1. Commercial Paper Law

Commercial Paper Law

Video Playlist: 45 Videos: 102 Minutes


Topics: Learning Material

Introduction to Commercial Paper
Commercial paper is a document that promises to pay a sum of money to the holder or possessor of the instrument. It is very common to use commercial paper as consideration in a business transactions rather than cash. This chapter introduces commercial paper. It identifies the main types and requirements (elements) of commercial paper. It explains the rights of a holder or possessor of the commercial paper and the obligations of the payor of the instrument. It also provides for the rights of subsequent transferees or purchasers of the commercial paper. Notably, it introduces the concept of a holder in due course. Lastly, it provides for the potential liability of any maker, drawer, transferor, signor, or individual presenting the commercial paper for payment. For further written and video explanation, discussion and practice questions, see Commercial Paper (Intro)

What is “Commercial Paper”?
Commercial paper is a broad categorization of financial instruments (also referred to as an “instrument”) promising to pay or ordering payment to a person legally entitled to enforce the instrument. Because it has value for the individual in possession or holding the instrument, it is used as a substitute to money in commercial transactions. For further written and video explanation, discussion and practice questions, see What is "Commercial Paper"?

Common Types of Commercial Paper
When examining the attributes of commercial paper, it is important to differentiate between the most common types of instrument. The types of commercial instrument include: Notes - This is a promise to pay money. It involves two parties. The maker of the note makes an unconditional promise to pay the payee. The payee is the personal entitled to payment of the note. This is normally the holder of the notes. The payment may be due at a date certain or on payable on demand. Drafts - This is an order directing someone else to pay money. It involves three parties. The “drawer” is the maker of the draft. The “drawee” is the party ordered to make payment to the “payee” or holder of the draft. A draft can involve a drawee who is an individual or business. Either of these types of types of instrument can be a negotiable instrument if they meet specific requirements. For further written and video explanation, discussion and practice questions, see What are the common types of commercial paper?

“Holder” of Negotiable Instrument
A holder is one who has possession of and is entitled to enforce the instrument. So, a person who is named as payee and possesses an instrument is a holder. If the commercial paper is not payable to a particular person (i.e., it is payable to anyone in possession of the paper), anyone who has possession is a holder. An individual who is issued a note or draft is a holder. A person can also become a holder by receiving the draft through “negotiation” of the instrument. Negotiation is discussed separately. For further written and video explanation, discussion and practice questions, see Who is a "holder" of a negotiable instrument?

“Negotiability” of an Instrument
Negotiation is the transfer of negotiable paper from one holder to another. To be a substitute for money, commercial paper must be freely transferable in the marketplace. That is, the paper must be “negotiable”. Negotiability concerns the rights of the holder of commercial paper. Paper that is not negotiable may still be transferred; however, it is far less valuable than negotiable paper. This is because the holder has fewer rights in enforcing payment of the non-negotiable, commercial paper. The rights of a holder of each type of paper is as follows: Non-negotiable Commercial Paper - An individual in possession of a non-negotiable instrument stands in the shoes of the original issuee. That is, she has the exact same rights in the instrument as the original issuee held. This means that, if the original party loses his right to be paid (think of defenses to payment of a contract), so does the transferee of the commercial paper. As such, the value of non-negotiable instrument is far less valuable to a subsequent transferee who cannot be certain that she will receive payment without being subject to a payor defense. Negotiable Commercial Paper - The holder of negotiable paper may have greater rights than the original issuee. That is, when paper is negotiable and validly negotiated to a subsequent holder who qualifies as a “holder in due course”, the holder may acquire greater rights to enforce the instrument against the payor or maker. The holder in due course will have a greater right to payment because the maker or payor cannot assert certain defenses (personal defenses) to payment against the holder in due course. For further written and video explanation, discussion and practice questions, see What is "negotiability" and why is it important?

Requirements for “Negotiability”
An instrument is negotiable if it meets the following qualifications: Writing - The instrument must be in writing; Signed by Issuer - The issuer must sign the instrument. A mark may constitute a signature if the issuer intends for the mark to be a signature. Unconditional Promise to Pay - The instrument must contain an unconditional promise to pay. A condition is any requirement that a holder must undertake before she has the right to present the paper for payment. Definite Amount - The instrument must state a specific amount of money that it will pay. Payable on Demand or on Time - A “demand instrument” must be paid whenever the holder requests payment, while a payable “on time” instrument indicates a specific date and time. Payable to Order or To Bearer - To be negotiable, an instrument must be either “order paper” or “bearer paper”. Order paper is payable to a specific individual. This individual’s signature is required if the instrument is transferred to another holder. Bearer paper means that any holder of the paper can present it for payment. No Further Undertaking - With limited exception, the instrument cannot require the holder to undertake any action other than present the instrument to receive payment. Remember, non-negotiable paper may still be transferred. The transferee of non-negotiable paper may have fewer rights than the holder of negotiable paper through a valid negotiation. For further written and video explanation, discussion and practice questions, see What is required for commercial paper to be "negotiable"?

“Unconditional Promise to Pay”
Any condition placed on the payment makes the instrument non-negotiable. A condition is any requirement that a circumstance come to fruition or that the holder undertake any additional actions in order to receive payment upon presentation of the instrument. For further written and video explanation, discussion and practice questions, see When does commercial paper contain an "unconditional promise to pay?

“Payable on Demand” or “Payable on Time”
A negotiable instrument must either be payable on demand or payment on time. An on-time instrument is payable at a specific time and date. The date must be able to be determined at the time the instrument is issued. It may be payable after an elapsed period of time that is readily ascertainable at the time the promise or order is issued, subject to rights of prepayment, acceleration, and extensions. If the instrument is not clear, but there is evidence of an intent to make it payable at a specific date and time, the note is not negotiable. An instrument is payable on demand if it states as much or it does not state any time of payment. For further written and video explanation, discussion and practice questions, see What is "payable on demand" or "payable on time"?

“Order Paper” and “Bearer Paper”
To constitute a negotiable instrument (both notes and drafts), an instrument must be either order paper or bearer paper. Order Paper - Order paper must include the words “pay to the order of (identified person)” or “to (identified person) or order”. Including the word “order” indicates that the instrument is not limited to only one person. That is, the payee of the instrument can designate someone else to receive payment. This generally requires the identified person to indorse (sign) the instrument. Signing the instrument makes it bearer paper, unless the signor identifies a person to whom the instrument is being transferred. Bearer Paper - If the commercial paper is made out “to bearer” or it is not made out to any specific person, it is bearer paper. It can be redeemed by any holder of the paper, subject to certain defenses. If all other requirements are met, the UCC provides an exception to the “order paper” or “bearer paper” requirement for commercial paper to be negotiable, but this exception does not apply to notes. Primarily, this exception applies to drafts drawn on third-party institutions that inadvertently leave off the “to order” language, but the nature of the paper is obvious. For further written and video explanation, discussion and practice questions, see What is "order paper" and "bearer paper"?

Identifying the Payee
A negotiable instrument is payable to the holder of the instrument. A holder may either be an individual named in the instrument (order paper) or an individual in possession of the instrument (bearer paper). An instrument that names a payee may name or identify the payee in any number of methods, including by name, identifying number, office, or account number. As a general rule, an instrument is payable to the person intended by the issuer, whether or not that person’s correct name appears on the instrument. If the payee is identified only by account number, the instrument is payable to the owner of that account. If the payee is identified by account number and name, the instrument is payable to the named person whether or not that person owns the account. If the instrument is payable to “either Identified Person or Identified Person” (this may use the word “alternatively” or some derivative thereof), it may be negotiated or enforced by any or all of the named individuals. If the instrument is made out collectively to two or more individuals (“not alternatively”), it is payable to all of them and must be enforced by all individuals together. That is, all individuals must indorse the instrument for transfer or present it for payment. If it is ambiguous as to whether the paper is payable in the alternative, it is assumed to be payable alternatively. For further written and video explanation, discussion and practice questions, see How is a payee identified on the negotiable instrument?

Court Rules in Determining Negotiability
The UCC favors negotiability of commercial instruments. It contains a number of rules to resolve any uncertainty as to the terms of the instrument and to supply missing terms. The following rules apply to situations where terms in a negotiable instrument contradict each other: words take precedent over numbers; handwritten terms prevail over typed and printed terms; and typed terms win over printed or boiler-plate terms. These rules can allow for any number of general assumptions about the intent and obligations of the parties. For further written and video explanation, discussion and practice questions, see What rules does the court apply in determining negotiability?

Negotiation of Commercial Paper to a Holder
“Negotiation” means that an instrument has been transferred (either voluntarily or involuntarily) to the holder by someone other than the issuer. If an individual acquires paper by a method other than negotiation, she is a “transferee” and not a “holder” of the paper. The paper is negotiated upon: transfer of possession, and indorsement (signature) by the holder. The holder of the instrument has the right to force the transferor to indorse the instrument. This is very important for purposes of enforcement and liability if the instrument is not paid when validly presented by a subsequent holder. That is, the indorser may be liable for paying an instrument that is dishonored when presented. For further written and video explanation, discussion and practice questions, see How is commercial paper negotiated to a holder?

Transfer of a Negotiable Instrument
An instrument is transferred when it is delivered by a person (other than its issuer) with the purpose of bestowing the right to enforce the instrument pursuant to its terms. Transfer vests in the transferee the rights of the transferor to enforce the instrument. While the transferee receives the rights of the transferor, it means the transferee may also be subject to any defenses the payor may have to payment of the instrument. That is, the transferee stands in the same position as the transferor with regard to the payor’s defenses against payment. For further written and video explanation, discussion and practice questions, see What is "transfer" of a negotiable instrument?

Indorsement of a Negotiable Instrument
Indorsement of an instrument means signing it. The indorsement signifies that the individual signing the instrument certifies certain things about it to the primary parties liable on the instrument (maker or drawer) and to any subsequent holder of the document. If paper being negotiated is order paper (as apposed to bearer paper), the paper must be indorsed by the person to whom the paper is payable prior to transfer to another holder. Indorsement by the payee may change the paper from order to bearer paper (and vice versa), as well as put other limiting characteristics on the instrument. A payee may indorse the instrument to make it bearer paper or have a special/restrictive/qualified/anonymous indorsements to limit the rights of the future holder of the paper. Indorsement is not always required for negotiation of the instrument. No indorsement is required to negotiate commercial paper if the paper in possession of the transferor is bearer paper. As such, the mere transfer of possession is a negotiation. In this case, even involuntary transfer (such as when the paper is lost or stolen) or voidable transfer (such as from an infant, through fraud, duress, misrepresentation,etc.) are sufficient to constitute negotiation. For further written and video explanation, discussion and practice questions, see What is "indorsement" of a negotiable instrument?

Various Types of Indorsement
Indorsement is the signature of an individual on the commercial instrument. There are several common types of endorsement, each of which has a different effect upon the instrument: Blank Indorsement - This means signing the instrument without designating any particular payee or making any other form of limiting designation. A blank endorsement turns order paper into bearer paper. Special Indorsement - Special indorsement is a signature and instruction that limits the instrument to a particular person. A special indorsement may limit the indorser’s potential liability, but is not effective to prevent further negotiation by the holder. Restrictive Indorsement - A restrictive indorsement includes the payee’s signature and instructions that limit the instrument to a particular use. Generally, a restrictive indorsement is not effective to prevent further negotiation of the paper. There are, however, special rules that apply to certain restrictive indorsements of checks. Qualified indorsement - A qualified indorsement is an individual’s signature including the words, "without recourse”. The purpose of this form of indorsement is to limit the potential liability of the indorser who is transferring the instrument in the event the payor ultimately dishonors the instrument. The idea is that the indorser is transferring any rights she has in the instrument, but she is not warranting that the payor of the instrument will honor it. While this type of indorsement may limit the indorser’s liability to subsequent holders of the instrument, it does not affect or limit the ability to further transfer or negotiate the instrument. Anomalous indorsement - This is an indorsement by someone other than the holder or transferor of the instrument. It is made to guarantee or incur surety liability on the instrument. This can give a transferee confidence in accepting the instrument. This type of indorsement is not necessary for negotiation. For further written and video explanation, discussion and practice questions, see What are the various types of indorsement?

Holder Received Payment on a Negotiable Instrument
A negotiable instrument may be traded for value up until the time of payment. If there is no specified payment time, there is no limit on how long or how many times it can be negotiated to another party. A holder of the instrument may seek payment from a person obligated to pay the instrument through a process known as “presentment”. Presentment is simply a demand made by a person entitled to enforce the instrument to an individual obligated to pay the instrument. The process for presenting a note for payment is slightly different than presenting a draft. The holder presents a note to the maker of the note, while a holder of a draft presents the draft to the third-party payor (such as a drawee bank). The person making presentment must exhibit the instrument, give reasonable identification, and surrender the instrument. For further written and video explanation, discussion and practice questions, see How does a holder receive payment on a negotiable instrument?

Who is Obligated to Pay Negotiable Instrument?
The maker of a note or drawee of a draft is “primarily obligated” to pay the instrument. If the maker or drawee pays the note or draft, it is satisfied. If, however, the maker or drawee fails to honor the note or draft, anyone who held and then transferred the instrument may be liable to pay it. These third parties are “secondarily liable” to pay the instrument. By transferring the instrument, they warrant that the instrument being held is valid and payable. This is known as “transfer warranty”. An individual who signs an instrument as indorser is also potentially liable to pay the instrument if it is dishonored. This is known as “indorser liability”. Generally, an indorser is also a transferor and incurs potentially liability as a transferor and indorser; however, in some cases, a third party will indorse and instrument but not be a holder or transferor of the instrument. This is common when third parties are asked to co-sign or act as guarantor of the note. The warranties provided by transferors and indorsers of a negotiable instrument (and other parties potential liability to pay the instrument) are discussed separately. For further written and video explanation, discussion and practice questions, see Who is potentially liable on (or obligated to pay) a negotiable instrument?

Liability for Representative Signing Negotiable Instrument
If a representative (an agent) signs a commercial instrument on behalf of a the represented person or business (the principal), the principal is bound and made liable by the representative signing either the principal’s name or the agent’s name. The representative is not liable on the instrument if: the form of the signature shows unambiguously that the signature is made on behalf of the represented person, and the instrument identifies the represented person. This standard goes beyond the contract law standards for agent authority and principal liability. For further written and video explanation, discussion and practice questions, see When is an individual liable for a representative signing a negotiable instrument?

Rules for a Lost Negotiable Instrument

Payment of Negotiable Instrument Overdue
An instrument is overdue when the obligation to pay arises (upon presentment), but it has not been paid. An overdue instrument may give rise to a cause of action against a maker or drawee for failure to pay; also, it may make the instrument unenforceable as against a payor or drawee. When a negotiable instrument becomes overdue varies depending on whether the instrument is payable on time or on demand. A payable on demand instrument is overdue on the earliest of: the day after demand for payment is duly made; for a check, 90 days after its posted date; or after a period of time unreasonably long under the circumstances. An instruments that is payable at a definite time is overdue the day after the due date for making the whole payment or payment of an installment. If the instrument requires presentment for payment, the instrument would be overdue the day after demand for payment is made. If the note has a clause calling for acceleration of all future payments upon default (such as becoming overdue), the document is overdue after the day established as the accelerated due date. For further written and video explanation, discussion and practice questions, see When is payment of a negotiable instrument overdue?

Effect of Negotiable Instrument on Underlying Obligation
Most negotiable instruments arise pursuant to an underlying agreement, contract, or obligation. A maker or drawer creates the instrument and issues it to the holder in satisfaction of her obligation under an underlying agreement. For “ordinary instruments” the underlying obligation is merged and suspended until the negotiable instrument is payed. That is, the issuee may withhold performance of her obligation under the contract (such as delivery of goods) until the instrument is paid. An ordinary instrument is any instrument that does not qualify as a “near-cash instrument”. If the commercial paper is a near-cash instrument, the maker or drawer’s obligation is discharged at the time the instrument is accepted by the party to the underlying agreement. The idea is that these instruments are the equivalent of cash and thus satisfy the maker or drawer’s obligation. Near cash instruments include certified checks, cashier’s checks, and teller’s checks. For further written and video explanation, discussion and practice questions, see What effect does a negotiable instrument have on the underlying obligation?

What is a “Holder in Due Course”?
If certain conditions are met, a holder of a negotiable instrument may further elevate her rights to enforcement (receive payment) of the negotiable instrument. That is, the holder of a negotiable instrument is elevated to a higher status than that of a simple holder if she qualifies as a “holder in due course” (HDC). Qualifying as a holder in due course (HDC) makes the negotiable instrument more valuable to the holder, as a HDC has a stronger right to payment of the instrument than an ordinary holder. If a holder is not a HDC, her rights in the instrument are the same as the original payee of the instrument prior to transfer. That is, her right to payment of the instrument depends upon the relationship between the issuer and the original payee. Upon receipt of the instrument, she inherits the rights of the original payee along with whatever claims and defenses that the maker or drawer has against the original payee arising out of the contract. HDC status makes the holder immune from these defenses at the time of presenting the instrument. HDC benefits are as follows: The payor of the instrument is estopped (stopped from) denying the validity of the instrument or asserting any personal defenses to payment of the instrument. The instrument may be purged of any defects that are not apparent to the holder in due course. The holder in due course may assert her right to payment against any prior indorsers or immediate transferor of the instrument if the instrument is dishonored (not payed) upon presentment. Liability of transferors or indorsers of a negotiable instrument is discussed separately. For further written and video explanation, discussion and practice questions, see What is a "holder in due course"?

Requirements to be a Holder in Due Course
To qualify as a HDC, the holder of the commercial paper must meet the following requirements: Value - The holder must take the instrument for value. This means that the holder must provide money or goods for the instrument. The transfer cannot be a gift or inheritance. Good Faith - The holder must receive the instrument in good faith. This means that the holder cannot have the intent to defraud anyone in receiving the instrument. It is easy to imagine any number of schemes in which a transferor would try to manipulate the law by transferring an instrument to a holder with a greater right to repayment. Unaware of Defenses - The holder cannot have notice that there is a valid defense to enforcement of the instrument. This is generally deemed to be actual notice, but constructive notice from the situation could disqualify the individual as well. HDC status is determined at the time that the holder receives the instrument. If the holder meets the above requirement at the moment when she takes possession, she is a HDC. It does not matter if afterwards she learns of a potential defense. Each of the elements for HDC status is discussed separately. For further written and video explanation, discussion and practice questions, see What are the requirement for a holder to become a holder in due course?

Receive and Instrument for Value
The holder must provide some form of value, such as assets, services, or money in exchange for the instrument. Receiving the instrument as a gift is not “for value”. Value may also mean taking the instrument as payment of an antecedent debt, as consideration for a fully-performed contract, in exchange for another negotiable instrument, or in exchange for an irrevocable obligation. When exchanging the instrument for services or irrevocable obligations, the key characteristic is that the value must have already been provided. That is, there is no future obligation (such as a promise to sell goods or perform services) as part of the transfer for value. For further written and video explanation, discussion and practice questions, see Receive an instrument for value?

receive and Instrument in Good Faith
Receiving an instrument in good faith means acting in accordance with reasonable commercial standards and honesty in fact (no fraudulent intent in receiving the instrument). A holder must meet two tests to determine if good faith is present: Subjective Test - Did the holder believe the transaction was completed without the intent to defraud or deceive? Objective Test - Would a reasonable person believe the transaction to be commercially reasonable? For further written and video explanation, discussion and practice questions, see Receive an instrument in good faith?

Receive Instrument without Notice of a Valid Defense
A recipient of a negotiable instrument cannot become a holder in due course if she is aware (or has “reason to know”) that there are some valid defenses that the payor may assert against payment of the instrument. Remember, status as holder in due course would insulate the holder against these defenses. Valid defenses of the payor against payment of the instrument may include: Overdue - If the instrument has a stated time for payment and that time or date has passed, it is overdue. Dishonored - If the instrument has been presented for payment and is dishonored. Default on Collateral Instrument - This generally arises when the instrument is issued as part of a series of transactions. Knowledge of an uncured default in another instrument issued as part of the same series is notice of a valid defense. Instrument is Altered, Forged, or Incomplete - An unauthorized alteration, unauthorized filling in of an incomplete instrument, or a forgery of an instrument is a valid defense against payment. Notice of these defenses may be actual or constructive. That is, if the name signed on the instrument is wrong or incorrect, this could be considered constructive notice of a valid defense. Notice of Claims or Disputes - A valid defense includes when a third party has a claim to the instrument or there is a dispute between the original parties to the instrument. This places the risk on the maker or drawer responsible for creating the incomplete instrument. The UCC specifically excludes a list of individuals from HDC status based upon the manner in which they became holder of the instrument. Judgment creditors, bulk instrument purchasers, and heirs inheriting the instrument, for example, do not qualify as HDCs. For further written and video explanation, discussion and practice questions, see Receive an instrument without notice of a valid defense?

Effect of “Discharge” of Underlying Obligation
Negotiable instruments are generally created as consideration in a contract between two parties. That is, there is a contractual relationship (known as the underlying agreement) between the original creator (issuer) and recipient (issuee and holder) of the negotiable instrument. If the parties to the underlying agreement fail to carry out their obligations, it may affect the ability of a holder to later enforce the instrument against the payor. This is because the holder (as transferee) receives the same rights and the transferor. She also is subject to any defenses the payor may have against the issuee with regard to the underlying contract. A HDC, however, is not subject to the payor’s personal defenses to payment of the instrument. Pursuant to the above-stated rules, discharge of either party from her obligations under the contract giving rise to the negotiable instrument may serve as a defense to the payor having to pay the instrument. Discharge of the underlying obligation does not, however, affect the payment rights of a HDC who takes the instrument without notice of the discharge. While notice of discharge of the underlying obligation does not constitute “notice of a valid defense”, it may affect the HDC’s right to seek payment against the payor if the HDC received the instrument with knowledge of the underlying discharge. For further written and video explanation, discussion and practice questions, see How does discharge of the "underlying obligation" affect a holder in due course?

What is the “Shelter Rule”?
Status as a holder in due course (HDC) may strengthen the rights of a holder to receive payment on a negotiable instrument. When a holder may not qualify as a HDC, the “shelter rule” is a separate principle that may protect her rights. Pursuant to the shelter rule, the transferee of a negotiable instrument receives all of the rights of the transferor of the instrument, unless the transfer is carried out by fraud or illegal means. This is important in situations where the transferor is a holder in due course, but the transferee is not. The shelter rule provides liquidity to a HDC who, after accepting an instrument, learns of a defense against its enforcement. The HDC could validly transfer the instrument to another holder who has notice of the underlying defense. The new holder would have the same rights as the HDC. It is important to note that, if a holder in due course learns that there is a valid defense against enforcement or that the underlying obligation has been discharged, she must disclose that information to the transferee who provides value for the instrument. If not, the transfer by the HDC to the new holder could be deemed fraudulent. This would destroy the shelter principle protections. For further written and video explanation, discussion and practice questions, see What is the "Shelter Rule"?

Limit Transferee from Holder in Due Course Status
In some situations, it is possible for the issuer of a note to limit the ability of anyone to whom the note is transferred to become a holder in due course. The Federal Trade Commission allows such a limitation for notes used in sales of goods. The note must have the proper language in the legend or footnoted that the paper may be subject to applicable defenses and a possessor is not a holder in due course. This action preserves the ability of the maker of the note to assert any defenses to payment (particularly those arising in the underlying agreement) against a later transferee of the note. For further written and video explanation, discussion and practice questions, see Can you limit a transferee from becoming a holder in due course?

What are “Personal Defenses”?
A holder in due course (HDC) has greater rights to enforce an instrument against the payor than does a mere holder of the instrument. The HDC is shielded from certain defenses against enforcement of an instrument. Generally, a payor may assert any number of “personal and real defenses” against enforcement of a note by a holder. The payor, however, can assert only real defenses, not personal defenses, against the holder in due course. Personal Defenses - Personal defenses are generally defenses applicable to the underlying agreement or between the original parties to the underlying agreement. Common personal defenses are as follows: Breach of Contract, Failure of a Condition, Lack or Failure of Consideration, Mistake, Waiver, Prior Payment, Theft of the Instrument, Unauthorized Completion, Fraud in the Inducement. For further written and video explanation, discussion and practice questions, see Personal Defenses?

What are “Real Defenses”?
Real Defenses - Real defenses apply against any holder, including a holder in due course. Common real defenses are as follows: Forgery, Bankruptcy, Alteration, Fraud in Fact. For further written and video explanation, discussion and practice questions, see Real Defenses?

What is a “Claim in Recoupment”?
A claim in recoupment is similar to a personal defense. It allows a payor to offset any claim that she has against the claimant or the original issuee. For further written and video explanation, discussion and practice questions, see What is a "claim in recoupment"?

Rights of Holder in Due Course if Consumer Transaction
There is a broad exception to the heightened rights afforded a holder in due course if the instrument is issued pursuant to a consumer transaction. This situation generally arises when a consumer of a good signs a note promising to pay the debt arising from purchase of the good. It may not be fair to force a consumer who writes a note to have to pay a third-party, holder in due course if the underlying contract is breached. As such, the Federal Trade Commission and some states require consumer credit contracts (and sometimes consumer promissory notes) to contain the designation “consumer paper”. This designation makes the instrument non-negotiable. As such, no one can be a holder in due course under the UCC. For further written and video explanation, discussion and practice questions, see What are the rights of a holder in due course if the instrument involves a consumer transaction?

Forged Negotiable Instrument
A forged negotiable instrument is not enforceable against the party whose name was forged. The forged instrument is, however, enforceable against the forger. Basically, the instrument is treated as though the forger signed her own signature. Also, a forged negotiable instrument puts affirmative duties on parties implicated in the forgery. For example, a drawee bank on a forged check must use ordinary care in inspecting a potentially forged signature when paying check. The owner of the check may be liable if the check is stolen and forged because of her own negligence. The owner has a duty to verify records to identify forged instruments. The drawer is barred from contesting improper payment of the check by a one-year statute of limitations. For further written and video explanation, discussion and practice questions, see What happens if a negotiable instrument is "forged"?

Stolen Negotiable Instrument
A negotiable instrument made out to a specific individual is order paper. If the instrument is stolen, the thief can only transfer it by altering or forging the payee’s signature. As such, a transferee of stolen, forged order paper is not a holder or holder in due course and therefore does not take free of the payor’s defenses. Bearer paper, on the other hand, may be transferred by anyone in possession of the instrument. A thief can negotiate stolen bearer paper to a holder. A holder of the paper would be subject to a payor’s personal defenses or a claim by a payee that the instrument was stolen. In contrast, a holder in due course of stolen bearer paper takes the instrument free of the claims of the payor that it was stolen. For further written and video explanation, discussion and practice questions, see What happens if a negotiable instrument is "stolen"?

“Guarantor” or “Surety” of a Negotiable Instrument
A guarantor (also known as a surety or co-signor) serves to add certainty of payment of a negotiable instrument. A guarantor of a note or draft is an “accommodation party” who signs the instrument as an indorser. There are a couple of forms of guarantor, as follows: Guarantor of Payment - A co-maker’s accommodation indorsement guarantees payment. The holder may demand payment from her without first seeking payment from other co-maker. Guarantor of Collection - A collection guarantor is an accommodation party who is liable only if a judgment is rendered against a payor and the judgment is uncollectible against the debtor or is returned unsatisfied. For further written and video explanation, discussion and practice questions, see What is the role of a guarantor or surety of a negotiable instrument?

“Accord & Satisfaction” of a Negotiable Instrument
An accord and satisfaction is a resolution of a contested debt. For example, the payor and holder of a negotiable instrument may have a dispute as to the amount and duty of payment of the instrument. Often a payor of the debt will offer a lesser amount than what is claimed by the holder in full satisfaction of the debt owed. This is an offer of settlement of the disputed debt. An instrument that purports to be full payment for an obligation will discharge an obligation if certain requirements are present: Good Faith - One party, in good faith, tenders an instrument to the claimant as full satisfaction of the claim; Bona Fide Dispute - The amount of the claim is subject to a bona fide dispute; Payment Accepted - The party receiving the offer of settlement obtains payment of the instrument; and Adequate Notice - The instrument or accompanying written communication contains a conspicuous statement to the effect that the instrument is tendered as full satisfaction of the claim. A creditor receiving an offer of accord and satisfaction who inadvertently accepts the payment (not aware of accord language), upon learning of the other party’s intent, may make or offer repayment within 90 days of receipt. For further written and video explanation, discussion and practice questions, see What is an "accord & satisfaction"?

Primary and Secondary Liability on Negotiable Instrument
There are two main types of liability on a negotiable instrument - primary and secondary liability. The maker of a note and drawee of a draft are primarily liable to pay the instrument. Parties who later sign, transfer, or present an instrument may be secondarily liable to pay the instrument. Secondary liability is conditioned upon the note or draft being dishonored upon presented for payment to the primarily liable party. When a payor dishonors an instrument, the holder may seek payment from third parties who previously signed or transferred that instrument. The ability to receive payment from previous signors and transferors is based upon theories of warranty. These individuals, in certain circumstances, warrant to later transferees or holders that the instrument is valid and payable. For further written and video explanation, discussion and practice questions, see What is primary and secondary liability on an instrument?

“Drawer or maker liability” for a Negotiable Instrument
A drawer of a draft orders that at third-party drawee pay a specific amount to a payee who presents the instrument. The drawer, as creator of the instrument, is liable if the drawee dishonors (refused to pay) the draft. Likewise, a maker of a note is liable to a holder who presents the note for payment. If a maker or drawer wrongfully refuses to pay the instrument, any person entitled to enforce the instrument or any indorser who paid the instrument may sue for wrongful dishonor. For further written and video explanation, discussion and practice questions, see What is "drawer or maker liability" for a negotiable instrument?

“Transferor Warranty”
A transferor of a negotiable instrument warrants the following to the recipient of the instrument: Good Title - The transferor has good title to the instrument; Enforceability - The transferor is entitled to enforce the instrument; Authorization - All signatures are authorized and authentic; Alterations - There have been no alterations to the instrument; Defenses - There are no defenses to enforcing the instrument; and Solvency - The transferor does not know the payor to be insolvent. Transfer warranties apply when the transferor transfers the instrument for consideration. The new holder only receives transfer warranties from an immediate transferor. Thus, a holder cannot enforce the instrument pursuant to transfer warranty against anyone who transferred the instrument without consideration or did not directly transfer the instrument to her. For further written and video explanation, discussion and practice questions, see What is "transferor warranty" of a negotiable instrument?

What is “Indorser Warranty”?
Assurances to the marker or drawer include: Good Title - She has good title to the instrument; Forgery - She has no knowledge of forgery; and Materially Altered - The instrument is not materially altered. An indorser warrants to a subsequent holder that: Good Title - She has good title; Signatures - All signatures are genuine; Alterations - The instrument is not materially altered; Defenses - There are no known defenses against payment of the instrument, and Insolvency - There is no knowledge of the maker or drawer’s bankruptcy. Liability for a failure of these assurances is known as “indorser liability”. The difference between indorser warranties and transferor warranties is that any good-faith holder of the note may enforce these warranties against any indorser. Recall, transfer warranties are limited to the immediate transferor. Indorser warranties make the indorser (signor) of an instrument secondarily liable to a holder. That is, the indorser is liable to pay an instrument that has been dishonored. An indorser who pays the instrument is left to seek reimbursement from a prior indorser or anyone who transferred the instrument to her. For further written and video explanation, discussion and practice questions, see What is "indorser warranty" of a negotiable instrument?

What is “Presentment Warranty”?
Presentment warranty applies when a person entitled to payment of an instrument presents it to a maker or drawee for payment. The presenter warrants to a good faith payor the following: Enforceability - She is entitled to enforce the instrument; No Alterations - The terms of the instrument are genuine and there have been no alterations; and No Forgeries - The drawer of the instrument’s signature is genuine. Presentment warranties generally apply to drafts, as all drafts must be presented for payment. This warranty is broader than the name implies. A payor of an instrument can enforce these warranty provisions against the presenter and all prior transferors of the instrument. The theory is that any transferor of the instrument represents that the instrument may be presented for payment in accordance with the above warranties. For further written and video explanation, discussion and practice questions, see What is "presentment warranty" of a negotiable instrument?

What is “Warrantor’s Liability” for Dishonored Note?
An individual presenting a draft or note for payment that is dishonored may recover damages from a prior warrantor of the instrument. That is, a person receiving an instrument in good faith and subject to warranties may recover from the warrantor an amount equal to the loss suffered as a result of the dishonor. The holder may recover the amount payable on the instrument, plus expenses and loss of interest incurred as a result of the dishonor. For further written and video explanation, discussion and practice questions, see What is a warrantors liability for a dishonored note or draft?

Time Limitation for Warranty of Negotiable Instrument
The holder of an instrument must make a warranty claim to a warrantor within 30 days of notice of dishonor of the instrument. Failure to give this notice within 30 days may relieve the warrantor from liability for any losses incurred as a result of the failure of the claimant to give timely notice. For further written and video explanation, discussion and practice questions, see What is the time limitation for warranty of a negotiable instrument?

Discharge from Warranties on Negotiable Instrument
Transferor, indorser, and presenter liability is discharged by any manner that would effectively discharge a party’s obligation on a contract at common law. These provisions may relieve the obligation of a payor or payee, but could still subject transferors or indorsers to liability. For further written and video explanation, discussion and practice questions, see When are the warranties of a negotiable instrument discharged?


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