Keith Barnett discusses the complex interplay between payroll processing, Nacha rules, and state labor laws.
In this episode of Payments Pros, Keith Barnett discusses the complex interplay between payroll processing, Nacha rules, and state labor laws. Building on previous discussions about earned wage access (EWA), Keith examines common issues such as duplicate payments and overpayments, highlighting the importance of adhering to Nacha rules and state-specific labor laws. He explains how erroneous entries are defined under Nacha and the conditions under which reversals can be initiated.
The episode also explores the challenges posed by state labor laws, particularly in California and New York, emphasizing the need for employers and processors to navigate both federal and state regulations carefully.
Payments Pros – The Payments Law Podcast
Wage Wonders: Unraveling Payroll Mysteries With Nacha and State Insights
Keith Barnett:
Welcome to another episode of Payments Pros, a Troutman Pepper Lock podcast, focusing on the highly regulated and ever evolving payment processing industry. This podcast features insights from members of our FinTech and payments practice, as well as guest commentary from business leaders and regulatory experts in the payments industry. My name is Keith Barnett and I'm one of the hosts of the podcast. Before we jump into today's episode, let me remind you to visit and subscribe to our blog, TroutmanFinancialServices.com. And don't forget to check out our other podcasts on troutman.com/podcasts. We have episodes that focus on trends that drive enforcement activity, digital assets, consumer financial services and more. And make sure to subscribe to hear the latest episodes. Today I will talk about the interplay between payroll processing, the Nacha rules, and state labor laws. The reason why we're doing this is because in the past we've done a couple of episodes on EWA earned wage access, and during those podcasts we discussed what EWA is and how it works, along with attempts to regulate it from a state and federal law perspective.
Those podcasts led to a larger discussion about the interplay between the payroll processing industry, generally the Nacha rules and the state laws that affect payroll. And when I say state laws that affect payroll, I'm referring to state labor laws, right? I'm not talking about state money transmitter laws or state lending laws, which by the way, we've also done podcasts on those as well. But in any event, the larger discussion focuses on several things that can occur with EWA payments, but also payroll generally. And those several things are one, duplicate payments that can occur in the EWA space and in payroll processing. Generally, someone can get paid multiple times by mistake twice or more than twice by mistake, either from the ODFI, the processor or some other reason.
And a second thing that can occur are overpayments. Someone could be paid more than what the intent was, and at least in the EWA space, that is why it is important to limit the percentage of funds that an employee could obtain early.
Some of our EWA clients limit this to 70 to 80%. Let's also talk about the Nacha rules. We have not discussed that at all in connection with EWA or payroll in our prior podcast. So under the Nacha rules, the originator, which would most likely be the employer, or I guess in some cases the EWA provider, or very rarely it would be the payroll processor because they would be a third party sender. But the originator can initiate a reversing entry to correct an erroneous entry within five days of settlement of the erroneous entry. And under the Nacha rules, an erroneous entry can only be one of five things. It could be either duplicate entry, which we have discussed before, that's one erroneous entry. A second one is a payment to or from a receiver different than the receiver intended to be credited or debited by the originator.
In the case of payroll, the receiver would be the employee, and these would be credits not debits. The third way is a payment in a dollar amount different than was intended by the originator, which we've already discussed. The fourth way is payment of a credit entry on a date later than the receiver was intended to be credited by the originator. And finally, the fifth way is a credit PPD entry that is related to a receiver's employment. The value of the credit PPD entry is fully included in the amount of a check delivered to the same receiver at or prior to the receiver separation from employment. And the credit PPD entry was transmitted by the originator prior to the delivery of the check to the receiver. The bottom line here is that fifth method is if someone receives both an electronic payment and a payroll check, another form of duplicate payment, which we would not see in EWA, and is not the focus of this discussion.
But you also need to keep in mind that the five reasons that I just provided are the only allowed erroneous entries under the Nacha rules. In other words, a reversal cannot occur unless one of those five things have happened. And as I mentioned before, what EWA and payroll processors will most likely incur are the duplicate payments or payment in a dollar amount different than what was intended. Nacha has made it clear that an erroneous entry does not occur and reversal is improper. If, for example, there is a lack of funding in the account with the ODFI and a payment is sent anyway, that is not an erroneous entry. It cannot be reversed. So if the employer or processor does not have enough funds in the account and there's a return, there is no reversal allowed under the Nacha rules. The next thing that I want to mention is this.
We have all heard stories about money being sent to the wrong person through a payments network and the recipient not returning the money. Well, the same thing can happen in the payroll context, right? You run that same risk with EWA if someone is overpaid or if they're duplicate payments or if money is sent to the wrong employee. The issues become even trickier when the employee is an hourly employee. And even more tricky if that employee has left the company and they have received an overpayment duplicate payment or payment made to the wrong person. But let's back up for a second and let's present a hypothetical situation. Let's assume that the reversal is for a proper reason. So one of the five reasons that I mentioned before, if that's the case, the not your rules require the ODFI or the originator to make a reasonable attempt to notify the recipient of the funds no later than the settlement date of the reversal.
To be clear here, the Nacha rules do not define what is reasonable, but in the employment context, you'd like to believe that the employer should have the employee's contact information, even if the person has left the employer. And one thing that I forgot to mention earlier, because this goes along with the timeline, if a reversal is attempted, it must be attempted within five days of settlement. So you would like to believe that the employer has the employee's contact information or at least last known contact information within that five day window. But here's where the interplay with state labor laws occurs. Even if you provide reasonable notice under the Nacha rules, you need to keep in mind that there are state labor laws that need to be followed depending on the state in which the employee is located. And I will give you a couple of examples before we wrap this whole thing up for the day, the California and New York State labor laws.
So let's start with California. California has a state law Labor Code Section 2 21 that prohibits employers from clawing back or deducting wages that have already been paid to employees. This law is pretty clear. It's absolute right now through other portions of the statute and case law, there are procedures through which an employer can recover an overpayment or duplicate payment. But the bottom line here is that reasonable notice is not enough. The employer in California has to go through several hurdles in addition to reasonable notice before they can attempt to claw back any overpayment of funds. So the lesson here is even if you provide the reasonable notice under the Nacha rules, a California employer needs to make sure it follows California state labor laws before attempting a clawback. New York is another example. New York has a state law that requires more than reasonable notice. New York provides a procedure through which an employer can recover overpayments that the employer must follow.
And this notice under New York law must be given at least three days before a deduction in some instances and three weeks before a deduction. In other instances, New York also requires the employer to have a procedure to allow the employee to dispute the employer's contention that there was an overpayment or the terms of recovery and the failure to provide the procedure to the employee creates the presumption that the contested deduction was not permissible.
So the point that I'm trying to convey here is that it would be prudent for all employers processors, EWA providers, compliance people, everyone along the payment scale to take both the NACHA rules and state labor laws into account when processing payments for payroll, especially when you're dealing with earned wage access.
Thank you to our audience for listening to today's episode. And don't forget to visit our blog, TroutmanFinancialServices.com and subscribe so you can get the latest updates. Please make sure to subscribe to this podcast via Apple Podcast, Google Play, Stitcher, Spotify, or whatever platform you choose, and we look forward to the next time.
Copyright, Troutman Pepper Locke LLP. These recorded materials are designed for educational purposes only. This podcast is not legal advice and does not create an attorney-client relationship. The views and opinions expressed in this podcast are solely those of the individual participants. Troutman does not make any representations or warranties, express or implied, regarding the contents of this podcast. Information on previous case results does not guarantee a similar future result. Users of this podcast may save and use the podcast only for personal or other non-commercial, educational purposes. No other use, including, without limitation, reproduction, retransmission or editing of this podcast may be made without the prior written permission of Troutman Pepper Locke. If you have any questions, please contact us at troutman.com.