Alan L Tyree

Conversion of altered cheques

Alan L Tyree*

Abstract: The English Court of Appeal has held that a materially altered cheque is a worthless piece of paper. Only nominal damages may be awarded in an action for conversion, and the paying bank may not debit the account of the drawer. The facts are examined in the light of the Cheques Act 1986 and the allocation of losses considered.

1  The rule in Smith

In Smith v Lloyd’s TSB Bank plc1 the English Court of Appeal has held that only nominal damages may be awarded for the conversion of a materially altered cheque.

The Insolvency Service sent the plaintiff liquidators a cheque payable to the Revenue. The cheque was crossed “account payee only” which, under the UK legislation, made the cheque non-transferable. The cheque was stolen from the plaintiffs by a rogue who changed the name of the payee to his own name and deposited the cheque with the defendant who collected the proceeds on his behalf.

The claimants sued in conversion for the face value of the cheque. The defendant bank argued that s64 of the Bills of Exchange Act (UK) 1882 entitled the claimants to only nominal damages. Section 64(1) of the Act reads:

Where a bill or acceptance is materially altered without the assent of all parties liable on the bill, the bill is avoided except as against a party who has himself made, authorised, or assented to the alteration, and subsequent endorsers. Provided that, where a bill has been materially altered, but the alteration is not apparent, and the bill is in the hands of a holder in due course, such holder may avail himself of the bill as if it had not been altered, and may enforce payment of it according to its original tenor…

The parties agreed to the following facts:

The leading judgment was delivered by Pill LJ who held that

The Court also heard a second appeal, Harvey Jones Ltd v Woolwich plc which concerned a materially altered bank cheque. I will not consider the bank cheque issues in this article: see Edwards [1] for a discussion of the bank cheque issues and a slightly different view of the Smith case.

Rather than consider the reasoning in depth, it is useful to consider the Australian position.

2  Application to Australian cheques

Suppose that Smith came before an Australian court. The parties would probably agree to the first, second, fifth and sixth point above. However, differences in the Australian Cheques Act 1986 would leave the other two points open for argument.

2.1  Is the cheque discharged?

The Cheques Act analogue to s64(1) is s78(2):

(2) A cheque is also discharged if the cheque is fraudulently and materially altered by the holder.

The difference from the English Bills of Exchange Act is striking. First, the cheque is only discharged if the alteration if fraudulent. It would seem beyond argument that the alteration in Smith was fraudulent, but it may sometimes be difficult to establish.

More importantly, the section only discharges the cheque if the alteration was both material and made by the holder.

It is not clear from the report if the cheque was an order cheque or a bearer cheque. Slightly different considerations apply to each.

If the cheque was an order cheque, then the alteration was not made by the holder. The holder is a payee or indorsee in possession as payee or indorsee: s3(1). The rogue who made the alteration is neither so the cheque is not discharged under s78(2).

If the cheque was a bearer cheque, then the holder is the bearer, the person in possession of it. However, in this case there is a question as to whether the alteration is “material”. A material alteration is defined in s3(8):

An alteration of a cheque is a material alteration if it alters, in any respect, a right, duty or liability of the drawer, an indorser or the drawee institution.

There is an obvious argument that the alteration of the name of the payee does not alter any of the obligations on a bearer cheque. It might be argued that altering the name of the payee changes a duty of the drawee bank with respect to the cheque, but the argument is tenuous at best: see Tyree [2] at para 10.78. It clearly alters the duty of a collecting bank, particularly if the cheque is crossed non-negotiable and a/c payee only, but the collecting bank is not one of the parties mentioned in s3(8).

It does not seem possible to argue that the cheque is discharged under any other rule. The Bills of Exchange Act 1909 does not apply since by s6 of that Act it does not apply to any instrument to which the Cheques Act 1986 applies. It might be argued that the savings of the Common Law in s4(2) of the Cheques Act might come to the rescue, but since the Act directly addresses the question of the effect of material alteration it seems likely that the Common Law rule would be “inconsistent” with the terms of the Act.

If either of these arguments for the plaintiff succeeds then the cheque is not discharged by the alteration, and the entire Smith decision becomes inapplicable.

2.2  Effect of discharge

By s82 of the Act, the discharge of a cheque by material alteration extinguishes all rights on the cheque subject to:

(3) Where a cheque is discharged under subsection 78(2) by an alteration of the cheque, then:

(a) a person who, but for the discharge of the cheque, would be the holder may enforce payment of the cheque, according to the tenor of the cheque as altered, against:

(i) the person who made the alteration;

(ii) a person who authorized or agreed to the alteration; or

(iii) a person who indorsed the cheque after the alteration was made; as if the cheque had not been discharged; and

(b) in a case where the alteration is not apparent–a person who, but for the discharge of the cheque, would be a holder in due course may enforce payment of the cheque, according to the original tenor of the cheque, against any other person as if the cheque had not been discharged.

Although the language is different from the UK Bills of Exchange Act, the result of these two sections seems to be quite similar. Consequently, if the cheque was “discharged” it would seem to have the same effect as the “avoided” cheque in the Smith case.

3  Who should bear the loss?

Whatever the details of the reasoning, it is useful to consider the allocation of losses under the Smith decision. The holder and the collecting bank have both dealt with the rogue, and it seems reasonable that one or both of them should bear the loss. Under the pre-Smith rule, the collecting bank suffered the loss subject to its statutory defence which, if established, left the loss to lie with the holder.

We consider each of the parties separately.

3.1  The holder

Under the Smith rule, the holder suffers the loss. The Smith case contains some suggestions that the holder may either obtain a replacement cheque or be able to sue on the “lost” cheque. Whatever the position might be in England, the holder has no such rights in Australia.

Section 115 of the Cheques Act gives a former holder a replacement right under certain circumstances. However, the section only applies if the cheque has been lost or destroyed and has not been presented for payment or discharged. Under the Smith rule, the cheque is discharged and so no replacement is available.

Section 116 raises the possibility of suing on a cheque which has been lost or destroyed. However, the only consequence of the section is that the absence of the instrument may not be set up as a defence. In the Smith-type case, there are no longer any rights on the cheque since it has, ex hypothesi, been “discharged”.

It also is questionable if the former holder can sue the drawer on the original debt. Payment by cheque is conditional discharge of the debt, the condition being a condition subsequent that the cheque not be dishonoured on due presentment: National Australia Bank Ltd v KDS Construction Services Pty Ltd.2 In KDS it was said:3

Generally speaking, when a cheque is given in payment of a debt, it operates as a conditional payment. The payment is subject to a condition that the cheque be paid on presentation. If it is dishonoured the debt revives.

Since the cheque has not been dishonoured, it is, on this reading of KDS, not possible to sue on the debt.

The position is not entirely clear, however. Some old bills of exchange cases have held that the former holder may sue on the consideration in certain circumstances: see, for example, Burchfield v Moore.4 In this argument, the impossibility of presenting the cheque would revive the debt. This also receives some support from KDS since later in the same paragraph the Court said “The condition is a condition subsequent so that, if the cheque is met, it ranks as an actual payment from the time it was given.” This suggests that the cheque must actually be presented at some time.

3.2  The paying bank

It is trite law that a bank pays away its own money when paying a cheque. It may only debit its customer’s account if it has acted strictly within the terms of its mandate or if it may rely on some other “defence”.

The Court in Smith noted that the paying bank could not debit the drawer’s account since it had paid contrary to its mandate. This must be read subject to any other law which would permit the bank to debit the account.

It must be emphasised here that the alteration in the cheque was not facilitated by the drawer. In a case where the cheque is carelessly drawn, the bank may debit the account under the principle of London Joint Stock Bank Ltd v Macmillan and Arthur.5

The statutory defences probably do not apply here. The most likely one is s92:

Subject to subsection 32(1), where the drawee institution, in good faith and without negligence, pays a crossed cheque to a financial institution, the drawee institution is taken to have paid the cheque in due course.

However, the whole basis of the rule in Smith is that the instrument was no longer a “cheque”. We can’t have it both ways, that the instrument is no longer a “cheque” for the purposes of conversion but that it is a “cheque” for the purposes of s92.

This interpretation receives support from s91, which gives the bank the right to debit the account of the drawer where the only alteration is that the amount of the cheque has been raised. In that case, the bank may debit the account with the amount of the original cheque, provided that it has paid in good faith and without negligence to the holder.

The paying bank cannot rely on the so-called “equitable defence” established in Liggett (B) Liverpool Ltd v Barclays Bank Ltd6 since none of the money paid has gone to discharge a debt of the drawer.

Finally, the paying bank cannot recover the payment as made under a mistake of fact since the collecting bank has already accounted to its principal: see Gowers v Lloyds & National Provincial Foreign Bank Ltd;7 Australia and New Zealand Banking Group Ltd v Westpac Banking Corporation.8

The result seems to be that the paying bank has suffered a loss equal to the face value of the cheque.

3.3  The drawer

If the above arguments are correct, then the drawer of the cheque suffers no loss and may gain a windfall under the Smith rule. The former payee/holder cannot demand a new cheque under s115 since the old one has been discharged and cannot sue on the lost cheque because it has been discharged. It is at least possible that the payee/holder cannot demand fresh payment from the payee since the cheque provided a discharge of the debt, subject to the comments above.

4  Conclusion

The alterations to the Smith cheque may not result in the discharge of the cheque under the Cheques Act 1986. This is due both to the requirement that the alteration be made by the holder and the different definition of “material”.

Assuming that the cheque is discharged, the Smith rule does not lead to a sensible allocation of losses. The collecting bank and the holder are the parties best placed to avoid the loss. The Smith rule always throws the loss on the paying bank. Assuming that the former holder cannot recover the debt from the drawer, the former holder also suffers a loss and the drawer gains an undeserved windfall. Whether the former holder can recover from the drawer or not, the banking system as a whole always suffers a loss under the Smith rule.

One way to avoid the result would be to adopt Phillimore LJ’s suggestion in Morison v London County and Westminster Bank Ltd9 where he said “It may be also that any one who has obtained its value by presenting a cheque is estopped from asserting that it has only a nominal value.” This would put the collecting bank back in the same position as it was before Smith. If it could show that it collected without negligence, the loss would accrue to the former holder.

If this cannot be done, then s95 should be altered to make it clear that it applies to altered cheques.

Neither change would necessarily solve the problem of the paying bank. To do that, s91 should be altered to apply to all altered “cheques” provided the paying bank paid either the apparent holder or a collecting financial institution. The conclusion of s91 could be altered so that the cheque is deemed to be paid in due course. This would protect the paying bank, provided it acted without negligence, as well as the drawer who could rely on the deemed payment of the cheque to resist any calls for further payment of the debt.

These solutions would restore the reasonable allocation of losses. The drawer and the paying bank would be protected by the revised s91. The losses would be fairly allocated to either the former holder or the collecting bank, the parties who are best able to guard against the fraud.

References

[1]
Robin Edwards. Non-liability of banks for conversion of materially altered cheques. Australian Banking & Finance Law Bulletin, 16(3):41, Sep 2000.
[2]
Alan L Tyree. Banking Law in Australia. Butterworths, Sydney, third edition, 1998.

*
Consultant, Mallesons Stephen Jaques, Sydney; formerly Landerer Professor of Information Technology and Law, University of Sydney. The views expressed in this article are my own and do not necessarily reflect the views of Mallesons Stephen Jaques or anyone else. Special thanks to Greg Burton for some suggestions to improve the original draft.
1
[2001] 1 All ER 424
2
(1987) 62 ALJR 63.
3
At para 13 of the joint judgment of Mason C.J., Brennan, Deane, Dawson and Toohey JJ.
4
(1854) 23 LJQB 261.
5
[1918] AC 777.
6
[1928] 1 KB 48.
7
[1938] All ER 766.
8
(1988) 164 CLR 662.
9
[1914] 3 KB 356.