Eliminating the paper: the truncation of paper checks.

• Author: Anderson, Cliff G.

As the world witnessed the destruction of buildings and loss life on September 11, 2001, the payment system in the United States came to an abrupt halt. (1) Following the attacks, the airline system was grounded for several days causing the national float of bank checks to rise to an estimated $47 billion dollars. (2) The delay nearly stopped the nation's commerce and after September 11, 2001, the industry decided to find a better way to clear bank checks. (3) The banking industry turned to technology to find that better way which radically changed the way checks are processed. (4) On October 28, 2003 Congress passed the Check Clearing for the 21st Century Act (Check 21)5 that will help facilitate the truncation of checks by encouraging banks to process checks electronically instead of physically processing checks. (6)

The "Check 21 Act brings check processing from the Pony Express era to the computer age". (7) While Check 21 has great benefits it does not have everyone's support. Consumer groups believe Check 21 takes away some consumer rights and does not provide enough safeguards against other rights. (8) While it is true Check 21 does not give consumers all their previous rights, the benefits to the economy far outweigh the negative impact a small percentage of consumers will face. (9) The electronic processing of checks will save the banking industry billions of dollars in processing fees and will make funds available to bank customers faster. (10)

Check 21 has its roots in the Expedited Funds Availability Act (EFAA) enacted on August 10, 1987. (11) The EFAA was enacted to impose limits on how long banks could withhold access to deposits once a customer made the deposit. (12) In the EFAA, Congress directed the Board of Governors of the Federal Reserve System (Board) to consider ways to provide for check truncation. (13) The EFAA gave the Board full authority to regulate the payment system including any related functions of the payment system affecting checks. (14) The

EFAA also gave the Board full authority to pre-empt any state law as well as the Uniform Commercial Code (UCC) in order to carry out their regulations. (15)

Check law is primarily found in state statutes, the UCC articles three and four, and in federal law and regulations. (16) Congress enacted the EFAA in order to protect consumers from excessive periods of float not forbidden by some state statutes and the UCC. (17) The EFAA was the first set of rules to combat the excessive periods of float and Congress believed that by truncating checks the periods of float for a check would be reduced even further, hence Congress enacted Check 21. (18)

Check 21 requires all drawee banks (19) to accept substitute checks from depository banks (20) in lieu of original checks. (21) This requirement provides banks a legal way to send check information electronically to the drawee bank, eliminating the need to physically transport checks. (22) However, because of the enormous cost to require all banks to implement check imaging, Check 21 does not require banks to send information electronically and banks may still use the paper clearing process. (23) The goal of Check 21 is to enable banks to handle more checks electronically, which should improve the speed and efficiency of check clearing. (24)

Check 21 encourages overall efficiency and check truncation by authorizing substitute checks. (25) A substitute check is a paper copy of both sides of the original check. (26) Check 21 allows this new substitute check to act as the legal equivalent of an original check so long as the substitute check accurately reflects all of the information on both sides of the check and bears the legend: "This is a legal copy of your check." (27) A substitute check may be created by the drawee bank once the drawee bank receives the electronic image of the original check from a depository bank. (28) Once the substitute check has been created it can be processed like any other original paper check. (29)

Substitute checks must be accompanied with certain warranties by any bank that transfers, presents, or returns substitute checks. (30) These warranties include the legal equivalence warranty and the duplicative payment warranty. (31) The legal equivalence warranty warrants that the information on a substitute check accurately represents the front and back of the original check. (32) The duplicative payment warranty ensures that a substitute check has not been presented or returned multiple times. (33) The bank that receives the electronic image of a check, prints the check out, and transfers, presents, or returns the newly created substitute check becomes the first warrantor. (34) These warranties continue to flow to the ultimate recipient of the substitute check that pays on the check. (35)

Check 21 was designed to help banks process checks faster and at the same time save banks money. (36) Faster check processing will reduce the float time of checks in many cases from 2-4 days to just a few hours. (37) Faster processing also allows return checks to be processed faster improving risk management for banks. (38)

Perhaps the greatest benefit of Check 21 is the cost savings benefit the banks will incur. (39) In 2003, the Federal Reserve processed 15.5 billion checks a decrease of 4% from 2002; however, the check processing unit cost increased 13.3% to over $0.05. (40) Check 21 has the potential to save the banking industry $2 billion annually in transportation and processing costs related to the physical clearing of checks. (41) Cost savings will take smaller banks longer to realize because of the high-tech equipment that will be needed to implement electronic processing; however, smaller banks, especially rural banks, have the greatest incentive to make the switch because of the long distances they must transport their checks. (42)

While Check 21 will save banks money, many consumer advocacy groups such as Consumers Union, believe the new law comes at a big expense to consumers as well as taking away some consumer rights. (43) The increase in bounced checks is one issue that will affect consumers once banks begin to fully implement Check 21. (44) Consumers who routinely play the bank float and write checks that cannot be covered by their accounts will find that their checks are clearing...