Commercial Paper

Question 1

What is the basic idea behind these types of problems?

Answer 1

1) Instrument’s holder wants to be paid;
2) Person obligated to pay doesn’t want to pay; and
3) The person who ultimately pays the instrument will want to recover from someone else.

Question 2

What is the basic approach to these questions?

Answer 2

1) Determine if the instrument is a negotiable instrument;
2) Determine whether the instrument was PROPERLY negotiated;
3) Determine whether the instrument’s holder is a HOLDER IN DUE COURSE (HDC);
4) Determine whether the individual who is obligated to pay has any defenses against payment;
5) Determine whether those defenses are REAL OR PERSONAL DEFENSES; AND
6) Can the one who paid the instrument hold anyone else responsible?

Question 3

What are the types of Commercial Paper and who are the parties involved?

Answer 3

NOTES AND DRAFTS - MAKERS MAKE NOTES AND DRAFTERS DRAW DRAFTS.

NOTES - these are characterized by a promise to pay and have two parties:

1) MAKER - the person making the promise to pay; AND
2) PAYEE - the person to whom the instrument is payable.

DRAFTS - these are orders to pay money and there are three parties involved:

1) DRAWER - the person ordering payment;
2) DRAWEE - the person being ordered to pay; and
3) PAYEE - the person to whom the instrument is payable.

Question 4

What is a certificate of deposit?

Answer 4

This is a type of NOTE where:

1) Bank acknowledges receipt of money; AND
2) Bank promises the payee/depositor to repay the money.

Question 5

What is a check? What are the different types of checks?

Answer 5

This is a type of DRAFT that requires the following:

1) The bank is the drawee; and
2) the instrument is ON DEMAND.

TYPES OF CHECKS:

1) Ordinary Checks;
2) Traveler’s Checks - another draft form which must be COUNTER-SIGNED by a person whose “specimen signature” appears on the traveler’s check;
3) Cashier’s Check - The drawer and the drawee are the same bank; and
4) Teller’s check - Check drawn by one bank on another bank.

Question 6

What if an instrument contains contradictory terms?

Answer 6

1) HAND-WRITTEN terms PREVAIL OVER BOTH PRINT AND TYPEWRITTEN TERMS;
2) Typewritten terms prevail over printed terms;
3) Words prevail over numbers.

Question 7

What if an instrument is not negotiable?

Answer 7

Then Article 3 of the UCC does NOT apply.

Question 8

What are the formal requirements of negotiability?

Answer 8

PART 1:

1) The document must be in WRITING (CANNOT BE ORAL) and SIGNED by the MAKER OR DRAWER;
2) Thee promise or order to pay must be UNCONDITIONAL; AND
3) The payment obligation must be for a FIXED amount of money.

PART 2:

1) The writing must be payable to ORDER OR BEARER;
2) The writing must be payable on demand or at a definite time;
3) The writing must OBLIGATE the payor to do one thing, which is to PAY MONEY and nothing else (NO ADDITIONAL UNDERTAKINGS OR INSTRUCTIONS ALLOWED).

Question 9

T/F - A negotiable instrument must be reduced to a tangible form.

Answer 9

True.

Question 10

What does “signed” mean?

Answer 10

Includes using any symbol executed or adopted with the present intent to adopt or accept a writing.

Examples of acceptable signature forms:

1) Traditional signature;
2) Printed;
3) Stamped;
4) Written;
5) Thumbprint;
6) Trade or business name;
7) Computer generated.

Question 11

Explain the “unconditional” requirement of a negotiable instrument.

Answer 11

The promise to order to pay must be unconditional (ex: I, Mary, promise to pay to the order of Paul $50,000).

Typical scenarios that make the promise or order conditional:

1) Express conditions to payment - CANNOT condition the payment on a condition precedent (I promise to pay to the order of Paul $50,000 if he mows my lawn).
2) Subject to another writing - CANNOT do this (I promise to pay to the order of Paul $50,000 subject to the written contract between him and me dated January 1, 2013).

Items that DO NOT make the promise or order to pay conditional:

1) References to other documents - Mere references to other documents do not make the promise to order to pay conditional (I promise to pay . . . in accordance with the written contract between . . . dated January 1, 2013). EXAM TIP: reference that is there for informational purposes only are not conditional.
2) Payment from a particular fund - A provision that payment must be from an identified fund does NOT render the promise conditional.
3) Counter-Signature - The requirement of a counter-signature, as in a traveler’s check, does not render an instrument non-negotiable.
4) Prepayments and collateral - References to other records regarding rights as to collateral, prepayment, or acceleration do NOT make the promise to pay conditional.

Question 12

What does the requirement of a “fixed amount” mean?

Answer 12

The PRINCIPAL amount due on the instrument must be a FIXED AMOUNT of money.

INTEREST CAN BE VARIABLE.

EXAM TIP: Be aware of fact patterns in which the interest rate may not be fixed or readily ascertainable. The writing in question will still be negotiable as long as the principal amount is fixed.

Question 13

A negotiable instrument must either be an __________ or ___________ instrument.

Answer 13

Order or bearer instrument.

Question 14

What is an order instrument? What is a bearer instrument?

Answer 14

ORDER INSTRUMENT - payable to a specific person. Requires specific language or words of negotiability. The key phrases are:

1) Pay to the order of, or
2) Pay [name} or his order.

BEARER INSTRUMENT - Generally, anyone in possession has legal rights to the instrument. Any instrument that does not attempt to pay a specific person. Language that is acceptable:

1) Payable to bearer;
2) Payable to the order of bearer;
3) Payable to cash;
4) Payable to {blank line].

Question 15

What if a negotiable instrument is payable to both bearer and order?

Answer 15

If the writing has characteristics of both an order instrument and a bearer instrument, then the writing will be TREATED AS BEARER PAPER.

Question 16

T/F - Checks are an exception to the “words of negotiability” requirement for negotiable instruments.

Answer 16

True

Policy: Article 3 makes this exception simply because checks are prevalent. It would be cumbersome to distinguish between those checks that contained such language and those that did not.

Question 17

What is payable on demand vs. at a definite time?

Answer 17

A writing must be clear as to when the one required to pay the instrument must do so.

An instrument is payable ON DEMAND when the instrument’s payee or holder can present the negotiable instrument IMMEDIATELY after being issued the instrument.

An instrument is payable at a DEFINITE TIME when the instrument’s payee or holder can present the negotiable instrument AT A FUTURE TIME that is CLEAR OR READILY ASCERTAINABLE.

Question 18

T/F - Checks (drafts) are typically payable on demand.

Answer 18

True

Question 19

T/F - Notes are typically payable on demand.

Answer 19

False.

These are normally payable at a definite time.

Question 20

What is the effect of acceleration and extension clauses?

Answer 20

Acceleration Clause - makes payment due immediately upon the happening of an event.

Extension Clause - Provision in the instrument that extends the due date. An instrument can contain provisions allowing for the obligor to extend the due date, provided the extension is to a DEFINITE TIME. The instrument can also contain automatic extensions upon a specified event as long as the date is extended to another definite time.

Question 21

What does it mean to have a date that is readily ascertainable?

Answer 21

When you look at the instrument, you should be able to readily ascertain when the payment must occur.

Question 22

What constitutes an additional undertaking?

Answer 22

REMEMBER: The writing must commit the obligor to one legal obligation and nothing else; the obligation to pay money.

Basically anything extra (requirement to bake a cake in addition to payment would be an additional undertaking).

EXCEPTIONS - Some additional undertakings are ALLOWED:

1) Promises or orders concerning collateral (“shall provide additional collateral if current collateral falls below FMV”);
2) Provision that allows holder to procure judgment (“holder is hereby granted the authority to confess judgment against maker in any appropriate court.”

Question 23

What are the requirements for a negotiable instrument again?

Answer 23

1) Writing and signed;
2) Promise or order to pay is unconditional;
3) Principal amount must be fixed, but the interest rate can be variable;
4) Payable to order or bearer (words of negotiability must be used);
5) Writing must be payable on demand or at a definite time (if at a definite time, must be readily ascertainable); AND
6) No additional undertakings (obligor’s sole obligation is to pay money.

Question 24

What is the basic idea behind acquiring “holder status?”

Answer 24

The person who takes the instrument via negotiation will want to acquire status as a HOLDER IN DUE COURSE (HDC) because this status gives him legal rights that are SUPERIOR to those of a MERE HOLDER.

Question 25

How does a person become a holder?

Answer 25

TWO WAYS:

1) Issuance - the first delivery of an instrument from the maker/drawer to the payee; OR
2) Proper Negotiation - A transfer of possession, whether VOLUNTARY OR INVOLUNTARY, by a person other than the issuer to a person who becomes the holder.

Question 26

How is a bearer instrument negotiated?

Answer 26

Requires transfer of POSSESSION ONLY.

Question 27

How is an order instrument negotiated?

Answer 27

Requires transfer of POSSESSION PLUS A PROPER INDORSEMENT of the instrument BEFORE transfer.

Question 28

What are the different kinds of indorsement?

Answer 28

SPECIAL INDORSEMENT - “Pay to [name] /s/ Paul.”

BLANK INDORSEMENT - Not made to a specific person . . . simply “/s/ Paul.”

QUALIFIED INDORSEMENT - Used to limit one’s liability on an instrument. “Without Recourse /s/ Paul.”

RESTRICTIVE INDORSEMENT - used to limit what the holder can do with the instrument. “For Deposit Only /s/ Paul.” MUST BE VALID (can’t say “Pay Harry if he mows my lawn /s/ Paul.”)

ANOMALOUS INDORSEMENT - Used by accommodation parties (discussed later in flashcards).

Question 29

How are multiple Payees handled?

Answer 29

PAYABLE JOINTLY - Requires ALL payees to indorse for a valid negotiation. “To the order of Paul and Harry.”

PAYABLE SEVERALLY - Either party can sign the instrument for a valid negotiation. “To the order of Paul or Harry.”

Question 30

Again, what is necessary for proper negotiation of bearer and order instruments?

Answer 30

Bearer - possession only.

Order - possession PLUS proper indorsement.

Question 31

How does one acquire status as an HDC?

Answer 31

1) Acquire status as a holder (discussed earlier);
2) Must pay VALUE for the instrument;
3) Must take the instrument in GOOD FAITH; and
4) WITHOUT NOTICE that there are any problems that might affect the obligor’s obligation to pay the instrument.

Question 32

What is considered value?

Answer 32

The person must GIVE something of value, DO something of value, OR FORGIVE something of value.

GIFTS - NOT VALUE

UNEXECUTED PROMISES TO PERFORM - NOT VALUE

Question 33

T/F - Paying less than the note’s full face value is acceptable.

Answer 33

True if the payee accepts.

Example: In exchange for a negotiable promissory note with a face value of $50,000, Harry pays Paul $40,000. The note will mature in 12 months from the date of issue. This is acceptable.

Question 34

Can HDC status be gained by partial performance?

Answer 34

Yes, you can get PARTIAL HDC RIGHTS.

Example: In exchange for a negotiable promissory note with a face value of $50,000, Harry agrees to pay Paul $40,000; $20,000 the day Paul negotiates the note, and an additional $20,000 five months from that date. The note will mature 12 months from the negotiation date. On the date Paul negotiates the note, Harry has rights as an HDC FOR $25,000 ($20,000/$40,000 X $50,000) as Harry has paid half of the agreed-upon consideration.

Question 35

T/F - Forgiving a preexisting obligation constitutes value.

Answer 35

True

Example - In exchange for a negotiable promissory note with a face value of $50,000, Harry agrees to accept the note as satisfaction for a $30,000 loan that Harry gave Paul two years ago. Harry’s forgiveness of the debt obligation is considered value.

Question 36

How is taking an instrument in “good faith” determined?

Answer 36

TWO PART ASSESSMENT:

1) HONESTY-IN-FACT - What the person receiving the instrument ACTUALLY knew (subjective); AND
2) OBSERVANCE OF REASONABLE COMMERCIAL STANDARDS OF FAIR DEALING - What the person receiving the instrument should have surmised given the context in which the instrument was negotiated (objective).

Question 37

What does it mean to take the instrument “without notice?”

Answer 37

Cannot acquire status as an HDC if the holder is aware of any reason as to why the legal obligation to pay the note may be COMPROMISED.

What constitutes notice:

1) Actual notice;
2) Receives notice through the mail;
3) Has REASON TO KNOW there may be a problem.

Question 38

What constitutes an “infirmity?”

Answer 38

1) The holder has notice of any CLAIM IN RECOUPMENT;
2) Holder has notice of forged, altered, or otherwise irregular instrument; or
3) Holder has notice the instrument is overdue.

Question 39

When is an instrument “overdue?”

Answer 39

CHECKS ARE OVERDUE 90 DAYS AFTER DATE OF ISSUE.

Any instrument that is due ON DEMAND is overdue after demand for payment is made.

Instruments due at a DEFINITE TIME are overdue the DAY AFTER THE DUE DATE.

NOTE: If the due date is ACCELERATED, then the note is overdue the day AFTER the accelerated due date.

NOTE: When payments are due in INSTALLMENTS, the instrument is overdue the day AFTER the installment due date.

Question 40

What is the effect of notice of overdue interest payments?

Answer 40

Notice of an overdue interest payment will NOT compromise the holder’s ability to claim HDC status, but notice of overdue PRINCIPAL payments WILL COMPROMISE the holder’s ability to claim HDC status.

Question 41

What limits are there on HDC status?

Answer 41

In some instances, a person’s ability to claim status as a HDC will be limited.

FOR CONSUMER NOTES, the Federal Trade Commission (FTC) regulations protect consumers in certain transactions that otherwise involve the use of a negotiable instrument by requiring that the FOLLOWING NOTICE BE PLACED on the NI BEFORE THE CONSUMER SIGNS THE NI:

• Any Holder of this consumer credit contract is subject to all claims and defenses which the debtor could assert against the seller of goods or services obtained pursuant hereto or with the proceeds hereof. Recovery hereunder by the debtor shall not exceed amounts paid by the debtor hereunder.

THIS ALLOWS THE DEBTOR TO ASSERT CLAIMS AND DEFENSES AGAINST THE INSTRUMENT’S HOLDER (EVEN IF THEY ARE AN HDC).

EXAM TIP - If this is tested, the likely challenge is to determine whether the NI in question is required to have such notice.

Question 42

When is the FTC notice provision required?

Answer 42

THREE REQUIREMENTS:

1) The Maker/Drawer is signing the note in a consumer transaction (acquiring an item for personal or family use);
2) The transaction in question must be for sale or lease of goods or services (ex: buying a car or boat); AND
3) The seller must be one who sells the item in question in his ordinary course of business.

Question 43

What is value again?

Answer 43

Requires the holder to GIVE, DO, or FORGIVE something of value.

Question 44

What must you remember about notice and HDCs?

Answer 44

If you have a good faith issue, holders may have trouble claiming HDC status.

Question 45

What are transfers?

Answer 45

Transfer is the instrument’s movement OTHER THAN BY THE MAKER OR DRAWER for the purpose of giving the person receiving it the right to enforce the instrument.

The first movement from maker to payee is an ISSUANCE, NOT A TRANSFER.

Subsequent movement prior to the payment ARE TRANSFERS.

Question 46

What is the Shelter Rule?

Answer 46

THE RIGHTS FOLLOW THE INSTRUMENT. Whatever rights the transferor had transfer to the transferee.

EXAM TIP - In the event an instrument is transferred, ask yourself whether the transferor was a HOLDER or HDC.

Question 47

What is the right to the transferor’s indorsement?

Answer 47

When a transferee pays VALUE for an instrument and the transferor fails to provide a necessary indorsement, the transferee has a LEGAL RIGHT to have the transferor provide the necessary indorsement to complete the negotiation.

Question 48

Is there an exception to the Shelter Rule?

Answer 48

A transferee who commits FRAUD or otherwise engages in some type of ILLEGAL ACTIVITY as it relates to the instrument CANNOT ACQUIRE RIGHTS AS AN HDC.

Example: A fraudulently induces Maker to issue a note to A. A negotiates the note to C, who takes the note as a holder in due course. C sells the note back to A. A DOES NOT ENJOY C’S RIGHT AS A HDC DUE TO A’S PRIOR FRAUD WITH RESPECT TO THE NOTE.

Question 49

What are transfer warranties?

Answer 49

Warranties that a transferor makes to a transferee. These warranties include:

1) The warrantor is a person ENTITLED to enforce the instrument. This is breached by a FORGED DRAWER’S SIGNATURE;
2) All signatures on the instrument are authentic and authorized;
3) There are no defenses or claims that can be asserted against the transferor;
4) Warrantor has no knowledge of any insolvency proceedings;
5) With respect to any remotely-created constumer check, the person on whose account the check is drawn has authorized the issuance of the item in the amount for which the item is drawn.

Question 50

What warranties should you consider if you are dealing with a question about a thief?

Answer 50

1) Transfer Warranties

2) Presentment Warranties (will be discussed in later flashcards).

Question 51

Who has to prove what when trying to enforce an instrument?

Answer 51

The PLAINTIFF seeking enforcement must prove:

1) That plaintiff is a person entitled to enforce the instrument; and
2) That the signatures on the instrument are valid.

VALIDITY OF SIGNATURES - Party claiming validity generally has the burden of proving that the signatures are valid, if denied in the pleadings. Signatures are accepted as authentic UNLESS specifically denied in the pleadings.

Question 52

Who is entitled to enforce an instrument?

Answer 52

1) A holder;
2) A non-holder in possession of the instrument who has the rights of a holder; OR
3) A person not in possession but who has the right to enforce (e.g., the instrument has been lost or stolen).

Question 53

What defenses are able to be asserted once a plaintiff establishes a prima facie case?

Answer 53

Defendant can assert any REAL OR PERSONAL DEFENSES at his disposal. If the plaintiff is a HDC, plaintiff can re-establish the right to payment if the ONLY defenses proffered are personal defenses (because personal defenses are not available against HDCs).

Question 54

What rights does a plaintiff have if the instrument was lost, stolen, or destroyed?

Answer 54

Plaintiff has the right to enforce an instrument even if the instrument was lost or stolen. As long as the loss of possession did not result from the holder transferring the instrument, and the holder cannot reasonably obtain possession of the instrument because the instrument is either lost or destroyed.

Question 55

Is conversion an action in commercial paper actions?

Answer 55

A person converts the property of another when he wrongfully deprives the other of that property or its value.

An instrument is converted if it is taken by transfer OTHER THAN A NEGOTIATION, from a person not entitled to enforce the instrument or receive payment.

DAMAGES - The measure of liability is generally the amount payable on the instrument. They can be sought from the thief and any banks that took the instrument.

Question 56

Who cannot bring an action for conversion?

Answer 56

1) ISSUERS AND ACCEPTORS; AND

2) PAYEES AND INDORSEES who did not receive delivery of the instrument.

Question 57

What are an issuer’s remedies in the case of conversion?

Answer 57

Issuers must seek a STOP PAYMENT ORDER OR have the bank RECREDIT their account by asserting that the check was NOT PROPERLY PAYABLE.

Question 58

What are the “real defenses” that can be asserted by obligors?

Answer 58

1) Infancy - can assert this defense in states where contracts with minors are either VOID or VOIDABLE;
2) Incapacity - State law MUST render contract with these VOID;
3) Duress - matter of degree (extreme duress vs. mere threat of something bad happening). State law must make contracts made under duress VOID;
4) Illegality - An obligor may assert this defense when state law states that notes drawn for the purpose of reimbursing or repaying money lent for gaming are VOID;
5) Fraud in the Factum - This is a real defense and can be asserted against an HDC. This is where the Signer is NOT AWARE that he is signing a negotiable instrument AND he MUST NOT HAVE HAD A REASONABLE OPPORTUNITY TO BE COME AWARE

NOTE: Fraud in the Inducement HOWEVER is only a personal defense not assertable against an HDC. This is where the Signer is AWARE that he is signing a negotiable instrument BUT Signer is induced into signing based on misrepresentations;

6) Discharge of Insolvency - If an obligor has had his debts discharged through bankruptcy proceedings, that discharge is a real defense;
7) Alteration & Forgery - Any type of alteration or forgery that is apparent enough to cause a reasonable person to question its authenticity can be asserted as a real defense;
8) Statute of Limitations

Question 59

What are the statute of limitations for drafts and notes?

Answer 59

DRAFTS:

1) Unaccepted Drafts (i.e., bank checks) - THREE YEARS from date of dishonor OR TEN YEARS from the date of the draft, WHICHEVER IS EARLIER.
2) Certified, Teller’s, Cashiers, or Traveler’s checks - If presenting, THREE YEARS AFTER demand for payment.

NOTES:

1) For notes payable AT A DEFINITE TIME - the action must be brought within SIX YEARS of the note’s due date.
2) For notes payable ON DEMAND - the action must be brought within SIX YEARS after demand for payment.

Question 60

What personal defenses are available for obligors?

Answer 60

PERSONAL DEFENSES ARE EFFECTIVE ONLY AGAINST THOSE WHO HAVE HOLDER STATUS (NOT HDC).

1) Non-Issuance - it is a personal defense if you did not actually issue the note/draft (left it somewhere and someone picked it up);
2) Contract Defenses - same type of defenses asserted under contract law - breach of contract, failure of consideration, breach of warranty;
3) Claims of Recoupment - An OFFSET against the amount owed on an instrument. For example, A buys a boat and issues a note payable to B. The boat is actually damaged. A can assert the repair costs as on offset to the note.

NOTE: CLAIMS IN RECOUPMENT MUST ARISE FROM THE TRANSACTION THAT GAVE RISE TO THE INSTRUMENT. FURTHER, THE OBLIGOR MAY ONLY ASSERT HIS OWN RECOUPMENT CLAIM (NOT THE CLAIMS OF OTHERS).

Question 61

What happens if an instrument gets issued to an impostor (drawer gets duped)?

Answer 61

Generally - Issuers MUST be careful to whom they issue instruments.

If the issuer is duped into issuing an instrument to an impostor, the issuer may nonetheless be liable on the instrument.

If an impostor induces the issuer to issue an instrument to the impostor, an indorsement of the instrument by ANY PERSON in the name of the payee may be effective as the payee’s indorsement.

Generally, this scenario is invoked when either a drawer or a maker is tricked into issuing a check to someone who misrepresents who they are. Here, the law places the loss on the instrument’s issuer, the rationale being that the issuer is in the best position to control to whom he issues an instrument.

Question 62

What if an instrument is payable to fictitious or unintended payees (when good employees go bad)?

Answer 62

If a person whose intent determines to whom an instrument is payable and that person:

1) Does not intend for the payee to have any interest in the instrument; OR
2) The payee is fictitious; THEN
3) Any person in possession of the instrument is the instrument’s holder; and an indorsement by ANY PERSON in the name of the stated payee may be effective as the payee’s indorsement.

Generally this scenario is invoked in the corporate context when a treasurer either writes checks payable to real customers but instead indorses the checks himself and deposits the money, OR creates fictitious payees and writes checks to them but keeps the checks for himself.

THE CORPORATION BEARS THE LOSS AS IT IS IN THE BEST POSITION TO PREVENT THESE ACTS FROM HAPPENING.

Question 63

What is an employer’s liability for employee’s fraudulent indorsement?

Answer 63

An employee ENTRUSTED (MUST BE ENTRUSTED) with check-writing privileges forges indorsements. The employee misplaces that trust by forging the indorsements. The EMPLOYER will bear the responsibility for the loss.

Question 64

Who are “benefited parties?”

Answer 64

These are the parties who take the instruments through impostors, unintended/fictitiously, or employee fraud. These parties are usually banks or good faith purchasers for value.

If these parties fail to exercise ordinary care in taking these instruments, and that failure SUBSTANTIALLY contributes to loss resulting from payment of the instrument, the person bearing the loss may recover from the person failing to exercise ordinary care to the extent the failure to exercise ordinary care contributed to the loss.

Question 65

What are alterations?

Answer 65

These are unauthorized modifications of an instrument. This includes changes to both words and numbers.

Question 66

What is the legal effect of an altered instrument?

Answer 66

OBLIGOR IS DISCHARGED on the instrument.

Payor bank or drawee who pays a fraudulently altered instrument may enforce rights with respect to the instrument according to its original terms before the alteration.

HDCs may enforce rights with respect to the instrument according to its original terms before the alteration.

Question 67

What are “incomplete” instruments?

Answer 67

A signed writing, whether or not issued by the Signor, the contents which show that the signer intended the instrument to be completed by the addition of words or numbers.

AUTHORIZED COMPLETIONS ARE ENFORCEABLE.

UNAUTHORIZED COMPLETIONS - the obligor is DISCHARGED on the instrument, but a payor bank or an HDC can enforce the instrument as completed.

Question 68

What are bank statements?

Answer 68

Statements given to a bank customer about their account.

Customers have an obligation to inspect their bank statements for unauthorized payments stemming from an alteration or an unauthorized signature.

If the nature of the alteration or unauthorized signature is such that the customer reasonably should have discovered, then the customer must promptly notify the bank of the relevant facts.

A CUSTOMER HAS ONE YEAR AFTER THE STATEMENT OR ITEMS HAVE BEEN MADE AVAILABLE TO REPORT; otherwise, the customer is precluded from asserting the alteration or unauthorized signature against the bank.

Question 69

What is required for other parties who have potential liability on an instrument to be liable?

Answer 69

PRESENTMENT AND DISHONOR serve as preconditions for liability for other parties who have potential liability on the instrument.

Example: Mary issues a note to Paul. Paul indorses the note, “Pay to Harry /s/ Paul,” and then negotiates the note to Harry in good faith for value. Harry presents the note to Mary. Mary asserts the real defense of infancy and then dishonors the note. Thus, Paul, as the indorser, would now be liable because the note was initially presented to Mary who dishonored.

PRESENTMENT CAN BE EXCUSED WHEN:

1) The presenter cannot locate the one liable to whom presentment must be made;
2) The maker or the acceptor has repudiated the obligation to pay;
3) The instrument’s terms do not require presentment;
4) The drawer or indorser has waived the presentment requirement;
5) The drawer has instructed the drawee not to pay the instrument.

Question 70

What are “presentment warranties?”

Answer 70

Presentment warranties come into play when a thief or forger enters into the chain. The breach of presentment warranty allows a PAYOR BANK TO SUE “UP-STREAM” those through whose hands the check has passed for breach of one of the warranties.

When a “person” presents an item for payment, the presentment comes with all of the following WARRANTIES:

1) The warrantor is a person entitled to enforce the instrument (a warrant that there are no unauthorized or missing indorsements);
2) The draft has not been altered;
3) The warrantor has no knowledge that the drawer’s signature is unauthorized; AND
4) With respect to any remotely-created consumer item, the person on whose account the item is drawn has authorized the issuance of the item in the amount for which the item is drawn.

The warranty that the warrantor is a person entitled to enforce the instrument is not breached by a forged drawer’s signature, but is generally breached by the forgery of a necessary indorsement (e.g., a payee’s signature). This places the burden of determining the validity of the drawer’s signature on the drawee.

Question 71

What is the Maker’s liability?

Answer 71

Maker has PRIMARY liability, which means the Maker must pay the instrument WHEN IT COMES DUE.

Question 72

What is the Drawer’s liability?

Answer 72

Drawer has SECONDARY liability. The drawer’s obligation to pay RIPENS ONLY UPON PRESENTMENT AND DISHONOR.

Question 73

What is the Drawee’s liability?

Answer 73

A drawee is NOT LEGALLY OBLIGATED on the instrument UNLESS the drawee SIGNS the instrument for the PURPOSE of accepting liability on the instrument.

Drawees generally do not sign instruments; therefore, their liability is not on the instrument itself but to the BANK CUSTOMER who has funds deposited at the bank.

Question 74

What is the Acceptor’s liability?

Answer 74

ACCEPTANCE - The drawee’s signed agreement to pay a draft as presented.

Banks are the entities that usually accept drafts.

Certified, teller’s, and cashier’s checks are the common context in which acceptance occurs.

Question 75

What is an Indorser’s liability?

Answer 75

By indorsing an instrument, you agree to pay the instrument in the event the one who has PRIMARY liability does not pay.

The indorser’s liability ripens when:

1) The note is DISHONORED; AND
2) The indorser receives NOTICE OF THIS DISHONOR.

NOTE: BE AWARE OF INDORSEMENTS THAT STATE “WITHOUT RECOURSE,” WHICH DISCLAIMS THE INDORSERS LIABILITY.

Question 76

What if more than one person signs the instrument (joint signers)?

Answer 76

Joint signers of an instrument have JOINT AND SEVERAL LIABILITY, meaning either one or both may be sued for the entire amount.

Question 77

What is the basic idea behind accommodation parties?

Answer 77

BASIC IDEA:

1) Maker wants to borrow money but has bad credit;
2) Lender won’t lend because of Maker’s bad credit;
3) Maker gets an accommodation party to act as a surety.

KEY ASPECTS:

1) The accommodation party must SIGN the instrument;
2) The accommodation party must NOT be a DIRECT BENEFICIARY of the value given for the instrument;
3) The accommodation party’s liability on the instrument depends on the CAPACITY in which they sign.

Question 78

What is the difference between “guaranteeing collection” and “guaranteeing payment?”

Answer 78

GUARANTEEING COLLECTION - Lender must seek payment from the MAKER FIRST.

GUARANTEEING PAYMENT - Lender can seek payment from EITHER maker or guarantor first.

Question 79

What if the guarantor simply signs their name on the back of a promissory note in no capacity?

Answer 79

The guarantor is an ANOMALOUS INDORSER and has SECONDARY LIABILITY. Thus, the lender must go after the MAKER FIRST, and can seek payment from the indorser ONLY AFTER the note is dishonored.

Question 80

What are the legal rights of an Accommodation Party?

Answer 80

Accommodation Parties are entitled to:

1) Reimbursement from the maker (full repayment);
2) Contribution from co-accommodation parties (reimbursed a pro-rata amount); AND
3) The same defenses against payment that an accommodated party would have.

Question 81

T/F - Accommodation parties are liable to accommodated parties that pay the instrument.

Answer 81

False, they are not.

Question 82

What if agents sign negotiable instruments? When is an agent liable?

Answer 82

The general laws of agency apply here. The principal is generally liable on a NI signed by an AUTHORIZED agent. The AGENT’S LIABILITY HINGES ON WHETHER;

1) The agent was authorized to sign;
2) The agent indicated clearly that he was an agent; AND
3) Whether the person presenting the instrument for payment is a HDC OR MERE HOLDER.

Question 83

What is a Principal’s liability?

Answer 83

The principal is NOT BOUND if the agent did NOT HAVE AUTHORITY to sign on the principal’s behalf.

The principal may RATIFY the agent’s unauthorized signature if the principal ADOPTS the signature or FAILS TO DENY the signature’s validity.

The principal may be ESTOPPED from denying liability AGAINST A HDC IF the principal NEGLIGENTLY contributed to the agent’s unauthorized signature.

Question 84

What is an agent’s liability?

Answer 84

UNAUTHORIZED SIGNATURE - The agent will be BOUND by signing an instrument when the agent did NOT have authority to act on the principal in signing the instrument.

AUTHORIZED SIGNATURE:

1) The principal is liable when an authorized agent signs the principal’s name only;
2) An authorized agent who signs an instrument that clearly indicates that the agent is signing in his CAPACITY AS AGENT will NOT BE LIABLE on the instrument;
3) If authorized agent signs his own name but does not clearly indicate that he is signing in a representative capacity or who does not identify the principal in the instrument, will have PERSONAL LIABILITY to a HDC who takes the instrument WITHOUT NOTICE OF THE AGENCY. But the agent is NOT LIABLE TO A NON-HDC if he can establish that the parties never intended for the agent to be personally liable;
4) An authorized agent is NOT LIABLE for signing his own name as DRAWER on a check if the check is DRAWN ON THE PRINCIPAL’S ACCOUNT.

Question 85

T/F - A person is generally not liable on an instrument unless that person signs the instrument.

Answer 85

True

Question 86

T/F - A person who signs an instrument is generally liable on the instrument regardless of whether the signature was authorized or not.

Answer 86

True

Question 87

T/F - A person will be liable on an instrument in the capacity in which he signed the instrument.

Answer 87

True

Question 88

What if a signature is forged?

Answer 88

FORGED MAKER’S SIGNATURE:

1) Person whose signature was forged is NOT LIABLE;
2) Person who forged the signature WILL BE LIABLE.

FORGED DRAWER’S SIGNATURE:

1) Person whose signature was forged is NOT LIABLE;
2) Person who forged the signature WILL BE LIABLE.

FORGED INDORSER’S SIGNATURE:

1) Person whose signature was forged is NOT LIABLE;
2) Person who forged the signature WILL BE LIABLE.

Question 89

What if payment was made by mistake by a drawee to a payee (in the case of a stop payment order or the instrument containing a forgery)?

Answer 89

In some cases, the drawee can seek restitution from the one to whom payment was made. The drawee can seek restitution under Article 3 in TWO COMMON CASES:

1) Drawee pays a check on the mistaken belief that the drawer’s signature was an authorized signature;
2) The drawee pays a check on the mistaken belief that a stop payment order had NOT been issued.

HOWEVER, the drawee may not recover a mistaken payment when the one entitled to enforce the instrument is a GOOD FAITH pruchaser for value, or is one who in good faith CHANGED POSITION IN RELIANCE on the payment.

Question 90

T/F - Restitution is NOT available for a drawee when payment is mistakenly made to a HDC.

Answer 90

True

Question 91

What are the two obligations in a negotiable instrument?

Answer 91

1) The underlying obligation; AND

2) The obligations on the negotiable instrument.

Question 92

When is a person discharged on the underlying obligation?

Answer 92

1) if a certified, cashier’s, or teller’s check is taken for an obligation, the underlying obligation is DISCHARGED.

EXAMPLE - Terry is two months behind on rent payments. He gives Larry a cashier’s check to cover the two months. Terry’s obligation is discharged when Larry takes the check.

2) If an UNCERTIFIED check or note is taken for an obligation, the underlying obligation is SUSPENDED. IF the check or note is subsequently PAID, the underlying obligation is then DISCHARGED. IF the check or note is DISHONORED, the note’s holder can sue on either the instrument or the underlying obligation.

EXAMPLE - Same facts as above, except the note matures in three months, and Larry decides he doesn’t want to wait that long. Larry MUST WAIT until the note’s due date. After that, Larry can sue, if rent hasn’t been paid, on the instrument or on the underlying past due rent.

3) Lost Instruments - If one entitled to enforce the instrument loses the instrument, the remedy is limited to suing on the instrument itself.
4) Discharge by Tender of Payment - When person tenders payment, INTEREST AFTER PAYMENT IS DISCHARGED. When person tenders payment and payment is refused, INDORSERS AND ACCOMMODATION PARTIES are DISCHARGED.

Question 93

What if a transferee acquires an instrument through a bulk sale?

Answer 93

A person cannot become an HDC if the instrument is purchased in a bulk transaction, not in the regular course of the transferor’s business.

Question 94

Explain an accord and satisfaction.

Answer 94

When a claim is unliquidated or otherwise subject to dispute, the claim can be discharged if the person against whom the claim is asserted in good faith tenders an instrument that contains a conspicuous statement to the effect that the instrument was tendered as full satisfaction of the claim, and the claimant obtains payment of the instrument.

The language must be conspicuous either on the instrument or on a letter accompanying the instrument.

Good faith amounts to honesty-in-fact and the observance of reasonable commercial standards of fair dealing.

Question 95

Are words that are merely italicized considered conspicuous?

Answer 95

Likely, but it is up to the court.