Power Point Slides to Accompany CONTEMPORARY BUSINESS AND

Power. Point Slides to Accompany CONTEMPORARY BUSINESS AND ONLINE COMMERCE LAW 5 th Edition by Henry R. Cheeseman Chapter 20 Holder in Due Course and Liability Slides developed by Les Wiletzky and Associates Copyright © 2006 by Pearson Prentice-Hall. All rights reserved.

Introduction n If payment is not made on a negotiable instrument when it is due, the holder can use the court system to enforce the instrument n Various parties, including both signers and non-signers, may be liable on it n Accommodation parties (i. e. , guarantors) can also be held liable Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 2

Holder Versus Holder In Due Course Holder n A person who is in possession of a negotiable instrument that is drawn, issued, or indorsed to him or his order, or to bearer, or in blank Holder in Due Course (HDC) n A person who takes a negotiable instrument for value, in good faith, and without notice that it is defective or is overdue Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 3

Requirements for HDC Status To qualify as an HDC, the transferee must meet the requirements established by the UCC n The person must be the holder of a negotiable instrument that was taken: 1. For value 2. In good faith 3. Without notice that it is overdue, dishonored, or encumbered in any way, and 4. Bearing no apparent evidence of forgery, alterations, or irregularity [UCC 3 -302] n Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 4

Holder in Due Course (HDC) Maker or Drawer Negotiabl e Instrume nt Payee or Bearer Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Negotiabl e Instrume nt Holder in Due Course (HDC) 1. 2. Holder 3. 4. For value 5. Without notice of defect 6. The instrument bears no apparent evidence of forgery, alterations, or 20 - 5 irregularity Takes a negotiable instrument In good faith

Holder in Due Course: Taking for Value n Value has been given for a negotiable instrument if the holder: 1. Performs the agreed-upon promise 2. Acquires a security interest or lien on the instrument 3. Takes the instrument in payment of or as security for an antecedent claim 4. Gives a negotiable instrument as payment 5. Gives an irrevocable obligation as payment Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 6

Holder in Due Course: Taking in Good Faith n A holder must take the instrument in good faith to qualify as an HDC n Good faith means honesty in fact in the conduct or transaction n It is the holder’s subjective belief that can be inferred from the circumstances Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 7

Holder in Due Course: Taking Without Notice of Defect n A person cannot qualify as an HDC if he or she has notice that the instrument is defective in any of the following ways: 1. It is overdue 2. It has been dishonored 3. It contains an unauthorized signature or has been altered 4. There is a claim to it by another person 5. There is a defense against it Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 8

Holder in Due Course: No Evidence of Forgery, Alteration, or Irregularity n A holder cannot become an HDC to an instrument that is apparently forged, or altered, or is so otherwise irregular or incomplete as to call into question its authenticity Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 9

Signature Liability of Parties n A person cannot be held contractually liable on a negotiable instrument unless his or her signature appears on the instrument n The signatures on a negotiable instrument identify those who are obligated to pay it n If it is unclear who the signer is, parol evidence can identify the signer Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 10

Signature Defined n Any name, word, or mark used in lieu of a written signature n Any symbol that is: Handwritten, typed, printed, stamped, or made in almost any other manner; and n Executed or adopted by a party to authenticate a writing n Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 11

Signers of instruments sign in many different capacities, including: n A maker of notes and n An indorser who certificates of deposit indorses an instrument n A drawer of drafts and checks n An agent who signs on behalf of others n A drawee who certifies or accepts n An accommodation checks and drafts party Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 12

Agent’s Signatures n Agent – A person who has been authorized to sign a negotiable instrument on behalf of another person n Principal – A person who authorizes an agent to sign a negotiable instrument on his or her behalf n Unauthorized Signature – A signature made by a purported agent without authority from the purported agent Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 13

Signature Liability: Primary Liability n Makers of promissory notes and certificates of deposit have primary liability for the instrument n Upon signing a promissory note, the maker unconditionally promises to pay the amount stipulated in the note when it is due n Makers are absolutely liable to pay the instrument, subject only to certain real defenses Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 14

Signature Liability: Secondary Liability n Drawers of checks and drafts and unqualified indorsers of negotiable instruments have secondary liability on the instrument n This liability is similar to that of a guarantor of a simple contract n It arises when the party primarily liable on the instrument defaults and fails to pay the instrument when due Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 15

Signature Liability: Accommodation Party n A party who signs an instrument and lends his or her name (and credit) to another party to the instrument n The accommodation party is obliged to pay the instrument in the capacity in which he or she signs n Accommodation Maker – primarily liable n Accommodation Indorser – secondarily liable Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 16

Warranty Liability of Parties n The law implies certain warranties on transferors of negotiable instruments n Warranty liability is imposed whether or not the transferor signed the instrument n There are two types of implied warranties: Transfer Warranties n Presentment Warranties n Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 17

Transfer Warranties (1 of 2) n Transfer – Any passage of an instrument other than its issuance and presentment for payment n Transfer Warranties – any of the following five implied warranties: 1. The transferor has good title to the instrument or is authorized to obtain payment or acceptance on behalf of one who does have good title 2. All signatures are genuine or authorized Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 18

Transfer Warranties (2 of 2) 3. The instrument has not been materially altered 4. No defenses of any party are good against the transferor 5. The transferor has no knowledge of any insolvency proceeding against the maker, the acceptor, or the drawer of an unaccepted instrument Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 19

Presentment Warranties n Any person who presents a draft or check for payment or acceptance makes the following warranties to a drawee or acceptor who pays or accepts the instrument in good faith: 1. The presenter has good title to the instrument or is authorized to obtain payment or acceptance of the person who has good title 2. The instrument has not been materially altered Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 20

Defenses n The creation of negotiable instruments may give rise to a defense against its payment n There are two general types of defenses: Real Defenses n Personal Defenses n n A holder in due course (HDC) takes the instrument free from personal defenses but not real defenses Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 21

Real Defenses 1. Minority 2. Extreme duress 3. Mental incapacity 4. Illegality 5. Discharge in bankruptcy 6. Fraud in the inception 7. Forgery 8. Material alteration Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Effect Real defenses can be raised against both holders and holders in due course 20 - 22

Personal Defenses 1. Breach of contract 2. Fraud in the inducement 3. Mental illness that makes a contract voidable instead of void 4. Illegality of a contract that makes the contract voidable instead of void 5. Ordinary duress or undue influence 6. Discharge of an instrument by Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Effect Personal defenses cannot be raised against a holder in due course 20 - 23

HDC Status Eliminated with Respect to Consumer Credit Transactions n The Federal Trade Commission (FTC) has adopted a rule that eliminates HDC status with regard to negotiable instruments that arise out of certain consumer credit transactions n Sellers of goods and services are prevented from separating the consumer’s duty to pay the credit and the seller’s duty to perform n©Thus, both personal and real defenses 20 - 24 Copyright 2006 by Pearson Prentice-Hall. All rights reserved.

Discharge n Actions or events that relieve certain parties from liability on negotiable instruments n There are three methods of discharge: 1. Payment of the instrument 2. Cancellation 3. Impairment of the right of recourse Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 25

Impairment of the Right of Recourse n Certain parties (holders, indorsers, accommodation parties) are discharged from liability on an instrument if the holder: 1. Releases an obligor from liability; or 2. Surrenders collateral without the consent of the parties who would benefit by it Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 20 - 26