CHAPTER
33
LIABILITY OF
PARTIES
I.
OBJECTIVES:
The objective of this chapter is to explain the various ways a person can become liable on
a
negotiable instrument and the nature of the liability incurred. The chapter also discusses
the
various ways that liability can be discharged. After reading the chapter and attending class,
a
student should be able
to:
1. Explain the difference between primary and secondary liability on a negotiable
instrument.
2. Recall the obligations of makers, drawees or acceptors, drawers, indorsers,
and
accommodation
parties.
3. Explain when a person’s signature on a negotiable instrument makes the person
contractually
liable on it.
4. Explain what is meant by presentment of a note or of a check or
draft.
5. List the five warranties made by persons who transfer negotiable instruments to
someone
else.
6. List the three warranties made by persons who present negotiable instruments for payment
or
acceptance.
7. Discuss the three exceptions to the normal liability rules, negligence, the impostor rule,
and
the fictitious payee rule.
“
8. Explain how the inability of a party to pay an instrument is normally
discharged.
II. ANSWER TO
INTRODUCTORY PROBLEM
A. The first question following the hypothetical that appears at the beginning of the chapter
ask
what liability a person assumes by indorsing a check that is payable to you and then
“cashing
“the
check at a check-cashing service. An indorser is secondarily liable and obligated
on
dishonor of the instrument to pay the amount due on the instrument according to its terms
at
the time he indorsed it or if he indorsed it when it was incomplete, then according to its
terms
when completed, provided that it is completed as authorized. The obligation is owed to
a
person entitled to enforce the instrument or to any subsequent indorser who had to pay it.
B. The second question asks what the liability of a drawer that makes a check out in a way
that
allows someone else to raise the amount of the check. If a person has been negligent
in
writin
g
or signing a negotiable instrument, Article 3 precludes her from using the alteration
as
a reason
for noting paying a person that in good faith pays the instrument or takes if for
value
C. The third question asks for the rights of an employer who has a dishonest employee
who
make
s
out checks payable to fictitious payees and cashes them for her own benefit. The
UCC
allows any indorsement in the name of the fictitious payee to be effective as the
payee’s
indorsement in favor of any person that pays the instrument in good faith or takes it for
value
or collection. This forces the loss back on the employer of the faithless employee unless
he
can locate and recover the money from
employee.
Chapter 33
-Liability
of
Parties
33-1
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D. The fourth question asks whether in some circumstances it would be unethical to use
a
qualified indorsement to avoid the contractual liability of an indorser. The Ethics in
Action
problem in the text supposes you are considering negotiating a note you have taken
(
and
about which you have concerns as to whether the maker will make it good) to an
elderly
neighbor looking for an investment. there is a good case to be made that in
those
circumstances you should put yourself in the shoes of the neighbor and ask what would
I
want to know in that situation. Chances are good that you’d want to know both about
the
uncertainty as to
payment-and
what is the legal effect of the qualified indorsement?
The
situation might be quite different if the person to whom you were negotiating the
instrument
was sophisticated about financial matters and able to look out for
herself.
III. SUGGESTIONS FOR LECTURE
PREPARATION:
A.
Introduction/Liability
in General. Outline the various liabilities of persons who sign,
transfer,
or pay for negotiable instruments. This introduction should include the obligations of
signers,
warranties made by transferors and presenters, and liability for conversion of
instruments.
B. Contractual
Obligations
1. Generally. Note that the obligation of signers is also termed liability on
the
instrument.
These obligations are incurred by persons who sign instruments, and should be
contrasted
with warranty liability, which is imposed on nonsigners as well as
signers.
2. Primary Liability. A person who is primarily liable on an instrument is obligated to
pay
it. The holder need not ask for payment from any other person before he may require
the
primarily liable party to pay. Makers, accommodation makers, drawees who
have
accepted drafts, and banks who have certified checks have primary liability. Note
that
payment may be asked of the accommodation maker before it is sought from the
maker.
Define acceptance. Note that an acceptance or certification releases all prior
indorsers
and the drawer from their obligations on the
instrument.
Harrington v. McNab (page 904). Where the attorney at a settlement where the
purchaser
of property proferred a personal
check-rather
than the required certified
check-called
the drawee of the personal check to ascertain whether there were funds available in
the
drawer’s
account to cover the check and was advised there were funds
(
subsequently
confirmed in writing that while there were funds they had not yet been collected),
the
attorney could not maintain a cause of action against the drawee on a claim of
negligent
representation and/or that a hold was to have been placed on the account to cover
the
check.
Points for Discussion: Note that court confirms the principle that a drawee has no
liability
on an instrument to a holder unless it has certified or accepted the instrument.
Discuss
what steps the payee might have taken to protect himself in this
circumstance-either
having the drawer get the check certified or providing a
cashier’s
check-and declining
to go ahead with the closing unless/until the buyer did
so.
3. Secondary Liability. A person who is secondarily liable is obligated to pay
subsequent
holders on an instrument if it is dishonored and he receives notice of the
dishonor.
Drawers, accommodation drawers, indorsers, and accommodation indorsers
have
secondary liability. The holder must seek payment from the person primarily
obligated
(or the drawee if it is an unaccepted draft, or the bank if it is an uncertified check),
have
payment refused, and give notice of the dishonor before the secondarily obligated
party
must pay. Note that drawers and indorsers may sign without recourse,
and
thereby eliminate their contractual obligation or
liability.
Example: Problem Case
#1.
Ethics in Action: Would Qualifying an Indorsement Be Ethical? (p. 905): This
problem
raises the issue of whether it is ethical for you to take advantage of a legal shield
through
information you have but do not share with the other primarily affected
person,
particularly
one who may not be in a position to know about the shield or to ask
the
relevant questions to protect herself. Again, you should ask yourself how would you
view
the situation if you were in the shoes of the elderly neighbor; how would you want
the
other person to act? What would you
expect?
4. Examples. Ask the students who has what obligation in the following
situations:
a. Mel issues a negotiable note to Paula, who indorses it in blank and sells it to
Henry.
Henry delivers the note without indorsement to
Stella.
b. Mary signs a negotiable note under her daughter Susan’s
name.
c. Dee draws a check on First Bank payable to Peter. Peter indorses the check and
buys
groceries with it at Grocery
Store.
d. Same
a
s
,
except Grocery takes the check to First Bank, who certifies it.
Grocery
indorses and cashes the check at Second
Bank
5. Signing an Instrument. Point out that no person is obligated on an instrument unless
his
signature appears on
it.
6. Signature by an Authorized Agent. Note that the signature can be put there by an
agent.
Review the law of agency and the consequence of an agent signing improperly and
thereby obligating himself on the instrument. For example, you may ask the
students
who is liable on a note signed as
follows:
a. Astra
Corp.
by Ted Tolbert,
Treas.
b. Astra
Corp.
Ted Tolbert,
Treas.
c. Astra
Corp.
Ted
Tolbert.
Additional Examples: Problem Cases #2 and
#3.
Marion T v. Northwest Metals Processors (page 908). Under Indiana’s version of
the
Code, a representative who signs his name as drawer of a check without an indication
of
the representative status and the check is payable from the account of the person who
is
identified on the check, the signer is not liable on the check if the signature is an
authorized signature of the represented person. However, a different rule prevails
under
the criminal law where the person signs the check with fraudulent
intent.
Cyberlaw in Action (page 906): Use the increased prevalence of fake checks and
money
orders to show students the risks they may take on by indorsing negotiable
instruments
which they believe to be legitimate but are in fact bogus. Discuss the various steps
one
might take to protect themselves in circumstances where they do not really know
the
person from whom they are acquiring an
instrument.
7. Unauthorized Signature. Point out that the forgery of another’s signature operates as
the
forger’s signature. The forger has contractual liability although his name
appears
nowhere on the instrument. By contract the person whose signature was forged has
no
contractual
liability.
Example:
Problem Case
#4.
C. Contractual Liability in
Operation
1. Presentment. Define presentment as a demand for payment or acceptance upon
the
maker, acceptor, drawee, or other payor by or on behalf of the holder. Presentment
is
necessary to obtain payment from parties who are secondarily liable and to
prevent
parties from being discharged from their contractual obligations on the
instrument.
2. Time of Presentment. Timely presentment is essential to holding parties liable on
an
instrument. The instrument must be presented when due. Note that unexcused delay
will
release indorsers from liability on the instrument, and may release makers and
drawers
(but
only in rare
situations
).
3. Examples. The students will better understand presentment and its functions if you
ask
them how and when the following instruments should be
presented:
a. A check drawn by Dan and dated May 1, indorsed by Pat on May 3, and indorsed
by
Ida on May
5.
b. A demand note issued by Mark and dated May 1, and indorsed by Hannah on May
5.
c. A note issued by Marty, dated May 1 and due June 15, and indorsed by Ira on
May
10.
D. Warranty
Liability
1. Generally. Emphasize that warranty liability is separate and distinct from
contractual
liability.
It
may exist whether or not contractual liability exists, and is an
alternative
ground on which a holder may receive payment. Warranty liability has one
major
advantage over contractual liability: it offers a means of recovery to a holder prior to
the
due dates of the
instrument.
2. Transfer Warranties. List and explain the six transfer warranties. Note that the
non-
indorsing transferor makes these warranties only to his immediate transferor while
the
indorsing transferor makes the warranties to all subsequent
transferors.
Bank One, NA. v. Streeter (page 913).
Where
the
defendant presented
three
instruments
for
deposit
that had been
altered
to state his
name rather
than
the
payees
to
whom
the
instruments
were, he
breached
the
transfer warranties.
According
to the
Indiana
Code, “a
person
who
transfers
an
instrument
for
consideration warrants
to the
transferee…
that: (1) the
warrantor
is a
person
entitled
to
enforce
the
instrument…
(3) the
instrument
has not been
altered. The
transferor’s knowledge
of the
alteration
is not
required
to
establish
the
breach.
Further,
the
defendant
was not
entitled
to
enforce
the
instruments because,
without
the
endorsement
of the
original payees,
he was not a
proper payee.
3. Presentment Warranties. Note that Revised Article 3 sets out four
presentment
warranties that are made in the course of presenting a draft for payment or
acceptance
and one presentment warranty that is made when a dishonored draft is presented
for
payment to the drawer or an indorser or when any other instrument such as a note
is
presented for payment to the party obligated to pay the
instrument.
4. Examples. To aid students’ understanding of the relation of contractual and
warranty
liability and knowledge of the operation of warranty liability, run through the
examples
that appear in the text under the subheading “Operation of Warranties.” The
students
should identify who has liability to
whom.
Additional Examples: Problem Cases #5 and
#6.
E. Other Liability
Rules
1. Exceptions
to
Payor
Bank’s
Liability
to
Drawer. Note that although the payor bank
must
ordinarily re-credit the customer-drawer’s account for paying altered or forged items,
if
the
customer-drawer was responsible for the alteration or forgery, the payor bank will
not
be required to recredit the customer-drawer’s account. The three most common
grounds
are negligence, the imposter rule, and the fictitious payee
rule.
2. Negligence. Explain the operation of the rule concerning negligence and explain
its
rationale–imposition
of liability
on the person best able to prevent the alteration
or
forgery.
Example: Problem Case
#7.
3. Imposter Rule. Describe some common imposter situations and explain the
application
of the imposter rule. Note its rationale–imposition of liability on the person best able
to
prevent the
fraud.
4. Fictitious
Payee
Rule. Describe some common business situations in which a
fictitious
payee may arise and explain the application of the fictitious payee rule. Again, note
the
rationale: that the drawee is in the best position to stop the alleged alteration or
forgery.
Note that there is no forgery when the imposter or fictitious payee rules apply:
any
person may properly sign the imposter or fictitious payee’s name. Note that if
the
signature of an imposter or fictitious payee were a forgery of a necessary indorsement,
no
subsequent transferee could become a
holder.
Victory Clothing Co., Inc. v. Wachovia Bank,
NA.
(page 918). The court
applied
comparative negligence principles to split the loss between a company whose
employer
forged checks and a depositary bank which allowed the forger to deposit the checks
to
her own personal account in violation of its own
rules.
Points for Discussion: Note how the policy rationale behind the fictitious payee rule
is
served by the result in this case. What should the drawer have done to protect
itself?
What should the bank have
done?
Additional Example: Problem Case
#8.
5. Conversion. Define conversion, and explain that the most common example
of
conversion in negotiable instrument law is paying on a forged
indorsement.
Additional Example: Problem Case
#9.
F.
Discharge
List on the chalkboard the ways a person becomes discharged from contractual liability on
a
negotiable instrument.
It
should be noted, however, that discharge does not relieve a
person
from transfer warranty or presentment warranty liability. Discharge by alteration
is
especially
important. Refer back to the materials on timely presentment and review the
rules
for discharge applicable in that
context.
N.
RECOMMENDED
REFERENCES:
See the same references listed for Chapter 31, Negotiable
Instruments.