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Chapter 14. Negotiable Instruments. Quote of the Day. “A negotiable bill or note is a courier without luggage.” John B. Gibson, Overton v. Tyler, 1846. Commercial Paper. System for transferring paper funds easily Types of commercial paper Negotiable Non-negotiable.

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Chapter 14

Chapter 14

Negotiable Instruments

Quote of the day
Quote of the Day

“A negotiable bill or note is a courier without luggage.”

John B. Gibson,

Overton v. Tyler, 1846

Commercial paper
Commercial Paper

  • System for transferring paper funds easily

  • Types of commercial paper

    • Negotiable

    • Non-negotiable

Types of negotiable instruments
Types of Negotiable Instruments

  • Note: (promissory note) is a promise that you will pay money

    • Two people involved

      • Maker: Issuer of a promissory note

      • Payee: Someone who is owed money under the terms of an instrument

Types of negotiable instruments1
Types of Negotiable Instruments

  • Draft: Order directing someone else to pay money for you

    • Check: Most common form of a draft

      • Order telling a bank to pay money

    • Three people involved

      • Drawer: Person who issues a draft

      • Drawee: One ordered by the drawer to pay money to the payee

      • Payee

  • Issuer: All purpose term that means both maker and drawer

Fundamental rule of commercial paper
Fundamental Rule of Commercial Paper

  • Possessor of commercial paper has an unconditional right to be paid, so long as:

    • Paper is negotiable

    • It has been negotiated to the possessor

    • Possessor is a holder in due course

    • Issuer cannot claim a valid defense

Requirements for negotiability
Requirements for Negotiability Paper

  • The instrument must:

    • Be in writing

    • Be signed by the maker or drawer

    • Contain an unconditional promise or order to pay

    • State a definite amount of money

    • Be payable on demand or at a definite time

    • Be payable to order or to bearer

Interpretation of ambiguities
Interpretation of Ambiguities Paper

  • When terms contradict, three rules apply:

    • Words take precedence over numbers

    • Handwritten terms prevail over typewritten terms

    • Typed terms prevail over printed terms

Negotiation Paper

  • Means that an instrument has been transferred to the holder by someone other than the issuer

    • To be negotiated, order paper must first be indorsed and then delivered to the transferee

    • Bearer paper must simply be delivered to the transferee

      • No indorsement is required

Negotiation Paper

  • Order paper: Instrument that includes the words “pay to the order of” or their equivalent

  • Bearer paper: Note is a bearer paper if it is made out to “bearer” or it is not made out to any specific person

    • Can be redeemed by any holder in due course

  • Indorsement: Signature of a payee

Holder in due course
Holder in Due Course Paper

  • Has an automatic right to receive payment for a negotiable instrument

  • Requirements for holder in due course:

    • Is a holder who has given value for the instrument, in good faith

      • Without notice of outstanding claims or other defects

Holder in due course1
Holder in Due Course Paper

  • Requirements for holder in due course

    • Holder: For order paper, anyone in possession of the instrument if it is payable to or indorsed to her

      • For bearer paper, anyone in possession

    • Value:Holder has already done something in exchange for the instrument

    • Good faith

      • Two tests to determine

        • Subjective test

        • Objective test

Notice of outstanding claims or other defects
Notice of Outstanding Claims or Other Defects Paper

  • The instrument is overdue

  • The instrument is dishonored

  • The instrument is altered, forged, or incomplete

  • The holder has notice of certain claims or disputes

Defenses against a holder in due course
Defenses against a Holder in Due Course Paper

  • Issuer of a negotiable instrument is not required to pay if:

    • Signature on the instrument was forged

    • After signing, debts were discharged in bankruptcy

    • Amount was altered after he signed it

    • Signed under duress, mentally incapacitated, or part of illegal transaction

    • Tricked into signing the instrument

Consumer exception
Consumer Exception Paper

  • Federal Trade Commission has special rules for consumer credit contracts

  • Consumer credit contract: Consumer borrows money from a lender to:

    • Purchase goods and services from a seller who is affiliated with the lender

Liability for negotiable instruments
Liability for Negotiable Instruments Paper

  • Signature liability:Liability of someone who has signs an instrument

  • Warranty liability:Liability of someone who receives payment on an instrument

Primary versus secondary liability
Primary versus Secondary Liability Paper

  • Primary liability: Unconditionally liable

    • Must pay unless he has a valid defense

  • Secondary liability: Must pay only if the person with primary liability does not pay

  • The holder of an instrument must first try to get payment from:

    • The party with primary liability before making demands against a party with secondary liability

Signature liability
Signature Liability Paper

  • The maker is primarily liable

  • The drawer of a check has secondary liability

  • The bank (drawee) is not liable to:

    • The holder and owes no damages to the holder for refusing to pay the check

Signature liability1
Signature Liability Paper

  • Drawee

    • Certified check: A check the issuer’s bank has signed, indicating its acceptance of the check

    • Acceptor: Bank (drawee) that accepts a check (draft), thereby becoming primarily liable on it

    • Cashier’s check: Check drawn on the bank itself

      • Promise that the bank will pay out of its own funds

Signature liability2
Signature Liability Paper

  • Indorser: Anyone, other than an issuer or acceptor, who signs an instrument

    • Secondary liable

  • Indorsers are not liable if:

    • They write the words “without recourse” next to their signature on the instrument

    • Bank certifies the check

    • Check is presented for payment more than 30 days after the indorsement

    • Check is dishonored and the indorser is not notified within 30 days

Accommodation party
Accommodation Party Paper

  • Someone, other than an issuer, acceptor, or indorser:

    • Who adds her signature to an instrument for the purpose of being liable on it

  • Accommodated party: Someone who receives a benefit from an accommodation party

  • An accommodation party has the same liability to the holder as the person for whom he signed

Rules of warranty liability
Rules of Warranty Liability Paper

  • The wrongdoer is always liable

  • The drawee bank is liable if it pays a check on which the drawer’s name is forged

    • The bank can recover from the payee only if the payee had reason to suspect the forgery

  • In any other case of wrongdoing, a person who first acquires an instrument from a wrongdoer is ultimately liable to anyone else who pays value for it

Transfer warranties
Transfer Warranties Paper

  • When someone transfers an instrument, she warrants that:

    • She is the holder of the instrument

    • All signatures are authentic and authorized

    • Instrument has not been altered

    • No defense can be asserted against her

    • As far as she knows the issuer is solvent

Comparison of signature liability and transfer warranties
Comparison of Signature Liability and Transfer Warranties Paper

  • A forged signature is invalid and creates no signature liability for the person whose name was signed

    • The recipient of a forged item may recover under transfer warranties

  • Signature liability rules do not apply to the transfer of bearer paper since no indorsement is required

    • Transfer warranties apply

Presentment warranties
Presentment Warranties Paper

  • Apply to someone who demands payment for an instrument from the maker, drawee, or anyone else liable

  • Presenter warrants that:

    • She is a holder

    • The check has not been altered

    • She has no reason to believe the drawer’s signature is forged

  • Anyone who presents a promissory note for payment warrants that he is a holder of the instrument

Other liability rules
Other Liability Rules Paper

  • Conversion liability

    • Conversion: Means that:

      • Someone has stolen an instrument

      • Bank has paid a check that has a forged indorsement

  • Impostor rule

    • If someone issues an instrument to an imposter:

      • Any indorsement in the name of the payee is valid as long as the person who pays the instrument does not know of the fraud

Other liability rules1
Other Liability Rules Paper

  • Fictitious payee rule

    • If an instrument is issued to a person who does not exist:

      • Indorsement in the name of the payee is valid as long as the payer does not know of the fraud

  • Employee indorsement rule

    • If an employee with responsibility for issuing instruments forges an instrument:

      • Indorsement in the name of the payee is valid as long as the payer does not know of the fraud

Negligence Paper

  • Anyone negligent in creating or paying an unauthorized instrument is liable to an innocent third party

    • Anyone careless in paying an unauthorized instrument is liable:

      • Despite the three rules

    • Anyone careless in allowing a forged or altered instrument to be created is also liable:

      • Whether or not he has violated one of the three rules

“It is never wise to play an important game without understanding the rules. The rules of negotiable instruments are complex, but important because this game is played by virtually everyone.”