Check 21: A Catch 22?

            On October 28, 2003, the U.S. Congress passed legislation called “The Check Clearing for the 21st Century Act” which has become known in banking industry shorthand as “Check 21.”  While touted by the banking industry as a way to more quickly clear checks and allow banks to process payments without physically moving the checks, the news is not necessarily all good for banking customers.  The Act went into effect on October 28, 2004 and consumers may already have noticed that they are no longer receiving all of their original cancelled checks back from their bank along with their monthly statements.  Instead, you may have noticed the inclusion of what appear to be photocopied checks amongst your original checks.  These are what are known as “substitute checks”, a new type of negotiable instrument created by the Act.

            What precisely is a substitute check?  A substitute check is a paper reproduction created from an electronic image of the original check that is similar in size to the original check written by the account holder with a slightly reduced image of the front and back of the original check.  The front of the substitute check will contain a statement that “this is a legal copy of your check.  You can use it the same way you would use the original check.”  In other words, a consumer may use a substitute check as proof of payment just like the original check.  “Check 21” supercedes any conflicting state laws and provides that a properly prepared substitute check is for all purposes the legal equivalent of the original check.

            While Check 21 Act does not require any bank to accept checks electronically or to produce substitute checks, in practice, most banks are moving rapidly in this direction.  The majority of consumers already do not receive their original cancelled checks with their account statements.  Many receive check images on their statements but these do not typically qualify as substitute checks.  In an effort to further reduce paperwork and transaction costs, many banks are even offering their account holders incentives to go entirely paperless:  while offered on-line access to their statements and copied checks, the account holder foregoes receiving a monthly statement in the mail.

            The provisions of “Check 21” allow banks to process substitute checks electronically.  This substantially speeds up the check clearing processing time from what had previously been several days to, in some cases, only a few minutes.  Essentially, the new procedures allow banks to transmit to other banks electronic images of checks, instead of the original paper checks, as was done in the past.  This will purportedly save billions of dollars for the banking industry, but may not be such good news for the individual account holder. 

            Many bank account holders still assume that checks which they issue will not clear their bank account for a number of days and rely upon this “float” period in order to be sure that sufficient funds are on hand in their account when the original paper checks are presented for payment.  Under Check 21, this “float” period will in many cases be greatly reduced, if not entirely eliminated.  For example, certain banks are already gearing up to allow merchant account holders to process checks in-house and present them to their bank without the merchant ever taking the original check to its bank.  In these instances, a check becomes the functional equivalent of a debit card, with the funds being withdrawn from the presenter’s bank account almost immediately.  Also, timely placing a “stop payment” on a check quickly enough to prevent its processing will become increasingly difficult, if not impossible.

            Additionally, some consumer groups are concerned that substitute checks will provide further opportunities for fraud, error, bounced check fees and other problems for checking account holders.  Specifically, some consumer advocates believe that with both original and substitute checks circulating, there is a greater danger that the same check will be negotiated multiple times, either fraudulently or simply by mistake.

            If you do notice a mistake or error on your checking account statement, Check 21 provides particular provisions that allow a consumer to assert a claim for a refund, also known as an “expedited re-credit” under the Act.  The amount of a consumer’s refund is limited to the amount of their loss or the amount of the substitute check that was received, whichever is less, plus any lost interest on an interest bearing account.  If the loss exceeds the amount of the substitute check, a consumer has other rights under the law to recover additional amounts of money.  Pursuant to the Act, a bank should credit an account holder’s refund by the next business day after the bank’s confirmation of the error.  If, however, the bank can show that the substitute check did not cause an error in the consumer’s account, the bank may later reverse the refund.

            Banking customers may also have noticed that they have recently received informational notices from their banks regarding substitute checks and consumer’s rights thereunder.  Read these notices carefully as they include specific procedures for reporting errors involving substitute checks.  If you do notice any problem with a substitute check, you should immediately contact your bank.  The special refund procedures for substitute checks require that you do so no later than 40 days after the bank returns your substitute check to you or from the date that your statement shows the error.  Your claim should be made in writing and should describe:

1)         why you think there is an error in a charge to your account;

2)         why you think the original check or a clearer version of the substitute check is needed to ascertain whether the substitute check should have been deducted from your account;

3)         provide an estimate of the money lost because of the substitute check (including any fees you are charged as a result of the substitute check and any lost interest); and

4)         provide a copy of the substitute check or provide other information to the bank that will help it identify the particular check and investigate your claim.

            The bottom line for consumers:  Before writing a check, be sure that your checking account has adequate funds to cover the check as it will become increasingly likely that your check will clear in very little time.   If you don’t already have it, request overdraft protection for your account from your bank to cover any unanticipated shortfalls and to avoid the embarrassment and hefty fees associated with a “bounced” check.  By contrast (and consumers would say unfairly), a bank is still permitted to hold your deposits for as many as five days before crediting them to your account.  Ironically, many consumer advocates are now advising consumers to make greater use of debit cards and credit cards, as they offer stronger consumer protections than paper checks.  It is often easier to dispute charges and fix mistakes with your credit card company without compromising your checking account.