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184
his friends.” Confucius
I. Teacher to Teacher Dialogue
There are two main theories for attaching liability in negotiable instruments. The first is
found in the rights and duties arising out of the signatures of parties to the instrument. These
rights and duties are essentially derived from contract law as modified by the UCC. The second
source of liability is found in a set of warranties imposed by the UCC. Warranties are promises
instruments vis-à-vis each other are of critical importance through the entire spectrum of UCC
studies. How those respective rights and duties finally fall into place at the point of discharge of a
II. Chapter Objectives
parties for negotiable instruments.
them.
3. Identify universal (real) defenses that can be asserted against a holder in due course.
LIABILITY, DEFENSES, AND
DISCHARGE
24
Liability, Defenses, and Discharge
III. Key Question Checklist
Does the instrument bear any evidence of forgery, alteration, or irregularity?
Does the shelter principle exception apply?
IV. Text Materials
HDCs make most instruments free of most defenses, with the exception of universal defenses that
Signature Liability for Negotiable Instruments
If a person’s signature appears on a negotiable instrument, they are contractually liable under the
Signature Defined – A signature may be any name, word, or mark, including handwritten, typed,
Primary Liability for Negotiable Instruments
Primary liability lies with the makers of promissory notes and CDs. There is no primary liability
Secondary Liability for Negotiable Instruments
Drawers of checks and drafts and unqualified indorsers of negotiable instruments have secondary
Unqualified Indorsers – Unqualified indorsers have secondary liability.
Qualified Indorsers – Indorsers who indorse instruments without recourse have no secondary
Requirements for Imposing Secondary Liability – A party is held to have secondary liability if
Liability of an Accommodation Party – A party that signs an instrument with the intention of
Chapter 24
Agent’s Signature – Agents may be empowered to sign as a representative of a principal,
Unauthorized Signature – When a person signs a negotiable instrument on behalf of another and
Forged Negotiable Indorsements
Usually, unauthorized indorsements cannot serve as indorsements of the person whose name is
signed. The loss, in these cases, falls to the party who first takes the forged instrument.
Ethics: Imposter Rule
poses as an agent.
Ethics: Fictitious Payee Rule
The drawer or maker is liable on forged or unauthorized indorsements when they intend the
Warranty Liability for Negotiable Instruments
Transfer Warranties
Any person transferring a negotiable instrument warranties that he has good title or is authorized
to act as the agent for the person that has good title, that all signatures are genuine, that the
checks.
Presentment Warranties
The person who presents a draft or check warrants that he has good title, that the instrument has
drawer is unauthorized.
Universal (Real) Defenses
Liability, Defenses, and Discharge
Minority – Infancy, provided there has been no misrepresentation, allows for disaffirmance.
Extreme Duress – This requires some form of force or violence; ordinary duress is not enough.
Mental Incompetence – Adjudication of incompetence is required.
Discharge in Bankruptcy – This is a universal defense.
Fraud in the Inception – Fraud in the factum or the execution are universal defenses.
Material Alteration – If an instrument has been fraudulently and materially altered, it cannot be
enforced.
Critical Legal Thinking – The risks of the universal defense actually are very similar to those
Personal Defenses
Personal defenses cannot be raised against an HDC, but are allowed against ordinary holders.
Breach of Contract – This is a personal defense effective against only the ordinary holder.
Fraud in the Inducement – This is a personal defense that is not effective against HDCs, but is
against ordinary holders.
contract, ordinary duress, discharge, and cancellation.
Critical Legal Thinking – A personal defense is one which may not be raised against an HDC
Chapter 24
raised?
Decision: Sands is an HDC.
Transactions
The FTC rule eliminates HDC status arising out of certain consumer credit transactions.
Discharge of Negotiable Instruments
from liability or surrenders posted collateral without the consent of the parties that would benefit
from the security.
Critical Legal Thinking – The FTC Rule nullifies the HDC status. It is supported by public
policy in favor of consumers.
V. Key Terms and Concepts
liable on the instrument.
Accommodation party—A party who signs an instrument and lends his or her name (and
credit) to another party to the instrument.
another person.
Breach of contract—Breach of contract is one of the most common defenses raised by a party
Cancellation—Cancellation 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)
obligation.
Discharge—Actions or events that relieve certain parties from liability on negotiable
Discharge in bankruptcy—Discharge in bankruptcy is a universal defense against the
Liability, Defenses, and Discharge
and universal defenses can be raised against HDCs of negotiable instruments that arise from
consumer credit transactions.
Fictitious payee rule—A rule that says a drawer or maker is liable on a forged or
unauthorized indorsement of a fictitious payee.
statement (i.e., misrepresentation) to another person to lead that person to enter into a contract
with the wrongdoer.
FTC HDC rule—A rule adopted by the FTC to soften the severity of the harshness of HDC
status against a consumer on a consumer credit transaction.
liable on the instrument.
Guarantee of payment—A form of accommodation in which the accommodation party
guarantees payment of a negotiable instrument; the accommodation party is primarily liable
on the instrument.
Holder—A person who is in possession of a negotiable instrument that is drawn, issued, or
indorsers, accommodation parties) are discharged from liability on an instrument if the holder
(1) releases an obligor from liability or (2) surrenders collateral without the consent of the
parties who would benefit by it.
Impairment in the right of recourse—A holder who releases an obligor or surrenders
obligation on the instrument.
Implied warranty—Certain warranties that the law implies on transferors of negotiable
instruments. There are two types of implied warranties: transfer and presentment warranties.
Imposter rule—A rule that says if an imposter forges the indorsement of the named payee, the
drawer or maker is liable on the instrument and bears the loss.
Chapter 24
holder.
Notice of dishonor—The formal act of letting the party with secondary liability to pay a
negotiable instrument know that the instrument has been dishonored.
Ordinary duress or undue influence—Ordinary duress makes a negotiable instrument still
payment or acceptance makes to a drawee or an acceptor who pays or accepts the instrument
in good faith: (1) The presenter has good title to the instrument or is authorized to obtain
universal (real) defenses.
Principal—A person who authorizes an agent to sign a negotiable instrument on his or her
behalf.
Qualified indorser—Those who disclaim liability and are not secondarily liable on
instruments they endorse.
when due.
Signature—Any name, word, or mark used in lieu of a written signature; any symbol that is
(1) handwritten, typed, printed, stamped, or made in almost any other manner, and (2)
executed or adopted by a party to authenticate a writing.
Signature liability—Liability in which a person cannot be held contractually liable on a
contract liability.
Signer—A person signing an instrument who acts in the capacity of (1) a maker of notes or
certificates of deposit, (2) a drawer of drafts or checks, (3) a drawee who certifies or accepts
checks or drafts, (4) an indorser who indorses an instrument, (5) an agent who signs on behalf
of others, or (6) an accommodation party.
acceptor, or the drawer of an unaccepted instrument.
Unauthorized signature—A signature made by a purported agent without authority from the
purported principal.
Liability, Defenses, and Discharge
instrument.
