1. Negotiable Instruments
Chapter 14
Negotiable Instruments

2. “A negotiable bill or note is a courier without luggage.”
Quote of the Day
“A negotiable bill or note is a courier without luggage.”
John B. Gibson,
Overton v. Tyler, 1846

3. Commercial Paper System for transferring paper funds easily
Types of commercial paper
Negotiable
Non-negotiable

4. Types of Negotiable Instruments
Note: (promissory note) is a promise that you will pay money
Two people involved
Maker: Issuer of a promissory note
Payee: Someone who is owed money under the terms of an instrument

5. Types of Negotiable Instruments
Draft: Order directing someone else to pay money for you
Check: Most common form of a draft
Order telling a bank to pay money
Three people involved
Drawer: Person who issues a draft
Drawee: One ordered by the drawer to pay money to the payee
Payee
Issuer: All purpose term that means both maker and drawer

6. Fundamental Rule of Commercial Paper
Possessor of commercial paper has an unconditional right to be paid, so long as:
Paper is negotiable
It has been negotiated to the possessor
Possessor is a holder in due course
Issuer cannot claim a valid defense

7. Difference between Negotiable and Non-negotiable Commercial Paper

8. Requirements for Negotiability
The instrument must:
Be in writing
Be signed by the maker or drawer
Contain an unconditional promise or order to pay
State a definite amount of money
Be payable on demand or at a definite time
Be payable to order or to bearer

9. Interpretation of Ambiguities
When terms contradict, three rules apply:
Words take precedence over numbers
Handwritten terms prevail over typewritten terms
Typed terms prevail over printed terms

10. Negotiation
Means that an instrument has been transferred to the holder by someone other than the issuer
To be negotiated, order paper must first be indorsed and then delivered to the transferee
Bearer paper must simply be delivered to the transferee
No indorsement is required

11. Negotiation
Order paper: Instrument that includes the words “pay to the order of” or their equivalent
Bearer paper: Note is a bearer paper if it is made out to “bearer” or it is not made out to any specific person
Can be redeemed by any holder in due course
Indorsement: Signature of a payee

12. Holder in Due Course
Has an automatic right to receive payment for a negotiable instrument
Requirements for holder in due course:
Is a holder who has given value for the instrument, in good faith
Without notice of outstanding claims or other defects

13. Holder in Due Course Requirements for holder in due course
Holder: For order paper, anyone in possession of the instrument if it is payable to or indorsed to her
For bearer paper, anyone in possession
Value: Holder has already done something in exchange for the instrument
Good faith
Two tests to determine
Subjective test
Objective test

14. Notice of Outstanding Claims or Other Defects
The instrument is overdue
The instrument is dishonored
The instrument is altered, forged, or incomplete
The holder has notice of certain claims or disputes

15. Defenses against a Holder in Due Course
Issuer of a negotiable instrument is not required to pay if:
Signature on the instrument was forged
After signing, debts were discharged in bankruptcy
Amount was altered after he signed it
Signed under duress, mentally incapacitated, or part of illegal transaction
Tricked into signing the instrument

16. Consumer Exception
Federal Trade Commission has special rules for consumer credit contracts
Consumer credit contract: Consumer borrows money from a lender to:
Purchase goods and services from a seller who is affiliated with the lender

17. Liability for Negotiable Instruments
Signature liability: Liability of someone who has signs an instrument
Warranty liability: Liability of someone who receives payment on an instrument

18. Primary versus Secondary Liability
Primary liability: Unconditionally liable
Must pay unless he has a valid defense
Secondary liability: Must pay only if the person with primary liability does not pay
The holder of an instrument must first try to get payment from:
The party with primary liability before making demands against a party with secondary liability

19. Signature Liability The maker is primarily liable
The drawer of a check has secondary liability
The bank (drawee) is not liable to:
The holder and owes no damages to the holder for refusing to pay the check

20. Signature Liability Drawee
Certified check: A check the issuer’s bank has signed, indicating its acceptance of the check
Acceptor: Bank (drawee) that accepts a check (draft), thereby becoming primarily liable on it
Cashier’s check: Check drawn on the bank itself
Promise that the bank will pay out of its own funds

21. Signature Liability
Indorser: Anyone, other than an issuer or acceptor, who signs an instrument
Secondary liable
Indorsers are not liable if:
They write the words “without recourse” next to their signature on the instrument
Bank certifies the check
Check is presented for payment more than 30 days after the indorsement
Check is dishonored and the indorser is not notified within 30 days

22. Accommodation Party
Someone, other than an issuer, acceptor, or indorser:
Who adds her signature to an instrument for the purpose of being liable on it
Accommodated party: Someone who receives a benefit from an accommodation party
An accommodation party has the same liability to the holder as the person for whom he signed

23. Rules of Warranty Liability
The wrongdoer is always liable
The drawee bank is liable if it pays a check on which the drawer’s name is forged
The bank can recover from the payee only if the payee had reason to suspect the forgery
In any other case of wrongdoing, a person who first acquires an instrument from a wrongdoer is ultimately liable to anyone else who pays value for it

24. Transfer Warranties
When someone transfers an instrument, she warrants that:
She is the holder of the instrument
All signatures are authentic and authorized
Instrument has not been altered
No defense can be asserted against her
As far as she knows the issuer is solvent

25. Comparison of Signature Liability and Transfer Warranties
A forged signature is invalid and creates no signature liability for the person whose name was signed
The recipient of a forged item may recover under transfer warranties
Signature liability rules do not apply to the transfer of bearer paper since no indorsement is required
Transfer warranties apply

26. Presentment Warranties
Apply to someone who demands payment for an instrument from the maker, drawee, or anyone else liable
Presenter warrants that:
She is a holder
The check has not been altered
She has no reason to believe the drawer’s signature is forged
Anyone who presents a promissory note for payment warrants that he is a holder of the instrument

27. Other Liability Rules Conversion liability Impostor rule
Conversion: Means that:
Someone has stolen an instrument
Bank has paid a check that has a forged indorsement
Impostor rule
If someone issues an instrument to an imposter:
Any indorsement in the name of the payee is valid as long as the person who pays the instrument does not know of the fraud

28. Other Liability Rules Fictitious payee rule Employee indorsement rule
If an instrument is issued to a person who does not exist:
Indorsement in the name of the payee is valid as long as the payer does not know of the fraud
Employee indorsement rule
If an employee with responsibility for issuing instruments forges an instrument:

29. Negligence
Anyone negligent in creating or paying an unauthorized instrument is liable to an innocent third party
Anyone careless in paying an unauthorized instrument is liable:
Despite the three rules
Anyone careless in allowing a forged or altered instrument to be created is also liable:
Whether or not he has violated one of the three rules

30. “It is never wise to play an important game without understanding the rules. The rules of negotiable instruments are complex, but important because this game is played by virtually everyone.”