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Order for a third person to pay the payee.
AKA: check or draft.
Drawer and drawee are the same bank (e.g. the bank orders itself to pay). Customer who buys a cashier's check is called a "remitter."
a promissory note.
Note that a certificate of deposit (CD) is a promise by a bank to pay back money on deposit.
Article 3 of the UCC
Applies only to negotiable instruments
- 7/8-part Test - If it fails this test, then the instrument is not "negotiable"; it is merely a payment K and subject to general K law.
- 1) written and signed promise or order to pay
- 2) unconditional; can't explicitly make payment subject to the terms of another referenced document, though it can refer to an accompanying loan or security agreement and can limit payment to a particular source
- 3) transfers money (as opposed to non-monetary value)
- 4) For a fixed amount; can be pursuant to a formula and even a floating interest rate.
- 5) Magic words of negotiability; e.g. "to bearer" or "to order".
- 6) definite time for payment or upon demand - demand is the default; prepayment and acceleration are OK.
- 7) no extraneous undertakings: no promises or orders to do anything other than pay money, though there are 3 exceptions: (i) give/maintain/protect collateral; (ii) confess judgment; (iii) waiver protections fro the maker/indorser.
- 8) must not state conspicuously that the instrument is not negotiable
Contradictory Terms on a negotiable instrument
- 1) words trump numerals
- 2) hand-written terms prevail over typed/printed words
Effect of issuance of a note or check
- 1) generally, the payee accepts the instrument, and the underlying obligation is suspended until the instrument is paid/discharged or dishonored (in which case the obligation is reinstated.
- 2) Accord and Satisfaction
Note- if payee accepts a cashier's check, the obligation is discharged immediately.
Accord & Satisfaction
- Using a discounted 'full payment' instrument works to finalize settlement of disputed obligations if three factors are present:
- 1) drawer's 'good faith' to settle a bona fide dispute with respect to the existence or amount of debt;
- 2) the 'full payment' legend appears conspicuously on the instrument (indicating it satisfies the debt in full)
- 3) payee obtains payment and doesn't refund that payment within 90 days.
Note - crossing off the 'full payment' legend, 'reserving rights,' and/or accepting the money under protest will have no effect. Payee can't accept the money and reserve rights.
Only a holder can negotiate an instrument. A holder can be anyone in possession.
Bearer Paper - anyone in possession is a holder and can enforce the instrument.
Order Paper - only the person identified as the payee can be a holder entitled to enforce.
- Transfer of the rights to payment under the instrument to other people.
- Bearer Paper - simply pass possession (even involuntarily via theft)
- Order Paper - pass possession and indorse the instrument
Three Types of Indorsement
- Blank Indorsement: simple signature; has the effect of converting order paper into bearer paper
- Special Indorsement: signature under instructions directing payment to a specific person; the effect is the instrument either continues as or becomes order paper.
- Restrictive Indorsement: signature under a restriction 'for deposit only,' which requires money from payment for the instrument to go into the indorser's deposit account
Anomalous indorser serves as a surety/guarantor of payment to anyone who later becomes a holder. Typically, this is signed on the back of a check.
More commonly, a guarantor will sign as a co-maker on the front of a note with clear and known intention of guaranteeing that the note/loan will be repaid.
Protections for Accommodation Parties
- Release: In IL (contrary to general law of suretyship), a holder's release of the principal obligor does not release accommodation parties.
- However, in 2002, UCC 3-605 was amended to provide that the release of the principal releases the accommodation parties as well.
- Indorser can reserve rights against accommodation parties (except against indorsers of checks) by specifically preserving the right to pusue the secondary obligor and the secondary's recourse against the principal.
- Extension/Modification: extension of the principal's time to pay, modification of the note, impairment of collateral discharges accommodation parties who do not consent to the modification, but only to the extent that the modification causes them loss (e.g. making it impossible to later find and collect from the principal; reducing the value of the collateral to a degree that the secondary's contribution right cannot fully be covered by recourse to the collateral).
- Holder Refuses to Accept Payment - where the maker of a note and the holder refuses the tender of payment, the secondary liability of the accommodation parties is discharged to the extent of the amount of the tender.
Enforcing lost or stolen instruments
Generally, the holder must be in possession, though lost or stolen instruments can be enforced nonetheless.
- Holder must prove two things:
- 1) holder must prove the terms of the instrument
- 2) entitlement to enforce it, including that he was a holder when the instrument went missing and it was not negotiated/transferred.
- 3) maker gets adequate protection against someone else coming forward (security)
Holder in Due Course Status
Makers can typically assert defenses to payment, e.g.
promised payment in exchange for the instrument wasn't delivered. These defenses are based on the underlying obligation.
- HIDCs can enforce the instrument free of claims to the instrument and all but a few defenses. Thus, the maker must pay the HIDC and sue the original payee for reimbursement. Four Part Test:
- 1) must be a holder of the instrument through proper negotiation.
- 2) must have acquired the instrument "for value" (must be past or present value; future promises are not value until they are performed)
- 3) must have taken the instrument in 'good faith' (honesty in fact and observance of reasonable standards of commercial fair dealing).
- 4) must have acquired the instrument without notice of any of the following four problems:
- (i) instrument is overdue, dishonored, or the principal payment is in default;
- (ii) instrument contains an unauthorized signature (forged) or has been altered (no obvious signs of tampering or forgery);
- (iii) someone has a claim to the instrument
- (iv) any drawer or maker of the instrument has a defense to payment or a claim in recoupment (e.g. failure of consideration or payment).
Only successful assertion of a "real defense" by a drawer/maker can prevent payment to an HIDC
When an HIDC transfers its instrument to a trasnferee, the transferee can exercise the transferor's HIDC rights thereafter, even if the transferee would not qualify for HIDC-status in his own right. E.g., Where an HIDC donates (not "for value") an instrument to a charity, the charity becomes an HIDC.
Only 4 defenses can be asserted against payment to an HIDC
- 1) Infancy of the maker/drawer
- 2) duress, lack of capacity, or illegality of the underlying debt IF the defense renders the contract void (if the defense merely renders the contract voidable, the defense will fail).
- 3) fraud in factum - (maker did not know or have any reasonable way of knowing that the signed paper was an instrument. This is exceedingly rare.
- 4) discharge in bankruptcy of the debt pursuant to federal law.
Note - Fraud in factum differs from fraud in the inducement, wherein the maker was tricked into signing an instrument in relation to a fraudulent scheme.
Enforcing against indorsers/accommodation parties
- 1) the obligation must have been dishonored by the maker's or the drawee's bank (note the bank and the drawer become liable)
- 2) time notice of dishonor is given to the indorser
- 3) BUT unlike makers/drawers, indorsers can waive liability to pay dishonored instruments by signing 'without recourse'
- Anyone who transfers an instrument in exchange for value warrants five things to their transferee (including indorsers):
- 1) transferor is entitled to enforce the instrument
- 2) all signatures on the instrument are authentic and authorized
- 3) the instrument has not bee altered
- 4) the instrument is not subject to any defense or claim that can be asserted against the transferor; and
- 5) transferor doesn't know that the maker/drawer has initiated bankruptcy.
These warranties cannot be waived on checks, but they can be on notes
If someone accepts the instrument for value and later learns of one of these five problems, the holder can enforce a dishonored instrument either on indorser liability (if not waived) or the transfer warranty against the transferor and any previous indorser.
Forged Signatures - often tested
- Step one:
- Forged Signature of a Drawer/Maker - only someone who actually signs an instrument is liable; writing another person's name counts as the writer's signature, not the named person's. Moreover, the payor bank can't charge drawer's account for forged checks (b/c they aren't properly payable).
improper negotiation over forged indorsement = possessor is not a 'holder' and the instrument is 'not properly payable' to that person. For checks, the proper payee of a stolen check has a claim of conversion against a depository bank or a payor bank who gave payee's money to a thief over a forged indorsement.
Step 2: Negligence
If maker's/drawer's or payee's failed to use ordinary care substantially contributed
to/facilitated the forgery/alteration, he is precluded
from asserting the forgery/alteration against anyone who gave value for the instrument in good faith
(doesn't have to be HIDC).
However, the maker/drawer can in turn claim that the banks failed to exercise ordinary care in paying the item and the loss will be distributed via comp. neg.
Forged signatures and fictitiuos payees
any indorsement in the fictitious name is effective; payor has to recover via fraud.
Forged signatures and impostors
impostor can effectively negotiate by indorsing the named payee's name
Forged signatures and responsible employees
where an employee w/ check processing duties fraudulently indorser's the employer's instrument, the indorsement is effective to for negotiation.
Note - this rule does not apply to forged drawer signatures.
Fraudulent Alteration or Completion
- General rule: alteration discharges the maker/drawer liability, but . . .
- 1) An instrument fraudulently changed can be enforced according to its original terms, but only by someone who acquired the instrument for value, in good faith, and without notice of the alteration. However, the negligence rules might preclude drawer's assertion of an alteration defense.
- 2) A signed but incomplete instrument later fraudulently completed can be enforced according to its terms as completed, but only by someone who acquired it for value, in good faith, and without notice of the completion.