Top Student Exam Answers, Payments: Spring 2005

Note: These were, in my judgment, the best answers received under examination conditions. They should not be taken as model answers, in that they all contain extraneous material as well as omitting useful information. Some even reach incorrect conclusions. However, they all take intelligent approaches to the questions, are well organized and reasoned, and make sensitive use of the facts.

Because answers were scanned from originals to prepare this page, be aware that odd characters and typos may have been unintentionally inserted into the text.

Question 1, Answer 1

Forged Checks, rights and duties Governed by UCC

Under UCC 4-401 Chip the bank can only charge Chip's account for properly payable items. As the signatures on the Leather Loft check and the Cash checks were unauthorized under 3-403, they are ineffective as Chip's signatures, and Chip has the right of charge-back for these items. However, provisions regarding Chip's duties and liabilities will affect what he can collect.

Under 3-406, if failed to exercise ordinary care which contributed to the forgeries, he may be precluded from ay claims against the bank, or at least his comparative negligence will be weighed against that of the Bank. The bank has the burden of proving Chip's failure, and in this case, it would be hard to show that Chip's negligence led to the forgeries. Ordinary care is not defined for consumers in Art. 3, but given the context, Chip may be accused for lack of care becuase he knew his daughter was prone to committing forgeries against his account, however, he did attempt to hide the checks from her, and he cannot be entirely faulted for her excellent criminal acumen. There is a chance his negligence will lead to a "comparative negligence determination", but this is unlikely. However, he may be said to be negligent in failing to check the location of where he has hidden his checks and other payment instruments, and should have discovered sooner that they were disappearing. It may have been negligent of him to hide them and not keep them on his person. This approach is more likely to open him to a comparative negligence claim.

The bank also has a duty to exercise ordinary care, a right that Chip is entitled to, but ordinary care for a bank as defined in 3-103 does not require them to inspect the signature of every single check - mass processing of checks militates in the banks favor in this case. Therefore, Chip has a duty under 4-406 to inspect his bank statements, and he has a right for the statements to make the transactions identifiable, including item number, amounts, and dates of payment - if any of this information is missing from the bank statements (which is unlikely), Chip has a stronger right against the bank for failing to make the items identifiable. Whether Chip has a claim against the bank hinged in part on the language in 4-406(c) on whether based on the information he should reasonably have discovered the unauthorized payment. It may be difficult to say he reasonably should have discovered the "Cash" checks, as he may regularly engage in cashing checks made out to cash and could not reasonably have distinguished those transactions. The Leather Loft check he did discover and promptly notified the bank, and so his case for chargeback on that check is much stronger than on the "Cash" checks, subject to a comparative negligence claim.

Of course, much of the rights and duties in 4-406 may be contracted around under 4-103 in not "manifestly unreasonable". The question is whether the agreement limiting claims to be submitted within twenty days from the mailing of a statement is manifestly unreasonable. There isn't a solid standard on which to determine whether the agreement is manifestly unreasonable, but 20 days may not be considered necessarily to be unreasonable. That the cutoff is from the day the statement is mailed may cause some concern, which will shorten the customer's right to claim on an item, depending on the speed of the mails. Given that most mail can make it across the country within a few days of being sent, Chip's right is only cut short by a few days. He has effectively two weeks to report on a contested item, and weighing the interests of the liquidity of the check system and his duties as customer, and the rights to contract, this agreement does not seem manifestly unreasonable.

Given that the agreement is unlikely to be found manifestly unreasonable, Chip's rights on the checks are limited to 20 days to make a claim. The facts are unclear, but it seems that Chip has made the complaint on the Leather Loft check within twenty days, and he is entitled to charge back rights from the bank, subject to a claim of comparative negligence, which the bank must prove. As regarding the cash checks, he may be able to claim on them as well if they are contained on the same statement as the Leather Loft checks. The facts seem to indicate this is not the case, though it may be the case that Chip was monitoring his account online and only noticed the wrongful check on his monthly statement then realized the other charges were unauthorized. If the "Cash" checks are on this same statement, he should be able to claim charge-back, but given Chip's carelessness, this is unlikely. According to the agreement with the bank, he must likely eat the loss for those two checks.

VISA Charges, rights and duties governed by TILA:

I am assuming the VISA charges are on a credit account, the analysis will vary if the Visa is a debit card, and would be governed by EFTA (discussed below). Chip's agreement with the bank is pre-empted by the TILA rules, so he has greater hope of charge-back on the Visa charges.

Chip is not liable for unauthorized use of a credit card under TILA Sec. 133. For a cardholder (Chip) to be liable, the card must be an accepted credit card, the liability must not exceed $50, the card issuer gives notice of potential liability (and other provisions which are not as relevant). This means Chip faces liability for the transactions because they were less than $50. However, VISA generally has waived it's right to the $50 deductible, and so Chip has hope here. Chip's right to recover is not subject to his prompt notice, his charge-back right absolute. However, under TILA, Chip's chargeback right is limited to local merchants (same state or within 100 miles) and does not appear to be a local merchant. Classifying an internet transaction is difficult, because it seemingly occurs at two ends - locally, and for the seller wherever their servers are located or wherever their corporate headquarters are located. In the end, this analysis is not as relevant as this isn't really about Chip's right to rescind but about unauthorized use. The bank may want to argue the use was not unauthorized, but the definition of unauthrorized use under TILA 103 indicates there must be actual, implied, 'apparent authority for the use, and that the cardholder receive benefit. There is no authority in this case, and it will be difficult for the bank to prove there was, so Chip should be able to chargeback the tunes purchases (given that VISA's chargeback rights are more generous than the statute requires).

Likewise, he should be able to recover for the grocery transactions. These clearly pass the $50 deductible, and are also local transactions. Again, there is no authority, explicit, implicit, or apparent, so Chip should be protected for the amounts charged on the VISA card.

ATM and Cash Withdrawals, rights and duties governed by EFTA:

EFTA also preempts the UCC rules and the bank agreement where applicable -specifically the ATM transactions and the Visa transactions if they are debit cards.

If Chip's Visa is a debit card, he has chargeback rights similar to under TILA, with a few very important differences. Chip has a a $50 deductible, like TILA (which in this case Visa has also waived), but he is subject to comparative negligence claims and a duty to promptly report. Under 909 Chip has a duty to report unauthorized transactions within 60 days - we are not sure on the timeline on this one, but it appears he has reported within sixty days. However, it may be argued that Thea's use was authorized, as she had to have his "secret pin number" to obtain the cash. He did not give, nor authorize this number, she was just lucky to guess it (or he was careless to make it the same number as one he knew she knew). It will be on the bank to prove that Thea's use was authorized. Another area is which Chip's negligence arises in his duty to report loss or theft of the card within 2 days after he learns of the loss or theft. This doesn't say after "he should have learned of the loss or theft" so he doesn't appear to have a duty to discover that it was lost, and he appears only under an obligation to report loss or theft after he knows of it. He discovered the theft upon reviewing his bank statement and so should have the 60 day window to report the unauthorized transactions. His VISA charges can be charged-back if he has reported his loss within 60 days.

Chip's ATM losses will be subject to a $50 deductible, and he has charge-back rights under EFTA 909 if he has reported the losses within 60 days of transmission of the statement. So any charges 60 days prior to his discovery of Thea's theft cannot be charged back. Also, the bank will claim authorized use because of the pin number, but the bank has the burden of proof.

 ^ TOP

Question 1, Answer 2

I. The Checks:

Under 4-401(a), the bank had no right to charge Chip's account for the checks cashed at Speedy's or the check used to pay for the boots at Leather Loft, because Chip did not authorize them. So, if no other facts were present, that would be the end of the inquiry -- the payor bank would take the loss for the forged checks.

However, the bank has a number of counter-arguments. First, the depositor's agreement states that claims must be submitted within 20 days of the mailing of the bank statement. It's unclear how much time passed from the hypothetical from when the bank statement was mailed to when it arrived at Chip's home. However, this amounts to an alteration of the general preclusion rule of 4-406(f), stating that if a customer does not report unauthorized items that appeared on a bank statment within a year, he cannot obtain a recredit. Alterations are allowed under 4-103 to this general rule, but when changing the standards by which the bank's responsibility is to be measured, the terms cannot be manifestly unreasonabIe. The terms here seem to be manifestly unreasonable, since they are based upon when the bank sends the statement, as opposed to when it arrives at Chip's home, and twenty days does not seem like enough time for the average consumer to find every unauthorized payment and report it. Some courts have allowed the one year preclusion to be cut down to 60 days, but no court yet has allowed a 20 day cut-off. Given that the statements are supposed to arrive each month, it makes sense that one have at least a 30 day period from the time the statement arrives to look it over. Thus I would hold the contract term void as being manifestly unreasonable.

However, the bank could still claim that the customer failed to exercise reasonable promptness in examining the statement under 4-406(c), and and then promptly notifying the bank of unauthorized payments. This seems like a weak claim from the bank though, since Chip immediately informed Worthy Bank upon seeing his bank statement and realizing that the check to Leather Loft was. This seems like reasonable promptness, but the question remains somewhat open since it is unclear when or if he ever noticed the checks to Speedy on his bank statement.

Had these come on a prior statement, and had Chip never reported them to the bank, then the bank would have a strong claim under 4-406(c).

The bank might also assert the repeater rule of 4-406(d)(1 ).(2) -- if the bank can show that it suffered a loss on the transaction (which it would if it had to pay the checks, since no one here violated a presentment warranty under 3-417; 4-208), and that the same wrongdoer made out further checks after making out an initial check that the customer should have discovered, the bank can shift the loss back to the customer. Here, however, we do not know how much time passed between the two checks made out to Speedy's and the check made out to Leather Loft. If the cash checks at Speedy's showed up on an earlier statement than the Leather Loft charge, then under 4-406(c) outlined above, the customer wouldn't have exercised reasonable promptness in examining his statement, and the customer would be precluded from gaining a charge-back on the second Leather Loft Check (or for that matter the second CASH check, if that occurred in the next month). But again, the times are unclear from the hypothetical, and since 4-406(d) relies on (c), and it seems that Chip was reasonably prompt, this defense probably fails as well.

Still, assuming that Chip was not reasonably prompt under (c), and that (d) applies, Chip could assert that the bank was negligent under 4-406(e), and then a comparative negligence standard would be applied and the two would share the loss. While banks do not usually check signatures anymore, there may have been a reason to be concerned about these checks. Was , it usual for Chip to make out checks to CASH, and at a place like Speedy's that charges a $5 transaction fee? This, perhaps, should have tipped somebody at the bank off. Of course, much of this would turn on the contract between Chip and the Bank, but should the bank win under (c) and (d), Chip seems to have a not totally unreasonable claim under (e).

Next, the bank could assert that Chip was negligent in leaving his checks in a place where Thea and Zeke could find them, or of letting them into his house. If Chip was actually negligent under 3-406, this could preclude him from gaining a refund; if Chip was partially negligent, moreover, there could be a comparative negligence standard applied, and the bank and Chip would share the loss based on their level of fault 3-406(b). However, it doesn't appear that Thea and Zeke were living with Chip, and he did have a hiding place, so Chip doesn't appear to have been negligent -- the bank loses again.

II. VISA Charges

These credit card charges are clearly unauthorized. Under TILA 103(o), an unauthorized use "means a use of a credit card by a person other than the cardholder who does not have actual, implied or apparent authority for such use and from which the cardholder receives no benefit." Thea and Zeke certainly had no actual authority from Chip, no implied authority considering the card was taken from a hiding place, and also no apparent authority since Chip did nothing which could have led a third party to believe that he had given Thea and Zeke the use of his credit card. Assuming also that Chip didn't eat any of the groceries or listen to any of Tunes, we have an unauthorized use since he received no benefit from the use.

However, Chip's liability will be capped at $50 under TILA 133. Chip appears to have been notified of the Tunes charge, and done nothing about it -- rather stupid really, just not caring because they were in a small amount. As a result, under 133(a)(1)(E), since the subsequent unauthorized charges amounting to about $270 at the grocery store occurred after Chip was on notice that someone unauthorized was using his card, he will be liable for them --~-'but again, this is capped at $50 under 133(a)(1)(B)

Ill. ATM Transactions

These ATM transactions appear to be unauthorized under EFTA 903(11), which states that an unauthorized electronic funds transfer occurs when someone without actual authority initiates a transfer from which the consumer receives no benefit. Further, under (A) the funds transfer must not have been initiated by a person "who was furnished with the card, code or other means of access to such customer's account." Here, Chip did not furnish Zeke and Thea with the card -- they found it in his hiding place. Secondly, he didn't furnish them with the code or pin number, they guessed it based on the home security alarm system. Assuming that Chip didn't tell Zeke and Thea that he always used the same code number for various purposes, or didn't tell them outright what his pin number is, then he didn't furnish them with this access device.

The next question is consumer liability, which is tough to answer given that no 1.>information is offered on how much the ATM transactions were for or when they occurred. The base rule under EFTA is that the lesser of $50 or the amount charged in the unauthorized use is the maximum liability. EFTA 909(a)(1 ),(2). However, if two days went by, which one can infer from the hypo, after the time the ATM card was taken and Chip didn't inform the bank -- which he doesn't appear to have done -- then his liability cap will increase to $500, or whatever was withdrawn, whichever is less. Finally, if more than two months went by, Chip received his statements and never reported the withdrawals, then his liability is unlimited. So, depending on how much was charged, and when Chip informed the bank of his card going missing, his liability could range anywhere from $50 to whatever Thea and Zeke charged -- given that these transactions occurred over a three month period, it's possible that Chip allowed more than 60 days to go by without reporting unauthorized uses, and if so, he'll be liable for whatever was withdrawn after those sixty days went by.


Question 2, Answer 1 

1. Polyester Products (PP)

Under 3-310(b), the obligation underlying a check is suspended when it is taken for an obligation. Therefore, whether the check was taken for the obligation of Discount Depot (DD) by PP is a crucial question. Although the general rule pertaining to offer and acceptance under the Article 2 is a mailbox rule, the wording here seems to indidcate the instrument must be received by the payee for the suspension of obligation would occur. If so found, PP has never taken the check for the obligation it is owed, and therefore can enforce the original obligation upon DD. PP cannot enforce the stolen check under 3-310(b)(4), and 3-309 would not apply since the  check is already paid to the thief.

One thing is worth noting: PP cannot recover under a conversion theory under from the any of the banks, since PP never received delivery of the item.

2. NationsBank (NB)

i. Against DD

As to the check, under 3-407(b), a fraudulent alteration of an instrument discharged the liability of the drawer on the check. However, 3-407(c) provides exception to this rule: as to the drawee who paid the check in good faith and without notice of the alteration, the check is enforceable against the drawer up to its original terms. Therefore, the pivotal question here is whether NB paid the item in good faith and without notice of the alteration.

Good faith is defined under 3-103(a)(4) as honesty in fact and observance of reasonable and commercial standards of fair dealing. The subjective element is satisfied since NB did not pay the check with dishonesty against DD. Whether the objective portion is met can be argued, but it seems NB has a solid ground here too: it set up a positive pay mechanism with DD to verify the MICR with the information provided from DD, and it followed the procedure. Although the payee's name was altered to show a different font and kerning, a detection of such would presumably require a human employee who are very familiar with DD's prior checks to visually inspect the check, which would be very burdensome to NB and as a general matter undesirable for the banking system to work. Even if a machine can be set up to inspect the fonts and kearning, this would incur costs that may not be justified by the benfit on both the banks and the customers. Therefore, NB is likely to succeed in showing that it discharged its duty as to the objective element of good faith. On the other hand, notice is defined under 1-201(25). In this '7 case, NB had neither actual knowledge nor receipt of notification. Therefore, the only avenue possible for DD to argue back would be that NB had reason to know it exists from all known facts and circumstances. As discussed above, the mere fact that the alteration used different fonts and kerning would not give rise to reason to know such alteration existed. Therefore, the lack of notice requirement seems to be satisfied too.

Therefore, NB may charge DD for the payment of the altered check.

ii. Against Federal Reserve Bank (FRB) and SBT

FRB, as the person obtaining payment, and SBT, as the previous transferor of the instrument, breached the presentment warranty provided under 3-417 and 4-208, since the check was altered. FRB and SBT may not assert NB's negligence, if any, as its defense. Therefore, NB may recover from either the FRB or SBT the amount it paid less any amount it charged DD, plus any expenses and consequential losses.

3. Discount Depot

First, as discussed supra 1, PP is likely to have a valid claim on the previous contractual obligation under DD. DD will be responsible for this obligation.

Also, as discussed supra 2, NB is likely to have a valid ground to charge DD. Therefore, DD will II not be entitled to recredit. 

DD's best chance for avoiding double payment, therefore, seems to be from Taylor. If Taylor can be located, obviously OD can recover from him directly or through his bank under various theories of common law and UCC. If Taylor is nowhere to be found, but when he has not yet managed to withdraw the funds from the Bermuda bank, the unwiring of the wire transfer would be the next option conceivable for DD to adopt. Since the wire transfer order was originated and properly authorized by Taylor, however, no one else than Taylor may issue cancellation order or claim erroneous transfer under Article 4A. Maybe the best avenue is, therefore, a direct claim of possessory interest over the fund under the common law theories.


Question 2, Answer 2

A) With Respect to Altered Check

 1) Discount Depot (DD) and Nations Bank (NB) - To begin with, this is an altered check under section 3-407, because the check was altered in a way that changed the obligation of the drawer (by changing the payee). Under 3-407(b), an alteration that is fraudulently made discharges the party whose obligation is effected, in this case DD. However, a payor bank or drawee (NB) can enforce the item against the drawer on its original terms, provided that it accepted in good faith and without notice of alteration. There is some question here as to whether NB exercised good faith in its acceptance of the check. Good faith is defined in section 3-103 as "honesty in fact" and "reasonable commercial standards of fair dealing." There does not appear to be an honesty in fact question here, but it could certainly be questioned whether the failure to do a visual analysis of the check would comply with reasonable commercial standards. It would probably be useful to know the terms of the positive pay agreement or the general depositor's agreement between DD and NB. If the parties agreed that compliance with an MICR based positive pay agreement would be the standard means of validating checks that size, then this would likely not be an issue. At any rate, the right to enforce according to and items original terms is typically applicable to checks where the amount has been altered, and it is unclear how NB would enforce the check in favor of Polyester (P) when the payee has been changed. Thus, it appears that DD's obligation under the check remains discharged.

NB, however, does have a right to collect from SBT due to breach of the presentment warranty under section 3-417. A presenter warrants, among other things, that the draft has not been altered. Since this warranty was clearly breached, though through no fault of SBT, NB can collect from SBT the amount paid out, plus interest and expenses. This right is maintained despite the fact that final payment has been made and SBT has already wired the money out in a subsequent transaction. If SBT is to recover, they must do so under a section 4A theory (below). Though it would be duplicative anyway, it is worth noting that NB cannot pursue rights under section 3-418 on mistake payment. This is because the mistake payment remedy is resticted to two situations under subsection (a). The drawee must have accepted under the ~ mistake belief that the i) the payment has not been stopped, which is not applicable here, or ii) that the signature on the check is authorized. In this case, both of these conditions are satisfied, as neither was affected by the alteration. 3-417 is the proper route to recovery.

2) Polyester - Simply stated, Polyester still has a claim against DD under the underlying obligation. They do not have any rights under a theory of conversion, because they never possessed the check. They can wait for another check to be issued or pursue any other common law claims they may have.

3) SBT - As a preliminary point, even though SBT was the party that encoded the MICR line which led to the check being accepted by NB, they did not in any way breach that warranty because all of the information encoded appears to have been correct. However, as discussed above, they are liable to NB for breach of the presenter's warranty. However, the transferor's warranty that the check has not been altered was also breached by Taylor, so they can recover against him, if they can find him and if he still has the money.

 4) Federal Reserve Bank - It is unclear (to me) what role exactly the fed plays in this transaction. I would assume that they are essentially SBT's agent for presenting the check, and would not have liability on it themselves. If this is not the case, then they are the party subject to liability for breach of the presentment warranty. The final result is the same however, because if they are the presenter then SBT is a transferor and breached the transferor's warranty instead. The fed could push liability back down the chain and SBT would still be in the uncomfortable position of having to collect from Taylor.

B) With Respect to Wire Transfer. SBT now is liable to pay back NB and likely will not be able to collect from Taylor directly, since he's likely hiding or judgment proof. Unfortunately, it appears that they have no remedy under article 4A for having issued a wire transfer on Taylor's behalf. First of all, section 4A-21 1 allows stop orders, but they must be received in time for the beneficiary bank to act upon them. It is likely that the wire transfer had been completed by the 20th, since it was issued on the 19th and wire transfers can be executed almost instantaneously. Wire transfers can be revoked after acceptance, but only if the transfer was unauthorized or issued by mistake. While Taylor possessed the money illegally, he was still authorized to conduct wire transactions on his account and everything was carried out according to his instructions. While SBT made a good faith effort to investigate the situation prior to making the wire transfer, the fact is that no one told them anything that was not true. NB told them that the check had been cleared, which it had, notwithstanding the later discovery that NB had a claim for reimbursement. DD also did not definitively state that the check was authorized, so it does not appear that SBT could claim reliance on DD. Thus, SBT's only remedy appears to be against Taylor himself.



Question 3, Answer 1

Significance of the Problem

First, while the number of checks used each year will indeed decline, increased per­-check costs will be at least partially offset by Check 21 and increased electronic presentment. Check 21 encourages check truncation and thereby reduces handling costs even within a single banking institution. It also encourages electronic presentment generally, though banks may insist on at least physical substitute check presentment for inter-institution transfers. However, savings is expected to reach $2 billion annually from moving to an electronic system (Dew­Page 8 of 13 Becker). Moreover, the net savings is just beginning a ramp-up, since transitioning costs could reach $10 billion. As transition costs are passed, the full savings will be achieved. Thus, savings from electronic systems will increase simultaneously to the per-check cost increase as a result of decreased check use. Of course, savings from electronic presentment could be increased still further, if desired, with a law requiring that banks accept electronic presentment in every case. This seems unnecessary, however, since the market will help move holdouts against electronic presentment into such agreements as it becomes efficient for them. Such a law might simply accelerate transition costs without affecting the end result, and thus would be a net loss (due to time-value of money).

Still, per-check costs may increase. How significant is the problem of being stranded?

Check use falls into six major categories:

1) paychecks

2) inter-business payments

3) IRS tax payments/refunds

4) bill payments and business/commercial loan payments

5) consumer purchases (in person or remote)

6) interpersonal debt payments or gifts

Let us analyze each in turn. Paychecks are almost exclusively deposited into an existing account, and usually made by businesses which can well afford to bear increased check costs or can easily affect ACH payroll transfers. For small business owners, the problem may be slightly more significant, but again, businesses can most easily switch to electronic payments of one form or another. (2) we are not worried about because businesses are sophisticated enough to bear the increased cost or switch methods. (3) can be helped by encouraging the IRS to adapt alternate payment methods, for example, a form could be mailed to the IRS instructing them to initiate a ACH "pull" order from an account described by the taxpayer. On the other hand, taxes are also of little concern since they usually involve at most 1 check per year, and perhaps I refund check received if one is lucky. (4)&(5) are slightly larger problems, however, all bill payments, most loan payments, and most consumer purchases involve a business on the receiving end. This is advantageous because that business can easily set up alternative methods of collection from the user. Certainly, bills and remote purchases are increasingly paid online. But even consumers without a computer need not be disadvantaged-­to avoid a paper check, a telephone may be used to provide a credit card number or even the routing and account numbers from a check to create a customer authorized draft (CAD). CADS may still be printed up and therefore involve check costs, but ACH is also a viable alternative. As for in-person purchases, they are already more often completed using cash, credit, or debit, and stranded check users should not be much of a problem. This leaves us with item (6), which presents the largest stranding problem. Because individuals are on both sides of the transaction, check use may be unavoidable. PTP payments can alleviate this, but this contributes to the stranding problem rather than eliminating it--especially because they require access to the internet, which not all consumers may have. Mondex type alternatives are even more cumbersome, requiring investment in a "wallet."

In sum, interpersonal payments are the only form that involve a significant stranding problem. These may be gifts, or payments for an obligation such as a sale by an individual. Fortunately, such payments are probably a minority of transactions. However, they are still significant, and present the greatest stranding problem to those without computer access--the very people likely least able to afford increased check costs.


There is no obvious regulation that can provide easy alternatives to checks for interpersonal payments. Cash of course is only practical in certain circumstances. Individuals almost always cannot accept credit/debit cards directly. Stored value has not been widely accepted in this country, and is generally not transferable to other consumers, or only transferable in person with special equipment--making it even more cumbersome than cash. ACH and other electronic funds transfers are difficult and unfamiliar to the ordinary consumer. PTP systems can more easily allow credit/debit or ACH transactions between consumers, but currently require computer access. Nonetheless, from the foregoing, three avenues of assistance present themselves: Making ACH more readily available, making PTP more readily available, and capping check costs.

ACH accessibility

ACH transfers in principle do not require more information than is used in check writing. While the fund recipient's bank must at least be known, using only pull orders solves the issue. Individual A can fill out a check-like form authorizing B to initiate a pull order in a given amount and containing the requisite information on A's account. The costs to fulfill such an order using ACH should be equivalent to using fully electronic presentment, since once the depositary bank receives the ACH slip, the order is entirely electronic. However, the clearinghouse may exact a fee, actually making this more expensive. Besides, it shows no advantage over the move to electronic presentment which is already in progress in the market.

PTP accessibility

Short of improving internet access and literacy--which is already occurring naturally--PTP could be made available by another means, such as the telephone or at in-person locations (such as the payor's bank). Currently, online PTP systems require an email address to identify the recipient, but in theory some other form of ID, such as a telephone number or other code, could be used. That the market has not provided this indicates that it is not highly cost-effective (phone calls tend to cost more than internet access) or convenient. Regulation encouraging it does not seem to be worthwhile, as there are no regulatory barriers that need to be stripped away.

Limiting Checking Costs

There are two options for reducing check costs to consumers. First, by reducing the per-check costs to banks. The primary way to do this was described above: encouraging greater acceptance of electronic presentment. However, as things stand, there is also guarantee that banks will pass on such savings to users of checks. Indeed, in a bid to encourage users to move to even cheaper forms of payment (such as fully electronic systems), banks will likely keep checking fees artificially high. Regulation could be enacted which would require banks to pass on check-cost savings (hard to monitor), or indirectly simply by enacting Option 2 for reducing check costs: absolute caps. 12 CFR 7.4002 has essentially given banks a free pass to impose whatever costs they want on checking accounts, but perhaps it is time to rethink this regulation. The regulation could simply be repealed, again allowing for legal action to limit check costs, but this is inefficient for many reasons (including that lawyers will take too much for themselves!). A better alternative would be to specifically adopt clearly defined caps on checking fees, revising or supplementing 12 CFR 7.4002.


In sum, if it seems that market inefficiencies are preventing adoption of electronic presentment despite Check 21's lowering the barriers thereto, those inefficiencies should be identified and eliminated, or mandatory acceptance of EP should be considered. In addition or standing alone, caps on checking fees should be considered to protect those users of interpersonal checks who have restricted access to new payments systems.


Question 3, Answer 2

Memo Re Decline of the Checking System

Magnitude of the Problem

The vicious cycle described in the decline of the checking system, by which I mean lower check volume leading to higher per-unit costs, is likely over-exaggerated. This may have been the case in the past where the check collection system was highly human-dependant. When countless man-hours were required to sort and process checks, per-unit costs would clearly be increasing if there were a substantial decline in the volume of check processing, since each human agent would be processing fewer checks and so unit costs would increase. However, it was precisely because the huge scale of check collection became unmanageable by manual processing that per-unit costs are significantly decreased. Electronic check processing makes check collection and unit costs minimal as everything is automated. Why do I surmise that a decrease in check volume would not lead to higher per-unit costs in the automated world? Because establishing the automated system is for the most part, a fixed cost. Large initial investment must be made in the automated system, but after the funds to establish this system are sunk and the investment recovered, continued use of the system requires only maintenance, i.e. electricity, machine supplies, repairs, etc. Under the automated system, per unit costs are minimal, and even as check volume decreases, per unit costs are likely to remain minimal given the fixed nature of most of the cost including the reduced level of wear and tear the machinery will undergo through the automated process.

This is not to say that reduced volume in check collection will not lead to increased per unit costs at all, simply that these per-unit costs will be minimal. The trouble may arise as banks recognize less of a need to invest in future check collection systems, these leading the current machinery to fall into disrepair and unuse, thereby causing increased per-unit costs for check collection. This situation could be troubling for those check using holdouts who do not transfer to the newer forms of payment systems. And if the hold-outs truly are the poor, this will create burdens for them which may seem unfair or unmanageable.

It must be noted that the potential increase in per-unit costs for check collection will not happen in a vacuum. As competing payment products develop, the costs and benefits associated with them may adjust, and it may make sense, even for the last of the holdouts, to transfer their primary payment system to one of the alternative systems developing. While the checking system may represent the lowest cost and greatest benefit for certain holdouts at this point, it is unclear that it would not be in these people's interest to transfer to another payment system when costs in the checking system become prohibitive.

Regulations to Address the Perceived Problem

Any regulations that may address the perceived problem of check use decrease should take account of these factors as mentioned. First, recognition that the low per-unit costs come from automated equipment that significantly speeds the process and is realized as a large one­ time cost. Second, recognition that alternative payment systems are available, may be cheaper, or superior in other ways to the checking system, to which the check writing hold-outs can turn as check-cashing costs may increase.

With an eye to the first recognition, regulation could be introduced regarding the technology of the check collection system. Perhaps banks could be required to maintain minimum standards regarding the maintenance and service of their check processing equipment. Or in a more severe stance, banks could be required to regularly update their automated equipment with the latest technologies and processes. Or, with an eye simply to keeping check-cashing costs low, regulation may mandate banks may not charge above a certain amount for checking fees or for check cashing

All of these alternative are rather severe and fail to allow the banking market to develop with new technology and respond to market demand. Further, banks under these regulations would force their customers using alternative payment methods to subsidize the payments of the technological hold-outs. This clearly already happens in many instances (see processing charges for returned checks), but whether bank regulation should force wealth distribution from one payment system user to another is another story. As regarding the check-processing equipment standards, banks surely are engaged in such endeavors already as the costs are reasonable considering the demand for checking products. Regulation simply to maintain equipment in working order may not be objectionable, but as payments systems and technology develops along other lines, it may make less and less for banks to hold onto this outdated technology as they respond to customer demand. A requirement that banks update their equipment for check processing regularly (say every few years) could become prohibitively expensive and the cross-subsidization of the checking system by alternative payments could become unbearable for the alternative customers. Limiting banks ability to charge fees for checking would likely be necessary to maitain current technology and not force the costs on check-users if the cost to check users is our concern. So rather than limiting fees on checking as an alternative, it may become a necessity in a system where check-processing technology is mandated. This may lead to more regulatory burdens than are warranted. Though banks have been and continue to be highly regulated, there is value in flexibility to the system to allow the banking system to develop and operate efficiently and offer the best products to its customers at the lowest costs.

Which leads to regulations with an eye to the changing and developing nature of payment systems. There are alternatives to check-writing that the check-writing holdouts could take advantage of with fewer costs than even they realize. If already in possession of a bank account, most of these individuals should be able to take advantage of debit cards. Likewise, the ACH system is available for electronic bill payment, and if an individual holds an account for writing checks, they should be able to take advantage of the ACH system for electronic bill payment. Clearly, the rights and risks of these systems differ in degree, but some of the options they offer in convenience and speed of payment can overcome the costs associated with writing checks. While these systems are subject to regulation under EFTA, they are still developing, and regulation with an eye toward encouraging development of these systems could help decrease their costs and risks, and incentivize check-writers to transfer their primary payment system to one of these alternatives. Regulations of these systems may encourage open access, seek to protect privacy if that is a concern for individuals, and increase availability. At the current time when a large volume of checks are still in use, it may make sense for users of the checking system to cross-subsidize these developing payment systems, though whether such should be regulated or left to market forces is perhaps an issue better left for the banks to determine.

Workable Payment Alternatives

Debit cards and ACH transfers are alternatives to the checking system. Check user hold-outs may find them less attractive because there is quicker finalty (the remorseful buyer will not have the opportunity to put a stop-order as easily). They may be concerned with exposure to fraud as these new systems develop. These concerns are legitimate for these users, but may be mitigated as the technology develops and becomes more attractive for security reasons, and for efficiency reasons. While the benefits of a stop-payment on a check may be lost in debit and ACH transactions, the reality is that these rights are very limited anyway, and EFTA has made possible for increased charge-back rights for consumers of debit transactions. While not near the level of chargeback rights for credit transactions under TILA, the debit and ACH consumer is not entirely unprotected and should take these protections into account when comparing their rights in the checking system to the rights under EFTA.

Also alternative to the checking system are Stored Value Cards. Though developing and still in their infant stages, these cards represent an alternative to the check writer. While closed L systems like those operated by Starbucks and MTA represent few options for use and storing value, they still demonstrate the effectiveness of such payment systems on a limited scale. These payment systems help increase the speed and efficiency in executing transactions, and the value stored is generally secure, though the uncertainty of how the accounts may be regulated, and how escheat rights and claims of loss or theft may be treated stil leave many open questions in these regimes. As systems such as these become more open, it will represent a place for the "poor consumer" for which we are concerned to store value. A stored value card such as those offered by VISA offers an alternative to a banking account, to which the poor may turn if turned away by a bank. While treatment of payments under this system is very different from the checking system, it is still an alternative. Not quite cash, not quite debit cards, not a check, these cards may resemble something more like Cashier's Checks in their acceptance and use. This can be highly valuable for both merchants and consumers who desire to enter transactions with finality and avoid risks of bounced checks. While charge-back rights will be limited, the option of stored value, efficiency, and finality may overcome this for many consumers and many merchants.

In addition to debit, ACH and stored value cards, developing systems like PayPal and Digital Cash may provide alternatives for check users. While the life of digital cash seems to have been short-lived, PayPal does represent an online alternative, though if our concern is over the poorer users of the payment systems, this may not be an alternative to those who do not have access to the technology.

In sum, the check user hold-out is not likely to be stranded in check limbo. First, the reality is that per-unit check costs are not highly likely to increase dramatically, i.e., the vicious cycle of rising per-unit costs is likely exaggerated. Second, in the event this became a reality (though slow and gradual the coming may be), low income payment systems users have alternatives for payment that, while not offering the identical protections as checks, are viable alternatives and offer other advantages.