I. the Basic Checking Relationship and the Bank S Right to Pay Checks

I. The Basic Checking Relationship and the Bank’s Right to Pay Checks

General
The Basic Relationship
3-103(a)(2), 4-104(a)(8), 4-105(3): Definition of “drawee” or “payor bank”
3-103(a)(3), 3-105(c): Definition of “drawer” or “issuer”
4-105(2): Definition of “depositary bank”
4-105(4): Definition of “intermediary bank”
Promulgation of Rules
Both Federal and State law makes rules. 4-103(b) acknowledges the preemptive effect of rules that are promulgated by the federal rules over state rules
The UCC
Article I is general principles that apply to all substantive topics covered by the UCC
Definitions in 1-201(b)
Obligation of Good Faith in 1-304
Article III is negotiable instruments
Article IV is Bank Deposits and Colllections
The Bank’s Right to Pay
When is it proper for the Bank to Pay?
4-401(a): A Bank can pay only when the check is “properly payable”
It is properly payable if the “customer has authorized the payment.” 4-401comment 1

2. If a check is given to an intermediary bank, then the intermediary becomes a person entitled to enforce the check. 1-201(b)(25), (27)

If a check is stolen through no fault of the payee, the bank does not have the right to pay the check. 4-401 comment 1, sentence 5-7.
Overdrafts
The payor bank can charge the account, but (absent some specific agreement) it is also free to dishonor the check and refuse to pay it. 4-401(a), 4-402(a)
McGuire v. Bank One, Louisiana, N.A.
Man representing himself as investment broker offers to sell woman bonds. She writes him $200,000 check, says not to cash it until later date. He cashes right away, and money has not transferred from her investment account into another account, creating an overdraft of $188,000. He does not buy bonds with her money, but keeps it for himself (conversion). She believes bank failed to exercise ordinary care. Held, Bank had the right to cash the check. (1) The check was “properly payable” under 4-401. (2) 4-401 permits a bank to charge a properly payable check against a customers account even if an overdraft results. (3) Under 4-103 the bank must exercise ordinary care. (4) B/c the check was properly payable under 4-401(a), this is ordinary care under 4-103. (5) Case law has shown that it doesn’t matter how big of an overdraft that is caused, it does not affect ordinary care.
Rationale for Overdraft Acceptance
Rule that required banks to pay overdraft would be unduly burdensome for banks that would have to deal w/holding the bag if nobody reimbursed them
Rule that required banks not to pay overdrafts would be unduly burdensome on customers who would have bad credit and bounced checks
Bank’s can agree to pay overdrafts, and thus become obliged to do so. 4-402(a) states that “a bank may dishonor an item that would create an overdraft unless it has agreed to pay the overdraft” and 4-103(a) states that “the effect of the provisions of this Article may be varied by agreement.
The UCC does not regulate how much banks can charge in overdraft fees. However, some state courts have found that a huge charge violates the banks obligation of good faith if charge was “not in the reasonable contractual obligations of the parties” and some courts have found them unconscionable.
Banks are allowed to pay checks in ANY order they choose. 4-303(b)
Stopping Payment
Customer must give the payor bank timely and adequate notice of the stop payment. 4-403
Bank cannot charge account over a stop payment order. 4-403 & Comment 7
Three considerations limit the practicality of the customer’s right to stop payment:
The customer must act promptly to exercise the right. 4-403(a)
“Received at a time and in a manner that affords the bank a reasonable opportunity to act on it before any [final] action by the bank with respect to the item.”
Unlikely to work if stop payment comes more than a few days after check has been written
The duration of the stop payment order is six months, and can be revived by the payee after that. 4-403(b)
The underlying obligation for which the check was written.
Payee has two separate rights on the check:
The right to enforce the check
The underlying obligation
To handle these two rights, UCC provides two rules:
3-310(b): UCC “suspends the payee’s right to pursue the customer on the underlying transaction when the payee accepts the customer’s check.
3-310(b)(1): The statute provides that the suspension ends if the check is dishonored.
Remedies for Improper Payment. 4-401
Bank must reverse the improper transaction. B/c item was not properly payable, the bank cannot sustain the charge on the customer’s account. Bank must thus recredit.
Statute also provides for consequential damages in cases which the charge to the account leads the bank to dishonor other checks. Must pay damages to the customer for all things proximately caused. 4-402(b)
4-407 sharply limits the recredit issue. 4-407 “subrogates” the bank’s rights to the rights of the payee so that the bank can assert the payee’s rights against the drawer as a defense to the bank’s obligation to recredit the account.
Case: McIntyre v. Harris

II. The Bank’s Obligation to Pay Checks

When are funds available for payment
The bank has the option to pay any item that is properly payable from the customer’s account
When the account has funds “available” the bank has an affirmative duty to pay the account
Two questions must be answered:
When is the determination made?
What is the balance in the account at that time?
Time of Evaluation
The statute essentially chooses the moment that the payor bank evaluates the check as the the point in time when the account must have sufficient funds
Under § 4-402(c), the bank is free to determine whether the account has sufficient funds “at any time between the time the item is received by the payor bank and the time that the payor bank returns the item.”
Dishonor remains appropriate notwithstanding new credits to the account after the bank has evaluated the sufficiency of the funds in the account.
Availability of funds
Reg CC establishes a framework of deadlines within which a depositary bank must release funds that its customers deposit by check.
Unlike UCC § 4-215, those deadlines apply even if the depositary bank does not determine by the deadline if the payor bank will honor the check in question.
First, distinguish among four separate dimensions:
General
Customer deposited in the form of local check
Customer deposited non-local check
Non local check is “any check drawn on a bank located outside the check-processing region of the bank at which the check is deposited
Customer wishes to use funds indirectly (writing checks against them)
Customer wishes to use funds directly (withdrawing cash).
Noncash withdrawls from local checks
The bank must make $100 available on the first business day after the banking day on which the funds are deposited.
The rest must be available for withdrawal no later than the second business day
Noncash withdrawls from nonlocal checks
The bank has to make $100 available on the first business day after the banking day on which the funds are deposited.
The rest must be made available for withdrawal no later than the fifth business day after the . . .
Cash withdrawals from local checks
The bank must make $100 available on the first business day after the banking day of deposit
Must make an additional $400 available the second business day
Must make remainder available on third day
Cash withdrawals from non-local checks
Must make $100 available on the first business day
Must make additional $400 available on the fifth business day
Must make remainder available on the sixth business day.
Banking v. Business Day
Banking Day: Those business days on which the bank is open “for carrying on substantially all of its banking functions
Business Day: All calendar days except Saturday, Sunday, and Federal Holidays
Seven ways you can get all available funds the next day. However, you must be (a) the original payee of the instrument and (b) personally deposit the item (no ATM):
Cash Deposits
Checks drawn on a local branch of the bank where they are deposited
US Treasury Checks
USPS money orders
Checks drawn on a federal reserve bank or federal home loan bank
Checks drawn on a local governmental entity
Cashier’s Checks or similar items drawn on banks
Low-risk items that are not deposited with a teller in the payee’s own account:
A treasury check or Postal Service money order deposited by somebody other than the original payee is treated as if it were a typical local check
If a Federal Reserve Check, local government check, or cashier’s check is deposited by somebody other than the original payee, the check is processed under the standard rules, with the availability of funds depending on whether the check is a local or non-local check
Low Risk items deposited in an ATM:
If Cash, Postal Service Money Order, Federal Reserve Checks, Local Government Checks, or Cashier’s Checks are deposited at an ATM into an account owned by the payee of the check, the availability is deferred a single day, to the second business day.
So, customer can’t get shit until 2nd business day ($100 then)
Justification for prompt funds availability
First, Reg CC doesn’t unconditionally obligate the bank to release funds immediately
Second consideration is convenience
Third, the likely long-term effects of giving banks the risk of loss that they face if deadlines force them to release funds without determining whether a check will clear

4. First National Bank v. Colonial Bank (Check Kiting Scheme/Risk of Loss)

Wrongful Dishonor: What happens in a bank refuses to pay
If a bank doesn’t pay a check it was obligated to pay, it has wrongfully dishonored the check
Customer is entitled to “all of the damages proximately caused by the wrongful dishonor.” UCC § 4-402(b)

a. Maryott v. First National Bank

III. Collection of Checks

The Payor Bank’s Obligation to the Payee
Although the payor bank might be liable to the drawer for wrongful dishonor, the payee itself can usually do nothing to force the payor bank to pay the check
Illustration: Outdoor Technologies v. Allfirst Financial, Inc.
H gave a $700g check to Outdoor for outstanding payments. The check stated it was drawn on an account at FNB, but it was actually drawn on Omni Bank. Outdoor wanted to get the check cashed as quickly as possible because H was about to institute bankruptcy proceedings. Outdoor sent someone to drive to a branch of FNB to cash it. They said it was an Omni check, that Omni was owned by BankCorp. and to call the lawyer of Omni/BankCorp. Lawyer says neither bank has to cash it - however, he says that if the guy goes to the closest Omni branch and presents “proper authorization” they will cash it. When he got to the branch, the lawyer said a letter wasn’t “proper authorization,” that he needed board approval. He couldn’t get it in time, and H filed bankruptcy, freezing the accounts. (1) There is no fraud by the lawyer. (2) No negligent Misrepresentation.
If the payee is concerned that the payor bank won’t pay, it can protect itself:
Payee could refuse to accept an ordinary check
Ask for a special check that offers an assurance the bank will pay it
Payee can ask for a certified check under 3-409(d)
Ask for a cashier’s check or teller’s check. § 3-104(g), (h)
These require inconvenience to get
The Process of Collection
Payee has two options to collect on a check:
Go directly to the payor bank and Obtain Payment Itself
Cash the check, by presenting it ”for immediate payment over the counter” 4-301(a)
If payor bank cashes, payment is final. 4-215(a)(2), comment 4 p 5
If payee has account at same bank as drawer
The bank sees this as an “on us” item
Will give the depositor a provisional credit on the day it receives the item
As long as the payor bank provides that provisional settlement on the day it receives the item, the payor bank has until its “midnight deadline” – midnight of the next banking day – to decide whether to honor the check. 4-301(a), (b).
If honored, it adds to payee’s account and deducts from drawer’s
If dishonored, notice is sent to payee/customer.
Then, can charge back payee’s account
If bank does nothing by midnight deadline, it loses its right to dishonor the check. 4-214(c), 4-301(b).
Obtain payment through intermediaries: Two Steps
Payee à Depositary Bank
First, an agency relationship is set up between the bank and the customer. § 4-201.
Thus, the depositary bank becomes the “collecting bank”
Also, comes with a duty of ordinary care. 4-202(a)
Second, bank gives provisional settlement, reserves its charge back right if the payor bank doesn’t honor the check. § 4-214
Depositary Bank à Payor Bank
Depositary Bank has broad discretion on how to collect
Must move quickly to meet funds availability rules
Typically, the check (paper) is transmitted to the payor bank, who pays it
Methods of transmission
Clearinghouse Arrangements
See p. 347 for a clearinghouse hypo
Note: If bank doesn’t follow clearinghouse rules regarding a provisional settlement, it can lose its right to dishonor under the UCC
Can’t recover from depositary bank, clearinghouse, or payee after that
See: Kimberly Allen Trust p. 348
Trust deposited into its account with Lakewood a $110g check. Lakewood presented to the payor bank the check the day after it was received, and placed a hold on trust account pending payment of the check. Lakewood received a provisional credit. After payor bank notified Lakewood the check had cleared, the hold was lifted from the account. Five days later, the payor bank said it was returning the check for insufficient funds, and Lakewood charged back the account and a fee. Trust filed action seeking its funds from Lakewood. (1) Under 4-214, a bank loses its right to charge back when payment becomes final. (2) Under 4-215(d), after payment becomes final, the bank is accountable to the customer for the item and any provisional credit when it becomes final. (3) 4-215(a) tells when something is “finally paid”. (4) Pursuant to 4-302, if an item is presented to and received by a payor bank, that bank is “accountable” for the amount of the demand item if it retains the item beyond midnight of the banking day of receipt without settling for it or, whether ot not it is also the depositary bank, does not pay or return the item, or send notice of dishonor until after its midnight deadline (midnight of the next banking day after receipt.
Bilateral Arrangements (Direct Send and correspondents clearing)
A pair of banks that have a relationship – a lot of checks drawn on them each day - will enter into this type of relationship – contractual, where they give provisional credits and then send the checks to the bank.
Cheaper and Faster than the Federal Reserve method
Collection Through the Federal Reserve System
System of last resort because it is most expensive and slower
Send to Federal Reserve Bank, who sends it to Payor bank – must honor or notify by midnight deadline –
If the payor wants to dishonor, go to Reg CC:
The Reg CC return deadline:
Payor bank must return the check in an “expeditious manner” in order to meet one of two deadlines”:
Two Day/Four Day Rule:
Requires the dishonoring payor bank to send the check so that the check would normally be received by the depositary bank not later than 4pm on the deadline: the fourth business day for nonlocal checks; the second business day for local checks. CC 229.30(a)(2)
Reg CC and the UCC midnight deadline
Whereas the UCC deadline requires the payor bank to put it in the mail by midnight of the next banking day, Reg CC allows them to wait until the next day if they use a mode of delivery that results in a faster return than the midnight deadline
First extension, deadline is waived if you return the check to the transferor (Fed Reserve Bank) by the day after the midnight deadline
Second extension waives the midnight deadline if the payor bank uses a “highly expeditions meas of transportation, even if this means of transportation ordinarily would result in delivery after the receiving banks next banking day.”
Reg CC notice of non-payment deadline
A payor bank that dishonors a check for $2500 or more must get notice of its determination to the depositary bank by 4pm on the second business day after the banking day on which the payor bank received the check.
Whether non-local or not
Allows depositary to release funds the second business day after the banking day
Difference between failure to meet the Reg CC rules and failure to meet the midnight deadline:
Failure to meet the deadline affects the settlement process:
Payor bank becomes accountable for the item under § 4-302, payment becomes final under § 4-215, and depositary bank loses any right of charge back under § 4-214
Failure to meet Reg CC:
Generally limited to damages CC § 229.38
Common Practice: Return notice over the Electronic Earns System(359)