Gempesaw vs. Court of Appeals

A drawer whose gross negligence in issuing and verifying checks facilitates forged payee indorsements is precluded under Section 23 of the Negotiable Instruments Law from setting up the forgery against the drawee bank; nevertheless, the drawee bank may be held liable to share the loss where it violates its internal rules and fails to exercise the high degree of diligence required of banking institutions.

Petitioner Natividad Gempesaw owned and operated grocery stores in Caloocan City and maintained a checking account with respondent Philippine Bank of Communications (PBCom) at its Caloocan City Branch. She drew checks against that account to pay suppliers, and PBCom, as drawee bank, debited checks presented and paid. The dispute required application of the Negotiable Instruments Law, particularly Section 23 on forged signatures, and the Civil Code provisions on negligence and contractual liability, including Articles 1170, 1172, and 1173.

Petitioner Natividad O. Gempesaw owned and operated four grocery stores located at Rizal Avenue Extension and Second Avenue, Caloocan City, including D.G. Shopper's Mart and D.G. Whole Sale Mart. She maintained checking account No. 13-00038-1 with the Caloocan City Branch of respondent Philippine Bank of Communications (PBCom), against which she drew checks to pay her suppliers. Her customary practice was to have her trusted bookkeeper, Alicia Galang, an employee for more than eight years, prepare and fill up the checks as to all material particulars. Galang then submitted the completed checks to Gempesaw for signature, together with the corresponding invoice receipts showing the correct obligations due to suppliers. Gempesaw signed each check without verifying its accuracy against the invoices because she reposed full and implicit trust and confidence in Galang. The issuance and delivery of the checks to the payees were left to Galang, and Gempesaw admitted that she did not verify whether the checks were actually delivered to their respective payees.

Although PBCom notified Gempesaw of all checks presented to and paid by the bank, she did not verify the correctness of the returned checks or check whether the payees actually received the checks in payment for supplies. PBCom also furnished her with a monthly statement of her bank transactions, attaching all cancelled checks debited against her current account. Over a period of two years, following this practice, Gempesaw issued a total of 82 checks in favor of several suppliers. These checks were presented by indorsees as holders to PBCom and honored by it, and PBCom debited the amounts against her checking account. Most of the checks were for amounts in excess of her actual obligations to the payees as shown in the corresponding invoices. For example, Check No. 621127 dated June 27, 1984, in the amount of P11,895.23 in favor of Kawsek Inc., corresponded to an actual obligation of only P895.33; Check No. 652282 issued on September 18, 1984, in favor of Senson Enterprises in the amount of P11,041.20, corresponded to an actual obligation of only P1,041.20; Check No. 589092 dated April 7, 1984, for P11,672.47 in favor of Marchem, corresponded to an obligation of only P1,672.47; Check No. 620450 dated May 10, 1984, in favor of Knotberry for P11,677.10, corresponded to an actual obligation of only P677.10; Check No. 651862 dated August 9, 1984, in favor of Malinta Exchange Mart for P11,107.16, corresponded to an obligation of only P1,107.16; Check No. 651863 dated August 11, 1984, in favor of Grocer's International Food Corp. in the amount of P11,335.60, corresponded to an obligation of only P1,335.60; Check No. 589019 dated March 17, 1984, in favor of Sophy Products in the amount of P11,648.00, corresponded to an obligation of only P648.00; Check No. 589028 dated March 10, 1984, for P11,520.00 in favor of Yakult Philippines, corresponded to an invoice of only P520.00; and Check No. 62033 dated May 24, 1984, in the amount of P11,504.00 in favor of Monde Denmark Biscuit, corresponded to an obligation of only P504.00. Practically all the checks issued and honored by PBCom were crossed checks. It was only after more than two years that Gempesaw found out about the fraudulent manipulations of her bookkeeper.

All 82 checks with forged signatures of the payees were brought to Ernest L. Boon, Chief Accountant of PBCom at the Buendia branch, who, without authority, accepted them all for deposit at the Buendia branch to the credit of Alfredo Y. Romero and Benito Lam. Boon was a very close friend of Romero. Sixty-three of the 82 checks were deposited in Savings Account No. 00844-5 of Romero at PBCom's Buendia branch, and four checks in his Savings Account No. 32-81-9 at its Ongpin branch. The rest were deposited in Account No. 0443-4, under the name of Benito Lam, at the Elcano branch of PBCom. The checks were then indorsed for a second time with the names of Romero and Lam, and those second indorsements were genuine. About 30 of the payees whose names were specifically written on the checks testified that they did not receive or even see the subject checks and that the indorsements appearing at the back of the checks were not theirs. The record does not establish how or by whom the forgeries were committed. The team of auditors from PBCom's main office which conducted periodical inspection of branch operations failed to discover, check, or stop Boon's unauthorized acts.

Under PBCom's rules, only a Branch Manager, and no other official, may accept a second indorsement on a check for deposit. In this case, all the deposit slips for the 82 checks were initialed or approved for deposit by Boon. The Branch Managers of the Ongpin and Elcano branches accepted the deposits made in the Buendia branch and credited the accounts of Romero and Lam in their respective branches. On November 7, 1984, Gempesaw made a written demand on PBCom to credit her account with the money value of the 82 checks totaling P1,208,606.89 for having been wrongfully charged against her account. PBCom refused to grant the demand. On January 23, 1985, Gempesaw filed the complaint with the Regional Trial Court.

The trial court and the Court of Appeals found that Gempesaw failed to examine her records with reasonable diligence, whether before signing the checks or after receiving her bank statements. Had she compared the sums written in the 82 checks with the pertinent sales invoices, she would have discovered that some amounts did not tally; had she carefully examined the daily reports or made random scrutiny of her cancelled checks returned monthly, she could have discovered the fraud being perpetrated by Galang and reported it to PBCom. These factual findings underpinned the lower courts' conclusion that her negligence was the proximate cause of the loss.

• Proximate Cause and Forgery Defense: Petitioner argued that the Court of Appeals erred in ruling that the negligence of the drawer was the proximate cause of the resulting injury to the drawee bank and that the drawer was precluded from setting up the forgery or want of authority.
• Bank's Gross Negligence and Fraud: Petitioner maintained that the Court of Appeals erred in not finding that the gross and inexcusable negligence and fraudulent acts of the respondent bank's officials and employees in forging the payees' signatures, and the wrong or illegal payments made to persons other than the intended payees, were the direct and proximate cause of the damage to her after her savings account was debited.
• Recredit and Legal Interest: Petitioner argued that the Court of Appeals erred in not ordering the respondent bank to restore or re-credit her checking account in the Caloocan City branch by the value of the 82 checks, amounting to P1,208,606.89, with legal interest.
• Crossed Checks: Petitioner argued that the respondent bank should not have honored the checks because they were crossed checks.
• Multiple Indorsements: Petitioner contended that banking rules prohibit the drawee bank from having checks with more than one indorsement.

• Drawer's Negligence and Forgery Defense: Whether the Court of Appeals erred in ruling that the drawer's negligence was the proximate cause of the loss and that the drawer is precluded from setting up the forgery or want of authority.
• Drawee Bank's Negligence and Liability: Whether the gross and inexcusable negligence and fraudulent acts of the drawee bank's officials and employees in forging the payees' signatures and paying persons other than the intended payees was the direct and proximate cause of the damage to petitioner.
• Crossed Checks: Whether the drawee bank should not have honored the checks because they were crossed checks.
• Multiple Indorsements: Whether banking rules prohibiting the drawee bank from accepting checks with more than one indorsement invalidated the checks or their negotiation or transfer.
• Recredit, Loss Sharing, and Remand: Whether the drawee bank should be ordered to restore or re-credit petitioner's checking account by P1,208,606.89 with legal interest, or whether the loss should be shared and the case remanded to determine the exact amount.

• Drawer's Negligence and Forgery Defense: Yes. Under Section 23 of the Negotiable Instruments Law, petitioner was precluded from setting up the forgery because her gross negligence in issuing and verifying the checks was the proximate cause of the loss.
• Drawee Bank's Negligence and Liability: Yes. The bank violated its internal rule requiring branch manager approval for second indorsements and failed to exercise the high degree of diligence required of banking institutions, making it liable under Articles 1170 and 1173 of the Civil Code.
• Crossed Checks: No. Issuing a crossed check imposes no legal obligation on the drawee not to honor it; it is a warning that the check cannot be presented to the drawee bank for payment in cash.
• Multiple Indorsements: No. The banking rule banning acceptance of checks with more than one indorsement does not invalidate the instrument or its negotiation or transfer; only a restrictive indorsement under the Negotiable Instruments Law stops further negotiation.
• Recredit, Loss Sharing, and Remand: No outright recredit of P1,208,606.89 with legal interest. The bank is liable to share the loss on a 50-50 ratio under Article 1172, and the case is remanded to determine the exact amount of loss, considering petitioner's partial benefit from the checks.

• Drawer's Negligence and Forgery Defense: Section 23 of the Negotiable Instruments Law provides that a forged signature is wholly inoperative and no right to retain the instrument, give discharge, or enforce payment against any party can be acquired through or under it, unless the party against whom the right is sought is precluded from setting up the forgery or want of authority. The provision covers forged indorsements, not only forged signatures of makers or drawers. A forged indorsement prevents subsequent parties from acquiring rights against parties prior to the forgery. The exception applies here. Petitioner admitted that Galang prepared the checks and that she signed them without verifying the amounts against the invoices, despite receiving daily notices and monthly statements with cancelled checks. She did not verify whether the payees received the checks. Over two years, 82 checks were issued, many for amounts far exceeding her actual obligations. The lower courts found that had she compared the checks with the invoices or examined the returned checks, she would have discovered the discrepancies and stopped the fraud. It was also highly improbable that in two years not one supplier complained of non-payment; any such complaint would have required investigation and would have led to discovery. Her failure to set up an accounting or business procedure reasonably calculated to prevent or render difficult the forgery of indorsements by her own employee, and her failure to report promptly after discovery, constituted gross negligence that caused the bank to honor the checks. She was therefore precluded from using forgery as a basis to recover. The rule that a drawee bank cannot charge the drawer's account for a check paid on a forged indorsement yields to the exception where the drawer's negligence caused the bank to honor the check.
• Drawee Bank's Negligence and Liability: Although petitioner's negligence was the proximate cause of her loss, the bank was not free from liability. There is a contractual relation between the depositor and the drawee bank. The bank's internal rules and regulations form part of that contract. PBCom's rules allowed only a Branch Manager to accept a second indorsement on a check for deposit, but Boon, a Chief Accountant, accepted all 82 checks without authority. The Branch Managers of Ongpin and Elcano accepted the deposits and credited the accounts of Romero and Lam. The bank's auditors failed to discover the irregularity despite periodic inspections. Under Article 1170 of the Civil Code, those who in the performance of their obligations are guilty of fraud, negligence, or delay, or who contravene the tenor thereof, are liable for damages. Under Article 1173, fault or negligence consists in the omission of the diligence required by the nature of the obligation and corresponding to the circumstances. Banking business is impressed with public interest, and the appropriate standard of diligence is a high degree of diligence, if not the utmost diligence. The bank failed to meet that standard. Its liability as obligor was primary, not merely vicarious, so the defense of due diligence in the selection and supervision of employees was of no moment. The decision to hold the drawee bank liable was based on law and substantial justice, not on mere equity, and although the case was not brought on breach of contractual obligations, the courts were not precluded from applying the pertinent laws.
• Crossed Checks: Issuing a crossed check imposes no legal obligation on the drawee not to honor the check. It is more of a warning to the holder that the check cannot be presented to the drawee bank for payment in cash. Instead, the check can only be deposited with the payee's bank, which in turn must present it for payment against the drawee bank in the course of normal banking transactions between banks. The crossed check cannot be presented for payment but can only be deposited, and the drawee bank may only pay to another bank in the payee's or indorser's account. Thus, the fact that the checks were crossed did not by itself prevent PBCom from honoring them or make PBCom liable for doing so.
• Multiple Indorsements: The banking rule banning acceptance of checks for deposit or cash payment with more than one indorsement unless cleared by some bank officials does not invalidate the instrument, nor does it invalidate the negotiation or transfer of the check. In effect, the rule would destroy the negotiability of bills or checks by limiting their negotiation by indorsement of only the payee. Under the Negotiable Instruments Law, the only kind of indorsement that stops further negotiation is a restrictive indorsement that prohibits further negotiation. Under Section 36, a restrictive indorsement must be written in express words at the back of the instrument so that any subsequent party may be forewarned that it ceases to be negotiable. Under Section 37, the restrictive indorsee acquires the right to receive payment and bring any action thereon as any indorser, but cannot transfer his rights as such indorsee where the form of the indorsement does not authorize him to do so. The checks here did not bear such a restrictive indorsement. Although the holder of a check cannot compel a drawee bank to honor it because there is no privity between them, the bank may not legally refuse to honor a negotiable check drawn against it with more than one indorsement if there is nothing irregular with the check and the drawer has sufficient funds. The drawee cannot be compelled to accept or pay the check by the drawer or any holder because, as drawee, it incurs no liability on the check unless it accepts it, but it will make itself liable to a suit for damages at the instance of the drawer for wrongful dishonor.
• Recredit, Loss Sharing, and Remand: Under Section 196 of the Negotiable Instruments Law, any case not provided for in the Act is governed by existing legislation. Under the Civil Code, petitioner cannot point to the bank's negligence in the selection and supervision of its employees as the cause of the loss because her negligence was the proximate cause, and under Article 2179 she may not be awarded damages. However, under Article 1170, the bank may be held liable for damages for contravening the tenor of its obligation. The bank violated its internal rules and failed to discover the irregularity despite audits. Article 1172 provides that responsibility arising from negligence in the performance of every kind of obligation is demandable, but such liability may be regulated by the courts according to the circumstances. The bank was therefore adjudged liable to share the loss with petitioner on a 50-50 ratio. Because petitioner partly benefited from the issuance of the questioned checks, since the obligations for which she issued them were apparently extinguished, only the excess amount over and above the total of her actual obligations must be considered as loss, one half of which must be paid by the bank. The case was remanded to the trial court for reception of evidence to determine the exact amount of loss.

• Forged Indorsement Under Section 23 of the Negotiable Instruments Law — A forged signature is wholly inoperative, and no right to retain the instrument, give a discharge therefor, or enforce payment against any party can be acquired through or under such signature, unless the party against whom the right is sought is precluded from setting up the forgery or want of authority. The rule covers forged indorsements, not only forged signatures of makers or drawers. A forged indorsement prevents any subsequent party from acquiring rights against any party whose name appears prior to the forgery. The exception is preclusion, which the Court applied against the drawer because of her gross negligence.
• Drawer's Duty to Prevent and Report Forged Indorsements — While a depositor has no duty to look for forged indorsements on cancelled checks in contrast to a duty to look for forgeries of his own name, a depositor is under a duty to set up an accounting system and business procedure reasonably calculated to prevent or render difficult the forgery of indorsements, particularly by the depositor's own employees. If the drawer learns that a check drawn by him has been paid under a forged indorsement, the drawer is under a duty promptly to report that fact to the drawee bank. For negligence or failure either to discover or to report promptly the forgery, the drawer loses his right against the drawee who has debited his account under the forged indorsement.
• Proximate Cause and Preclusion from Setting Up Forgery — The negligence of a depositor that prevents recovery of an unauthorized payment is based on failure to act as a prudent businessman would under the circumstances. A depositor may not sit idly by after knowledge has come that funds seem to be disappearing or that there may be a leak in the business, and refrain from taking steps a careful and prudent businessman would take. If she fails to take such steps, the facts may establish her negligence, and she would be estopped from recovering from the bank. Here, petitioner's negligence was the proximate cause of her loss, and she was precluded from using the forgery to prevent the bank's debiting of her account.
• Crossed Checks — Issuing a crossed check imposes no legal obligation on the drawee not to honor the check. It is more of a warning to the holder that the check cannot be presented to the drawee bank for payment in cash; instead, the check can only be deposited with the payee's bank, which in turn must present it for payment against the drawee bank in the course of normal banking transactions between banks. The crossed check cannot be presented for payment but can only be deposited, and the drawee bank may only pay to another bank in the payee's or indorser's account.
• Multiple Indorsements and Negotiability — The banking rule banning acceptance of checks for deposit or cash payment with more than one indorsement unless cleared by some bank officials does not invalidate the instrument, nor does it invalidate the negotiation or transfer of the check. Under the Negotiable Instruments Law, only a restrictive indorsement stops further negotiation. A restrictive indorsement must be written in express words at the back of the instrument so that any subsequent party may be forewarned that it ceases to be negotiable. The restrictive indorsee acquires the right to receive payment and bring any action thereon as any indorser, but cannot transfer his rights as such indorsee where the form of the indorsement does not authorize him to do so.
• High Degree of Diligence Required of Banks — Banking business is so impressed with public interest, where the trust and confidence of the public in general is of paramount importance, that the appropriate standard of diligence must be a high degree of diligence, if not the utmost diligence. The drawee bank's liability as obligor is not merely vicarious but primary, such that the defense of exercise of due diligence in the selection and supervision of its employees is of no moment. Here, PBCom failed to meet that standard by allowing a Chief Accountant to accept second indorsements without branch manager approval and by failing to discover the irregularity through its auditors.
• Loss Sharing Under Article 1172 of the Civil Code — Responsibility arising from negligence in the performance of every kind of obligation is demandable, but such liability may be regulated by the courts according to the circumstances. The Court applied this provision to adjudge the drawee bank liable to share the loss with the petitioner on a 50-50 ratio, with the case remanded to determine the exact amount of loss, considering that petitioner partly benefited from the checks.

• "When a signature is forged or made without the authority of the person whose signature it purports to be, it is wholly inoperative, and no right to retain the instrument, or to give a discharge therefor, or to enforce payment thereof against any party thereto, can be acquired through or under such signature, unless the party against whom it is sought to enforce such right is precluded from setting up the forgery or want of authority." — This is the controlling provision, Section 23 of the Negotiable Instruments Law, as quoted in the decision; it states the general rule on forged signatures and the exception of preclusion that the Court applied against the drawer.
• "As a rule, a drawee bank who has paid a check on which an indorsement has been forged cannot charge the drawer's account for the amount of said check. An exception to this rule is where the drawer is guilty of such negligence which causes the bank to honor such a check or checks." — This passage states the general rule and the exception that resolved the drawer's liability, grounding the Court's conclusion that petitioner's negligence precluded her from recovering the debited amounts.
• "We hold that banking business is so impressed with public interest where the trust and confidence of the public in general is of paramount importance such that the appropriate standard of diligence must be a high degree of diligence, if not the utmost diligence." — This defines the standard of diligence required of banks and supports the holding that PBCom's failure to meet that standard made it liable despite petitioner's negligence.
• "Premises considered, respondent drawee Bank is adjudged liable to share the loss with the petitioner on a fifty-fifty ratio in accordance with Article 1172 which provides: 'Responsibility arising from negligence in the performance of every kind of obligation is also demandable, but such liability may be regulated by the courts, according to the circumstances.'" — This is the Court's loss-sharing ruling, applying Article 1172 of the Civil Code to apportion the loss equally between the drawer and the drawee bank.

• Great Eastern Life Insurance Co. vs. Hongkong & Shanghai Bank, 43 Phil. 678 (1922) — Distinguished. In that case, the check was fraudulently taken and the payee's signature was forged not by an agent or employee of the drawer; the drawer was not negligent, so the drawee was duty-bound to restore the amount paid under the forged indorsement. Here, the forgery was committed by or through the drawer's own bookkeeper, and the drawer's negligence precluded recovery.
• City of New York vs. Bronx County Trust Co., 261 N.Y. 64, 184 N.E. 495 (1933) — Cited for the rule that a drawer loses his right against the drawee who debited his account under a forged indorsement for his negligence or failure to discover or report the forgery promptly.
• Detroit Piston Ring Co. vs. Wayne County & Home Savings Bank, 252 Mich. 163, 233 N.W. 185 (1930) — Cited for the same rule and for the principle that a depositor may not sit idly by after knowledge that funds seem to be disappearing or that there may be a leak in the business.
• C.E. Erickson Co. vs. Iowa Nat. Bank, 211 Iowa 495, 230 N.W. 342 (1930) — Cited for the rule that the drawer's negligence or failure to discover or report the forgery precludes recovery against the drawee.
• Defiance Lumber Co. vs. Bank of California, N.A., 180 Wash. 533, 41 P. 2d 135 (1935) — Cited for the preclusion of the drawer from complaining when the bank refuses to recredit the account due to the drawer's negligence.
• National Surety Co. vs. President and Directors of Manhattan Co., et al., 252 N.Y. 247, 169 N.E. 372 (1929) — Cited for the same preclusion rule.

• Section 23, Negotiable Instruments Law (Act No. 2031) — A forged signature is wholly inoperative, and no right to retain the instrument, give a discharge therefor, or enforce payment against any party can be acquired through or under such signature, unless the party against whom the right is sought is precluded from setting up the forgery or want of authority. Applied to preclude petitioner from setting up the forgery because of her gross negligence.
• Section 16, Negotiable Instruments Law — Every contract on a negotiable instrument is incomplete and revocable until delivery of the instrument to the payee for the purpose of giving effect thereto. Applied to show that petitioner completed the checks by signing them and that delivery by her bookkeeper to Boon instead of the payees did not create a valid contract with the payees.
• Section 191, paragraph 10, Negotiable Instruments Law — The first delivery of the instrument, complete in form, to the payee who takes it as a holder is called issuance of the instrument. Applied to explain that without initial delivery to the payee, there can be no valid and binding contract and no liability on the instrument.
• Section 36, Negotiable Instruments Law — An indorsement is restrictive when it prohibits further negotiation of the instrument. Applied to hold that only a restrictive indorsement stops further negotiation and that the banking rule against multiple indorsements does not invalidate the instrument.
• Section 37, Negotiable Instruments Law — The restrictive indorsee acquires the right to receive payment and bring any action thereon as any indorser, but cannot transfer his rights as such indorsee where the form of the indorsement does not authorize him to do so. Applied in the discussion of restrictive indorsements.
• Section 196, Negotiable Instruments Law — Any case not provided for in the Act shall be governed by the provisions of existing legislation. Applied to allow recourse to the Civil Code provisions on negligence and contractual liability.
• Article 1170, Civil Code — Those who in the performance of their obligations are guilty of fraud, negligence, or delay, and those who in any manner contravene the tenor thereof, are liable for damages. Applied to hold the drawee bank liable for violating its internal rules and failing to exercise required diligence.
• Article 1172, Civil Code — Responsibility arising from negligence in the performance of every kind of obligation is also demandable, but such liability may be regulated by the courts according to the circumstances. Applied to adjudge the drawee bank liable to share the loss on a 50-50 ratio.
• Article 1173, Civil Code — The fault or negligence of the obligor consists in the omission of that diligence which is required by the nature of the obligation and corresponds with the circumstances of the persons, time, and place. Applied to hold the bank to a high degree of diligence and to find it negligent.
• Article 2179, Civil Code — When the plaintiff's negligence is the proximate cause of the damage, she may not be awarded damages. Applied to note that petitioner could not point to the bank's negligence in selection and supervision as the cause of the loss, although the bank remained liable under Article 1170.
• Rule 45, Rules of Court — The petition for review was filed under Rule 45. Applied as the procedural vehicle by which petitioner elevated the Court of Appeals decision to the Supreme Court.

Narvasa, C.J. (Chairman), Feliciano, Regalado, and Nocon, JJ.