Negotiable Instruments

A piece of commercial paper where the drawer (account holder) orders the payor bank or drawee to pay out money from a deposit account to a third person, called the payee. Example: A check. Quirky Example: A cashier's check. This is unusual because the drawer and the drawee are the same person. The customer who buys the cashier's check is called the "remitter" and he is not generally liable if the check is dishonored.

A piece of commercial paper where the maker promises to pay a third party an amount of money in the future. Example: A promissory note. Example: A certificate of deposit. This is just a promise by the bank to pay back the amount of money you deposited into the account.

A negotiable instrument is a (1) written and signed (2) unconditional promise to pay (3) a fixed amount of money (4) payable to the bearer or order of a person (5) at a definite time or on demand (6) with no extraneous undertakings, and (7) must also not state that it is non-negotiable.

An instrument is conditional and thus non-negotiable if it expressly states a condition to payment or states that the promise/order is subject to or governed by another writing

An instrument is not conditional if it merely refers to another writing for a statement of rights regarding collateral, prepayment, or acceleration. Or if it states another instrument that the promise or order "arises out of ." In which case the contents of the separate writing are irrelevant to the negotiability of the document.

Includes any medium of exchange authorized or adopted by a government. An instrument will not be negotiable if it calls for payment in anything other than money.

To be negotiable the principal due under the instrument must be fixed. No interest is due unless the instrument provides for the payment of interest. The rate of interest does not need to be fixed or determinable from the face of the instrument, and if unspecified the court will apply the rate on a court judgment.

Can be payable to a person or the order of a person. Intent of the drawer(s) control(s), dual intent=payment to either is proper.

Includes any conjunction/disjunction with bearer, order does not state payee (pay to the order of ____________) , or payable to cash or merry christmas.

instrument is negotiable and payable upon demand.

Not negotiable if the event is certain to happen but uncertain as to time

will not cause an instrument to be non-negotiable.

okay if to further a definite time stated in the instrument "may be extended by the maker/event for one month after the original due date" - okay, "can be extended at the option of the maker/event" - NOT okay.

Always permitted because the holder always has the option of giving extra time for payment.

To be negotiable an instrument a promise or undertaking will destroy negotiability unless it is: (1) An undertaking or power to give, maintain, or protect collateral, (2) an authorization or power to the holder to confess judgment or realize on or dispose of collateral, or (3) A waiver of the benefit of any law intended for the advantage or protection of the obligor.

Words prevail over figures. Hardwritten terms prevail over typewritten words which prevail over pre-printed words. Unless ambiguous, uncertain, illegible.

When an instrument is issued, the holder is the person originally entitled to payment. The holder must be in possession of the instrument, but not everyone who obtains possession is automatically a holder. To allow someone other than the original holder to enforce the instrument, a holder must negotiate the instrument to someone else.

Bearer paper is validly negotiated simply by passing possession of the instrument - even a thief can take possession and become a holder (even though he may incur liability under other applicable law).

In order to negotiate order paper, the instrument must be indorsed and possession passed. There are several kinds of indorsement:

This transforms the order paper into bearer paper. Then, anyone, including a thief, can be the next holder and can enforce the instrument.

Signature under an instruction directing payment to some specific person (ex., "pay to John Smith, /s/ Jason Kilborn). For a special indorsement, the instrument either continues on as order paper, now payable only to the newly identified person, or if it was originally bearer paper, the bearer paper is transformed to order paper.

The only one recognized is "for deposit only." This requires that the next holder must be a bank, and it requires money from payment to the instrument to go into the indorser's deposit account.

If a person other than the holder indorses an instrument, there is a presumption that the person who indorsed signed as a surety of payment of the instrument to anyone who later becomes a holder.

If the person seeking to enforce the instrument is a holder in due course, he has the right to enforce the instrument free of claims to the instrument and subject to only four real defenses. If the person seeking to enforce the instrument is simply a holder, then the maker/drawer can assert both personal and real defenses.

In order to be a holder in due course, four requirements must be met. First, the person must (1) be a holder (which requires that the instrument was validly negotiated to him), (2) must have given value for the instrument, which can include value to a third party (3) must have been in good faith in acquiring the instrument (no dishonesty or failure to observe commercial standards of fair dealing), and (4) must have been without notice that the instrument was overdue/in principal default, contained a fraudulent signature or was altered, that anyone had a claim to the instrument, or that anyone had a defense to payment.

Even if someone is not a holder in due course, that person could still inherit the rights of a HIDC if that person acquired the instrument from a HIDC. The "shelter principle" gives the transferee of property all of the transferor's rights. So, if a HIDC donated an instrument to a charity, the charity could not be a HIDC, because it gave nothing of value in exchange for the instrument, but the holder can still exercise the rights of the transferor, who was a HIDC.

If a person is a HDC, only 4 real defenses may be asserted against payment: infancy of the drawer; bankruptcy: illegality of the debt; fraud in the factum. • Illegality of the Debt Underlying the Instrument: Fraud or duress doesn't work - those are only relative nullities. It requires something to be an absolute nullity. • Fraud in the Factum: This is exceedingly rare, because it requires that the maker did not know and had no reasonable way of knowing that the thing he signed was an instrument.Distinguish from Fraud in the Inducement, which is where the maker was tricked into signing an instrument - i.e., a fake charity; fake goods, etc . . .

If a person is not a HDC, then he is also subject to personal defenses to payment, which generally includes contractual defenses such as failure of consideration, fraud, payment to an earlier holder of the note, etc.

Only someone who signs an instrument is liable, and thus if the account holder did not sign the instrument, it is not "properly payable" and he is not liable for the loss. The payor bank bears the loss for a check that is not properly payable.

If the maker, drawer, or payee's failure of ordinary care substantially contributed to the forgery or alteration, the maker/drawer/payee will be precluded from asserting the forgery or alteration against anyone who gave value for the instrument in good faith.

If the bank failed to exercise ordinary care in paying the item, then we would use comparative fault and distribute the loss according to how negligent each party was. Common Example: If the Bank failed to follow its own internal policy, this could be evidence that the Bank failed to exercise due care.

For either defense, if the party is a bank or business, the standard of care is industry custom. This can be significant, because if industry custom is not to verify signatures above $5,000, a bank is not negligent and thus the maker/drawer would be precluded from asserting the forgery.

Even if the Bank was negligent in paying the forged check, the maker/drawer will be precluded from asserting that the check was forged (and thus not properly payable) if he has not complied with the statement review rule. Drawers have a duty to review their bank account statement "reasonably promptly," which means 30 days within mailing a statement, and to report any fraudulent payments. If the account holder fails to do this, he is precluded from asserting later forgeries by the same wrongdoer if the Bank pays the forged instruments in good faith.

The Bank is liable for forgeries appearing on the first 2 statements, but if $the account holder hasn't reported it, then subsequent forgeries by the same wrongdoer are the account holder's responsibility. The One Year Rule: The first forgery remains challengeable so long as it is caught within 1 year.

If any of these three situations apply, the maker/drawer's negligence is essentially presumed, and the drawer/maker cannot assert that the Bank was negligent and thus responsible for paying the forged instrument.

Only for Indorsements - Not Fraudulently Issued Checks: This only applies to indorsements - not the signature on the front of the note of the check. The only rules which apply when the front of the check has been forged/altered are the statement review rule and the negligence rule. Must Have More than "Access" to the Checks: A Responsible Employee is the Person who is directly responsible for checks . . . Who deposits checks once they arrive, who makes sure accounts are paid . . . Just having access to them is not enough.

Fictitious Payees: Any indorsement in a fictitious name is effective. A check issued in a fictitious person and which is subsequently indorsed is effective - essentially, you were negligent in issuing a check to a fictitious person, so you're precluded from asserting that the bank was negligent in paying the check. Imposters: If someone induces the drawer/maker to issue an instrument made payable to a real person by impersonating that real person, any indorsement of that check in the real person's name is valid and effective. It was negligent as a matter of law to issue that check to that impersonator without checking his identification, and thus any indorsement of that check in the name of the impersonated person is effective, and the maker/drawer is precluded from asserting that the bank was negligent in paying him. "Responsible Payees": A "responsible employee" is an employee of the Maker or Drawer who is charged with check processing duties. A responsible employee making a forged signature (either of the payee when the check is from the Employer; or forging the indorsement of the Employer's when the check is to the Employer), the loss ultimately falls on the Employer when the forgery is performed by a responsible employee.

When someone forge's the payee's signature, the instrument is not validly negotiated. Thus, the forger does not become a holder, and the instrument is "not properly payable" from the drawer's account. Proper Payee's Action for Conversion: The proper payee on a check also has a cause of action for conversion against both the payor bank and the depositary bank to recover the proceeds which were rightly his - can only recover from one, though.

In general, there are two kinds of fraudulent changes to an instrument: alterations and completions. The general rule is that alterations relieve the maker/drawer of any liability for the instrument, subject to one exception for each.

An alteration occurs when someone changes a word or number which was already written on the instrument. Example: changing a check for $100 to $1,000. Exception: An issued instrument that is fraudulently altered changed from its original terms can be enforced according to its original terms, but only by someone who acquired the instrument for value, in good faith, and without notice of the alteration. Example: Daughter takes check from her Dad for $100 and goes to the mall and changes the $100 to $900. This is an alteration, and the store that takes it in good faith for value and without notice of the alteration can enforce it according to its original terms - i.e., for $100.

A completion occurs when someone adds information which wasn't already written on the instrument. Example: Writing in an amount in a check which has been left blank, or writing in an amount in excess of that which has been authorized. Note: If the payee line has been left blank and is filled in, that's just bearer paper being converted to order paper - not a completion. Exception: Signed but Incomplete Instruments: A signed but incomplete instrument (e.g., the amount is left blank) that is later fraudulently completed can be enforced according to its terms as completed, but again, only by someone who acquired it for value, in good faith, and without notice of the completion. Example: Daughter takes check from her Dad, who has left the amount blank but told her she can only spend $100. She performs a completion and makes it $900 instead of the $100 which was authorized. This can be enforced as it was completed if the store gave her value in good faith without knowledge of the completion.

If the maker/drawer refuses or is unable to pay, the holder can seek to enforce the instrument against any prior indorser of the instrument. Indorsers are secondarily liable to pay dishonored instruments. Indorsers can be liable in two ways: (1) basic indorser liability for dishonored instruments; or (2) for breach of any of the 5 indorser's warranties.

If you've become a holder of an instrument, and there is a chain of indorsers on the instrument, you can sue anyone who has indorsed that instrument before you to enforce the instrument, provided three additional factors are met: • The Instrument was Dishonored When Presented for Payment When Due • Timely Notice of the Dishonor is Given to the Indorser • The Indorser Has Not Waived Liability (by writing "without recourse" under the indorsement): Unlike makers and drawers, indorsers can waive liability to pay dishonored instruments by signing "without recourse."

Any person who transfers an instrument in exchange for value makes 5 warranties to their own transferee. If the transferor indorses the instrument, he also makes these warranties to any subsequent transferee of the instrument. The Five Transfer Warranties: Acronym (E-BADS . . . Entitled to enforce - Bankruptcy; Alterations; Defenses/claims; Signatures are authentic and authorized) o The Transferor is Entitled to Enforce the Instrument (thus he is warranting that it has been properly negotiated to him) o All Signatures on the Instrument are Authentic and Authorized o The Instrument Has Not Been Altered: o The Instrument is Not Subject to Any Defense or Claim that Can be Asserted Against the Transferor: (For instance, failure of consideration; duress; infancy) o Transferor Doesn't Know That the Maker/Drawer Has Initiated Bankruptcy Proceedings: