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Banking Law: A Bank's Liability for Wrongful Dishonor

Introduction

What happens when a person presents a check for payment and the drawee bank refuses to honor (provide funds to cover) that check? What makes such a refusal "wrongful" in the first place, and who may recover for any harm that results from the wrongful dishonor? Although there are some guidelines in this area, the answers to these questions often turn on the specific facts of any given case. For this reason, it is important to seek an attorney experienced in the areas of banking and commerce regulation when deciding how to proceed in cases of wrongful check dishonor.

A Bank's Liability for Wrongful Dishonor

A bank's liability for wrongful dishonor (failure to provide payment upon presentation of a check) is governed by the Uniform Commercial Code (UCC), Section 4-402. This rule provides that a payor bank is liable to its customers for damages proximately caused by the wrongful dishonor of a check. The rule also provides that a bank's liability is limited to actual damages proved by the party who was wronged. In addition, proximately caused and proved damages may include damages for an arrest or prosecution of the customer or other consequential damages that resulted from the wrongful dishonor. Whether any consequential damages are proximately caused by the wrongful dishonor is a question of fact to be determined in each case.

In general, "dishonor" includes a refusal to accept or pay a draft or promissory note when duly presented. An instrument is dishonored when a necessary or optional presentment is duly made and due acceptance or payment is refused, or cannot be obtained within the prescribed time. This definition includes the insurer of a letter of credit refusing to pay or accept a draft or demand for payment.

The UCC states that a bank wrongfully dishonors an item if it dishonors an item that is properly payable. A dishonor would not be wrongful in the case where the customer's account balance is not sufficient to cover the amount of the item presented by the payee unless the bank has agreed to pay the overdraft.

Courts generally base their determination of whether a dishonor is wrongful or not on the specific facts or activity which led to the dishonor. For example, courts have been unwilling to rule that a dishonor was wrongful where a customer is unable to establish that he would have had enough money in his account to cover the item presented, but for some improper action by the bank with respect to his account.

Courts consider many, varied banking activities when determining whether a dishonor was wrongful under the Uniform Commercial Code. In some cases, courts have held that a bank is liable for wrongful discharge when a "setoff" by the bank leaves insufficient funds to pay the item presented in the customer's account. In most cases, where a customer owes money to a bank, that bank may use funds in the customer's account to setoff the amount owed. However, where the evidence shows that the setoff occurred after the item posted, or was presented for payment, courts have held that the subsequent dishonor was, in fact, wrongful. Courts found similar incidents of wrongful dishonor where a setoff was placed on the wrong depositor's account and where the depositor, in fact, did not owe the amount upon which the setoff was based.

In determining whether the dishonor of an item was wrongful, courts also review such activities as freezing or impounding funds in a customer's account, debiting a customer's account to correct an erroneous credit (after assuring the customer that the credit was proper), and a bank's refusal to honor its own cashier's check.

The Uniform Commercial Code, Section 4-402, also governs who may bring an action of wrongful dishonor against a bank. Only a "person" who is a customer of the payor bank may bring such an action. There are many, sometimes conflicting court decisions as to the definition of "customer," but the term generally includes any person having an account with the bank. Even so, most courts answer this question of who is a customer by reviewing the facts of each individual case.

Loan applicants, generally, cannot bring a claim against a bank because they are not "customers" of the bank for purposes of determining liability under UCC, Section 4-402. In one particular instance, a person who had a car loan with one bank attempted to secure a loan with a second bank for the purpose of paying off the first loan. The second bank initially approved the loan and the original bank issued a draft on behalf of the applicant. However, the second bank later denied the loan application and refused the draft of the original bank. That bank repossessed the applicant's car, and the applicant sued the second bank for wrongful dishonor of the draft issued by the original bank. The court held that the applicant had no cause of action against the second bank since, as a loan applicant, it was not yet a customer of that bank.

Generally, a payee on a check may not bring a cause of action against a drawee bank for the same reason. That is, the payee is not the bank's "customer." The customer in this case would be the payor/drawer who made out the check for the payee's benefit. However, in some jurisdictions, courts hold that the payee does have a cause of action where the item presented is a cashier's check. This is because courts deem the bank to be its own "customer" on a cashier's check. Not all jurisdictions follow this line of reasoning, though, and one should consult an attorney for a more thorough investigation of this matter.

Similarly, an officer or shareholder of a close corporation may or may not have a cause of action for damages proximately caused by a bank that wrongfully dishonors the corporation's checks, depending upon the facts of each individual case. In one case, the court found that only the owners controlled the corporation's finances, and that they personally vouched for its fiscal responsibility to the bank as well as to the corporation's suppliers and employees. Given these facts, the court held that it was foreseeable that any dishonor of the corporation's checks would directly impact on the reputation and credit of these owners/officers. Therefore, the owners/officers, and not the corporation itself, were the proper parties to bring a cause of action for wrongful dishonor. Courts apply a similar analysis to cases involving partnerships.

Conclusion

In sum, the determination of whether or not a bank is liable for the wrongful dishonor of an item presented turns upon the specific facts of each case and upon the state in which the case is brought. Courts will consider the specific activities leading up to the dishonor of the item when deciding whether there is a cause of action in the first place. Then, they will determine whether or not the person or entity bringing the action is recognized as the bank's "customer" under Section 4-402 of the Uniform Commercial Code. The complainant will have standing to bring a cause of action for damages resulting from the wrongful dishonor if the court decides that the person is, or is deemed to be, the bank's actual "customer."

Form: Demand to Make Good on Bad Check

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Demand to Make Good on Bad Check

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