1. C H A P T E R
33
Liability of Parties
Always do right.
This will gratify some people, and astonish the rest.
Mark Twain, Speech to Young People’s Society (1901)
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2. Learning Objectives
• Explain difference between primary
and secondary liability
• List five warranties made to transfer
negotiable instruments and three
warranties made when presenting
these for payment or acceptance
• Discuss three exceptions to normal
liability rules
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3. Overview
• If a person signs a negotiable instrument
as maker, drawer, indorser, or some other
capacity, the person is contractually liable
to pay on the instrument
• Liability also arises from:
– (1) improper transfer or presentment of an
instrument; (2) negligence in instrument
issuance, alteration, or indorsement; (3)
improper payment; or (4) conversion
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4. Primary vs. Secondary Liability
• A person may be primarily liable if s/he
agreed to pay the negotiable instrument.
– The maker of a promissory note is primarily
liable for paying the debt
• A person who is secondarily liable is a
contract guarantor and, under UCC
Article 3, must pay the instrument only if
the person who is primarily liable defaults
on the obligation
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5. Acceptor and Drawee Liability
• The acceptor of a draft must pay the
draft according to the terms at the time
of acceptance (drawee’s signed
engagement to honor the draft as
presented)
• A drawee has no liability on a check or
draft unless it certifies or accepts it
– In Harrington v. MacNab, the drawee
bank had no liability to a payee for a
drawer’s insufficient funds
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6. Indorser Liability
• A person who indorses a negotiable
instrument usually is secondarily liable
– Indorsers are liable to each other in
chronological order, from the last indorser
back to the first
• To trigger secondary liability, the instrument
must be properly presented for payment or
acceptance, the instrument must be
dishonored, and notice of the dishonor must
be given to the person secondarily liable
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7. Discharge of Indorser Liability
• An indorser is discharged from liability if:
– A bank accepts a draft after indorsement
[3–415(d)]
– Notice of dishonor is required and proper
notice is not given to the indorser [3–415(c)]
– No one presents a check or gives it to a
depositary bank for collection within 30
days after the date of an indorsement [3–
415(e)]
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8. Signing an Instrument
• No person is contractually liable for negotiable
instrument unless s/he or an authorized agent
has signed it
– Signature is binding on the represented person
– Signature can be any name, word, or mark used in
place of a written signature [3–401]
• Marion T, LLC v. Northwest Metals Processors, Inc.
: if an agent or a representative signs negotiable
instrument on behalf of someone else, agent should
indicate clearly that signature was representative of
someone else
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9. Presentment of a Note
• Since the maker of a note is primarily liable
to pay it when due, dishonor occurs if the
maker does not pay amount due when:
2) it is presented in the case of (a) a demand note
or (b) a note payable at or through a bank on a
definite date and presented on or after that
date, or
3) if it is not paid on the date payable in the case of
a note payable on a definite date (but not
payable at or through a bank) [3–502]
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10. Presentment of a Draft or Check
• To obtain payment or acceptance on a
draft or check, holder must present it to
drawee by any commercially reasonable
means
– Written, oral, or electronic [3–501]
• Drawee obligated when it accepts (certifies)
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11. Warranty Liability
• Person who transfers negotiable
instrument or presents it for payment
may have liability for implied warranties
of presentment or transfer
– Bank One, N.A. v. Streeter: Person who
deposited checks to his account on which
the payee’s name had been altered
breached transfer warranties and was not
entitled to enforce the instruments
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14. Mistake in Payment or Acceptance
• Revised Article 3 follows
general rule that payment
or acceptance is final in
favor of a holder in due
course or payee who
changes position in
reliance on payment or
acceptance
– Bank bears burden of
mistake
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15. Other Liability Rules
• Negligence: A person who
writes a negotiable instrument
so as to invite alteration may
not use the alteration or lack
of authorization as a reason
for not paying a person that
in good faith pays the
instrument or takes it for value
[3–406]
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16. Other Liability Rules
• Imposter rule: An impostor
convinces a drawer to make a
check payable to the person
impersonated or an organization
the person claims to represent.
UCC makes any indorsement
“substantially similar” to that of
named payee effective [3–
404(a)]
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17. Other Liability Rules
• Fictitious payee rule: If someone writes
a check to a fictitious payee, UCC
allows any indorsement in the name of
the fictitious payee to be effective as
payee’s indorsement in favor of any
person that pays instrument in good
faith or takes it for value or for
collection [3–404(b) and (c)]
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18. Other Liability Rules
• Fraudulent indorsements by employees:
Revised Article 3 specifically addresses
employer liability for fraudulent
indorsements by employees, adopting rule
that the risk of loss for indorsements by
employees entrusted with responsibilities
for instruments (primarily checks) should
fall on employer rather than the bank that
takes the check or pays it [3–405]
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19. Victory Clothing Co., Inc. v.
Wachovia Bank, N.A.
• Facts and Decision:
– Employee engaged in double forgery of
checks and a depositary bank allowed
forger to deposit the checks to her own
personal account, violating its own
banking procedures and rules
– Employer sued bank for negligence
– Court applied comparative negligence
principles to split the loss between the
company (30%) and the bank (70%)
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20. Other Liability Rules
• Conversion:
Revised Article 3
provides that the
law applicable to
conversion of
personal property
applies to
instruments
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21. Discharge of
Negotiable Instruments
• An obligor is discharged from liability by:
2. Payment of the instrument
3. Cancellation of the instrument
4. Alteration of the instrument
5. Modification of principal’s obligation causing a
loss to a surety or impairing collateral
6. Unexcused delay in presentment or notice of
dishonor with respect to a check
7. Acceptance of a draft by a bank (e.g., if a
check is certified by a bank)
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22. Test Your Knowledge
• True=A, False = B
– When a person signs a negotiable
instrument as maker, the person becomes
contractually liable on the instrument.
– The maker of a promissory note is
secondarily liable for paying the debt.
– A drawee has liability on a check or draft
the moment it is presented for
acceptance.
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23. Test Your Knowledge
• True=A, False = B
– An indorser is not discharged from liability
until the instrument is presented for
payment or acceptance.
– A person who transfers a negotiable
instrument or presents it for payment may
incur liability from implied warranties.
– A person who indorses a negotiable
instrument usually is secondarily liable.
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24. Test Your Knowledge
• Multiple Choice
– Norbert worked in payroll for Will Co. and
signed payroll checks. Norbert wrote a
check to Bradley Pitte, a fictitious
employee, took it to the bank with fake
I.D., indorsed the back with “Pitte’s”
signature, and was paid in cash.
a) Bank is liable for wrongful acceptance
b) Bank is not liable under the common law
of conversion
c) Bank is not liable under UCC liability rules
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25. Test Your Knowledge
• Multiple Choice
– Which of the following is not a
transferee warranty?
a) Warrantor is entitled to enforce the
instrument
b) The drawer has sufficient funds to pay
the instrument
c) The instrument has not been altered
d) All signatures are authentic or authorized
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26. Thought Questions
• What steps would you take to make sure
that fictitious payees and fraudulent
indorsement did not occur in your
business?
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Editor's Notes
To trigger the secondary liability, t he instrument must be properly presented for payment or acceptance, the instrument must be dishonored , and notice of the dishonor must be given to the person secondarily liable. Revised Article 3 states that the drawer of a cashier’s check has the same obligation as the maker or issuer of a note . Thus, it treats the bank drawer of a draft drawn on a bank the same as a note for purposes of the issuer’s liability rather than treating the issuer as a drawer of a draft [3–412].
Hyperlink is to the opinion on the Leagle.com website. The principle that a drawee has no liability on an instrument to a holder unless it has certified or accepted the instrument is illustrated in Harrington v. MacNab. To negotiate a check from client McNab, attorney Harrington inquired about the availability of funds to cover the check. Ms. Ruark of Merrill Lynch sent a fax to Harrington that read as follows: “This letter is to verify that the funds are available in the Merrill Lynch account. There is a pend on the funds for the check that was given to you.” Harrington interpreted “pend” to mean that a hold would be placed on the MacNabs’ account to cover the check in question. Merrill Lynch later claimed it meant that the funds deposited to cover that check were not themselves yet cleared. In fact, the MacNabs’ account did not contain sufficient cleared funds to cover the check, which bounced. Subsequent promises by the MacNabs to make the check good came to naught. Harrington obtained a judgment against the MacNabs, but it was never satisfied in full. Harrington then brought suit against Merrill Lynch for negligent misrepresentation. The court clearly thought a real estate attorney should have known better and ruled in favor of the drawee bank.
The indorser can avoid this liability only by qualifying his indorsement, such as “without recourse,” on the instrument when he indorses it [3– 415(b)].
The indorser can avoid this liability only by qualifying his indorsement, such as “without recourse,” on the instrument when he indorses it [3– 415(b)].
Hyperlink is to the court’s order on the Justia.com website.
For example, Susan Strong borrows $1,000 from Jack Jones and gives him a promissory note for $1,000 at 9 percent annual interest payable in 90 days. Jones indorses the note “Pay to the order of Ralph Smith” and negotiates the note to Ralph Smith. At the end of the 90 days, Smith takes the note to Strong and presents it for payment. If Strong pays Smith the $1,000 and accrued interest, she can have Smith mark it “paid” and give it back to her. If Strong does not pay the note to Smith when he presents it for payment, then she has dishonored the note. Smith should give notice of the dishonor to Jones and advise him that he intends to hold Jones secondarily liable on his indorsement. Smith may collect payment of the note from Jones. Jones, after making the note good to Smith, can try to collect the note from Strong on the ground that she defaulted on the contract she made as maker of the note. Of course, Smith also could sue Strong directly on the basis of her maker’s obligation.
For example, Janet Payne has $850 in a checking account at First National Bank and writes a check for $100 drawn on First National and payable to Ralph Smith. The writing of the check is the issuance of an order by Payne to First National to pay $100 from her account to Smith or to whomever Smith requests it to be paid. First National owes no obligation to Smith to pay the $100 unless it has certified the check. However, if Smith presents the check for payment and First National refuses to pay it even though there are sufficient funds in Payne’s account, then First National is liable to Payne for breaching its contractual obligation to her to pay items properly payable from existing funds in her account. Chapter 34, Checks and Electronic Transfers, discusses the liability of a bank for wrongful dishonor of checks in more detail.
Bank One, N.A. v. Streeter: Person who deposited checks to his account on which the payee’s name had been altered breached transfer warranties and was not a person entitled to enforce the instruments. Here, the defendant was NOT credible. Court: “Streeter baldly contends that he was the person entitled to enforce the instruments because the checks were delivered to him as partial payment on his contract. Aside from Streeter’s affidavit, he cites to nothing in the record or any other authority to support this assertion. Nor does Streeter present any case law or authority for the proposition that if he did not alter the checks himself, he cannot be held liable for breach of warranty.”
Thus, if a drawee bank mistakenly paid a check over a stop-payment order, paid a check with a forged or unauthorized drawer’s signature on it, or paid despite the lack of sufficient funds, the bank cannot recover if it paid the check to a presenter who had taken the instrument in good faith and for value.
This is check has been altered. Also note that the payee line seems blank.
Tip: don’t leave important items of identification lying around!
The hyperlink is to the court’s opinion. Specifically, employee Lunny’s scheme involved double forgeries. In her position as office manager, she prepared checks in Victory Clothing Company’s computer system and made them payable to known vendors of Victory (e.g., Adidas) to whom no money was actually owed. The checks were for dollar amounts that were consistent with the legitimate checks to those vendors. She then would forge the signature of Victory’s owner, Mark Rosenfeld, as drawer on the front of the check, and then forge the indorsement of the unintended payee (Victory’s various vendors) on the reverse of the check. After forging the indorsement of the payee, Lunny either indorsed the check with her name followed by her account number, or referenced her account number following the forged indorsement. She then deposited the checks into her personal account at Wachovia Bank. At the time of the fraud by Lunny, Wachovia’s policies and regulations regarding the acceptance of checks for deposit provided that “checks payable to a non-personal payee can be deposited ONLY into a non-personal account with the same name.” Victory brought suit against Wachovia pursuant to the Pennsylvania Commercial Code claiming that Wachovia should be liable to it for the entire amount of the losses it sustained by virtue of Lunny’s forgery scheme. Victory contended that Wachovia had failed to exercise ordinary care in taking the instruments that were payable to various businesses and allowing them to be deposited into Lunny’s personal accounts. Court: “The Court finds that Wachovia failed to exercise ordinary care, and that failure substantially contributed to Victory’s loss resulting from the fraud. Therefore, the Court concludes that Wachovia is seventy (70) percent liable for Victory’s loss…. Victory, on the other hand, was also negligent in its supervision of Lunny, and for not discovering the fraud for almost a two-year period…. the Court concludes that Victory is also thirty (30) percent liable for the loss.” Would the answer be different today when many banks no longer return copies of cancelled checks—or even photocopies of them—regularly to the customer. What steps would you take to prevent something like this from happening without your being aware of the fact an employee was forging checks on the company’s account?
Example, check presented for payment or acceptance, and the person to whom it is presented might refuse to pay or accept and refuse to return it. An instrument also is converted if a person pays an instrument to a person not entitled to payment—for example, if it contains a forged indorsement.
Example, check presented for payment or acceptance, and the person to whom it is presented might refuse to pay or accept and refuse to return it. An instrument also is converted if a person pays an instrument to a person not entitled to payment—for example, if it contains a forged indorsement.
True. False. The maker of a promissory note is primarily liable for paying the debt. False. A drawee has no liability on a check or draft unless it certifies or accepts it.
False. An indorser is discharged from liability if a bank accepts a draft after indorsement [3–415(d)], notice of dishonor is required and proper notice is not given to the indorser [3–415(c)], or no one presents a check or gives it to a depositary bank for collection within 30 days after the date of an indorsement [3–415(e)]. True. True.
The correct answer is (c).
The correct answer is (d). There is no warranty of sufficient funds, just the following: Warrantor is entitled to enforce the instrument (no unauthorized or missing indorsements) All signatures authentic or authorized Instrument has not been altered Instrument not subject to defense or claim in recoupment against the warrantor Warrantor has no knowledge of any insolvency proceedings commenced with respect to the maker or acceptor, or drawer [3–416(a)]
Opportunity to discuss management action as a method of reducing the number of legal disputes.
