Chapter 24 The Function and Creation of Negotiable Instruments

§1: Article 3 of the UCC A “negotiable instrument” is a signed writing containing an unconditional promise to pay an exact sum of money. History of negotiable instruments began in England “bills of exchange” so that merchants were able to exchange money while keeping their money say in the banks. Today, UCC Article 3.

§2: The Function of Instruments To function as a substitute for money or credit device. In order for an instrument to operate practically, it has to be easily transferable. Laws of assignment did not allow for ease of transfer because the assignee was always subject to the defenses that could be used against the assignor. Article 3 provided that some defenses could not be used against certain assignees.

§3: Types of Negotiable Instruments Drafts and checks are 3 party instruments: Drawer, Drawee and Payee. Checks (cashier’s, teller’s and traveler’s) are drafts on a bank. Trade acceptances seller is drawer and payee. Notes are two party instruments (Promisor and Promisee). Certificates of deposit (CDs): two party instruments.

§4: Requirements for Negotiability Writing signed by the maker or the drawer. Unconditional promise or order to pay a fixed amount of money. Payable on demand or at a definite time. Be payable to order or to bearer, unless it is a check.

§5: Factors Not Affecting Negotiability Omission of date. Postdating or antedating. No place for payment: address or Drawee or maker or, if none, place of business or, if none, residence. Handwritten over typewritten or printed.. Words over numbers. With interest = judgment rate. Mention of collateral.

Case 24.1: Flatiron Linen v. 1st American (Checks) FACTS: Fluffy-Reed promised to secure a $2 million loan for Flatiron Linen, Inc., for which Flatiron paid a fee. Flatiron later accused Fluffy of fraud in the deal. As a partial refund of the fee, Fluffy issued a $41,00 check to Flatiron, drawn on First American. First American returned the check due to insufficient funds. Five months later, Flatiron secured a cashier’s check from First American for $4,100. However, Fluffy had asked the bank not to honor the original check. When the bank discovered its mistake, it refused to pay the cashier’s check. Flatiron sued.

Case 24.1: Flatiron Linen v. 1st American (Checks) HELD: FOR FLATIRON. Once a cashier’s check has been issued, a bank may not legitimately refuse to pay it. The state supreme court pointed out that it agreed with the majority of courts, which “hold that a cashier’s check is the equivalent of cash, accepted when issued.” The court also noted that “[t]he commercial world treats cashier’s checks as the equivalent of cash. People accept cashier’s checks as a substitute for cash because the bank, not an individual, stands behind it.”

Case 24.2: U.S. v. Durbin (Promissory Notes) FACTS: Durbin took out a student loan and signed a promissory note for its repayment. When he defaulted, the bank collected the amount due from the federal government, which had guaranteed the loan. After Durbin also failed to pay the government, the government filed a suit in a federal district court against Durbin to collect.

Case 24.2: U.S. v. Durbin (Promissory Notes) HELD: FOR U.S. Durbin is liable for the unpaid balance of the note, plus interest, costs, and fees. Durbin issued the note, the government owned it, and it was in default and unpaid. “A note is an unconditional promise to pay. It is an obligation of the borrower to the lender. *  *  * [A] note is enforceable unless the borrower can show that he paid the note or that the note was forged.”

Case 24.3: Barclays Bank v. Johnson (Payable on Demand) FACTS: Johnson signed a promissory note for $28,979.15 in favor of Healthco International as part of Johnson’s purchase of supplies from Healthco. Blanks regarding the number of installment payments, their amounts, and the date of the first payment were not filled in. Barclays Bank PLC bought the note. When Johnson defaulted, Barclays sued Johnson. Johnson argued Barclays was not a HDC because the note was not negotiable because it was not payable at a definite time. The court issued a summary judgment in Johnson’s favor. Barclays appealed.

Case 24.3: Barclays Bank v. Johnson (Payable on Demand) HELD: FOR JOHNSON. AFFIRMED. The Court of Appeals of North Carolina affirmed. To be negotiable, an instrument must state that it is payable on demand or at a definite time. Because it did not, Barclays was not an HDC.