Commercial Paper and Secured Transactions

Question 1

Post-Dated Check

Answer 1

It does not represent a current demand to pay. However, a bank is protected against liability for paying the check before its date unless the customer expressly notifies the bank of the postdating. This allows the bank to identify the check as it is processed through its computers.

Question 2

Contrary terms

Answer 2

Whenever there is a conflict between written words and numbers, the written words prevail.

If the instrument contains contrary terms, words control figures unless the words are ambiguous or uncertain (i.e., illegible), in which case, figures control.

Question 3

Alteration of an instrument

Answer 3

Where a person fails to exercise ordinary care and thereby substantially contributes to an alteration of an instrument, that person is precluded from asserting the alternation against a person who, in good faith, pays the instrument and takes it for collection. If a bank knows of an alteration, this does not apply.

Question 4

Large blank space on check

Answer 4

A large blank space left after the figure and the words on the check do constitute a failure to exercise ordinary care.

Question 5

Unauthorized completion of check

Answer 5

An unauthorized, but not fraudulent, completion of a check does not discharge the drawer from the obligation. A check can be enforced according to its altered format since it was not for an amount in excess of the debt owed to the payee. Further, if the alteration was made possible only because of the failure to exercise ordinary care by the drawer in leaving large blanks, the drawer cannot complain of the alteration of the document and is precluded from asserting the alteration against a person who, in good faith, pays the instrument as completed.

Question 6

What counts as value?

Answer 6

An antecedent debt.

Question 7

To whom does a bank owe an obligation

Answer 7

A bank does not owe any obligation to a holder of a draft drawn on the bank to pay the draft; rather the bank’s only obligation runs to its customer, and that obligation is to pay drafts that are properly payable.

Question 8

Holder in Due Course

Answer 8

A holder is someone in possession of an instrument with a right to enforce it.

A person who takes the instrument for value, in good faith, and without notice of any defenses or claims to the instrument is a holder in due course. A HDC takes free of most defenses—they are subject only to “real” defenses (e.g., incapacity) and not personal defenses (e.g., theft).

Question 9

Negotiation of an order instrument

Answer 9

Negotiation of an order instrument requires a transfer of possession plus the indorsement of the payee.

Question 10

Fraudulent alteration

Answer 10

Fraudulent alteration generally discharges all parties from liability on the check. However, in the case of an incomplete instrument altered by unauthorized completion, a person who takes the instrument for value, in good faith, and without notice of the alteration may enforce the instrument according to its terms as completed.

Question 11

Good faith

Answer 11

Look out for large discount, suspicious circumstances, hesitation on the part of the potential HDC in making the exchange.

Question 12

Infancy defense

Answer 12

Infancy is a real defense if it would be a defense against a simple contract under state law. In Virginia, infancy is a defense in a simple contract action except when the contract is for necessaries.

Question 13

Checks and obligations

Answer 13

A check does not discharge the obligation for which it is given, but merely suspends the obligation until paid. If a check payable to a particular person is lost or stolen and is not indorsed by the payee, the payee retains ownership of the check.

Question 14

Stop payment orders

Answer 14

A bank customer is entitled to have its account recredited when the bank pays out over a valid stop payment order. Oral stop payment orders are valid for fourteen days; written stop payment orders are valid for six months.

Question 15

Warranty of presentment

Answer 15

A party who breaches the warranty of presentment is liable to the drawee. The warranty of presentment warrants that the party presenting the check has title to the instrument and that the presenter is entitled to enforce the instrument.

Question 16

What kinds of forgeries/alterations prevent HDC status?

Answer 16

Forgery of payee’s indorsement of an order will prevent the title from passing (payee’s indorsement must be authorized and valid for order paper to be negotiated).

Question 17

Priority between two creditors with perfected security interests in an item of collateral

Answer 17

As between two creditors with perfected security interests in an item of collateral, priority goes to the first to file or perfect, whichever occurs first.

Question 18

Attachment

Answer 18

For a security interest to be perfected, it must attach to the collateral. A security interest attaches to goods when (i) the parties agree to create a security interest evidenced by an authenticated security agreement or the secured party’s possession of the goods; (ii) the creditor gives value; and (iii) the debtor has rights in the goods.

Question 19

Perfection

Answer 19

Security interests in most goods can be perfected by filing a financing statement. If filing occurs before attachment takes place, the security interest will be perfected upon attachment.

Question 20

Forgery in chain of title

Answer 20

A forgery in the chain of title prevents someone from being a holder, thereby precluding HDC status.

Question 21

Estoppel by negligence

Answer 21

A person whose negligence substantially contributes to a forgery is estopped from asserting the forgery against someone who took the instrument for value and in good faith.

Question 22

Transfer Warranties

Answer 22

A person who transfers an instrument for consideration warrants that (i) she is entitled to enforce the instrument; (ii) all signatures on the instrument are authentic and authorized; (iii) no defenses are good against her; (iv) the instrument has not be altered; and (v) she has no knowledge of any insolvency proceedings.

Warranty iii (defenses) can be negated except with respect to checks, but only by language clearly indicating that no warranty is being made.

Question 23

Indorser’s contract

Answer 23

A person who signs a note other than as a maker or acceptor incurs secondary liability as an indorser becoming obligated to pay it according to its terms if the maker does not pay. A forged signature on an instrument is deemed to be the signature of the forger.

Question 24

Requisites for negotiability

Answer 24

To be negotiable, a note must be signed by its maker and be an unconditional written promise to pay a fixed amount of money, with or without interest, to order or to bearer, on demand or at a definite time, without any undertaking or instruction not authorized by law.

An authorized agent can sign on behalf of a principal. Notes not stating when payable are payable on demand. Sufficient if note says “payable to X or its order.”

Question 25

Proper negotiation

Answer 25

To be properly negotiated, a note payable to a named payee must be indorsed and delivered to the holder.

Question 26

“Without recourse”

Answer 26

That language is sufficient to negate an indorser’s contract liability, i.e., an implied promise to pay, if the note is presented for payment, is dishonored, and notice of dishonor is given to the endorser. It is not sufficient to negate warranty liability.

Question 27

Who is liable for unaccepted checks?

Answer 27

Drawers are liable for unaccepted checks dishonored by a bank. A drawer’s contract liability cannot be unilaterally revoked by issuing a stop payment order. The effect of a stop payment order is merely to prohibit the drawee bank from paying the check.

Question 28

When can a bank charge an item against a customer’s account?

Answer 28

Generally, a bank can charge an item against a customer’s account only if the item is properly “payable,” which in turn, requires that the item be authorized by the customer. A check is properly payable only if it is signed by the drawer or the drawer’s authorized agent.

Question 29

Accord and satisfaction

Answer 29

In the Commonwealth, if a claim is unliquidated or subject to dispute, it can be discharged in full if the person against whom the claim is asserted in good faith tenders an instrument that conspicuously states that it is tendered in full satisfaction of the claim and the claimant obtains payment of the instrument. If the requirements are met, an accord and satisfaction are presumed.

Question 30

Alteration of “Payment in Full”

Answer 30

Virginia does not allow avoidance where the altered instrument was tendered in good faith as full payment of the disputed debt.

Question 31

Avoiding accord and satisfaction

Answer 31

One can avoid the risk of an accord and satisfaction if you tender repayment of the amount of the check within 90 days of its payment.

Question 32

Duty to read bank statements

Answer 32

A customer has a duty to the bank to examine monthly statements and exercise reasonable care to discover any unauthorized payments resulting from alteration or forgery of the drawer’s signature and to notify the bank promptly after any such discovery.

A customer is precluded from asserting an alteration or forgery of his signature if he does not notify the bank of the alteration or forgery within one year after the bank has made the instrument available to him.

Additionally, if a statement has been available to the customer for a reasonable period, more than thirty days, and he does not object to any of the signatures or alterations, the customer is estopped from demanding recredit on any other items forged by the same wrongdoer.

Question 33

Conditional

Answer 33

An instrument is conditional if it expressly states a condition for payment or states that the promise or order is subject to or governed by another writing. This renders an instrument nonnegotiable.

Question 34

Foreign currency

Answer 34

An instrument does not lose its negotiability merely because it is payable in foreign money. An instrument payable in foreign money may be paid in an equivalent amount of dollars in the current bank-offered spot rate at the place of the payment.

Question 35

Payable to order or bearer

Answer 35

A negotiable instrument must be payable “to order” or “bearer” at the time of its issuance. The words “or any other person” do not defeat negotiability. They will have the effect of making this instrument one that is in effect “bearer paper,” not payable to an identifiable person but to bearer.

Question 36

Acceleration clause

Answer 36

An instrument is payable at a definite time if it is payable: (i) on a fixed date; (ii) on the lapse of a specified period of time after sight or acceptance; or (iii) at some time readily ascertainable at the time the instrument is issued.

When an instrument calls for “earlier of” it is an acceleration clause. Any clause that accelerates the time of payment upon the occurrence of an event does not destroy negotiability.

Question 37

Interest

Answer 37

No interest will be due unless the instrument provides for the payment of interest. If the instrument says that it is payable with interest, but does not state the rate, the judgment rate (the rate on a court judgment) will be implied.

Interest is payable from the date of the instrument.

Question 38

Restrictive indorsement

Answer 38

A restrictive indorsement (i.e., an indorsement limiting payment to a particular person or otherwise prohibiting further transfer or negotiation of the instrument) is not effective to prevent further transfer or negotiation of the instrument.

Question 39

Where must a financing statement be filed?

Answer 39

For corporate debtor, state of incorporation. For individual, state where she resides.

Question 40

Attachment of a security interest

Answer 40

In order for a security interest to attach, three things must occur: first, the parties must have an agreement that the security interest attached that is evidenced by either a record authenticated (e.g., signed) by the debtor, possession, or control; second, value must be given by the secured party; third and last, the debtor must have rights in the collateral.

These three requirements must coexist but can occur in any order.

Question 41

Perfected security interests and subsequent buyers

Answer 41

Generally, a perfected security interest in collateral is good against subsequent buyers. An important exception to this rule involves buyers in the ordinary course of business. A buyer in the ordinary course of business is defined as someone who buys goods from a seller who is engaged in the business of selling goods of the kind purchased.

Under Virginia law, a buyer in the ordinary course of business who buys goods from a seller who is engaged in the business of selling goods of the kind purchased takes free of any security interest created by his seller unless: (i) he knows of the security interest and (ii) he knows that the sale is in violation of the terms of the security agreement.

Question 42

PMSI

Answer 42

A purchase money security interest (PMSI) arises when a creditor sells the goods to the debtor on credit and retains a security interest in the goods for all or part of the purchase price (creditor and seller are the same person); or when a creditor advances funds that are used by the debtor to purchase the collateral (creditor and seller are different persons). A PMSI in consumer goods is perfected automatically, no filing is necessary.

Question 43

Garage sale rule

Answer 43

This rule provides that a consumer purchaser who buys consumer goods from another consumer takes free of a perfected security interest if he buys the goods without knowledge of the security interest and before a financing statement covering the goods has been filed.

Question 44

PMSIs and Priority

Answer 44

When perfected security interests in the same collateral conflict, the secured creditor that was first to file or perfect generally has priority. There is an exception to the first to file or perfect rule for PMSIs. A PMSI in noninventory collateral, such as equipment, will have priority over other perfected security interests in the same collateral if the interest is perfected before or within 20 days after the debtor receives possession of the collateral.

Question 45

PMSI in Consumer Goods

Answer 45

A PMSI in consumer goods is automatically perfected upon attachment.

Question 46

Collateralized Instruments and Subsequent Purchasers

Answer 46

Under UCC Article 9, an HDC prevails over secured parties claiming an interest in the promissory note.

Question 47

Fixtures and security interests

Answer 47

A security interest in a fixture may be perfected only by making a fixture filing describing the real property to which the fixture is affixed. While financing statements generally must be filed with the State Corporation Commission, a fixture filing must be filed in the local office where a mortgage on real property would be filed.

Question 48

Perfection of a security interest in a motor vehicle

Answer 48

Security interests in motor vehicles are required to be titled, except those created by dealers are perfected by notation on the certificate of title. No Article 9 filing is required. Security interests created by dealers in vehicles held for sale or lease are perfected by ordinary filing under the UCC even if certificate of title covering the vehicle is outstanding. Security interests in farm tractors and special construction and forestry equipment are perfected only by filing a financing statement.

Question 49

Perfection by pledge

Answer 49

A secured party may perfect a security interest in most types of collateral simply by taking possession of it. The interest is perfected from the moment of possession and continues as long as possession is retained.

Question 50

Default with Non-Goods Collateral

Answer 50

With a non-goods collateral, such as chattel paper, if the debtor who gave a security interest in the collateral defaults, the secured party may notify the person owing money to the debtor (i.e., the account debtor) to make payment to the secured party rather than to the debtor. Upon notification, the account debtor must pay the secured party rather than the debtor.

Question 51

Incomplete terms

Answer 51

Under Article 3, an incomplete instrument may be enforced according to its incomplete terms or as augmented by authorized completion. Alteration of an instrument generally does not discharge a party unless the alteration was fraudulent.

Virginia law states that an “alteration” is an unauthorized change in an instrument that purports to modify the obligation of a party or an unauthorized addition of words or numbers relating to the obligation of a party.

Question 52

Local filing permitted

Answer 52

The Virginia Code authorizes local filing only if the collateral is a fixture, as-extracted collateral, or timber to be cut.