Banks, the Banking Process, and Electronic

Banks, the Banking Process, and Electronic

As a manager, depending on the type of business you are involved with, you will probably have frequent interaction with banks and financial institutions. Understanding fundamental banking processes, then, is essential to carrying out your day-to-day activities. 15.1 The Debtor–Creditor Relationship Between a Business

and a Bank

The first essential ingredient of your relationship with a bank is that it is a debtor–creditor relationship. This is the relationship that exists when one person (the creditor) loans money, provides services, or extends credit to another (the debtor). The debtor, in turn, is the person who owes the money or some other obligation to the creditor. The act of loaning a friend $10 is an example of how simple it is to create this relationship; no other formalities need be involved. So, when a business deposits money in a bank account, the business becomes a creditor of the bank and the bank is the debtor. As a result of that relationship, the creditor has the right to demand its money from the bank and concomitantly the bank has the duty to pay the money out of the account. The debtor–creditor relationship can also be an informal arrangement created by a private transaction (see Chapter 16 for further explanation).

The debtor–creditor relationship is governed by UCC Article 4. The rules of Article 4 are often modified by the contract entered into by the bank and the customer. Although every agreement between a bank and a customer has unique features, the following is representative of the clauses that often appear.

USA PATRIOT Act

Since passage of the USA PATRIOT Act, banks have been under intense government scrutiny. One result of that scrutiny is increased identification requirements. Therefore, businesses dealing with banks may be required to produce identification every time they deal with their bank, as will all employees authorized to deal with the bank. It is essential that the business implement policies regarding the identification of employees. A passage in a commercial contract may appear like this:

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IDENTIFICATION NOTICE (USA PATRIOT ACT) To help the government fight the funding of terrorism and money-laundering activities, Federal law requires all financial institutions to obtain, verify, and record information that identifies each person who opens an account.

What This Means for You When you open an account, we will ask for your name, address, date of birth, and other information that will allow us to identify you. We may also ask to see other identifying documents like a driver’s license or documents showing your existence as a legal entity.

Existing Customers Even if you have been a customer of ours for many years, we may ask you to provide this kind of information and documentation because we may not have collected it from you in the past or we may need to update our records.

Failure to Provide Information If, for any reason, any owner is unable to provide the information necessary to verify their identity, their account(s) may be blocked or closed, which may result in additional fees assessed to the account(s).

When the business sets up the account and thereafter, the bank will want to know who is authorized to access the account. Each owner of your account is independently permitted to authorize someone else to access your account. For example, here is a passage from a commercial agreement establishing which persons will have access to your account:

1. Any person listed on a signature card, resolution, or certificate of authority as being authorized to make withdrawals or transfers, by check or otherwise, from your account;

2. Any person that you authorize to make withdrawals or transfers from the account by whatever means the account allows (for example, preauthorized withdrawals, wire transfers, ATM card, or check card transactions);

3. Any person you give rights to act on your behalf, such as a power of attorney; 4. Any person to whom you make your checkbook or your checking account num-

ber available for purposes of transacting business on the account. We discourage this type of “authorization” because it is possible that we will detect such trans- actions and treat them as unauthorized. If you give any such person “authority,” we are not responsible whether we honor the transactions or dishonor them; and

5. Any person to whom you make your ATM card or check card personal identifi- cation number available. By allowing this type of “authorization” the person to whom you make your personal identification number available may be able to access all of your accounts held with us by using the telephone, ATM, Internet, or other banking access channels. If you give any person such “authority,” we are not responsible for actions they take with respect to your account.

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Authorization is usually accomplished by use of signature cards or the use of a power of attorney form. Note under paragraph 4 of the above agreement that the bank deems simply making a checkbook, account number, or ATM card available to an employee “authorization,” thus exculpating the bank from any liability for a wrongful unauthor- ized withdrawal.

Overdrafts

An overdraft occurs when you take more money out of your account than is available to you for withdrawal, or if it is available to you but is later reversed. The relationship between the bank and the customer is that of a debtor to a creditor, but when an overdraft occurs, that relationship is reversed, and the customer becomes the debtor. As such, the customer is required to pay any overdrafts and the penalties that result. Note from the agreement below that anyone who works for the business is liable to the bank for any employee who overdraws the account. The following sample contract passage relates to overdrafts:

The account owner(s) is responsible to us to repay any overdraft and any fees charged to an account, no matter which owner caused it or why. That repay- ment is due immediately, and we will take it from your next deposit or when- ever funds become available in your account. If there is more than one owner, each owner is separately, and all owners are jointly, responsible for an over- draft and any account fees (this means we can collect the total from any owner, but we won’t collect it more than once).

Banking is a business, and just like any other business, banks need to make a profit to remain solvent. As such, the bank “controls” the agreement, and there is little room for negotiation about most aspects of the contract. Thus, the bank sets the limits of its liability and protects itself from all foreseeable problems. Banks do have more leeway with regard to charges and lending costs than they do with regard to the contract that customers sign. For this reason, high-volume customers may expect that the bank will make up for some of the stringent aspects of the contract by giving them more lenient rates.

15.2 Types of Checks Commonly Seen in Banking

In previous chapters we discussed the most common type of paper seen in banking transactions: the check (see also Chapter 12). A check is three-party paper in which the drawer orders the drawee to pay the payee. The distinguishing feature of a check is that the drawee is always a bank. In this section we will discuss specific types of checks.

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Cashier’s Checks

A type of instrument commonly seen in banking transactions is the cashier’s check. A cashier’s check is a check in which the bank is both drawer and drawee. While at first blush this might sound strange, it makes a lot of business sense. Suppose that a person or a business did not have a bank account but instead had only cash from a transaction. That person needs to make the cash usable in commerce (or perhaps mail it), so he or she needs the cash converted into a check. The customer can give the bank the money to deposit into its own accounts, and the bank can then draw from that account. Thus, the bank is both drawer (writing the check) and drawee (drawing from its own account). The cus- tomer receives a bank check even though he or she has no account at the bank, and the check is highly acceptable because the bank has agreed to be primarily liable on it by virtue of its being a cashier’s check. The money is guaranteed.

Certified Checks

When the payee wants to make sure that the drawer’s check won’t “bounce” (be dishon- ored for insufficient funds), the payee can insist that the drawer pay for goods with a certified check. This instrument is similar to a cashier’s check, except that in this case, the drawer is a customer with an account at that bank. Usually the customer writes the check from his or her checkbook and hands it to the teller. The teller then moves the money out of the customer’s account into a special bank account. In this way, the funds are guaran- teed and the drawer no longer has access to them. The teller then writes “CERTIFIED,” “ACCEPTED,” or some other word on the front of the check as public notice that the bank is now primarily liable on the instrument.

One word of caution about certified and cashier’s checks: It is always wise to have these checks made payable to the drawer himself, rather than the payee. In the event that the sale falls through, the drawer can then deposit the check back into his account. If the check is made payable to the payee, and the payee becomes angry with the drawer, the payee may refuse to endorse the check. Now the drawer has in his hands a check made payable to a very uncooperative payee. By making the check payable to himself, the drawer can then show up to buy the goods and complete the transaction by endorsing the check to the seller.

Invalid Checks

As discussed throughout this unit, no one is liable on commercial paper unless that per- son’s signature appears on it. However, several special circumstances can render such an instrument invalid in a business transaction.

Cashier’s checks are guaranteed because a bank has agreed to be primarily liable.

McClatchy Tribune/Getty Images

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Forged Checks If the bank pays out from a customer’s account and the customer did not sign the check as the drawer, then the bank is in the wrong. This is referred to as a forged drawer’s signature. In these cases, someone has usually stolen the drawer’s checkbook and forged his or her name on the front of the check in the signature line—a serious crime in all jurisdictions.

How does a bank doing hundreds of transactions a day watch out for such forgeries? One way is by requiring identification. But some thieves are very good at their trade. Banks usually check the cards they have on file, called signature cards, that the customer signed when first opening the account. If there is a discrepancy, the bank may refuse to pay. In addition, bank customers have a positive duty to inspect their bank statements to be watchful for unauthorized activity and must report any errors to the bank within 30 days. If they fail to do so, the bank will not be liable. However, if such an error is discovered after the fact but before the 30 days expire, the bank is obligated under the UCC to “recredit” the customer’s account.

However, if the forgery on the front of the check was somehow the fault of the drawer, then the bank has no liability for crediting the drawer’s account. For example, some busi- nesses have check machines that process checks and sign them. Others have stamps with an authorized employee’s name that can take the place of an actual signature. Failing to protect apparatuses such as these and allowing them to fall into the wrong hands is neg- ligent and no fault of the bank.

Sometimes, a bank will pay out on a forged endorsement. This involves different legal liability than for a forged drawer’s signature. Erroneous payouts fall under the theory of presentment warranties (see Chapter 14). Recall that the person presenting the instrument for payment is guaranteeing that it was not stolen and that it is genuine. Therefore, the bank can sue the “presenter” on the basis of breaching this warranty, even if the presenter was completely unaware of any problem with the instrument. Here, too, the bank will have to recredit the drawer’s account.

Altered Checks Another problem that banks have is when people alter the face value of checks. If the bank pays out of a customer’s account on an altered check, the bank must recredit the cus- tomer’s account for whatever the bank erroneously paid. There are two amounts involved in these situations. One is called the original tenor, which is the amount that the drawer drew the check for. Suppose the drawer wrote a check for $45.00 and it was changed by a thief to $450.00. The amount of $45.00 is the original tenor and the amount of $450.00 is the altered amount. Unless the customer’s negligence led to the alteration, the bank will have to recredit the difference between the altered amount and the original tenor. In this context, negligence by the drawer may include writing in pencil, leaving large gaps or spaces when writing checks, thereby facilitating alterations, or failing to inspect monthly bank statements.

Stop Orders Banks are also liable for paying on a check after a stop order has issued. Stop orders take two forms: one is in writing and is effective for six months, and the other is oral and

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Section 15.3 Special Business Problems With Banking CHAPTER 15

is effective for 14 days. Customers must follow strict bank rules to invoke a stop order. When the order expires, a customer may renew the order, but fees are involved with all of these requests because they require extensive monitoring and employee time.

Stale Checks According to the UCC, checks that are more than six months old are “stale,” and the bank does not have to accept them. If a customer requests the bank to credit his or her account, or to provide cash for a stale check and the bank refuses, the customer will have no “case” against the bank for its refusal. On the other hand, if the bank does pay out on a stale check, it has no liability for doing so. In short, the bank is not liable whether it pays out on a stale check or whether it refuses.

Postdated Checks

People often write what are called “postdated checks” on their account. Such checks are dated in the future, when the customer expects he or she will have money in the account to cover the amount. Is a bank liable for immediately paying out on a check that is dated in the future? The answer is no, unless the drawer notifies the bank not to pay either orally or in writing. Otherwise, the bank has no liability, even if the transaction overdraws the customer’s account.

Posthumous Checks

Sometimes a business will receive a check from a customer who dies soon after. The family members may trace the check back to the business and ask for a refund of their deceased family member’s money. Perhaps the business has already deposited the check into its account and the family wants the bank to stop payment. If the bank is unaware that a customer has died and it processes such a check, the bank has no liability, even for 10 days after learning of the death. Nor will the bank have liability for crediting the business’s account. As with overdrafts, a bank can pay out of a customer’s account even if it creates a deficit; alternatively, if it chooses, the bank may dishonor the check after learning of the drawer’s death.

15.3 Special Business Problems With Banking

On occasion, the news will cover a scheme by a fictitious payee. Sometimes these schemes are right out of Hollywood—as clever as they are diabolical. A fictitious payee scheme is one of an employer’s worst nightmares. In it, a trusted employee (who usually works in the payroll office and handles checks on a regular basis) goes to a bank and sets up a bank account in a fake name. Then the employee makes checks pay- able from the business to the fake named account, deposits them, and spends the pro- ceeds. As a general rule, the employer usually discovers the scheme and races to the bank, demanding that the bank recredit the employer’s account for the thousands of dollars stolen. Unfortunately for the employer in this situation, the bank is not liable. By law, the loss usually falls on the person hiring the errant employee. The employer suffers the loss for having used bad judgment in hiring a thief to work in the payroll office.

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Key Terms CHAPTER 15

Another popular scam is for a thief to pose as a charity or a needy relative. Suppose a thief shows up at a business and claims to be representing the United Way or another well- known cause. The employer, wishing to be charitable, gives the thief a check. In cases such as these, where the drawer purposefully made the check out to the poseur without questioning his or her identity, the drawer will suffer the loss. Employees and employers, for that matter, are supposed to use common sense and not hand checks to people with- out first verifying who they are. The bank in these cases has no obligation to recredit the donor’s account.

Key Terms

cashier’s check A check in which the bank is both the drawer and drawee.

creditor The party to a financial relation- ship who has the right to demand money at a given time.

debtor The party to a financial relation- ship who has the duty to pay the creditor money.

debtor–creditor relationship A contrac- tual arrangement between, for example, a customer and a bank, where the creditor can demand money from the debtor, who has the duty to pay from that account. Can also be an informal relationship created by a private transaction.

fictitious payee A sham account holder created by an employee who then depos- its company checks into that account for personal use.

guaranteed Funds that are certain to be paid on an instrument because they are backed up by a bank’s special account or certification.

original tenor The amount the drawer drew the check for; its face value.

overdraft Taking more money out of your account than is available for withdrawal, or that is available to you but is later reversed.

postdated check A check that is dated in the future, when the writer expects he or she will have money in the account to cover the amount.

power of attorney An instrument in writing by which one person, as princi- pal, appoints another as his or her agent and confers upon the agent authority to perform specified acts or kinds of acts on behalf of the principal.

stale check A check that is outstanding for longer than six months.

stop order A request made in writing, valid for six months, or made orally, valid for 14 days, for a bank to refuse payment on an outstanding check.

USA PATRIOT Act A 2001 federal act to combat terrorism. It requires strict over- sight of banks’ standards for identifying customers in transactions and verifying their signatures.

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Critical Thinking and Discussion Questions CHAPTER 15

Critical Thinking and Discussion Questions

1. Why is the relationship between a business and a bank known as a debtor–creditor relationship?

2. Who is the drawer of a cashier’s check? Who is the drawee? 3. List three circumstances when a check would be considered invalid. 4. How can employers and managers ensure against fictitious payee schemes? As a

manager, how would you advise your supervisor with regard to preventing these schemes from occurring at your workplace?

5. Your business deals with numerous buyers every day, and it is customary in your business to take checks in payment. Write a company policy regarding stale, postdated, and antedated checks so that your employees have some guidance about which checks to accept.

6. Your supervisor asks you to place a stop order on a check that your business has written. Discuss whether you would place an oral or written stop order; what the process would be to place the order; how much it would cost; and what the advantages and disadvantages are to each type of stop order.

7. Glenda is in need of a car to get to school and back. Finally, the perfect car was advertised and she went to test-drive it. The car was perfect! Now she wishes to buy it. The seller insists that Glenda give him either a certified or a cashier’s check.

a. What is the difference between these checks, and how would she go about getting each one of these?

b. How would you advise Glenda to draw the check? In other words, who would you advise her to name as the payee on the instrument? Why?

c. Now Glenda arrives on the big day to pick up her car, but the seller has sold it to someone else! Glenda has a check in her hand in the amount of $12,500 to pay for the car. Now what are her options with regard to the check?

8. Bobby lives in a very overcrowded dormitory and has a roommate who leaves the door unlocked. Bobby’s roommate has dozens of friends who also have access to the room. One day, Bobby returns to find that his checkbook is missing.

a. Bobby does not check any bank statements for six months. When he finally does check his statements, he realizes that someone has written and cashed a check for $1,000 on his account. In a lawsuit between Bobby and his bank, who would be liable for this money? What factors would the court consider in such a case?

b. Suppose that Bobby found his checkbook and made out a check to his girl- friend for $50. His girlfriend then altered the check so that it appeared to be for the amount of $5,000. In a lawsuit between Bobby and his bank, who would be liable for the money?

c. Assume that Bobby kept his checkbook locked in his desk drawer. Neverthe- less, someone stole a check out of it and cashed it at the bank. Bobby imme- diately noticed the withdrawal from his account and reported it to the bank, which refused to recredit his account. In a lawsuit by Bobby against his bank, who would win and why?

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