Chapter 18: Negotiable Instruments –
Transferability and Liability
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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.
• History of negotiable instruments
began in England “bills of exchange”
so that merchants were able to
exchange money while keeping their
money safe in the banks.
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Amendments to UCC Articles 3 & 4
• 1990 Revisions are incorporated into
the text content.
• 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.
• 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 nonoccurrence 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 18.1 Foundation Property
Investments, LLC v. CTP, LLC.
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
• By Assignment.
– Transferee is an Assignee.
• 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 18.2 Georg v. Metro Fixtures
Contractors, Inc.
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 18.3 South Central Bank of Daviess
County v. Lynnville National Bank.
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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