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Glenn R. McCluskey is legal counsel to ACA International, Inc., an international trade association of debt collection professionals, credit grantors, and attorneys. He is a cum laude graduate of William Mitchell College of Law.

Checks remain the number one form of payment at U.S. retail locations and restaurants. According to the Federal Reserve Bank, 68 billion checks are written each year.3 One to two percent of them are dishonored, costing retailers about $11 billion annually.

Although currently rare in some areas of the country, the electronic presentment of checks through the ACH Network is persistently growing, especially at the checkout counter of stores, known as "point-of-sale transactions." Only certain check items are eligible for conversion. Those currently not eligible include business checks, checks written for over $2,500, third-party and payroll checks.4

Relatively inexpensive check scanning units can "convert" a consumer's check into the electronic data necessary to effectuate an ACH transaction. The check itself becomes largely superfluous once the magnetic line on the bottom of the check is scanned. The banking transit number, which tells the bank where to send the check for payment, and the check number are picked up by the scanner and stored in the merchant's system. The checkout person then must manually enter the exact amount of the check because the scanner is not able to read the handwritten amount. Nor is it able to read or store the consumer's signature, name, address or telephone number. Nevertheless, with the essential routing number and amount entered, the check can be voided and given back to the consumer.

An ACH transaction is "off-line," meaning that funds are not immediately withdrawn from the consumer's checking count at the time of the transaction. There is still a "float" of about two days, just as with traditional paper checks. However, there is no paper to transport, store, or keep track of. Merchants, extremely sensitive to the happiness of their customers, have begun to help educate those customers in how this system works. Although some customers have resisted, the economic incentive for the merchant to use this form of payment is huge. The cost savings are potentially momentous because of reduced paper handling and accounting costs. The average retail store handles a paper check six times. This totals 62.69 seconds of handling time per check.5

Moreover, merchants using ACH find out faster whether a check is good and if so, they are paid. If the check is dishonored, they can more quickly take whatever action they determine is best within the law and their business framework. That may mean calling the customer or sending the account to a check collector.

Paper check transactions come under the scope of the Uniform Commercial Code.6 The bad check writer is liable to the holder for an NSF service fee, possible civil damages, and attorney fees under the recently amended Minn. Stat. ¤ 332.50 (2000)7. Traditional check law does not govern electronically converted checks. These ACH transactions are governed by the National Automated Check Clearinghouse Association (NACHA) Operating Rules and Regulation E.8

NACHA NACHA is the organization charged with setting up rules for the operation of the ACH Network. In 1974, in association with the Federal Reserve's Board of Governors, the National Automated Check Clearinghouse Association was formed to create and coordinate rules under which ACH transactions move. According the 2001 NACHA Operating Rules Book, the ACH Network is a processing and delivery system that provides for the distribution and settlement of electronic credits and debits among financial institutions.9

Like a giant web, the ACH Network is composed of financial institutions that either send or receive checking account-based transactions for payment. Through a nationwide communications network each ACH "operator" is able to quickly and efficiently communicate financial debit and credit information with other ACH operators. An operator is either a Federal Reserve Bank or a private entity, which through express agreement with NACHA, agrees to perform ACH transfer services in compliance with NACHA rules and applicable laws.10 The Uniform Commercial Code also specifically provides that checks may be presented electronically.11

For a small per-transaction fee, the ACH operator transfers the funds between accounts. Only these operators have access to the ACH network. Consequently, merchants and others wishing to transfer funds this way must contract with an operator to handle the task. NACHA states 32 million paper check were converted in this manner at retail locations in 2000. This is a significant increase over its earlier prediction of 25 million.12 Further, NACHA states that bill payments and other consumer debit payments made over the ACH Network in 2000 totaled 2.2 billion transactions, an 18.4 percent increase over 1999.13

Historical Check Framework. In a traditional check payment system, a merchant accepts a check from a consumer, batches that check with the day's receipts and takes the bundle to the merchant's own bank where a deposit is made. The merchant's bank unwraps the bundle, deposits the cash into the merchant's account and sorts the checks. Because the checks are written on several consumer banks, both local and non-local, some system of sending those checks to the various banks and requesting payment must exist.

The movement of checks, like any other hard goods, takes time and costs money. Historically, these checks are physically moved by truck, courier, armored car or other means. This transportation of paper has become a huge industry. As well, the storage of checks after they have been paid requires the use of vast amounts of space.

NACHA rules, based on Regulation CC, require that the physical check must be available for 90 days after the transaction is completed and that a copy or image of the check must be retained for seven years.14

Paper checks are negotiable instruments15 and are marked, stamped and endorsed at each stage of the process. Each mark has a meaning to the "handlers" involved. Account numbers, routing numbers, restrictive endorsements and calculations are all among the various marks placed on paper checks. For banks, the marks serve as warranties and disclaimers of warranties. A bank must assure that only "properly payable items" are honored . Otherwise the bank will be liable for the amount erroneously paid.16 This means that banks take a very cautious approach to each check. Before taking the money from the checkwriter's account and sending it to the merchant's bank, they must be sure the check is not bogus and that there are enough funds in the check writer's account to cover the check. When they have diligently completed this checking process, the bank honors the checkwriter's "order" to pay the merchant. Funds are transferred into the name of the merchant. If, however, the check is not "properly payable" because funds do not exist to pay the check or the check itself is in some way deficient, the check is rejected. It may be "dishonored" resulting in its being stamped "NSF" for "not sufficient funds" or ""uncollected funds" meaning that although money may have been deposited into the account, it is not available to pay the check for whatever reason.17 Because of the liability that falls on banks if they are negligent in honoring their presentment warranties, the NACHA Rules which govern ACH transactions have been crafted and amended in a rulemaking system by member organizations where the complicated politics of the banking world and economic conservatism have hit head on with new technologies and cutting edge law. The result is a crazy quilt of ACH rules, the nuances of which many players find hard to understand.

NACHA historically has relied heavily on Regulation E in setting up its own operating rules for the ACH Network. Regulation E is the set of federal regulations that implements the Electronic Fund Transfer Act.18 The Federal Reserve Board of Governors has issued and recently updated its official Staff Commentary to Regulation E.19 The Staff Commentary provides an interpretation of how the staff views the workings of Regulation E and how it should be applied. According to the Federal Reserve Board, the goal of modifying Regulation E was to clarify the rights, responsibilities, and liabilities of the parties involved in ACH transactions and ensure that consumers are aware of how their payments are being handled to avoid placing financial institutions in the position of dealing with claims for unauthorized electronic fund transfers (EFTs), ACH transactions, and disputes between merchants and consumers.20

Check as Access Device. Under the Federal Reserve Commentary to Regulation E, a check tendered to a merchant at the point-of-sale becomes a "source document" for creating an electronic fund transfer. This occurs when the customer authorizes an ACH transaction. Consequently, traditional check law no longer applies. The check is not negotiated and must be stamped void and given back to the customer.21 Only the vital information from the check is transferred via the ACH Network. Thus, an EFT is created.

Converted Checks. Checks presented by a consumer at the point-of-sale may be converted and transmitted for only the face amount of the check. Banks, in turn, are allowed to pay only the face amount on these debit items. If the check is dishonored by the consumer's bank, the merchant is notified. The merchant can then re-present the check through the ACH Network according to the rules. Checks re-presented after being dishonored once have a reasonably good chance to be honored on the second time through.

Re-presented Checks. Unlike a check that is converted at the point-of-sale, a "re-presented check" (RCK) is a paper check which has been returned, for insufficient or uncollected funds. The check keeps its legal status as a negotiable instrument and the U.C.C. controls. The Federal Reserve Board deems a subsequent presentment transaction to be a continuation of the original payment by check, even though it is re-presented as an ACH item.22 NACHA rules provide that a check can be presented a total of three times in any combination. Thus, once as an original paper check and twice more as an "electronic re-presentment."23

Notice Required. Notice must be provided to the check writer prior to the check being sent through the ACH system. Unfortunately for merchants and their customers, different types of notice are required for different types of ACH transactions. A check converted immediately at the point-of-sale requires that the check writer authorize the transaction in writing, signed or similarly authenticated. This language is borrowed from Regulation E.24 The theory is that the transaction is a pure EFT and not a check transaction. However, if the check writer provides the actual check in a traditional check transaction, the merchant may still re-present it electronically if it is returned NSF. Authorization for this subsequent transaction may be obtained through a posted sign. No signed writing is required. The Federal Reserve Board believes that the U.C.C. provides enough consumer protections in that situation and therefore no additional signed authorization is needed.

Most bad checks are the result of accounting errors or mistakes in the customer's timing of getting a deposit into the account. Traditionally, a dishonored check is collected in one of two ways. Merchants may call their steady customers and tell them that their recent check has gone bad. If a good relationship exists between the customer and merchant, the merchant is only too glad to allow the customer to come in to the store and make good on the check. If this is an isolated incident in an otherwise profitable relationship, the matter is settled and forgotten. More often, however, in today's society, where fewer merchants know their customers on sight, a bad check will be forwarded to a licensed collection agency. Third-party debt collectors are governed by the Federal Fair Debt Collection Practices Act.25 The collector will send a collection notice to the check writer for the face amount of the bad check along with the applicable state's NSF service fee. In Minnesota, that is an amount "not to exceed $30."26

Generally, the merchant receives the full face amount from a successful collection attempt and the collector retains the service fee as compensation for its collection activity.

NSF Service Fee. Under current NACHA Operating Rules the only way to collect a bad check fee on an ACH transaction, as allowed by state statute, is to have the check writer sign a statement at the time they write the check, authorizing the merchant to collect such a fee if the check is dishonored. A posted sign alone is not enough.27 This extra signed writing obviously slows the transaction time at the checkout counter and creates more paper in the form of the signed statement. This is converse to the idea of electronic presentment which in its pure form eliminates the paper check and streamlines the payment process. Moreover, since only about 1 check in 1,000 goes bad, the merchant is getting 999 signed statements to collect one service fee.28 In most cases, this additional paperwork and checkout counter hassle is not worth it to them.

When the merchant has procured the proper authorization at the time of sale, the additional fee can be obtained from the consumer's account. However, a signed authorization does not override the NACHA rule that only the face amount of the original ACH debit can be paid. It supplements it. This means that a separate ACH transaction must be initiated for the service fee. The two amounts cannot be combined into one transaction. If they are, the consumer can object to the bank.. In that case it is likely that the consumer's bank will reverse the entire transaction. Banks have stated that there is currently no good language that explains these combined entries on the bank records they view when a consumer calls to complain. Because the banks do not have the information and are fearful of having improperly paid a debit item, they will simply put the money back into the consumer's account and so inform the merchant's bank. That puts the consumer and the merchant back to square one to deal with the original bad check problem.

Checks that are received through the U.S. mail for payment of goods or services may be "truncated" by the receiving party. This process provides that the receiving entity can scan the checks and present them for payment via the ACH Network. Under NACHA's rules, the receiving party must inform the check writer of its truncation policy prior to receiving the first item in any series of payment. The consumer must be offered either the option to specifically authorize the truncation in writing or the opportunity to opt-out. If they do not opt out, the checks may be truncated.29 Truncated checks remains subject to traditionally check law.30

As with converted checks, no additional fees may be added to truncated checks that are electronically presented without the consumer's separate signed authorization.31

Federal Truncation Act. The Federal Reserve Bank has developed a draft law that would remove the current legal impediments to check truncation. The purpose of the law is to facilitate check payment or return, saving money in transportation and time of processing.

Currently, banks must transport the original paper check, unless they have a specific inter-bank agreement to do otherwise. This makes it difficult to truncate checks and turn them into electronic ACH transactions.

Under the proposed Check Truncation Act, a bank could truncate any check electronically by agreement or by substituting paper copies of the check, called "substitute checks." The law would specify that such substitute checks are the legal equivalent of the original check for all purposes. Substitute checks would be delivered to banks that do not accept checks electronically.32 Banks could truncate a check at the point-of-deposit, transmit the check images to a central bank, and eliminate the need for daily transportation of the paper.

Telephone Transactions. On September 14, 2001, an amendment to the NACHA Operating Rules became effective permitting a consumer to authorize single debit transactions over the telephone. The rules require that there must be an existing relationship between the consumer and the ACH originator or that the consumer has initiated the call to the originator. The telephone call authorizing such an ACH transaction must be tape recorded with the consent of the consumer. In the alternative, a written notice may be mailed to the consumer confirming the authorization. This must be provided before any actual transfer of funds takes place.33

Web Checks. Another NACHA Operating Rule is now in effect allowing Internet-based ACH authorization.34 This remains an emerging area of rules, although these transactions are subject to Regulation E.35 Currently, ACH originators are obligated to ensure that such transactions are handled in a commercially reasonable manner to avoid fraudulent transfers and assure secure authorization methods. Whether an ACH originator has acted in a commercially reasonable manner is determined based on the overall circumstances and a balancing of the costs and available technology.36 Presumably, as costs go down and technology for securing such transactions improves, this standard will become more stringent.

What's Next? No one knows what the future holds for electronic transactions or how the law will develop in this area. Thus far, the law has lagged behind the new payment technology. There is a dearth of reported case law relating to electronic transactions. The Federal Reserve Bank, the U.S. Treasury, NACHA and others are patching together a system of law using existing models which may or may not be truly applicable to each individual transaction method which they purport to govern. One can speculate that over time, economics will drive the electronic transaction system in one or more specific directions and the law will focus on those areas. As that occurs, Congress, federal agencies, state legislatures and the courts will hone the law as necessary to regulate the participants and protect the consumers.

1 2001 ACH Rules, ACH Primer 13, The National Automated Clearing House Association (2001).
2 See 31 C.F.R. ¤ 210. The Financial Management Service of the U.S. Department of the Treasury is responsible for establishing federal government ACH rules and policy.
3 Remarks of Roger W. Ferguson Jr., vice chairman, Federal Reserve Board of Governors, before the Independent Community Bankers of America, Washington, D.C., 5/21/2001.
4 2001 ACH Rules, Operating Guideline 150, The National Automated Clearing House Association (2001).
5 BankServ, News Release, (2000).
6 Minn. Stat. ¤ 336, Art. 3 (2001).
7 As amended by 2001 Minn. Sess. Law Serv. Ch. 204 (S.F. 103).
8 12 C.F.R. ¤ 205 et seq..
9 2001 ACH Rules, ACH Primer 13, The National Automated Clearing House Association (2001).
10 2001 ACH Rules, Operating Guideline 4, The National Automated Clearing House Association (2001).
11 See Minn. Stat. ¤ 336.4-110 (2001) ("Agreement for electronic presentment").
12 NACHA, "Thirty-Two Million Electronic Checks Processed in 2000 NACHA Estimates, Exceeding Expectations," News Release, 2/16/2001.
13 NACHA, "Commercial ACH Payments Increase by 14 Percent in 2000, NACHA Announces," News Release, 4/23/2001.
14 12 C.F.R. ¤ 229 et seq.; 2001 ACH Rules, Revisions 7, The National Automated Clearing House Association (2001); 12 C.F.R. ¤ 205.13(b).
15 Minn. Stat. ¤ 336.3-104 (2001).
16 Minn. Stat. ¤ 336.4-402.
17 Minn. Stat. ¤ 336.3-502 402.
18 15 U.S.C. ¤1693 (1997); 12 C.F.R. ¤ 205.1(a) and (b).
19 12 C.F.R. ¤ 205. Supp. I.
20 Comments of Natalie Taylor, Counsel, Board of Governors of the Federal Reserve System, 9/13/2000.
21 12 C.F.R. ¤ 205, Supp. I, 3(b).
22 12 C.F.R. ¤ 205, Supp. I.
23 2001 ACH Rules, Operating Guideline 146, The National Automated Clearing House Association (2001).
24 12 C.F.R. ¤ 205.10(b).
25 See 15 U.S.C. ¤ 1692 (a) et seq. (1997).
26 Minn. Stat. ¤ 332.50 (1995 as amended by 2001 Minn. Sess. Law Serv. Ch. 204 (S.F. 103).
27 2001 ACH Rules, Operating Guideline 146, The National Automated Clearing House Association (2001).
28 Nilson Report, ISH Consultants, Inc., December 2000.
29 2001 ACH Rules, Operating Guideline 155, The National Automated Clearing House Association (2001).
30 Comments of Natalie Taylor, supra n. 20.
31 2001 ACH Rules, Operating Guideline 155, The National Automated Clearing House Association (2001).
32 Remarks of Roger W. Ferguson Jr., supra, n. 3.
33 2001 ACH Rules, Operating Guideline 167, The National Automated Clearing House Association (2001).
34 NACHA, "Rules for Secure Internet Payments from Consumer Checking Accounts Become Effective Today," News Release, 3/16/2001.
35 12 C.F.R. ¤ 205.
36 2001 ACH Rules, Operating Guideline 161, and Revision 7, The National Automated Clearing House Association (2001).