Commercial Paper

Question 1

What is a promissory note?

Answer 1

A promise to pay a specific amount. There are two parties involved - maker and a payee/bearer.

Bank Certificate of Deposit (CD): two party (bank and payee) that acknowledges receipt of money and promises to repay at a future date the principal plus interest.

Question 2

What is a draft?

Answer 2

A commercial paper involving three parties- a drawer; a payee and a drawee.

A drawer orders a sum to be paid to a payee by the drawee

May be payable on demand or in the future

**Not a check - the drawee is a person in a draft

Question 3

What is a check?

Answer 3

A type of draft with two characteristics:

1. Drawee (those in possession of the drawer’s funds) is a bank
2. Must be payable on demand

*Checks do not need the words “to order” or “to bearer” like other drafts and notes

Question 4

What is the difference between a post-dated check and a negotiable time draft?

Answer 4

A check is payable on demand, even if post-dated.

Commercial paper (note or draft) can be payable either on demand (demand/sight note) or at a specified future date (time note or draft).

Question 5

What is a trade acceptance?

Answer 5

A type of draft drawn by the payee (seller of the goods) on the drawee (buyer of the seller’s goods) and accepted by the drawee.

Question 6

What is the purpose of the negotiation of commercial paper?

Answer 6

Transfers ownership to another party

UCC seeks to protect holders in due course and most transferees of holders in due course.

Question 7

What are the requirements to be a negotiable instrument, as defined within Article 3?

Answer 7

1. Be in writing
2. Be signed by the maker (note) or the drawer (draft)
3. Contain an unconditional promise (note) or order (draft) to pay
4. Be for a fixed amount of money
5. Be payable on demand or at a definite time
6. Be payable to order or bearer (exception: checks)
7. Contain no additional undertaking or instruction not authorized by the UCC

Question 8

What characteristics will cancel the negotiability of a commercial paper?

Answer 8

An additional promise is stated in addition to the promise to pay (like the option to purchase Real Estate)

The promise to pay occurs after some action by another party or an event; it cancels negotiability

Cannot allow for an alternative such as payment or some other action by the maker

Note: a stated amount of payment plus a stated % of interest is OK

Question 9

How do you become a holder through the negotiation process?

Answer 9

If bearer paper (payable to “cash” or bearer): delivering the instrument to a transferee

Order paper: Negotiation requires delivery to that person AND any subsequent transfer requires the specified payee’s endorsement (signature) plus delivery

Question 10

What are the major types of endorsements on commercial paper?

Answer 10

1. Special or blank
2. Restrictive or unrestrictive
3. Qualified or unqualified

Question 11

If endorsed, within what amount of time must a check be presented for payment in order to hold the ENDORSER liable?

Answer 11

30 days

Question 12

On a commercial paper; which value will supersede - words or numerical dollar amount?

Answer 12

Written amount supersedes the numerical dollar amount. For example: if the words say “one hundred dollars” and the numerical amount states $1,000, the value of the paper will be $100.

Question 13

Define primary liability with respect to a negotiable instrument.

Answer 13

First in line to pay on the note/draft

Makers: enters into a contract to pay the note when due according to its terms when signed.

Drawee: primarily liable after acceptance. An acceptor enters into a contract that it will honor a draft as presented. Acceptance discharges all prior endorsers. Happens when the drawee signs/certifies the check.

Question 14

Define secondary liability with respect to contract liability

Answer 14

Drawers are secondarily liable if drawee refuses to pay (i.e. “dishonors the draft”) and the holder informs the drawer of the dishonor. Drawee is contractually obligated to honor draft as shown if there are sufficient funds available on deposit to cover the draft. Drawee may be liable to drawer in that case.

Oral stop payments are good for 14 days, written for six months. Bank needs reasonable time to act and is not under obligation to do so.

Endorsers (the payee) are secondarily liable unless signed with a restriction “without recourse.”

Question 15

Define endorser’s contract liability.

Answer 15

The endorser will pay a subsequent holder of the instrument, according to its terms, if:

1. the holder presents the instrument to the maker or drawee for payment
2. the maker or drawee dishonors (refuses to pay)
3. the endorser is given proper notice of the dishonor

Question 16

When does warranty liability occur?

Answer 16

If the transferor does not endorse the instrument, the warranties only run to the immediate transferee and not to subsequent holders

If the transferor endorses, the warranties run to all subsequent holders

Question 17

What five warranties occur with every commercial paper transfer?

Answer 17

1. The transferor is entitled to enforce the instrument (i.e., has good title) or is authorized to act for one who is entitled to enforce
2. All signatures are genuine or authorized
3. The instrument has not been materially altered
4. No defense of any party is good against the transferor
5. The transferor has no knowledge of any insolvency proceeding that has been instituted against the maker, acceptor, or drawer of an unaccepted instrument

*Can disclaim by signing “the transferor makes no warranties” except on checks

Question 18

What are the requirements for a holder to be a holder in due course?

Answer 18

1. Become a holder through proper negotiation
2. Taking the paper “in due course”:
   - For value (not a gift)
   - In good faith; and
   - Without notice of any defenses to or claims of ownership on the instrument

*If any of these requirements are missing, the holder merely gets the same rights as a transferor

Question 19

What are the personal defenses against a holder in due course (HDC)?

Answer 19

Personal defenses cannot be raised against an HDC or her assignees

All other defenses other than real defenses (FAIDS)

Common personal defenses: unauthorized completion (leaving the amount blank on the instrument), and failure of consideration

Question 20

What are the REAL defenses against a holder in due course (HDC) and non-HDCs?

Answer 20

“FAIDS”

1. Fraud in the execution
2. Forgery
3. Adjudicated insanity
4. Material Alteration
5. Infancy
6. Illegality
7. Duress (extreme duress which would render a contract void)
8. Discharge in bankruptcy
9. Suretyship defenses
10. Statute of limitations (3 yrs on drafts, 6 yrs on notes)

*If a negotiable instrument is negotiated to a HDC, the HDC takes free from personal defenses and claims and is subject to only real defenses.

Question 21

What is a “holder in due course?”

Answer 21

A person who takes a negotiable instrument for value, in good faith, and without notice of any defenses on or claims to the instrument.

HDC Rule: if a negotiable instrument is negotiated to a HDC, the HDC will take the instrument subject to very few defenses (real defenses).

Question 22

What is negotiable paper/commercial paper governed by?

Answer 22

Article 3 of the UCC

Warehouse receipts, bills of lading, stocks, etc, are governed by other articles.

The UCC does not apply to cash/money - only the substitute.

Question 23

What are the “magic words” of negotiability?

Answer 23

When stated that the instrument is payable to an identified person, it must include “to the order of John Smith” or “John Smith or order.”

When the instrument is payable to anyone who has possession of it, it must be payable to “to bearer, order of bearer, to a named person or bearer, and bearer, to cash, or to the order of cash.”