978-1285770178 Lecture Note BL ComLaw 1e IM-Ch13 Part 1

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whole or in part.

2 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS

CHAPTER OUTLINE

I. Negotiation

When a transfer is by negotiation, the transferee can become a holder in due course and acquire greater

rights than the transferor had [UCC 3–203(b), 3–305].

A. NEGOTIATING ORDER INSTRUMENTS

An order instrument is negotiated by delivery with any necessary indorsements.

but if there is no room, an indorsement can be written on a separate piece of paper (an allonge) “firmly

affixed” to the instrument [UCC 3–204(a)].

A. BLANK INDORSEMENTS

A blank indorsement specifies no particular indorsee and can be a mere signature [UCC 3–205(b)].

Why do banks require all checks, including bearer instruments, to be indorsed? Banks impose this

requirement because the indorsement creates indorser liability for the indorsing party. Also, it is more efficient

and safer for a bank to have a policy requiring indorsement of all checks rather than for tellers to make

individual assessments of whether checks are order or bearer instruments.

ANSWER TO “THE LEGAL ENVIRONMENTAL DIMENSION”

QUESTION IN CASE 13.1

Even though forged or unauthorized signatures on negotiable instruments are uncommon, should

U.S. Bank have had to prove that the indorsements on this note were valid and authorized? Why or

why not? No. U.S. Bank should not have had to prove that the indorsements on the Bass note were valid and

authorized. Under the UCC, an indorsement is presumed to be authentic and authorized until evidence is

introduced that it is forged or unauthorized. In other words, unless Bass produced such evidence, U.S. Bank

was not required to prove that the indorsements were valid. And in this case, the facts do not indicate that

Bass offered any evidence to show the possibility of forgery, error, or a lack of authorization in the

indorsements.

ANSWER TO “THE ECONOMIC DIMENSION”

QUESTION IN CASE 13.1

How does presuming that an indorsement is legitimate “without unambiguous evidence to the

contrary” protect the transferability of a negotiable instrument? The presumption that an indorsement is

legitimate “without unambiguous evidence to the contrary” protects the transferability of a negotiable

instrument by giving force to the information presented on the face of the instrument. Thus, a signature is an

indorsement unless accompanying words, the terms of the instrument, the location of the signature, or some

other circumstance unambiguously indicates that the signature was made for a purpose other than

indorsement. Parties can buy, sell, or trade the instrument, trusting that the indorsements on it are legitimate

without having to validate every indorsement with every transfer. This encourages and supports the market

for such instruments.

into an order instrument.

C. QUALIFIED INDORSEMENTS

Most indorsements are unqualified. A qualified indorsement disclaims an indorser’s liability.

2. Special versus Blank Qualified Indorsements

whole or in part.

pays or applies the proceeds consistently with the indorsement, the indorsee is a holder and can

become a holder in due course [UCC 3–206(d), (e)].

E. HOW INDORSEMENTS CAN CONVERT ORDER INSTRUMENTS TO BEARER INSTRUMENTS AND VICE VERSA

Before negotiation, an order instrument can be converted to a bearer instrument and vice versa through

A. MISSPELLED NAMES

An indorsement should be identical to the name that appears on the instrument. A payee or indorsee

whose name is misspelled can indorse with the misspelled name, the correct name, or both [UCC 3–

204(d)].

necessary.

1. If the Instrument Is Ambiguous

If an instrument payable to two or more persons does not clearly indicate whether it is payable in

the alternative or jointly, it is payable alternatively [UCC 3–110(d)].

A. HOLDER VERSUS HOLDER IN DUE COURSE

A holder has the status of an assignee of a contract right. A holder obtains only those rights that the

transferor had in the instrument and is normally subject to the same defenses. An HDC takes an in–

strument free of most defenses against payment on it or claims to it.

proceeding.

• Taking an instrument in payment of or as security for an antecedent debt.

• Giving a negotiable instrument as payment.

• Giving an irrevocable commitment as payment [UCC 3–303(a)].

A holder may pay for an instrument but not acquire HDC status by—

• Purchasing an instrument at a judicial sale such as a bankruptcy or a creditor’s sale

• Obtaining an instrument by taking over a trust or estate (as administrator)

• Acquiring an instrument as part of a corporate purchase of assets

8 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS

whole or in part.

has a defense. Subsection (b) [states that “the issuer has a defense to the extent performance of the

promise is due and the promise has not been performed”].

2. Taking in Good Faith

The holder must have acted honestly in the process of acquiring the instrument. Good faith is

“honesty in fact and the observance of reasonable commercial standards of fair dealing” [UCC 3–

103(a)(4)]. This requirement applies only to the holder.

CASE SYNOPSIS—

Case 13.3: Georg v. Metro Fixture Contractors, Inc.

Cassandra Demery worked as a bookkeeper at Clinton Georg’s business Freestyle until he discovered

she had embezzled over $200,000 and failed to pay $240,000 of Freestyle’s taxes. Georg fired Demery and

demanded repayment. Demery went to work for her parents’ firm Metro Fixtures. She wrote a check to

Freestyle for $189,000 on Metro’s account without authorization and deposited it directly into Freestyle’s

account, telling Georg that it was a loan to her from her family. When Metro discovered Demery’s theft, it filed

a suit in a Colorado state court against Georg and Freestyle for conversion. The court issued a summary

judgment in Freestyle’s favor. On Metro’s appeal, a state intermediate appellate court reversed. Georg and

Freestyle appealed.

The Colorado Supreme Court reversed. On the question of whether Freestyle took the check in good

faith, so as to qualify as a holder in due course, the court emphasized Demery’s authority to issue checks for

Metro. Georg had no reason to know that Demery did not have the authority to write this specific check.

Under the UCC, when two innocent parties are victims, the loss falls on the party who created the

circumstances that enabled the wrongdoing. Metro gave Demery authority to write checks, so it bore the loss.

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Notes and Questions

In an attempt to describe how the standard of “good faith” under Article 3 should be applied, a different

state court articulated the following test in Maine Family Federal Credit Union v. Sun Life Assurance Co. of

Canada, 727 A.2d 335 (Sup. Jud. Ct. 1999).

The factfinder must therefore determine, first, whether the conduct of the holder comported with industry

or “commercial” standards applicable to the transaction and, second, whether those standards were

reasonable standards intended to result in fair dealing. Each of those determinations must be made in the

context of the specific transaction at hand. If the factfinder’s conclusion on each point is “yes,” the holder

will be determined to have acted in good faith even if, in the individual transaction at issue, the result

appears unreasonable. Thus a holder may be accorded holder in due course status where it acts

pursuant to those reasonable commercial standards of fair dealing—even if it is negligent—but may lose

that status, even where it complies with commercial standards, if those standards are not reasonably

related to achieving fair dealing.

had no personal relationship that would be very suspicious. In contrast, it is believable that her parents may

lend her fund to help her out. Certainly, though this would not be true with strangers.

that Demery did not have the authority to write this specific check.

had no personal relationship that would be very suspicious. In contrast, it is believable that her parents may

lend her fund to help her out. Certainly, though this would not be true with strangers.

that Demery did not have the authority to write this specific check.

What do your students think about this standard of “good faith”?

Why is good faith required to attain HDC status? To allow otherwise would provide an incentive for

holders to manipulate the rules dishonestly with the knowledge that the enforcement of an instrument could

still be sought in a court.

Was it right for Georg to let the loss fall on Metro, and was it reasonable for him to believe that

Demery’s parents had loaned her the funds? Because there was a family relationship, the claim of a loan

was believable. Demery knew criminal charges could be pressed if she did not repay, so the family might help

her. Given the family relationship, his taking the funds was not unreasonable or indeed unethical.