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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
