Chapter 1: Legal Ethics
1
Learning Objectives
1. What requirements must an instrument
meet to be negotiable?
2. What are the requirements for attaining the
status of a holder in due course (HDC)?
3. What is the difference between signature
liability and warranty liability? 
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2
Learning Objectives
4. Certain defenses are valid against all holders,
including HDC’s. What are these defenses
called? Name four defenses that fall within
this category.
5. 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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3
Types of Instruments
 A “negotiable instrument” is a signed
writing containing an unconditional
promise to pay an exact sum of
money.
 Most negotiable instruments are
paper documents, referred to as
commercial paper.
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4
Types of Instruments
 The UCC specifies four types of
negotiable instruments:
–Drafts, Checks, Notes, and Certificates
of Deposit.
–Orders to Pay or Promises to Pay.
–Can also be demand instruments or
time instruments.
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Types of Instruments
 Drafts and Checks (Orders to Pay).
–Unconditional order involves three
parties: Drawer (creator of draft),
Drawee (financial institution) and
Payee.
–Most common type of draft is a bank
check. 
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Types of Instruments
 Drafts and Checks (Orders to Pay).
–Time Drafts and Sight Drafts.
• Time Draft: payable certain future time.
• Sight Draft: payable on sight. May be
payable on acceptance (drawee’s written
promise to pay the draft when due).
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Types of Instruments
 Drafts and Checks (Orders to Pay).
–Trade Acceptances.
• Type of draft frequently used in sale of
goods.
• Trade acceptance: seller of goods is both
drawer and payee. Buyer of goods is the
drawee.
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Types of Instruments
 Drafts and Checks (Orders to Pay).
–Checks.
• Three parties: Writer of the check is
drawer, the bank is drawee, and person to
whom check is made is payee.
• Checks are payable on demand.
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Types of Instruments
 Promissory Notes and Certificates of
Deposit (Promises to Pay).
–Promissory Notes are two party
instruments:
• Maker (Promisor) and
• Bearer (Promisee).
• Can be payable at a definite time or on
demand.
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Types of Instruments
 Promissory Notes and Certificates of
Deposit (Promises to Pay).
– Certificates of Deposit. Certificate of
Deposit: type of note issued when a party
deposits funds with a bank, and bank
promises to repay funds with interest on
certain date.
– Bank is maker, and Depositor is Payee.
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Requirements for Negotiability
 For an Instrument to be negotiable, it
must:
–Be Signed by the Maker or Drawer.
• Signature Requirements: manual or by a
device.
• Placement of the Signature. 
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Requirements for Negotiability
 For an Instrument to be negotiable, it
must:
–Be an Unconditional Promise or Order
to Pay.
• Promise or Order.
• Unconditionality of the Promise or Order.
–State a Fixed Amount of Money.
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Requirements for Negotiability
 For an Instrument to be negotiable, it
must:
– Be Payable on Demand or at a Definite Time.
• On Demand: “Payable at sight” or “Payable
upon presentment.”
• CASE 16.1 REGER DEVELOPMENT, LLC V. NATIONAL
CITY BANK (2010). Why doesn’t the duty of good
faith apply to lenders seeking payment on demand
notes?
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Requirements for Negotiability
 For an Instrument to be negotiable, it
must:
–Be Payable on Demand or at a Definite
Time.
• Payable at a Definite Time: specified date,
within definite period of time, date or time
readily ascertainable. 
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Requirements for Negotiability
 Acceleration Clause: allows holder to
demand full payment if a certain
event occurs.
 Extension Clause: the reverse of an
extension clause.
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Requirements for Negotiability
 Be Payable to Order or Bearer, Unless
It is a Check.
–Order Instruments: payable to “the
order of” an identified person, or to “an
identified person or order.” 
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Requirements for Negotiability
 Be Payable to Order or Bearer, Unless
It is a Check.
–Bearer Instruments: the holder is the
payee.
• CASE 16.2 LAS VEGAS SANDS, LLC V. NEHME
(2011). Why was the marker a bearer
instrument?
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Requirements for Negotiability
 Factors That Do Not Affect
Negotiability.
–Omission of Date.
–Postdating or Antedating.
–Handwritten Terms outweigh
typewritten and preprinted terms.
–Words outweigh figures. 
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Requirements for Negotiability
 Factors That Do Not Affect
Negotiability.
–If instrument states “with interest” but
doesn’t specify the rate, it is the
judgment rate of interest.
–Check is negotiable even if there is a
“nonnegotiable” note on it.
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Transfer of Instruments
 A negotiable instrument can be
transferred by assignment or
negotiation.
 Transfer by Assignment.
–Gives assignee only those rights
assignor possessed.
–Transferee is an assignee, not a holder.
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Transfer of Instruments
 Transfer by Negotiation.
–Creates a holder, who receives the
rights of a previous possessor.
–There are two methods of negotiation
so receiver becomes a holder,
depending on whether instrument is an
order or bearer instrument. 
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Transfer of Instruments
 Transfer by Negotiation.
–Negotiating Order Instruments: requires
both indorsement and delivery.
–Negotiating Bearer Instruments:
delivery only. Indorsement is not
necessary.
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Indorsements
 Signature with or without additional
words or comments.
 Blank Indorsements: does not specify
a particular indorsee and may consist
of a mere signature.
 Special Indorsements: contains
signature and identifies payee. 
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Indorsements
 Qualified Indorsements: indorser who
does not wish to be liable (“without
recourse”).
–Effect of Qualified Indorsements.
–Special versus Blank Indorsements.
–CASE 16.3 HAMMETT V. DEUTSCHE BANK
NATIONAL CO. (2010). What was the legal
effect of the blank qualified indorsement?
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Indorsements
 Restrictive Indorsements: requires
indorsee to comply with certain
instructions regarding funds.
–Conditional Indorsements.
–Indorsements for Deposit or Collection.
–Trust (Agency) Indorsements. 
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Indorsements
 Miscellaneous Indorsement Problems.
–Misspelled Names. Indorsement should
generally be identical to name on
instrument.
• Misspelled name OK.
–Instruments Payable to Legal Entities.
• Negotiable by authorized representative of
the entity.
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Indorsements
 Miscellaneous Indorsement Problems.
–Alternative or Joint Payees.
• Alternative Payees Presumed- either may
indorse. Jointly - both must indorse.
• Suspension of the Drawer’s Obligation.
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Holder in Due Course (HDC)
 Holder versus Holder in Due Course
(HDC).
–Holder possess an order or bearer paper
and the instrument is drawn or indorsed
to the holder.
–HDC: holder plus takes for value, takes
in good faith, and without notice of
defense to payment.
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Holder in Due Course (HDC)
 Requirements for HDC Status.
–Taking “For Value”: No value if gift or
inheritance. Not the same as
consideration. Holder can take for value
by:
• Performing the instrument’s promise.
• Acquiring a security interest or other lien
in the instrument. 
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Holder in Due Course (HDC)
 Requirements for HDC Status.
–Taking for Value.
• Taking instrument in payment for an
antecedent debt.
• Giving a negotiable instrument as
payment.
• Giving irrevocable commitment as
payment.
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Holder in Due Course (HDC)
 Requirements for HDC Status.
–Taking in Good Faith.
• Honesty in fact and observance of
reasonable commercial standards of fair
dealing.
• Only applies to holder, not transferor.
• CASE 16.4 TRIFFIN V. LICCARDI FORD, INC.
(2011). Why wasn’t Triffin a holder in due
course?
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Holder in Due Course (HDC)
 Requirements for HDC Status.
–Taking Without Notice: Holder takes the
instrument with notice if he knows/has
reason to know:
• Instrument is overdue.
• Instrument has been dishonored.
• Actual knowledge or any suspicious event.
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Holder in Due Course (HDC)
 Holder through an HDC.
–“Shelter Principle”: A person who does
not qualify to be a HDC but who derives
her title through an HDC can acquire
the rights and defenses of an HDC. 
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Holder in Due Course (HDC)
 Holder through an HDC.
–Purpose of the Shelter Principle: extends
benefits of HDC and allows HDC to
dispose of instrument.
–Limitations on the Shelter Principle: no
fraud, illegality, claim or defense.
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Signature and Warranty Liability
 Signature Liability.
–Relates to signatures on instruments.
–Signers of negotiable instruments are
potentially liable for amount stated on
instrument.
• Primary Liability: Makers/Acceptors. 
• Secondary Liability: Drawers/Indorsers.
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Signature and Warranty Liability
 Signature Liability.
–Primary Liability. Person:
• Promises to pay the note.
• Obligated to pay terms of instrument at
time of signing.
• Acceptors: Drawee promises to pay an
instrument when presented for
payment.
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Signature and Warranty Liability
 Signature Liability.
–Secondary Liability.
• Proper Presentment: Must be timely
(checks w/in 30 days).
• Timely Presentment: Manner of Notice in
any Reasonable manner.
• Dishonor.
• Proper Notice.
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Signature and Warranty Liability
 Signature Liability.
–Unauthorized Signatures: arise in two
situations:
• Forgery: does not bind Principal but Bank
may be liable if negligent.
• Unauthorized Signature: Agent is
personally liable, but Principal is not,
unless ratified. 
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Signature and Warranty Liability
 Signature Liability.
–Unauthorized Signatures: Exceptions to
the General Rule of No Liability:
• Ratification of Signature: principal become
liable.
• Negligence: party who substantially
contributed to forgery is liable. 
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Signature and Warranty Liability
 Signature Liability.
–Special Rules for Unauthorized
Indorsements.
• Unauthorized indorsement does not bind
maker/drawer except:
–Imposter Rule: one who induces a maker to
issue an instrument in the name of an
impersonated payee. 
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Signature and Warranty Liability
 Signature Liability.
–Special Rules for Unauthorized
Indorsements.
• Unauthorized indorsement does not bind
maker/drawer except:
• Fictitious Payees: cause an instrument to
be issued to a payee who will have no
interest in the instrument.
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Signature and Warranty Liability
 Warranty Liability.
–Transferors make certain implied
warranties regarding instruments they
negotiate.
–Warranty Liability not subject to
conditions of proper presentment,
dishonor, or notice.
–Warranties: Transfer or Presentment.
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Signature and Warranty Liability
 Warranty Liability.
–Transfer Warranties: Following
warranties extend to all subsequent
holders:
• Transferor is entitled to enforce the
instrument.
• Signatures are authentic and authorized.

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Signature and Warranty Liability
 Warranty Liability.
–Transfer Warranties: Following
warranties extend to all subsequent
holders:
• Instrument has not been altered.
• Instrument not subject to defense.
• Transferor has no notice of insolvency.
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Signature and Warranty Liability
 Warranty Liability.
–Transfer Warranties.
• Parties to Whom Warranty Liability
Extends: Extends warranty to any holder who
takes in good faith. Without indorsement,
warranties extend only to immediate
transferee.
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Signature and Warranty Liability
 Warranty Liability.
–Transfer Warranties.
• Recovery for Breach of Warranty: good
faith holder can sue for breach of
warranty. Notice of the claim within 30
days.
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Signature and Warranty Liability
 Warranty Liability.
–Presentment Warranties: person who
presents an instrument makes the
following presentment warranties:
• No missing or unauthorized indorsements.
• Instrument has not been altered.
• Person obtaining payment has no
knowledge signature is unauthorized.
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Defenses, Limitations
and Discharge
 Universal (or Real) - can be used to
defeat a holder and a HDC. 
 Personal - can be used to defeat a
holder but not a HDC. 
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Defenses, Limitations
and Discharge
 Universal Defenses.
–Forgery of maker’s or drawer’s
signature.
• Or if an authorized agent exceeds his
authority to the amount which exceeds his
authority.
–Fraud in the Execution: the ”autograph”
situation, not fraud in the inducement. 
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Defenses, Limitations
and Discharge
 Universal Defenses.
–Material Alteration: changes the contract
terms in any way. Making any changes in
the amount, date, or rate of interest is
material.
• Complete or Partial Defense: material
alteration is a complete defense against a
holder, partial defense against an HDC. 
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Defenses, Limitations
and Discharge
 Universal Defenses.
–Discharge in Bankruptcy.
–Minority (infancy): to the extent allowed
by state law.
–Illegality: statute must make
transaction illegal and void. 
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Defenses, Limitations
and Discharge
 Universal Defenses.
–Mental Incapacity: adjudicated by court.
–Extreme Duress: If instrument signed
under threat of immediate force or
violence.
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Defenses, Limitations
and Discharge
 Personal Defenses.
–Valid against holders but not HDC’s.
• Breach of Contract or Warranty.
• Lack or Failure of Consideration.
• Fraud in the Inducement (Ordinary Fraud).
• Mental Incapacity.
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Defenses, Limitations
and Discharge
 Federal Limitations on the Rights of
HDC’s.
–In 1976 the FTC abolished the HDC
doctrine when it applied to consumer
transactions.
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Defenses, Limitations
and Discharge
 Discharge from Liability.
–Can occur by:
• Payment or Tender of Payment.
• Cancellation or Surrender.
• Reacquisition.
• Impairment of Recourse.
• Impairment of Collateral.
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