Commercial Paper Flashcards
Structured approach to answering commercial paper questions
(1) Identify the type of paper
(2) Identify the parties
(3) Determine whether the instrument is negotiable
(4) Determine whether the instrument was properly negotiated
(5) Determine whether the transferee is a holder in due course
(6) Determine the plaintiff’s causes of action, such as contract, warranty, tort, or not-properly-payable claims
(7) Determine the defendant’s defenses
(8) If the defendant is held liable, can he pass liability on to another party?
What is the difference between a note and a draft?
A note is a promise to pay money and is a two-party instrument. The maker promises to pay and the payee is entitled to payment.
A draft is an order to pay money and is a three-party instrument. The drawer orders payment, the drawee makes payment, and the payee receives payment. The most common type of draft is a check, where the bank is the drawee and the instrument is payable on demand.
What does “negotiability” mean? What are the elements for an instrument to be properly negotiable?
“Negotiability” refers to the form of the instrument and is determined at the time of issuance. Negotiability is important because, under normal contract law, a transferee gets no better rights than the transferor. But, if the paper is negotiable and properly negotiated, it may reach the hands of a holder in due course, who gets better rights than the transferor and so can get paid even if the obligor (maker or drawer) has defenses to payment under normal contract law. To be negotiable, an instrument must be:
- (1) a written and signed,
- (2) unconditional (does not state a condition for payment and is not governed by another writing),
- (3) promise (note) or order (draft) to pay,
- (4) a fixed amount of money (with or without interest),
- (5) payable to order or bearer,
- (6) payable on demand or at a definite time, and
- (7) states no unauthorized undertaking or instruction by the person promising or ordering payment.
What types of undertakings and instructions are authorized by the UCC and will not destroy the negotiability of an instrument?
Only three undertakings or instructions are authorized by the UCC; any other undertaking or instruction will destroy negotiability:
- (1) promise to give, maintain, or protect collateral,
- (2) an authorization or power given to the holder to confess judgment or to realize on or dispose of collateral, and
- (3) waiver of law meant to benefit the obligor.
What types of date change matters won’t prevent an instrument from being payable at a definite time?
The following date change matters don’t prevent an instrument from being payable at a definite time:
- (1) Repayment of instrument (obligee may pay earlier than the stated date).
- (2) Acceleration of due date (holder may demand payment earlier than stated upon certain named events).
- (3) Provisions extending the due date at the option of the maker and extensions that are automatic on the happening of an event are acceptable if the extension is to a further definite time stated in the instrument.
What is the difference between order paper and bearer paper? What happens if the instrument contains language of both? Are there any exceptions?
An instrument is payable “to order” if it is payable to the order of an identified person (for example, “pay to the order of Frank Smith”) or to an identified person or order (for example, “pay to Becky or her order”). Order language is typically pre-printed on checks.
An instrument is payable to bearer if it:
- (a) states that it is “payable to bearer” (“I promise to pay bearer”), “payable to the order of bearer,” or otherwise indicates the possessor is entitled to payment;
- (b) does not name a payee; or
- (c) is payable to “cash” or otherwise indicates that it isn’t payable to an identified person.
If the instrument contains both order and bearer language, the bearer language controls.
If this is the only element of negotiability missing and the instrument is a check, the order/bearer language requirement is waived.
Who is a “holder” of commercial paper?
A holder is a person in possession of an instrument with a right to enforce it. Holder status requires possession of the instrument and good title, which depends on if it is order or bearer paper.
How are bearer instruments properly negotiated?
Bearer instruments are negotiated by transferring possession of the instrument (for example, if Yolanda gives Zack a bearer note, there is a negotiation). Note that if an instrument initially is order paper (because it says it’s payable to a specific person), and that named person indorses (signs on the back) and doesn’t name a new person to whom the instrument is payable (that is, a “blank indorsement”), the instrument is converted to bearer paper and can now be negotiated by transfer alone.
How are order instruments properly negotiated? What is an indorsement? What is the effect of transferring paper that is not indorsed?
An indorsement is a signature on a negotiable instrument by someone other than the maker, drawer, or acceptor, normally on the back of the instrument. An instrument payable to an identified person (the payee, such as John Smith) is negotiated by transferring possession plus the identified person’s indorsement. For example, John Smith may negotiate a check payable to his order by indorsing the check and delivering it to a transferee. In the case of multiple indorsements, the last in time controls.
Generally, the right to enforce won’t pass unless the payee’s indorsement is authorized and valid. In most cases, forging the payee’s name breaks the chain of title, and generally no subsequent possessors of the instrument can qualify as holders.
The delivery of an order instrument without required indorsements may transfer possession but is not a negotiation. Unless they obtain the indorsement, the transferee doesn’t have holder status.
What is a blank indorsement?
A blank indorsement is a signature that isn’t accompanied by the naming of a specific indorsee. The indorser merely signs his own name, the way most people indorse any physical check they receive. Blank indorsements create bearer paper, which means further negotiations may be by delivery alone.
What is a special indorsement?
A special indorsement is accomplished by the payee’s signature plus a designation of a new person to whom the instrument is payable. For example, “Pay John Smith [signed] Peter Payee.” The indorsee (John Smith) must sign in order for the instrument to be further negotiated. Words of negotiation (such as “pay to the order of”) are not required in indorsements, and extra words generally don’t impair negotiability.
What is a qualified indorsement?
An indorsement with the words “without recourse” is a qualified indorsement and limits the contract liability imposed on indorsers.
What is a restrictive indorsement?
Any other language added to an indorsement creates a restrictive indorsement. Restrictive indorsements generally are ineffective to limit transfer or negotiation or to condition payment. For example, a check indorsed “pay Pete Payee only” may be further negotiated to anyone, and a check indorsed “pay John if he fixes my car” may be further negotiated even if John has not fixed the car. However, an instrument with words requiring bank collection (such as “for deposit,” “for collection”) must be paid consistently with the indorsement by any person or the first bank into which the instrument is deposited (the depositary bank) or it will be deemed to have been converted.
If an instrument contains a restrictive indorsement and the depositing bank does not comply with the indorsement, it will be liable to the payee for conversion.
What is an anomalous indorsement?
An anomalous indorsement is an indorsement made by a person who is not a holder of the instrument, usually for accommodation (suretyship) purposes. The anomalous indorser becomes liable on the instrument.
For example, you write a check to Friendly Sam the Used Car Man but Sam is worried that you might not have sufficient funds in your account and asks you to have your rich aunt add her indorsement on the back of the check.
What is a holder in due course? When does HDC status become relevant? How does the shelter rule apply to HDCs?
A holder is a person in possession of an instrument with the right to enforce it. The instrument must be payable to bearer or to the person in possession and free of forgery. To be a holder in “due course,” the holder must have taken the instrument:
- (1) for value (broader than what is required for consideration),
- (2) in good faith (honesty in fact plus observance of objectively reasonable commercial standards), and
- (3) without notice of irregularities (such as forgery or alteration).
HDC status is important if the obligor raises a defense to payment.
Even if a holder doesn’t qualify as an HDC, they may still have rights of an HDC by shelter. A transferee acquires whatever rights their transferor had and so is said to take “shelter” in the status of their transferor. So, if an HDC transfers an instrument, their transferee and subsequent transferees get the HDC’s rights (they do not become a HDC, but simply have the HDC’s rights). The shelter rule does not apply to persons who attempt to succeed a HDC’s rights through fraud or illegality.
