Chapter 13
Negotiable Instruments
Learning Objectives
What are the requirements for an instrument to
be negotiable?
What are the minimum requirements for HDC
status?
What is the key to liability on a negotiable
instrument?
What are the bank’s responsibilities regarding
stale checks, stop payments and forged checks?
What is e-money and how is it stored?
Article 3
A negotiable instrument is a signed
writing that contains an unconditional
promise or order to pay an exact sum of
money on demand or at a specified time
to a specific person or bearer.
Can function as a substitute for money or
an extension of credit.
Types of Instruments
 Drafts and Checks (Orders to Pay)
 Draft—unconditional written order that
involves three parties.
• Drawer (creates the draft) who
• Orders the party holding the money (the Drawee) to
pay money
• To a Third Party (the Payee)
 Time Draft
 Sight Draft
Types of Instruments
Promissory Notes and C.D.’s
(Promises to Pay)
Promissory Note—written promise to
pay money by Maker to Payee.
C.D.—type of note. Created when party
deposits money with bank who promises
to pay, with interest, on a certain date.
Requirements for Negotiability
Must meet the following criteria:
Be in Writing
Be signed by the Maker or Drawer
Be unconditional promise or order to pay
State a fixed amount of money.
Be payable on demand or definite time
Be payable to order or bearer, unless a
check.
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
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.
Requirements for HDC
A Holder in Due Course must:
Give value for the instrument
• Performance
• Payment for preexisting debt
• Irrevocable commitment
Take in Good Faith (honesty in fact)
Take Without Notice (of any defect)
Signature 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
Signature Liability
 Accommodation Parties
 Signs for the purpose of lending her name as
credit for another party.
 Agents’ Signatures
 If authorized, can bind the principal.
 If unauthorized (forgery) signature is void.
 Unauthorized Indorsements
 Imposters
 Fictitious Payees
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
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.
Defenses to Liability
 Universal (Real) Defenses to Avoid Liability
by ALL Holders, including HDC
 Forgery
 Fraud in the Execution
 Material Alteration
 Discharge in Bankruptcy
 Infancy (Minor)
 Illegality
 Mental Incapacity
 Extreme Duress
Defenses to Liability
 Personal (or limited ) Defenses (only for
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
Checks and Banking System
 Special type of draft by maker (drawer)
drawn on a bank (drawee) ordering bank
to pay third party (payee).
 Cashier’s Check—bank is both drawer and
drawee.
 Traveler’s Check—payable on demand, payable
by a financial institution, designated as a
traveler’s check.
 Certified Check—accepted in writing by drawee
bank.
Bank’s Duties
 Drawee (Bank) has a legal duty to honor
Drawer’s (Maker) checks.
 If it wrongfully dishonors a check, it is liable
for damages.
 Overdrafts
 Postdated Checks (Notice required)
 Stale Checks (six months)
 Stop-Payment Orders
Bank’s Duties
Death or Incompetence of Customer
Forged Drawers’ Signatures
General Rule—no legal effect
Customer Negligence—bank normally not
liable.
Timely Examination of Statements by
Customer
Time Limit for Bank’s Liability
Bank’s Duties
Forged Instruments
Bank must recredit customer’s account if
payment made on forged instrument.
Altered Checks
Bank has a Duty to Accept Deposits
Availability Schedule for Deposited Checks
Collection Process (local and Federal Reserve)
Electronic Fund Transfers
 EFT is a transfer of funds via the use
electronic means
 Types of EFT systems:
 Automated Teller Machine
 Point of Sale (debit card)
 Direct Deposit and Withdrawal
 Pay by Telephone
 Error Resolution and Damages
 Commercial Transfers
E-Money
 Stored-Value Cards (pre-paid cards for
use with long distance, cellular and
library copy machines)
 Smart Cards—can authenticate the validity of
transactions with digital signatures.
 Deposit Insurance
 Legal Protection
 Encyrption and Privacy Protection
Online Banking
Virtual Banks (e.g., Bank of the
Internet at www.bofi.com )
Uniform Money Services Act
August 2001, NCCUSL would subject
online banking and e-money to same
regulations as traditional banks.
Internet-Based Money—Paypal.com?