I. DEFINITION
Overdraft arises when a customer draws from the bank more money than is standing to drawer’s credit in an account with the bank. By creating an overdraft, the bank has essentially loaned money to the drawer.
II. BANK OBLIGATIONS AND RIGHTS
A. Is a Bank Under Any Obligation to Honor an Overdraft?
No. To honor or not is a business judgment at the option of the bank (unless by some other agreement that may apply between the bank and its customer). See, U.C.C. § 4-401.
B. Does a Bank Expose Itself to Liability by Making Payment on a Check if the Depositor’s Account Contains Insufficient Funds to Cover the Check?
The bank is authorized to cash properly payable checks and to charge them against the customer’s account, even when the charge creates an overdraft. Caution must be taken, however, to ensure that the check has been completed and signed by the depositor and has not been altered in any way.
C. Who may authorize an overdraft?
The power to loan is ultimately vested in the bank’s board of directors, but the board may delegate such power, with proper limits, to the cashier or other appropriate officer. As a practical matter, unless there exist agreements to the contrary, overdrafts are usually approved at the board meeting.
D. Does Bank Have the Right to Recover an Overdraft from a Depositor?
An overdraft, in and of itself, implies a promise to repay.
E. Does Bank Have a Right of Set-Off to Apply to Deposit Accounts?
Yes, but not against a “special deposit” or a deposit known by the bank to belong to a third person, e.g., a fiduciary or trust account.
F. Does Bank Have Right to Interest and Other Reasonable Charges?
Yes, but only by specific agreement. Service charges may be permissible, however an issue may arise as to whether the service charge exceeds the legal rate of interest and therefore may be considered in violation of usury statutes.
G. Can the Bank Charge Continuing Overdraft Fees Until the Overdraft is Covered?
A one-time fee is acceptable, but if fees continue to build over time it could have both usury rate and Reg. Z implications, particularly if it involves a consumer, nonbusiness account.
When a bank pays an overdraft, the payment creates a loan from the bank to the customer and the bank may charge a one-time, flat fee to cover costs associated with the overdraft.
Some bankers ask whether they can go one step further and charge repeated or continuing overdraft fees until the overdraft has been covered. It is believed that a repeated or continuing overdraft fee may be inappropriate for the following reasons:
If a bank wants more than a one-time, flat overdraft fee, it probably should establish an overdraft protection line of credit and may assure compliance with both usury laws and Truth-in-Lending.
H. Other Issues
1. Loan Limits
Should a borrower meet the lending limits of the bank and further incur an overdraft, the result could be a technical violation of the lending limit statute.
2. Hold for Future Payment
The bank is under no duty to hold and could potentially incur liability (See, W.B. Farms v. Fremont National Bank, 756 Fed.2d 663 (8th Circuit, 1985) case).
3. Fair Debt Collection Act
Attempts to recover overdrafts may subject the bank to the regulations under this Act.
4. Joint Accounts
On a joint account, a customer is not liable for the amount of an overdraft if the customer did not sign the item unless that nonsigning joint account customer benefited from the proceeds of the item. (See, U.C.C. § 4-401(b)). This may be varied by agreement. (See, U.C.C. § 4-103(a)).
III. PAYMENT ORDER OF CHECKS
This is a rather common problem especially in accounts that are subject to overdrafts.
The bank is not liable to pay checks in any particular order; however, you may not show a preference in which case some liability could be incurred. Normally checks are paid in the order in which they are received, but an acceptable practice would be to select a number of checks that could be paid under existing collected funds and not pay the others.