1. © 2004 West Legal Studies in Business A Division of Thomson Learning 1 Chapter 26 Liability, Defenses, and Discharge Chapter 26 Liability, Defenses, and Discharge

2. © 2004 West Legal Studies in Business A Division of Thomson Learning 2 Liability There are two kinds of liability associated with negotiable instruments:  Signature liability.  Warranty Liability. There are two kinds of liability associated with negotiable instruments:  Signature liability.  Warranty Liability.

3. © 2004 West Legal Studies in Business A Division of Thomson Learning 3 §1: Signature Liability Relates to signatures on instruments. Signers of negotiable instruments are potentially liable for amount state on instrument.  Primary Liability: Makers/Acceptors.  Secondary Liability: Drawers/Indorsers. Relates to signatures on instruments. Signers of negotiable instruments are potentially liable for amount state on instrument.  Primary Liability: Makers/Acceptors.  Secondary Liability: Drawers/Indorsers.

4. © 2004 West Legal Studies in Business A Division of Thomson Learning 4 § 2: Primary versus Secondary Liability Makers.  Promises to pay the note.  Obligated to pay terms of instrument at time of signing. Acceptors.  Drawee promises to pay an instrument when presented for payment. Makers.  Promises to pay the note.  Obligated to pay terms of instrument at time of signing. Acceptors.  Drawee promises to pay an instrument when presented for payment.

5. © 2004 West Legal Studies in Business A Division of Thomson Learning 5 Secondary Liability Proper Presentment.  Must be timely (checks w/in 30 days). Dishonor.  Case 26.1: Messing v. Bank of America (2002). Proper Notice.  Manner of Notice in any Reasonable manner.  Notice to Indorsers. Proper Presentment.  Must be timely (checks w/in 30 days). Dishonor.  Case 26.1: Messing v. Bank of America (2002). Proper Notice.  Manner of Notice in any Reasonable manner.  Notice to Indorsers.

6. © 2004 West Legal Studies in Business A Division of Thomson Learning 6 Accommodation Parties Signs instrument to lend name as credit to another party on the instrument. Makers v. Indorsers. Signs instrument to lend name as credit to another party on the instrument. Makers v. Indorsers.

7. © 2004 West Legal Studies in Business A Division of Thomson Learning 7 Authorized Agents’ Signatures Agent agrees to act for Principal. Agents can hold Principal liable if authorized to sign. Principal must be clearly named. Agent is personally liable when Principal is not named or disclosed, unless check is drawn on Principal’s account. Case 26.2: Caraway v. Land Design Studio (2001). Agent agrees to act for Principal. Agents can hold Principal liable if authorized to sign. Principal must be clearly named. Agent is personally liable when Principal is not named or disclosed, unless check is drawn on Principal’s account. Case 26.2: Caraway v. Land Design Studio (2001).

8. © 2004 West Legal Studies in Business A Division of Thomson Learning 8 Unauthorized Signatures Forgery does not bind owner but Bank is liable. If Agent has no authority, Agent is personally liable, but Principal is not, unless ratified. Exceptions:  Ratification of signature.  Negligence of party.  Holder in Due Course. Forgery does not bind owner but Bank is liable. If Agent has no authority, Agent is personally liable, but Principal is not, unless ratified. Exceptions:  Ratification of signature.  Negligence of party.  Holder in Due Course.

9. © 2004 West Legal Studies in Business A Division of Thomson Learning 9 Special Rules for Unauthorized Indorsements Unauthorized indorsement does not bind maker/drawer except:  “Imposter Rule”: imposter induces maker/drawer to issue check to imposter.  When imposter signs as/on behalf of maker/drawer intending payee has no interest in the instrument.  Fictitious Payee. Unauthorized indorsement does not bind maker/drawer except:  “Imposter Rule”: imposter induces maker/drawer to issue check to imposter.  When imposter signs as/on behalf of maker/drawer intending payee has no interest in the instrument.  Fictitious Payee.

10. © 2004 West Legal Studies in Business A Division of Thomson Learning 10 §3: Warranty Liability Extends to both signers and non-signers. Breach of warranty can occur when the instrument is transferred or presented for payment. Extends to both signers and non-signers. Breach of warranty can occur when the instrument is transferred or presented for payment.

11. © 2004 West Legal Studies in Business A Division of Thomson Learning 11 Warranty Liability Transferors make certain implied warranties regarding instruments they negotiate. Liability not subject to dishonor, presentment, notice. Liabilities: Transfer or Presentment. Transferors make certain implied warranties regarding instruments they negotiate. Liability not subject to dishonor, presentment, notice. Liabilities: Transfer or Presentment.

12. © 2004 West Legal Studies in Business A Division of Thomson Learning 12 Transfer Warranties Following transfer warranties extend to all subsequent holders:  Transferor is entitled to enforce the instrument.  Signatures are authentic and authorized.  Instrument has not been altered.  Instrument not subject to defense.  Transferor has no notice of insolvency. Following transfer warranties extend to all subsequent holders:  Transferor is entitled to enforce the instrument.  Signatures are authentic and authorized.  Instrument has not been altered.  Instrument not subject to defense.  Transferor has no notice of insolvency.

13. © 2004 West Legal Studies in Business A Division of Thomson Learning 13 Presentment Warranties Person who presents an instrument makes the following presentment warranties:  No missing or unauthorized indorsement.  Instrument has not been altered.  Person obtaining payment has no knowledge signature is unauthorized. Case 26.3: First National Bank of Chicago v. MidAmerica Federal Savings (1999). Person who presents an instrument makes the following presentment warranties:  No missing or unauthorized indorsement.  Instrument has not been altered.  Person obtaining payment has no knowledge signature is unauthorized. Case 26.3: First National Bank of Chicago v. MidAmerica Federal Savings (1999).

14. © 2004 West Legal Studies in Business A Division of Thomson Learning 14 §4: Defenses Universal or Real - can be used to defeat a holder and a HDC. Personal - can be used to defeat a holder but not a HDC. Universal or Real - can be used to defeat a holder and a HDC. Personal - can be used to defeat a holder but not a HDC.

15. © 2004 West Legal Studies in Business A Division of Thomson Learning 15 Universal Defenses Forgery of maker’s or drawer’s signature.  Or if an authorized agent exceeds his authority to the amount which exceeds his authority. Fraud in the execution - the ”autograph” situation, not fraud in the inducement. Forgery of maker’s or drawer’s signature.  Or if an authorized agent exceeds his authority to the amount which exceeds his authority. Fraud in the execution - the ”autograph” situation, not fraud in the inducement.

16. © 2004 West Legal Studies in Business A Division of Thomson Learning 16 Universal Defenses [2] Material Alteration.  Do not have to pay the altered amount ($8 to $800), only a personal defense to the original amount ($8).  Not a real defense if instrument left blank, (.. filled in $800), then have to pay all ($800). Discharge in Bankruptcy. Infancy (Minority). Material Alteration.  Do not have to pay the altered amount ($8 to $800), only a personal defense to the original amount ($8).  Not a real defense if instrument left blank, (.. filled in $800), then have to pay all ($800). Discharge in Bankruptcy. Infancy (Minority).

17. © 2004 West Legal Studies in Business A Division of Thomson Learning 17 Universal Defenses [3] Illegality - severe enough to make contract void. Mental Incapacity (adjudicated by court). Extreme Duress. If instrument signed under threat of immediate force or violence. Illegality - severe enough to make contract void. Mental Incapacity (adjudicated by court). Extreme Duress. If instrument signed under threat of immediate force or violence.

18. © 2004 West Legal Studies in Business A Division of Thomson Learning 18 Personal Defenses Valid against holders but not HDC’s.  Breach of contract or warranty.  Lack of consideration.  Fraud in the inducement.  Illegality - not severe enough to make void. Valid against holders but not HDC’s.  Breach of contract or warranty.  Lack of consideration.  Fraud in the inducement.  Illegality - not severe enough to make void.

19. © 2004 West Legal Studies in Business A Division of Thomson Learning 19 Personal Defenses [2] Mental incapacity - not severe enough to make void. Discharge.  By payment or cancellation.  Unauthorized completion.  Non-delivery of instrument.  Ordinary duress or undue influence rendering contract voidable. Mental incapacity - not severe enough to make void. Discharge.  By payment or cancellation.  Unauthorized completion.  Non-delivery of instrument.  Ordinary duress or undue influence rendering contract voidable.

20. © 2004 West Legal Studies in Business A Division of Thomson Learning 20 Federal Limits on HDC Rights FTC Rule 433 (1976) abolished the HDC doctrine in consumer credit transactions.  Allows Buyer to assert any defense she might have against the Seller of goods or services (Car Dealer), against the subsequent HDC (Bank) as well.  So Buyer’s duty to pay is conditional on Seller’s full performance under contract. FTC Rule 433 (1976) abolished the HDC doctrine in consumer credit transactions.  Allows Buyer to assert any defense she might have against the Seller of goods or services (Car Dealer), against the subsequent HDC (Bank) as well.  So Buyer’s duty to pay is conditional on Seller’s full performance under contract.

21. © 2004 West Legal Studies in Business A Division of Thomson Learning 21 §5: Discharge Discharge from liability on an instrument can occur by:  Payment.  Cancellation or Surrender.  Reacquisition.  Impairment of Recourse.  Impairment of Collateral. Discharge from liability on an instrument can occur by:  Payment.  Cancellation or Surrender.  Reacquisition.  Impairment of Recourse.  Impairment of Collateral.

22. © 2004 West Legal Studies in Business A Division of Thomson Learning 22 Law on the Web Legal Research Exercises on the Web.