Check 21: The Basics and More

by Mary Beth Guard, BOL Guru

The Check 21 Act ("Check 21") is a major new federal law scheduled to take effect Oct. 28, 2004. Designed to promote greater efficiency in the check processing system, the law permits, but does not require, check truncation. For those in compliance, it also imposes new responsibilities.

When a check is "truncated," that means an image is created from the original paper check and the original paper check is then removed from the check collection or return process. Under Check 21, the truncating bank has two possible options.

Option 1 does not require any sort of agreement between the parties. Option 1 allows a "substitute check" to be sent to a recipient, in lieu of the original paper check. The "substitute check" is a crucial component of the new law. It is a paper reproduction of the original check that meets four criteria described below and is the legal equivalent of the original. More on substitute checks in a minute, but first, back to the options for the truncating institution.

Option 2 allows data taken from the MICR line of the original check or an electronic image of the original check to be sent to a recipient in lieu of the original check, so long as there is an agreement between the parties to allow it. [These "agreements" may be between multiple parties, rather than individual bank to individual bank. For example, there may be a network agreement, or clearinghouse rules that constitute the "agreement.]

Obviously, the efficiency of the payment system will not be greatly enhanced if parties in the chain insist upon paper. If a recipient demands paper, a substitute check must be created and couriers will be needed to transport the item from point A to point B. If an image can instead be exchanged, it can be digitally transported, with resulting savings in time and money.

A substitute check is a paper reproduction of the original check. To qualify as a substitute check, the reproduction must:

contain an image of the front and back of the original check;
bear a MICR line containing all the information appearing on the MICR line of the original check;
conform, in paper stock, dimension, and otherwise, with generally applicable industry standards for substitute checks; and
be suitable for automated processing in the same manner as the original check.

If a bank must produce a substitute check (because the next person in the chain refuses to agree to accept an image), it will incur costs as a result, so it is anticipated that an institution required to produce a substitute check will want to be compensated with a fee. Check 21 is applicable to all deposit accounts.

October 2004 may seem like a distant future date, but it's time to start preparing for the new compliance responsibilities that accompany the new law.

Disclosing new fees
If you plan to charge for producing or providing substitute checks, increasing any of your existing fees, or imposing any other new fees, your Truth in Savings account disclosures will need to be amended to incorporate the new/revised fees. Since the addition of a new fee will be a change in terms that is adverse to your consumer customers, you must provide a change in terms notice under Reg DD no less than 30 calendar days before the effective date of the change. (Business customers will similarly be adversely impacted by the new fee, but TISA disclosures are inapplicable to them.)

New customer notices
While Check 21 applies to all deposit accounts, there are special protections built into the Act for consumers. One protection is a notice/disclosure that consumer depositors must be given. The second protection consists of an expedited process for recrediting the account of a customer who makes a covered claim relating to a substitute check.

The law mandates that the notice to consumer customers cover two areas: the legal equivalence of a substitute check and a description of what the consumer?s expedited recrediting rights are in the event of certain problems with substitute checks. The Federal Reserve Board has nine months to adopt model notice language and there is a safe harbor of protection for institutions that use the model language in their notices.

There are three possible triggers for providing the notice. The first relates to the effective date of the law. A copy of the notice must be provided to each consumer by the first regularly scheduled communication with the consumer after the effective date of the Act. Look at your schedule for providing statements on the various types of deposit accounts you offer. The Federal Reserve is interpreting this part of the requirement to only apply to the extent the consumer customer currently receives their original checks back, and you intend to continue returning paper checks (some of which will be substitute checks) after the effective date of the Act. If that is the case, identify the first statement date following the Oct. 28, 2004 effective date. That is the latest date for providing the notice. It is permissible to provide the notices prior to that date, but, obviously, you will need to wait until the Federal Reserve issues model language. And, if you're providing only imaged statements, you don't need to give this new consumer awareness notice to all your existing customers.

The second trigger occurs when a new account is opened. The law provides that the notice must be provided to each consumer who will receive original checks or substitute checks, at the time at which the customer relationship is initiated. If an individual opening a new account is an existing customer, however, it is not necessary to provide another copy of the notice if you provided it to them previously. Again, if you provide only imaged statements on the type of account being opened, no notice is required at the time of account opening.

From the wording, it appears that if there is a joint account, the notice must be given to each of the joint accountholders, and perhaps The regulations should help clarify whether that is the case on both the notices on new accounts and those that must be given to existing customers.

A consumer?s request for a copy of a check is the third trigger. If a consumer customer requests a copy of a check and receives a substitute check in response, the bank must provide a copy of the notice at the time of the request. Presumably, this timing for the notice is designed to put the information into the hands of the consumer at a time when it is most meaningful because the consumer will actually be dealing with a substitute check.

How do you deliver the notice? You may mail it or send it ?by any other means through which the consumer has agreed to receive account information.?

When the model forms and disclosures are issued in final form by the Federal Reserve, we?ll be looking to see how much flexibility is there. What are the standards?

For example, you cannot just post the Check 21 notice, like you can the CIP notice. The statute talks about Mode of Delivery and says a bank may send the notices by mail or by any other means through which the customer has agreed to receive account information.

Another significant issue for you to consider is to what extent you may wish to go beyond the two areas the statute requires you to cover. And if you do decide to provide expanded awareness material to your consumer customers, should you do so within the context of the same disclosure or in a lobby brochure, statement stuffer or letter to depositors?

There?s also the issue of when you should start raising customer awareness. Don't forget about commercial customers. While they are not entitled to a notice under the Act itself, they will still need to be informed, as a practical matter, because the changes will affect them.

Consider what the big changes are for customers:

In some cases, there will be no way to ever get the customer's original check back;
If the customer is accustomed to receiving all their original checks back in their statement, they're going to experience a change, because, at the very least, some of them will be substitute checks instead of originals. Think your customers will be unhappy receiving mere images or copies of images? You need to decide "how happy you want to make the customer" and you'll need to take into account how much money it will cost you to obtain substitute checks to include in customer statements on a routine basis. You may decide that you will accept images, but reserve the right to request substitute checks.
If the customer is used to an imaged statement, your operations folks will need to start working on the challenge of how to assimilate a statement that may contain:
- images you create in-house (where, for example, the payee has cashed the on-us check at your bank and you have truncated);
- images presented to you by other institutions; or
- substitute checks or images of substitute checks.

Before Oct. 28, 2004 arrives, your employees will need to be trained to follow a procedure for providing the notice in a timely manner when a customer requests a copy of a check and receives a substitute check. The statute says the notice must be given "at the time of the request." New account personnel also will need to provide the notice at the time of account opening to new consumer depositors.

Expedited recrediting procedure
Put on your Sherlock Holmes hat. The second component of the consumer protection measures in Check 21 is an error resolution/ investigation procedure that is analogous to Reg E . with some notable differences.

The entire procedure revolves around substitute checks and problems that a consumer may experience with them. Its goal is to resolve errors in a speedy manner so that the customer is not wrongly without the use of disputed funds for an extended period of time.

In order for the procedure to apply:

It must be a consumer making a claim for expedited recredit;
the claim must be in connection with a substitute check
not an image, not a copy, not an original;
the bank must have charged the consumer's account for a substitute check that was provided to the consumer;
the consumer must make a claim in good faith;
the claim must be made before the end of the 40-day period beginning on the later of l) the date on which the statement was mailed or delivered; or 2) the date on which the substitute check was made available;
the customer must have suffered a loss; and
the production of either the original check or a better copy of the original must be necessary to determine the validity of the claim;
The claim must relate to one of the following two grounds:
- the check was not properly charged to the consumer's account; or
- the consumer has a warranty claim with respect to the substitute check.

There are a number of steps you will need to take in order to ensure the expedited recrediting procedure has been properly put into place. Here's a quick list of some of the decisions to be made:

Figure out who's in charge of processing such a claim. Who will handle the calendaring, the claim review, the investigation, the communication with the customer and the recrediting (if recrediting needs to occur, or the reversal, if a decision is made that provision recredit was not warranted after all).
You have the option to require the claim to be in writing. Are you going to require written claims?
Do you plan to have a special complaint form? That will be the best way to cover all the bases and make sure you quickly and easily get the information you need.
Are you going to have a document that explains to the customer in layman's language, when this procedure is or is not appropriate and what the standards/requirements are? Having such a document will help reduce the number of claims that do not meet the statutory criteria.
You will need notice forms - or form letters - for communicating your decision to the customer. Three flavors will be required:
- Yes, there was an error and we will recredit.
- Sorry, but there was no error, so we're not changing anything.
- We gave you provisional credit. Now, we've determined the claim isn't valid, so we're taking back the credit, and here's how that process will work.
You might want one additional form letter - saying that this is not the type of claim that can be made under Check 21 (for example, if it is a UCC claim).
A calendaring mechanism will be required. Either a log or a spreadsheet could be used for determining your timeframes, so you do what you're supposed to do when you're supposed to do it.
A checklist would be useful to help you determine whether the claimant has met the timing and substance requirements have been met.

Proper grounds for claims
There are only two permissible grounds a consumer may use to invoke the expedited recrediting procedure. The consumer must allege in good faith either that the check was not properly charged to the consumer's account, or that the consumer has a warranty claim with respect to the substitute check.

In terms of the first basis, the customer may seek to prove the item was not actually drawn on his account, for example, and mistakenly debited to it.

In terms of the consumer asserting a warranty claim, it is crucial to understand the nature of the substitute check warranty. The substitute check warranties are contained in Section 5 of the Act. Under that section, the substitute check warranties are made:

by a bank that transfers, presents or returns a substitute check and receives consideration for the check warrants, as a matter of law, or
to the transferee, any subsequent collecting or returning bank, the depositary bank, the drawee, the drawer, the payee, the depositor and any endorser (regardless of whether the warrantee receives the substitute check or another paper or electronic form of the substitute check or original check).

The substance of the warranty is that:

the substitute check meets all the requirements for legal equivalence under section 4(b) of the Act (described earlier in this article); and
no depositary bank, drawee, drawer or endorser will receive presentment or return of the substitute check, the original check or a copy or other paper or electronic version of the substitute check or original check such that the bank, drawee, drawer or endorser will be asked to make a payment based on a check that the bank, drawee, drawer or endorser has already paid.

Timing for the consumer's claim
A claim for expedited recrediting under Check 21 must be submitted by the consumer before the end of the 40-day period beginning on the later of the date the statement which contains the relevant information was mailed or delivered to the consumer, or the date on which the substitute check is made available to the consumer.

Interestingly, the statute offers an extension for "extenuating circumstances," giving the consumer a longer period of time in which to make a claim in the event of extended travel or illness of the consumer.

Keep that in mind when formulating that language on your claim form. If the original claim is being made beyond the 40-day deadline, you will want to determine if the circumstances would earn the consumer a statutory extension.

Required content for claim
There are four required components for a proper claim:

The consumer must describe his claim, explaining why the substitute check was not properly charged to his account or what the warranty claim is with respect to the check;
There must be an allegation that the consumer suffered a loss, and the consumer must estimate what the loss amount is;
The consumer must state the reason why production of either the original check or a better copy is necessary to determine the validity of the charge to the consumer's account or the warranty claim; and
Sufficient information must be provided to allow the bank to identify the substitute check and investigate the claim.

You get to decide whether you will require the claim to be in writing and whether you wish to permit the submmission to be made electronically.

Avoiding recredit
If a consumer makes a claim for expedited recrediting, the bank must recredit if:

the consumer's claim meets the statutory requirements; and
the bank has not provided to the consumer either the original check or a copy (which could even be an image or a substitute check) that accurately represents the information on the front and back of the original as of the time the item was truncated; and
the bank has not demonstrated to the consumer that the substitute check was properly charged to the consumer account.

Timing of recredit
If the consumer satisfies the standards set forth above, you must recredit his account no later than the end of the business day following the business day on which you determine the claim is valid.

If you need more time, the law provides that if you haven't determined the validity of the customer's claim before the end of the 10th business day after the business day on which the claim was submitted, you must recredit the account for the lesser of the amount of the substitute check that was charged against the consumer account, or $2,500 (with interest, if it's an interest-bearing account) no later than the end of that 10th business day. Then, you must recredit the account with the remaining amount of the substitute check (if the check was for an amount greater than $2,500, plus interest if it was an interest-bearing account) no later than the 45th calendar day following the business day on which the consumer submits the claim.

First published on BankersOnline.com 05/24/04