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Business Law and the Legal Environment for a New Century
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Quote of the Day
“The law is not the place for the
artist or the poet. The law is the
calling of the thinkers.”
Oliver Wendell Holmes,Jr.
Supreme Court Justice
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Liability
 Signature liability – liability of someone
who has signed a document.
 Warranty liability -- liability of someone
who has received payment.
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Contract vs. Instrument
 Negotiable instruments are issued to
fulfill a contract.
 The instruments create a second
contract to pay the debt created by the
first agreement.
 Once an instrument is accepted in
payment for a debt, the debt is
suspended until the instrument is paid
or dishonored.
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Enforcing an Instrument
 In a signature liability, to whom is the
signer liable?
• To the holder of the instrument.
• To anyone to whom the shelter rule applies
(non-holder with the rights of a holder).
• A holder who has lost the instrument.
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Primary vs. Secondary Liability
 Someone with primary liability must pay
unless he has a valid defense.
 Someone with 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 Payment Process
 Presentment – holder demands
payment.
 Dishonor – if payment is not received
when due or demanded, the instrument
is considered dishonored.
 Notice of Dishonor – notice is given to
the party with secondary liability when
the instrument is dishonored.
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Signature Liability
 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.
 Indorsers are secondarily liable.
• See next slide for more detail.
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Signature Liability -- Indorsers
 Indorsers are not liable if:
• they write the words “without recourse” next
to their signature on the instrument,
• a bank certifies the check,
• the check is presented for payment more
than 30 days after the indorsement, or
• the check is dishonored and the indorser is
not notified within 30 days.
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Accommodation Party
 An accommodation party (sometimes
called a co-signer or guarantor) is
someone who adds her signature to an
instrument in a capacity other than
issuer, acceptor or indorser, in order to
be liable for the instrument.
 An accommodation party has the same
liability to the holder as the person for
whom she signed.
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Agent
 To avoid personal liability when signing
an instrument, an agent must:
• indicate that she is signing as an agent and
• give the name of the principal.
 The principal is liable if the agent signs
correctly, the agent signs just her own
name, or the agent signs only the name
of the principal.
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Rules of Warranty Liability



The culprit 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.
In any other case of wrongdoing, a person
who first acquires an instrument from a culprit
is ultimately liable to anyone else who pays
value for it.
Click here for online advice on how to avoid check fraud.
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Transfer Warranties
 When someone transfers an
instrument, she warrants that:
•
•
•
•
She is the holder of the instrument,
All signatures are authentic and authorized,
The instrument has not been altered,
No defense can be asserted against her,
and
• As far as she knows the issuer is solvent.
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Presentment Warranties
 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, and
• She has no reason to believe the drawer’s
signature is forged.
 Anyone who presents a promissory
note for payment warrants only that he
is a holder of the instrument.
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Other Liability Rules
 Conversion Liability
• Conversion means that (1) someone has
stolen an instrument or (2) a bank has paid
a check that has a forged indorsement.
 Imposter Rule
• If someone issues an instrument to an
imposter, then any indorsement in the
name of the payee is valid as long as the
person (a bank, say) who pays the
instrument does not know of the fraud.
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Other Liability Rules (cont’d)
 Fictitious Payee Rule
• If an instrument is issued to a person who
does not exist, any indorsement in the
name of the payee is valid as long as the
payer does not know of the fraud.
 Employee Indorsement Rule
• If an employee with responsibility for
issuing instruments forges an instrument,
any indorsement in the name of the payee
is valid as long as the payer does not know
of the fraud.
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Negligence



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
(impostor rule, fictitious payee rule and
employee indorsement rule).
Anyone careless in allowing a forged or
altered instrument to be created is also liable.
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Crimes
 Bouncing a check
• Writing a check on an account with insufficient
funds is illegal, but usually only has a monetary
penalty if the funds are deposited quickly.
 Check Kiting
• An illegal scheme where checks are passed
between overdrawn accounts at two banks,
earning interest at one bank before reversing
the process to “repay” the other account.
 Forgery
• Creating a fake document or passing on a
known fake document is illegal.
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Discharge
 Discharge means that liability on an
instrument terminates.
By Payment
By Cancellation
By Alteration
By Agreement
By Certification
 Discharge of an indorser or
accommodation party
• Article 3 provides that virtually any change
in an instrument that harms an indorser or
accommodation party also discharges them
unless they consent to the change.
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“It is never wise to play an
important game without
understanding the rules. The
rules of negotiable instruments
are complex, but important
because this game is played by
virtually everyone.”
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