Last Wednesday the Federal Reserve published approved final amendments to Regulation CC (Availability of Funds and Collections of Checks) which update the liability provisions of Reg. CC to address the nearly-complete conversion of the nation’s check collection system from a paper to an electronic environment.

Historically, when banks disputed which party should be responsible for the liability arising from an unauthorized check, the risks were split in two.  The paying bank (the bank that would pay on a check associated with an account it held) was responsible for forged checks; it would have a signature specimen from its customers, and be able to examine the signature of a presented check against the specimen signature; it would also know if the entire check was forged, since it was the bank’s check.  If the signatures didn’t match, or the check wasn’t an original check from the paying bank, yet the paying bank paid and there was a subsequent loss by the customer, the paying bank would be responsible for that loss, because it was in the best place to detect the forgery.

The depositary bank (the bank holding the account where check funds would be deposited) was responsible for altered checks; it was deemed to be in the best place to determine whether, for example, the amount of the check had been changed from $100 to $10,000.  This division of risk is old, originally established in 18th Century English law (in the case of Price v. Neal, 97 Eng. Rep. 871 (1762)), and enshrined in the U.S. under UCC Articles 3-407 and 3-417.  It also assumes the presentment and receipt of paper checks.

Virtually all checks presented in 2018 within the US are not presented in paper form.  Instead, an image of the check is taken, the original check is destroyed, and the depositary bank presents this check image (a truncated check) to the paying bank.  Notwithstanding the dramatic increase in settlement speed and dramatic reduction in processing costs, electronic images of checks create a potential problem in the event of a bank dispute over whether a check has been forged or altered.  The original check is destroyed, making it impossible to examine the original check to determine whether the check was altered, or whether it was a forgery.  Regulation CC currently does not provide any presumptions as to whether a check is altered or forged.

The new amendment provides this guidance, adding a new presumption of liability for substitute and electronic checks.  If there is a dispute between the paying bank and the depositary bank as to whether a substitute or electronic check is an altered or a forgery (now described as “derived from an original check that was issued with an unauthorized signature of the drawer”), the presumption is that the substitute/electronic check contains an alteration.  This generally shifts liability on fraudulent checks to depositary banks; this presumption may be overcome if a preponderance of the evidence proves the substitute or electronic check does not contain an alternation, or that it was a forgery.  The presumption does not apply if there is an original check to examine.

It’s a reasonable allocation of risk; the depositary bank is receiving, imaging and destroying the check, and then presenting the image to the paying bank.  If there is a later dispute over the fraudulent nature of the check, then the party that destroyed the original check, and was in the best place to preserve the check as evidence, should bear the risk associated with evidentiary questions.

The amendment goes into effect January 1, 2019.