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FEDERAL RESERVE BAihlK OF NEW YQRtC [ Circular No. 9807 February 25, 1985 AM ENDM ENT TO REG U LA TIO N J Notification of N onpaym ent For Checks of $2,5©© o r M ore To All Depository Institutions, and Others Concerned, in the Second Federal Reserve District: Following is the text of a statement issued by the Board of Governors of the Federal Reserve System: The Federal Reserve Board has adopted an amendment to Regulation J, governing checks, to improve the system of notification for nonpayment of checks of $2,500 or more that are processed through the Federal Reserve. At the same time, the Board approved a proposal to improve notification services offered by the Reserve Banks as part of the check collection process. Both actions will become effective in October 1985. The Board’s action, in general, requires a depository institution upon which a large dollar check is drawn (payor institution) to notify the institution of first deposit within a specified time limit that it is returning the checks. To assist payor institutions in meeting this requirement, Reserve Banks will enhance their current notification service. An enhanced notification service will also be available to depository institutions for checks collected outside the Federal Reserve. A fee schedule, reflecting the estimated cost of providing these services, is outlined in the attached document. Enclosed is a copy of the Board’s official notice, including the text of the amendment, which has been reprinted from the Federal Register of February 12. Questions on this matter may be directed to our Check Services Department (Tel. No. 212-791-6551). E. Gerald Corrigan, President. BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM C O LLEC TIO N O F CHECEC8 AND O TH E R ITEM S AND W IR E TRANSFERS OF FUNDS A M E N D M E N T T O R E G U L A T IO N J (effective October 1, 1985) (202-452-3760), Division of Federal Reserve Bank Operations; Joseph R. Alexander, Attorney (202-452-2489), or Robert G. Ballen, Attorney (202-4523265), Legal Division, Board of Governors of the Federal Reserve System, Washington, D.C. 20551. FEDERAL RESERVE SYSTEM 12CFR Part 210 [Docket No. R -0522] Federal Reserve Bank Cfi@©k <D@SS©eti@n System S U P P L E M E N T A R Y IN F O R M A T IO N : AQENev: Board of Governors of the Federal Reserve System. ACTON: Final rule. The Board of Governors has amended Regulation J to strengthen the current requirement that payor depository institutions provide notice when they are returning unpaid large dollar checks presented through the Federal Reserve. The amendment requires the payor institution to provide timely notice to the depository institution at which the check was originally deposited that the' check is being returned unpaid. The federal Reserve Banks will enhance toe notification service they currently provide to assist payor institutions in meeting this requirement. The Federal Reserve’s notification service will also be available to depository institutions for checks collected outside the Federal Reserve. EFFECTIVE ©a y e : October 1,1985. FOR! FURTHER INFORMATION CONTACT Elliott C. McEntee, Associate Director (202-452-2231), or Bill Brown, Manager SUMMARY: Background Significant attention has recently been focused on the issue of delayed availability, that is, the practice of some depository institutions of delaying a depositor’s ability to withdraw funds deposited by check for extended periods <?f time. Although the risk of loss to depository institutions associated with returned items is relatively small in the aggregate, many institutions point to the potential losses they could incur on particular returned checks as the reason for their delayed availability policies. The Board, in conjunction with other federal banking regulators, has urged institutions to review their policies on making funds available to customers and to consider taking into account factors that indicate toe degree to which a given situation presents a risk of loss. (See joint release of Federal Financial Institutions Regulators, March 22,1984.) These factors include the length of time the account has been maintained, toe past experience with the depositor, the identity of toe drawer, the type of check, P R I N T E D IN N E W Y O R K , F R O M FEDERAL REGISTER, F o r th is R e g u la tio n to b e c o m p le t e retain : 1) R e g u la tio n J p a m p h le t d a te d A u g u s t 1 2 , 1 9 8 1 . 2 ) A m e n d m e n t e f f e c t i v e A p r il 2 , 1 9 8 4 . 3 ) T h is s lip s h e e t. [E n c . C ir . N o . 9 8 0 7 ] and the location of toe payor institution. The Board recognizes that many institutions may be unwilling to modify their hold policies unless some effort is made to reduce w hat these institutions believe is their exposure to potential losses as a'result of returned checks. The Board believes that, at this juncture, modification to the Federal Reserve’s current requirement that payor institutions provide notification when they return unpaid large dollar checks appears to be an effective way of reducing risk to institutions of first deposit. This reduction in risk will permit depository institutions to reevaluate the length of their hold periods, CwrenSt Requirement Federal Reserve Bank operating circulars currently required a payor institution returning a check in the amount of $2500 or more that has been presented to it by a Reserve Bank to provide a notification of nonpayment. This notice is usually given to the presenting institution, which is generally the Reserve Bank. W hen the Reserve Bank receives a notification from a payor institution, the Reserve Bank initiates a notification to the institution that sent the check to the Reserve Bank for collection. The current procedure is not entirely satisfactory for several reasons. Payor V O L . 5 0 , N O . 29 institutions do not provide notification in all cases in which notification is required in part because the Federal Reserve has not indicated w hat liability an institution incurs if it fails to provide a notification. Moreover, there is no requirement that the payor institution notify the institution of first deposit directly that the check is being returned and |h e time-period for providing notification is not specified. As a result, in some cases the returned check gets to the institution of first deposit at the same time as or before the notification. Finally, even when a timely notice is provided, it often does not contain enough information to be helpful to the institution of first deposit. Proposed Notification Requirement The Board proposed in June 1984 to amend Regulation J to improve the current notification requirement (49 FR 26597). Under the proposal, a payor institution that does not pay a check of $2500 or more that had been collected through the Federal Reserve would be required to provide notice of nonpayment such that the notice is received by the institution of first deposit by midnight of the second banking day following the day on which the payor institution is required to dishonor the check. The notification would be required to include specific information provided the payor institution could determine the requisite information from the check. The payor institution could select among several means of providing notice, including providing notification by telephone or returning the check such that it is received by the institution of first deposit before the notification deadline. In this regard, the Reserve Banks would enhance their current notification service to assist payor institutions in meeting the notification requirement. (An enhanced Federal Reserve notification service would be available to depository institutions for all checks, including those collected outside the Federal Reserve. The Federal Reserve would, however, continue not to handle returned checks it did not originally collect.) A payor institution that failed to exercise ordinary care in providing timely and accurate notification could incur liability up to the amount of the item for resulting losses incurred by the institution of first deposit. In those cases where the Reserve Bank agreed to provide notification for the payor institution, the Reserve Bank would incur this liability rather than the payor institution. The process by which the physical item itself would be returned would not, however, be affected by this proposal. depositor. The Board also believes that the proposal would provide significant public benefits by providing depository institutions the opportunity to make funds available sooner to their Discussion and Analysis of Comments customers. Accordingly, the Board has Two hundred and sixty non-Reserve determined to adopt the notification Bank comments were received in proposal. response to the Board’s proposal, over Although the requirement would 90 percent of which were from initially apply only to checks collected depository institutions. One hundred through the Federal Reserve, depository and fifty three (59 percent) of these institutions may voluntarily extend commenters supported the proposal. notification to all cheeks of $2,SCO or Thirty, or approximately 60 percent, of more so as to simplify processing the comments received from large operations. In this regard, the Federal correspondent depository institutions Reserve would make an enhanced and 67, or approximately 78 percent, of notification service available to the comments received from other depository institutions for checks depository institutions supported the collected outside the Federal Reserve. proposal. Sixty four (25 percent) of the Finally, the Board indicated that it commenters opposed the proposal. The would support legislation to extend the remaining 43 commenters (16 percent] notification requirement to checks not did not specify whether they favored or originally collected through the Federal opposed the proposal. Reserve. (One hundred and twentyCommenters favoring the proposal seven commenters, or 85 percent of the indicated that the proposal would, at commenters commenting on this issue, minimal cost, result in a reduction in strongly supported such legislation.) losses incurred by depositing The Board estimates that the proposal institutions from returned checks and will be less costly to the banking check kiting, as well as improve funds industry compared to the current availability for customers of depository notification requirement. (The proposal institutions. In this regard, 75 will, however, result in modest cost commenters, or 44 percent of the increases for depository institutions that commenters commenting on this issue, currently are not complying with the reported that the proposal would enable notification requirement.) The proposal depository institutions to improve their will provide a number of cost savings as delayed availability policies because compared to the current notification institutions would be able to protect requirement. The payor institution will themselves from potential losses on not be required to provide notice for large dollar checks without imposing those checks that will be returned to the extended holds on all check deposits. institution of first deposit within the Commenters opposing the proposal notification deadline. Currently, a payor generally indicated that it would not institution is required to provide notice result in improvements in availability for all large dollar returned checks because the notification requirement collected through the Federal Reserve. would apply only to checks collected Moreover, intermediary collecting through the Federal Reserve or because institutions will realize cost savings they do not currently delay availability. because they will no longer be required Accordingly, these commenters to pass along notifications to their prior concluded that the cost of this proposal endorsers. For these reasons, it is outweighed its benefits. Finally, many of estimated that the proposal will reduce the number of required notifications for these commenters stated that other payor and intermediary institutions by approaches should be pursued, such as half. speeding up the return of the physical check through direct return to the Several commenters suggested other institution of first deposit or automation alternatives to improve the return item of the return item process. process. While the Board expects the notification requirement to improve the The Board believes that timely return item process in the near term, it is notification of nonpayment will enable recognized that this is an interim the institution of first deposit to take steps to protect itself from potential loss. solution and further initiatives will be required to achieve long-term Such m easures may include extending a comprehensive solutions to the hold it may have placed on the account processing of return items. These or placing a hold on other funds of the 2 initiatives are likely to include development and implementation of endorsement standards, assessm ent of technology to substitute automation for the largely manual handling of returns, and consideration of means other than telephone and wire to speed the flow of payment information. In this regard, the Dallas Reserve Bank has been experimenting with enhancements to its return item service that include returning unpaid checks directly to institutions of first deposit that are located in the Dallas Reserve Bank’s D istrict1 The Federal Reserve will continue to take an active role in working with the industry and Congress to pursue improvements to the return item process. Recognizing that some check processing equipment may not accommodate certain endorsement standards and the difficulties of ensuring compliance with an endorsement standard, the Federal Reserve also intends to work with the industry to improve the quality of endorsements and implement endorsement standards. One hundred and twenty-nine commenters, or 91 percent of the commenters commenting on this issue, supported implementation of an endorsement standard to assist the payor institution in identifying, and providing notice to, the institution of first deposit. Technical issues A. Scope o f the notification requirement. Under the Board’s proposal, the notification requirement would apply to all cash items (e.g., checks), including items drawn on a Reserve Bank and items presented through a clearing house, ill an amount of $2,500 or more that were collected through the Federal Reserve. It is estimated that approximately one-third of all checks w ritten are collected through the Federal Reserve. The proposal would not apply to items indorsed by, or for credit to, the United States Treasury. One hundred and thirty one commenters, or 79 percent of the commenters commenting on this issue, agreed with the $2500 cut off in the 1 As part of this pilot, the Dallas Reserve Bank currently is providing notification of nonpayment to the institution of first deposit. The Reserve Bank will continue to provide this notification under the terms and conditions of the pilot for the duration of the pilot. payor institution would be required to Board’s proposal. The current provide notification of nonpayment such notification requirement applies only to that it is received by the institution of checks in amounts of $2500 or more. first deposit by the second banking day Moreover, such checks account for over 50 percent of the dollars associated with following the day on which the payor institution's required to dishonor the returned checks but comprise only approximately 2 percent of all returns. check. That is, if a Reserve Bank For these reasons, the Board has presents a check to a payor institution determined that the notification on Monday, that institution would be requirement will apply only to checks in required to determine whether to return amounts of $2500 or more. The impact of the check by midnight Tuesday and the $2500 cut off will be evaluated over would be required to provide a time to determine the feasibility of notification of return such that it is reducing the cut off. The same dollar cut received by the institution of first off will apply to all returned checks, deposit by Thursday. regardless of the reason for return, so as Sixty nine commenters, or 44 percent to avoid unduly complicating the of the commenters that commented on notification requirement. this issue, agreed with the Board's The Board believes that the proposal. These commenters believed exemption in the proposal for checks that this time period was necessary to indorsed by, or for credit to, the United accommodate internal operations and to States Treasury should be adopted. permit the payor institution to take Depository institutions typically do not advantage of the most cost effective delay availability of funds represented means of providing notice. Several of by checks indorsed by, or for credit to, these commenters indicated that a the United States Treasury. Morever, the shorter time period would result in Board believes that this exemption operational problems, particularly for should be extended to checks drawn on smaller depository institutions that the U.S. Treasury. Checks drawn on the return checks through the U.S. mail or U.S. Treasury are not returned for have other entities (e.g., correspondent insufficient funds. Moreover, if such banks or processing centers) process checks are returned for other reasons their checks. On the other hand, 84 (e.g., forged endorsement), the return commenters, or 54 percent of the typically w ill occur long after the commenters commenting on this issue, expiration of any hold period imposed believed that this time period should be by the institution of first deposit. shortened by one day. These (Returned checks drawn on the U.S. commenters believed that it was Treasury are not subject to the Uniform feasible to provide the notification Commercial Code’s (“U.S.C.”) time within the shorter time frame and that limits concerning return.) Accordingly, the sooner the institution of first deposit requiring notification of nonpayment of received notification, the greater the checks drawn on the U.S. Treasury reduction in the loss exposure to serves little purpose because such notice depository institutions and the sooner would not be given in a time frame to be funds could be made available to value to the institution of first deposit. customers. The Board believes that the The Board has determined to adopt notification requirement should apply to the proposed deadline in view of the all other large dollar checks collected operational considerations raised by a through the Federal Reserve. An significant number of commenters exemption should not be provided for concerning the shorter deadline. checks returned for improper Accordingly, a payor institution that indorsement, as suggested by six determines to return a check collected commenters, because such checks also through the Federal Reserve is required represent a risk of loss to the institution to provide notification such that it is of first deposit that notification of received by the institution of first nonpayment could help avoid. For deposit by the payor institution’s second example, such a risk of loss could occur banking day following the day the payor with an improperly indorsed check in institution is required to return the the case where one joint payee attempts check. The Board indicated that it to obtain the funds represented by thd intends to evaluate this deadline over check without the permission of the time to determine whether it could be other joint payee(s). shortened by one day after experience is B. Time b y which notification m ust be gained with the notification requirement. received b y the institution o f first Under the Board’s proposal, the deposit. Under the Board’s proposal, a deadline for receipt of notice would be 3 established at midnight of the banking day, rather than at the institution of first deposit’s close of business. Eighty three commenters, or 55 percent of the commenters commenting on this issue, agreed with the Board’s proposal. These commenters indicated that they were accustomed to the midnight deadlines of the U.G.C. They stated that payor institutions could not be expected to be aware of the closing time of each institution of first deposit. Furthermore, a deadline based upon close of business (e.g., 2:00 p.m.) would give W est Coast depository institutions only a few hours to provide same day notification to East Coast depository institutions. For these reasons, the Board has determined to require the payor institution to provide notice such that it is received by midnight of the second banking day following the day on which the payor institution is required to dishonor the check. The Board believes that it is appropriate to base this deadline upon time of receipt by the institution of first deposit because it is that institution that would take this information into account in providing its customer with availability by a date certain. (In many cases, it would not m atter whether the deadline is established in terms of the time the payor institution sends the notice or the time the institution of first deposit receives the notice because the day upon which the notice is sent by the payor institution and the day upon which it is received by the institution of first deposit will often be the same day.) The Board expects that the institution of first deposit will establish procedures to ensure that the notification is brought to the attention of the individual(s) at the institution of first deposit responsible for receiving such notice as quickly as reasonably possible. Timely notification that otherwise satisfies the notification requirements would relieve the payor institution from liability with regard to the notice. The failure of the institution of first deposit to ensure that the ■notification is brought to the attention of the responsible' individual(s), would not shift liability to a payor institution that otherwise satisfies the notification requirements. C. D ay upon which notification is required is not a business d ay for the institution of first deposit. Under the Board’s proposal, if the day the payor institution provides notice to the institution of first deposit is not a business day for that institution, receipt of notice on the institution of first deposit’s next business day would constitute timely notice. One hundred and forty-five commenters, or 98 percent of the commenters commenting on this issue, agreed with the Board’s proposal. These commenters indicated that the institution of first deposit would not release funds to its customers on a non business day even if it received notice on that day. Accordingly, the Board has detemined that if the Hay the payor institution is required to provide notice to the institution of first deposit is not a business day for the institution of first deposit, receipt of notice on the institution of first deposit’s next business day consititutes timely notice. Four commenters suggested that if the next business day for the institution of first deposit is not also a business day for the payor institution, the payor institution should not be required to provide notice until the next day that is a business day for both the payor institution and the institution of first deposit. It will be quite uncommon for the institution of first deposit’s next business day to not also be a business day for the payor institution. In those rare instances where this day is not a business day for the payor institution, the payor institution could use another entity to provide notice on that day. In addition, the payor institution also would have the option of providing the notification to the institution of first deposit on the day prior to its closing. For these reasons, the Board has detemined to require the payor institution to provide notice to the institution of first deposit on the institution of first deposit’s next business day, regardless of whether that day is also a business day for the payor institution. D. Information to be provided in the notification. The Board's proposal required the payor institution to provide the following information: (1) The name of the payor institution; (2) the name of the payee; (3) the amount of the check; (4) the reason for return; (5) the date of the indorsement of the institution of first deposit; (8) the account number of the depositor; (7) the branch at which the check was first deposited; and (8) the trace number on the chefck of the institution of first deposit. One hundred and six, or 97 percent of the commenters commenting on this issue, stated that the information specified in the Board’s proposal would 4 be useful to the institution of first deposit. Accordingly, the Board has determined that the payor institution is required to provided in the notification the information specified in the proposal provided it, exercising ordinary care and acting in good faith, is able to determine such information from the check itself. For example, the account number of the depositor, the branch at which the check w as deposited and the trace number on the check could be provided in the notification only if the institution of first deposit had placed such information on the check. In those cases in which another entity provides notice for the payor institution, the payor institution would of course be required to provide that entity with information concerning the indentity of the institution of first deposit. Several commenters suggested additional information not included in the Board’s proposal that would also be useful to the institution of first deposit. After evaluating these suggestions, the Board has determined to encourage, but not require, the payor institution to include the following information in the notification: (1) The drawer of the check (name and account number); (2) the number of the check; (3) the date of the check; (4) the last non-depository institution indorser if different from the payee; and (5) any other information that the payor institution believes might be useful to the institution of first deposit. The requirements as to the information to be included in the notification will be uniform among all Reserve Banks. E. Method of providing notification. Under the Board’s proposal, the payor institution could select among several means of providing notice, including providing notification by telephone or returning the check such that it is received by the institution of first deposit before the notification deadline. Virtually all of the commenters commenting on this issue supported the options provided to the payor institution for satisfying the notification requirement. Accordingly, the Board has determined to permit the payor institution to use any m eans to satisfy the notification requirement. For example, the payor.institution could return the unpaid check such that it is received by the institution of first deposit by midnight of the second banking day following the payor institution’s midnight deadline for dishonor of the check. This alternative would generally be feasible when the payor institution is returning a check to a nearby institution of first deposit, either directly or perhaps through a local clearing house. The payor institution could also itself provide a notification directly to the institution of first deposit. The notice could be given by telephone or other telecommunications networks such as Bankwire,. SWIFT, Telex or the Federal Reserve’s Communications System, which would pass the message on to the institution of first deposit. The payor institution could also provide its Reserve Bank, such as by telephone, with all of the required information concerning the unpaid check. The Reserve Bank would then advise the institution of first deposit that the check is being returned and provide it with the appropriate information. For checks collected through the Federal Reserve, a payor institution could return the check to the Reserve Bank with instructions that the Reserve Bank initiate a notification to the institution of first deposit. T he Reserve Bank would then provide the appropriate information on the check to the institution of first deposit. Institutions exercising either of these latter two options will be required to provide the information or the check (as the case may be) to the Reserve Bank in advance of the time by which notification will have to be received by the institution of first deposit. These deadline's will be specified in the Reserve Banks’ operating circulars. In cases where the Federal Reserve initiated the notification or the payor institution initiated the notification through the Federal Reserve’s Communications System, the notification would follow a standard format that will be developed well in advance of the implementation date. In addition, the Federal Reserve will work with the industry to develop a standard format for notifications that could be used regardless of whether the notification is made through the Federal Reserve or through other means. W hen the payor institution makes use of the Federal Reserve’s notification service, the institution of first deposit will be able to specify to the Reserve Bank whether the institution desires to receive notification of dishonor via the telephone or the Federal Reserve’s Communications System. The institution of first deposit will also be to specify the department (or other entity) that should receive the notice. Moreover, in those cases in which the Reserve Bank gives the notification, the Reserve Bank will retain documentation of the notification for the time period within which the institution of first deposit must initiate action concerning the notification of nonpayment and will provide this documentation to the payor institution upon request. The Reserve Banks will develop procedures to ensure that they do not erroneously send a second notice in those cases in which the payor institution has itself provided notice and returned the check to the Federal Reserve for collection. For example, each Reserve Bank may require each payor institution in advance to notify the Reserve Bank whether the institution wants the Reserve Bank to provide notification on all or none of the institution’s return items. The Board proposed to charge the payor institution, rather than the institution of first deposit, for these enhanced notification services because the Reserve Bank is assisting the payor institution in fulfilling its responsibility to provide notification and because its customer is usually responsible for the returned check. Although the institution of first deposit does enjoy benefits from the notification, as asserted by a few of the commenters, the Board continues to believe it to be appropriate to charge the payor institution for the reasons indicated in the proposal The Board proposed that a three tiered fee structure apply to the services offered’by the Reserve Bank. If the institution provides notification through the use of an on-line Fedwire message, a fee of $2.25 per advice would be charged. This fee is based upon the estimated cost of providing the service, including any notification that the Reserve Bank must make by telephone to the institution of first deposit. If the payor institution provides the information, such as by telephone, to the Reserve Bank and requests it to provide the required information to the institution of first deposit, a fee of $4.25 . per advice would be charged. This fee reflects additional labor and other costs involved in transcribing the information provided by the payor institution. Finally, if the payor institution returns a check collected through the Federal Reserve to the Reserve Bank with instructions to provide notification to the institution of first deposit, a fee of $4.25 would be charged. This fee 5 includes the costs of processing, reading the indorsements, initiating the wire advice, and other costs. Five commenters stated that the Federal Reserve’s fees should be costjustified. As indicated above, the proposed fees are established to recover the projected cost of providing the service. These fees have been based upon projected volumes and experience with the cost of providing similar services. Accordingly, the Board has determined to adopt the fees as proposed. The Board intends to review these fees at the time it reviews the fee schedule for the Federal Reserve’s check collection services and adjust the fees for the notification service, if necessary, to ensure that they continue to reflect the cost of providing the service. In the interest of maintaining a simple fee structure, the Board has determined not to adopt different fees depending upon whether the notification is being sent to an on-line or off-line institution as recommended by three of the commenters. F. Permitting or requiring institution of first deposit to specify to the payor institution the department or entity to receive notice. Under the Board’s proposal, the institution of first deposit would not be required to specify to the payor institution the department or entity to receive the notice. The Board's proposal was, however, silent as to whether the institution of first deposit would be permitted to specify to the payor institution this information. Eighty one commenters, or 84 percent of the commenters commenting on this issue, opposed requiring the institution of first deposit to specify to the payor institution where notice should be sent. Sixty eight commenters, or 54 percent of the commenters commenting on this issue, opposed permitting the institution of first deposit to specify to the payor institution where notice should be sent. These commenters indicated that placing this information on the check would clutter the check and further complicate the reading of endorsements. These commenters stated that requiring the payor institution to look beyond the check for this information would be unduly complicated and costly, particularly in view of the rapid rate that this information would be updated and revised. Moreover, the institution of first deposit should easily be able to route the notification to the appropriate area. For these reasons, the Board has determined that the institution of first. deposit will not be required or permitted to specify to the payor institution the departm ent of the institution (or other entity) that must receive the notification. Similarly, the Board believes that it is not necessary to specify in the regulation the area of the institution of first deposit to be notified (e.g., Return Item Unit). As indicated above, the institution of first deposit would be able to specify to its Reserve Bank the department or entity to receive the notice. Similarly, a payor institution could agree with a particular institution of first deposit to provide the notice as directed by the institution of first deposit. The Board encourages bank directories to include information to assist the payor institution in providing notice. G. Institutions o f first deposit located outside the United States. Three commenters questioned how the notification requirement would apply if the institution of first deposit were located outside the United States. The Board believes that it would be an inordinate burden for the payor institution to provide notification to institutions of first deposit located outside the United States. Accordingly, in such cases, the payor institution should provide notification to the depository institution in the United States that first handled the item. H. Cancellation o f a previous notification. Five commenters raised questions concerning the case in which the payor institution provides notification but subsequently decides to pay the check. The Board has determined to adopt the suggestion of one of the commenters and require a payor institution that determines not to return a check subsequent to the provision of a notice of nonpayment to send a second notification as soon as reasonably possible cancelling its previous notification of nonpayment. This second notification should indicate that it is a second notification that is cancelling a previous notification of nonpayment. It should also contain sufficient information to enable the institution of first deposit to match this second notification with the previous notification of nonpayment. I. Liability fo r failure to com ply with notification requirement. Under the Board's proposal, a payor institution that failed to exercise ordinary care in complying with the notification requirement would be liable for losses incurred by the institution of first deposit up to the amount of the item if the loss would have otherwise been avoided had the payor institution exercised ordinary care. A payor institution that failed to act in good faith (i.e., failure to exercise honesty in fact) in complying with the notification requirement would be liable for consequential damages. (These are the same liability standards as are contained in the U.C.C. Indeed, several courts already have applied this standard in cases involving the failure of a payor institution to provide notification of return.) Similarly under the proposal, in cases where the Reserve Bank assists the payor institution in providing notification, the Reserve Bank would be liable for a loss incurred by the institution of first deposit up to the amount of the item if the loss would have otherwise been avoided had the Reserve Bank exercised ordinary care in providing the notification. Accordingly, if the payor institution returns the check to the Reserve Bank in accordance with established deadlines and requests the Reserve Bank to initiate the notification, the Reserve Bank would incur the same liability to the institution of first deposit under the proposal as would the payor institution. One hundred and forty commenters, or 93 percent of the commenters commenting on this issue, supported the Board's proposal. These commenters indicated that incorporating the same liability standards as are prescribed in the U.C.C. will result in the immediate application of an existing body of case law; thereby obviating the necessity of litigating the meaning of the language employed. Accordingly, the Board has determined to adopt the standards of liability as proposed. Fourteen commenters suggested that the Board should specify how these standards of ordinary care and good faith would apply in the context of the notification requirement (e.g., should there be liability if the failure of the payor institution to provide notification was due to an act of God or computer down time). Regulation J currently provides a bank with an extension from the requirements in the regulation if the delay in complying is due to an interruption of communication facilities, war, emergency conditions or other circumstances beyond the bank’s control. The Board does not believe that it would be appropriate to specify further how the standards of ordinary care and good faith would apply in particular factual circumstances 6 because the factual circumstances cannot be anticipated prior to actual occurances and this task is more appropriately performed by the courts. The commenters were evenly split on whether the institution of first deposit, if it prevails in litigation, should be able to recover its court costs and reasonable attorneys’ fees from the payor institution. The Board has determined that the institution of first deposit should be permitted to recover such costs to facilitate the recovery by the institution of first deposit of its economic loss (particularly for smaller institutions). Hbwever, so as not to unduly disadvantage the payor institution, the Board has adopted the suggestion of two commenters to permit the payor institution to recover its court costs and reasonable attorneys’ fees if it prevails in litigation. (The costs of in-' house counsel should be based upon the actual costs incurred by the party.) Under the Board’s proposal, only the payor institution would be required to provide notification of nonpayment. One commenter recommended that an institution to whom a check is presented for payment be required to provide notification even if that institution is not the payor institution. This commenter suggested that this would help alleviate the recent problem of MICR fraud (i.e., the intentional altering of a check so that it indicates one or more fictitious payor institutions in order that its collection and return be delayed beyond expiration of the institution of first deposit’s availability of funds hold). The Board has determined not to adopt this suggestion because it would be unfair to impose this duty, and presumably liability for any failure to meet this duty, on an institution that is involved only because a malefactor identified the institution, without its consent or knowledge, as a party on the check. Similarly, intermediary collecting institutions would not have any responsibilities concerning the notification of nonpayment. This would be true even if an intermediary institution mistakenly receives a notification of nonpayment. Four commenters raised the issue of whether the institution of first deposit is required to pass on the notification to its customer. The Board believes that this is an issue most appropriately left to agreement between the institution of first deposit and its customer given that the needs of each will vary from case to case. Accordingly, the rule adopted by the Board does not require the institution of first deposit to pass along the notification to its customer. Several commenters raised questions concerning how the liability provisions of the notification requirement would overlap with existing requirements in the U.C.C. The Board believes that it would be possible to have duplicative or overlapping liability if the payor institution failed to comply with the notification requirement and another depository institution failed to comply with the U.C.C.’s requirements concerning the return of the physical check. Similarly, the failure of the payor institution to satisfy the notification requirement should not defeat the claims that the institution otherwise would have against the institution of first deposit for breach of warranty. One commenter asked w hat statute of limitations applied to the institution of first deposit’s claim against the payor institution for failure to comply with the notification requirement. This question will be addressed separately in the context of Regulation J as a whole. As discussed above, a Reserve Bank that provides a notification on behalf of the payor institution would incur the same liability as woud be applicable to the payor institution had it itself provided the notification. Accordingly, the Board believes that it would be appropriate, as suggested by one of the commenters, for the Reserve Bank to indemnify the payor institution for any claim brought against it by the institution for first deposit that resulted from the Reserve Bank’s failure to exercise ordinary care or failure to act in good faith in providing the notice. Similarly, the payor institution is to indemnify the Reserve Bank for any claim brought against it by the institution of first deposit that resulted from the payor institution’s failure to exercise ordinary care or failure to act in good faith. J. Implementation date. Several commenters indicated that a substantial lead time was necessary to establish procedures,irain personnel, improve indorsements, and work for legislation to apply the notification requirement to all checks. Accordingly, the Board has. determined that the new notification requirement be effective on October 1, 1985. The impact of this amendment to Regulation J on small entities has been considered m acordance with the Regulatory Flexibility Act (Pub. L. 98354; 5 U.S.C. 604). The amendment specified by the operating circular of the paying bank’s Reserve Bank by the depositary bank by midnight of the second banking day of the paying bank following the deadline for return of the item as specified in paragraph (a) of this section. If the day the paying bank is required to provide notice to the depositary bank is not a banking day for the depositary bank, receipt of notice on the depositary bank’s next banking day shall constitute timely notice under this paragraph. Notice may be provided through any means, including return of the cash item so long as the cash item is received by the depositary bank within the time limits specified in this subparagraph. (3) The information contained in the notice shall include the name of the paying bank, the name of the payee, the amount of the item, the reason for return, the date of the indorsement of the depositary bank, the account number of the depositor, the branch at which the item w as first deposited, and the trace number on the item of the depositary bank, and should otherwise List off Subjects in 12 CFR Part 210 be in accordance with uniform Banks, Banking, Federal Reserve standards and procedures specified by System. the operating circular of the paying Pursuant to its authority under section bank’s Reserve Bank. A paying bank is 13 of the Federal Reserve Act, (12 U.S.C. not required to provide any information in the notice that it, after exercising 342); section 16 of the Federal Reserve ordinary care and acting in good faith, is Act (12 U.S.C. 248(g), 360); and section not able to determine with reasonable ll(i) of the Federal Reserve Act (12 U.S.C. 248(i)), the Board has amended 12 certainty from the item itself. (4) A paying bank is not required to, CFR Part 210 (Regulation J), effective but may voluntarily, provide notice to October 1,1985, as follows: the department of the depositary bank or other entity specified by the PAR T 210— l A M E N D ED ] depositary bank to receive the notice. In § 210.12, the last sentence of the (5) If a paying bank provides a notice section is designated as paragraph (d), pursuant to subparagraph (1) of this and new paragraph (c) is added after paragraph and subsequently determines paragraph (b) to read as follows: to pay the item, the paying bank shall provide to the depositary bank a second §210.12 Return @1©ash items. notice as soon as reasonably possible. * * * * * This second notice should indicate that (c) Notification o f Nonpayment. (1) A it is a second notice that is cancelling a paying bank that receives a cash item in previous notice and should contain the amount of $2500 or more directly or sufficient information to enable the indirectly from a Reserve Bank and depositary bank to match the second determines not to pay it shall provide notice with the previous notice. notice to the first bank to which the item (6) A paying bank that fails to was transferred for collection exercise ordinary care in meeting the (“depositary bank”) that the paying requirements of this paragraph shall be bank is returning the item unpaid. If the liable to the depositary bank for losses depositary bank is not located in a state, incurred by the depositary bank, up to the paying bank shall provide the notice the amount of the item, reduced by the to the bank located in a state that first amount of the loss that the depositary handled the item for collection. bank would have incurred even if the (2) The paying bank shall provide the paying bank had used ordinary care. A notice such that it is received as paying bank that fails to act in good should not result in a significant burden on small depository institutions because all depository institutions currently are required to provide notification of nonpayment of checks of $2500 or more collected through the Federal Reserve. That is, a payor institution currently is requried to incur the cost of providing notice of nonpayment of such checks to the presenting institution. Under the amendment, a payor institution will be required to provide this notice of nonpayment directly to the institution of first deposit rather than to the presenting institution. As discussed above, it is estimated that the proposal will reduce the costs for smaller payor depository institutions as compared to the current notification requirement by reducing the number of required notifications. Moreover, the Reserve Banks will provide an enhanced notification service which will reduce any operational effect this action may have. Finally, the amendment imposes no new reporting or recordkeeping requirements on depository institutions. 7 have incurred even if the Reserve Bank the depositary bank that results from the faith in meeting the requirements of this had used ordinary care. A Reserve Bank Reserve Bank's failure to exercise paragraph may be liable for other that fails to act in good faith in damages, if any, suffered by the ordinary care or failure to act in good undertaking to provide the notice depositary bank as a proximate faith in providing the notice. The paying required in this paragraph on a paying consequence. If the paying bank or the bank shall indemnify a Reserve Bank bank’s behalf may be liable for other depositary bank prevails in litigation that undertakes to provide the notice damages, if any, suffered by the involving.the requirements of this required in this paragraph on the paying depositary bank as a proximate paragraph, it may recover its court costs bank's behalf for any claim brought consequence. If the Reserve Bank or the against the Reserve Bank by the and reasonable attorneys' fees. A depositary bank prevails in litigation paying bank shall not be liable for depositary bank that results from the involving the requirements of this mistake, neglect, negligence, paying bank's failure to exercise misconduct, insolvency or default of any paragraph, it may recover its court costs ordinary care or failure to act in good other bank or other person in connection and reasonable attorneys’ fees. A faith in connection with the provision of Reserve Bank shall not be liable for with providing notice under this the notice. mistake, neglect negligence, (9) This paragraph does not apply to paragraph. (7) Notwithstanding the provisions of misconduct, insolvency or default of any an item drawn on the account of the JJ.S. other bank or-other person, including the Treasury or to an item indorsed by, or section 210.8 of this subpart, a Reserve for credit to, the U.S. Treasury. paying bank in connection with Bank that fails to exercise ordinary care * ft * ☆ ☆ providing notice under this paragraph. in undertaking to provide the notice (8) Notwithstanding the provisions of required in this paragraph on a paying By order of the Board of Governors, § 210.6 of this subpart, a Reserve Bank bank’s behalf shall be liable to the February 7,1985. that undertakes to provide the notice depositary bank for. losses incurred by William W. Wiles, the depositary bank, up to the amount of required in this paragraph on a paying bank’s behalf shall indemnify the paying Secretary of the Board. the item, reduced by the amount of the bank for any claim brought against it by [FR Doc. 85-3462 Filed 2-11-85; 8:45 am] loss that the depositary bank would 8
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