Federal Limits on HDC Rights

Federal Limits on HDC Rights

FTC Rule 433 (1976) abolished the HDC doctrine in consumer credit transactions.

§ Allows Buyer to assert any defense she might have against the Seller of goods or services (Car Dealer), against the subsequent HDC (Bank) as well.

§ So Buyer’s duty to pay is conditional on Seller’s full performance under contract.

Discharge

Discharge from liability on an instrument can occur by:

§ Payment.

§ Cancellation or Surrender.

§ Reacquisition.

§ Impairment of Recourse.

§ Impairment of Collateral.

Defenses

Defenses

Universal or Real - can be used to defeat a holder and a HDC.

Personal - can be used to defeat a holder but not a HDC.

Universal Defenses

Forgery of maker’s or drawer’s signature.

§ Or if an authorized agent exceeds his authority to the amount which exceeds his authority.

Fraud in the execution - the”autograph” situation, not fraud in the inducement.

Material Alteration.

§ Do not have to pay the altered amount ($8 to $800), only a personal defense to the original amount ($8).

§ Not a real defense if instrument left blank, (.. filled in $800), then have to pay all ($800).

Discharge in Bankruptcy.

Infancy (Minority).

Illegality - severe enough to make contract void.

Mental Incapacity (adjudicated by court).

Extreme Duress. If instrument signed under threat of immediate force or violence.

Personal Defenses

Valid against holders but not HDC’s.

§ Breach of contract or warranty.

§ Lack of consideration.

§ Fraud in the inducement.

§ Illegality - not severe enough to make void.

Mental incapacity - not severe enough to make void.

Discharge.

§ By payment or cancellation.

§ Unauthorized completion.

§ Non-delivery of instrument.

§ Ordinary duress or undue influence rendering contract voidable.

Warranty Liability and Transfer Warranties

Warranty Liability

Extends to both signers and non-signers.

Breach of warranty can occur when the instrument is transferred or presented for payment.

Transferors make certain implied warranties regarding instruments they negotiate.

Liability not subject to dishonor, presentment, notice.

Liabilities: Transfer or Presentment.

Transfer Warranties

Following transfer warranties extend to all subsequent holders:

§ Transferor is entitled to enforce the instrument.

§ Signatures are authentic and authorized.

§ Instrument has not been altered.

§ Instrument not subject to defense.

§ Transferor has no notice of insolvency.

Presentment Warranties

Person who presents an instrument makes the following presentment warranties:

§ No missing or unauthorized indorsement.

§ Instrument has not been altered.

§ Person obtaining payment has no knowledge signature is unauthorized.

Case 26.3: First National Bank of Chicago v. MidAmerica Federal Savings (1999).

Accommodation Parties & Authorized Agents’ Signatures.

Accommodation Parties

Signs instrument to lend name as credit to another party on the instrument.

ü Makers v. Indorsers.

Authorized Agents’ Signatures

ü Agent agrees to act for Principal.

ü Agents can hold Principal liable if authorized to sign.

ü Principal must be clearly named.

ü Agent is personally liable when Principal is not named or disclosed, unless check is drawn on Principal’s account.

Case 26.2:  Caraway v. Land Design Studio (2001).

Unauthorized Signatures

Forgery does not bind owner but Bank is liable.

If Agent has no authority, Agent is personally liable, but Principal is not, unless ratified.

Exceptions:

§ Ratification of signature.

§ Negligence of party.

§ Holder in Due Course.

Special Rules for Unauthorized Indorsements

Unauthorized indorsement does not bind maker/drawer except:

§ “Imposter Rule”: imposter induces maker/drawer to issue check to imposter.

§ When imposter signs as/on behalf of maker/drawer intending payee has no interest in the instrument.

§ Fictitious Payee.

Liability, Defenses, and Discharge

Liability

There are two kinds of liability associated with negotiable instruments:

§ Signature liability.

§ Warranty Liability.

Signature Liability

Relates to signatures on instruments.

Signers of negotiable instruments are potentially liable for amount stated on instrument.

§ Primary Liability: Makers/Acceptors.

§ Secondary Liability: Drawers/Indorsers.

Primary versus Secondary Liability

Makers.

§ Promises to pay the note.

§ Obligated to pay terms of instrument at time of signing.

Acceptors.

§ Drawee promises to pay an instrument when presented for payment.

Secondary Liability

Proper Presentment.

§ Must be timely (checks w/in 30 days).

Dishonor.

Case 26.1:  Messing v. Bank of America (2002).

Proper Notice.

§ Manner of Notice in any Reasonable manner.

§ Notice to Indorsers.

Holder vs. HDC

Holder vs. HDC

Holder is one in possession of order or bearer paper and the instrument is drawn or indorsed to the holder.

Holder in Due Course (HDC) results if the holder also meets the following requirements:

§ Takes for Value.

§ Takes in Good Faith.

§ Takes without Notice of a Defense to Payment.

HDC:  Taking for “Value”

No value if gift or inheritance. Not the same as consideration.

Holder can take for value by:

§ Performing the instrument’s promise.

§ Acquiring a security interest or other lien in the instrument.

§ Taking instrument in payment for an antecedent debt.

§ Giving a negotiable instrument as payment.

§ Giving irrevocable commitment as payment.

HDC:  Taking in “Good Faith”

Good faith is honesty in fact and the observance of reasonable commercial standards of fair dealing.”

Only applies to holder, not transferor.

Case 25.2: Maine Family Federal Credit Union v. Sun Life Assurance (1999).

HDC: “Taking With Notice”

Holder takes the instrument with notice if he knows/has reason to know:

§ Instrument is overdue.

§ Instrument has been dishonored.

§ Actual knowledge or any suspicious event.

§ That a claim or defense exists.

§ So irregular, incomplete, or bears such evidence of forgery.

Case 25.3: Travelers Casualty and Surety v. Wells Fargo Bank (2002).

Holder through an HDC

“Shelter Principle”: Person is not an HDC but derives title through HDC.

Limitations on the shelter principle: no fraud, illegality, claim or defense.

HDC in International Context

Good Faith and Protected-Holder Status.

UN approved Convention on International Bills of Exchange and International Promissory Notes (CIBN)

CIBN affords Greater Protection for Protected Holders.
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Indorsements

Indorsements

Signature with or without additional words or comments:

§ Blank Indorsements.

§ Special Indorsements.

§ Qualified Indorsements.

§ Restrictive Indorsements.

Miscellaneous Indorsement Problems

Misspelled Names. Indorsement should generally be identical to name on instrument.

§ Misspelled name OK.

Instruments Payable to Legal Entities.

§ Negotiable by authorized representative of the entity.

Alternative or Joint Payees.

§ In the alternative - either may indorse.

§ Jointly - both must indorse.

Case 25.1: GMAC v. Abington Casualty (1992).

Transferability and Holder in Due Course

Introduction

Negotiable instruments can be transferred to others by negotiation or by assignment.

Negotiation

Transfer by negotiation creates a holder, who at the very least receives the rights of a previous possessor.      

AND

A holder in due course (HDC) acquires more rights in the instrument than the previous possessor. This means defenses that can be raised against the transferor may or may not be able to be raised against the transferee.

Two Ways to Negotiate

Negotiating Order Instruments endorsement and delivery required.

Negotiating Bearer Instruments—delivery only.

§ Converting Order to Bearer and vice versa.

Converting Order Instruments to Bearer Instruments, and Vice Versa.

§ Must be done at the time of negotiation.

Factors Not Affecting Negotiability

Factors Not Affecting Negotiability

   ü Omission of date.
ü Postdating or antedating.
ü No place for payment: address or Drawee or maker or, if none,  place of business or, if none,  residence.

ü Handwritten over typewritten or printed.

ü Words over numbers.

ü With interest = judgment rate.

ü Mention of collateral.

Requirements for Negotiability

Requirements for Negotiability 

Writing signed by the maker or the drawer.

Unconditional promise or order to pay a fixed amount of money.

Payable on demand or at a definite time.

§ Acceleration and Extension clauses.

Be payable to order or to bearer, unless it is a check.

Case 24.3: Barclay’s Bank v. Johnson (1998).

Types of Negotiable Instruments

Types of Negotiable Instruments

Drafts and checks are 3 party instruments: Drawer, Drawee and Payee.

§ Checks (cashier’s, teller’s and traveler’s) are drafts on a bank.

§ Trade acceptances seller is drawer and payee.

Case 24.1:  Flatiron Linen v. First American State Bank  (2001).

Promissory Notes are two party instruments:

§ Maker (Promisor) and

§ Bearer (Promisee).

Certificates of deposit (CDs): two party instruments. 

Case 24.2: U.S. v. Durbin (1999).

The Function of Instruments

The Function of Instruments

To function as a substitute for money or credit device.

In order for an instrument to operate practically, it has to be easily transferable.

Laws of assignment did not allow for ease of transfer because the assignee was always subject to the defenses that could be used against the assignor.

Article 3 provided that some defenses could not be used against certain assignees.

The Function and Creation of Negotiable

Instruments 

Articles 3 and 4 of the UCC

A “negotiable instrument” is a signed writing containing an unconditional promise to pay an exact sum of money.

History of negotiable instruments began in England “bills of exchange” so that merchants were able to exchange money while keeping their money safe in the banks.

Today, UCC Article 3.