When will a banker be justified in refusing payment of a cheque?

The relationship between a banker and his customer is not merely that of a service provider and client — it is, in the language of the courts, a relationship of debtor and creditor, with a superadded obligation on the part of the banker to honour the customer's cheques so long as there are funds of the customer in the banker's hands. This was clearly stated by the Supreme Court in Canara Bank v Canara Sales Corporation (AIR 1987 SC 1603), where the court reiterated that whenever a cheque purporting to be drawn by a customer is presented, it carries a mandate to the bank to pay, and any refusal not sanctioned by law exposes the banker to a claim for damages under Section 31 of the Act. Yet the law does not make the banker's duty to honour an absolute one — there is a well-recognised category of circumstances in which the banker is fully justified, and in some cases positively bound, to dishonour a cheque. To understand these circumstances is to understand the precise limits of the banker's contractual and statutory obligation.

The Foundation: Section 31

Section 31 of the Act lays down the basic rule. 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. In default of such payment, he must compensate the drawer for any loss or damage caused by the wrongful dishonour — not merely pecuniary loss, but also loss of credit and injury to reputation. The Bombay High Court, in Marzetti v Williams, recognised that dishonour is "a discredit to a person" and is particularly injurious to a person in trade; a trader customer is presumed to suffer injury from wrongful dishonour and need not prove actual damage. The entire edifice of justified dishonour must, therefore, be understood as exceptions to this fundamental duty.

When the Banker Is Justified

A Post-Dated Cheque Presented Before Its Ostensible Date

A banker is fully justified in refusing to pay a post-dated cheque that is presented before the date it bears. A cheque that has not yet reached its ostensible date is, in commercial reality, not yet an operative payment instrument. In Bank of Baroda Ltd. v Punjab National Bank Ltd. (71 IA 124), it was held that even where a bank manager had without authority certified a post-dated cheque, the bank was not liable to a holder in due course when on the actual due date there were no funds — and this reasoning extends, a fortiori, to presentment before the date.

Insufficient Funds

If the customer has no funds to his credit, or if the balance is insufficient to cover the whole amount of the cheque, the banker is justified in refusing payment. The law does not impose any obligation on the banker to make part-payment of a cheque. Suppose a customer draws a cheque for five hundred rupees while his account holds only four hundred and ninety-nine — the banker may refuse, without any liability. However, if the banker has agreed to honour cheques even without sufficient funds by extending an overdraft facility, a dishonour of the cheque would render the banker liable for breach of contract.

Funds Not Properly Applicable

A subtler situation arises when the banker has sufficient funds in the customer's account but those funds are not properly applicable to the payment of the cheque. The clearest example is where the funds are subject to the banker's lien or a right of set-off. A banker should not honour a cheque or make any application of a customer's balance when he knows that by doing so he would be participating in fraud or misapplying trust money. The duty to pay runs only to funds which are lawfully at the customer's free disposal.

Irregular, Ambiguous, or Materially Altered Cheques

A banker is justified in refusing payment of a cheque that is irregular or ambiguous on its face — for instance, one that has been materially altered in parts without proper authentication by the drawer. Where an alteration appears on the face of the cheque, the banker is put on inquiry and should refer it back to the customer before paying. As held in Westminster Bank Ltd. v Hilton (1927 136 LT 315), the banker should refuse to pay a cheque showing an irregularity on its face, such as a post-dated cheque presented after a countermand with a wrong number specified in the countermand. Equally, a cheque bearing the forged signature of the drawer is a nullity — no mandate exists, and the banker who pays on a forged signature cannot debit the customer's account.

Cheque Presented at a Wrong Branch

Where a customer's account is with one branch of a bank, a cheque drawn on that account presented at another branch where the customer has no account is a cheque not properly addressed, and the branch concerned is justified in refusing payment. The bank's promise to repay is, in essence, a promise to repay at the branch where the account is kept, as the courts have long recognised.

Countermand by the Customer

The customer's authority to countermand or stop payment is one of the most commercially significant rights he possesses, and the moment a valid countermand reaches the banker, the banker's authority and duty to pay the cheque is determined. In order to be effective, the countermand must be clear, specific, and communicated to the bank in writing, giving sufficient particulars of the cheque, the payee, and the amount. Once a valid stop payment instruction is received, the banker is bound to refuse payment; indeed, a payment made by the acceptor or drawee after receiving orders to stop payment has been held not to be a "payment in due course" within Section 10 of the Act.

Death of the Customer

Notice of the death of the customer determines the banker's authority to honour his cheques. Once the bank receives notice of the customer's death, it must suspend operations on the account, for the deceased customer's order is no longer a subsisting mandate. In Vijay Singh v Manali Malik (160 2009 DLT 259), the Delhi High Court held that a cheque presented for payment after the death of the drawer ceased to be a valid cheque, since it ceased to be an order of a person entitled to give such an order. Payment made before receiving notice of death, however, is valid and the banker cannot be held liable for it.

Insolvency of the Customer

When a customer is adjudicated insolvent or an order of adjudication is passed against him, all his assets vest in the official assignee. Thereafter, the banker should refuse to pay the customer's cheques. The rationale is straightforward: the customer no longer has the free and unencumbered title to the funds lying in his account. Payment of a cheque at that stage would be a payment to a person who has, in law, been divested of the very property sought to be drawn upon.

Mental Incapacity of the Customer

By notice that the customer has become mentally unsound, all operations on his account are to be suspended. Contractual capacity is foundational to the bank-customer relationship, and a person of unsound mind cannot lawfully authorise the bank to pay. The authority to draw cheques is a continuous contractual mandate, and that mandate ceases when the customer is rendered legally incompetent to give it.

Garnishee and Court Orders

Service of a garnishee order or other legal process upon the banker, directing him not to part with the funds to the credit of the customer, is a circumstance in which the banker is not merely justified but positively bound to refuse payment. The court's intervention operates as an authority higher than the customer's mandate. Any payment made in the teeth of such an order would expose the banker to contempt of court and to the wrath of the judgment creditor at whose instance the order was issued.

Crossed Cheques Presented in Violation of Crossing

Where a crossed cheque is presented for payment otherwise than through a banker — that is, across the counter and not through the clearing system — the banker is bound to refuse payment in contravention of the crossing. Section 126 of the Act mandates that a cheque crossed generally shall be paid only to a banker; if crossed specially, payment must be made only to the particular banker named in the crossing. The banker who pays in violation of the crossing is liable to the true owner for any loss sustained.

The Consequence of Wrongful Dishonour

It bears emphasis that the above circumstances represent the permissible boundaries of justified refusal. Outside these boundaries, a dishonour by the banker is wrongful and actionable. Where a bank dishonours a cheque despite sufficient, properly applicable funds, it is liable to compensate the drawer — and in the case of a trader customer, substantial damages will be awarded without proof of actual loss, for the law presumes that dishonour injures the reputation of a person in commerce. In N. Santosh v Indian Overseas Bank (AIR 2003 AP 187), the Andhra Pradesh High Court held that by refusing to pay when there was no justification, the bank had violated both its contractual and statutory obligations, and had exposed itself to damages under Section 31 of the Act. The banker's duty to pay, and the narrow range of exceptions to that duty, must always be read together, for the two sides define the outer boundaries of the banker-customer relationship in the law of negotiable instruments.