Negotiable Instruments: Notes on Material Alteration (Sec 125, NIL)

CONCEPT OF MATERIAL ALTERATION:

1.   Define material alteration of instrument.

Under Sec. 125 of the Negotiable Instruments Law (NIL), material alteration is any alteration which changes:

(a) The date;

(b) The sum payable, either for principal or interest;

(c) The time or place of payment;

(d) The number or the relations of the parties;

(e) The medium or currency in which payment is to be made; or which adds a place of payment where no place of payment is specified, or any other change or addition which alters the effect of the instrument in any respect is a material alteration.

*In other words, it refers to any change in the instrument which affects or changes the liability of the parties in any way.

2.   Give examples of material alteration in an instrument:

-         Unauthorized change in an instrument that purports to modify in any respect the obligation of a party;

-         Unauthorized addition of words or numbers;

-         Other change to an incomplete instrument relating to the obligations of a party;

-         Substitution of the words: “or bearer” for “or order” (Builders Lime & Cement Co. v. Weymer, 151 N.W. 100);

-         Writing the words “protest waived” above a blank indorsement (Sawyer State Bank v. Sutherland, 162 N.W. 966); and

-         Erasure of the words “without recourse” above the signature of the indorser (Waltham State Bank v. Tuttle, 199 N.W. 970)

-         The insertion of the words "Agent, Phil. National Bank," which converts the bank from a mere drawee to a drawer and therefore changes its liability, constitutes a material alteration of the instrument (Montinola v. PNB, GR No. L-2861, February 26, 1951) 

-         One which changes the items which are required to be stated under Sec. 1 of NIL (PNB v. CA, 256 SCRA 491).

3.   Provide examples when alteration is NOT material to the instrument.

-         Adding words implied by law or making marginal figures to make them correspond to the sum written in words (Smith v. Smith, 1 R.I. 398.)

-         A serial number is an item which is not an essential requisite for negotiability under Sec. 1 of NIL, and which does not affect the rights of the parties, hence its alteration is not material. (PNB vs. CA, 256 SCRA 491)

-         An extension of time given by the holder of a note to the principal maker without the consent of a surety co-maker, because alteration refers to physical alteration.

4.   Section 125 provides for material alterations in the instrument sufficient to avoid the instrument as against those who did not consent thereto. Is the list exclusive?

NO. The enumerated instances are not exclusive in view of the last part of the above section which reads “any other change or addition which alters the effect of the instrument in any respect.”

5.   Is material alteration a personal defense or a real defense?

Material alteration is a personal defense when it is used to deny liability according to the original tenor of the instrument. It can also be a real defense when relied on to deny liability according to altered terms.

EFFECTS OF MATERIAL ALTERATION:

6.   Generally, what is the effect of any material alteration in the instrument?

(A)         When alteration is made by a party, it avoids the instrument except as against the party who made, authorized or assented to the alteration, and subsequent indorsers.

-         In other words, the effect of a material alteration by the holder is to discharge the instrument and all prior parties thereto who did not give their consent to such alteration. Since no distinction is made, it does not matter whether it is favorable or unfavorable to the party making the alteration (Franklin Ins. Co. v. Courtney, 60 Ind. 134) or the interests of prior parties (Keller v. State Bank, 24 N.E. 94), or whether it is innocently or fraudulently made. (First Nat. Bank of Sparta v. Yowell, 294 S.W. 1101). So that where the instrument has been altered although innocently, it is discharged but the innocent party can sue upon the original debt for which it has been given. (First Nat. Bank of Sparta v. Yowell, 294 S.W. 1101).

What is the exception to the above general rule?

When the altered instrument is in the hands of a holder in due course (HDC), not a party to the alteration, he may enforce payment thereof according to its original tenor (Section 124, NIL).

EXAMPLE 1:

         M makes a promissory note for P3,000 payable to P or order. P negotiates the note to A who, with the consent of P, raises the amount to P8,000 and thereafter indorses it to B, B to C, and C to D, under circumstances which make D not a holder in due course.

         The note is discharged as against M; hence, D cannot enforce it against M even for the original tenor. A, however, would be liable to D for P8,000 as he is the party who himself made the alteration although D is not a holder in due course. Moreover, as indorser, A warrants that the instrument is genuine and in all respects what it purports to be (Secs. 65 and 66, NIL).

         P would also be liable to D for P8,000 as he authorized or assented to the alteration. Likewise, B and C would be liable to D for P8,000 as they are subsequent indorsers.

EXAMPLE 2:

         Where a promissory note made for P5,000, payable to P was altered in the amount by P or subsequent holder to P9,000, the instrument is null and void because of the material alteration, unless it reaches the hands of a HDC who can enforce it according to the tenor of the instrument before it was altered (for P5,000 only instead of P9,000).

(B) When alteration was made by a stranger (spoliation), the effect is the same as where the alteration is made by a party which a HDC can recover on the original tenor of the instrument. (Sec. 124, NIL)

BAR QUESTION 1 (1977, 1972 Bar)

Pedro writes out a check for P1,000 in favor of Jose or order against his current account with Bank of America. Juan steals the checks, erases the name of Jose and superimproses his own name. Juan deposits the check at Citibank and after clearing; Juan withdraws the amount and absconds. Upon discovery by Pedro of the material alteration, he lodged a complaint at the Bank of America, who credited the amount to Pedro. Bank of America demands reimbursement from Citibank which refuses on the ground that it only acted as an agent for collection.

Who bears the loss? Why?

 ANSWER: Between Bank of America, the drawee bank and Citibank, the bank which received for deposit the materially altered check (collecting bank), the latter will have to bear the loss.

            Under the NIL, where a negotiable instrument is materially altered without the assent of the parties liable thereon (Pedro, the drawer in the problem), it is avoided, except as against a party who has himself made, authorized or assented to the alteration and subsequent indorsers.

            In banking practice the collecting bank (Citibank in the problem) “guarantees all prior indorsements”. By virtue of said indorsement, the collecting bank becomes liable to the drawee bank under the said indorsement, and therefore will have to reimburse the drawee bank the amount of the materially altered check.

            It is true that Citibank acted only as collecting agent for its depositor, but since the check was materially altered after it left the drawer’s hands, the collecting bank had no right at all to pay the sum stated therein to the person responsible for the material alteration or anyone else deriving his right from the materially altered instrument.

            Citibank which previously had been paid by Bank of America the amount of the materially altered check has to reimburse Bank of America the said amount, without prejudice to Citibank running after Juan, the person who materially altered the check and who deposited the check with it (Citibank).

BAR QUESTION 2 (1993 bar)

Larry issued a negotiable promissory note to Evelyn and authorized the latter to fill up the amount in blank with his loan account in the sum of P1,000. However, Evelyn inserted P5,000 in violation of the instruction. She negotiated the note to Julie who had knowledge of the infirmity. Julie in turn negotiated said note to Devi for value and who had no knowledge of the infirmity.

a.    Can Devi enforce the note against Larry, and if she can, for how much? Explain.

Yes. Devi can enforce the note against Larry for P5,000.00 because she is a HDC hence fee from any defect of tile of prior parties and from defenses available to prior parties among themselves, and may enforce the instrument for the full amount (see Section 57, NIL).

b.    Supposing Devi endorses the note to Baby for value but who has knowledge of the infirmity, can the latter enforce the note against Larry?

Yes, Baby can enforce the note against Larry. Even if she is not a HDC because she has knowledge of the infirmity of the note, she has all the rights of a HDC because she derived her title from Devi, a HDC, and was not a party to the fraud or illegality of the instrument (see section 58, NIL).

BAR QUESTION 3 (1971 bar)

A executed a bill of exchange for P500 in favor of B, who altered the amount to P5,000 and presented the bill to the drawee for acceptance. The drawee, not knowing the alteration which was neatly done, accepted the bill. Thereafter, B negotiated the bill to C, who now seeks to hold the drawee liable for P5,000. The drawee contends that under the rule on alteration, he can only be liable up to P500.

a.    Is the drawee’s contention tenable? Reason.

Yes, the drawee’s contention is tenable. Even if C is a HDC, he can enforce payment only according to the original tenor of the instrument. As the instrument was originally drawn for P500, C can enforce the instrument for P500 only; its original tenor.

b.    Can the drawee debit the account of A and, if so, to what extent? Reason.

Yes, the drawee can debit A’s account but only up to P500, because the bill binds A also up to that amount only.

BAR QUESTION 4

In consideration of some goods he bought, A issued to B a personal check in the amount of P280. Without the knowledge of A, B raised the amount of P2,800. The alteration is not apparent to the naked eye. B then deposited the altered check in his account with the PNB, which released it for clearing. BPI, which is the drawee bank did not notice the alteration and the check was therefore cleared.

B was able to withdraw the P2,800 after which he closed his account. When A received his bank statements and cancelled checks for that month, he noticed the discrepancy in the amount when he compared the altered check with his check stub. He immediately notified BPI and demanded a re-credit. The BPI in turn demanded re-credit from the PNB, which cannot now locate B. Discuss the rights and liabilities of the parties under the circumstances.

ANSWER: This is a case of an altered check. Under the NIL, when an altered check reaches the hands of a HDCA, the latter may endorse the instrument according to its tenor before it was altered.
Applied to the case at bar, PNB would have the status of a HDC and can enforce payment of the check against the drawer bank, BPI for P280.00, the original unaltered tenor of the check, but it cannot collect the difference (P2,520) from BPI. BPI in turn will have to re-credit A’s account with P2,520, the increase in the amount consequent to the alteration.

As BPI cleared the check, in effect paying PNB the amount of the altered check, PNB will have to re-credit BPI with the P2,520 difference. PNB’s recourse for P2,520 is against B if he can be found.

BAR QUESTION 5 (1996 bar)

William issued to Albert a check for P10,000 drawn on XM Bank. Albert altered the amount of the check to P210,000 and deposited the check to his account with ND Bank. When ND Bank presented the check for payment through the Clearing House, XM Bank honored it. Thereafter, Albert withdrew the P210,000 and closed his account.

            When the check was returned to him after a month, William discovered the alteration. XM Bank re-credited P210,000 to William’s current account, and sought reimbursement from ND Bank. ND Bank refused, claiming that XM Bank failed to return the altered check to it within 24-hour clearing period. Who, as between, XM Bank and ND Bank, should bear the loss? Explain.

SUGGESTED ANSWER: 

            ND Bank should bear the loss if XM Bank returned the altered check to ND Bank within 24 hours after its discovery of the alteration. Under the given facts, William discovered the alteration when the altered check was returned to him after a month. It may safely be assumed that William immediately advised XM Bank of such fact and that the latter promptly notified ND Bank thereafter. Central Bank Circular No.9, as amended, on which the decisions of the Supreme Court in Hongkong and Shanghai Banking Corp v. People’s Bank & Trust Co and Republic vs CA were based was expressly cancelled and superseded by CB. No. 317 dated Dec 23, 1970. The latter was in turn amended by CB Circular No.580, dated Sept. 19, 1977. As to altered checks, the new rules provide that the drawee bank can still return them even after 4:00pm of the next day provided it does so within 24 hours from discovery of the alteration but in no event beyond the period fixed or provided by law for filing of a legal action by the returning bank against the bank sending the same. Assuming that the relationship between the drawee bank and the collecting bank is evidenced by some written document, the prescriptive period would be 10 years. (Campos, NIL 5^th ed 454-455)

(C)         If negotiated to a NHIDC, he cannot enforce payment against the party prior to the alteration. He may however enforce payment according to the altered tenor from the person who caused the alteration and from the indorsers. (Sec. 124, NIL)

7. Give the liability of the acceptor.

The acceptor by accepting the instrument engages that he will pay it according to the tenor of his acceptance, and admits:

(a)  The existence of the drawer, the genuiness of his signature, and his capacity and authority to draw the instrument; and

(b)  The existence of the payee and his then capacity to indorse.

QUESTION 1:

M makes a promissory note for P10,000 payable to the order of P. After the issuance to him of the note, P altered the amount to US$10,000. P then indorsed the note to A, A to B, and B to H. Only P knew of the alteration.

            The parties and their possible liabilities are:

            1.         M, P10,000

            2.         M, US $10,000

            3.         M, nothing

            4.         A and B, P10,000.00

            5.         A and B, US $10,000.00

            6.         A and B, nothing

If H is a holder in due course, the parties from where he may collect and the amount of the said parties’ liability are:

            a. 1 and 4

            b. 2 and 5

            c. 1 and 5

            d. 3 and 4

QUESTION 2:

M delivers a promissory note payable to the order of P for P10,000. P alters the amount to P 40,000 and thereafter indorses the note to A who had no knowledge of the alteration; then A to H, HDC. Which of the following is incorrect?

            a. H can recover P10,000 from M.

            b. H can recover P40,000 from P.

            c. H can recover P40,000 from A.

d. H cannot recover any amount from M because M is a party before the alteration. H cannot also recover from A because A was not aware of the alteration.

QUESTION 3:

M made a promissory note in favor of P or order. The note, which was payable after 60 days from date of issue, amounts to P100,000 and bears interest at 10% per annum. After the delivery of the note to him, P altered the interest rate to 18% per annum without the knowledge of M and indorsed it to A who knew nothing of the alteration. Thereafter, A indorsed the note to H, a HDC.

a. H may not collect any amount, whether of the principal or of the interest, from M.

            b. H may collect P100,000 and interest at 10% per annum from M.

            c. H may collect P100,000 and interest at 18% per annum from M.

d. H may collect any amount, whether of the principal or of the interest,    from A, since A was not aware of the alteration.   .

References:

De Leon, Hector. The Law on Negotiable Instruments. (2004 Edition).

Soriano, Fedelito. Notes in Business Law (2011 Edition).

Miravite, Jorge. Bar Review Materials in Commercial Law. 2007 (14^th Edition).

Pointers in Business Law of CPA Reviewees., Volume 2 (2008 Edition).

San Beda College of Law Red Notes, 2010 Centralized Bar Operations

University of Santo Tomas, Mercantile Law, 2014 Golden Notes

University of the Philippines Bar Reviewer. 2006 Bar Operations Committee