Community banks operate in an environment where fraud schemes constantly evolve. The accelerating pace of digital commerce, coupled with consumer expectations for swift transaction processing, has heightened the vulnerability of traditional payment channels like checks and wires—alongside emerging options such as remote deposit capture (RDC) and ACH debits. To reduce these risks, community banks can deploy a combination of strong legal documentation, well-designed operational services, and strong customer education.
This paper explores common contractual provisions, procedural safeguards, and protective measures that a community bank can integrate into its account agreement with the customer, this includes treasury management agreement (“TMS Agreement”) and deposit account agreement. related documents. It also provides sample “bank protection” clauses that can help the institution define clear boundaries of liability and indemnification, while encouraging customers to adopt recommended security procedures and monitoring tools.
1. Legal Framework
1.1. The Uniform Commercial Code (UCC)
Article 4A of the UCC governs funds transfers and provides the statutory basis for several key provisions in the Agreement. Notably:
- Section 4A-202 establishes that security procedures are commercially reasonable if they verify authenticity and detect error
- Section 4A-204 limits a bank’s liability for unauthorized payments when compliant with security procedures
- Section 4A-305 caps consequential damages absent bad faith
A bank’s agreement’s liability limitations and security procedure requirements should directly implement UCC provisions.
1.2. FFIEC Guidance
The FFIEC’s 2021 Supplement to the Authentication in an Internet Banking Environment guidance emphasizes layered security controls that the Agreement operationalizes through:
- Multi-factor authentication mandates
- Anomaly detection requirements
- Customer security obligations
Examiners increasingly expect bank agreements to formalize these controls — not only as a defense against liability, but also as evidence of sound risk management under the FFIEC’s 2021 guidance.
2. The Importance of Clear, Comprehensive Legal Agreements
2.1. Establishing Responsibilities
Critically, a TMS or Account Agreement sets out the roles of both the bank and the customer. The bank typically pledges to process transactions—such as checks, wires, and ACH payments—in accordance with security procedures. Meanwhile, the customer is expected to protect account access information, reconcile account statements promptly, and notify the bank of any unauthorized entries or discrepancies within a specific timeframe.
When these responsibilities are expressed in clear yet thorough language, expectations are better managed, and liability disputes are minimized if fraud does occur.
2.2. Liability Limitations and Indemnities
Well-defined liability restrictions can shield the bank from losses stemming from the customer’s oversights, errors or negligence. For instance, Agreements should contain a disclaimer of consequential or punitive damages. A typical example reads as follows:
“To the fullest extent permitted by applicable law, the bank will not be liable for any consequential, incidental, special, or punitive damages, or for any indirect loss that you may incur or suffer in connection with these services, even if we have been advised of the possibility of such damages.”
This kind of language underscores that the bank’s exposure is limited to direct losses tied to the bank’s own failures, not broader business or reputational damage that might result from a fraud incident.
In addition, Agreements should include indemnification clauses that require the customer to defend and hold the bank harmless for losses caused by the customer’s actions or by someone the customer has authorized. An illustrative provision states:
“You agree to indemnify, defend, and hold the bank, along with its officers, directors, and employees, harmless from and against any damage, loss, or liability (including reasonable attorneys’ fees) arising directly or indirectly from any claim related to your use of the services or your failure to adhere to the procedures described herein, except to the extent such damage or loss is caused solely by the bank’s gross negligence or willful misconduct.”
Such language prompts the customer to maintain strong internal controls and cooperate fully in loss recovery efforts.
3. Managing Authorized Signers and Customer Authority.
3.1. Authorization Controls
Fraud frequently arises from internal oversights in designating and supervising authorized signers. A strong Agreement will detail that the customer must designate and maintain a clear list of Authorized Signers and Authorized Representatives, who are each permitted to initiate or approve transactions. Provisions obligate the account holder to ensure that personnel with transactional authority are well-chosen and closely monitored.
By requiring Authorized Signers to be explicitly listed, and by refusing to process transactions that do not come from these recognized individuals (unless the bank determines, in good faith, that instructions appear to be from an authorized user), the bank reduces the chance that unauthorized employees or external persons can exploit vague or outdated approvals.
3.2. Requirement to Update Bank on Personnel Changes
Another common but often overlooked loophole arises when the employer fails to inform the bank of staffing changes—whether an employee has left the company, shifted roles, or otherwise no longer maintains transaction authority. When an agreement compels the customer to notify the bank of any changes in authorized personnel “promptly and in writing,” it preserves the bank’s ability to rely on the most current signature cards or electronic banking user lists.
4. Security Procedures and Customer Responsibilities
4.1. Commercially Reasonable Controls
Most Agreements describe a series of “Security Procedures” that banks offer, such as password protocols, IP filters, multi-factor authentication, and dual control. By adopting or declining these controls, the customer bears some measure of risk. If a customer declines a recommended measure and fraud ensues, the agreement should clearly shift that risk to the customer.
For instance, a TMS Agreement might say:
“If you refuse a commercially reasonable security control that we have offered, you agree to assume responsibility for any payment order that we accept in good faith and in accordance with the security procedures you have chosen.”
4.2. Customer Duties to Monitor and Notify
Another component of fraud mitigation is the customer’s obligation to check account statements and online transaction records frequently, then report any unauthorized items or errors within a short window—often 30 days (this can be shortened for commercial customers). If the customer fails to do so, the bank is typically released from liability for those transactions. The agreement might use language such as:
“You must promptly examine the statements and transaction records we provide. If you fail to notify us of any unauthorized or erroneous payment within thirty (30) days from the date we first made that information available, we are not liable for any subsequent losses or claims related to that payment.”
This notice requirements places responsibility on the customer to act diligently and review their financial transactions frequently.
5. Fraud Prevention Services and Their Legal Underpinnings
5.1. Positive Pay and Reverse Positive Pay for Check Fraud Mitigation
Positive Pay is a leading service for deterring check fraud. It hinges on the customer submitting a list (or “check issued file”) of authorized checks. As checks clear, the bank compares them to the authorized list. If a mismatch emerges, it becomes an “exception item” that the customer must decide to pay or return by a stated deadline (e.g., 10:30 a.m. the next business day).
To reinforce the bank’s protections, an agreement should clarify that if the customer misses the response deadline or fails to submit accurate check information, any resulting payment or non-payment of an item will not be the bank’s responsibility. Typical language might read:
“If you do not provide us with timely instructions regarding an exception item, we may, at our sole discretion and without liability, either pay or return the item based on the default instructions designated in your setup forms.”
Reverse Positive Pay places more responsibility on the customer; all presented checks are flagged, and the customer must review every check rather than rely on a bank-match process. An agreement should state that if the customer fails to review or respond, the bank will process items according to default rules (e.g., pay all or return all).
5.2. ACH Block and Filter
For ACH transactions, banks can provide “Block” or “Filter” services. A block automatically returns all ACH debits that the customer has not specifically authorized. A filter might instead allow certain originators or transaction codes while blocking others.
Legal disclaimers associated with these services typically say that if a legitimate debit is inadvertently returned due to the customer’s instructions, the bank will not be liable for a wrongful return. Conversely, if a fraudulent debit is allowed because the customer has not kept its filter instructions up to date, the bank also is shielded from liability.
5.3. Wire Transfer Protections
Wire transfers involve large amounts of money and are typically irreversible once completed. Agreement should require that a customer must provide precise wire instructions, so that the bank may rely on an account number even if the beneficiary’s name does not match, and that the bank is not liable if the customer provides erroneous or fraudulent details. Sample phrasing might be:
“We may rely solely on the identifying number you provide for the beneficiary’s bank, even if the name of the bank or the account number do not match. We are not responsible for any loss arising from your error or omission in providing wire instructions.”
Additionally, the bank usually states it will attempt to recover funds upon written request if the customer realized a wire was fraudulent, but it cannot guarantee success and assumes no liability if the beneficiary or intermediary bank refuses to return the money.
5.4. Remote Deposit Capture Requirements
Remote Deposit Capture (RDC) services enable customers to deposit checks electronically using scanners or mobile devices. These same conveniences can expose customers to fraud risks, including duplicate deposits of the same item. Agreements should therefore explain that once a check is scanned and credited, the customer must mark it as deposited and destroy it by a specified deadline. A standard clause could read:
“You agree to secure each original check after scanning and to destroy it within [X] days. You also acknowledge that if the same item is later presented for payment in any form, we will not be responsible for losses resulting from the duplicate deposit.”
6. Indemnity and “Bank Protection” Language
An indemnification framework should ensure that if the bank complies with its stated security protocols and procedures, the customer will absorb any losses tied to the customer’s own errors, omissions, or negligence. This stance is commonly reinforced by disclaimers making clear that the bank:
- Will not be liable for any errors caused by incorrect information or untimely instructions submitted by the customer or anyone authorized on the customer’s behalf.
- Is not responsible for detecting errors in the content of any electronically transmitted instruction—such as a wrong account number or incorrect payment amount—beyond verifying compliance with the agreed security procedure.
- Is not obligated to risk a loss for the sake of the customer if it suspects or detects possible fraudulent activity but lacks explicit authorization or timely instructions from the customer to proceed or to stop a transaction.
An all-encompassing indemnity provision might say:
“You agree to indemnify, defend, and hold us harmless from any claim, liability, damage, or expense (including attorneys’ fees and costs) that we incur as a result of any action we take in good faith in accordance with this Agreement, including any instruction we process or decline to process, except to the extent it is caused by our gross negligence or willful misconduct.”
7. Customer Education
Beyond contractual protections, community banks should continuously educate their customers about best practices. For instance:
- Dual Control: Encourage or require the customer to have one employee initiate a transaction (whether a wire, ACH, or check issuance) and another employee approve or release it.
- Regular Reconciliation: Stress the importance of daily or near-daily balancing of accounts.
- Employee Training: Remind customers that many fraud attempts—such as phishing emails—exploit employees. Urge them to train staff on how to spot suspicious messages.
- Timely Updates: Emphasize that the customer must promptly notify the bank if a user’s authorization or signatory privileges are revoked, or if a password or other credential might be compromised.
Farley Law specializes in working with both community banks and small businesses. If you are interested in learning more about these or any other income-generating activities for banks, please feel free to contact us at Farley Law, where we help our client financial institutions develop new products and financial services.