In auditing check holds over the years, I have often found violations of of Regulation CC. These violations result from a number of things, such as incorrectly calculating the amount of a hold or incorrectly choosing the wrong date to make funds available. Often times, there isn’t a pattern or practices as to why these violations occur - other than a lack of training - though I have noticed a trend of violations relating to one specific special exception hold reason: The reasonable cause to doubt collectibility.
An Overview of the Reasonable Cause to Doubt Collectibility Hold Reason
“Reasonable cause to doubt collectibility” is one of six special “exception” reasons permitted under 229.13 of Regulation CC. Unlike some of the other reasons which are more straightforward, the “reasonable cause” hold reason is a bit more complex than the others and often results in violations. The reasons for this, of course, is that the “reasonable cause” hold reason must be accompanied with an actual reason as to why a financial institutions believes a check will not be paid. While this may seem straightforward upon first thought, it is actually a bit more complicated that it should be.
Part of the reason for the confusion behind this reason is that Regulation CC is somewhat ambiguous in the rule:
“(1) In general. Sections 229.10(c) and 229.12 do not apply to a check deposited in an account at a depositary bank if the depositary bank has reasonable cause to believe that the check is uncollectible from the paying bank. Reasonable cause to believe a check is uncollectible requires the existence of facts that would cause a well-grounded belief in the mind of a reasonable person. Such belief shall not be based on the fact that the check is of a particular class or is deposited by a particular class of persons. The reason for the bank's belief that the check is uncollectible shall be included in the notice required under paragraph (g) of this section.”
As you can see, the rule says that the “reasonable cause” hold can be invoked if there are “facts that would cause a well-grounded belief in the mind of a reasonable person.” As we all know from our relationships with family and friends, this statement about a “well-grounded belief in the mind of a reasonable person” is extremely subjective. The problem with this subjectivity, however, is that this is the test that would be used in a court proceeding. Due to this gray line in the guidance, it is important for financial institutions to err on the side of caution and take a conservative approach to this rule.
Reasonable Cause Examples of Insufficient Reasons
Before we discuss some examples of acceptable “reasonable cause” special exception hold reasons, I think it is important to rule out a couple of reasons that I have seen repeatedly result in violations at financial institutions.
First, I have seen a number of violations result when a financial institution uses an “other” reason of “unable to verify funds.” In these cases, my conversations with tellers and managers have revealed that the “reasonable cause” hold reason was invoked because the teller was unable to verify funds from the paying bank. In today’s age of privacy, very few banks will verify funds anymore, though is was a common practice a few decades ago. As most banks will no longer verify funds, it would not be considered a “well-grounded belief in the mind of a reasonable person” to place a hold on a check just because a bank was unable to verify funds in an account at a third party. In my mind, using a reason of “unable to verify funds” will result in a violation every time.
In fact, this is backed up by the following commentary from Regulation CC:
“ For example, a depositary bank cannot invoke this exception simply because the check is drawn on a paying bank in a rural area and the depositary bank knows it will not have the opportunity to learn of nonpayment of that check before funds must be made available under the availability schedules.”
Secondly, I have seen a number of violations result from a “reasonable cause” “other” reason of “credit card check.” When questioned about this, tellers and managers have advised that, due to large numbers of returned credit card checks (which are counter-type checks that can be used by a person to access their line of credit on a credit card), they feel they have a reasonable cause to doubt the collectability of those types of checks, Unfortunately, Regulation CC is pretty clear that a “reasonable cause” hold cannot be placed on a check due to it being a certain “class of check.” In other words, you can’t discriminate against a type of check.
This is explained in the commentary as follows:
“Reasonable cause to believe a check is uncollectible requires the existence of facts that would cause a well-grounded belief in the mind of a reasonable person. Such belief shall not be based on the fact that the check is of a particular class or is deposited by a particular class of persons.”
Finally, and similarly to discriminating based on a class of check, Regulation CC prohibits a financial institution from placing a hold on a check due to the race or national origin of the depositor. This is explained in the commentary as follows:
“Similarly, a depositary bank cannot invoke the reasonable cause exception based on the race or national origin of the depositor.”
Special Exception Hold Reasonable Cause Examples
As we have been discussing what can’t be used for a reasonable cause exception hold, you may be wondering what can be used. While the actual text of the regulation doesn’t provide any specific reasons of acceptable situations where the exception could be used, Model Form C-13 provides the following examples of reasons that could be used for “reasonable cause” as follows:
--We received notice that the check is being returned unpaid.
--We have confidential information that indicates that the check may not be paid.
--The check is drawn on an account with repeated overdrafts.
--We are unable to verify the endorsement of a joint payee.
--Some information on the check is not consistent with other information on the check.
--There are erasures or other apparent alterations on the check.
--The routing number of the paying bank is not a current routing number.
--The check is postdated or has a stale date.
--Information from the paying bank indicates that the check may not be paid.
--We have been notified that the check has been lost or damaged in collection.
--Other:----------------------------------------------------------------------
In addition to these scenarios, the commentary explains another acceptable reason of “confidential information that indicates that the check might not be paid,” which could be used in the event of kiting activity or if you had a reasonable belief as to the insolvency or pending insolvency of the drawer of the check or drawee bank:
d. There are reasons that may cause a bank to believe that a check is uncollectible that are based on confidential information. For example, a bank could conclude that a check being deposited is uncollectible based on its reasonable belief that the depositor is engaging in kiting activity. Reasonable belief as to the insolvency or pending insolvency of the drawer of the check or the drawee bank and that the checks will not be paid also may justify invoking this exception. In these cases, the bank may indicate, as the reason it is invoking the exception, that the bank has confidential information that indicates that the check might not be paid.
Beyond these reasons, the commentary does explain that the scenarios they provided were not meant to be an all inclusive list.
3. The Board has included a reasonable cause exception notice as a model notice in appendix C (C-13). The model notice includes several reasons for which this exception may be invoked. The Board does not intend to provide a comprehensive list of reasons for which this exception may be invoked; another reason that does not appear on the model notice may be used as the basis for extending a hold, if the reason satisfies the conditions for invoking this exception. A depositary bank may invoke the reasonable cause exception based on a combination of factors that give rise to a reasonable cause to doubt the collectibility of a check. In these cases, the bank should disclose the primary reasons for which the exception was invoked in accordance with paragraph (g) of this section.
In other words, other reasons could be used for “reasonable cause” if they are based on “a well-grounded belief in the mind of a reasonable person.” For example, I once saw a bank that had something like “customer insists that the check will be returned,” which, based on the supporting documentation accompanying the hold, appeared to be appropriate.
Final Thoughts for Using the Reasonable Cause Special Exception Hold
While the regulation, commentary, and model forms permit a number of reasons to be used for the reasonable cause to doubt collectibility special exception, my experience has proven that “other” reasons beyond those listed in the model form and commentary often result in violations. In other words, the “other” reason option for a “reasonable cause” hold is typically abused MUCH more than it is used correctly.
Due to the fact that violations typically out pace correct reasons (probably about 20:1 in my opinion) when using the “other” option, I believe the best practice is one of two things. First, some financial institutions have removed the “other” reason all together so it isn’t an option at all. Secondly, I have seen other financial institutions train to never use the other reason and then reserve it only with the approval of the compliance officer or capable ops manager.
The bottom line is that the “other” reason is a common area for violations so limiting its use can reduce the risk of violations in this area.
