Negotiable Instruments: Liability of Parties

Part 4 of Article 3 deals with liability of parties.  The basic rule is contained in Section 3-401:

(a)  A person is not liable on an instrument unless (i) the person signed the instrument, or (ii) the person is represented by an agent or representative who signed the instrument and the signature is binding on the represented person under Section 3-402.

Therefore, if a person has not ‘signed’ an instrument, the person is not liable on the instrument. That is not to say that he or she may not be liable on an underlying transaction for which the instrument has been issued; it is however, a statement that the person will not be liable on the instrument.  As noted in Section 3-401(a) however, in  a principal agent scenario, the principal can be bound on an instrument signed by an appropriately designated agent under Section 3-402.

To understand what Section 3-401(a) means, and the ‘person’ to be liable, we must again first apply the broad definition of ‘person’ under Section 1-201(b)(27):

"Person" means an individual, corporation, business trust, estate, trust, partnership, limited liability company, association, joint venture, government, governmental subdivision, agency, or instrumentality, public corporation, or any other legal or commercial entity.

Once we know who the ‘person’ is, we must go on to examine all of the elements contained in Section 3-104 to determine if the writing is negotiable.  One of those elements is that the writing be ‘signed’ by the maker or drawer of the instrument.  We will discuss the liability of these parties under the UCC shortly, but for now, in order to establish that a writing is in fact an instrument, we must determine whether, as a matter of law, it has been signed. 

That term is defined under Section 1-201(b)(37).

"Signed" includes using any symbol executed or adopted with present intention to adopt or accept a writing. [Emphasis added]

Once again, the language is unmistakably clear—there must be a ‘present intention’ to authenticate the writing.  The potential impact on the enforcement of a negotiable instrument is immediately seen.  Did the person whose signature appears on the writing have a present intention to authenticate the writing?  Or, was their some condition precedent that the lender or some other party was supposed to take before the signature became ‘active’? 

            The question of when something becomes ‘signed’ will be discussed in the next post.  For now, I simply wanted to bring this up since it is rarely discussed, and equally because the potential impact on the ‘present intent’ requirement on enforcing an obligation on an instrument is enormous.  That discussion will wait until we have laid out the basic liabilities of parties on an instrument.

            The liability of an issuer of a note is contained in Section 3-412.  Before addressing that section, it is necessary to reexamine ‘issue’ so that we can determine who the issuer is, and hence, who is liable and for what. ‘Issue’ is defined under Section 3-105(a) as:

[T]he first delivery of an instrument by the maker or drawer, whether to a holder or nonholder, for the purpose of giving rights on the instrument to any person.

The liability for the issuer [maker] of a note is ‘to pay the instrument (i) according to its terms as the time it was issued….’  Section 3-412. Leaving aside any special rules, this is the basic rule—whatever amount the note was originally made out for is the amount owed by the maker. Section 3-412 goes on to state: ‘The obligation is owed to a person entitled to enforce the instrument or to an indorser who paid the instrument under Section 3-415’.

"Person entitled to enforce" an instrument means (i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to Section 3-309 or 3-418(d)…. Section 3-301

Therefore, if Maker signs a note for $5,000.00 payable to the order of Payee, who in turn negotiates the note to Third Party, the latter becomes the holder of the instrument and hence the ‘person entitled to enforce’ the instrument.  Until the negotiation, Maker would be the holder, and hence the ‘person entitled to enforce’.

            Whereas the obligation of the maker vests upon the issue of the note, the liability of the drawer of a draft does not kick in until the instrument is dishonored:

(a)  If an unaccepted draft is dishonored, the drawer is obliged to pay the draft (i) according to its terms at the time it was issued or, if not issued, at the time it first came into possession of a holder….The obligation is owed to a person entitled to enforce the draft or to an indorser who paid the draft under Section 3-415.                       Section 3-414(b)

Unlike a note in which the maker promises to make payment, the drawer of a draft is ordering payment by a third party.[Section 3-103(e)].  If the draft is drawn on a bank and payable on demand, it is a check per Section 3-104(f), the third party of course, is the bank upon which the check was drawn. If the bank refuses payment, the check would be dishonored under Section 3-502 and the liability of the drawer would activate under Section 3-414(b).

            It is interesting to note that the issuing of a check does not, in and of itself, create a liability by the bank on the instrument:

A check or other draft does not of itself operate as an assignment of funds in the hands of the drawee available for its payment, and the drawee is not liable on the instrument until the drawee accepts it.  Section 3-408

Therefore, at the time the check is issued, no one is immediately liable. The drawer is not liable until the check is dishonored, and the bank is not liable until it accepts.

"Acceptance" means the drawee's signed agreement to pay a draft as presented. It must be written on the draft and may consist of the drawee's signature alone. Acceptance may be made at any time and becomes effective when notification pursuant to instructions is given or the accepted draft is delivered for the purpose of giving rights on the acceptance to any person.  Section 3-409(a)

The final liability to be discussed at this time is that of the indorser. Indorsement is defined under Section 3-204(a):

(a)  "Indorsement" means a signature, other than that of a signer as maker, drawer, or acceptor, that alone or accompanied by other words is made on an instrument for the purpose of (i) negotiating the instrument, (ii) restricting payment of the instrument, or (iii) incurring indorser's liability on the instrument….

(b) "Indorser" means a person who makes an indorsement.

The indorser’s liabililty is similar to that of the drawer insofar as it does not kick in until the instrument has been dishonored:

(a)  Subject to subsections (b), (c), and (d) and to Section 3-419(d), if an instrument is dishonored, an indorser is obliged to pay the amount due on the instrument (i) according to the terms of the instrument at the time it was indorsed… The obligation of the indorser is owed to a person entitled to enforce the instrument or to a subsequent indorser who paid the instrument under this section.

From the foregoing it is seen that the basic rule regarding the liability of the parties is to pay the instrument according to its terms at the time it was signed.  These basic rules are subject to some important exceptions including, among others, instruments signed when the instrument is incomplete or when there is negligence involved in the preparation or issuing of an instrument.  These exceptions will be discussed in future posts.  The groundwork for these discussion is in place with an understanding of the basic liabilities discussed in this post.

The next post will discuss the meaning of ‘signed’ in detail.  The importance of this definition on the enforceability and drafting of negotiable instruments will become quickly apparent.