We recently started offering remote deposit capture (RDC) for consumer accounts through mobile phones. A customer recently deposited a check using our RDC phone app. Three days later, the check was cashed at a currency exchange (we don’t know if it was our customer who cashed the check or someone else), and the currency exchange’s deposit of the check was returned. The currency exchange is demanding that we reimburse it under the Check 21 Act warranty provisions and as a “holder in due course” under the Uniform Commercial Code. Are we required to reimburse the currency exchange?

No, we do not believe that your bank is required to reimburse the currency exchange under these circumstances.

There have been two attempts to deposit this check. First, your customer deposited the check using your bank’s mobile app, and your bank successfully obtained payment from the paying bank (the bank on which the check was drawn). Second, an unidentified individual cashed the same check at a currency exchange, which also attempted to deposit the check, but failed — the check was returned because the paying bank already had paid it.

The Check 21 Act came into play when your customer used your remote deposit capture (RDC) app to deposit the check electronically. Using the app, your customer took pictures of the check and sent them to your bank, while retaining the physical check. Your bank converted those pictures into an electronic “substitute check,” which is governed by the Check 21 Act. (Some RDC systems process payments by ACH transfer, but that is not the case here.) As permitted by the Check 21 Act, your bank presented the substitute check to the paying bank for settlement and credited your customer’s account. Your bank never had any contact with the physical check.

At the currency exchange, the check popped up again, this time in physical form. The currency exchange paid cash for the check on the assumption that it would be able to deposit it. However, when the currency exchange attempted to deposit the check, the paying bank returned it unpaid, and the currency exchange’s depository bank declined to credit its account for the check (or it revoked a provisional credit for the deposit, if any).

We do not believe that the Check 21 Act or the Uniform Commercial Code (UCC) require you to reimburse the currency exchange for this transaction. While the Check 21 Act requires your bank to protect other parties from “double payments” if you convert a check into a substitute check for electronic processing, those protections do not apply in this case, because there was no double payment — the paying bank returned the check to avoid a double payment.

Similarly, the UCC requires a bank that transfers a check to protect other parties from defects such as an improper endorsement. But in this case, your bank never “transferred” the check. Under the UCC, “transferred” means physical delivery of the check to another person for payment. Instead of physically transferring the check, your bank presented a substitute check for electronic processing.

While we do not believe that the currency exchange can rightfully claim reimbursement from your bank under either the Check 21 Act or the UCC, arguably there are other scenarios in which your bank could be liable to the drawee (the paying bank) if it were to make a double payment on the check (which theoretically could still happen). However, it is difficult to predict which parties ultimately would be liable under such scenarios without all of the facts, and also because this area of law remains relatively undeveloped.

For example, we have found just one reported court decision dealing with a similar situation (which happens to be in Illinois). In 1409 West Diversey v. JPMorgan Chase Bank, the drawer of a check was an employer whose employee deposited the check at her bank (the depository bank) using a mobile app, and then she later presented and cashed the same check at a currency exchange. The employer (the drawer) sued the bank that provided the mobile app (the depository bank), claiming the depository bank had been negligent in permitting the mobile deposit. The court rejected the employer’s claim, but its analysis was limited to a discussion of common law negligence and the general principle that a bank “does not owe a common law duty of care to a non-customer.” However, we would not recommend relying on this simple analysis alone, as both a negotiable instrument and a substitute check are involved, and the UCC and the Check 21 Act create numerous warranties between multiple parties for such items.

Notably, in the commercial context, many banks have long required visible markings like restrictive endorsements or franking to be placed on paper checks that have been imaged and deposited in order to reduce duplicate presentments and payments of remotely deposited checks. This practice appears to be migrating to the consumer context, as noted by the Federal Reserve Bank of Atlanta below, and your bank may wish to consider this approach going forward.

For resources related to our guidance, please see:

Check 21 Act, 12 USC 5004 (“A bank that transfers, presents, or returns a substitute check and receives consideration for the check warrants, as a matter of law, to the transferee, any subsequent collecting or returning bank, the depositary bank, the drawee, the drawer, the payee, the depositor, and any endorser (regardless of whether the warrantee receives the substitute check or another paper or electronic form of the substitute check or original check) that . . . . (2) no depositary bank, drawee, drawer, or endorser will receive presentment or return of the substitute check, the original check, or a copy or other paper or electronic version of the substitute check or original check such that the bank, drawee, drawer, or endorser will be asked to make a payment based on a check that the bank, drawee, drawer, or endorser has already paid.”)
Uniform Commercial Code, 810 ILCS 5/3-416(a) (“A person who transfers an instrument for consideration warrants to the transferee and, if the transfer is by indorsement, to any subsequent transferee that: (1) the warrantor is a person entitled to enforce the instrument, (2) all signatures on the instrument are authentic and authorized, (3) the instrument has not been altered, (4) the instrument is not subject to a defense or claim in recoupment of any party which can be asserted against the warrantor, and (5) the warrantor has no knowledge of any insolvency proceeding commenced with respect to the maker or acceptor or, in the case of an unaccepted draft, the drawer.”)
UCC, 810 ILCS 5/3-203(a) (“An instrument is transferred when it is delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument.”)
UCC, Official Staff Commentary, Section 3-203, Comment 1 (“The right to payment is transferred by delivery of possession of the instrument ‘by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument.’”)
1409 West Diversey Corporation v. JPMorgan Chase Bank, N.A., 2016 WL 4124293 (August 3, 2016)
FRB Atlanta Whitepaper, Remote Deposit Capture for Consumers, pages 6–7, notes 15–16 (“With commercial RDC, banks have required certain visible markings be placed on the paper checks that have been imaged and deposited to help reduce item duplication, such as restrictive endorsements and franking. Franking refers to printing ‘Electronically Presented,’ ‘Processed,’ or other similar language on the front of the original check that has been scanned for conversion to an electronic image. The purpose is to indicate that the paper check has been processed electronically and should not be deposited in physical form. Similarly, some banks offering consumer capture require a restrictive endorsement before the check is scanned. A restrictive endorsement is a signature placed on the back of the check with instructions to deposit to a specific bank or account, such as ‘Jane Smith, Account #12345678.’ This type of endorsement limits the risk of fraud by restricting the deposit to the specific account indicated.”)
Electronic Check Clearing House Organization (ECCHO) White Paper, Avoid Duplicates!