1. Commercial Paper Negotiable Instruments Negotiation & Holder in Due Course Liability of Parties Checks and Electronic Transfers © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

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

3. Learning Objectives The Basics of Contractual Liability Contractual Liability in Operation Warranty Liability Other Liability Rules Discharge of Negotiable Instruments 33 - 3

4. When a person signs a negotiable instrument as maker, drawer, indorser, or some other capacity, the person becomes contractually liable on the instrument (i.e., to pay) 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 33 - 4

5. A person may be primarily liable if s/he agreed to pay the negotiable instrument. –The maker of a promissory note is primarily liable for paying the debt A person who is secondarily liable is a contract guarantor and, under UCC Article 3, must pay the instrument only if the person who is primarily liable defaults on the obligation Primary vs. Secondary Liability 33 - 5

6. The acceptor of a draft must pay the draft according to the terms at the time of acceptance ( drawee’s signed engagement to honor the draft as presented) A drawee has no liability on a check or draft unless it certifies or accepts it See Harrington v. MacNab in which the drawee bank had no liability to a payee for a drawer’s insufficient funds Acceptor and Drawee Liability 33 - 6

7. A person who indorses a negotiable instrument usually is secondarily liable –Indorsers are liable to each other in chronological order, from the last indorser back to the first To trigger secondary liability, the instrument must be properly presented for payment or acceptance, the instrument must be dishonored, and notice of the dishonor must be given to the person secondarily liable Indorser Liability 33 - 7

8. An indorser is discharged from liability if: –A bank accepts a draft after indorsement [3– 415(d)] –Notice of dishonor is required and proper notice is not given to the indorser [3–415(c)] –No one presents a check or gives it to a depositary bank for collection within 30 days after the date of an indorsement [3–415(e)] Discharge of Indorser Liability 33 - 8

9. Since the maker of a note is primarily liable to pay it when due, dishonor occurs if the maker does not pay the amount due when: (1) it is presented in the case of (a) a demand note or (b) a note payable at or through a bank on a definite date and presented on or after that date, or (2) if it is not paid on the date payable in the case of a note payable on a definite date (but not payable at or through a bank) [3–502] Presentment of a Note 33 - 9

10. To obtain payment or acceptance on a draft or check, holder must present it to drawee by any commercially reasonable means –Written, oral, or electronic [3–501] Drawee obligated when it accepts (certifies) Presentment of a Draft or Check 33 - 10

11. A person who transfers a negotiable instrument or presents it for payment may incur 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 five warranties to immediate transferee Warranty Liability 33 - 11

12. Transferor gives transferee five warranties: –Warrantor is entitled to enforce the instrument (no unauthorized or missing indorsements) –All signatures authentic or authorized –Instrument has not been altered –Instrument not subject to defense or claim in recoupment against the warrantor –Warrantor has no knowledge of any insolvency proceedings commenced with respect to the maker or acceptor, or drawer [3–416(a)] Transfer Warranties 33 - 12

13. 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 Mistake in Payment or Acceptance 33 - 13

14. Negligence: A person who writes a negotiable instrument so as to invite alteration may not use the alteration or lack of authorization as a reason for not paying a person that in good faith pays the instrument or takes it for value [3–406] Other Liability Rules 33 - 14

15. Imposter rule: An impostor convinces a drawer to make a check payable to the person impersonated or an organization the person purports to represent. UCC makes any indorsement “substantially similar” to that of named payee effective [3–404(a)] Other Liability Rules 33 - 15 Tip: don’t leave important items of identification lying around!

16. Fictitious payee rule: If someone writes a check to a fictitious payee, UCC allows any indorsement in the name of the fictitious payee to be effective as payee’s indorsement in favor of any person that pays instrument in good faith or takes it for value or for collection [3–404(b) and (c)] –See C & N Contractors v. Community Bancshares, Inc. Other Liability Rules 33 - 16

17. Fraudulent indorsements by employees: Revised Article 3 specifically addresses employer liability for fraudulent indorsements by employees, adopting rule that the risk of loss for indorsements by employees entrusted with responsibilities for instruments (primarily checks) should fall on employer rather than the bank that takes the check or pays it [3–405] Other Liability Rules 33 - 17

18. Conversion: Revised Article 3 provides that the law applicable to conversion of personal property applies to instruments Other Liability Rules 33 - 18

19. An obligor is discharged from liability by : 1.Payment of the instrument 2.Cancellation of the instrument 3.Alteration of the instrument 4.Modification of principal’s obligation causing a loss to a surety or impairing collateral 5.Unexcused delay in presentment or notice of dishonor with respect to a check 6.Acceptance of a draft by a bank (e.g., if a check is certified by a bank) Discharge 33 - 19

20. 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. 33 - 20

21. 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. 33 - 21

22. 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 33 - 22

23. 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 33 - 23

24. 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? 33 - 24