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Part Five: Negotiable Instruments
CONTENTS
Chapter 26 Form and Content
Chapter 27 Transfer and Holder in Due Course
Chapter 28 Liability of Parties
Chapter 29 Bank Deposits, Collections, and Funds Transfers
ETHICS QUESTIONS RAISED IN THIS PART
1. Should a customer have the right to stop payment on a check? If so, under what circumstances? Who should
bear the expense of a stop payment order: Why?
2. Who should bear the loss for a forged check–the bank or the account holder? Why? What should be the
determining factor(s) in deciding who should bear the risk of loss?
3. What obligations does a bank have to inform its customers of their rights as a depositor? What obligations
does a customer have to inform himself of his rights?
4. What essential services should a bank or other financial institution provide for its customers? Should banks
be allowed to charge small customers more for financial services than they charge large customers?
5. Should a bank be allowed to "hold" deposited checks before making the funds available to their depositors?
ACTIVITIES AND RESEARCH PROBLEMS
1. Has your state adopted Revised Article 3? If so, why? If not, why not?
2. Visit a local bank to see first-hand how the check collection process works, or have someone from the bank
visit the class to tell about the process.
3. Have students bring copies of the customer agreements from their own banks and compare the provisions of
these agreements. Discuss the obligations of the bank and of the customer. Are the provisions in these
agreements in accordance with the provisions in the UCC?
Chapter 26
FORM AND CONTENT
A. Negotiability
1. Development of Law of Negotiable
Instruments
2. Assignment Compared with Negotiation
B. Types of Negotiable Instruments
1. Drafts
2. Checks
3. Notes
4. Certificates of Deposit
C. Formal Requirements of Negotiable
b. The Particular Fund Doctrine
5. Fixed Amount
6. Money
7. No Other Undertaking or Instruction
8. Payable on Demand or at a Definite Time
a. Demand
b. Definite Time
c. At a Definite Time and On Demand
9. Payable to Order or to Bearer
a. Payable to Order
Cases in This Chapter
Heritage Bank v. Bruha
NationsBank of Virginia, N.A. v.
Barnes
Cooperatieve Centrale
Raffeisen-Boerenleenbank B.A. v. Bailey
Chapter Outcomes
After reading and studying this chapter, the student should be able to:
Describe the concept and importance of negotiability.
Identify and describe the types of negotiable instruments involving an order
to pay.
Identify and describe the types of negotiable instruments involving a promise
to pay.
TEACHING NOTES
The term "negotiable instruments" (instruments) refers to checks, drafts, checks,
promissory notes and certi&cates of deposit. For a number of reasons, payment by
noncash means is preferable in many transactions. Noncash payments take two
forms: paper (checks and drafts) and electronic (debit cards, credit cards, automated
clearinghouse [ACH], and prepaid cards).
By number of transactions, electronic payments now exceed three-quarters of all
noncash payments while payments by check are now less than one-quarter of all
noncash payments.
By value, electronic payments constitute about 55 percent of all noncash payments
while checks represent 45 percent of all noncash payments. More speci&cally, in the
United States in 2009, the number of checks paid was approximately 24.5 billion
with a value of approximately $32 trillion. Although by number of transactions, debit
cards are now the most used noncash payment in the United States, by value, debit
card payments amount to only 2 percent of all noncash payments.
The &nancing or credit function of negotiable instruments is indispensable.
promissory notes are used extensively in &nancing sales of goods
In 1990, the American Law Institute and the National Conference of Commissioners
on Uniform Laws approved a Revised Article 3 to the Uniform Commercial Code
(UCC). Named “Negotiable Instruments,” the new Article maintains the basic scope
and content of prior Article 3 (Commercial Paper). In 2002, the American Law
Institute and the Uniform Law Commission completed updates to Articles 3 and 4. All
*** Chapter Outcome ***
Discuss the concept and importance of negotiability.
A. NEGOTIABILITY
Negotiability is a legal concept that allows written instruments to be used as a
readily accepted form of payment in substitution for money; it de&nes the way in
which rights and obligations are assigned in the area of negotiable instruments.
Development of Law of Negotiable Instruments
Under common law, and as far back as the Middle Ages, the payment of money was
a contract right only of the intended payee; contract rights and obligations could not
Merchants involved in the Courishing trade of the time still wanted more reform,
because it was diDcult to &nd people willing to accept an assignment. Thus, the
concept of the holder in due course developed, allowing certain good faith
transferees who give value to acquire the right to be paid, free of most of the
defenses to which an assignee is subject.
Assignment Compared with Negotiation
The obligee's contractual rights to payment could not be assigned. Over time,
however, contract rights to the payment of money became assignable. In an
assignment, the assignee gets only the contract rights that the assignor had and is
subject to the same claims as the original obligor had against the assignor.
*** Chapter Outcomes ***
Identify and describe the types of negotiable instruments involving an order to pay.
Identify and describe the types of negotiable instruments involving a promise to pay.
B. TYPES OF NEGOTIABLE INSTRUMENTS
Drafts and checks each contain orders or directions to pay money.
Notes and certi&cates of deposit each contain promises to pay money.
Drafts
A draft involves three parties:
The drawer, (owner or controller of the money) orders a second party, the drawee,
(who is in possession of money that belongs to the drawer) to pay a &xed amount of
money to a third party, the payee.
NOTE: See Figure 26-1 for an outline of this relationship.
A time draft is a draft payable at a speci&ed future date; a sight draft is payable on
presentation to the drawee.
NOTE: A sample of a draft instrument is reproduced in Figure 26-2.
Checks
A check is a specialized form of draft drawn on a bank and payable on demand (that
is, upon the payee’s or holder’s request for payment).
NOTE: See Figure 26-3.
A cashier’s check is a check drawn by a bank on itself to the order of a payee. In this
case, the bank serves both as the drawer and the drawee.
The Check Clearing for the 21st Century Act (also called Check 21 or the Check
Truncation Act), which went into effect in late 2004, creates a new negotiable
instrument called a substitute check or image replacement document (IRD). The law
permits banks to truncate original checks, to process check information
Notes
A promissory note involves two parties; the maker promises to pay to the order of a
second party, the payee, a stated amount of money. A note payable at a certain time
is referred to as a time note. A note payable upon the request or demand of the
payee or holder is a demand note.
NOTE: See Figure 26-5.
Certificates of Deposit
A certi&cate of deposit, or a CD as it is frequently called, is a specialized form of a
promissory note, given by a bank, to pay money. The bank (the maker)
acknowledges the receipt of money from a payee, and promises to repay the payee
on demand or at a stated date, with interest calculated at a stated rate.
NOTE: See Figures 26-4 and 26-6.
*** Chapter Outcome ***
List and explain the formal requirements that an instrument must meet to be
negotiable.
C. FORMAL REQUIREMENTS OF NEGOTIABLE INSTRUMENTS
Because negotiability is a matter of form not all negotiable instruments will qualify
for this special status. The four corners rule requires that the instrument contain all
the elements of negotiability within the document itself. Reference to other
documents is not permitted. If the paper is non-negotiable, the law of assignment
applies to the transferee.
CASE 26-1
HERITAGE BANK v. BRUHA
Supreme Court of Nebraska, 2012
283 Neb. 263, 812 N.W.2d 260 http://scholar.google.com/scholar_case?
case=17014896784596098115&q=283+Neb.+263&hl=en&as_sdt=2,34
Connolly, J.
* * *
[Jerome J. Bruha signed a promissory note on December 16, 2008, with Sherman County Bank. The note
evidenced a promise to pay "the principal amount of Seventy-five Thousand & 00/100 ($75,000.00) or so
much as may be outstanding, together with interest on the unpaid outstanding principal balance of each
On this note, Bruha received advancements in the amount of $10,000 on December 16, 2008, $40,000
on December 17, and $1,000 on January 30, 2009. This totaled $51,000. Bruha then invested the money in
accounts with a trading company, which allegedly shared management with Sherman County Bank.
There are a few typographical errors on the note. First, the maturity date on the note is February 1,
2008, which, read literally, means that the note would have matured about 10 months before Bruha signed it.
Other notes he had signed stated maturity dates of February 1, 2009. Second, in a section titled
"COLLATERAL" the note reads: "Borrower acknowledges this Note is secured by an assignment of hedge
account from Jerome Bruah [sic] to Sherman County Bank dated DATE [sic]." Thus, Bruha's name is
misspelled and a line for a date is unfilled.
* * *
Bruha argues that Heritage is not a holder in due course. Similarly, he argues that the FDIC was not a
holder in due course when it held the note. A holder in due course is, with some exceptions, "immune to
defenses, claims in recoupment, and claims of title that prior parties to commercial paper might assert. The
holder in due course always enjoys certain pleading and proof advantages." So if Heritage were a holder in due
course, it would enjoy an advantageous position in litigation with Bruha.
We conclude, however, that Heritage is not a holder in due course because the note was not
"negotiable" and article 3 of the Uniform Commercial Code does not apply to this case.
Neb. U.C.C. § 3-104(a) provides: "Except as provided in subsections (c) and (d), ‘negotiable
instrument’ means 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. …" (Emphasis supplied.) Here, the note fails to meet the
definition of a "negotiable instrument" because it was not a promise "to pay a fixed amount of money."
Although the Uniform Commercial Code allows notes to have a variable interest rate, under §
Here, the text of the note states that Bruha "promises to pay … the principal amount of Seventy-five
Thousand & 00/100 Dollars ($75,000.00) or so much as may be outstanding . …" Further, the note states that it
"evidences a revolving line of credit" and that Bruha could request advances under the obligation up to
$75,000. This fails the "fixed amount of money" requirement of § 3-104(a); one looking at the instrument itself
cannot tell how much Bruha has been advanced at any given time. So, the note is not negotiable. Stated simply,
"[a] note given to secure a line of credit under which the amount of the obligation varies, depending on the
extent to which the line of credit is used, is not negotiable . . . ."
To be negotiable, an instrument must meet the following criteria:
Writing
This requirement is given a broad interpretation. Printing and typewriting are
included, and the writing need not be on paper.
Signed
May be any symbol executed or adopted by a party with the intention to
authenticate a writing; may be any word or mark used in place of a written
signature, such as initials, an X, or a thumbprint. It can also consist of a trade name
or an assumed name. Location of the signature on the document is unimportant.
Revised Article 1 changes the word “authenticate” to “adopt or accept.”
Promise or Order to Pay
A negotiable instrument must contain either a promise to pay money (with a note or
certi&cate of deposit) or an order to pay (with a draft or check).
Unconditional
A promise or order to pay is unconditional if it is absolute and not subject to any
contingencies or quali&cations.
Reference To Other Agreements — destroys negotiability if the instrument is
made subject to the terms of another agreement, but not if another instrument is
merely mentioned.
The Particular Fund Doctrine — Prior Article 3 considered a promise to pay only
out of a particular fund nonnegotiable, but Revised Article 3 reverses this.
Fixed Amount
You should be able to determine from the instrument itself the minimum speci&c
amount that the holder is entitled to receive. The "&xed amount" provision refers
only to the principal, so the instrument’s provisions may increase the amount of
Money
The term money means legal tender. It must be a medium of exchange authorized or
adopted by a sovereign government as part of its currency; does not include
commodities which are not sanctioned as legal tender. (Revised 1–201(b)(24) adds
that the authorized or adopted currency must be the current oDcial currency of the
government.)
No Other Undertaking or Instrument
A negotiable instrument must contain a promise or order to pay money, but it may
not contain an order or promise to do an act in addition to paying money.
Payable on Demand or at a Definite Time
CASE 26-2
NATIONSBANK OF VIRGINIA, N.A. v. BARNES
Virginia Circuit Court, Twentieth Circuit, 1994
in part. The court will address Defendant’s affirmative defenses as they relate to each note specifically, and to
both Notes in general.
* * *
The following facts are undisputed with respect to the 1991 Note which is the subject of Count II of the
Motion for Judgment. Defendants Ad Barnes, Trustee, Ad Barnes and Elaine Barnes executed a * * * Note to
Sovran Bank, N.A. on August 27, 1991, in the principal amount of $200,000. Plaintiff NationsBank is the
successor by merger to Sovran and is now the holder of this Note. * * * By letter dated February 17, 1993,
NationsBank made demand on the 1991 Note.
The factual question still in dispute concerning the 1991 Note is whether it is a demand note. Plaintiff
argues that the language of the note is unambiguous and is clearly a demand note. Defendants argue that the
detailed enumeration of events constituting default is inconsistent with a demand note. Thus, a standard of
good faith must be applied before a demand for accelerated repayment can be made.
[UCC] §1–203 establishes a general duty of good faith in every contract governed by the Commercial
De0nite Time — Time paper refers to all other instruments that are payable at a
de&nite time but not on demand. A de&nite payment date is established when the
instrument is payable:
1. at a &xed date or dates,
2. at a de&nite period of time after sight or acceptance, or
3. at a time readily ascertainable at the time the promise or order is issued.
Be Payable to Order or to Bearer
Words of negotiability must be present on the face of the instrument (not in an
indorsement) at the time it is &rst issued or when it comes into the possession of
the bearer. The magic words of negotiability typically are "to the order of" or "to
bearer", although other words that carry the same meaning may also ful&ll this
requirement.
Revised Article 3 allows checks that meet all requirements except this one to still be
considered negotiable. Revised Article 3 further disallows use of the word "assigns."
Payable to Order — Negotiable instruments are payable to the order if it is payable
to the order of an identi&ed person or to an identi&ed person or order. Most checks,
CASE 26-3
COOPERATIEVE CENTRALE RAIFFEISEN-BOERENLEENBANK B.A. v. BAILEY
United States District Court, Central District California, 1989
710 F.Supp. 737
http://scholar.google.com/scholar_case?case=15799376056319723245&q=710+F.Supp.
+737&hl=en&as_sdt=2,10
Rea, J.
This matter comes before the court on the motion of both parties to this action for partial summary adjudication
and on plaintiff’s motion for summary judgment. * * *
This is an action for collection on a promissory note brought by plaintiff, Cooperatieve Centrale
Raiffeisen-Boerenleenbank, B.A. (“the Bank”), against the maker of the note, William Bailey, M.D. (“Bailey”).
Bailey executed the note in December, 1982, in favor of “California Dreamstreet,” a joint venture which
solicited investments in a cattle-breeding operation. California Dreamstreet negotiated the note in 1986 to the
Bank, which in turn filed this action on August 29, 1988.
The note states in relevant part:
DR. WILLIAM H. BAILEY * * * hereby promises to pay to the order to CALIFORNIA
DREAMSTREET * * * the sum of Three Hundred Twenty Nine Thousand Eight Hundred ($329,800.00)
Dollars. * * *
* * *
The authorities are unhelpful. There is apparently no case on record in which a variance this small from
the language of the Code has been called into question. Both parties direct the Court’s attention to Official
UCC Comment 5 to Code §3–104, which states:
5. This Article omits the original Section 10, which provided that the instrument need not follow the
language of the act if it ‘clearly indicates an intention to conform’ to it. The provision has served no useful
purpose, and it has been an encouragement to bad drafting and to liberality in holding questionable paper
to be negotiable. The omission is not intended to mean that the instrument must follow the language of this
In the court’s opinion, the Comment fails to persuasively support either party’s position. Rules of grammar
belie the Bank’s argument that the preposition “to” is an apt substitute for “of” since the resulting sentence,
read literally, is not just ambiguous but incomplete. On the other hand, the Comment expressly disavows
Bailey’s argument that the Code drafters intended to set forth certain “magic words,” the absence of which
precludes negotiability.
What does emerge from the Comment is the need for certainty in determining negotiability. Though
sensitive to this goal and to the potentially harsh result of such a finding, the court does not find the instant
facts to present the kind of “doubtful” case which should be resolved against negotiability. In this context, the
phrase “pay to the order to” can plausibly be construed only to mean “pay to the order of.” While other
*** Chapter Outcome ***
Discuss the effect on the negotiability of an instrument’s (a) being undated, antedated,
or postdated;
(b) lack of completion of the instrument; and (c) ambiguity.
Terms and Omissions and Their Effect on Negotiability
Certain omitted provisions or ambiguous terms may cause questions about an
instrument’s negotiability or at least may cause problems with the interpretation of
the instrument. Accordingly, the UCC contains rules for the construction of
negotiable instruments that apply to every type.
Dating of the Instrument — An instrument’s negotiability is not affected by the
