BANKS AND BANKING
Sec. 130. Formation. Banks, institutions organized for the
purpose of receiving deposits and discounting commercial paper,
are required by the laws of most states and, in the case of national
banks, by the federal government to operate under the corporate
form of organization. In addition, the statutes usually stipulate a
minimum of capital required at the time of incorporation, the
amount being dependent upon the size of the community in which
the bank is located. In other respects, the organization of a bank-
ing corporation is quite similar to the organization of other corpo-
It should be noted, however, that under the law firms of most of our
states preferred stock may not be issued. Recently the National
Banking Act has been amended so as to provide, within certain
limits, for the issuance of preferred as well as common stock.
Sec. 131. Agents and liability for their acts. A bank, like any
other principal, is responsible for the acts of its agents so long as
the latter are performing duties within the scope of their authority.
Whenever they exceed their actual or apparent authority, the lia-
bility of the bank for their conduct ceases. There are, however,
three or four situations which merit particular attention.
The matter of theft, by one of the bank's agents, of assets left
with the bank for safekeeping has always presented a difficult prob-
lem for solution. The majority of the courts deny any recovery
against the bank in such cases on the theory that the employee is
acting outside the scope of his authority when the embezzlement
takes place. There are a few recent cases to the effect, however,
that the bank should bond its employees in order to protect those
who deposit property with the bank for safekeeping against loss.
Even where the bank is not required to place its employees under
bond to protect those who leave property with it for safekeeping,
it is always incumbent upon the bank to exercise reasonable care in
the selection and retention of its employees.
A second situation of importance arises when a customer of the
bank leaves securities with a bank's agent for discounting. In case
the agent takes the paper and tells the customer that his account
will be credited, but instead has the bank officials credit his personal
account with the amount derived from discounting the paper, the
bank is liable to the true owner for the value of the paper, provided
BANKS AND BANKING 213
the agent was one authorized to discount commercial paper. In
this connection it should be borne in mind that the cashier is the
true financial officer of the bank. An individual has a right to as-
sume that the cashier is vested with authority to discount commer-
cial paper and to make small loans. The president of a bank, on
the other hand, has no implied authority as a financial officer. His
powers are only those which are expressly delegated to him.
The authority of the officers of a bank to recommend investments
for depositors in the bank is a matter of some dispute. Of course,
if the bank possesses securities of its own, the agents of the bank
authorized to dispose of them would bind the bank by any state-
ments made in connection with a sale thereof, except a guaranty of
payment which has been held by the courts to be ultra vires. How-
ever, where an officer of the bank is authorized by a depositor to
make investments through drawing on the depositor's account, it is
very questionable if any liability rests on the bank in case the officer
makes unsound investments 1 or mishandles the funds. The officer
in such a case acts as an agent of the depositor and not as an agent
of the bank.
A cashier who issues a certificate of deposit when he receives no
consideration therefor binds the bank as effectively as though the
purchaser of the certificate had paid for it, if the certificate reaches
the hands of an innocent third party.
The directors of the bank are in reality responsible for its man-
agement and loan policy. In case the affairs of the bank are con-
ducted in a negligent and improper manner without due regard for
the interests of the depositors or stockholders, the directors are per-
sonally liable for the resulting losses.
The absence of the directors from meetings, or the fact that meet-
ings are not regularly held, does not relieve them. If they do not
supervise the loans, or if the officials in active charge make excessive
loans to projects in which they are personally interested, the direc-
tors are personally liable for the losses which result. 2 Statutes
usually place limitations on loans which may be made to a single
individual. In case of excessive loans, the directors are personally
liable for resulting losses.
Sec. 132. Special deposit. There exist in the eyes of the law
three distinct types of deposit in which the legal relationship of
the bank and depositor are essentially different. These types of
deposit are called special, specific, and general. A special deposit
consists of a bailment relationship. It arises whenever property
Downing v. Lake County State and Savings Bank et al., 1930, 133 Or. 322, 290
Pac. 236; p. 636.
a Gamble v. Brown et al., 1928, C.C.A. 29 F.(2d) 366; p. 636.
214 NEGOTIABLE INSTRUMENTS
is placed with the bank for safekeeping. In such cases the bank
owes a duty to the depositor to exercise reasonable care for the
safekeeping of the items deposited. The courts treat the relation-
ship as a mutual benefit bailment, this being true whether the bank
receives any compensation for the service or not. 3
In case the bank of deposit becomes insolvent, the depositor
should be able to obtain possession of his deposit at any time he
can identify it. In case the property is or has been improperly con-
verted by the bank and used in its business, the depositor's rights
are dependent upon several facts. If the items of deposit were
bearer negotiable instruments and were sold to holders in due
course, the depositor is limited to his right against the bank. If
he can trace the items or proceeds into the bank's assets, he will be
treated as a preferred creditor. If he is unable to trace them into
the assets, he has a claim on the same plane as any other depositor,
being an ordinary creditor of the bank, 4 provided he can establish
that the negligence of the bank or its officials occasioned his loss.
As to those items which are not negotiable instruments payable
to bearer, the depositor may reclaim them wherever he can find
them. No one can pass better title to such property than he has.
Therefore, any purchaser of them would necessarily be called upon
to return them to the true owner.
Sec. 133. Specific deposit. Whenever money or commercial
paper is left with a bank for a special purpose, a specific deposit is
created. Such a relationship arises whenever the bank is made an
agent or a trustee of the depositor. Deposits of items for collec-
tion, of amounts left with the bank for the payment of taxes or for
purposes of investment by the bank or which the bank is to use in
satisfaction of a particular obligation of the depositor offer illustra-
tions. 5 All escrow transactions are likewise of this type. The
theory of such deposits is that the bank has no right to commingle
the deposits with the other assets of the bank. Since it is an agent
or a trustee of the particular deposit, a duty rests upon it to keep
the deposit intact for the purpose specified.
Since the deposit should be segregated from the other assets of
the bank, at time of insolvency the depositor should be able to
identify his deposit and thus recover in full any amount which he
might have left with the bank. In case the bank violates its duty
to the depositor by mingling the deposit with the general assets of
3 Holmes v. First National Bank, 1929, 105 N.J.L. 621, 147 A. 441; p. 637.
4 Harmer v. Rendleman, 1933, 64 Fed.(2d) 422; p. 638.
5 Andrew, State Superintendent of Banking, v. Peoples Saving Bank, 1930, 209 la.
1147,229 N.W. 907; p. 639.
BANKS AND BANKING 215
the bank, the depositor becomes a preferred creditor. It is neces-
sary in such a case that the assets be traced into the general funds
of the bank. It is not enough to show that the bank used the de-
posit or reduced its liabilities with the items, but it is necessary to
show that it became a part of the general assets of the bank, thus
swelling the total remaining at the time of insolvency. If the de-
posit is traced into the general funds of the bank, it is presumed to
remain there unless the cash items of the bank fall, in total, below
the amount of the specific deposit. In other words, it is assumed
that the bank uses its own funds first in making payments from its
If a bank collects an item drawn upon itself, the weight of au-
thority is to the effect that a specific deposit arises as soon as it
charges the account of its depositor. The federal courts, however,
have held otherwise. They conclude that as soon as the item is col-
lected the bank becomes a debtor of the party for whom the collec-
tion was made.
Sec. 134. General deposit. A general deposit is one which
creates a debtor-creditor relationship between the bank and its de-
positor. It is broad enough to include, in addition to ordinary
checking accounts, deposits in savings accounts, certificates of de-
posit, and purchases of bank drafts or cashier's checks. In fact,
any deposit which makes a bank the debtor of its depositor creates
a general deposit. In case a bank becomes insolvent, the general
depositor becomes an ordinary creditor. In the case of deposits of
all kinds, it should be borne in mind that the proper place to make
the deposit is in the bank. There are numerous cases in which it
has been decided that persons who had made deposits to agents
of the bank at places other than the bank had no claim against the
bank, where the agent violated the confidence reposed in him and
failed to turn over the deposit to his principal.
Sec. 135. Checking accounts. The outstanding duties of a
bank to its depositors of checking accounts are: (1) to pay out
when, and only when, ordered to do so by the depositor; and (2) to
pay in strict accordance with the terms of the depositor's order.
Whenever an account stands in the name of two or more individ-
uals, it is necessary for all of the parties to sign the checks issued
against the account unless each has authorized the issuance of
checks by certain designated persons. In the case of a joint ac-
count one which goes to the survivor in case of death either
party may draw checks against it during his or her lifetime.
Postdated checks checks dated later than the time they are
issued are properly paid by the bank only when the date inserted
216 NEGOTIABLE INSTRUMENTS
on the check arrives. In case a postdated check is paid by the
bank before the date indicated thereon, thus resulting in a loss to
the depositor, the bank must suffer the loss.
An error in the balance of a depositor's account can always be
corrected. Thus, if the balance resulting from the mistake is larger
than it should have been, it may be reduced to the proper amount.
If the remaining balance is insufficient to care for the error, the de-
positor must make good the deficit. Likewise, if the mistake favors
the bank, the bank is obligated to correct it. This is true even
though the error may be discovered some time after it is made.
The language on the statement issued to a depositor demanding
that he report all errors within a reasonably short period of time
cannot relieve the bank of its duty to correct its own mistakes.
A bank which fails to pay a check properly drawn on it is liable
in damages to the depositor who drew the check. If the depositor
is a businessman, substantial damages are implied from the very
nature of his position in the community. In other instances the
depositor must present evidence of actual injury sustained. It
should be pointed out that the bank owes the holder of a check
drawn on it no duty of payment unless the check has been certified.
The holder's recourse, in case an ordinary check is dishonored, is
against the drawer or indorsers thereof and not against the bank.
Sec. 136. Forgeries. Forgeries, so far as checks are concerned,
are of three kinds: (1) forged signature of the drawer; (2) forged
indorsement of an indorser; and (3) an alteration of the face of the
Since a bank is authorized to pay out funds only when instructed
to do so by the depositor, it should be clear that payments made as
a result of a forged signature of the depositor are erroneous. Such
payments give the bank no right to charge the account of the de-
positor. In such cases, however, it becomes the duty of the deposi-
tor to notify the bank of the forgery within a reasonable time after
the cancelled checks are returned to the depositor. What is not
quite so readily understood, however, is the bank's inability to re-
cover the amount from the person to whom it paid the money or
from the indorsers. Since it is the bank's duty to recognize the
signature of its depositors, and since payment is in effect an accept-
ance, which warrants the genuineness of the signature of the
drawer, the bank is prohibited from recovering of anyone except
the forger. 6
To this rule there is one well-recognized exception. If the per-
son or concern taking the check from the forger is negligent in any
e First National Bank v. U.S. National Bank, 1921, 100 Or. 264, 197 Pac. 547 ; p.
BANKS AND BANKING 217
manner, the drawee bank may recover from the party first taking
the check from the forger. A bank of deposit which takes such a
check without identifying the forger is certainly careless and, as
between it and the drawee bank, should suffer the loss. 7
A second exception has been worked out with reference to savings
accounts. Since the account book should be presented at the time
of withdrawals, and since the bank has little opportunity to famil-
iarize itself with the signature of the depositor, the bank is not lia-
ble for payments made, provided it has exercised reasonable care in
making the payment to the one in possession of the bankbook.
Depositors are required by the courts and statutes to report to
the bank of deposit all cases of forged signatures promptly after the
cancelled checks have been returned. The depositor is obligated
to review his checks within a reasonable time after they have been
returned and, in case forgeries are involved, to give notice thereof to
the bank. If such is not done, and other forgeries follow, the loss
will fall upon the depositor. Quite often the cancelled checks are
returned to the person who has been guilty of the forgery, usually
an employee of the depositor. Naturally, in such a case, the for-
gery will not be called to the attention of the drawer. He is held
liable, however, even under such circumstances, if he does not re-
port promptly the forged instrument. He is responsible for his
agent's act in not calling attention to the forgery.
Sec. 137. Forged indorsements. Upon payment of order
paper which bears a forged indorsement, the situation so far as the
bank and depositor are concerned, is quite similar to one in which
the signature of the drawer has been forged. By paying to a per-
son not possessed of title, the bank fails to follow the order of the
depositor. Consequently, a bank which pays a check as a result of
a forged indorsement has no right to charge the account of the
drawer. It must surrender the check to the true owner, 8 but it
does, in this instance, have a right to recover from the indorsers of
the check who became such subsequent to the forgery. Likewise,
the bank may recover from the person to whom it made payment
of the check, even though that party did not indorse the instru-
ment. It is suggested, however, that if the person who collected
the money from the drawee bank acted merely as an agent, and, not
having indorsed the instrument or guaranteed prior indorsements,
has accounted to his principal for the amount collected, the drawee
bank has recourse only against the principal.
7 Louisa National Bank v. Kentucky National Bank, 1931, 239 Ky. 302, 39 S.W.(2d)
497; p. 641.
8 Goodall Real Estate and Insurance Company v. North Birmingham American
Bank, 1932, 225 Ala. 507, 144 S. 7; p. 642.
218 NEGOTIABLE INSTRUMENTS
The drawee bank is liable to the true owner of a check which has
been paid to a person having no title, upon the following theories:
payment to the wrong party is an acceptance in favor of the true
owner; wrongful payment is a conversion of the instrument; the
return to the true owner of the check with the forged indorsement
revives all the rights previously held by the true owner on the
To illustrate, let us assume that P, the payee of a check, loses it,
and his name is indorsed by a forger. H, the indorsee, presents it
to the drawee bank and receives payment. The loss and forgery
are later discovered. In many states, P, the true owner, has a
three-way choice. He may recover from the bank of H the amount
of the check; he may sue the bank for damages for conversion of
the check; or he may repossess the check with its original status.
The drawer of a check which bears a forged indorsement is under
duty to report to the drawee bank promptly after the forgery is
discovered, although in many cases the discovery is not made until
long after the cancelled checks have been returned.
If the forged indorsement is executed by an employee of the
drawer or payee, and the latter is negligent in not uncovering such
forgeries if they have continued over a period of time, the loss must
be borne by the employer-drawer. He should have such internal
accounting controls in his business as would make loss from such
indorsements difficult, if not impossible.
Sec. 138. Altered checks. In the case of raised or altered
checks, the only recourse is to recover from the party to whom pay-
ment was made or from indorsers who became such following the
alteration. The drawer is not liable for the altered amount, al-
though in a majority of the states he is liable to the drawee bank
which has paid the check if he has facilitated the alteration by leav-
ing blank spaces in the check. A few of the states hold the drawer
liable to a holder in due course in such cases.
There seems almost no authority to the effect that the drawer
must protect the bank or third parties by using pen rather than
pencil or by using a checkwriter. The use of protective devices
does, however, avoid much inconvenience in cases of this character,
since if they are not used and alteration takes place, there is often
much conflict as to how the check was originally drawn or whether
the drawer was negligent in leaving blank spaces. The use of a
machine usually obviates any uncertainty as to the original tenor
of the instrument.
Sec. 139. Payment. In case a bank is made aware of the true
ownership of a fund, it then becomes its duty to make payment to
the true owner regardless of the fact that the fund has been depos-
BANKS AND BANKING 219
ited in another's name. Thus, if an agent deposits in his own name
his principal's money, the bank upon notice of such fact must ac-
count to the principal therefor.
If the bank in such a case changes its position in reliance upon
the deposit, it is under no duty to account for the money to its
detriment. On the other hand, if the agent becomes insolvent
while owing the bank money, the bank in satisfaction of the indebt-
edness has no right to appropriate the bank account, which belongs
in reality to the principal. It must pay the deposit to the true
owner, and recover as best it can from its debtor. Of course, if the
loan was made in any sense in reliance upon the deposit, the bank
might be entitled thereto as against the true owner. 9
In this connection it is well to observe that some confusion has
existed in lawyer relative to rights obtained when checks are in-
dorsed by fiduciaries or drawn to the order of a fiduciary by himself
in his fiduciary capacity. So far as banks are involved, there are
two distinct problems. First, if a fiduciary, such as a trustee, exec-
utor, or agent, is in possession of a check or bill of exchange drawn
by a third person to the order of the fiduciary in such a manner that
the fiduciary relationship is indicated, is the bank free to permit the
fiduciary to indorse the instrument and deposit it in his personal ac-
count? There is authority to the effect that, since the bank is
placed on notice by the nature of the instrument, it is not a taker
in good faith of the instrument. Consequently, if the fiduciary
mishandles the proceeds, the bank would be liable. Legislation has
been enacted in many states which permits the bank to accept de-
posits of such instruments to the credit of the fiduciary's individual
account and to pay them out as he directs without any liability to
the true owner of the fund unless the bank has knowledge of the
breach of trust. 10
Second, if a fiduciary, or an agent who has been authorized to
draw on account of his principal, executes a check to his own order,
is the bank free to pay it or is the bank charged with notice of the
fact that normally an agent should not be using his principal funds
for personal use? Legislation has again been enacted which au-
thorizes the bank to pay out money even though the instrument is
drawn by the fiduciary to himself personally. This legislation
leaves the bank unprotected in two cases. First, the bank has no
right to accept a check drawn to its own order in payment of a per-
sonal obligation of the fiduciary to the bank, and second, the bank
has no right to pay such an instrument drawn by or payable to the
"Berg v. Union State Bank, 1932, 186 Minn. 529, 243 N.W. 696; p. 643.
10 Boston Note Brokerage Co. v. Pilgrim Trust Co., 1945, 318 Mass. 224, 61 N.E.(2)
113; p. 644.
220 NEGOTIABLE INSTRUMENTS
fiduciary if it knows he is violating the trust reposed in him. How-
ever, if the check is drawn to the order of the fiduciary personally
and is then indorsed by him, even in payment of a personal obliga-
tion, the third party may accept it in good faith.
The right to pay checks is terminated by the known death of the
depositor or by a stop order given to the bank within a reasonable
time before the check is presented for payment. The stop order
may be oral or written. In case it is written and contains a state-
ment to the effect that the signer releases the bank from damages
in case the bank pays the item through mistake, accident, or over-
sight, the statement according to the majority view is binding. A
clause releasing the bank from liability under circumstances indi-
cated therein imposes upon the depositor the loss arising from fail-
ure to stop payment.
Sec. 140. Payment effective when. In cases of forgery, the
insolvency of a bank, or the cashing of a check where insufficient
funds exist for payment, a question often arises as to the time
when payment is made. If money is passed over the counter to
the holder of the check by the drawee bank, payment is effective.
In such cases the fact that the drawer has insufficient funds on
deposit to meet the check or has no account with the bank is im-
material. Since payment has taken place, the bank's only recourse
is to recover from the drawer of the check.
In general, it can be said that payment takes place whenever the
drawee bank credits the account of the holder. This situation
arises where the holder of the check and the drawer deposit with
the same bank. By reason of statutes in many states, and in nu-
merous other cases by reason of contract between the bank and the
depositor, the bank reserves the right, during the next business day,
of reversing an entry if it finds that the check should not have been
paid. Thus, if the holder's account is credited, and later, when the
check is to be charged, it is discovered that the account of the
drawer is insufficient to meet it, the holder's account may be cor-
rected accordingly. Unless something intervenes, however, to in-
dicate that payment is improper, payment dates from the time the
account of the holder is credited.
It can also be said that payment takes place whenever the ac-
count of the drawer is charged. 11 Statutes in many states have
created one exception to this rule. If checks are sent for collection
directly to the bank on which they are drawn, the sending bank
has an option in those cases in which the check is cancelled and
charged to the drawer without any remittance being made to the
sender. Where the drawee bank closes before remitting in cash or
u ln re Goebel's Estate, 1946, 295 N.Y. 73, 65 N.E,(2) 174; p. 646.
BANKS AND BANKING 221
solvent credits, the sender may elect to treat the check as dishon-
ored or to file a preferred claim against the insolvent bank. In
those states where no legislation has been enacted, most of them
have held that payment was concluded at the time the drawee bank
charged the drawer. They then permitted the sending bank to file
a preferred claim against the bank that had failed to remit in sol-
If the drawee bank is a member of a clearinghouse and the check
is charged to the drawee bank by the clearinghouse, it is paid at
that time unless notice of dishonor is given within the time and
according to the provisions of the clearinghouse agreement.
Sec. 141. Depositor's indebtedness. Normally a bank has
a right to charge a depositor's account for any money due and
owing to it. That is, whenever a note of a depositor matures, the
bank is at liberty to charge it against the account of the depositor,
and it is not necessary that the depositor be notified thereof. Even
though checks are issued by the depositor before the maturity of the
debt, the bank is under no duty to pay them if the balance is inade-
quate after satisfying the indebtedness in favor of the bank. The
right to dishonor the depositor's check exists only if the account has
been charged with the indebtedness before checks are presented.
Until such time as the account is actually charged, it must pay the
checks as presented. The bank has no right to charge the account
in case it holds ample securities for the payment of the debt.
In many states, by reason of a provision in the Uniform Nego-
tiable Instruments Act, a note which is payable at a particular bank
is, at maturity, equivalent to an order on the bank for payment.
In such cases the bank pays the note when it is presented to it and
charges the account of the depositor.
If a bank holds a note upon which there are sureties, the bank
owes a duty to the sureties to charge the account of the drawer.
If it fails to do so when it might thus have recovered the indebted-
ness from the principal debtor, it loses its right to recover from the
Sec. 142. Collection items. As indicated in a previous sec-
tion, items left with a bank for collection form a specific deposit and
give peculiar rights in case the bank becomes insolvent. Whether
a deposit of items is for collection or deposit often becomes a very
Title to checks deposited may be retained in the depositor until
such time as collected, thus making the bank of deposit a collection
agent, by one of three devices: (1) by agreement, usually indicated
on the deposit slip, that all items are received by the bank as a col-
lecting agent only; (2) by a restrictive indorsement such as "for
222 NEGOTIABLE INSTRUMENTS
collection/' "for collection and deposit," "for deposit/' or "for col-
lection and remittance"; or (3) by reason of enactment in a par-
ticular state of the Bank Collection Code.
On most bank deposit slips will be found a statement to the effect
that the bank accepts all items for deposit or collection as a collec-
tion agent only and is not to be liable except for failure to exercise
due care in the selection of agents during the collection process.
More recently the Bank Collection Code, which has been adopted
in quite a number of the states, reaches the same result by con-
taining substantially the same language. It ought to be clear in
such cases that, since the bank is acting only as an agent, title to
the items deposited remains in the depositor until such time as they
are actually collected. This seems to be the result worked out by a
majority of the courts, and it is not affected by the fact that the
bank has credited the depositor with the amount of the items
in dispute, except that, if checks are drawn against the account,
the bank has a lien on the items for the amount drawn against the
deposit. 12 There are a few states, however, which state that the
crediting of the depositor's account and the courtesy of permitting
him to check against the deposit clearly indicate an agreement to
have title pass to the bank despite the statement on the deposit
slip or statutory provision.
Clearly, in all cases, a restrictive indorsement is an effective man-
ner of retaining title until the collection process is completed. As
soon as collection is completed, title to the proceeds passes to the
bank and the item becomes at that time a general deposit unless it
is indorsed for collection and remittance. In the latter case it re-
mains a specific deposit until the proceeds are actually surrendered
to the depositor, and the bank has no right to confuse the proceeds
of collection with its general assets.
Sec. 143. Effect of retention of title by depositor. If title
passes to the bank of deposit at the time items on other banks are
deposited, the debtor-creditor relationship arises. The checks and
bills belong to the bank, and the depositor's account should be
credited, giving the depositor a right to draw against it. Of
course, if any of the items are not paid, upon their dishonor the
bank may give notice and charge them back to the depositor's ac-
count, because of the indorsement of the depositor. Likewise, the
bank, even though it acts only as a collection agent, may, if it so
desires, permit the depositor as a matter of convenience to draw
against the deposit before collection is completed.
If during the collection process the bank of deposit which takes
13 Ware v. Hogansville Banking Company et al., 1930, 171 Ga. 167, 155 S.E. 4;
BANKS AND BANKING 223
title becomes insolvent, the depositor is an ordinary creditor and
must share alike with other depositors of the bank/ 3 whereas, if
title had been retained by the depositor, he could have seized the
proceeds of collection from the agent in possession of them at the
time of insolvency. Thus, there is no loss to him who retains title
to items in the collection process at the time his bank is closed. If
the items are collected by the bank's receiver after closing, they
must be held in trust by the receiver for the benefit of the depositor.
There is another important difference between passing title to
the bank and retaining title. If title passes to the bank at the time
of deposit, the bank is responsible during the collection process. It
selects its own agents to aid in the collection procedure and is re-
sponsible for any misconduct on their part. Thus, if a collecting
agent defaults or becomes insolvent, thus causing a loss, the loss
falls upon the bank of deposit rather than upon the depositor. On
the other hand, where title is retained by the depositor, the bank of
deposit acts as an agent and has authority to appoint other agents
subagents to aid in the collection. Thus the depositor is ac-
countable for the acts of any agent in the collection chain. If any
loss results from an agent's misconduct, it falls upon the depositor.
It is for this reason that the banks have sought by contract and by
statute to be regarded merely as agents. It relieves them of re-
sponsibility for the acts of those who aid in collection of items left
for deposit, although in a strong minority of the states all agents
in the collection process become agents of the first bank rather than
agents of the depositors, unless a different agreement is reached be-
tween the depositor -and his bank.
Sec* 144. Duty of collecting agent. Where statutes have not
intervened to change the canadian law, it is held that a bank which is en-
trusted with items for collection has no right to send them directly
to the bank upon which they are drawn or to accept anything other
than money in payment thereof. 14 Since this ruling greatly en-
cumbered the means of collection and did not coincide with banking
practice, statutes in many states were enacted providing that items
might be sent directly to the bank on which they were drawn and
that bills, drafts, or cashier's checks might be accepted as condi-
tional payment thereof. In those states which have not adopted
such legislation, the same result is usually accomplished by a con-
tract on the deposit slip giving the bank the right to follow the
customary banking procedure in such matters.
Assuming that a bank is permitted to send an item directly to the
"In re Receivership of Washington Bank, 1898, 72 Minn. 283, 75 N.W. 228; p. 647.
14 First National Bank v. Commercial Bank and Trust Company, 1926, 137 Wash.
335, 242 Pac. 356; p. 650.
224 NEGOTIABLE INSTRUMENTS
bank on which it is drawn, it is possible in such cases for the drawee
bank to charge the depositor's account and to mark the check
"paid" without remitting to the collecting bank; or, in case remit-
tance is made by mail, it is possible for the remittance to be dis-
honored because of the failure of the remitting bank. In such
cases, the question arises as to whether or not the item was paid.
The weight of authority holds that the item is paid as soon as it is
charged to the drawer's account. If for any reason the remittance
fails, these courts in most instances hold that the collecting bank
is a preferred creditor. 15 The federal courts, however, have refused
to allow a preferred claim, and hold that the person having title to
the item possesses only an ordinary claim. To care for this situa-
tion, the Uniform Bank Collection Code provides that in such cases
the collecting bank may treat the item as dishonored and look again
to the drawer, even though he is actually in possession of his can-
celed check, or it may present a preferred claim payable out of the
general assets of the closed bank.
Sec. 145. Assessment of bank stock. The statutes of most
states and those of the federal government provide for the assess-
ment of bank stock. Thus, whenever the bank examiner discovers
that the capital of a bank has been depleted through losses of any
kind, the stockholders may be called upon to pay an assessment
sufficient to restore the capital to par. In case an assessment is
levied, most of the statutes give the stockholder an option. He is
permitted to pay the assessment or to surrender his stock, or at least
enough of it to realize the amount of the total assessment from a
sale thereof. If he surrenders his stock, he- incurs no personal
liability for the assessment.
Payment of an assessment does not relieve a stockholder of his
double liability in event of the bank's later insolvency. In those
few states which have retained double liability, he must contribute
again at that time.
Preferred stock, now authorized in the case of national banks,
is not subject to assessment.
Sec. 146. Right of setoff. A bank is said to be insolvent when-
ever its liabilities exceed its assets or whenever it cannot meet its
current demands. As soon as a bank reaches such a state it is
placed in the hands of a receiver, unless it continues to operate
When a receiver takes charge, the rights of the depositors im-
mediately present numerous issues. Perhaps the most important
rule is one which gives to the depositor the right of setting off
* Federal Reserve Bank of Richmond v. Peters et al., 1924, 139 Va. 45, 123 S.E.
379; p. 651.
BANKS AND BANKING 225
against what he owes the bank the amount that he has on deposit
at the time of closing. 16 Thus, if a depositor owes a bank $3,000
and has on deposit $2,500 at the time of the bank's closing, his
account is applied to his indebtedness and he owes the bank a bal-
ance of $500.
This right of setoff applies only where the accounts are similar.
A husband may not use his wife's account to pay his obligation or
a partner use a firm's deposit to pay his individual obligation. A
surety may not use his balance to pay an obligation upon which he
is surety unless he can clearly show that it will be impossible for
him to recover from the principal debtor. In case the debtor is
hopelessly insolvent, the surety may exercise the right of setoff.
It must be borne in mind that the claims which one seeks to set off
against an indebtedness owing to the bank must have existed at the
closing of the bank. A claim may not be purchased thereafter for
the express purpose of setting it off.
The right of setoff does not apply to an obligation which has been
discounted by the bank to some third party. The depositor must
pay his obligation to the third party and take his loss on the deposit
along with other bank creditors. If the obligation, along with
others, has merely been pledged as security for an obligation of the
bank, two possibilities exist. If the bank receiver uses cash on
hand or collected to pay off the obligation and redeem the collateral,
the right of setoff will be applicable as soon as the collateral is re-
turned to the receiver. If it is not returned to the receiver, the
debtor may insist that the holder collect first from those who have
no setoff. Thus, if the third party can realize the total amount of
the indebtedness in this manner, the balance of the obligations will
return to the receiver, with the right of setoff undisturbed.
Sec. 147. Double liability. A few state statutes or constitu-
tions provide that, in case a bank is closed and insufficient assets
are available to satisfy all creditors, stockholders may be assessed
an additional par value. Thus, a holder of bank stock at time of
insolvency loses not only his investment but is called upon to pay
an additional par value to the receiver. In this case he may not
set off a deposit in the bank against his liability. Since the double
liability is to benefit all creditors, he may not pursue this method of
receiving all of his deposit.
Paid-in surplus offers no help in cases of this kind. The stock-
holder who has created or helped to create a paid-in surplus is
nevertheless liable for an additional par value. Usually the double
liability continues only for a definite time 60 days after the trans-
16 Rossi Brothers v. Commissioner of Banks, 1933, 283 Mass. 114, 186 N.E. 234;
226 NEGOTIABLE INSTRUMENTS
fer if the transfer is bona fide. It ceases after the end of that time
for the old stockholder, but is assumed by the new one.
Double liability has recently been discarded for national banks
by federal legislation, and the same result has been obtained for
state banks in most of the states by similar legislation. Require-
ments for the creation of specified surpluses and more careful in-
spection are relied upon for protection of the depositor rather than
double liability. The insurance protection given to certain depos-
its may likewise be considered as a substitute for double liability
in these states. There are a few states, however, which retain
double liability as well as these other devices for the protection of
In Illinois and two other states, by reason of peculiar language
used in the constitution or statute, there is no release from the lia-
bility, and, if it is necessary to satisfy creditors on claims which
arose while they were stockholders, all stockholders, past and pres-
ent, are independently liable for the full par value.
The double liability cannot be avoided by constructing a corpo-
ration that is intended for the express purpose of holding bank
stock and that does not possess other assets from which the double
liability might be realized. Neither is the liability of stockholders
discharged when another bank takes over its business and assumes
all of the old liabilities. It is only where a merger or consolidation
takes place and the old bank loses its identity that the old stock-
holders are released.
Sec. 148. Preferred claims. Preferred claims are paid before
general claims in those cases where sufficient cash assets exist to
satisfy them. It might be well to suggest first some claims which
are not preferred. Bank drafts, certified checks, cashier's checks,
certificates of deposit, and savings accounts do not give rise to pre-
ferred claims. Such claims, merely because of their form, are not
superior to other claims which are based upon the debtor-creditor
relationship. Of course, if the bank draft or cashier's check has
been issued in payment of an item collected by the bank, thus be-
coming in essence a specific deposit, it results in a preferred claim.
All specific deposits which are traced into the general assets of
the bank are preferred claims. 17 Likewise, deposits made after the
bank is known by its officials to be insolvent create a preferred
claim if they can be identified at the time of closing. Many states
allow a preferred claim in such cases if the bank's assets are defi-
nitely increased as a result.
By reason of recent legislation, all banks, both national and state,
17 Jefferson Standard Life Insurance Company v. Wisdom C.C.A., 1932, 58 F.(2d)
565; p. 653.
BANKS AND BANKING 227
which are members of the federal reserve system must likewise be
associated with the Federal Deposit Insurance Corporation. Be-
cause of contributions made by the various banks to this corpora-
tion, all accounts up to five thousand dollars are guaranteed in the
event of insolvency. If an account is in excess of that amount, the
excess will be subject to loss if the bank fails to pay all its indebted-
Sec. 149. State funds. Undistributed state funds, especially
when deposited in a state bank, form a preferred claim at the time
of insolvency. If the claim is that of a certain county, city, or
school official, no preference exists, since the money is no longer
state money but belongs to the particular local unit involved. As
a result, it has become customary for local units of government to
demand collateral security for deposits made by them. If no stat-
ute exists which permits such practice on the part of the bank, a
question arises at to the legality of this pledge, since the rights of
other depositors are prejudiced thereby. The majority of courts
enforce the lien in case of public officials, but hold that the contract
is ultra vires and unenforceable so far as ordinary depositors are
concerned. 18 Therefore, an ordinary depositor whose account is
secured by collateral is unsecured unless definite legislation author-
izes the banks in a particular state to secure ordinary depositors.
Sec. 150. Illegal acts. An official of a bank, whether he be an
officer or a director, who accepts deposits after knowing that his
bank is insolvent is guilty of criminal conduct. The penalty varies
from state to state, but usually carries with it the possibility of im-
prisonment for each offense.
One who, with intent to defraud, issues a check without sufficient
funds to meet it is subject to criminal prosecution. The gist of the
crime is not the issuance of the check without funds to meet it, but
is, rather, the intent to defraud.
Review Questions and Problems
1. Distinguish between the three types of deposit. To which class
does a savings account belong?
2. First National Bank sold certain bonds to H, and guaranteed ulti-
mate payment of them. The bonds were not paid and suit was brought
by H against the bank as guarantor. Was it liable?
3. State Bank collected a bill of exchange from the drawee, the bank
acting only as a collection agent. After the proceeds had been remitted
by the bank to its principal, it was discovered that an essential indorse-
ment was forged. Will the drawee be able to recover from State Bank
the money paid?
4. A bank statement carried a printed provision to the effect that all
18 Texas & P. Ry. Co. v. Pottorff, C.C.A. 1933, 63 Fed.(2d) 1; p. 654.
228 NEGOTIABLE INSTRUMENTS
errors were to be reported within ten days after canceled checks were re-
turned. Thirty days after M received his canceled checks, he learned
that one of them carried a forged indorsement. Will he be able to return
the check and have the bank credit his account for the wrongful payment?
5. M gave his check to P in payment of merchandise, but, when the
merchandise failed to arrive, stopped payment on the check. The stop
order which he signed contained language to the effect that the bank was
to be relieved in case it paid the check through error or mistake. The
check was paid at the lunch hour by an assistant to the teller. Will the
loss fall upon M or the bank?
6. M drew a check for $500 in favor of P in payment of a used car.
The check was drawn on State Bank and deposited by P in National
Bank, which mailed it directly to State Bank for collection. The latter
charged the check to M and mailed a Chicago draft to National Bank in
settlement of the item. Before the draft could clear, State Bank closed,
the draft, as a result, being dishonored.
a. Was the check paid? May M still be held on the check?
b. May National Bank have a preferred claim against State Bank?
c. If a collection loss develops, will it be borne by P or National
7. M owed his bank a note for $1,500, which matured on August 1,
1939. The bank charged it to his account on that day, the result being
that several of M's checks were dishonored. Does M have a cause of
action against his bank?
8. Suppose the note in the above case had been drawn in favor of P,
merely being payable at M's bank. Would the bank have had a right to
pay it without further authorization?
9. M drew his check for $1,750 in favor of P on National Bank in
payment of grain purchased. Although P received the check after bank-
ing hours, he gained admittance to the bank and received a duplicate
deposit ticket for the check. No entries were made on the bank's records
and the bank failed to open the next morning. Who suffers the loss,
10. D had on deposit in the bank a large sum of money when the bank
failed. A corporation, of which he was the principal stockholder, owed
the bank money. He desired to have the note set off against his account.
Was he entitled to have such action taken by the receiver?
11. Does the holder of a certified check have a preferred claim at time
of the drawee bank's insolvency?
12. M's name was forged by J3, his bookkeeper, to a $750 check. When
the canceled checks were returned, they were handed to the bookkeeper
and, as a consequence, the bank was not notified of the forgery. Six
months later the forgery was discovered and the bank was notified, but
other checks amounting to $7,500 have been forged in the meantime.
Will the loss fall upon M or the drawee bank?
13. A check was stolen from P, the payee, and was paid to a holder
after P's indorsement had been forged. Has the drawee bank the right
to charge the check to the drawer's account?