MBE commercial paper (negotiable instruments) Flashcards
intro
The instrument’s holder wants to be paid.
The person obligated to pay doesn’t want to pay.
The person who ultimately pays the instrument will want to recover from someon else
approach
* Determine if the instrument is a negotiable instrument.
* Determine whether the instrument was properly negotiated
* Determine whether the instrument’s holder is a holder in due course
* Determine whether the individual who is obligated to pay has any defenses against payment
* Determine whether those defenses are real or personal defenses
* Can the one who paid the instrument hold anyone else responsible?
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types of commercial paper and the parties involved
Two types: note and draft
(1) the note is a two party instrument
promise to pay
* A note is characterized by a promise to pay.
parties
* Maker – the person making the promise to pay
* payee: the person to whom the instrument is payable
Certificate of Deposit (a type of note)
* A draft is an order to pay
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(2) the draft is a three-party instrument (like a check)
order to pay
a draft is an order to pay
parties
* The drawer – the person ordering payment
* The drawee – the person being ordered to pay
* The payee – the person to whom the instrument is payable
*check (a type of draft)
1) requirements
* the bank is the draww and
* the instrument is payable on demand
2) types of checks
* ordinary check
* traveler’s check (draft form which must be countersigned by person whose “specimen signature” appears on the traveler’s check
* cashier’s check (drawer and drawee are the same bank)
* teller’s check (check drawn by one bank on another bank)
3) contradictory terms
If an instrument contains contradictory terms:
* handwritten terms prevail over both typewritten and printed terms.
* Typewritten terms prevail over printed terms.
* words prevail over numbers.
formal requirements of negotiability
First question: Is the writing a negotiable instrument (NI)? if not, article 3 will not apply
Formal Requirements of “Negotiability”
(1) part 1
* The document must be in writing and signed by the maker or drawer.
* The promise or order to pay must be unconditional
* The payment obligation must be for a fixed amount of money.
(2) part 2
* the writing must be payable to order
* The writing must be payable on demand or at a definite time.
* The writing must obligate the payor to do one thing, which is to pay money, and nothing else (i.e., no additional undertakings or instructions).
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Writing and Signed
* Writing: A negotiable instrument may not be oral.
* KEY – the NI must be reduced to tangible form
* Signed” includes using any symbol executed or adopted with the present intention to adopt or accept a writing
Examples of acceptable signature forms:
* Traditional signature
* Printed
* Stamped
* Written
* Thumbprint
* Trade or business name
* Computer generated
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The Promise or Order to Pay Must be Unconditional
The promise or order to pay must be unconditional.
Typical scenarios that make the promise or order conditional:
* Express conditions to payments
* Subject to another writing
Items that do not make the promise or order to pay conditional
* References to other documents
Mere references to other documents do not make the promise or order to pay conditional.
* A provision that payment must be from an identified fund does not render the promise conditional.
Countersignature
* The requirement of a countersignature, as in a traveler’s check, does not render an instrument non-negotiable.
Prepayments and collateral
* References to other records regarding rights as to collateral, prepayment, or acceleration do not make the promise to pay conditional.
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The principal amount due on the instrument must be a fixed amount of money.
Interest can be variable
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remember!!
- The document must be in tangible form.
- The document can be signed a number of ways as long as the signer’s intent was to legally be bound
- Payable at a definite time
- Mere reference to information does not make the promise to pay conditional.
- The writing must be payable to order or bearer
- The writing must be payable on demand or at a definite time
- The writing must obligate the payor to do one thing, which is to pay money and nothing else (no
additional undertakings or instructions).
formal requirements for negotiability: payable to order or to bearer
A negotiable instrument must be either an order or a bearer instrument.
Order instrument – payable to a specific person
Bearer instrument – generally, anyone in possession has legal rights to the instrument
order instrument
An instrument payable to a specific person requires specific language or words of negotiability. The key phrases are either “pay to the order of” or “pay [Paul] or his order.”
bearer instrument
Any instrument that does not attempt to pay a specific person
* Payable to bearer
* Payable to the order of bearer
* Payable to cash
* Payable to [the payee line left blank]
payable to both bearer and order
If a writing has characteristics of both an order instrument and a bearer instrument, then the writing will be treated as bearer paper
Checks are the exception to the “words of negotiability” requirement
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.
formal requirements: payable on demand or at a definite time
The 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.
payable on demand
Checks (drafts) are typically payable on demand.
At a definite time
notes are typically payable at a definite time.
Acceleration and extension clauses
The instrument cannot contain a provision that permits the obligor to extend the payment date at his discretion without any restriction.
* The instrument can contain provisions allowing for the obligor (the one obligated to pay) to extend the due date, provided the extension is to a definite time
Payment date must be readily ascertainable.
* When you look at the instrument, you should be able to readily ascertain when the payment must occur.
No additional undertakings or instructions
The writing must commit the obligor to one legal obligation and nothing else: The obligation to pay money
additional undertaking
* Exceptions – additional undertakings that are allowed:
* Promises or orders concerning collateral
* Provisions that allow holder to procure
formal requirements: key things to remember
The document must be in writing and signed
The promise or order to pay must be unconditional.
the principal amount must be fixed, but the interest rate can be
variable.
Payable to order or bearer (remember “words of negotiability” for order paper).
The writing must be payable on demand or at a definite time (payment time must be readily ascertainable).
No additional undertakings (i.e., the obligor’s sole obligation is to pay money)
acquiring holder status
BASIC IDEA – The person who takes the instrument via negotiation will want to acquire status as a holder in due course because this status gives him legal rights that are superior to those of a mere holder.
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taking the instrument as a holder
A person can become a holder in two ways: issuance or negotiation
issuance
* maker/drawer—> payee
* Issuance – the first delivery of an instrument
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negotiation
A transfer of possession, whether voluntary or involuntary, by a person other than the issuer to a person who becomes the holder
To negotiate a bearer instrument – Requires transfer of possession only
To negotiate an order instrument – Requires transfer of possession PLUS a proper endorsement of the instrument before transfer.
* Special indorsement
* Blank indorsement: Indorsement not made to a specific person
* Qualified indorsement: Used to limit one’s liability on an instrument
* Restrictive indorsement: Used to limit what the holder can do with the instrument
* Anomalous indorsement: Used by accommodation parties
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multiple payees
payable jointly – Requires all payees to indorse for a valid negotiation
Payable severally – Either party can sign the instrument for a valid negotiation.
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summary
Negotiating a bearer instrument requires transfer of possession only.
Negotiating an order instrument requires transfer of possession
PLUS a proper endorsement
acquiring status as a holder in due course
Must first acquire status as a holder
Must pay value for the instrument
Must take the instrument in good faith and
without notice that there are any problems that might affect the
obligor’s obligation to pay the instrument
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value
The person must give something of value, do something of value, or forgive something of value.
* A gift is not value.
* Unexecuted promises to perform are not value.
* Paying less than the note’s full face value is okay
* Partial performance = partial HDC rights
* Forgiving a preexisting obligation constitutes value.
Value in the context of a bank
* Banks give value to the extent deposited money is withdrawn.
* Amounts are withdrawn using the “first-in, first-out” method (FIFO).
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Taking the Instrument in Good Faith (two-part assessment)
Honesty-in-fact: What the person receiving the instrument actually knew; AND
The 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.
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taking the instrument without notice
Cannot acquire status as a HDC if the holder is aware of any reason as to why the legal obligation to pay the note may be compromised.
notice:
* Receives notice through the mail
* Has reason to know there may be a problem
infirmity:
* holder has any notice of defect
* Holder has notice of forged, altered, or otherwise irregular instrument
* Holder has notice the instrument is overdue
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.
* If the due date is accelerated, then the note is overdue the day after the accelerated due date.
* When payments are due in installments, the instrument is overdue the day after the installment due date.
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special limits on HCD status
In some instances, a person’s ability to claim status as a HDC will be limited.
Consumer Notes
* Context: The Federal Trade Commission (FTC) regulations protect consumers in certain transactions that otherwise involve the use of a negotiable instrument (NI) 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 language allows the debtor to assert claims and defenses against the instrument’s holder, even if that person is a HDC.
THIS NOTICE IS REQUIRED WHEN THREE CRITERIA ARE MET:
* The Maker/Drawer is signing the note in a consumer transaction (i.e., acquiring an item for personal or family use).
* The transaction in question must be for the sale or lease of goods or services (e.g., buying a car or boat).
* The seller must be one who sells the item in question in his ordinary course of business
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key things to remember
value: Requires the holder to give, do, or forgive something of value
Regarding the good faith requirement – if the facts make you say, “hmmm, something’s not right here,” then you may have a good faith issue and the holders in your fact pattern may have trouble claiming HDC status, which you should address.
transfer for instrument
transfer of instrument
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 movements prior to the payment are transfers.
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shelter rule
The rights follow the instrument.
Shelter rule: Whatever rights the transferor had transfer to the transferee.
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right to transferor’s indorsement
When a transferee pays value for an instrument and the transferor fails to provide a necessary indorsement, the transferee has the legal right to have the transferor provide the necessary indorsement to complete the negotiation.
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Exception to the shelter rule
A transferee who commits fraud or otherwise engages in some type of illegal a as it relates to the instrument cannot acquire rights as a holder in due course.
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Key Things to Remember
* Transfers occur after the initial issuance.
* When transfers occur in the fact pattern, be sure to take note of the transferor’s status.
* Is the transferor a holder in due course or a mere holder?
* The transferor’s rights will transfer under the Shelter Rule.
transfer warranties
Basic idea: Transfer warranties are often the remedy provided when money is paid to an unauthorized party (e.g., a thief).
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transfer warranties
Warranties that a transfer makes to a transferee. Warranties include:
* The warrantor is a person entitled to enforce the instrument
* All signatures on the instrument are authentic and authorized
* The instrument has not been altered
* There are no defenses or claims that can be asserted against the transferor;
* Warrantor has no knowledge of any insolvency proceedings;
* With respect to any remotely-created consumer 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.
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key things to remember
When the fact pattern involves a thief, you should consider the transfer and presentment warranties.
Identify the context of the fact pattern – you must properly identify which warranties were breached.
enforcement of an instrument
prima facie case
Plaintiff seeking enforcement must prove:
* That plaintiff is a person entitled to enforce the instrument; and
* That the signatures on the instrument are valid.
Who is a “person entitled to enforce?”
* a holder
* A non-holder in possession of the instrument who has the rights
of a holder; or
A person not in possession but who has the right to enforce
(e.g., the instrument has been lost or stolen)
Validity of signatures – Signatures are accepted as authentic unless specifically denied in the pleadings. The party claiming validity generally has the burden of proving that the signatures are valid.
Defenses – Once the plaintiff establishes the prima facie case, defendant can then assert any real or personal defenses at his disposal. If plaintiff is a HDC, plaintiff can re-establish the right to payment if the only defenses proffered are personal defenses.
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Lost, Destroyed, or Stolen Instrument
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 lost or destroyed
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conversion
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.
* The measure of liability is generally the amount payable on the instrument
things to watch out for
* issuers and acceptors can bring an action for ocnversion
* payees and indorsees who did not receive delivery of the instrument may not bring conversion actions.
defenses- real defenses
real defenses
Infancy – can assert this defense in states where contracts with minors are either void or voidable
Incapacity – state law must render contract with these parties void (not voidable).
Duress – a matter of degree
* Extreme duress versus mere threat of something bad happening
* State law must make contracts made under duress is void
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
fraud
* Fraud in the factum = real defense (can be asserted against HDC)
* Fraud in the inducement = Personal defense (cannot be asserted against HDC)
- Fraud in the factum = (1) Signer is not aware that he is signing a negotiable instrument AND (2) he must not have had a reasonable opportunity to become aware.
- Fraud in the inducement = Signer is aware that he is signing a negotiable instrument but signer is induced into signing based on misrepresentation
(can defend against HDC enforcement)
Discharge of insolvency proceedings (bankruptcy) – If an obligor has had his debts discharged through bankruptcy proceedings, that discharge is a real defense
Alteration and 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.
Statute of limitations
drafts
* For drafts (e.g., bank checks) – 3 years from date of dishonor OR 10 years from the date of the draft, whichever is earlier
* For certified, teller’s, cashier’s, or traveler’s checks – If presenting, 3 years after demand for payment
notes
* For notes payable at a definite time, the action must be brought within 6 years of the note’s due date.
* For notes payable on demand, the action must be brought within 6 years after demand for payment
impossibility
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key things to remember
Real defenses can be asserted against a HDC.
Personal defenses cannot
defenses- personal defenses
personal defenses
Personal defenses are effective only against those who have holder status.
Personal defenses are ineffective against those who have HDC status.
(1) issuance
(2) contract defenses
* Same type of defenses asserted under contract law – breach of contract, failure of consideration, breach of warranty
* Only can be asserted against a holder (not a HDC)
(3) claims in recoupment
* An offset against an amount owed on an instrument
* Claims in recoupment must arise from the transaction that gave rise to the instrument
* Defenses and claims in recoupment of other persons (The obligor may only assert his own recoupment claim; not the claims of others)
* A non-HDC takes an instrument subject to all valid claims of a property or possessory interest in the instrument.
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key things to remember
* Does the obligor have any defenses?
* Real or personal defenses?
* Is the holder a HDC or merely a holder?
unauthorized signatures and imposters
Instruments Issued to Impostors (the Drawer Gets Duped)
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.
Context: Generally, this scenario is invoked when either a drawer or a maker (but usually a drawer) 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.
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Instruments Payable to Fictitious or Unintended Payees (When Good Employees Go Bad)
If a person whose intent determines to whom an instrument is payable and that person:
* Does not intend for the payee to have any interest in the instrument; or
* The payee is fictitious;
* Then 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.
Context: Generally, this scenario is invoked in the corporate context when a treasurer (or someone who has check-writing privileges) 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. Here again, the corporation bears the loss as it is in the best position to prevent these acts from happening.
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Employer’s Liability for Employee’s Fraudulent Indorsement
Context: An employee entrusted with check-writing privileges forges indorsements. The employee misplaces that trust by forging indorsements. The employer will bear the responsibility for the loss.
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benefitted parties
The alteration of a negotiable instrument (e.g., the unauthorized addition of words and numbers to the instrument) discharges the obligation of a party whose obligation is affected by the alteration. However, a party whose negligence substantially contributes to the alteration cannot assert the alteration as a defense against a holder in due course.
Context: These are the parties who take the instruments mentioned in items A–C above. These parties are usually banks or good faith purchasers for value. If these parties fail to exercise ordinary care in taking the 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 substantially contributed to the loss.
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key things to remember
Context-driven facts
Watch for instances when the issuer is duped by an imposter.
When good employees go bad: The law will hold responsible the one who was in the best position to prevent the event from happening.
alterations and incomplete instruments
alterations
The unauthorized modification of an instrument
* Includes both words and numbers
Legal effect of altered instrument: Obligor is discharged on the instrument
* A payor bank or drawee who pays a fraudulently altered instrument may enforce rights with respect to the instrument according to its original terms before alteration.
* Likewise, a HDC may enforce rights with respect to the instrument according to its original terms before the alteration
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incomplete instruments
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.
Incomplete instruments are enforceable
Context: Maker makes an instrument but leaves key information blank (e.g., payee) intending to complete the information later.
Authorized completions are enforceable
Unauthorized completions – the obligor is discharged on the instrument, but a payor bank or a holder in due course can enforce the instrument as completed.
presentment warranties
presentment
General idea: A demand for payment made to a maker or drawee by the person entitled to
enforce the instrument.
* Presentment and dishonor serve as preconditions for liability for other parties who have potential liability on the instrument.
Presentment is excused when:
* The presenter cannot locate the one liable to whom presentment must be made;
* The maker or the acceptor has repudiated the obligation to pay;
* The instrument’s terms do not require presentment;
* The drawer or indorser has waived the presentment requirement;
* The drawer has instructed drawee not to pay
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presentment warranties
Context: 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 “upstreat” those through whose hands the check has passed for breach of one of the warranties.
Presentment warranties: When a “person” presents an item for payment, the presentment comes with all of the following warranties:
* The warrantor is a person entitled to enforce the instrument (a warrant that there are no unauthorized or missing indorsements);
* The draft has not been altered
* The warrantor has no knowledge that the drawer’s signature is
forged;
* 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
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key things to remember
presentment warranties are made to the drawee (in most cases the drawee will be a bank).
Be sure to distinguish the presentment warranties from the transfer warranties.
parties to the instrument and their potential laibility
approach:
* Determine in what capacity the person signed.
* Determine the type of liability the person has incurred on the
instrument.
* Understand when and under what circumstances that person’s liability on the instrument will
ripen.
maker’s liability (makers make notes)
Maker has primary liability, which means the makes must pay the instrument when it comes due
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drawer’s liability (“drawers draw drafts)
Drawer has secondary liability. The drawer’s obligation to pay ripens only upon presentment and dishonor.
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drawee’s liability
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.
(1) properly payable rule
The bank is obligated to honor a check that is properly payable.
* The customer has sufficient funds in his account, and
* Has authorized payment.
If a check has an alteration, the bank may charge the customer’s account for the amount authorized, not for the altered amount.
Post-dated checks
* A bank may properly pay a post-dated check unless the customer gives bank timely
notice of the post-dated check.
(2) Wrongful Dishonor
A customer can sue for damages that are proximately caused by the wrongful dishonor.
The customer has a duty to inspect the bank statement and they must exercise reasonable care to discover unauthorized payments resulting from a forged signature or forged alteration.
(3) Stop Payment
Oral stop payment is valid for 14 days, written stop payment is valid for six months.
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Acceptor’s Liability
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.
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indorser’s liability
By indorsing an instrument, you agree to pay the instrument in the event that 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 dishonor.
NOTE:
An indorser’s liability as an indorser of the check is discharged if more than 30 days have passed since the indorsement.
An indorser is not liable unless the indorser receives notice of the dishonor (except when waived) within 30 days after the person seeking to hold the indorser liable himself received notice of the dishonor.
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liability of joint signers
Joint signers of an instrument have joint and several liability, meaning either one or both may be sued for the entire amount
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key things to remember
A party is only liable on an instrument when the party signs the instrument.
A party is liable in the capacity in which the party signs.
accomodation parties
basic idea
Maker wants to borrow money but has bad credit.
Lender won’t lend because of Maker’s bad credit.
Maker gets an accommodation party to act as a gurantor
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key aspects
The accommodation party must sign the instrument
The accommodation party must NOT be a direct beneficiary of the
value given for the instrument.
The accommodation party’s liability on the instrument depends on the
capacity in which they sign.
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Legal Rights of an Accommodation Party
Accommodation parties are entitled to:
* reimbursement from the maker (full repayment);
* contribution from co-accommodation parties; and
* The same defenses against payment that an accommodated party would have.
Accommodation parties are not liable to accommodated parties that paid the instrument.
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key things to remember
The two key things for accommodation party status:
1. The party signs the instrument for the purpose of incurring liability on the instrument.
2. The party must not be a direct beneficiary of the value given for the instrument.
