ONE DEPOSIT, TWO DEPOSIT, FRAUD— Mobile Remote Deposit Capture and Double Presentment

Simon PLC Attorneys & Counselors – May 2024 Memorandum

ONE DEPOSIT, TWO DEPOSIT, FRAUD— Mobile Remote Deposit Capture and Double Presentment

Troy, MI. The Check Clearing for the 21st Century Act (Check 21) is a federal law that took effect on October 28, 2004. It was implemented in Subpart D of Regulation CC (Availability of Funds and Collection of Checks). 12 C.F.R Part 229. Its purpose was to enable banks to handle more checks electronically, which streamlined check processing by making it faster and more efficient. Essentially, Check 21 gave financial institutions the right to convert paper checks they receive into electronic images, to process those images for payment instead of the paper checks, and to subsequently destroy those paper checks. This process is referred to as Electronic Check Presentment (ECP). So rather than banks physically moving paper checks from the bank where the checks are deposited to the bank that pays them, Check 21 essentially gave banks and other organizations the ability to create electronic images of consumers’ checks in a process known as check truncation. However, it is important to note in check truncation, the paper check is no longer in possession of the depositor that presented the check for payment. The electronic copy of the paper check is known as a substitute check. The substitute check is legally the same as the paper check if it accurately represents the information on the paper check and includes the following statement: “This is a legal copy of your check. You can use it the same way you would use the original check.” The substitute check must also have been handled by a bank.

Although ECP is a technological and administrative advancement that has benefitted both the financial industry and its customers, there are risks. At the time Check 21 was passed, mobile banking, specifically Mobile Remote Deposit Capture (mRDC) was not only unheard of, but the resulting fraud was not anticipated. Check 21 opened the door to allowing banks to substitute mobile deposit checks if they are the legal equivalent to a paper check.  Specifically, mRDC involves an individual customer taking a picture of a paper check with a mobile device and transmitting the check image to his or her bank (Bank A) for deposit and collection. Bank A then processes the image and transmits the substitute check to the paying bank (Bank B) while Bank A’s customer remains in possession of the paper check. Bank B pays the check and Bank A receives settlement for the check. Subsequently, the individual customer immediately deposits the paper check into another bank (Bank C), or many times cashes the paper check at a check cashing store. Bank C makes the funds available to the individual customer who then immediately withdraws the funds or the check cashing store, after paying the customer, deposits the paper check with their bank.  Either bank, using the check truncation process presents the check to Bank B for payment. Ultimately, the end result is that Bank B does not pay on the check because it already paid it to Bank A, resulting in a loss to the latter banks. Who is responsible?

To address problems such as duplicate presentments, Regulation CC was amended effective July 1, 2018, to provide a new indemnity (not warranty which is also provided in Check 21) with regard to checks deposited in image form via mRDC.  See 12 C.F.R 229.53, et seq.. Like the scenario depicted above, the mRDC Bank (Bank A) receives an image of a check, but does not receive the paper check, and does not receive a return of the image unpaid. Subsequently, a second Bank (Bank C) later receives the paper check for deposit and sustains a loss resulting from the return of the check unpaid due to a duplicate payment or presentment. Under the Check 21 indemnity provision, the party that originally converted the paper check into an electronic image provides the indemnity (in our case Bank A) to the extent of the subsequent bank’s loss. However, Bank C that took the paper check to be indemnified must show that at the time of the deposit that (1) there was no restrictive indorsement on the check that was ignored and (2) one year had not lapsed when the bank that accepted the paper check incurred its loss. The logic for placing the responsibility for indemnifying on the mRDC bank is by allowing the paper check to remain in circulation it opened up the possibility for duplicate presentments. It must be noted that the indemnity is strictly between the banks and does not protect the bank’s customers. So, in our scenario above, if the bank accepting the paper check for deposit (Bank C) recoups the loss from its depositor (via contract with its customer or under the applicable provisions of the Uniform Commercial Code), the bank accepting the paper check has no claim in indemnity against the bank accepting the paper check via mRDC.

While there are regulatory changes and risk mitigation technology being implemented regularly, duplicate check presentments as well as various mobile deposit fraud that exploits the delay between when money is available and when the checks clears are still a challenge for lenders. Studies have shown that mobile banking has increased from 54% in 2022 to 73% in 2023 as banks offer their customers more mobile services. However, with the increase of the convenience of mobile banking, mobile fraud has increased as well from 47% in 2022 to 61% in 2023. See BioCatch, 2023 Digital Banking Fraud Trends in North America, December 2023. Therefore, it is crucial for lenders to have legal assistance to safeguard their interest from such fraud and the attorneys at Simon PLC Attorneys and Counselors have that skill and experience.

N.B. Not Legal Advice: Please contact us if you would like to discuss the facts and circumstances of your specific matter. Simon PLC Attorneys & Counselors expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this memorandum. The information contained herein may not reflect current legal developments and is provided without any knowledge as to the recipient’s location, industry, identity or specific circumstances. No recipients of this content, clients or otherwise, should act, or refrain from acting, on the basis of any content included in this memorandum without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from an attorney licensed in the jurisdiction for which the recipient’s legal issue(s) involve. The application and impact of relevant laws varies from jurisdiction to jurisdiction, and our attorneys do not seek to practice law in states, territories and foreign countries where they are not properly authorized to do so.