F-204 Law and Practice of Banking

Topic 07: Paying Banker and Collecting Banker

Exam Notes (from slides + past questions) — for first-time learners, easy words

Exam Frequency at a Glance (based on past questions) — “How many times each topic came ”
• Statutory protection (paying banker) + (collecting banker) — asked most often (4+ times). Master
both.
• Paying banker: definition + 10 precautions — 29th Final, 26th Final.
• Collecting banker: holder for value vs agent — 25th 2nd Mid, 24th 1st Mid.
• Conversion + duties of collecting banker — 29th 2nd Mid.
• When paying banker refuses / dishonours cheque — 23rd 2nd Mid.
• Instances of negligence of collecting banker — 23rd 2nd Mid, 29th Final.
• Case questions (forged endorsement / conversion) — 29th Final, 29th 2nd Mid.

1 Relationship between Banker and Customer

• The banker–customer relationship is mainly that of a debtor and creditor.
• Which one depends on the state of the account:
– Credit balance → Customer is the creditor, bank is the debtor.
– Debit balance → Customer is the debtor of the bank.
• A bank does not act as a trustee of the customer’s deposited money.
• Deposited money is not kept separately; it is treated as a debt owed by the bank. On accepting deposits, the
bank is legally bound to repay an equivalent amount.
• Repayment is made on demand or as per the customer’s order.
• The bank must honour cheques issued by the customer, subject to these conditions:
(a) sufficient balance in the account of the customer;
(b) the cheque is properly drawn and presented; and
(c) there is no legal restriction on payment.

2 THE PAYING BANKER

2.1 Definition
[Asked 29th Final & 26th Final]

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 the “Paying Banker” or “Drawee Bank.”
He is called the drawee bank because the cheque is drawn on him, and the duty to pay arises from a contractual
obligation.

2.2 Risk of a Banker in Honouring Cheques

• A cheque cannot be honoured if sufficient funds are not available. If payment is made by oversight without
funds, the banker bears the loss and may have to make good the amount.
• The banker also faces risk if a cheque is wrongfully dishonoured despite sufficient funds — the banker is liable
for damages to the customer.
• So the banker runs risk in both situations: wrongful payment and wrongful dishonour.
2.3 Precautions for Payment of Cheques
[Asked 29th Final & 26th Final] These are the 10 things a paying banker must check before honouring a cheque:
1. Proper Form — the cheque must be complete and regular in all respects (properly drawn).
2. Open or Crossed Cheque — note whether it is open or crossed; a crossed cheque is paid only through a banker.
3. Place of Presentment — the cheque must be presented at the proper place (the branch on which it is drawn).
4. Date of the Cheque — the cheque must not be post-dated or stale; the date must be valid.
5. Mutilated Cheque — refuse if the cheque is torn/mutilated so its validity is doubtful.
6. Words and Figure — the amount in words and in figures must match; if they differ, pay the smaller amount (as
per NI Act) or return if doubtful.
7. Alterations and Overwritings — refuse if there is any material alteration not properly authenticated (signed
by the drawer).
8. Proper Endorsement — for order cheques, the endorsement must be proper and regular.
9. Sufficiency of Fund — the customer must have sufficient balance.
10. Verification of Drawer’s Signature — compare the signature with the specimen signature; verify it is genuine.

1
 2.4 Statutory Protection (for the Paying Banker)
[Asked 26th 2nd Mid & 26th Final] The paying banker gets protection under the Negotiable Instruments Act,
1881 in five cases:
1. Protection in Case of Bearer Cheque — Sec. 85C.
2. Protection in Case of Order Cheque — Sec. 85.
3. Protection in Case of Crossed Cheque — Sec. 128.
4. Protection in Case of Obliterated Cheque — Sec. 89 (protection when the alteration is not apparent).
5. Protection in Case of Drafts — Sec. 85A.

Easy meaning: If the bank pays in good faith and in due course (genuine-looking cheque, no notice of any
defect), the bank is protected (discharged) from liability — even if later a problem is found in the endorsement
or the crossing.

2.5 Dishonour of Cheques

[Asked 23rd 2nd Mid] In these 8 situations the paying banker must refuse payment (even if funds exist):
1. When the Customer Countermands the Payment (stop-payment order).
2. Notice of the Customer’s Death.
3. Notice of Customer’s Insanity.
4. Notice of the Customer’s Insolvency (bankruptcy).
5. Receipt of the Garnishee Order (court order attaching the money in the account).
6. Notice of Assignment.
7. Trust Accounts (when payment would break the trust).
8. Suspicion about the Title over the cheque.
2.6 When a Banker can Dishonour Cheque
[Asked 23rd 2nd Mid] In these 11 situations the banker may refuse payment (defects in the cheque itself):
1. Post-dated Cheques — pay only after the date arrives.
2. Insufficiency of Funds.
3. Presentation of Cheque — presented at the wrong place or wrong time.
4. Joint Accounts — must be signed by all the required persons.
5. Material Alterations — not authenticated.
6. Stale Cheques — presented after a long time (usually more than 6 months).
7. Drawer’s Signature — signature differs from the specimen / is forged.
8. Difference between Words and Figures.
9. Endorsement — improper or irregular.
10. Proper Form of the Cheque — incomplete.
11. Drawn on Another Branch.

3 COLLECTING BANKER
3.1 Role of the Collecting Banker
[Asked 24th 1st Mid]
• A banker is not legally bound to collect cheques and bills of his customers — it is not a legal duty.
• But modern banks collect cheques and bills — it has become an accepted part of banking functioning (crossed
cheques must be collected through a banker).
• While collecting, the banker acts as an agent of his customer.
• The banker is bound to use reasonable skill, care and diligence.

How can a bank act while collecting its customer’s cheques? (24th 1st Mid) — It can act in two ways:
(1) as an agent of the customer, or (2) as a holder for value. Examples of each are given below.

3.2 Collecting Banker as Holder for Value

[Asked 25th 2nd Mid & 24th 1st Mid]

A collecting banker is a holder for value if he gives the value of the cheque in any form to his customer
before collecting the proceeds of the cheque deposited by the customer.

• Then the banker does not remain an agent — he becomes the owner of the cheque in his own right (he paid
value for it and acquired ownership in good faith).
• The banker is then called a holder for value and becomes a holder in due course.
According to Paget, a banker becomes a holder for value by:

2
1. lending further on the strength of the cheque;
2. paying the amount of the cheque before it is cleared (full or part; in cash or in account);
3. agreeing that the customer may draw before the cheque is cleared;
4. accepting the cheque in reduction of an existing overdraft;
5. giving cash over the counter for the cheque when deposited for collection.
If the banker proves he gave value in good faith, he can resist any claim by the true owner, provided:
• the cheque was not tainted with forgery;
• he had no notice of any previous dishonour or defect in the title of the customer;
• the cheque was not crossed “not negotiable”;
• the cheque was not overdue for the purpose of negotiation;
• the cheque was regular in all respects.
• If the cheque is dishonoured, the collecting banker can claim against (sue) all previous parties after giving
them notice of dishonour.
• Risk: the banker takes a risk as holder for value — if one endorsement proves forged, the banker will be
in difficulty. He will be liable to the true owner of the cheque, but he can recover the amount from his
customer.
3.3 Collecting Banker as an Agent of the Customer
[Asked 25th 2nd Mid & 24th 1st Mid]
• The banker credits the account only after collecting the proceeds from the drawee banker.
• He acts as an agent of his customer.
• He does not get a better title to the cheque than that of the customer.
• He must perform his duties diligently (like any other agent). Delay or not exercising the expected normal skill
makes him liable to his customer.
• The customer can draw the amount only after his account is credited with the proceeds.
• If the title of the customer is defective, the banker collecting the cheque runs the risk of being liable to the
true owner.
• If a cheque collected by the banker does not belong to the customer, the banker will be liable for conversion
of money (illegal interference with the rights of the true owner).
• Reasonable time for presenting the cheque:
– within one day — cheque drawn on a bank in the same place;
– on the following day — cheque drawn on a bank in another place.
• After the expiry of the reasonable time, the customer paying in the cheque is entitled to presume that it has been
collected and the proceeds are credited to his account.

3.4 Difference: Holder for Value vs Agent

[Asked 25th 2nd Mid]

Point Holder for Value Agent

Ownership Becomes the owner of the cheque in his Does not own the cheque; acts for the cus-
own right tomer
Title Gets a better title (becomes holder in due Gets no better title than the customer
course)
When credit given Gives value before collection (advances Credits the account only after proceeds
money) are collected
Statutory protec- No protection Yes protection
tion (Sec. 131)
Risk If an endorsement is forged, liable to the Runs risk if the customer’s title is defec-
true owner tive
If cheque dishon- Can sue previous parties after notice Money is simply not credited to the cus-
oured tomer

4 CONVERSION
[Asked 29th 2nd Mid]

3
 Definition: Conversion is a legal term meaning wrongful interference with another person’s property, incon-
sistent with another’s right of possession.
• It applies only to tangible property (not debts). Negotiable instruments (cheques) are treated as tangible
property.
• If the collecting banker collects a cheque for a customer having a defective title, he deprives the true owner
of the cheque of payment — he is liable and may be charged for conversion.
• Purpose of the rule: so the rightful owner can recover payment from anyone who takes the cheque without
his authority and in whose hands it can be traced.

Banker is liable for conversion to the true owner:

• when he collects a cheque bearing a forged endorsement, or for a customer having no title at all;
• when he borrows the proceeds of a cheque for his customer on which the customer has no title or a defective
title;
• when he takes, as a holder for value, a cheque marked “not negotiable.”
Banker is not liable for conversion to the true owner:
• where there is no forgery and the instrument comes into the hands of a holder in due course;
• where there is forgery but the instrument is a cheque and payment was made in due course by the banker.

5 Statutory Protection to Collecting Banker

[Asked 29th Final & 23rd 2nd Mid] Section 131 of the NI Act, 1881:

Where a banker, in good faith and without negligence, receives payment for a customer of a cheque
crossed generally or specially to himself, and the customer has no title or a defective title thereto, the
banker shall not incur any liability to the true owner of the cheque by reason only of having received
such payment.

The protection of Section 131 is not absolute but qualified (conditional). To claim protection, all four conditions
below must be fulfilled:
5.1 1. Good faith and without negligence
• Good faith means honesty and without notice/interest of fraud. It does not necessarily require carefulness.
• Negligence means failure to exercise reasonable care. The burden of proof is on the banker (the banker
must prove he acted without negligence).
• The banker should have exercised reasonable care and diligence.
• What constitutes negligence depends on the facts of each case.
Instances which constitute negligence [Asked 23rd 2nd Mid & 29th Final]:
1. Failure to obtain a reference for a new customer when opening the account.
2. Collection of cheques payable to trust accounts for crediting to the trustee’s personal accounts.
3. Collection of cheques payable to a partnership account for crediting to a partner’s personal account.
4. Omission to verify endorsements on order cheques.
5. Failure to pay attention to the “not negotiable” crossing.

5.2 2. Collection for a customer

• Collection on behalf of his customer only → statutory protection.
• Collection on behalf of a stranger or non-customer → no protection.
• Collection as a holder for value → no protection.
• Case: Great Western Railway v London and County Banking Co. Ltd — a rate collector who regularly cashed his
cheques at the bank was not considered a customer, because he did not maintain an account with the bank.
5.3 3. Acts as an agent
• The banker must receive payment as an agent of the customer, and not as a holder under an independent title.
• A banker who is a holder for value is not competent to claim protection from liability in conversion.
• In case of forgery, the holder for value (banker) is liable to the true owner of the cheque.

5.4 4. Crossed cheques

• Protection is available only for crossed cheques, not for uncrossed or open cheques.
• Crossed before reaching the banker → protection is available.
• Crossed after reaching the banker → protection is not available.
• In the case of uncrossed or open cheques, there is no need to collect them through a banker.
• Even drafts are covered by this statutory protection.

6 Duties and Responsibilities of a Collecting Banker

4
[Asked 29th 2nd Mid]
1. Due care and diligence in the collection of the cheque.
2. Agent for collection (collect only for the customer).
3. Collection of bill of exchange (also).
4. Serving notice of dishonour (inform the customer quickly if a cheque is not paid).
5. Remittance of proceeds to the customer (hand over the money collected).

7 MARKING OF CHEQUE
• Marking means a cheque which is marked or certified by the drawee banker that it is “good for payment”
— i.e., the drawer has sufficient balance in his account.
• It is done by writing “good for payment” across one corner, signed by the bank’s authorized official +
stamped.
• The drawee (bank) certifies that: (i) the drawer has sufficient balance; (ii) the cheque will not be dishonoured
by NSF (not sufficient funds).
• Marked cheques are very useful for businessmen for purchasing goods — sellers accept marked cheques like
currency notes.
• Marking of post-dated cheques is not valid.
Who can get the cheque marked?
1. At the request of the drawer.
2. At the request of the payee (holder).
3. At the request of another banker.
1. Marking at the request of the drawer:
• The drawer cannot stop payment.
• The banker is bound to honour the cheque.
• Even on death / insanity of the customer, the banker still has to pay.
• On NSF, the banker has statutory protection in refusing other cheques.
2. Marking at the request of the holder (or payee):
• Does not virtually place any liability on the banker.
• It simply means the drawee had sufficient funds at the time of marking.
• No guarantee of payment when presented later.
• If funds are sufficient → immediate payment by the banker.
3. Marking at the request of another banker:
• Marking is done for clearance purpose.
• It entitles the paying banker to appropriate the necessary funds to meet the cheque.
• The paying banker is undertaking an obligation to honour the cheque.
• Sufficient balance must be on credit with the drawer on that particular date.

8 Past Questions — How to Answer

Case 1 (29th Final): ABC Bank collected a cheque for its customer Mr. X. The cheque was stolen
from the rightful owner and Mr. X forged the endorsement. The true owner sued ABC Bank for
conversion. Bank claimed statutory protection as a collecting banker.
Answer: Yes, ABC Bank is liable for conversion.
• Sec. 131 protection requires the banker to act in good faith and without negligence. This is a qualified
protection, not absolute.
• Collecting a cheque bearing a forged endorsement for a customer with no title at all is a clear case of
negligence (the customer had no title because a forged endorsement gives no title).
• Omission to verify the endorsement on an order cheque is one of the listed instances of negligence.
• So the bank cannot claim the protection of Sec. 131 and must compensate the true owner. The bank may
then recover from Mr. X, its customer.

5
Case 2 (29th 2nd Mid): Mr. Islam issued an order cheque to Walton Sports Ltd. The employee
Mr. Sharif fraudulently endorsed it in his own name and deposited it in his personal account. The
paying banker verified the endorsement, found it to appear genuine, and paid in good faith. Mr.
Islam demanded reimbursement.
Answer: The bank is protected and does not have to reimburse Mr. Islam.
• Here the bank is the paying banker (the bank on which the cheque was drawn). The drawer’s signature
was genuine — only the endorsement was forged.
• Under Sec. 85 NI Act, where an order cheque purports to be endorsed by or on behalf of the payee, the
drawee is discharged by payment in due course.
• The bank verified the endorsement, found it genuine-looking, and paid in good faith and in due course —
so it is protected.
• Contrast (important for exams): if the drawer’s signature itself had been forged, the bank would be
liable (payment would not be in due course) and could not debit Mr. Islam’s account.
• Mr. Islam’s remedy is against the fraudulent employee Sharif (and possibly Walton Sports Ltd), not the
bank.

Quick pointers for the theory questions

• Define a paying banker + precautions (29th Final, 26th Final): definition box above + list the 10
precautions.
• Meaning + duties/responsibilities of a paying bank (26th Final): paying bank = drawee bank bound
by contract to honour cheques. Duties: honour valid cheques (3 conditions), take the 10 precautions, must
refuse in the 8 situations, may refuse in the 11 situations, and enjoy statutory protection in 5 cases.
• Statutory protection of paying banker (26th 2nd Mid & 26th Final): list the 5 cases (bearer, order,
crossed, obliterated, drafts) with sections.
• Conditions for collecting banker’s protection (29th Final): the 4 conditions of Sec. 131.
• Conversion + duties of collecting banker (29th 2nd Mid): conversion definition + when liable/not liable +
the 5 duties.
• Holder for value vs agent (25th 2nd Mid): use the comparison table.
• How a bank acts while collecting (24th 1st Mid): two ways (agent / holder for value) + Paget’s examples.
• When paying banker refuses payment (23rd 2nd Mid): the 11 “can dishonour” + the 8 “must dishonour”
situations.
• Instances of negligence (23rd 2nd Mid): the 5 instances listed above.