verdun commercial paper outline

Commercial Papers Outline I. Overview Note- Instrument in which a party promises to pay money to a designated party Maker- person promising to pay the note Payee- person designated to receive money from note Draft- Instrument in which a party orders another party (often a bank) to pay money to a third party Drawer- creator of instrument ordering payment Drawee- party (often a bank) ordered to pay the money Payee- person designated to receive money Holder in Due Course- if i) an instrument meets the technical requirements of negotiability ii) it is transferred so that a negotiation occurs and iii) a bona fide purchaser pays value for the instrument without notice of claims or defenses to it, the purchaser becomes a holder in due course The HDC may sue prior parties who are liable on the instrument but those parties have no defenses, with a few exceptions, against the HDC. Prior parties must simply pay the HDC. If the transferee of the instrument doesn’t qualify as an HDC, the transferee is merely the assignee of a contract, and takes the instrument subject to all valid claims and defenses to it. II. Negotiability The extensive protection afforded to buyers of commercial paper, and applies only when the instrument in question is negotiable No HDC status in nonnegotiable instruments. A negotiable instrument is an instrument capable of transfer by endorsement or delivery. Negotiability provides a means of passing on to the transferee the rights of the holder, including the right to sue in his or her own name, and the right to take free of equities as against the assignor/payee.

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Page 1: Verdun Commercial Paper Outline

Commercial Papers Outline

I. Overview

Note- Instrument in which a party promises to pay money to a designated party

Maker- person promising to pay the note

Payee- person designated to receive money from note

Draft- Instrument in which a party orders another party (often a bank) to pay money to a

third party

Drawer- creator of instrument ordering payment

Drawee- party (often a bank) ordered to pay the money

Payee- person designated to receive money

Holder in Due Course- if i) an instrument meets the technical requirements of

negotiability ii) it is transferred so that a negotiation occurs and iii) a bona fide purchaser

pays value for the instrument without notice of claims or defenses to it, the purchaser

becomes a holder in due course

The HDC may sue prior parties who are liable on the instrument but those parties have

no defenses, with a few exceptions, against the HDC. Prior parties must simply pay the


If the transferee of the instrument doesn’t qualify as an HDC, the transferee is merely the

assignee of a contract, and takes the instrument subject to all valid claims and defenses to


II. Negotiability

The extensive protection afforded to buyers of commercial paper, and applies only when

the instrument in question is negotiable

No HDC status in nonnegotiable instruments.

A negotiable instrument is an instrument capable of transfer by endorsement or delivery.

Negotiability provides a means of passing on to the transferee the rights of the holder,

including the right to sue in his or her own name, and the right to take free of equities as

against the assignor/payee.

Page 2: Verdun Commercial Paper Outline

Elements of Negotiability: 3-104 (a)

A) Writing- A negotiable instrument cannot be oral. The written contract does not need

to be real formal and doesn’t have to be on paper (electronic)

B) Signed

Any mark or symbol place on the instrument (or already there and subsequently adopted)

by the maker or drawer with the intent to authenticate the writing constitutes a signature.

*A full formal signature is not required if the requisite intent to authenticate was present.

1-201 (39) There has to be an intention to authenticate, can use symbol, stamped or


3-401 (a)- not liable on a instrument unless you sign, or an agent signs on your behalf

3-401 (b)- a signature may be made manually or by means of a device or machine

and by the use of any name, including a trade or assumed name, or by a word, mark, or

symbol executed or adopted by a person with present intention to authenticate a writing

The name of the maker or drawer may be placed on an instrument by an authorized agent.

The maker or drawer is bound even if he signs with an assumed name or a trade name.

(ex. Alice is the sole proprietor of Carroll Books and signs all the store’s checks “Carroll

Books” Alice is nevertheless bound on the checks just as if she had signed her own


Forged signatures are unauthorized signatures and the person’s name who is fraudulently

signed is not liable on the instrument unless he ratifies the signature or is precluded.

The unauthorized forger is liable to the instrument as if he had signed his own name.

C) Unconditional Promise to Pay

A note must contain an “unconditional promise” to pay and a draft must contain an

“unconditional order” to pay to be negotiable

Promise means “undertaking to pay”

Order means more than authorization to pay, this is ordering the drawee to pay

* Implied or constructive conditions in the instrument do not destroy negotiability. Must

have an express condition to destroy negotiability

Page 3: Verdun Commercial Paper Outline

Mere reference to or description of agreements or other writings does not affect


An incorporation of other matters into an instrument makes the instrument nonnegotiable

Ex. Note stating “this instrument is subject to the terms of a separate contract” makes the

note nonnegotiable.

An instrument that states that it is executed or matures in accordance with another

contract or as per another contract is negotiable, these two phrases constitute a mere

reference to other matters, rather than an incorporation of such matters.

Incorporation of Pre Payment or Acceleration clauses from other instrument are not

considered an express condition and do not destroy negotiability

3-104 (a) (3)You can put in a few things in a negotiable instrument- 3-104 (a) (3)

can have a

1) security agreement to protect collateral,

A statement in an instrument that the underlying obligation is secured and describing,

but not incorporating, the collateral and security agreement, does not affect


Instrument may state that the collateral has been given as security for repayment of

the obligation, also may have a clause providing that upon default the holder ma

foreclose on the collateral

The instrument can contain the coupling of an Article 9 security interest with an

Article 3 note

2) waiver of right,

Can have clause in negotiable instruments that waive certain laws.

3) authorization or power to the holder to confess judgment or realize on or dispose of


3-106 (a): A promise or order is unconditional unless it states:

1) an express condition to payment then instrument is not unconditional

2) that the promise or order is subject to or governed by another record

3) that rights or obligation with respect to the promise or order are stated in another


Page 4: Verdun Commercial Paper Outline

3-106 (a) allows the instrument to mention the details of the underlying contract

without destroying negotiability as long as payment of the note is not made “subject

to” the performance of that contract. (ex. I have rented the Music Hall and I promise

to pay $800 to the Music Hall, this mentions the contract but makes no conditions so

its fine.

3-106 (a) last sentence permits a refernce to the underlying contract, though an

incorporation of the terms of the contract, (without restating them in the note itself)

would be fatal to negotiability.

If something is void after a certain period of time then there is a condition and it

destroys negotiability, but courts have said that it is negotiable

D) Fixed Amount of Money

Absolute certainty as to the sum due at all times is not required. It is sufficient if, as

of any particular time, the amount due on the instrument may be mathematically

computed. The fixed amount may include “interest or other charges”.

Have to tell the party how much you are going to pay. Ex. I’m going to pay

$100,000 with 3% interest

3-112: Can have fix or variable interest rate

If a note merely states that it is payable “with interest” but does not state the intrest

rate, the not is still negotiable. The state judgment interest rate will be implied.

E) Courier without Luggage (no other promise requirement)

With certain exceptions, the instrument must not state any other undertaking or

instruction by the person promising or demanding payment to do any act in addition to

the payment of money.

Ex. A promise to pay $500 and deliver a quantity of goods, this makes the instrument


Requiring some act to be doen in lieu of payment of money destroys the negotiability of

the instrument

Ex. A promise to pay $500 or to deliver goods, which ever is requested. This would be


Page 5: Verdun Commercial Paper Outline

F) On Demand or at a Definite Time

Unless it can be determined from the face of the instrument when, or at least upon what

events, the obligation will become due, the instrument is not negotiable.

There is no requirement that the instrument be dated at the time signed. We do have

to know when payment is due

An instrument is payable on demand if it is expressly made so payable, if words similar

import are use (at sight, upon presentation)

An undated instrument that specifies no time of payment is treated as an instrument

payable on demand by the holder (3-108 (a) (ii) )

Outside of a check, if a note doesn’t have a date on it, then it is not a demand instrument

and is not negotiable. Only check or a document named a demand instrument will fall

under 3-108 (a) (ii)

An instrument payable at a definite time in the future is referred to as a time instrument

An instrument is payable at a definite time if it is payable i) on a fixed date ii) on or

before a fixed date iii) at a time readily ascertainable when the instrument is issued, or

iv) after elapse of a specified period after sight (this is different than payable at sight)

Ex. A) Payable 30 days after sight, this is acceptable can have a elapse of a definite

period of time after sight 3-108 (b)

Acceleration clause: language that makes payment in the future, have the option to

payment right now.

Can have an Acceleration clause on insecurity , acceleration clauses are very open.

Acceleration clauses are fine with negotiability

Ex. Payable when the sun comes up tomorrow, this is not negotiable because we

have no date, if we had a date then this would be fine

Extension of payment agreement has to be specifically set to a certain event or to a

definite future time.

Ex. Payable 100 years from today, but if my uncle dies before that, instrument shall

become payable 10 days after death. This is fine there is a definitive date 100 years

after today, and there is an acceleration clause (if uncle dies before the 100 years is


Page 6: Verdun Commercial Paper Outline

Ex. Payable on my next birthday, this wouldn’t work because it doesn’t state when

the birthday is on the instrument.

G) Payable to the Order or to the Bearer

The basic definition of negotiability requires that the instrument be payable either “to the

order or “to the bearer”.

Order Paper- names a specific payee and requires the payee’s indorsement for further


An instrument is payable to order when it is drawn “payable to the order of an identified


Must have the “pay to the order of” except in the situation of checks, you don’t need the

wording “pay to the order of” when it comes to checks.

Bearer Instrument: instrument names no specific payee and can be transferred without

indorsement, just like cash

an instrument is payable to bearer only if it is drawn payable i) to bearer ii) to a specified

person or bearer (ex. Pay to John Doe or bearer), or iii) to “cash”, the “order of cash” or

any other indication that does not purport to designate a specific payee

Ex. Pay to John Smith. This doesn’t have “pay to order” language in the instrument so it

is not negotiable. However this rule does not apply to checks

Ex. Pay to John Smith or Bearer. This is a bearer instrument

Ex. Pay to the order of cash. This is a bearer instrument 3-109 (a) (3).

Ex. Pay to a Merry Christmas. This is a bearer instrument, language of “payment to”

and there is an unidentified person then it’s a bearer instrument 3-109 (3)

* If an instrument is made payable both to order and to bearer (ex. Pay to the order of

John Jones and bearer) the bearer language controls

Page 7: Verdun Commercial Paper Outline

Special and Blank Indorsements

3-205 (a): Special Indorsement

If a payee wishes to preserve the instrument as order paper, the original payee must

specify the new payee by writing “ PAY (name of new payee)” above the indorsement.

This is known as a special indorsement

Words of negotiability (i.e. pay to the order of) are not required in an indorsement, thus

the lack thereof does not affect the negotiability of the instrument

3-205 (b): Blank Indorsement:

The payee can simply sign the back of the instrument, such signature is called a blank

indorsment and has the legal effect of converting the instrument into bearer paper

When indorsed in blank, an instrument becomes payable to bearer and may be negotiated

by transfer of possession alone until specially indorsed

3-205 (c): Converting Blank Indorsement into Special Indorement

The holder may convert a blank indorsement that consists only of a signature into a

special indorsement by writing, about the signature of the indorser, words identifying the

person to whom the instrument is made payable


3-105 (a) Issue: An issue is the first delivery of an instrument by the maker or drawer to

a holder or a remitter

3-201(a) Negotiation: process by which an instrument is transferred by a person other

than the issuer to a subsequent party who qualifies as a holder

3-201(b) Except for negotiation by a remitter, if an instrument is payable to an identified

person, negotiation requires 1) transfer of possession of the instrument and 2) its

indorsement by the holder. If an instrument is payable to bearer, it may be negotiated by

transfer of possession alone

1-201 (b) (21) Holder: the person in possession of a negotiable instrument, that is

payable either to bearer or to an identified person that is the person in possession; or

To be a holder there must be a negotiation on the instrument

In order to be a holder, the person who gives you the paper must be a holder as well.

Page 8: Verdun Commercial Paper Outline

Once a person is not a holder subsequent people with the instrument will not be holders

3-203 Transfer: delivery by a person other than the issuer for the purpose of giving to

the person receiving delivery the right to enforce the instrument

Remitter: person who makes payment using an instrument created by someone else (ex.

A bank cashier’s check drawn up at the request of a customer and sent to a creditor)

3-301 Person Entitled to Enforcement: Person entitled to enforce an instrument means,

the holder of the instrument. However, there are situation where a person may be a

person entitled to enforce the instrument even though the person is not the owner of the

instrument or is in wrongful possession of the instrument

Negotiation Process

3-205 Indorsement: a) "Indorsement" means a signature, other than that of a

signer as maker, drawer, or acceptor, that alone or accompanied by other words

is made on an instrument for the purpose of (i) negotiating the instrument, (ii)

restricting payment of the instrument, or (iii) incurring indorser's liability on the

instrument, but regardless of the intent of the signer, a signature and its

accompanying words is an indorsement unless the accompanying words, terms of

the instrument, place of the signature, or other circumstances unambiguously

indicate that the signature was made for a purpose other than indorsement For the

purpose of determining whether a signature is made on an instrument, a

paper affixed to the instrument is a part of the instrument.

* An indorsement must be written on the instrument, if the indorsement is written on a

paper affixed to the instrument then that will be enough to be considered written on the


Bearer Paper: Anyone in possession of a bearer instrument is a holder thereof.

Possession makes the holder entitled to enforce the instrument

Order Paper: the named payee becomes a holder upon acquiring possession of the

instrument. Before a subsequent transferee can acquire title, the payee must indorse the

instrument and surrender possession to the transferee

A person will not be entitled to enforce an order instrument unless the payee’s

indorsement is authorized and valid. Forging the payee’s name prevents further

negotiation, and no subsequent possessors of the instrument can qualify as holders, nor a

person entitled to enforce the instrument.

* There are certain situation discussed later where an unauthorized signature can be made

effective under principles of ratification and estoppel

The forgery of the payee’s name is treated as if the forger had signed his own name. The

forger will be liable on the instrument, but still the instrument has not be negotiated.

Page 9: Verdun Commercial Paper Outline

3-110 (d) Multiple Payees: An instrument may be made payable to more than one

payee. If the names on the payee line are connected by “or” or “and/or” the instrument

is payable to the payees alternatively and the valid indorsement of any one of them is

sufficient to pass title to a subsequent transferee

If there is some ambiguity as to if both signatures are need, courts usually will allow 3-

110 (d) to be applied

If their names on the payee line are connected by an and, the instrument is payable to

them jointly and any subsequent negotiation is effective only if all indorse the


If the note states John and Mary, this isn’t in the alternative so 3-110 (d) doesn’t apply

and you have to have both sign

If the instrument has been indorsed several times, some specially and some in blank, the

last valid indorsement controls what is necessary for further negotiation.

3-204 (d) Instrument Payable to Holder Under Wrong Name:

If an instrument is payable to a holder under a name that is not the name of the holder,

indorsement may be made by the holder in the name stated in the instrument or in the

holder's name or both, but signature in both names may be required by a person paying

or taking the instrument for value or collection.

Ex. If the persons name is Sue Moot and the Check says Sue Moort, Sue could sign

either her actually name or the name on the paper.

If the name is to far off then 3-204 (d) won’t apply.

If there is not indorsement then the transferee cannot negotiate the instrument.

3-203 (c) Transferee Pays for Value but Instrument is not indorsed by Transferor:

If the transferee paid value for the instrument, the transferee has the specifically

enforceable right to have the unqualified indorsement of the transferor. The transferee

would still have to sue in equity for a decree ordering the transferor to indorse

If a transferee gets an instrument with out the transferor’s indorsement, he is not a holder

with a right to enforce, but if the transferee does obtain transferor’s signature later than he

will get holder status and have a right to enforce the instrument.

*In determining if a transferee had notice of any adverse claim or defense to the

instrument, the transferee’s knowledge is measured at the time the transferee obtains the

missing indorsement. If a transferee finds out about a claim between the time of paying

for and obtaining possession of the instrument and the time the missing indorsement is

obtained, the transferee cannot qualify as a Holder in due course.

Page 10: Verdun Commercial Paper Outline

3-203 (d) Indorsement of Partial Interest: if the transferor purports to transfer only

part of an instrument, no negotiation occurs. An indorsement that attempts to convey less

than the complete amount of the instrument is not a negotiation and the transferee does

not qualify as a holder

Ex. Drawer draws a check payable to Paula, Paula indorses it and makes a special

indorement stating, pay George 2/3 and Martha 1/3 of check. This is not negotiable.

Different Indorsement Rules for Banks


If a customer delivers an item to a depositary bank for collection:

(1) the depositary bank becomes a holder of the item at the time it receives the item

for collection if the customer at the time of delivery was a holder of the item, whether

or not the customer indorses the item, and, if the bank satisfies the other requirements

of Section 3-302, it is a holder in due course;

The depository bank warrants to later parties that the check was paid to the customer or

deposited into the customers account. In effect this is a warranty that the money got to

the right place, and puts the risk that it did not on the depository bank.

Ex. A bank taking a check that was jointly made to two people and only one person

signs, the bank is liable for conversion to the one person who didn’t sign.

IV. Holder in Due Course

3-302 Holder in Due Course: i) a holder who takes the instrument ii) for value iii) in

good faith, and iv) without notice that it is overdue or has been dishonored, or of any

defense against or claim to it on the part of anyperson

A prerequisite to being a HDC is that there instrument must be negotiable (3-104) and

there is a valid negotiation (3-201)

Page 11: Verdun Commercial Paper Outline

Elements of Holder in Due Course

1) Holder- See Negotiability and Negotiation

2) For Value

3-303 Value:

(a) An instrument is issued or transferred for value if:

(1) the instrument is issued or transferred for a promise of performance, to the extent the

promise has been performed;

(2) the transferee acquires a security interest or other lien in the instrument other than a

lien obtained by judicial proceeding;

(3) the instrument is issued or transferred as payment of, or as security for, an

antecedent claim (the person giving the note already owed money to transferee/holder)

against any person, whether or not the claim is due;

* you can only get the value of the antecedent claim (can include interest), can’t get

more than the antecedent claim

(4) the instrument is issued or transferred in exchange for a negotiable instrument; or

(5) the instrument is issued or transferred in exchange for the incurring of an irrevocable

obligation to a third party by the person taking the instrument.

* value is not consideration, there must be actual value (have you done whatever you

said you were going to do), no promises. The service must have already been


Ex. If lawyer says I’m going to represent you and the client gives the lawyer a note, the

lawyer has not given value since he has not yet represented his client

* Value is only important to see if there is holder in due course status

Zach bought a car signing a promissory note for $23,000 to Fillmore, Fillmore sold the

note to the Pierce for $22,800, is Pierce a holder in due course for $23,000 or $22,800?

Pierce is a holder in due course for $23,000, the promise was performed, they just gave

Fillmore a discount rate to get the money right now. If the discount payment was like

only $10,000 then it might not work.

B) Fillmore owed his mother $21,000 and gave her the note with the understanding that

the extra $2,000 was a gift. Would the mother be a holder in due course for the full

amount. Under 3-303 (a) (3) Fillmore owed a antecedent of $21,000 to his mom. SO

Page 12: Verdun Commercial Paper Outline

that $21,000 would be considered value but that is all that his mom would be a holder in

due course for. The other $2,000 the mom would have to go to court

Special Rules for Banks in Regards to Value

This is when an instrument is negotiated to a bank (that is not the drawee) as part of the

collecting process, and the bank credits the depositor’s account accordingly

4-214 Crediting Depositor’s Account: Merely crediting the depositor’s account is not


4-210 Permitting Withdrawals from depositors account

(a) A collecting bank has a security interest in an item and any accompanying

documents or the proceeds of either:

(1) in case of an item deposited in an account, to the extent to which credit given for

the item has been withdrawn or applied

The bank has a security interest whenever it has permitted precollection (depository bank

hasn’t received money from the drawee bank yet) withdrawal for the depositing customer



For purposes of determining its status as a holder in due course, a bank has given value

to the extent it has a security interest in an item, if the bank otherwise complies with the

requirements of Section 3-302 on what constitutes a holder in due course.

Any time the collecting bank has a security interest in the item being collected, the bank

has given value

*This works in relation with 4-210, and allows a banks security interest in precollection

withdrawals to be value, if it meets all the other requisites then the bank can be a HDC

for the money that was allowed to be withdrawn

4-210 (b) If credit given for several items received at one time or pursuant to a single

agreement is withdrawn or applied in part, the security interest remains upon all the

items, any accompanying documents or the proceeds of either. For the purpose of this

section, credits first given are first withdrawn.

Ex. If Tom deposits a check for $1,000 and there is already $500 in the bank, if that

check for $1,000 is bad and Tom takes out $500, the bank is not a holder in due course

for that $500 because of the First in, first out. However if Tom then drew out another

$200 that the bank credited before finding out the check was bad, the bank would be a

holder in due course for the $200. This is the First In, First Out rule

Page 13: Verdun Commercial Paper Outline

3) Purchas in Good Faith

Good Faith 1-201 (19) and 3-103 (a) (4): means honest in fact in the conduct or

transaction concerned. 3-301 (a) (4) also puts the requirement of commercially

reasonable standards of fair dealing

Holder is under no duty to inquire as to possible defenses, such as failure of

consideration, unless the circumstances of which he has knowledge rise to the level that

the failure of the inquire reveals a deliberate desire on his part to evade knowledge

because of a belief or rear that investigation would disclose a defense arising from the


Look for relationships between breaching party and 3rd

parties, if there is a close

relationship and the third party doesn’t inquire about defenses there could be a good faith


3-307 (b) If (i) an instrument is taken from a fiduciary for payment or collection or

for value, (ii) the taker has knowledge of the fiduciary status of the fiduciary, and

(iii) the represented person makes a claim to the instrument or its proceeds on the

basis that the transaction of the fiduciary is a breach of fiduciary duty, the following

rules apply:

If the taker (bank) knows that the person giving check has a fiduciary duty to another

entity (usually a company) and that person uses the company note to pay a personal

obligation, which the company has not allowed and it breaches a fiduciary duty, then the

bank is not a holder in due course and the company can get their money back.

The fiduciary relationship must be known or should have been known by the bank in

order for the bank to lose there holder in due course status. (ex. A company check

paying a persons personal bill isn’t apparent that this would violate a fiduciary duty with

the company).

A holder must act in a way that is fair according to commercial standards that are

themselves reasonable

Can look to industry for standards.

Page 14: Verdun Commercial Paper Outline

4) Without Notice

Without Notice 3-302 (a) (2) (iii): The Holder must purchase the instrument without

notice (knowledge or reason to know) that it is overdue, or has been dishonored, or of

any defense against or claim to it on the part of any person.

If the purchaser of the instrument acquires the instrument with reason to know that it is

already overdue, the purchaser cannot be a HDC

Existence of Default

Notice that any part of the principal amount is overdue, or that there is an uncured

default in payment of another instrument of the same series prevents HDC status

Instruments Payable on Demand 3-304 (a): Demand instruments become overdue

1) on the day after the day demand for payment is duly made

2) Check becomes overdue 90 days after its date

3) Other Instruments (promissory notes) that are demand instruments becomes overdue

when the instrument has been outstanding for a period of time after its date which is

unreasonably long

Instruments payable at a definite time 3-304 (b): instruments at a definite time become


1) When the principal is paid in installments, the instruments becomes overdue for non

payment of an installment

2) If instrument is not payable in installments, the instrument becomes overdue on the

day after the due date

3) If a due date with respect to principal has been accelerated, the instrument becomes

overdue on the day after the accelerated due date

Default in Interest Payments 3-304 (c):

Unless the due date of principal has been accelerated, an instrument does not become

overdue if there is default in payment of interest but no default in payment of


* Knowledge of the obligor’s default in payment of other obligation or instruments does

not prevent HDC unless the instruments were of the same series

Page 15: Verdun Commercial Paper Outline

Notice of Dishonor of an Instrument

* If the purchaser acquires the instrument with reason to know that it has been

dishonored, the purchaser cannot qualify as a HDC

Dishonor occurs when the instrument is returned after presentment without payment or

acceptance within the allotted time.

Notice of Defenses and Claims

If the purchaser acquires the instrument with reason to know of defenses or claims to

the instrument, the purchaser cannot qualify as a HDC

Time When notice received as affecting HDC status 3-302 (f)

Notice to the purchaser must have been received in such a manner and within such time

as to afford the purchaser a reasonable opportunity to act upon it.

Notice after purchase of the instrument does not affect HDC status

Purchaser’s good faith and notice are measured as of the time the purchaser acquires and

gives value for the instrument as a holder

Ex. If the purchaser of instrument doesn’t get transferor’s indorsement, he is not a holder

until he gets indoresment. So if he obtains notice of default or defense before getting the

indoresement then he cannot be a HDC

Whether a holder qualifies as a HDC is determined as of the moment that the instrument

is negotiated to the holder and/or the holder gives value thereof, which ever occurs later

If the transferee of a negotiable instrument acquires notice of a claim or defense to the

instrument prior to either negotiation or the giving of value the transferee cannot be a


Notice to purchaser where instrument incomplete or irregular (Red Light Doctrine)

Apparent evidence of forgery or alteration or is otherwise so irregular or incomplete as to

call into question its authenticity, knowledge of potential defenses or claims is imputed to

the purchaser, and the purchaser cannot be a HDC

* Someone writing 2007 and crossing off the 7 and putting an 8 is not so irregular

because people do it all the time. It has to be something very irregular to but someone on


Page 16: Verdun Commercial Paper Outline

If and omission or alteration would raise a question as to the bona fides of the instrument

then there is imputed knowledge to the purchaser

Closed Eyes Doctrine 1-201(25) (c)

Mere grounds of suspicion are not enough to constitute notice, a purchaser cannot ignore

the obvious or purposefully avoid finding out the truth.

A person is charged with notice of any fact if from all of the facts and circumstances

known to the person at the time in question he has reason to know that such fact exists

Forgotten Notice 1-201 (25)

Holders who have received notice of a claim or a defense may nevertheless achieve HDC

status if, at the time the holder acquires the instrument, the holder has forgotten about the

earlier information. If sufficient time has passed between time of notice and the

acquisition of the instrument

Miscellaneous Factors for notice

If there is a very large discount rate with other suspicious circumstances this may lead

courts to believe that there was a lack of good faith or notice

Notice of usury: if there is a note that is worth a lot of money and it is sold at a very

discounted price, this should bring up a red flag and the person buying the note should

inquire about why the note is so cheap. If the holder doesn’t inquire about this they will

not be a holder in due course

Payee as HDC 3-302 Comment 4

Ex. Alex and Beth sign a note as co-makers. Alex by fraud induces Beth to sign and,

without authority from Beth, delivers the note to Payee, who takes it for value, in good

faith, and without notice.

Alex defrauds the maker into signing an instrument payable to Payee. Payee pays Alex

for it in good faith and without notice, and the maker delivers the instrument directly to


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Successor To Holders in Due Course (Shelter Rule)

Shelter Rule (Common law)- It is basic rule of commercial law that a transferee

acquires whatever rights the transferor had. The transferee is said to take shelter in the

status of the transferor.

UCC Shelter Doctrine 3-302(b):

Transfer of an instrument, whether or not the transfer is a negotiation, vests in the

transferee any right of the transferor to enforce the instrument, including any right as a

holder in due course, but the transferee cannot acquire rights of a holder in duce course

by a transfer, directly or indirectly, from a holder in due course if the transferee engaged

in fraud or illegality affecting the instrument

This allows any transferee to step into the shoes of the HDC who formerly held the

instrument and to obtain the rights of an HDC, even though the transferee otherwise

clearly fails to meet requirements of due course holdings (ex. Didn’t give value or was

aware of claims or defenses)

Ex. Harry holds a promissory note in which he is the holder of, Harry is a qualified HDC.

Harry gives the note to his son as a gift. The son would not qualify as a HDC because it

was a gift and the son gave no value. However, due to 3-302(b) shelter doctrine, the son

is a HDC as well.

Underlying reason of the shelter rule is to protect the free negotiability of commercial

paper. Once the instrument comes into the hands of an HDC, defenses that could not be

asserted against the HDC cannot be allowed against any transferee. Otherwise the

obligor could, by putting all potential transferees on notice of claimed defense, vastly

restrict the HDC’s market for the instrument and thereby interfere with the free passage

of commercial paper.

Parties of Fraud or Illegality (Washing Through Exception) 3-302 Comment 4

The shelter rule never grants HDC rights to persons who were parties to fraud or

illegality affecting the instrument, whether or not such persons are prior holder of the


A party so implicated cannot sell the instrument to an HDC and reobtain it, in order to be

from defense of fraud of illegality. (This is a laundering provision)

Ex. Harry gets a promissory note from Tom by fraud. Harry then sells the note to Jake in

order to make Jake a HDC (Jake does have HDC status, it is not affected by the washout

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rule), and then Harry wants to have Jake sell the note back to him thus giving him HDC

status against Tom. The UCC will not allow this laundering.

Once a person ahs qualified as an HDC, all subsequent transferees will acquire the

same HDC right not matter how far down the chain the transferees there may be.

Unless they are transferees after a transferor who failed to obtain HDC right because the

transferor was a party of fraud or illegality affecting the instrument.

Burden of Proof as a Holder in Due Course 3-308 (b)

There is a presumption that every holder is entitled to recover. If the plaintiff can

establish that they are a holder (i.e. the transferee in possession of a bearer instrument,

or the indorsee in possession of an order instrument, in other words there is a valid

negotiation), and can produce the instrument and establish the validity of the

signatures thereon the instrument, the burden is on the defendant to prove a defense

The holder will ultimately have to prove they are a HDC, but they won’t have to do this

until the defendant shows and proves a defense.

Where Plaintiff Cannot Produce Instrument

The owner of an instrument can win without producing the instrument, but failure to

produce it will prevent the attachment of presumption under 3-308. The burden is then

on the plaintiff to prove due execution, negotiation, and each fat essential to the validity

of the instrument and the claim of ownership.

Missing Instrument 3-309

If the original instrument has been lost, stolen, or destroyed, the owner (possible HDC)

may recover by proving up its terms together with the facts why the original cannot be


Court also may require the owner of the instrument (possible HDC) to indemnify the

defendant (person owner/HDC is trying to collect from) against loss by reason of any

future claims if the instrument should show up.

If that proof is made for missing instrument and that plaintiff is a holder, then 3-308

applies as if the person seeking enforcement had produced the instrument

HDC status still must be proved, even with the 3-308 presumption that defendant needs

to provide a claim.

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Claims and Defenses on Negotiable Instruments

Claim 3-306

an affirmative cause of action for recovery on the instrument based upon superior

ownership rights of the claimant .

* A HDC takes the instrument free of all such claims

Defense: A defense is a ground for refusing to pay all or part of a negotiable instrument.

The few defenses that can be asserted against an HDC (as well as a non HDC) are called

real defenses

Defenses that cannot be asserted against an HDC (but are good against non HDC) are

called personal defenses

Claim in recoupment: Right of someone who owes a debt to subtract from the amount

due arising from the same transaction that gave rise to the instrument

Ex. Bob buys a stereo from Steve for $200, Bob gives Steve a promissory note for the

stereo. The stereo is defective (breaching warranty) and Bob puts $50 to repair it. Bob

has a $50 claim in recoupment. This claim can be made against any non HDC, but can

only be made against a HDC if the HDC had notice of the warranty claim before

negotiation or giving value. 3-305 (b) and Comment 3

Real Defenses 3-305 (a) (1)

An HDC takes free of most defenses to the instrument. The Few defenses that may be

asserted against an HDC are commonly called real defenses

If there is a real defense it can be used against both HDC and non HDC

Infancy 3-305 (a) (1) (i)

The person contracting is under legal age to make contract

If state law does not make the contracts of an infant void or voidable, infancy would be

only a personal defense

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Incapacity to Contract 3-305 (a) (1) (ii)

Persons other than infants may also lack the capacity to contract (i.e. persons declared


Before such incapacity will constitute a real defense the state law must render the

contract void rather than voidable, this makes it distinguishable from infancy which can

make a contract void or voidable.

Illegality 3-305 (a) (1) (ii)

Some illegality in the underlying transaction reders the obligation void (as opposed to

voidable) this is a real defense against a HDC, even if the HDC had nothing to do with

the illegality.

If the obligation is merely voidable under state law, the illegality is a personal defense.

Duress 3-305 (a) (1) (ii)

Duress occurs in a contract situation where one party acts involuntarily

Fraud In Factum 3-305 (a) (1) (iii)

There are two kinds of fraud: real and personal. Real fraud (fraud in factum) is assertable

against an HDC and is defined as:

Fraud that induced the obligor to sign the instrument with neither knowledge nor

reasonable opportunity to learn of its character or its essential terms

* Basically have to sign something and not know that it is a negotiable instrument in

order to get a Fraud in Factum real defense. Also if a person had an opportunity to read it

and didn’t then they are likely not going to get the fraud in Factum defense.

Example of fraud in factum: Sven, from Norway, cannot read English signs a promissory

note that his attorney tells Hans is a credit application. Here there is fraud in factum,

Sven doesn’t know that it’s a promissory note, and he cannot read English so he cannot

have a reasonable opportunity to learn it’s a negotiable instrument. Sven could assert this

against a HDC.

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Discharge in Insolvency Proceedings 3-305 (a) (1) (iv)

Insolvency proceedings include and assignment for the benefit of creditors and any other

proceeding intending to liquidate or rehabilitate the estate of the person involved.

The most common of proceedings is discharge in a federal bankruptcy proceeding, which

excuses the debtor from most of the debts listed in the bankruptcy petition.

Alteration of Instrument 3-407 (a) "Alteration" means (i) an unauthorized change in an instrument that purports to modify in

any respect the obligation of a party, or (ii) an unauthorized addition of words or numbers or

other change to an incomplete instrument relating to the obligation of a party.

(b) Except as provided in subsection (c), an alteration fraudulently made discharges a party

whose obligation is affected by the alteration unless that party assents or is precluded from

asserting the alteration. No other alteration discharges a party, and the instrument may be

enforced according to its original terms.

(c) A payor bank or drawee paying a fraudulently altered instrument or a person taking it for

value, in good faith and without notice of the alteration, may enforce rights with respect to the

instrument (i) according to its original terms, or (ii) in the case of an incomplete instrument

altered by unauthorized completion, according to its terms as completed.

If an HDC takes the instrument that is altered in good faith then they may collect on the

instrument according to its original terms.

Ex. A thief may altr the amount of a check from $10.00 to $1000, here if there is a HDC

he could possibly collect the $10.00 on the original instrument.

The difference between alteration (changing the terms that the maker or drawer inserted

in the instrument) and unauthorized completion (filing in blanks left by the maker or


Generally the maker will not be liable for the altered amount (except a HDC that gives

value and in good faith), but maker will be liable for the full amount of the

unauthorized completion

Suretyship as a Real Defense

If an HDC knew prior to acquiring an negotiable instrument that some of the prior parties

were sureties (accommodating parties) the HDC takes subject to the right of these parties

to raise their suretyship defenses.

If the HDC did not know that a prior party had signed as a surety, the surety defenses is

personal and cannot be raised against a HDC

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Forgery 3-401 & 3-403

3-401: No person is liable on an instrument unless that person has signed the instrument

3-403: an unauthorized signature is not effective as that of the person whose name is

signed (person whose signature was forged), but does operate as that of the forger or non

agent (the person who forged the name is liable as if he signed his own name).

3-305 (a) (2) frees HDC only from the defenses of a party to pay the instrument. Thus

a party whose name is forged is not a party to pay the instrument, and the person whose

signature is forged may bring defenses (personal or real) against the HDC


(a) In an action with respect to an instrument, the authenticity of, and authority to make, each

signature on the instrument is admitted unless specifically denied in the pleadings. If the

validity of a signature is denied in the pleadings, the burden of establishing validity is on the

person claiming validity, but the signature is presumed to be authentic and authorized unless

the action is to enforce the liability of the purported signer and the signer is dead or incompetent

at the time of trial of the issue of validity of the signature. If you are denying that the signature is

yours, you have to specifically claim it in the pleadings.

The person claiming validity is the plaintiff saying that they are the one with an instrument with

defendants signature on it. So once you deny its your signature its on the other party to prove that

it was your signature.

However the signature is presumed to be authentic unless the defendant shows some evidence

that the signature is forged.

Just having a person saying it isn’t my signature is not enough evidence to force the other party to

prove that the signature is authentic. Must have some evidence to show that there was a forgery.

Personal Defenses: Discharge by Payment 3-602

The liability of any party on an instrument is discharged by a good faith payment to a

holder, even though some other person asserts a claim to the instrument.

3-602(b) If the other party wants to stop payment, that person must obtain a court order

or supply indemnity to protect the payor in the even that payment is eventually ordered

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Liability of the Parties

If a an instrument is technically negotiable so as to come within the scope of UCC

Article 3, the UCC authorizes the following types of lawsuits on the instrument:

i) suits on the instrument’s contractual obligations

ii) Suits in property, based on implied warranties arising upon transfer or presentment

of the instrument, and

iii) Suits in tort for conversion

Merger Rule 3-310(b)

When the instrument is issued, the obligation becomes merged into the instrument and,

unless the parties have agreed otherwise, it is not available as a cause of action (at least


Where a negotiable instrument is accepted as conditional payment for the underlying

obligation, that obligation cannot be the basis of a cause of action until the instrument

is presented for payment or dishonored

Ex. Tenant delivers a rent check to landlord. Tenant’s rent obligation is suspended unitl

the check is presented for payment to Tenant’s bank. If the bank pays the check, the rent

obligation is discharged. If the bank refuses payment (ex. Tenant has stopped payment

on the check), Landlord can sue on the check, on the underlying lease agreement, or on


* If the parties understand that the instrument is merely partial payment of the underlying

obligation, then the obligation is suspended only pro tanto (by that much)

Ex. If Tenant gives Landlord a check for one half of the rent owed, Landlord can sue for

the half still due even before cashing the check.

If a negotiable instrument is dishonored, the holder may sue on theinstrument or the

underlying obligation, or both

If liability on the instrument is discharged in any way (by payment, cancellation,

alteration, bankruptcy) liability is also discharged on the underlying obligation. 3-310(b)

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Cancellation of Underlying Obligation: Party primarily liable on negotiable

instrument is the bank 3-310(a)

Where the party primarily liable on a negotiable instrument is a bank (a cashier’s check,

certified check, or certificate of deposit) the underlying obligation is completely

discharged, as long as the person who owed the obligation is not liable on the


Ex. Ralph give $1000 in cash to bank, bank draw up a check payable to his ex wife Lou

to meet his $1000 monthly alimony. The bank does so, signing its name as drawer and

the wife’s name as payee. When Lou takes this check, Ralph’s alimony obligation is

discharged. If the check bounces, Lou must look to the bank rather than Ralph.

If bank had listed Ralph as payee on the check and he had indorsed it over to Lou, the

underlying obligation (alimony) would not be canceled, because Ralph’s indorsement

created recourse against him on the instrument

* Keep the merger rule in mind whenever the question deals with an instrument that has

not yet been presented for payment for payment. A party can sue on the underlying

obligation only after the instrument has been dishonored.

Procedural Rights

Some parties who may be liable on an instrument are entitled ot the technical procedural

rights of presentment or notice of dishonor prior to being sued. A party having the

benefit of the procedural right is said to be secondarily liable on the instrument.

These procedures must be either complied with or excused before UCC contract liability

arises. Drawers and indorsers are typical examples of such secondary parties

Parties not accorded these rights are said to be primarily liable because of their

vulnerability to immediate suit.

Defenses Available to Maker 3-412

The maker of a promissory note has none of the technical procedural rights of a

secondary liable party. The maker’s obligation is a simple one: the maker promises to

pay the note according to its terms as of the moment of signature

If sued on the note, the maker can assert whatever claims or defenses are available

against the party suing.

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Ex. D promissory note comes due, he pays the full amount to the payee, but fails to

demand return of the note. The next month the note is again presented for payment by a

new holder. D’s obligation to pay the note according to its original terms does not

prevent him from raising his defense of discharge by payment. This would prevail unless

the holder qualifies as a HDC. If holder is a HDC then D only has real defenses.

Incomplete Instrument Signed by Maker 3-412, 3-115,3-406, 3-407

If the maker signs an incomplete note (one having blanks on spaces) the maker is bound

by the terms as subsequently filled

Co-Makers 3-116(a)

If two or more persons sign as co-makers in the same transaction, they are jointly and

severally liable, This is true even if the body of the note fails to use plural pronouns (i.e.

a note beginning with “I promise to pay”) that is signed by moer than one maker

Right to Contribution 3-116(b)

If one co-maker is forced to pay the full amount to the holder, the co-maker may seek

pro rata reimbursement from the other co-makers

Suretyship 3-419(e)

If the co-maker forced to pay the full amount is a surety for one of the other co-makers,

he may seek complete reimbursement from the principal

Obligation of an Indorser 3-415 (a)

Indorsing one’s name to the back of a negotiable instrument makes the indorser a type

of surety for all prior parties (including the maker or drawer). By indorsing the

instrument, the indorser promises to pay it to any later holder, but this promise is

conditioned on the indorser first being accorded the technical procedural rights of

presentment and notice of dishonor

Indorsement “Without Recourse” 3-415 (b)

An indorser who does not wish to incur the liability of an indorser may add the words

“without recourse” to the indorsement and thereby avoid any promise of payment.

This is known as a qualified indorsement, and has the effect of negotiating the

instrument without incurring liability

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Ex. Harry gives Rhonda a check for a debt he owes her. Rhonda signs her name on the

back and cashes it at a local grocery store. If the check bounces the store may collect

from Rhonda on the indorser’s obligation without suing Harry first or even joining him in

the suit. However, if Rhonda had made a qualified indorsement on the check (signing her

name on the back and saying without recourse) the store would have no action against


Draft accepted by a Bank 3-415 (d)

If a draft is accepted by a bank after an indorsement is made, the liability of the

indorser under subsection (a) is discharged

Joint Payees 3-116(a)

If the instrument is made payable to joint payees (i.e. pay to the order of John and Mary)

and they both indorse the instrument, they are presumed to be co-sureties and liable to

each other only for their respective shares. However, the law presumes that they are

both jointly and severally liable to the rest of the world.

Reacquisition and Cancellation 3-207

Reacquistion occurs if an instrument reenters the hands of a prior indorser. Upon

reacquisition, the reacquirer may cancel indorsements that were made between the

time he formerly held the instrument and the present.

This cancellation has the effect of discharging the indorsers whose signatures were

canceled, and the discharge is effective against any subsequent holder, including a


Ex. Pat negotiates a note to Sara by special indorsement as payment for goods. Pat finds

that the goods are defective and returns them to Sara. Sara has already indorsed the note,

but offers to return it to Pat, if he promises to strike Sara’s indorsement. Pat agrees and

does in fact strike Sara’s indorsement. He then negotiates the note to Stan, another

goods supplier. Sara has no liability on the note because her indorsement was canceled.

If Pat had not canceled Sara’s indorsement, she would owe indorser liability to Stan, but

not to Pat.

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Obligation of a Surety

Common Law Rights for Surety

Exoneration- At maturity of the obligation, the surety may bring an equitable action to

compel the principal to pay the debt and thereby exonerate the surety from liability

*surety sues principal demanding performance

Subrogation- If the surety is forced to pay the principal’s debt to the creditor, the surety

is subrogated to (acquires) any rights the creditor had- such as rights to other collateral or

the right to a preferred position in the principal’s insolvency proceeding.

surety can also take whatever rights the principal has as a defense

Reimbursement- Upon paying the principal’s debt to the creditor, the surety may sue the

principal for reimbursement. This is also codified in UCC section 3-419(e).

Contribution- If there is more than one surety on the instrument, sureties signing as part

of the same transaction are entitled to recover pro rata from each other. In other words,

the parties are presumed to co-sureties.

UCC rights to Surety

The UCC refers to the surety as an accommodating party

The principal (the lead person on the instrument) is called the accommodated party

If the surety adds words of guaranty to the signature (Jane, guarantor; I Jane, guarantee

this obligation) the surety becomes a guarantor (3-419 (e))

A Guarantor is a special party, but the guarantor is also a surety

Obligation of the accommodating party

A surety who signs in the place where a maker usually signs incurs the same

obligations as a maker does (3-419(b), 3-412)

A surety who signs in the place where an indorser usually signs (the back of the

instrument) makes the obligation of an indorser (3-419(b), 3-415)

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Accommodating makers and accommodation indorsers therefore have the UCC rights of

nonsurety makers and indorsers plus the special common law and UCC rights given to

sureties (3-419)

3-419(c) If an indoresment seems out of place in the usual chain of title every

subsequent taker of the instrument is conclusively presume to know that the indorsement

was meant as a surety’s signature , also if the signature is accompanied by words

indicating that the signer is acting as surety or guarantor then subsequent holders take

notice that there is surety

Proof of Surety Status

Oral proof of the accommodation nature of a surety’s signature may be introduced,

except against an HDC with no notice of surety status (3-605 (h)

If the instrument itself indicates that one of the signatures was meant to accommodate

another party (i.e. John Doe, surety) even an HDC takes subject to suretyship defense

Surety not liable to Principal

The surety is not liable to the accommodated person, regardless of the place in which the

surety has signed the instrument. 3-419(e)

3-419(f) also codifies the right to reimbursement on the instrument, regarless of the

order in which the parties have signed.

Ex. Harry wants to buy a car, but John (the car dealer) will not accept his check. Harry

then persuades his friend Gloria to write the check for him, payable to John. Harry signs

as an indorser, and obtains the car. When John tries to cash the check, it bounces. IF

John collects the amount of the check from Gloria, she may seek reimbursement from

Harry even though check drawers may not usually sue the indorser on their UCC

section3-415 obligation. Similarly , if John collected the money from Harry, Harry

would have no right to sue Gloria on her drawer’s obligations. Both of these results

occur because Gloria was in fact a surety for Harry, even though Harry signed as the

indorser of her check

* although an accommodating party is never liable to the party accommodated, he is

liable to other parties in the capacity in which he signed.

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Tender Payment 3-603

The tender of payment acts to protect sureties and anyone else (i.e. indorsers) who would

have a right of recourse against some prior party if forced to pay on the instrument.

(Indorsers have a right of recourse aginst the maerk/drawer and/or prior indorsers) The

rule has two parts:

3-603(c)- If, at maturity the surety (or an indorser) tenders payment to the holder of

the instrument and the holder refuses to accept the money, the surety (or indorser) is

still liable for the full amount, but is not liable for any subsequent interest.

3-603(b)- If the tender is made by the principal (or by the party against whom the

indorser has a right of recourse) the surety or indoreser is completely discharged

Ex. Luke promissory note is payable to Darth, and indorsed first by R and the by C.

When the note matures, R tenders payment but Darth refuses to accept. This refusal

invokes 3-603 and discharges C because he had a rigt of recourse against R, but it leaves

R liable for the tender amount.

Ex. If luke had tendered payment and Darth refused, Luke would still beliable for the

tender amount (but not for any subsequent interest, costs, or attorneys fees). However,

both accommodating indorsers, R and C, would be discharged because both had a right to

recourse against luck on his maker’s contract.

Agreements between creditor and principal

Both at common law and UCC, the failure of the creditor to press the principal for

payment at maturity of an obligation does not discharge the surety

Agreements to Extend Time of Payment 3-605(c)

An agreement to extend the time of payment discharges nonconsenting sureties only if

they can prove harm caused by the extension

Agreements Not to Sue 3-605 (b)

An agreement by the holder of the note not to sue the principal does not discharge

nonconsenting sureties as well

Ex. Alice signed a $5000 promissory note, payable to Bank on April 1, and her father,

John, indorsed the note on the bank as a guarantor. Early in January, Alice told the bank

that she was considering filing for bankruptcy, but would forego doing so if the bnak

would accept $3000 and forgive the rest of the debt. The bank agreed and took the

$3000. John still owes the bank $2000. He can then try to get reimbursement from


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Agreements to Modify the terms of the instrument 3-605(d)

If the principal and the creditor agree to a modification of the loan agreement other than

a release of the principal or an extension of time, nonconsenting sureties are

discharged up to the amount of harm suffered by the modification, which is presumed

to be the amount the surety owes unless the creditor can prove lesser amount of


Consent by Surety 3-605(i)

If the surety or a party with a right to recourse, such as indorser consents to an

extension/suspension agreement, that person is not discharged

Such consent is implied for the circumstances.

The terms of a note may likewise bind all sureties in advance to an extension without


New notes and the merger rule

If the maker gives the holder either a new note or a postdated check as a means of paying

the original note, the merger rule suspends the makers liability on the original note. In

effect this is the same thing as an extension of time in which to pay the original note, and

has the legal consequences of an agreement by creditor and principal to extend time of


Nonconsenting sureties and indorsers would be discharged only to the extent they could

prove loss by reason of extension (i.e. principals financial situation is likely to worsen

during extension)

Obligation of guarantor of collection 3-419(d)

If a surety adds words to the signature indicating that she is guaranteeing collection,

there is a special contract. Before a guarantor of collection can be required to pay the

instrument, the holder must first pursue the maker or acceptor to an unsatisfied judgment

or show that such action would be useless (as where the maker is insolvent).

Collection guarantee must be clear

If the surety merely calls herself a guarantor, that alone in no way changes the usually

obligation of a surety. Sureties who call themselves guarantors are only garden variety

accommodation parties whose liability depends on the capacity in which they sign, unless

they make it clear they are guaranteeing collection, in which case their liability is

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


Obligation of a Drawer 3-414(a)

If a draft is dishonored the drawer is obliged to pay the draft according to its terms at

the time it was issued, or if the drawer signed an incomplete instrument, according to

its terms when completed.

The obligation is owed to the person entitled to enforce the draft or to an indorser who

paid the draft

The obligation incurred by the drawer of a draft is similar to that of an indorser, in that

the drawer promises to pay the draft only if first accorded certain technical procedural


Effect of adding “Without Recourse” 3-414(e)

The drawer can eliminate contractual liability on the instrument by adding “without

recourse” to his signature

* This is not effective if the draft is a check

Presentment 3-501(a)

Presentment is a demand for payment or acceptance made by the holder of the

instrument. Presentment is made at the place of business or residence of the maker or

drawee, or at the location specified in the instrument.

In the case of promissory notes, presentment is made to the maker.

Where a draft is involved, presentment is made to the drawee

Rights of presentee (Maker or drawee)

Authorized Demands 3-501(b) (2), (3)

When presentment is made, the maker or drawee may demand the following

1) Exhibition of the instrument

2) Reasonable identification from the person making presentment

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Thumb print is another form of signature so the banks can ask for it under 3-501 (b) (2)

(ii) as reasonable identification, there is no dishonor if bank requires this.

3) Evidence of the presenter’s authority, if presentment of the instrument is made on

behalf of another

4) Production of the instrument at a reasonable place and hour

5) A signed receipt on the instrument for any partial or full payment (presentee is

entitled only to a signed receipt, not the unqualified indorsement of the presenter

6) Surrender of the instrument if the presentee pays in full

7) the party to whom presentment is made may return the instrument for lack of a

necessary indorsement

The bank has a right to demand a signature in order for the bank to be holder 3-501 (b)

(3) (i), there will be no dishonor if the bank requires this, thus the drawer doesn’t have to

be pay until there is a dishonor.

Effect of Failure to comply with demands 3-501(b)

If the presenter cannot or will not comply with one or more of the above demands, a

presentment has not occurred, and the presentee’s refusal to pay on the instrument is

therefore not a dishonor

Time for presentment of domestic checks 3-415(e)

A reasonable time for presenting (or initiating collection on) uncertified checks drawn

and payable in the United States and not drawn up by a bank is presumed to be to be 30

days after their date for indorsers

If a check is not presented for payment or given to a depository bank for collection

within 30 days after the day the indorsement was made, the liability of the indorser is

discharged (3-415(e))


Presentment across the Counter 3-502(b)(2), 3-420(a)

If a draft is payable on demand and is presented to the drawee across the counter for

immediate payment, it must be paid or returned by the close of business on that day.

If paid, a check is canceled and returned to the drawer.

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If returned and not paid, the there is a dishonor, if 3-501 doesn’t apply

If neither payment or return of the check occurs, the drawee has converted the

instrument and is liable for the amount of the instrument as if the drawee had agreed to

pay it.

Presentment through bank Collection Channels (Midnight Deadline Rules) 4-301

Banks typically collect checks from each other by making a provisional settlement on

their own books before presenting a check to the drawee bank. This provisional

settlement allows the drawee bank and extra day within which to decide whether to pay

the item.

This system of giving drawee banks until their midnight deadline (midnight of the

banking day following the banking day of receipt) within which to dishonor an item is

called deferred posting

The Rationale

The policy here is to force the drawee to act quickly or assume liability for the amount of

the check. Quick action helps to cut down on “float” (the period of time in which a

check is in t transit)

What constitutes a Banking Day 4-108

A banking day is defined as that part of a day in which the bank is open to the public for

carrying on substantially all banking functions.

For purposes of clearing up paperwork, the UCC allows a bank to establish a cutoff

hour (2:00 P.M. or later) and to treat items received after that hour as if they were

received on the next banking day. This can have the effect of moving the midnight

deadline back one day

Notice of Dishonor 3-503 (a)

The obligation of an indorser stated in 3-415(a) and the obligation of a drawer state in 3-

414(d) may not be enforced unless the indorser or drawer is given notice of dishonor of

the instrument

Notice of dishonor can be given to any person who may be laible on a negotiable

instrument. Once given, it operates for the benefit of all parties who have rights on the

instrument against the party notified.

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Form of Notice 3-503(b)

The notice of dishonor may be oral, written, or electronically communicated. It must

identify the instrument and state that it has been dishonored.

Return of an instrument given to a bank for collection is sufficient notice of dishonor

Time for giving notice 3-503(c)

Banks must give notice before the expiration of the midnight deadline. Parties other

than banks have 30 days in which to give notice of dishonor

Regulation CC notice of dishonor 12 C.F.R. §229.33

Under regulation CC, the dishonoring bank must send a direct notice to the depositary

bank (the first bank to which an item is transferred for collection) any time it decides not

to pay a check in the amount of $2500 or more. The notice must be received at the

depositary bank by 4:00 PM (depositary bank time) on the second business day

following the banking day on which the check was presented to the payor bank.

The notice must include the name of the paying bank, the name of the payee, the amount,

the reason for return, the date of the indorsement of the depositary bank, the account

number of the depositor, the branch where the item was first deposited, and the trace

number on the item of the depositary bank, unless these matters cannot be reasonably

determined from an examination of the item itself

Necessity for presentment and notice of Dishonor

Indorser’s liability 3-415(c), 3-503(a)

Because the indorser’s obligation is conditioned upon notice of dishonor, presentment

and notice of dishonor are necessary to bind indorsers. Indorsers are released from

liability if these are not properly accomplished.

Drawer’s Liability 3-414(f)

The code requires that checks be presented to the drawee for payment within 30 days of

their date. If presentment is delayed beyond this period and the drawee becomes

insolvent during the period of delay, the drawer’s liability is excused upon assigning to

the holder the drawer’s rights against the drawee

* this only applies when a drawee bank becomes insolvent, this rarely happens

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Stale Checks 4-404

If a non certified check is presented more than six months after its date, it is said to be

stale. A bank that dishonors a stale check may not be sued for wrongful dishonor by

the drawer.

Even though the check is stale, it is still dishonor by the bank, so drawer will then

become liable.

Where the bank acts in good faith, it may pay a stale check, although most courts and

commentators agree that if the bank should have noticed that the check was stale, it

would be bad faith to pay the check without first checking with the drawer

3-118 (c) statute of limitations: Except as provided in subsection (d), an action to

enforce the obligation of a party to an unaccepted draft to pay the draft must be

commenced within three years after dishonor of the draft or 10 years after the

date of the draft, whichever period expires first.

Situations in Which technical procedures are excused

Compliance with the technical procedures of presentment and notice of dishonor is

excused in certain circumstances

Circumstances beyond Bank’s Control 3-504(c)

Payor and collecting banks are excused from compliance with Article 3 and Article 4

time limits if the delay is caused by circumstances beyond the bank’s control (ex.

Interruption in communication facilities, insolvency of another bank, war, etc.) and if the

bank uses reasonable diligence under the circumstances to avoid the problem.

Ex. Computer breakdown could excuse payor bank from having to dishonor checks by its

midnight deadline

* Bank claiming the excuse has the burden of proof to show circumstance was beyond

banks control

Compliance excused completely

Compliance with the technical procedures is completely excused in the following


Waiver 3-504 (a),(b)

The right to presentment and notice of dishonor can be waived in the instrument or by

conduct of the parties. A waiver written into the body of the instrument binds all

parties, while waiver written above the signature of an indorser binds only the


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Waiver by Conduct

Waiver can be implied from the circumstances.

Unavailability of primary party 3-504 (a) (ii)

If the maker, acceptor, or drawee is dead or the subject of insolvency proceedings,

presentment is excused except as to documentary drafts

Impossibility 3-504(a) (i)

Compliance with the technical rights is also completely excused where such compliance

would be impossible despite reasonable diligence

Where Compliance would be a useless thing

Anticipatory Repudiation 3-504(a) (ii)

If a party announces in advance that they will not pay the instrument at maturity, no

presentment is necessary

Countermanded payment 3-504 (a) (v)

A party who has stopped payment or has requested another to do so has not right to

presentment or notice of dishonor, and is not discharged from liability upon failure to get


No right to expect payment 3-504 (a)(iv)

A party who has no reason to expect or right to require that the instrument be accepted or

paid” cannot complain about failure to receive technical procedural rights.

Obligation of a Drawee of Acceptor

A drawee incurs no UCC contractual liability merely by being named as such by the

drawer (this excuses the drawee from liability to the holder of a draft). This is because

1)The drawee’s name on the draft is not a signature 2) issuance of negotiable instrument

does not work an immediate assignment of the drawer’s funds

Obligation of the Acceptor

Acceptor Defined 3-409(a)

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

Acceptance defined 3-409(c)

Acceptance is the drawee’s signed agreement to honor the draft as presented. It may

consist of the drawee’s signature alone, written on the draft. If the draft is a check, the

drawee bank’s acceptance is called certification

Purpose of Acceptance

Acceptance by the drawee creates an acceptor’s obligation to honor the draft when

presented for payment. Following acceptance, the acceptor returns the draft to the holder

who has presented it, and it may then be further negotiated.

Characteristics of Acceptor’s obligation 3-413

The acceptor’s signature on a draft creates primary liability indentical with that of the

maker of a promissory note. In other words, the acceptor promises to pay the instrument

according to the terms at the time accepted (or, if then incomplete, as subsequently


Acceptor has all the defenses availbe that a drawer or as 3-305 allows

Exception for certified checks 4-303

A certified check should be treated as money, so that an acceptor must pay the check

when presented for payment—even if the bank has a defense or the drawer has tried to

stop payment.

Check Certification 3-409, 3-413,4-303(a)(1)

When a drawee bank agrees to certify a check, it typically freezes a like amount in the

drawer’s account so that funds will be available when the check is presented for payment.

Once the bank has certified the check and either returned it to the presenter or notified the

presenter of certification, the bank becomes primarily liable thereon by incurring the

obligation of an acceptor, and it is too late for the drawer to stop payment.

Discharge by Certification 3-414(c), 3-415(d)

No matter who procures certification, the drawer and indorsers are immediately

discharged from all liability by the act of certification

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Liability of an Agent 3-402(a)

The signature rule provides that no one is liable on an instrument unless that person has

signed the instrument. However, a signature can be made by an agent on behalf of the


Authority of an agent maybe expressed, implied, or apparent.

Unauthorized signatures 3-403 (a)

An unauthorized signature usually does not bind the person whose name is

purportedly signed, but it does act as the signature of the person who signs.

Ratification 3-403(a)

An unauthorized signature can be ratified, thereby making the principal liable on the

same baiss as if the principal had authorized the signature.

Ratification occurs when a principal knowingly adopts a signature as his own or when,

with full knowledge of the circumstances, the principal appropriates the benefit of the

unauthorized signing or fails to deny the validity of the signature, knowing that silence

may mislead others.

Signature as agent

It follows that an agent must be very careful to sign in such a way as to bind the principal

but not the agent. Otherwise, the agent may be personally liable on the instrument and

unable to introduce evidence of agency status

Requirements 3-402

To escape liability against all persons (even a HDC) an agent must:

1) Name the principal, and

2) Indicate that the agent’s signature is made only in a representative capacity

* the name of the agent followed by the agent’s official title and coupled with the name

of the principal is sufficient to relieve the agent of liability

Use of the word “By” 3-402(b)

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The word “by” in front of a signature is usually sufficient to indicate that the signer is an

agent of the named principal

Effect of failure to complete one of two requirements 3-402(b)

If 1) the agent indicates representative capacity but fails to name the principal, or 2)

names the principal but fails to indicate representatives capacity, the agent is

personally liable only to an HDC, but in a lawsuit with a non HDC is permitted to

prove that the original parties did not intend for the agent to be personally liable

Unidentified Principal

If someone signs a negotiable instrument on behalf of someone else, the principal is

bound (as long as he authorized the agent to do this) and this is true even if the

principal is not named in the instrument

Warranty Suits

Warranty suit involving a negotiable instrument arise off the instrument. The plaintiff in

an action for breach of warranty need not possess the instrument because liability arises

from implied warranties created automatically when the instrument is physically shifted

from one party to another.

An implied warranty on a negotiable instrument is a property right and does not depend

on the intentions of the parities.

The plaintiff need not qualify as a holder of the instrument

There are three stages a negotiable instrument goes through issuance, transfer, and

presentment. The warranties arising at each of these stages are mutually exclusive, so

that the implied warranties made on transfer are not also made at the moment of


No Warranties on Issuance

No implied warranties are created by the issuance of a negotiable instrument (first

delivery to the payee)

Warranties of Transfer 3-416, 4-207

Transfer-Any movement of an instrument other than an issuance or presentment is a


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3-416 is for people who transfer an instrument and 4-207 is for Banks and customers of


Transfer warranties are rights given to the transferee that may be asserted against a

transferor if litigation arises on the instrument. Won’t see your first transfer until there is

interaction between the person issued the instrument and a 3rd


Person entitled to enforce instrument 3-416(a)(1), 4-207(a)(1)

Warranty that the transferor is a “person entitled to enforce the instrument” Meaning

that the transferor has taken the instrument pursuant to a valid negotiation and is

therefore a holder.

Valid Signatures 3-416(a)(2), 4-207(a)(2)

Warranty that all signatures are authentic and authorized.

No Alterations 3-416(a)(3), 4-207(a)(3)

A warranty against any alterations to the instrument

Instrument not subject to a defense or claim 3-416(a)(4), 4-207(4)

Warranty that there are no legal defenses or claims in recoupment that are good against

the transferor

Ex. Pam defrauds Myron into giving Pam a promissory note, which Pam promptly

negotiates to Loan Company. Because Myron could successfully defend a suit on the

note by Pam, transfer of the note to Loan Company breached the warranty that there was

no good defense against Pam. So if Loan Company has to give back the instrument or

couldn’t collect, they could collect money from Pam for breaching her warranty

* If Loan Company was a HDC, meaning that Loan Company took the instrument free of

defenses, they could still sue Pam for breach of warranty because Pam did have a defense

good against her as a transferor. So even though they are a HDC free of defenses, Loan

Company could still sue Pam for breach of warranty if litigation arises.

No Knowledge of Insolvency Proceedings 3-416(a)(5), 4-207(a)(5)

Warranty that the transferor has no knowledge of any insolvency proceeding (ex.

Bankruptcy) instituted by or gains the party from whom payment is expected

* This only warrants that the transferor has no knowledge of an insolvency proceeding,

there actually might be one that transferor doesn’t know about and he wouldn’t be

breaching his warranties.

Warranties depend on receipt of consideration 3-416(a), 4-207(a)

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Transfer warranties are made only by transferors who receive consideration, a transferor

who receives no consideration makes no transfer warranties

* Once someone begins bank collection, the Article 4 rules apply

Warranties of Presentment 3-417, 4-208

Warranties made on presentment for payment or acceptance are considerably narrower

than transfer warranties.

Doctrine of Price v. Neal--- Drawee’s responsibility

A drawee is responsible for knowing the drawer’s signature, so that if the drawee were

mistaken the drawee could not seek restitution form the innocent presenter.

Effect of Final Payment 3-418,4-215

Once final payment has occurred the foregoing doctrine indicates that the drawee (or

maker in the case of a promissory note) cannot undo the transaction and recover the

money paid unless a presentment warranty has been breached or the person who

received the payment was not acting in good faith

Presentment Warranties

Person Entitled to enforce instrument 3-417(a)(1), 4-208(a)(1)

Warranty that collecting person is a person entitled to enforce the instrument

The presenter is saying to the drawee that they have taken the instrument pursuant to a

valid negotiation and is therefore a holder.

No alteration 3-417 (a)(2), 4-208(a)(2)

Warranty that there has been no alteration of the instrument.

No Knowledge that the signature of drawer or maker was unauthorized 3-417(a)(3),


Warranty that the presenter has no knowledge that the signature of the drawer or maker

is unauthorized.

Presenter just can’t have knowledge that the signature was forged or unauthorized.

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If the presenter didn’t have knowledge of unauthorized signature, and there was a forged

drawer’s name it wouldn’t violate 3-417(a)(1), 4-207(a)(1), because under 3-403, the

forged name is treated as like the thief had drawn a check using his own name and there

can be valid negotiation and right to enforcement, since the signature is treated as the

thief own

The drawee could attempt to collect by suing the thief, because his forgery of drawers

name is like signing his own name (3-403), so the bank could sue on the instrument or

sue for fraud, but this likely won’t be successful because the thief will more than likely

have fled town.

* N.B. If the bank pays out on a forged indorser’s signature (i.e. special indorsement/

payee indorsement) a presentment warranty is breached because the presenter didn’t

have the right to enforce against the drawer because of forgery.

Persons deemed to make presentment warranties 3-417(a), 4-207(a)

Everyone who transfers a negotiable instrument automatically makes presentment

warranties, as does the party who physically receives payment or acceptance. This

permits the payor to sue anyone in the chain for breach of presentment warranties.

Notice Requirements 3-416(c),3-417(e),4-207(d), 4-208(e)

For both transfer and presentment warranties, the Code requires that notice of claim of

breach be given with 30 days after the claimant has reason to know of breach. Failure

to give notice within that period discharges the liability of the warrantor to the extent of

any loss caused by the delay in giving notice. Doesn’t completely discharge warrantor.

Conversion 3-420(a)

Conversion is the unauthorized exercise of the rights of ownership over personal property

belonging to another. UCC preserves this common law notion

Forged or Missing Indorsements

If an instrument is taken by transfer other than a negotiation (this is excluding gifts) or

a bank makes payment to someone not entitled thereto, a conversion occurs.

A conversion occurs anytime there is a forgery of a necessary indorsement or such a

necessary indorsement is missing. All transfers and payments thereafter would be


Ex. Donna drew a check payable to the order of John and Mary. John took the check

and signed his own name on the back, and forged Mary’s name below his. He cashed the

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Check at Drug Store, which deposited the check in its bank, which forwarded the check

to the drawee bank for payment. Because Mary’s valid signature had to be on the check

for there to be a true negotiation, she may sue in conversion John, Drug Store, Drug

Store’s bank, and the Drawee bank. Whoever is sued will use warranty theories to pass

the loss back to John.

Appropriate Plaintiffs in Conversion Suits

The appropriate Plaintiff in a conversion suit based on forged or missing indorsements is

the person whose property rights are being violated.

In the above example Donna the drawer wouldn’t be the appropriate plaintiff because she

issued the check thus giving up her property right. Conversion actions may not be

brought by the issuer of an instrument

Also conversion claim cannot be brought by a payee or indorsee who did not receive

delivery of the instrument either directly or through an agent, or a co-payee

Bank Deposits and Collections

When someone opens a checking account and begins using it, both UCC Article 4 and the

Federal Expedited Funds Availability Act regulate the legal issues that arise from the

passage of checks through the bank collection machinery

Two big things to understand in this section

- A bank may charge a customer’s account only if an item is properly payable

- Once final payment has been made, a bank loses the right to return items

Article 4 governs the bank collection process

UCC Article 4 amplifies or alters Article 3 provisions governing negotiable instruments

where items become part of the bank collection process

Wrongful Dishonor 4-402

If a check or other item is properly payable from the drawer’s account but the bank

wrongfully refuses to honor it, the drawer has a cause of action against the bank for

wrongful dishonor

Only drawer may sue Because the drawer, through contract creating the account, is the only one in privity with

the payor bank, only the drawer may sue for wrongful dishonor. Other parties cannot sue

the payor bank unless it has accepted the instrument

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Damages under the Code 4-402(b)

Requires injured parties to prove actual damages. If the wrongful dishonor is

indefensible and outrageous than drawer can sue for punitive damages. Also can sue for

consequential damages

Death or Incompetence of Customer 4-405(a)

A banks collection of payment actions taken prior to knowledge of the death or

incompetency of a customer are valid

Knowledge means actual knowledge, plus reasonable time within which to act

Even where the bank has knowledge of a customer’s death, a bank may elect to pay or

certify checks for 10 days following the death 4-405(b)

What Constitutes a Properly Payable Item 4-401(a)

A bank must charge a customer’s account for an item (check, note, etc.) only if item is

properly payable. If the item is not properly payable the bank usually must replace the

money in the account if the customer complains within relevant time limits.

Whether is properly payable depends on

- The terms of the deposit contract between customer and bank

- who presents the item

- the terms of the item

- the usages of trade (drawee bank requiring a holder to have an account to get payment is

not reasonable commercial standard and would be wrongful dishonor)

Ask if the customer authorized the payment and if the payment does not violate any

agreement that may exist between the bank and its customer

* An item containing a forged drawer’s signature or forged indorsement is not

properly payable.

Overdrafts 4-401(a)

If payment of the item in question would overdraw the customer’s account, the bank

need not pay but may do so even where the bank and its customer have no agreement

concerning overdrafts

A bank may charge the customer’s account for an item even though payment results in a


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Altered and Completed Items 4-401(d)(1)

If an item has been altered the bank may charge the account only according to the

original terms of the item unless the customer’s negligence led to the alteration, in

which case the bank may pay the item as altered (this must be done in good faith)

If a customer leaves blanks in the item that are later filled in, the bank may assume that

the item as completed is proper (unless it knows otherwise) and the account may be

charged accordingly 4-401(d)(2)

A bank in their properly payable contract with the customer cannot contract out of

exercising ordinary care 4-103

Proper Presenter 3-301, 4-401

The payor bank may charge its customer’s account with the amount of an item only if it

pays a person who qualifies as a person entitled to enforce the instrument (usually a


If a bank makes a payment to a nonholder, it does so without authority, because it has not

followed the customer’s order, which was to pay to the order of payee. This would mean

the instrument is not properly payable and the drawer could get his money put back in his


Postdated Checks 4-401(c)

Postdated checks are properly payable unless the customer gives the bank notice of the

postdating before the bank pays or certifies the check.

A customer wishing to postdate a check must notify the payor bank of its postdating time

to allow the bank to act on the customer’s notice before the bank has to commit itself to

pay the check. If the customer fails to act on the customer’s timely notice, it may be

liable for damages for the resulting loss which may include damages for dishonor of

subsequent items.

Stop Payment Orders 4-403

Item on which a bank has stopped payment is not properly payable, provided drawer

gives reasonable notice

No Stop payment on bank obligations 4-403(a)(1)

In the case of cashier’s checks and certified or accepted items, banks may not stop

payment at the request of the drawer, such items remain properly payable in spite of the

stop payment order

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Requirement of reasonable notice 4-403(a)

A customer may stop payment (on all items not mention above) by giving notice that

reasonably identifies the item and is received sufficiently before payment that the bank

has a reasonable opportunity to act on it.

On a stop payment order a customer must describe their check with reasonable

accuracy. (So a check that is described by number, payee, but the amount Is off by 50

cents is still reasonably accurate, and banks must stop payment and if they don’t they

have to give customers money back

Oral Notice 4-403(b)

The customer’s stop payment notice may be oral, but an oral notice is good only for 14

days unless renewed in writing within that period

Written Notice 4-403(b)

A written stop payment notice is good for 6 months, but it may be renewed in writing

for further 6 month period

- A bank can charge a stop payment fee

Customer Has burden of proving loss 4-403(c), Comment 7

If the bank pays an item in spite of a stop payment order, the customer has the burden

of proving that a loss occurred and the amount of the loss.

If there is a HDC in the chain of transferees of the item, the customer cannot recover,

because even if payment had been stopped, the customer would have to pay the HDC

Ex. Dion draws a check to his nephew as a gift, but decides to stop payment. The

nephew cashes the check at his bank, State Bank, which presents it to the payor bank.

The payor bank, carelessly failing to obey Dion’s stop orde, makes the payment. Dion

has no loss because State Bank was a HDC (having given value for the check by cashing

it) and if the payor bank had dishonored the check, Dion would still have been liable to

State bank. This is known as a subrogation right (4-407) and customer couldn’t go

after the bank even though they didn’t follow the stop payment order.

Right of Subrogation 4-407

If an items is not properly payable but the bank nevertheless pays it, the bank is

subrogated to (steps into the shoes of) any person connected with the instrument

(drawer, payee, holder, or HDC) to the extent necessary to prevent unjust enrichment

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4-407: If customer stops payment on a check and the bank actually pays the check any

ways, if the customer still owed the payee money any way (payee was a HDC), the bank

has actually satisfied an obligation that the drawer owes to the payee. It would be unfair

for the obligation owed by drawer to be satisfied yet the bank has to reimburse the

customers bank account as well. See the example above.

Subrogation gives the Bank the rights of any HDC on the item against the drawer or

maker (4-407(1));

the rights of the payee or any holder of the item against the drawer or maker either on

the item or under the transaction out of which the item arose (4-407(2));

rights of the drawer or maker against the payee or any other holder of the item with

respect to the transaction out of which the item arose (4-407(3))

Right of Setoff for Bank (Common Law)

Traditionally, banks (a debtor’s, with the customer being the bank’s creditor) have

exercised a common law right available to all debtors to subtract (set off) from the

amount owed the customer any debt the customer owes the bank. This is the right of

“setoff” generally referred to by bankers as “offset”

Ex. Annie misses a payment on the school loan she has borrowed from her bank, so the

bank pays itself out of her checking account. Annie has no recourse, even if the

withdrawal causes her outstanding check for her dog’s food to bounce.

- the Federal Fair Credit Billing Act of 1975 prohibits banks from setting off the unpaid

credit card debts of their customer-cardholders

Notice of Setoff

Banks need not notify the customer prior to setoff

Applies only to general Accounts

A bank’s right of setoff may be exercised only against general checking or savings

account. If the account is earmarked for a special purpose (ex. Tax accounts) there can

be no setoff of unrelated debts from it

Effect of Final Payment 4-303(a)(1), (2)

If the bank has certified an item or has made final payment thereon, it is too late to set

off a claim against the amount necessary to pay that item

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*Bank cannot make setoff i) for unpaid credit card debt ii) against special accounts, or iii)

for items that have been certified or for which payment is final

* Setoff off of a customer’s account is considered the bank giving value, this is important

for HDC status

Bank Collection Procedures

Deposit Availability Under Federal Law: Regulation CC 12 C.F.R. part 229

If a bank customer puts money or checks in an account, a federal statute, the Expedited

Funds Availability Act, regulates how quickly the customer must be allowed to draw

against that account.

Government checks and bank checks CC §229.10

Funds from government checks that are deposited in a bank account must be made

available on the next business day. This includes checks issued by any branch of

government: federal, state or local.

The same one-day availability period is mandated for the deposit of checks drawn on the

same bank in which deposited, cashier’s checks, certified checks, or teller’s checks.

Electronic deposits are treated just like cash deposits, so funds must be made available

the next day

The $100 availability Rule: CC §229.10(c)(1)(vii)

For all the following checking transactions mentioned, the customer must be permitted to

withdraw $100 of the check deposited on the business day after deposit

Local Checks: CC §229.12(d)

For local checks (those drawn on banks located in the same geographical available area

served by the Federal Reserve processing center) Funds must be available for

withdrawal by check payable to third parties no later than two business days after

deposit. Could also withdrawal $100 on the day after check was deposited.

For Cash withdrawals, the customer must be permitted to take out $100 on the business

day after the date of deposit , must be permitted to withdraw $400 more by 5 P.M. of

the second business day, and must be allowed to withdraw all the rest as cash on the


business day after deposit

*Keep in mind that banking and business day are two separate days

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Non Local Checks: CC § 229.12(c)

For nonlocal checks (those not drawn on banks located in the same geographical area

served by the Federal Reserve check processing center) , the funds must be available for

withdrawal by check payable to third parties no later than 5 business days after


For Cash withdrawals on non local checks, the customer must be permitted to take out

$100 on the business day after the date of deposit. On the 5th

day after deposit $400

worth of cash must be available for withdrawal no later than 5 P.M. and the rest of the

cash at the opening of the 6th

business day.

ATM Deposits: CC § 229.12(f)

For deposits made at an ATM owned or controlled by the depository bank, the above

rules apply, except items requiring next day availability are given an extra day

Safe Guard exceptions

New Accounts: CC §229.13(a)

During the first 30 days of the existence of a new account, there must be next day

availability for cash or wire deposits, government checks, and for bank generated checks

(ex. Cashier’s checks). However if a government check or bank generated check

exceeds $5000 the depositary bank may put a hold on the amount that exceeds $5000 for

up to 9 business days.

There are no rules that describe the time period for the availability of local or nonlocal

checks for new accounts; thus the UCC rules would apply

Large Checks: CC §229.13(b), (h)

To the extent a day’s deposit exceeds $5000, the bank may hold the excess for further

reasonable time (presumed to be 5 business days for local checks and six business days

for non local checks) over the usual time period

Repeated Overdrafts: CC §229.13(d), (h)

If a customer repeatedly overdraws an account in any given 6 month period, then for the

next 6 months thereafter the bank may hold deposited checks for a further reasonable

time (presumed to be 5 business days for local checks and six business days for non local

checks) over the usual time. The is repeated overdrafts when a accounts balance is

negative for 6 or more banking days in a six month period

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Reasonable Cause Exception: CC § 229.13(e)

If a bank has reasonable cause to believe that a check is uncollectible, it may ignore the

usual rules if it gives notice to the customer.

Notice: CC § 229.13(g)

Except in the new account situation, where a bank plans to take advantage of any of

these exceptions, the depositor must be notified as soon as possible of the date the funds

will be made available

Damages for breach by bank: CC § 229.21

Can be sued for actual damages, punitive damages , plus attorney’s fees

Deposit Availability Under the UCC

If Regulation CC does not regulate the availability of funds, article 4 of UCC will do so.

Money 4-215(f)

A customer may draw against money deposited in an account on the next banking day

Ex. On April 10, Freda deposits $100 in her checking account. That same afternoon,

Freda writes a check to her landlord for $100, and the landlord proceeds straight to the

bank and presents the check to the drawee bank. Freda has no complaint if the bank

elects to dishonor the check because it has until the next day to process it.

Checks 4-105

The length of time that a check must be deposited in an account before it must be made

available for withdrawals under the UCC varies according to how far the check must

travel to reach payor bank (the drawee).

Where depositary bank and payor bank are one and the same 4-215(e)(2)

If the check drawer and the payee happen to have accounts at the same bank, that bank

will be both the depositary bank and the payor bank. If the bank does not dishonor the

item, the amount specified in the check becomes available for withdrawal by the payee

at the opening of the second banking day after the deposit.

*if regulation CC applies it requires the next business day availability for checks

deposited in the same bank on which drawn

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All other situations- (Final Settlement Rule) 4-215(e)(1)

If the check must travel within a city or across the country, the depositary bank must be

allowed sufficient time for the check to go to the pay bank and if dishonored to come

back before being required its depositor to draw against eh amount involved.

Recap of Midnight Deadline rule

The payor bank has until its midnight deadline to dishonor an item presented to it

through banking channels. If it does not do so by that time, final payment occurs and

there can be no dishonor. The payor bank is then accountable for the amount involved,

even if no such drawer or account exists.

Final Payment 4-215(a)

An item is finally paid by a payor bank when the bank has done the first of any of the


1) Paid the Item in cash 2) does not dishonor by midnight deadline

*Once there is final payment then you have to go to transfer and presentment warranties

to recoup money

Final Settlement

At the moment of final payment, all provisional settlements made as bookkeeping entries

by banks in the collection chain firm up and become “final settlements” Dishonor of the

item is no longer possible, so that the bank

Right to Charge back 4-214

Prior to final settlement, a depositary bank or any other collecting bank that learns that

payment on the item will not be made, may charge back (reverse) any provisional

settlement given its customer for the item

Prior us of Credit 2-414(d)(1)

The depositary bank’s right of charge back is not affected by the fact that it has already

permitted its depositor to draw against the item returned; the depositor must repay the


Failure to use ordinary care 4-202

A collecting bank must use ordinary care in collecting items. Failure to do so makes the

bank liable for the amount of the item

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Speed of Collection 4-202, 4-108

A collecting bank usually must pass items (or notice of dishonor) along the chain before

its midnight deadline or be found not to have exercised ordinary care. In effect this gives

each collecting bank two days in which to act. If a bank takes longer to act, it has the

burden of establishing that the delay was reasonable.

Right of charge back not affected by negligence 4-214(d)(2)

The failure of a collection bank to exercise ordinary care in its collection duties does not

destroy the bank’s right to charge back.

Effect of final settlement 4-214(a)

The right of a depositary bank to charge back an uncollected check expires at the moment

final settlement occurs (i.e. at the moment the payor bank makes final payment)

Notice of Charge Back: 4-214(a)

The depositary bank need not give notice to its customer that its is charging back the

amount of a returned check before doing so, but it must send notice to the customer

that charge back has occurred before expiration of its midnight deadline

Final Payment

Final payment occurs at the moment the payor bank becomes accountable for the amount

of the item presented, and the provisional bookkeeping entries firm up so that final

settlement occurs.

Final Payment Occurs When 4-215

Payment in Cash 4-215(a)(1)

Once the payor bank hands over the money, final payment occurs and it is too late to

dishonor the check

Settlement 4-215(a)(2)

Final payment occurs when a bank settles for an item and has no right to revoke the

settlement. Ex. Bank pays for a presented item with a cashier’s check

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Failure to revoke provisional settlement 4-215(a)(3)

If the payor bank has already made a provisional settlement (conditional settlement) for

the item presented, the payor bank has until the midnight deadline of the banking day

following day of presentment in which to reverse the provisionsal settlement in favoer of

the presenting bank and send the item back.

This is most common method of final payment, and it is basically saying that the time

limit is up for a bank to be able to dishonor

Regulation CC and midnight deadline rule

Regulation CC permits payor bank to miss their midnight deadlines and still avoid final

payment in two situations

Day after midnight deadline passes: CC § 229.30(c)(1)

Where the bank will be able to return the item to the depositary bank before the close of

business on the next banking day

Ex. National Bank returns checks to the Federal Reserve bank by putting them in its

armored car and sending them back to the Fed. The armored car makes its last run at 4.

A check is presented by the Fed to National Bank on Monday Morning. On Tuesday at 6

P.M., National Bank decides to dishonor the check. If were just following UCC, it

defines send as including mailing. So the Bank would put the letter in the mail.

Regulation CC allows the bank to wait for the next day’s armored car run as long as the

check will ordinarily be received by the Fed before its cutoff hour on Wednesday, thus

getting it back quicker than mailing would.

Highly expeditious means of transportation: CC § 229.30(c)(1)

Regulation CC also permits a payor bank to miss its midnight deadline as long as it uses

highly expeditious means of transportation, even if this transportation would ordinarily

result in delivery after the receiving bank’s next banking day.

Legal effect of final payment 4-302

When final payment occurs the bank is accountable for the amount of the item and

usually has no way to avoid payment

* Once either certification or final payment occurs notice of problems, bank’s right to

setoff, service of legal process (garnishment of wages), or a stop payment order, can stop

the bank from paying the item

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Ex. On Friday payor bank certifies Drawers check. At noon Friday, the sheriff serves a

writ of garnishing Drawers account. The writ comes to late to encompass the certified

check, because certification makes the bank itself liable on the check.

Rights of payor bank after payment

Once final payment has occurred, the payor must pay the item and cannot recover the

payment made except in the following circumstances:

Bad Faith Presenter 1-103,1-203,3-418

The common law doctrine of restitution for payment made due to mistake or fraud will

permit the payor bank to undo final payment where the equities favor the bank and the

other party acted in bad faith

Presentment Warranties 4-208

Final payment doesn’t deprive the payor bank o fits right to sue for breach of presentment

warranty. That is because the suit is off the instrument

Check Truncation

229.51- if a bank provides a copied form of the original check and it shows all of the

telling markers then that check must be accepted as evidence in legal matters. These

checks are known as substitute checks.

No one can refuse to take a substitute check

A substitute check must be a paper reproduction, with the routing numbers, the indorsers,

Truncating bank- 229.2 . This is the bank that takes the deposits and makes an electronic

image of the check.

229.2 The reconverting bank- the bank that creates the substitute check, this is usually

the payor bank.

What happens when they try to convert the electronic image of the check to paper but

something goes wrong? You have warranties and indemnities

229.52 Warranties on reconverting of the check- person who creates or transfers check is

warranting that the checks are legally accurate.

Reconverting bank is responsible for warranties

If the check is not accurante the reconverting bank is responsible for damages

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229.53 Indemnity- the person who truncates the check, agrees to indemnify any

reconverting bank if the there is a mistake on their behalf while making an electronic


Truncating bank is responsible for indemnity

The reconverting bank may not have been the one who caused the problem in making a

bad substitute check, but instead it was the truncating bank, then the reconverting bank

can sue for indemnity

Warranties is between customer and reconverting bank

Indemnity is between reconverting bank and truncating bank

Most banks hold the original copies of a check for 45 days, even though technically they

should hold it for 120 days.

Forgery or Alteration of Negotiable Instruments

Unauthorized signatures will not be deemed that of the person whose name is signed

unless that person is precluded from denying it

No Damages Defense

No matter what happens to a negotiable instrument (forgery, alteration, etc.) it is a

defense at common law that the proceeds reached the person entitled to them. If this

occurs there can be no successful lawsuit because there is no damages

Forger Rule 3-403(a)

An unauthorized signature will not be deemd to be that of the person whose name is

signed unless that person is precluded from denying it.

An unauthorized signature can be ratified by an authorized person. Requires 1)

Knowledge of the unauthorized signature 2) consent to the unauthorized signature

Ratification is a retroactive adoption of the unauthorized signature by the person whose

name is signed and may be implied by conduct as well from express statements. The

unauthorized signature becomes valid so far as its effect as a signature is concerned

Imposter Rule 3-404(a)

An imposter is one who pretends to be someone else. The UCC requires that drawers

and makers be careful with whom they deal with, and if they are duped into issuing an

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instrument to an impostor, the resulting forgery of the payee’s name is nonetheless



(a) If an impostor, by use of the mails or otherwise, induces the issuer of an

instrument to issue the instrument to the impostor, or to a person acting in

concert with the impostor, by impersonating the payee of the instrument or a

person authorized to act for the payee, an indorsement of the instrument by any

person in the name of the payee is effective as the indorsement of the payee in favor

of a person who, in good faith, pays the instrument or takes it for value or for


Ex. Larry tells Jessie that he is Milton Money, and that he is collecting for a new public

library. Jessie writes out a $50 check payable to Milton Money. Larry’s subsequent

forgery of the name to the instrument is effective to pass good title to his tranferees. If

Jessie finds out the truth, she has no complaint to her bank that the check was not

“properly payable” due to forgery of the payee’s name

Impostor need not communicate Fact to Face 3-404(a)

The UCC doesn’t require face to face dealings, so the rule applies as well to

misrepresentations through mail or other forms of communication.

Identity of actual Forger Irrelevant

Once the drawer or maker has issued an instrument to an imposter, the resulting

indorsement of the payee is validated regardless of who actually forges it (i.e. it need not

be forged by the original imposter)

Issuance of Fictitious payee or payee not intended to have interest in instrument 3-

404(b) (b) (Fictitious Payee) If (i) a person whose intent determines to whom an

instrument is payable (Section 3-110(a) or (b)) does not intend the person

identified as payee to have any interest in the instrument, or

(ii) the person identified as payee of an instrument is a fictitious person, the

following rules apply until the instrument is negotiated by special indorsement:

(1) Any person in possession of the instrument is its holder.

(2) An indorsement by any person in the name of the payee stated in the

instrument is effective as the indorsement of the payee in favor of a person

who, in good faith, pays the instrument or takes it for value or for collection

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3-110- The person who signs the instrument, if that person does not intend the name

payee to have any interest in the instrument or, regardless of what that person intended, if

the named payee is a fictitious person, the forgery of the payee’s name is effective to

negotiate an instrument

Employer’s responsibility for Fraudulent indorsements by employee 3-405(a), (b) (a) In this section:

(1) "Employee" includes an independent contractor and employee of an

independent contractor retained by the employer.

(2) "Fraudulent indorsement" means (i) in the case of an instrument payable to

the employer, a forged indorsement purporting to be that of the employer, or

(ii) in the case of an instrument with respect to which the employer is the issuer, a

forged indorsement purporting to be that of the person identified as payee.

(3) "Responsibility" with respect to instruments means authority (i) to sign or

indorse instruments on behalf of the employer, (ii) to process instruments

received by the employer for bookkeeping purposes, for deposit to an account,

or for other disposition, (iii) to prepare or process instruments for issue in the

name of the employer, (iv) to supply information determining the names or

addresses of payees of instruments to be issued in the name of the employer, (v) to

control the disposition of instruments to be issued in the name of the employer, or

(vi) to act otherwise with respect to instruments in a responsible capacity.

"Responsibility" does not include authority that merely allows an employee to

have access to instruments or blank or incomplete instrument forms that are

being stored or transported or are part of incoming or outgoing mail, or similar


(b) For the purpose of determining the rights and liabilities of a person who, in good

faith, pays an instrument or takes it for value or for collection, if an employer

entrusted an employee with responsibility with respect to the instrument and the

employee or a person acting in concert with the employee makes a

fraudulent indorsement of the instrument, the indorsement is effective as the

indorsement of the person to whom the instrument is payable if it is made in the

name of that person. If the person paying the instrument or taking it for

value or for collection fails to exercise ordinary care in paying or taking the

instrument and that failure substantially contributes to loss resulting from the

fraud, the person bearing the loss may recover from the person failing to

exercise ordinary care to the extent the failure to exercise ordinary care

contributed to the loss.

Effect of Negligence by Subsequent parties 3-404(d), 3-405(b)

If subsequent parties do not observe ordinary care in taking or dealing with the

instrument after the payee’s name is forged, there is comparative negligence

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(a) A person whose failure to exercise ordinary care substantially

contributes to an alteration of an instrument or to the making of a forged

signature on an instrument is precluded from asserting the alteration or the

forgery against a person who, in good faith, pays the instrument or takes it

for value or for collection.

(b) Under subsection (a), if the person asserting the preclusion fails to exercise

ordinary care in paying or taking the instrument and that failure substantially

contributes to loss, the loss is allocated between the person precluded and the

person asserting the preclusion according to the extent to which the failure of each

to exercise ordinary care contributed to the loss.

* This is the comparative negligence term for 3-406

(c) Under subsection (a), the burden of proving failure to exercise ordinary care is on

the person asserting the preclusion. Under subsection (b), the burden of proving

failure to exercise ordinary care is on the person precluded.

Examples of Failure to Exercise Ordinary Care by a drawer or maker of an

instrument 3-406 Comment 3

Leaving blanks or spaces on instrument

Filling in a blank or space without authority is an alteration, but if the maker or drawer

carelessly leaves such blanks available to the wrong doer, the maker or drwer should not

be able to complain

Mailing an instrument to someone with same or similar name of payee

If the issuer of the instrument carelessly sends it to someone who will have no trouble

cashing it because she has the same or similar name as the intended payee, that violates

the standard of ordinary care

Failure to follow internal procedures

If the issuer has created a system designed to avoid check forgeries, it is negligence not to

follow that procedure

Failure to guard signing device

If the issuer signature is place on the instrument by a machine or rubber stamp, the issuer

is negligent if the machine or stamp is not closely guarded and gets into the wrong hands

Some courts require that the negligence be the proximate cause of the of the forgery or


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Agent’s Authority to indorse not presumed

An agent’s authority to sign the name of the principal to a negotiable instrument is never

presumed. Hence, one who cashes checks for an alleged agent is negligent if the

authority of the agent is not carefully checked.


(a) In this section:

(1) "Fiduciary" means an agent, trustee, partner, corporate officer or director, or

other representative owing a fiduciary duty with respect to an instrument.

(2) "Represented person" means the principal, beneficiary, partnership,

corporation, or other person to whom the duty stated in paragraph (1) is owed.

(b) If (i) an instrument is taken from a fiduciary for payment or collection or for

value, (ii) the taker (i.e. bank) has knowledge of the fiduciary status of the

fiduciary, and (iii) the represented person makes a claim to the instrument or its

proceeds on the basis that the transaction of the fiduciary is a breach of fiduciary

duty, the following rules apply:

(1) Notice of breach of fiduciary duty by the fiduciary is notice of the claim of

the represented person.

(2) In the case of an instrument payable to the represented person or the fiduciary

as such, the taker has notice of the breach of fiduciary duty if the instrument is

(i) taken in payment of or as security for a debt known by the taker to be the

personal debt of the fiduciary, (ii) taken in a transaction known by the taker

to be for the personal benefit of the fiduciary, or (iii) deposited to an account

other than an account of the fiduciary, as such, or an account of the represented


Trustees don’t use assets in the trust to pay personal obligations, a bank seeing this

will be notice of a breach of a fiduciary duty.

If the bank has notice of breach of fiduciary duty

If you have 3-405 claim by the bank and a 3-307 claim by the principal then you

measure the weight of each claim. Its very similar to a comparative negligence

claim. Ask who would have an easier time detecting the fraud. Who every had the

easier time detecting fraud will lose the claim

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Bank Statement Rule 4-406

Once a month, a bank will return canceled checks to its customers, along with a statement

of account. Failure to examine this statement is a form of negligence that that can

preclude the defense of forgery and alteration.

Customer’s Duty to examine statement 4-406(c)

After receiving a statement, the customer must promptly use reasonable care in examing

it for two things 1) an unauthorized signing of the customer’s own name as drawer, and

2) any alteration on any item

Check Truncation and a duty to examine

If the bank pursuant to an agreement with its customer, does not return checks, the bank

may send the customer a description of the checks in lieu of the checks themselves.

The statement at a minimum must describe the following with regard to each check:

Item number, amount, and date of payment 4-406 Official Comment 1

This minimal information should be enough to alert the customer to problems 4-406(a)

Customer’s right to copies of the checks 4-406(b)

If the bank does not return items to the customer, the customer has the right to request

legible copies of them for 7 years

Effect of Failure to examine statement 4-406(d)(1)

If the customer fails to report a forgery or alteration problem within a reasonable

time, the customer is precluded from complaining to the bank that the item in question

was not properly payable (4-401(a)), if the bank can prove a further loss (other than

original payment) caused by this delay

*Where, the bank has only its original loss from the improper payment and cannot show

further damages caused by the delay in reporting, the customer is not precluded from

asserting forgery or alteration

* This is why forged signatures usually don’t usually work for 4-406(d)(1), because if the

check and properly payable then the bank would still have to pay the amount of the


Customer must exercise reasonable promptness in examining a statement, reasonable

promptness is not defined so it varies in each case. Customer must also have reasonable

time to have discovered the unauthorized statement

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Ex. If a person takes your check and makes themselves payee and takes out $1000,

the bank doesn’t suffer a loss because if the customer found the unauthorized

statement promptly the bank would have to pay back the customers account

anyway. So no matter what the bank was going to lose $1000

Repeat Offender Rule 4-406(d)(2)

Where the statement has been available to the customer for a reasonable period of time

(not more than 30 days) and there is no complaint about an unauthorized signature or

alteration, the customer is precluded from demanding recredit on any other items

forged or altered by the same wrong doer and subsequently paid by the bank (until

customer gives notice)

(2) the customer's unauthorized signature or alteration by the same wrongdoer on

any other item paid in good faith by the bank if the payment was made before

the bank received notice from the customer of the unauthorized signature or

alteration and after the customer had been afforded a reasonable period of

time, not exceeding 30 days, in which to examine the item or statement of

account and notify the bank.

Result where bank is also negligent 4-406 (e) If subsection (d) applies and the customer proves that the bank failed to

exercise ordinary care in paying the item and that the failure substantially

contributed to loss, the loss is allocated between the customer precluded

and the bank asserting the preclusion (comparative negligence) according to the

extent to which the failure of the customer to comply with subsection (c) and the

failure of the bank to exercise ordinary care contributed to the loss. If the customer

proves that the bank did not pay the item in good faith, the preclusion under

subsection (d) does not apply.

Burden of Proof 4-406 (d), (e)

Each side has the burden of establishing lack of care by the other party. To take

advantage of a section 4-406 preclusion, the bank must therefore establish that the

customer failed to use reasonable care in examining the statement. To spread loss, the

customer must show that the bank failed to use ordinary care in paying the item.

Cutoff Period (Statute of limitations) 4-406(f)

No matter who was negligent, UCC bars all customer complaints first made more than

1 year after the statement was made available to the customer.

Bank must assert section 4-406 defenses

If a customer complains to the bank about an unauthorized signature or alteration and the

bank has a defense under the bank statement rule, the bank must raise that defense against

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its customer. If it does not do so, the bank may not pass its loss on to prior parties

through breach of warranty suits or otherwise.

Alteration 3-407

An alteration of the terms of a negotiable instrument occurs if it changes the instrument

in any way. Changing the names or relations of the parties, changing the amount, are

examples of alteration

Fraudulent Alteration 3-407(b)

If a fraudulent alteration occurs, all prior nonnegligent parties are completely discharged

from liability on the instrument, and due to the merger rule, on the underlying obligation

as well

Negligent Alteration 3-406,3-407(b)

If the alteration was caused by negligence of a party, that party (drawer or prior

indorsers) is not discharged, and is in fact liable on the instrument as it now reads, at least

when sued by later good faith parties.

*3-407 (b) usually applies to negligent drawers when they fall under 3-406

Discharge is personal defense 3-407(b), 3-601(b)

Discharge is a personal defense, thus if an alteration causes parties to be discharged on

the instrument, they are still liable according to the original terms of the instrument if

the instrument is transferred to a HDC

Rights of drawee bank 3-407(c), 4-401(d)(1)

A drawe or payor bank may charge and altered instrument against the drawer’s account

according to the original terms. (This wouldn’t violate 4-401 improperly payable)

Bank as an agent 4-201

Bank is the agent of a customer and if customer gives there bank a check that they have

not yet signed as an indorser, the bank may indorse it for the customer

Incomplete instruments 3-407(c), 4-401(d)(2)

The unauthorized completion of an incomplete instrument is an alteration, but an HDC

and a drawee/payor bank may nevertheless enforce the instrument according to its terms

when completed.

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* Completion is not alteration, completion happens when there are blanks on the

instrument, alteration occurs when terms are changed

Lost, Destroyed, or Stolen Instruments

General Rule 3-309

If an instrument is lost, destroyed or stolen, its true owner (payee or payee transferees)

may still sue upon it, but must first prove ownership and explain the reasons for not

producing the instrument. To protect the defendant form double liability in cse the

instrument should turn up in the hands of a HDC, the court may require the owner to post

bond or give the defendant security against loss by reason of future claims.

Cashiers check- check drawn by the bank on itself

Tellers check- is one drawn by one bank on another or that it is payable through another


Certified check- is an ordinary check that the drawee bank has signed thus exposing

itself to primary liability.

Declaration of loss 3-312

A customer who lost banks checks as mentioned above, may come into the issuing bank

and fill out a form called a declaration of loss describing the problem. If the bank check

is presented within 90 days period following the date of the check the bank will pay


If the check is not presented within the 90 days period, at the end of the period the bank

pays the money to the customer who filled out the declaration of loss, and if the check

shows up later, even in the hands of a HDC the bank has no further liability, and the

person in possession of the bank check will have to try and get the money from the