CHAPTER 27- LIABILITY, DEFENSES, AND DISCHARGE
Universal defenses
-(also called real defenses) are valid against all holders (including HDCs and holders through HDCs) 1. forgery of a signature on the instrument 2. fraud in the execution 3. material alteration 4. discharge in bankruptcy 5. minority 6. illegality, mental incapacity, or extreme duress
Discharge
-(blank) from liability on an instrument can come from payment, cancellation, or material alteration -can also occur if a party reacquires an instrument, if a holder impairs another party's right of recourse, or if a holder surrenders collateral without consent
Minority
-(or infancy) is a universal defense only to the extent that state law recognizes it as a defense to a simple contract -since state laws on (blank) vary, so do determinations of whether minority is a universal defense against an HDC
Breach of contract or breach of warranty
-A breach of the underlying contract for which the negotiable instrument was issued is a personal defense -If a breach occurs, the maker of a note can refuse to pay it—or the drawer of a check can order his or her bank to stop payment on the check
Acceptors (primary liability)
-A drawee that promises to pay an instrument when it is presented later for payment -Drawee's acceptance is a promise to pay that places the drawee in almost the same position as the maker of a promissory note
Recovery for breach of warranty (transfer warranties)
-A holder who takes an instrument in good faith can sue for breach of a warranty as soon as he or she has reason to know of the breach -Failure to give notice relieves the warrantor from liability for any loss caused by a delay
when the holder is a holder in due course (unauthorized signatures)
-A person who forges a check or signs an instrument without authorization can be held personally liable for payment by a holder in due course
Fraud in the inducement (ordinary fraud)
-A person who issues a negotiable instrument based on false statements by the other party will be able to avoid payment on that instrument, unless the holder is an HDC
Accommodation parties
-A person who signs an instrument for the purpose of lending his name as credit to another party on the instrument -Banks may require an (blank) (a cosigner) to secure against nonpayment of a negotiable instrument
Discharge by payment or tender of payment
-All parties to a negotiable instrument will be discharged when the party primarily liable on it pays to a holder the full amount due -The liability of all parties is also discharged when the drawee of an unaccepted draft or check makes payment in good faith to the holder Good faith required: -A party will not be discharged if that party knowingly pays a holder who acquired the instrument by theft or who obtained the instrument from someone else who acquired it by theft -An exception to this rule is made if the person has the rights of an HDC Tender of payment: -If tender (offer) of payment is made to a person entitled to enforce the instrument and the tender is refused, the indorsers and accommodation parties are discharged to the extent of the amount of the tender
Authorized agent's signatures
-An agent is a person who agrees to represent or act for another, called the principal -Agents can sign negotiable instruments and thereby bind their principals -certain requirements must be met before the principal becomes liable on the instrument
Material alteration
-An alteration is material if it changes the contract terms between two parties in any way. Making any change in the amount, the date, or the rate of interest—even if the change is a tiny one—is material -A Complete or Partial Defense: (blank) is a complete defense against an ordinary holder but only a partial defense against an HDC -An ordinary holder can recover nothing on an instrument that has been materially altered -An HDC Can Enforce an Incomplete Instrument That Was Subsequently Altered: If an instrument was originally incomplete and was later completed in an unauthorized manner, alteration can no longer be claimed as a defense against an HDC
Discharge by cancellation or surrender
-Intentional cancellation of an instrument discharges the liability of all parties -Destruction or mutilation of a negotiable instrument is considered cancellation only if it is done with the intention of eliminating obligation on the instrument -Any of these acts—if done by the holder with the intent to cancel the obligation—will discharge liability: 1. Writing "Paid" across the face of an instrument 2. Intentionally tearing up an instrument 3. Crossing out a party's signature. Doing this will discharge that party's liability and the liability of subsequent indorsers who have already signed the instrument 4. Surrendering the instrument to the party to be discharged
Liability of the agent (Authorized agent's signatures)
-An authorized agent may be held personally liable on a negotiable instrument in the following three situations: 1. When the agent signs his or her own name on the instrument with no indication of agency status, an HDC can hold the agent personally liable 2. When the agent signs in both the agent's name and the principal's name, but nothing on the instrument indicates the agency relationship, the agent may be liable 3. When the agent indicates his or her agency status in signing a negotiable instrument but fails to name the principal, the agent may be liable -To protect against potential liability, an authorized agent should disclose the identity of the principal on the instrument and indicate that the agent is signing in a representative capacity
Liability of the principal (Authorized agent's signatures)
-An authorized agent usually binds a principal on an instrument if the agent clearly names the principal in the signature (in handwriting or by some mark or symbol) -In this situation, the UCC presumes that the signature is authorized and genuine
Secondary liability-- dishonor
-An instrument is also (blanked) when the required presentment is excused and the instrument is not properly accepted or paid -A delay in payment or a refusal to pay an instrument will *not* (blank) the instrument in the following situations: 1. When presentment is made after an established cutoff hour, a bank can postpone payment until the following business day without (blanking) the instrument 2. When the holder refuses to exhibit the instrument, to give reasonable identification, or to sign a receipt for the payment on the instrument, a bank's refusal to pay does not (blank) the instrument 3. when an instrument is returned because it lacks a proper indrosement, the instrument is not (blanked)
The general rule (Unauthorized signatures)
-An unauthorized signature is wholly inoperative and will not bind the person whose name is signed or forged -If an agent lacks authority to sign the principal's name or has exceeded the authority given by the principal, the signature does not bind the principal but will bind the "unauthorized signer"
Presentment warranties
-Any person who presents an instrument for payment or acceptance makes the following presentment warranties to any other person who in good faith pays or accepts the instrument: 1. The person obtaining payment or acceptance is entitled to enforce the instrument or is authorized to obtain payment or acceptance on behalf of a person who is entitled to enforce the instrument 2. The instrument has not been altered 3. Person obtaining payment has no knowledge signature is unauthorized
FTC Rule 433
-Applies to consumers who purchase goods or services for personal, family, or household use with a consumer credit contract -It allows consumers to assert any defense they might have against the seller of goods or services and against a subsequent HDC as well. Rule 433 requires a provision to be included in boldface type in consumer credit contracts that alerts HDCs to their potential liability effect of the rule: -When a negotiable instrument contains the required notice, a consumer can bring any defense that she or he has against the seller of a product against a subsequent holder as well -The rule makes the buyer's duty to pay conditional on the seller's full performance of the contract
Secondary liability
-Drawers and indorsers are (blank) -On a negotiable instrument, (blank) liability is *contingent liability* -A drawer or indorser will be liable only if the party that is primarily responsible for paying the instrument refuses to do so (dishonors the instrument) -Parties are (blank) on a negotiable instrument only if the following events occur: 1. The instrument is properly and timely presented 2. The instrument is dishonored 3. Timely notice of dishonor is given to the secondarily liable party
Mental incapacity
-If a court has declared a person to be (blank), then any instrument issued by that person is void. The instrument is void ab initio (from the beginning) and unenforceable by any holder or HDC
Mental incapacity
-If a maker or drawer issues a negotiable instrument while mentally incompetent but before a court has declared him or her to be so, the instrument is voidable
Fraud in execution
-If a person is deceived into signing a negotiable instrument by being told that it is something else, fraud in the execution (or inception) is committed against the signer -This defense cannot be raised if a reasonable inquiry would have revealed the nature and terms of the instrument
Illegality
-If a statute provides that an illegal transaction is void, then the defense is universal -If the law merely makes the instrument voidable, then the illegality is a personal defense against an ordinary holder, but not against an HDC
Checks signed by agents (Authorized agent's signatures)
-If the agent signs his own name on a check that is payable from the account of the principal and the principal is identified, the agent is not personally liable
Transfer warranties
-Implied warranties, made by any person who transfers an instrument for consideration to subsequent transferees and holders who take the instrument in good faith -The following (blank) warranties extend to all subsequent holders: 1. Transferor is entitled to enforce the instrument 2. Signatures are authentic and authorized 3. Instrument has not been altered 4. Instrument is not subject to defense 5. the transfer has no knowledge of any bankruptcy (or insolvency) proceedings against the maker, the acceptor, or the drawer of the instrument
Imposter rule (Special rules for unauthorized indorsements)
-Imposter induces a maker to issue an instrument in the name of an impersonated payee -Focus Is on the Maker's or Drawer's Intent: The UCC's imposter rule provides that an imposter's indorsement will be effective (not a forgery) insofar as the drawer or maker is concerned -Comparative Negligence Applies: The comparative negligence standard also applies to situations involving imposters
Discharge by material alteration
-Materially altering an instrument may discharge the liability of all parties -(However, an HDC may be able to enforce a materially altered instrument against its maker or drawer per the instrument's original terms.)
Secondary liability--Proper notice
-Once an instrument has been dishonored, secondary parties must be notified in any reasonable manner, including oral notice, written notice (including e-mail or fax), and/or a notice written or stamped on the instrument -Any necessary notice must be given by a bank before its midnight deadline (midnight of the next banking day after receipt) -Any party other than a bank must give notice within thirty days following the day of dishonor (or the day on which the person learned of the dishonor
Discharge by impairment of recourse
-Ordinarily, when a holder collects the amount of an instrument from an indorser, the indorser has a right of recourse (right to seek reimbursement) against prior indorsers, the maker or drawer, and accommodation parties
Discharge by reacquisition
-Reacquisition of an instrument by a person who held it previously discharges all intervening indorsers against subsequent holders who do not qualify as HDCs -The person reacquiring the instrument may be liable to subsequent holders if the instrument is dishonored
Signature liability
-Signers of negotiable instruments are potentially liable for the amount stated on the instrument -A person is *not* liable on an instrument unless he or she has signed it personally or through an authorized representative
Makers (Primary liability)
-The (blank) of a promissory note unconditionally promises to pay the note according to its terms -The (blank's) promise to pay renders the instrument negotiable
Lack or failure of consideration
-The absence of consideration (value) may be a successful defense in some instances -If delivery of goods becomes impossible, a party who has issued a draft or note under the contract has a defense for not paying it
Accommodation indorser
-The accommodation party who signs on behalf of a payee or another holder is only secondarily liable on the instrument
Accommodation maker
-The accommodation party who signs on behalf of the maker is primarily liable on the instrument
Federal limitations on the rights of HDCs
-The federal government limits the rights of HDCs in certain circumstances because of the harsh effects that the HDC rules may have on consumers
Defenses and limitations
-There are two general categories of defenses: universal defenses and personal defenses
Parties to whom warranty liability extends (Transfer warranties)
-Transfer of an order instrument by indorsement and delivery extends warranty liability to any subsequent holder who takes the instrument in good faith -Without indorsement, warranties extend only to immediate transferee
Warranty liability
-Transferors make certain implied warranties regarding instruments they negotiate -arises even when a transferor does not indorse (sign) the instrument -fall into two categories: Those that arise from the transfer of a negotiable instrument and those that arise on presentment
Discharge by impairment of collateral
-When a holder "impairs the value" of the collateral [given as security] without the consent of the parties who would benefit from it in the event of nonpayment, those parties are discharged to the extent of the impairment
Forgery
-When a person (blanks) an instrument, the person whose name is (blanked) has no liability to pay any holder or any HDC the value of the forged instrument
Extreme duress
-When a person signs and issues a negotiable instrument under (blank), the instrument is void and unenforceable by any holder or HDC -An immediate threat of force or violence would qualify as (blank)
Discharge in bankruptcy
-an absolute defense on any instrument regardless of the status of the holder -This defense exists because the purpose of (blank) is to settle all the insolvent party's debts
Unauthorized signatures
-arise in two situations: 1. When a person forges another person's name on a negotiable instrument 2. When an agent who lacks the authority signs an instrument on behalf of a principal
Fictitious payees (Special rules for unauthorized indorsements)
-can be a person or firm that does not truly exist or an identifiable party that will not acquire any interest in the instrument -Under the UCC, the payee's indorsement is not treated as a forgery, and an innocent holder can hold the maker or drawer liable on the instrument
Secondary liability- presentment
-proper (blank): can be made by any commercially reasonable means, including oral, written, or electronic communication -A note or certificate of deposit (CD) must be presented to the maker for payment. A check is presented to the drawee (bank) for payment -timely (blank): Timeliness is important for proper (blank)
Exceptions to the general rule (Unauthorized signatures)
-ratification: Signature is ratified andprincipal becomes liable -Negligence: Party who substantially contributed to forgery is liable
Two kinds of liability associated with negotiable instruments
-signature liability: arises from the person's signature on the instrument -warranty liability: arises from warranties that are implied when the person presents the instrument for negotiation
Personal defenses
-sometimes called limited defenses) are used to avoid payment to an ordinary holder of a negotiable instrument -They are not a defense against an HDC or a holder through an HDC include: 1. breach of contract or breach of warranty 2. lack or failure of consideration 3. fraud in the inducement (ordinary fraud) 4. illegality 5. mental incapacity 6. ordinary duress or undue influence rendering the contract voidable 7. previous payment or cancellation 8. unauthorized completion of an incomplete instrument 9. nondelivery of the instrument
Protect the transferee (Presentment warranties)
-these warranties are referred to as presentment warranties because they protect the person to whom the instrument is presented. -limitations: The second and third warranties do not apply to makers, acceptors, and drawers
Special rules for unauthorized indorsements
-uGenerally, if instrument is forged or unauthorized, burden of loss falls on the first party (not maker) to take the instrument -This general rule has two important exceptions that arise when an indorsement is made by an imposter or by a fictitious payee
Primary liability
-unconditional -a person who is (blank) on a negotiable instrument is absolutely required to pay the instrument--unless, of course, he or she has a valid defense to payment -liability is immediate when the instrument is signed or issued -no action by the holder of the instrument is required -only *makers* (who promise to pay) and *acceptors* (such as a bank that has agreed to pay an instrument when presented later) are (blank)
