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52 Cards in this Set

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Generally
SC has adopted article 3 for negotiable instruments and article 4 for checks.

Most tested issues:
- Personal defenses not applicable to HDCs
- 2 parties > note, 3 parties > check
- Valid Negotiable Instrument requirements
- HDCs
- Shelter rule
- Real defenses (HDC subject to)
Types of instruments - Note
Notes - two party instrument
- unconditional
- promise or order to pay
- fixed amount of money (can include interest)
- payable to bearer or order
- on demand or at specific time

Maker - borrower - liability on note is separate from liability for underlying transaction to Payee (lender)

Transfers through NEGOTIATION - indorsement and delivery

Indorser becomes secondarily liable on the note - transferor/indorser will be liable to transferee
Types of instrument - Drafts (checks incl.)
3 party instrument - Drawer orders Drawee (depositary bank) to pay Payee (person entitled to enforce / receive money)

Signing draft - drawer becomes secondarily liable

Transferred through negotiation - payee can indorse draft and transfer to a third party. Transferee can seek recovery from either the payee/transferor or from drawer
Negotiability - formal requirements to make an instrument negotiable
- Signed by maker or drawer
- Unconditional promise to pay
- sum certain
- on demand or specific time
- order or bearer
Negotiability - Signature
Person whose signature is FORGED is NOT liable

Forged signature does operate as the forger's signature and the writing still qualifies as an instrument
Negotiability - unconditional promise or order to pay
Mere reference to another agreement does NOT make it conditional

Implied conditions do NOT render conditional

Still unconditional if (ok as NI):
- reference to another agreement
- reference to prepayment or acceleration clauses of another agreement
- Statement that instrument under letter of credit
- statement that instrument is secured by mortgage
Sum certain
Amount of payment must be determined from instrument itself without other necessary computation

Fixed interest rates ok - adjustable not
Payable on Demand or definite time
Still definite if subject to acceleration, extension at option of holder

Cannot be payable on death
Payable to order or bearer
Order - negotiated by indorsement and delivery
- Payable "To JS" >> NOT order paper
- Payable to order of JS - order paper

Bearer paper - negotiated by delivery
- "cash" "order of bearer" "specific person and bearer" "order of cash"
Omissions or incompleteness
Predating, postdating, undated does NOT affect negotiability

Incompleteness - cannot be enforced - later completion effective

Unauthorized completion triggers material alteration rules

Amount left blank > unauthorized completion is effective
Liability - signature
No person liable on an instrument unless they have signed it

- agents ok
- Unauthorized agents will have personal liability unless names principal and representative capacity

Unauthorized signatures operate as signature of signor
Nature of liability - makers and drawers
Makers of notes and acceptors of drafts are PRIMARILY liable on the note or draft
Nature of Liability - Drawers and indorsers
Drawers of drafts are SECONDARILY liable because their liability is subject to the condition of
- presentment
- dishonor, and
- notice of dishonor

Presentment - must be made within reasonable time after issuance
- check - 30 days of date of issuance
- late presentment only discharges a drawer's liability to extent drawee's insolvency prejudices the drawer's ability to recover from drawee
- indorsement - 7 days is reasonable

Late notice of dishonor
- Notice of dishonor for both a draft and an indorser must be given by the bank before its midnight deadline on the third business day after dishonor
- Late notice discharges INDORSER's , but not a drawer unless drawee became insolvent during delay (see above)

Disclaiming liability - "without recourse" is operative
Payment to a holder
Discharges liability on an instrument.

Only the person making payment is discharged and ONLY TO HOLDERS

Holder - person in possession of an instrument drawn, issued, or indorsed to him for his order or to bearer or in blank

Holder can discharge any party by
- cancellation
- renunciation
- surrender
Fraudulent and Material Alteration
as against any party other than a Holder in Due Course a fraudulent or material alteration discharges the liability of any party whose contract was changed

HDC can still enforce an altered instrument up to ORIGINAL amount
- if a completed instrument > Up to completed amount

Unauthorized completion = material alteration
Reacquisition
If a party reacquires an instrument
- intervening indorsers are discharged from obligations as against party and subsequent holders NOT in due course
Certification of check
drawee accepts draft prior to payment > signed engagement to honor draft upon presentment
Relationship between liability on an instrument and liability on underlying obligation - general rule
When an instrument is taken for an underlying obligation, the obligation is suspended until instrument is due. If instrument is dishonored, action lies on instrument OR underlying obligation.

Discharge on the instrument will act as discharge on the underlying obligation.

Satisfaction of the underlying obligation will provide the maker of a note or drawer of a draft a defense to payment on instrument - BUT this defense is NOT effective against Holders in Due Course
Persons Entitled to Enforce the instrument
1) Holders to whom the instrument is issued

2) Transferees who take by negotiation and become holders
- transferees receive rights of transferor

3) Nonholders in possession of an instrument with the rights of a holder
- this includes transferees who take without an indorsement

4) Person NOT in possession is entitled to enforce if:
- were entitled to enforce when instrument lost
- did not transfer or lose possession b/c of lawful seizure
- AND cannot reasonably obtain possession

4) Holders in Due Course
- Holders with secuirty interests in Instrument are Holders in Due Course to extent of the interest
Negotiation - how a transferee becomes a Holder
Generally - paper
- order paper - need indorsement and delivery
- bearer paper - need delivery only
Definition of a Holder
ap erson in possession of an instrument is a holder if the instrument is drawn, issued, or indorsed:
- to the person in possession (indorsed)
- to the order of the person in possession (order paper)
- to bearer (bearer paper)
- or in Blank
Transferees of thieves holders?
NO - neither a thief who steals and forges an indorsement on order paper, nor a subsequent transferee claiming through the thief qualifies as a holder.

BUT - bearer paper transferees of thieves are holders
Types of indorsement
Special
- indorsement specifies to whom or to whose order an instrument is payable
- must be indorsed by the named person

Blank
- does not specify an indorsee. BECOMES BEARER paper

Qualified
- "without recourse" indorser NOT liable on instrument

Restrictive
- "for deposit" "for benefit of"
- does not prevent further negotiation of instrument
- All persons who take must comply or be liable for conversion
- If to a bank - only the first bank to take must comply
Transfer Warranties
Generally - in addition to liability on the instrument, a party transferring the instrument may be liable for breach of warranty.

Given by a person who transfers an instrument and receives consideration.

Every transferor who transfers by indorsement to a subsequent holder will be liable for a breach.

Warrants:
- good title
- all signatures are genuine or authorized
- No material alteration
- No defenses of any party that is good against transferor
- the note CAN be paid (no knowledge of insolvency of maker/acceptors/transferors)
Presentment Warranties
Made by - person receiving payment or acceptance of instrument by any prior transferors

Made to - person who in good faith pays or accepts instrument

Warrants GOOD TITLE
- all necessary indorsement are made with NO forgery or unauthorized signatures

Breach of warranty allows paying party to shift loss to party warranting and can recover amount paid

Warrants NO KNOWLEDGE that signature of drawer or maker is unauthorized
- NOT warranting that all signatures are authorized, just no knowledge of unauthorized
- HDC acting in good faith does NOT give this warranty when presenting a check of payment to drawer or maker

Warrants NO MATERIAL ALTERATION
- An HDC does not give this warranty when presenting
Holders in Due course
Requirements:
- Holder
- In possession
- takes for value
- In good faith
- without notice of dishonor, overdue, or subject to claim or defense by any party
Shelter Rule
For holders in due course

If an HDC transfers to another > the transferee becomes a HDC even if he wouldn't qualify on his own

Transferee only obtains HDC status of transferor - which affects personal defenses

Shelter Rule does NOT enable a person who participated in fraud or who had notice of claim or defense to improve his position by washing the instrument through a HDC
Rights of an HDC
HDCs are PETEs

- Take free of all claims of ownership by any person
- take free of PERSONAL defenses (lack of delivery, failure of consideration, fraud in the INDUCEMENT)

But - SUBJECT TO real defenses (anything affecting the validity of a typical contract)
- infancy, lack of capacity, illegality, duress
- fraud in the factum - party signed instrument w/o knowledge or reasonably opportunity to gain knowledge essential to the instrument
If HDC is also Payee
HDC takes subject to

Claims in Recoupment
- claims that arise from same transaction that gave rise to the instrument, and asserted to reduce the amount owed on the instrument
Forgery and Alteration Defenses
Unauthorized signature of a maker is wholly inoperative, so there can be NO enforcement

But an HDC takes subject to a maker's claim of material and fraudulent alteration
- can enforce up to original amount if altered, or
- up to FULL amount if unauthorized completed
Consumer Credit Transactions
Consumer can assert personal defenses against an HDC when the instrument arose from a consumer credit transaction
Check Collection - forward collection generally
Buyer ISSUES check to Seller

Seller DEPOSITS check with Seller's bank (depositary bank)

Depositary Bank FORWARDS the check to Federal Reserve Bank (collecting and presenting bank)

Fed Reserve Bank PRESENTS check to Buyer's bank (payor bank)

- depositary bank provisionally credits Seller's account (uncollected funds)

- upon presentment - payor bank can pay or dishonor the check
Payor bank is accountable for amount of a check presented for payment
Payor bank is accountable on presentment of a check if payor fails to settle the check by MIDNIGHT on the banking day on which it received the check

Settlment - can be final or provisional (still satisfies settlement requirement)

If Payor bank and depositary bank are the same - check is "on us"

Failure to return check prior to midnight deadline
- Payor bank accountable for check
- Provisional settlements will become final
Check collection - presentment for cash
When check is presented to payor bank and cash is given at counter this consitutes FINAL payment > no recovery
Final Payment
Point in time when payor bank is accountable for a check

- pays in cash
- settles check without reservation of right to revoke
- completion of posting to account to be charged
- a decision to pay + entry of debit on customer/drafter account
- No dishonor or payment revocation before midnight of next banking day following presentment
Recovery after final payment (payor bank)
Bank may be able to recover from presenting party by asserting a breach of warranty claim

Payor bank can seek restitution, but cannot seek recovery from a HDC
Problems in check collection - check not properly payable
Check drawn on insufficient funds - justifies payor bank dishonor, but does not violate any obligations to customer when it pays an overdrafted check (will be treated as a loan)

But - failure to dishonor and return check prior to midnight deadline > final payment, bank accountable > otherwise can revoke a provisional settlement

Other checks not properly payable
- customer gave a timely and sufficient stop payment
- check is stale
- check is affected by fraud - forged drawer's signature, forged or missing, indorsement, material alteration
Problems in collection - wrongful dishonor
Payor bank wrongfully dishonors when it refuses to pay a check that is properly payable

Claim for wrongful dishonor may only be brought by customer who drew the check
- can recover all actual damages proximately caused by wrongful dishonor including consequential
Problems in collection - stop payment order (bar favorite)
(This area tests HDCs in check transactions)

A customer has a right to order his bank to stop payment for any reason.

Can be no claim for wrongful dishonor, however, because check is not properly payable

Order must - describe check with reasonable certainty and payor bank must receive order at a time that gives the bank reasonable opportunity to act

Oral orders - good for 14 days

Written - good for 6 months unless renewed

Payment in violation
- bank may be liable to recredit account

Subrogation rights (shifting the loss) - payor bank is subrogated to
- rights of any HDC against drawer
- rights of payee/drawer against the drawer/payee on the check or on the underlying transaction
Stop payment order on Cashier check and bank check
Cashier's check - check drawn by a bank on itself

Bank check - check drawn by one bank on that bank's account at another bank

NO RIGHT TO STOP PAYMENT on these checks

Specialty Flooring Case - tested
- Bank stop payment order on its own teller check was valid against the purchaser of the teller check b/c consideration paid for the check failed (personal defense)
- if purchaser had negotiated the check to an HDC and the check was dishonored as a result of the order, the bank would have been liable for amount of check, but not consequentials
Check fraud - three types
- Forged or unauthorized DRAWER signatures
- Forged, unauthorized, or missing indorsements
- Alterations
Check fraud - claims, defenses, counter defenses
Claims - customer assertion that payor bank should recredit account > check was not properly payable

Defenses - negligence of drawer

Counter - payor bank negligence
Shifting check loss through warranty and conversion
Payor bank who pays an improperly payable check may be able to bring a warranty action to shift loss to parties and banks who dealt with the check before presentment for final payment (UPSTREAM)

Forged indorsement - PAYEE can bring action directly against payor or depositary bank for conversion
Shifting loss on forged drawer signature
Breach of warranty (presentment - no knowledge, transfer - no forgeries)

restitution - cannot be recovered from person receiving payment if that person was a HDC or had changed position on good faith reliance on check
Forged Indorsements - claims
Payee v. Drawer - buyer obligation on check has not been discharged because it was not paid to a holder. Buyer will still be liable to both check and underlying transaction (SCARY)

Drawer v. payor bank - forged indorsement makes check not properly payable. Payor bank must recredit account absent defenses
Forged indorsements - payor bank defenses
Negligence by the drawer (resulting in forged indorsement)

3 year bar - drawer is barred from claiming forgery 3 years after receipt of bank statement
Forged indorsements - payor bank defenses - imposter, fictitious payee, and padded payroll
indorsement by any person in name of payee is EFFECTIVE if:

- imposter - person who induces the drawer to issue check directly to imposter by posing as intended payee

- fictitious payee - drawer does not intend the payee to have an interest in check

- padded payroll - employee induces his employer to sign a check payable to named party intending named party to have no interest in check
Shifting loss upstream
Payor bank v. presenting bank
- as presentment warranties good title (all indorsements were valid and authorized) if there is a forgery, the presenting bank has breached the warranty and is liable

Drawer v. Presenting Bank - warranty of good title (all indorsements valid and authorized) extends to payor bank and any other payor. Drawer considered another payor and can bring action directly to presenting bank

Presenting bank v. Prior customer - customer who transfers check also warrants good title (all indorsements valid and authorized). Bank may shift loss to the customer, who may in turn shift loss to earliest transferor before forgery
Conversion actions
Payee v. payor bank - payee to whom a check has been delivered is the owner of the check and can maintain a conversion action.
- payment of a check bearing a forged indorsement is a conversion, so the payee can recover from payor bank.

Payee v. Depositary bank - payee of stolen check bearing a forged indorsement can have conversion action against a depositary bank where the thief deposited the check. Limited to proceeds of check remaining in thief's account. *tracing rules may apply
Alterations - claims, defenses, counters
Claims against Payor bank - a material alteration is not properly payable - payor bank becomes HDC and can pay a check in good faith. Will not be liable up to original amount of check.
- a completed check is enforceable in its entirety

Defenses (payor bank)
- negligence
- bank statements (ie should have alerted drawer)
- subsequent checks with alteration by same wrongdoer not acted upon
- 1 year absolute bar

Counters
- negligence of payor bank
- payor bank did not act with ordinary care in paying the check

Payor bank may seek to shift the loss upstream for breach of warranty
- LIMITED - bank cannot assert warranty claim against person who obtained payment if bank had a defense but paid check and recredited account
Incomplete checks
Bank may pay up to full amount unless has notice that completion was improper
Accomodation and Guarantee
Accommodation party - any party who signs as surety or guarantor
- can be maker or indorser
- accommodation party who pays has recourse against accommodated party

Proof of status
- must show that only signed as accommodation
- if against an HDC - be in WRITING

Defenses
- release of rights
- Holder impairs collateral
- reservation of rights

Guarantors - makes a party a co-maker and primarily liable
- NOVATION - execution of a novation may release a prior guarantor from liability on guaranty