Negotiable Instruments Flashcards
What is the difference between a negotiable instrument and a nonnegotiable instrument?
Nonnegotiable instruments are not able simply to be transferred by the will of its owner, but are restricted by some sort of contract rights
Thus, while the Uniform Commercial Code (UCC) governs negotiable instruments, the contract law of assignments governs nonnegotiable instruments
What different ways can negotiable and nonnegotiable instruments be transferred?
Nonnegotiable instruments can be transferred only by assignment, but negotiable instruments can be transferred by either assignment or negotiation
How is negotiation superior to assignment regarding transferability?
Negotiation involves full transferability, while assignment has restrictions that make certain types of assignments void
How is negotiation superior to assignment regarding property rights transferred?
Assignment does not allow the assignee to acquire greater property rights than the assignor, but negotiation does allow the transferee to have greater rights
How is negotiation superior to assignment regarding defenses against other claims?
An assignee assumes any defenses against the assignor, while a transferee in a negotiation is free of any such defenses against the transferor
What is a draft?
A kind of negotiable instrument: a written order (by a drawer to a drawee) to pay money to a third party (the payee)
Most common type of draft today is a check, where the owner of the checking account is the drawer, the bank is the drawee, and the recipient of the check is the payee. The drawer orders the bank (drawee) to pay money from his account to the payee.
What is a note?
A kind of negotiable instrument: a written unconditional promise to pay the payee, either at some particular future time or on demand
Most essential to a note is the fact that it is a promise to pay (rather than a mere acknowledgment of debt)
If there is ambiguity whether an instrument is a draft or a note, how is it legally treated?
However the holder desires to treat it
Even if it is clearly a draft, the holder can treat it as a note if the drawer and drawee are the same person (because it would then effectively be a note)
What are some rules for interpreting ambiguous terms in an instrument?
All other things being equal…
(1) Handwritten terms carry more weight than typewritten and preprinted terms
(2) Typewritten terms > preprinted terms
(3) Words > figures
If multiple people sign an instrument (whether as maker, drawer, etc.), are they jointly or severally liable for their end of the bargain?
Both, unless the instrument itself specifies which
The words “I promise to pay” do not count as specifying either one
What does it mean if an instrument is payable to two people “in the alternative”?
It means it is payable to EITHER one person or the other (rather than both)
They are “alternative payees” rather than “joint payees,” and thus either can exercise his rights without the other
What is a holder in due course (HDC)?
The purchaser of a negotiable instrument who is free of any claims that can be used against the original holder of the instrument
What is an alteration of a negotiable instrument?
Not just any change, but any unauthorized change in a negotiable instrument, changing the duties of the parties involved
What is a letter of credit?
A type of nonnegotiable instrument: a buyer can request his bank to send a letter (i.e. a letter of credit) to a seller, assuring the seller that the buyer’s payments will be made
What is the statute of limitations for liabilities on bank deposits and collections?
Any suit to enforce such a liability must be within three years from the cause of the breach
What is the difference between a sight draft and a time draft?
Sight draft = payable on demand (i.e. when presented to the drawer bank)
Time draft = payable within a certain time period
What is a trade acceptance?
A draft drawn directly on the buyer by the seller, payable to the seller in the future
Basically, a promise by the buyer to pay the seller in the future, which is written by the seller for the buyer to accept (i.e. sign)
What is a banker’s acceptance?
Very similar to trade acceptances, but they are drawn on the buyer’s bank
When someone draws a check on a bank, is there a principal-agent relationship involved?
Yes, the drawer/depositor is the bank’s principal, and the drawee/bank is the depositor’s agent
What does it mean to say that a check is a “conditional payment”?
It means that giving a check does not automatically count as payment or discharge the buyer’s duty – the buyer’s duty is discharged only when (i.e. only on the condition that) the bank pays it
What is a bank draft?
A draft (or check) which one bank draws upon another
What is a cashier’s check?
A check which a bank draws upon itself, ordering itself to pay a third person
Who are the different parties involved with a note?
The promisor is the maker; the promisee is the payee or bearer
What is a certificate of deposit?
A type of note: a promise by a bank to repay a particular amount of money
What is check certification?
When a bank assures that an account has enough funds deposited and set aside to be paid through a check
The bank is not usually obligated to certify checks
Does certification change the liability of the parties involved?
Yes, depending on who certifies
If the check holder certifies it, the drawer and any other endorsers are not liable (the bank is)
If the drawer certifies it, only endorsers lose liability – the drawer remains liable (secondarily to the bank)
To whom is a bank obligated to honor checks?
To the depositor, but not to the payee
Thus if a bank wrongly dishonors a check, the payee should act against the drawer (who should then act against the bank), UNLESS the check is certified by the bank
Is a bank obligated to honor stop-payment orders from depositors?
Yes, so long as the bank has a reasonable time after the order to do so
How long is a bank obligated to honor a stop-payment order?
Six months if written, 14 days if oral
What is the depositor’s duty towards the bank?
To check monthly statements for mistakes or forged checks
How does liability work for a forged check if a bank is negligent?
The bank is liable even if the drawer was negligent too
When is the drawer liable for negligence regarding a forged check?
If he negligently does not discover the forgery, or if he fails to report a forgery within 30 days
What guarantees a drawer to be liable for a forged check?
Either:
(a) if he fails to report an unauthorized alteration within a year of receiving the bank statement
(b) if he fails to report an unauthorized endorsement within three years of the statement
What are the six prerequisites for an instrument to count as negotiable?
(1) Signed and in writing
(2) Unconditional promise/order to pay
(3) Fixed amount of money
(4) Payable to order or to bearer at issuance (except for checks)
(5) Payable on demand or at some definite time
(6) No other promise (or order or duty) except as the UCC authorizes
(These are very important requirements to memorize, especially #4.)
Does the maker or drawer’s signature need to be a handwritten name?
No, it can be printed, and it can be any symbol intended as a signature
What is a general rule of signatories’ liability?
No one is liable for an instrument without his name signed
This is very relevant for agent-principal situations
Under what circumstances is an agent personally liable for a negotiable instrument?
If his name is signed on it
As long as the principal’s name is on it, however, he could then recover any damages from him
The agent’s name does not need to be on the instrument, for agency can be established orally
What does not count as an order to pay?
A mere request or authorization for someone else to pay does not count as an order for a negotiable instrument
What makes a promise/order conditional (and thus makes an instrument nonnegotiable)?
If the instrument is subject to another agreement or requires another act to be performed
Look especially for terms “subject to”
When can a promise/order be conditional but still count as negotiable?
(a) if the condition cannot be found in the writing of the instrument (i.e. if it’s oral)
(b) if the instrument is subject only to implied or constructive conditions
For a negotiable instrument, what does it mean for a payable amount to be a “sum certain”?
The payment amount is fixed, and this satisfies that requirement for negotiability
When does a payment date NOT count as a “definite time”?
If the payment date is subject to some uncertain event – this would make an instrument nonnegotiable
However, if the date is definite but allows prepayment in case of an uncertainty (e.g. “July 1, 2012, or the death of the holder, whichever is sooner”), then it still counts as a definite time
What are the specific words of negotiability that must be on all negotiable instruments besides checks?
They must be payable “to order” or “to bearer”
E.g. if an instrument is merely payable to a particular person, but not “to the order of” that person, then it is nonnegotiable
What would be an invalid way to make an instrument payable to its bearer?
If it is payable to a particular person WHO IS the bearer (e.g. “payable to John Smith, bearer”) – this would make it nonnegotiable
If it is payable to a particular person OR the bearer, then it is negotiable
Can an instrument be payable to order AND to bearer?
An instrument can say so – but it is automatically payable to order unless the words for the bearer are typed or handwritten (rather than printed), in which case it is payable to bearer
What are the two ways a negotiable instrument can be transferred after being originally issued?
Negotiation – the transferee becomes a holder
Assignment – the transferee becomes an assignee
Is it possible for an endorsement to be partial?
No, it must be for the entire instrument or else it is considered a partial assignment (i.e. not even a negotiation)
If it is ambiguous as to which role someone signed an instrument as (e.g. drawer, endorser, maker, etc.), how should it be understood?
That person is deemed to be an endorser
What does endorsement ordinarily establish?
It makes the endorser secondarily liable for the instrument (i.e. bound to pay it if the maker or drawee do not)
What are bearer paper and order paper, and how are they negotiated?
Bearer paper = paper payable to bearer; negotiated only by physical delivery
Order paper = paper payable to order; negotiated by endorsement + delivery
How can bearer paper become order paper and vice versa?
Bearer –> order = if the most recent endorsement is a special endorsement
Order –> bearer = if the most recent endorsement is a blank endorsement
What are special endorsements and blank endorsements?
Special endorsements = specify the person to whom the instrument is now payable
Blank endorsement = no person is specified; only the transferor’s signature is present
Do drawees (banks) bear the loss if an endorsement is forged?
No, but they do if the drawer’s signature is forged, since they are responsible for recognizing that
What are restrictive endorsements?
Endorsements which decrease the rights of transferees with respect to the instrument (e.g. “for deposit” or “pay only upon” a certain condition)
Endorsements which restrict later negotiation are invalid
What is a qualified endorsement?
An endorsement which disclaims the endorser’s secondary liability to pay the instrument, usually with the words “without recourse”
What is an anomalous endorsement?
An endorsement by a non-holder in order to claim liability on the instrument
Can be called an “accommodation endorsement,” because made by an “accommodation party”
What endorsements can a holder strike out?
Any which are not necessary to his title
What are the requirements for a holder to be a holder in due course (HDC)?
He takes the instrument
(1) in exchange for value
(2) in good faith, and
(3) without notice of dishonor, defense, or claim
What sort of consideration counts as “value” exchanged for a negotiable instrument?
Only actually performed consideration – not mere promises to perform
Exception: negotiable instruments can count as value, even though they are unfulfilled promises
How might a bank give value (and this fulfill a prerequisite to become a HDC)?
(1) if, when someone deposits a negotiable instrument, the bank credits the depositor and also permits his withdrawal of that deposited instrument
(2) if the bank takes an instrument at a discount from its face value
Is it possible to be a HDC only to part of an instrument?
Yes – if someone receives notice that an instrument has been dishonored (or is overdue, etc.) after becoming its holder but before completing performance, then he is a HDC to the extent performance was completed before the notice
When is an instrument payable on demand considered to be overdue?
After a reasonable time – 90 days max for domestic checks
What is the shelter provision?
Applied to HDCs, a transferee obtains the rights which transferors had – and thus a transferee can have the rights of a HDC so long as a transferor was a HDC before him
What are exceptions to the shelter provision?
(1) A person cannot acquire HDC rights by negotiating an instrument to a HDC and then negotiating again to re-obtain it
(2) A person who is part of the fraud or illegality related to the instrument (or part of the defense) cannot obtain HDC rights
Can a holder be a HDC if he is informed that one of the parties to an instrument has been discharged of his duty?
Yes – a holder is disqualified from being a HDC only if he is informed that ALL parties were discharged
If someone is not a HDC or a transferee of some chain with a HDC, what does that mean?
He is subject to all claims against the instrument and any defenses to the instrument
Against whom do personal defenses and real defenses apply?
Personal defenses = good only against non-HDCs
Real defenses = good against non-HDCs and HDCs
What characterizes a personal defense?
The defense usually deals more with an excuse a promisor has not to perform his contractual duty (regarding the negotiable instrument) than with the validity of the instrument itself
For negotiable instruments, what is the difference between fraud in the inducement and fraud in the factum?
Inducement = fraud to get someone to sign an instrument, even though the instrument is exactly as it claims to be (e.g. signing an instrument in exchange for a shoddy car that is passed off as good); this is a personal defense
Factum = fraud concerning the instrument itself; this is a real defense
What are other phrases for “fraud in the factum”?
Fraud in the essence
Fraud in the execution
If an instrument is fraudulently completed by someone else (e.g. stealing an unfinished check and writing yourself in as recipient), how would it affect the parties involved?
As a personal defense, this would remove any duty from the parties involved EXCEPT unto HDCs
E.g. the original signer of a stolen unfinished check would owe the HDC the amount of the check
What defense does a material alteration to an already-completed instrument provide?
If an already-completed instrument is materially altered, then the original party has a PERSONAL defense as to the original conditions (“original tenor”), but a REAL defense as to the alteration
E.g. an HDC could enforce the instrument to be paid for the original amount, but not for the altered amount
What defense does a material alteration to an incomplete instrument (i.e. a fraudulent completion of the instrument) provide?
The instrument had no “original tenor,” and there is no real defense – a HDC can enforce the instrument as is
Most material alterations provide a real defense, but unauthorized completion is the exception to the rule
If a material alteration ordinarily provides a real defense (e.g. for altering an already-completed instrument), when could the original party still not use the alteration as a defense?
If he was negligent in such a way that substantially contributed to the fraud
Does insolvency or bankruptcy count as a real defense?
Yes
When does incapacity (e.g. being an infant) count as a real defense?
Most types of incapacity are real defenses only if they would make a contract void (not voidable), but infancy can be a real defense even though it makes one voidable
Does illegality count as a real defense?
Yes, it renders an instrument void
How do forged signatures act as defenses?
A forged signature creates no liability for anyone to anyone, but simply acts as the signature of the forger himself
Exception: someone whose signature was forged can be liable if his negligence facilitated the forgery
How do endorsements by impostors relate to forgery?
They do not count as forgery, so the liability still falls on the drawer
When does fraud in the factum not count as a real defense?
If the defrauded party (who signed the instrument) had no reasonable chance to learn of the instrument’s forgery
How does duress count as a defense?
Duress which renders a contract void is a real defense, but duress which renders a contract voidable is only a personal defense
What is presentment?
Demanding acceptance or payment for an instrument
Refusing to pay upon presentment is dishonor
What is the holder’s duty if his instrument is dishonored?
Notifying the drawer or the endorser that it was dishonored
This is not always required, however
How does acceptance of an instrument affect a drawee’s (e.g. a bank’s) relation to it?
The drawee is not primarily liable for the instrument until it accepts it
What kind of instruments are ordinarily presented for acceptance rather than for payment?
Time drafts are ordinarily presented for acceptance
Demand drafts (i.e. checks) are ordinarily presented for payment
Besides fixing a drawee’s primary liability, what does acceptance do?
It is sometimes required to fix secondary liability for drawers and endorsers
- when the draft itself requires it
- when the place of payment is elsewhere than the drawee’s residence or business
- when the payment date requires a presentment for acceptance (e.g. “payable 15 days after sight”)
When must a check be paid or dishonored after it is presented?
By midnight of the next business day
When is a check considered overdue?
Either the day after payment has been demanded, or 90 days after the check’s date, whichever is earlier
When is an endorser of a check free from liability?
If the check is not presented within 30 days of the endorsement
What are different ways for an instrument to have a payable date?
It can mention a specific date, a fixed time period after a specific date, or a fixed time period after sight/acceptance
What is an accelerated instrument?
It must be presented for payment within a “reasonable time” after its acceleration
Works out to 30 days after issuance or after the instrument’s date, whichever is later – or 30 days after endorsement
What are different means of presenting an instrument?
- by mail
- through clearing house
- at place specified
- if no place specified, at place of business/residence
If a presented instrument is dishonored, what is the holder’s usual recourse?
To seek restitution from the secondarily liable parties (which usually also requires notifying them of dishonor)
A notice of dishonor is ordinarily needed to hold which parties responsible?
(1) maker of a bank note
(2) acceptor of a bank draft
(3) any drawer
(4) any endorser
Does a failure to give notice of dishonor discharge the relevant parties absolutely?
It discharges endorsers absolutely, but not the rest
The rest are discharged only insofar as the lack of notice – especially of a party’s insolvency – causes that party to suffer further loss
How soon must a notice of dishonor be given?
Banks must give notice by midnight of the next banking day; others within 30 days
The notice is effective when sent, not when received
What is a protest?
A formal certificate of an instrument’s dishonor
Is a protest necessary for all dishonored instruments?
No, only for foreign drafts
Who can make a protest?
Only someone legally authorized to certify an instrument’s dishonor (e.g. a notary)
Who are the primarily liable parties for notes and drafts?
The maker of a note, and the acceptor of a draft
This should be intuitive: the one who makes a promise for the note – the maker – is primarily responsible, while the one who accepts (or certifies) a draft, like a check – the acceptor, or drawee – is primarily responsible
When do makers (for notes) and acceptors (for drafts) become primarily liable?
Makers become liable when the note is originally executed (when the promise is made)
Acceptors become liable when they actually accept/certify the draft – and this requires their signature
Is the acceptor of a draft liable for any alterations made to the draft after acceptance?
No, since he becomes liable only to pay the draft as it was accepted
What can occur if a drawee wishes to change the terms of a draft?
The holder can either treat the draft as dishonored, or agree to the changes
However, agreement to the changes discharges any other drawer and endorser who did not agree
When are secondarily liable parties to an instrument responsible to pay for it?
When the primarily liable party fails to pay for it, and when the various prerequisite conditions have been fulfilled: presentment of the instrument, notice of dishonor, and (sometimes) protest
How does a drawer or endorser disclaim any liability on an instrument?
By signing/endorsing it “without recourse”
When an endorser endorses an instrument, what is his liability?
His liability is to pay the instrument, according to its terms when he endorsed it, if the instrument is dishonored
What does it mean if an endorsement is signed with the words “payment guaranteed”?
When the endorser’s secondary liability kicks in, the endorser becomes primarily liable in the event of nonpayment – and thus conditions precedent (like presentment and notice of dishonor) are not relevant to the endorser’s liability
What is an accommodation party?
Basically a surety – he signs an instrument simply to become liable (in whatever capacity in which he signs)
Can an accommodation party sign an instrument as a maker or acceptor?
Yes, and the accommodation party thereby becomes primarily liable for the instrument
How does the liability work regarding the accommodation party and the accommodated party?
The accommodation party will be liable for the instrument even if payment is not first demanded from the accommodated party – yet, because he is effectively a surety, he can then be reimbursed for this by the accommodated party
What are the two main kinds of warranties for instruments?
Transferor’s warranties and presenter’s warranties
What does a transferor warrant to a transferee (and later holders) of an instrument?
That the signature is genuine, that it’s not been materially changed, that no other party has a defense against him, that the maker is not insolvent, etc.
Can accommodation endorsers be held liable for a transferor’s warrant?
No, for implied warranties exist only when there’s been a sale, i.e. an exchange of the instrument for consideration – but an accommodation party receives no consideration from the transferee
What does a presenter (who is not a HDC) warrant to a presentee (i.e. acceptor or payor)?
That the presenter has a good title, that the instrument hasn’t been materially altered, and that the signature is good
A HDC merely warrants that he has a good title
Can these implied warranties be disclaimed?
Yes, so long as they are disclaimed by an agreement between the parties involved
If a HDC gets payment (or acceptance) for an instrument when the maker’s/drawer’s signature was actually forged, what are his obligations?
None – the payment (or acceptance) is final
The rationale is that though the maker or drawee did not have to accept the fraudulent instrument, if he did, it was likely due to negligence
If the promisor for an instrument tenders payment to the holder when the instrument is due (or after), and the holder wrongly refuses the payment, is the promisor then discharged?
No, he is still liable to pay – although he is then discharged from later interest, legal fees, etc.
If the holder refuses a tendered payment from a promisor, does it affect any other parties?
Yes, it discharges parties who have a right of recourse against the party who tendered payment
What is the most common way for a holder to cancel an instrument?
Writing “paid” on its face
If an instrument is reacquired by a prior party, how does it affect others’ liability?
All intervening parties are discharged from liability to the reacquirer, as well as to any subsequent parties (except for an applicable HDC)
