I. The Basic Checking Relationship and the Bank’s Right to Pay Checks a. General
i. The Basic Relationship
1. 3-103(a)(2), 4-104(a)(8), 4-105(3): Definition of “drawee” or “payor bank” 2. 3-103(a)(3), 3-105(c): Definition of “drawer” or “issuer”
3. 4-105(2): Definition of “depositary bank” 4. 4-105(4): Definition of “intermediary bank” ii. Promulgation of Rules
1. Both Federal and State law makes rules. 4-103(b) acknowledges the preemptive effect of rules that are promulgated by the federal rules over state rules
iii. The UCC
1. Article I is general principles that apply to all substantive topics covered by the UCC
a. Definitions in 1-201(b)
b. Obligation of Good Faith in 1-304 2. Article III is negotiable instruments
3. Article IV is Bank Deposits and Colllections b. The Bank’s Right to Pay
i. When is it proper for the Bank to Pay?
1. 4-401(a): A Bank can pay only when the check is “properly payable”
a. It is properly payable if the “customer has authorized the payment.” 4-401comment 1
2. If a check is given to an intermediary bank, then the intermediary becomes a person entitled to enforce the check. 1-201(b)(25), (27)
3. If a check is stolen through no fault of the payee, the bank does not have the right to pay the check. 4-401 comment 1, sentence 5-7.
c. Overdrafts
i. The payor bank can charge the account, but (absent some specific agreement) it is also free to dishonor the check and refuse to pay it. 4-401(a), 4-402(a)
ii. McGuire v. Bank One, Louisiana, N.A.
1. Man representing himself as investment broker offers to sell woman bonds. She writes him $200,000 check, says not to cash it until later date. He cashes right away, and money has not transferred from her investment account into another account, creating an overdraft of $188,000. He does not buy bonds with her money, but keeps it for himself (conversion). She believes bank failed to exercise ordinary care. Held, Bank had the right to cash the check. (1) The check was “properly payable” under 4-401. (2) 4-401 permits a bank to charge a properly payable check against a customers account even if an overdraft results. (3) Under 4-103 the bank must exercise ordinary care. (4) B/c the check was properly payable under 4-401(a), this is ordinary care under 4-103. (5) Case law has shown that it doesn’t matter how big of an overdraft that is caused, it does not affect ordinary care.
iii. Rationale for Overdraft Acceptance
1. Rule that required banks to pay overdraft would be unduly burdensome for banks that would have to deal w/holding the bag if nobody reimbursed them
2. Rule that required banks not to pay overdrafts would be unduly burdensome on customers who would have bad credit and bounced checks
iv. Bank’s can agree to pay overdrafts, and thus become obliged to do so. 4-402(a) states that “a bank may dishonor an item that would create an overdraft unless it has agreed to pay the overdraft” and 4-103(a) states that “the effect of the provisions of this Article may be varied by agreement.
1. The UCC does not regulate how much banks can charge in overdraft fees. However, some state courts have found that a huge charge violates the banks obligation of good faith if charge was “not in the reasonable contractual obligations of the parties” and some courts have found them unconscionable. v. Banks are allowed to pay checks in ANY order they choose. 4-303(b)
d. Stopping Payment
i. Customer must give the payor bank timely and adequate notice of the stop payment. 4-403
ii. Bank cannot charge account over a stop payment order. 4-403 & Comment 7 iii. Three considerations limit the practicality of the customer’s right to stop payment:
1. The customer must act promptly to exercise the right. 4-403(a)
a. “Received at a time and in a manner that affords the bank a reasonable opportunity to act on it before any [final] action by the bank with respect to the item.”
i. Unlikely to work if stop payment comes more than a few days after check has been written
2. The duration of the stop payment order is six months, and can be revived by the payee after that. 4-403(b)
3. The underlying obligation for which the check was written. a. Payee has two separate rights on the check:
i. The right to enforce the check ii. The underlying obligation
b. To handle these two rights, UCC provides two rules:
i. 3-310(b): UCC “suspends the payee’s right to pursue the customer on the underlying transaction when the payee accepts the
customer’s check.
ii. 3-310(b)(1): The statute provides that the suspension ends if the check is dishonored.
e. Remedies for Improper Payment. 4-401
i. Bank must reverse the improper transaction. B/c item was not properly payable, the bank cannot sustain the charge on the customer’s account. Bank must thus recredit.
1. Statute also provides for consequential damages in cases which the charge to the account leads the bank to dishonor other checks. Must pay damages to the customer for all things proximately caused. 4-402(b)
ii. 4-407 sharply limits the recredit issue. 4-407 “subrogates” the bank’s rights to the rights of the payee so that the bank can assert the payee’s rights against the drawer as a defense to the bank’s obligation to recredit the account.
II. The Bank’s Obligation to Pay Checks a. When are funds available for payment
i. The bank has the option to pay any item that is properly payable from the customer’s account
1. When the account has funds “available” the bank has an affirmative duty to pay the account
ii. Two questions must be answered:
1. When is the determination made?
2. What is the balance in the account at that time? b. Time of Evaluation
i. The statute essentially chooses the moment that the payor bank evaluates the check as the the point in time when the account must have sufficient funds
ii. Under § 4-402(c), the bank is free to determine whether the account has sufficient funds “at any time between the time the item is received by the payor bank and the time that the payor bank returns the item.”
1. Dishonor remains appropriate notwithstanding new credits to the account after the bank has evaluated the sufficiency of the funds in the account.
c. Availability of funds
i. Reg CC establishes a framework of deadlines within which a depositary bank must release funds that its customers deposit by check.
1. Unlike UCC § 4-215, those deadlines apply even if the depositary bank does not determine by the deadline if the payor bank will honor the check in question. ii. First, distinguish among four separate dimensions:
1. General
a. Customer deposited in the form of local check b. Customer deposited non-local check
i. Non local check is “any check drawn on a bank located outside the check-processing region of the bank at which the check is
deposited
c. Customer wishes to use funds indirectly (writing checks against them) d. Customer wishes to use funds directly (withdrawing cash).
2. Noncash withdrawls from local checks
a. The bank must make $100 available on the first business day after the banking day on which the funds are deposited.
b. The rest must be available for withdrawal no later than the second business day
3. Noncash withdrawls from nonlocal checks
a. The bank has to make $100 available on the first business day after the banking day on which the funds are deposited.
b. The rest must be made available for withdrawal no later than the fifth business day after the . . .
4. Cash withdrawals from local checks
a. The bank must make $100 available on the first business day after the banking day of deposit
c. Must make remainder available on third day 5. Cash withdrawals from non-local checks
a. Must make $100 available on the first business day
b. Must make additional $400 available on the fifth business day c. Must make remainder available on the sixth business day. iii. Banking v. Business Day
1. Banking Day: Those business days on which the bank is open “for carrying on substantially all of its banking functions
2. Business Day: All calendar days except Saturday, Sunday, and Federal Holidays iv. Seven ways you can get all available funds the next day. However, you must be (a) the
original payee of the instrument and (b) personally deposit the item (no ATM): 1. Cash Deposits
2. Checks drawn on a local branch of the bank where they are deposited 3. US Treasury Checks
4. USPS money orders
5. Checks drawn on a federal reserve bank or federal home loan bank 6. Checks drawn on a local governmental entity
7. Cashier’s Checks or similar items drawn on banks
v. Low-risk items that are not deposited with a teller in the payee’s own account: 1. A treasury check or Postal Service money order deposited by somebody other
than the original payee is treated as if it were a typical local check
2. If a Federal Reserve Check, local government check, or cashier’s check is deposited by somebody other than the original payee, the check is processed under the standard rules, with the availability of funds depending on whether the check is a local or non-local check
vi. Low Risk items deposited in an ATM:
1. If Cash, Postal Service Money Order, Federal Reserve Checks, Local Government Checks, or Cashier’s Checks are deposited at an ATM into an account owned by the payee of the check, the availability is deferred a single day, to the second business day.
a. So, customer can’t get shit until 2nd business day ($100 then) vii. Justification for prompt funds availability
1. First, Reg CC doesn’t unconditionally obligate the bank to release funds immediately
2. Second consideration is convenience
3. Third, the likely long-term effects of giving banks the risk of loss that they face if deadlines force them to release funds without determining whether a check will clear
4. First National Bank v. Colonial Bank (Check Kiting Scheme/Risk of Loss)
viii. Wrongful Dishonor: What happens in a bank refuses to pay
1. If a bank doesn’t pay a check it was obligated to pay, it has wrongfully dishonored the check
2. Customer is entitled to “all of the damages proximately caused by the wrongful dishonor.” UCC § 4-402(b)
III. Collection of Checks
a. The Payor Bank’s Obligation to the Payee
i. Although the payor bank might be liable to the drawer for wrongful dishonor, the payee itself can usually do nothing to force the payor bank to pay the check
1. Illustration: Outdoor Technologies v. Allfirst Financial, Inc.
a. H gave a $700g check to Outdoor for outstanding payments. The check stated it was drawn on an account at FNB, but it was actually drawn on Omni Bank. Outdoor wanted to get the check cashed as quickly as possible because H was about to institute bankruptcy proceedings.
Outdoor sent someone to drive to a branch of FNB to cash it. They said it was an Omni check, that Omni was owned by BankCorp. and to call the lawyer of Omni/BankCorp. Lawyer says neither bank has to cash it - however, he says that if the guy goes to the closest Omni branch and presents “proper authorization” they will cash it. When he got to the branch, the lawyer said a letter wasn’t “proper authorization,” that he needed board approval. He couldn’t get it in time, and H filed
bankruptcy, freezing the accounts. (1) There is no fraud by the lawyer. (2) No negligent Misrepresentation.
ii. If the payee is concerned that the payor bank won’t pay, it can protect itself: 1. Payee could refuse to accept an ordinary check
2. Ask for a special check that offers an assurance the bank will pay it a. Payee can ask for a certified check under 3-409(d)
b. Ask for a cashier’s check or teller’s check. § 3-104(g), (h) i. These require inconvenience to get
b. The Process of Collection
i. Payee has two options to collect on a check:
1. Go directly to the payor bank and Obtain Payment Itself
a. Cash the check, by presenting it ”for immediate payment over the counter” 4-301(a)
i. If payor bank cashes, payment is final. 4-215(a)(2), comment 4 p 5 b. If payee has account at same bank as drawer
i. The bank sees this as an “on us” item
ii. Will give the depositor a provisional credit on the day it receives the item
iii. As long as the payor bank provides that provisional settlement on the day it receives the item, the payor bank has until its “midnight deadline” – midnight of the next banking day – to decide whether to honor the check. 4-301(a), (b).
1. If honored, it adds to payee’s account and deducts from drawer’s
2. If dishonored, notice is sent to payee/customer. a. Then, can charge back payee’s account
3. If bank does nothing by midnight deadline, it loses its right to dishonor the check. 4-214(c), 4-301(b).
2. Obtain payment through intermediaries: Two Steps a. Payee Æ Depositary Bank
i. First, an agency relationship is set up between the bank and the customer. § 4-201.
1. Thus, the depositary bank becomes the “collecting bank” 2. Also, comes with a duty of ordinary care. 4-202(a)
ii. Second, bank gives provisional settlement, reserves its charge back right if the payor bank doesn’t honor the check. § 4-214
b. Depositary Bank Æ Payor Bank
i. Depositary Bank has broad discretion on how to collect 1. Must move quickly to meet funds availability rules
ii. Typically, the check (paper) is transmitted to the payor bank, who pays it
3. Methods of transmission
a. Clearinghouse Arrangements
i. See p. 347 for a clearinghouse hypo
ii. Note: If bank doesn’t follow clearinghouse rules regarding a provisional settlement, it can lose its right to dishonor under the UCC
1. Can’t recover from depositary bank, clearinghouse, or payee after that
iii. See: Kimberly Allen Trust p. 348
iv. Trust deposited into its account with Lakewood a $110g check. Lakewood presented to the payor bank the check the day after it was received, and placed a hold on trust account pending payment of the check. Lakewood received a provisional credit. After payor bank notified Lakewood the check had cleared, the hold was lifted from the account. Five days later, the payor bank said it was returning the check for insufficient funds, and Lakewood charged back the account and a fee. Trust filed action seeking its funds from Lakewood. (1) Under 4-214, a bank loses its right to charge back when payment becomes final. (2) Under 4-215(d), after payment becomes final, the bank is accountable to the customer for the item and any provisional credit when it becomes final. (3) 215(a) tells when something is “finally paid”. (4) Pursuant to 4-302, if an item is presented to and received by a payor bank, that bank is “accountable” for the amount of the demand item if it retains the item beyond midnight of the banking day of receipt without settling for it or, whether ot not it is also the depositary bank, does not pay or return the item, or send notice of dishonor until after its midnight deadline (midnight of the next banking day after receipt.
b. Bilateral Arrangements (Direct Send and correspondents clearing)
i. A pair of banks that have a relationship – a lot of checks drawn on them each day - will enter into this type of relationship –
contractual, where they give provisional credits and then send the checks to the bank.
c. Collection Through the Federal Reserve System
i. System of last resort because it is most expensive and slower ii. Send to Federal Reserve Bank, who sends it to Payor bank – must
honor or notify by midnight deadline – iii. If the payor wants to dishonor, go to Reg CC:
1. The Reg CC return deadline:
a. Payor bank must return the check in an “expeditious manner” in order to meet one of two deadlines”:
i. Two Day/Four Day Rule:
ii. Requires the dishonoring payor bank to send the check so that the check would normally be received by the depositary bank not later than 4pm on the deadline: the fourth
business day for nonlocal checks; the second business day for local checks. CC
229.30(a)(2)
2. Reg CC and the UCC midnight deadline
a. Whereas the UCC deadline requires the payor bank to put it in the mail by midnight of the next banking day, Reg CC allows them to wait until the next day if they use a mode of delivery that results in a faster return than the midnight deadline
b. First extension, deadline is waived if you return the check to the transferor (Fed Reserve Bank) by the day after the midnight deadline
c. Second extension waives the midnight deadline if the payor bank uses a “highly expeditions meas of transportation, even if this means of transportation ordinarily would result in delivery after the
receiving banks next banking day.” 3. Reg CC notice of non-payment deadline
a. A payor bank that dishonors a check for $2500 or more must get notice of its determination to the depositary bank by 4pm on the second business day after the banking day on which the payor bank received the check.
i. Whether non-local or not
ii. Allows depositary to release funds the second business day after the banking day d. Difference between failure to meet the Reg CC rules and failure to meet
the midnight deadline:
i. Failure to meet the deadline affects the settlement process: 1. Payor bank becomes accountable for the item under §
4-302, payment becomes final under § 4-215, and depositary bank loses any right of charge back under § 4-214
1. Generally limited to damages CC § 229.38
e. Common Practice: Return notice over the Electronic Earns System(359)
Obligation Action Required Citations
Midnight Deadline Send the item by midnight on the next banking day unless Reg CC extends the deadline
UCC §§ 301(a),
4-104(a)(10), 1-201(38); Reg CC § 229.30(c)(1)
Reg CC return Return the Item to the
depositary bank either by the two-day/four-day rule or by the forward collection rule
Reg CC § 229.30(a)
Reg CC notice If the item is for $2500 or more, give notice to the
depositary bank by 4pm on the second business day
IV. Risk of Loss in the checking System – The Basic Framework
a. There are two tiers that address the issues of risk of loss in the Checking System
i. Tier One: A Basic Framework that distributes losses based on generalized assumptions about the relative abilities of parties to prevent certain types of losses
ii. Tier Two: Several situation-specific exceptions to the general first-tier rules b. Basic Tier One Problems
i. Nonpayment 1. General
a. Two fundamental elements of the system make nonpayment losses relatively common:
i. (1) The payee’s inability to know when it takes a check whether the payor bank will honor it
ii. (2) The relatively long delay between the time that the payee accepts the check and the time that the payee finds out whether the check will be honored
b. UCC 3-415 is the principal indorser liability statute 2. Endorsements
a. 3-204: Endorsement itself need be nothing more than a signature by the person selling the check
b. 3-205(b): This is a “blank indorsement” has the legal effect of making the check “bearer paper” so that the any party in possession of the check can enforce it
c. Or, endorsement can be a “special endorsement” payable to a specified person, entity, etc.
i. 3-205(a): This makes the check “order paper” which can be enforced only by the identified party
d. Or, the party can endorse the check “for deposit only” or “for collection.” i. 3-206: This is called “restrictive endorsements” which restrict the
right of later parties to transfer the check except in accordance with the endorsement.
3. UCC rules on indorsements and indorsement liability
a. 3-415: each party that indorses a check makes an implied contract with subsequent parties that acquire the check. That contract obligates the indorser to pay the check if the payor bank dishonors it.
b. The rule results in a chain of liability under which each party can pass a dishonored check back up the chain to the last person in the chain that is able to pay (the earliest indorser)
c. 3-414(b): Liability on the drawer of the insolvent check 4. Protecting the indorser from liability on stale obligations
a. 3-415(e): The indorser’s liability is conditioned on the check’s being deposited or presented within 30 days of the indorsement – or the indorser has no liability
b. 3-415(c): Any person seeking to enforce a claim of liability on an indorsement to give prompt notice of the dishonor to the indorser. c. 3-503(c): If the person giving the notice is a collecting bank (both
midnight of the banking day after it learns of the dishonor. In all other cases, the notice must come within 30 days.
5. Avoiding indorsement liability
a. 3-415(b): All the indorser must do to disclaim the liability is to add the phrase “without recourse” to the indorsement. If an indorsement is made “without recourse,” subsequent owners of the check cannot sue the indorser even if the check is dishonored.
ii. Forged Signatures 1. General
a. Responses from the system
i. The first response of the system is the obvious one that the unauthorized signer – the thief – should be responsible for all losses caused by the forgery
ii. The difficult task is to determine who is liable in the event that the unauthorized signer cannot be located
b. Forged Drawers Signatures and the Rule of Price v. Neal i. The check is a complete forgery
ii. The allocation of losses from that kind of forgery depends on whether the payor bank (a) is duped into paying the check or (b) notices the forgery and dishonors the check
c. Payor Bank Pays the Forged Check
i. Price v. Neal: Payor Bank bears the loss if it fails to notice the forgery and honors the check (check was not properly payable because the drawer never authorized it)
ii. 4-401(a): payor bank has no right to charge the account if drawer doesn’t authorize it
d. Two exceptions that allow a shift in liability
i. 3-418(a)(ii): payor bank can seek recover from “the person to whom or for whose benefit payment was made.”
ii. 3-418(c): Does not apply against a person that took the instrument in good faith
iii. 4-208: series of implied presentment warranties in favor of the payor bank. If any of those warranties if false, the payor bank can recover from the party that presented the check to the payor bank or from any previous transferor in the chain of collection of the check
iv. 4-208(a)(3): Warranty liability if the transferor had knowledge that the signature of the drawer was unauthorized
1. 1-202: Distinguishing between “knowledge” and “notice” v. It makes some sense to leave the responsibility of loss with the
payor bank. A legal rule that puts the losses from forged checks on payor banks gives payor banks every incentive to work to develop institutions that limit losses from forged checks
e. Payor Bank Dishonors the Check
i. If the payor bank notices the check is forged and dishonors it, then the collecting bank is left holding the uncollectible check
ii. UCC contains two legal rules on which the presenting bank can rely:
1. (1) Creates a special set of warranties that limit claims about forged drawers’ signatures;
a. 3-417(a)(3) & 4-208(a)(3): Step 1 appears in the qualification of the warranty regarding the drawer’s signature that permits a payor bank to complain only if the warrantor had “knowledge that the drawers signature was unauthorized
b. 3-416(a)(2) & 4-207(a)(2): The analogous transfer warranty includes an absolute avowal of the authenticity of the drawer’s signature
2. (2) it limits payor banks to pursuing that limited set of warranties
a. 3-416(a) & 4-207(a): Step 2 appears in the rule that the parties that can pursue transfer warranties must be parties to whom an instrument has been
transferred
b. Because an instrument is presented to the payor bank, not transferred to it, the payor bank cannot pursue the broader transfer warranties
f. One twist on the warranty rules is the interaction between articles 3 and 4 i. The article 4 transfer warranties provide liability only against
banks and their customers. Accordingly, a party seeking to pass liability to a party that handled the check before it got to a bank would have to rely on the Article 3 transfer warranties (3-416)
1. The only significant difference is the rule in 3-416(a) that Article 3 transfer warranties can be enforced by remote transferees only against entities that indorsed the check iii. Forged Indorsements
1. General
a. The drawer actually signs the check in the first instance, but some other party subsequently forges an indorsement on the check
i. These rules are more favorable to the payor bank
b. Generally, the payor bank can – even if honor was mistaken – pass the loss back to the earliest solvent person in the chain after the forgery 2. Payor Bank Dishonors the Check Because of Forged Indorsement
a. The presenting bank is left with the bad check, but can recover its losses through transfer warranties.
b. 4-207(a)(1 & 2) or 3-416(a)(1 & 2): Because neither the forger nor any party after the forger in the process of collection is a person entitled to enfordce the instrument, and because the indorsement itself is forged, each of those parties has breached its transfer warranty under one of these statutes
a. It is no more proper to charge the drawers account in this instance than in the forged signature area
i. 4-401(a) & comment 1: payor bank had no right to charge drawers account because they weren’t authorized to cash the check
b. 3-418: (payment by mistake) payor bank cannot recover under this theory either if the prior parties took the instrument in “good faith and for value” c. 4-208(a)(1): payor bank can recover for a breach of presentment warranty
– the presenting bank warrants that “it is a person entitled to enforce the draft” or is collecting the check on behalf of a person entitled to enforce the draft
i. 3-301: Absent a valid indorsement by the payee, nobody other than the payee can become a person entitle to enforce a check
ii. Therefore, payor bank can recover its loss from the presenting bank
iii. 4-207(a)(1 & 2): The presenting bank, in turn, would be entitled to pass the loss to parties earlier in the chain of collection b/c those earlier parties would have breached the transfer warranties in these statutes
d. The loss should pass to the earliest solvent person after the forger iv. Conversion
1. The payee of a stolen instrument is barred from enforcing the underlying obligation under 3-310(b)(4)
2. First, payee has a common law right to pursue the thief for conversion
3. 3-420(a): grants the victim a statutory action for conversion against parties that purchase the check from the thief. The victim can pursue a bank that cashes the check for the thief or a payor bank that honors the check over the forged
indorsement
a. However 3-420(a) is limited by 3-420(c) which prohibits any action against nondepositary “representatives” in the collection process. The comment 3 explains that the statute is designed to bar a suit against an intermediary bank that does nothing but process the check for collection as a representative of the depositary bank’s customer.
4. 4-407(2): The payor bank is protected by this subrogation provision, which allows the payor bank that pays the payee under 3-420(a) to charge the drawer’s account just as if the item had been properly payable.
v. Alterations
1. Two main types:
a. A change in some relevant aspect of the check as originally written i. Treat just like the treatment for forged indorsements
ii. If payor bank honors the check, it cannot charge the drawer’s account for the amount that it paid out on the check
iii. 3-407(c): Payor bank in this instance can enforce the check only “according to the original terms” of the check
iv. 4-208(a)(2): Payor bank can recover any loss by pursuing earlier parties in the chain of collection for a breach of the presentment warranty
v. 4-207(a)(3) & 3-416(a)(3): Any party against whom the payor bank recovers is entitled, in turn, to pursue earlier parties based on a breach of a similar transfer warranty
vi. Thus, the loss will rest with the earliest solvent party to handle the check after the alteration
b. An addition to an instrument that was incomplete when written
i. 3-407, Comment 2: The payor bank can enforce the instrument as completed, even if “the instrument was stolen from the issuer and completed after the theft.”
ii. 4-401(d)(2): The bank is entitled to charge the drawer for such an item
V. Risk of Loss in the Checking System – Special Rules a. Negligence
i. General
1. Loss is on the drawer if the drawer’s negligence substantially contributes to the forgery. 3-406(a)
a. Precludes a “party whose failure to exercise ordinary care substantially contributes to . . . the making of a forged signature . . . from asserting the . . . forgery against a person who, in good faith, pays the instrument.” 2. Illustration: HSBC Bank USA v. F&M Bank Northern Virginia
a. Written check had lots of blank, and someone inserted new numbers. (1) § 3-406 provides no claim if a thief who is not the payee indorses the check in the thief’s name rather than the payee’s name. (2) UCC also imposes ordinary care on banks – which means “general banking usage.” (3) If a bank can show that most banks have not yet adopted a new procedure that would have prevented a loss, then the bank’s potential liability if it keeps the old procedure is low. (4) Also, the UCC recognizes comparative negligence, under which any party should bear the portion of the loss attributable to its failure to exercise ordinary care. § 3-406(b).
b. Bank Statements i. General
1. Rests on the assumption that customers can stop forgery schemes if they would just look at their fucking bank statements!
2. When a drawer fails to discover a forgery evident from its monthly bank
statements, the UCC normally transfers ensuing losses from the payor bank to the drawer by precluding the drawer from challenging the payor bank’s decision to honor future checks by the same forger. § 4-406(d)(2)
ii. The UCC does not make the bank wholly responsible for losses, but would call for each party to bear a portion of the loss based on the extent to which its shortcomings
contributed to the loss. § 4-406(e)
1. Illustrative Case: Stowell v. Cloquety Co-op Credit Union
a. Dude steals guys check and then steals his banks statement mail. Man did not receive bank statement from December 92 to September 93, and he notified the bank in December 92 that he hadn’t received one. (1) The draft agreement with the bank defines “reasonable promptness” as that’s used under the UCC [under the UCC, you have 30 days from the mailing date of the statement to object to the check – 4-406(d)(2). (2) The man is at fault – the risk is on him to take measures – the bank can’t bear such a risk.
iii. Although 4-406(e) exposes the bank to a risk of responsibility for comparative negligence much like 3-406, 4-406(f) removes that risk if the customer fails to examine the statement sent by the bnak w/in one year.
c. Theft by employees i. General
1. Most common case is when an employee forges the employer’s indorsement on a check payable to the employer
2. In many cases, the general negligence rule or the bank statement rule will place this loss on employers
ii. When the loss is caused by a responsible employee, the UCC placesthe loss on the employer even if those more general rules don’t apply. § 3-405
iii. However, employer will try to shift the loss back to the bank: 1. First, under comparative negligence: Here, 3-405(b)
2. Second, a claim that a bank’s willingness to allow an employee to obtain funds from an employers account amounts to participation in the employee’s breach of fiduciary duty: § 3-307
a. Illustrative Case: Cable Cast Magazine v. Premier Bank
i. Employee had been stealing checks, was confronted, and admitted it. Cable claims bank violated 3-307 by accepting checks with knowledge that employee was breaching fiduciary duty. Bank claims only employer liable under 3-405 and 3-406. Held, the bank is not liable. (1) The employer must bear the loss under 3-405 upon a showing that an employee with responsibility commits a fraudulent endorsement. However, Cable seeks to default 3-405 by asserting that Bank was not in good faith when it took the check from employee. 1-201(19) defines good faith as honesty in fact in the conduct or transaction concerned. (2) There is nothing here that indicates that the Bank knew the employee wasn’t the company, or was a fiduciary of the company. (3) Even so, Bank had to exercise reasonable care – here they did.
3. The employer may have no substantial claim b/c the check will not appear sufficiently unusual. The question then, is: can the employer pursue a claim directly against the depositary bank for losses the employer sustained from a scheme?
a. Illustrative Case: Gina Chin & Assoc. v. First National Bank
i. Employee wrote checks to suppliers, forged the drawer’s signature, then forged the payees signature for indorsement purposes. The sole cause of action is against drawee banks for charging her accounts in the amount of the forged checks. (1) 3-404 and 405 change the law by allowing comparative negligence. Court holds that these provisions ARE TRIGGERED IN A DOUBLE
FORGERY SITUATION d. Impostors
i. General
1. Checks procured by impostors or payable to fictitious persons. 2. General rule is that the person victimized should bear the loss. 3-404
a. Illustrative Case: Meng v. Maywood State Bank
i. Person has check made payable to himself and fictional person. (1) The fictitious payee rule completely absolves a bank from any liability for payment over a forged endorsement. (2) It states in 3-404(b) that when something is made out to a fictitious payee, an indorsement in the name of the payee is effective as the
that places the loss on the bank for payment of a forged
indorsement. (4) As a matter of law, the designation of two payee’s on a cashier’s check is ambiguous where no directives are stated on the checks to determine the manner of payment (payment can be made to either of the named payees). (5) Here, P’s can’t demonstrate the bank failed to exercise ordinary care.
VI. Issuer-Cardholder Relationship a. Four Major Participants
i. Purchaser that holds the card ii. The issuer that issues the card
1. Agrees to pay the purchases that the cardholder makes in accordance with the agreement between the issuer and the cardholder
iii. Merchant that makes the sale
iv. Acquirer who collects payment from the merchant b. Universal Cards
i. Visa and Mastercard, basically c. Statutes
i. No UCC generally applicable to credit cards
ii. Must use Federal Truth in Lending Act (TILA) & the Federal Reserves Regulation Z 1. TILA is limited to Consumer Transactions
2. Limited to Credit Cards extended to individuals
a. Exception: TILA § 104(1), Reg Z § 226.3(a)(2):
b. Also does not apply to transactions of more than $25,000. TILA § 104(3) d. Definitions
i. Credit Cards: TILA § 103(k): “any card . . . or other credit device existing for the purpose of obtaining money, property, lavor, or services on credit.”
e. General Rules
i. Cannot issue credit cards without a request or application. TILA § 132, Z 226.12(a) ii. Must provide customer a “clear and conspicuous” written disclosure that summarizes the
applicable legal rules. Z 226.5(a)(1)
1. Closely resemble model disclosures provided by the Federal Reserve in Appendix G of Reg Z. Can be enforced in federal court.
f. Overview of System
i. Exactly the opposite of the checking relationship
ii. Credit cards and Checkign accounts at same bank: Pursuant to agreement, Credit card issuer can periodically deduct an amount from the funds to pay a prearranged portion of the charges. TILA 169(a), Z 226.12(d)(3)
iii. Because credit cards can’t invest funds as banks can, they make their money off of interest rates
iv. Convenience users are those people that pay their bills every month – and some issuers have responded to these people by imposing annual fees limited to convenience users v. TILA § 169 deals with the ability of issuing bank to offset charges against other accounts
(checking) of customer held at the bank
vi. Fraudulent transactions are judged by algorithms and such g. The mechanics of collection
i. Merchant has an agreement with a member of the applicable network (VISA, etc.), the acquiring bank
ii. Was once a ban on allowing merchants to offer discounts to people who pay cash. TILA § 167 now prohibits those agreements and leaves merchants free to offer any cash discounts they find appropriate. Z § 226.12(f)
iii. Merchant, after process, receives 95-98% of the amount charged; merchant bank gets about 2.5%; issuer gets about 1.5%; holder pays 100%
iv. Note, acquirers charge higher rates for people who make sales over the phone, b/c of bigger risk of fraud
h. Finality of payment
i. Right to cancel payment by consumers is much greater than in other competing systems ii. The issuing bank’s obligation to pay does not become final at the time of the initial
payment to the acquirer.
1. TILA § 170(a) grants a cardholder the right to withhold payment on the basis of any defense that it could assert against the original merchant. Therefore, if you get bad goods, you have the right to assert a “goods don’t conform to contract”
defense on the credit card people.
iii. Qualification on cardholders right to cancel payment:
1. TILA 170(a) is only a right to withhold payment from an issuer, it does not include a right to seek a refund from the issuer or the merchant
2. Accordingly, the right dissipates as the cardholder pays off the credit card balance generated by the transaction in question
a. TILA § 170(b) and Z 126.12(c): limits challenge right to “the amount of credit outstanding with respect to the transaction”
3. TILA § 170(a)(1): the cardholder must “make a good faith attempt to obtain satisfactory resolution of the disagreement . . . from the merchant honoring the credit card.”
4. TILA § 170(a) prevents cardholders from withholding payment on transactions that occur outside the state where the cardholder resides and more than 100 miles from the cardholder’s billing address
a. Cases by telephone have had mixed results
iv. Card issuing network has rules that pass risk back to the merchant
1. TILA § 170(a) the issuer can charge back the challenged credit slip to the acquirer
VII. Erroneous Charges a. General
i. First, cardholder has the right to withhold payment under TILA § 170
ii. TILA § 161 sets out detailed provisions of resolving alleged billing errors related to credit cards. SEE Z 226.13
1. Under TILA § 161(a), the cardholder must provide written notice to the issuer within 60 days after the date on which the creditor sent the relevant statement to the cardholder
a. “Billing Error” under 161(b) and Z 226.13(a) includes not only claims that the cardholder did not make the charge in question, but also claims that the merchant failed to deliver the goods and services covered by the charge in question, and eve requests for additional clarification about the charge.
2. The issuer must send a written statement of the notice within 30 days and must resolve the issue within two billing cycles
3. If the holder claims the merchant didn’t deliver goods, the issuer must “conduct a reasonable investigation and determine that the property or services were actually delivered.” Z 226.13(f) & TILA § 161(a)(B)(ii)
4. If the issuer doesn’t accept holder’s accusation, the issuer must give the
cardholder a written statement of the issuer’s reason for not correcting the charge. Z 226.13(c)(2), (f) & TILA 161(a)
5. The creditor is barred from closing or restricting the cardholder’s account for failure to pay the disputed amount during the pendency of the investigation. TILA § 161(d), Z 226.13(d)
a. Issuer can accrue a finance charge against the disputed amount, which is due only if the dispute is resolved against the cardholder. Z 226.13(d)(1) n. 30 & Z 226.13(g)(1)
6. The statute provides only a $50 penalty against the creditor for failure to follow these procedures. TILA § 161(e)
7. Illustrative Case: Belmont v. Associates National Bank (Deleware)
iii. If a charge is erroneous, it gets passed back to the acquirer, who in turn passes it back to the merchant
b. Unauthorized charges
i. Very strong cardholder protection
1. TILA § 133(a)(1)(B) limits the cardholder’s liability to $50, regardless of how much is charged, even if no notice is sent. Z 226.12(b)(1)
a. However, prompt notice can help a cardholder. Once notice is received by the issuer, the cardholder is immune to all other charges. TILA §
133(a)(1)(E)
b. Also, VISA and MASTERCARD have provisions where, if you send notice within (2) business days following the theft of the card, you are immune from all liability
2. Although you are only charged $50 or less, the cardholder should be wary b/c some courts will say that your conduct was so negligent that you should have to pay beyond the $50 amount of TILA.
ii. There is an unusual aspect of TILA that states the provisions that protect cardholders from paying unauthorized charges apply not only in consumer transactions, but also in business and commercial transactions
1. However, in the business context, the issuer and cardholder can contract out of the statutory allocation of loss from unauthorized charges.
2. TILA § 135 permits any business that issues credit cards to at least ten of its employees to accept liability for unauthorized charges without regard to the provisions of TILA § 133, so long as the business does not attempt to pass on to the individual employees any liability greater than the liability under § 133. Z 226.3(a) n.4, Z 226.12(b)(5) (explanation of TILA § 135).
iii. Liability
1. In face to face transactions, the issuer bears the loss from unauthorized charges as long as the merchant followed the requisite procedures (verified the signature and obtained the appropriate authorization for the transaction).
2. In remote transactions (phone, internet) the risk of loss is left with the merchant. iv. Issues
1. Identity theft is an issue; also, never received cards that are stolen from a thief are an issue (this has been cut back because of phone verification)
VIII. General Debit Things
a. Payment with a Debit Card
i. The primary difference between credit and debit is that a debit card always serves as an adjunct to a checking or savings account
ii. There is no reason why credit and debit features cannot be combined, and thus this has become common. Reg E, 12 CFR § 205.12
1. In this situation, it depends on whether customer pays with the credit or debit function
2. Debit functioned governed by debit rules, credit governed by TILA and Reg Z iii. The use of an impulse to obtain funds directly from an account qualifies it as an
electronic funds transfer, and is regulated by the Electronic Funds Transfer Act (ETFA) 1. Title IX of the Consumer Credit Protection Act (TILA is Title I)
iv. EFTA § 903(6): “ETFA applies to transfer of funds . . . initiated through an electronic terminal so as to order . . . a financial institution to debit . . . an account”
b. Establishing the Debit Card Relationship
i. EFTA imposes two significant restrictions on banks ability to update its checking account relationship with debit cards:
1. First, EFTA § 911 generally allows a bank to send an unsolicited debit card to a customer only if the card is sent in an unvalidated condition.
2. Second, there are disclosure requirements that require the bank to provide the consumer a detailed up-front disclosure of the terms and conditions that will govern use of the card. Reg E § 205.7(a)
a. Keep in mind nearly nobody will read this. c. Transferring funds with a debit card
i. Debit card allows a person to go to an electronic machine (ATM) and do any of the functions it could have done at a bank teller in person
ii. EFTA § 906 requires that a customer be given written documentation of each transaction that they inititate.
d. Collection by the Payee
i. A merchant must enter into a contract, either directly with the bank that issued the card or indirectly through a network that processes debit-card transactions for the card-issuing bank.
ii. Two major types of networks 1. Pin Based
a. Characterized by the requirement that the customer enter a PIN number b. Under the typical network rules, the payor bank’s obligation to pay
becomes final at the moment that it transmits the electronic message back to the merchant
c. The actual payment is usually made be a single daily deposit ot an account designated by the merchant, giving it credit for all of the days debit
transactions
d. The payor bank becomes obligated to honor the payment request before the customer leaves the counter. Thus, risk to merchant is limited to payor bank insolvency or failure of the processing system
2. Pin Less
i. Rather, there is an authorization transaction while the cardholder is at the terminal, which confirms the availability of funds in the account to cover the transaction
ii. Then, over the next few days, the merchant obtains funds from the transaction in the same way as it would obtain funds for a standard credit-card transaction
1. These are called “offline” debit; PIN based are called “online” debit
b. This system costs the merchant as much as standard credit-card transactions (1 – 2 %)
i. PIN based transactions cost the merchant must less (7 cents per transaction)
c. The key difference is finality; under the PIN less system, you have the rights of TILA in collection
iii. Error and Fraud in Debit Card Transactions 1. Erroneous Transactions
a. Two types (these have not caused significant losses)
i. Improper withdrawal (withdrawal of the wrong account or of the wrong amount)
1. If they charge the wrong account, they recredit the wrong one and charge the other one
ii. Could fail to make a withdrawal that it should have made b. The system might fail in such a way that the merchant believes that it is
receiving authorizations when it in fact is not communicating with the payor bank.
i. The POS network rules protect the merchant and pass the loss back to payor bank; they can mitigate losses from this easier
c. Insufficient Funds
i. Bank can pay or not pay and pursue customer on overdraft 2. Fraudulent Transactions
a. General
i. Several features of Debit minimize loss
1. The rules preventing unsolicited mailing of activated cards 2. Both the authorization request from the merchant to the
bank and the bank’s reply are encrypted
ii. 99% of fraud on debit cards resulted from card usage by a close acquaintance of the cardholder
iii. Consumer faces much bigger problem with unauthorized transactions on debit than on credit
b. Who bears the loss between merchant who accepts stolen card and bank on which the card draws?
i. Network rules allocate the loss to the bank; much better position to mitigate these losses
c. Who bears loss between customer and bank?
i. Positive law provides an answer that protects the cardholder considerably even apart form the parties own agreements
ii. Federal law provides two separate protections related to
unauthorized transactions, as well as a set of specified procedures for determining whether a particular transaction was authorized
1. First set of rules: establishes threshold requirement that a card have some minimal security feature (PIN, signature, picture, etc.). EFTA § 909(a)
a. In the absence of feature, no consumer liability 2. Other is 909(a) provisions, discussed next
3. Lost of Stolen Debit Card
a. EFTA § 909(a) establishes a rule limiting customer’s loss from each unauthorized transfer
i. These rules apply to “any series of related unauthorized transfers.” Reg E § 205.6
1. Thus, if thief used card 10 times before caught, the dollar limits in § 909(a) describe the consumer’s exposure for the entire incident, not the individual transactions
b. This rule allows the bank to hold the consumer liable for up to $50 of unauthorized transfers that occur before the financial institution learns of the consumer’s loss of the card. “In no event . . .” EFTA § 909(a)
i. Applies w/o regard to fault or diligence on the part of the consumer c. Fault-based notice rule: allows the bank to charge the customer for losses
if the consumer does not promptly notify the bank after it discovers that the card has been stolen. “In addition . . .” EFTA § 909(a)
i. Operates on the assumption that customer should notify within two business days after he knows of the theft
ii. All charges after the two day limit can be charged to consumer, with maximum at $500.
1. This $500 includes the $50 that could have been charged the consumer from the first rule
d. Consumer has 60 days to review the statements of the bank. If consumer fails to report an unauthorized transaction within that 60 day period, the consumer bears responsibility for any subsequent unauthorized
transactions that would have failed had the consumer identified the transaction on the statement. EFTA § 909(a); Reg E 205.6(b)(3) 4. Limiting Liability even futher
a. States can limit the consumer’s share of the loss more narrowly. This is allowed under EFTA § 919.
b. The PIN less networks (VISA and MASTERCARD) have altered their network rules to limit the consumer’s exposure to losses.
i. Both networks voluntarily agreed that the banks issuing their cards will limit customer liability for unauthorized transactions to $50, even if the consumer fails to notify the issuer of the theft of the card and fails to ID any fraudulent trasaction within the 60-day EFTA period.
a. Customer must give bank notice within 60 days after bank mails statement. EFTA § 908(a)
b. Bank must respond within 10 days or give customer a provisional credit. i. VISA and MASTERCARD lower this to 5 days
c. Then, bank proceeds with investigation, which it must complete within 90 days after receiving customer notice.
i. Federal court can impose treble damages on any bank that (a) fails to recredit an account within the 10-day period when required to do so o r (b) unreasonably rejects a customers claim of error. EFTA § 908; Reg E § 205.11(c)(3)
IX. Negotiable Instruments
a. Negotiability and Liquidity i. General
1. Liquidity refers to the ease at which an asset can be sold at a price that reflects its proper economic value
2. The lack of a market makes sale difficult b/c it makes the seller expand its effort to locate a buyer and educate the buyer about the value of the asset
3. Rules that relate to negotiability enhance liquidity:
a. First, negotiable instruments offer an easy way for verifying a party’s power to transfer an enforceable interest in the instrument (the info is on the instrument)
b. Second, there is a defense stripping rule that makes a negotiable instrument more valuable in the hands of a purchaserthan it was in the hands of the payee that sold it.
i. A person that becomes a “holder in due course” takes the instrument free from all “personal defenses”
ii. Basic Framework of Negotiable Instruments 1. A typical transaction
a. Bookseller in St. Louis is buying books from distributer in London. Businessman goes to his bank to purchase the draft. The draft somewhat says that it wants Barklay’s bank in London to pay this man for the books. Business gives to distributer, who can present the draft to Barclays bank or sell it to his own bank. American bank notifies Barclays of the draft so that it will recognize it when presented. Barclays, upon receiving the draft, deducts from an account the American Bank has at Barclays for such a purpose. If a person did a lot, the bank could give them software that allowed them to do the drafts, and notifies the bank when he does one, which in turn notifies Barclays.
2. The terms
a. The party that directs the payment (American bank) is the “drawer” or the “issuer”
b. The person who caused the draft to be issued (the businessman) is called the “remitter”
c. The person to who the draft is being paid (the London guy) is the “payee” d. The person on whom the draft is drawn (Barclays Bank London) is the
“drawee” iii. The Two Stage Framework
Requirement Statutory References
1 The obligation must be a written promise or order
3-104(a); 1-201(43); 3-103(a)(2), (3), (5), (6), (9); 3-104(e), (f), (g), (h)
2 The obligation must be unconditional 3-104(a); 3-106 3 The obligation must require the payment
of money
3-104(a); 1-201(24); 3-107 4 The amount of the obligation must be 3-104(a); 3-112(b)
fixed
5 The obligation must be payable to bearer or order
3-104(a)(1) & (c); 3-109; 3-115 comment 2 6 The obligation must be payable on
demand at a definite time
3-104(a)(2), 3-108 7 The obligation must not contain any
extraneous undertakings
3-104(a)(3)
1. General Definition of Negotiable Instruments a. General
i. UCC § 3-104(a)
ii. If an instrument misses any of the requirements, the rules of article III don’t apply
b. The Promise or Order Requirement
i. Order: 3-103(a)(6): An instruction by one person (the drawer) directing some other party to pay (the drawee)
1. An instrument that contains an order is called a “draft” 2. Three most common kinds of drafts:
a. A check – draft on a bank: 3-104(f)
b. Cashier’s Check – drawer and drawee are the same bank: 3-104(g)
c. Teller’s Check – A draft by one bank on another bank: 3-104(h)
ii. Promise: 3-103(a)(9): A direct commitment to pay 1. The party that makes a promise is a “maker”
2. The instrument that contains the promise is a “note” 3.
iii. All negotiable instruments must be in writing c. The Unconditional Requirement
i. UCC 3-106
1. Limits negotiability to instruments that are absolute and include on their face all of the terms of payment
a. Can’t Include Conditional Payment Obligation ii. Case: DBA Enterprises v. Findlay
1. Promissory note contained a statement that “Maker’s obligation under this note is subject to the conditions recited in that Bill of Sale and Covenants not to Compete between the parties of even date.” (1) This makes the note non-negotiable.
iii. § 3-106(a)(ii) and (iii) states that a document is non-negotiable if it states that it is “subject to or governed by” another writing or if it states “that rights or obligations with respect to the document are stated in another writing.”
iv. Two Exceptions – 3-106(b):
1. In a note for which a maker gives collateral that includes reference to other writings (security agreement, loan
agreement, mortgage) that describes rights related to the collateral and to the payee’s remedies upon default, these terms do not undermine negotiability. 3-106(b)(i)
2. If a document contains a statement that “payment is limited to a particular fund or source” this does not undermine negotiability. 3-106(b)(ii)
a. E.g. a “nonrecourse” real-estate note d. The Money Requirement
i. The promise or order must be for the payment of money 1. Includes domestic and foreign currency
e. The Fixed amount requirement
i. The amount of the obligation must be FIXED
1. This does not exclude statements with interest or other charges
a. Also, interest can be variable or fixed
2. Just can’t be: “I’ll pay you half of what I get for the sale of my books.”
ii. Case: Nagel v. Cronebaugh
1. Note doesn’t contain a fixed amount, and thus isn’t negotiable – so you go to basic contract principals to interpret the note
f. The Payable to Bearer or Order Requirement i. § 3-104(a)(1)
ii. Must be payable to “bearer” or “order” iii. Bearer – two ways:
1. It must state:
a. “Payable to Bearer”
b. “Payable to the order of Bearer”
c. Or, if it otherwise indicates that the person in possession of the promise or order is entitled to payment. 3-109(a)(1)
2. Not payable to identified person: a. Doesn’t state a payee b. Made payable to “cash” iv. Order – two ways:
1. Payable to an identifiable person
a. “Pay to the order of Dan Keating” 2. Payable to “an identifiable person or order”
a. Pay to Dan Keating or Order”
b. Must include both “order” and “an identifiable person” in the statement
c. If misses one, it is not an instrument v. Exception:
1. A check that fails the bearer-or-order requirement, but satisfies all of the remaining negotiability requirements qualifies as an instrument
g. The Demand and Definite Time Requirement i. § 3-104(a)(2)
ii. Must be payable on demand or at a definite time iii. Can be payable “on demand” or at “no time”
iv. Includes times that allow the holder to extend the time for payment v. Includes times that allow acceleration and prepayment
vi. The only obligation that would fail the rule would be a document giving the issuer either a completely unqualified option to extend or a qualified option to extend that did not state a date to which the extension would run
h. The No Extraneous Undertakings Requirement
i. 3-104(a)(3): Forbids inclusion of a promise calling for something other than the payment of money
ii. Cannot be negotiable if it includes any non-monetary promises 1. To deliver wheat, etc.
iii. Three exceptions:
1. An undertaking or power to give, maintain, or protect collateral to secure payment.
2. An authorization or power to the holder to confess judgment or realize on or dispose of collateral
3. Conditions in which the borrower waives laws intended for the benefit or protection of the borrower or obligor
a. Waivers of the Requirements of presentment, dishonor, notice of dishonor, and the like
X. Transferring a negotiable Instrument a. General
i. A transfer of a negotiable instrument never requires anything more than delivery of the instrument and a signature by the transferor
b. Negotiation and Status as a Holder
i. Two concepts central to the transfer
1. “Holder” has a right to enforce the instrument. 3-301(i)
a. No person can be a holder w/o possession of the instrument b. Bearer paper
i. If an instrument is bearer paper, possession is determinative. Any person isn possession of bearer paper is a holder. 1-201(b)(21) – even a thief
c. Order paper
i. Order paper must be payable to some identifiable person. This is the only person that is the holder. 1-201(b)(21)
ii. Payable to more than one person
1. If “Husband or Wife” than either one; if “husband and wife” then both must be present
iii. Payable to account number
1. Holder of the account is the identified person 2. The act of “negotiation” by which it is transferred to a new holder
a. “Negotiation” is any transfer of possession, even an involuntary one, by a person other than the original issuer that causes the transferee to become holer. 3-201(a)
ii. Special and Blank Indorsements
1. To make the purchaser of an instrument the indentified person, the seller must make an indorsement
a. As simple as a signature,”unless the circumstances unambiguously
indicate that the signature was made for purpose other than indorsement.” 3-204(a)
b. Courts recognize signature in bottom right of instrument as the signature of the issuer. 3-204 comment 1 paragraph 2. Signature in any other place is treated as an indorsement
2. Special Indorsements
a. Identifies the person to who the check is to be paid
b. Transfers the identified person to the indorsement person. 3-205(a) c. If you have bearer paper, the special indorsement changes it to bearer
paper. 3-109(c), 3-205(a) 3. Blank Indorsement
a. Any indorsement made by a holder that does not indicate an indentified person
i. A blank indorsement transforms order paper to bearer paper, so that anyone in possession can enforce it. 3-109(c), 3-205(b)
ii. A blank indorsement on bearer paper has no effect on the character of the instrument, but it does create liability for the indorser under 3-415.
4. Bank rules that depart from abovementioned rules
a. First, Article 4 generally dispenses with the requirement of indorsements for transfers of checks in the check-collection system
i. Depositary bank automatically becomes a holder of a check deposited by its customer. 4-205(1)
ii. Bank need not indorse a check when it transfers to another bank. 4-206
b. Reg CC provides that no party other than a bank can become the holder of a check once it has been indorsed by a bank
i. The only way a different party can become the holder is if the bank specially indorses the check to a nonblank party or returns the check to the depositor (dishonored checks). Reg CC and 4-201(b) iii. Restrictive and Anomalous Indorsements
1. Restrictive Indorsements
a. Putting a condition other than “for deposit only” or “for collection” b. § 3-206(a), (b) invalidates almost all other restrictive indorsements c. If an instrument bears one of the allowable restrictive indorsements, a
party who pays or purchases the instrument commits conversion unless the proceeds of the instrument are received by the indorser or applied
consistently with the indorsement. 3-206(c) 2. Anomolous Indorsements
a. Indorsement made by a person that was not a holder at the time it made the indorsement. 3-205(d)
b. If a person who is not the holder signs order paper, it remains payable to the person it is payable to.
c. Article 3 assumes that these indorsements are made for “accommodation” so that the anomalous indorser becomes a guarantor of the instrument. 3-419
c. Enforcement and Collection of Instruments i. The right to enforce an instrument
1. Any person that holds an instrument is a “person entitled to enforce the instrument” under 3-301(i)
2. You can sell an instrument, and than that person has all of your rights under the instrument. 3-203(b)
3. 3-203 also allows the purchaser a right to make a party sign the instrument after the sale
ii. Presentment and Dishonor 1. Two step approach:
a. Presentment
i. A demand for payment made by a person entitled to enforce an instrument. 3-501(a)
1. If a note, demand is made to the maker of the note. 2. If a draft, made to the drawee. 3-501(a)
b. The response of the party to whom presentment is made
i. In most cases, the system assumes that a party intends to dishonor the instrument if it does not take an affirmative action to honor it.
1. In most cases, it is considered dishonored if it is not paid at the time of presentment. 5-502(a)(1), (b)(2)
iii. Defenses to enforcement
1. As long as the person entitled to enforce the instrument is not a holder in due course, Article III allows the obligor to impose a wide bariety of defenses, which include not only any defense cereated by Article III, but also any claim the obligor has against the payee with respect to the original transaction. 3-305(a)(2), (3)
2. Case: Turman v. Ward’s Home Improvement (failure ot provide the goods or services for which the instrument was given).
d. Liability on an instrument
i. First, 3-401 articulates a general rule of exclusion. Except for the transfer and
presentment warranty liability, no party is liable on an instrument unless it has signed the instrument.
1. Two major problems:
a. Some authorizing mark other than a signature: extremely broad definition which includes markings in 3-401(b); see 1-201(b)(37)
b. Individual acting as an agent or representative:
i. Signing party is the “representative” and the person they are agent for is the “represented person”
ii. Is represented person liable:
1. Bound by the same principles as contract and agency law. 3-402(a)
iii. Representative liable:
1. Is not liable if (a) the signature shows unambiguously that he is signing on behalf of the represented person and (b) the instrument identifies the represented person. If either of these tests is failed, representative is liable unless he can prove that the original parties did not intend for him to be bound. 3-402(b)(1), (b)(2)
c. Determine the liability of the parties that have signed the instrument, there are four rules (TABLE 40.1, p. 647)
i. The party that issues the note is directly and unconditionally liable on the instrument. 3-412
ii. Drawee has no liability on a draft at the time it is issued. 3-408. If it accepts the draft (just a signature) the drawee is liable for the draft. 3-413
iii. Drawer of a draft is not liable on the draft unless it is dishonored. 3-414(b)
1. Drawers liability if discharged if the bank accepts the draft. 3-414(c)
iv. Indorser liable only if the instrument is dishonored. 3-415(a). The indorser’s liability is dishcharged if the bank accepts the
instrument after it has been indorsed. 3-415(d). An indorser can limit its liability by indicating that it is signing the instrument “without recourse.” 3-414(e), 3-415(b)
e. The effect of the instrument on the underlying obligation i. General
1. When a party issues a negotiable instrument, it incurs liability that is completely separate from its liability on the underlying obligation
ii. 3-310 sets out the rules governing the relation between liability on the instrument and liability on the underlying obligation.
iii. Two Classes
1. Near-cash instruments. 3-310(a), (c)
a. Certified Checks, Cahier’s checks, and tellers checks.
b. Cashiers and Tellers Checks are checks on which a bank is the drawer, so the bank has liability under 3-412 and 3-414(b) respectively
c. 3-310(a) and (c) provide that the underlying obligations is dischared when the obligee takes one of the near-cash instruments
2. Ordinary Instruments. 3-310(b)
a. The statute does not immediately discharge the underlying obligation b. It is suspended, instead. 3-310(b)(1), (2).
i. In the instrument is paid, the underlying obligation is discharged. 3-310(b)(1), (2).
ii. If the instrument is dishonored, the suspension terminates, and the oblige has the option to enforce either the instrument or the underlying obligation. 3-310(b)(3). So, you can sue on the check, or on the obligation.
iv. A discharge of the underlying obligation under 3-310 is effective only to the extent of the amount of the instrument. 3-310(a), (b)
v. Resolving disputes, and “paid in full” clauses. 3-311 generally supports that use of instrument to resolve disputes
1. A paid in full clause will discharge an underlying obligation if (a) the instrument is tendered for full satisfaction of a disputed claim, or (b) the payor conspicuously notifies the payee that it intends the instrument to constitute full satisfaction of the claim, and (c) the payee successfully obtains payment of the instrument. 3-311(a), (b).
a. Illustrative Case: McMahon Corp. v. Burger Dairy Co. (Paid in Full Instruments)
