MODULE - 2

Paying and Collecting Banker

MEANING OF PAYING BANKER
Paying banker refers to the banker who holds the account of the drawer of the cheque and is
obliged to make payment, if the funds of the customer are sufficient to cover the amount of his
cheque drawn or if overdrawing facility is given to the customer.
The banker who is liable to pay the value of a cheque of a customer as per the contract,
when the amount is due from him to the customer is called Paying Banker. The payment to be made
by him has arisen due to the contractual obligation. He is also called drawee bank as the cheque is
drawn on him.

ROLE OF PAYING BANKER

The role of paying banker are as follows:
1. Acting as agent: While collecting an instrument, whether for credit to customer's account or for
himself, the Bankers works as agent of his customer. As an agent he has generally to take such steps
& precautions to protect the interest or his customer as a man of ordinary prudence would take to
safeguard his own interest.

2. Scrutinising the instruments: Name of the holder, Branch name, date, amount in world and
figure, any cutting without signature, material alteration of any to be checked carefully.

3. Checking the endorsement: Bankers has to check the instrument whether it has been endorsed
properly.

4. Presenting the instrument in due time: It is the responsibility of the collecting bank to present
the instrument in due time to the paying bank.

5. Collecting the proceeds in the payee's account: It is the duty of collecting banks to collect and
credit the proceeds of the instruments to the proper account.

6. Notice of dishonour and returning the instruments: If any instrument is dishonored by the
paying bank it should be informed to the customer on the business day following the receipt of
unpaid instrument.

THE DUTIES OF PAYING BANKER

A paying banker has to check various things before the final transaction takes place. He or she will
be responsible if there is any wrong thing found about the check after the final transaction.
Therefore, he/she needs to be very careful while verifying the cheques. Here, we will discuss the
duties of a paying banker.

A. The paying banker has to verity whether the signature on the cheque is done by the account
holder or not. The signature on the check must be done by the person who has an account in the
bank, only then the check is considered valid. If the signature is fake, the paying banker can take
strict action against it.
B. The paying banker has to verify that the account holder's name written on the cheque is still
valid. It means his account must be active. For, this they may check the documents available in the
bank related to the account holder. It the account is not valid, the transaction cannot be processed.

C. The amount written on the check must be available in the account holder's account. If the amount
isn't available then, the paying banker can stop the transaction. Therefore the account of account
holder's account must have enough balance for the transaction.

D. Cheques drawn on branch: The paying banker shall honor only those cheques which are drawn
against the account maintained at a branch of the bank where the cheques are presented.

E. Presentation within validity needed: The paying banker is legally bound to pay only such
cheques which are presented to him for payment within a reasonable time. Reasonable time is six
months from the date of issue of the cheque. Usually the cheque presented after six months of their
issue are considered "stale" cheque.

F. Presentation within banking hours: Cheque must be presented within the banking hours. Any
cheque presented after the banking hours has no legal effect and thereof banker cannot be held
liable for refusing payment on such cheques.

G. Sufficient bankers: Funds in the account must be sufficient and available to honor the cheques.

H. Must be valid instrument: Cheques not drawn in the proper form are refused by the paying
banker. Section 5 & 6 of the N.I. Act provide that the banker should examine the contents of the
cheque to ensure that it is perfectly a valid instrument containing an unconditional order to pay a
certain sum of money.

PRECAUTIONS WHILE MAKING PAYMENT OF CHEQUES

The banker has to take the following precautions while honouring the cheques of his customers:
1. Open or Crossed Cheque: The most important precaution that a banker should take is about
crossed cheques. A banker has to verify whether the cheque is open or crossed. He should not pay
cash across the counter in respect of crossed cheques. If the cheque is a crossed one, he should see
whether it is general crossed or special crossed. If it is general crossing, the holder must be asked to
present the cheque through some banker and should be paid to a banker. If the cheque bears a
special crossing, the banker should pay only the bank whose name is mentioned in the crossing. If it
is a open cheque, a banker can pay cash to the payee or the holder across the counter. If the banker
pays against the instructions as indicated above, he is liable to pay the amount to the true owner for
any loss sustained. Further, a banker loses statutory protection in case of forged endorsement.

If it is a 'Not Negotiable' crossing, the paying banker has to verify the genuineness of all the
endorsements. If it is an 'Account Payee' crossing, the banker can credit the account of the payee
named in the cheque and not that of any other person.

2. Proper Form: A banker should see whether the cheque is in the proper form. That means the
cheque should be in the manner prescribed under the provisions of the Negotiable Instruments Act.
It should not contain any condition.
3. Presentment of Cheque: A banker can honour the cheques provided it is presented with that
branch of the bank where the drawer has an account. If the cheque is presented at another branch of
the same bank, it should not be honoured unless special arrangements are made by the customer in
advance. The reasons are:
(a) A banker undertakes to pay cheques only at the branch where the account is opened.
(b) The specimen signature of the customer will be with the office of the bank at which he has an
account.
(c) It is not possible for other branches to know that the customer has adequate balance to meet the
cheque
4. Date of the Cheque: The paying banker has to see the date of the cheque. It must be properly
dated. It should not be either a post-dated cheque or a stale-cheque. If a cheque carries a future date,
it becomes a post-dated cheque. If the cheque is presented on the date mentioned in the cheque, the
banker need not have any objection to honour it. If the banker honours a cheque before the date
mentioned in the cheque, he loses statutory protection. If the drawer dies or becomes insolvent or
countermands payment before the date of the cheque, he will lose the amount. The undated cheques
are usually not honoured.

A stale cheque is one which has been in circulation for an unreasonably long period. The custom of
bankers in this respect varies. Generally, a cheque is considered stale when it has been in circulation
for more than three months. Banker does not honour such cheques.
However, banker, may get confirmation from the drawer and honour cheques which are in
circulation for a long time. So, verification of date is very important.

5. Mutilated Cheque: The banker should be careful when mutilated cheques are presented for
payment. A cheque is said to be mutilated when it has been cut or torn, or when a part of it is
missing. Mutilation may be either accidental or intentional. If it is accidental, the banker should get
the drawer's confirmation before honouring it. If it is intentional, he should refuse payment. The
cheque is to be returned with a remark 'Mutilated cheque' or 'Mutilation Requires Confirmation) In
Scholey Vs Ramsbottom, the banker was held liable for wrong payment of a cheque which was
dirty and bore visible marks of mutilation.”

6. Words and Figures: The amount of the cheque should be expressed in words, or in words and
figures, which should agree with each other. When the amount in words and figures differ, the
banker should refuse payment. However, Section 18 of the Negotiable Instruments Act provides
that, where there is difference between the amount in words and figures, the amount in words is the
amount payable. If the banker returns the cheque, he should make a remark 'amount in words and
figures differ’.

7. Alterations and Overwriting: The banker should see whether there is any alteration or
overwriting on the cheque. If there is any alteration, it should be confirmed by the drawer by putting
his full signature. The banker should not pay a cheque containing material alteration without
confirmation by the drawer. The banker is expected to exercise reasonable care for the detection of
such alterations. Otherwise, he has to take risk. Material alterations make a cheque void.

8. Proper Endorsements: Cheques must be properly endorsed. In the case of bearer cheque,
endorsement is not necessary legally. In the case of an order cheque, endorsement is necessary. A
bearer cheque always remains a bearer cheque. The paying banker should examine all the
endorsements on the cheque before making payment. They must be regular.
But it is not the duty of the paying banker to verify the genuineness of the endorsements, unless the
cheque bears 'Not-Negotiable' crossing. He is not expected to know the signatures of all payees. So
he gets statutory protection in case of forged endorsements. In India, even in the case of bearer
cheques, bankers insist on endorsement though it is not required.

STATUTORY PROTECTION FOR PAYING BANKER

The payment must be made to the right person and the banker must get order from his customer to
debit his account. The banker might not be able to make detailed enquiries before making the
payment. Thus, the act provides him some legal protection, if the banker fulfills the obligations laid
down by the Act. The paying banker should take the following protection, in order to protect himself
and customer's interest, while making the payment of his customer's cheques.

1. Protection regarding the cheque

In case of an order cheque, Section 85(1) of the NI Act provides statutory protection to the paying
banker as follows, where a cheque payable to order purports to be endorsed by or on behalf of the
payee, the drawee is discharged by payment in due course.
In case, payment is made to a wrong person whose signature is not according to specimen signature,
the protection is given to a banker under Section 16 (2) of the Negotiable Instruments Act: "It is not
possible for a banker to know each of the endorsers and their signatures." For getting the protection,
the banker should note the following:

(a) Regular Endorsement: According to Section 85 (1) of the Act the endorsement should be regular.
For example, if a cheque is payable to a right person and signature is bearing same name and the
same spelling this is known as regular endorsement. Though; this is not a valid endorsement.
(b) Payment in Due Course: According to Section 10 of the Act the cheque should be paid in due
course. In case the payment is made on forged signature of the endorser and not that of the drawer,
the banker gets statutory protection under Section 10 of the Act.

2. Protection in case of bearer cheques

Section 85 (2) of the Negotiable Instruments Act, 1881 states, "Whereas a cheque is originally
expressed to be payable to bearer, the drawee is discharged by payment in due course to the bearer
thereof, notwithstanding any endorsement whether in full or in blank appearing thereon,
notwithstanding that any such endorsement purports to restrict or exclude further negotiation." The
protection is given in the Act on the basis that a bearer cheque always remains a bearer cheque and
it bears endorsement in blank or full whether any endorsement restricts further negotiation or not. In
case a bearer cheque is stolen or lost and the banker honours the cheque without any knowledge, the
banker will be discharged from his duty under the protection given in Section 85 (2) of the said Act.
In such a case, the paying banker is not required to verify the endorsement on bearer cheque. In case
a bearer cheque is crossed, the paying banker has no right to pay it across the counter in disregard of
the crossing.

3. Protection in case of crossed cheques

Regarding payment of crossed cheque, the paying banker gets the protection under Section 128 of
the Negotiable Instruments Act, 1881: "Whereas the banker on whom a crossed cheque is drawn has
paid the same in due course, the banker paying the cheque and the drawer thereof (in case such
cheque has come to the hands of the payee shall be entitled respectively to the same rights and
placed in the same position if the amount of the cheque had been paid to and received by the true
owner thereof."
In case the payment is made on the instructions of the drawer in good faith without any negligence,
the paying banker gets the statutory protection under the Negotiable Instruments Act,
1881: "The payment of crossed cheque in due course makes the drawee banker liable to the true
owner of the cheque besides disentitling himself to debit the customer's account.”

4. Protection in case of obliterated cheques

Payment of instrument on which alteration is not apparent where a promissory note, bill of
exchange or cheque has been materially altered but does not appear to have been so altered, or
where a cheque is presented for payment which does not at the time of presentation appear to be
crossed or to have had a crossing which has been obliterated, payment thereof by a person or banker
liable to pay, and paying the same according to the apparent tenor thereof at the time of payment
and otherwise in due course, shall discharge such a person or banker from all liability thereon, and
such payment shall not be questioned by reason of the instrument having been altered, or the cheque
crossed.

5. Protection in case of draft

Section 85A of the NI Act states that, Drafts drawn by one branch of a bank on another payable to
order where any draft, that is an order to pay money, drawn by one office of a bank upon another
office of the same bank for a sum of money payable to order on demand, purports to be endorsed by
or on behalf of the payee, the bank is discharged by payment in due course.

RIGHT OF PAYING BANKER

The banker's duty to pay customer's cheques is delicate and hence, to be handled judiciously as
well as cautiously. The banker has to take the following precautions while honouring the
cheques of his customers:
1. Proper form: A banker should see whether the cheque is in the proper form. That means the
cheque should be in the manner prescribed under the provisions of the commercial code. It should
not contain any condition.
2. Open or crossed cheque: The most important precaution that a banker should take is about
crossed cheques. A banker has to verify whether the cheque is open or crossed. He should not pay
cash across the counter in respect of crossed cheques.
3. Place of presentment of cheque: A banker can honour the cheques provided it is presented with
that branch of the bank where the drawer has an account. If the cheque is presented at another
branch of the same bank, it should not be honoured unless special arrangements are made by the
customer in advance. The reasons are:
(a) A banker undertakes to pay cheques only at the branch where the account is kept.
(b) The specimen signature of the customer will be with the office of the bank at which he has an
account.
(c) It is not possible for other branches to know that the customer has adequate balance to meet the
cheque.

4. Date of the cheque: The paying banker has to see the date of the cheque. It must be properly
dated. It should not be either a post-dated cheque or a stale-cheque. If a cheque carries a future date,
it becomes a post-dated cheque. If the cheque is presented on the date mentioned in the cheque, the
banker need not have any objection to honour it. If the banker honours a cheque before the date
mentioned in the cheque, he loses statutory protection. If the drawer dies or becomes insolvent or
countermands payment before the date of the cheque, he will lose the amount. The undated cheques
are usually not honoured.

5. Mutilated cheque: The banker should be careful when mutilated cheques are presented for
payment. A cheque is said to be mutilated when it has been cut or torn, or when a part of it is
missing. Mutilation may be either accidental or intentional.

6. Words and figures: The amount of the cheque should be expressed in words, or in words and
figures, which should agree with each other. When the amount in words and figures differ, the
banker should refuse payment. However, there is difference between the amount in words and
figures; the amount in words is the amount payable. If the banker returns the cheque, he should
make a remark 'amount in words and figures differ.

7. Alternatives and over-writings: The banker should see whether there is any alteration or over-
writing on the cheque. If there is any alteration, it should be confirmed by the drawer by putting his
full signature. The banker should not pay a cheque containing material alteration without
confirmation by the drawer. The banker is expected to exercise reasonable care for the detection of
such alterations.

8. Proper Endorsements: Cheques must be properly endorsed. In the case of bearer cheque,
endorsement is not necessary legally. In the case of an order cheque, endorsement is necessary. A
bearer cheque always remains a bearer cheque.

9. Sufficiency of funds: The banker should see whether the credit balance in the customer's account
is sufficient to pay the cheque or not. If there is an overdraft agreement, he should see that the limit
is not exceeded. The banker should not make part-payment of the cheque. He should pay either full
amount or refuse payment. In case of insufficiency of funds, the banker should return the cheque
with the remark 'No Funds' or 'Not Sufficient Funds'.
10. Verification of drawer's signature: The banker takes specimen signatures of his customers' at the
time of opening the account. He should compare the drawer's signature on the cheque with the
specimen signature of the customer. He should carefully examine the signature to find out whether
the drawer's signature is forged or not. If there is any difference or doubt, he should not honour the
cheque. He should get the confirmation of the drawer. If there is forgery and there is negligence on
the part of the banker to detect the same, there is no protection to the banker.

DISHONOUR OF CHEQUE
A cheque is said to be dishonoured when the payment is not made (to a customer) on its
presentation of the banker.

CIRCUMSTANCES FOR DISHONOUR OF CHEQUES

A paying banker must refuse payment on cheques, issued by his customers, in the following
Circumstances:

1. Insufficiency of funds: When adequate funds are not available in the account of a customer, then
the cheque can be dishonoured. If the banker pays a countermanded cheque, he will not only be
required to reverse the entry but also be held liable to pay damages for dishonouring the cheques
presented subsequently which would have been honoured otherwise.

2. Notice of the Customer's Death: The banker should not make payments on cheques presented
after the death of the customer. He should return the cheque with the remark
'Drawer Deceased'. However, if the payment is made without knowing the fact of the customer's
death, the banker cannot be held liable.

3. Notice of Customer's Insanity: The banker should stop the payment on cheques drawn and
received after the receipt of notice of the customer's insanity. However, the banker should be very
careful in this regard. He can believe that the customer is insane only when the latter is sent to the
lunatic asylum. Otherwise, he has to obtain a certificate from competent doctor.
Cheques drawn at a time when the customer was rational may be honoured.

4. Notice of the Customer's Insolvency: A banker should refuse payment on the cheques soon after
the customer is adjudicated as insolvent.

5. Receipt of the Garnishee Order: Where Garnishee order is received attaching the whole
amount, the banker should stop payment on cheques received after the receipt of such an order. But
if the order is for a specific amount, leaving the specified amount, cheques should be honoured if
the remaining amount is sufficient to meet them.

6. Notice of Assignment: The banker should stop the payment, on receipt of the notice of
assignment signed by the customer of the credit balance in his account.

7. Trust Accounts: If the banker feels suspicious that the trustee wants to use the amount of the
cheque for his personal use, he must stop payment.

8. Suspicion about the title over the Cheque: When the banker believes that the person presenting
the cheque is not entitled to receive the payment, he should refuse to make payment. For example:
stolen cheque.
9. Presentation of a stale cheque or post dated cheque: The banker may refuse the cheque when
they are presented after three months of its issue or they are presented before due dale in case of
stale cheques and post dated cheques respectively.
10. Joint Accounts: In the case of joint account, the banker can refuse to make payment on the
cheque if it is not signed by all the joint account holders.

11. Material Alterations: When there is material alteration in the cheque, the banker may refuse
payment.

12. Stale Cheques: When the cheque is presented after a period of three months from the date it
bears, the banker may refuse to make payment.

13. Drawer's Signature: If the signature of the drawer on the cheque does not tally with the
specimen signature, the banker may refuse to make payment.

14. Difference between Words and Figures: If there is difference between the amount written in
words and figures, the banker may refuse to make payment.

15. Endorsement: If the endorsement is irregular, the banker may refuse payment on the cheque.

16. Proper Form of the Cheque: If the cheque is not in the proper form ie., in accordance with the
provisions of the Negotiable Instruments Act and with conditions, the banker should refuse the
payment.

17 Drawn on another Branch: If the cheque is presented at another branch of the same bank, it
should not be honoured unless special arrangements are made by the customer in advance.

TYPES OF DISHONOUR
Dishonour of cheque cab be divided into two categories i.e.,:

(a) Rightful Dishonour: Dishonour of cheque by the drawee banker for any of the reasons
specified above or for any other rightful reason. In this case there is no remedy available against
the banker but the holder in due course has remedy both civil and criminal against the drawer.

(b) Wrongful Dishonour: Dishonour of cheque by the banker due to negligence or carelessness by
its employees. The drawer may bring an action against the bank for losses suffered by him.
The payee has no action against the banker in this case.

CONSEQUENCES OF WRONGFUL DISHONOUR OF CHEQUES

The various consequences for wrongful dishonour of cheques are as follows:
1. The damages that the banker has to pay will be more in case of wrongful dishonour of cheques of
the trader-customer.
Example: New Central Hall vs. United Commercial Bank Ltd

2. The amount of damages claimed by the customer need not depend on the amount of the cheque.
It means the smaller is the amount of the cheque dishonoured, the greater will be the amount of
damages. This is because it is presumed that the dishonour of a cheque of a smaller amount will
result in greater loss to the credit of the customer.

3. The customer can declare substantial general damages without having any monetary loss.

4. In case of trustee account, normally substantial general damages will be awarded for wrongful
dishonour.

5. In case of non trader customer, the damage will be nominal.

6. The particular damages are awarded for the financial loss incurred by the customer as a
consequence of wrongful dishonour, provided the loss must be proved by the customer.

COLLECTING BANKER
Banking operations are the legal transactions executed by a bank in its daily business, such as
providing loans, mortgages and investments, depending on the focus and size of the bank.

A Collecting Banker is one who undertakes to collect various types of instruments representing
money in favour of his customer or his own behalf from the drawers of these instruments; some are
negotiable instruments as provided for in the negotiable instruments Act.
1881 and some are quasi negotiable instruments.

Paying Banker is a banker on whom the cheque is drawn should pay the cheque, when it is
presented for payment. It is his obligation by section 31 of the NI Act. A banker is bound to honour
his customer's cheque to the extent of the fund available & the existence of no legal bar for
payment. The paying banker should use reasonable care and diligence in paying a cheque so as to
abstain from any action likely to damage his customer's credit.

Commercial banks undertake a wide variety of activities, which play a critical role in the economy
of a country. They pool and absorb risks for depositors and provide a stable source of investment
and working capital funds to various sectors of the economy. In addition, they provide a smooth
functioning payment system that allows financial and real resources to flow relatively freely to their
highest return uses. They are also a back up source of liquidity for any sector in the economy in
temporary difficulty. Banks are a particularly important source of funds for small borrowers who
often have limited access to other sources of external finance. The three main interrelated functions
of commercial banks are holding of deposits; creating credit through lending and investment
activities; and providing a mechanism for payments and transfers of funds for various productive
activities. The extension of credit or lending is, thus, the principal activity of a commercial bank.

Meaning of Collecting Banker

A collecting banker is one who undertakes to collect the amount of cheques and bills for his
customer from the paying banker. In other words, every crossed cheque is necessarily to be
collected through any bank, who is known as collecting banker.
LEGAL STATUS OF COLLECTING BANKER
The legal status of collecting bank or banker is discussed below:
1. Collecting Banker as Holder for Value
Normally collection of cheques takes some time, especially in case of outstation cheques in such
cases, when a collecting banker pays to the customer or credit (deposits) such amount to his
customers account and allows him to draw it, before the amount of the cheque is actually paid by
paying banker. In such cases the collecting banker is deemed to be its 'holder for value’.

The customer in such case is obliged to reimburse the banker if the cheque is dishonoured
bv paying banker. A collecting banker becomes a holder for value, if he has paid the value of the
cheque to the customer before the cheque is actually collected. In other words, a collecting banker
becomes a holder for value, when he collects his customer's cheque for himself, and not for the
customer. In its following circumstances, a collecting banker becomes a holder for value:

A. When he acquires from the customer the cheque meant for collection in exchange for cash.
When he pays to the customer the amount of the cheque deposited for collection before it is
collected.

B. When he expressly or impliedly allows the customer to draw against the cheque deposited for
collection before it is collected.

C. When he receives from the customer the cheque meant for collection in settlement of an existing
debt or advance.

D. When he lends to the customer on the strength of the cheque deposited for collection.

E. When he exercises his lien on the cheque deposited for collection for any amount due from the
customer.

2. Rights of the Collecting Banker as a Holder for Value

When a collecting banker acts as a holder for value, he enjoys the following rights:
A. As he has already paid the value of the cheque to the customer, he can receive the amount of the
cheque in his own name and retain the amount for himself.
B. In case the cheque accepted for collection is dishonoured, he can recover the amount from all or
any of the endorsers of the cheque.
C. If any of the endorsements on the cheque accepted for collection is forged, he can recover the
amount from all or any of the endorsers subsequent to the forgery.
D. If his customer has no title or has a defective title to the cheque accepted for collection, he can
recover the amount from all the previous endorsers of the cheque as holder in due course.

3. Liabilities of the Collecting Banker as a Holder for Value

When a collecting banker acts as a holder for value, he undertakes the following liabilities:
A. If he collects for himself an uncrossed cheque bearing any forged endorsement, he becomes
liable to the true owner of the cheque.

B. If he collects for himself an uncrossed or a crossed cheque to which his customer has no title or
has a defective title, he becomes liable to the true owner of the cheque.
HOLDER FOR VALUE
A collecting banker is holder for value if he gives the value of the cheque in any form to its
customer before collecting the proceeds of the cheque deposited by the latter. He does not remain an
agent of the customer, but becomes the owner of the cheque in his own right since he has paid value
for it, and has acquired the ownership right in good faith. In such a situation, the banker is called
holder for value and he is also the holder in due course.

When collecting banker becomes a holder for value?

According to Sir John Paget, a banker becomes a holder for value in the following ways:
(a) By lending further on the strength of the cheque;
(b) By paying the amount of the cheque or part of it in cash or in account before it is cleared;
(c) By agreeing that the customer may draw before the cheque is cleared;
(d) By accepting the cheque in avowed reduction of an existing overdraft;
(e) By giving cash over the counter for the cheque at the time it is deposited in for collection.

In the above circumstances, the banker becomes the holder for value. Further, if he proves that he
gave value for a cheque in good faith, he will be able to resist any claim by the true owner provided
that (a) the cheque was not tainted with forgery, (b) he had no notice of any previous dishonour or
of any defect in the title of his customer, (c) the cheque was not crossed
'not negotiable (d) the cheque was not overdue for the purpose of negotiation, and (c) the cheque
was regular on the face of it in all respects.

If the cheque is dishonoured, the collecting banker can use all the previous parties after giving them
the notice of dishonour. The banker undertakes a risk also when he acts as a holder for value. He
will be in a difficulty if last, but one endorsement proves to be a forged one. The banker will be
liable to the true owner of the cheque. However, he can recover the amount from
his customer.

HOLDER IN DUE COURSE

Holder in Due Course is one holding a cheque or promissory note, received for value, in good faith,
and with no suspicion that it might be no good, claimed by another, overdue, or previously
dishonoured. Such a holder is entitled to payment by the maker of the cheque or note.
A Holder in Due Course (HDC) is a person who takes a negotiable instrument, such as a promissory
note or cheque for value without knowledge of neither any apparent defect in the instrument nor any
notice of dishonour. Status as a "holder in due course" is an affirmative defect against all legal
claims the debtor may have against the original creditor. In other words, a "holder in due course"
does not become responsible for the original creditor's alleged misdeeds in the original credit
transaction.

A person typically becomes a "holder in due course" through the following steps: (1) an original
creditor loans money to a person in return for a promise to repay that money with interest; (2) The
original creditor then sells the credit contract (the right to receive repayment of the loan) to a "new
creditor" (such as a bank); and (3) the new creditor takes the debt without any knowledge of (a) a
defect in the note, (b) any misrepresentations made by the original creditor to the debtor, or () any
other act that would give the debtor a legal claim against the original creditor. For example, a
consumer might purchase a car on the installment plan from a car dealer. The credit transaction
would be secured by a promissory note and a chattel mortgage, deed of trust, or other security
instrument. The retailer may then sell the note and related documents to a bank or other finance
company. The latter would assert that it is an HDC and therefore not responsible for any defects in
the car or for any misrepresentations about it that the retailer made to the consumer.

Example: A gives B a promissory note in payment of a contract to be performed by B. B breaks the

contract. B negotiates the note to C. To escape being subject to this defense C must have acquired
the note under the circumstances that make him a holder in due course.

Example: A borrows money from B and gives his promissory note thereof. B negotiates this note to
C. As A has no defense against any one, it is useless to inquire whether or not C acquired as a holder
in due course. All that interests A is whether C is really the legal owner. C may have acquired the
paper by way of gift and may have taken long after maturity. This is immaterial.

Sec. 70. Who Is Holder In Due Course:

In order to claim the peculiar advantages of the law merchant, the holder must be a holder in due
course, that is, he must have acquired (1) paper complete and regular on its face; (2) for value; (3)
in good faith and (4) before the paper was overdue. Manifestly one cannot be a holder in due course
unless he acquires an instrument negotiable in form and if it is incomplete or irregular when he
obtains it, if in fact it does not lack negotiability, it at least imposes upon him the necessity of
inquiry.

DUTIES OF A COLLECTING BANKER

The duties and responsibilities of a collecting banker are discussed below:
1. Due Care and Diligence in the Collection of Cheques
(The collecting banker is bound to show due care and diligence in the collection of cheques
presented to him. In case a cheque is entrusted with the banker for collection, he is expected to
show it to the drawee banker within a reasonable time According to Section 84 of the Negotiable
Instruments Act, 1881, *Whereas a cheque is not presented for payment within a reasonable time of
its issue, and the drawer or person in whose account it is drawn had the right, at the time when
presentment ought to have been made, as between himself and the banker, to have the cheque paid
and suffers actual damage, through the delay, he is discharged to the extent of such damage, that is
to say, to the extent to which such drawer or person is a creditor of the banker to a large amount
than he would have been if such cheque had been paid.”

2. Serving Notice of Dishonour

When the cheque is dishonoured, the collecting banker is bound to give notice of the same to his
customer within a reasonable time. It may be noted here, when a cheque is returned for
confirmation of endorsement, notice must be sent to his customer. If he fails to give such a notice,
the collecting banker will be liable to the customer for any loss that the customer may have suffered
on account of such failure. Whereas a cheque is returned by the drawee banker for confirmation of
endorsement, it is not called dishonour. But in such a case, notice must be given to the customer. In
the absence of such a notice, if the cheque is returned for the second time and the customer suffers a
loss, the collecting banker will be liable for the loss.

3. Agent for Collection

In case a cheque is drawn on a place where the banker is not a member of the 'clearing-house', he
may employ another banker who is a member of the clearing-house for the purpose of collecting the
cheque. In such a case the banker becomes a substituted agent. According to Section 194 of the
Indian Contract Act, 1872, "Whereas an agent, holding an express or implied authority to name
another person to act in the business of the agency has accordingly named another person, such a
person is a substituted agent. Such an agent shall be taken as the agent of a principal for such part of
the work as is entrusted to him.”

4 Remittance of Proceeds to the Customer

In case a collecting banker has realised the cheque, he should pay the proceeds to the customer as
per his (customer's) direction. Generally, the amount is credited to the account of the customer on
the customer's request in writing; the proceeds may be remitted to him by a demand draft. In such
circumstances, if the customer gives instructions to his banker, the draft may be forwarded. By
doing so, the relationship between principal and agent comes to an end and the new relationship
between debtor and creditor will begin.

5. Collection of Bills of Exchange

There is no legal obligation for a banker to collect the bills of exchange for its customer.
But, generally, bank gives such facility to its customers. In collection of bills, a banker should
examine the title of the depositor as the statutory protection under Section 131 of the Negotiable
Instruments Act, 1881. Thus, the collecting banker must examine very carefully the title of his
customer towards the bill. In case a new customer comes, the banker should extend this facility to
him with a trusted reference.

STATUTORY PROTECTION FOR COLLECTING BANKER

The protection provided by Section 131 is not absolute but qualified. A collecting banker can claim
protection against conversion if the following conditions are fulfilled:

1. Good Faith and Without Negligence

Statutory protection is available to a collecting banker when he receives payment in good faith and
without negligence. The phrase in "good faith" means honestly and without notice or interest of
deceit or fraud and does necessarily require carefulness. Negligence means failure to exercise
reasonable care. It is not for the customer or the true owner to prove negligence on the part of the
banker. The burden of proving that he collected in good faith and without negligence is on the
banker. The banker should have exercised reasonable care and diligence. What constitutes
negligence depends upon facts of each case.

2. Collection for a Customer

(Statutory protection is available to a collecting banker if he collects on behalf of his customer only.
If he collects for a stranger or non-customer, he does not get such protection. As Jones Aptly puts it
"duly crossed cheques are only protected in their collection, if handled for the customer." A bank
cannot get protection when he collects a cheque as holder for value) In Great Western Railway Vs
London and Country Bank case it was held that "the bank is entitled for protection as it received
collection for an employee of the customer and not for the customer."
3. Acts as an Agent
A. collecting banker must act as an agent of the customer in order to get protection. He must receive
the payment as an agent of the customer and not as a holder under independent title. The banker as a
holder for value is not competent to claim protection from liability in conversion. In case of forgery,
the holder for value is liable to the true owner of the cheque.

4. Crossed Cheques
Statutory protection is available only in case of crossed cheques. It is not available in case of
uncrossed or open cheques because there is no need to collect them through a banker.
Cheques, therefore, must be crossed prior to their presentment to the collecting banker for
clearance. In other words, the crossing must have been made before it reaches the hands of the
banker for collection. If the cheque is crossed after it is received by the banker, protection is not
available. Even drafts are covered by this protection. To conclude, it is necessary that the collecting
banker should have acted without negligence if he wants to claim statutory protection under Section
131 of the said Act. The statutory protection is available to the banker if he collects a cheque
marked "Not Negotiable" for a customer, whose name is not used as the payee there-in, provided
the requirements of the said sections are duly complied with.

STATUTORY PROTECTION
(a) To get protection under Section 131 of the Negotiable Instruments Act, 1881, cheques should be
crossed by the customers before they are tendered to the Bank for collection. Affixing the Bank's
crossing stamp on cheques at the time of receiving the cheques or thereafter would not suffice for
claiming protection under the Act. Branches should, therefore, ensure that only crossed cheques are
accepted for collection. For this, customer should be educated/advised to cross the cheques before
tendering for collections.
(b) Cheques should be collected only for properly introduced account holders of the Bank. It is
possible that the branches may be having unintroduced savings bank accounts, in which case
sufficient care must be exercised to ensure that the cheques are accepted for collection only after the
accounts are introduced. Further, cheques favouring only account holders should be collected in
savings bank accounts. No third party cheques should be accepted in savings bank accounts.
Cheques/instruments payable jointly to two or more persons should not be collected for credit of the
proceeds in single account of one of the payees or in another joint account wherein name of one of
the account holders is mentioned as payee but the name of other account holder is not mentioned in
the instrument.
(c) Cheques should be accepted and collected without negligence. Section 131 of the Act provides
that-"A banker who has in good faith and without negligence received payment for a customer of a
cheque crossed generally or specially to himself, shall not, in case the title to the cheque proves
defective, incur any liability to the true owner of the cheque by reason only of having received such
payment". Section 131 of the Act confers a special protection on the collecting banker which is
available to him subject to fulfilment of certain conditions.

If the following conditions do not co-exist, this protection would be denied to the collecting
banker:

(i) The collecting banker should have acted in good faith and without negligence: In Loyds Savouy
Co. (1933) A.C. 201, the court held that if the banker receives payment of a cheque to which the
customer has no title, the onus is on him to disprove negligence. What amounts to negligence is,
however a question of fact in each case. "Negligence" means want of “reasonable care" with
reference to the interest of the true owner. The test of "negligence" is whether the transaction of
paying in any given cheque coupled with the circumstances antecedent and present was so
flagrantly out of the ordinary course that it ought to have aroused suspicion in the mind of the
banker and caused him to make enquiry (Bopulal Prem Chand v. The Nath Bank Ltd. 48 Bom.
L.R.393).

(ii) That the collecting banker acts only to receive payment of the crossed cheque for a customer.:
To make a person a customer of a bank it is essential that there must be some sort of account, either
a deposit or a current account or some similar relationship. Protection under section 131 is available
only when the banker is acting as an agent for collection but not to a case where the banker is
himself the holder.

(iii) That crossing had been made before the cheque fell into the hands of the collecting banker.
Section 131 does not provide an absolute immunity to the collecting banker and unless the banker
brings himself within the conditions stipulated under this section, he is left to his common law for
conversion. The onus of proving that he had taken all reasonable steps to ensure compliance with
the requirements of this section lies on the banker. It shall be the duty of the banker who receives
payment based on an electronic image of a truncated cheque held with him, to verify the prima face
genuineness of the cheque to be truncated and any fraud, forgery or tampering apparent on the face
of the instrument that can be verified with due diligence and ordinary care.