1. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Slides developed by Les Wiletzky PowerPoint Slides to Accompany ESSENTIALS OF BUSINESS AND ONLINE COMMERCE LAW 1 st Edition by Henry R. Cheeseman Chapter 14 Negotiable Instruments and Digital Banking Chapter 14 Negotiable Instruments and Digital Banking

2. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 2 Negotiable Instruments (1 of 2) Revised Article 3 (Negotiable Instruments) of the Uniform Commercial Code (UCC)  To qualify as a negotiable instrument (commercial paper), the document must meet certain requirements established by Revised Article 3 (Negotiable Instruments) of the Uniform Commercial Code (UCC) Article of the UCC that establishes rules for the creation of, transfer of, enforcement of, and liability on negotiable instruments

3. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 3 Negotiable Instruments (2 of 2) holder in due course  If the requirements of Article 3 are met, a transferee who qualifies as a holder in due course takes the instrument free of many defenses that can be asserted against the original payee  In addition, the document is considered an ordinary contract that is subject to contract law

4. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 4 Functions of Negotiable Instruments  Negotiable instruments serve the following functions: Substitute for money Credit device Record-keeping device  Most purchases by businesses and many individuals are made by negotiable instruments instead of cash

5. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 5 Types of Negotiable Instruments Instrument  Term that means negotiable instrument [UCC 3-104(b)]Instrument Revised Article 3 recognizes four kinds of instruments: 1. Drafts 2. Checks 3. Promissory Notes 4. Certificates of Deposit Revised Article 3 recognizes four kinds of instruments: 1. Drafts 2. Checks 3. Promissory Notes 4. Certificates of Deposit

6. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 6 Drafts draft  A draft is a three-party instrument that is an unconditional written order by one party that orders the second party to pay money to a third party Drawer of a draft Drawee of a draft Payee of a draft

7. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 7 Checks  A distinct form of draft drawn on a financial institution and payable on demand Drawer of a check Drawee of a check Payee of a check  Article 4 of the UCC  Article 4 of the UCC establishes the rules and principles that regulate bank deposit and collection procedures

8. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 8 Special Types of Checks  Bank Checks  Bank Checks – Checks for which the bank is solely or primarily liable: Certified Check Cashier’s Check Traveler’s Check

9. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 9 Promissory Notes  A two-party negotiable instrument that is an unconditional written promise by one party to pay money to another party Maker of a note borrower Maker of a note – the party who makes the promise to pay ( borrower ) Payee of a note lender Payee of a note – the party to whom the promise to pay is made ( lender )

10. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 10 Certificates of Deposit (CD)  A two-party negotiable instrument that is a special form of note created when a depositor deposits money at a financial institution in exchange for the institution’s promise to pay back the amount of the deposit plus an agreed-upon rate of interest upon the expiration of a set time period agreed upon by the parties Maker of the CD borrower Maker of the CD – the bank ( borrower ) Payer of the CD lender Payer of the CD – the depositor ( lender )  A two-party negotiable instrument that is a special form of note created when a depositor deposits money at a financial institution in exchange for the institution’s promise to pay back the amount of the deposit plus an agreed-upon rate of interest upon the expiration of a set time period agreed upon by the parties Maker of the CD borrower Maker of the CD – the bank ( borrower ) Payer of the CD lender Payer of the CD – the depositor ( lender )

11. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 11 Summary: Types of Negotiable Instruments (1 of 2) Orders to Pay PartyDescription of Party DraftDrawer Drawee Payee Person who issues the draft Person who owes money to the drawer; person who is ordered to pay the draft and accepts the draft Person to whom the draft is made payable CheckDrawer Drawee Payee Owner of a checking account at a financial institution; person who issues the check Financial institution where drawer’s checking account is located; party who is ordered to pay the check Person to whom the check is made payable

12. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 12 Summary: Types of Negotiable Instruments (2 of 2) Promises to Pay PartyDescription of Party Promissory Note Maker Payee Party who issues the promissory note; usually the borrower Party to whom the promissory note is made payable; usually the lender Certificate of Deposit (CD) Maker Payee Financial institution that issues the certificate of deposit Party to whom the certificate of deposit is made payable; usually the depositor

13. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 13 According to UCC 3-104(a), a negotiable instrument must:  Be in writing  Be signed by the maker or drawer  Be an unconditional promise or order to pay  State a fixed amount of money  Not require any undertaking in addition to the payment of money  Be payable on demand or at a definite time  Be payable to order or to bearer  Be in writing  Be signed by the maker or drawer  Be an unconditional promise or order to pay  State a fixed amount of money  Not require any undertaking in addition to the payment of money  Be payable on demand or at a definite time  Be payable to order or to bearer

14. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 14 Summary: Formal Requirements for a Negotiable Instrument (1 of 4) RequirementDescription WritingWriting must be permanent and portable. Oral or implied instruments are nonnegotiable [UCC 3-104(d)]. Signed by maker or drawerSignature must appear on the face of the instrument. It may be any mark intended by the signer to be his or her signature. Signature may be by an authorized representative [UCC 3-104(a)]. Unconditional promise or order to pay Instrument must be an unconditional promise or order to pay [UCC 3-104(a)]. Permissible notations listed in UCC 3-106(a) do not affect instrument’s negotiability. If payment is conditional on the performance of another agreement, the instrument is nonnegotiable.

15. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 15 Summary: Formal Requirements for a Negotiable Instrument (2 of 4) RequirementDescription Fixed amount of money Fixed amount: Amount required to discharge the instrument must be on the face of the instrument [UCC 3- 104(a)]. Amount may include payment of interest, discount, and costs of collection. Revised Article 3 provides that variable interest rate notes are negotiable instruments. In money: Amount must be payable in U.S. or foreign country’s currency. If payment is to made in goods, services, or non-monetary items, the instrument is nonnegotiable [UCC 3-104(a)].

16. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 16 Summary: Formal Requirements for a Negotiable Instrument (3 of 4) RequirementDescription Cannot require any undertaking in addition to the payment of money A promise or order to pay cannot state any other undertaking to do an act in addition to the payment of money [UCC 3-104(a)(3)]. A promise or order to may include authorization or power to protect collateral, dispose of collateral, waive any law intended to protect the obligee, and the like.

17. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 17 Summary: Formal Requirements for a Negotiable Instrument (4 of 4) RequirementDescription Payable on demand or at a definite time Payable on demand: Payable at sight, upon presentation, or when no time for payment is stated [UCC 3-108(a)]. Payable at a definite time: Payable at a definite date, or before a stated date, a fixed period after a stated date, or at a fixed period after sight [UCC 3-108(b)(c)]. Instrument payable only upon the occurrence of an uncertain act or event is nonnegotiable.

18. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 18 Nonnegotiable Contract  A promise or order to pay that does not meet the requirements of a negotiable instrument  It is not subject to the provisions of UCC Article 3  A nonnegotiable contract can be enforced under normal contract law

19. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 19 Transfer by Assignment or Negotiation Transfer by Assignment  The transfer of rights under a contract  It transfers the rights of the transferor ( assignor ) to the transferee ( assignee ) Transfer by Assignment  The transfer of rights under a contract  It transfers the rights of the transferor ( assignor ) to the transferee ( assignee ) Transfer by Negotiation  The transfer of a negotiable instrument by a person other than the issuer  The person to whom the instrument is transferred becomes the holder  Negotiating order paper  Negotiating bearer paper Transfer by Negotiation  The transfer of a negotiable instrument by a person other than the issuer  The person to whom the instrument is transferred becomes the holder  Negotiating order paper  Negotiating bearer paper

20. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 20 Indorsement  The signature (and other directions) written by or on behalf of the holder somewhere on the instrument  The signature may: Appear alone Name an individual to whom the instrument is to be paid, or Be accompanied by other words

21. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 21 Holder Versus Holder In Due Course Holder  A person who is in possession of a negotiable instrument that is drawn, issued, or indorsed to him or his order, or to bearer, or in blankHolder Holder in Due Course (HDC)  A person who takes a negotiable instrument for value, in good faith, and without notice that it is defective or is overdue Holder in Due Course (HDC)  A person who takes a negotiable instrument for value, in good faith, and without notice that it is defective or is overdue

22. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 22 Requirements for HDC Status  To qualify as an HDC, the transferee must meet the requirements established by the UCC holder  The person must be the holder of a negotiable instrument that was taken: 1.For value 2.In good faith 3.Without notice that it is overdue, dishonored, or encumbered in any way, and 4.Bearing no apparent evidence of forgery, alterations, or irregularity [UCC 3-302]  To qualify as an HDC, the transferee must meet the requirements established by the UCC holder  The person must be the holder of a negotiable instrument that was taken: 1.For value 2.In good faith 3.Without notice that it is overdue, dishonored, or encumbered in any way, and 4.Bearing no apparent evidence of forgery, alterations, or irregularity [UCC 3-302]

23. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 23 Holder in Due Course (HDC) Negotiable Instrument 1.Holder 2.Takes a negotiable instrument 3.For value 4.In good faith 5.Without notice of defect 6.The instrument bears no apparent evidence of forgery, alterations, or irregularity Maker or Drawer Payee or Bearer Holder in Due Course (HDC)

24. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 24 Real Defenses Effect 1.Minority 2.Extreme duress 3.Mental incapacity 4.Illegality 5.Discharge in bankruptcy 6.Fraud in the inception 7.Forgery 8.Material alteration Real defenses can be raised against both holders and holders in due course

25. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 25 Personal Defenses Effect 1.Breach of contract 2.Fraud in the inducement 3.Mental illness that makes a contract voidable instead of void 4.Illegality of a contract that makes the contract voidable instead of void 5.Ordinary duress or undue influence 6.Discharge of an instrument by payment or cancellation Personal defenses cannot be raised against a holder in due course

26. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 26 HDC Status Eliminated with Respect to Consumer Credit Transactions eliminates HDC status  The Federal Trade Commission (FTC) has adopted a rule that eliminates HDC status with regard to negotiable instruments that arise out of certain consumer credit transactions  Sellers of goods and services are prevented from separating the consumer’s duty to pay the credit and the seller’s duty to perform personal and real defenses  Thus, both personal and real defenses can be raised against an HDC eliminates HDC status  The Federal Trade Commission (FTC) has adopted a rule that eliminates HDC status with regard to negotiable instruments that arise out of certain consumer credit transactions  Sellers of goods and services are prevented from separating the consumer’s duty to pay the credit and the seller’s duty to perform personal and real defenses  Thus, both personal and real defenses can be raised against an HDC

27. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 27 The Bank – Customer Relationship Creditor – Debtor Relationship  Created when a customer deposits money into the bank  The customer is the creditor and the bank is the debtor Creditor – Debtor Relationship  Created when a customer deposits money into the bank  The customer is the creditor and the bank is the debtor Principal – Agent Relationship  Created if the: deposit is a check that the bank must collect for the customer or the customer writes a check against his or her account  The customer is the principal and the bank is the agent Principal – Agent Relationship  Created if the: deposit is a check that the bank must collect for the customer or the customer writes a check against his or her account  The customer is the principal and the bank is the agent

28. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 28 The Collection Process  A bank is under duty to accept deposits into a customer’s account  This includes collecting checks that are drawn on other banks and made payable or indorsed to the depositor  UCC Article 4  UCC Article 4 regulates the collection process

29. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 29 The Check Collection Process DRAWERPAYEE METRO BANK CITY BANK COUNTRY BANK (Depository and collecting bank) (Intermediary and collecting bank) City Bank sends the check to Country Bank for collection (Drawee and payor bank) Drawer issues a check to Payee drawn on Country Bank Payee deposits the check in her account at Metro Bank Metro Bank sends the check to City Bank for collection Drawer has a checking account at Country Bank

30. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 30 Electronic Fund Transfer Systems  Electronic fund transfer systems (EFTS)  Electronic fund transfer systems (EFTS) are supported by contracts among and between customers, banks, private clearinghouses, and other third parties  The most common forms of EFTS are: 1. 1. Automated Teller Machines (ATM) 2. 2. Point-of-Sale (POS) Terminals 3. 3. Direct Deposits and Withdrawals 4. 4. Paid-by-Internet  The most common forms of EFTS are: 1. 1. Automated Teller Machines (ATM) 2. 2. Point-of-Sale (POS) Terminals 3. 3. Direct Deposits and Withdrawals 4. 4. Paid-by-Internet

31. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 31 Wire Transfers (1 of 2)  UCC Article 4A – Fund Transfers  UCC Article 4A – Fund Transfers governs wholesale wire transfers: Applies only to commercial electronic fund transfers Electronic Fund Transfer Act Consumer fund transfers subject to the Electronic Fund Transfer Act are not subject to Article 4A

32. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 14 - 32 Wire Transfers (2 of 2)  UCC Article 4A  UCC Article 4A (continued) Governs the rights and obligations between parties to a fund transfer unless they have entered into a contrary agreement If a receiving bank mistakenly pays a greater amount to the beneficiary than ordered, the originator is liable for only the amount he or she instructed to be paid