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2017 Lecture notes for the balance of the semester, Part One

 
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PostPosted: Tue May 02, 2017 12:04 pm    Post subject: 2017 Lecture notes for the balance of the semester, Part One Reply with quote

IF YOU BRING THESE TO CLASS FOR THE REST OF THE SEMESTER'S LECTURES YOU WILL BE ABLE TO FOLLOW THE LECTURE WITH MUCH MORE EASE!!!

Again, these are my lecture notes. THEY ARE RESTRICTED BY THIS CAVEAT: They may contain spelling errors, grammatical errors, or even contextual errors. They are being reproduced here just to provide students in Law 2 with an opportunity to supplement their class notes on this subject matter.


SECURITIES REGULATION

RULE lOb-5 AND SECTION 16(b)

BASICALLY ANY ATTEMPT TO CHEAT IS UNLAWFUL

SEE YOUR E-MAIL FROM INSTRUCTOR OR
SEE INSTRUCTOR'S WEBSITE

Violation of rule can result in private suit for damages, an SEC suit for injunctive relief, or criminal prosecution.

GENERAL ELEMENTS OF CAUSE OF ACTION UNDER RULE 10b-5

To recover damages Private plaintiff must show following:

FRAUDULENT CONDUCT

ANY TYPE OF Making material misstatement or making material omission.

MATERIALITY

Statement/omission considered material if substantial likelihood reasonable investor would consider it important in making investment decision. EXAMPLE: Several insiders bought stock in their mining company on basis of inside information regarding substantial mineral find. When information publicly released, price of stock soared. Mineral discovery material fact. [SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968)]

SCIENTER (Guilty Mind)

To be fraudulent and actionable under 10b-5, conduct must have been undertaken w/intent to deceive, manipulate, or defraud. USSCT.: Includes cases where misstatement made knowingly, but has reserved issue whether misstatements made recklessly are proscribed (Circuit courts uniformly held recklessness to be sufficient).

IN CONNECTION WITH PURCHASE OR SALE OF A SECURITY BY PLAINTIFF

PLAINTIFF PRIVATE INDIVIDUAL

Term "in connection with" interpreted broadly. Broker's sale of client's securities w/intent to misappropriate proceeds constituted fraud

WITH A SALE OF A SECURITY BY PLAINTIFF

Term includes transactions such as exchanges of stock for assets, mergers, contracts to sell, etc.
NONTRADING DEFENDANTS CAN BE HELD LIABLE

Focus here: On sale/purchase by PLAINTIFF, DEFENDANT need not have purchased or sold any securities. Thus, nontrading defendant, such as a company that intentionally publishes misleading press release, can be held liable to persons who purchased or sold securities on market on basis of press release.

PRIVATE PLAINTIFF MAY NOT MAINTAIN SUIT BASED ON BASIS OF DEFENDANT'S AIDING AND ABETTING OTHER DEFENDANTS FRAUD

Government may.

IN INTERSTATE COMMERCE

Fraudulent conduct must involve use of some means of interstate commerce; something as simple as use of the telephone or mail will suffice.

RELIANCE

PRESUMED

Generally: Reliance element of l0b-5 C/A. However, in nondisclosure case reliance presumed; i.e., plaintiff need not prove reliance on undisclosed information. Similarly, in misrepresentation action on securities sold in well-defined market (e.g., national stock exchange), reliance on any public misrepresentations may be presumed based on fraud on market theory: Investor who buys/sells stock at price set by market does so in reliance on integrity of stock, which in turn based on publicly available information. [Basic, Inc. v. Levinson, 485 U.S. 224 (1988)]

1) REBUTTAL OF PRESUMPTION

Presumption may be rebutted (e.g., by showing plaintiff would have acted same way even w/full disclosure; price not affected by misrepresentation, or plaintiff didn't trade in reliance on integrity of market).

DAMAGES

Private plaintiff must show defendant's fraud caused plaintiff damages.

INSIDER TRADING

May not be obvious, BUT lOB-5's greatest impact: prohibits most instances of trading securities on basis of inside information (i.e., information not disclosed to public that an investor would think important when deciding whether/not to invest in the security).

Early insider trading cases: Focused on duty of trader to disclose or abstain from trading. Trend: Clear person violates l0b-5 if he breaches duty of trust and confidence owed to: (i) the issuer, (ii) shareholders of the issuer, or (iii) misappropriation (see below), 3rd. party person source of the material nonpublic information.

WHO MAY BE LIABLE?

"INSIDERS"

Anyone who breaches duty not to use inside information for personal benefit can be liable under lOB-5.

Typical securities insiders, such as directors, officers, controlling shareholders, and employees of the issuer are deemed to owe duty of trust and confidence to their corporation which is breached by trading inside information.

CONSTRUCTIVE INSIDERS, such as securities issuer's, CPAs, attorneys, and bankers performing services for the issuer, also owe such a duty. EXAMPLE: Monday, Dee, President of a publicly held mining company, told by company geologists just discovered huge cache of gold on company property. Dee contacts company's outside attorney, Alex, to discuss how she should go about disclosing information. Dee and Alex decide: best to announce information to public Friday. Announcement will probably cause company's stock to skyrocket. Neither geologists. Dee, nor Alex may purchase company stock before information made public, unless they disclose information to anyone selling them stock.

TIPPERS AND TIPPEES

Where insider gives tip of inside information to someone else who trades on basis of inside information, tipper can be liable under l0b-5 if the tip made for any improper purpose (e.g., in exchange for money/kickback, as a gift, for a family member's benefit, for reputational benefit, etc.).

Tippee can be held liable derivatively if tipper breached duty and tippee knew tipper was breaching duty. EXAMPLE: Same facts: Dee meets her brother, Bob, in restaurant and tells him about the gold find, and Bob purchases company stock before announcement, Dee can be held liable as a tipper and Bob derivatively as tippee. But: stranger, Steve, overhears Dee telling Bob and purchases stock before public announcement made, Steve would not be liable under l0b-5.


INSIDER TRADING

38.5. Chiarella worked as a "markup man' in NY composing room Pandick Press, a financial printer. Documents Chiarella handled: 5 secret announcements of corporate takeovers. Tender offerors had hired Pandick Press to print offers, would be made public when tender offers made to shareholders of target corporations. Documents delivered to Pandick Press, identities of acquiring and target corporations concealed by blank space or false names. True names would not be sent to Pandick Press until night of final printing. Chiarella able to deduce names of target companies before final printing. W/o disclosing knowledge, he purchased stock in target companies and sold shares immediately after takeover attempts were made public. Chiarella realized gain of $30K in 14 months. Federal government indicted Ghiarella for criminal violations of Section 10(b) of Securities Exchange Act of 1934. Is Chiarella guilty? Chiarella v. United States, 445 U.S. 222, 100 S Ct 1108 63 , L.Ed.2d 348 (1980)]

Insider Trading

38.5. U.S. Supreme Court reversed trial court's judgment that had convicted Chiarella on all counts. Court of Appeals: Anyone an insider or not who receives material nonpublic information may not use that information to trade in securities until information made public. USSCT. rejected rule, holding: SECTION 10B-5: Not liable for insider trading unless owes duty to disclose information. Duty only arises if person owes fiduciary duty to company in whose shares he has traded.
Chiarella did not owe fiduciary duty to target companies of whose shares he purchased. Court: Not every instance of financial unfairness constitutes fraudulent activity under Section 10(b). Element required making silence fraudulent: duty to disclose absent in this case. No duty could arise from Chiarella's relationship w/sellers of target company's securities for Chiarella had no prior dealings with them. He was not their agent, he was not a fiduciary, and he was not a person in whom sellers had placed their trust and confidence. He was, in fact, a complete stranger who dealt with the sellers only through impersonal market transactions. Duty to disclose under �10(b) not arise from the mere possession of nonpublic market information.

MISAPPROPRIATORS: MISAPPROPRIATION DOCTRINE

Government can prosecute under l0b-5 for trading on market information (i.e., information about supply or demand for stock of particular company in breach of a duty of trust and confidence owed to source of information;
Here's a nonexclusive list of circumstances under which person deemed to owe duty of trust and confidence in misappropriation case:

SEE CLASS HANDOUT

JURISDICTION

Federal courts exclusive jurisdiction over claims arising under l0b-5.

REMEDYS FOR 10B-5 VIOLATIONS

Individual plaintiffs can sue for damages or rescission.

Damages based on difference between price paid (or received) by plaintiff, and average share price in 90-day period after corrective information disseminated.

Rescission available in lieu of damages. NOTE punitive damages not available under 10b-5, but might be under appropriate state law claims for fraud.

INSIDER TRADING SANCTIONS ACT AND
INSIDER TRADING AND SECURITIES FRAUD ENFORCEMENT ACT 1934 Act �21A

Important weapon against insider trading. Authorizes SEC (SECURITIES AND EXCHANGE COMMISSION) to sue persons who illegally trade on SECURITIES EXCHANGES while in possession of material, nonpublic information (and their tippees), as well as persons who violate Act by communicating such information, for a civil penalty equal to THREE TIMES profit gained or loss avoided by defendant's unlawful purchase, sale, or communication.

Treble-damages penalty important, because it means defendant may lose more than ill-gotten profits, thereby creating powerful disincentive to insider trading.

PRIVATE RIGHT OF ACTION INSIDER TRADING AND SECURITIES FRAUD
ENFORCEMENT ACT

Creates private remedy against one who illegally trades while in possession of material, nonpublic information on behalf of any person who contemporaneously traded same class of securities.

CRIMINAL PENALTIES

Civil penalties discussed above in addition to all other existing sanctions, including jail terms up to 10 years, and criminal fines of up to $1M for individuals and $2.5M for corporations.

B. SECTION 16(B) OF THE SECURITIES EXCHANGE ACT OF 1934

Any profit realized by director, officer, or shareholder owning more than 10% of outstanding shares of corporation from any purchase and sale, or sale and purchase, of any equity security of his corporation w/in a period of less than six months must be returned to the corporation.

Applies to publicly held corporations whose shares traded on national exchange or that have at least 500 shareholders in any outstanding class and at least $10M in assets.

STRICT LIABILITY IMPOSED

Purpose of section 16(b) to prevent unfair use of inside information and internal manipulation of price. Accomplished by imposing strict liability for covered transactions whether or not any material fact that should or could have been disclosed NO PROOF OF USE OF INSIDE INFORMATION IS REQUIRED.

ELEMENTS OF CAUSE OF ACTION

PURCHASE AND SALE OR SALE AND PURCHASE W/IN SIX MONTHS

Only to profits from purchases and sales made w/in six month period. Most instances, easy to define purchase or sale. However, some areas of corporate stock transactions such as reclassification, conversion, and exercise of stock options where time and event of purchase or sale is uncertain. Test normally applied to determine whether there is a purchase or sale is whether "this is the kind of transaction in which abuse of inside information is likely to occur."

EQUITY SECURITY

Applies only to purchases and sales of equity securities. An equity security: Any security other than pure debt instrument, including options, warrants, preferred stock, common stock, etc.

OFFICER, DIRECTOR, OR TEN PERCENT SHAREHOLDER

APPLIES ONLY TO PURCHASES AND SALES MADE BY OFFICERS, DIRECTORS, OR MORE THAN 10% SHAREHOLDERS.

DEPUTIZATION OF DIRECTOR

Ordinarily, easy to identify officers, directors, and 10% shareholders. Income instances, however: Person may "deputize" another person to act as his representative on board. In these cases, securities transactions of principal will come w/in section 16(b).

TIMING ISSUES

OFFICERS OR DIRECTORS

Purchases/sales made by persons before becoming officer or director generally EXCLUDED from 16(b), because person generally not have access to inside information sought to be protected from abuse under section 16(b) before becoming officer or director.

Other hand, purchases and sales made w/in six months AFTER ceasing to be officer/director can come w/in section 16(b).

TEN PERCENT SHAREHOLDER

Person is more than 10% shareholder if directly or indirectly owns more than 10% of any class of equity security of Corp. at time immediately before both purchase and sale.

Thus, purchase that brings shareholder over the 10% threshold is not w/in scope of section 16(b).

PROFIT REALIZED "SHORT SWING PROFITS"

Not only traditional profits, also losses avoided. "Profit" determined by matching highest sales price against lowest purchase price during any six-month period.

REMEMBER use of inside information not material to recovery.

EXAMPLE: SEE CLASS HANDOUT

NEW TOPIC:

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

I. COMMERCIAL PAPER

Documents facilitating transfer of $/Extension of Credit.

II. ONE TYPE OF COMMERCIAL PAPER IS THE NEGOTIABLE INSTRUMENT:

A. REQUIREMENTS:
1. Written; 2. Signed; 3 unconditional promise/order to pay; 4. A fixed amount of money to
i. ORDER/BEARER on either (a) demand or at (b) definite time

NEGOTIATION MEANS
Both possession of, AND title to instrument transferred from one party to another, w/transferee becoming a "HOLDER"
HOLDER: Possesser of NI (a) issued or (2) DRAWN, or (3) indorsed to that person

III. TWO IMPORTANT TYPES OF COMMERCIAL PAPER:

A. PROMISE TO PAY MONEY (1). promissory note & (2). Bank certificates of deposit); AND

B. ORDER TO PAY MONEY (1). The Draft & (2). The check which is the most common type of draft, it's an ORDER directed to a bank.


WHY NI's BECAME A FORM OF COMMERCIAL PAPER

1. Became impracticable always pay cash/commodities
2. Much less risk of loss or theft.
3. Also: means of extending credit. Borrower agrees, in writing, to repay loan. Document (e.g., a promissory note), a simple money-substitute document (e.g., a check), is special type of commercial paper: the NI.
4. Constantly being used by businesses/consumers. Most major business transactions depend on credit. W/o NI's: no efficient, readily understood method of extending credit on such a grand scale. Likewise, consider checks: most common form of commercial paper (excluding money itself), and millions of checks written every day.

THE UNIFORM COMMERCIAL CODE, UCC ARTICLES 3 AND 4.

Article 3 (NI's) and Article 4 (Bank Deposits & Collections).

Attempt: simplify, clarify, and make uniform nation's commercial law. The process is ongoing. 1990 revised Article 3 adopted by 48 states (all but New York and South Carolina).

IV. ELEMENTS OF NEGOTIABILITY (Review)

TO BE NEGOTIABLE AN INSTRUMENT MUST BE:
Written;

Signed by maker or drawer;

Contain unconditional promise or order to pay fixed amount of $$$, w/ or w/o interest or other charges described in the instrument; and no other undertaking or instruction given by maker or drawer;

Payable on demand or at definite time; and

Payable to order or to bearer.

REQUIREMENTS STRICTLY CONSTRUED. Ambiguities resolved in favor of non-negotiability; and, if instrument is plainly non-negotiable, parties to instrument cannot agree to make it negotiable.

Negotiability restricted to drafts, checks, certificates of deposit, and notes.

SIGNATURE OF MAKER OR DRAWER

Signature: Any symbol party executes/adopts to authenticate writing. Need not be handwritten, must be on instrument itself.

Law presumes signature authentic and authorized: w/actual, implied, or apparent consent of person to be bound by signature. Some cases, even unauthorized signature treated as if authorized: example: person whose signature unauthorized knew about it but failed to inform innocent parties who reasonably believed signature authorized.

UNCONDITIONAL PROMISE OR ORDER TO PAY

THE TERM "UNCONDITIONAL": promise/order not limited or changed by clause or any other item contained w/in or incorporated into instrument. Conditions include tying payment to occurrence of an event or performance of an agreement.

E.G.: STATEMENTS WHEREIN DOCUMENT REMAIN NEGOTIABLE

Statements placed on instrument if such statements are not deemed to be conditions on promise or order to pay,

STATEMENTS DESTROYS NEGOTIABILITY (BECOMES CONDITIONAL)

U.C.C. 2 TYPES:

1. Express condition on payment.

2. Statement instrument subject to or governed by another agreement.

E.G.: WRITE ON IT: "Not Negotiable."

FIXED AMOUNT OF MONEY

Must be expressly stated/readily verifiable from terms of instrument. "Fixed" even if includes specified interest rate,

Term "money" encompasses all means of exchange authorized by some government as part of its currency. Therefore instrument payable in dinars, francs, or some other foreign currency can be negotiable. NOT STUFF!!!

TO BE NEGOTIABLE MUST BE PAYABLE ON DEMAND OR AT A DEFINITE TIME
ON DEMAND

IF NI does not state time for payment, states payable on demand, or at sight, or otherwise indicates payable @ will of holder (e.g., a check). Becomes due (is to be paid) simply upon being presented for payment.

AT A DEFINITE TIME INSTRUMENT MAY BE PAYABLE AT:

Readily ascertainable when instrument issued; e.g.:

"Definite time"

Fixed date or dates;

Fixed period after sight (presentment) or acceptance;

Payment time cannot be based on special act/event uncertain as to time of occurrence, even though the act is certain to happen some time. EXAMPLE: Instrument nonnegotiable if payable on Mr. X's death; although death is a certainty, when Mr. X's death will occur is uncertain.

ELEMENTS OF NEGOTIABILITY CONTINUED:

PAYABLE TO ORDER/OR TO BEARER

"To order: includes instruments that state:

Pay to the order of A (an identified person) and pay to A or his/her order.

"To bearer" includes instruments that do not state a payee, and instruments that state:

(a) pay bearer;

(b) pay to the order of bearer;

(c) pay A or bearer; and

(d) pay cash or to the order of cash

PERSONS can indorse instrument in such a way as to convert it from order to bearer paper, or vice-versa.

RULES OF CONSTRUCTION

1. NI's may be postdated, antedated, or undated, and need not state place where instrument is drawn or payable. The dates on instruments are presumed correct.

2. Rules of agency applicable: Authorized agents may complete an instrument.

3. If unclear whether NI is a draft or a note, the holder may treat it as either.

4. When disputes as to terms of an instrument, following rules govern:

(1). Handwriting prevails over typewriting and print.

(2). Typewriting prevails over print.

(3). Words prevail over numbers.

5. Unspecified rate of interest treated as being the same as the judgment rate (interest rate earned on unpaid judgments) Unless stated differently in the instrument, interest runs from the date of the instrument or, if undated, from the issue date.

6. Two or more persons may sign in the same role (e.g., as comakers or codrawers). Unless otherwise specified, each such person fully responsible for any liability charged to that "role," be it maker, drawer, or whatsover.

IMPORTANT FACT: IF Instrument is nonnegotiable (as an NI) does not mean it is worthless. It still may evidence a valid, enforceable contract.

TYPES OF NEGOTIABLE INSTRUMENTS see handout #1

NOTE

Often called promissory note: Two-party instrument in which one person (the maker) makes an unconditional, written promise to pay another person (the payee), or person specified by the payee, a fixed amount of money either on demand or at a particular time in the future.

SEE H.O. # 1 NUMBER ONE

Johnny Deeep is the maker, and Matthew Klein is the payee.

Issued by a FINANCIAL INSTITUTION (e.g., a bank) as an acknowledgment that the institution has received a particular sum of money, certificate of deposit is the institution's note to pay the depositor that sum of money, plus a stated rate of interest.

DRAFT

Three-party instrument in which one person (the drawer) orders a second person (the drawee) to pay a fixed amount of money to third person (the payee), or another person specified by the payee, either on demand or at a particular time in the future.


Thompson is the drawer, Erstwhile the drawee, and Pseudo the payee.

SEE HANDOUT #1 NUMBER TWO


CHECK


SEE HANDOUT #1 NUMBER THREE

Special type of draft in which drawee is always a bank and the instrument is payable on demand.


Mary Merchant is the payee, Bob Buyer the drawer, and Name of Bank is drawee.


CASHIER'S CHECKS (ALSO CALLED BANK CHECKS):

Drawn by banks upon themselves. The financial institution is both drawer and drawee, but w/ payee/holder required to sign a specimen signature on the instrument when it is issued and then re-sign when cashing.

CERTIFIED CHECKS "accepted" by drawee bank in advance.

Bank certifies there's money in the drawer's account to cover the check. (Discussed under banking.)

THE PARTIES TO A NEGOTIABLE INSTRUMENT

Notes originates with TWO:

1. Maker, who promises to pay.

2. Payee (depositor), who will be paid by the maker.

Drafts start with THREE parties:

1. Drawer, roughly comparable to note's maker.

2. Drawee, the party ordered by drawer to make payment.

3. Payee, essentially equivalent to the note's payee.

Maker of noted promises to pay, more or less directly; Payee, the drawer of a draft states THIRD party-the drawee, will actually pay the payee. The drawee pays w/funds from an account drawer maintains with the drawee.

Both notes and drafts may have additional parties known as INDORSERS. Although indorsements come in different forms, they all have a common feature: the signature of the indorser.

ADVANTAGES OF NI's OVER ORDINARY CONTRACTS

While they're greater formal requirements conveyed to holders it's balanced by greater rights. Also, rights, duties, and liabilities of the parties are generally clearer under Article 3 of the UCC than under the common law of contracts.

MAJOR DIFFERENCES OVER ORDINARY CONTRACT:

Contracts consideration must be proved. NI consideration presumed unless evidence to contrary introduced. Even if party proves no consideration, holder's case will generally not be affected if he/she deemed to be a HOLDER IN DUE COURSE (HDC) (To be discussedLater on.) Past consideration (e.g., a pre-existing debt) not usually enforceable basis for ordinary contracts, sufficient for negotiable instruments.

Most important: Assignee of ordinary contract subject to personal defenses HDC generally not (i.e., many defenses ordinarily available under contract law are not as readily available against some holders).

ASSIGNEE OF CONTRACT VERSUS HOLDER OF NEGOTIABLE INSTRUMENT

ASSIGNEE OF CONTRACT

Synopsis of Law 1 coverage: "Ordinary" contract: Rights assignable (e.g., the right to receive money or goods). The party assigning is called the assignor, party to whom assignor assigns his/her contractual rights is the assignee. Although not usually a party to the original contract, the assignee "STEPS INTO THE SHOES OF THE ASSIGNOR" and not only gains all of the assignor's contractual rights, but also is subject to all of the contractual defenses to which the assignor was subject.

Assignee takes a risk, particularly if cannot verify rights and defenses being assumed.

HOLDER OF NI

To be readily accepted as safe substitute for cash, potential "acceptor" must be confident commercial paper does not entail many risks assumed by assignee of ordinary contract.

If Holder possesses an instrument passing to him/her via an unbroken chain of negotiation, e.g. transferred (see below) and (1) issued, drawn or indorsed to him/her or to his/her order, or (2) payable to bearer.

To qualify as (HDC), holder must have good title which he/she paid value, w/no notice of any claims or defenses, and acquired in good faith. This concept is discussed later on in totality.

NEGOTIATION.

Inherent value of negotiable paper rests largely on easy, relatively safe manner in which possession of such paper and title to it can be transferred. The transfer process is called negotiation.

NI's are "negotiated" when transferred to a holder.

Bearer paper, (e.g. checks made out to "Cash" or indorsed in blank (holder's name is signed on the back w/o any accompanying instruction, such as "Pay to the order of X" or "For deposit only"), can be negotiated merely by a change in possession, that is, by "delivery." Holders of such instruments may not be the lawful owners; for instance, a thief may take bearer paper.

HOWEVER, Order paper negotiation, requires not only delivery but also proper indorsement(s). E.G.: An instrument payable to the order of Joe Smith not
negotiated to Barbara Brown until delivered to her with Joe Smith's indorsement. W/o the indorsement, Barbara (and anyone else who acquires the instrument from her) is a mere transferee and NOT A HOLDER.

To have rights under an instrument (e.g., obtain payment), mere transferee (someone to whom instrument was transferred, but to whom there was no effective negotiation) must prove instrument is valid and that he/she has title to it. No presumptions in favor of transferee's claim. A holder, though, benefits from negotiation. Opposing parties have burden of proving holder not entitled to payment.

INDORSEMENTS
DEFINITION

Written on an NI by/on behalf of the holder: Signature of the holder, w/ or w/o additional or qualifying words, so title to instrument and holder's property interest in instrument transferred to new holder. Instrument may be indorsed on front or back, or on an allonge (a paper physically attached to, and made a part of, the instrument).

AMBIGUOUS INDORSEMENTS

Treated as an indorsement.

MISSPELLED INDORSEMENTS

Indorsement may be made either correct name, name as mis-spelled, or both. (Dual indorsement can be demanded by person taking the instrument.)

SEVERAL TYPES OF INDORSEMENTS: A MERE SIGNATURE

IN BLANK No particular indorsee; Effect: makes instrument payable to bearer.

SPECIAL INDORSEMENTS ARE ORDER PAPER

Specifies person to whom, or to whose order, instrument payable. E.G.: John Smith, payee of a check, specifically indorses check to Mary Jones by writing on instrument "Pay to the order of Mary Jones [signed] John Smith." John Smith could simply indorse "Pay Mary Jones. It renders instrument order paper (to Mary Jones), even though front of NI should not be made out that way.

IMPORTANT RULE: Instrument may have any number and combination of blank and special indorsements. The last (most recent) indorsement determines whether instrument is bearer or order paper.


FOUR TYPES OF THE RESTRICTIVE INDORSEMENT.
1. Conditional. Indorsements can contain conditions that would destroy negotiability if they were in the instrument itself.

FYI ONLY: However, despite its negotiability, no holder except a bank handling or paying instruments in normal course of collection) has any right to enforce the conditionally indorsed instrument until the condition is met. EXAMPLE: Conditional Indorsement John James, payee of a check, indorses it as follows:
"Pay Jane Jones when she delivers 250 shares of Blue chip Stock to me [signed] John James." John then delivers the check to Jane, who in return promises to transfer the stock to John. Jane could negotiate the check to another holder. However, until she met the condition, most subsequent holders could not enforce payment.

2. Attempts to prohibit further transfer of instrument. Like conditional indorsement, an indorsement prohibiting further transfer has no effect on instrument's negotiability. EXAMPLE: "Pay to the order of Joe Doe only." In effect, the UCC converts such an indorsement to "Pay to the order of Joe Doe."

3. Include words "for collection," "for deposit only," "pay any bank," or similar expressions. Like conditional indorsements, those made to facilitate deposits or collections have no effect on negotiablty. However, holder who first receives such indorsed instrument must obey that indorsement, Although subsequent holders need not. "Pay any bank" also means that only a bank may be a holder of the instrument unless it is specially indorsed by the bank or returned to the indorser.

IMPORTANCE OF TERM "WITHOUT RECOURSE"

Regardless of type, indorsements can have disclaimers. They place subsequent holders on notice that the indorser disclaims liability on the instrument if it is not paid.

IMPORTANT HYPOTHETICALS: 22.1 P.369; ALL 22.1-6 P. 373; 22.7 P. 374; 23.1 P. 389; AND 23.1 P. 377.

ALSO THESE HYPOTHTICALS:
A. Marcus Wiley, James Tate, and James Irby partners buying and selling used cars under name Wiley, Tate & Irby. Extended period, partnership sold number of automobiles to Billy Houston, sole proprietor doing business as Houston Auto Sales (Houston). In connection w/each purchase, HOuston executed and delivered to partnership a negotiable instrument drawn on Peoples Bank and Trust Company of Tupelo, Mississippi. Upon delivery of each NI, automobiles delivered to Houston. Each instrument involved contained number of variations in text and form. However, each similar in that each drawn on a bank, signed by the maker, and contained an unconditional order to pay sum certain on demand of the payee. What type of negotiable instrument is each?

B. Broadway) owned & operated American Nursing Center. Briggs received services from center and had executed an instrument to pay for those services. Instrument read, in relevant part, "Ninety days after date, I, we, or either of us, promises to pay to the order of $3,498.45." Briggs refused to pay on the note. Broadway claimed note was bearer paper and payable to the holder. Briggs claimed note was order paper and payable only to a named payee. Can Broadway, as its bearer, collect on this note?

NEW PART

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, usually by payment

GENERAL RULE CENTRAL TENET OF NEGOTIABLE INSTRUMENTS LAW.

(HDC) of NI is not generally 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),

Purchases 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 subjective good faith. In adddition to size of any discount from instrument'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 instrument has been outstanding for unreasonable period of time (more than 30 days, presumably, for certified checks; longer for other instruments).

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

For drafts dishonoring 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 instruments 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 demanded 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 signing w/words "without recourse." The indorsement then
"qualified." 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 contributes to alteration of instrument or making of forged signature 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 negligence, negligence must be significant ("substantially contributes"), not just remotely responsible." E.G.: Upon receiving notice forgeries are occurring, failure to act to prevent 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.

CONTINUED ON PART TWO
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