Protection of the Paying and Collecting Banker

In one line

A bank that pays the wrong person or collects for the wrong person is liable to the true owner, unless the Act protects it, and the protection is bought with good faith, absence of negligence and payment in due course.

In the wording a student can write in an exam: a banker paying a cheque is protected by section 85 of the Negotiable Instruments Act, 1881 where a cheque payable to order purports to be indorsed by or on behalf of the payee and is paid in due course, by section 85A for bank drafts, by section 89 where a material alteration is not apparent, and by section 128 where a crossed cheque is paid in due course; and a banker collecting a crossed cheque for a customer is protected by section 131 where he acts in good faith and without negligence.

Why a bank needs protection at all

The bank stands between two people, and it can be liable to either.

If it refuses to pay a cheque it should have paid, it breaks the duty to honour under section 31, and a trader recovers substantial damages without proof of loss, as chapter 330 works.

If it pays a cheque it should not have paid, it has paid without a mandate, so it cannot debit its customer, and it may also be liable to the true owner of the instrument in conversion, because it has dealt with somebody else's property.

The bank must decide in seconds, across a counter or in a clearing cycle, with no means of investigating title. A rule that made it liable whenever the presenter turned out to have no title would make banking impossible.

So the Act protects the bank on conditions, and the conditions are the whole of this chapter. The protections are not gifts; each requires the bank to have done its own job properly.

Payment in due course: section 10

Everything for the paying banker turns on this definition, and it must be known word for word.

Section 10. "'Payment in due course' means payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof under circumstances which do not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned."

Four elements, and all four must be present.

In accordance with the apparent tenor of the instrument. Payment must match what the instrument says on its face: the right amount, after the date, not before a post-date, not after it is stale, and in accordance with a crossing.

In good faith and without negligence. Good faith is honesty; absence of negligence is a separate and higher requirement, and it is where banks usually fail. A bank that pays without noticing an obvious irregularity is honest and negligent.