BLAW 2 Exam 1

Contractual Obligation

Contractual Obligation

Obligation to pay cash

Assignor

The party making the assignment

Assignee

The party to whom the assignment is made

Obligor

One who owes an obligation to another

Negotiability

Characteristic of a document that allows it to be legally/freely assignable, saleable, or transferable. Elements include a signature, it must be written, and must state the amount to be paid

Negotiable Instrument

A written promise or order to pay a specific sum of money that may be transferred by endorsement or delivery. The transferee then has the original payee's right to payment.

EX:

-Checks

-Promissory Notes

-Drafts

-Certificates of Deposits

-Bonds

-Mortgages

-Credit/Debit Cards

Notes (Promise to Pay)

A written promise by a maker (issuer) to pay a payee (2 parties)

Certificates of Deposit (CD) (Promise to Pay)

A specialized form of note that is given by a bank

Drafts (Order to Pay)

Involves three parties: The drawer orders the drawee to pay a fixed amount of money to the payee

• Drawee possesses money belonging to drawer or owes drawer money

Checks (Order to Pay)

A specialized form of draft that is drawn on a bank and payable on demand; the drawer (check signer) orders the drawee (bank) to pay the payee on demand

Drawee

The person, company, or financial institution ordered to pay a draft

Drawer

The person who executes any draft (Check)

Writing (First Requirement of Negotiable Instruments)

Any intentional reduction to tangible form is sufficient

• Need not be on paper

• Electronic documents

Signed (Second Requirement of Negotiable Instruments)

Any symbol executed or adopted by a party with the present intention to authenticate/adopt or accept a writing

• Signature most common, but not required

• Mark, symbol, initials, tradename

• Indicates intent to satisfy obligation

Promise (note) (Third Requirement of Negotiable Instruments)

An undertaking to pay, which must be more than a mere acknowledgment or recognition of an existing debt

• IOU

• Two party instrument

Order (draft) to pay (Third Requirement of Negotiable Instruments)

Instruction to pay

• Three party instrument

Affirmative Act

Policies and procedures designed to compensate for past discrimination against women and members of minority groups

Unconditional (Fourth Requirement of Negotiable Instruments)

An absolute promise/order to pay that is not subject to any contingencies

• A promises to pay B if the goods are delivered on time

Unconditional Reference to Other Agreements

Does not destroy negotiability unless the recital makes the instrument subject to or governed by the terms of another agreement EX: I promise to pay to order of Tom $10,000 if the goods as described in attached Purchase Order are delivered

The Particular Fund Doctrine

Order or Promise to pay only out of a particular fund (source) no longer is conditional and does not destroy negotiability

Recital of Consideration

• Not destroy negotiability

• "This note is made in consideration of a purchase of a computer"

Fixed Amount (Fifth Requirement of Negotiable Instruments)

The holder (Payee) must be assured of a determinable minimum amount

• Lump sum or installments

• Provisions in the instrument may increase the amount of recovery under certain circumstances

• Not apply to interest (or other charges)

Money (Sixth Requirement of Negotiable Instruments)

Legal tender authorized or adopted by a sovereign government as part of its currency

• Need not be US currency

• Virtual Currency

• Not commodities (gold)

No Other Obligation/Undertaking (Seventh Requirement of Negotiable Instruments)

Promise or order to do anything in addition to the payment of money destroys negotiability

• Promise to pay money and only money

• Collateral OK

Payable on Demand or Definite Time (Eighth Requirement of Negotiable Instruments)

Instrument is demand paper if it must be paid upon (holder's) request

• Instrument is TIME paper if it is payable at a DEFINITE time

• Date must be determined from the instrument itself

• Dated instrument

• "Payable 90-days after issuance"

• Latest date for payment

Payable to Order or Bearer (Ninth Requirement of Negotiable Instruments)

Negotiable instrument must contain words indicating that the maker or drawer intends that it pass into the hands of someone other than the payee

• Instrument may be transferred by payee to others

• "Magic words of negotiability"

Payable to Order

Payable to the "order of" (or equivalent words) a named person or anyone designated by that person

Payable to Bearer

Payable to bearer or order of bearer

• Payable to Cash or left blank

• Payable to order of Payee or bearer

• Whoever has possession

Incomplete Instrument

Instrument is not negotiable until completed

Ambiguous Instruments

Holder may treat instrument as either a draft or a note if it is unclear

Holder

Possessor of an instrument with all necessary indorsements

• Entitled to get paid

• Includes original payee

• Bear paper only required possession

Assignment

Assignee stands in shoe of assignor

• Not negotiation

• B may normally assign its right to get paid to another party (C)

Negotiation of Order Paper

Transferred by possession and indorsement by all appropriate parties

Negotiation of Bearer Paper

Transferred by possession alone

The Imposter Rule

An indorsement of an imposter in the name of the named payee is effective if the imposter has induced the maker/drawer to issue the instrument to him using the name of the payee

• A issues check to man claiming to be Elon Musk. Payee forges Musk's name

The Fictitious Payee Rule

An indorsement by any person in the name of the named payee is effective if an agent/employee of the maker/drawer has supplied her with the name of the fictitious payee

• A's employee issues check payable to "Ajax Inc." & forges indorsement by Ajax to that employee

Indorsements

Signature/Mark (on the instrument) of a payee, drawee, accommodation party, or holder

Blank Indorsement

One specifying no indorsee and making the instrument bearer paper

Special Indorsements

Identify an indorsee to be paid and makes the instrument order paper

Unrestrictive Indorsements

Do not limit rights of indorsee

Restrictive Indorsements

Limit purpose for which the proceeds of can be applied

Indorsements for Deposit or Collection

Limit further negotiation to those consistent with the indorsement

Indorsements in Trust

Require indorsee to pay or apply all funds in accordance with the indorsement

Indorsements with Ineffective Restriction

Conditional indorsements and indorsements attempting to prohibit further negotiation

Unqualified Indorsement

One that imposes liability on the indorser

Qualified Indorsement

Without recourse, one that limits the indorser's contractual liability

Indorsement: "John Doe"

Blank, Nonrestrictive, Unqualified

Indorsement: "Pay to Richard Roe, John Doe"

Special, Nonrestrictive, Unqualified

Indorsement: "Without Recourse, John Doe"

Blank, Nonrestrictive, Qualified

Indorsement: "Pay to Richard Roe in trust for John Roe, without recourse, John Doe"

Special, Restrictive, Qualified

Indorsement: "For collection only, without recourse, John Doe"

Blank, Restrictive, Qualified

Indorsement: "Pay to XYZ Corp., on the condition that if it delivers goods ordered this date, John Doe"

Special, Nonrestrictive, Unqualified

Place of Indorsements

Must be on the instrument or on an allonge (paper attached to the instrument)

• Often on back of instrument

Incorrect or Misspelled Indorsement

Holder may require indorsement to be in the name stated, the correct name, or both

Holder in Due Course

One who acquires a negotiable instrument in good faith and for consideration, and thus has certain rights above the original payee

• Takes instrument free of all personal defenses

Value

Differs from contractual consideration and consists of any of the following:

• Performance of legal consideration (excludes executory promises)

• The acquisition of a security interest/lien

• Taking the instrument in payment for a debt

• The giving of a negotiable instrument; or

• The giving of an irrevocable commitment to a third party

Good Faith

Honesty in fact and the observance of reasonable commercial standard of fair dealing

• Subjective = Honesty

• Objective = Reasonable commercial standards

Notice an Instrument is Overdue

• Time paper is overdue after its stated date

• Demand paper is overdue after demand has been made or after it has been outstanding for an unreasonable amount of time

Notice an Instrument Has Been Dishonored

Dishonor is refusal to pay or accept an instrument when it is due

Notice of a Claim or Defense

A defense protects a person from liability, but a claim is an assertion of ownership

Without Reason to Question its Authenticity

Instrument cannot bear such apparent evidence of forgery or alteration or otherwise be so irregular or incomplete as to call into question its authenticity

A Payee may be Holder in Due Course

• 3rd party involvement

• EX: A fraudulently induces B to write check payable to C. C may qualify as HDC

The Shelter Rule

The transferee of an instrument acquires the same rights that the transferor had in the instrument

• If transferor was HDC, later transferee is HDC (Even if transferee does not qualify as HDC)

• Unless transferee was participant in the fraud or other wrongful act

Real Defenses

Real defenses are available against ALL holders, including HDC:

• Infancy

• Void Obligations

• Fraud in the Execution

• Discharge in Insolvency Proceedings

• Discharge of Which the Holder Has Notice

• Unauthorized Signature

• Fraudulent Alteration

Personal Defenses

All other defense that might be asserted in the case of any action for breach of contract

• Voidable

• EX:

• Fraud in inducement

• Non-physical duress

• Failure of consideration

Federal Trade Commission

• Consumer Credit Contracts

• Transferee of consumer credit contracts cannot take as a holder in due course

Contractual Liability: Signature

No person has contractual liability unless their signature appears on it:

• Bearer paper

• Signature loosley defined

• Signature of agent

• Unauthorized signature

• Forgery

• EX: Maker, Drawer, Endorser, Acceptor

Primary Liability

Absolute obligation to pay a negotiable instrument

Makers

The maker guarantees that he will pay the note according to its original terms

Acceptors

A drawee assumes primary liability when she accepts it

Acceptance

A drawee's signed engagement to honor the instrument

• Certification acceptance of a check by a bank

Secondary Liability

If the instrument is not paid by a primary party, indorsers and drawers are secondarily liable unless they have disclaimed their liability or have a valid defense (forgery)

• If a draft (check) is accepted by a bank (drawee), the drawer and all prior indorsers are discharged from contractual liability

Acceptor

A drawee that has accepted the draft for payment

Disclaimer

Drawer (except on a check) or indorser may disclaim contractual liability by a qualified drawing or indorsement ("WITHOUT RECOURSE")

Contractual liability

Liability assumed through a hold-harmless agreement.

Hold-Harmless Agreement

A contractual agreement that transfers the liability of one party to another party; it is used by landlords, contractors, and others as a way to avoid or reduce risk.

Dishonor

Involves the refusal to pay an instrument when presented

Drawer of Unaccepted Draft

Liability contingent upon dishonor (by drawee)

Any Indorser or the Drawer of an Accepted Draft

Liability is contingent upon dishonor and notice of dishonor

Contractual Liability: Conversion

Occurs when the instrument is taken by transfer, other than negotiation, from a person not entitled to enforce the instrument OR a bank makes payment for a person not entitled enforce or receive payment

• EX: Drawee bank pays a check with a forged or missing indorsement

Discharge

Liability is terminated due to:

• Payment

• Tender of Payment

• Cancellation

• Renunciation

Warranty Liability (Article 3)

1. Transferor's Warranties

2. Presenter's Warranties

• Applies regardless of signature

• Negotiation of bearer paper by transferring possession alone (no signature) - Transferor warranty only applies to immediate transferee

• May be disclaimed

• Express language required

Transferor's Warranties

Transfers instrument to subsequent holder and receives consideration. Includes:

• Entitlement to Enforce

• Authentic and Authorized Signatures

• No Alteration

• No Defenses

• No Knowledge of Insolvency

Warrantor

All people who obtain payment/acceptance of an instrument as well as all prior transferors

Beneficiary

The presenter's warranties run to any person who in good faith pays/accepts the instrument

• Payor of instrument

Warranty Liability

A liability that is recorded for the future costs of claims that are anticipated because of product warranty agreements

Warranty (Warranty Liability)

Drawees of unaccepted drafts (banks)

• Entitled to Enforce

• No Alteration

• Genuineness of Drawer's Signature

Depositary Bank

The bank in which the payee or holder deposits a check for credit

Intermediary Bank

A bank, other than the depositary/payor bank, involved in the collection process

Payor Bank

Under its contract with the drawer, the payor bank (drawee) agrees to pay to the payee, or his order, checks that are issued by the drawer

• Provided it is not countermanded by a stop payment order and provided there are sufficient funds in the drawer's account

• Wrongful dishonor & "stale checks"

Stop Payment Order

Command from a drawer to a drawee not to pay an instrument

• Oral stop payment order is binding for 14 days; a written order is effective for six months and may be renewed

Provisional Credit

Tentative credit for the deposit of an instrument until final credit is given

• Amount not available for withdrawal

Final Credit

After payment of the instrument by the payor bank

• Provisional credits become final

• If the payor bank (drawee) does not pay the check, the depositary bank reverses the provisional credit

Collecting Bank (Depositary & Intermediary Banks)

Responsibilities including agency, duty of care, duty to act timely, indorsements, and warranties

Agency

A collecting bank is an agent of the owner of the check until the settlement becomes final

Duty of Care

Must exercise ordinary care

Duty to Act Timely

A collecting bank acts timely if it takes proper action before its midnight deadline

• Banking day (9-4)

Collecting Bank Indorsements

If an item is restrictively indorsed "for deposit only," only a bank may be a holder

Warranties

Customers and collecting banks give warranties on transfer, presentment, and encoding

Final Payment

Occurs when the payor bank does any of the following, whichever happens first:

1. Pays an item in cash;

2. Settles and does not have the right to revoke the settlement; or

3. Makes a provisional settlement and does not properly revoke it