Chapter 19 Negotiable Instruments Negotiability Transferability and Liability

Article 3 of the UCC § A “negotiable instrument” is a signed writing containing an unconditional promise to pay an exact sum of money. § To function as a substitute for money or credit device. § In order for an instrument to operate practically, it has to be easily transferable. © 2002 by West Legal Studies in Business A Division of Thomson Learning 2

Types of Negotiable Instruments § Drafts and checks are 3 party instruments: Drawer, Drawee and Payee. – Checks (cashier’s, teller’s and traveler’s) are drafts on a bank. – Trade acceptances seller is drawer and payee. § Notes are two party instruments (Promisor § and Promisee). Certificates of deposit (CDs): two party instruments. © 2002 by West Legal Studies in Business A Division of Thomson Learning 3

Requirements for Negotiability § Writing signed by the maker or the drawer. § Unconditional promise or order to pay a fixed amount of money. § Payable on demand or at a definite time. § Be payable to order or to bearer, unless it is a check. © 2002 by West Legal Studies in Business A Division of Thomson Learning 4

Transfer of Instruments § Transfer by Assignment – Assignee receives all rights to the instrument; any defenses that can be raised against a holder can be raised against the assignee. © 2002 by West Legal Studies in Business A Division of Thomson Learning 5

Transfer Of Instruments § Transfer by negotiation creates a holder, who at the very least receives the rights of a previous possessor. AND § A holder in due course (HDC) acquires more rights in the instrument than the previous possessor. This means defenses that can be raised against the transferor may not be able to be raised against the transferee. © 2002 by West Legal Studies in Business A Division of Thomson Learning 6

Holder vs. HDC § Holder is one in possession of ORDER OR BEARER PAPER. § Holder in Due Course (HDC) results if the holder also meets the following requirements: – Takes for Value. – Takes in Good Faith. – Takes without Notice. © 2002 by West Legal Studies in Business A Division of Thomson Learning 7

HDC: Taking for Value § No value if gift or inheritance. Not the same as consideration. § Holder can take value by: – Performing the instrument’s promise. – Acquiring a security interest or other lien in the instrument. – Taking instrument in payment for an antecedent debt. – Giving a negotiable instrument as payment. – Giving irrevocable commitment as payment. © 2002 by West Legal Studies in Business A Division of Thomson Learning 8

HDC: Taking in Good Faith § Good faith is honesty in fact and the observance of reasonable commercial standards of fair dealing. ” § Only applies to holder, not transferor. § Case 19. 1 Adamar v. Chase Lincoln (1994). © 2002 by West Legal Studies in Business A Division of Thomson Learning 9

HDC: Taking Without Notice § Holder takes the instrument without notice if he knows/has reason to know: – Instrument is overdue. – Instrument has been dishonored. – Actual knowledge or any suspicious event. – That a claim or defense exists. – So irregular, incomplete, or bears such evidence of forgery. © 2002 by West Legal Studies in Business A Division of Thomson Learning 10

Holder through an HDC § “Shelter Principle”: Person is not an HDC but derives title through HDC. § Limitations on the shelter principle: no fraud, illegality, claim or defense. © 2002 by West Legal Studies in Business A Division of Thomson Learning 11

Liability § There are two kinds of liability associated with negotiable instruments: – Signature liability. – Warranty Liability. © 2002 by West Legal Studies in Business A Division of Thomson Learning 12

Signature Liability § Relates to signatures on instruments. § Signers of negotiable instruments are potentially liable for amount state on instrument. – Primary Liability: Makers/Accepters. – Secondary Liability: Drawers/Indorsers. © 2002 by West Legal Studies in Business A Division of Thomson Learning 13

Signature Liability § Proper Presentment. – Must be timely (checks w/in 30 days). § Dishonor. § Proper Notice. § Accommodation Parties: Signs instrument to lend name as credit to another party on the instrument. © 2002 by West Legal Studies in Business A Division of Thomson Learning 14

Signature Liability § Authorized Agent’s Signature. – To hold Principal liable agent must be authorize to sign and Principal must be clearly named. – Agent personally liable when Principal is not named or disclosed, unless check is drawn on Principal’s account. © 2002 by West Legal Studies in Business A Division of Thomson Learning 15

Signature Liability § Unauthorized Signatures. – Forgery does not bind owner but Bank is liable. – If Agent has no authority, Agent is personally liable, but Principal is not, unless ratified. © 2002 by West Legal Studies in Business A Division of Thomson Learning 16

Signature Liability § Unauthorized indorsement does not bind maker/drawer except: – “Imposter Rule”: imposter induces maker/drawer to issue check to imposter. – When imposter signs as/on behalf of maker/drawer intending payee has no interest in the instrument. © 2002 by West Legal Studies in Business A Division of Thomson Learning 17

Warranty Liability § Extends to both signers and non -signers. § Breach of warranty can occur when the instrument is transferred or presented for payment. © 2002 by West Legal Studies in Business A Division of Thomson Learning 18

Warranty Liability § Transferors make certain implied warranties regarding instruments they negotiate. § Liability not subject to dishonor, presentment, notice. § Liabilities: Transfer or Presentment. © 2002 by West Legal Studies in Business A Division of Thomson Learning 19

Transfer Warranties § Following transfer warranties extend to all subsequent holders: – Transferor is entitled to enforce the instrument. – Signatures are authentic and authorized. – Instrument has not been altered. – Instrument not subject to defense. – Transferor has no notice of insolvency. © 2002 by West Legal Studies in Business A Division of Thomson Learning 20

Presentment Warranties § Person who presents an instrument makes the following presentment warranties: – No missing or unauthorized indorsement. – Instrument has not been altered. – Person obtaining payment has no knowledge signature is unauthorized. © 2002 by West Legal Studies in Business A Division of Thomson Learning 21

Defenses To Liability § Universal or Real - can be used to defeat a holder and a HDC. § Personal - can be used to defeat a holder but not a HDC. © 2002 by West Legal Studies in Business A Division of Thomson Learning 22

Universal Defenses § Forgery of maker’s or drawer’s signature. – Or if an authorized agent exceeds his authority to the amount which exceeds his authority. § Fraud in the execution - the “autograph” situation, not fraud in the inducement. © 2002 by West Legal Studies in Business A Division of Thomson Learning 23

Universal Defenses § Material Alteration. – Do not have to pay the altered amount ($8 to $800), only a personal defense to the original amount ($8). – Not a real defense if instrument left blank, (. . filled in $800), then have to pay all ($800). § Discharge in Bankruptcy. § Infancy (Minority). © 2002 by West Legal Studies in Business A Division of Thomson Learning 24

Universal Defenses § Illegality - severe enough to make contract void. § Mental Incapacity (adjudicated by court). § Extreme Duress. If instrument signed under threat of immediate force or violence. © 2002 by West Legal Studies in Business A Division of Thomson Learning 25

Personal Defenses § Valid against holders but not HDC’s. – Breach of contract or warranty. – Lack of consideration. – Fraud in the inducement. – Illegality - not severe enough to make void. § Case 19. 3 Kedzie & 103 rd St. Currency Exchange v. Hodge (1993). © 2002 by West Legal Studies in Business A Division of Thomson Learning 26

Personal Defenses § Mental incapacity - not severe enough to make void. § Discharge. – By payment or cancellation. – Unauthorized completion. – Non-delivery of instrument. – Ordinary duress or undue influence rendering contract voidable. © 2002 by West Legal Studies in Business A Division of Thomson Learning 27

Discharge from Liability § Discharge from liability on an instrument can occur by: – Payment. – Cancellation. – Material Alteration. © 2002 by West Legal Studies in Business A Division of Thomson Learning 28

Discharge by Payment § All parties to an instrument will be discharged when the party primarily liable on the instrument pays to the holder the amount due in full. © 2002 by West Legal Studies in Business A Division of Thomson Learning 29

Discharge by Cancellation § Intentional cancellation of an instrument discharges the liability of all parties. – Examples: Intentionally writing “paid” on the front of an instrument, or tearing it up or mutilating it, cancels the instrument. © 2002 by West Legal Studies in Business A Division of Thomson Learning 30