1. Copyright © 2009 by Pearson Prentice Hall. All rights reserved. PowerPoint Slides to Accompany CONTEMPORARY BUSINESS AND ONLINE COMMERCE LAW 6 th Edition by Henry R. Cheeseman Chapter 21 Holder in Due Course and Liability of Parties

2. 21 - 2Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Introduction If payment is not made on a negotiable instrument when it is due, the holder can use the court system to enforce the instrument. Various parties, including both signers and non-signers, may be liable. Accommodation parties (i.e., guarantors) can also be held liable.

3. 21 - 3Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Holder Versus Holder In Due Course Holder A person who is in possession of a negotiable instrument that is drawn, issued, or indorsed to him or his order, or to bearer, or in blankHolder Holder in Due Course (HDC) A person who takes a negotiable instrument for value, in good faith, and without notice that it is defective or is overdue Holder in Due Course (HDC) A person who takes a negotiable instrument for value, in good faith, and without notice that it is defective or is overdue

4. 21 - 4Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Requirements for HDC Status To qualify as an HDC, the transferee must meet the requirements established by the UCC. holder The person must be the holder of a negotiable instrument that was taken: 1.For value 2.In good faith 3.Without notice that it is overdue, dishonored, or encumbered in any way, and 4.Bearing no apparent evidence of forgery, alterations, or irregularity [UCC 3-302]

5. 21 - 5Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Holder in Due Course (HDC) Negotiable Instrument 1.Holder 2.Takes a negotiable instrument 3.For value 4.In good faith 5.Without notice of defect 6.The instrument bears no apparent evidence of forgery, alterations, or irregularity Maker or Drawer Payee or Bearer Holder in Due Course (HDC)

6. 21 - 6Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Holder in Due Course: Taking for Value Value has been given for a negotiable instrument if the holder: 1. 1. Performs the agreed-upon promise 2. 2. Acquires a security interest or lien on the instrument 3. 3. Takes the instrument in payment of or as security for an antecedent claim 4. 4. Gives a negotiable instrument as payment 5. 5. Gives an irrevocable obligation as payment

7. 21 - 7Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Holder in Due Course: Taking in Good Faith A holder must take the instrument in good faith to qualify as an HDC. Good faith Good faith means honesty in fact, conduct or transaction. It is the holder’s subjective belief that can be inferred from the circumstances.

8. 21 - 8Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Holder in Due Course: Taking Without Notice of Defect A person cannot qualify as an HDC if he or she has notice that the instrument is defective in any of the following ways: 1. 1. It is overdue 2. 2. It has been dishonored 3. 3. It contains an unauthorized signature or has been altered 4. 4. There is a claim to it by another person 5. 5. There is a defense against it

9. 21 - 9Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Holder in Due Course: No Evidence of Forgery, Alteration, or Irregularity A holder cannot become an HDC to an instrument that is apparently forged, or altered, or is so otherwise irregular or incomplete as to call into question its authenticity.

10. 21 - 10Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Signature Liability of Parties A person cannot be held contractually liable on a negotiable instrument unless his or her signature appears on the instrument. The signatures on a negotiable instrument identify those who are obligated to pay it. If it is unclear who the signer is, parol evidence can identify the signer.

11. 21 - 11Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Signature Defined Any name, word, or mark used in lieu of a written signature Any symbol that is: Handwritten, typed, printed, stamped, or made in almost any other manner; and Executed or adopted by a party to authenticate a writing

12. 21 - 12Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Signers of instruments sign in many different capacities, including: A maker of notes and certificates of deposit A drawer of drafts and checks A drawee who certifies or accepts checks and drafts A maker of notes and certificates of deposit A drawer of drafts and checks A drawee who certifies or accepts checks and drafts An indorser who indorses an instrument An agent who signs on behalf of others An accommodation party An indorser who indorses an instrument An agent who signs on behalf of others An accommodation party

13. 21 - 13Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Agent’s Signatures Agentauthorized Agent – a person who has been authorized to sign a negotiable instrument on behalf of another person. Principal Principal – a person who authorizes an agent to sign a negotiable instrument on his or her behalf. Unauthorized Signature Unauthorized Signature – a signature made by a purported agent without authority from the purported agent.

14. 21 - 14Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Signature Liability: Primary Liability primary liability Makers of promissory notes and certificates of deposit have primary liability for the instrument. Upon signing a promissory note, the maker unconditionally promises to pay the amount stipulated in the note when it is due. Makers are absolutely liable to pay the instrument, subject only to certain real defenses.

15. 21 - 15Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Signature Liability: Secondary Liability secondary liability Drawers of checks and drafts and unqualified indorsers of negotiable instruments have secondary liability on the instrument. This liability is similar to that of a guarantor of a simple contract. It arises when the party primarily liable on the instrument defaults and fails to pay the instrument when due.

16. 21 - 16Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Signature Liability: Accommodation Party A party who signs an instrument and lends his or her name (and credit) to another party to the instrument. The accommodation party is obliged to pay the instrument in the capacity in which he or she signs. Accommodation maker Accommodation maker – primarily liable Accommodation indorser Accommodation indorser – secondarily liable

17. 21 - 17Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Warranty Liability of Parties implies The law implies certain warranties on transferors of negotiable instruments. Warranty liability is imposed whether or not the transferor signed the instrument. There are two types of implied warranties: Transfer warranties Presentment warranties

18. 21 - 18Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Transfer Warranties (1 of 2) Transfer Transfer – any passage of an instrument other than its issuance and presentment for payment. Transfer warranties Transfer warranties – any of the following five implied warranties: 1.The transferor has good title to the instrument or is authorized to obtain payment or acceptance on behalf of one who does have good title 2.All signatures are genuine or authorized

19. 21 - 19Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Transfer Warranties (2 of 2) 3.The instrument has not been materially altered 4.No defenses of any party are good against the transferor 5.The transferor has no knowledge of any insolvency proceeding against the maker, the acceptor, or the drawer of an unaccepted instrument

20. 21 - 20Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Presentment Warranties presents Any person who presents a draft or check for payment or acceptance makes the following warranties to a drawee or acceptor who pays or accepts the instrument in good faith: 1.The presenter has good title to the instrument or is authorized to obtain payment or acceptance of the person who has good title 2.The instrument has not been materially altered 3.The presenter has no knowledge that the signature of the maker or drawer is unauthorized

21. 21 - 21Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Defenses The creation of negotiable instruments may give rise to a defense against its payment. There are two general types of defenses: Real defenses Personal defenses holder in due course (HDC) A holder in due course (HDC) takes the instrument free from personal defenses but not real defenses.

22. 21 - 22Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Real Defenses Effect 1.Minority 2.Extreme duress 3.Mental incapacity 4.Illegality 5.Discharge in bankruptcy 6.Fraud in the inception 7.Forgery 8.Material alteration Real defenses can be raised against both holders and holders in due course.

23. 21 - 23Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Personal Defenses Effect 1.Breach of contract 2.Fraud in the inducement 3.Mental illness that makes a contract voidable instead of void 4.Illegality of a contract that makes the contract voidable instead of void 5.Ordinary duress or undue influence 6.Discharge of an instrument by payment or cancellation Personal defenses cannot be raised against a holder in due course.

24. 21 - 24Copyright © 2009 by Pearson Prentice Hall. All rights reserved. HDC Status Eliminated with Respect to Consumer Credit Transactions eliminates HDC status The Federal Trade Commission (FTC) has adopted a rule that eliminates HDC status with regard to negotiable instruments that arise out of certain consumer credit transactions. Sellers of goods and services are prevented from separating the consumer’s duty to pay the credit and the seller’s duty to perform. personal and real defenses Thus, both personal and real defenses can be raised against an HDC. eliminates HDC status The Federal Trade Commission (FTC) has adopted a rule that eliminates HDC status with regard to negotiable instruments that arise out of certain consumer credit transactions. Sellers of goods and services are prevented from separating the consumer’s duty to pay the credit and the seller’s duty to perform. personal and real defenses Thus, both personal and real defenses can be raised against an HDC.

25. 21 - 25Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Discharge Actions or events that relieve certain parties from liability on negotiable instruments. There are three methods of discharge: 1.Payment of the instrument 2.Cancellation 3.Impairment of the right of recourse

26. 21 - 26Copyright © 2009 by Pearson Prentice Hall. All rights reserved. Impairment of the Right of Recourse Certain parties (holders, indorsers, accommodation parties) are discharged from liability on an instrument if the holder: 1.Releases an obligor from liability; or 2.Surrenders collateral without the consent of the parties who would benefit by it