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106 Cards in this Set

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A two-party commercial paper. A written and signed promise (undertaking by one party, the "maker," to pay money to another party, the "payee" or "bearer.").
Certificate of Deposit (CD)
Like a note, because two parties are involved. But it is an instrument made by a bank containing:
(1) an acknowledgment that a sum of money has been received by the bank, and
(2) a promise by the bank to repay the sum of money.
What if an instrument qualifies as a note AND a draft?
The person entitled to enforce the instrument may enforce as either.
Three-party commercial paper. A written and signed instruction by one person ("the drawer") to another person ("the drawee") demanding that drawee pay money to third person (the "payee" or "bearer"). In practice, the term "bill of exchange" is a draft.
Specific type of draft, namely one drawn on a bank and payable on demand. An instrument will be deemed a check if it meets these requirements, even if instrument is described on its face by another term (e.g., a money order).
Other Terms and Instruments
Other instruments (stocks/bonds, etc) are dealt with in other parts of the UCC. If they show up on the exam, answer in analogy to Article 3.

UCC does NOT apply to money.

Issue: First delivery of an instrument by maker/drawer for purposes of giving rights on the instrument to any person. Maker/drawer is the issuer.
A negotiable instrument means a written and signed
(1) unconditional
(2) promise or order
(3) to pay a fixed amount of money with or without interest or other charges described in promise/order that
(a) is payable to order or bearer at time issued or first comes into possession of a holder,
(b) is payable on demand or at a definite time, and
(c) does not state any unauthorized undertaking or instruction by person promising or ordering payment.
Unconditional Instrument
An instrument will be conditional, and therefore not negotiable, if it:
(1) expressly states a condition to payment, or
(2) states that the promise/order is subject to or governed by another writing.

Promise/order will not be deemed conditional merely because it:
(1) refers to another writing for a statement of rights regarding collateral, prepayment, or acceleration,
(2) limits payment to a particular source or fund, or
(3) requires as a condition of payment a countersignature by person whose specimen signature appears on the promise/order (traveler's checks).

May not be subject to, but may refer to, another writing.
Promise or Order to Pay
Promise: written undertaking to pay money signed by person undertaking to pay.

Order: written instruction to pay money signed by person giving order.

Writing required - UCC says any intentional reduction to tangible form will suffice.

Signature required - UCC is very liberal as to what constitutes a signature.
Fixed Amount of Money
Money - any medium of exchange authorized or adopted by a government. "Currency" and "current funds" = money.

Instrument may be negotiable even if it calls for payment in foreign money. Unless otherwise provided, payable in specified currency or its equivalent in US dollars at current exchange rate at time/place instrument is paid.

An instrument will not be negotiable if it calls (or allows) for payment other than money (e.g., an ounce of gold).

Principal due MUST be fixed, but interest need not be. Interest rate may be variable or fixed. If rate not specified, the going rate for a court judgment will be used.
Payable to Order or to Bearer
Payable to order only if payable to an identified person ("pay to the order of John Smith") or to an identified person or order ("pay John Smith or his order").

Promise/order is payable to bearer if:
(1) states it is payable to bearer, order of bearer, to order of bearer, to order and bearer, or otherwise indicates person in possession is entitled to payment,
(2) doesn't state a payee ("pay to the order of _______"), or
(3) states is payable to CASH or otherwise indicates not payable to an identified person.

Person to whom an instrument is payable is governed by the intent of the person signing as or on behalf of the issuer. If more than one person issues the instrument, any person intended by any signer may properly be paid. May be identified by anything: name, office, account number, etc.
On Demand or at a Definite Time
Payable on demand if it states that it:
(1) is payable "on demand" or "at sight" or otherwise indicates that it is payable at will of holder, or
(2) doesn't state a time for payment.

Definite time if payable:
(1) on a fixed date,
(2) on elapse of a specified period of time after sight or acceptance, or
(3) at sometime readily ascertainable at time instrument is issued.

If payable on or after state time/event certain to happen but uncertain as to time, not negotiable.

An acceleration clause doesn't destroy negotiability.

Extension clause at option of maker or on happening of event is OK if extension is to a further definite time stated in the instrument. Extension at option of holder is always permitted.
No Unauthorized Undertaking or Instructions
To be negotiable, an instrument generally cannot contain any unauthorized undertakings or promises. However, UCC explicitly permits 3 undertakings or instructions that may be included:
(1) an undertaking or power to give, maintain, or protect collateral;
(2) an authorization or power to the holder to confess judgment or realize on or dispose of collateral; and
(3) a waiver of benefit of any law intended for advantage or protection of obligor (e.g., waiver of presentment, etc).

Any other promise/undertaking will destroy negotiability.
Rules of Construction
If an instrument contains contradictory terms, typewritten terms control printed terms, and handwritten terms control both. Words control figures unless words are ambiguous or uncertain (illegible), in which case figures control. Thus, "pay five hundred dollars ($5,000)" is construed as an order to pay $500.
Opting Out
A promise or order that otherwise meets requirements of a negotiable instrument will NOT be negotiable if, at the time it is issued or first comes into possession of a holder, it contains a conspicuous statement that it is not a negotiable instrument or that Article 3 is not applicable.

Note: This rule doesn't apply to checks. Such instruments are often used in ads offering a discount.
Two or More Signers in Single Capacity
Unless instrument otherwise specifies, two or more persons who have same liability on an instrument as makers, acceptors, drawers, or endorsers who endorse as joint payees or anomalous endorsers are jointly and severally liable in the capacity in which they sign.

For example, if two people sign as makers of the note, either one can be held liable for the full value of the note.
Incomplete Instruments
A signed writing (whether or not issued by signer), contents of which show that instrument was incomplete at time of signing but the signer intended it to be completed by addition of words or numbers. Under Article 3, an incomplete instrument may be enforced according to its incomplete terms or as augmented by an authorized completion. True even if instrument wouldn't qualify as an instrument but for the completion. If instrument is completed without authorization, treated as a fraudulently altered instrument.
Negotiation Process
Code's definition:
(1) Negotiation is a transfer of possession of an instrument (voluntary or involuntary) by a person other than issuer to a person who thereby becomes its holder, and
(2) A holder is a person in possession of the instrument if the instrument is payable to bearer; if instrument payable to identified person, that person is the holder as soon as she gets possession.

In other words, a holder is a person in possession of an instrument with a right to enforce it.
Bearer Instruments
A negotiable instrument that is issued as bearer paper or subsequently converted into bearer paper (e.g., by blank endorsement) is negotiated simply by transferring possession of instrument. Once the transferee has possession, she technically qualifies as a holder.

Examples: Drawer writes check to "Cash" --> bearer instrument. Drawer writes check to "Grocer" --> Grocer is holder.
Order Instruments
Instrument payable to an identified person is negotiated by transferring possession of instrument along with endorsement of identified person.
Right to enforce an order instrument will not pass unless payee's endorsement is authorized and valid. Forging payee's name breaks chain of title and no subsequent possessors of instrument can qualify as "holders."
Signature (genuine) obtained by fraud or from infant is effective for purpose of negotiation.
All necessary signatures must be included.
May be payable to multiple payees. If connected by "and," payable to all JOINTLY, and any subsequent negotiation requires all to endorse. If connected by "or" or "and/or," payable to all severally, and endorsement by one is sufficient.
Endorsement must be written on instrument somewhere, or on a paper affixed to the instrument (an "allonge").
Liabilities and Remedies for Order Instruments
Delivery of order instrument without endorsement(s) required may be effective to transfer possession, but no negotiation until endorsement made. Transferee (if paid value for instrument) may sue in equity to compel endorsement. If instrument is due, transferee can sue to enforce, but must prove ownership rights in instrument. A depository bank that takes instrument for collection is a holder if customer was a holder at the time of delivery, even if not endorsed. Doesn't remove bank's liability if they mishandle the funds. Upon obtaining transferor's endorsement, right to enforce is vested in transferee (now a holder). For purpose of determining whether transferee had notice of any adverse claim or defense to instrument, knowledge is measured as of the time she obtains the missing endorsement.

If endorsement attempts to convey less than complete amount of instrument, it is not a negotiation and transferee doesn't qualify as a holder. If an instrument has been partially paid (e.g., an installment note), endorsement of all that remains will be an effective negotiation.
Special Endorsement
One that names a particular person as "endorsee." Endorsee must sign in order for instrument to be further negotiated.

Words of negotiability (e.g., "pay to the order of") not required.

Extra words in endorsement do not impair validity.
Blank Endorsement
Signature that is not accompanied by the naming of a specific endorsee. Blank endorsements create a bearer paper, which may then be negotiated by delivery alone.

A writes check to B who endorses on back. Check is lost and C finds it. C is a holder.

A writes check to B. B writes on back "Pay to C" then signs. Check is lost and D finds it. D is not a holder.
Endorsement of Names Not Necessary to Chain of Title
Forgery of names not necessary to chain of title and will not keep later takers from becoming holders.
Forgery of Drawer's Name
Doesn't break chain of title, and, thus, subsequent transferees may qualify as holders. This is because the forgery operates as the genuine signature of the forger.
Multiple Endorsements
If instrument has been endorsed several times, some in blank and some specially, the last endorsement controls what is necessary for further negotiation.
Qualified Endorsement
Endorsement that adds words "without recourse" is a "qualified" endorsement. The effect is to limit the legal liability otherwise imposed on endorsers under the UCC.
Restrictive Endorsements
Any other language added to an endorsement creates a "restrictive" endorsement. Examples: Conditions, trust endorsements, and endorsements restricting further negotiation to the check collection system (e.g., "for deposit only"). Endorsement limiting payment to a particular person or otherwise prohibiting further transfer or negotiation is not effective to prevent transfer or negotiability. Endorsement stating a condition to payment is not effective to condition payment.

If endorsement includes words that indicate the purpose of having the instrument collected by bank for endorser (e.g., "for deposit"), a person or depository bank must pay instrument consistently with the endorsement or will be deemed to have converted the instrument. Intermediary banks and the payor bank may disregard the restrictive endorsement.
Anomalous Endorsements
An endorsement made by a person who is not a holder of the instrument. This is usually done for purpose of accommodation. Such an endorsement does not affect the manner in which the instrument may be negotiated, but it does make the signer liable on the instrument.
Holder in Due Course
Holder - has possession and instrument must be payable to bearer or person in possession. Instrument must be free of forgeries of names necessary to chain of title.

Due Course - Holder who takes instrument:
(1) for value,
(2) in good faith, and
(3) without notice that:
(a) instrument is overdue or has been dishonored, or that there is an uncured default with respect to payment of another instrument issued as part of the same series,
(b) instrument contains an unauthorized signature or has been altered,
(c) there is a claim to the instrument, or
(d) any party has a defense or claim in recoupment (a claim that reduces the amount payable) on the instrument.
Five things that constitute value:
(1) performance of the agreed consideration,
(2) acquisition by the holder of a lien or security interest in the instrument other than a lien obtained by judicial proceeding,
(3) taking instrument as payment of or security for an antecedent debt,
(4) trading a negotiable instrument for another instrument, or
(5) giving the instrument in exchange for the incurring of an irrevocable obligation to a third person by the person taking the instrument.

Executory promise (promise to give value in future) is not value. Value need not be equivalent to face value. However, if one pays less than agreed amount, becomes a partial HDC.

Time value is given is important, because whether one takes an instrument in good faith and without notice is measured at the time instrument is negotiated or when value is given, whichever is later.

Bank deposits: Merely crediting depositor's account is not value. However, bank becomes holder for value to the extent that it permits withdrawals of amount credited to depositor's account using first money in, first money out (FIFO) rule to determine if particular credited item has been reached.
Good Faith
Honesty in fact and observance of reasonable commercial standards of fair dealing.

Honesty in fact is subjective (what actor actually believed). "Pure heart, empty head" test.

Fair dealing is objective (actor must proceed fairly in light of the facts and commercial standards). Different from the ordinary care standard.
Notice to Purchaser
Notice = actual knowledge (subjective standard) or reason to know (objective standard). Must be received in such time/manner to give reasonable opportunity to act.
Facts NOT Constituting Notice
(1) Instrument antedated, undated, or postdated,
(2) Instrument issued in return for executory promise,
(3) Mere fact that party has signed for accommodation,
(4) Incomplete instrument,
(5) Fiduciary negotiated,
(6) Default in payment of interest on instrument or any other instrument unless of same series,
(7) Filing or recording of document,
(8) Purchase at a discount,
(9) Notice of discharge of a party other than discharge in an insolvency proceeding.
Facts Constituting Notice
(1) Instrument overdue (any part of principal overdue, acceleration made, demand made, or more than reasonable time has elapsed after issue - 90 days for checks),
(2) Notice of unauthorized signatures or alteration,
(3) Notice that another has property or possessory right in the instrument or its proceeds or that negotiation is rescindable,
(4) Notice of breach of fiduciary duty involving the instrument,
(5) Notice of defense available to obligor (infancy, duress, etc),
(6) Notice of claim recoupment.
Transactions Precluding HDC Status
Holder does not become an HDC of an instrument taken by:
(1) legal process or purchase at creditor's sale;
(2) acquiring it as a successor in interest to an estate or other organization; or
(3) purchasing it as part of a bulk transaction not in the regular course of business of the transferor.
Time at Which HDC Status Determined
At the moment instrument is negotiated to the holder and she gives value therefor, whichever occurs later.
Holder of Security Interest
If person entitled to enforce an instrument has only security interest in instrument, and person obliged to pay instrument has a defense or claim that may be asserted against person who granted security interest, person entitled to enforce instrument may assert HDC rights only to the extent of unpaid secured obligation.
Payees as HDCs
Payee of instrument might qualify as an HDC. But generally, because payee is involved in transaction giving rise to the instrument, and has dealt with the person he wishes to sue (e.g., maker or drawer of instrument), payee will be subject to that person's defenses.
Successors to HDCs
Shelter Rule: Transferee acquires whatever rights her transferor had. Exceptions: Shelter rule never grants HDC status to persons who were parties to fraud or illegality affecting the instrument. A party so implicated cannot sell the instrument to an HDC and reobtain it in order to free herself from a defense of fraud or illegality.

Once a person has qualified as HDC, all subsequent transferees will acquire same HDC rights no matter how far down the chain of transferees they may be, unless they are transferees after the holder failed to obtain HDC rights because she was a party to fraud/illegality affecting the instrument.
Claims on Negotiable Instruments
An affirmative right to a negotiable instrument because of superior ownership. For example, if a check is stolen from the payee and the payee's name is forged thereon, payee is still the true owner of the check and may bring a replevin action to claim it from the person who now possesses it. In this case, possessor cannot be an HDC because he can't qualify as a holder.
Real Defenses
May be asserted against HDCs and non-HDCs:
(1) Forgery
(2) Fraud in the Factum (Real Fraud)
(3) Alteration of Instrument
(4) Incapacity to Contract
(5) Infancy
(6) Illegality
(7) Duress
(8) Discharge in Insolvency Proceedings
(9) Statute of Limitations
(10) Accommodation (Suretyship) Defenses
(11) Discharges Known to HDC
Forgery - Real Defense
If name of payee or any special endorsee is unauthorized, no subsequent taker can be an HDC. However, if person whose name was forged ratifies unauthorized signature or is estopped from denying it, subsequent takers can qualify as HDCs.

Forgery of names not necessary to title doesn't affect right to enforce; and subsequent takers may qualify as HDCs if they meet the usual tests. But party whose name forged has real defense of unauthorized signature unless he ratifies or is estopped from denying.
Fraud in the Factum (Real Fraud) - Real Defense
Under the UCC, there are two kinds of fraud: real and personal. "Real" fraud is assertable against an HDC, and is defined as "fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms." Any other type of fraud (which encompasses most types) is a personal defense not assertable against an HDC. Even where defendant was unaware he was signing a negotiable instrument, can't be real fraud if he failed to take reasonable steps to ascertain nature of transaction.
Alteration of Instrument - Real Defense
A change to the terms of the instrument. For example, a thief might alter amount of check from $10.00 to $1,000 by eliminating the decimal point. In certain circumstances, an HDC may be able to collect only the original amount, so that the material alteration is a partial "real" defense. In other situations, an HDC may be able to collect on the instrument as altered.
Incapacity to Contract - Real Defense
Under state law, certain persons may lack capacity to contract (declared incompetent by courts, or corporations who have failed to take the necessary legal steps to transact business within the state). Before incapacity will be a real defense, state law must render contract void from its inception rather than merely voidable at option of the incompetent, in which case incompetency is a personal defense and cannot be raised against an HDC.
Infancy - Real Defense
Infancy is a real defense if it would be a defense under state law in a simple contract action. If state law doesn't make contracts of an infant void or voidable, infancy would only be a personal defense.
Illegality - Real Defense
If some illegality in the underlying transaction renders obligation void (as opposed to merely voidable), this is a real defense even if HDC had nothing to do with the illegality. If obligation is merely voidable, it is a personal defense.
Duress - Real Defense
Occurs in contract situation where one party acts involuntarily. Real defense if state law would render contract void. Personal defense if state law would render contract merely voidable.
Discharge in Insolvency Proceedings - Real Defense
Insolvency proceedings include an assignment for the benefit of creditors (a state liquidation proceeding) and any other proceeding intending to liquidate or rehabilitate the estate of the person involved.
Statute of Limitations - Real Defense
If statute of limitations has run on the instrument, even an HDC cannot enforce it.

Three Years: Actions on unaccepted drafts must be brought within 3 years of date of dishonor or 10 years after date of draft (earlier of 2). Actions against acceptor of certified checks, or issuer of teller's, cashier's, or traveler's checks must be brought within 3 years of demand for payment made. All other actions brought within 3 years of accrual.

Six Years: Actions on notes payable at a definite time or on demand must be brought within 6 years after due date or demand. Actions on CDs must be brought within 6 years after demand for payment is made, but limitations period does not commence before any stated due date.
Accommodation (Suretyship) Defenses - Real Defense
An accommodation party is one who signs in instrument for the purpose of incurring liability on the instrument without being a direct beneficiary of the instrument. If an HDC knows of the accommodation when he takes the instrument, the takes subject to the accommodation party's suretyship defenses - discharge to the extent of loss caused by: (1) an extension of the due date; (2) a material modification of the obligation; or (3) impairment of collateral.
Dicharges Known to HDC - Real Defense
An HDC takes a negotiable instrument subject to any discharge of which he has notice when he acquires HDC status.

Discharge, unless apparent from the face of the instrument or HDC knows of it, is a personal defense and not assertable against an HDC.
Personal Defenses
Cannot be asserted against an HDC.

Absence of consideration is a valid personal defense.
In defending a lawsuit, must rely on your own defenses and cannot use those of third party as yours.
Payment Rule: Liability of any party obligated to pay on an instrument is discharged by payment to a person entitled to enforce the instrument unless another person has an enforceable claim to the instrument and:
(1) payment is made with knowledge that it is prohibited by an injunction;
(2) in cases not involving a cashier's, teller's, or certified check, party making payment has accepted (from a person with claim to the instrument) indemnity against loss for refusal to pay the person entitled to enforce instrument; or
(3) person making payment knowns instrument is stolen and that the person being paid is in wrongful possession.
Exception to relying on own defenses: THEFT. Payment without raising issue of theft (if known) will discharge liability.
Who May Enforce an Instrument?
(1) Holder of the instrument.
(2) A non-holder in possession of the instrument who has the rights of a holder (e.g., person who obtained the instrument through subrogation); and
(3) A person not in possession of the instrument but who is entitled to enforce it (e.g., lost, stolen, or destroyed instrument situation).
Burden of Proof
To make out a prima facie case for payment, the person presenting the instrument for payment need only prove that:
(1) signatures on the instrument are genuine, and
(2) she is a person entitled to enforce the instrument.

If these elements are proved, person presenting the instrument is entitled to payment unless the defendant proves a defense or claim in recoupment. Note that the issue of whether the person presenting the instrument for payment has the status of an HDC is irrelevant unless defendant raises defenses.
Proof of Signatures
Unless defendant specifically denies validity of any signature in his pleadings, its validity is deemed admitted. If defendant specifically denies validity of a signature, person claiming it is valid has the ultimate burden of proof; however, presumption of validity still applies, and so no evidence of validity is necessary until defendant presents evidence of invalidity, unless the action is to enforce liability of purported signer, who is now dead or incompetent.

If plaintiff is seeking to enforce instrument against an undisclosed principal (e.g., instrument signed by agent in his own name on behalf of and with authorization from a principal whose name does not appear on the instrument), plaintiff has burden of establishing that principal is liable on the instrument as a represented person.
Proof of Defenses
If the person presenting the instrument has made out a prima facie case, she is entitled to payment unless defendant raises a defense or claim in recoupment. If a defense or claim in recoupment is made, plaintiff can cut off the defense by proving that she is entitled to HDC status.
Where Instrument is Lost, Stolen, or Destroyed
If person entitled to enforce instrument can't produce for one of these reasons, she is nevertheless entitled to maintain an action on the instrument as though she could produce it, providing she can prove her ownership, the terms of the instrument, and the facts that prevent her production of it. The court in such a case is entitled to require protection indemnifying the defendant against loss by reason of additional claims on the instrument. Adequate protection may be provided by any reasonable means; it need not be by security bond.
Procedure for Missing Certified, Cashier's, or Teller's Check
A drawer or payor of a certified check or the remitter (a person who purchases an instrument from its issuer payable to a third party) or payee of a cashier's or teller's check may claim a right to payment if the check is lost, destroyed or stolen. The claimant must inform the bank in writing and under oath that the check is missing, giving bank reasonable time to prevent payment to another, and must provide reasonable identification if the bank requests. Claim is enforceable at the later of the time it is asserted or 90 days after the date of check (90 days after acceptance for certified checks). In the interim, check may be paid if person entitled to enforce the check presents it, and such payment discharges liability to the claimant. If claim becomes enforceable (i.e., check hasn't been presented for payment in the interim), the bank is obliged to pay claimant and need not pay a person later presenting the check for payment. However, if the later presenter has the rights of an HDC, the claimant must refund the money to the bank or pay the HDC.
Action for Conversion
A person entitled to possession of an instrument may bring an action for conversion of the instrument. Conversion, generally, is governed by the law applicable to the conversion of personal property. Note, however, that neither the issuer nor a payee or endorsee who never received delivery of the instrument may maintain an action for conversion.
Vouching In
It should be noted that it is possible to "vouch in" parties to an instrument who may be liable to the party sued. Procedure is as follows:
(1) If a defendant to a suit on an instrument has a right of recourse against someone else if he is required to pay, then he may give that third party written notice of the litigation.
(2) Notice will say that person notified may come in and defend, and that if he doesn't, he'll be bound by the outcome.
(3) If the person doesn't come in after receipt of such notice, then he will be bound if in a subsequent lawsuit he is sued by the party who gave the notice. Again he will be bound by the facts found in first suit common in both suits.
(4) Any person "vouched in" under this procedure may in turn "vouch in" any person who may be liable to him, and so on.
Maker of Note/Issuer of Check's Liability
Maker of note or issuer of cashier's check, merely by signing her name, becomes obligated to pay the instrument according to its terms at the time it was issued, or if instrument not issued, at the time it first came into possession of a holder. Her promise is unconditional - she must pay the instrument on the due date, although she is permitted to assert the defenses as described previously. Note: If a note is payable at the bank ("I promise to pay to the order of Pete Payee at Payee National Bank") the person entitled to enforce the note must take the instrument to the bank and present it for payment.
Endorser's Liability
Considered secondarily liable on an instrument, meaning that a person entitled to enforce an instrument looks to the maker/drawee first for payment, and will look to endorser for payment only if maker or drawee will not pay. Endorser can be held liable in two ways: endorser's contract or in warranty.

Endorser's Contract: This obligation arises from signing name. Obligation is to pay according to terms of instrument at time of endorsement (or if endorsing incomplete instrument, according to its terms as completed). Obligation can be negated if the endorsement is qualified (i.e., signed "without recourse"). Generally, three prerequisites to endorser's obligation: (1) presentment, (2) dishonor, and (3) notice of dishonor.

Warranty: When an endorser transfers instrument for consideration, endorser becomes a transferor and can be liable for the transfer warranties.
Demand for payment made by person entitled to enforce an instrument. Usually made to drawee of a draft or maker of a note.
Endorser's liability on check will be discharged unless it is presented for payment or given to depository bank for collection within 30 days of endorsement.
Presentment can be made by any commercially reasonable means, including oral, written, or electronic communication, and can be made at any contemplated place of payment (but if instrument is payable at a bank in the U.S., presentment must be made there).
Presentment for payment/acceptance excused if:
(1) person entitled to present instrument cannot with reasonable diligence present;
(2) maker or acceptor has repudiated the obligation to pay or is dead or insolvent;
(3) by terms of instrument, presentment is unnecessary;
(4) obligor has waived presentment; or
(5) drawer instructed drawer not to pay or drawee was not obligated to pay.
Occurs when maker of note or drawee of draft doesn't pay or accept the instrument within allowed time after presentment. Note the following timing rules:

Generally, demand instruments (i.e., instruments not stating a date for payment) other than checks will be considered dishonored if not paid on date presented for payment.

Time notes payable at or through a bank and most time drafts payable on a specific date are considered dishonored if they are not paid on the date they become payable according to their terms or the date they are presented, whichever is later. A time note not payable at or through a bank is dishonored if it is not paid on date it is payable. A time draft presented for acceptance rather than payment is dishonored if it is not accepted on the date it is presented.
Notice of Dishonor
Notification that instrument was dishonored. May be given by any commercially reasonable means of communication. Obligation of an endorser is discharged if he's not given notice of dishonor.

Note that notice of dishonor doesn't have to be given to a maker of a note (because he knows he didn't pay it) or the drawer of a draft unless the draft was accepted by an acceptor.

Generally, notice of dishonor must be given within 30 days after dishonor. For instruments taken for collection by collecting banks, notice must be given before the midnight deadline.

Delay in giving the notice is excused if the delay is caused by circumstances beyond the control of the person giving notice, and person giving notice exercised reasonable diligence after cause of delay ceased to exist.

Notice of dishonor is excused entirely if the terms of the instrument make notice unnecessary or the obligor has waived notice.
Multiple Endorsers
Where more than one endorsement appears on an instrument, any endorser is severally liable for the full amount to any holder or later endorser of the instrument.
Example of Endorser Liability
A gives B a $1,000 as payment for a car. B owes C $950 for a ring B purchased from C, so B endorses his name on back of check and gives to C. Before B is liable to C on that check:
(1) C must present check for payment or deposit check within 30 days of B endorsing;
(2) Drawee bank must refuse to pay (dishonor); and
(3) C must give B notice of dishonor within 30 days of the dishonor.
Transferor Liabilities
(1) Five warranties.
(2) If transfer not by endorsement, the warranties run ONLY to immediate transferee. But if transfer by endorsement, warranties run to all subsequent transferees.
(3) Presentment, notice of dishonor, etc, are irrelevant to warranty liability.
(4) Warranty liability (other than on checks) can be negated by the transferor if she places proper words on the instrument (e.g., "without warranty"). Words "without recourse" are probably not sufficient.
Five Transfer Warranties
Whenever someone transfers an instrument for consideration, transferor makes the following 5 warranties:
(1) Transferor warrants that he is a person entitled to enforce the instrument (basically that all endorsements necessary to chain of title are genuine).
(2) Signatures are authentic and authorized.
(3) Instrument hasn't been altered.
(4) That no defense or claim of any party is good against her.
(5) That he has no knowledge of any insolvency proceeding that has been instituted against the maker, acceptor, or drawer of an unaccepted instrument.
Drawer Liabilities
Generally, if draft is dishonored, drawer of draft is obligated to pay draft according to its terms when drawer signed the instrument (or if instrument was incomplete, according to its terms as completed, as controlled by the rules regarding incomplete instrument). Thus, like an endorser, drawer has secondary liability.

If draft accepted by bank (signed by bank so bank has primary liability on draft), drawer is discharged from his obligation on the draft regardless of when the draft was accepted or by whom acceptance was obtained.
Drawee's Liability
Drawee cannot have any liability on instrument unless and until drawee signs the instrument. When drawee does sign, it becomes an acceptor.

Death of a customer doesn't revoke bank's authority to pay a check until bank (1) knows of death and (2) has reasonable time to act on such knowledge. Even with such knowledge, bank may keep paying checks for 10 days after date of death unless person claiming interest in account orders that payment be stopped.

Bank that pays check is subrogated to the rights of the person it pays against the customer. Thus, if a bank pays an HDC, it can assume the position of HDC in attempting to charge its customer's account.

Generally, payment is final. If bank erroneously pays out on forged instrument to an HDC, can't recover payment back unless breach of transfer warranty or presentment warranty.

Bank can recover for any item paid up until it has made "final payment." Thus, if bank makes provisional settlement by crediting holder's account, can revoke payment anytime prior to midnight deadline (midnight of next banking day).
Duties of Drawee Bank to Customer
Bank is obligated to honor its customer's check if there are sufficient funds to cover. If bank wrongfully dishonors, customer can recover damages. If check more than 6 months old, bank may refuse to pay unless ordered by drawer.

Bank cannot charge account:
(1) if no order by the depositor (forged signature);
(2) for more money than original order (alteration by third party);
(3) if bank pays wrong person (forgery of payee's or endorsee's signature); or
(4) if item is postdated, customer gives bank notice of post-dating, and bank pays item before state date.

If bank pays check in violation of these principals, customer entitled to recredit on account.
Duties of Customer to Bank
Upon receipt of bank statement, customer has duty to bank to exercise reasonable care and promptness to discover any unauthorized payments resulting from an alteration/forgery and to notify bank promptly of such discovery.

Bank can charge customer's account if it can show:
(1) customer failed to comply with his duty, and
(2) bank suffered loss by reason of the failure.

Customer may answer such proof by showing bank was negligent in paying the item. If bank was negligent, loss will be allocated between customer and bank in proportion to the fault of each. If bank did not pay item in good faith, bank will bear the entire loss.
Stop Payment Orders
Written stop payment order is binding on bank for 6 months, but oral stop payment order lapses after 14 days if not confirmed in writing within that period. Bank under no obligation to honor a stop payment on a cashier's check.

If bank pays item in spite of stop payment order, customer has burden of proving that loss occurred and amount of loss. If there is an HDC in the chain of transferees of the item, customer cannot recover - because even if payment had been stopped, customer would have had to pay HDC.
Acceptor's Liability
Acceptance: Process whereby acceptor (usually a drawee bank) signs a draft and thereby becomes primarily bound to pay the instrument.

Accepted drafts often required when payee doesn't want to rely on credit of unknown drawer (example - certified check). Draft presented to acceptor who signs and returns to party presenting for acceptance. Bank, at this time, will normally charge its customer's account, because after acceptance, customer is no longer liable. This process is called "Presentment for acceptance" and may be sought by any party entitled to enforce the instrument and at any time.

Acceptor may change terms of draft (called variance). If the acceptor wants to do this:
(1) holder may refuse to take varied acceptance, then may treat instrument as dishonored and pursue other parties, or
(2) holder may accept variance which will discharge all prior non-consenting parties to instrument from liability.

Bank's failure to certify may constitute dishonor.

Certification discharges drawer and all prior endorsees from liability.

If acceptor wrongfully refuses to pay, person asserting right to enforce check generally is entitled to expenses and interest resulting from the failure to pay. If bank receives notice of particular circumstances, will also be liable for consequential damages arising from those circumstances.
Accommodation Party's Liability
Accommodation party: One who signs an instrument for purpose of lending her name and credit to another party to the instrument (surety). If accommodation party pays the instrument, she will have an action on the instrument against party accommodated. Accommodation party is never liable to party accommodated, but is liable on instrument in capacity in which he signs (maker, endorser, etc) even where taker is unaware of accommodation.

Person signing an instrument presumed to be an accommodation party and there is notice of accommodation status if signature is made by person not a holder or otherwise indicates signer is acting as surety/guarantor on instrument.

Oral proof is generally allowed for fact of accommodation. Exception: Case of HDC who took without notice of the accommodation.

"Collection guaranteed" or the equivalent means that signer enters into contract that she will be liable on instrument only if:
(1) person entitled to enforce instrument has reduced his claim to judgment and it hasn't been satisfied,
(2) maker/acceptor has become insolvent,
(3) maker/acceptor can't be served with process, or
(4) it otherwise appears that it is useless to proceed against maker/acceptor.
Effect of Persons Signing Jointly
If parties to an instrument sign jointly (A AND B), they have joint and several liability on th instrument, so either one or both can be sued for entire amount due. If one party pays more than his share, he generally has a right of contribution against other jointly liable party. A release of one jointly liable party by a third party doesn't affect right of contribution.
Liability of Principal (Represented Person)
Principal (P) liable if Agent (A) authorized, generally. Two situations where P may be liable even if A was unauthorized:
(1) Ratification - P ratifies signature after the fact.
(2) Estoppel - P can be precluded from denying authorization if by his negligence he contributed to making of unauthorized signature; preclusion operates in favor of one who is otherwise an HDC or one who, in good faith, pays instrument in accordance with reasonable commercial standards of his business.
Liability of Agent (Representative)
If Agent (A) signs Principal's (P's) name without putting her own name on the instrument, P will be liable if A was authorized, but A will not be liable because her name is not on the instrument.

If A signs her name and discloses P and A has authorization, A not liable.

If A signs her name, but doesn't disclose P's name or the agency relationship, A will be liable to an HDC who takes instrument without notice that A was not intended to be liable, but A will not be liable to non-HDCs if she can prove original parties didn't intend that she be liable.

If an A with authority signs her own name to P's check, she can't be held liable on check if drawn on P's account and indicates P's identity, even if A doesn't indicate her representative capacity.
Effect of Unauthorized Signatures
General rule is that an unauthorized signature is wholly ineffective as the signature of person whose name is signed, but is effective as signature of signer. Thus, unauthorized signer assumes obligations on the instrument to those who, in good faith, give value for the instrument. Five exceptions exist where forgery or unauthorized signature will be validated because person whose name is used has done something to preclude her from raising forgery issue:
(1) Fictitious payee,
(2) Fraudulent endorsements by employees,
(3) Failure to exercise ordinary care (negligence rule),
(4) Bank statement rule, and
(5) Estoppel by certification.
Fictitious Payee
If drawer/maker is duped into issuing an instrument to an imposter, resulting forgery is effective to pass the right to enforce. Applies when person to whom instrument is issued misrepresents that she is an agent of payee. Will be validated regardless of who forges endorsement.

If drawer, maker, or other person whose intent determines to whom instrument is payable doesn't intend person identified to have any interest in the instrument, or if person identified in instrument is fictitious:
(1) any person in possession of instrument is a holder, and
(2) any endorsement in a name substantially similar to payee stated on instrument is effective as an endorsement of the named payee as to anyone who takes the instrument in good faith and for value.

Person paying or taking an instrument involving a fictitious payee must use ordinary care in paying or taking instrument. If ordinary care is not exercised, person bearing risk of loss on instrument may recover from party that failed to exercise ordinary care to the extent that failure contributed to the loss.
Fraudulent Endorsements by Employees
If an employer entrusts an employee (including independent contractors) with responsibility with respect to an instrument and the employee makes a fraudulent endorsement on the instrument, endorsement is effective (though person who takes instrument without exercising ordinary care may be held liable to extent of loss caused by failure).
Failure to Exercise Ordinary Care
AKA negligence rule. Person whose failure to exercise ordinary care substantially contributes to alteration or forged signature on an instrument is precluded from asserting forged signature or alteration against a person who in good faith paid instrument or took it for value or collection.

Actions usually constituting negligence:
(1) leaving blanks or spaces on the instrument,
(2) mailing an instrument to person having same name as payee,
(3) failing to follow internal procedures designated to avoid forgeries.

A prior person's failure to exercise due care does not relieve later persons from exercising due care regarding the instrument. Thus, if a person asserting preclusion has failed to exercise ordinary care in taking instrument himself, loss is allocated between both parties according to share of the loss that resulted from each party's failure.
Bank Statement Rule
After receiving statement, customer must promptly use reasonable care in examining for (1) unauthorized signing of customer's own name as a drawer, and (2) any alteration on the item. If customer fails to promptly report forgery or alteration, she is precluded from complaining to bank that item was not "properly payable." Also estopped from demanding recredit on other items by same wrongdoer after statement available for reasonable period (not more than 30 calendar days) and customer hasn't complained.

If bank fails to use ordinary care in paying a check, loss allocated between customer and bank (unless bank didn't pay in good faith).

No matter which party is negligent, customer precluded from asserting an alteration or forgery of his signature if he doesn't notify bank within 1 year of bank making instrument available to him.

Customer precluded from asserting forged endorsement more than 3 years after cause of action accrues.
Estoppel by Certification
Bank that certifies check has opportunity of checking ID and bonafides of the transaction with person seeking certification. If bank certifies the check, it is therefore estopped as against subsequent parties from claiming that named payee was not original payee.
Nonfraudulent Alteration
Nonfraudulent alterations don't discharge any party, and instrument may be enforced according to its original terms.
Fraudulent Alteration
Has effect of discharging every party obligated on the instrument unless the party assents to or is precluded from asserting the alteration.

However, payor bank or drawee paying a fraudulently altered instrument or person who takes it for value, in good faith, and without notice of alteration may enforce instrument:
(1) according to its original terms; or
(2) in the case of an incomplete instrument altered by an unauthorized completion, according to its terms as completed.
When Can Maker Safely Pay and Avoid Further Liability?
If party seeking payment is holder, maker may safely pay him, even if she knows that third party has a claim to the instrument. Up to third party to protect own interests. If party seeking payment is not a holder, and primary obligor pays, will have to pay true holder when she comes along.

Third party can protect his claim by:
(1) offering to indemnify maker/acceptor in an amount deemed OK by maker/acceptor while other two parties fight it out, or
(2) seek an injunction in an action in which maker/acceptor, holder, and third party are parties.

Maker/acceptor may not safely pay holder of an instrument where she knows holder acquired instrument by theft or through someone who did. If holder is an HDC, then maker can pay him.
Finality of Payment
General rule is that payment is final to an HDC or one who in good faith changed her position in reliance on payment. Two exceptions - Payor can recover from party paid if (1) that party neither took for value nor in good faith nor detrimentally relied on the payment, or (2) party paid breached a transfer warranty or presentment warranty.
Presentment Warranties
Presentment warranties on an unaccepted draft:
(1) Warranty of good title (entitled to enforce) - forgery of drawer's name doesn't destroy good title. However, forgery of endorsement does destroy good title.
(2) Instrument not altered
(3) Warrantor has no knowledge that drawer's signature is unauthorized

Presentment warranties on other instruments: Only that party receiving payment and prior transferors were entitled to enforce.

Presentment warranties are made by: (1) any person who obtains payment or acceptance, and (2) any prior transferor.

Presentment warranties are made to: any person who in good faith pays or accepts.
Statutory Provisions on Methods of Discharge
Extent of discharge of any party from liability on an instrument is governed by sections on:
(1) payment,
(2) tender of payment,
(3) cancellation or renunciation,
(4) impairment of right of recourse or of collateral,
(5) reacquisition of instrument by a prior party,
(6) fraudulent alteration,
(7) certification of a check,
(8) acceptance varying a draft, and
(9) unexcused delay in presentment or notice of dishonor.
Effect of Instrument on Obligation for Which It Was Taken
(1) Certified, cashier's, or teller's check - generally discharges obligation to same extent that cash would.
(2) Any other negotiable instruments - obligation is suspended to same extent as if cash given. Suspension continues until instrument paid or dishonored. If paid, obligation discharged. If dishonored, may enforce instrument or obligation or, if third party, may only enforce instrument.
(3) Lost, stolen, destroyed instruments - obligation remains suspended to the extent of the instrument, and obligee's rights limited to enforcement of instrument.
(4) Tenders "in full satisfaction" (Accord and Satisfaction) - Person tenders instrument that says conspicuously that it is tendered as full payment and claimant obtains payment --> obligation discharged. However, if claimant is organization, may require that such instruments be sent to designated person/place to be effective. Either way, discharge not effective if claimant returns payment within 90 days.
Discharge by Payment
Liability of any party is discharged to extent of her payment or satisfaction to person entitled to enforce instrument even if payment made with knowledge of claim of another person to instrument unless prior to payment person making claim either (1) supplies indemnity deemed adequate by party seeking discharge, or (2) enjoins payment or satisfaction by order of a court of competent jurisdiction in an action in which adverse claimant and holder are parties.

Neither is there discharge if person making payment knows that the instrument is stolen and pays person who she knows is in wrongful possession of instrument.

On holder's request, code allows payment prior to maturity and dispenses with requirements that payment be made in good faith and without notice that title of holder is defective.
Discharge by Tender of Payment
If payment of an obligation on an instrument is tendered to a person entitled to enforce instrument, effect of tender governed by principles of law applicable to tender of payment under simple contract.

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

Any person who has right of recourse against party making tender is discharged to the extent of amount tendered, whether person is a prior party or subsequent one who has been accommodated.
Discharge by Cancellation or Renunciation
Person entitled to enforce an instrument may (even without consideration) discharge a party:
(1) by an intentional, voluntary act, such as surrender of instrument to the party, destroying the instrument, or striking out a party's signature, or
(2) by agreeing in a signed writing not to sue or otherwise renouncing rights against the party.

Remember: no discharge of any party is effective against a subsequent HDC unless HDC has notice thereof when she takes the instrument.
Suretyship Defenses
(1) Discharge of obligated party doesn't discharge obligation of endorser/accommodating party with right of recourse.
(2) Extension of due date or other material modification discharges endorser/accommodating party with right of recourse (in case of extension - must show loss, other times, loss presumed).
(3) Impairment of collateral discharges endorser/accommodating party with right of recourse.

(1) Accommodating party not discharged as provided above unless person entitled to enforce instrument knows of accommodation.
(2) Party will not be discharged if he consented to even or conduct that is the basis of the ground for discharge or he has waived his defenses based on suretyship or impairment of collateral.
Impairment of Collateral
Value of interest in collateral is impaired if:
(1) there is a failure to perfect a security interest or otherwise file,
(2) collateral is released without obtaining substitute collateral,
(3) there is a failure to do any act required by agreement or law to preserve the value of collateral, or
(4) there is a failure to dispose of the collateral as the law requires.
Discharge by Reacquisition
Reacquisition occurs if an instrument is transferred to a former holder. Upon reacquisition, reacquirer may cancel endorsements made between time she formerly held instrument and the present. This cancellation discharges those endorsers whose signatures were canceled, and discharged is effective against any subsequent holder, including an HDC.
Other Discharges
(1) Discharge by any act that will discharge a simple contract.
(2) Discharge by failure to give notice of dishonor.
(3) Fraudulent alteration discharges every party obligated on instrument unless assents to or is precluded. However, HDCs may enforce as to original terms.
(4) If check not presented for payment or given to depository bank within 30 days of endorsement, endorser is discharged.
(5) If check not given to depository bank or presented for payment within 30 days of its date, and drawer deprived of funds to pay because of delay, drawer discharged to extent of loss caused by delay.
(6) If draft accepted by bank after endorsement, endorser is discharged.
(7) If draft accepted by bank, drawer is discharged.
Bank in Collection Process
Unless it is made clear to the contrary, bank is an agent for collection. Owes customers duty of ordinary care and liable only for its negligence.

If bank advances money for an item, it acquires a security interest in the instrument and to the extent of that security interest can become an HDC. Security interest satisfies value requirement.

Banks not required to allow a depositor to draw funds against deposited check until check has sufficient time to be presented to drawers bank for payment or dishonor. Deposit results in "provisional settlement." Credit may be reversed until "final settlement," which is when drawer's bank makes "final payment."
Warehouse Receipts
A document of title issued by a warehouse entitling named person, or his order, or the bearer, to delivery of stored goods. HDC for this is a holder to whom a negotiable document of title has been duly negotiated. No particular form required.

Following terms are required (or else warehouseman is liable for damages caused by the omission to a person injured thereby):
(1) Location of warehouse where goods are stored;
(2) Date of issue of receipt;
(3) Number of the receipt;
(4) Person to whom delivery is due;
(5) Charges;
(6) Description of goods/packages;
(7) Signature of warehouseman or his authorized agent;
(8) Warehouseman's ownership, if any; and
(9) A statement of amount of advances made and of liabilities incurred for which warehouseman claims a lien or security interest.

A warehouseman may insert into receipt any terms that do not impair his obligation of delivery or his duty of care, as such terms would be ineffective.
Bill of Lading
Similar to warehouse receipt, except that it must also specify point of shipment and destination. Misdating, nonreceipt, or misdescription are all grounds for damages. Exception where document indicates issuer doesn't know whether any part or all of the goods were received or conform to the description (where description is in terms of marks or labels of kind, quantity, etc).

When goods are loaded by an issuer who is a common carrier, issuer must count packages of goods if package freight and ascertain the kind and quantity if bulk freight.

Shipper is deemed to have guaranteed to the issuer the accuracy at time of shipment of description, marks, labels, number, kind, quantity, condition, and weight as furnished by him, and shipper shall indemnify issuer against damage caused by inaccuracies in such particulars.
Direct Holding System Rules
Protected Purchaser (Article 8's HDC): Purchaser of a certificated or non-certificated security who (1) gives value, (2) does not have notice of any adverse claim to the security, and (3) obtains control of the security. Acquires whatever rights his transferee had and takes security free of adverse claims.

(1) Certificated securities: purchaser has control as soon as it is delivered to him. Registered form is when instrument delivered to purchaser and is either endorsed to purchaser in blank or registered by issuer in name of purchaser.
(2) Uncertificated Securities: Purchaser has control of one of these if delivered to purchaser, or securities intermediary has agreed that it will comply with instructions originated by purchaser without further consent from registered owner.
Indirect Holding System Rules
Security Entitlement: Ownership interest of an "entitlement holder" in a financial asset.

Entitlement Holder: Person identified in records of a securities intermediary as the person having rights in securities of the intermediary.

Person who purchases a security entitlement from an entitlement holder takes free of any adverse claim to the financial asset or security entitlement if purchaser gives value, doesn't have notice of the adverse claim, and obtains control.

Generally, purchaser has control of security entitlement if purchaser becomes entitlement holder or the securities intermediary has agreed that it will obey purchaser's orders without further consent from entitlement holder.