National Check Payments Certification Regulations – Uniform Commercial Code NCP 2015 Exam Cycle...

National Check Payments Certification

Regulations – Uniform Commercial Code

NCP 2015 Exam CycleCore Training Series

Session 2

Copyright© 2014 by the Electronic Check Clearing House Organization

NOTICESThis training course may provide an introduction to or summary of various aspects of check payments and the legal and rules framework for check image exchange. Responsibility for compliance with image exchange rules, and/or the legal, operational and regulatory requirements applicable to check image exchange, remains at all times with the financial institution participating in check image exchange and/or the individual or company using a check image exchange service.

This presentation and the information contained herein is not intended as legal or compliance advice or recommendation to any person or company. This document could include technical inaccuracies or typographical errors and individual users are responsible for verifying any information found in this presentation and related “live” webinar or webinar playback. Financial institutions should consult with their legal counsel regarding legal and operational requirements applicable to any check image exchange program they may offer or in which they participate.

These program training materials may not be reproduced or published, in whole or in part, without the express permission of ECCHO.

Copyright© 2014 by the Electronic Check Clearing House Organization(Certain contributed content subject to third party copyrights)

National Check Payments Certification 2

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Session Overview

• Warranty and Indemnity in Payments• Uniform Commercial Code (UCC)

–Article 3 – Negotiable Instruments–Article 4 – Bank Deposits and Collections


Warranty and Indemnity in Payments

• Inter-bank exchange of checks subject to state/federal law• Rules and agreements important in assigning liability

– Address exchange issues in uniform mannerRules may be applied to exchanges across multiple financial institutions and

exchange networks

• Check Image Rules – Establish legal rights and obligations of financial institutions in exchanging check images– Address operational and technical requirements– Reduce risk to exchange participants

• Financial institutions exchanging check images without rules /agreements– Potentially expose both sending and receiving banks to increased

payment /operational risksNational Check Payments Certification 5

Warranty and Indemnity in Payments

• Role of Uniform Commercial Code (UCC)– Model state laws as adopted by each state

Example: Transfer and presentment warranties• Role of Regulation CC – Federal law implementing regulations

for:– Expedited Funds Availability Act (“EFAA”)– Check Clearing for the 21st Century Act (“Check 21 Act”)

Example: Substitute check warranties• Clearinghouse Rules (ECCHO Rules)

– Agreement covering clearinghouse members for images exchanged under uniform rulesExample: “Chain of warranties” and forged and counterfeit check warranty

• Federal Reserve Operating Circulars– Rules governing all exchanges to /from FRB

Example: Defines liability of the FRB vs. presenting or returning bankNational Check Payments Certification 6

Indemnification Example• Bank A warrants it will not ask

Paying Bank to pay an item it has already paid(“no double debit” warranty)

• Bank A sends duplicate image resulting in breach of warranty

• Paying Bank is indemnified from loss– Can make a claim back to Bank A – Bank A breached its warranty

Bank A

Paying Bank

Paying Bank’s

Customer

StatementIMAGE

DUPLICATE IMAGE

Breach of Warranty Claim


Overview of Check Regulations

• Uniform Commercial Code–Article 3: Negotiable Instruments–Article 4: Bank Deposits and Collections

Focus of this session• Regulation CC

–Availability of Funds and Collection of Checks• Regulation J

–Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers through Fedwire


Uniform Commercial Code

10National Check Payments Certification

Uniform Commercial Code – Purpose

• Set of standardized state laws that govern business and financial contracts; first published in 1952– Establishes general duty standards for parties to act in good faith and

exercise ordinary care in their transactions.

• UCC and revisions written by experts in commercial law– Updates submitted as drafts for approval to National Conference of

Commissioners on Uniform State Laws (NCCUSL)Group now referred to as the Uniform Law Commission (ULC)

• Model state law – must be adopted by each state– Enacted in all 50 states and District of Columbia, Puerto Rico, Guam and

U.S. Virgin Islands

• Together with case law, Articles 3 and 4 document legal boundaries for most aspects of check processing

UCC Article 3 Overview• UCC 3 – Negotiable Instruments• Establishes general duty standards for parties to:

– “Act in Good Faith”– “Exercise Ordinary Care”

• Covers– Definition and requirements of a negotiable instrument– Negotiation, transfer and endorsement of these instruments, and– Liability of the parties

• Sample topics: – Standards of care required for processing checks– Establishing the identity of the payee– Negligence of maker in case of forgery or alteration– Forgery and fraud loss allocation– Employer’s responsibility for employee fraud


UCC Article 4 Overview• UCC 4 – Bank Deposits and Collections• Covers check collection, payment, liabilities, time

frames and responsibilities• Any provision under Article 4 may be varied by

agreement between bank and customer– Except bank’s duty to “Act in Good Faith” and “Exercise

Ordinary Care”• Sample topics:

– When a bank may charge a customer’s account– Customer’s right to stop payment– Bank’s option not to pay stale-dated items– Customer’s obligation to report unauthorized signatures


UCC 3: Negotiable Instrument

• Written order signed by the drawer–Must be a writing (physical item)

• Unconditional promise or order to pay a fixed sum of money–Unconditional unless:

States an express condition to paymentPromise or order is subject to or governed by another recordRights or obligations with respect to promise or order are

stated in another record• Instrument is a:

– Draft: if it is an “order”– Note: if it is a “promise”



UCC 3: Check Definition• Instrument is a “draft” if it is an order

– Check definition can be found in UCC [3-104(f)]Within negotiable instrument definition

• "Check" means a: (i) Draft: Payable on demand / drawn on a bank; or (ii) Cashier's check or teller's check– May be check even though described by another term, such

as "money order“• Cashier’s Check and Teller’s Check

– Cashier’s check: Drawer and drawee (Paying Bank) are the same

– Teller’s check: Drawn by a bank on another bank or payable through a bank

UCC 3: Demand Instrument

• Payable on demand or at a definite time–On Demand

Payable on demand or at sight, or otherwise indicates that it is payable at the will of the holder

Does not state any time of payment– Payable at a Definite Time

Payable on elapse of a definite period of time after sight or acceptance; or

At a fixed date; or At a time readily ascertainable when order is issued

–Date of instrumentIf undated, the date is:

o Date of its issue or o Date it first comes into possession of a holder


UCC 3: Payable To

• Payable To options:–To a named payee; or–To bearer if it states that it:

Is payable to the Order of bearer; orIndicates that the person in possession of order is

entitled to payment; orDoes not state a payee; orIs payable to cash


UCC 3 – Date

• Day on or after which the transfer of the amount of the check may take place–Required for negotiability

• Post-dated checks–Bank may charge a customer’s account even though

payment is made before the date on the checkUnless the customer gives bank notice of the postdating

• Stale-dated checks–Bank may, but is not obligated to, pay a check

presented more than six months after its date


UCC 3 – Amount• Value which will pass from the account of the Drawer to

the Payee– Required for negotiability

• To inhibit unauthorized alteration, amount should appear twice on the check– Written in numbers: Courtesy amount or convenience amount– Written in words: Legal amount

• Contradictory Terms of Instrument (UCC3-114)– If instrument contains contradictory terms:

Typewritten terms prevail over printed termsHandwritten terms prevail over bothWords prevail over numbers


UCC 3 – Payee• Name of the person or organization that is to receive

the amount of the check• Usually preceded by the words: “Pay to the order of...”

or “Pay to...” or “Pay...”–Required for negotiability

• Identity of the payee is determined by the intent of the Drawer

• Joint Payees - Payable to two or more–Check payable to A or B - Separated by “/” or “,”

Either may indorse and negotiate– Payable to A and B

Both must indorse and negotiateNational Check Payments Certification 19

UCC 3 – Identification of Payee• Intention of the signer

– Payable to the person intended by the signer even if that person is identified in the instrument by a name or other identification that is not that of the intended person

• Method of identification– May be identified in any way, including by name, identifying number,

office, or account number– If instrument is payable to an account identified by number and by

the name of a person, the instrument is payable to the named person, whether or not that person is the owner of the account identified by number

• Trusts, estates or agents– If trust or estate, payable to the trustee, representative, whether or

not the beneficiary or estate is also namedNational Check Payments Certification 20

UCC 3 – Signature

• Authorizes the paying bank to disburse funds–Required for negotiability

• Must coincide with the conditions of payment on the signature card

• May contain restrictive notations for which bank may require an indemnity


UCC 3 – Unauthorized Signature

• Person is not liable on an instrument unless he or she signs it

• If person’s name is signed without authority, the signature is unauthorized


UCC 3 – Signature and Unauthorized Signature

• No particular form of signature required–Manually or by device or machine–Name including trade or assumed name–Mark or symbol with intent to authenticate

• Signature by a representative–Represented person is liable if instrument is signed by a

representative• Multiple signatures

– If signature of more than one person is required to constitute the authorized signature of an organization, it is unauthorized if one of the required signatures is lacking


Negotiation

• Result of the transfer of possession of instrument–From Holder to another person or bank who

becomes Holder as a result of the transfer

Depositary Bank

Deposits or Cashes Check

Exchanges check “for value”

$Individual Payee

“Holder” of Check


Unindorsed Item

• Depositary Bank becomes a holder of the item at the time it receives the item for collection–If the customer was holder of the item,

whether or not the customer indorses the item–Depositary Bank warrants that amount of the

item was paid to the customer or deposited to the customer's account


Holder vs. Holder in Due Course

• Holder in Due Course (HIDC) (UCC 3-302)– Took the item in good Faith– Took item for value– Holder who has possession– Without notice signature unauthorized or item altered– Without knowledge of claims against it

• HIDC concept – Represents a “chain of ownership”– No other payment system has this

• Benefit of being the HIDC– Can enforce item against drawer even if item was

returned unpaid by drawee (Paying Bank)


Paying Bank

Bank of First Deposit(BOFD)

SalesPerson / Payee / DepositorDrawer

(1)Goods

Purchased(1)

Check Deposited

Image

Image

Returned(3)

(2)Drawer issues Stop Pay order

(3)Chargeback Attempt;

Payee Closed Account

(4)BOFD /HIDC

Claim

(2)Goods found

to be fraudulent

Holder In Due Course

• Depositary Bank (BOFD) is Holder In Due Course– Can make claim back to Drawer

X


Holder in Due Course (HIDC)

• Financial intermediary, such as Depositary Bank (BOFD) or Collecting Bank–Should not be affected by disputes between

the Drawer and Payee of check regarding the underlying transaction

–Can make HIDC claim back to Drawer


UCC 3 – Indorsement

• Signature either alone or accompanied by other words–For purpose of:

Negotiating the instrumentRestricting payment of instrumentIncurring indorser’s liability on instrument

–Transfers ownership to another partyPayee indorses check to deposit, cash or transfer ownership of

the instrument• Payee Indorsement

–Need not be exact–May be “substantially similar” as clarified in 1991 revision

to UCC (3-404)



UCC 3 – Payee Indorsements

• Blank Indorsement–Payee simply signs his/her name–“Blank” does not mean un-endorsed

Check becomes a bearer instrument and can be transferred to anyone simply by giving the check to another party

• Special Indorsement–Transfers the check to a specified payee–Endorsed as payable to someone else

Negotiation then requires that person’s subsequent indorsement


UCC 3 – Payee Indorsements

• Restrictive Indorsement– Imposes limitations on transferring check–Conditional or qualified indorsement

Common example: “For Deposit Only”• Anomalous Indorsement

–Made by person who is not holder of the instrument–Only effect of anomalous indorsement

Makes the signer liable on the instrument as an indorser Normally made by an “accommodation party” (defined

in UCC3-419)

UCC 3 – Incomplete Instruments

• At time of signing it is incomplete but that signer intended it to be completed by the addition of words or numbers–Must meet the requirements of a negotiable

instrument• Incomplete Instrument and Alteration

–Words or numbers added to incomplete instrument without authority of signer is an alteration (UCC 3-407)


UCC 3 – Employer’s Responsibility • Covers two categories of fraudulent indorsements made by

employees– Indorsement made in name of employer on instrument (check)

payable to employer; and– Indorsement made in name of payee on instrument (check) issued by

employer• Employee of the company or a person acting in concert with the

employee (e.g.; an independent contractor) makes a fraudulent indorsement– Checks written, stamped or deposited fraudulently using the

company’s accountEmployee was entrusted with responsibility for checksBank was not negligent

– Employer is liable and not the Paying BankNational Check Payments Certification 33

Forged Drawer’s Signature

• Price v. Neal–Case decided in English court in 1762

Decision essentially was that a Paying bank is in best position to detect a forged drawer’s signatureo Should bear the loss arising from its payment of a check

containing a forged drawer’s signatureDecision commonly known as the “Rule of Price v.

Neal” o Embodied in the UCC 3-417(a) and 4-208(a).


UCC 4 – When Bank May Charge Account

• Bank May Charge Customers Account–Even though the charge creates an overdraft

Customer is not liable for overdraft if they didn’t sign or benefit from the proceeds of the item

–Even though payment was made before the date of the checkUnless customer has given notice to bank of the

postdating describing the check with reasonable certainty


UCC 4 – Customers Duty to Report• Customers Duty to Discover and Report Unauthorized

Signature or Alteration (UCC 4-406)– Bank sends or makes available a statement showing payment of

items– Return or make available the items paid or provide information

in the statement of account sufficient to allow the customer reasonably to identify the items paidFurnish legible copies of items for seven years if requested

– Customer must exercise reasonable promptness in examining the statement and must promptly notify the bank of the relevant factsReport an unauthorized signature to the bank within one year from

the date that the statement was made available– Bank Deposit agreement can vary this timing


BOFD Paying Bank(Drawee)

Agreement

Company

Statement

UCC Warranties

• Warranty travels with the item– Chain of warranties

• Transfer warranties: From person (customer) to BOFD to Collecting Bank• Presentment warranties: From Collecting Bank/Presenting Bank to Paying Bank

CustomerIntermediary /

Collecting Bank / Presenting Bank

37

PresentmentWarranty

Transfer Warranty

Transfer Warranty

Deposit

IMAGEIMAGE

National Check Payments Certification

UCC Transfer Warranties

• Person or collecting bank transferring item warrants:–Entitled to enforce the item–All signatures on the item are authentic and

authorized;– Item has not been altered;– Item is not subject to a defense or claim–Warrantor has no knowledge of any insolvency

proceeding with respect to the maker –For RCC the person on whose account the item is drawn

authorized item and amount for which the item is drawn


Bank A / BOFD

Bank B / Intermediary/

Collecting BankPaying Bank

Company / RDC Customer

ConsumerCustomer

UCC Transfer Warranties

• Does the UCC Transfer Warranty extend to the Paying Bank?

Scans & Deposits

Makes a purchase / Pays

with a Check

Note: Banks are all members of same clearinghouse

Image Image Image

No – Stops with last collecting bank in the forward presentment chainNational Check Payments Certification 39

Bank A / BOFD

Paying Bank

Customer

UCC Presentment Warranties

Company / RDC Customer

Bank B / Intermediary/

Collecting Bank

Makes a purchase / Pays with a

Check

Scans &

Deposits

Image Image Image

• Which institution receives the UCC Presentment Warranty?

Paying Bank


UCC Presentment Warranties

• Person obtaining payment and previous transferor presenting item warrants: –Entitled to enforce draft

Or authorized to obtain payment/acceptance of draft on behalf of a person entitled to enforce the draft;

– Item has not been altered; and –Warrantor has no knowledge that signature of the

purported drawer of the draft is unauthorized; and–For RCC, person on whose account the item is drawn

authorized item and amount for which it is drawn


Statute of Limitations

• Designed to prevent fraudulent / stale claims from arising after all evidence lost or after facts have become obscure through passage of time– Defense ordinarily asserted by defendant to defeat an

action brought after appropriate time has elapsed– Enacted by the legislature, which may either extend or

reduce time limits, subject to certain restrictions• Statute of Limitations:

– Under UCC = 3 years


Questions

????? ?National Check Payments Certification 43

Recommended Resources

• Uniform Commercial Code (UCC)–Article 3 – Negotiable Instruments–Article 4 – Bank Deposits and Collections

• CheckImage Central Website: www.checkimagecentral.org

–White paper on “Need for rules”:www.checkimagecentral.org/pdf/RoleOfPrivateSecRulesAndFRSRules.pdf

• Supplemental Materials–“UCC Warranties” handout


http://www.checkimagecentral.org/

http://www.checkimagecentral.org/pdf/RoleOfPrivateSecRulesAndFRSRules.pdf

Thank You!

Regulations – Uniform Commercial Code

NOTICEThis NCPC Program document contains copyrighted materials of its publisher.

These program training materials may not be reproduced or published, in whole or in part, without the express permission of ECCHO.

Ellen Heffner, NCPDirector and Education Manager

[email protected]

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