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Reg CC Goes “Paperless”: New Amendments Address Electronic Checks, Remote Deposit Capture, and Other Modern Banking Trends



Regulation CC first became law back in 1992. Yes, that was when Sir Mix-a-Lot was “back” on the top of the charts, audiences were eating up Silence of the Lambs, and bowl cuts were a thing. Times have changed, but oddly Reg CC hasn’t. Since 1992, Reg CC—which governs funds availability and how financial institutions handle check collection and return processes—has stayed mostly the same. But think about how much banking has evolved over the last quarter century, especially in light of the widespread use of electronic items, checks, and processing systems.

You might be surprised to learn that a large chunk of Reg CC still applies only to paper checks. Thankfully, the law is getting a modern makeover to acknowledge the fact that today's check collection world is now virtually entirely electronic. In June 2017, the Federal Reserve issued final amendments to Reg CC to get with the times, and the CFPB is expected to do the same shortly. These amendments will take effect on July 1, 2018, and they aim to recognize current collection practices.

Here are the highlights of a few of the Federal Reserve's amendments to Reg CC:

Shifting the Loss for Remote Deposit Capture
Although remote deposit capture is convenient for customers, the service can be a nightmare for a bank. For example, when a person uses remote deposit capture, he or she retains the original paper check, which he or she could attempt to cash again. When this happens (and yes, it happens quite frequently), several parties are stuck arguing about who should take the loss. Typically, the bank that ends up paying the original paper check will bring a UCC claim against the check writer (who then has little redress unless he or she can track down the individual who cashed the check twice).

Under the new rules, the bank that accepts the remote deposit capture indemnifies the bank that receives a later deposit of the original paper check against the risk that the paper check will be deposited again. In other words, the rule shifts the risk of loss to the remote deposit capture bank. Many in the industry believe this change will deter banks from offering remote deposit capture service, while others think the remote deposit capture bank is in the best position to prevent multiple deposits of the same item. Thankfully, the Federal Reserve carved out an exception to this rule. This indemnity will not apply if the subsequent bank accepted an original check with a restrictive indorsement that is inconsistent with the means of deposit, such as a designation on the check that it is "for mobile deposit only."

As you can see, this convenient service can expose an institution to potential liability. We recommend that banks and credit unions review their remote deposit capture agreements to ensure they are protected from bad actors. For example, since remote deposit capture now more than ever poses a credit risk for the institution, it may decide to only offer its remote deposit capture service to customers who have built a satisfactory history of deposits, or it may impose more restrictive remote capture deposit limits to curtail the potential exposure. Institutions might also consider discussing these issues with their third-party vendors providing remote deposit capture software to investigate whether the software can scan for proper restrictive indorsements.

New Warranties for "Electronic Checks" and "Electronic Returned Checks"
The Federal Reserve amended Reg CC to create new definitions that address issues not contemplated in 1992 when checks were still confined to paper. Beginning next year, if a financial institution presents an "electronic check" or an "electronic returned check" and receives settlement, the institution makes the following two new warranties:

  1. That the electronic image accurately represents the front and back of the original check (and includes an accurate record of all MICR line information); and
  2. That no person will receive a transfer, presentment, return of, or otherwise be charged again for a check that has already been paid.

In the case of an "electronic check" sent for collection, these warranties will flow to the transferee bank, any subsequent collecting bank, the paying bank, and the drawer of the check. In the case of an "electronic returned check," these warranties will flow to the transferee returning bank, any subsequent returning bank, the depository bank, and the owner of a returned check. Interestingly, by extending these warranties to drawers and owners of checks, the Federal Reserve essentially guarded these persons against certain types of harm that are typically beyond their control, such as harm resulting from illegible images or incorrect MICR lines.

Despite all of the above, the Federal Reserve recognizes the fact that "electronic checks" and "electronic returned checks" are currently governed by written agreements between financial institutions. In an effort to maintain this flexibility, the Reg CC amendments will allow financial institutions to continue to vary these new warranties by agreement (and other Subpart C provisions of Reg CC as they apply to "electronic checks" and "electronic returned checks") based on the notion that institutions are in the best position to address and limit these perceived risks and to determine their risk tolerance.

New Indemnity for Electronically Created Items
Keeping pace with technology is tough, especially in the world of electronic "check-like" items that never existed in paper form, such as electronic remotely created checks (e.g., online bill pay systems, etc.). To tackle this issue, amended Reg CC will also govern so-called "electronically created items," which are electronic images that have all the attributes of electronic checks or electronic returned checks but were created electronically and not derived from paper checks. As you can guess, an "electronically created item" can sometimes be difficult to distinguish from electronic images of paper checks.

During its rule making process, the Federal Reserve pondered extensively over how to best address "electronically created items" and whether to amend Reg CC to build new warranties or indemnities into its regulatory framework. After deliberation, the Federal Reserve determined that depository institutions should bear the risk of loss for these items. Under amended Reg CC, if a depository institution transfers or presents an "electronically created item" and receives settlement, the depository institution will indemnify subsequent banks in the collection chain from losses due to the fact that an "electronically created item" (a) was not derived from a paper check, (b) was unauthorized, or (c) was transferred or presented for payment more than once. Although Reg CC itself does not allow the depository institution to assert this new indemnity against the depositor, the institution can allocate that liability to the depositor under a separate written agreement.

Hint, Hint: Banks Should Accept Electronic Returns
To help decrease the risk to a depository bank that a check will be returned after funds have already been made available for withdrawal, Reg CC generally requires the "expeditious" return of checks. In part, a paying bank is currently deemed to have "expeditiously" returned a check if it returns the check to the depository bank in a manner such that the check would normally be received by the depository bank not later than 4:00 p.m. on the second business day following the banking day of presentment. If the paying bank fails to return a check expeditiously, the paying bank can find itself liable for losses incurred by the depository bank.

The amendments to Reg CC will slightly modify the expeditious return rule for all returned checks, both paper and electronic. Under the new rule, all returned checks must be returned in an expeditious manner such that the check would normally be received by the depository bank not later than 2:00 p.m. on the second business day following the banking day of presentment. In addition to moving the cutoff hour from 4:00 p.m. to 2:00 p.m., the Federal Reserve also added a new condition to the expeditious return rule to incentivize the electronic return of checks. Under the new rule, a paying bank may be liable to a depository bank for failing to return a check expeditiously only if the depository bank has arrangements in place such that the paying bank could return the returned check electronically by commercially reasonable means.

If one thing is clear from the Federal Reserve's amendments to Reg CC, the Board is set on encouraging financial institutions to be tech-savvy and forward thinkers. The Fed believes this new expeditious return rule will incentivize depository banks to receive electronic returns to preserve their ability to make claims that certain checks were not returned expeditiously. In essence, the Federal Reserve has used its rule-making power to encourage Luddite financial institutions to begin receiving electronic returns if they haven't already done so.

The "Midnight Deadline" Survives, and It Can Still be Extended
In general, the “midnight deadline” refers to a state law requirement in the UCC that a paying bank must dishonor a check (if it chooses) no later than midnight of the banking day following the day the check was presented. For example, if a paying bank is presented with a $100,000 check on Monday morning and decides to dishonor the check, it must typically do so by midnight on Tuesday (hence the name, the "midnight deadline"). If the paying bank fails to do so, the "midnight deadline" would have passed and the paying bank could find itself liable for the check. Notably, Reg CC contains some provisions that allow for a federal extension of the "midnight deadline" (e.g., qualified return checks, prompt delivery).

Banks can still extend the midnight deadline, though the amendments to Reg CC make some slight tweaks. For example, currently a paying bank can extend the deadline if it returns a check in a manner that would ordinarily deliver the check to the depository bank before its next banking day following the deadline. But as amended, the deadline is extended only if the depository bank actually receives the return before certain cutoff times. To help accomplish that, the amendments permit electronic returns if the paying bank has an agreement to do so with the receiving bank, whether between themselves or according to a Federal Reserve operating circular, clearinghouse rule, or other interbank agreement. These amendments, like those discussed already, further nudge the industry to embrace modern technology.

“Refer to Maker” Is No Longer the Easy Way Out.
As a general rule, when a paying bank returns a check, the paying bank must indicate on the face of the check the reason for the return. At some point in time, it became a common practice for paying banks unsure of the reason(s) for return to simply stamp "Refer to Maker" on returned checks - this was likely the result of permissive commentary under current Reg CC. Under the new rules, a paying bank will be required to indicate clearly the reason the bank is returning a check (e.g., NSF, alteration). Going forward, ambiguous reasons, such as “Refer to Maker,” will no longer be appropriate in most circumstances, especially in situations involving altered or unauthorized checks.

There are No "Non-Local" Checks Anymore (Proposed Amendments).
Under the current language of Reg CC, a bank can hold a “non-local” check (i.e., a check processed in a different region than the depository institution) for five business days after the customer's deposit. However, because the Federal Reserve currently has only one check processing site (in Atlanta), this reference to "non-local" checks is a relic of the past (because all checks are processed in the same region as the depository institution). In other words, all checks today are considered "local" checks. Proposed amendments to Reg CC (which have not yet been finalized) will help clean up this obsolete language and eliminate the distinction between "local" and "non-local" checks. Take note that the regulatory language in Reg CC with respect to "non-local" checks is no longer relevant, and this old language will likely be fixed in the Federal Reserve's next set of amendments. Nowadays, all checks are "local" checks and must be made available to the customer by the second business day, unless of course an exception otherwise applies under Reg CC.

Please keep in mind that the above list is merely a summary of a select few highlights of the Federal Reserve's amendments to Reg CC. There are many more important amendments being made to Reg CC (which have not been discussed in this article) to acknowledge the rapidly changing industry, and there are even more proposals being considered. In sum, the various amendments to Reg CC are a good starting point and will (hopefully) help the industry keep pace with the ever-changing technology in use today.

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