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219 terms

Commercial Paper

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What governs commercial paper?
Article 3 of the UCC governs the rights and liabilities of parties to what the Code calls "commercial paper."
What does "paper" call for?
This "paper" calls for a party to pay money rather than deliver goods or perform service.
The type of commercial paper governed by Article 3 of the UCC can be divided into 2 basic categories:
1. NOTES; and
2. DRAFTS
Note: Generally
A note is a 2 party instrument:
1. MAKER: the person who signs or is identified in a note as the person undertaking to pay.
2. PAYEE: the person to whom the notes is payable.
Draft: Generally
A draft is a 3 party instrument:
1. DRAWER: the person who signs or is identified in a draft as the person ordering payment.
2. DRAWEE: the person ordered in a draft to make payment.
3. PAYEE: the person to whom the draft is payable.
When the drawee is a bank, and it is payable on demand:
Then the draft is a CHECK.
Certificate of deposit:
CD'S are an acknowledgment by a bank that a sum of money has been received, and a promise by the bank to repay the sum of money.
Seller and Buyer sign a K. Seller delivers goods to Buyer, w/ Buyer agreeing to pay w/in 60 days. Can Seller assign this right to receive payment to X?
Yes. Seller is assignor, X is assignee.
If the goods turn out to be defective, must Buyer pay X?
No. You learn that any defense that can be raised by assignor can be raised by assignee.
Now assume that when Seller delivers the goods to Buyer, Buyer issues to Seller a NEGOTIABLE INSTRUMENT (check or promissory note). Seller than NEGOTIATES the NETOTIABLE INSTRUMENT to X, a HOLDER IN DUE COURSE (HDC) who gives value, in good faith, w/ no notice that it is overdue or has been dishonored or of any defenses or claims.
Here, X takes free of most defenses (personal defenses) that Buyer could have raised against Seller (including the defense that the goods are defective).
- If you negotiate → they get greater rights than you had.
- BUT NOTE: certain defenses (real defenses) can be raised even as against a HDC.
When do the general concepts of K law apply?
If commercial paper is non-negotiable, then general principles of K law apply → the assignee stands in the shoes of the assignor.
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: The Requirements Generally:
The Requirements Generally:
1. Writing;
2. Signed by the Maker (note) or Drawer (check);
3. Unconditional;
4. Promise to Pay or Order to Pay;
5. Fixed Amount;
6. In Money;
7. No Other Undertaking or Instruction;
8. On Demand or at a Definite Time;
9. To Order or to Bearer.
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: a Writing
A Writing: there is no such thing as an oral negotiable instrument. It must be something TANGIBLE. Almost always a piece of paper, but need not be (a t-shirt, a cow, a tamales, etc. → all technically ok).
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: signed by maker (if note) or drawer (if check)
Code defines "signed" as including "any symbol executed or adopted by a party w/ a present INTENTION to authenticate a writing"
1. Can be printed, stamped, written;
2. Can be initials or thumbprint;
3. Can be a trade name or assumed name;
4. Can appear in the body of the instrument.
5. Ex: "I Mike Sabbath promise to pay": written by maker, no signature, but could be signature if intended, can be w/in the body of the instrument.

6. KEY: whether the party intended for that symbol to operate as her signature.
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: unconditional
Conditional promises are OK under K law, but they destroy negotiability.
Hypo: Maker promises to pay $100 to the order of Payee only if the Atlanta Braves win the World Series. Negotiable?
This is NOT negotiable.
Does it destroy an instrument if it simply refers to another agreement?
It does not destroy negotiability if the instrument simply refers to another agreement.
Hypo: I promise to pay $100 to the order of Payee "in accordance w/" (or "as per") the K we signed today. Negotiable?
This is negotiable. It is ok to mention the underlying K w/o destroying negotiability so long as payment of the instrument is not made "subject to" or "conditioned upon" performance of the underlying K.
Assume the promise to pay is "subject to" a K
Upon examining the K, it is clear that it puts no conditions on the promise to pay. This is NOT NEGOTIABLE. The negotiability of an instrument must be clear on the face of the instrument itself. The terms of the incorporated document are irrelevant. The fact of incorporation destroys negotiability.
Art. 3 specifically provides that a promise or order will not be deemed conditionally merely b/c it:
-Still generally negotiable;
1. Refers to another writing for a statement of rights regarding collateral, prepayment, or acceleration;
2. Limits payment to particular source or fund (i.e. "I promise to pay out of the funds received from the sale of my next wheat crop");
3. Requires as condition to payment a countersignature by a person whose specimen signature appears on the promise or order (such conditions are common on traveler's checks).
Promise to Pay (if note) or Order to Pay (if checks):
1. An IOU is NOT negotiable. It is not a promise to pay.
2. "I wish you would pay" is not an order to pay. Not negotiable.
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: a fixed amount
When the instrument is payable, the holder must be able to determine FROM THE INSTRUMENT ITSELF THE PRINCIPAL AMOUNT DUE. The requirement of a fixed amount applies ONLY to principal; it does not apply to interest (or to other charges that are often included in an instrument, such as collection costs and attorney's fees).
1. A note providing for variable interest rates (e.g. 3% over prime, adjusted each 6 months based on then prevailing bank rates in New York City") is negotiable (it is ok for interest rate to require reference to an outside source).
2. If the instrument states that it is payable "with interest" but does not state how much interest, the judgment rate (the rate on a court judgment) will be implied.
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: in money
1. A promise to pay 100 bales of cotton Is a non-negotiable promise.
2. Foreign money is ok (as long as the US recognizes the currency).
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: no other undertaking or instructions
A negotiable instrument must be a "courier w/o luggage" - it must not be burdened w/ anything other than a simple, clean unconditional promise or order. If a note contains additional undertakings or instructions, the holder is given notice that the note is or may be conditioned on the performance of those additional undertakings or instructions.
- "I promise to pay if you cut my grass." There is value, but the likelihood of payment is not increased.
The UCC does permit a number of extra undertakings or instructions. A promise or order may contain:
1. An undertaking or power to give, maintain, or protect collateral to secure payment;
2. An authorization or power to the holder to confess judgment or realize on or dispose of collateral;
3. A waiver of the benefit of any law intended for the advantage or protection of the obligor (e.g. waiver of a homestead exemption, or trial by jury, or right to notice of dishonor).
***Each of these strengthens the promise to pay (increases likelihood of payment), but has no independent value.

- NOTE: Also Ok to promise to pay costs of collection and attorney's fees.
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: on demand or at a definite time
A holder of an instrument must be able to tell when it comes due or the instrument is non-negotiable. This doesn't mean that the instrument must be dated. An undated instrument, which specifies no time for payment, is treated as an instrument payable on demand by the holder.
A post-dated check?
Still negotiable. You need to notify the bank, reasonably identify the check, or the bank can pay it before the date.
A note containing an acceleration clause.
1. A clause that permits the instrument to be extended at the option of the maker is still negotiable SO LONG AS the extension is to a further definite time stated in the instrument (e.g., "This instrument can be extended for one months after the original due date"). If it simply provides that it can be extended at the option of the maker, it is not negotiable. (May be paid sooner but must be paid by that date).
2. A clause that permits the instrument to be extended at the option of the holder is negotiable, since the holder always has the option of giving extra time for payment.
Events certain to happen but uncertain as to time.
If an instrument is payable on or after a stated time or event certain to happen but uncertain as to time (e.g., "payable on my Uncle Buck's death"), it is not negotiable b/c there is no definite time for payment.
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: to order or to bearer
A negotiable instrument must contain certain MAGIC WORDS—either ORDER language or BEARER language. A writing lacking these magic words is not negotiable and is not governed by Article 3.
Hypo: I promise to pay Paul.
Not negotiable.
Hypo: I promise to pay to the order of Paul (or "to Paul or his order").
Negotiable. This is called a paper order.
Hypo: I promise to pay bearer (or "to the order of bearer" or "to Paul or bearer").
Negotiable; bearer paper.
Hypo: Pay to the order of cash (or payable to cash);
Negotiable; bearer paper.
Hypo: Pay to the order of a bowl of soup (or a keg of nails or Happy Birthday).
Negotiable; bearer paper when it otherwise indicates that it is not payable to an identified person (like cash).
THE REQUIREMENTS FOR A NEGOTIABLE INSTRUMENT: to order or to bearer: EXCEPTION
NOTE THIS IMPORTANT EXCEPTION: a check need not contain words of negotiability. A check payable "Pay John Doe" is fully negotiable, and is covered by Article 3, and a transferee of it can become a holder in due course.
- Notes must have language though.
NEGOTIABILITY (OR NOT) BY DECLARATION
A writing cannot be made a negotiable instrument w/in Article 3 by contract or conduct of the parties.
1. Ex: if a writing contains a conditional promise, a statement that "This Note is Negotiable" would not be effective to make this writing a negotiable instrument.

2. Parties can use a form that is a negotiable instrument and avoid negotiability by declaring, on the instrument, that it is "NOT NEGOTIABLE" except for a check. A declaration on a check that is not negotiable is ineffective.
NEGOTIATION: Assignment Distinguished from Negotiation: Assignment
Assignment: A payee who has been issued a negotiable instrument can simply assign it to a third party. The third party is then an assignee, and has no greater rights than the assignor does on the instrument. Any defenses that could be raised against the payee also could be raised against the assignee.
NEGOTIATION: Assignment Distinguished from Negotiation: Negotiation
Negotiation: But if the payee NEGOTIATES the instrument to a third party, then that third party is not a mere assignee, but is a HOLDER. If the holder gives value, in good faith, w/ no notice, then the holder is a HOLDER IN DUE COURSE, who takes free of most defenses that could have been raised against the payee.

- Negotiation is the customary way of transferring an instrument.
How Does One Negotiate an Instrument?
Depends on whether it is bearer paper or order paper.
How Does One Negotiate an Instrument? - Order paper
ORDER PAPER IS NEGOTIATED BY TRANSFER OF POSSESSION PLUS INDORSEMENT BY THE HOLDER (THE IDENTIFIED PERSON TO WHOM THE INSTRUMENT IS PAYABLE).
Transfer of possession
May be voluntary or involuntary.
Endorsement: 2 types
1. Special endorsement;
2. Blank endorsement.
Special endorsement:
Special Endorsement: specifies the person to whom the instrument is payable. Usually we don't do that. (Ex: payable to Kroger grocery stores).
Blank endorsement:
Blank Endorsement: Does not specify the person to whom the instrument is payable; generally consists of a mere signature. (Signing our name).
How Does One Negotiate an Instrument? - Bearer paper
BEARER PAPER MAY BE NEGOTIATED BY TRANSFER OF POSSESSION ALONE. (May not be a holder, but can transfer to someone → holder).
Don Drawer issues a check (order paper) to Peter Payee. Payee wants to negotiate the check to Publix. Payee must deliver the check to Publix, but must first endorse it. Assume that Payee signs, "Pay to Publix, Peter Payee" on the back of the check. What type of endorsement is this?
Special endorsement.
After this endorsement, is the check order paper or bearer paper?
Order paper (after special endorsement → stayed order paper).
Publix wishes to further negotiate the check to Heinz, what must Publix do?
Transfer of possession, but you have to endorse it first.
Assume that Publix simply signs the check "Publix" beneath the previous endorsement. What type of endorsement is this?
Blank endorsement.
After this endorsement, is the check order paper or bearer paper?
Now, it is bearer paper. Special endorsement order paper, after blank endorsement → bearer paper.
If Heinz wishes to further negotiate this check to Ken Ketchup, what must Heinz do?
A lot of times, person will make you endorse it. Transfer it, and probably endorse it.
Assume that Heinz signs the check, "Pay to Ken Ketchup, Heinz" beneath the previous endorsements. After this endorsement, is the check order paper or bearer paper?
Special endorsement → turns it back into order paper.
How Does One Negotiate an Instrument? Bottom line.
Bottom Line: once parties start indorsing, you need to look at the LAST ENDORSEMENT to determine whether the instrument is order paper or bearer paper.
Order Paper or Bearer Paper → So what? Bearer paper.
Bearer paper: remember that bearer paper can be negotiated by a transfer of possession alone, and that this transfer can be voluntary or involuntary. (Don't need any endorsements).
Thief steals the paycheck that had been issued to Peter Payee by his employer. Peter had endorsed the check "Peter Payee" before it was stolen. Was the check order paper when it was stolen?
Bearer paper b/c of blank endorsement.
Is Thief a "holder' of this check?
Yes. Involuntary transfer of possession makes it negotiated to thief (but not a HDC → no good faith).
Can Thief negotiate this check?
Yes. Bearer paper. Can negotiate to a HDC.
Order Paper or Bearer Paper → So what? Order paper.
Order paper: order paper can be negotiated only by transfer of possession PLUS an endorsement by the holder. To be a holder of order paper, it must be issued to him, or properly endorsed to him.
Thief steals a paycheck that had been issued to Paul Payee by his employer. The check had not been endorsed when it was stolen. Was the check order paper or bearer paper when it was stolen?
Generally, checks start out as order paper.
Is Thief a holder of this check?
Holder, but it must be either issued to you or endorsed to you.
Can Thief negotiate this check?
Need transfer of possession and endorsed by holder. Thief is not a holder → can't negotiate.
Assume that Thief forges Payee's name and delivers the check to Publix. Has the check been "negotiated" to Publix so as to make Publix a "holder" and possibly a HDC?
No. It must be negotiated by a holder.
Order Paper or Bearer Paper → So what? -Bottom line
Another bottom line: When order paper contains a forged endorsement, none of the parties from the forger on are holders—none have good title—none are entitled to the money. In fact, they all have converted the check. The drawee cannot properly pay any one of them. The drawee can only pay a holder—someone w/ good title to the check.
- NOTE: while most endorsements are unqualified, a party can endorse an instrument "w/o recourse". This is irrelevant to negotiation, though it does negate contractual liability.
Order Paper or Bearer Paper → So what? -Different rule for banks
Different rule for banks: ordinarily, order paper must be transferred and endorsed in order to make the transferee a "holder". But a depository bank (a bank in which an item is first deposited) that takes an unendorsed instrument for collection becomes a holder of the instrument if the customer was a holder at the time of delivery, even if the customer has note endorsed the instrument.
- Ex: Payee receives a check from Drawer and deposits the check in his checking account at Bank. Payee forgets to endorse the check, but Bank takes it for deposit anyway. Even w/o the endorsement, Bank is a "holder" of the check.
Holder in due course- generally
GENERALLY: A holder in due course is (1) a holder; (2) who gives value; (3) in good faith; (4) w/o notice.
Holder in due course: holder
HOLDER: a holder is in possession of bearer paper or in possession of order paper that has been issued or properly endorsed to him.
Holder in due course: value
VALUE: look for EXECUTED CONSIDERATION. A party is a HDC to the extent that the agreed consideration has been performed. A mere promise to give value is not enough. A party that hasn't actually given value yet does not need HDC protection. If a promise is executory, a holder who learns of a defense or claim can normally avoid her loss by refusing to carry out her promise.
Hypo: Maker issues a $20,000 note to Payee payable in 1 year. Payee doesn't want to wait for 1 year, and discounts (negotiates it for less than face value) the note to Holder for $18,000. Assuming good faith and no notice, b/c 100% of the agreed consideration has been performed, Holder is a HDC as to 100% of the face amount of the note $20,000. What if Holder pays Payee $9,000 now and promises to pay $9,000 later?
Only 50% of the agreed consideration has been performed. So Holder is a HDC as to 50% of the face amount of the note -- $10,000.
What if Holder pays $9,000 now, learns of a defense, then pays the other $9,000?
Only 50% of the agreed consideration has been performed when Holder learned of the defense. So Holder is a HDC as to 50% of the face amount of the note -- $10,000.
What if Holder pays $9,000 case, and also gives Payee a note for $9,000?
Giving a negotiable instrument is giving value (the payee might negotiate the note to a HDC). So Holder is a HDC as to the face amount of the note—20,000 [same as if gave $18,000 cash].
When else does a holder give value for an instrument?
A holder also gives value for an instrument when he takes it in payment of or as security for an antecedent claim, or when he makes an irrevocable commitment to a third person.
Hypo: On January 1, 2010, Mary borrowed $1,000 from Lois, orally promising to pay the money back by June 1, 2010. On June 1, Mary was unable to pay the $1,000, but negotiated to Lois a note she had received from Charles. What has Lois done?
Lois has given value for the note.
Holder in due course: value: bank deposits
Bank deposits: a bank does not become a holder "for value" merely by crediting a depositor's account. The bank does not need holder in due course protection b/c the bank can take back the credit from the customer's account if the check is dishonored. If, however, the customer is permitted to draw against a deposited item, the bank immediately becomes a holder for value to the extent of the w/drawal. When a bank credits a depositor w/ a series of deposits and permits a number of w/drawals over a period of time, it may be difficult to determine whether the depositor has been permitted to w/draw funds credited on the basis of a particular item before the bank learns of a claim or defense on that item. In tracing the deposits to w/drawals, the "first in, first out" or "FIFO" rules is used.
Hypo: i. Payee receives a $1000 check from Drawer and deposits the check into his checking account w/ Bank. At the time of the deposit, the account already has $500 in it. The next day, Payee w/draws $500 from the account. What is the bank? What would change the result?
Bank is NOT a HDC. Payee is presumed to have w/drawn her own money (the $500 in the account before the deposit). If Payee had w/drawn $750 instead of $500, Bank would be a HDC as to $250.
Holder in due course: good faith
GOOD FAITH: Honesty in fact and the observance of reasonable commercial standards of fair dealing. (When a business person).
Holder in due course: good faith: honesty in fact:
The HONESTY IN FACT component of good faith is SUBJECTIVE (sometimes called the "white heart-empty head" test).
Holder in due course: good faith: fair dealing:
The FAIR DEALING component of good faith is OBJECTIVE. It is concerned w/ the fairness of conduct (NOT w/ the care w/ which an act is performed). A business person engaged in a commercial transaction, to be a HDC, must show (in addition to "honesty in fact") that his actions meet the generally accepted standards current in his business, trade, or profession.
Holder in due course: no notice
An HDC must take the instrument w/o notice (which includes actual knowledge and reason to know (objective)) that:
1. The instrument is so irregular or incomplete as to call into question its authenticity;
2. The instrument is overdue or has been dishonored;
3. The instrument contains an unauthorized signature or has been altered;
4. There is a claim to the instrument;
5. Any party has a defense or a claim in recoupment (a claim that reduces the amount payable) on the instrument.
Shunk wrote a check on January 2, 2010, but mistakenly wrote down "2009" as the year. He noticed his error, crossed out the "2009" and wrote "2010" above it. Can anyone be a HDC of the check?
Yes. A minor erasure or change would not excite the interest of a reasonable person.
Maker made a note payable to Payee for $1000. Before the note was delivered, the parties agreed to change the amount of the note from $1000 to $1500, and crudely accomplished this result by striking over the $1000 and writing $1500 above it. Payee discounted the note at his bank. Subsequently, Maker found that Payee had fraudulently induced him to issue the note by misrepresenting certain facts about the underlying business transaction. Can bank be HDC of this instrument? (Here the defense has no relationship to the irregularity).
Current law: bank is not a holder. Defense doesn't have to have a relationship to the irregularity.
Holder in due course: what effect does knowledge of a default in the interest payment or principal amount have?
Knowledge of a default in an interest payment is harmless—knowledge of any part of the principal amount being overdue deprives one of HDC statute.
- Ex: Friendly Finance was the payee of a promissory note signed by Mary Maker. The note called for Mary to make 24 monthly interest payments before the note matures. Friendly discounted the note w/ Big Bank. When it was discounted to Big Bank, the note had written on it in large letters the notation "Missed Paying First Installment" (has been dishonored). Big Bank may still be an HDC.
Donna Drawer wrote a check on January 10 to Peter Painter, a house painter, for $500 for services rendered. Peter endorsed the check over to Herb's Paint Shop on June 5, and it was dishonored on June 8, when the drawee bank informed Herb that Drawer had stopped payment on the check b/c she was unhappy w/ Painter's work. Is Herb's Paint Shop a HDC?
A check becomes overdue 90 days after its date.
Able purchased some equipment for his business from Baker Equipment, and executed a note payable to Baker for $3000. Baker discounted the note to Corleone Finance Company for $100. Is Corleone Finance Company a HDC?
Probably not. When you have a huge discount like this, courts ask, how could you have taken w/o notice.
Close-connectedness doctrine:
Close-connectedness doctrine: the more that the holder knows about the underlying transaction, and particularly when it controls or becomes involved in it, the less likely it is a good faith purchaser w/o notice. (You and banker are so closely connected, any defenses asserted against banker, should be asserted against you.
Hypo: Able purchased some equipment for his business from Baker Equipment, and executed a note payable to Baker for $3000. Baker discounted the note to Corleone Finance Company for $2700. Assume Corleone Finance Company supplied Baker w/ all forms, established financing charges, investigated each customer, and reserved the right to reject any note. What is Corleone Finance Co?
Corleone Finance Company likely is not a HDC.
Holder in due course: what is the effect if a holder has knowledge that a fiduciary had negotiated the instrument in payment of or as security for the fiduciary's own debt or in any transaction for the fiduciary's own benefit or has otherwise breached his duty?
The holder has notice of the claim.
Ex: The treasurer of Acme Corporation takes a check that was made payable to Acme Corporation, endorses the check and negotiates the check to her bank in payment of a personal debt that the treasurer owes to her bank. The bank would have notice of a claim that would not be a HDC.
- Why would treasurer take a check payable to company and use it to pay personal debt?
Notice.
Holder in due course: vi. TRANSACTIONS PRECLUDING HDC STATUS:
TRANSACTIONS PRECLUDING HDC STATUS: A holder does not become a HDC of an instrument taken by: (1) legal process or by purchase in an execution, bankruptcy, or creditor's sale or similar proceeding; (2) purchase as part of a bulk transaction not in the ordinary course of business of the transferor; or (3) as the successor in interest to an estate or other organization.
Maker is fraudulently induced to issue a note to Payee. Payee negotiates the note to Harold, a HDC. Harold then endorses the note and gives it to his son Carl as a graduation present. When Carl demands payment from Maker, Maker raises fraud as a defense. A HDC takes free of the defense of fraud in the inducement. Does Carl take free of the fraud defense?
The shelter rule:
1. Carl is a holder, took in good faith w/ no notice, but it was a gift - not value given.
2. Not a HDC.
3. Even though no HDC, Carl took from Harold who was a HDC, Carl takes shelter in Harold's right and has the rights of an HDC.
4. If take from HDC → has rights of HDC, UNLESS holder participated in fraud.
Holder in due course: the FTC rule:
The rule basically provides that every consumer credit K contain a notice that any holder or assignee is subject to all claims and defenses that the debtor could assert against the seller of the goods or services covered by the K.
1. The rule also applies to direct lender loans made to a consumer where the creditor is "affiliated" w/ the seller (by common control, etc.), or where the creditor has had consumers "referred" to it by the seller on a regular basis. Any consumer K covered by such "purchase money" loans must contain the FTC notice provision.
- NOTE: such a clause does not make the note "conditional." It is still a negotiable instrument and article 3 applies. But there can be no HDC of the instrument.

2. Does away w/ HDC doctrine in consumer K.
Real defenses:
Can be raised, even against a HDC.
i. While a HDC takes free of personal defenses and claims, she takes subject to "real defenses." These real defenses are listed in the UCC as follows:
1. INFANCY, to the extent that it is a defense to a simple K;
2. Such other INCAPACITY, or DURESS, or ILLEGALITY of the transaction, as renders the obligation of the party to a nullity;
3. Such MISREPRESENTATIONS as has induced the party to sign the instrument w/ neither knowledge nor reasonable opportunity to obtain knowledge of its character or its essential terms;
4. Discharge in insolvency proceedings;
5. Any other discharge of which the holder has notice when he takes the instrument.
Hypo: Myrna Minor looked much older than her actual age (15). Minor purchased a motorcycle at City Cycle, and signed a promissory note for $2,000 payable to the order of the City Cycle. City Cycle was unaware of Minor's age. City Cycle then discounted the note w/ Big Bank for $1800. When the first payment came due, Minor refused to pay, saying that she was disaffirming the K and wished to return the motorcycle. Must Minor pay the bank?
So long as state law permits her to disaffirm, minor does not need to pay. Even against a HDC. Make sure there is no ratification of the K.
Hypo: When Barry Builder filed for bankruptcy, he listed among his debts a loan he had taken from First Bank, which was evidenced by a promissory note that he had signed. As a result of the bankruptcy proceeding, the judge ordered that Builder be discharged from all his scheduled debts. A year later, the note surfaced in the possession of Second Bank, which claimed to be a HDC. Must Builder pay Second Bank?
No discharge in bankruptcy is a real defense. Can be raised, even against a HDC.
Hypo: Bank was unwilling to lend Able money w/o a co-signor who owned property in the county. Able approached Baker, whom Able supervised at work. Baker was "a little slow," had little education and virtually no ability to read. Able told Baker that he needed someone to attest to his good character, and displayed a paper which he said contained a statement that he, Able, was of good character and could be depended upon to repay the loan. In fact, this paper was a promissory note. Baker signed the paper w/o even attempting to read it. If Baker is sued on the note by a HDC, can Baker raise the defense that he was tricked and did not realize what he was signing?
- Fraud in the inducement (a personal defense):
1. A personal defense that cannot be raised against HDC.
2. Person is aware of character and essential terms, but induced to sign b/c of deception as of some other matter.

- Fraud in the factum (fraud in the execution) (a real defense):
1. Can be raised.
2. Person is induced to sign by deception w/ respect to the writings, character, or terms.
3. Must also be excusable terms (tough standard).
Hypo: Mary borrowed some money from her friend, Betty, and issued a promissory note to Betty for $1000. The note was dated July 1, 2009 and was due on January 1, 2010. On December 20, 2009, Mary mailed a check to Betty for the full amount of the loan plus interest. On an enclosed car, Mary asked that the note be returned, "Whenever Betty could get to it." Betty spent the proceeds of the check, and on Christmas Day, negotiated Mary's note to Edgar, in payment for obligations owed to him. On January 1, 2010, Edgar demanded payment from Mary. Did Mary's payment to Betty discharge her on the note, even if Edgar is an HDC?
1. No. Discharge by payment is a personal defense. Not affected if note gets into hands of HDC.
2. Lesson: get the note back and stamp it.
Nature of liability: the underlying obligation
The Underlying Obligation: Generally, once an instrument is offered and accepted in satisfaction of an underlying obligation, the obligation merges w/ the instrument, and the underlying obligation is SUSPENDED. Payment of the instrument discharges the instrument and the underlying obligation. If the instrument is dishonored, the party issuing the instrument is liable on the instrument and on the underlying obligation (only 1 recovery).
Hypo: Mike is 4 months past due on his rent. Mike gives his landlord a $2000 note to cover this past due rent, the note being payable in 6 months. Landlord agrees to accept the note, and places it in a safe in his home. Landlord then brings suit against Mike for non-payment of rent (can't do that). When landlord accepted the note as payment, this suspended the landlord's right to sue on the underlying obligation. Assume that then note comes due, and Mike makes payment on it. What happens to the underlying obligation?
When the note is paid, the note is discharged along w/ the underlying obligation.
Assume that when the note comes due, Mike fails to make payment on it. May the landlord now sue on the underlying obligation?
If note is dishonored, landlord can sue on note or underlying obligation (can only recover once though).
NATURE OF LIABILITY: The Underlying Obligation: NOTE
Note that the underlying obligation is discharged if the instrument given is a cashier's check (same bank is both drawer and drawee), or a teller's check (bank is drawer and different bank is drawee), or a certified check (a check "accepted" by the bank on which it is drawn). If the party endorses the instrument and so becomes obligated on it, the underlying obligation is still discharged, but a right of recourse on the instrument against the party is preserved.
-It's almost like cash, Underlying obligation is not just suspended, it is discharged.
Nature of liability: maker's contract liability
Maker's contract liability: the maker is obligated to pay the instrument according to its terms at the time it was issued. If there is more than one maker, the makers are jointly and severally liable on the instrument.
Hypo: A, B, and C al sign as makers of a $6000 note payable to Bank. When the note matured, Bank sued only A, demanding the entire amount. May A defend on the basis that Bank should have sued all three of them?
No. Unless otherwise specified, J & S liable.
Hypo: If Bank wins, can A recover from B and/or C? If so, how much from each?
Yes. A can get contribution. 1/3 from each of them. $2000 from B, $2000 from C.
Nature of contract liability: endorser's contract liability
Endorser's contract liability: Obligated to pay according to the terms of the instrument at the time of the endorsement. Those signing later in time can get complete reimbursement from those signing prior in time.
Hypo: Drawer issued a $900 check to A, who then endorsed it to B, who then endorsed it to C, who then endorsed it to Store. Store presented the check to Drawee Bank, which dishonored it. Store gave appropriate notice of dishoner to all parties to the instrument. Store demands payment of the $900 from C alone. C claims that he is liable, at most, for only 1/3 of the amount ($900). Is C correct?
No. C is liable for the entire amount. When signing, you obligate yourself.
Hypo: Could store "skip over" C and recover the $900 from B? From A?
Yes, you can recover from any one of them.
Hypo: Assume that Store recovers the $900 from C. May C recover the $900 from B? From A?
If C has to pay, can get it from A or B, as long as they endorsed ahead of him.
Hypo: Assume that Store recovers $900 from C, and C recovers the $900 from A. Can A recover from B? From Drawer?
1. A cannot recover from those that signed after him (B).
2. A can recover from drawer.
Nature of contract liability: endorser's liability: exception
EXCEPTION: where the parties have made an "anomalous" endorsement (one made by a non-holder, i.e., surety), the endorsers are jointly and severally liable.
Hypo: Corporation wishes to borrow $20,000 from Bank. Bank says that it will make the loan, but only if Adam, Bob, Carl (3 corporate officers) sign the note along w/ Corporate (they would be signing to "accommodate" Corporation). Corporation is the maker of the note, and then Adam, Bob, and Carl (in that order) sign as endorsers. When the note comes due and it is presented to Corporation for payment, Corporation dishonors it. Notice of dishonor is given to each of the endorsers. A, B, and C are jointly and severally liable. Who must endorse first?
Doesn't matter who endorses first. Helping maker out.
Who is liable when the instrument is made payable to joint payees and both payees endorse? Who must endorse first?
When an instrument is made payable to joint payees (e.g., H and W) and both payees endorse, they are jointly and severally liable.
- Doesn't matter who endorses first.
NOTE: What liability does an endorser have?
NOTE: an endorser is "secondarily" liable. An endorser is liable only after the instrument has been PRESENTED to the maker (if a note) or the drawee (if a check), that party has dishonored the instrument, and a NOTICE OF DISHONOR has been given to the endorser.
- Must present w/in 30 days after you made the endorsement.
- If bounces, must notify quickly.
W/ respect to the liability of an endorser, when is presentment due?
W/ respect to the liability of an endorser, PRESENTMENT is due w/in a reasonable time after such party becomes liable thereon. A reasonable time is determined by the nature of the instrument, any usage of banking or trade and the facts of the particular case.
- NOTE: in the case of a check, an endorser is discharged unless the check is presented for payment or given to a depository bank for collection w/ 30 days after the day the endorsement was made.
Endorser's contract liability: notice of dishonor.
Notice of dishonor: w/ respect to a check must be given by a bank before its "midnight deadline" (midnight of the next banking day following the banking day on which the bank received notice), and by any other person, w/in 30 days following the day on which she herself received notice. W/ respect to any other instrument, notice of dishonor must be given w/in 30 days following the day on which dishonor occurs.
If presentment and notice of dishonor are either not made or are delayed beyond the time when due, what happens to endorser liability?
If presentment and notice of dishonor are either not made or are delayed beyond the time when due, an endorser is excused from contractual liability on the instrument.
Hypo: Drawer issues a check to Payee on March 1. On March 3, Payee endorses the check to Holder. Holder presents the check to Drawee Bank for payment on June 25, and the check is dishonored for insufficient funds. What is Payee's liability?
Payee would be excused on his endorsement contract.
Promissory notes contain a clause providing that all parties to the instrument waive presentment and notice of dishonor:
NOTE: most promissory notes contain a clause providing that all parties to the instrument waive presentment and notice of dishonor. Such waiver is permissible. In additional, presentment and notice of dishonor may be delayed or even entirely excused under certain circumstances (e.g., presentment will be excused where the maker has repudiated the obligation or is dead or insolvent, or cannot be found w/ reasonable diligence, or the drawer has instructed the drawee not to pay; delay in giving notice of dishonor is excused if the delay was caused by circumstances beyond the control of the person giving notice, and the party exercised reasonable diligence after the cause of the delay ceased to exist).
- If delay in presentment is understandable → likely excused from timely notification.
Endorser's contract liability: qualified endorsement:
Qualified endorsement: Dan Drawer issues a check to the order of Peter Payee, who endorses the check "Peter Payee, w/o recourse" and negotiates the check to Harry Holder.
- If the check is dishonored and appropriate notice is given, Payee is not liable as an endorser.
Drawer's contract liability:
Drawer's contract liability: the drawer is obligated to pay the draft according to its terms when the drawer signed the instrument. Like the endorser, a drawer is "secondarily" liable. The drawer is liable after presentment and dishonor. W/ respect to the liability of a drawer, a check must be presented to the drawee for payment, or be given to a depository bank for collection w/in 30 days after the date of the instrument.
Drawer's contract liability: NOTE
Note: unlike the endorser, a drawer is excused from contractual liability on the instrument due to delay in presentment ONLY in the unlikely event that the drawee bank has become insolvent during the delay and there is no insurance to cover the loss.
Hypo: Drawer isses a check to Payee on March 1. Payee places the check on his desk and forgets about it for several months. On June 1, Payee comes upon the check, and the next day presents it to Drawee Bank. The check is dishonored for insufficient funds. May Payee successfully sue Drawer on his drawer's contract?
Yes. Unless drawee's bank becomes insolvent and no insurance → still have to pay. Drawees get off. Drawers don't get off.
Is a drawer generally entitled to a notice of dishonor?
NOTE: a drawer generally is not entitled to notice of dishonor. A drawer will or should know of the dishonor on her own b/c of her relationship w/ the drawee.
Drawee's contract liability: Drawer issues a check to Payee. When Payee presents the check to Drawee Bank, it is wrongfully dishonored due to a computer foul-up (assumer there was, in fact, enough in the account to cover the check). By the time the Payee can locate Drawer to give notice of dishonor, Drawer has skipped town having closed his bank account. Can Payee recover from Drawee Bank?
No. Drawee is not liable on the instrument. Drawee never signed it.
Would your answer be the same if it had been a certified check?
Drawee is liable as an acceptor. Whatever amount in on check, liable for that amount. Bank certifies that amount → liable for it.
ACCOMMODATION PARTIES (co-signor): generally
An accommodation party is one who signs the instrument in any capacity for the purpose of lending his name to another party to it. The accommodation party is liable in the capacity in which he signed.
Hypo: Steve needs some new equipment for his business, but, unfortunately, Steve has a rather "spotty" credit record. Steve finds the equipment that he needs, but the seller, Reliable Equipment, refuses to extend credit to Steve alone. Therefore, Steve calls his rich doctor friend Norman, who signs a promissory note "to help Steve out." Both Steve and Norman sign as makers of the note. The note is payable in 60 equal installments. Reliable also requires that Steve put up some stock that he owns as collateral. Assume that, after the 15th installment, Steve can no longer pay. Who may Reliable recover from?
Reliable may recover from Norman, as Norman is liable as a maker.
Hypo: Assume that Steve does not pay (assume he has no defense—he simply doesn't have the money) and Norman therefore pays. Can Norman recover from anyone?
Norman can get complete reimbursement (not just contribution) from Steve (not simply contribution like an ordinary co-maker).
Hypo: Suppose that Reliable sues Steve and Steve does not pay the note. What can Steve do?
Steve may NOT sue Norman for contribution. The accommodation party is not liable to the party accommodated.
Hypo: Assume that Steve is having difficulty making payments to Reliable and is able to persuade Reliable to grant him a 6-month extension. Assume this is done w/o the knowledge or consent of Norman. What is Norman's liability?
This extension w/o Norman's consent discharges Norman to the extent that Norman can prove that the extension caused him some loss.
Hypo: Assume that Reliable gives Steve permission to sell off some of the stock that he had used as collateral. Assume that this is done w/o the knowledge or consent of Norman. WHat is Norman's liability?
This release of the collateral w/o Norman's consent discharges Norman to the extent that Norman can prove that the release of collateral caused him some loss. Put B on accommodation party to show harm.
Hypo: Assume that the equipment that Steve purchased turns out to be defective, and Steve refuses to make any further payments. What happens if Reliable sues Norman?
If Reliable sues Norman, Norman may defend on a breach of warranty basis. Norman can raise any defenses that Steve could raise EXPECT insolvency, infancy, and lack of legal capacity.
ACCOMMODATION PARTIES (co-signor): collection guaranteed- generally
Collection guaranteed: or equivalent language means that the signor agrees that she will be liable on the instrument ONLY IF (1) execution of judgment against the other party has been returned unsatisfied; (2) the other party is insolvent or in insolvency proceedings; (3) the other party cannot be served w/ process; or (4) it is otherwise apparent that payment cannot be obtained from the other party.
Hypo: Jane Doe is the president of Software Corp. Jane signed a promissory note "Software Corporation." Assume that Jane had authority (express or implied) to sign the note on behalf of Software Corp. Is Software Corp liable on the instrument?
Yes. As long as she was authorized, she was liable.
Hypo: Is Jane Doe personally liable?
No. She made it clear she was signing on behalf of Corp.
Hypo: Assume that Jane signs the note "Software Corp, by Jane Doe, President." Is Software Corp liable on the instrument?
Yes. As long as she was authorized, software is liable.
Hypo: Is Jane Doe personally liable?
No. She made it clear.
Hypo: Assume that Jane signs the note "Jane Doe, President." Is Software Corp liable on the instrument?
Yes. As long as she was authorized, software is liable.
Hypo: Is Jane Doe personally liable? Is parol evidence admissible to clear up the liability of Doe?
Yes. You can bring in parol evidence, except for a HDC that takes w/o notice.
Assume that Jane simply signs the note "Jane Doe." Is Software Corp liable on the instrument?
Yes, if she was authorized, the company is liable.
Is Jane Doe personally liable? Is parol evidence admissible to clear up the liability of Doe?
Party instrument w/ this signature might be HDC w/o notice → can't bring in parol evidence.
Can an agent w/ authority who signs her name to a principal's check be held liable on the check if it is drawn on the principal's account and indicates the identity of the principal?
An agent w/ authority who signs her name to a principal's check cannot be held liable on the check if it is drawn on the principal's account and indicates the identity of the principal. It does not matter whether the agent indicates her representative capacity.
Not personally liable.
BANKS AND THEIR CUSTOMERS→ THE CHECKING ACCOUNT: the properly payable rule
The "Properly Payable" Rule: the bank may pay out the customer's money ONLY if it follows the customer's orders exactly. If it does not do so, it must recredit the account.
BANKS AND THEIR CUSTOMERS→ THE CHECKING ACCOUNT: forged drawer's signature
Forged Drawer's Signature: Thief steals Sheldon's checkbook. A month later Sheldon's bank returned his canceled checks, including one payable to Toys-R-Us for $200, to which Sheldon's name was forged as drawer. Sheldon promptly notified his bank. Is the check properly payable?
1. Assuming no negligence, not properly payable.
2. Sheldon never authorized the bank to pay.
Hypo: Harry Homeowner issued a check for $100 to Gary Gardener for some yardwork that Gary had done. Gary's friend, Tony Thief, stole the check from Gary. Thief then forged Gary's endorsement on the back of the check and presented the check to Drawee Bank for payment. Drawee Bank paid the check, and Homeowner is demanding that his account be recredited. Was the check properly payable?
When order paper is stolen, no one from thief on is a holder. None had good title. None entitled to $.
Hypo: Harry Homeowner issued a check for $100 to Gary Gardener for some yardwork that Gary had done. Gary endorsed the check. Gary's friend, Tony Thief, stole the check from Gary. Thief then presented the check to Drawee Bank for payment. Drawee Bank paid the check, and Homeowner is demanding that his account be recredited. Was the check properly payable?
Bearer paper. When thief stole it, thief is a holder. Properly payable.
Hypo: B issued a check to H and W jointly. H endorsed the check and also forged W's endorsement. Drawee Bank paid the check and charged B's account for the amount of the item. W never got a dime of the payment. Must Drawee Bank recredit B's account?
If issued to H and W, need both endorsements. If one was forged, then not properly payable.
Hypo: B issued a check payable to H or W (or H and/or W). H endorsed the check and also forged W's endorsement. Drawee Bank paid the check and charged B's account for the amount of the item. W never got a dime of the payment. Must Drawee Bank recredit B's account?
Just need 1 endorsement. Had it when H signed it.
Hypo: Check is payable to H and W, except H did not forge W's endorsement. The check carried only H's endorsement. Drawee Bank paid the check even though W's endorsement was missing. Was the check properly payable?
No. Need both endorsements.
Hypo: Bob issued a $50 check to Sam, who skillfully raised the amount to $500. Sam presented the check to Drawee Bank, which paid Sam $500. To what extent, if any, can Drawee Bank properly charge Bob's account?
Only properly payable as to $50. Only authorized to pay $50. Assuming no negligence.
Hypo: B issued a check to S, leaving the amount blank. S was authorized to complete the check in an amount not to exceed $100. S filled in the amount of $300 and presented the check to Drawee Bank, which paid S $300. To what extent, if any, can Drawee Bank charge B's account?
$300. If you leave it black, whatever amount filled in is properly payable.
Hypo: A check that Sally had written and dated 2 years earlier was presented and paid against her account, creating an overdraft. Sally argues that the check was not properly payable b/c it was so old, and b/c it created an overdraft. Is Sally correct?
1. A check is "stale" after 6 months. The bank is not obligated to pay, but it may (so long as payment is made "in good faith").
2. The bank Is not obligated to pay if it creates an overdraft (unless the customer has overdraft protection), but it may pay if it chooses to pay. Even if 1 penny short.
Hypo: On May 1, Drawer issued a check to Payee, dating the check May 15 (the check was postdated). Payee presented the check on May 3, and drawee bank paid. Drawer argues that payment could not properly be made from his account until May 15, the date of the check. Is drawer correct?
Not properly payable if customer gives notice to bank of post dating, describing the check w/ reasonable certainty.
BANKS AND THEIR CUSTOMERS→ THE CHECKING ACCOUNT: wrongful dishonor
Wrongful dishonor: a bank is liable to its customer for damages caused by the wrongful dishonor of an item. Liability is limited to actual damages proved and may include damages for arrest or prosecution or other consequential damages.
BANKS AND THEIR CUSTOMERS→ THE CHECKING ACCOUNT: Death or Incompetence of Customer
The death or incompetence of a customer does not revoke the bank's authority to pay a check until the bank knows of the death or adjudication of incompetence and has had a reasonable opportunity to act on it. Even w/ such knowledge, the bank may for 10 days after the date of death keep paying checks, unless a person claiming an interest in the account orders that payment be stopped.
- Can still honor for up to 10 days or stop paying immediately.
Hypo: Ned Nudnik was tricked by Sam Slick into buying a $150 freezer for $600. Nudnik paid Sam by check and took the freezer home in his pick-up truck. A soon as he arrived home, his neighbor, Ward Cleaver, told Nudnik that he had been "ripped off". Ned immediately called his bank, and told the bank clerk: "This is Ned Nudnik. Do not honor the check that I gave to Sam Slick this morning. He is a crook. He sold me a cheap freezer, and I paid too much." Nudnik then hung up. The next day Sam presented the check for payment, and the bank paid. Nudnik is now demanding that the bank recredit his account. Bank argues that the stop payment order did not give enough information to be effective. Is this correct?
1. The stop payment order must describe the item "w/ reasonable certainty;" a reasonably prudent banker w/ that information should be able to find the check. (Ck #, payee, amount).
2. The stop payment order must be received a time and in a manner that affords the bank a reasonable opportunity to act on it.
How long is a stop payment order effective for?
A stop payment order is effective for 6 months, but it lapses after 14 calendar if the original order was oral and was not confirmed in writing w/in this period.
May the bank contract out of liability for negligently failing to honor a valid stop payment order?
The bank may not K out of liability for negligently failing to honor a valid stop payment order.
Who has the burden of establishing the fact and amount of loss resulting from the payment over a valid stop payment order?
The burden of establishing the fact and amount of loss resulting from the payment over a valid stop payment order is on the customer.
Hypo: Goniff fraudulently induced Nebbish to issue him a check. Goniff then negotiated the check to Harold, a HDC. Meanwhile, Nebbish gave a valid stop payment order to his bank. When Harold presented the check for payment, Nebbish's bank mistakenly paid it. Nebbish is demanding that his account be recredited. Must his bank recredit his account?
Bank will argue that yes, we screwed up, but we can't pay you b/c you can't show any loss b/c you would have to HDC anyways.
FORGERY AND BANK RECOVERY (this is why warranty stuff is important): Forged Endorsement: Remember:
Remember: the forgery of the payee's name (or of a special endorsee's name) means that no valid negotiation takes place, and so no one taking the instrument thereafter can qualify as a holder. The payee has several different possible courses of action whenever a check that has been delivered to him is stolen, his name is forged thereon, and the instrument is paid by the Drawee Bank (also called the Payor Bank).
a. Payee received his weekly paycheck of $200 from Drawer. Shortly thereafter, Thief broke into Payees home and stole the check. Thief forged Payee's endorsement and cashed the check at Brown's, a local liquor store. Brown's endorsed the check and deposited it in its account at Depositary Bank, which then endorsed the check and presented it to Drawee Bank which made payment. What may payee recover? Who may payee sue?
1. Payee may recover the $200 from Drawer. Drawer will then demand that Drawee Bank recredit its account b/c the check was not properly payable (b/c of the forged endorsement).
2. The payee can sue Drawee Bank, or anyone taking the check after the forgery (Thief, Brown's Depositary Bank), in conversion.
3. NOTE: the payee would have no conversion action if the check had been stolen from the mails before it had been received by Payee.
Hypo: Assume that Payee (suing in conversion) or Drawer (claiming check not properly payable) recovers the $200 from Drawee Bank. Drawee would like to recover the $200 from the party that it paid, but there is a problem.
1. The Drawee cannot recover from a prior party on its contractual liability as an endorser or drawer b/c the check was not dishonored, and b/c the Drawee is not a holder or someone w/ the rights of a holder who has the rights to enforce the instrument.

2. In addition, the Drawee cannot recover from a prior party simply by claiming that the payment was made by mistake.
FORGERY AND BANK RECOVERY: Forged Endorsement: General rule
General rule: payment to a HDC (here b/c of the forged endorsement, payment was made to a non-holder so not a HDC) or to one who in GOOD FAITH changed her position in reliance on the payment is final, so the payor cannot recover payment back from the party paid. The party paid by the Drawee Bank usually will in good faith have changed its position in reliance on the payment.
FORGERY AND BANK RECOVERY: Forged Endorsement: 2 Exceptions to the general rule
Two Exceptions to the General Rule: the payor can recover from the party paid if:
1. That party neither took for value nor in good faith, nor detrimentally relied on payment [which is unlikely], or
2. The party breached a transfer or presentment warranty.
Hypo: Assume that Payee (suing in conversion) or Drawer (claiming check not properly payable) recovers the $200 from Drawee Bank. Drawee would like to recover the $200 from the party that it paid, but there is a problem. When there is a payment over a forged endorsement, what can Drawee Bank recover?
When there is a payment over a forged endorsement, Drawee Bank can recover the $200 from Depository Bank, Brown's and/or Thief b/c each of them has breached its PRESENTMENT WARRANTY.
- Ex: had good title. Every person from thief on → no good title.
Hypo: who warrants to the Drawee Bank that they are "a person entitled to enforce the draft."?
The party presenting the check for payment to the Drawee Bank (in this case Depository Bank) and each of the earlier transferors of the check (Brown's and Thief) warrants to the Drawee Bank that they are "a person entitled to enforce the draft." B/c of the forged endorsement, non of the parties from the forger on had good title to the instrument—none are entitled to enforce the check. Drawee Bank can recover the $200 from any of them for breach of this presentment warranty.
Hypo: Assume that Drawee Bank recovers the $200 from Depository Bank for breach of its presentment warranty. What can depository bank recover?
1. Depository Bank can then recover from Brown's and/or Thief (assuming she can be found) b/c each of them has breached a TRANSFER WARRANTY.
- Ex: warrant you have good title.
2. Each party that transfers an instrument and receives consideration warrants that they are "a person entitled to enforce the instrument" and that "all signatures on the instrument are authentic and genuine." This warranty has been breached by Brown's and by Thief.

3. NOTE: The Drawee Bank does not receive transfer warranties b/c the instrument is presented to the Drawee Bank for payment, not transferred to it. The Drawee Bank may only recover for breach of presentment warranties.
In the end, where does the loss pass?
In the end, then, the loss generally should pass to the earliest solvent person after the forger (or the forger itself in the unusual case in which the forger is solvent and available).
- Liability works its way back down to this.
Hypo: Payee received his weekly paycheck of $200 and immediately made the following endorsement: For deposit only /s/ Peter Payee. Shortly thereafter, Thief broke into Payee's home and stole the check. Thief wrote her own name below that of Payee and cashed the check at Brown's, a local liquor store. Brown's endorsed the check and deposited it in its own account at Depositary Bank, which then endorsed the check and presented it to Drawee Bank, which made payment. Was the check converted by Drawee Bank?
No. The Drawee Bank and any intermediary bank may disregard the restrictive endorsement. (Machines didn't see it).
Case Payee sue anyone for conversion of the check?
1. Yes. Thief, Liquor Store, and Depositary Bank all acted inconsistently w/ restrictive endorsement = conversion.
2. Brown's should have known something didn't look right.
FORGERY AND BANK RECOVERY: Forged Drawer's signature
Forged Drawer's Signature: when a forger forges the drawer's name (as opposed to that of the payee), the law reaches a very different result.
Hypo: Joe Crooks steals one of Daisy Drawer's blank checks and fill sit in, making it payable to the order of "Joe Crooks" for $500, and forges Daisy's name on the drawer's line. Joe writes his own name on the back of the check and takes it to his own bank, Depositary Bank, asking to cash the check for him. Depositary Bank pays Joe $500 and, after stamping its own endorsement under Joe's, presents the check to Drawer Bank. Drawee Bank pays the check.
Daisy demands that Drawee Bank recredit her account. Must drawee bank recredit her account?
Drawee Bank must do so b/c the check was not properly payable.
Hypo: can drawee bank recover the money from anyone?
Drawee Bank probably cannot recover the $500 from anyone. Unlike the situation involving a forged endorsement, Depositary Bank here does have "good title" (though it is good title to a check w/ Joe Crooks as drawer).

1. Drawee Bank takes the risk that the drawer's signature is unauthorized unless a prior party in the chain of collection had knowledge that the drawer's signature was unauthorized (the presentment warranty does not include a warranty that the party "has no knowledge that the signature of the drawer is unauthorized"). It is likely that the forger would be the only one w/ this knowledge (and the forger probably is insolvent or unavailable). This generally leaves the loss on the Drawee Bank.
- Have insurance to cover it; and
- Customer signature card → should have checked.

2. Good title w/ thief as drawer:
- No forged endorsement → good title.
VALIDATION OF THE FORGERY: Ratification:
Ratification: ratification occurs when a party, w/ full knowledge of the forgery (or alteration) accepts the benefits thereof or actively assents to the wrongful activity.
VALIDATION OF THE FORGERY: The imposter rule:
The Imposter Rule: this rule validates the forged endorsement of the payee's name where the maker or drawer has been duped by an imposter to issue the instrument.
Hypo: Upon answering the door, Amy, an animal lover, found a man at her door who said he was Wally Woodall, and that he was seeking contributions so that he could save the endangered species, "the snipe" (which he claimed was around the country). Amy gave the man a check for $100 payable to the order of Wally Woodall. In fact, the man's name was Sam Slick, a con artist. Sam took the check, endorsed it "Wally Woodall," then signed his own name underneath the forged signature. Sam then presented the check to Drawee Bank, which paid for it. Upon discovering that she had been swindled, Amy demanded that her bank recredit her account. Amy argues that the check was not properly payable b/c of the forged instrument. Is Amy correct?
Endorsement is effective. Innocent bank does not have to recredit. Amy takes the hit.
VALIDATION OF THE FORGERY: fictitious payee rule
Fictitious Payee Rule: If the drawer, maker, or other person whose intent determines to whom an instrument is payable does not intend (at the time that the instrument was issued) for the person identified to have any interest in the instrument, or if the person identified in the instrument as the payee is fictitious, then an endorsement in the name of the payee is effective.
- NOTE: if the signature of the issuer of an instrument is made by automated means, such as a check-writing machine, the relevant intent is that of the person who supplied the name of the payee.
Hypo: The treasurer of D Corporation, who is authorized to write checks on the company's account, embezzles funds by drawing 2 checks totaling $50,000. One check is drawn payable to X Corporation, a company w/ which D Corp often does business. The other check is drawn payable to Y Corp, a fictitious company. When these checks are issues, the treasurer does not intend for either of the payees to have any interest in these checks. The treasurer endorses both checks so that it appears that officers of the payee companies signed them. He then chases the checks and disappears w/ the proceeds. The checks are paid and charged to the account of D Corp. D Corp argues that the checks were paid over forged endorsements, and so were not properly payable. It demands that the drawee bank recredit its account. Must drawee bank recredit the account?
General Rule: when not endorsed → not properly payable. But when checks written, employee never intended for X and Y to get $ → endorsements are valid.
VALIDATION OF THE FORGERY: fraudulent endorsements by employees
Fraudulent Endorsements by Employees: if an employer entrusts an employee (including an independent contractor) w/ responsibility w/ respect to an instrument and the employee makes a fraudulent endorsement on the instrument, the endorsement is effective.
RESPONSIBILITY W/ RESPECT TO AN INSTRUMENT
Includes authority (1) to sign or endorse instruments on behalf of the employer; (2) to process instruments received by the employer for bookkeeping purposes, for deposit to an account, or for other disposition; (3) to prepare or process instruments for issue in the name of the employer; (4) to supply information determining the names or addresses of payees of instruments to be issued by the employer; and (5) to control the disposition of instruments issued in the name of the employer.
Hypo: Bob works in the billing department of a law firm, and his duties include receiving checks and positing them to the firm's account. Bob steals a check made out to the firm, forges the endorsement of the firm, and transfers the check to X. Is the endorsement effective?
Yes. He had responsibility → effective.
Hypo: If instead of Bob stealing the check, it had been stolen by a janitor who then forged the name of the firm, would the endorsement be effective?
No. No responsibility. Not entrused w/ instrument.
Hypo: Company give E, and employee, responsibility for verifying electronically recording, and mailing checks that Company draws to pay accounts owed to other people. One day, E stole several checks and forged the payee's endorsements. Are these endorsements effective?
Yes. He had responsibility—effective.
Hypo: Carl Contractor was sitting in his office when his secretary brought him his checkbook. The secretary informed him that he owed $2000 to Rex Roofer for some work that he done for Contractor. Contractor wrote out a check for that amount to Roofer, and the secretary forged Roofer's name to the check an pocketed the proceeds. Is the check properly payable from Contractor's account?
Yes, if you provide payee's names → sufficient responsibility.
VALIDATION OF THE FORGERY: the negligence rule
If a person, by his negligence, SUBSTANTIALLY CONTRIBUTES to a material alteration or to the making of an unauthorized signature, he is precluded from asserting the alteration or lack of authority against a HDC or the drawee or other payor who pays in good faith and in accordance w/ the reasonable commercial standards of the drawee's or payor's business.
- NOTE: Not just any negligence effects preclusion. The negligence must actually CONTRIBUTE to the forgery or alteration. That is, it must afford an opportunity of which advantage is taken. Examples of negligence might be signing blank checks, or failure to look after one's signature stamp or automatic signing device. Any form of slovenly business practice may be negligent.
VALIDATION OF THE FORGERY: comparative negligence
Comparative Negligence: if the drawee bank or other person paying the instrument or taking it for value or for collection fails to exercise ordinary care, the person bearing the loss (under the imposter rule, the fictitious payee rule, the fraudulent endorsement by employee rule, or the negligence rule) may recover from the drawee bank or other person failing to exercise ordinary care to the extent the failure to exercise ordinary care contributed to the loss.
VALIDATION OF THE FORGERY: the bank statement rule
The Bank Statement Rule: a customer must exercise reasonable promptness in examining the statement or the items to determine whether any payment was not authorized b/c of an alteration of an item or b/c a purported signature by or on behalf of the customer was not authorized. Prompt notice must then be given to bank by its customer of any unauthorized payment that the customer reasonably should have discovered. If the customer fails to do this, AND THE BANK CAN SHOW THAT IT SUFFERED A LOSS BY REASON OF THIS FAILURE, the bank need not recredit its customer's account. MOREOVER, where the statement has been available to the customer for a reasonable period (not more than 30 calendar days) and she does not complain about an unauthorized signature or alteration, the customer is estopped from demanding recredit on any items forged or altered by the same wrongdoer and subsequently paid by the bank.

1. If the bank itself fails to exercise ordinary care in paying a check (e.g., sloppy forgery or obvious alteration), the loss is allocated between the bank and the customer according to the extent that each contributed to the loss.

2. NOTE: w/o regard to which party was negligent, a customer is precluded from asserting an unauthorized signature or any alteration on the fact of the instrument if he does not notify the bank w/in 1 year after the statement or items are made available to the customer. The customer is precluded from asserted a forged endorsement more than 3 years after the cause of action arises.
Hypo: Maker borrows money from Corleone Loan Co, and signs a $2000 note payable in 6 months. After Maker leaves the officer, Corleone skillfully altered the amount of the note to read $20,000. When the note came due, Corleone demanded the $20,000 from Maker. What amount, if any, must Maker pay Corleone?
Nothing. A holder who fraudulently alters an instrument, discharges the party's to the instrument as against the holder.
Hypo: Assume that, after altering the note, Corleone had negotiated the note to Finance Co, a HDC. When the note comes due, Finance Co presents the note to Maker for payment. What amount, if any, must Maker pay Finance Company?
A HDC can enforce it as to the original amount. ($2000).
Hypo: If Finance Company cannot recover the full $20,000 from Maker; can Finance Company recover anything from Corleone?
Yes, they can get the other $18,000 from Corleone b/c a party transferring an instrument warrants no material alterations.
Hypo: S takes a personal check from B for $100 in payment for the price of goods sold by S to B. S alters the instrument to read $1000 and cashes at his own bank, Local Bank. Local Bank then presented it to Drawee Bank, which paid the $1000. When B received his bank statement, he immediately complained to Drawee Bank, demanding that his account be recredited. Must Drawee Bank recredit B's account? If so, how much?
Only properly payable as to original amount, $100. Must recredit $900.
Hypo: If B's bank must recredit B's account, could it recover anything from Local Bank (The bank presenting the check)?
Yes, a party presenting a check warrants no material alterations.
STATUTE OF LIMITATIONS: Article 3 provides 2 general statutes of limitations:
3 years and 6 years
3 years:
3 Years: in the case of an ordinary check or other unaccepted draft, an action must be brought w/in 3 years after the date of dishonor or w/in 10 years after the date of the draft, whichever period expires first. Actions against the acceptor of certified checks or the issuer of teller's, cashier's or traveler's checks must be brought w/in 3 years after demand for payment is made to the acceptor or the issuer. Actions for conversion of an instrument and the like, for breach of warranty, or to enforce other obligations or rights arising under Article 3 must be brought w/in 3 years after the cause of action accrues.
6 years:
6 Years: for a note payable at a definite time, an action must be brought w/in 6 yrs of the due date or dates stated in the note, or if a due date is accelerated, w/in 6 years of the accelerated due date. For a demand note, an action must be brought w/in 6 years after the demand.

- NOTE: if no demand for payment is made to the maker on the demand note, an action to enforce the note is barred if neither principal not interest on the note has been paid for a continuous period of 10 years.
Funds availability: generally
If a customer puts cash or checks in an account, federal law (the Expedited Funds Availability Act and regulation CC) regulates how quickly the customer must be allowed to draw against the account.
Government checks, cashier's checks, certified checks, teller's checks (all of these are "low-risk")
The bank must make the entire amount of funds available from such items on the first business day (all calendar days except Saturday, Sunday, and federal holidays) after the banking day (a business day on which the bank is open "for carrying on substantially all of its banking functions") on which the funds are deposited.
Local checks
Drawn on banks located in the same geographic area served by the Federal Reserve check processing center.
Local checks: cash w/drawals
Cash Withdrawals:
1. $100 on the first business day after the date of deposit;
2. Additional $400 on the second business day after the date of deposit;
3. Remaining funds on the third business day after the date of deposit.
Local checks: noncash w/drawals
Noncash Withdrawals:
1. $100 on the first business day after the date of deposit;
2. Remaining funds on the second business day after the date of deposit.
Nonlocal Checks: Cash Withdrawals:
1. $100 on the first business day after the date of deposit;
2. Additional $400 on the fifth business day after the date of deposit;
3. Remaining funds on the sixth business day after the date of deposit.
Nonlocal Checks: NonCash Withdrawals:
1. $100 on the first business day after the date of deposit;
2. Remaining funds on the fifth business day after the date of deposit.
ATM Deposits: Made at ATM owned or controlled by the depositary bank.
The other rules apply.
ATM Deposits: Made at ATM not owned or controlled by the depositary bank.
1. Funds from cash, local checks and governmental checks must be made available for w/drawal no later than 2 business days after the date of deposit;
2. Funds from nonlocal checks must be available no later than 5 business days after the date of deposit.
Hypo: Ford Motor Company owes $20 million to Bridgestone Corporation for tires that it has purchased. Bridgestone has an account at Tennessee State Bank (TSB) in Nashville and Ford has an account at Michigan State Bank (MSB) in Detroit. To pay Bridgestone, Ford instructs MSB to transfer $20 million from Ford's account to the Bridgestone account at TSB. MSB carries out this order by issuing a payment order to the Federal Reserve Bank in Detroit (FRB) to cause it to issue a payment order to TSB to credit the account of Bridgestone w/ $20 million.
This is a typical credit transfer governed by UCC Article 4A. When there is a final payment by TSB, the debtor (Ford) is discharged and the transaction concluded.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Definitions: Payment order
Payment order: an instruction to a bank to pay, or to cause another bank to pay, a fixed or determinable amount of money.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Definitions: Sender
iSender: the person given the instruction to the receiving bank.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Definitions: Originator
Originator: the sender of the first payment order in a funds transfer.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Definitions: receiving bank
Receiving bank: the bank to which the sender's instruction is addressed (it also is the "originator's bank" if it receives the payment order of the originator).
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Definitions: Beneficiary's bank
Beneficiary's bank: the bank identified in a payment order in which the account of the beneficiary is to be credited or which otherwise is to make payment to the beneficiary.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Definitions: Beneficiary
Beneficiary: the person to be paid by the beneficiary's bank.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Definitions: Intermediary bank
Intermediary bank: a receiving bank other than originator's bank or the beneficiary bank.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Acceptance and Rejection
1. A receiving bank is not required to accept a payment order (absent a contractual agreement w/ other banks to honor order). A receiving bank can reject a payment order by giving notice (oral, electronic, or written) to the sender that the receiving bank will not accept. No particular words are necessary.

2. Once a receiving bank "accepts" a payment order, however, the sender of that payment order has a duty to pay the amount involved. What constitutes acceptance depends on whether a bank is the beneficiary bank.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Acceptance and Rejection: Acceptance by a bank other than beneficiary's bank
Acceptance by bank other than beneficiaries bank: a payment order is accepted when the receiving bank "executes" the order (when the receiving bank passes on the order that it received to the next receiving bank).
1. Assume in the Ford hypo Ford issued its order to MSB at 2pm on Tuesday to be carried out at once. Assume an employee of MSB prepares a payment order at 2:10 and at 2:12 sends the order to FRB. A that point, Ford's payment is accepted, and Ford (the sender) has a duty to pay the amt involved. A sender can cancel or amend a payment order only if it has not yet been accepted.
2. Assume that FRB passes the payment order on to TSB at 2:30. At that point, FRB has accepted MSB's payment order and MSB (the sender) has a duty to pay the amount involved.
COMMERCIAL ELECTRONIC FUNDS TRANSFERS (UCC ARTICLE 4A): Acceptance and Rejection: Acceptance by beneficiary's bank
A beneficiary bank accepts by doing any of the following:
1. Paying the beneficiary is cash;
2. Notifying the beneficiary that the money is available (simply crediting the beneficiary's account w/o this notice would not be an acceptance);
3. Receiving full payment of the funds from the sender of the payment order; or
4. Failing to reject the payment order w/in an hour of its funds-transfer business day (i.e., the part of the day that the bank is open to process and receive funds transfers) that follows the payment order to date.

5. NOTE: once the beneficiary's bank accepts a payment order, it must pay the funds to the beneficiary even if it does not receive them from the sender. If the beneficiary's bank refuses to pay, it is liable for all damages caused by its refusal unless the bank can show that it had reasonable doubt concerning the right of the beneficiary to the payment. A sender who is injured as a result of a receiving bank's wrongful failure to pay the beneficiary also may be able to recover damages.
PAYMENT TO WRONG BENEFICIARY: Erroneous payment orders:
Erroneous payment orders: if an error is made during the transmission of a payment order (e.g., the order is sent twice), the entity that made the mistake bears the loss.
PAYMENT TO WRONG BENEFICIARY: Improper description of beneficiary:
Improper description of beneficiary: a fund transfer can describe the beneficiary both by name and account number. Banks are permitted to ignore the beneficiary's name and rely solely on the account number. If the beneficiary's account number is wrong, the beneficiary's bank is not liable if it puts the money into the identified account, and generally the person who made the mistake bears the loss (unless the bank becomes aware of the mistake before payment; then it must investigate to find the right beneficiary or the bank will bear the loss.
FRAUD: Security procedure not followed:
Security procedure not followed: Most banks have developed security procedures to thwart wire transfer fraud (e.g., the bank and the customer agree that payment orders from the customer will be considered only if they include a certain "password"). If a loss results from a party's failure to follow a security procedure (e.g., the bank sends a payment order despite lack of the password), that party must bear the loss.
FRAUD: Fraud in spite of security procedure:
Fraud in spite of security procedure: if despite adherence to established procedures fraud occurs, the customer is liable if the criminal gained access through the customer's system, and the bank is liable if the criminal gained access through the bank.