Mobile Check Deposits: Understanding the Risks

Mobile Check Deposits: Understanding the Risks

It’s meant to be a convenience for banking customers: simply use your smartphone and your bank’s mobile banking app, take a picture of the check you wish to deposit, and deposit a check from anywhere, skipping the trip to the bank or check cashing place. But what actually happens to the check after the mobile deposit has been made?

Mobile check deposits are increasing in popularity, and with their increased usage also comes new risks and avenues for fraud.

At Tricom, we process thousands of payroll checks every week for our staffing clients. With the rise of mobile check deposits, staffing companies have been increasingly faced with the following scenario:

The staffing company issues a paper check to one of its employees. The employee remotely deposits the check with his or her bank by snapping an image of it with his or her smartphone, using the bank’s mobile deposit app. The bank electronically creates a “substitute check” and presents it to Tricom for payment on behalf of our client.

Meanwhile, the employee retains the original paper check and later cashes that original check at a check-cashing store. The check-cashing store deposits the original paper check with its depository/bank (“Bank C”). Bank C converts that check to an electronic item and presents it to Tricom through an election forward-collection cash letter. Tricom identifies the check as a suspected duplicate because the “substitute check” has already been presented for payment. Tricom dishonors the check as a suspected duplicate, and the check bounces back to Bank C, which will charge the item back to its customer’s (the check-cashing store) deposit account.

The duplicate deposit may have been an accident or it might have been the result of fraudulent intent. Either way, the employee is double depositing the check. The question becomes who is left to make good on these multiple transactions if the parties are unable to recover directly from the employee?

The check-cashing store will assert that it is entitled to payment from the “drawer” (or in this case, the staffing company), as a “holder in due course,” and will contact the staffing company for payment. The “holder in due course” doctrine governs negotiable instruments, such as checks. The doctrine says that a party who acquires a negotiable instrument in good faith, for value, and without notice of certain facts, takes the instrument free of competing claims of ownership and most defenses to payment. The underlying idea is that a party properly acquiring a check should not have concerns about a third party honoring it.

The rules and interpretations of the Uniform Commercial Code and of the Check 21 Act govern this matter. Currently, there is minimal case law interpreting these rules in mobile deposit cases. As written, the UCC is not helpful. The UCC imposes no warranty obligation from a potential double deposit situation such as the one outlined above. Simply stated, the UCC does not address the possibility that a single instrument could be presented for payment multiple times. Accordingly, the check-cashing store has a strong argument that it is a “holder in due course” if it took the check by proper endorsement, in good faith, for value, and without notice that it was a duplicate.

The Check 21 Act provides the answer. The Check 21 Act, which was enacted in 2004, authorizes the use of a “substitute check” — an electronic reproduction of the front and back of the original check. As a result, a bank may permit its customers to scan checks and deposit them electronically using the bank’s mobile deposit app. The Check 21 Act does not require destruction of the original paper check after the creation of the substitute check. Thus, it enables the scenario where a “substitute check” is created and deposited and the original paper check is also deposited.

The key provision of the Check 21 Act is that it imposes a warranty and indemnity obligations upon a bank issuing a substitute check. A bank creating a substitute check assumes the risk that arises from the creation of multiple legally enforceable copies of the same item. The employee’s bank in the scenario above is deemed to have warranted to each subsequent handler of the check that it will not receive multiple presentments of the check such that it will be asked to make a payment based on a check that is already paid. The Check 21 Act specifically states:

…no depositary bank, drawee, drawer, or endorser will receive presentment or return of, or otherwise be charged for, the substitute check, the original check, or a paper or electronic version of the substitute check or original check such that the bank, drawee, or endorser has already paid.
12 U.S.C. §504

Accordingly, in the situation described above, if the employee utilizes their bank’s mobile deposit app and then later cashes the original paper check at a check-cashing store, the liability for the double payment falls on the employee’s bank due to that bank’s Check 21 Act warranty, not the staffing company issuing the check. Liability for the loss falls to the bank that allowed a customer to use its mobile deposit app. The warranties described in the Check 21 Act dictate that the act of accepting a mobile deposit and creating the substitute check places responsibility for any multiple payments on the bank that created the “substitute check.”

So, while ultimately as an employer, you will not be held responsible for one of your payroll checks that are deposited multiple times via a mobile deposit app and a check cashing store, you can still take steps to help curb fraud that may occur from such attempts.

By encouraging direct deposit for employees who have bank accounts (and presumably employees will have a bank account if they are able to use a mobile deposit app), you can eliminate the possibility of a payroll check being presented more than once for payment. Not only does it reduce mobile deposit fraud, it also means that funds are immediately available to employees in their accounts on payday – they don’t have to wait for a physical check.

For more information on migrating your employees to direct deposit, or questions about mobile deposit fraud, please contact your Tricom payroll processing professional.

For additional clarification or questions, feel free to call Mary Jo Heim, Tricom’s Director of Accounting, at 800-348-4815.