Notice of Dishonor: What it is, How it Works, Example

What Is a Notice of Dishonor?

A notice of dishonor is a formal notice stating that the bank will not accept a check or draft presented to the institution. A notice of dishonor may be given to the holder or presenter of the instrument. It may also be given to the issuing institution.

Understanding a Notice of Dishonor

A notice of dishonor typically occurs when there are insufficient funds for a bank draft or check. This can happen when a person or institution is low on funds or misses a needed deposit to make the transaction whole.

The creation of a notice of dishonor is governed by Article 3 of the Uniform Commercial Code (UCC), one of many uniform acts that exist to standardize laws governing commercial transactions across all 50 U.S. states, territories, and the District of Columbia. Article 3 governs the use of negotiable instruments, including checks and promissory notes.

According to Article 3, Section 503 of the UCC, a notice of dishonor “may be given by any commercially reasonable means.” This includes electronic, written, and oral communication. The notice is valued as long as it is issued and delivered in a reasonable and professional manner. A notice of dishonor must be signed by a notary public, but any person can deliver it. Any notice that is promptly delivered completely discharges any obligation of the endorser of the instrument.

A properly executed notice of dishonor should identify the instrument being dishonored and clarify that said instrument is not being honored, accepted, or paid. The return of an instrument that has been given to a bank for collection can serve as sufficient notice of dishonor, such as the return of a check for insufficient funds.

Article 3, Section 503 of the UCC states that when a bank takes a negotiable instrument for collection, it must give a notice of dishonor “before midnight of the next banking day following the banking day on which the bank receives notice of dishonor of the instrument.” If another person takes an instrument for collection, they must give a notice of dishonor within 30 days of the dishonor of the instrument.

A notice of dishonor can also occur as a result of an online scam. In this type of scheme, a sender of a check would ask the recipient to deposit it; at the same time, they would pay the sender some of the monies. In this situation, the check would eventually bounce and, as a result, the recipient will be at a loss for the amount of the bank fees and whatever money they gave to the sender. The sender had no intention of using real funds, so the recipient is left holding a net loss because their bank cannot retrieve the funds from the sender's bank.

Example of a Notice of Dishonor

For example, suppose that person X writes a check to person Y, but person X has insufficient funds to pay the check. When person Y attempts to deposit that check in their bank account, person Y’s bank returns it to person X’s bank with a notice of dishonor. The notice states that they will not pay the check due to insufficient funds. Person X is now liable for the amount of the check, and, secondarily, so is person X’s bank.