India: Liability Of Banks With Regard To Fraudulent Transactions

Last Updated: 22 November 2016
Article by Link Legal India Law Services

There are certain liabilities casted upon Banks with regard to Frauds related to negotiable instruments, cheque and other instruments. Whether bank can escape from its liability by establishing that the inaction on the part of the customer in not informing the bank about the irregularities in the account and deliberately withholding such information from the bank constitute negligence and operate as estoppels against the customer from claiming the amount, on the ground of adoption or acquiescence?


The relationship between a bank and its customer arose for consideration before the Supreme Court of India in the case reported as  Bihta Co-operative Development and Cane Marketing Union Ltd and Anr. vs. Bank of Bihar and Ors., AIR 1967 SC 389.

In the above case, a suit was filed by the Society for illegal withdrawal of Rs. 11000/- from the bank. The suit was decreed by the trial court and affirmed by the High Court. The case then came before the Supreme Court of India. The plea taken by the bank was that if the customer chooses to dispense with the ordinary precautions and permits a forgery to be committed and if owing to the negligence of such precautions, it is put into the power of any dishonest person to increase the amount by forgery, the customer must bear the loss. For this argument, reliance was placed on a decision of House of Lords given in the case of London Joint Stock Bank Ltd v. Macmillan and Arther, 1918 AC 777.

The Supreme Court of India was, however, of the opinion that what was said in Macmillan's case above would not be applicable because the accepted principle of law that if signature on the cheque is genuine and there is a mandate by the customer to pay then the banker has no obligation but to discharge the liability but if the signatures on the cheque or at least one of the signature is not genuine, then there is no mandate on the part of customer to pay and there would no question of any negligence on the part of the customer, such as, Waving the cheque book carelessly so that a third party would easily get hold of it would afford no defense to the Bank.

The same has been upheld in a subsequent judgment, Canara Bank v. Canara Sales Corporation and Ors.  1987 AIR 1603 Also, the Apex Court observed that, the relationship between the customer of a bank and the  is that of a creditor and debtor. When a cheque which presented for encashment contains a forged signature the bank  has no authority to make payment against such a cheque. The bank would be acting against law in debiting the customer with the amounts covered by such cheques. When a customer demands payment for the amount covered by such cheques, the bank would be liable to pay the amount to the customer. The Apex Court held that the bank can escape liability only if it can establish knowledge to the customer of the forgery in the cheques and Inaction for a continuously long period cannot by itself after a satisfactory ground for the bank to escape its liability. There is a duty of the customer to inform the bank of irregularities when he comes to know of them and such a duty will not exist when the customer is unaware of such fraudulent transactions.

Also, in the case of In Babulal Agarwalla v. State Bank of India, Bikaner and Jaipur, AIR 1989 Cal 92 the Calcutta High Court applied the ratio of the Bihar Co-Operative case. The court held that,

"The mandate of the customer to bank to pay the cheque signed by him for the bearer, which is statutorily recognised by  Section 85(2)  of the Negotiable Instruments Act, ceases as soon as it is proved that the cheque paid by the bank was a forged one because a forged cheque is no cheque issued by the customer. There is no mandate of the customer to the bank to pay on such a forged cheque. Therefore, the protection given to the bank by  Section 85  is not available to the bank in respect of a forged cheque. The bank is not liable to debit the said amount of the cheque even if it is found that the customer did not take proper care to keep the cheque or the relevant cheque book in proper custody. It was held that the bank cannot avoid the liability by merely proving that it made payment in due course according to the apparent tenor of the cheque or by verifying the signatures in the cheque with the specimen signature and finding no apparent discrepancy. It was observed that the bank can avoid the liability only if it can prove that there was ratification or estoppel."

Section 85(2) of the Negotiable Instruments Act, 1881 states that;

Cheque payable to order:

  • Where a cheque payable to order purports to be indorsed by or on behalf of the payee, the drawee is discharged by payment in due course.
  • Where a cheque is originally expressed to be payable to bearer, the drawee is discharged by payment in due course to the bearer thereof, notwithstanding any indorsement whether in full or in blank appearing thereon, and notwithstanding that any such indorsement purports to restrict or exclude further negotiation.)

The same ratio was also upheld by the Jammu and Kashmir High Court in the case of Citizen Cooperative Bank Ltd. And v Ritesh Mittal AIR 2003 J K 67.


Hence, it is understood that the Bank is Liable Contractually as there exist a contractual relationship established between the banker and a customer. In order to escape its liability the Bank has to establish that the customer had knowledge of the forgery in the cheques and it was a duty of the customer to inform the bank of irregularities when he comes to know of them but such a duty will not exist in case where the customer is unaware of such fraudulent transactions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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