Essay Commercial Paper

Question 1

What is commercial paper governed by?

Answer 1

Articles 3 and 4 of the UCC

Question 2

What is the holder in due course (HDC) rule

Answer 2

If an instrument is in a special form (called “negotiable”) and is transferred in a special way (by “negotiation”) to a person who takes the instrument for value, in good faith, and without notice of any defenses to or claims on the instrument (i.e., an “HDC”), the HDC will be able to force someone to pay the money due under the instrument unless the person from whom payment is sought has available one of the very few so-called real defenses provided by Article 3

Question 3

What are the two basic instruments of commercial paper and what is the main example of each?

Answer 3

The note (e.g., promissory note) and the draft (e.g., a check).

Question 4

What is a note and who are the two parties involved?

Answer 4

A note is a promise to pay. Two basic parties are involved: the party promising to pay (the “maker”) and party to whom payment is promised (the “payee” or “bearer”)

Question 5

What is a Certificate of Deposit and is it a note?

Answer 5

A certificate of deposit is like a note. It is an instrument made by a bank containing: (i) an acknowledgment of money received; and (ii) a promise to repay

Question 6

What is a draft and who are the three parties involved?

Answer 6

A draft is an order to pay. Three basic parties involved are: one party (the “drawer”) orders another party (the “drawee,” often a bank) to pay money to a third party (the “payee”) or to bearer

Question 7

What is a check?

Answer 7

A check is any draft payable on demand and drawn on a bank

Question 8

For the formal requisites of negotiability for commercial paper, what does ‘negotiability’ depend on? what are the three elements that make up negotiability?

Answer 8

Whether an instrument is negotiable depends on its form. To be negotiable, an instrument must be a written and signed: 1) unconditional 2) promise or order to pay 3) a fixed amount of money (with or without interest) that: is payable to order or bearer when issued or first in possession of a holder; is payable on demand or at a definite time; and states no unauthorized undertaking or instruction by the person promising or ordering payment
Note: on your exam you will very likely have to determine whether an instrument is negotiable. The only way to make the determination is to see whether the above elements are present. Thus, you must memorize these elements.

Question 9

One of what two things will make an instrument condition (and thus not negotiable)?

Answer 9

if (i) it expressly states a condition for payment (e.g., “I promise to pay $500 if this thing happens”), or (ii) it states that the promise or order is subject to or governed by another writing

Question 10

A promise or order is NOT condition merely because it: (4)

Answer 10

A promise or order is NOT conditional merely because it:

(i) refers to another writing regarding collateral, prepayment, or acceleration;
(ii) limits payment to a particular source or fund;
(iii) requires a countersignature of a specimen signature (e.g., traveler’s checks); or
(iv) contains a statement required by law that the holder is subject to claims and defenses of the original payee.

Question 11

Does recitation of the consideration out of which the instrument arose violate the unconditionality requirement for negotiability?

Answer 11

No. Bar examination questions frequently deal with an instrument that recites the consideration out of which the instrument arose. Remember that such recitation does not make the instrument conditional.

Question 12

What are the rules as to what constitutes a writing or signature as required for a negotiable instrument?

Answer 12

A note must contain a promise to pay (e.g., “I promise to pay”). A draft must contain an order to pay (e.g., “First Bank, pay….”). The UCC rules are liberal as to what constitutes a writing or signature.

Question 13

How does requiring 1) foreign currency as payment, or 2) something other than money (e.g., gold) as payment affect negotiability?

Answer 13

The requirement that it be a fixed amount of money means that requiring foreign currency does not destroy negotiability, but requiring payment in something other than money makes an instrument nonnegotiable.

Question 14

What does it mean for the amount of money to be “fixed” as for negotiability?

Answer 14

To be negotiable, the principal due under the instrument must be fixed. Variable or indexed interest rates are acceptable. The “judgment rate” will be applied if the instrument states that it is payable “with interest” but the rate is not specified.

Question 15

What does it mean for the requirement for negotiability that the fixed amount of money must be payable to order or bearer? (including the three things, any one of which make it payable to bearer)

Answer 15

An instrument is payable to “order” if it is payable to the order of an identified person (e.g., pay to the order of Beck) or to an identified person or order (pay to Becky or her order).
An instrument is payable to bearer if it:
(i) states that it is payable to “bearer” (e.g., “I promise to pay bearer”), “order of bearer,” “order or bearer,” “order and bearer,” or otherwise indicates the possessor is entitled to payment; (ii) does not name a payee; or (iii) is payable to “cash” or otherwise indicates that it is not payable to an identified person (e.g., I promise to pay to the order of Mickey Mouse).
Note: the person to whom an instrument is payable is governed by the intent of the maker or drawer. A payee may be identified by any means, and more than one payee may be named.

Question 16

When is a negotiable instrument payable on demand as goes the requirement for negotiability that it must be payable either on demand or at a definite time?

Answer 16

An instrument is payable on demand if it fails to state a time for payment or states that it is payable “on demand,” “at sight,” etc.

Question 17

When is a negotiable instrument payable at a definite time as goes the requirement for negotiability that it must be payable either on demand or at a definite time?

Answer 17

An instrument is payable at a definite time if it is payable: (i) on a fixed date; (ii) after elapse of a specified period after sight; or (iii) at a time readily ascertainable when the instrument is issued. (Note that events that will occur on an uncertain date (e.g., “after my death”) are not “readily ascertainable.”

Question 18

What are acceleration clauses and extension clauses and do either destroy negotiability?

Answer 18

Acceleration clauses (e.g., “pay bearer $5,000 on April 15, 3000, or at my death if I should die sooner”) do not destroy negotiability. Extensions at the option of the maker and extensions that are automatic on the happening of an event, are acceptable if the extension is to a further definite time state in the instrument (e.g., “pay bearer $5,000 on August 12, 2005, but if a Uranus mission has been launched, payment may be made on August 12, 2015”). An extension at the option of the holder is always permitted (but he may not exercise it if the maker objects and tenders payment).

Question 19

As to the requirement of negotiability, only three undertaking or instructions are authorized by the UCC; any other undertaking or instruction will destroy negotiability. The UCC permits:

Answer 19

1) an undertaking or power to give, maintain, or protect collateral;
2) an authorization or power given to the holder to confess judgment or to realize on or dispose of collateral; and
3) a waiver of the benefit of a law that protects the obligor

Question 20

Where figures on an instrument are handwritten, typed, and printed. What is the order of authority?

Answer 20

Handwritten controls supreme over type and print. Type controls over print.

Question 21

If there are two or more signers in a single capacity on a negotiable instrument, how does liability work?

Answer 21

Each of the two or more signers are joint and severally liable in that capacity.

Question 22

How are incomplete instruments treated as to negotiability?

Answer 22

An incomplete instrument may be enforced according to its incomplete terms or as augmented by an authorized completion. If the instrument is completed without authority, it is treated as a fraudulently altered instrument

Question 23

Ultimately, what are the six elements to check for to determine whether an instrument is negotiable?

Answer 23

Make sure it has the following characteristics to be considered negotiable:

(i) unconditional (does not state a condition for payment and is not subject to or governed by another writing);
(ii) promise (note) or order (draft) to pay (written and signed);
(iii) a fixed amount of money (with or without interest);
(iv) is payable to order or bearer;
(v) on demand or at a definite time;
(vi) contains no unauthorized promise or undertaking

Question 24

To become an HDC, one must first become a holder. (essentially, a person in possession of an instrument with a right to enforce it). A person becomes a holder through a transfer that qualifies as a negotiation. The steps needed to negotiate an instrument depend on what?

Answer 24

Whether the instrument is payable to bearer or to order

Question 25

What are the steps needed to negotiate an instrument that is payable to a bearer?

Answer 25

Bearer instruments are negotiated by transferring possession of the instrument (e.g., Yolanda gives Zack a bearer note; there is a negotiation)

Question 26

How is an order instrument negotiated?

Answer 26

An instrument payable to an identified person (the payee, such as John Smith) is negotiated by transferring possession along with the identified person’s indorsement (e.g., John Smith may negotiate a check payable to his order by indorsing the check and delivering it to a transferee)

Question 27

What two things are needed as to the payee’s indorsement in order for the right to enforce to pass in an order instrument?

Answer 27

Generally, the right to enforce will not pass unless the payee’s indorsement is authorized and valid. In most cases, forging the payee’s name breaks the chain of title, and generally, not subsequent possessors of the instrument can qualify as holders.
Note: all necessary signatures of all payees and special indorsees are required

Question 28

For multiple payees in an order instrument, what are the requirements for the instrument being payable jointly (e.g., “to the order of Becky and Cindy”), and what are the requirements for the instrument being payable severally (e.g., “to the order of Beck or Cindy”).

Answer 28

An instrument may be payable to more than one payee, either jointly (e.g., “pay to the order of Becky and Cindy”), in which case EACH must indorse, or severally (e.g., “pay to the order of Beck or Cindy”), in which case any one may indorse

Question 29

What is the required location of the indorsement for an order instrument?

Answer 29

An indorsement must be written on either the instrument or an allonge affixed to the instrument.

Question 30

Every indorsement can be described by three certain qualities (and the inverse), what are these?

Answer 30

special or blank; qualified or unqualified; and restrictive or unrestrictive

Question 31

What is a special indorsement as opposed to a blank indorsement?

Answer 31

A special indorsement names a particular person as indorsee, e.g., “Pay John Smith [signed] Peter Payee.” The indorsee (John Smith) must sign in order for the instrument to be further negotiated. Words of negoitation (such as “pay to the order of”) are NOT required in indorsements, and extra words generally do not impair negotiability.
A blank indorsement is a signature that is not accompanied by the naming of a specific indorsee (e.g., the indorser merely signs his own name, probably the way most people indorse their paychecks). Blank indorsements create bearer paper, which may then be negotiated by delivery alone.

Question 32

Does forgery of the drawer’s name break the chain of title for indorsement? Why or why not?

Answer 32

Forgery of the drawer’s name does not break the chain of title, and thus subsequent transferees may qualify as holders. This is because the forgery operates as the genuine signature of the forger.

Question 33

If there have been multiple indorsement, which indorsement controls?

Answer 33

The last indorsement controls what is necessary for further negotiation

Question 34

What is a qualified indorsement as opposed to an unqualified indorsement?

Answer 34

An indorsement with the words “without recourse” is a qualified indorsement and limits the contract liability imposed on indorsers.

Question 35

What is a restrictive indorsement as opposed to an unrestricted indorsement?

Answer 35

Any other language added to an indorsement creates a restrictive indorsement. Restrictive indorsements generally are ineffective to limit transfer or negotiation (e.g., a check indorsed “pay Pete Payee only” may be further negotiated to anyone) or to condition payment (e.g., a check indorsed “pay John if he fixes my car” may be further negotiated even if John has not fixed the car). However an instrument with words requiring bank collection (e.g., “for deposit” or “for collection”) must be paid consistently with the indorsement by any person or the first bank into which the instrument is deposited (i.e., the depositary bank) or it will be deemed to have been converted.

Question 36

What is an anomalous indorsement and what is the effect?

Answer 36

An anomalous indorsement is an indorsement made by a person who is not a holder of the instrument, usually for accommodation (i.e., suretyship) purposes. The anomalous indorser becomes liable on the instrument.

Question 37

Why is it important to determine whether a holder is an HDC? (what is the benefit of being an HDC)

Answer 37

If a negotiable instrument is negotiated to a holder in due course, the HDC takes free of most defenses. Thus on the exam it is very important to determine whether the holder trying to enforce an instrument is an HDC.

Question 38

What is the two-step process for determining HDC status?

Answer 38

(i) Is the person a holder?

(ii) Does the person hold in due course?

Question 39

What is a holder?

Answer 39

A holder is a person in possession of an instrument with the right to enforce the instrument. The instrument must be payable to bearer or to the person in possession and free of forgery.

Question 40

What are the three requirements to holding in due course?

Answer 40

“Due course” requires the holder to take for value, in good faith, and without notice.

Question 41

Any one of what five things constitutes value?

Answer 41

(i) Performance of the agreed consideration;
(ii) Acquisition by the holder of a lien or a security interest in the instrument (other than a judicial lien);
(iii) Taking the instrument as payment of or security for an antecedent debt;
(iv) Trading a negotiable instrument for another instrument; or
(v) Giving the instrument in exchange for incurring an irrevocable obligation to a third person by the person taking the instrument.
Note: do not confuse value with consideration for the underlying contract. For example, an antecedent debt is value, but not consideration.

Question 42

Does the value need to be equivalent to the face amount to satisfy the due course requirement for the holder to take for value?

Answer 42

No. The value given in exchange for an instrument need not be equivalent to the face amount of the instrument. An instrument purchased at a discount (e.g., a $1,000 promissory note purchased for $900) is sold for full value as long as the full price agree dupon has been given.

Question 43

What happens if one pays less than the agreed-upon value when selling an instrument from one to another? (what is the effect to HDC status )

Answer 43

If one pays less than the agreed-upon value, one becomes a partial HDC in proportion to the percentage of the value paid.

Question 44

how is the time of payment important in determining HDC status when it the selling of the instrument from one to the other?

Answer 44

The time of payment can be important because good faith and notice are determined at the time of negotiation or the time of payment, whichever is later

Question 45

In the due course requirement of good faith for a holder in due course, what does it mean for the instrument to be in good faith? Also, what two tests are there for this requirement?

Answer 45

To be an HDC, the holder must take the instrument in good faith. Good faith means honesty in fact (a subjective test) and observance of reasonable commercial standards (an objective test)

Question 46

For the due course requirement of ‘without notice,’ what does that mean and include?

Answer 46

The holder must purchase the instrument without notice of certain things. Notice includes both actual notice and reason to know from facts surrounding the transaction

Question 47

What are five facts that constitute notice for the due course requirement that the HDC be without notice?

Answer 47

1) Instrument overdue;
2) unauthorized signature or alteration;
3) claims to the instrument;
4) defenses or claims in recoupment;
5) when and how notice must be received (to be effect, notice must be received in such time and manner as to give a reasonable opportunity to act on it)

Question 48

A purchaser has notice that an instrument is overdue if one of what three things is true?

Answer 48

if:

(i) any part of the principal is overdue;
(ii) an acceleration has been made; or
(iii) more than a reasonable time has elapsed after issue of a demand instrument (for checks, 90 days)

Question 49

The knowledge of what 9 facts, in and of themselves, does not give the purchaser notice?

Answer 49

1) the instrument is antedated, postdated, or undated;
2) the instrument was issued in return for an executory promise, unless the purchaser has notice that a defense or claim has arisen from the terms thereof;
3) any party signed for accommodation;
4) an incomplete instrument has been completed, unless the purchaser has notice of any improper completion;
5) any person negotiating the instrument was a fiduciary, unless the purchaser also knows that the negotiation constituted a breach of trust;
6) that there has been a default in payment of interest;
7) there is a public filing or recording of a document (e.g., security agreement) concerning the instrument;
8) the instrument was sold at a discount; or
9) notice of discharge of a party, other than a discharge in an insolvency proceeding

Question 50

What three transactions preclude HDC status?

Answer 50

If the instrument is taken by:
legal process or purchase at a judicial sale;
acquiring it as a successor in interest to an estate or other organization; or
purchasing it as part of a bulk transaction not in the regular course of business of the transferor

Question 51

At what point is HDC status determined to start?

Answer 51

HDC status is determined at the moment the instrument is negotiated to the holder OR when she gives value, whichever occurs later. Thus, if the transferee acquires notice of a claim or defense prior to negotiation or the giving of value, she will not qualify as an HDC.

Question 52

To what extent is a holder an HDC if there is a security interest on the obligation?

Answer 52

If the holder merely has a security interest in the instrument and the person obligated to pay has a defense or claim against the person who created the security interest, the holder is an HDC only to the extent of the unpaid portion of the secured obligation.

Question 53

What is the shelter rule as it pertains to HDCs

Answer 53

A transferee acquires whatever rights her transferor had and thus is said to take “shelter” in the status of her transferor. The purpose of this rule is to protect the free negotiability of commercial paper.

Question 54

What is the exception to the shelter rule?

Answer 54

No HDC rights are given to persons who were parties to fraud or illegality affecting the instrument

Question 55

What is the difference between the sort of defenses an HDC is entitled to as opposed to a holder who is not an HDC?

Answer 55

An HDC can enforce any instrument subject only to real defenses (i.e., the HDC takes free of personal defenses and claims). Thus, whether an obligated party such as a maker, drawer, or indorser will be forced to pay depends on whether the holder is an HDC and on the nature of the obligated party’s defenses. If the holder is not an HDC, the obligated party may assert any of the ordinary contract defenses (e.g., failure of consideration). If the holder is an HDC, the obligated party is limited to so-called real defenses.

Question 56

What are the eleven real defenses that apply to both holders that are HDC and those who aren’t?

Answer 56

1) Forgery (unless the person whose name was forged ratifies the unauthorized signature or is estopped from denying it);
2) Fraud in the Factum (real fraud);
3) Alteration of Instrument;
4) Incapacity to Contract (only if void, not voidable);
5) Infancy (unless the state does not make such contracts void or voidable);
6) Illegality;
7) Duress (as long as it is extreme duress (e.g., gun pointed at head));
8) Discharge in Insolvency Proceedings;
9) Statute of Limitations (in certain situations);
10) Accommodation (Suretyship) Defefenses; and
11) Discharges Known to HDC
Note: Real defenses can be remembered by FAIDS: Forgery, Fraud, Alteration, Adjudicated Incompetency; Infancy, Illegality, Duress, Discharge; Statute of Limitations, and Suretyship

Question 57

What is Fraud in the Factum and how is it different from other frauds that don’t constitute a real defense to HDC?

Answer 57

Fraud that causes the 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 which is really a promissory note) is a real defense. Other fraud (most types, such as when the obligor gives a promissory note in exchange for a fraudulent promise) is only a personal defense

Question 58

To what extent is alteration of instrument a real defense to HDC?

Answer 58

In certain circumstances, an HDC may be able to collect only the original amount (i.e., not the altered amount), so that the alteration is a partial “real” defense. In other situations, the HDC may be able to collect on the instrument as altered.
Note that there is a 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, the maker will not be liable for the altered amount but will be liable for the full amount of the unauthorized completion.

Question 59

What are the five actions to which there is a three year statute of limitation defense applicable to HDCs?

Answer 59

(i) on unaccepted drafts;
(ii) against issuers/acceptors of cashier’s checks, certified checks, etc.;
(iii) for conversion;
(iv) for breach of warranty; and
(v) to enforce other Article 3 rights (after accrual).

Question 60

What are the two actions to which there is a six year statute of limitation defense applicable to HDCs?

Answer 60

(i) on notes payable at a definite time or on demand (after due date or demand for payment); and
(ii) on certificates of deposit (after demand for payment, but the period does not start to run until the stated due date).

Question 61

What is the real defense of Accomodation (Suretyship) still applicable against an HDC?

Answer 61

An accommodation party is, in effect, a surety. By signing the instrument, she incurs liability without being a direct beneficiary. If an HDC knows of the accommodation, he takes subject to the surety’s defenses (i.e., discharge to the extent of loss caused by: (i) extension of due date; (ii) material modification of obligation; or (iii) impairment of collateral).

Question 62

Does the defense that the contract out of which the commercial paper arose was not properly or fully performed stand against an HDC? why or why not?

Answer 62

No. This defense is a personal defense out of a simple contract action and cannot be used against an HDC.

Question 63

One must raise their own defenses to a claim against an HDC besides these two exceptions:

Answer 63

(i) accommodation party can raise most defenses available to party accommodated, and
(ii) payor must raise the defense of theft if known

Question 64

Who may enforce a commercial paper instrument?

Answer 64

(i) a holder; (ii) a nonholder in possession with rights of a holder (e.g., a subrogee); or (iii) a person not in possession but entitled to enforce (e.g., lost, stolen, or destroyed instruments)

Question 65

What two elements are required to make a prima facie case in a negotiable paper case?

Answer 65

requires proof that:

(i) signatures are genuine; and
(ii) the person presenting the instrument is entitled to enforce it

Question 66

In a negotiable instrument case, what happens if the validity of a signature is not specifically denied?

Answer 66

It is admitted - there is presumption of validity in proof of signature

Question 67

What happens in a negotiable paper case when the instrument is lost, destroyed, or stolen?

Answer 67

If an instrument is lost, destroyed, or stolen, a person entitled to enforce may maintain an action if she can prove that she was entitled to enforce the instrument when the loss of possession occurred, the the terms of the instrument, and the facts that prevent production of the instrument. In such a case, the court has discretion to require protection (such as a bond) to indemnify the defendant against other claims

Question 68

A person entitled to possession may bring an action for conversion in a negotiable paper case unless, except for what?

Answer 68

except for issuers, payers, and indorsees who never received delivery

Question 69

What is “vouching in” in a negotiable paper case?

Answer 69

It is possible to “vouch in” parties to an instrument who may be liable to the party sued. If a defendant to a suit on an instrument has a right of recourse against someone else if he is required to pay, then he may give that third person written notice of the litigation. If, after receiving notice, the third person fails to appear and defend, he will be bound by an determination of fact common to a suit against him by the party giving the notice. A person “vouched in” may also “vouch in” person liable to him.

Question 70

What is the determinant as to whether a party may be held liable to a negotiable instrument? (and what is the basic rule)

Answer 70

A number of parties to a negotiable instrument may be held liable simply because their names appear on the instrument. Generally, no one may be held liable unless her signature or the signature of an authorized representative is on the instrument.

Question 71

What is the scope of liability of the maker of a note (or the issuer of cashier’s check)?

Answer 71

By signing her name, the maker of a note makes a contract to pay the instrument according to its terms at the time it is issued. The promise is unconditional, but proper defenses may be raised. Similar liability is imposed on the issuer of a cashier’s check.

Question 72

How should a question about the liability of parties on an instrument be approached?

Answer 72

You should first identify the status of each party (e.g., maker, indorser, etc.), and then discuss each party’s liability. If the fact situation is complex, chart the transfer chain.

Question 73

What is the nature of an indorser’s liability on a negotiable paper?

Answer 73

An indorser may sign an instrument for any number of purposes: (i) negotiating the instrument; (ii) restricting payment; or (iii) incurring indorser’s liability. An indorser is considered to be secondarily liable (i.e., a person entitled to enforce the instrument looks first to the drawee or maker). Indorsers may be held liable on contract or warranty theories.

Question 74

From what does the indorser’s contract arise (where does the obligation begin)?

Answer 74

The indorser’s contract–the basic obligation to pay according to the terms of the instrument at the time of indorsement–arises merely from the indorser’s signing her name on the instrument, although the obligation may be negated if the indorser includes the words “without recourse” with her indorsement. However, before holder can look to an indorser for payment, the holder must fulfill three prerequisites: presentment, dishonor, and notice of dishonor.

Question 75

What is the requirement of ‘presentment’ as it relates to the prequisites that a holder must fulfill before looking to an indorser for payment (through action)?

Answer 75

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 76

At what point is an indorser’s liability on a check discharged?

Answer 76

An indorser’s liability on a check is discharged unless the check is presented for payment or given to a depositary bank for collection within 30 days after the indorsement.

Question 77

When is the requirement of ‘presentment’ excused as it relates to the prerequisites the a holder must fulfill before looking to an indorser for payment (through action)? (5 situations)

Answer 77

presentment is excused 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 78

What is the requirement of ‘dishonor’ as it relates to the prerequisites that a holder must fulfill before looking to an indorser for payment (through action)?

Answer 78

Dishonor occurs when the maker or drawee 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 79

What is the requirement of ‘notice of dishonor’ as it relates to the prerequisites that a holder must fulfill before looking to an indorser for payment (through action)?

Answer 79

An indorser is not liable on an instrument unless she is given timely notice that the instrument has been dishonored. Notice of dishonor may be given by any commercially reasonable means, and generally must be given within 30 days after dishonor (or 30 days after a collecting bank’s midnight deadline if the instrument was taken by the bank for collection).
Note: notice of dishonor need not be given to the maker of a note or the drawer of a draft

Question 80

When is a delay in the requirement of notice of dishonor as it relates to the prerequisites that a holder must fulfill before looking to an indorser for payment (through action) permitted?

Answer 80

Delay in giving notice is excused if caused by circumstances beyond the control of a notifier who exercised reasonable diligence after the cause of the delay ceased to exist. Notice of dishonor is excused entirely if: (i) the terms of the instrument make it unnecessary; or (ii) the obligor waives notice.

Question 81

When will the warranty liability of an indorser arise?

Answer 81

When an indorser transfers an instrument for consideration, the indorser becomes liable as a transferor

Question 82

How are transfer warranties made in negotiable instruments, and how far do they run?

Answer 82

Warranties are made by (i) any person who transfers (i.e., any movement except issuance or presentment) an instrument or customer or collecting bank that transfers an item (ii) for consideration.
Warranties run to all subsequent holders if the transfer is by indorsement, but run only to the immediate transferee if the transfer is not by indorsement. Presentment, notice of dishonor, etc., are irrelevant to warranty liability. Other than on checks, warranty liability can be negated by a transferor if she places words to that effect on the instrument, but a customer or collecting bank cannot disclaim its obligation to pay a dishonored item.

Question 83

For negotiable instruments, what five things does a transferor warrant?

Answer 83

in general, a transferor warrants that:

a. she is entitled to enforce the instrument or item (ie., that all indorsements necessary to the chain of title are genuine and that the transferor is a proper person, in her own right or as agent, to make presentment and obtain payment);
b. all signatures are authentic and authorized;
c. the instrument or item has not been altered;
d. no defense or claim of any party is good against her; and
e. she has no knowledge of any insolvency proceedings that have been instituted against the maker, acceptor, or drawer

Question 84

What is the nature of a drawer’s liability on a negotiable paper?

Answer 84

Generally, if a draft is dishonored, the drawer is obliged to pay according to the draft’s terms when the drawer signed (or if incomplete, according to its terms as completed). A drawer, like an indorser, has secondary liability. However, if a draft is accepted by a bank, the drawer is discharged and cannot be held liable if the bank fails to pay.

Question 85

What is the nature of a drawee’s liability on a negotiable paper?

Answer 85

The drawee of a draft cannot have any liability unless and until she signs the instrument (and thus becomes an acceptor). Thus, a holder generally cannot force a drawee to pay out on a draft.

Question 86

What are the duties of a drawee bank to its customer?

Answer 86

`When a bank is the drawee, the bank may be liable to its customer for failure to accept the draft, because a contractual relationship exists which imposes duties on both bank and customer. A bank is obliged to honor its customer’s check if sufficient funds are on deposit to cover the draft. A bank may choose to honor a check even if the customer has insufficient funds, which case the customer is liable to the bank for the overdraft. If a bank wrongfully dishonors a draft, the customer may collect damages for harm proximately caused by the wrongful dishonor. Banks may refuse to pay checks over six months old, unless again ordered to pay by the drawer.

Question 87

What are the four instances in which the bank cannot charge the account?

Answer 87

the bank must honor a check as drawn. Therefore it cannot charge the account:
(i) if there is no order by the depositor (where the drawer’s signature is forged);
(ii) for more money than the original order (where a third party altered the amount);
(iii) if the bank pays the wrong person (e.g., the forger of the payee’s or indorsee’s signature); or
(iv) if the item is postdated and the customer notifies the bank of the postdating (the bank cannot pay it before the stated date).
If the bank violates these principles, the customer is entitled to a recredit on her account.

Question 88

What are the duties of a customer to the bank?

Answer 88

The bank can successfully charge the customer’s account if it can show that it suffered a loss because the customer negligently failed to discover, and notify the bank of, any unauthorized payments on his bank statement resulting from an alteration or forgery of his signature. The customer may answer such proof by showing that the bank was negligent in paying the item. The loss will then be allocated between the bank and the customer in proportion to the fault of each.

Question 89

When will the death of a customer revoke the bank’s authority to pay a check?

Answer 89

Not until the bank
(i) knows of the death and
(ii) has a reasonable time to act on the knowledge.
Note: even with such knowledge, the bank may continue paying checks for 10 days after the date of death unless someone claiming an interest in the account orders that payment be stopped.

Question 90

How do stop payment orders work?

Answer 90

Under the UCC, an oral stop payment order is effective for 14 days and then lapses unless confirmed in writing within that period. A written stop payment order is binding for six months. The bank must be given reasonable time to act and is not obliged to honor stop payment orders on cashier’s checks. If the bank pays an item in spite of a stop payment order, the customer has the burden of proving that a loss has occurred and the amount of the loss. Thus, if there is an HDC in the chain of transferees of the item, the customer cannot recover–since even if payment had been stopped, the customer would have to pay the HDC

Question 91

What is the bank’s right to recover erroneous payment from a party paid?

Answer 91

If the bank erroneously pays out on a forged instrument to an HDC, it generally may not recover back from the party paid unless there has been a breach of a transfer warranty or a presentment warranty

Question 92

What is the nature of an Acceptor’s liability on a negotiable paper?

Answer 92

An acceptor (usually, but not necessarily, a drawee bank) signs a draft and thereby becomes primarily bound to pay the instrument. In essence, the acceptor contracts to pay the draft when due in accordance with its terms when accepted. Accepted drafts are often required when the payee does not want to rely on the credit of an unfamiliar drawer. The draft is usually presented to the acceptor, which signs the draft (and usually charges its customer’s account at that time) and returns it to the presenting party. This process is called presentment for acceptance. Acceptance may be sought at any time by any party entitled to enforce the instrument.

Question 93

What is Certification of a Check and what is the effect?

Answer 93

Certification is the acceptance of a check by the bank on which it was drawn. Certification discharges the drawer and all prior indorsers. The bank does not have to certify a check, absent some special agreement with the customer, but if the bank chooses to certify, it puts its own credit on the line. A bank will therefore charge its customer’s account immediately upon certification, rather than waiting for the check to be paid. Failure to certify may constitute a dishonor.

Question 94

What is an Accommodation Party and what is its nature of liability on a negotiable paper?

Answer 94

An accommodation party signs an instrument to lend his credit to another party to the instrument and receives no direct benefit. He is, in essence, a surety. The accommodation party may sign in any capacity (e.g., as a co-maker or as an indorser). An accommodation party is never liable to the party accommodated. He is liable to other parties in the capacity in which he signed.

Question 95

If an accommodation party pays the instrument, may he have action on the party accommodated? What are his rights?

Answer 95

If an accommodation party pays the instrument, he will have an action on the instrument against the party accommodated, irrespective of the parties’ formal positions on the instrument. He is also subrogated to (i.e., acquires) the rights of the party paid–including any right to collateral. Thus, impairment of collateral discharges him to the extent of the impairment.

Question 96

What is the level of proof needed for accommodation status?

Answer 96

A person signing an instrument is presumed to be an accommodation party, and there is notice of accommodation status, if the signature is anomalous (i.e., by a person who is not a holder) or otherwise indicates that the signer is acting as surety or guarantor. To give the accommodation party the benefit of any discharge relating to his character as surety, parol evidence is generally allowed to show accommodation, except when the holder is an HDC without notice of the accommodation.

Question 97

A party who clearly indicates that she is only a guarantor of collection (e.g., by signing “collection guaranteed”) will be liable only if one of what two things occurs?

Answer 97

(i) the person entitled to enforce has reduced his claim to judgment against the maker or acceptor and execution is returned unsatisfied, or (ii) seeking judgment would be futile (because of insolvency, etc.)

Question 98

What the effects of persons signing an instrument jointly?

Answer 98

If parties to an instrument sign jointly, they have joint and several liability on the instrument, and thus either one or both can be sued for the entire amount due. If one party pays more than his share, he generally has a right of contribution against the other jointly liable party. A release of one jointly liable party by a third party does not affect the right of contribution.

Question 99

What is the liability of a Principal if a representative (agent) signs her own name or the name of the principal?

Answer 99

The principal is bound if the agent had authority to sign. The principal may be bound even if the agent lacked authority in cases of: (i) ratification (where the principal adopts the signature, appropriates benefits, or fails to deny the signature’s validity); or (ii) estoppel (where the principal’s negligence contributed to the making of the unauthorized signature). Estoppel operates in favor of one who is otehrwise an HDC or one who pays the instrument in good faith, applying reasonable commercial standards.
Note that a principal can be held liable even if her signature does not appear on the instrument.

Question 100

What does the liability of the agent (in signing for a principal) depend on?

Answer 100

Liability of the agent depends on whether the agency and the principal’s identity were disclosed.

Question 101

What is the liability of an agent when 1) the agent signs principal’s name only, and 2) when the agent signs own name but discloses principal, and 3) when the agent signs own name but does not disclose princpal’s name and/or agency relationship

Answer 101

1) If the agent signs only her principal’s name, the principal will be liable if the agent was authorized, but the agent is not liable because neither her name nor her authorized agent’s name appears on the instrument.
2) If the agent signs her own name with the principal’s authority, the agent is not bound if the signature shows it was made on behalf of the principal identified in the instrument (e.g., signature “Blue Corp., by Joan Smith, Treasurer”; Smith not personally liable).
3) If the signature does not show it was made in a representative capacity or the principal is not identified in the instrument, the agent is liable to HDCs who take without notice (but not to non-HDCs if she can prove the original parties did not intend her to be liable)

Question 102

What is the general effect of unauthorized signatures?

Answer 102

Generally, an unauthorized signature is ineffective as the signature of the person whose name is signed but is effective as the signature of the signer. The unauthorized signer therefore assumed all obligations to any party who gave value for the instrument. However, the Code specifies 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.

Question 103

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

Answer 103

1) Fictitious Payee - Carelessness of a maker or drawer in issuing an instrument may make forgery of the payee’s name likely. In such cases, the resulting forgery is effective to pass the right to enforce the instrument to later transferees. (as long as good faith and ordinary care are used).
2) Fraudulent Indorsements by Employees - If an employer entrusts an employee with responsibility for an instrument (e.g., an employer’s cashier) and the employee fraudulently indorses, the indorsement is effective. (Again, the take or payor must exercise ordinary care.)
3) Failure to Exercise Ordinary Care (Negligence Rule) - If a person fails to exercise ordinary care and that failure substantially contributes to an alteration or forged signature, that person is precluded from raising the alteration or forgery against a person who paid the instrument in good faith or took it for value or for collection.
4) Bank Statement Rule - Failure to examine one’s bank statement is a form of negligence that can preclude the defenses of forgery and alteration. Also if one fails to promptly report a forgery or alteration, she is precluded from complaining that the item was not properly payable. (A customer may not assert an alteration or a forgery of his signature if he does not notify the bank within one year after the bank has made the instrument available to him. A customer may not assert a forged instrument more than three years after the cause of action accrues.)
5) Estoppel by Certification - Because a bank has opportunity for checking identification and bona fides if it certifies a check, it is estopped from claiming that the named payee was not the original payee as against subsequent parties.

Question 104

What is alteration and what does the effect of the alteration depend on?

Answer 104

An alteration is an unauthorized change that purports to modify the obligation of any party. Its effect depends on whether the alterer’s intent was fraudulent or nonfraudulent

Question 105

What is the effect of a nonfraudulent alteration?

Answer 105

Nonfraudulent alterations do not discharge parties, and the instrument may be enforced according to its original terms

Question 106

What is the effect of a fraudulent alteration?

Answer 106

Unless the party assents or is estopped from asserting the alteration, a fraudulent alteration discharges all parties, except that a payor bank, a drawee paying a fraudulently altered instrument, or an HDC may enforce the instrument: (i) according to its original terms; or (ii) in the case of unauthorized completion, according to its terms as completed.

Question 107

What are the three general issues of payment?

Answer 107

(i) When can the maker or acceptor safely pay?
(ii) What if the maker or acceptor pays by mistake? and
(iii) What if an acceptor finds she should not have accepted?

Question 108

What is the primary step in making sure, as a maker, that you can safely pay while avoiding further liability?

Answer 108

Determine if party seeking payment is a holder - The maker must first determine that the party seeking payment is a holder. If he is, the maker may safely pay him, even if the maker knows that a third party has a claim to the instrument. If the maker pays someone who is not a holder, she will have to pay the true holder when he comes along.

Question 109

How can a third party protect his claim to an instrument? (2 ways)

Answer 109

(i) he can offer to indemnify the maker or acceptor in an amount deemed sufficient by the maker or acceptor while the other two parties fight it out or
(ii) seek an injunction in an action in which the maker or acceptor, the holder, and the third party are parties.

Question 110

Payment of a negotiable instrument is final, except that (what two things):

Answer 110

(i) the payor can pursue those who breach transfer warranties; and
(ii) the rule of finality operates only in favor of persons who took for value and in good faith and those who in good faith change their position in reliance on the payment or acceptance.
Thus, if the person who receives payment is not one of the persons described in (ii) above, an action to recover the payment can be maintained.

Question 111

What are the two types of presentment warranties?

Answer 111

(i) those made to drawees on unaccepted drafts; and

(ii) those made to payors out of other instruments or items

Question 112

May a drawee (e.g., a bank) recover for breach of a presentment warranty even from HDCs and persons who detrimentally relied on payment?

Answer 112

Yes

Question 113

On unaccepted drafts, persons obtaining payment and previous transferors warrant what three things?

Answer 113

(i) the warrantor is entitled to enforce the draft or is authorized by one who is (in essence a warranty of “good title”–that there are no unauthorized or missing indorsements);
(ii) the draft has not been altered; and
(iii) the warrantor has no knowledge that the drawer’s signature is unauthorized
Note the difference in result between a forged drawer’s signature and a forged indorser’s signature. If a bank pays out on a forged drawer’s signature, payment is final and the bank cannot recover the money back from the party paid because no presentment warranty is broken (the forgery is treated as a valid signature of the roger and thus the presenter had the right to enforce the forger’s instrument as against the forger). But if the bank pays out on a forged indorser’s signature, a presentment warranty is broken (the presenter did not have the right to enforce against the drawer because of the forgery).

Question 114

Who makes presentment warranties?

Answer 114

The warranties are made by: (i) any person who obtains payment or acceptance, and (ii) any prior transferor. Note that these warranties on presentment are similar, but no identical to, the transfer warranties made by an indorser. The warranties are made to any person who in good faith pays or accepts.

Question 115

How does discharge work in general?

Answer 115

An instrument itself never dies by discharge because discharge of a party is a personal defense, which an HDC can cut off. No discharge of any party is effective against a subsequent HDC unless the HDC has notice of the defense when he takes the instrument.

Question 116

If a certified, cashier’s, or teller’s check is given to fulfill an obligation, what is the effect?

Answer 116

The obligation is discharged as if cash were given, but this does not affect any indorser liability of the obligor

Question 117

If any other negotiable instrument other than a certified, cashier’s, or teller’s check is given to fulfill an obligation, what is the effect?

Answer 117

The underlying obligation is suspended until the instrument is paid or certified (which results in discharge) or is dishonored. If the instrument is dishonored, the person seeking payment can sue on the instrument. If he is the obligee on the obligation for which the instrument was given, he may choose instead to sue on the underlying obligation.

Question 118

What is discharge by payment?

Answer 118

The liability of a party is discharged to the extent of her payment (or satisfaction) to the current holder of the instrument and, in the case of notes, to a prior holder of the note if the maker lacks notice that the note has been transferred at the time of payment. The foregoing rule is true even if the payment is made with knowledge of a claim of another person to the instrument, unless the claimant indemnifies the payor or enjoins the payment. On the holder’s request, payment may be made prior to maturity, and need not be made in good faith and without notice that the title of the holder is defective, but there is no discharge if the payor knows the instrument is stolen and pays a person she knows is in wrongful possession.

Question 119

What is discharge by tender of payment?

Answer 119

The effect of tender is governed by contract law principles. Tender of the amount due on an instrument discharges any duty to pay interest after the due date. Any person with a right of recourse against the tendering party is discharged to the extent of the amount tendered.

Question 120

What is discharge by cancellation or renunciation?

Answer 120

Even without consideration, persons entitled to enforce may discharge a party through: (i) intentional voluntary acts (e.g., surrendering or destroying an instrument or striking out a signature); or (ii) renouncing rights in a signed writing. But note that such discharge is not effective against a subsequent HDC without notice.

Question 121

What is discharge by release and impairment of recourse or collateral–suretyship defenses?

Answer 121

Release of an obligated party will discharge to the same extent an indorser or accommodation party on the instrument. Furthermore, the impairment of collateral, extension of the due date, or other modification of an obligation discharges such parties to the extent of the impairment or the loss caused by the modification. In cases of time extensions or other modifications, the loss must be proven. For an impairment of collateral, the loss is presumed.

Question 122

What is discharge by reacquisition?

Answer 122

Upon reacquisition (transfer to a former holder), the reacquirer may cancel indorsements made between the time she formerly held the instrument and the present. Cancellation discharges such indorsers as against subsequent holders, including HDCs. Reacquisition automatically cancels the intervening indorsers’ liability to the reacquirer.

Question 123

What is discharge by an act that will discharge a simple contract?

Answer 123

Parties are discharged from liabilities to other parties on an instrument by acts or agreements that would discharge obligations to pay money under a simple contract.

Question 124

What is discharge by delay in presentment of a check?

Answer 124

If a check is not presented for payment or given to a depositary bank within 30 days after the indorsement, the indorser is discharged. If a check is not presented for payment or given to a depositary bank for collection within 30 days after its date and the delay deprives the drawer of funds to pay the obligation (e.g., bank goes bankrupt), the drawer is discharged to the extent of the loss if he assigns his rights against the drawee to the party entitled to enforce.

Question 125

What is discharge by failure to give notice of dishonor?

Answer 125

If notice of dishonor is required and not given, the indorser is discharged from his indorsement obligation. Drawers and makers usually are not entitled to notice.

Question 126

What is discharge by acceptance of a draft by a bank?

Answer 126

If a draft is accepted by a bank, the drawer is discharged. If a draft is accepted by a bank after indorsement, the indorser is discharged.

Question 127

What is discharge by alteration?

Answer 127

Fraudulent alterations discharge every party obligated on the instrument unless a party assents or is estopped from asserting the alteration, but HDCs may enforce according to original terms (or terms as completed in cases of fraudulent completion).