The Board of Governors of the Federal Reserve System (“Board”) is proposing important changes to Regulation CC, 12 C.F.R. § 229, which implements the Expedited Funds Availability Act of 1987 (“EFA Act”) and the Check Clearing for the 21st Century Act of 2003 (“Check 21 Act”).  See Availability of Funds and Collection of Checks, 79 Fed. Reg. 6674-01 (proposed Feb. 14, 2014) (to be codified 12 C.F.R. § 229).  The Board’s proposal includes a revised regulatory framework for subpart C of Regulation CC, dealing with the forward collection and return of checks.  In particular, the Board’s proposal would amend 12 C.F.R. § 229.34 to provide new indemnity provisions relating to remote deposit capture services.

Remote deposit capture (“RDC”) is a service increasingly being offered by financial institutions to commercial and retail customers to permit deposits to accounts to be made by sending an electronic image of the check to the bank.  The depositary institution which receives the image often sets forth the terms of the RDC service in its agreements with its customers.  See Availability of Funds and Collection of Checks, 79 Fed. Reg. at 6684.  Terms usually include a time limitation regarding how long the customer retains the check after sending the remote deposit to the bank.  Id.

Even a casual study of the marketplace shows that RDC availability is dramatically increasing, with no sign of slowing down, particularly given the ever increasing use of smartphones and tablets. The technology related to RDC is ever being refined and is increasingly available to even the smallest of financial institutions.  As of 2013, fifty-one percent of United States adults, and sixty-one percent of internet users, bank online.  Susannah Fox, 51% of U.S. Adults Bank Online, Pew Research (August 7, 2013) http://www.pewinternet.org/2013/08/07/51-of-u-s-adults-bank-online/. While financial institutions continue to adjust to this new normal, proposed new regulations by the Board must be considered as banking institutions evaluate the pros and cons of new mobile banking service offerings.      

Existing Framework: 12 C.F.R. § 229.34

The existing provisions of subpart C were built on the presumption that banks generally handle their checks in paper form.  Electronic checks and RDC services are two new technologies which were essentially not accounted for at the time the regulations were adopted.  Currently, under 12 C.F.R. § 229.34(d), a bank transferring or presenting a remotely created check, and which receives settlement or other consideration, warrants to the transferee bank, any collecting bank, and the payor bank that (1) the person on whose account the remotely created check is drawn authorized the issuance of the check, (2) in the amount stated on the check, and (3) to the payee stated on the check.  See 12 C.F.R. § 229.34(d).  Under this current framework, any bank that both transfers or presents a remotely created check and receives settlement for that check essentially warrants the contents and authenticity of that check. 

The Board recognizes the current framework breaks down when the issue of double presentment arises in the context of RDC services.  A common scenario is when a paper check’s payee takes a “picture” of the check for deposit to his or her account at one institution using RDC services and then deposits or negotiates the original paper check at another institution or check cashing business.  If the original paper check is deposited after the image of the check is deposited through a RDC service, the original paper check would usually be returned unpaid to the depositary bank, either upon the initiative of the payor or the check writer (usually pursuant to the UCC’s §§ 4-401/4-406).  When the paying bank returns the original paper check to the depositary bank which accepted the paper check’s deposit, that depositary bank too often found it was not able to recover the provisional credit from its depositing customer because the customer had already withdrawn the funds.  See Availability of Funds and Collection of Checks, 79 Fed. Reg. at 6684.  In this scenario, under the current framework, it is unclear as to whether the depositary bank that accepted the original paper check would be able to recover any loss from the “second” depositary bank that received the earlier settlement for a deposit made through an RDC service.  Id.       

Federal Reserve Board’s Proposal: Indemnity Under New 12 C.F.R. § 234(g)

Under the Board’s proposal, electronic images and electronic information would be treated as checks under subpart C.  Id. at 6683.  The Board would directly address the issues related to RDC services by adding a new indemnity provision, 12 C.F.R. § 229.34(g).  Under New § 229.34(g) the depositary bank whose customer created the image of the front and back of the check and deposited the check through an RDC service would become a truncating bank, as defined in § 229.2(eee)(2), despite having never received the original paper check.[1]  New § 229.34(g) would indemnify another depositary bank that accepts the original paper check for deposit for that bank’s losses due to the check already having been paid.  Id. at 6684  Thus, the depositary bank that accepts the deposit of an original check is allowed to recover directly from the truncating bank that permitted its customer to deposit the check via RDC.  Id. at 6685, 6697. 

This new indemnity recognizes the Board’s belief that the depositary bank that accepts the original paper check should not bear the loss in those instances when the check has been deposited multiple times.  Id. at 6685. The Board seeks to place the risk on “the depositary bank that introduced the risk of multiple deposits of the same check by offering RDC services.”  Id.    Whether one agrees with the new allocation of risk or not, one cannot but help see shades of the famous (or infamous?) Price v. Neal[2] rule at play, as the new regulation attempts to shift the risk of loss in the system to the perceived party best able to guard against the loss event.   

Reception of New 12 C.F.R. § 234(g) in the Financial Community

The Board’s proposals and additions to Regulation CC, 12 C.F.R. § 229, were introduced in February 2013 and were open for public comments until May 2, 2014.  As expected, many financial institutions weighed in.

A large national banking institution weighed in with its support stating that the Board’s new indemnity provision “addresses a scenario where it is reasonable to impose the loss on the truncating bank which was best positioned to control the subsequent deposit of the paper check by its customer.”  Letter to Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System (May 1, 2014).  It was also suggested by this bank and others, that the final rule include a specific time period within which the indemnified depositary bank must act to claim indemnification from the truncating bank.  Id.  Additionally, it was suggested that indemnification under New § 229.34(g)  only be applicable when (1) the second bank of deposit qualifies as a Holder in Due Course under the UCC, and (2) has possession of or access to the original check.  Id

By in large the published comments indicate a positive attitude towards the Board’s proposed changes.  One commentator suggested that New § 229.34(g) is in need of several additional provisions: (1) that the depositary bank seeking indemnification be a holder of the original paper check at the time of deposit, (2) that the paying bank be obligated to provide indentifying information to the depositary bank regarding the truncating bank, and (3) that there be a limited defense for the truncating bank unless the depositary bank asserts its claim for indemnification against the truncating bank within 30 days after it has reason to know of the breach of warranty and the identity of the truncating bank.  Letter to Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System (May 1, 2014).

On the other hand, opponents of New § 229.34(g) contend that the indemnity provision would discourage financial institutions from offering RDC services.  Opponents argue that rather than indemnity from the truncating bank, the proposal should require banks offering RDC services to place a “remote deposit restrictive endorsement” on the back of the check such as “for remote deposit at XXX Credit Union/Bank only.”  Letter to Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System (May 1, 2014).  Therefore, a depositary bank who accepts the check that includes such a description should bear the loss in the event of double presentment.  Id.               

Current Status of 12 C.F.R. § 234(g)

The revisions and additions to Regulation CC, 12 C.F.R. § 229, including the New§ 234(g) indemnity provision are still at the proposed rule making stage.  The Board expects further action on the proposed regulations to take place sometime in December 2014.