NEGOTIABLE INSTRUMENTS 1 I. TERMINOLOGY A. Note is a promise to pay. Involves two parties. B. Draft is an order to pay. Involves three parties. C. A promissory note is a note. D. A check is a draft. E. The first transfer is the issue. F. Issuer of note is maker. G. Issuer of draft is drawer. H. Bank is drawee. II. REGUIREMENTS FOR A NEGOTIABLE INSTRUMENT A. A signed writing B. Which contains an unconditional promise to pay or order to pay A condition may be express, such as "If the Rockies win the World Series, or it may be a statement that the instrument is subject to or governed by another writing. But the promise or order is not conditional if the instrument refers to another writing, for example a promissory note that refers to a mortgage. The promise or order is not conditional if it limits payment to a particular source or fund. A requirement of a countersignature on a travelers check is not conditional. C. A fixed amount D. Of money Money is any medium of exchange authorized by a government. E. On demand or at a specified time Paper is on demand if it says on demand, if it says on sight, or if it does not state a payment date. F. To bearer or to order Bearer paper is paper which can be enforced by any one in possession. Order paper is paper that is pay to order of a specific person or persons. There can be multiple payees. Order paper can become bearer paper if it is endorsed in blank. Bearer paper can become order paper if it is specially indorsed. G. With no other undertaking. H. Miscellaneous Written words govern written numbers. Two signers in the capacity of co-makers, co-drawers or co-indorsers are jointly and severally liable. An incomplete instrument can be enforced according to its terms, or as completed if completion is authorized. Unauthorized completion is a fraudulently altered instrument. Forging payee's 1 Copyright 2008 Daniel Wilson. Revised 2010. This material is drawn from released Colorado bar exam essays and released Multi-state essays from the National Conference of Bar Examiners. Permission is freely given to use this outline to prepare for the Colorado bar exam. 1
name in order to negotiate instrument breaks the chain of title and no subsequent possessors can be holders. III. NEGOTIATION A transfer to one who is entitled to enforce. If the paper is bearer paper, then mere transfer of possession is negotiation, If paper is order paper the paper must be indorsed by the person to whom the paper is payable to. If the paper is bearer paper involuntary transfer (lost or stolen) is sufficient. IV. HOLDER A holder is one who has possession and also is entitled to enforce the instrument. Therefore, if the paper is bearer paper whoever has possession is a holder. Exception is if the paper at one time was order paper and the indorsement of the named person was forged. In that case the chain of title is broken and no subsequent possessor can be a holder. If the paper is order paper the person who is named is a holder if he also has possession. V. INDORSEMENT A. Special indorsement specifies who the paper is order to. "Pay John Smith." Only John Smith can negotiate or enforce the instrument. B. Blank indorsement is the indorsement of order paper by the named person. It converts order paper to bearer paper. Ex: Check made to order of John Smith is order paper. Only John Smith can negotiate or enforce. John Smith endorses "John Smith." The paper is now bearer paper. It can be negotiated by transfer alone, voluntary or involuntary. C. Qualified indorsement. An indorsement necessary for negotiation, "without recourse." No indorser liability. Ex: Check to order of John Smith. John Smith's endorsement is necessary to negotiate check. John Smith endorses "John Smith, without recourse." Paper is now bearer paper and can be negotiated by transfer alone and enforced by anyone in possession, but in the event it is dishonored John Smith will not have indorser liability. D. Restrictive indorsement. A limiting indorsement is not effective to prevent further negotiation. "Pay Pete only" makes the paper order paper pay to the order of Pete. But Pete can indorse the paper and negotiate it. Conditional indorsement, "pay Pete if he washes my car" is ineffective to limit negotiability. E. Anomalous indorsement. Not necessary for negotiation, made to incur surety liability. VI. HOLDER IN DUE COURSE A. A holder who 1) takes for value; 2) in good faith; 3) without notice of a claim or defense. 2
B. Value means for antecedent debt; for fully performed consideration; trading for another for another negotiable instrument; or an irrevocable obligation. Promise to perform in the future is not value. C. Good faith means reasonable commercial standards and honesty in fact. D. No notice that instrument is overdue; unauthorized or altered signature; of claims to the instrument; no notice of defenses. E. Payee can be HDC. VII. REAL AND PERSONAL DEFENSES A. HDC is subject to real defenses. That means that when the HDC tries to enforce the instrument he is not subject to these defenses. 1. Fraud in the factum "Fraud that induces obligor to sign instrument with neither knowledge or opportunity to learn of its character." 2. Forgery of payee or other necessary indorsement breaks chain of title so no subsequent possessor can be a holder. 3. Alteration. 4. Incapacity 5. infancy 6. illegality 7. Duress 8. Bankruptcy 9. Statute of Limitations B. HDC is not subject to personal defenses 1. lack of consideration 2. failure of consideration 3. theft of instrument 4. breach of contract 5. failure of condition precedent 6. mistake 7. waiver VIII. FORGERY AND THEFT A. Forgery of drawer's signature does not destroy title, but it acts as though forger signed his own signature. Thief steals Fred's checkbook, writes check payable to Thief, forges Fred's signature as drawer. It is as though Thief was the drawer. B. Drawee bank must use ordinary care in inspecting forged signature when paying check. C. Owner of checkbook may be liable if check stolen and forged because of owner's negligence. D. Owner barred from contesting improper payment by statute of limitations of one year. 3
E. A HDC of stolen bearer paper takes free of the claim of a payee that it was stolen by the person who transferred it to the HDC. F. A transferee of stolen order paper who takes it from a thief who forges the indorsement is not a HDC and therefore does not take free of the claim of the payee. IX. SHELTER RULE A transferee of a HDC enjoys the same protection as the HDC would. X. LIABILITIES A. Indorser. Indorser is secondarily liable. That means of the instrument is dishonored the holder must look to the drawer first. If there are multiple indorsers holder must look to the drawer or maker before indorsers. If any indorser honors the instrument he may look to indorsers before him. B. If drawee dishonors Drawer is secondarily liable. If bank accepts draft drawer is discharged. C. Drawee. If drawee is a bank, bank is obligated to pay a properly presented draft. That means sufficient funds. Drawer is subject to bank if bank pays a draft with insufficient funds. Bank not subject to drawer if it cashes a draft with a forged signature of drawer, draft is altered, if the indorsement of payee is forged. D. Duties of customer to bank. Reasonable duty to inspect bank statement; Bank can charge customer's account if 1) customer breached duty, and 2) bank suffered a loss because of it. Customer may defend if bank was negligent. E. Statute of limitations is one year if the drawer's signature is forged and 3 years if the forgery is that of a necessary indorsement. XI. ACCOMMODATION PARTIES A. A surety on a note or draft is an accommodation party. Usually a co-maker or an anomalous indorsement. B. Co-maker liable to same extent as other co-maker. C. Accommodation party liable if instrument is dishonored. D. Guarantee of collection means accommodation party is liable only if a judgment is returned unsatisfied. XII. MISCELLANOUS A. When instrument is made payable to two payees with words "to A and B" signatures of both are required to negotiate. If payable "to A or B", either A or B can enforce or transfer. B. When a bank pays an instrument that requires two signatures, without two signatures, bank has converted the check. 4
C. An attorney who signs client's name may be his client's agent. Use agency rules of actual and apparent authority. If bank does convert liability is limited to the client's interest. D. An IOU is not a NI unless it contains a promise to pay. ADDENDUM TO NEGOTIABLE INSTRUMENTS OUTLINE JULY 2009 1. ACCORD AND SATISFACTION. Follows the C/L rule. a. Instrument offered in satisfaction b. Instrument clearly says it is in accord and satisfaction c. Debt is disputed or unliquidated. d. Satisfaction offered in g/f. e. Defense: If creditor inadvertently cashes check, which means not aware of accord language and tenders repayment w/in 90 days of receipt of payment. 2. Agent can indorse instruments. 3. Conversion. When instrument is taken by someone other than by transfer or by negotiation from a person not entitled to enforce the instrument. True owner can recover amount of the instrument bearing a forged indorsement. 4. Employee entrusted with check-handling responsibilities, not authorized to indorse, forged endorsement is effective. 5. Negligence by account holder that leads to stolen check may be liable to person who takes check. The customer must fail to exercise ordinary care and that failure must substantially contribute to the loss. 6. Co-makers are jointly and severally liable. 7. Shelter rule: A transferee of an instrument takes all the rights of the transferor. 8. Obligation of payor may be modified by a separate agreement of the obligor and the person entitled to enforce the note if the instrument was issued as a part of the same transaction that gave rise to the instrument. 9. A co-maker who pays an instrument is entitled to contribution from comaker. 10. Lost instrument. An obligor may pay a lost instrument. This will satisfy obligor's obligations to other parties who find the note, unless the original holder negotiated the instrument. 11. Lost instrument. Holder must prove a. He was in possession and entitled to enforce when instrument was lost. b. Loss was not result of transfer or lawful seizure. c. Instrument's location cannot be determined. d. Must prove terms of instrument. e. Must provide adequate protection, such as a surety bond. 12. Agency principles in Article 3. Principal is "represented person." Agent is "fiduciary." If agent misappropriates instrument principal has a claim to 5
the instrument or its proceeds against agent and subsequent takers unless the are HDC. 13. Transfer warranties a. entitled to enforce the instrument b. signatures are authorized and authentic 14. Guarantee of payment vs. guarantee of collection. A co-maker's accommodation indorsement guarantees payment. Therefore holder may demand payment from him without first seeking payment from other comaker. If guaranty is for collection, guarantor is not liable until holder is unsuccessful in collecting from other co-maker. 15. Discharge by tender of payment. If tender of payment is made and person refuses, obligation is discharged to the extent of the tender. 16. Extension of time to pay. If a person entitled to enforce extends due date obligation is discharged as to co-maker if co-maker can show extension of time damaged him. 17. A certified check is cash. All obligations are discharged. 18. Presentment warranty. A person who presents an instrument for payment warrants that he is entitled to enforce the instrument. 6