PNB vs Rodriguez

Facts:
Spouses Erlando and Norma Rodriguez were clients of petitioner Philippine National Bank. They were
engaged in the informal lending business.  In line with their business, they had a discounting arrangement
with the Philnabank Employees Savings and Loan Association (PEMSLA), an association of PNB
employees that maintained current and savings accounts with petitioner bank. PEMSLA regularly granted
loans to its members. Spouses Rodriguez would rediscount the postdated checks issued to members
whenever the association was short of funds. As was customary, the spouses would replace the
postdated checks with their own checks issued in the name of the members. It was PEMSLA's policy not
to approve applications for loans of members with outstanding debts. To subvert this policy, some
PEMSLA officers devised a scheme to obtain additional loans despite their outstanding loan accounts.
They took out loans in the names of unknowing members, without the knowledge or consent of the latter. 
The PEMSLA checks issued for these loans were then given to the spouses for rediscounting. The
officers carried this out by forging the indorsement of the named payees in the checks. In return, the
spouses issued their personal checks (Rodriguez checks) in the name of the members and delivered the
checks to an officer of PEMSLA. The PEMSLA checks, on the other hand, were deposited by the spouses
to their account. Meanwhile, the Rodriguez checks were deposited directly by PEMSLA to its savings
account without any indorsement from the named payees. This was an irregular procedure made possible
through the facilitation of Edmundo Palermo, Jr., treasurer of PEMSLA and bank teller in the PNB Branch.
The spouses issued sixty nine (69) checks, in the total amount of P2,345,804.00. These were payable to
forty seven (47) individual payees who were all members of PEMSLA.

Petitioner PNB eventually found out about these fraudulent acts. Thus, PNB closed the current account of
PEMSLA.  As a result, the PEMSLA checks deposited by the spouses were returned or dishonored for
the reason "Account Closed." As a result, because the PEMSLA checks given as payment were returned,
spouses Rodriguez incurred losses from the rediscounting transactions. They filed a civil complaint for
damages against PEMSLA, the Multi-Purpose Cooperative of Philnabankers (MCP), and petitioner PNB.
They sought to recover the value of their checks that were deposited to the PEMSLA savings account
amounting to P2,345,804.00. The spouses contended that because PNB credited the checks to the
PEMSLA account even without indorsements, PNB violated its contractual obligation to them as
depositors. PNB paid the wrong payees, hence, it should bear the loss. On the other hand, PNB claimed
it is not liable for the checks which it paid to the PEMSLA account without any indorsement from the
payees. The bank contended that spouses Rodriguez, the makers,  actually did not intend for the named
payees to receive the proceeds of the checks. Consequently, the payees were considered as "fictitious
payees" as defined under the Negotiable Instruments Law. After trial, the RTC rendered judgment in
favor of spouses Rodriguez. PNB appealed the decision of the trial court to the CA on the ground that the
disputed checks should be considered as payable to bearer and not to order. The CA reversed and set
aside the RTC disposition. The CA concluded that the checks were obviously meant by the spouses to be
really paid to PEMSLA. The CA found that the checks were bearer instruments, thus they do not require
indorsement for negotiation, and that spouses Rodriguez and PEMSLA conspired with each other to
accomplish this money-making scheme. The CA reversed itself via an Amended Decision. The CA ruled
that the checks were payable to order.  According to the appellate court, PNB failed to present sufficient
proof to defeat the claim of the spouses Rodriguez that they really intended the checks to be received by
the specified payees.

Issue: W/N the subject checks are payable to order or to bearer.

Ruling:
The subject checks are  presumed order instruments.

As a rule, when the payee is fictitious or not intended to be the true recipient of the proceeds, the check is
considered as a bearer instrument. A check is a bill of exchange drawn on a bank payable on demand. It
is either an order or a bearer instrument. The distinction between bearer and order instruments lies in
their manner of negotiation. Under Section 30 of the NIL, an order instrument requires an indorsement
from the payee or holder before it may be validly negotiated. A bearer instrument, on the other hand, does
not require an indorsement to be validly negotiated. It is negotiable by mere delivery. A check that is
payable to a specified payee is an order instrument.  However, under Section 9(c) of the NIL, a check
payable to a specified payee may nevertheless be considered as a bearer instrument if it is payable to the
order of a fictitious or non-existing person, and such fact is known to the person making it so payable.

A review of US jurisprudence yields that an actual, existing, and living payee may also be "fictitious" if the
maker of the check did not intend for the payee to in fact receive the proceeds of the check.  This usually
occurs when the maker places a name of an existing payee on the check for convenience or to cover up
an illegal activity. If the payee is not the intended recipient of the proceeds of the check, the payee is
considered a "fictitious" payee and the check is a bearer instrument. In a fictitious-payee situation, the
drawee bank is absolved from liability and the drawer bears the loss. When faced with a check payable to
a fictitious payee, it is treated as a bearer instrument that can be negotiated by delivery. The underlying
theory is that one cannot expect a fictitious payee to negotiate the check by placing his indorsement
thereon. And since the maker knew this limitation, he must have intended for the instrument to be
negotiated by mere delivery.  Thus, in case of controversy, the drawer of the check will bear the loss.

However, there is a commercial bad faith exception to the fictitious-payee rule.  A showing of commercial
bad faith on the part of the drawee bank, or any transferee of the check for that matter, will work to strip it
of this defense. The exception will cause it to bear the loss. In this case, the Rodriguez checks were
payable to specified payees. It is shown that the 69 checks were payable to specific persons.  Likewise, it
is uncontroverted that the payees were actual, existing, and living persons who were members of
PEMSLA that had a rediscounting arrangement with spouses Rodriguez. For the fictitious-payee rule to
be available as a defense, PNB must show that the makers did not intend for the named payees to be
part of the transaction involving the checks. This lack of knowledge on the part of the payees, however,
was not tantamount to a lack of intention on the part of respondents-spouses that the payees would not
receive the checks' proceeds. Considering that respondents-spouses were transacting with PEMSLA and
not the individual payees, it is understandable that they relied on the information given by the officers of
PEMSLA that the payees would be receiving the checks. Verily, the subject checks are  presumed order
instruments. The bank failed to satisfy a requisite condition of a fictitious-payee situation - that the maker
of the check intended for the payee to have no interest in the transaction. Because of a failure to show
that the payees were "fictitious" in its broader sense, the fictitious-payee rule does not apply.  Thus, the
checks are to be deemed payable to order.  Consequently, the drawee bank bears the loss. A bank that
regularly processes checks that are neither payable to the customer nor duly indorsed by the payee is
apparently grossly negligent in its operations. In a checking transaction, the drawee bank has the duty to
verify the genuineness of the signature of the drawer and to pay the check strictly in accordance with   the
drawer's instructions. The checks were drawn against respondents-spouses' accounts. PNB, as the
drawee bank, had the responsibility to ascertain the regularity of the indorsements, and the genuineness
of  the signatures on the checks before accepting them for deposit. Lastly, PNB was obligated to pay the
checks in strict accordance with the instructions of the drawers. Petitioner miserably failed to discharge
this burden. The facts clearly show that the bank did not pay the checks in strict accordance with the
instructions of the drawers, respondents-spouses. Instead, it paid the values of the checks not to the
named payees or their order, but to PEMSLA, a third party to the transaction between the drawers and
the payees. PNB was negligent in the selection and supervision of its employees. The trustworthiness of
bank employees is indispensable to maintain the stability of the banking industry. Thus, banks are
enjoined to be extra vigilant in the management and supervision of their employees. PNB's tellers and
officers, in violation of banking rules of procedure, permitted the invalid deposits of checks to the
PEMSLA account. PNB's argument that there is no loss to compensate since no demand for payment has
been made by the payees must also fail. Damage was caused to respondents-spouses when the
PEMSLA checks they deposited were returned for the reason "Account Closed." A bank that has been
remiss in its duty must suffer the consequences of its negligence.