Bankers know that what is commonly called Check 21 is at the heart of our present payment system. The check images delivered pursuant to its terms have made check processing simpler and faster for more than a decade.

So it may come as a surprise that basic legal questions under the Expedited Funds Availability Act (the formal name for Check 21) continue to arise. What happens for example when two of the regulations intend to implement the Act require contrary conclusions.  Such as for example, the question of the meaning of the warranty under Regulation J that an electronic check image “must accurately represent all of the information on the front and back of the original check….” when another regulation, Regulation CC, suggests that is not always required.

The question raised by the Fumiko Bandit case is the meaning of the Regulation J warranty when a paper check is imaged in the manner required by Regulation CC so the image can be presented for collection. Under Regulation CC, it is clear that some information on a paper check is not required to survive the imaging process.  But Regulation J requires check images show “all of the information” on paper checks.

The case that turn on the answer to this question started simply enough. A Chicago lawyer received an email inquiry from a new client named “Fumiko Anderson.”  She was seeking legal representation in her divorce.  The lawyer was willing to provide assistance.  One of the commentators on the ensuing litigation suggested the lawyer may have been “naive.”

Shortly thereafter the lawyer received a check from the husband in the amount of $86,176.96. The check was drawn by First Aid Corporation on its account at First American Bank.  The lawyer promptly deposited the check in his trust account, and shortly thereafter he wired “some or all” of the funds to Japan.

Later, the lawyer received a similar check but this one was in the amount of $486,750.33 which he again endorsed and deposited into his trust account. He again promptly caused “some or all” of the funds to be wired to Japan.

Litigation ensued because both of the checks were fraudulent and not properly payable. Fumiko Anderson was in fact the person or persons known to law enforcement as the “Fumiko Bandit.”

First American brought the litigation to recover its loss on the larger check which arose because it was the payor bank. Under the Uniform Commercial Code that applies in every state, the payor bank makes the basic promise that, as the bank administering the checking account, it will only pay checks written by the owner of the checking account.

So the litigation was an opportunity for First American to marshal the best legal arguments it could to recover the proceeds of the check which First Aid Corporation had forced the bank to return to First Aid’s account at First American.

What makes the case notable from a commercial law perspective is one of the arguments that First American raised in its attempt to recover its funds. It claimed that there had been a breach of the Regulation J warranty by the banks that presented for payment an electronic image of the check.  The alleged warranty breach was that the check image did not contain all of the information on the front and back of the paper check.  Had the check image been complete, First American argued, it would have caught the forgery.

The defendant banks admitted that some information was omitted in the imaging process. Their claim was that the omitted information was not required by Regulation CC and that with respect to this aspect of the Check 21 imaging process, Regulation CC trumped Regulation J.

The District Court, and ultimately the Seventh Circuit Court of Appeals, agreed there had been no breach of warranty based on the requirements of Regulation CC regarding imaging.

The basis for First American’s claim was that the electronic image of the paper check did not accurately present all of the information that was contained on the original check as Regulation CC requires. This was so, First American argued, because the check did not show watermarks, micro-printing and other physical security features.  First American argued the image of the check was poorly prepared and that some of the preprinted information describing the security characteristics of the check stock should have survived imaging.  First American argued that its personnel were trained to watch for signs of counterfeiting such as irregularities in the physical characteristics of the stock on which the check is presented.  Had the image been proper, the bank argued, it would have caught the forgery of the drawer’s signature.

The courts faced with this argument found the language in Regulation CC to be dispositive. The regulation acknowledges that some information on a paper check may not survive the imaging process and are therefore not required.  This information includes “. . . characteristics of the check, such as watermarks, micro printing, or other physical security features that cannot survive the imaging process or decorative images . . .”  12 C.F.R. Part 299, Appendix E, XXX(A)(3), regarding the imaging requirements of section 12 C. F. R. section 229.51(a).

In this case First American as the payor bank bore the loss caused by the Fumiko Bandit notwithstanding First American’s creative legal argument pitting Regulation CC against Regulation J.  The Court’s opinion is here.