Claims and Defenses on Negotiable Instruments

Question 1

Basic Idea

Answer 1

If holder is a HDC, obligated party only assert REAL defenses (i.e. the HDC takes free of personal defenses and claims) to payment. If holder is not a HDC, the obligated party may assert any of the ordinary contract defenses.

thus, whether an obligated party will be forced to pay depends on whether the holder is a HDC and the nature of the obligated party’s defenses.

Question 2

List the real defenses

Answer 2

FAIDS

Forgery
Fraud in the Factum
Alteration of Instrument
Adjudicated Incapacity
Infancy
Illegality
Duress 
Discharge in insolvency proceedings
Statute of limitations
Suretyship

Question 3

Real defense:

Forgery

Answer 3

Forgery of name necessary to title: if signature of payee or any special endorsee was forged, no subsequent taker can be an HDC because no one can obtain the right to enforce necessary to qualify as a holder. BUT, if the person whose name was forged ratifies the unauthorized signature or is estopped from denying it, subsequent takers can qualify as HDCs.

Forgery of names not necessary to title: forgery of any other name other than payee or special endorsee (maker, drawer, acceptor, or endorser on bearer instrument) does not affect right to enforce and subsequent takers may qualify as HDCs if test is met.

Question 4

Real defense:

Fraud in the factum (real fraud)

Answer 4

fraud that causes obligor to sign an instrument without knowledge or reasonable opportunity to learn of its character or essential terms (e.g. obligor signs what he thinks is an autograph book but turns out it is a promissory note)

other fraud (e.g. obligor giving promissory note in exchange for a promise) is only a personal defense

Question 5

Real defense:

Alteration of Instrument

Answer 5

in certain circumstances, HDC may be able to collect only the original amount (i.e. not the altered amount) so that the alteration is only a partial real defense.

In other situations, the HDC may be able to collect on the instrument as altered.

*remember the difference between alteration (changing the terms that the maker or drawer inserted in the instrument) and unauthorized completion (filling in blanks left by the maker or drawer). Generally, maker or drawer will not be liable for altered amount but will be liable for full amount of unauthorized completion.

Question 6

Real defense:

Incompetency to Contract

Answer 6

if person lacks capacity to contract (e.g. person declared incompetent) and the contract is rendered void, the incapacity constitutes a real defense.

if the obligations of the incompetent are merely voidable at the option of the incompetent, the incompetency is a personal defense and cannot be raised against HDC.

Question 7

Real defense:

Infancy

Answer 7

Real defense if it is a defense in a simple contract action under state law.

If state law does not make such contracts void or voidable, it is only a personal defense.

Question 8

Real defense:

Illegality

Answer 8

if illegality in the underlying transactions renders the obligation void, it is a real defense, even if the HDC was not involved. If the contract is merely voidable, it is a personal defense.

Question 9

Real defense:

Duress

Answer 9

it is a real defense if one party acts involuntarily in a contract situation under extreme duress.

Question 10

Real defense:

Discharge in Insolvency Proceedings

Answer 10

discharge of debt in any proceeding intended to liquidate or rehabilitate a person’s estate is a defense.

Question 11

Real defense:

Statute of limitations

Answer 11

Three years: actions on (i) unaccepted drafts (after date of dishonor), (ii) against issuers/accepters of cashier’s checks, certified checks, etc., (iii) for conversion, (iv) for breach of warranty, and (v) to enforce other Art. 3 rights

Six years: actions on: (i) notes payable at a definite time or on demand (after due date or demand), (ii) on certificates of deposit (after demand for payment after stated due date)

Question 12

Real defense:

Accommodation (Suretyship) Defenses

Answer 12

accommodation party is, in effect, a surety. By signing this instrument, she incurs liability without being a direct beneficiary.

If HDC knows of the accommodation, he takes subject to the surety’s defenses (e.g. discharge to the extent of loss caused by: (i) extension of due date, (ii) material modification of obligation, or (iii) impairment of collateral)

Question 13

Discharges known to HDC

Answer 13

HDC takes subject to any discharge of which he had notice.

“discharge” means discharging events named in Art. 3 and other acts that would discharge an obligation to pay under a simple contract.

Question 14

*Personal Defenses: General Idea

Answer 14

personal defenses cannot be asserted against one having rights of an HDC, but any transferee of a negotiable instrument without HDC rights takes the instrument subject to all personal defenses, which include every defense available in simple contract actions

**most common action on the bar is failure to fully perform or properly perform (e.g. give a promissory note as consideration for construction work and then failing to complete the work; can’t get promissory note back)

Question 15

Personal Defenses:

Lack of consideration

Answer 15

Negotiable instruments must be support by consideration, and the lack thereof is a defense, except against an HDC

Question 16

Personal Defenses:

Claims or Defenses of Another

Answer 16

Generally, one must rely on one’s own defenses and cannot use the claims and defenses of a third party as a defense.

Question 17

Personal Defenses:

Examples

Answer 17

• lack of consideration;
• failure of consideration;
• duress,
• undue influence,
• misrepresentation that does not render the transaction void;
  breach of warranty;
  unauthorized completion of an incomplete instrument; prior payment.

Question 18

Claim in recoupment

Answer 18

claim in recoupment is a claim of the obligor on an instrument against the original payee of the instrument that arises from the transaction for which the instrument was given (e.g. buyer gives seller a check in exchange for goods, which turns out to be defective; Buyer has a claim in recoupment)

claim in recoupment may not be asserted against an HDC but may be asserted against other transferees of the instrument in order to reduce the owings on the instrument.

Question 19

Trial Procedure in Negotiable Instrument Cases:

Who may enforce?

Answer 19

instrument may be enforced by:

(a) holder,
(b) non-holder in possession with rights of holder (e.g. a subrogee; or
(c) a person not in possession but entitled to enforce (e.g. lost, stolen, or destroyed instruments)

Question 20

Trial Procedure in Negotiable Instrument Cases:

Burden of proof

Answer 20

prima facie case that: (i) signatures are genuine (specifically denied or else admitted); and (ii) the person presenting the instrument is entitled to enforce it.

Proof of defenses: P who proves a valid prima facie case is entitled to payment unless the defendant raises a defense or claim.

If a defense or claim is raised, P can cut off defenses by establishing HDC status.

Question 21

Trial Procedure in Negotiable Instrument Cases:

Instrument lost, stolen, or destroyed

Answer 21

If this happens, person is entitled to enforce instrument if she can prove:

(i) that she was entitled to enforce the instrument when loss of possession occurred;
(ii) the terms of the instrument;
(iii) facts that prevent production of the instrument

Question 22

*Trial Procedure in Negotiable Instrument Cases:

Action for Conversion

Answer 22

person entitled to possession (except for issuers, payees, and *indorsees who never received delivery) may bring an action for conversion of the instrument against a person who wrongfully possesses it.

Question 23

*Can a person who never receives possession of a check because it was mailed to the wrong address maintain an action against the drawee bank for paying that check to the wrong person?

Answer 23

bank may be liable to a named payee of a check for conversion if the
bank pays that check to an unauthorized person who forges the payee’s indorsement.

However, there is an exception to this rule where the named payee never receives possession of the check because it was mailed to the wrong address. In that instance, the named payee’s recourse is to
demand payment from the drawer for the debt.

The drawer may have claims against the drawee
bank for wrongful payment, but the payee does not.