Image Replacement Document (Substitute Check)

Front view of a substitute check

Rear view of a substitute check

A substitute check (also called an Image Replacement Document or "IRD") is a negotiable instrument used in the United States to represent the digital reproduction of an original paper check. As a negotiable instrument, a substitute check maintains the status of a "legal check" in lieu of the original paper check as authorized under the Check Clearing for the 21st Century Act (Check 21 Act). Financial institutions and payment processing centers electronically transmit data from substitute checks for collection and settlement through the Federal Reserve System instead of presenting the original paper checks.^[1]

Substitute checks are recognized as legal checks as long as the documents meet specific requirements. These requirements include the faithful reproduction of the paper checks and warranty of the payment instruments by the reconverting bank — the bank that created the substitute checks or the first bank that transferred or presented them during the check clearing process.^[2] Substitute checks are subject to the Uniform Commercial Code (UCC), existing federal and state check laws and new regulations specific to consumer rights affecting acceptance of these instruments.^[3] Although substitute checks are subject to the UCC and existing state and federal check laws, the Check 21 Act takes precedence in governing issues related to substitute checks.^[4]

[edit] General

Under the Check 21 Act, payment instruments that are eligible for conversion into substitute checks include consumer (personal) checks, commercial (business) checks, money orders, traveler's checks and treasury checks.^[5] The Check 21 Act permits any financial institution (such as a commercial bank or credit union) that participates in the check collection process to remove or "truncate" the original paper check from the forward collection or return without first requiring an existing agreement between the bank of first deposit (BOFD) and the paying bank.^[3][5] Elimination of the original paper checks from the clearing process saves the banking industry the costs of handling, sorting, transporting, storing, guarding and mailing paper checks. After the bank truncates the original paper checks in favor of substitute checks, the bank can store or archive the paper checks, return them to its customers according to state law or later destroy the paper checks.

[edit] Legal requirements

A properly prepared substitute check is considered the legal equivalent of the original paper check that can be accepted for payment or proof of payment in the same manner as the original check. Every substitute check must adhere to the following requirements before it can be recognized as the legal equivalent of the original paper check:

1. The substitute check must accurately represent all details and information depicted on the front and back of the original check (such as payor, payee, payment amount, endorsements and encoding information) at the time the financial institution truncated the original check.
2. The substitute check must accurately represent the MICR line of the original check.
3. The substitute check must bear the legend "This is a legal copy of your check. You can use it the same way you would use the original check."
4. The financial institution that truncated the original check must provide a warranty for the substitute check.
5. The financial institution that truncated the original check from the forward collection or return process must follow ASC X9 standards in the capture of check images and MICR data for the production of the substitute check.^[1]

Pictures or images of multiple paper and/or substitute checks on one page (image statements), photocopies of the original checks and images of checks posted online are not recognized as legal equivalents of substitute checks.^[6] Unlike a substitute check, a photocopy of an a check cannot be presented through the check collection process for settlement since the photocopy of the check does not strictly adhere to requirements for substitute checks under the Check 21 Act.^[3]

Since substitute checks are considered legal "checks," substitute checks are subject to existing check laws and regulations. Laws and regulations that govern handling of substitute checks include the Expedited Funds Availability Act under U.S. federal law, Article 3 (Negotiable Instruments)^[7] and Article 4 (Bank Deposits and Collections)^[8] of the Uniform Commercial Code (UCC), in addition to a variety of state and federal regulatory laws. If any state law, federal law or provision of the UCC conflicts with the Check 21 Act that governs substitute checks, the Check 21 Act takes precedence to the extent of the inconsistencies among those laws and provisions.^[4] U.S. federal laws also include Federal Reserve regulations that provide for recrediting the amount of the substitute check in the case of fraud and duplicate payments from settlement of both the substitute check and the original paper check used for creating that substitute check.^[1][3][5]

[edit] Clearing process

Each substitute check processed for forward collection is encoded with a "4" as the External Processing Code or "EPC" in position 44 of the MICR line.^[9] An example of the forward collection process for substitute checks involves the following steps:^[1]

1. The payee endorses the original paper check and presents it to the depository bank or bank of first deposit.
2. The bank of first deposit or "BOFD" (Bank 1) stamps its endorsement on the rear of the original paper check.
3. Bank 1 as the "truncating" bank captures an image of the front and back of the original check and captures the MICR line data from the front of the original check and then removes the original check from the clearing process.
4. Bank 1 electronically transmits the check images and MICR line data to its correspondent or intermediary bank (Bank 2) in lieu of the original paper check. Bank 1 includes its endorsement data in the electronic record transmitted to Bank 2. If Bank 2 does not have an agreement to exchange the check images and data with its correspondent bank, Bank 1 must provide either the original paper check or the legally equivalent substitute check to Bank 2.
5. The correspondent or intermediary bank (Bank 2) adds its electronic endorsement data to the record, and then Bank 2 transmits the check images and MICR data to the its own correspondent or intermediary bank (Bank 3). If Bank 2 does not have an agreement in place with Bank 3, Bank 2 must likewise provide the original paper check or a legally equivalent substitute check to Bank 3.
6. The correspondent or intermediary bank (Bank 3) as the "reconverting" bank adds its electronic endorsement to the record for the item and uses the check images, MICR line data, its own electronic endorsement the electronic endorsements received from Bank 1 and Bank 2 to create a substitute check. Any financial institution that participates in the forward collection (or return) process can become the reconverting bank if that bank creates the substitute check for transmittal to the paying bank.
7. Bank 3 presents the check images and MICR data to the paying bank (Bank 4) for settlement. If no agreement exists between Bank 3 and Bank 4, Bank 3 must provide Bank 4 with either the original paper check or a legally equivalent substitute check received from a bank that participated in the clearing process for the item.
8. The paying bank (Bank 4) uses check images and MICR data or the information from the substitute check received from the reconverting bank (Bank 3) to process the item for settlement in the normal course of settling the payment.
9. After the settlement process, Bank 4 provides a copy of the substitute check to the customer who wrote the original paper check in that customer's monthly or periodic statement.

If a substitute check must be returned unpaid because of insufficient funds, the paying bank (Bank 4) stamps the item NSF (non-sufficient funds) as the reason for the return. Bank 4 encodes a "5" as the EPC on the MICR line and encodes the routing number of the depository bank and the dollar amount of the substitute check on a return strip, perforated strip or carrier document that the bank attaches attached to the unpaid substitute check.^[9] The paying bank (Bank 4) then returns the unpaid substitute check through the routing process to the BOFD (Bank 1) for further handling. Once the BOFD (Bank 1) receives the returned substitute check, the bank issues a chargeback notice to its customer who deposited or offered the original paper check.^[1]

[edit] See also

• Remote deposit

[edit] References

1. ^ ^{a b c d e} "Check Clearing for the 21st Century Act Foundation for Check 21 Compliance Training". Federal Financial Institutions Examination Council. (n.d.). http://www.ffiec.gov/exam/check21/Check21FoundationDoc.htm. Retrieved May 28, 2009. 
2. ^ About Check Clearing for the 21st Century Act. (2006, March 1). U.S. Federal Reserve Board. Retrieved January 16, 2007.
3. ^ ^{a b c d} "Consumer Guide to Check 21 and Substitute Checks". U.S. Federal Reserve Board. (2004, February 16). http://www.federalreserve.gov/pubs/check21/consumer_guide.htm#whatis. Retrieved May 28, 2009. 
4. ^ ^{a b} Substitute checks. 12 C.F.R. § 229.59 (2009). Retrieved October 4, 2009.
5. ^ ^{a b c} "The Check Clearing for the 21st Century Act ("Check 21"): Frequently Asked Questions". U.S. Department of Justice. (2004, October 28). http://www.usdoj.gov/ust/eo/private_trustee/library/chapter07/docs/check21/Check21FAQs-final.pdf. Retrieved May 30, 2009. 
6. ^ "Check 21: Q's and A's". U.S. Controller of the Currency. (n.d.). http://www.occ.gov/Consumer/check21.htm. Retrieved May 30, 2009. 
7. ^ Negotiable instrument. 3 U.C.C. § 104 (2009). Retrieved October 11, 2009.
8. ^ Electronic presentment. 4 U.C.C. § 110 (2009). Retrieved October 11, 2009.
9. ^ ^{a b} "Check 21 Resource Document". Electronic Check Clearing House Organization. (2009). http://www.eccho.org/check21_resource.php. Retrieved May 28, 2009. 

[edit] External sources

• Accredited Standards Committee (ASC) X9 Financial Industry Standards: Statement on Check 21 adoption (October 23, 2004)
• Anatomy of a substitute check. (2004). Federal Reserve Financial Services.
• Ways to Use Check 21. (March 2004). Electronic Check Clearing House Organization (ECCHO)
  (diagram of the check clearing process for substitute checks)
• Substitute Checks: Development of Processing & Quality Standards. Electronic Check Clearing House Organization (ECCHO)
  (callouts to identify parts of a substitute check from the forward collection and return processes included at the end of the document)