4000 - Advisory Opinions
Bank Check Guarantee Card Arrangements
August 4, 1980
Robert J. Green, Regional Attorney
This is in response to your letter of May 29, 1980, to Regional Counsel Paulson, and further to our conversation of June 24, 1980, concerning check guarantee cards.
While it does not appear to be the bank's intention to enter into a letter of credit arrangement, practical use of the guarantee card triggers the bank's commitment to honor any check presented to the bank for payment regardless of whether sufficient funds are maintained in the customer's account. Essentially, it is an arrangement which substitutes the credit of the issuing bank for that of its cardholding customer.
A letter of credit is generally thought of as an engagement by an issuing bank made at the customer's request that the bank will honor drafts or other demands for payment upon compliance with the terms of the credit. No particular form of phrasing is required to establish a letter of credit and the consideration or lack of consideration flowing from the customer to the bank is not a significant concern to the party relying upon the letter of credit. 50 Am. Jur. Letters of Credit § 11 (1970); U.C.C. § 3-105, Official Comment. A bank issuing a letter of credit on behalf of its depositor to a third person who acts on it cannot justify its refusal to honor its obligation based upon the underlying contractual relationship (and possible absence of consideration) between the bank and its depositor. White and Summers, Uniform Commercial Code § 18-2; § 18-6 at p. 626-7 (1972).
Traditionally, a letter of credit involves an arrangement by the issuing bank to pay the beneficiary--usually a seller of goods--on presentation of whatever documents are required by the letter of credit. It also involves a separate contract between the account party--the buyer of the goods--and the beneficiary, and an agreement between the bank and the account party for the issuance of the credit.
In the situation presented, although no formal arrangement exists between *** and area merchants, those who do accept guaranteed checks1 appear to be relying upon the bank's advertised representation and practice that the checks will be honored when presented to the bank. In effect, the bank is acting as a guarantor of payment irrespective of the fact that there may not be sufficient funds on deposit in the customer's checking account. Of course, it is understood by the parties that the customer would normally have available funds on deposit and that the customer is under an absolute obligation to reimburse the bank. Based upon this particular aspect of the bank's guarantee program, it is difficult not to conclude that the bank is engaging in the practice of offering its participating customers "standby letters of credit". Moreover, the function of the guarantee card is clearly distinguishable from a credit card since under a credit card arrangement the customer normally does not have funds readily available and it is the expectation of both the bank and customer that the bank will routinely extend the necessary credit.
Despite a bank's characterization of the guarantee check card as merely an identification or check facilitating device, the bank is making an implicit commitment to make payment on behalf of its customers whenever necessary and thus would be liable to pay checks issued by the customer without regard to the underlying contract between its customer and the merchant presenting the check. This is typical of the standby letter of credit and is evidenced by the fact that the customer cannot stop payment on the check.
Unlike a guarantee prohibited by section 332.1 of the Corporation's regulations, the bank is not merely securing the promise or debt of its customer when the customer is unable to perform, but rather, is assuming an original and primary obligation to honor any guaranteed check with a subsequent but separate right to seek reimbursement from the customer.
Section 337.2(a) of the Corporation's regulations establishes guidelines for certain letter of credit practices that may have adverse effects upon the safety and soundness of insured state nonmember banks. The definition of a standby letter of credit is "any letter of credit, or similar arrangement however named or described, which represents an obligation to the beneficiary on the part of the issuer (1) to repay money borrowed by or advanced to or for the account of the account party, or (2) to make payment on account of any indebtedness undertaken by the account party, or (3) to make payment on account of any default (including any statement of default) by the account party in the performance of an obligation." Given the broad scope of section 337.2(a) in providing for many variations of the standby letter of credit, it is apparent that your bank's commitment to pay its participating customer's checks fits within the regulation. Accordingly, the bank's practice would be subject to the restrictions contained in section 337.2(b) with respect to applicable lending limits. It is suggested that, in order for the bank to comply with the regulation the maximum amount of checks which may be guaranteed by the bank be combined with all other loans to the individual customer for the purpose of applying any legal limit on loans to individuals. To comply with section 337.2(d), the bank should also reflect as a separate item in its financial information the average total contingent liability of the bank under its guarantee check card program for all participating customers for the accounting period in question.
Consideration should also be given to the safety and soundness of the bank's guarantee program in terms of lending policy and customer credit risk. Absent any verification of a customer's account at that point of check acceptance, it should be recommended to the bank that issuance of a guarantee check card be based upon sound credit evaluation of participating customers.
1 Guaranteed checks are only those checks which are presented to a merchant with a *** Guarantee Card. The merchant in turn is required to make a notation of the customer's guarantee card code number on the back of the check before presentment to the bank. Apparently, the bank will not accept any check in which this procedure is not followed. Go back to Text