CUNA Regulatory Comment Call

August 10, 2001

Revised Check Truncation Act



The Federal Reserve System has distributed a third version of its proposal to create a draft law for widespread check truncation the Check Truncation Act. The proposed law aims to increase the ability of financial institutions to convert paper checks into electronic checks and to use electronic checks in the check collection/return process. The Federal Reserve would like comments by September 14, 2001. Please submit your comments to CUNA by September 4, 2001.

Please feel free to fax your responses to CUNA at 202-371-8240; e-mail them to Associate General Counsel Mary Dunn at -and to Assistant General Counsel Michelle Profit at; or mail them to Mary and Michelle c/o CUNA’s Regulatory Advocacy Department, 805 15th Street, NW, Suite 300, Washington, DC 20005. For the current version of this "Check Truncation Act" please press here.

Any comments that you would like to send directly to the Federal Reserve should be e-mailed to Margaret Owens, Division of Reserve Bank Operations and Payment Systems, at, by September 14, 2001.

The Federal Reserve will consider comments in development of the next version of the law that will be sent to the Federal Reserve Board of Governors for its endorsement. After that, the Federal Reserve will introduce the proposal to Congress.


Currently, the law requires that paper checks be returned to the issuing institution unless the parties agree to accept check information electronically. The requirement that institutions have a formal agreement in place limits the ability of financial institutions to engage in widespread check truncation. Thus, the Check Truncation Act would allow institutions to send checks electronically without a formal agreement beforehand.


The draft law would permit a financial institution to collect or return electronic checks with other financial institutions that agree to accept electronic checks. If a financial institution does not agree to receive electronic checks, then the originating financial institution would not send an electronic version of the check, but would send a substitute paper machine-readable copy of the check ("substitute checks"). No prior agreement is required before a financial institution may return or send for collection a substitute check. Any financial institution would be required to accept the substitute check. In the collection process, the original check could be converted into an electronic version and back into a substitute check as required by the receiving financial institution.

This draft law would become effective one year after enactment and it would supersede any law that is inconsistent with it, including federal law, state law, and the Uniform Commercial Code. The Federal Reserve would write the regulations for this law.

A substitute check would be the legal equivalent of the original check for federal laws, including IRS laws, and state laws. These substitute checks must be accurate and legible and bear the legend: "This is a legal copy of your check. You can use it the same way you would use the original check." The reconverting bank (a bank that converts an electronic check into a substitute check) shall ensure that the substitute check has the endorsement of previous institutions that indorsed it. In addition, a reconverting bank would have to identify itself on the substitute check as the converting institution.

Financial institutions that transfer or present substitute checks and receives consideration for them make two warranties to subsequent financial institutions and persons who use them. First, they warrant that the substitute check meets the requirements to be legally equivalent to the original. Second, they warrant that no institution will be required to pay twice on the same substitute check because of its alternate forms.

In the proposal, a reconverting bank would indemnify subsequent parties for losses due to receipt of a substitute check instead of the original check. The indemnity would be up to the amount of the check, plus interest and expenses if that loss would not have occurred if the recipient had the original check. If the loss is partially the fault of the financial institution/person indemnified, then that person shall be responsible for a proportionate amount of the loss. If the indemnifying bank produces the original check, it is liable only for losses that are incurred up to that time, and all excess money it paid must be returned. Production of the original check does not absolve the indemnifying bank from any liability on a warranty that it has given under this Act or other law.

A member of a credit union may claim that a substitute check cannot be properly charged to a consumer's account or that it breaches a warranty and an original check is needed in connection with the claim. If a consumer seeks a recredit, then (s)he must provide to the indemnifying institution the following items: a description of the claim; a statement that the member suffered a loss and the amount of the loss; a reason why only the original check will suffice; and sufficient information to identify the check and to investigate the claim. The consumer must make this claim within 60 days after the relevant statement or check is made available to the consumer. This time period can be delayed for extenuating circumstances.

Once a consumer makes a claim, then the credit union must both produce the original and show that it was properly payable or recredit the consumer's account. The recredit applied to the account would be for amount of the check or $2,500, whichever is less, by the business day following the banking day of the claim. The credit union must credit the remainder, the part over $2,500, within 20 business days following the banking day of the claim. A credit union must make recredited funds available for withdrawal by the start of the next business day after the recredit is required to be applied to the account. Under most circumstances, this would be the start of the second business day following the banking day of the claim. A credit union may delay availability of the recredit until the twentieth business day following the banking day if the account is less than 30 days old; if the account is frequently overdrawn; if there is reasonable belief that there is fraud; and in cases of emergency.

A financial institution may make a claim against a bank that indemnified it if a consumer makes a warranty claim related to the substitute check or the bank wants to assert such a claim. To recover the bank must have suffered a loss or been forced to pay a consumer recredit and the original check must be necessary to verify the charge. The bank has 120 days after the day of the transaction that gave rise to the claim. A credit union may reverse the recredit to the member's account when it provides the original check to its member, as long as the substitute check is a proper charge to the account. Providing a recredit does not absolve a financial institution from liability for wrongful dishonor under the Uniform Commercial Code or other law.

If a financial institution seeks a recredit, then it must provide the following: a description of the claim; a statement the original check is necessary; a statement that it has suffered a loss and how much the loss is for; and sufficient information to identify the check and to investigate the claim. If that happens, then the indemnifying financial institution must produce the original check or provide expedited recredit rights. The recredit is due within 10 business days. Providing the recredit does not absolve the indemnifying bank from liability for additional damages.

If the indemnifying credit union produced the share draft after the 10 days has elapsed, it has a right to a refund of any amount it had previously recredited to the other institution that exceeds legitimate losses incurred up to that time. The indemnifying credit union may recover from any indemnified party if the charge to the member account is appropriate or the warranty claim has no merit. An indemnifying financial institution that provides a recredit may attempt to recover from another party based on a warranty or other claim.

Any warranty action must be brought within three years of this cause of action. If a claim is raised later than 30 days after a claimant has reason to know about the claim, then the financial institution is not liable for losses that result from the delay.


  1. The draft law would cover only substitute checks and not all checks. This would mean that the normal truncation functions of credit unions would not be covered. Thus, expedited consumer recredit rights and other liabilities would not apply to the truncation that credit unions already do. Do you support this scope for the Act?

  2. Only a financial institution that transfers or presents a substitute check would make warranties that the substitute checks meets the standards for legal equivalence and that there is no double presentment for a paid substitute check. The financial institutions that transfer electronic checks make no such warranties regarding electronic check standards and double presentment. Supposedly, the reconverting bank would have a private agreement with the bank that converted the paper check into electronic form regarding liabilities. Would this system work? What are the benefits and negatives of such a system?

  3. A credit union would indemnify "a recipient of a substitute check, if that loss is due to the receipt of a substitute check instead of the original check." Under this law, would credit unions ever be liable to a member? Please explain how this would happen. Under truncation, it does not appear likely, but please explain any scenario.

  4. This draft includes in the indemnity amount consequential damages resulting from the loss. This amount includes check, interest, attorney costs and other losses. Do you agree with this definition of damages? Also, there is comparative negligence standard. Do you agree that the Check Truncation Act should use a comparative negligence standard sharing liability based on fault?

  5. The Federal Reserve delayed the deadline that the financial institution had for recrediting a consumer for amounts over $2,500 from 10 days to 20 days. Do you agree with this extension of extra time? Why?

  6. The Federal Reserve added a new provision that allows financial institutions to delay making recredit funds available until after the start of the second business day following the claim. Do you agree with this approach? Why? Also, a credit union may delay availability of the recredit for 20 days if the account is less than 30 days old; frequently or severely overdrawn; if there is a reasonable belief of fraud; or under emergency circumstances. Do you support these provisions? Are there any other reasons that financial institutions should be able to delay availability for twenty days? Why?

  7. Should there be a set of procedure for small businesses that have claims because they do not receive the original checks? What type of procedures should apply? Should they have expedited recredit rights?

  8. Should there be a provision in the Act that allows financial institutions to legitimately deny consumer claims and provide no recredit?

  9. There is no mention of noncompliance penalties for converter financial institutions that fail to indemnify paying financial institutions. Should there be noncompliance penalties for these institutions?

  10. The Department of Treasury (Treasury) may opt out of this proposal, so that Treasury's substitute checks would not fall under the Check Truncation Act. As a result, Treasury may not be subject to the indemnities and warranties if it converts an electronic item into a substitute check. Would you support Treasury's ability to opt-in or opt-out? What issues does this raise?

  11. In the Act, to recredit a member, the member's credit union must both produce the original check and show that the check was properly payable or provide the recredit. The credit union may be able to obtain a good copy of the original. Should there be a provision that allows the credit union to show a good quality copy and avoid the recredit, if the good quality copy would satisfy the claim?

  12. Should CUNA support this proposal in its entirety? Should CUNA support only some provisions? Please explain.

Eric Richard • General Counsel • (202) 508-6742 •
Mary Mitchell Dunn • SVP & Associate General Counsel • (202) 508-6736 •
Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 •
Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 •