An introduction to the fundamentals of dynamic business law and business ethics chap017

Chapter 17 Ethical DilemmaAccording to UCC 3-416a, “a person who transfers an instrument for consideration warrants to the transferee, and, if the transfer is by indorsement, to any sub

Chapter 17

Holder in Due Course, Liability,

and Defenses

Chapter 17 Case Hypothetical

Timothy Jones drafts a check in the amount of $12,000 in full and final payment for a car that Andre Hastings is scheduled to deliver to him the following Friday Andre immediately completes a special endorsement to Clint Patterson on the back of the check (“Pay to Clint Patterson, Signed, Andre Hastings”), and

transfers the check to Clint in return for a lot of land Clint deeds to him.

Andre fails to deliver ownership and possession of the car to Timothy the

following Friday One week later, Clint approaches Timothy, and requests

payment of the $12,000 Clint shows Timothy Andre’s special endorsement to

him on the back of the check Timothy states “I don’t owe you anything Andre never delivered the car I was supposed to get for that $12,000 If you have

problems with what I’ve just said, go talk to Andre.”

Is Clint Patterson entitled to the $12,000 from Timothy Jones? If so, does

Timothy have any legal recourse against Andre Hastings?

Chapter 17 Case Hypothetical

Nora Abbey, eighteen years old, is overjoyed to have received her first paycheck from

her first employer, Nightingale Fashions, Inc The check is in the amount of $542.00, and

is drawn on the Bank of the Homeland Eager to document here entitlement to the

paycheck, Abbey turns the check over, and signs her name in the “endorsement” section She gets into her car, and heads to the Bank of the Homeland, where she has a

checking account, to make a deposit Unbeknownst to Nora, the check has slipped out of her pocketbook, and onto Main Street

A cross-wind blows the check onto a street corner An unidentified woman picks up the

check, and later that day, at another Bank of the Homeland branch, she cashes the

check Four weeks later, Nora notices that the check has been processed, and she

immediately calls the vice-president of the Bank of the Homeland branch she frequents,

requesting that the $542 be credited to her account The bank vice-president assures

Nora that she will “look into it,” but offers no assurances

Must the bank credit Nora’s account?

Chapter 17 Ethical Dilemma

According to UCC 3-416(a), “a person who transfers an instrument for consideration warrants to the

transferee, and, if the transfer is by indorsement, to any subsequent transferee that:

(1) the warrantor is a person entitled to enforce the instrument;

(2) all signatures on the instrument are authentic and authorized;

(3) the instrument has not been altered;

(4) the instrument is not subject to a defense or claim in recoupment of any party which can be asserted

against the warrantor; and

(5) the warrantor has no knowledge of any insolvency proceeding commenced with respect to the maker or

acceptor or, in the case of an unaccepted draft, the drawer.”

The above-referenced implied promises are commonly referred to in the legal profession as “transfer

warranties.” They are implied by law, meaning that the transferor of commercial paper need not expressly

make these warranties; instead, they are recognized automatically by operation of law Most laypersons are

not familiar with these warranties (that is, until a complainant seeks to hold the transferor liable for breach of

one or more of them!)

From an ethical standpoint, is it fair to hold transferors of commercial paper responsible for transfer warranties, even though the transferor does not expressly make them?

Chapter 17 Case Hypothetical

Ira Ofseyer is an eighteen-year-old freshman at Golden State University He arrives on

campus several days before classes begin, and learns of a party scheduled at Tau Phi

Gamma Fraternity on Friday evening Ofseyer arrives at the party, confident that a

thorough university education means more much more than mere academics

Beer is served at the party, and that night, Ira consumes the first alcohol of his young life

In the haze of the alcohol, and caught up in socializing with the Tau Phi fraternity brothers (who are trying to convince him of the merits of fraternity membership,) Ofseyer

inadvertently leaves his checkbook on the dining room table

Three days later, Ira realizes he is missing his checkbook He returns to the fraternity to

find his checkbook, but to no avail He hurries to his bank’s university branch on

University Avenue, and learns that one check has been written on his account in the last three days, for $3,500 at University Stereo Shack Ofseyer’s remaining checking account balance is $5.83 His parents will not be happy

Is Ofseyer’s bank legally obligated to re-credit his account in the amount of $3,500?

Holder in Due Course Doctrine

Provides incentive for financial

intermediaries to engage in

transactions, because they receive

greater legal protection by virtue of

“holder in due course” status

Requirements for “Holder In Due Course”

Status

• Be holder of complete and authentic negotiable

instrument

• Take instrument for value

• Take instrument in good faith

• Take instrument without notice that it is overdue

or dishonored, that it has been altered or has

an unauthorized signature, or that it is subject

to adverse claims or defenses to enforceability

of instrument

Holder Takes Instrument “For Value” If

Holder:

• Performs promise for which instrument issued

• Acquires security interest or other lien in

instrument

• Takes instrument for payment of preceding claim

• Exchanges instrument for another negotiable

instrument

• Exchanges instrument for an irrevocable

obligation to third party

Advantage of Holder In Due Course Status

Holder in due course is generally free from following “personal”

• Unauthorized completion or material alteration of instrument

• Unauthorized acquisition of instrument

Holder In Due Course Is Subject to Following

“Real” Defenses:

• Fraud in the Essence

• Discharge of the Party Liable Through

Bankruptcy

• Forgery

• Material Alteration of Completed Instrument

• Infancy (When party below legal age of

consent)

“Shelter” Principle:

If holder cannot attain holder in due

course status, holder can acquire rights

and privileges of holder in due course, if

item transferred from a holder in due

course

Federal Trade Commission Rule: Negotiation of

consumer notes may not be subject to holder in due

course status, if consumer credit contract or purchase

money loan contains following statement:

“ANY HOLDER OF THIS CONSUMER CREDIT

CONTRACT IS SUBJECT TO ALL CLAIMS AND

DEFENSES WHICH THE DEBTOR COULD

ASSERT AGAINST THE SELLER OF GOODS

OR SERVICES OBTAINED PURSUANT

HERETO OR WITH THE PROCEEDS HEREOF

RECOVERY HEREUNDER BY THE DEBTOR

SHALL NOT EXCEED AMOUNTS PAID BY THE

DEBTOR HEREUNDER”

Signature Liability

General Rule: Party liable for an

instrument only if party has signed

instrument

Parties Signing Negotiable Instrument

• Maker

-Person promising to pay set sum to holder of

promissory note/certificate of deposit -Promises to pay money

• Acceptor

-Person (drawee) who accepts and signs draft

to agree to pay draft when it is presented -Pays money (or responsible for paying

money) when it is requested

Parties Signing Negotiable Instrument

(Continued)

• Drawer

• Person ordering drawee to pay

• Orders someone (drawee) to pay

• Endorser

• Person who signs instrument to restrict

payment of it, negotiate it, or incur liability

• Signs instrument at some point during

process of negotiation

“Primary” Liability Versus “Secondary”

Liability

• Primary Liability of Makers and Acceptors:

Must pay stated amount on instrument when it

is presented for payment

• Secondary (Conditional) Liability of Drawers

and Endorsers: Must pay amount on

instrument if following conditions met:

-Presentment (on party with primary liability)

-Dishonor (by party with primary liability)

-Notice of Dishonor (given to party with

Proper Presentment of Negotiable

Instrument

• Presented to Proper Party

• Presented in Proper Way

• Presented in Timely Manner

Accommodation Party

Definition: Party who signs

instrument to provide credit for

another party who has also signed

instrument

Unauthorized Signature

General Rule: If signature to

negotiable instrument unauthorized,

signature will not impose liability on

named party

Negotiable Instrument Warranty

Liability

• Transfer Warranty: When party transfers

instrument to another party for consideration,

party makes certain guarantees/warranties

regarding instrument and transfer itself

• Presentment Warranty: When party properly

presents instrument for acceptance, party

makes certain guarantees/warranties

regarding instrument and transfer itself

• Instrument has not been altered

• Instrument not subject to defense or claim in

recoupment

• Transferor has no knowledge of insolvency

proceedings against maker, acceptor, or drawer

of instrument

Presentment Warranties

• Warrantor of instrument is entitled to

enforce instrument

• Instrument has not been altered

• Warrantor has no knowledge that drawer’s

signature or draft is unauthorized

Avoiding Liability for Negotiable

Instruments

Defenses to Liability

• Real Defenses

• Personal Defenses

“Real Defenses” (Applicable to All Parties):

• Infancy (below legal age of consent)

• Duress

• Lack of legal capacity

• Illegality of transaction

• Fraud in factum (fraud in execution, fraud in essence)

• Discharge through insolvency proceedings

(bankruptcy)

• Forgery

Common Law Personal Defenses (Applicable to

Holders, But Not Holders In Due Course):

Personal Defenses (Applicable to

Holders, But Not Holders In Due Course):

• Non-issuance, conditional issuance, or

issuance for special purpose

Avoiding Liability for Negotiable