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Duplicates, RDC Duplicates &

Holder in Due Course – Are They Playing a New Tune?

Navigating Payments 2014

Presented by: Ellen Heffner, NCP

Oct

ob

er 8

, 20

14

Copyright© 2014 by the Electronic Check Clearing House Organization

Copyright© 2014 by the Electronic Check Clearing House Organization 2

NOTICES This presentation may provide an introduction to or summary of various aspects of check payments and the legal and rules framework for check image exchange. Responsibility for compliance with image exchange rules, and/or the legal, operational and regulatory requirements applicable to check image exchange, remains at all times with the financial institution participating in check image exchange and/or the individual or company using a check image exchange service. This presentation and the information contained herein is not intended as legal or compliance advice or recommendation to any person or company. This document could include technical inaccuracies or typographical errors and individual users are responsible for verifying any information found in this presentation and related “live” webinar or webinar playback. Financial institutions should consult with their legal counsel regarding legal and operational requirements applicable to any check image exchange program they may offer or in which they participate.

This presentation may not be reproduced or published, in whole or in part, without the express permission of ECCHO.


Agenda

• ECCHO Overview • Duplicates

– Duplicate Background – Legal Concepts/Warranty – Resolutions – Remote Deposit Capture - HIDC – Claims Between BOFDs

• Resources • Q&A

ECCHO Overview


ECCHO Overview • Electronic Check Clearing House Organization

– Not-for-profit, created in 1990 – Only national private sector Image Rules organization – Owned by its membership; currently over 3,000

• Every depository financial institution is eligible for membership

– ECCHO Rules apply to check image exchanges between ECCHO Members • All ECCHO members have equal coverage under rules

– Vendor and Solution Independent • Rules designed to work with all solutions

– Three primary functions: • ECCHO Operating Rules • Industry Advocacy and • Education, including NCP Program

Duplicate Background


Definition • Webster’s New Collegiate Dictionary [Copyright 1977]

• Duplicate – Consisting of or existing in two corresponding or

identical parts or examples – Being the same as another – Either of two things that exactly resemble or

correspond to each other – Two copies both alike – To make an exact copy of


There are No Duplicates!! • Check 21 Act passed in 2003; implemented

October 2004 • No double debit warranty under Check 21 and

other image exchange rules • By early 2005 duplicate substitute checks

– Print issues – Mostly remedied – System issues – Mostly remedied

• Image exchange caused image duplicates – System issues – Mostly remedied

• As RDC growth continues, duplicates will continue – Some caused by unintentional Error – “Sammy Stupid” – Some caused by fraudulent intent – “Sammy Shyster”


RDC Issues? • What’s the Issue? • RDC duplication different from banks’ past

experience – Internal bank duplicates: Caused inside banking

system • No HIDC outside of banking system

– Customer RDC duplicates: Caused outside the banking system • Holder in Due Course (HIDC) may have original check • HIDC can (and often does) demand payment from

Drawer (who is generally the innocent party!)

Legal Concepts/Warranty


Duplicate Warranty • Reg CC, ECCHO Rules and Reg J duplicate warranty

– With minor variations the warranty reads (ECCHO) (Section XIX(L)(7)) • “Sending Bank warrants to Receiving Bank with respect to each Electronic

Image sent to the Receiving Bank that: (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 paid;”

• Intended to protect Receiving Bank regardless of form of duplicate item

• NACHA rules have similar provisions against presentment of original item for check conversion

• No duplicate warranty exists on original item


Duplicate Warranty • Reg CC Commentary states

– Warranty given even if demand for duplicative payments results from fraudulent substitute check about which warranty bank had no knowledge

– Example provided: • Electronic version (an image) sent to Bank A and Bank B

– Both create substitute checks and send to Bank C (Paying Bank)

• Bank A and Bank B both made warranties to Bank C • Bank C could pursue warranty claim for loss as result of

duplicative payment (duplicate substitute check) against either Bank A or Bank B


• Who can Paying Bank make claim against? – Either BOFD A or BOFD B – BOFD A and BOFD B both made warranty that no person will be asked

to pay an item it has already paid – BOFD B being second does not limit Paying Bank claim

BOFD A

Paying Bank BOFD B

Return/Adjust as

Duplicate

Return/Adjust as

Duplicate

Either/Or

Duplicate Warranty

IMAGE

IMAGE

IMAGE


Re-presented Items • Warranty limited to situation where Paying Bank

pays item already paid – Not applicable if first item was returned and settlement

reversed, then second item is received (see example)

– Receiving Bank only paid single item


Re-presented Duplicates • Paying Bank return system should interface timely

with duplicate system – How long maintain items for duplicate detection

• Proper Handling of Re-presented Item – Avoid incorrect identification as duplicate – Proper use of return reason codes on re-presentment

• Without return reason, item may be flagged as duplicate by intermediary bank with no knowledge item was returned

– Use IRD for re-presentment • Contains return reason code and all indorsements • Do not pull original and re-present


Re-presented Duplicates • Not required to use original

– Check 21 language: “Substitute check is accurate representation of original at time item truncated” • Original item already truncated • Very difficult to use original and properly populate return

codes in file

– Example: Using original item incorrectly • RDC customer pulls original for re-presentment • Item returned needs some physical correction such as:

– Payee Indorsement; or – WIC stamp

• Put indorsement/required stamps on the IRD


Re-presented Duplicates • Can customer deposit IRDs through RDC?

– Previously most banks did not allow; More do today

– When not permitted to re-present IRD, customer may pull original item and re-deposit • Makes duplicate detection more difficult

• Allowing customer to re-present returned IRD can potentially help with duplicates – IRD used for re-presentment contains prior return

reason code and all indorsements • History of what happened to this item • Allows Paying Bank to more accurately determine

re-presented checks vs. true duplicates


Holder In Due Course

• Definitions: – Holder: Person that comes into possession

of negotiable instrument

– Holder in Due Course (HIDC): Type of holder who has possession and: • Took the item in good faith • Took the item for value • Without notice signature was unauthorized or

item was altered • Without knowledge of claims against the item


Holder In Due Course • HIDC Claim:

– May make claim against Drawer regardless of certain defenses

– Not every holder qualifies as “holder in due course” • Depends on facts and circumstances

• Benefit of being the HIDC – Can enforce item against Drawer even if item was

returned unpaid by Drawee (Paying Bank)

• Concept under UCC 3-302 – Represents “chain of ownership” of negotiable

instrument • No other payment type has this doctrine


Summary • Paying Banks and Drawer customers encouraged not

pay HIDC claims if believe holder does not have legitimate claim for payment of item

• ECCHO Rules and Regulation J do not provide warranty directly to Drawer – Warranty against double payment made only to Paying

Bank (Drawee under UCC)

• Application of warranty against double payment consistent with Check 21, Regulation CC and Rules – Designed to protect Paying Bank and Drawer – Sending bank introduces risk by offering RDC to customer

• Appropriate to bear risk of loss from double payments

Resolutions


Paying Bank BOFD

IMAGE

Image

Adjustment

Image Return

or

Sub Ck

Drawer

Customer

Duplicate

Sub Check

Return

Deposit Ck IMAGE

Depositing

Customer

Returns vs. Adjustments

• Known operational duplicates may be resolved as adjustments

• During initial work on duplicates industry felt adjusting duplicates was best – Made sense for errors caused within banking system – Can minimize customer impact


Returns vs. Adjustments

• RDC duplicates: Cause usually outside banking system – Return may reach customer faster when funds still available – When cause unknown, fraud may be involved

• Return would protect legal rights

• Timing is key – Before midnight return deadline, option to return or adjust – After midnight return deadline, not eligible for return

IMAGE

Deposit Chk

Image Return

Image Adjustment

and

or

Sub Ck

Duplicate

Sub Check

IMAGE

Depositing

Customer

Drawer

Customer

Paying Bank BOFD


Resolutions

• Duplicates can affect innocent parties • Decision to return or adjust at discretion

of bank – Bank performs its own risk analysis – Encouraged to seek legal counsel on

potential legal risks


Resolutions – Returns • Faster – Timely Settlement • May have negative impact on innocent parties

(depositing customer and drawer customer) – Use correct return reason code for “Duplicate” to

avoid negative impacts • “Y” return code used in electronic return record

• Benefit –Do not lose right of return – Significant issue if item is counterfeit or forged

and not duplicate


Resolutions – Adjustments • Adjustments

– Made to appropriate party • Minimum negative impact to customers

– Handled within banking system • Personnel historically familiar with process resolve these

issues

– Less efficient than returns • Slower – Less timely settlement

– May have dollar limits, fees and more paperwork associated with adjustments

– Due to timing may lose right to return item • Waived right to return within midnight deadline • Significant issue if item is counterfeit or forged and not

duplicate

Remote Deposit Capture

&

Holder in Due Course


HIDC Scenario • Check Casher took check in good faith without knowledge of

issue with check – Check Casher is Holder of item; Has original item

• Not all check cashers or other claimants have HIDC status or have valid claim

• Paying Bank returns or adjusts item back to BOFD B, who charges Check Casher – Paying Bank could make claim to either BOFD B or BOFD A

• Check Casher makes HIDC claim directly to Drawer as permitted under UCC – Sends demand letter outside banking system – Can only make this claim to Drawer

• Drawer already paid item - Posted to its account at Paying Bank • Drawer pays Check Casher due to fear of potential bad credit

– Has now paid twice on the same item

• Drawer requests/receives reimbursement from Paying Bank • Paying Bank can make claim to BOFD A under duplicate

warranty


HIDC Scenario

BOFD A

Paying Bank Mobile Deposit

Customer Drawer

BOFD B

Check Casher

HIDC

Returns

as

Duplicate

Charge

Account

HIDC Claim

Agreement

IMAGE

Statement

IMAGE (ICL)

IMAGE IMAGE

Paying Bank Pays

$$$

Adjust Duplicate

Drawer Pays

HIDC Claim

Bank Reimburse

Drawer

$$$


HIDC – ECCHO Rules Commentary

• Duplicate warranty covers HIDC duplicate warranty claims – Warranty language same under Reg J as ECCHO rules

• Application of ECCHO commentary – Check Casher is HIDC – Drawer already paid item when posted to its account at

Paying Bank • Drawer pays Check Casher (HIDC) due to fear of potential bad

credit • Double payment arises because Drawer paid same item twice

– Drawer requests reimbursement from Paying Bank for item it already paid

– Paying Bank can make claim to BOFD A under duplicate warranty; To recover losses in compensating Drawer


HIDC Alternative Scenarios • Alternative 1

– Customer makes deposit through RDC at BOFD A – Customer takes same original check to Check

Casher • Check Casher is HIDC • Check Casher deposits check with BOFD B

– Paying Bank returns or adjusts duplicate item to BOFD B

– BOFD B tells Paying Bank it or its customer has original item, is HIDC and will make claim

– Paying Bank makes adjustment claim to BOFD A


HIDC Alternative #1

BOFD A

Paying Bank Mobile Deposit

Customer Drawer

BOFD B

Check Casher

HIDC

Returns

as

Duplicate

Charge

Account

Agreement

IMAGE

Statement

IMAGE (ICL)

IMAGE IMAGE

Paying Bank Pays

$$$

Adjusts Duplicate

Rejects

Claim


HIDC Alternative #2 • Alternative 2

– Customer makes deposit through RDC at BOFD A – Customer takes same original check to Check

Casher • Check Casher is HIDC • Check Casher deposits check with BOFD B

– Paying Bank returns or adjusts duplicate item to BOFD B

– BOFD B tells BOFD A it or its customer has original item, is HIDC and will make claim

– BOFD B makes claim to BOFD A

• Legally no claim exists between BOFD B and BOFD A


HIDC Alternative #2

BOFD A

Paying Bank

Mobile Deposit

Customer Drawer

BOFD B

Check Casher

HIDC

Adjusts

as

Duplicate

Agreement

IMAGE

Statement

IMAGE (ICL)

IMAGE

Paying Bank Pays

$$$

Statement


Advantages to Alternatives • Alternatives could avoid some complications of HIDC

claims and subsequent warranty claims – Drawer customer does not receive direct HIDC claim – Resolution of duplicate payment handled within banking

system; More expeditious claims process

• Appropriate for BOFD A to bear risk of loss from double payments (see Reg CC) – BOFD A introduced risk by allowing customer to engage in

remote deposit capture (RDC) – RDC customer did not secure original paper

• Should be requirement in RDC product agreement

– BOFD A in best position to collect on claim from customer • Customer and bank typically have legal contract (RDC agreement)

designed to protect depositary bank from such losses


Industry Reaction • ECCHO, through Returns and Adjustment

Subcommittee, developed new white paper: – “Improving Duplicate Payment Adjustment Resolution – An

ECCHO Suggestion Document”

• In typical scenario banks beginning to attempt to make claim to BOFD A – Following alternatives to avoid HIDC claims to Drawer

• But there are exceptions – Still working on how to best handle:

• Stale dated • Stolen checks • Re-presented checks • Altered/Counterfeit

Claims Between BOFDs


Claim Between BOFDs • Is there basis for claim between BOFDs? • Rules and check law does not address claims

between BOFDs – No exchange between BOFDs, no warranty made – Warranties arise from exchange of check images

• Reg CC does not address this for substitute checks

– Unknown if there is basis for loss sharing under other law • Consult legal counsel • Discuss with 2nd BOFD to reduce or share loss

• Holder in Due Course issue – How is duplicate claim affected when one party has

original check


Claim Between BOFDs • BOFD A and its customer has agreement,

usually requiring customer to secure original paper check – That agreement is contract law between BOFD

A and its customer • No other party is subject to that agreement

• Nothing in any rule set regarding not “securing original paper” – No legal basis / reason for:

• BOFD B to reject claim from Paying Bank; or • BOFD B to make claim to BOFD A


BOFD A

Paying Bank BOFD B

IMAGE

Return/Adjust as

Duplicate

IMAGE

Does BOFD B

have Claim against

BOFD A?

Claims Between BOFDs

• No – legally no

claim exists

• No warranty was

made


Proposed Reg CC • New indemnity by BOFD A to BOFD B –

Truncating Bank Indemnity • BOFD A is truncating bank

– Did not receive original check – Receives settlement or other consideration – Does not receive check returned unpaid

• BOFD A’s potential liability arises when it permits customer to truncate check and deposit image – RDC customer retains original check – May intentionally or mistakenly deposit paper check

in another bank • BOFD B receives indemnity from BOFD A

– Receives original check for deposit • Not through RDC

– Indemnification from BOFD A to BOFD B for losses due to check having already been paid


BOFD A

Paying Bank BOFD B

Mobile

Deposit

Customer

Indemnity Claim

Proposed Regulation CC

IMAGE

IMAGE

RDC

Agreement

Return as

Duplicate

IMAGE Agreement


Proposed Reg CC • Indemnity permits BOFD B that accepts original paper

check to make claim against BOFD A that permitted customer to truncate – Claim made to any truncating bank, even if multiple

truncating banks – Claim exists only if check returned to BOFD B due to fact

check already paid • Allows BOFD A to allocate loss to depositing RDC customer by

agreement • Fed’s Rationale for Proposal

– Believes BOFD A receives benefit from customer RDC – BOFD A should internalize risk/cost to other banks

• Fed’s RFC on Reg CC – Any unintended consequences? – Would BOFD B be able to identify BOFD A? – Are there other remedies to address problem?


Proposed Reg CC • Truncating Bank Indemnification Response in Industry Group

Comment Letter – Indemnity novel approach in check law

– General support for Fed’s initiative to address issue

• Certain clarifications to proposal, if indemnity adopted – Second BOFD not required to attempt to charge its customer – Rule should include time period to make claim – Indemnity to apply when BOFD receives claim through adjustments (not

only returns) – Commentary provide examples where indemnity not applicable

• Altered and counterfeit items

– May encourage behavior that unnecessarily increases risk – Indemnification should not be available if:

• Second BOFD or customer is not HIDC • Same entity made deposit in both banks • Evidence on item suggests it was deposited previously (e.g.; indorsement)


Proposed Reg CC • Truncating Bank Indemnification Responses

– 36 responses to Reg CC RFC – Approximately 20 commenting organizations were

Credit Unions or representing CUs • All but one opposed this indemnification

– May not have understood the RDC bank already is responsible for duplicate

– Many stated there was risk mitigation in place at RDC bank


Proposed Reg CC • Truncating Bank Indemnification Responses

(continued)

– Almost all who issued opposing comments also suggested use of restrictive indorsement • As alternative or in addition to indemnification

– Restrictive indorsement recommendation: • "For deposit only / account number / financial

institution name / signature"


Reference Sources • For additional information please see the following

– ECCHO Rules • https://www.eccho.org/cc/index.php?p_sector=cc_rules&p_matter=cc_login_rules

– Regulation J • http://www.ecfr.gov/cgi-bin/text-

idx?c=ecfr&sid=635f26c4af3e2fe4327fd25ef4cb5638&tpl=/ecfrbrowse/Title12/12cfr210_main_02.tpl

– FIs offering RDC should review and implement FFIEC guidance on RDC which addresses FI responsibility to identify and control risks

• http://www.ffiec.gov/pdf/pr011409_rdc_guidance.pdf

– White Paper: Additional Issues Regarding Possible Duplicate Payment of Check items • http://www.eccho.org/uploads/WhitePaperDuplicateIdentiticationVersion_08_05_2013(1).pdf • http://www.eccho.org/uploads/HIDC%20White%20Paper%20(2)%20Aug%202013.pdf

– Improving Duplicate Payment Adjustment Resolution – An ECCHO Suggestion Document • http://www.eccho.org/uploads/Duplicate%20Suggestion%20Paper%20July%2014.pdf

– Regulation CC Joint Comment Letter • http://www.eccho.org/uploads/2014%20Reg%20CC%20Joint%20Industry%20Comment%20Lett

er.pdf

– Avoid Duplicates! • http://www.eccho.org/documents/Duplicates_000.pdf

– A Guideline Document on Duplicate Image/IRD Prevention and Detection • http://checkimagecentral.org/pdf/DuplicatePreventionAndDetection.pdf

– Resolving Duplicates as Adjustments versus Returns • http://checkimagecentral.org/pdf/ResolvingDuplicatesAsAdjustmentsVersusReturns.pdf

https://www.eccho.org/cc/index.php?p_sector=cc_rules&p_matter=cc_login_rules

http://www.ecfr.gov/cgi-bin/text-idx?c=ecfr&sid=635f26c4af3e2fe4327fd25ef4cb5638&tpl=/ecfrbrowse/Title12/12cfr210_main_02.tpl






http://www.ffiec.gov/pdf/pr011409_rdc_guidance.pdf

http://www.eccho.org/uploads/WhitePaperDuplicateIdentiticationVersion011711(1).pdf

http://www.eccho.org/uploads/HIDC White Paper (2) Aug 2013.pdf






http://www.eccho.org/documents/Duplicates_000.pdf

http://checkimagecentral.org/pdf/DuplicatePreventionAndDetection.pdf

http://checkimagecentral.org/pdf/ResolvingDuplicatesAsAdjustmentsVersusReturns.pdf



Questions?

Thank You!

Ellen Heffner, NCP

Director – Education Manager

[email protected]

214-273-3211

Electronic Check Clearing House Organization 3710 Rawlins Street; Suite 1075

Dallas, Texas 75219

www.eccho.org

Oct

ob

er 8

, 20

14

Copyright© 2014 by the Electronic Check Clearing House Organization

mailto:[email protected]

http://www.eccho.org/

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