Chapter 27: Negotiable Instruments Flashcards
Commercial paper
Written, transferable, signed promise or order to pay specified sum of money; a negotiable instrument
Article 3 of the UCC
Defines the types of negotiable instruments and the parties for each
Article 4 of the UCV
Covers checks, banking, and electronic funds transfers
Kinds of negotiable instruments
1) promises to pay (inc. promissory notes and certificates of deposit)
2) orders to pay (inc. drafts and checks)
Promissory note
Unconditional promise in writing made by one person to another, signed by the maker, to pay on demand, or at a definite time, a sum certain in money
Promissory note
Unconditional promise in writing made by one person to another, signed by the maker, to pay on demand, or at a definite time, a sum certain in money
Certificate of deposit
A promise-to-pay instrument issued by a bank
Acknowledges customers deposit of sum and promises to pay that sum + interest when certificate is surrendered
Draft, or bill of exchange
An unconditional order in writing by one person upon another, signed by the person giving it, and ordering the person to whom it is directed to pay upon demand or at a definite time a sum certain in money
Drawee not bound to pay a draft simply because drawer has placed their name on it but may agree to pay draft by accepting it
Drawer
Person who writes out and creates a draft or bill of exchange, including a check
Party who gives the order to pay
May also be named as payee
Drawee
Part on whom the order is to pay the specified amount/ to whom the draft is addressed (party ordered to pay)
Not bound simply by creation of draft, must accept it. No responsibility until accepted
Usually the buyer in a transaction
Drawee oh a check is the bank
Payee
Party of draft to whom payment is made
May be drawer
Usually the seller in a sales transaction
Payee
Party of draft to whom payment is made
May be drawer
Usually the seller in a sales transaction
Money order
Draft (usually written by a company, banks and non-banks) issued for a fee
Check
Order by a depositor on a bank to pay a sum of money to a payee; a bill of exchange drawn on a bank and payable on demand
Draft payable on demand and drawn on a credit union or a bank
Check
Order by a depositor on a bank to pay a dum of money to a payee; a bill of exchange drawn on a bank and payable on demand
Maker
Party who writes or creates a promisor’s note
Person promising to pay amount specified by the note
Payee
Party named in then instrument who is entitled to receive payment
Negotiability
Quality of an instrument that affords special rights and standing (protections under article 3 of UCC)
Distinguishes commercial paper and instruments from ordinary contracts and increases the likelihood of payment
Transfer can be made with assurance of payment and no need to investigate the underlying contract
Non-negotiable instrument
Contract, note, or draft that does not meet negotiability requirements of article 3
Treated as a contract, governed by contract law
Requirements for negotiability under article 3
1- a writing or record
2- signed by the maker or drawer
3- words of negotiability: payable to bearer or order
4- unconditional promise or order to pay
5- sum certain in money
6- payable on demand or at a definite time
Automated clearing house
ACH
Electronic check withdrawals authorized by drawers via phone or internet
Requirement: record
No particular form is required
Customers of banks may agree to use banks forms as park of their contract with their banks
Requirement: authentication
Signatures usually at lower right on the face of instrument but there is no requirement for placement
Authentication may be made by the drawer or the maker or by their agent
Agent signatures
Authenticating agent should disclose following on the instrument:
- the identity of the principal
- the fact that the authentication was done in a representative capacity
(having this on the face of the instrument avoids liability on the agent’s part)
Representative capacity
Action taken by one on behalf of another, as the act of a personal representative on behalf of a decedent’s estate, or as a shareholders bringing a representative action
Agent signatures without representative capacity or identification of lrincipal
If instrument fails to show the representative capacity of the person authenticating then the person authenticating may be personally liable for the instrument
Instrument is a final agreement so parole evidence rule applies and cannot introduce external evidence to clarify representative capacity
(Check preprinted with employer’s name is sufficient identification of the principle)
Requirement: words of negotiability
Instrument must contain words that permit is transfer
Promissory note: includes promise to pay money (not just acknowledgement of debt)
Certain phrases are required Pay to the order of x Pay to x or order Pay to bearer Shows no intention of restricting payment to single individual
Checks may be made simply “pay to x” but it is not negotiable on other instruments
Whitaker v. Limeco Corp
- Whitaker and Fletcher loaned Limeco director Kidd $750,000 for the purchase of a hockey team that never happened
- July 1, 2002 parties entered into “what they referred to as promissory notes” with language stating “on demand, for value received, I promise to pay to R.W. Whitaker… The sum of Three Hundred, Seventy-five Thousand Dollars.”
- Dec, 11 2003 Whitaker and Fletcher filed suit to recover money
- trial court dismissed suit for being outside contract’s statute of limitations
- Whitaker and Fletcher appealed stating notes were negotiable instruments subject to the six year statute of limitations on negotiable instruments
- court dismissed sui
- words of negotiability an absolute requirement for a negotiable instruments, without them it is just a contract (suit required to be filed within three years)
- if document had contained words of negotiability suit could have proceeded
Requirement: unconditional promise or order to pay
If duty to pay is dependent upon an event the promise is conditional and the instrument is non-negotiable (enforceable as a contract but not under article 3)
Order for payment from a particular find is negotiable. But the fund must be currently in existence (or the payment is conditional on the creation of the fund)
Reference to collateral in a promissory note
Does not affect negotiability
Sum certain
Amount due under an instrument that can be computed from its face with only reference to interest rate
Money
Any medium of exchange adopted or authorized by the United States, a foreign government, or an intergovernmental organization
Requirement: sum certain in money
Negotiable instrument must be for an exact amount of money.
Some exceptions:
- market rate (non fixed) mortgage
- note providing for costs and attorney fees in event of litigation
If not payable in money (ex stock or goods) instrument is non-negotiable
Definite time
Time if payment computable from the face of the instrument
Requirement: payable on demand or at a definite time
Negotiable instruments must be payable on demand or at a definite time
if time is “when convenient” not negotiable. May never be paid. If payment is contingent on an event instrument is not negotiable
Time of payment still considered definite if there are provisions for prepayment/acceleration/extensions
Payable on demand
Instrument expressly states it is payable “on demand” at sight, or on presentation
If no date listed then instrument is payable on demand
Smith v. Vaughn
- Vaughn signed document stating that the smiths were lending him $9,900 to be repaid “when you can”
- 18 months later Smith’s sure for entire amount
- Vaughn moved for summary judgment saying he did not have to pay if he did not have the ability to do so
- trial court granted summary judgement. Smiths appealed
- appeals court: payable “when you can” is not payable on demand and isn’t a negotiable instrument. Parties had an open ended agreement which might form the basis for a contractual obligation
- potential issue of unjust enrichment and borrower obligation to pay debt
- case sent back to trial court for resolution of these contract issues
When an instrument contains ambiguous language
Rules
- Words control figures where conflict exists
- Handwriting supercedes conflicting typewritten or printed terms
- Typewritten terms supercede preprinted terms
- If there is a failure to provide for the payment of interest or if there is a provision for the payment of interest but no rate is mentioned, the judgement rate at the place of payment applies from the date of the instrument
Negotiation
The transfer of commercial paper by indorsement and delivery by the person to whom it is then payable in the case of order paper and by physical transfer in the case of bearer paper
The process of transferring a negotiable instrument in a manner that permits.thr transferee to become a holder
Holder
Someone in possession of an instrument that runs into that person (is made payable to that person, is indorsed to that person, or is bearer paper)
Order paper
Instrument payable to order: payable to the order or any person described in it
Specific words of negotiability determine if order paper or bearer paper
Bearer paper
Instrument where no specific person is expressly identified or is only identified by “bearer” (or instruments that include “x person or bearer”
New Mexico v. Herrera
- Herrera found a purse in a dumpster and the purse was returned to the owner.
- Herrera returned to the dumpster and found more items including a check made out to cash
- he added “to Joshua Herrera” next to cash on the payee line and indorsed the check (on instruction of the credit union teller)
- pled guilty to forgery but moved to have indictment dismissed on the grounds that adding his name to a bearer instrument was not forgery
- court denied motion to dismiss, Herrera appealed
- court ruled since instrument found was bearer paper adding his name after cash did not change the character of the instrument and since he did not alter the nature of the instrument he could not be charged with forgery
Delivery
May be accomplished by constructive or actual transfer of possession of the instrument such that the transferree has exclusive access
Negotiation of bearer instruments
Bearer instruments negotiation by delivery (actual or constructive transfer of possession)
Negotiated without regard to whether possession of instrument is lawful. (Some consideration for liability issues)
Negotiation of order instrments
Negotiation of order instruments require indorsement and transfer of possession of the paper by the payee or indorsee or their authorized agent
Indorsement
Signature of the payee on an instrument
Not necessary that indorsement require words order or bearer to continue to be negotiable as long as words of negotiability are on the front of the instrument. Only need “pay to”
Blank indorsement
An indorsement that does not name the person to whom the paper, document of title, or investment security is negotiated
Turns an order instrument into a bearer instrument so person who possesses the instrument on which the last indorsement is a blank endorsement is the holder
Special indorsement
An indorsement that specifies the person to whom the instrument is indorsed (to whom the indorser makes the instrument payable)
Continues the order instrument as an order instrument now negotiable by the indorser
Indorsee
Party to whom special indorsement is made
Town of Freeport v. Ring
- Ring behind on property taxes
- he received a check made out to him for $11k
- on the back of the check he wrote “payable to town of Freeport property taxes” and he sent it with a letter to the town offices
- his property then leined by the tax clerk
- ring asserted he paid his taxes
- clerk said not paid as check was not indorsed
- there was no indorsement as ring had not signed his name, which was required for further negotiation
“Indorsements vary according to the method of signing and the words used along with the signature. The nature of an indorsement also affects the future of the instrument in terms of its requirements for further negotiation.”
Qualified indorsement
An indorsement that includes words such as “without recourse” that disclaims certain liability of the indorser to a maker or a drawee without affecting the transfer or title or negotiable character of the instrument. Any words that indicate intent to limit liability will work.
(Limits liability to the indorser in the even the maker/drawee does not pay on the instrument)
Restrictive indorsement
An indorsement that restricts further transfer, such as in trust for or to the use of some other person, is conditional, or for collection or deposit
Ex. “For deposit only”
Specifies the purpose of the instrument or its use but does not prevent transfer or negotiation once the initial restriction is honored
Multiple payees and indorsements
Possible to name two or more payees on an instrument. Instrument may specify if payable to any one or more or that it is payable to all jointly
If jointly requires indorsement of all payees to negotiate
Alternative payees
Those persons to whom a negotiable instrument is made payable, any one of whom may indorse and take delivery of it
Check city v. L&T enterprises
- L&T issued checks to one of their subcontractors and one of that subcontracts suppliers (presumably payable jointly?)
- check city cashed the check with only the indorsement or the subcontractor not the supplier
- it was clear that the check was missing the second required signature
- check city filed suit against L&T for negligence
- trial court ruled L&T breached duty by failing to exercise ordinary care and substantially contributing to an alteration of an instrument or forged signature
- L&T appealed
- judgment reversed. Check city had failed to obtain necessary signatures for the payees and had liability for the losses as duty to ensure signatures were there and genuine is on the first party to receive the check
Holder in due course
A holder who has given value, taken in good faith without notice of dishonor, defenses, or that instrument is overdue, and who is afforded special rights and status
Receives the rights of a negotiable instrument without the obligations of the seller who formed the contract (some consumer credit contracts allow for defenses against holders in due course: FTC protections
Rights and liabilities of the parties to an instrument
Rights of a holder like the rights of a contract assignee - ordinary holder is subject to legitimate defenses against payment
Holders in due course mostly free of contract assignment defenses, unless a consumer credit contract under FTC rule
Holder in due course requirements
Four requirements for obtaining holder in due course (HDC) status
- value (consideration in exchange)
- good faith
- no knowledge of the instrument’s being overdue or dishonored
- ignorance of defenses and adverse claims
Value
Consideration or antecedent debt or security given in exchange for the transfer or a negotiable instrument or creation of a security interest
Not a promise to be performed
Can be value given previously
Courts do not consider if value is sufficient. Just if it has been given
Good faith
Honest in fact and observance of reasonable commercial standards of fair dealing
Requires a holder of a negotiable instrument act with honest in fact in acquiring the instrument
Good faith
Honest in fact and observance of reasonable commercial standards of fair dealing
Requires a holder of a negotiable instrument act with honest in fact in acquiring the instrument
Close connection doctrine
Circumstantial evidence, such as an ongoing or close relationship, that can serve as notice of a problem with an instrument
If a holder has taken so many instruments from its transferor or is so closely connected with transferor that any knowledge the transferor had is deemed transfered to the holder
Negotiating when instrument is Dishonored/overdue
Still can be negotiated. Transferee is still a holder. But cannot be a holder in due course as the fact that the instrument is circulating overdue/after it has been dishonored is suspicious. There may be adverse claim or defense
Recorded documents do not give notice
Discharge of a party does not prevent the taker from being a holder in due course
Defense against payment
Prior parties in an instrument may have defenses that entitle them to without payment from the holder (ex:defective merchandise)
If a transferee is aware of any potential defenses they cannot be a holder in due course. Simply a holder
In re Trevino
- Trevinos had a mortgage on their home
- when they went into bankruptcy it was arranged that the trustee would make payments on the mortgage. Plan did not provide for payment of real estate taxes
- payments of taxes were made both by trustee and mortgage company which resulted in litigation
- mortgage transfers from HSBC to US bank and trust, who claims they were holders in due course (free and clear of any previous issues and claims)
- not holders in due course because the note was overdue when transferred and us bank and trust knew that
“A mortgage company or lender that takes over a note following bankruptcy cannot be an HDC.”
Negotiable instrument
A transferable, written, signed promise or order to pay a specified sum of money
Cashier’s check
Draft drawn by a bank on itself
Teller’s check
Draft drawn by a bank on another bank
Traveler’s check
Check payable on demand provided it is countersigned
Acceptor
Drawee who has accepted the liability of paying the amount specified in the draft
Secondary obligator
Aka accommodation party
Person who allows their name to be added to add strength to the collectability of an instrument
Who can be a party to a negotiable instrument
- natural person
- artificial person
- unincorporated enterprise
Statute of limitations on negotiable instruments
Generally 3 years
CDs and accepted drafts have a 6 year statute
Williams v. Huston plants & garden world
- Green valley growers (owned by Massey) contracted for services and materials from KC Crushed (owned by Smith)
- GVG took out a loan and paid proceeds to KC Crushed
- Massey and Smith “executed” (wrote) a promissory note saying that Massey (named) would pay Smith (named) the money with interest
- GVG went into bankruptcy (trustee Randy Williams)
- Smith and Massey contend that the note was between the companies KC Crushed and GVG, not themselves as individuals, ergo they are not liable for the debts as individuals
- Smith claims signed without reading the note believing signing for KC crushed
Holding: Smith and Massey liable. GVG wrote payment checks to Smith, not KC Crushed. + Parties presumed to know contents of documents they signed (subjective beliefs cannot contradict what is written in the contract) and obligations determined Wiley from written agreement p
Defenses holder in due course may be subject to
“real defenses”
- infancy
- duress
- legal incapacity
- illegality of the transaction
- fraud in the factum (inducing the obligor to sign the instrument without knowledge of it’s essential character and terms)
Defenses a holder in due course is free of
“personal defenses”
Including:
- fraud in the inducement (obligor could still know content of instrument)
- misrepresentation
- lack of consideration
- undue influence
- breach of warranty
- discharge by payment to someone other than the holder of the instrument
- statutory violations
Missing indorsement
If parties intend to negotiate an order instrument but fail to indorse, there is no negotiation and the transfer has the effect of a contract assignment
Correction of name by indorsement
May be used only when the instrument was intended to be payable to the person making the correction
Bank indorsement
Between banks, any agreed method which identifies the transferor bank is sufficient
Agent or officer indorsement
An instrument payable to the order of an office holder may be negotiated by the person who holds the office at that time
An instrument payable to a corporation maybe indorsed by any corporate officer
Forged and unauthorized indorsements
Not a valid indorsement
Effect of incapacity or misconduct on negotiation
Negotiation is effective even though:
- made by a minor
- an act beyond corporate powers
- obtained by fraud, duress, or mistake
- a part of an illegal transaction or breach of duty
Lost order instruments
Finder does not become holder because instrument not indorsed and delivered
Lost bearer instruments
Finder as possessor is the holder and entitled to enforce payment
B.D.G.S inc v. Balio
BDGS contracted with Balio to manage a warehouse including collecting and depositing rent
- discovered that many checks had been made out to slightly wrong name (DBGS) and endorsed over to another company (owned by Balio)
- brought suit against Balio, the other company and the ban
- bank determined to be liable
- it is the bank’s responsibility to verify that the party with the checks is actually the payee and authorized to deposit the checks
Imposter Rule
Any person may indorse payee’s name. Indorsement is treated as genuine and cannot be attacked.
Doesn’t applies when a valid check to an actual creditor is forged
Negligence of drawee not required
Unlimited adjusting group Inc v. Wells Fargo bank
- Won Charlie Yi solicited and was given money by investors under the claim he would invest it in equities
- he created his own account at wells fargo, deposited the money there, and later absconded with it
- investors filed against wells fargo to recover losses (claim lack of ordinary care)
- original and appeal court ruling for Wells Fargo
- the checks were made out to and deposited by intended payee, even if not always precise. Since investors intended money to go to Charlie’s company bank is not liable for losses simply because the investors later realized he was untrustworthy. Checks were essentially legitimate
Reasons for attaining holder in due course status
to obtain payment on the negotiable instrument free of any underlying problems between the original parties
Limited Defenses
- ordinary contract defenses
- fraud in the inducement
- miscellaneous defenses (non-delivery, duress via threat, prior payment or cancellation, breach of warranty, unauthorized completion)
May be called “personal defenses”
not valid against a holder in due course
Ordinary contract defenses
Defenses that involve breach of contract issues
- lack, failure, or illegality of consideration
- misrepresentation of goods
- failure to perform
defects to underlying transactions
HDC not subject to these defenses with exception for certain consumer contracts
Fraud in the inducement
Fraud that occurs when a person is persuaded or induced to execute an instrument because of fraudulent statements
cannot be defense against HDC
Classifications of defenses and Holders in due course
Limited defenses- HDCs are not subject to these defenses
Universal defenses (real defenses)- HDCs are subject to these defenses
Holders subject to all defenses
RR Maloan Investments v New HGE Inc
- payee Shelly Mckee got check from HGE for purported rolex (check postdated three days)
- she indorsed the check and presented it to RR Maloan, which cashed it for her
- HGE discovered watch was counterfeit and issued stop payment, so their bank refused to honor the check
- RR Maloan stated they were a holder in due course and sued HGE for payment
- Since HGE not present on trial date, default judgement to RR Maloan. Maloan appealed
- Question before the court:
o do you lose HDC status because it was a post-dated check?
BUT the bank is not actually required to honor the post-dated date, as long as legit can pay it then
o Is fraud on the underlying transaction a defense against an HDC - RR Maloan found to be holder in due course and fraud by payee is not a defense against an HDCs right to payment
o Postdating of check does not change HDC status (does not impose duty on RR Maloan to investigate circumstances surrounding check)
Universal Defenses
Regarded as so basic that the social interest in preserving them outweighs the social interest of giving negotiable instruments the freely transferable quality of money. May be raised against all holders. Includes:
- fraud in the instrument (in factum)
- Forgery/ lack of authority
- Duress depriving control
- incapacity
- illegality
- alteration
Fraud in the factum
Fraud committed by deceiving the signing party about the nature of the document being signed (false representation)
a universal defense
Forgery or lack of authority
Defense that a signature was forged or signed without authority
universal defense
that negligence of drawer helped wrongdoer does not prevent drawee from raising defense of forgery
Duress depriving control
If a negotiable instrument is executed or indorsed in response to a force of such a nature that, under general principles of law, duress makes the transaction void (not just voidable)
Universal defense
Physical duress = universal defense
economic duress = personal/ limited defense
Incapacity
Incapacity is a universal defense if:
- raised by a minor
- if effect of incapacity is to make the instrument void (formal declaration of insanity)
illegality
Instrument is void by law if illegal
universal defense
Alteration
The unauthorized change or completion of a negotiable instrument designed to modify the obligation of a party to the instrument
recovery is still possible under original terms if proof of original terms available
universal defense
Effect of alteration on negotiable instrument
If alteration is fraudulent then the person whose obligations affect by the alteration is discharged of the liability under the instrument
instrument may still be enforced on original terms by holders in due course who had no notice of the alteration
Primary party
Party to whom the holder in due course must turn first to obtain payment
For a note or CD: the maker
For a draft: the drawee (it the drawee has accepted the draft. Though the bank is not primarily liable for the instrument in the case of a check they are still the party turned to first)
Secondary parties
Called secondary obligors under revised article 3, parties to an instrument to whom holders turn when the primary party, for whatever reason, fails to pay the instrument
Notes: indorsers
Checks and drafts: drawers and indorsers
Leaves the secondary party to collect from the primary party
Indorser
A party who signs and transfers a negotiable instrument; secondary party (or obligor) on a note
Steps for enforcing contract liability
1) presentment
2) dishonor and notice of dishonor
Presentment
Formal request for payment on an instrument according to it’s terms
Primary party then required to pay unless there are valid defenses
Primary party’s rights on presentment
can require presentment be made in a “commercially reasonable manner”
can make specific requirements for receipt of funds (authorization, ID, etc…)
Can require a valid indorsement prior to payment
Dishonor
Status when the primary party refuses to pay the instrument according to it’s terms
Holder left to turn to secondary parties
Notice of dishonor
Notice that an instrument has been dishonored required from primary party refusing to pay. Can be oral, written or electronic but subject to time limitations
Non-bank primary parties must give notice of dishonor within 30 days, at which time the holder can turn to secondary parties for payment
reason for dishonor
A primary party must have a valid reason for refusing to pay or they will be liable for wrongful dishonor
Valid reasons include any valid defenses or failure of the presenting party to provide sufficient identification
Warranties
Promises that parties to an instrument give to other parties to that instrument that provide assurances of payment and grounds for liability
At both creation and at transfer
Warranties of those who present an instrument for payment
Warrants that presenter:
- is authorized to present and enforce the draft
- that the draft has not been altered
- that the presenter had no knowledge that the signature of the drawer is forged
Presenter
Those who present the instrument to the primary party for payment
Warranties of transferors
- that they are entitled to enforce the instrument
- that the signatures are genuine and authorized
- that there has been no alterations
- that there are no defenses to an instrument that are good against the transferor (may be disclaimed with a qualified indorsement)
- that the transferor has no knowledge of any insolvency proceeding
Warranties always return responsibility to the first person who could have prevented the problem
Artisan bread senario
- Artisan breads receives promissory note for $2,500 from Diego’s
- Will (A/R employee) stamps ab endorsement on the back of the note and then fails to put it away correctly and it is lost
- Diego’s rebilled for same services (told past due).
- Diego’s manager tells Will that the note had been presented to them by factoring firm Financial Advisors and they had paid it since artisan had endorsed it so they assumed it was a legit firm
- Financial Advisors said they had received the note in the mail with a preprinted return envelope and had issued payment to that address (not the artisan breads addresss
- because there was an authorized blank endorsement on the note financial advisors properly presented it for payment. Diego’s may be able to recover from artisan breads /not pay twice as Artisan is reasonable for lax internal controls that allowed theft
- it there had been no blank indorsement Diego’s would be entitled to demand returned funds from Financial Advisers who would then have to go after forger (FAmay try to use negligence defense against Artisan)
