Can Wire Transfers and ACH Credits Be Reversed?
Can Wire Transfers and ACH Credits Be Reversed?
Thoughts from A Seller’s Perspective
By Michael Dickey, Esq.
In all purchase and sale transactions, but especially as the dollar value of the transaction grows, it becomes more and more important to the seller that the goods or real estate being sold remain their property until final payment is received. The last thing a seller wants is to receive payment, pass title and then discover that the payment has been reversed. Prudent sellers and their counsel are aware that personal or business checks can be stopped or returned due to insufficient funds, so two common alternative methods of payment employed by prudent sellers and their counsel are to require the buyer to transfer funds by wire transfer or ACH credit. Both of these methods of payment reduce the risk of reversal, however, the question remains - Do they eliminate all risk of reversal?
The short answers to this question for these two types of alternative payment methods are in order: Wire – pretty much eliminated, and ACH credit – some risk remains.
Going beyond these short answers however, it is important to realize that the laws and rules governing wires and ACH credits are complex; it is not the intent of this short article to provide a comprehensive analysis of all the issues involved. Rather, it is the aim of this article to provide an overview of these two payment methods, the relevant rules regarding reversals and, hopefully, provide sellers with some thoughts to keep in mind that might help them choose between these two methods of payment.
At its most basic level, a wire transfer is a fairly simple transaction. In the case of a purchase and sale, the buyer will instruct it’s bank to debit it’s account in the amount of the purchase price and credit those funds to the account of the seller. The law calls the buyer’s payment instruction to it’s bank a “payment order”, most everybody else calls it a wire. If the buyer and seller share the same bank, the bank will affect the payment order by means of a “book entry” essentially adjusting it’s internal books and records to reflect the debit to the buyer’s account and corresponding credit to the seller’s account. If the buyer and seller do not share the same bank, the buyer’s bank will have to communicate the payment order to the seller’s bank. The three primary networks over which payment orders are transmitted are: (1) Fedwire, (2) Clearing House Interbank Payment System (CHIPS), and (3) the Society for Worldwide International Financial Telecommunications (SWIFT). In some instances, especially in more complex transactions such as international transactions, a payment order might make short stops at one or more intermediary banks for further processing along it’s way from the buyer’s bank to the seller’s bank.
A wire transfer can be viewed as a chain which consists of discrete links. It might help to imagine a line of people with the buyer at the head, passing a dollar bill to the second person in line. That person then in turn passes the dollar to the person behind them. This series of exchanges continues until the dollar is passed from the second to last person in line into the hands of the seller. The law terms the entire chain of interconnected exchanges a “funds transfer” and treats each exchange in the chain as a separate payment order. Each party to a funds transfer has very clear and distinct rights and obligations. These various rights and obligations are laid out in detail in Article 4A of the Uniform Commercial Code. It is the provisions of Article 4A then, that one must consult in order to determine under what circumstances a buyer can cancel and recall a wire.
The person or entity who receives funds in exchange for goods or real estate in a purchase and sale transaction is commonly called the seller. Article 4A, calls the seller, or perhaps more accurately, the person or entity that ends up with funds in their account at the completion of a funds transfer, the “beneficiary”. Article 4A terms the seller’s bank the “beneficiary’s bank” and the buyer and the other banks in the funds transfer chain as with as either a “sender” or a “receiving bank”.
The ability of a sender to recall a wire hinges primarily on whether or not the payment order has been accepted by the receiving bank. The reason for this is that the general rule under 4A is that a cancellation order is effective as long as it is received at a time and in a manner that affords a receiving bank a reasonable opportunity to act on the cancellation order before the receiving bank accepts the order. Put another way, as long as the seller’s bank hasn’t accepted the payment order, chances are good that the buyer can reverse the wire. However, after acceptance by the seller’s bank occurs, the scales tip in favor of the seller; cancellation orders are generally ineffective. The key time for a seller therefore, is the point in time at which it’s bank accepts the payment order.
The rules regarding acceptance of a payment order are set out in §4A-209. §4A-209 sets out a couple of different events which will trigger acceptance of a payment order. As far as a seller is concerned, by far the most important trigger is set out in §4A-209(b)(1) which basically states that the beneficiary’s bank accepts a payment order when it pays the beneficiary or notifies the beneficiary that it’s account has been credited. Therefore, once a seller or seller’s counsel learns or is notified by it’s bank that funds have been credited to their account, the seller can safely assume that the payment order has been accepted and that therefore, the funds cannot be recalled.
This comfort level is based on the text of §4A-211(c) which reads in part: “After a payment order has been accepted, cancellation or amendment of the order is not effective unless the receiving bank agrees…” What this language essentially means, is that once a beneficiary’s account has been credited (i.e. the beneficiary’s bank has accepted the payment order), there is no legal obligation upon the seller’s bank to act upon requests received from the buyer’s bank to recall or reverse the wire. One should note that the term employed in §4A-211(c) is “receiving bank” not “beneficiary’s bank” which means that all receiving banks (including obviously, receiving banks which are also beneficiary banks) which have accepted a payment order have the right to refuse to reverse a wire. For beneficiary banks specifically, §4A-211 goes even further to add additional restrictions on reversals of wires.
§4A-211(c)(2) states that cancellation of a payment order after acceptance by the beneficiary’s bank is only available in instances where the payment was unauthorized or there was a mistake by the sender and that mistake falls into one of three categories: (i) duplicate payment, (ii) payment to a person or entity not entitled to the funds, or (iii) payment which resulted in the beneficiary receiving more that they were entitled to. The effect of this language is to take issues such as buyer’s remorse completely off the table and legally limit the instances where a buyer can even attempt to recall funds already credited to the seller’s account to only those instances where the buyer can make a claim that the seller received funds to which it was not entitled.
In summary, the general rule is that once a seller’s account has been credited, the buyer is effectively limited to claiming that the seller was not entitled to some or all of the funds if the buyers wants to recall the wire, and even then, the seller’s bank is fully protected by Article 4A if it elects to ignore the buyer’s recall request. At this point then, the discussion has to shift a little bit from the rules set out in Article 4A to how the application of these rules plays out in practice. The fact of the matter is that banks are ill suited to adjudicating disputes between different parties, they recognize this fact, and seek to avoid acting as judge and jury in disputes involving their customers. Whether or not a bank’s customer is or is not entitled to the funds that were just credited to their account is exactly therefore, the type of dispute a bank will seek to avoid becoming involved in. With Article 4A protecting them if they choose to ignore a buyer’s recall request, absent a court order or clear and convincing evidence that a mistake or fraud has occurred, most banks’ default position will be to refuse to agree to reverse the payment order absent the permission of their customer. What this means for the seller and seller’s counsel is that once funds coming in via wire hit their account its almost a certainty that they will not be pulled back out without their permission.
“ACH” stands for automated clearinghouse. It refers to a payment system in which funds are transferred in large batches via the electronic transmission of payment data between financial institutions. However, rather than the data transmissions going directly from bank to bank (as is the case with wire transfers), a central clearing facility operated by a private organization or the Federal Reserve acts as the central node in a “hub and spoke” arrangement. ACH transactions are governed by rules and guidelines promulgated by the National Automated Clearinghouse Association or “NACHA”. NACHA rules and guidelines stipulate that the initiator of an ACH transaction (the “Originator” in NACHA parlance) must enter into a contract with it’s bank (the “Originating Depository Financial Institution” or “ODFI”) and that this contract contain a provision by which the Originator agrees to be bound by the NACHA rules and guidelines. Therefore, NACHA rules and guidelines govern the ability of a buyer to reverse an ACH credit entry to the seller.
At the risk of getting too far down into the weeds, in addition to the buyer or Originator, and the buyer’s bank or ODFI, the other players in a typical purchase and sale transaction settled by means of an ACH transaction, are: (i) the clearing house or “ACH Operator” through which the ODFI sends a batch data file containing a number of individual ACH transactions or “entries” including the entry containing an instruction to credit the seller’s account in the amount of the purchase price, (ii) the seller’s bank or “Receiving Depository Financial Institution” or “RDFI”, and (iii) the seller or “Receiver” of the ACH credit entry initiated by the buyer.
Pursuant to Article Two section 2.5 of the NACHA 2006 Operating Rules, a buyer who feels an ACH entry to the seller has been sent in error, can initiate a “reversing entry” to it’s bank (aka ODFI) to recall the erroneous entry. Not every entry can be recalled however, the NACHA rules provide that only “erroneous entries” can be recalled. The NACHA rules define erroneous entries as only those entries which fall into one of the following three categories: (i) a duplicate of a previously initiated entry, (ii) an entry which orders payment to or from a Receiver not intended to be credited or debited by the Originator, or (iii) an entry that orders payment in an amount different than was intended by the Originator. Put another way, a buyer can only attempt to recall a payment made to a seller via an ACH credit if the buyer claims the seller was already paid by a previous ACH credit entry, or the seller was not the correct recipient of the funds or the original ACH payment was in the wrong amount.
As noted above, a buyer requests it’s bank to reverse an ACH credit entry by initiating a reversing entry. When the ODFI acts on this instruction and submits the reversing entry to the ACH Operation, NACHA guidelines make it clear that the ODFI is warranting to the ACH Operator and the RDFI the appropriateness of this recall request. NACHA rules further provide (subsection 2.5.2 of Article Two of the 2006 Operating Rules) that when an ODFI submits a reversing entry it must indemnify the ACH Operator and the RDFI.
The word “request” was employed in the preceding paragraph intentionally. NACHA guidelines make it clear that the seller’s bank is not required to return an ACH credit when requested to do so by an ODFI (Paragraph D of Section III, Chp. 5 of the 2006 Operating Guidelines). In addition, the RDFI is given the explicit right under NACHA guidelines to require a written letter of indemnification from the buyer’s bank prior to returning an ACH entry.
The NACHA rules and guidelines impose two other key requirements upon a buyer who is seeking to reverse an ACH credit entry to it’s seller.
First, NACHA rules require the buyer to notify the seller that it is reversing the original payment no later than the settlement date of the reversing entry. The NACHA rules do not prescribe the method by which the buyer must notify the seller, but the important point to remember is that the seller must have at least some prior notice (if only same day) that the buyer is planning to reverse the ACH payment. The obvious implication of this is that if a seller has not received prior notice of a reversal from the buyer, can rightly claim that NACHA rules were violated and the recall invalid. Presumably, if prior notice is received, a seller can take such actions as it deems appropriate in order to protect it’s interests.
Second, every reversing entry must be transmitted to the buyer’s bank no later than midnight of the fifth banking day following settlement of the original entry. Sellers therefore, can take some comfort in knowing that five banking days after payment from the buyer is received, the buyer is precluded under NACHA rules from recalling the payment through the ACH system.
It would appear then, as if the rules regarding the reversals of wire transfers and ACH credits are quite similar. In both instances, the buyer has to base it’s reversal request on an allegation that the seller was not entitled to the funds in some way and the seller’s bank is under no obligation to actually agree to the reversal request. However, it was stated at the start of this article that there was more risk of a reversal occurring with an ACH credit than with a wire transfer. If the rules are very similar, how can this be the case?
The answer lies in the differences between these two payment methods. Each wire transfer is a unique and stand alone transaction. As each wire is processed individually, banks assume that they are accurate and correct and reversal requests are immediately flagged and questioned. ACH entries are batched together in files often containing thousands of individual entries. In addition, many ACH entries are smaller dollar transactions of a reoccurring nature. For example, when consumers arrange their monthly power, gas and cable bills to be automatically debited from their accounts each month, those payments are made via ACH not via wire. With literally thousands and thousands of entries packed into an ACH file, banks (rightly or wrongly) don’t assume anything is unusual if a mistake in an individual ACH entry is claimed. The practical effect of this assumption is that financial institutions will generally routinely process ACH reversal entries without paying any special attention to them. Unfortunately, this puts sellers and their counsel at greater risk if they choose to settle their sale transaction via ACH than if they choose to do so by wire.
Michael Dickey has been a Vice President & Counsel for Citizens Bank since 2000. In addition to advising Citizens personnel on commercial lending issues, his responsibilities include supporting the Global Markets and Cash Management Units, which entails providing advice on international and domestic funds transfers. Admitted to the Massachusetts Bar in 1993, he is a graduate of the Dalhousie University School of Law and also earned a Masters in Banking Law from Boston University’s Morin Center. Michael can be reached at Michael.Dickey@Citizensbank.com .
This article is provided for educational purposes only and not as a solicitation by Citizens for any product or service. Furthermore, although the information contained herein is believed to be reliable, it should not be considered legal advice, and Citizens makes no representation or warranty as to the accuracy or completeness of any information contained herein.