Summary of the business threat posed by check/entry processing order lawsuits.

There is an increasing number of highly publicized lawsuits being filed against banks seeking damages based on the order in which the banks process for payment their account holders’ checks and/or electronic debits. Further, these cases are often being filed as class action lawsuits. Large dollar verdicts are feared, and at least one bank elected to resolve its lawsuit for a $9.5M settlement.

What are these cases about?

Banks are generally free to process the checks and electronic debits of their customers in any order the bank selects. Thus banks are free to process presented items in the highest-to-lowest, lowest-to-highest, on-us or any other sequence which has a rational basis, so long as it is performed with chronological integrity (i.e., so long as each day’s Items and Entries are timely processed). Some banks commit to a particular processing order by contract, often within their written customer Account Agreements. Some banks have different processing sequences for paper checks, electronic entries, and on-us items.

The lawsuits springing up across the country appear to have the common allegation that the defendant-banks selected a processing sequence in order to generate the highest amount of fee income for the institution. Generally, it is alleged that the processing order selected is highest-to-lowest, because of the suspicion that this processing order creates the maximum number of Overdraft or Not Sufficient Fund charges which may be billed to the account holders.

Is any processing order system mandated by law?

No. Respecting paper checks KRS 355.4-303 states “…items may be accepted, paid, certified, or charged to the indicated account of its customer in any order.” The UCC’s Official Comments also includes the language, “As between one item and another no priority rule is stated.” As Article 4 of the UCC tends to speak to Items, i.e., written instructions like checks, Article 4A speaks to funds transfers, i.e., which includes many common electronic debits and credits. In Article 4A, attention is given to KRS 355.4A-504, “…the bank may charge the sender’s account with respect to the various orders and items in any sequence.”

Because nothing in banking compliance is ever to be too easy, Article 4A excludes from its coverage funds transfers which are governed by the Electronic Fund Transfer Act (15 U.S.C. 1693, et seq.) Under the EFTA and its Reg. E there is not a processing order requirement. The last time the Fed considered the question, no sequencing order was mandated. While sheer operational necessity requires that banks follow a sequencing method, whatever method is ultimately chosen is bound to disadvantage some group or another of the bank’s customers, which group(s) even may vary day to day.

Can we change our current processing order if we want?

Yes. With the freedom to select your processing order flows the ability to change that order. Whether or not your processing order has been committed to by a written contract (e.g., within your Account Agreement), a serious question exists as to whether or not it is good practice to provide written advance notice to your customers, in the event the bank changes its practice. It may be that notice of a material change in your handling of your customers’ transactions may be helpful to your bank’s competitive and reputational interests, particularly for those of your customers who have come to rely on your “old” processing order. Respecting account arrangements subject to the EFTA, the law may require such advance notice. Respecting paper checks, questions of whether to provide notice must be evaluated against the general guidance that it is not necessary to commit in writing to any particular order of processing. Regulation DD does not require an "order of payment" disclosure, and as such would not require a re-disclosure upon a change. Of course, the OTS guidance says the order of payment should be disclosed: "Savings associations should also clearly disclose rules for processing and clearing transactions." Otherwise, guidance from the other agencies merely suggests that consumers be told the order of payment can affect fees, but not what the specific order of payment is selected: "Explain impact of transaction clearing policies. Clearly explain to consumers that transactions may not be processed in the order in which they occurred, and that the order in which transactions are received by the institution and processed can affect the total amount of overdraft fees incurred by the consumer. " Against this regulatory direction (or lack thereof) must be weighed the bank’s reputational business interests and the legal risks that might perhaps flow from a perceived change in a contractual course of dealing in the minds of your customers.

Where might I learn more about the new lawsuits?

Two of the most important high profile lawsuits are summarized in the below website:

The following are a number of the more recently filed class action lawsuits:

- Schulte v. Fifth Third Bank, USDC, N.D. of Ill., Case 1:09-cv-06655 ($9.5M settlement announced)

- Pamela Harris v. Associated Bank, N.A., Circuit Court of Milwaukee County, Wisconsin, Case No. 10 CV 012266

- Donald and Vickie Stevens of Crestline v. FirstMerit Corporation, Summit County Common Pleas Court in Akron, Ohio.

Will the litigation threat affect community banks?

Until you have actually been sued, the threat is only theoretical. Concern arises because (1) your customers will be learning about these nationally publicized lawsuits and case settlements; (2) lawyers who are not adverse to suing banks may come to believe that such cases present a viable business model for them to pursue; (3) after the larger banks are sued, there may be a trickle down to litigation against community banks; and (4) processing order may not have been examined as an operational issue at your bank for sometime and/or your bank may have entered into a vendor relationship respecting the handling of electronic Entries where this issue was not considered at the time.

Is there any Kentucky case law guidance in this area?

No. There is no recorded Kentucky case law decision we have discovered. Many bankers will remember that this similar threat, respecting check processing order claims, arose in the late-1990’s. At that time, Kentucky bankers were successful in defeating the litigation brought against the banks.

How do I assess the risk to my bank?

Obviously, the first step is to assemble an operational team to investigate current procedures to assess the risk level. However, internal investigation must be properly performed. Otherwise, the risk is that the bank ends up creating a “road map” that you may be forced to produce to your adversary if litigation is filed against you. Your own bank’s counsel can give you advice about the proper way to structure a confidential and legally privileged internal investigation.

If you contract some or all of the processing work to an outside vendor, research into the vendor’s actual protocol may be warranted. You may also want to look into the vendor’s marketing material, for example to see if fee income presentations were made, and to investigate if the vendor’s contract contains any important representations or warranties. It may also be worth considering the potential risk under your bank’s insurance coverage, just to have a preliminary guess as to what coverage may be available.