Commercial Papers Outline

I. Overview Note- Instrument in which a party promises to pay money to a designated party Maker- person promising to pay the note Payee- person designated to receive money from note Draft- Instrument in which a party orders another party (often a bank) to pay money to a third party Drawer- creator of instrument ordering payment Drawee- party (often a bank) ordered to pay the money Payee- person designated to receive money Holder in Due Course- if i) an instrument meets the technical requirements of negotiability ii) it is transferred so that a negotiation occurs and iii) a bona fide purchaser pays value for the instrument without notice of claims or defenses to it, the purchaser becomes a holder in due course The HDC may sue prior parties who are liable on the instrument but those parties have no defenses, with a few exceptions, against the HDC. Prior parties must simply pay the HDC. If the transferee of the instrument doesnt qualify as an HDC, the transferee is merely the assignee of a contract, and takes the instrument subject to all valid claims and defenses to it. II. Negotiability The extensive protection afforded to buyers of commercial paper, and applies only when the instrument in question is negotiable No HDC status in nonnegotiable instruments. A negotiable instrument is an instrument capable of transfer by endorsement or delivery. Negotiability provides a means of passing on to the transferee the rights of the holder, including the right to sue in his or her own name, and the right to take free of equities as against the assignor/payee.

Elements of Negotiability: 3-104 (a) A) Writing- A negotiable instrument cannot be oral. The written contract does not need to be real formal and doesnt have to be on paper (electronic) B) Signed Any mark or symbol place on the instrument (or already there and subsequently adopted) by the maker or drawer with the intent to authenticate the writing constitutes a signature. *A full formal signature is not required if the requisite intent to authenticate was present. 1-201 (39) There has to be an intention to authenticate, can use symbol, stamped or written 3-401 (a)- not liable on a instrument unless you sign, or an agent signs on your behalf 3-401 (b)- a signature may be made manually or by means of a device or machine and by the use of any name, including a trade or assumed name, or by a word, mark, or symbol executed or adopted by a person with present intention to authenticate a writing The name of the maker or drawer may be placed on an instrument by an authorized agent. The maker or drawer is bound even if he signs with an assumed name or a trade name. (ex. Alice is the sole proprietor of Carroll Books and signs all the stores checks Carroll Books Alice is nevertheless bound on the checks just as if she had signed her own name. Forged signatures are unauthorized signatures and the persons name who is fraudulently signed is not liable on the instrument unless he ratifies the signature or is precluded. The unauthorized forger is liable to the instrument as if he had signed his own name. C) Unconditional Promise to Pay A note must contain an unconditional promise to pay and a draft must contain an unconditional order to pay to be negotiable Promise means undertaking to pay Order means more than authorization to pay, this is ordering the drawee to pay * Implied or constructive conditions in the instrument do not destroy negotiability. Must have an express condition to destroy negotiability

Mere reference to or description of agreements or other writings does not affect negotiability An incorporation of other matters into an instrument makes the instrument nonnegotiable Ex. Note stating this instrument is subject to the terms of a separate contract makes the note nonnegotiable. An instrument that states that it is executed or matures in accordance with another contract or as per another contract is negotiable, these two phrases constitute a mere reference to other matters, rather than an incorporation of such matters. Incorporation of Pre Payment or Acceleration clauses from other instrument are not considered an express condition and do not destroy negotiability 3-104 (a) (3)You can put in a few things in a negotiable instrument- 3-104 (a) (3) can have a 1) security agreement to protect collateral, A statement in an instrument that the underlying obligation is secured and describing, but not incorporating, the collateral and security agreement, does not affect negotiability Instrument may state that the collateral has been given as security for repayment of the obligation, also may have a clause providing that upon default the holder ma foreclose on the collateral The instrument can contain the coupling of an Article 9 security interest with an Article 3 note 2) waiver of right, Can have clause in negotiable instruments that waive certain laws. 3) authorization or power to the holder to confess judgment or realize on or dispose of collateral 3-106 (a): A promise or order is unconditional unless it states: 1) an express condition to payment then instrument is not unconditional 2) that the promise or order is subject to or governed by another record 3) that rights or obligation with respect to the promise or order are stated in another record

3-106 (a) allows the instrument to mention the details of the underlying contract without destroying negotiability as long as payment of the note is not made subject to the performance of that contract. (ex. I have rented the Music Hall and I promise to pay $800 to the Music Hall, this mentions the contract but makes no conditions so its fine. 3-106 (a) last sentence permits a refernce to the underlying contract, though an incorporation of the terms of the contract, (without restating them in the note itself) would be fatal to negotiability. If something is void after a certain period of time then there is a condition and it destroys negotiability, but courts have said that it is negotiable

D) Fixed Amount of Money Absolute certainty as to the sum due at all times is not required. It is sufficient if, as of any particular time, the amount due on the instrument may be mathematically computed. The fixed amount may include interest or other charges. Have to tell the party how much you are going to pay. Ex. Im going to pay $100,000 with 3% interest 3-112: Can have fix or variable interest rate If a note merely states that it is payable with interest but does not state the intrest rate, the not is still negotiable. The state judgment interest rate will be implied.

E) Courier without Luggage (no other promise requirement) With certain exceptions, the instrument must not state any other undertaking or instruction by the person promising or demanding payment to do any act in addition to the payment of money. Ex. A promise to pay $500 and deliver a quantity of goods, this makes the instrument nonnegotiable. Requiring some act to be doen in lieu of payment of money destroys the negotiability of the instrument Ex. A promise to pay $500 or to deliver goods, which ever is requested. This would be nonnegotiable.

F) On Demand or at a Definite Time Unless it can be determined from the face of the instrument when, or at least upon what events, the obligation will become due, the instrument is not negotiable. There is no requirement that the instrument be dated at the time signed. We do have to know when payment is due An instrument is payable on demand if it is expressly made so payable, if words similar import are use (at sight, upon presentation) An undated instrument that specifies no time of payment is treated as an instrument payable on demand by the holder (3-108 (a) (ii) ) Outside of a check, if a note doesnt have a date on it, then it is not a demand instrument and is not negotiable. Only check or a document named a demand instrument will fall under 3-108 (a) (ii) An instrument payable at a definite time in the future is referred to as a time instrument An instrument is payable at a definite time if it is payable i) on a fixed date ii) on or before a fixed date iii) at a time readily ascertainable when the instrument is issued, or iv) after elapse of a specified period after sight (this is different than payable at sight) Ex. A) Payable 30 days after sight, this is acceptable can have a elapse of a definite period of time after sight 3-108 (b) Acceleration clause: language that makes payment in the future, have the option to payment right now. Can have an Acceleration clause on insecurity , acceleration clauses are very open. Acceleration clauses are fine with negotiability Ex. Payable when the sun comes up tomorrow, this is not negotiable because we have no date, if we had a date then this would be fine Extension of payment agreement has to be specifically set to a certain event or to a definite future time. Ex. Payable 100 years from today, but if my uncle dies before that, instrument shall become payable 10 days after death. This is fine there is a definitive date 100 years after today, and there is an acceleration clause (if uncle dies before the 100 years is up)

Ex. Payable on my next birthday, this wouldnt work because it doesnt state when the birthday is on the instrument. G) Payable to the Order or to the Bearer The basic definition of negotiability requires that the instrument be payable either to the order or to the bearer. Order Paper- names a specific payee and requires the payees indorsement for further negotiation An instrument is payable to order when it is drawn payable to the order of an identified person Must have the pay to the order of except in the situation of checks, you dont need the wording pay to the order of when it comes to checks.

Bearer Instrument: instrument names no specific payee and can be transferred without indorsement, just like cash an instrument is payable to bearer only if it is drawn payable i) to bearer ii) to a specified person or bearer (ex. Pay to John Doe or bearer), or iii) to cash, the order of cash or any other indication that does not purport to designate a specific payee Ex. Pay to John Smith. This doesnt have pay to order language in the instrument so it is not negotiable. However this rule does not apply to checks Ex. Pay to John Smith or Bearer. This is a bearer instrument Ex. Pay to the order of cash. This is a bearer instrument 3-109 (a) (3). Ex. Pay to a Merry Christmas. This is a bearer instrument, language of payment to and there is an unidentified person then its a bearer instrument 3-109 (3)

* If an instrument is made payable both to order and to bearer (ex. Pay to the order of John Jones and bearer) the bearer language controls

Special and Blank Indorsements 3-205 (a): Special Indorsement If a payee wishes to preserve the instrument as order paper, the original payee must specify the new payee by writing PAY (name of new payee) above the indorsement. This is known as a special indorsement Words of negotiability (i.e. pay to the order of) are not required in an indorsement, thus the lack thereof does not affect the negotiability of the instrument 3-205 (b): Blank Indorsement: The payee can simply sign the back of the instrument, such signature is called a blank indorsment and has the legal effect of converting the instrument into bearer paper When indorsed in blank, an instrument becomes payable to bearer and may be negotiated by transfer of possession alone until specially indorsed 3-205 (c): Converting Blank Indorsement into Special Indorement The holder may convert a blank indorsement that consists only of a signature into a special indorsement by writing, about the signature of the indorser, words identifying the person to whom the instrument is made payable

III. NEGOTIATION 3-105 (a) Issue: An issue is the first delivery of an instrument by the maker or drawer to a holder or a remitter 3-201(a) Negotiation: process by which an instrument is transferred by a person other than the issuer to a subsequent party who qualifies as a holder 3-201(b) Except for negotiation by a remitter, if an instrument is payable to an identified person, negotiation requires 1) transfer of possession of the instrument and 2) its indorsement by the holder. If an instrument is payable to bearer, it may be negotiated by transfer of possession alone 1-201 (b) (21) Holder: the person in possession of a negotiable instrument, that is payable either to bearer or to an identified person that is the person in possession; or To be a holder there must be a negotiation on the instrument In order to be a holder, the person who gives you the paper must be a holder as well.

Once a person is not a holder subsequent people with the instrument will not be holders 3-203 Transfer: delivery by a person other than the issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument Remitter: person who makes payment using an instrument created by someone else (ex. A bank cashiers check drawn up at the request of a customer and sent to a creditor) 3-301 Person Entitled to Enforcement: Person entitled to enforce an instrument means, the holder of the instrument. However, there are situation where a person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument

Negotiation Process 3-205 Indorsement: a) "Indorsement" means a signature, other than that of a
signer as maker, drawer, or acceptor, that alone or accompanied by other words is made on an instrument for the purpose of (i) negotiating the instrument, (ii) restricting payment of the instrument, or (iii) incurring indorser's liability on the instrument, but regardless of the intent of the signer, a signature and its accompanying words is an indorsement unless the accompanying words, terms of the instrument, place of the signature, or other circumstances unambiguously indicate that the signature was made for a purpose other than indorsement For the purpose of determining whether a signature is made on an instrument, a paper affixed to the instrument is a part of the instrument.

* An indorsement must be written on the instrument, if the indorsement is written on a paper affixed to the instrument then that will be enough to be considered written on the instrument. Bearer Paper: Anyone in possession of a bearer instrument is a holder thereof. Possession makes the holder entitled to enforce the instrument Order Paper: the named payee becomes a holder upon acquiring possession of the instrument. Before a subsequent transferee can acquire title, the payee must indorse the instrument and surrender possession to the transferee A person will not be entitled to enforce an order instrument unless the payees indorsement is authorized and valid. Forging the payees name prevents further negotiation, and no subsequent possessors of the instrument can qualify as holders, nor a person entitled to enforce the instrument. * There are certain situation discussed later where an unauthorized signature can be made effective under principles of ratification and estoppel The forgery of the payees name is treated as if the forger had signed his own name. The forger will be liable on the instrument, but still the instrument has not be negotiated.

3-110 (d) Multiple Payees: An instrument may be made payable to more than one payee. If the names on the payee line are connected by or or and/or the instrument is payable to the payees alternatively and the valid indorsement of any one of them is sufficient to pass title to a subsequent transferee If there is some ambiguity as to if both signatures are need, courts usually will allow 3110 (d) to be applied If their names on the payee line are connected by an and, the instrument is payable to them jointly and any subsequent negotiation is effective only if all indorse the instrument If the note states John and Mary, this isnt in the alternative so 3-110 (d) doesnt apply and you have to have both sign If the instrument has been indorsed several times, some specially and some in blank, the last valid indorsement controls what is necessary for further negotiation. 3-204 (d) Instrument Payable to Holder Under Wrong Name: If an instrument is payable to a holder under a name that is not the name of the holder, indorsement may be made by the holder in the name stated in the instrument or in the holder's name or both, but signature in both names may be required by a person paying or taking the instrument for value or collection. Ex. If the persons name is Sue Moot and the Check says Sue Moort, Sue could sign either her actually name or the name on the paper. If the name is to far off then 3-204 (d) wont apply. If there is not indorsement then the transferee cannot negotiate the instrument. 3-203 (c) Transferee Pays for Value but Instrument is not indorsed by Transferor: If the transferee paid value for the instrument, the transferee has the specifically enforceable right to have the unqualified indorsement of the transferor. The transferee would still have to sue in equity for a decree ordering the transferor to indorse If a transferee gets an instrument with out the transferors indorsement, he is not a holder with a right to enforce, but if the transferee does obtain transferors signature later than he will get holder status and have a right to enforce the instrument. *In determining if a transferee had notice of any adverse claim or defense to the instrument, the transferees knowledge is measured at the time the transferee obtains the missing indorsement. If a transferee finds out about a claim between the time of paying for and obtaining possession of the instrument and the time the missing indorsement is obtained, the transferee cannot qualify as a Holder in due course.

3-203 (d) Indorsement of Partial Interest: if the transferor purports to transfer only part of an instrument, no negotiation occurs. An indorsement that attempts to convey less than the complete amount of the instrument is not a negotiation and the transferee does not qualify as a holder Ex. Drawer draws a check payable to Paula, Paula indorses it and makes a special indorement stating, pay George 2/3 and Martha 1/3 of check. This is not negotiable. Different Indorsement Rules for Banks 4-205 DEPOSITARY BANK HOLDER OF UNINDORSED ITEM: If a customer delivers an item to a depositary bank for collection: (1) the depositary bank becomes a holder of the item at the time it receives the item for collection if the customer at the time of delivery was a holder of the item, whether or not the customer indorses the item, and, if the bank satisfies the other requirements of Section 3-302, it is a holder in due course; The depository bank warrants to later parties that the check was paid to the customer or deposited into the customers account. In effect this is a warranty that the money got to the right place, and puts the risk that it did not on the depository bank. Ex. A bank taking a check that was jointly made to two people and only one person signs, the bank is liable for conversion to the one person who didnt sign.

IV. Holder in Due Course 3-302 Holder in Due Course: i) a holder who takes the instrument ii) for value iii) in good faith, and iv) without notice that it is overdue or has been dishonored, or of any defense against or claim to it on the part of anyperson A prerequisite to being a HDC is that there instrument must be negotiable (3-104) and there is a valid negotiation (3-201)

Elements of Holder in Due Course 1) Holder- See Negotiability and Negotiation 2) For Value 3-303 Value: (a) An instrument is issued or transferred for value if: (1) the instrument is issued or transferred for a promise of performance, to the extent the promise has been performed; (2) the transferee acquires a security interest or other lien in the instrument other than a lien obtained by judicial proceeding; (3) the instrument is issued or transferred as payment of, or as security for, an antecedent claim (the person giving the note already owed money to transferee/holder) against any person, whether or not the claim is due; * you can only get the value of the antecedent claim (can include interest), cant get more than the antecedent claim (4) the instrument is issued or transferred in exchange for a negotiable instrument; or (5) the instrument is issued or transferred in exchange for the incurring of an irrevocable obligation to a third party by the person taking the instrument. * value is not consideration, there must be actual value (have you done whatever you said you were going to do), no promises. The service must have already been performed. Ex. If lawyer says Im going to represent you and the client gives the lawyer a note, the lawyer has not given value since he has not yet represented his client * Value is only important to see if there is holder in due course status Zach bought a car signing a promissory note for $23,000 to Fillmore, Fillmore sold the note to the Pierce for $22,800, is Pierce a holder in due course for $23,000 or $22,800? Pierce is a holder in due course for $23,000, the promise was performed, they just gave Fillmore a discount rate to get the money right now. If the discount payment was like only $10,000 then it might not work. B) Fillmore owed his mother $21,000 and gave her the note with the understanding that the extra $2,000 was a gift. Would the mother be a holder in due course for the full amount. Under 3-303 (a) (3) Fillmore owed a antecedent of $21,000 to his mom. SO

that $21,000 would be considered value but that is all that his mom would be a holder in due course for. The other $2,000 the mom would have to go to court Special Rules for Banks in Regards to Value This is when an instrument is negotiated to a bank (that is not the drawee) as part of the collecting process, and the bank credits the depositors account accordingly 4-214 Crediting Depositors Account: Merely crediting the depositors account is not value 4-210 Permitting Withdrawals from depositors account (a) A collecting bank has a security interest in an item and any accompanying documents or the proceeds of either: (1) in case of an item deposited in an account, to the extent to which credit given for the item has been withdrawn or applied The bank has a security interest whenever it has permitted precollection (depository bank hasnt received money from the drawee bank yet) withdrawal for the depositing customer 4-211. WHEN BANK GIVES VALUE FOR PURPOSES OF HOLDER IN DUE COURSE For purposes of determining its status as a holder in due course, a bank has given value to the extent it has a security interest in an item, if the bank otherwise complies with the requirements of Section 3-302 on what constitutes a holder in due course. Any time the collecting bank has a security interest in the item being collected, the bank has given value *This works in relation with 4-210, and allows a banks security interest in precollection withdrawals to be value, if it meets all the other requisites then the bank can be a HDC for the money that was allowed to be withdrawn 4-210 (b) If credit given for several items received at one time or pursuant to a single agreement is withdrawn or applied in part, the security interest remains upon all the items, any accompanying documents or the proceeds of either. For the purpose of this section, credits first given are first withdrawn. Ex. If Tom deposits a check for $1,000 and there is already $500 in the bank, if that check for $1,000 is bad and Tom takes out $500, the bank is not a holder in due course for that $500 because of the First in, first out. However if Tom then drew out another $200 that the bank credited before finding out the check was bad, the bank would be a holder in due course for the $200. This is the First In, First Out rule

3) Purchas in Good Faith Good Faith 1-201 (19) and 3-103 (a) (4): means honest in fact in the conduct or transaction concerned. 3-301 (a) (4) also puts the requirement of commercially reasonable standards of fair dealing Holder is under no duty to inquire as to possible defenses, such as failure of consideration, unless the circumstances of which he has knowledge rise to the level that the failure of the inquire reveals a deliberate desire on his part to evade knowledge because of a belief or rear that investigation would disclose a defense arising from the transaction. Look for relationships between breaching party and 3rd parties, if there is a close relationship and the third party doesnt inquire about defenses there could be a good faith violation.
3-307 (b) If (i) an instrument is taken from a fiduciary for payment or collection or for value, (ii) the taker has knowledge of the fiduciary status of the fiduciary, and (iii) the represented person makes a claim to the instrument or its proceeds on the basis that the transaction of the fiduciary is a breach of fiduciary duty, the following rules apply:

If the taker (bank) knows that the person giving check has a fiduciary duty to another entity (usually a company) and that person uses the company note to pay a personal obligation, which the company has not allowed and it breaches a fiduciary duty, then the bank is not a holder in due course and the company can get their money back. The fiduciary relationship must be known or should have been known by the bank in order for the bank to lose there holder in due course status. (ex. A company check paying a persons personal bill isnt apparent that this would violate a fiduciary duty with the company). A holder must act in a way that is fair according to commercial standards that are themselves reasonable Can look to industry for standards.

4) Without Notice Without Notice 3-302 (a) (2) (iii): The Holder must purchase the instrument without notice (knowledge or reason to know) that it is overdue, or has been dishonored, or of any defense against or claim to it on the part of any person. If the purchaser of the instrument acquires the instrument with reason to know that it is already overdue, the purchaser cannot be a HDC

Existence of Default Notice that any part of the principal amount is overdue, or that there is an uncured default in payment of another instrument of the same series prevents HDC status Instruments Payable on Demand 3-304 (a): Demand instruments become overdue 1) on the day after the day demand for payment is duly made 2) Check becomes overdue 90 days after its date 3) Other Instruments (promissory notes) that are demand instruments becomes overdue when the instrument has been outstanding for a period of time after its date which is unreasonably long Instruments payable at a definite time 3-304 (b): instruments at a definite time become overdue 1) When the principal is paid in installments, the instruments becomes overdue for non payment of an installment 2) If instrument is not payable in installments, the instrument becomes overdue on the day after the due date 3) If a due date with respect to principal has been accelerated, the instrument becomes overdue on the day after the accelerated due date Default in Interest Payments 3-304 (c): Unless the due date of principal has been accelerated, an instrument does not become overdue if there is default in payment of interest but no default in payment of principal. * Knowledge of the obligors default in payment of other obligation or instruments does not prevent HDC unless the instruments were of the same series

Notice of Dishonor of an Instrument * If the purchaser acquires the instrument with reason to know that it has been dishonored, the purchaser cannot qualify as a HDC Dishonor occurs when the instrument is returned after presentment without payment or acceptance within the allotted time.

Notice of Defenses and Claims If the purchaser acquires the instrument with reason to know of defenses or claims to the instrument, the purchaser cannot qualify as a HDC

Time When notice received as affecting HDC status 3-302 (f) Notice to the purchaser must have been received in such a manner and within such time as to afford the purchaser a reasonable opportunity to act upon it. Notice after purchase of the instrument does not affect HDC status Purchasers good faith and notice are measured as of the time the purchaser acquires and gives value for the instrument as a holder Ex. If the purchaser of instrument doesnt get transferors indorsement, he is not a holder until he gets indoresment. So if he obtains notice of default or defense before getting the indoresement then he cannot be a HDC Whether a holder qualifies as a HDC is determined as of the moment that the instrument is negotiated to the holder and/or the holder gives value thereof, which ever occurs later If the transferee of a negotiable instrument acquires notice of a claim or defense to the instrument prior to either negotiation or the giving of value the transferee cannot be a HDC Notice to purchaser where instrument incomplete or irregular (Red Light Doctrine) Apparent evidence of forgery or alteration or is otherwise so irregular or incomplete as to call into question its authenticity, knowledge of potential defenses or claims is imputed to the purchaser, and the purchaser cannot be a HDC * Someone writing 2007 and crossing off the 7 and putting an 8 is not so irregular because people do it all the time. It has to be something very irregular to but someone on notice.

If and omission or alteration would raise a question as to the bona fides of the instrument then there is imputed knowledge to the purchaser

Closed Eyes Doctrine 1-201(25) (c) Mere grounds of suspicion are not enough to constitute notice, a purchaser cannot ignore the obvious or purposefully avoid finding out the truth. A person is charged with notice of any fact if from all of the facts and circumstances known to the person at the time in question he has reason to know that such fact exists

Forgotten Notice 1-201 (25) Holders who have received notice of a claim or a defense may nevertheless achieve HDC status if, at the time the holder acquires the instrument, the holder has forgotten about the earlier information. If sufficient time has passed between time of notice and the acquisition of the instrument

Miscellaneous Factors for notice If there is a very large discount rate with other suspicious circumstances this may lead courts to believe that there was a lack of good faith or notice Notice of usury: if there is a note that is worth a lot of money and it is sold at a very discounted price, this should bring up a red flag and the person buying the note should inquire about why the note is so cheap. If the holder doesnt inquire about this they will not be a holder in due course

Payee as HDC 3-302 Comment 4 Ex. Alex and Beth sign a note as co-makers. Alex by fraud induces Beth to sign and, without authority from Beth, delivers the note to Payee, who takes it for value, in good faith, and without notice. Alex defrauds the maker into signing an instrument payable to Payee. Payee pays Alex for it in good faith and without notice, and the maker delivers the instrument directly to Payee.

Successor To Holders in Due Course (Shelter Rule) Shelter Rule (Common law)- It is basic rule of commercial law that a transferee acquires whatever rights the transferor had. The transferee is said to take shelter in the status of the transferor.

UCC Shelter Doctrine 3-302(b): Transfer of an instrument, whether or not the transfer is a negotiation, vests in the transferee any right of the transferor to enforce the instrument, including any right as a holder in due course, but the transferee cannot acquire rights of a holder in duce course by a transfer, directly or indirectly, from a holder in due course if the transferee engaged in fraud or illegality affecting the instrument

This allows any transferee to step into the shoes of the HDC who formerly held the instrument and to obtain the rights of an HDC, even though the transferee otherwise clearly fails to meet requirements of due course holdings (ex. Didnt give value or was aware of claims or defenses) Ex. Harry holds a promissory note in which he is the holder of, Harry is a qualified HDC. Harry gives the note to his son as a gift. The son would not qualify as a HDC because it was a gift and the son gave no value. However, due to 3-302(b) shelter doctrine, the son is a HDC as well. Underlying reason of the shelter rule is to protect the free negotiability of commercial paper. Once the instrument comes into the hands of an HDC, defenses that could not be asserted against the HDC cannot be allowed against any transferee. Otherwise the obligor could, by putting all potential transferees on notice of claimed defense, vastly restrict the HDCs market for the instrument and thereby interfere with the free passage of commercial paper.

Parties of Fraud or Illegality (Washing Through Exception) 3-302 Comment 4 The shelter rule never grants HDC rights to persons who were parties to fraud or illegality affecting the instrument, whether or not such persons are prior holder of the instrument. A party so implicated cannot sell the instrument to an HDC and reobtain it, in order to be from defense of fraud of illegality. (This is a laundering provision) Ex. Harry gets a promissory note from Tom by fraud. Harry then sells the note to Jake in order to make Jake a HDC (Jake does have HDC status, it is not affected by the washout

rule), and then Harry wants to have Jake sell the note back to him thus giving him HDC status against Tom. The UCC will not allow this laundering. Once a person ahs qualified as an HDC, all subsequent transferees will acquire the same HDC right not matter how far down the chain the transferees there may be. Unless they are transferees after a transferor who failed to obtain HDC right because the transferor was a party of fraud or illegality affecting the instrument. Burden of Proof as a Holder in Due Course 3-308 (b) There is a presumption that every holder is entitled to recover. If the plaintiff can establish that they are a holder (i.e. the transferee in possession of a bearer instrument, or the indorsee in possession of an order instrument, in other words there is a valid negotiation), and can produce the instrument and establish the validity of the signatures thereon the instrument, the burden is on the defendant to prove a defense The holder will ultimately have to prove they are a HDC, but they wont have to do this until the defendant shows and proves a defense.

Where Plaintiff Cannot Produce Instrument The owner of an instrument can win without producing the instrument, but failure to produce it will prevent the attachment of presumption under 3-308. The burden is then on the plaintiff to prove due execution, negotiation, and each fat essential to the validity of the instrument and the claim of ownership. Missing Instrument 3-309 If the original instrument has been lost, stolen, or destroyed, the owner (possible HDC) may recover by proving up its terms together with the facts why the original cannot be produced. Court also may require the owner of the instrument (possible HDC) to indemnify the defendant (person owner/HDC is trying to collect from) against loss by reason of any future claims if the instrument should show up. If that proof is made for missing instrument and that plaintiff is a holder, then 3-308 applies as if the person seeking enforcement had produced the instrument HDC status still must be proved, even with the 3-308 presumption that defendant needs to provide a claim.

Claims and Defenses on Negotiable Instruments Claim 3-306 an affirmative cause of action for recovery on the instrument based upon superior ownership rights of the claimant . * A HDC takes the instrument free of all such claims

Defense: A defense is a ground for refusing to pay all or part of a negotiable instrument. The few defenses that can be asserted against an HDC (as well as a non HDC) are called real defenses Defenses that cannot be asserted against an HDC (but are good against non HDC) are called personal defenses

Claim in recoupment: Right of someone who owes a debt to subtract from the amount due arising from the same transaction that gave rise to the instrument Ex. Bob buys a stereo from Steve for $200, Bob gives Steve a promissory note for the stereo. The stereo is defective (breaching warranty) and Bob puts $50 to repair it. Bob has a $50 claim in recoupment. This claim can be made against any non HDC, but can only be made against a HDC if the HDC had notice of the warranty claim before negotiation or giving value. 3-305 (b) and Comment 3

Real Defenses 3-305 (a) (1) An HDC takes free of most defenses to the instrument. The Few defenses that may be asserted against an HDC are commonly called real defenses If there is a real defense it can be used against both HDC and non HDC Infancy 3-305 (a) (1) (i) The person contracting is under legal age to make contract If state law does not make the contracts of an infant void or voidable, infancy would be only a personal defense

Incapacity to Contract 3-305 (a) (1) (ii) Persons other than infants may also lack the capacity to contract (i.e. persons declared incompetent) Before such incapacity will constitute a real defense the state law must render the contract void rather than voidable, this makes it distinguishable from infancy which can make a contract void or voidable.

Illegality 3-305 (a) (1) (ii) Some illegality in the underlying transaction reders the obligation void (as opposed to voidable) this is a real defense against a HDC, even if the HDC had nothing to do with the illegality. If the obligation is merely voidable under state law, the illegality is a personal defense.

Duress 3-305 (a) (1) (ii) Duress occurs in a contract situation where one party acts involuntarily

Fraud In Factum 3-305 (a) (1) (iii) There are two kinds of fraud: real and personal. Real fraud (fraud in factum) is assertable against an HDC and is defined as: Fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms * Basically have to sign something and not know that it is a negotiable instrument in order to get a Fraud in Factum real defense. Also if a person had an opportunity to read it and didnt then they are likely not going to get the fraud in Factum defense. Example of fraud in factum: Sven, from Norway, cannot read English signs a promissory note that his attorney tells Hans is a credit application. Here there is fraud in factum, Sven doesnt know that its a promissory note, and he cannot read English so he cannot have a reasonable opportunity to learn its a negotiable instrument. Sven could assert this against a HDC.

Discharge in Insolvency Proceedings 3-305 (a) (1) (iv) Insolvency proceedings include and assignment for the benefit of creditors and any other proceeding intending to liquidate or rehabilitate the estate of the person involved. The most common of proceedings is discharge in a federal bankruptcy proceeding, which excuses the debtor from most of the debts listed in the bankruptcy petition.

Alteration of Instrument 3-407

(a) "Alteration" means (i) an unauthorized change in an instrument that purports to modify in any respect the obligation of a party, or (ii) an unauthorized addition of words or numbers or other change to an incomplete instrument relating to the obligation of a party. (b) Except as provided in subsection (c), an alteration fraudulently made discharges a party whose obligation is affected by the alteration unless that party assents or is precluded from asserting the alteration. No other alteration discharges a party, and the instrument may be enforced according to its original terms. (c) A payor bank or drawee paying a fraudulently altered instrument or a person taking it for value, in good faith and without notice of the alteration, may enforce rights with respect to the instrument (i) according to its original terms, or (ii) in the case of an incomplete instrument altered by unauthorized completion, according to its terms as completed.

If an HDC takes the instrument that is altered in good faith then they may collect on the instrument according to its original terms. Ex. A thief may altr the amount of a check from $10.00 to $1000, here if there is a HDC he could possibly collect the $10.00 on the original instrument. The difference between alteration (changing the terms that the maker or drawer inserted in the instrument) and unauthorized completion (filing in blanks left by the maker or drawer). Generally the maker will not be liable for the altered amount (except a HDC that gives value and in good faith), but maker will be liable for the full amount of the unauthorized completion

Suretyship as a Real Defense If an HDC knew prior to acquiring an negotiable instrument that some of the prior parties were sureties (accommodating parties) the HDC takes subject to the right of these parties to raise their suretyship defenses. If the HDC did not know that a prior party had signed as a surety, the surety defenses is personal and cannot be raised against a HDC

Forgery 3-401 & 3-403 3-401: No person is liable on an instrument unless that person has signed the instrument 3-403: an unauthorized signature is not effective as that of the person whose name is signed (person whose signature was forged), but does operate as that of the forger or non agent (the person who forged the name is liable as if he signed his own name). 3-305 (a) (2) frees HDC only from the defenses of a party to pay the instrument. Thus a party whose name is forged is not a party to pay the instrument, and the person whose signature is forged may bring defenses (personal or real) against the HDC
3-308. PROOF OF SIGNATURES AND STATUS AS HOLDER IN DUE COURSE (a) In an action with respect to an instrument, the authenticity of, and authority to make, each signature on the instrument is admitted unless specifically denied in the pleadings. If the validity of a signature is denied in the pleadings, the burden of establishing validity is on the person claiming validity, but the signature is presumed to be authentic and authorized unless the action is to enforce the liability of the purported signer and the signer is dead or incompetent at the time of trial of the issue of validity of the signature. If you are denying that the signature is yours, you have to specifically claim it in the pleadings. The person claiming validity is the plaintiff saying that they are the one with an instrument with defendants signature on it. So once you deny its your signature its on the other party to prove that it was your signature. However the signature is presumed to be authentic unless the defendant shows some evidence that the signature is forged. Just having a person saying it isnt my signature is not enough evidence to force the other party to prove that the signature is authentic. Must have some evidence to show that there was a forgery.

Personal Defenses: Discharge by Payment 3-602 The liability of any party on an instrument is discharged by a good faith payment to a holder, even though some other person asserts a claim to the instrument.

3-602(b) If the other party wants to stop payment, that person must obtain a court order or supply indemnity to protect the payor in the even that payment is eventually ordered

Liability of the Parties If a an instrument is technically negotiable so as to come within the scope of UCC Article 3, the UCC authorizes the following types of lawsuits on the instrument: i) suits on the instruments contractual obligations ii) Suits in property, based on implied warranties arising upon transfer or presentment of the instrument, and iii) Suits in tort for conversion

Merger Rule 3-310(b) When the instrument is issued, the obligation becomes merged into the instrument and, unless the parties have agreed otherwise, it is not available as a cause of action (at least temporarily) Where a negotiable instrument is accepted as conditional payment for the underlying obligation, that obligation cannot be the basis of a cause of action until the instrument is presented for payment or dishonored Ex. Tenant delivers a rent check to landlord. Tenants rent obligation is suspended unitl the check is presented for payment to Tenants bank. If the bank pays the check, the rent obligation is discharged. If the bank refuses payment (ex. Tenant has stopped payment on the check), Landlord can sue on the check, on the underlying lease agreement, or on both. * If the parties understand that the instrument is merely partial payment of the underlying obligation, then the obligation is suspended only pro tanto (by that much) Ex. If Tenant gives Landlord a check for one half of the rent owed, Landlord can sue for the half still due even before cashing the check. If a negotiable instrument is dishonored, the holder may sue on theinstrument or the underlying obligation, or both If liability on the instrument is discharged in any way (by payment, cancellation, alteration, bankruptcy) liability is also discharged on the underlying obligation. 3-310(b)

Cancellation of Underlying Obligation: Party primarily liable on negotiable instrument is the bank 3-310(a) Where the party primarily liable on a negotiable instrument is a bank (a cashiers check, certified check, or certificate of deposit) the underlying obligation is completely discharged, as long as the person who owed the obligation is not liable on the instrument Ex. Ralph give $1000 in cash to bank, bank draw up a check payable to his ex wife Lou to meet his $1000 monthly alimony. The bank does so, signing its name as drawer and the wifes name as payee. When Lou takes this check, Ralphs alimony obligation is discharged. If the check bounces, Lou must look to the bank rather than Ralph. If bank had listed Ralph as payee on the check and he had indorsed it over to Lou, the underlying obligation (alimony) would not be canceled, because Ralphs indorsement created recourse against him on the instrument * Keep the merger rule in mind whenever the question deals with an instrument that has not yet been presented for payment for payment. A party can sue on the underlying obligation only after the instrument has been dishonored. Procedural Rights Some parties who may be liable on an instrument are entitled ot the technical procedural rights of presentment or notice of dishonor prior to being sued. A party having the benefit of the procedural right is said to be secondarily liable on the instrument. These procedures must be either complied with or excused before UCC contract liability arises. Drawers and indorsers are typical examples of such secondary parties Parties not accorded these rights are said to be primarily liable because of their vulnerability to immediate suit.

Defenses Available to Maker 3-412 The maker of a promissory note has none of the technical procedural rights of a secondary liable party. The makers obligation is a simple one: the maker promises to pay the note according to its terms as of the moment of signature If sued on the note, the maker can assert whatever claims or defenses are available against the party suing.

Ex. D promissory note comes due, he pays the full amount to the payee, but fails to demand return of the note. The next month the note is again presented for payment by a new holder. Ds obligation to pay the note according to its original terms does not prevent him from raising his defense of discharge by payment. This would prevail unless the holder qualifies as a HDC. If holder is a HDC then D only has real defenses. Incomplete Instrument Signed by Maker 3-412, 3-115,3-406, 3-407 If the maker signs an incomplete note (one having blanks on spaces) the maker is bound by the terms as subsequently filled

Co-Makers 3-116(a) If two or more persons sign as co-makers in the same transaction, they are jointly and severally liable, This is true even if the body of the note fails to use plural pronouns (i.e. a note beginning with I promise to pay) that is signed by moer than one maker

Right to Contribution 3-116(b) If one co-maker is forced to pay the full amount to the holder, the co-maker may seek pro rata reimbursement from the other co-makers

Suretyship 3-419(e) If the co-maker forced to pay the full amount is a surety for one of the other co-makers, he may seek complete reimbursement from the principal

Obligation of an Indorser 3-415 (a) Indorsing ones name to the back of a negotiable instrument makes the indorser a type of surety for all prior parties (including the maker or drawer). By indorsing the instrument, the indorser promises to pay it to any later holder, but this promise is conditioned on the indorser first being accorded the technical procedural rights of presentment and notice of dishonor Indorsement Without Recourse 3-415 (b) An indorser who does not wish to incur the liability of an indorser may add the words without recourse to the indorsement and thereby avoid any promise of payment. This is known as a qualified indorsement, and has the effect of negotiating the instrument without incurring liability

Ex. Harry gives Rhonda a check for a debt he owes her. Rhonda signs her name on the back and cashes it at a local grocery store. If the check bounces the store may collect from Rhonda on the indorsers obligation without suing Harry first or even joining him in the suit. However, if Rhonda had made a qualified indorsement on the check (signing her name on the back and saying without recourse) the store would have no action against her.

Draft accepted by a Bank 3-415 (d) If a draft is accepted by a bank after an indorsement is made, the liability of the indorser under subsection (a) is discharged

Joint Payees 3-116(a) If the instrument is made payable to joint payees (i.e. pay to the order of John and Mary) and they both indorse the instrument, they are presumed to be co-sureties and liable to each other only for their respective shares. However, the law presumes that they are both jointly and severally liable to the rest of the world.

Reacquisition and Cancellation 3-207 Reacquistion occurs if an instrument reenters the hands of a prior indorser. Upon reacquisition, the reacquirer may cancel indorsements that were made between the time he formerly held the instrument and the present. This cancellation has the effect of discharging the indorsers whose signatures were canceled, and the discharge is effective against any subsequent holder, including a HDC. Ex. Pat negotiates a note to Sara by special indorsement as payment for goods. Pat finds that the goods are defective and returns them to Sara. Sara has already indorsed the note, but offers to return it to Pat, if he promises to strike Saras indorsement. Pat agrees and does in fact strike Saras indorsement. He then negotiates the note to Stan, another goods supplier. Sara has no liability on the note because her indorsement was canceled. If Pat had not canceled Saras indorsement, she would owe indorser liability to Stan, but not to Pat.

Obligation of a Surety Common Law Rights for Surety Exoneration- At maturity of the obligation, the surety may bring an equitable action to compel the principal to pay the debt and thereby exonerate the surety from liability *surety sues principal demanding performance Subrogation- If the surety is forced to pay the principals debt to the creditor, the surety is subrogated to (acquires) any rights the creditor had- such as rights to other collateral or the right to a preferred position in the principals insolvency proceeding. surety can also take whatever rights the principal has as a defense Reimbursement- Upon paying the principals debt to the creditor, the surety may sue the principal for reimbursement. This is also codified in UCC section 3-419(e). Contribution- If there is more than one surety on the instrument, sureties signing as part of the same transaction are entitled to recover pro rata from each other. In other words, the parties are presumed to co-sureties.

UCC rights to Surety The UCC refers to the surety as an accommodating party The principal (the lead person on the instrument) is called the accommodated party If the surety adds words of guaranty to the signature (Jane, guarantor; I Jane, guarantee this obligation) the surety becomes a guarantor (3-419 (e)) A Guarantor is a special party, but the guarantor is also a surety

Obligation of the accommodating party A surety who signs in the place where a maker usually signs incurs the same obligations as a maker does (3-419(b), 3-412) A surety who signs in the place where an indorser usually signs (the back of the instrument) makes the obligation of an indorser (3-419(b), 3-415)

Accommodating makers and accommodation indorsers therefore have the UCC rights of nonsurety makers and indorsers plus the special common law and UCC rights given to sureties (3-419) 3-419(c) If an indoresment seems out of place in the usual chain of title every subsequent taker of the instrument is conclusively presume to know that the indorsement was meant as a suretys signature , also if the signature is accompanied by words indicating that the signer is acting as surety or guarantor then subsequent holders take notice that there is surety

Proof of Surety Status Oral proof of the accommodation nature of a suretys signature may be introduced, except against an HDC with no notice of surety status (3-605 (h) If the instrument itself indicates that one of the signatures was meant to accommodate another party (i.e. John Doe, surety) even an HDC takes subject to suretyship defense Surety not liable to Principal The surety is not liable to the accommodated person, regardless of the place in which the surety has signed the instrument. 3-419(e) 3-419(f) also codifies the right to reimbursement on the instrument, regarless of the order in which the parties have signed. Ex. Harry wants to buy a car, but John (the car dealer) will not accept his check. Harry then persuades his friend Gloria to write the check for him, payable to John. Harry signs as an indorser, and obtains the car. When John tries to cash the check, it bounces. IF John collects the amount of the check from Gloria, she may seek reimbursement from Harry even though check drawers may not usually sue the indorser on their UCC section3-415 obligation. Similarly , if John collected the money from Harry, Harry would have no right to sue Gloria on her drawers obligations. Both of these results occur because Gloria was in fact a surety for Harry, even though Harry signed as the indorser of her check * although an accommodating party is never liable to the party accommodated, he is liable to other parties in the capacity in which he signed.

Tender Payment 3-603 The tender of payment acts to protect sureties and anyone else (i.e. indorsers) who would have a right of recourse against some prior party if forced to pay on the instrument. (Indorsers have a right of recourse aginst the maerk/drawer and/or prior indorsers) The rule has two parts: 3-603(c)- If, at maturity the surety (or an indorser) tenders payment to the holder of the instrument and the holder refuses to accept the money, the surety (or indorser) is still liable for the full amount, but is not liable for any subsequent interest. 3-603(b)- If the tender is made by the principal (or by the party against whom the indorser has a right of recourse) the surety or indoreser is completely discharged Ex. Luke promissory note is payable to Darth, and indorsed first by R and the by C. When the note matures, R tenders payment but Darth refuses to accept. This refusal invokes 3-603 and discharges C because he had a rigt of recourse against R, but it leaves R liable for the tender amount. Ex. If luke had tendered payment and Darth refused, Luke would still beliable for the tender amount (but not for any subsequent interest, costs, or attorneys fees). However, both accommodating indorsers, R and C, would be discharged because both had a right to recourse against luck on his makers contract. Agreements between creditor and principal Both at common law and UCC, the failure of the creditor to press the principal for payment at maturity of an obligation does not discharge the surety Agreements to Extend Time of Payment 3-605(c) An agreement to extend the time of payment discharges nonconsenting sureties only if they can prove harm caused by the extension

Agreements Not to Sue 3-605 (b) An agreement by the holder of the note not to sue the principal does not discharge nonconsenting sureties as well Ex. Alice signed a $5000 promissory note, payable to Bank on April 1, and her father, John, indorsed the note on the bank as a guarantor. Early in January, Alice told the bank that she was considering filing for bankruptcy, but would forego doing so if the bnak would accept $3000 and forgive the rest of the debt. The bank agreed and took the $3000. John still owes the bank $2000. He can then try to get reimbursement from Alice.

Agreements to Modify the terms of the instrument 3-605(d) If the principal and the creditor agree to a modification of the loan agreement other than a release of the principal or an extension of time, nonconsenting sureties are discharged up to the amount of harm suffered by the modification, which is presumed to be the amount the surety owes unless the creditor can prove lesser amount of harm

Consent by Surety 3-605(i) If the surety or a party with a right to recourse, such as indorser consents to an extension/suspension agreement, that person is not discharged Such consent is implied for the circumstances. The terms of a note may likewise bind all sureties in advance to an extension without notice New notes and the merger rule If the maker gives the holder either a new note or a postdated check as a means of paying the original note, the merger rule suspends the makers liability on the original note. In effect this is the same thing as an extension of time in which to pay the original note, and has the legal consequences of an agreement by creditor and principal to extend time of payment Nonconsenting sureties and indorsers would be discharged only to the extent they could prove loss by reason of extension (i.e. principals financial situation is likely to worsen during extension) Obligation of guarantor of collection 3-419(d) If a surety adds words to the signature indicating that she is guaranteeing collection, there is a special contract. Before a guarantor of collection can be required to pay the instrument, the holder must first pursue the maker or acceptor to an unsatisfied judgment or show that such action would be useless (as where the maker is insolvent). Collection guarantee must be clear If the surety merely calls herself a guarantor, that alone in no way changes the usually obligation of a surety. Sureties who call themselves guarantors are only garden variety accommodation parties whose liability depends on the capacity in which they sign, unless they make it clear they are guaranteeing collection, in which case their liability is

limited to 3-419(d) (guarantor is not liable until collection attempts prove futile against principal).

Obligation of a Drawer 3-414(a) If a draft is dishonored the drawer is obliged to pay the draft according to its terms at the time it was issued, or if the drawer signed an incomplete instrument, according to its terms when completed. The obligation is owed to the person entitled to enforce the draft or to an indorser who paid the draft The obligation incurred by the drawer of a draft is similar to that of an indorser, in that the drawer promises to pay the draft only if first accorded certain technical procedural rights Effect of adding Without Recourse 3-414(e) The drawer can eliminate contractual liability on the instrument by adding without recourse to his signature * This is not effective if the draft is a check Presentment 3-501(a) Presentment is a demand for payment or acceptance made by the holder of the instrument. Presentment is made at the place of business or residence of the maker or drawee, or at the location specified in the instrument. In the case of promissory notes, presentment is made to the maker. Where a draft is involved, presentment is made to the drawee

Rights of presentee (Maker or drawee) Authorized Demands 3-501(b) (2), (3) When presentment is made, the maker or drawee may demand the following 1) Exhibition of the instrument 2) Reasonable identification from the person making presentment

Thumb print is another form of signature so the banks can ask for it under 3-501 (b) (2) (ii) as reasonable identification, there is no dishonor if bank requires this. 3) Evidence of the presenters authority, if presentment of the instrument is made on behalf of another 4) Production of the instrument at a reasonable place and hour 5) A signed receipt on the instrument for any partial or full payment (presentee is entitled only to a signed receipt, not the unqualified indorsement of the presenter 6) Surrender of the instrument if the presentee pays in full 7) the party to whom presentment is made may return the instrument for lack of a necessary indorsement The bank has a right to demand a signature in order for the bank to be holder 3-501 (b) (3) (i), there will be no dishonor if the bank requires this, thus the drawer doesnt have to be pay until there is a dishonor.

Effect of Failure to comply with demands 3-501(b) If the presenter cannot or will not comply with one or more of the above demands, a presentment has not occurred, and the presentees refusal to pay on the instrument is therefore not a dishonor

Time for presentment of domestic checks 3-415(e) A reasonable time for presenting (or initiating collection on) uncertified checks drawn and payable in the United States and not drawn up by a bank is presumed to be to be 30 days after their date for indorsers If a check is not presented for payment or given to a depository bank for collection within 30 days after the day the indorsement was made, the liability of the indorser is discharged (3-415(e))

Dishonor Presentment across the Counter 3-502(b)(2), 3-420(a) If a draft is payable on demand and is presented to the drawee across the counter for immediate payment, it must be paid or returned by the close of business on that day. If paid, a check is canceled and returned to the drawer.

If returned and not paid, the there is a dishonor, if 3-501 doesnt apply If neither payment or return of the check occurs, the drawee has converted the instrument and is liable for the amount of the instrument as if the drawee had agreed to pay it.

Presentment through bank Collection Channels (Midnight Deadline Rules) 4-301 Banks typically collect checks from each other by making a provisional settlement on their own books before presenting a check to the drawee bank. This provisional settlement allows the drawee bank and extra day within which to decide whether to pay the item. This system of giving drawee banks until their midnight deadline (midnight of the banking day following the banking day of receipt) within which to dishonor an item is called deferred posting The Rationale The policy here is to force the drawee to act quickly or assume liability for the amount of the check. Quick action helps to cut down on float (the period of time in which a check is in t transit)

What constitutes a Banking Day 4-108 A banking day is defined as that part of a day in which the bank is open to the public for carrying on substantially all banking functions. For purposes of clearing up paperwork, the UCC allows a bank to establish a cutoff hour (2:00 P.M. or later) and to treat items received after that hour as if they were received on the next banking day. This can have the effect of moving the midnight deadline back one day

Notice of Dishonor 3-503 (a) The obligation of an indorser stated in 3-415(a) and the obligation of a drawer state in 3414(d) may not be enforced unless the indorser or drawer is given notice of dishonor of the instrument Notice of dishonor can be given to any person who may be laible on a negotiable instrument. Once given, it operates for the benefit of all parties who have rights on the instrument against the party notified.

Form of Notice 3-503(b) The notice of dishonor may be oral, written, or electronically communicated. It must identify the instrument and state that it has been dishonored. Return of an instrument given to a bank for collection is sufficient notice of dishonor Time for giving notice 3-503(c) Banks must give notice before the expiration of the midnight deadline. Parties other than banks have 30 days in which to give notice of dishonor Regulation CC notice of dishonor 12 C.F.R. 229.33 Under regulation CC, the dishonoring bank must send a direct notice to the depositary bank (the first bank to which an item is transferred for collection) any time it decides not to pay a check in the amount of $2500 or more. The notice must be received at the depositary bank by 4:00 PM (depositary bank time) on the second business day following the banking day on which the check was presented to the payor bank. The notice must include the name of the paying bank, the name of the payee, the amount, the reason for return, the date of the indorsement of the depositary bank, the account number of the depositor, the branch where the item was first deposited, and the trace number on the item of the depositary bank, unless these matters cannot be reasonably determined from an examination of the item itself

Necessity for presentment and notice of Dishonor Indorsers liability 3-415(c), 3-503(a) Because the indorsers obligation is conditioned upon notice of dishonor, presentment and notice of dishonor are necessary to bind indorsers. Indorsers are released from liability if these are not properly accomplished. Drawers Liability 3-414(f) The code requires that checks be presented to the drawee for payment within 30 days of their date. If presentment is delayed beyond this period and the drawee becomes insolvent during the period of delay, the drawers liability is excused upon assigning to the holder the drawers rights against the drawee * this only applies when a drawee bank becomes insolvent, this rarely happens

Stale Checks 4-404 If a non certified check is presented more than six months after its date, it is said to be stale. A bank that dishonors a stale check may not be sued for wrongful dishonor by the drawer. Even though the check is stale, it is still dishonor by the bank, so drawer will then become liable. Where the bank acts in good faith, it may pay a stale check, although most courts and commentators agree that if the bank should have noticed that the check was stale, it would be bad faith to pay the check without first checking with the drawer
3-118 (c) statute of limitations: Except as provided in subsection (d), an action to enforce the obligation of a party to an unaccepted draft to pay the draft must be commenced within three years after dishonor of the draft or 10 years after the date of the draft, whichever period expires first.

Situations in Which technical procedures are excused Compliance with the technical procedures of presentment and notice of dishonor is excused in certain circumstances Circumstances beyond Banks Control 3-504(c) Payor and collecting banks are excused from compliance with Article 3 and Article 4 time limits if the delay is caused by circumstances beyond the banks control (ex. Interruption in communication facilities, insolvency of another bank, war, etc.) and if the bank uses reasonable diligence under the circumstances to avoid the problem. Ex. Computer breakdown could excuse payor bank from having to dishonor checks by its midnight deadline * Bank claiming the excuse has the burden of proof to show circumstance was beyond banks control Compliance excused completely Compliance with the technical procedures is completely excused in the following situation: Waiver 3-504 (a),(b) The right to presentment and notice of dishonor can be waived in the instrument or by conduct of the parties. A waiver written into the body of the instrument binds all parties, while waiver written above the signature of an indorser binds only the indorser.

Waiver by Conduct Waiver can be implied from the circumstances. Unavailability of primary party 3-504 (a) (ii) If the maker, acceptor, or drawee is dead or the subject of insolvency proceedings, presentment is excused except as to documentary drafts Impossibility 3-504(a) (i) Compliance with the technical rights is also completely excused where such compliance would be impossible despite reasonable diligence

Where Compliance would be a useless thing Anticipatory Repudiation 3-504(a) (ii) If a party announces in advance that they will not pay the instrument at maturity, no presentment is necessary Countermanded payment 3-504 (a) (v) A party who has stopped payment or has requested another to do so has not right to presentment or notice of dishonor, and is not discharged from liability upon failure to get them. No right to expect payment 3-504 (a)(iv) A party who has no reason to expect or right to require that the instrument be accepted or paid cannot complain about failure to receive technical procedural rights. Obligation of a Drawee of Acceptor A drawee incurs no UCC contractual liability merely by being named as such by the drawer (this excuses the drawee from liability to the holder of a draft). This is because 1)The drawees name on the draft is not a signature 2) issuance of negotiable instrument does not work an immediate assignment of the drawers funds

Obligation of the Acceptor Acceptor Defined 3-409(a)

An acceptor is a drawee who becomes liable on the instrument by signing thereon

Acceptance defined 3-409(c) Acceptance is the drawees signed agreement to honor the draft as presented. It may consist of the drawees signature alone, written on the draft. If the draft is a check, the drawee banks acceptance is called certification Purpose of Acceptance Acceptance by the drawee creates an acceptors obligation to honor the draft when presented for payment. Following acceptance, the acceptor returns the draft to the holder who has presented it, and it may then be further negotiated. Characteristics of Acceptors obligation 3-413 The acceptors signature on a draft creates primary liability indentical with that of the maker of a promissory note. In other words, the acceptor promises to pay the instrument according to the terms at the time accepted (or, if then incomplete, as subsequently completed. Acceptor has all the defenses availbe that a drawer or as 3-305 allows Exception for certified checks 4-303 A certified check should be treated as money, so that an acceptor must pay the check when presented for paymenteven if the bank has a defense or the drawer has tried to stop payment. Check Certification 3-409, 3-413,4-303(a)(1) When a drawee bank agrees to certify a check, it typically freezes a like amount in the drawers account so that funds will be available when the check is presented for payment. Once the bank has certified the check and either returned it to the presenter or notified the presenter of certification, the bank becomes primarily liable thereon by incurring the obligation of an acceptor, and it is too late for the drawer to stop payment. Discharge by Certification 3-414(c), 3-415(d) No matter who procures certification, the drawer and indorsers are immediately discharged from all liability by the act of certification

Liability of an Agent 3-402(a) The signature rule provides that no one is liable on an instrument unless that person has signed the instrument. However, a signature can be made by an agent on behalf of the principal Authority of an agent maybe expressed, implied, or apparent. Unauthorized signatures 3-403 (a) An unauthorized signature usually does not bind the person whose name is purportedly signed, but it does act as the signature of the person who signs. Ratification 3-403(a) An unauthorized signature can be ratified, thereby making the principal liable on the same baiss as if the principal had authorized the signature. Ratification occurs when a principal knowingly adopts a signature as his own or when, with full knowledge of the circumstances, the principal appropriates the benefit of the unauthorized signing or fails to deny the validity of the signature, knowing that silence may mislead others. Signature as agent It follows that an agent must be very careful to sign in such a way as to bind the principal but not the agent. Otherwise, the agent may be personally liable on the instrument and unable to introduce evidence of agency status Requirements 3-402 To escape liability against all persons (even a HDC) an agent must: 1) Name the principal, and 2) Indicate that the agents signature is made only in a representative capacity * the name of the agent followed by the agents official title and coupled with the name of the principal is sufficient to relieve the agent of liability Use of the word By 3-402(b)

The word by in front of a signature is usually sufficient to indicate that the signer is an agent of the named principal

Effect of failure to complete one of two requirements 3-402(b) If 1) the agent indicates representative capacity but fails to name the principal, or 2) names the principal but fails to indicate representatives capacity, the agent is personally liable only to an HDC, but in a lawsuit with a non HDC is permitted to prove that the original parties did not intend for the agent to be personally liable Unidentified Principal If someone signs a negotiable instrument on behalf of someone else, the principal is bound (as long as he authorized the agent to do this) and this is true even if the principal is not named in the instrument Warranty Suits Warranty suit involving a negotiable instrument arise off the instrument. The plaintiff in an action for breach of warranty need not possess the instrument because liability arises from implied warranties created automatically when the instrument is physically shifted from one party to another. An implied warranty on a negotiable instrument is a property right and does not depend on the intentions of the parities. The plaintiff need not qualify as a holder of the instrument There are three stages a negotiable instrument goes through issuance, transfer, and presentment. The warranties arising at each of these stages are mutually exclusive, so that the implied warranties made on transfer are not also made at the moment of presentment. No Warranties on Issuance No implied warranties are created by the issuance of a negotiable instrument (first delivery to the payee) Warranties of Transfer 3-416, 4-207 Transfer-Any movement of an instrument other than an issuance or presentment is a transfer.

3-416 is for people who transfer an instrument and 4-207 is for Banks and customers of banks Transfer warranties are rights given to the transferee that may be asserted against a transferor if litigation arises on the instrument. Wont see your first transfer until there is interaction between the person issued the instrument and a 3rd party Person entitled to enforce instrument 3-416(a)(1), 4-207(a)(1) Warranty that the transferor is a person entitled to enforce the instrument Meaning that the transferor has taken the instrument pursuant to a valid negotiation and is therefore a holder. Valid Signatures 3-416(a)(2), 4-207(a)(2) Warranty that all signatures are authentic and authorized. No Alterations 3-416(a)(3), 4-207(a)(3) A warranty against any alterations to the instrument Instrument not subject to a defense or claim 3-416(a)(4), 4-207(4) Warranty that there are no legal defenses or claims in recoupment that are good against the transferor Ex. Pam defrauds Myron into giving Pam a promissory note, which Pam promptly negotiates to Loan Company. Because Myron could successfully defend a suit on the note by Pam, transfer of the note to Loan Company breached the warranty that there was no good defense against Pam. So if Loan Company has to give back the instrument or couldnt collect, they could collect money from Pam for breaching her warranty * If Loan Company was a HDC, meaning that Loan Company took the instrument free of defenses, they could still sue Pam for breach of warranty because Pam did have a defense good against her as a transferor. So even though they are a HDC free of defenses, Loan Company could still sue Pam for breach of warranty if litigation arises. No Knowledge of Insolvency Proceedings 3-416(a)(5), 4-207(a)(5) Warranty that the transferor has no knowledge of any insolvency proceeding (ex. Bankruptcy) instituted by or gains the party from whom payment is expected * This only warrants that the transferor has no knowledge of an insolvency proceeding, there actually might be one that transferor doesnt know about and he wouldnt be breaching his warranties. Warranties depend on receipt of consideration 3-416(a), 4-207(a)

Transfer warranties are made only by transferors who receive consideration, a transferor who receives no consideration makes no transfer warranties * Once someone begins bank collection, the Article 4 rules apply Warranties of Presentment 3-417, 4-208 Warranties made on presentment for payment or acceptance are considerably narrower than transfer warranties. Doctrine of Price v. Neal--- Drawees responsibility A drawee is responsible for knowing the drawers signature, so that if the drawee were mistaken the drawee could not seek restitution form the innocent presenter. Effect of Final Payment 3-418,4-215 Once final payment has occurred the foregoing doctrine indicates that the drawee (or maker in the case of a promissory note) cannot undo the transaction and recover the money paid unless a presentment warranty has been breached or the person who received the payment was not acting in good faith Presentment Warranties Person Entitled to enforce instrument 3-417(a)(1), 4-208(a)(1) Warranty that collecting person is a person entitled to enforce the instrument The presenter is saying to the drawee that they have taken the instrument pursuant to a valid negotiation and is therefore a holder.

No alteration 3-417 (a)(2), 4-208(a)(2) Warranty that there has been no alteration of the instrument.

No Knowledge that the signature of drawer or maker was unauthorized 3-417(a)(3), 4-208(a)(3) Warranty that the presenter has no knowledge that the signature of the drawer or maker is unauthorized. Presenter just cant have knowledge that the signature was forged or unauthorized.

If the presenter didnt have knowledge of unauthorized signature, and there was a forged drawers name it wouldnt violate 3-417(a)(1), 4-207(a)(1), because under 3-403, the forged name is treated as like the thief had drawn a check using his own name and there can be valid negotiation and right to enforcement, since the signature is treated as the thief own The drawee could attempt to collect by suing the thief, because his forgery of drawers name is like signing his own name (3-403), so the bank could sue on the instrument or sue for fraud, but this likely wont be successful because the thief will more than likely have fled town. * N.B. If the bank pays out on a forged indorsers signature (i.e. special indorsement/ payee indorsement) a presentment warranty is breached because the presenter didnt have the right to enforce against the drawer because of forgery. Persons deemed to make presentment warranties 3-417(a), 4-207(a) Everyone who transfers a negotiable instrument automatically makes presentment warranties, as does the party who physically receives payment or acceptance. This permits the payor to sue anyone in the chain for breach of presentment warranties.

Notice Requirements 3-416(c),3-417(e),4-207(d), 4-208(e) For both transfer and presentment warranties, the Code requires that notice of claim of breach be given with 30 days after the claimant has reason to know of breach. Failure to give notice within that period discharges the liability of the warrantor to the extent of any loss caused by the delay in giving notice. Doesnt completely discharge warrantor.

Conversion 3-420(a) Conversion is the unauthorized exercise of the rights of ownership over personal property belonging to another. UCC preserves this common law notion Forged or Missing Indorsements If an instrument is taken by transfer other than a negotiation (this is excluding gifts) or a bank makes payment to someone not entitled thereto, a conversion occurs. A conversion occurs anytime there is a forgery of a necessary indorsement or such a necessary indorsement is missing. All transfers and payments thereafter would be conversions Ex. Donna drew a check payable to the order of John and Mary. John took the check and signed his own name on the back, and forged Marys name below his. He cashed the

Check at Drug Store, which deposited the check in its bank, which forwarded the check to the drawee bank for payment. Because Marys valid signature had to be on the check for there to be a true negotiation, she may sue in conversion John, Drug Store, Drug Stores bank, and the Drawee bank. Whoever is sued will use warranty theories to pass the loss back to John. Appropriate Plaintiffs in Conversion Suits The appropriate Plaintiff in a conversion suit based on forged or missing indorsements is the person whose property rights are being violated. In the above example Donna the drawer wouldnt be the appropriate plaintiff because she issued the check thus giving up her property right. Conversion actions may not be brought by the issuer of an instrument Also conversion claim cannot be brought by a payee or indorsee who did not receive delivery of the instrument either directly or through an agent, or a co-payee

Bank Deposits and Collections When someone opens a checking account and begins using it, both UCC Article 4 and the Federal Expedited Funds Availability Act regulate the legal issues that arise from the passage of checks through the bank collection machinery Two big things to understand in this section - A bank may charge a customers account only if an item is properly payable - Once final payment has been made, a bank loses the right to return items Article 4 governs the bank collection process UCC Article 4 amplifies or alters Article 3 provisions governing negotiable instruments where items become part of the bank collection process Wrongful Dishonor 4-402 If a check or other item is properly payable from the drawers account but the bank wrongfully refuses to honor it, the drawer has a cause of action against the bank for wrongful dishonor Only drawer may sue Because the drawer, through contract creating the account, is the only one in privity with the payor bank, only the drawer may sue for wrongful dishonor. Other parties cannot sue the payor bank unless it has accepted the instrument

Damages under the Code 4-402(b) Requires injured parties to prove actual damages. If the wrongful dishonor is indefensible and outrageous than drawer can sue for punitive damages. Also can sue for consequential damages Death or Incompetence of Customer 4-405(a) A banks collection of payment actions taken prior to knowledge of the death or incompetency of a customer are valid Knowledge means actual knowledge, plus reasonable time within which to act Even where the bank has knowledge of a customers death, a bank may elect to pay or certify checks for 10 days following the death 4-405(b) What Constitutes a Properly Payable Item 4-401(a) A bank must charge a customers account for an item (check, note, etc.) only if item is properly payable. If the item is not properly payable the bank usually must replace the money in the account if the customer complains within relevant time limits. Whether is properly payable depends on - The terms of the deposit contract between customer and bank - who presents the item - the terms of the item - the usages of trade (drawee bank requiring a holder to have an account to get payment is not reasonable commercial standard and would be wrongful dishonor) Ask if the customer authorized the payment and if the payment does not violate any agreement that may exist between the bank and its customer * An item containing a forged drawers signature or forged indorsement is not properly payable. Overdrafts 4-401(a) If payment of the item in question would overdraw the customers account, the bank need not pay but may do so even where the bank and its customer have no agreement concerning overdrafts A bank may charge the customers account for an item even though payment results in a overdraft

Altered and Completed Items 4-401(d)(1) If an item has been altered the bank may charge the account only according to the original terms of the item unless the customers negligence led to the alteration, in which case the bank may pay the item as altered (this must be done in good faith) If a customer leaves blanks in the item that are later filled in, the bank may assume that the item as completed is proper (unless it knows otherwise) and the account may be charged accordingly 4-401(d)(2) A bank in their properly payable contract with the customer cannot contract out of exercising ordinary care 4-103

Proper Presenter 3-301, 4-401 The payor bank may charge its customers account with the amount of an item only if it pays a person who qualifies as a person entitled to enforce the instrument (usually a holder) If a bank makes a payment to a nonholder, it does so without authority, because it has not followed the customers order, which was to pay to the order of payee. This would mean the instrument is not properly payable and the drawer could get his money put back in his account. Postdated Checks 4-401(c) Postdated checks are properly payable unless the customer gives the bank notice of the postdating before the bank pays or certifies the check. A customer wishing to postdate a check must notify the payor bank of its postdating time to allow the bank to act on the customers notice before the bank has to commit itself to pay the check. If the customer fails to act on the customers timely notice, it may be liable for damages for the resulting loss which may include damages for dishonor of subsequent items. Stop Payment Orders 4-403 Item on which a bank has stopped payment is not properly payable, provided drawer gives reasonable notice No Stop payment on bank obligations 4-403(a)(1) In the case of cashiers checks and certified or accepted items, banks may not stop payment at the request of the drawer, such items remain properly payable in spite of the stop payment order

Requirement of reasonable notice 4-403(a) A customer may stop payment (on all items not mention above) by giving notice that reasonably identifies the item and is received sufficiently before payment that the bank has a reasonable opportunity to act on it. On a stop payment order a customer must describe their check with reasonable accuracy. (So a check that is described by number, payee, but the amount Is off by 50 cents is still reasonably accurate, and banks must stop payment and if they dont they have to give customers money back Oral Notice 4-403(b) The customers stop payment notice may be oral, but an oral notice is good only for 14 days unless renewed in writing within that period Written Notice 4-403(b) A written stop payment notice is good for 6 months, but it may be renewed in writing for further 6 month period - A bank can charge a stop payment fee Customer Has burden of proving loss 4-403(c), Comment 7 If the bank pays an item in spite of a stop payment order, the customer has the burden of proving that a loss occurred and the amount of the loss. If there is a HDC in the chain of transferees of the item, the customer cannot recover, because even if payment had been stopped, the customer would have to pay the HDC Ex. Dion draws a check to his nephew as a gift, but decides to stop payment. The nephew cashes the check at his bank, State Bank, which presents it to the payor bank. The payor bank, carelessly failing to obey Dions stop orde, makes the payment. Dion has no loss because State Bank was a HDC (having given value for the check by cashing it) and if the payor bank had dishonored the check, Dion would still have been liable to State bank. This is known as a subrogation right (4-407) and customer couldnt go after the bank even though they didnt follow the stop payment order. Right of Subrogation 4-407 If an items is not properly payable but the bank nevertheless pays it, the bank is subrogated to (steps into the shoes of) any person connected with the instrument (drawer, payee, holder, or HDC) to the extent necessary to prevent unjust enrichment

4-407: If customer stops payment on a check and the bank actually pays the check any ways, if the customer still owed the payee money any way (payee was a HDC), the bank has actually satisfied an obligation that the drawer owes to the payee. It would be unfair for the obligation owed by drawer to be satisfied yet the bank has to reimburse the customers bank account as well. See the example above. Subrogation gives the Bank the rights of any HDC on the item against the drawer or maker (4-407(1)); the rights of the payee or any holder of the item against the drawer or maker either on the item or under the transaction out of which the item arose (4-407(2)); rights of the drawer or maker against the payee or any other holder of the item with respect to the transaction out of which the item arose (4-407(3))

Right of Setoff for Bank (Common Law) Traditionally, banks (a debtors, with the customer being the banks creditor) have exercised a common law right available to all debtors to subtract (set off) from the amount owed the customer any debt the customer owes the bank. This is the right of setoff generally referred to by bankers as offset Ex. Annie misses a payment on the school loan she has borrowed from her bank, so the bank pays itself out of her checking account. Annie has no recourse, even if the withdrawal causes her outstanding check for her dogs food to bounce. - the Federal Fair Credit Billing Act of 1975 prohibits banks from setting off the unpaid credit card debts of their customer-cardholders Notice of Setoff Banks need not notify the customer prior to setoff Applies only to general Accounts A banks right of setoff may be exercised only against general checking or savings account. If the account is earmarked for a special purpose (ex. Tax accounts) there can be no setoff of unrelated debts from it Effect of Final Payment 4-303(a)(1), (2) If the bank has certified an item or has made final payment thereon, it is too late to set off a claim against the amount necessary to pay that item

*Bank cannot make setoff i) for unpaid credit card debt ii) against special accounts, or iii) for items that have been certified or for which payment is final * Setoff off of a customers account is considered the bank giving value, this is important for HDC status Bank Collection Procedures Deposit Availability Under Federal Law: Regulation CC 12 C.F.R. part 229 If a bank customer puts money or checks in an account, a federal statute, the Expedited Funds Availability Act, regulates how quickly the customer must be allowed to draw against that account. Government checks and bank checks CC 229.10 Funds from government checks that are deposited in a bank account must be made available on the next business day. This includes checks issued by any branch of government: federal, state or local. The same one-day availability period is mandated for the deposit of checks drawn on the same bank in which deposited, cashiers checks, certified checks, or tellers checks. Electronic deposits are treated just like cash deposits, so funds must be made available the next day The $100 availability Rule: CC 229.10(c)(1)(vii) For all the following checking transactions mentioned, the customer must be permitted to withdraw $100 of the check deposited on the business day after deposit Local Checks: CC 229.12(d) For local checks (those drawn on banks located in the same geographical available area served by the Federal Reserve processing center) Funds must be available for withdrawal by check payable to third parties no later than two business days after deposit. Could also withdrawal $100 on the day after check was deposited. For Cash withdrawals, the customer must be permitted to take out $100 on the business day after the date of deposit , must be permitted to withdraw $400 more by 5 P.M. of the second business day, and must be allowed to withdraw all the rest as cash on the 3rd business day after deposit *Keep in mind that banking and business day are two separate days

Non Local Checks: CC 229.12(c) For nonlocal checks (those not drawn on banks located in the same geographical area served by the Federal Reserve check processing center) , the funds must be available for withdrawal by check payable to third parties no later than 5 business days after deposit For Cash withdrawals on non local checks, the customer must be permitted to take out $100 on the business day after the date of deposit. On the 5th day after deposit $400 worth of cash must be available for withdrawal no later than 5 P.M. and the rest of the cash at the opening of the 6th business day. ATM Deposits: CC 229.12(f) For deposits made at an ATM owned or controlled by the depository bank, the above rules apply, except items requiring next day availability are given an extra day Safe Guard exceptions New Accounts: CC 229.13(a) During the first 30 days of the existence of a new account, there must be next day availability for cash or wire deposits, government checks, and for bank generated checks (ex. Cashiers checks). However if a government check or bank generated check exceeds $5000 the depositary bank may put a hold on the amount that exceeds $5000 for up to 9 business days. There are no rules that describe the time period for the availability of local or nonlocal checks for new accounts; thus the UCC rules would apply Large Checks: CC 229.13(b), (h) To the extent a days deposit exceeds $5000, the bank may hold the excess for further reasonable time (presumed to be 5 business days for local checks and six business days for non local checks) over the usual time period Repeated Overdrafts: CC 229.13(d), (h) If a customer repeatedly overdraws an account in any given 6 month period, then for the next 6 months thereafter the bank may hold deposited checks for a further reasonable time (presumed to be 5 business days for local checks and six business days for non local checks) over the usual time. The is repeated overdrafts when a accounts balance is negative for 6 or more banking days in a six month period

Reasonable Cause Exception: CC 229.13(e) If a bank has reasonable cause to believe that a check is uncollectible, it may ignore the usual rules if it gives notice to the customer. Notice: CC 229.13(g) Except in the new account situation, where a bank plans to take advantage of any of these exceptions, the depositor must be notified as soon as possible of the date the funds will be made available Damages for breach by bank: CC 229.21 Can be sued for actual damages, punitive damages , plus attorneys fees

Deposit Availability Under the UCC If Regulation CC does not regulate the availability of funds, article 4 of UCC will do so. Money 4-215(f) A customer may draw against money deposited in an account on the next banking day Ex. On April 10, Freda deposits $100 in her checking account. That same afternoon, Freda writes a check to her landlord for $100, and the landlord proceeds straight to the bank and presents the check to the drawee bank. Freda has no complaint if the bank elects to dishonor the check because it has until the next day to process it. Checks 4-105 The length of time that a check must be deposited in an account before it must be made available for withdrawals under the UCC varies according to how far the check must travel to reach payor bank (the drawee). Where depositary bank and payor bank are one and the same 4-215(e)(2) If the check drawer and the payee happen to have accounts at the same bank, that bank will be both the depositary bank and the payor bank. If the bank does not dishonor the item, the amount specified in the check becomes available for withdrawal by the payee at the opening of the second banking day after the deposit. *if regulation CC applies it requires the next business day availability for checks deposited in the same bank on which drawn

All other situations- (Final Settlement Rule) 4-215(e)(1) If the check must travel within a city or across the country, the depositary bank must be allowed sufficient time for the check to go to the pay bank and if dishonored to come back before being required its depositor to draw against eh amount involved. Recap of Midnight Deadline rule The payor bank has until its midnight deadline to dishonor an item presented to it through banking channels. If it does not do so by that time, final payment occurs and there can be no dishonor. The payor bank is then accountable for the amount involved, even if no such drawer or account exists. Final Payment 4-215(a) An item is finally paid by a payor bank when the bank has done the first of any of the following 1) Paid the Item in cash 2) does not dishonor by midnight deadline *Once there is final payment then you have to go to transfer and presentment warranties to recoup money Final Settlement At the moment of final payment, all provisional settlements made as bookkeeping entries by banks in the collection chain firm up and become final settlements Dishonor of the item is no longer possible, so that the bank

Right to Charge back 4-214 Prior to final settlement, a depositary bank or any other collecting bank that learns that payment on the item will not be made, may charge back (reverse) any provisional settlement given its customer for the item Prior us of Credit 2-414(d)(1) The depositary banks right of charge back is not affected by the fact that it has already permitted its depositor to draw against the item returned; the depositor must repay the money Failure to use ordinary care 4-202 A collecting bank must use ordinary care in collecting items. Failure to do so makes the bank liable for the amount of the item

Speed of Collection 4-202, 4-108 A collecting bank usually must pass items (or notice of dishonor) along the chain before its midnight deadline or be found not to have exercised ordinary care. In effect this gives each collecting bank two days in which to act. If a bank takes longer to act, it has the burden of establishing that the delay was reasonable. Right of charge back not affected by negligence 4-214(d)(2) The failure of a collection bank to exercise ordinary care in its collection duties does not destroy the banks right to charge back. Effect of final settlement 4-214(a) The right of a depositary bank to charge back an uncollected check expires at the moment final settlement occurs (i.e. at the moment the payor bank makes final payment) Notice of Charge Back: 4-214(a) The depositary bank need not give notice to its customer that its is charging back the amount of a returned check before doing so, but it must send notice to the customer that charge back has occurred before expiration of its midnight deadline

Final Payment Final payment occurs at the moment the payor bank becomes accountable for the amount of the item presented, and the provisional bookkeeping entries firm up so that final settlement occurs. Final Payment Occurs When 4-215 Payment in Cash 4-215(a)(1) Once the payor bank hands over the money, final payment occurs and it is too late to dishonor the check Settlement 4-215(a)(2) Final payment occurs when a bank settles for an item and has no right to revoke the settlement. Ex. Bank pays for a presented item with a cashiers check

Failure to revoke provisional settlement 4-215(a)(3) If the payor bank has already made a provisional settlement (conditional settlement) for the item presented, the payor bank has until the midnight deadline of the banking day following day of presentment in which to reverse the provisionsal settlement in favoer of the presenting bank and send the item back. This is most common method of final payment, and it is basically saying that the time limit is up for a bank to be able to dishonor Regulation CC and midnight deadline rule Regulation CC permits payor bank to miss their midnight deadlines and still avoid final payment in two situations Day after midnight deadline passes: CC 229.30(c)(1) Where the bank will be able to return the item to the depositary bank before the close of business on the next banking day Ex. National Bank returns checks to the Federal Reserve bank by putting them in its armored car and sending them back to the Fed. The armored car makes its last run at 4. A check is presented by the Fed to National Bank on Monday Morning. On Tuesday at 6 P.M., National Bank decides to dishonor the check. If were just following UCC, it defines send as including mailing. So the Bank would put the letter in the mail. Regulation CC allows the bank to wait for the next days armored car run as long as the check will ordinarily be received by the Fed before its cutoff hour on Wednesday, thus getting it back quicker than mailing would. Highly expeditious means of transportation: CC 229.30(c)(1) Regulation CC also permits a payor bank to miss its midnight deadline as long as it uses highly expeditious means of transportation, even if this transportation would ordinarily result in delivery after the receiving banks next banking day. Legal effect of final payment 4-302 When final payment occurs the bank is accountable for the amount of the item and usually has no way to avoid payment * Once either certification or final payment occurs notice of problems, banks right to setoff, service of legal process (garnishment of wages), or a stop payment order, can stop the bank from paying the item

Ex. On Friday payor bank certifies Drawers check. At noon Friday, the sheriff serves a writ of garnishing Drawers account. The writ comes to late to encompass the certified check, because certification makes the bank itself liable on the check. Rights of payor bank after payment Once final payment has occurred, the payor must pay the item and cannot recover the payment made except in the following circumstances: Bad Faith Presenter 1-103,1-203,3-418 The common law doctrine of restitution for payment made due to mistake or fraud will permit the payor bank to undo final payment where the equities favor the bank and the other party acted in bad faith Presentment Warranties 4-208 Final payment doesnt deprive the payor bank o fits right to sue for breach of presentment warranty. That is because the suit is off the instrument Check Truncation 229.51- if a bank provides a copied form of the original check and it shows all of the telling markers then that check must be accepted as evidence in legal matters. These checks are known as substitute checks. No one can refuse to take a substitute check A substitute check must be a paper reproduction, with the routing numbers, the indorsers, Truncating bank- 229.2 . This is the bank that takes the deposits and makes an electronic image of the check. 229.2 The reconverting bank- the bank that creates the substitute check, this is usually the payor bank. What happens when they try to convert the electronic image of the check to paper but something goes wrong? You have warranties and indemnities 229.52 Warranties on reconverting of the check- person who creates or transfers check is warranting that the checks are legally accurate. Reconverting bank is responsible for warranties If the check is not accurante the reconverting bank is responsible for damages

229.53 Indemnity- the person who truncates the check, agrees to indemnify any reconverting bank if the there is a mistake on their behalf while making an electronic copy Truncating bank is responsible for indemnity The reconverting bank may not have been the one who caused the problem in making a bad substitute check, but instead it was the truncating bank, then the reconverting bank can sue for indemnity Warranties is between customer and reconverting bank Indemnity is between reconverting bank and truncating bank Most banks hold the original copies of a check for 45 days, even though technically they should hold it for 120 days.

Forgery or Alteration of Negotiable Instruments Unauthorized signatures will not be deemed that of the person whose name is signed unless that person is precluded from denying it No Damages Defense No matter what happens to a negotiable instrument (forgery, alteration, etc.) it is a defense at common law that the proceeds reached the person entitled to them. If this occurs there can be no successful lawsuit because there is no damages Forger Rule 3-403(a) An unauthorized signature will not be deemd to be that of the person whose name is signed unless that person is precluded from denying it. An unauthorized signature can be ratified by an authorized person. Requires 1) Knowledge of the unauthorized signature 2) consent to the unauthorized signature Ratification is a retroactive adoption of the unauthorized signature by the person whose name is signed and may be implied by conduct as well from express statements. The unauthorized signature becomes valid so far as its effect as a signature is concerned Imposter Rule 3-404(a) An imposter is one who pretends to be someone else. The UCC requires that drawers and makers be careful with whom they deal with, and if they are duped into issuing an

instrument to an impostor, the resulting forgery of the payees name is nonetheless effective
3-404. IMPOSTORS; FICTITIOUS PAYEES (a) If an impostor, by use of the mails or otherwise, induces the issuer of an instrument to issue the instrument to the impostor, or to a person acting in concert with the impostor, by impersonating the payee of the instrument or a person authorized to act for the payee, an indorsement of the instrument by any person in the name of the payee is effective as the indorsement of the payee in favor of a person who, in good faith, pays the instrument or takes it for value or for collection.

Ex. Larry tells Jessie that he is Milton Money, and that he is collecting for a new public library. Jessie writes out a $50 check payable to Milton Money. Larrys subsequent forgery of the name to the instrument is effective to pass good title to his tranferees. If Jessie finds out the truth, she has no complaint to her bank that the check was not properly payable due to forgery of the payees name Impostor need not communicate Fact to Face 3-404(a) The UCC doesnt require face to face dealings, so the rule applies as well to misrepresentations through mail or other forms of communication. Identity of actual Forger Irrelevant Once the drawer or maker has issued an instrument to an imposter, the resulting indorsement of the payee is validated regardless of who actually forges it (i.e. it need not be forged by the original imposter) Issuance of Fictitious payee or payee not intended to have interest in instrument 3404(b)
(b) (Fictitious Payee) If (i) a person whose intent determines to whom an instrument is payable (Section 3-110(a) or (b)) does not intend the person identified as payee to have any interest in the instrument, or (ii) the person identified as payee of an instrument is a fictitious person, the following rules apply until the instrument is negotiated by special indorsement: (1) Any person in possession of the instrument is its holder. (2) An indorsement by any person in the name of the payee stated in the instrument is effective as the indorsement of the payee in favor of a person who, in good faith, pays the instrument or takes it for value or for collection

3-110- The person who signs the instrument, if that person does not intend the name payee to have any interest in the instrument or, regardless of what that person intended, if the named payee is a fictitious person, the forgery of the payees name is effective to negotiate an instrument Employers responsibility for Fraudulent indorsements by employee 3-405(a), (b)
(a) In this section: (1) "Employee" includes an independent contractor and employee of an independent contractor retained by the employer. (2) "Fraudulent indorsement" means (i) in the case of an instrument payable to the employer, a forged indorsement purporting to be that of the employer, or (ii) in the case of an instrument with respect to which the employer is the issuer, a forged indorsement purporting to be that of the person identified as payee. (3) "Responsibility" with respect to instruments means authority (i) to sign or indorse instruments on behalf of the employer, (ii) to process instruments received by the employer for bookkeeping purposes, for deposit to an account, or for other disposition, (iii) to prepare or process instruments for issue in the name of the employer, (iv) to supply information determining the names or addresses of payees of instruments to be issued in the name of the employer, (v) to control the disposition of instruments to be issued in the name of the employer, or (vi) to act otherwise with respect to instruments in a responsible capacity. "Responsibility" does not include authority that merely allows an employee to have access to instruments or blank or incomplete instrument forms that are being stored or transported or are part of incoming or outgoing mail, or similar access. (b) For the purpose of determining the rights and liabilities of a person who, in good faith, pays an instrument or takes it for value or for collection, if an employer entrusted an employee with responsibility with respect to the instrument and the employee or a person acting in concert with the employee makes a fraudulent indorsement of the instrument, the indorsement is effective as the indorsement of the person to whom the instrument is payable if it is made in the name of that person. If the person paying the instrument or taking it for value or for collection fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss resulting from the fraud, the person bearing the loss may recover from the person failing to exercise ordinary care to the extent the failure to exercise ordinary care contributed to the loss.

Effect of Negligence by Subsequent parties 3-404(d), 3-405(b) If subsequent parties do not observe ordinary care in taking or dealing with the instrument after the payees name is forged, there is comparative negligence

NEGLIGENCE CONTRIBUTING TO FORGED SIGNATURE OR ALTERATION OF INSTRUMENT 3-406

(a) A person whose failure to exercise ordinary care substantially contributes to an alteration of an instrument or to the making of a forged signature on an instrument is precluded from asserting the alteration or the forgery against a person who, in good faith, pays the instrument or takes it for value or for collection. (b) Under subsection (a), if the person asserting the preclusion fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss, the loss is allocated between the person precluded and the person asserting the preclusion according to the extent to which the failure of each to exercise ordinary care contributed to the loss. * This is the comparative negligence term for 3-406 (c) Under subsection (a), the burden of proving failure to exercise ordinary care is on the person asserting the preclusion. Under subsection (b), the burden of proving failure to exercise ordinary care is on the person precluded.

Examples of Failure to Exercise Ordinary Care by a drawer or maker of an instrument 3-406 Comment 3 Leaving blanks or spaces on instrument Filling in a blank or space without authority is an alteration, but if the maker or drawer carelessly leaves such blanks available to the wrong doer, the maker or drwer should not be able to complain Mailing an instrument to someone with same or similar name of payee If the issuer of the instrument carelessly sends it to someone who will have no trouble cashing it because she has the same or similar name as the intended payee, that violates the standard of ordinary care Failure to follow internal procedures If the issuer has created a system designed to avoid check forgeries, it is negligence not to follow that procedure Failure to guard signing device If the issuer signature is place on the instrument by a machine or rubber stamp, the issuer is negligent if the machine or stamp is not closely guarded and gets into the wrong hands Some courts require that the negligence be the proximate cause of the of the forgery or alteration

Agents Authority to indorse not presumed An agents authority to sign the name of the principal to a negotiable instrument is never presumed. Hence, one who cashes checks for an alleged agent is negligent if the authority of the agent is not carefully checked. NOTICE OF BREACH OF FIDUCIARY DUTY 3-307
(a) In this section: (1) "Fiduciary" means an agent, trustee, partner, corporate officer or director, or other representative owing a fiduciary duty with respect to an instrument. (2) "Represented person" means the principal, beneficiary, partnership, corporation, or other person to whom the duty stated in paragraph (1) is owed. (b) If (i) an instrument is taken from a fiduciary for payment or collection or for value, (ii) the taker (i.e. bank) has knowledge of the fiduciary status of the fiduciary, and (iii) the represented person makes a claim to the instrument or its proceeds on the basis that the transaction of the fiduciary is a breach of fiduciary duty, the following rules apply: (1) Notice of breach of fiduciary duty by the fiduciary is notice of the claim of the represented person. (2) In the case of an instrument payable to the represented person or the fiduciary as such, the taker has notice of the breach of fiduciary duty if the instrument is (i) taken in payment of or as security for a debt known by the taker to be the personal debt of the fiduciary, (ii) taken in a transaction known by the taker to be for the personal benefit of the fiduciary, or (iii) deposited to an account other than an account of the fiduciary, as such, or an account of the represented person. Trustees dont use assets in the trust to pay personal obligations, a bank seeing this will be notice of a breach of a fiduciary duty. If the bank has notice of breach of fiduciary duty If you have 3-405 claim by the bank and a 3-307 claim by the principal then you measure the weight of each claim. Its very similar to a comparative negligence claim. Ask who would have an easier time detecting the fraud. Who every had the easier time detecting fraud will lose the claim

Bank Statement Rule 4-406 Once a month, a bank will return canceled checks to its customers, along with a statement of account. Failure to examine this statement is a form of negligence that that can preclude the defense of forgery and alteration. Customers Duty to examine statement 4-406(c) After receiving a statement, the customer must promptly use reasonable care in examing it for two things 1) an unauthorized signing of the customers own name as drawer, and 2) any alteration on any item Check Truncation and a duty to examine If the bank pursuant to an agreement with its customer, does not return checks, the bank may send the customer a description of the checks in lieu of the checks themselves. The statement at a minimum must describe the following with regard to each check: Item number, amount, and date of payment 4-406 Official Comment 1 This minimal information should be enough to alert the customer to problems 4-406(a) Customers right to copies of the checks 4-406(b) If the bank does not return items to the customer, the customer has the right to request legible copies of them for 7 years Effect of Failure to examine statement 4-406(d)(1) If the customer fails to report a forgery or alteration problem within a reasonable time, the customer is precluded from complaining to the bank that the item in question was not properly payable (4-401(a)), if the bank can prove a further loss (other than original payment) caused by this delay *Where, the bank has only its original loss from the improper payment and cannot show further damages caused by the delay in reporting, the customer is not precluded from asserting forgery or alteration * This is why forged signatures usually dont usually work for 4-406(d)(1), because if the check and properly payable then the bank would still have to pay the amount of the check. Customer must exercise reasonable promptness in examining a statement, reasonable promptness is not defined so it varies in each case. Customer must also have reasonable time to have discovered the unauthorized statement

Ex. If a person takes your check and makes themselves payee and takes out $1000, the bank doesnt suffer a loss because if the customer found the unauthorized statement promptly the bank would have to pay back the customers account anyway. So no matter what the bank was going to lose $1000

Repeat Offender Rule 4-406(d)(2) Where the statement has been available to the customer for a reasonable period of time (not more than 30 days) and there is no complaint about an unauthorized signature or alteration, the customer is precluded from demanding recredit on any other items forged or altered by the same wrong doer and subsequently paid by the bank (until customer gives notice)
(2) the customer's unauthorized signature or alteration by the same wrongdoer on any other item paid in good faith by the bank if the payment was made before the bank received notice from the customer of the unauthorized signature or alteration and after the customer had been afforded a reasonable period of time, not exceeding 30 days, in which to examine the item or statement of account and notify the bank.

Result where bank is also negligent 4-406 (e)

If subsection (d) applies and the customer proves that the bank failed to exercise ordinary care in paying the item and that the failure substantially contributed to loss, the loss is allocated between the customer precluded and the bank asserting the preclusion (comparative negligence) according to the extent to which the failure of the customer to comply with subsection (c) and the failure of the bank to exercise ordinary care contributed to the loss. If the customer proves that the bank did not pay the item in good faith, the preclusion under subsection (d) does not apply.

Burden of Proof 4-406 (d), (e) Each side has the burden of establishing lack of care by the other party. To take advantage of a section 4-406 preclusion, the bank must therefore establish that the customer failed to use reasonable care in examining the statement. To spread loss, the customer must show that the bank failed to use ordinary care in paying the item. Cutoff Period (Statute of limitations) 4-406(f) No matter who was negligent, UCC bars all customer complaints first made more than 1 year after the statement was made available to the customer. Bank must assert section 4-406 defenses If a customer complains to the bank about an unauthorized signature or alteration and the bank has a defense under the bank statement rule, the bank must raise that defense against

its customer. If it does not do so, the bank may not pass its loss on to prior parties through breach of warranty suits or otherwise.

Alteration 3-407 An alteration of the terms of a negotiable instrument occurs if it changes the instrument in any way. Changing the names or relations of the parties, changing the amount, are examples of alteration Fraudulent Alteration 3-407(b) If a fraudulent alteration occurs, all prior nonnegligent parties are completely discharged from liability on the instrument, and due to the merger rule, on the underlying obligation as well Negligent Alteration 3-406,3-407(b) If the alteration was caused by negligence of a party, that party (drawer or prior indorsers) is not discharged, and is in fact liable on the instrument as it now reads, at least when sued by later good faith parties. *3-407 (b) usually applies to negligent drawers when they fall under 3-406 Discharge is personal defense 3-407(b), 3-601(b) Discharge is a personal defense, thus if an alteration causes parties to be discharged on the instrument, they are still liable according to the original terms of the instrument if the instrument is transferred to a HDC Rights of drawee bank 3-407(c), 4-401(d)(1) A drawe or payor bank may charge and altered instrument against the drawers account according to the original terms. (This wouldnt violate 4-401 improperly payable) Bank as an agent 4-201 Bank is the agent of a customer and if customer gives there bank a check that they have not yet signed as an indorser, the bank may indorse it for the customer Incomplete instruments 3-407(c), 4-401(d)(2) The unauthorized completion of an incomplete instrument is an alteration, but an HDC and a drawee/payor bank may nevertheless enforce the instrument according to its terms when completed.

* Completion is not alteration, completion happens when there are blanks on the instrument, alteration occurs when terms are changed Lost, Destroyed, or Stolen Instruments General Rule 3-309 If an instrument is lost, destroyed or stolen, its true owner (payee or payee transferees) may still sue upon it, but must first prove ownership and explain the reasons for not producing the instrument. To protect the defendant form double liability in cse the instrument should turn up in the hands of a HDC, the court may require the owner to post bond or give the defendant security against loss by reason of future claims. Cashiers check- check drawn by the bank on itself Tellers check- is one drawn by one bank on another or that it is payable through another bank Certified check- is an ordinary check that the drawee bank has signed thus exposing itself to primary liability. Declaration of loss 3-312 A customer who lost banks checks as mentioned above, may come into the issuing bank and fill out a form called a declaration of loss describing the problem. If the bank check is presented within 90 days period following the date of the check the bank will pay presenter. If the check is not presented within the 90 days period, at the end of the period the bank pays the money to the customer who filled out the declaration of loss, and if the check shows up later, even in the hands of a HDC the bank has no further liability, and the person in possession of the bank check will have to try and get the money from the customer.