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.