Story Case

Elmer Hillis was the president of the Millvale State Bank, and in active charge of its operations. One of the customers of the bank, Martin Baxter, had received several loans from the bank, on his notes, to assist him in financing his rapidly growing grain business. In anticipation of a great number of small payments for which he had no funds on hand, he applied to Hillis for an additional loan. Because of indefiniteness in the amount wanted, and to avoid the necessity of paying interest on the whole sum from the start, as would be the case if a note for the whole amount had been given, an agreement was reached whereby the bank consented to pay checks drawn upon it during the following three months, up to an amount not to exceed, $3,500 balance overdrawn at any one time, and Baxter agreed to deposit promptly all receipts of the grain business and to give his note, at the end of the three months, secured by mortgages, for any balance which would then remain owing to the bank on account of checks drawn on and paid by the bank.

After about two or three months had passed, and when Baxter owed the bank about $3,000 for checks drawn without funds in the bank, there was a great disturbance in the wheat market. Baxter was forced to make some of his deliveries at a great loss, and on every side was losing money. His expanded business had already been such a strain on his resources that he was forced into bankruptcy, and the bank realized only $600, or twenty per cent, of the $3,000 due. The stockholders of the bank insisted that Hillis was to blame for their loss, and required the directors to depose him and to sue him for the amount the bank had lost. Hillis pleaded that the transaction was wholly regular and within his authority as head of the bank, but the directors insisted that an overdraft was not a loan, but an irregularity which an officer could not properly allow and which he must be responsible for. Should the court give judgment for the bank, or for the defendant Hillis?

Ruling Court Case. Franklin Bank Vs. Byram, Volume 39 Maine Reports, Page 489

In this case Byram had kept an account with the bank. With the permission of the cashier of the bank, who had no authority to grant such permission, he had overdrawn his account to a large amount. When this condition of affairs was discovered by the bank authorities, this action was brought to recover the amount.

Mr. Justice Appleton said: "If the cashier, without authority, misappropriates the funds of the bank, if he violates his trust, if he pays away money wrongfully, and that money can be traced into the hands of one aware of his breach of trust, and who participates in his wrongdoings, it is difficult to perceive why redress should be denied the bank. In this view, it is immaterial whether or not it is paid out on a check." Judgment was held that the bank could recover the amount of the overdraft from Byram.

Ruling Law. Story Case Answer

When a bank permits a depositor to draw out from the bank an amount beyond that which he has on deposit, such a transaction is known as an overdraft. If the officer of the bank who paid out the money had authority, the transaction really amounts to a loan, and the bank may sue to recover the same. If, however, the officer had no authority to pay out such an amount, and the depositor was aware of the fact, it is a wrongful act, a breach of trust, and the depositor becomes a constructive trustee of the money thus received.

It is clearly a breach of authority for a mere paying teller to give out money on a check he knows is not covered by funds on deposit. But it becomes a mere matter of form when a loan, which might properly be made by a credit on account of a sum for which a note is given, is instead made by the payment of orders drawn from time to time, for the payment of which the drawer has contracted. Some states have statutes making it a crime to draw a check on a bank where there are no funds, but this is intended to cover the cases where the drawer knows the check will not be paid. But there are also statutes prohibiting banks from allowing overdrafts and penalizing officers who consent to them. These are the result of a misconception as to the nature of a properly authorized overdraft, and of a prejudice against them. It is true that in some states such statutes are persistently violated by banks, in order to use this convenient form of loan. Assuming that no statute applies in the Story Case, there is no reason for holding Hillis responsible, in the absence of negligence on his part, and the bank should not recover.