By Craig W. Smith, J.D., Author, CCH Deposit Law Notes.
As a rule, if a bank dishonors an item drawn on sufficient collected funds it will be liable to its customer for wrongful dishonor.
A fundamental principle under the revised UCC is that a financial institution will be liable to its customer if it dishonors an item that is properly payable. A properly payable item is defined as an item that is authorized by the customer and is in accordance with any agreement between the customer and the bank (Revised UCC § 4-401). In general, this means that a check is properly payable as long as the signatures and endorsements appearing on the item are legitimate and as long as there are sufficient collected funds on deposit in the account to pay the item.
For instance, if an item is stale dated (more than six months old), postdated or subject to a stop payment order, then a bank may refuse to pay the item without risking a wrongful dishonor claim. Moreover, a check that bears a customer’s forged signature or the payee’s forged endorsement is not properly payable.
If a bank applies the proceeds in a deposit account to satisfy a delinquent loan obligation of the account owner, then generally it will not be liable for the dishonor of any items it returns because of the setoff. Likewise, a financial institution will not be responsible for any checks it dishonors because the Internal Revenue Service or a judgment creditor has attached a customer’s account. In addition, unless it has agreed otherwise, a bank may refuse to pay a check that would overdraw its customer’s account without subjecting itself to a wrongful dishonor claim.
Be aware that the UCC does provide that damages for wrongful dishonor may include those for the arrest and prosecution of the customer because of the wrongful dishonor or other consequential damages. These damages presumably could include, among other things, attorney’s fees, the costs associated with any bail requirements, lost income, lost value of a business and emotional distress.
Furthermore, the UCC does not prohibit the award of punitive damages in wrongful dishonor cases. Instead, it relinquishes the determination of the propriety of punitive damages to other rules of law. This means that if a bank’s wrongful dishonor is motivated by malice or is oppressive in nature or is in reckless disregard of a customer’s rights, then punitive damages might be granted.
The following recently decided case illustrates the circumstances under which a bank may be liable to its depositor for both loss of income and the value of a business that was shut down because of the wrongful dishonor of checks.
On September 30, the president and another bank representative met with Maryott to discuss the Oconto situation. After the meeting the bank representatives concluded that Maryott was involved in or the victim of “suspicious activity” because he was not keeping them up to date on the Oconto situation. Accordingly, the bank decided to dishonor the three checks that it had paid on September 30, despite the fact that the dishonor occurred after the Bank’s midnight deadline had expired. Once the funds were restored to Maryott’s account, the Bank immediately froze the account, deemed itself insecure and used the proceeds of the dishonored checks to pay down the balance of Maryott’s loans with the Bank.
As a result of the dishonor of the checks, claims were made by Maryott’s creditors in excess of the $70,000 bond he was required to post to maintain his cattle dealer’s license. Because the claims on the bond exceeded the amount of the bond, Maryott was required to forfeit his dealer’s license. Without a license, Maryott could not independently deal livestock, which effectively shut down his business.
Maryott then sued the Bank for wrongful dishonor of the three checks that it originally paid on September 25. The jury awarded Maryott $600,000 in damages for lost income, the value of his business and emotional distress. The Bank appealed the judgment.
THE ARGUMENTS. The Bank argued that there is no connection between the three dishonored checks and the damage caused to Maryott, namely, the loss of his dealer’s license and the closing of his business. In addition, the Bank argued that the evidence presented in the case did not support the jury’s award of damages for emotional distress. Maryott argued that the trial court erred in not submitting his claim for punitive damages to the jury.
THE COURT DECISION. The Court first observed that under the UCC a payor bank is liable to its customer for damages proximately caused by the wrongful dishonor of an item. It then noted that there is no question that the Bank wrongfully dishonored the three checks in question since they were returned after the Bank’s midnight deadline for returning the items had expired. In addition, the Court noted that the dishonor of the items was the proximate cause of Maryott’s loss of income in the amount of $250,000 and loss of his business in the amount of $200,000. The Court pointed out that the evidence presented at trial clearly indicated that Maryott’s creditor’s would not have moved against his bond causing the loss of his license to do business if the Bank had not dishonored the checks in question.
The Court next determined that the evidence did not support the jury’s award of damages for emotional distress. It noted that recovery for emotional damages is only allowed when intentionally inflicted or accompanied by actual physical injury. In addition, the Court also denied Maryott’s claim for punitive damages. It noted that punitive damages can be awarded in wrongful dishonor cases, but are only justified when there is oppressive, fraudulent or malicious conduct by the bank, which was not present in this case.
Consequently, the Court upheld the jury’s verdict in favor of Maryott for $450,000 in damages for loss of income and the value of Maryott’s business. The Court, however, reversed the jury’s award of damages for emotional distress and denied Maryott’s claim for punitive damages. Maryott v. First National Bank, Supreme Court Case No. 21539 (SD 2001).
Financial institutions should endeavor to avoid wrongful dishonor claims. This is because the damages that can be awarded to a customer under a wrongful dishonor case can be significant. For instance, as illustrated in the Maryott case damages may include lost income and the value of a business closed down because of the wrongful dishonor of checks. Furthermore, if a financial institution’s action in dishonoring a check is malicious in nature or is in willful disregard of its customer’s rights, then the potential for punitive damages or damages involving emotional distress also exists. Remember, however, that the dishonor alone is not sufficient to justify an award for damages. Instead, the customer must prove that he or she was actually injured or lost money because of the wrongful dishonor.