R7.1 – Commercial Paper (UCC Article 3)

Question 0

Notes

Answer 0

Note = promise by one party (maker) to pay money to another party (the payee or to bearer)

Note = two-party commercial paper

Certificate of Deposit = bank promissory note
– 2 parties = bank and payee
– CD is negotiable instrument issued by a bank that acknowledges receipt of money and promises to repay at a future date

Question 1

Commercial Paper

Answer 1

UCC Article 3 (Negotiable Instruments) governs commercial paper

Commercial paper = convenient and safe substitute for cash

Types of commercial paper
Notes
Drafts

Question 2

Drafts

Answer 2

Drafts = an order by one person (drawer) to another person (drawee) to pay money to a third person (payee)

Drafts = 3 party commercial paper

Checks
– Drawee = bank
– Payable on demand

Trade acceptance = draft drawn by payee (usually seller) on the drawee (usually buyer) and accepted by drawee
– Used in international trade
– Essentially is an order by the seller to the buyer to pay the seller (sort of like an invoice, but with teeth)

Question 3

Demand vs Time Instruments

Answer 3

Commercial paper can be payable either on demand or at a specified date

On demand = on demand note, demand draft

Specified date = time note, time draft

Question 4

Holder in Due Course & Holder in Due Course Rule

Answer 4

To facilitate freely transferable substitute for cash, central theme of Article 3 is holder in due course rule

Holder in due course = a person who takes a negotiable instrument

1. for value
2. in good faith, and
3. without notice of any defenses to or claims of ownership on the instrument

Holder in due course rule = if a negotiable instrument is negotiated to a holder in due course, the holder in due course will take the instrument subject to very few defenses
– Maker or drawer of the commercial paper can avoid paying out on the instrument only if he can raise one of 10 specific (“real”) defenses
– Other defenses that can be used against an ordinary transferee of a contract right can not be used against an HDC.

Question 5

Analyzing a Commercial Paper Question

Answer 5

1. Determine whether the instrument is a note or draft
2. Determine whether the instrument is negotiable
3. Determine whether the holder qualifies as a holder in due course
4. Determine whether the maker/drawer has a “real” or “personal” defense.

Question 6

Negotiability

Answer 6

The front of the instrument determines negotiability

The instrument must

1. Be a writing
2. Be signed by the maker (note) or 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 to bearer, with the exception of checks
7. Contain no undertaking or instruction not authorized by the UCC

Question 7

Negotiability – Be a writing

Answer 7

The UCC is very liberal about what constitutes a writing.

Can be printing, typing, or any other intentional reduction to tangible form

Question 8

Negotiability – Be signed by the maker (note) or drawer (draft).

Answer 8

The UCC is very liberal about the signing requirement

Can be a rubber stamp, typed, etc., or any mark affixed with intent to service as a signature

Question 9

Negotiability – Contain an unconditional promise (note) or order (draft) to pay

Answer 9

No terms in separate instrument

If the payment is “conditional,” the instrument is not negotiable.

Question 10

Negotiability – Be for a fixed amount of money

Answer 10

Money only; any legal currency

Not money and/or goods or services

“Payable with interest” (percentage stated or unstated or variable) is okay

“Payable with a stated discount or addition” if paid before of after the date fixed for payment is okay

“Payable with costs of collection attorney’ fees upon default” is okay

Question 11

Negotiability – Be payable on demand or at a definite time

Answer 11

Definite time = on or before stated date, at the fix period after stated date, at a time readily ascertainable at time instrument issued, or as a definite period of time after the site or acceptance

Not a definite time if payable only upon an event that is not certain to happen

Not a definite time if payable upon an event that is certain to happen at a time that cannot be stated certainly

Acceleration clauses don’t destroy negotiatiability— just define latest date instrument can be paid

Extension clauses do not destroyed negotiatiability – just state the latest date payment will be payable

Undated instrument payable on demand

Question 12

Negotiability – Be payable to order or to bearer, with the exception of checks

Answer 12

Order = specified party
– Order paper must state that it is payable to the order of a specified person or payable to identify person oh order
✔️ Pay to order of John Smith 
✔️Pay John Smith or order
✖️Pay John Smith(unless a check)

Bearer = anyone who possesses it
✔️ Pay to bearer 
✔️ Pay to order or bearer
✔️Pay John Smith or bearer 
✔️Pay John Smith and bearer 
✔️Pay cash 
✔️Pay to order of cash

Checks — no need to be payable to order of bearer
✔️ Pay John Smith

Question 13

Negotiability – Contain no undertaking or instruction not authorized by the UCC

Answer 13

Authorized promises
– Authorization to give, maintain, or protect collateral
– Authorization of confession of judgment or disposition of collateral if instrument not paid when due
– Term leaving benefits of laws intended for benefit of obligor (e.g. trial by jury, homestead allowances)

Question 14

Rules of Construction

Answer 14

Typewritten terms control over printed terms

Handwritten terms control over typewritten and printed terms

Words control figures, unless words are ambiguous
– Pay five hundred dollars ($5,000) will be interpreted as pay $500 not pay $5000.

Question 15

Non-Negotiable Instruments

Answer 15

No holder in due course

Treated as ordinary contract
– Transferees of instruments take it subject to any defense against payment a party might have

Question 16

Article 3 Protection Requirements

Answer 16

To have Article 3 protection the instrument
1. must be negotiable
and
2. must have been transferred in a proper way

Question 17

Negotiation

Answer 17

The first step in becoming an HDC is to become a holder.
– One becomes a holder through proper negotiation of commercial paper
– Negotiation = process by which commercial part paper is transferred

Negotiation of bearer paper = Deliver the instrument to a transferee

Negotiation of order paper
= Deliver to the specified person
and
Any subsequent transfer requires a specified payee’s endorsement (signature) plus delivery

Question 18

Negotiation – Endorsements

Answer 18

The order vs. bearer nature of commercial paper can be changed through the use of certain types of endorsements

The last endorsement determines if the instrument will be order or bearer after endorsement

Endorsement have three qualities

1. Special or blank – This determines if the instrument will be order or bearer
2. Restrictive or on restrictive
3. Qualified or unqualified

To be holder, every prior endorsement must have been proper, otherwise the chain of title has been broken
– Every transferee after the break cannot be a holder

Forged drawer’s or maker’s signature does not break chain of title

Question 19

Negotiation – Special vs Blank Endorsements

Answer 19

Special endorsement = order paper
– Names a particular person
– Further negotiation requires the signature of the special endorsee plus delivery

Blank Endorsement = bearer paper
– No endorsee specified
– Negotiated by delivery alone

Question 20

Negotiation – Qualified Endorsements

Answer 20

Qualified endorsements = Endorsement that add the words “without recourse”

Means that days no guarantee of payment by endorser

No contract liability

Warranty liability still attaches

Question 21

Negotiation – Restrictive Endorsements

Answer 21

Created by adding any of the language to want to endorsement

Three types of restrictive endorsement
1. Conditional = Payment is conditional upon the event happening
2. Prohibitive = Purports to prohibit for the transfer of instrument
– Does not actually prevent further transfer or negotiation of instrument
3. For deposit or collection = Makes bank collection agent of the endorser

Restrictive endorsements generally have no effect on negotiability

Question 22

Becoming a Holder in Due Course

Answer 22

The second step to becoming an HTC is to obtain the paper “in due course” i.e. take the paper

1. For value
2. In good faith, and
3. Without notice of any defenses to or claims of ownership on the instrument

Question 23

Becoming a Holder in Due Course – Value

Answer 23

Value is not the same as consideration

Value includes
– Performance of the agreed concentration
– Acquisition of lien or a security interest in the instrument
– Taking the instrument as payment of security for an antecedent debt
– Giving a negotiable instrument for the instrument
– Making an irrevocable commitments to third parties

A past debt can be value for HDC purposes

Executory promise is not value
– Executory promise is a promise to give value in future
– Executory promise qualifies as contract consideration

Value does not have to be equivalent to face value of instrument
Can be a partial HDC if part of agreed value is executory
– HDC status is proportional to percentage of agreed-upon value that is not executory

Question 24

Becoming a Holder in Due Course – in Good Faith

Answer 24

Good faith = honesty in fact

Question 25

Becoming a Holder in Due Course – Without Notice of any Defenses to or Claims of Ownership on the Instrument

Answer 25

Holder must purchase instrument without notice or knowledge that it is overdue, or has been dishonored, or of any defense or claim against the instrument

Measured objectively – what a reasonable person would have known in similar circumstances

The following do not constitute notice:
– Instrument is antedated or postdated
– Purchasing an instrument at a discount

Question 26

Transactions Precluding HDC Status

Answer 26

Instrument purchased at a judicial sale

Instrument acquired in taking over an estate

Instrument purchased as part of a bulk transaction not in the regular course of transferor’s business

Question 27

Shelter Doctrine

Answer 27

Subsequent transferees of an HDC can “succeed to” or “take shelter in” the rights of the HDC

Even though transferee cannot qualify as HDC, he can claim rights of an HDC who held the commercial paper before him

Shelter doctrine only protects innocent parties

Question 28

Real Defenses

Answer 28

Real defenses can be successfully raised by a maker or drawer (so the maker/drawer does not have to pay), even against an HDC

HDC wins against any other defense; all other defenses are personal defenses

10 real defenses = FAIDS^2

1. Fraud in the execution
2. Forgery of a necessary signature
3. Adjudicated insanity
4. Alteration of the instrument
5. Infancy
6. Illegality
7. Duress
8. Discharge in bankruptcy
9. Suretyship defenses
10. Statute of limitations

Question 29

Real Defenses – Fraud in the execution

Answer 29

Person tricked into signing something that he does not know is a negotiable instrument

All other frauds are personal defenses against which an HTC will win

Question 30

Real Defenses – Forgery of a necessary signature

Answer 30

Necessary signature
– Drawer’s or maker’s signature
– Endorsement of named payee
– Special endorsee

Question 31

Real Defenses – Adjudicated insanity

Answer 31

Adjudicated insanity that under state law renders contract void from its inception, not just merely voidable

Question 32

Real Defenses – Alteration of the instrument

Answer 32

Material alteration

Defense only to the extent of the alteration

Question 33

Real Defenses – Infancy

Answer 33

To the extent it renders the contract voidable on the state law

Question 34

Real Defenses – Illegality

Answer 34

Illegality that renders the underlying contract void

Question 35

Real Defenses – Duress

Answer 35

Duress that renders an obligation to avoid

Question 36

Real Defenses – Discharge in bankruptcy

Answer 36

And other discharges known to the HTC

Question 37

Real Defenses – Suretyship defenses

Answer 37

To the extent the HDC knew prior to acquiring the instrument that the party was signing as a surety or “accommodation party”

Question 38

Real Defenses – Statute of limitations

Answer 38

3 years after dishonor or acceptance for drafts

6 years after demand or other due dates on notes

Question 39

Liability – Maker

Answer 39

Maker = primarily liable

When a maker signs a note, the maker enter into a contract to pay the note when due according to its terms

Question 40

Liability – Drawer

Answer 40

Drawer = secondarily liable

The drawer agrees to pay the draft according to its terms if the draft is presented to the drawer for payment, the drawee refuses to pay, and the holder informs the drawer of the dishonor

Question 41

Liability – Drawee

Answer 41

Drawee = primarily liable after acceptance

To be liable, drawee must have signed instrument

If drawee signs, drawee becomes an acceptor and is primarily liable
– Acceptor enters into contract that it will honor on a draft as presented
– Acceptance discharges all prior endorsers

Certification of a check is equivalent to acceptance
– Certification = acceptance of a check by a drawee bank
– Certification discharges all prior endorsers, and in most states, the drawer as well

Question 42

Liability between Drawer & Drawee

Answer 42

A holder cannot force a drawee to pay out a draft. However, drawee may be liable to drawer for refusing to pay

Drawee banks are contractually obligated to honor a customer’s draft as shown if there are sufficient funds on deposit to cover the draft

Stop payment orders
– Oral stop payment order is binding on a bank for 14 days
– Written stop payment order is binding on a bank for 6 months
– Bank is under no obligation to honor a stop payment order on a cashier’s check

Question 43

Liability – Endorsers

Answer 43

An endorser is one who signs his name to an instrument for the purpose of negotiating the instrument to another or making himself secondarily liable on the instrument

An endorser can be liable into ways
– Contract
– Warranty

Question 44

Liability – Endorsers: Contract Liability

Answer 44

Endorse is secondarily liable if

1. Instrument is presented for payment
2. The maker or drawee dishonours, and
3. Endorser is given notice of dishonor

Notice of dishonor can be made orally

For checks, presentment must be made within 30 days to preserve endorser’s liability

Endorsement “without recourse” negates contract liability i.e. there is no guarantee of payment
Transfer warranties still apply

Question 45

Liability – Endorsers: Warranty Liability

Answer 45

Any person, including endorsers, who transfers an instrument for consideration makes 5 warranties

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 is not materially altered
4. No defense of any party is good against the transferor
5. Transferor has no knowledge of any insolvency proceedings against maker, acceptor, or drawer

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

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

Presentment and notice of dishonor are irrelevant to warranty liability

Transfer warranties can be disclaimed by language indicating such intent e.g. transferor makes no warranties
– Exception = checks

Question 46

Liability – Accommodation Party

Answer 46

Accommodation party = one who signs an instrument for the purpose of lending his name and credits to another party i.e. a surety

Liable in capacity in which signed

Never liable to person accommodated

Question 47

Liability – Effect of an Agent Signing

Answer 47

Principal liable for instrument signed by an authorized agent, even though principal’s signature does not appear on instrument

Question 48

Liability – Effect of Forgery

Answer 48

Forger is always liable

If forger is missing, who is liable depends on which party’s signature is forged
– Drawer’s signature forged = Drawee liable
– Payee’s signature forged = first person forger passed instruments to is liable

Exceptions where payee’s forged name passes good title

1) Imposter rule – If maker or drawer issues instrument to imposter, any resulting forgery of payee’s name will be effective
2) Fictitious payee rule – If drawer or maker issues commercial paper to a payee he does not actually intend to have any interest in the instrument, a resulting forgery of the payee’s name is effective to pass good title to later transferees

Question 49

Liability – Discharge

Answer 49

Parties can be discharged from their liabilities by:
– Payment, satisfaction, or tender payment to a holder
– Cancellation or renunciation
– All parties discharged if holder intentionally destroys instrument
– Individual discharge by crossing out signatures
– Oral renunciation not effective
– Impairing recourse or collateral
– Delay in presentment or failure to give notice of dishonor
– Acceptance of a draft by a bank

Discharge is a personal defense that cannot be used against HDC unless HDC knows
– Therefore note all discharges on the basis of instrument