What Exactly Is Good Funds Law?
Good funds law refers to legislation or regulations within a governing jurisdiction that dictate how financial transactions should be conducted and how funds should be handled. This is essential for establishing the manner in which financial institutions and users conduct transactions, and serves various purposes including the protection of both the sender and receiver of payments. Adherence to good funds law is critical when it comes to settlements and disbursements, particularly in real estate transactions where the risk of fraud is prevalent due in part to the large sums of money involved.
Good funds law is not an arbitrary requirement. In fact, it is designed to protect clients of all kinds: consumers, both those who pay and those who receive payment, and not just in real estate transactions . For instance, where appropriate, settlement agents should disburse all funds related to a transaction (not just those for which sufficient cash has been deposited) from one pooled trust account into a separate, single-purpose disbursement account. To guard against the risk of loss of interest, settlement agents distribute the accrued interest among other customers who benefitted during the period from the agent’s investment of the funds in a pooled trust account. Also, settlement agents and other relevant parties are expected to hold the earnest money deposit until all the following conditions are met: the buyer’s loan is approved, the seller’s loan is paid off, and all required documents are in place.
The Origins of Good Funds Law
The exact origins of the Good Funds Law are lost to the passage of time; however, the general idea of protecting clients from the loss caused by fraud is not. As early as 1189, the first recorded disappearance of client money from a lawyer’s account occurred in England, when "executor accounts" of lawyers were kept in a short book that ultimately vanished. The disappearance of this book along with client money resulted in a law dated March 15, 1234 . . . which said that in the future such accounts should be kept in the ‘writings of another,’ meaning that such accounts should be kept in a manner and in a place separate from the lawyer’s own books and papers." For reasons of both client protection and increased demand for lawyers as business people, the legal profession moved away from the old model. Over the course of the next several hundred years, promises to keep client money separate from the lawyer’s own financial interests expanded. In the 1600s, money was kept in safes. By the late 1700s, money was kept in barrels or boxes. By 1861, Safe Depository Associations were created. If there was any question about the adequacy of these safekeeping measures, an insurance industry commitment arose, insuring the security of such accounts.
How Good Funds Law Shields Consumers
At its core, good funds law protects consumers by providing them with confidence that the money they receive is valid. When a consumer cashes a check, for example, they should be able to trust that the funds being exchanged will not bounce. In Texas, the law went into effect on January 1, 2013 and requires that all financial institutions providing closing services for real estate transactions comply with the law. The funds referenced include wire transfers, cashier’s checks, electronic deposits and cash. When examining what type of funds will "clear" before the transaction closes, not all currency is treated equally. Some banks hold a portion of direct deposits or cashier’s checks until funds clear their own institution before releasing them into their clients’ account, whereas wired funds are generally available immediately. Regarding cashier’s checks, the new law specifies that they must be issued for at least 80% of their face value by a federally insured institution in order for it to be considered "good funds." A money orders is also acceptable under the law; however, they must be purchased from a financial institution in order to be valid.
How Good Funds Law Applies to Real Estate Transactions
Good funds means good fortune in a real estate transaction. The Good Funds Law, originally designed to deter financial crooks who would issue bad checks to closing attorneys and real estate agents, has become a great boon and savior of buyers and sellers. How? The law, which has been adopted in some form or other in most states, mandates that a buyer and/or seller must have the entire required funds at or prior to closing and that the funds must be checked by the attorney to make sure the funds are correct and valid. Having the funds on hand means no waiting for a check to clear or waiting for a deposit to be made. For sellers, not having to wait can mean a lot. Once a seller knows that the buyer’s funds are there he can go ahead and close the deal. For buyers, the Good Funds Law creates an obligation to pay the full amount due at or prior to closing. Nothing less can result in closing. Payment doesn’t have to be in the form of cash, as in when this law was enacted in Georgia 30 years ago. But the payment must still be paid in full with "good funds." The Good Funds Law also means that the costs of the transaction are clearly stated up front. Sellers know exactly how much is coming their way and buyers know up front what they’ll need to pay in order to walk away with a signed, sealed and delivered property. Buyers will also save money by virtue of the fact that they don’t have to pay interest on the money while waiting for it to clear. The seller won’t see the funds until all funds are cleared, so the anticipated income for the seller will be delayed without Good Funds. Thanks to the law, buyers, sellers and those who handle closings benefit from timely transactions. No one can be shorted the funds they are supposed to receive or be delayed in waiting for those funds to come through. At the end of the day, buyers and sellers can sign the papers they need to, and also make sure that everything they are expecting is in place.
Legal Requirements and Compliance
The implementation of Good Funds Law also brings new compliance requirements for financial institutions and businesses. Failure to comply with Good Funds Law carries significant penalties. In addition to the New York Department of Financial Services’ authority to pursue civil enforcement, non-compliance can also lead to referral for criminal prosecution under Penal Law § 210.00, Penal Law § 180.03, Penal Law § 470.05, and Education Law §§ 6512 and 6530(20). And, of course, failure to adhere to Good Funds Law brings the very real risk that one might ultimately become a party to a case of mortgage fraud.
Section 500.18 of the New York Banking Law requires banks to ensure that demand deposit accounts are available to receive electronic payments and that they are used for their intended short-term purpose to receive third-party funds and then transfer those funds to other providers. Banks must have controls in place for receiving ERL’s to ensure that all required information is collected, and the funds deposited in accordance with Good Funds Law. The Money Transmission Business is one that is highly regulated in NY. As such, if one is in the business of transmitting money electronically, or for that matter, issuing physical checks, the Good Funds Law must be adhered to, and must be considered up front in the business plan.
At the core of the Good Funds Law is the goal that the payment being received clears as soon as the account holder has the right to take possession of the funds and make an effective transfer of those funds to another party. Most people are familiar with the nightmare scenario wherein a check has "cleared" the bank and the payee has access to the funds solely for the item to bounce days later leaving the unforeseen potential for legal liability to both sides of the transaction. Such a situation is now expressly prohibited by Good Funds Law. The construction of Section 500.18 of the NY Banking Law makes this clear:
Article 1 , section 537 of the New York Consolidation Laws defines the term "electronic funds transfer," and is expanded by the Banking Law to include "a lawful method of doing businesses whereby each party involved engages a third party who is licensed as a money transmission business to three-way wire transmittance." While the statute does not define the term "money transmission business," it would appear to include bank money orders, cashiers’ checks and similar products that allow customers to transmit money to beneficiaries without the need for the deposit of funds directly by a financial institution (that is to say, without any record that a particular customer provided the funds). In this way, Good Funds Law would also apply to the issuance of physical bank instruments.
The procedural changes that come with Good Funds Law may be summarized as follows: A primary defender of Good Funds Law is Informa Research Services, Inc. which advises that its subscribers will be able to report on any violations found to have occurred with service providers. Other than this level of accountability, there is currently no official organization fulfilling a role in regard to Good Funds Law compliance that is analogous to, say, FINRA, although such an idea may have its genesis in the $2 million settlement of Thomas E. Potts, doing business as T.E.P., Inc., and T.E.P. Compliance Services, commuting from their original home state of Arizona to operate in New York. Nevertheless, banks, credit unions, and licensed money transmitters are subject to mandatory examination by the New York Department of Financial Services so we should anticipate an increase in enforcement actions against non-compliant entities and individuals.
Again, as a point of emphasis, it is well to stress that although Good Funds Law expressly requires financial institutions to refuse to accept a mortgage payoff on a non-ERL check, banks, credit unions, and licensed money transmitters can expect to see a significant uptick in the number of lawsuits they will need to defend.
Controversies and Critiques Surrounding Good Funds Law
While Good Funds Law has clear benefits, it also presents certain challenges and criticisms that stakeholders must navigate. One of the primary challenges is the administrative burden it places on all parties involved in a transaction. From gaining pre-closing funding approval from lenders to managing trust and escrow account fees, the requirements of Good Funds Law can add significant costs and time to closing closings. Real estate agents are often tasked with coordinating these pre-closing fundings, which can prove time consuming and complex. While the legislature undertook Good Funds Law to protect buyers, those who know firsthand the realities of the closing process understand this is not a simple procedure.
Another criticism of Good Funds Law is that, in some cases, it can slow down the efficiency of transactions in an already-tight housing market. The scrutiny and data-entry requirements associated with the Good Funds requirements can add time to the closing process. This may be less of an issue for buyers in lesser populated areas that generally do not have the same number of transactions in close proximity to each other, but in highly populated areas with lots of buying and selling activity it can present a logistical issue. It can also result in a very mild, yet noticeable, dip in sales prices for transactions involving a bank financing transaction that requires a wire notice to be sent to the lender.
On the critical side, few feel that Good Funds Law is a one-size-fits-all solution to real estate transactions, especially given the different realities increasingly facing buyers and sellers of homes and commercial property. While many of its key principles may be universally applicable, there are exceptions: for instance, some homebuyers may find it more prudent or convenient to make a deposit using a trust account check rather than a wire transfer. The most common exception is that many new construction homes or larger commercial builds use Good Funds when it comes to making their down payments vs. portioning them out to pay the vendors as the project progresses. Implementation of Good Funds Law in these cases may not be cost-effective – or even possible – for buyers or sellers.
The Evolution of Good Funds Law
The evolution of the practice and related technology may very well lead to reform in this area. The Good Funds Law was designed more than two decades ago when people kept their financial records on paper and Wall Street was not so accessible from small town America. It is not a stretch to envision a future where there is no need for checks or debit cards. Electronic transfers will occur and instantaneously. And with no checks to cash at the bank (after clearing), there is no need for funds to be on hold for clearance.
How then will we deal with notifications, confirmations, and instructions to which the existing law refers? Electronic communication and tracking systems will certainly evolve to solve these issues. But further , it is not hard to envision that the fundamentals of an attorney’s handling of money, the attorneys’ reliance upon and understanding of the financial institutions’ process for handling funds also becoming electronic and reflected through the trust account. In that world, there may be no need for any rules regarding withholding. It will all simply resolve itself in a digital and electronic world.
Like many things, the Good Funds Law impacts a very specific sector of banking and professional regulation. But it is one of many that must ultimately evolve alongside changes in banking systems and information sharing.