We have accepted a late return of an NSF item and charged it back to the customer's account causing our customer to become overdrawn. The customer is demanding that we reverse the offset and reimburse the NSF fees charged to him because of the offset to his account. Are we required to honor his request since we should not have accepted the late return in the first place?

Absolutely.

Take the check and return it to the bank that returned it late, as a collection item. Mark the reason as late return. They know they are wrong and sent it to you just to see if they could get away with it. You do the same.

If they don't honor the collection item they will state a reason. That reason coupled with the late return will be the basis for your protest. You can win this

Be amount conscious. If this is a small amount you may not want the hassel or expense so write it off. The larger the amount the more you want to do to prevent a loss.