Liability and Discharge in Instruments
Liability on Instruments
Liability Concepts
Signature Liability: Happens when someone signs an official financial paper (like a check), taking responsibility for it. They can be either mainly responsible or secondarily responsible, depending on how they signed (e.g., as the person who wrote the check, or endorsed it).
Warranty Liability: This responsibility comes from giving or showing an official financial paper to someone else. It protects the people receiving or paying the paper from certain problems, even if no one signed it.
Secondary Liability: People who endorse checks (indorsers) and writers of checks (drawers) usually have secondary liability. This means they only have to pay if the main person responsible doesn't pay and they are properly told about it.
Primary Liability: People who promise to pay on notes (makers) and banks that agree to pay drafts (acceptors) have primary liability. They absolutely must pay the paper when it's due.
Warranty Liability
Definition: Warranty liability happens when someone gives or shows an official financial paper. It's a promise from the person giving or showing it that certain things about the paper are true.
Characteristics:
No signature needed: Unlike signing liability, warranty liability starts just by giving or showing the paper, even if no one writes their name on the back (indorses).
Doesn't depend on proper showing, non-payment, or notice: These steps are for secondary (signing) liability. Warranty liability is separate from these.
About who takes the risk of loss; people who can protect themselves best should handle the risks: This means the person who could have most easily found a problem (like a changed paper) usually pays the final cost.
Transfer Warranties
Definition: These promises are made when an official financial paper is given to someone for something of value (like a sale or delivery). They protect everyone who gets the paper afterward and, if the paper was endorsed, the person who got it directly from the endorser.
Key Points: When an official paper is handed over, the person handing it over usually promises that:
They have the right to get money from the paper.
All signatures on the paper are real and allowed.
The paper hasn't been changed.
No one can use a reason to avoid paying the paper against the person who handed it over.
They don't know if the person who made the paper, accepted it, or wrote an unaccepted draft has started bankruptcy (is unable to pay debts).
The person receiving the paper must ask for payment, which then creates a promise based on what happens.
Presentment Warranties
Definition: These promises protect the person who is asked to pay (like the bank, maker, or acceptor) and who pays or accepts the paper honestly.
Key Warranties Include:
The person asking for payment or acceptance has the right to get money from the paper (or is an authorized agent): This makes sure the person paying is giving money to the right owner and avoids paying someone else.
The paper has not been changed: This protects the payer from paying more money because of a fake change.
There's no knowledge that the writer's signature is fake: This means the person showing the paper doesn't know the writer's signature is a forgery. (Note: The bank that pays, not the person showing the paper, usually takes the risk if the writer's signature is fake).
Breach of Warranty
Claim: A problem arises as soon as the owner knows about a broken promise, like finding a fake endorsement or a change to the paper.
Notice Requirement: The owner must tell the person who transferred the paper about the broken promise within 30 days of finding it. If they don't give notice on time, the transferor might not be responsible for the loss if the delay caused it.
Damages:
Up to the full amount of the paper.
Plus costs and lost interest: This can include lawyer fees and other costs because of the broken promise.
Discharge of Liability
Definition: This happens when someone who was responsible for an official financial paper no longer has to pay for it, either because it's been paid or certain actions have been taken.
Ways to Discharge Liability:
Payment or offer to pay: This is the main way responsibility ends.
Canceling or Giving Up: An owner can purposely cancel a paper or give it back to a party, which stops that party's responsibility.
Getting it Back: If someone who was responsible for a paper before gets it back, then anyone who endorsed it in between is no longer responsible to the person who got it back or later owners.
Harming the right to get money back: If an owner harms another person's right to get money back (for example, by giving the maker of the note more time to pay without asking the endorser), that other person might no longer be responsible.
Harming the collateral: If an owner has a security interest (a claim) in property used as backup for the paper and damages the value of that property, those whose responsibility is affected might be let off the hook for the amount of the damage.
Payment and Tender of Payment
Definition: When the main person responsible (maker/drawee/acceptor) pays, it ends the responsibility for everyone else on the paper, including endorsers and any promises made, as long as the payment goes to the right person and isn't done dishonestly.
Effect on Liability: When the main person pays, all other related responsibilities (secondary signing responsibility and promise responsibility) usually end because the paper's goal has been met.
Certified and Cashier’s Checks
Certified Checks: These are checks approved by banks, meaning the bank promises to pay and sets money aside. This stops people from canceling payments or having issues with not enough money. Once certified, the person who wrote the check and any previous endorsers are no longer responsible, as the bank becomes mainly responsible.
Cashier’s Check: This is a check where the bank is both the writer and the payer. The bank is required to pay in most situations. The bank's own money is behind the check, making it a very safe way to pay, often used by banks or by customers who need assured funds.
Relationship Between Bank and Customer
Types of Relationships:
Debtor-Creditor: When a customer puts money in, the bank owes that money to the customer. The bank must pay checks as agreed, up to the money available in the account.
Contractual Relationship: The rules for the bank account are written down in an agreement, which is a contract between the bank and the customer. This covers things like fees, overdrafts, and how to solve disagreements.
Agency Relationship: The bank sometimes acts for the customer, like when it collects payment on a check the customer deposited (the bank acts like the customer's helper in getting the money).
Forged and Altered Checks
Forged Drawer’s Signature: A check with a fake signature from the person who wrote it usually can't be charged to that person. The bank takes the loss if such a check is paid, because banks are supposed to know their customers' signatures.
Exceptions include customer's carelessness or not checking bank statements in time: If the customer's carelessness largely helped the forgery happen (e.g., leaving blank checks lying around), or if they don't quickly report a forgery after getting their bank statement, the customer might have to take the loss.
Forged Indorsements: If an endorsement (a signature on the back) is fake, the paper wasn't properly transferred, and the person who pays on that fake endorsement usually takes the loss.
Altered Checks: If a check has been dishonestly changed (e.g., the amount is different), the bank that pays it can usually only charge the customer's account for the original amount of the check.
Check Clearing Process
Overview: This is how checks move from the bank where they were put in (depository bank) to the bank that will pay them (payor bank).
Checks are put into depository banks and are paid by payor banks.
Banks must send checks along quickly, usually overnight, to make the payment process faster.
Check 21 Act (Check Clearing for the 21st Century Act): This is a federal law that lets banks process checks electronically by making digital pictures (substitute checks) instead of sending the actual paper checks. This makes the process much faster and cheaper.
Liens
Definition: A lien is a legal claim against someone's property that gives a lender a direct interest in that property as security for a debt. Lenders can use this specific property to get their money back if the borrower doesn't pay.
Types of Liens
Mechanics Liens: These are legal claims set up by law to ensure payment for work, services, or materials used to improve real estate (like building a house). They are usually filed by builders, sub-contractors, or material suppliers who haven't been paid.
Artisan’s Liens: These are legal claims, based on old laws or new ones, that ensure payment for work and materials used to fix or improve personal items (like a car). For this claim to be good, the artisan (the worker) must keep the item until the debt is paid.
Judgment Liens: These happen when a lender wins a lawsuit against a borrower and then records that court decision in public records (e.g., where the borrower's property is). This creates a claim on the borrower's real estate, possibly allowing the lender to force a sale of the property to pay the debt.
Secured Credit
Types of Liens:
Non-consensual (by law or court order) vs. consensual (by agreement): Mechanics, artisan, and judgment liens usually happen without agreement (they come from law or court). Article 9 security interests are by agreement, made between the borrower and lender.
Benefits: Loans that are secured by property often have lower interest rates for borrowers than unsecured ones because the backup property makes the loan less risky for the lender. If the borrower doesn't pay, the secured lender has a specific asset to go after.
Security Interests
Creation (Attachment): A security interest (under Article 9 of the UCC) is created and becomes valid against the borrower when three things are met:
Written agreement (or holding/controlling the item): There must be a written agreement, signed by the borrower, that describes the property used as collateral. Or, the lender takes physical possession or control of the collateral.
Value given to the borrower: The lender must give something of value (like a loan) in return for the security interest.
Borrower's rights to collateral: The borrower must own the collateral or have the power to give rights in the collateral to the lender.
Attachment and Perfection of Security Interests
Attachment: This happens when the lender gets rights against the borrower for the collateral, as explained above. This makes the security interest valid between the borrower and the lender.
Perfection: This is how a lender makes its security interest strong against most other people (like other lenders or buyers). It usually gives the lender priority over claims that come later. Perfection is most often done by filing a UCC-1 statement with the right public office (usually the Secretary of State's office). Other ways include holding the collateral or automatic perfection for some types of collateral.
Bankruptcy Overview
Purpose: This is a detailed federal legal process made to do two main things:
To provide a fair way to collect debts from many people at once
Trustee: An official (usually a lawyer) named by the court to handle the bankruptcy case. Their job is to gather all the money and property of the person/company in bankruptcy, sell it if needed, and pay back the creditors (the people/companies owed money) fairly. The trustee makes sure everything follows the bankruptcy rules.
Types of Bankruptcy:
Chapter 7 (Liquidation): This is for individuals or businesses who can't pay their debts. A trustee sells off certain non-exempt property to pay creditors. The remaining eligible debts are usually wiped out, giving the debtor a "fresh start." Often referred to as "straight bankruptcy."
Chapter 11 (Reorganization): This is mainly for businesses, but sometimes for individuals with very large debts. It allows the debtor to keep their business running while working out a plan to repay creditors over time. The goal is to reorganize debts and continue operations.
Chapter 13 (Adjustment of Debts of an Individual with Regular Income): This is for individuals with a steady income who want to develop a plan to repay all or part of their debts over three to five years. Debtors keep their property, and payments are made to a trustee who then pays the creditors.
Creditors' Claims: People or companies who are owed money (creditors) must file a "proof of claim" to get paid in a bankruptcy case. The bankruptcy laws set rules for which creditors get paid first (priority claims).
Automatic Stay: When a bankruptcy case is filed, an "automatic stay" immediately stops most collection actions against the debtor. This means creditors can't call, sue, or try to collect debts until the bankruptcy court allows it.
Exemptions: In Chapter 7 bankruptcy, debtors can keep certain essential property (like a house up to a certain value, car, personal items) that is protected by federal or state laws. This property is "exempt" from being sold by the trustee.
Discharge: This is the legal act that wipes out a debtor's personal responsibility for most debts. Once a debt is discharged, creditors can no longer try to collect it. Not all debts are dischargeable (e.g., student loans, child support, certain taxes may not be).
Reaffirmation Agreement: Sometimes a debtor wants to keep a secured debt (like a car loan) and continue making payments on it, even if the debt would otherwise be discharged. This is done through a "reaffirmation agreement" which must be approved by the court.
Preferential Transfers: The bankruptcy trustee can sometimes take back money or property that the debtor paid to a creditor shortly before filing for bankruptcy (usually within 90 days for regular creditors, or one year for insider creditors). This is to ensure all creditors are treated fairly and prevent debtors from favoring certain creditors.
Property of the Estate: When bankruptcy is filed, almost all of the debtor's property becomes part of the "bankruptcy estate." This includes property owned on the filing date, and sometimes certain property received within 180 days after filing (like inheritances). The trustee manages this estate to pay creditors.