P A R T
7
Commercial Paper
Negotiable Instruments
Negotiation & Holder in Due Course
Liability of Parties
Checks and Electronic Transfers
McGraw-Hill/Irwin Business Law, 13/e
© 2007 The McGraw-Hill Companies, Inc. All rights reserved.
C H A P T E R
33
Liability of Parties
“Always do right. This will gratify some
people, and astonish the rest.”
Mark Twain, speech to Young People’s Society (1901)
Learning Objectives
 The
Basics of Contractual Liability
 Contractual Liability in Operation
 Warranty Liability
 Other Liability Rules
 Discharge of Negotiable Instruments
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Overview
When a person signs a negotiable instrument
as maker, drawer, or indorser, the person is
contractually liable to pay the instrument
 Liability also arises from:


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(1) improper transfer or presentment of an
instrument; (2) negligence in instrument
issuance, alteration, or indorsement; (3)
improper payment; or (4) conversion
Details of Liability
The maker or drawer of a promissory note is
primarily liable for paying the debt
 UCC Article 3 requires a person who is
secondarily liable to pay the instrument only
if the person primarily liable defaults



An indorser usually is secondarily liable
A drawee has no liability on a check or draft
unless it certifies or accepts it
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Presentment

Holder of a note may present it to maker on
or after the date payable



Dishonor: maker fails to pay amount due
Since maker is primarily liable, holder of the
note may demand payment from person with
secondary liability
To obtain payment or acceptance on a draft
or check, holder must present it to drawee by
any commercially reasonable means
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Warranty Liability

Person who transfers negotiable instrument
or presents it for payment may bear liability
from implied warranties:


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Presentment warranties: Warrantor/transferor is
entitled to enforce draft or authorized to obtain
payment, draft has not been altered, warrantor
has no knowledge of an unauthorized signature
Transfer warranties: Transferor gives warranties
to immediate transferee related to authenticity
and enforceability of instrument
Other Liability Rules
Mistake: Revised Article 3 follows general
rule that payment or acceptance is final in
favor of a holder in due course or payee who
changes position in reliance on payment or
acceptance; bank bears burden of mistake
 Conversion: Revised Article 3 provides that
the law applicable to conversion of personal
property applies to instruments

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Other Liability Rules
Negligence: Person who writes a negotiable
instrument to invite alteration may not use
alteration or lack of authorization as reason
for not paying an innocent holder [3–406]
 Imposter rule: If an impostor convinces the
drawer to make a check payable to imposter,
any indorsement “substantially similar” to
that of named payee is effective [3–404(a)]

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Other Liability Rules

Fictitious payee rule: Any indorsement in the
name of a fictitious payee is effective as
payee’s indorsement [3–404(b), (c)]


Protects person that pays instrument in good
faith or takes it for value or collection
Fraudulent indorsements by employees: Risk of
loss for fraud by employees entrusted with
negotiable instruments falls on employer
rather than bank that pays check [3–405]
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Discharge of Obligor

Discharge from liability occurs
by payment, cancellation, or
alteration of the instrument;
modification of principal’s
obligation that causes loss to
surety or impairs collateral;
unexcused delay in presentment
or notice of dishonor of a check;
or acceptance of draft by a bank
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Test Your Knowledge

True=A, False = B



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When a person signs a negotiable instrument
as maker, the person becomes contractually
liable on the instrument.
The maker of a promissory note is
secondarily liable for paying the debt.
A drawee has liability on a check or draft the
moment it is presented for acceptance.
Test Your Knowledge

True=A, False = B



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An indorser is not discharged from liability
until the instrument is presented for payment
or acceptance.
A person who transfers a negotiable
instrument or presents it for payment may
incur liability from implied warranties.
A person who indorses a negotiable
instrument usually is secondarily liable.
Test Your Knowledge

Multiple Choice

Norbert worked in payroll for Will Co. and
signed payroll checks. Norbert wrote a check
to Bradley Pitte, a fictitious employee, took it
to the bank with fake I.D., indorsed the back
with “Pitte’s” signature, and was paid in cash.
(a) The bank is liable for wrongful acceptance
 (b) The bank is not liable under the common
law of conversion
 (c) The bank is not liable under UCC liability
rules

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Test Your Knowledge

Multiple Choice

Which of the following is not a transferee
warranty?
(a) Warrantor is entitled to enforce the
instrument
 (b) The drawer has sufficient funds to pay the
instrument
 (c) The instrument has not been altered
 (d) All signatures are authentic or authorized

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Thought Questions

What steps would you take to make sure
that the UCC rules concerning fictitious
employees and fraudulent indorsement did
not occur in your business?
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