Liability of Parties

Question 1

Basic idea

Answer 1

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 2

Parties Who May Be Liable on an Instrument:

Maker of Note, Issuer of Cashier’s Check

Answer 2

by signing her name, maker of note (or issuer of cashier’s check) makes a contract to pay the instrument according to its terms at the time it is issued.

This promise is unconditional, but proper defenses may be raised.

Question 3

Parties Who May Be Liable on an Instrument- Indorser:

Indorser

Answer 3

indorser signs instrument (usually on its backside) for a number of purposes:

e.g. negotiating the instrument, restricting payment, 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 drawer or maker)

Question 4

Parties Who May Be Liable on an Instrument- Indorser:

Basic Obligation: Indorser’s Contract

Answer 4

indorser’s contract, the basic obligation to pay according to the terms of the instrument at the time of the indorsement, arises merely from the indorser’s signing her name on the instrument,.

BUT, the obligation may be negated if the indorser includes the word “without recourse” with her indorsement.

Before a holder can look to an indorser for payment, the holder must fulfill three prerequisites: presentment, dishonor, and notice of dishonor.

Question 5

Parties Who May Be Liable on an Instrument- Indorser:

Presentment

Answer 5

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

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

Question 6

Parties Who May Be Liable on an Instrument- Indorser:

When Presentment May Be Excused

Answer 6

presentment is excused if:

(i) the person entitled to present cannot with reasonable diligence;
(ii) the maker or acceptor 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 has instructed the drawee not to pay or the drawee was not obligated to pay.

Question 7

*Parties Who May Be Liable on an Instrument- Indorser:

Dishonor

Answer 7

occurs when the maker or drawee does not pay within the allowed time after presentment

Time instruments (e.g. instruments payable at a particular time): dishonored if not pay when due or date of presentment, whichever is later.

Checks: dishonored if it is presented for payment and payment is refused. If check is presented for other than immediate payment (e.g. when you deposit whole paycheck into your checking account without receiving cash back), it is dishonored if the bank returns the check or sends a written notice of dishonor before final payment (which usually occurs after settlement through a clearinghouse) or before the bank’s midnight deadline (i.e. the midnight of the next banking day after the day the instrument is deposited)

*if payout some of the money from a check before settlement, that money is considered final settlement of that portion of the check and cannot become regained.

Question 8

*Parties Who May Be Liable on an Instrument- Indorser:

Notice of Dishonor

Answer 8

indorser not liable on an instrument unless she is given timely notice that the instrument has been dishonored.

Notice may be given by any commercially reasonable means, and generally must be given within 30 days after dishonor

notice of dishonor need not be given to the maker of a n note or the drawer of a draft

Question 9

Parties Who May Be Liable on an Instrument- Indorser:

Notice of Dishonor Excused

Answer 9

delay excused: if delay is caused by circumstances beyond the control of a notifier who exercised reasonable diligence after the cause of the delay ceased to exist.

notice entirely excused if:

(i) the terms of the instrument make it unnecessary; or
(ii) obligor waives notice

Question 10

Parties Who May Be Liable on an Instrument- Indorser:

Multiple Indorsers

Answer 10

an indorser is liable for the full amount of the instrument at the time she indorsed it to any holder or later indorser of the instrument

Question 11

*Parties Who May Be Liable on an Instrument- Indorser:

Transferor-Transfer Warranties

Answer 11

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 for consideration

Warranties run to all subsequent holders if the transfer is by indorsement, but only to the immediate transferee if transfer is not by indorsement.

Question 12

*Parties Who May Be Liable on an Instrument- Indorser:

Negating transfer warranties

Answer 12

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 13

*Parties Who May Be Liable on an Instrument- Indorser:

List of Warranties

Answer 13

Transferor warrants:

• she is entitled to enforce the instrument
• all signatures are genuine or authorized
• instrument or item has not been materially altered
• no defense or claim of any party is good against her
• she has no knowledge of any insolvency proceedings that have been instituted against the maker or drawer;
• if the instrument is a “remotely created item”, creation of the instrument was authorized by the person identified as the drawer (remotely created item: created by a third party other than payor bank, under the purported authority of the drawer, for the purpose of charging the customer’s account with a bank, and does not bear a handwritten signature purporting to be the signature of the drawer)

Question 14

*Parties Who May Be Liable on an Instrument- Indorser:

Contract Liability vs. Warranty Liability

Answer 14

Transferor who transfers the instrument or item without consideration warrants nothing (so no warranty), although this does not shield her from contract liability (i.e. the obligation to pay the instrument according to its terms when the endorser signed if there is presentment, dishonor, and notice of dishonor)

• discuss both K liability and warranty liability if there is a question about indorsers

Question 15

Parties Who May Be Liable on an Instrument- Drawer

Answer 15

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)

However, if a draft is accepted by a bank, the drawer is discharged and cannot be held liable if the bank fails to pay.

If drawer signs the draft “without recourse”, she is not liable to pay in the event of dishonor, but note that checks may not be drawn without recourse

Question 16

Parties Who May Be Liable on an Instrument- Drawee

Answer 16

Drawee does not have any liability on an instrument unless and until she signs the instrument (and thus becomes an acceptor).

Thus, a holder generally cannot force a drawee to pay out on draft.

while there is no liability for on an instrument absent acceptance, a bank can incur common law tort or contract liability with regard to an instrument (e.g. if Payee calls Drawee Bank to ask whether Drawer has sufficient funds to cover a check, and Bank says there are sufficient funds when in reality there are not, Bank can be liable under promissory estoppel)

Question 17

Parties Who May Be Liable on an Instrument- Drawee

Duties of a Drawee Bank to Customer

Answer 17

when a bank is drawee (E.g. checks), the bank may be liable to its customer for failure to honor the draft, because a contractual which imposes duties on both bank and customer.

Bank is obliged to honor its customer’s check if sufficient funds are available to to cover the draft and if 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 18

Parties Who May Be Liable on an Instrument- Drawee

Duties of a Drawee Bank to Customer: Insufficient Funds and When Bank Cannot Charge the Account

Answer 18

Insufficient Funds: if the customer has insufficient funds to cover a check, the bank may pay it anyway, and the customer is liable to the bank for the overdraft.

When a Bank Cannot Charge the Account: 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 19

*Parties Who May Be Liable on an Instrument- Drawee

Duties of Customer to Bank

Answer 19

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 alteration or forgery of his signature.

Customer may answer such proof by showing that bank was negligent in paying the item (if this is the case, then the loss will be allocated between the bank and the customer in proportion to the fault of each)

Question 20

Parties Who May Be Liable on an Instrument- Drawee

Death of Customer

Answer 20

customer’s death does not revoke the bank’s authority to pay a check until the bank:

(i) knows the death; and
(ii) has a reasonable time to act on the knowledge

even with such knowledge, 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 21

Parties Who May Be Liable on an Instrument- Drawee

Subrogation

Answer 21

bank that pays check is subrogated to the rights of the person it pays against the customer.

e.g. if a bank pays an HDC, it can assume the position of an HDC in attempting to charge its customer’s account.

Question 22

*Parties Who May Be Liable on an Instrument- Drawee

Stop Payment Orders

Answer 22

written stop payment order is binding for six months and may be renewed.

*Bank must be given reasonable time to act

If 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.

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 had to pay the HDC.

Question 23

Parties Who May Be Liable on an Instrument- Drawee

Bank’s Right to Recover Payment from Party Paid

Answer 23

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 transfer warranty or a presentment warranty

Question 24

Parties Who May Be Liable on an Instrument- Acceptor

Answer 24

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. 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.

Typically called “presentment by acceptance” and may be sought at any time by any party entitled to enforce the instrument.

Question 25

Parties Who May Be Liable on an Instrument- Acceptor

Certification of a Check

Answer 25

certification is acceptance of a check by the bank on which it was drawn.

Certification discharges the drawer and all prior indorsers.

Bank does not have to certify check, absent some agreemenet with the customer, but if the bank chooses to certify, it puts its own credit on the line. As a result, the bank will charge its customer’s account immediately upon certification, rather than waiting for the check to be paid.

Failure to certify may constitute dishonor.

Question 26

Parties Who May Be Liable on an Instrument- Accommodation Parties

What is it?

Answer 26

accommodation party signs the instrument for the purposes of incurring liability on the instrument without being a direct beneficiary of the value given for the instrument

e.g. a surety

Accommodation party may sign in any capacity (e.g. maker, co-maker, indorser)

Question 27

Parties Who May Be Liable on an Instrument- Accommodation Parties

Liability

Answer 27

accommodation party is only liable in the capacity she signed and is never liable to the party being accommodated.

An HDC’s awareness of accommodation status allows the accommodation party to raise her suretyship defenses, but does not release her from her liability as maker, indorser, etc.

However, she may raise any defense available to the party accommodated, other than infancy, incapacity, or discharge in bankruptcy.

Question 28

Parties Who May Be Liable on an Instrument- Accommodation Parties

Payment

Answer 28

if an accomodation party pays the instrument, she will have an action against the party accommodated, irrespective of the parties’s formal positions on the instrument.

She is also subrogated to (i.e. acquires) the rights of the party paid- including including any rights to collateral.

Thus, impairment of collateral discharges her to the extent of the impairment.

Question 29

Parties Who May Be Liable on an Instrument- Accommodation Parties

Proof of Accommodation Status

Answer 29

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 a surety or guarantor.

To give the accommodation party the benefit of any discharge relating to her character as surety, parol evidence is generally allowed to show accommodations, except when the holder is an HDC without notice of the accommodation.

Question 30

Parties Who May Be Liable on an Instrument- Accommodation Parties

Collection Guarantee

Answer 30

a party who clearly indicates that she is only a guarantor of collection (e.g. by signing “collection guaranteed”) will be liable only if:

(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 31

Effect of Representative Agent Signing:

Answer 31

Generally, no one is liable on an instrument unless her signature or the signature of an authorized agent appears on the instrument.

Question 32

*Effect of Representative Agent Signing:

Liability of Represented Person (“Principal”)

Answer 32

if a representative (“agent”) signs her own name or the name of the principal, the principal is bound if the agent had authority to sign.

Principal may be bound even if the agent does not have authority in cases of:

(i) ratification (where 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.

Question 33

*Effect of Representative Agent Signing:

Liability of Representative (“Agent”)

Answer 33

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

Agent signs principal’s name only: if 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 appeared on the instrument.

Agent signs own name but discloses principal: if 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 is not personally liable)

• Agent signs own name but does not disclose principal’s name and/or agency relationship: if the signature does not show that 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)
• Check cases: an agent with authority who signs her name to her principal’s check is not liable if it is drawn on the principal’s account and indicates the principal’s identity.

Question 34

Effect of Unauthorized Signatures (e.g. someone signing in your name):

Answer 34

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.

Unauthorized signer therefore assumes all obligations to any party who gave value for the instrument.

However the UCC specifies 5 instances 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:

• imposter or fictitious payee
• fraudulent endorsements by employee (“trusted employee rule”)
• Negligence rule
• Bank Statement Rule
• Estoppel by certification

Question 35

Effect of Unauthorized Signatures (e.g. someone signing in your name):

Imposter or Fictitious Payee

Answer 35

carelessness of a maker or drawer in issuing an instrument may make forgery of the payee’s name more likely.

In such cases, the resulting forgery is effective to pass the right to enforce the instrument to later transferees.

Issuance to imposters: if a person pretends to be someone else (or pretends to be an agent) and induces the drawer or maker to issue an instrument, the forgery of the payee’s name (or a name substantially similar to the payee’s) will pass the right to enforce against the drawer or maker.

Issuance to Payee Not Intended to Have Interest in Instrument: if an instrument payable to a fictitious payee (i.e. someone who does not exist) or to a person whom payment was not really intended (e.g. where employee dupes employer into signing a check payable to supplier to whom no money is owed):

(i) any person in possession of the instrument is a holder; and
(ii) an indorsement in a name similar to that of the named payee is effective as an indorsement as to anyone who takes in good faith and for value

Requirement of ordinary care: persons paying or taking fictitious payee instruments must use reasonable care in doing so. Otherwise, they are liable to the extent that the failure to exercise reasonable care contributed to the loss.

Question 36

*Effect of Unauthorized Signatures (e.g. someone signing in your name):

Fraudulent Indorsements by Employees

Answer 36

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 taker or payor must use reasonable care and are liable to the extent that the failure to exercise reasonable care contributed to loss.

• only applies to indorsements, not drawer’s originating signature

Question 37

*Effect of Unauthorized Signatures (e.g. someone signing in your name):

Failure to Exercise Ordinary Care- Negligence Rule

Answer 37

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 in good faith paid for the instrument or took it for value/collection.

Negligence includes: leaving blanks or spaces on the instrument, mailing the instrument to someone with the same name as the payee, and failing to follow internal procedures designed to avoid forgeries.

A prior person’s failure to exercise due care does not relieve later parties from the same standard.

Loss may be allocated between the parties based on the share of the loss resulting from each party’s negligence.

Question 38

*Effect of Unauthorized Signatures (e.g. someone signing in your name):

bank statement rule

Answer 38

Customer’s duty to examine statement: customer must examine her own bank account, signatures, and the amount of each check.

If customer fails to promptly report a forgery or alteration, she is precluded from complaining about how the the item was not properly payable. Typically must notify the bank within one year after the bank has made the instrument available.

Repeated wrongdoer: If the statement has been available for a reasonable time, and she fails to report the forgery or alteration, the customer is estopped from demanding recredit on other items forged or altered by the same wrongdoer and subsequently paid. Typically have up to 30 days to notify bank after bank has made the instrument available for repeated wrongdoers.

If bank fails to exercise ordinary care in paying a check, the loss is allocated between the bank and the customer, but if the bank did not pay in good faith, the bank bears the entire loss.

Question 39

Effect of Unauthorized Signatures (e.g. someone signing in your name):

Estoppel by Certification

Answer 39

Because a bank has the opportunity for checking id 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 40

Effect of Alteration and Incomplete Instruments

Answer 40

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 not.

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

fraudulent alteration: 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 41

*E.g. Customer gives check to Businessperson for goods. Thief steals checks. Thief forges signature and deposits them in thief’s account at XYZ bank. XYZ Bank then presents check to ABC Bank, which paid the check and debited Customer’s account. Thief withdraws and is unknown. Who bears loss?

Answer 41

Since check is not properly payable and thief is gone, the ABC Bank bears the loss. But ABC Bank could hold XYX Bank liable under presentment warranties.

Customer can sue for wrongful payment.

Businessperson can sue for conversion.

If thief was findable, XYZ could sue thief for breach of transfer warranties.