(Reprinted from The Tax-Exempt Organization Alert!®)

The Check Clearing for the 21st Century Act (aka “Check 21”), which took effect October 28, is designed to increase the efficiency of the check processing system utilized in the U.S. The law was enacted in response to the banking delays experienced after the September 11, 2001 terrorist attacks.

Check 21 permits, but does not require, any institution involved in the check processing chain to “truncate” a check and convert it to an image. The term “truncate” refers to the removal of the original check. Once an image of a check is created, either this image or a “substitute check” will be transmitted to the next institution in the check processing chain, depending on the policies adopted by the next institution (each party in the chain is permitted, but not required, to accept an image in place of a substitute check). The payor bank, therefore, may receive the original check back, a copy of an image, or a substitute check.

A “substitute check” is a paper reproduction of the original check that contains an image of the front and back of the original check. It will also indicate the routing number of the truncating bank, as well as the number of the bank that created the substitute check.

If a substitute check is created that conforms to the requirements specified in the law, it is considered to be the legal equivalent of the original check for all purposes under state and federal law. Accordingly, it will be acceptable in legal proceedings and cases arising out of investigations into fraud, embezzlement, and other matters.

Any bank in the chain may truncate a check. The truncating bank keeps the original check, but may destroy it after a period of time. The time period that an original check is kept is not specified in the law. Rather, it will be established through agreements and clearinghouse rules.

If a customer or any party in the chain requires a paper document, it will be a substitute check reconverted from the electronic image created by the truncating bank. The greatest benefits of Check 21 come from the quality and timeliness of electronic images. These digital images can be transmitted much more quickly than paper documents (original checks or substitute checks). As a result, many fraudulent checks and check tampering schemes may be prevented or detected much sooner when banks utilize electronic images rather than original or substitute checks.

The benefits of Check 21 are minimal when substitute checks are involved. This could be especially true if an investigation is involved. When original checks are available, investigators can perform ink analysis on the check. This will not be possible with substitute checks. Certain aspects of handwriting analysis may also become more difficult or impossible with substitute checks.

In addition, some security features included on original checks may be lost in the imaging and conversion to substitute check processes. For instance, paper-based watermarks may not survive the imaging process. Certain other security features may continue to work effectively.