Commercial Paper

Question 1

What is a note?

Answer 1

A note is a promise to pay money – a two party instrument.

Parties are the maker (debtor, obligor) who promises to pay, and the payee – the promisee – who is entitled to payment.

Question 2

What is a certificate of deposit?

Answer 2

It is a note issued by a financial institution. Financial institution acknowledges receipt of money, and financial institution promises the payee/depositor to repay the money.

Question 3

What is a draft?

Answer 3

A draft is an order to pay money – a three party instrument.

Question 4

Who are the parties to a draft?

Answer 4

Drawer – person order payment (guy writing the check)

Drawee – person to make the payment (payor bank)

Payee – person to receive the payment

Question 5

What is a check?

Answer 5

A check is a special type of draft. It requires that (1) a financial institution is the drawee, and is payable on demand.

Question 6

What is a remotely created item?

Answer 6

A draft not signed by the drawer but created with the drawer’s authority so that a third party can get paid from the drawer’s account at a bank. Third party is usually a seller in a phone or internet transaction.

Question 7

What does it mean if an instrument is negotiable?

Answer 7

This refers to the form of the instrument determined at the time of issuance. If an instrument says it is non-negotiable, it is non-negotiable (unless it is a check). Cannot expressly opt in.

Question 8

What are the elements of negotiability?

Answer 8

Instrument is in writing, signed by Maker or drawer, with an unconditional promise or order to pay a fixed amount in money with no other obligations, payable on demand or at a definite time, containing words of negotiability.

Question 9

What are items that make a promise or order conditional (and thus not negotiable)?

Answer 9

(1) Express condition to payment
(2) Promise or order “subject to” or “governed by” another record
(3) Incorporation of rights or obligations by reference

BUT NOT merely a statement of consideration or reference to another record (“as per,” “in accordance with”), incorporating by reference items not hurting the holder, limitation of payment to particular fund, countersignature, consumer protection language (this does prevent HDC status though)

Question 10

What if an instrument does not state a date on which it is due for payment?

Answer 10

It is a demand instrument (and can still satisfy the “payable on demand or at a definite time” element of negotiability (which just means a time readily ascertainable at the time the promise or order is issued.

Question 11

What is bearer language?

Answer 11

Language that indicates that the possessor is entitled to payment. There is no payee stated (i.e. it is not payable to an identified person).

“Payable to bearer,” “Payable to order of bearer,” “to cash,” “to order of cash”

Question 12

What is order language?

Answer 12

“Payable to the order of . . . .”

Question 13

What if an instrument contains both order and bearer language?

Answer 13

Bearer language controls.

Question 14

What element of negotiability is waived if missing from a check?

Answer 14

Words of negotiability.

Question 15

What is negotiation of an instrument?

Answer 15

This is the transfer of a negotiable instrument so transferee is a HOLDER. The payee transfers the instrument to a third party rather than just getting the money, e.g. as payment for sale, to donee as a gift, to bank to deposit in payee’s account, etc.

Question 16

How does one achieve holder status?

Answer 16

(1) Possession of negotiable instrument, and
(2) Good title

The method of obtaining depends on the words of negotiability used. With bearer paper, possession alone gives good title. With order paper, must have possession plus necessary indorsements.

Question 17

What are indorsements?

Answer 17

Generally, an indorsement is a signature on a negotiable instrument by someone other than the maker, drawer, or acceptor normally on the back of the instrument.

Question 18

What is a blank indorsement and what is the effect?

Answer 18

It is an indorsement with the payee’s signature only. The effect is that it creates bearer paper, and thus, further negotiations may be by transfer of possession alone.

Question 19

What are special indorsements?

Answer 19

This is the payee’s signature plus a designation of a new person to whom the instrument is now payable. Thus, this creates order paper, and further negotiations will require the indorsement of the person to whom it was made payable.

Could also be a restrictive indorsement.

Intent of issuer determines initial payee.

Question 20

What if there are multiple payees?

Answer 20

If “and” separates the names of the payees, it requires ALL payees to indorse.

If “or” or “and/or” separates the names of the payees, it requires any one of the payees.

Question 21

Transferee’s right to transferor’s indorsement

Answer 21

If the instrument is transferred for value, transferee has a specifically enforceable right to the transferor’s indorsement

Question 22

What if the indorsing payee lacks capacity?

Answer 22

Negotiation is effective even if the payee was a minor, incompetent, unduly influenced, etc.

Question 23

What is the relevance of being a HDC?

Answer 23

When obligor raises defenses to payment.

Question 24

What are the elements of HDC status?

Answer 24

(1) Negotiable instrument
(2) Holder (possession + good title)
(3) Authenticity not apparently questioned
(4) Holder must pay value
(5) Good faith (honesty in fact plus observance of reasonable commercial standards of fair dealing)
(6) Without notice at time of instrument acquisition (a subjective test)
(7) Burden of proof is on person claiming HDC rights

Question 25

What must the HDC not have notice of at the time the instrument is acquired?

Answer 25

(1) The principal is overdue,
(2) Instrument is dishonored,
(3) Uncured default with respect to payment of another instrument issued as part of the same series
(4) Unauthorized signature
(5) Alteration
(6) Any claim
(7) Any defense or claim in recoupment

Question 26

What is the Shelter Rule with respect to an HDC?

Answer 26

The transferee has rights of transferor. Even if a holder does not qualify as HDC, person may still have rights of HDC by shelter. The transfer of an instrument vests in the transferee the rights that the transferor had.

Having HDC rights by shelter does not make you an HDC.

A person who was a party to fraud or illegality affecting the instrument cannot get HDC rights by shelter.

Question 27

What defenses are HDCs subject to?

Answer 27

HDCs are subject to the real defenses. These include:

(1) Infancy (to the extent a defense under state contract law)
(2) Duress which voids obligation
(3) Lack of legal capacity making obligation void
(4) Illegality making obligation void
(5) Fraud in the execution (factum) – i.e. signer lacked knowledge of instrument’s character or essential terms and signer lacked reasonable opportunity to learn of the instrument’s character or essential terms
(6) Discharge in insolvency
(7) Omission of required consumer protection language
(8) SOL
(9) Payment to former holder
(10) Alteration
(11) Unauthorized signatures and forgeries

Question 28

What defenses are HDCs protected from?

Answer 28

HDCs prevail against all other defenses of the obligor, either under U.C.C. or common law, that are not real defenses. E.g. failure of consideration, breach of warranty, fraud in the inducement).

Question 29

What does it mean that the HDC is free from claims of others to the instrument?

Answer 29

No claimant can take an instrument from HDC; HDC is a “perfect defendant.” Even a true owner cannot recover an instrument from a HDC.

Question 30

When does an agent escape personal liability after signing his name to an instrument, binding the principal?

Answer 30

If (1) principal is identified in the instrument, and (2) Signature unambiguously shows it made on behalf of the principal.

Question 31

What if an agent is liable on a note binding the principal?

Answer 31

(1) To HDC, agent is liable to HDC unless agent can prove that the holder had notice of the representative nature of agent’s signature.
(2) To non-HDC, agent is liable to a non-holder in due course unless agent can prove the original parties did not intend the agent to be liable.

Special rule for checks – agent for drawer is note personally liable if principal’s name is on check (even if agent did not indicate agency capacity).

Question 32

May a drawer of a draft disclaim liability?

Answer 32

A drawer may not disclaim liability on a check but may disclaim liability on other drafts.

Question 33

When will a drawer be secondarily liable?

Answer 33

Drawer liable only after two conditions are first satisfied: (1) presentment and (2) dishonor.

Question 34

May an indorser of a note or draft disclaim liability?

Answer 34

Yes. May disclaim contract liability. The indorsement then is effective only in passing title. Indorsers are liable to each other in the order of their signatures. Sue prior indorsers for pyament, liable to later indorsers.

Question 35

When is an indorser secondarily liable?

Answer 35

Only after three conditions are first satisfied:

(1) Presentment, (2) dishonor, and (3) notice of dishonor

Question 36

What is the rule regarding the drawee on the negotiable instrument contract?

Answer 36

The general rule is that a drawee makes no negotiable instruments contract.

Question 37

When is drawee liable for conversion?

Answer 37

Drawee who pays on a forged indorsement is liable to the payee in conversion. Person suing in conversion must have received delivery of the instrument. No conversion action if check never reaches payee because it was lost in the mail.

Question 38

What is the rule regarding payment of checks after the drawer’s death?

Answer 38

Generally, the drawee bank may continue to pay checks until it knows that the drawer has died and has reasonable opportunity to act on that knowledge. Drawee bank may pay for no more than 10 days after the drawer’s death if the bank knows of the drawer’s death. But, if someone claiming an interest in the account requests that the drawee bank stop paying the drawer’s checks immediately, the drawee bank must comply.

Question 39

What is an accommodation party?

Answer 39

These are co-signers, sureties, and guarantors. A person who signs an instrument to lend his or her credit to another party but who does not receive any direct benefit, i.e. does not receive any of the borrowed money.

Question 40

How is accommodation status demonstrated?

Answer 40

Express language, or an anomalous indorsement – an indorsement by a person who was not the holder of the instrument, i.e. an indorsement outside the chain of title, is notice of its accommodation character.

Question 41

How do transfer warranties arise?

Answer 41

Impliedly. Defendant transferor who receives consideration makes the warranty. Does not arise in a gift context; the person transferring must receive consideration. It is made to the immediate transferee and subsequent transferees if transferor indorsed.

Note that drawees and makers can NEVER sue for breach of transfer warranty – they get instruments presented to them, not transferred.

Question 42

What are the transfer warranties?

Answer 42

Warrantor is entitled to enforce the instrument (basically a warrant of your holder status). All signatures are authentic and authorized. There is no alteration. There are no good defenses against the transferor. There is no knowledge of insolvency proceedings against the maker, acceptor, or drawer of an unaccepted draft.

Question 43

When are presentment warranties made?

Answer 43

Impliedly on presentment. Presentment warranties and transfer warranties are mutually exclusive. Made by the presenter and previous transferors to parties who pay in good faith (makers, drawees, accepters.

Question 44

What are the presentment warranties?

Answer 44

Warrantor is entitled to enforce draft or obtain payment. There is no alteration. There is no knowledge of unauthorized drawer’s signature. If a remotely created item, that person identified as the drawer authorized the item.

Question 45

How do you know whether plaintiff should sue indorser for breach of warranty or for breach of indorser’s contract?

Answer 45

Determine the identify of the plaintiff. If plaintiff is holder: If payor has not paid the instrument (e.g. check bounces or promissory note unpaid by maker), then holder sues indorser on breach of indorser’s contract. If plaintiff is payor: If the payor has paid and later discovers the payor should not have paid (e.g. the check was forged or the note was altered), then the payor will attempt to sue the indorser for breach of warranty.

Question 46

What if the maker’s signature is forged?

Answer 46

The alleged maker is NOT LIABLE because maker’s signature does not appear on the note. Alleged maker’s conduct may ratify the forgery or cause alleged maker to be precluded from denying the forgery.

The forger is liable on the note because their signature appears thereon.

Question 47

What if the drawer’s signature is forged?

Answer 47

The alleged drawer is NOT LIABLE. Drawee bank must recredit alleged drawer’s account as check was not properly payable unless drawee bank has a defense. Bank is unable to pass on loss unless breach of presentment warranty has occurred. Normally, no presentment warranties will be breached; parties had right to enforce the forger’s obligation. Forger is the real drawer because forger signed when the forger forged the alleged drawer’s signature. Drawee takes risk that drawer’s signature unauthorized unless presenter actually knew it was unauthorized.

Question 48

Bank’s defense to recrediting (defenses to the alleged drawer’s not properly payable action)

Answer 48

Drawer’s negligence – if drawer’s negligence substantially contributes to the forgery of the drawer’s name, the drawer may not raise the forgery.

Bank statement rule – duty to inspect statement (customer has duty to inspect statement and canceled checks in timely manner and report forgeries to bank). Forged drawer’s signatures must be reported to bank within one year regardless of bank’s or customer’s negligence.

Repeat offender rule – if same person forging a series of checks, the drawer must report the forgeries within 30 days of when statement was available. If not, bank will not recredit the account for subsequent forgeries by same person.

Question 49

What if payee’s name is forged in the indorsement?

Answer 49

Irrelevant if bearer paper since indorsement is not necessary to negotiate bearer paper. If order paper, forgery breaks chain of title and check is not properly payable. Accordingly, the drawer may demand that the drawee bank recredit the drawer’s account as the check was not properly payable.

Question 50

Situations where a party is precluded from asserting forgery of payee’s name

Answer 50

(a) Imposter Rule – drawer/maker estopped from denying validity of forged indorsement. These are situations where the maker or drawer is deemed to have acted carelessly in issuing the check and thus to have contributed to the forgery.
(b) Fraudulent indorsements by employees – if employer entrusts employee (or ind. cont.) w/ responsibility with respect to an instrument and the employee makes a fraudulent indorsement, the indorsement is effective. Payee is estopped from asserting the forgery.

Question 51

Liability of Drawee when forgery occurs

Answer 51

Conversion liability to payee – payee can sue payor bank (and depositary bank and non-bank converters) for conversion, or;

Not properly payable liability to drawer – drawer of check can see the payor/drawee bank since a check with a forged payee’s name is not properly payable

Drawee protected from double liability – a successful conversion action against drawee by payee will eliminate drawer’s not properly payable action

Question 52

Bank’s defense when forgery occurs

Answer 52

(1) Imposter rule
(2) Fraudulent indorsement by employee entrusted with check
(3) Drawer’s negligence
(4) Failure to timely sue (drawer must sue w/in 3 years)

Question 53

Liability of presenter when forgery occurs

Answer 53

The drawee bank can then sue the presenter and those prior to the presenter for breach of presentment warranty of entitled to enforce.

Question 54

Liability of transferor when forgery occurs

Answer 54

The presenter who loses to payor for breach of presentment warranty of good title may sue entities further up the chain for breach of the various transfer warranties of (1) entitled to enforce, (2) all signatures authentic or authorized, and (3) no good defenses.

Question 55

What is presentment?

Answer 55

Presentment is a demand for payment made by a person entitled to enforce the instrument. Presentment is usually made on the drawee of a draft or the maker of a note. Presentment may be made by any commercially reasonable means.

Question 56

When is presentment excused?

Answer 56

If: (i) the person entitled to present cannot with reasonable diligence do so; (ii) the maker has repudiated the obligation to pay or is dead or insolvent; (iii) by the instrument’s terms, presentment is unnecessary; (iv) the obligor has waived presentment; or (v) the drawer instructed the drawee not to pay or the drawee was not obligated to pay.

Question 57

When is an instrument dishonored?

Answer 57

When the maker (of a note) or the drawee (of a draft) does not pay within the allowed time after presentment. Generally, demand instruments other than checks are considered dishonored if not paid on the date presented.

Question 58

For how long is an oral stop payment order effective?

Answer 58

14 days, then it lapses, unless confirmed in writing within that period. A written stop payment order is binding for 6 months.

Question 59

What are the five circumstances in which a forgery or unauthorized signature will be validated because the person whose name is used has done something to preclude her from raising the issue?

Answer 59

(1) Fictitious payee
(2) Fraudulent indorsements by employees
(3) Failure to exercise ordinary care
(4) Bank statement rule
(5) Estoppel by certification