PROFESSOR NEAL F. NEWMAN - Cloud Object...

COMMERCIAL PAPER PROFESSOR NEAL F. NEWMAN

TEXAS A&M UNIVERSITY SCHOOL OF LAW

CHAPTER 1: INTRODUCTION & TYPES OF NEGOTIABLE INSTRUMENTS

A. Basic Idea

• The instrument’s ____________________ wants to be paid. • The person obligated to pay doesn’t want to pay. • The person who ultimately pays the instrument will want to recover from

________________________________.

B. Bar Exam Approach

• Determine if the instrument is a ____________________________ instrument • Determine whether the instrument was properly ________________________________ • Determine whether the instrument’s holder is a _____________________________________

(HDC) • Determine whether the individual who is obligated to pay has any ______________________

against payment • Determine whether those defenses are ________________ or personal defenses • Can the one who paid the instrument hold anyone else responsible?

C. Types of Commercial Paper and the Parties Involved

Two types: ________________ and _________________

Exam Tip 1: Mnemonic: “Makers make notes; drawers draw drafts”

1. THE NOTE is a two-party instrument

o Promise to pay

A note is characterized by a promise to pay.

Example 1: “I, Mark, promise to pay to the order of Paul the sum of $1,000.”

o Parties

Maker – the person making the promise to pay ____________ – the person to whom the instrument is payable

Example 2: In example above, Mark is the note’s maker and Paul is the _____________.

2 | © 2017 Themis Bar Review, LLC | Commercial Paper

o Certificate of Deposit (a type of note)

Bank acknowledges ___________________ of money; and Bank promises the payee/depositor to repay the money.

2. THE DRAFT is a three-party instrument (e.g., check)

o Order to pay

A draft is an order to _______________________.

o Parties

The drawer – the person ___________________________________ The drawee – the person being ordered to pay The payee – the person to whom the instrument is payable

o Check (a type of draft)

Requirements

• The bank is the __________________; and • The instrument is _____________________________________.

Example 3: Mark is a customer of Payor Bank. Mark draws a check and issues it to Paul.

Answer: Mark is the drawer, Paul is the payee, and Payor Bank is the _________________.

Types of checks

• Ordinary check • Traveler’s check

o Another draft form which must be __________________________________ by a person whose “specimen signature” appears on the traveler’s check

• Cashier’s check

o The drawer and the drawee are the _________________ bank.

• Teller’s check

o Check drawn by one bank on another bank

• Contradictory terms

o If an instrument contains contradictory terms:

___________________________ terms prevail over both typewritten and printed terms Typewritten terms prevail over printed terms _____________________ prevail over numbers

Commercial Paper | © 2017 Themis Bar Review, LLC | 3

CHAPTER 2: FORMAL REQUIREMENTS OF NEGOTIABILITY [PART 1]

• First question: Is the writing a negotiable instrument (NI)?

o If the writing in question is NOT a negotiable instrument, then Article 3 ___________________ apply.

A. Formal Requirements of "Negotiability"

1. Part 1

o The document must be in ______________________ and signed by the maker or drawer. o The promise or order to pay must be _____________________________. o The payment obligation must be for a fixed amount of money.

2. Part 2

o The writing must be payable to _______________________________________. o The writing must be payable on demand or at a definite time. o The writing must obligate the payor to do one thing, which is to pay ___________________,

and nothing else (i.e., no additional undertakings or instructions).

B. Writing and Signed

• Writing: A negotiable instrument may not be oral. • KEY – the NI must be reduced to ______________________ form • “Signed” includes using any symbol executed or adopted with the

________________________________________ to adopt or accept a writing.

o Examples of acceptable signature forms:

Traditional signature Printed Stamped Written Thumbprint Trade or business name Computer generated

C. The Promise or Order to Pay Must be Unconditional

• The promise or order to pay must be unconditional.

Example 4: “I, Mary, promise to pay to the order of Paul $50,000.”

• Typical scenarios that make the promise or order conditional:

o Express conditions to ______________________

Example 5: “I, Mary, promise to pay to the order of Paul $50,000 if he mows my lawn.”


This language would disqualify the writing as a NI because Mary’s payment obligation is ________________________ upon Paul mowing Mary’s lawn.

o Subject to another writing

Example 6: “I, Mary, promise to pay to the order of Paul $50,000 subject to the written contract between Mary and Paul dated January 1, 2013.”

Answer: This language would disqualify the writing as a NI because Mary’s payment obligation is _____________________ the written terms in the contract dated January 1, 2013.

• Items that do not make the promise or order to pay conditional

Editor's Note 1: Professor Newman’s reference to section B.2. is to the Commercial Paper outline, not this handout.

o References to other documents

Mere references to other documents do not make the promise or order to pay conditional.

Example 7: “I, Mary, promise to pay to the order of Paul $50,000 in accordance with the written contract between Mary and Paul dated January 1, 2013.”

Example 8: “I, Mary, promise to pay to the order of Paul $50,000. This payment represents a down payment on a contract for the purchase of a two-story house.”

Note: The key with references to other documents is that as long as the reference is there for ___________________________ purposes only, then the promise or order to pay is not a conditional one.

o Payment from a particular fund

A provision that payment must be from an identified fund does not render the promise conditional.

Example 9: “I will pay from the proceeds of the sale of my household furniture.”

Answer: This language qualifies as an _____________________________ promise; the instrument remains negotiable.

o Countersignature

The requirement of a countersignature, as in a traveler’s check, does not render an instrument non-negotiable.

o Prepayments and collateral


References to other records regarding rights as to collateral, prepayment, or acceleration ________________ make the promise to pay conditional.

Example 10: “I promise to pay to the order of Paul $50,000 on January 1, 2013. The collateral for this note is a security interest in the maker’s art collection. For rights and duties on default, see the security agreement signed this date creating a security interest.”

D. To Pay a Fixed Amount of Money

• The ________________________ amount due on the instrument must be a fixed amount of money.

• Interest can be ____________________.

Example 11: “I, Mary, promise to pay to the order of Paul $50,000, plus interest at a rate of 2% above the prime rate, to be measured on the date the note matures.”

Answer: This writing is a negotiable instrument even though the interest rate will have to be researched upon maturity date. The principal amount is fixed at $50,000, so the instrument qualifies as being payable for a fixed amount of money.

Exam Tip 2: Be aware of fact patterns in which the interest rate may not be fixed or readily ascertainable. The writing in question will still be a negotiable instrument as long as the principal amount is fixed.

CHAPTER 3: FORMAL REQUIREMENTS OF NEGOTIABILITY [PART 2]

Part 2

• The writing must be payable to _________________________________. • The writing must be payable on demand or at a _______________________________. • The writing must obligate the payor to do one thing, which is to pay money and nothing else (no

additional undertakings or instructions).

A. Payable to Order or to Bearer

• A negotiable instrument must be either an _______________ or a _____________________ instrument.

• Order instrument – Payable to a ___________________ person • Bearer instrument – generally, anyone in possession has legal rights to the instrument

a. Order Instrument

An instrument payable to a specific person requires specific language or words of _______________________________. The key phrases are either “pay _______________________" or “pay [Paul] or his ___________________."


Example 12: "I, Mary, Promise to pay to the order of Paul $50,000." The key phrase "to the order of" makes the writing an order instrument.

Example 13: "I, Mary, promise to pay Paul $50,000."

Answer: This writing would ________________ considered an order instrument because even though it is payable to a specifically identified person, it does NOT have the key phrase “to the order of” or “or his order” in the writing.

b. Bearer Instrument

Any instrument that does not attempt to pay a ________________________________

• Payable to ____________________ • Payable to the order of bearer • Payable to _____________ • Payable to the payee line left ___________________

Exam Tip 3: When the maker or drawer is not attempting to pay a specific person, the phrase “to the order of” or “pay [NAME] or his order” is not required.

Example 14: "I, Mary, promise to pay bearer $50,000."

Answer: This writing would still qualify as a NI even without the phrase “to the order of” because the writing is not payable to a ___________________________.

Example 15: “I promise to pay cash $50,000” is a negotiable bearer instrument.

Example 16: “I promise to pay [payee left blank] $50,000” is a negotiable bearer instrument.

c. Payable to Both Bearer and Order

If a writing has characteristics of both an order instrument and a bearer instrument, then the writing will be treated as ___________________ paper.

Example 17: “I, Mary, promise to pay to the order of Paul or bearer $50,000” would be considered a bearer instrument because it is payable both to a specifically identified person (Paul) and to bearer.

d. Checks Are the Exception to the “Words of Negotiability” Requirement

Example 18: A check made payable to Paul that reads “pay to the order of Paul” is a negotiable instrument even though the phrase “to the order of” is crossed out.


Policy: Article 3 makes this exception simply because checks are prevalent. It would be cumbersome to distinguish between those checks that contained such language and those that did not.

B. Payable “On Demand” or at a “Definite Time”

• The writing must be clear as to when the one required to pay the instrument must do so. • An instrument is payable on demand when the instrument’s payee or holder can present the

negotiable instrument _________________________ after being issued the instrument. • An instrument is payable at a definite time when the instrument’s payee or holder can present

the negotiable instrument ______________________________ that is clear or readily ascertainable.

a. Payable on Demand

Checks (drafts) are typically payable on demand.

Example 19: Mary writes a check “Pay to the order of Paul $50,000.” This check is a negotiable instrument that is payable on demand. Paul can present this check for payment as soon as Mary issues the check to him.

b. At a Definite Time

_________________ are typically payable at a definite time.

Example 20: “I, Mary, promise to pay to the order of Paul $50,000 on January 1, 2013.”

Answer: This is a negotiable promissory note that is payable at a definite time.

Acceleration clauses

Example 21: Consider an instrument dated and issued January 1, 2012, that provides, “I, Mary, promise to pay to the order of Paul $50,000, to be paid on June 1, 2014. But if the Dallas Cowboys win the Super Bowl prior to June 1, 2012, then payment will be due immediately after the game.”

Answer: The writing remains a negotiable instrument because there is a definite due date upon which the instrument is due.

Extension clauses

• The instrument cannot contain a provision that permits the obligor (the one obligated to pay) to extend the payment date at his discretion without any restriction

Example 22: “Payable January 1, 2013, but the holder may extend the payment date at the holder’s discretion.” is not a negotiable instrument because it is not payable at a definite time.


Editor's Note 2: This example should read, “Payable January 1, 2013, but the obligor may extend the payment date at the obligor’s discretion.” Such an instrument is not a negotiable instrument because it is not payable at a definite time.

• The instrument can contain provisions allowing for the ___________________ (the one obligated to pay) to extend the due date, provided the extension is to a _____________________________.

Example 23: “Payable January 1, 2013, but I, the obligor, may extend the payment date to January 1, 2014, at my discretion.” is a negotiable instrument because it is payable at a definite time.

• The instrument can also contain automatic extensions upon a specified event as long as the date is extended to another ______________________________.

Example 24: “Payable on January 1, 2013. But if Uncle Sal dies before that date, the instrument shall be due January 1, 2014.” is a negotiable instrument because it is payable at a definite time.

Payment date must be readily ascertainable.

• When you look at the instrument, you should be able to readily ascertain when the payment must occur.

Example 25: The writing provides that “payable upon the death of my father” is not a negotiable instrument because although the father is certain to die at some point, the exact date of that death is not readily ascertainable.

c. No Additional Undertaking or Instructions

The writing must commit the obligor to one legal obligation and nothing else: the obligation to __________________________.

What constitutes an additional undertaking?

Example 26: “I, Mary, promise to pay to the order of Paul $50,000 on January 1, 2013, and I promise to bake Paul an apple pie on that same date.”

Answer: The writing in question is not a negotiable instrument because the writing obligates Mary to pay money ($50,000) and to __________________________________.

Exceptions – Additional Undertakings That Are Allowed

• Promises or orders concerning ______________________

Example 27: A note contains the provision “Maker shall provide additional collateral securing the note if the present collateral’s fair market value falls below [X] dollars.”


Answer: This is an additional undertaking that is permissible.

• Provisions that allow holder to procure _______________________

Example 28: “Holder is hereby granted the authority to confess judgment against maker in any appropriate court.”

C. Key Things to Remember: The Requisites of a Negotiable Instrument

• The document must be in ______________________ and signed. • The promise or order to pay must be unconditional. • The ______________________ amount must be fixed, but the interest rate can be variable. • Payable to order or bearer (remember “words of negotiability” for order paper). • The writing must be payable ___________________________ or at a definite time (payment

time must be readily ___________________________). • No additional undertakings (the obligor’s sole obligation is to pay money)

Exam Tip 4: Be dialed in to how the bar examiner may test your “alertness” to any of these requisites.

CHAPTER 4: ACQUIRING HOLDER STATUS

• BASIC IDEA – The person who takes the instrument via _____________________________ will want to acquire status as a _______________________________________ because this status gives him legal rights that are __________________________ to those of a mere holder.

• Goal: By the end of this lecture, you should understand the requisites for a proper negotiation (i.e., the instrument’s transfer from (b) to (c) on the diagram).

1) Issuance – the first delivery of an instrument

Payee (creditor) (b) (holder)

Maker/Drawer (obligor) (a) (issuer)

2) Negotiation – A transfer of possession by a person other than the issuer…who becomes a holder

Transfer + Proper Indorsement – (if instrument is order paper)

Holder – (acquires holder status pursuant to a proper negotiation)-(c)

“bearer” or “order” instrument?


A. Taking the Instrument as a Holder

• A person can become a holder in two ways: ____________________________ or ____________________________

Issuance

Maker/Drawer Payee

o Issuance – the first ________________________ of an instrument

B. Negotiation

• A transfer of possession, whether voluntary or involuntary by a person other than the ________________ to a person who becomes the __________________

• To negotiate a bearer instrument – Requires transfer of __________________________ only

Example 29: Paul is in possession of a negotiable promissory note that is “payable to bearer.” The note was issued to Paul from Mary. Paul takes the note and gives it to Harry without making any indorsement on the back of the instrument.

Answer: Paul’s transfer was a proper negotiation because Paul was in possession of ____________________________. When the instrument is a bearer instrument, transfer of possession is all that is required to negotiate the instrument.

• To negotiate an order instrument – Requires transfer of __________________________ PLUS a proper ___________________________ of the instrument before transfer.

o Special indorsement

Example 30: Paul is in possession of a negotiable promissory note that is payable to Paul. Paul takes the note and writes on the back “Pay to Harry /s/ Paul.” Paul then transfers the note to Harry.

Answer: This type of indorsement is called a ___________________ indorsement. Paul’s transfer of possession to Harry was a proper negotiation because Paul __________________ the instrument and then he transferred it to Harry. At this point, Harry is the ONLY person who has legal rights to the instrument. Only Harry can present the note for payment or further negotiate it.

o Blank indorsement: Indorsement not made to a _______________________ person

Example 31: Paul is in possession of a negotiable promissory note that is payable to Paul. Paul indorses it on the back “/s/ Paul.” Paul then gives the note to Harry.


Answer: This type of indorsement is a blank indorsement. Paul’s transfer of possession to Harry was a proper negotiation because he indorsed the instrument and then transferred it to Harry.

o Qualified indorsement: Used to limit one’s ______________________ on an instrument

Example 32: Paul is in possession of a negotiable promissory note that is payable to Paul. Paul takes the note and indorses it on the back “Without Recourse /s/Paul.” Paul then gives the note to Harry.

Answer: Signing the instrument in this fashion absolves Paul of any potential liability on the instrument.

o Restrictive indorsement: Used to _________________ what the holder can do with the instrument

Valid restrictive indorsement:

Example 33: Paul receives a check payable to Paul. He signs the back of the check “For Deposit Only /s/ Paul.”

Invalid restrictive indorsement:

Example 34: Paul signs the same check on the back “Pay Harry if he mows my lawn /s/ Paul.”

This restrictive language is not a condition to payment for Harry. Harry would be entitled to enforce payment regardless of whether Harry mowed Paul’s lawn.

o Anomalous indorsement: Used by accommodation parties (discussed later in the lecture)

C. Multiple Payees

• Payable jointly – Requires _________ payees to indorse for a valid negotiation

Example 35: An instrument payable “to the order of Paul and Perry”

Answer: _____________ must indorse the instrument before negotiating.

• Payable severally – Either party can sign the instrument for a valid negotiation.

Example 36: An instrument payable “to the order of Paul or Perry”

Answer: Either Paul or Perry may sign the instrument to negotiate it.

D. Summary

• Negotiating a ____________________ instrument requires transfer of possession only. • Negotiating an __________________ instrument requires transfer of possession PLUS a proper

_____________________________.


CHAPTER 5: ACQUIRING STATUS AS A HOLDER IN DUE COURSE

• Must first acquire status as a ___________________ (covered previously) • Must pay ________________ for the instrument (what constitutes value?) • Must take the instrument in __________________________; and • Without ____________________ that there are any problems that might affect the obligor’s

obligation to pay the instrument

A. Value

• The person must ________________ something of value, __________ something of value, or _____________________ something of value.

o A gift is not value.

Example 37: Out of sheer gratitude for Harry’s precious friendship, Paul gives Harry a promissory note that has a face value of $50,000.

Answer: Harry did not _________________________.

o Unexecuted promises to perform are not value.

Example 38: In exchange for a negotiable promissory note received from Mary, Harry promises to mow Mary’s lawn.

Answer: Harry will not be deemed to have given value until he actually ___________________ the promised act, which is mowing the lawn.

o Paying less than the note’s full face value is okay.

Maker/Drawer (obligor)

Bearer or order instrument?

Payee (creditor) holder

Transfer + Indorsement (if order paper) Transfer Only – (if bearer paper)

Negotiation?

Holder in Due Course?

value? good faith? w/o notice?


Example 39: In exchange for a negotiable promissory note with a face value of $50,000, Harry pays Paul $40,000. The note will mature 12 months from the date of issue.

Answer: Harry will be deemed to have given value for the instrument. Value need not be the note’s ____________________ value.

o Partial performance = partial HDC rights

Example 40: In exchange for a negotiable promissory note with a face value of $50,000, Harry agrees to pay Paul $40,000; $20,000 the day Paul negotiates the note, and an additional $20,000 five months from that date. The note will mature 12 months from the negotiation date.

Answer: On the date Paul negotiates the note, Harry has rights as an HDC for $_________________ ($20,000/$40,000 x $50,000) as Harry has paid half of the agreed-upon consideration.

o Forgiving a preexisting obligation constitutes value.

Example 41: In exchange for a negotiable promissory note with a face value of $50,000, Harry agrees to accept the note as satisfaction for a $30,000 loan that Harry gave Paul two years ago.

Answer: Harry’s forgiveness of the debt obligation would be considered ________________.

• Value in the context of a bank

o Banks give value to the extent deposited money is withdrawn. o Amounts are withdrawn using the “first-in, first-out” method (FIFO).

Example 42: Tom has $500 in his account. Tom deposits an additional $1,000. The bank has not given value for any amount because the money has not been withdrawn. One week later, Tom withdraws $500 in cash from his bank. Under the FIFO method, the bank has given value for the initial $__________, but not for the $1000.

Example 43: Three days later, Tom withdraws another $250. The bank has given value for a portion of the $1000 deposit. Of that $1000 deposit, the bank has given value for $250.

B. Taking the Instrument in Good Faith (two-part assessment)

• Honesty-in-fact: What the person receiving the instrument _______________________________; AND

• The observance of reasonable commercial standards of fair dealing: What the person receiving the instrument should have surmised given the context in which the instrument was negotiated.


Example 44: A man in a business suit walks into a local check-cashing store with a check payable for $50,000. The businessman is willing to take $35,000 for the check. Unbeknownst to the clerk, the “businessman” was really a con man who was issued the check by telling a 90-year-old man that he would invest that money for him (fraud in the inducement).

Would the check-cashing store be taking the instrument in “good faith?”

Honesty in fact? Unless the clerk asked the circumstances surrounding the taking of the check, the clerk can honestly say that he in fact did not know that the con man had received the check by committing fraud.

The observance of reasonable commercial standards of fair dealing? A ______________________ person would likely ask why a well-dressed businessman was cashing a $50,000 check at a check-cashing store and was willing to take much less than face value.

C. Taking the Instrument Without Notice

• Cannot acquire status as a HDC if the holder is aware of any reason as to why the legal obligation to pay the note may be compromised

• What constitutes notice?

o _____________________________ o Receives notice through the mail o Has reason to know there may be a problem

• What constitutes an infirmity?

o Holder has notice of any __________________________________________

Example 45: On June 1, 2011, Mary issues a promissory note to Paul stating “I, Mary, promise to pay to the order of Paul $300 for painting my kitchen. Payment due June 1, 2012. ”

On July 1, 2011, Paul paints the kitchen but chips the counter-top when he drops a bucket of paint.

Mary and Harry are neighbors. On July 10, 2011, Mary complains to Harry about the chipped countertop. This is considered notice of an infirmity. She tells Harry that she does not intend to pay Paul the full amount on the note because of the damage.

The following day, Paul approaches Harry and offers to negotiate to Harry the promissory note Paul received from Mary. Paul states, “I got this for painting Mary’s kitchen but I need the money now.”

Is Harry a HDC?


Answer: _________. At this point Harry had notice that Mary has a ____________________________________. If Harry takes the instrument, he will not be able to claim HDC status. He will take the instrument subject to the recoupment claim.

o Holder has notice of forged, altered, or otherwise irregular instrument

Example 46: Harry is offered a promissory note for $4,000. But the note is taped together in several pieces. The “4” is smudged and looks like it was written over a “1.” The maker’s signature is a different color than the rest of the writing on the instrument. Is Harry a HDC?

Answer: Harry will have trouble claiming HDC status, as there is apparent evidence of alteration, forgery, and irregularities.

o Holder has notice the instrument is overdue

Checks are overdue _________ days after date of issue. Any instrument that is ________________________________ is overdue after demand

for payment is made. Instruments due at a definite time are overdue the day ________________ the due

date.

• If the due date is ____________________________, then the note is overdue the day after the accelerated due date.

• When payments are due in _________________________, the instrument is overdue the day after the installment due date.

Exam Tip 5: Be careful to distinguish between overdue interest payments and overdue principal payments. Notice of an overdue interest payment will NOT compromise the holder’s ability to claim holder in due course status, but notice of overdue principal payments WILL compromise the holder’s ability to claim holder in due course status.

D. Special Limits on HDC Status

• In some instances, a person’s ability to claim status as a HDC will be limited.

o Consumer Notes

Context: The Federal Trade Commission (FTC) regulations protect consumers in certain transactions that otherwise involve the use of a negotiable instrument (NI) by requiring that the following NOTICE be placed on the NI before the consumer signs the NI:

• “ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF GOODS OR SERVICES OBTAINED PURSUANT HERETO OR WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER BY THE DEBTOR SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR HEREUNDER.”


This language allows the debtor to assert claims and defenses against the instrument’s holder, even if that person is a holder in due course.

Exam Tip 6: THE KEY FOR YOU: If tested, the likely challenge for you is to determine whether the NI in question is required to have such a notice.

THIS NOTICE IS REQUIRED WHEN THREE CRITERIA ARE MET:

• The Maker/Drawer is signing the note in a ______________________ transaction (i.e., acquiring an item for personal or family use).

• The transaction in question must be for the sale or lease of goods or services (i.e., buying a car or boat).

• The seller must be one who sells the item in question in his __________________________________________.

Example 47: Carrie Consumer buys a car from Selig Motors, an established car dealership, paying $500 as a down payment and signing a negotiable promissory note agreeing to pay the $10,000 balance one year from the date of issue. Carrie will be using the car for her personal use.

Answer: The promissory note would be subject to the NOTICE requirement, as:

Carrie is buying the car for personal use (i.e., a consumer);

The transaction involves the purchase of a _____________ (the car); and

Selig Motors sells cars in the ordinary course of business.

E. Key Things to Remember:

• Value: Requires the holder to give, do, or forgive something of value • Regarding the good faith requirement – if the facts make you say, “hmmm, something’s not

right here,” then you may have a good faith issue and the holders in your fact pattern may have trouble claiming HDC status, which you should address.


CHAPTER 6: TRANSFER OF INSTRUMENT

A. Transfer of Instrument

• Transfer is the instrument’s movement other than by the _______________________________ for the purpose of giving the person receiving it the right to enforce the instrument.

• The first movement from maker to payee is an issuance (not a transfer). • Subsequent movements prior to the payment are transfers.

B. Shelter Rule

• The rights follow the instrument. • Shelter rule: Whatever rights the transferor had transfer to the transferee

Exam Tip 7: In the event an instrument is transferred, ask yourself whether the transferor was a holder or a holder in due course?

Example 48: A negotiates the instrument to B. B pays value for the instrument and meets the criteria for a holder in due course. B transfers the instrument to C. C pays nothing for the instrument. What are C’s rights?

Even though C did not pay value for the instrument, C has B’s ___________________________________ rights due to the shelter rule.

Example 49: A negotiates the instrument to B. B does not pay value for the instrument. B transfers the note to C. C pays nothing for the instrument.

C has B’s rights under the shelter rule. Because B was not a HDC (did not pay value), C is not a __________________________________.

Maker (a)

Transfer

Issuance

Transferee (c)

Presentment

Holder or HDC (b)

Transferee (d)

Transfer


C. Right to Transferor’s Indorsement

When a transferee pays _________________ for an instrument and the transferor fails to provide a necessary __________________________, the transferee has the legal right to have the transferor provide the necessary indorsement to complete the negotiation.

Example 50: A, the payee of a negotiable promissory note, receives $1000 from B in exchange for the note. A forgets to indorse the instrument before transfer. B can require A to indorse the instrument because B gave _______________ for the note.

D. Exception to the Shelter Rule

A transferee who commits _________________ or otherwise engages in some type of ___________________________________ as it relates to the instrument cannot acquire rights as a holder in due course.

Example 51: A fraudulently induces Maker to issue a note to A. A negotiates the note to C, who takes the note as a holder in due course. C sells the note back to A.

A does not enjoy C’s right as a HDC due to A’s prior _______________ with respect to the note.

Editor's Note 3: In the example above, Professor Newman misspoke when he stated that A negotiated the note to B. Instead, he meant to state that A negotiated the note to C.

Example 52: Assume that same facts as above, except that C instead transfers the note to D. D is aware of A’s fraud because A told him about it after the fact.

D enjoys C’s rights as a ____________________________ and is not subject to A’s fraud in the inducement defense, even though D was aware of A’s fraud at the time he took the note.


CHAPTER 7: TRANSFER WARRANTIES

A. Example

Bernie Thad steals check

(a customer of

Payor

Bank)

Basic idea – Transfer warranties are often the remedy provided when money is paid to an ______________________________ party (e.g., thief).

Exam Tip 8: When you have thieves in a fact pattern, consider whether transfer or presentment warranties are at issue in the question.

B. Transfer Warranties

• Warranties that a ______________________ makes to a ________________________. Warranties include:

o The warrantor is a person entitled to _____________________ the instrument;

Note 1: The warranty that the warrantor is a person entitled to enforce the instrument is breached by a forged drawer’s signature.

Editor's Note 4: Professor Newman misspoke regarding the effect of a forged drawer’s signature. Note 1 is correct.

o All signatures on the instrument are ___________________________ and ___________________________;

Cara

Payee

Thad forges Cara’s name –(forged indorsement), then

indorses “Thad” and deposits

Depositary

Bank

(warrantor)

Payor

Bank

PRESENTMENT

WARRANTIES

Second

Intermediate

(warrantor)

First

Intermediate

(warrantor)

TRANSFER

WARRANTIES

Issuance


o The instrument has not been _____________________; o There are no __________________________________ that can be asserted against the

transferor; o Warrantor has no knowledge of any insolvency proceedings; o With respect to any remotely-created consumer check, the person on whose account the

check is drawn has authorized the issuance of the item in the amount for which the item is drawn.

Example 53: Bernie issues a check to Cara for $700, naming Cara as the Payee. Thad steals the check from Cara and forges Cara’s signature on the back. Thad then signs his own name and then deposits the check at Depositary Bank. Depositary Bank transfers check to First Intermediate Bank. First Intermediate Bank transfers check to Second Intermediate Bank. Second Intermediate Bank presents the check to Payor Bank for payment. Payor Bank pays the check. Thad promptly withdraws the money from his account at Depositary Bank, closes his account, and is nowhere to be found. Who is liable to whom for what?

Bernie vs. Payor Bank – (check not properly payable)

Answer: Payor Bank would have to _________________ Bernie’s account, because they honored a check that was not ___________________________________, as it contained a forged indorsement. Here, Thad’s forged indorsement of Cara’s name made the item not properly payable.

Payor Bank vs. Second Intermediate Bank – (breach of presentment warranty, which will be covered in detail later)

Answer: Second Intermediate Bank would have to __________________ Payor Bank for the $700 due to a _________________ of presentment warranty. Second Intermediate Bank was not a person entitled to enforce the instrument because the instrument contained a ___________________________________.

Second Intermediate Bank v. First Intermediate Bank (breach of transfer warranty)

Answer: First Intermediate Bank would have to reimburse Second Intermediate Bank for breach of the transfer warranty. First Intermediate Bank was not a person entitled to enforce the instrument because the instrument contained a _________________ indorsement.

First Intermediate Bank v. Depositary Bank (breach of transfer warranties)

Answer: Depositary Bank would have to reimburse First Intermediate Bank for breach of the transfer warranty. Depositary Bank was not a person entitled to


enforce the instrument because the instrument contained a ________________ indorsement.

Depositary Bank v. Thad

Depositary Bank has a transfer warranty action against Thad if Thad can be found.

C. Key Things to Remember

• When the fact pattern involves a thief, you should consider the transfer and presentment warranties

• Identify the context of the fact pattern – must properly identify which warranties were breached

CHAPTER 8: ENFORCEMENT OF AN INSTRUMENT

Who has to prove what in the courtroom?

A. The Prima Facie Case

• Plaintiff seeking enforcement must prove (1) that plaintiff is a person _______________________________________ the instrument and (2) that the ________________________ on the instrument are valid.

• Who is a “Person Entitled to Enforce?”

o A __________________ o A non-holder in __________________________ of the instrument who has the rights of a

holder; or o A person not in possession but who has the right to ___________________ (e.g., the

instrument has been lost or stolen)

• Validity of signatures – Signatures are accepted as authentic unless specifically ___________________ in the pleadings. The party claiming validity generally has the burden of proving that the signatures are valid.

Editor's Note 5: The professor misspoke regarding the burden of proof. If the validity of a signature is denied in the pleadings, the burden of establishing validity is on the person claiming validity.

• Defenses – Once the plaintiff establishes the prima facie case, defendant can then assert any ____________________________________ defenses at his disposal. If Plaintiff is a HDC, plaintiff can re-establish the right to payment if the only defenses proffered are __________________________ defenses.

B. Lost, Destroyed, or Stolen Instrument

Plaintiff has the right to enforce an instrument even if the instrument was lost or stolen. As long as the loss of possession did not result from the holder __________________________ the instrument,


and the holder cannot reasonably obtain possession of the instrument because the instrument is _________________________________.

C. Conversion

• A person converts the property of another when he wrongfully ____________________ the other of that property or its value.

o One method by which an instrument may be converted is if it is taken by transfer other than a ____________________________, from a person not entitled to enforce the instrument or receive payment.

o The measure of liability is generally the amount payable on the ________________________.

Example 54: Thad steals a check written and made payable to Paula. Thad forges Paula’s indorsement and then signs his name under that. Thad then deposits the check into his bank account. When the check clears, Thad withdraws the money and is nowhere to be found.

Answer: An action for conversion would allow Paula to bring an action against:

1) Thad (as the one who stole the instrument); or

2) The _______________________ bank where Thad deposited the money (as the bank took the check from a person not entitled to enforce the check); or

3) The payor bank (as payor bank likewise took the check from a person not entitled to enforce the check).

• Things to watch for:

o Who cannot bring an action for conversion?

___________________ and acceptors

Example 55: Bernie issued a check to Cara. Thief steals check from Cara.

Answer: Bernie (as the issuer) may not bring an action against Thief for conversion. His remedies are to issue a stop payment order or have the bank recredit his account by asserting that the check was not properly payable.

_____________________ and ______________________ who did not receive delivery of the instrument may not bring conversion actions.

Example 56: Bernie makes a check payable to Paula. When in the process of handing over the check, Thief runs by and snatches check from Bernie’s hand.

Answer: Paula would not be able to bring a conversion action because she never ___________________________________ of the instrument.


CHAPTER 9: DEFENSES – REAL DEFENSES

Real Defenses v. Personal Defenses

Available against holder Available against holder

Available against HDC Not available against HDC

A. Real Defenses

• Infancy – can assert this defense in states where contracts with minors are either ____________ or _______________________

• Incapacity

o Key – State law must render contract with these parties ______________ (not voidable).

Example 57: A person is ruled mentally incompetent; guardianship; ultra vires action of a corporation

• Duress – A matter of degree

o Extreme duress vs. mere threat of something bad happening o State law must make contracts made under duress ________________.

Example 58: “Sign this promissory note or I will shoot you with this gun.” One signing an instrument under this circumstance would have the _________________________ of duress.

Maker/Drawer (obligor) Real Defenses? (good against HDC) Personal Defenses are not good against a HDC

Issuance – the first delivery of an instrument

bearer or order instrument?

Payee (creditor) holder

Transfer + proper indorsement (if order paper)

Negotiation?

Holder in due Course? (subject to Real Defenses) (can defeat Personal Defenses)

present for payment


Example 59: Duress not extreme (personal defense): “Sign this promissory note or I will prosecute your son for fighting.”

• Illegality – An obligor may assert this defense when state law states that notes drawn for the purpose of reimbursing or repaying money lent for gaming are _______________.

Example 60: Gary had an unlucky day at poker and lost $10,000. Gary issues a negotiable promissory note for that amount. Harry, a good faith purchaser for value, presents the promissory note to Gary on the due date. Gary’s jurisdiction has declared gambling an illegal activity and that all transactions related to settling gambling debts as void.

Answer: Gary can assert the real defense of ______________________ to avoid paying the instrument on the due date.

Exam Tip 9: Refer to the MBE contracts and related state distinctions outlines for determining in which incapacity, duress, and illegality make a contract void.

• Fraud

o Fraud in the factum = ________________ defense (can be asserted against HDC) o Fraud in the inducement = Personal defense (cannot be asserted against HDC)

1) Fraud in the factum = (1) Signer is ____________________________ that he is signing a negotiable instrument AND (2) he must not have had a ______________________________________________ to become aware.

Example 61: After a recent big game, Romo is mobbed by autograph seekers in a crowd of thousands. Romo signs as many autographs as he can to please his adoring fans. One of those pieces of paper happens to be a negotiable promissory note.

Answer: Romo would have a strong argument to assert the real defense of fraud in the _________________ because he did not know he was signing a promissory note and it would be very difficult to expect him to read each piece of paper in this circumstance.

2) Fraud in the inducement = Signer is aware that he is signing a negotiable instrument but signer is induced into signing based on ___________________________________.

Example 62: Romo is told by the car dealer that the Bentley he is considering for purchase has only 500 miles on it, when in fact that Bentley has 40,000 miles on it. Romo signs a $90,000 promissory note payable to dealer based on this fraudulent representation.


Answer: Here, Romo would have the ___________________ defense of fraud in the inducement because Romo knew he was signing a negotiable instrument but he did so under _______________________________.

• Discharge of Insolvency Proceedings (bankruptcy) – If an obligor has had his debts discharged through bankruptcy proceedings, that discharge is a ________________ defense.

• Alteration & Forgery – Any type of alteration or forgery that is apparent enough to cause a ______________________________________ to question its authenticity can be asserted as a real defense.

Example 63: A promissory note that is pieced together with tape or a signature that is of a different color than the rest of the writing

• Statute of Limitations

o Drafts

For unaccepted drafts (i.e., bank checks) – _______ years from date of dishonor OR ______ years from the date of the draft, whichever is earlier

For certified, teller’s, cashier’s, or traveler’s checks – If presenting, _______ years after demand for payment

o Notes

For notes payable at a definite time, the action must be brought within ________ years of the note’s due date

For notes payable on demand, the action must be brought within _________ years after demand for payment.

CHAPTER 10: DEFENSES - PERSONAL DEFENSES

A. Personal Defenses

Personal defenses are ineffective against a HDC, but can be asserted against those who have only holder status.

1. Issuance

Example 64: Michael writes a note, “I promise to pay Bearer $50,000.” Michael leaves this note on his desk to be picked up by Thief who absconds undetected. Thief comes back the next day and has the temerity to present the note to Michael for payment.

Answer: Michael can assert the __________________ defense of _______________________ because he did not issue the instrument.


Example 65: Same facts as example above, except this time Thief steals the note and then negotiates it to Harry, a good faith purchaser for value for $49,500.

Answer: The non-issuance defense would not be effective because Harry is a HDC.

2. Contract Defenses

o Same type of defenses asserted under contract law – breach of contract, failure of consideration, breach of warranty

o Cannot be asserted against a HDC, but can be asserted against those who have only holder status.

3. Claims in Recoupment

o An _________________ against an amount owed on an instrument

Example 66: Sammy sells a boat to Jerry for $50,000. Jerry issues Sammy a negotiable promissory note for $50,000 due one year from the issue date. Later, Jerry learns that the boat has a damaged propeller, which costs $1,000 to fix.

Answer: Jerry has a claim in recoupment for _________________. This means that when the note is presented for payment, Jerry can _______________ the amount owed on the note. Accordingly, he is obligated to pay $_____________ to a holder.

But, if the person who presents the note for payment is a HDC, then Jerry would be required to pay the whole $50,000 because __________________________________ are not enforceable against a HDC.

o Claims in recoupment must arise from the transaction that gave rise to the __________________________.

Example 67: Sellers and Buyers enter into two separate contracts for purchase and sale. Under the first contract, Buyers purchases widgets issuing a $12,000 promissory note to sellers payable on May 1. Under the second contract, Buyers purchases gaskets for $5,000 in cash. The widgets are fine, but the Buyers had to spend $800 to repair broken gaskets.

The buyers would still owe the full $12,000 on the promissory note because the $800 gasket repairs did not arise from the transaction that gave rise to the promissory note.

o Defenses and Claims in Recoupment of Other Persons

The obligor may only assert his own recoupment claim; not the claims of others.


o A non-HDC takes an instrument subject to all valid claims of a property or possessory interest in the instrument.

B. Key things to remember:

• Does the obligor have any defenses? • Real or personal defenses? • Is the holder a HDC or merely a holder?

CHAPTER 11: UNAUTHORIZED SIGNATURES AND IMPOSTERS

A. Instruments Issued to Impostors (the drawer gets duped)

• Generally: Issuers must be careful to whom they issue instruments. • If the issuer is duped into issuing an instrument to an impostor, the issuer may nonetheless be

__________________ on the instrument. • If an impostor induces the issuer to issue an instrument to the impostor, an indorsement of the

instrument by ______________________________ in the name of the payee may be effective as the payee’s indorsement.

• Context: Generally, this scenario is invoked when either a drawer or a maker (but usually a drawer) is tricked into issuing a check to someone who _______________________________ who they are. Here, the law places the loss on the instrument’s issuer, the rationale being that the issuer is in the best position to control to whom he issues an instrument.

Example 68: To the ring of his doorbell, Daryl Drawer is greeted by Chris Conman, an individual purporting to be Harry Humane, the founder of an organization called The Shelter for Dogs Charity. On this fraudulent representation, Daryl issues a check made payable to Harry Humane. Chris takes the check, indorses “Harry Humane” on the back, and deposits it into his bank. The check is presented to Daryl’s bank who pays the check. Daryl learns of this ruse, but not before the check is cashed. Daryl calls the bank explaining the mistake and asks the bank to recredit his account.

Answer: Bank would NOT be required to recredit Daryl’s account because an indorsement in the name of the payee by __________________________ is effective.

B. Instruments Payable to Fictitious or Unintended Payees (when good employees go bad)

• If a person whose intent determines to whom an instrument is payable:

o Does not intend for the payee to have ________________________________ in the instrument; or

o The payee is _______________________;


o Then any person _____________________________ of the instrument is the instrument’s holder; and an indorsement by _____________________________ in the name of the stated payee may be effective as the payee’s indorsement.

• Context: Generally this scenario is invoked in the corporate context when a treasurer (or someone who has check-writing privileges) either writes checks payable to real customers but instead indorses the checks himself and deposits the money, OR creates fictitious payees and writes checks to them but keeps the checks for himself. Here again, the _______________________ bears the loss as it is in the best position to prevent these acts from happening.

Example 69: Terry, X Corporation’s treasurer, devised a scheme to increase his income. Terry created fictitious company employees and drew checks made payable to these individuals. Terry would then indorse the checks in the payees’ names and deposit the checks in accounts opened under those fake names. When such checks were presented to X Corporation’s bank, the checks were cashed.

Are these checks properly payable?

Answer: __________. Terry wrote checks to fictitious persons. As the one in possession, he is the instrument’s holder. His indorsements are effective because they were taken by the bank in good faith for collection.

C. Employer’s Liability for Employee’s Fraudulent Indorsement

• Context: An employee ENTRUSTED with check-writing privileges forges indorsements. The employee misplaces that trust by forging indorsements. The __________________________ will bear the responsibility for the loss.

Example 70: Mr. Refund runs a thriving tax practice. He employs Bernie, who handles client accounts. He sends out bills as needed and deposits checks sent to Mr. Refund as payment. Bernie starts forging Mr. Refund’s indorsement and depositing checks into his own account at Downtown Bank and Trust. The checks are drawn on Mr. Refund’s account with Pay Town Bank. Eventually Mr. Refund figures thinks out. He fires Bernie and now wants recourse for money drawn from his account.

Bernie’s indorsement would be considered effective because Bernie was an employee ____________________ to handle deposits and Bernie made a fraudulent indorsement by forging Mr. Refund’s indorsement. As long as the banks that took the instrument for payment acted in good faith, then these checks are properly payable.


D. Benefitted Parties

Context: These are the parties who take the instruments mentioned in items A-C above. These parties are usually banks or good faith purchasers for value. If these parties fail to exercise ________________________________________ in taking the instruments, and that failure ____________________________ contributes to loss resulting from payment of the instrument, the person bearing the loss may recover from the person failing to exercise ordinary care to the extent the failure to exercise ordinary care _________________________ to the loss.

Example 71: Carry Crook, the treasurer of X Corporation wrote a check on X Corporation’s behalf payable to Tony Romo, a purported employee of X Corporation, in the amount of $50,000. The treasurer forges Tony Romo’s signature and deposits the check in an account under Tony Romo’s name. Carry Crook shows up to bank purporting to be Tony Romo and seeks to withdraw all $50,000. The bank fails to ask Carry Crook for any identification or identify proof of any sort, and gives Carry Crook the money, no questions asked.

Answer: X Corporation may be able to recover from the bank because the bank failed to exercise __________________________ by failing to determine Cary Crook’s identity.

E. Key things to remember:

• Context-driven facts • Watch for instances when the issuer is duped by an imposter • When good employees go bad

o Key: The employee must have been entrusted with money-handling privileges, then the employer will bear the loss.

CHAPTER 12: ALTERATIONS AND INCOMPLETE INSTRUMENTS

A. Alterations

• The ______________________________ modification of an instrument

o Includes both _______________ and _________________________

• Legal effect of altered instrument: Obligor is __________________________ on the instrument

o A payor bank or drawee who pays a fraudulently altered instrument may enforce rights with respect to the instrument according to its ________________________ terms before alteration.

o Likewise, a _____________________________________ may enforce rights with respect to the instrument according to its original terms before the alteration.


Example 72: Mary Maker issues a promissory note to Larry Loan Shark for $1,000. Larry takes the instrument and using some special chemicals erases the “1” and replaces it with a “9,” thereby making the promissory note payable for $9,000. Larry then negotiates the note to Harry Holdit. Harry was a frequent purchaser of Larry’s altered paper. When the note matures, Harry presents the instrument to Mary for payment.

Answer: Mary’s obligation on the instrument would be ___________________ because the alteration affected Mary’s obligation on the instrument by changing the amount payable from $1,000 to $9,000.

Mary is NOT liable to Harry Holdit because the facts indicate that Harry is not a holder in due course. Harry, as a frequent purchaser of Larry’s altered paper, was aware of such alteration and therefore cannot claim status as a HDC.

B. Incomplete Instruments

• A signed writing, whether or not issued by the signor, the contents which show that the signer intended the instrument to be completed by the addition of words or numbers

• Context: Maker makes an instrument but leaves key information blank (e.g., amount) with the intent to complete the information later.

• Authorized completions are ___________________________. • Unauthorized completions – the obligor is discharged on the instrument, but a

_________________________ or a holder in due course can enforce the instrument as completed.

Example 73: Buyer takes a blank check in his checkbook and fills in a sporting goods store as the payee. He enters the amount for $2,000, but does not sign the check. He puts it in his wallet and heads to the store. At this point, the check is not an incomplete instrument.

Example 74: Buyer signs the check and the amount, but he leaves blank the payee. He gives the check to his assistant, Maxine, instructing her to buy a product at the store and fill in the payee when the payee is determined. Here, the check is an incomplete instrument because it is signed and the buyer intended to complete it later.

Example 75: Buyer makes a promissory note to Barry’s Plumbers and signs it leaving the amount blank. He tells the plumber fixing his sink, “I am authorizing charges up to $500. If the amount exceeds that, then let me know.” The plumber nods his head in agreement but when Buyer leaves he fills in the amount for $600. This incomplete instrument, as completed, would not be enforceable because it was unauthorized. Here, Buyer would be discharged because the plumber filled in an amount in excess of the authorized amount.


CHAPTER 13: PRESENTMENT WARRANTIES

EXAMPLE:

Bernie Thad steals check

(a customer of

Payor

Bank)

A. Presentment

• General idea: A demand for payment made to a maker or drawee by the person entitled to _________________ the instrument.

o Presentment and dishonor serve as ___________________________ for liability for other parties who have potential liability on the instrument.

Example 76: Mary issues a note to Paul. Paul indorses the note, “Pay to Harry /s/ Paul,” and then negotiates the note to Harry, a good faith purchaser for value. Harry presents the note to Mary. Mary asserts the real defense of infancy and then dishonors the note.

Answer: Paul, as the _____________________________ would now be liable on the instrument because the note was initially presented to Mary, who dishonored.

• Excused presentment

o Presentment is excused when:

Cara

Payee

Thad forges Cara’s name –(forged indorsement), then

indorses “Thad” and deposits

Depositary

Bank

(warrantor)

Payor

Bank

PRESENTMENT

WARRANTIES

Second

Intermediate

(warrantor)

First

Intermediate

(warrantor)

TRANSFER

WARRANTIES

issuance


The presenter cannot locate the one liable to whom presentment must be made The maker or the acceptor has _______________________ the obligation to pay The instrument’s terms do not require presentment The drawer or indorser has __________________ the presentment requirement The drawer has instructed drawee _____________________

B. Presentment Warranties

• Context: Presentment warranties come into play when a thief or forger enters into the chain. The breach of presentment warranty allows a ________________________ to sue "_________________________" those through whose hands the check has passed for breach of one of the warranties.

• Presentment warranties: When a “person” presents an item for payment, the presentment comes with all of the following warranties:

o The warrantor is a person _______________________ to enforce the instrument (a warrant that there are no unauthorized or missing indorsements)

o The draft has not been ____________________ o The warrantor has no ________________________ that the drawer’s signature is

____________________________ o With respect to any remotely-created consumer item, the person on whose account the

item is drawn has authorized the issuance of the item in the amount for which the item is drawn

Example 77: Bernie issues a check to Cara for $700, naming Cara as the payee. Thad steals the check from Cara and forges Cara’s signature on the back. Thad then signs his own name and then deposits the check at Depositary Bank. Depositary Bank transfers check to First Intermediate Bank. First Intermediate Bank transfers check to Second Intermediate Bank. Second Intermediate Bank presents the check to Payor Bank for payment. Payor Bank pays the check. Thad promptly withdraws the money from his account at Depositary Bank, closes his account, and is nowhere to be found. Who is liable to whom for what?

Bernie vs. Payor Bank – (check not properly payable)

Answer: Payor Bank would have to ________________ Bernie’s account, because they honored a check that was not __________________________________, as it contained a forged indorsement. Here, Thad’s forged indorsement of Cara’s name made the item not properly payable.

Payor Bank vs. Second Intermediate Bank – (breach of presentment warranty)


Answer: Second Intermediate Bank would have to ____________________ Payor Bank for the $700 due to a breach of presentment warranty. Second Intermediate Bank was not a person entitled to enforce the instrument because the instrument contained a ____________________________________.

CHAPTER 14: PARTIES TO THE INSTRUMENT AND THEIR POTENTIAL LIABILITY

Approach:

• Determine in what ______________________ the person signed • Determine the _________________________________ the person has incurred on the

instrument • Understand when and under what circumstances that person’s liability on the instrument will

ripen

A. Maker’s Liability (“makers make notes”)

Maker has _____________________ liability, which means the maker must pay the instrument ______________________________.

B. Drawer’s Liability (“drawers draw drafts”)

Drawer has ________________________ liability. The drawer’s obligation to pay ripens only upon ____________________.

Example 78: Darryl signs a check and issues it to Paul. Paul presents the check to Darryl’s bank for payment. Bank dishonors the check due to Darryl having insufficient funds in his account.

Answer: Darryl’s liability on the instrument has now ripened and Paul can _________________ payment against Darryl.

Maker

(obligor)

Payee

(creditor)

(indorser)

Transfer Negotiation

Holder in due course?

(indorser)

present for payment


C. Drawee’s Liability

• A drawee is not legally obligated on the instrument unless the drawee ________________ the instrument for the purpose of _____________________________________________ on the instrument.

• Drawees generally do not sign instruments; therefore, their liability is not on the instrument itself but to the ________________________________ who has funds deposited at the bank.

Example 79: Darryl signs a check and issues it to Paul. Paul presents the check to Darryl’s bank, BarPrep Bank & Trust. Bank dishonors the check due to Darryl having insufficient funds in his account.

Answer: As a result, Paul’s recourse would be against _______________, the drawer of the draft, not against the _____________, the drawee of the draft, because the Bar Prep Bank & Trust did not sign the instrument.

• Properly payable rule: The bank is obligated to honor a check that is properly payable.

o “Properly payable” means the customer has ___________________ funds in his account and the customer has _____________________ payment.

o Alteration - If a check has an alteration, the bank may charge the customer’s account for the ______________________ amount (not the altered amount).

o Postdated check – A bank may properly pay a postdated check unless customer gives bank timely __________________ of the postdated check.

• Wrongful dishonor – A bank dishonors a check that was properly payable.

o The customer can sue for damages proximately ___________________ by the wrongful dishonor.

• Customers have a duty to inspect the bank statement

o Must exercise ____________________________ care and promptness to discover unauthorized payments resulting from a forged signature or alteration

• Customer’s right to stop payment

o Oral stop payment is valid for ____________________. o Written stop payment is valid for _____________________.

D. Acceptor’s Liability

• Acceptance: The drawee’s signed agreement to pay a draft as presented • Banks are the entities that usually accept drafts. • Certified, teller’s, and cashier’s checks are the common context in which acceptance occurs.

E. Indorser’s Liability

• By indorsing an instrument, you agree to pay the instrument in the event the one who has _______________________ liability does not pay.


• The indorser's liability ripens when: (1) the note is ________________________ and (2) the indorser receives __________________________________.

Example 80: Mary issues a negotiable promissory note to Paul. Paul places his indorsement on the note’s back and negotiates the note to Harry, a good faith purchaser who paid value for the note. Harry presents the note to Mary on the due date. Mary asserts the real defense that she is not of legal age to enter into contracts and dishonors the note. Harry informs Paul that Mary has dishonored the note.

Answer: Mary has dishonored the note and Paul has received notice of the dishonor. At this point, Paul is _______________ on the instrument as the note’s ___________________.

Exam Tip 10: Be aware of indorsements that state “Without recourse” which disclaims the indorsers liability.

F. Liability of Joint Signers

Joint signers of an instrument have ______________________________________ liability, meaning either one or both may be sued for the entire amount.

CHAPTER 15: ACCOMMODATION PARTIES

Maker/Drawer – (bad credit)

(Accommodated Party)

Lender/Creditor –

(won’t lend unless maker/drawer has guarantor)

Accommodation Party(good credit)

signs instrument as well

(no direct benefit for value given for instrument)


A. Basic Idea

• Maker wants to borrow money but has bad credit. • Lender won’t lend because of Maker’s bad credit. • Maker gets an accommodation party to act as a __________________.

B. Key Aspects:

• The accommodation party must ______________ the instrument. • The accommodation party must NOT be a ___________________ beneficiary of the value given

for the instrument. • The accommodation party’s liability on the instrument depends on the ____________________

in which they sign.

Example 81: Mary wants to borrow money from Lender, but Mary has bad credit. Aaron agrees to act as a guarantor for the loan. In a separate document, Aaron agrees to act as Mary’s guarantor. Mary then signs a negotiable promissory note and issues it to Lender.

Answer: Aaron is a guarantor, but does not have the official designation of an accommodation party because he did not _________________________________________. Therefore, his surety rights and obligations ____________________ governed by UCC Article 3.

Example 82: Mary wants to borrow money from Lender to buy a boat. Aaron signs the instrument as a co-maker. Mary takes possession of the boat and registers the boat in her name only. Mary agrees to let Aaron ride the boat anytime she’s not using it.

Answer: Aaron has the designation as an accommodation party because he signed the instrument to incur liability, AND he is not a _________________________________ of the value given for the instrument. Mary, as the boat’s registered owner and the one in possession, is the direct beneficiary.

Example 83: (Guaranteeing collection vs. guaranteeing payment): Same facts as above, except Aaron signs the instrument as a co-maker with the additional words “Guarantees Collection” next to his signature.

Answer: Lender must seek payment from ______________________________.

Example 84: Same facts as above, except Aaron signs the instrument as a co-maker with the additional words “Guarantees Payment” next to his signature.

Answer: Lender can seek payment from _________________ Mary or Aaron when the note comes due.


Example 85: Same facts as above, except Mary signs the front of the instrument as a maker. Aaron then takes the instrument and signs the instrument on the back and then the note is issued to Lender.

Answer: Aaron has made an anomalous indorsement. As an indorser, Aaron has ___________________________________. Lender must go after _______________ first. Lender can seek payment from Aaron only after the note is _____________________.

C. Legal Rights of an Accommodation Party

• Accommodation parties are entitled to:

o ______________________________ from the maker (Full repayment); o _________________________ from co-accommodation parties (reimbursed a pro-rata

amount); and o The same defenses against payment that an accommodated party would have.

• Accommodation parties are not liable to accommodated parties that __________ the instrument.

CHAPTER 16: WHEN AGENTS SIGN NEGOTIABLE INSTRUMENTS

A. Basic Idea

• General laws of __________________ apply here. • The principal is generally liable on an instrument signed by an __________________________

agent. • The agent’s liability hinges on whether:

o The agent was authorized to sign; o The agent indicated clearly that he was __________________________________; and o Whether the person presenting the instrument for payment is a

__________________________________ or a ____________________________.

B. The Principal’s Liability

• The principal is not bound if agent did not have the ______________________ to sign on the principal’s behalf.

• The principal may __________________ the agent’s unauthorized signature if the principal _________________ the signature or _________________________ the signature’s validity.

• The principal may be ____________________ from denying liability against a HDC if the principal ________________________ contributed to the agent’s unauthorized signature.


C. The Agent’s Liability

• Unauthorized signature: The agent will be bound by signing an instrument when the agent did not have authority to act on the _______________________________ in signing the instrument.

• The agent’s liability for authorized signature:

o The principal is liable when an authorized agent signs the ________________________ name only.

o An authorized agent who signs an instrument that clearly indicates that the agent is signing in his ___________________ as an agent will not be liable on the instrument.

Example 86: A, treasurer of X, Inc., signs a promissory note payable to Y, Inc., in the following manner: “X, Inc., by A, Treasurer.”

Answer: Here, A is _______________________ on the note because A ______________________________ that he was signing as an agent for X, Inc.

o An authorized agent who signs his own name but does not clearly indicate that he is signing in a representative capacity or who does not identify the principal in the instrument, will have ____________________ liability to a HDC who takes the instrument without _______________________________________. But the agent is not liable to a non-HDC if he can establish that the parties never intended for the agent to be personally liable.

Example 87: A, P’s authorized agent, signs “A” on a note payable to C.

Answer: A may be liable on the note if the note is presented to A for payment by a HDC who took the instrument without notice of A’s agency because A didn't clearly show that A signed as ___________________.

Example 88: A, an authorized agent of P, signs “A, agent” on a note payable to C. P was not identified in the instrument.

Answer: A may be liable to an ________________________________ if the HDC took without notice that the agent was not to be liable on the instrument because P was not identified in the instrument.

o An authorized agent is not liable for signing his own name as drawer on a check if the check is drawn on _________________________________.

D. Unauthorized Signatures

• Generally, a person is not liable on an instrument unless that person _____________ the instrument.

• A person who signs an instrument is generally liable on that instrument regardless of whether the signature was ________________________.

• A person will be liable on an instrument in the __________________ in which he signed the instrument.


a. Forged Maker’s Signature

Person whose signature was forged – ______________________ Person who forged the signature – ___________________

Example 89: Fred forges Mary’s name as maker on a promissory note payable to Paul.

Answer: Mary is ________________________ on the instrument because she did not ____________ the instrument. Instead, Fred is liable because he is the one who actually ____________________.

b. Forged Drawer’s Signature

Person whose signature was forged – _________________________ Person who forged the signature – __________________

Example 90: Thief steals check from David. Thief forges David’s signature and issues check payable to “Cash” (bearer paper). Thief deposits the check into Thief’s bank. Bank presents check to David’s bank. David’s bank cashes the check.

Answer: David’s bank must credit David’s account because the check was not ______________________________ as David did not sign the check.

c. Forged Indorser’s Signature

Person whose signature was forged – _____________________ Person who forged the signature – _________________

CHAPTER 17: PAYMENT AND DISCHARGE

A. Payment

• Context: Drawee pays an instrument by _____________________ due to a stop payment order having been issued, or the instrument contained a ____________________________________________. In some cases, the drawee can seek restitution from the one to whom payment was made.

• Payment by mistake: Article 3 allows the drawee to seek restitution in two common cases:

1) The drawee pays a check on the mistaken belief that the drawer’s signature was an ______________________________________.

2) The drawee pays a check on the mistaken belief that a stop payment order had not been issued.

• Restitution not available when payment made to a HDC: However, the drawee may not recover a mistaken payment when the one entitled to enforce the instrument is a


______________________ purchaser for value, or is one who in good faith changed position in ____________________ on the payment.

B. Discharge

• Instrument’s Effect on Underlying Obligation

o In most NI transactions, there are two contractual obligations: (1) the ______________________ obligation and (2) the obligations on the ___________________________________.

If a certified-, cashier’s-, or teller’s check is taken for an obligation, the underlying obligation is _______________________.

Example 91: Terry Tenant is two months behind on his rent. Terry gives Larry Landlord a cashier’s check to cover the two months past due rent.

Answer: Terry’s obligation is ___________________ when Landlord takes the check.

If an ________________________ check or note is taken for an obligation, the underlying obligation is ______________________.

• If the check or note is subsequently ______________, the underlying obligation is then discharged.

• If the check or note is _______________________, the note’s holder can sue on either the ___________________ or the _________________________________.

Example 92: Terry Tenant is two months behind on his rent. Larry Landlord takes a promissory note for the past due amount. The note will mature three months from the issue date. After thinking about it, Larry decides that he doesn’t want to wait that long for his past due rent. Larry goes to Tenant and asks for the past due rent in cash.

Answer: Larry’s acceptance of the promissory note __________________ the underlying rental obligation. At this point, even though the rent is past due, Larry cannot take any further action and must wait until the note’s due date. If Terry fails to pay when the note comes due, then Larry can sue on the instrument or on the underlying past due rent obligation.

• Lost Instruments

o If one entitled to enforce the instrument loses the instrument, the remedy is limited to suing on the _____________________.

Example 93: Buyer writes Seller a check for $1,000. Seller loses the check before depositing.


Answer: Seller cannot sue Buyer on the underlying obligation because the underlying obligation is __________________ until the check is ______________________________. Neither would occur in this case because the check was lost. Seller is limited now to enforcing payment of the instrument even though the instrument is not in Seller’s possession.

• Discharge by Tender of Payment

o When person tenders payment, ___________________ after the due date is discharged. o When person tenders payment and payment is refused, ____________________ and

________________________________________ are discharged.

• Impairment of Collateral

o If a party’s obligation to pay an instrument is secured by collateral and the person entitled to enforce the instruments impairs the value of the interest in collateral, then indorsers and accommodation parties are discharged.

Example 94: Moe needs to borrow $70,000 to do repairs on his tavern. Bank agrees to loan him the money if he puts all of the tavern’s equipment for collateral and gets a co-signor. Moe puts up the collateral and Curly agrees to co-sign. Moe defaults on the loan. The bank fails to perfect his interest. The equipment was worth $30,000. How does this affect Curly’s obligation on the note as an accommodation party?

Answer: Curly is discharged to the extent of the ___________________ ($30,000) because the collateral was impaired due to the Bank’s failure to perfect its interest.

C. PEP TALK – EXAM APPROACH:

• Practice for “game day” – Prepare by simulating what you will have to do on test day by doing prior bar exam questions.

• Get organized – Diagram every question so you can sort out who is doing what to whom. • Appreciate – Article 3 by design lends itself to a correct answer. Responses should be drafted

with this in mind. • Matters you should ALWAYS be aware of:

o Is the instrument a _____________________________________? o Was there a proper negotiation? o Are we dealing with a holder or a _________________________________? o What ___________________ can the obligor assert? o Who else can be held _______________________?

• Follow the trail and address whatever part of the trail the Bar Examiner wants you to discuss.


• RELAX! Be methodical in your preparation. Take comfort in the fact that you have prepared diligently. The exam is just a culmination of all your hard work.

GOOD LUCK!!

[END OF HANDOUT]

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