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Class notes for Commercial Paper Pt. II

 
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PostPosted: Mon Apr 28, 2014 8:30 am    Post subject: Class notes for Commercial Paper Pt. II Reply with quote

THIS IS A USER FRIENDLY OUTLINE FOR MY STUDENT'S USE. IT PARALLELS PART V (PART TWO) OF CHEESEMAN'S TEXTBOOK. MY STUDENTS ARE FREE TO DOWNLOAD THIS FOR THIS OWN USE AND FOLLOW ALONG WITH MY LECTURES BASED ON IT.



INTRODUCTION TO HDC (HOLDER IN DUE COURSE)

TERMINOLOGY:

What makes a HDC? THE KEY RULE: X takes an AUTHENTIC¬ APPEARING NI

FOR VALUE;

IN GOOD FAITH, and

WITHOUT NOTICE IT IS OVERDUE, HAS BEEN DISHONORED, OR HAS CERTAIN DEFENSES/CLAIMS AGAINST IT

What is a "REAL" /UNIVERSAL DEFENSES:
Defenses to enforcement of instrument: Which are Good against anyone, including HDC’s

PERSONAL (LIMITED) DEFENSES:
Not "real" defenses; generally, insufficient against HDC’s

DISHONOR OF NI

Refusal to pay/accept for later payment

DISCHARGE
Removal of parties' liability on instrument, usual¬ly by payment

GENERAL RULE CENTRAL TENET OF NEGOTIABLE INSTRUMENTS LAW.

(HDC) of NI is not gen¬erally subject to claims/personal defenses that could be raised by original parties to the instrument.


WHAT HAPPENS WHEN SOMETHING GOES WRONG REGARDING N.I.'S.

HOLDER IN DUE COURSE PAYEES AS HDC – POSSIBLE OR NOT?

Payees can be HDCs. However in vast majority of cases: Payee was directly involved in the transaction that caused the instrument to be issued (e.g., the payee sold goods/services to maker or drawer). Payee very likely would have had notice of any claim or defense against being paid by maker or drawer, and payee therefore, not HDC. REMEMBER: IF THERE IS NOTICE CANNOT BE A HDC

EXPLANATION OF THE REQUIREMENTS FOR HOLDER TO BE A HDC

WHEN AUTHENTICITY QUESTIONED

When issued/negotiated to a holder: MUST NOT: Bear evidence of forgery/alteration/other irregularities or incompleteness.

AND IF NI contains an unauthorized signature, or has certain defenses or claims against it.
WHAT DOES VALUE MEAN?
1. EXTENT OF CONSIDERATION, 2. SECURITY INTEREST, OR 3. LIEN ON INSTRUMENT

TAKING FOR VALUE

Value is measured by the extent that: there is an agreed-upon consideration or the instrument has been acquired as a security interest or lien on the instrument.
EXAMPLE: TAKING FOR VALUE: C obligated to pay B $500 in order to receive a check from A to B in same amount. If C pays B the $500, C can be a HDC for FULL AMOUNT of the check. If C gives less than $500; only HDC for amount actually gave value to B.


EXECUTORY PROMISE Obligation to do something in the future
can be good consideration for contracts, including UCC contracts DOES NOT constitute "value" necessary to make HDC

PREEXISTING CLAIMS, RECIPROCAL NEGOTIABLE INSTRUMENTS, AND IRREVOCABLE COMMITMENTS

HDC "value" also exists when X takes instrument as security or payment for pre-existing claim, whether/not claim is due. EXAMPLE: B claimed C owed him money, instrument from C to pay B's claim would be for "value."

HDC "value" X gives a NI or makes an irrevocable commitment to third party. EXAMPLE: S gives "value" by giving J a check in return for taking J's promissory note.

NON-HDC VALUE:

Gifts

Inheritances,

Unperformed promises (except binding ones to third parties),

Pur¬chases pursuant to legal proceedings such as foreclosures

WHAT DOES GOOD FAITH MEAN?

IF acts honestly. Test: SUBJECTIVE: Did holder actually believe instrument was “regular” (genuine, authorized, and conforming w/law)? Usually irrelevant reasonable person ("objective") test might have acted differently.

OBVIOUS defenses may lead, however, to a presumption against subjec¬tive good faith. In adddition to size of any discount from instru¬ment's face amount, Courts look at the parties' relationship, instrument's appearance, time remaining before due date, and time and place of instrument's transfer.

ABSENCE OF NOTICE

Most disputes about HDC status concern alleged notice of claim or defense; whether "value" was given is generally easy to determine, and good faith is usually assumed.

"Notice" includes what holder actually knew and SHOULD HAVE KNOWN from all facts and circumstances. (REASONABLE PERSON STANDARD) E.G.: Obvious forgeries, alterations, or blanks in material terms are themselves sufficient to suggest potential claims or defenses to instrument. In these cases: nothing else is necessary to show notice.

CAUTION: HOWEVER, THERE ARE Other cases: Court needs look beyond instrument itself to determine notice.

THE INSTRUMENT IS OVERDUE.

FOR TIME INSTRUMENTS

If Specific due date, "overdue" means some/all of amount of instrument remains unpaid after due date.

FOR DEMAND INSTRUMENTS

Either demand for payment has been made, yet money remains due, or instru¬ment has been outstanding for unreasonable period of time (more than 30 days, presumably, for certified checks; longer for other instru¬ments).

THE INSTRNMENT HAS BEEN DISHONORED, REFUSED PAYMENT OR REFUSED ACCEPTANCE.

For drafts dis¬honoring generally by drawee, while for notes it usually the maker.

THERE ARE DEFENSES AGAINST, OR CLAIMS TO, THE INSTRUMENT.

Aside from obvious forgeries or alterations: THERE EXISTS: notice of claims or defenses arisen from awareness obligations of one or more parties are voidable or parties have been discharged.

Merely filing document or recording it (e.g., in the land records, w/governmental agency or the like does not provide notice to a holder. Courts look beyond such "constructive" (legally implied) notice to determine whether holder ACTUALLY KNEW/SHOULD have known about that defense or claim. (I Question this rule!!!)

EXAMPLE: Notice of Defense: Doofus pays Skippy Skunk $10K cash to obtain $11K check payable to Skippy w/words "trustee for Molly Minor" written in bold face in memorandum section of check, Doofus may be deemed to have notice of defense to payment Memo seems to indicate payment intended to for benefit of Molly Minor, but from the $1K discount and fact payment is in cash reasonable person could reasonably infer Skippy will keep money for himself. W/o the discount or the cash payment, Doofus probably could argue successfully that he neither knew nor should have known Skippy was violating duties as Molly's trustee. (Notice of Breach of Fiduciary Duty).

Notice effective only if received early enough to give potential holder time to respond.

EXAMPLE: Inadequate (Untimely) Notice: Company X's branch manager in one location receives notice 30 seconds before Company X's branch manager at another location accepts instrument in question, Company X may still be a HDC. Notice was not timely.

Obviously, late notice cannot serve to undo HDC status; HOWEVER, CAN limit status to cover only amount already given for instrument. HDC not HDC for subsequent, post-notice value provided in instrument.



THE SHELTER RULE OR THE SHELTER PRINCIPLE


X, a Non-HDC in own right will usually take whatever rights transferors had. Thus X the transferee is not a HDC (e.g., a donee no "value"; instrument is a gift), takes an instrument from Y a HDC, X acquires all the rights of HDC. The reason for the rule: it furthers transferability of instruments and benefits HDC status; HDCs and potential transferees know latter will acquire HDC status.

EXAMPLE: Maker induced by Payee's fraud to issue Payee promissory note. Payee negotiates note to Sam, who takes it for value, in good faith, w/o notice it is overdue, has been dishonored, or has defenses or claims to it. After note becomes obviously overdue, Sam negotiates to Safehaven. Safehaven clearly not HIDC (he has notice note is overdue), BUT Sam was HDC. Therefore Safehaven takes all the HDC rights Sam had, and Safehaven is free of Maker's personal defense (fraudulent inducement). We will further discuss the distinction between personal and universal (real) defenses.

PRECEDING EXAMPLE, once Sam takes instrument, all subsequent transferees, no matter how far down line, also have HDC rights.

2nd. Example: Javier buys a used car from Debbie for 10% down with a negotiable promissory note for the remainder of the purchase price, with interest, in 36 equal monthly installments. At the time of sale, Debbie materially misrepresented the mileage of the automobile. (A personal defense.) Later, Debbie negotiates the note to Eric, who has no notice of the misrepresentation. Eric, a HDC, negotiates the note to Joanna. Assume that Joanna does not qualify as an HDC in her own right. She becomes an HDC, however, because she acquired the note through an HDC (Eric). Joanna can enforce the note against Javier.

Shelter rule covers anyone who can trace title back to HDC.



However, remember the following rules apply:

The holder does not have to qualify as an HDC in his or her own right. The holder must acquire the instrument from an HDC or be able to trace his or her title back to an HDC.
The holder must not have been a party to a fraud or
illegality affecting the instrument. And The holder cannot have notice of a defense or claim against the payment of the instrument




WHO IS EXCEPTED?

Transferees cannot use rule if they participated in fraud or illegality affecting instrument. Unseemly to let party acquire HDC status by "laundering" instrument through one or more transferees then reacquiring it.


DEFENSES THERE ARE TWO MAIN DEFENSES: UNIVERSAL (REAL DEFENSES WHICH WORK EVEN AGAINST HDC’s AND PERSONAL DEFENSES WHICH DON’T WORK AGAINST HDC’s

UNIVERSAL DEFENSES REAL DEFENSES RAISABLE AGAINST ALL

If a real defense is proven, the holder or HDC cannot recover on the instrument.

P. 400-402 (2013)

A. MINORITY INFANCY, OR MINORITY, to the extent it's a defense to a simple contract. In California , a minor who does not misrepresent her/his age can disaffirm contracts, including negotiable instruments. Usually, minors must pay the reasonable value of necessities of life.

B. EXTREME DURESS: Usually some form of force or violence (e.g., a promissory note signed ar gunpoint) ORDINARY DURESS IS A PERSONAL DEFENSE.


C. MENTAL INCAPACITY -ADJUDICATED MENTAL INCOMPETENCE Cannot issue a negotiable instrument. The instrument is void from is inception. NON-ADJUDICATED MENTAL INCOMPETENCE, WHICH IS USUALLY ONLY A PERSONAL DEFENSE.

D. ILLEGALITY: If instrument rises out of an illegal transaction, the illegality is a universal defense if the law declares the instrument void. E.G.: State's law declares gambling illegal and gambling contracts to be void. Gordon wins $1K from Jerry in an illegal poker game, and signs a promissory note promising to pay Gordon this amount plus interest in 30 days. Gordon negotiates this note to Dawn, an HDC. When Dawn presents the note to Jerry for payment, Jerry can raise the universal defense of illegality against the enforcement of the note. Dawn's recourse is against Gordon. IF THE LAW MAKES AN ILLEGAL CONTRACT VOIDABLE INSTEAD OF VOID, IT IS ONLY A PERSONAL DEFENSE.

E. DISCHARGE IN BANKRUPTCY Bankruptcy’s purpose is to relieve debtors of burdensome debts, including obligations to pay NI. instruments. E.G.: Hunt borrows $10K from Amy and signs a note promising to pay Amy this amount plus interest in one year. Amy negotiates note to Richard, an HDC. Before note is due, Hunt declares bankruptcy and receives a discharge of his unpaid debts. Richard cannot thereafter enforce the note against Hunt, but he can recover against Amy.


F. FRAUD IN THE INCEPTION also called FRAUD IN THE FACTUM OR FRAUD IN THE EXECUTION) It’s when a person is deceived into signing a NI, thinking that it is something else. E.G.: Sam, a door-to-door salesman, convinces Lance, an illiterate consumer, to sign a document purported to be an agreement to use a plasma TV set on a 90-day trial basis. In actuality, the document is a promissory note in which Lance has agreed to pay $5K for the plasma TV set. Sam negotiates the note to Stephanie, an HDC. Lance can raise the universal defense of fraud in the inception against the enforcement of the note by Stephanie. Stephanie, in turn, can recover from Sam. HOWEVER: A PERSON IS UNDER A DUTY TO USE REASONABLE EFFORTS TO ASCERTAIN WHAT HE OR SHE IS SIGNING. (I.E. The reasonable person standard used here.) The court inquires into a person's age, experience, education, and other factors before allowing fraud in the inception to be asserted as a universal defense to defeat an HDC. FRAUD IN THE INDUCEMENT (DISCUSSED LATER) IS ONLY A PERSONAL DEFENSE.

G. FORGERY The unauthorized signature of a maker, a drawer, or an indorser is wholly inoperative as that of the person whose name is signed unless that person either ratifies it or is precluded from denying it. In the latter case, a person can be estopped from raising the defense forgery if his or her negligence substantially contributes to the forgery. A forged signature operates as the signature of the forger. Thus, the forger is liable on the instrument!!!

H. MATERIAL ALTERATION An instrument that has been fraudulently and materially altered cannot be enforced by an ordinary holder. Material alteration consists of adding to any part of a signed instrument, removing any part of a signed instrument, making changes in the number or relations of the parties, or completing an incomplete instrument without the authority to do so. It’s only a partial defense a HDC can enforce it’s original terms.

PERSONAL DEFENSES P. 402-403 (2013)

Cannot be raised against an HDC, but can be raised against enforcement of a NI by an ordinary holder.

A. BREACH OF CONTRACT one of the most common defenses raised by a party to a NI. This personal defense is effective only against an ordinary holder. E.G.: ex Brian purchases a used car on credit from Karen, signing a note promising to pay Karen the $10K purchase price plus interest, in 36 equal monthly installments. The sales agreement warrants car is in perfect working condition. A month later, the car's engine fails; the cost of repair is $3K. Brian, the maker of the note, can raise breach of warranty as a defense against enforcement of the note by Karen.

HOWEVER: Outcome different if Karen negotiated the promissory note to Max (an HDC) immediately after the car was sold to Brian. Max would be an HDC, and Brian could not raise the breach of warranty defense against him. Max could enforce the note against Brian. Brian's only recourse would be to seek recovery for breach of warranty from Karen.

B. FRAUD IN THE INDUCEMENT Occurs when Wrongdoer makes a false statement (i.e., misrepresentation) to another person to lead that person to enter into a contract w/Wrongdoer. NI’s often arise out of such transactions. It’s a personal defense and not effective against HDCs. It is effective against ordinary holders, however.

E.G.:Morton represents to investors he will accept funds to drill for oil and investors "will share in the profits from the oil wells. His real plan to use funds for own use. Relying on Morton's statements, Mimi draws a $50K check payable to him. Morton absconds w/funds. Because Morton is an ordinary holder, Mimi can raise the personal defense of fraud in the inducement and, if she stops payment on the check before Morton receives payment, not pay the check. However, if Morton had negotiated the check to Tim, an HDC, Tim could enforce the check against
Mimi. Because personal defenses are not effective against Tim (an HDC), Mimi's only recourse is to recover against the wrongdoer (Morton), if he can be found!!!!

Other Personal Defenses The following personal defenses can be raised against enforcement of a negotiable instrument by an ordinary holder:

These are additional personal defenses:
Non adjudicated Mental illness making a contract voidable instead of void.

2. Illegality of a contract that makes the contract voidable instead of void

3. ORDINARY DURESS OR UNDUE INFLUENCE

4. Discharge of an instrument by payment or cancellation [UCC 3-602, 3-604]

REMEMBER: Personal defenses cannot be raised against a holder in due course.

STATE LAWS TO PROTECT CONSUMERS

HDC's special status sometimes runs counter to modern law's emphasis on consumer protection. E.G.: Connie Consumer buys refrigerator from Manny's Manufacturers, usual law of commercial paper would allow HDC to enforce payment from Connie on her check to Manny; would not matter Manny not entitled to pay¬ment from Connie because numerous problems w/ refrigerator.

Many state laws not designed to protect people such as Connie Consumer. State legislatures/Courts have reduced/eliminated HDC's right to collect from consumers who have personal defenses.

Another approach: simply eliminate HDC status in certain cases. Uniform Consumer Credit Code (UCCC), enacted by several states, does that for most consumer transactions involving negotiable instru¬ments other than checks; and courts often deny HDC status to finance companies closely tied to sellers of consumer products. (For more on the UCCC, see Chapter 13.)

UCC 3-302(g) specifically subordinates HDC status to these other laws favoring consumer protection and other public policy concerns.

THE FEDERAL TRADE COMMISSION RULE

In certain situations, the HDC rule can cause a hardship for the consumer.

Illustration: Creg Consumer, purchases stereo on credit from Lou's Stereo, signing a note promising to pay purchase price + interest to Lou's Stereo in 12 monthly installments. Lou's Stereo immediately negotiates note at discount to Bank for cash. Bank is an HDC. Stereo is defective. Consumer would like to stop paying, but HDC rule protects him from asserting any personal defenses against Bank. Under UCC, Consumer's only recourse: Sue Lou's Stereo, often an unsatisfactory result because Consumer has no leverage against Lou's Stereo, bringing a court action is expensive and time consuming.

To correct this harsh result,(FTC), a federal administrative agency, in charge of consumer protection, adopted a rule that eliminates; HDC status w/ regard to NI’s arising out of certain consumer credit transactions. This federal law takes precedence over State’s UCC’s.

Sellers of goods and services are prevented from separating the consumer's duty to pay the credit and the seller’s duty to perform. This subjects HDC of a consumer credit instrument to all the defenses and claims of the consumer. In the prior example, Consumer can raise the defect in the stereo as a defense against enforcement of the promissory note by Bank, an HDC.

The FTC rules applies to consumer credit transactions in which (1) Buyer signs a sales contract that includes a promissory note, (2) Buyer signs installment sales contract containing a waiver of defenses clause, and (3) Seller arranges consumer financing w/3rd. party lender. Note that payment for goods and services with a check is not covered by this rule because it is not a credit transaction.

The FTC rule requires that the following clause be included in bold type in covered consumer credit sales and installment contracts:

Notice. Any holder of this consumer credit contract is subject to all claims and defenses which the debtor could assert against the seller of the goods or services obtained pursuant hereto or with the proceeds hereof Recovery hereunder by the debtor shall not exceed amounts paid by the debtor hereunder.

The FTC can impose severe monetary fines for violations.

LIABILITIES AMONG PARTIES

Liability in absence of any defense.

LIABILITY MAY BE BASED ON EITHER UNDERLYING CONTRACT OR ON INSTRUMENT ITSELF.

PRIMARY AND SECONDARY LIABILITY ON THE INSTRUMENT

Parties to instrument are either primarily or secondarily liable. Primary parties: Drawers (for unaccepted drafts), Makers, and Acceptors (usually Drawees), while secondary parties are Indorsers.

PRIMARY PARTY MUST PAY ON AN INSTRUMENT:

(1) As it existed when drafted by drawer or maker or accepted by drawee, or

(2) For incomplete instrument, as it was ultimately completed (if completion was authorized). Secondary party usually can assume primary party will pay on the instrument.

If primary party has not paid, secondary party has obliga-tion to pay, provided person seeking payment first demand¬ed payment from primary party, and secondary party received notice primary party dishonored (refused to pay) instrument.

INDORSER'S SECONDARY LIABILITY

Is for the amount stated at time of indorsement. This contractual liability can be avoided by sign¬ing w/words "without recourse." The indorsement then
"quali¬fied." The Indorser is saying: "I make no guarantee primary party will pay; if he does not, I will not pay, either." (When multiple, unquali¬fied indorsements on an instrument, indorsers generally liable to one another in order in which they indorse (i.e., each indorser is liable to the subsequent indorser); that chronological order is presumably the order in which signatures appear on the instrument.)

THREE MAIN TYPES OF LIABILITY BASED ON THE INSTRUMENT

Three main types of liability problems involve negligent persons, impostors or fictitious payees, and signers lacking capacity or authority.

IMPOSTER RULE IMPERSONATING A PAYEE

One who impersonates a payee and induces the maker or drawer to issue an instrument in the payee's name and give the instrument to the imposter. If the imposter forges the indorsement of the named payee, the drawer or maker is liable on the instrument to any person who, in good faith, pays the instrument or takes it for value or for collection [UCC 3-404(a)]. This rule is called the imposter rule.

E.G.: Fred purchases goods by telephone from Cynthia. Fred’s never met Cynthia. Beverly goes to Fred and pretends to be Cynthia. Fred draws a check payable to the order of Cynthia and gives the check to Beverly, believing her to be Cynthia. Beverly forges Cynthia's indorsement and cashes the check at a liquor store. Under the imposter rule. Fred is liable and the liquor store is not because Fred was in the best position to have prevented the forged indorsement.

POSING AS AN AGENT

The imposter rule does not apply if the wrongdoer poses as the agent of the drawer or maker.

Example: Suppose in the preceding example Beverly lied to Fred and said she was Cynthia's agent. Believing this, Fred draws the check payable to the order of Cynthia and gives it to Beverly. Beverly forges Cynthia's indorsement and cashes the check at a liquor store. Here, the store is liable because the imposter rule does not apply. The liquor store may recover from Beverly, if she can be found.

NEGLIGENT PERSONS

Any person whose negligence substantially con¬tributes to alteration of instrument or making of forged sig¬nature precluded from asserting such alteration or signature against anyone who pays instrument in good faith or takes it for value or for collection. Negligence: same definition as for common law tort of negligence: failure to exercise ordinary care. UCC Further provides if party asserting preclusion also negligent, loss apportioned between negligent persons according to comparative negligence standards.

To preclude a claim because of negli¬gence, negligence must be significant ("substantially con¬tributes"), not just remotely responsible." E.G.: Upon receiving notice forgeries are occurring, failure to act to pre¬vent more forgeries. Negligence in controlling access to, and use of, a signature stamp. Drawer's failure to include corporate designation (e.g., Co., Corp., Inc.) after corporate name. Delivery of instrument to wrong person. Failure to audit corporate books.

FYI ONLY: SIGNERS W/O CAPACITY OR AUTHORITY

Negotiation effective even though may be subject to rescission because of incapacity, illegality, duress, fraud, mistake, or break of duty (UCC §3-202). Furthermore, negotiation cannot be rescinded against HDC if problem amounts to merely personal defense, not a "real" defense. UCC provision to be distinguished from blatantly unauthorized signatures (forgeries), which simply do not constitute negotiation and thus cannot create holders, let alone HDCs.

ANOTHER BASIS FOR LIABILITY: WARRANTIES.

Any person who obtains payment/acceptance of instrument, or who transfers instrument and receives consideration, makes warranties. Under these, like other warranties (e.g., sales warranties, party may be liable for damages if are breached. (Note: HDCs ordinarily can enforce payment on instrument despite presence of alleged warranties.)

A. PRESENTMENT WARRANTIES

Any person who presents a draft or check for payment or acceptance makes the following presentment warranties to a drawee or an acceptor who pays or accepts the instruments 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.

A drawee who pays an instrument may recover damages for breach of presentment warranty from the warrantor. The amount that can be recovered is limited to the amount paid by the drawee less the amount the drawee received or is entitled to receive from the drawer because of the payment plus expenses and interest.

E.G.: Maureen draws a $1K check on Bank "payable to the order of Paul." Paul c1everly raises the check to $10K and indorses and negotiates the check to Neal. Neal presents the check for payment to Bank. As the presenter of the check, Neal makes the presentment warranties to Bank. Bank pays the check as altered ($10K) and debits Maureen's account, when Maureen discovers the alteration, she demands Bank re-credit her account, which Bank does. Bank can recover against the presenter (Neal), based on breach of the presentment warranty that the instrument was not altered when it was presented. Neal can recover against the wrongdoer (Paul), based on breach of the transfer warranty that the instrument was not altered.

B. TRANSFER WARRANTIES

Any passage of an instrument other than its issuance and presentment for payment is considered a transfer. Any person who transfers NI for consideration makes the following five warranties to the transferee. If the transfer is by indorsement, the transferor also makes these warranties to any subsequent transferee:

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.

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.

Transfer warranties cannot be disclaimed with respect to checks, but they can be disclaimed with respect to other instruments. An indorsement that states "without recourse" disclaims the transfer warranties. SO: ALWAYS USE THIS TERM!!!!!!!

A transferee who took the instrument in good faith may recover damages for breach of transfer warranty from the warrantor equal to the loss suffered. The amount recovered cannot exceed the amount of the instrument plus expenses and interest.

Example: Jill issues a $1K note to Adam. Adam cleverly raises the note to $10K and negotiates note to Nick. Nick indorses the note and negotiates it to Matthew. Then Matthew presents the note to Jill for payment, she has to pay only the original amount of the note, $1K. Matthew can collect the remainder of the note ($9K) from Nick, based on a breach of the transfer warranty. If Nick, is lucky, he can recover the $9K from Adam.

C. SIGNATURE LIABILITY
A person cannot be held contractually liable on a NI unless his or her signature appears on it. Therefore, this type of liability is often referred to as signature liability or contract liability_ Signatures on NI’s identifies who is obligated to pay them. If it is unclear who the signer is, parol evidence can identify the signer. This liability does not attach to bearer paper because no indorsement is needed.
Signers of instruments sign in many different capacities, including as makers of notes and certificates of deposit, drawers of drafts and checks, drawees who certify or accept checks and drafts, indorsers who indorse instruments, agents who sign on behalf of others, and accommodation parties. The location of the signature on an instrument generally determines the signer's capacity. For example, a signature in the lower-right corner of a check indicates that the signer is the drawer of the check, a signature in the lower right corner of a promissory note indicates that the signer is the maker of the note. The signature of the drawee named in a draft on the face of the draft or another location on the draft indicates that the signer is an acceptor of the draft. Most indorsements appear on the back or reverse side of an instrument. Unless the instrument clearly indicates that such a signature is made in some other capacity, it is presumed to be that of the indorser.
Every party that signs a negotiable instrument (except qualified indorsers and agents that properly sign the instrument) is either primarily or secondarily liable on the instrument.

ACCOMMODATION PARTY

One who signs an instrument for purpose of lending his/her name (and credit) to another party. May sign the instrument as maker, drawer, acceptor, or indorser, and is obliged to pay the instrument in the capacity in which s/he signs. If they pay an instrument they can recover reimbursement from the accommodated party and enforce the instrument against him or her.

TWO TYPES of types of accommodation party:

1. GUARANTEE OF PAYMENT. Accommodation party may sign an instrument guaranteeing either payment or collection. One who signs an instrument guaranteeing payment is primarily liable on the instrument. The debtor can seek payment on the instrument directly from the accommodation maker w/o first seeking payment from the maker.

Example: Sonny, college student, wants to purchase an automobile on credit from ABC Motors. Doesn’t have sufficient income/credit history to justify the extension of credit to him alone. Sonny asks his Mom to co-sign the note to ABC Motors, which she does. Sonny's mother is an accommodation maker and is primarily liable on the note.

2. GUARANTEE OF COLLECTION. Accommodation party may sign instrument guaranteeing collection rather than payment. Here: Accommodation party is only secondarily liable on the instrument. To reserve this type of liability, the signature of the accommodation party must be accompanied by words indicating that he or she is guaranteeing collection rather than payment of the obligation.

An accommodation party who guarantees collection is obliged to pay the instrument only if (1) execution of judgment against the other party has been returned unsatisfied, (2) the other party is insolvent or in an insolvency proceeding, (3) the other party cannot be served with process, or (4) it is otherwise apparent that payment cannot be obtained from the other party [UCC 3-419(d)].

DISCHARGE

DISCHARGE

The UCC specifies when and how certain parties are discharged (relieved) from liability on NI’s. Generally, all parties to NI are discharged from liability if (1) the party primarily liable on the instrument pays it in full to the holder of the instrument or (2) a drawee in good faith pays an unaccepted draft or check in full to the holder.

THE REST IS FYI ONLY:

When a party other than a primary obligor (e.g., an indorser) pays a negotiable instrument, that party and all subsequent parties to the instrument are discharged from liability [UCC 3-602].

The holder of a NI can discharge the liability of any party to the instrument by cancellation which can be accomplished by (1) any manner apparent on the face of the instrument or the indorsement (e_g., writing "canceled" on the instrument) or (2) destruction or mutilation of a NI w/intent of eliminating the obligation.

Intentionally striking out signature of an indorser cancels that party's liability on the instrument and the liability of all subsequent indorsers. Prior indorsers are not discharged from liability. The instrument is not canceled if it is destroyed or mutilated by accident or by an unauthorized third party. The holder can bring suit to enforce the destroyed or mutilated instrument.

A party to a NI sometimes posts collateral as security for the payment of the obligation. Other parties (e.g., holders, indorsers, accommodation parties) look to the credit standing of the party primarily liable on the instrument, the collateral (if any) that is posted, and the liability of secondary parties for the payment of the instrument when it is due. A holder owes a duty not to impair the rights of others when seeking recourse against the liable parties or the collateral, Thus, a holder who either (1) releases an obligor from liability or (2) surrenders the collateral without the consent of the parties who would benefit thereby discharges those parties from their obligation on the instrument. This discharge is called impairment of the right of recourse.

AND THESE HYPOTHETICALS:

23.2-3 P. 389; 23.4-7 P. 390; 24.1-5 P. 406; 24.6-8 P. 407

AND THESE HYPOTHETICALS AS WELL:

C. Wright met w/Jones, president of Community Bank, to request a loan of $7,500. Because Wright was already obligated on several existing loans, he was informed his request would have to be reviewed by the bank's loan committee. Jones suggested that delay could be avoided if loan were made to Mrs. Wright. Wright asked his wife to go to the bank and "indorse" a note for him. Mrs. Wright went to the bank and spoke to Jones. Although she claims that Jones told her she was merely indorsing the note, the language of the note clearly indicated she would be liable in case of default. Mrs. Wright signed instrument in its lower right comer. Wright did not sign. The $7,500 deposited directly into Wright's business account. The Wrights were subsequently separated. Following separation, Mrs. Wright received notice she was in default on the note. The notice indicated she was solely obligated to repay the instrument. Is Mrs. Wright obligated to repay the note?


D. Wade was employed by Fazzari, an immigrant unable to speak or read English. Wade prepared a promissory note in the amount of $400, payable at Glen National Bank. Wade took the note to Fazzari and told him document was a statement of wages earned by Wade during the course of his employment. Fazzari signed the instrument after Wade told him necessary for income tax purposes. Fazzari not in debt to Wade, no consideration given for the note. Four months later, note presented to the First National Bank of Odessa by Wellington Doane, a customer of the bank and an indorsee of payee, Wade. Doane indorsed the check in blank and accepted a $400 cashier's check in exchange for the note. Fazzari and Glen National Bank refused paymentof the note. Did Wade act ethically in this case? Can the First National Bank of Odessa enforce payment of the note as a holder in due course?

E. Thompson went to Central automobile dealership, to purchase a car. Assisted by Central's sales manager, Boles, Thompson selected automobile. Boles drew up loan agreement: 35 monthly installments and a final installment of $5,265. An annual interest rate of 8%. Boles assured Thompson when the $5,265 installment became due, he would be allowed to sign a second note to cover that amount and the second note would also be 8%. With this assurance, Thompson signed the original loan agreement and note and made all payments except final one. When Thompson went to sign the second note, told interest would be 12%, not 8%. Thompson refused to sign the second note or make the balloon payment on the original note.
Instead, he returned the car. Central was able to sell the car, but it sued Thompson to recover a deficiency judgment. Who wins?
F. The Mahaffeys approached by salesman from Five Star w/offer to install home insulation for $5,289. Told insulation reduces heatiug bills by 50%. Mahaffeys executed note promising to pay price w/interest, in installments. Note secured by deed of trust on home. Following language: Notice: Any holder of this consumer credit contract is subject to all claims and defenses which the debtor could assert against the seller of goods or services obtained pursuant hereto or with the proceeds thereof" Several days after Five Star finished work sold installment note to Mortgage Finance. Major defects in insulation: Large holes left in walls, heater blankets and roof fans never delivered. Mahaffeys refused to make payments on note. Mortgage Finance instituted foreclosure proceedings. Mahaffeys alleged Federal Trade Commission rule protects them allows them assert defense of breach of contract by Five Star against enforcement. Can Mahaffeys successfully assert defense of breach of contract by Five Star against the enforcement of the note by Mortgage Finance?
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