16. Who is potentially liable on (obligated to pay) a 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.
• Note: Generally, a holder must present an instrument for payment and that demand must be denied before the holder can seek payment from an transferor or indorser.
• Discussion: Why do you think the law makes transferors and indorsers secondarily liable on the instrument? How does transferor and indorser liability relate to the nature of a negotiable instrument?
• Practice Question: Olivia is the holder of a note. She presents the note to the payor for payment. The payor rejects the note and refuses to pay. What are Olivia’s options for seeking payment?