Checks, the Banking System, and E-Money CHAPTER TWENTY-TWO Checks, the Banking System, and E-Money

Checks Checks are a form of draft. The parties are: The drawer: the checking account owner/depositor The drawee: the bank upon which the check is drawn The payee: the person to whom the check is made payable Checks are the most frequently used negotiable instrument for doing business in the United States. Checks are considered safe substitute for cash. – The drawer can notify the bank to stop payment if the check is lost or stolen. Copyright © Houghton Mifflin Company. All rights reserved.

The Bank-Customer Relationship When a checking account is opened, the depositor places funds into an account with the bank. From this point on whenever the bank receives a check written by the depositor it charges the depositors account to cover the amount of the check. Basically the depositor and the bank have established an contractual relationship with each other. The contract between the depositor and the bank outlines their rights and duties. Any rights and duties not covered in the bank/depositor contract are addressed in UCC article 4. Copyright © Houghton Mifflin Company. All rights reserved.

The Bank-Customer Relationship (continued) Banks generally send their customers a monthly statement detailing transactions in their account. Depositors have a responsibility to examine their monthly statements and report to the bank the following: – Suspected or known alterations of checks – Forged signatures on checks – Forged endorsements If the depositor fails to take these steps, he/she will be liable to the bank for any loss the bank suffers on these checks. Copyright © Houghton Mifflin Company. All rights reserved.

The Bank-Customer Relationship (continued) When a depositor opens a checking account, the depositor and the bank have entered a debtor-creditor relationship. – The depositor is the creditor (party owed money). – The bank is the debtor (party that owes money). A bank can loan money to a depositor if the depositor writes an “overdraft” (a check for more than is the account). – A bank can refuse to pay an overdraft and “bounce” the check, or – A bank can loan the money to the depositor (this causes the relationship to change: the bank becomes the creditor and the depositor becomes the debtor). Copyright © Houghton Mifflin Company. All rights reserved.

Duty of a Bank to Honor Checks A check is a demand instrument. – The bank is bound to pay on (honor) the check when it is presented for payment – as long as there are sufficient funds in the account to cover the check. – The bank may pay checks in any order until the depositor’s funds run out. – A bank may pay a stale check (one more than six months old).  Banks don’t normally pay stale checks unless they contact the depositor first. If the bank wrongfully dishonors (refuses to pay) the check, the bank will be liable for any damages caused to the depositor. Copyright © Houghton Mifflin Company. All rights reserved.

Duty of a Bank To Honor Checks (continued) A bank may legally refuse to honor a check if any of the following are true: There are insufficient funds in the account to cover the check. The check lacks proper endorsement. The check is stale. The depositor has stopped payment. The check contains a material omission such as no amount entered. The bank has reason to be suspicious of the holder or the check. Copyright © Houghton Mifflin Company. All rights reserved.

Postdated Checks A check dated after its actual date of issue is a postdated check. A postdated check is not payable on demand. A postdated check is generally not considered fraud or a bad check. The issue is, the bank has no obligation to pay the check until its due date. – In some states a bank will not be liable for premature payment of a postdated check unless the drawer notifies the bank that the check is postdated. Copyright © Houghton Mifflin Company. All rights reserved.

Stop-Payment Order Depositors will sometimes wish to stop payment on a check. – A stop-payment order is an instruction by the depositor to the bank to refuse to pay the check. – The bank is bound by the stop payment order. Reasons depositors stop payment: Merchandise purchased is defective The depositor has been a victim of fraud in a transaction The depositor wishes to revoke the transaction A stop-payment order may be oral or written. Copyright © Houghton Mifflin Company. All rights reserved.

Obligations of a Depositor The UCC imposes on a depositor the requirement to act carefully in: Writing checks, by ensuring they are written so as to minimize fraud. Examining monthly statements and promptly advising the bank of any mistakes. Keeping sufficient funds in the account to cover checks written. A bad check is one written by the depositor when he or she knows there are not sufficient funds to cover the check. This is a criminal act. Copyright © Houghton Mifflin Company. All rights reserved.

Special Types of Checks A certified check is a personal check that the bank guarantees to pay. A cashier’s check is a check that a bank draws from its own funds, payable to a specific payee. Usually the depositor pays a fee for this service. Traveler’s checks are a type of cashier’s check and are used by travelers to ensure a safe method of carrying funds; – They may be purchased in denominations such as $20, $50, or $100. – They are issued with the payee omitted; the payee is filled in by the traveler later. Copyright © Houghton Mifflin Company. All rights reserved.

Bank’s Liability for Wrongful Payment of a Check A bank can be liable in the following situations: Alteration of a check (the check has been altered to pay an amount larger than the amount written by the depositor) The bank that accepts that check will be liable for the amount in excess of the original check. The bank is responsible for detecting the alteration. The depositor can be liable if he or she has written the check in such a way as to allow the alteration to take place. A bank can avoid responsibility by taking reasonable steps to inspect the checks before paying. Additionally, a bank may avoid liability if the depositor does not report the alterations to the bank in a reasonable time. Copyright © Houghton Mifflin Company. All rights reserved.

Bank’s Liability for Wrongful Payment of a Check (continued) Forgery of a drawer’s signature: A bank is generally liable to a drawer-depositor where it pays a forged check. The drawer is obligated to report the forgery to the bank in a timely manner after the canceled check has been returned. (Usually 30 days but no longer than 1 year). The bank requires that a signature card be on file with the bank. This allows the bank to compare a signature on check with that on the signature card. Copyright © Houghton Mifflin Company. All rights reserved.

Bank’s Liability for Wrongful Payment of a Check (continued) Forgery of an endorsement – A bank that pays a check with a forged endorsement can recover from the prior transferor. – A forgery not reported within three years from the time the canceled check with a forged endorsement was returned to the depositor relieves the bank of liability. Copyright © Houghton Mifflin Company. All rights reserved.

Bank’s Liability for Wrongful Payment of a Check (continued) Missing endorsement: a bank may be liable if it cashed a check without an endorsement. Death of the depositor: death revokes a check (an order to pay). – The bank may continue to pay checks for 10 days after the death of the depositor as long as the bank has not been notified by a person with an interest in the account to stop paying. Copyright © Houghton Mifflin Company. All rights reserved.

Availability of Funds from Deposited Checks The Expedited Funds Availability Act of 1987 was passed to improve the availability of funds from deposited checks. The Federal Reserve Board, which oversees the nation’s banking system, issued Regulation CC to implement the EFAA. Regulation CC sets predetermined times funds will be available at the depositor’s bank. Congress has also enacted legislation known as Check21 to further expedite check processing by banks. This legislation became effective in 2004. Copyright © Houghton Mifflin Company. All rights reserved.

The Collection Process The steps in a check’s life are generally as follows: – The check is issued by the drawer to the payee. – The payee deposits check in his or her bank account (known as the depository bank). This is the first bank to receive the check for payment. – The depositary bank usually forwards the check into the Federal Reserve Banking System. – The Federal Reserve Banking System eventually forwards the check to the drawer’s bank. – If the drawer’s bank pays the check, the transaction is complete. – If the check is not paid, each bank in the collection process revokes the provisional credit it gave and the unpaid check is returned to the depositor. Copyright © Houghton Mifflin Company. All rights reserved.

Electronic Funds Transfer Electronic Funds Transfer (EFT) has become the modern way to transfer funds. Many believe that EFT will lead our nation to become a checkless society. No physical cash is used. – Debit cards are treated as cash at many businesses, in a point of sale purchase. – Online banking allows bank customers to stop using checks and pay bills and conduct other banking transactions through the Internet. Copyright © Houghton Mifflin Company. All rights reserved.

Electronic Funds Transfer (continued) Electronic Funds Transfer is now becoming the predominant means for: Employers to deposit payroll directly into an employees account. The government to deposit payments such as social security or income tax refunds in peoples’ accounts. Recurring monthly payments can be set up to be directly deducted from a person’s account. Copyright © Houghton Mifflin Company. All rights reserved.

Electronic Funds Transfer Act The Electronic Funds Transfer Act states that: If the debit card is lost, and the bank is notified within 2 days, the customer’s liability for loss is only $50. If notification to the bank is not made within two days, liability jumps to $500. If the customer fails to notify the bank within 60 days, the customer can be liable for more than $500. A bank must provide a written receipt of the transaction. A customer has 60 days to notify the bank of an error on his or her bank statement. Copyright © Houghton Mifflin Company. All rights reserved.

Electronic Funds Transfer Act (continued) The Electronic Funds Transfer Act states that (continued): A bank can send an unsolicited EFTS debit card to a customer only if the card is not able to be used until validated. A bank must provide a monthly statement to an EFTS customer at the end of the month that the customer conducts a transaction. Otherwise, a quarterly statement must be provided to the customer. Copyright © Houghton Mifflin Company. All rights reserved.