LAW OF BANKING AND NEGOTIABLE INSTRUMENTS: Unit-IV:

PAPER-II:

LAW OF BANKING AND NEGOTIABLE INSTRUMENTS:

Unit-IV:

🔶 1. Explain the obligations and duties of a Paying Banker while honouring a cheque.

A paying banker is a banker on whom a cheque is drawn and who is responsible for making payment to the payee or holder of the cheque. The banker is under a contractual and fiduciary duty to honour the customer’s cheques as per the mandate given in the account opening and the Negotiable Instruments Act, 1881. However, this duty is subject to several legal, contractual, and prudential obligations.

✅ 1. Duty to Honour Valid Cheques

The fundamental obligation of the paying banker is to honour the customer’s cheques provided:

The cheque is properly drawn and signed,
There are sufficient funds in the account,
There are no legal impediments (e.g., court order, garnishee order, insolvency),
The cheque is within its validity period (generally 3 months from the date).

This obligation arises from the banker-customer contractual relationship, particularly when the customer maintains a current or savings account.

✅ 2. Verification of Signature and Instrument

The paying banker must verify the drawer’s signature with the specimen signature available in bank records. If the signature is forged, the banker must not honour the cheque, even if sufficient funds are available. Also, any material alteration in the cheque should be checked. If alterations are present without proper authentication, payment must be refused.

✅ 3. Reasonable Care and Prudence

The banker must act with due diligence. This includes:

Ensuring the cheque is not post-dated or stale-dated,
Checking for any suspicious transactions or irregularities on the cheque,
Verifying the endorsements in case of order cheques.

Failure to exercise reasonable care may lead to liability for negligence or conversion.

✅ 4. Payment in Due Course (Sec. 10, Negotiable Instruments Act)

The payment must be made in accordance with Section 10 of the Negotiable Instruments Act, which defines “payment in due course” as payment made:

In accordance with the apparent tenor of the instrument,
In good faith and without negligence,
To the person in possession of the cheque (payee or rightful holder).

Only when payment is made in due course can the paying banker claim statutory protection under the Act.

✅ 5. When Payment Must be Refused

A paying banker is obliged to dishonour the cheque under the following circumstances:

Stop Payment Order: If the drawer has instructed the bank not to pay,
Insufficient Funds: When the account balance is inadequate,
Account Closed: Cheques from closed accounts cannot be honoured,
Death or Insolvency of Customer: Once informed, the bank must freeze the account,
Garnishee Order: If a court directs the banker to withhold funds,
Forgery or Alteration: If the cheque appears to be forged or tampered with.

✅ 6. Duty of Confidentiality

While dealing with the payment of cheques, the banker must respect the confidentiality of the customer’s account information, unless required by law to disclose.

✅ 7. Responsibility Towards Other Stakeholders

The paying banker must also consider potential liabilities towards:

The payee, in case of wrongful dishonour,
The customer, if the cheque is wrongly dishonoured,
The bank itself, to avoid losses and reputational harm.

✅ 8. Consequences of Wrongful Dishonour

If a banker wrongfully dishonours a valid cheque, especially that of a trader or business, it may lead to:

Legal action for damages by the customer,
Damage to the customer’s credit and reputation,
Loss of customer trust and possible litigation.

✅ Case Law:

Canara Bank v. Canara Sales Corporation (1987) – The Supreme Court held that a banker is under a duty to exercise proper care in honouring cheques, and negligence could lead to liability.

✅ Conclusion

The paying banker plays a critical role in the banking system and must adhere to a high standard of diligence and care while honouring cheques. The banker’s obligations are not just to the customer but also governed by the legal framework, especially the Negotiable Instruments Act, 1881. Ensuring compliance with legal norms and exercising due care helps the banker avoid liability while maintaining customer trust and operational efficiency.

🔶 2. Discuss the limitations on the Paying Banker’s duty to honour a customer’s cheque. Under what circumstances can a banker refuse payment?

A paying banker is under a legal and contractual duty to honour a customer’s cheque when it is presented, provided certain conditions are fulfilled — such as sufficient balance, properly drawn cheque, and no legal hindrance. However, this duty is not absolute. There are important limitations on the paying banker’s obligation to pay. In certain circumstances, the banker must or may refuse payment to protect either the bank, the customer, or comply with legal requirements.

✅ 1. Insufficient Funds

One of the most common and clear limitations is when the customer’s account lacks sufficient funds to cover the cheque amount. In such a case, the banker is not bound to honour the cheque. Honouring such a cheque without permission may expose the banker to financial loss.

✅ 2. Countermanding of Payment (Stop Payment Instructions)

If a customer gives a stop payment instruction to the bank before the cheque is presented, the banker is legally bound to dishonour the cheque. This is known as countermanding. The banker must act promptly upon receiving such instruction, even if the account has sufficient funds.

✅ 3. Irregular or Stale Cheques

If a cheque is:

Post-dated (dated in the future),
Stale (presented after 3 months of the date on the cheque),
Materially altered without authentication, or
Mutilated or incomplete,

The banker has the right — and sometimes the duty — to refuse payment, as such cheques may not be considered valid instruments.

✅ 4. Forgery or Irregular Signature

A cheque with a forged signature of the drawer is not a valid mandate. The banker has no authority to debit the customer’s account based on a forged cheque. Honouring such a cheque would make the bank liable for the loss. Similarly, if the signature differs from the specimen or is incomplete, payment must be denied.

✅ 5. Account Closed

If the account on which the cheque is drawn has been closed prior to presentation, the banker is obliged to dishonour the cheque. It must also be marked as “account closed”, and returning it to the payee.

✅ 6. Legal Orders and Injunctions

The duty of a paying banker is also limited by legal or judicial orders, such as:

Garnishee Orders (court order to seize funds in the customer’s account),
Injunctions prohibiting payments,
Income tax authority attachment orders,
Receiver orders in cases of insolvency or liquidation.

In these situations, the banker must freeze the account or comply with the court directive, even if the customer has sufficient funds.

✅ 7. Customer’s Death, Insolvency, or Mental Incapacity

Upon receiving notice of the customer’s death, the banker must stop all payments on the account until the legal representative or executor is appointed. The same rule applies in case of:

Insolvency of the customer,
Lunacy or declaration of mental incapacity.

Failing to stop payment in such cases can make the bank liable.

✅ 8. Mandate Revoked or Exhausted

In situations where a mandate given by a customer (such as Power of Attorney or agent authority) is revoked or terminated (due to death or expiration), the bank must not honour any cheques drawn under such authority.

✅ 9. Multiple or Conflicting Cheques

When multiple cheques are presented and the balance is insufficient to honour all of them, the banker has discretion in deciding which cheque(s) to pay. However, if a court directs or a priority rule is in place, it must be followed.

✅ 10. Ambiguous or Uncertain Instrument

A banker is justified in refusing to honour a cheque which is:

Ambiguous in its language,
Illegibly written,
Incomplete in essential particulars (like missing date or amount).

✅ Consequences of Wrongful Dishonour

While the above circumstances justify dishonour, wrongful dishonour of a valid cheque without sufficient reason may:

Damage the customer’s business reputation,
Lead to legal action for defamation or breach of contract,
Require the bank to pay damages.

This is especially critical when the customer is a trader or business entity, as commercial reputation is legally protected.

✅ Case Law: Marzetti v. Williams (1830)

The bank was held liable for dishonouring a merchant’s cheque despite the presence of sufficient funds. The court awarded damages for harm to commercial reputation.

✅ Conclusion

Although the paying banker is primarily obligated to honour cheques drawn by the customer, this duty is not absolute. It is subject to several limitations arising from contract law, banking regulations, customer instructions, and judicial directives. A banker must act with caution and prudence while honouring or dishonouring a cheque to avoid legal liability and protect both the bank’s and the customer’s interests.

🔶 3. Define the term ‘Payment in Due Course’ under the Negotiable Instruments Act. What are its essential conditions and significance for a Paying Banker?

(Long Answer – Approx. 700 words)

The concept of “Payment in Due Course” is a crucial principle in the law of negotiable instruments and plays a significant role in protecting the interests of the paying banker. It ensures that when payment is made properly and honestly, the paying banker is discharged from liability, even if defects in the title are discovered later. This concept is codified under Section 10 of the Negotiable Instruments Act, 1881.

✅ Definition under Section 10 of the Negotiable Instruments Act, 1881

“Payment in due course” means payment made 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.

In simple terms, payment in due course refers to proper, honest, and regular payment of a negotiable instrument by the paying banker to the rightful holder, following the rules of law and banking practice.

✅ Essential Conditions of Payment in Due Course

To constitute a valid payment in due course, the following essential conditions must be satisfied:

🔷 1. Payment According to the Apparent Tenor of the Instrument

The payment must be made in accordance with the terms written on the face of the cheque or bill.
If the instrument is payable on demand, it must be paid only when demanded.
Post-dated cheques must not be paid before the date.
Stale or materially altered cheques must not be honoured.

🔷 2. Payment in Good Faith

The payment must be made with honesty and sincerity, without any intent to defraud or favour.
There must be no suspicion regarding the transaction or the person presenting the instrument.
A banker who pays a cheque knowing it to be forged or irregular cannot claim that the payment was made in good faith.

🔷 3. Without Negligence

The paying banker must act with reasonable care and prudence.
The signature of the drawer must be verified.
Any material alterations must be checked and authenticated.
Suspicious instruments (e.g., overwriting, mismatch in amount in figures and words) must be scrutinized properly.

Negligence on the banker’s part will deprive him of the protection granted under the Act.

🔷 4. To the Possessor of the Instrument

The cheque must be paid to the person in lawful possession of the instrument.
If the instrument is bearer, it can be paid to whoever presents it.
If it is order type, payment must be made only to the payee or to someone who is properly endorsed.

Paying someone who is not the rightful holder may result in wrongful payment.

🔷 5. No Reasonable Grounds to Suspect

There should be no apparent defects or irregularities.
If there are any visible signs that indicate forgery or doubt in entitlement, the banker must not proceed with payment.

Failure to take reasonable care may constitute gross negligence, disqualifying the banker from statutory protection.

✅ Significance for the Paying Banker

🔷 1. Statutory Protection (Sections 85 and 89)

If payment is made in due course, the banker is protected under:

Section 85: For cheques payable to order and bearer.
Section 89: For instruments with unauthorized endorsements or crossings.

Even if the instrument later turns out to be forged or stolen, the banker is not liable if payment was made in due course.

🔷 2. Discharge from Liability

Once payment in due course is made:

The drawer’s account is debited,
The banker is relieved from liability,
The drawer cannot claim a refund unless the banker was negligent.

🔷 3. Avoidance of Conversion or Negligence Claims

If a banker fails to ensure payment in due course and pays a wrong person:

He may be sued for conversion,
May be liable to compensate the true owner of the cheque,
May suffer reputational and financial damage.

✅ Case Law: Canara Bank v. Canara Sales Corporation (1987)

In this case, the bank honoured a cheque with a forged endorsement. The court held the banker negligent and denied the protection of “payment in due course.”

✅ Conclusion

“Payment in Due Course” under Section 10 of the Negotiable Instruments Act is a vital legal doctrine that protects the paying banker when due diligence is observed. It emphasizes the importance of honesty, care, and proper procedure in cheque transactions. A banker who adheres to this principle is shielded from liability, even if the instrument has underlying defects. Thus, for every paying banker, understanding and following this rule is essential for safe and lawful operation.

🔶 Q4. Under what conditions must a Paying Banker refuse payment of a cheque? Support your answer with legal reasoning and examples.

A Paying Banker is the bank on which a cheque is drawn and which is required to make payment when a cheque is presented. However, there are certain conditions under which the banker must refuse to honour the cheque. Failure to do so may lead to the banker incurring legal liability.

✅ Conditions Where Paying Banker Must Refuse Payment:

1. When the Drawer has Countermanded Payment (Stop Payment Instruction):

If the drawer gives clear written instructions to the bank not to pay a particular cheque before it is presented, the bank is bound to honour such instructions.
Legal Reasoning:
Under Section 31 of the Negotiable Instruments Act, 1881, the bank must act according to the drawer’s mandate.
Example:
Mr. A issues a cheque to Mr. B but later instructs his bank not to pay the cheque. If the cheque is presented, the bank must refuse payment.

2. When the Drawer Dies, Becomes Insolvent, or Lunatic:

Upon receiving notice of the death, insolvency, or mental incapacity of the drawer, the bank must stop payment.
Legal Reasoning:
The authority of the banker to act on behalf of the customer ends upon these events.
Example:
Mr. C dies, and the bank is informed before the cheque is presented. The bank must not honour the cheque even if there is balance.

3. When There Are Insufficient Funds in the Account:

A banker must refuse to honour a cheque if the account has insufficient balance unless it is an overdraft facility.
Legal Reasoning:
Payment without sufficient funds may not be covered by Section 31 and may expose the banker to loss.
Example:
A cheque of ₹50,000 is drawn but only ₹20,000 is available. The bank must dishonour it.

4. When the Cheque is Post-dated and Presented Early:

If a post-dated cheque is presented before its due date, it must be refused.
Legal Reasoning:
A post-dated cheque is not payable until the date mentioned.
Example:
A cheque dated 10th July is presented on 30th June; the banker must refuse payment.

5. When the Cheque is Stale (More Than 3 Months Old):

A cheque is valid for 3 months from the date of issue. If presented after that, it becomes stale.
Legal Reasoning:
RBI guidelines instruct banks not to honour stale cheques.
Example:
A cheque dated 1st January is presented on 5th May; the banker must reject it.

6. When There is a Material Alteration Without Proper Authentication:

Any material alteration (e.g., change in amount, date, payee) not duly signed by the drawer makes the cheque invalid.
Legal Reasoning:
Under Section 87 of the Negotiable Instruments Act, materially altered cheques are void unless authenticated.
Example:
If the amount is changed from ₹5,000 to ₹50,000 without the drawer’s signature, the bank must dishonour it.

7. When the Signature of the Drawer Does Not Match:

If the drawer’s signature does not match the specimen signature held by the bank, payment must be refused.
Legal Reasoning:
It indicates fraud or forgery, and the bank must protect the customer’s interests.
Example:
If a cheque is signed by someone other than the account holder, and the signature does not match, the bank cannot process it.

8. When the Cheque is Mutilated or Torn:

If the cheque is damaged, torn, or illegible, the banker may refuse payment.
Legal Reasoning:
A mutilated cheque raises doubts about its authenticity and validity.
Example:
A cheque with a torn corner that hides part of the amount may be dishonoured.

9. When the Cheque is Not Properly Drawn:

This includes missing essential elements like:
- Date
- Amount (in figures or words)
- Signature
Legal Reasoning:
An incomplete cheque is not a valid instrument under Section 5 of the NI Act.
Example:
A cheque without the date is invalid and must be dishonoured.

🔚 Conclusion:

A Paying Banker is duty-bound to ensure that cheques are honoured only when they are valid, properly drawn, and within legal and contractual limits. Any payment made contrary to these rules may lead to liability for negligence or breach of contract. Therefore, the banker must act cautiously and refuse payment in the above circumstances to protect both the bank and the customer.

🔶 Q5. What statutory protection is available to a Paying Banker under the Negotiable Instruments Act? Discuss with relevant sections.

A Paying Banker is one who makes payment on a cheque drawn by a customer. In the ordinary course of business, the banker is expected to honour the cheque if it is in proper form. However, if the banker, in good faith and without negligence, makes payment of a cheque that later turns out to have legal defects (e.g., forged endorsements), then the banker is protected under certain statutory provisions of the Negotiable Instruments Act, 1881.

✅ Statutory Protection to Paying Banker – Overview:

The Negotiable Instruments Act, 1881 provides limited protection to a banker in cases where he pays a cheque that appears regular on its face but is later found to be defective. The two major sections that confer this protection are:

🔹 1. Section 85 – Cheques Payable to Order

📘 Section 85(1):

“Where a cheque payable to order purports to be endorsed by or on behalf of the payee, the banker is discharged by payment in due course.”

➤ Meaning and Application:

If a cheque is payable to order, and the endorsement appears valid, the banker gets protection even if the endorsement later turns out to be forged.
However, the protection is available only if the payment is made in due course (defined under Section 10).

🧾 Example:

A cheque is payable to “Ram or order”, and an endorsement appears to be in Ram’s handwriting. The bank pays the amount. Later it is found that the endorsement was forged. The banker is not liable, provided he acted in good faith and without negligence.

🔹 2. Section 85(2): Cheques Payable to Bearer

“Where a cheque is originally expressed to be payable to bearer, the banker is discharged by payment in due course to the bearer thereof, notwithstanding any endorsement.”

➤ Explanation:

For bearer cheques, the banker is protected even if endorsements are forged or irregular, as long as the payment is made to the bearer and in good faith.

🧾 Example:

A cheque marked “Pay Cash” or “Pay to XYZ or bearer” is presented by a third party. The bank pays the cheque. Even if the bearer had no title, the banker is protected.

🔹 3. Section 128 – Protection in Case of Payment of Crossed Cheque

“Where the banker on whom a crossed cheque is drawn in good faith and without negligence pays it, and it bears no indication that it has been transferred to someone else, the banker is protected.”

➤ Key Points:

Applies to crossed cheques (specially or generally crossed).
If the bank pays such cheque in due course, it is not liable even if the payee had no title.
Helps promote smooth functioning of cheque clearing systems.

🧾 Example:

A cheque crossed “A/c Payee – SBI Ltd” is deposited by an employee of SBI, and the bank honours it. If the employee later turns out to have misused it, the paying bank is protected, if it acted without negligence.

🔹 4. Section 10 – Meaning of Payment in Due Course

“Payment in due course means payment made in accordance with the apparent tenor of the instrument, in good faith and without negligence, to the person in possession thereof under circumstances which do not afford a reasonable ground for believing that he is not entitled to receive payment.”

➤ Importance:

Protection to banker is available only if payment is made in due course.
Any negligence, lack of good faith, or suspicious circumstances can make the banker liable.

✅ Essential Conditions for Protection:

Payment must be in due course as per Section 10.
Good faith and absence of negligence is essential.
Cheque must be apparently regular (no visible defects).
Protection is not available if:
- Signature of the drawer is forged.
- Banker pays a post-dated or stale cheque.
- Banker ignores stop-payment instructions.

❌ No Protection in Case of Forged Drawer’s Signature:

Even a small error in verifying the drawer’s signature nullifies the protection, because such a cheque is not considered a valid mandate from the customer.

Leading Case: Canara Bank v. Canara Sales Corporation (1987)
➤ Bank was held liable for honouring cheques with forged drawer’s signatures.

🔚 Conclusion:

The Negotiable Instruments Act provides statutory protection to paying bankers under Sections 85 and 128, provided they act in good faith, without negligence, and make payment in due course. This protection ensures that bankers are not unjustly penalized for trusting documents that appear valid on their face, and it encourages efficiency and trust in cheque-based transactions.

🔶 Q6. Define a Collecting Banker. What are the obligations and duties of a Collecting Banker in handling cheques on behalf of customers?

✅ Definition of a Collecting Banker:

A Collecting Banker is a banker who collects cheques and other negotiable instruments on behalf of his customer from the Paying Banker (the bank on which the cheque is drawn). The collection may be done either for clearing or on collection basis. The banker acts as the agent of the customer in this process.

⚖️ Legal Definition:
A Collecting Banker is one who undertakes to collect cheques, bills of exchange, or other instruments on behalf of his customer and credits the amount to the customer’s account.

📘 Relevant Legal Provision:

🔹 Section 131 of the Negotiable Instruments Act, 1881

“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.”

🔸 Protection under Section 131 is available only when:

The cheque is crossed
The banker acts in good faith
There is no negligence

✅ Obligations and Duties of a Collecting Banker:

The Collecting Banker must perform certain responsibilities while handling cheques to ensure due diligence and avoid legal liability.

🔹 1. Duty to Act as Agent of the Customer:

The collecting banker acts as an agent, not as an owner.
The banker receives the cheque, presents it for payment, and credits the proceeds to the customer’s account.

🔹 2. Duty to Collect in Good Faith and Without Negligence:

This is essential for availing protection under Section 131.
The banker must make reasonable inquiries, especially in case of suspicious circumstances or third-party cheques.
Example: If a cheque drawn in favour of Company A is deposited in Mr. X’s personal account, the banker must verify the authority.

🔹 3. Duty to Verify the Regularity of the Instrument:

The banker must examine:
- Date and amount
- Crossing
- Endorsements
- Alterations
Any material irregularity must be checked to avoid negligence.

🔹 4. Duty to Ensure Proper Endorsement:

The banker must verify whether the endorsement is:
- In the correct name
- Not forged
- In chain (if there are multiple endorsements)
Endorsement must match the payee’s name exactly.

🔹 5. Duty to Open Accounts with Care:

If the bank allows cheque collection for a newly opened or suspicious account without proper verification (like KYC), it may be held liable.
Leading Case: Ladbroke v. Todd (1914) – Bank was held negligent for opening an account without proper references.

🔹 6. Duty to Present Cheque Promptly:

The banker must present the cheque for collection within a reasonable time.
Delay may result in loss of right to protection under Section 131.

🔹 7. Duty Not to Misuse Customer’s Funds:

The bank must credit the amount to the rightful customer.
The banker should not set off such amounts against any other dues without customer’s consent.

🔹 8. Duty to Maintain Confidentiality:

The banker must not disclose the customer’s transaction details to third parties except under legal compulsion.

🔹 9. Duty to Observe Mandate Instructions:

The collecting banker must follow the customer’s instructions related to collection and credit of the cheque.

🔹 10. Duty to Return the Instrument if Uncollected:

If a cheque cannot be collected (e.g., dishonoured), the banker must return it to the customer with proper reasons.

❌ When Protection under Section 131 is Not Available:

If the cheque is not crossed
If the bank is negligent
If the bank acts without good faith
If the bank collects for a person who is not its customer

📌 Important Case Laws:

Commissioner of Taxation v. English, Scottish & Australian Bank (1920):
- Collecting banker must act honestly to avail protection.
Indian Overseas Bank v. Industrial Chain Concern (1990):
- The bank was held negligent in collecting a third-party cheque for someone not entitled to it.

🔚 Conclusion:

A Collecting Banker plays a vital role in handling cheques on behalf of customers and is expected to act with reasonable care, due diligence, and honesty. Though Section 131 provides statutory protection, it is conditional and depends on good faith and absence of negligence. The banker must observe all duties carefully to avoid liability and ensure secure banking operations.

🔶 Q7. What is meant by ‘conversion’ in relation to a Collecting Banker? When can a Collecting Banker be held liable for conversion?

✅ Meaning of ‘Conversion’ in Banking Law:

In legal terms, ‘conversion’ refers to an unauthorized or wrongful act of dealing with goods or property in a way that is inconsistent with the rights of the lawful owner.

In the context of a Collecting Banker, conversion means:

“Wrongful collection or handling of a cheque by a banker on behalf of someone who has no title or defective title to it, thereby depriving the true owner of his property (i.e., the cheque or its proceeds).”

Even though the banker may not have intended to defraud, he may still be held strictly liable in tort for conversion if he collects a cheque negligently or without authority.

✅ Illustration:

A cheque is payable to Mr. X.
Mr. Y forges X’s endorsement and deposits the cheque in his own account.
The Collecting Banker collects and credits the amount to Y without verifying.
In this case, the banker may be liable for conversion, as the true owner (Mr. X) has been deprived of his rightful money.

✅ Legal Basis for Liability:

Although the Negotiable Instruments Act, 1881, does not define “conversion”, the concept is derived from tort law.
However, Section 131 of the Act provides protection to the collecting banker against liability for conversion, subject to certain conditions.

📘 Section 131 – Protection to Collecting Banker:

“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 incur any liability to the true owner of the cheque by reason only of having received such payment.”

🔸 Thus, if the banker:

Collects a crossed cheque,
Acts in good faith,
Is not negligent, then he is protected from liability for conversion, even if the customer had no proper title.

✅ When Can a Collecting Banker Be Held Liable for Conversion?

A collecting banker will be held liable for conversion in the following circumstances:

🔹 1. Collecting for a Non-Customer:

If the bank collects a cheque for someone who is not a customer, it cannot claim protection under Section 131.
Example: Collecting a cheque for a walk-in stranger.

🔹 2. Collecting an Uncrossed (Open) Cheque Wrongfully:

Section 131 protects the banker only for crossed cheques.
If an open (uncrossed) cheque is collected wrongly, the banker is liable.

🔹 3. Failure to Exercise Due Diligence (Negligence):

If the banker does not verify the endorsement, identity, or the authority of the person presenting the cheque, he may be considered negligent.
Any negligence negates the protection of Section 131.
Example: Bank collects a cheque in favour of a company into the account of a director personally, without inquiry.

🔹 4. Collecting Cheques with Forged Endorsements:

If a banker collects a cheque with a forged endorsement and fails to detect it, he may be held liable unless he acted diligently.
Example: Cheque payable to “Mr. A”, but collected by Mr. B with a forged signature.

🔹 5. Opening Account Without Proper Verification (KYC):

If a cheque is collected in a fraudulently opened account, the bank is responsible for negligence.
Case: Ladbroke v. Todd (1914) – Bank was held liable for conversion for collecting cheques in a fictitious account.

🔹 6. Wrongful Credit or Misappropriation of Funds:

If the banker credits the proceeds of the cheque to the wrong account or uses it to adjust other liabilities of the customer without authority, it can amount to conversion.

✅ Important Case Laws:

🔸 Lloyds Bank Ltd. v. Chartered Bank of India (1929)

A bank collected cheques for a person with no title.
Held: Banker was liable for conversion as he failed to verify the customer’s authority.

🔸 Indian Overseas Bank v. Industrial Chain Concern (1990)

Cheques payable to a firm were credited to a partner’s personal account.
Held: Bank was negligent and liable for conversion.

✅ How to Avoid Liability for Conversion?

Ensure that the cheque is crossed.
Act in good faith and without negligence.
Verify the identity and title of the person presenting the cheque.
Do not collect for someone who is not a customer.
Follow Know Your Customer (KYC) norms strictly.
Check endorsements and irregularities.

🔚 Conclusion:

‘Conversion’ in banking refers to the unauthorized collection or misappropriation of cheques leading to the loss of the true owner. A Collecting Banker can be held liable in tort for conversion if he collects a cheque for someone with no title, without proper verification, or negligently. However, Section 131 of the Negotiable Instruments Act offers protection, provided the banker acts in good faith and without negligence. To avoid liability, the banker must act diligently and maintain strict adherence to banking norms and procedures.

🔶 Q8. Explain the statutory protection available to a Collecting Banker under Section 131 of the Negotiable Instruments Act. Under what conditions can this protection be claimed?

✅ Introduction:

A Collecting Banker is a banker who undertakes to collect cheques or other negotiable instruments on behalf of a customer and credit the proceeds to the customer’s account. In doing so, the banker acts as an agent of the customer. While collecting cheques, the banker may sometimes collect a cheque from a person who is not the true owner, which could expose the banker to a tortious liability for conversion or wrongful interference with property.

To protect bankers acting in good faith, the Negotiable Instruments Act, 1881 provides statutory protection under Section 131.

📘 Section 131 – Protection to Collecting Banker:

“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.”

✅ Key Elements of Section 131:

To claim protection under this section, certain essential conditions must be fulfilled, as explained below:

🔹 1. The Banker Must Act as an Agent for Collection:

The banker should collect the cheque on behalf of a customer, not for himself.
He must not become the holder or owner in his own name.

🔹 2. Cheque Must Be Crossed:

The protection is applicable only to crossed cheques, whether:
- Generally crossed (with two parallel lines) or
- Specially crossed (to a particular bank).
If the cheque is not crossed, Section 131 does not apply.

🔹 3. The Customer Must Have a Bank Account:

The collecting banker must collect the cheque for a person who maintains an account with the bank.
Collecting cheques for non-customers nullifies the protection.

🔹 4. Banker Must Act in Good Faith and Without Negligence:

The banker must be honest and exercise due diligence.
If there are suspicious circumstances, the banker must inquire further.
Negligence will deprive the banker of protection, even if he had good faith.

✅ What Constitutes “Without Negligence”?

The banker is expected to:

Verify endorsements.
Match payee’s name and account holder’s name.
Confirm authority in case of third-party or company cheques.
Follow KYC norms when opening accounts.
Not ignore irregularities or warning signs.

❌ When Protection Under Section 131 is Not Available:

If the cheque is not crossed.
If the banker collects for a non-customer.
If there is negligence in collecting the cheque.
If the cheque is collected for a fraudulent purpose.
If the cheque has a forged endorsement, and the banker fails to detect it.

✅ Examples Illustrating Protection and Liability:

✔️ Example 1 – Protection Available:

A crossed cheque is payable to “Mr. A”.
Mr. A deposits it in his account in Bank X.
The cheque is later found to have been stolen, but the bank had no reason to suspect.
The bank acted in good faith and without negligence → Protected under Section 131.

❌ Example 2 – No Protection:

A cheque payable to “XYZ Pvt. Ltd.” is deposited in Mr. A’s personal account.
Bank does not verify authority or ask questions.
This is negligence → Bank not protected under Section 131.

✅ Important Case Laws:

🔹 Lloyds Bank v. Savory & Co. (1933):

The banker was held liable because of negligence in collecting cheques with suspicious endorsements.

🔹 Indian Overseas Bank v. Industrial Chain Concern (1990):

Cheques drawn in favour of a firm were credited to a partner’s personal account.
Bank held liable due to negligence.

🔹 Marfani & Co. Ltd. v. Midland Bank Ltd. (1968):

Court emphasized that mere good faith is not enough; absence of negligence is also required.

✅ Significance of Section 131:

It balances bankers’ operational responsibility and the need for legal protection.
Encourages banks to handle instruments efficiently without fear of liability, provided they act diligently.
Promotes security and trust in cheque clearing systems.

🔚 Conclusion:

Section 131 of the Negotiable Instruments Act offers statutory protection to a Collecting Banker, shielding him from liability for conversion or wrongful collection if the cheque turns out to have a defective title. However, this protection is conditional upon the banker acting in good faith, without negligence, and only collecting crossed cheques for a customer. Any lapse in diligence or reckless conduct will deprive the banker of this valuable legal shield.