that determines not to pay a check of $5,000 (increased from the current $2,500 threshold) or more will also be required to provide a notice of nonpayment so that the notice will normally be received by the depositary bank not later than 2:00 p.m. (shortened from the current 4:00 p.m. deadline) local time of the depositary bank on the second business day after the banking day the check was presented to the paying bank. Changes are also made to the content requirements of the notice of nonpayment.

Warranties

The amended regulation adds new warranties to checks collected electronically. The current rule contains existing paper-check warranties–returned check warranties; notice of nonpayment warranties; settlement amount, encoding, and offset warranties; and transfer and presentment warranties–as well as Check 21-like warranties that a bank will not be asked to pay an item twice and that the electronic image and electronic information are sufficient to create a substitute check. Each of these warranties will also apply to electronic returned checks under the new rule. As with the warranties for paper checks, these new warranties for electronic returned checks may be varied by agreement of the exchanging banks.

Indemnities

Several new indemnities are added for electronically-created items and items deposited through RDC. A bank transferring an electronically-created item will be required to indemnify each transferee bank, any subsequent collecting bank, the paying bank, and any subsequent returning bank against any loss, claim, or damage resulting from the fact that the image or information was not derived from a paper check. The amount of the indemnity will be limited to 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.

A depositary bank that receives a deposit of an original paper check that was returned unpaid because the check was previously deposited via RDC would be indemnified unless the original check deposited with the depositary bank contains a restrictive endorsement in consistent with the means of deposit (e.g., “for mobile deposit only”). In a shift from existing allocation of liability, this Regulation CC change now places the risk of multiple deposits of the same item on the financial institution accepting the item through RDC.

Commentary to the new rule indicates that a depositary bank can, by agreement, allocate liability for loss incurred from subsequent deposit of the original check to the bank’s customer that deposited the item through RDC.

Same-Day Settlement

The existing same-day settlement rule for paper checks is not being extended to electronic checks; the process for electronically presenting checks is still subject to agreement of the exchanging banks.

Funds Availability

There are no changes to Subpart B of the regulation, which imposes funds availability requirements. (While the FRB has sole rulemaking authority over the majority of the EFAA, the FRB shares rulemaking authority with the Consumer Financial Protection Bureau over the provisions of the EFAA governing funds availability.) The funds availability requirements generally apply to “checks.” The definition of “check,” which states that “check” includes “an original check and a substitute check,” also has not been changed under the final rule.

So for now, the funds availability requirements of Regulation CC do not appear to expressly apply to electronic checks or electronically-created items. And their application to checks deposited through RDC remains ambiguous, although arguably an item that clearly began its life as a “check” under the applicable definition should remain so for funds availability purposes. However, that view has not been codified into EFAA or Regulation CC.

Next Steps

Financial institutions should start planning for these changes now as some of the changes will require coordination with financial institutions’ third-party vendors, which can be a lengthy process.

Several steps should be taken to address the new RDC indemnity as that Regulation CC change creates a new form of risk that must be cabined. Financial institutions should review and revise all of their customer-facing agreements that include RDC provisions–consumer and business, mobile and cash management–to require financial institution customers to include restrictive endorsements on each RDC item the customer deposits, and to allocate liability for loss regarding RDC items to the customer in connection with subsequent deposits of the same item.

Requiring restrictive endorsements is not enough, though. Financial institutions will need to enforce these restrictive endorsement requirements to take advantage of the exception to the new RDC indemnity. This means that financial institutions will need to check each item deposited via RDC and reject each item that does not contain a restrictive endorsement. The most obvious way for financial institutions to do this is to have their RDC vendor enable optical scanning of the back of each item for a restrictive endorsement. If the back of the item does not contain an appropriate restrictive endorsement, the RDC software should be programmed to reject the deposit. This process would serve as a defense to an indemnification claim from a financial institution that accepts a subsequent deposit of the same item with the restrictive endorsement. Without this type of process, the financial institution may not have a defense to such an indemnification claim under Reg CC or other claims such as holder-in-due-course claims (e.g., from check cashers).

Financial institutions will also need to update their internal policies and procedures for returning checks and sending notices of nonpayment. To the extent a financial institution varies Subpart C (Collection of Checks) of Reg CC by agreement, any such agreement may need to be updated to reflect the changes in the final rule.

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Photo of Erin F. Fonté Erin F. Fonté

Erin Fonté assists clients with a broad range of matters related to payments/payment systems, digital commerce, banking and financial services (including related legal and regulatory issues), technology/Internet products, privacy and data protection laws, and general corporate matters. Erin regularly advises financial institutions and alternative payment providers regarding mobile banking, mobile payments and mobile wallet products and services. She has been involved in the creation of new payment networks and has worked extensively on products, services and network operating rules related to emerging and mobile payment systems.