Chapter 16: Negotiable Instruments

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Chapter 16 Negotiable Instruments Indorsements
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What Youll Learn

• How to name the parties to each type of
  negotiable instrument (pp. 506-509)

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Why Its Important
Knowing the purpose and types of negotiable
instruments will help you manage your financial
affairs throughout life.
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Section Outline
Purposes of Negotiable Instruments   Notes
Certificates of Deposit
Drafts
Checks
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Pre-Learning Question
What is a negotiable instrument?
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Purpose of Negotiable Instruments
The law of negotiable instruments was developed
to allow people to transact business without
carrying around large sums of money and to
purchase items they will pay for later.
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Purpose of Negotiable Instruments
A negotiable instrument is a written document
giving special legal rights to the transferee
that may be transferred by endorsement or
delivery.
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Purpose of Negotiable Instruments
There are two basic kinds of negotiable
instruments

• Notes (including certificates of deposit), and
• Drafts (including checks)

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Pre-Learning Question
What is a note?
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Notes
A note (often called a promissory note) is a
written promise by one person, called the maker,
to pay money to another person, called the payee.
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Notes
When two persons sign a note, they are known as
comakers.
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Notes

• A demand note is payable when the payee demands
  payment.
• A time note is payable at a future date, which is
  written on the face of the note.

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23.1
Demand Note
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Certificates of Deposit
A certificate of deposit (CD) is a note provided
by a bank. Its a banks written receipt of money
and a promise to pay the money back, usually with
interest, on the due date.
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Certificates of Deposit
CDs are written for a specific time period such
as six months, one year, two years, or five
years. Banks pay higher interest on longer-term
CDs.
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Certificates of Deposit
The interest paid on a CD is higher than the
amount paid on a regular savings or checking
account because the depositor cannot withdraw the
money before the due date without penalty.
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23.1
Certificate of Deposit
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Checks
A check is a draft drawn on a bank and payable on
demand. It is the most common kind of draft in
use today.
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Checks
When issuing a check, you put money in the bank
and then order the bank to pay your money to
others by writing out checks.
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Section 23.1 Assessment
Reviewing What You Learned

1. What is the purpose of a negotiable instrument?

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Section 23.1 Assessment
Reviewing What You Learned
Answer
It allows people to transact business without
carrying around large sums of money and to
purchase items they will pay for later.
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Section 23.1 Assessment
Reviewing What You Learned

1. Name the two basic kinds of negotiable
   instruments.

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Section 23.1 Assessment
Reviewing What You Learned
Answer
Notes, including certificates of deposit and
drafts, including checks.
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Section 23.1 Assessment
Reviewing What You Learned

1. Define the parties to each kind of negotiable
   instrument.

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Section 23.1 Assessment
Reviewing What You Learned
Answer
The note is a written promise by the maker to pay
money to another person (payee). When two people
sign a note, they are known as comakers.
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Section 23.1 Assessment
Reviewing What You Learned
Answer
A draft is an instrument in which one party,
called the drawer, orders another party, the
drawee, to pay money to a third party, the payee.
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End of Section 23.1
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Section 25.2
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What Youll Learn

• How to state the legal effect of a forged
  indorsement (p. 550)
• How to discuss the warranties that you make when
  you indorse negotiable instruments (p. 550)

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What Youll Learn

• How to explain the contract you make when you
  indorse negotiable instruments (p. 553)

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Why Its Important
Understanding the types of indorsements will help
you handle your finances wisely.
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Section Outline
Multiple Payees   Forged Indorsements   Warranties
of Indorsers   Contract of Indorsers
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Pre-Learning Question
What are some different kinds of indorsements?
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Main Kinds of Indorsements
An instrument is indorsed when you write your
name on it, indicating your intent to transfer
ownership to another.
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Main Kinds of Indorsements
Regulation CC, issued by the Federal Reserve
Board under the Competitive Banking Act, has
established standards for check indorsements.
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Main Kinds of Indorsements
Under the regulation, the back of a check is
divided into specific sections designed to
protect the indorsement of the depository bank
(the bank of first deposit).
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Main Kinds of Indorsements
There are four principal types of indorsements,
and each fulfills a special purpose.

• Blank indorsements
• Special indorsements
• Restrictive indorsements
• Qualified indorsements

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Blank Indorsement
A blank indorsement consists of the signature
alone on the instrument. This type indorsement
says, in effect, This instrument may be paid to
anyone.
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25.2
Blank Indorsement
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Special Indorsement
A special indorsement (also called an indorsement
in full) is made by writing the words pay to the
order of or pay to followed by the name of the
person to whom the instrument is to be
transferred (the indorsee) and the signature of
the indorser.
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Special Indorsement
When signed this way, the instrument remains an
order instrument and must be indorsed by the
indorsee before it can be further negotiated.
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25.2
Special Indorsement
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Restrictive Indorsement
A restrictive indorsement is one in which words
have been added, in addition to the signature of
the transferor, to limit its use. An example of a
restrictive indorsement is For deposit only.
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25.2
Restrictive Indorsement
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Conditional Indorsement
A conditional indorsement, a type of restrictive
indorsement, makes the rights of the indorsee
subject to a specific event or condition.
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25.2
Conditional Indorsement
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Qualified Indorsement
A qualified indorsement is one in which words
have been added to the signature to limit the
liability of the indorser.
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Qualified Indorsement
The words without recourse added to an
indorsement mean the indorser is not liable in
the event the maker or drawer does not pay the
instrument.
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25.2
Qualified Indorsement
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Pre-Learning Question
How is a check with multiple payees indorsed?
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Multiple Payees
If an instrument is payable to either of two
payees, only one of the payees needs to indorse
it to make it negotiable.
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Multiple Payees
However, if an instrument is payable to both of
two payees, both payees would need to indorse the
check for proper negotiation.
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Fill in the blanks.

1. A _____ indorsement is one in which words have
   been added, in addition to the signature of the
   transferor, to limit its use.

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ANSWER
Restrictive
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1. A _____ indorsement is made by writing the words
   pay to the order of followed by the name of the
   person to whom the instrument is to be
   transferred and the signature of the indorser.

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ANSWER
Special
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1. A _____ indorsement consists of the signature
   alone on the instrument.

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ANSWER
Blank
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Pre-Learning Question
What happens if an indorsement is forged?
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Forged Indorsements
A forged indorsement is not valid, and anyone who
takes a forged instrument does not acquire title
and is not a holder.
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Forged Indorsements
Anyone who pays an instrument on which there is a
forged indorsement is liable to the true owner
for the amount of the instrument.
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Pre-Learning Question
What warranties are made by an indorser?
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Warranties of Indorsers
To encourage people to accept negotiable
instruments from others, a system of implied
warranties is part of the law of negotiable
instruments.
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Warranties of Indorsers
Indorsers who receive consideration for an
instrument make five warranties to subsequent
transferees of the instruments.
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Warranties of Indorsers
They warrant that

1. They have good title to the instrument.
2. All signatures are genuine or authorized.

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Warranties of Indorsers
They warrant that

1. The instrument has not been altered.
2. No defense of any party is good against the
   indorser.

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Warranties of Indorsers
They warrant that

1. They have no knowledge of any bankruptcy
   proceeding that would affect the instrument.

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Pre-Learning Question
What is the contract of indorsers?
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Contract of Indorsers
Unless an indorsement states otherwise, every
indorser agrees to pay any subsequent holder the
face amount of the instrument if it is dishonored.
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Contract of Indorsers
To enforce this obligation, the holder must do
two things.
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Contract of Indorsers

1. He or she must present the instrument for payment
   to the maker or drawer when it is due. If that
   person refuses to pay the instrument, it has been
   dishonored.

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Contract of Indorsers

1. The holder must notify indorsers of the dishonor
   before midnight of the third full business day
   after the date of the dishonor.

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Section 25.2 Assessment
Reviewing What You Learned

1. What are the four main kinds of indorsements?

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Section 25.2 Assessment
Reviewing What You Learned
Answer
Blank, special, restrictive, qualified.
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Section 25.2 Assessment
Reviewing What You Learned

1. If an instrument is payable to both of two
   payees, as in the check that is payable to David
   and Melanie Mueller, who must indorse it?

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Section 25.2 Assessment
Reviewing What You Learned
Answer
The indorsement of both payees is necessary.
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Section 25.2 Assessment
Reviewing What You Learned

1. What are the legal effects of a forged instrument?

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Section 25.2 Assessment
Reviewing What You Learned
Answer
Anyone who takes an instrument after forgery does
not acquire title and is not a holder. Anyone who
pays an instrument that has been a forged is
liable to the true owner.
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Section 25.2 Assessment
Reviewing What You Learned

1. List the five warranties of indorsers.

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Section 25.2 Assessment
Reviewing What You Learned
Answer
They warrant that (1) They have title. (2) All
signatures are genuine. (3) The instrument has
not been altered.
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Section 25.2 Assessment
Reviewing What You Learned
Answer
(4) No defense of any party is good against the
indorser. (5) They have no knowledge of any
bankruptcy proceeding that would affect the
instrument.
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Section 25.2 Assessment
Reviewing What You Learned

1. What two things are necessary to enforce the
   contract of indorsers?

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Section 25.2 Assessment
Reviewing What You Learned
Answer
(1) The holder must first present the instrument
for payment to the maker when it is due. If that
person refuses to pay the instrument, it is
dishonored.
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Section 25.2 Assessment
Reviewing What You Learned
Answer
(2) The holder must notify indorsers of the
dishonor before midnight of the third full
business day after the date of the dishonor.
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End of Section 25.2
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Section 26.1
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What Youll Learn

• How to determine if a person is a holder in due
  course (p. 560)
• How to contrast personal defenses with real
  defenses (p. 563)

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Why Its Important
Recognizing the parties and defenses to
negotiable instruments will keep you alert to
problems regarding negotiable instruments.
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Section Outline
Holder in Due Course
Holder Value Good Faith Without Notice Holder
Through a Holder in Due Course
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Section Outline
Defenses to Negotiable Instruments
Personal Defenses Real Defenses
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Pre-Learning Question
What is a holder in due course?
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Holder in Due Course
A holder in due course is a holder who takes an
instrument for value, in good faith, and without
notice.
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Holder in Due Course

• Holders in due course are treated more favorably
  than holders are.
• They receive more rights in negotiable
  instruments.
• This allows negotiable instruments to be used
  almost like money.

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Holder
To be a holder in due course, you must first be a
holder, which means that the instrument must have
been issued or indorsed to you, to your order, or
to bearer.
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Value
A person must give value for an instrument to
qualify as a holder in due course.
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Value
You give value when you give the consideration
that was agreed upon or when you accept an
instrument in payment of a debt.
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Good Faith
To be a holder in due course, the holder must
take the instrument in good faith.
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Good Faith
Good faith means honesty in fact and fair
dealing. It requires that the taker of a
negotiable instrument act honestly.
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Without Notice
To be a holder in due course, a holder must not
have notice of any claim or defense to the
instrument, or notice that the instrument is
overdue or has been dishonored.
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Without Notice

• A claim is an argument asserted by a person
  claiming the instrument.
• A defense is something that is asserted as a
  reason not to pay it.

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Holder Through a Holder in Due Course
A holder who receives an instrument from a holder
in due course acquires the rights of the holder
in due course, even though he or she does not
qualify as a holder in due course.
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Holder Through a Holder in Due Course
This provision is called a shelter provision. It
is designed to permit holders in due course to
transfer all of the rights they have in the paper
to others.
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Holder Through a Holder in Due Course
This provision does not apply to a holder who has
committed fraud or an illegal act.
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26.1
Holder Through a Holder in Due Course
Clara indorsed the check and gave it to her niece
as a gift. Claras niece is a holder through a
holder in due course.
Brisa endorsed the check and gave it to Clara in
payment for a debt. Clara is a holder in due
course.
Alfonso wrote a check to Brisa. Brisa is a
holder.
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Jerome indorses Sanis check to Jeremy, and
Jeremy indorses the check to his credit card
company. Who is (are) the holder(s) in due
course? Why?
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ANSWER
Jeremy and the credit card company are holders in
due course because they both gave value.
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Section 26.1 Assessment
Reviewing What You Learned

1. What requirements must a holder in due course
   meet?

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Section 26.1 Assessment
Reviewing What You Learned
Answer
Must be a holder, must give value for the
instrument, must take the instrument in good
faith, and must take the instrument without
notice.
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Section 26.1 Assessment
Reviewing What You Learned

1. What is the difference between a personal defense
   and a real defense? Provide an example of each.

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Section 26.1 Assessment
Reviewing What You Learned
Answer
A personal defense can be used against a holder,
but not a holder in due course. A real defense
can be used against anyone.
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End of Section 26.1