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Essentials of Business Law for a New CenturyEssentials of Business Law for a New Century

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Quote of the DayQuote of the Day“The law is not the place for the artist or the poet. The law is the calling of

the thinkers.”Oliver Wendell Holmes,Jr.

Supreme Court Justice


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LiabilityLiability Signature liability – liability of someone

who has signed a document. Warranty liability -- liability of someone

who has received payment.


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Contract vs. InstrumentContract vs. Instrument Negotiable instruments are issued to

fulfill a contract. The instruments create a second

contract to pay the debt created by the first agreement.

Once an instrument is accepted in payment for a debt, the debt is suspended until the instrument is paid or dishonored.


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Enforcing an InstrumentEnforcing an Instrument In a signature liability, to whom is the

signer liable?• To the holder of the instrument.• To anyone to whom the shelter rule applies

(non-holder with the rights of a holder).• A holder who has lost the instrument.


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Primary vs. Secondary LiabilityPrimary vs. Secondary Liability

Someone with primary liability must pay unless he has a valid defense.

Someone with secondary liability must pay only if the person with primary liability does not pay.

The holder of an instrument must first try to get payment from the party with primary liability before making demands against a party with secondary liability.


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The Payment ProcessThe Payment Process Presentment – holder demands

payment. Dishonor – if payment is not received

when due or demanded, the instrument is considered dishonored.

Notice of Dishonor – notice is given to the party with secondary liability when the instrument is dishonored.


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Signature LiabilitySignature Liability The maker is primarily liable. The drawer of a check has secondary

liability. The bank (drawee) is not liable to the

holder and owes no damages to the holder for refusing to pay the check.

Indorsers are secondarily liable.• See next slide for more detail.


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Signature Liability -- Indorsers Signature Liability -- Indorsers Indorsers are not liable if:

• they write the words “without recourse” next to their signature on the instrument,

• a bank certifies the check, • the check is presented for payment more

than 30 days after the indorsement, or • the check is dishonored and the indorser is

not notified within 30 days.


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Accommodation PartyAccommodation Party An accommodation party (sometimes

called a co-signer or guarantor) is someone who adds her signature to an instrument in a capacity other than issuer, acceptor or indorser, in order to be liable for the instrument.

An accommodation party has the same liability to the holder as the person for whom she signed.


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AgentAgent To avoid personal liability when signing

an instrument, an agent must: • indicate that she is signing as an agent and • give the name of the principal.

The principal is liable if the agent signs correctly, the agent signs just her own name, or the agent signs only the name of the principal.


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Rules of Warranty LiabilityRules of Warranty Liability The culprit is always liable. The drawee bank is liable if it pays a check

on which the drawer’s name is forged. The bank can recover from the payee only if the payee had reason to suspect the forgery.

In any other case of wrongdoing, a person who first acquires an instrument from a culprit is ultimately liable to anyone else who pays value for it.

Click here for online advice on how to avoid check fraud.


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Transfer WarrantiesTransfer Warranties When someone transfers an

instrument, she warrants that:• She is the holder of the instrument,• All signatures are authentic and authorized,• The instrument has not been altered,• No defense can be asserted against her,

and• As far as she knows the issuer is solvent.


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Transfer Warranty RulesTransfer Warranty Rules One who violates transfer warranty rules

is liable for the value of the instrument, plus expenses and interest.

Transfer warranties flow to all subsequent holders in good faith who have indorsed the instrument.

Transfer warranties for bearer paper only extend to the first transferee.


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Transfer Warranty RulesTransfer Warranty Rules Warranty claims must be made within

30 days of discovering the breach or damages may be reduced.

Transfer warranties apply only if the transfer is made for consideration; if given as a gift, no warranties apply.


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Presentment WarrantiesPresentment Warranties Apply to someone who demands

payment for an instrument from the maker, drawee, or anyone else liable.

Presenter warrants that:• She is a holder,• The check has not been altered, and• She has no reason to believe the drawer’s

signature is forged.

Anyone who presents a promissory note for payment warrants only that he is a holder of the instrument.


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Other Liability RulesOther Liability Rules Conversion Liability

• Conversion means that (1) someone has stolen an instrument or (2) a bank has paid a check that has a forged indorsement.

Imposter Rule• If someone issues an instrument to an

imposter, then any indorsement in the name of the payee is valid as long as the person (a bank, say) who pays the instrument does not know of the fraud.


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Other Liability Rules (cont’d)Other Liability Rules (cont’d)

Fictitious Payee Rule• If an instrument is issued to a person who

does not exist, any indorsement in the name of the payee is valid as long as the payer does not know of the fraud.

Employee Indorsement Rule• If an employee with responsibility for

issuing instruments forges an instrument, any indorsement in the name of the payee is valid as long as the payer does not know of the fraud.


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NegligenceNegligence Anyone negligent in creating or paying an

unauthorized instrument is liable to an innocent third party.

Anyone careless in paying an unauthorized instrument is liable despite the three rules (impostor rule, fictitious payee rule and employee indorsement rule).

Anyone careless in allowing a forged or altered instrument to be created is also liable.


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CrimesCrimes Bouncing a check

• Writing a check on an account with insufficient funds is illegal, but usually only has a monetary penalty if the funds are deposited quickly.

Check Kiting • An illegal scheme where checks are passed

between overdrawn accounts at two banks, earning interest at one bank before reversing the process to “repay” the other account.

Forgery • Creating a fake document or passing on a

known fake document is illegal.


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DischargeDischarge Discharge means that liability on an

instrument terminates.By Payment By AgreementBy CancellationBy CertificationBy Alteration

Discharge of an indorser or accommodation party• Article 3 provides that virtually any change

in an instrument that harms an indorser or accommodation party also discharges them unless they consent to the change.


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“It is never wise to play an important game without

understanding the rules. The rules of negotiable instruments

are complex, but important because this game is played by

virtually everyone.”

Documents

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