Negotiable Instruments

Question 1

Note

Answer 1

A note is a two-party commercial paper.

It’s a written and signed promise by one party (called the maker) to pay money to another party (called the payee or bearer).

Question 2

Certificates of Deposit

Answer 2

A CD is an instrument made by a bank containing (i) an acknowledgement that a sum of money has been received by the bank, and (ii) a promise by the bank to repay the sum of money.

Question 3

Maker

Answer 3

Someone who makes a note (e.g., a check)

Question 4

Draft

Answer 4

A draft is a three party commercial paper.

It’s a written and signed instruction by one person (called the drawer) to another person (called the drawee) demanding that the drawee pay money to a third person (called the payee or bearer).

Question 5

Check

Answer 5

A check is a type of draft drawn on a bank and payable on demand.

As long as it meets these two requirements, it’s a check–regardless of what it purports to be.

Question 6

Cashier’s Check

Answer 6

A draft drawn by a bank on itself.

Question 7

Issue

Answer 7

The first delivery of an instrument by the maker or drawer for the purpose of giving rights on the instrument to any person.

The maker or drawer is the issuer.

Question 8

What are the formal requirements for a negotiable instrument?

Answer 8

A negotiable instrument must be:

(1) a written and signed
(2) unconditional
(3) promise or order to pay
(4) a fixed amount of money, with or without interest, that:
(4. a) is payable to order or to bearer at the time it is issued or first comes into possession of a holder
(4. b) is payable on demand or at a definite time
(4. c) does not state any unauthorized undertaking or instruction by the person promising or ordering payment

Question 9

Things that make an instrument non-negotiable

Answer 9

(a) If it expressly states a condition to payment
(b) If it states that the promise or order (or rights and obligations subject thereto) is subject to or governed by another writing
(c) If it calls for payment with something other than money or allows such payment in the alternative
(d) if the instrument is payable on or after a stated time or event certain to happen but uncertain as to time

Question 10

Things that do not make an instrument conditional

Answer 10

(a) reference to another writing for a statement of rights re: collateral, prepayment, or acceleration
(b) limitation on payment to a particular source or fund
(c) requirement of a countersignature as a condition of payment
(d) containing a statement required by law that the holder is subject to claims and defenses of the original payee

Question 11

Promise or Order to Pay

Answer 11

A promise is a written undertaking to pay money signed by the person undertaking to pay. A note must contain a promise to pay.

An order is a written instruction to pay money signed by the person giving the order. A draft must contain an order to pay.

Question 12

Things that need/don’t need to be fixed

Answer 12

The principal must be fixed.

The interest rate does not need to be fixed.

It can be variable or just say “with interest,” but if there’s nothing about interest written, then there can be no interest demanded.

Question 13

Payable to Order

Answer 13

A promise or order is payable to order if it is payable to the order of an identified person or to an identified person or order.

Question 14

Payable to Bearer

Answer 14

A promise or order is payable to bearer if:

(a) it states that it’s payable to bearer, to order of bearer, to order or bearer, to order and bearer, etc., indicating that the person in possession of the promise or order is entitled to payment
(b) does not state a payee
(c) states that it is payable to cash or otherwise indicates that it is not payable to an identified person

Question 15

Payable on Demand

Answer 15

An instrument is payable on demand if it states that it:

(a) is payable “on demand” or “at sight” or otherwise indicates that it is payable at the will of the holder, or
(b) does not state a time for payment

Question 16

Payable at a Definite Time

Answer 16

An instrument is payable at a definite time if it is payable:

(a) on a fixed date
(b) on elapse of a specified period of time after sight or acceptance, OR
(c) at some time readily ascertainable at the time the instrument is issued

Question 17

Acceleration Clauses

Answer 17

These are permissible and do not destroy negotiability.

Question 18

Extension at Option of Maker or

on Happening of an Event

Answer 18

These may be included on a negotiable instrument without destroying negotiability if the extension is to a further definite time stated in the instrument.

Question 19

Extension at Option of Holder

Answer 19

This type of clause is always permitted because the holder always has the option of giving extra time for payment.

Question 20

Undertakings or Instructions that May be Included

Answer 20

(1) an undertaking or power to give, maintain, or protect collateral
(2) an authorization or power to the holder to confess judgment or realize on or dispose of collateral
(3) a waiver of the benefit of any law intended for the advantage or protection of the obligor

Any other promise or undertaking will destroy negotiability.

Question 21

Enforcement of Incomplete Instruments

Answer 21

These may be enforced according to its incomplete terms or as augmented by an authorized completion.

Question 22

Holder

Answer 22

A holder is a person in possession of an instrument with a right to enforce it.

Question 23

How to Negotiate a Bearer Instrument

Answer 23

Bearer instruments are negotiated simply by transferring possession of the instrument.

Once the transferee has possession, she technically qualifies as a holder.

Question 24

How to Negotiate an Order Instrument that’s Payable to a Single Person

Answer 24

An instrument that’s payable to an identified person is negotiated by transferring possession of the instrument along with the indorsement of the identified person.

* The right to enforce an order instrument will not pass unless the payee’s indorsement is authorized and valid.

Question 25

How to Negotiate an Order Instrument that’s Payable to Multiple People

Answer 25

If the names on the payee line are connected by an “and,” the instrument is payable to the payees jointly, and any subsequent negotiation is effective only if all payees endorse the instrument.

If the names on the payee line are connected by an “or” or an “and/or,” the instrument is payable to the payees severally, and the valid endorsement of any one payee is sufficient to pass the right to enforce to a subsequent transferee.

Question 26

Special Endorsement

Answer 26

One that names a particular person as “endorsee.” That named person must sign in order for the instrument to be further negotiated.

Question 27

Blank Endorsement

Answer 27

A signature that is not accompanied by the naming of a specific endorsee.

Blank endorsements create bearer paper, which may then be negotiated by delivery alone.

Question 28

Effect of Forgery of Names NOT Necessary to the Chain of Title

Answer 28

This will not keep later takers from becoming holders.

Question 29

Forgery of Drawer’s Name

Answer 29

This does not break the chain of title, and thus subsequent transferees may qualify as holders.

The forgery operates as the genuine signature of the forger.

Question 30

Without Recourse

Answer 30

An endorsement that adds the words “without recourse” is a qualified endorsement.

The effect is to limit the legal liability otherwise imposed on endorsers.

Question 31

Anomalous Endorsement

Answer 31

An endorsement made by a person who is not a holder of the instrument.

This is usually done for the purpose of accommodation.

It doesn’t affect the manner in which the instrument may be negotiated, but it does make the signer liable on the instrument.

Question 32

Requirements for Becoming a Holder in Due Course

Answer 32

1. Be a holder
2. Take the instrument for value
3. Take the instrument in good faith
4. Take the instrument without notice
   (a) that it’s overdue or has been dishonored;
   (b) it contains an unauthorized signature;
   (c) there’s a claim to it; or
   (d) any party has a defense or claim in recoupment

Question 33

Sufficiency of Value

Answer 33

Value given in exchange for commercial paper doesn’t need to be equivalent to the face amount of the instrument.

As long as the full price agreed upon is given, full value has been paid.

Question 34

Good Faith

Def. for HDC

Answer 34

“Honesty in fact and the observance of reasonable commercial standards of fair dealing.”

Question 35

Time at which HDC Status is Determined

Answer 35

Whether a holder qualifies as an HDC is an ssue determiend at the moment the instrument is negotiated to the holder and she gives value therefor, whichever occurs later.

Question 36

Shelter Rule

Answer 36

The transferee acquires whatever rights her transferor had. The transferee is said to take shelter in the status of her transferor.

This rule allows any transferee to step into the shoes of the HDC who formerly held the instrument and to obtain the rights of an HDC, even though she otherwise clearly fails to meet the requirements of due course holding.

Question 37

Claim

Answer 37

A claim is an affirmative right to a negotiable instrument because of superior ownership.

Question 38

Real Defenses

Answer 38

These can be asserted against both HDC and non-HDC transferees:

(i) forgery
(ii) fraud in the factum
(iii) alteration of instrument
(iv) infancy
(v) incapacity to contract, other than infancy
(vi) illegality
(vii) duress
(viii) discharge in insolvency proceedings
(ix) prescription
(x) discharges known to HDC

Question 39

Persons Entitled to Enforce an Instrument

Answer 39

(1) A holder of the instrument,
(2) A nonholder in possession of the instrument who has the rights of a holder, and
(3) A person not in possession of the instrument but who is entitled to enforce it

Question 40

If instrument is lost, stolen, or destroyed

Answer 40

The holder is entitled to maintain an action on the instrument as though she could produce it, providing she can prove her ownership, the terms of the instrument, and the facts that prevent her from producing it.

The court in such a case is entitled to require protection indemnifying the defendant against loss by reason of additional claims on the instrument.

Question 41

Presentment

Answer 41

A demand for payment made by a person entitled to enforce an instrument.

Question 42

Acceptance

Answer 42

A process whereby the acceptor (usually a drawee bank) signs a draft and thereby becomes primarily bound to pay the instrument.

Question 43

Dishonor

Answer 43

Occurs when the maker of a note or the drawee of a draft does not pay or accept the instrument wihtin the allowed time after presentment.

Question 44

Transfer Warranties

Answer 44

Whenever a person transfer an instrument or a customer or collecting bank transfer an item for consideration, the transferor makes five transfer warranties:

(1) That she is a person entitled to enforce the instrument or item
(2) That the signatures are authentic and authorized
(3) That the instrument or item has not been altered
(4) That no defense of any party is good against her
(5) That she has no knowledge of any insolvency proceedings that have been instituted against the maker, acceptor, or drawer of an unaccepted instrument

Question 45

Who is obligated to pay when a draft is dishonored?

Answer 45

The drawer of the draft.

Like an endorser, a drawer has secondary liability.

Question 46

Accommodation Party

Answer 46

One who signs an instrument for the purpose of lending her name and credit to another party to the instrument and who does not directly benefit from the value given.

She’s essentially a surety.

Question 47

When Bank Cannot Charge the Account

Answer 47

(1) If there’s no order by the depositor (forged signature of drawer)
(2) For more money than the original order (alteration of amount by third party)
(3) If the bank pays the wrong person (forgery of payee or endorsee’s signature)
(4) If the item is postdated, the customer gives the bank notice of the postdating, and the bank pays the item before the stated date.

If a bank pays a check in violation of these principles, the customer is entitled to a re-credit on her account.

Question 48

Impostor

Answer 48

One who pretends to be someone else

Question 49

What constitutes negligence?

Answer 49

• Leaving blanks or spaces on the instrument
• Mailing an instrument to a person having the same name as the payee
• Failing to follow internal procedures designed to avoid forgeries

Question 50

Bank Statement Rule

Answer 50

Failure to examine statements is a form of negligence that can preclude the defenses of forgery and alteration.

(a) Customer must promptly use reasonable care in examining the statements for two things: an unauthorized signing of the customer’s own name as drawer, and any alteration of an item.
(b) If the customer fails to promptly report a forgery or alteration, she is precluded from complaining to the bank that the item in question was not properly payable.
(c) If bank was also negligent, the loss is allocated between the bank and the customer according to the extent that each contributed to the loss.

Question 51

Effect of Nonfraudulent Alterations

Answer 51

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

Question 52

Effect of Fraudulent Alterations

Answer 52

A fraudulent alteration has the effect of discharging every party obligated on the instrument unless the party assents to or is precluded from asserting the alteration.

Question 53

Recovery for Instruments Mistakenly Paid or Accepted

Answer 53

The general rule is that payment of a negotiable instrument to an HDC or one who in good faith changed her position in reliance on the payment is final.

Two exceptions:

(1) If the party paid neither took for value nor in good faith, nor detrimentally relied on the payment, or
(2) If the party paid breached a transfer warranty or a presentment warranty.

Question 54

Presentment Warranties on Unaccepted Drafts

Answer 54

1. That the warrantor is a person entitled to enforce the draft or is authorized to act on behalf of one who is entitled to enforce.
2. That the instrument is not altered.
3. That the warrantor has no knowledge that the drawer’s signature is unauthorized.

Question 55

Who makes presentment warranties?

Answer 55

• Any person who obtains payment or acceptance, and
• Any prior transferor

Question 56

To whom are presentment warranties made?

Answer 56

To any person who in GF pays or accepts

Question 57

Discharge by Delay in Presentment of a Check

Answer 57

If a check is not presented for payment or given to a depositary bank within 30 after the date of endorsement, the endorser 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 b/c of the delay the drawer is deprived of funds with which to pay the obligation, the drawer is discharged to the extent of the loss caused by the delay if he assigns his drawer’s rights agaisnt the drawee to the party entitled to enforce the check.

Question 58

If notice of dishonor is required but not given…

Answer 58

the endorser is discharged from his endorsement obligation.