Same-day Settlement

As we pointed out earlier, you “settle” for a check by making the funds represented by the check available to the party from whom you receive it. Except where a check is presented over the counter for cash, a paying bank settles for a check with the bank that presents the check for payment (the “presenting bank”). The Uniform Commercial Code says the paying bank must settle for or return such a check by midnight of the banking day on which the paying bank receives the check. If the paying bank settles within this deadline, the paying bank has until midnight of the following banking day to return the check and revoke the settlement. [UCC, Section 4-301(a)] If the paying bank fails to either settle for or return the check by midnight of the banking day of receipt, then the paying bank becomes “accountable” for, or liable for, the check and may not return it.

For example, suppose the paying bank receives a check for presentment on Monday, a banking day. The paying bank must either settle for or return the check by midnight Monday. If it does not, the paying bank becomes accountable for the check and may not return it. If the paying bank settles for the check by midnight Monday, it has until midnight Tuesday (assuming Tuesday is also a banking day) in which to return the check and revoke the settlement. If the paying bank misses this second deadline (which is called the “midnight deadline”), the paying bank becomes accountable for the check.

Paying banks have found ways to avoid the UCC requirement that they settle for an item on the same day they receive it (“same-day settlement”). They accomplish this by making same-day settlement less desirable to the presenting bank. For example, they might impose a fee for same-day settlement or require that the presenting bank maintain an account with the paying bank in order to get same-day settlement. (This account will usually be subject to maintenance fees.) Sometimes paying banks will settle on the same day as receipt, but do so by sending a teller’s or cashier’s check to the presenting bank. This teller’s or cashier’s check has to be collected, meaning the funds are not immediately available to the presenting bank. (The 1990 version of the UCC, however, allows the presenting bank to demand that settlement be in the form of cash or credit to an account at a Federal Reserve Bank. [UCC, Section 4-213, Comment 1] This would eliminate the last technique for frustrating same-day settlement.)

Paying banks have not, however, been able to employ these tactics against Federal Reserve Banks. Checks collected by Federal Reserve Banks are governed by Regulation J, a Federal Reserve Board regulation, which has for some time had settlement rules which are more favorable to Reserve Banks as presenters than the UCC rules would be. [12 CFR 210] The problem has centered on presentments made by “private-sector” banks—banks other than Federal Reserve Banks.

The Federal Reserve Board has, for a number of years, felt that practices frustrating same-day settlement with private-sector banks make the check collection system slower and more costly. In October of 1992, the Board announced it was using its general authority to improve the check collection system (under the Expedited Funds Availability Act) to enhance presenting banks’ ability to obtain same-day settlement. The Board’s rule, which was effective January 3, 1994, is found in Subpart C of Regulation CC. [12 CFR 229.36(f)] (Incidentally, the Board also amended Regulation J in October of 1992 to require even earlier settlement on checks collected by Federal Reserve Banks—as early as one hour after the paying bank receives the checks. The effective date of the Regulation J amendments was October 14, 1993. For details, see the Federal Register for October 14, 1992, beginning at page 46950.)

In essence, the new private-sector rule says that if the presenting bank meets certain conditions regarding the time, location, and manner for presenting a check, the paying bank must either settle for the check or return it by the close of Fedwire on the business day it receives the check. [12 CFR 229.36(f)(1) and (2)] (Fedwire is the Federal Reserve’s wire-transfer service.) The settlement must take the form of a credit to an account at a Federal Reserve Bank designated by the presenting bank or an alternative form of payment specified by the presenting bank. [Commentary, 12 CFR 229.36(f)-3a] The paying bank may not charge a fee for the settlement. [Commentary, 12 CFR 229.36(f)-3a] These same-day settlement requirements do not, however, apply to a check drawn upon the United States Treasury, to a U.S. Postal Service money order, or to a check drawn on a state or a unit of general local government that is not payable through or at a bank.

The presenting bank must meet four conditions to get same-day settlement.

First, the presenting bank must demand payment under the same-day settlement rule. [12 CFR 229.36(f)(1)] This means the presenting bank must include information with the presented checks that indicates the presenting bank wants same-day settlement. The Commentary suggests the statement: “These checks are being presented for same-day settlement.” [Commentary, 12 CFR 229.36(f)-2a.i] The presenting bank must also include a demand for payment of the total amount of the checks together with appropriate payment instructions (pay in cash, by credit to account at Federal Reserve Bank, etc.). [Commentary, 12 CFR 229.36(f)-2a.i]

Second, the presenting bank must deliver the check “in accordance with reasonable delivery requirements established by the paying bank.” [12 CFR 229.36(f)(1)] For example, the paying bank could require the presenting bank to place the checks in a night depository if the paying bank is not yet open when the presenting bank delivers the checks. The paying bank may also require that checks presented for same-day settlement be sorted from other checks. [12 CFR 229.36(f)(1)] (The need for sorting might arise where the paying bank is the correspondent of the presenting bank and the presenting bank delivers a bundle of checks, some of which are drawn on the paying bank and others of which are to be forwarded to other banks for collection.) The presenting bank is responsible for contacting the paying bank for details on such delivery requirements and, as long as the requirements are reasonable, must meet them in order to obtain same-day settlement. [Commentary, 12 CFR 229.36(f)-2b]

Third, the presenting bank must deliver the checks to a location designated by the paying bank. [12 CFR 229.36(f)(1)] (The paying bank may only designate a location that is within the check processing region consistent with the routing number on the check. [Commentary, 12 CFR 229.36(f)-2a.ii]) If the paying bank does not designate a location, the proper location is: (1) an address associated with a routing number on the check; (2) any branch or head office, if the bank is identified on the check by name without address; or (3) a branch, head office, or other location consistent with the name and address of the bank on the check if the bank is identified on the check by name and address. [Commentary, 12 CFR 229.36(f)-2a.iii]

Fourth, and finally, the presenting bank must meet all of these conditions by 8 A.M. on a business day. [12 CFR 229.36(f)(1)(ii)] The 8 A.M. deadline is local time at the proper location for presentment. “Business day” is any day other than a Saturday, Sunday, or federal legal holiday. [12 CFR 229.2(g)]

If the paying bank is closed on the business day a check is presented for same-day settlement, the paying bank has until the close of Fedwire on its next banking day to either settle for or return the check. [12 CFR 229.36(f)(3)] The settlement again must take the form of a credit to an account at a Federal Reserve Bank designated by the presenting bank (or an alternative form specified by the presenting bank). [12 CFR 229.36(f)(3)(i) and (ii)] If the bank was closed voluntarily, the bank must pay interest on the amount of the check for each day following the business day on which the check was presented until settlement, including the day of settlement. [12 CFR 229.36(f)(3)] The rate of interest is the average of the Federal Funds rates published by the Federal Reserve Bank of New York for each of the days for which interest must be paid, divided by 360. [12 CFR 229.2(oo)]

For example, if the paying bank is voluntarily closed on a Wednesday which is a business day, it has until the close of Fedwire on Thursday to settle for or return checks presented on Wednesday for same-day settlement. (This assumes Thursday is a banking day for the paying bank.) But if it takes advantage of this extra time, the paying bank must pay one day’s worth of interest on the checks to the presenting bank. The rate is determined by taking the average of the Federal Funds rates for Thursday and dividing it by 360.

These are the basic rules governing same-day settlement with private-sector banks. Paying banks and presenting banks are free to negotiate different rules to accommodate each other, but presenting banks are in a better bargaining position than they were under the rules of the Uniform Commercial Code. The new rules guarantee them same-day settlement without fees or other obstructions as long as conditions are met.

In the course of following these rules or negotiating different rules, both presenting banks and paying banks are governed by the “good faith” doctrine. This means they must be honest with each other and must observe reasonable commercial standards of fair dealing. The Commentary provides two examples where the good faith standard might be violated. First, a paying bank could violate the standard if it designates or changes presentment locations for the purpose of discouraging banks from presenting checks for same-day settlement. Second, a presenting bank may violate the standard by presenting a large volume of checks without giving prior notice to the paying bank. [Commentary, 12 CFR 229.36(f)-5] The good faith doctrine seems to require that both paying and presenting banks cooperate in an effort to make same-day settlements operate smoothly.