BANKING LAW RESEARCH PAPER

BANK’S DUTY TO HONOUR CHEQUES

AND ITS LIABILITY FOR FAILURE

SUBMITTED BY:
SUPERVISED BY:

Siddhant Raj Prof. Anil Kumar Rai

69LLB16

NATIONAL LAW UNIVERSITY

DELHI
2019
 TABLE OF CONTENTS
ABSTRACT....................................................................................................................................3

BANKER-CUSTOMER RELATIONS...........................................................................................3

OBLIGATIONS AND DUTIES OF A BANK WITH RESPECT TO ITS CUSTOMERS...........4

A BRIEF OVERVIEW OF THE DEBTOR-CREDITOR RELATIONSHIP.................................5

LIABILITY OF A BANK AS A DRAWEE OF THE CHEQUE...................................................6

WHAT IS THE DUTY OF BANK IN THE CASE OF FORGERY OF DRAWER’S

SIGNATURE?.................................................................................................................................7

WHEN IS A BANK JUSTIFIED OR BOUND TO DISHONOUR CHEQUES?..........................8

WHEN IS A BANK SAID TO BE WRONGFULLY EXERCISING ITS POWER TO

DISHONOUR CHEQUES AND LIABILITY OF THE DRAWEE-BANK FOR WRONGFUL
DISHONOUR?..............................................................................................................................10

OVERVIEW OF SECTION 138 IN DEALING WITH DISHONOUR OF CHEQUES FOR

INSUFFICIENCY ETC. OF FUNDS............................................................................................11

OVERDRAFT FACILITY EXTENDED BY THE BANK..........................................................12

BIBLIOGRAPHY..........................................................................................................................13

2
 ABSTRACT
For the purposes of this research project titled “Bank’s duty to honor cheques and its liability for failure”,
the researcher by initially taking a broad perspective has discussed about banker-customer relations along
with the rights and obligations that a bank has vis-a-vis the customer. Post that, there is a detailed
discussion on the duty that a bank has towards the drawer of the cheque stated under Section 31 of the
Negotiable Instruments Act, 1881. After this section, the researcher throws light upon the scenario where
bank doesn’t owe a duty to honor cheque or can go ahead with dishonouring of a cheque. The researcher
then delves into the case where a bank “wrongfully” dishonours a cheque and tries to carve out a test of
dishonour. Towards the end, a section has been devoted for overdraft facility that a bank provides. Here,
the normal debtor-creditor (banker-customer) relationship gets reversed.

BANKER-CUSTOMER RELATIONS
A bank’s primary functions include accepting deposit and lending or investing the same. The money, so
deposited should be repayable to the depositor on demand made through letter or as per the agreement
reached between the two parties.

The relationship between a banker and a customer is premised on the type of transaction. In such a
relationship, both the parties have their share of obligations and rights. There are various types of
relationships that a bank shares with the customer:

i. Debtor and Creditor

ii. Licensor and Licensee
iii. Pledger and Pledgee
iv. Bailor and Bailee
v. Hypothecator and Hypothecatee
vi. Trustee and Beneficiary
vii. Agent and Principal
viii. Advisor and Client

The research project bases itself on the relationship of a debtor-creditor that a bank has with the customer.

3
 OBLIGATIONS AND DUTIES OF A BANK WITH RESPECT TO ITS
CUSTOMERS
Banker-customer relationship gives rise to obligations of a banker towards its customers in the form of:

1. Honouring cheques: The bank is under an obligation to honor its customers’ cheques depending
upon the amount standing to the credit in the account. In the case of wrongful refusal of the bank
to honor the cheque, it is considered to be liable for compensation. Though the obligation is not
of an absolute character. It is subject to certain conditions (formalities):

 Presence of sufficient funds in the customer’s account

 Proper applicability of the funds for the payment of customer’s cheque
 Cheque must be properly drawn up
 Presentment of cheque to be made within reasonable time
 Absence of legal bar that prevents payment on such cheques

2. Maintaining secrecy: The bank is under a duty to not disclose customer’s account details as the
disclosure may adversely impact the credit worthiness of the customer. However, the exceptional
scenarios where a disclosure can be made is where it is required as per the law and where it has
been a practice amongst the banks.

3. Keeping proper records: The Bank is supposed to keep track of all the transactions of its
customers.

4. Following customer’s instructions: It has to follow the instructions on account of the contractual
nature of banker-customer relationship.

5. Giving notice before closure of the account: A reasonable notice ought to be provided to the
Bank if it wishes to close the account of its customer.

On the other hand, banks also have corresponding rights like right of general lien, right of set-off, right of
appropriation, right to charge interest and commission and closing of account. Section 171 of Indian
Contract Act, 1972 confers the right of general lien upon the bankers. It entitles the banking entity to
retain goods and securities until all its claims so pending against the customer come to be satisfied. Such a
right comes to be exercised only where bank is not functioning as a bailee. Banker’s lien is an implied
pledge.1 However, the right to lien is not exercisable in cases where valuables are in safe custody, money
or documents are deposited because of a specific underlined purpose, some securities remain with the
1
Ranjay, “What are the rights and obligations of a bank in relation to its customers?
<https://ignoubcom.wordpress.com/2016/01/02/what-are-the-rights-and-obligations-of-a-bank-in-relation-to-
customers-briefly-explain/> last accessed 12 November, 2019

4
bank due to mistake, bank is apprised of the notice of trust and lastly where it has been expressly stated in
the agreement that the bank won’t be exercising its right to lien.

Right of set off is a right where the debtor can find out the net balance which is payable by adjusting the
amounts due to him from the creditor and the amounts payable to him by the creditor. Right to
appropriation is where the bank, in the absence of particular instructions is said to have the right to
appropriate the customer’s amount for satisfaction of any loan or a time barred debt, on the condition that
it must apprise the customer of such an appropriation. An implied right exists with the banks to charge
interests on loans and advances and also to charge commission for the services that it renders. It also has
the right to close the account after intimating the customer.

A BRIEF OVERVIEW OF THE DEBTOR-CREDITOR RELATIONSHIP

After a customer opens an account having a credit balance with the bank, then that relationship will be
that of a debtor-creditor. With respect to savings, fixed deposit and current account (having credit
balance), the bank is the debtor while the customer is the creditor. A right to retrieve money as per her
will is vested with the customer vis-a-vis the bank. In the case of loan/advance accounts, such a
relationship is reversed. The bank turns into the creditor while the customer becomes the debtor. Here, the
banker can demand the repayment of loan or the amount advanced on the due date and the customer is
obligated to repay the debt. A customer retains the status of a creditor till there is credit balance in his
bank account though she doesn’t get any charge over the assets of the bank. Her status remains that of an
unsecured creditor of the banker.

A debtor-creditor relationship is different from commercial debts on account of the following factors:

1. The creditor (customer) must demand payment. The bank doesn’t repay the debt on its own.
However, in case of fixed deposits, the bank is under a duty to inform the customer about the
maturity.

2. The creditor is supposed to demand the payment at the right venue and time. The right place
would be the branch of the bank where the account has been opened. The right time would be “in
the course of working hours” and on the “date of maturity” in case of fixed deposits. 2

3. The creditor’s demand must be made in a proper manner i.e. in the form of cheques, withdrawal
slips or pay order.

2
“Banker-customer relationship explained” <https://kalyan-city.blogspot.com/2012/04/banker-customer-
relationship-explained.html> last accessed on 12 November, 2019

5
 LIABILITY OF A BANK AS A DRAWEE OF THE CHEQUE
The bank’s responsibility to honor the cheques comes under Section 31 which discusses about the liability
of drawee of cheque. The section is stated as follows:

“The drawee of a cheque having sufficient funds of the drawer in his hands, properly
applicable to the payment of such cheque must pay the cheque when duly required so to do, and
in default of such payment, must compensate the drawer for any loss or damage caused by such
default.”

Discussion of the prevailing law through cases:

Pott v Clegg3 stated that the banker-customer relationship arose out of a contract and was generally one of
a debtor and a creditor. It came with an added obligation upon the banker to honor its customers’ cheques
so long as there were funds in the customers’ accounts with the bank. Cumming v Shand and Md.
Hussain v Chartered Bank4, on the other hand discussed about the extension of banker’s obligation to
honor its customer’s cheque to allow overdraft facility to a certain limit, by way of agreement buttressed
by a valid consideration. London Joint Stock Bank Ltd. v Macmillan and Arthur 5, was an important
case in terms of highlighting the duties of both the bank as well as the customer. While the case saw
cheque as a mandate upon the banker to pay the amount as per the tenor of the cheque, at the same time, it
also cast a duty upon the customer to draw cheques in a manner that enabled the banker to meet its
obligations, not leaving room for any sort of misgiving. Bradley v Agra Bank6 lay down the precedent
with regard to ending of the contract between a banker and customer. It stated that either of the parties
could initiate the process of ending the contract. The customer could recover his loan by way of drawing a
cheque for the due amount by presenting it to the bank. On the other hand, the bank after having decided
to not continue dealings with the customer can also close the account after sufficiently notifying the
customer, post which it can repay the money. State Bank of India v Vathi Samba Murthy 7 stated that a
cheque leaf which came to be issued for use on one account could not be used for drawing upon another
customer’s account. Going by the same rule, Clare v Dresdner Bank8 states that a customer having
balance at a particular branch is not allowed to withdraw at another branch though he has the option of

3
Pott v Clegg (1847) 16 M&W 321
4
Cumming v Shand (1860) 29 LJ Ex 129; Md. Hussain v Chartered Bank (1965) 2 Comp LJ 37.
5
London Joint Stock Bank Ltd v Macmillan and Arthur [1918] AC 777.
6
Bradley v Agra Bank 101 PR 1885.
7
State Bank of India v Vathi Samba Murty AIR 1988 Ori 50
8
Clare v Dresdner Bank [1915] 2 KB 576.

6
applying to have the branch transferred. Joachimson v Swiss Bank9 reaffirms the earlier statement by
limiting the ambit of the bank’s promise to repay its customer to the branch where the customer’s account
is. The bank cannot be called upon to repay at a branch which doesn’t have the customer’s account. Indo
Allied Industries v Punjab National Bank also relaxes the bank’s obligation to pay in case where its’
customer’s account is located in its foreign branch. Thus, if the customer asks for funds to be transferred
to India but the obligation of bank gets hindered by the foreign branch, the bank cannot be said to still
have an unconditional obligation to pay at an alternative office. Lall Chand v Agra Bank10 highlighted
the duty of banker to make payment to the appropriate person i.e. the holder, his servant or agent. Thus, if
the bank ends up paying to the wrong person, it will not be discharged of its liability.

WHAT IS THE DUTY OF BANK IN THE CASE OF FORGERY OF

DRAWER’S SIGNATURE?
A bank (drawee) cannot be said to have any statutory protection where it pays, operating under good
faith, a cheque bearing forged signatures of the drawer. Thus, the bank has an obligation to be acquainted
with the signature of its customer. If it pays upon such a cheque, it is bound to suffer a loss. A customer’s
account in such cases doesn’t get debited due to the fact that it is the bank’s duty to prevent the business
of forgery from being prevalent.

An exception exists to the above mentioned scenario. When the document in the format of cheque is
forged, it is considered to be a nullity ab initio. Due to operation of such a nullity, a bank wrongfully
making a payment on such a cheque cannot make the customer liable except where negligence is
imputable to the customer or where it is found to be intimately connected with the transaction and
was the proximate cause of the loss to the bank. 11 Section 10 of the Act doesn’t regard payment made
on a forged cheque to be payment in due course. Allahabad Bank v Kul Bhushan (1961) was central in
laying down the point that the victims of fraud were both the bank and the customer. Thus, in case of two
innocent parties, the negligent party whose fault led to the loss is to be held primary liable.

Keptigalla Rubber Estates case rendered an important holding. It stated that when a customer is said to
initiate an action against the banker for recovery of amount paid on forged cheques, the Bank cannot
point out that the customer hadn’t perused entries in the pass book or account statement. Thus, the
customer cannot be estopped just because he could have been aware of the forgeries if he had been
slightly diligent.12
9
Joachimson v Swiss Bank Corp [1921] KB 110
10
Lall Chand v Agra Bank (1891) 18 IA 111
11
Khergamvala on Negotiable Instruments Act, 1881
12
Ibid.

7
Where the customer is held liable:

However, it is the customer’s duty to issue mandates to the bank to take reasonable care in order to not
mislead the bank. Wherein the bank makes a payment due to the negligent inducement by the customer,
the bank is not supposed to bear the loss. If the customer ends up drawing a cheque in a manner so
negligent such as to facilitate any alteration to the payable amount, then the loss resulting on account of
such alteration will fall upon the customer and not the bank. Canara Bank v Canara Sales Corporation
is another case that exempts the bank from liability where the bank is able to establish that it had adopted
the payment but was estopped from denying it.

WHEN IS A BANK JUSTIFIED OR BOUND TO DISHONOUR CHEQUES?

A bank is justified or bound to dishonour cheques under the following scenarios:

1. When a post dated cheque is presented prior to the date it bears: Bank of Baroda Ltd. v Punjab
National Bank13 stated that where a bank sans authority had certified a post dated cheque, it
could not be made liable towards a holder in due course when on the date of presentation, there
were no funds in the drawer’s account.

2. The bank is bound to pay a cheque only when it is found to have sufficient funds of the drawer in
its hands. Therefore in the scenario where a customer is not found to have no funds to his credit
or the funds are insufficient to cover the entire amount of the cheque, the bank is seen as justified
in refusing payment. The exception would be when the bank extends an overdraft to the
customer.

In the scenario where the bank agrees to honor cheque despite absence of sufficient funds, a
dishonour of customer’s cheque will render the banking entity liable to an action alleging breach.
This was ruled in Flemming v Bank of New Zealand. (1900)

The conditions under which the Bank is said to be justified in refusing to honor the cheque are
summarized below:

a) A banker is bound to honor the cheques on the pre condition that funds in customer’s hands are
held to be properly applicable in payment of such cheques. By proper applicability vis-a-vis
payment of customer’s cheque, it is implied that the funds should not be subject to lien or set-off
by the bank.

13
Bank of Baroda Ltd v Punjab National Bank Ltd (1944) 71 IA 124

8
 b) The bank can refuse to honor a cheque which is of an ambiguous, irregular and illegal character.
Emmanuel v Roberts14 ruled that refusal to honor was justified where the cheque was found to be
materially altered and improperly authenticated by the drawer.

c) Woodland v Fear15 established no duty of the bank to honor cheques where the cheque drawn by
a customer having credit with respect to one branch of the bank was in effect drawn upon another
branch which had no account. Thus, the branches of the same bank are justified in their refusal to
honor cheques where customer’s account is absent.

d) Post insolvency of the customer or the passing of an order of adjudication asking all the assets to
be vested in the official assignee is one of those conditions where the bank can refuse to honor
customer’s cheque.16

e) A bank’s duty and authority to pay on a cheque drawn on it by its customer is dependent upon
customer countermanding payment.

f) Notice of the customer’s death is another factor that influences the authority of the banker to
honor its cheque though payment that a bank makes prior to receiving notice is considered to be
valid.

g) All operations with respect to a customer’s account get suspended the moment she turns mentally
unsound.

h) Banks’ dealing with the customer’s account gets impacted by the service of a garnishee or other
form of legal order attaching or otherwise money in the account.

i) Bank may also be prevented by any govt. or exchange from honouring the cheques of a particular
customer or a class of persons to which the customer also belongs.

j) When the notice regarding closing of account, given by either parties takes immediate effect.

k) A bank can refuse to honor a cheque which has been drawn in breach of trust where it has the
notice of such a breach.

There are two scenarios where a bank ought to observe precaution in its dealing. In the first case where
the alleged payee/holder of a cheque informs the drawee bank about the cheque being lost, the bank
should ask him to get in touch with the drawer as soon as possible so that countermanding of cheque may
be done. If the cheque happens to be presented for payment prior to the payment getting stopped, great
care and caution ought to be observed while dealing with the account. The bank is vested with the
14
Emanuel v Roberts (1868) 9 B&S 121
15
Woodland v Fear [1857] 26 LJQB 202
16
Mathew v Sherwell, (1810) 2 Taunt 439

9
discretion if the circumstances are such so as to postpone the payment. In the second case, the banker
should again observe caution where the accounts come to be operated through agents or authorized
officials. In such cases, the bank owes a duty of care to the customer and not the authorized
intermediaries. Consequently, the bank has the power to make reasonable inquiries if it has sufficient
facts to indicate that the intermediaries are defrauding their principal. It must be understood that a
banker’s knowledge of rules of a company for signing cheques does have an impact upon the bank’s
ability to detect any irregularity in the notice when it is apparently instructed regarding disposal of
company’s moneys.

WHEN IS A BANK SAID TO BE WRONGFULLY EXERCISING ITS

POWER TO DISHONOUR CHEQUES AND LIABILITY OF THE
DRAWEE-BANK FOR WRONGFUL DISHONOUR?
A bank is bound to pay when the cheque is presented for payment in the course of working hours.
However, in the case where a cheque is presented to the bank, with sufficient assets at the customer’s
disposal and the bank dishonours such a cheque, it is then held liable to pay compensation to the customer
for any loss or damage (pecuniary or loss to reputation) as a result of this dishonour. A general
presumption about the trader customer suffering injury as an outcome of wrongful dishonour of cheque
prevails. Therefore, he is entitled to substantial damages without having to prove actual damage. 17

Discussion on the law through cases:

Hopkinson v Forster18 set the boundaries of liability of the bank. The bank was held to be liable to pay
compensation to the drawer in the wrongful dishonour scenario but it couldn’t be held liable towards the
holder of the cheque. No privity of contract exists between the holder of the cheque and the bank. Thus, a
holder’s remedy is confined to the drawer and not against the banker. Despite the fact that a bank is under
sufficient control of the drawer’s funds, it cannot be held liable towards the holder of the cheque.

Gupta Biscuits P Ltd. v United Commercial Bank19 is an important case law that considered drawee-
bank’s action as unjustified, unfair and arbitrary when it dishonoured cheques despite the availability of
sufficient funds in the customer’s account. The bank exceeded its power when it commented that the
funds should have been used by the customer for repayment of loan borrowed from another bank which
had requested the drawee bank to take steps for protection of bank’s interests. N. Santosh v Indian
17
Supra note 11.
18
Hopkinson v Forster (1894) LR 19 Eq 74
19
Gupta Biscuits P Ltd v United Commercial Bank AIR 1988 Cal 265

10
Overseas Bank20 also cast an ‘unequivocal obligation’ upon the bank to honor cheques and amounts due.
That it was unjustified for the bank to withhold payments simply on account of the fact that it suspected
money held by the customer was for and on behalf of person who owed amount to it. Prehn v Royal
Bank of Liverpool stated that where the drawer was not found to have suffered any actual damage, he
was held entitled to recover only nominal damages.21

Exceptional Case:

Metropolitan Police Commissioner v Charles 22 is a landmark case as it lay down the exception to the
general rule that arose where the cheque was issued under a cheque card or credit card plan. The bank was
deemed to be bound to honor the cheque even if the customer had exceeded the credit limit set by it after
the card had been produced by the customer and the issue of cheque was in compliance of the conditions.

OVERVIEW OF SECTION 138 IN DEALING WITH DISHONOUR OF

CHEQUES FOR INSUFFICIENCY ETC. OF FUNDS
Globalization led to a rapid increase in trade, commerce, prevalence of cheques etc. The basic objective
underlying Sections 138-142 is to promoting efficiency in every day banking transactions and also
ensuring credibility in business transactions carried out through cheques. Section 138 ensures that the
person issuing cheque towards debt discharge whose cheque ultimately gets dishonoured is made
criminally liable with an imprisonment or fine. The section targets those people who show the interest to
discharge their liability by way of issuing a cheque to that effect but do not intend to do so. In order to
prevent wrongful prosecutions of drawers, the section has provisos to that effect. Its’ ultimate objective is
to bring forth vigilance in order to curb callous mindset of drawers while discharging their debt and
liability.

There are three salient features to the section. Firstly, the cheque drawn by the accused must be on
account that he has with the bank. Secondly, the cheque bearing the amount should be for the purpose of
discharging the debt/liability. Thirdly, the cheque is to be returned as unpaid due to lack of funds or that
the amount of the debt exceeds the arrangement made with the bank. The offence stands constituted the
moment the cheque is returned as unpaid.

20
N Santosh v Indian Overseas Bank (2003) II BC 637 (AP).
21
Ibid
22
Metropolitan Police Commr. v Charles [1976] 3 All ER 112.

11
Since the objective of the Parliament was to consolidate and propagate the use of cheques, therefore, it
deemed it to be necessary for such a section to be devoid of the requirement of mens rea i.e. guilty state of
mind.

OVERDRAFT FACILITY EXTENDED BY THE BANK

Wont get dishonored but credit would be added after honouring for which interest would be paid

Cumming v Shand and Md. Hussain v Chartered Bank23, on the other hand discussed about the
extension of banker’s obligation to honor its customer’s cheque to allow overdraft facility to a certain
limit, by way of agreement buttressed by a valid consideration.

An overdraft is nothing but an extension of credit from a lending institution 24 in the scenario where the
account is left with no balance. By virtue of an agreement with the bank, the customer becomes entitled to
withdraw money despite the fact that the account is left with no or insufficient funds in it to make for the
withdrawal. Here, there is a reversal of roles in the banker-customer relationship. The bank which
generally was the debtor becomes the creditor while the customer, the creditor.

Thus, it can be understood that the bank makes the payment to a customer which would it would have
otherwise rejected (in case of actual cheques) or the cheque would have bounced and returned without
proper payment.

Similar to any other loan, the borrower is supposed to pay interest on the balance outstanding wrt
overdraft loan. Generally, the interest on a loan is lower as compared to the interest charged on credit
cards, thereby making the overdraft facility as a viable short term option in case of emergency.

23
Cumming v Shand (1860) 29 LJ Ex 129; Md. Hussain v Chartered Bank (1965) 2 Comp LJ 37.
24
“ What is Overdraft?” <https://www.investopedia.com/terms/o/overdraft.asp> last accessed on 12 November,
2019

12
 BIBLIOGRAPHY

Case laws referred to:

1. Pott v Clegg (1847) 16 M&W 321
2. Cumming v Shand (1860) 29 LJ Ex 129; Md. Hussain v Chartered Bank (1965) 2 Comp LJ 37.
3. London Joint Stock Bank Ltd v Macmillan and Arthur (1918) AC 777.
4. Bradley v Agra Bank 101 PR 1885.
5. State Bank of India v Vathi Samba Murty AIR 1988 Ori 50
6. Clare v Dresdner Bank [1915] 2 KB 576.
7. Joachimson v Swiss Bank Corp (1921) KB 110
8. Lall Chand v Agra Bank (1891) 18 IA 111
9. Bank of Baroda Ltd v Punjab National Bank Ltd (1944) 71 IA 124
10. Emanuel v Roberts (1868) 9 B&S 121
11. Woodland v Fear [1857] 26 LJQB 202
12. Bank of Baroda Ltd v Punjab National Bank Ltd (1944) 71 IA 124
13. Emanuel v Roberts (1868) 9 B&S 121
14. Woodland v Fear (1857) 26 LJQB 202
15. Mathew v Sherwell, (1810) 2 Taunt 439
16. Hopkinson v Forster (1894) LR 19 Eq 74
17. Gupta Biscuits P Ltd v United Commercial Bank AIR 1988 Cal 265
18. N Santosh v Indian Overseas Bank (2003) II BC 637 (AP).
19. Metropolitan Police Commr. v Charles [1976] 3 All ER 112

Important sites referred to:

1. “What are the rights and obligations of a bank in relation to its customers?”
https://ignoubcom.wordpress.com/2016/01/02/<what-are-the-rights-and-obligations-of-a-bank-in-
relation-to-customers-briefly-explain/> last accessed on 12 November, 2019
2. “Banker-customer relationship explained” <https://kalyan-city.blogspot.com/2012/04/banker-
customer-relationship-explained.html> last accessed on 12 November 2019

Book referred to:

1. Khergamvala on Negotiable Instruments Act, 1881

13