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Principles Of Business Law - CHAPTER VI























































Sec. 62. Classification of parties. The parties on negotiable
paper may be divided into two groups primary parties and sec-
ondary parties. The primary parties are the makers of promissory
notes and the acceptors of bills of exchange. The secondary par-
ties are drawers of bills of exchange, drawers of checks, indorsers,
and accommodation parties. This classification is helpful in dis-
tinguishing the liabilities of the two types of parties. A primary
party is primarily liable ; that is, he is a person who, by the terms
of the instrument, is absolutely required to pay the same. A sec-
ondary party is secondarily liable; that is, he becomes liable only
when the primary party fails to pay and the holder performs cer-
tain conditions precedent, namely presentment, notice, and dis-
honor, Which will be discussed more in detail in Chapter VII.

Primary Parties

Sec. 63. The maker. Under the Uniform Negotiable Instru-
ments Act, the maker of a negotiable instrument, by making it,
engages that he will pay it according to its tenor and admits the
existence of the payee and his capacity to indorse. He is under an
absolute obligation to pay the instrument, when it is due, accord-
ing to its terms. If he makes the instrument payable to himself
and then indorses it, he is nevertheless liable as a maker.

Sec. 64. The acceptor. The acceptor of a bill of exchange is
the primary party upon the paper. By accepting the instrument,
he engages that he will pay it according to the tenor of his accept-
ance, and admits the existence of the drawer, the genuineness of his
signature, his capacity and authority to draw the instrument, the
existence of the payee, and his then capacity to indorse. Before
accepting the bill of exchange, the acceptor is called the drawee.
The instrument may be drawn by the drawer and negotiated to sev-
eral persons before its acceptance by the drawee. The instrument
may also be accepted by the drawee before it is drawn, in which
case the acceptance is usually on a separate sheet or piece of paper
and is attached to the bill when it is drawn. As mentioned before,
one who draws a bill of exchange (drawer) is usually a creditor of
the drawee or has arranged with the drawee to draw on him.
Some credit or contract right probably exists in the drawer against
the drawee. For instance, John Doe enters into an agreement with
the First: National Bank whereby the latter agrees, to accept bills



of exchange for a certain amount drawn on the bank by John Doe.
The bank is not liable to the payee of the bill until it accepts the
bill. If it does not accept, it is only liable to John Doe for breach
of contract to accept. After acceptance, the bank is liable to the
payee as well as to the drawer.

The promise constituting the acceptance must satisfy the re-
quirements of a promise in a promissory note, and must be in writ-
ing and signed by the drawee-acceptor. Acceptance is usually
made by the drawee's writing the word "accepted/' with his name
and the date, across the face of the instrument, although the use of
the word "accepted" is not necessary. 1 The acceptance, however,
is not completed until delivery of the instrument or notification of
the acceptance.

Sec. 65. Acceptance on a separate sheet of paper. Section
134 of the Uniform Negotiable Instruments Act provides that,
where an acceptance is written on paper other than the bill itself,
it does not bind the acceptor except in favor of a person to whom
it is shown, and who, on the faith thereof, receives the bill for value.
Thus, suppose a salesman who is traveling in Eugene, Oregon,
wishes to draw a draft on a bank located in New York, but the
hotel is unwilling to cash the draft unless the drawee bank will ac-
cept it. The salesman may wire the bank for an acceptance of the
draft. If the hotel, upon receipt of the wired acceptance, discounts
the draft, it can, in case of nonpayment, sue and recover from the
bank. Some states provide that the acceptance is good as against
the acceptor, even though the acceptance is not shown to the per-
son purchasing. In those states, reliance upon such acceptance is

Sec. 66. Promise to accept. Section 135 of the Uniform Ne-
gotiable Instruments Act states that "an unconditional promise in
writing to accept the bill before it is drawn is deemed an actual ac-
ceptance in favor of every person who upon the faith thereof re-
ceives the bill for value." But such promise must be positive and
unequivocal. 2 Some states provide that an unconditional prom-
ise to accept a bill before or after it is drawn is an actual accept-
ance. However, the purchaser of a bill of exchange, who takes it
in ignorance of such a promise to accept, cannot bind the acceptor,
because the paper was not purchased on the faith of the promise of
the acceptor. A drawee, therefore, may be an acceptor under these
circumstances to one holder and not to another.

Sec. 67. Kinds of acceptance. An acceptance may be general,
qualified, or implied. The general acceptance is the usual type of
acceptance, being an assent to pay without qualification, according
to the order of the drawer.

A qualified acceptance is conditional, partial, local, or qualified
as to time. The conditional acceptance is a promise to pay, de-
pending upon a condition. A partial acceptance is an acceptance
to pay only a part of the amount for which the bill is drawn. A
local acceptance is an acceptance to pay at a particular place only;
and one qualified as to time is an acceptance to pay at a particular
time. An acceptance is qualified also if less than all of the draw-
ees accept. If the acceptance is qualified, the holder may refuse
to take such acceptance and may treat the bill as dishonored by
nonacceptance. If the holder takes the qualified acceptance, the
drawer and the indorsers are discharged on the bill unless they have
expressly or impliedly authorized or subsequently assented to the
taking of the qualified acceptance. However, the drawer and the
indorsers must express their dissent within a reasonable time after
they are notified of the qualified acceptance, or they will be deemed
to have assented thereto and will be bound.

An implied acceptance is an acceptance which may be presumed
from the acts of the drawee. Under the Uniform Negotiable In-
struments Act, the drawee is allowed twenty-four hours after pre-
sentment in which to decide whether he will accept the bill. If the
drawee destroys the bill, or refuses to return it within twenty-four
hours or within such other period as the holder may allow, he will
be deemed to have accepted the bill. Some courts hold that a de-
struction of the bill does not constitute an implied acceptance, but
an unauthorized taking of the bill. It is clear that an intentional
destruction of the instrument acts as an acceptance, but some ques-
tion exists as to whether mere retention for more than twenty-four
hours, in the absence of a demand for its return, constitutes an ac-
ceptance. A few courts hold that there has been no refusal to re-
turn the bill by the drawee until the holder has asked for it, but the
weight of authority clearly supports the contention that mere re-
tention of the bill in excess of the allotted time is an acceptance.
This is particularly true of checks which have been forwarded to
the drawee bank for payment. The bank is obligated to pay the
instrument or to return it within twenty-four hours or such other
period as has been agreed upon. Failure to return it promptly acts
as an acceptance.

Secondary Parties

Sec. 68. In general. In the previous sections we have consid-
ered the liabilities of the maker and the acceptor, the parties pri-
marily liable on the instrument. In the following sections we shall


consider the liabilities of the secondary parties, the indorsers, ac-
commodation indorsers, and the drawers of bills of exchange. The
indorsers of negotiable paper may be divided into unqualified and
qualified indorsers, with respect to the extent of their liability.

Sec. 69. Unqualified indorsers. The unqualified indorsers are
those who indorse by blank and special indorsement. Their lia-
bility is of two kinds conditional and unconditional. The qual-
ified indorsers have only one type of liability, namely, uncondi-
tional liability. The difference in liability between these two types
of indorsers is determined by -the contract of indorsement. The
unqualified indorsers, by reason of blank and special indorsements,
indicate that they will pay the instrument, in case of default of the
primary parties, on the happening of certain conditions precedent:
namely, presentment, dishonor, and notice. This promise to pay
is termed the conditional liability of the unqualified indorsers.
The unconditional liability of the unqualified indorser is practically
the same as the liability of the qualified indorser and arises by rea-
son of the fact that all indorsers, by the transfer of the instrument,
sell a chattel. In effecting the sale, both the qualified and the
unqualified indorsers make certain warranties which are uncondi-
tional. We will now consider the nature of the liabilities of the
unqualified indorser.

Sec. 70. Conditional liability. The conditional liability of un-
qualified indorsers is set forth in the Uniform Negotiable Instru-
ments Act as follows: "Every indorser who indorses without qual-
ification . . . engages that on due presentment, the instrument
shall be accepted or paid or both as the case may be, according to
its tenor, and that if it be dishonored and the necessary proceedings
on dishonor be duly taken, he will pay the amount thereof to the
holder or to any subsequent indorser who may be compelled to pay

In order, therefore, for the holder or the holder in due course to
recover against an unqualified indorser on his conditional liability,
three conditions precedent must be satisfied. First, the instru-
ment must be presented to the primary party for payment; second,
the instrument must be dishonored by the primary party; third,
notice of the dishonor must be given by the holder to the indorser
to be charged. The indorsees duty arises when and only when the
above-named conditions precedent have been satisfied and thus
make the liability of such indorser conditional. If any one of the
three conditions is omitted, no conditional liability will vest in the
unqualified indorser. Thus, suppose P indorses a check in blank
or specially to X, a holder in due course. X presents the check to
the drawee bank for payment, but payment is refused because the


drawer has not sufficient funds to cover the check. X then notifies
P of the dishonor. P is now liable to X for the tenor of the check.
P would not have been liable if X had not presented the check for
payment or if X had not given P notice of dishonor.

Sec. 71. Unconditional liability. The warranties of the un-
qualified indorser are set forth in the Act as follows: "Every in-
dorser who indorses without qualification warrants to all subse-
quent holders in due course: (1) that the instrument is genuine and
in all respects that which it purports to be; (2) that he has good
title to it; (3) that all prior parties had capacity to contract; (4)
that the instrument is, at the time of his indorsement, valid and
subsisting." Under this section a liability immediately attaches
at the time of the indorsement. This liability arises out of the fact
that the indorser is a seller of property, and every seller of property
makes certain warranties. Therefore, one who passes negotiable
paper of necessity impliedly warrants the paper to be that which it
purports to be, including the other warranties enumerated above.
For example, if A sold B a watch and the article delivered was not
a watch, B should recover from A. Likewise, if A sold B a paper
purporting to be a negotiable instrument and the paper delivered
was not genuine, B should recover from A. The indorser is liable
to his vendee, irrespective of whether the holder has fulfilled the
conditions precedent mentioned in the preceding section and even
before maturity of the instrument, because the warranties, enu-
merated above, if breached, are breached at the time of the deliv-
ery of the instrument. For example, A indorses to C a note which
purports to be signed by B. jB's signature is a forgery. C, the
holder in due course, is, upon presenting the note to B, faced with
a real defense. A is liable to C, in that, by his sale of the instru-
ment to (7, he warranted the instrument to be genuine and in all
respects what it purported to be. Since it was void for forgery, C
may recover from A on A's unconditional liability.

Sec. 72. Qualified indorsers. A qualified indorser is one who
indorses without recourse. When an indorser places the words
"without recourse" after his indorsement or when he passes a bearer
instrument by delivery, he states, in effect, that he will not be lia-
ble in case of nonpayment of the instrument. That is, he does not
guarantee the solvency of the primary party. By such an indorse-
ment the indorser is merely relieved of the conditional liabilities of
the special and blank indorser, in that he makes no offer to be
bound, even though the conditions precedent presentment, dis-
honor, and notice have been satisfied. The transferor of bearer
paper who passes title by delivery occupies a similar position, in
that such transferor has no conditional liability.


The qualified indorser and the transferor by delivery, however,
do have unconditional liabilities as set forth in the Uniform Nego-
tiable Instruments Act: "Every person negotiating an instrument
by delivery or by qualified indorsement warrants: (1) that the in-
strument is genuine and in all respects what it purports to be; (2)
that he has a good title to it; (3) that all prior parties had capacity
to contract (the provisions of subdivision (3) of this section do not
apply to persons negotiating public or corporation securities, other
than bills and notes) ; (4) that he has no knowledge of any fact
which would impair the validity of the instrument or render it val-
ueless. 3 But when the negotiation is by delivery only, the war-
ranty extends in favor of no holder other than the immediate trans-
feree." The warranties of an unqualified indorser, however, extend
to all subsequent holders of the indorsed paper.

For example, if P indorses a check: "Pay to X, without recourse,
(signed) P" X will have no recourse against P in case of nonpay-
ment; but if it appears that the check was issued by an infant or
an insane person, who has disaffirmed his contract, P will be liable
to X by reason of the breach of his warranty that all prior parties
had capacity to contract. If P delivers a check, payable to bearer,
to X, who delivers it to F, P will be liable on his unconditional war-
ranties to X, his immediate transferee, but not to F. X, in turn,
would be liable to F on his unconditional warranties. The uncon-
ditional warranties of a qualified indorser are practically the same
as the unconditional warranties of an unqualified indorser.

One who indorses bearer paper, specially or in blank, is liable as
an indorser on both the unconditional and the conditional liabil-
ities, to such holders as make title through his indorsement.

Sec. 73* Accommodation indorsers. An accommodation in-
dorser is one who signs his name upon an instrument, without
receiving any consideration therefor, for the primary purpose of
lending his name as surety for some other person. Such an indorser
is liable to a holder in due course, even though the holder in due
course knows that such an indorser is an accommodation party.
Such an accommodation indorser occupies a very different position
from that of other indorsers, in that the accommodation indorser
never has title to the paper. He never becomes an owner of the
instrument unless the instrument is not paid and he pays it. Un-
der these circumstances the accommodation indorser becomes a
purchaser or holder.

In determining the parties to whom the accommodation indorser
is liable, it is necessary to note at whose request his signature is
placed upon the instrument and when. Section 64 of the Uniform

"Leekley v. Short et al, 1933, 216 Iowa 376, 249 N.W. 363; p. 61L


Negotiable Instruments Act provides as follows: " Where a person
not otherwise a party to an instrument places thereon his signature
in blank before delivery, he is liable as indorser in accordance with
the following rules: (1) if the instrument is payable to the order of
a third person, he is liable to the payee and to all subsequent par-
ties; (2) if the instrument is payable to the order of the maker or
drawer or is payable to bearer, he is liable to all parties subsequent
to the maker or drawer; (3) if he signs for the accommodation of
the payee, he is liable to all parties subsequent to the payee."

The Uniform Negotiable Instruments Act states, in Section 63,
that where a person places his signature upon an instrument other-
wise than as a maker, drawer, or acceptor, he is liable as an indorser
unless he clearly indicates by appropriate words that he is bound in
some other capacity.

From an inspection of the instrument, therefore, it would be im-
possible to tell whether an indorsees name was one for accommo-
dation or for negotiation. Under the Act it seems the accom-
modation indorser is liable upon both conditional and unconditional
liabilities even though such accommodation indorser never had
title to the instrument. Since an accommodation indorser is not
in the chain of title, it would seem that the unconditional liabilities
or warranties of a vendor of chattels should not bind him. The
courts are in conflict on this point, some permitting the introduc-
tion of oral evidence to show the liability of the accommodation
indorsers, and others permitting only the admission of such evi-
dence as shows the time and place that the signature was placed
upon the instrument.

Under the Act the accommodation indorser is an indorser and is,
therefore, entitled to notice by the holder where the instrument has
been presented for payment to the primary party and dishonored. 4

Sec. 74. Order of liability of indorsers. A holder of an in-
strument which has been dishonored may hold all those indorsers
liable who have indorsed unqualifiedly, provided he has complied
with the conditions precedent. He may seek recovery from the last
indorser, or from the first indorser, or from intermediate indorsers.
In many states he may join all the indorsers in one action. But
an indorser who pays an instrument may recover only from an in-
dorser prior to him. Indorsers are liable prima facie in the order
in which they indorse ; but evidence is admissible to show that be-
tween or among themselves they have agreed otherwise. For ex-
ample: A, B, C, D, and E are indorsers on a check drawn by M, A
being the first indorser, and E the last. H, the holder, on nonpay-

'Rockfield et al. v. First National Bank of Springfield, 1907, 77 Oh. St. 311, 83 N.E.
392; p. 612.


ment of M's check, may recover from D. If D pays, E is no longer
liable. D may seek payment from C, and C from B, and B from A.
However, if A and B had an agreement whereby A was not to be
liable to B, A, in an action by B, would be permitted to introduce
this evidence in order to avoid liability.

Sec. 75. Drawers of bills of exchange, excepting drawers of
checks. The drawer of a bill of exchange has both conditional and
unconditional liabilities, but his unconditional liability is not so ex-
tensive as the unconditional liability of the indorser. The condi-
tional liabilities of the drawer, with the exception of the drawer of
checks, are exactly the same as those of the indorser. With respect
to unconditional liabilities, the drawer makes no warranties, al-
though he cannot deny the existence of certain facts; that is, by
drawing an instrument, he admits the existence of the payee and
his then capacity to indorse. The liability of the drawer of a check
will be considered in a later chapter.

Defenses of Parties

Sec. 76. In general. We learned in the last chapter that a
holder in due course occupies a protected position and holds the
instrument free from certain defenses. The defects to which the
holder in due course is not subject are called personal defenses.
There are certain defenses, however, which the maker and the ac-
ceptor may successfully maintain even against the holder in due
course. These defenses are called real defenses. If the holder of
the instrument is not a holder in due course, personal as well as real
defenses may be successfully interposed against him, just as though
the instrument were nonnegotiable.

Real and personal defenses are also available to secondary parties
in suits brought by the holder, just as they are available to the
maker and the acceptor. In short, an indorser may set up his real
defenses against any holder subsequent to him, and he may set up
personal defenses, such as failure of consideration, against his im-
mediate indorsee.

Personal Defenses

Sec. 77. Nature. Personal defenses are those which relate to
the consideration for which the instrument was given and to losses
resulting from some negligence on the part of the primary party in
creating or executing the instrument. They may be classified as
follows: fraud in the inducement or consideration; lack, failure, or
illegality of consideration; payment; improper delivery of a com-


pleted instrument; slight duress; unauthorized completion; and
material alteration made possible by negligent conduct.

Sec. 78. Fraud. Fraud in the inducement or consideration is
fraud pertaining to the consideration for which the instrument is
given. 5 The primary party intended to create an instrument, but
was fraudulently induced to do so. Such a defense is not available
against a holder in due course, but is available against any other
holder. For example, A is induced by B, through fraud, to pur-
chase stock. A, in settlement therefor, executes and delivers to B
his promissory note. B negotiates this note to C, a holder in due
course. A, upon learning that the stock is valueless, cannot set up
this defense against C on the date of maturity. He could have set
it up against B if the latter had retained the note.

Sec. 79. Lack, failure, or illegality of consideration. While
lack, failure, or illegality of consideration is not a defense against
a holder in due course, it is a defense against one not a holder in due
course, just as it would be a defense in any action on a simple con-
tract. For example, A gives B his promissory note in payment for
merchandise. The merchandise does not meet the requirements of
the contract, or it is never delivered. B negotiates the note to X,
who has knowledge of the breach. X negotiates the note to C, a
holder in due course. C, the holder in due course of A's note, may
recover on the same, free from A's defense, but X, had he retained
the note, would have been subject to the defense.

If the consideration for the instrument arises out of an illegal
transaction, the fact that the consideration is illegal is a defense in
a suit between the immediate parties; but if the instrument gets
into the hands of a holder in due course, the illegality of considera-
tion will be no defense. Thus, A gave B a check for the rent of a
house, which B knew A was using contrary to the lawyer as a gambling
and liquor den. B negotiated the check to X, a holder in due
course. Payment of the check is not enforceable by B, but is en-
forceable by X, the holder in due course.

The problem of illegality will be further considered in connec-
tion with Real Defenses.

Sec. 80. Payment before maturity. Payment of a negotiable
instrument prior to maturity is only a personal defense, and one
making such a payment should do so only if the instrument is sur-
rendered. Likewise, payment to the wrong person is not available
as a defense against a holder in due course. In this connection it
is well to remember that the primary party to commercial paper

5 W. M. Barnett Bank v. Chiatovich, 1925, 48 Nev. 319, 232 Pac. 206; p, 613.
6 Lozano v. Meyers, 1929, Tex. Com. App., 18 S.W.(2d) 588; p. 614.


has no right to assume that it remains in the hands of the origi-
nal party. Since a negotiable instrument may be freely negotiated
without notice thereof reaching the primary party, the burden rests
upon him to locate the instrument before making payment.

The question of discharge by payment at or after maturity will
be considered further in the chapter on Discharge.

Sec. 81. Nondelivery of a completed instrument. An instru-
ment may be drawn in correct form, executed upon consideration,
may reach the hands of the payee, and yet be unenforceable be-
cause of the lack of another requirement: namely, delivery. The
Uniform Negotiable Instruments Act provides that every contract
on a negotiable instrument is incomplete and revocable until deliv-
ery of the instrument for the purpose of giving effect thereto. De-
livery means transfer of possession, actual or constructive, from one
person to another.

What, then, is the liability of a party whose signature appears on
a completed instrument which has never been delivered but which
in some way gets into circulation? The Uniform Negotiable In-
struments Act provides that, as between immediate parties and as
to remote parties, other than holders in due course, the delivery, in
order to be effective, must be made either by or under the author-
ity of the party making, drawing, indorsing, or accepting the instru-
ment. As between immediate parties, the delivery may be shown
to be conditional or for some special purpose only, and not for the
purpose of transferring title in the instrument until the happening
of some event. For instance, in a suit by B, A may show that he
delivered to B a certain check to be negotiated only on condition
that B first paint A's picture. Evidence of J5's failure to paint the
picture is a good defense as against B.

A holder in due course of an instrument which is complete in
every respect except delivery can enforce it against all prior parties
whose names appear thereon. If a completed instrument falls into
the hands of a holder in due course, delivery is conclusively pre-
sumed. 7 Consequently, a holder in due course is not concerned
with the question of the delivery of an originally completed instru-
ment. Thus, if a completed instrument has been lost or stolen and
can be negotiated without the forging of an indorsement, a holder
in due course can obtain good title thereto.

Sec. 82, Duress. If the party can show that he signed or in-
dorsed an instrument because of duress, which consisted of threats
and no more, his defense is personal and cannot be raised as against
a holder in due course, but it may be interposed as to any other
holder. Duress so extreme that it robs the party of his freedom of

7 Angus v. Downs, 1915, 85 Wash. 75, 147 Pac. 630; p. 615.


action, so severe that his act is not his own but becomes that of an-
other party, is a real defense. For instance, if a person's hand is
forcibly taken and he is compelled to write his name, the signature
is not his act, and no contract has been made, whether the pur-
chaser of the paper knows the facts or not. Duress of this type is
a real defense available against a holder in due course.

Sec. 83. Completion not as authorized. Where a holder in-
trusts an instrument to another for the purpose of completing it as
to the amount, payee, and so forth, the fact that the instructions
were not obeyed is usually held to constitute no defense to an ac-
tion by a holder in due course. Such a violation of authority would
be a defense to an action by one not a holder in due course,

Sec. 84. Effect of negligence on liability of a party. There
are three outstanding situations in which negligence has an impor-
tant bearing on the rights of the parties. First, negligence over the
control of an incomplete instrument bars the drawer, or maker,
from asserting lack of delivery as a real defense. Whenever an in-
strument originally incomplete finds its way in completed form into
the hands of a holder in due course, as a result of negligence, lack
of delivery becomes a personal defense only. As between the
holder in due course of an instrument and the maker or drawer
whose carelessness, or the negligence of whose agent, made it pos-
sible for the instrument to get into circulation, the loss should be
borne by the maker or drawer. The second situation is somewhat
similar. If a maker, or drawer, of a negotiable instrument, by fail-
ing to fill all of the blank spaces, makes alteration thereof easy, 8
some courts hold the maker, or drawer, liable to a holder in due
course in accordance with the terms of the altered instrument.
Failure to fill in with a wavy line the blank space following the
amount has been held by these courts as carelessness on the part of
the drawer of a check.

Third, normally, a bank which pays a forged check drawn on it
must suffer the loss unless it can recover from the forger, A drawer
who is negligent in scanning his cancelled checks, however and
thus facilitates the forging of other checks or the escape of the
forger should bear the loss which results from his failure promptly
to report the forged signatures. Failure to notify the drawee bank
within a reasonable time after a forged check has been returned is
negligence and makes the drawer responsible for any loss occa-
sioned thereby.

So far as a drawee bank is concerned, one who signs checks in
blank is always deemed to be negligent. Since the bank is bound

8 National Exchange Bank of Albany v. Lester, 1909, 194 N.Y. 461, 87 N.E. 779; p.


to respect and honor the checks of its depositors, lack of delivery of
an incompleted instrument is only a personal defense so far as the
drawee bank is concerned. 9 The bank is justified in paying such a
check before it receives notice of the theft and may charge it to the
drawer's account.

Real Defenses

Sec. 85. Nature. A real defense, sometimes called an absolute
defense, is one that is available to the primary or secondary parties
against the holder in due course, as well as against other holders.
A real defense arises by virtue of the fact that no instrument or lia-
bility was ever created in contemplation of the canadian law; or if such in-
strument or liability was created, it is rendered void by public pol-
icy or statute, or it is rendered void to the extent of the alteration,
if materially altered ; or if such instrument or liability was created,
the person suing cannot enforce payment because of lack of title as
the result of a forged indorsement. If, therefore, no instrument or
liability was created in the first instance, or if such instrument or
liability has been destroyed, no right or title passes into the hands
of the holder. Real defenses available to a party against the holder
are: fraud in the inception; forgery; duress (see Personal de-
fenses); lack of title; material alteration, to the extent of the al-
teration; incapacity; illegality; and theft of an incompleted instru-

Sec. 86. Fraud in the inception. Fraud in the inception or
execution exists where a negotiable instrument is procured from a
party when circumstances are such that the party does not know
he is giving a negotiable instrument. Therefore, since the party
primarily to be bound has no intention of creating an instrument,
none is created. For example: A, intending to sign a lease at the
request of B, unknowingly and by trickery on the part of B, signs
a negotiable instrument. B negotiates the instrument to C, a bona
fide purchaser. Upon presentation of this instrument by C to A
for payment, A will have a real defense of fraud in the inception.
Since A created no paper, C purchased none.

Carelessness on the part of the maker which facilitates or makes
easy fraud in the execution robs him of a real defense, reducing it to
one which is personal only. Thus, in the above illustration, if A
had signed the so-called lease without reading it and had allowed
himself to be deceived into thinking the negotiable instrument he
signed was a lease, he would have been liable to a holder in due

9 Trust Co. of America v, Conklin, 1909, 65 Misc. (N.Y.) 7, 119 N.Y. Supp. 367; p.


course of the instrument. In such a case, he cannot throw the loss
occasioned by his negligence on the holder in due course.

Sec. 87. Forgery. It is clear that a person whose signature or
indorsement is forged upon an instrument should not be bound
thereon, in the absence of negligence or estoppel, because no in-
strument is created by the person whose name is forged. Between
the person whose name is forged and the holder in due course, the
loss should fall on the holder in due course. He will have a right
against his immediate vendor and all prior parties subsequent to
the forgery. Thus, the loss ultimately falls upon the person who
dealt directly with the forger. The Uniform Negotiable Instru-
ments Act states : " Where a signature is forged or made without the
authority of the person whose signature it purports to be, it is
wholly inoperative, and no right to retain the instrument or to give
a discharge therefor or to enforce payment thereon against any
party thereto can be acquired under such signature, unless the
party against whom it is sought to enforce such right is precluded
from setting up the forgery or want of authority." Therefore, a
forged indorsement would not only fail to pass title, but would give
the indorser, whose indorsement was forged, a real defense against
all subsequent parties.

Sec. 88. Lack of title. A forged indorsement by a thief or
finder of order paper passes no title to the indorsee. Consequently,
any subsequent party will be unable to enforce payment of the
same against prior parties. Lack of title is a real defense and can
be asserted against a holder in due course. The true owner of the
paper, however, may hold the wrongdoer as a converter. It. should
be pointed out that bearer paper requires no indorsement. Con-
sequently, a forged indorsement of paper which at the time is pay-
able to bearer does not affect the title obtained by the purchaser.
A thief or finder of such paper may pass good title to a holder in
due course, although the title of such thief or finder was defective.

Signing another's name without authority is not forgery in all
cases, particularly when the person so signing indicates he signs as
as agent. Nevertheless, if he fails to possess the authority to make
the indorsement which he attempts to execute, the purchaser ac-
quires no title to the instrument.

Occasionally, one person impersonates another, and persuades a
third person to make a check or note payable to the person who has
been impersonated and, having received the instrument from the
maker, the impersonator indorses on it the name of the payee.
Such an indorsement is not considered a forgery, and the indorsee
obtains good title to the instrument. 10 Under such circumstances,

10 Strieker v. Buncombe County et al., 1934, 235 N.C. 536, 172 S.E. 188; p. 618.


the maker of the instrument really intended the impersonator to
obtain the money, although he thought him to be somebody else.

When two people have the same name, and the person not in-
tended to be the payee gains possession of a negotiable instrument
and adds his indorsement to it, forgery has taken place. Some
cases hold that if the maker or drawer is careless in delivering the
instrument to the wrong party, he may be held liable thereon.

Sec. 89. Material alteration to extent of alteration. Material
alteration is not a defense against a holder in due course in an ac-
tion to recover the original tenor of the instrument. It is a de-
fense, however, even against a holder in due course, to the extent of
the alteration. Thus, when an instrument is raised from $100 to
$1,000, the maker, acceptor, drawer, or prior indorsers have an ab-
solute defense to the extent of $900, the amount of the alteration,
unless the alteration has been facilitated by their negligence.

Sec. 90. Incapacity. Negotiable paper executed by infants,
insane persons, drunkards, and other persons under legal aid disability
is not legally binding as to such persons. Therefore, such persons
may, at their election, assert a real defense against any holder. In-
capacity is available only to the incapable parties and is not a de-
fense to the other parties on the instrument. The indorsement or
assignment of any person under legal disability passes title in the
instrument; but this fact in itself does not give subsequent parties
a right to recover against such persons under legal disability. Such
persons may disaffirm their indorsement and recover possession of
the instrument from any subsequent holder; or they may set up
their incapacity as a real defense if they are makers, drawers, or ac-

Sec. 91. Illegality. The statutes of many states make void
particular kinds of contracts, such as gambling and usurious con-
tracts. 11 An instrument that carries a usurious rate of interest
which is declared void by statute continues void even in the hands
of a holder in due course. The consideration out of which an in-
strument arises may be illegal. Nevertheless, the instrument it-
self, unless specifically or impliedly made void by statute, is valid.

Sec. 92. Nondelivery of an incompleted instrument. The
question arises as to the liability of a party whose signature is
placed on an incompleted instrument which has never been deliv-
ered, but is in some way subsequently completed and placed in cir-
culation. The Uniform Negotiable Instruments Act provides that
where an incompleted instrument has not been delivered, but is
taken, completed, and negotiated without authority, such an in-
strument is not a valid contract in the hands of any holder as

u Sabine v. Paine, 1918, 223 N.Y. 401, 119 N.E. 849; p. 619.


against any person whose signature was on the instrument before
it was taken. Thus, suppose A, without negligence, leaves a prom-
issory note lying on his desk, which note was signed by himself but
which named no payee and specified no amount. B finds the note
and completes it without authority, making it payable to himself
for $1,000. B sells the note to X, who takes it in good faith, with-
out notice, before maturity and for value. The note is invalid as
to A ; but it is enforceable against B } who became a party to it after
the taking of the note.

It must be noted that the above situation is different from one
where the incompleted instrument was in fact delivered by the
maker, or drawer, but was not filled out in accordance with the au-
thority given. Here the maker, or drawer, is liable to all holders in
due course for the amount of the instrument, for he delivered the
instrument and authorized its completion. In the former situation
he did neither. In effect he issued no instrument and therefore can
be held liable on none.

Review Questions and Problems

1. Must a bill of exchange be accepted before it is negotiable? How
is it customary to accept a bill of exchange?

2. D's signature is forged to a bill of exchange drawn in favor of P
on drawee Y. P takes the bill to Y and has it accepted and then nego-
tiates it to H, a holder in due course. H presents it for payment to 7,
who refuses to pay because he has learned of the forgery. May H re-
cover from F?

3. Must an acceptance be in writing? May it be on paper other than
the bill of exchange? Suppose A purchases a bill of exchange which has
been accepted by the drawee upon another piece of paper. Under what
circumstances may he hold the drawee?

4. //, a holder, presents a bill of exchange to Y for payment. Y takes
the bill of exchange, but for three days he refuses either to return or to
pay it. Is he liable to H, although he later offers to return the paper?

5. What is the meaning of personal defenses? Against whom are
they available?

6. A determines to make a gift to his son P, but not having the "ready
cash" he makes a note for $1,000 to P. P immediately negotiates the
note to H, a holder in due course. May A set up the defense of lack of
consideration against #?

7. M pays his negotiable note to P thirty days before maturity, but
fails to take up the paper. Shortly thereafter P negotiates the note to
Hj a holder in due course. May H compel M to pay the note a second

8. A leaves with his agent a check signed in blank, to be filled in and
delivered to a certain creditor. The agent makes it payable to P, a


friend, and P negotiates it to a holder in due course. Can the holder
recover from A, who has stopped payment at the bank?

9. What is meant by fraud in the execution? Is it a real or a personal

10. A found a negotiable note made payable to the order of P. He
indorsed the name of P thereon and transferred it to H, who had no
knowledge of his misconduct. May H recover from the maker of the

11. What is the effect of a material alteration by the payee? May a
later holder in due course recover on the note?

12. A statute in Illinois provides that all checks, bills, and notes given
in payment of a gambling debt shall be null, void, and of no effect. Sup-
pose such a note falls into the hands of a holder in due course; may he
recover from the maker?

13. What is necessary to establish the conditional liability of the in-

14. H holds a note which, unknown to him, has been forged. He, by a
qualified indorsement, indorses it to A, a holder in due course. It is pre-
sented and payment is refused. A desires to hold H liable on his in-
dorsement. May he do so?

15. Name the warranties of a qualified indorser. What is the differ-
ence between the warranties of a mere transferor of bearer paper and
those of a qualified indorser?

16. What is an accommodation indorser? Is he entitled to notice of

17. X accused Y of an assault, and threatened criminal prosecution.
Y admitted his wrong and offered to settle. Y tendered to X his note for
$300, to be held by X for three days until Y considered the matter. If Y
did not appear, the note was to be taken as a settlement. If Y did ap-
pear, the note was to be cancelled and other arrangements were to be
made. Y appeared at the end of the third day and demanded the note,
which X refused to return. X sues Y on the note. Y sets up a defense
of nondelivery. What is the result?

18. D drew a draft on the Y Company in favor of the X Company.
The X Company secured an acceptance of the draft from the Y Com-
pany and indorsed it to P. At the time of the acceptance it was orally
agreed between the X Company and the Y Company that if the acceptor,
the Y Company, could not meet the draft when presented for payment,
D would renew the draft. P had knowledge of these facts. P sues the
Y Company on the draft. The Y Company sets up defense of nonde-
livery. What is the result? Suppose P had no knowledge of the under-
standing between the X Company and the Y Company?

19. M signed the following note, leaving it on his desk:

Seattle, Washington.
May 4, 1940.
On or before six months from date I promise to pay to the order



(Signed) M.


A, an agent, stole and completed the instrument. He then negotiated
the note to 7, who indorsed to P. P sues M, who sets up the defense of
nondelivery. What is the result?

20. D drew a check payable to P or bearer, leaving the check on his
desk. P took the check and transferred it to X. Has D a defense
against XI Against P?

21. D signs a number of checks in blank for the benefit of his clerk
and locks them securely in his safe. The safe is robbed and one of the
checks is completed and finds its way into the hands of an innocent party.
May the innocent party recover on the check?

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