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CHAPTER 14: LIABILITY, DEFENSES, AND DISCHARGE 11
whole or in part.
whole or in part.
ADDITIONAL BACKGROUND—
Does the Notice Required by the FTC Rule Make a Note Conditional?
The FTC Rule makes it impossible for there to be an HDC of a consumer credit note. Under unrevised
Article 3, the rule may also have had the effect of making the note conditional. Revised Article 3 provides,
however, that such a required statement does not make a note conditional [UCC 3–106(d)]. There cannot be
a holder in due course of the note, but the note has the benefits of other revised Article 3 rules [UCC 3–
302(g)].
UCC 3–106(d) applies only if such a statement is required by statutory or administrative law. Comment 3
to UCC 3–106(d) explains, “The prime example is the Federal Trade Commission Rule (16 C.F.R. Part 433) .
. . . Subsection (d) is designed to make it possible to preclude the possibility of a holder in due course without
excluding the instrument from Article 3. Most of the provisions of Article 3 are not affected by the holder-in-
due-course doctrine and there is no reason why Article 3 should not apply to a note bearing the FTC legend if
holder-in-due-course rights are not involved.”
Is the result different if the phrasing of a legend or statement is different from that stated in UCC
3–106(d)? No. Comment 3 states, “No particular form of legend or statement is required by subsection (d).
The form of a particular legend or statement may be determined by the other statute or administrative law. For
example, the FTC legend required in a note taken by a seller in a consumer sale of goods or services is
tailored to that particular transaction and therefore uses language that is somewhat different from that stated
in subsection (d), but the difference in expression does not affect the essential similarity of the message
conveyed.”
IV. Discharge
A. DISCHARGE BY PAYMENT OR TENDER OF PAYMENT
All parties to an instrument are discharged when the party primarily liable on it pays to a holder the
amount due in full [UCC 3–602, 3–603]. Payment by any other party discharges only that party and
subsequent parties.
payment offered to a person entitled to enforce the instrument and the tender is refused.
B. DISCHARGE BY CANCELLATION OR SURRENDER
With the intent to cancel, a holder can discharge any party by cancellation [UCC 3–604]. Sufficient acts
include—
whole or in part.
whole or in part.
CHAPTER 14: LIABILITY, DEFENSES, AND DISCHARGE 15
CHECKLIST FOR THE PURCHASE OF NEGOTIABLE INSTRUMENTS
1. Make sure that a demand instrument is not overdue before purchasing it.
2. Make sure that the negotiable instrument has no obvious defects—look for indications that the maker or
drawer of the instrument might have a valid reason for refusing to pay.
TEACHING SUGGESTIONS
1. Because agency relationships permeate commercial law, ask the class to discuss some of the ways in
which agency relationships may be created and destroyed. How can an agent avoid incurring personal
liability while acting on behalf of his principal, especially if the principal is either unknown or insists
on remaining anonymous? Conversely, a principal will not wish to allow his agent to act on his behalf as the
agent sees fit; instead the principal will want to limit his agent’s authority to a particular area of activity. What
can the principal do to protect himself from liability arising from unauthorized acts of his agent?
2. To help keep the material in this chapter understandable to the majority of your students, emphasize only
those points that you think are most important for them to know and remember—the points that you will test
them on or the points that those who will take the CPA examination will need to remember for that test.
Cyberlaw Link
What effect might the existence of banking on the Internet have on the legal principles discussed
in this chapter?
DISCUSSION QUESTIONS
2. Must a party sign his or her name in full in order to be bound by the terms of a negotiable instrument?
No. The UCC defines a signature as “any name, including a trade or assumed name”, or “a word, mark, or symbol
executed or adopted by a person with the present intention to authenticate a writing” [UCC 1–209(39); UCC 3–
401(b)]. A signature can be handwritten, typed, or printed; it also can be made by mark, by thumbprint, by machine, or
16 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
4. When is an instrument dishonored? An instrument is dishonored when presentment is properly made and
acceptance or payment is refused or cannot be obtained within the prescribed time, or when presentment is excused
and the instrument is not properly accepted or paid. To determine whether an instrument is properly payable, payment
can be postponed without dishonor after an established cut-off hour (not earlier than 2 P.M.), but not beyond the close
principal alone will liable. If the agent signed his or her name alone without also indicating the name of the principal,
by contrast, then the agent—but not the principal—will be liable.
6. When may a person whose forged signature appears on a negotiable instrument be liable on that in-
strument? In general, a person is not normally liable to pay on a negotiable instrument in which his signature has
name.
7. Who assumes the burden of loss when there is a forged or unauthorized indorsement? In general, the
burden of loss falls on the first party to take the forged indorsement because a forged indorsement does not transfer
title. (Consequently, the party taking an instrument with a forged indorsement cannot become a holder.) The loss
words or numbers, or making any other change in an unauthorized manner that relates to the obligation of a party
[UCC 3–407(a)]. Material alteration is a complete defense to an ordinary holder but only a partial defense at best
against an HDC.
9. What are the ways in which an instrument may be discharged? Discharge from liability on an instrument
can come from payment, cancellation, or material alteration. Discharge can also occur if a party reacquires an
instrument, if a holder impairs another party’s right of recourse, or if a holder surrenders collateral without consent.
whole or in part.
ADDITIONAL BACKGROUND—
Does the Notice Required by the FTC Rule Make a Note Conditional?
The FTC Rule makes it impossible for there to be an HDC of a consumer credit note. Under unrevised
Article 3, the rule may also have had the effect of making the note conditional. Revised Article 3 provides,
however, that such a required statement does not make a note conditional [UCC 3–106(d)]. There cannot be
a holder in due course of the note, but the note has the benefits of other revised Article 3 rules [UCC 3–
302(g)].
UCC 3–106(d) applies only if such a statement is required by statutory or administrative law. Comment 3
to UCC 3–106(d) explains, “The prime example is the Federal Trade Commission Rule (16 C.F.R. Part 433) .
. . . Subsection (d) is designed to make it possible to preclude the possibility of a holder in due course without
excluding the instrument from Article 3. Most of the provisions of Article 3 are not affected by the holder-in-
due-course doctrine and there is no reason why Article 3 should not apply to a note bearing the FTC legend if
holder-in-due-course rights are not involved.”
Is the result different if the phrasing of a legend or statement is different from that stated in UCC
3–106(d)? No. Comment 3 states, “No particular form of legend or statement is required by subsection (d).
The form of a particular legend or statement may be determined by the other statute or administrative law. For
example, the FTC legend required in a note taken by a seller in a consumer sale of goods or services is
tailored to that particular transaction and therefore uses language that is somewhat different from that stated
in subsection (d), but the difference in expression does not affect the essential similarity of the message
conveyed.”
IV. Discharge
A. DISCHARGE BY PAYMENT OR TENDER OF PAYMENT
All parties to an instrument are discharged when the party primarily liable on it pays to a holder the
amount due in full [UCC 3–602, 3–603]. Payment by any other party discharges only that party and
subsequent parties.
payment offered to a person entitled to enforce the instrument and the tender is refused.
B. DISCHARGE BY CANCELLATION OR SURRENDER
With the intent to cancel, a holder can discharge any party by cancellation [UCC 3–604]. Sufficient acts
include—
whole or in part.
whole or in part.
CHAPTER 14: LIABILITY, DEFENSES, AND DISCHARGE 15
CHECKLIST FOR THE PURCHASE OF NEGOTIABLE INSTRUMENTS
1. Make sure that a demand instrument is not overdue before purchasing it.
2. Make sure that the negotiable instrument has no obvious defects—look for indications that the maker or
drawer of the instrument might have a valid reason for refusing to pay.
TEACHING SUGGESTIONS
1. Because agency relationships permeate commercial law, ask the class to discuss some of the ways in
which agency relationships may be created and destroyed. How can an agent avoid incurring personal
liability while acting on behalf of his principal, especially if the principal is either unknown or insists
on remaining anonymous? Conversely, a principal will not wish to allow his agent to act on his behalf as the
agent sees fit; instead the principal will want to limit his agent’s authority to a particular area of activity. What
can the principal do to protect himself from liability arising from unauthorized acts of his agent?
2. To help keep the material in this chapter understandable to the majority of your students, emphasize only
those points that you think are most important for them to know and remember—the points that you will test
them on or the points that those who will take the CPA examination will need to remember for that test.
Cyberlaw Link
What effect might the existence of banking on the Internet have on the legal principles discussed
in this chapter?
DISCUSSION QUESTIONS
2. Must a party sign his or her name in full in order to be bound by the terms of a negotiable instrument?
No. The UCC defines a signature as “any name, including a trade or assumed name”, or “a word, mark, or symbol
executed or adopted by a person with the present intention to authenticate a writing” [UCC 1–209(39); UCC 3–
401(b)]. A signature can be handwritten, typed, or printed; it also can be made by mark, by thumbprint, by machine, or
16 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
4. When is an instrument dishonored? An instrument is dishonored when presentment is properly made and
acceptance or payment is refused or cannot be obtained within the prescribed time, or when presentment is excused
and the instrument is not properly accepted or paid. To determine whether an instrument is properly payable, payment
can be postponed without dishonor after an established cut-off hour (not earlier than 2 P.M.), but not beyond the close
principal alone will liable. If the agent signed his or her name alone without also indicating the name of the principal,
by contrast, then the agent—but not the principal—will be liable.
6. When may a person whose forged signature appears on a negotiable instrument be liable on that in-
strument? In general, a person is not normally liable to pay on a negotiable instrument in which his signature has
name.
7. Who assumes the burden of loss when there is a forged or unauthorized indorsement? In general, the
burden of loss falls on the first party to take the forged indorsement because a forged indorsement does not transfer
title. (Consequently, the party taking an instrument with a forged indorsement cannot become a holder.) The loss
words or numbers, or making any other change in an unauthorized manner that relates to the obligation of a party
[UCC 3–407(a)]. Material alteration is a complete defense to an ordinary holder but only a partial defense at best
against an HDC.
9. What are the ways in which an instrument may be discharged? Discharge from liability on an instrument
can come from payment, cancellation, or material alteration. Discharge can also occur if a party reacquires an
instrument, if a holder impairs another party’s right of recourse, or if a holder surrenders collateral without consent.
