Commercial Paper (Overview) (First-Read)

Negotiable Instrument: A signed writing that orders or promises a payment of money Negotiability: Determines the rights and obligations of the various parties involved with commercial paper.

Analysis: 1. What is the nature of the instrument? -Is it negotiable and has it been negotiated? 2. Who is the P and what are his rights? -Is he a Holder in Due Course (HDC)? 3. Who is the D and what is the nature of Ds liability? 4. What is the Ds Defense? -Is the Defense one that is cut off? Types of Negotiable Instruments nd 1. Note: A 2-party instrument in which one party (the maker) promises to pay a 2 party (the payee) a sum of money -Ex: I Promise to pay Paula $2500 on demand, signed Mike. -Certificate of Deposit: is an instrument in which a bank acknowledges that it has received a sum of money and promises to repay that sum. It is treated as a note of the bank. 2. Draft: A 3-party instrument in which one party (the drawer) orders a 2 party (the drawee or rd payor) to pay a sum of money to a 3 party (the payee). -Ex: To Drawee Bank, pay Paul $1K, signed Dave. -Check: is a draft drawn upon a bank and payable to demand -Travelers Check: is an instrument that is payable on demand, draw on or payable at or through a bank and designed as travelers check. It must be countersigned. Requirements of a Negotiable Instrument (SUFPON) 1. Signed Writing 2. Unconditional Promise 3. Fixed amount of Money 4. Payable to order or bearer 5. On Demand or at a Definite Tim 6. No Undertaking or Instruction
nd

Definitions -Order: a written undertaking to pay money signed by the person giving the instruction -Promise: a written undertaking to pay money signed by the person undertaking to pay

Requirements of a Negotiable Instrument 1. Signed Writing -by the person liable 2. Unconditional Promise 3. Fixed amount of money -determinable interest rate -has to be money, not goods/services 4. Payable to Order or Bearer -a check not payable to order or bearer is still negotiable if satisfies other requirements -Payable to Bearer -States it is payable to bearer or order of bearer -Does not state a Payee -States it is payable to cash, or -Indiicates it is not payable to an identifiable person. -Payable to Order -Payable to the order of an identified person or to an identified person or order 5. On Demand or at a Definite Time -On Demand -states that it is payable on demand or at sight -indicates that it is payable at the will of the holder -it does not state any time for payment -Definite Time -payable at the end of a definite period of time (ex: in 90 days) -payable at a fixed date (12/31/2013) -payable at a time readily ascertainable at the time of issue, even if subject to the rights of prepayment, acceleration, or extension. -An instrument that is payable upon the happening of some event is nonnegotiable, even if that event is certain to happen, so long as the time is uncertain. -Ex: A note that is payable at or at a fixed time after death nonnegotiable 6. No Undertaking or Instruction -may not state any other undertaking or instruction by the person promising or ordering payment to do anything besides pay money. -these undertakings do not destroy negotiability -an undertaking or power to maintain or protect collateral to secure payment -an authorization or power to confess judgment or realize on or dispose of collateral -a promise or provision waiving benefit or any law intended for the obligors protection Negotiation Negotiation: A voluntary or involuntary transfer of possession of an instrument by a person other than the issuer to a person who thereby becomes its holder. -Order Instrument: -If an instrument is payable to an identified person (an order instrument), negotiation requires transfer of possession and indorsement by the holder. -Ex: endorsing the check on back

-Bearer Instrument -If an instrument is payable to bearer (a bearer instrument), it may be negotiated by transfer of possession alone. Transfer -The transfer of an instrument occurs when it is delivered by a person other than its issuer for the purpose of giving the right to enforce the instrument to the person receiving delivery. -Transfer Is negotiation for bearer instrument -for Order instrument Need indorsement as well -If transfer is less than the entire instrument, negotiation of the instrument does not occur. The transferee obtains only the rights of a partial assignee Indorsements -An Indorsement is 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 to negotiate the instrument, restrict payment of the instrument, or incur th e indorsers liability on the instrument. -The transferor of an instrument controls the method by which the transferee can further negotiate the instrument by his indorsement. -Blank Indorsement: has the name of the transferor written on the back of the instrument. -If the indorsement is blank, then the instrument becomes bearer paper and the transferee can further negotiate by delivery alone. -ex: (from) Paul Payee -The Holder may convert a blank indorsement that consists only of a signature into a special indorsement by writing, above the signature of the indorser, who its payable to. -Special Indorsement: names the Transferee and directs payment to him. -Ex: To Nancy, signed Paul. -If the indorsement is special, then the instrument becomes order paper and the transferees indorsement is necessary for further negotiation. -When indorsement is made, the Transferee becomes a Holder. He may become a HDC if the requirements are met. -Anomalous Indorsement -Made by a person other than the Holder -The indorsement is extraneous to the chain of title and has no effect on the manner in which the instrument may be negotiated. -May create liability on the instrument of the indorser -Restrictive Indorsements -An indorsement limiting payment to a particular person or otherwise prohibiting further transfer or negotiation of the instrument will not prevent further transfer or negotiation of the instrument Rescission for Illegality or Incapacity -If minor or incapacitated person negotiates an instrument negotiation is effective to transfer the instrument even though the person may not undertake the contractual obligations of an indorser or be responsible for breach of warranty. -Same is true when the negotiation is: by a corporation exceeding its powers, obtained by fraud, duress, or mistake, part of an illegal transaction, or made in breach of duty.

-That person may rescind, but cannot do so against subsequent HDC or person paying the instrument in good faith and without knowledge of facts that are a basis for rescission. Presentment -Making a demand of payment -From the maker or drawee -It is not a negotiation -The party paying (usually the bank) does not become a holder in due course

Persons Entitled to Enforce the Instrument Person Entitled to Enforce: 1. Holder or Holder in Due Course 2. Non-holder in possession of the instrument who has the rights of a holder 3. A person not in possession who is nonetheless entitled to enforce the instrument -person who is not the owner or in wrongful possession may still be able to enforce

Holder: A person who is in possession of the instrument if: instrument is payable to holder, bearer, or indorsed in bank + all necessary indorsements are valid -A holder has both possession of and rights to the instrument -The first person who becomes a holder is the payee of the instrument Typical Problems with status as Holder: -Forged Indorsement: a forged necessary indorsement prevents the possessor of an instrument from being a holder. -Fictitious Payee: Most often applied when an employee attempts to defraud his employer by drawing checks supposedly for the purpose of paying the employers bil ls, while actually cashing the checks himself and pocketing the proceeds. -Indorsement would still be effective, but person would not be a HDC. -Impostor -When a person impersonates the payee and induces the drawer or maker to issue an instrument to the imposter payable to the name of the impersonated person, an indorsement by anyone in the name of the payee is effective in favor of a person, who in good faith, pays the instrument or takes it for value on for collection. -Ex: If Tom Thief tells Marry Maker that he is Paul Payee, and Marry draws a check payable to Paul Payee and gives it to Tom, anyone, including Tom, may indorse the check Paul Payee and effectuate a negotiation so that subsequent taker is a holder Holder in Due Course: A holder who is a good faith purchaser 1. Value 2. Good Faith 3. Without Notice HDC 1. Value -The giving of something other than a promise for the instrument or the acquiring of a security interest in the instrument. 2. Good Faith

-honesty in fact and the observance of reasonable commercial standards of fair dealing -take it without actual knowledge or reason to know of some defect 3. Without Notice -Without notice that its: -Overdue or dishonored -unauthorized signature or alteration -defense or claim -Test for Notice -A person has notice of a fact when: -he has actual knowledge of it -he has received a notice or notification of it, or -based on all the facts and circumstances known to him at the time in question, he has reason to know it exists.

No HDC for Instrument taken: 1. By legal process or by purchase in an execution, bankruptcy, or creditors sale, 2. By purchase as part of a bulk transaction not in the transferors ordinary course of business, or 3. As the successor in interest to an estate or other organization The Umbrella/Shelter Doctrine -When a person fails to meet one of the HDC requirements, that person may still have rights of a HDC derivatively. -A transferee of an instrument obtains any right of the transferor to enforce it, including any right as a HDC -A transferee who engaged in fraud or illegality cannot obtain HDC rights from transferor Person Not in Possession May Enforce a Lost/Stolen Instrument If: 1. Was in possession and entitled to enforce at time of loss 2. Loss was not from voluntary transfer or lawful seizure 3. Person cannot reasonably obtain possession Lost or Destroyed Checks 1. Claimant may assert a claim with the bank. 2. Must claim enforceability, must meet requirements: -must be the drawer or payee of the check -declaration of loss of the claimant with respect to the check -communication received at time and manner affording bank reasonable time to act -claimant provides reasonable ID if requested 3. When claim is enforceable, the bank is obligated to pay -----Liability of Signatories on the Instrument General -Liability on commercial paper is primarily promissory -Promisors liable on the promises they make

Signatures 1. Liability of Principal -When a Representative signs either his name or Principals name on the instrument Principal is bound to the extent he would be bound if the signature was on a simple contract -If Representative signs her name to an instrument, and it is an authorized signature of the Principal then the Principal is liable on the instrument whether or not hes identified on it. -If Representative signs and isnt authorized to do so may still be effective if Representative has ratified it. -Unauthorized signature by Representative may be estopped from bringing as a Defense against a subsequent HDC or person who pays the instrument in good faith. 2. Liability of Representative -If representative signs his name to an instrument, and its authorized signature of the Principal, then: 1. If the form of the signature unambiguously shows it is made on behalf of Principal and hes identified in instrument Representative not liable. 2. If the form of the signature does not -unambiguously show that it is made in a representative capacity or -clearly identify the Principal Representative is liable to a HDC who took the instrument w/o notice that the Representative was not intended to be liable, and the Representative is liable to any other person unless he proves that the original parties did not intend her to be liable. Unauthorized Signatures -Where a person signs someone elses name without authority the signature does not operate as the signature of the person whose name is signed, but does operate as the signature of the unauthorized signer, as long as the person who pays the instrument or takes it for value acts in good faith. Liability of the Maker of the Note -The Maker or Issuer of a Note must pay the amount promised when the instrument becomes due, unless she has a defense. -The Maker is obliged to pay the instrument according to its terms at the time it was issued, or if not issued, at the time it first came into possession of a holder. -Primary Liability there are no conditions to her liability -Suit may be instituted even when no demand for payment has been made. However, where the note is payable on a particular date, the Payees cause of action does not accrue until the day after the due date. Liability of the Drawer of a Draft -NOT the Maker -Has somewhat same position of the Maker, but Drawer does not make any express promise to do anything he is merely ordering the drawee to pay -Does not have primarily liability. However, there is liability when the Drawee fails to pay. -Secondary Liability The drawer becomes liable only if there has been: 1. Presentment to the Drawee 2. Dishonor by the Drawee, and

3. Notice of the Dishonor to the Drawer. Liability of the Drawee of a Draft/Acceptor (Bank) -Initially, the Drawee on a draft has no liability to the Payee or a subsequent holder. The instrument is simply an order to the Drawee. -The Drawees liability, if any, for wrongfully dishonoring the instrument (refusing to pay when it should pay) runs only to the Drawer and must be based upon some contract between the Drawer and the Drawee -If the Drawee accepts the draft it becomes liable as an Acceptor. -Acceptance is a promise by the Drawee to pay the instrument when it becomes due and payment is demanded. -Acceptance is made on the instrument and may be made simply by the Drawees signature. The instrument becomes effective when it, with acceptance, is delivered. The most familiar type of acceptance is the certification of a check. Transferors- Warranties -The Transferor of a negotiable instrument who receives consideration warrants to his immediate transferee that: 1. The Transferor is entitled to enforce the instrument 2. All signatures are authentic and authorized 3. The instrument has not been altered 4. The instrument is not subject to defenses 5. The transfer has no knowledge of insolvency proceedings -If the Transferor does not indorse the instrument then the warranties run only to the immediate transferee. -If the Transferor does indorse then the warranties run to all subsequent holders who take the instrument in good faith. Indorsers -If the Transferor of an instrument indorses the indorser becomes liable to pay the instrument if upon demand, the maker or drawer does not pay and the Indorser is given notice of the refusal to pay. -Secondary Liability and will be discharged from his obligation unless there is presentment, dishonor, and notice of dishonor. -Indorser may disclaim liability on her indorsement by giving a qualified indorsement. Writing without recourse -However, he may still remain liable on transfer warranties. Accommodation Parties (Surety) -One who signs a commercial paper that is issued for value simply to lend his credit to some party to the instrument, and who does not directly receive any of the value given. -Is liable on the instrument in the capacity in which he signs )maker, drawer, acceptor, or indorser), even though the one taking the instrument knows that he is an accommodation party. -Has no liability on the warranties of a Transferor because: 1. He does not transfer the instrument, and 2. He does not usually receive consideration. -An indorsement which shows that it is not in the chain of title (an anomalous indorsement) serves as notice to all subsequent takers that the indorsement is for accommodation.

Joint and Several Liability -Except as otherwise provided in the instrument, 2 or more persons who have the same liability on an instrument as makers, drawers, acceptors, indorsers who indorse as joint payees, or anomalous indorsers are jointly and severally liable in the capacity in which they sign. Liability Overview -Maker Primary -Drawer Secondary -Drawee -Without Acceptance Secondary -With Acceptance Primary -Indorser Secondary -Accommodation Party Depends on what capacity the party signed. --Presentment and Dishonor Conditions Precedent -Conditions precedent to a partys liability on the instrument may include presentment and, fo r certain parties with secondary liability, dishonor of the instrument and notice of dishonor. Presentment -Presentment for payment is a particular type of demand on the party who ought to pay the instrument the Maker of a Note or the Drawer of a Draft. -The demand for payment must be made on time. -Presentment must be made: 1. On or after the date stated in the instrument, if a date is stated; or 2. Within a reasonable time after the person to be charged becomes liable on the instrument. When Presentment is Excused: 1. The person entitled to present the instrument cannot with reasonable diligence make presentment 2. The Maker or Acceptor has repudiated an obligation to pay the instrument or is dead or in insolvency proceedings 3. By the terms of the instrument, Presentment is not required to enforce the obligation of indorsers or the drawer. 4. The Drawer or Indorser whose obligation is being enforced has waived Presentment or otherwise has no reason to expect, or right to require, that the instrument be paid or accepted; or 5. The Drawer instructed the Drawee not to pay or accept the draft, or the Drawee was not obligated to the Drawer to pay the draft. Presentment Warranties: -If an unaccepted draft is presented to the Drawee for payment or acceptance and the Drawee pays or accepts the draft, the person who presented and obtained payment, as well as any previous transferor of the draft, warrants to the Drawee that: 1. The warrantor is, or was at the time of transfer, a person entitled to enforce the draft 2. The draft has not been altered, and 3. He has no knowledge that the Drawers signature is forged.

Dishonor and Notice of Dishonor Generally -Dishonor: occurs when a proper Presentment for payment is made and payment is refused. I -It also occurs when a required or optional presentment for acceptance is made and acceptance is refused. -Dishonor does not occur when payment is refused because the instrument lacks a necessary indorsement Checks -A check that is duly presented for payment to the payor bank other than for immediate payment over the counter (ex: for deposit) is dishonored if Payor bank: 1. Makes timely return of the check 2. Sends timely notice of dishonor or nonpayment, or 3. Becomes accountable for the amount of the check. -The check must be returned before the bank has made final payment and before the midnight deadline (midnight of the next banking day following the day on which the instrument was received). Demand Instruments Other than Checks -A note payable on demand is dishonored if Presentment is duly made to the Maker and the note is not paid on the day of presentment -A draft payable on demand (ex: a check presented for immediate payment or a demand draft other than a check) is dishonored if Presentment is duly made to the Drawee and the draft is not paid on the day of Presentment Instruments Payable at a Definite Time -A note that is not payable on demand and is payable at or through a bank is dishonored if Presentment is duly made and the note is not paid on the day it becomes payable or the day of Presentment, whichever is later. -A note that is not payable on demand and is not payable at or through a bank is dishonored if it is not paid on the day it becomes payable -A draft payable on a date stated in the draft is dishonored if Presentment for payment is duly made to the drawee and payment is not made on the day the draft becomes payable or the day of presentment, whichever is later. Notice of Dishonor -Notice of Dishonor may be given by any commercially reasonable means, such as a phone call, letter, or electronic communication. -Time of Notice Notice of dishonor must be given by a collecting bank before the midnight deadline (unless excused), and by any other person within 30 days following the day on which the person receives notice of dishonor. -Delay: Delay in giving notice of dishonor is excused if: 1. The delay was caused by circumstances beyond the control of the person giving notice, and 2. The person giving the notice exercised reasonable diligence after the cause of the delay ended.

Warranties: Transfer vs. Presentment -Transfer Warranties -Runs from Transferor to Immediate Transferee only, unless instrument indorsed -Entitled to enforce the instrument -The instrument has not been altered -All signatures are authentic and authorized -The instrument is not subject to any defense -No knowledge of any insolvency proceedings -Presentment Warranties -Runs from Person Presenting and All Previous Transferors to Drawee -Entitled to enforce the instrument -The instrument has not been altered -No knowledge of forgery Actions to Enforce the Instrument Burdens of Proof -Validity of Signatures: The authenticity of and authority to make each signature on an instrument is admitted unless specifically denied in the pleadings. If the validity of a signature is put into question, the burden of establishing its validity is upon the person claiming that it is valid. -Plaintiffs Status: The P must not only show that all necessary signatures are valid but also that he is entitled to enforce the instrument or is authorized to seek payment on behalf of a person who is entitled to enforce the instrument -Defenses or Claims in Recoupment: If the validity of signatures is admitted or proved, and if the P proves that he is entitled to seek enforcement of the instrument the burden shifts to the D to prove a defense or claim in recoupment. -HDC Status: If a defense or claim in recoupment to the obligation sued upon is proved, the party claiming to be HDC has the burden of establishing HDC status. Adverse Claims -A Person taking an instrument is subject to claims of property or possessory rights in the instrument or its proceeds, including claim to rescind the negotiation and to recover the instrument or its proceeds. -HDC takes the instrument free from all claims to it by others. Real Defenses -Generally: The defenses that an obligor on an instrument may raise depend on the status of the P. HDC takes free of all personal defenses, but is subject to real defenses. -Infancy: The minority of the D is always a real defense and is available even as against a HDC. The extent to which the defense is available is the same as under K law. The effect is to render the instrument voidable, but not void. -Duress, Capacity, Illegality: Duress, Lack of Legal Capacity, and Illegality of the Transaction are real defenses only when they are said to render the contract void. If the effect is merely to

render the obligation voidable at the election of the obligor, the defense is cut off against a HDC and is only a personal defense. -Fraud in the Factum -Fraud in the Factum: Is fraud that induced the party to sign the instrument with neither knowledge nor reasonable opportunity to learn of the instruments character or essential terms. -Fraud in the Inducement: Is not a real defense. The distinction lies in whether the individual signing knew that he was signing a NI. -Discharge in Insolvency Proceedings: Insolvency proceedings are any assignment for the benefit of creditors or other proceedings intended to liquidate or rehabilitate the estate of the person involved. A discharge in an insolvency proceeding is a real defense available against a HDC. -Discharges of Which the Debtor Has Notice: A discharge of a partys obligation is not a defense to a HDC unless the holder has notice of the discharge when he takes the instrument. Personal Defenses -Personal Defenses: Defenses other than real defenses. These cannot be asserted against an HDC. -Other than in the case of an accommodation party, a party may not assert defenses or claims of another person unless the other person is joined in the action and personally asserts the claim against the person seeking to enforce the instrument. -Contract Defenses: The person entitled to enforce the instrument may assert any defense that would be available if that person were enforcing a right to payment under a simple contract. -Non-Issuance/Conditional Issuance/ Issuance for a Special Purpose : If an instrument is conditionally issued or is issued for a special purpose, failure of the condition or special purpose to be fulfilled is a defense. -Failure of Consideration: The maker or drawer of an instrument has a defense if the instrument is issued without consideration sufficient to support a simple K. -Not Title/Lost or Stolen Instrument: The defense of not title arises where the P in the action cannot trace his title back to the obligor. If the obligor proves that the instrument is a lost or stolen instrument, the obligor is not entitled to pay the instrument unless the person seeking to enforce it is a HDC.

Defenses: Real vs. Personal Real Defenses -Infancy -Duress -Lack of Legal Capacity -Illegality of the Transaction -Fraud in the Factum -Discharge in Insolvency Proceedings -Discharge of which Debtor has Notice Personal Defenses -Contract Defenses -Non-Delivery -Conditional Delivery -Delivery for a Special Purpose -Failure of Consideration -No Title/ Lost or Stolen Instrument

Discharge -Discharge: is a personal defense. A partys obligation on a NI may be discharged in a number of ways. Discharge is only effective against a HDC if the holder has notice of discharge. -May be effected: 1. By an act or agreement that would effect a discharge of an obligation to pay money under a simple K. 2. By payment by or on behalf of a party obliged to pay the instrument, to a person entitled to enforce the instrument; 3. By tender of an instrument in satisfaction of a claim 4. By tender of payment 5. By cancellation or renunciation 6. By impairment, extension, or modification, as applied to an accommodation party 7. By reacquisition 8. By delay in presentment 9. By acceptance varying the terms of a draft 10. By failure to give notice of dishonor (as to indorser) 11. By acceptance of a draft by a bank, or 12. By alteration Alterations -Alteration: is an unauthorized change in an instrument that purports to modify a partys obligation, or an unauthorized addition to an incomplete instrument relating to a partys obligation. -When the alteration is fraudulent a part a party whose obligation is affected by the alteration is discharged, except as to HDC, unless the party raising the defense is estopped from raising it. Even where the alteration is fraudulent, a HDC may enforce it to its original tenor. -When the alteration is not fraudulent no person is discharged and the instrument may be enforced as to its original tenor even by a non-HDC. -Where the alteration consists of an unauthorized completion then a HDC may enforce it as completed.

-A person whose negligence substantially contributed to an alteration is precluded (estopped) from raising the alteration as a defense against a person who, in good faith, paid the instrument or took it for value or for collection. Forgery -Forgery: is available as a defense even as against a person who in good faith fays the instrument or takes it for value it is of the nature of a real defense. -However, where a forgery exists, or where an agent signs without authority the forger or agent becomes liable, just as thought he had signed his own name, to a HDC. -If the partys negligence substantially contributed to the unauthorized signature, he is estopped from raising it as against an HDC. Defenses: Discharge vs. Alteration vs. Forgery

Discharge

Alteration

Forgery

Definition

Release of obligation instrument

a partys on an

Unauthorized change or addition modifying an obligation Personal Defense

Unauthorized signature on an instrument

Type of Defense

Personal Defense

Real Defense

Availability Against HDC

Against HDC if holder had notice of the discharge

Not available against HDC

Available against HDC for person whose name is signed unless estopped Not available for forger against HDC

Defenses of Accommodation Parties -Derivative Defenses: In an action to enforce the obligation of an accommodation party to pay an instrument, the accommodation party may assert against the person entitled to enforce the instrument any defense or claim in recoupment that the accommodated party could assert against such person, except the defenses of discharge in insolvency, infancy, and lack of legal capacity. -Suretyship Defenses: -If the due date of an instrument is extended, the instrument is modified, or the value of collateral is impaired by a person entitled to enforce the instrument and, as a result, an accommodation party suffers a loss with respect to its right of recourse against an accommodated party, the accommodation partys obligation is discharged to the extent of the loss.

-An accommodation party is not discharged if: 1. The person entitled to enforce the instrument did not know of or have notice of the accommodation 2. The accommodation party consents to the event or conduct that is the basis of the discharge, or 3. The accommodation party has waived any defenses that could be the basis for discharge.