Receiving payment for goods or services by directly withdrawing funds from a customer or client's bank account, a practice known commonly as a pre-authorized debit (a "PAD"), is an efficient and effective payment mechanism for many businesses. In Canada, the use of PADs is regulated by the Canadian Payments Association (the "CPA"), a not-for-profit association created in 1980 by the Canadian Payments Act (the "Act"),1 and charged with establishing and operating national systems for the clearing and settlement of payments and other arrangements. The CPA carries out this mandate by bringing together representatives of CPA members and stakeholder groups to develop and implement rules that apply to the clearing and settlement of different types of payments between its member financial institutions, including PADs.2 Rule H1 – Pre-Authorized Debits ("Rule H1") governs the use of PADs in Canada. The Act, and by extension the Rules, are binding on financial institutions in Canada, and every business using PADs to collect payments must comply with Rule H1.
The purpose of this article is to review key changes to Rule H1 that came into effect on June 20, 2008, and will be enforced as of February 28, 2010. The changes to Rule H1 will affect every business that collects payment through the use of PADs (a "Payee"), every Payee's financial institution and every customer who pays an invoice by way of a PAD (a "Payor").
Changes Relating to a Payor's Relationship with its Financial Institution
Pursuant to Rule H1, a Payee must have a contractual arrangement with its financial institution that processes PADs on its behalf (defined as a "Payee Letter of Undertaking" in Rule H1). While the use of such an agreement is not a new requirement, as of February 28, 2010, there are additional mandatory elements that must be included in every Payee Letter of Undertaking. These new elements are as follows:
- a provision restricting the Payee from assigning the Payee
Letter of Undertaking without the consent of the financial
institution holding the accounts of the Payee;
- an agreement by the Payee that, subject to a notice period of
not more than 30 days, it will cease using PADs upon receipt of any
written or oral communication from a Payor;
- an undertaking by the Payee to accept and act on notices of
change of a Payor's payment information received from the
Payee's financial institution (meaning that it is not the
responsibility of the Payee's financial institution to make
- a provision stating that the Payee may only retry to process
any PADs returned for reason of non-sufficient funds one time,
within 30 days of the original attempt, and the Payee may not
include any additional interest, NSF or other additional charges;
- an undertaking to make the terms of any Payor PAD agreements
available to Payors and, where possible, to provide a copy of the
agreement to Payors.
These new requirements for Payee Letters of Undertaking are retroactive and will apply to every current and future Payee Letter of Undertaking. This means that before February 28, 2010, all Payee Letters of Undertaking will need to be modified to include the above provisions.
Changes Relating to PAD Agreements
In addition to a Payee Letter of Undertaking, Rule H1 also requires a Payee to have an agreement with each Payor in respect of any PADs (a "PAD Agreement"). The CPA provides a comprehensive list of the requirements for PAD Agreements as well as sample forms on its website.3 As of February 28, 2010, all new PAD Agreements will also be required to contain certain additional elements. These additional elements include:
- a provision stating that the Payee has the authority to debit a
specific account (with particulars for that account);
- a provision restricting the Payee from assigning a PAD
Agreement, except if such assignment clause is prominently
displayed (i.e. printed in bold and highlighted) and allows for at
least ten days notice to the Payor;
- a provision requiring the Payee to give the Payor at least ten
days notice if it is going to change its name;
- the amount and timing of the PAD (if the amount or schedule is
variable, the PAD Agreement must indicate this, and further
- the PAD category (i.e. business, personal or funds
- the date of the agreement, and for paper agreements, the
- a provision stating that the Payor may cancel the PAD Agreement
at any time, with the minimum advance notice specified;
- a provision clearly stating the method by which a Payor can
cancel all future PADs;
- a provision stating that the time required to cancel the PAD
Agreement before the next PAD will not exceed 30 days;
- a statement advising Payors that they may obtain a sample
cancellation form, or further information on their right to cancel
a PAD Agreement, at their financial institution or by visiting the
CPA's web site;
- a statement advising of Payee contact information that may be
used for inquiries, to obtain information or seek recourse for
improperly authorized PADs;
- if the Payor is reducing any notification periods for PADs
required by Rule H1, for example the notice required prior to
completing the first PAD, such reductions must be prominently
displayed (i.e. printed in bold and highlighted); and
- the following standard statement about the recourse available
to the Payor:
"You have certain recourse rights if any debit does not comply with this agreement. For example, you have the right to receive reimbursement for any PAD that is not authorized or is not consistent with the terms of this PAD Agreement. To obtain more information on your recourse rights, contact your financial institution or visit www.cdnpay.ca." (www.cdnpay.ca)
It is important to note that there is no requirement to amend existing PAD Agreements, meaning that PAD Agreements currently in place will be valid after February 28, 2010, whether or not they include the above elements. However, for any agreement made after February 28, 2010, or if a Payee or a Payor wishes to amend an existing PAD Agreement after February 28, 2010, such agreements will need to include the elements discussed above. In addition, every Payee is required to submit their new form of PAD Agreement, which must include the above elements, to its financial institution for review and confirmation that it meets the standards set out in Rule H1.
Changes Relating to Electronic PAD Agreements
Provided that all mandatory elements of a written PAD Agreement are incorporated, a Payee may establish a PAD Agreement through electronic means (i.e. through the Internet, or over the phone). However, when doing so the Payee must now use "Commercially Reasonable" means to confirm the identity of the Payor and the Payee must send the Payor written confirmation of the PAD Agreement within 15 calendar days. Confirmation of identity is required to ensure that the personal and banking information used in the PAD Agreement actually belongs to that Payor.
"Commercially Reasonable" is a defined term in Rule H1, used to describe the threshold that must be met by a Payee when confirming the identity of a Payor. Whether or not a Payee has met the standard of Commercially Reasonable is a subjective test, and depends on several factors including: the procedure itself, the commercial circumstances of the Payee, the nature of the business involved, the amount of the transaction, the Payee's volume of payments, the sophistication of the parties, the availability and/or rejection of alternative procedures, the cost of alternative procedures, the procedures used in similar types of businesses and whether there is an existing business relationship between the parties.
Some of the examples of what may be considered Commercially Reasonable methods of identity verification include: requesting several forms of identification documents, obtaining information from a credit bureau or third party databases and asking the Payor to answer questions relating to that information, sending information to a Payor's independently confirmed address and requesting verification of that information, the use of caller identification and the use of biometric methods like voice recognition. While there is no doubt that the Commercially Reasonable standard imposed by Rule H1 is somewhat vague, a Payee can take comfort in the fact that, regardless of the methods used, its identity verification process must be reviewed by its financial institution prior to implementation. This will help a Payee to confirm that the method devised for identity verification is satisfactory and meets the requirements of Rule H1.
Other Changes to Rule H1
There are other changes to relating to PADs that will come into force on February 28, 2010. Due to the expansion of certain defined terms in Rule H1, PADs may now be at set intervals which occur as the result of a criterion or event defined in the PAD Agreement, even though the actual timing and frequency may vary. This will no doubt make PADs more useful for businesses that do not bill on a regular cycle. Additional requirements relating to such variable PADs (i.e. PAD that is not for a consistent amount) and sporadic PADs (i.e. a PAD that does not occur on at regular intervals) apply, and a Payee should consult Rule H1 and its financial institution to ensure compliance with Rule H1.
Finally, Payees should note that after February 28, 2010, a Payor will be given the right to dispute a PAD pursuant to Rule H1 in a broader array of situations. These include situations where a Payee fails to provide written confirmation of an electronic PAD Agreement to a Payor, as described above, or does not meet the defined periods for sending the confirmation prior to the first PAD. It is therefore more important than ever that all Payees ensure compliance with the requirements of Rule H1.
Consequences for Non-Compliance
If a Payee does not comply with the amended Rule H1 by February 28, 2010, it will be in violation of its revised Payee Letter of Undertaking and could be subject to penalties and/or potentially denial of service by its financial institution. If the CPA becomes aware of such non-compliance, the Payee's financial institution is notified and is required to investigate the issue. If an instance of non-compliance is not resolved, the CPA has the ability to impose a maximum penalty of $250,000 on the Payee's financial institution. Depending on the contractual arrangement with the Payee's financial institution, this fine could be passed along to the Payee and the financial institution could deny further service. Furthermore, a Payee could have difficulties finding another financial institution that will sponsor its use of PADs.
All Payees and their financial institutions should, by this point, have completed or be well on their way to completing the required revisions to Payee Letters of Undertaking and PAD Agreements, and ensuring that methods for confirming identity are in compliance with Rule H1. For those who have not yet made the required changes to standard forms and decided how best to identify customers, quick action should be taken to ensure compliance by February 28, 2010, thereby avoiding liability for any fines that the CPA may impose.
1 R.S.C. 1985, c. C-21
2 See: http://www.cdnpay.ca/about/overview.asp (www.cdnpay.ca/about/overview.asp).
3 See: http://www.cdnpay.ca/news/pdfs_news/rule_h1_appendix_2.pdf (www.cdnpay.ca/news/pdfs_news/rule_h1_appendix_2.pdf).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.