Chapter 16: Negotiability, Transferability, and Liability

1

Chapter 1: Legal EthicsCHAPTER 16:

NEGOTIABILITY,TRANSFERABILITY, AND

LIABILITY

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Learning Objectives1. What requirements must an instrument

meet to be negotiable? 2. What are the requirements for attaining

the status of a holder in due course (HDC)?3. What is the difference between signature

liability and warranty liability?

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Learning Objectives4. Certain defenses are valid against all holders,

including HDC’s. What are these defenses called? Name four defenses that fall within this category.

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

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Types of Instruments A “negotiable instrument” is a signed

writing containing an unconditional promise to pay an exact sum of money.

Most negotiable instruments are paper documents, referred to as commercial paper.

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Types of Instruments The UCC specifies four types of

negotiable instruments: –Drafts, Checks, Notes, and Certificates

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

time instruments.

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Types of Instruments 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.

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Types of Instruments Drafts and Checks (Orders to Pay).–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).

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Types of Instruments Drafts and Checks (Orders to Pay).–Trade Acceptances.• Type of draft frequently used in sale of

goods.• Trade acceptance: seller of goods is both

drawer and payee. Buyer of goods is the drawee.

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Types of Instruments Drafts and Checks (Orders to Pay).–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.

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Types of Instruments Promissory Notes and Certificates of

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.

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Types of Instruments

Promissory Notes and Certificates of Deposit (Promises to Pay).–Certificates of Deposit. 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.

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Requirements for Negotiability

For an Instrument to be negotiable, it must:–Be Signed by the Maker or Drawer.• Signature Requirements: manual or by a

device.• Placement of the Signature.

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Requirements for Negotiability

For an Instrument to be negotiable, it must:–Be an Unconditional Promise or Order

to Pay.• Promise or Order.• Unconditionality of the Promise or Order.

–State a Fixed Amount of Money.

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Requirements for Negotiability

For an Instrument to be negotiable, it must:–Be Payable on Demand or at a Definite Time.• On Demand: “Payable at sight” or “Payable upon

presentment.”• CASE 16.1 REGER DEVELOPMENT, LLC V.

NATIONAL CITY BANK (2010). Why doesn’t the duty of good faith apply to lenders seeking payment on demand notes?

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Requirements for Negotiability

For an Instrument to be negotiable, it must:–Be Payable on Demand or at a Definite

Time.• Payable at a Definite Time: specified date,

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

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Requirements for Negotiability

Acceleration Clause: allows holder to demand full payment if a certain event occurs.

Extension Clause: the reverse of an extension clause.

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Requirements for Negotiability

Be Payable to Order or Bearer, Unless It is a Check.–Order Instruments: payable to “the

order of” an identified person, or to “an identified person or order.”

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Requirements for Negotiability

Be Payable to Order or Bearer, Unless It is a Check.–Bearer Instruments: the holder is the

payee.• CASE 16.2 LAS VEGAS SANDS, LLC V.

NEHME (2011). Why was the marker a bearer instrument?

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Requirements for Negotiability

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

typewritten and preprinted terms.–Words outweigh figures.

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Requirements for Negotiability

Factors That Do Not Affect Negotiability.–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.

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Transfer of Instruments A negotiable instrument can be

transferred by assignment or negotiation.

Transfer by Assignment.–Gives assignee only those rights

assignor possessed.–Transferee is an assignee, not a holder.

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Transfer of Instruments Transfer by Negotiation.–Creates a holder, who receives the

rights of a previous possessor.–There are two methods of negotiation

so receiver becomes a holder, depending on whether instrument is an order or bearer instrument.

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Transfer of Instruments Transfer by Negotiation.–Negotiating Order Instruments: requires

both indorsement and delivery.–Negotiating Bearer Instruments:

delivery only. Indorsement is not necessary.

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Indorsements Signature with or without additional

words or comments. Blank Indorsements: does not specify

a particular indorsee and may consist of a mere signature.

Special Indorsements: contains signature and identifies payee.

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Indorsements Qualified Indorsements: indorser who

does not wish to be liable (“without recourse”).–Effect of Qualified Indorsements.–Special versus Blank Indorsements.–CASE 16.3 HAMMETT V. DEUTSCHE BANK

NATIONAL CO. (2010). What was the legal effect of the blank qualified indorsement?

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Indorsements• Restrictive Indorsements: requires indorsee to

comply with certain instructions regarding funds.– Conditional Indorsements.– Indorsements for Deposit or Collection.– Trust (Agency) Indorsements.

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Indorsements• Miscellaneous Indorsement Problems.– Misspelled Names. Indorsement should

generally be identical to name on instrument. • Misspelled name OK.

– Instruments Payable to Legal Entities.• Negotiable by authorized representative of the entity.

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Indorsements• Miscellaneous Indorsement Problems.– Alternative or Joint Payees.• Alternative Payees Presumed- either may indorse. Jointly -

both must indorse.• Suspension of the Drawer’s Obligation.

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Holder in Due Course (HDC) Holder versus Holder in Due Course

(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.

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Holder in Due Course (HDC) 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.

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Holder in Due Course (HDC) Requirements for HDC Status.–Taking for Value.• Taking instrument in payment for an

antecedent debt.• Giving a negotiable instrument as

payment.• Giving irrevocable commitment as

payment.

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Holder in Due Course (HDC)

Requirements for HDC Status.–Taking in Good Faith.• Honesty in fact and observance of reasonable

commercial standards of fair dealing. • Only applies to holder, not transferor.• CASE 16.4 TRIFFIN V. LICCARDI FORD, INC.

(2011). Why wasn’t Triffin a holder in due course?

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Holder in Due Course (HDC) Requirements for HDC Status.–Taking Without Notice: Holder takes the

instrument with notice if he knows/has reason to know: • Instrument is overdue.• Instrument has been dishonored.• Actual knowledge or any suspicious event.

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Holder in Due Course (HDC) Holder through an HDC.–“Shelter Principle”: A person who does

not qualify to be a HDC but who derives her title through an HDC can acquire the rights and defenses of an HDC.

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Holder in Due Course (HDC) Holder through an HDC.–Purpose of the Shelter Principle: extends

benefits of HDC and allows HDC to dispose of instrument.–Limitations on the Shelter Principle: no

fraud, illegality, claim or defense.

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Signature and Warranty 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.

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Signature and Warranty Liability

Signature Liability.–Primary Liability. Person:• Promises to pay the note.• Obligated to pay terms of instrument at

time of signing.• Acceptors: Drawee promises to pay an

instrument when presented for payment.

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Signature and Warranty Liability

Signature Liability.–Secondary Liability. • Proper Presentment: Must be timely

(checks w/in 30 days).• Timely Presentment: Manner of Notice in

any Reasonable manner.• Dishonor.• Proper Notice.

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Signature and Warranty Liability

Signature Liability.–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.

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Signature and Warranty Liability

Signature Liability.–Unauthorized Signatures: Exceptions to

the General Rule of No Liability:• Ratification of Signature: principal become

liable.• Negligence: party who substantially

contributed to forgery is liable.

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Signature and Warranty Liability

Signature Liability.–Special Rules for Unauthorized

Indorsements. • Unauthorized indorsement does not bind

maker/drawer except:– Imposter Rule: one who induces a maker to

issue an instrument in the name of an impersonated payee.

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Signature and Warranty Liability

Signature Liability.–Special Rules for Unauthorized

Indorsements. • Unauthorized indorsement does not bind

maker/drawer except:• Fictitious Payees: cause an instrument to

be issued to a payee who will have no interest in the instrument.

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Signature and 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.

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Signature and Warranty Liability

Warranty Liability.–Transfer Warranties: Following

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

instrument.• Signatures are authentic and authorized.

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Signature and Warranty Liability

Warranty Liability.–Transfer Warranties: Following

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

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Signature and Warranty Liability

Warranty Liability.–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.

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Signature and Warranty Liability

Warranty Liability.–Transfer Warranties.• Recovery for Breach of Warranty: good

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

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Signature and Warranty Liability

Warranty Liability.–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.

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Defenses, Limitations and Discharge

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.

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Defenses, Limitations and Discharge

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.

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Defenses, Limitations and Discharge

Universal Defenses.–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.

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Defenses, Limitations and Discharge

Universal Defenses.–Discharge in Bankruptcy.–Minority (infancy): to the extent allowed

by state law.–Illegality: statute must make transaction

illegal and void.

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Defenses, Limitations and Discharge

Universal Defenses.–Mental Incapacity: adjudicated by court.–Extreme Duress: If instrument signed

under threat of immediate force or violence.

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Defenses, Limitations and Discharge

Personal Defenses.–Valid against holders but not HDC’s.• Breach of Contract or Warranty.• Lack or Failure of Consideration.• Fraud in the Inducement (Ordinary Fraud).•Mental Incapacity.

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Defenses, Limitations and Discharge

Federal Limitations on the Rights of HDC’s.–In 1976 the FTC abolished the HDC

doctrine when it applied to consumer transactions.

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Defenses, Limitations and Discharge

Discharge from Liability.–Can occur by:• Payment or Tender of Payment.• Cancellation or Surrender.• Reacquisition.• Impairment of Recourse.• Impairment of Collateral.