I. Liability vis-à-vis Notes: Suretyship Outlinea. Generally

i. Definition: 1. Contract where one assumes the debt of another2. Anomalous endorser is surety!

ii. Cast of characters1. Debtor / principal – the person who has the debt.2. Creditor – the person to whom the debt is owed3. Surety / Obligor – the person who assumes the debt of the debtor

iii. Distinguish between:1. All of these are suretys in the general sense; the way to distinguish

between them is to look to the manifest intent. There was a long hypo for this – basically, we give the parties what they want, not necessarily what they say.

2. Specific surety: a. Primary obligor who signs in lower right hand corner as an

accommodation makerb. As soon as the debt is owing, the creditor can go against the

surety or the other party. c. Primary liabilityd. Ex: Parent signing for minor

3. Guarantor: a. Secondary obligor who signs on back as an accommodation

endorser, thereby forming a contract of guaranteeb. Subject to liability only if primary obligor will not payc. Secondary liability

4. Guarantor of Collectibility: a. Signs on face or back of the instrument, but specifies “I am

guaranteeing collection only” or something similarb. Subject to liability if sue debtor and cannot collect c. Secondary liability +

5. Preferred kindsa. The creditor will always want a strict surety b/c then he

basically has two people he can collect from.b. The surety always wants to be a guarantor of collectibility

b. Statute of Frauds and suretyshipi. Rule

1. Suretyships are subject to the statute of frauds and therefore must be in writing. All promises to backstop the debt of another must be in writing.

2. Even if less than $500 – still in SOF as under the suretyship provision

ii. Exception: Main Purpose Rule1. If main purpose of the promise is to benefit the surety instead of

the debtor, then oral promises are enforceable

a. Policy – if you made the promise to benefit yourself, then you probably really made the promise.

b. Ex: Contractor calls you, wants to buy materials on credit, and the material man says credit too thin. Call the creditor and say that you will backstop. Binding b/c the main purpose is to get the building built, not to help out the debtor.

c. Creation of a suretyshipi. By Contract … consideration

1. B/c a suretyship is a contract, there must be consideration.2. Compensated Surety

a. Consideration = Moneyb. Actually paid to be surety

3. Gratuitous Surety a. Surety does it out of love and affection for the debtor. b. Need to look at a few things to determine if a Gratuitous

Surety will be bound. i. Current Surety = surety at the same time.

1. If all promises were made at the same, then the consideration is whatever was bought.

2. Dad signs as surety for son for car. Car is the consideration and thus, the surety is bound.

ii. Noncurrent Surety = Promises were made at different times

1. If surety on a negotiable instrument, code says no consideration necessary, bound in the capacity signed (front as a maker, back as an endorser)

2. If surety on a nonnegotiable instrument, no consideration then not bound.

4. So who isn’t bound? A non-negotiable, non-current, gratuitous surety. Everyone else is bound.

ii. By operation of law1. Constructive suretyship2. 3rd party contracts with a debtor and no novation (substitute party),

debtor becomes a surety by operation of law3. Spak signs promissory note for mortgage. Spak sells house to

another dude and this dude agrees to pay Spak’s house payments. Spak becomes a surety for the guy making the house payments. Might do this b/c when Spak got his mortgage, he locked in at 4%, and now the bank would charge 7% interest.

d. Rights of a suretyi. Against creditor: Surety v. Creditor

1. No rights other than obligation to pay2. Notice

a. No right of notice of debtor default – Creditor does not have to inform surety of debtor default (this can be bad for surety if there is an acceleration clause).

3. Compel Collection – Can Surety compel creditor to go to debtor first?

a. Primary surety = no, maker i. Strict sureties cannot because they are primarily

liableb. Secondary surety = yes, only endorser

4. Application of the security held – Can the surety require that the item being held as security be sold before the creditor comes after him?

a. No – If there is security, the surety cannot require it to be sold.

b. Exception – Illinois Equity – Where the surety can show that it is crucial for the surety and the creditor can easily sell at a lost cost to him the security, may be able to require that the security held be sold.

5. Application of fundsa. If there is more than one debt between the debtor and the

creditor (but surety is only surety to one of the debts), the surety cannot require that any payment be applied against the back stopped debt.

b. Only the debtor can require this and if he is silent then it is up to the creditor. Creditor will always apply to non-backstopped debt

ii. Against debtor: Surety v. Debtor 1. Right to exoneration

a. Suit to compel payment: Surety v. Debtor saying pay the debt before the debtor comes to me. Don’t have to do anything first – does not have to pay a dime! The creditor does not have to wait for the suit to end – so may have to pay before suit is over.

b. Right triggered by relationship2. Right to subrogation

a. When surety has paid in full, he takes the place of the creditor and has all the rights the creditor had toward the debtor. Steps into shoes of creditor

b. Derived right from full satisfaction; triggered by full payment of debt

3. Right to reimbursement/indemnification a. Surety pays any part of the debt—he is entitled to get it

back from the debtor. Must pay something first.b. Right triggered by payment

iii. Against co-surety: Surety v. Surety 1. Co-surety generally

a. One who does not want the whole risk so they make contracts with other to determine the liability

b. Makers are jointly and severally liable for the entire debt2. Right to exoneration

a. Suit to compel payment of fair share … Surety can sue co-surety to require payment of his share

b. The instrument will specify what each surety’s share is – if it is silent, then a court will assume there was supposed to be an equal share.

3. Right to subrogationa. Triggered by payment of the full amount … step into the

shoes of the creditor and has same rights against co-surety as the creditor would

b. As such, may be able to collect entire debt from a co-surety4. Right to contribution

a. If pay more than fair share, right to get that amount back. b. Triggered by payment of more than fair share

5. Case: Pace v. Pace – a. Promissory note, 16K, payable to Cheek. b. Three co-makers

i. Talbot – debtorii. Pace 1 – surety

iii. Pace 2 – suretyc. Cheek could get 16K from any of them, as co-makers. d. Does Cheek know that the two Paces are sureties? Yes –

he insisted on it. Subsequent holders might not know that.e. Bankruptcy – by Talbot. 100% bankrupt. Cheek wants to

collect. If he goes to Talbot, dead and nothing from estate. Pace 1 is dead and paying 50 cents on the dollar. So he collects 16K from Pace 2.

f. So what can Pace 2 do?i. Against Talbot – nothing b/c he’s VERY dead and

broke.ii. Brother’s estate – co-surety.

1. Exoneration – Pony up 8K, estate is paying ½, so this is worth 4K.

2. Contribution – Pony up your fair share. Worth 4K

3. Subrogation – Since I satisfied the debt in full, Talbot could have sued bro for 16K, and will collect 8K!

e. Defenses of Surety: Debtor Defensesi. The surety can use the any of the debtor’s defenses where

1. the debt was illegitimate and 2. the creditor had unclean hands.

ii. Surety cannot use the following defenses of the debtor:

1. infancy2. insanity3. bankruptcy4. Surety may use these defenses if he himself is infant, insane, or

bankrupt.f. Variation of risk: Any change made without the sureties consent

i. Compensated or Art. 3 Surety1. Discharged pro tanto, extent surety can show a loss as a result of

the changeii. Noncompensated surety

1. If surety was not compensated for being surety, then he is totally discharged from any obligation.

2. Change thus requires gratuitous surety’s consent.iii. Types of Variation of Risk

1. Modification of Ka. Debtor and creditor make K to build a building for 10M.

There is a surety. What is the effect on the surety if D and C decide to change the K – check shack instead of 10 story building?

2. Extension of time: a. D and C K that payments will be made on the first. What is

the effect on S if you wait one month, then five months, and D goes bankrupt!

3. Release of Securitya. Creditor holds 50 shares of IBM stock, but agrees to take

them back b/c there is now a surety.4. Release of a co-surity

a. Creditor decides not to hold one of three co-sureties5. Non-filing under Article 9

II. Agency Problems:a. Generally:

i. Where agent signs a commercial paper on behalf of a principalii. An agent is not bound if he:

1. SIGNS (his own name) and2. indicates on the paper:

a. the party represented b. and his representative capacity

iii. CHECK rule: Agent is not bound if he1. SIGNS (his own name) and2. indicates the party represented (should be on check)3. The representative capacity is not necessary – check by law shows

representative capacityiv. Agent is bound if he:

1. SIGNS (his own name) and2. DOES NOT indicate

a. The party represented OR

b. His representative capacityv. Principle is ALWAYS bound

b. Power of Attyi. General power of attorney allows agent to make almost any contract that

principal could make with four exceptions:1. Joining the military2. Marriage by proxy3. Making a will4. Voting in an election

ii. Specific power of attorney only gives agent specific authorityc. Application

i. Possible outcomes1. Principal bound2. Agent bound3. Both bound 4. Neither Bound

ii. Scenarios1. Agent signs principals name

a. Principal boundb. Agent did not sign his own name.c. If, however, the agent wrote down the principal’s name b/c

he looks like the principal (ie forgery), the principal is not bound.

i. Forgery rule: A forged instrument is totally effective as to the forger, but totally ineffective as to the forged.

2. Agent signs agent’s namea. Both boundb. Agent is bound b/c he did not indicate the party represented

and his representative capacity3. Agent signs principals name, principal and “by” own name, agent

a. Principal bound4. Agent signs own name, identifying agent status but not the party

representeda. Both bound

5. Agent signs principals name and agents namea. Both bound

6. Agent signs and notes representative capacity and the party represented

a. Principal boundb. Hypo: Signs for principal, signs for self, “treasurer”.

Agent is most likely not bound, b/c the capacity is “treasurer.” However, there is an argument that the “treasurer” is a description and not an indication of representative capacity.

7. Agent signs without noted representative capacity

a. Both bound8. Agent signs without noting representative capacity on a check

a. Principal bound … b. representative capacity unnecessary on a check – therefore

agent is not bound

III. Indorsements—Holder v. Indorsora. Definition

i. Signature other than that of the maker, drawer, or acceptor1. Usually on the back, b/c makers, drawers, and acceptors usually

sign on the front.ii. Acceptor is the drawee who has agreed to pay the instrument

iii. Four purposes of an indorsement:1. Negotiating the instrument (special v. blank)2. Restricting payment of the instrument (restrictive)3. Incurring indorser’s liability (unqualified)4. Show suretyship

iv. Allonge: a piece of paper may be attached and considered part of the instrument as long as it is attached firmly.

b. Indorser Liabilityi. Generally

1. Contract of secondary liabilityii. Requires (before liability)

1. Presentment : Holder must go to the primary party (maker/drawee) and demand payment

2. Dishonor : Primary party refuses payment3. Notice of dishonor : Holder tells the secondary party

c. Types of indorsementsi. Special v. Blank

1. Special specifies the person or agency to whom it is further payable.

a. If special = order paper2. blank does not specify (can be cashed by anyone!)

a. If blank = bearer paper3. Ex: Dan Drawer draws a check payable to the order of Paula Payee

and gives it to her, which makes Paula a “holder.” Paula wishes to negotiate the check to her mother, Flora Flowers, so she indorses it “Pay to Flora Flowers, /s/ Paula Payee.” This special indorsement means that Flora alone (upon obtaining possession) is the only possible “holder” of the check. No one after Flora can qualify as a holder w/o Flora’s valid indorsement.

4. Ex: John Smith has a check in his possession made payable “to the order of cash.” The back of the check is as follows:

Pay John Smith/s/ Rudy

This check was bearer paper when drawn since it was payable to cash. Rudy Ochoa turned it into order paper by putting the special indorsement (“Pay John Smith”) on it. Thus the check can be negotiated further only if it is indorsed by John Smith and delivered.

ii. Qualified v. Unqualified 1. Qualified says “w/o recourse” thereby negating the contract of

secondary liability. Disclaiming liabilitya. Can still be liability under warranty theory, but not under

contract theory2. Unqualified does not say “without recourse”

iii. Restrictive v. Unrestrictive1. Any other language added to an indorsement creates a restrcitve

indorsement.2. One of four types:

a. Purports to prohibit further negotiation: “Pay X only”i. Does not in fact prevent further transfer or

negotiation of the instrumentii. Ex: Check indorsed “pay Pete Payee only,” Pete

can indorse and further negotiate.b. For deposit only

i. Ex: Pete Payee received his paycheck at work. He indorsed it “Pete Payee for Deposit,” since he was planning to go to the bank right after work. When he left he was pick-pocketed by Hot Harry who took it to a betting parlor and lost it. The betting facility took it to its bank, Gamblers National who credited the parlor’s account and forwarded the check to Employer’s National, the bank on which the check was drawn. The Parlor and Gambler’s National are liable for converting the check.

c. Trust restrictive: “To X for the benefit of Y”d. Conditional Restrictive: “Pay X only if they deliver food in

satisfactory manneriv. Anomalous v. Nonanomalous

1. Generallya. Accommodation endorser on the back = suretyb. Signature between two essential circles in the chain, out of

chain endorsements. 2. Result

a. Surety has right of recourse against accommodated party

3. Example: The face of the instrument says it is payable to Peter Payee. On the back on the instrument the indorsement chain says pay A, Peter Payee, Pay B, A, Pay C, B. We expect to see C’s indorsement, but instead there is one by X on the back of the check. Then there is an indorsement by C. The indorsement by X is out of the chain. This is anomalous. This identifies suretyships. This is because the code says all accommodation parties are sureties and they are liable in the capacity that they signed.

4. Example: Max wants to buy a car from Peter. Peter Payee says to Max, “I found out that you are only 17, an infant in this state. Get your Dad to sign the note with you, I don’t like to sell cars to infants because they can disaffirm. If Dad signs as a Maker under Peter’s (the son) signature, the Dad is a co-maker. This means that the Payee or the holder can go against Peter or his Dad. Another way that Dad could sign is on the back of the instrument, this would make him an accommodation Indorser, liable secondarily, as an indorser.

a.d. Warranties v. Contracts in Negotiable Instruments

Warranties ContractsTypes Transfer:

Title Signatures Genuine No alterations No defenses No knowledge of

insolvencyPresentment

Right to Enforce Sigs Genuine

Contract of MakerContract of IndorserContract of DrawerContract of Acceptor

When Made At either transfer or presentment (see above)Never made at issuance

Made when the contract is signed

Who Makes Anyone who transfers for consideration

Maker, drawer, indorser, acceptor

Are signatures necessary? No YesIs consideration necessary Yes No – liable in the capacity

signed regardlessTo Whom there is liability If transfer by an indorsement,

then the warranty protection extends to all subsequent transferees. If transfer with no indorsement, then warranty protection only to the

All subsequent holders.

immediate transfereePermissibility of disclaimers Yes, can disclaim except for

checksYes

Damages for breach Actual loss, but not more than face value

Face value

Condition precedent No, except for check Yes, contracts of secondary liability, therefore require presentment, dishonor, notice within 30 days

i. Warranties Made and Contracts Made1. Warranties of Transfer (Do not need to sign to make these

warranties – just have to transfer for consideration)a. Warranty of title: Person warrants that he has title to the

instrumentb. All signatures are genuine: Warrants that all signatures on

the instrument are genuinec. No alterations: Warrants there have been no alterations

made to the instrumentd. No defenses vs. warr’or: Warrants that there are no

defenses.e. No knowledge of insolvency: Just warrants that indorser

doesn’t have any knowledge of insolvency. There still may be insolvency.

2. Contractsa. Contract of a Maker 3-412 – liable to pay (primarily liable)b. Contract of an endorser 3-415 – conditionally liablec. Contract of a drawer 3-414 – secondarily liabled. Contract of an acceptor 3-413 – primarily liable

ii. When warranties and contracts are made1. Warranties

a. At issuance i. No protection

b. Upon transfer (movement for consideration even if lacking signature)

i. Right to enforceii. Signature genuine

iii. No alterationiv. No defensesv. No knowledge of insolvency by transferor

c. Upon presentment (final surrender)i. Right to enforce

ii. NO warranty of genuine signatures2. Contracts

a. Made when the contract is signediii. Who makes warranties and contracts

1. Warrantiesa. A person who transfers for consideration

2. Contractsa. Maker, drawer, endorser, acceptor

iv. Signatures necessary for 1. Warranties

a. No, only transfers for consideration2. Contracts

a. Yesv. Is consideration or value necessary

1. Warrantiesa. Yes, requires consideration

2. Contractsa. No, liable in the capacity signed regardless of consideration

vi. To whom is there liability1. Warranty

a. If transfer by an endorsement then the warranty protection extends to all subsequent transferees

b. If transfer with no endorsement then the warranty protection only applies to the immediate transferee

2. Contractsa. All subsequent holders, can hold all makers and all

endorsersvii. Permissibility of disclaimers

1. Warrantya. Yes, except checks

2. Contracta. Yes

viii. Damages for breach1. Warranty

a. Actual loss but not more than the face value2. Contracts

a. Face valuei. Condition Precedent

1. Warrantya. No, except for checks

2. Contractsa. Yes, … contracts of secondary liability therefore require

presentment, dishonor, and notice within 30 days.b. Yes – endorser, drawer

i. 3-105(a): endorser1. presentment2. dishonor3. Notice of dishonor

ii. 414: Drawer1. Presentment

2. Dishonor3. Notice of Dishonor4. Pro-Tanto – must show suffer loss,

otherwise unjust enrichmenta. You did some work, you get a check.

1 for 1. If you draw a draft, you have given up nothing. Someone gives you something. To let you off the hook for no reason is unfair, b/c you got something for it.

3. Protest – for international drafts

Article 3 – Commercial Paper

Holder in Due Course Rule:- Negotiable Instrument 3-104- Negotiated 3-201- To a Holder in Due Course 3-302- Who takes free from personal defenses and claims subject only to real defenses 3-305

IV. Commercial Paper Generallya. Purposes

i. Serves as a substitute for cashii. Used for Credit

b. Typesi. Note—two party paper

1. Ex: a. Promissory note, b. CD (bank promising to repay holder), etc.

2. Definitiona. An instrument where a maker promises to pay a payeeb. Two parties – two roles – maker and payee. Could be more

than two parties, but there will always be these too parties.c. Certificate of Deposit = Where promise by bank to repay

3. Parties (roles)a. Maker—may be co-makersb. Payee—may multiple payees

4. Liability of Makera. Even if signed when blank, the maker is bound by the filled

in amountb. Primary liabilityc. If more than one than joint and several liability

i. Liability of comakers to each other is purely contractual but if they do not give percentages, presume equal

5. Statute of limitations: Six years

ii. Draft—three party paper1. Definition

a. An instrument where drawer orders a drawee to pay a payee.

b. Check = Payable on demand, drawn on bank, even if lacking the words of negotiability

2. Partiesa. Drawer -- Makerb. Drawee – Bank (usually)c. Payee – gets $$

3. Liability of drawera. Conditional/secondary – will only pay if the payee goes

through certain conditions. Requires presentment (to drawee) and if dishonored, then will pay for it.

4. Inconsistent words and numbersa. Can have just wordsb. Can have just numbersc. If different/inconsistent, the words prevail

5. Statute of limitations – 3 years

iii. Difference between Note and Draft1. Note is promise, draft is order to pay2. Only common party on both instruments is the payee.

a. Makers make notesb. Drawers draw drafts

c. Parties

I promise to pay to the order

Of _______Peter Payee___________

$100 ___Max Maker___

To: Drawee National Bank

tothe

Pay order _____Patricia PayeeOf One-Hundred --- Dollars $100

Donna Drawer

i. Makers—Primary party to a noteii. Drawers—Secondary party to a draft

iii. Indorsers—Can be parties to notes or drafts

V. The concept of negotiability: Negotiable Instrument—Holder v. Maker Step 1 – NO NOTES YET!!a. Negotiable instrument:

i. Definition1. Signed writing containing an unconditional promise or order to pay

a fixed amount of money to order or bearer on demand or at a definite time with no unauthorized promises

ii. If does not meet1. Article III does not apply and apply regular contract law.

b. Elementsi. Writing

1. Determined through tangibility2. Cannot be oral

a. Ex: Where person promises pope to pay $500 in front of 500 witnesses – not negotiable b/c not oral. May be enforceable under contract theory.

3. As long as it is in writing, it does not matter what it is written ona. Need not be on paper.

i. Ex: Someone sends in income tax payment with a check, drawn on the bank, written on a shirt. They will say here is the shirt off their back. This is a negotiable instrument – it is a writing b/c it is TANGIBLE.

ii. Signed by Maker/Drawer1. Can use any mark as signature that person is known for or has

adopted. So test is adoption – can be stamps, x’s, etc.a. Can be handwritten, typed, printed, made in any other

manner2. Only bound if the maker/drawer signed it or someone signed it

with their authorization.3. Agency Issues

a. See Infrab. Principal is liable if the agent is authorizedc. Agent is liable if signed without showing represented party

or representative capacity4. Forgery

a. Operative as to forger, not to party whose name is forged—totally ineffective as to name forged, totally effective as to name of forger

5. Burden of Establishing Signatures [§3-308(a)]

a. Where Δ’s pleadings do not raise issue: Unless specifically denied in the pleadings, each signature on an instrument is deemed admitted.

b. Where Δ raises issue in pleading: If the defendant or obligor raises an issue in the pleadings as the validity of any signature, the burden is on Π (as the party claiming under the signature) to prove that the signature is genuine.

c. Presumption of Validity: Π has rebuttable presumption that all signatures are genuineor authorized.

i. Exception – Death/Incompetence of Signer: where the signer has died or become incompetent, Π must prove genuineness w/o the presumption.

d. Effect: Δ must then produce evidence of forgery etc., or the plaintiff-holder will be entitled to recover.

iii. Unconditional1. Conditions: A negotiable instrument cannot have conditions.

a. No express conditions—cannot modify the act of payment b. Implied or constructive conditions acceptable

i. Implied – conductii. Constructive – from the law

iii. Ex: A promisory note stating that it is given as a down payment on a K to rent an apartment is not conditional merely b/c of the possibility that the building might burn down.

c. Note – conditions are just fine and dandy in contract law.i. Commercial paper is supposed to be a simple

substitute for money – therefore no conditions are permitted

d. Policy – purchaser needs to be able to tell what he is getting merely by looking at the instrument. Could not evaluate the worth of an instrument if the liability of its maker or drawer were conditioned upon an extraneous matter

2. Writing will not be deemed unconditional merely b/c it: a. Refers to another writing for a statement of rights

regarding collateral, prepayment, or acceleration.i. Ex: Statements that use “as per” or “accordance

with”ii. Ex: A promisory note stating that “this note arises

out of a K signed this date” is negotiableiii. Ex: A draft stating that it is “drawn under a letter of

credit.iv. Note: mere reference to another writing is irrelevant

to negotiability and rights of HDC’s (unless the HDC knows of the terms of the separate writing), but as b/t two parties the writing modifies or

controls terms of the instrument. However, watch out for parol evidence issues.

b. Gives descriptions of consideration or other transactions: A description of collateral or of other transactions connected with the instrument does not by itself, make the instrument conditional as to matters described.

i. Ex: A promisory note describing in detail the K that gave rise to the note (including all of the K terms) is negotiable as long as the promisory note is not made subject to the K (see below.)

c. Limits payment to a particular source or fundi. Ex: “I promise to pay out of funds from my next

wheat crop”d. Requires a countersignature as a condition to payment by

a person whose specimen signature appears on the promise or order.

i. Ex: This is normally done in travelers checks.iv. Promise or Order

1. A note must contain a promise to paya. Promise: A promise is a written undertaking to pay signed

by the person undertaking to pay.i. Ex: “I promise to pay…”

2. A draft must contain an order to paya. Order: An order is a written instruction to pay money

signed by the person giving the order.i. Ex: “Pay to the order of John Smith”

ii. “%” is shorthand for “order”v. To pay a fixed amount

1. Generallya. To be negotiable, the principal due under the instrument

must be fixed.b. Interest

i. Can be with or without interest1. Interest is irrelevant to whether the amount

is fixed or variableii. Can be a fixed or variable rate

1. Ex: “3% over prime, adjusted each six months based on the then prevailing bank rates in New York City” is negotiable.”

iii. Unspecified Interest Rate: The judgment rate (rate on a court judgment) will be applied where the instrument states “with interest” but does not say how much interest.

2. Examplesa. 6 or 7 is not a fixed amount

b. % ____________ is a fixed amountc. %_____________ or bearer is a fixed amount

vi. Of money1. Does not qualify:

a. Other considerationi. Woodcarvings

ii. Gold b. Payment in the alternative if alternative is other

consideration than moneyi. $400 or ounce of gold

2. Does qualifya. US gold b. Lire (foreign money is acceptable as long as gov’t

recognized by US)i. If amount if given in foreign money, can be paid in

its equivalent in US dollars at the current bank exchange rate at the time and place the instrument is paid – as long as the instrument doesn’t specify otherwise.

ii. Cuba is not recognized by USc. DM d. DM in Frankfurt (can domicile a note)e. Dollars in New York (can domicile a note)

i. Cannot domicile in two places.vii. To order or bearer

1. Two types of negotiable instruments2. Order Paper: names a specific payee. Order paper is payable

only to that person named or his order and requires the payee’s indorsement for further negotiation.

a. An instrument may be drawn to the order of: i. A payee or drawee who is not the maker.

1. Ex: “Pay to the order of John Smith”2. Ex: “Pay to the order of John Smith or his

order.”ii. The maker or drawer

1. Ex: The maker can write a check to herself (the obligor).

iii. To several payees jointly or severally1. Ex: “Pay to the order of X and Y”2. Ex: “Pay to the order of either X or Y”

iv. Partnership or other unincorporated association v. Estate, trust, or fund.

1. In this case it is payable to the order of the representative of such entity

2. Ex: A check drawn to the “Community Chest” may be cashed by its representative.

vi. Public Office or Officeholder1. Ex: “to the order of the County Tax

Collector”2. Ex: “to the order of John Jones, Tax

Collector” – in which case it is paid to the incumbent holder of the office.

3. Identification of Payee: The person to whom an instrument is payable is governed by the intent of the maker or drawer. A payee may be identified by any means, and multiple payees may be named.

a. Ex: name, office, account number (if done by account number it is payable only to the person on the account).

4. Bearer Paper is unspecific and is payable to anyone legitimately possessing the instrument and can be transferred without indorsement just like cash.

a. An instrument is payable to bearer only if it is drawn payable to:

i. Bearer1. Ex: “Pay to bearer”2. Ex: “Pay to order of bearer”

ii. A specified person or bearer1. Ex: “Pay to John Doe or bearer”2. Ex: “Pay to order and bearer”

iii. Cash1. Ex: “Pay to the order or cash”

iv. Or any other indication that does not purport to designate a specific payee. Note: If it purports to a specific person it is Order paper.

1. Ex: “Pay to the order of Happy Birthday” creates bearer paper.”

2. Ex: “I promise to pay Bearer”3. Ex: “I promise to pay to the order of Merry

Christmas”b. Bearer paper controls: If an instrument is payable both to

order and to bearer (e.g., “pay to the order of John Jones and bearer”) the bearer language controls.

viii. On demand or at a definite time1. Demand paper is like cash and time paper is for borrowing.

a. Instrument is payable on demand if it is expressly made so payable OR there is it fails to state a time for payment

i. On demand, at will, at sight are all ok and are considered demand

ii. Where there is no maturity date on the instrument, the law construes it as being payable on demand, and parol evidence to the contrary is inadmissible.

2. Definite time:a. An instrument is payable at a definite time in the future.

i. On a fixed date:1. Ex: dated, April 1, 20012. Ex: “On February 10, 2008” (or at any date

in the future)3. Ex: “On or before February 10, 2008 (or at

any date in the future)ii. After elapse of a specified period after sight or

acceptance1. Ex: “Sixty days after date” (or any period

more or less then 60 days)2. Ex: “Sixty days after sight” (or any period

more or less than 60 days)a. Note: remember that an instrument

stating that it is payable “at” sight is a demand instrument.

iii. At a time readily ascertainable when the instrument is issued.

b. Uncertain time of certain event or date left offi. If the date is left off the instrument and its maturity

depends on a date being stated (e.g., “payable 60 days after _____”), the instrument is not enforceable until the date is filled in by someone with authority to do so.

ii. Note: if the date is inserted by someone without the authority to do so the rules on alteration apply.

iii. Ex: “Payable on my Uncle Sam’s death” is not negotiable

iv. Ex: “Payable 30 days after my uncle Sam’s death” is not negotiable.

c. Acceleration Clauses: Code permitsi. Acceptable because only modify the time to pay,

not whether or not payment will occurii. “if you miss one payment, the whole amount

becomes due”iii. Examples of Acceptable clauses

1. On demand2. On 1/1/063. On sight4. On will5. 30 days after sight6. Maker can extend to 2003 (not a condition

because a condition modifies the act of payment and this only modifies the time of payment)

7. On 1/1/9999 accelerated by the death of X (allow acceleration clauses)

8. Silence (presumes demand)iv. Examples of unacceptable clauses

1. NOT 30 days after the world series in 2006 (not certain event will occur)

2. NOT 30 days after the 2001 world series (already passed)

3. NOT maker can extend (illusory, no enforcement)

4. NOT on the death of X (do not presume everyone dies)

d. Extension Clauses: Clauses that extend rather than shorten the time when payment is due. There are three kinds:

i. Extensions at the Option of the Maker or Drawer: OK If the extension is to extend to a further definite time stated in the instrument.

1. Ex – not ok: An instrument containing the clause, “This instrument can be extended at the option of the maker” is nonnegotiable b/c it does not specify when it is due.

2. Ex – ok: “This instrument may be extended by the maker for one month after the original due date,” is negotiable.

ii. Extensions that are Automatic on the Happening of An Event: These are very popular with farmers.

1. Ex: “in six months, but extended another six months if my crop fails” with a date would be negotiable. If there is no date then nonnegotiable.

iii. Extensions at the Option of the Holder: This type is always permitted whereas the other two are not.

1. The holder always has the option of giving extra time for payment.

2. Ex: “extension at the option of holder” is negotiable and deemed payable at a definite time.

ix. NO UNAUTHORIZED UNDERTAKING OR INSTRUCTIONS [§104(a)(3)]: The instrument must not state any other undertaking or instruction by the person promising or demanding payment to do any act in addition to the payment of money. The purpose of this is to keep the document free of clutter.

1. Ex: A promise to pay $500 and deliver a quantity of goods makes the instrument nonnegotiable.

2. Wording an instrument giving the holder the election of requiring some act to be done in lieu of payment of money destroys the negotiability of the instrument.

a. Ex: a promise to pay $500 or to deliver goods, whichever is requested, is nonnegotiable.

3. Exceptions: The UCC permits three undertakings or instructions to be included:

a. An undertaking or power to give, maintain, or protect collateral.

i. Ex: a provision requiring the promisor to protect security deposited for the loan.

b. An authorization or power to the holder to confess judgment or realize on or dispose of collateral; and

i. Ex: confession of judgment against the promisor if the note is not paid when due is permissible.

c. A waiver of the benefit of any law that protects the obligor

i. Ex: Waiver of presentment, notice of dishonor, homestead exemption, trial by jury, do not destroy negotiability.

d. “Payment in full” clauses [§3-311]: the addition of such a clause does not destroy the negotiability of a check and the payee who cashes such a check has no further rights against the drawer unless, payee returns the check within 90 days or the drawer sent it to the wrong place.

i. Ex: It is common amongst debtors who pay disputed debts by check to add a clause stating that by cashing the check the creditor/payee acknowledges it as “payment in full” for the entire amount owed.”

ii. Ex: Even if payee crosses off the “payment in full” it is still negotiable.

c. Non-negotiable Instrumenti. A non-negotiable instrument can still have value (possibly more than a

negotiable instrument)ii. Can sue for breach of contract if non-negotiable.

1. A non-negotiable instrument is merely a K that has been assigned, and the assignee picks up the rights of the assignor.

VI. Are the following problems negotiable?

a. Maker signs a promisory note to pay $100 in wood or wood carvings? No because it must be a fixed amount of money and the or makes is not fixed.

b. $100 in wood carvings? Not negotiable because the amount must be money

c. In gold? No, not negotiable must be money.

d. In US Gold Coins? Yes, This is negotiable b/c by act of congress US gold coins are considered money.

e. From pension funds? Yes, it will still be a fixed amount

f. Italian Lira or Deutch Marks? Yes, they are money.

g. 1,000 Deutch Marks in Franfurt? Can you domicile it to say where it will be paid? Yes, this is not a condition.

h. 500$ in NY or 1,000 DM in Frankfurt? As of today 1 DM is worth .50 cents. No, this is not negotiable. If you made it payable for one or the other it would be negotiable. But the “or” means that they are not going to always be even as a fixed amount. It would be ok to say 500 dollars in NY or 500 dollars in Frankfurt.

i. With ____% interest? Even though the % is blank it is negotiable. It takes a rule of construction. They use the Judgment Rule.

j. With ___10% interest? Fixed amount even though no specific time is given because constructively written with rates of interest is a presumption of per annum. The law presumes per annum if “interest of what” is not specified.

k. With 2% discount if paid 1/1/01? Fixed amount even though there are two different amounts possible because it’s either one or the other.

l. On Demand? Yes, this is negotiable because on demand means as soon as you give it.

m. On 1/1/06? Yes this is at a definite time.

n. At sight or at will? Yes, this is demand paper.

o. A (blank) instrument that says literally nothing? Yes this is negotiable b/c silence is demand under [3-108]. Presumption is demand.

p. 30 days after sight? Yes, this is negotiable.

q. 30 days after acceptance? negotiable; payable at a definite time

r. 30 days after the 2002 World Series? No, this is not a definite time. There might not even be a world series.

s. 30 days after the 2000 World Series? It is not negotiable if you made it for this even though it has in fact occurred.

t. For an installment contract, “if no payment or mortgage is breached, entire instrument is due immediately”? This is an acceleration clause that is negotiable; acceleration clauses don’t destroy negotiability

u. The maker may extend (provision) the time for payment? No, this is illusory.

v. The maker may extend to 1/1/06? Yes, this is the opposite of an acceleration (which is ok) but it gets you the same principle backwards.

w. However, the holder may extend? Yes, because a holder can always extend. You never have to ask for money.

x. Holder may extend to 1/1/06? Yes he may extend to a definite time

y. Pay to John? Not negotiable because words of negotiability are necessary, “to the order of” or “to bearer”

z. Pay to John (on a check)? negotiable under the UCC, words of negotiability aren’t needed

aa. Negotiable instrument (opt in)? Not negotiable; can’t opt in to using words of negotiability, must actually put the words (unless using a check).

bb. On the death of my rich Uncle Charles? No, it is a post-obit note. To be negotiable it must be payable on demand or at a definite time and these may never occur. There is no proof to the proposition that everyone dies.

cc. On 1/1/9999 however if my uncle dies b/f then it is on that day? Yes because it is an acceleration clause.

dd. Non-negotiable (opt out)? This is not negotiable; you can always opt out.

ee. Promise to pay _____ or bearer? Yes, to be negotiable it must be payable on demand or time to order or to bearer so we simply read it as bearer since no name is given.

ff. Promise to pay order of _____? Yes, but the words to pay order of must be there if they are not then it is non-negotiable.

gg. I promise to pay to a can of sardines? Yes this is bearer. It is bearer if it does not purport to be payable to a specific payee.

hh. Peter and Mary tax payer? Yes

ii. Or? No

jj. And or? No

kk. Instrument does not say where? No

ll. If no date? Yes it is presumed payable on demand from the date of issue.

mm. “Two hundred dollars” ($300)? This is payable for two hundred not 300. Words prevail over figures.

nn. At prime rate? A government statement is allowed.

oo. Is this a negotiable note? Why or Why not?

The above is a negotiable note since it (i) is in writing, (ii) is signed by the maker (Max Maker), (iii) contains an unconditional promise to pay (“the undersigned promises to pay”), (iv) a fixed amount of money ($1,200), (v) on demand (b/c no payment date is stated), (vi) to bearer, and (vii) contains no unauthorized undertaking or instruction.

pp. Is this a negotiable draft? Why or Why not?

The above is a negotiable draft since it (i) is in writing, (ii) is signed by the maker (Debbie Dante), (iii) contains an unconditional order to pay (“To: Dan Duke…Pay”), (iv) a fixed amount of money ($5,000), (v) on demand (since no time is stated for payment it is considered payable on demand), (vi) to order (“the order of Pam Payee”), and (vii) contains no unauthorized undertaking or instruction.

Max Maker Markets, Inc. No. 123123 Market StreetErehwon, NY

On demand (v) the undersigned promises topay (iii) Bearer (vi) $1,200Twelve Hundred and 00/100-------------dollars (iv)

Max Maker Markets, Inc. By /s/ Max Maker,

Pres. (ii)

To: Dan Duke January 1, 1997P.O. Box 37Denver, Colorado

Pay (iii) to the order (vi) of Pam Payee $5,000Five thousand and 00/100----------------dollars (iv)

/s/ Debbie Dante (ii)

VII. Negotiation (negotiated)—Holder v. Maker step 2a. Generally

i. Negotiation: Transfer of possession, whether voluntary or involuntary, of an instrument to a person other than the issuer to a person who thereby becomes its holder.

1. If negotiation HOLDERii. Holder: A person in possession of an instrument if the instrument is

payable to bearer; if the instrument is payable to an identified person, that person is the holder as soon as she gets possession.

1. Holder is person in possession of instrument with right to enforce it.

iii. Vs. Transfer: Transfer is not necessarily negotiation. All negotiations are transfers.

1. Particular kind of transfer making the transferee a holderiv. Must transfer the entire instrumentv. Impediments do not affect negotiation. The signature is effective even

though there is an impediment.1. Ex: Payee is 5 years old

vi. Remitter: 1. Three parties even though there are visually on the note only two

vii. If purported to prohibit negotiation, you don’t. Too bad!b. Last Endorsement Rule of the UCC

i. Look to the last endorsement to determine whether it was special or blank and what is necessary to make the next acquiror a “holder”

ii. Paper can go from order to bearer and bearer to order depending on the chain of indorsements

c. Two Applicationsi. Order paper requires proper endorsement plus delivery.

1. Last Endorsement Rule of the UCC : Where the last endorsement is special, it is order paper requiring another endorsement

2. eg. An instrument payable to order of Sue Jones. In order for Sue to negotiate it to Isobel, Sue must indorse it and deliver it.

3. Indorsement must be valid – The right to enforce will not pass unless the payee’s indorsement is authorized and valid.

a. Forgery: Breaks the chain of title. Forging the payee’s name breaks the chain of title and no subsequent possessors of the instrument can qualify as holders or a person entitled to enforce the instrument.

i. EXC: cases of ratification or estoppelii. Ex: Dan Drawer writes a check payable to the order

of Paula Payee. Before indorsement by Paula, the check is stolen from her by Harry Thief, who signs

“Paula Payee” on the back and deposits the check in his account at Forgers National Bank for collection from Big Bucks Bank (“the drawee bank”). The check is still the property of Paula Payee. No one taking the check after the forgery (not Harry, Forgers National, or subsequent transferees) can qualify as a “holder” or a “person entitled to enforce the instrument.”

4. Impediments are irrelevant except for forgery.ii. Multiple Payees are Ok

1. Jointly: Connected by “and.” If there is a subsequent negotiation all parties have to sign.

a. Ex: Check made payable to George and Martha Washington requires that both of them sign to negotiate it further. If they don’t both sign the subsequent transferee is not a holder.

2. Severally: Connected by “and/or” and for a subsequent negotiation a signature by any one of them is sufficient to transfer title.

a. Ex: Check payable to George or Martha Washington or a check to George and/or Martha Washington can be negotiated by the indorsement of either payee and that signature is sufficient to transfer title.

3. Unclear if Jointly or Severally: then it is presumed to be and/or.

iii. Location of Indorsement [§3-204(a)]: An indorsement (any signature other then maker, drawer, or acceptor) must be written on the instrument. Typically, the indorsement is placed on the reverse side of the instrument, but it may also properly be placed on the front or on an allonge – i.e., paper affixed to the instrument.

1. Ex – of Allonge: You want a paycheck cashed and you go to Jewel and write pay Jewel signed Mike. They put pay Wonder bread signed Jewel. Wonder bread puts pay Flower signed Wonder bread. Wonder bread wants to pay Spak but there is no more room what happens. Attach a piece of paper called an allonge – an attachment so firmly fixed there to that it has to be part there of.

a. What can it be affixed with? Scotch tape, staple, safety pin are all allonges.

iv. Effect of transferring an Order Instrument without Indorsement: The delivery of an order instrument without required indorsements may transfer possession but is not a negotiation.

1. Rights of Transferee without Indorsement: Unless and until she obtains the indorsement, the transferee does not have the status of a holder and is not an HDC. She can:

a. Sue to Compel Indorsement: If she paid value for the instrument, the transferee can sue in equity to compel indorsement.

b. Sue to Enforce w/o Indorsement: Similarly, if the instrument is due, the transferee can bring suit to enforce it without indorsement.

c. Note [§3-308]: lacking status of holder gives transferee the burden of proving the validity. A holder is prima facie entitled to recover i.e., once the signatures are established, the burden is always on the Δ to prove some defense.

2. Different Rules For Banks [§4-205(1)]: A depository bank that takes an unindorsed instrument for collection becomes a holder if the customer was a holder at the time of delivery. This is true even if the customer had not indorsed the instrument.

a. Note: this rule only applies for collection. Thus for example, if the bank held an instrument as collateral for a loan to a customer, it would have no power to supply the customer’s indorsement. Also, the rule does not insulate the bank for mishandling funds represented by the instrument.

b. Ex: Check drawn payable to A and B; Bank cashes check on A’s signature only and forward check for collection (supplying B’s indorsement). Bank is liable to B for conversion of her interest in the check. It makes no difference that the bank was acting in good faith.

3. When Indorsement Obtained Later: Upon obtaining the transferor’s indorsement, transferee becomes a holder – having both the right to enforce and possession.

a. HDC Status: The transferee may qualify as an HDC if other requirements are met.

i. Notice of Adverse Claim or Defense [§3-203(c)]: For the purpose of determining whether the transferee had notice of any adverse claim or defense to the instrument (an essential element for due course holing), her knowledge is measured as of the time she obtains the missing indorsement.

1. Ex: If the transferee finds out about any defense or claim in the interval b/t the time of paying for and obtaining possession of the instrument and the time the missing indorsement is obtained, the transferee

cannot qualify as an HDC.

v. Partial Indorsement is Not Negotiation: An indorsement that attempts to convey less then complete amount of the instrument is not a negotiation and the transferee is not a holder. The rationale being that a cause of action on a negotiable instrument cannot be split up.

1. Ex: Dan Drawer draws a check payable to the order of Paula Payee, who indorses it: “Pay George Washington two-thirds and Martha Washington one-third, /s/ Paula Payee.” Neither George nor Martha qualifies as a holder.

2. Exception – Partial Payment of Instrument: Indorsement of the balance of a partially paid note is a negotiation (e.g., an installment note).

vi. Bearer paper requires mere delivery: Anyone in possession of bearer paper is a holder thereof.

1. Last Endorsement Rule of the UCC : Where the last endorsement is blank, it is bearer paper requiring only delivery

2. eg. An instrument payable to cash. In order for Sue to negotiate it to Isobel, Sue must deliver

VIII. Holder in Due Course—Holder v. Maker step 3a. FIRST – must be 1) negotiable instrument 2) negotiated to holder THEN 3)

HDCb. Elements

i. Taken for valueii. In good faith

iii. Without notice, “knowledge” of1. Irregularity2. Overdue3. Claims4. Defenses

c. Value i. Definition: Value means performed consideration.

1. Any of the following constitutes valuea. Performance of the agreed upon considerationb. Acquisition by the holder of a lien or a security interest in

the instrumentc. Taking the instrument as payment of or security for an

antecedent debti. Remember, this is NOT consideration, but VALUE.

ii. Ex: Jerry is indebted to Ben for $2,500. In payment of that debt, Jerry negotiates to Ben a $3,000 bearer

note payable to Jerry. Ben has given value for the note.

iii. Eg. Lawyer earned $1000 three years ago but was not paid. Yesterday he received a $1000 negotiable instrument for the work done, this is value

d. Giving a negotiable instrument for the instrumente. Giving the instrument in exchange for incurring an

irrevocable obligation to a third party2. The following do NOT constitute value:

a. Executory Promise: A promise to give value in the future is not value.

i. Value means performed consideration. It is not something you are going to do in the future.

ii. Eg. Note or check from a client in return for services. Value is not the same as consideration and a promise to pay for future service is not value—Lawyer receives $1000 negotiable instrument as an advance on fees. This is not value because it is executory, not executed although it is consideration

iii. EXC: Availability retainer: Where atty gets a retainer and it does not go into client trust account, but instead goes into personal account. Used to secure time and NOT advance fees.

ii. Bank as an HDC1. A bank typically cannot be an HDC because did not give for value2. A bank can be an HDC if it gives value, eg. cashing a check, allow

drawing on account before check clearsiii. Finder of note cannot be HDC b/c did not take for value.

d. In Good Faithi. Subjective portion—Honesty in fact

ii. Objective portion—Observance of reasonable commercial standards of fair dealing

iii. Which test do we use? This appears to differ between old UCC and new UCC.

iv. EXAMPLE : A bum offers to sell you a $1MM instrument for a bottle of wine. Would you have honestly taken in good faith? No. The test includes what a reasonable prudent person would do.

e. Without noticei. Holder must purchase instrument without notice (knowledge or

reason to know) that it is OVERDUE, or has been DISHONORED, or of ANY DEFENSE OR CLAIM to it on the part of any person.

ii. Notice: 1. Includes both actual notice and reason to know from facts

surrounding the transactiona. OBJECTIVE TEST

iii. Overdue

1. Person has notice that an instrument is overdue if:a. Any part of the principal is overdueb. An acceleration has been madec. More than a reasonable time has elapsed after issue of

demand instrument i. For checks, 90 days

2. Existence of Default on overdue Principala. Ex: Where an instrument bears a fixed maturity date, the

purchaser must have acquired it b/f midnight on the date set for its payment.

b. Ex: If the principal is payable in installments, notice that the maker has defaulted on any installment of principal makes it impossible for a subsequent purchaser to be an HDC.

c. Ex: Knowledge of a default merely in interest payments does not prevent due course holding.

d. Ex: Knowledge of the obligors default in payment of other obligations or instruments does not prevent due course holding, unless the instruments were on the same series (i.e., issued at the same time maturing on different dates).

3. Accelerationa. Ex: Ira Investor buys a promisory note having a maturity

date of Feb 1, 2002, but payable earlier if Bill Clinton should win the presidency. If Ira purchases the note in 1995, he cannot qualify as an HDC –since he has reason to know that the note is overdue.

4. Demand Instruments: Instruments currently dated or payable “at sight” or “on demand” become overdue as follows:

a. Checks: Become overdue 90 days after their date. Someone acquiring a check after this time could not become a HDC.

b. Other Instruments: such as promisory notes that are demand instruments become overdue according to a fact test: “when the instrument has been outstanding for a period of time after its date which is unreasonably long under the circumstances of the particular case in light of the nature of the instrument and usage of trade.”

iv. Dishonored1. Any unauthorized signature or alteration that one has notice of will

prevent them from becoming an HDC2. Handwriting on a typewritten document … indication of

incompleteness of due datev. Any defense or claim or IRREGULARITY

1. Claims: Notice of claims prevents HDC status. A claim is a defense to payment obligations, which includes knowledge that

another party has property or possessory right or that a fiduciary has negotiated the instrument for his own benefit.

2. Defenses or Recoupment: Notice of defenses (e.g., infancy, duress) or claims in recoupment by the obligor (which reduce the amount payable) prevent HDC status.

3. Apparent evidence of forgery, alterationsa. Dates looks like it might have been added

4. Incomplete Instrumenta. Missing date: “after the above date ____” not HDC

i. But NOT merely no date (demand)b. A missing payee is ok – merely bearer paperc. If draft is missing a drawee, not HDC

5. Irregularitya. Handwriting on a typewritten document … indication of

incompleteness of due dateb. Missing drawee on three party paper … must be a drawee

to determine who pays.c. Missing language of negotiability on note or draft.d. Stamp “PAID”e. Written “NULL & VOID”

6. Does not call into question:a. Blank payee … bearer paper.b. Missing language of negotiability on check.c. Missing “I” in language of negotiability d. Missing additional interest amount to be paid … assume

judgment rate.e. Missing numerals for amount but words appear.

vi. Notice of Facts NOT Defeating HDC1. Instrument is antedated, postdated, or undated;2. Instrument was issued in return for an executory promise unless

the purchaser has notice that a defense or claim has arisen from the terms thereof;

3. That any party signed for accommodation;4. That an incomplete instrument has been completed, unless she

has notice of any improper completion;5. That any person negotiating it was a fiduciary, unless she also

knows that the negotiation constituted a breach of trust;6. That there has been a default in payment of interest; or 7. That there is a public filing or recording of a document (e.g.,

security agreement) concerning the instrument or that the instrument was sold at a discount.

f. Time at Which HDC Status Determined: i. At the moment the instrument is negotiated to the holder and when she

give value, whichever occurs later. Thus, if the transferee acquires notice of a claim or defense prior to negotiation or the giving of value, she will not qualify as an HDC.

g. Partial HDCi. A seller may discount a note and the buyer would still be a full HDC

ii. If a HDC agrees to pay half today and half tomorrow and finds out about a swindle before paying second half, he is a partial HDC for the full amount—code adopts a ratable/proportional principal for HDC

h. Successors to Holders in Due Course: Shelter Doctrinei. In certain circs, a transferee can acquire the rights of an HDC without

actually qualifying as an HDC.ii. Shelter Rule: A transferee acquires whatever rights her transferor has and

thus is said to take “shelter” in the status of her transferor. The purpose of the rule is to protect the free negotiability of commercial paper.

1. Note on shelter: There is no difference b/t being an HDC yourself and being a Non-HDC with the rights of an HDC. If you have the rights of an HDC you prevail.

2. Ex: A promisory note is held by H, who qualifies as an HDC. H makes a gift of the note to his son, S. Since S paid no consideration for the note he obviously would not otherwise qualify as an HDC; however, since his father has that status, S succeeds to the rights of an HDC too. The result would be the same even if S knew of some defense to the instrument.

3. Exception to Shelter Rule: No HDC rights are given to persons who were parties to a fraud or illegality affecting the instrument.

iii. HDC Rights and Remote Transferees: Once a person qualifies as an HDC, all subsequent transferees will acquire the same HDC rights, unless they are transferees after the holder failed to obtain HDC rights b/c she was a party to fraud or illegality.

1. Ex: M signs a promisory note payable to A, who negotiates it to B, an HDC. B makes a gift of the to C, who makes a gift of it to D, who in turn donates the note to E. C, D, and E do not qualify as HDC’s in their own right, since none has paid value. Nevertheless, C obtained B’s HDC rights under the shelter rule; and when C gave the note to D, D likewise received all of C’s rights (which include B’s HDC rights). E then took shelter in D’s status, which included acquisition of B’s HDC rights.

i. EXCs: Owners who are never an HDC (but may have the rights of an HDC under the shelter doctrine)

i. Buyer in Bulk: 1. Where there is a bulk sale of instruments, the buyer cannot be a

HDC for those instruments.2. CAN get rights of an HDC under the Shelter Doctrine3. Ex: Where Marshal Fields is sold – everything including the cash

registers is sold, including the notes and drafts. The buyer (Macy’s) is not an HDC, but because Marshall Fields was an HDC, Macy’s is covered under the Shelter doctrine.

4. EXC: Where federal agency takes as successor in interest, they are HDC even if purchase was in bulk. Federal law trumps state law.

ii. Judicial Sale1. Where instruments sold to a good faith purchaser during a sale to

satisfy a judgment, the buyer cannot be an HDC.2. CAN get rights of an HDC under the shelter doctrine if seller was

HDCiii. Purchase from an Estate

1. A purchaser of instruments from an estate cannot be an HDC.2. CAN get rights of HDC if decedent was HDC.

IX. Defenses—Holder v. Maker step 4a. MUST have already established –

i. Negotiable instrumentii. Negotiated

iii. HDCiv. NOW -- Defenses

b. General Rulei. HDC takes free of all personal defenses, but still takes subject to the

real defenses.c. Real Defenses—FFAAIIDDSS: (HDC takes subject to these)

i. Forgery1. Totally ineffective as to name forged, totally effective as to forger

ii. Fraud in Factum1. Key—switch document fraud, real fraud where you didn’t know

what you were doing2. Personal Defense Fraud: Usually lie cases

a. Inducementb. Considerationc. Ex: Buys “diamonds” that are really just glass. This is

personal fraud b/c purchaser knew they were buying something, even though it turned out to be glass.

d. Ex: Cure for arthritis, actually causes arthritis. Personal fraud.

3. Real Defense Fraud: Usually switch casesa. Inceptionb. Procurementc. Executiond. Essencee. Factumf. Ex: Contract is switched between time maker sees it and

the time she signs it. Real fraud – lack of knowledge by the maker.

g. Ex: Autograph of celeb turned into sig on a note – real fraud b/c celeb didn’t know what he was signing.

iii. Alteration1. Like partial forgery

2. Maker is liable only to extent of pre-altered amount3. Ex: Person writes check for $50, later altered to $5000. Person is

obligated to pay only the $50.4. EXC: Negligence – where person is negligent and therefore the

note/draft is altered.a. Ex: Person writes check for $50 and does not draw a line

to block out the rest of the space and the crook writes in $500,000. This person is negligent and cannot assert alteration offense against an HDC.

iv. Adjudicated Insanity1. Must be adjudicated – not merely claiming insanity2. Renders instrument a nullity

v. Infancy1. May not be a defense if for a necessity2. Necessity depends on the person

a. STD: Station of life testb. Ex: mink coat/caviar for trust fund baby

3. NO LONGER infant once marrieda. If divorced, still not infant even if under 18

4. NO LONGER infant if joined military5. See previous infancy sections

vi. Illegality1. Contract is void2. illegal subject matter, not illegal purpose

a. Ex: paid to kill maker’s wife – illegal subject matter so void.

b. Ex: Purchase of something that is eventually used for illegal purpose – voidable, personal defense

3. Need not prove the illegality in writing – must merely testify to the illegality.

4. A payee not qualified to do business in a state is a personal defense everywhere but Arkansas where it is deemed to be illegality

5. Gambling: Illegal in some jurisdictionsa. In IL, there is a general law against gambling; however,

certain forms of “gambling” are authorized by statute.vii. Duress

1. Void duress: imminent fear of great bodily harm to self or to person to whom you own legal duty.

a. Nullifies the obligation of the obligor2. Voidable duress is a Personal defense: “I’ll tell”

viii. Discharge in Bankruptcy1. Cannot squeeze blood from a turnip

ix. Statute of Limitations1. 3 years for drafts2. 6 years for notes3. Article 4 – 4 years (forgery)

4. If demand instrument and no demand, then 10 yearsx. Surety defenses if known

1. Variation of risk so long as you have notice of the surety2. If there is notice that the person exercising the defense is a surety,

variation of risk is a defense.d. Real v. Personal Defenses

i. A personal defense is any defense that is not a real defenseii. Timing of Personal defenses

1. Defenses arising from the inducement of the contract.2. Defenses arising from the consideration of the contract.

iii. Timing of Real defenses 1. Defenses arising from the inception of the contract2. Defenses arising from the procurement of the contract3. Defenses arising from the execution of the contract4. Defenses arising from the essence of the contract5. Defenses arising from the factum of the contract

e. ClaimsI) Claims The HIDC of a negotiable instrument takes free from all other

defense as well as claims. (Claims is an affirmative like Defenses is a negative)Example of a Claim: A person loses a bearer instrument (bearer on its face or a paycheck that was signed on the back, converting it into bearer). The finder would not be an HIDC because he didn’t give value. But if the finder sold it to someone that new person in good faith, for value, without notice that new person would be a HIDC. If he came to the maker, the maker would have to pay, because the defenses of failure of consideration or lost defenses are just personal defenses. (1) If the makers sued the new person, under property law that lost

property goes to the finder, except if the true owner is found. The new person still takes free of this claim, because he (new owner) is a HIDC and he takes free of all claims and defenses.

f. Shelter Doctrine (umbrella/umbrella protection)i. Shelter Rule

1. Anyone who takes after an HDC, gets the rights of an HDC.2. Therefore, although the current owner may not be a holder as

demonstrated by the rules, because a prior owner was a holder, the current owner gets the rights of an HDC.

ii. Purpose1. Expand and give power to the HDC rule. Allow the world to be a

marketplace.iii. Example

1. Endorsement: Pay Conviser, /s HDC2. Facts: Conviser got it as a gift (no value), in bad faith and with

actual knowledge of fraud.3. Issue: Is he an HDC?4. Answer: YES: He can win under the Shelter Doctrine

X. Two other ways for Maker to get out of paying HDC: a. HDC rule has been abolished in part (ameliorated) by the FTC Rule where:

i. HDC rule is state law, federal law (FTC) trumps.ii. Human buys

1. Not corporation2. Aliens are ok

iii. Consumer goods1. Goods for family use2. Not land, inventory, equipment3. Car is a consumer good (if for family use)

iv. Or consumer services1. Health club contracts2. Dance studio contracts

v. On credit1. payment in at least five installments

a. Must be more than 4vi. Purchaser can refuse to pay the finance company if you have a real

defense. Can also sue the finance company for previous payments made because of the fraud.

b. Even without the FTC rule, could get out of the deal if you can show that the person who claims to be an HDC is not because he is CLOSELY RELATED to the crook.

XI. Checks and Drafts—Drawer v. Draweea. Drawer/Drawee relationship (contractual and properly payable rule)

i. Situation1. Drawer puts money in drawee and drawee pays out according to

drawers orders2. Contractual relationship

a. Bank has advantage b/c they both draft the contract and draft the law

ii. Properly Payable Rule1. General Rule

a. Contractual relationship between you and your bank. You put money in the bank and they pay out according to your order.

2. Overdraftsa. Occurs where the bank pays a check where there are

insufficient funds in the bankb. Bank does not have to pay on an overdraft but if they do

then they can charge the customer for a loan even though the customer did not ask

3. Post dated checksa. Still a draft, but it is a time draft, not a checkb. The bank can pay it if they want to, they don’t have to pay

attention to the date—date is irrelevant4. Stale checks

a. A stale check is one that is predatedb. Bank can pay on it if it wants to but doesn’t have toc. Dates are unimportant but the bank can pay if want

5. Dead drawersa. A bank should not pay if the customer is dead but they can

of they want tob. Death does not terminate the agency relationship

6. Stop paymenta. Saying to the bank that you want them to cancel an order

… withdrawing an order to the bank to payb. Bank cannot get away with paying on a stop payment

except for shelter or subrogation when they pay an HDCiii. If drawee should have paid but did not—constitutes breach

1. Wrongful dishonor a. It is a wrongful dishonor for the bank not to pay something

if there is money available to pay itb. Drawee is liable to drawer for wrongful dishonor

2. Contract awaya. Cannot enter into an agreement with you to have a clause

that says you cannot hold them responsible for damagesb. Cannot contract away

iv. If drawee should not have paid but did—constitutes breach1. Liability

a. Drawee is liable to drawer for breach of contract2. Forged drawer

a. Where there is a forgery, it is ineffective as a real order … if you didn’t sign it, you are not ordering the bank to pay

b. The bank must return the money to the account if they paid out on a forged drawer

3. Forged indorsera. Allows someone other than the intended payee to cash the

check b. The bank should not have paid and they are responsible—

the bank must return the money to the account if they paid out on a forged indorser

4. Exceptions—Drawer negligence, drawer becomes responsiblea. Fictitious payee rule

i. Dealing (Imposter)1. Negligence in dealing

a. Eg. Pay to the order of Robert Redford

2. Where dealing with an imposter, any indorsement is effective—even though it is not a real signature, it is effective

3. Drawer will suffer, not the bankii. Accounting (Corporate Comptroller)

1. Negligence in accountinga. Eg. Pay to the order of Marshall

Fields2. Never have the same person crediting the

accounts as preparing the deposits, taking the deposits in, preparing the books, ect … if one person does everything, it is easy to steal

3. Either the payee or drawer will suffer, not the bank

iii. Hiring (Payroll Padding)1. Negligence in hiring2. Where get a dishonest employee that is

preparing checks for you and then endorse them in pencil only to later erase them

3. Shifts the loss to the employer where negligent in overseeing their own funds

b. Drawer Negligence in draftingi. Not Negligence

1. Pencill2. Easily erasable paper3. Don’t use Protectograph4. Blank checks left in easy to steal places

ii. What is negligence?1. Leaving the amount line blank2. Leave lots of space following a word

c. Drawer Negligence in notifying draweei. General Rule

1. Drawee suffers when pays without asking for any form of identification

ii. Limits to Rule1. Drawer must be prompt in notifying the

bank or they do not have to put the money back

iii. Forged drawer1. 1-year limit

iv. Forged endorser1. 3-year limit

v. Multiple forgeries by the same wrongdoer 1. 30 days from when you get the statement

back

b. Holder-Drawer (payee) relationship—Holder v. Draweri. Secondary liability

ii. Holder in due course rule worksc. Drawee-Payee relationship – Payee v. Drawee

i. Generally1. No relationship without drawee acceptance

ii. Example1. Where W hands S a check and the bank wont pay … there is no

relationship between the bank and the payee unless the bank accepts the check.

2. Where the bank certifies the check, there is a relationship.3. A note merely suspends obligation until the check clears

iii. Assignment1. Drawing is not an assignment of funds2. Check notification is not an assignment

iv. What is an Acceptance?1. Generally

a. A signature … where the drawee signs it, there is an acceptance

2. Third party beneficiarya. Third party beneficiary is not acceptanceb. Where W says to the bank, Ill give you $500 and then Ill

give S $50 … this is not how it works3. Trust

a. Trust is not acceptanceb. One person names a legal title holderc. Does not work since it is a contract with a bank to pay a

draft, not a trust4. Extrinsic evidence of acceptance

a. Acceptance must be on the instrumentv. Effect of Acceptance

1. Specific acceptance: eg. Certifying a checka. On drawee: Primary liabilityb. On drawer: Discharge of liability

2. Generic acceptancea. Drawee has primary liability but the drawer is not

discharged, still has secondary liability

IX. Finality of Paymenta. Price v. Bank: Forged Drawer

i. Payment is final, the bank loses with no negligence exceptionii. Drawees suffer on notes with forged drawers

b. Canal Bank: Forged endorser i. Payment is not final and the bank can recover from the innocent party paid

with no negligence exception

ii. Presenters (the innocent party) suffers upon notes with forged endorsers.c. Other issues

i. If the drawee is the USA then payment is always finalii. If there are both a forged drawer and a forded endorser then payment in

finaliii. Finality of payment is also extended to information under the banks

control like account information.