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Commercial Law
Southern Illinois University School of Law
Camero, Jennifer

Camero-Spring 2012

Financial Systems: The Law Governing Checks

· The Basic Checking Relationship

o Definitions

§ Drawer (or Issuer) – pays with the check, the purchaser

§ Payee – accepts payment by check, the seller

§ Depository (or Collecting Bank) – Bank where payee has account, where he deposits the check

§ Payor Bank/Drawee – bank where drawer has the account, where funds are debited from.

o The Bank’s Right to Pay

§ General Rules

ú The bank may pay any item which is properly payable. UCC 4-401 (a).

· An item is properly payable if:

o The customer has authorized its payment. UCC 4-401 (a) com. 1.

ú If the payee gives the check to an intermediary, they become a person entitled to enforce the check. UCC 3-301.

· But if it is stolen by a third party and presented for payment, it is not properly payable because they are not authorized. UCC 4-401 com. 1.

§ Overdrafts:

ú The bank MAY pay an overdraft, but may also decline to do so (“dishonor”). UCC 4-401 (a) & (b).

· Unless it has previously agreed to pay the overdraft. If it has, it must pay or become liable for wrongful dishonor. UCC 4-402 (a).

ú The UCC does not limit the fees the banks can charge; some states have done so with common law.

ú Banks may pay items in any order, even if doing so would create multiple ovedrafts. UCC 4-303 (b).

§ Stop Payments

ú A customer may stop payment if it gives: (1) timely and (2) effective notice. UCC 4-303.

· It must be received “at a time and in a manner that affords the bank a reasonble opportunity to act before any final action is taken with regard to the item.” UCC 4-303 com. 7.

ú Stop payment orders last six months. UCC 4-303 (b).

· Banks usually pay checks whose stop payment orders that have expired, so the drawer must renew every six months.

§ Underlying obligations

ú When the payee accepts a check, their right to enforce the underlying obligation is suspended. UCC 3-310 (b)

· If the check is dishonered, they regain their right to enforce the underlying obligation. UCC 3-310 (b) (1).

o Remedies for Improper Payments

§ Generally, the bank has to reverse the transaction and recredit the consumer’s account, plus consequential damages. UCC 4-402.

§ But the payor bank is subrogated to the rights of the payee, so if the drawer was supposed to pay the payee for whatever reason, the bank can assert their defenses as against the recredit. UCC 4-407.

· The Bank’s Obligation to Pay

o A bank must pay any item if the drawer has sufficient available funds to cover it. Otherwise, they commit wrongful dishonor, and they’re liable to the payee for consequential damages proximately caused. UCC 4-402.

§ This is evaluated “at any time between when the item is received by the payor and the time the payor bank returns the item.” UCC 4-402 (c).

ú So basically whenever the bank decides they want to evaluate it.

o Availability of Deposited Funds

§ Regluation CC overrides UCC 4-215 (e), which allowed banks to just make funds available whenever they wished.

ú Definitions for the next section:

· A local check is one drawn on a bank in the same federal reserve distrcit as the depository bank; a non-local check is one drawn on a bank outside the federal reserve district that the depository bank is in. Reg CC 229.2 (m).

· A business day is everything but a weekend or a federal holiday. Reg. CC 229.2 (f)

· A banking day is a business day on which the bank does all of its banking. Reg. CC 229.2 (g).

§ Check deposit availability (Reg CC)

ú Local Checks for Cash Withdrawals (in business days):

· Day 1: $100

· Day 2: another $400 (total $500)

· Day 3: the remainder

ú Non-Local Checks for Cash Withdrawals

· Day 1: $100

· Day 5: another $400 (total $500)

· Day 6: the remainder

ú Local Checks for Non-Cash Withdrawals

· Day 1: $100

· Day 2: the remainder

ú Non-Local Checks for Non-Cash Withdrawals

· Day 1: $100

· Day 5: the remainder

§ Low-risk item availability

ú Low risk items are:

· Cash

· On-us items (drawn on the same branch of the bank or a local brach of the bank)

· Treasury Checks

· Money Orders

· Federal Reserve Checks

· Local government checks

· Cashier’s checks

ú Low

he “collecting bank” and must exercise ordinary care. UCC 4-105 (5); UCC 4-202 (a).

· This creates the provisional settlement and allows the bank to charge back subject to the payor bank’s dishonor. UCC 4-214

ú Depository Bank to Payor Bank

· Although it must exercise ordinary care, the Depository Bank then has the ability to do whatever it wants to cllect the check (although because it must make the funds available to the customer subject to the rules about availability of funds, it generally wants to act as quickly as possible to minimize the risk that the cusomter will withdraw the money and create neecssity for a lawsuit).

· The bank uses check sorters to encode a MICR line on the check with its information and then sends it on to one of two places:

o Clearinghouse: the bank sends it to a local clearinghouse, which aggregates checks and “nets” them to accounts of all the local banks, then forwards the physical checks to the payor banks for presentment and payment.

§ Typically, clearinghouses give a shorter deadline than midnight the next business day for a bank to decide whether to honor or dishonor – this can be varied by agreement, but it’s typcially late the next morning.

§ Payment is final when the bank makes a provisional settlement (automatically done through the clearinghouse) and then does not exercise its right to dishonor before the clearinghouse deadline. UCC 4-215 (a) (3).

§ And then the bank no longer has the right to a charge back.

§ If the bank decides to dishonor, they return the check by putting a new MICR line on it and putting it in the mail. UCC 1-201 (b) (36).

§ This results in a chargeback to the payee. UCC 4-214.

§ And the payee can then go after the drawer for the underlying obligation UCC 3-310 (b).