What is Wrongful Dishonor?

Wrongful dishonor refers to a bank's failure to honor a valid negotiable instrument, such as a check or draft that has been presented to it for payment. If the check is valid and there are sufficient funds in the account to cover it, a bank's failure to honor it within the time period stipulated by the Uniform Commercial Code (UCC) would constitute wrongful dishonor.

Understanding Wrongful Dishonor

Article 4, Section 402 of the UCC states that a bank wrongfully dishonors a negotiable instrument, such as a check or draft, if it refuses payment even though the instrument is properly payable, meaning that it has been authorized by the customer and is in accordance with the bank’s agreement with that customer.

Key Takeaways

  • Wrongful dishonor occurs when a bank or credit union fails to honor a valid check or draft sent to it.
  • A bank is liable for its mistake if it is proved that wrongful dishonor has occurred on its watch.
  • Dishonor refers to a check or draft presented to a bank by a party with insufficient funds.

However, a bank may dishonor an instrument if honoring it would create an overdraft of the customer’s account, unless the bank has a preexisting agreement to honor that customer’s overdrafts, for example, through overdraft protection.

Dishonor for Insufficient Funds vs. Bank Liability for Wrongful Dishonor

A bank may choose to dishonor an instrument due to insufficient funds at any time between the receipt of that instrument and the time that the payor bank returns the instrument or gives notice of dishonor. Only one such determination is necessary. However, if the bank later decides to reevaluate that decision to dishonor, it should use the customer’s account balance as it stands at that later time in its reevaluation.

It’s up to the courts to decide whether consequential damages are, in fact, the result of the wrongful dishonor.

A payor bank is liable to its customer for damages caused by wrongful dishonor of an instrument, limited to actual damages proved, including potential consequential damages. Included damages can include those for actions such as arrest or prosecution of the customer caused by the wrongful dishonor of the instrument in question.

Example of Wrongful Dishonor

A widely studied case of wrongful dishonor is that of Loucks v. Albuquerque National Bank. The plaintiff, Loucks, owned a business, L & M Paint and Body Shop, with a partner, Martinez, and, as a partnership, they held a checking account with the defendant bank. Loucks owed the bank $402, an individual debt, but the bank charged that debt to the partnership’s checking account, even though it knew that it was not a partnership debt.

Afterward, the bank dishonored multiple checks drafted against the partnership’s account, because the debit of $402 left the account with insufficient funds. The plaintiffs sued for the $402 plus several thousands of dollars in damages, but were ultimately awarded only the $402, as the court found that there was no basis for wanton conduct on the part of the defendant bank.