Payment and Discharge

Question 1

When can a maker safely pay and avoid further liability?

Answer 1

1. Determine if party seeking payment is a holder
   - Holder = the maker may safely pay him, even if the maker knows that a 3P has a claim to the instrument
   - Non-holder = maker will have to pay the true holder when he comes along
2. For a 3P to protect his claim to the instrument, he can:
   (i) offer to indemnify the maker or acceptor in an amount deemed insufficient by the maker or acceptor while the other two parties fight it out, or
   (ii) seek an injunction in an action in which the maker or acceptor, the holder, and the 3P are parties
3. The maker or acceptor may not safely pay the holder of an instrument if she knows that the holder acquired the instrument by theft or that he holds through one who acquired by theft. If the holder is an HDC, the maker may pay him

Question 2

Finality of Payment

Answer 2

Payment of a negotiable instrument is final, except:

(i) the payor can pursue those who breach transfer warranties; and
(ii) the rule of finality operates only in favor of persons who took for value and in good faith and those who in good faith change their position in reliance on the payment of acceptance.

If the person who receives payment is not one of the persons described in (ii) above, an action to recover the payment can be maintained

Question 3

Presentment Warranties

Answer 3

The payment is final rule does not affect a payor’s right to sue for breach of a presentment warranty

Two sets of presentment warranties:

(1) those made to drawees on unaccepted drafts
(2) those made to payors of other instruments or items

Question 4

*Presentment Warranties on Drafts

Answer 4

A drawee (bank) can recover for breach of a presentment warranty, even from HDCs and persons who detrimentally relied on payment

On unaccepted drafts, person obtaining payment and previous transferors warrant that:

(i) the warrantor is entitled to enforce the draft or is authorized by one who is (in essence a warranty of good title - that there are no unauthorized or missing indorsements)
(ii) the draft is not altered
(iii) the warrantor has no knowledge that the drawer’s signature is unauthorized
(iv) if the instrument is a remotely created item, there is a presentment warranty that creation of the item in the indicated amount was authorized by a person identified as drawer

A forged indorser’s signature destroys “good title,” but a forged drawer’s signature does not

Question 5

Forged Drawer’s Signature vs. Forged Indorser’s Singature

Answer 5

If bank pays out on a forged drawer’s signature, payment is final and the bank cannot recover the money back from the party paid because no presentment warranty is broken (the forgery is treated as a valid signature of the forger and thus the presenter had the right to enforce the forger’s instrument as against the forger)

But if the bank pays out on a forged indorser’s signature, good title is destroyed so a presentment warranty is broken (the presenter did not have the right to enforce against the drawer because of the forgery)

Question 6

Presentment Warranties on Other Instruments

Answer 6

On other instruments or items presented to a party obligated to pay, only the warranty that one is entitled to enforce (or represents one who is) applies, b/c the drawer, maker, or acceptor should know whether his signature is forged or whether the instrument or item is altered

Question 7

Who makes the warranties?

Answer 7

The warranties are made by:

(i) any person who obtains payment or acceptance
(ii) any prior transferor

Warranties on presentment are similar, but not identical to, the transfer warranties made by an indorser. The warranties are made to any person who in good faith pays or accepts

Question 8

Discharge

Answer 8

An instrument itself never dies by discharge b/c discharge of a party is a personal defense, which an HDC can cut off

No discharge of any party is effective against a subsequent HDC, unless the HDC has notice of the defense when he takes the instrument

Question 9

Certified, Cashier’s, or Teller’s Check Generally Discharges Obligation

Answer 9

If a certified, cashier’s, or teller’s check is given to fulfill an obligation, the obligation is discharged as if cash were given, but this does not affect any indorser liability of the obligor

Question 10

Other Instruments Generally Suspend Obligation

Answer 10

If any other negotiable instrument is given to fulfill an obligation, the underlying obligation is suspended until the instrument is paid or certified (which results in a discharge) or is dishonored

If the instrument is dishonored the person seeking payment can sue on the instrument. If he is the obligee on the underlying obligation, he may choose instead to sue on the underlying obligation

Question 11

Lost, Stolen, or Destroyed Instruments

Answer 11

If the obligee is entitled to enforce the instrument, but is no longer in possession b/c of loss, theft, or destruction, the obligation remains suspended to the extent of the instrument, and the obligee is limited to enforcement of the instrument

Question 12

*Tenders “in Full Satisfaction” - Accord and Satisfaction

Answer 12

If a claim is unliquidated or subject to dispute, the claim can be discharged in full if the person against whom the claim is asserted in good faith tenders an instrument that conspicuously states that it is tendered in full satisfaction of the claim (e.g., the memo line says “payment in full”) and the claimant obtains payment of the instrument

However, if the claimant is an organization, it can, by notice sent before the instrument is tendered, require that such instruments be tendered to a designated person, office, or place to be effective. If the claimant sends no such notice or is not an org, the discharge will not be effective if the claimant returns the payment w/in 90 days

Question 13

Discharge by Payment

Answer 13

The liability of a party is discharged to the extent of her payment (or satisfaction) even if made w/ knowledge of a claim of another person to the instrument, unless the claimant indemnifies the payor or enjoins the payment

On the holder’s request, payment may be made prior to maturity, and need not be made in good faith and w/o notice that the title of the holder is defective, but there is no discharge if the payor knows the instrument is stolen and pays a person whom she knows is in wrongful possession

A note is paid to the extent that payment is made by a party obliged to pay the note to a person formerly entitled to enforce the note only if at the time of the payment, the party obliged to pay has not received notification that the note has been transferred and payment is to be made to the transferee

Question 14

Discharge by Tender of Payment

Answer 14

The effect of tender is governed by K law principles

Tender of the amount due on an instrument discharges any duty to pay interest after the due date

Any person w/ a right of recourse against the tendering party is discharged to the extent of the amount tendered

Question 15

Discharge by Cancellation or Renunciation

Answer 15

Even w/o consideration, persons entitled to enforce may discharge a party through:

(i) intentional voluntary acts
(ii) renouncing rights in a signed writing

Such a discharge is not effective against a subsequent HDC w/o notice

Question 16

Release

Answer 16

If a person entitled to enforce an instrument releases the obligation of a principal obligor and another party is a secondary obligor on the instrument (including an indorser), the release:

(i) discharges the principal obligor from any duties owed to the secondary obligor to the extent of the release; and
(ii) discharges the secondary obligor to the same extent as the principal obligor unless the release reserves the right to enforce the instrument against the secondary obligor

Even if a right to enforce is reserved, the secondary obligor is discharged to the extent of the consideration given and to the extent that the release causes the secondary obligor any loss

Question 17

Extension of Modification of Obligation

Answer 17

If a person entitled to enforce an instrument grants a principal obligor an extension of the time at which one or more payments are due on the instrument, or agrees to a modification of the obligation, and another party is a secondary obligor on the instrument:

(i) the extension or modification correspondingly extends the time for performance or modifies any duties owed to the secondary obligor by the principal obligor; and
(ii) the secondary obligor is discharged to the extent that the extension or modification would cause him a loss

Question 18

Impairment of Collateral

Answer 18

If the person entitled to enforce the instrument impairs the value of the interest in collateral, the obligation of the secondary obligor is discharged to the extent of the impairment

If the secondary obligor demonstrates prejudice caused by the impairment, and the amount of loss is not reasonably ascertainable, there is a presumption that the impairing act caused a loss equal to the secondary obligor’s liability

Impairing the value of an interest in collateral includes:

(i) Failure to obtain or maintain perfection or recordation of the interest in collateral,
(ii) Release of collateral w/o substitution of collateral of equal value or equivalent reduction of the underlying obligation,
(iii) Failure to perform a duty to preserve the value of collateral owed by law to a debtor, and
(iv) Failure to comply w/ applicable law in disposing of or otherwise enforcing the interest in collateral

Question 19

Impact of Knowledge and Consent

Answer 19

A secondary obligor is not discharged unless the person entitled to enforce the instrument knows that the person is a secondary obligor or has notice that the instrument was signed for accommodation

Additionally, a secondary obligor is not discharged if he consents to the basis of the discharge or if he waives suretyship or impairment defenses

Question 20

Right of Recourse

Answer 20

A release or extension preserves a secondary obligor’s recourse if the terms of the release or extension provide that the person entitled to enforce the instrument retains the right of enforcement against the secondary obligor and that the recourse of the secondary obligor continues as though the release or extension had not been granted

Question 21

Burden of Proof for Discharge of Secondary Obligor

Answer 21

A party asserting a discharge always bears the burden of proof w/ respect to either the occurrence of the acts alleged to harm the secondary obligor and loss caused by those acts

However, the party entitled to enforce the instrument bears the burden of proof if he alleges that the secondary obligor’s loss is less than his total liability

Question 22

Discharge by Reacquisition

Answer 22

Upon reacquisition (transfer to a former holder), the reacquirer may cancel indorsements made b/w the time she formerly held the instrument and the present

Cancellation discharges such indorsers as against subsequent holders, including HDCs

Reacquisition automatically cancels the intervening indorser’s liability to the reacquirer

Question 23

Discharge by Any Act That Will Discharge a Simple K

Answer 23

Parties are discharged from liabilities to other parties on an instrument by acts or agreements that would discharge obligations to pay money under a simple K

Question 24

Discharge by Delay in Presentment of a Check

Answer 24

If a check is not presented for payment or given to a depository bank w/in 30 days after the indorsement, the indorser is discharged

If a check is not presented for payment or given to a depository bank for collection w/in 30 days after its date and the delay deprives the drawer of funds to pay the obligation, the drawer is discharged to the extent of the loss if he assigns his rights against the drawee to the party entitled to enforce

Question 25

Discharge by Failure to Give Notice of Dishonor

Answer 25

If notice of dishonor is required and not given, the indorser is discharged from his indorsement obligation

Drawers and makers usually are not entitled to notice

Question 26

Discharge by Acceptance of a Draft by a Bank

Answer 26

If a draft is accepted by a bank, the drawer is discharged. If a draft is accepted by a bank after indorsement, the indorser is discharged

Question 27

Discharge by Alteration

Answer 27

Fraudulent alterations discharge every party obligated on the instrument unless a party assents or is estopped from asserting the alteration, but HDCs may enforce according to the original terms (or terms as completed in cases of fraudulent completion)

Question 28

Status of Bank in Collection Process

Answer 28

Art. 4 of the UCC covers bank deposits and collections

Unless clearly to the contrary, a bank is an agent for collection, and risk of loss is on the depositor.

if the bank advances money, it has a security interest in instruments, and is an HDC to that extent

A bank is an agent when it wants to be and a purchaser when it needs to be (i.e., the bank almost never loses)