R7.1 – Commercial Paper (UCC Article 3) Flashcards
Notes
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
Commercial Paper
UCC Article 3 (Negotiable Instruments) governs commercial paper
Commercial paper = convenient and safe substitute for cash
Types of commercial paper
Notes
Drafts
Drafts
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)
Demand vs Time Instruments
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
Holder in Due Course & Holder in Due Course Rule
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
- for value
- in good faith, and
- 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.
Analyzing a Commercial Paper Question
- Determine whether the instrument is a note or draft
- Determine whether the instrument is negotiable
- Determine whether the holder qualifies as a holder in due course
- Determine whether the maker/drawer has a “real” or “personal” defense.
Negotiability
The front of the instrument determines negotiability
The instrument must
- Be a writing
- Be signed by the maker (note) or drawer (draft).
- Contain an unconditional promise (note) or order (draft) to pay.
- Be for a fixed amount of money
- Be payable on demand or at a definite time
- Be payable to order or to bearer, with the exception of checks
- Contain no undertaking or instruction not authorized by the UCC
Negotiability – Be a writing
The UCC is very liberal about what constitutes a writing.
Can be printing, typing, or any other intentional reduction to tangible form
Negotiability – Be signed by the maker (note) or drawer (draft).
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
Negotiability – Contain an unconditional promise (note) or order (draft) to pay
No terms in separate instrument
If the payment is “conditional,” the instrument is not negotiable.
Negotiability – Be for a fixed amount of money
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
Negotiability – Be payable on demand or at a definite time
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
Negotiability – Be payable to order or to bearer, with the exception of checks
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
Negotiability – Contain no undertaking or instruction not authorized by the UCC
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)
Rules of Construction
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.
Non-Negotiable Instruments
No holder in due course
Treated as ordinary contract
– Transferees of instruments take it subject to any defense against payment a party might have
Article 3 Protection Requirements
To have Article 3 protection the instrument
1. must be negotiable
and
2. must have been transferred in a proper way
Negotiation
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
Negotiation – Endorsements
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
- Special or blank – This determines if the instrument will be order or bearer
- Restrictive or on restrictive
- 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
Negotiation – Special vs Blank Endorsements
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
Negotiation – Qualified Endorsements
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
Negotiation – Restrictive Endorsements
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
Becoming a Holder in Due Course
The second step to becoming an HTC is to obtain the paper “in due course” i.e. take the paper
- For value
- In good faith, and
- Without notice of any defenses to or claims of ownership on the instrument
Becoming a Holder in Due Course – Value
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
Becoming a Holder in Due Course – in Good Faith
Good faith = honesty in fact
Becoming a Holder in Due Course – Without Notice of any Defenses to or Claims of Ownership on the Instrument
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
Transactions Precluding HDC Status
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
Shelter Doctrine
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
Real Defenses
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
- Fraud in the execution
- Forgery of a necessary signature
- Adjudicated insanity
- Alteration of the instrument
- Infancy
- Illegality
- Duress
- Discharge in bankruptcy
- Suretyship defenses
- Statute of limitations
Real Defenses – Fraud in the execution
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
Real Defenses – Forgery of a necessary signature
Necessary signature
– Drawer’s or maker’s signature
– Endorsement of named payee
– Special endorsee
Real Defenses – Adjudicated insanity
Adjudicated insanity that under state law renders contract void from its inception, not just merely voidable
Real Defenses – Alteration of the instrument
Material alteration
Defense only to the extent of the alteration
Real Defenses – Infancy
To the extent it renders the contract voidable on the state law
Real Defenses – Illegality
Illegality that renders the underlying contract void
Real Defenses – Duress
Duress that renders an obligation to avoid
Real Defenses – Discharge in bankruptcy
And other discharges known to the HTC
Real Defenses – Suretyship defenses
To the extent the HDC knew prior to acquiring the instrument that the party was signing as a surety or “accommodation party”
Real Defenses – Statute of limitations
3 years after dishonor or acceptance for drafts
6 years after demand or other due dates on notes
Liability – Maker
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
Liability – Drawer
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
Liability – Drawee
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
Liability between Drawer & Drawee
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
Liability – Endorsers
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
Liability – Endorsers: Contract Liability
Endorse is secondarily liable if
- Instrument is presented for payment
- The maker or drawee dishonours, and
- 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
Liability – Endorsers: Warranty Liability
Any person, including endorsers, who transfers an instrument for consideration makes 5 warranties
- 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
- All signatures are genuine or authorized
- The instrument is not materially altered
- No defense of any party is good against the transferor
- 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
Liability – Accommodation Party
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
Liability – Effect of an Agent Signing
Principal liable for instrument signed by an authorized agent, even though principal’s signature does not appear on instrument
Liability – Effect of Forgery
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
Liability – Discharge
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
