Printer Friendly

Negotiating funds transfer agreements.

Many states have begun to adopt Article 4A of the Uniform Commercial Code, which governs funds transfers. Lenders should be aware of the obligations and liabilities under the new article and be savvy enough to know which provisions to negotiate.

Mortgage lenders depend daily on the speed and efficiency of wire funds transfer systems. The recent wave of state adoptions of Article 4A of the Uniform Commercial Code (UCC), which governs funds transfers, has altered the respective rights and liabilities of mortgage lenders and the banks with which they deal.

Many of the banks that provide mortgage lenders with wire transfer services have begun requiring mortgage lenders to enter into new funds transfer agreements that aggressively shift liabilities away from the bank and toward the mortgage lender. Because of the technical nature of Article 4A and the eagerness of banks to reduce their exposure under it, mortgage lenders should have a working knowledge of the obligations, duties and liabilities under Article 4A and, in particular, the provisions of Article that banks will attempt to al funds-transfer agreements.

Laws affecting funds transfers

Mortgage lenders deliver loan settlement funds, as well as loan, commitment and other fees through wire transfers as part of the near-$2 trillion that are wire transferred almost every day. Despite the volume of wire transfers, there has never been a uniform body of law governing the rights and duties of those who use funds transfer systems. When disputes arose over unauthorized, fraudulent, erroneous or misdirected payment orders, courts struggled to apply common law concepts of tort and agency, or the principles of Article 3 and Article 4 of the UCC, usually with differing results. As a result, much uncertainty has surrounded the rights, obligations and liabilities of the parties who use funds transfer systems.

In an attempt to provide a uniform body of law to govern funds transfers, the National Conference of Commissioners on Uniform State Laws and the American Law Institute approved Article 4A to the UCC in 1989. Currently, 36 states and the District of Columbia have adopted Article 4A and it has been introduced in seven other states. The remaining states are expected to adopt it by the end of 1992.

Article 4A establishes the basic rights, obligations and duties of the participants in a funds transfer, except to the extent that Article 4A permits these rights, duties and obligations to be varied by agreement. Like many of the other articles of the UCC, Article 4A has technical provisions that can seem both confusing and difficult to apply to an actual transaction.

The scope of Article 4A

Article 4A applies to "funds transfers." A funds transfer is defined by Article 4A as a series of transactions, made for the purpose of making payment to the beneficiary of a payment order. A payment order, which is an instruction to pay a fixed or determinable sum of money to a beneficiary, can be transmitted by any means, including oral communication or even first-class mail. While Article 4A generally covers all funds transfers, the most common form of a finds transfer is the wire transfer.

However, Article 4A covers only certain types of wire transfers. Wire transfers are of two types: credit transfers, which are governed by Article 4A, and debit transfers, which are not. A credit transfer is one in which an instruction to pay a person is given by the person who is making the payment - that is, the person whose account is debited. In a debit transfer, the instruction to pay is made by the party to be paid. If any part of a wire transfer is a debit transfer, the entire transfer is treated as a debit transfer and is not subject to Article 4A. In addition, Article 4A does not apply to a wire transfer any part of which is governed by the federal Electronic Fund Transfer Act of 1978. This Act covers a variety of electronic-funds transfers involving consumers.

The players in a funds transfer

In order to understand how Article 4A operates, mortgage lenders must first become familiar with the labels Article 4A attaches to the participants in a wire transfer. Grasping the terminology is crucial, because the labels attached to each participant in a wire transfer can change depending on the role the participant plays.

In a typical wire transfer, an "originator" issues a payment order to the "originators bank," instructing the payment of a certain sum to a named beneficiary. The originator's bank, in turn, initiates a conforming payment order to the "beneficiary's bank" either directly or through one or more "intermediary banks.' Article 4A also uses the terms "sender," which is the entity giving a payment order (at any point in the wire transfer), and "receiving bank," which is the bank receiving a payment order. Within a single wire transfer, consisting of a series of transactions, the identity of the sender and receiving bank can change for each of these transactions.

For example, in the typical wire transfer, the originator is the sender of the payment order to the originator's bank. The originator's bank is considered the receiving bank with respect to the order issued by the originator. The originator's bank becomes the sender when it sends the conforming payment order to the beneficiary's bank, which would be the receiving bank as to the originator's bank's payment order. If the originator's bank sends the conforming payment order to an intermediary bank, the intermediary bank would be the receiving bank when receiving the payment order and would be the sender when sending the payment order to the beneficiary's bank. The labels attached to these participants are illustrated in Figure 1.

When rights and obligations are

triggered

The event that triggers the rights and obligations of the parties to a funds transfer is "acceptance." Until the receiving bank accepts the sender's payment order, the receiving bank has no duty or liability to the sender with respect to that payment order. Generally, acceptance of a payment order by a bank is voluntary. A bank has no duty to accept a payment order unless the bank agrees, in a funds-transfer agreement, to accept the sender's payment orders. If the bank enters into such a funds-transfer agreement, the bank is contractually obligated to accept payment orders in accordance with the terms of that agreement and can be held liable for breach of the contract if it fails to do so.

The manner in which acceptance occurs depends upon the role of the bank receiving the mortgage lender's payment order. If the bank receiving the payment order is the beneficiary's bank, the bank accepts the payment order when it (1) pays the beneficiary, (2) notifies the beneficiary of receipt of the payment order or credits the beneficiary's account or (3) receives payment of the amount of the payment order from the sender, whichever occurs first. Until one of these three events occur, the beneficiary's bank incurs no obligation to pay the beneficiary.

If the bank is acting in a role other than as the beneficiary's bank (i.e., as the originator's bank or an intermediary bank), the bank accepts the payment order when it "executes" the order. A payment order is "executed" by the receiving bank when it issues a conforming payment order intended to carry out the payment order received by the bank.

For example, when the originator's bank receives a payment order from a mortgage lender to pay $1 million to "X," the originator's bank accepts the payment order when it issues an order to X's bank to pay X $1 million, or when it issues an order to an intermediary bank to pay X's bank $1 million for the benefit of X. Again, until the originator's bank accepts the payment order of the mortgage lender by executing the order, the originator's bank incurs no obligation or liability to the mortgage lender with respect to that payment order. However, as mentioned, the originator's bank would incur liability to the mortgage lender if it has entered into a funds-transfer agreement with the mortgage lender under which the bank obligated itself to execute the mortgage lender's payment order.

An important feature of Article 4A, commonly known as the "money-back guaranty," is linked to the concept of acceptance. An originator is generally required to pay the originator's bank the amount of its payment order upon acceptance of the order by the originator's bank. The originator is relieved of this obligation, however, if the wire transfer is not completed by the beneficiary's bank's acceptance of a payment order instructing payment to the intended beneficiary. If the originator has already paid the originator's bank the amount of the payment order, the originator is entitled to a refund with interest. This money-back guaranty assures the originator that it will not lose money if something goes wrong in the wire transfer.

Negotiating: what happens when

things go wrong

Banks that provide mortgage lenders with wire transfer services typically require each mortgage lender to enter into a funds-transfer agreement that defines the terms and conditions under which the bank will execute wire transfers. To the extent permitted under Article 4A, the bank will usually endeavor to limit its liability for unauthorized payment orders, erroneous execution of payment orders and the like. Therefore, mortgage lenders should be aware of how the bank's proposed form of funds-transfer agreement will attempt to vary the terms of Article 4A in order to limit the bank's exposure when something goes wrong with a wire transfer.

Payment order security procedures

Under the general rules of agency, if a bank and mortgage lender have not agreed upon a security procedure by which the authenticity of payment orders issued by the mortgage lender are to be verified, the bank shoulders the risk of loss if it executes an unauthorized payment order. Article 4A provides an exception to this general rule. If the bank and the mortgage lender agree that the authenticity of payment orders issued by the mortgage lender to the bank will be verified in accordance with a designated security procedure, a payment order received by the bank is effective, whether or not authorized, if (1) the security procedure is commercially reasonable, and (2) the bank accepts the payment order in good faith and in compliance with the security procedure. "Good faith" means honesty in fact and the observance of reasonable commercial standards of fair dealing.

A security procedure under Article 4A is a procedure established by agreement of a customer and a receiving bank for the purpose of either (1) verifying that a payment order or a communication amending or cancelling a payment order is actually issued by the originator, or (2) detecting error in the transmission or the content of a payment order. Security procedures often require the use of codes, identifying words or numbers, callback procedures to designated individuals and similar devices. Article 4A cautions that the simple comparison of a signature on a payment order with an authorized specimen signature of the originator is not by itself a security procedure.

Whether or not a security procedure is commercially reasonable is a question of law determined by a judge, rather than a jury. Commercial reasonableness of a security procedure is determined by considering such things as the wishes of the originator expressed to the bank; the circumstances of the originator, such as the size, type and frequency of payment orders normally issued by the originator; alternative security procedures offered to the originator and security procedures in general use by originators and receiving banks similarly situated. Under Article 4A, a security procedure is automatically deemed to be commercially reasonable if (1) the security procedure was chosen by the originator after the bank offered, and the originator refused, a security procedure that was commercially reasonable for that originator, and (2) the originator expressly agreed in writing to be bound by any payment order, whether or not authorized, issued in its name and accepted by the bank in compliance with the security procedure chosen by the originator.

Banks seize on this Article 4A provision by which a security procedure is automatically deemed commercially reasonable when they offer in the funds-transfer agreement two or more security procedures that range from the most secure to the least secure. The most secure system often involves the use of codes, sophisticated call-back procedures, and other careful payment-order verification procedures. The less-secure procedures are comparatively loose and result in greater risk that an unauthorized payment order will be accepted by the bank. Not surprisingly, the least secure of the security procedures typically costs the originator less than the more sophisticated one.

Assuming that the more sophisticated and expensive security procedure is commercially reasonable for the mortgage lender, and the mortgage lender chooses the less-secure procedure, the less-secure security procedure is automatically deemed commercially reasonable if the mortgage lender expressly agrees in the funds-transfer agreement to be bound by any payment order, whether or not authorized, issued in the mortgage lender's name and accepted by the bank in compliance with that security procedure. This means that if litigation ensues over an unauthorized payment order, the mortgage lender is foreclosed from arguing that the procedure it chose was not commercially reasonable. Accordingly, mortgage lenders should carefully consider which security procedure is appropriate for them and should think twice before rejecting a security procedure offered by the bank. It may be advantageous for the mortgage lender to elect the most secure security procedure because it may offer the best protection to the mortgage lender, and the mortgage lender will not have conceded that the security procedure is commercially reasonable in the event of litigation. An alternative security procedure offered by the bank should be accepted only if the mortgage lender determines that the security procedure will offer adequate protection and that it can be incorporated into the mortgage lender's internal wire transfer procedures.

If a bank accepts a payment order in good faith and in compliance with a commercially reasonable security procedure, that payment order is effective against the mortgage lender even if it was unauthorized. Article 4A, however, provides two circumstances under which the mortgage lender will not be held liable for such unauthorized payment orders. The first is in the unlikely event that the bank in its funds-transfer agreement agrees to bear the risk of loss for such unauthorized payment orders. The second circumstance arises if the mortgage lender proves that the unauthorized payment order was not caused by a security breach; that is, the person who sent the unauthorized payment order did not obtain confidential information necessary to send a payment order that satisfied the security procedure from an agent or former agent of the mortgage lender or from a source controlled by the mortgage lender. If this is proven, the loss resulting from the unauthorized payment order is shifted to the bank.

Article 4A specifically prohibits this last provision from being varied by agreement. Therefore, a proposed funds-transfer agreement should never contain a clause by which the mortgage lender is held liable for an unauthorized payment order caused by a person outside the mortgage lender's control.

Misdescription of beneficiary,

intermediary bank or the beneficiary's

bank

Usually, a mortgage lender will bear the loss for issuing erroneous payment orders, such as ones instructing payment to an unintended beneficiary, instructing payment of an amount greater than intended or duplicating a payment order previously sent. This is because Article 4A shifts this loss to the bank only if the bank and the mortgage lender agree upon a security procedure to detect errors in payment orders. Because of this liability, banks seldom agree upon such a security procedure and agree only to a security procedure for verifying the authenticity of payment orders.

Questions, however, often arise as to who is required to pay a payment order that incorrectly describes the beneficiary. Frequently, payment orders describe beneficiaries by both a name and a bank account number. Sometimes, the name and number identify different persons. Article 4A provides banks an opportunity to avoid liability if the wrong beneficiary is paid. Absent agreement between the bank and the mortgage lender to the contrary, the Article 4A rules discussed below apply.

If the beneficiary's bank does not know that the name and the number in the payment order refer to different persons, the bank may rely on the number as the proper identification of the beneficiary. The beneficiary's bank does not have to determine whether the name and the number refer to the same person. However, if the beneficiary's bank pays the person identified by name or knows that the name and number identify different persons, the mortgage lender is not required to pay the payment order unless the person paid by the beneficiary's bank was the intended beneficiary.

If the beneficiary's bank pays the person identified by number (as opposed to the person identified by name), the mortgage lender is not obligated to pay the order if it proves that the person identified by number was not entitled to receive payment. If the mortgage lender has already paid the order, the bank must refund to the mortgage lender the amount of the payment order, with interest, under Article 4A's money-back guaranty. The bank, in turn, has a right to recover the amount of the payment order from the unintended beneficiary to the extent allowed by the law governing mistake and restitution.

The mortgage lender's bank, however, can avoid the obligation to pay the payment order if it proves to the court that the mortgage lender had notice that the beneficiary's bank might pay the payment order on the basis of an identifying or bank account number even if it identifies a person different from the named beneficiary. The bank satisfies this burden of proof if it shows that the mortgage lender, before the payment order was accepted by the mortgage lender's bank, signed an agreement that sets forth the notice. A proposed funds-transfer agreement will usually contain this notice. In negotiating a funds-transfer agreement, attempts should be made to have the notice removed. However, banks generally will insist on its inclusion. Therefore, care should be taken to ensure that payment orders correctly identify the beneficiary. If both name and identifying number are used, the mortgage lender should be certain that they consistently identify the intended beneficiary.

Similar rules apply to payment orders that inconsistently identify an intermediary bank or the beneficiary's bank by name and an identifying number. If the receiving bank proves that the mortgage lender, before the payment order was accepted, had notice that the receiving bank might rely on the number as the proper identification of the intermediary or beneficiary's bank, even if it identifies different entities, the bank may rely on the number as the proper identification if it does not know that the name and number identify different entities. The receiving bank need not determine whether the name and number refer to the same entity or whether, indeed, the number refers to a bank. To take advantage of this protection, funds-transfer agreements proposed by banks will often contain this notice as well. As in the case of the notice regarding a beneficiary bank's reliance upon numbers to identify a beneficiary, banks will usually insist on inclusion of this notice regarding the identification of intermediary and beneficiary banks.

Cancellation and amendment of

payment order

Senders of payment orders are generally permitted to cancel or amend their payment orders. A mortgage lender may wish to stop or change a payment order if it changes a decision previously made about the transaction or if the lender discovers that a payment order is erroneous. Under Article 4A, a cancellation or amendment of a payment order generally is effective if the receiving bank has a reasonable opportunity to act on the cancellation or amendment order before the receiving bank accepts the payment order. In other words, unless the funds-transfer agreement provides otherwise, the bank must cancel or amend the payment order if asked to do so before it has sent a conforming payment order to an intermediary bank or the beneficiary's bank. The communication that cancels or amends a payment order, whether oral, electronic or written, is not effective unless the communication is verified through the security procedure established by the funds-transfer agreement.

If the payment order has been accepted and the mortgage lender wishes to cancel or amend it, the cancellation or amendment is not effective unless the receiving bank agrees to it. If the bank agrees to such a cancellation or amendment after acceptance, the mortgage lender is liable to the bank for any resultant loss and expenses, including reasonable attorney's fees, incurred by the bank.

Mortgage lenders should be sure that the funds-transfer agreement obligates the bank to cancel or amend a payment order if requested by the mortgage lender before the bank accepts the payment order. Banks will sometimes attempt to limit their obligation to cancel or amend payment orders before they are accepted by leaving cancellation or amendment to the bank's sole or reasonable discretion. Because a bank usually incurs no liability if it cancels or amends an order before it is accepted, the funds-transfer agreement should not eliminate or limit the bank's obligation to cancel or amend under these particular circumstances.

Erroneous execution of payment order

In addition to establishing rights and obligations in the event that payment orders are incorrect, Article 4A sets out rights and obligations in the event that the bank that receives a payment order incorrectly executes it. just as banks will attempt to limit their liability for accepting unauthorized or incorrect payment orders, they will also seek to restrict their obligation to pay a payment order that they improperly execute.

A bank will sometimes mistakenly execute a mortgage lender's payment order by sending a payment order in an amount greater than the amount of the mortgage lender's order; issuing a payment order in execution of the mortgage lender's order and then issuing a duplicate order or; issuing a payment order in an amount less than the amount of the mortgage lender's order.

If the bank issues a payment order in a greater amount or issues a duplicate order, the bank is only entitled to payment of the correct order if the beneficiary of the order is actually paid. The bank is then entitled to recover from the beneficiary the excess to the extent allowed by the law governing mistake and restitution.

If the bank executes a payment order in an amount less than the mortgage lender's order, the bank is entitled to payment of the proper amount of the mortgage lender's order only if the beneficiary is paid and the bank corrects its mistake by issuing an additional payment order that makes up the difference. If the error is not corrected, the bank is entitled to receive payment from the mortgage lender only of the lesser amount of the order that was actually paid to the beneficiary.

If the bank executes the payment order and orders payment to an entity other than the intended beneficiary and that person is paid, the mortgage lender is not obligated to pay the payment order, and if it has paid the bank, it is entitled to a refund of the amount of the order, with interest, under Article 4A's money-back guaranty. The bank, in turn, is entitled to recover from the unintended beneficiary the payment received to the extent allowed by the law governing mistake and restitution.

The mortgage lender, however, must be diligent in this area. Under Article 4A, the mortgage lender must review wire transfer confirmations or statements issued by its bank and notify the bank of an erroneous execution of a payment order within a reasonable period of time not exceeding 90-days after the mortgage lender receives the confirmation or statement. If the mortgage lender fails to notify the bank within this time period, the bank does not have to pay interest on the amount it refunds under the Article 4A moneyback guaranty. Banks usually try to shorten this 90-day period in their proposed form of funds-transfer agreement. The mortgage lender should attempt to keep as much of the 90-day period as possible.

A bank may also attempt to limit or eliminate its obligations to make good for erroneous execution of payment orders as discussed. As these obligations of the bank are critical to mortgage lenders, mortgage lenders should make certain that none of these provisions of Article 4A are altered by a funds-transfer agreement.

Late or improper execution and failure

to execute payment order

Article 4A establishes a "floor level" of liability for a bank that improperly executes a payment order or fails to execute a payment order. If an improper action of the bank results in non-completion of the funds transfer, failure to use the intermediary bank designated by the mortgage lender or issuance of a payment order that does not comply with the terms of the original payment order, the bank is liable to the mortgage lender for the mortgage lender's expenses and for incidental expenses and interest lost resulting from the improper execution. The bank is not liable for any additional damages, including consequential damages, unless the bank agrees in the funds-transfer agreement to pay such damages.

Moreover, if the bank obligates itself in its funds-transfer agreement to execute the mortgage lender's payment orders and fails to execute a payment order, the bank is liable for the mortgage lender's expenses in the transaction and for incidental expenses and interest lost resulting from the failure to execute. Again, the bank is not liable for any other damages, including consequential damages, unless the bank agrees in the funds-transfer agreement to pay these damages.

Because of a bank's liability if it fails to execute a payment order it is obligated to execute, mortgage lenders should try to negotiate funds-transfer agreements that obligate the bank to accept payment orders with as few restrictions as possible. In this regard, particular attention should be paid to the cut-off time established by the proposed finds-transfer agreement after which the bank is not obligated to accept a payment order. Mortgage lenders should attempt to set cut-off times as late in the day as possible. This will allow more time during a given day to send payment orders to the bank. In addition, it is in the mortgage lender's best interest to have the bank assume liability for consequential damages in the event of an improper execution or failure to execute a payment order.

Not surprisingly, mortgage lenders will meet considerable resistance from banks with respect to paying consequential damages because of the potential size of these damages. With this in mind, mortgage lenders should choose their bank carefully, especially if improper execution of a wire transfer or failure to execute a wire transfer can result in large losses for the mortgage lender.

Article 4A provides a measured system of allotting rights and liabilities for wire transfers. This magazine article has illustrated a few of the more important of these issues. Because certain provisions of Article 4A can be altered by agreement, mortgage lenders who are entering funds-transfer agreements with banks should be aware of the issues that can be negotiated. A savvy negotiator can cut-off or reduce the impact of a bank's attempt to shift the risk of loss when something goes wrong in a wire transfer-and maybe even convince the bank to shoulder a bigger share of the liability that may arise out of erroneous or improperly executed wire transfers.

Arthur B. Axelson is a director and David J. McPherson is an associate with the Washington, D. C. law firm of Melrod, Redman and Gartlan where they specialize in transactional and regulatory mortgage banking matters.
COPYRIGHT 1992 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Title Annotation:use of Article 4A of the Uniform Commercial Code
Author:Axelson, Arthur B.; McPherson, David J.
Publication:Mortgage Banking
Date:Jun 1, 1992
Words:4615
Previous Article:CRA getting good grades.
Next Article:Selecting superior sales staff.
Topics:


Related Articles
What you should know about wire-transfer liabilities.
An antidote to federal mandates.
Getting online to pay.
Where do I e-sign?
Midland awarded outsourcing assignment with Prima Capital. (Commercial).
Inderscience to launch "Int'l J. of Information Policy & Law".
The ABCs of the UCC; article 4A: Funds transfers, 2d ed.

Terms of use | Copyright © 2016 Farlex, Inc. | Feedback | For webmasters