Court Opinion

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Opinions of the United
2004 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit

12-30-2004

NBT Bank NA v. First Natl Comm Bank
Precedential or Non-Precedential: Precedential

Docket No. 03-4231

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PRECEDENTIAL

   IN THE UNITED STATES COURT OF APPEALS
            FOR THE THIRD CIRCUIT

                   Case No: 03-4231

       NBT BANK, NATIONAL ASSOCIATION,

                               Appellant

                              v.

       FIRST NATIONAL COMMUNITY BANK

                 ___________________

     On Appeal from the United States District Court
           for the Middle District of Pennsylvania
               District Court No. 01-CV-00936
  District Judge: The Honorable Thomas I. Vanaskie, C.J.

                ____________________

               Argued September 28, 2004

                _____________________

Before: RENDELL, FUENTES and SMITH, Circuit Judges
                (Filed: December 30, 2004)
                 _____________________

                OPINION OF THE COURT
                 _____________________

COUNSEL: Robert J. Tribeck, Esq. (Argued)
         Rhoads & Sinon, LLP
         One South M arket Square
         P.O. Box 1146
         Harrisburg, PA 17108-1146
         Attorney for Appellant

             Raymond P. Pepe, Esq.,
             David R. Overstreet, Esq. (Argued),
             and Marsha A. Sajer, Esq.
             Kirkpatrick & Lockhart, LLP
             240 North Third Street
             Harrisburg, PA 17101
             Attorneys for Appellee

SMITH, Circuit Judge.

       This is an appeal from an order of the District Court
denying the motion of Appellant NBT Bank, N.A. (“NBT”)
for summary judgment, and granting summary judgment in
favor of Appellee First National Community Bank (“FNCB”).
At issue is a claim by NBT under Article 4 of Pennsylvania’s
Uniform Commercial Code (“UCC”), 13 Pa. Cons. Stat. Ann.

                             2
§§ 4101-4504, seeking to recover the face value of a
$706,000 check (the “Disputed Check”) that was drawn on an
FNCB account and deposited at NBT by a participant in a
check-kiting scheme.

       In accordance with its established practice, NBT
forwarded the Disputed Check to the Federal Reserve Bank of
Philadelphia (“Reserve Bank”), which serves as a
clearinghouse or transferor for checking transactions
involving a number of banks, including both NBT and FNCB.
When the Disputed Check was presented by the Reserve Bank
to FNCB for payment, FNCB recognized that the drawer had
overdrawn its account. Thus, FNCB sought to dishonor the
Disputed Check and to return it to the Reserve Bank. Under
the UCC, FNCB was required to return the Disputed Check to
the Reserve Bank prior to the “midnight deadline,” defined as
midnight of the following banking day after the day the check
was first presented to FNCB.

       The parties agree that the Disputed Check was
physically delivered to the Reserve Bank prior to the midnight
deadline. The parties also agree that FNCB prepared the
Disputed Check as a “qualified return check,” meaning it was
to be encoded with a magnetic strip containing information
that would facilitate automated processing by the Reserve
Bank. However, FNCB erroneously encoded the magnetic
strip with the routing number for PNC Bank (which otherwise
has no connection to this appeal), rather than NBT. The

                              3
parties agree that NBT did not suffer damages as a result of
this encoding error. Nonetheless, NBT seeks to hold FNCB
accountable for the full amount of the Disputed Check,
pursuant to the strict accountability provisions of §§ 4301 and
4302 of the UCC. The key issue in this appeal is whether
FNCB’s violation of a Federal Reserve regulation requiring
proper encoding provides a basis for imposing strict
accountability on FNCB under § 4302 of the UCC, despite the
fact that NBT incurred no actual loss as a result of FNCB’s
error.

       Because we believe the District Court correctly
concluded that NBT may not recover on the facts presented
here, we will affirm the District Court’s order granting
summary judgment in favor of FNCB.

I.     FACTUAL BACKGROUND

       A.     The Disputed Check

        In the proceedings before the District Court, the parties
stipulated to the facts. The dispute arises out of a check-
kiting scheme under which a small group of Pennsylvania
business entities arranged to write checks on one account,
drawing on non-existent funds, and then cover these
overdrafts with checks drawn on another account that also
lacked sufficient funds. In this manner, the perpetrators of the
scheme sought to obtain funds to which they were not

                               4
entitled. The scheme collapsed when three checks initially
deposited at NBT, and subsequently presented for payment to
FNCB, were discovered by FNCB to have been drawn on an
FNCB account that lacked sufficient funds.1 There is no
dispute between the parties that two of these three checks
were properly returned by FNCB to the Reserve Bank prior to
the applicable midnight deadline.

        The Disputed Check (i.e., the third check, for
$706,000), was drawn on an FNCB account and drafted by an
entity called Human Services Consultants, Inc. On March 8,
2001, the Disputed Check was proffered for deposit at NBT
by an entity called Human Services Consultants Management,
Inc., d/b/a “PA Health.” Thus, in relation to the Disputed
Check, NBT was the “depositary bank” (the first to receive
the item), and FNCB was the “payor bank,” meaning that the
Disputed Check was drawn on an FNCB account held by a
participant in the check-kiting scheme.

     1
      The record does not provide additional information
concerning the details of the check-kiting scheme and the fate
of the scheme’s perpetrators. However, at oral argument,
counsel for NBT indicated that the funds that were fraudulently
obtained by the scheme’s perpetrators have not been recovered
by NBT.

                              5
          B.   The Provisional Settlement

       After the Disputed Check was presented for deposit at
NBT, the bank gave provisional credit to the depositor, PA
Health, for the amount of the Disputed Check. NBT also
transmitted the Disputed Check to the Reserve Bank for
presentment to FNCB. Upon transmission to the Reserve
Bank, NBT was given a provisional credit from FNCB’s
Reserve Bank account for the face amount of the Disputed
Check.2 The Reserve Bank then forwarded the Disputed
Check to FNCB, and FNCB received it on March 12, 2001.
Under the UCC, if FNCB wished to refuse payment on the
Disputed Check, FNCB was obligated to revoke the
provisional settlement granted to NBT by 11:59 p.m. on
March 13, 2001.3 See 13 Pa. Cons. Stat. Ann. §§ 4301, 4215.

      2
       The Reserve Bank was acting as a clearinghouse or
transferor bank for items moving between other banks, including
FNCB and NBT. The Reserve Bank’s services are used to
facilitate prompt payment, accurate accounting, and expedited
availability of funds.
  3
    A brief summary of the provisional credit process under the
UCC may aid understanding of the issues raised in this appeal.
Article 4 of the UCC provisionally assumes that when a check
is deposited for payment, it will be paid by its drawer. See 13
Pa. Cons. Stat. Ann. §§ 4201(a), 4214(a), 4215(a)(2), 4301. See
generally 1 Barkley Clark & Barbara Clark, T HE L AW OF B ANK
D EPOSITS, C OLLECTIONS AND C REDIT C ARDS, § 6.01 (5th ed.

                              6
       C.     FNCB’s Efforts To Return The Disputed
              Check

        On March 13, 2001, FNCB determined it would not
pay the Disputed Check because of the absence of sufficient
funds in the account on which the check was drawn. That
same day, FNCB sought to return the Disputed Check to NBT
through the Reserve Bank. The parties agree that the
Disputed Check was physically delivered to the Reserve Bank
prior to 11:59 p.m. on March 13. In addition to sending the
Disputed Check back to the Reserve Bank on March 13,

1999) (hereinafter “Clark & Clark”) (outlining the provisional
credit process). Based upon this assumption, the depositary
bank provisionally places the value of the check into the payee’s
account and forwards the check to the clearinghouse or
transferor bank for collection. The clearinghouse provisionally
shifts the value of the check from the clearinghouse account of
the payor bank to the clearinghouse account of the depositary
bank. Unless the payor bank revokes the provisional credit in
accordance with § 4301 of the Pennsylvania UCC, the payor
bank is deemed to have finally paid the check and is accountable
to the depositary bank for the full amount of the check. See 13
Pa. Cons. Stat. Ann. §§ 4215, 4302; see also Colorado Nat’l
Bank v. First Nat’l Bank & Trust Co., 459 F. Supp. 1366, 1368-
69 (W.D. Mich. 1978) (discussing provisional credit process);
Channel Equip. Co. v. Cmty. State Bank, 996 S.W.2d 374, 377-
78 (Tex. Ct. App. 1999) (same).

                               7
FNCB also sent a notice of dishonor to NBT via the FedLine,4
in which FNCB indicated that it did not intend to pay the
Disputed Check. NBT received this notice prior to the close
of business on March 13. In addition, on the morning of
March 14, 2001, FNCB executives telephoned NBT officials
and telefaxed a letter to NBT, advising NBT that FNCB had
decided to dishonor the Disputed Check.

       D.     FNCB’s Encoding Error

        When FNCB sent the Disputed Check to the Reserve
Bank on March 13, 2001, FNCB included a letter designating
it as a “Qualified Return Check” prepared for high speed
processing.5 In so doing FNCB communicated to the Reserve
Bank that it had attached to the Disputed Check a strip of
paper encoded with magnetic ink that would permit the check
to be processed through the Reserve Bank’s automated
processing system. However, FNCB erroneously encoded the
strip with the routing number for PNC Bank instead of the
routing number for NBT.

 4
  The FedLine is a telecommunications service provided by the
Federal Reserve for the purpose of, among other things, sending
notices of dishonor.
 5
   Banks may convert checks to qualified return checks in order
to expedite processing and save on per-check processing fees.
See 12 C.F.R. § 229.30(a).

                              8
        In sum, the Reserve Bank physically received the
Disputed Check complete with the wrongly encoded strip
prior to 11:59 p.m. on March 13, 2001. Because the Disputed
Check was improperly encoded, NBT did not receive it back
from the Reserve Bank until March 16, 2001. With proper
encoding the Disputed Check likely would have been received
on March 14, 2001. The parties have stipulated, however,
that NBT suffered no damages or actual loss as a result of the
encoding error, inasmuch as NBT had actual notice from
FNCB on March 13 that the Disputed Check had been
dishonored.6

II.    THE DISTRICT COURT PROCEEDINGS

       NBT instituted this action against FNCB on May 25,
2001. The only claim before the District Court was a claim
under the Pennsylvania UCC. NBT claimed that FNCB’s

  6
   After receiving the Disputed Check on March 16, 2001, NBT
sent it back to the Reserve Bank as a “Late Return” on March
26, 2001. Upon receiving notice of NBT’s actions, FNCB
submitted to the Reserve Bank a “Paying Bank Response to
Claim of Late Return,” in which it certified that it had returned
the Disputed Check prior to the applicable March 13, 2001
midnight deadline. Following this exchange, the Reserve Bank
reversed the provisional credit of $706,000 that it had originally
given to NBT when NBT first forwarded the Disputed Check to
the Reserve Bank on March 13.

                                9
encoding error meant FNCB had failed to return the Disputed
Check prior to the midnight deadline as required by the UCC,
and that FNCB was therefore accountable to NBT for the full
amount of the Disputed Check. The parties stipulated to the
facts and filed cross-motions for summary judgment.

       The District Court granted FNCB’s motion and denied
NBT’s motion. See NBT Bank v. First Nat’l Comm. Bank,
287 F. Supp. 2d 564 (M.D. Pa. 2003). The District Court
found that FNCB had returned the Disputed Check by the
March 13 midnight deadline as required by § 4301, that
FNCB’s encoding error did not negate or nullify what
otherwise constituted proper return as defined in § 4301(d),
and that, in any event, NBT could not recover where it
suffered no actual loss resulting from FNCB’s conduct. The
District Court reasoned that (1) the Reserve Bank was not a
“clearinghouse” as that term is used in § 4301(d)(1), thus
rendering that particular UCC provision inapplicable; (2)
FNCB’s encoding error did not negate FNCB’s compliance
with the UCC midnight deadline rule under § 4301(d)(2),
which provides that an item is returned by a payor bank
“when it is sent or delivered to the bank’s customer or
transferor [here, the Reserve Bank] or pursuant to his
instructions[;]” and (3) NBT could not recover where it
suffered no loss as a result of FNCB’s conduct, and where, by
operation of law, NBT and FNCB were parties to a binding
agreement that incorporated federal regulations indicating that
the measure of damages for a failure to exercise ordinary care

                              10
in encoding was to be measured by the actual loss incurred.
NBT appeals.

III.   DISCUSSION

       A.     Jurisdiction and Standard of Review

       Federal court jurisdiction over this diversity action is
proper under 28 U.S.C. § 1332. We have appellate
jurisdiction pursuant to 28 U.S.C. § 1291. We review the
District Court’s decision to grant summary judgment under
our plenary standard of review. See Curley v. Klem, 298 F.3d
271, 276 (3d Cir. 2002); Chase Manhattan Bank, N.A. v.
Government of the Virgin Islands, 300 F.3d 320, 322 (3d Cir.
2002). Affirming the grant of summary judgment is proper
where there are no genuine issues of material fact and the
moving party is entitled to judgment as a matter of law. See
Curley, 298 F.3d at 276-77 (quoting Fed. R. Civ. P. 56).

       B.     Pennsylvania UCC Provisions Governing
              Check-Return Procedures

       Article 4 of the UCC as adopted by Pennsylvania
defines the rights between parties with respect to bank
deposits and collections involving banks located in
Pennsylvania. See 13 Pa. Cons. Stat. Ann. § 4102(b). To the
extent not preempted or superseded by federal law, Article 4
governs the process by which banks present checks for

                              11
payment, settle on checks, and, if necessary, dishonor and
return checks. NBT notes three interrelated UCC provisions
that establish the circumstances under which a bank may
return a dishonored check.

        The first key provision is § 4301. Section 4301(a)
provides that a bank may dishonor or return a check or other
disputed item if, before the bank’s midnight deadline, it either
(1) returns the item; or (2) sends written notice of dishonor or
nonpayment if the item is unavailable for return. 13 Pa. Cons.
Stat. Ann. § 4301(a)(1)-(2). Section 4301(d) defines the ways
in which a bank may “return” an item for purposes of
compliance with § 4301(a)(1). Section 4301(d) provides:

       Acts constituting return of item. – An item is
       returned:

         (1) as to an item presented through a clearinghouse,
       when it is delivered to the presenting or last collecting
       bank or to the clearinghouse or is sent or delivered in
       accordance with clearinghouse rules; or

         (2) in all other cases, when it is sent or delivered to
       the bank’s customer or transferor or pursuant to his
       instructions.

13 Pa. Cons. Stat. Ann. § 4301(d)(1)-(2). Notably, the UCC
defines the terms “delivery” and “send.” “Delivery” with
respect to “instruments, documents of title, chattel paper or

                               12
certificated securities means voluntary transfer of
possession.” 13 Pa. Cons. Stat. Ann. § 1201. “Send,”

       [i]n connection with any writing or notice, means to
       deposit in the mail or deliver for transmission by any
       other usual means of communication with postage or
       cost of transmission provided for and properly
       addressed and[,] in the case of an instrument[,] to an
       address specified thereon or otherwise agreed, or[,] if
       there be none[,] to any address reasonable under the
       circumstances. The receipt of an item or notice within
       the time at which it would have arrived if properly sent
       has the effect of a proper sending.

Id.

      The second key UCC provision with respect to a payor
bank’s attempt to dishonor a check is § 4302. Section 4302
provides in relevant part that:

       [i]f an item is presented to and received by a payor
       bank[,] the bank is accountable for the amount of [the
       item], whether properly payable or not, if the bank . . .
       retains the item beyond midnight of the banking day of
       receipt without settling for it or . . . does not pay or
       return the item or send notice of dishonor until after its
       midnight deadline.

13 Pa. Cons. Stat. Ann. § 4302(a)(1). Section 4302 thus
imposes strict accountability on a payor bank (subject to two

                               13
enumerated defenses not relevant here) that fails to revoke its
provisional settlement on a dishonored check prior to the
midnight deadline. See Chrysler Credit Corp. v. First Nat’l
Bank & Trust Co. of Wash., 746 F.2d 200, 201 (3d Cir. 1984)
(per curiam) (interpreting Pennsylvania law); Lombardo v.
Mellon Bank, N.A., 685 A.2d 595, 598 (Pa. Super. Ct. 1996);
Nat’l Check v. First Fid. Bank, 658 A.2d 1375, 1378 (Pa.
Super. Ct. 1995);; see also First Union Nat’l Bank of Fla. v.
First Fla. Bank, N.A., 616 So.2d 1168, 1171 (Fla. Dist. Ct.
App. 1993) (noting that in most states “it is well established
that sections 4-301 and 4-302 of the Uniform Commercial
Code create a statutory doctrine of strict accountability by the
payor bank to the presenting bank if notice is not
accomplished within the midnight deadline”) (citing L.A.
Nat’l Bank v. Bank of Canton of California, 280 Cal. Rptr.
831 (Cal. Ct. App. 1991); First State Bank of Sherwood v.
Twin City Bank of North Little Rock, 720 S.W.2d 295 (Ark.
1986); Northwestern Nat’l Insurance Co. v. Midland Nat’l
Bank, 292 N.W .2d 591 (Wis. 1980)).

        The third UCC provision invoked by NBT is § 4215,
which addresses when a check is “finally paid.” Upon “final
payment” a provisional settlement by the payor bank becomes
final, and the payor bank is accountable for the face amount
of the check. Under § 4215, a check “is finally paid by a
payor bank when the bank has . . . made a provisional
settlement for the item and fail[s] to revoke the settlement in
the time and manner permitted by statute, clearinghouse rule

                               14
or agreement.” 13 Pa. Con. Stat. Ann. § 4214 (a)(3). Official
Comment 4 to § 4215 states that “[a] primary example of a
statutory right on the part of the payor bank to revoke a
settlement is the right to revoke conferred by Section 4-301.” 7

       C.     Regulation CC, Reserve Bank Operating
              Circulars, and Variation By Agreement

       The Pennsylvania UCC provisions governing check-
return procedures do not operate in a vacuum. Federal law
forms part of the legal framework within which check-
processing activities take place. Of particular relevance to
this appeal are the 1988 regulations adopted by the Federal
Reserve implementing the Expedited Funds Availability Act,
12 U.S.C. §§ 4001-4010. See 12 C.F.R. Pt. 229. These
regulations, referred to collectively as “Regulation CC,”
complement but do not necessarily replace the requirements
of Article 4 of the UCC. See 12 C.F.R. § 229.41.

       Subpart C of Regulation CC, 12 C.FR. §§ 229.30-
229.43, applies to and governs the collection, processing, and
return of checks. See 12 C.F.R. § 229.1(b)(3). The
provisions of subpart C “supersede any inconsistent

  7
   Under Pennsylvania law, the official comments of a drafting
commission may be given weight in the construction of a
statute. See Young v. Kaye, 279 A.2d 759, 765 n.3 (Pa. 1971).

                               15
provisions of the UCC as adopted in any state, or of any other
state law, but only to the extent of the inconsistency.” 12
C.F.R. § 229.41; see also 13 Pa. Cons. Stat. Ann. § 4103, cmt.
3. Regarding encoding, subpart C provides:

       A paying bank may convert a check to a qualified
       return check. A qualified returned check must be
       encoded in magnetic ink with the routing number of
       the depositary bank, the amount of the returned check,
       and a ‘2’ in position 44 of the MICR [Magnetic Ink
       Character Recognition] line as a return identifier.

12 C.F.R. § 229.30(a)(2)(iii).

        Subpart C of Regulation CC also contains its own
liability standard and its own remedy provision for a failure to
comply with its requirements:

       A bank shall exercise ordinary care and act in good
       faith in complying with the requirements of this
       subpart [,which includes the encoding requirements
       referenced above]. A bank that fails to exercise
       ordinary care or act in good faith under this subpart
       may be liable to the depositary bank, the depositary
       bank’s customer, the owner of a check, or another
       party to the check. The measure of damages for failure
       to exercise ordinary care is the amount of the loss
       incurred, up to the amount of the check, reduced by the
       amount of the loss that party would have incurred even

                                 16
       if the bank had exercised ordinary care.

12 C.F.R. § 229.38(a).

        Along with Regulation CC, the Federal Reserve has
adopted Operating Circulars utilized by Reserve Banks in
connection with their check-processing services. Both
Regulation CC and Federal Reserve Operating Circular No. 3
(which contains provisions relevant to this appeal), “apply to
the handling of all cash items that [Reserve Banks] accept for
collection and all returned checks that [Reserve Banks] accept
for return.” See Federal Reserve Op. Circ. No. 3 (Jan. 2,
1998), at 1, ¶ 1.1. The opening section of Operating Circular
No. 3 also states:

       This Circular is issued pursuant to Sections 4, 13,
       14(e), and 16 of the Federal Reserve Act, the
       Expedited Funds Availability Act, and related statutes
       and in conformance with Regulations J and CC. It is
       binding on each party interested in an item we handle.
       The provisions of this Circular vary by agreement any
       inconsistent provisions of the Uniform Commercial
       Code or of Regulation CC, but only to the extent of the
       inconsistency.

Id.

       Operating Circular No. 3 is not the original source of
the encoding requirement at the center of this appeal, which

                              17
instead is set forth in subpart C of Regulation CC, as noted
above. However, Operating Circular No. 3 emphasizes that in
handling a “qualified return check” the Reserve Bank may
rely on the accuracy of “the identification of the depositary
bank by routing number in magnetic ink.” See Federal
Reserve Op. Circ. No. 3, at 10, ¶ 15.6. Circular No. 3 further
provides that the payor bank will indemnify the Reserve Bank
for any loss or expense incurred by the Reserve Bank arising
from an encoding error by the payor bank. See id. Circular
No. 3 also notes that if for any reason a returned check is
mistakenly forwarded by the Reserve Bank to the wrong
depositary bank, the recipient should either send the returned
check directly to the proper depositary bank or promptly
return it to the Reserve Bank. See id. at 11, ¶ 15.12.

        The Pennsylvania UCC also addresses the applicability
of the federal regulatory provisions contained in Regulation
CC and Operating Circular No. 3. Section 4103(a) of the
UCC directs that the terms of the UCC may be varied by
agreement, although parties cannot disclaim the duty to act in
good faith and exercise ordinary care or limit the measure of
damages for a failure to exercise ordinary care. Section
4103(b) states that “Federal Reserve regulations and operating
circulars, clearinghouse rules and the like have the effect of
agreements under subsection (a), whether or not specifically
assented to by all parties interested in items handled.” Section
4103(c) notes that a bank’s compliance with Federal Reserve
regulations and operating circulars constitutes prima facie

                              18
evidence of the exercise of ordinary care.

        In sum, under the UCC, the provisions of Regulation
CC function as a binding agreement between the parties with
respect to check-return transactions. This agreement
supersedes any inconsistent provisions of the UCC itself, but
only to the extent of the inconsistency. Similarly, the
provisions of Operating Circular No. 3 are also binding on the
parties in connection with the check-return activities at issue
here. The rights and obligations granted and imposed by
Operating Circular No. 3 overlap to a certain extent with the
parties’ rights and obligations under the UCC’s statutory
provisions and under Regulation CC. The provisions of
Operating Circular No. 3 take precedence over any
inconsistent portions of Regulation CC, but only to the extent
of the inconsistency.

       D.     Construing The UCC’s Check-Return
              Provisions

        NBT’s claim raises a number of difficult questions of
statutory construction under the UCC. An understanding of
these issues aids in assessing the underlying theory of NBT’s
claim. Nonetheless, we ultimately conclude that even if these
questions were to be resolved in NBT’s favor, it would not
change the outcome here. Thus, while our discussion may
provide additional clarity concerning the issues implicated by
NBT’s appeal, we need not definitively resolve all the

                              19
disputes between the parties concerning the construction of
the UCC’s check-return provisions.

       As noted above, NBT invokes three interrelated UCC
provisions governing the circumstances under which a bank
may return a dishonored check. Section 4301(d) defines the
acts that constitute “return” of an item. The parties dispute
whether it is § 4301(d)(1) or § 4301(d)(2) that applies under
the facts in this case. The District Court found that §
4301(d)(2) applied, ruling that the Reserve Bank was a
“transferor” rather than a “clearinghouse.” We need not
resolve this issue, because our analysis concerning the
encoding requirement invoked by NBT is the same, regardless
of whether the encoding requirement is viewed as a
clearinghouse rule under § 4301(d)(1) or a transferor
instruction under § 4301(d)(2).

        Under § 4301(d)(1), an item is deemed returned “when
it is delivered . . . to the clearinghouse or is sent or delivered
in accordance with clearinghouse rules.” 13 Pa. Cons. Stat.
Ann. § 4301(d)(1) (emphasis added). Under § 4301(d)(2), an
item is returned “when it is sent or delivered to the bank’s . . .
transferor or pursuant to his instructions.” 13 Pa. Cons. Stat.
Ann. § 4301(d)(2) (emphasis added). The phrasing of these
sections is disjunctive, and here the parties agree that the
Disputed Check was dispatched by FNCB on March 13, 2001,
and was physically delivered to the Reserve Bank prior to the
March 13 midnight deadline. Under one reading of §

                               20
4301(d), this would end the inquiry, because the Disputed
Check was “delivered” to the clearinghouse or transferor prior
to the midnight deadline. NBT challenges this reading,
arguing that § 4301(d)’s references to simple delivery as
constituting a valid “return” are relevant only where there are
no applicable clearinghouse rules or transferor instructions
that govern sending or delivery. NBT argues that only this
construction gives effect to all the terms of § 4301(d),
including the simple delivery option as well as delivery “in
accordance with clearinghouse rules” or “pursuant to
[transferor] instructions.”

        However, at least two other possible interpretations
would give effect to § 4301(d)’s references to clearinghouse
rules and transferor instructions while also maintaining the
viability of the simple delivery option. First, the phrases “sent
or delivered in accordance with clearinghouse rules” and
“sent or delivered . . . pursuant to [transferor] instructions”
could be read as referring to instances where a disputed item
is to be returned to some address other than the clearinghouse
or transferor from which it was initially received. Second,
these phrases may also be meant to account for situations in
which a payor bank attempts to deliver a disputed item to the
clearinghouse or transferor, but through negligence of the
clearinghouse or transferor the disputed item does not actually

                               21
arrive at the proper location.8

         The multiple possible readings of § 4301(d) illustrate
that even when the UCC’s check-return provisions are
considered in isolation from Regulation CC, NBT is not
bound to recover on its claim for strict accountability.
Similarly, even if NBT is correct in arguing that FNCB was
obligated to comply with certain clearinghouse rules or
transferor instructions in order to satisfy § 4301(d), it is not
clear that the encoding requirement for returned checks is a
rule that relates to “sending” or “delivery” under the UCC.
Indeed, the District Court found that “the midnight deadline
rule focuses on timing and a physical transfer.” NBT Bank,
287 F. Supp. 2d at 571. The UCC defines “delivery” as
“voluntary transfer of possession.” 13 Pa. Cons. Stat. Ann. §
1201. Even if the encoding requirement is a rule or
instruction that FNCB was bound to follow, such a rule does
not necessarily relate to the question of whether FNCB
voluntarily transferred possession of the Disputed Check from
itself to the Reserve Bank prior to the midnight deadline.9

      8
    The most obvious example of such a situation would be
where a clearinghouse or transferor had provided a payor bank
with an inaccurate return address.
  9
   Likewise, § 4215's requirement that a provisional settlement
be revoked in the “time and manner permitted by statute,
clearinghouse rule or agreement” does not necessarily support

                                  22
Thus, FNCB’s failure to comply with such a rule or
instruction would not necessarily preclude a finding under §
4301(d) that FNCB returned the Disputed Check prior to the
midnight deadline.

        While the foregoing issues concerning the proper
construction of the UCC’s check-return provisions need not
be definitively resolved, it is clear that NBT’s interpretation
poses numerous difficulties. We may nonetheless assume that
if the UCC provisions are read in isolation from Regulation
CC, FNCB was obligated to encode the Disputed Check
correctly in order to effectively “return” it within the meaning
of § 4301(d). We may further assume that a failure to do so
by FNCB would mean FNCB had not properly revoked its
provisional settlement in a manner permitted under § 4215.

the position taken by NBT. The encoding requirement invoked
by NBT arises in the context of Regulation CC’s instructions for
preparing a check as a “qualified return check.” Regulation
CC’s encoding provision does not specifically indicate that
accurate encoding is a prerequisite for proper revocation of a
provisional settlement under the UCC. See Col. Nat’l Bank, 459
F. Supp. at 1371-73 (citing the absence of language concerning
revocation and strict accountability in the Federal Reserve
regulation requiring wire advice of nonpayment, and holding
that the payor bank’s failure to comply with wire advice
requirement was not sufficient grounds for imposing strict
accountability under § 4302 of the UCC); Yeiser v. Bank of
Adamsville, 614 S.W.2d 338, 342-43 (Tenn. 1981) (same).

                              23
This assumption would lead to the conclusion that under the
UCC, the Disputed Check was “finally paid” by FNCB, thus
rendering FNCB accountable to NBT for the full amount of
the Disputed Check pursuant to § 4302. In the end, however,
such assumptions do not change the result, because, as set
forth in part III.E below, the UCC’s check-return provisions
do not operate in a vacuum. Even if NBT’s interpretation of
the UCC’s check-return provisions is correct, Regulation CC
and Operating Circular No. 3 preclude NBT from holding
FNCB strictly accountable for the Disputed Check where
NBT suffered no actual loss as a result of FNCB’s encoding
error.

       E.     The Damage Limitations Included In
              Regulation CC And Incorporated In
              Operating Circular No. 3 Preclude NBT
              From Recovering On Its UCC Claim

       NBT argues that under § 4301(d) of the UCC, FNCB’s
encoding error effectively nullifies FNCB’s efforts to “return”
the Disputed Check. NBT contends that Regulation CC’s
encoding requirement for qualified return checks is a
clearinghouse rule or transferor instruction concerning the
manner in which the Disputed Check was to be returned.
NBT argues that FNCB’s failure properly to comply with
such a rule or instruction means that (1) FNCB did not revoke
its provisional settlement in the “manner permitted by statute,
clearinghouse rule or agreement[,]” as required by § 4215;

                              24
and (2) the Disputed Check was not returned prior to the
midnight deadline as required under § 4301. Thus, according
to NBT, FNCB is strictly accountable for the full amount of
the Disputed Check pursuant to § 4302.

        FNCB counters that, because all of Regulation CC is
binding on the parties (pursuant to both Regulation CC’s own
terms, and as an “agreement” under § 4103 of the UCC),
NBT may not rely on FNCB’s encoding error as a basis for
recovering the amount of the Disputed Check. FNCB notes
that Regulation CC specifies that damages for a bank’s failure
to exercise ordinary care in fulfilling its obligations under
Regulation CC must be calculated based upon the actual loss
caused by such failure. Implicit in FNCB’s position is the
concession that it failed to exercise ordinary care in encoding
the Disputed Check. FNCB argues that, even if NBT’s
reading of the UCC is correct (a proposition FNCB disputes),
Regulation CC has effectively amended §§ 4215, 4301, and
4302 of the UCC to preclude strict accountability where a
payor bank’s failure to return an item by the midnight
deadline is based solely on the payor bank’s noncompliance
with an obligation imposed by Regulation CC. Instead,
according to FNCB, where a payor bank’s violation of a
clearinghouse rule or transferor instruction arises solely from
its failure to exercise ordinary care in executing its obligations
under Regulation CC, Regulation CC’s clause tying the
measure of damages to a claimant’s actual loss is incorporated
into the UCC by operation of section 4103. FNCB contends

                               25
this analysis precludes imposition of strict accountability in
situations where, as here, the claimant seeking recovery
concedes it suffered no loss as a result of the payor bank’s
actions.

       We believe the District Court’s analysis of this issue,
which is largely consistent with FNCB’s position, is correct.
Regulation CC indisputably binds the parties, pursuant to both
its own terms, see 12 C.F.R. § 229.1(b)(3), as well as § 4103
of the UCC, which indicates that “Federal Reserve
regulations” are to be treated as agreements that may vary the
terms of the UCC, see 13 Pa. Cons. Stat. Ann. § 4103(a)-(b).
Such agreements are binding “whether or not specifically
assented to by all parties interested in items handled.” 13 Pa.
Cons. Stat. Ann. § 4103(b). Thus, the District Court properly
held that “[i]n this case, Regulation CC forms part of the
agreement among the parties with respect to the disputed
check.” NBT Bank, 287 F. Supp. 2d at 574.

        Because Regulation CC as a whole is binding on the
parties, and because Regulation CC is the source of the
encoding requirement invoked by NBT, the extent of FNCB’s
liability for its encoding error must be measured by the
standards set forth in Regulation CC. See Bank of Wyandotte
v. Woodrow, 394 F. Supp. 550, 556-57 (W.D. Mo. 1975)
(noting that Federal Reserve regulations are “controlling and
enforceable” as agreements under the UCC, and, that the
measure of damages for violation of such regulations is “the

                               26
amount of the item reduced by an amount which could not
have been realized even if all [applicable] requirements had
been met”) (internal quotations omitted). Regulation CC
states that a bank that fails to exercise ordinary care in
complying with the provisions of subpart C of Regulation CC
(which includes the encoding requirement referenced above)
“may be liable” to the depositary bank. Then, in broad,
unrestricted language, Regulation CC states:

      The measure of damages for failure to exercise
      ordinary care is the amount of the loss incurred, up to
      the amount of the check, reduced by the amount of the
      loss that the [plaintiff bank] would have incurred even
      if the [defendant] bank had exercised ordinary care.

12 C.F.R. § 229.38(a). This provision does not provide an
exception to this standard for measuring damages in instances
where noncompliance with Regulation CC is alleged to have
resulted in noncompliance with the UCC’s midnight deadline
rule. Here, the parties have stipulated that NBT suffered no
loss as a result of FNCB’s encoding error. Thus, under the
plain language of Regulation CC, NBT may not recover from
FNCB for the amount of the Disputed Check.

       This analysis is reinforced by Appendix E to
Regulation CC, which contains the Federal Reserve Board’s
commentary interpreting the provisions of Regulation CC and
providing examples “to aid in understanding how a particular

                             27
requirement is to work.” 12 C.F.R. Part 229, App. E, § I, A,
1. Appendix E states:

       Generally, under the standard of care imposed by §
       229.38, a paying or returning bank would be liable for
       any damages incurred due to misencoding of the
       routing number, the amount of the check, or return
       identifier on a qualified return check . . . . A qualified
       return check that contains an encoding error would still
       be a qualified return check for purposes of the
       regulation.

Id. at § II, BB, 2 (emphasis added). This Reserve Board
commentary is significant, because as noted above, both
Regulation CC and the UCC indicate that Regulation CC’s
provisions are binding on the parties, and that Regulation
CC’s provisions supersede any inconsistent provisions of the
UCC. The fact that Appendix E specifically contemplates the
possibility that a payor bank could encode a returned check
with the wrong routing number, and yet states that the remedy
for such an error is to be calculated based upon the damages
caused by the error, strongly indicates that encoding errors do
not give rise to strict accountability for a payor bank.

       Notably, Appendix E also states that a wrongly
encoded check is still considered a qualified return check.
This statement illustrates that there is a distinction between
whether a check has been properly encoded and whether a
check has been properly returned. NBT’s attempt to

                               28
incorporate the proper encoding of a routing number as an
essential element in determining whether a check has been
“returned” under § 4301 of the UCC is contrary to the
approach required under Regulation CC. Thus, FNCB’s
encoding error, while constituting a violation of Regulation
CC’s encoding requirements, does not provide an adequate
basis for imposing strict accountability on FNCB pursuant to
the UCC’s midnight deadline provisions.

        NBT offers two reasons why it believes it should
recover the full amount of the Disputed Check
notwithstanding the measure of damages specified in
Regulation CC. We find that these arguments lack merit.
NBT’s primary argument challenges the applicability of the
Regulation CC provision concerning calculation of damages
based upon actual loss. NBT believes this provision has no
relevance because NBT’s claim is brought under the UCC
rather than under Regulation CC. NBT states, “[w]hether or
not [FNCB] would have been liable on a claim under
Regulation CC is wholly irrelevant to the issue presented
here. The issue here is whether [FNCB] is accountable under
the UCC[.]”

       There are several problems with NBT’s attempt to
draw a sharp distinction between a claim “under the UCC”
and a claim covered by Regulation CC. It is obvious that
NBT’s UCC claim is at least partially dependent on
Regulation CC, in that Regulation CC is the source of the

                             29
encoding requirement that directs a payor bank to include the
routing number of the depositary bank in magnetic ink on all
qualified return checks. Indeed, to the extent the UCC itself
addresses encoding, it specifically provides that the measure
of damages for an encoding error is the actual loss incurred by
the claimant. See 13 Pa. Cons. Stat. Ann. § 4209(a), (c).
NBT’s position also overlooks the fact that, pursuant to §
4103 of the UCC, all of Regulation CC is binding on the
parties. Moreover, to the extent there is a conflict between
Regulation CC’s broadly worded “actual loss” remedy and the
provisions of the UCC that create a strict accountability
regime with respect to the midnight deadline rule, such a
conflict must be resolved in favor of Regulation CC. Support
for this result flows from subpart C of Regulation CC itself,
which states that “the provisions of this subpart supersede any
inconsistent provisions of the UCC as adopted in any state . . .
.” See 12 C.F.R. § 229.41. This result is also supported by §
4103 of the UCC, which, as set forth above, indicates that
Federal Reserve regulations are binding on all parties
operating under the UCC and that such regulations are
considered “agreements” that may vary the effect of the
UCC’s provisions. See 13 Pa. Cons. Stat. Ann. § 4103(a)-(b).
In sum, where NBT’s claim is dependent upon FNCB’s
noncompliance with the encoding requirements imposed by
Regulation CC, NBT cannot render the Regulation CC
damages clause inapplicable merely by characterizing its
claim as an effort to hold FNCB accountable under the UCC.

                              30
        NBT offers a second argument in support of its view
that Regulation CC’s ordinary care liability standard and
“actual loss” remedy provision do not alter the UCC’s regime
of strict accountability for noncompliance with the midnight
deadline rule in the circumstances presented here. NBT
asserts that § 4301(d) of the UCC requires a payor bank to
comply with clearinghouse rules or transferor instructions in
order effectively to return an item prior to the midnight
deadline. NBT points out that the rules or instructions
governing the Reserve Bank’s check-processing services are
contained in Federal Reserve Operating Circular No. 3. NBT
argues that Operating Circular No. 3's references to encoding
requirements, when read in conjunction with § 4301 of the
UCC, create an independent obligation on the part of FNCB
to encode the Disputed Check with the correct routing
number, and that FNCB’s failure to do so means that the
Disputed Check was not “returned” within the meaning of the
midnight deadline rule.

        While NBT correctly states that Operating Circular No.
3 binds the parties, NBT incorrectly asserts that the Circular’s
references to encoding requirements somehow negate
Regulation CC’s requirement that damages be measured with
reference to actual loss. Operating Circular No. 3 does not
contain an independent encoding requirement. Instead, it
incorporates subpart C of Regulation CC in its entirety,
including both the encoding requirement as well as ordinary
care liability standard and the remedy provision stating that

                              31
the measure of damages for failure to comply with subpart C
of Regulation CC is to measured by the claimant’s actual loss.
See Fed. Reserve Op. Circ. No. 3, at 1, ¶ 1.1. While
Operating Circular No. 3 does state that its own provisions
supersede any inconsistent provisions of the UCC and
Regulation CC, nothing in Operating Circular No. 3
contradicts or is inconsistent with the Regulation CC
provision calling for measurement of damages based upon
actual loss. Nor does Operating Circular No. 3 impose an
encoding requirement separate or apart from its incorporation
of the encoding provisions of Regulation CC. The Circular’s
references to encoding simply emphasize that Reserve Banks
retain the right to rely on the routing number encoded on a
qualified return check, while stating that a payor bank that
erroneously encodes a routing number agrees to indemnify the
Reserve Bank for any loss suffered as a result of the error.
See id. at 10, ¶ 15.6.

       These encoding references in Operating Circular No. 3
do not impose a separate encoding obligation apart from the
encoding requirement imposed by Regulation CC, and they in
no way alter or conflict with Operating Circular No. 3's
incorporation of the Regulation CC provision requiring that
damages resulting from noncompliance be measured with
reference to the claimant’s actual loss. Thus, to the extent
Regulation CC’s encoding requirement is deemed a
“clearinghouse rule” or “transferor instruction” by virtue of its
incorporation into Operating Circular No. 3, it is a rule or

                               32
instruction with a specific remedy attached. Moreover, to the
extent that this remedy (damages based upon actual loss)
conflicts with the strict accountability remedy available under
the UCC’s check-return provisions, the conflict must be
resolved in favor of the former. As discussed above, this
result is dictated by Operating Circular No. 3, which states
that the Circular’s provisions supersede any inconsistent
provisions of the UCC. See id. at 1, ¶ 1.1. This result is also
supported by the UCC itself, which provides that
clearinghouse rules are binding on the parties involved in a
checking transaction, and that such a binding agreement may
vary the UCC so long as it does not purport to disclaim a
bank’s obligation to act in good faith and exercise ordinary
care. See 13 Pa. Cons. Stat. Ann. § 4103(a)-(b).

IV.    CONCLUSION

       NBT has consistently emphasized that it seeks
recovery pursuant to §§ 4215, 4301, and 4302 of the UCC.
The UCC itself directs that its provisions, including those that
create a strict accountability regime in connection with the
midnight deadline rule, may be altered by agreement. The
UCC also provides that Federal Reserve regulations and
operating circulars are by operation of law deemed binding
agreements governing all parties subject to Article 4 of the
UCC. The encoding requirements invoked by NBT are found
in subpart C of Regulation CC. Subpart C indicates that
compliance with its provisions is to be measured by a

                               33
standard of ordinary care. Subpart C also states that the
measure of damages for a failure to exercise ordinary care in
complying with its requirements is the actual loss a claimant
suffers as a result of such failure.

       In the present case, the parties stipulated that NBT did
not suffer any actual damages as a result of FNCB’s encoding
error. The parties are bound by Regulation CC in its entirety,
including its remedy provision, which supersedes any
inconsistent provisions of the UCC. NBT thus may not
invoke §§ 4215, 4301, and 4302 of the UCC to require that
FNCB be held strictly accountable for the Disputed Check
based upon FNCB’s failure to comply with Regulation CC’s
encoding requirement.

        The fact that the parties are also bound by Federal
Reserve Operating Circular No. 3 does not change the result.
To the extent Operating Circular No. 3 incorporates the
encoding requirement of Regulation CC, it also incorporates
Regulation CC’s liability standard and remedy provision. As
with Regulation CC, the provisions of Operating Circular No.
3 by operation of law form an agreement that binds the parties
and that varies any inconsistent UCC provisions. NBT’s
attempt to invoke UCC provisions that create strict
accountability in connection with the midnight deadline rule
fails to acknowledge that, in this case, these provisions have
been effectively amended by Operating Circular No. 3's
incorporation of Regulation CC’s “actual loss” remedy

                              34
provision.

       Accordingly, because the facts are not in dispute, and
because NBT’s claim fails as a matter of law, we affirm the
order of the District Court granting summary judgment in
favor of FNCB

                              35