City of Douglas v. Federal Reserve Bank of Dallas

Background

A county check was drawn on a small Arizona bank and given to a customer, who signed it over and deposited it at a local bank. The depositor’s passbook said out-of-town items were credited "subject to final payment." The local bank sent the check on to the Federal Reserve branch to collect. The drawee bank at Willcox paid, then sent its own check through another bank, but that substitute check was dishonored and both collecting banks failed. The local bank received no money and charged the depositor’s account, and the depositor sued the Federal Reserve bank claiming negligent collection practices.

Reasoning

The Court examined who could be held responsible when a deposited check is not ultimately paid. It described competing rules used by courts: one treating the first bank as a guarantor of its correspondents’ solvency and another making the initial bank merely an agent. The Court did not decide which rule governs generally. Instead it held that when a depositor freely signs over a check and the bank credits the depositor’s account, the bank becomes the owner of the paper. That means the depositor’s rights are contractual only against the depositor’s own bank. The Court also held the passbook note about "final payment" did not change that legal relationship.

Real world impact

The decision means the depositor cannot sue the collecting Federal Reserve bank for its alleged negligence. Losses from unpaid out-of-town checks fall back on the depositor’s contract with the local bank, not on the collecting correspondent. The lower court’s judgment for the Federal Reserve bank was affirmed.