The Law of Check Clearing: a Primer on the Midnight Deadline Rule in Georgia

• Publication year: 2002
• Pages: 0001

Georgia Bar Journal Volume 8.

GSB Vol. 8, No. 2, Pg. 1. The Law of Check Clearing: A Primer on the Midnight Deadline Rule in Georgia

Georgia State Bar Journal
Vol. 8, No. 2, October 2002

"The Law of Check Clearing: A Primer on the Midnight Deadline Rule in Georgia"

By Jerome L. Kaplan and Blake E. Lisenby

Two weeks ago, after a lengthy and successful trial, you received and deposited a $75,000 fee check from your client Your bank called to say the check was returned for insufficient funds. In the interim, you paid salaries and other obligations assuming the check was good. Unfortunately you now learn that your client is out of business, and there is no chance he will pay the money. Normally, you would be out $75,000, and it might be difficult (if not impossible) to cover the overdraft. What can you do? At about the same time the client's bank realizes that it waited four days after receiving the check to return it for insufficient funds Could that bank have a problem?

Consider a completely different scenario. Suppose you represent a bank and it calls to say that it suspects a customer of kiting checks. The bank waited three days to return the checks and is now concerned that it waited too long. Does your client have a problem? What do you advise?

These scenarios are, unfortunately, not uncommon and illustrate how crucial it is to have a basic knowledge of banking law. A bank's response time can determine who will bear the loss. For instance, the bank (Payor Bank) on which the $75,000 check was drawn may be liable for the amount of the check because it waited too long to return it for insufficient funds. When a check is deposited, the Payor Bank has a limited amount of time to process that check and determine whether to pay it. The Midnight Deadline Rule (Rule) found in the Uniform Commercial Code (UCC) establishes both the time permitted for processing the check, as well as the penalty for exceeding the time permitted. The midnight deadline (Deadline) is midnight of the next banking day following the banking day on which the Payor Bank received the check.1

Banks sometimes violate the Rule; however, they do so at their peril. The Rule provides that, by its Deadline, a Payor Bank must return the check or send notice of dishonor, failing which, it is liable for the amount of the check.2 Generally, exceeding the Deadline to pay or return a check makes a Payor Bank liable3 for the face amount of a check, which can be thousands or millions of dollars. However, few attorneys or business people are aware of the Rule and its potentially expensive consequences.

With millions of checks computer-processed daily by banks, it seems harsh, upon initial consideration, for a bank to be held almost strictly liable for the amount of a check not processed in what is usually less than 48 hours. After all, it is not the bank's fault that the account has insufficient funds or was closed. However, the public policy behind imposing this near strict Deadline is to provide certainty to the public that a check will be paid within a specific time. Prior to the enactment of the Rule, banks and bank customers could not be sure when they could rely upon deposited checks, and depositary banks could not be sure when the provisional settlement they had given to their customers (the credit to the customer's bank account) became final. Accordingly, the Rule was enacted because the benefit of this certainty to the public and to the banking system was deemed greater than the potential cost to Payor Banks. Pursuant to the Rule, Payor Banks bear the burden of being certain the Deadline is not missed.

Therefore, all the parties in the check-collection process, and their lawyers, should be very sensitive to the Rule, as well as the defenses and extensions thereto. The Rule, if violated, may create a substantial loss for the Payor Bank that fails to meet its requirements, as well as a corresponding benefit for the depositor of the check. However, careful attention to the statutes and regulations governing the return of checks, as well as to relevant internal procedures, may allow banks to avoid the Rule's near-strict penalty.

AN OVERVIEW OF THE CHECK-COLLECTION PROCESS

The check-collection process begins with the drawer of a check who issues the check to the payee-depositor shown on the check. The check is drawn on an account at a bank known as the Payor Bank. The payee usually deposits the check with its bank (Depositary Bank), typically a different bank4 from the Payor Bank.

After the payee deposits the check at its Depositary Bank, the Depositary Bank then delivers the check to the Payor Bank for payment. Often, when the delivery is not direct, there is an intermediary bank, sometimes known as a collecting bank (Intermediary Bank), that receives the check during the payment process between the Depositary and Payor banks. The Federal Reserve Banks are commonly used Intermediary Banks.5

The result of this series of transfers is intended to be the receipt of funds by the payee from the drawer of the check. In the millions of such transfers that occur daily in this country alone, the overwhelming majority result in the timely receipt of funds by the payee. Occasionally, however, the system does not operate as intended and, sometimes, large dollar amounts are involved. When this occurs, the wary payee (or the Depositary Bank, if it is unable to recover for the check from the payee) would be wise to be conscious of the Rule, its defenses and exceptions, so as not to be the party left holding the proverbial bag.

THE MIDNIGHT DEADLINE RULE AND LIABILITY FOR ITS VIOLATION

The Rule is directed at the Payor Bank.6 It regulates what a Payor Bank must do with a check presented for payment in the ordinary course of business. In general, the Rule is this: by midnight of the next banking day after receipt, the Payor Bank must: (1) pay the check; or (2) return the check, if it has the check and does not intend to pay it; or (3) send7 notice8 of its...