Negotiable Instruments Flashcards
Note
Promise to pay-2 parties
Maker and payee
Draft
Order to Pay (check) - 3 parties You are commanding that a bank pay on your behalf Drawer - signs Drawee - bank Payee- person entitled to money
Requirements for Negotiability
She Won Unlimited Free Dunkin’ Donuts Or Bagels
(S)igned by maker or drawer; (W)riting; (U)nconditional promise or order to pay; (F)ixed amount of money; Payable on (D)emand or at a (D)efinite time; Payable to (O)rder or (B)earer.
and states no authorized undertaking or instruction by person promising or ordering payment
If it is conditional, then it is non-negotiable. What does conditional mean?
Expressly states a condition for payment
OR
is subject to or governed by another writing.
Its ok if it references another writing for terms (e.g. prepayment)
If there is a separate writing, does it affect a HDC
No, only applies to parties to the writing.
What does it mean that an amount of money is fixed?
To be negotiable, the principal due under the instrument must be fixed. Variable or indexed interest rates are acceptable.
Payable to Order
payable to an identified person
Magic words “Pay to the order of X”
If it just says Pay x, it is not negotiable unless it is a check
Payable to Bearer
Payable to cash or to possessor; does not name a payee.
Do acceleration clauses destroy negotiability?
No
Do extensions destroy negotiability?
No, s/l/a extension is for a definite time.
What happens if there is a conspicuous statement that the instrument is NON NEGOTIABLE
Negotiability is destroyed, except in the case of checks.
What is a holder?
A person in possession of an instrument with a right to enforce it.
How are bearer instruments negotiated?
Transferring possession
How are order instruments negotiated?
Payable to a specific payee - transfer of possession plus indorsement
-forging name breaks chain of title - indorsement must be authorized and valid.
Negotiation of order instrument with multiple payees
-If payable jointly (A and B), by indorsement of all parties
If payable severally - A or B, any one may indorse.
When a bank takes a check for collection, do you need payee’s indorsement?
No. Possession is enough to negotiate - but this is just with banks
Burden of proof on assignment of note vs. negotiation
Assignment - assignee needs to prove why he should be paid.
In negotiation, HDC brings the instrument to court and D has burden of proving why he doesn’t have to pay.
Factors That Do Not Affect Negotiability
Undated Checks. Treated as payable on demand.
Pre or Post-Dated Checks.
Handwritten Terms Outweigh Printed Terms.
Words Outweigh Numbers.
Writing NON-NEGOTIABLE on a Check does not destroy negotiability.
BUT BE CAREFUL! Writing Non-Negotiable on anything else DOES destroy negotiability.
What if the Instrument is Not Negotiable?
It can still be redeemed for cash.
It can still be sold, transferred, assigned, gives as security . . . it’s still “commercial paper.”
But, if an obligation is transferred to a third party (by assignment instead of negotiation), that third party is now subject to all sorts of contract claims and defenses that may make it harder for him to get paid.
Where can indorsement be written?
On back or on an allonge
Types of indorsements
- Special or blank
- Qualified
- Restrictive indorsements
- Anamolous Indorsements
Blank indorsement
- the indorser just signs.
- blank indorsement specifies no particular indorsee.
- If the payee is the indorser, the payee can now redeem the instrument and receive payment. That’s why you sign the back of your checks.
- You can put a blank indorsement on order paper or bearer paper.
NOTE: if you put a blank indorsement on order paper, it converts it to bearer paper.
Special Indorsement
-the indorser signs and names a third party as indorsee
-You can put a special indorsement on order paper or bearer paper.
NOTE: if you put a special indorsement on bearer paper, it converts it to order paper. Now, it can only be negotiated again by indorsement and delivery.
Qualified Indorsement
-similar to a special indorsement, but with limited liability to the indorser:
-Pay to Warren Buffett without recourse
Bill Gates
-This means that the indorser is not guaranteeing payment. The only thing that is happening is a transfer of ownership.
-By contrast, most blank and special indorsements transfer ownership and include a guarantee of payment.
-If the instrument is dishonored by the drawee (bank), a blank or special indorser may be liable to pay instead.
Typically, the words “without recourse” are used.
Restrictive Indorsement
-Any other language added to an indorsement creates a restrictive indorsement. It typically attempts to impose a condition or restriction on how the instrument will be further negotiated.
Example: “Pay to Buffett only”
Example: “Pay to Buffett, but only if he uses the property as a hotel”
Example: “No further negotiation or indorsement permitted”
-Generally, restrictions and conditions included in an indorsement do not affect negotiability. We would treat most of them as ordinary special indorsements.
-This is unlike conditions on the face of the instrument which do destroy negotiability.
Anomalous Indorsement:
-Typically, the holder indorses the instrument for the purpose of negotiating it to another party.
-Or, the payee indorses the instrument for the purpose of presenting it to the drawee/maker for payment.
If someone other than a holder or payee indorses the instrument, it is called an anomalous indorsement.
-The anomalous indorser becomes a surety (guarantor) for the instrument and is now liable for payment. Their liability is secondary.
-Look for an indorser who was never a holder or payee. That is an anomalous indorser, and he’s now on the hook as a “surety.”
Last Indorsement Rule
The last indorsement on an instrument determines whether this is order or bearer paper, regardless of how it started.
If the last indorsement is blank, the instrument is bearer.
If the last indorsement is special or qualified, it is order.
So, if you want to know whether an instrument is order or bearer paper, look at the last indorsement. If there are no indorsements, look at how it started.
Holder vs. Holder in Due Course
“holder” is not the same as a “holder in due course.”
Do not abbreviate—be very specific on this point.
Anyone who receives ownership of an instrument by negotiation is a holder.
The holder gets the right to enforce the instrument.
But, the holder is typically subject to the same defenses that the transferor was subject to.
So, at this point, negotiation hasn’t offered us any special benefits. It is the same as an assignment (except that the burden of proof has shifted in court—see above).
A holder in due course (HDC) has some extra special protections. He is much better than an ordinary holder.
Becoming a Holder in Due Course
To become an HDC: -The transfer must have taken place by negotiation. -The new owner must take ownership: For value; In good faith; and Without notice of defects.
What is Value
- Value does not need to be the “face” amount of the instrument.
- If the holder received the instrument by gift or inheritance, he did not pay value, and he is NOT a holder in due course.
- Value is not the same thing as consideration. –Consideration can be value, but there are some things that constitute “value” but would not satisfy a contract consideration standard. e.g., antecedent debt
What constitutes value?
- Performance of the agreed consideration.
- The holder takes a security interest in the instrument (Swift makes a new loan to Cuban for $300,000 and takes a security interest in the Gates note as collateral) 🡪 OK!
- Taking the instrument as payment of (or security for) an old outstanding debt (Cuban owes Swift $400,000. Instead of paying, Cuban negotiates the Gates not to Swift as payment). This would not be consideration (legal duty rule), but it is value 🡪 OK!
- Trading a negotiable instrument for another instrument (self-explanatory) 🡪 OK!
Good faith
Good faith means:
Honesty in fact (a subjective test); AND
Observance of reasonable commercial standards (an objective test).
Just say this in your essay, there isn’t much more to know about it.
Without Notice of Defects
-The holder must obtain the instrument without notice of certain serious defects.
-Notice of the any of the following destroys HDC status:
Instrument is overdue for payment;
There is an unauthorized signature or alteration;
There are third parties with claims to the instrument;
There are defenses to payment or claims that would reduce the amount payable.
-purchased as a part of a bulk sale of instruments
Is an HDC protected against personal defenses?
Yes. These are basic contract defenses.
Are regular holders protected against personal defenses?
No.
Are assignees protected against personal defenses?
No
Are assignees, holders, and holders in due course are subject to the Real Defenses?
Yes
What are the real defenses?
FAIDS
Forgery of a necessary party
Fraud in the factum
Alteration
Adjudicated incompetent
Infancy
Illegality
Duress (extreme!)
Discharge through bankruptcy
Suretyship defenses
Statute of limitations
Forgery of a necessary party
if the signature of the payee or a special indorsee was forged, no subsequent taker can be an HDC.
Fraud in the factum
fraud that causes a party to sign an instrument without knowledge or reasonable opportunity to learn of its character or essential terms. Not aware of what he was signing.
Fraud in the inducement is a personal defense
Alteration
someone altered the instrument after it was issued (e.g., adding an extra zero to a check, turning 100 into 1,000).
Adjudicated incompetent
the party we are trying to enforce against has been declared mentally incompetent by a court.
Infancy
the obligation of the party we are trying to enforce against is void or voidable because he was under the age of 18 at the time of the contract.
Illegality
the underlying transaction was illegal (even if the HDC was not involved). For example, a check paid in consideration for a murder.
Duress
the party acts involuntarily due to extreme duress (e.g., a gun to the person’s head). Moderate duress does not qualify (e.g., “sign or I’ll tell your partner you are insolvent”).
Discharge through bankruptcy
asserting that any debt that has been discharged by a bankruptcy court is a real defense.
Suretyship defenses:
If the party who we are trying to enforce against was just a surety—a guarantor (someone just adding their credit to a transaction, but not primarily liable)—the surety party can enforce certain additional defenses.
Statute of limitations
The holder must assert their claim within the statute of limitations or be barred. 3 years for unaccepted drafts, cashiers’ checks, certified checks, conversion, or breach of warranty. 6 years for notes payable at a definite time or on demand and certificates of deposit.
Shelter Principle
An instrument can be negotiated multiple times, from party-to-party.
Anyone who takes ownership of an instrument from an HDC inherits the protections of an HDC under the “shelter principle” (as long as the HDC intended to give the new possessor the right to enforce the instrument).
This is true even if the subsequent holder is not a holder in due course himself.
This will continue down the chain, as long as everyone can trace their possession back to an HDC.
However, someone who has possession under the shelter rule can’t always negotiate. He’s not a holder himself. He can transfer in other ways, but no negotiation!
Exception: if any subsequent transferee was involved in fraud or illegality related to the instrument, he will not get HDC protection. That “bad actor” will break the chain, and no subsequent transferees can claim protection under the shelter principle. If they want protection, they have to be full-fledged HDCs themselves.
Signature Liability
Every party who signs a negotiable instrument is liable for payment.
Two types of liability:
Primary liability: liable to pay the full amount of the instrument, according to its terms.
Secondary liability: liable to pay, but only if a primary party fails to do so.
Exception: remember, a party who makes a qualified endorsement will not be personally liable at all.
Does a drawee have liability to pay?
No - it only has to pay when it signs the draft and becomes the acceptor. Then it is primarily liable to make payment.
Except - certified check - bank is primarily liable from the outset.
Primary Liability
Only two parties can be held primarily liable, with unqualified obligations to make payment:
Notes: the maker;
Drafts: the “acceptor.” - the bank when it signs the draft
Secondary Liability
- Everyone else that signed the instrument has secondary liability. They pay only if a party who is primarily liable does not pay.
- A drawer pays if the drawee doesn’t (e.g., the drawee refuses to accept the draft).
- An indorser pays if a maker doesn’t.
What are the Prerequisites for Seeking payment from an Indorser
(P)resentment: the instrument was presented to a primary party for payment.
(D)ishonor: the primary party refused to pay.
(N)otice of dishonor: the holder notifies the indorser that the primary party refused to pay.
- *Indorser may be held liable on contract theory or warranty theory
- if there are multiple indorsers, any one can be held liable for full amount
When is a Drawer Liable for Payment
-The drawer of a check has secondary liability (or at least, we can say that to keep things simple).
Remember, a draft is an order for the drawee to pay on behalf of the drawer. When you write a check, you are -the drawer.
-For drafts, the “acceptor” (often the drawee) has primary liability. The acceptor is typically your bank.
-The drawer is only liable to pay if the draft is dishonored by the drawee (the bank). We need PDN, just like an indorser.
-This makes sense—you have ordered your bank to pay. You don’t expect someone to hand you back the check and ask for cash. But you might expect them to do that if the bank refuses to pay. You are secondarily liable; the drawee is primarily liable.
-If the drawee accepts the draft and becomes the acceptor, the drawer’s liability is completely discharged. Now if the acceptor refuses to pay, the drawer is off the hook.
When is a Co-Maker Liable for Payment
-A note can have more than one maker.
Example: Michael and Dwight are business partners and they are trying to purchase an office building in Coral Gables. They obtain a loan from Magic City Bank for the purchase price, and both Michael and Dwight sign the promissory note. Michael and Dwight are co-makers.
-Co-makers are jointly-and-severally liable. The payee can seek the full amount of the debt from either maker, or both.
-As makers, they are both primarily liable.
Compare: Only Michael signed the note as maker. Dwight signed a separate agreement (or a separate portion of the note) promising to pay the loan, but only if Michael fails to do so. Dwight is a guarantor, not a maker. There is NO joint-and-several liability. Dwight has secondary liability. Notice also, Dwight is not an indorser—he is not signing to negotiate the instrument. He is just adding his credit to the loan.
Stop Payment Orders
Oral stop payment orders to the drawee are effective for 14 days.
Written stop payment orders to the drawing are binding for 6 months.
If the drawee makes the payment anyway (due to error, miscommunication, etc.), the drawer has the burden of proving that a loss has occurred. Essentially, the drawer must prove that the payee was in fact not entitled to payment and must prove why the drawer cannot recover from the payee.
If there is an HDC in the chain of ownership, the drawer cannot recover. Even if the payment had been stopped, that is not a valid defense against the HDC.
When you SELL commercial paper, you make certain warranties. What are the 5 warranties made by the transferor
-applies to assignments, negotiations, or any other sale for CONSIDERATION
A transferor for consideration make 5 warranties—Everyone Screams About Negotiable Instruments:
- The transferor is entitled to ENFORCE the instrument;
- SIGNATURES on the instrument are authentic;
- Instrument has not been ALTERED;
- NO defenses or claims exist against transferor;
- Transferor has no knowledge of INSOLVENCY proceedings (against maker, acceptor, or drawer).
Who can enforce a transfer warranty on order paper?
Any subsequent holder who takes the instrument in good faith can assert the transfer warranties against the transferor (which can be an indorser or drawer/maker). It doesn’t matter if it’s the first guy or the tenth guy who ends up owing the instrument—they can all go back and sue the transferor under the warranties.
Who can enforce a transfer warranty on bearer paper?
Only the immediate transferee can enforce the transfer warranties. Remote holders cannot enforce them. Only the guy who took ownership directly from the drawer/maker can sue him under the warranties. If the instrument is negotiated to another party, the transfer warranties disappear.
What are two potential ways to seek payment from indorser, when there was consideration paid (order paper)?
- If there was consideration, the holder can seek payment from the indorser under the transfer warranties (5 warranties) AND/OR under indorser contract liability (Presentment, Dishonor, Notice).
- The holder has two potential ways to seek payment from an indorser!
- If there was no consideration, the holder must rely on the indorser’s contract liability ONLY.
What transactions preclude HDC status
Taking at a judicial sale, purchasing as part of bulk transaction, as a successor in interest to an estate
Time at which HDC status determined
At the moment it is negotiated to the holder, or when she gives value, whichever is later.
Who has BOP on HDC status?
No need to prove HDC status until someone raises defense against payment.
Accession
Goods that are physically united with other goods in such a manner that identity of original goods is not lost e.g. tires on a car
Fixtures
Goods that have become so related to particular real property that an interest arises in them under real property law. Interest in fixtures may arise under both the Code and under the law of real estate.
Do transfer warranties apply to all types of transfers?
No, only to those for value.
When you take without notice of defects, what type of notice counts?
-Notice includes actual notice and “reason to know” from facts surrounding the transaction.
