978-1285860381 Chapter 26 Solution Manual Part 2

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Negligence

You Be the Judge: Gulf States Section, PGA, Inc. v. Whitney National

Bank of New Orleans1

Facts: Adrenetti Collins was a secretary who worked in the PGA office. During a four-month period,

she forged 18 PGA checks totaling $22,699.81. To avoid detection, she intercepted two of the bank

statements sent by Whitney National Bank and replaced them with forged statements that left out the

numbers of the checks she had stolen. The usual Whitney statement was printed on vanilla-colored

paper measuring a non-standard 6 ¾  11 inches. The forged statements were on standard 8½  11

inch white paper. They were not dated but they did contain the Whitney logo. Collins’s boss, Robert

Brown, received two forged statements and then no statements at all for two months.

Whitney’s policy was to verify signatures on checks equal to or greater than $5,000. One of the

forged checks was in the amount of $5,000, but Whitney did not verify Brown’s signature before

paying it. Brown’s signature was a semi-legible letter or two and a long loop. The forged signature on

the check looked very similar to the real one.

Issue: Is Whitney liable to the PGA for the forged checks it paid?

Holding: Judgment for Whitney. The court held that Brown was negligent and that his negligence

substantially contributed to the forgeries. Furthermore, there was no evidence that Whitney had

violated reasonable commercial standards. Other Louisiana banks, for example, only verify checks for

more than $10,000 or even $20,000. Also, the forged signature was so similar to Brown’s real

signature that, even if it had been verified, the forgery would probably not have been detected.

Question: Aren’t banks liable if they pay forged checks?

Question: Was the PGA negligent in this case?

Answer: The court held that it was. The blank checks should have been locked up and Brown

Question: Wasn’t the bank negligent, too? After all, it violated its own policy by cashing a $5,000

check without verifying the signature.

Answer: There is no rule that banks must verify checks over a certain amount. Indeed, a number

Question: Who would be liable if both the PGA and the bank were negligent?

Crimes

It is beyond the scope of this chapter to catalog all of the crimes that can be committed with negotiable

instruments, but students should be aware of these.

Bouncing a Check

It is illegal to write a check on an account that has insufficient funds. Generally, no serious penalties

are imposed if sufficient funds are immediately deposited.

Check Kiting

Check kiting means moving funds between bank accounts to take advantage of the float. It is possible

because banks start paying interest before deposits clear. But it is illegal.

1 689 So. 2d 638, 1997 La. App. LEXIS 167 Court of Appeal of Louisiana, Fourth Circuit, 1997

Forgery

It is illegal to forge an instrument or to pass on (utter) an instrument that one knows to be forged.

Discharge

Discharge means that liability on an instrument terminates. Article 3 establishes five different ways to

discharge an instrument:

By payment

By agreement

By cancellation

By certification

By alteration

Case: Manley v. Wachovia Small Bus. Capital2

Facts: File this case under:

What parents will do for their children (whether or not they should).

Wachovia Bank loaned Daniel Manley $420,000 and, in return, he gave the bank a promissory note in

that amount. His father, Thomas, guaranteed payment of the note. Seven years later, Daniel stopped

making payments, so Wachovia sent him a default notice. When he did not resume payments, the

bank filed suit to collect the money owed.

At trial, Thomas testified that, shortly after Daniel received his first default notice, he had taken

$375,000 in $100 bills to Wachovia as a payment on the note. Thomas further testified that he had asked

for a receipt from the bank em

ployee to whom he had given the cash but the employee had told him

that a receipt would be mailed to him after the cash was counted. Thomas

never got a receipt but,

three months later, Daniel received the original note in the mail. It was in a Wachovia envelope and had

been stamped “Paid.”

Wachovia employees testified they had no record of a $375,000 cash payment and that the note had

never been paid. Nor could they find the original note. They had no idea who had marked the note paid,

or how Daniel had possession of it.

The jury did not believe Thomas .It found both Daniel and Thomas liable on the note .The father and

son appealed. They argued that, because Wachovia had marked the note “paid,” it had been

discharged and they were no longer liable on it.

Issues: Was the note discharged? Were the Manley men liable on it?

Excerpts from Justice Moseley’s Decision:3

The Manleys rely on [Section 3.604 of the UCC], which provides that the person entitled to enforce the

instrument may discharge the obligation by an intentional voluntary act. The Manleys contend

Wachovia’s acts of stamping the original note “paid and sending it to Daniel were intentional and

voluntary and are conclusive evidence that Wachovia discharged the note. [T]hey assert that only the act

(stamping and returning the note) must be intentional and voluntary, not the result (discharge of the

obligation). We disagree.

Discharge requires the intent to render the instrument ineffective as a legal obligation. This intent

requirement has led courts

to conclude that mistakenly marking a note “paid (or the

equivalent) will

not discharge the debt.

There is evidence that although the note was stamped paid

, it had not, in fact, been paid and amounts

remained due and owing at the time of

trial. There is also evidence Wachovia’s normal procedures

following the payment of a note were not fol

lowed in this case, and [an employee] testified that it was

a mistake for Daniel to receive the note. This, along with other evidence in the record, is some

evidence that the surrender of the note and stamping it paid were the result of a mistake and not

intentional or voluntary.

2 349 S.W.3d 233 Court of Appeals of Texas, 2011

3 For ease of reading the opinion, we have substituted “the Manleys” for “Appellants.”

[W]e conclude the mere fact Daniel received the original

note in a Wachovia envelope with “paid

stamped on it does not conclusively prove that Wachovia, by an intentional voluntary act, discharged

Daniel’s obligation on the note.

Question: What does “discharge” mean?

Question: According to the court, what is the intent requirement of discharge?

Example

Joe and Roberta borrowed money from her father, Howard, and signed two promissory notes. While

Howard was near death in the hospital, his wife Evelyn (who was Roberta’s stepmother) found the

notes. Howard asked Joe to retrieve the notes so that he (Howard) could discharge them. Evelyn

refused to give the notes to Joe and, instead, added her name as a payee. Howard died without

discharging the notes.

Question: Are Joe and Roberta liable to Evelyn on the notes?

Multiple Choice Questions

1. CPA QUESTION A check has the following indorsements on the back:

Paul Frank

without recourse

George Hopkins

payment guaranteed

Ann Quarry

Collection guaranteed

Rachel Ott

Which of the following conditions occurring subsequent to the indorsements would discharge all of

the indorsers?

(a) Lack of notice of dishonor

(b) Late presentment

(d) Certification of check

2. CPA QUESTION Which of the following actions does not discharge a prior party to a

commercial instrument?

(a) Good faith payment or satisfaction of the instrument

(b) Cancellation of that prior party’s indorsement

(d) The holder’s intentional destruction of the instrument

3. What is the difference between a co-maker and an accommodation party?

(a) A co-maker is liable both to the holder and the other co-maker, an accommodation party is

liable only to the holder

(b) A co-maker is liable to subsequent indorsers, an accommodation party is not

holder

(d) A co-maker is not liable once a bank certifies a check, an accommodation party is still liable

even after certification.

4. Karim writes a check to Lew but Karim’s bank accidently refuses to pay the check, despite the fact

that Karim’s account has sufficient funds. As a result, Lew bounces many checks from his own

account and has to pay substantial fees to his bank. Which of the following statements is true?

(a) Lew can recover damages from both Karim and Karim’s bank.

(b) Lew can recover damages only from Karim.

(d) Lew cannot recover any damages.

5. Nan forges Mina’s name on a check to buy a television set from Costmart. The store deposits that

check into its account at Bank, but Bank does not credit Costmart’s account for the amount of the

check. From whom can Costmart recover?

(a) Nan

(b) Mina

(d) All of the above

Case Questions

1. One of Doris’s job responsibilities at Winkie, Inc .was preparing company checks for the

president, Willie, to sign. Using Winkie’s check-signing machine, Doris forged $150,000 of checks

on her employer’s account. Willie did not (1) look at the sequence of check numbers, (2) examine

the monthly account statements, or (3) reconcile company records with bank statements. Winkie’s

bank, as a matter of policy, did not check indorsements on checks with a face value of less than

$1,000. By accident, it paid a forged check that had not even been indorsed. Is the bank liable to

Winkie, Inc., for the forged checks?

Answer: The court found for the bank on the grounds that the owner of the company had been

2. Before Parris’s lawsuit against Railroad had settled, he left town and closed out his account with

Bank. Railroad then issued a check to him which somehow came to be in Eddy’s possession. Eddy

indorsed the check “Railroad Eddy” and deposited it in his own account at Bank. Parris sued Bank,

alleging that it was liable to him for having paid the check over an unauthorized indorsement. Is

Bank liable to Parris? On what theory?

Answer: An unauthorized indorsement is the same as a forged indorsement. The court held that

3. You Be the Judge: WRITING PROBLEM Melco, Inc., issued a promissory note

for $12,000, payable to the order of Marjorie. On the back of the note, Charles had signed the

following statement: “For and in consideration of funds advanced herein to Melco, Inc., we

irrevocably guarantee Marjorie against loss by reason of non-payment of this note.” After the

instrument was overdue, Marjorie sued Charles to enforce the note before demanding payment

from the issuer. Is Charles liable on the note before demand is made on the issuer? Argument for

Marjorie: Charles was an accommodation party and, as such, was liable on the instrument even if

no demand had been made on the issuer. Argument for Charles: If the accommodation party

writes, “I guarantee collection,” he is not liable until the issuer fails to pay. In this case, the words

Charles wrote are the equivalent of “I guarantee collection.” Marjorie’s response: To avoid liability

in this case, Charles had to comply with the exact requirements of the statute. How was she to

know that he thought he was writing the equivalent of “I guarantee collection”?

Answer: An accommodation party is liable on an instrument even if the issuer has not defaulted,

4. Arnold and Palmer signed two promissory notes for a total of $25,000 payable to the Banking Co.

The two men argued that they were not liable on the notes because they had signed as agents for

Sunshine Sales. The notes made no reference to Sunshine, but the men alleged that an officer at

Banking had promised to type “Sunshine Sales Corporation” above their signatures on the notes.

Are the men liable on the notes?

Answer: To avoid personal liability, the two men were required to give the name of the principal

5. Merlyn borrowed money from Finance Co. to buy equipment for his farm. He promised Finance

that he would accept payment for his crops only with checks that named him and Finance as

co-payees. This way, Merlyn could not cash the checks without Finance’s indorsement. Merlyn

sold corn to Farmer’s Co-op, which paid by check made out to “Merlyn, Finance Co.” When

Merlyn deposited this check, the comma between Merlyn and Finance appeared as “or.” Only

Merlyn had indorsed the check. When Finance sued Bank for having paid this check, Bank in turn,

filed suit against Merlyn demanding indemnification for Finance’s claims. What claim did Bank

make against Merlyn?

Discussion Questions

1. Recall the Quimby case. This type of fraud is increasingly common. What could Quimby have done

to protect himself?

Answer: When dealing with strangers, only accept cashier’s checks. In this case, Quimby obtained

2. Regions Bank refused to lend money to ZLM, Inc. unless its owner, Stewart, signed the note as an

accommodation party. He did, and, sadly, ZLM did not repay the loan. But because the note was

due on February 16, which that year happened to be Mardi Gras Day (a major festival in

Louisiana), the bank waited until the next day to declare the note in default. Stewart alleged that he

was not liable on the note because the extension had discharged his liability. Do you agree?

3. ETHICS When Steven was killed in an automobile accident, he left his wife, Debra a life

insurance policy for $60,000. She decided to move from Bunkie to Sulphur, Louisiana. Debra

executed a document authorizing her mother-in-law, Helen, to sign checks on Debra’s account at

the bank. Debra also signed several blank checks and gave them to Helen with instructions to use

them to pay off the remaining debt on Debra’s trailer. When Helen received the life insurance

checks, she deposited them in Debra’s account. So far so good. But then she immediately withdrew

$50,000 from the account by using one of the blank checks Debra had left her. She did not use these

funds to pay off the trailer debt. When Debra discovered the theft, she sued the bank for having

paid an unauthorized check. How would you rule in this case? Debra has suffered a grievous loss—

her husband died tragically in an automobile accident. She trusted her mother-in-law and counted

on her help. Should the bank show compassion? If the bank made good on the forged checks, how

great would be the injury to the bank’s shareholders compared with the harm to Debra if she loses

this entire sum?

Answer: The court held that Debra had been negligent in leaving blank checks with her

4. Banks are liable for forged checks except in the case of the three rules (Imposter Rule, Fictitious

Payee Rule, and the Employee Indorsement Rule). Do you think this is the proper allocation of

liability? Why should banks be liable for forged checks, in this era of automated check machines?

Alternatively, could you argue that the three rules provide too much protection to banks?

5. Many accommodation parties and guarantors do not understand their liability when they sign an

instrument. (As the saying goes, “Nothing is more dangerous than a fool with a pen.”) Should the

UCC require that some sort of disclosure be made to an accommodation party or guarantor before

they sign, or that their obligations be clearly spelled out? What language would you require for a

guaranty to be valid?