Rights and Duties of Parties CHAPTER TWENTY-ONE

21 | 2 Copyright © Houghton Mifflin Company. All rights reserved. Liability of Parties to a Negotiable Instrument To hold a person liable on a negotiable instrument: – His/her signature must appear on the instrument or the signature of his/her agent. – Liability does not apply to a bearer instrument because no endorsement is needed.

21 | 3 Copyright © Houghton Mifflin Company. All rights reserved. Liability of Parties to a Negotiable Instrument (continued) Primary parties are those who are first in line to be obligated to pay on the instrument. –Makers of promissory notes are primary parties. –Drawees who agree to pay drafts at the request of drawers are primary parties. –A primary party is unconditionally liable. In accepting a draft, a drawee becomes primarily liable for payment to the payee. A certified check is one in which the bank has promised to pay on the instrument.

21 | 4 Copyright © Houghton Mifflin Company. All rights reserved. Secondary parties are those who are legally obligated to pay if the primary party fails to pay. –The secondary party liability is considered conditional. –Secondary parties are: Drawers of checks or drafts The payees or endorsers of any negotiable instruments Liability of Parties to a Negotiable Instrument (continued)

21 | 5 Copyright © Houghton Mifflin Company. All rights reserved. Secondary parties are liable only if they: –Presented the instrument in a timely and proper manner for payment, and –The primary party dishonors the instrument, and –Notice of the dishonor is given in a timely manner to the secondary party. Liability of Parties to a Negotiable Instrument (continued)

21 | 6 Copyright © Houghton Mifflin Company. All rights reserved. Presentment for Payment Presentment is the demand for payment of a negotiable instrument by a party entitled to do so (usually the holder). Presentment must be: – To the proper person, – In a proper manner, and – At a proper time.

21 | 7 Copyright © Houghton Mifflin Company. All rights reserved. Dishonor of Instrument Dishonor means refusal by the primary party to pay an instrument when it is properly presented for payment. If the primary party dishonors a note: –Notice of the dishonor must be given to the secondary party by the holder to hold the secondary party liable. –Endorsers of negotiable instruments are generally liable in the order in they endorse the instrument.

21 | 8 Copyright © Houghton Mifflin Company. All rights reserved. Holder A holder of a negotiable instrument is a person who possesses the negotiable instrument and is either: – The bearer in possession of a bearer instrument, or – A person in possession of an instrument in which he or she is the named payee or an instrument that has been endorsed to him or her. A party who is a holder would have the same rights on the instrument as the person who either issued or endorsed the instrument to the holder. (This rule is similar to the rules regarding what rights an assignee obtains when a contract right is transferred to him or her.)

21 | 9 Copyright © Houghton Mifflin Company. All rights reserved. Holder in Due Course Once a person becomes a holder, the question becomes, can that person become a holder in due course? The designation of a holder in due course is important because a holder in due course gains the right to cut off certain defenses that could be raised against a holder. –The ability to cut off defenses by a holder in due course is in the law to make negotiable instruments more marketable.

21 | 10 Copyright © Houghton Mifflin Company. All rights reserved. Holder in Due Course (continued) To obtain holder in due course status, a party must prove they took the instrument: –For value: actual consideration must be paid to obtain the instrument. –In good faith: the holder must act honestly and not take the instrument under suspicious circumstances. –Without notice that the instrument is Overdue, or That it was presented for payment and dishonored, or That the instrument is so irregular or incomplete as to call into question its authenticity.

21 | 11 Copyright © Houghton Mifflin Company. All rights reserved. Holder in Due Course (continued) The Shelter Principle A person who does not qualify as a holder in due course but acquires ownership of an instrument from a holder in due course can obtain the rights and privileges of a holder in due course. The UCC in 2-302(b) allows a person taking an instrument the same rights as the person transferring the instrument. –Taking an instrument from a holder in due course allows the person taking the instrument to acquire holder in due course status. –The right to become a holder in due course will not take place if: Transferee engaged in fraud in transferring the instrument, or The transferee engaged in illegality affecting the instrument.

21 | 12 Copyright © Houghton Mifflin Company. All rights reserved. Holder in Due Course (continued) A holder in due course may cut off the following personal defenses raised by the party obligated to pay: –Fraud in the inducement to enter a contract –Failure or lack of consideration –Payment at or before maturity –Lack of delivery –Unauthorized completion of a incomplete instrument –Slight duress (duress of an economic, not physical, nature)

21 | 13 Copyright © Houghton Mifflin Company. All rights reserved. Holder in Due Course (continued) A holder in due course cannot avoid the following real defenses: –Fraud in the execution –Forgery –Minority –Material alteration –Illegality –Serious duress (actual physical duress)

21 | 14 Copyright © Houghton Mifflin Company. All rights reserved. Defenses Against Holders in Due Course The FTC rule thus applies to consumer credit transactions in which: A consumer signs a sales contract that includes a promissory note The consumer signs an installment sales contract with a waiver of defense clause The seller arranges consumer financing with a third-party lender Note: these rules will not apply where the consumer pays for the purchase by check. The FTC rule applies only to credit transactions.

21 | 15 Copyright © Houghton Mifflin Company. All rights reserved. Federal Trade Commission HDIC Rule The Federal Trade Commission has declared that holder in due course status cannot be raised as a defense against ultimate consumers when they buy goods or services on credit from a merchant seller. If the seller negotiates the instrument to a bank or finance company, the bank or finance company cannot become a holder in due course. – The bank or finance company becomes an assignee, with only the rights of an assignee.

21 | 16 Copyright © Houghton Mifflin Company. All rights reserved. Accommodation Parties An accommodation party lends his/her signature to an instrument to provide the lender or bank additional assurance of payment. An accommodation maker signs on behalf of the maker and becomes primarily liable on the instrument. An accommodation endorser signs on behalf of the payee and has secondary liability.