Discharge of Negotiable Instruments

Topics: Negotiable instrument, Commercial paper, Promissory note Pages: 19 (2939 words) Published: November 21, 2014
Discharge of Negotiable Instruments
Explain how the liability of a party to pay an instrument is normally discharged. Discharge of Liability
The obligation of a party to pay an instrument is discharged (1) if he meets the requirements set out in Revised Article 3 or (2) by any act or agreement that would discharge an obligation to pay money on a simple contract. Discharge of an obligation is not effective against a person who has the rights of a holder in due course of the instrument and took the instrument without notice of the discharge [3–601]. The most common ways that an obligor is discharged from his liability are: 1.Payment of the instrument.

2.Cancellation of the instrument.
3.Alteration of the instrument.
4.Modification of the principal’s obligation that causes loss to a surety or impairs the collateral. 5.Unexcused delay in presentment or notice of dishonor with respect to a check (discussed earlier in this chapter). 6.Acceptance of a draft [3–414(c) or (d); 3–415(d)]; as noted earlier in the chapter, a drawer is discharged of liability of a draft that is accepted by a bank (e.g., if a check is certified by a bank) because at that point the holder is looking to the bank to make the instrument good. 1.Discharge by Payment

Generally, payment in full discharges liability on an instrument to the extent payment is (1) by or on behalf of a party obligated to pay the instrument and (2) to a person entitled to enforce the instrument. For example, Arthur makes a note of $1,000 payable to the order of Bryan. Bryan indorses the note “Pay to the order of my account no. 16154 at First Bank, Bryan.” Bryan then gives the note to his employee, Clark, to take to the bank. Clark takes the note to Arthur, who pays Clark the $1,000. Clark then runs off with the money. Arthur is not discharged of his primary liability on the note because he did not make his payment consistent with the restrictive indorsement. To be discharged, Arthur has to pay the $1,000 into Bryan’s account at First Bank. To the extent of payment, the obligation of a party to pay the instrument is discharged even though payment is made with knowledge of a claim to the instrument by some other person. However, the obligation is not discharged if: (1) there is a claim enforceable against the person making payment and payment is made with knowledge of the fact that payment is prohibited by an injunction or similar legal process; or (2) in the case of an instrument other than a cashier’s, certified, or teller’s check, the person making the payment had accepted from the person making the claim indemnity against loss for refusing to make payment to the person entitled to enforce payment. The obligation also is not discharged if he knows the instrument is a stolen instrument and pays someone he knows is in wrongful possession of the instrument [3–602]. 2.Discharge by Cancellation

A person entitled to enforce a negotiable instrument may discharge the liability of the parties to the instrument by canceling or renouncing it. If the holder mutilates or destroys a negotiable instrument with the intent that it no longer evidences an obligation to pay money, the holder has canceled it [3–604]. For example, a grandfather lends $5,000 to his grandson for college expenses. The grandson gives his grandfather a promissory note for $5,000. If the grandfather later tears up the note with the intent that the grandson no longer owes him $5,000, the grandfather has canceled the note. An accidental destruction or mutilation of a negotiable instrument is not a cancellation and does not discharge the parties to it. If an instrument is lost, mutilated accidentally, or destroyed, the person entitled to enforce it still can enforce the instrument. In such a case, the person must prove that the instrument existed and that she was its holder when it was lost, mutilated, or destroyed. 3.Altered Instruments; Discharge by Alteration

A person paying a fraudulently altered instrument, or...
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