978-1285427003 Chapter 22 Lecture Note Part 2

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Defenses against a Holder in Due Course

Fundamental Rule Part (4): The issuer cannot claim any of a limited

number of “real” defenses

Real Defenses: valid against both a holder

and a holder in due course

Personal Defenses: valid only against a holder

Forgery

Bankruptcy

Being Underage

Alteration

Duress

Mental incapacity

Illegality

Fraud in the execution

Breach of contract

Lack of consideration

Prior payment

Unauthorized completion

Fraud in the inducement

Non-delivery

Real Defenses vs. Personal Defenses

Question: Why are both real and personal defenses valid against a holder; but only real defenses are valid

against a holder in due course? What is the difference between real and personal defenses?

Answer: Real defenses deal with fundamental challenges to the basic validity of the instrument itself.

Question: In the discussion of personal defenses in the text, why is Ross a “mere holder,” and not a

holder in due course?

Answer: A holder in due course must take an instrument in good faith, for value, without notice of

The Fundamental “Rule” of Commercial Paper, Revisited

If, at the beginning of class, you asked students to name examples of commercial paper that they have

used in the last month, you may want to ask the following question now.

Question: Does the holder of this commercial paper have an unconditional right to be paid?

Answer: To answer this question, students would have to decide:

Consumer Exception

A consumer credit contract is one in which a consumer borrows money from a lender to purchase goods

and services from a seller who is affiliated with the lender. No one can be a holder in due course of an

instrument that contains the Federal Trade Commission (FTC) consumer exception language.

Case: Antuna v. Nescor, Inc.1

1 2002 Conn. Super. LEXIS 1003, SUPERIOR COURT OF CONNECTICUT, 2002.

Facts: Steven Vlohotis was a salesman for NESCOR, a home improvement company. He convinced the

Antunas to sign a consumer credit contract with NESCOR to install vinyl siding and windows. The

contract provided that the Antunas would pay for the improvements in installments. NESCOR assigned

the contract to First Consumer Credit, LLC, which reassigned it to The Money Store (TMS). In keeping

with FTC requirements, the contract contained the following language: “Any holder of this consumer

credit contract is subject to all claims and defenses which the debtor could assert against the Seller of the

goods or services pursuant hereto or with the proceeds hereof.”

Connecticut law (the Act) provides that, “No home improvement contract shall be valid or

enforceable against an owner unless it is entered into by a registered salesman or a registered contractor.”

The NESCOR salesman, Vlohotis, was not registered.

Unhappy with NESCOR’s work, the Antunas stopped making payments under the contract. TMS filed

suit, seeking to foreclose on their house. The Antunas moved for summary judgment, arguing that TMS

could not enforce the contract because it was not a holder in due course.

Issue: Does TMS have the right to foreclose on the Antunas’ home? Was TMS a holder in due course?

Excerpts from Judge Shortall’s Decision: In employing Vlohotis to call on the plaintiffs as its salesman

NESCOR was performing an illegal act, one explicitly prohibited. Accordingly, the court finds that

NESCOR’s material noncompliance with [the statute] renders the home improvement contract invalid and

unenforceable and precludes it from enforcing the consumer credit contract against the plaintiffs.

The plaintiffs are seeking summary judgment against TMS on its counterclaim, which seeks to

foreclose upon the plaintiffs’ home because of their default under the consumer credit contract now held

by TMS. They argue that summary judgment is appropriate because NESCOR’ s violation of the Act bars

any recovery by TMS.

It is only by giving consumers like the plaintiffs a shield against enforcement of these consumer

credit contracts that the Act’s declaration that a contract is invalid and unenforceable has any meaning.

The language appearing in the consumer credit contract held by TMS, viz., that the contract is “subject to

all claims and defenses which” the plaintiffs could assert against NESCOR is mandated in all such

contracts by the FTC to prevent the seller of goods from cutting off the consumer’s right to assert claims

and defenses against the seller’s assignee. So, in this case, where the Act, itself, gives the plaintiffs the

right to defend against enforcement of the home improvement contract, the language in the consumer

credit contract held by TMS gives them the same right as against TMS.

Accordingly, because the TMS is subject to those same claims and defenses under the very language

of its contract with the plaintiffs. TMS may not enforce the consumer credit contract it holds by

foreclosing on the plaintiffs’ property for nonpayment.

The plaintiffs’ motion for summary judgment is granted.

Question: What caused the contract with NESCOR to be invalid?

Question: Is this a harsh penalty for The Money Store or should they have verified that NESCOR

was in fact registered?

Additional Case: Scott v. Mayower Home Improvement Corp.2

Facts: Mary Johnson signed a contract with Mayflower to perform repair work on her home for a fee of

$25,900. Mayflower arranged for Johnson to pay for this work by borrowing money from Sterling

Resources. The note she signed with Sterling had an unconscionably high price of $50,108.60 and an

interest rate of 17.98%.

Johnson alleges that Mayflower was running a scam, hiring unlicensed salespeople to target minority

neighborhoods for home repairs. Its contracts contained deceptive or incomplete specifications and

payment terms. The actual work was shoddy or incomplete, using poor quality materials. Sterling

routinely loaned money to Mayflower customers. Sterling then sold the loans to banks and other financial

institutions.

Johnson failed to make the payments due on the note and the Lender sued, moving for summary

judgment against Johnson on the grounds that, as a holder in due course, it was entitled to enforce the

note regardless of her claims against Mayflower or Sterling. She responded that, under the FTC consumer

exception rule, the Lender was not a holder in due course and therefore subject to whatever defenses she

had against Sterling or Mayflower.

Issue: Was the Lender a holder in due course?

Holding: No, summary judgment is denied for the Lender but granted for Johnson. The purpose of the

FTC Holder Rule is to protect innocent consumers from unethical merchants and their financiers. The

note that Johnson signed contained the FTC Holder notice. Therefore, the Lender was on notice and is not

a holder in due course.

Question: What was going on in this case?

Question: Why didn’t Mayflower keep the note that Mary Johnson signed?

Question: Was the Lender, in the end, a holder in due course?

Question: Why did Mayflower and the Lender think they could enforce a note that contained this

language?

Suggested Additional Assignment: Writing Exercise

If you asked students to write their own mystery story modeled on the vignette that opens the chapter, this

would be an appropriate time to ask them to break into groups and share their stories with the group. They

could then select the best story from their group to read aloud to the class.

Liability for Negotiable Instruments

The liability of someone who has signed an instrument is called signature liability. The liability of

someone who receives payment on an instrument is called warranty liability.

2 363 N.J. Super. 145; 831 A.2d 564; 2001 N.J. Super. LEXIS 524 SUPERIOR COURT OF NEW

JERSEY, 2001

Primary versus Secondary Liability

More than one person may be liable on the same negotiable instrument. Someone with primary liability

is unconditionally liable – he must pay unless he has a valid defense. Those with secondary liability must

pay only if the person with primary liability does not.

Additional Case: You Be The Judge: Messing v. Bank of America3

Facts: Jeff Messing attempted to cash a check for $976 at a Bank of America branch office. The check

was made out to Messing and drawn on the Bank of America. A teller asked Messing to provide

identification. Messing presented his driver’s license and a major credit card but Bank of America policy

required a thumbprint signature from anyone wishing to cash a check who did not have an account at the

bank. When Messing declined, the teller refused to cash the check.

You Be the Judge: Was the bank’s thumbprint policy permissible under the UCC? Had Messing provided

reasonable identification?

Holding: Judgment for Bank of America affirmed. Providing a thumbprint signature may not confirm

identification of the checkholder at presentment, but it does assist in the identification of the checkholder

should the check later prove to be bad. The thumbprint therefore serves as a powerful deterrent to those

who might otherwise attempt to pass a bad check. A reduction of risk facilitates commerce, which is an

important goal of the UCC.

Question: Why didn’t Messing just deposit the check in his own checking account instead of trying

to cash it at a bank where he had no account?

Answer: If Messing deposited the check in his account and it bounced, Messing’s bank would

Question: Is there anything wrong with that?

Question: Why did Messing refuse to provide a thumbprint?

Question: What is the trade-off in this case?

Question: Who should win this case?

Biometric Authentication

Students who have completed the biometric authentication assignment should relate their findings now.

Signature Liability

Once you sign an instrument, you are potentially liable for paying it. However, liability depends upon the

capacity in which you sign–the liability of an indorser is different from that of a maker, for instance.

The maker of a note is primarily liable. If two makers sign a note, they are both jointly and

severally liable.

The drawer of a check has secondary liability. He is liable only after he has received notice that

the bank has dishonored the check.

The drawee is the bank on which the check is drawn. The bank is not liable to the holder.

Indorsers are only secondarily liable; they must pay if the issuer or drawee does not. But

indorsers are only liable to those who come after them in the chain of ownership.

3 373 Md. 672, 2003 Md. LEXIS 155 Court of Appeals of Maryland, 2003.

Example: Read the back before indorsement

Before indorsing a check, beware of any contracts written on the back. Robert Beken bought a $35

software book from Computer City in San Diego. When he saw the clerk type his name and address into

the computer, he insisted that his name not be added to any mailing lists. The clerk assured him that it

would not. Beken wrote on the back of his check:

Computer City agrees NOT to place Robert Beken on any mailing list or send him any advertisements or

mailings. Computer City agrees that breach of this agreement by Computer City will damage Robert

Beken and that these damages may be pursued in court. Further, that these damages for the first breach

are $1,000. The deposit of this check for payment is agreement with these terms and conditions.

When Beken received junk mail from the store, he sued for breach of contract. The court awarded him

$1,021 (court costs were $21).4

Accommodation Party

An accommodation party is someone—other than an issuer, acceptor, or indorser—who adds her

signature to an instrument for the purpose of being liable on it. The accommodation party has the same

liability to the holder as the person for whom he signed.

Additional Case: IN RE Couchot5

Facts: Jean Couchot borrowed $6,317.48 from the bank to pay her son’s funeral expenses. Kathy, the

son’s wife, signed as an accommodation party. The bank issued a check to Kathy and Jean Couchot,

which somehow got changed to Kathy or Jean Couchot. Jean cashed the check and spent the money on

funeral and other expenses. Jean did not repay the loan. The bank sued Kathy.

Issue: Is an accommodation party liable for the full amount of a note when she received only a small

portion of the proceeds? Is an accommodation party liable even though the check was altered?

Holding: An accommodation party is liable whether or not she benefits from the loan. Although the

check had been altered, Jean had spent the loan proceeds as anticipated. Kathy is liable.

Question: What is an accommodation party?

Question: Why do people agree to serve as accommodation parties?

Answer: Generally for two reasons. Either there is a family relationship—parents guaranteeing a

Question: What are the differences among a guarantor, an accommodation party, and a co-maker?

Answer: An accommodation party is liable whether or not the holder has first tried to collect against

Question: Is the result in this case fair? After all, Kathy did not receive any of the money from the

check.

Question: Why did Kathy agree to be an accommodation party?

Question: Was it used for that purpose?

4 Ross Kerber, “Litigious Crusader Uses Checks To Ensure No Junk Is in the Mail,” Wall Street Journal,

Feb. 2, 1996, p. B1.

5 169 B.R. 40, 1994 Bankr. LEXIS 899 United States Bankruptcy Court, Southern District of Ohio, 1994.

Question: Would Kathy have been liable if the proceeds had been used for Jean’s personal expenses?

Question: What is the moral of this story?

Warranty Liability

Basic Rules of Warranty Liability

1. The wrongdoer is always liable.

2. The drawee bank is liable if it pays a check on which the drawer’s name is forged. The bank can

recover from the payee only if the payee had reason to suspect the forgery.

3. In any other case of wrongdoing, a person who first acquires an instrument from a wrongdoer is

ultimately liable to anyone else who pays value for it.

The following case nicely illustrates both the liability of indorsers and transfer warranties.

Additional Case: American National Bank v. Augustine 6

Facts: John and Nancy Augustine hired Hanover Homes to build a house. They took out a construction

loan from South Bend Bank. When directed by the Augustines, South Bend would issue a check payable

to John, Nancy, and Hanover; John and Nancy would indorse it and deliver it to Hanover. However, there

was one check that John indorsed and delivered to Hanover without Nancy’s indorsement. Hanover

deposited the check in its account at St. Joseph Valley Bank. Hanover then filed for bankruptcy. South

Bend discovered the missing indorsement and demanded repayment from St. Joseph. Although St. Joseph

could have demanded repayment from Hanover, there was no point since Hanover was bankrupt. So,

instead, St. Joseph demanded repayment from Nancy and John. The lower court held that John was liable

to St. Joseph as an indorser and for violating his transfer warranties. John appealed.

Issue: Is John liable to St. Joseph as an indorser?

Holding: The appeals court held that John was not liable because only a holder has the right to demand

payment on an instrument, and St. Joseph was not a holder because the check had not been properly

indorsed to it (Nancy’s indorsement was missing).

Question: Has John violated his transfer warranty to St. Joseph?

Answer: The court held that John had not violated his transfer warranty. When John transferred the

check, he warranted that:

He was a holder of the instrument

The court observed that an indorser does not warrant against future forgeries or alterations. The wrong in

this case—namely, depositing the check without all necessary indorsements—occurred after John’s

Transfer Warranties

When someone transfers an instrument, she warrants that:

6 389 N.E.2d 379 Indiana Court of Appeals, 1979.

• She is a holder of the instrument – in other words, she is a legitimate owner

• 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.

You Be the Judge: Quimby v. Bank of America7

Facts: Steve Szabo, a Venezuelan resident, had a checking account with the Bank of America in Palm

Beach Gardens, Florida. Someone with an internet address in Nigeria hacked into Szabo’s accounts

on-line, called customer service to change the telephone number listed on his account and ordered blank

checks.

Someone then wrote a check on Szabo’s account for $120,000 to pay for an investment in Freddie

Quimby’s gold mine. On February 20, Quimby presented the check for payment at the Bank of America’s

branch in Osburn, Idaho. At Quimby’s request, the branch manager verified through Bank of America’s

records that Szabo’s account had sufficient funds to cover the check. The branch manager also called the

telephone number in Szabo’s account records and spoke to someone claiming to be Szabo who confirmed

that the check was valid.

Quimby endorsed the check to the bank and received in return a cashier’s check for $120,000, which he

deposited to his account at Bank of America in Baker City, Oregon. [You remember that a cashier’s check

is a check drawn on the bank itself.] “Szabo” then contacted Quimby, stating that he had changed his

mind about the gold mine investment and asking Quimby to return the funds. On February 22, Quimby

wired $111,000.00 from his account with Bank of America to an account in Hong Kong. Those funds

disappeared and Bank of America has been unable to reclaim them.

On March 3, the real Szabo reported to the Bank that his signature on the Quimby check was a forgery.

The Bank repaid Szabo and then filed suit against Quimby, seeking repayment on the cashier’s check it

had issued to him, with interest. The Bank argued that Quimby had violated his transfer warranties when

he endorsed the forged check to it.

You Be the Judge: Did Quimby violate his transfer warranties? Is he liable to the Bank of America for

$120,000?

Argument for the Bank: When Quimby endorsed the check to the Bank, he warranted that all signatures

were authentic and authorized. That was not true – the signature was a forgery and the check was invalid.

Moreover, he only waited two days before wiring the funds. If he had waited longer, the fraud might have

been discovered in time. The Bank had to refund $120,000 to Szabo. Quimby must repay the Bank.

Argument for Quimby: This whole problem is the Bank’s fault. Let us count the ways: the Bank (1)

permitted a thief to hack into Szabo’s account; (2) issued blank checks to the thief; (3) assured Quimby

that there were good funds to pay the check; (4) issued a cashier’s check to Quimby; and (5) wired funds

to Hong Kong that it cannot trace. In short, the Bank was repeatedly negligent and now it seeks recovery

from Quimby, who did all he could to ensure that the check was valid. That is unfair and preposterous.

Holding: Judgment was entered in favor of the Bank requiring Quimby to repay the Bank over $117,000.

Question: Assuming Quimby was not part of the scam, how could he have avoided finding himself in

this situation?

7 2009 U.S. Dist. LEXIS 98575 United States District Court For The District Of Oregon, 2009.

Presentment Warranties

Anyone who presents a check for payment warrants that (1) she is a holder, (2) the check has not been

altered, and (3) she has no reason to believe the drawer’s signature is forged. Anyone who presents a note

for payment warrants only that she is a holder of the instrument.