Chapter 26 Liability, Defenses and Discharge

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

3 §1: Signature Liability Relates to signatures on instruments. Signers of negotiable instruments are potentially liable for amount state on instrument. Primary Liability: Makers/Accepters. Secondary Liability: Drawers/Indorsers.

4 Signature Liability [2] Proper Presentment. Must be timely (checks w/in 30 days). Dishonor. Proper Notice. Accommodation Parties: Signs instrument to lend name as credit to another party on the instrument.

5 Signature Liability [3] Authorized Agent’s Signature. To hold Principal liable agent must be authorize to sign and Principal must be clearly named. Agent personally liable when Principal is not named or disclosed, unless check is drawn on Principal’s account.

6 Signature Liability [4] 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.

7 Signature Liability [5] 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.

8 §2: Warranty Liability Extends to both signers and non-signers. Breach of warranty can occur when the instrument is transferred or presented for payment.

9 Warranty Liability Transferors make certain implied warranties regarding instruments they negotiate. Liability not subject to dishonor, presentment, notice. Liabilities: Transfer or Presentment.

10 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.

11 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.

12 §3: 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.

13 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.

14 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).

15 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.

16 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.

17 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.

18 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.

19 §4: Discharge from Liability Discharge from liability on an instrument can occur by: Payment. Cancellation. Material Alteration.

20 Discharge by Payment All parties to an instrument will be discharged when the party primarily liable on the instrument pays to the holder the amount due in full.

21 Discharge by Cancellation Intentional cancellation of an instrument discharges the liability of all parties. Examples: Intentionally writing “paid” on the front of an instrument, or tearing it up or mutilating it, cancels the instrument.

22 Case 26.1: Quality Wash v. Hallak (Accommodation Parties) FACTS: Allan built a car wash that was sold to the Hallak. Hallak signed a promissory note in favor of Allan. Hallak sold the car wash to Quality Wash. Quality and the Hallak signed an amendment to the Allan note under which Quality assumed primary liability. When Quality stopped making payments, Allan sued Quality and Hallak to collect. Quality paid off the note and then filed a claim against Hallak. The court ruled in part that the Hallaks were not liable, and Quality appealed.

23 HELD: FOR HALLACK. By signing the amendment to the Allan note Hallak falls within the definition of ‘accommodation party’ under UCC 3–419(a). Having assumed the Allan note as part of the purchase price of the car wash, Quality was the direct beneficiary of the value given for the note and, therefore, was the ‘accommodated party.’ An accommodated party is not entitled to contribution from an accommodation party. Case 26.1: Quality Wash v. Hallak (Accommodation Parties)

24 Case 26.2: Caraway v. Land Design (Agent’s Signatures) FACTS: Caraway was the president of International Realty when IR hired Land Design Studio to landscape the Deerfield Project. After Land Design completed the work, the parties executed a promissory note. The note stated, In consideration of design services rendered, I (We) Hugh Caraway [sic], International Realty, Inc. * * * do hereby promise to pay Land Design Studio * * * the amount of $42, ” The note was signed by Caraway. Payment in full was to be made in less than seven months, but no payment was received. Land Design sued Caraway.

25 HELD: FOR LAND DESIGN. CARAWAY PERSONALLY LIABLE. Caraway had argued he was personally liable on the note, arguing in part that he had intended to sign it in a representative capacity. The note did not indicate, and Caraway did not otherwise disclose, that he signed only as an agent of Realty. Case 26.2: Caraway v. Land Design (Agent’s Signatures)

26 Case 26.3: First Nat’l Bank v. MidAmerica (Presentment Warranties) FACTS: FNB issued a cashier’s check to Mustafa, and mailed the check to his address. Mustafa’s nephew deposited the check into his account at MidAmerica Federal Savings. The check had the purported signature of Mustafa and the signature of his nephew on it. MidAmerica presented it for payment at FNB and the nephew withdrew the funds. When the truth came out, FNB paid Mustafa and sued MidAmerica for breach of the presentment warranty that there were no unauthorized indorsements on the check.

27 HELD: FOR FNB. Under UCC 3–417(a), a bank that accepts and pays a check with an unauthorized or forged indorsement warrants to subsequent transferees the validity of that indorsement and may be held liable on that warranty. The rule recognizes that, while none of the parties may have had reason to suspect a fraud, the one who took from the forger was the closest to the person causing the loss and is presumed to have had the best opportunity to have prevented the loss. Case 26.3: First Nat’l Bank v. MidAmerica (Presentment Warranties)