P A R T P A R T Commercial Paper Negotiable Instruments Negotiation & Holder in Due Course Liability of Parties Checks and Electronic Transfers 7 McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

Liability of Parties PA E TR HC 33 “Always do right. This will gratify some people, and astonish the rest.” Mark Twain, speech to Young People’s Society (1901)

Learning Objectives  The Basics of Contractual Liability  Contractual Liability in Operation  Warranty Liability  Other Liability Rules  Discharge of Negotiable Instruments

 When a person signs a negotiable instrument as maker, drawer, or indorser, the person is contractually liable to pay the instrument  Liability also arises from:  (1) improper transfer or presentment of an instrument; (2) negligence in instrument issuance, alteration, or indorsement; (3) improper payment; or (4) conversion Overview

 The maker or drawer of a promissory note is primarily liable for paying the debt  UCC Article 3 requires a person who is secondarily liable to pay the instrument only if the person primarily liable defaults  An indorser usually is secondarily liable  A drawee has no liability on a check or draft unless it certifies or accepts it Details of Liability

 Holder of a note may present it to maker on or after the date payable  Dishonor : maker fails to pay amount due  Since maker is primarily liable, holder of the note may demand payment from person with secondary liability  To obtain payment or acceptance on a draft or check, holder must present it to drawee by any commercially reasonable means Presentment

 Person who transfers negotiable instrument or presents it for payment may bear liability from implied warranties:  Presentment warranties: Warrantor/transferor is entitled to enforce draft or authorized to obtain payment, draft has not been altered, warrantor has no knowledge of an unauthorized signature  Transfer warranties: Transferor gives warranties to immediate transferee related to authenticity and enforceability of instrument Warranty Liability

 Mistake: Revised Article 3 follows general rule that payment or acceptance is final in favor of a holder in due course or payee who changes position in reliance on payment or acceptance; bank bears burden of mistake  Conversion : Revised Article 3 provides that the law applicable to conversion of personal property applies to instruments Other Liability Rules

 Negligence : Person who writes a negotiable instrument to invite alteration may not use alteration or lack of authorization as reason for not paying an innocent holder [3–406]  Imposter rule : If an impostor convinces the drawer to make a check payable to imposter, any indorsement “substantially similar” to that of named payee is effective [3–404(a)] Other Liability Rules

 Fictitious payee rule : Any indorsement in the name of a fictitious payee is effective as payee’s indorsement [3–404(b), (c)]  Protects person that pays instrument in good faith or takes it for value or collection  Fraudulent indorsements by employees : Risk of loss for fraud by employees entrusted with negotiable instruments falls on employer rather than bank that pays check [3–405] Other Liability Rules

 Discharge from liability occurs by payment, cancellation, or alteration of the instrument; modification of principal’s obligation that causes loss to surety or impairs collateral; unexcused delay in presentment or notice of dishonor of a check; or acceptance of draft by a bank Discharge of Obligor

Test Your Knowledge  True=A, False = B  When a person signs a negotiable instrument as maker, the person becomes contractually liable on the instrument.  The maker of a promissory note is secondarily liable for paying the debt.  A drawee has liability on a check or draft the moment it is presented for acceptance

Test Your Knowledge  True=A, False = B  An indorser is not discharged from liability until the instrument is presented for payment or acceptance.  A person who transfers a negotiable instrument or presents it for payment may incur liability from implied warranties.  A person who indorses a negotiable instrument usually is secondarily liable

Test Your Knowledge  Multiple Choice  Norbert worked in payroll for Will Co. and signed payroll checks. Norbert wrote a check to Bradley Pitte, a fictitious employee, took it to the bank with fake I.D., indorsed the back with “Pitte’s” signature, and was paid in cash.  (a) The bank is liable for wrongful acceptance  (b) The bank is not liable under the common law of conversion  (c) The bank is not liable under UCC liability rules

Test Your Knowledge  Multiple Choice  Which of the following is not a transferee warranty?  (a) Warrantor is entitled to enforce the instrument  (b) The drawer has sufficient funds to pay the instrument  (c) The instrument has not been altered  (d) All signatures are authentic or authorized

Thought Questions  What steps would you take to make sure that the UCC rules concerning fictitious employees and fraudulent indorsement did not occur in your business?