Negotiable InstrumentsNegotiation and Holder in Due Course

Liability of PartiesChecks and Electronic Transfers

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Liability of Parties

Always do right. This will gratify some people, and astonish the rest.

Mark TwainSpeech to Young

People’s Society (1901)

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives

The Basics of Contractual LiabilityContractual Liability in OperationWarranty LiabilityOther Liability RulesDischarge of Negotiable

Instruments

33 - 3

When a person signs a negotiable instrument as maker, drawer, indorser, or some other capacity, the person becomes contractually liable on the instrument (i.e., to pay)

Liability also arises from: (1) improper transfer or presentment of an

instrument; (2) negligence in instrument issuance, alteration, or indorsement; (3) improper payment; or (4) conversion

Overview

33 - 4

A person may be primarily liable if s/he agreed to pay the negotiable instrument. The maker of a promissory note is primarily

liable for paying the debt A person who is secondarily liable is a

contract guarantor and, under UCC Article 3, must pay the instrument only if the person who is primarily liable defaults on the obligation

Primary vs. Secondary Liability

33 - 5

The acceptor of a draft must pay the draft according to the terms at the time of acceptance (drawee’s signed engagement to honor the draft as presented)

A drawee has no liability on a check or draft unless it certifies or accepts it In Harrington v. MacNab, the drawee

bank had no liability to a payee for a drawer’s insufficient funds

Acceptor and Drawee Liability

33 - 6

A person who indorses a negotiable instrument usually is secondarily liable Indorsers are liable to each other in chronological

order, from the last indorser back to the first

To trigger secondary liability, the instrument must be properly presented for payment or acceptance, the instrument must be dishonored, and notice of the dishonor must be given to the person secondarily liable

Indorser Liability

33 - 7

An indorser is discharged from liability if: A bank accepts a draft after indorsement [3–415(d)] Notice of dishonor is required and proper notice is

not given to the indorser [3–415(c)] No one presents a check or gives it to a depositary

bank for collection within 30 days after the date of an indorsement [3–415(e)]

Discharge of Indorser Liability

33 - 8

Since the maker of a note is primarily liable to pay it when due, dishonor occurs if the maker does not pay the amount due when:

(1) it is presented in the case of (a) a demand note or (b) a note payable at or through a bank on a definite date and presented on or after that date, or

(2) if it is not paid on the date payable in the case of a note payable on a definite date (but not payable at or through a bank) [3–502]

Presentment of a Note

33 - 9

To obtain payment or acceptance on a draft or check, holder must present it to drawee by any commercially reasonable means Written, oral, or electronic [3–501]

Drawee obligated when it accepts (certifies)

Presentment of a Draft or Check

33 - 10

Person who transfers negotiable instrument or presents it for payment may have liability for implied warranties of presentment or transfer: Presentment warranties:

Warrantor/transferor warrants to transferee that transferor entitled to enforce draft or authorized to obtain payment, draft has not been altered, and warrantor has no knowledge of an unauthorized signature

Warranty Liability

33 - 11

Transfer warranties (Bank One, N.A. v. Streeter): transferor warrants to transferee –

All signatures authentic or authorized Warrantor is entitled to enforce the instrument (no

unauthorized or missing indorsements) Instrument has not been altered Instrument not subject to defense or claim in

recoupment against the warrantor Warrantor has no knowledge of any insolvency

proceedings commenced with respect to the maker or acceptor, or drawer [3–416(a)]

Warranty Liability

33 - 12

Revised Article 3 follows general rule that payment or acceptance is final in favor of a holder in due course or payee who changes position in reliance on payment or acceptance Bank bears burden of

mistake

Mistake in Payment or Acceptance

33 - 13

Negligence: A person who writes a negotiable instrument so as to invite alteration may not use the alteration or lack of authorization as a reason for not paying a person that in good faith pays the instrument or takes it for value [3–406]

Other Liability Rules

33 - 14

Imposter rule: An impostor convinces a drawer to make a check payable to the person impersonated or an organization the person purports to represent. UCC makes any indorsement “substantially similar” to that of named payee effective [3–404(a)]

Other Liability Rules

33 - 15

Fictitious payee rule: If someone writes a check to a fictitious payee, UCC allows any indorsement in the name of the fictitious payee to be effective as payee’s indorsement in favor of any person that pays instrument in good faith or takes it for value or for collection [3–404(b) and (c)]

Other Liability Rules

33 - 16

Fraudulent indorsements by employees: Revised Article 3 specifically addresses employer liability for fraudulent indorsements by employees, adopting rule that the risk of loss for indorsements by employees entrusted with responsibilities for instruments (primarily checks) should fall on employer rather than the bank that takes the check or pays it [3–405]

Other Liability Rules

33 - 17

Facts and Decision: Employee engaged in double forgery of

checks and a depositary bank allowed forger to deposit the checks to her own personal account, violating its own banking procedures and rules

Employer sued bank for negligence Court applied comparative negligence

principles to split the loss between the company (30%) and the bank (70%)

Victory Clothing Co., Inc. v. Wachovia Bank, N.A.

33 - 18

Conversion: Revised Article 3 provides that the law applicable to conversion of personal property applies to instruments

Other Liability Rules

33 - 19

An obligor is discharged from liability by:

1. Payment of the instrument2. Cancellation of the instrument3. Alteration of the instrument4. Modification of principal’s obligation causing a

loss to a surety or impairing collateral5. Unexcused delay in presentment or notice of

dishonor with respect to a check 6. Acceptance of a draft by a bank (e.g., if a check is

certified by a bank)

Discharge of Negotiable Instruments

33 - 20

Test Your Knowledge

True=A, False = B When a person signs a negotiable

instrument as maker, the person becomes contractually liable on the instrument.

The maker of a promissory note is secondarily liable for paying the debt.

A drawee has liability on a check or draft the moment it is presented for acceptance.

33 - 21

Test Your Knowledge

True=A, False = B An indorser is not discharged from

liability until the instrument is presented for payment or acceptance.

A person who transfers a negotiable instrument or presents it for payment may incur liability from implied warranties.

A person who indorses a negotiable instrument usually is secondarily liable.

33 - 22

Test Your Knowledge

Multiple Choice Norbert worked in payroll for Will Co. and

signed payroll checks. Norbert wrote a check to Bradley Pitte, a fictitious employee, took it to the bank with fake I.D., indorsed the back with “Pitte’s” signature, and was paid in cash.(a) Bank is liable for wrongful acceptance(b) Bank is not liable under the common law

of conversion (c) Bank is not liable under UCC liability rules

33 - 23

Test Your Knowledge

Multiple Choice Which of the following is not a

transferee warranty? (a) Warrantor is entitled to enforce the

instrument(b) The drawer has sufficient funds to pay

the instrument(c) The instrument has not been altered(d) All signatures are authentic or

authorized33 - 24

Thought Questions

What steps would you take to make sure that fictitious payees and fraudulent indorsement did not occur in your business?

33 - 25