The Check Clearing for the 21st Century Act--a Wrong Turn in the Road to Improvement of the U.s. Payments System

• Publication year: 2021

85 Nebraska L. Rev. 52. The Check Clearing for the 21st Century Act--A Wrong Turn in the Road to Improvement of the U.S. Payments System

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Carl Felsenfeld(fn*) and Genci Bilali(fn**)

The Check Clearing for the 21st Century Act--A Wrong Turn in the Road to Improvement of the U.S. Payments System

TABLE OF CONTENTS

I. Introduction ....................................................... 52
II. The Current Pattern of Check Clearing/Presentment ................. 55
A. Electronic Presentment of Checks Under Current
Statute ........................................................ 56
1. Electronic Presentment in Articles 3 and 4 .................. 56
2. Electronic Presentment Within the Banking
System ...................................................... 57
3. Electronic Presentment by the Federal Reserve
System ...................................................... 58
B. Electronic Presentment Under Private Modification
of Law ......................................................... 58
III. Electronic Innovations ........................................... 61
IV. The Check Clearing for the 21st Century Act ....................... 82
V. Visions for the Future or Adherence to the Past .................... 95
VI. The Turn that Should Have Been Taken .............................. 114
VII. Conclusion ....................................................... 119

I. INTRODUCTION

The Check Clearing for the 21st Century Act(fn1) (Check 21 Act) was introduced to Congress by the Federal Reserve System, enacted by

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Congress, signed by the President on October 28, 2003, and became effective one year later, on October 28, 2004. It makes a modest change in the check-clearing system designed to speed the movement of checks from the depositary to the paying bank. It is anticipated that it will eventually lead to what is called "electronic presentment," a process that may make the clearing of checks almost as swift as today's electronic payment systems.

In this way, the Federal Reserve has given a kind of imprimatur to the checking system and added to its life. The checking system is-- even with the Check 21 Act modification--the oldest, slowest, most expensive, and easily the most complex of the payment devices in use. Checking has its roots in the Middle Ages(fn2) where, along with the bill of exchange and early forms of promissory notes, checks were traded in the fourteenth century merchant fairs and litigated in the merchant "pied-poudre"(fn3) courts. The device moved indoors in the eighteenth century largely through a series of cases before the King's Bench and decided by stellar judges such as Lord John Mansfield. The law was codified in the English Bills of Exchange Act of 1882 and received in the United States in the first uniform law, the Uniform Negotiable Instruments Law of 1895. Checks are currently governed by four different laws: Article 3 of the Uniform Commercial Code (U.C.C.), Negotiable Instruments U.C.C. Article 4, Bank Deposits and Collections 12 C.F.R. pt 210 [hereinafter Regulation J], and 12 C.F.R. pt. 229 [hereinafter Regulation CC]. The interrelationship of these laws almost defies understanding.(fn4)

Starting about ten years ago, both the number and the volume of checks started to decline.(fn5) Simpler, cheaper, and faster payment devices like credit and debit cards, and electronic payments, including internet payments and the Automated Clearing House system, were gradually replacing checks as the payment systems of choice. It was widely anticipated that checks would simply phase out of use and become an ugly memory. Through the Check 21 Act, the Federal Reserve has stalled this evolution and given new life to the checking system.

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This Article gives the authors' views of on the current state of affairs. Part II explains why, with our dazzling array of technological innovations, we have not been able to clear checks instantaneously as we do electronic funds transfers, and why checks must still be physically loaded on trucks, planes, and ships and moved to payor banks. In essence, the burdensome legal system does not allow for a change that has been technologically feasible for years.

Part III describes the role that emerging electronic payment methods are playing in the U.S. payments system. Relying on multiple data and statistics, this Part provides a summary of the evolution of these electronic payments, including credit and debit cards, wire transfers, automatic clearinghouse payments, "e-money"/"e-cash," electronic benefit transfers, stored-value cards, mobile payments, automated teller machines, consumer-to-consumer online payments, and others. In contrast, this Part shows that the use of checks in the U.S. payments system is in gradual but steady decline. The societal trend is shifting from paper-based (cash and checks) to checkless, electronic-based payment methods.

Part IV provides a background of the enactment of the Check 21 Act as well as a detailed analysis of it. This Part discusses the provisions of the Act including the definition of a substitute check the way that the substitute check operates expedited recredit rights for consumers warranties and their breach by banks, which deal with substitute check transactions and consumers' liability and damage claims against the banks. The Part also discusses the legal aspects of the Act on the Uniform Commercial Code in check transactions and the effects of the Act on the Federal Reserve's Regulations CC and J.

Part V discusses the impact that the Check 21 Act will have on check payment transactions. Through testimony from bankers and leading scholars in the field and from official statistics, this Part concludes that the Act may not generate positive results consistent with the purpose of its enactment. Banks and bankers, individuals, businesses, and consumer advocates express concern about the implementation of the Act, and more importantly, question the likelihood that it will facilitate check payment system efficiency. Many banks are unprepared to handle new procedures associated with the substitute check or simply find it too costly. Vast numbers of consumers are unaware of the Act and its purpose. The Act's enactment has caused tremendous headaches for banks that will now have to undertake new measures to curb check fraud, invest in unknown and uncertain areas of check-image equipment and check-image-exchange devices, or simply outsource such services. In short, comparing the positive effects expected from the Act (for example, reducing the time a check takes to clear, though this effect is yet to be seen), and the difficulties in its

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implementation, this Part concludes that the Act may actually represent a step backward in development of the U.S. payments system.

Part VI gives the authors' views on what the Federal Reserve should have done rather than engineer enactment of the Check 21 Act. It acknowledges that the Act may result in simplification of the checkclearing system but concludes that meaningful simplification will come not through modifications of check clearing instead, it will come through selection of one of the electronic payment systems that are now taking over the market. A multitude of electronic systems, limited only by the imagination of bank marketing executives, has come into existence. They will replace the dying checks the Check 21 Act only prolongs the agony. The Federal Reserve is, of course, not the only regulatory body that could make the selection we propose. It is, however, dominant in the eyes of the public and of Congress as our senior financial spokesperson, and its position as regulator or statutory draftsman could be crucial. In this Article, the authors do not suggest a payment device for official anointment. Directed study of the system, including the systems in use abroad where the use of efficient and economical electronic payments is not infrequently superior to our own, is required for this selection to be made.

The Article concludes by asserting that the Check 21 Act should not have been enacted. The blame for its enactment should fall squarely on the Federal Reserve Board. The Federal Reserve may never admit this, but it rushed its judgment and used the favor in which it is held by Congress when it proposed the Act. Instead, the Federal Reserve should have proposed legislation which would improve the innovative and current electronic payment transactions which are increasingly in use. Issuing the Act to improve the checkclearance process while checks' use is in decline will probably be marked as a mistake in the history of the U.S. payments system.

II. THE CURRENT PATTERN OF CHECK CLEARING/PRESENTMENT

The rules of U.C.C. Articles 3 and 4 provide the legal source of the transfer of money through the checking system.(fn6) This, of course, means the physical movement of paper ("instruments" in Article 3, "items" in Article 4). The transfer of paper from hand to hand among the parties to the checking process--from the writing (or drawing) of a check through its collection--harkens back to a medieval payment system that seems much more cumbersome and expensive than it

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need be in today's electronic society.(fn7) In their current versions, therefore, Articles 3 and 4 contain various thrusts into the more modern world where paper does not move physically and where funds are transferred through some form of electronic processing.

A. Electronic Presentment of Checks Under Current Statute

1. Electronic Presentment in Articles 3 and 4

Presentment to the drawee/payor of a check is required for a check to be paid. Current law under the U.C.C. provides for presentment by any reasonable means, including electronic.(fn8) Electronic check presentment allows a bank in the collection system to capture the information from a magnetic-ink-character-recognition (MICR)...