Refusal to Pay Overdrafts: Potential Bank Liability

Although notes and checks are both negotiable instruments, their ‘journey’ is very different. Notes may change hands several times, acquire the involvement of secondary obligors, and the main time a bank examines a note is if it is going to assume the role of the lender.  The presentment of a note will initially be made to the maker, not a bank.  Further, there will not be presentment if the maker is paying in a timely manner.  Checks, on the other hand, have a much quicker journey and the check, or the image of the check, will end up in one spot: the payor bank, i.e. the bank upon which the check is drawn.  Hence, in examining the stolen and forged check in the book excerpt posted, one must of necessity, look at the activities of the payor bank.  The central involvement of the payor bank requires an examination of when it has the authority to charge its customers account. 

            That analysis begins with section 4-401, which requires banks that banks to pay items that are ‘properly payable’.

(a)  A bank may charge against the account of a customer an item that is properly payable from that account even though the charge creates an overdraft. An item is properly payable if it is authorized by the customer and is in accordance with any agreement between the customer and bank.  Section 4-401(a)

The second sentence of Section 4-401(a) states two requirements for an item to be properly payable.  First, it must be authorized by the customer.  Second, it must be in accordance with the agreement between the bank and customer. It follows that an item is not ‘properly payable’ if it is not authorized by the customer, or if the payment is in violation of the agreement that the customer has with its bank.

            Before addressing Section 4-401(a) in connection with the check Harold stole from Jerry [facts stated in the last post], I would like to start by taking a look at the first sentence to Section 4-401 and section 4-402(1) in connection with the overdraft language used in each section.  Section 4-402(1) states as follows:

Except as otherwise provided in this chapter, a payor bank wrongfully dishonors an item if it dishonors an item that is properly payable, but a bank may dishonor an item that would create an overdraft unless it has agreed to pay the overdraft.

Section 4-401(1) appears on its face to ‘allow’ an overdraft if the item is otherwise ‘properly payable’—i.e.—authorized by the customer and in accordance with any agreement the customer may have with its bank.  Section 4-402 allows a bank to dishonor an overdraft ‘unless it has agreed to pay the overdraft’.       

This scenario below is being presented in the context of the discussion on the importance of agreement in the April 16, 2015 and April 20, 2015 posts. This will demonstrate some of the practical applications of that discussion in the relationship between the bank and its customer.

Assume for a moment that a particular bank customer routinely overdraws its account, and that the bank had always paid the items, confident that it would be subsequently covered.  Assume further that the bank makes an internal policy decision to stop paying any overdrafts going forward so when customer’s bank is presented a check, creating an overdraft, it is dishonored by the bank. who cites Section 4-402(1) stating it has never ‘agreed’ to pay an overdraft.  The bank further points to the customer-bank contract which explicitly states that the bank is under no duty to honor overdrafts by a customer.

As a result of the bank’s refusal to pay the overdraft, the customer was unable to close a deal for which the dishonored check was the down payment. 

Plaintiff’s profit on the lost deal would have been $250.000.00, for which plaintiff seeks damages under Section 4-402(2) for wrongful dishonor, stating that the behavior of the bank, in paying past overdrafts, made that an ongoing term of the contract.

A payor bank is liable to its customer for damages proximately caused by the wrongful dishonor of an item. Liability is limited to actual damages proved and may include damages for an arrest or prosecution of the customer or other consequential damages. Whether any consequential damages are proximately caused by the wrongful dishonor is a question of fact to be determined in each case.

            All of this takes us back to the very basic definitions of ‘contract’ and ‘agreement’ which were discussed in detail in earlier posts.  To determine what that contract is, we must first look at the definition of agreement:

"Agreement", as distinguished from "contract", means the bargain of the parties in fact, as found in their language or inferred from other circumstances, including course of performance, course of dealing, or usage of trade as provided in Section 1-303.

                                               Section 1-201(b)(3)

The language in this case would primarily consist of the written agreement between the customer and the bank, as well as the course of performance and course of dealing between the parties.

            Course of performance, if you recall, is defined under Section 1-303(a) as follows:

(a)  A "course of performance" is a sequence of conduct between the parties to a particular transaction that exists if: (1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection.

In this case, the agreement involved ‘repeated occasions for performance’ and the bank accepted the performance by paying the overdrafts and did so ‘without objection’.  The bank would argue that the statement in the customer depositor agreement which negates the bank’s duty to pay overdrafts, trumps course of performance under Section 1-303.  This in turn takes us back to Section 1-303(e):

(e) Except as otherwise provided in subsection (f), the express terms of an agreement and any applicable course of performance, course of dealing, or usage of trade must be construed whenever reasonable as consistent with each other. If such a construction is unreasonable: (1) express terms prevail over course of performance, course of dealing, and usage of trade; (2) course of performance prevails over course of dealing and usage of trade; and (3) course of dealing prevails over usage of trade.

Section 1-303(e) is discussed in post dated April 27, 2015. ‘Do Express Terms Really Control?—and will not be repeated here.  The goal of the plaintiff in this case would be to demonstrate to the court that the depositor/customer agreement and course of performance can be construed ’as consistent with each other’, and further that it is reasonable to do so.  In the earlier post I expressed concerns about any result which placed express language over a course of performance which was inconsistent with the express terms.  As noted in the post however, most cases have reached the result that express terms do in fact control when inconsistent with the course of performance.  However, none of these cases have addressed the construction principle noted above—i.e.—can the express terms and apparently inconsistent course of performance or course of dealing be construed as reasonably consistent with each other.  That is the challenge of advocacy.

            Course of dealing would also be involved in this case since the bank had a long history of honoring the overdrafts of its customer:

 A "course of dealing" is a sequence of conduct concerning previous transactions between the parties to a particular transaction that is fairly to be regarded as establishing a common basis of understanding for interpreting their expressions and other conduct.                  Section 1-303(b)

Clearly, the bank’s payment of overdrafts over a long period of time is a ‘sequence of conduct’ that would be fairly regarded as establishing a ‘common basis’ of understanding that the bank would pay overdrafts.  Once again, the apparent conflict between Section 1-303(e) and enforcing terms ostensibly created by a course of dealing would have to be addressed.

            Assuming that the potential conflict between Sections 1-303(e) is resolved favorably for the plaintiff, the agreement will be interpreted to mean that the bank has in fact ‘agreed’ to pay overdrafts as a result of the course of performance and course of dealing incorporating this term between the parties.  Hence, the dishonor would be in violation of the agreement between the parties for which the bank would be liable.

           

Representative and Forged Signatures

The following is an excerpt from The Uniform Commercial Code Made Easy.  I will complete the Continuing Legal Education presentations this week and will resume writing posts next week.  I do want to say that the work put into the blog has been very helpful in the CLE presentations, a wonderful byproduct of this process. 

Section 10

Doug came to work early the next morning to be sure to get the bank letter as soon as it came in. When it did, Doug was overjoyed. He took it with him to the coffee room hoping someone would ask him what he was reading. As he sipped his morning coffee, he read the following letter:

Dear Doug:

Enclosed please find a copy of a memorandum sent to Mr. Ron Nichols, our vice-president in charge of the legal department. This sets forth the facts of the lawsuit which we discussed yesterday. Should you have any questions, please contact Mr. Nichols or myself.

Very truly yours,

Fred Houstrant

MEMORANDUM

TO:            Ron Nichols, Esq.

FROM:      Sandra Oronski

RE:           Burger Czar check matter

On February 20, 2006, we were informed of the following facts by Alfredo Thomas, vice-president and secretary of Burger Czar:

On Friday January 5, 2006, Burger Czar received a shipment of beef patties from Butcherama, Inc. for which a postdated check in the amount of $12,000 was given (it was postdated to allow time for a deposit to clear).

The check was signed by Thomas in his corporate capacity as treasurer. Sometime shortly thereafter, Butcherama was robbed, the check being taken along with some $27,000 in cash.

On Monday morning, January 8, 2006, a man posing as Brad Garcia, treasurer of Butcherama, presented what appeared to be a proper identification (probably taken in the robbery) and cashed the check at Central Dade Bank where Burger Czar maintained its account.

When Butcherama found out that the check had been taken, it notified Burger Czar immediately who thereupon notified us. It was, of course, too late as the check had already been cashed.

Burger Czar is demanding that its account be recredited...

This case raises several sections already discussed in the book as well as some new material. Several general points can be noted at the outset. First, a postdated check is considered to be an instrument ‘payable at a definite time’ within Section 3-108(b). As the facts indicate, the check was signed in a corporate capacity by Alvin Thomas as treasurer of Burger Czar, and as such, would be a signature by representative governed by Section 3-402.

Subsection (a) to Section 3-402 states the basic rule under which a represented person is bound [here, Burger Czar]:

If a person acting, or purporting to act, as a representative signs an instrument by signing either the name of the represented person or the name of the signer, the represented person would be bound to the same extent the represented person would be bound if the signature were on a simple contract.

Comment 1 to Section 3-402 explains this by saying ‘If under the law of agency the represented person would be bound’ by the representative’s signature, ‘the signature is the authorized signature of the represented person.’  In the present case, Thomas was acting in his corporate capacity as treasurer. He clearly was acting within the scope of his authority, and therefore, the corporation would be bound by his representative signature. As the second sentence to Section 3-402(a) states:

If the represented person is bound, the signature of the representative is the “authorized signature of the represented person” and the represented person is liable on the instrument...

It is important to note that the form in which the representative’s signature is made is extremely important for a few reasons. First, if the representative signature is in the proper form, and is in fact authorized, the representative is not liable on the instrument:

If the form of the signature shows unambiguously that the signature is made on behalf of the represented person who is identified in the instrument, the representative is not liable. Section 3-402(b)(1).

The corollary to that rule is stated in Section 3-402(b)(2):

Subject to subsection (c), if (i) the form of the signature does not show unambiguously that the signature is made in a representative capacity or (ii) the represented person is not identified in the instrument, the representative is liable to a holder in due course that took the instrument without notice that the representative was not intended to be liable....

Finally, Section 3-402(c) referred to in 3-402(b)(1) states:

If a representative signs the name of the representative as drawer of the check without indication of the representative status and the check is payable from an account of the represented person who is identified on the check, the signer is not liable on the check if the signature is an authorized signature of the represented person.

When the beef patties in the present case were received by Burger Czar, it made payment by check. The check which was delivered was stolen, and the endorsement was forged. The thieves endorsed the check as Brad Garcia and were given cash. Brad’s forged endorsement was:

...an unauthorized signature [and] is ineffective except as the signature of the unauthorized signer [the thief who cashed the check] in favor of a person who in good faith pays the instrument or takes it for value. Section 3-304(a).

Therefore, the thief was not a ‘holder’ nor a ‘person entitled to enforce the instrument’ [Section 3-301], and, as a result the check was not properly payable. Absent some culpable conduct by Burger Czar, it would be entitled to have its account recredited.

Restrictive Indorsements & Conversion

The memorandum below is a continuation of last week’s post.  I am reproducing the facts again to put the discussion below into context.

                                                            The Facts

Jerry Zamanski is a salesman at Stephen’s boats. On December 21, 2005 Stephen’s Boats issued an $850 commission check to Jerry. Jerry wrote ‘for deposit only’ on the back of the check and placed it in his desk drawer. Jerry’s identical twin brother Harold stole the check & raised it from $850 to $8,500. Harold took the altered check to East Dade Bank, where Jerry had his account.

Harold explained to the teller, that he had changed his mind on depositing the check and wanted cash for an upcoming vacation. The teller knew Jerry very well, and had done business with him for many years and, believing Harold to be Jerry, allowed him to cross out ‘for deposit only’ followed by his initials. Harold then signed Jerry’s name and was given $8,500 in cash. Two weeks later, the theft, alteration and forgery were discovered.

Stephen’s bank, South Dade, has charged his account $8,500. Jerry has asked Stephen to give him another commission check. Stephen would like an analysis of this situation. Particularly, Stephen wants to know whether he is responsible for the charge to his account, and whether he must reissue the commission check to Jerry.

I would appreciate it very much if you would review these facts in light of the relevant law contained in the Uniform Commercial Code.

Overview: Part II

(A) The Restrictive Indorsement;

(B) Person Entitled to Enforce the Instrument;

(C) The Alteration;

(D) When Payor Bank May Charge Customer’s Account;

A.   The Restrictive Indorsement

You have indicated that when Jerry received the check, he wrote the words “for deposit only” on the back of it. With this language, and accompanying indorsement, this would have been a restrictive indorsement of the check under Section 3-206(c):

If an instrument bears an indorsement ... using the words “for deposit” “for collection,” or other words indicating a purpose of having the instrument collected by a bank for the indorser or for a particular account. . .[it is a restrictive indorsement].

A Depository Bank has strict duties when it receives a check which is restrictively indorsed:

A depository bank that purchases the instrument or takes it for collection when so indorsed converts the instrument unless the amount paid by the bank with respect to the instrument is received by the indorser or applied consistently with the indorsement. Section 3-206(c)(2).

Therefore, any credit given by East Dade for the check should have been “deposited” to Jerry’s account. Harold clearly had no authority to alter the restrictive indorsement. Furthermore, his forged signature of Jerry is ineffective to transfer any rights in the check.[1]

B. Person Entitled to Enforce the Instrument

The only person who was entitled to enforce the instrument as it was originally made out was Jerry:

“Person entitled to enforce” an instrument means:

i.      the holder of the instrument;

ii.     a nonholder in possession of the instrument who is entitled to enforce the instrument; or

iii.   a person not in possession of the instrument who is entitled to enforce the instrument pursuant to 3-309 [Lost or Stolen Instruments] or 3-418(d) [Payment by Mistake]. Section 3-301(i)(ii)(iii).

Sections 3-301(ii)(iii) are outside the general movement of checks and in any event do not apply here. Under Section 3-301(i), the only person entitled to enforce the instrument would be the holder, which is defined as follows:

“Holder” means: the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is in possession. Section 1-201(b)(21)(A).

Harold was not a bearer of the check simply because he had possession of it:

A promise or order is payable to bearer if it:

(1) states that it is payable to bearer or to the order of bearer or otherwise indicates that the person in possession of the promise or order is entitled to payment. Section 3-109(a)(1).

The check was payable to an identified person—Jerry. While in possession, he would have been the holder, and the only person who could have that status [unless he indorsed it]. Therefore, Harold was not a holder, and hence not “entitled to enforce” the instrument.

A.   The Alteration

When Harold raised the check to $8,500, he altered the item:

“Alteration” means (i) an unauthorized change in an instrument that purports to modify in any respect the obligation of a party ... Section 3-407(a).[2]

Of course, in raising the check, the obligation of the drawer was changed from $850 on the check to $8,500. The unauthorized change in the instrument [the check] purported to modify the contract of the drawer [Stephen’s Boats]. Additionally, the change of the restrictive indorsement purported to modify the obligation of East Dade Bank, and was itself an alteration.

The fact that an alteration occurred in the instant situation, however, does not insure that the drawer’s account may not be charged.

A person whose failure to exercise ordinary care substantially contributes to an alteration of an instrument or to the making of a forged signature on an instrument is precluded from asserting the alteration or the forgery against a person who, in good faith, pays the instrument or takes it for value or for collection. Section 3-406(a).

In the present case, Stephen probably issued the check via customary business practices, and would not be within 3-406(a). If however, he would have written the check in pencil, and such conduct, were deemed ‘a failure to exercise ordinary care [which] substantially contribute[d] to the alteration’ Stephen would be precluded from asserting the alteration against the bank, provided, that the bank paid in accordance with the standard set forth in Section 3-406(a).

Similarly, if Jerry were found somehow to be negligent within Section 3-406, he would be similarly precluded from asserting the alteration against his bank. [For example, would it matter if Harold had a history of theft, forgery, or was known to be in desperate need of money?  These are the types of questions that are activated once you get into the facts of a particular case. Does Harold, being an identical twin, figure into this at all?]

D. When a Payor Bank May Charge

Customer’s Account

Part 4 of Article 4 deals with the relationship between the payor bank and its customer, here, South Dade and Stephen. Section 4-401 states when a bank may charge its customer’s account and reads in relevant part as follows:

A bank may charge against the account of a customer an item that is properly payable from the account even though the charge creates an overdraft. An item is properly payable if it is authorized by the customer and is in accordance with any agreement between the customer and the bank. Section 4-401(a).

In the present situation, Stephen’s Boats did not authorize payment in the amount of $8,500, nor did he authorize payment to Harold. Therefore, the item is not ‘properly

payable’ and Stephen should have his account recredited [unless he fell within Section 3-406].

If on the other hand, Jerry had altered the item and taken it for collection, the indorsement would have been effective, and Stephen’s account could have been charged, although not $8,500:

(d) A bank that in good faith makes payment to a holder may charge the indicated account of its customer according to:

(1)  The original terms of the altered item;

(2)  The terms of the completed item, even though the bank knows the item has been completed unless the bank has notice that the completion was improper.

Section 4-401(d)(1)(2).

If in fact Jerry had altered the item, Section 4-401(d)(1) would control. East Dade would have been a ‘holder’ within 1-201(b)(21)(A) since Jerry would have endorsed the check to its order. South Dade would have made a good faith payment to East Dade, and therefore would be entitled to enforce the instrument according to its original terms.

Among the ‘original terms’ of the altered item was the amount to be paid. That amount was $850 and thus, South Dade would be entitled to charge Stephen’s account at least that amount.[3]

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[1] Subsection (a) to Section 3-403 states in pertinent part:

…[A]n unauthorized signature is ineffective except as the signature of the unauthorized signer in favor of a person who in good faith pays the instrument or takes it for value….

Therefore, Harold’s signature was not ‘effective’ as Jerry’s, but in fact operated as Harold’s.

Furthermore, Jerry would not be liable on the instrument since neither he, nor his authorized representative signed it:

A person is not liable on an instrument unless (i) the person signed the instrument, or (ii) the person is represented by an agent or representative who signed the instrument and the signature is binding on the represented person under Section 3-402. Section 3-401(a). 

[2] The obligations of the drawer and endorser are set forth in Sections 3-414 and 3-415 respectively. These sections are discussed in detail later in the book but are reproduced here in case the reader wants to examine the respective obligations of drawer or indorser (in connection with the statement which was the basis for this footnote).

 

[3] Before leaving this case, a few other points should be briefly noted. First, South Dade Bank would have a cause of action against East Dade Bank for breaching warranties under Section 4-207(a)(1)(2)(3):

(a)  A customer or collecting bank that transfers an item and receives a settlement or other consideration warrants to the transferee and to any subsequent collecting bank that:

(1) the warrantor is a person entitled to enforce the instrument;

(2) all signatures on the instrument are genuine and authorized;

(3) the item has not been altered.

It should also be noted that East Dade would have a cause of action against Harold for similar warranties under Section 3-417(a)(1)(2)(3). [See Statutory Supplement for text of these sections.]  Finally, a customer of a bank, such as Stephen, is under a duty to promptly examine his bank statement to discover forgeries or alterations which must be promptly reported to the bank:

If a bank sends or makes available a statement of account or items pursuant to subsection (a), the customer must exercise reasonable promptness in examining the statement or the items to determine whether any payment was not authorized because of an alteration or an item or because a purported signature by or on behalf of the customer was not authorized. If, based on the statement of the items provided, the customer should reasonably have discovered the unauthorized payment, the customer must promptly notify the bank of the relevant facts. Section 4-406(c).

If the bank proves that the customer failed with respect to an item, to comply with the duties imposed on the customer by subsection (c), the customer is precluded from asserting against the bank:

(1) the customer’s unauthorized signature or any alteration on the item, if the bank also proves that it suffered a loss by reason of the failure…. Section 4-406(d)(1).

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