For many community banks, the legal side of banking can be overwhelming and difficult to navigate. At ICBB, we hope to be a resource for community banks in all aspects of their operations. We’ve asked our friends at Dinsmore & Shohl LLP to provide information on legal subjects within banking.
DISCLAIMER: The information contained in this article is provided for informational purposes only and should not be construed as legal advice on the subject matter.
Fraud is an unfortunate reality for your community bank, and for your commercial customers. However, without careful oversight, poor wording or holes in your commercial (not consumer) account agreements can leave your bank responsible for losses due to fraud committed against the business. Unlike consumer account transactions, which are mostly governed by the Electronic Fund Transfer Act and the Uniform Commercial Code, the allocation of responsibility and risk of loss for commercial accounts is mostly governed by the terms of the account agreement. So, it is critical your bank periodically review the account agreement and ensure the allocation of responsibility and risk is expressly set out and reflects the current market conditions.
Fraudsters are After Your Small Business Customers
We are seeing a shift in where fraud occurs. Fraudsters are beginning to target small to medium size businesses. These businesses often have not updated their processes to identify and prevent fraud or have not purchased software to assist in identifying and preventing fraud. When those businesses suffer a loss related to a check or wire, they often request for the bank to cover the loss because:
- the loss will have a substantial impact on their business;
- they don’t understand their obligation to put into place protective measures to prevent fraud; and
- they believe (incorrectly) that the bank is responsible for these types of losses.
Even worse, the business may accuse the bank of not having the correct measures in place to stop the fraud and initiate litigation. Not only can this be costly, but it could also result in reputational risk to the bank.
What Should the Account Agreement Include?
Thus, we recommend your bank revisit its account agreement. The agreement should:
- detail the obligations of the business, including the obligation to enact internal controls to prevent employee theft of checks and access to the electronic signature or stamp.
- require the business to implement its own anti-fraud measures and protective measures as it relates to online access.
- detail the security features expected on checks and transfers of funds.
- include a limitation of liability and indemnification to protect the bank if the business’s internal controls fail or if the business refuses to enact any type of control.
Further, the bank can offer additional anti-fraud services, which should also be noted. Failure to utilize the bank’s services or its own internal control measures should place the risk of loss solely on the business, not the bank.
While the risk of check or wire fraud is not going away, we are seeing a shift where it occurs with businesses and commercial accounts. So, revisiting and potentially revising the account agreement to reflect market conditions will ensure the account agreement appropriately allocates responsibility and risk.