Check 21 was probably the most important check-cashing law passed in the last two decades. Although this law was implemented nearly 20 years ago, it still defines the processes banks, credit unions, and other financial institutions use when cashing checks. Here’s an overview of this law.
What Is Check 21?
Check 21 refers to a federal law that allows banks to process checks electronically and to create substitute checks for banks that still use paper processing. Effective in 2004, this law doesn’t require banks to accept electronic checks, but by allowing banks to move away from paper checks, it paved the way for a faster and more efficient check-cashing process.
What Are Substitute Checks?
A substitute check is bigger than your original check. It includes a photo of your original check as well as some additional information.
The photo of the front of the check appears on the front of the substitute check, while the photo of the back appears on the back. The margins around the photo show the account holder’s routing number, account number, and check number. The front also tends to contain language such as “This is a legal copy of your check. You can use it the same way you would use the original check.”
Impact on Check Processing
When Check 21 was signed into law, it allowed banks to transmit check details by taking a picture of the front and bank of a check along with the associated payment information. The banks could use these images to create a substitute check for other banks that still used paper processing.
In many cases, this sped up check processing. Generally, it meant that checks were debited from the writer’s account the business day following the day the recipient deposited the check into their own account. Before Check 21, this process often took days to complete.
How Check 21 Affects Hold Times
Check 21 didn’t directly change how long banks are allowed to hold checks before crediting them to a customer’s account. However, the Federal Reserve Board makes decisions about holding times based on processing times. It tries to prevent banks from holding checks longer than their processing time. Due to this, Check 21 has had an indirect effect on check hold times.
Substitute Checks Vs. Electronic Funds Transfer
Sometimes, checks hit writers’ accounts on the very day that they write the check, but typically, if this happens, it’s not related to Check 21. Instead, it’s because the merchant who received the check processed it as an electronic funds transfer (EFT). Merchants must advise customers that they’re doing this, and these types of payments aren’t subject to check processing rules.
However, your customers may not always understand this distinction — make sure your employees understand the differences between EFTs and traditional check processing under Check 21 so they can answer questions as needed.
Check 21 and Mobile Deposits
Check 21 also helped to create mobile deposits. Due to the technology approved by Check 21, customers can deposit their checks by snapping a photo of the front and back of the check. Then, the bank uses the details in the photo to credit the depositor’s account, and they use the photos to create a substitute check to send to the bank on which the check was written. The substitute check will also be provided if the writer of the check requests a canceled check for any reason.
You must disclose to your customers when you are providing them with a substitute check. In particular, if someone opens a new account at your bank and you send canceled checks with their account statements, you need to let them know that some of the checks may come in the form of a substitute check.
Similarly, if a customer contacts you and requests a canceled check, you must let them know if you’re providing them with a substitute check instead of a canceled paper check.
Customers may ask for canceled checks if they need proof of payment. For instance, if the IRS says they didn’t pay their tax bill, they may request a canceled check. In this case, you can provide them with a canceled check or a substitute check, but again, you must disclose if you’re doing the latter.
Liability for Losses
Liability for check losses varies based on multiple factors. Typically, the account holder’s bank is responsible for the losses unless they notify the depository bank within a very short time frame of receiving the check. If the customer notices the issue, they must alert the bank within 40 days. Failure to do so can cause the customer to be liable for the losses.
If your customer notifies you within 40 days, you can take some time to investigate the issue, but if you don’t have an answer within 10 business days, you must refund the account holder their losses up to the amount of the substitute check or $2,500 whichever is greater. However, you can put a hold on these funds if you’re dealing with a new account holder, someone who has a history of overdrafts, or you have reason to believe the claim is fraudulent.
Unless you decide that the customer’s complaint is invalid, you must pay back all of their losses up to the amount of the substitute check plus interest by the 45th calendar day after you receive the claim. If you made a temporary payment after the 10th business day but then decided that the claim was invalid, you can reverse that refund and assess interest on your customer.
Note that you’re only liable for the losses associated with the fraudulent substitute check. You are not responsible for additional losses such as fees related to other bounced checks or the time your customer spends to resolve the issue. That said, you may sometimes have to offer relief for these extra costs to protect your reputation.
Ready to talk more about your approach to fraud? Then, contact us today. At SQN Banking Systems, we work hard to provide our clients with check fraud prevention and detection systems that protect their bottom lines.