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20.5 Summary and Exercises


Negotiation is the transfer of an instrument in such a form that the transferee becomes a holder. There are various methods for doing so; if the procedures are not properly adhered to, the transfer is only an assignment.

An instrument payable to the order of someone must be negotiated by indorsement and delivery to the transferee. The indorsement must convey the entire instrument. An instrument payable to bearer may be negotiated simply by delivery to the transferee.

Those who sign the instrument have made a contract and are liable for its breach. Makers and acceptors are primary parties and are liable to pay the instrument. Drawers and indorsers are secondary parties and are conditionally liable. Signatories are liable under a warranty theory.

Various forms of indorsement are possible: blank or special, restrictive or unrestrictive, qualified or unqualified.

Between drawer and drawee, liability for a forged instrument—one signed without authority—usually falls on the drawee who paid it. There are, however, several exceptions to this rule: where an imposter induces the maker or drawer to issue an instrument in the name of the payee, where the instrument is made to a fictitious payee (or to a real person who is intended to have no interest in it), and where the instrument is made by an employee authorized generally to deal in such paper


  1. Mal, a minor, purchased a stereo from Howard for $425 and gave Howard a negotiable note in that amount. Tanker, a thief, stole the note from Howard, indorsed Howard’s signature and sold the note to Betty. Betty then sold the note to Carl; she did not indorse it. Carl was unable to collect on the note because Mal disaffirmed the contract. Is Betty liable to Carl on a contract or warranty theory? Why?
  2. Would the result in Exercise 1 be different if Betty had given a qualified indorsement? Explain.
  3. Alphonse received a check one Friday from his employer and cashed the check at his favorite tavern, using a blank indorsement. After the tavern closed that evening, the owner, in reviewing the receipts for the evening, became concerned that if the check was stolen and cashed by a thief, the loss would fall on the tavern. Is this concern justified? What can the owner of the tavern do for protection?
  4. Martha owns a sporting goods store. She employs a bookkeeper, Bob, who is authorized to indorse checks received by the store and to deposit them in the store’s bank account at Second Bank. Instead of depositing all the checks, Bob cashes some of them and uses the proceeds for personal purposes. Martha sues the bank for her loss, claiming that the bank should have deposited the money in the store’s account rather than paying Bob. Is the bank liable? Explain.
  5. Daniel worked as a writer in order to support himself and his wife while she earned her MBA degree. Daniel’s paychecks were important, as the couple had no other source of income. One day, Daniel drove to Old Faithful State Bank to deposit his paycheck. Standing at a counter, he indorsed the check with a blank indorsement and then proceeded to fill out a deposit slip. While he was completing the slip, a thief stole the check and cashed it. Whose loss? How could the loss be avoided?
  6. You are the branch manager of a bank. A well-respected local attorney walks into the bank with a check for $100,000 that he wants to deposit in the general account his firm has at your bank. The payee on the check is an elderly widow, Hilda Jones, who received the check from the profit-sharing plan of her deceased husband, Horatio Jones. The widow indorsed the check “Pay to the order of the estate of Horatio Jones. Hilda Jones.” The attorney produces court documents showing that he is the executor of the estate. After the attorney indorses the check, you deposit the check in the attorney’s account. The attorney later withdraws the $100,000 and spends it on a pleasure trip, in violation of his duties as executor. Discuss the bank’s liability.
  7. Stephanie borrows $50,000 from Ginny and gives Ginny a negotiable note in that amount. Ginny sells the note to Roe for $45,000. Ginny’s indorsement reads, “For valuable consideration, I assign all of my rights in this note to Roe. Ginny.” When Stephanie refuses to pay the note and skips town, Roe demands payment from Ginny, claiming contract liability on the basis of her signature. Ginny argues that she is not liable because the indorsement is qualified by the language she used on the note. Who is correct? Explain.
  8. The state of California issued a check that read, “To Alberto Cruz and Roberta Gonzales.” Alberto endorsed it “Pay to the order of Olivia Cruz.” What rights does Olivia get in the instrument?
    1. Bill’s weekly paycheck was stolen by a thief. The thief indorsed Bill’s name and cashed the check at the drawee bank before Bill’s employer had time to stop payment. May the drawee bank charge this payment against the drawer’s account? Explain.
    2. Would the result change in (a) if Bill had carelessly left his check where it could easily be picked up by the thief? Explain.
    3. Would the result change in (a) if the bank had specific regulations that tellers were not to cash any check without examining the identification of the person asking for cash?
    4. Would the result change if Bill’s employer had carelessly left the check where it could be found by the thief?

Self-Test Questions

  1. A person who signs a negotiable instrument with a blank endorsement has

    1. warranty liability
    2. contract liability
    3. both of the above
    4. neither of the above
  2. “For deposit” is an example of

    1. a special indorsement
    2. a restrictive indorsement
    3. a qualified indorsement
    4. a blank indorsement
  3. “Pay to the order of XYZ Company” is an example of

    1. a special indorsement
    2. a restrictive indorsement
    3. a qualified indorsement
    4. a blank indorsement
  4. The indorser’s signature alone is

    1. a special indorsement
    2. a restrictive indorsement
    3. a qualified indorsement
    4. a blank indorsement
  5. Generally, liability for a forged instrument falls on

    1. the drawer
    2. the drawee
    3. both of the above
    4. neither of the above
  6. State whether each of the following is (1) blank or special, (2) restrictive or nonrestrictive, or (3) qualified or unqualified:

    1. “Pay to David Murphy without recourse.”
    2. “Ronald Jackson”
    3. “For deposit only in my account at Industrial Credit Union.”
    4. “Pay to ABC Co.”
    5. “I assign to Ken Watson all my rights in this note.”

Self-Test Answers

  1. c
  2. b
  3. a
  4. d
  5. b
    1. special, nonrestrictive, qualified
    2. blank, nonrestrictive, unqualified
    3. special, nonrestrictive, unqualified
    4. special, restrictive, unqualified
    5. special, restrictive, unqualified