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The Check Collection Process - Module 3 of 6

Module 3: The Check Collection Process

UCC Article 4 Terminology

Article 4 of the UCC addresses check collection by banks.[1] 

Articles 3 and 4 diverge in terminology and at times use different words and phrases to convey similar concepts.  While Article 3 calls a check a “draft,” Article 4 refers to it as an “item.”  In the check collecting process, the drawer who issues a check is called the “customer” and the check’s payee is called a customer when she goes to cash or deposit a check.  The bank that hosts the check writer’s account is called the “payor bank.” The other banks involved in the check collection process are called “collecting banks.” 

The initial recipient of the check is called the “depositary bank” while the other banks are referred to as “intermediary banks.”  The customer of the depositary bank deposits her check in her account there.  The bank then seeks payment from the payor bank by presenting the check.  ”Presentment” is a special term in the Code that means referring a check for a demand for payment.[2]  Banks enter into clearinghouse arrangements, which are central depositaries where banks exchange checks and settle the total amounts owed to each other.[3]

The check may be routed through what the Code calls “intermediary banks” on its way from the depositary bank to the payor bank.  For the payor bank to honor the check upon presentment, two conditions must be satisfied.  First, there must be sufficient funds in the drawer’s account at the payor bank and, second, the check must be “properly payable,”[4] which means that the check fulfills certain criteria for payment.  While checks have historically traveled physically through the payments system, today, federal law provides for electronic check processing.   

During check collection, one very important concept is “settlement.”[5]  When a customer deposits a check into her account at her bank (the depositary bank), the bank will credit her account in a transaction the Code calls a “provisional settlement.”  Provisional, in this case, means temporary.  A provisional settlement can be revoked by a bank any time prior to final settlement by the payor bank.  Once the payor bank makes final settlement by paying the check, the provisional settlements become final.[6]

For example, assume Alice has a checking account with First Bank and Barbara has a savings account with Second Bank.  Alice writes Barbara a check drawn on her account at First Bank and Barbara deposits the check into her savings account at Second Bank.  Second Bank has made a provisional settlement and will make the amount of the check available for Barbara to use.   Second Bank will then collect the value of the check from First Bank (the payor bank), and First Bank will deduct the amount of the check from Alice’s account.

Check Settlement Requirements

When a check is presented to a bank, the bank  must decide whether to honor or dishonor (typically, for insufficient funds) the check by the “midnight deadline,” which is midnight of the “banking day” following that of its receipt of the check.[7] The same is true if there was a provisional settlement when the check was first deposited. The bank must revoke the settlement by the midnight after the following banking day. Otherwise, it loses the right to revoke its earlier provisional settlement.[8] Most checks are processed by the passage of the midnight deadline when the bank does not return the check.   

When a bank receives the check or notice pertaining to its processing, the clock starts towards the midnight deadline.  “Banking days” are any days the bank is open for business.[9] A bank is allowed, under the Code, to set 2 p.m.  as the final time at which an item may be treated as received on that banking day, and any check received after that time may be treated as having been received on the following day.[10] 

For example, assume Alice writes Barbara a check drawn on Alice’s account at First Bank and Barbara deposits the check into her savings account at Second Bank on Monday.  The midnight deadline would be the next banking day which is Tuesday.  If the bank’s deadline is 2 p.m. and Barbara waited until 3:00 p.m. to deposit the check on Monday, then the Code would view the check as if it was deposited on Tuesday morning and the midnight deadline for processing would be midnight, Wednesday night.  If Second Bank is closed on Saturdays and Sundays, and Barbara deposited the check on Friday morning, then the midnight deadline would be Monday.  If Monday were a holiday, then it would be Tuesday.       

If the payor bank misses the midnight deadline, the check is deemed to have been finally paid, and the payor bank incurs liability for the check. If the payor bank later discovers that there were insufficient funds in the drawer’s account , it may still be able to recover its losses from other entities in the collection process under warranty, fraud or restitution theories.[11]

The “Properly Payable” Requirement

Once the payor bank makes final payment, then other settlements become final and the banks in the collection process become liable to their customers.  Ultimately, the payor bank needs to collect the funds from its customer, who is the drawer of the check.  It may only do so if the check is “properly payable,” which means that it is authorized by the customer and is issued in accordance with the agreement between the customer and the bank.  If there are insufficient funds in the customer’s account (called an “overdraft”) then the bank is not required to pay the check.  Banks however, frequently enter into arrangements with their customers to provide overdraft protection in the form of a line of credit.  In the case of joint accounts, when a customer has neither signed a check nor received any benefit from its issuance, then the customer is not liable on the instrument.[12]

For example, Thomas and Allan are business partners with a joint checking account.  Allan writes a check to make a mortgage payment on his home.  Assume the check is dishonored because the account did not have sufficient funds and the bank seeks to collect a fee from Thomas.  Since Thomas neither signed the check nor benefitted from its issuance, he would not be liable to the bank.

An unsigned instrument or a forgery is not properly payable and does not create liability for the customer.  A forged drawer’s signature does not create a validly payable instrument, but an indorser may be liable for a forged instrument.[13]   

Common Problems in Check Settlements

Stop Orders

After issuing a check, a customer might want to stop payment, and the Code gives customers this right with some restrictions.[14]  The customer must be able to describe the check with “reasonable certainty” and the bank must receive the stop order within a reasonable time. Courts are divided on whether a small deviation in the customer’s description would absolve the bank of liability.[15]  Sometimes it comes down to the agreement the customer has with the bank. In one case, a misplaced digit did not invalidate a stop order, although the customer agreement stipulated that the customer’s description of the check need to be correct “to the penny.”[16]  In another case, a misplaced digit invalidated the order.[17]   

An oral stop order is valid for fourteen days and a written stop order is valid for six months.  Written stop orders are renewable. [18] A bank that receives a valid stop payment order, but pays the check anyway may be able to validly charge the customer’s account if the customer had an obligation to pay.[19] 

Post-Dated Checks

Banks process large volumes of checks mechanically by using the MICR line on a check which includes the routing, account and check numbers.  However, the date that a drawer writes on a check is not encoded on the MICR line.  Sometimes, a drawer will write a date on the check later than its issue so that the payee will not be able to cash the check right away.  This procedure, called “post-dating,” allows the drawer time to ensure the funds are properly in her checking account.  Nevertheless, the Code provides that a post-dated check is not properly payable unless the drawer has notified the bank with reasonable time and describes the check with “reasonable certainty.”[20]   


If the drawer’s account has insufficient funds then the payor bank may return the check, which is called “dishonor.” [21]  If the payor bank dishonors a check when it should have been paid, the bank has committed a wrongful dishonor and liability can be significant.  English common law historically embodied the “trader rule” which penalized banks for wrongful dishonor as slanderous against a merchant, but today the law requires a showing of actual damages.[22]

Assume John wins an auction for a collectible car that he intended to restore and resell to Wellington’s Car Museum at a substantial profit.  The terms of the auction stated that non-paying bids would be invalid, and the item would be either sold to the next highest bidder or relisted.  John pays Robert, the seller, with a check which John’s bank erroneously dishonors.  As a result, Robert sells the car to the next highest bidder and when it learns of the failed sale, Wellington’s Car Museum cancels John’s restoration project.  John’s claim against the bank includes “actual damages” for the cancellation of the restoration agreement.  

Moreover, some courts have allowed punitive damages where the bank’s conduct was intolerable.  In one case, a forger stole a couple’s checkbook and passed some bad checks.  While the offender was quickly caught, the bank imposed a hold on their account because the husband had a prior criminal record.  Although he was not at fault for the forgeries,the bank maintained the hold for four years.  The couple sued the bank for emotional distress and the jury awarded them $18,500.[23] 

Regulation CC

In addition to state law, Congress has passed federal legislation that governs certain UCC topics; specifically, the Expedited Funds Availability Act[24] and the Federal Reserve’s Regulation CC.[25]  While its aim is to clarify some of the Code’s provisions, it sometimes adds complexity and uncertainty.[26]  For instance, the federal terminology is not consistent with Code.  The payor bank is called the “paying bank.”  Any bank that returns a check upon dishonor is a “returning bank,” but that term only applies to intermediary banks, not for paying or depositary banks that return checks.[27]

The federal rules also define “business days” and “banking days.”[28]  A “business day” is any weekday other than a federal holiday while a “banking day” is a business day when a bank is open to the public for substantially all banking functions. The UCC, on the other hand, designates any day the bank is open as a banking day.  So, a bank that is open on a Saturday, Sunday, or holiday will be subject to those days counting as banking days for the purposes the UCC, but not Regulation CC.   

Subpart B of Regulation CC spells out when a bank must make funds available to the depositor.[29]  The regulation reflects the risks to the bank in honoring checks in determining the proper deadlines. Cash, low-risk checks, electronic deposits, and the first one hundred dollars of any deposit are subject to next-day availability (which means not later than one business day after the banking day of deposit), with the remaining balance and up to $400 for cash withdrawal available on the second day.  Higher risk checks, which includes most checks, must be available no later than the second business day following the banking day on which the funds are deposited. 

For example, Carmen writes a check payable to Dane who deposits the check in his bank account at First Bank on a Friday, with the following Monday a federal holiday.  His check is subject to second day availability.  In this situation, that would be the following Wednesday, the second business day after the banking day of deposit.   

Beyond these rules, certain exceptions apply and the depositary bank is required to give the depositor notice of the applicable exceptions.[30]  These exceptions include deposits not made in person, such as deposits to an ATM, withdrawals in cash, deposits outside the continental United States and ATMs owned by entities other than the depositary bank (called “non-proprietary-ATMs”). Additional exceptions include new accounts, large deposits, checks that were returned and redeposited, repeated overdrafts by the customer, and some emergency conditions.[31]   

Actionable damages for Regulation CC violations include penalties between $100 and $1,000 per violation, plus reasonable attorney’s fees.  The maximum penalty is $500,000, or 1% of the net worth of the bank.  The bank may defend a Regulation CC claim if it can demonstrate the error was unintentional and the bank reasonably attempted to avoid errors.[32]    

While the UCC requires that banks send checks back through the collection process, it doesn’t address when they must do so. Regulation CC, though, requires banks to send checks through the collection process in an “expeditious manner.”[33]   

There are two tests Regulation CC provides to measure the “expeditious manner” requirement. Satisfying either test is okay.

The “two-day/four-day test” is satisfied if the bank returns the check to the depositary bank by 4:00 PM of the second business day following the banking day on which the check was presented to the paying bank. If the paying bank is in a different check processing region than the depositary bank, it has until 4:00 PM of the fourth business day. [34] 

The alternative “forward collection test” is satisfied even if the bank misses the 2-day/4-day deadline if  “it sends the returned check in a manner that a similarly situated bank would normally handle a check” under the circumstances and forwards the check for collection to the similarly situated bank by noon on the next banking day.[35]

In returning a check to the depositary bank, the payor bank makes four warranties: that it met its deadlines, that the bank is authorized to return the check, that the check has not been materially altered and that no notice of dishonor has been sent. [36]

Damages for breach of warranty include the consideration given for the check along with interests and costs. Lawsuits for breach of warranty may be brought by the bank or a private party, though they are subject to statutes of limitations in that they must be brought by banks within 30 days of when the bank became aware of the claim’s supporting facts[37] or by private plaintiffs within a year from the date of the violation.[38]

The regulation imposes “good faith” and “ordinary care” standards for the commercial transactions it governs and uses a comparative negligence standard to apportion liability among offending banks if multiple banks’ offending actions cause harm. 

Check 21

To secure the benefits of the electronic processing of checks, Congress passed the Check Clearing for the 21st Century Act[39] in 2003, called Check 21, which effectively reduces the payment system’s dependence on paper-based financial transactions.[40]  The law allows banks to convert paper checks into electronic images for the purposes of check collection, a process known as “check truncation.”  The Act also provides for the creation of “substitute checks” which are gray-scale images of original checks, and function as their original counterparts.[41] 

Check 21 assigns responsibility for any issues arising with the substitute check to the bank that produced the substitute check from electronic data.  This bank is called the “reconverting bank” and the transmitting bank is called the “truncating bank.”[42]  Any bank that transfers, presents, or returns a substitute check warrants that the images are accurate and includes a notice indicating it is the equivalent of the original.[43]

It is noteworthy that when Check 21 took effect in 2004, most checks were paper-based transactions in the Federal Reserve System, but just a decade later, over 99 percent of checks deposited in the Federal Reserve System were in electronic form.

Our next module continues our discussion of check collection with a more detailed look at warranties, the bank-customer agreement, loss allocation, electronic funds transfer and debit and credit cards.

[1] Stephen C. Veltri, The ABCs of the UCC: Article 3: Negotiable Instruments; Article 4: Bank Deposits and Collections and Other Modern Payment Systems.  10. (3d ed. 2015).; Uniform Commercial Code – Bank Deposits and Collections. § 4-102(a).

[2] Uniform Commercial Code – Negotiable Instruments. § 3-501.

[3] Uniform Commercial Code – Bank Deposits and Collections. § 4-104(a)(4).

[4] Uniform Commercial Code – Bank Deposits and Collections. § 4-401(a).

[5] Uniform Commercial Code – Bank Deposits and Collections. § 4-104(a)11).

[6] Uniform Commercial Code – Bank Deposits and Collections. § 4-201; § 4-214(a); § 4-215(d)

[7] Uniform Commercial Code – Bank Deposits and Collections. § 4-104(a)(10).

[8] Uniform Commercial Code – Bank Deposits and Collections. § 4-215; § 4-301.

[9] Uniform Commercial Code – Bank Deposits and Collections. § 4-104(a)(3);

[10] Uniform Commercial Code – Bank Deposits and Collections. § 4-108.

[11] Floyd, 125.

[12] Floyd, 126-127.

[13] Floyd, 128.; Uniform Commercial Code – Negotiable Instruments. § 3-401; § 3-415(a);

[14] Uniform Commercial Code – Bank Deposits and Collections. § 4-403.

[15] Veltri, 110.

[16] Staff Services, Inc. v. Midland National Bank, 504 A.2d 148 (N.J. Super Ct. 1985), quoted in Veltri, 110.

[17] Poullier v. Nacua Motors, Inc. 439 N.Y.S.2d 85 (Sup. Ct. 1981), quoted in Veltri, p. 110.

[18] Uniform Commercial Code – Bank Deposits and Collections. § 4-403.

[19] Uniform Commercial Code – Bank Deposits and Collections. § 4-407.  For a discussion of a bank’s subrogation rights in these types of situations, see Veltri, 113-115.

[20] Uniform Commercial Code – Bank Deposits and Collections. § 4-401(c).

[21] Uniform Commercial Code – Bank Deposits and Collections. § 4-402.

[22] Veltri, 116-117.

[23] Twin City Bank v. Isaacs, 283 Ark. 127, 672 S.W.2d 651 (1984) quoted in Veltri, 116.

[24] 12 U.S.C.A. §§ 4001-4010.

[25] 12 C.F.R. Part 229 (Reg. CC).

[26] Floyd, 133.

[27] Reg. CC § 229.2

[28] Reg. CC § 229.2

[29] Reg. CC § 229.10.; § 229.12.

[30] Reg. CC § 229.13.

[31] Reg. CC § 229.12;  § 229.13.

[32] Reg. CC § 229.21.

[33] Reg. CC § 229.30; § 229.31.

[34] Reg. CC § 229.30; § 229.31.

[35] Reg. CC § 229.30; § 229.31.

[36] Reg. CC § 229.34.

[37] Reg. CC § 229.30; § 229.34; Floyd, 148.

[38] Reg. CC § 229.30; § 229.21; Veltri, 108.

[39] 12 U.S.C.A. §§ 5001-5018.

[40] See generally, Veltri, 167-175; Floyd, 148-152.

[41] 12 U.S.C.A. § 5002; § 5003.

[42] 12 U.S.C.A. § 5002.

[43] 12 U.S.C.A. § 5004.