PAYMENT SYSTEMS CHECKLIST SPRING 2003 1) CHECKING SYSTEM a) Banks Obligation to the Customer UCC 4-401

i) Mandatory Payment of Check (1) Properly payable (a) Authorized by the customer and in accordance with agreement UCC 4-401 (b) Authorized means signed by the customer on the account UCC 4-401 (c) Agreement can vary Art. 4 but bank cannot contract away its duties of good faith and ordinary care. Parties can determine their own standards of ordinary care UCC 4-103 (2) Sufficient Funds (a) Bank needs to check for sufficient funds only once UCC 4-402 (b) If bank checks again, that determination controls UCC 4-402 (3) No valid stop payment order UCC 4-403 (4) If bank does not pay, bank wrongfully dishonored the check UCC 4-402

ii) Discretionary Payment of Check UCC 4-401 (1) Properly payable even if it creates an overdraft (2) Post-dated checks without notice from customer of delaying payment if the bank acts
in good faith UCC 4-401 (a) Honesty in fact and (b) Observance of reasonable commercial standards of fair dealing UCC 4-104 iii) Prohibited Payment of Check (1) When not properly payable (forgeries) UCC 4-401 (2) Valid stop payment order UCC 4-403 (a) Any customer on the account notifies the bank to stop payment (b) Written or oral notice (i) Written = 6 month effectiveness (ii) Oral = 2 weeks effectiveness (c) Describing the check with reasonable certainty (d) Given within a reasonable time so the bank can act (e) Can be renewed (f) Once expired, bank can pay if it pays in good faith

iv) Wrongful Honor UCC 4-407

(1) Bank wrongfully pays an item it should not have (2) General Rule: Bank is required to recredit the customer's account (3) Exception: If unjust enrichment results, bank is subrogated to the rights of the party unjustly enriched (4) Effect: Bank need not recredit customer b) Funds Availability i) General Rules (1) UCC Rule: Bank need not make funds available until bank receives payment (settles) UCC 4-215 (2) Exception: Expedited Funds Availability Act and Regulation CC (3) Definitions Reg. CC 229 (a) Business Days: weekdays not including holidays (b) Banking day: business days that bank conducts banking business ii) Basic Funds Availability Rules (1) There is no rule allowing for same day availability of funds

(2) Noncash withdraw from local check (a) Day 1: $100; Day 2: Balance (3) Noncash withdraw from nonlocal check (a) Day 1: $100; Day 5: Balance (4) Cash Withdraw from local check (a) Day 1: $100; Day 2: $400; Day 3: Balance (5) Cash Withdraw from Nonlocal Check (a) Day 1: $100; Day 5: $400; Day 6: Balance

iii) Next-Day Availability: No Risk Items Reg. CC 229

(1) In-person cash deposit directly to teller in your own account (2) Deposit of US government check (Treasury Check) in your name (3) Deposit of state or local government check in your name from the same state as bank (4) In-person deposit of cashier's, certified, or tellers' check in your name and in your account (5) Deposit of "on-us" item (6) $100 of the aggregate amount of all checks (not counting next-day availability checks) in any one banking day

iv) Second-Day Availability: Slightly Higher Risk Items Reg. CC 229

(1) (2) (3) (4) Local checks Local third party cashier's check U.S. Treasury check and state/local government checks signed over to 3rd person ATM deposits at ATM owned or controlled by depositary bank

v) Five-Day Availability: High Risk Items Reg. CC 229 (1) Funds from a deposit of a nonlocal check must be made available on the fifth business
day following the banking day of the deposit (2) Nonlocal third party cashier's check (3) ATM deposits at ATM not owned or controlled by depositary bank

vi) Exceptions: Extension of Availability Schedule for Highly Risky Items Reg. CC 229
(1) (2) (3) (4) (5) New Account Deposits (open for 30 days or less) Amounts over $5000 (UCC 4-215 applies for amounts over $5000) Redeposited Checks Deposits into "repeatedly overdrawn" account Deposits where there is "reasonable cause to doubt collectibility" (case-by-case determination)

c) Check Collection System i) Definitions UCC 4-105 (1) Payor Bank: bank that is the drawee of a draft (2) Depositary Bank: where check is depositedcan be payor bank as well (3) Collecting Bank: Any bank that handles an item for collection except the payor bank. (4) Intermediary Bank: transferring bank except the depository and payor bank (5) Presenting Bank: any bank presenting an item except a payor bank (6) Midnight deadline: midnight of the next banking day after a bank receives the check UCC 4-104 (7) End of Banking Day: 2 P.M. or later so the bank can (1) process (2) prove balances and (3) make entries. If deposited after cutoff, treated as deposited the next banking day. UCC 4-108 (8) Branches: Each branch of a bank is separate bank for deadline purposes UCC 4-107 ii) Forward Collection (1) Depositary bank receives item and gives provisional credit for the deposit by midnight of the banking day it receives the item (unless it's an "on-us" item)

(2) Collecting banks must use "ordinary care" in collecting the item UCC 4-202
(a) Collecting banks are "agents" of the customer during the collection process (b) Agency relationship terminates when the item is finally paidthen, depositary bank becomes debtor of the customer (because it owes the customer the amount of the check) (3) "Ordinary care" means forwarding the check for collection before its midnight deadline UCC 4-202 (4) If the check is dishonored, depositary bank can revoke settlement, chargeback the amount of the item, or obtain a refund from the customer UCC 4-214 (a) Must return the item by its midnight deadline or a reasonable time after it learns of the facts or (b) Notifies the customer of the facts if the item cannot be returned (c) If the depositary bank is the payor bank also, it must meet its midnight deadline (5) Liability for Depositary Bank's Failure to Meet Requirements (a) Loses ability to revoke settlement (b) Loses chargeback right iii) Return (1) Payor bank must settle by midnight of the banking day it receives the item for payment (2) "Settle" means to give provisional credit or pay (3) Final Payment: UCC 4-215 (a) Payor bank pays item in cash or (b) Fails to revoke settlement before its midnight deadline (4) Dishonor (a) Payor bank has ability to dishonor an item if (i) It is a demand item (ii) Not presented for immediate payment (iii) Returned before midnight deadline and before final payment (b) Payor Bank must "send" dishonored check before its midnight deadline UCC 1201; 4-104 (c) Bank must comply with expeditious return requirements Reg. CC 229 (i) 2-day test for local checks (ii) 4-day test for nonlocal checks (iii) forward collection test: send the check the same way it was presented (d) Bank must give notice of dishonor for return of checks exceeding $2500 (5) Liability for Payor Bank's Failure to Meet Requirements (a) Payor bank is "accountable" for the amount of the item if it does not meet the return process requirements UCC 4-302 (b) Payor bank loses ability to revoke settlement (c) Payor Bank breaches warranty of expeditious return Reg. CC 229

iv) Encoding Warranties UCC 4-209; Reg CC 229

(1) Person who encodes information on an item warrants to (1) subsequent collecting banks and (2) payor bank that encoded information is correct (2) If customer of bank is the encoder, than the customer's bank also makes the warranty (3) If information is incorrect, encoder is liable to the payor bank (4) NOTE: Reg CC only applies to banks and warrants that the MICR line is correct d) General Risk of Loss Rules (Banks Usually Bear Risk) i) Nonpayment (1) Risk of nonpayment is allocated according to indorser liability and drawer liability (2) Indorsers Liability: Any indorser is liable for the amount of the check UCC 3-415 (a) Indorser liable to person entitled to enforce the item and subsequent indorsers who paid the instrument (b) Applies when check is dishonored

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(i) Banks must give notice of dishonor to indorsers by midnight deadline (ii) Other parties must give notice of dishonor to indorsers within 30 days (c) Indorser Liability can be disclaimed by stating "without recourse" after indorsement Drawer Liability: Drawer of the check is liable if the bank dishonors the check UCC 3415

ii) Forgeries (1) Forged Drawer's Signature (a) If the Payor Bank Pays (i) Payor bank should not have charged the customer's account (ii) Payor bank bears the risk of loss (iii) Bank deemed to know the signature of its customers Price v. Neal (iv) Payor bank almost always bears risk, but there are two very limited exceptions: 1. Payment by Mistake: UCC 3-418 a. If payor bank pays under mistaken belief that drawer's signature was authorized, payor bank can recover from the person who benefited from the payment b. Exception: Person took in good faith and for value (fails here because most times everyone in the chain takes in good faith and for value) 2. Presentment Warranties UCC 4-208 a. Banks that present checks to payor bank warrant that they do not actually know that the drawer's signature is forged b. Fails here because everyone in the chain would have to "actually know" that the scoundrel forged the drawer's signaturemost times, they don't actually know (b) If the Payor Bank Dishonors (i) Presenting banks bear the risk of loss (ii) Loss can be passed to the earliest solvent party that dealt with the thief (2) Forged Indorsements (a) If the Payor Bank Pays (i) Payor bank should not have charged the customer's account (ii) Payor bank bears the risk of loss (iii) To shift the loss, Payor Bank can pursue Presentment Warranty UCC 4208 1. Banks that present checks for payment warrant that a. Transferor entitled to enforce the item b. No alterations c. Transferor does not actually know that the drawer's signature is forged 2. Once proven, loss shifts to the parties that breached presentment warranties (b) If the Payor Bank Dishonors (i) Presenting bank bears the risk of loss (ii) To shift the loss, presenting bank can pursue Transfer Warranty UCC 4-207; UCC 3-416 1. Customers and collecting banks that transfer items and receive settlement or consideration warrant that a. Transferor is entitled to enforce the item b. All signatures are authentic and authorized c. There are no alterations 2. Once proven, loss shifts to the earliest solvent party that dealt most closely with the thief iii) Alterations (1) Incomplete Checks Later Completed UCC 3-407 (a) Payor bank can pay the full amount of the check as written (b) Payor bank can charge the drawer for the amount

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(c) Rationale: drawer should've done a better job completing the check Terms of the Check have been changed UCC 3-407; 4-401 (a) Drawer can only be charged according to the check's original terms (b) Payor bank can sue under presentment warranty to recover the balance UCC 4208

e) Special Risk of Loss Rules (Risk can Shift Back to the Customer) i) Negligence UCC 3-406 (1) General Negligence (Bank's Burden of Proof) (a) Failure to exercise ordinary care (b) Substantially contributes to alteration or forgery (c) Effect: legitimizes any forgery (2) Comparative Negligence (Customer's Burden of Proof) (a) Bank must also exercise ordinary care in payment (b) Bank can share the loss if there was an obvious forgery (c) Plaintiff bears burden of proving comparative negligence

ii) Bank Statement Rule UCC 4-406

(1) Banks are not required to issue statement but do so to avoid liability. Statement includes (a) Copies of the checks or (b) Sufficient information so the customer can identify the check (2) Customer must exercise reasonable promptness to examine and determine any unauthorized activity (3) If customer does not act reasonably prompt, customer cannot assert against the bank (a) Any unauthorized signatures or alterations (b) Subsequent forgeries by the same wrongdoer (4) One Year Rule: If customer waits one year to report forgeries, customer is liable for all forgeries during that year

iii) Employee Fraud UCC 3-405

(1) General Rule: Employers are not responsible for employee fraud if they exercise ordinary care (2) Ordinary care means safeguarding checks Comment (3) Exception: If the employee has check-writing authority, employer can be liable for the amount of the check

iv) Imposters UCC 3-404

(1) If imposter induces drawer to issue an instrument, the forgery is deemed properly payable (2) Risk of loss shifts to the drawer (3) Rationale: drawer dealing with the imposter is in the best position to prevent fraud

v) Conversion UCC 3-420

(1) Instruments (checks) are personal property (2) At common law, conversion was aimed at scoundrel (3) Under Article 3, bank can be liable if (a) Payor bank pays on the instrument (b) Payment made to a person not entitled to enforce the instrument 2) NEGOTIABLE INSTRUMENTS a) Negotiability Requirements UCC 3-104 i) Unconditional promise or order in writing for a fixed amount of money payable to bearer or to order on demand or at a definite time and does not state any other undertakings in addition to the payment of money (1) Unconditional means no express conditions to the payment of money UCC 3-106

"Promise" is an undertaking to pay money (Promissory Notes) UCC 3-103 "Order" is an instruction to pay money (Drafts, Checks) UCC 3-103 "Fixed Amount" can include variable or fixed interest UCC 3-104; UCC 3-112 "Payable to bearer" is payable to an unspecified person UCC 3-109 "Payable to order" is payable to an identified person UCC 3-109 "Payable on Demand" means payable at the will of the holder UCC 3-108 "Payable at a definite time" means payable at the end of the term subject to rights of (1) acceleration; (2) prepayment; (3) extension by the holder or (4) extension by maker to a further definite time UCC 3-108 (9) "No other undertakings" means no other non-monetary undertakings (e.g., waivers of liability would be non-monetary undertakings) ii) If any element fails, Article 3 does not apply

(2) (3) (4) (5) (6) (7) (8)

b) Transfer of Negotiable Instrument UCC 3-201 i) Negotiation: transfer of possession (voluntary or involuntary) by a person other than the
original issuer that causes the transferee to become a holder

ii) Holders UCC 1-201 (1) Holders have are entitled to enforce the instrument UCC 3-301 (2) Any person in possession of bearer paper is a holder (even a thief) UCC 1-201 (3) The identified person in possession of order paper is a holder UCC 1-201 (4) Banks UCC 4-205
(a) Banks automatically become holders as long as the customer was a holder (b) Banks need not indorse the check when it transfers to any other bank iii) Indorsements (1) Special (Order Paper) UCC 3-205 (a) Identifies the person to whom the instrument is payable (b) Effect: Only the named party can be the holder (2) Blank (Bearer Paper) UCC 3-205 (a) Identifies no one (b) Effect: becomes bearer paper, and anyone in possession becomes the holder (3) Anomalous UCC 3-205 (a) Indorsement by person who was not a holder when indorsed (b) Effect: indorser acts as a guarantor and can be liable (4) Restrictive UCC 3-206 (a) General Rule: restrictive indorsements have no effect (b) Exception: "For deposit only" or "For collection" c) Enforcement of Negotiable Instrument i) Right to Enforce (1) Holders (a) Have a right to enforce the instrument UCC 3-301 (b) Holder has the legal right to call for payment from any party obligated to pay (2) Transferees: Non-Holders UCC 3-203 (a) Transferee acquires all rights of transferor (b) If transferor was a holder, transferee has rights of a holder ii) Presentment and Dishonor (1) Presentment (a) Demand for payment made by person entitled to enforce (b) Holders present the instrument for payment (c) If the instrument is a note, demand is made to the maker/issuer of the note (d) If the instrument is a draft or check, presentment is made (2) Dishonor (a) Party to whom presentment is made can honor or dishonor

(b) If the instrument is a note, system assumes that the party intends to dishonor if it does not act immediately (c) If the instrument is a check, system assumes that the party intends to honor unless it takes immediate steps to dishonor

iii) Defenses to Enforcement UCC 3-305

(1) Party obligated to pay can raise defense of nonperformance of the underlying obligation against a holder (not HDC) who presents the instrument for payment d) Liability on Instrument i) Indorser Liability: No party is liable unless the party signed the instrument UCC 3-401 (1) Representative Signatures UCC 3-402 (a) If principal would be liable under agency law, principle is liable for indorsement (b) Representative will not be liable if (i) Signature unambiguously indicates that he is signing as a representative and (ii) Instrument identifies the represented person (2) Indorser liability is conditioned upon dishonor UCC 3-415 (3) Liability is discharged if the bank accepts the instrument after indorsement UCC 3401 (4) Liability can be limited by writing "without recourse" on the instrument UCC 3-414; UCC 3-415

ii) Issuer of a Note UCC 3-412

(1) Party who makes the note (2) No conditions to liability

iii) Drawee of a Draft UCC 3-408; UCC 3-413

(1) Person ordered in a draft to make payment (e.g., payor bank) (2) No liability once the draft is issued (3) Liability conditioned on acceptance (signature = acceptance)

iv) Drawer of a Draft UCC 3-414

(1) Person who signs or is identified in a draft as a person ordering payment (e.g., person who writes the check payable to another) (2) Liability conditioned upon dishonor (3) Liability is discharged if the bank accepts the draft

e) Effect of the Instrument on Underlying Obligation UCC 3-310

i) Near-Cash Instruments (cashier's checks, certified checks, teller's checks) (1) Obligation is discharged once the obligee takes the instrument (2) Bank has incurred liability directly

ii) Ordinary Instruments (uncertified checks and notes) (1) Obligation is suspended when the obligee takes the instrument (2) Suspension continues until dishonor or payment (3) If paid, obligation is discharged (4) If dishonored, suspension terminates and obligee can sue on the instrument or underlying obligation

iii) Accord & Satisfaction UCC 3-311

(1) Instrument is tendered as full satisfaction of a bona fide disputed claim (2) Payor conspicuously notifies the payee that it intends the instrument to constitute full satisfaction of the claim (PAID IN FULL) (3) Payee successfully obtains payment (4) Exception for Businesses UCC 3-311(c)(1) (a) Business can require disputed claim to be sent to a designated place (submit

disputes to claims department) (b) If payor does not send to this place, there can be no accord & satisfaction (c) If, within 90 days, the business sends money back, then there is no accord & satisfaction

f) Holder in Due Course UCC 3-302

i) Rule: Holder that takes instrument for value and in good faith without notice of certain information (1) Holder: possession of bearer paper or possession by identified party to order paper (2) Value: promise of performance, security interest, or exchange of instruments UCC 3303 (a) Banks give value to the extent that they have security interest or lien in an item UCC 4-211 (b) Bank has security interest if depositor has right to withdraw credit from bank (3) Good faith: honesty in fact and observance of reasonable commercial standards UCC 3-103 (4) Cannot have notice that (a) Payment is overdue (b) Instrument is dishonored (c) Uncured default in payment (d) Instrument has unauthorized signature (e) Instrument has been altered (f) Claims or defenses to payment exist (i) Obligor is discharged when paid or released from obligation UCC 3-602 (ii) Discharge of obligation is not claim or defense for HDC status (5) Instrument cannot appear forged or incomplete UCC 3-302

g) Effect of HDC Status UCC 3-305

i) HDC takes free of personal defenses (1) Article 3 Defenses (2) Contract Defenses (3) Claims in Recoupment

ii) HDC takes subject to real defenses (1) Infancy (2) Duress (3) Lack of capacity (4) Illegality (5) Fraud in the factum (signer has no reasonable opportunity to discover the true nature of the notee.g., signer was blind etc. VERY RARE) (6) Discharge in Bankruptcy

iii) Shelter Principle: NO HDC STATUS UCC 3-203

(1) (2) (3) (4) Transferee gets all the rights of the transferor If HDC transfers to transferee, transferee has rights of HDC Transferee can take free of personal defenses NOTE: If transferee engages in fraud or illegality, cannot get rights of HDC

iv) Consumer Notes (1) No one can become a HDC of consumer credit contracts (2) FTC Legend must appear on the note: "Any holder is subject to all claims & defenses" v)