Current Legal Issues Affecting Central Banks, Volume V
Chapter

COMMENT

Author(s):
Robert Effros
Published Date:
May 1998
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Author(s)
ROBERT G. BALLEN

Electronic cash, or e-cash, and stored value cards raise a number of important issues for central banks and related government regulatory entities around the world, including issues related to consumer protection, central bank reserve requirements, deposit insurance, money laundering, commercial and payment law, counterfeiting and other fraud, privacy, and safety and soundness.

Hypotheticals

Three hypotheticals are presented below by way of illustration. Although these hypotheticals involve stored value cards, they are equally applicable to e-cash type arrangements.

Hypothetical Number 1: Lost or Stolen Stored Value Cards

Charles Consumer purchases with cash from Issuing Bank stored value card Number 1 containing $100 of value. Charles Consumer also purchases from Issuing Bank, using his credit card, stored value card Number 2 containing $1,000 of value. Charles Consumer walks out of Issuing Bank and is robbed by Thomas Thief who steals Charles Consumer’s stored value cards. Charles Consumer runs back into Issuing Bank and reports the robbery of the stored value cards.

  • Should Charles Consumer be able to obtain a refund from Issuing Bank of all or a portion of the value on either stored value card Number 1 or stored value card Number 2?

  • Should Issuing Bank be required to have the ability to block transactions with respect to either stored value card Number 1 or stored value card Number 2?

  • If Charles Consumer is refunded the value on either of the stolen stored value cards and transactions with the stolen cards are not blocked, who bears the loss from these transactions: Issuing Bank, other financial institutions seeking settlement from Issuing Bank on behalf of their merchant customers, or a merchant that accepts the stored value from either Thomas Thief or from another person that took the stored value from Thomas Thief in exchange for goods and services?

Hypothetical Number 2: Terminal Malfunction

Charlotte Consumer purchases with cash from Issuing Bank stored value card Number 3 containing $100 of value. Charlotte Consumer also purchases from Issuing Bank, using her credit card, stored value card Number 4 containing $1,000 of value. Later that day, Charlotte Consumer desires to purchase $50 in groceries from Mike Merchant. Charlotte Consumer puts stored value card Number 3 (containing $100 of value) into the terminal at Mike Merchant’s cashier checkout. The terminal does not appear to register the transaction. Charlotte Consumer then puts stored value card Number 4 (containing $1,000 of value) into the terminal, and this transaction appears to register. Charlotte Consumer leaves Mike Merchant with her $50 of groceries. Because of a further terminal malfunction, the terminal does not register that any value was transferred to Mike Merchant. Several days later, when Charlotte Consumer next uses stored value card Number 3, she realizes that the $50 had been deducted from it by the terminal of Mike Merchant. Moreover, several days after that, when Charlotte Consumer next uses stored value card Number 4, she realizes that the terminal has deducted $500 in value (rather than $50) from it as well.

  • Has Charlotte Consumer’s obligation to Mike Merchant for the groceries she purchased been discharged when the stored value was deducted from Charlotte Consumer’s stored value card? Or, does Charlotte Consumer have a continuing obligation to Mike Merchant until he receives final settlement from Issuing Bank?

  • Should Charlotte Consumer be refunded the debits to either stored value card Number 3 or Number 4 in excess of one $50 debit for the groceries she purchased? If so, who should be responsible for that refund: Issuing Bank or Mike Merchant? If Terminal Bank leases or operates the terminal at Mike Merchant’s store, should Terminal Bank be responsible for the refund? What if the terminal is owned by a nonbank processor instead of Terminal Bank?

  • If the terminal at Mike Merchant’s store does not provide or maintain written receipts or other documentation, how will the transactions in question be reconstructed?

Hypothetical Number 3: Issuing Bank Insolvency

Issuing Bank is the issuer of a large number of stored value cards. As a result of unsafe and unsound practices that are unrelated to its stored value card program, Issuing Bank becomes insolvent and is taken over by the government authorities. At that time, there is $1.5 billion in value outstanding on stored value cards issued by Issuing Bank.

  • Is the government or other deposit insurance entity, as receiver of Issuing Bank, obligated to reimburse holders of stored value cards issued by Issuing Bank? Is the government or other deposit insurance entity obligated to reimburse merchants who have sold goods or services to holders of stored value cards issued by Issuing Bank? Should it matter whether the merchant received this value before or after the insolvency of Issuing Bank?

  • Should the result be different if the issuer of the stored value cards is not a bank?

  • To the extent that stored value obligations become a substitute for cash in a nation’s economy, what steps should the government take for ensuring confidence in a stored value system?

Analysis

Hypothetical Number 1: Lost or Stolen Stored Value Cards

Because stored value cards represent a new payment instrument that has not been addressed fully by U.S. payment laws or U.S. bank regulators, there is no definitive answer to Hypothetical Number 1. Instead, identified below are various factors and policy considerations that may affect the ultimate resolution of the hypothetical.

The relationship between Charles Consumer and Issuing Bank may be governed solely by the terms and conditions of the agreement between Charles Consumer and Issuing Bank. If so, Issuing Bank may be able to hold Charles Consumer fully responsible for a stolen card, or Issuing Bank may agree, under the terms and conditions, to refund some or all of Charles Consumer’s money in order to encourage consumers to hold the stored value cards as a cash substitute. This would be similar to the refund that is available to consumers for lost or stolen traveler’s checks from the issuers of the traveler’s checks. Alternatively, it may be determined by statute or regulation that, as a policy matter, consumers should be protected against the risk of loss from stolen stored value cards and that Issuing Bank should bear some or all of the risk of loss. This sort of consumer protection would be analogous to the limitations under U.S. federal law on consumer liability for lost or stolen credit cards and automatic teller machine (ATM) cards.1 It is unclear whether placing some or all of the risk of loss on the issuers of stored value cards would limit the willingness of at least certain issuers to offer these products to consumers.

Whether Issuing Bank should be required to have the ability to block transactions with a stored value card has a number of important implications. First, not all stored value systems under development include the technological capability to block transactions. Indeed, the costs associated with such capacity may preclude on economic grounds the use of such systems for certain types of transactions. Second, requiring Issuing Bank to block transactions necessitates that it track or have the capacity to track individual card transactions and link them to a particular card or person. This may have the unintended (and undesired) result that Issuing Bank will develop a large database of consumer transactions (such as merchant locations, amounts, and dates). This type of database could raise personal privacy concerns with the users of the stored value cards.2

Assuming that Charles Consumer has been refunded his value, the question of which party in the payments process bears the ultimate risk of loss may be resolved in a number of ways. First, to encourage the widespread acceptance of a particular stored value system, the institutions that develop the system (which may be Issuing Bank and other depository institutions in an association of member banks) may decide that they will accept responsibility as a group for liability arising from the use of lost or stolen cards at merchant locations. Alternatively, Issuing Bank may agree to provide indemnification only to those merchants (and their collecting banks) that have followed certain security procedures when accepting stored value cards. These security procedures, such as the use of an electronic negative file, would cut down on losses attributable to stolen stored value cards. Finally, it is possible that a stored value card system could adopt an operating rule (analogous to rules under U.S. check laws) that the party that first deals with the thief (in this case, the merchant) bears the risk of loss. The allocation of this loss likely will be governed by the Issuing Bank contract, terms and conditions, system rules, or other agreements governing the stored value card.

Hypothetical Number 2: Terminal Malfunction

Again, because stored value cards represent a new payment instrument that has not been addressed fully by U.S. payment laws or U.S. bank regulators, there is no definitive answer to Hypothetical Number 2. Instead, identified below are various factors and policy considerations that may affect the ultimate resolution of the hypothetical.

The issue of discharge of the underlying obligation highlights one of the significant differences between the stored value card and U.S. currency or other legal tender. Under U.S. law, the payment of U.S. currency (legal tender) by a consumer to a merchant in the amount of the obligation owed, as a matter of law, fully satisfies and discharges the obligation at the time the currency is transferred.3 The fact that the merchant subsequently loses the U.S. currency, or the U.S. currency is destroyed (such as in a fire), does not change the legal status of the consumer’s full discharge of the underlying obligation. By comparison, stored value does not meet the definition of U.S. currency or other legal tender because it is not issued by the U.S. Treasury Department and/or is not backed by the U.S. government. Because it is not U.S. currency, a transaction with stored value does not automatically, by operation of law, discharge Charlotte Consumer’s obligation to Mike Merchant.

It is likely that the operating rules that will be developed for stored value systems will address the issue of discharge and may well adopt a rule similar to the legal tender rule. Such a systemwide discharge rule will give the consumer the assurance that a merchant will not be able to come after him or her at a later date and demand payment for a failed stored value transaction. It is also possible that commercial law will be developed to address this issue of discharge, either in the absence of an applicable system operating rule or perhaps in spite of a contrary rule.

Rules regarding responsibility for the failure of a particular stored value transaction will likely be addressed in the operating rules of the stored value systems. Given that stored value systems, at least in the United States, represent a new payment system, there may be pressure on the issuing institutions to indemnify merchants for losses caused by malfunctioning technology in order to encourage merchants to accept these new payment products.

It may be possible to reconstruct transactions with a stored value card using a record of transactions that is stored on the stored value card itself or alternatively in the terminal or at a central database. Depending on the applicable technology, it also may be possible to reconstruct transactions (or at least the amount of the lost stored value) from the record of “unredeemed” value held at the issuing institution that corresponds to the out-standing stored value on the stored value card in question.

Hypothetical Number 3: Issuing Bank Insolvency

As previously noted, because stored value cards represent a new payment instrument that has not been addressed fully by U.S. payment laws or U.S. bank regulators, there is no definitive answer to Hypothetical Number 3. Again, identified below are various factors and policy considerations that may influence the ultimate resolution of the hypothetical.

The question of deposit insurance for stored value obligations is an issue to be determined by the applicable government agency. As in the United States, a particular government may decide that only certain stored value systems qualify for deposit insurance protection, while others do not. For example, a government may require that the issuers of stored value cards maintain certain types of records on the individual holders of the stored value cards in order to qualify for deposit insurance. These records would allow the insurer to determine which of those holders of stored value cards had valid claims against the failed issuer and which did not.

To the extent that stored value systems have replaced cash in a nation’s economy, there would be a strong policy incentive for the government to insure the outstanding stored value in order to prevent a loss of confidence in the entire payment system resulting from the failure of a single issuing institution.

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