The scenarios below illustrate how a payor’s legal rights and responsibilities may vary depending upon whose payment service the payor uses.
Hypothetical 1: Person-to-Person Payment
CoolPay is a nonbank payment service that provides CoolPay accounts to its users and enables them to send funds to each other through its service. CoolPay makes payments in two ways. If a payor-user has funds in his or her CoolPay account, CoolPay will pay the payee through a book transfer: i.e., a debit entry to the payor’s CoolPay account and a credit entry to the payee’s Cool-Pay account. If a payor-user does not have funds in his or her account, CoolPay will initiate an ACH debit to the payor-user’s bank account and then credit the payee-user’s CoolPay account once CoolPay’s bank account is credited for the ACH debit it sent to the payor-user’s bank account.
Jane and George are CoolPay users. Jane uses CoolPay to send George $100 for his birthday. Although Jane is a CoolPay user, she does not keep funds in her CoolPay account. Hence, to effectuate the payment, CoolPay instructs its bank, Bank A, to send an ACH debit for $100 to Jane’s bank, Bank B. Once Bank A receives settlement from Bank B for the ACH debit, it credits CoolPay’s bank account. CoolPay then credits George’s CoolPay account for $100. What if CoolPay makes a mistake and credits Ted’s CoolPay account rather than George’s?
Given that CoolPay provides a payment service that enables consumers to hold funds in CoolPay accounts, CoolPay will be subject to the new prepaid account requirements of Regulation E, including its disclosure and error-resolution requirements, when it goes into effect. The rule will require CoolPay to: (i) disclose to Jane that she has error-resolution rights; and (ii) investigate the error upon timely notice from Jane that her bank account has been debited, but that George has not received his birthday money. CoolPay generally will be required to investigate and determine whether an error occurred within 10 days of Jane’s notice. If CoolPay determines that an error occurred, it must correct the error within one business day of such determination.
Note that, until the CFPB’s prepaid rule is effective, Jane’s ability to seek redress from CoolPay will be determined by the terms and conditions governing Jane’s use of the CoolPay service or possibly her state’s money transmission laws. It should further be noted that, due to the fact that the debit to Jane’s bank account was in the correct amount, it is unlikely that Jane could have sought redress from her bank for CoolPay’s error because the debit was authorized, in the correct amount, and her bank made no error is transmitting the funds to CoolPay’s account with Bank A.
It is also the case that, if CoolPay acted as only a payment facilitator and did not hold consumer funds in CoolPay accounts, the CFPB’s prepaid rule will not be applicable to Jane’s payment. She would again look to the terms and conditions of CoolPay’s service and her state’s money transmission laws for redress.
Hypothetical 2: Business-to-Business Payment
Company A and Company B are CoolPay users. Company A instructs CoolPay to pay Company B $10,000 via transfer from Company A’s CoolPay account to Company B’s CoolPay account. Company A has sufficient funds credited to its CoolPay account to pay for the transfer without the need to debit Company A’s bank account. Hence, CoolPay debits Company A’s CoolPay account for $10,000. However, CoolPay erroneously credits Company C’s CoolPay account rather than Company B’s CoolPay account.
If CoolPay were a bank, this type of error would be an error in execution. Under article 4A, if Company A’s bank paid a party other than the beneficiary Company A identified in its payment instruction, Company A would be entitled to a refund under article 4A’s money-back guarantee provisions for the amount of the payment. Company A’s bank could seek to recover the amount from Company C, but it would be required to refund Company A regardless of whether it does so. Under article 4A, the bank would not be permitted to vary its obligation to refund Company A by agreement.
In the absence of article 4A, the rights of Company A and CoolPay will be governed by the terms and conditions of CoolPay’s service, other agreements among the parties, and common law. In addition, if CoolPay’s terms are not favorable to Company A, it may find itself in court arguing by analogy to article 4A that CoolPay must provide a refund. If Company A is unable to recover from CoolPay, it may also be able to recover from Company C under CoolPay’s terms or common-law theories, but Company C, its jurisdiction, and a number of other factors will be completely unknown to Company A.
Hypothetical 3: Business-to-Business Payment with Distributed Ledger
Let us add a variation to the previous two examples where CoolPay provided payment services to the payor and payee: What if instead it is simply banks providing those services? Does it matter if those banks, in turn, choose to use a fundamentally new infrastructure, such as blockchain, to settle with each other?
Suppose Company A wishes to pay Company B $10,000 for products that it purchased. Company A has an account with Bank A, and Company B has an account with Bank B. Company A opts to make that $10,000 payment by a funds transfer from its account at Bank A to Company B’s account at Bank B. The funds transfer begins with a debit to Company A’s account on Bank A’s books (funds are withdrawn from the payor’s account), and ends with a credit to Company B’s account on Bank B’s books (funds are deposited into the payee’s account).
Suppose, however, that Bank A and Bank B do not have a direct relationship with each other that enables Bank A to credit an account it holds for Bank B, or for Bank B to debit an account it holds for Bank A. Instead, they choose to use blockchain technology—CoolChain—to clear and settle payment from Bank A to Bank B in real time on their own books. A detailed description of how the banks may use blockchain technology in this way is provided in a March 2016 article by Jessie Cheng and Benjamin Geva. In essence, blockchain technology allows banks with no direct relationship to establish trust and coordinate their actions to settle with each other.
Does the fact that the banks in the funds transfer opt to use CoolChain, rather than a traditional funds transfer system like CHIPS or Fedwire, to transact with each other in this way mean that the payment is outside the scope of article 4A? Not necessarily. Article 4A focuses on the type of entities involved, not the means by which they transact with each other. The primary focus of article 4A is the “funds transfer,” the transfer of bank credit from the payor to the payee. The hypothetical above—where Company A transmits an instruction to its bank, Bank A, to pay or cause another bank to pay Company B—falls within article 4A’s definition of “funds transfer” in section 4A-104. This remains so even where Bank A and Bank B happen to choose to use CoolChain or any other blockchain technology to settle with each other. That transfer is still a series of transactions, beginning with Company A’s payment order (Company A’s instructions to Bank A to pay or cause another bank, like Bank B, to pay a fixed amount of money to Company B) made for the purpose of making payment to Company B, the beneficiary of the order. Thus, Bank A’s and Bank B’s choice to use CoolChain to settle with each other would not remove the transfer from the ambit of article 4A.
Although article 4A can be read to apply to a funds transfer involving blockchain rails as a general matter, the application of the technology varies from blockchain to blockchain, and each implementation must be analyzed to determine whether or precisely how certain of its concepts map onto an article 4A framework. Thus, might the legacy article 4A concepts of “funds transfer system” apply to a network of banks that all use CoolChain and together agree to a certain set of payment rules governing their interbank rights and obligations? As described above, one could interpret section 4A-105(a)(5)’s definition of “funds transfer system” and its official commentary to say “yes,” even though the official commentary has not been updated to specifically recognize emerging systems that fundamentally differ from legacy payment rails. The same may not be true of another blockchain rail.
The robust competition for payment services in the United States offers consumers and businesses many ways to pay. However, the legal framework that applies to payments, and that ultimately determines the rights and responsibilities of consumers and businesses when they make and receive payments, is dependent upon a combination of whether the payments begin and end at a bank and, for consumers, the characteristics of the payment service.