Вы находитесь на странице: 1из 41

PAYMENT SYSTEMS VERDUN SUMMER2011 NEGOTIABLE INSTRUMENTS ................................................................................................................................................................................ 4 I) INTRODUCTION ............................................................................................................................................................................................ 4 A) Negotiable Instruments (NI) ........................................................................................................................................................................

.. 4 B) Governing Law: UCC.................................................................................................................................................................................. 4 C) Types of Negotiable Instruments (notes & drafts) ....................................................................................................................................... 4 II) A) B) REQUIREMENTS FOR NEGOTIABILITY ................................................................................................................................................... 4 Introduction ................................................................................................................................................................................................. 4 3-104(a): Negotiability Requirements & Applicable Code Sections ........................................................................................................... 4

HOLDER IN DUE COURSE (HDC) ............................................................................................................................................................................ 6 I) HDC RULE ...................................................................................................................................................................................................... 6 II) A) B) C) D) III) A) B) C) D) E) HOLDER STATUS .......................................................................................................................................................................................... 6 General Rule ................................................................................................................................................................................................ 6 Ways of Acquiring Holder Status: Issuance or Negotiation ........................................................................................................................ 6 Indorsement ................................................................................................................................................................................................. 6 4-205(1): Depositary Banks Status as Holder ............................................................................................................................................ 7 VALUE ............................................................................................................................................................................................................. 7 Promise of Performance .............................................................................................................................................................................. 7 SI or Lien ..................................................................................................................................................................................................... 7 For Antecedent Claim Taken for value if Instrument issued or transferred as payment or, or security for, an antecedent claim ............. 7 3-303(a): Negotiable Instrument or Irrevocable Commitment ..................................................................................................................... 7 Gifts Gift of an instrument will never create HDC statute in the donee (no value given) ......................................................................... 7

IV) GOOD FAITH (GF) ......................................................................................................................................................................................... 7 A) Introduction GF is partially subjective & partially objective .................................................................................................................... 7 B) Subjective Element Honesty in fact .......................................................................................................................................................... 7 C) 3-103(a)(4): Objective Element - Requires observance of reason_ commercial standards of fair dealing .................................................. 7 V) A) B) C) NOTICE ........................................................................................................................................................................................................... 9 Introduction ................................................................................................................................................................................................. 9 Manner of Obtaining Notice ........................................................................................................................................................................ 9 Situation Involving Notice Issues ................................................................................................................................................................ 9

VI) DEFENSES, CLAIMS TO THE INSTRUMENT, CLAIMS IN RECOUPMENT & DISCHARGES ........................................................... 10 A) 3-308(b): Recovery from Obligor .............................................................................................................................................................. 10 B) Real Defenses - Defenses that all Holders (including HDC) takes Subject to ........................................................................................... 10 C) Personal Defenses - Defenses that only Non-HDC takes Subject to.......................................................................................................... 11 D) Discharges (other than Discharges in Bankruptcy) .................................................................................................................................... 11 VII) TRANSFER OF INSTRUMENT & SHELTER RULE ................................................................................................................................ 12 A) 3-203(b): Rights of Transferee When instrument is transferred, transfer vests in transferee all rights of his transferor ......................... 12 B) 3-203(c): Right to Transferors Indorsement ............................................................................................................................................. 12 C) The Shelter Rule ........................................................................................................................................................................................ 12 D) 3-207: Reacquisition by Prior Holder ........................................................................................................................................................ 12 VIII) DEFENSES & CLAIMS TO BANK CHECKS ........................................................................................................................................... 12 A) Right of Bank to Raise Defenses ............................................................................................................................................................... 12 B) 3-411(b): Penalty for Wrongfully Refusing to Pay .................................................................................................................................... 12 C) 3-411(c): Banks defenses to liability for expenses and consequential damages ....................................................................................... 12 NATURE OF LIABILITY ON INSTRUMENTS ...................................................................................................................................................... 12 I) LIABILITY OF MAKER/ISSUER, DRAWER, DRAWEE AND INDORSER ............................................................................................ 12 A) Introduction ............................................................................................................................................................................................... 12 B) 3-412: Obligation of Maker/Issuer ............................................................................................................................................................ 12 C) 3-414: Obligation of Drawer ..................................................................................................................................................................... 13 D) 3-408: Obligation of Drawee ..................................................................................................................................................................... 13 E) 3-415: Obligation of Indorser .................................................................................................................................................................... 13

II) A) B) C) D) III) A) B) C) D)

PRESENTMENT, DISHONOR & NOTICE OF DISHONOR ...................................................................................................................... 13 Introduction ............................................................................................................................................................................................... 13 Presentment ............................................................................................................................................................................................... 13 Dishonor .................................................................................................................................................................................................... 14 Notice of Dishonor .................................................................................................................................................................................... 14 ACCOMMODATION PARTIES ................................................................................................................................................................... 14 What is an Accommodation Party? ........................................................................................................................................................... 14 Relationship b/w Accommodation & Accommodated parties ................................................................................................................... 16 Relationship b/w Accommodation Parties ................................................................................................................................................. 16 Discharge of Indorsers & Accommodation Parties.................................................................................................................................... 16

IV) LIABILITY OF AGENTS, PRINCIPALS, AND CO-OBLIGORS ............................................................................................................... 17 A) Liability of Represented Person................................................................................................................................................................. 17 B) Liability of Representative ........................................................................................................................................................................ 17 C) Liability of Persons Signing in the Same Capacity in the Same Transaction ............................................................................................ 17 V) A) B) EFFECT OF TAKING INSTRUMENT ON THE UNDERLYING OBLIGATION ...................................................................................... 19 Ordinary Instruments ................................................................................................................................................................................. 19 Bank Checks .............................................................................................................................................................................................. 19

VI) ENFORCEMENT OF LOST, DESTROYED, OR STOLEN INSTRUMENTS ............................................................................................ 19 A) Ordinary Instruments ................................................................................................................................................................................. 19 B) Bank Checks .............................................................................................................................................................................................. 19 FORGERY, ALTERATION, AND OTHER FRAUDULENT ACTIVITY............................................................................................................. 20 I) UNAUTHORIZED SIGNATURES ............................................................................................................................................................... 20 A) 3-403(a): Introduction ............................................................................................................................................................................... 20 B) 2 Consequences of Unauthorized Signature .............................................................................................................................................. 20 C) Transfer Warranties ................................................................................................................................................................................... 20 D) Presentment Warranties ............................................................................................................................................................................. 20 E) Recovery by Payor of Payment Made by Mistake ..................................................................................................................................... 20 F) Conversion ................................................................................................................................................................................................ 20 G) Application of Rules .................................................................................................................................................................................. 21 II) A) B) C) D) III) A) B) C) D) E) ALTERATIONS & INCOMPLETE INSTRUMENTS .................................................................................................................................. 22 3-407(a): What is an Alteration? ............................................................................................................................................................... 22 Allocation of Loss in Case of Alteration ................................................................................................................................................... 22 Discharge of Party Whose Obligation is Affected ..................................................................................................................................... 22 Incomplete Instruments ............................................................................................................................................................................. 22 GROUNDS OF PRECLUSION ...................................................................................................................................................................... 23 3-403(a): Ratification ................................................................................................................................................................................ 23 1-103: Estoppel A party may be estopped to deny the authenticity of a signature.................................................................................. 23 Negligence Rule ........................................................................................................................................................................................ 23 Imposters Rule & Fictitious Payees ........................................................................................................................................................... 23 Bank Statement Rule ................................................................................................................................................................................. 24

IV) RESTRICTIVE INDORSEMENTS ............................................................................................................................................................... 25 A) Introduction ............................................................................................................................................................................................... 25 B) 3-206(c): For Deposit Restrictive Indorsement ......................................................................................................................................... 25 C) 3-206: Effect of For Deposit or For Collection Indorsement .............................................................................................................. 25 PAYOR BANK/CUSTOMER RELATIONSHIP ...................................................................................................................................................... 25 I) WHEN ITEM PROPERLY PAYABLE ......................................................................................................................................................... 25 A) Properly Payable Rule ............................................................................................................................................................................... 25 B) 4-401(c): Postdated Checks ....................................................................................................................................................................... 25 C) 4-404: Bank not obligated to pay check 6 months old ............................................................................................................................... 25 D) Banks Right of Set-off.............................................................................................................................................................................. 26 E) 4-405(b): Death or incompetence of customer .......................................................................................................................................... 26 II) VARIATION BY AGREEMENT .................................................................................................................................................................. 26

III) A) B) IV) A) B) C) D) E) V) A) B) C)

WRONGFUL DISHONOR ....................................................................................................................................................................... 26 4-402(a): Banks Liability ......................................................................................................................................................................... 26 Sufficient Funds in Account ...................................................................................................................................................................... 26 CUSTOMERS RIGHT TO STOP PAYMENT ........................................................................................................................................ 26 4-403(a): Customer has a right to stop payment of any item drawn on its account ................................................................................... 26 4-403(b): Requirement s for Stop Payment Order ..................................................................................................................................... 26 4-303(a):Timeliness of Stop Payment Orders ............................................................................................................................................ 27 4-403(c): Damages for payment in violation of stop payment order ......................................................................................................... 27 Payor banks right of subrogation on Improper Payment .......................................................................................................................... 27 FUNDS AVAILABILITY UNDER REGULATION CC ............................................................................................................................... 27 Introduction ............................................................................................................................................................................................... 27 Reg CC 229.10: Funds Subject to Next-Day Availability ......................................................................................................................... 28 Availability of Ordinary Checks ................................................................................................................................................................ 28

BANK COLLECTION PROCESS ............................................................................................................................................................................. 28 I) INTRODUCTION TO THE CHECK COLLECTION PROCESS ................................................................................................................. 28 A) Check Collection Process - Generally ....................................................................................................................................................... 28 B) Types of Banks under Art. 4 ...................................................................................................................................................................... 28 C) Variation by Agreement ............................................................................................................................................................................ 28 II) A) B) C) D) III) DUTIES OF PAYOR BANK ......................................................................................................................................................................... 29 4-301(a): Duty to pay or settle on day of presentment............................................................................................................................... 29 Means of Dishonoring Item ....................................................................................................................................................................... 29 Final Payment ............................................................................................................................................................................................ 29 Duties to Return Unpaid Items .................................................................................................................................................................. 30

DUTIES OF COLLECTING BANKS ............................................................................................................................................................. 30 A) Collecting Banks Status as Agent............................................................................................................................................................. 30 B) Right of Chargeback .................................................................................................................................................................................. 31 C) Duty of Collecting Bank to Use Ordinary Care in Collecting and Returning Items .................................................................................. 31 D) Check 21 (Check Truncation).................................................................................................................................................................... 31

ELECTRONIC BANKING ......................................................................................................................................................................................... 32 I) WIRE TRANSFERS (AKA WHOLESALE FUNDS TRANSFERS) ............................................................................................................ 32 A) Terminology .............................................................................................................................................................................................. 32 B) What is a Fund Transfer ............................................................................................................................................................................ 32 C) Payment Obligations in Chain of Title ...................................................................................................................................................... 32 D) Duties & Liabilities of Receiving Bank ..................................................................................................................................................... 32 E) Duties of Beneficiarys Bank..................................................................................................................................................................... 33 F) 4A-406(a): Effect of Acceptance on Underlying Obligation ..................................................................................................................... 34 G) Cancellation (Stopping Payment) of Payment Order ................................................................................................................................. 34 H) Liability for Authorized Payment Orders .................................................................................................................................................. 36 I) Liability for Unauthorized Payment Orders............................................................................................................................................... 36 J) Erroneous Payment Orders ........................................................................................................................................................................ 36 K) Misdescriptions ......................................................................................................................................................................................... 37 II) A) B) C) D) E) F) III) A) B) C) D) CONSUMER ELECTRONIC FUND TRANSFERS ..................................................................................................................................... 38 Introduction ............................................................................................................................................................................................... 38 Consumer Liability for Unauthorized Transfers ........................................................................................................................................ 38 Stopping Payment of Electronic Fund Transfers ....................................................................................................................................... 39 Consumer Liability to 3P in Event of System Malfunction ....................................................................................................................... 39 Documentation Requirements ................................................................................................................................................................... 39 Error Resolution Procedures ...................................................................................................................................................................... 39 LENDER CREDIT CARDS ........................................................................................................................................................................... 40 Terminology in Credit Card Transactions ................................................................................................................................................. 40 Law Governing Credit Card Transactions ................................................................................................................................................. 40 Liability for Unauthorized Use .................................................................................................................................................................. 40 Right to Refuse Payment ........................................................................................................................................................................... 40

NEGOTIABLE INSTRUMENTS I) INTRODUCTION A) Negotiable Instruments (NI) 1) Generally NI is a cross b/w a contract & money 2) Primary Difference from Ordinary Contract Right (i) Assignee of an ordinary contract takes subject to all defenses to which assignor took subject (ii) Holder in Due Course (HDC) of a NI takes free from virtually all defenses B) Governing Law: UCC 1) Art. 3 - Governs writings meeting negotiability requirements of 3-104(a) (excludes money, investment securities & payment order) 2) Art. 4 - Governs the bank collection process for items 3) 3-102(b) & 4-102(a): Art. 4 Prevails over Art. 3 if there are any conflicts in the results b/w them Types of Negotiable Instruments (notes & drafts) 1) Notes (i) Definition - Promise by 1 party (maker) to pay another party (payee) a sum of money (serves as credit function to evidence debt) (ii) 3-104(j): Certificates of Deposit (CoD) - CoD is a note issued by a bank Drafts - Draft is a 3 party instrument by which the drawer orders a person called the drawee to pay the payee (i) 3-104(f): Checks - Drafts drawn on bank (called either drawee bank or payor bank) that are payable on demand (ii) 3-104(g): Cashiers Check If check is drawn by bank on itself (bank both drawer & drawee) (iii) 3-104(h): Tellers Check If one bank draws a draft on another bank or makes the draft payable through another bank (iv) Travelers Checks (a) 3-104(i): To be one, check must require as a payment condition, a countersignature by person whose specimen appears on it (b) 3-106(c): HDC does not take subject to the risk that the travels check was stolen & countersignature forged

C)

2)

II)

REQUIREMENTS FOR NEGOTIABILITY A) Introduction 1) Only a writing complying w/ requirements of 3-104(a) is a NI & negotiability is determined solely by reference to its 4 corners 2) A separate agreement cant affect the negotiability of an instrument B) 3-104(a): Negotiability Requirements & Applicable Code Sections 1) Signed Writing Must be in writing & must be signed by the maker or drawer; signature can be (i) 1-201(37): Any symbol executed/adopted w/ present intent 2 adopt or accept writing (printed,stamped,written,initials,thumbprint) (ii) 3-401(b): Sig may be made manually or by a device or machine & may be any name, including assumed or trade name 3-106: Unconditional Promise or Order (i) Generally - A promise or an order that is expressly conditioned upon the happening of a specified even is not unconditional

2)

(ii) 3-106(a): A promise or order is unconditional UNLESS it states: (a) An express condition to payment (b) That the promise or order is subject to or governed by another writing, or (c) That rights or obligations w/ respect to promise or order are stated in another writing (d) However, a reference to another writing does not of itself make promise or order conditional (iii) 3-106(b): Except - A promise or order is not made conditional (a) By reference to another writing for a statement of rights w/ respect to collateral, prepayment, or acceleration, or (b) B/c payment is limited to resort to a particular fund or source (iv) Implied Conditions - Instrument is not made conditional by (a) Implied or constructive conditions on it (fact its possible that maker will no longer have liability), or (b) If the provisions on the instrument only restates the law (v) Example (a) Conditional (not NI b/c expressly condition) - I promise to pay $100 to the order of Doe if he conveys Blackacre (BA) to me (b) Unconditional (b/c condition implied) - In consideration of Does promise to convey BA, I promise to pay $100K to the order of Doe

3)

3-112: Principal sum must be payable in a fixed amount of money (i) Generally - Instrument must allow the ready calculation of the amount that the make or drawer has promised to pay

(ii) Money (a) 1-201(24): Medium of exchange authorized or adopted by a domestic or foreign govt as a part of its currency (b) 3-107: May be payable in foreign currency, but presumed to be payable in US or foreign unless instruments limits to foreign (iii) 3-112: Interest (a) Interest and other charges do not have to be payable in a fixed amount (b) Instrument may state obligation to pay interest as a fixed or variable amount of money or rate (c) Amount or rate of interest may require reference to information not contained in the instrument w/o destroying negotiability 4) 3-109: Must be payable to bearer or to order (i) 3-109(a): Bearer Paper - Promise or order is payable to bearer if it (a) States that it is payable to bearer; does not state a payee, it is payable to an unidentified person, or (b) Use language indicating that person in possession is entitled to payment (e..g., to holder, cash, or to the order of cash)

(ii) 3-109(b): Order Paper (must say order on it) (a) Instrument is payable to order if it is payable to the order of [an identified person] or to [identified person] or order (b) When an instrument is payable both to order and to bearer, the instrument is payable to bearer (iii) 3-109(c): Transforming bear paper to order paper and vice versa (a) Instrument payable to bearer may become payable to identified person if it is specially indorsed pursuant to 3-205(a). (b) Instrument payable to identified person may become payable to bearer if it is indorsed in blank pursuant to 3-205(b) (iv) 3-104(c): Check Exception (a) Checks that otherwise meet the requirements of 3-104(a) is still a negotiable instrument (b) Even if it is not made payable to order or bearer 5) 3-108: Must be payable on demand or at a definite time (i) 3-108(a): Payable on Demand - Promise or order is payable on demand if it states that it is (a) Payable on demand, presentation, or at sight, otherwise indicates that it is payable at will of the holder, or (b) Fails to state when payment is due (c) Instrument otherwise payable on demand remains payable on demand even if it is postdated or antedated

(ii) 3-108(b): Payable at a definite time (a) Promise or order is payable at a definite time if it is payable (i) At a fixed date, definite period after a stated date, or (ii) On elapse of a definite period of time after sight or acceptance (b) Instrument that is otherwise payable at a definite time remains so even if (i) Time of payment is subject to acceleration, prepayment, or holder has right to extend time of payment indefinitely, or (ii) Extension to a further definite time, at option of maker or acceptor, or automatically upon or after a specified event (c) Incomplete Instruments (i) A note or draft payable at a fixed period after date that does not state a date is an incomplete instrument (ii) Once it is completed by the addition of a date, instrument becomes payable at a definite time 6) 3-104(a)(3): Courier w/o Luggage (i) Limitation - Instrument must not state any other undertakings or instruction by person promising or ordering payment, except

(ii) Collateral - Negotiable instrument may contain an undertaking or a power to (a) Give, maintain, or protect collateral to secure payment (b) Including provision granting holder SI in collateral, securing obligation in instrument itself & any other obligation of obligor (iii) Confessing Judgment/ Disposing of Collateral/Waiver of Benefit of Law (a) Negotiable instrument may also contain an authorization or power of the holder to confess judgment or (b) Realize on, or dispose of, collateral, or a waiver of benefit of any law intended for advantage/protection of obligor

HOLDER IN DUE COURSE (HDC) I) HDC RULE A) 3-302(a) - To obtain HDC status, purchaser of instrument must take it as a holder, for value, in GF, & w/o notice of certain proscribed facts HOLDER STATUS A) General Rule 1) In order for a person to qualify as holder of an instrument, person must have possession of instrument, and 2) The obligation evidenced by the instrument must run to him B) Ways of Acquiring Holder Status: Issuance or Negotiation 1) 3-105(a): Issuance (i) Instrument is issued when it is first delivered by maker or drawer to either a holder or nonholder (ii) For the purpose of giving rights on the instrument to any person 3-201: Negotiation (i) 3-201(a) (a) Negotiation is a transfer of possession of an instrument, whether voluntary or involuntary, by a person, other than issuer (b) To another person who thereby becomes its holder

II)

2)

(ii) Payable to Bearer (a) When an instrument is payable to bearer, transfer of possession alone is sufficient for negotiation (b) Therefore, a thief or finder of an instrument payable to bearer becomes holder even if transfer was involuntary (iii) 3-201(b): Payable to Order - To negotiate instrument payable to order, it must also be indorsed to that person or to bearer C) Indorsement 1) 3-201(b): Generally (i) Authorized Signature - Indorsement sufficient to negotiate instrument must be written by or on behalf of the holder (ii) Forged or Unauthorized Indorsement (a) A forged or unauthorized indorsement is not effective to negotiate the instrument (b) If indorsement in chain of title is forged or unauthorized, no transferee subsequent to it can become a holder Types of Indorsements 2 Types of indorsements can be used to negotiate an instrument (i) 3-205(a): Special Indorsements Identifies the person to whom the instrument is payable

2)

(ii) 3-205(b): Blank Indorsement (a) Indorsement that is not payable to an indentified person (e.g., signed w/o naming payee or accompanied w/ pay to bearer) (b) Instrument indorsed in blank becomes payable to bearer & any person who possesses it becomes its holder (iii) 3-205(c): Conversion of blank to special indorsement (a) Any holder of an instrument indorsed in blank may convert the blank indorsement into a special indorsement by (b) Writing over the signature of the indorser the name of an indorsee 3) 4) 5) 3-204(a): Indorsement must be written on instrument (can be a separate piece of paper if that paper is affixed to the instrument) 3-205: Manner of negotiation depends on last indorsement (determining whether it is bearer paper or order paper) 3-110: Determining who may indorse as payee (i) Generally (a) Person to whom instrument is initially payable (therefore, able to indorse) determined by intent of person signing instrument (b) Or, in the name of the issuer, or on behalf of the issuer whether or not that person is authorized

(ii) 3-110(a): Need not be real name of payee (a) Generally - Instrument payable to person intended by signer even if payee is indentified by name other than real name (b) 3-204(d): Whether payee designated by true name or name on instrument, both are effective to negotiate instrument (iii) 3-110(a): More than one person signing as issuer (a) If an instrument is signed by more than 1 person as maker or drawer & each signer intends a different person (b) Instrument is payable to any person intended by any one of the signers 6

(iv) Intent of forger determinative (a) When drawers signature on the check is forged (b) The payee is the person to whom the forger intended that payment be made (v) 3-110(b): Checkwriting Machine - When signature of the issuer is made by automated means (a) Identity of payee is determined by the intent of the person who supplied the name of the payee (b) Whether or not the person was an authorized agent or even connected w/ the issuer (vi) 3-110(d): Two or More Payees Instrument payable to 2 or more payees is payable to them either jointly or in the alternative (a) Jointly - If instrument is payable jointly, all payees must participate in any negotiation, discharge, or enforcement of it (b) Alternative - If payable in the alternative may be negotiated, discharged, or enforced by any payee who is in possession of it D) 4-205(1): Depositary Banks Status as Holder 1) If a customer delivers an item to a depositary bank for collection, whether or not the customer indorses the item 2) Depositary bank becomes a holder of the item at the time it receives the item of the customer 3) If the customer, at the time of delivery, was a holder of the item III) VALUE A) Promise of Performance 1) 3-303(a)(1) (i) Instrument is issued or transferred for value when its taken for a promise of performance, to extent promise has been performed (ii) Any promise that would constitute consideration under contract law constitutes a promise of performance under Art. 3 3-302(d) (i) When a holder has only partially performed agreed-on consideration, holder has rights of a HDC to extent of (ii) Fraction of amount payable under instrument equal to value of partial performance divided by value of promised performance

2)

B)

SI or Lien 1) 2) Generally - Holder takes for value to extent she acquires SI in, or other lien on, the instrument other than a lien by judicial proceedings SI in Instrument Holder may acquire a SI or a lien on an instrument in 2 ways: (i) 3-303(a)(2): Voluntary transfer by debtor, usually an Art. 9 SI, or

(ii) 4-210(a): SI that a collecting bank automatically acquires in an item (a) Collecting bank acquires SI in items deposited w/ it to extent that provisional credit given customer on item is withdrawn, or (b) When collecting bank applies item in part or in full payment of a debt owed to it by its customer (iii) 4-210(b): FIFO Rule - Funds first in r first out; therefore, if depositor has funds available & withdraws, bank not HDC for those $ 3) 3-303(a): Lien on Instrument (i) Generally A person who has a lien on an instrument by operation of law takes instrument for value (e.g., bankers lien) (ii) Lien acquired by judicial process (attachment, garnishment, or execution) Does not constitute value 3-302(e): Lienholder or secured party takes instrument for value only to extent of amount owed on underlying debt

4) C)

For Antecedent Claim Taken for value if Instrument issued or transferred as payment or, or security for, an antecedent claim

D) 3-303(a): Negotiable Instrument or Irrevocable Commitment 1) An instrument is taken for value if it is issued or transferred in exchange for a negotiable instrument or 2) For the incurring of an irrevocable commitment to a 3P by the person taking the instrument E) Gifts Gift of an instrument will never create HDC statute in the donee (no value given)

IV) GOOD FAITH (GF) A) Introduction GF is partially subjective & partially objective B) Subjective Element Honesty in fact 1) The particular holder must be honest in fact in the transaction 2) Person is honest in fact if she honestly is unaware of claim or defense even though a reason_ person would have been 3-103(a)(4): Objective Element - Requires observance of reason_ commercial standards of fair dealing 1) Conduct of the holder comported w/ industry or commercial standards applicable to the transactions, and 7

C)

2)

Those standards were reasonable standards intended to result in fair dealing

V) NOTICE A) Introduction 1) 3-302(a)(2): Notice of Infirmity - Holder cant become HDC if it has notice of any infirmity in instrument or in underlying transaction 2) If holder has notice Holder is completely denied HDC status & takes subject to all claims, defenses, & claims in recoupment 3) Effect of Subsequent Notice Once purchaser becomes HDC, notice subsequently obtained does not destroy its HDC status B) Manner of Obtaining Notice 1) Actual Knowledge (i) Holder has actual knowledge of an infirmity when she is (ii) Subjectively aware of the existence of the claim, defense, or claim in recoupment Notification (i) 1-201(26): Person receives a notice or notification when it comes to her attention or when it is duly delivered (ii) 3-302(a)(2)(iii): Effective Notification (a) Notification is effective even if holder didnt actually read the notification & thereby acquire actual knowledge (b) However, notification must be received at such time & in such manner as to give a reason_ opportunity to act on it 1-201(25)(c): Reason to Know (i) Generally (a) Purchaser may also have notice of an infirmity if, from all the facts and circum known to him at the time in question, (b) He has reason to know of the infirmity

2)

3)

(ii) Duty to Inquire (a) Generally If instrument appears 2b negotiable in form & regular on its face, holder has no duty to inquire into defenses (b) Duty to Inquire Test (i) Whether a reason_ person, considering all the facts & circum known to holder, would have further investigated and (ii) Thereby discovered existence of the claim, defense, or claim in recoupment (c) Suspicious Circumstances (i) Holder must investigate if suspicious circum indicate that some infirmity exists in instrument or underlying transaction (ii) If it appears from facts & circum that reason_ businessman wud have found purchase suspicious C) Situation Involving Notice Issues 1) Executory Promise (i) Knowledge that instrument was issued or negotiated in return for executory promise does not give a purchaser notice (ii) Purchaser does not have a duty to inquire as to whether promise has been performed (iii) Purchase has notice only if she has notice that a breach has already occurred Purchase at a Discount (i) Purchaser is not imputed w/ notice solely b/c her knowledge that the instrument was purchased at a substantial discount (ii) However, purchaser has a duty to inquire as to why the instrument is selling at such as large discount Close Connection Doctrine (i) Denies HDC Status (a) Where a close bus. association b/w payee & one who purchases instrument from him (b) Purchaser is said to be on notice of defenses that the payee has knowledge of

2)

3)

(ii) Determining Close Connection (a) Is buyer-transferee alter ego of seller-transferor? Same officers, personnel, or location? (b) Who drafted original promissory note? (c) Is buyer-transferee mentioned in the note? (d) Does seller-transferor sell paper to other buyers, or is buyer-transferee the only market? (e) Did buyer-transferee get involved in transaction by which note was created (such as conducting a credit check)? (f) Did buyer-transferee have some knowledge of seller-transferors poor past performance of similar contracts? 4) 3-307: Notice of Breach of Fiduciary Duty Purchaser deemed to have notice if (i) 3-307(b)(iii): Represented person makes a claim to the instrument

(ii) 3-307(b)(ii): Taker knows that person w/ whom he is dealing is a fiduciary 9

(iii) 3 Situations Involving Notice of Breach of Fiduciary Duty (a) 3-307(b)(2): When instrument made payable to represented party or to fiduciary as such (i) Taker has notice of a breach of fiduciary duty if instrument is taken in payment of, or as security for a. Debt known by taker to be personal debt of fiduciary b. Taken in a transaction known to taker to be for personal benefit of the fiduciary, or c. Deposited in an account other than the fiduciary, as such, or of the represented person (ii) Holder not deemed to have notice unless it knows that value is being given for personal benefit of fiduciary (b) 3-307(b)(4): When instrument drawn or made by represented person or fiduciary as such directly to taker (i) Taker has notice of a breach of fiduciary duty if instrument is taken in payment of, or as security for a. Debt known by taker to be the personal debt of fiduciary b. Taken in a transaction known to taker to be for personal benefit of the fiduciary, or c. Deposited in an account other than the fiduciary as such or of the represented person (ii) Holder not deemed to have notice unless it knows that the value is being given for the personal benefit of the fiduciary (c) 3-307(b)(3): When payable to fiduciary personally (e.g., tustees paying themselves out of a trust) (i) Taker has notice of a breach of fiduciary duty only if it has actual knowledge of breach (ii) Holder must therefore know not only that the value is being applied for personal benefit of the fiduciary, but (iii) Also that such application is a breach of her fiduciary duty 5) 3-302(a)(1): Notice that instrument is forged, altered, or otherwise irregular (i) Purchaser cant be HDC if instrument, when issued or negotiated to holder bears such apparent evd of forgery, alteration, or (ii) is otherwise so irregular or incomplete that instrument on its face is so suspect that reason_ person would question its authenticity Notice that instrument is overdue or has been dishonored (i) 3-302(a)(2)(iii): Purchaser denied HDC status if he has notice than an instrument is overdue or has been dishonored

6)

(ii) When Instrument is Overdue (a) 3-304(a)(1)-(2): Checks Earlier of, day after day demand for payment is duly made or 90 days after its stated date (b) 3-304(a)(1) & (3): Other demand instruments They become overdue at the earlier (i) The date after the day demand for payment is duly made, or (ii) When the instrument has been outstanding for a period of time after its date that is unreason_ long (c) 3-304(b)(1): When date accelerated (i) Once an instrument has been accelerated causing the entire principal amount to be immediately due (ii) The instrument becomes overdue on the day after the accelerated due date (d) 3-304(b)(1): Payable in Installments (i) Absent acceleration, instrument payable in installments becomes overdue upon default for nonpayment of installment (ii) Instrument remains overdue until the default is cured (e) 3-304(b)(2): Not payable in installments - Absent acceleration, instru not payable in install overdue on day after its due date (f) 7) 3-304(c): Interest - Not overdue is theres only a default in interest (as long as there is no default in payment of principal)

3-302: Notice of Discharge (i) Notice of the discharge of a party, other than a discharge in an insolvency proceeding, is not notice of a defense (ii) However, a holder who has notice of a discharge will take subject to any discharge of which he has notice (iii) Taker denied HDC if he knows that the maker, drawer, or acceptor has been discharged in insolvency proceedings

VI) DEFENSES, CLAIMS TO THE INSTRUMENT, CLAIMS IN RECOUPMENT & DISCHARGES A) 3-308(b): Recovery from Obligor 1) Any holder or person w/ rights of a holder (i.e., person entitled to enforce an instrument) 2) May recover from obligor in absence of a claim to the instrument, defense, claim in recoupment, or discharge B) Real Defenses - Defenses that all Holders (including HDC) takes Subject to 1) 2) 3-305(a)(3) & (b): Defenses & claims in recoupment assertible against holder itself arising from transaction instrument was issued 3-305(a)(1)(i): Infancy - To the extent that the obligors infancy is a defense to a simple contract 10

3)

3-305(a)(1)(ii): Incapacity, duress, or illegality (i) Legal incapacity (e.g., mental incompetency or corp statutory incapacity to execute instruments exceeding its corp powers) (ii) Duress, or illegality (e.g., use of instrument to pay a gambling debt) (iii) To extent that such defenses render obligation of obligor a nullity (only if statutes or case law makes transaction void) 3-305(a)(1)(iii): Fraud in the Factum (i) Obligor induced by fraud to sign instrument (a) W/ neither knowledge, nor reason_ opportunity to learn, (b) Of instruments character or its essential terms

4)

(ii) Example of Fraud in Fact - Maker who is tricked into signing note in belief that it is merely receipt or some other doc (iii) Instruments Character (a) Obligor is ignorant of instruments character if he is under impression that (b) He is signing something other than a promise to pay money (iv) Essential Terms (a) Obligor ignorant of the instruments essential terms if he believes, for example, (b) That he is signing a note payable in 2 years when, in fact, it is payable on demand (v) Except - Knew or Should have Known (a) Obligor cant raise defense if he, under the circum, knew or should have discovered character or essential terms (b) If obligor had the opportunity to, but did not, read the instrument, the defense will not be available 5) C) 3-305(a)(1)(iv): Discharge in insolvency proceeding Discharge in insolvency proceedings is a defense against any person

Personal Defenses - Defenses that only Non-HDC takes Subject to 1) Introduction (i) Generally - Following defenses are available only against person who do not have the rights of HDC (ii) 3-305(b): All these defenses are cut off when the instrument is acquired by a HDC 3-305(a)(2): Ordinary Defenses (i) A person not having the rights of HDC takes subject to virtually any defenses including (ii) Any defense that would be available if the obligation rose out of an ordinary contract 3-305(a)(3): Claims in Recoupment - Claim in recoupment is assertible against any person not having rights as HDC 3-306: Claims to the Instrument (i) Person who lacks HDC takes instrument subject to all valid claims of property or possessory interest in instrument or its proceeds (ii) Including a claim to rescind a negotiation & to recover the instrument or its proceeds

2)

3) 4)

D) Discharges (other than Discharges in Bankruptcy) 1) 3-601(b): Introduction (i) Discharge effective against any person except HDC who was w/o notice of discharge when she took instrument (ii) However, HDC does have notice if payments are made directly to HDC 3-602(a): Discharge by Payment (i) Instrument discharged to extent that payment is made by or on behalf of party obliged to pay it & to person entitled to enforce it (ii) Payment must be made to person entitled to enforce instrument for discharge 3-604(a): Discharge by cancellation or renunciation (i) A person entitled to enforce an instrument may, w/o consideration, discharge any party to the instrument (ii) In any manner apparent on the face of the instrument or the indorsement by (a) Renouncing its rights in a signed writing or surrender of the instrument to the party to be discharged (b) Unless cancellation, renunciation, or surrender is ineffective if its unintentional, unauthorized, or procured by fraud/mistake 3-601(a): Discharge of simple contract (i) Party is discharged from liability on instrument to another party by any act or agreement w/ such party (ii) That would discharge a simple contract for the payment of money

2)

3)

4)

11

VII) TRANSFER OF INSTRUMENT & SHELTER RULE A) 3-203(b): Rights of Transferee When instrument is transferred, transfer vests in transferee all rights of his transferor B) 3-203(c): Right to Transferors Indorsement 1) If transferee does not become holder of instrument b/c transferor failed to supply a necessary indorsement, and 2) If transfer is for value, transferee has the specifically enforceable right to obtain transferors unqualified indorsement The Shelter Rule 1) 3-203(b): Shelter Rule (i) Transferee may acquire rights of HDC through transfer even if transferee does not himself qualify as HDC (ii) E.g., if a HDC gives instrument as a gift (no value) transferee still acquires the rights of a HDC 3-305(b): Includes right to take free of all claims, defenses, & claims in recoupment to same extent as his transferor/HDC Subsequent Transferees (i) Subsequent transferee are also is entitled to any rights transferor inherited from his own transferor, but (ii) Subject to any claim of ownership, recoupment, or defense to which his transferor/HDC would take subject 3-203(b): Except (i) No transferee who has engaged in any fraud or illegality affecting the instrument can acquire the rights of HDC (ii) Through a transfer directly or indirectly from a HDC

C)

2) 3)

4)

D) 3-207: Reacquisition by Prior Holder 1) On reacquisition of instrument, reacquirer is given right to cancel any indorsement not necessary to its chain of title 2) Thereby enabling it to become holder of instrument & have right to further negotiate the instrument 3) Indorsers are Discharged (i) Reacquirers cancellation of intervening indorsements discharges any indorser whose indorsement has been cancellation (ii) By virtue of the cancellation, subsequent purchasers are deemed to have notice of the canceled indorsers discharge VIII) DEFENSES & CLAIMS TO BANK CHECKS

A) Right of Bank to Raise Defenses 1) Obligated bank retains same right as drawer of check to raise defenses or 3P claims 2) However, certain penalties are assessed against bank if it wrongfully refuses to pay a bank check B) 3-411(b): Penalty for Wrongfully Refusing to Pay 1) Obligated bank that wrongfully refuses to pay bank check is liable to person asserting right to enforce check for any 2) Expenses, including atty fees and loss of interest resulting from the nonpayment, and 3) Consequential damages if obligated bank refuses to pay check after receiving notice of particular circum giving rise to them 3-411(c): Banks defenses to liability for expenses and consequential damages 1) Obligated bank suspends payments (i.e., is insolvent) 2) Obligated bank has reason_ grounds to believe that banks claim or defense is available against person entitled to enforce instrument (i) If bank has a defense of its own arising out of issuance of the bank check and (a) Reason_ believes that this defense would be assertible against the holder (b) Bank not liable for either consequential damages or expenses, whether or not it is successful in raising the defense (c) But is liable for holders loss of interest on those funds (ii) Obligated bank receives no protection if it unsuccessfully attempts to raise 3P claim to the instrument 3) Obligated bank has a reason_ doubt that the person is entitled to payment or 4) Obligated bank is prohibited by law from making payment

C)

NATURE OF LIABILITY ON INSTRUMENTS I) LIABILITY OF MAKER/ISSUER, DRAWER, DRAWEE AND INDORSER A) Introduction 1) A party may sign a negotiable instrument in various capacities 2) Maker of a note or issuer of cashers check (the bank), drawer of a draft, and an indorser B) 3-412: Obligation of Maker/Issuer 1) Generally (i) Maker of a promissory note & bank issuing a cashiers check are absolutely liable on the instrument (ii) Obligation is owned to a person entitled to enforce the instrument or to an indorser who paid for the instrument 12

C)

2) More than 1 Maker - Presumed to be j&s liable, but they have a right to contribution from their co-makers 3-414: Obligation of Drawer 1) 3-414(b): Dishonor by drawee must occur b/f a drawer is liable on a draft; liability as a drawer is not conditioned on notice of dishonor 2) 3-414(c): Drawer is completely discharged when a draft is accepted by a bank

D) 3-408: Obligation of Drawee 1) A check or other draft does not itself operate as an assignment of any of the drawers funds held by the drawee 2) Drawee is not liable to the holder UNLESS the drawee accepts the draft E) 3-415: Obligation of Indorser 1) 3-204(a): When is a signature an indorsement - Signature is deemed to be an indorsement regardless of signers intent unless (i) Accompanying words, terms of the instrument, place of the signature, or other circum unambiguously indicate (ii) That the signature is made for a purpose other than as an indorsement When Indorser is Liable (i) 3-415(a): Indorser not liable until instrument has been dishonored and, unless notice is excused, notice of dishonor is given (ii) 3-415(a): Indorsers obligation to pay is owed to person who entitled to enforce instrument or to subsequent indorser who pays it (iii) 3-415(b): However, an indorser may disclaim liability on his indorsers contract by indorsing instrument w/o recourse When Indorsers Liability is Discharged (i) 3-415(c): If notice of dishonor of instrument is required by 3-503 & notice not given to indorser (ii) 3-415(d): If a draft is accepted by a bank after an indorsement is made (iii) 3-415(e): If check is not presented for payment or given to depositary bank for collection w/i 30 days after day indorsement made

2)

3)

II)

PRESENTMENT, DISHONOR & NOTICE OF DISHONOR A) Introduction 1) Dishonor of instrument is a condition to liability of both drawer & indorser 2) Instrument is dishonored when drawee or maker refuses, or fails, to pays instrument on a proper presentment for payment 3) When presentment is excused, dishonor occurs only if the instrument is not duly paid B) Presentment 1) 3-501(a): Presentment (i) Presentment is a demand for payment made by, or on behalf of, the person entitled to enforce the instrument (ii) Presentment for payment must be made to drawee or to a party obliged to pay the instrument 3-501(b)(1): Manner of Presentment - Presentment may be made by commercially reason_ means: orally, writing, or by elect comm. 3-501(b)(1): Where presentment can be made (except Reg CC determines where check may be presented) (i) In absence of Fed Reg, clearinghouse rule, or contrary agreement, (ii) Presentment made wherever drawee/maker can be found even if instrument specifies a particular place of payment (iii) If party expected to pay cant be found, instrument may be presented at its place of payment 3-501(b)(2): Rights of drawer to required ID (w/o dishonoring instrument) (i) Once a demand for payment is made, party to whom presentment is made has right to demand, w/o dishonoring instrument (ii) That presenter exhibit instrument, show reason_ ID, & give a signed receipt on instrument or surrender it on full payment Effect of Delay in Presentment (i) 4-415(e): Indorsers Liability (a) Indorser of a check is discharged from indorsers liability if check is not presented for payment or (b) Given to a depositary bank for collection w/i 30 days after her indorsement

2) 3)

4)

5)

(ii) 3-414(f): Drawer Liability (a) Drawer of check is discharged only when check is not presented for payment or given to a depositary bank for collection (b) W/i 30 days of checks stated date & only to extent that she is deprived of funds maintained w/ drawee bank (c) B/c drawee bank has suspended payment after expiration of the 30 day period and failed to make payment on the check 6) When Presentment Excused (i) Generally - When presentment or delay in presentment is excused, presentment treated as having been made w/i prescribed time (ii) When Presentment is Excused (a) 3-504(a)(i): Excused if it cant be made by the exercise of reason_ diligence (b) 3-504(a)(v): Excused as to drawer when drawer has instructed drawee not to pay draft (doesnt apply to indorser) (c) 3-504(a)(iv): Excused when drawer or indorser has no reason to expect or right to require that instrument be paid (d) 3-504(a)(iii): When presentment waived under terms of instrument, excused as to drawer or indorser 13

(e) 3-504(a)(ii): Excused when maker repudiates obligation to pay the instrument or is in insolvency proceedings or has died C) Dishonor 1) 2) 3) 3-502(a)(1): Demand Note Dishonored if the note is not paid on the day of presentment 3-502(a)(3): Note not payable on Demand Dishonored if it is not paid the day it becomes payable (no presentment required) 3-502(b)(1): Dishonor of Check (other than for immediate payment over counter) (i) Return Check or Notice Payor bank returns check or sends notice of dishonor/nonpayment in compliance w/ 4-301 & 4-302 (ii) Payor Bank becomes Accountable - Payor bank fails to promptly return check (or send notice of nonpayment) & fails to settle 3-502(b)(2): Dishonor of Demand Draft (includes checks presented over the counter) - Not paid on the day of presentment Dishonor of Draft not Payable on Demand (i) 3-502(b)(3)(i): If draft is presented for payment & its not paid on day it is due or day of presentment, whichever is later (ii) 3-502(c): However, payment may be delayed w/o dishonor until close of drawees 3 bus. day following day payment required

4) 5)

D) Notice of Dishonor 1) Introduction (i) 3-415(c): Unless excused, a delay in giving notice of dishonor discharges indorser (ii) 3-503: However, delay in dishonor does not discharge a drawer 3-503(b): Manner - Notice of dishonor may be given by any commercially reason_ means: oral, electronic, phone, or in writing 3-503(c): Time w/i which notice of dishonor must be given (i) Instrument not taken for collection 30 days (a) When an instrument is not taken by a collecting bank for collection (b) Notice of dishonor must be given w/i 30 days after day on which the instrument is dishonored

2) 3)

(ii) Instrument is taken for collection Midnight rule (a) When an instrument is taken by a collecting bank for collection (b) Collecting bank must give notice of dishonor b/f midnight of next banking day following banking day (c) On which the bank receives notice of dishonor (iii) Persons, other than collecting bank 30 days (a) Persons, other than collecting bank must give notice of dishonor w/i 30 days following the day (b) On which the person receives notice of dishonor 4) 3-504(c): When delay in notice of dishonor is excused (i) A delay in giving notice of dishonor is excused if delay is caused by circum beyond control of person and (ii) Person giving notice exercises reason_ diligence after cause of delay ceases to operate 3-504(b)(ii): When notice of dishonor excused Whenever it is waived in the instrument or otherwise

5)

III) SURETIES & ACCOMMODATION PARTIES A) What is an Accommodation Party? 1) 3-419(a): Accommodation Party (i) If an instrument is issued for value given for benefit of a party to the instrument (accommodated party) and (ii) Another party to the instrument (accommodation party) signs instrument for purpose of incurring liability on it (iii) W/o being a direct bene of value given for the instrument, instrument is signed by accommodation party for accommodation 3-419(a): Person is accommodation party only when both the surety & debtor sign the same instrument 3-419(d): Guaranteeing Collection v. Guaranteeing Payment (i) Introduction (a) When collection guaranteed or equivalent words are added to a signature that unambiguously indicate (b) An intention to guarantee collection only, signer undertakes only a guaranty of collection (not of payment)

2) 3)

(ii) Result (a) A guarantor of collection is obliged to pay amount due only if holder cant collect from the accommodated party (b) If guarantying payment, creditor may proceed directly against guarantor w/o first proceeding against accommodated party 14

4)

3-419(b): Accommodation party liable in capacity in which she signs (i.e., indorser, maker, acceptor, or drawer)

15

B)

Relationship b/w Accommodation & Accommodated parties 1) 3-419(e): No liability to accommodated party (i) An accommodation party is not liable on the instrument to the party accommodated, nor is he liable for (ii) Contribution to the accommodated party in the event of payment by the accommodated party 3-419(e): Right of Subrogation/Reimbursement (i) Accommodation party, on full payment of the instrument, is entitled to enforce the instrument against the party accommodated (ii) Accommodation party obtains all the rights of the party he paid both on the instrument and to any collateral

2)

C)

Relationship b/w Accommodation Parties 1) Generally (i) In absence of agreement to contrary, 2 parties who sign in same capacity in accommodation for another party are co-sureties (ii) Co-sureties are jointly and severally liable 3-116(b): Right of Contribution - One who pays disproportional share of obligation has right of contribution from other co-surety Defenses Available to Accommodation Party (i) 3-419: May not raise lack of consideration (a) As long as instrument was issued for value for the benefit of the accommodated party (b) Accommodation party may not raise defense of lack of consideration even though he has, in fact, received no benefit

2) 3)

(ii) 3-305(d): Right of accommodation party to raise accommodated partys defenses (a) Accommodation party pay raise any of accommodated partys defenses or claims in recoupment (b) However, accommodation party may not raise, as a defense to his own obligation to pay (c) Accommodated partys discharge in insolvency proceedings, infancy, or lack of legal capacity D) Discharge of Indorsers & Accommodation Parties 1) 2) 3-605(a): Right to a discharge under 3-605 is limited to accommodation parties & indorsers 3-605(h): To be discharged person entitled to enforce instrument must have knowledge or notice of the accommodation status (i) That the party has signed as guarantor, surety, or accommodation party, or (ii) From fact that signature is an anomalous indorsement that is presumed to be made in capacity of accommodation party 3-605(b): Release of Principal Debtor (i) Release of principal debtor (discharge by cancellation or renunciation) does not discharge accommodation party or indorser (ii) Notwithstanding release of principal debtor, accommodation party or indorser retains both right of recourse on the instrument and (iii) Right of reimbursement against the principal debtor If there is notice of Accommodation & then Extension or Modification (i) 3-605(c) & (d): Extension & Modifications (a) An accommodation party or indorser, having a right of recourse against principal debtor, may be entitled to discharged (b) If person entitled to enforce instrument materially modifies obligation of, or grants & extension to principal debtor

3)

4)

(ii) 3-605(c) & (d): Extent of Discharge (a) Extension or modification granted to principal debtor only discharges accommodation party or indorser to extent that (b) It causes accommodation party or indorser a loss w/ respect to his right of recourse against the principal debtor (iii) 3-605(i): Consent & Waiver Any party who consent to a modification or extension is not discharged (consent may be implied) 5) Impairment of Collateral & Discharge (i) 3-605(e): Generally - If obligation to pay instrument is secured by interest in collateral and (a) Person entitled to enforce instrument impairs value of the collateral (b) Obligation of indorser/accommodation party having right of recourse against obligor is discharged to extent of impairment

(ii) 3-609(h): To be discharged person entitled to enforce instrument must have knowledge or notice of accommodation (a) An accommodation party or indorser is discharged under 3-605(e) only if person entitled to enforce the instrument (b) Knows of the accommodation or has notice of the accommodation under 3-419(c) (iii) 3-605(f): Discharge of Co-Obligors (a) If a person entitled to enforce instrument impairs value of interest in the collateral (b) Obligation of any party who is jointly & severally liable w/ respect to secured obligation is discharged 16

(c) To extent that impairment causes party asserting discharge to pay more than he would have otherwise (iv) 3-605(g): When is Collateral Impair (a) Generally (i) Impairment of collateral occurs when some unjustifiable act or omission (ii) On part of person entitled to enforce instrument causes collateral no long to be available to satisfy the instrument (b) Duty of Reasonable Care (i) Unless otherwise agreed, if collateral is property in possession of person entitled to enforce the instrument (ii) That person has duty to use reason_ care in its custody & possession of the collateral (c) Acts Constituting Impairment NonExclusive List (i) Failure to Protect Failure to obtain or maintain perfection or recordation of the interest in collateral (ii) Release of Collateral Release of collateral w/o substitution of collateral of equal value (iii) Duty to Preserve Failure to perform a duty to preserve the value of the collateral (iv) Improper Disposal Failure to comply w/ an applicable law in disposing of collateral (v) 3-605(i): Consent to Impairment of Collateral Party is denied discharge if he has consented to act constituting the impairment IV) LIABILITY OF AGENTS, PRINCIPALS, AND CO-OBLIGORS A) Liability of Represented Person 1) 3-402(a): Generally - Represented person is liable on instrument if representative is authorized to sign for represented person 2) 3-402(a): In name of represented person - Rep may sign name of represented person either w/ or w/o, adding his own name or capacity 3) 3-401(a): Undisclosed Principal - Undisclosed principal is liable on instrument even though his signature or identify isnt on it B) Liability of Representative 1) 3-403(a): Unauthorized Signature (i) If rep is not authorized to sign for represented person or exceeds his authority in making the signature (ii) The signature will operate as the signature of the representative personally Authorized Signatures (i) 3-401(a): Agent not personally liable if he signs in the represented persons name only

2)

(ii) 3-402(b)(1): Unambiguously Signs in Representative Capacity (representative capacity & representeds name) (a) An authorized rep who signs his own name to instrument is not personally liable (b) When rep signs his name together w/ his representative capacity & the represented persons name (iii) Ambiguous Signature (a) 3-402(b): Rep liability to HDC - When rep does not make it clear that he is signing on behalf of the represented person (i) Rep is personally liable to HDC who takes instrument w/o notice (ii) That rep was not intended by original parties to the instrument to be personally liable (b) 3-402(b)(2): As to other persons (i) As to any other person, the rep is liable on the instrument (ii) Unless he proves an actual agreement, whether express or implied, w/ payee that he was not personally liable (c) 3-402(c): Check Exception (i) Authorized rep who signs as drawer on check payable from account of represented person w/o indicating rep status (ii) Is not liable as long as represented person is identified somewhere on the check C) Liability of Persons Signing in the Same Capacity in the Same Transaction 1) 3-116(a): Generally (i) Except as otherwise specified in the instrument, 2 or more persons who sign an instrument as makers, acceptors, or drawers (ii) Are jointly and severally liable in the capacity in which they sign Right of Contribution (i) 3-116(b): Unless parties otherwise agree, a party having j&s liability is entitled to contribution from his j&s obligors (ii) 3-116(c): If party having j&s liability is discharged by holder, his j&s obligors still have right to receive contribution from him 3-116(a): Liability of Indorsers (i) Subject to certain exceptions, indorsers are not jointly & severally liable (ii) Indorsers who are copayees and anomalous indorsers are jointly and severally liable 17

2)

3)

(iii) Unless 1 payee is accommodating the other payee or they agree to be liable otherwise than as jointly and severally

18

V) EFFECT OF TAKING INSTRUMENT ON THE UNDERLYING OBLIGATION A) Ordinary Instruments 1) Obligation Suspended (i) 3-310(b): Generally (a) Unless parties otherwise agree, when person entitled to enforce instrument takes ordinary instrument 4 underlying obligation (b) Obligation is suspended to same extent that obligation would be discharged if payment had been made in money

(ii) 3-310(b)(1): Checks (a) When an uncertified check is taken, suspension of obligation continues until check is dishonored, paid, or certified (b) If check is paid or certified, obligation is discharged to extent of the amount of the check (iii) 3-310(b)(2): Notes (a) When note is taken, suspension of obligation continues until dishonor or payment of the note (b) The obligation is discharged to the extent that the note is paid 2) Effect of Dishonor (i) 3-310(b)(3): Person entitled to enforce is the same person the underlying obligation is owed (a) When person entitled to the instrument is also the person who the underlying obligation is owed (b) The person may enforce the instrument or obligation once the instrument is dishonored

(ii) 3-310(b)(4): Person entitled to enforce is not the same person the underlying obligation is owed (a) When person entitled to enforce the instrument is not the person to whom the underlying obligation is owed (b) The person entitled to enforce the instrument may enforce only the instrument B) Bank Checks 1) 3-310(a) & (c): Discharge of obligation (i) Unless otherwise agreed, if a bank check (or any other instrument on which a bank is a maker or acceptor) (ii) Is taken for an obligation, the obligation is discharged to the same extent as had payment been made in cash 3-310(a): Debtor Indorses Instrument (i) If the debtor indorses the instrument, although the underlying obligation is discharged (ii) His liability as an indorser on the instrument is not discharged

2)

VI) ENFORCEMENT OF LOST, DESTROYED, OR STOLEN INSTRUMENTS A) Ordinary Instruments 1) 2) 3-309(b): Generally - Person entitled to enforce instrument may maintain an action as if he had produced the instrument 3-309(b): What the claimant must prove (i) He was either holder or had rights of a holder at the time he lost possession (ii) Loss of possession was not the result of his transfer of the instrument or of a lawful seizure of the instrument (iii) Terms of the instrument include any terms necessary to make the instrument negotiable (iv) He cant reason_ obtain possession of instrument: destroyed, lost, in wrongful possession of unknown person

B)

Bank Checks 1) 3-312(a)(3)(iii) (i) Only drawer or payee of certified check, & remitter or payee of a tellers or cashers check may proceed under 3-312 (ii) Indorsee of bank check is denied advantages of 3-312 & must proceed as if he were suing on an ordinary lost or stolen instrument 3-312(b): Asserting Claim - Claimant must send comm.. to issuing bank asserting claim accompanied by a declaration of loss When Claim is Effective (i) 3-312(b)(2): Claim is not valid for 90 days; during 90-day period, bank may pay person entitled to enforce the check (ii) 3-312(b)(4): After the 90-day period, issuing bank becomes liable to claimant Bank discharge by payment to Claimant (i) 3-312(b)(4): Payment to claimant discharges banks liability to a person entitled to enforce the check (ii) 3-312(b): When applies to a HDC (a) If a HDC presents bank check after bank pays claimant, issuing bank may pay HDC & claimant obliged to repay bank (b) If bank refuses to pay the HDC, claimant must pay the holder 19

2) 3)

4)

FORGERY, ALTERATION, AND OTHER FRAUDULENT ACTIVITY I) UNAUTHORIZED SIGNATURES A) 3-403(a): Introduction 1) Subject to certain exceptions, unauthorized signature is ineffective as signature of person whose name is signed 2) Unauthorized signature is effective as signature of unauthorized signer in favor of one who in GF pays instrument or takes it for value B) 2 Consequences of Unauthorized Signature 1) 3-401(a): Person whose signature is signed is not liable on the instrument 2) 3-201(b): If unauthorized signature is indorsement in chain of title, no person following unauthorized indorsement can be a holder Transfer Warranties 1) 4-204(a)(1) & 3-416(a)(1): Transferor warrants that transferor is person entitled to enforce the instrument, and 2) 4-204(a)(2) & 3-416(a)(2): That all signatures are authentic & authorized

C)

D) Presentment Warranties 1) 4-208(a); 3-417(a): Payor Bank on a Check (and any drawee of an unaccepted draft) gets 3 warranties (i) That warrantor is entitled to enforce draft or authorized to obtain payment or acceptance on behalf of person entitled (ii) The warrantor has no knowledge that signature of drawer is unauthorized, and (iii) The draft has not been altered 4-208(c); 3-417(c): Defenses against presentment warranty Drawers negligence (i) If payor bank could have asserted drawers negligence against the drawer (ii) Person against whom payor bank is bringing breach of presentment warranty action (iii) May assert drawers negligence as a defense to payor banks action

2)

E)

Recovery by Payor of Payment Made by Mistake 1) Introduction (i) Even absent a presentment warranty, payor bank may be able to recover mistaken payment from its recipient under 3-418 (ii) Drawee can revoke its acceptance in identical circumstances that it could recover payment had payment been made instead Typical Mistakes: Payment over forged drawers signature, check drawn on insufficient funds, or over valid stop payment order 3-418(c): Protected Persons - Payment may not be recovered from 2 classes of protected persons (i) Any person who takes the instrument in GF and for value, or (ii) Any person who has in GF changed position in reliance on the payment 3-418(d): Consequences when payment is recovered (i) In the event that payment is recovered, instrument is treated as having been dishonored (ii) Person from whom payment is recovered can enforce the instrument against the drawer, maker, or indorser

2) 3)

4)

F)

Conversion 1) 3-420(a): Generally - Instrument is converted if (i) It is taken by transfer, other than by negotiation, from person not entitled to enforce instrument (ii) If payor bank or other payor makes payment w/ respect to instrument to person not entitled to enforce or receive payment (iii) If indorsement in chain of title is unauthorized or missing (iv) Doesnt apply to instruments payable to bearer since they are negotiated by transfer of possession alone (no conversion possible) 3-420(c): When taking instrument by agent is conversion (i) Person other than depositary bank (a) Person who holds instrument solely as a rep of another person (other than depositary bank) who has, in GF (b) Dealt w/ an instrument or its proceeds on behalf on one who was not the person entitled to enforce the instrument (c) Is not liable in conversion or otherwise beyond the amount of any proceeds that it has not paid out

2)

(ii) Depositary Bank - Depositary bank is liable for conversion whether or not it acts n GF or retains any proceeds from the check 3) 3-420(a): Who may bring an action for conversion (i) Proper party to bring action for conversion is person who, b/f theft or loss, was person entitled to enforce instrument (ii) Payee may bring action only if instrument has been delivered to her (iii) Action for conversion may not be brought by drawer, acceptor, or other issuer of the instrument 20

G) Application of Rules 1) Signature of Maker or Acceptor Unauthorized (i) 3-401(a) (a) In absence of estoppel, ratification, or negligence, maker or acceptor is not liable on an instrument on which his signature (b) Is forged or unauthorized b/c he did not sign the instrument

(ii) 3-418 (a) If the maker or acceptor makes payment, they will suffer loss if person to whom payment is make is protected under 3-418 (b) B/c neither maker nor acceptor is given a presentment warranty as to the authenticity of his own signature 2) Signature of Drawer is Unauthorized (i) 4-208(a)(3); 3-417(a)(3): Drawee Makes Payment & Effect of Presentment Warranty (a) When drawee makes payment of check or other draft w/ forged signature of drawer, drawee will usually suffer the loss (b) Neither presenter nor prior transferors warrant to drawee that drawers signature is genuine (c) The only warranty they make is that they have no knowledge that drawers signature is unauthorized

(ii) Not Properly Payable & Drawees Remedies (a) 4-401(a): Drawee or payor bank may not debit drawers account b/c draft is not properly payable (b) 3-418(c): Drawee can only recover mistaken payment from a person who is not a protected party, or (c) 3-420(a): Drawee may sue in conversion against a person not entitled to enforce the instrument or receive payment (iii) 3-416(a)(2); 4-207(a)(2): Drawee Does not Make Payment; Effect of Transfer Warranty (a) If drawee does not make payment, loss will go back down chain of title to the first solvent party after the forger (b) Transfer warranty given by each transferor that all signatures are genuine & authorized passes loss down chain of title 3) When Indorsement is Unauthorized (i) Allocation of Loss when Check not Delivered to Payee (a) 3-420(a): Payee (i) When check or other draft has not been delivered to payee, payee has no right to sue for conversion (ii) Payee, however, retains whatever rights she had against drawer on underlying obligation for which check was taken (b) 3-417: Drawer (i) Drawer has no right to sue depositary or other collecting bank for conversion, or for breach of presentment warranty (ii) Drawer has not suffered a loss b/c payor bank may not debit his account under 3-401(a) (not properly payable) (c) 3-201(b): If unauthorized sig is indorsement in chain of title, no person following unauthorized indorsement can be holder (d) 4-208(a)(1); 3-417(a)(1): Presentment Warranty (i) Payor bank may recover from presenting bank & prior transferors (ii) From breach of their presentment warranty that they are a person entitled to enforce the instrument (e) 4-207(a)(1): Transfer Warranty (i) Whether or not the check is paid, loss will flow back to the 1 st solvent transferor following the forgery (ii) B/c each transferor warrants that it is a person entitled to enforce the instrument (ii) Allocation of Loss After Delivery to Payee - Payees rights depend on whether instrument has been paid (a) Payee Rights if Instrument Not Paid (i) 3-309: Payee may recover from drawer by complying w/ requirements for enforcement of lost destroyed or stolen instr

(ii) 3-310(b)(4): However, payee may not recover from the drawer on the underlying obligation (iii) 3-420(a): If check is found prior to payment, a. Payee may recover possession of the check from the possessor due to conversion b. Once payee recovers possession of the check, she may present the check for payment c. If it is not paid, she can recover from drawer on her drawers contract or on the underlying obligation (iv) 3-416(a)(1); 4-207(a)(1): Party thats required to return the check a. Party required to return check can then recover from her transferor and any prior transferors for b. Beach of transfer warranty that they are the person entitled to enforce the instrument 21

(b) Payee Rights if Instrument Paid (i) 3-420(a): If check paid, payee may recover from payor bank, depositary bank, or any nonbank transferor for conversion

(ii) 4-208(a)(1): Presentment Warranty a. Ultimately, 1st solvent party after person who made the unauthorized indorsement bears the loss b. Payor bank can recover from presenter or prior transferors for breach of presentment warranty c. That they are a person entitled to enforce the instrument (iii) 3-416(a)(1); 4-207(a)(1): Transfer Warranty a. Each transferee can recover from prior transferors for breach of their transfer warranty b. That they are a person entitled to enforce the instrument II) ALTERATIONS & INCOMPLETE INSTRUMENTS A) 3-407(a): What is an Alteration? 1) Alteration is any unauthorized change in an instrument that attempts to modify, in any respect, obligation of any party 2) Includes any unauthorized addition of words, numbers, other change to an incomplete instrument B) Allocation of Loss in Case of Alteration 1) 3-407(b): Generally (i) In absence of her own assent, or preclusion (i.e., negligence), a party who signs instrument only promises to pay instrument (ii) According to its terms at time she signed instrument Payment by Drawee (i) 4-401(d)(1): If drawee pays check or draft, (a) Drawee may debit drawers account only in amount as originally drawn by drawer (b) Unless drawer is negligent or otherwise precluded from asserting the alteration

2)

(ii) 3-417(a)(2); 4-208(a)(2): Presentment Warranty (a) In absence of grounds for precluding drawer, drawee may recover from (b) Any previous transferor for breach of the presentment warranty that the draft has not been altered (iii) 3-416(a)(3); 4-207(a)(3): Transfer Warranty (a) Party from whom drawee recovers can recover from his transferor & any prior transferors for breach of transfer warranty (b) That the draft had not been altered 3) 3-416(a): When Instrument Not Paid (i) If instrument is not paid, person entitled to enforce instrument may recover from any prior transferor (ii) For breach for breach of its transfer warranty of no alternation

C)

Discharge of Party Whose Obligation is Affected 1) 3-407(b); 3-203(b): Generally - Fraudulently made alternations discharges a party whose obligation is affect by the alteration (i) Unless that party assents to alternation or is precluded from asserting the alternation (ii) Any transferee, other than one who takes instrument for value in GF & w/o notice of alteration, also takes subject to the discharge 3-407(c): Except for Payor Banks (i) Payor bank paying fraudulently altered instrument or person taking it for value in GF & w/o notice of alternation (ii) May enforce the instrument according to its original terms 3-407(b): When alteration is not fraudulent, instrument may be enforced according to its original terms

2)

3)

D) Incomplete Instruments 1) 2) 3-115(b): When completion of incomplete instrument is authorized, instrument may be enforced as completed 3-407(c): Payor Bank Enforcement (i) When completion is unauthorized, a payor bank, acting in GF, may enforce instrument as completed (ii) Person taking instrument 4 value in GF & w/o notice of improper completion may enforce it according to its terms as completed 4-401(d)(2): If drawee pays check or draft, (i) Drawee may debit drawers account in the amount as completed even if the drawer knows its been completed (ii) Unless the drawee has notice the completion was improper 22

3)

4) 3-407(b): As to any other persons, obligor is discharged and is not liable on the instrument at all III) GROUNDS OF PRECLUSION A) 3-403(a): Ratification 1) Unauthorized signature may become effective 2) As signature of person whose name is signed if ratified by that him B) C) 1-103: Estoppel A party may be estopped to deny the authenticity of a signature Negligence Rule 1) 3-406: Generally (i) A person whose failure to exercise ordinary care substantially contributes to an alternation or to the making of a forged signature (ii) Is precluded from asserting alteration or forgery against a person who in GF pays the instrument or takes it for value 3-406(a): Substantially Contributes (i) For failure to exercise ordinary care to preclude negligent party, failure must substantially contribute to forgery or alteration (ii) Requires that negligence must have been contributing cause & significant factor, in enabling forgery/alteration to have been made 3-406(b): Comparative Negligence If negligence found loss is allocated according to principles of comparative negligence Failure to Exercise Ordinary Care Traditional tort test for negligence; examples of negligence (i) Giving a check to a 3P to deliver to the payee; careless business practices (ii) Negligence in hiring or supervising employees; and preventing alterations by making it that it cant be easily altered Failure of Payor Bank to Exercise Ordinary Care (i) Introduction (a) A drawer who is precluded from asserting that a signature is unauthorized may attempt to prove that (b) Payor bank also failed to exercise ordinary care so loss will be split b/w them under principle of comparative negligence

2)

3) 4)

5)

(ii) Duty to Discover Forged Indorsements (a) When payor bank is also depositary bank or when item is presented over the counter for payment (b) Bank fails to exercise ordinary care if it doesnt discover obvious irregularities in ID of person presenting item for payment (iii) 4-406: When not presented over the counter (a) Where there is obvious forgery of drawers signature & bank doesnt discover it (b) B/c it processes checks for payment by computer w/o visually inspecting checks, (c) Fact that payor bank doesnt visually examine check doesnt mean that payor bank is negligent (d) As long as its procedure is reason_ & commonly followed by other comparable banks in the area D) Imposters Rule & Fictitious Payees 1) Imposter Rule (i) 3-404(a): Generally (a) Imposter is one who represents himself to be named payee & by such representation (b) Induces issuer to issue instrument to him or to a person acting in concert w/ him (c) Person is also an imposter if she falsely represents herself to be the agent of the named payee

(ii) Indorsement Effective (a) 3-404(a): Indorsement effective (i) An indorsement by any person (including the imposter) in the name of the payee is effective in favor of a person who (ii) In GF pays the instrument or takes it for value or for collection (b) 3-404(c)(ii): Depositary Bank & Unindorsed Instrument (i) As long as instrument is deposited in a depositary bank to account in a name substantially similar to that of the payee (ii) Depositary bank is the holder of the instrument regardless of whether the instrument is indorsed (iii) 3-404(d): Comparative Negligence (a) When the taker or payor is negligent, loss is allocated under comparative negligence principles (b) B/w the drawer and the negligent party 2) Fictitious Payee Rule (i) Situations in which a payee is regarded as a fictitious payee 23

(a) 3-404(b)(ii): Nonexistent Payee Person identified as the payee does not in fact exists (b) 3-404(b)(i): Person who issues instrument intended that named payee to have no interest (ii) 3-110(a) & (b): Relevant intent is of the party making signature (a) In determining whether a payee is a fictitious payee, it is necessary to look at intent of the person whose intent (b) Determines whom an instrument is payable (iii) 3-404(b)(1): If payee is fictitious, then any person in possession of the instrument is a holder (iv) Who may assert that the indorsement is effective (a) Generally Indorsement by any person in the name of the payee is effective to negotiation the instrument (b) 3-404(b)(2): GF Required Payor or taker who does not act in GF may not assert that the indorsement is effective (c) 3-404(d): Comparative Negligence (i) When the taker or payor is negligent, loss is allocated under comparative negligence principles (ii) B/t the drawer and the negligent party (v) Double Forgeries (forged drawers signature and forged indorsement) (a) When person who forges the drawers name also intend that the payee have no interest in the check, payee is fictitious (b) Payor bank, rather than depositary bank, suffers the loss when there is both forged drawers signature & indorsement 3) Employee Indorsement Rule (i) Generally (a) When an employer hires an employee and gives the employee responsibilities regarding instruments (b) Employer is liable when the employee makes a fraudulent indorsement

(ii) 3-405(b): Indorsement Effective (a) Indorsement in name of payee is effective in favor of any person who in GF pays instrument or takes if 4 value or collection (b) Whenever an employer entrusts an employee w/ responsibility w/ respect to the instrument, and (c) The employee or person acting in concert w/ him makes a fraudulent indorsement (iii) 3-405(a)(2): Fraudulent Indorsement (a) Indorsement made in the name of the employer on an instrument payable to the employer, or (b) Indorsement in the name of the payee on an instrument issued by the employer (iv) Responsibility (a) 3-405(a)(1) & (b): For indorsement 2b effective, employer must entrust employee w/ responsibility w/ respect to instruments (b) 3-405(a)(3): Responsibility means authority to do any of the following (i) Sign or indorse instrument on behalf of employer (ii) Process instrument received by employer for bookkeeping purposes, deposit, or other disposition (iii) Prepare or process instruments for issue in the name of the employer (iv) Supply info for determining the names and addresses of payees (v) Control the disposition of instruments issued in the name of the employer (vi) Act otherwise w/ respect to instruments in a responsible capacity (c) 3-405(a)(3): Not responsibility if mere access to instruments (i) Employee doesnt have responsibility w/ respect to an just b/c he has access to instruments or incomplete forms (ii) As part of incoming or outgoing mail or otherwise E) Bank Statement Rule 1) Generally (i) Certain duties are imposed on a customer if its bank sends, or makes available, to the customer (ii) A statement of account showing payment of items for her account 4-406(a): When duty triggers (i) To trigger these duties, bank must either return or make available to the customers the items paid or (ii) Provide info in the statement of account sufficient to allow the customer to reason_ identify the items paid 4-406(a): Description of Item (i) When neither the item not its image is returned, bank fulfills its duty to provide sufficient info if (ii) It gives to customer the number of the item, its amount, and date of payment 4-406(c): Customers duty to examine bank statement (i) Once bank sends or makes available a statement of account or the items themselves (ii) Customer has duty to exercise reason_ promptness in examining statement or items to determine 24

2)

3)

4)

(iii) Whether any payment was unauthorized due to an alteration or b/c a signature was unauthorized (iv) If customer should reason_ discover unauthorized payment from statement or items provided, he must promptly notify bank 5) 4-406(d)(1): Duty of bank to prove loss (i) Even when a customer fails to reason_ discover or report a forgery or alteration, (ii) Customer is only precluded from asserting its unauthorized signature or alteration (iii) If the bank proves that it suffers a loss by reason of the failure 4-406(d)(2): Forgery or alternation by same wrongdoer (i) Customer is also precluded from asserting an unauthorized sig or alteration by same wrongdoer on any item (ii) Paid in GF by bank b/f it received notice from customer of unauthorized sig or alteration and (iii) After customer had been afforded reason_ period of time, not exceeding 30 days, to examine the item or statement & notify bank 4-406(e): GF & Comparative Negligence (i) If customer proves that the bank failed to act in GF in paying the item, loss falls completely on the bank (ii) Also, comparative negligence applies to split the loss in the event that the bank has failed to (iii) Exercise ordinary care in paying the item and that failure substantially contributed to the loss 4-406(f): 1-year Preclusion (i) If customer does not discover & report customers unauthorized sig or alteration on item w/i 1 year (ii) After statement or item is made available to the customer (iii) Customer precluded from asserting alteration or unauthorized sig against bank regardless whether or not bank negligent

6)

7)

8)

IV) RESTRICTIVE INDORSEMENTS A) Introduction 1) Restrictive indorsement is an indorsement written by, or on behalf of, holder 2) That limits negotiation of instrument to a specific use B) 3-206(c): For Deposit Restrictive Indorsement 1) Indorsement that signifies a purpose of deposit or collection is a restrictive indorsement 2) For deposit indorsement indicates that proceeds of the instrument can be credited only to the indorsers bank account 3) For collection indorsement that specifically designates a bank indicates intent that proceeds to be deposited into indorsers account 3-206: Effect of For Deposit or For Collection Indorsement 1) 2) 3-206(c)(4): Any bank in the bank collection process, exception depositary bank, may disregard a for deposit or similar indorsement 3-206(c)(2): Depositary Bank & Conversion (i) Depositary bank, whether it purchases the instrument or takes it for collection, converts instrument unless (ii) It pays indorser or applies proceeds consistently w/ the indorsement by applying it to the indorsers account 3-206(e): Depositary bank can only become HDC to the extent that it applies the funds for the indorsers benefit

C)

3)

PAYOR BANK/CUSTOMER RELATIONSHIP I) WHEN ITEM PROPERLY PAYABLE A) Properly Payable Rule 1) 4-401(a): Properly Payable (i) Payor bank may charge against its customers account only items that are properly payable (ii) An item is properly payable if it is both 1) authorized by customer & 2) complies w/ the bank/customer agreement Items Creating Overdrafts (i) 4-401(a): Bank may charge customers account for item, even though it creates an overdraft, if it is otherwise property payable (ii) 4-402(a): Although having right, bank has no duty to pay an item that creates an overdraft, absent an agreement to the contrary

2)

B)

4-401(c): Postdated Checks 1) Payor bank may charge against its customers account a check that is otherwise properly payable, 2) Even though payment was issued b/f date of check unless customer has given notice to bank of the postdating 3) Procedure for giving notice & consequences of bank paying check contrary to proper notice is same as for placing stop payment order 4-404: Bank not obligated to pay check 6 months old 1) Bank is under no obligation to its customer to pay a check presented more than 6 months after its date (stale check) 2) If in GF, a bank may pay a stale check & charge its customers account for amount of check 25

C)

D) Banks Right of Set-off 1) Bank has right to sett off against its customers account any matured debt the customer owes to the bank 2) Set-off is available only if debt customer owes the bank has matured 3) No requirement that the bank give notice w/i any specified time b/f or after the set-off absent a statutory requirement E) 4-405(b): Death or incompetence of customer 1) Knowledge of Death or Incompetence (i) Customers death or incompetence doesnt revoke banks authority to pay or collect item or account for proceeds of its collection (ii) Unless bank knows of death or adjudication of incompetence & has a reason_ opportunity to act on it 10-Day Rule (i) Even after bank learns of customers death, bank may (no duty to pay it though) for 10 days after date of death pay a check, (ii) Unless bank is ordered to stop payment by a person (any person) claiming an interest in the account

2)

II)

VARIATION BY AGREEMENT A) 4-101: Art. 4 is not a Regulatory Statute - It doesnt regulates terms of nor prescribes consumer protection on bank/customer accounts B) 4-103(a): Standards of Banks Responsibility 1) Agreement b/w bank & customer may set standards by which banks responsibility measured, but they cant be manifestly unreason_, 2) Such agreements may not disclaim banks liability for its own lack of GF or failure to exercise ordinary care or limit damages for such

III) WRONGFUL DISHONOR A) 4-402(a): Banks Liability 1) Payor bank is liable to its customer for wrongful dishonor if it dishonors an item that is properly payable 2) However, payor bank has no duty to pay an item that, although properly payable, would create an overdraft B) Sufficient Funds in Account 1) Introduction (i) Generally (a) In determining whether an item has been wrongfully dishonored, pivotal question is whether (b) There are adequate funds in the customers account to cover payment of the dishonored item

(ii) When Wrongful Dishonor (a) Bank wrongfully dishonors a check if reason that the customers account did not contain sufficient funds was that (b) Bank wrongfully debited account as a result of, for example, a wrongful set-off or payment of a check w/ forged sig 2) 3) 4-303(b): Bank may pay checks in any order - Payor bank has right to pay checks drawn on customers account in any order it desires 4-402(c): Time for determining whether sufficient funds exists (i) Bank need only examine a customers account once in deciding whether to dishonor an item for insufficient funds (ii) Any credits added to customers account after bank has examined the account are not considered 4-402(b): Duty owed only to customer (i) Generally Bank is liable only to its customer for wrongful dishonor of an item (ii) Payees - Payee or other holder of the item has no cause of action against bank for wrongful dishonor of an item 4-402(b): Damages (i) Payor bank that wrongfully dishonors item is liable to its customer for all damages proximately caused by wrongful dishonor (ii) Damages may include loss of profits, damage to reputation, emotional distress, and punitive

4)

5)

IV) CUSTOMERS RIGHT TO STOP PAYMENT A) 4-403(a): Customer has a right to stop payment of any item drawn on its account 1) When 2 or more persons entitled to write items on an account, any of them may stop payment even it she didnt sign the item 2) Neither the payee, indorsee, nor remitter has a right to stop payment on a check or other item B) 4-403(b): Requirement s for Stop Payment Order 1) Stop payment order must (i) Describe item w/ reason_ certainty (ii) Be received at a time & manner that affords bank a reason_ opportunity to act on the order (iii) B/f any of the actions in 4-303(a) (see below) have been taken by the bank w/ respect to the item 26

2)

Description (i) Info bank requires customer to supply is info that bank must have under current technology to identify item w/ reason_ certainty (ii) Most banks require that customer supply either precise amount of check or number of the check

C)

3) Order may be oral or written - Stop payment order may be oral or written (written effective for 6 months, oral lapses after 14 days) 4-303(a):Timeliness of Stop Payment Orders 1) Stop payment order arrives too late if it comes after the following (i) When bank accepts or certifies an item (ii) When bank has paid an item (cash, settlement w/o right to revoke under statute, clearinghouse rule, or agreement) (iii) When a bank becomes accountable for an item under 4-302 (iv) Checks - If stop payment order arrives after (a) Cut-off hr established by the bank or, (b) If no cut-off hr has been established, after close of next banking day after banking day on which bank receives the check (c) Bank cant establish cut-off hr earlier than 1 hr after opening of next banking day following banking day bank received check Effect of stop payment order arriving on time (i) If stop payment order arrives prior to any of specified events, the payor bank has neither (ii) The right to pay the check nor a duty to drawer to pay the check (iii) Bank is liable to the drawer if, in spite of the timely stop payment order, it pays the check Effect of stop payment order arriving too late (i) Generally - If stop payment order comes too late, payor bank has right to pay item & incurs no liability to drawer if it does (ii) Payor Bank Option - However, payor bank does not have to pay the check in that it may waive its right (a) Payor bank has the option as to whether or not to honor the stop payment order upon until (b) The point at which it would be liable to the holder under 4-215 or 4-302(a) for paying or returning the check Same Rules Apply to Other Legals (i) Other Legals Include (a) Legal process, such as writs or garnishment or execution (b) Payor bank acquires knowledge that drawer has filed a bankruptcy petition, died, or became incompetent (c) Banks right to setoff against the customers account a debt owed to it by the customer (ii) If these come in time, bank no longer has duty to customer to pay check; if it refuses, payor bank not liable for wrongful dishonor

2)

3)

4)

D) 4-403(c): Damages for payment in violation of stop payment order 1) Generally - Payor bank is liable to customer for any damages suffered by customer when it pays an item over valid stop payment order 2) Damages - Diff b/w amount paid by bank & amount customer would have been obligated to pay on item had payment been stopped & (i) Losses from payment in contrary to stop payment order may also include damages for wrongful dishonor of subsequent items E) Payor banks right of subrogation on Improper Payment 1) Introduction (i) When payor bank makes a payment for which it cant debit its customers account, in order to prevent unjust enrichment (ii) Bank is subrogated to the rights of any party who otherwise would be unjustly enriched What constitutes improper payment - Situations Include (i) 4-403: Payment in violation of a valid stop payment order (ii) 4-401(c): Early payment of a postdated check in violation of a proper notice of the postdating (iii) 4-405(b): Payment, w/ knowledge of its customers death, of a check more than 10 days after the death Payor bank subrogated to other parties rights against drawer (i) 4-407(1): To prevent drawer from being unjustly enriched, payor bank subrogated to rights of any HDC of item against drawer (ii) 4-407(2): Or of the payee or any other holder of the item against the drawer either on the item or from the transaction item arose 4-407(3): Payor bank subrogated to drawers rights (i) In order to prevent payee or other holder from being unjustly enriched, payor bank is also subrogated to the drawers rights (ii) Against the payee or any other holder of the item w/ respect to the transaction out of which the item arose

2)

3)

4)

V) FUNDS AVAILABILITY UNDER REGULATION CC A) Introduction 1) Reg CC 229.14(a): Mandatory Availability Schedule (i) Provides mandatory availability schedules under which depositary banks must permit their depositor use of deposited funds (ii) The schedule provides reason_ time period w/i which customer must be allowed to use funds represented by deposit (iii) Corresponding w/ the likely time w/i which the bank would obtain notice of an items nonpayment 27

2) 3)

Reg CC 229.19(c): Max hold time only - Depositary bank may allow its customer immediate use of funds deposited Subject to Chargeback (i) Depositary banks obligation to make funds available to its customer is subject to (ii) Its right to charge bank the customers account in the event that the check is returned unpaid

B)

Reg CC 229.10: Funds Subject to Next-Day Availability 1) Cash deposits made directly to teller (same rule as 4-215(f)) 2) Deposits by electronic payment 3) Deposit of Fed, State, or Local Govt checks 4) Deposit of cashiers, certified, or tellers checks 5) Deposit of an on us check (payor bank is same bank as the depositary bank) 6) $100 of the aggregate amount of all checks (not counting those that are otherwise entitled to next-day) in any 1 banking day Availability of Ordinary Checks 1) Local v. Non-Local Checks (i) Local Banks are local if they are physically located in the same Fed reserve district (ii) Non-Local Banks are non-local is they are not physically located in the dame Fed reserve district Local Checks (i) Reg CC 229.10(c)(1)(vii): Next Bus. Day 1st $100 of days deposit must b made available 4 cash withdrawal or check writing

C)

2)

(ii) 2nd Business Day (a) Reg CC 229.12(b): Entire deposit amount must be available for check writing purposes (b) Reg CC 229.12(d): $400 more must be available for cash withdrawal (or purchasing a cashiers check) no later than 5pm (iii) Reg CC 229.12(d): 3rd Business Day - Remainder of deposit must be made available for cash withdrawal 3) Non-Local Checks (i) Reg CC 229.10(c)(1)(vii): Next Bus. Day 1st $100 of days deposit must b made available 4 cash withdrawal or check writing

(ii) 5th Business Day (a) Reg CC 229.12(c): Entire deposit amount must be available for check writing purposes (b) Reg CC 229.12(d): $400 more must be available for cash withdrawal (or purchasing a cashiers check) no later than 5pm (iii) Reg CC 229.12(d): 6th Bus. Day - Remainder of deposit must be made available for cash withdrawal BANK COLLECTION PROCESS I) INTRODUCTION TO THE CHECK COLLECTION PROCESS A) Check Collection Process - Generally 1) Process by which holder of check converts check into cash when he deposits check into his bank account, and his bank 2) Either directly or through 1+ other banks, presents check to & obtains payment from bank on which check is drawn B) Types of Banks under Art. 4 1) 2) 4-105(3): Payor Bank Bank that is a drawee of a draft 4-105(2): Depositary Bank (i) First bank to take an item even though it is also payor bank unless (ii) Item presented for immediate payment over the counter 4-105(5): Collecting Bank (i) Any bank handling an item for collection except the payor bank (ii) A depositary bank, as long as it is not also the payor bank, is also a collecting bank 4-105(4): Intermediary Bank - Any bank to which item is transferred in course of collection except the depositary bank or payor bank 4-105(6): Presenting Bank Any bank presenting an item except a payor bank

3)

4) 5) C)

Variation by Agreement 1) 4-103(a); Reg CC 229.37 28

(i) Rules set out in Art. 4 & in Reg CC can be varied by an agreement b/w the affected parties (ii) As long as agreement is w/ respect to item being handled, banks customer is bound by any agreement that is made by the bank (iii) In the process of collecting the item for him even though he is not a party to the agreement 4-103(b) (i) Clearinghouse rules have the effect of agreements varying the rules of Art. 4 for items collected through the clearinghouse (ii) Whether or not specifically assented to by all parties interested in the items handled DUTIES OF PAYOR BANK A) 4-301(a): Duty to pay or settle on day of presentment 1) Payor Bank Options - When check is presented for payment, payor bank can either (i) Pay or return check on day of presentment or (ii) Defer posting of the check Defer Posting (i) When payor bank defers posting a check, bank waits until next banking day to decide whether to pay or return the check (ii) In order to defer posting a check, payor bank must settle w/ presenting bank b/f midnight of banking day of receipt (iii) This settlement can be revoked if payor bank decides the next day to return the check 4-301(a): Exception for immediate payment over the counter (i) When demand item is presented for immediate payment over counter, (ii) Payor bank has no right to defer its decision as to whether to pay the item 4-302(a)(1): Failure to settle for demand item on day of receipt (i) If payor bank neither settles for item nor returns the item by midnight of the next banking day of receipt (ii) Payor bank is penalized by being make accountable (liable) for the amount of the item 2)

II)

2)

3)

4)

B)

Means of Dishonoring Item 1) 4-301(a)(1) & (2): Generally (i) If payor bank, after properly settling for the item on the day of its receipt, decides that it will not pay the item (ii) It may revoke the settlement and recover the payment if (a) It returns the item b/f it has finally paid the item and (b) B/f its midnight deadline (midnight the next banking day after the banking day of receipt) 4-108(a) & (b): Cut-off Hour (i) Bank may fix 2pm or later as a cut-off hr for the handling of money & the making of entries on its books (ii) Bank may treat any item received after the cut-off hr as having been received on the next banking day 4-109(b); Reg CC 229.38(e): Extension of midnight deadlines for emergencies Payor bank excused from midnight deadline when (i) Unanticipated circumstances beyond the banks control prevent it from doing so (ii) Circumstances could not be prevented by the bank through the exercise of reason_ care, and (iii) Bank exercised reason_ diligence as the circum required in both (a) Anticipating effects of any foreseeable events and (b) In dealing w/ the circumstances once they arise Reg CC 229.30(c)(1): Special extensions under Reg CC (i) Rapid means of return (a) Midnight deadline extended by 1 day if paying bank uses means of delivery that would ordinarily result (b) In the check being received by the bank to which it is sent on or b/f the next banking day following midnight deadline

2)

3)

4)

(ii) Highly expeditious means (a) Midnight deadline is extended further if a paying bank uses a highly expeditious means of transportation (b) Even if means of transportation would ordinarily result in delivery after the receiving banks next banking day C) Final Payment 1) Result of Final Payment (i) When payor bank finally pays an item, payment process has been completed (ii) Payor bank may no longer revoke its settlement (iii) Depositary bank becomes accountable to its customer for the amount of the item (iv) Drawer and indorsers are discharged from liability 4-215(a): When Final Payment Occurs - Item is finally paid by payor bank when bank has first done any of following: (i) Paid item in cash; 29

2)

(ii) Settled for item w/o having right to revoke settlement under statute, clearing-house rule, or agreement; or (iii) Made provisional settlement & failed to revoke in time & manner permitted by statute, clearing-house rule, or agreement 3) Failure to settle or timely return item (i) 4-302(a)(1): Payor Bank Liability (a) If payor bank fails to settle for a demand item on the day of receipt or fails to pay or return the item by its midnight deadline (b) Bank becomes accountable for the item whether or not the item is properly payable (ii) Defenses Against Liability (a) 3-418(d): Mistake - Payor bank may defend against its accountability for item if payment made by mistake (b) 4-302(b): Presentment Warranties (i) Payor bank may defend by proving that the presenter breached one of the presentment warranties under 4-208 or (ii) By proving that the presenter presented or transferred the check intending to defraud the payor bank D) Duties to Return Unpaid Items 1) Generally (i) Reg CC imposes 2 duties on a paying bank to ensure that the depositary bank quickly learns of a checks dishonor (ii) Duty to expeditiously return unpaid items & duty to give prompt notice of nonpayment of any item in amount of $2500 or greater Duty of expeditious return (i) Reg CC 229.30(a): Generally (a) Paying bank may meet either of 2 tests in order to satisfy its duty of expeditious return (b) 2-day/4-day test or forward collection test

2)

(ii) 2-day/4-day Test (a) Reg CC 229.30(a)(1)(i): Local Checks (i) Time limit for the depositary bank to receive the return of a local check is (ii) Not later than 4pm on the 2nd business day after the check was presented to the paying bank (b) Reg CC 229.30(a)(1)(ii): Nonlocal Checks (i) Time limit for the depositary bank to receive the return of a nonlocal check is (ii) Not later than 4 pm on the 4th business day after presentment (iii) Reg CC 229.30(a)(2)(iii): Forward Collection Test (a) Paying bank returns a check in an expeditious manner if it does so (b) In a manner that a similarly situated bank would normally handle a check drawn on the depositary bank and (c) Deposited for forward collection in that bank by noon on the banking day following (d) The banking day on which the check was presented to the paying bank 3) Reg CC 229.33(a): Duty to send notice of nonpayment (i) Paying bank has duty to send notice of nonpayment of any check in amount of $2500+ directly to the depositary bank (ii) Notice may be communicated in any way as long as it is received by the depositary bank (iii) By 4pm on 2nd bus. day following the banking day on which the check was presented to the paying bank Reg CC 229.38(a): Liability for violation of paying banks duty of expeditious return & notice of nonpayment (i) Breach of Duties (a) Paying bank is liable for damages for breach of its duties of expeditious return or of transmitting notice of nonpayment (b) Only if the bank fails to exercise ordinary care or to act in GF

4)

(ii) Liability (a) Paying bank that violates its duty of ordinary care is liable to the injured party for the amount of the check (b) Less the amount of loss that would have been incurred had ordinary care been exercised III) DUTIES OF COLLECTING BANKS A) Collecting Banks Status as Agent 1) 4-201(a) (i) When customer deposits item into her account, depositary bank becomes customers agent for purpose of collecting item (ii) Subsequent collecting banks become the subagent for the customer 30

2) B)

4-201(a); 4-214(a): Agency status of the depositary and other collecting banks terminate when the finally settle for the item

Right of Chargeback 1) Generally (i) 4-214(a): Chargeback (a) Depositary bank may charge back customer account, or obtain refund for amount of any provisional settlement given to her (b) If, for any reason, the item is not finally paid by the payor bank (ii) 4-214(d)(2): Chargeback available even if depositary bank did not exercise reason_ care (a) Right exists even if depositary bank failed to exercise ordinary care in sending item for collection caused the dishonor (b) Bank remains liable to customer for any damages caused by its failure to exercise ordinary care in collecting deposited item 2) Requirements for Chargeback (i) 4-214(a) (a) Depositary bank must, but its midnight deadline (or w/i a longer reason_ time after it learns of the facts) (b) Either return the item or send notification of the facts if the item is not available for return

(ii) 4-214(c): If the bank is both the depositary bank & the payor bank, it must act by it midnight deadline 3) 4-214(a): Consequences of Failing to Meet Requirements (i) Even if the depositary bank fails to act w/i required time, it may still revoke its settlement, chargeback customer, or obtain refund (ii) Only consequence of the untimely act is that it is liable for any loss to the customer resulting from the delay

C)

Duty of Collecting Bank to Use Ordinary Care in Collecting and Returning Items 1) 2) 4-202(a): Collecting bank owes a duty of ordinary care to their customers in performing their collecting and return duties 4-202(b): Midnight Deadline (i) Collecting bank must take proper action b/f its midnight deadline following receipt of the item, notice, or settlement (ii) Taking action w/i a longer time may be considered reason_ but burden is on collecting bank to established the timeliness 4-109(b): Collecting bank is allowed additional time in the case of emergencies 4-103(e): Measure of Damages (i) Failure to exercise ordinary care n handling item is $ of item reduced by $ that couldnt have been realized by using ordinary care (ii) On showing of BF, damages may include damages the party has suffered as a proximate consequence

3) 4)

D) Check 21 (Check Truncation) 1) Generally (i) Where the depositary bank simply keeps deposited check and forwards only a description of it through bank collection process (ii) Customer never gets check back although it is reflected on bank statement under 4-406 Reg CC 229.2: Creating Image & Substitute Check (i) Check Imaging - Banks have option (not duty) to create image of original check & pass it on if receiving bank agrees (ii) Truncating Bank Bank creating such an image (iii) Reconverting Bank Bank than prints out paper version if someone refuses imaged version & wants paper (iv) Substitute Check Paper version is a substitute check but it must meet the standards for substitute checks Reg CC 229.51(b): Requirements for Substitute Check - Reconverting bank has duty to ensure substitute check (i) Bears all indorsements applied by parties that previously handled the check in any form (ii) Identifies reconverting bank in a manner that preserves any previous reconverting bank identifications (iii) Identifies the bank that truncated the original check Legal Equivalence (i) Generally - No one can refuse to take substitute check, which is legally the same for all purposes as the original (a) Customers cant insist on getting the original back (b) If parties agree to imaging w/o paper copy being created, the image also has the same legal effect as the original

2)

3)

4)

(ii) Reg CC 229.51 (a) Substitute check shall be the legal equivalent of the original check for all purposes (satisfies best evd rule) if it (b) Accurately represents all the info on the front and bank of the original check as of the time the original was truncated & (c) Bears the legend: This is a legal copy of your check. You can use it the same way you would use the original check 31

5)

Warranty Liability (i) Generally - Parties passing on substitute check make both transfer & presentment warranties

(ii) Reg CC 229.52: The warranties made by reconverting banks that create the substitute check and transfer it to others (a) The substitute check meets all the requirements for legal equivalence under Check 21 4(b), and (b) No depositary bank, drawee, drawer, or indorser will be asked to make a payment based on a check more than once (iii) Breach of Warranty of Legal Equivalence - Liability flows back to reconverting bank if the check copy is no good (a) Example Image of the substitute check is blurry so that the account numbers were wrong Indemnity Liability (i) Reg CC 229.53 (a) Creates indemnity liability against banks transferring either the image or the substitute check (b) If doing so causes damages that could have been prevented by use of the original check

6)

(ii) Example (a) Drawer received substitute check but there was a forgery of original and (b) A pen pressure test would be necessary to discover it so cant prove forgery w/ substitute check (iii) Liability (a) No warranty claim since substitute check is the legal equivalent of the original & no one asked to pay more than once (b) Truncating bank would be liable for indemnity to drawer bank to the amount of the substitute check ELECTRONIC BANKING I) WIRE TRANSFERS (AKA WHOLESALE FUNDS TRANSFERS) A) Terminology 1) Originator 1st sender of an order 2) Originator Bank - 1st receiving bank of order, sender of order, debits originators account, and executes payment order 3) Beneficiary Bank - Receiving bank, credits benes account 4) Beneficiary Receives the amount of the order B) What is a Fund Transfer 1) 4A-104(a): Funds Transfer (includes wire transfers but applicable to other payment order methods, i.e., oral & written) (i) Series of transactions, beginning w/ originators payment order, made for purpose of making payment to bene of order (ii) Includes all payment orders issued for purpose of carrying out originators payment order 4A-104: Funds transfers must be b/w banks Requirement for a Payment Order Instruction must meet 3 requirements (i) 4A-103(a)(1)(i): Unconditional - Instruction cant state a condition to obligation to pay bene other than as to the time of payment (ii) 4A-103(a)(1)(ii): Reimbursed by Sender Receiving bank must be paid or reimbursed by the sender (iii) 4A-103(a)(1)(iii): Transmitted Directly to Receiving Bank - Instructions must be transmitted by sender directly to receiving bank 4A-108: Consumer Transactions Excluded - Art. 4 does not apply to any transaction if any part of transaction is covered by EFTA

2) 3)

4) C)

Payment Obligations in Chain of Title 1) 4A-402(c): Acceptance of order by Receiving Bank (i) Obligation of Sender - Acceptance of payment order by a receiving bank obligates sender to pay bank amount of senders order (ii) Money-Back Guarantee - Sender bank gets their money back if order is not accepted by benes bank 4A-402(b): Acceptance of order by Benes Bank (i) When a payment order is issued to benes bank, acceptance of order by the benes bank (ii) Obligates the sender to pay benes bank the amount of the order Underlying Obligation (i) On acceptance by benes bank, obligation of originator to pay bene on underlying obligation is discharged (ii) The obligation of the benes bank to pay the bene is substituted for it

2)

3)

D) Duties & Liabilities of Receiving Bank 1) Introduction (i) 4A-209: Receiving bank is not obligated to accept a payment order 32

(ii) 4A-212: Receiving bank has no duties until it accepts the order (iii) 4A-209(a):Receiving bank(unless benes bank)accepts payment order only when it executes order; no notice of rejection required 2) Duty to Issue Payment Order (i) 4A-302(a)(1): Generally - On acceptance of payment order, receiving bank must issue a payment order on execution date

(ii) 4A-209(d): Time when payment order can be accepted (a) Originators bank cant accept the originators payment order until the execution date (b) If the receiving bank is also the benes bank, it cant accept the order until the payment date (iii) 4A-305(a), (b) & (d): Damages for breach of duty by receiving bank (a) If receiving bank breaches its duty to properly execute an order, receiving bank is liable for (b) Senders expenses in funds transfer & for incidental expenses & interest lost as result of its failure to properly execute order (c) Absent express written agreement to the contrary, consequential damages are not available to the sender 3) Erroneous Execution of Payment Order (i) 4A-303(a) & (c); 4A-402(c): Introduction (a) When receiving bank executes a payment order (i) In an amount greater than amount of senders order (ii) Issues a duplicate order to bene, or (iii) Issues an order wrong bene (b) Sender, not having authorized these erroneous orders, is only obligated to reimburse receiving bank (c) For whatever payment was properly made according to senders original order

(ii) Recovery from Recipient (a) 4A-303(a) (i) Whether receiving bank can recover excess payment from bene or improper payment from recipient (ii) Depends on CL mistake and restitution (b) Courts apply 2 rules in determining whether the receiving bank may recover from bene (i) Mistake of Fact Rule - Receiving bank may recover from bene unless bene detrimentally relied on the payment (ii) Discharge for Value Rule a. Bene (or recipient) is entitled to retain funds as long as it had given value to sender b. From this or some other transaction c. Had made no misrepresentations to the receiving bank, and d. Had no notice of the banks mistake (c) 4A-303: Right of Subrogation (i) If, under the law of restitution, bene or recipient can retain the excess payment, receiving bank (ii) Becomes subrogated to any rights that bene had against the sender (iii) 4A-303(b): Payment in a Lesser Amount (a) If receiving bank issues a payment order in a lesser amount than authorized (b) It is entitled to payment from sender in lesser amount only, unless receiving bank issues an additional payment order for diff E) Duties of Beneficiarys Bank 1) Overview (i) 4A-104(a); 4A-406(a): Funds transfer complete once benes bank accepts the originators banks payment order (ii) 4A-404(a): On its acceptance of payment order, benes bank becomes indebted to bene in amount of order on the payment date (iii) Underlying Contract Once acceptance by benes bank, originators debt to bene on the underlying contract is discharged Manner in which benes bank accepts payment order (i) Generally (a) 4A-209(d): Acceptance cant take place b/f the payment date (b) 4A-210(d): Once benes bank accepts the payment order, it may not later reject the order

2)

(ii) Acceptance of payment order by benes bank occurs when the first of any of the following acts occur (a) 4A-209(b)(1)(i): Payment When benes bank pays the bene (b) 4A-209(b)(1)(ii): Acceptance by notification - Benes bank notifies bene of receipt of order or credits benes account 33

(c) 4A-209(b)(2): Acceptance by receipt of payment When benes bank receives payment of the entire amount of the order (d) 4A-209(b)(3): By Inaction (i) Unless benes bank rejects order w/i 1 hr after opening of its next funds-transfer bus day after payment date of the order (ii) Acceptance occurs automatically on opening of that same day (iii) If either amount of order is covered by sufficient funds in authorized account that sender maintains w/ benes bank or (iv) Benes bank has otherwise received full payment from the sender 3) 4A-404(a): When must benes bank pay bene? (i) On its acceptance of payment order, benes bank becomes indebted to bene in amount of order on the payment date (ii) Bank must pay bene immediately upon acceptance 4A-405: What is considered Payment? (i) If benes bank credits account of bene of payment order, (a) Payment of bank's obligation under 4A-404(a) occurs when & to the extent (b) Beneficiary is notified of right to withdraw credit (c) Bank lawfully applies credit to debt of bene, or (d) Funds w/ respect to order are otherwise made available to bene by the bank.

4)

(ii) Conditions to payment by Benes Bank to Bene are not enforceable 5) 6) 4A-405(c)(1): Banks Right to Setoff - Bank may credit benes account, but $$ credited may be setoff against obligation owed 4A-404(a): Liability for failure to make prompt payment (i) When Consequential Damages Available (a) If benes bank refused to pay bens after proper demand by bene & (b) Receipt of notice of particular circum giving rise to damages (c) Benes may recover consequential damages

(ii) Consequential Damages Not Available if - Bank didnt pay b/c of reason_ doubt concerning right of bene to payment 7) 4A-404(b): Duty to Notify Bene (i) If benes bank accepts payment order that requires payment to an account of bene, it must give notice to bene of its receipt (ii) B/f midnight of the next funds-transfer bus. day following the payment date (iii) If order doesnt instruct payment to an account of bene, benes bank is required to notify bene only if order requires notification

F)

4A-406(a): Effect of Acceptance on Underlying Obligation 1) Payment by originator to bene occurs when order is accepted by benes bank 2) When accepted, underlying obligation is discharged unless all of the following conditions are met (i) Means of payment was prohibited under the contract governing the underlying obligation (ii) W/i a reason_ time after receiving notice of order, bene notified originator of its refusal to accept the means of payment (iii) Funds were neither withdrawn by bene not applied to its debt, and (iv) Bene would suffer a loss that could have reason_ been avoided if payment had been made in way that complied w/ contract

G) Cancellation (Stopping Payment) of Payment Order 1) 4A-211(e): Introduction (i) A cancelled payment order cant be accepted; (ii) When an accepted order has been cancelled, acceptance nullified & no person has any right or obligation based on the acceptance Right to cancel unaccepted orders (i) 4A-211(b): Generally (a) B/f the receiving bank has accepted the order, the sender has the absolute right to cancel the order (b) If the sender gives timely notice of cancellation

2)

(ii) 4A-211(a): Manner of Cancellation (a) Sender may cancel its order orally, electronically, or in writing (b) When there is a security procedure in effect b/w sender & receiving bank, cancellation is not effective (c) Unless it is verified pursuant to the security procedure (iii) 4A-211(d): Cancellation by Operation of Law (a) An unaccepted payment order is cancelled by operation of law at close of 5 th funds-transfer bus. day of receiving bank (b) After the execution date or payment date of the order 34

3)

4A-211(c)(1): Cancellation of order accepted by receiving bank (i) Receiving bank has no obligation to cancel an accepted order (ii) Even if it chooses to do so, cancellation not effective unless receiving bank cancels payment order it sent in execution of senders 4A-211(c)(2): Cancellation of order after acceptance by benes bank (i) Once benes bank has accepted an order, it has no obligation to agree to cancel the order (ii) Although having no duty to agree to cancellation, benes bank may agree to cancellation in 4 situations (a) If payment order is unauthorized (b) If payment order is duplicative of a payment order previously sent (c) Id payment order is mistakenly sent to a bene who is not entitled to payment from originator, or (d) If payment order is issued by mistake in an amount greater than the bene is entitled to receive from originator

4)

35

H) Liability for Authorized Payment Orders 1) 4A-203: Sender has the duty to reimburse the receiving bank for the amount of any authorized payment order 2) 4A-202(a): Payment order is authorized if sender either actually or apparently authorized order or otherwise bound by order by agency I) Liability for Unauthorized Payment Orders 1) 4A-202(b): Introduction (i) Sender is liable for an unauthorized order if it qualified as a verified payment order (ii) An order that passes the security procedure is a verified payment order Requirements for senders liability for verified payment orders (i) Determining whether sender is liable to receiving bank for an unauthorized but verified payment order is a 2-step process

2)

(ii) First Step Receiving bank must prove that order is a verified payment order by proving following (a) Customer Agreement Bank has agreement w/ its customer that order would be verified pursuant to a security procedure (b) Procedure Security procedure is commercially reason_ method of providing security against unauthorized payment orders (c) 4A-202(b): Bank complied w/ procedure (i) Bank accepted payment order in GF and in compliance w/ the security procedure, and (ii) Any written agreement or instructions of the customer (iii) Second Step (a) 4A-202(b): Generally (i) If bank proves that order was a verified order, order is effective as order of customer whether or not authorized (ii) Customer is, therefore, liable to receiving bank for amount of the order (b) How can customer avoid liability (i) Generally a. Customer can avoid liability by proving that the breach of security was not attributable to customer itself b. Customer must prove order was not caused, directly or indirectly, by person who falls into following categories

(ii) 4A-203(a)(2)(i); Entrusted w/ duties as to payment orders a. Any person who was entrusted at any time w/ duties to act for customer w/ respect to b. Payment orders or to the security procedure (iii) 4A-203(a)(2): Access to source or facilities - Any person who a. Obtained access to customers transmitting facilities, or b. Obtained, from a source controlled by the customer & w/o authority of receiving bank, i. Info facilitating breach of the security procedure ii. Regardless of how the info was obtained or whether customer was at fault iii. Info includes any access device, computer software, or the like 3) 4A-204: Summary of when loss falls on the bank (i) No commercially reason_ security procedure was in effect (ii) Bank did not comply w/ the security procedure in place (iii) Customer can prove that wrongdoer did not obtain info to facilitate breach of security procedure from it (iv) Bank agreed to assume all or part of the loss

J)

Erroneous Payment Orders 1) Introduction - An erroneous payment occurs when sender makes a mistake (i) In amount of payment order it sends, or (ii) In identifying bene to whom order is sent, and (iii) Receiving bank accepts order w/o noticing error 4A-205: Allocation of loss when no security procedure in place (i) Sender suffers loss in event that there is no established security procedure (ii) To determine the accuracy of the order 4A-205(a)(1): Allocation of loss when security procedure in place (i) When an established security procedure is in place to detect such errors, loss shifts to the receiving bank, if sender proves (ii) That it complied w/ the security procedure and that the error would have been detected if receiving bank also complied w/ it

2)

3)

36

4)

Duty of sender on receipt of notice or acceptance (i) 4A-304; 4A-204(a) (a) After receipt of notice (i) On receipt of notice of executed order or of debiting of its account, sender has duty to exercise ordinary care (ii) To determine whether order was erroneously executed or unauthorized or contained any other error and (iii) If so, notify receiving bank of relevant facts w/i reason_ time not exceeding 90day after notification received by sender (b) Senders Liability for Breach of Duty (i) Only penalty for senders failure to perform this duty is that receiving bank is not obligated to pay interest (ii) On any amount refundable to the sender for the period prior to the time b/f the banks learns of the execution error (ii) 4A-205(b): Senders Liability on Erroneous Payment Orders (a) In the case of an erroneous payment order, sender is also liable for any loss, not exceeding the amount of the order, (b) Which the receiving bank incurred as a result of the failure (iii) 4A-505: Sender Preclusion (a) Sender may be precluded from objecting to the receiving banks retention of its payment for the order (b) If sender doesnt notify receiving bank of its objection w/i 1 year after sender received notification reason_ identifying order

K) Misdescriptions 1) 4-207(a): Nonexistent or unidentifiable person or account (i) If name, bank account number, or other ID of bene refers to a unidentifiable person or account, (ii) No person has rights as bene to order & bene cant accept order & funds transfer cant be completed (iii) Each sender is relieved of liability & is entitled to refund to extent of any payment When bene identified by both name & number (i) 4A-207(b)(1): Name & account dont match (a) When bene is identified by both name & an identifying or bank account number and (b) Name & number identify different persons (c) Benes bank may rely on number as proper ID of bene & credit account number

2)

(ii) 4A-207(c)(2): Senders bank liability (a) Loss will generally fall on bank sending the order (b) Customer is not obligated to pay order unless receiving bank proves that (i) B/f acceptance of customers order, customer received notice from receiving bank that payment might be (ii) Made on the basis of identifying number or bank account number even if it identifies a different person (iii) 4A-207(b)(2): Benes bank knows name & account number are for different persons (a) When benes bank either pays person identified by name or knows that name & number are different persons (b) Benes bank assumes risk that it has failed to pay person intended by sender (c) If it pays proper person, benes bank is entitled to payment; but (d) If it does not, no acceptance can occur & originators bank has no obligation to pay benes bank 3) Misdiscription of intermediary bank or benes bank (i) Identification by number only (a) 4A-208(a)(1): Sending bank is liable to intermediary or benes bank (i) When payment order identifies intermediary bank or benes bank by identifying number only & number wrong (ii) Bank sending order will suffer any loss caused by order being accepted by wrong bank (b) 4A-208(a)(2): Originator is liable to originator bank (i) If originator supplied only number & not name of benes bank (ii) Originator would be obligated to reimburse originators bank (ii) Conflict b/w name & number (a) 4A-208(b): Receiving bank may rely on number (i) When there is a conflict b/w name of benes bank (or intermediary bank) & identifying number (ii) Receiving bank may rely on number as proper ID of those banks (iii) If it does not know, at time it executes order, the name and number identify different persons

37

(b) 4A-208(b)(2): Sending bank & nonbank sender liability (i) Sending Bank Liability - Sending bank thus suffers loss and may not recover from its customer (ii) Nonbank Sender Liability to Sending Bank a. If nonbank sender had included conflicting description of benes bank in its order to sending bank b. It would be obligated to reimburse sending bank for any losses or expenses incurred in executing order c. If sender received notice that sending bank might rely on identifying number b/f order accepted by sending bank (c) 4A-208(b)(4): Bank knows that name & number identify different banks (i) If receiving bank knows that name & number identify different banks (ii) Reliance on either name or number, if correct, is a breach of its duties in executing senders payment order II) CONSUMER ELECTRONIC FUND TRANSFERS A) Introduction 1) 2) Law Governing Consumer Electronic Fund Transfers (EFT) Electronic Fund Transfer Act (EFTA) 15 USC 1963 & Reg E What is an EFT (i) Reg E 205.3(b) (a) Any transfer of funds that is initiated through an electronic terminal, telephone, or computer or magnetic tape (b) For the purpose of instructing a financial institution to debit or credit a consumer asset account

(ii) Reg E 205.3(b)(5): Transfer from a consumer account initiated though use of a debit card is also covered B) Consumer Liability for Unauthorized Transfers 1) 2) Introduction Consumer has only limited liability for unauthorized transfers out of her account Reg E 205.2(k): What is an unauthorized fund transfer (i) Unauthorized (a) EFT is unauthorized if transfer is initiated by a person w/o actual authority to initiate transfer and (b) The consumer did not receive the benefit from the transfer

(ii) Not Unauthorized (a) Electronic fund transfer is not unauthorized if consumer gave to the person initiating the transfer an access devise (b) Unless consumer has notified financial institution involved that transfers by that person are no longer authorized (iii) No longer authorized after notification (a) Any transfer becomes unauthorized transfer once cardholder notifies card issuer that (b) The person having the card is no longer authorized to use the access devise (iv) Reg E 205.2(k)(3): Obtained through robbery or fraud (a) Any transfer is an unauthorized EFT if it is made w/ an access device that was obtained either through (b) Robbery or through fraudulent inducement 3) Reg E 205.6(a): Conditions to consumers liability for unauthorized fund transfers (i) Transfer through accepted access device Unauthorized transfer must have been made by an accepted access device (ii) Means to ID consumer - Financial institution must have provided some means to ID consumer when she uses device (iii) Disclosures Financial instit must have provided consumer w/ certain written disclosures to her liability 4 unauthorized transfers Reg E 205.6(b): Consumer liability - If conditions met, consumer liable for lesser of 1) amount of unauthorized fund transfer or 2) $50 (i) Consumer is NOT liable for any unauthorized fund transfers that occur after consumer has (a) Given notice to the financial institution that (b) Unauthorized EFT involving her account has been or may be made (ii) Limitations apply regardless as to whether or not the consumer is negligent Reg E 205.6(b)(2): Failure to Report Loss of Device w/i 2 business days (i) If consumer doesnt notify its financial institution of loss or theft of access device w/i 2 bus. days after learning of it (ii) Consumer liability increases to the lesser of (a) $500 or the sum of (b) $50 (or amount of unauthorized electronic fund transfers that occur b/f close of 2 bus days) whichever is less, and (c) Amount of unauthorized electronic transfers that (i) Financial institution establishes would not have occurred but for consumers failure to notify institution w/i 2 days (ii) After it learns of the loss or theft of the access device, and (iii) That occurred after the close of the 2 bus days and b/f notice to the financial institution 38

4)

5)

6)

Reg E 205.6(b)(3): Failure to report unauthorized transfers on periodic statement (i) In event that consumer fails to report w/i 60 days of a statements transmittal (ii) Any unauthorized EFT that appears on periodic statement, consumer is liable to financial institution for (a) Up to $50 of any unauthorized transfer(s) that appear on the statement, plus (b) Full amount of unauthorized transfers after close of 60day after transmittal of statement & b/f consumer gives notice Reg E 205.6(b)(3): Combination of failure to report lost device and failure to report unauthorized transfers (i) Unauthorized transfers prior to close of 60 days after transmittal of periodic state Governed by failure to report loss of device (ii) Unauthor transfers after close of 60days after transmittal of periodic state Governed by failure to report transfers on statement

7)

C)

Stopping Payment of Electronic Fund Transfers 1) 2) No right to reverse ordinary fund transfers - EFTA gives a consumer no right to reverse an EFT (other than a preauthorized EFT) Reg E 205.10(c): Stopping payment on preauthorized EFTs (i) Theres a right to stop payment of any preauthorized EFT from consumers account (ii) Consumer can stop payment by giving oral or written notice to its financial institution at any time up to 3 day b/f date of transfer (iii) If oral notice, financial institution may require that written confirmation be given w/i 14 days of oral notification (iv) Neither EFTA or Reg E spells out damages if the financial institution fails to stop a preauthorized transfer

D) Consumer Liability to 3P in Event of System Malfunction 1) If there is a malfunction in fund transfer system that prevents preauthorized payment from being made 2) Consumers obligation to make payment is suspended upon malfunction is corrected & EFT may be completed 3) Consumer may pay bill if at any time b/f malfunction is corrected, creditor demands in writing that payment be made by other means E) Documentation Requirements 1) Receipts at Electronic Terminals (i) When consumer initiates an EFT at an electronic terminal, the financial institution itself, or through another party (e.g., POS) (ii) Must provide a written receipt containing certain basic info as to the transaction Reg E 205.9(b): Periodic Statements (i) The financial institution must provide period statements to the consumer providing certain basic info for each transfer (ii) Occurring during the period covered for each account to, or from which, EFTs can be made

2)

F)

Error Resolution Procedures 1) Reg E 205.11(b)(1)(i): Introduction (i) Consumer must give oral or written notice of error to the financial institution no later than 60 days after (ii) The bank provided the consumer w/ the periodic statement indicating the error Reg E 205.11(c): Banks duty to investigate (i) Generally - On receipt of notice, financial institution has duty to promptly investigate & determine whether error has occurred

2)

(ii) Does not recredit (a) If financial institution does not provisionally recredit the consumer account during the investigation (b) It must transmit results of its investigation to the consumer w/i 10 bus. days (iii) Recredits (a) If bank provisionally recredit account in amount of alleged error (including any applicable interest) w/i 10 bus days of notice (b) Financial institution may, if it acts promptly, take up to 45 calendar days to transmit results of investigation 2 the consumer G) 1693h(c): Liability for Failing to Make Correct Fund Transfer 1) Financial institution is liable to its customer if it fails to make a fund transfer in the correct amount and in a timely manner 2) If banks failure was unintentional and occurred despite reason_ precautions established by it to guard against such failures 3) Damages are limited to actual damages proved

39

III) LENDER CREDIT CARDS A) Terminology in Credit Card Transactions 1) Cardholder - Person who uses a credit card to make a purchase 2) Issuing Bank Bank which issued the card to the cardholder 3) Merchant Store or other party that takes the credit card in payment 4) Merchants Bank Bank at which the merchant maintains its account B) Law Governing Credit Card Transactions 1) Consumer Credit Cards: Truth in Lending Act; 15 USC 1601, and 12 CFR part 226 (Reg Z) 2) Bus. Credit Cards - Also subject to rules governing liability for unauthorized use Liability for Unauthorized Use 1) Reg Z 226.12(b): Max consumer liability for unauthorized use is $50 (i) Cardholder has very limited liability for an unauthorized use of her card (ii) Liable only for lesser of $50 or amount of money, prop, labor, or services obtained by the unauthorized use Conditions to Liability Cardholder has no liability for unauthorized use unless 3 conditions met (i) Reg Z 226.12(b)(2)(i): Accepted Card Card must be an accepted credit card

C)

2)

(ii) Reg Z 226.12(b)(2)(ii): Disclosures (a) Care issuer must have provided the cardholder w/ adequate notice of its max potential liability and (b) Of the means by which it can notify card issuer of the loss or theft of its card (iii) Reg Z 226.12(b)(2)(iii): Merchant Identification (a) Card issuer must have provided means by which the merchant could have identified the cardholder (b) As the authorized user of the card 3) Reg Z 226.12(b): Unauthorized Use (i) Use of credit card by person, other than cardholder, (ii) Who does not have actual, implied, or apparent authority for such use & from which cardholder receives no benefit Authorized Use Use is authorized when user has either actual or apparent authority to use the card (i) Actual Authority When cardholder either expressly or by implication gives the user authority to use the card

4)

(ii) Apparent Authority (a) Generally - User have apparent authority when cardholder gives the impression to 3Ps that user is authorized to use the card (b) Knowingly Given Card to User (i) If cardholder voluntarily and knowingly gives the care to another person, (ii) The person whom the card is given has apparent authority to use the card (iii) However, if consumer gives credit card to other person, cant cure any unauthorized use by giving notice to card issuer D) Right to Refuse Payment 1) Reg Z 226.12(c)(1): Consumers Right to Refuse Payment (not about unauthorized use; about poor products or services) (i) If consumer fails to satisfactorily resolve a dispute as to a product purchased w/ his credit card (ii) Consumer can assert against card issuer all claims (other than tort) & defenses (a) Arising out of the transaction and (b) Relating to the failure to resolve the dispute Conditions to Right to Withhold Payment 3 conditions to consumers right to withhold payment of her credit card bill for a purchase (i) Reg Z 226.12(c)(3)(i): GF attempt to resolve dispute Consumer must make GF attempt to resolve dispute w/ merchant (ii) Reg Z 226.12(c)(3)(ii): More than $50 Charge for the purchase must be more than $50 (iii) Reg Z 226.12(c)(3)(iii): Purchase w/i same state or w/i 100 miles Reg Z 226.12(c)(3): Exceptions Geographic & monetary limits dont apply when the merchant (i) Is the same person as the card issuer (ii) Is directly or indirectly controlled by or controls the card issuer (iii) Is a franchised dealer of the card issuers products or services, or (iv) Has obtained the order for the disputed transaction through a mail solicitation made or participated in by the card issuer Reg Z 226.12(c)(1): Limited to amount of credit outstanding (i) Amount of claim or defense that may be asserted cant exceed amount of credit outstanding for disputed transaction (ii) At the time cardholder first notifies card issuer or merchant of existence of the claim or defense 40

2)

3)

4)

41