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Chapter 23

Negotiable Instruments

INTRODUCTION

Article 3 of the Uniform Commercial Code (UCC) governs the transfer of negotiable instruments. Because the holder of a negotiable instrument may enjoy greater rights than the holder of a nonnegotiable instrument, it is im-portant for your students o understand the distinctions between these two types of instruments. This chapter examines the essential features of various instruments that qualify as negotiable and the roles and responsibilities of the parties who create these instruments.

Also, this chapter examines the process of negotiation—that is, the transfer of negotiable instruments from one person to another. In particular, the chapter discusses the requirements for a negotiable instrument, some of the omissions and terms that do not affect an instrument’s negotiability, and the types of indorsements that are required whenever certain types of instruments are being negotiated. This chapter also notes some common indorsement problems that may arise during the process of negotiation, as well as the consequences of various types of indorse-ments.

CHAPTER OUTLINE

I. Types of Negotiable InstrumentsA. DRAFTS AND CHECKS (ORDERS TO PAY)

A draft is an unconditional written order.

1. Time Drafts versus Sight DraftsA time draft is a draft payable at a definite future time. A sight (or demand) draft is payable on sight.

2. Acceptances

• A trade acceptance is a draft often used in sales of goods. The seller is both the drawer and the payee, and the draft orders the buyer to pay a specified sum of money to the seller, usually at a stated time in the future.

• A banker’s acceptance (often used in international trade deals) orders the buyer’s bank to pay.

3. ChecksA check is a draft, drawn on a bank and payable on demand.

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2 UNIT THREE: COMMERCIAL TRANSACTIONS

B. PROMISSORY NOTES (PROMISES TO PAY)A promissory note (or simply note) is a written promise between two parties. Notes are used in a num-ber of credit transactions and often bear the name of the transaction involved.

C. CERTIFICATES OF DEPOSIT (PROMISES TO PAY)A certificate of deposit (CD) is a type of note issued by a bank.

BASIC TYPES OF NEGOTIABLE INSTRUMENTS

INSTRUMENTS CHARACTERISTICS PARTIES

ORDERS TO PAY

Draft

Check

An order by one person to another person or to bearer [UCC 3–104(e)].

A draft drawn on a bank and payable on demand [UCC 3–104(f)].a Checks include:

a. Cashier’s check—a draft in which the drawer and drawee are the same bank [UCC 3–104(g)].

b. Teller’s check—a draft drawn by a bank on another bank or payable at or through another bank [UCC 3–104(h)].

c. Traveler’s check—an instrument drawn or payable at or through a bank that requires, as a condition to payment, a countersignature by a person whose signature appears on the instrument [UCC 3–104(i)].

Drawer—the person who signs or makes the order to pay [UCC 3–103(a)(3)].

Drawee—the person to whom the order to pay is made [UCC 3–103(a)(2)].

Payee—the person to whom payment is ordered.

PROMISES TO PAY

Note

Certificate of deposit

A promise by one party to pay money to another party or to bearer [UCC 3–104(e)].

A note made by a bank acknowl-edging a deposit of funds made payable to the holder of the note [UCC 3–104(j)]. b

Maker—the person who promises to pay [UCC 3–103(a)(5)].

Payee—the person to whom the promise is made.

a. Under the UCC, “banks” include savings banks, savings and loan associations, credit unions, and trust companies.


CHAPTER 23: NEGOTIABLE INSTRUMENTS 3

b. A holder is the person who, by the terms of a negotiable instrument, is legally entitled to payment on it.

II. Requirements for NegotiabilityFor an instrument to be negotiable, it must (1) be in writing, (2) be signed by the maker or the 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, and (6) be payable to order or to bearer, unless it is a check.

ENHANCING YOUR LECTURE—

WHAT IS A NEGOTIABLE INSTRUMENT? The UCC leaves a lot of room for imagination when it comes to negotiable instruments. Bearer in -

struments, for example, need not always be written to “cash” or to “bearer.” They can be written to “Merry Christmas” or “Happy New Year” or just about any nonexistent or inanimate object. Even more extraordinary is the UCC’s lack of specificity as to the form of a negotiable instrument. When we think of a check, for example, we normally envision a preprinted form with the “normal” terms and phrases on it, such as the bank’s name and address and “Pay to the order of.” The UCC, however, says nothing to indi cate that negotiable instruments must be typed or printed or placed on any specific kind of material. The UCC stipulates only that a negotiable instrument must be in writing, the writing must lend itself to permanence, and the writing must be freely transferable (movable).

THE BOTTOM LINE

As might be imagined, this lack of specificity has led to some extraordinary negotiable instruments. Checks and notes have been written on napkins, menus, tablecloths, shirts, and a variety of other materials—including a tractor fender, an eggshell, a watermelon, underwear, and a tamale.

A. WRITTEN FORMNegotiable instruments must be in written form [UCC 3–103(a)(6)].

• The writing must be on material that lends itself to permanence.• The writing must have portability.

B. SIGNATURES

• Initials, an X, a thumbprint, a rubber stamp, and a trade name or an assumed name (even if false) will suffice [UCC 1–201(39), 3–401(b)]. A handwritten statement such as “I, Jane Doe, promise to pay to the order of John Doe” can constitute Jane’s signature.

• The location of the signature on the document is unimportant.

C. UNCONDITIONAL PROMISE OR ORDER TO PAY

1. Promise or Order



To be negotiable, an instrument must contain an express order or promise to pay [UCC 3–104(a)]. An I.O.U. does not qualify, unless such words as “due on demand” are added.

2. Unconditionality of Promise or OrderOnly unconditional promises or orders are negotiable [UCC 3–104(1)(b)]. Reference to another agreement or to the security for the instrument does not affect negotiabil ity. An instrument is negotiable even if its payment is to be made only out of a particular fund [UCC 3–106(b)(ii)].

CASE SYNOPSIS—

Case 23.1: Alpacas of America, LLC v. Groome

Sam and Odalis Groome entered into two contracts to buy alpacas from Alpacas of America, LLC (AOA) and signed two notes to finance the purchases. Within a few months, the Groomes stopped making payments. More than four years later, AOA filed a suit in a Washington state court to collect. The court ruled that the notes, which contained references to the contracts, were not negotiable instruments, and applied the UCC’s four-year statute of limitations on contract actions (instead of Article 3’s six-year limit) to dismiss the suit. AOA appealed.

A state intermediate appellate court reversed. The notes were negotiable. Despite containing references to the contracts, the notes were unconditional promises to pay. The notes did not include express conditions on the promises, they did not state that they were subject to or governed by another writing, and they did not indicate that the rights or obligations with respect to the promises were stated in another writing.

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Notes and Questions

In circumstances like those in the Alpacas case, could a maker successfully argue that a note is conditional, and thus not negotiable, because it is not separate from its underlying contract but merely enforces it? Probably not. Although this reasoning might have persuaded the trial court that initially heard AOA’s claim, it is not likely that the appellate court would have agreed. A party asserting this defense might emphasize that the documents all refer to each other—the contract, the note, the payment schedule, and the security agreement. The party might point out that the contract and the note were signed at the same time and in conjunction with each other. And most likely, a holder attempting to enforce payment would attach both the contract and the note to its complaint. But these circumstances would not make the note conditional and render it non-negotiable.

If a note is the best primary evidence of the existence of a debt, what might be the best evidence of the amount of the debt and the interest calculation? The lender’s records of the debt are the best evidence of the amount of the debt and the interest calculation. And there should be a witness who is familiar with the records not only as a user but also as someone with a working acquaintance of the methods by which the records are made to testify about them. For example, if a record of the debt is kept on the lender’s computer, screenshots could be sufficient to show the amount and the interest, and the person who serviced the note could explain them.



D. A FIXED AMOUNT OF MONEYTo be fixed, an amount must be ascertainable from the face of an instrument. The amount of interest or its rate may be determined with reference to information not contained in the instrument but ascertainable from a formula or source described in the instrument [UCC 3–112(b)]. Variable interest rate notes are negotiable.

ADDITIONAL BACKGROUND—

Variable Rate NotesAdjustable interest rate notes—with, for example, the interest rate tied to the rate of interest on U.S.

Treasury securities—have been in routine use since 1980. If such a note came before a court for a determination regarding its negotiability, however, there was no certainty as to how the court would rule. In some cases, courts concluded that such notes were not negotiable. Commercial practices had changed much since UCC Article 3 was originally drafted in the 1940s, however, and other courts concluded that such a note is negotiable if its interest rate is readily obtainable from a published source.

Because the conflicting case law was making uncertain what to businesspersons was otherwise certain, state legislatures were being urged to change the law. Even before revisions to Article 3 were presented to the states, some states (notably New York) had changed their versions of the UCC to render variable rate notes negotiable.

E. PAYABLE ON DEMAND OR AT A DEFINITE TIME

1. Payable on DemandInstruments payable on demand include those that contain the words “payable at sight” or “payable upon presentment,” those that say nothing about when payment is due, and checks

2. Payable at a Definite TimeAn instrument is payable at a definite time if it states that it is payable (1) on a specified date, (2) within a definite period of time after sight or acceptance, or (3) on a date or time readily ascertainable at the time the promise or order is issued [UCC 3–108(b)].

3. Acceleration ClauseInstruments that include acceleration clauses are negotiable.

4. Extension ClauseInstruments that include extension clauses are negotiable when the right to extend is given to the maker, if the interval of the extension is specified. If only the holder of the instrument can extend it, the maturity date does not have to be specified.

F. PAYABLE TO ORDER OR TO BEARER

1. Order Instruments



An order instrument is payable (1) “to the order of an identified person” or (2) “to an identified per -son or order” [UCC 3–109(b)]. An identified person is the person “to whom the instrument is ini tially payable” as determined by the maker or drawer’s intent [UCC 3–110(a)].



2. Bearer InstrumentsA bearer instrument does not designate a specific payee [UCC 3–109(a)]. A bearer is a person in possession of an instrument that is payable to bearer or indorsed in blank [UCC 1–201(5); 3–109(a), (c)].


When the Name of the Payee Is Left Blank

In a case decided in 1920, the Kentucky Court of Appeals (Kentucky’s highest state court until 1976) stated that “the rule is well settled that the name of the payee may be left blank, which makes the instrument payable in effect to the bearer” [Finley v. Rose, 189 Ky. 359, 224 S.W. 1059 (1920)]. Under the UCC, which Kentucky adopted in 1958, this rule was superseded. Comment 2 to UCC 3–111 explains that the drafters of the UCC reworded parts of Section 9 of the Uniform Negotiable Instruments Law in drafting UCC 3–111 “to remove any possible implication that ‘Pay to the order of _____’ makes the instrument payable to bearer. It is an incomplete order instrument, and falls under Section 3–115.”

In a case decided in 1992, the Court of Appeals of Kentucky held that a note with the name of the payee left blank was not a bearer instrument. In 1984, Aubrey and Jessie Davis were married. Aubrey allegedly gave his mother, Eva Davis, a note for $12,000 as payment for property in 1985. Aubrey died in 1987, Eva in 1988. Darrell Davis (Aubrey’s son by a previous marriage), claimed that Eva had given him the note. The note had been written on a preprinted bank form, but the bank’s name was scratched out, as was the town. The note had been dated and signed by Aubrey, but no payee was indicated. Darrell sought payment from Jessie, alleging that he was the holder of a bearer instrument. Jessie refused to pay, claiming that Darrell had no ownership rights in the note. She also claimed that the note could not be enforced because it had been materially altered. The trial court held that the note was a bearer instrument and granted summary judgment for Darrell. Jessie appealed.

The appellate court reversed. The court pointed out that UCC 3–111 describes bearer paper as “[a]n instrument * * * payable to bearer [that] by its terms it is payable to (a) bearer or the order of bearer; or (b) a specified person or bearer; or (c) ‘cash’ or the order of ‘cash,’ or any other indication which does not purport to designate a specific payee.” The court reasoned that the note was not a bearer instrument under any of these definitions. The instrument was incomplete and could not be enforced until it was completed. Because there was no indication that Aubrey had authorized anyone to complete the note, the note was unenforceable [Davis v. Davis, 838 S.W.2d 415 (Ky.App. 1992)].

Would the result in this case have been different if it had been decided under revised Article 3? Probably not. The phrasing of UCC 3–111 (the section under which the Davis case was decided) is not distinctly different from the phrasing of UCC 3–109—revised Article 3’s related section, which states in part that “[a] promise or order is payable to bearer if it: states that it is payable to bearer or to the order of bearer or otherwise indicates that the person in possession of the promise or order is enti tled to payment; does not state a payee; or states that it is payable to or to the order of cash or otherwise indicates that it is not payable to an identified person.”

G. FACTORS THAT DO NOT AFFECT NEGOTIABILITYFactors not affecting negotiability include—



• The fact that an instrument is undated, unless the date of an instrument is necessary to determine a definite time for payment [UCC 3–113(b)].

• Postdating or antedating an instrument [UCC 3–113(a)].

• Handwritten terms (in fact, handwritten terms control typewritten and printed terms, and typewritten terms control those that are printed [UCC 3–114].

• The use of words (in fact, words control figures unless the words are ambiguous [UCC 3–114].

• A provision for interest at an unspecified rate (the rate would then be the judgment rate at the place of payment and runs from the date of the instrument or, if undated, from the date of its issue [UCC 3–112(b)]).

• A notation on a check that it is “nonnegotiable” has no effect on the negotiability of the check (al-though any other instrument can be made nonnegotiable by such a note if it is conspicuous) [UCC 3–104(d)].

CASE SYNOPSIS—

Case 23.2: Charles R. Tips Family Trust v. PB Commercial, LLC

The Charles R. Tips Family Trust signed a promissory note in favor of Patriot Bank to buy a house. The note identified the principal amount as “ONE MILLION SEVEN THOUSAND AND NO/100 ($1,700,000.00) DOLLARS.” The trust made payments totaling only $595,586. PB Commercial, LLC acquired the note, sold the residence for $874,125, and pursued litigation in a Texas state court against the borrower, alleging default. The defendant argued that the written words in an instrument control and that the note had been satisfied in full—“in fact, PBC has collected a surplus of $189,111.” The court entered a judgment in the bank’s favor. The Trust appealed.

A state intermediate appellate court reversed. Under the UCC, “if an instrument contains contradictory terms, * * * words prevail over numbers.” In this case, the words and the numerals in the note are in conflict. Thus “the words ‘one million seven thousand’ control over the numerals ‘$1,700,000’ to set the amount of the promissory note.”

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Notes and Questions

Why is it necessary to know when payment on an instrument is required? Time of payment is needed (1) to determine the value of an instrument, (2) to know when secondary parties will be obligated for its payment, (3) to calculate the amount and timing of interest payments, and (4) to ascertain the tolling of the statute of limitations.

The duty to act in good faith does not apply to lenders seeking payment on demand notes. Why is this? By its very nature, a demand instrument allows the holder to demand payment at any time from the appropriate party. Good faith plays no role in this transaction. If a holder’s right to payment was conditioned on good faith (either of the holder or of the party from whom payment is demanded), a promissory note, such



as in this case, would not be an unconditional promise to pay—and thus would not qualify as a negotiable instrument. Allowing good faith to apply to such transactions would be contrary to the fundamental function of negotiable instruments, which is to be easily transferable without danger of being uncollectible.

ADDITIONAL CASES ADDRESSING THIS ISSUE —

Requirements for Negotiability

Cases involving the negotiability of instruments include the following.

• In re Sabertooth, LLC, __ 443 Bankr. 671 (Bkrptcy. E.D. Pa. 2011) (promissory notes were not “negotiable instruments” when they were subject to other rights and obligations that were stated in other loan documents, making the notes conditional).

• U.S. Life Insurance Co. in City of New York v. Wilson, __ Md.App. __, __ A.3d __ (2011) (a check sent to an insurer to reinstate a lapsed life insurance policy was valid and properly payable from the time it came into existence, notwithstanding that it was postdated to a date after the insured's death).

• Gallwitz v. Novel, __ Ohio App.3d __, __ N.E.2d __ (2011) (a note containing an unconditional promise to pay a fixed amount of money was an enforceable negotiable instrument, even though the note did not contain any schedule or time for repayment—the note would be payable on demand).

• Pineridge Associates, L.P. v. Ridgepine, LLC., __ S.W.3d __ (Tex.App.—Fort Worth 2011) (a nonrecourse note has the effect of making a note payable out of a particular fund or source, namely, the proceeds of the sale of the collateral securing the note).

III. Transfer of Instruments

A. TRANSFER BY ASSIGNMENTOn a transfer by assignment, the assignee contains only those rights that the assignor possessed and any defenses that can be raised against the assignor can be raised against the assignee.

B. TRANSFER BY NEGOTIATIONOn a transfer by negotiation, the transferee can become a holder in due course and acquire greater rights than the transferor had [UCC 3–203(b), 3–305].

1. Negotiating Order InstrumentsAn order instrument is negotiated by delivery with any necessary indorsements.

2. Negotiating Bearer InstrumentsA bearer instrument is negotiated by delivery alone.



C. INDORSEMENTSGenerally, by indorsing, an indorser promises to pay the holder or any subsequent indorser the amount of the instrument if the drawer or maker defaults [UCC 3–415(b)]. Types of indorsements and their consequences are charted in the text. These include the following.

1. Blank IndorsementsA blank indorsement specifies no particular indorsee and can be a mere signature [UCC 3–205(b)].

CASE SYNOPSIS—

Case 23.3: In re Bass

To buy a house, Tonya Bass signed an adjustable rate note with Mortgage Lenders Network USA, Inc., to borrow $139,988, repayable with interest in monthly installments of $810.75. The note was transferred by stamped imprints to Emax Financial Group LLC, Residential Funding Corp., and finally to U.S. Bank N.A. When Bass stopping paying on the note, U.S. Bank foreclosed. From North Carolina trial and intermediate appellate decisions in Bass’s favor, based on the lack of a “proper indorsement,” U.S. Bank appealed.

The North Carolina Supreme Court reversed, holding that “with no unambiguous evidence indicating the signature was made for any other purpose, the stamp was an indorsement that transferred the Note.”

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Notes and Questions

Even though forged or unauthorized signatures on negotiable instruments are uncommon, should U.S. Bank have had to prove that the indorsements on this note were valid and authorized? Why or why not? No, U.S. Bank should not have had to prove that the indorsements on the Bass note were valid and authorized. Under the UCC, an indorsement is presumed to be authentic and authorized until evidence is introduced that it is forged or unauthorized. In other words, unless Bass produced such evidence, U.S. Bank was not required to prove that the indorsements were valid. And in this case, the facts do not indicate that Bass offered any evidence to show the possibility of forgery, error, or a lack of authorization in the indorsements.

What sort of signature is required by the UCC to create a negotiable instrument? UCC 1-201(39) defines the word “signed” as including “any symbol executed or adopted by a party with present in tention to authenticate a writing.” According to UCC 3–401(b), a “signature may be made (i) manually or by means of a device or machine, and (ii) 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.” What is important is not the symbol but the intent by the signatory that the symbol serve as his signature. As a result, the signatory may use his initials or an X or even a thumbprint. Trade names and rubber stamp signatures will also bind the signatory if the requisite intent can be demonstrated.

Why do banks require all checks, including bearer instruments, to be indorsed? Banks impose this requirement because the indorsement creates indorser liability for the indorsing party. Also, it is more efficient and safer for a bank to have a policy requiring indorsement of all checks rather than for tellers to make individual assessments of whether checks are order or bearer instruments.



2. Special IndorsementsA special indorsement names the indorsee [UCC 3–205(a)]. An instrument indorsed in this way is an order instrument. A blank indorsement converted to a special indorsement converts a bearer instrument into an order instrument.

3. Qualified IndorsementsMost indorsements are unqualified. A qualified indorsement disclaims an indorser’s liability.

a. The Effect of Qualified IndorsementsThe notation “without recourse” is commonly used, often by persons acting in a representative capacity.

b. Special v. Blank Qualified IndorsementsA qualified indorsement is accompanied by a special or blank indorsement that determines further negotiation. A special qualified indorsement creates an order instrument, and indorsement and delivery are required for negotiation. A blank qualified indorsement creates a bearer instrument, and only delivery is required for negotiation.

4. Restrictive IndorsementsRestrictive indorsements require indorsees to comply with certain instructions.

a. Conditional IndorsementsA conditional indorsement conditions payment on the occurrence of a specified event [UCC 3–205(a)]. (A person paying or taking for value the instrument can disregard the condition without liability [UCC 3–206(b)].)

b. Indorsements for Deposit or CollectionAn indorsement for deposit or collection makes the indorsee a collecting agent of the indorser.

c. Trust (Agency) IndorsementsIndorsements that state they are for the benefit of the indorser or a third person are trust in-dorsements, and legal title vests in the original indorsee. [UCC 3–206(d), (e)].

5. Misspelled NamesAn indorsement should be identical to the name that appears on the instrument. A payee or indorsee whose name is misspelled can indorse with the misspelled name, the correct name, or both [UCC 3–204(d)].

6. Alternative or Joint Payees

• An instrument payable to two or more persons in the alternative requires the indorsement of only one for negotiation.

• If an instrument is payable to two or more persons jointly, then all the payees’ indorsements are necessary.

• If an instrument payable to two or more persons does not clearly indicate whether it is payable in the alternative or jointly, then it is payable alternatively [UCC 3–110(d)].



IV. Holder in Due Course (HDC)A holder has the status of an assignee of a contract right. A holder obtains only those rights that the transferor had in the instrument and is normally subject to the same defenses. An HDC takes an instrument free of most defenses against payment on it or claims to it.

A. REQUIREMENTS FOR HDC STATUSFirst, the instrument must be negotiable, and whoever seeks HDC status must be a holder. Then, the following requirements must be met [UCC 3–302].

1. Taking for ValueA gift or inheritance does not meet the requirement of value for HDC status, nor does a promise to give value in the future. Also, a holder takes an instrument only to the extent that a promise has been performed [UCC 3–303(a)(1)]. A holder takes an instrument for value by—

• Performing the promise for which the instrument was issued or transferred.• Acquiring a security interest or other lien in the instrument, except a lien obtained by a judicial

proceeding.• Taking an instrument in payment of or as security for an antecedent debt.• Giving a negotiable instrument as payment.• Giving an irrevocable commitment as payment [UCC 3–303(a)].


Taking for Value

The Official Comments of the Uniform Commercial Code explain the purposes and the changes in the prior law that were effected by the UCC. The following is from the text of UCC 3–303, Comment 1.

1. * * * The distinction between value and consideration is a fine one. Whether an instrument is taken for value is relevant to the issue of whether a holder is a holder in due course. If an instrument is not issued for consideration the issuer has a defense to the obligation to pay the instrument. * * * [O]utside Article 3, anything that is consideration is also value. A different rule applies in Article 3. Subsection (b) of Section 3–303 states that if an instrument is issued for value it is also issued for consideration.

Case # 1. X owes Y $1,000. The debt is not represented by a note. Later X issues a note to Y for the debt. Under subsection (a)(3) [an instrument issued as payment or security for an antecedent claim is issued for value, and thus] X’s note is issued for value. Under subsection (b) [an instrument issued for value as stated in subsection (a) is also issued for consideration, and thus] the note is also issued for consideration whether or not, under contract law, Y is deemed to have given consideration for the note.

Case # 2. X issues a check to Y in consideration of Y’s promise to perform services in the future. Although the executory promise is consideration for issuance of the check it is value only to the extent the promise is performed [as stated in] Subsection (a)(1).



Case # 3. X issues a note to Y in consideration of Y’s promise to perform services. If at the due date of the note Y’s performance is not yet due, Y may enforce the note because it was issued for consideration. But if at the due date of the note, Y’s performance is due and has not been per formed, X has a defense. Subsection (b) [states that “the issuer has a defense to the extent performance of the promise is due and the promise has not been performed”].

2. Taking in Good FaithThe holder must have acted honestly in the process of acquiring the instrument. Good faith is “honesty in fact and the observance of reasonable commercial standards of fair dealing” [UCC 3–103(a)(4)]. This requirement applies only to the holder.

ADDITIONAL CASES ADDRESSING THIS ISSUE —

Taking in Good FaithCases in which a party’s good faith to attain HDC status was at issue include the following.

• In re AppOnline.com, Inc., __ Bankr. __ (E.D.N.Y. 2002) (the purchaser of mortgage notes from the original mortgagee for value and in good faith, and without actual knowledge that the checks to closing agent would be dishonored or of the seller’s claims, qualified as HDCs).

• Any Kind Checks Cashed, Inc. v. Talcott, __ So.2d __ (Fla.App. 4.Dist. 2002) (a check cashing store that released funds represented by a check to the person to whom the check was issued through fraudulent inducement did not qualify as holder in due course because the store failed to comport with reasonable commercial standards of fair dealing).


GOOD FAITH, INTERNATIONALLY Good faith is an issue not only in domestic transactions involving negotiable instruments but also

internationally. Under the United Nations Convention on International Bills of Exchange and International Promissory Notes (CIBN), the equivalent of a holder in due course is known as a “protected holder.” As under the UCC, a protected holder is afforded greater protection than an ordinary holder.

Unlike the UCC, however, the CIBN does not provide an objective test by which to measure good faith. Article 3 of the UCC, as revised in 1990, defines good faith as “honesty in fact and the observance of reasonable commercial standards of fair dealing.” By including the phrase “the observance of reasonable commercial standards of fair dealing” in the definition, the UCC gives courts some objective guidelines as to what constitutes good faith. The CIBN, in contrast, qualifies someone as a protected holder if she or he was merely “without knowledge” of a fraud or other defense against the instrument. Generally, the CIBN’s test for protected-holder status is easily passed. In fact, every holder is presumed to be a protected holder unless there is proof to the contrary.



FOR CRITICAL ANALYSIS

What might be a reason that the CIBN contains only a very broad and subjective definition of good faith?

3. Taking without NoticeA person will not be afforded HDC protection if he or she knew or should have known at the time the instrument was acquired that it was defective because—

• It was overdue.• It had been dishonored.• There was an uncorrected default with respect to another instrument issued as part of the

same series.• The instrument contains an unauthorized signature or has been altered.• There is a defense against it or a claim to it.• The instrument is so irregular as to call into question its authenticity.

a. What Constitutes Notice?A person has notice of a fact when he or she has: (1) actual knowledge of the fact, (2) receipt of notice of the fact, or (3) reason to know that the fact exists, given all the facts and circum -stances known at the time [UCC 1–201(25)].

b. Overdue InstrumentsA demand instrument is overdue if it is taken after demand has been made or an unrea-sonable time after its date (ninety days in the case of a check) [UCC 3–304(a)]. A time instrument is overdue if it is taken after its expressed due date [UCC 3–304(b)].

c. Dishonored InstrumentsA holder has notice if he or she knows an instrument has been dishonored, or knows of facts that would lead him or her to suspect that an instrument has been dishonored [UCC 3–302(a)(2)].


HOW TO BUY NEGOTIABLE INSTRUMENTS Negotiable instruments are transferred every business day of the year. Most purchasers of negotiable

instruments do not encounter any problems in further negotiating and transferring the instruments or in collecting payment on them if they are time instruments. Potential problems exist, however, and purchasers should take precautions against them.

OVERDUE INSTRUMENTS

Suppose that you wish to purchase a demand instrument as a holder in due course (HDC). By definition, such an instrument has no stated time for payment and therefore may be overdue—that is, the payee may have demanded payment but not received it, or a reasonable amount of time may have passed. (With



checks, a reasonable amount of time is presumed to be ninety days from the date on the check.) If you have any doubt about whether a demand instrument is overdue, you should investigate.

NOTICE OF DEFECTS

As a prospective holder, you cannot afford to ignore a defect in any negotiable instrument. A four-month-old date on a check, for example, constitutes notice that the instrument is overdue. Generally, whenever an instrument has a defect, you will not qualify as an HDC, and you may be unable to obtain payment. In other words, it is prudent to determine whether the instrument is complete and, in some situations, whether the transfer will qualify you for HDC status.

CHECKLIST FOR THE PURCHASE OF NEGOTIABLE INSTRUMENTS

1. Make sure that a demand instrument is not overdue before purchasing it.

2. Make sure that the negotiable instrument has no obvious defects—look for indications that the maker or drawer of the instrument might have a valid reason for refusing to pay.

d. Notice of Claims or DefensesA holder cannot be an HDC if—

• The holder knows of a claim to the instrument or defense against it [UCC 3–302(a)]. A holder has notice if an irregularity on the face of an instrument calls into question its validity or terms of ownership, or creates ambiguity as to who to pay.

• An instrument is so incomplete that an element of negotiability is lacking [UCC 3–302(a)(1)].

B. HOLDER THROUGH AN HDCAnyone who can trace his or her title to a negotiable instrument back to an HDC has the rights of an HDC [UCC 3–203(b)]. This shelter principle helps an HCD to readily dispose of a negotiable instrument, promoting its marketability and transferability. If a holder was a party to fraud or some other illegality affecting an instrument, however, he or she cannot acquire HDC rights by reacquiring the instrument from an HDC.

V. Signature and Warranty Liability

A. SIGNATURE LIABILITYEvery party—except a qualified indorser—who signs a negotiable instrument is either primarily or secondarily liable for payment of the instrument when it comes due.


Signature Liability

Signature liability is the essence of negotiable instrument law. Once it is established that a party signed an instrument, the UCC defines that party’s liability.



An authorized agent or representative may sign for a party. Under the unrevised UCC, the courts differed as to when signatures by agents or representatives gives rise to their personal liability. Generally, an agent or representative was personally liable on his or her signature if the principal was not named or the agent or representative did not sign in a representative capacity [UCC 3–403(2)]. The same was true if the instrument named the principal but did not show that the agent or representative signed in a representative capacity, or the principal was not named but the agent or representative indicated that he or she signed in a representative capacity.

Basically, revised Article 3 retains the same principles when a holder in due course (HDC) is involved. That is, an agent or representative is liable on an instrument to an HDC who had no notice that the agent or representative was not intended to be liable. As to others, however, an agent or representative can escape liability if he or she can prove that the original parties did not intend the agent or representative to be liable on the instrument [UCC 3–402(b)(2)].

Although this is a subtle difference, it emphasizes the importance of agents or representatives’ signatures and HDC status. Organizations that require more than one signature on a check should be alerted that the signature of the organization is considered unauthorized if one of the required signatures is lacking [UCC 3–403(b)].

1. Primary LiabilityA person who is primarily liable is required to pay the instrument, subject to certain defenses [UCC 3–305]. Only makers and acceptors are primarily liable. If an instrument is incomplete when the maker signs it, then the maker’s obligation is to pay it as completed [UCC 3–115, 3–407(a), 3–412]. An acceptor is a drawee who, by signing an instrument (trade acceptance, certified check), agrees to pay it when it is presented for payment [UCC 3–409(a)].

2. Secondary LiabilityDrawers and indorsers have secondary liability. On a draft, a drawer’s liability arises if the drawee fails to pay or to accept the instrument. On a note, an indorser’s liability arises if the maker defaults [UCC 3–412, 3–415]. To trigger this liability—

• The instrument must be properly and timely presented.• It must be dishonored.• Notice of dishonor must be given in a timely manner to the secondarily liable party.

a. Proper and Timely PresentmentPresentment can be made by any commercially reasonable means, including oral, written, or electronic communication, and is usually effective on demand for payment or acceptance.

• A note or certificate of deposit must be presented to the maker for payment; a draft to the drawee for acceptance, payment, or both.

• Failure to present on time is the most common reason for the discharge of unqualified indorsers.

b. DishonorDishonor can occur when acceptance or payment is refused, cannot be obtained, or is excused and the instrument is not accepted or paid [UCC 3–502(c)].



c. Proper Notice of DishonorNotice, which may be given in any reasonable manner, must be given by a bank before its midnight deadline and by all others within thirty days [UCC 3–503].

3. Unauthorized Signatures

a. The General RuleA forged or an unauthorized signature does not bind the person whose name is forged.

b. Exceptions to the General Rule

• If the person whose name is signed ratifies the signature, he or she is bound [UCC 3–403(a)].

• If the person whose name is signed was negligent, and this negligence substantially contributed to the forgery, he or she is bound [UCC 3–115, 3–406, 4–401(d)(2)].

4. Special Rules for Unauthorized IndorsementsWhen there is a forged or unauthorized indorsement, the burden of loss usually falls on the first party to take the instrument with it (because a forged indorsement does not transfer title, and thus, whoever takes on a forged indorsement cannot become a holder).

a. Imposter RuleA loss falls on a drawer or maker when an imposter induces the maker or drawer to issue an instrument to the imposter [UCC 3–404(a)].

b. Fictitious Payee RuleA loss falls on a drawer or maker when a person causes an instrument to be issued to a payee who has no interest in it [UCC 3–404(b); 3–405]. A common context for this situation is employment—a dishonest employee deceiving his or employer.

B. WARRANTY LIABILITYTransfer warranties arise even if a transferor does not indorse the instrument [UCC 3–416, 3–417].


Warranty Liability

Transfer and presentment warranties are implied warranties that transferors make regarding the instruments they negotiate. Article 3 sets out the warranties in UCC 3–416 and 3–417.

Revised Article 3 changed previous law in two respects that are important. The first change is that the warranties cannot be disclaimed with respect to checks. The second change is that notice of a claim for breach of warranty must be given to the “warrantor” within thirty days “after the claimant has reason to know of the breach and the identity of the warrantor” [UCC 3–416(c), 3–417(e)]. Failure to give the notice discharges the warrantor “to the extent of any loss caused by the delay.”



1. Transfer WarrantiesAny person who transfers an instrument for consideration warrants to all subsequent transferees and holders who take the instrument in good faith—

• The transferor is entitled to enforce the instrument.• All signatures are authentic and authorized.• The instrument has not been altered.• The instrument is not subject to the defense or claim of any party that can be asserted against

the transferor.• The transferor has no knowledge of any insolvency proceedings against the maker, the

acceptor, or the drawer.

2. Presentment WarrantiesAny person who seeks payment or acceptance of an instrument impliedly warrants to any other person who in good faith pays or accepts the instrument that—

• The party is entitled to enforce the instrument or is authorized to obtain payment or acceptance on behalf of a person who is entitled to enforce the instrument.

• The instrument has not been altered.• The party has no knowledge that the issuer’s signature is unauthorized [UCC 3–417(a), (d)].

VI. Defenses, Limitations, and Discharge

A. UNIVERSAL DEFENSESUniversal defenses are good against all holders, including HDCs and holders who take through HDCs.

1. Forgery of a Maker’s or Drawer’s Signature [UCC 3–403(a)]

2. Fraud in the ExecutionThis defense cannot be raised when a reasonable inquiry would have revealed the nature and terms of the instrument.

3. Material AlterationMaterial alteration is only a partial defense against an HDC, who can enforce the instrument against the maker or drawer according to the original terms. If the instrument was originally incom-plete, the HDC can enforce it as completed [UCC 3–407(b)].

4. Discharge in BankruptcyThis is an absolute defense against all parties because the purpose of bankruptcy is to settle all of the insolvent party’s debts [UCC 3–305(1)(a)].

5. MinorityThis is a universal defense only to the extent that state law recognizes it [UCC 3–305(a)(1)(i)].

6. IllegalityIf a statute makes an illegal transaction void, this defense is universal. If the transaction is only voidable, this is a personal defense [UCC 3–305(a)(1)(ii)].



7. Mental IncapacityAny instrument issued by a mentally incompetent person is void, and this defense is universal, if the person has been declared mentally incompetent by a court [UCC 3–305(a)(1)(ii)]. If not, this defense is personal.

8. Extreme Duress [UCC 3–305(a)(1)(ii)]

B. PERSONAL DEFENSES

1. Breach of the Underlying Contract or Breach of Warranty

2. Lack or Failure of Consideration [UCC 3–303(b), 3–305(a)(2)]

3. Fraud in the Inducement (Ordinary Fraud)

4. IllegalityIf a statute makes an illegal transaction voidable, this is a personal defense.

5. Mental IncapacityAny instrument issued by a mentally incompetent person is voidable, and this defense is personal, if the person has not been declared mentally incompetent by a court [UCC 3–305(a)(1)(ii)].

6. Ordinary Duress


Personal Defenses

In addition to the personal defenses listed in the text, a number of other personal defenses can be used to avoid payment to an ordinary holder, but not a holder in due course (HDC), of a negotiable instrument. These include—

• Undue influence [UCC 3–305(a)(1)(ii)].

• Discharge by payment or cancellation [UCC 3–601(b), 3–602(a), 3–603, 3–604].

• Unauthorized completion of an incomplete instrument [UCC 3–115, 3–302, 3–407, 4–401(d)(2)].

• Nondelivery of an instrument [UCC 1–201(14), 3–105(b), 3–305(a)(2)].

C. FEDERAL LIMITATIONS ON THE RIGHTS OF HDCSA Federal Trade Commission (FTC) rule (16 C.F.R. Part 433)—”Rule 433”—effectively abolished the HDC doctrine in consumer transactions.

D. DISCHARGE FROM LIABILITY

• All parties to an instrument are discharged when the party primarily liable on it pays to a holder the amount due in full [UCC 3–602, 3–603]. Payment by any other party discharges only that party and subsequent parties.



• A holder can discharge any party by cancellation [UCC 3–604]. Crossing out a party’s indorsement cancels that party’s liability and the liability of subsequent indorsers who have already indorsed the instrument.

• Discharge can also occur when a party’s right of recourse is impaired [UCC 3–605].

TEACHING SUGGESTIONS

1. Because many students find it difficult to distinguish among the various forms of instruments, a small packet of blank forms consisting of sample drafts, checks, notes, and certificates of deposit can be assembled and passed out to students. The students can then fill out the forms together and familiarize themselves with the characteristics and terminology of each type of instrument. Students may also be selected to play the roles of drawer, drawee, payee, maker, etc. (depending on the type of instrument being considered), to dramatize how each instrument is typically used.

2. The concept of negotiability is often confusing to students because it refers to the process by which in-struments are transferred from one party to another and imposes a number of requirements that must be sat -isfied before an instrument will be considered negotiable. Ask the class to discuss the requirements of nego-tiability, as well as the process by which negotiable instruments are transferred. Ask students to play the roles of different parties to a transaction and indorse a check in different ways (to create different indorsements—blank, special, qualified, unqualified, restrictive or unrestrictive) and follow the progress of the check, pointing out the various conditions imposed by each indorsement, as well as when order paper is converted into bearer paper and vice versa.

3. The drafters of the UCC do not create rules out of thin air, but attempt to codify existing business practices. For this reason, students should be reminded that even if they are not pursuing the study and application of business law any further than this class, the requirements of negotiability are important and have a practical application. Students may find it most helpful simply to memorize these requirements.

4. Ask the students to compare the concept of value in negotiable instruments law with that of consideration in contract law. Not all consideration is value. The extraordinary protection conferred on an HDC is given only when an individual has parted with something that has real economic worth. Although a promise to do something is valid consideration in contract law, it is not value for purposes of determining HDC status unless it is a formal promise such as another negotiable instrument given in exchange. Ask the students to consider whether some things that are not consideration can be value (such as antecedent obligations or debts).

5. When considering whether a specific party is an HDC, students might find it helpful to divide the question into two parts: (1) the party must first be a holder, and (2) if the party is a holder, he or she must be in dues course. To qualify as an HDC, all of the requirements must, of course, be met.

6. It is important to remind students that if more than one indorsement appears on an instrument, each indorser is liable for the full amount to any later indorser or to any holder.

7. Point out that an indorsement can convert an order instrument to a bearer instrument and vice versa. For example, a bearer instrument payable to “cash” can be made an order instrument by a special indorsement such as “pay to John.” An order instrument indorsed in blank becomes a bearer instrument.



Cyberlaw Link

What are the differences, and the benefits and the risks, of payment systems that are designed for cyberspace? Which requirements of negotiability seem unnecessary for an online transaction? Is there any part of the HDC concept that would need to be changed to adapt it to an electronic payment system?

DISCUSSION QUESTIONS

1. Why is a transfer by negotiation preferable to a transfer by assignment? In a transfer of commercial paper by negotiation, unlike a transfer by assignment, the transferee (the party to whom the instrument is transferred) not only receives the rights of the transferor (the party transferring the instrument) but may also receive even more rights in the instrument. Article 3 of the Uniform Commercial Code provides that a person who acquires an instrument for value, in good faith, and without notice that it is defective or overdue or that any person has a claim to it or defense against it acquires the special status of a holder in due course (HDC). If a transferee has met the requirements for HDC status, he or she takes the instrument free of most defenses to payment on the instrument or adverse claims to it.

2. What do your students think about the standard of “good faith”? Why is good faith required to attain HDC status? To allow otherwise would provide an incentive for holders to manipulate the rules dishonestly with the knowledge that the enforcement of an instrument could still be sought in a court.

3. What are some of the practical limitations concerning the writing evidencing a negotiable instrument and the substance on which it is placed? The writing must be on material that lends itself to permanence. Paper satisfies the necessary requirement that the writing be permanent although one could presumably use other materials such as cloth or even stone tablets. Yet the permanence requirement is qualified because the writing must also be portable. The portability of a writing will be construed in terms of existing commercial practices so that even if the object on which the writing is placed (such as the hide of a cow) can be moved, it may be unsatis factory because it is commercially impractical.

4. When may reference to other agreements be made in a negotiable instrument without destroying its negotiability? Mere reference to another agreement does not affect negotiability. If, on the other hand, the instrument is made subject to the other agreement, it will be nonnegotiable. If language is included simply to keep a record or give information to any interested party, then such language will not affect the negotiability of the instrument. References to separate agreements by themselves will also not affect the negotiability of the instrument. If the instrument states that it is dependent on the satisfaction of obligations contained in a separate agreement, however, then it will not be negotiable.

5. What is the difference between a blank and a special indorsement? A blank endorsement is a mere signa-ture by the indorser, whereas a special indorsement names the person (indorsee) to whom the indorser intends to make the instrument payable. The words “pay to the order of John Doe,” followed by the indorser’s signature, constitute a special indorsement, whereas the indorser’s signature alone constitutes a blank indorsement.



6. What is the difference between a holder and a holder in due course? A holder is a person who possesses a negotiable instrument drawn, issued or indorsed to him or his order or to bearer or in blank. To be a holder, a person must have possession and good title. The holder is the person who, by the terms of the instrument, is legally entitled to payment. A holder has the status of an assignee of a contract right and obtains only those rights that the predecessor-transferor had in the instrument. A holder in due course (HDC) is a special-status transferee of a negotiable instrument who, by meeting certain acquisition requirements, takes the instrument free of most defenses or adverse claims to it. Alternatively stated, an HDC can normally acquire a higher level of immunity to defenses against payment on the instrument or claims of ownership to the instrument by other parties.

7. What sorts of omissions on the face of a financial instrument will prevent a purchaser from becoming a holder in due course? A purchaser cannot expect to become an HDC of an instrument so incomplete on its face than an element of negotiability is lacking (for example, the name of the payee on order paper is missing or the amount is not filled in). Minor omissions, by contrast, are permissible because they do not call into question the validity of the instrument. The omission of connective words such as the "or" in "Pay to Johnson or order," does not affect negotiability, and neither does the omission of the date from a check that has the month and year.

8. Why must a negotiable instrument be signed? A signature is necessary to impose liability on the party signing the negotiable instrument. The parties to a negotiable instrument are bound by all of the terms implied by their signatures by operation of law. Once it is established that a party signed a negotiable instrument (or that it was signed by that party's agent), then the UCC will define that party's liability. The liability is con tractual in the sense that each party voluntarily incurs it and thus can modify it.

9. Who assumes the burden of loss when there is a forged or unauthorized indorsement? In general, the burden of loss falls on the first party to take the forged indorsement because a forged indorsement does not transfer title. Consequently, the party taking an instrument with a forged indorsement cannot become a holder. As a result, a forged indorsement is no indorsement at all for purposes of negotiation and transferring title. Yet the loss resulting from a forged indorsement will fall on the drawer or maker in two situations: (1) when an imposter induces the maker or drawer of an instrument to issue it to the imposter; or (2) when a person signs as or on behalf of a maker or drawer, intending that the payee have no interest in the instrument (the fictitious payee rule).

10. What is the practical reason for the warranty that a check presented for payment has not been altered since its issuance? (Hint: Presentment warranties often shift liability back to a party that was in the best position to prevent the wrongdoing.) The practical basis for this rule is to impose the liability for a loss in this circumstance on the party that most likely could have prevented it at the lowest cost. A presenting bank would be in a better position than a drawee bank to suspect that its depositor was not an intended payee and in as good a position as the drawee bank to spot the check’s alteration. Should any changes be made to the UCC’s allocation of liability in its warranty provisions in light of the changes to technology? If so, who should make those changes? If necessary, any changes to the allocation of liability under these sections of the UCC in the light of modern technology should be left to the National Conference of Commissioners on Uniform State Laws rather than, for example, a federal court.

ACTIVITY AND RESEARCH ASSIGNMENTS

1. The use of a negotiable instrument as both a cash-substitute and a credit instrument is not a recent innovation. Commercial paper of one form or another has been around since the Middle Ages when merchants, for reasons of convenience and safety—as well as legal considerations—used it to finance and conduct their affairs. Ask the class



to examine the factors that originally gave rise to the need for commercial paper, and negotiable instruments in particular, and to assess whether these factors are still relevant. Are there other factors that can better explain the continued growth in the use of negotiable instruments? How will the shift to an electronic “cashless” banking system affect the principles governing negotiable instruments?

2. Article 3 of the Uniform Commercial Code is revised in part in response to changing commercial realities and methods of doing business. Some states adopt the revision of Article 3, but some do not. What may be the effect if some states never adopt revised Article 3?

3. There are a number of defenses that may be raised when the holder of a negotiable instrument makes a demand for payment. Universal defenses may be raised to avoid payment to all holders of a negotiable instrument including an HDC or one who holds through an HDC. Personal defenses, by contrast, may be used to avoid pay ment only to ordinary holders—not HDCs. Because universal and personal defenses are often confused with each other, ask each student in the class to prepare two charts—one listing universal defenses and one listing personal defenses. Each of these defenses should be defined and each chart should have a heading explaining the concepts of real defenses or personal defenses as appropriate.

4. Students sometimes find it difficult to understand why a person whose signature has been forged should have to pay on the instrument in any situation. Ask students to call local banks and ask the bank managers to describe what sorts of procedures are used to verify whether the signatures on instruments are genuine or forged. Each student might be assigned a particular bank to avoid duplicating each other’s efforts.

5. Have students research the shelter principle, and find and read cases that involve this rule. What are the positive and negative features of the shelter principle? Because this principle may permit one who has acted in bad faith or taken an overdue instrument, for example, to recover as though that person were an HDC, the students should consider the purposes served by this rule, as well as whether some alternative rule might be more appropriate.

EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT

Footnote 6: National City Bank lent money to Reger Development, LLC to fund potential development opportunities in Illinois. The loan took the form of a line of credit, which was structured as a promissory note, under an agreement that required Reger to “pay this loan in full immediately upon Lender’s demand.” When the bank asked Reger to pay down some of the loan, however, the borrower—who was not in default—filed a suit in an Illinois state court against the bank, alleging breach. The case was removed to a federal court, which dismissed the complaint on the bank’s motion. Reger appealed. In Reger Development, LLC v. National City Bank, the U.S. Court of Appeals for the Seventh Circuit affirmed. The court cited “the repeated, explicit contract language setting forth the lender’s right to demand payment at any time.” Reger’s “failure to pay at that point in time . . . would constitute default.” Reger pointed to language in the note that it contended was “fundamentally inconsistent with the nature of a demand instrument.” But “the mere use of the terms ‘due date’ or ‘default’ “ do not change the nature of the arrangement. “The language merely reinforces National City’s right to collect scheduled monthly payments and does not deviate from the structure of a demand note.”

If National City had demanded “payment of the line” instead of just indicating that there was a possibility it might do so in the future, would the outcome of this case be any different? Explain. The outcome of the case would be the same, because in either situation National City had the right, as a holder of the demand note, to demand payment from Reger Development at any time.



Why might a creditor such as National City Bank prefer a note that is payable on demand? A term that makes a note payable on demand appears to increase its negotiability. A demand for payment of the note can be made by or on behalf of a person entitled to enforce an instrument at any time. This feature could make the instrument more attractive to third parties, which would include other creditors such as banks and other lenders and even private investors. It might be attractive because it would make the funds available at any time to the party entitled to them. This might be important if, for example, the party has suffered losses from other investments or is apprehensive that it will suffer a loss with respect to the debtor on the note.

Of course, to obtain a demand term on a note, there might be a feature that would undercut this advantage. For example, the interest rate on the note could be lower than on a similar note payable at a definite time rather than on demand. Or the debtor might present more risk to the party entitled to enforce the note.

Why might a debtor such as Reger Development agree to a note that includes a term making it payable on demand? A debtor might agree to a note that includes a term making it payable on demand because the debtor might not otherwise be able to obtain the funds represented by the note. In other words, the debtor might present more risk of default to a party entitled to enforce the note. A debtor who is eligible for, or who can negotiate, a note that is payable at a definite time in the future might present less financial risk to the party who can enforce the note.

Of course, as seems to have occurred in this case, a debtor might simply execute a contract and agree to pay a note without carefully reading all of the terms. Only later, when a demand for payment of the note is made by or on behalf of a person entitled to enforce the instrument, might the debtor become aware of the demand term.

Footnote 7: Amine Nehme applied for credit at the Venetian Resort Hotel Casino in Las Vegas, Nevada, and was granted $500,000 in credit. He soon accrued more than $1.2 million in gambling debts, which he paid. About a year later, Nehme deposited $1,000 with the Venetian and signed a marker for $500,000. Nehme quickly lost that amount gambling. The Venetian presented the marker for payment to Bank of America, Nehme’s bank, which returned it for insufficient funds. The casino’s owner, Las Vegas Sands LLC, applied Nehme’s deposit against the marker and filed a suit against him to recover the remainder—$499,000—plus interest, for failure to pay a negotiable instrument. A federal district court issued a summary judgment in the Venetian’s favor. Nehme appealed. In Las Vegas Sands, LLC v. Nehme, the U.S. Court of Appeals for the Ninth Circuit agreed with the lower court that the marker was a negotiable instrument. The marker fit the UCC’s definitions of negotiable instrument and check. It is a means for payment of $500,000 from Bank of America to the order of the Venetian. It does not state a time for payment and thus is payable on demand. It is unconditional and states no “undertaking” by Nehme in addition to the payment of a fixed amount of money. The Venetian can enforce the marker against Nehme unless he can establish a defense to liability. To determine whether he could establish a defense, the appellate court reversed the lower court’s judgment and remanded the case for a trial.

To obtain credit, Nehme filled out a credit application that stated the Venetian “endorses responsible gaming. We will cancel or reduce your credit line upon your request.” Nehme’s attorney later wrote a letter to the casino, asking that no further credit be extended to Nehme. In defense to the casino’s suit, Nehme claimed that by later granting him credit for $500,000, the casino breached the terms of the credit application. How might the Venetian have breached its credit application agreement with Nehme? There are a couple of possibilities. If the casino simply failed to cancel Nehme’s credit line on receipt of Bennett’s letter, this would have breached the promise to “cancel or reduce your credit line upon your request.” If, however, the casino had canceled the credit line and simply reinstated it when Nehme signed the marker, this would have made the promise to ensure “responsible gaming” illusory. In either situation, Nehme’s duty to pay the maker would be discharged.

Suppose that the marker had stated “Payable to the order of the Venetian.” Could the casino have transferred it for collection? If so, how? Yes, the casino could have transferred the marker if it had been “Payable



to the order of the Venetian.” This term would have made the item an order instrument. In an order instrument, the person specified must be identified with certainty because the transfer of the item requires the indorsement, or signature, of the payee. An indorsement is a signature placed on the instrument, such as on the back of a check, for the purpose of transferring the payee’s rights in it. Thus, the casino could have transferred this marker for collection by adding its indorsement to the instrument.

What is the advantage to the Venetian of the holding that Nehme’s marker is a negotiable instrument? A negotiable instrument is easily transferable without the danger of its being uncollectible. This is the fundamental function of a negotiable instrument. The advantage to the Venetian in this case of the holding that Nehme’s marker is negotiable is the ease with which the casino could present it to Nehme’s bank for payment.


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