Liability for

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CHAPTER 24
Liability for Negotiable Instruments
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Quote of the Day

• The law is not the place for the artist or the
  poet. The law is the calling of the thinkers.
• Oliver Wendell Holmes,Jr.
• Supreme Court Justice

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Liability

• Signature liability liability of someone who
  has signed a document.
• Warranty liability -- liability of someone who
  has received payment.

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Contract vs. Instrument

• Negotiable instruments are issued to fulfill a
  contract.
• The instruments create a second contract to pay
  the debt created by the first agreement.
• Once an instrument is accepted in payment for a
  debt, the debt is suspended until the instrument
  is paid or dishonored.

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Enforcing an Instrument

• In a signature liability, to whom is the signer
  liable?
• To the holder of the instrument.
• To anyone to whom the shelter rule applies
  (non-holder with the rights of a holder).
• A holder who has lost the instrument.

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Primary vs. Secondary Liability

• Someone with primary liability must pay unless he
  has a valid defense.
• Someone with secondary liability must pay only if
  the person with primary liability does not pay.
• The holder of an instrument must first try to get
  payment from the party with primary liability
  before making demands against a party with
  secondary liability.

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The Payment Process

• Presentment holder demands payment.
• Dishonor if payment is not received when due or
  demanded, the instrument is considered
  dishonored.
• Notice of Dishonor notice is given to the party
  with secondary liability when the instrument is
  dishonored.

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Signature Liability

• The maker is primarily liable.
• The drawer of a check has secondary liability.
• The bank (drawee) is not liable to the holder and
  owes no damages to the holder for refusing to pay
  the check.
• Indorsers are secondarily liable.
• See next slide for more detail.

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Signature Liability -- Indorsers

• Indorsers are not liable if
• they write the words without recourse next to
  their signature on the instrument,
• a bank certifies the check,
• the check is presented for payment more than 30
  days after the indorsement, or
• the check is dishonored and the indorser is not
  notified within 30 days.

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Accommodation Party

• An accommodation party (sometimes called a
  co-signer or guarantor) is someone who adds her
  signature to an instrument in a capacity other
  than issuer, acceptor or indorser, in order to be
  liable for the instrument.
• An accommodation party has the same liability to
  the holder as the person for whom she signed.

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Agent

• To avoid personal liability when signing an
  instrument, an agent must
• indicate that she is signing as an agent and
• give the name of the principal.
• The principal is liable if the agent signs
  correctly, the agent signs just her own name, or
  the agent signs only the name of the principal.

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Rules of Warranty Liability

• The culprit is always liable.
• The drawee bank is liable if it pays a check on
  which the drawers name is forged. The bank can
  recover from the payee only if the payee had
  reason to suspect the forgery.
• In any other case of wrongdoing, a person who
  first acquires an instrument from a culprit is
  ultimately liable to anyone else who pays value
  for it.

Click here for online advice on how to avoid
check fraud.
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Transfer Warranties

• When someone transfers an instrument, she
  warrants that
• She is the holder of the instrument,
• All signatures are authentic and authorized,
• The instrument has not been altered,
• No defense can be asserted against her, and
• As far as she knows the issuer is solvent.

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Presentment Warranties

• Apply to someone who demands payment for an
  instrument from the maker, drawee, or anyone else
  liable.
• Presenter warrants that
• She is a holder,
• The check has not been altered, and
• She has no reason to believe the drawers
  signature is forged.
• Anyone who presents a promissory note for payment
  warrants only that he is a holder of the
  instrument.

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Other Liability Rules

• Conversion Liability
• Conversion means that (1) someone has stolen an
  instrument or (2) a bank has paid a check that
  has a forged indorsement.
• Imposter Rule
• If someone issues an instrument to an imposter,
  then any indorsement in the name of the payee is
  valid as long as the person (a bank, say) who
  pays the instrument does not know of the fraud.

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Other Liability Rules (contd)

• Fictitious Payee Rule
• If an instrument is issued to a person who does
  not exist, any indorsement in the name of the
  payee is valid as long as the payer does not know
  of the fraud.
• Employee Indorsement Rule
• If an employee with responsibility for issuing
  instruments forges an instrument, any indorsement
  in the name of the payee is valid as long as the
  payer does not know of the fraud.

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Negligence

• Anyone negligent in creating or paying an
  unauthorized instrument is liable to an innocent
  third party.
• Anyone careless in paying an unauthorized
  instrument is liable despite the three rules
  (impostor rule, fictitious payee rule and
  employee indorsement rule).
• Anyone careless in allowing a forged or altered
  instrument to be created is also liable.

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Crimes

• Bouncing a check
• Writing a check on an account with insufficient
  funds is illegal, but usually only has a monetary
  penalty if the funds are deposited quickly.
• Check Kiting
• An illegal scheme where checks are passed between
  overdrawn accounts at two banks, earning interest
  at one bank before reversing the process to
  repay the other account.
• Forgery
• Creating a fake document or passing on a known
  fake document is illegal.

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Discharge

• Discharge means that liability on an instrument
  terminates.
• By Payment By Agreement
• By Cancellation By Certification
• By Alteration
• Discharge of an indorser or accommodation party
• Article 3 provides that virtually any change in
  an instrument that harms an indorser or
  accommodation party also discharges them unless
  they consent to the change.

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It is never wise to play an important game
without understanding the rules. The rules of
negotiable instruments are complex, but important
because this game is played by virtually
everyone.
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