The Substitute Paper Bill

An elaborate statutory and regulatory scheme providing for the ‘substitute check', replacing an electronic image of the original cheque, exists in the US under the Check Clearing for the 21st Century Act (‘Check 21 Act'),^[897] which has been implemented by Regulation CC.^[898] In essence, the Check 21 Act authorises a collecting bank^[899] to create a substitute cheque,^[900] being a paper reproduction of the original cheque, for further negotiation or presentment.

9.35

In practice, the creation of a substitute cheque by a collecting bank is predicated upon the existence of two preconditions. First, the creating bank must have received the transmission of an image of the original cheque instead of the cheque itself. The sender of that transmis­sion will be a customer, the holder of the cheque (in which case the creating bank is the depositary bank in the chain), or a prior collecting bank (in which case the creating bank is an intermediary bank). Second, the bank receiving the substitute cheque, being either a collecting/intermediary bank or the drawee bank, must not have agreed to accept electronic transmission of an image, which would likely be the case for a small bank that does not have the required processing equipment.

9.36

Stated otherwise, the Check 21 Act does not require banks to accept electronic transmission of cheque information or image.

9.37

By truncating paper cheques, the Check 21 Act eliminates the long-distance transpor­tation of the physical cheques, though it does not eliminate or bypass intra-city or local

transportation. The following hypothetical example will demonstrate the circumstances governed by the Check 21 Act. Suppose a drawer has a bank account with a payor bank in New York. The drawer sends a cheque drawn on that account to the payee in California, who deposits the cheque in his or her account with a Californian depositary bank. The latter is a large institution that has equipment for the transmission of the image of the cheque. At the same time, the payor bank is a small institution that does not have processing equip­ment capable of receiving the electronic transmission of a cheque. There is nothing in the UCC, the Check 21 Act, or any other instrument, to force the payor bank to accept elec­tronic transmission; hence, electronic presentment is not an option for the depositary bank. Rather, the depositary bank may transmit the image of the cheque to an intermediary bank in New York, which is capable of accepting such transmission.^[904] In effect, this is an elec­tronic negotiation of the cheque. Having agreed to accept the electronic transmission, the New York intermediary bank is now required under the Check 21 Act to create a paper substitute cheque.

9.38 A substitute cheque is a paper production of the original cheque that contains the image of that cheque's front and back; the substitute also bears a MICR (Magnetic Ink Character Recognition) line containing the information appearing on the MICR line of the original cheque, and conforms, particularly in paper stock, dimension, and otherwise, with gener­ally applicable industry standards for substitute cheques. It must be suitable for automated processing in the same manner as the original cheque.^[905] To be the legal equivalent of the original cheque, a substitute cheque must ‘accurately represent... all of the information on the front and back of the original check as of the time the original check was truncated' 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.'^[906]

9.39 As in the example above, a substitute cheque is typically created by a collecting intermediary bank. However, it can also be created by the depositary bank, where it has agreed to re­ceive the deposit of the cheque from the payee/holder by means of electronic transmission. Furthermore, a substitute cheque may even be created by the payee/holder. For example, such would be the case for a large organisation that receives cheques in various locations, but would prefer to deposit them in one place. The organisation may then arrange for the electronic transmission of cheque images to one place where substitute cheques will be cre­ated for deposit.

One can attempt to derive from the above discussion of the Check 21 Act the provisions that should be included in a (future) statute governing the electronic transmission (effectively, negotiation) of an electronic image of a bill to a collecting bank and the procedures that should be followed. That proposed statute should define a substitute bill as a paper produc­tion of the original bill that contains the image of the front and back of the original bill. The proposed statute should further provide that the substitute bill should: (i) conform, particu­larly in paper stock, dimension, and otherwise, with generally applicable industry standards for substitute bills, and (ii) be suitable for automated processing in the same manner as the original bill.^[907] As well, under the proposed statute, in order to be the legal equivalent of the original bill, a substitute bill must ‘accurately represent... all of the information on the front and back of the original [bill] as of the time the original [bill] was truncated' and bear an ap­propriate legend identifying it as a legal copy of the original bill.^[908]

9.41

In connection with a substitute bill, the proposed statute should also provide for warran­ties and an indemnity. The warranties should be, first, that the substitute bill meets the re­quirements for legal equivalence, and second, against double payment on the original bill or any other representation of it.^[909] The indemnity should be ‘to the extent of any loss in­curred... due to the receipt of a substitute [bill] instead of the original [bill]'.

9.42

The proposed statute should provide that substitute bill warranties are to be given by each bank ‘that transfers, presents, or returns a substitute [bill] and receives consideration for the [bill]’ In turn, indemnity liability should be incurred by ‘[a] reconverting bank and each bank that subsequently transfers, presents, or returns a substitute [bill] in any electronic or paper form, and receives Page 1-69 (Rel 22) consideration for such transfer, presentment, or return... '.^[911] A ‘reconverting bank' should be defined as the bank that creates the substi­tute bill or, where the substitute bill is created by the indorser to the remitting bank, the first bank that transfers or presents the substitute bill, namely, the remitting bank.^[912] Arguably, having been listed as a party liable to indemnify for loss caused by the breach of warranty, the reconverting bank ought also to be listed as one of the warrantors.^[913]

9.43 The proposed statute should further provide that both substitute bill warranties and the indemnity are to be stated to run to the benefit of the transferee, any subsequent collecting or returning bank, the remitting bank, the drawee, the drawer, the payee and any indorser.^[914] Since a bill could be transformed from electronic form into a substi­tute bill several times in the course of the collection and return process, it is possible that there could be multiple substitute bills, and thus multiple reconverting banks, with respect to the same payment transaction.

9.44 The proposed statute might also cover the unusual case where a paper bill is drawn to a payee's, and not the drawer's order, and it is the payee (or any subsequent holder) who converts it into an electronic image transmitted to the remitting bank.^[915] In such a case, in the footsteps of Regulation J,^[916] a sender of an electronic bill derived directly from the original paper bill is to make for it two sets of warranties. To begin with, the first set covers the transfer warranties that apply as if the electronic bill were a paper bill gov­erned by bills of exchange law. Under English law, this corresponds to precluding the sender from denying what falls under the transfer warranties in the UCC.^[917] The second is a warranty that applies as if the electronic bill were a substitute bill. Accordingly, to cover the case where an electronic image has been created from an original bill that was deficient in some respect, an end-to-end combined liability structure is provided.^[918]

9.45 Finally, the proposed statute ought to explicitly authorise transacting with the substitute bill by indorsement and otherwise. While this derives from the legal equivalency principle, it is important to be explicit in asserting that such legal equivalency is dynamic and not static, so that it is not limited to the status of the bill as it was originally converted.

V.