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Dishonored Checks On The Rise—How Your Banker Can Help
By: Don Mosher, CAE, CBF
Issue: 2009oct
If you’re not seeing more dishonored checks lately, you probably will—and getting your money isn’t as simple as it used to be. With the recession creating plenty of challenges for businesses, dishonored checks are on the rise. (Formerly called returned checks, the term is becoming obsolete because as we shift more and more to electronic banking, there are fewer and fewer paper checks to return.) While no one publishes statistics on dishonored checks on a national level, you can find plenty of supporting anecdotal evidence in your local newspaper—and maybe even in your own receivables.
The simple fact is that the U.S. has not seen such a drastic downturn in cash flow since the prime interest rate hit 22 percent in November 1982. Those of us in business back then remember that dishonored checks hit record highs shortly thereafter for many of the same reasons we’re experiencing today. So it makes good business sense to be ready when a dishonored check appears.
Here’s a simple rule of thumb: If it took a week or more for the dishonored check to show up, call your banker right away and ask to verify that the debtor’s bank did not exceed the Midnight Rule (see sidebar).
Most businesses know dishonored checks can be deposited a second time, a process that has been in place for years. Thanks to the Midnight Rule, banks are motivated to move quickly when a check can’t be settled.
And thanks to Check 21, the 2004 law designed to speed up fund transfers and reduce check processing costs, banking is rapidly becoming more and more electronic. Many businesses now use one of those nifty desktop-deposit devices to swipe a paper check and convert it into an electronic substitute (also known as a truncated check).
So if a check is dishonored, why bother your banker? You just swipe it again, right?
Wrong. Banks take great pains to avoid processing the same check twice, whether it’s due to a simple mistake or a deliberate attempt by fraudsters to double dip (i.e., depositing both the paper check and the electronic substitute).
Unfortunately, this well-intentioned procedure has created an unintended nightmare for some creditors. Forius has seen two recent cases where a company used the desktop-deposit device to resubmit a customer’s dishonored check. However, because of the complexities of electronic banking, the electronic resubmission could not be presented to the payer’s bank and had to be reversed.
It took 45 days for Company A’s bank to research and determine that the check got caught up somewhere in the Federal Reserve System and was never re-presented for payment. For Company B, the process took nearly 12 months.
There’s yet another chapter to Company A’s story: Due to staff turnover, it took several more months before Company A realized it needed to go back to the customer, who, by that time, had gone out of business. (Company B was more fortunate; its customer was still in operation and agreed to replace the dishonored check.)
So why call your banker? It can save precious time. Even with weekends and extra bank holidays, there are either four or five banking days in a week and most checks clear, or are dishonored, in just a couple of days. So if a dishonored check takes 7-10 days (or longer) to get to you, something may be wrong, and your banker is in the best position to help. Mention the Midnight Rule (it’ll get his or her attention) and be sure to follow his or her instructions to the letter for physically redepositing the check. You also may want to ask about having the check placed in the bank’s manual collections process.
One more tip: Be sure to ask your banker about any dishonored check that’s marked “Refer To Maker.” It’s a broad term banks use when they decide not to honor the check, even though there may be sufficient funds on deposit.
The bottom line is to take time now to review your check-handling process. Whether you do it yourself or use an outside service, make sure that everyone is on the same page so that you’re ready when that dishonored check appears.
Don’t Mess With Taxes
Your secretary of state is at least partially to blame for the increase in dishonored checks.
At Forius, we estimate that roughly 80 percent of small businesses—that’s 20 million—do not qualify for normal working-capital loans from banks. As a result, they’re forced to find other ways to finance their operations if they can’t lean on their vendors, including you.
Unfortunately, some firms believe it’s less risky to delay payment of their state obligations such as withholding, sales tax, workers compensation, unemployment and such. This is a big mistake. Recent news stories tell us that state revenues are down across the country and significantly so in nearly 40 states. So, to make up the shortfall, many states are taking a very fast track to register tax liens and judgments against businesses. Then, 45 days after recording the lien (the waiting period specified in the Internal Revenue Code), the state enforces the lien against the debtor’s checking account or other assets.
There’s more. Banks can protect themselves by offsetting their loans ahead of the government or by paying the government lien and then dishonoring all checks that can’t be covered thus adding to the anticipated increase in the rate of dishonored checks.
By the way, government entities have the right to “pierce the corporate veil” and make the principal of a business personally liable for a corporate debt. That’s why your customers seldom tell you if there’s a tax lien or judgment on their business. So you could find yourself with a dishonored check from even your best customers if they’ve given the secretary of state and/or the bank a reason to step in and get paid first.
What can you do? If you suspect one of your customers may be messing with taxes, look at an Experian credit report, which includes public record information such as tax liens.
And, if you actually do receive a dishonored check, follow the rule of thumb and call your banker right away.
Don Mosher, CAE, CBF, is retiring at year-end after more than 25 years as president of Forius™ Business Credit Resources, PPAI’s endorsed partner for business credit information.
The Midnight Rule Is Your Friend
The Midnight Rule is a fundamental piece of the U.S. banking system. It’s key to the settlement process, which is how banks agree on who owes what to whom. The rule comes from section 4-213 of the Uniform Commercial Code (UCC) first published in 1952 and revised over the years so that it now covers both paper and electronic checks.
In plain English, the Midnight Rule works like this: You accept a check from XYZ Corporation and deposit it in your bank on Tuesday. XYZ’s bank receives the check for processing on Wednesday. Therefore, XYZ’s bank has until midnight Thursday to clear the check and send the funds to your bank.
Why is the Midnight Rule your friend? Because if a check is dishonored after the midnight deadline, the depositor—that’s you—has the right to ask your bank to review the situation and determine whether the debtor’s bank should honor the check under the Midnight Rule. It may not change anything, but you won’t know until you ask.
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