- A maker signs a promissory note under mental incapacity that renders their contracts void under state law. Is this defense available against a holder in due course?
Answer: Yes, if state law makes the contract void (not merely voidable), mental incapacity is a real defense effective against all holders, including an HDC.
Under UCC Section 3-305(a)(1)(ii), mental incapacity that makes the obligation void under applicable law is a real defense, effective against all holders including an HDC. If state law renders a mentally incompetent person's contract void (typically requires adjudication of incompetency), the instrument cannot be enforced against them. If state law makes it only voidable, it is a personal defense. Answer A is incorrect because incapacity that voids the contract is classified as a real defense. Answer C is incorrect because real defenses do not require the HDC to have had knowledge; they are effective against all holders regardless. Answer D is incorrect because the UCC expressly defers to state law on capacity in Section 3-305.
- Under UCC Section 3-601, which of the following acts will discharge a party's liability on a negotiable instrument?
Answer: Payment of the instrument in full to a person entitled to enforce it.
Under UCC Section 3-601, a party's liability on an instrument is discharged by payment in full to the person entitled to enforce the instrument. Payment satisfies the obligation and ends the payer's liability. Answer B is incorrect because the statute of limitations bars enforcement but does not technically discharge the underlying obligation (the debt still exists, just cannot be legally enforced). Answer C is incorrect because an oral agreement to accept partial payment is generally insufficient to discharge the full obligation without additional consideration or a signed written accord and satisfaction. Answer D is incorrect because the death of the maker does not discharge the instrument; the estate remains liable.
- Accord and satisfaction using a negotiable instrument is governed by UCC Section 3-311. Under this provision, if a debtor in good faith tenders a check conspicuously marked 'payment in full' and the creditor cashes the check, what is the result?
Answer: The debt is discharged because the creditor's cashing of the check constitutes acceptance of the accord and satisfaction.
Under UCC Section 3-311, if a person in good faith tenders a check as full satisfaction of a disputed claim and the check or accompanying written communication conspicuously states that the instrument is tendered as full satisfaction, the claim is discharged when the claimant obtains payment of the instrument. Cashing the check constitutes acceptance of the accord and satisfaction, discharging the entire debt. Answer A incorrectly preserves the creditor's right to sue for the balance. Answer B is incorrect because no separate written release is required; cashing the check operates as acceptance. Answer D is incorrect because once an accord and satisfaction is completed, the entire claim is discharged, not just the amount of the check.
- An instrument is issued without consideration (a gift check). The issuer stops payment before the donee cashes the check. The donee assigns the check to a creditor who qualifies as an HDC. Which of the following correctly states the HDC's rights?
Answer: The HDC can collect the full amount because lack of consideration is a personal defense cut off by HDC status.
Lack of consideration (or failure of consideration) is a personal defense under UCC Article 3. When the instrument is transferred to an HDC, personal defenses are cut off. The HDC may enforce the instrument despite the absence of consideration in the original transaction. A stop-payment order by the drawer on a check also does not defeat an HDC's right to collect; the HDC retains the right to sue the drawer. Answer A is incorrect because lack of consideration is a personal, not universal (real), defense. Answer B is incorrect because a gift check is not void; it is an enforceable instrument with a personal defense available to the drawer. Answer C is incorrect because a stop-payment order does not defeat an HDC's enforcement rights.
- Orion Corp issued a promissory note to Belmont Supplies as payment for goods. Belmont subsequently negotiated the note to First National Bank, which qualifies as an HDC. Orion later discovers that Belmont delivered defective goods. Can Orion assert the defective goods defense against First National Bank?
Answer: No, because the defective goods defense is a personal defense that cannot be asserted against an HDC.
The defense of defective goods (failure of consideration or breach of contract) is a personal defense arising from the underlying transaction between Orion and Belmont. Under UCC Section 3-305(b), personal defenses are cut off when the instrument is transferred to an HDC. First National Bank, as an HDC, takes free of Orion's personal defense based on the defective goods. Orion's remedy is against Belmont, not the bank. Answer A is incorrect because an HDC does not step into the transferor's shoes for personal defenses. Answer C is incorrect because defective goods constitute a personal defense, not a real defense. Answer D is incorrect because the timing of discovery is irrelevant; the personal defense is cut off when an HDC acquires the instrument.
- A qualified endorsement ('without recourse') is placed on a negotiable instrument. What is the effect of a qualified endorsement on the endorser's secondary liability?
Answer: The endorser disclaims secondary contractual liability for payment but still makes the transfer warranties under UCC Section 3-416; because the endorsement is qualified, the warranty regarding defenses is limited to a warranty that the transferor has no knowledge of any defense or claim against the instrument.
A qualified endorsement ('without recourse') disclaims the endorser's secondary contract liability - the endorser will not pay if the instrument is dishonored. However, the endorser still makes transfer warranties under UCC Section 3-416, including that the instrument is authentic and not forged, the transferor has good title, and all signatures are authorized. Under UCC Section 3-416(c), when the transfer is by qualified endorsement, the warranty regarding defenses is modified: the endorser warrants only that they have no knowledge of any defense or claim in recourse against the instrument, rather than warranting the absence of any such defense. Answer D is correct. Answer A is incorrect because 'without recourse' specifically eliminates the secondary payment obligation. Answer B is incorrect because 'without recourse' reduces, not increases, the endorser's liability. Answer C is incorrect because transfer warranties survive a qualified endorsement; only the contractual payment obligation is disclaimed.
- An endorser's liability on a negotiable instrument is secondary, meaning the endorser is liable only if certain conditions are met. Which of the following must occur before an unqualified endorser can be held liable?
Answer: The instrument must be properly presented for payment, dishonored, and the endorser must receive timely notice of dishonor.
An unqualified endorser (secondary party) is conditionally liable. To hold an endorser liable, the holder must: (1) properly present the instrument for payment on time, (2) have the instrument dishonored, and (3) give the endorser timely notice of the dishonor. Failure to satisfy any of these conditions may discharge the endorser's liability. Answer A is incorrect because no court judgment against the maker is required; presentment and dishonor are sufficient. Answer B is incorrect because there is no pre-presentment notification requirement by certified mail; notice of dishonor is given after dishonor. Answer C is incorrect because the maker's bankruptcy is not a prerequisite; the instrument simply must be dishonored.
- An accommodation party signs a promissory note as a co-maker to lend their credit to another party (the accommodated party). If the instrument is dishonored, what are the accommodation party's defenses?
Answer: The accommodation party may assert any defense the accommodated party would have, except discharge in insolvency proceedings of the accommodated party.
Under UCC Section 3-305(d), the accommodation party may assert any defense that the accommodated party could assert against enforcement, with the exception that the accommodation party cannot assert the accommodated party's discharge in insolvency proceedings. The accommodation party's suretyship status gives them derivative defenses. Answer A is incorrect because accommodation parties do have defenses. Answer C is incorrect because accommodation parties may assert personal defenses of the accommodated party, not just real defenses. Answer D is incorrect because accommodation party liability is based on their signing status, not their financial contribution.
- A promissory note is materially altered after issuance by raising the amount from $1,000 to $10,000. A holder in due course later takes the instrument. Under UCC Section 3-407, what amount may the HDC enforce against the original maker?
Answer: $1,000, the original amount, because an HDC may enforce an altered instrument according to its original terms.
Under UCC Section 3-407(c), a holder in due course may enforce an instrument that has been fraudulently and materially altered according to its original terms. Against the original maker, the HDC can only recover $1,000 (the original amount), not the fraudulently raised $10,000. The maker's defense of material alteration is a real defense as to the altered portion but the HDC may still recover the original amount. Answer A is incorrect because an HDC cannot enforce the fraudulently altered amount against the original maker. Answer B is incorrect because material alteration is not a complete defense; the HDC recovers the original amount. Answer D has no basis in the Code.
- A holder intentionally cancels a promissory note by writing 'VOID' across it and returning it to the maker. Under UCC Section 3-604, what is the effect of this cancellation?
Answer: The maker's obligation is discharged because the holder intentionally cancelled the instrument.
Under UCC Section 3-604, a person entitled to enforce an instrument may discharge the obligation of a party by intentionally cancelling the instrument (such as destroying it, mutilating it, or writing 'void' across it) or striking out the party's signature. Writing 'VOID' across the instrument and returning it constitutes an intentional cancellation, discharging the maker's obligation. Answer A is incorrect because no court order is required for voluntary cancellation by the holder. Answer C is incorrect because a general cancellation of the instrument discharges all parties, not just the maker. Answer D is incorrect because intentional cancellation by the holder is immediately effective as a discharge.
- A check is drawn on Westover Bank and the payee presents it for payment. Westover Bank dishonors the check due to insufficient funds. What are the payee's rights?
Answer: The payee may seek payment from the drawer, and if the check was endorsed, from any endorsers who received proper notice of dishonor.
When a check is dishonored for insufficient funds, the payee may seek payment from the drawer based on the drawer's secondary contract liability on the check. The drawer's obligation is conditioned on proper presentment, dishonor, and timely notice of dishonor. Additionally, if the check was endorsed by third parties, those endorsers (also secondary parties) may be held liable after proper notice of dishonor is given. The drawee bank is not liable to the payee simply for dishonoring an item it was not obligated to pay. Answer B is correct. Answer A is incorrect because the payee's recourse on dishonor runs to the drawer (and any endorsers), not to the bank. Answer C is incorrect because the bank's dishonor does not discharge the drawer; the drawer remains liable on the instrument as a secondary party. Answer D is incorrect because the drawee bank, when it does not accept the instrument, is not liable to the payee.
- Which of the following defenses would be considered a personal defense, available only against ordinary holders and not against a holder in due course?
Answer: Unauthorized completion of an incomplete instrument beyond the agreed terms.
When a maker or drawer delivers an incomplete instrument with authority to complete it in a certain way, and the holder completes it for a different amount, the defense of unauthorized completion is generally a personal defense under UCC Section 3-407. An HDC may enforce an incomplete instrument as completed, even if the completion exceeded the original authorization. Answer A (forgery) is a real defense - a forged signature is wholly inoperative. Answer B (discharge in bankruptcy) is a real defense under federal law. Answer C (fraud in the factum) is a real defense where the signer did not know the nature of the instrument.
- A drawer issues a check and later convinces the payee to release the drawer from liability in exchange for a small payment. This release is in writing. Under UCC Section 3-601, what is the effect on secondary parties (endorsers) of this release?
Answer: The release of the drawer discharges endorsers to the extent they would have had a right of recourse against the drawer, unless the holder expressly reserves rights against endorsers.
Under UCC Section 3-605, when a holder releases a party from liability, parties who have a right of recourse against the released party are also discharged to the extent the release impairs their recourse rights, unless the holder expressly reserves rights against those parties. If a holder releases the drawer but expressly reserves rights against endorsers, the endorsers remain liable. Answer A overstates the discharge by making it automatic and total. Answer B is incorrect because private written releases are effective under the UCC without court involvement. Answer D is incorrect because the release of the drawer does not void the check or discharge the drawee bank's separate obligations.
- Under the shelter rule (UCC Section 3-203), a transferee who does not qualify as an HDC may nonetheless acquire the rights of an HDC. Which of the following correctly describes the shelter rule?
Answer: A transferee who takes from an HDC acquires the HDC's rights, including the ability to enforce the instrument free of personal defenses, even if the transferee itself does not meet the HDC requirements.
The shelter rule provides that a transferee receives at least the rights of the transferor. Therefore, a person who acquires an instrument from an HDC receives the HDC's superior rights, including freedom from personal defenses, even if the new holder does not independently qualify as an HDC (e.g., because they had notice of a defense). This promotes the free transferability of commercial paper. Answer B is incorrect because the shelter rule does not transform every transferee into an HDC; it transfers the transferor's rights. Answer C is incorrect because the shelter rule does not cut off real defenses, which remain effective against all parties. Answer D is incorrect because the shelter rule applies to any transfer under Section 3-203, not only indorsed transfers.
- Under UCC Article 3, defenses to payment of a negotiable instrument are classified as either real (universal) defenses or personal (limited) defenses. Which of the following is a real defense that is effective against even a holder in due course (HDC)?
Answer: Forgery of the maker's signature on a promissory note.
Real defenses are effective against all holders, including holders in due course. Forgery of the maker's signature (or the drawer's signature) is a real defense because a forged signature is wholly inoperative under UCC Section 3-403; the person whose name was forged has no obligation on the instrument. Answer A (failure of consideration) is a personal defense, not effective against an HDC. Answer C (breach of contract) is a personal defense arising from the underlying transaction. Answer D (fraud in the inducement) is a personal defense; only fraud in the factum - where the signer did not know they were signing a negotiable instrument - is a real defense.
- A minor (person under 18) issues a promissory note. The minor later seeks to avoid the obligation. Under UCC Section 3-305, how is the infancy defense classified?
Answer: As a real defense to the extent that infancy is a defense under applicable state law.
Under UCC Section 3-305(a)(1), infancy is a real defense to the extent that state law makes the minor's obligation voidable or void. Most states allow minors to disaffirm contracts, so infancy is treated as a real defense that can be asserted against all holders, including HDCs. The UCC defers to state law on the scope of the infancy defense. Answer A is incorrect because infancy is a real, not personal, defense under Section 3-305. Answer B is partially correct in outcome but misclassifies it as personal. Answer D is incorrect because while minors may be liable for necessities, that rule is an exception, not a basis for eliminating the infancy defense on a promissory note.
- Fraud in the factum (also called real fraud) is a real defense to payment of a negotiable instrument. Which of the following scenarios best illustrates fraud in the factum?
Answer: A person signs a promissory note believing it to be an autograph request, having no knowledge that the document is a negotiable instrument.
Fraud in the factum occurs when a person is deceived about the very nature of the instrument being signed - they do not know they are executing a negotiable instrument at all. This is a real defense effective against all holders, including an HDC. Answer B describes fraud in the inducement, a personal defense, where the signer knew they were signing a note but was misled about the underlying transaction. Answer C is also fraud in the inducement; the signer knew the document was a promissory note. Answer D describes duress or undue pressure but not fraud in the factum because the person understood what they were signing.
- Which of the following correctly lists the real (universal) defenses to payment of a negotiable instrument that are effective against a holder in due course?
Answer: Forgery, fraud in the factum, material alteration, discharge in bankruptcy, duress that voids the obligation, infancy (to extent state law allows), and illegality that voids the obligation.
Real (universal) defenses under UCC Section 3-305(a)(1) are effective against all parties including an HDC. They include: (1) forgery or unauthorized signature, (2) fraud in the factum (signer did not know the nature of the instrument), (3) material alteration (as to the altered amount), (4) discharge in bankruptcy, (5) duress voiding the obligation, (6) infancy to the extent state law makes the obligation voidable, and (7) illegality that voids the obligation. Answer A lists only personal defenses. Answer B lists personal defenses related to delivery conditions and payment. Answer C lists personal defenses relating to consideration and mistake.
- A promissory note contains an illegal interest rate that violates state usury law, rendering the obligation void under state law. Is this a real or personal defense, and may it be asserted against an HDC?
Answer: Real defense; it can be asserted against all parties, including an HDC, because illegality that voids the obligation under applicable law is a real defense.
Under UCC Section 3-305(a)(1)(ii), illegality of the transaction that renders the obligation void under applicable law is a real defense, effective against all parties including an HDC. If the usury law makes the contract void (not merely voidable), the defense is real. Note that if the applicable law makes the contract merely voidable, it would be a personal defense. Answer A and B are incorrect because if state law voids the obligation (as opposed to making it voidable), illegality is a real defense. Answer D incorrectly conditions the defense on a mathematical threshold not found in the UCC.
- Duress that renders a contract void (as opposed to merely voidable) is classified as a real defense to payment of a negotiable instrument. Which of the following examples illustrates duress that would constitute a real defense?
Answer: A maker signs a promissory note at gunpoint, with no true consent to the transaction.
Extreme duress that renders the transaction void at its inception - such as signing at gunpoint - is a real defense because there was no genuine consent and the instrument is void, not merely voidable. Under UCC Section 3-305(a)(1), duress that voids the obligation is a real defense effective against even an HDC. Answer B describes economic or legal duress (threat of a lawsuit), which is typically only voidable duress and constitutes a personal defense. Answer C describes business pressure that does not rise to the level of duress voiding the contract. Answer D describes misrepresentation, not duress.
