Chapter 14: Liability, Defenses, and Discharge Miller Chapter 14: Liability, Defenses, and Discharge

Introduction There are two kinds of liability associated with negotiable instruments: Signature liability. Warranty Liability.

§1: Signature Liability Relates to signatures on instruments. Signers of negotiable instruments are potentially liable for amount stated on instrument. 

Signature Liability Primary Liability. Makers. Promises to pay the note. Obligated to pay terms of instrument at time of signing.

Signature Liability Primary Liability. Acceptors. Drawee promises to pay an instrument when presented for payment. Secondary Liability: Drawers/Indorsers. 

Signature Liability Secondary Liability. Proper and Proper Presentment. Dishonor. Proper Notice. Manner of Notice in any Reasonable manner. Notice to Indorsers.

Signature Liability Accommodation Parties. Signs instrument to lend name as credit to another party on the instrument. Makers. Indorsers.

Signature Liability Authorized Agents’ Signatures. Agent acts for Principal, and can hold Principal liable if authorized to sign for Principal. Liability of Principal: Principal must be clearly named. 

Signature Liability Authorized Agents’ Signatures. Liability of the Agent: Agent is personally liable when Principal is not named or disclosed, unless check is drawn on Principal’s account. 

Signature Liability Authorized Agents’ Signatures. Checks Signed by Agents: if the agent signs his own name on a check and the principal is identified, the agent is not personally liable. CASE 14.1 Jeanmarie v. Peoples (2010).

Signature Liability Unauthorized Signatures. Arise in two situations: Forgery: does not bind Principal but Bank may be liable if negligent. Unauthorized Signature: Agent is personally liable, but Principal is not, unless ratified. 

Signature Liability Unauthorized Signatures. Exceptions to the General Rule of No Liability: Ratification of Signature: principal become liable. Negligence: party who substantially contributed to forgery is liable.

Signature Liability Unauthorized Signatures. Exceptions to the General Rule of No Liability: Holder in Due Course: person who forges a check can be held liable for payment by an HDC.

Signature Liability Special Rules for Unauthorized Indorsements. Generally, if instrument is forged or unauthorized, burden of loss falls on the first party (not maker) to take the instrument. 

Signature Liability Special Rules for Unauthorized Indorsements. Exceptions: Imposter Rule: imposter induces a maker to issue an instrument in the name of an impersonated payee. Indorsement will be effective.

Signature Liability Special Rules for Unauthorized Indorsements. Exceptions: Fictitious Payees: cause an instrument to be issued to a payee who will have no interest in the instrument.

§2: Warranty Liability Transferors make certain implied warranties regarding instruments they negotiate. Warranty Liability not subject to conditions of proper presentment, dishonor, or notice. 

Warranty Liability Transfer Warranty. The following transfer warranties extend to all subsequent holders: (1) Transferor is entitled to enforce the instrument. (2) Signatures are authentic and authorized. 

Warranty Liability Transfer Warranty. The following transfer warranties extend to all subsequent holders: (3) Instrument has not been altered. (4) Instrument not subject to defense. (5) Transferor has no notice of insolvency.

Warranty Liability Transfer Warranty. Parties to Whom Warranty Liability Extends: Extends warranty to any holder who takes in good faith.  Without indorsement, warranties extend only to immediate transferee.

Warranty Liability Transfer Warranty. Recovery for Breach of Warranty. Good faith holder can sue for breach of warranty. Notice of the claim within 30 days.

Warranty Liability Presentment Warranty. Person who presents an instrument makes the following presentment warranties: Entitled or authorized to enforce (no missing or unauthorized indorsements).

Warranty Liability Presentment Warranty. Person who presents an instrument makes the following presentment warranties: No alterations. Person obtaining payment has no knowledge signature is unauthorized.

§3: Defenses and Limitations 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. 

Defenses Against Liability

Defenses and Limitations Universal. Forgery of maker’s or drawer’s signature. Or if an authorized agent exceeds his authority to the amount which exceeds his authority.

Defenses and Limitations Universal. Fraud in the Execution: the ”autograph” situation, not fraud in the inducement. 

Defenses and Limitations Universal. Material Alteration. Changes the contract terms in any way. Making any changes in the amount, date, or rate of interest is material.

Defenses and Limitations Universal. Material Alteration. Complete or Partial Defense: complete defense against a holder, partial defense against an HDC. HDC Can Enforce an Incomplete Instrument Subsequently Altered.

Defenses and Limitations Universal. Discharge in Bankruptcy. Minority (infancy): to the extent allowed by state law. Illegality: statute must make transaction illegal and void. 

Defenses and Limitations Universal. Mental Incapacity: adjudicated by court. Extreme Duress: If instrument signed under threat of immediate force or violence.

Defenses and Limitations Personal Defenses: valid against holders but not HDC’s. Breach of Contract or Warranty. Lack or Failure of Consideration. CASE 14.2 Mills v. Chauvin (2013).

Defenses and Limitations Personal Defenses: valid against holders but not HDC’s. Fraud in the Inducement (Ordinary Fraud). Illegality. Mental Incapacity.

Federal Limitations on HDC Rights FTC Rule 433: severely limits rights of HDC’s in consumer credit transactions. Effect of the Rule: allows consumer to assert any defense she might have against the seller of goods or services, against the subsequent HDC as well.

§4: Discharge Discharge from liability on an instrument can occur by: Payment or Tender of Payment. Cancellation or Surrender. Material Alteration. Reacquisition.

Discharge Discharge from liability on an instrument can occur by: Impairment of Recourse. Impairment of Collateral.