NEGOTIABLE INSTRUMENTS LAW

MODULE 3

LEARNING OUTCOMES
At the end of this module, you are expected to:
A. Distinguish real defenses from personal defenses;
B. Determine the material alterations of a negotiable instrument and its
effects;
C. Define an accommodation party;
D. Determine who are the persons with primary and secondary liability;
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13. REAL DEFENSES

REAL DEFENSES PERSONAL DEFENSES

1. Minority (available only to the minor) 1. Failure or absence of Consideration

2. Forgery 2. Illegal Consideration

3. Forgery 3. Illegal Consideration

4. Non-delivery of incomplete instrument 4. Conditional delivery of complete instrument

5. Ultra vires acts if a corporation 5. Fraud in induce,ment

6. Fraud in factum or in esse contractus 6. Filling up blank not within authority

7. illegality -if declared void for any pur- 7. Duress or intimidation

pose
8. Vicious force or violence 8. filling up blank beyond reasonable time

9. Want of Authority 9. Transfer in breach of faith or trust

10. Prescription 10. Mistake

11. discharge in insolvency 11. Insertion of wrong date

12. 12. Antedating or Postdating for illegal or

fraudulent purpose

13,01. Distinguish real defenses from personal defenses

Real or absolute defenses are attached to the instrument and are available
against all holders, whether in due course or not, but only by the party or parties
entitled to raise them. On the other hand, personal or equitable defenses are
available only against the holder who stands in privity with the party who is
entitled to set up the defense, or against those who are not or do not have the
rights of a holder in due course.

13.02. FORGERY

a. What are the effects of Forgery? (Sec. 23, NIL) When 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 thereof against any party thereto, can
be acquired through or 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.
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b) Rules in relation to forgery:

1) Only the forged signature is wholly inoperative, not the instrument

itself, and not the genuine signatures;
2) In case of forgery of an indorsement of an instrument payable to
order, it is not only the person whose signature was forged who would
not be liable, but also the parties prior to such person. Payment under a
forged indorsement is not to the drawer's order;

(i) Cut-Off Rule: Parties prior to the forgery are generally cut-off
from the parties after the forgery.

3) Despite the forgery of the signature, there may be parties who shall be
precluded fromsetting up forgery or want of authority, and are therefore liable
such as: (i) those who warrant the genuineness of signatures like the acceptors,
and indorsers after the forgery; (li) those who ratified the forgery express or
implied; and (it) those who were negligent.

(i) In one case, the drawer was not allowed to recover although
his signature was allegedly forged because it was established that
the person who encashed the checks was his trusted secretary.
The drawer's negligence was considered the proximate cause of
his loss because he entrusted his blank checks and credit cards to
his secretary. He also entrusted to his secretary the verification
and reconciliation of his accounts. He did not personally check his
statement of accounts and cancelled or used checks as the same
were also entrusted to his secretary.

4) A forged indorsement in a promissory note is inoperative; the maker can

raise such defense against the holder. General indorsers after the forged
indorsement are liable. The drawee may likewise refuse to pay if there was
forgery of the indorsement of the payee of a bill of exchange. However, in case of
forgery of an indorsement in a bearer promissory note, the maker cannot raise
the defense of forgery because the indorsement is not necessary for the title of
the holder; he may however raise the defense that the instrument was complete
but undelivered if the holder is not a holder in due course.

5) If the payee's indorsement was forged in a check, the drawee bank cannot
debit the drawer's account and that loss shall be borne by the drawee bank. The
rule applies if there are two joint payees but only one indorsed. The depositary
or collecting bank is liable to the drawee in case of forged indorsement because
it guarantees all prior indorsement. The collecting bank assumes all warranties
of a general indorsers

(i) The collecting bank can in turn collect from its depositor - the
person who deposited (who indorses the check when making the deposit) is
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liable for the warran- ties under Section 66 including the warranty that it is
valid and subsisting

(ii) This is subject to the qualification that the drawee himself was not negligent
or guilty of such conduct as would estop him from asserting the forged character
of the indorsement as against the drawer.

(iii) In another case, the Supreme Court explained that only the drawee may
be held liable if it was not established that the checks containing forged
indorsements passed through the alleged collecting bank The drawee in this
case encashed checks (one of which is crossed) presented by unknown persons
although said checks were payable to BIR Hence, the drawee was clearly
negligent in encashing the checks.

6) If the signature of the drawer in a check is forged, the drawee cannot charge the
account of the drawer and the drawee can not recover from the collecting bank because
the drawee bank assumes all warranties of an acceptor after payment including the
warranty that the drawer's signature is genuine.

7) If the check is deposited in an account of a person who is not the payee without
authority, the drawee cannot debit the account of the drawer. The collecting bank
is liable even to the payee and the drawer

13.03. Give the effects of each of the following: a) Incomplete, but delivered instrument; b)
Complete, but undelivered instrument; and c) Incomplete undelivered instrument

a) Incomplete but Delivered. Where the instrument is wanting in any material

particular the person in possession thereof, is prima facie presumed authorized to
complete it.

(1) A signature on a blank paper delivered by the person making the signature
in order that it may be converted into a negotiable instrument operates as prim
face authority to fill it up as such for any amount.

(2) In both cases, however, the instrument must be filled up strictly in

accordance with the authority given and within a reasonable time in order that
it may be enforced against any person who became a party thereto prior to its
completion. However, persons negotiating after its completion are liable
because of their warranties.

(3) A holder in due course may enforce the instrument as if it had been filled up
strictly in accordance with the authority given and within a reasonable time.
Hence, it is no defense in an action to enforce a negotiable promissory note that
it was signed in blank as Section 14 of the NIL concedes prima face authority of
the person in possession of negotiable instruments to fill in the blanks.
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(5) Where corporate check is incomplete be cause it lacks the name of the payee
but the officer or secretary of the drawer corportion was the one that completed
it by inserting his or her name (officer or secre-tary), the defense is also
personal under Section 14. Comparative negligence rule also applies against the
drawer.

EXAMPLE:

Blank checks were entrusted to NG with the specific instruction not to fill them
out without previous notification to and approval by the drawer, AP so that AP could
verify the validity of the payment and make the proper arrangements to fund the
account. Instead, NG delivered the checks to Mr. M as a security for a loan. Mr. M had
knowledge that the petitioner is not privy to the loan. AP can invoke against Mr. M, who
is not a holder in due course, the defense that the check was not completed strictly
under the authority given by AP. NG has exceeded the authority to fill up the blanks and
use the check. AP gave NG pre-signed checks to be used in their business provided that
he could only use them upon his approval. NG's authority was limited to the use of the
checks for the operation of their business, and on the condition that the petitioner's
prior approval be first secured.

b) Complete and Delivered. Delivery is essential to the validity of any negotiable

instrument. As between immediate parties and those who are similarly situated,
delivery must be coupled with the intention of transferring title to the instrument.

(1) However, if the instrument is in the hands of a holder in due course, valid
delivery to him is conclusively presumed.

(2) The defense of want of delivery or conditional delivery or delivery for a

special purpose only of a complete instrument is only a personal defense (Sec.
16, NIL).

c) Incomplete not Delivered. Non-delivery of an incomplete instrument is a real

defense (Sec 15, NIL)

13.04. UNDATED INSTRUMENT

A negotiable promissory note payable at a fixed period after date was issued undated
and without any amount and was delivered to the payee named therein. Will the filling up of
the blanks with any date and for any amount avoid the note in the hands of the holder?
No. Under Section 13 of the NIL, the insertion of a wrong date will not avoid the
instrument in the hands of a subsequent holder in due course; but as to him, the date so
inserted is to be regarded as the true date. And under Section 14, NIL, if an incomplete
instrument, after completion, is negotiated to a holder in due course, it is valid and effectual
for all purposes in his hands and he may enforce it as if it had been filled up strictly
in accordance with the authority given within reasonable time.
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13.05. MATERIAL ALTERATION AND ITS EFFECTS (Secs. 124 and 125, NIL).

a) Material Alteration - any alteration which changes the date, sum payable, time or
place of payment, number or relation of parties, or medium or currency of
payment, or adds a place of payment where none is specified or which alters the
effect of the instrument in any respect.

b) Effect of Material Alteration - it avoids the instrument, except as against the party
who made, authorized, or assented to the alteration and subsequent indorsers.
HDC can enforce it according to its original tenor (Sec. 124, NIL).

1) The drawee of a check assumes all the warranties of an acceptor if the drawee
paid even with prior acceptance. If the amount of the check was altered, the
holder in due course can recover from the drawee according to its original tenor
(the amount before alteration) although the acceptor is liable according to the
tenor of acceptance in view of the provisions of Section 124 of the NIL.
Subsequent indorsers are however liable for the altered amount (Sec. 124, NIL).

2) As between the drawee and the collecting bank (that is treated as a general
indorser), it is the collecting bank that should suffer the loss in case of alteration
of the amount (1996 Bar). Exception: If the negligence of the drawee bank is the
proximate cause of the loss.

3) In case of alteration of the payee's name, the drawee bank has no right to debit
the account of the drawer; the alteration prevents recovery by the holder (1977
Bar).
c) Is the alteration of the serial number of a check a material alteration?

No. The alteration of the serial number of the check does not alter the ef-
fect of the instrument, nor does it modify in any respect the obligation of a party
thereto. It does not change the items which are required to be stated under Sec-
tion 1, NIL .
13.06. "Fraud in execution"

a)(fraud in factum or fraud in esse contractus) - present when a person is induced to

sign an instrument not knowing its character as a note or a bill. The person who signs
the instrument does not know that he is signing a negotiable instrument. Example: A
blind person was made to sign a piece of paper he believes to be a credit application
although it is really a promissory note.

b)"Fraud in inducement' - the person who signs the instrument intends to sign the
same as a negotiable instrument, but was induced to do so only through fraud; his con-
sent to issue a negotiable instrument was vitiated by fraud.

b) Fraud in factum is a real defense, while fraud in inducement is a personal defense.

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13.07. FAILURE, ABSENCE OF, OR ILLICIT CONSIDERATION

These are only personal defenses. However, with respect to illegality, the
exceptional case when it is a real defense is if the statute declares the instrument
void for any purpose. Examples: (1) where the note was given to the sister as a gift ;
(2) the bill of exchange drawn by the husband with the wife as drawee payable to the
husband's paramour; (3) When the drawer issued the check as payment for a ring that
she already returned or when the seller failed to deliver the goods purchased to the
drawer.

13.08. MINORITY OR INCAPACITY, OR WANT OF AUTHORITY

a) Minority or incapacity (i.e., insanity) may be invoked by the minor or incapacitated

as real defense. However, other parties who are capacitated cannot invoke such
defense. The defense is personal to the minor or incapacitated only (1989 Bar).
Transfer of title by the minor is however effective negotiation.

b) The fact that indorsement or issuance of an instrument as an ultra vires act of a

corporation is a real defense.

13.09. PRESCRIPTION

a) Prescription is a real defense that may be raised against a holder in due course. The
prescriptive period for the filing of a claim based on negotiable instruments is 10 years
from the time the cause of action accrued. In case of checks, the action of the depositor
against his drawee bank commences to run from the time he is given notice of payment.
In the case of the payee, his cause of action accrued from the time of the issuance of the
check.

b) In one case, the payee did not encash the check for more than 10 years from the
issuance thereof. The Supreme Court ruled that failure of the payee to encash a check
for more than 10 years "'undoubtedly resulted in the impairment of the check through
his unreasonable and unexplained delay." The Court invoked Article 1249 of the Civil
Code stating that acceptance by the payee" of the check implies an undertaking of due
diligence in presenting it for payment, and if he from whom it is received sustains loss
by want of such diligence, it will be held to operate as actual payment of the debt or ob
ligation for which it was given." However, in a case, the Supreme Court ruled that the
contractual obligation remains even if the check is not presented for payment if the
same is enforced within the prescriptive period (Art. 1249, CC).

c) Stale Checks. There is a bank policy that a check becomes stale after six months
from issuance. The drawee bank can dishonor the check if it becomes stale not on the
ground of prescription but because of failure of the payee to present the instrument
within a reasonable time from its issuance.
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14. PERSONS WITH SECONDARY AND PRIMARY LIABILITY

14.01. What are the liabilities of: a) maker (Sec. 60), b) drawer (Sec. 61), and c)
acceptor (Sec. 62)

a) Maker - primary liability: (1) engages to pay according to the tenor of the
instrument; and (2) admits the existence of the payee and his capacity to indorse.

b) Acceptor (and Drawee who pays without accepting the instrument) - primary
liability: (1) engages to pay according to the tenor of his acceptance; (2) admits the
existence of the drawer, the genuineness of his signature and his capacity and authority
to draw the instrument; (3) admits the existence of the payee and his capacity to
indorse. Example: The drawee-acceptor is not free from liability if it turned out that the
drawer is a fictitious person because the acceptor admits the existence of the drawer
(Sec. 62, NIL).

(1) A drawee that accepts a bill of exchange without acceptance assumes all the
warranties of an acceptor under Section 62 of the NIL.
(2) If, on the other hand, there is no payment nor acceptance of a check and
there was dishonor, the drawee bank cannot be sued by the payee even if the
dishonor was wrongful because there is no privity between the drawee and the
payee; there is no assignment of funds in favor of the payee when a bill of ex
change is issued. However, the drawee bank is liable to its client, the drawer, in
case of wrongful dishonor.

c) Drawer - there is secondary liability. His warranties are: (1) admits the existence of
payee and his capacity to indorse; (2) engages that the instrument will be accepted or
paid by the party primarily liable; and (3) engages that if the instrument is dishonored
and proper proceedings are brought, he will pay to the party entitled to be paid.

(1) The drawer is liable to a subsequent indorser who paid the holder on the
basis of the indorser's secondarily liability after dishonor by non-acceptance.
(2) A drawer may sign through an agent and the agent may sign per procuration
which means that there is a notice that the authority of the agent is limited. In
which case, the holder examining the bill of exchange must determine the extent
of the authority of the agent. This rule applies to acceptance or indorsement
through an agent per procuration (Sec. 21, NIL; 2011 Bar).

14.02 Warranties of: (a) qualified endorser (Sec. 65), (b) general endorser (Sec. 66)
a) Qualified Indorser and Persons negotiating by delivery (Sec. 65) - Every person
negotiating an instrument by delivery or by a qualified endorsement warrants:
1) that the instrument 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;
4) that he has no knowledge of any fact which would impair the validity of the
instrument or render it valueless.
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Notes: (1) The warranty of persons negotiating by mere delivery extends to the
Immediate transferee only; (2) a person negotiating by mere delivery and a
qualified indorser are not secondarily liable (1986, 1988, and 2011 Bar): (3) A
qualified indorser is liable if there was forgery of the maker's signature because
the qualified indorser warrants that the instrument is genuine.

b) General Indorser (Sec. 66)- Every indorser who endorses without qualification,
warrants to all subsequent holders in due course:

1) that the instrument 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,
4) that the instrument is, at the time of the endorsement, valid and subsisting.

Notes:
(1) The general indorser is second.arily liable because he also engages
that on due presentment, it shall be accepted or paid, or both, as the case may
be, according to its tenor; and 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 it;

(2) The secondarily liability is not dependent on the capability or ability

of the drawee to pay; there is liability so long as there is dishonor;

(3) A general indorser of an instrument that is originally payable to

bearer is liable to those who make title through his or her indorsement (Sec. 40,
NIL)

EXAMPLES:

(1) A general indorser who is being made secondarily liable cannot use as a
defense the fact that the promissory note was issued in payment for shabu because the
general indorser warrants under Section 66 that the note is valid and subsisting;

(2) A general indorser cannot likewise use as a defense the fact that the amount
was altered by a prior party like the original payee from P1 Million to P12 Million be
cause a general indorser warrants under Section 66 that the instrument is genuine and
in all respect what it purports to be;

(3) (3)2 Mr. A makes a promissory note that is payable to bearer that then
delivers it to Mr. B who, in turn delivers it to Mr. C. Mr. C indorses IT specially to D and
then D in turn indorsed it to E and then E delivers it to F. F cannot hold B and E
secondarily liable but they are liable in case of breach of warranty; F cannot likewise
make Mr. C and D secondarily liable because F did not obtain his title from the
indorsement of Mr. Cand D.
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14.03.| Accommodation party (Sec. 29, NIL).

a)An accommodation party is one who has signed the instrument as maker, drawer,
acceptor, or indorser, without receiving value therefor and for the purpose of lending his
name to some other person. The requisites are:

(1) he must be a party to the instrument signing as maker, drawer, acceptor or

indorser;
(2) he must not have received value therefor (instrument);
(3) he must sign for the purpose of lending his name or credit to some other
person (

b) An accommodation party is liable to a holder for value, notwithstanding such holder,

at the time of taking the instrument, knew him to be only an accommodation party. Absence of
consideration cannot be raised by the accommodation party.

c) A corporation cannot act as an accommodation party. The issue or endorsement of

negotiable instrument by a corporation without consideration and for the accommodation of
another is ultra vires.

d) The accommodation party can ask for reimbursement from the accommodated party
after paying the holder.

e) Extension of the term or period to pay in favor of the accommodated party without
the consent of the accommodation party does not discharge the accommodation party.