NI

Issue

An "issue" is the first delivery of an instrument by the maker or drawer to a holder or remitter (i.,e a person who makes payment using an instrument)

Note

Promise to pay money. A two-party instrument between the maker (obligor) and the payee (promisee)

Checklist of Technical Procedures

Unless presentment or notice of dishonor is waived per for drawers and indorser's § 3-504

Liability of Drawer of Draft

*SECONDARY* b/c the draft must be first *presented* to the drawee for payment (within 30 days), drawee has to *dishonor* (not accept or pay it), then give *notice of dishonor* to drawer that it didn't fulfill its obligation and therefore making the drawer liable to pay it (presentment, dishonor, and notice of dishonor) Note- technical procedures could be waived! Drawers can't disclaim liability on a check but can on other drafts (can't write "without recourse")

What constitutes negligence?

*The following are examples of negligence that can validate forgeries or alterations:* 1. Leaving blanks or spaces on the instrument is fault of the drawer/maker 2. Mailing the instrument to someone with the same or similar name as the payee 3. Failing to follow procedures designed to avoid forgeries is careless of drawer/maker 4. Failing to safeguard the signing device (rubber stamp or signing machine)

Effect of Instrument on Underlying Obligation (merger)

1) Certified, cashier's or teller's check - discharged 2) Uncertified checks and notes - underlying obligation suspended until paid. If check or note is dishonored, holder may sue on instrument or underlying obligation.

Stages in life of a NI

1) Issuance (by drawer or maker) 2) Transfer (between indorsers/holders) 3) Presentment (by collecting/depositary bank to drawee bank)

Safeguard Exceptions

A bank does not have to follow the EFAA in the following circumstances: 1. *New accounts* - during first 30 days, bank must follow EFAA for cash, gov't checks & bank-generated checks up to $5,000, but may hold excess for nine business days 2. *Large checks* - bank may hold excess of $5,000 for a reasonable time* 3. *Redeposited checks* - banks may hold for a reasonable time* unless check returned for missing endorsement or it was postdated 4. *Repeated overdrafts* - bank may hold for a reasonable time* during six months following six months of repeated overdrafts 5. *Reasonable cause* to doubt collectibility 6. *Emergency conditions* - bank may hold during emergencies beyond its control but customer must be notified when funds become available. * A *reasonable time* is presumed to be five business days for local checks and six business days for nonlocal checks.

Properly Payable

A bank may charge the account if the item is *properly payable*: if it's authorized by the customer & is in accordance with any agreement between customer and bank. *DRAWER* CAN SUE FOR VIOLATION OF THE PROPERLY PAYABLE RULE. If an item was *not* properly payable (forgery), the bank must re-credit the customer's account if a timely complaint is made within a certain amount of time. (aka- bank statement rule) Whether an item is *properly payable* depends on: a. the terms of the deposit contract between the customer and the bank, b. who presents the item, c. the terms of the item, d. the usages of trade (i.e., common understanding) *Overdrafts*: If payment of the item in question would overdraw the customer's account, the bank does not have to pay but MAY do so - even where the bank and its customers have no agreement concerning drafts. *Exam Tip*: in the case of insufficient funds in the drawer's account, remember that the bank does not have to honor the check. If the bank chooses to do so, the customer is liable to the bank for overdraft and may also be charged a fee. *Altered & completed items*: If an item has been altered (e.g., the amount changed), the bank may charge the account only according to the *original terms* of the item unless the customer's negligence let to the alteration, in which case the bank may pay the item as altered. If a customer leaves blanks in the item that are later filled in, the bank may assume that the item as completed is proper (unless it knows otherwise), and the account may be charged accordingly. *Proper Presenter*: (per §4-401) - A bank may only charge a customer's account with the amount of an item only if it pays a person who qualifies as a "person entitled to enforce the instrument" (usually a "holder") - i.e., someone in possession of the instrument to whom the instrument has been validly negotiated. - A bank has *not paid a holder* if it pays an instrument with: a forged signature, or a forged endorsement. (if the bank makes a payment to a NON-HOLDER, it does so *WITHOUT* authority b/c it has not followed the customer's order, which was to pay to the order of [payee]." *Example*: Drawer writes check on account at State Bank payable to order of Payee. Check is stolen from Payee and his name is forged thereon. Forger cashes check at his bank, Capital Bank, which in turn presents it to State Bank for payment. Meanwhile, Payee reports loss of check to Drawer and she notifies her bank. State bank must return the money to Drawer's account because item was not "properly payable." Drawer had ordered the bank to pay to order of Payee and Payee had not ordered further payment to anyone (so negotiation stops with him). After re-crediting Drawer's account, however, State Bank may proceed against Capital Bank (or the forger) for breach of presentment warranty that it was a person entitled to enforce instrument. *Pre-Authorized drafts*: If a customer pre-authorizes a check by phone, the bank must honor it even though the customers never signed it. *Postdated checks*: A bank may honor a post dated check & charge it against the customers account unless the customer give the bank notice that: 1. The postdated check has been issued, 2. Describe it with reasonable certainty and state 3. That the bank shouldn't pay it until the date written on the check 4. However notice must be given in such a manner as to allow the bank a reasonable opportunity to act on it *Note*: If *proper notice* is given and the bank pays it anyways, the *bank is liable* for *damages* for the loss resulting from its act; the loss may include damages for dishonor of subsequent items. *Stale Checks:* A bank isn't obligated to its customer to pay a check that is presented 6 mths after the date on the check. However, it can charge the customer account for payment made after 6 mths in good faith.

Signature Liability Rule

A party is NOT liable on an instrument unless they sign the instrument or have an authorized agent sign the instrument. *Someone who is suing is trying to get paid for the FIRST time but there is NO liability without the person's signature.*

Fictitious payees

A payee that either is a person whose name it completely made up or it could be a different kind of fictitious payee. a. Issuance to a fictitious payee or a person not intended to have an interest will validate a forged indorsement. b. An agent or employee only need furnish the payee's name. c. The person forging the indorsement does not have to be the person who supplied the name of the payee.

What is the general rule when a HOLDER fraudulently alters an instrument?

Discharges the parties as against that holder (but a subsequent HDC can enforce as to the original amount) so, if holder changes $2000 note to $20000, can't even recover the original $2000

Dishonor

Drawee or maker refuses to pay.

Requirements for Check (Draft)

Financial institution is the drawee. *Payable on demand* (whenever the payee wants it!)

"Perfect defendant"

HDC is free from claims of others to the instrument

Indorsement - EXAMPLE

Harry has in possession a check that was drawn payable "to the order of Paula Payee.: The back of the instrument is as follows: *Analysis*: Harry cannot qualify as a holder of the check. As originally drawn, the check was order paper ("paper to the order of Paula Payee"). When Paula indorsed, she named a specific payee (John Smith) and so the paper remained order paper (requiring Smith's signature for negotiation). Smith signed in blank but did not name a new special indorsee) and so the check was converted to bearer paper and could be negotiated by delivery alone. At some point, the paper was negotiated to Fred Farmer who changed the check back into order paper by naming a new special indorsee (Peggy Lee). Thus, further negotiation required Peggy Lee's indorsement plus delivery. The check apparently was delivered to Delta Dawn, but there was no indorsement by Peggy Lee. Delta Dawn signed in blank and the paper was delivered to Harry. Unfortunately, Harry does not qualify as a holder because the check was not properly negotiated because Peggy Lee did not indorse.

Liability of Presenter

If bank pays, it may sue presenter for breach of presentment warranty of being entitled to enforce.

Liability of transferor

If presenter loses, he may sue other transferors for breach of various transfer warranties is entitled to enforce; authentic & authorized sigs; and no good defenses.

Fraudulent Alteration § 3-407(a)

If the alteration is fraudulent: - all prior non-negligent parties are completely discharged from liability on the instrument and on the underlying obligation but NOT the party that caused the negligence-that party is liable

Anomalous Indorsement

Indorsement by a person who wasn't the holder of the instrument - outside the chain of title - is notice of its *accommodation* character.

Certificate of deposit

Note issued by financial institution - financial institution acknowledges receipt of money and promises payee/depositor to repay the money.

I I I I Favor Defenses (IIIIFD)

Real defenses that can be asserted against a HDC or non-HDC: *I* = Infancy *I* = Incapacity to contract *I* = Illegality *I* = Insolvency *F* = Fraud in the Factum *D* = Duress

Payor and collecting banks are excused from complying with time limits by showing per §4-109(b) that:

Such delay was caused by circumstances beyond the bank's control and the bank used reasonable diligence under the circumstances to avoid the problem or to comply after the problem ceases

HDC Subject to "Real Defenses"

THE ONLY DEFENSES THAT CAN BE USED AGAINST AN HDC: -*Infancy* (a defense under state law otherwise it's personal d) -*Duress* (instrument signed at gun point voids obligation but one signed under threat of prosecuting makers son who's a thief - is merely voidable so cannot be used against HDC) -*Lack of legal capacity* (making obligation void) -*Illegality* (making obligation void) -*Fraud in the factum* (signer lacked knowledge of instrument's character or reasonable opportunity to learn of it otherwise it's personal d) -*Discharge in insolvency* (bankruptcy - if person's estate is liquidated or rehabilitated through bankruptcy, all their debts are dissolved and that instrument is included) -*Omission of required consumer protection language* -*SOL* (6 yrs from due date - if unaccepted draft, 3 yrs after dishonor/10 yrs after issue), *payment to former holder, alteration, unauthorized signatures and forgeries* - Suretyship (Accommodation) - by signing instrument, accommodation party incurs liability without being a direct beneficiary. If HDC knows of it, he takes subject to that party's defense.

AMAID has obligations (obv)

The following may incur liability based on an obligation on the instrument: *A* = Acceptor (as drawee) *M* = Maker *A* = Accommodation Party (surety, guarantor) *I* = Indorse *D* = Drawer

Example of a Negotiable Draft

The is is a *negotiable* DRAFT because it (i) is in writing, (ii) is signed by the maker (Debbie Dante), (iii) contains an unconditional order to pay ("To: Dan Duke...Pay"), (iv) a fixed amount of money ($5,000), (v) on demand (because no time is stated for payment it is considered payable on demand), (vi) to order ("the order of Pam Payee"), and (vii) contains no unauthorized undertaking or instruction.

Obligor

The party to the instrument who is being sued by the holder of the instrument. Thus, the obligor could be the drawer of a note, the maker of a note, or someone who indorsed the instrument.

What is a Transfer Warranty?

These warranties can be enforced against all transferors for *consideration* by all transferees. They are made by: a transferor of the instrument for consideration to the transferee, and if indorsed, to any subsequent transferee. The DRAWEE does NOT receive transfer warranties because the instrument is *presented* to the *drawee*, not transferred to it.

"BFINE" forgeries

Under the general rule, a forged signature is NOT effective as the signature of the person whose name is forged. But here, the *drawer* is *validating* the *forgeries* by acting *carelessly*. he BFINE ;) *B* = Bank statement rule violated - failure to discover forgeries or alterations within a reasonable time after receiving bank statements *F* = Fictitious payee signature forged - issuance to an IMPOSTER or a payee not intended to have an interest in the instrument. *I* = Impostor: pretending to be someone else *N* = Negligence contributed to forgery - for example, leaving blank spaces or making it to person with the same name as payee. *E* = Entrusted employee's forges signatures - includes agents, not just employees.

If drawer issues check for $100, payee alters it to $1000, drawee bank pays it, drawer notices it on his bank statement and immediately complains to drawee bank, must drawee bank recredit the account?

Yes, $900 recredit, only properly payable as to $100.

If the payee of a check alters the check by changing "$50" to "$500" and bank pays, does bank have to recredit the customer's account?

Yes, has to recredit as to $450 as long as he complains within a reasonable amount of time.

Person Entitle to Enforce (PETE)

a. Holder of the instrument b. A non-holder in possession of the instrument who has the rights of a holder c. A person not in possession of the instrument who is entitled to enforce the instrument pursuant d. A person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument (e.g., stolen instrument)

Should the one who is suing bring Breach of Warranty Action? Or Action under Endorsement contract?

if plaintiff is holder & obligor has not paid instrument (check bounces, or note not paid - trying to get money for first time) - then sue on indorser's contract. If plaintiff is payor (i.e payor bank) & if payor has paid and later discovers the payor shouldn't have paid b/c check is forged, or note is altered (trying to get money back) - then attempt to sue indorser for breach of warranty, transfer or presentment

Discharge by holder

surrendering instrument to obligor, destroying it, canceling it (e.g., writing "void"), etc.

Drawer's do not have warranty liability because:

- Drawers do not make these warranties. - Drawers do not "transfer" instruments. - Drawers "*ISSUE*" instruments.

Transfer

A delivery by a person other than the issuer for the purpose of giving one the right to enforce the instrument.

Defenses on Negotiable Instruments

An HDC can enforce an instrument subject only to real defenses; he takes free of personal defenses and claims. Whether an obligated party such as a maker, drawer, or indorser will be forced to pay depends on whether the holder is an HDC and on what defenses the obligated party has. If the holder is not an HDC, obligated party can assert both Real Defenses and Personal Defenses. If the holder is an HDC, obligated party can assert only Real Defenses.

Charge Back

Prior to final settlement, a depository bank or any other collecting bank that learns that payment on the item will not be made, the bank may *"charge back" (reverse)* any temporary (provisional) settlement given its customer for the item. *The depositor must repay the money* (doesn't matter if bank has already permitted its depositor to draw against the item) *Notice of charge back* The depository bank doesn't need to give notice to its customer that it is charging back the amount of a returned check *before* doing so, BUT it must send notice to the customer that charge back has occurred *before expiration of its midnight deadline* (i.e., midnight of the banking day following the banking day on which it learned the check was being returned).

Banking day

That part of the day when the bank is open to the public for carrying on substantially all of its banking functions.

Words of Negotiability

*BEARER PAPER*: "good luck on the bar exam", "payable to bearer" - does not identify a person as payee *ORDER LANGUAGE*: "to the order of Frank Smith" **IF BOTH ORDER AND BEARER LANGUAGE - BEARER CONTROLS!** Exception for checks: order or bearer language is waived (ONLY for checks!!)

Discharge as a personal defense

*Discharge due to alteration is a personal defense, not a real defense.* Therefore discharged parties may be liable: - according to the original terms of the document - to a holder in due course. A payor or drawee bank -may charge an altered instrument against the customer's account according to the instrument's original terms and an HDC or drawee/payor bank may enforce the instrument according to its term when completed for an *incomplete instrument*

Collection speed and route

*Speed of Collection* A collecting bank exercises ordinary care when it: - passes items or notices of dishonor along the chain - BEFORE its midnight deadline or be found not to have exercised ordinary care. If the bank takes longer to act, it has the burden of showing that the delay was reasonable. *Collection Route* A collecting bank: - is required to use a "reasonable prompt method" of collection and - may not use a circuitous route for collection in order.

Presentment and dishonor are necessary (unless excused) to

BIND INDORSERS AND DRAWERS.

Transfer Warranties

Everyone that places their indorsement on the instrument *AFTER* issuance is warranting that: - Warrantor is a person entitled to enforce the instrument - All signatures are authentic and authorized - Instrument has not been altered - Instrument isn't subject to a defense or claim in recoupment of any party that can be asserted against the transferor - Transferor (warrantor) has no knowledge of any insolvency proceedings of maker or acceptor or drawer of an unaccepted draft - The amount of a remotely-created consumer item is authorized by the drawer. Any transferee who took the instrument in good faith may recover from the warrantor as damages for any breach of warranty an amt. equal to the loss suffered as a result of the breach, but not more than the amount of the instrument plus expenses and loss of interest as a result of breach. The cause of action for breach of warranty accrues when the claimant has reason to know of the breach. Warranties w/ checks: - Can't disclaim checks. - Notice of the claim must be given to the warrantor within *30 days* of the claimant having reason to know of the breach of warranty and the identity of the warrantor, or else the warrantors liability is discharged to extent of loss caused by the delay in giving notice of the claim.

Example of a Negotiable Note

This is a *negotiable* NOTE because it (i) is in writing, (ii) is signed by the maker (Max Maker), (iii) contains an unconditional promise to pay ("the undersigned promises to pay"), (iv) a fixed amount of money ($1,200), (v) on demand (no payment date is stated), (vi) to bearer, and (vii) contains no unauthorized undertaking or instruction.

Bank Statement Rule: Burden of Proof and Statute of Limitations § 4-406(f)

- Each party has the burden of proving the other party's lack of care. - All customer complaints must be made *within one year* after bank statements were made available to the customer. - If the customer timely complains and the bank fails to take appropriate action, the customer has *three years* to file suit. (§ 4-111)

Liability of Maker of Note

-*PRIMARY LIABILITY* - must pay instrument when it's due according to its terms at the time it was issued or if a maker signs a note with blank spaces, the maker is bound by the subsequent filled in terms -Liable to holder or indorser who paid instrument -You have an obligation to pay the note unless you have some defense that is effective and will defeat beating the note (defenses depend on status of holder) -*Co-makers*: can be sued individually or as a group but have right to contribution of their share; *JOINT AND SEVERALLY LIABLE*

Draft

-AKA a check -Order to pay money (3 party instrument) Drawer = person ordering payment Drawee = person to make payment (bank) Payee - person to receive payment

Payable in Money

-Authorized medium of exchange: foreign, or domestic, no Monopoly money -CANNOT be payable in goods or services -*WORDS PREVAIL OVER FIGURES* - if it says "$500" but it is written "five thousand", then it is $5000

Payment of checks after the Drawer's death

Generally, drawee bank may continue to pay checks until it knows drawer has died and has a reasonable opportunity to act on that knowledge. The bank may continue to pay on the account of a deceased customer for *10 days* after the death unless a person claims an interest & asks the bank to stop paying before then. - Bank returning checks is a dishonor 3-502 - But it would *not* be a wrongful dishonor

Liability of Agent on an Instrument

If principal isn't identified on instrument through signature, agent is liable to the HDC *unless* they can prove the holder had notice of the representative nature of agent's signature, OR to non-holder in due course *unless* agent can prove that the original party didn't intend the agent to be liable. *NO* liability if principal's name is on the check!

Alteration

Obligor doesn't want to pay because the instrument was altered. - occurs when a holder makes unauthorized change that changes the contract of any party in any respect such as modification of the number, or relation, of the parties, change, addition or removal of parts of the original instrument or unauthorized completion of blanks

Transferee

We refer to the transferee as an holder. This is the person to whom the instrument is transferred. Becoming a holder is the first step to becoming a HDC.

Checklist for determining when item is NOT properly payable

*A bank cannot charge a customers account*: 1) For more money than the original order (alteration of amount by third party) 2) If there is no order by depositor (forged signature of drawer) 3) If the bank pays the wrong person (forgery of payee or indorsee's signature) 4) If item is post-dated, and customer gives bank notice of post-dating and bank pays item before stated date.

Payable on Demand

*PAYABLE ON DEMAND*: -"Payable on demand" - states that it is payable on demand -"Payable at sight" - states that it is payable on sight -"Payable upon presentation" -"Will of holder" - it otherwise indicates that it is payable at the will of the holder - No time stated - payable on demand (the payee can demand payment whenever he/she wants it!) **BECOMES OVERDUE**: An instrument that's payable on demand becomes overdue at the earliest of: -On the day demand for payment was made -If it's a check - *90 days* after its date or -If not a check - when the instrument was outstanding for period *after its date*, which is unreasonably long under the circumstances of the case in light of the nature of the instrument & the usage of trade

Interest

-There's a presumption of no interest (like an ordinary check) -Interest may be stated but not violate the fixed amount requirement if it still states amount of money (as long as it is readily ascertainable) -Can also include references to outside sources

Other Indorsement Issues

-Transferee's right to transferor's indorsement - if instrument is transferred for *value*, transferee has specifically enforceable right if it is missing. -*Depositary Bank* becomes *holder* even w/o transferee's signature. -Misspelled - payee can indorse with correct name. -Payee lacking capacity can effectively indorse.

Stop payment order (under PP rule)

A customer may stop payment (on ordinary checks, prom. notes, sales, drafts, etc) by giving notice that *reasonably identifies* the item and is received sufficiently before payment that the bank has a *reasonable opportunity* to act on it. May be: - *oral*: good for only 14 days (unless renewed in writing within that period) - *written*: good for 6 months (but may be renewed in writing for further 6 mo. periods) *CANNOT* include: bank obligations (e.g., cashier's checks, teller's checks, and certified or accepted items) If the bank pays an item in spite of a stop payment order, the customer has the *burden of proving* that a loss has occurred and the amount of the loss. If there is an HDC in the chain of transferees of the item, the customer cannot recover - b/c even if payment had been stopped, the customer would have to pay the HDC anyway. (subrogation rule below)

Remotely-Created item (Demand Draft)

A draft not signed by the drawer but created with the drawer's authority so that a third party can get paid from the drawer's account at the bank (3rd party is usually a seller in an Internet transaction or when you pay bills over the phone by giving creditor your checking acct #) *Example*: A vendor calls you selling you something and you authorize payment but you don't have a check (not face to face) but you authorize them to take the money out of your account. There is *no* signature that check but it remotely belongs to *you* since it is a "remotely created check"

Imposter Rule

An imposter is someone pretending to be someone else. a. Issuance to an impostor will validate a forged indorsement. b. An impostor need not communicate in person with the drawer. c. The person forging the indorsement does not have to be the person who was the impostor. Drawer or maker may be estopped to deny the validity of forged endorsement if they acted carelessly (responsible for determining true identity of payee). Example: A person who shows up your house and pretends they're part of a charity and you give them a check to that charity and it turns out that person was pretending to be someone else. When imposter puts in a fake payee name and indorses the check to themselves, that means I was negligent and I am liable b/c I validated the forgery. (Negligent means: failure by action, behavior, or response, willful or to maintain the expected care required from a reasonable, prudent person under the circumstances).

Liability of Drawee

Drawee has no liability unless drawee *signs* the instrument. There is no liability on a drawee (bank) until it *accepts* the check by agreeing to honor it. *ACCEPTANCE OR CERTIFICATION* - Drawee signed agreement to pay draft as presented or by writing on the check indicating that is certified. If bank certifies the check, it is *primarily liable* as an *acceptor* & the drawer may NOT stop payment. CERTIFICATION DISCHARGES THE DRAWER AND INDORSERS. Remember: The drawee of a check has no obligation to certify or sign/accept the check, and refusal to certify it is *not dishonor* of the check. But if bank does certify a check and then refuses to pay, the bank could be liable to HDC who comes after it. *FINAL PAYMENT* - when drawee bank pays the item in cash or doesn't revoke a provisional settlement by the midnight deadline of the next banking day after the day of receipt (if bank provisionally issues a check but then waits to see if customer puts enough $ in the account, then doesn't withdraw the check, it's issued!) *CONVERSION LIABILITY* - drawee bank who pays on forge indorsement is liable - *MUST* have received delivery of the instrument. Payee can sue the drawee bank for conversion and the drawer can then sue the drawee bank for paying on a forged endorsement which is not properly payable!

PETE

HDC = a person trying to make another pay on a negotiable instrument must be a Person Entitled To Enforce. (Almost all PETEs are Holders.) *P* = Person *E* = Entitled *T* = To *E* = Enforce

Alteration - Effect on HDC

HDC can enforce for the original amount (if A issues a promissory note to B for $100, and B alters it to read $1,000 and sells it to C, C can enforce against A for $100, and then A has a defense of alteration for the other $900) *Unauthorized completion* - HDC may enforce as completed (A signs a check but leaves the amount blank, hands it to B saying he can spend up to $100, but B writes the check out for $1,000 - A is liable for $1,000)

Negotiability

Refers to the form of the instrument - it's determined at the time of issuance. *If it says it is NON-NEGOTIABLE, then it is - can't opt in.

Death or Incompetence

The bank may continue to pay on the account of a deceased customer for *10 days* after the death unless a person claims an interest & asks the bank to stop paying. a. Bank returning checks is a dishonor b. But it wouldn't be wrongful dishonor *Exam tip*: If you see a question where a bank's customer dies or is adjudged incompetent, remember that ordinary agency rule does NOT apply to revoke the bank's authority. Instead the customer's death does *not revoke* the bank's authority to pay a check until the bank (i) *knows* of the death and (ii) has a *reasonable time to act* on the knowledge. Even w/ such knowledge, the bank may continue paying checks for *10 days* after the date of death unless someone claiming an interest in the account orders that payment be stopped.

Burden of Establishing Defenses as *HDC*

"If the validity of signatures is admitted or proved and there is compliance with subsection [3-308(a) - regarding proof of signatures], a plaintiff producing the instrument is entitled to payment IF the plaintiff proves entitlement to enforce the instrument under 3-301, UNLESS the DEFENDANT proves a defense or claim in recoupment. This results in a presumption that every holder is entitled to recover. If the plaintiff can establish that she *is* a holder (i.e., the transferee in possession of a bearer instrument, or the indorsee in possession of an order instrument), and can *produce the instrument* and establish the validity of the signatures thereon, the BURDEN is on the DEFENDANT to prove a defense. *Where plaintiff cannot produce instrument* The owner of an instrument can win without producing the instrument, but failure to produce it will prevent the attachment of the presumption under section 3-308. The burden is then on the plaintiff to prove due execution, negotiation, and each fact essential to the validity of the instrument and the claim of ownership. *Missing instruments* If the original instrument has been lost, stolen, or destroyed, the owner may recover by proving up its terms together with the facts why the original cannot be produced. *Burden of Establishing Due Course Holding* "If a defense or claim in recoupment is proved, the right to payment of the plaintiff is subject to the defense or claim, except to the extent the plaintiff proves that the plaintiff has rights of a HDC which are NOT subject to defense or claim." Thus, HDC status is not presumed, but must be proved by the person so claiming. *EXAM TIP*: Remember that HDC status is determined at the moment the instrument is *negotiated* to the holder *and/or* the holder gives *value* therefore, whichever occurs later. It does not matter if the holder acquires notice of a claim or defense *after* that moment.

Presentment Warranties

*A person obtaining payment on a check or a previous transferor of the check is warranting to the drawee-payor bank that*: - Warrantor is a person entitled to enforce or authorized to accept payment; - The draft has not been altered; - No knowledge that the signature of the drawer is unauthorized; and - The amount of a remotely-created consumer item is authorized by the drawer.

Surety's Rights

*Exoneration*: At maturity of the obligation, the surety may bring an equitable action to compel the principal to pay the debt and thereby *exonerate the surety from liability*. *Subrogation*: If the surety is forced to pay off the creditor, the *surety is surrogated to whatever rights the creditor had*, such as rights to other collateral or the right to a preferred position in the principal's insolvency proceeding. *Reimbursement*: Promise of *principal to reimburse the surety* if the surety is forced to pay off on the surety's promise to the creditor. *Contribution*: Right of *partial reimbursement* that co-sureties have against each other for proportionate share of the debt. Ex: XYZ sign M's note agreeing to be co-sureties. The payee may enforce the entire obligation against any of one the three & the right of contribution will allow one to sue the other two for their shares.

Forgery of Payee's name or of Special Indorsee's name

*Forgery of payee means* the forger is liable on the instrument and everyone taking an instrument after an invalid negotiation of an item with the forged instrument is NOT a "person entitled to enforce the instrument." *Forgery of special indorsee's name means* no one taking an instrument after the forged indorsement qualifies as a "person entitled to enforce the instrument." -The risk of loss is on the party who interacted with the payee (depository bank) -The bank must check for ID, fingerprint etc... or else its held liable *Exception*: If a check is made out to bearer or if the payee had indorsed it in blank before the check was stolen. In that case anyone in possession would be a holder and possibly an HDC if requirement's are met - (it is bearer paper and obv. anyone in possession of bearer paper is entitled to enforce!)

Negotiability/negotiable (form) v. Negotiation (transfer)

*Is the instrument negotiable*?": Asks if the instrument is in proper form to meet the technical requirements of negotiability - refers to FORM *Has the instrument been negotiated*?: Asks about the legal validity of the attempted transfer of the instrument - refers to TRANSFER

What makes a promise or order to pay UNCONDITIONAL?

*Items that make it CONDITIONAL (are non-negotiable)*: -Express condition to payment -Promise *subject to* another record -Incorporation by reference (rights or obligations w/ respect to the promise or order are stated in another record) *Items that DO NOT make it CONDITIONAL (are negotiable)*: -Statement of consideration ("I promise to pay $50 to ABC for a TV") -Reference to another record ("as per", "accordance with") -Incorporation by reference of items that wouldn't hurt holder: rights regarding collateral, prepayment (right to pay earlier), acceleration (right to get paid early upon some event) -Limitation of payment to a particular fund or source -Countersignature -Consumer protection language

Final Payment [remember: a payment that brings a balance to 0 to pay an obligation]

*Occurs at the moment the payor/drawee bank becomes accountable for the amount of the item presented and the provisional, temporary bookkeeping entries firm up so that final settlement occurs through the collections chain. [4-215-a-1] 1. *Payment in cash* Once the payor bank hands over the money, final payment occurs and it is too late to dishonor the check. 2. *Settlement* Once a bank settles for an item (i.e., pays presented item by issuing a cashier's check), final payment occurs and the bank has no right to revoke the settlement even if the cashiers check is later dishonored. (i.e., if bank teller gives you cash and then bank teller tries to revoke its settlement, and you're still in the bank, the teller CANNOT come after you to get the money back. If the bank did this, they would be liable for conversion if they try to take the funds back from you) 3. *Failure to revoke provisional settlement* If payor bank has already made a provisional (conditional) settlement for the item presented, as it does for items presented through the check collection system, the payor bank has until midnight of the banking day following the banking day of presentment in which to reverse the provisional settlement in favor of the presenting bank and send the item back. If it fails to do so, the provisional settlement becomes final and final payment occurs. - This is the most common method of making final payment, simply by letting the time limits for dishonor expire.

Payable at a Definite Time

*PAYABLE AT A DEFINITE TIME*: -On a fixed date (i.e., a mortgagor payable on the 15th of every month) -On or before a fixed date -At a time readily ascertainable when the instrument is issued -After elapse of a specified period of time after sight *NOTE*: An instrument dated 1/10/08 is payable at a *definite time* if it states it payable: a. "On 2/X/Y" b. "On or before X" c. "60 days after X" or "60 days after sight" If the date is left off the instrument & its maturity depends on a date being stated ["payable 60 days after _______] - the instrument is not enforceable *until the date is filled in* by some with *authority* to do so. *CAN prepay, OR accelerate the due date* ("payable on January 1, 2015 but if Uncle Fred dies earlier, may accelerate note to 30 days after Fred's death") **BECOMES OVERDUE**: -If the principal is payable in installments & due date hasn't been accelerated: (it's overdue when an installment is missed & the instrument remains overdue until the default is paid) -If the payable isn't payable in installments & the due date hasn't been accelerated: (it's overdue on the day after the due date) -If the due date on the principal has been accelerated: (the instrument is overdue on the date after the accelerated due date)

Liability of Indorser of Note or Draft

*SECONDARY * b/c instrument must first have been presented to the maker (if a note) or to the drawee (if a draft), must have been dishonored (by maker or drawee), and indorser must have received notice of dishonor *No duty to pay the instrument*: a. If indorser has disclaimed liability or states "without recourse" b. If an instrument is dishonored & notice of dishonor was required but wasn't given to indorser, then indorsers duty to pay is discharged c. If a bank accepts a draft after an indorsement is made, the indorser isn't liable if the instrument is dishonored & thus doesn't have to pay it d. If an indorser of a check has a duty to pay it & isn't presented for payment or given to depository bank for collection within 30 days after the indorsement was made - indorser doesn't have to pay If payee indorses check and writes "without recourse" - this prevents him/her from incurring liability - just effective to pass time

Bank's right to setoff

*Setoff* is when a bank is able to withdrawal from the account of a customer in order to pay a debt the customer owes to the bank, itself. Example: Amy misses a payment on the school loan she has borrowed from her bank, so the bank pays itself out of her checking account. Amy has no recourse, even if the withdrawal causes her outstanding check for something to bounce. NO setoff for credit card debts and if the bank has certified an item or made a final payment, it is too late to set off a claim against the amount necessary to pay that item. *Remember for Exam*: When a bank is owed money by its customer, the bank can "set off" the amount owed by helping itself to the funds in the customer's general checking or savings accounts. HOWEVER, the bank *cannot* make setoffs: for unpaid credit card debt against special accounts or for items that have been certified or for which payment is final.

Undoing Final Payment

*The Legal Effect of "Final Payment*" [4-302] When final payment occurs under any of the 3 methods just discussed, the bank is "accountable" for the amount of the item and usually has no way to avoid payment. *Events that CANNOT undo final payment*: ("four legals" no longer apply) a. *Notice* of problems (e.g., notice of the drawer's death, incompetence, or bankruptcy) b. Bank's right of *setoff* c. Service of *legal process* d. *Stop payment order* *Events that CAN undo final payment* a. *Bad faith* of the presenter (payment made due to mistake or fraud permits bank to undo final payment) b. *Breach of a presentment warranty* (final payment does not deprive payor bank of right to sue for breach of presentment warranty)

Only With Focus Can People Understand Liability (OWFCPU L)

*Types of liability on a negotiable instrument*: *O* = Obligation on the instrument (anyone who signs the instrument - maker, acceptor, drawer, indorser, accommodation party) *W* = Warranty liability (transfer and presentment) *F* = Final payment/payment by mistake *C* = Conversion *P* = Properly payable drawee bank v. drawer [customer] issue) *U* = Underlying Contract (the underlying obligation that was the reason a check or note was given in payment)

Bank Statement Rule: Negligence of Bank § 4-406(e)

- If a bank is negligent in paying a forged or altered item, the bank is liable for its negligence. - If the customer is also negligent, the bank and the customer may share the loss. - If the bank did not pay the forged or altered item in good faith (no notice of alteration or forgery), the customer prevails even if the customer failed to report the items to the bank.

Customers Duty to Examine Bank Statements

- after a bank pays an item, it cancels them and returns the items to the customer with a statement of account - failure by customer to use reasonable care in promptly examining the statement and reporting any unauthorized signatures or alterations on an item may validate what would have been an improper payment

Types of Checks

-*Ordinary* -*Certified* - bank has accepted it and agreed to pay -*Cashiers* - drawer and drawee are the same bank; person buying the check is the remitter (amt. debited from bank customer's acct) -*Tellers* - checks drawn by one bank on another bank; (person buying the check is the remitter) -*Travelers* - demand instruments requiring countersignature by a person whose specimen signature already appears on the instrument

What makes an instrument negotiable?

-In writing -Signed by maker or drawer (mark X, signature, thumbprint, computer-generated) -Unconditional promise or order to pay -Fixed amount of money with or w/o interest -No other undertaking or instruction -Payable on demand OR at a definite time -Has words of negotiability

No other undertaking or instruction

-JUST promises to pay money - not a full contract -EXCEPTIONS: permitted undertakings or instructions, promises concerning collateral ("the maker will provide additional collateral"), confession of judgment clauses, waiver of law mean to benefit the obligor

Elements of HDC status

-Must be a HOLDER of a NI -Authenticity not apparently questioned (doesn't bear evidence of forgery or alteration or isn't otherwise so irregular or incomplete as to call it into question) -Holder must pay *VALUE* (could even pay less than the face value - also, past consideration *IS* considered value) -*GOOD FAITH* - honesty in fact and observations of reasonable commercial standards of fair dealing - *WITHOUT NOTICE* at the time of acquisition (*NOTICE* is actual knowledge, receipt of notice coupled with a reasonable time to act on it; person has reason to know based on facts and circumstances - just filing doesn't put someone on notice)

Indorsements

-Signature on the back of the instrument -*Blank* - payee signature only - does not state a particular person to whom it should be paid - this creates *BEARER PAPER* -*Special indorsements* - payee's signature PLUS designation of new person to whom instrument payable - creates *ORDER PAPER* -*Restrictive indorsement* - makes it only for deposit or collection ("For Deposit Only", "For Deposit into my BOA acct #123 Only") -ID of person to whom instrument is payable - intent determines initial payee, if it is unclear on its face -*Multiple payees* - "and" separates the names of the payees (requires ALL payees to indorse), "or" also separates (requires ANY ONE of the payees to indorse)

Holder

-The person in current *possession* of an instrument. It's either the payee or the person who has taken the instrument AFTER that, pursuant to a valid *negotiation*. -Good title (for bearer, that means possession; for order, that means possession PLUS necessary indorsements)

Bank statement rule

A customer has a duty to examine bank statements and canceled items for alteration and forgery. If the customer does not report an alteration or forgery within a reasonable time, the customer is precluded from claiming the item was not properly payable *if the customer's delay caused the bank further loss*

Failure to use ordinary care (under charge back)

ALL collecting banks must use ordinary care in collecting items. Failure to do so makes the bank liable for the amount of the item but not consequential damage unless the bank acted in *bad faith* BUT negligence does not destroy the bank's right to charge back.

Forgery of Drawer's Name

Alleged drawer is *NOT* liable. The drawee/payor bank is ALWAYS held liable because they are in the best position to detect that forgery because they should know their customer's signature. (Price v. Neal) Bank can't pass on the loss unless they sue for breach of presentment warranty. Presentment warranties allow a drawee/payor bank that has paid on a check certain conditions to sue back "upstream" to those whose hands the check has passed, if the earlier party passed or presented the check in breach of one of the warranties. Drawee bank must recredit alleged drawer's account as check wasn't properly payable unless drawee bank has a defense (i.e., BFINE - failure to examine bank statement, fictitious payee, imposter rule, negligence rule, fake employee)

Transfer Warranties Exam Tip

Although a transferor who gratuitously transfers the instrument warrants nothing, she is not shielded from the contract liability of an indorser if she indorses because an indorser is obliged to pay instrument according to its terms when indorser signed if there is presentment, dishonor and notice of dishonor. (b/c signature is on the instrument) **ON EXAM don't forget to discuss both the indorser's contract liability and warranty liability and why either or both are applicable or not

HDC protected from "Personal Defenses"

CANNOT BE USED AGAINST AN HDC: Failure of consideration, claim in recoupment, breach of warranty, fraud in the inducement (when signer knew what he was signing)

LIABILITY OF PARTIES ON EXAM

EXAM ANALYSIS ON LIABILITY: 1. Identify the status of each party 2. Discuss each party's liability RULE: Generally, no one may be held liable unless her signature or the signature of an authorized representative is on the instrument. Parties who May be Liable: 1. Maker of Note/Issuer of Cashier's Check 2. Indorser - Secondarily Liable 3. Transferor 4. Drawer - Secondarily Liable 5. Drawee 6. Acceptor 7. Accommodation Parties

Banks as Holders

If a customer delivers an item to a depositary bak for collection, the depositary bank becomes a holder of the item at the time it receives the item for collection if the customer at the time of delivery was a holder of the item, whether or not the customer indorse the item.

Negligence rule

If a person fails to exercise ordinary care and that failure: *Substantially contributes to* - an alteration or - a forgery That person is precluded from asserting the alteration or forgery against a person who - pays the instrument or - takes it for value or for collection. Effect of negligence: *A party is NOT discharged by the alteration and is LIABLE on the instrument as altered*: if the alteration was caused by the failure of a party to exercise ordinary care; the failure to exercise ordinary care substantially contributed to the alternation; and when sued by another party who in good faith pays the instrument or takes it for value or collection.

Dishonor of a Draft occurs:

If check or draft is presented to drawee across counter for immediate payment, it must be paid or returned by the close of business on that day. - If paid, check is cancelled and returned to drawer - If check is returned, dishonor has taken place - If neither occurs, drawee has converted instrument and is liable for amount of instrument as if drawee had agreed to pay it If presented through bank collection channels ("midnight deadline rule"): Using local clearinghouse agreements or Federal Reserve System mechanisms, banks typically collect checks from each other by making a provisional settlement on their own books *before* presenting a check to the drawee bank ("the payor bank"). This *provisional settlement* allows the drawee bank an extra day within which to decide whether to pay the item - in which case it simply lets the time for dishonor expire, whereby the the provisional settlement becomes final (and payment is made by remittance draft) - or to dishonor and return in. In the latter case, the provisional bookkeeping entries on the books of the collecting bank are reversed ("charged back"). This system of giving drawee banks until their *midnight deadline* (defined as as midnight of the banking day *following* the banking day of receipt) within which to dishonor an item is called "deferred posting." *Example*: A check drawn by Drawer on Antitrust National Bank ("ANB") is deposited by Payee in her bank, Payee's State Bank ("PSB"). PSB (pursuant to prior agreement with ANB) marks its books as if ANB has already paid the check, and then presents it to ANB for payment on Monday, June 1. If ANB does nothing, its deadline will expire at midnight on June 2, at which time ANB will become accountable (i.e., liable) for the item. This is true even if ANB meant to dishonor (where, e.g., the drawer's account at ANB did not contain enough money to pay the check)

Importance of Negotiability

If paper is negotiated and transferred (properly negotiated), it can reach the hands of a special good faith purchaser called a holder in due course (HDC), who gets better rights than the transferor and can get paid from the obligor even if the obligor has defenses like good reasons not to pay under normal contract law.

Subrogation rule (under PP rule)

If the bank accidentally pays over the stop-payment order and recredits the account it can use subrogation rule to step into the shoes of its customer and sue any party he could have sued. 4-407. Anytime there is a HDC in the chain bank doesn't have to credit back the customer bc HDC rights subrogate to bank. From class notes: Someone issues a stop payment order and the bank gets it. Therefore, the check should be stopped when it comes in. BUT the bank screws up and they pay the payee anyway (over the stop order). Under the rule we read, the bank IS liable if they pay over a stop order. HOWEVER, under the rule of *subrogation*, if there was no defense to payment by the payee or drawer of check, and you would have had to pay anyway, it does NOT mean we have to recredit your account. If you owed that money anyway and you didn't have a defense to payment, the bank does not have to recredit your account! For exam purposes, if a question asks something about a stop payment over, it automatically triggers subrogation. So if it asks: "whether a bank has to recredit a customer's account" - to answer this question, you have to look under the subrogation rule to see if it applies.

Exam tip regarding Alteration:

If you see a question where someone has fraudulently altered a NI, first determine whether the party is *estopped* from asserting the alteration (as in the case of negligence). If not, then the fraudulent alteration discharges all parties from liability on the instrument. However, b/c discharge is a personal defense, a drawee/payor bank or HDC may enforce the instrument against the discharged party: (i) according to its *original terms*; or (ii) in the case of an unauthorized completion, according to its terms *as completed*

Forged Indorsements

Irrelevant for bearer paper b/c indorsement isn't needed Forgery breaks chain of title for order paper and check isn't properly payable - drawer may demand bank (drawee) to recredit his account unless bank has defense against drawer.

Negotiation

Is the *process* by which an instrument is transferred by a person other than the issuer to a subsequent transferee who qualifies as a *HOLDER*. (payee transfers the instrument to a 3rd party rather than just getting the money - e.g., as payment for a sale, to donee as a gift, etc).

Burden of Proof as to *HDC*

It becomes *necessary* for the holder to prove *HDC status* only when (and if) the defendant has established some defense to the instrument that an HDC would cut off. This is because anyone who qualifies as a *holder* of the instrument (whether or not an HDC) is entitled to recover on the instrument until the defendant-obligor proves some defense. The Revision not only allows a mere holder to enforce the instrument, but it also gives other parties other than a holder the right to sue. These include: a non-holder who (b/c of the Shelter Rule) has the rights of a holder, the former holder of an instrument that has been lost or destroyed, and a person from whom a mistake payment was recovered. These are ALL "persons entitled to enforce the instrument. (PETE)

What is a Presentment Warranty?

Made for an unaccepted draft made by: the person obtaining payment or acceptance and a previous transferor of the draft at the time of transfer and in good faith. These warranties can be enforced against the presenter and all transferors by the drawee and *ONLY* the *DRAWEE*. No other party other than the drawee is entitled to exercise this remedy.

Chain of command theory

Only the bank receiving after a *restrictive indorsement* is liable for *conversion* for violating the indorsement. Section 3-206(c) provides that only a *depositary bank* is liable for non-compliance with a restrictive indorsement.

Sureties and Liability

Person who signs an instrument to lend his credit to another party but who does not get any direct benefit of the value given for the instrument. *ACCOMMODATED*: principal/debtor/obligor (person with bad credit) *ACCOMMODATION*: surety/cosigner (person with good credit) *HOLDER*: creditor/obligee (person who wants payment assured) *Liability*: Accommodation party may sign in any capacity: maker, drawer, acceptor, or indorser, but is obligated to pay the instrument in which he/she signs (i.e., if surety signs on the front, it incurs same liability as maker) *CAN* limit language - "collection guaranteed only" (guarantor) - creditor has to try to recover from obligor first *If surety pays the instrument, they are entitled to recover from the obligor/debtor.*

EX. OF *SUBROGATION* RULE After he had purchased a new car from Flash Motors, Thomas Crandall got the car home and discovered that it clashed with the color of his garage. He couldn't stand this, of course, so he phoned his bank, Octopus National, and placed an oral stop=payment order on the check he had written for the car. Negligently, the bank paid the check anyway. Must the bank recredit the account? See 4-407

Problem 89 - the bank steps into the shoes of the payee, Flash motors under 4-407(2) and now can argue the legal rights of Flash Motors. Flash Motors would win in a legal dispute with Crandall as Crandall cannot get out of his car purchase contract because the color clashed with his garage. Therefore, if Crandall would lose to Flash Motors, the failure of the bank to stop payment on the Crandall check has not resulted in a loss to Crandall as he would have had to pay Flash Motors anyway and the bank would have to honor the check from Crandall. Subrogation is a wonderful thing for the banks especially if the bank has violated the properly payable rule of 4-401!

The Expedited Funds Availability Act

Regulates how quickly a customer is allowed to withdraw deposited funds. *Government checks and bank checks*: Banks must make available on the next banking day after depositing funds from*: government checks and bank checks drawn on the same bank in which deposited, including cashier's checks, certified checks, teller's checks or similar bank generated checks *$100 Availability Rule*: Not counting government and bank checks, the customer may withdraw $100 on the banking day following the banking day of the deposit *Local Checks*: Funds from checks drawn on the same geographical area as the depositary bank must be available as follows: - Check withdrawals: must be payable to a third party NO LATER than two business days AFTER deposit - Cash withdrawals: the customer must be permitted to: take out $100 on the business day AFTER the date of deposit, must be permitted to withdraw up to $400 more by 5 p.m. on the second business day after deposit, and must be allowed to withdraw all the rest as cash on the next business day *Nonlocal checks*: (For nonlocal checks (i.e., those not drawn on banks located in the same geographical area), the funds must be available for withdrawal as follows: - Withdrawal by check: must be payable to third parties NO LATER than five business days after deposit - Cash withdrawals: $400 worth of the cash must be available for withdrawal NO later than 5 p.m., and the rest of the cash at the opening of the next business day

Dishonor of a Note occurs:

Since the maker of a note is primarily liable to pay it when due, dishonor occurs if the maker does not pay amount due when: - for a demand note, it is not paid by the maker upon presentment; - for a non-demand note, it is not paid if it is not on the later of the day of presentment or the due date when payment may be made at or through a bank or the note's term require presentment

DEFENSES to ALTERATION

The alteration of a NI can result in: - breach of both transfer and presentment warranties, - and negligence on the part of one connected w/the transaction

Midnight deadline rule

The following midnight of banking day, following the day of presentment (basically 2 days after presentment) Regulation CC and midnight deadline rule *permits* payor banks to miss their midnight deadlines and still avoid final payment in 2 situations: *Day after midnight deadline passes* 1) First situation is where bank will be able to return item to depositary bank before close of business on next banking day (or, if the return is made to a Federal Reserve Bank, before its cutoff hour) *Example*: Every day ONB returns checks to the Federal Reserve Bank by putting them in its armored car and sending them back to the Federal Reserve Bank. The armored car makes its last run at 4 p.m. The Federal Reserve Bank presents a check for $500,000 on Monday morning. On Tuesday at 6 p.m., ONB decides to dishonor the check. Before the Regulation CC rule just mentioned, the bank would have to "send" it back before Tuesday midnight, and the UCC defines "send" to include mailing so that bank would put it in the mail, thus complying with the letter of the law. Regulation CC allows the bank to wait for the next days armored car run as long as the check will ordinarily be received by the Federal Reserve Bank before its cutoff hour on Wednesday, thus getting it back quicker than mailing would. 2) *Highly expeditious means of transportation* Regulation CC also permit payor bank to miss midnight deadline as long as it uses "highly expeditious means of transportation", even if this means of transportation would ordinarily result in delivery after the receiving bank's next banking day *Example*: ONB located in California receives a check for $2 million on Monday morning. On Tuesday evening, ONB decides to dishonor the check. It phones the depositary bank, located in Miami and gives that bank a notice of large check return. On Wednesday morning, ONB delivers the check to an air courier for transportation directly to Miami, instructing the air courier to take it immediately to the depositary bank. Even though ONB did not "send" the check back before its midnight deadline, its use of a high expeditious means of transporting the check back to the depositary bank excuses its violation of the usual rule.

Bank Statement Rule: No Further Loss and Repeat Offender § 4-406(d)

There is no further loss - where the bank has only suffered its original loss and - the customer may assert the alteration or forgery. Repeat Offender - when a customer does not report an alteration or forgery within 30 days of receiving a bank statement - that customer may not receive a recredit for any other forged or altered item *by the same wrongdoer* paid by the bank during the delay by the customer if the delay causes the bank a loss.

Warranty Liability

Warranty liability places loss on party best able to detect a defect in the instrument. (when trying to get money back after money is already paid) - Warranty suits arise off the instrument. - Plaintiff in an action for breach of warranty doesn't need to possess the instrument b/c liability arises from implied warranties created automatically when the instrument is physically shifted from one party to another. - Implied warranty on a negotiable instrument is a property right and does not depend on the intent of the parties. - And plaintiff doesn't need to qualify as a holder of the instrument.

Shelter Rule

When HDC transfers a negotiable instrument, the transferee gets the same rights as the transferor (HDC) under the shelter rule. BUT this rule does NOT apply if transferee is party to fraud or illegality affecting the instrument. *BURDEN OF PROOF* is on person claiming *HDC status* or *rights* by shelter *EXAM TIP*: If you find that a particular person does not qualify for HDC status, don't stop there. Be sure to see if some holder farther up the chain of transfers was an HDC because if so, his rights as an HDC continue down to later transferees unless cut off by a holder who was a party to fraud involving the instrument.

Wrongful Dishonor

When an item is properly payable from the drawer's account but the bank wrongfully refuses to honor it, the drawer, and only the *DRAWER*, may sue b/c the drawer is the only one in privity w/ the payor bank - through the contract creating the account. *Damages* for wrongful dishonor: - A court may award the drawer actual and consequential damages for wrongful dishonor. Non compensatory damages, such as punitive damages, are awarded ONLY for outrageous conduct by the bank. - Only those damages that are *proximately caused* by the wrongful dishonor may be recovered by the drawer. However, such damages may include consequential damages for arrest & prosecution of the customer. - Automatic ("punitive" damages) were *presumed* b/c the dishonor was deemed to cause widespread damage to the drawer's credit rating and this type of damage was very hard to establish. - 4-402(b) requires injured drawers to *prove actual damages*. Punitive damages, if recoverable, must be sought under other theres than mere wrongful dishonor. Nonetheless, courts have awarded punitive damages where the dishonor is indefensible & outrageous.

Conversion

a) Occurs when an instrument is taken by transfer other than a negotiation, or a bank makes payment to someone not entitled. b) Only the person whose property rights are adversely affected may sue for conversion. (holder) c) Since only the payee can be the holder of an instrument *only the payee* has sufficient property interest to become the Plaintiff (or if it has been negotiated the instrument to another, only that person can be the holder having a property interest in the instrument) d) *You can't sue in conversion if there was no delivery* (i.e., a check made out to X in the mail doesn't get to X but is forged and cash; X had no delivery), *however X can sue on the underlying obligation.* *An instrument may be converted as a result of*: - Theft (after delivery to payee or indorsee) - Forged endorsement - Missing Endorsement - Not immediately depositing a check after a "For Deposit Only" Indorsement. - An *ISSUER* or *ACCEPTOR* of an instrument cannot sue in conversion. *What the payee can do if the drawee bank pays a check that was stolen and forged of the payee's name*: 1. Payee can sue the drawee bank or anyone taking the check after the forgery in conversion. 2. If drawee is forced to pay the payee, the drawee will sue the check's presenter for breach of presentment warranty that he was a "person entitled to enforce the instrument." 3. Then that person being sued can sue the transferee for breach of transfer warranties. 4. So the loss will pass back up the chain until it reaches the forger or, if the forger has departed for parts unknown, the first person to trust the forger. *Drawee's Obligation*: Since the check is still the property of the payee, he can replevy it from its current possessor (probably the drawer, who will have it among the canceled checks), cross off the forged indorsement, sign it, and present it to the drawee bank for payment. If the drawee pays it, good, but if not, the dishonor will have occurred and the payee may then sue the drawer on the drawer's obligation or the underlying obligation. *Measures of Damages*: The measure of liability is presumed to be the amt payable on the instrument so damages are limited to the Plaintiff's interest in the instrument. *Note*: If check is made out to "Pam and Dave" both must sign it, if only one signs it and the bank pays it, the other can sue for conversion b/c the bank misappropriated the funds of that person, however the bank may be able to seek subrogation.

What are causes of action in forgery circumstances?

a. *Properly payable rule* - arguing that the bank shouldn't have paid it b. *Warranty* (transfer and presentment warranties) - If you sign off on a check & sign either as indorser or drawer, you are warranting to the person who gets the check certain things. c. *Conversion* - someone who intentionally misappropriate (or took/used someone else's property)

Employer's responsibility for fraudulent endorsements by employee

a. An employer bears the loss for employee forgeries if the employee is entrusted with responsibility with respect to an instrument. b. *Responsibility* defined in § 3-405(a)(3) means any significant employee dealings with the instrument including: - the instrument's preparation and mailing; - bookkeeping duties - check reconciliation. c. Employee indorsement rule applies to checks issued by the employer and check's issued to the employer, naming the employer as payee. Example: Let's assume I have an employee who is given the duty of preparing, mailing, bookkeeping, balancing checkbooks, etc. If that employee forges the name or indorsement of the employer, the employer would bear the loss of the forgeries. The employer, in effect, has validated the forgeries of the employee, because the employee was the one who entrusted the employee with those duties.