Advantages of Negotiable Instruments Over Normal Contracts
Negotiable instruments help facilitate commerce by allowing a holder in due course to receive payment even though the maker or payor may not be required to pay the payee.
B. Two-Party Paper – (promissory notes) “A two-party instrument has a maker and a payee.”
C. Three-Party Paper – (checks and drafts) “A three-party instrument has a drawer, a drawee bank, and a payee.”
1. Check – including cashier’s check, teller’s check, or money order
2. Draft – drawer’s order to drawee to pay payee or bearer; sight draft: payable on presentment
D. Certificate of Deposit – bank’s written acknowledgment of receipt of $ and bank’s promise to repay the sum on demand or at a specified date
NEGOTIABLE INSTRUMENT − NUTSS
“A negotiable instrument is a signed writing containing an unconditional promise to pay to order or bearer on demand or a date certain in the future a sum certain in money, with no additional undertakings.”
A. Negotiable Words
1. Order Paper – “pay to the order of” if payee identified, unless alternative to pay “bearer” also included on instrument
2. Bearer Paper – “pay to bearer” or “pay to cash”
3. Contradictory Terms
a. Handwritten → typed → printed
b. Words control over numerals
B. Unconditional Promise to Pay – instrument must be payable in all events
1. Promise to Pay Only – but maker/drawer can seek collateral to secure a debt
2. Future Contract – payment can’t be subject to future completion of contingency; non-negotiable
3. Non-Violating Conditions – implied/constructive conditions, statements of consideration or collateral given, words indicating source of agreement or reference to past transaction
4. Surety Involvement – joint and several liability if involved w/maker
5. Legal Right Retention Clause – OK to specify that any assignee takes their rights subject to all claims or defenses that issuer could assert against original payee
C. Time Certain – for payment of the obligation principal (not interest accrual)
1. Face of Instrument – time of payment definite if on demand or from instrument’s face; payable on demand if no time specified; payable at a fixed period is OK
2. Dates and Substitution – payment date→presentment by holder→acceptance by payee→issue by drawer/maker (hierarchy of controlling dates)
3. Extension or Acceleration Provisions – holder may have indefinite extension option, but maker can only extend to a definite future time; acceleration, pre-payment options OK
4. Occurrence Time Uncertain – non-negotiable: “I will pay when I receive my inheritance”
5. Undated Instrument – OK so long as date of payment specified
D. Sum Certain in Money – of principal obligation
1. Currency of Any Country – or legal medium of exchange permitted
2. Permissible Inclusions – interest, discounts, penalties, collection costs, or attorney fees
3. Open Sum and Option – commodity notes, promises to pay future property taxes=non-negotiable
E. Signed by Maker/Drawer – maker’s required if PN; drawer’s required if check, draft
1. Acceptable Signatures – written, machine, engraving, X, stamp, or other present intent to authenticate
2. Representative Liability – must have authority to issue instrument on behalf of principal; agent must ID principal and agent’s capacity in order to ensure only principal liable to 3d parties
Issue and Incomplete Instruments
“An instrument is issued when the maker or drawer first voluntarily transfers and delivers possession to a payee or bearer with an intent to transfer payment rights.”
Incomplete Instrument – when signer of instrument intended for other party to add in words, #s
a. Enforceable When Properly Completed – if maker or drawer intended for payee to complete instrument, enforceable as completed b. Examples – if date or amount incomplete, and parties agree, payee can fill in those terms c. Payee Incomplete – if no payee designated, enforceable as bearer instrument d. Improperly Completed – instrument is altered if payee adds in unauthorized terms or #s; loss is usually placed on party who left instrument incomplete
HOLDER IN DUE COURSE
“To be a holder in due course, a person must take an instrument for value, in good faith, without notice of claim or defense, and the instrument must be properly negotiated (endorsed and delivered for order paper; merely delivered for bearer paper).”
A. For Value – can be ordinary payment, release of pre-existing claim against S
1. Gift Donee – can’t be HDC
2. Partial HDC – if holder purchases instrument for < full face value (½ HDC, ½ assignee)
3. Future Performance – inadequate value
B. In Good Faith – whether holder had actual knowledge of claim or defense when acquired instrument
C. No Notice – holder can’t have constructive knowledge of claim or defense to enforceability (overdue, dishonored, in default, forgery, alteration, 3d party claims to instrument)
D. Negotiation
1. Order Paper – endorsed and delivered
2. Bearer Paper – transferred; HDC can collect even if stolen
3. Prohibited Negotiation – holder can’t become HDC by purchasing from estate, bankruptcy, business bulk, or creditor’s sale
E. Shelter Rule – “An assignee who receives the negotiable instrument as a gift may still qualify for HDC status under the Shelter Rule, if there is a previous HDC up the chain who passed HDC status by assignment.”
1. Cannot Improve Position – party to fraud in original transaction can’t cleanse instrument by passing on to HDC and then repurchasing
Exceptions to Negotiation Requirement
“Subsequent assignees are deemed HDCs if they take an instrument that was improperly endorsed due to maker or drawer’s negligence.”
- Fictitious Payee – where maker intended named payee to have no real interest in instrument
a. Dummy Vendor – bookkeeper makes out check to fake vendor, then endorses and converts funds to own use
b. Phantom Employee – supervisor creates timecard for fake EE; endorses and converts - Impostor – poses as another and induces maker to issue and execute instrument payable to them
Personal Defenses − MUFFLO
“Personal defenses are not valid against a holder in due course, but are good against the payee and include mutual mistake, unauthorized completion of the instrument, unfulfilled condition precedent, fraud in the inducement, failure of consideration, and others’ claims.”
- Mutual Mistake – by both parties
- Unauthorized Completion – payee completed NI wrongfully; wrong amount on blank check
- Unfulfilled Condition Precedent – extrinsic condition required before K payment due
- Fraud in the Inducement – FIRD: false inducement, intention to deceive, reliance by V, damages
- Lack of Consideration – negligence in performance of services, non-delivery of goods
- Other’s Claims – catch-all category; UCC favors finding defenses personal so HDC can collect
- Federal Trade Commission – HDC treated as assignee in consumer credit sale w/no greater rights than original promise; consumer-buyer can assert personal defenses
Real Defenses − FIDDLS FUM
“Real defenses are good against a holder in due course. These include fraud in the execution, illegality, discharge in bankruptcy, duress, lack of capacity, statute of limitations, forgery, unauthorized signature, and material alteration.”
- General Real Defenses
a. Fraud in Execution – D signed believing something other than promise to pay
b. Illegality – of transaction or creditor charging usurious credit rate
c. Discharge in Bankruptcy
d. Duress
e. Lack of Capacity – usually infancy
f. Statute of Limitations – w/in 6 years from due date or demand
g. Forgery – of maker’s, drawer’s, or special endorsee’s signature
h. Unauthorized Signature – lacking actual or apparent authority
i. Material Alteration – of amount; HDC can collect original amount - “Forgery, unauthorized signature, and material alternations can become personal defenses if the maker, drawer, or endorser’s negligence contributed to the defense.”
a. E.g. – maker not controlling signature stamp, mailing bearer paper to wrong person
b. HDC collects
c. Negligent Supervision
d. Comparative Negligence – loss allocated comparatively between negligent drawer and bank that wrongfully honored instrument
LIABILITY OF PARTIES
“A holder may sue under 1) contract liability, 2) breach of transfer or presenter warranty, 3) conversion of the instrument, or 4) the underlying obligation.”
Primary Liability
“Primary liability is with the maker of the note or drawer of the check. Secondary liability of endorsers depends upon the character and the extent and conditions associated with the endorsement.”
- Issue and Acceptance – drawee becomes potentially liable if they accept the instrument; issue required for liability to attach to maker
- Co-Makers – joint and several liability applies; person entitled to enforce can recover from either; co-makers can bring contribution claim against each other if one over pays
- Liability for Dishonored Checks – drawer penalized unless nonpayment resulted from justifiable “stop payment” order
Secondary Liability
- In General – rests w/3d party endorsers; sureties behind maker and drawee bank
a. Chronological Liability – up the ladder; transferee→holder→transferor
b. Liability Discharged – if notice of dishonor not given to endorser, or check not presented w/in 30 days after day of endorsement
c. Banks and HDC Limitations – drawee bank has until midnight of next day to dishonor; HDC must notify transferor w/in 30 days of receiving notice of dishonor
Warranty Liability
“Transferors warrant that 1) they have good title and are entitled to enforce the instrument; 2) material alterations are not present; 3) they have no knowledge of maker’s insolvency; 4) no defenses can be asserted against the warrantor; and 5) all signatures are genuine and authorized.”
- Transfer Parties Warranties − GANDS – if instrument transferred to subsequent party for consideration, transferor warrants:
a. Good Title to Instrument
b. Alterations Not Present
c. No Knowledge of Insolvency
d. Defenses Not Present
e. Signatures are Genuine & Authorized
“Presenters to the drawee bank warrant 1) that they have good title to the instrument; 2) material alterations are not present; and 3) the drawer’s signature is authorized.”
- Presentment Party Warranties − GAD – presenter warrants to maker or drawee bank:
a. Good Title to Instrument
b. Alterations Not Present
c. Drawer’s Signature is Authorized - Excluded Subjects – warranty that instrument will be paid
- Exception to Warranty Liability – accommodation endorser b/c not involved in chain of title
- Warranty Disclaimer – of transfer or presentment warranties, except for checks
Underlying Obligation
“The underlying obligation to an instrument is discharged to the same extent as if money was exchanged if the instrument is a certified, cashier’s, or teller’s check taken for the obligation.”
“The underlying obligation is suspended if regular check or note taken, and it is lifted upon dishonor. A holder can sue maker/drawer on the original obligation, or to enforce the instrument.”
IMPROPER NEGOTIATION
A. In General – forgery: signature by one other than the maker/drawer or an endorser made w/an intent to impersonate another
B. Maker’s/Drawer’s Signature Forged
1. Bank Liability and Recovery – if bank wrongfully honors check, must return $ to drawer; may recover from presenting party under breach of presentment warranty
2. Exception for Owner’s Negligence – if owner leaves check unprotected, bank may pay and has defense against owner
C. Unauthorized Payee Completion – maker/drawer not liable to thief if instrument property signed and thief completes in her favor; payee cannot recover if maker/drawer pays subsequent HDC
D. Endorser’s Signature Forged – no liability to endorser who was falsely represented, unless negligent; breaks chain of title, no subsequent transferee can become HDC
E. Enforcement of Lost, Destroyed, or Stolen Instruments – payee can still enforce K amount against maker/drawer; instrument acceptance does not discharge underlying obligation; sworn declaration required; maker/drawer must be protected from claims of another trying to enforce
F. Forgery – action for conversion may also lie if intent to defraud; applies to forger and subsequent holder w/knowledge of forgery; also a crime
ARTICLE 4 – BANK DEPOSITS AND COLLECTIONS
Drawee’s Responsibilities – banks cannot disclaim obligation of good faith, duty to exercise ordinary care
- Wrongful Honor – “A bank can be negligent by wrongfully honoring an instrument which was forged or irregular on its face or paying out over a valid stop payment order.”
- No Duty to Presenter – unless bank has certified instrument; must return before midnight on next day to avoid liability to presenter
- Overdue / Postdated / Overdraft – overdue = 90 days past date; bank may pay; may charge customer’s account if check is properly payable, even if it creates an overdraft
- Hold Periods – depository bank can hold customer’s funds for not more than 2 days for deposit of a local check, 5 days for deposit of a non-local check, so bank can collect funds before customer draws on them
- Multiple Payees – payable to “cash” or “A or B” either can endorse; “A and B” both endorse
- Wrongful Dishonor – “Under the properly payable rule, a bank is liable to the customer for wrongful dishonor unless it would have created an overdraft.”
Stop Payment Order and Transaction Sequence
customer can order bank to stop payment and not honor any items payable on their account; if bank pays over stop order, wrongful honor
- Oral Orders − 14 Days – binding
- Written Orders − 6 Months – unless renewed in writing for longer
- Bank Decides Sequencing – of accepting, paying, or charging account; checks returned “stop payment” can’t be presented again
Unauthorized Signature or Alteration
- Period to Report – depends on drawer:
a. Businesses − 60 days – from receipt of account statement
b. Consumers − 1 year – from receipt of cancelled check - Forged Instrument Liability – bank usually liable b/c assumed to know customer’s signature; if paid, bank can recover against presenting party or endorsers under warranty theory
- Drawer’s Negligence Exception – leaving signed check in unsecured area, dummy vendor, etc.
Comparative Negligence
“As between the negligent drawer and the bank who wrongfully honored the instrument, monetary loss is to be allocated based upon comparative negligence.”
Certification
“If a holder procures bank certification, the drawer and former endorsers are discharged, and the bank is liable to any holder in due course.”
Subrogation Rights
“A payor bank has full subrogation rights if it pays out over a stop payment order or other circumstances objected to by the drawer/maker.”
Opening Argument
UCC Article 3 governs transactions involving negotiable instruments and Article 4 governs bank - customer relations.
Special Endorsement
identifies next transferee who must indorse to further negotiate instrument
Unqualified / Blank Endorsement
signature w/out specifying endorsee; converts order paper to bearer paper; assignee can demand unqualified endorsement
Restrictive Endorsement
Conditional and purports to prohibit further transfer; ineffective to prohibit assignment under UCC, except “for deposit only”
Qualified Without Recourse
eliminates K liability on instrument; transfer warranty liability still applies
