OVERDRAFT
1. Introduction to Overdraft Facility
An overdraft facility is a unique financial arrangement provided to customers
holding a Current Account (usually for commercial purposes involving large
transactions).
Definition: It allows the customer to withdraw more money than what is
available in their deposit, up to an agreed limit.
Nature: It is generally provided to reliable customers for short periods,
and interest is charged on the withdrawn amount.
Flexibility: Unlike other loans, there is no need for prior notice for
withdrawal; the customer can withdraw anytime within the limit.
2. Nature of the Contract: Express vs. Implied
An overdraft is essentially a contract between the bank and the customer.
However, this contract does not always need to be written or express; it can be
implied from the conduct of the parties.
Case Law: In Bank of Maharashtra v. United Construction Co., there
was no written contract for overdrafting. The customer overdrew money,
and when the bank charged interest, the customer refused to pay. The
Bombay High Court held that the facility can be implied. The customer
was directed to pay the money along with the interest.
Case Law: In Indo Allied Industries Ltd. v. Punjab National Bank
Ltd. (1970), the court noted that in the absence of an express contract, a
bank allows withdrawal facilities only in the branch where the customer
holds the account.
3. Termination of Overdraft Facility
Banks cannot arbitrarily stop a facility that a customer has been relying on
without proper notice.
Case Law: In Indian Overseas Bank v. Naranprasad Govindlal Patel
(1980), the plaintiff had enjoyed an overdraft facility for four years (1966–
1970). The bank unilaterally terminated it without notice. The Gujarat High
Court held that the uninterrupted enjoyment of the facility created a
contract. The bank acted wrongly in terminating it unilaterally; a proper
notice of intention to terminate was required so the customer would not
issue cheques exceeding their balance.
4. Banker’s Lien and Right to Set-Off
The relationship between a banker and a customer gives rise to specific rights
regarding the appropriation of funds.
Case Law: In the landmark decision of Firm Jaikishen Dass Jinda Ram
v. Central Bank of India Ltd., the court held that two rights flow from
the debtor-creditor relationship:
1. Customer's Right: To demand repayment of amounts due to him.
2. Banker's Right (Lien): To appropriate monies, funds, and
securities of the customer to repay the customer's debt to the bank.
Key Principles of Set-Off:
Mutuality: Set-off is only valid if demands exist between the same
parties in the same capacity.
Partnership Firms: In the Firm Jaikishen Dass case, there were two
partnership firms with the same partners but separate accounts. The Court
opined that the bank had the right to set off the funds of one firm against
the overdraft of the other, as the two firms did not constitute separate
legal entities.
5. Banker’s Duty of Secrecy
According to Sir John Paget in Law of Banking, the duty of secrecy is legal
(arising from the contract), not just moral. However, it is not absolute.
Exceptions where disclosure is allowed:
1. Under the Banker’s Book Evidence Act.
2. Duty to the State/Public (higher duty).
3. To claim payment of an overdraft: The bank can state the amount of
the overdraft on a writ claiming payment.
4. Where the customer authorizes the reference.
6. Minors and Overdrafts
Legal Status: Under the Indian Majority (Amendment) Act, 1999, a
person under 18 is a minor.
Contractual Capacity: While minors cannot enter contracts, Section 26
of the Negotiable Instruments Act, 1881 allows a minor to draw,
indorse, and negotiate instruments to bind all parties except himself.
Restriction: A minor cannot be allowed to overdraft. The bank must
ensure the minor does not withdraw more than their deposit. The minor is
not liable to pay back any overdraft.
7. Liability in Case of Agents and Misuse
Case Law: In Midland Bank Ltd. v. Reckitt (1933), an agent was given
power to withdraw money "without restriction." The agent used this power
to issue a cheque to buy a car for himself to settle his private overdraft.
The House of Lords held the principal was not liable, as the bank (agent's
creditor) knew the payment was without authority.
Case Law: In Thomson v. Clydesdale Bank Ltd., a broker used
cheques from share sales to settle his private overdraft. The bank was not
held liable because it had no reason to believe the money belonged to
someone else.
8. Damages for Wrongful Dishonor
If a bank wrongly refuses to honor a cheque despite an overdraft agreement, it
may be liable for damages.
Case Law: In Fleming v. Bank of New Zealand (1900), it was held that
if a banker has agreed to provide an overdraft and forgets that agreement,
refusing the customer’s cheque, the banker is liable in damages.
Case Law: In Brahma v. Chartered Bank (1956), the court held that a
previous agreement allowing a customer to overdraw is sufficient to
impose liability on the bank to honour cheques up to that limit.
Case Law: In Rae v. Yorkshire Bank Plc., the bank overlooked an
overdraft agreement and dishonored a cheque. However, the bank was
liable only for nominal damages because the customer was not a trader
and could not prove specific losses.
XX
1. Introduction to Overdraft Facility
Overdraft facility: The customers having a current account are allowed to
withdraw more than the available deposits up to an agreed limit. Such facilities
are generally provided to reliable customers for short period and interest is
charged on the amount which is withdrawn by the customer.
2. Current Account Features
A current account is opened for commercial purposes where huge money is
involved. A current account provides the facility of large number of transactions
with no bar on the amount of transaction. There is no need of prior notice that
has to be given to the bank and the customer can withdraw money anytime. The
customer also enjoys the unique overdraft facility with this type of account.
3. Nature of Overdraft Contract
Indo Allied Industries Ltd. v. Punjab National Bank Ltd., AIR 1970 All 1o8:
(1969) 39 Comp Cas ro.—One important thing to be noted is that in absence of
any expressed contract, a bank can allow withdrawal facility to a current account
holder only in that branch of the bank where the customer holds the account.
The overdraft facility attached with a current account makes it all more important
for a commercial purpose. By this arrangement the customer can borrow more
than the deposited funds up to a certain limit. Overdraft is like a contract
between the bank and customer.
In Bank of Maharashtra v. United Construction Co., there was no written
contract of overdrafting. The customer overdrew money and on repayment the
bank charged interest over the same. The customer rejected to pay down any
form of interest and the bank filed a suit against the customer after such denial.
The decision of the Bombay High Court was that there is no need of an express
contract for overdraft facility, rather it is implied. The customer was directed to
pay the money along with the interest.
4. Termination of Facility
Indian Overseas Bank v. Naranprasad Govindlal Patel, AIR 1980 Guj 158.
The banks cannot cancel the overdraft facility at their will and a proper notice
should be given to the customer. The bank provides the overdraft facility for
earning interest while the customer uses it to run his business smoothly.
Therefore, there is an implied contract between the two.
In Indian Overseas Bank v. Naranprasad Govindlal Patel the court held as
follows: In other words, overdraft dealings between the Bank on one hand and
the plaintiff on the other hand during a period of four years—from February 19,
1966 to February 11, 1970—clearly leads to an inference that there was a
contract between the plaintiff and the Bank in respect of over-draft facility. The
uninterrupted enjoyment of this facility could not have been terminated by the
Bank unilaterally. If the Bank wanted to terminate it, the Bank ought to have
given notice of its intention to do so in which case the plaintiff would not have
issued a cheque for the amount exceeding the cash balance in its account. We
have no doubt in our minds that the Bank acted wrongly in terminating the
facility unilaterally which the plaintiff enjoyed continuously for a period of four
years. Hence, it can be inferred that overdraft facility between a banker and
customer is contractual in nature and the same cannot be terminated by the
bank unilaterally even if it is temporary.
5. Banker's Lien and Set-Off
In the landmark decision of Firm Jaikishen Dass Jinda Ram v. Central Bank
of India Ltd. it was held: Two rights flow out of the relationship of debtor and
creditor, namely (1) the right of the customer to demand repayment of the
amounts due to him if and when he so desires and (2) the right of the bank to
appropriate the monies, funds and securities of the customer coming into its
possession in the course of their dealings for repayment of the customer’s
indebtedness. This latter right is known as banker’s lien and it rests on the
principle of the law-merchant that any credit given by a bank to a customer is
given on the faith that sufficient monies and securities belonging to the customer
will come into the possession of the bank in the due course of further
transactions. The right is akin to the right of set-off which obtains between
persons occupying the relation of debtor and creditor and between whom there
exist mutual demands.
As mutuality is essential to the validity of a set-off, it is necessary that before
one demand can be set off against another both must mutually exist between
the same parties and between them in the same capacity. The mutual nature of
the debt and not the mutual nature of the parties should be considered. Debts
accruing in different rights cannot be set off against each other. A bank can
enforce its lien if mutual demands exist between itself and the customer, that is
when they mutually exist between the same parties and between them in the
same capacity. In this case there were two partnership firms having same
partners but separate accounts. Court opined that bank had right to appropriate
the monies of one firm for payment of an overdraft of another as the two firms
do not signify two separate legal entities.
6. Duty of Secrecy
Paget in his book Law of Banking observed: Out of the duties of the banker
towards the customer among those duties may be reckoned the duty of secrecy.
Such duty is a legal one arising out of the contract, not merely a moral one.
Breach of it therefore gives a claim for nominal damages or for substantial
damages if injury is resulted from the breach. It is, however, not an absolute duty
but qualified subject to certain reasonable if not essential exceptions. The
instances are (a) the duty to obey an order under the Banker’s Book Evidence
Act, (b) cases where a higher duty than the private duty is involved, as where
danger to the State or public duty may supersede the duty of the agent to his
principal; (c) of a bank issuing a writ claiming payment of an overdraft, stating on
the face of it the amount of the overdraft; (d) the familiar case where the
customer authorises a reference to his banker. Thus, we can conclude that
bankers are under an obligation of treating their customer’s affairs in confidence
and disclosure should be made only in exceptional and justifiable circumstances.
In Thomson v. Clydesdale Bank Ltd., there was one broker who presented few
cheques before the bank which the bank knew came from the sale of some
shares, but had no reasons to believe that those shares belonged to someone
else. The broker used those cheques to settle the overdraft on his private
account. The bank was not held liable for the same.
7. Minors
According to the Indian Majority (Amendment) Act, 1999 a person who attains
the age of 18 is a major. Therefore, a person who is less than 18 years of age will
be considered as a minor. As per the Indian Contract Act, 1872 a minor is
incapable of entering into any form of contract but Section 26, NI Act, 1881
poses an exception for the minor.
Minor.—A minor may draw, indorse, deliver and negotiate such instruments so as
to bind all parties except himself. A minor is not allowed to overdraft or encash
money more than his deposits, a minor can open an account, draw negotiable
instrument and even loan can be taken on behalf of minor but the bank should
keep certain precautions like not allowing the minor to overdraft or not allowing
the minor to deposit money more than a certain limit. Customer must also pay
back any overdraft done by him.
8. Liability for Unauthorized Payment
Midland Bank Ltd. v. Reckitt, 1933 AC 1 (HL). When person to whom payment
is made by an agent knows that it is without authority, he cannot retain it. An
agent was given wide powers of withdrawing principal’s money “without
restriction”. The principal was held not liable when the agent issued cheque to
get a car for himself and to settle his overdrafts.
9. Wrongful Dishonour
In Rae v. Yorkshire Bank Plc., there were two cheques dishonour, and
overlooking the overdraft agreement, the bank was held liable to pay only
nominal damages because the customer was not a trader and he had also not
proved any specific losses.
Fleming v. Bank of New Zealand, 1900 AC 577 (PC). Similarly, where a banker
has agreed to provide credit or overdraft facility to a customer and forgetting
that agreement refuses the customer’s cheque, the banker is liable in damages.
Thus the banker’s obligation to honour the customer’s cheques depends entirely
on the contract between the customer and the banker. When the banker has in
his possession securities of the customer, he will be liable, even if he has no cash
balance of the customer in the account, when in the previous course of similar
dealings he honoured the customer’s cheques. It is not necessary that the
customer must on each occasion make a request for an overdraft and the bank
must accede to such request before the cheque for overdraft can be drawn.
Brahma v. Chartered Bank, AIR 1956 Cal 399. If there is a previous agreement
allowing the customer to overdraw that is enough to impose a liability on the
bank to honour the cheques for excess amount to the maximum amount of the
limit of the overdraft, if there is such a limit.