Ch. 25: Negotiable Instruments & Ch. 26: Transferability and HDC
(25-3 Promissory Notes) A college student, Austin Keynes, wished to purchase a new entertainment system from Friedman Electronics, Inc. Because Keynes did not have the cash to pay for the entertainment system, he offered to sign a note promising to pay $150 per month for the next six months. Friedman Electronics, eager to sell the system to Keynes, agreed to accept the promissory note, which read, "I, Austin Keynes, promise to pay to Friedman Electronics or its order the sum of $150 per month for the next six months." The note was signed by Austin Keynes. A week later, Friedman Electronics, which was badly in need of cash, signed the back of the note and sold it to the First National Bank of Halston. Give the specific designation of each of the three parties on this note.
Keynes - maker Friedman - payee First National Bank - holder (transferred to them) when Friedman transferred the note to the bank by signing the back = Indorser Bank = Indorsee
Mario makes a check payable to "cash," intending to withdraw money from his bank. Kirby takes the check from Mario's notebook and gives it to Nathan in payment for a debt, telling him it is a good check. Who has rights to the check?
Nathan has rights to the check because he is an innocent third party, and when Kirby transferred the check to him negotiation of the check as a bearer instrument was complete. (delivery was executed)
Example of negotiable vs. non-negotiable extension interval:
Negotiable - "The holder of this note at the date of maturity, January 1, 2026, can extend the time of payment until the following June 1 or later, if the holder so wishes." - length of extension does NOT have to be specified bc option to extend is solely of the holder Non-negotiable - "The maker has the right to postpone the time of payment of this note beyond its definite maturity date of January 1, 2026. This extension, however, shall be for no more than a reasonable time." - not negotiable bc does NOT satisfy the definite-time requirement - the right to extend is the maker's & the maker has NOT indicated when the note will be due after extension
Negotiable Vs. Nonnegotiable instruments
Negotiable - special requirements relating to form & content must be met - governed by the UCC Nonnegotiable - governed by common law
Ben contracts with Amy to fix her roof. Amy writes Ben a check, but Ben never makes the repairs. Carl knows Ben breached the contract but cashes the check anyway. Can Carl become an HDC? Why or why not?
No - one of the requirements of HDC: holder must have performed the promise for which the instrument was issued --> Ben did NOT perform Carl took instrument from Ben and cannot be protected as an HDC
(26-2 HDC) Through negotiation, Emilio has received from dishonest payees two checks with the following histories: a) The drawer issued a check to the payee for $9. The payee cleverly altered the numeral amount on the check from $9 to $90 and the written word from "nine" to "ninety." b) The drawer issued a check to the payee without filling in the amount. The drawer authorized the payee to fill in the amount for no more than $90. The payee filled in the amount of $900. Discuss whether Emilio, by giving value to the payees, can qualify as a holder in due course of these checks.
Only issue - requirement #3 (did he take notice of defect?) a) Yes - Emilio can qualify as an HDC - no notice of defect - unauthorized alteration b) Yes - can qualify as an HDC - no knowledge of payee's unauthorized actions
How Indorsements can convert Order Instruments TO Bearer Instruments
Order paper: convert to Bearer paper by BLANK indorsement Bearer paper: convert to Order paper by SPECIAL indorsement
Example of trust indorsement:
Raj Gupta asks his accountant, Stephanie Malik, to pay some bills for him while he is out of the country. Gupta indorses his payroll check to Stephanie Malik "as agent for Raj Gupta." This trust (agency) indorsement obligates Malik to use the funds only for the benefit of Gupta.
Example of Blank indorsement:
Rita Chou indorses in blank a check payable to her order and then loses it on the street. If Schaefer finds the check, he can sell it to Duncan for value without indorsing it. This constitutes a negotiation because Schaefer has made delivery of a bearer instrument (which was an order instrument until it was indorsed in blank).
Example of HDC:
Shanna Morrison buys a BMW X3 SUV for her business from Heritage Motors in Irvine, California, signing a promissory note for $50,000 as part of the deal. Heritage negotiates the note to Apollo Financial Services, which promises to pay Heritage for it in six months. During the next two months, Morrison has significant problems with the SUV and sues Heritage for breach of contract. She also refuses to make further payments on the note. Whether Apollo can hold Morrison liable on the note depends on whether it has met the requirements for HDC status. If Apollo has met these requirements and thus has HDC status, it is entitled to payment on the note. If Apollo has not met the requirements, it has the status of an ordinary holder, and Morrison's defense against payment to Heritage will also be effective against Apollo.
A Qualified indorsement can be accompanied by a Special or a Blank indorsement.
Special Qualified Indorsement - includes the name of the indorsee as well as the words "without recourse" - order instrument (required indorsement & delivery for negotiation) Blank Qualified Indorsement - bearer instrument (only delivery required) - "without recourse, [signed] Diana Medrano"
Shelter Principle
States that a holder can get HDC status if he/she acquires an instrument through an HDC; - allows a person who does not qualify as a HDC but who derives his or her title through a HDC to acquire the rights and privileges of a HDC, whether or not the transfer was a negotiation.
Charles R. Tips Family Trust v. PB Commercial, LLC (words > figures)
The Charles R. Tips Fam Trust signed a promissory note in favor of Patriot Bank to obtain a loan to buy a house in Harris County, Texas. The note identified the principal amount of the loan as "ONE MILLION SEVEN THOUSAND AND NO/100 ($1,700,000.00) DOLLARS." ($1,007,000 written and the numerals, $1,700,000.) Court Ruling: ruled that words prevail over numerals; therefore, the "one million seven thousand" counted over the $1,700,000 numerals as the amount of the promissory note
Factors that don't affect Negotiability
(still a negotiable instrument) 1. Date - undated instruments do not affect negotiability - unless the date is necessary to fix the time for payment 2. Postdating or Antedating an instrument - antedating: when a party puts a date on an instrument that is BEFORE the actual calendar date - postdating: when a party puts a date on an instrument that is AFTER the actual date 3. Handwritten terms outweigh typewritten & printed terms - typewritten > printed terms 4. Words outweigh figures unless words are ambiguous - example: Reirson issues a check payable to Reliable Appliance Company. For the amount, she fills in the number "$100" but writes out the words "One thousand and 00/100" dollars. The check is payable in the amount of $1,000. 5. If instrument states "with interest" but does NOT specify a particular interest rate, the interest rate is the judgement rate of interest (int fixed by statute) 6. Notation of non-negotiable - check: no effect, still negotiable - any other instrument: non-negotiable
Types of Drafts
Time Draft - payable at a definite future time Sight Draft - or demand draft - payable on sight or on acceptance Trade acceptances - draft frequently used in the sale of goods - the seller of the goods is BOTH the drawer & the payee
5. Be payable on demand or at a definite time
*Payable on Demand* - "payable at sight" - "payable upon presentment" (presentment occurs when a person brings the instrument to the appropriate party for payment or acceptance) - checks are payable on demand - if no payment is specified, then it is payable on demand *Payable at a Definite Time* - if not payable on demand, the time for payment must be specified on the face of the instrument - an instrument is payable at a definite time if it states: ---that it's payable on a specified date ---that it's payable within a definite period of time after being presented for payment ---that it's payable on a date/time readily ascertainable at the time the promise or order is issued
3. Taking without notice of a defect (req. of HDC)
*if know or have reason to know that the instrument is defective --> CANNOT be an HDC* if holder does NOT know --> can be an HDC examples of defects: 1. overdue instruments - when person takes a demand instrument knowing that demand already has been made - time instruments: overdue on day after it's due 2. dishonored instruments - when party to whom the instrument is presented refuses to pay it - holder that knows/has reason to know that an instrument is dishonored, cannot claim HDC - insufficient funds 3. unauthorized signature (forgery) or instrument has been altered 4. another claim to instrument or defense against instrument 5. instrument is so irregular or incomplete to make authenticity suspect - incomplete: element of negotiability missing - irregularity: obvious things in face of instrument like forgery or alteration
Any instrument containing terms such as the following is a bearer instrument:
- "Payable to the order of bearer." - "Payable to Simon Reed or bearer." - "Payable to bearer." - "Pay cash." - "Pay to the order of cash."
Qualified Indorsements
- Unqualified indorsements: the indorser will pay the holder or any subsequent indorser the amount of the instrument in the event the drawer or maker defaults on payment - *Qualified Indorsement:* indorser who does NOT wish to be liable on an instrument can use this --- *created when "without recourse" is added* --- used by agents acting on behalf
a common law assignment occurs when:
- a non-negotiable instrument is transferred to a 3rd party OR - a negotiable instrument is transferred improperly (not meet requirements)
4. State a fixed amount of money
- amount must be ascertainable from the face of the instrument - must be payable IN MONEY and no other promise
6. Be payable to the Order or to Bearer
- be payable to order or to bearer at time it's issued or first comes into the possession of the holder *Order Instruments* - instrument that's payable • "to the order of an identified person" or • "to an identified person or order" --- an identified person is the person whom the instrument is initially payable; they may transfer the instrument to whoever they wish = "Order" --- example: "Payable to the order of James Yung" or "Pay to James Yung or order." The maker/drawer has indicated that payment will be made to Yung or to whomever Yung designates. --- person must be named with specificity
2. Signed by the maker (note or CD) or drawer (draft or check)
- can be signed by an authorized agent - a signature (any - thumb, initials, etc.) - placement of signature is unimportant
4 types of Negotiable Instruments:
- drafts - checks - notes - certificates of deposit (governed by UCC)
(25-1 Negotiable Instrument) Sabrina Runyan writes the following note on a sheet of paper: "I, the undersigned, do hereby acknowledge that I owe Leo Woo one thousand dollars, with interest, payable out of the proceeds of the sale of my horse, Lightning, next month. Payment is to be made on or before six months from date." Discuss specifically why this is NOT a negotiable instrument.
- name of maker (Sabrina) is missing - no signature - maker did not make a definite promise to pay, just acknowledged the debt - conditional (proceeds of horse - sale has not happened) - no date specified ("from date") = NON-negotiable instrument
3. Be an Unconditional Promise or Order to Pay
- terms of the promise must be in the fact of the instrument - terms must also be unconditional (cannot be conditioned on the occurrence/nonoccurrence of an event) - promise/ order to pay: must be affirmative - an order must be a command ("please pay")
1. Be in writing
- writing must be on material that lends itself to permanence (ex- can't be written in sand) - writing must have portability (movable)
Requirements of a Negotiable Instrument:
1. Be in writing 2. Signed by the maker or drawer 3. Be an unconditional promise or order to pay 4. State a fixed amount of money 5. Be payable on demand or at a definite time 6. Be payable to the order or to bearer
Miscellaneous Indorsement Problems
1. Mispelled Names - if name on instrument is mispelled/incorrect, the indorsement can be the incorrect name, correct name or both 2. Instruments payable to entities - an authorized representative of the entity can negotiate the instrument 3. Multiple Parties - *Alternate payees*: joined by the word "or"; can be payable/indorsed by EITHER of the 2+ persons ---- "pay to the order of Mary or John" - *Joint payees*: joined by "and"; ALL of the payee's indorsements are necessary for negotiation
2 methods of Negotiating an instrument (so that the receiver becomes a holder):
1. Order Instrument 2. Bearer Instrument
4 Types of Indorsements:
1. blank 2. special 3. qualified 4. restrictive
2 classifications of Negotiable Instruments:
1. orders to pay - drafts - checks 2. promises to pay - promissory notes - CDs
Instruments that include an acceleration clause are negotiable b/c -
1. the exact value of the instrument can be ascertained 2. the instrument will be payable on a specified date if the event allowing acceleration does NOT occur (thus, the specified date is the outside limit used to determine the value of the instrument)
Example of order to bearer conversion:
A check is made payable to the order of Jessie Arnold. Arnold indorses it in blank by signing her name on the back. The instrument, which is now a bearer instrument, can be negotiated by delivery without indorsement. Arnold can negotiate the check to whomever she wishes merely by delivery, and that person can negotiate by delivery without indorsement. If Arnold loses the check after she indorses it, anyone who finds the check can negotiate it further.
Example of bearer instrument:
Alonzo Cruz writes a check payable to "cash," thus creating a bearer instrument. Cruz then hands the check to Blaine Parrington (a delivery). Parrington puts the check in his wallet, which is subsequently stolen. The thief now has possession of the check. At this point, the thief has no rights in the check. If the thief "delivers" the check to an innocent third person, however, negotiation will be complete. All rights to the check will pass absolutely to that third person, and Parrington will lose all right to recover the proceeds of the check from that person [UCC 3-306]. Of course, Parrington can recover his funds from the thief—if the thief can be found.
Requirements for HDC Status
An HDC *must be a holder* of a negotiable instrument & must have taken the instrument: 1. for value 2. in good faith, and 3. without notice that it is defective
(25-4 Bearer Instrument) Adam's checks are imprinted with the words "Pay to the order of" followed by a blank. Adam fills in an amount on one of the checks and signs it, but he does not write anything in the blank following the phrase "Pay to the order of." Adam gives this check to Beth. On another check, Adam writes in the blank "Carl or bearer." Which, if either, of these checks is a bearer instrument, and why?
Both instruments are bearer "Pay to the order of _______" - doesn't specify a payee, so anyone can cash it "Carl or bearer" - carl or any one else that presents it can cash t
Negotiable instruments may ALSO be classified as either demand instruments OR time instruments.
Demand Instrument - payable on demand or sight after it's issued - "issue" is the first delivery of an instrument by the maker or drawer Time Instrument - payable at a future date
1. Must take the instrument for value (req. of HDC)
Examples of value: - by performing the promise for which the instrument was issued or transferred - by acquiring a security interest or other lien in the instruments (other than lien obtained by a judicial proceeding) - by taking an instrument in payment of, or as security for, an antecedent (preexisting) claim ----example: Zon owes Dwyer $2,000 on a past-due account. Zon negotiates a $2,000 note signed by Gordon to Dwyer. If Dwyer accepts it to discharge the overdue account balance, Dwyer has given value for the instrument. - by giving a negotiable instrument as payment ----example: Paige needs cash, so Lexi gives value for the note by paying $2,000 in cash & issuing Paige a check for $3,000 (5k note)
Negotiating Bearer Instruments
If an instrument is payable to bearer, it's negotiated by 1. Delivery (by transfer into another person's possession) - Indorsement is NOT necessary The use of bearer instruments involves a greater risk of loss/theft than the use of order instruments
Blank Indorsements
Indorser does NOT specify a particular Indorsee (to whom it's payable to) & can consist of a mere signature - creates a *bearer instrument* (from order instr.) & can be negotiated by delivery - anyone can cash
Restrictive Indorsements
Indorser requires the indorsee to comply with certain instructions regarding the funds involved - "For deposit (or collection) only" - does NOT prohibit further negotiation of the instrument - only a BANK can become a holder 4 Types: 1. Indorsements to pay only a named payee 2. conditional indorsements 3. Indorsements for deposit or collection 4. trust (agency) indorsements
Example of bearer to order conversion:
Jessie Arnold takes the check that she indorsed in blank (now a bearer instrument) and negotiates it, by delivery, to Jonas Tolling. Tolling indorses the check "Pay to Mark Hyatt, [signed] Jonas Tolling." By adding this special indorsement, Tolling has converted the check into an order instrument. The check can be further negotiated only by indorsement (by Mark Hyatt) and delivery [UCC 3-205(b)].
Aurora needs to have her car's radiator replaced. She takes it to José, who makes the necessary repair. Aurora writes him a check to pay for the work. In this transaction, presentment occurs when:
Jose presents the check to Aurora's bank (for payment)
(25-2 Negotiability) Juan Sanchez writes the following note on the back of an envelope: "I, Juan Sanchez, promise to pay Kathy Martin or bearer $500 on demand." Is this a negotiable instrument? Discuss fully.
Yes, the instrument is negotiable b/c meets all requirements - - it's in writing - name of maker - unconditional promise - fixed amount of money - payable on demand - payable to order or bearer
Negotiable Instruments (commercial paper)
a *signed writing* that contains an *unconditional promise OR order to pay* an *exact/fixed sum of money* either on *demand or at an exact future date*
3. Indorsements for deposit or collection
a bank is almost always the collecting agent of the indorser (holder) "for deposit only" "for collection only" - have the effect of locking the instrument into the bank collection process - ONLY a bank can acquire rights of a holder
Holder in Due Course (HDC)
a holder who meets 3 additional requirements - receives a higher level of protection from defenses & claims asserted by other parties with the obligation to pay
Indorser
a person who transfers a note/draft by signing (indorsing) it & delivering it to another person
Indorsement
a signature with or without additional words/statements - required whenever an order instrument is negotiated - signature is most often written on the back of the instrument, but can be on a separate piece of paper attached called an allonge.
Assignment
a transfer of rights under a contract gives the assignee ONLY those rights that the assignor possessed
Checks
a type of draft - demand instruments - a draft drawn on a Bank & payable on demand 1. *Drawer* - writer of the check 2. *Drawee* - bank on which the check is drawn 3. *Payee* - person to whom the check is made payable to (gets payed)
Cerfiticate of Deposit (CD)
a type of note, issued by the bank issued when a party deposits funds w/ a bank & the bank promises to repay the funds, with interest, on a certain date to the note holder an investment tool *Maker* - the bank *Depositor* - payee
Promissory Notes
a written promise by 1 party to pay back borrowed money to another party - payable on demand OR a definite time *Maker* - party that makes the promise *Payee* - party that gets payed
1. Indorsements to pay only a named payee
"Pay to Julie Diaz only, [signed] Thomas Fasulo" - same legal effect as special indorsement, negotiable
Negotiation
the transfer of an instrument in such form that the transferee becomes a "holder" a "holder" receives the rights of the previous possessor - can make it possible for a holder to receive MORE rights in the instrument than the prior possessor had - a holder that receives more rights: *Holder in Due Course*
CDs are -
time deposits the purchaser-payee is NOT allowed to withdraw the funds before the date of maturity, if they want to, they can sell/negotiate the CD to a 3rd party
Holder
when an instrument is transferred, a holder obtains ONLY those rights that the transferor had in the instrument person in possession of an instrument - has same status as an assignee - subject to the same defenses that could be asserted against the transferor
2. Conditional indorsements
when payment depends on the occurrence of some even specified in the indorsement --> conditional example: "Pay to Lars Johansen if he completes the renovation of my kitchen by June 1, 2026, [signed] Keenan Barton." - if condition is on the FACE of the instrument --> not negotiable b/c does NOT meet the requirement that a negotiable instrument must contain an unconditional promise to pay - condition must be in back of instrument
(26-1 Indorsements) A check drawn by Cullen for $500 is made payable to the order of Jordan and issued to Jordan. Jordan owes his landlord $500 in rent and transfers the check to his landlord with the following indorsement: "For rent paid, [signed] Jordan." Jordan's landlord has contracted to have Deborah do some landscaping on the property. When Deborah insists on immediate payment, the landlord transfers the check to Deborah without indorsement. Later, to pay for some palm trees purchased from Better-Garden Nursery, Deborah transfers the check with the following indorsement: "Pay to Better-Garden Nursery, without recourse, [signed] Deborah." Better-Garden Nursery sends the check to its bank indorsed "For deposit only, [signed] Better-Garden Nursery." a) Classify each of these indorsements. b) Was the transfer from Jordan's landlord to Deborah, without indorsement, an assignment or a negotiation? Explain.
a) - "For rent paid, Signed Jordan" - blank indorsement - "Pay to Better-Garden Nursery, without recourse, [signed] Deborah." - special qualified indorsement - "For deposit only, [signed] Better-Garden Nursery." - restrictive indorsement b) Negotiation - the landlord got bearer paper from Jordan (for rent paid, signed jordan) and he delivered it to Deborah, which is the only requirement for bearer paper
(26-3 Negotiation) Bertram writes a check for $200 payable to "cash." He puts the check in his pocket and drives to the bank to cash the check. As he gets out of his car in the bank's parking lot, the check slips out of his pocket and falls to the pavement. Jerrod walks by moments later, picks up the check, and later that day delivers it to Amber, to whom he owes $200. Amber indorses the check "For deposit only, [signed] Amber Dowel" and deposits it into her checking account. In light of these circumstances, answer the following questions: a) Is the check a bearer instrument or an order instrument? b) Did Jerrod's delivery of the check to Amber constitute a valid negotiation? Why or why not? c) What type of indorsement did Amber make? d) Does Bertram have a right to recover the $200 from Amber? Explain.
a) bearer b/c no payee name b) Yes b/c delivery is the only requirement for bearer paper c) Restrictive indorsement d) No, Bertram can't recover the $200 from Amber. When Jerrod delivered the check to the creditor, ALL rights in the checked passed to the creditor.
Acceleration Clause
allows a payee/holder (one that lends) of a time instrument to demand payment of the entire amount due, with interest, if a certain event occurs - a "holder" is any person in possession of a negotiable instrument that is payable to the bearer or to an identified person that is the person in possession (receives amount)
Bearer Instruments
an instrument that does NOT designate a specific payee bearer - person in possession of an instrument that is payable to bearer or indorsed in blank (w/ signature only) - the maker or drawer agrees to pay anyone who presents the instrument for payment
Drafts
an unconditional written order with 3 parties. an order by 1 person to another person 1. *Drawer* - the party who creates the order to pay & signs it 2. *Drawee* - the party whom the order is made for (to pay payee) 3. *Payee* - the party who receives the money
How can a negotiable instrument function as?
as a substitute for cash OR an extension of credit example: - checks you receive are negotiable instruments that act as a sub for cash. - the promissory note that you signed to obtain a loan is a neg. inst. that functions as an extension of credit
whenever a transfer fails to qualify as a negotiation b/c it fails to meet 1+ requirements of a negotiable instrument, it's treated as an -
assignment
For a negotiable instrument to operate practically as a sub for cash or credit device, it's essential that it can -
be easily TRANSFERABLE w/o danger of being uncollectible
(Beg Ch. 26) How can a negotiable instrument be transferred to others?
by assignment OR by negotiation
Special Indorsements
contains the signature of the Indorser & identifies the Indorsee (person to whom the indorser intends to make the instrument payable to) "Pay to the order of Russell Clay" "Pay to Russel Clay" - creates an *order instrument* (negotiation requires indorsement & delivery) - to avoid risk, blanks are converted to special indorsements by holder
Limitations on the Shelter Principle
if a holder participated in fraud/illegality affecting the instrument --> NOT allowed to improve status by repurchasing the instrument from a later HDC if a holder disqualifies as an HDC, and then reacquires the instrument after an HDC in order to get HDC status --> CANNOT be an HDC
4. Trust (agency) indorsements
indorsements to persons who are to hold or use the funds for the benefit of the indorser or a 3rd party Result: - legal rights in the instrument are transferred to the original indorsee - original indorsee has a duty to use the funds only for the benefit of the indorser: fiduciary duty
Is Value = Consideration?
no - if a person promises to perform/give value in the future, rather the present, that person is NOT an HDC - a promise of payment/performance in the future (executory promise) is value ONLY to the extent that pmt/performance has been PERFORMED
is a promissory note a debt?
no only the evidence of a debt
Claude creates and signs a promissory note. He promises to pay Audrey 1,000 euros plus $500-worth of custom made shirts on October 15, in exchange for Audrey's help in renovating his kitchen. The note is:
nonnegotiable, bc it calls for payment in shirts
Negotiating Order Instruments
order instrument --> contains the NAME of a PAYEE capable of indorsing as in "Pay to the order of Jamie Fowler" Requirements: 1. indorsement (signature) 2. delivery (giving it to the teller) example: if NOT signed, then it's not negotiable - it would be treated as an assignment & bank would become assignee rather than holder
Extension Clause
reverse of an acceleration clause allows the date of maturity (due date) to be extended into the future - if the extension interval is *given to the maker/drawer*, it MUST be specified to be negotiable - if the extension interval is *given to the holder*, it need NOT be specified to be negotiable
Acceptance
the drawee's written promise to pay the draft when it comes due
2. Taking in Good faith (req. of HDC)
the holder must have acted honestly in the process of acquiring the instrument applies ONLY to the holder no clear guidelines exits on determination of good faith
Indorsee
the person to whom the check is indorsed and delivered to