what requirements must an instrument meet to be negotiable? what requirements must an instrument...

• What requirements must an instrument What requirements must an instrument meet to be negotiable?meet to be negotiable?• What are the requirements for attaining What are the requirements for attaining

the status of a holder in due course the status of a holder in due course (HDC)?(HDC)?• What is the difference between signature What is the difference between signature

liability and warranty liability? liability and warranty liability?

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2

• Certain defenses are valid against all Certain defenses are valid against all holders, including HDCs. What are these holders, including HDCs. What are these defenses called? Name four defenses defenses called? Name four defenses that fall within this category.that fall within this category.• Certain defenses can be used against an Certain defenses can be used against an

ordinary holder but are not effective ordinary holder but are not effective against an HDC. What are these defenses against an HDC. What are these defenses called? Name four defenses that fall called? Name four defenses that fall within this category.within this category.


• A “negotiable instrument” is a signed A “negotiable instrument” is a signed writing containing an unconditional writing containing an unconditional promise to pay an exact sum of promise to pay an exact sum of money.money.• Most negotiable instruments are Most negotiable instruments are

paper documents, referred to as paper documents, referred to as commercial paper.commercial paper.


• The UCC specifies four types of The UCC specifies four types of negotiable instruments: negotiable instruments: –Drafts, Checks, Notes, and Certificates

of Deposit. • Can be Orders to Pay or Promises to Pay.• Can also be demand instruments or time

instruments.


• Drafts and Checks (Orders to Pay).Drafts and Checks (Orders to Pay).–Unconditional order involves three

parties: Drawer (creator of draft), Drawee (financial institution) and Payee.–Most common type of draft is a bank

check.


• Drafts and Checks (cont’d).Drafts and Checks (cont’d).–Time Drafts and Sight Drafts.• Time Draft: payable certain future time.• Sight Draft: payable on sight. May be

payable on acceptance (drawee’s written promise to pay the draft when due).

–Trade Acceptances: seller of goods is both drawer and payee. Buyer of goods is the drawee.


• Drafts and Checks (cont’d).Drafts and Checks (cont’d).–Checks.• Three parties: Writer of the check is

drawer, the bank is drawee, and person to whom check is made is payee. • Checks are payable on demand.


• Promissory Notes and Certificates of Promissory Notes and Certificates of Deposit (Promises to Pay).Deposit (Promises to Pay).–Promissory Notes are two party

instruments:•Maker (Promisor) and • Bearer (Promisee).• Can be payable at a definite time or on

demand.


• Promissory Notes and Certificates of Promissory Notes and Certificates of Deposit (cont’d).Deposit (cont’d).–Certificate of Deposit: type of note

issued when a party deposits funds with a bank, and bank promises to repay funds with interest on certain date. –Bank is maker, and Depositor is Payee.


• For an instrument to be negotiable, it For an instrument to be negotiable, it must:must:–Be in Writing.• Permanence.• Portability.

–Be Signed by the Maker or Drawer.• Signature Requirements: manual or by a

device.• Placement of the Signature.


• Be an Unconditional Promise or Be an Unconditional Promise or Order to Pay.Order to Pay.–Promise or Order.–Unconditionality of the Promise or

Order.• State a Fixed Amount of Money.State a Fixed Amount of Money.–Ascertainable. –U.S. Currency.


• Be Payable on Demand or at a Definite Be Payable on Demand or at a Definite Time.Time.–On Demand: “Payable at sight” or

“Payable upon presentment.”• CASE 22.1 Roger Development, LLC v. Roger Development, LLC v.

National City Bank National City Bank (2010). Why doesn’t the duty of good faith apply to lenders seeking payment on demand notes?


• Be Payable on Demand or at a Be Payable on Demand or at a Definite Time (continued).Definite Time (continued).–Payable at a Definite Time: specified

date, within definite period of time, date or time readily ascertainable.


• Be Payable on Demand or at a Be Payable on Demand or at a Definite Time (cont’d).Definite Time (cont’d).–Acceleration Clause: allows holder to

demand full payment if a certain event occurs.–Extension Clause: allows date of

maturity to be extended into the future.


• Payable to Order or Bearer.Payable to Order or Bearer.–Order Instruments: payable to “the

order of” an identified person, or to “an identified person or order.”–Bearer Instruments: the holder is the

payee.


• Factors That Do Not Affect Factors That Do Not Affect Negotiability.Negotiability.–Omission of Date.–Postdating or Antedating.–Handwritten Terms outweigh

typewritten and preprinted terms.–Words outweigh figures.


• Factors That Do Not Affect Factors That Do Not Affect Negotiability (cont’d).Negotiability (cont’d).–If instrument states “with interest” but

doesn’t specify the rate, it is the judgment rate of interest.–Check is negotiable even if there is a

“nonnegotiable” note on it.


• A negotiable instrument can be A negotiable instrument can be transferred by assignment or transferred by assignment or negotiation. negotiation. • Transfer by Assignment. Transfer by Assignment. –Similar to assignments discussed in

Chapter 17. Transferree is the assignee, rather than a holder.


• Transfer by Negotiation.Transfer by Negotiation.–Negotiating Order Instruments:

requires both indorsement and delivery.–Negotiating Bearer Instruments:

delivery only. Indorsement is not necessary.


• Signature with or without additional Signature with or without additional words or comments.words or comments.• BlankBlank Indorsements: Indorsements: does not specify a does not specify a

particular indorsee and may consist of a particular indorsee and may consist of a mere signature.mere signature.• SpecialSpecial Indorsements: Indorsements: contains contains

signature and identifies payee. signature and identifies payee.


• QualifiedQualified Indorsements Indorsements: indorser who : indorser who does not wish to be liable (“without does not wish to be liable (“without recourse”).recourse”).–Effect of Qualified Indorsements.–Special versus Blank Indorsements.–CASE 22.2 Hammett v. Deutsche Bank Hammett v. Deutsche Bank

National Co. National Co. (2010). What was the legal effect of the blank qualified indorsement?


• RestrictiveRestrictive Indorsements: requires Indorsements: requires indorsee to comply with certain indorsee to comply with certain instructions regarding funds.instructions regarding funds.–Conditional Indorsements.–Indorsements for Deposit or Collection.–Trust (Agency) Indorsements.


• Miscellaneous Indorsement Miscellaneous Indorsement ProblemsProblems–Misspelled Names. Indorsement

should generally be identical to name on instrument.–Alternative or Joint Payees: either may

indorse. Jointly - both must indorse..


• Holder versus Holder in Due Course Holder versus Holder in Due Course (HDC). (HDC). –Holder possess an order or bearer

paper and the instrument is drawn or indorsed to the holder.–HDC: holder plus takes for value, takes

in good faith, and without notice of defense to payment.


• Requirements for HDC Status.Requirements for HDC Status.–Taking For Value: No value if gift or

inheritance. Not the same as consideration. Holder can take for value by:• Performing the instrument’s promise. • Acquiring a security interest or other lien

in the instrument.


• Requirements for HDC Status (cont’d).Requirements for HDC Status (cont’d).–Taking For Good Faith.• Honesty in fact and observance of

reasonable commercial standards of fair dealing. • Only applies to holder, not transferor.


• Requirements for HDC Status (cont’d).Requirements for HDC Status (cont’d).–Taking Without Notice (cont’d).• Holder takes the instrument with notice if

he knows/has reason to know: – Instrument is overdue.– Instrument has been dishonored.–At least one instrument has an uncured default.–Contains an unauthorized signature or

alteration.© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 28

• Requirements for HDC Status (cont’d).Requirements for HDC Status (cont’d).–Taking Without Notice (cont’d).• Holder takes the instrument with notice if

he knows/has reason to know: –Defense or claim against the instrument.–The instrument is so irregular or incomplete

as to call into question its authenticity.


• Requirements for HDC Status (cont’d).Requirements for HDC Status (cont’d).–Taking Without Notice (cont’d).• CASE 22.3 South Central Bank of Daviess South Central Bank of Daviess

County v. Lynnville National BankCounty v. Lynnville National Bank (2009). What were the ‘real’ defenses the HDC could have raised?


• Requirements for HDC Status (cont’d).Requirements for HDC Status (cont’d).–Holder Through an HDC.• Shelter Principle: A person who is not an

HDC but who derives her title through an HDC can acquire the rights and defenses of an HDC. Extends benefits of HDC and allows HDC to dispose of instrument.• Limitations on the Shelter Principle: no

fraud, illegality, claim or defense.© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 31

• Signature Liability.Signature Liability.–Relates to signatures on instruments.–Signers of negotiable instruments are

potentially liable for amount stated on instrument.• Primary Liability: Makers/Acceptors. • Secondary Liability: Drawers/Indorsers.


• Signature Liability.Signature Liability.–Primary Liability.•Makers promise to pay the note and are

obligated to pay terms of instrument at time of signing.• Acceptors: drawee promises to pay an

instrument when presented for payment.


• Signature Liability (cont’d).Signature Liability (cont’d).–Secondary Liability.• Proper Presentment.–Must be timely (checks w/in 30 days).–Dishonor?

• Proper Notice.–Manner of Notice in any Reasonable manner.–Notice to Indorsers.


• Signature Liability (cont’d).Signature Liability (cont’d).–Unauthorized Signatures arise in two

situations:• Forgery: does not bind Principal but Bank

may be liable if negligent.• Unauthorized Signature: Agent is

personally liable, but Principal is not, unless ratified. • Exceptions.


• Signature Liability (cont’d).Signature Liability (cont’d).–Unauthorized Signatures (cont’d).• Exceptions. –Ratification of Signature: principal become

liable.–Negligence: party who substantially contributed

to forgery is liable.–Holder in Due Course: person who forges a

check can be held liable for payment by an HDC.


• Signature Liability (cont’d).Signature Liability (cont’d).–Special Rules for Unauthorized

Indorsements: does not bind maker/drawer except:• Imposter Rule: imposter indorsement will be

effective. • Fictitious Payee Rule: payee’s indorsement is

not a forgery and an innocent holder can hold the maker liable.


• Warranty Liability.Warranty Liability.–Transferors make certain implied

warranties regarding instruments they negotiate. –Warranty Liability not subject to

conditions of proper presentment, dishonor, or notice.–Warranties: Transfer or Presentment.


• Warranty Liability (cont’d).Warranty Liability (cont’d).–Transfer Warranties. Following transfer

warranties extend to all subsequent holders:• Transferor is entitled to enforce the

instrument.• Signatures are authentic and authorized.


• Warranty Liability (cont’d).Warranty Liability (cont’d).–Transfer Warranties. Following transfer

warranties extend to all subsequent holders:• Instrument has not been altered.• Instrument not subject to defense.• Transferor has no notice of insolvency.


• Warranty Liability (cont’d).Warranty Liability (cont’d).–Transfer Warranties. • Parties to Whom Warranty Liability

Extends: Extends warranty to any holder who takes in good faith. Without indorsement, warranties extend only to immediate transferee.• Recovery for Breach of Warranty: good faith

holder can sue for breach of warranty. Notice of the claim within 30 days.


• Warranty Liability (cont’d).Warranty Liability (cont’d).–Presentment Warranties: person who

presents an instrument makes the following presentment warranties:• No missing or unauthorized indorsements.• Instrument has not been altered.• Person obtaining payment has no

knowledge signature is unauthorized.


• UniversalUniversal (or Real) - can be used to (or Real) - can be used to defeat a holder and a HDC. defeat a holder and a HDC. • PersonalPersonal - can be used to defeat a - can be used to defeat a

holder but not a HDC. holder but not a HDC.


• Universal Defenses.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.


• Universal Defenses (cont’d).Universal Defenses (cont’d).–Material Alteration: changes the contract

terms in any way. Making any changes in the amount, date, or rate of interest is material.• Complete or Partial Defense: material

alteration is a complete defense against a holder, partial defense against an HDC.


• Universal Defenses (cont’d).Universal Defenses (cont’d).–Discharge in Bankruptcy.–Minority (infancy): to the extent

allowed by state law.–Illegality: statute must make

transaction illegal and void.–Mental Incapacity: adjudicated by

court. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 46

• Universal Defenses (cont’d).Universal Defenses (cont’d).–Extreme Duress: If instrument signed

under threat of immediate force or violence.

• Personal Defenses: valid against Personal Defenses: valid against holders holders but not HDC’sbut not HDC’s..–Breach of Contract or Warranty.–Lack or Failure of Consideration.


• Personal Defenses (cont’d).Personal Defenses (cont’d).–Fraud in the Inducement (Ordinary

Fraud).–Illegality: if statute provides

transaction is voidable, only a personal defense.–Mental Incapacity: not severe enough

to make void.© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 48

• Federal Limitations on the Rights of Federal Limitations on the Rights of HDC’s.HDC’s.–FTC Rule 433: severely limits rights of

HDC’s in consumer credit transactions.–Effect of the Rule: allows consumer to

assert any defense she might have against the seller of goods or services, against the subsequent HDC as well.


• Discharge from Liability on an Discharge from Liability on an instrument can occur by:instrument can occur by:–Payment or Tender of Payment.–Cancellation or Surrender.–Reacquisition.–Impairment of Recourse.–Impairment of Collateral.


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