An Outline for Cats, Written by Dogs

Commercial Paper

Maggs – Fall 2002

Part I – Enforcement of NIs

Introduction to Negotiable Instruments

  1. NI’s generally
  2. 2 Doctrines
  3. Merger Doctrine
  4. obligation is merged into the instrument itself
  5. destruction of an NI discharges it
  6. suspends obligations – only rights are rights on the instrument, not the underlying obligation
  7. Good Faith Purchaser Doctrine
  8. strips away defenses
  9. what distinguishes NI’s from ordinary contracts – modifies K rules of assignment
  10. 2 Types of NIs
  11. Promissory Notes (3-104(e) – an I is a note if it is a promise)
  12. Checks (3-104(e) – an I is a draft if it is an order)
  13. NI’s are a type of K
  14. if it’s not an NI, “HIDC” status doesn’t strip defenses
  15. 3 Qs M  P  H
  16. Is it a Negotiable Instrument?
  17. Is H a person entitled to enforce it?
  18. Can M assert any defenses against H? (ie is H a HIDC, which strips ordinary defenses?)?
  1. Formal Requirements of NI’s
  2. Negotiable Instrument Definition 3-104
  3. unconditional promise or order to pay fixed amount of money, w/ or w/o interest or other charges described on the promise or order IF
  4. it is payable to bearer or to order at the time it is issued or first comes into posession of a holder AND
  5. is payable on demand or at a definite time AND
  6. does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money
  1. Promise 3-103(a)(9) (promissory note)
  2. written undertaking to pay $ signed by the person undertaking to pay (NOT oral)
  3. an acknowledgement of an obligation by the obligor is not a promise unless the the obligor also undertakes to pay the obligation (NOT an IOU)
  1. Order 3-103(a)(6) (check)
  2. written instruction to pay $ signed by the person giving the instruction
  3. may be addressed to any person including the person giving the instruction
  4. authorization to pay is not any order unless the person authorized to pay is also instructed to pay
  1. Unconditional 3-106(a), (b)
  2. unconditional UNLESS
  3. there is an express condition to payment
  4. promise or order is governed by or subject to another writing (“subject to our K to sell property”)
  5. rights or obligations w/r/t the promise or order are stated in another writing (“pay an amount calculated by the formula in our K”)
  6. 3-106(b) - mere reference to another writing, as in home loans and mortgages (collateral, prepayment, acceleration), doesn’t make it conditional – just tells you that you may have some additional security above and beyond your claim on the NI
  1. Money 1-201(24)
  2. medium of exchange authorized or adopted by a domestic or foreign government and includes a monetary unit of account established by an intergovernmental organization or treaty ($ ¥ etc.)
  3. “I promise to deliver 100 books” is NOT an NI
  1. Fixed Amount 3-112 cmt 1
  2. nothing you can disagree about (ie NOT “the current value of my car”)
  3. applies only to principal, not interest
  4. can include things like collection costs including atty fees
  5. Taylor v. Roeder – Pre 1990 Revision of the UCC (Revision is NOT retroactive) - Taylor is paying on notes owed to VMC but doesn’t get VMC to surrender them, VMC assigns the notes to Pruitt, Taylor continues to pay VMC and pays off the notes. Pruitt (Roeder) forecloses b/c Taylor hasn’t paid him. Court says the note is NOT an NI b/c it contains a variable interest rate, and thus ordinary K law applies and Taylor was discharged by paying VMC b/c he had no notice of the assignment of the K
  1. Interest 3-112(b)
  2. can be fixed or variable amount or rate
  3. described in any manner, may require reference to info not in the document s/a “prime Chase Manhattan rate on the 1st of the Month”
  1. Payable to Bearer or to Order
  2. 3-109(a) payable to bearer if
  3. says payable to bearer or to the order of bearer or otherwise indicates that the person in possession is entitled to payment OR
  4. it does not state a payee OR
  5. states that it is payable to or to the order of “cash” or otherwise indicates that it is not payable to an identified person (“PTO Happy Birthday”)
  6. 3-109(b) payable to order
  7. payable to order if it is payable to an identified person
  8. “Magic Words” 3-104(c) “pay to” is sufficient on checks (dealing w/ designer check problems)
  9. otherwise, NI’s must say “PAY TO THE ORDER OF ______” (magic words for BOTH checks and promissory notes)
  10. argument -- “It’s not an NI because it says “pay to”, not “pay to the order of””  “Yes it is b/c “pay to” is sufficient on something that otherwise meets the definition of a check”
  1. Payable on demand or at a definite time
  2. demand instrument – usually checks
  3. time instrument – promissory notes or Cds
  1. Conspicuous Statement of Non-Negotiability 3-104(d)
  2. NOT an NI if it contains a conspicuous statement s/a “Non-Negotiable” at the time it is issued or first comes into the hands of a holder
  3. the resulting note is still a K and enforceable as such, just not an NI
  4. for those who don’t want their defenses stripped…
  5. doesn’t work on checks
  1. People and Actions
  2. People
  3. Maker 3-103(a)(5)
  4. person who signs or is identified as undertaking to pay
  1. Bearer
  2. person in posession of an instrument payable to bearer or indorsed in blank 1-201(5)
  3. payable to bearer 3-109(a)(1)
  4. payable to cash OR
  5. payable to bearer OR
  6. no payee named
  1. Payee
  2. person to whom instrument is initially payable
  3. cf. 3-110(a) – example of UCC’s non-use of word “payee”
  1. Holder
  2. in posession AND 1-201(20)
  3. payable to bearer OR
  4. payable to you
  5. how to become a holder
  6. have an I negotiated to you - 3-201(a) negotiation is the transfer of posession (by anyone but issuer), whether involuntary or voluntary, to a person who then becomes a Holder
  7. have an I issued to you
  1. Owner CL
  2. can intentionally transfer your rights on an I w/o negotiating it
  3. UCC doesn’t displace CL rules of property ownership
  4. there is no general rule of “finders keepers, losers weepers”
  1. Loser
  2. Loser entitled to enforce 3-309(a)
  3. if in posession and entitled to enforce when I was lost
  4. loss of posession not result of lawful seizure or transfer
  5. can’t reasonably recover b/c destroyed, whereabouts unknown, wrongful posession of an unknown/inaccessible person
  6. 3-309(b) must provide “adequate protection” to person paying the instrument (usually Lost Instrument Bond)
  1. Actions
  2. Deliver 1-201(14)
  3. voluntary transfer of possession (not loss or theft)
  4. Issue 3-105(a)
  5. first delivery of an NI
  6. by the maker / drawer
  7. whether to an H or nH
  8. for purpose of giving rights on the I to any person
  1. Negotiate 3-201(b)
  2. of an I payable to an identified person:
  3. transfer of posession AND
  4. endorsement by H
  5. of a bearer I
  6. transfer of posession alone
  7. whether voluntary or involuntary (loss/theft)
  8. purpose of negotiating an I is to make receiver a Holder
  1. Indorse
  2. signature by anyone other than maker/drawer 3-204(a)
  3. alone or w/ other words
  4. for purpose of negotiating, restricting payment, or incurring indorser liability
  5. indorsement in blank 3-205(b)
  6. creates a bearer instrument
  7. just signature – no person indicated
  8. can include restrictive words s/a “for deposit only”
  9. special indorsement 3-205(a)
  10. I becomes payable to identified person
  11. negotiated only by indorsement of that person
  12. special indorsement of a bearer I makes it not a bearer I any more
  1. Transfer 3-203(a)
  2. delivered (by other than issuer) w/ intent to give the other person the right to enforce
  3. 3-203(b) gives the transferee any rights the transferor had, including rights as a HIDC

Enforcement of Negotiable Instruments

  1. Enforce 3-301, 3-310(b) (force maker to pay the I)
  2. who can enforce? 3-301
  3. holder 1-201(20)
  4. even if you aren’t an owner
  5. even if you’re in wrongful posession
  6. non-holder in posession w/ rights of a holder 3-203(a)
  7. I transferred to them, but not negotiated
  8. “mere transferee”
  9. Losers
  10. person not in posession who is entitled to enforce under 3-309
  11. to enforce you must show 3-308(b)
  12. validity of signatures – Cmt 1
  13. admitted unless specifically denied in the pleadings
  14. presumption of validity – ∆ must present evidence that sig is invalid (if no evidence presented,  wins)
  15. you are a person entitled to enforce (H, nonholder in posession w/ rights of a holder, loser)
  16. if loser, this entails showing chain of posession and providing adequate protection
  17. MORAL – its good to be a holder b/c easier to enforce (just present the I and rest – if ∆ produces nothing, you win)
  1. Presentment 3-501(a)
  2. demand to pay the I made by/on behalf of a person entitled to enforce
  3. 3-501(b)(2) on demand of the Presentor, the person presenting must
  4. exhibit the I
  5. give reasonable ID (and showing of authority if applicable)
  6. sign receipt on I for any payment made or surrender I if paid in full
  7. Presentment Warranties 3-417(a), 4-208(a)
  8. When presenting an item for payment, you make 3 warranties
  9. Presenter is a person entitled to enforce
  10. if forged endorsement, NO ONE is entitled to enforce
  11. if forged drawer’s /s/, person is entitled to enforce (against forger, not against person whose name was forged)
  12. draft has not been altered
  13. Presenter has NO KNOWLEDGE that /s/ of Drawer is unauthorized
  1. Payment & Discharge 3-602(a)
  2. payment to person entitled to enforce discharges liability on the I
  3. pay the wrong guy – no discharge
  4. get discharge even if you know there is a competing ownership claim
  5. Exceptions 3-602(b) – no discharge IF
  6. payment prohibited by injunction
  7. you KNOW the instrument was stolen
  8. Lambert v. Barker – Barker and Harwood pay off a promissory note to Davis, after Davis pledged the note as collateral to Lambert, b/c Davis claims he “lost it”. Lambert then seeks payment from the Harwoods. If an ordinary K, Harwoods would be discharged by paying Davis b/c they were never notified of the assignment to Lambert. B/c it’s an NI, they didn’t discharge their obligation b/c they paid someone not entitled to enforce. (Harwoods should’ve insisted on lost instrument bond).
  1. RESPA – if you have a residential mortgage, and your bank transfers it to another bank, the transferee must give you notice of the change and you get discharge for all payments made to the transferor until you get the notice

Holders in Due Course

  1. Holder in Due Course Doctrine – strips defenses
  2. Holder in Duc Course 3-302(a)
  3. Holder
  4. takes the I for value
  5. in good faith
  6. no notice that NI is overdue/altered, that sig’s are unauthorized, or of other claims or defenses
  7. no notice when takes the note – can find out later and still be HIDC
  8. “reason to know” – actual OR constructive
  1. HIDC’s take free of claims and defenses except real defenses
  2. Takes free of competing ownership claims 3-306
  3. Miller v. Race – Bank of England draft “to Finney or bearer” is stolen by a thief who uses it to pay Miller, an innkeeper for services/goods. Miller presents it to Race, the bank clerk. Lord Mansfield says that Miller owns the note, and is not subject to competing ownership claims, because he took it for value in good faith and w/o notice of problems. W/o this rule, no one would want to take banknotes as currency.
  1. Takes free of all defenses except “real defenses” 3-305
  2. the real defenses 3-305(a)(1) – can be asserted against both H’s and HIDCs
  3. infancy of obligor
  4. duress
  5. illegality of transaction
  6. incapacity
  7. fraud in the factum
  8. insolvency
  9. regular K defenses 3-305(a)(2) – can be asserted against H’s, NOT against HIDC’s
  10. 3 most common = fraud in the inducement, lack of consideration, failure of the consideration
  11. claims in recoupment 3-305(a)(3) – can be asserted against H’s, NOT against HIDC’s
  12. claim that maker has against payee arising out of the same transaction (ex- defective goods)
  1. Example 1 – Claims in Recoupment

“PTO B $1000” “B”

A  B  C



goods $

  1. A’s claim against B = $600 for breach of warranty
  2. can A assert claim against B?
  3. YES if claim arises from same transaction as the note
  4. if C is NOT a HIDC (ex – if C knew of the problem when she took the note), how much can C recover from A?
  5. only $400
  6. if C IS a HIDC?
  7. all $1000
  1. Example 2 – Claims in Recoupment

“PTO Merchant $10K” “Merchant”

PlumberMerchantFinance Co.

 

goods $

  1. Plumbers claim against Merchant
  2. $8000 for plumbing work (unrelated counterclaim asserted in the litigation)
  3. $4000 for defects in the goods (recoupment claim)
  4. how much can M get from P?
  5. M can recover NOTHING

M has $10K in claims

P has $12K in claims

  1. how much can Finance Co recover?
  2. if FC is an H = $6K ($10K -$4K recoupment claim)
  3. if FC is an HIDC = $10K ( HIDC takes free of claims in recoupment)

not subject to unrelated claims

  1. Shelter Doctrine 3-203(b) + cmt 2
  2. whatever rights you have on an I, you can give or sell to someone else, including your rights as a HIDC
  3. Exception – transferee can’t get rights of a HIDC if transferee engaged in fraud/illegality w/r/t the I (can’t money launder using the Shelter Doctrine)
  4. cmt 2- reason for the Shelter Doctrine is to ensure HIDC has a free mkt for the I
  1. How to be a HIDC - took for value, w/o notice and in good faith
  2. NO APPLICATION TO ORIGINAL PARTIES TO THE TRANSACTION (ie the payor/drawer and payee)
  1. 3-302 Holder in Due Course means the holder of an instrument if:
  2. the instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alteration or is not otherwise so irregular or incomplete as to call into question its authenticity AND
  3. the holder took the instrument
  4. for value
  5. in good faith
  6. w/o notice that the I is overdue or has been dishonored or that there is an uncured default w/r/t payment of another instrument issued as part of the same series
  7. w/o notice that the I contains an unauthorized signature or has been altered
  8. w/o notice of any claim to the I described in 3-306 (property or possessory right including claim to rescind the negotiation)
  9. w/o notice that any party has defense or claim in recoupment described in 3-305(a) (real defenses, ordinary defenses, claims in recoupment)
  1. Overdue and Irregular I’s
  2. Irregular 3-302(a)(1)
  3. Overdue – does NOT mean its not enforceable, just that defenses can’t be stripped in favor of a HIDC
  4. checks 3-304(a)(1), (2)
  5. Dishonor of checks 3-304(a)(1) - overdue on the day after demand for payment is duly made (check is a demand I)
  6. When a check is dishonored, 3 options (payee gets check back so they can be a holder and sue on the I)

call payor to get payment

wait and present the check again

send the check to a collection agency

  • bank marks dishonored (bounced) checks “NSF” in red to give notice that the check has been presented and is thus overdue (collection agencies are never HIDCs for this reason)

stamp makes sure no one can ever be a HIDC – otherwise wouldn’t know that it had been presented and payment refused

  1. (a)(2) checks are otherwise overdue 90 days after its date
  1. Demand notes 3-304(a)(1), (3) (Miller v. Race – “PTO Finney or bearer”)
  2. (a)(1) – overdue day after demand for payment is duly made
  3. (a)(3) – if the I is NOT a check, when the I has been outstanding for a period of time after the date which is unreasonably long under the circumstances (in light of nature of I and usage of trade)
  4. Notes payable at a definite time
  5. in installments 3-304(b)(1)
  6. Note is overdue while in default (until cure), or once it has been accelerated
  7. Definitions

default – you miss one payment

arrears – how much you owe in back $

cure – payment plus interest or fee

 acceleration – pay entire amt. immediately (may be required by terms of the note after in default for a certain period)

  1. lump sum 3-304(b)(2)
  2. overdue the day after its due date
  1. Period of Limitation
  2. When the I becomes unenforceable
  3. 3-118(a) – notes – w/in 6 yrs after stated due date or date of acceleration
  4. 3-118(c) – checks – 3yrs after dishonor, or 10 yrs after date of draft
  5. what if check says “void after 180 days”? obligation is still enforceable, just an instruction to bank not to pay, usually they pay anyway
  1. Example – S issues note to B for $6500 to cover potential problems w/ house payable in 75 days; they have a side agmt the if repairs cost less than $6500, S will pay only the actual expenditures. Actual expenditures = $4200. B sells note to  for $3000 5 months later. How much can  recover?
  1. if  is HIDC, he can get $6500 (the additional agreement is a defense that gets stripped)
  2.  took in good faith and for value BUT it was overdue (more than 75 days had passed), so  is not a HIDC and can only recover $4200
  3. S shouldn’t have issued this note – should’ve made an ordinary K instead
  1. Example – Maker issues note to Payee. Payee gives note to Bank only for them to collect payments while Payee is at war, indorses it in blank at Bank’s insistence. Maker stops paying, Bank sells the note to Purchaser. Purchaser knew that 4 payments had been missed, but didn’t know about the circumstances by which Bank acquired note. Payee comes back and sues Purchaser to reclaim the note.
  1. Payee has a 3-306 claim for ownership of the note
  2. if Purchaser is a HIDC, Payee cannot reclaim the note
  3. Purchaser took for value, in g.f., is a holder BUT note was overdue b/c maker had defaulted at time of purchase
  1. Value
  2. Defined
  3. 3-303(a)(1) HIDC bought the I
  4. promise of performance to the extent it has been performed
  5. merely promising to pay isn’t enough – need to actually pay before value is given
  6. 3-303(a)(3) HIDC took I as payment for a debt
  7. giving up a claim to the underlying obligation for a claim on the I
  8. NOT receivers of gratuitious transfers, finders, thievcs
  9. must get the value before you get notice, act in bad faith, whatever else might make you not a HIDC
  10. Consideration 3-303(b)
  11. VALUE is needed to be a HIDC (and is also sufficient as consideration)
  12. CONSIDERATION is a defense someone liable on a note might make
  13. executory promise can be consideration, but never value (until it is performed)
  14. “partial” HIDC status 3-302(d) + cmt 6
  15. Holder may exert rights of a HIDC to the extent of % he’s paid
  16. Ex – Note for $1000 by Maker to X, H agrees to buy it from X for $900 (at a discount), he pays X $600, Maker calls H and asserts a defense, how much can H recover? 600/900 = 2/3 = 66%, 66% of $1000=$660 (If M had no defenses, H could’ve collected the entire amount $1000)
  1. Application of “VALUE” to Depositary Banks
  2. Depositary Bank
  3. 4-105(2) – Depositary Bank is the first bank to take an item (even if it is also the Payor bank) unless the item is presented over the counter for immediate payment
  4. Options for dishonored checks – what rights if you deposit a check and it is returned to Depositary Bank unpaid?
  5. revoke credit given to depositor 4-214(a)

if they give provisional credit and don’t get paid for it, can charge back or get refund from the customer

must act by midnight deadline after they get notice of dishonor from Payor bank or reasonable time thereafter

(1)if longer, must pay damages caused to Payee

may be impractical for bank if no $ in acct

  • enforce check against Drawer 3-301

Can Bank enforce the I? – YES, holder

(1)4-205(1) bank automatically becomes a holder when you deposit the check, whether or not you endorse

Can Drawer assert any defenses against the Bank? – Bank can be a HIDC if 3-302 is met – NEED TO GIVE VALUE

  1. 4-211 – Bank gives value to the extent it has a security interest in the item
  2. Security Interest in Deposited Checks
  3. banker’s lien (CL)
  4. by agreement w/ customer (Art 9)

Bowling Green v. State Street Bank – BG uses check to pay BowlMor for equipment, BM deposits the check in SSB (knowing they will never deliver) and goes b.r. BG sues SSB alleging check is held in constructive trust b/c BM acted fraudulently. SSB says it’s a HIDC so no defenses. BG says not a HIDC b/c they gave credit for the check AFTER they knew BM was in b.r. (notice of possible defense). Ct says they got a Security Interest before they made the credit b/c they had an Agreement w/ BM!