The Legal Environment Of Business

UCC Articles 3 & 4 Outline

1. Types of Negotiable Instruments

1. Drafts

1. Three party instruments. Drawer orders drawee to pay the payee
2. Can be paid at a definite time in the future. If the draft is negotiable, then the instrument is called a negotiable time draft.
3. Can be paid on demand (also known as presentment). A check can be called a demand draft. Banks are drawees of a check
4. A trade acceptance is a type of draft that is used in the sale of goods. Here the seller is both the drawer and payee, while the buyer become the drawee by accepting the goods
5. A draft is an order to pay

1. Promissory Notes

1. Two party instruments. The maker/promisor promises to pay the payee either on demand or at a time in the future
2. A bank CD is not a draft. The CD is a type of note

1. The following are not forms of negotiable instruments under Article 3

1. Investment Securities (covered under Article 8)
2. Warehouse Receipts (covered under Article 7)
3. Money (currency) (The purpose of negotiable instruments is to act as a substitute for money)

1. Negotiability (3-104) (in order to tell if an instrument is negotiable, the holder of the note must look to the face of the instrument. Under 3-104 the instrument must meet the following requirements in order to be negotiable)

1. Be in WRITING
2. Be SIGNED by the maker of the note or the drawer of the check
3. Be an UNCONDITIONAL promise (note) or order (draft) to pay.

1. Negotiable

1. If the instrument refers how the transaction arose. The instrument would be nonnegotiable if the instrument was governed or conditioned on the transaction
2. If an instrument is secured by a mortgage, the instrument is still negotiable

1. Sum Certain in Money
2. Be PAYABLE ON DEMAND or at a DEFINTIED TIME
3. Be PAYABLE TO ORDER or to BEARER

1. Bearer paper – General Rule is that bearer paper will contain the word "Bearer"
2. Order Paper – General Rule is that order paper should be issued to a specific named person with the words "or to his order" The Revised Article does not require the draft to be "payable to order’" the instrument may day "Pay To"

1. Transfer and Negotiation

1. General Rules

1. In order to negotiate order paper, there must be endorsement and delivery
2. In order to negotiate bearer paper, there must be delivery

1. Endorsement

1. General Rules

1. Since endorsements appear in the back of an instrument, endorsements cannot change the negotiability of an instrument.
2. Since no one is liable on an instrument unless his/her name appears on it, endorsements are used to create liability. Hence, the transferees can demand the unqualified endorsement of their immediate transferor

1. Types of Endorsement

1. Blank – Changes order paper to bearer paper
2. Special – Changes bearer paper to order paper
3. Qualified, e.g. "Without recourse" – a qualified endorsement that negate contract liability and limits certain transfer warranties to knowledge warranties
4. Restrictive – Does not change the negotiability

1. Holder in Due Course (CORE OF ARTICLE !!!!!!!!!)

The central question of Article 3 is to determine if the holder of an instrument is a HDC. The HDC is in a stronger position and subject to fewer defenses than a mere holder. In addition, the HDC can pass their status to other transferees under the "Shelter Principle."

1. Creation of HDC

1. A HOLDER – Under 1-201 (20) a holder is a person in possession of a negotiable instrument and who has good title. In other words, the instrument contains all necessary signatures, and there are no forgeries. If the instrument contains a forgery, then no one can be a holder since the potential holder does not have good title. If not one can be a holder, then no one can be a HDC.
2. Of a NEGOTIABLE INSTRUMENT
3. Who takes the instrument for VALUE
4. In GOOD FAITH
5. And WITHOUT NOTICE that the instrument is

1. OVERDUE, or
2. Has been DISHONORED, or
3. Any DEFENSE or CLAIM to it on the part of any person

1. Defenses – A HDC is subject to "universal" or "real" defenses, but is not subject to "personal" defenses. (KNOW THESE!!!!!!!!!!)

1. Real or Personal Defenses (HDC is subject to and hence, loses)

1. Infancy, Incapacity, Duress and Illegality (UCC 3-305(2)(a) and (b))
2. Forgery (execution by one who is without authority to sign)
3. Discharge in Bankruptcy
4. Fraud in the Execution (Differs from "Fraud in the Inducement) (In Fraud in the Execution, the signer of the instrument has been deceived to believe the instrument they signed is not a negotiable instrument, e.g someone wants your autograph, but you just signed a promissory note. This is Fraud in the Execution and a HDC would lose).
5. Material Alteration – While a HDC is subject to the defenses of a material alteration in the cases of a raised amount, the HDC is still an HDC for the original amount of the instrument

1. Personal Defenses (HDC is not subject to, and hence, wins!)

1. Breach of contract
2. Non-performance of a condition precedent
3. Lack of consideration
4. Wrongful filling of a blank payable amount by the issuer
5. Stolen instrument or other claims of ownership
6. Fraud in the Inducement (e.g the Seller fraudulently induces a commercial buyer to sign a contract for aluminum siding, when infact the siding is made out of cardboard. An HDC is not subject to this type of fraud and can still demand payment. The commercial buyer’s recourse is to sue the salesman)

1. The Shelter Principle – If a person can trace their ownership back to an HDC, then the person will have the rights of an HDC (e.g a transferee who receives the instrument as a gift)

1. Liability

1. Contract Liability – General Rule is that no one has contract liability on the instrument unless their signature appears

1. Primary Liability – a party who has primary liability is required to pay the original tenor of the instrument

1. The maker of a promissory note is primarily liable
2. The acceptor of a draft (when a bank certifies a check) is primarily liable. No one is primarily liable on a check at issue!

1. Secondary Liability – here the party is not immediately liable on the instrument

1. Who is liable?

1. Drawers
2. Endorsers

1. Discharge

1. Discharge by Payment
2. Discharge by Renunciation (This absolute surrender of rights to the instrument must be in writing)
3. Certification (Certification by the bank discharges the drawer and any prior endorsers, if certification is asked by the holder. If the drawer requests certification, then the drawer remains secondarily liable

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Index on Class Notes

MBLW 600

AMBA 740

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