Liability of Transferors and Banks in Negotiable Instruments

1. Chapter 17 Holder in Due Course, Liability, and Defenses

2. Chapter 17 Case HypotheticalTimothy Jones drafts a check in the amount of $12,000 in full and final payment for a car that Andre Hastings is scheduled to deliver to him the following Friday. Andre immediately completes a special endorsement to Clint Patterson on the back of the check (“Pay to Clint Patterson, Signed, Andre Hastings”), and transfers the check to Clint in return for a lot of land Clint deeds to him.Andre fails to deliver ownership and possession of the car to Timothy the following Friday. One week later, Clint approaches Timothy, and requests payment of the $12,000. Clint shows Timothy Andre’s special endorsement to him on the back of the check. Timothy states “I don’t owe you anything. Andre never delivered the car I was supposed to get for that $12,000. If you have problems with what I’ve just said, go talk to Andre.”Is Clint Patterson entitled to the $12,000 from Timothy Jones? If so, does Timothy have any legal recourse against Andre Hastings?

3. Chapter 17 Case HypotheticalNora Abbey, eighteen years old, is overjoyed to have received her first paycheck from her first employer, Nightingale Fashions, Inc. The check is in the amount of $542.00, and is drawn on the Bank of the Homeland. Eager to document here entitlement to the paycheck, Abbey turns the check over, and signs her name in the “endorsement” section. She gets into her car, and heads to the Bank of the Homeland, where she has a checking account, to make a deposit. Unbeknownst to Nora, the check has slipped out of her pocketbook, and onto Main Street.A cross-wind blows the check onto a street corner. An unidentified woman picks up the check, and later that day, at another Bank of the Homeland branch, she cashes the check. Four weeks later, Nora notices that the check has been processed, and she immediately calls the vice-president of the Bank of the Homeland branch she frequents, requesting that the $542 be credited to her account. The bank vice-president assures Nora that she will “look into it,” but offers no assurances.Must the bank credit Nora’s account?

4. Chapter 17 Ethical DilemmaAccording to UCC 3-416(a), “a person who transfers an instrument for consideration warrants to the transferee, and, if the transfer is by indorsement, to any subsequent transferee that:(1) the warrantor is a person entitled to enforce the instrument;(2) all signatures on the instrument are authentic and authorized;(3) the instrument has not been altered;(4) the instrument is not subject to a defense or claim in recoupment of any party which can be asserted against the warrantor; and(5) the warrantor has no knowledge of any insolvency proceeding commenced with respect to the maker or acceptor or, in the case of an unaccepted draft, the drawer.”The above-referenced implied promises are commonly referred to in the legal profession as “transfer warranties.” They are implied by law, meaning that the transferor of commercial paper need not expressly make these warranties; instead, they are recognized automatically by operation of law. Most laypersons are not familiar with these warranties (that is, until a complainant seeks to hold the transferor liable for breach of one or more of them!)From an ethical standpoint, is it fair to hold transferors of commercial paper responsible for transfer warranties, even though the transferor does not expressly make them?

5. Chapter 17 Case HypotheticalIra Ofseyer is an eighteen-year-old freshman at Golden State University. He arrives on campus several days before classes begin, and learns of a party scheduled at Tau Phi Gamma Fraternity on Friday evening. Ofseyer arrives at the party, confident that a thorough university education means more much more than mere academics.Beer is served at the party, and that night, Ira consumes the first alcohol of his young life. In the haze of the alcohol, and caught up in socializing with the Tau Phi fraternity brothers (who are trying to convince him of the merits of fraternity membership,) Ofseyer inadvertently leaves his checkbook on the dining room table.Three days later, Ira realizes he is missing his checkbook. He returns to the fraternity to find his checkbook, but to no avail. He hurries to his bank’s university branch on University Avenue, and learns that one check has been written on his account in the last three days, for $3,500 at University Stereo Shack. Ofseyer’s remaining checking account balance is $5.83. His parents will not be happy.Is Ofseyer’s bank legally obligated to re-credit his account in the amount of $3,500?

6. Holder in Due Course Doctrine Provides incentive for financial intermediaries to engage in transactions, because they receive greater legal protection by virtue of “holder in due course” status

7. Requirements for “Holder In Due Course” Status Be holder of complete and authentic negotiable instrument Take instrument for value Take instrument in good faith Take instrument without notice that it is overdue or dishonored, that it has been altered or has an unauthorized signature, or that it is subject to adverse claims or defenses to enforceability of instrument

8. Holder Takes Instrument “For Value” If Holder: Performs promise for which instrument issued Acquires security interest or other lien in instrument Takes instrument for payment of preceding claim Exchanges instrument for another negotiable instrument Exchanges instrument for an irrevocable obligation to third party

9. Advantage of Holder In Due Course Status Holder in due course is generally free from following “personal” defenses: Lack or failure of consideration Breach of contract Fraud in the inducement (in underlying contract) Incapacity Illegality Duress Unauthorized completion or material alteration of instrument Unauthorized acquisition of instrument

10. Holder In Due Course Is Subject to Following “Real” Defenses: Fraud in the Essence Discharge of the Party Liable Through Bankruptcy Forgery Material Alteration of Completed Instrument Infancy (When party below legal age of consent)

11. “Shelter” Principle: If holder cannot attain holder in due course status, holder can acquire rights and privileges of holder in due course, if item transferred from a holder in due course

12. Federal Trade Commission Rule: Negotiation of consumer notes may not be subject to holder in due course status, if consumer credit contract or purchase money loan contains following statement: “ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF GOODS OR SERVICES OBTAINED PURSUANT HERETO OR WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER BY THE DEBTOR SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR HEREUNDER”

13. Signature Liability General Rule: Party liable for an instrument only if party has signed instrument

14. Parties Signing Negotiable Instrument Maker -Person promising to pay set sum to holder of promissory note/certificate of deposit -Promises to pay money Acceptor -Person (drawee) who accepts and signs draft to agree to pay draft when it is presented -Pays money (or responsible for paying money) when it is requested

15. Parties Signing Negotiable Instrument (Continued) Drawer Person ordering drawee to pay Orders someone (drawee) to pay Endorser Person who signs instrument to restrict payment of it, negotiate it, or incur liability Signs instrument at some point during process of negotiation

16. “Primary” Liability Versus “Secondary” Liability Primary Liability of Makers and Acceptors: Must pay stated amount on instrument when it is presented for payment Secondary (Conditional) Liability of Drawers and Endorsers: Must pay amount on instrument if following conditions met: -Presentment (on party with primary liability) -Dishonor (by party with primary liability) -Notice of Dishonor (given to party with secondary liability)

17. Proper Presentment of Negotiable Instrument Presented to Proper Party Presented in Proper Way Presented in Timely Manner

18. Accommodation Party Definition: Party who signs instrument to provide credit for another party who has also signed instrument

19. Unauthorized Signature General Rule: If signature to negotiable instrument unauthorized, signature will not impose liability on named party

20. Negotiable Instrument Warranty Liability Transfer Warranty: When party transfers instrument to another party for consideration, party makes certain guarantees/warranties regarding instrument and transfer itself Presentment Warranty: When party properly presents instrument for acceptance, party makes certain guarantees/warranties regarding instrument and transfer itself

21. Transfer Warranties Transferor entitled to enforce negotiable instrument Signatures on instrument authentic and authorized Instrument has not been altered Instrument not subject to defense or claim in recoupment Transferor has no knowledge of insolvency proceedings against maker, acceptor, or drawer of instrument

22. Presentment Warranties Warrantor of instrument is entitled to enforce instrument Instrument has not been altered Warrantor has no knowledge that drawer’s signature or draft is unauthorized

23. Avoiding Liability for Negotiable Instruments Defenses to Liability Real Defenses Personal Defenses

24. “Real Defenses” (Applicable to All Parties): Infancy (below legal age of consent) Duress Lack of legal capacity Illegality of transaction Fraud in factum (fraud in execution, fraud in essence) Discharge through insolvency proceedings (bankruptcy) Forgery Material Alteration

25. Common Law Personal Defenses (Applicable to Holders, But Not Holders In Due Course): Breach of contract/warranty Lack or failure of consideration Fraud in inducement Illegality Mental Incapacity

26. Personal Defenses (Applicable to Holders, But Not Holders In Due Course): Non-issuance, conditional issuance, or issuance for special purpose Modification/nullification of obligation by second agreement Non-delivery of instrument Unauthorized, non-fraudulent completion of instrument

27. Avoiding Liability for Negotiable Instruments Discharge of Liability Payment/Tender of Payment Cancellation/Renunciation Reacquisition Impairment of Recourse Impairment of Collateral