chapter 26: liability, defenses and discharge

©2001 West Legal Studies in Business. All Rights Reserved.1

Chapter 26: Chapter 26: Liability, Defenses Liability, Defenses

and Dischargeand Discharge


LiabilityLiability

• There are two kinds of liability associated with negotiable instruments:– Signature liability.– Warranty Liability.


§1: §1: Signature LiabilitySignature Liability

• Relates to signatures on instruments.• Signers of negotiable instruments are

potentially liable for amount state on instrument.– Primary Liability: Makers/Accepters.– Secondary Liability: Drawers/Indorsers.


Signature Liability Signature Liability [2][2]

• Proper Presentment.– Must be timely (checks w/in 30 days).

• Dishonor.• Proper Notice.• Accommodation Parties: Signs instrument to

lend name as credit to another party on the instrument.

• Case 26.1: Quality Wash Group v. Shawkat Hallak (1996).



• Authorized Agent’s Signature.– To hold Principal liable agent must be authorize

to sign and Principal must be clearly named.– Agent personally liable when Principal is not

named or disclosed, unless check is drawn on Principal’s account.



• Unauthorized Signatures.– Forgery does not bind owner but Bank is liable.– If Agent has no authority, Agent is personally

liable, but Principal is not, unless ratified.



• Unauthorized indorsement does not bind maker/drawer except:– “Imposter Rule”: imposter induces

maker/drawer to issue check to imposter.– When imposter signs as/on behalf of

maker/drawer intending payee has no interest in the instrument.


§2: §2: Warranty LiabilityWarranty Liability

• Extends to both signers and non-signers.• Breach of warranty can occur when the

instrument is transferred or presented for payment.


Warranty LiabilityWarranty Liability

• Transferors make certain implied warranties regarding instruments they negotiate.

• Liability not subject to dishonor, presentment, notice.

• Liabilities: Transfer or Presentment.


Transfer WarrantiesTransfer Warranties

• Following transfer warranties extend to all subsequent holders:– Transferor is entitled to enforce the instrument.– Signatures are authentic and authorized.– Instrument has not been altered.– Instrument not subject to defense.– Transferor has no notice of insolvency.


Presentment WarrantiesPresentment Warranties

• Person who presents an instrument makes the following presentment warranties:– No missing or unauthorized indorsement.– Instrument has not been altered.– Person obtaining payment has no knowledge

signature is unauthorized.• Case 26.2: First National Bank v.

MidAmerica Federal Savings (1999).


§3: §3: DefensesDefenses

• Universal or Real - can be used to defeat a holder and a HDC.

• Personal - can be used to defeat a holder but not a HDC.


Universal DefensesUniversal Defenses

• Forgery of maker’s or drawer’s signature.– Or if an authorized agent exceeds his authority

to the amount which exceeds his authority.• Fraud in the execution - the ”autograph”

situation, not fraud in the inducement.


Universal Defenses Universal Defenses [2][2]

• Material Alteration.– Do not have to pay the altered amount ($8 to

$800), only a personal defense to the original amount ($8).

– Not a real defense if instrument left blank, (.. filled in $800), then have to pay all ($800).

• Discharge in Bankruptcy.• Infancy (Minority).


Universal Defenses Universal Defenses [3][3]

• Illegality - severe enough to make contract void.

• Mental Incapacity (adjudicated by court).• Extreme Duress. If instrument signed under

threat of immediate force or violence.


Personal DefensesPersonal Defenses

• Valid against holders but not HDC’s.– Breach of contract or warranty.– Lack of consideration.– Fraud in the inducement.– Illegality - not severe enough to make void.

• Case 26.3: Kedzie & 103rd St. Currency Exchange v. Hodge (1993).


Personal Defenses Personal Defenses [2][2]

• Mental incapacity - not severe enough to make void.

• Discharge.– By payment or cancellation.– Unauthorized completion.– Non-delivery of instrument.– Ordinary duress or undue influence rendering

contract voidable.


Federal Limits on HDC RightsFederal Limits on HDC Rights

• FTC Rule 433 (1976) abolished the HDC doctrine in consumer credit transactions.– Allows Buyer to assert any defense she might

have against the Seller of goods or services (Car Dealer), against the subsequent HDC (Bank) as well.

– So Buyer’s duty to pay is conditional on Seller’s full performance under contract.


§4: §4: Discharge from LiabilityDischarge from Liability

• Discharge from liability on an instrument can occur by:– Payment.– Cancellation.– Material Alteration.


Discharge by PaymentDischarge by Payment

• All parties to an instrument will be discharged when the party primarily liable on the instrument pays to the holder the amount due in full.


Discharge by CancellationDischarge by Cancellation

• Intentional cancellation of an instrument discharges the liability of all parties.– Examples: Intentionally writing “paid” on the

front of an instrument, or tearing it up or mutilating it, cancels the instrument.


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• Legal Research Exercises on the Web.

chapter 26: liability, defenses and discharge

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