978-1285860381 Chapter 25 Solution Manual Part 1

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Suggested Additional Assignments

Writing Exercise

Ask students to write their own mystery story modeled on the vignette that opens the chapter. This

exercise will help them consolidate their grasp of the material in the chapter. In class, ask them to break

into groups and share their stories with the group. They will then select the best story from their group to

read aloud to the class.

Research: Indorsements

Ask students to look at the checks that have been returned with their bank statements and find as many

different types of indorsements as they can: blank, special, or restrictive. Ask them to bring photocopies

of the indorsements to class.

Chapter Overview

Chapter Theme

This chapter lays the foundation for the three chapters on negotiable instruments. Students will learn the

important fundamentals: the types of negotiable instruments, the concept of negotiability, and the rights of

a holder in due course.

Quote of the Day

“A negotiable bill or note is a courier without luggage.” –John B. Gibson, Overton v. Tyler, 3 Pa. 346, 347

(1846).

Commercial Paper

Commercial paper is a contract to pay money. It is used as a substitute for money or a loan of money.

The fundamental “rule” of commercial paper is:

The possessor of a piece of commercial paper has an unconditional right to be paid, as long as

(1) the paper is negotiable;

(2) it has been negotiated to the possessor;

(3) the possessor is a holder in due course; and

(4) the issuer cannot claim any of a limited number of “real” defenses.

The Role of Commercial Paper

Students use commercial paper all the time, without realizing its legal name. Everyone in the class will

have written or received a check at some point.

Question: What types of commercial paper have you used in the last month?

Question: Have you ever signed a promissory note? For what purpose?

Types of Negotiable Instruments

There are two kinds of commercial paper: negotiable and non-negotiable instruments.

A note (also called a promissory note) is your promise that you will pay money. A promissory note is used

in virtually every loan transaction, whether the borrower is paying for a multimillion dollar company, a

TV, or college tuition.

A draft is an order directing someone else to pay money for you. A check is the most common form of a

draft—it is an order telling a bank to pay money. In a draft three people are involved: the drawer orders

the drawee to pay money to the payee.

Negotiability

Quote of the Day

“A negotiable bill or note is a courier without luggage.”

Question: What does the Code require to create a negotiable instrument?

Answer: UCC §3-104(a) states that to be negotiable an instrument must:

Be in writing

Be signed by the maker or drawer

Contain an unconditional promise or order to pay

State a definite amount of money

Be payable on demand or at a definite time, and

Be payable to order or to bearer.

Question: Why are these requirements essential for negotiability?

Question: Why is a negotiable instrument like a courier without luggage?

Answer: The possessor of non-negotiable commercial paper has the same rights as the person who

Question: Is the quote completely accurate?

Answer: No, because the holder of a negotiable bill is subject to both personal and real defenses

Interpretation of Ambiguities

When the terms in a negotiable instrument contradict each other, three rules apply:

Words take precedence over numbers.

Handwritten terms prevail over typed and printed terms.

Typed terms win over printed terms.

You Be the Judge: Blasco v. Money Services Center1

Facts: Christina Blasco entered into a “payday loan” with Money Services Center (MSC). MSC loaned

Blasco $500 and return Blasco left MSC with a signed check for $587.50 which it promised not to cash

1 2006 Bankr. LEXIS 2899, United Stated Bankruptcy Court for the Northern District of Alabama, 2006.

for two weeks. (Note that Blasco is laying 17.5% interest for a two-week loan, which is an annual

compounded rate of 6500%.)

Before MSC could cash the check, Blasco filed for bankruptcy. Although MSC knew this, it

deposited the check. It is illegal for creditors to attempt to collect a debt once a debtor has filed for

bankruptcy, but creditors are entitled to payment on negotiable instruments.

The numerical amount on Blasco’s check was $587.50, but the amount written in words was “five

eighty-seven and 50/100 dollars.” Did the words mean “five hundred eighty-seven” or “five thousand

eighty-seven”? Was the check negotiable despite this ambiguity?

You Be The Judge: Was this check a negotiable instrument? Was it for a definite amount?

Holding: Yes, the note was negotiable, it was for a definite amount. According to the court, to determine

whether the check was a negotiable instrument, it must state a promise to pay a definite amount of money.

The numerical amount of the check was “$ 587.50”, but the amount stated in words was “five

eighty-seven and 50/100 dollars.” For the words to prevail over the numbers, the two have to be

contradictory. The words “five eighty-seven and 50/100 dollars” did not contradict the numbers $587.50;

the numbers clarified the ambiguity in the words.

Question: To be negotiable, what must a note look like?

Answer: It must:

Be in writing

Question: Was this note in writing?

Question: Was it signed by Blasco?

Question: Did it contain an unconditional promise or order to pay?

Question: Presumably Blasco knew the amount of the check, after all she wrote it. Why then did she

sue saying the check was not negotiable?

Negotiation

The possessor of a piece of commercial paper has an unconditional right to be paid, as long as (1) the

paper is negotiable, (2) it has been negotiated to the possessor, (3) the possessor is a holder in due course,

and (4) the issuer cannot claim any of a limited number of real defenses. Negotiation means that an

instrument has been transferred to the holder by someone other than the issuer.

NEGOTIATED PAPER CONSEQUENCES

Issuer (maker or

drawer)

Payee or drawee Holder (possessor)

Note or draft

Received from issuer,

later transferred to

Issuer liable to holder

regardless of any

claims it has against

payee or drawee

NON-NEGOTIATED PAPER

Issuer (maker or Payee or drawee

drawer)

Note or draft Received from issuer

Issuer’s liability

subject to any claims

it has against payee or

drawee

Negotiation

To be negotiated, order paper must first be indorsed and then delivered to the transferee by someone other

than the issuer. Bearer paper must simply be delivered to the transferee; no indorsement is required.

Question: What are the differences between order paper and bearer paper?

Answer: Bearer paper is like cash. No indorsement is necessary and any holder is eligible to be a

Research: Indorsements

If students undertook the indorsements research, copy some samples on the board and ask students to

identify the different types.

Holder in Due Course

A holder in due course has an automatic right to receive payment for a negotiable instrument unless the

issuer can claim a limited number of real defenses. In other words, a holder in due course has a greater

probability of being paid than a mere holder—a fact that gives negotiable instruments tremendous value

and fuels market demand for them.

Question: What are the requirements for a holder in due course?

Question: Why are holders in due course entitled to this special treatment?

Answer: The theme throughout this chapter is that an instrument has little value unless the holder

can be reasonably sure she will be paid. An innocent holder, who has no reason to believe there is

Additional Case: Rosenbaum v. Bulow2

Facts: Maude Rosenbaum wanted to post bail to get out of prison. Harvey Bowen agreed to post bail of

$7,500 in return for a $7,500 promissory note signed by Rosenbaum and secured by her house. Bowen

was not a licensed bondsman and therefore, under state law, was not entitled to any payment for posting

bail. To solve this problem, Bowen asked Rosenbaum to sign a second note to his niece’s husband, W. F.

Bulow (who was not a bondsman, either).

Issues: Did Bulow give value for the promissory note? Did he act in good faith?

22 1997 Bankr. LEXIS 555 United States Bankruptcy Court for the Eastern District of North Carolina,

1997

Holding: Bulow cannot collect on the note. At best, Bowen was trying to make a gift to Bulow of his

illegally obtained profit. Bulow did not give value to Rosenbaum. Nor did Bulow act in good faith. He

could not have believed that Rosenbaum simply wanted to make a gift to him of $7,500. If he did not

already know why she was signing the note to him, he should have investigated.

Question: What did Rosenbaum and Bowen agree to do?

Question: What does “secured by her house” mean?

Question: Is this arrangement fair?

Answer: No. As long as Rosenbaum returns to prison when ordered by the court, Bowen will get his

Question: Is this arrangement with Rosenbaum legal?

Question: Why did Rosenbaum agree to Bowen’s deal?

Question: Why did Bowen ask Rosenbaum to sign a second note to Bulow?

Question: Could Bulow enforce the second note?

Question: Why hadn’t he given value?

Question: Why hadn’t he acted in good faith?

Question: Both Bowen and Rosenbaum were wrong. She reneged on the deal; he illegally accepted

a bond fee. Why should Rosenbaum win?

Notice of Outstanding Claims or Other Defects

In certain circumstances, a holder is on notice that an instrument has an outstanding claim or other defect.

Case: Hartford Accident & Indemnity Co. v. American Express Co.2

Facts: Stratford Skalkos was a manager at Avon Products. He issued Avon checks to pay his personal

debts. So that no one in the company would know what he was doing, he disguised the name of the

payees. For example, to pay his American Express bill, he issued an Avon check to “Amerex Corp.”

Avon sued the recipients of the checks, demanding that the funds be returned. The trial court ruled

against Avon and granted defendants’ motion for summary judgment, concluding that defendants were

holders in due course and thus took the checks free of any claims or defenses. Avon appealed.

Issue: Were the defendants holders in due course?

2 74 N.Y.2d 153, 542 N.E.2d 1090, 1989 N.Y. LEXIS 881 New York Court of Appeals, 1989

Holding: American Express and the others were holders in due course. There was no reason why they

should have been suspicious simply because Skalkos was paying his bills with company checks. Many

companies pay entertainment and other expenses for their employees. Therefore, American Express was

not “on notice of any claims or disputes”.

Question: Is this a fair result?

Answer: As the court observed, Avon was the company that (1) had hired a dishonest employee and

Question: Should American Express have been on notice when it received checks payable to

Amerex? Similarly, should the Metropolitan Opera Company have wondered why it got checks made

out to “Metropolitan Oprtg. Co.?”

Additional Example

A financial columnist for the Chicago Tribune received this question from a reader:

I received a promissory note and accompanying letter (copies enclosed). The letter attests to the

legitimacy and negotiability of the note, which is for $1 million. Is this really a valid document? Can I

convert this to cash before the maturity date? 3

The note was for one million dollars, payable 20 years later.

Question: If you received such a promissory note in the mail, what difficulties might you have in

enforcing it? Are you a millionaire?

Answer: First, the person who signed the note does not have to pay you anything for 20 years. Even if

Third, suppose you sell the note to a third party. The buyer would argue that she can enforce the note

because she has given value and is, therefore, a holder in due course. The maker of the note would claim,

3 “Promises, Promises! But Will They Make You a Millionaire?” by Phil Vettel, Chicago Tribune, Feb.

24, 1985, p. 2.