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Chapter 29

BANK DEPOSITS, COLLECTIONS, AND FUNDS

TRANSFERS

I. Bank Deposits and Collections

A. Collection of Items

1. Collecting Banks

a. Duty of Care

b. Duty to Act Timely

c. Indorsements

d. Warranties

e. Final Payment

2. Payor Banks

B. Relationship Between Payor Bank and

Its Customer

1. Payment of an Item

2. Substitute Check

3. Stop Payment Orders

4. Bank’s Right to Subrogation on

Improper Payment

1. Automated Teller Machines

2. Point-of-Sale Systems

3. Direct Deposits and Withdrawals

4. Pay-By-Phone Systems

5. Personal Computer (Online) Banking

6. Wholesale Electronic Funds Transfers

B. Consumer Funds Transfers

1. Disclosure

2. Documentation and Periodic

Statements

3. Preauthorized Transfers

4. Error Resolution

5. Consumer Liability

6. Liability of Financial Institution

C. Wholesale Funds Transfers

1. Scope of Article

Cases in This Chapter

Honeycutt v. Honeycutt

Leibling, P.C. v. Mellon PSFS National Association

Seigel v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

Union Planters Bank National Association v. Rogers

Chapter Outcomes

After reading and studying this chapter, the student should be able to:

Identify and explain the various stages of and parties to the collection

of a check.

Identify and explain the duties of collecting banks.

Explain the relationship between a payor bank and its customers.

Define a consumer electronic funds transfer, identify the various types

TEACHING NOTES

Credit cards, charge accounts, and various deferred payment plans have

made cash sales increasingly rare. Credit sales are usually settled by check

rather than cash. In some sales, credit is extended by the seller or a third

party. In other sales, a noncash payment is made either by paper (checks

and drafts) or electronically (debit cards, credit cards, automated

clearinghouse [ACH], and prepaid cards).Generally, the buyer’s check must

I. BANK DEPOSITS AND COLLECTIONS

Article 4 of the UCC, entitled “Bank Deposits and Collections,” provides the

principal rules governing the bank collection process. In 2002, the American

Law Institute and the Uniform Law Commission completed updates to Article

4. At least ten States have adopted the 2002 version. This part of the text

will discuss the pre-2002 Article 4.

The end result of the collection process is either the payment of the check or

the dishonor (refusal to pay) of the check by the drawee bank. As items in

the bank collection process are essentially those covered by Article 3,

“Commercial Paper,” and to a lesser extent by Article 8, “Investment

Securities,” these Articles often apply to a bank collection problem. In

*** Chapter Outcome ***

Identify and explain the various stages and parties to the collection of a check.

A. COLLECTION OF ITEMS

When a check is deposited (in the depositary bank), the bank credits the

account for that amount. This is provisional credit and, normally, a bank

does not permit a customer to draw funds against a provisional credit. If the

bank does permit its customer to draw against the provisional credit, it has

given value and may qualify to be a holder in due course. Under the

customer’s contract with her bank, the bank must make a reasonable e<ort

to obtain payment of all checks deposited for collection. When the amount

represented by) various types of instruments.

Where the depositary and payor banks are di<erent, a check must pass from

one bank to the other, either through one or more intermediary banks or

through a clearinghouse — an association, composed of banks or other

payors, whose purpose is to settle its members’ accounts on a daily basis.

NOTE: See Figure 29-1.

*** Chapter Outcome ***

Identify and explain the duties of collecting banks.

Collecting Banks

A collecting bank is one that handles an instrument for payment, excluding

the payor bank. Typically, the depositary bank gives a provisional credit to

its customer and then transfers the item to the next bank in the chain,

receiving a provisional credit or “settlement” from it, and so on to the payor

bank, which then debits the drawer’s account. When the check is paid, all

the provisional settlements become final; the transaction is completed.

If the payor bank does not pay the check, however, it returns the check, and

Duty of Care — Collecting banks are required to exercise ordinary care in

the handling of checks and must act with reasonable care and within a

reasonable time to forward them for presentment. They must also use care

in routing items and selection of intermediary banks and agents.

CASE 29-1

Honeycutt v. Honeycutt

Thieme, J.

In this appeal, we review two orders

entered by the Circuit Court for

Baltimore City, which granted two

separate Motions for Summary Judgment

filed by Bank of America, N.A., appellee,

against Sheldon, Inc., appellant

(“Sheldon”), and Nancy Honeycutt,

Personal Representative of the Estate of

Ron Honeycutt, appellant (“the Estate”).

Appellants’ claims arose when Christine

Honeycutt (“Christine Honeycutt”)

withdrew approximately $13,000 from

On March 13, 2000, Sheldon

commenced an action against Christine

Honeycutt, the former vice-president

and secretary of Sheldon, in the District

Court of Maryland for Baltimore City in

connection with her withdrawal of funds

from Sheldon’s account with the Bank *

* * . On May 4, 2000, Sheldon amended

its original Complaint in the District

Court to assert additional claims against

* * *

On May 22, 2001, the Bank filed a

Motion for Summary Judgment * * * . In

its Motion, the Bank argued that * * * (ii)

at the time Christine Honeycutt

withdrew funds from Sheldon’s account,

she was an authorized signatory on the

account and, therefore, the Bank

committed no legal wrong when it

permitted the withdrawal. * * *

presided and rendered a verdict in favor

of the Estate and against Christine

Honeycutt on the breach of contract

claim.

The Estate and Sheldon filed a timely

Notice of Appeal, on March 13, 2002,

and now present two questions for our

review:

I. WAS THE LOWER COURT LEGALLY

CORRECT IN GRANTING THE MOTION

FOR SUMMARY JUDGMENT OF APPELLEE,

BANK OF AMERICA, N.A. (“APPELLEE

BANK”) AGAINST APPELLANT SHELDON,

HAD BEEN NEGLIGENT IN THIS MATTER?

* * *

For the reasons that follow, we shall

aDrm the judgment of the circuit court.

Factual Background

Ron Honeycutt was the president,

treasurer, and sole stockholder of

Sheldon, Inc., which trades as Sheldon’s

Lounge, a bar located in Baltimore City.

Christine Honeycutt was, at one time,

Ron Honeycutt’s wife and held the

Ron Honeycutt and Christine Honeycutt

executed a signature card for the

account. The signature card read, in

pertinent part:

In consideration of the opening of this

account and the maintenance thereof by

Maryland National Bank (hereinafter

“Bank), the signer(s) (hereinafter

“depositor”) by the signature(s)

subscribed below agree(s) to the Rules

withdrawals of funds, or the transaction

of any business to this account.

Depositor acknowledges receipt of a

copy of the Rules and Regulations

governing this account.

On the signature card, Ron Honeycutt

and Christine Honeycutt checked o< the

box requiring only one signature to

Ron Honeycutt died February 10, 2000.

On February 15, 2000, Christine

Honeycutt withdrew funds in the amount

of $13,066.48 from Sheldon’s account.

At the time of withdrawal, an employee

of the Bank retrieved and reviewed the

signature card on file with the Bank in

order to verify Christine Honeycutt’s

authority to direct and conduct

transactions on Sheldon’s account. The

Bank did not inquire as to Christine

Honeycutt’s status with respect to

Sheldon, nor did they inquire of anyone

at Sheldon as to her status. At the time,

Discussion

* * *

Sheldon argues that the Bank breached

its duty of care “by failing to make an

adequate inquiry as to the authority of

Christine Honeycutt to conduct banking

on behalf of the business.” We disagree.

“A bank and its customers enjoy a

debtor/creditor relationship in which the

rights and liabilities of each are

contractual.” [Citations.] “Implicit in the

contract [between the bank and

customer] is the duty of the bank to use

ordinary care in disbursing the

depositor’s funds.” [Citations.] * * *

* * *

Here, Ron and Christine Honeycutt, on

July 1, 1984, opened a business

checking account in the name of

Sheldon’s Lounge with the Bank’s

predecessor. On that same day, Ron and

Christine Honeycutt executed a

signature card and checked o< the box

requiring only one signature to transact

any business on the account. * * * [T]he

signature card created a contractual

obligation on the part of the Bank to pay

the depositor’s funds only as authorized

by the signature card. The plain

the Bank did not breach any standard of

care owed to appellants. The Bank

exercised reasonable care when it

inspected the signature card on file for

Sheldon’s account and verified that

Christine Honeycutt was an authorized

signatory on the account. Moreover, we

are persuaded that no further inquiry

Case Questions

1. What are the duties of a collecting bank?

2. Did Austin exercise ordinary care? Explain.

Ethical Question: Did any of the parties act unethically? Explain.

Critical Thinking Question: Do you agree with the court’s decision?

Explain.

Duty to Act Timely — The midnight deadline refers to the midnight of the

next banking day subsequent to the day on which an instrument was

received. A collecting bank is considered to have acted timely if it forwards

or presents an item by this deadline.

Indorsements — A restrictive indorsement such as “Pay any bank” locks

the check into the bank collection process, and protects the collecting bank

by making it impossible for the item to stray from regular collection

channels. A depository bank that receives an item without indorsement

becomes a holder if the customer was a holder.

Warranties — Customers and collecting banks give the same transfer

warranties as parties, including: 1) he is entitled to enforce the item, 2) all

signatures are authentic and authorized, 3) there are no alterations, 4) he is

not subject to any defense or claim in recoupment; and 5) he has no

knowledge of any insolvency proceeding involving the maker or the drawer

of an unaccepted draft. The presenter’s warranties to a drawee on a draft

Payor Banks

A payor (drawee) bank is obligated to pay on a drawer’s check assuming no

stop payment order has been filed and adequate funds are available in the

account. In most cases, a payor bank must give its transferor a provisional

settlement; otherwise it may become liable to its transferor for the amount

of the item unless it has a valid defense, such as breach of a presentment

warranty.

The bank may dishonor an item because: the drawer has no account or the

account has insuDcient funds, a signature may be forged, or the drawer may

have stopped payment on the item.

*** Chapter Outcome ***

Explain the relationship between a payor bank and its customers.

B. RELATIONSHIP BETWEEN PAYOR BANK AND ITS

CUSTOMER

A bank may not validly (1) disclaim responsibility for its lack of good faith, (2)

disclaim responsibility for its lack of ordinary care, or (3) limit its damages for

a breach constituting such lack or failure. The parties may by agreement,

however, determine the standards by which such responsibility is to be

measured, as long as these standards are not clearly unreasonable.

Payment of an Item

A payor bank owes a duty to its customer, the drawer, to pay checks

properly drawn by the customer on an account that has funds suDcient to

cover the items, although the holder of a check has no right to require the

drawee bank to pay it. However, if an item which is less than six months old

is presented to a payor bank and the bank improperly refuses payment, it

will incur a liability to the customer from whose account the item should

have been paid. Checks over six months old are considered “stale” but may

be paid at the bank’s option if done in good faith.

Substitute Check

The Check Clearing for the 21st Century Act (also called Check 21 or the

Check Truncation Act), which went into e<ect in late 2004, permits banks to

remove an original paper check from the check collection or return process

and sending (1) a substitute check or, (2) by agreement, information relating

to the original check (including data taken from the MICR line of the original

check or an electronic image of the original check). The substitute check is

the legal equivalent of an original check for all purposes, if the substitute

A substitute check is a paper reproduction of the original check that: (1)

contains an image of the front and back of the original; (2) bears a MICR

(magnetic ink character recognition line) containing all the information

appearing on the MICR line of the original check; (3) conforms, in paper

stock, dimension, and otherwise, with generally applicable industry

standards for substitute checks; and (4) is suitable for automated processing

in the same manner as the original check.

The law does not require banks to accept checks in electronic form nor does

Stop Payment Orders

A customer may revoke the order to pay a sum of money (as contained in a

check) with a stop payment order. If the order does not come too late, the

bank is bound by it.

CASE 29-2

Leibling, P.C. v. Mellon PSFS (NJ) National Association

Rand, J.

Facts

Mr. Scott D. Liebling, P.C. (hereinafter

“Plainti<”) is an attorney at law. Plainti<

maintains an attorney trust account

(“Account”) at Mellon Bank (NJ)

National Association (“Mellon”) * * * .

Mellon uses a computerized system to

process checks for payment.

Plainti< represented, defendant, Fredy

Winda Ramos (“Ramos”) in a personal

injury action which resulted in a

settlement. On or about May 19, 1995,

plainti< issued Check No. 1031 in the

On December 21, 1996, some nineteen

months after plainti< issued the Check No.

1043, Ramos cashed the check from Puerto

Rico.

Plainti< filed this complaint against both

Ramos and Mellon. Ramos was served and

defaulted. Plainti<’s complaint against

Mellon alleges breach of duty of good faith,

negligence, breach of fiduciary duty,

payment of a stale check, and breach of

contract as a result of Mellon honoring the

second check, Check No. 1043.

* * *

Issue

A stop-payment order may be renewed

for additional six-month periods by a

writing given to the bank within a

period during which the stop-payment

order is e<ective.

In addition, [UCC] 4–404 states:

A bank is under no obligation to a

customer having a checking account to

pay a check, other than a certified

check, which is presented more than

the responsibility to act in good faith

and to exercise ordinary care. The

drafters of the Code chose not to

provide an explicit definition of

‘ordinary’ care, stating only that the

term is to be used ‘with its normal tort

meaning and not in any special sense

relating to bank collections.’” [Citation.]

* * *

In addition, the Third Circuit case of

[citation] appears to be analogous to

the present issue. In [that case], an

insurance company brought a

bank had acted in good faith, the court

analyzed the definition of “good faith.” The

court stated that “[UCC] §1–201 defines

good faith as ‘honesty in fact.’ This

definition must be viewed subjectively; a

finding of bad faith must be predicated on

a showing of dishonesty. Likewise, mere

negligence does not preclude a finding of

good faith.” [Citation.] In holding that the

bank had acted in good faith, the court

stated:

* * *

In contrast, plainti<’s argument centers on

the proposition that the bank’s duty of

good faith required it to inquire or consult

with plainti< before honoring a stale check

that had a previous oral stop payment

order on it. * * *

However, in the Uniform Commercial Code

Treatise, Mr. Hawkland stated that the

above cases are not consistent with the

Uniform Commercial Code, specifically,

“[t]he duty [of inquiry] is inconsistent with

the provisions of subsection 4–403(2) on

Articles III and IV of the Code were

substantially revised relating to, among

other things, bank deposits and

collections to become e<ective on June

1, 1995. The court is satisfied as

pointed out by the defendant that

those Amendments were enacted in

order to address the e<ect of

automated systems utilized by banks

with the substantial increase in check

usage after the original enactment of

the Code. The ODcial Code Comment

to the 1995 Amendments for §[UCC]

4–101, states as follows:

1. The great number of checks handled

[Citation.]

* * *

Thus, in determining whether the

defendant bank in the present action acted

in good faith, the above cited material

must be analyzed and applied. First, it

appears clear that the Uniform Commercial

Code acknowledges that computerized

check processing systems are common

and accepted banking procedures in the

United States. [Citation.] Therefore, it

cannot be said that defendant bank acted

in bad faith by using a computerized

system when it honored plainti<’s “stale”

check. Furthermore, it appears that the

Case Questions

1. Would the plainti< have had a stronger case if he had initially issued a written

stop payment request?

2. What could the plainti< have done to protect himself in this case?

Ethical Question: What is Ramos’ ethical responsibility in this case? Explain.

Critical Thinking Question: Do you think that banks should be required to

o<er a permanent stop payment option? Explain.

Bank’s Right to Subrogation on Improper Payment