The Risk Manager, Fall 2004

For years it has been good risk management as well as prudent business practice to have canceled checks returned with firm bank statements and filed as part of the documentation supporting financial transactions. Standard advice on client trust account management is to retain and file all pre-numbered canceled checks or other instruments drawn on an account for at least five years and preferably ten.

The Check Clearing for the 21st Century Act, effective October 28, 2004, will over time do away with the ability to receive original canceled checks. Under this law a bank may provide an image replacement document called a “substitute check” instead of the original check. A substitute check is the legal equivalent of the original check for all purposes -- federal law, state law, and all persons -- provided it contains all the information on the front and back of the check when it was removed (truncated) from the check collection process and complies with certain other technical requirements. (“Check 21 Act” – 12 U.S.C. 5001, Pub. L. No. 108-100, 117 Stat. 1177 Oct. 28 2003.)

The Check 21 Act may introduce valuable efficiencies in the check clearing process, but it also creates greater risk of multiple presentation of the same check for payment and makes it more difficult, if not impossible, to detect and prove alterations and forgery. At the time this is being written it is not clear how banks will implement the Check 21 Act, but some commentators believe that banks will seek to avoid sending substitute checks and try to obtain customer agreement to accept informal electronic check images that do not qualify as substitute checks. Until the implications of the Check 21 Act are fully understood, it is recommended that firms unable to obtain cancelled checks from a bank request substitute checks for client trust accounts, firm business accounts, and fiduciary accounts.

It is beyond the scope of this newsletter to cover the specifics of the Check 21 Act. Lawyers need to understand how under this law original checks are truncated, what happens to the original check, how substitute checks are created, what bank warranties on substitute checks are, what drawer recredit rights are, what bank liability is, what remedies bank customers have, and the Act’s relationship to other laws. A Google Internet search will provide this information and more.