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Commercial Law
Rutgers University, Newark School of Law
Ondersma, Chrystin

Commercial Law

Professor Chrystin Ondersma

Spring 2012

Part I

Payment Systems

1. The Basic Checking Relationship

a. When is it proper for a bank to pay?

i. When the check is “properly payable” (UCC 4-401(a))

ii. A check is “properly payable” when:

1. The customer authorizes payment; and

2. There is not a contrary agreement between the bank/customer

a. UCC 4-401(a) → look to contractual relationship (e.g., K specifies bank will not charge customer’s account if an overdraft would occur)

b. Overdrafts

i. If properly payable, bank may charge account even if charges creates an overdraft unless the customer/bank had previously agreed upon a different course of action (UCC 4-401 comment 1 → look to contractual relationship)

ii. Can the overdraft fee be limited?

1. Not addressed by UCC and depends on the jurisdiction; some courts have found high overdraft fees (1) violate implied duty of good faith, or (2) are unconscionable.

c. When can a customer stop payment?

i. A customer may stop payment if payor bank is given timely and adequate notice and adequately describes the check (UCC 4-403)

1. If stop payment is properly executed, essentially revokes authorization; no longer “properly payable” as required under UCC 4-401

ii. Stop payment is only valid for 6 months

d. Payment that arises from an underlying obligation (for which check was written)

i. Two rights are at play: (1) right to enforce the check and (2) right to pursue the check writer on the underlying transaction

ii. If the payee accepts a check, he or she forfeits the right to pursue the underlying transaction. (UCC 3-310)

1. If the check is stopped or dishonored, however, the underlying obligation right is REVIVED.

e. Postdating checks

i. Bank must be notified if customer postdates check (notification must include a sufficient description of the check). If no notice is provided, the bank may authorize or deny (and charge an overdraft fee) an account IF made in “good faith” (UCC 4-401(c))

1. “Good faith” includes behavior that comports with “reasonable commercial standards of fair dealing” (UCC 1-201(b)(2) & 3-103(a)(6))

f. Remedies for Improper Payment

i. If the bank improperly pays check, the bank must re-credit the customers account (i.e., reverse the improper transaction).

ii. Under the principle of “subrogation” the bank may assert the rights of the payee and seek recovery for the underlying obligation/transaction if the bank will be double paying (UCC 4-407)

2. The Bank’s Obligation to Pay Checks

a. When may a bank dishonor a check?

i. Only if check is not properly payable (not authorized or there are insufficient funds in the account) (UCC 4-402).

1. Time of evaluation – a decision to dishonor will remain appropriate even if new funds are added to account after the bank has evaluated the check (even if on same day)

2. Availability of funds – depositary banks typically limit access to funds from check until it is certain the check will be honored by another bank.

a. Although the UCC imposes no time restraints on fund availability (UCC 4-215(e)), a depository bank must comply with Regulation CC, which establishes a framework of deadlines within which a depositary bank must transfer funds

ii. OR, if the check is more than 6 months old, the bank may dishonor. If bank does charge customer’s account, the payment must be made “in good faith.” (UCC 4-404)

1. Good faith = behavior that comports with “reasonable commercial standards of fair dealing”

b. Regulation CC (a framework of deadlines; when a depository bank MUST transfer funds to customer’s account)

*Note, the regulation differentiates between attempts to

use funds indirectly (write a check) or indirectly (withdrawing cash)*

i. Noncash withdrawals

1. 1st day after deposited: must make $100 available [Reg CC 229.10(c)(1)(vii)]

2. 2nd day: all funds must be available (up to $5,000)

3. If more than $5,000, the funds must be made available a “reasonable period after funds would have been required” [Reg CC 229.13(d)]

a. “Reasonable period” is an extension of FIVE b

s account has sufficient funds. Payor bank’s obligation runs to the drawer.

ii. In relation to transporting the check to the payor bank, the depository bank’s only obligation is one of “ordinary care” (UCC 4-202)

1. But remember, DB has an incentive to act quickly because of funds availability requirements

iii. Collection process varies based on whether:

1. Direct payment – payee cashes check at payor bank OR drawer/payee have the same bank (“on us”)

a. If cashing check at payor bank, the payment is final (UCC 4-215(a)(1))

b. If “on us” —

i. Bank gives account a “provisional credit”

ii. Bank has until the midnight deadline to decide whether to honor the check; if bank does nothing, it loses the right to dishonor the check.

iii. If bank dishonors a check, it can “charge back” the credit given to payee’s account

1. If funds already withdrawn, bank can sue to recover money, so long as midnight deadline is met (UCC 4-214(c), 4-301(b))

2. Indirect payment – drawer and payee have different banks

a. Options for collection process include: federal reserve; clearing house; bilateral relationship

b. When the customer deposits the check into his account, an agency relationship is created between customer and depository bank.

i. A provisional settlement is given to customer (may be recovered if payor does not honor check) (UCC 4-214)

iv. Separate bank locations are treated as separate banks for the purpose of computing time requirements (UCC 4-107)

v. A bank may cut off banking day at 2 PM; if received after, treated as being received at the opening of the next banking day (UCC 4-108)