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1
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.
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.
..................................................................................................................................................
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.
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.
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.
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.
..................................................................................................................................................
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.
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.
