33-1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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7• Negotiable Instruments

• Negotiation and Holder in Due Course• Liability of Parties

• Checks and Electronic Transfers

Commercial Paper

PART

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Liability of Parties

PA ET RHC 33

Always do right. This will gratify some people, and astonish the rest.Mark Twain, Speech to Young People’s Society (1901)

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Learning Objectives

• Explain difference between primary and secondary liability

• List five warranties made to transfer negotiable instruments and three warranties made when presenting these for payment or acceptance

• Discuss three exceptions to normal liability rules

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• A person may be primarily liable if s/he agreed to pay the negotiable instrument. – The maker of a promissory note is primarily

liable for paying the debt

• A person who is secondarily liable is a contract guarantor and, under UCC Article 3, must pay the instrument only if the person who is primarily liable defaults on the obligation

Primary vs. Secondary Liability

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• The acceptor of a draft must pay the draft according to the terms at the time of acceptance (drawee’s signed engagement to honor the draft as presented)

• A drawee has no liability on a check or draft unless it certifies or accepts it– In Harrington v. MacNab, the drawee

bank had no liability to a payee for a drawer’s insufficient funds

Acceptor and Drawee Liability

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• A person who indorses a negotiable instrument usually is secondarily liable– Indorsers are liable to each other in

chronological order, from the last indorser back to the first

• To trigger secondary liability, the instrument must be properly presented for payment or acceptance, the instrument must be dishonored, and notice of the dishonor must be given to the person secondarily liable

Indorser Liability

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• An indorser is discharged from liability if: – A bank accepts a draft after indorsement

[3–415(d)]– Notice of dishonor is required and proper

notice is not given to the indorser [3–415(c)]

– No one presents a check or gives it to a depositary bank for collection within 30 days after the date of an indorsement [3–415(e)]

Discharge of Indorser Liability

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• Since the maker of a note is primarily liable to pay it when due, dishonor occurs if the maker does not pay amount due when:

1) it is presented in the case of (a) a demand note or (b) a note payable at or through a bank on a definite date and presented on or after that date, or

2) if it is not paid on the date payable in the case of a note payable on a definite date (but not payable at or through a bank) [3–502]

Presentment of a Note

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• To obtain payment or acceptance on a draft or check, holder must present it to drawee by any commercially reasonable means– Written, oral, or electronic [3–501]

• Drawee obligated when it accepts (certifies)

Presentment of a Draft or Check

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• Person who transfers negotiable instrument or presents it for payment may have liability for implied warranties of presentment or transfer– Bank One, N.A. v. Streeter: Person who

deposited checks to his account on which the payee’s name had been altered breached transfer warranties and was not entitled to enforce the instruments

Warranty Liability

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• Revised Article 3 follows general rule that payment or acceptance is final in favor of a holder in due course or payee who changes position in reliance on payment or acceptance– Bank bears burden of

mistake

Mistake in Payment or Acceptance

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• Imposter rule: If impostor convinces drawer to make check payable to the impersonated person or organization s/he “represents,” UCC makes any indorsement substantially similar to that of named payee effective

• Fictitious payee rule: If check written to fictitious payee, UCC allows any indorsement in name of fictitious payee to be effective as payee’s indorsement in favor of any person that pays in good faith or takes for value or collection

Other Liability Rules

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• Fraudulent indorsements by employees: Risk of loss for indorsements by employees given responsibilities for instruments (e.g., checks) falls on employer rather than bank that takes check or pays it

• Conversion: Law applicable to conversion of personal property applies to instruments

Other Liability Rules

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• An obligor is discharged from liability by:1. Payment of the instrument

2. Cancellation of the instrument

3. Alteration of the instrument

4. Modification of principal’s obligation causing a loss to a surety or impairing collateral

5. Unexcused delay in presentment or notice of dishonor with respect to a check

6. Acceptance of a draft by a bank (e.g., if a check is certified by a bank)

Discharge of Negotiable Instruments

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Thought Questions

• What steps would you take to make sure that fictitious payees and fraudulent indorsement did not occur in your business?