ACH Developments 2010

1. ACH Developments 2010 Bridgette Roman General Counsel, Vice President & Assistant Secretary CheckSmart Financial Company 7001 Post Road, Dublin, Ohio 43016 broman@Checksmart.com Stephen Solomon Solomon Law Firm Dallas, Texas Telephone: 972-713-9753 StephenSolomonAttorney@yahoo.com Justin B. Hosie Chambliss, Bahner & Stophel, P.C. 1000 Tallan Building Two Union Sq. Chattanooga, Tennessee 37402 (423) 756-3000 www.cbslawfirm.com jhosie@cbslawfirm.com http://twitter.com/consumerfinance Ronald D. Gorsline Chambliss, Bahner & Stophel, P.C. 1000 Tallan Building Two Union Sq. Chattanooga, Tennessee 37402 (423) 756-3000 www.cbslawfirm.com rgorsline@cbslawfirm.com

2. Overview • AmeriCash • NACHA Rules • Bankruptcy Cases • 362(b)(11) and In re Roete • In re Meadows • In re Kearns • In re Brewer • In re Snowden • Others • State Payday Laws, Regulations, and ACH Issues • Questions

3. AmeriCash - Facts • Optional PEFT. Among 3 installment loan repayment options, Plaintiff chose to pay by “voluntary payroll deduction,” not the Check/ACH option. • Backup ACH. Agreement nevertheless included a “backup ACH” clause for various default/acceleration issues. The clause disclosed revocation and stop payment rights related to the ACH. • Bank Information. Plaintiff signed the form, but failed to specify the name of her bank, or provide her checking account number, in the spaces provided. But, AmeriCash had that information on file from prior transactions.

4. AmeriCashIssue and Arguments by Plaintiff • Issue: Whether the EFT authorization form can meet the statutory requirements of “collateral” or “security interest.” • Plaintiff: EFT authorization is “the functional equivalent of a check, which gave AmeriCash rights and remedies under the Illinois bad check statute and, thus provided AmeriCash with a security interest that had to be disclosed pursuant to the TILA.”

5. AmeriCash - Arguments • Merely a Method of Payment. “EFT is simply a method of payment, like a voluntary payroll deduction, which does not need to be disclosed.” • Bad Check Law Does NOT Cover EFTs. UCC includes the Illinois bad check statute, and does not apply to electronic fund transfers. • Not Personal Property. EFT is not “personal property,” so it can’t be a “security interest” under UCC. • No EFTA Remedy for Canceling ACH. EFTA does not provide a remedy for canceling or rejecting an electronic funds transfer. • Akin to Voluntary Payroll Deduction. Precedent in Cobb case indicates voluntary payroll deductions should not be disclosed as security, as they are “mere devices for consumers to make regular payments.”

6. AmeriCashConcepts Court Examined • TILA. Requires creditors to disclose any security interest taken and to describe the property in which the interest is taken. • Regulation Z. Defines as “an interest in property that secures performance of a consumer credit obligation and that is recognized by State or Federal law.” • Illinois Law. Defines a “security interest” as “an interest in personal property *** which secures payment or performance of an obligation.” • Bad Check Remedy. A post-dated check with a high-interest consumer loan was a security interest because the check confers rights and remedies for bad checks, in addition to those under the loan agreement.

7. AmeriCash - Holding • Holding. Based the following facts, the Court held that “Plaintiff sufficiently stated a claim that AmeriCash took a security interest in her checking account.” • Termination Hurdle. Plaintiff could not terminate the agreement without written notice to AmeriCash in sufficient time for it to act on its rights. • Used as a Backup. Authorization allows AmeriCash to debit plaintiff’s checking account if she reneged on her promise to repay the loan through the wage allotment option. • Bad Check Collection Process. Any debit to the account returned unpaid could be collected in the same manner as an unpaid paper check.

8. NACHA Rules Update • Two key changes announced in June. • Rules Simplification and Mobile ACH Payments • Become effective on January 1, 2011

9. NACHA Rules Simplification • Regroup Materials by Participant Type. Goal to provide a more user-friendly set of rules and guidelines for ACH Network participants through (1) the re-organization and re-grouping of material by each type of participant in the ACH Network. • Clearer Language. Use of clearer and more consistent language to facilitate user understanding and compliance with the Rules.

10. NACHA Rules Simplification • Stated Intention. Intended to make Rules information easier to find and easier to understand without altering the substantive meaning of the underlying Rules. • BUT – Increased Emphasis on Oversight. Simplified Rules also explicitly recognize that: • ODFIs are the entry points into the ACH Network for corporate users and third parties and • Financial institutions are responsible for those parties’ compliance with the Rules.

11. NACHAMobile ACH Payments Rule • Mobile ACH Entries as the Goal. Goal to establish a framework in the NACHA Operating Rules for initiating consumer debit entries via a mobile device.

12. NACHA – MAPR! Rule • WEB Definition Expanded. The Mobile ACH Payments Rule expands the definition of Internet-Initiated Entries (WEB) to include consumer ACH debits authorized and/or initiated via Wireless Networks • Must Use WEB Code. Requires use of the WEB Standard Entry Class (SEC) Code.

13. NACHA WEB Includes Wireless Networks • Revised “WEB” Entry Definition. • a debit Entry initiated by an Originator to a Consumer Account of the Receiver based on: • (1) an authorization that is communicated, other than by an oral communication, from the Receiver to the Originator via the Internet or a Wireless Network, or • (2) any form of authorization if the Receiver’s instruction for the initiation of the individual debit Entry is designed by the Originator to be communicated, other than by an oral communication, to the Originator via a Wireless Network. • Amendment adds “Wireless Network” as a defined term within the NACHA Operating Rules, establishing, for ACH purposes, the concept of an Unsecured Electronic Network for the communication of data using wireless technology.

14. NACHAUnsecured Electronic Networks • Also revised definition of “Unsecured Electronic Network” to include Wireless Networks within its scope and to provide additional clarification on such networks • Defines an “Unsecured Electronic Network” as a network, public or private, that (1) is not located entirely within a single, contiguous, physicalfacility, and (2) either (a) transmits data via circuits that are not dedicated to communication between two end-points for the duration of the communication, or (b) transmits data via wireless technology (excluding a communication that begins and ends with a wireline connection, but that is routed by a telecommunication provider for a portion of the connection over a wireless system). • Deems the Internet as an Unsecured Electronic Network, even though secure transmissions may be made over that otherwise unsecure network. • Revises the requirements for the transmission of ACH information via Unsecured Electronic Networks to clarify that voice or keypad inputs over a wireless telephone to a live operator or VRU will not be subject to the requirement to secure the connection with a minimum of 128-bit RC4 encryption.

15. Bankruptcy Code 362(b)(11) • General Rule. 11 U.S.C. § 362(a)(6) Except as provided in subsection (b), a bankruptcy petition operates as a stay of … any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title.... • Exception. 11 U.S.C. § 362(b)(11). Filing a bankruptcy petition does not operate as a stay … of the presentment of a negotiable instrument and the giving of notice of and protesting dishonor of such an instrument.

16. In re Roete • Creditor received a check pre-petition, and then presented it post-petition. • According to the Court: • The exception “permits holders of checks drawn by the debtor to deposit them for the purpose of preserving their rights on the instruments despite the filing of a bankruptcy petition." • The key issue in such cases should simply be whether the Creditor "presented" a "negotiable instrument." • Under the UCC • “the mere demand for payment constitutes presentment.” • “a negotiable instrument is a writing, signed by a maker or drawer, containing an unconditional promise to pay a sum certain, payable on demand or at a definite time, and payable to order or bearer.” • Thus, “the automatic stay was not violated by the Creditor' presentment of a negotiable instrument.” The creditors' actions clearly fall within the plain meaning of section 362(b)(11).”

17. In re Meadows • Facts. Plaintiff asserted payday lender violated the automatic stay when, it did not unconditionally return funds received from its post-petition presentment of debtor’s prepetition, postdated check. Bankruptcy Court held that lender willfully violated the stay and ordered it to return the funds and to pay debtor’s reasonable attorneys fees. Lender appealed. • Holding. Bankruptcy Appellate Panel (BAP), held: • when debtor’s prepetition check was honored post-petition, the estate’s property interest in the bank funds was transferred to lender and the funds ceased to be property of the estate; • lender’s retention of the funds did not violate the automatic stay; and • the unauthorized transfer to lender was subject to avoidance under the section of the Bankruptcy Code governing post-petition transactions. • One Notable Quote From the Court: The purpose of § 362(b)(11) is to encourage the free flow of commerce by permitting parties to present and honor negotiable instruments without having to worry about a potential violation of the automatic stay. This purpose is thwarted if the party honoring the check is required to distinguish between checks written concurrently with payment of goods and services and checks post-dated in repayment of loans.

18. In re Kearns • The FastBucks Idaho district was lending about $10,000 per month that was immediately being discharged in chapter 7 bankruptcy cases. A pattern was evident. • In all probability, several Idaho debtor’s attorneys were instructing clients to go to FastBucks to fund the attorneys’ legal fees. This was done, in spite of exposing themselves to potential state bar proceedings for ethics violations. • A Bankruptcy Adversary Proceeding may be filed to have the debt owed the lender excepted from discharge under 11 USC §523(a). These proceedings are expensive, but also serve as a financial institution’s strong warning to the bankruptcy debtor’s bar to stop the practice of taking advantage of the financial institution. • In the 1990’s I was lead counsel on The Bank of New York’s 24 filings of §523(a) Adversary Proceedings wherein debtors had taken large cash advances on their credit cards and almost immediately filed chapter 7 bankruptcy. Prevailing on all of them, I was successful in bringing the bank’s Visa and MasterCard losses down dramatically.

19. Advice Based on Kearns • In the past, where a pattern has been discovered, I have contacted bankruptcy debtor’s attorneys around the country and stated that management is instructing me to file a grievance with their state bar for their probable ethics violations in instructing their clients x, y, and z to go to FastBucks and obtain a loan to pay the attorney’s fees. • Usually, FastBucks’ losses would stop shortly thereafter. But, Idaho lawyers were resistant and defiant to stop their practices and a test case was sought to be published in the Bankruptcy Reporter to make an example of unethical bankruptcy debtor’s attorneys. • A loud warning to the Idaho Bankruptcy bar was required. But, I thought we could save legal fees by engineering a test case outside of an Adversary Proceeding.

20. Engineering a Test Case – Take Cautious and Purposeful Steps: • Hire local counsel! • Only if the debtor is in Chapter 7 and has not yet received a discharge, go to the debtor’s bank on or after the date the debt is due and present the debtor’s original check. Obtain cash or exchange the check for a cashier’s check. • It is best to make sure the debtor has received a paycheck post-petition. Post-petition earnings are not property of the bankruptcy estate in a chapter 7 and are not protected by the automatic stay of 11 USC §362(a). Indeed, FastBucks was permitted to retain the $968 in the Kearns bankruptcy. An added bonus but not the purpose of a test case. • Caveat: These results are not obtainable in a chapter 13 case as post-petition earnings are property of the estate and check proceeds will likely be paid over to the chapter 13 trustee or even back to the debtor. • Do not contact the debtor. It is best to simply negotiate the check.

21. Further Advice fromKearns Cont’d • Cash the actual signed original check of debtor. • Do not create demand drafts or paper debits. • Do not utilize an Electronic Debit (ACH) as 11 USC §362(b)(11) does not include an exception for ACHs. The bankruptcy code is not likely to be expanded to include ACHs because ACHs are not a negotiable instrument. Or, are they? Question to the Audience: Are state statutes on negotiable instruments being expanded or interpreted to make ACH authorizations a negotiable instrument? See Snowden • One reason I doubt my ACH authorizations will become negotiable instruments is due to the fact that they are not for a specific amount, but are instead for an amount of $1 up to the full amount owed (not for an amount certain or calculable on the face of the loan documents).

22. Exceptions from Discharge in Chapter 7 Bankruptcy • All debtors should sign a separate statement with wording similar to: “I have not consulted an attorney or obtained legal advice in the past six months relating to filing for or planning a bankruptcy. I do not anticipate filing bankruptcy in the next six months.” These representations are contained in FastBucks’ loan applications and the clause is individually signed by all debtors. • A debtor’s representation similar to the above on a loan application facilitates relief under 11 USC §523(a). The debt may be excepted from discharge thereby allowing the loan company to continue collections even after their other obligations have been discharged. • In Kearns, the debtor misrepresented his recent consultation with a bankruptcy debtor’s attorney and his imminent intent to file bankruptcy. The payday loan was obtained on December 4, 2009 and the chapter 7 bankruptcy petition was filed on December 11, 2009. FastBucks exchanged (presented and negotiated) the held check on December 19, 2009 for a cashier’s check. • Had we not gotten a favorable published opinion on our utilization of 11 USC §362(B)(11) (cashing the check), we would have then filed an Adversary Proceeding under 11 USC §523(a) and had the debt determined to be non-discharged. • The Idaho district of FastBucks has suffered significantly less discharged debt in bankruptcy since Kearns was published.

23. In re Brewer • Payday lender presented check, post-petition • Holding: • Creditor did not violate automatic stay either by its post-petition presentment of Chapter 13 debtor’s check to drawee bank for payment or by its receipt of funds from debtors’ account; but • Genuine fact issues precluded entry of summary judgment on whether creditor’s refusal to turn over proceeds of this post-petition transfer was exercise of control over property of the estate, of kind prohibited by automatic stay.

24. In re Snowden - Facts • Payday Loan with BOC Disclosure. Debtor obtained a prepetition payday loan from Creditor.Debtor gave check as "security" and “payment” for the loan. The Agreement included the following disclosure: • “[w]hen you provide a check as payment, you authorize us either to use information from your check to make a one-time electronic funds transfer from your account orto process the payment as a check transaction.” (emphasis added) • Post Petition Debiting of Funds. Debtor filed chapter 7 petition, listing Creditor as an unsecured creditor. After filing, Creditor made an electronic funds transfer for such amount.

25. In re Snowden • Creditor argued the ACH debit entry was merely the means by which Creditor presented the negotiable instrument. • RCW 62A.3-501(b)(1) specifically authorizes “presentment” by any commercially reasonable means, “including electronic” communication.

26. In re Snowden - Holding • This EFT was NOT Presentment. The electronic transfer was not a "presentment" under the UCC. • So No Exception Applies. Since Creditor did not enforce Debtor's agreement via presentation of an instrument, the § 362(b)(11) stay exception is inapplicable • Violated Automatic Stay. Creditor willfully violated the automatic stay when it initiated a post-petition electronic transfer from Debtor's bank account.

27. In re Snowden - Reasoning • To qualify as “presentment” Washington law requires : • exhibiting the instrument, • giving reasonable identification and, if presentment is made on behalf of another person, reasonable evidence of authority to do so, and • signing a receipt on the instrument for any payment made or surrender the instrument if full payment is made. RCW 62A.3-501(b)(2). • Key Facts the Court Noted: • ACH Records did not “identify Debtor's bank's routing number, her account number, her name, a check date, and an amount. • ACH Records did not “specify the check number.” ACH Records do not “specifically identify Debtor's check.” • ACH Records listed the “check date” as the day of debiting, not check’s date. • Creditor did not surrender Debtor's check, “nor is it apparent how that could be done electronically.” • Therefore, the court concluded that “the electronic transfer was not presentment” of Debtor's check.

28. In re SnowdenOther Notable Quotes • BOC Authorization Model Suggests a Choice Between Check Transaction and EFT. • The Agreement allowed Creditor either to process the payment as a check transaction or to "use information from [Debtor's] check to make a one-time electronic funds transfer from [Debtor's] account.“ • Court Said Company Chose EFT, Not Check Option. Creditor “chose the latter and made a one-time electronic funds transfer; it did not present the check electronically.” • Consequence is no Bankruptcy Exception. One of the consequences of this choice was…that the EFT in this instance was not "presentment" as contemplated in Article 3 of the UCC. “

29. In re SnowdenCan an ACH be Presented? • “This is not to say that an EFT could never be presentment, but it would necessarily have to specify the particular instrument, andcould not be some other transaction authorized by the parties' agreement. • Although a check might provide the basis and the necessary information for the transaction, there can be no "presentment" without specific identification of the particular instrument, even if surrender could be overlooked.”

30. In re SnowdenOther Reasons 362(b)(11) Fails • Court noted § 362(b)(11)'s exception may be inapplicable here for other reasons as well: • “Exceptions to the stay are narrowly construed, and anything Creditor did beyond the statutory requirements of presentation would violate the stay. “ • “Arguably, even indorsement (sic) of a paper check for deposit into the payee's or holder's account, with attendant warranties, RCW 62A.3-417, is outside the strict requirements of presentment, and thus outside the exception.” • “If, under the contractual provisions governing the ACH system or the rules of that system by which Creditor agreed to be bound, any warranties or other actions beyond exhibiting and surrendering the instrument would also seem to fall outside the exception's ambit. But neither the agreements by which Creditor joined the ACH system, nor the rules of that system, are in evidence, so that question must await another case.”

31. ACH State Considerations • Virginia • California • Elsewhere

32. Disclaimer This presentation is provided with the understanding that the presenters are not rendering legal advice or services. Laws are constantly changing, and each federal law, state law, and regulation should be checked by legal counsel for the most current version. We make no claims, promises, or guarantees about the accuracy, completeness, or adequacy of the information contained in this presentation. Do not act upon this information without seeking the advice of an attorney. This outline is intended to be informational. It does not provide legal advice. Neither your attendance nor the presenters answering a specific audience member question creates an attorney-client relationship.