Part 7- Credit, Chapter 33: Liability of Parties, Doc 5

Key Concepts on Discharge and Conversion in Negotiable Instruments 1. Discharge of Liability: o Liability on a negotiable instrument can be discharged in several ways, primarily by full payment to a party entitled to enforce it, cancellation of the instrument, or modification of the obligation. Discharge protects the obligor (the person responsible for payment) when they fulfill their obligation as per the instrument’s terms or under specific circumstances outlined by the UCC. 2. Conversion of an Instrument: o Conversion occurs when an instrument is wrongfully handled, such as when it is paid to a party not entitled to it, often due to forgery or unauthorized indorsement. If a bank pays out on a forged instrument, it is liable for conversion and must reimburse the rightful party. 3. Negligence and Comparative Fault: o If a party’s negligence contributes to a loss, such as enabling forgery or alteration, they may be partially or fully liable. Comparative negligence allows for a proportionate allocation of liability based on each party's fault, as seen in the Victory Clothing Co. v. Wachovia Bank case where both the bank and employer shared liability for an employee’s fraudulent acts. 4. Altered Instruments: o Fraudulent alterations, such as unauthorized changes to increase the amount, typically discharge the original obligors unless the alteration was due to their negligence. However, if a party in good faith accepts a fraudulently altered instrument, they may enforce it for its original terms. For example, if a check's amount is altered from $10 to $10,000 and a third party accepts it without knowledge of the fraud, they can enforce payment for only the original $10. 5. Case Example: American Federal Bank v. Parker: o Parker signed a blank promissory note that a third party fraudulently filled out for an amount higher than agreed. The court held Parker liable, as his negligence in signing a blank note substantially contributed to the fraud, allowing the bank (a holder in due course) to enforce the note’s completed terms. 6. Discharge by Cancellation and Modification: o If a party cancels a negotiable instrument with intent, such as by tearing it up, they discharge it. Furthermore, modifications or impairment of collateral that negatively affect an accommodation party (one who co-signs to lend credit) may discharge that party’s liability if it impacts their recourse. 7. Discharge of Indorsers and Accommodation Parties: o If an instrument’s terms are materially modified without consent, indorsers and accommodation parties (secondary liable parties) may be discharged from their obligations, especially if the modification or loss of collateral affects their potential for recovery. Problems and Cases 1. Goss and Arrazza’s Obligation to Credit Union: o Goss and Arrazza indorsed and deposited a check, which was later dishonored due to insufficient funds. As indorsers, they are secondarily liable and obligated to make good on the check if the maker fails to do so. 2. Formica Construction Case: o Daniel Mills signed a promissory note for construction work on behalf of Mossi Inn, Inc., which he managed. The specific obligations of Mills and Mossi Inn, as well as the validity of the promissory note under agency authority, would need to be analyzed to determine liability for payment if challenged.