1. Negotiable Instruments
Commercial Law
Negotiable Instruments

2. Introduction Article 3 governs negotiable instruments.
Negotiable Instruments are safe substitute for cash that are freely transferable.
If an instrument is in a special form, i.e. negotiable,
Transferred in a special way, i.e., negotiated
To a person who takes the instrument for
Value
In good faith and
Without notice of any defenses to or claims on the instrument, i.e., a holder in due course or “HDC.”
The person will be able to enforce the instrument subject to very few defenses.

3. Negotiable Instruments
Basically two kinds of Article 3 instruments
Note
Draft

4. Notes A note is two-party negotiable instrument
A written signed promise (undertaking)
By one party (the maker)
To pay to another party (the payee or bearer) [See U.C.C. §§ 3-103(a)(9), 3-104(e)]
Maker makes a note
A drawer (next slide) draws a draft
Certificates of Deposit
A CD is like a note in that two parties are involved, but the UCC specifically defines CD as an instrument made by a bank containing (i) an acknowledgement that a sum of money has been received by the bank; and (ii) a promise by the bank to repay the sum of money. [UCC §3-104(j)]
Promissory Note
I, Max Maker, promise to pay to the order of Peter Payee one hundred dollars ($100).
/s/ Max Maker

5. Drafts
A draft, also known as “bill of exchange,” is a three-party negotiable instrument
A written and signed instruction by one person (the drawer)
To another person (the drawee) demanding that the drawee pay money
To still a third person (the payee or bearer)

6. Drafts Example Drew Drawer 101 123 Pierce Rd 11/20/06 Anytown, USA
Pay to the order Paula Payee $100
One Hundred and 00/ dollars
Second Bank of Anytown (drawee)
memo /s/ Drew Drawer

7. Checks
A specific type of draft, namely one drawn on a bank and payable on demand.
An instrument will be deemed a check if it meets these requirements, even if the instrument is described on its face by another term, (a money order). [UCC §3-104(f)]

8. Negotiability A negotiable instrument means a written and signed:
Unconditional
Promise or order
To pay a fixed amount of money (with or without interest or other charges described in the promise or order)
Is payable to order or to bearer (at the time it is issued or first comes into possession of a holder)
Is payable on demand or at a definite time and
Does not state any unauthorized undertaking or instruction (by the person promising or ordering payment) [UCC §§ 3-103, 3-104]

9. The Negotiation Process
Negotiation is a transfer of possession of an instrument, whether voluntary or involuntary, by a person other than the issuer to a person who thereby becomes its holder [UCC §3-201(a)].
A holder is a person in possession of the instrument if the instrument is payable to bearer; if the instrument is payable to an identified person, that person is the holder as soon as she gets possession [UCC §1-201(21)].

10. Bearer Instruments
A negotiable instrument that is issued as bearer paper or subsequently converted into bearer paper (e.g. by blank indorsement) is negotiated simply by transferring possession of the instrument. Once the transferee has possession, she technically qualifies as a “holder.” [UCC §3-201(b)].
Ex. Drawer writes a check payable to “Cash” which makes the check a bearer instrument. If drawer transfers the check to Grocer, Grocer become a holder.

11. Order Instruments Negotiation to Specific Payee
An instrument that is payable to an identified person is negotiated by transferring possession of the instrument along with the indorsement of the identified person. [UCC § §3-201(b), (a)]
Dan Drawer writes a check payable to Paula Payee. Upon receiving the check, Paula qualifies as a “holder.” If Paula subsequently wishes to negotiate the check, she must indorse it and deliver possession to her transferee, who will then also qualify as a “holder.”
Payee’s Indorsement must be valid. Generally the right to enforce an order instrument will not pass unless the payee’s indorsement is authorized and valid. In most cases, forging the payee's name breaks the chain of title and no subsequent possessors of the instrument can qualify as “holders.”
Ex: Dan drawers writes a check payable t order to Paula Payee. Before indorsement by Paula, the check is stolen from her by Harry Thief, who signs, “Paula Payee” on the back and deposits check. Title stops with Paula and the check is still her property.
No one taking the check after the forgery has the right to enforce the instrument and therefore no one Harry, forgers National, nor subsequent innocent transferees can qualify as a “holder.”

12. Location of Indorsement
Must be written on the instrument.
Usually placed on back of instrument, but may be placed on front or on a paper affixed to the instrument (an allonge) [UCC §3-204(a)]

13. Effect of Transferring Order Instrument without Indorsement
May be effective to transfer possession, but does not constitute a negotiation until the indorsement is made [UCC §3-203(c)]
Rights of Transferee without indorsement
Needs to obtain indorsement or does not have status of “holder,” and certainly cannot qualify as an HDC.
Cannot negotiate the instrument
Suit to compel Indorsement
Suit to Enforce Indorsement
Suit to compel indorsement
If the transferee paid value for the instrument, she has a “specifically enforceable right to the unqualified indorsement of the transferor” [UCC §3-203 (c)],
Transferee would have to sue in equity for decree ordering the transferor to indorse.
Suit to enforce instrument
If instrument is due, the transferee can bring suit to enforce it even thought it lacks an indorsement,

14. Types of Indorsements Special
One that names a particular person as indorsee (pay Joan Smith). The indorsee must sign in order for the instrument to be further negotiated. [UCC §3-205(a)]
Blank
A signature that is not accompanied by the naming of a specific indorsee.
Blank indorsements create bearer paper, which may then be negotiated by delivery alone
Pay Joan Smith is same as “pay to the order of Joan Smith”
Extra words do not impair validity of indorsement: I hereby assign Or I herby guarantee payment . .
Blank: Dan Drawer writes a check to the order of Paula Payee, who signs the check on the bak /s/ Paula Payee” (a blank indorsement). The check blows out of the window and is recovered by Frank Forger. Frank is a holder.
If in the previous example Paula had written, “pay to mark Money, /s/ Paula Payee,” there would have been a special indorsement and the check would have remained order paper

15. Holders in Due Course
Determining whether a person is an HDC is a two-step process
First, determine if the person is a “holder”
Second, determine if the person holds in “due course.”

16. Holder Under UCC §1-201(21) the transferee must Have possession and
The instrument must be payable either to bearer or to the person in possession [UCC §1-201(21)]
The instrument must be free of forgeries of those names necessary to the chain of title (the payee and any special indorsees).

17. Due Course
The UCC provides that the HDC is a holder who takes the instrument:
(i) for value;
(ii) in good faith; and
(iii) without notice that:
The instrument is overdue or has been dishonored
The instrument contains an unauthorized signature or has been altered
A claim to the instrument exists
Any party has a defense or claim in recoupment (a claim that reduces the amount payable on the instrument)

18. HDC: Value [UCC §3-303] Types of value:
Performance of the agreed consideration
Acquisition by the holder of a lien or a SI in the instrument other than a lien obtained by judicial proceeding
Taking the instrument as payment of or security for an preexisting debt
Trading a negotiable instrument for another instrument

19. HDC: Good Faith [UCC §3-103(a)(6)]
Honesty in Fact-is subjective (what actor actually believed), “pure heart, empty head” test. Not a reasonable person standard.
Reasonable Commercial Standards of Fair Dealing- is objective (the actor must proceed fairly in light of the facts and commercial standards) Note that the standard is different from ordinary care.

20. Notice to Purchaser Actual knowledge (a subjective standard)
Reason to know (an objective standard) [UCC §1-202]

21. HDC: Shelter Rule Transferee Acquires Transferor’s rights [UCC §3-203]
Transferee takes “shelter” in the status of her transferor
This rule allows any transferee to “step into the shoes” of the HDC who formerly held the instrument and to obtain the right of an HDC
A promissory note is held by M, who qualifies as an HDC. M makes a gift of the note to her daughter D. Because D did not give value for the note, she obviously would not otherwise qualify as an HDC, but because her mother had the status, D succeeds to the rights of an HDC too.
Protects the Free Negotiability of Negotiable Instruments
Exception: never grants HDC rights to persons who were parties to fraud or illegality affecting the instrument