Update: How Safe Is The Safety Net For Image Clearing Of Cheques?
Raymond Cox QC
14 February 2018
How safe is the “safety net” proposed by the Treasury in relation to the system for clearing images of cheques?
The new system for presenting images of the front and back of the paper cheque, rather than the paper cheque itself, was introduced in October 2017, and will be available in relation to all cheques during 2018. Cheques will be cleared within two business days of deposit. The Treasury has recently consulted on proposed regulations in relation to image clearing system (ICS), with the regulations yet to be finalised.
One of the stated purposes of the proposed regulations is to provide a “ ‘safety net’ to require that the payee’s bank compensate a customer, who has not been complicit in fraud or acted in a grossly negligent way, for a direct loss they have incurred in connection with the presentment of a cheque under the new ICS” (Legislation to support cheque imaging: consultation, Treasury, published 3 November 2017).
The proposed regulations provide for the drawer to be able to claim compensation from the collecting bank for loss incurred by the drawer in connection with the presentment of images under ICS where the image was not eligible for presentment under ICS, the image purported to be but was not of a cheque, the image had been stolen, or the cheque was converted. Loss excludes consequential loss, and loss resulting from gross negligence or fraud by the drawer.
The policy seems to be that the collecting bank is in the best position to prevent the introduction into ICS of offending images or converted cheques, and therefore should be encouraged to do so by the introduction of the proposed liability to the drawer. However, the Treasury views the claim as a safety net, and stated that “industry agreements should remain the first indicator of which party – the paying bank, the payee’s bank/beneficiary bank, or the collecting bank (if different to the payee’s bank) – compensates a customer”. In fact, the rules of the ICS scheme do not include provisions which would alter the potential rights of the drawer or true owner. Nor do the Payment Services Regulations 2017 apply to payments based on paper cheques.
To understand the significance of the proposals it is necessary to keep in mind two points about new system.
First, the bedrock of the system continues to be the paper cheque which will be physically drawn by the drawer and physically delivered to the payee; what the ICS (and the enabling changes to Part 4A of the Bills of Exchange Act 1882 (the Act)) do is to treat electronic presentment of an electronic image of the paper cheque as if it were physical presentment of the paper cheque, so that after presentment of an image, the paying and collecting banks are under the same duties as if the paper cheque had been physically presented.
Second, under the ICS there is no need for the paper cheque to be retained once an image has been made and presented; this is of fundamental practical importance because the need to be able to produce the physical cheque was a key impediment to earlier efforts to do away with physical presentment of cheques.
In summary, for reasons explored below, it does not seem likely that the safety net will be needed or called upon in the situations most likely to lead to loss. The position of the drawer and indeed the payee (true owner) of the cheque will be protected by the Bills of Exchange Act 1882 (the Act) and the common law without the new regulations. But, if there should prove to be a need, the drawer (and only the drawer) would have the benefit of a claim against the collecting bank for sums paid away as a result of the ICS, but not for any other loss.
The position of the drawer
From the point of view of the drawer of the paper cheque, and before ICS, the main risks were of the cheque being stolen, forged, altered, written in excess of authority, or paid after countermand. Those risks remain in relation to cheques cleared through the ICS.
In addition, there are new risks arising from ICS, in particular: more than one image may be presented, and the image may be unauthorised, stolen, or altered.
There is an obvious risk of more than one image being made and presented. Under the ICS, the payment against the first image presented will discharge the cheque (s.59 of the Act). If a second image was presented, the cheque was already discharged, and the paying bank was not entitled to debit the drawer again for the amount of the cheque. The drawer was not likely to need the safety net.
The paper cheque may have been stolen by a thief who then delivered the paper cheque to a collecting bank, which made an image, and presented the image for payment. In that case, the thief never became a holder of the paper cheque, and payment to the thief therefore could not discharge the cheque. The paying bank was not entitled to debit the account of the drawer, and again the drawer was not likely to need the safety net.
The position would be no different if the thief made his own image of the paper cheque, and delivered that to the collecting bank for presentment (this facility is proposed to be available, possibly using a mobile phone). The thief did not become the holder of the paper cheque in that case either.
It is possible to conceive of a case where the payee retained the paper cheque, but the thief stole the image, and obtained payment under the ICS. Again, payment was not made to the holder of the cheque, and the paying bank was not entitled to debit the drawer’s account.
Then there is a situation which could not have arisen before the ICS, where the image but not the paper cheque was altered, to change the name of the payee, or the amount of the cheque. The alterations to the image did not avoid the cheque. Unless the image was so altered that it was no longer an “image” of the cheque to which the ICS applied, on presentment of the altered image, the paying bank was under the same duties as if the paper cheque had been presented. In that case, the paying bank’s duty to the drawer was to pay the amount of the paper cheque (which might be different from the amount in the altered image), and to pay the payee named on the paper cheque (who may be different from the payee on the altered image). If the paying bank was misled, and paid the wrong payee, the cheque was not discharged, and the paying bank could not debit the drawer. If the paying bank paid the correct payee a larger sum than was stated on the paper cheque, the paying bank could not debit the excess to the account of the drawer. In neither case was the safety net required.
The position of the true owner of the cheque
The other person likely to be most affected by the introduction of the ICS is not mentioned in the proposed regulations at all.
Before the ICS, if the paper cheque was delivered to the payee, the payee might lose out if the paper cheque was stolen or altered, and presented, and the proceeds diverted to a thief.
There are new risks for the payee arising from ICS, in particular: the image of the payee’s cheque may be unauthorised, stolen, or altered.
Broadly, the outcome should be no different under the ICS from what it was before the ICS. Assuming that the payee was indeed the true owner of the paper cheque (which can be an issue of some nicety), and that a third party without authority delivered the paper cheque to the collecting bank which made and presented an image, there is little reason to doubt the true owner would have a claim against the collecting bank for conversion of the paper cheque because the making and presentment of the image interfered with the rights of the true owner under the cheque to present the cheque and collect the proceeds. The interference by presenting the image is no less than the interference by presenting the paper cheque under the physical clearing system, even if the cheque is not discharged by payment to a holder. The damages would similarly be the face value of the paper cheque.
The outcome should not be different if the third party made the image itself without authority and delivered the image to the collecting bank for presentment. However, if the true owner retained the cheque it could simply represent an image of the cheque for payment because the cheque was not discharged by payment to a non-holder.
If the image was altered, possibly by altering the name of the payee, and presented, the paper cheque was not avoided, but again the rights of the true owner were interfered with by presentment of the altered image, and the collecting bank would be liable to the true owner.
Evidence of payment
The proposed regulations provide that the drawer may request an image of the paper cheque and use it as evidence of payment. This is necessary because paper cheques will not be retained by the collecting banks under ICS.
See Raymond’s recent Banking and Finance work.