BUSINESS LAW TODAY
Essentials 9 th Ed.
Roger LeRoy Miller - Institute for University Studies, Arlington, Texas
Gaylord A. Jentz - University of Texas at Austin, Emeritus
Chapter
14
Negotiable Instruments
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Learning Objectives

What requirements must an instrument meet to be negotiable?

What are the requirements for attaining the status of a holder in due course (HDC)?

What is the difference between signature liability and warranty liability?

Certain defenses are valid against all holders, including HDCs. What are these defenses called?
Name four defenses that fall within this category.

Certain defenses can be used against an ordinary holder but are not effective against an
HDC. What are these defenses called? Name four defenses that fall within this category.
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Articles 3 and 4 of the UCC

A “negotiable instrument” is a signed writing containing an unconditional promise to pay an exact sum of money.

2002 Revisions updated UCC with regard to e-commerce and UETA.
 The term “Record” now replaces “Writing.”
 Other updates related to telephone transactions.
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Types of Instruments
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Drafts and Checks

Draft is Unconditional Order to Pay involving Three Parties:
 Drawer (Customer), Drawee (Bank) and
Payee.
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Drafts and Checks

Time Drafts and Sight Drafts.
 Time: payable at a future time.
 Sight: payable on sight (on demand).
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Drafts and Checks

Trade acceptances: Seller is drawer and
Payee.
 Checks (cashier’s, teller’s and traveler’s) are drafts on a bank.
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Promissory Note
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Promissory Notes and CD’s

Promissory Notes are PROMISES to pay.

Two party instruments:
 Maker (Promisor) and
 Bearer (Promisee).

Certificates of Deposit (CDs): two party instruments.
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Small CD
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Requirements for Negotiability

(1) Writing signed by the maker or the drawer.

(2) Unconditional promise or order to pay

(3) A fixed amount of money.

(4) Payable on demand or at a definite time.

(5) Payable to Order or Bearer.
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Requirements for Negotiability

Written Form.
 Must be on material that lends itself to permanence.
 Writing must have portability.

Signatures.
 Signed by maker (if note or CD)
 Signed by drawer (if check or draft).
 Any symbol (or electronic) is good.
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Requirements for Negotiability

Unconditional Promise or Order to
Pay.
 Payment cannot be conditioned on the occurrence or nonoccurence of any event.
Only unconditional promises are negotiable.
 Express promise to pay.

Fixed Amount of Money.
 Ascertainable on face of instrument.
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Requirements for Negotiability

Payable on Demand or Definite Time.
 Includes words “payable at sight” or
“payable upon presentment.”
 If no time presented, it is presumed payable on demand.

Definite Time.
 To be negotiable, instrument must be payable on demand or at a definite time.
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Requirements for Negotiability

Acceleration Clause.
 Allows holder to demand payment if certain condition occurs.
 Negotiable because exact value can be determined and payable on a specific date.
 CASE 14.1
Foundation Property Investments,
LLC v. CTP, LLC (2007). Accepting repeated late payments waives the right to demand full payment under an acceleration clause.

Extension Clause.

Reverse of an acceleration clause, extends maturity date to be extended forward into time.
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Requirements for Negotiability

Payable to Order or Bearer.
 Order instrument is payable to identified person or order. Identified person may transfer check to whomever she wishes.
 Bearer instrument is literally payable to the possessor of the instrument.
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Factors That Do Not Affect Negotiability

Undated checks.

Pre or Post-Dating Checks.

Handwritten Terms.
 Outweigh typed or printed terms.

Words outweigh Figures.

“With Interest.”

Check says “Nonnegotiable.”
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Transfer of Instruments

Transfer by Assignment.
 Transferee is an Assignee.

Transfer by Negotiation.
 Transfer in which the transferee becomes a holder.
• Negotiating Order Instruments.
• Negotiating Bearer Instruments.
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Indorsements

Indorsement is a signature, with or without words or statements.

Indorser: person who transfers instrument by signing it and delivering to another person.
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Indorsements

Blank
Indorsements.


Special
Indorsements.


Qualified
Indorsements.

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Restrictive Indorsements

Conditional Indorsements.

Indorsements for Deposit and
Collection.
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Restrictive Indorsements

Trust (Agency) Indorsements.
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Miscellaneous Indorsement Problems

Misspelled Names. Indorsement should be identical to the name on the instrument.

Alternative or Joint Payees. Only one of the payees needs to indorse.

Suspension of the Drawer’s Obligation.
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Holder in Due Course (HDC)

A holder (assignee) is generally subject to the same defenses that the assignor is subject to.

A holder in due course (HDC) takes the instrument FREE of most of the defenses and claims that could be asserted against the transferor.
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Requirements for HDC Status

A Holder in Due Course must:
 Take for Value:
• Performance.
• Payment for preexisting debt.
• Irrevocable commitment.
 Taking in Good Faith (honesty in fact).
 CASE 14.2
Georg v. Metro Fixtures
Contractors, Inc. (2008). Payee of check that was embezzled was an HDC taking in good faith.
Loss is suffered by Metro.
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Requirements for HDC Status

A Holder in Due Course must:
 Take for Value:
 Taking in Good Faith (honesty in fact).
 Take Without Notice of any defect:
• Overdue, dishonored, uncured, contains unauthorized signature or alteration, defense or claim, irregular or incomplete.
• CASE 14.3
South Central Bank of Daviess
County v. Lynnville National Bank (2009).
South
Central took the check for value, in good faith, and without notice of a defects.
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Holder Through an HDC

The “Shelter” Principle: Holder, who does not qualify as an HDC, can acquire the rights and privileges of an HDC.
 Depends upon whether holder can ‘trace’ her title back to HDC.

Limitations:
 Reacquired instruments.
 Fraud or illegality.
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Signature and Warranty Liability

Every party who signs a negotiable instrument is either primarily or secondarily liable for payment.
 Primary Liability (only makers and acceptors are primarily liable).
 Secondary Liability (contingent liability):
• Proper and Timely Presentment.
• Dishonor.
• Proper Notice.
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Signature Liability

Accommodation Parties.
 Signs for the purpose of lending her name as credit for another party.

Authorized Agents’ Signatures.
 If authorized, can bind the principal.
 If unauthorized (forgery) signature is void.
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Special Rules for
Unauthorized Indorsements

Unauthorized Indorsements.
 Burden of loss falls on first party to take the instrument with the forged/unauthorized instrument.

Imposter Rule.

Fictitious Payee Rule.
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Warranty Liability

Transferors make certain implied warranties on instruments they are transferring: Transfer and Presentment.

Transfer Warranties (if consideration):
 Transferor has the right to enforce the instrument
 All signatures are authentic and authorized
 Instrument has not been altered.
 Instrument is not subject to a defense or claim.
 Transferor has no knowledge of insolvency.
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Warranty Liability

Presentment Warranties protect the person to whom the instrument is presented:
 Person obtaining payment has the right to enforce the instrument.
 Instrument has not been altered.
 Person accepting has no knowledge that instrument is unauthorized.
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Defenses, Limitations, and Discharge

Universal (Real) Defenses to Avoid
Liability by ALL Holders, including
HDC’s:
 Forgery.
 Fraud in the Execution.
 Material Alteration.
 Discharge in Bankruptcy.
 Infancy (Minor).
 Illegality.
 Mental Incapacity.
 Extreme Duress.
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Personal Defenses

Personal (limited ) Defenses (only holders, not HDC):
 Breach of Contract or Warranty.
 Lack or Failure of Consideration.
 Fraud in the Inducement.
 Illegality (voidable).
 Mental Incapacity.
 Discharge by Payment/Non-Delivery.
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Federal Limitations on HDC’s

Federal Trade Commission issued rule in
1976 that effectively abolished HDC status in consumer credit transactions.

FTC Rule 433.

Modern application is to car purchases that turn out to be ‘lemons.’
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Discharge From Liability

All parties are liable when primary party pays the holder the amount in full.

Intentional cancellation discharges the liability of all parties.

Can occur when right of recourse is impaired.
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