Check 21 refers to The Check Clearing for the 21st Century Act which was enacted on October 28, 2003 and becomes effective on October 28, 2004. This act is designed to improve the efficiency of check clearing and the payment systems. The enables banks to truncate (remove the paper check from the payment process and create a “substitute check” or electronic image of the check, with or without the subsequent delivery of the original paper check back to the originating bank or account holder.) checks.

Substitute checks:

• Are paper reproductions of the original paper check that contain images of both the front and back of the check,
• Carry the MICR line of the original check,
• Conform to prescribed industry standards for document, and
• Are suitable for automated processing consistent with the original check.

The ability to replace the original paper check enables banks to process the checks electronically and to not rely on the transportation and handling of the paper checks via air or road carriers. A bank is not required to accept an electronic form of a check. Banks not accepting electronic forms of the original paper check can request a “substitute check” from other banks for them to process.

Businesses will be impacted by Check 21 in the following ways:

1. Recordkeeping and internal document controls for checks and verifications of payments will need to be improved to address the fact that the original paper check will no longer be available as proof of payment in your records. Most, if not all, checks will not be returned to the company (or consumer) or the company bank.
2. Checks will clear more rapidly. The checks you write to vendors and employees will be processed the same day they enter the recipient bank, so accounts payable and payroll accounts will see the outflow of cash much more quickly. The same cannot be said on the accounts receivable side of the business. While banks will be processing and clearing the checks more rapidly, the law does not reduce the holding period on funds credited to your accounts.
3. Bank fees may increase. Banks will be saving on processing fees due to electronic processing, but they are not required to pass those savings on to you. Also, service fees for providing substitute checks for your records have not been capped. If you request substitute checks to provided with your statements (more on this later), then you will need to be aware of the potential costs associated with those documents.
4. Neither you nor your bank will have the original check, nor access to it
5. Neither you nor your bank will have the ability to control when the original paper check is destroyed or if not destroyed where it is stored. Previous requirements for your bank to hold checks for 7 years for recordkeeping purposes, if checks weren’t returned directly in your bank statements, will not apply.
6. Not all electronically processed checks will be treated the same for the right to correct or re-credit the transaction. When substitute checks are provided to the business (or consumer), the business will have 10 business days to get funds recredited for transactions that were processed twice, processed at the wrong amount or otherwise had a payment error. When substitute checks are not provided, the business’ rights are ambiguous as to what options they have for payment errors.
7. To maximize your rights under the new legislation, businesses should request return of substitute checks with their bank statements.
8. Substitute checks will be legal equivalents for proof of payment.
9. Use of information gathered from electronic check images by the bank is not restricted. A bank will be able to build a database from check images to profile customer buying patterns and other consumer characteristics.

The points above are just some of the aspects of the new law that businesses (and consumers) need to be aware of. There are additional limits on payment error corrections and other concerns – like proving fraud, forgery or alternation related to the original check.

Businesses need to start evaluating the payment, recordkeeping and internal control processes. Some of the points you should look for:

1. What controls currently exist for issuing checks?
2. Are you using duplicate (or triplicate) checkbooks?
3. Who can sign checks?
4. What is the procedure for verifying the amount of the check to the invoice?
5. How will you monitor your account between bank statements?
6. If you don’t request substitute checks with your statements
   
   a. How will you provide proof of payment in a dispute?
   b. How will you monitor transactions for payment errors between statements?
   
7. What process will you use to minimize the risk of fraudulent transactions in your payment system? (Remember you have no control of the original paper check for detecting alteration or forgery.)
8. What will be your recordkeeping processes to support taxable transactions?
9. What will the bank account reconciliation process look like? [You may have a mix of electronic transactions, substitute check transactions, and original paper transactions.]
10. What will the impact be on your cash flow? Payments clearing more quickly, receipt of cash not increasing.

Some banks have already begun converting the original paper check to electronic transfers. Chase Bank has in the past few months been converting the paper check payments made by credit card holders to ACH (automated clearinghouse) transactions. The change is coming, so start making the changes to your business processes that will reduce your risk and help you manage your cash flow under the new law.