Negotiable Instruments Flashcards
a note is
a two party instrument in which one party, the maker, promises to pay the payee (the second party) a sum of money
Is a writing that simply recognizes a debt a note?
No. Note must promise to pay; merely recognizing a debt is not enough
a draft is
a three party instrument in which one party, the drawer, orders a second party, the drawee, to pay a sum of money to a third party, the payee.
Is a draft a promise to pay?
No. It is an order to pay.
A cashier’s check is
when the drawer and the drawee are the same bank
a teller’s check is
when the drawer and drawee are two different banks
To be negotiable, an instrument must
- be a signed writing,
- contain an unconditional promise or order,
- pay a fixed amount of money
- be payable to order or to bearer
- be payable on demand or at a definite time
the signed writing element of a negotiable intsrument
the signature can be made manually, mechanically, or by any use of a name mark or symbol
Who is liable when the signature on the instrument is a forgery?
it constitutes the signature of the forger as though he signed in his own name
If a promise or order contains a statement, required by law, that the rights of a holder or transferee are subject to claims or defenses that the issuer could assert against the original payee:
such statement does not make the promise or order conditional
NOTE: In this case, however, there can be NO holder in due course.
can a negotiable instrument be for payment of anything other than money?
No. The instrument must be payable in money, and only money, and the amount due must be ascertainable from the instrument.
An instrument is payable to order if:
it identifies a person
If an instrument is made payable to two or more persons jointly
need both people to sign it for it to be negotiable
An instrument that is payable only upon the happening of an event:
only negotiable IF the happening of the event is certain and the date is also certain (so, 90 days after Christmas 2016 is fine, but 90 days after my death is not ok)
May an instrument place a charge on the bearer?
No. With three exceptions:
- an undertaking or power to maintain or protect collateral to secure payment
- an authorization or power to confess judgment
- a promise or provision waiving any law intended to protect the obligee.
If a transferor purports to transfer less than the entire instrument, negotiation of the instrument does not occur. The transferee
there obtains only the rights of a partial assignee
a blank endorsement
is simply the signature of the transferor written on the back of the instrument (no mention of to whom the thing is being transferred)
Thus, the instrument becomes bearer paper
a special endorcement
the signature of the transferor that also names the transferee and directs payment to him
When an order instrument is transferred by delivery without an endorcement
(forgot to sign) the transferee has a specifically enforceable right to the unqualified endorsement of the transferor, but there’s generally no negotiation until then (can get injunctive relief)
An anomalous endorsement is
one made by a person other than the holder; such an endorsement is extraneous to the chain of title, and it has no effect on the manner in which the instrument must be negotiated (e.g., rich uncle lou doesn’t have to sign the back to endorse it)
An endorsement limiting payment to a particular person or otherwise prohibiting further transfer or negotiation of the instrument
will not prevent further transfer or negotiation of the instrument
When the name stated on the instrument is different from the name of the holder, he may indorse the instrument either as his name is stated on the instrument or as it really is.
both names may be required by the person paying, or taking the instrument for value or collection
If a minor or other incapacitated person negotiates an instrument, it is effective to transfer the instrument notwithstanding the incapacity. The minor may still rescind in an appropriate case, but:
cannot rescind as to a subsequent holder in due course
If the person identified as the payee is not intended to have any interest in the instrument, or is a fictitious person
an endorsement of an instrument by any person in the name of the payee is effective as the endorsement of the payee in favor of the person who in good faith pays the instrument or takes it for value for collection
EXAMPLE: An employee regularly draws a check payable to “John Smith or order,” representing to his employer that a business debt is owed to Smith. The employee then “forges” the name of John Smith as an indorsement and transfers the check to X. If the regular rules of forged indorsements applied, X would not be a holder in due course because a necessary indorsement was forged. However, under § 3-404(b), the indorsement is effective even though it was forged.
EXAMPLE: Assume that the employee who wants to cheat his employer makes up the checks but does not have the authority to sign them; instead, he has to have the employer (or another employee) actually sign. In such a case, even if the one actually signing has the intent that the named payee take an interest in the instrument, anyone can indorse [§ 3-405].
When a person impersonates the payee and induces the drawer or maker to issue an instrument to the impostor payable to the name of the impersonated person, an indorsement by anyone in the name of the payee
is effective in favor of a person who in good faith pays the instrument or takes it for value or for collection.
EXAMPLE: Larry’s Lawn Service does landscaping work regularly for Company, and is owed $5,000 per month. One day, John decides to impersonate Larry and enters the Company requesting the monthly check. John is an imposter. John is successful and Company issues him a check. The loss is put on the Company, the check will be enforceable and John’s forgery of Larry’s name on the check will not break the chain of title if the check is later negotiated to an innocent third party.
A holder in due course is
a holder who is the good faith purchaser of the instrument
A holder in due course is a holder of a negotiable instrument who takes the instrument
- for value
- in good faith
- without notice that it is overdue or has been dishonored
- without notice of an unauthorized signature or alteration
- without notice of any defense against or claim to it on the part of any person
Value is given for the instrument when the instrument is issued or transferred:
- for a promise or performance, to the extent that the promise has been performed
- as payment of or security for an existing claim against a person whether or not payment is due
Three situations in which someone who typically would be a holder in due course will not acquire holder in due course rights
- when the instrument was obtained by legal process or by an execution, bankruptcy, or creditor sale
- by purchase of a bulk transaction that’s not a part of the transferor’s ordinary course of business
- as the successor in interest to an estate or an organization
A transferee of an instrument obtains any right of the transferor to enforce it, including any right as a holder in due course, except that a transferee who engaged in:
fraud or illegality affecting the instrument. Essentially, you cannot lauder your own bad acts.
A type of non-holder who may enforce an instrument is a person, who is not in possession of an instrument, enforcing a lost or stolen instrument. Such person is entitled to enforce the instrument if:
- the person was in possession of the instrument and entitled to enforce it when s/he lost possession
- the loss of possession was not the result of a voluntary transfer to a third party or lawful seizure
- the person cannot reasonably obtain possession of the instrument because it was destroyed; its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person, a person who cannot be found, or someone not amenable to service of process.
If a representative signs her name to an instrument, and it is an authorized signature of the represented person, then the representative will be held liable on the instrument to a third party holding it in due course unless:
the form of the signature unambiguously shows that it is made in a representative capacity and clearly identifies the represented person
If the issuer signed an incomplete instrument
he is obligated to pay the instrument according to its terms when completed (signed a blank check, must pay it after someone else fills it out; punishment for your negligence)
The liability of a drawer
that of secondary liability—they will only be liable where the bank refuses to pay the debt at presentment
EXAMPLE: Paul goes to Wayne’s bank, but the bank refuses to pay the amount of the check, informing Paul that Wayne’s account has been empty for months. The check is then dishonored by the bank. Paul goes to Wayne to collect the money, informing him that the check has been dishonored. This triggers Wayne’s secondary liability on the check.
Initially, the drawee on a draft has no liability to the payee or a subsequent holder. Only if the bank/drawee
chooses to accept the draft or certify the check do they become primarily liable
A bank’s authority to accept or pay a check is not rendered ineffective by interdiction (incompetence) of the customer/drawer existing at the time the item is issued or its collection is undertaken
if the bank has not yet received written notice of an adjudication of interdiction
Neither death nor interdiction of a banking customer revokes the bank’s authority to accept, pay, collect, or account until:
receipt of written notice addressed to the bank notifying it of the person’s interdiction AND the bank’s reasonable opportunity to act on it
Even following the receipt of written notice of a custimer’s interdiction, a bank may, for 10 days after the date of death, pay or certify checks drawn on or before that date
unless ordered to stop payment by a person claiming an interest in the account
A customer may stop payment of any item drawn on the customer’s account or close the account by
an order to the bank describing the item or account with reasonable certainty received at a time and in a manner that affords the bank a reasonable opportunity to act on it before any action by the bank with respect to the item.
An oral stop-payment order
lapses after 14 days if not confirmed in writing
A written stop-payment order is effective
for 6 months and may be renewed in writing for successive 6 month periods
The transferor of a negotiable instrument who receives consideration warrants to his immediate transferee (and all subsequent transferees if transfer is by endorsement) that
- the transferor is entitled to enforce the instrument
- all signatures are authentic and authorized
- the instrument has not been altered
- the instrument is not subject to a defense or claim in recoupment of any party against the transferor
- the transferor has no knowledge of any insolvency proceedings commenced with respect to the maker, acceptor, or drawer of an unaccepted draft
An endorser
is secondarily liable if the make or the bank doesn’t pay
An endorser may disclaim
liability on an endorsement by making a qualified endorsement
e.g., writing “without recourse”
An accommodation party (or a surety) is one who signs commercial paper that is issued for value
simply to lend his credit and is liable in whatever capacity s/he signed
EXAMPLE: Matt Maker wants to borrow money from Paul Payee and signs a promissory note to Paul Payee for $10,000. Paul, knowing Matt’s financial troubles, would feel safer if Matt’s wealthy Uncle Lou was involved in this deal. This can be done by having Uncle Lou signing on the back of the note as an indorser. He would be an accommodation indorser. He could also sign on the front of the note, and would then become an accommodation maker. Lou would be liable in whatever capacity he signed—if as an accommodation maker, he would be primarily liable; if as an accommodation indorser, he would be secondarily liable.
If a party signs the instrument along with words indicating unambiguously that the party is guaranteeing collection rather than payment of the obligation, the signer is obliged to pay the amount due only if
- execution of judgment against the other party has been returned unsatisfied
- the other party is insolvent or in insolvency proceedings
- the other party is not amenable to service of process
- it is otherwise apparent that payment cannot be obtained from the other party
Presentment must be made
on or after the date stated in the instrument or within a reasonable time
When the instrument is presented, the party to whom the presentment is made has the right to require
- that the instrument be exhibited
- identification of the party presenting
- a signed receipt on the instrument or surrender upon full payment
Presentment can be waived or excused if
a party cannot be found with due diligence, the maker has repudiated, or presentment is not required or waived
The person who presents and obtains payment on a draft warrants to the drawee that
- the warrentor is, or up on the time of transfer, entitled to enforce the draft
- the draft has not been altered
- has no knowledge that the signature of the drawer of the draft is unauthorized
Dishonor occurs when a proper presentment for payment is made and payment is refused. A dishonor does not occur when payment is refused because the instrument lacks a necessary indorsement
to all relevant parties once the instrument has been dishonored
A check that is duly presented for payment to the payor (drawee) bank other than for immediate payment over the counter (e.g., for deposit) is dishonored if the payor bank
- makes timely return of the check
a. The check must be returned before the bank has made final payment and before - send timely notice of dishonor or nonpayment a. This notice must also be sent before the bank has made final payment and before the midnight deadline.
- if it fails to take any action by the midnight deadline
a. A payor bank generally becomes accountable for a check if it fails to timely take any action, either giving provisional credit for the item, paying it, or returning it.
A payor bank wrongfully dishonors an item if the item is properly payable (i.e., funds are available), unless:
it would create an overdraft (unless it has agreed to pay the overdraft)
However, a bank is under no obligation to a customer having a checking account to pay a check, other than a certified check, which is presented more than
6 months after its date, but it may charge its customer’s account for a payment made in good faith after its date
A payor bank may intentionally or unintentionally pay an item for which the customer has insufficient funds in his account. The result is an overdraft for which
the customer is obligated to reimburse the bank, unless the customer neither signed the item not benefitted from the proceeds of it
A bank is not free to dishonor all of a number of checks that are presented in one day because the total would create an overdraft. The bank must pay to the extent that it can
but it may pay in any order convenient to the bank
The burden is initially on plaintiff. The authenticity of and authority to make each signature on an instrument is admitted:
unless specifically denied in the pleadings
If the validity of signatures is admitted or proved and the plaintiff proves that he is entitled to seek enforcement of the instrument
the burden shifts to the defendant to prove the defense or claim in recoupment
If a defense or claim in recoupment to the obligation sued upon is proved, the burden shifts to the plaintiff to establish:
holder in due course status
A claim in recoupment is a claim of the obligor
against the original payee of an instrument, if the claim arose from a transaction that gave rise to the instrument
EXAMPLE: Recall the earlier hypothetical with Jane and her buyer of services. The customer wanted to purchase something from Jane, but Jane did not provide it. The customer gave Jane a check for $50, but Jane did not fulfill her end of the bargain. The buyer can assert a defense. It could be a simple contract defense, or a claim in recoupment.
An instrument is converted when a drawee to whom it is delivered for acceptance
refuses to return it upon demand
An instrument is converted when any person to whom it is delivered for payment
refuses on demand either to pay or to return it
An instrument is converted when it is taken by transfer other than a negotiation
from a person not entitled to enforce the instrument or a bank makes or obtains payment with respect to the instrument for a person not entitled to enforce and or receive payment
An action for conversion prescribes in
one year
Discharge occurs by tender of an instrument that contains a conspicuous statement (either on the instrument itself or in an accompanying written communication) that the instrument is being tendered as full satisfaction of the claim, if
- that person in good faith tendered an instrument to the claimant as full satisfaction of the claim
- the claim was unliquidated or the amount was subject to a bonafide dispute
- the claimant obtained payment of the instrument
If the check or note is dishonored and the obligee of the obligation for which the instrument was taken is the person entitled to enforce the instrument, the obligee
may either enforce the instrument, or the underlying obligator
If the person entitled to enforce the instrument taken for an obligation is not the obligee, the obligee
then the obligee may not enforce the obligation to the extent it is suspended (e.g., Jim sold his note to someone else; Jim already got paid because he sold it).
A holder in due course takes free of all defenses except the so-called “real defenses,” which are
- infancy
- duress, lack of legal capacity, illegality (DOES NOT include economic duress)
- fraud
- discharge in insolvency proceedings
Infancy
EXAMPLE: A minor enters into a contract and issues or indorses a note. That minor has a defense of infancy—it is a real defense—and that minor will be able to assert that defense later.
Duress that would prevent a holder in due course from taking the instrument
EXAMPLE: Duress would be where a gun is pointed at someone’s head until he enters into a contract. This is a real defense and would be valid against even a holder in due course. Mere economic threat is not enough for duress, however.
EXAMPLE: Gambling debts are the most common example of illegal debts. If a debt is illegal, this is a real defense.
Fraud that would prevent a holder in due course from taking the instrument
EXAMPLE: Wayne is entering into a transaction with Greg to purchase some widgets. Greg lies to Wayne about the quality of the goods and what they will accomplish. Wayne signs a promissory note and gives it to Greg. Wayne has a contract defense, but this is not a real defense—he knows he is entering into a promissory note, he was merely deceived as to the transaction.
EXAMPLE: Wayne is blind, and Greg approaches Wayne to sign something, saying it is an autograph book. Wayne has no ability to discover the truth about what he is signing. This would be fraud in the factum.
special defenses that are essentially real defenses, but not quite
An alteration,
a forgery,
defenses of accommodation parties
Alteration
An alteration is an unauthorized change in an instrument that purports to modify a party’s obligation, or an unauthorized addition to an incomplete instrument relating to a party’s obligation
An alteration discharges the liable party, except as to holders-in-due-course
who many enforce it according to its original amount
EXAMPLE: Matt Maker issues a note to Paul Payee for $100. Paul Payee negotiates the note to Thaddeus Thief. Thaddeus then alters the note, adding a zero to the amount, and seeks to enforce it against Matt Maker for $1,000. This is an alteration, and Matt Maker is discharged.
EXAMPLE: Same facts as above, but Thaddeus instead negotiates the note to Henry Holder. Henry Holder will be unable to enforce the instrument for $1,000, but can still enforce it as to its original tenor, $100.
When a note has been dishonored by the maker due to alteration
the holder may sue endorsers or transferors under transfer warranty
A person whose negligence substantially contributed to an alteration
is precluded from raising the alteration as a defense against a person who in good faith paid the instrument or took it for value or for collection
Forgery is available as a defense
even against a person who in good faith paid the instrument or takes it for value; hence, it is of the nature of the nature of a real defense (even against a holder in due course)
A person whose negligence substantially contributed to a forgery
is precluded from raising the forgery as a defense against a person who in good faith paid the instrument or took it for value or for collection
The drawee of an unauthorized or altered check is liable to its customer and must
re-credit the account if it pays the check, as it is not properly payable from the account (i.e., the customer did not truly order the funds to be paid)
If the customer failed to discover the forgeries with reasonable promptness, by reviewing his bank statements and returned items, the bank is not liable to the customer for paying the forged item unless
the bank should have discovered it by use of ordinary care, in which case, the loss is allocated between the customer and the bank under a comparative fault theory
In any event, a customer must aid his bank by discovering his forged signature with “reasonable promptness,” not to exceed
one year after the item is made available to him with his periodic statements of accounts
A customer who does not discover and report an unauthorized signature or alteration within one year after the item is made available to him with his periodic statements of accounts is
precluded from asserting it against the bank, regardless of the care exercised by the bank or customer.
These rules do not apply to items bearing an unauthorized indorsement. Instead, a three-year prescription period allows a customer to seek to have the bank
recredit the account for any item bearing an unauthorized endorsement
A bank may vary the effect of the provisions of Article 4 by an agreement with the customer, but the agree-ment may not
disclaim the bank’s responsibility for its lack of good faith or failure to exercise ordinary care or limit its liability for damages [§ 4-103(a)].
In an action to enforce the obligation of an accommodation party to pay an instrument, the accommodation party may assert against the person entitled to enforce the instrument
any defense or claim in recoupment that the accommodated party could assert against such person except discharge in insolvency, infancy, and lack of legal capacity
EXAMPLE: Wayne wants to make a note payable to the order of Paul Payee. Paul Payee says that Wayne is not financially stable enough and demands that Wayne’s wealthy Uncle Lou sign as an accommodation indorser. If Wayne has a defense against Paul and Paul goes after Uncle Lou for payment, Lou can step into the shoes of Wayne and assert any defense Wayne would have against Paul.
If the due date of an instrument is extended, the instrument is modified, or the value of collateral is impaired by a person entitled to enforce the instrument
and as a result, the accommodation party suffers a loss with respect to its right of recourse against an accommodated party, the accommodation party’s obligation is discharged to the extent of the loss
EXAMPLE: Same facts as above, but Uncle Lou is an accommodation maker, and Wayne’s deal with Paul involved Wayne giving Paul some kind of collateral to secure the note. Wayne comes to Paul to ask for the collateral for a brief period to use it. Paul gives it to Wayne, who absconds with it. Wayne has impaired the value of the collateral that Paul had. Uncle Lou, as accommodation co-maker, can raise a defense against Paul as a result of this.
