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1
Chapter 27
Liability, Defenses, and Discharge
N.B.: TYPE indicates that a question is new, modified, or unchanged, as follows.
N A question new to this edition of the Test Bank.
+ A question modified from the previous edition of the Test Bank.
= A question included in the previous edition of the Test Bank.
TRUE/FALSE QUESTIONS
B1. Even if a promissory note is incomplete at the time a maker signs it, the maker
is still obligated to pay.
B2. Primary liability on a negotiable instrument is conditional.
BUSPROG: Analytic AICPA: BB-Legal
B3. On drafts and checks, a drawer’s secondary liability does not arise until the
drawer fails to pay or to accept the instrument.
B4. An indorser is secondarily liable on an instrument.
2 TEST BANK B—UNIT FIVE: NEGOTIABLE INSTRUMENTS
B5. A delay in payment or a refusal to pay an instrument will dishonor the
instrument in all circumstances.
B6. Notice of dishonor can be given in any reasonable manner, including notice
written or stamped on the instrument itself.
B7. The general law of agency does not apply to negotiable instruments.
B8. An unauthorized signature is wholly inoperative and will not bind the person
whose name is signed or forged.
B9. In some situations, the unauthorized indorsement of a payee’s name can be as
effective as if the real payee had signed.
B10. A person who signs an instrument without authorization can be held personally
liable for payment by a holder in due course.
B11. Under the fictitious payee rule, the payee’s indorsement is not treated as a
forgery, and an innocent holder can hold the maker or drawer liable on the
instrument.
B12. Warranty liability arises only when a transferor indorses the instrument.
CHAPTER 27: LIABILITY, DEFENSES, AND DISCHARGE 3
B13. A person who transfers an instrument for consideration makes transfer
warranties to all subsequent transferees and holders who take the instrument
in good faith.
B14. Presentment warranties cannot be disclaimed with respect to checks.
B15. The forgery of a signature on an instrument is a valid defense against all
holders except HDCs and holders through HDCs.
B16. The completion of an originally incomplete instrument in an unauthorized
manner is not a defense against payment on the instrument to an HDC.
B17. When there is a breach of an underlying contract for which an instrument was
issued, the drawer of a check can order his or her bank to stop payment on the
check.
B18. If delivery of goods becomes impossible, a party who has issued a draft or note
under the contract has a defense for not paying it.
B19. When a negotiable instrument contains the notice required under FTC Rule
433, a consumer can bring any defense to payment that he or she has against
the seller of a product against a subsequent holder as well.
4 TEST BANK B—UNIT FIVE: NEGOTIABLE INSTRUMENTS
B20. All parties to a negotiable instrument will be discharged when any party liable
on it pays to a holder the full amount due.
MULTIPLE CHOICE QUESTIONS
B1. Duke signs a note “payable to the order of Equity Bank.” Unless Duke has a
valid defense against payment, his liability on this note is
a. impaired.
b. primary.
c. secondary.
d. qualified.
B2. Rubin writes a check drawn on his account at Clearwater Bank and payable to
the order of Gwyn. The bank does not pay the check. Rubin is
a. absolved of liability on the check.
b. liable to Gwyn for the amount of the check.
c. liable to the bank for the amount of the check.
d. entitled to payment of the amount of the check from Gwyn.
B3. Employment Personnel Company draws a check payable to Felix. Felix
indorses the back and negotiates the check to Guaranty Bank. Primarily liable
on the check is
a. Employment Personnel.
b. Felix.
c. Guaranty Bank.
d. none of the choices.
CHAPTER 27: LIABILITY, DEFENSES, AND DISCHARGE 5
B4. Lewis makes a note payable to MaxiFinance Corporation. MaxiFinance
indorses the back of the note and negotiates it to Notes & Drafts Investments,
Inc. Primarily liable on the note is
a. none of the choices.
b. MaxiFinance.
c. Notes & Drafts Investments.
d. Lewis.
B5. Fiona writes a check “pay to the order of Gerri” drawn on Fiona’s account at
Home State Bank. Gerri presents the check for payment to Home State, which
accepts it. Primarily liable on the check is
a. Fiona.
b. Gerri.
c. Home State.
d. none of the choices.
Fact Pattern 27-1B (Questions B6–B7 apply)
Charlton is the maker of a $200,000 promissory note payable to Development & Sales
Corporation. Development & Sales indorses the note to Equity Lenders, which in turn
indorses it to First Select Investors, which then indorses it to Global Bank, the present
holder.
B6. Refer to Fact Pattern 27-1B. Global Bank properly presents the note to
Charlton for payment, but he dishonors it. With timely notice to the proper
parties, Global Bank may collect payment on the note from
a. Development & Sales, Equity Lenders, or First Select.
b. Development & Sales or Equity Lenders only.
c. First Select only.
d. no one.
6 TEST BANK B—UNIT FIVE: NEGOTIABLE INSTRUMENTS
B7. Refer to Fact Pattern 27-1B. Suppose that First Select pays Global Bank on the
note. With timely notice to the proper parties, First Select may then collect
payment on the note from
a. Charlton, Development & Sales, or Equity Lenders.
b. Charlton or Development & Sales only.
c. Equity Lenders only.
d. no one.
B8. Ada is the maker of a note, on which Bart is secondarily liable. Credit
Instruments Company is the current holder of the note. Bart will be obligated to
pay the note if
a. Ada defaults on the note.
b. Credit Instruments breaches a transfer warranty.
c. Credit Instruments negotiates the note to Delta Collection Agency, a
third party.
d. Credit Instruments presents the note for payment.
B9. Orson signs a check “pay to the order of Painless Dental” drawn on Orson’s
account in Quantum Bank. To impose liability on Orson if the bank dishonors
the check, Painless Dental should present it for payment within
a. one year.
b. six months.
c. ten days.
d. thirty days.
B10. Gulf Bank receives a check drawn by Hayward. The check is received after the
established “cutoff” hour. Payment can be postponed without dishonor
a. indefinitely.
b. under no circumstances.
c. for thirty days.
d. until the following business day.
CHAPTER 27: LIABILITY, DEFENSES, AND DISCHARGE 7
B11. Community Bank receives a check drawn by Dennis. The check lacks a proper
indorsement. Payment can be postponed without dishonor
a. indefinitely.
b. under no circumstances.
c. for thirty days.
d. until the proper indorsement is obtained.
B12. Dulcey agrees to cosign a promissory note for Excavation Equipment Leasing
& Sales to buy a backhoe. The note is payable to Federal Bank. Dulcey is an
accommodation
a. drawee.
b. indorser.
c. maker.
d. drawer.
B13. Logan is Mining Corporation’s agent and is authorized to write checks on
Mining’s account in Northwest Bank. Logan writes a check “pay to the order of
Oceanside Resort.” Logan signs the check “Mining Corporation, by Logan,
agent.” Northwest Bank dishonors the check. Liability extends to
a. Logan.
b. Oceanside.
c. Mining Corporation.
d. no one.
B14. Olivia is Physicians Clinic agent and is not authorized to sign checks or notes
on its behalf. Despite the lack of authority, Olivia issues a note “payable to the
order of Quik Loan Company [signed] Physicians Clinic, by Olivia.” Liability on
this note extends to
8 TEST BANK B—UNIT FIVE: NEGOTIABLE INSTRUMENTS
a. Physicians Clinic.
b. Olivia.
c. Quik Loan.
d. no one.
B15. Celine issues a note “payable to the order of Celine,” forges Dash’s signature
as the maker, and indorses the note “pay to Erica.” Celine sells the note to
Erica, who negotiates it by indorsement and delivery to Forest. Forest can
extend liability to
a. no one.
b. Celine.
c. Dash.
d. all of the parties.
B16. Kurt writes a check on his account at Liquidity Bank to Mandy, a famous singer.
The person claiming to be Mandy is an imposter, however, named Nila. Nila
indorses the check to Outsize Portions, a casino, restaurant, and nightclub, for
which Liquidity Bank cashes it. Ultimately, the loss will most likely fall on
a. Kurt.
b. Liquidity Bank.
c. Mandy.
d. Outsize Portions.
B17. Jackson pays Phil in good faith for a promissory note. Phil warrants that the
draft has not been altered. This is
a. a presentment warranty.
b. a transfer warranty.
c. a signature warranty.
d. a breach of warranty.
CHAPTER 27: LIABILITY, DEFENSES, AND DISCHARGE 9
B18. Danton, a mentally impaired person, is asked by Elmer to sign a piece of paper
that he says is an autograph book. In fact, the document is a note. If later sued
on the note by an HDC
a. Danton must pay the note.
b. Danton’s best defense would be fraud in the execution.
c. Danton’s best defense would be fraud in the inducement.
d. Danton’s best defense would be mistake.
B19. Qiana gives Rick a $50 check as payment for a debt. Rick crudely raises the
amount of the check to $500 and transfers it to SmartPhones & Minutes Store
for a new phone. SmartPhones & Minutes deposits the check in its Trade
Market Bank account. Qiana is liable for the payment of $500 to
a. no one.
b. Trade Market Bank.
c. Rick.
d. SmartPhones & Minutes.
B20. Home Entertainment, Inc., warrants its goods to be free of defects. Ira issues a
note to obtain goods from Home Entertainment that proves defective. If Home
Entertainment presents the note for payment
a. Ira’s best defense would be breach of warranty.
b. Ira must pay the note.
c. Ira’s best defense would be fraud in the inducement.
d. Ira’s best defense would be failure of consideration.
ESSAY QUESTIONS
B1. Equity Credit Company has in its possession an instrument dated May 1, 2014.
The instrument is payable to the order of First Choice Moving & Storage
10 TEST BANK B—UNIT FIVE: NEGOTIABLE INSTRUMENTS
Company “on June 1, 2015,” for $5,000. In the upper left corner is an address
for Greater Metro Development Corporation—10 Corporate Park Avenue,
Chicago, Illinois—and in the lower right corner is the signature of “Hilltop
Investments, Inc., By Ida, President.” In the lower left corner is stamped
“ACCEPTED: Greater Metro Development Corporation by John, President,
May 5, 2014.” On the back is the signature of “First Choice Moving & Storage
Company by Kathleen, President.” Who, if anyone, is primarily liable on this
instrument on May 1? On May 5? Who, if anyone, is secondarily liable on this
instrument?
B2. Frieda is an administrative assistant with Global Dispatch & Shipping
Corporation, but has no authority to sign Global Dispatch checks. Frieda orders
merchandise from Home & Office Furnishings Company delivered to her home
and pays with a Global Dispatch check, signing “Global Dispatch & Shipping
Corp. by Frieda, admin. assist.” Home & Office does not know that Frieda has
no authority to sign the check. Who is liable on the check, and why?
CHAPTER 27: LIABILITY, DEFENSES, AND DISCHARGE 11
