Chapter 13 Negotiable Instruments

Learning Objectives



What are the requirements for an instrument to be negotiable?



What are the minimum requirements for HDC status?

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What is the key to liability on a negotiable instrument?



What are the bank’s responsibilities regarding stale checks, stop payments and forged checks?



What is e-money and how is it stored?

Article 3



A negotiable instrument is a signed writing that contains an unconditional promise or order to pay an exact sum of money on demand or at a specified time to a specific person or bearer.

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Can function as a substitute for money or an extension of credit.

Types of Instruments

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Drafts and Checks (Orders to Pay)

 Draft—unconditional written order that involves three parties.

• Drawer (creates the draft) who • Orders the party holding the money (the Drawee) to pay money • To a Third Party (the Payee)  Time Draft  Sight Draft

Types of Instruments



Promissory Notes and C.D.’s (Promises to Pay)

 Promissory Note—written promise to pay money by Maker to Payee.

 C.D.—type of note. Created when party deposits money with bank who promises to pay, with interest, on a certain date.

Requirements for Negotiability



Must meet the following criteria:

 Be in Writing  Be signed by the Maker or Drawer  Be unconditional promise or order to pay  State a fixed amount of money.

 Be payable on demand or definite time  Be payable to order or bearer, unless a check.

Transfer of Instruments



By Assignment

 Transferee is an Assignee 

By Negotiation

 Transfer in which the transferee becomes a holder • Negotiating Order Instruments • Negotiating Bearer Instruments

Holder in Due Course (HDC)

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A holder (assignee) is generally subject to the same defenses that the assignor is subject to.

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A holder in due course (HDC) takes the instrument FREE of most of the defenses and claims that could be asserted against the transferor.

Requirements for HDC



A Holder in Due Course must:

 Give value for the instrument • Performance • Payment for preexisting debt • Irrevocable commitment  Take in Good Faith (honesty in fact)  Take Without Notice (of any defect)

Signature Liability



Every party who signs a negotiable instrument is either primarily or secondarily liable for payment.

 Primary Liability (only makers and acceptors are primarily liable)  Secondary Liability (contingent liability) • Proper and Timely Presentment • Dishonor • Proper Notice

Signature Liability

 

Accommodation Parties

 Signs for the purpose of lending her name as credit for another party.

Agents’ Signatures

 If authorized, can bind the principal.

 If unauthorized (forgery) signature is void.



Unauthorized Indorsements

 Imposters  Fictitious Payees

Warranty Liability

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Transferors make certain implied warranties on instruments they are transferring: Transfer and Presentment.

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Transfer Warranties (if consideration)

 Transferor has the right to enforce the instrument  All signatures are authentic and authorized  Instrument has not been altered.

 Instrument is not subject to a defense or claim  Transferor has no knowledge of insolvency

Warranty Liability



Presentment Warranties

protect the person to whom the instrument is presented:  Person obtaining payment has the right to enforce the instrument  Instrument has not been altered  Person accepting has no knowledge that instrument is unauthorized.

Defenses to Liability

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Universal (Real) Defenses to Avoid Liability by ALL Holders, including HDC

 Forgery  Fraud in the Execution  Material Alteration  Discharge in Bankruptcy  Infancy (Minor)  Illegality  Mental Incapacity  Extreme Duress

Defenses to Liability



Personal (or limited ) Defenses (only for holders, not HDC)

 Breach of Contract or Warranty  Lack or Failure of Consideration  Fraud in the Inducement  Illegality (voidable)  Mental Incapacity  Discharge by Payment/Non-Delivery

Checks and Banking System



Special type of draft by maker (drawer) drawn on a bank (drawee) ordering bank to pay third party (payee).

 Cashier’s Check—bank is both drawer and drawee.

 Traveler’s Check—payable on demand, payable by a financial institution, designated as a traveler’s check.

 Certified Check—accepted in writing by drawee bank.

Bank’s Duties

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Drawee (Bank) has a legal duty to honor Drawer’s (Maker) checks.

 If it wrongfully dishonors a check, it is liable for damages.

 

Overdrafts Postdated Checks

(Notice required)  

Stale Checks

(six months)

Stop-Payment Orders

Bank’s Duties



Death or Incompetence of Customer



Forged Drawers’ Signatures

 General Rule—no legal effect  Customer Negligence—bank normally not liable.

 Timely Examination of Statements by Customer  Time Limit for Bank’s Liability

Bank’s Duties

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Forged Instruments

 Bank must recredit customer’s account if payment made on forged instrument.

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Altered Checks

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Bank has a Duty to Accept Deposits

 Availability Schedule for Deposited Checks  Collection Process (local and Federal Reserve)

Electronic Fund Transfers

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EFT is a transfer of funds via the use electronic means



Types of EFT systems:

 Automated Teller Machine  Point of Sale (debit card)  Direct Deposit and Withdrawal  Pay by Telephone  Error Resolution and Damages 

Commercial Transfers

E-Money



Stored-Value Cards (pre-paid cards for use with long distance, cellular and library copy machines)



Smart Cards—

can authenticate the validity of transactions with digital signatures.

 Deposit Insurance  Legal Protection 

Encyrption and Privacy Protection

Online Banking



Virtual Banks (e.g., Bank of the Internet at www.bofi.com

)

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Uniform Money Services Act

 August 2001, NCCUSL would subject online banking and e-money to same regulations as traditional banks.

 Internet-Based Money—Paypal.com?