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6 th Edition. Fundamentals of Business Law. Chapter 18 Negotiable Instruments: Negotiability, Transferability, and Liability. Article 3 of the UCC. A “negotiable instrument” is a signed writing containing an unconditional promise to pay an exact sum of money.

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6th Edition

Fundamentalsof Business Law

Chapter 18Negotiable Instruments:Negotiability, Transferability,and Liability


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Article 3 of the UCC

  • A “negotiable instrument” is a signed writing containing an unconditional promise to pay an exact sum of money.

  • To function as a substitute for money or credit device.

  • In order for an instrument to operate practically, it has to be easily transferable.

  • Recent amendments conform Article 3 and 4 to include UETA.


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Types of Instruments

  • Drafts and Checks (Orders to Pay) are 3 party instruments: Drawer, Drawee and Payee.

    • Checks (cashier’s, teller’s and traveler’s) are drafts on a bank.

    • Trade acceptances seller is drawer and payee.

    • Case 18.1 Flatiron Linen, Inc. v. First American State Bank (2001).

  • Notes are two party instruments (Promissor and Promisee).

  • Certificates of deposit (CDs): two party instruments.


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Requirements for Negotiability

  • Writing signed by the maker or the drawer.

  • Unconditional promise or order to pay a fixed amount of money.

  • Payable on demand or at a definite time.

  • Be payable to order or to bearer, unless it is a check.


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Transfer of Instruments

  • Transfer by Assignment:

    • Assignee receives all rights to the instrument.

    • Any defenses that can be raised against a holder can be raised against the assignee.


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Transfer Of Instruments

  • Transfer by negotiation creates a holder, who at the very least receives the rights of a previous possessor.

    AND

  • A holder in due course (HDC) acquires more rights in the instrument than the previous possessor. This means defenses that can be raised against the transferor may or may not be able to be raised against the transferee.


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Holder vs. HDC

  • Holder is one in possession of ORDER OR BEARER PAPER.

  • Holder in Due Course (HDC) results if the holder has possession plus the following:

    • Takes for Value.

    • Takes in Good Faith.

    • Takes without Notice. 


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HDC: Taking for Value

  • No value if gift or inheritance. Not the same as consideration.

  • Holder can take value by:

    • Performing the instrument’s promise.

    • Acquiring a security interest or other lien in the instrument.

    • Taking instrument in payment for an antecedent debt.

    • Giving a negotiable instrument as payment.

    • Giving irrevocable commitment as payment.


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HDC: Taking in Good Faith

  • Good faith is honesty in fact and the observance of reasonable commercial standards of fair dealing.”

  • Only applies to holder, not transferor.

  • Case 18.2 Maine Family Federal Credit Union v. Sun Life Assurance Co. of Canada (1999).


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HDC: Taking Without Notice

  • Holder takes the instrument without notice if he knows/has reason to know:

    • Instrument is overdue.

    • Instrument has been dishonored.

    • Actual knowledge or any suspicious event.

    • That a claim or defense exists.

    • So irregular, incomplete, or bears such evidence of forgery.

    • Case 18.3 Travelers Casualty and Surety Co. of America v. Wells Fargo Bank, N.A. (2002).


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Holder through an HDC

  • “Shelter Principle”: Person is not an HDC but derives title through HDC.

  • Limitations on the shelter principle: no fraud, illegality, claim or defense.


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Liability

  • There are two kinds of liability associated with negotiable instruments:

    • Signature liability.

    • Warranty Liability.


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Signature Liability

  • Relates to signatures on instruments.

  • Signers of negotiable instruments are potentially liable for amount state on instrument.

    • Primary Liability: Makers/Accepters.

    • Secondary Liability: Drawers/Indorsers.


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Signature Liability

  • Proper & Timely Presentment.

    • Must be timely (checks w/in 30 days).

  • Dishonor.

    • Case 18.4 Messing v. Bank of America, N.A. (2002).

  • Proper Notice.

  • Accommodation Parties: Signs instrument to lend name as credit to another party on the instrument.


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Unauthorized Signatures

  • Authorized Agent’s Signature.

    • To hold Principal liable agent must be authorize to sign and Principal must be clearly named.

    • Agent personally liable when Principal is not named or disclosed, unless check is drawn on Principal’s account.


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Unauthorized Signatures

  • Unauthorized Signatures.

    • Forgery does not bind owner but Bank is liable.

    • If Agent has no authority, Agent is personally liable, but Principal is not, unless ratified.


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Unauthorized Indorsements

  • Unauthorized indorsement does not bind maker/drawer except:

    • “Imposter Rule”: imposter induces maker/drawer to issue check to imposter.

    • When imposter signs as/on behalf of maker/drawer intending payee has no interest in the instrument.


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Warranty Liability

  • Extends to both signers and non-signers.

  • Breach of warranty can occur when the instrument is transferred or presented for payment.


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Warranty Liability

  • Transferors make certain implied warranties regarding instruments they negotiate.

  • Liability not subject to dishonor, presentment, notice.

  • Liabilities: Transfer or Presentment.


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Transfer Warranties

  • Following transfer warranties extend to all subsequent holders:

    • Transferor is entitled to enforce the instrument.

    • Signatures are authentic and authorized.

    • Instrument has not been altered.

    • Instrument not subject to defense.

    • Transferor has no notice of insolvency.


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Presentment Warranties

  • Person who presents an instrument makes the following presentment warranties:

    • No missing or unauthorized indorsement.

    • Instrument has not been altered.

    • Person obtaining payment has no knowledge signature is unauthorized.


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Defenses To Liability

  • Universal or Real - can be used to defeat a holder and a HDC.

  • Personal - can be used to defeat a holder but not a HDC.


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Universal Defenses

  • Forgery of maker’s or drawer’s signature.

    • Or if an authorized agent exceeds his authority to the amount which exceeds his authority.

  • Fraud in the execution - the “autograph” situation, not fraud in the inducement.


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Universal Defenses

  • Material Alteration.

    • Do not have to pay the altered amount ($8 to $800), only a personal defense to the original amount ($8).

    • Not a real defense if instrument left blank, (.. filled in $800), then have to pay all ($800).

  • Discharge in Bankruptcy.

  • Infancy (Minority).


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Universal Defenses

  • Illegality - severe enough to make contract void.

  • Mental Incapacity (adjudicated by court).

  • Extreme Duress. If instrument signed under threat of immediate force or violence.


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Personal Defenses

  • Valid against holders but not HDC’s.

    • Breach of contract or warranty.

    • Lack of consideration.

    • Fraud in the inducement.

    • Illegality - not severe enough to make void.


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Personal Defenses

  • Mental incapacity - not severe enough to make void.

  • Discharge.

    • By payment or cancellation.

    • Unauthorized completion.

    • Non-delivery of instrument.

    • Ordinary duress or undue influence rendering contract voidable.


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Discharge from Liability

  • Discharge from liability on an instrument can occur by:

    • Payment.

    • Cancellation.

    • Material Alteration.


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Discharge by Payment

  • All parties to an instrument will be discharged when the party primarily liable on the instrument pays to the holder the amount due in full.


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Discharge by Cancellation

  • Intentional cancellation of an instrument discharges the liability of all parties.

    • Examples: Intentionally writing “paid” on the front of an instrument, or tearing it up or mutilating it, cancels the instrument.


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