Background. Effective July 1, 2018, recent changes to Regulation CC[1] provide new warranty and indemnity rights, liabilities, and obligations potentially impacting a bank, particularly a bank providing a remote deposit capture (RDC) service, including a mobile RDC service, in its role as a depository bank. The new indemnities and warranties are based in part on new definitions of “electronic check” and “electronic returned check” in Regulation CC § 229.2(ggg) for purposes of Regulation CC, subpart C, dealing with the forward collection and return of checks as both paper and electronic checks and electronic returned checks.[2] An “electronic check” and an “electronic returned check” mean an electronic image of, and electronic information derived from, a paper check or a paper returned check. Presently, Regulation CC, subpart C, applies only to paper checks.[3] Generally, Regulation CC, subpart C, presently presumes the forward collection and return of paper checks.[4] However, under Regulation CC § 229.30, as amended, both electronic checks and electronic returned checks are subject to subpart C, except where “paper check” or “paper returned check” is specified. These new warranty and indemnity rights, liabilities, and obligations could amplify the operational risks a bank faces, particularly those associated with RDC service, as detailed below.
- Image quality warranty and no double debit warranty. Under new Regulation CC § 229.34(a)(1), a bank transferring or presenting an electronic check or an electronic returned check and receiving settlement or other consideration for it warrants that (a) the electronic image of the check represents all of the information on the front and back of the original check as of the time that the original check was truncated, and the electronic information includes an accurate record of all MICR line information required for a substitute check under § 229.2(aaa) and the amount of the check (i.e., the Image Quality Warranty); and (b) no person will receive a transfer, presentment, or return of, or otherwise be charged for an electronic check or electronic returned check, the original check, a substitute check, or a paper or electronic representation of a substitute check such that the person will be asked to make payment based on a check it has already paid (i.e., the No Double Debit Warranty).[5] In explaining these new warranties, the Regulation CC commentary provides that the electronic check and electronic returned check warranties in § 229.34(a) “correspond to the warranties made by a bank that transfers, presents, or returns a substitute check . . . . (See § 229.52 and commentary thereto).”[6] In the case of a transfer of an electronic check for collection or presentment, under Regulation CC § 229.34(a)(2)(i), these warranties run in favor of the transferee bank, any subsequent collecting bank, the paying bank, and the drawer.[7] Whether a bank creates an electronic check or its customer creates an electronic check through RDC, the bank makes the Image Quality Warranty and the No Double Debit Warranty under Regulation CC § 229.34(a)(1) when it transfers or presents an electronic check. In the case of a transfer for return, a bank makes these warranties to a transferee returning bank, the depository bank, and the owner.[8] As a paying bank, when and as it identifies a check as a suspected duplicate check (a check it has previously paid) and elects to dishonor it by creating an electronic returned check, it could breach the Image Quality Warranty or the No Double Debit Warranty through the electronic returned check.
These risks under Regulation CC, as amended, are amplified when a bank provides a payable-through-draft service or a third-party draft service as a treasury management service to a commercial customer as the population of warrantees increases as to electronic checks. In instances where a bank provides a payable-through-draft service, a commercial customer issues drafts drawn on it and payable through the bank offering this service. In instances where a bank provides a third-party draft service, the bank provides its commercial customer with draft stock to be provided by the commercial customer to its customers to enable its customers to draw these third-party drafts on the commercial customer. Similar to the payable-through-draft service, the bank providing the third-party draft service acts as a “payable through bank” for drafts issued under such service. An example of a third-party draft is a “convenience check” drawn by a credit-card holder against the cardholder’s line of credit associated with the credit card issued by the commercial customer to the convenience check drawer. In both instances, a drawer of a payable through draft—a commercial customer—or a drawer of a third-party draft—a customer to a commercial customer—could be a warrantee of the Image Quality Warranty or the No Double Debit Warranty granted by the payable through bank if such drafts are converted to an electronic check and presented for payment under the service. Further, upon dishonor of a payable through draft or a third-party draft by its drawer or purchaser of the service, in instances where a payable through bank returns such draft as an electronic returned check, it could act as a warrantor of the Image Quality Warranty or the No Double Debit Warranty as well as to the returned electronic check. In sum, in the case of transfers of an electronic returned check for return, under Regulation CC § 229.34(a)(2)(ii), these warranties applicable to an electronic returned check (the Image Quality Warranty and the No Double Debit Warranty) run in favor of the transferee returning bank, any subsequent returning bank, the depository bank, and the owner[9] of an electronic returned check. A bank providing the payable-through-draft service or the third-party draft service could also be the depository bank of a payee of such draft. In such instances, a customer of that depository bank—the payee owner of the draft—could be a warrantee upon dishonor of the draft by the drawer or the commercial customer purchasing the service. The “consideration” the bank receives to cause the warranty liabilities to attach to it could be the revocation of the provisional credit granted by the bank (as depository bank) under Uniform Commercial Code § 4-214 to the payee owner through the original deposit transaction of the draft. Additionally, a bank providing an RDC service could also be the paying bank of a check it accepts for deposit from its payee owner through that RDC deposit service. As a paying bank of that check, it could elect to dishonor the check. If the dishonored check is viewed as an electronic returned check, the owner of the check could be a warrantee of the Image Quality Warranty and the No Double Debit Warranty.[10] Damages for breach of these warranties could be the consideration received by the bank that presents or transfers the check or returned check, plus interest compensation and expenses related to the check or returned check, if any.[11]
- A RDC indemnity. Under new Regulation CC § 229.34(f)(2), a novel indemnity is provided to address the allocation of liability where a depository bank accepts a check through RDC to create an electronic check for forward collection, and another depository bank suffers a loss resulting from the latter accepting the original paper check. Under Regulation CC § 229.34(f)(2), this indemnity would be provided by a bank that accepted a check via RDC (Bank A) to a bank that accepted the original paper check for deposit (Bank B),[12] in the event the latter bank incurs a loss because the check had already been paid. (Even if Bank B could, it has no obligation to charge the check against its customer; as a potential holder in due course, it has no obligation also to pursue a claim against the drawer of the check.) This indemnity obligation attaches to Bank A if it (a) is a truncating bank because it provides a RDC service, (b) does not receive the original check, (c) receives settlement or other consideration for an electronic check, and (d) does not receive a return of the check. Under Regulation CC § 229.34(f)(3), Bank B may not pursue an indemnity claim against Bank A if the original check bore a restrictive indorsement inconsistent with the means of deposit, e.g., “for mobile deposit at Depository Bank A only” and the payee’s account number.[13] The indemnity amount under Regulation CC § 229.34(i) is the amount of the loss suffered by Bank B up to the amount of settlement or other consideration received by Bank A, and interest and expenses incurred by Bank B, including costs and reasonable attorney’s fees. Under Regulation CC § 229.38(g), an action to enforce this indemnity must be commenced by Bank B within one year after the occurrence of the violation involved.
- Electronically created item indemnity. Under new Regulation CC § 229.34(g), a bank transferring or presenting an electronically created item (ECI) and receiving a settlement or other consideration for it must indemnify (as set forth in Regulation CC § 229.34(i) detailed above) each transferee bank, any subsequent collecting bank, the paying bank, and any subsequent returning bank against losses resulting from the fact that (a) the electronic image or electronic information is not derived from a paper check; (b) the person on whose account the ECI is drawn did not authorize the issuance of the item in the amount stated on the item or to the payee stated on the item; or (c) a person receives a transfer, presentment, or return of, or otherwise is charged for an ECI such that the person is asked to make payment based on an item or check it has already paid. In explaining the losses a paying bank could suffer with respect to an ECI, the Regulation CC Official Commentary provides that such losses include losses arising from a failure to comply with Regulation E because the paying bank would not be able generally to identify an ECI from an electronic check.[14] Given that the paying bank could view the ECI as an electronic check, it could fail to grant a consumer drawer of the check rights and remedies under Regulation E.
New terms to a deposit account agreement for a bank, particularly a bank providing a RDC service. In light of these new warranties and indemnity rights, liabilities, and obligations under Regulation CC, a bank may consider amending its deposit account agreement to strengthen a customer’s indemnity obligations to the bank, especially as to a commercial customer employing the bank’s RDC service (referenced as “you” and “your” in the sample below).[15]
Your Agreement to Indemnify. You will indemnify, defend, and save us and our parent company and its affiliates and each of their respective directors, officers, employees, and agents (collectively, “Indemnitees”) harmless from and against all liabilities, damages, claims, obligations, demands, charges, costs, or expenses (including reasonable fees and disbursements of legal counsel and accountants) awarded against or incurred or suffered (collectively, “Losses and Liabilities”) by Indemnitees arising directly or indirectly from or related to the following (except for Losses and Liabilities arising directly or indirectly from or related to our own gross negligence or willful misconduct):
- We warrant to a warrantee that (i) the electronic image of a check accurately represents all of information on the front and back of the original check as of the time that the original check was truncated, and the electronic information includes an accurate record of all MICR line information required for a substitute check and the amount of the check (“Image Quality Warranty”); and (ii) the warrantee will not receive a presentment of or otherwise be charged for an electronic check, an electronic returned check, the original check, a substitute check, or a paper or electronic representation of a substitute check, such that the warrantee will be asked to make payment based on a check it has already paid (“No Double Debit Warranty”).[16] In the case of transfers for collection or payment, we make the Image Quality Warranty and the No Double Debit Warranty to the transferee bank, any subsequent collecting bank, the paying bank, and the drawer. In the case of transfers for return, we make the Image Quality Warranty and the No Double Debit Warranty to the transferee returning bank, any subsequent returning bank, the depository bank, and the owner. If any Indemnitee suffers any Losses or Liabilities arising directly or indirectly from or related to a breach of any of these warranties, you will indemnify the Indemnitee and not hold it responsible or liable.[17]
- Through our providing the remote deposit capture service to you, we are required to indemnify a depository bank that accepts the original check from which an electronic check is created for losses incurred by that depository bank if the loss is due to the check having already been paid. If any Indemnitee suffers any Losses or Liabilities arising directly or indirectly from or related to such depository bank indemnity obligation, you will indemnify the Indemnitee and not hold it responsible or liable.
- If we transfer or present an “electronically created item” and receive settlement or other consideration for it, we are required to indemnify each transferee bank, any subsequent collecting bank, the paying bank, and any subsequent returning bank against losses that result from the fact that (i) the electronic image or electronic information is not derived from a paper check; (ii) the person on whose account the electronically created item is drawn did not authorize the issuance of the item or to the payee stated on the item; or (iii) a person receives a transfer or presentment, or return of, or otherwise is charged for an electronically created item such that the person is asked to make payment based on an item or check it has paid. If any Indemnitee suffers any Losses or Liabilities arising directly or indirectly from or related to such electronically created item indemnity obligation, you will indemnify the Indemnitee and not hold it responsible or liable.
The indemnity obligation under clause 1 above covers a drawer of a check payable by, at, or through a bank, including a payable through draft. In the case of a drawer of a payable through draft, the drawer enjoys as warrantee both the Image Quality Warranty and the No Double Debit Warranty under Regulation CC § 229.34(a)(1). A payable through bank could breach one or both of these warranties as it accepts a payable through draft through RDC as a depository bank, or creates an electronic check from a paper check and presents the draft to its drawer. Upon breach of one or both of these warranties, the drawer could press a claim against the payable through bank. In that instance, the bank could invoke the indemnity against the indemnitor, the transferor depositing the draft through a RDC service, or the customer depositing a paper check. In the case of transfers for collection or payment, the depository bank in the forward collection and presentment of an electronic check also makes the Image Quality Warranty and the No Double Debit Warranty to the transferee bank, any subsequent collecting bank, and the paying bank. In that instance, the indemnity obligation attaches under clause 1 as well.
In the case of a returned electronic check, a returning bank, any subsequent returning bank, a depository bank, and an owner of a check enjoys as warrantee both the Image Quality Warranty and the No Double Debit Warranty under Regulation CC § 229.34(a)(1) relating to a returned electronic check. A bank as a depository bank could breach one or both of these warranties not only as it charges back an “off-us” check it previously accepted upon return of that check through a return electronic cash letter, but also as a depository bank from a payee of an “on-us” check. Upon breach of one or both of these warranties, the owner could press a claim against the bank. In that instance, as against that owner, the bank would invoke the language “not hold it responsible or liable.” The bank would not invoke the indemnity obligation because it generally attaches if a third party maintains a claim against a bank for which an indemnitor is required to defend. In this case of a chargeback, no third-party claim would be involved.
Further, as a paying bank, when and as it identifies a check as a suspected duplicate check (a check it has previously paid) and elects to dishonor it by creating an electronic returned check, it could breach the Image Quality Warranty or the No Double Debit Warranty through the electronic returned check. In that case, the paying bank could turn to its customer to indemnify it if Losses or Liabilities are incurred by the bank through acts or omissions of the customer.
The indemnity obligations under clauses 2 and 3 above are new indemnities in light of the new remote deposit capture indemnity obligation and electronically created item indemnity obligation under the amended Regulation CC. Clause 2 is available to a bank providing a RDC service in the event another bank accepting the original paper check suffers a loss. If that bank maintains a claim under Regulation CC § 229.34(f)(2) against the bank providing the RDC service, this indemnity clause is available against its customer employing the RDC service. Clause 3 is available to a bank providing a RDC service in the event it incurs liability with respect to an electronically created item transferred or presented by it. Under clause 4, the bank could look to its customer—the party transmitting the electronically created item through RDC.
Conclusion. Effective July 1, 2018, amendments to Regulation CC § 229.34 provide new indemnity obligations and warranties as Regulation CC, subpart C, expands its coverage to capture both paper and electronic checks and electronic returned checks. As to the new Image Quality Warranty and No Double Debit Warranty, a transferee bank, any subsequent collecting bank, a paying bank, and a drawer could become a warrantee. Furthermore, a returning bank, any subsequent returning bank, a depository bank, and an owner of a returned electronic check could enjoy the new Image Quality Warranty and No Double Debit Warranty as a warrantee. Additionally, when a bank provides a RDC service, under Regulation CC § 229.34(f)(2), it could incur an indemnity obligation as to a bank accepting the original paper check. Finally, under Regulation CC § 229.34(g), when a bank provides a RDC service, it could incur a new indemnity obligation as to an electronically created item transferred or presented by it. To mitigate and to spread these risks, an amendment to a deposit account agreement may be in order, especially as to those banks providing a RDC service.
[1] Regulation CC (12 C.F.R. pt. 229) is issued under the Expedited Funds Availability Act (12 U.S.C. §§ 4001–4010) and the Check Clearing for the 21th Century Act (12 U.S.C. §§ 5001–5018), the recent amendments are available at 82 Fed. Reg. 27552 (June 15, 2017).
[2] On March 6, 2018, the Board of Governors of the Federal Reserve System proposed changes to Regulation J (12 C.F.R. pt. 210) in light of these changes to Regulation CC, among other considerations.
[3] Regulation CC § 229.2(k).
[4] 82 Fed. Reg. 27552 (June 15, 2017).
[5] The Image Quality Warranty and the No Double Debit Warranty is also presently in the ECCHO Operating Rules § XIX(L)(2) and (7):
Sending Bank Warranties and Indemnification. In addition to the warranties otherwise provided in the Code, Regulation CC, the Rules or other law, each Sending Bank warrants to the Receiving Bank with respect to each Electronic Image sent to the Receiving Bank that:
…
(2) the Electronic Image accurately reflects the Related Physical Check;
…
(7) the Receiving Bank and any other person will not receive a transfer, presentment or return of, or otherwise be charged for, the Electronic Image, the Related Physical Check of that Electronic Image, or a paper or electronic representation of the Related Physical Check such that the person will be asked to make a payment based on an item that it already has paid.
If the Sending Bank breaches any of its warranties set forth in this Section XIX (L), it shall indemnify the Receiving Bank and hold it harmless from and against any damage, expense, or loss, including attorneys’ fees, suffered as a result of the breach.
ECCHO is updating its Operating Rules to conform to the changes to Regulation CC, incorporating the warranties from Regulation CC by reference.
[6] See Regulation CC, Official Staff Commentary § 229.34(a)-2. The “drawee” enjoys these warranties under Regulation CC § 229.52(b); the drawee is not included as a warrantee under § 229.34(a)(1).
[7] In the supplementary information accompanying the final rule, in identifying a drawer (as well as an owner), as a warrantee, the Fed observes:
The Board believes that extending the warranties to the drawer of the check and the owner of the returned check is important to maintain a consistent chain of Check-21-like warranties regardless of whether the check is in the form of an electronic check or a substitute check. The final rule provides protection for drawers and owners from harm that is usually beyond their control, such as harm resulting from illegible images or incorrect MICR lines. (82 Fed. Reg. 27552, 27566–27567 (June 15, 2017).
[8] Regulation CC § 229.34(a)(2)(ii).
[9] Id.
[10] Under the definition of “depositary bank” in Regulation CC § 229.2(o), a depositary bank can also be the paying bank.
[11] Regulation CC § 229.34(h).
[12] The bank providing the RDC service accepting for deposit the check could also be the paying bank. In such a case, no Bank B would be involved.
[13] Regulation CC, Official Staff Commentary § 229.34(f)-2-b.
[14] See Regulation CC, Official Staff Commentary § 229.34(g)-2. This commentary appears to be incorrectly numbered; the correct citations should be Official Staff Commentary § 229.34(g)-3. See 82 Fed. Reg. 27552, 27594 (June 15, 2017).
[15] Under Regulation CC § 229.37, subpart C may be amended by agreement, except that no agreement can disclaim the responsibility of a bank for its lack of good faith or failure to exercise ordinary care, or can limit the measure of damages for such lack or failure. As a word of caution, including these terms in a deposit account agreement with a consumer may not be viewed sympathetically by a prudential regulator or a court. The Consumer Financial Protection Bureau may also view such terms unfavorably. Thus, a bank adopting these terms may limit the indemnity obligation to a commercial customer. Additionally, an indemnity obligation may be limited by other considerations. For example, public policy may limit or preclude an indemnitee’s right to enforce an indemnity obligation against an indemnitor.
[16] In the case of a payable through draft, a payable through bank grants this warranty in favor of a drawer of the draft, among others. In some instances, the payable through bank could also be the depository bank of the payee of the draft. In that role as depository bank, the bank could provide an RDC service; this indemnity protects the bank if its commercial customer deposits a payable through draft under which the payable through bank (the depository bank also acting as the payable through bank) incurs liability through a breach of this No Double Debit Warranty.
[17] In the case of a third-party draft, an indemnitor would be the commercial customer. In the case of a payable through draft, a bank providing the payable through draft service would turn to the language assuring that the commercial customer would not hold the bank “responsible or liable.”
