We are Bank A. Our customer wrote 3 checks to their vendor who mobile deposited the checks at Bank B with their endorsement and "mobile deposit" written under their endorsement. The vendor had a break in and the three checks were stolen and deposited at Bank C by the thief. The images of the checks coming through the second time still have "mobile deposit" written on the back. We returned these through our correspondent bank as "multiple presentment" and our correspondent bank returned them as unpaid to Bank B. Shouldn't our correspondent bank have returned these as unpaid to Bank C since they accepted the items with a restrictive endorsement?

Yes, if you returned the checks that were deposited at Bank C, your correspondent should have returned them there. Bank B can attempt to correct the return if there is evidence that Bank C was the bank that handled the checks that were returned. The "mobile deposit" restriction is irrelevant to the correct routing of the return. It's the record of who indorsed the check on the way to your correspondent that's key.

On the other hand, are you certain that you returned the correct checks?

If the checks had been returned to Bank C, Bank C would not have been able to make an indemnity claim against Bank B (because of the "mobile deposit" restriction).

Our correspondent bank is saying that since Bank C holds the live item, we have to return it to Bank B because it was their customer's fault for not securing the items.

Apparently, when we first sent the adjustment, we sent it to Bank C. Our correspondent said that was incorrect so they changed it to be sent to Bank B. Then our customer called us and told us that their vendor was getting the money taken from their account at Bank B. So then we called our correspondent and had them send the adjustment back to Bank C instead.

So now Bank B is whole, and Bank C is sending the adjustments back to us as "Entry in Error" because they hold the live item. When I argued with correspondent that the item has the restrictive endorsement and Bank C took the item for deposit in a way that is not consistent with the restrictive endorsement, correspondent said that doesn't matter since Bank C has the live item. That's not how I interpret Reg CC...

What am I missing here?

You've used two different terms interchangeably that aren't interchangeable. You can "return" a check unpaid before the midnight deadline. If the paper checks were returned in this manner, they would go back to Bank C and Bank C would determine whether it had an indemnity claim against Bank B (which apparently it doesn't).

But if the paper checks were paid (your bank did not revoke settlement by the midnight deadline), then your bank would be initiating an "adjustment" rather than a return. In that case, the adjustment entry is better sent to Bank B because Bank B made a warranty that no one would be asked to pay both the paper and the electronic version of the check. Bank C did not make any such warranty. Although you could initiate an adjustment to Bank C, that Bank could deny the adjustment because there was no breach of warranty.

We sent these as an adjustment with the reason being "Paid - Paid (2nd Presentment)" per guidance from our correspondent. We sent them back the same day they hit the account the second time, so we did it within the midnight deadline, but perhaps our bookkeeping department used the wrong method?

So you are saying that we should have returned them unpaid with the reason being "Duplicate Presentment" instead of doing the adjustment with the reason being "Paid - Paid (2nd Presentment)"?

If you learned of the double dipping in time to do a standard midnight deadline return, that would be the easier and preferable route. The return reason code for returning the image of the check would be "Y" - Duplicate presentment.