Negotiable Instruments
“A negotiable bill or note is a
courier without luggage.”
John B. Gibson,
Overton v. Tyler, 1846
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System for transferring paper funds easily
Types of commercial paper
◦ Negotiable
◦ Non-negotiable
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Note: (promissory note) is a promise that
you will pay money
◦ Two people involved
 Maker: Issuer of a promissory note
 Payee: Someone who is owed money under the terms
of an instrument
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Draft: Order directing someone else to pay
money for you
◦ Check: Most common form of a draft
 Order telling a bank to pay money
◦ Three people involved
 Drawer: Person who issues a draft
 Drawee: One ordered by the drawer to pay money to
the payee
 Payee
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Issuer: All purpose term that means both
maker and drawer
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Possessor of commercial paper has an
unconditional right to be paid, so long as:
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Paper is negotiable
It has been negotiated to the possessor
Possessor is a holder in due course
Issuer cannot claim a valid defense
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The instrument must:
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Be in writing
Be signed by the maker or drawer
Contain an unconditional promise or order to pay
State a definite amount of money
Be payable on demand or at a definite time
Be payable to order or to bearer
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When terms contradict, three rules apply:
◦ Words take precedence over numbers
◦ Handwritten terms prevail over typewritten terms
◦ Typed terms prevail over printed terms
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Means that an instrument has been
transferred to the holder by someone other
than the issuer
◦ To be negotiated, order paper must first be
indorsed and then delivered to the transferee
◦ Bearer paper must simply be delivered to the
transferee
 No indorsement is required
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Order paper: Instrument that includes the
words “pay to the order of” or their equivalent
Bearer paper: Note is a bearer paper if it is
made out to “bearer” or it is not made out to
any specific person
◦ Can be redeemed by any holder in due course
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Indorsement: Signature of a payee
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Has an automatic right to receive payment for
a negotiable instrument
Requirements for holder in due course:
◦ Is a holder who has given value for the instrument,
in good faith
 Without notice of outstanding claims or other defects
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Requirements for holder in due course
◦ Holder: For order paper, anyone in possession of
the instrument if it is payable to or indorsed to her
 For bearer paper, anyone in possession
◦ Value: Holder has already done something in
exchange for the instrument
◦ Good faith
 Two tests to determine
 Subjective test
 Objective test
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The instrument is overdue
The instrument is dishonored
The instrument is altered, forged, or
incomplete
The holder has notice of certain claims or
disputes
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Issuer of a negotiable instrument is not
required to pay if:
Signature on the instrument was forged
After signing, debts were discharged in bankruptcy
Amount was altered after he signed it
Signed under duress, mentally incapacitated, or
part of illegal transaction
◦ Tricked into signing the instrument
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Federal Trade Commission has special rules
for consumer credit contracts
Consumer credit contract: Consumer borrows
money from a lender to:
◦ Purchase goods and services from a seller who is
affiliated with the lender
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Signature liability: Liability of someone who
has signs an instrument
Warranty liability: Liability of someone who
receives payment on an instrument
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Primary liability: Unconditionally liable
◦ Must pay unless he has a valid defense
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Secondary liability: Must pay only if the
person with primary liability does not pay
The holder of an instrument must first try to
get payment from:
◦ The party with primary liability before making
demands against a party with secondary liability
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The maker is primarily liable
The drawer of a check has secondary liability
The bank (drawee) is not liable to:
◦ The holder and owes no damages to the holder for
refusing to pay the check
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Drawee
◦ Certified check: A check the issuer’s bank has
signed, indicating its acceptance of the check
◦ Acceptor: Bank (drawee) that accepts a check
(draft), thereby becoming primarily liable on it
◦ Cashier’s check: Check drawn on the bank itself
 Promise that the bank will pay out of its own funds
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Indorser: Anyone, other than an issuer or
acceptor, who signs an instrument
◦ Secondary liable
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Indorsers are not liable if:
◦ They write the words “without recourse” next to
their signature on the instrument
◦ Bank certifies the check
◦ Check is presented for payment more than 30 days
after the indorsement
◦ Check is dishonored and the indorser is not notified
within 30 days
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Someone, other than an issuer, acceptor, or
indorser:
◦ Who adds her signature to an instrument for the
purpose of being liable on it
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Accommodated party: Someone who receives
a benefit from an accommodation party
An accommodation party has the same
liability to the holder as the person for whom
he signed
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The wrongdoer is always liable
The drawee bank is liable if it pays a check on
which the drawer’s name is forged
◦ The bank can recover from the payee only if the
payee had reason to suspect the forgery
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In any other case of wrongdoing, a person
who first acquires an instrument from a
wrongdoer is ultimately liable to anyone else
who pays value for it
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When someone transfers an instrument, she
warrants that:
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She is the holder of the instrument
All signatures are authentic and authorized
Instrument has not been altered
No defense can be asserted against her
As far as she knows the issuer is solvent
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A forged signature is invalid and creates no
signature liability for the person whose name
was signed
◦ The recipient of a forged item may recover under
transfer warranties
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Signature liability rules do not apply to the
transfer of bearer paper since no indorsement
is required
◦ Transfer warranties apply
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Apply to someone who demands payment for
an instrument from the maker, drawee, or
anyone else liable
Presenter warrants that:
◦ She is a holder
◦ The check has not been altered
◦ She has no reason to believe the drawer’s signature
is forged
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Anyone who presents a promissory note for
payment warrants that he is a holder of the
instrument
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Conversion liability
◦ Conversion: Means that:
 Someone has stolen an instrument
 Bank has paid a check that has a forged indorsement
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Impostor rule
◦ If someone issues an instrument to an imposter:
 Any indorsement in the name of the payee is valid as
long as the person who pays the instrument does not
know of the fraud
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Fictitious payee rule
◦ If an instrument is issued to a person who does not
exist:
 Indorsement in the name of the payee is valid as long
as the payer does not know of the fraud
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Employee indorsement rule
◦ If an employee with responsibility for issuing
instruments forges an instrument:
 Indorsement in the name of the payee is valid as long
as the payer does not know of the fraud
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Anyone negligent in creating or paying an
unauthorized instrument is liable to an
innocent third party
◦ Anyone careless in paying an unauthorized
instrument is liable:
 Despite the three rules
◦ Anyone careless in allowing a forged or altered
instrument to be created is also liable:
 Whether or not he has violated one of the three rules