Use LEFT and RIGHT arrow keys to navigate between flashcards;
Use UP and DOWN arrow keys to flip the card;
H to show hint;
A reads text to speech;
113 Cards in this Set
- Front
- Back
|
Forms of Commercial Paper
Note |
Ex.: "I, Max Maker, promise to pay to the order of Peter Payee the sum of Ten Thousand Dollars ($10,000) due on demand. /S/ Max Maker."
A note is a two-party instrument:
- Maker: the person who signs or is identified in a note as the person undertaking to pay.
- Payee: the person to whom the note is payable. |
|
|
Forms of Commercial Paper
Check |
A check is a three party instrument
- Drawer: the person who signs or is identified in a check as the person ordering payment (Drew Drawer)
- Drawee: the person ordered in a check to make payment (Drawee Bank)
- Payee: the person to whom the check is payable. |
|
|
Forms of Commercial Paper
Check (Types of Bank Checks) |
A cashier's check is a check w/ respect to whic the drawer and drawee are the same bank.
A teller's check is a check where the trawer is a bank and a different bank is the drawee.
A certified check is one drawn by the drawee bank's customer and "accepted" by the drawee bank (typically by stamping/signing it "certified"). |
|
|
Importance of Negotiability |
If a particular piece of commercial paper is a negotiable instrument, then Article 3 governs, and the person holding the instrument may be able to claim the status of "Holder in Due Course."
If commercial paper is non-negotiable (and thus Art. 3 does not apply), then general principles of contract law apply. |
|
|
Requirements for Negotiable Instrument
Overview |
1) A writing 2) Signed by the Maker (note) or Drawer (check) 3) Promise to pay (note) or Order to pay (check) 4) Unconditional 5) Fixed Amount 6) Money 7) No other undertaking 8) Payable on demand or at a definite time 9) Payable to order or to bearer |
|
|
Requirements for Negotiable Instrument
SWUPFONO |
Signed Writing Unconditional Promise or order Fixed amount of money On demand or at definite time No unauthorized undertaking Order or bearer paper language (check exception) |
|
|
Requirements for Negotiable Instrument
Writing |
There is no such thing as an oral negotiable instrument. It must be something tangible. Almost always a piece of paper, but it need not be (e.g., writing on a t-shirt will suffice). |
|
|
Requirements for Negotiable Instrument
Signed |
Must by signed by the Maker or Drawer.
"Signed" includes "any symbol executed or adopted by a party with a present intention to authenticate a writing.
- Can be printed, stamped written - Can be initials or thumbprint - Can be a trade name or an assume name - Can appear in the body of the instrument
The key is whether the party INTENDED for that symbol to operate as her signature. |
|
|
Requirements for Negotiable Instrument
Promise/Order to Pay |
A note must have a promise by the maker to pay money ("I promise to pay John Smith..."
- An IOU or other acknowledgement of the debt is NOT a promise to pay, so non-negotiable.
A check is an order from the drawer to the drawee bank to pay money ("Pay to Peter Payee...")
- "I wish you would pay" is not an order to pay, so non-negotiable. |
|
|
Requirements for Negotiable Instrument
Unconditional promise/order to pay money
(General Rule) |
A note must contain an unconditional promise to pay money, and a check must contain an unconditional order to pay money.
While ok under contract law, conditional promises or orders to pay destroy negotiability. |
|
|
Requirements for Negotiable Instrument
Unconditional promise/order to pay money
(Refering to Another Agreement) |
A mere reference in the negotiable instrument to the underlying contract accompanying the instrument does not render the instrument's promise to pay conditional; thus, still negotiable.
Ex.: "I promise to pa $100 to the order of Payee in accordance with (or as per) the K we signed today." This is ok. |
|
|
Requirements for Negotiable Instrument
Unconditional promise/order to pay money
("Subject to" / "Goverened by") |
If the instrument is "subject to" or "governed by the terms of" another agreement is conditional, and so is non-negotiable.
Ex.: A note where Maker "promises to pay $200,000 to the order of Payee subject to the terms of the mortgage agreement." Non-negotiable.
EXCEPTION: An instrument that says rights concerning collateral, prepayment, or accelaration are stated in another writing (e.g., a security agreement) IS negotiable. |
|
|
Requirements for Negotiable Instrument
Unconditional promise/order to pay money
(Limiting Source of the Funds) |
A writing IS negotiable even though it limits payment to a particular source or funds.
Ex.: "I promise to pay $3,000 out of the proceeds from the sale of my house." That's ok. |
|
|
Requirements for Negotiable Instrument
Fixed Amount |
When the instrument is payable, the holder must be able to determine from the instrument itself the principal amount due.
The requirement of a fixed amount applies ONLY to PRINCIPAL; it does not apply to interest (or other charges often included on an instrument, such as collection costs and attorney's fees).
Ex.: A note promising to pay $1k and providing for a variable interest rate (e.g., "4% over prime, adjusted each six months based on then prevailing bank rates in Chicago") is negotiable, becaues the principal amount is fixed. |
|
|
Requirements for Negotiable Instrument
Fixed Amount (Patent Ambiguity) |
Scenario: check says "Pay Five Thousand Dollars ($500) to Paul Payee."
Rule of Construction: unambiguous WRITTEN words ("Five Thousand Dollars") control over conflicting numbers ("$500"). |
|
|
Requirements for Negotiable Instrument
Money |
Foreign money is permissible. However, a promise to pay 100 pounds of flour is a non-negotiable promise. Must be monetary. |
|
|
Requirements for Negotiable Instrument
No Other Undertaking (General Rule) |
A negotiable instrument must not have anything other than a simple, clean, unconditional promise or order to pay a fixed amount of money.
For example, a maker's promise to pay $400 and deliver a TV to the payee makes the note non-negotiable. |
|
|
Requirements for Negotiable Instrument
No Other Undertaking (Exceptions) |
The UCC does permit certain extra undertakings:
- A provision by the maker or drawer to give or maintain collateral securing payment;
- A provision authorizing the holder to confess judgment or realize on any collateral;
- A provision by the maker or the drawer waiving legal protections. (Examples: maker's waiver of trial by jury, or right to notice of dishonor, or suretyship defenses.)
- Also ok for maker or drawer to promise to pay for costs of collection and attorney's fees. |
|
|
Requirements for Negotiable Instrument
On Demand or at a Definite Time |
The holder of an unstrument must be able to tell when it comes due or the instrument is non-negotiable.
- An UNDATED instrument which specifies no time for payment is treated as payable on demand.
- A post-dated check is fine, because checks are generally demand instruments.
- A note containing an acceleration clause upon default is ok.
- A note made payable "only upon the death of Maker's father" is NOT negotiable b/c the time of payment is not ascertainable. |
|
|
Requirements for Negotiable Instrument
Payable To Order or To Bearer
(Order Paper) |
A promissory note or a check must be either order paper or bearer paper. If not, the instrument is not negotiable.
ORDER PAPER: a promissory note or check made payable (i) "to the order of" (ii) an identified person is called order paper
- Promissory note order paper should be made out: "I promise to pay to the order of Paul Payee..." (or "to Paul Payee or his order...).
- Check order paper should be made out: "Pay to the order of Paul Payee" (or "to Paul Payee or his order..."). |
|
|
Requirements for Negotiable Instrument
Payable To Order or To Bearer
(Order Paper - Check Exception) |
A CHECK need not contain "to the order of" words of negotiability. A check stating "Pay Paul Payee" is fully negotiable, covered by Art. 3, and a transferee of it can become a holder in due course. |
|
|
Requirements for Negotiable Instrument
Payable To Order or To Bearer
(Bearer Paper) |
A promissory note or a check made payable to the bearer of the instrument is called bearer paper.
- Promissory note bearer paper: "I promise to pay bearer..." (or "to the order of bearer" or "to the order of cash" or "to cash").
- Check bearer paper: Pay "to the order of cash" (or "to the order of bearer" or "to bearer"). |
|
|
Negotiation
Assignment vs. Negotiation |
Assignment: Under general K law principles, a payee who has been issued an instrument that is not a negotiable instrument under Art. 3 (or even a negotiable instrument) can still assign the instrument to a third party. The third party is then an assignee, and has no greater rights than the payee/assignor does on the instrument. Any defenses that could be raised against the payee/assignor could also be raised against the assignee.
Negotiation: If the instrument is a negotiable instrument under Art. 3, and in accordance w/ Art. 3's rules the payee negotiates the negotiable instrument to a third party, then that third party is not a mere assignee, but is the HOLDER of the instrument. |
|
|
Negotiation
Negotiation (Definition) |
Negotiation is a transfer of an instrument in a way that makes the transferee a holder. |
|
|
Negotiation
Holder (Definition) |
A holder is a person:
- in possession of bearer paper; or
- in possession of order paper that has been properly issued or properly indorsed to her. |
|
|
Negotiation
Negotiating ORDER Paper (Two-Step Process) |
Issued ORDER paper is negotiated by a two-step process:
1) Indorsement by the holder; and
2) Transfer of possesion (voluntary or involuntary). |
|
|
Negotiation
Indorsement (Definition; Special vs. Blank) |
Definition: An indorsement is a SIGNATURE on an instrument for the purpose of negotiating it and/or making the indorser liable under indorser liability.
- SPECIAL Indorsement: an indorsement by the holder which also names a particular person as indorsee (the person to whom the instrument is next payable).
- BLANK Indorsement: does not name an indorsee (the person to whom the instrument is next payable); generally consists of the holder's mere signature. |
|
|
Negotiation
Indorsement (Anamalous) |
An ANAMALOUS indorsement is an indorsement by a person who is not the holder. An anamalous indorsement is NOT effective for negotiation. |
|
|
Negotiation
Negotiating BEARER Paper |
Issued BEARER paper may be negotiated by transfer of possession alone (whether voluntary or involuntary). |
|
|
Negotiation
Effect of Indorsement on Order or Bearer Paper |
After issuance, indorsements determine whether the instrument remains order paper or bearer paper.
- If ORDER paper is indorsed in BLANK, it becomes BEARER paper.
- If BEARER paper is SPECIALLY indorsed, it becomes ORDER paper.
A holder can convert a blank indorsement into a special indorsement by naming an indorsee above the blank indorsement.
- Ex.: Bob was issued an order paper note which he indorsed in blank (mere signature). Note is now bearer paper. Bob then gave the note to Sally. Sally writes "pay to Sally" above Bob's signature, thus changing the blank indorsement to a special indorsement. The note is now order paper payable to Sally as indorsee. |
|
|
Negotiation
Special Rule for Banks |
Ordinarily, an order paper check must be indorsed by the holder and possession transferred to the identified payee in order to make the transferee the holder.
But a depositary bank (bank in which a check is first deposited for collection) can become a holder WITHOUT the signature of the depositor if the depositor was a holder at the time of deposit.
Ex.: Payee receives a check from Drawer and Payee deposits the check in his checking account at Depositary Bank. Payee forgets to indorse the check, but Depositary Bank takes it for deposit anyway. Even without the indorsement, Depositary Bank is a "holder" of the check, and is thus entitled to receive payment from Drawee Bank. |
|
|
Negotiation
Indorsement "Without Recourse" |
While most indorsements are unqualified, a party can indorse an instrument "without recourse."
This is irrelevant to negotiation; but it does negate indorser liability. |
|
|
Negotiation
Effect of Forgeries on Status of Holder
(General Rule re: Order Paper) |
General Rule: A person cannot be a holder if any necessary indorsement was forged (b/c an unauthorized signature is ineffective as the signature of the person whose name was signed.
Thus, when ORDER paper (e.g., a note or a check) contains a forged indorsement, none of hte parties from the forger on are holders--so none are enttled to the money. In the case of a note, the maker does not have to pay any of those parties. In the case of a check, the drawee bank cannot properly pay any of them, but only the (true) holder of the check.
Exceptions to General Rule: - Imposter Rule - Fictitious Payee Rules - Responsible Employee Rule - Negligence Rule |
|
|
Negotiation
Effect of Forgeries on Status of Holder
(Contrast w/ Bearer Paper) |
Bearer paper can be negotiated by transfer of possession alone, which can be voluntary or involuntary. Thus, a thief CAN be the "holder" of bearer paper. |
|
|
Negotiation
Lost, Stolen or Destroyed Instruments |
To be the holder of an instrument, a person must be in possession of it (and also be the identified payee if it is order paper).
Generally, a person who is not in possession of a negotiable instrument can pursue an action to collect on it if (i) he was entitled to enforce the instrument, and (ii) it was lost, stolen or destroyed.
To recover, the owner who is not in possession of the lost or stolen instrument must prove their right to enforce the instrument, the instrument's terms, and explain what prevents its production.
A court may not enter judgment in favor of hte person seeking enforcement unless the person required to pay is adequately protected against a claim by another person to enforce the instrument. |
|
|
Liability of Parties
Liability on the Instrument
(4 Types of Liability on the Instrument) |
1) Maker's liability on the note
2) Drawer's liability on the check
3) An indorser's liability on a note or check
4) Drawee bank's liability on a check |
|
|
Liability of Parties
Liability on the Instrument
(General Rules) |
1) No person or entity can be liable on a negotiable instrument UNLESS her/its SIGNATURE appears on the instrument (or the signature of an authorized agent).
2) A forged or otherwise unauthorized signature (e.g., an agent in excess of his authority) is NOT effective as a signature of the person/entity whose name is signed.
3) A signature by an authorized agent is valid just as if made by the principal. |
|
|
Liability of Parties
Liability on the Instrument
(Agent's Liability) |
(1) If an authorized agent signs her own name and
(2) the principal has given her authority to sign on its behalf, the agent is NOT bound if
(3) the form of the signature shows unambiguously that it was made on behalf of the principal and
(4) the principal is identified on the instrument. |
|
|
Liability of Parties
Liability on the Instrument
(Maker's Liability on the Note) |
A maker is obligated to pay the note according to its terms at the time it was issued. There are no conditions to maker's liability to pay the note; he is simply liable to pay the note when it isdue.
A maker's liability is owed to a person entitled to enforce the note (e.g., the holder). A maker's liability is also owed to an indorser who has paid the note due to his indorser liability. |
|
|
Liability of Parties
Liability on the Instrument
(Co-Makers/Drawers Joint and Several Liability) |
Except as otherwise specified in the instrument, two or more persons who sign an instrument as co-makers (or co-drawers) are jointly and severally liable.
Unless otherwise agreed, a party having joint and several liability is entitled to contribution from his joint and several co-makers (or co-drawers). |
|
|
Liability of Parties
Liability on the Instrument
(Drawer's Liability on a Check) |
A drawer is obligated to pay the check according to its terms when the drawer signed the instrument.
TRIGGERS to Drawer Liability: The drawer is liable to pay a check ONLY after PRESENTMENT to and DISHONOR (i.e., nonpayment) by the drawee bank.
A drawer generally is not entitled ot notice of dishonor. A drawer will or should know of the dishonor on her own check b/c of her relationship w/ the drawee bank.
A drawer's liability is owed to a person entitled to enforce the check (e.g., the holder). A drawer's liability is also owed to an indorser who has paid the check due to his indorser liability. |
|
|
Liability of Parties
Liability on the Instrument
(Drawee Bank's Liability on a Check) |
A drawee bank is NOT obligated to pay the check UNLESS the drawee bank "accepted" the check. - i.e., it is accepted upon presentment; or - it is a "certified"/stamped check by drawee bank. |
|
|
Liability of Parties
Liability on the Instrument
(Indorser's Liability on the Instrument - To Whom Owed) |
An indorser is obligated to pay according to the terms of hte instrument at the time of the indorsement.
An indorer's liability is owed to a person entitled to enforce the instrument (e.g., the holder). An indorser's liability is also owed to a person indorsing later in time who has paid the insturment due to hiw own indorser liability. |
|
|
Liability of Parties
Liability on the Instrument
(Indorser's Liability on the Instrument - Triggering Conditions - Overview) |
An indorser's liability is conditioned (triggered) upon:
1) Timely PRESENTMENT (a formal demand for payment)
2) DISHONOR of the instrument (the instrument isn't paid when due)
3) Timely NOTICE of dishonor must be given to the indorser or else the indorser is discharged. |
|
|
Liability of Parties
Liability on the Instrument
(Indorser's Liability on the Instrument - Triggering Conditions - Timely Presentment) |
An indorser's liability is conditioned upon, inter alia, timely PRESENTMENT (i.e., a formal demand for payment).
With a CHECK, the indorser is discharged if the check is not presented for payment or given to a depositary bank for collection with 30 days after the indorsement was made. |
|
|
Liability of Parties
Liability on the Instrument
(Indorser's Liability on the Instrument - Triggering Conditions - DISHONOR of instrument) |
An indorser's liability is conditioned upon, inter alia, DISHONOR of the instrument (i.e., the instrument isn't paid when due).
With a CHECK, the drawee bank must dishonor the check by returning hte check (or sending notice of dishonor if the check is not available) by its midnight deadline. Otherwise, the indorer's liability is not triggered.
The drawee bank's midnight deadline expires midnight of the next banking day following the banking day on which the drawee bank received the check. |
|
|
Liability of Parties
Liability on the Instrument
(Indorser's Liability on the Instrument - Triggering Conditions - Timely NOTICE of dishonor) |
An indorser's liability is conditioned upon, inter alia, timeliny NOTICE of dishonor being given to the indorser, or else the indorser is discharged.
With respect to a CHECK, a depsoitary bank which wants to sue on a person's indorser liability must give the indorser notice of dishonor w/ respect to a check before the bank's midnight deadline. Notice of dishonor w/ respect to a check must be given on any other person within 30 days following the day on which she herself received notice of the dishonor.
With respect to a NOTE, notice of dishonor must be given 30 days after the dishonor occurs. Ordinarily, dishonor of a note occurs when the note is presented to the maker and payment is not made on the day of presentment. - EXCEPTION: a note due at a definite time is deemed dishonored without presentment if it is not paid when due. |
|
|
Liability of Parties
Liability on the Instrument
(Indorser's Liability on the Instrument - Triggering Conditions - Waiver/Excuse) |
PRESENTMENT and NOTICE of dishonor may be waived or excused. |
|
|
Liability of Parties
Liability on the Instrument
(Indorser's Liability on the Instrument - Qualified Indorsement) |
Dave Drawer issues a check to the order of Peter Payee, who indorses the check "Peter Payee, without recourse" and negotiates the check to Harry Holder. If the check is dishonored and appropriate notice is given, is Payee liable as an indorser?
No, because "without recourse" language negates Peter's indorser's liability. |
|
|
Liability of Parties
Discharge of Liability
Methods of Discharge (Overview) |
1) Payment
2) Tender of Payment
3) Cancellation
4) Renunciation
5) Discharge on a simple contract |
|
|
Liability of Parties
Discharge of Liability
Methods of Discharge (Payment) |
General Rules re: Discharge by Payment:
1) If the instrument is paid to the proper person (e.g., the holder), payment discharges the paying party's liability on the instrument and liability on the underlying (K) obligation.
2) If the instrument is dishonored, the party is liable on both the instrument and on the underlying obligation, however the P can only get one recovery. |
|
|
Liability of Parties
Discharge of Liability
Methods of Discharge (Tender of Payment) |
Rule 1: Upon the holder's refusal of tender of payment, an indorser who has a right of recourse with respect to the obligation to which the tender relates is discharged to the extent of the amount tendered.
Illustration: Jerry is maker of a note issued to Ina. Ina indorsed the note and gave it to Hank, who becomes the Holder. Jerry tenders full payment to Hank on the note's due date, but Hank refuses to accept it. Hank then demands that Ina pay the note on her indorser liability. - Ina is not liable, b/c discharged under Rule 1.
Rule 2: A tender of the amount due discharges any duty to pay interest accrued after the due date.
Illustration: Same hypo, but Hank demands that Jerry pay interest that was incurred after the note's due date. Jerry is not liable for the interest under Rule 2. |
|
|
Liability of Parties
Discharge of Liability
Methods of Discharge (Cancellation) |
Any person entitled to enforce the instrument may discharge any party by a voluntary affirmative act such as:
- surrendering the instrument to the party to be discharged, - writing words like "void," paid," or "discharged on the instrument, -striking out the signature of the party to be discharged, or - tearing up the instrument.
No consideration is required for cancellation. |
|
|
Liability of Parties
Discharge of Liability
Methods of Discharge (Renunciation) |
Any person entitled to enforce the instrument may discharge any party by a signed writing agreeing not to sue or otherwise renouncing rights against the party to be discharged. No consideration is required for renunciation. |
|
|
Liability of Parties
Discharge of Liability
Methods of Discharge (Discharge on a Simple K) |
Any person liable on an instrument can be discharged by any act or agreement that would sicharge that party's liability on a simple K. |
|
|
Liability of Parties
Bank Checks |
When the instrument is a cashier's check (same bank is both drawer and drawee), or a teller's check (a bank is the drawer and a different bank is the drawee) or a certified check (a check is "accepted" by the drawee bank on which it is drawn), the Transferor's UNDERLYING OBLIGATION is discharged when the check is taken by the payee.
With respect to the liability on the instrument, for cashier and teller checks, the issuing bank is liable on the check. For a certified check, the certifying (accepting) drawee bank is liable on the check.
The bank's liability on the check is discharged when the bank pays the proper person (e.g., the holder).
Illustration: Buyer purchases a cashier's check from Bank to pay Seller for goods. (Buyer typically does not sign a cashier's or teller's check, and so is not liable on the check--rather, Bank is liable on the check.) When Seller takes the check from Buyer, Buyer's underlying obligation to pay Seller for the goods is discharged. When Bank pays the Seller (the holder), the Bank's liability on the check is discharged. |
|
|
Liability of Parties
Transer Warranty Liability
(Who is Liable?) |
Whenever a person (i) voluntarily TRANSFERS an instrument (either note or check), (ii) for CONSIDERATION, the transferor makes a number of separate transfer warranties as of the time of transfer. |
|
|
Liability of Parties
Transer Warranty Liability
(What is Warranted) |
A transferor who voluntarily transfers an instrument for consideration warrants that:
1) The transferor is a person entitled to enforce the instrument (e.g., he's the holder); and
2) All signatures are authentic and authorized; and
3) The instrument has not been altered; and
4) No defense or claim of any party is good against the transferor.
Note: The transferor need not have indorsed the instrument to incur transfer warranty liability.
Note: Transfer warranties are not made by the drawer of a check or maker of a note. |
|
|
Liability of Parties
Transer Warranty Liability
(To Whom does the Transferer Make Warranties) |
If the transfer is accompanied by transferor's indorsement, the transfer warranties run to ALL subsequent transferees.
If the transfer is NOT accompanied by the transferor's indorsement, the warranties run only to the transferor's IMMEDIATE transferee.
Illustration: - Payee defrauds Maker into giving Payee a $5k promissory note. Payee sells the note to Alice for $4,500. B/c of the fraud, Maker could successfully defend a suit on the note by Payee. Thus, when Payee transferred the note to Alice for consideration, Payee breached the transfer warranty that there was no defense against Payee. Alice can recover from Payee for any loss (up to the amount of the instrument) suffered as a result of the transfer warranty breach. |
|
|
Liability of Parties
Conversion Liability for Lost or Stolen Checks |
General Rule: An owner of a lost or stolen check may recover in conversion if the check is taken or paid over an unauthorized indorsement.
The owner of the check can recover ONLY if she had taken possession of the instrument (and possession through an agent IS sufficient).
Note: A drawer of a check may NOT sue and recover in converion.
The owner of the check may recover from the drawee bank, the depositary bank, and anyone else who took the check and did not act in good faith. |
|
|
Holder in Due Course (HDC)
Significance of Holder in Due Course |
Whether a person is a HDC is important when the holder of a note or of a check tries to collect on the note or check from a person obligated to pay the instrument (e.g., the maker, the drawer, or an indorser).
Where the obligated party refuses to pay due to a defense to payment, an HDC strips this party of his "PERSONAL defenses," and thus the obligated party must pay the HDC.
An HDC does NOT strip the obligated party's REAL defenses. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(Overview) |
A holder in due course is:
1) A holder 2) Who gives value for the instrument 3) In good faith 4) Without notice of certain things. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(Holder) |
- A holder is a person in POSSESSION of BEARER paper, or
- in possession of ORDER paper that has been issued or properly indorsed to him. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(Value for the Instrument) |
An HDC must have given value for the instrument. Look for execute dconsideration. (A mere promise to give value is not enough.)
A party is an HDC to the extent that the agreed consideration has been performed. (Can be a "PARTIAL HDC." |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(Good Faith) |
Good faith requires:
1) Honesty in fact (subjective component, cares about what the holder knew) and
2) Observance of Reasonable Commercial Standards of Fair Dealing (objective component, cares about the fairness of conduct as understood in the relevant community/industry.
Note: a person need not exercise due care in order to be in good faith. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Overview) |
An HDC must take the instrument without notice (which includes either actual knowledge or reason to know) that:
1) The instrument is so irregular or incomplete as to call into question its authenticity;
2) The instrument is overdue or has been discharged;
3) The instrument contains an unauthorized signature or has been altered.
4) There is a claim to the instrument.
5) Any party has a defense or a claim in recoupment (a counter-claim that reduces the amount payable) on the instrument. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Irregularities/Incompleteness) |
An HDC must take the instrument without notice (knoweldge or reason to know) that: the instrument is so irregular or incomplete as to call into question its authenticity.
Ex.: Midge issues a $20 check to Shane. Shane adds "000" to this number and "thousand" in very tiny letters in different colored ink between the words "twenty" and "dollars." Shane negotiates the check to Ralph. Is Ralph an HDC? - No, b/c Ralph had reason to know of the significant irregularities. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Overdue/Dishonored) |
An HDC must take the instrument without notice (knoweldge or reason to know) that: the instrument is OVERDUE or has been DISHONORED.
RULE 1: A purchaser has notice that an instrument is overdue if she knows or has reason to know that any part of the PRINCIPAL amount owed is overdue. (Doesn't matter if the interest payment is overdue.)
Rule 2: A check becomes overdue 90 days after its date. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Unauthorized Signature or Alterations) |
An HDC must take the instrument without notice (knoweldge or reason to know) that: the instrument contains an UNAUTHORIZED SIGNATURE or has been ALTERED.
Ex.: John works at Pizza Oven as a janitor. John shows his friend Sally a $5k check issued to John by Pizza Oven. Johns signature appears as the drawer of hte check. Without inquiry, Sally takes the check in exchange for an expensive Watch. - Sally is NOT an HDC b/c Sally has reason to know that John, as the janitor of Pizza Oven, is not authorized to issue this check (i.e., it's forged). |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Claim to the Instrument) |
An HDC must take the instrument without notice (knoweldge or reason to know) that: there is a CLAIM to the instrument.
Scenario: Bill sells a $5k stereo to Holly Maker, who issues Bill a $5k order paper note as payment. Bill indorses it in blank. Ron then steals thenote from Bill. Ron gives the note to Pam in exchange for a car.
- Pam is the holder of the note, b/c Ron became the holder of bearer paper and transferred possession to her.
- Bill has a claim to the note b/c it was stolen.
- Pam is an HDC b/c she is the holder in possession of bearer paper; she gave value for it; she acted in good faith; and she took without notice of Bill's claim. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Any Party Has a Defense - Overview) |
An HDC must take the instrument without notice (knoweldge or reason to know) that: any party has a DEFNSE or a claim in RECOUPMENT (a counter-claim that reduces the amount payable) on the instrument. Examples:
- Notice of Failure of Consideratoin
- Notice of Breach of Warranty
- Ntoice of Breach of Fiduciary Duty |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Any Party Has a Defense - Notice of Failure of Consideration) |
Scenario: Max Maker issues a $10k note to Peter Payee in payment for a defective car. Later, Max revoked his acceptance, and thus has a defense to payment on the note assertable against Peter.
- Peter negotiates the note to Harry, in exchange for $9k.
- Harry is an HDC who takes the note free of Maker's defense b/c he: became holder through negotiation process; gave value for it; acted in good faith; and took w/out notice of Maker's defense. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Any Party Has a Defense - Notice of Breach of Warranty) |
Scenario: Dave Drawer issued a $200 check to Peter Payee for a defective stereo. Drawer decided to keep the stereo anyway, and thus under Art. 2 Drawer must pay Peter for the goods. But Drawer has a breach of warranty counterclaim against Peter for $150.
- Peter negotiates the check to Sally in payment for a lawnmower. When Sally presents the check to Drawee Bank, it did not pay, so Sally demanded that Drawer pay $200 on the check. Is Sally an HDC who takes free of Drawer's $150 counterclaim?
- Yes, b/c: Sally is a holder through negotiation process; she gave value for the check; she acted in good faith; and she took without notice of the breach of warranty claim.
But note: If Sally knew of the breach of warranty claim, she's still a holder, but not an HDC. So Sally could only get $50 (b/c takes subject to Drawer's counterclaim). |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(Value for the Instrument - Bank Deposits) |
A depositary bank does not become a holder "for value" merely by provisionally crediting a depositor's account for a deposited check.
The depositary bank DOES give value when it allows its customer to withdraw against hte credited amount on a first-in, first-out basis. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - Any Party Has a Defense - Notice of Breach of Fiduciary Duty) |
A corporate officer is a fiduciary of his Company under his officer status. Officer gets a check payable to the Company and negotiates it to Bank to pay off a personal debt he owes to Bank. Bank knows this is the Company's corporate officer and a fiduciary. Is bank an HDC?
No, b/c Bank should know of the officer's breach of fiduciary duty. |
|
|
Holder in Due Course (HDC)
Elements to become HDC
(No Notice of Certain Things - What Does NOT Bar Becoming an HDC) |
Notice that an instrument is antidated, undated, or postdated.
Notice of an incomplete instrument that has been properly completed.
Notice of purchase at discount. - RULE: A large discount alone does not constitute taking in bad faith. But, coupled with other suspicious circumstances, a large discount gives rise to an argument that the person is taking the instrument in bad faith or with notice that someone else has a claim to the instrument. |
|
|
Holder in Due Course (HDC)
The Shelter Rule (General Rule) |
RULE: An instrument's transferee acquires whatever rights her transferor had.
Scenario: - Maker is fraudulently induced to issue a note to Payee. Payee negotiates the note to Frank, an HDC. - Frank then indorses the note and gives it to his daughter Carol as a gift. Carol is a holder, but is not HDC b/c did not give value. - When Carol demands payment from Maker, Maker raises fraud as defense. - B/c Carol is not an HDC, she does not take free of Maker's defense of fraud in the inducement. - However, Carol does take free of Maker's defense under the Shelter Rule (b/c Frank had been an HDC). |
|
|
Holder in Due Course (HDC)
The Shelter Rule (Exception) |
If Carol engaged in the fraud with Payee, she cannot acquire the rights of an HDC from Frank even if Frank is an HDC.
Also: - No shelter where transferor is the original payee to the underlying transaction that gave rise to the instrument. |
|
|
Real Defenses
Overview of Real Defenses |
While an HDC takes free of the obligated party's personal defenses and claims, the HDC take subject to "REAL DEFENSES." Which include:
1) Infancy of the maker/drawer, to the extent that it is a defense to a simple K;
2) Incapacity, extreme duress, or illegality of the transaction which, under other law, nullifies the party's obligation
3) Fraud in the EXECUTION of an instrument (fraud in the factum)
4) Any other discharge of which the holder has notice when he takes instrument
5) Statute of limitations |
|
|
Real Defenses
Statute of Limitations for Commercial Paper |
For a check: 3 years. For a note: 6 years.
On a demand instrument, the statutory period begins to run when demand for payment is made.
On a time instrument, the statutory period begins to run when payment is due. |
|
|
Real Defenses
Fraud in the Execution/Factum |
Fraud in the execution/factum = fradulent behavior designed to get someone's signature on a negotiable instrument without them knowing or having a reasonable opportunity to discover that it is a negotiable instrument.
Ex.: Larry goes to Tolstoy, who speaks little English, is poorly educated, and has little ability to read. Larry asks Tolstoy to sign a writing, saying it is a letter of reference for Larry. In truth it is a promissory note. This is fraud in the factum b/c: - Tolstoy was tricked about what he was signing; and - Did not have a reasonable opportunity to figure it out. |
|
|
Real Defenses
Discharge of Which Holder Has Notice (Example) |
Sally borrowed money from Norma, issued Norma a promissory note for $3k. The note was dated Sept. 1, 2003, and was due on March 1, 2006.
On June 5, 2005, Sally mailed a check to Norma for the full amount of the loan. Norma did not return the note to Sally, tear it up, or write "PAID" on it.
Instead, Norma spent the proceeds of the check and negotiated the ntoe to Frank in payment for obligations owed to him. On March 1, 2006, Frank as holder demands payment from Sally.
Sally's payment to norma on June 5, 2005 discharged both her underlying obligation to Norma and her obligation as the maker on the note.
BUT Sally could only raise this discharge by payment defense if Frank had notice of the payment. Otherwise, Frank is an HDC. |
|
|
Banks and Their Customers - Checking Accounts
The "Properly Payable" Rule
(General Rule) |
RULE: The payor bank may pay out the customer's money ONLY if it follows the customer's orders exactly. If it does not do so, it must recredit the customer's account. |
|
|
Banks and Their Customers - Checking Accounts
The "Properly Payable" Rule
(Examples of Violations of Properly Payable Rule) |
1) A check with a forged drawer's signature is not properly payable.
2) A check with a forged or missing indorsement is not properly payable.
3) Where a check has been altered, the customer's/drawer's account can be charged only the original (unaltered) amount of the check.
4) Payment over a customer's calid "stop payment" order is not properly payable.
5) "Overdrafts" and "stale" checks |
|
|
Banks and Their Customers - Checking Accounts
The "Properly Payable" Rule
(Instruments payable jointly vs. severally) |
If an instrument is payable to payees JOINTLY (e.g., "pay to X and Y"), the signature of ALL payees is necessary to negotiate or enforce the instrument.
If an instrument is payable to payees SEVERALLY (e.g., "to either X or Y"), ANY payee who is in possession of the instrument can negotiate or enforce the instrument. |
|
|
Banks and Their Customers - Checking Accounts
The "Properly Payable" Rule
(Customer's Valid "Stop Payment" Order - Standard) |
A customer may stop payment of a check drawn on the customer's account by an order to the drawee bank that:
1) Describes the check with reasonable certainty; and
2) Is received by the bank at a time and in a manner that affords the bank a reasonable opportunity to act on it.
NOTE: Satisfying either of these prongs may vary based upon the technology of the bank (i.e., how automated is the deposit process).
Best information to give to bank (especially if bank's deposit process is completely automated): checking account, specific check #, and the dollar amount. |
|
|
Banks and Their Customers - Checking Accounts
The "Properly Payable" Rule
(Customer's Valid "Stop Payment" Order - Other Rules) |
A stop payment order is effective for 6 months, but it lapses after 14 calendar days if the original order was oral and was not confirmed in writing within that period.
The bank may not contract out of liability for negligently failing to honor a valid stop payment order.
The burden of estbalishing the fact and amount of loss resulting from the payment over a valid stop payment order is on the customer. |
|
|
Banks and Their Customers - Checking Accounts
The "Properly Payable" Rule
(Overdrafts) |
OVERDRAFT Rule: a drawee bank may honor a check even if it creates an overdraft. But a drawee bank does not have to honor a check that creates an overdraft, unless it has agreed to do so with its customer (i.e., overdraft protection). |
|
|
Banks and Their Customers - Checking Accounts
The "Properly Payable" Rule
("Stale" Check Rule) |
STALE Check Rule: A bank is under no obligation to a customer to pay a check more than 6 months old, but it may charge the account thereafter in good faith. |
|
|
Banks and Their Customers - Checking Accounts
Wrongful Dishonor |
RULE: A payor bank is liable to its customer for damages caused by the wrongful dishonor of a check. Liability is limited to actual damages proved and may include damages for arrest or prosecution or other consequential damages.
Illustration: - George issues a check to secured Car Lender for his monthly car payment. George's bank dishonors the check even though it was properly payable. This is a wrongful dishonor. - Car Lender lawfully repossesses and sells George's car. Without his car, George loses work and wages. George can sue his bank to recover damages for the wrongful dishonor. |
|
|
Forgery and Bank Recovery
Forged Indorsement |
Generally, the loss for a forged indorsement should pass to the earliest solvent person after the forger (or the forger herself, in the unusual case in which she is solvent and locatable.
- This can be because of breach of the PRESENTMENT warranty that the person presenting the check is entitled to enforce the check. B/c of the forged indorsement, none of the parties from the forger on is entitled to enforce it.
- Or this can be because of the breach of two of the four TRANSFER warranties; namely, that the transferor had the right to enforce the instrument, and taht all signatures on the instrument were authentic and genuine. |
|
|
Forgery and Bank Recovery
Presentment warranties |
The party presenting the check for payment to Drawee Bank, and all earlier transferors of the check, each make three presentment warranties to Drawee Bank:
(i) it is a person entitled to enforce the check (e.g., it is the holder);
(ii) the check has not been altered; and
(iii) it has no ACTUAL KNOWLEDGE that the drawer's signature was forged. |
|
|
Forgery and Bank Recovery
Forged or Otherwise Unauthorized Drawer's Signature |
Where a drawee bank pays a check with a forged drawer's signature, it may seek recovery from earlier transferors under the breach of the presentment warranty that each of these earlier parties at the time of transfer had no actual knowledge that the drawer's signature was forged.
Such actual knowledge is rare, though, so the Drawee Bank typically suffers the loss in a forged drawer's signature scenario (except in the rare case that the forrger is available and solvent). |
|
|
Forgery and Bank Recovery
Restrictive Indorsement |
"For deposit only" = restrictive indorsement.
Secnario: - Drawer issued a $200 check payable to the order of Pam Payee. Payee immediately made the following indorsement: "For deposit only /s/ Pam Payee." - Shortly thereafter, Thief stole the check from Payee's purse. - Thief wrote her own name below that of Payee and cashed the check at Foody's. Foody's indorsed the check and deposited it in its own account at Depositary Bank, which then indorsed the check and prsented it to Drawee Bank, which made payment.
- Pam may sue Depositary Bank, Foody's or Thief for conversion of the check, b/c each of them failed to deposit the check's proceeds into her account, in violation of the restrictive indorsement.
- But Pam can't sue Drawee Bank for conversion, b/c the statute says so. |
|
|
Validation of the Forgery
Ratification |
Ratification of a forged or otherwise unauthorized indorsement or drawer's/maker's signature occurs when a party, with full knowledge of the forgery or lack of authorization, accepts the benefits thereof or actively assents to the wrongful activity.
(Just like agency rule.)
Ratification applies to alterations as well. |
|
|
Validation of the Forgery
Imposter Rule |
This rule validates the forged indorsement of the payee's name where the maker or drawer has been duped by an imposter to issue the instrument. The validation runs in favor of a person who, in good faith, pays the instrument or takes it for value or for collection.
Rationale: as between the maker/drawer and the party who takes the instrument in good faith, the maker/drawer was in the better position to recognize the imposter. |
|
|
Validation of the Forgery
Fictitious Payee Rules |
Rule 1: If the maker of a note or the drawer of a check does not INTEND at the time that the instrument was issued for the person identified as the payee to have any interest in the instrument, then an indorsement in the name of the payee is effective. The indorsement is effective in favor of a person who, in good faith, pays the instrument or takes it for value or collection.
- Ex.: Co. treasurer draws check to X, but does not intend to give it to X. Instead, treasurer forges X's indorsement and takes it to the bank to withdraw the funds.
Rule #2: If the person identified in the instrument as the payee is fictitious, then an indorsement in the name of the payee is effective. The indorsement is effective in favor of a person who, in good faith, pays the instrument or takes it for value or for collection.
Rationale: This is your employee--better that you bear the burden of his fraud. |
|
|
Validation of the Forgery
Fraudulent Indorsement by an Employee Entrusted with Responsibility |
If an employer entrusts an employee (including an independent contractor) with responsibility with respect to an instrument and the employee makes a fraudulent indorsement in the payee's name on the instrument, the indorsement is effective. The indorsement is effective in favor of a person who, in good faith, pays the instrument or takes it for value or collection.
Common scenarios: - Indorsements made in the name of the employer to instruments made payable to the employer. - Indorsements in the name of payees of instruments issued by the employer.
Rationale: This is your employee--better that you bear the burden of his fraud. |
|
|
Validation of the Forgery
The Negligence Rule |
If a person, by his negligence, substantially contributes to a material alteration or to the making of an unauthorized signature, he is precluded from asserting the alteration or lack of authority against an HDC or the drawee or other payor who pays in good faith and in accordance with the reasonable commercial standards of the drawee's or payor's business.
Ex.: Drawer's failure to safeguard his signature stamp or automatic signing device, or leaving signed blank corporate checks around and unguarded.
Look for any form of slovenly business practice. |
|
|
Validation of the Forgery
Comparative Negligence |
If the Drawee bank or other person paying the instrument or taking it for value or for collection (e.g., a depositary bank) fails to exercise ordinary care, teh person bearing the loss (under the Imposter Rule, Fictitious Payee Rule, etc.) may recover from the drawee bank or other person failing to exercise ordinary care to the extent that the failure to exercise ordinary care contributed to the loss. |
|
|
Validation of the Forgery
The Bank Statement Rule |
When a bank makes a bank statement (or returned check) available to its customer, the customer must use reasonable care and promptness to determine whether the customer's (drawer's) signature was unauthorized on a check of there was an alteration of a check, and must promptly notify the bank if the customer discovers such a problem.
The customer is liable for any loss where the same wrongdoer forges or alters a second (third, fourth, etc.) check, unless the customer gives the bank notice within a reasonable period (not to exceed 30 days) after the statement (or returned check) is made available to the customer.
If the drawee bank itself fails to exercise ordinary care in paying a check (e.g., it should have noticed a sloppy forgery or obvious alteration), the loss is allocated between the drawee bank and the customer according to the extent that each contributed to the loss.
Without regard to which party was negligent, a customer is precluded form asserting anunauthorized drawer signature or any alteration on the face of the instrument if she does not notify the bank within 1 year after the bank statement or checks are made available to the customer. |
|
|
Alteration
Definition and General Rule |
An alteration is an unauthorized change in an instrument that purports to modify the obligations of any party.
A nonfraudulent alteration does not discharge any party, and the instrument may be enforced according to its original terms.
In contrast, a fraudulent alteration discharges every party obligated on the instrument UNLESS the party assents to it or is precluded from asserting the alteration. |
|
|
Alteration
Altered Note
(Fraudulent Alteration of a COMPLETED Note) |
Rule: A person taking the altered instrument for value, in good faith, and without notice of alteration may enforce it according to its ORIGINAL terms.
Illustration: - Maker buys $5k worth of rugs from Carpet Shark and signs a completed $5k note payable in 12 months. After leaving the office, Carpet Shark carefully altered the amount of the note to $50k. - When the note came due, Carpet Shark demanded the $50k from Maker. - Maker owes NOTHING, because fully discharged by the fraudulent alteration.
- If Carpet Shark had negotiated the note to Finance Co., an HDC, then what can Finance Co. recover from Maker when due? $5k (original amount). - Finance Co. could then go after Carpet Shark for breach of transfer warranties. |
|
|
Alteration
Altered Note
(Fraudulent Alteration of an INCOMPLETE Note) |
Scenario: - Maker gives Payee a note with the dollar amount left blank with the understanding that Payee would later fill in the amount of $1k. - Payee later fraudulently fills in the amount of $6k (unauthorized completion of an incomplete note) and negotiates the note to Holder.
- If Holder knows of the unauthorized completion when the note is negotiated to him, Holder is not an HDC and takes subject to Maker's defense of unauthorized completion. In this case, as a mere holder, Holder can collect nothing from Maker b/c fully discharged.
- If Holder had no such notice of unauthorized completion, and otherwise qualifies as an HDC, he takes free of Maker's defense, and can collect the full $6k from Maker. |
|
|
Alteration
Altered Check |
A payor bank paying a fraudulently altered check may properly pay the check according to its ORIGINAL terms (but no more).
Anything paid beyond the check's original terms is not properly payable, and so must be recredited to the account. |
|
|
Accomodation Parties
Definition |
An accomodation party is one who signs the instrument in any capacity for the purpose of lending his name and credit for the benefit of another party to the same instrument (the "accomodated" party).
Typically, the accomodation party signs as either a co-maker or an indorser (depending on whether he signs on the face or the back of the instrument). |
|
|
Accomodation Parties
Liability |
An accomodation party is liable in the capacity in which he signed, again typically as an accomodation indorser or accomodation co-maker.
The liability of an accomodation indorser is conditioned upon dishonor and notice of dishonor.
The liability of an accomodation co-maker is NOT conditioned upon dishonor or notice of dishonor. |
|
|
Accomodation Parties
"Collection Guaranteed" Limitation on Accomodation Party's Liability |
If an accomodation co-maker adds to their signature "collection guaranteed" or equivalent words, the payee party must first use full efforts at collection from the accomodated party before trying to collect from the accomodation party. |
|
|
Accomodation Parties
Right to Reimbursement |
An accomodation party that pays the holder on the instrument is entitled to reimbursement from the accomodated party.
But not vice versa. |
|
|
Accomodation Parties
Defenses (General Rule) |
An accomodation party has all the defenses normally associated with the capacity in which he signed the instrument.
In addition to his own defenses, an accomodation party can assert any defense (real or personal) that the accomodated party could assert against the holder except the defenses of discharge in bankruptcy, infancy, and lack of legal capacity. |
|
|
Accomodation Parties
Defenses (vs. HDC) |
An HDC will strip the accomodation party's and the accomodated party's personal defenses. |
|
|
Accomodation Parties
Suretyship Defenses |
RULE: If a person entitled to enforce an instrument (e.g., the holder), without gaining the CONSENT of the accomodation party, does any of the following actions, the accomodation party's obligation to pay is discharged to the extent of the accomodation party's loss:
- Granting an extension of time on the note. - Any other material modification of the obligation unless the creditor can show the accomodation party did not suffer loss. - Impariment of collateral securing the obligation.
An accomodation party may assert the suretyship defenses only against a party who has notice of the accomodation (even an HDC if notice).
Obligee's release of the accomodated party's payment obligation does NOT discharge the accomodation party. |
|
|
Accord and Satisfaction
General Rule and Requirements |
Rule: If a person cashes or deposits an instrument with notice that it is tendered in full payment of a disputed debt, the debt is discharged in full.
Requirements: - The person tendering payment must act in good faith.
- The debt must be unliquidated or subject to a bona fide dispute.
- The person tendering the instrument must prove either: (i) the instrument contained a CONSPICUOUS statement that it was tendered in full satisfaction of the debt, OR (ii) the person accepting it actually knew that it was tendered in full satisfaction of the debt. |
