978-0077733711 Chapter 31 Lecture Note

CHAPTER

31

NEGOTIABLE

INSTRUMENTS

I.

OBJECTNESS:

The objective of this chapter is to introduce students to the nature and advantages of

negotiable

instruments and to discuss the requirements for negotiable instruments so as to lay a

foundation

for three chapters that follow. After reading this chapter and attending class, a student should

be

able

to:

1. Explain the advantages of commercial paper that can qualify as a negotiable

instrument.

2. Identify the different types of negotiable instruments and the key features of each type

of

instrument.

3. List and discuss the formal requirements that commercial paper must have to qualify as a

negotiable

instrument.

4. Apply the Code’s rules that are applicable when the terms of an instrument conflict or

are

ambiguous.

II. ANSWER TO

INTRODUCTORY PROBLEM

A. The first issue following the hypothetical that appears at the beginning of the

chapter

concerns the special qualities and benefits of negotiable instruments.

Negotiable

instruments are a special kind of commercial paper that

involve

promises or orders to

pay

money and can pass readily through the financial system and be accepted in place

of

money. They can be more advantageous than a normal contract rights because

an

assignee

of the negotiable instrument who qualifies as a holder in due course can

actually

get better

rights than his

assignor.

B. The second issue concerns the basic types of commercial paper and their

defining

characteristics.

There are two basic types: (1) promises to pay (notes and certificates

of

deposit) and (2) orders to pay (drafts; checks). Their defining characteristics are set

out

on pages

704-707.

C. The third issue concerns the formal requirements that must be met for instruments

to

qualify as negotiable instruments. For an instrument to be negotiable, it must: (1) be in

writing; (2) be signer by the issuer; (3) contain an unconditional promise or order to pay

a

fixed amount of money, with or without interest or other charges described in the

promise

or order; (4) be payable to order or to bearer at the time it is issued or first comes

into

possession of a holder; (5) be payable on demand or at a definite time; and (6) not

state

an

y

other undertaking or instruction by the person promising or ordering to do any act in

addition to the payment of money (but it may contain (a) an undertaking or

promise

relative to collateral to secure payment, (b) an authorization for confession of

judgment,

or (c) a waiver of benefit of any law intended for the advantage or protection of an

obligor

).

Chapter 31

-Negotiable Instruments

31-1

McGraw-Hill

Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in

any

manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or

part.

D. The fourth issue concerns the validity of a check in which there is a conflict between

the

amount as set forth in figures and the amount set out in words. When there

are

ambiguous terms in an instrument, the UCC sets out several general rules

of

interpretation

that are applied to resolve the conflict or ambiguity: (1) Typewritten

terms

prevail over printed terms; (2) handwritten terms prevail over printed and

typewritten

terms; and, (3) where words and numbers conflict the words control the

numbers.

III. SUGGESTIONS FOR LECTURE

PREPARATION:

A.

Introduction

1. Note the long historical use of various kinds of commercial paper and the functions

they

served.

B. Nature

of Negotiable Instruments

1. Uses of Negotiable Instruments. Lead the students through a discussion that exposes

the

uses of commercial paper. For example, students buy groceries with a check and

may

buy stereos with promissory notes. These uses show that commercial paper is

a

substitute

for

money.

2. The Purpose of the Law

of Negotiable

Instruments. Clarify how commercial paper is

a

substitute for money, although not a perfect substitute.

It

should be pointed out that

a

characteristic of money is free transferability; that is, a person has title to money free

of

another’s defenses or claims. Commercial paper is freely transferable in that a holder

in

due course takes it free of personal defenses, but not real defenses. Personal and

real

defenses should be briefly explained at this

time.

3. Make clear why our society wants to create a substitute for money: to reduce the cost

of

credit, and to reduce the cost of goods and services. Since a promissory note,

for

example, is negotiable, a merchant who takes a note can sell it to a factor or a

finance

company for more money that if it were not negotiable. Hence he does not have

to

increase the interest rate on credit sales or the cost of his merchandise to cover

his

expenses when notes he takes from customers are negotiable. To aid the

students’

understanding of the differing values given to negotiable instruments and

nonnegotiable

instruments, construct an example that shows an assignee of a contract taking the

contract

subject to all claims and defenses assertable against his assignor, and another

example

that shows the holder in due course of a negotiable instrument having greater rights

than

his

transferee.

Example: Problem Case

#2.

4. End this introduction to negotiable instrument law by stating that although the

law

imposes a harsh consequence on the issuer of a negotiable instrument, that burden

is

deemed to be offset by the benefit of receiving cheaper goods, services, and

credit.

5. Call the students’ attention to the recent revision to Articles 3 and 4, noting the

reasons

for the revisions as well as the effect they have on the study of negotiable

instruments

law.

C. Kinds of Commercial

Paper

On the chalkboard display the various kinds of commercial paper. The parties to

each

instrument should be identified. A note should be emphasized as a promise to pay, while

the

draft should be stressed as an order to pay. Note that a check must be payable on

demand.

Example: Problem Case #1.

Point out the distinguishing characteristics of a cashier’s check and a teller’s

check.

Cyber Law in Action: Check Conversion and Remotely Created Checks (page 865):

Discuss

the concept, process of creating, and the advantages/limitations of e-checks and

remotely

created

checks.

D. Formal Requirements for

Negotiability

I. Basic Requirements. List on the chalkboard the elements of negotiability and

discuss

them with students.

It

must be pointed out that the harsh consequences of

negotiability

will not be imposed on an issuer unless all these elements are

met.

2. Importance of Form. Note that the intent of the issuer is irrelevant; only the

form

matters.

E. In Writing and Signed by the

Issuer

I. In

Writing.

2. Signed by the Maker (if a Note) or the Drawer (if a Draft). Indicate that Martin

A.

Morgan, nicknamed Masher by his friends, could sign a note in any of different ways

and

be obligated on the note. Also show the problems that an agent can create for himself

by

signing

improperly.

Cyber Law in Action: E-payments Compared to Negotiable Instruments (page 868).

Use

this feature to discuss the differences between payments using negotiable instruments

and

e-payments.

F. Unconditional Promise or

Order

1. Unconditional Promise (if a Note) or Order (if a Draft) to Pay. Reemphasize that a

note

is a promise and that a draft is an order. Also tell students that this is the first of

three

different uses of the word “order” in negotiable instrument law. Refer students to

the

handout on the three uses of the word order, which is reproduced at the end of

this

chapter of the teacher’s

manual.

Examples: Problem Cases #3,n and

4.

Additional

Examples:

a. Pay to order of Joe, only if he sells me his bicycle.

Conditional.

b. Subject to contract #349.

Conditional.

c. Pursuant to contract #349.

Unconditional.

d. Pay out of pension account. Under original Article 3 it was considered

Conditional,

because it was not backed by the general credit of the issuer; however, under

Revised

Article 3 limiting payment to a particular fund or source does not make the

promise

or

order

conditional.

e. Debit pension account. Unconditional, because it merely requires an

accounting

entry.

f.. Problem Case #6.

Conditional.

2. Note that while conditional promises or orders to pay by the issuer destroy

negotiability,

such conditions in an indorsement do not destroy negotiability. Note that even if

the

condition has been met, the instrument is not negotiable; one has to look outside

the

instrument to see whether the condition has been

met.

G. Fixed Amount of

Money

1. Fixed Amount. Note that Revised Article 3 only requires that the principal payable be

set

forth in the instrument and, while permitting interest or other fixed charges to be

included

in the promise or order, they do may be calculated with reference to a formula or

index

identified in the instrument.

If

interest is payable, but the amount is not

ascertainable

from information in the instrument, then it is payable at the judgment rate. Thus,

Revised

Article 3 differs from original Article 3 that required a “sum certain” for an instrument

to

be negotiable. A sum was considered certain only if a person was able to calculate

from

the information on the note the amount required to pay it

off.

2. Payable in Money. Indicate that if a person obligated to pay can do something other

than

pay money, the instrument is not

negotiable.

H. Payable on Demand or at a Definite

Time

1. Explain what is meant by “demand” and “at sight.” Special attention should be given

to

acceleration and extension clauses. Indicate that these clauses will not

destroy

negotiability if one can tell with certainty the latest possible date that the instrument is

due. Ask the students whether the following clauses will destroy

negotiability:

a. Payable June 1, 2013, but payable at any time if the maker defaults.

Negotiable.

b. Payable June 1, 2013, but payable later if the maker so desires.

Nonnegotiable.

c. Payable June 1, 2014, but payable June 1, 2013, if the maker has temporary cash

flow

problems.

Negotiable.

2. Note the change made by Revised Article 3 in the handling of postdated checks–i.e.

a

bank may properly pay them before the stated date unless the drawer used

the

notification procedure set out in the

DCC.

Example: Problem

Cases#

5 and

6.

I.

Payable to Order or to

Bearer

1. These are the words of negotiability that will distinguish a negotiable instrument from

an

ordinary contract to pay money. List on the chalkboard the various examples of

order

language and bearer language. This is the second use of the word “order” in

negotiable

instrument law. Refer again to the handout on the uses of the word order at the end

of

thi

s

chapter of the teacher’s

manual.

2. Note the new rule introduced by Revised Article 3–i.e. that a check can be

negotiable

even if states only “pay to x” and that it does not have to be payable to order to be

negotiable.

Example: Problem

Case# 7.

3. Discuss the issue of whether certain checks where the payees names are separated by

the

virgule (I) are considered to be payable jointly or whether they are payable in

the

alternative with some courts concluding that they should be considered to be payable

in

the

alternative.

Pelican National Bank v. Provident Bank of Maryland (page 871): Where three

payees

on an insurance reimbursement check were listed on the check in stacked formation

on

the face of the check without any grammatical connector or punctuation, the court

held

that the check was ambiguous as to whether it was payable jointly or in the

alternative

and, accordingly, under DCC section

3-llO(d)

was considered to be payable in

the

alternative.

Points for Discussion: Ask the students whether in this situation the result reflects

the

intent of the drawer (and the expectations of the other payees)? Because it is payable

to

the three parties with an interest in the property, the result probably does not reflect

the

expectation of any of those parties.

If

so, what should the drawer do to avoid this

result

in the

future?

J. No Other Promise or

Obligation

1. Indicate that the negotiable instrument is a naked promise or order to pay money.

It may

not be burdened with other obligations. Do the following clauses destroy

negotiability?

a. Maker promises to maintain collateral pursuant to security agreement.

Negotiable.

b. I promise to pay $500 to the order of John and to sell him my dog.

Nonnegotiable.

c. Cashing this check acknowledges full satisfaction of any claim against

me.

Negotiable. (Note that this clause may or may not be enforceable,

however.

)

In Re Sia (873). The court found that the various provisions cited by the Maker

as

rendering the note non-negotiable were not in-fact provisions that altered any of

the

critical terms of the note or that imposed any additional obligation, promise

or

condition on the maker, but rather provisions that described the lender’s rights

and

obligations and had no effect on the

maker.

K. Ambiguous

Terms

1. Briefly explain the rules regarding construction of negotiable instruments with

unclear

terms.

L.

Summary

Remind the students that all the elements must be met for an instrument to be negotiable.

If

one of the elements is not met, the instrument will not be negotiable, but it may

nevertheless

be an enforceable

contract.

N.

RECOMMENDED

REFERENCES:

A. James Brook, Payment

Systems:

Examples

and

Explanations, Aspen Law & Business,

2009.

B. Uniform Commercial Code Reporting Service, Chicago, Callaghan & Co. A complete

Code

service, including the Code and variations made by adopting states. This service

publishes

many of the Code cases, which are easily accessed through the service’s indexing

system.

C. James J. White &

RobertS.

Summers, Handbook

of

the

Law

Under

the

Uniform

Commercial

Code, West Publishing Co. The standard handbook for the Code, this book presents

the

history

of the law concerning commercial transactions, explains why the law is what it is,

and

studies ambiguities in the

Code.

D. John Daniel, The

Elements

of

the

Law

of Negotiable

Instruments

(2010).

V.

ILLUSTRA

TNE

CHART:

Examples

and

Explanations

of

the

Three

Uses

of

the

Word

“Order”

in

Negotiable

Instrument

Law

Suppose an instrument on its face

says

Pay to the order of

John

1 2

3

We can categorize the three sections of this statement and illustrate the three interpretations of

the

word

“order.”

The

Words

Appearing

on

the

Instrument The

Interpretation

of

the

Words

1. Pay An order or command to the drawee by the drawer telling

the

drawee to pay someone. The word “pay” is the order or

command.

Its use makes the instrument a draft (or check) rather than a note.

2. the order Language of negotiability, making the contract a

negotiable

instrument. This is order language.

(Remember:

there may

be

bearer language also that makes the instrument negotiable. If

there

is no order or bearer language, then the contract is not a

negotiable

instrument.

)

3. John Requires that the person (John) indorse the note to negotiate it

(

i.e.,

to make his transferee a holder). This makes the instrument

an

order instrument, because it is payable to a specific

person.

Contrast an order instrument with a bearer

instrument,

which

may

be negotiated by delivery of possession

alone.

Suppose an instrument says on its face

I promise to pay to the

order of

bearer

2

Here only the second usage of “order” exists. This is a note (a promise to pay, not an order

to

pay).

It

has order language (the order of).

It

is a bearer instrument

(

bearer

).

Suppose a check is indorsed on its back

Pay to

Joe

3

Here the third use of “order” appears.

It

is an order instrument because of the special

indorsement

(Pay to Joe). If we looked at the face of the instrument, we would see the first

use of the word “order,” because a check is an order to the drawee to pay another person.

Also, the check may have order or bearer language on its face making it a negotiable

instrument. The indorsement has

nothing

to do with whether the check has order or bearer

language,

the language of negotiability.

31-7

©

2013 by McGraw-Hill Education.

This is

proprietary material solely

for

authorized instructor

use.

Not authorized

for

sale

or

distribution

in

any

manner. This document may

not

be copied, scanned, duplicated, forwarded, distributed,

or

posted

on a

website,

in

whole

or

part.