Article 3 Negotiable Instruments

Question 1

Differences between Drafts and Notes

Answer 1

1) A NOTE is a two-party instrument whereby one person (the maker) promises to pay money to a second person (the payee).

2) A DRAFT is a three-party instrument whereby one person (the drawer) directs a second person (the drawee) to pay money to a third person (the payee).

-An instrument is a “note” if it’s a promise, and if it’s a “draft” if it’s an order.

-If it falls within the definition of both a “note” and a “draft” then a person entitled to enforce the instrument may treat it as either.

Question 2

Note

Answer 2

A NOTE is a writing acknowledging a debt and promising payment. A note is NOT payment, only a promise to pay.

-A promissory note is a kind of negotiable instrument wherein the maker agrees to pay a sum certain at a definite time.

Question 3

Cashier’s Check

Answer 3

This is issued by the authorized officer of a bank, directed to another person, evidencing the fact that the payee is authorized to demand and receive upon presentation from the bank the amount of money represented by the check.

-The cashier’s check is drawn upon the bank’s own account and not that of a private person and as such has a higher guarantee that it will be honored. It is accepted for many transactions where a personal check would not be.

Question 4

Checks

Answer 4

A draft drawn upon a bank and payable on demand, signed by the maker or drawer, containing an unconditional promise to pay a sum certain in money to the order of the payee.

-The name of the person the check is being made out to can be left open (blank).

-The amount the check is being made for can be left blank for the person being paid to fill in so long as it gets filled in as what was orally agreed to.

Question 5

Draft

Answer 5

An order in writing directing a person, other than the maker, to pay a specified sum of money to a named person.

-3 parties involved

Question 6

Types of Negotiable Instruments

Answer 6

1) Drafts

2) Checks

3) Cashier’s Checks

4) Notes

Question 7

Types of Notes

Answer 7

1) Secured notes (collateral)

2) Unsecured notes (no collateral)

3) Demand notes (payable on demand)

4) Installment notes (pay over a certain period of time)

5) Mortgage notes (real property)

6) Negotiable notes (means creditor can sell it)

Question 8

Negotiation

Answer 8

The transfer of a check, promissory note or other negotiable instrument to another IN EXCHANGE for money, goods, services or other benefits.

-Done for some sort of consideration in exchange.

Question 9

Transfer

Answer 9

An instrument is transferred when it is delivered by a person, other than its issuer, for the purpose of giving to the person receiving delivery the RIGHT TO ENFORCE THE INSTRUMENT.

-NOTE: No consideration involved; typically gratuitous (but can be for consideration)

Question 10

Transfer Warranties

Answer 10

A person who transfers an instrument for consideration warrants to the transferee and, if the transfer is by indorsement, to any subsequent transferee that:

1) the warrantor is a person entitled to ENFORCE the instrument;

2) All signatures on the instrument are AUTHENTIC AND AUTHORIZED;

3) The instrument has NOT been ALTERED;

4) The instrument is not subject to a defense to a claim in recoupment of any party which can be asserted against the warrantor.

Question 11

Indorsement

Answer 11

Signature placed upon the back of an instrument, with or without other words, whose effect is to transfer the instrument and create a NEW AND SUBSTANTIVE CONTRACT by which the indorser becomes a party to the instrument and liable, on certain conditions, for its payment.

Question 12

Elements of a Negotiable Instrument

Answer 12

1) A writing which is SIGNED BY THE MAKER or drawer;

2) Contains an UNCONDITIONAL PROMISE or order to pay a sum certain in money;

3) Is payable on demand or at a definite time; and

4) Is payable to order or to bearer (i.e., person named or holder).

A draft, check, certificate of deposit and note may or may not be a negotiable instrument depending on whether the above elements of negotiability are satisfied.

Question 13

Enforcement of Instruments

Answer 13

The person(s) entitled to enforce an instrument is:

1) The holder of the instrument;

2) A non-holder in possession of the instrument who has the rights of a holder (i.e., an agent);

3) A person, not in possession of the instrument, who is entitled to enforce the instrument (ie., simply b/c the evidence (the note) is stolen doesn’t mean you don’t owe Lender the $).

Question 14

Requirements for Holder in Due Course

Answer 14

To qualify for this special status, one must be a HOLDER;

who takes the negotiable instrument FOR VALUE;

IN GOOD FAITH;

WITHOUT NOTICE that it is overdue or has been dishonored or of any defense against or claim to it on the part of any person.

-A HDC is a bonafide purchaser who takes free of most defenses of prior parties to the negotiable instrument.

-A HDC generally takes free of personal defenses, but not free of real defenses (this makes a check as close to cash as possible).

Question 15

Personal Defenses

(aka defenses against the person holding the check)

Answer 15

The following defenses apply against NON-HOLDERS IN DUE COURSE:

1) Breach of Contract or Warranty - the maker or drawer may not pay;

2) Lack of Failure of Consideration;

3) Fraud in the Inducement (i.e., issued based on a false statement);

4) Illegality - when a statute makes a transaction illegal;

5) Mental Capacity - if mentally incompetent when drafted, the instrument is voidable;

6) Others - discharge by payment or cancellation, unauthorized completion of incomplete instrument, non-delivery of an instrument, ordinary duress or undue influence.

–These are generally contract-based defenses

Question 16

Universal Defenses

(aka defenses against the person holding the check)

Answer 16

The following defenses apply against ALL holders, including HDCs:

1) FORGERY of a maker’s or drawer’s signature cannot bind the person named;

2) Fraud in the Execution - The defense is valid if a person is deceived into signing it believing it’s something else, but the defense is not valid if a reasonable inquiry would’ve revealed the nature of the instrument

3) Material Alteration - If it changes the contract terms between two parties in any way:

–(a) Complete Defense: against an ordinary holder (holder recovers nothing if an alteration is visible, the holder has notice and cannot be an HDC)

–(b) Partial Defense: against a HDC (if an instrument was originally incomplete and later completed in an unauthorized manner, a HDC can enforce it as complete)

4) Discharge in Bankruptcy - this is an absolute defense

5) Minority - this is a defense if recognized by state law

6) Illegality - this is a defense if a statute declares an instrument executed in connection w/ illegal conduct is void

7) Mental Incapacity - an instrument signed by a person whose been adjudicated mentally incompetent by state proceedings is void

8) Extreme Duress - an immediate threat of force or violence is a defense

Question 17

Accord and Satisfaction by Instrument

Answer 17

If a person against whom a claim is asserted proves that:

1) that person, in good faith, tendered an instrument to the claimant as full satisfaction of the claim;

2) the amount of the claim was unliquidated (conflicted) or subject to a bonafide dispute; and

3) the claimant obtained payment of the instrument, then the claim is discharged if the person against whom the claim is asserted proves that the instrument or an accompanying written communication contained a conspicuous statement to the effect that the instrument was tendered as full satisfaction of the claim.

Question 18

Holder through an HDC: The Shelter Rule

Answer 18

A person who does not qualify as an HDC but who acquires an instrument from an HDC, or from someone w/ HDC rights, receives the rights/privileges of an HDC.

-Limitations: A holder who was a party to fraud or illegality affecting an instrument or who, as a prior holder, had notice of a claim or defense cannot improve his status by repurchasing it from a later HDC.