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LA Law on Negotiable Instruments
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CHAPTER 20 Negotiable Instruments § 20.01 Introduction to Article 3 of the Uniform Commercial Code [1] Recent Developments in the Law of Negotiable Instruments [2] Scope of Article 3 [3] Nature of a Negotiable Instrument [4] Use of a Negotiable Instrument in an Accord and Satisfaction [5] Relevance of Article 3 to Writings Not Meeting Requisites of Negotiability [6] Caveats With Respect to the Organization of This Chapter § 20.02 The Requirements of a Negotiable Instrument [1] The Types of Writings That May Constitute Negotiable Instruments [2] A Negotiable Instrument Must Be Signed by the Maker or Drawer —What Constitutes a Signature? [3] A Negotiable Instrument Must Contain a Promise or Order to Pay—What Constitutes a Promise or Order to Pay? [a] Promise to Pay [b] Order to Pay [i] An Order Is a Direction and Must Be More Than an Authorization or Request [ii] An Order Must Identify the Person to Pay [c] Instruments Payable at a Bank [4] The Promise or Order to Pay Must Be Unconditional [a] In General [b] Implied and Constructive Conditions Do Not Destroy Negotiability [c] Statement of Consideration or Reference to Underlying Transaction or Agreement Does Not Destroy Negotiability [d] Reference to Fund From Which Payment Is to Be Made Will No Longer Destroy Negotiability [5] A Negotiable Instrument Must Be Payable for a Sum Certain or for a Fixed Amount [a] In General [b] Effect of Interest Rates [c] Other Clauses Affecting Amount Payable [6] A Negotiable Instrument Must Be Payable in Money [a] In General [b] Foreign Currency Rene Tierney
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CHAPTER 20 Negotiable Instruments

20.01 Introduction to Article 3 of the Uniform Commercial Code [1] Recent Developments in the Law of Negotiable Instruments [2] Scope of Article 3 [3] Nature of a Negotiable Instrument [4] Use of a Negotiable Instrument in an Accord and Satisfaction [5] Relevance of Article 3 to Writings Not Meeting Requisites of Negotiability [6] Caveats With Respect to the Organization of This Chapter

20.02 The Requirements of a Negotiable Instrument [1] The Types of Writings That May Constitute Negotiable Instruments [2] A Negotiable Instrument Must Be Signed by the Maker or DrawerWhat Constitutes a Signature? [3] A Negotiable Instrument Must Contain a Promise or Order to PayWhat Constitutes a Promise or Order to Pay? [a] Promise to Pay [b] Order to Pay [i] An Order Is a Direction and Must Be More Than an Authorization or Request [ii] An Order Must Identify the Person to Pay [c] Instruments Payable at a Bank [4] The Promise or Order to Pay Must Be Unconditional [a] In General [b] Implied and Constructive Conditions Do Not Destroy Negotiability [c] Statement of Consideration or Reference to Underlying Transaction or Agreement Does Not Destroy Negotiability [d] Reference to Fund From Which Payment Is to Be Made Will No Longer Destroy Negotiability [5] A Negotiable Instrument Must Be Payable for a Sum Certain or for a Fixed Amount [a] In General [b] Effect of Interest Rates [c] Other Clauses Affecting Amount Payable [6] A Negotiable Instrument Must Be Payable in Money [a] In General [b] Foreign Currency [7] A Negotiable Instrument Must Be Payable on Demand or at a Definite Time [a] In General [b] On Demand Defined [c] Definite Time Defined [8] A Negotiable Instrument Must Be Payable to Order or to Bearer [a] In General [b] Order Paper Defined [i] What Constitutes Payable to Order? [ii] To Whom May an Order Instrument Be Made Payable? [c] Bearer Paper Defined [9] A Negotiable Instrument Must Contain No Other Promise, Order, Obligation or Power [a] In General [b] Omissions Not Affecting Negotiability [c] Terms Not Affecting Negotiability [i] References in an Instrument to Collateral Do Not Affect Negotiability [ii] A Promise or Power to Maintain or Protect Collateral or to Give Additional Collateral Does Not Affect Negotiability [iii] Confession of Judgment Clauses Do Not Affect Negotiability Provided They Are Legal Under Non-Code State or Federal Law [iv] Inclusion in an Instrument of a Term Purporting to Waive the Benefit of Any Law Does Not Destroy Negotiability [v] Negotiability Is Not Affected by a Provision in Draft That Cashing or Indorsing of Same Is an Acknowledgement of Full Satisfaction of the Obligation Represented by the Draft [vi] Clauses Providing for Choice of Law, Venue, Jury Waivers, and Arbitration Are Enforceable and Do Not Affect or Destroy Negotiability [vii] Information in the Memo Portion of an Instrument Does Not Affect Negotiability [10] Rules of Construction for Ambiguous Instruments

20.03 The Holder of an Instrument [1] Distinctions Among Possessors of Instruments [2] Becoming a Holder [a] What Constitutes Possession of the Instrument? [b] Transfer and Negotiation of Bearer and Order Instruments [3] Rights of a Holder [a] The Right to Negotiate the Instrument [b] The Right to Secure a Discharge of the Instrument [c] The Right to Enforce Payment of the Instrument [i] A Holder Has Important Procedural Advantages Over an Ordinary Transferee or a Claimant Suing on the Underlying Claim [A] A Holder Need Only Bring Action on the Instrument Itself [B] Production of the Instrument Containing the Signature of the Obligor Gives the Plaintiff-Holder a Prima Facie Right to Recovery [ii] A Comparison Between the Procedures in an Action on an Instrument and in an Action on the Underlying Obligation [4] Rights of a Non-Holder [a] Lost or Stolen Instruments [b] The Shelter Principle [i] Scope of the Principle [ii] Limitations on the Shelter Principle

20.04 The Holder in Due Course. [1] In General [2] A Holder in Due Course Must Be a Holder.

20.05 A Holder in Due Course Must Take an Instrument for Value [1] A Holder Takes an Instrument for Value Only to the Extent That the Agreed Consideration Has Been Performed [2] A Holder Takes an Instrument for Value if the Holder Acquires a Security Interest in or Lien on the Instrument [3] A Holder Who Takes an Instrument in Payment of or as Security for an Antecedent Claim Takes for Value. [4] A Holder Takes for Value When Negotiable Instruments Are Exchanged [5] A Holder Who Makes an Irrevocable Commitment to a Third Person Takes for Value.

20.06 A Holder in Due Course Must Take an Instrument in Good Faith

20.07 Notice as an Element of Holder in Due Course Status [1] The Importance and Definition of Notice [2] Notice Within An Organization [3] When Is An Instrument Overdue? [4] Purchasers Who Take With Notice That the Instrument Has Been Dishonored Cannot Be Holders in Due Course [5] Purchasers Who Take With Notice of a Defense or Claim to the Instrument Cannot Be Holders in Due Course [a] Defense or Claim Defined [b] Voidability or Discharge of Obligation on Instrument [c] Breach of Duty by Fiduciary [d] Knowledge That Does Not Constitute Notice of a Defense or Claim [e] Notice in New York and the Doctrine of Forgotten Notice [6] Purchasers Who Take Instruments Bearing Irregularity Cannot Be Holders in Due Course

20.08 Additional Issues Affecting Holder in Due Course Status [1] Transfers Not in the Ordinary Course of Business That Prevent a Purchaser From Being a Holder in Due Course [2] The Payee as a Holder in Due Course

20.09 Causes of Action and Statutes of Limitation [1] Pre-Revision Provisions [2] Current Provisions

20.10 Rights of a Holder in Due Course [1] Assertion of Claims and Defenses Against a Holder in Due Course [a] In General [b] A Holder in Due Course Takes Free of All Claims [c] A Holder in Due Course Takes Free of Most Defenses Asserted Against Parties Other Than the Holder [d] Real Defenses That Can Be Asserted Against a Holder in Due Course [i] Infancy of the Obligor [ii] Incapacity, Duress, and Illegality as a Defense [iii] Usury as a Defense [iv] Fraud in the Factum as a Defense Against a Holder in Due Course [A] Defense of Fraud in the Factum as a Vehicle for Consumer Protection [v] Discharge as a Defense Against a Holder in Due Course [2] Assertion of Claims and Defenses Against One Not a Holder in Due Course [a] One Who Is Not a Holder in Due Course Takes an Instrument Subject to the Defense of Want or Failure of Consideration [i] What Constitutes Want of Consideration or Failure of Consideration? [ii] Pleading and Proof Required in Assertion of Defense [iii] No Consideration Is Necessary Where the Instrument Is Taken in Satisfaction of an Antecedent Debt [b] One Who Is Not a Holder in Due Course Takes an Instrument Subject to the Defense of Nonperformance of Conditions Precedent [i] Conditions Precedent to the Obligation on the Instrument [ii] Conditions Precedent to the Underlying Obligation [A] Express Conditions Precedent [B] Implied or Constructive Conditions Precedent [iii] Admissibility of Parol Evidence in Proof of Conditions Precedent [c] One Who Is Not a Holder in Due Course Takes an Instrument Subject to the Defense of Breach of a Condition as to Delivery [i] Nondelivery [ii] Delivery for a Special Purpose [iii] Conditional Delivery [iv] Admissibility of Parol Evidence [d] One Who Is Not a Holder in Due Course Takes an Instrument Subject to the Defense That It Was Acquired by or Through Theft [e] One Who Is Not a Holder in Due Course Takes an Instrument Subject to Restrictive Indorsements [f] One Who Is Not a Holder in Due Course Takes an Instrument Subject to the Defense That It Has Been Altered [i] Alteration in General [A] Effect of Alteration [B] Pleading and Proof [ii] The Nature of the Alteration [iii] The Alteration Must Be Fraudulent [iv] When the Defense Is Barred [A] Assent to an Alteration Will Bar Assertion of It as a Defense [g] Jus Tertii [i] Denial of Claims Based on Rights of Others [ii] Interpretative Difficulties in Section 3-305(c) [A] Claims vs. Defenses [B] Section 3-305(c) Is Not Confined to the Claims and Defenses of Third Parties to the Instrument [iii] Jus Tertii Arguments May Be Used to Attack the Plaintiffs Status

20.11 Signatures and Forgeries [1] Necessity of Signature for Liability to Attach [2] What Constitutes a Signature? [3] Whose Signature Is It? [a] Liability for Unauthorized Signatures [i] Ratification of Unauthorized Signatures [ii] Preclusion to Deny Authorization [b] Liability for Signature by an Authorized Representative [i] A Signature May Be Made by an Authorized Representative [ii] Failure Both to Indicate Representative Capacity and Name Principal [A] Personal Liability of Principal and Representative [B] The Use of Parol Evidence to Disestablish Signers Personal Liability [iii] Liability of Representative Where Principal Is Named [iv] Signature on Behalf of an Organization [4] Burden of Proof Regarding Signatures [a] Specific Denial Required to Place Authenticity of Signature in Issue [i] Effect of Failure to Deny Specifically [b] Burden of Establishing Genuineness Is on the Party Claiming Under the Signature [i] Presumption of Genuineness [ii] Plaintiffs Burden of Establishing Defined [5] Capacity in Which Signature Is Made [a] A Signature Is Presumed to Be an Indorsement [b] Parol Evidence Is Inadmissible to Explain the Intended Liability of the Signer [6] Liability for Unauthorized Signature Caused by Negligence [a] Effect of Negligence [b] Substantial Contribution and Proximate Cause [c] Comparative Negligence Standard and Burden of Proof [d] Availability of Defense to Depositary Bank [e] Imposter Rule and Fictitious Payee RuleIntroduction [i] Scope of Imposter Rule [ii] The Fictitious Payee Doctrine [iii] The Consequences of Negligence

20.12 Liability of the Maker or Issuer [1] The Maker or Issuers Obligation [a] The Maker or Issuer Promises to Pay According to the Terms of the Instrument as Issued [b] The Maker of Issuers Liability Is Primary [c] A Note is a Contract; Makers Obligation Is Subject to Contract Law

20.13 Liability of the Acceptor or Payor (Drawee) [1] Drawee as Acceptor [a] The Nature of a Draft [b] The Acceptors Obligation [2] Acceptance [a] What Constitutes Acceptance? [b] Personal Money Orders [c] Certified Checks; Certification as Acceptance [d] Refusal to Pay Instruments on Which Bank Is Obligated [e] When Acceptance Becomes Effective [3] Acceptance at Variance With Terms of Draft [a] Disclaiming the Obligation [b] Modifying the Obligation [c] Acceptance Varying Place of Payment [4] Finality of Payment or Acceptance Rule [a] Mistaken Payment and Restitution [b] What Constitutes Payment Under the Final Payment Rule? [c] Change of Position in Reliance on Payment or Acceptance [d] Negligence of the Holder Does Not Preclude Application of the Finality of Payment Rule

20.14 Liability of the Drawer [1] The Drawers Obligation [a] Conditions Precedent to the Drawers Obligation [b] Disclaiming Liability

20.15 Liability of the Indorser [1] Definition of an Indorsement [a] Elements Necessary to Constitute an Indorsement [b] Types of Indorsement [i] Special Indorsement [ii] Blank Indorsement [iii] Anomalous Indorsement [iv] Restrictive Indorsement [2] The Indorsers Obligation [a] The Indorsers Contract [b] Conditions Precedent to the Indorsers Obligation [c] Varying the Indorsers Contractual Obligation [i] Disclaiming the Indorsers Contractual Obligation [ii] Modifying the Indorsers Contractual Obligation [iii] Admissibility of Parol Evidence to Establish Indorsers Contract [d] To Whom Does the Indorsers Obligation Run? [e] In What Order Are Indorsers Liable?

20.16 Liability of the Surety [1] The Nature of a Suretyship Relationship [a] In General [b] Suretyship and Negotiable Instruments [2] Accommodation Parties [a] Definition of Accommodation Party [b] Establishing Accommodation Status [i] Admissibility of Parol Evidence [ii] Receipt of Benefit [c] To Whom Does the Accommodation Partys Obligation Run? [d] The Accommodation Partys Obligation Under the New York State Variation [e] Defenses Available to Accommodation Parties [i] Failure of Consideration Not a Defense [ii] Discharge or Release of Accommodated Party [iii] Extension of Time of Payment [iv] Modification of Accommodated Partys Agreement [v] Impairment of Collateral [f] Consent to, and Waiver of Discharge [g] The Accommodation Partys Right of Subrogation [3] Guarantors [a] In General [b] To Whom Does a Guarantors Obligation Run? [c] A Guaranty Is Not Rendered Unenforceable Because It Violates a Statute of Frauds [d] Guarantees in Consumer Transactions

20.17 Warranty Liability [1] In General [a] Contractual and Warranty Liability Distinguished [b] The Nature of Warranty Liability [i] Varying Warranty LiabilityModifications and Disclaimers [c] Accrual of Cause of Action [i] A Cause of Action for Breach of Warranty Accrues When the Instrument Is Transferred or Presented [ii] Statute of Limitations [d] Damages for Breach of Warranty [2] Transfer Warranties [a] Against Whom Are the Warranties Imposed? [i] There Must Be a Transfer of the Instrument [ii] The Transfer Must Be for Consideration [b] To Whom Do the Warranties Run? [i] Transfers With and Without Indorsements [c] The Specific Transfer Warranties [i] Person Entitled to Enforce [ii] All Signatures Are Authentic and Authorized [iii] No Alteration [iv] No Defense Good Against Transferor [v] No Knowledge of Any Insolvency Proceeding [vi] Warranty as to Remotely-Created Consumer Item under 2002 Revision [3] Presentment Warranties [a] Against Whom Are the Warranties Imposed? [b] To Whom Do the Warranties Run? [c] The Specific Presentment Warranties [i] The Presentment Warranties Operate in Conjunction With the Finality of Payment Rule of Section 3-418 [ii] Person Entitled to Enforce [A] In General [B] Title to Bearer Instruments and Order Instruments [iii] Authorized Signatures [A] The Basic Warranty [B] Exceptions to the Basic Warranty [iv] No Alterations [A] The Basic Warranty [B] Exceptions to the Basic Warranty [v] Right to Assert Drawees Defenses [d] Third Party Actions and Vouching-In

20.18 Conversion Liability and Forged Indorsements [1] In General [2] Incorporation of Common Law [3] Conversion by Payment on a Forged Indorsement [a] Introduction [i] Payee vs. Drawer [ii] Drawer vs. Drawee Bank [iii] Drawee Bank vs. Collecting Banks [iv] Payee vs. Drawee Bank [v] Drawer vs. Depositary Bank [vi] Payee vs. Collecting Bank [A] The Scope of Pre-Revision Section 3-419(3) [B] Reasonable Commercial Standards [C] Representative [D] Proceeds

20.01 Introduction to Article 3 of the Uniform Commercial Code*

[1] Recent Developments in the Law of Negotiable Instruments

Article 3 of the Uniform Commercial Code (herein referred to as the Code) concerns the payment mechanisms through which commercial transactions are most commonly financednegotiable instruments. Negotiable instruments or commercial paper, specifically drafts and checks, have long played an important role in commerce as representing one of several payment systems. Checks and drafts are used as a means for one person to make payment of funds to another person.1 Certain principles with respect to application of the Code must be recognized. The Code is a codification of the principles of the law merchant; it sets forth liabilities that are different than existed at common law.2 Where the Code provides for the situation in which the Code codifies the law on a subject, a common law claim cannot be asserted, as it is supplanted by the Code.3 Notwithstanding recent inroads made possible by technological advances in electronic payment systems, commercial suppliers of goods and services typically perform their obligations in return for the drafts, such as checks, and notes governed by Article 3. The provisions of this Article constitute a comprehensive codification of the rights and duties of the parties to negotiable instruments.4

Nevertheless, the law of negotiable instruments has recently been the subject of substantial changes on two fronts. Developments in the use of credit cards, electronic funds transfers, and check collection led to substantial debate about the need for a more comprehensive codification of the law of payment systems, including credit cards and electronic funds transfers. Early attempts to create a Payments Code, however, met substantial opposition.5 In response, the American Law Institute and the National Conference of Commissioners on Uniform State Laws adopted a comprehensive Revision to Article 3 and amendments to Article 4, which governs the check collection process.6 The current version of Article 3 retains the basic concepts and structure of prior law, but takes account of certain technological developments and purports to clarify ambiguous terminology and resolve interpretive conflicts among the courts.7 Other revisions, however, are substantive, and dramatically alter the law of negotiable instruments. (Indeed, Article 3 itself has been renamed Negotiable Instruments.). This 1990 revision and amendments effected by N.C.C.U.S.L have been recognized by the courts as having resulted in significant substantive revisions.8 At the same time, one also must not lose sight of the fact that many provisions from the Pre-Revision version are carried forward in the current version without any substantive changes. To the extent a particular provision remains the same under the successor or parallel section in the revised Code, case law interpretations based upon the Code provision will continue to provide precedent for construing the revised Code section.9

Further amendments to Uniform Commercial Code Articles 3 and 4 were drafted by N.C.C.U.S.L. as approved and recommended for enactment by the states at the N.C.C.U.S.L. annual conference meeting on July 26-August 2, 2002. Unlike the 1990 Official Text, the 2002 Amendments (referred to in this chapter as the 2002 Revision) affect significantly more modest revisions to Articles 3 and 4, and changes to the law. Topics that are addressed in the 2002 Revision cover transferring lost instruments; payment and discharge; tele-phonically generated checks; suretyship; electronic communications; consumer notes and United Nations Convention on International Bills of Exchange and International Promissory Notes.10 The more significant and substantial revisions effected by the 2002 Revision are, as to suretyship rights, to wit: the respective rights and liabilities of the parties to an instrument when certain parties are released by the person entitled to enforce an instrument or such person agrees to a change in the obligations of the principal obligor on the instrument (the entire current version of Code 3-605, Discharge of Indorsers and Accommodation Parties, has been deleted, and in substitution therefore, a new section has been added). Also, in connection with the revisions in the 2002 Revision, certain definitions were added.11 Two notable changes are that the definition of Good Faith has been deleted from Article 3 (in that an exact definition was added to the 2001 revisions to Article 1) and that a new definition of a term used in several sections in the 2002 Revision, Record, has been added to Article 1, in 1-201(33a). This chapter, therefore, discusses both the law of the pre-Revision version of Article 3, the modifications and clarifications of that law under the Revision, and the 2002 Revision. Citations to the Revision will be designated by section number alone. Citations to pre-Revision sections will be designated as pre-Revision Section 3-xxx in text and Pre-Revision UCC 3-xxx in footnotes. Reference to the 2002 Revisions will be designated as UCC 3-xxx (2002 Revision) in text and footnotes.

In addition, substantial portions of payments law are now governed by federal, rather than state law. The Expedited Funds Availability Act12 and Regulation CC of the Federal Reserve Board13 may pre-empt state law that governs the check collection process. Although most of the effects of these federal enactments limit the range of Article 4 of the Code, they also have implications for Article 3 provisions, such as the scope of the warranty made by a bank that transfers or presents a check for payment. Section 3-102(c) recognizes the increasing influence of federal law by providing: Regulations of the Board of Governors of the Federal Reserve System and operating circulars of the Federal Reserve Banks supersede any inconsistent provision of this Article to the extent of the inconsistency.

Adoption of the 1990 Amendments, the Revision, by the various states occurred over a period of several years. As a result, courts continue to hear disputes concerning transactions that occurredwhen the prior version of Article 3 was in effect. Courts in this position must decide what effect to give to the revised version where it varies from the prior version. This raises the question as to the prospective effect of the current version. Some courts have considered that substantive changes in the current version of Article 3 reflect a desire to clarify prior ambiguities or to make commercial law consistent with commercial practice. These courts have used the language of revised Article 3 to interpret provisions of the version in effect when the transaction in dispute arose. In Amberboy v. Societe de Banque PriveeAmberboy v. Societe de Banque Privee,14 for instance, the Texas Supreme Court determined that a note bearing a variable interest rate could satisfy the conditions of negotiability, notwithstanding explicit rejection of that position in a comment to the pre-Revision Code. The Court noted that the revised version of the Code (which had not been adopted in Texas) made such notes negotiable. The Court concluded that its interpretation was consistent with the Codes objective of reflecting modern commercial practices. Similarly, a New Jersey court concluded that an amendment to that states version of the Code adding the current version Article 3 was curative in nature and thus could be given retroactive effect with respect to notes bearing variable interest rates.15

Numerous appeals courts have recognized the general proposition that unless it is otherwise manifestly intended by the legislature, or expressly provided in the statute, a new law does not have retroactive effect.16

In an Illinois case that addressed the same issue, however, an appellate court determined that revised provisions that made such instruments negotiable were substantive in nature and thus could only apply prospectively. In Johnson v. Johnson,17 the court concluded:

While we believe that the 1992 amendment has no retroactivity, at least one State (New Jersey) has adopted a contrary view. Where the note was executed in 1989, the trial held in 1990, and the New Jersey U.C.C. amended in 1992, the New Jersey court determined that the amendment was curative, embracing the expectations of the parties. With remarkable casuistry, the New Jersey court suggests that as an exception to the non-retroactivity rule the amendment attempts to improve a statutory scheme and bring the law into harmony with the expectations of the parties and the law in the commercial marketplace. Applying such retroactivity does just the opposite. It is generally unfair and makes the parties unsure of the bargain they have struck. The New Jersey court has contorted the rules of statutory construction to meet the exigencies of current leading practices. In Illinois, we do not so bend.

Had our General Assembly desired, it could have designated that the amendment be given retroactive application. Had the American Law Institute which promulgated the uniform act had such a desire, retroactivity could have been included in the comment.

The Minnesota Supreme Court has adopted a view more similar to that of the Illinois appellate court. In deciding which parties were properly the subject of a conversion suit for a check bearing a forged indorsement, the court presumed that the legislature intended an amendment to effect a statutory change. Thus, in considering whether a depositary bank could be liable for conversion in a Pre-Revision transaction, the existence of the amendment imposing liability indicated that such institutions were previously exempt from liability. The current version of Article 3 was not be given any retroactive effect.18 A federal bankruptcy court similarly refused to give retroactive effect to a provision that was interpreted as expanding the conditions under which a forged indorsement by a faithless employee would be effective.19

The Pre-Revision will continue to apply to any case where the events or transactions upon which a claim or suit is based occurred prior to adoption of the revised Code in that state, notwithstanding that the current version may be in effect at the time a lawsuit is commenced or a decision rendered by a court.20 The revised Code is prospective and will apply where the transactions occurred after its adoption.21 However, a Minnesota appellate case22 recognized that if an amendment to a statute seeks only to clarify the intent of the old statute, then the new statute may be applied retroactively [citations omitted]. We rely upon the amended UCC to the extent that it serves merely to clarify usages and practices previously recognized. Finally, as recognized in a Washington appellate case,23 [S]tatutes are presumed to apply prospectively only [citations omitted]. An exception is recognized if the statute is remedial in nature, and retroactive application would further its remedial purpose [a law] is deemed remedial and applied retroactively when it relates to practice, procedure or remedies, and does not affect a substantive or vested right.24

Another important concept concerns whether the provisions of the Code displace other rules of law (statutory and case law). In Travelers Cas. & Sur. Co. of Am. v. Manufacturers Life Ins. Co.,25 the court stated the general rule of interpretation that there will be a displacement under circumstances where the Code articulates a loss distribution scheme that applies to fact patterns that are involved in the case. In other words, if a loss distributive scheme is available under the [Code] for a particular fact pattern, then related common law claims must be dismissed. (citations omitted)

Finally, 42 states and the District of Columbia have also adopted the Uniform Electronic Transactions Act, or UETA. This Act is designed to facilitate the use of electronic commerce by making electronic records and signatures legally equivalent to writings and written, or manually-signed, signatures. The UETA interacts with Article 3 insofar as instruments may be created and executed electronically. For instance, the Proposed 2002 Revision substitutes the term record for writing.26 A record is defined in corresponding revisions to Article 1 of the Uniform Commercial Code as information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.27 Other provisions in the Proposed 2002 Revision adopt from UETA the definition of an electronic signature as an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record.28 The federal Electronic Signatures in Global and National Commerce Act,29 however, does not apply to instruments governed by Article 3. Section 7003(a)(3) specifically exempts records governed by Article 3 from coverage of the federal provisions.

[2] Scope of Article 3

Generally, Article 3 is concerned only with negotiable instruments. Most importantly, Article 3 does not apply to money,30 although much of the law of negotiable instruments has the purpose and effect of transforming instruments into money substitutes. It also does not apply to electronic funds transfers governed by Article 4A or to securities, which are governed by Article 8.31 Nor does it apply to consumer electronic fund transfers such as credit card, debit card, or ATM card transactions. In addition, if there is any conflict between the provisions of Article 3 and those of Article 4, which deals with Bank Deposits and Collections, or Article 9, which deals with Secured Transactions, the provisions of Article 3 are subordinate.32

The Code establishes several requirements that must be satisfied for a writing to qualify as a negotiable instrument. These requirements will be discussed in detail later in this chapter.33 If an instrument is negotiable, the holder may qualify as a holder in due course, a status that provides rights far more substantial than those available to an obligee or assignee under a simple contract. For instance, a party with holder in due course status may take the instrument free from defenses to payment that could be asserted against a mere assignee of a common law contract right.34 It is in part for this reason that negotiable instruments are considered money substitutes. As in the case of a negotiable instrument, a transferor of money can give a good faith transferee better title than the transferor had.35 If the requirements of negotiability under the Code are not satisfied, however, the obligee under the instrument has only the rights of an obligee or assignee under a contract. As noted above, to the extent that Article 3 involves transactions governed by the Federal Reserve System, such as the collection and return of checks, the Code is superseded by federal law and regulations. This may be true even if no Federal Reserve Bank participates in the transaction. For instance, the Expedited Funds Availability Act36 confers broad authority on the Federal Reserve System to regulate check collection nationwide, even if the instrument at issue never passes through a Federal Reserve Bank.

[3] Nature of a Negotiable Instrument

A negotiable instrument usually has a dual nature. It is foremost an independent and unqualified promise to pay a fixed amount of money on demand or at some definite time in the future to either the bearer of the instrument or to the order of some person named in the instrument.37 In addition, the instrument will often serve as written evidence of some underlying obligation for which the instrument was given. This is not always the case, however, as where the instrument is given as a gift. Where the instrument is issued to satisfy an underlying obligation, that obligation is integrated or merged into the instrument. The legal effect of this merger is that the requirements to pay the instrument and to make payment on the underlying obligation rise or fall in concert. While the instrument is outstanding, for instance, the underlying obligation is suspended and the obligee cannot bring an action to enforce it unless the instrument is subsequently dishonored.38 Thus, an obligee who accepted a draft from an obligor within the statutory period for receiving compensation from the obligor could not claim that the period had been exceeded, even though the proceeds of the draft were not available to the obligee until after the end of the period.39 Additionally, payment of the instrument constitutes a discharge on the underlying obligation.40 (It is important to note, however, that payment is a specialized term that requires payment on behalf of the obligor on the instrument and payment to a person entitled to enforce the instrument.)41 This suggests both the value of negotiable instruments as payment devices and their ready acceptance in the commercial world as substitutes for cash transactions.

[4] Use of a Negotiable Instrument in an Accord and Satisfaction

Prior to the current version of Article 3, courts divided over the issue of whether a negotiable instrument could effect an accord and satisfaction when tendered and taken in an amount less than an alleged debt. First, one must define an accord and satisfaction. It is a contractual method by which a debt or claim can be discharged. The accord is the agreement between the parties, while the satisfaction is the execution or performance of the agreement.42 A federal district court43 observed that an accord and satisfaction must contain the elements of a normal contract; these are an offer, acceptance, and consideration. A Texas appellate court44 recognized that no separate consideration is necessary for the accord and satisfaction; specifically, for the satisfaction. The consideration supporting the accord and satisfaction is the good faith dispute as to liability on either a liquidated or unliquidated claim [which is what] furnishes sufficient consideration for an accord and satisfaction. Some courts resolved the issue through Section 1-207 of the Code, which permits a party to take a check, but explicitly to reserve rights when depositing the check, thereby avoidingany claim of accord and satisfaction. The current version of Article 3 addresses the issue directly. Section 1-207(2) provides that the authorization for a reservation of rights does not apply to an accord and satisfaction.45 Section 3-311 now governs checks that purport to be in full satisfaction of a debt.

Section 3-311 relieves a person who offers an instrument in payment of an obligation of further liability when four conditions are met. First, the party offering the instrument must have a good-faith belief that the instrument fully satisfies the claim. Second, the amount of the claim must be unliquidated or subject to a good-faith dispute. Third, the claimant must obtain payment of the instrument. If these conditions are satisfied, the underlying claim will be discharged if, fourth, the instrument or an accompanying writing contained a conspicuous statement that it was tendered in full satisfaction of the debt.46

Each of these four elements are explained and discussed in numerous cases. As indicated in an Illinois case,47 when the criteria of the section are satisfied there is an accord and satisfaction if there is a bona fide dispute and the creditor cashes the check, notwithstanding that the creditor protests that he does not accept the amount in full satisfaction. The creditor must either accept the payment with the condition or refuse. An Indiana court48 described 3-311 as providing a bright-line rule that the cashing of a check that is clearly marked full satisfaction check (and where the other conditions of 3-311 are met) operates as an accord and satisfaction. An endorsement of a full satisfaction check that purports to reserve the payee/creditors rights against the drawer/debtor is not effective to prevent the accord and satisfaction and discharge of the debtor on the underlying obligation.

The tender of the accord and satisfaction check must be made in good faith.49 Addressing the conspicuous requirement, a Virginia appellate case50 provides a useful explanation of the definition of conspicuous as provided in Section 1-201(10). It means a term that a reasonable person should notice. It is a physical attribute that is involved; the focus of the inquiry is the manner in which the statement is displayed, as no specific language is required. It is the province of the court to decide if a statement meets the requirement and is conspicuous. The debtor sent the creditor a letter that described the deficiencies of the creditors work. The final paragraph of the letter stated JSI stands by its final amounts as stated on the latest correspondence dated December 8, 2000. Enclosed, please find a check in the amount of $13,580.00 representing final payment on the contract. This statement, the court held, satisfied the conspicuous statementthat the check is tendered in full satisfaction.

Practical Hint:Although it is not necessary to use any particular word or phrase, in that UCC Section 3-311(b) provides what is required is a conspicuous statement to the effect that the instrument is tendered as a full satisfaction (emphasis added), use of the phrase in full and final payment or payment in full satisfaction is preferable and recommended so that there will be no fact question for a court to determine as to the drawers intention. A drawer-obligor who wants to more specifically describe the transaction can certainly do so but should accomplish that goal by adding additional language to one of the recognized phrases, in lieu of substituting other language. It is also recommended that the accord and satisfaction language be placed on the instrument and that the obligor not rely only on language in an accompanying letter, although the statute permits the language to be in a written communication that accompanies the instrument. It is a much clearer expression of intent if the language is on the instrument, and there can be no question as to whether the letter was received or not. The obligor can place the requisite language in both the letter and the instrument, if the obligor desires to send an accompanying letter. Finally, an obligor is encouraged to emphasize the language that tenders the check in full settlement, in a manner that satisfies the conspicuous definition, and not rely upon the determination of the court whether the language was or was not, as a fact determination, conspicuous.

Exceptions to this discharge rule are made in two cases. No discharge results if the claimant is an organization (defined in Section 1-201(28) to include corporations, governments, or other legal or commercial entities) that sent a conspicuous statement to the person against whom the claim is asserted, indicating that communications concerning disputes, including an accord and satisfaction, are to be sent to a particular person, office or place and that the instrument or communication was not received by that person, office, or place.51 Note that this rule requires receipt by the person, office or place, not simply the sending of the instrument to the designated person or location. In addition, no discharge results if the claimant tenders repayment of the amount of the instrument within 90 days of receiving payment as long as the claimant is not an organization that provided a statement about the proper person or location for receipt of communications concerning disputes.52 Finally, discharge results, notwithstanding the exceptions that would otherwise apply, if the claimant knew, within a reasonable time before collection of the instrument was initiated, that the instrument was tendered in full satisfaction of the claim. Thus, if a clerk in the organization who is not authorized to receive notices concerning disputes receives a check with a notation in full payment, the clerks failure to notice the notation and deposit of the check will not result in a discharge. Instead, the statement and 90-day provisions would be triggered. If, however, an agent of the organization who has been communicating with the alleged debtor receives such a check, notices the notation, and deposits the check, the claim is discharged.53

[5] Relevance of Article 3 to Writings Not Meeting Requisites of Negotiability

For the most part, writings that fail to satisfy the requirements of Section 3-104 cannot be negotiable instruments within the meaning of Article 3, which does not apply.54 Such a writing, though valid, will merely have the effect of a common-law contract.55 Nevertheless, some writings that do not meet the formal requisites of negotiability are statutorily deemed negotiable instruments.56 It is common, for instance, for legislation authorizing the issuance of bonds by the state or its political subdivisions to declare such bonds to be negotiable instruments. Other writings may bear elements of negotiability by judicial decision, contract or custom.57 Another important principle recognized by the courts is that negotiability of an instrument is dependent upon the form of the instrument and is to be determined by what appears on the face of the instrument. The determination of whether a note is negotiable is based upon the relevant law, not upon the intention of the parties (whether they intended it to be negotiable) or whether the instrument contains a statement that it is negotiable.58

Although Section 8-105(1) provides that certificated securities59 governed by Article 8 of the Uniform Commercial Code are negotiable instruments, they are governed by the provisions of Article 8, rather than of Article 3.60 Nevertheless, Article 8 largely incorporates Article 3 rules that define the rights and powers of parties to a negotiable instrument. Perhaps the most important distinction is the lack of necessity for an Article 8 security to satisfy the requirements concerning the form of an instrument that are found in Section 3-104.

Prior to its current version, Article 3 provided that a writing that was nonnegotiable by virtue of not being payable to order or bearer could still be subject to Article 3 if, by its own terms, the writing did not preclude transfer.61 Nevertheless, there could be no holder in due course of such an instrument. Thus, a writing that purported to be a check in every way other than that it was payable to X rather than to the order of X would be governed by those provisions of Article 3 other than those that grant special rights or powers to a holder in due course. Currently, Article 3 excludes nonnegotiable instruments from its coverage altogether, but includes some writings that previously did not satisfy the requirements of negotiability. The scope provision, Section 3-102, restricts the applicability of Article 3 to negotiable instruments, a phrase that excludes writings in the form Pay to X.62 Nevertheless, the definition of a negotiable instrument, includes a document that otherwise qualifies as a check but that is payable to X rather than to the order of X.63 Thus, a person in possession of such a check may be a holder and, if he or she otherwise satisfies the requirements, may be a holder in due course. The exception is justified because transferees of instruments that otherwise qualify as checks are unlikely to examine the document to ensure that it includes the usual to the order of language, and would be surprised to discover that a document otherwise in the form of a check failed the test of negotiability.64

Pre-Code cases permitted parties to some documents to obtain the benefits of negotiability, even with respect to documents that did not satisfy the formal requisites of negotiable instruments.65 Some cases decided under the Code have followed this line. For instance, a party to a writing that did not qualify as a negotiable instrument could be estopped by its conduct from asserting a defense against a bona fide purchaser. In First State Bank at Gallup v. Clark,66 the court found that a note that failed to satisfy the Codes requirements of negotiability could, under contract law, retain the elements of negotiability as between the parties involved in the transaction. Thus, where the maker of a nonnegotiable note expressly permitted pledge of the note by the payee as collateral for a loan, the court found the maker estopped from asserting defenses to payment against the pledgee. The doctrine of negotiability by estoppel was adopted very early in New York and accepted fairly generally under the Negotiable Instruments Law.67 While these cases suggest that an obligor will be estopped from denying negotiability against third parties only where the obligor has, by negligence or fraud, induced such parties to believe they had purchased negotiable instruments, other cases suggest that a contractual waiver of defenses against third-party purchasers estops the obligor from future assertion of such defenses.68 Comment 2 to Section 3-104 continues this policy by providing that a court could confer the benefits of negotiability through principles of estoppel or contract, even though the law of negotiable instruments did not apply.

Although parties may not contractually transform a nonnegotiable instrument into a negotiable one, substantial case law supports the conclusion that parties can contractually agree that a writing will have the same legal effect as a negotiable instrument. Early case law in New York recognized, at least in dicta, the creation of negotiable instruments by contract outside of the Negotiable Instruments Law.69 These cases suggested that as long as such contractual negotiability would not directly contravene provisions of the Negotiable Instruments Law, as for example where the statute merely enumerated requirements for negotiability without explicitly denying negotiability in their absence, an instrument might be made negotiable by contract without having satisfied all of the statutory requirements. In Cho v. Kacy Chi,70 the court makes it clear that although an instrument is not negotiable for failure to satisfy the elements of UCC 3-104(a), and is therefore not subject to the provisions of the Code (not subject to the law on negotiable instruments), that does not render the instrument unenforceable. The court enforced the instrument to the extent of the legal consideration given for the document.

Practical Hint:This is an important point. An instrument does not have to be negotiable to be enforceable against the maker, in accordance with general contract principles, since an instrument is a contract.71 A non-negotiable instrument is still enforceable, although lacking negotiability, as certain rights are not obtained by a holder, such as the ability to quality as a holder in due course.

The current version clarifies the effect of legends on instruments. An instrument which is nonnegotiable due to a failure to comply with the requirements of negotiability cannot be made negotiable by placing appropriate legends or statements in the instrument.72 However, the placement of legends or statements such as not negotiable on an otherwise fully negotiable instrument will be given effect and the instrument will not be negotiable for any purpose.73

Some scope for contractual negotiability appears to remain under the Code. In the words of the New York State Law Revision Commission: It would appear that negotiability by contract is still limited although not forbidden, by Bank of Manhattan v. Morgan, 243 N.Y. 28 (1926) and Enoch v. Brandon, 249 N.Y. 263, 164 N.E. 45 (1928).74

The form of contractual provision necessary to create negotiability by agreement, however, remains unclear. In Manhattan Co. v. Morgan, Judge Cardozo indicated that it was insufficient for a contract to provide, without more, that the maker may treat the bearer as the absolute owner for all purposes and shall not be affected by any notice to the contrary.75 While such a provision serves to protect a maker who, with notice of an adverse claim, pays the holder, it does not, according to Cardozo, adequately protect future holderspresumably because the maker is not required by such language to treat the bearer as absolute owner for all purposes.

One early commentator opined that to create negotiability by stipulation the parties must show their clear intention not to conform to the act, but to make the instrument involved negotiable in spite of the clear prohibition of these sections.76 Professor Beutel thus recommended insertion of a rather detailedcontractual provision to make it clear that the parties had, in fact, contracted to create the rights available to the holder of a negotiable instrument.

The limited case law in this area seems to support Beutels recommendation of a detailed contractual provision to reflect the parties intent to confer the benefits of negotiability. In Morgan Brothers v. Dayton Coal & Iron Co.,77 an elaborate provision waiving rights between the issuer and the original or any intermediate holder, inserted in what would otherwise have been nonnegotiable corporate debentures, was deemed sufficient to permit recovery by a subsequent innocent holder of the bonds.78 In one case, however, a Pennsylvania court suggested that an otherwise nonnegotiable instrument could be rendered negotiable by the mere inclusion of the words This note shall be negotiable printed in the body of the note.79

The limits of any attempt to create negotiability by contract are evident in Becker v. National Bank and Trust Co.80 In Becker, the payee of notes transferred those documents to a third party to secure performance of certain obligations. The transfer was accompanied by an assignment, but there was no negotiation sufficient to make the transferee a holder. The transferee subsequently retransferred the notes to the Bank. Each note bore a legend permitting the payee or its assignees to assign or negotiate this Note. The bank claimed that this legend transformed it into a holder in due course, not subject to the defense of fraud in the underlying transaction because the parties had contracted for assignment to take place without losing the benefits of negotiability. The Virginia Supreme Court disagreed. The Court held that any attempt to change the effects of assignment into those of negotiation was an alteration of the legal concepts or definitions of negotiation and holder in due course, an attempt barred by the Official Comment to Section 1-102. Thus, the bank was entitled solely to its status and rights as an assignee.

Comment 2 to pre-Revision Section 3-104 indicated that new types of commercial paper which commercial practice may develop in the future may create a custom of negotiability notwithstanding failure to satisfy the formal requisites of Article 3 instruments. Like negotiability by estoppel, the doctrine of customary negotiability received early judicial recognition by Judge Cardozo in Manhattan Co. v. Morgan.81 Nevertheless, the doctrine appears to assume the existence of a substantial tradition within the trade of treating a writing as negotiable. Cardozo was therefore unwilling to consider a note to be negotiable by custom where its form had only come into general use in the same year as the transaction that gave rise to the controversy at issue. Other cases, however, refused to recognize any possibility of creating negotiability through custom.82

Comment 2 to Section 3-104 contains an oblique appeal to the development of negotiability by custom. It indicates that it may be appropriate, consistent with the principles stated in Section 1-102(2), for a court to apply one or more provisions of Article 3 to the writing by analogy, taking into account the expectations of the parties and the differences between the writing and an instrument governed by Article 3. That Section indicates that Code provisions are to be interpreted, (b) to permit the continued expansion of commercial practices through custom, usage and agreement of the parties.83 Hence, development of a customary use of negotiable-like instruments could be enforced by a court notwithstanding the failure of the writings at issue to satisfy the technical requirements of negotiability. In addition to a court applying an Article 3 provision by analogy, notably, as also stated in Comment 2, parties to a contract may choose to include provisions from Article 3 in an instrument to determine their respective rights and obligations.

Conversely, instruments that satisfy the requirements of negotiability may lose the benefits of that characterization by virtue of other principles of law. Thus, the Federal Trade Commission has, by regulation, required that language be inserted in notes arising out of certain consumer transactions in order to preclude holders of those notes from asserting the rights of holders in due course.84 In addition to the Federal Trade Commission Rules, there are other federal statutes that in specific types of loans contain provisions providing certain consumer protection and limiting holder in due course status.85 Further, state statutes outside of the Code contain provisions limiting holder in due course status and rights in consumer transactions.86

[6] Caveats With Respect to the Organization of This Chapter

It is important to recognize that the Code is a highly integrated statute, and Article 3 in particular has many of the features of a jigsaw puzzle. The importance of a specific provision becomes clear only when one considers its relationship to complementary provisions. This is particularly true with respect to the law of negotiable instruments. The common situation of fraudulent checks, for instance, may involve all of the various theories of liability discussed in this chapter. The defrauded bank may seek to impose liability on the drawer of the check under a contract theory. Failing that, the bank may seek to shift the loss to a prior transferee through a warranty theory. The payee of a stolen check, on the other hand, may seek recovery on a conversion theory. To ensure that all possible actions have been considered in any given fact situation, the reader should make liberal use of the cross-references found in this chapter. These statements are recognized in Merrill Lynch Pierce Fenner & Smith, Inc. v. Fakih.87 The court acknowledged that the Code is a highly integrated body of statutes and then remarked that its provisions must be carefully read as such. Fair and just application of the UCC rarely involves reference to only one or a few of its provisions in isolation.

20.02 The Requirements of a Negotiable Instrument*

The current version of Article 3 of the Uniform Commercial Code applies exclusively to negotiable instruments.1 Section 3-104(b) defines instrument, as used in Article 3, to mean negotiable instrument. The requirements of negotiability have evolved over a substantial period of time and are currently codified in Section 3-104(a). These requirements bear substantial study since they are highly technical, and courts, mindful of the power that accompanies holder in due course status, are often persuaded to deny a claimant those powers by finding that the instrument in question was nonnegotiable.

One might infer that bright lines separate negotiable from nonnegotiable instruments. After all, if the requirements of negotiability were intended to permit transferees of such paper to recognize immediately whether they had substantial rights against makers or drawers, regardless of defenses those parties might have against the payee, then clear distinctions would seem necessary. While the history and justification for negotiable instruments law certainly suggests that parties to them be able to discern readily the nature of the document in front of them, the fact is that the Code requirements leave substantial room for ambiguity. We will concentrate on the potential for ambiguity and its resolution throughout the following discussion.

The requirements for an instrument to be negotiable are set forth in Section 3-104:

(a) 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, if it:

(1) is payable to bearer or to order at the time it is issued or first comes into possession of a holder;

(2) is payable on demand or at a definite time; and

(3) does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment, (ii) an authorization or power to the holder to confess judgment or realize on or dispose of collateral, or (iii) a waiver of the benefit of any law intended for the advantage or protection of an obligor.2

Notably, money does not qualify as a negotiable instrument.3 Nor do securities that are governed by Article 8 of the Code.4 In determining whether there has been compliance with the requisites of negotiability, it is important to recognize that the original drafters of the Code argued for strict compliance with the requirements of negotiability. Thus, doubtful cases should be resolved against negotiability.5 While this principle has not been explicitly endorsed or rejected in the current version of Article 3, it is sensible if one is concerned that a party who qualifies as a holder in due course, a status that can only be attained by holding a negotiable instrument, can cut off defenses of innocent parties who would otherwise be able to avoid liability on the instrument.6

In Qui Ngo v. Park,7 the court observed that courts require strict compliance with the requisites for negotiability provided in the Code section that defines a negotiable instrument. Courts, the court held, are encouragedto strictly interpret the definitional requirements to the extent that in doubtful cases the [courts] decision should be against negotiability. (citation omitted)

Article 3 also permits the issuer of a writing that otherwise qualifies as an instrument to remove it from coverage of the UCC by including a conspicuous statement that the promise or order is not negotiable. This right, however, does not apply to a check.8

[1] The Types of Writings That May Constitute Negotiable Instruments

Although Section 3-104 no longer specifically refers to the need for a writing and that it be signed, 9 a promise and order that falls within that provision is defined as a written instruction or written undertaking.10 Additionally, the Official Comment to Section 3-104 provides that a promise within the section is a written undertaking and an order is a written instruction. Section 1-201(46) defines written or writing to include printing, typewriting or any other intentional reduction to tangible form.11 There is no requirement that the writing be permanent or indelible and an instrument written in lead pencil or other erasable form is sufficient.12 The writing need not be on paper and one court has heldthat an oral contract was reduced to tangible form and qualified as a writing when the contract was tape recorded.13 In Bank Leumi Trust Co. v. Bank of Mid-Jersey,14 the court noted that UCC 3-104 does not require that a check be written on a customary bank form or on paper. There is also no question that a writing includes duplicated instruments of any sort.15 The advent of electronic funds transfer promises to generate questions of the scope of a writing.

Some writings take particular forms, several of which have been specified in Article 3. In Transcontinental Holding Ltd. v. First Banks, Inc.,16 the court set forth the substance of Section 3-104(a) (400.3-104 R.S.Mo. (2009)) and then observed that The UCC recognizes four basic types of negotiable instruments: notes, drafts, checks, and certificates of deposit. To be a negotiable instrument, the writing must meet certain statutorily-defined requirements, at the heart of which is an unconditional promise or order to pay a fixed amount of money.

An instrument is a note if it is a promise.17 A check, for instance, is a draft that is payable on demand and is drawn on a bank.18 A check may be a negotiable instrument even if it is not payable to bearer or order, as long as it meets all the other requirements of negotiability.19 This exception to the general rule that an instrument must be payable to order or bearer was created to address the concern that someone in possession of a pre-printed check forms that lacked language of order (as was the case with numerous drafts drawn by credit unions) could otherwise be misled into believing he or she was in possession of an instrument, and would be surprised to discover that he or she did not have a holders rights due to the technical omission of words of negotiability. Thus, a check that is drawn payable to X will retain its status as a negotiable instrument, although a note with the same language will fail the test of negotiability. In McMullen Oil Co. v. Crysen Ref., Inc.,20 the court appropriately observed that a check involves three parties: (1) drawer who writes the check, (2) the payee, to whose order the check is made out, and (3) the drawee or payor bank, the bank which has the drawers checking account from which the check is to be paid. It is also important to recognize that while a check is an order to pay money, the check does not constitute an assignment of funds in the hands of the drawee.21 In Lenares v. Miano,22 the court explained the differences between a check and note, which are, although fairly obvious, nevertheless worthy to quote. The court observed that while checks and notes have many similarities and perform substantially like functions in many commercial transactions [however] the basic difference between the two classes of paper is that a draft or check is an order to pay money, whereas a note is a promise or undertaking to pay money.

A tellers check is a draft drawn by a bank either on another bank or payable through or at a bank.23 Tellers checks are typically used by a savings bank or savings and loan association that maintains an account with and draws checks on a commercial bank. A teller check may also be referred to as an official check. A cashiers check is a draft on which the same bank serves as drawer and drawee.24 Typically, a bank will issue such an instrument after it has received funds in return for which the cashiers check is issued. The bank will typically not allow a withdrawal against the deposited funds, as they are held to secure the cashiers check. A travelers check is an instrument that is payable on demand, is drawn on or payable at or through a bank, is designated by the phrase travelers check or its equivalent, and requires, as a condition to payment, a countersignature by a person whose specimen signature appears on the instrument.25 Note that in order to be a negotiable instrument, a promise or order must be unconditional. The fact that a countersignature is required as a condition to payment of a travelers check, however, does not render the writing conditional for purposes of defining a negotiable instrument.26 A share draft is drawn on the drawers account at a credit union. A share draft may not contain the word order, but has been interpreted by courts to fall within the category of negotiable instruments. For purposes of Articles 3 and 4, such a document functions exactly like a check.27 A certificate of deposit is an instrument that contains an acknowledgement by a bank that a sum of money has been received by the bank and a promise to repay the sum of money. A certificate of deposit is a note of the bank that issues it.28 A money order is effectively a check and may be sold by banks and nonbanks.29

Two common situations have developed where a party may issue what has come to be recognized as pre-authorized drafts or telechecks In the first variation, a consumer, to whom a vendor is providing goods or services, agrees with the vendor that the vendor can prepare drafts drawn on the consumers account. The consumer provides the vendor with his or her account number, and the vendor prepares drafts on the consumers account and deposits them at the vendors bank for collection. The second variation involves the preparation of checks by telemarketers who have purportedly sold goods through a telephone order in the name of the purchaser as a means of obtaining payment for the goods sold. The draft may have a stamp on it in the place where the signature usually is found, stating authorization on file, verbally authorized by your depositor, or such similar notation. The liability of the parties under these instruments, as for instance where the consumer claims not to have given an authorization, is not provided for directly in the Code.

Several states, including Wisconsin, California, Colorado, Hawaii, Idaho, New Hampshire, North Dakota, Oregon, Texas, Utah, West Virginia, and Nebraska, have addressed this situation by amending 3-104, defining a negotiable instrument, to incorporate a new definition of a Demand draft30 and providing in the warranty sections under Articles 3 and 4 that the person creating the demand draft warrants that it was created with the authority of the person who is identified as the drawer.31 Similarly N.C.C.U.S.L. also addressed the situation by amending section 3-104 to incorporate a new definition of Remotely-created consumer item (which is, essentially, the same as a demand draft under the above identified states) in the 2002 Revision to Articles 3 and 4.

Numerous documents or writings may appear to be similar to an instrument but are not negotiable instruments.32 A withdrawal slip is not an instrument when it contains a statement that it is nonnegotiable.33

[2] A Negotiable Instrument Must Be Signed by the Maker or DrawerWhat Constitutes a Signature?

The current version of Article 3 (section 3104) omits the requirement, contained in earlier versions, that instruments be signed by a maker or drawer. Thus, one might initially argue that a promise or order that had been completed, except for the signature of a drawer or maker, still qualified as an instrument. As noted previously (see above 20.02[1]) the requirements that an instrument be written and signed are contained in the definitions of Order and Promise. Nevertheless, Article 3 retains the rule that no one is obligated on an instrument unless he or she signed it, or a representative signed it in a manner that binds the principal.34 As a result, even if a writing that contained a signature did constitute an instrument, no party could have a maker or drawers liability. Presumably, however, if some party subsequently signed the instrument as an indorser, that party would have an indorsers liability to subsequent transferees.

A signature may be made either manually or by means of a device or machine, such as a check writing machine that imprints the maker or drawers name. The drawer or maker may use any name,35 including a trade or assumed name, or a word, mark, or symbol executed or adopted by a person. The key requirementis that whatever name is used and however the signature is affixed to the instrument, the signer have a present intention to authenticate the writing.36

Thus, a signature may be typed, even if the rest of the instrument is hand written; or the signature may take the form of a symbol rather than the signers proper name. Virtually any form of printing, stamping or writing, on any part of the instrument, may constitute a signature. Moreover, objective intent governs, and where the issue is whether the instrument is negotiable, only the intent evidenced by the instrument itself is relevant.37 In the proper context, however, even a preprinted letterhead may constitute a signature, such as where the paper that contains the letterhead contains words of negotiability that appear to have been written with the intent to bind the party whose name appears on the document.38 Alternatively, a preprinted signature may render an instrument negotiable when combined with another indicium of intent to authenticate, as where a preprinted check is completed with an inscription written by a check writer.39 Courts have recognized the validity of facsimile signatures when they are authorized in account documentation (account rules and regulations governing an account).40

A signature need not be subscribed but may appear in the body of the instrument.41 For example, a note may read, I, X, promise to pay without any further signature by X. The instrument must be viewed as a whole to determine whether the inclusion of the name constitutes a signature. Thus, if the instrument was typewritten, contained no signature line, but the name was handwritten, a court might conclude that the handwriting evidenced an intention to authenticate the writing. Such a finding would justify the courts interpreting the document as a signed negotiable instrument. If, on the other hand, both the text of the instrument and the purported makers name were typewritten, and there was a signature line left blank, the court might conclude that there was no intention to authenticate the writing.42

While there may be a variety of signatures on an instrument, the vital signature is that of the drawer of a draft or maker of a note. An instrument signed only by parties other than drawers or makers has been held not to satisfy the requirements of negotiability.43

[3] A Negotiable Instrument Must Contain a Promise or Order to PayWhat Constitutes a Promise or Order to Pay?

A negotiable instrument must contain a promise or order to pay.44 An instrument that simply acknowledges an obligation or is an authorization or request is not negotiable.45

[a] Promise to PayA promise is an undertaking to pay and must be more than an acknowledgment of an obligation.46 In a Delaware appellate case,47 a document provided I Robert Harrison owe Peter Jacob $ 25,000. This document, the court held, is an acknowledgment of a debt; although one could imply that it is a promise to pay, it does not satisfy revised section 3-103(a)(9) that requires the promise to be an undertaking to pay. The court further stated that [S]uch an undertaking to pay does not exist on the face of the documenttherefore [the UCC] does not apply. Thus, an I.O.U. would not be a negotiable instrument.48 Similarly, a statement that I borrowed from H. Jones the sum of five hundred dollars with four percent interest; the borrowed money ought to be paid within four months from the above date would not constitute a promise to pay within the meaning of Article 3. Nevertheless, the breadth of the definition leaves unclear the effect of such language as I agree to pay, I am obligated to pay and I intend to pay. In an Alabama appellate case,49 wire transfer instructions and cash withdrawal slips were held not to be instruments (UCC 3-104(b)) because they were not undertakings or instructions to pay money. The policy of requiring strict compliance with the formal requisites of negotiability would seem to dictate that in questionable cases the courts should lean toward holding such instruments nonnegotiable.

Further, such cases as In re Nellis50 would be rejected under the Code. There the court held that a statement that a person had borrowed $2,000 which is subject to and payable on demand indicated a promise to pay. The court looked to the whole writing to discern its true nature. Under Article 3, the result would be different since the promise must stand on its own as an obligation to pay. The mere implication of a promise derived from a reading of the instrument as a whole should not be enough to confer negotiability.

[b] Order to Pay[i] An Order Is a Direction and Must Be More Than an Authorization or RequestAn order to pay is defined by the Code as a written instruction to pay.51 It must be more than an authorization or request to make payment.52 Occasionally, the distinction between a direction to pay and an authorization or request may not be clear. The drafters of the Code have suggested how the niceties of language may generate disparate legal results. The Official Comments to the prior version of Article 3 suggested that words of courtesy appearing before the direction, such as please pay, do not render the direction a request;53 but precatory language such as I wish you would pay will not qualify as an order.54 The instruction to pay may be to the person giving the order, as is the case with a cashiers check.55

[ii] An Order Must Identify the Person to PayThe prior version of the Code stated that the person who is ordered to pay must be identified with reasonable certainty.56 The current version adds rules which concern identifying the payee of an instrument, and so modifies the prior Code requirement that the payee be identified with reasonable certainty. Under the current version, intent of the issuer57 controls as to the identity of the payee.58

Where the payee designation is one of a common name, such as John Smith, the drawers intention as to which John Smith is the payee will determine the person to whom the check is payable.59 This rule also applies where there is an inaccurate description60 or a fictitious payee.61 In the case of a forgery of the drawers signature, the intent of the person making the unauthorized signature, not the purported drawer, controls since the person making the forged signature is the drawer and the person whose signature is forged is not liable on the instrument.62 Where a signature is made by automated means such as a check-writing machine or computer, the payee is determined by the intent of the person who supplied the name or identification of the payee, whether or not authorized to do so.63 The person whose intent controls will usually be an employee of the drawer but may be a stranger committing a fraud through improper use of the automated system.64

Editors Note:These principles are also discussed below; see 20.02[8]b][i].

An order may be addressed to two or more persons jointly or in the alternative.65 This recognizes the corporate practice of providing for a number of drawees across the country when issuing dividend checks.66 Drawees in succession are not permitted, however, because that would require a holder of the instrument to make presentment to each drawee before having recourse against the drawer and indorsers.67

[c] Instruments Payable at a BankIn one instance, the Code provides that an instrument which promises the payment of money may operate as an order instrument. Under Alternative A of Section 4-106, a note or acceptance payable at a bank that is identified in the item is treated as the equivalent of a draft (order instrument) drawn on the bank. Thus, the bank must make payment out of the account of the maker or acceptor when the instrument falls due and the Article 4 timing deadlines apply.68 In those states that have adopted Alternative B of Section 4-106, the fact than an instrument is made payable at a bank operates only to designate the bank as a collecting bank and requires the bank to present the item for payment. The banks only function is to notify the maker or acceptor that the instrument has been presented and to ask for instructions.69

[4] The Promise or Order to Pay Must Be Unconditional

[a] In GeneralIn order for an instrument to be negotiable, the promise or order to pay must be unconditional.70 A negotiable instrument is designed to circulate in a manner that permits the holder to determine all the terms of payment from the face of the writing. It is this feature that has provided the analogy that instruments are like a courier without luggage. The assumption is that avoiding the need to examine obligations and terms outside the writing will facilitate commercial use of the instrument.71 For this reason, the conditional or unconditional character of a promise or order must be determined by what is expressed in the instrument.72 Thus, a mere allegation that a promise or order was intended to be conditional will not be permitted to change the obligors legally unconditional promise to pay.73 Nor will a memorandum on the instrument, intended to facilitate the drawers own purposes, constitute a condition that destroys negotiability.74

To some extent, all instruments are subject to conditional promises. For instance, payment is to be made only when the maturity date arrives, and only upon production and surrender of the instrument properly indorsed. Unconditional, as used in Section 3-104, has a more narrow meaning. Unconditional is intended to exclude instruments not commercially acceptable because they do not state an absolute obligation, but an obligation contingent upon the occurrence of an event foreign to the instrument and the law applicable to it. Negotiable instruments law attempts to permit ready determination of cases that fall within and without this category. Section 3-106 purports to simplify the test of unconditionality by omitting many of the specific tests included in the priorversion of Article 3. Instead, that provision presumes that a promise or order is unconditional unless it states (i) an express condition to payment, (ii) that the promise or order is subject to or governed by another writing, or (iii) that rights or obligations of the maker or drawer are stated in another writing. The intent is to ensure that a transferee of the writing is able to determine the conditions of payment from the instrument itself. Mere reference to another writing alone will not render the promise or order unconditional.75

[b] Implied and Constructive Conditions Do Not Destroy NegotiabilityThe Official Comment to Section 3-106 indicates that the omission of specific examples of implied conditions contained in Section Pre-Revision 3-105(1) is not intended to change the law.76 Rather, the intent is to continue the understanding that the presumption of unconditionality is not rebutted by an implied condition.77 A condition may be defined as operative fact, one on which the existence of some particular legal relation depends.78 An implied condition is a condition which is supplied by the court in order to give effect to the presumed intent of the parties.79 A constructive condition, on the other hand, operates by reason of law apart from any expressed or implied intention of the parties.80 Thus, a recital on an instrument that it was given in return for an executory promise could give rise to an implied condition that the instrument is not to be paid if the promise is not performed.81 The presumption of Section 3-106 ensures that such a condition does not impair the negotiability of the instrument.82

A bankruptcy court83 addressed the issue of whether a note was conditional. The notes provided that The entire unpaid principal balance shall be due and payable in full upon completion of the project being financed by the funds secured by this note; or at any time either evidenced in writing by both parties, or within three (3) years of the execution of this note. The court found that the notes were unconditional promises to pay. The court reasoned that while completion of the project is a conditional event, and is beyond the control of the holder, the amount due is not contingent upon only that event. There is another event; if the project is never completed, the amount of the notes are still due at any time either evidenced in writing or within three years of the execution of this note. This latter language makes the notes unconditional on their face. In other words, there are two independent events that trigger payment: the notes are due within three years regardless of whether or not the project is completed, the statement that the notes are due upon completion of the project only provides one possible time when the balance may be demanded.

An example of an express condition to payment (conditional language) that will render a note non-negotiable can be found in a federal district case.84 The note, in which CDL is the maker, stated that The 10/1/08 payment will be made unless there are business or regulatory changesincluding code editswhich causes CDL to become insolvent. The court denominated this provision as the conditional clause.

The words upon acceptance on a draft generally do not indicate a conditional promise to pay because it is only a restatement of an implied or constructive condition of any draft which must be accepted to charge the drawee.85 In certain cases, the words upon acceptance may refer to an agreement by the payee to specific conditions precedent rather than to the liability of the drawee. Even in these cases, however, if the term is merely intended to indicate that the payee accepts the instrument in full satisfaction of the underlying obligation, the negotiability of the instrument is not impaired.86

[c] Statement of Consideration or Reference to Underlying Transaction or Agreement Does Not Destroy NegotiabilityA statement of the consideration for which the instrument was given will not destroy the negotiability of an instrument.87 It does not matter whether the consideration stated has been performed or is merely promised.88 The negotiability of an instrument is also not affected by the omission of the statement of any consideration.89

A negotiable instrument may refer to the transaction that gave rise to the issuance of the instrument.90 Similarly, it may refer to another writing for a statement of rights with respect to issues governing collateral, prepayment, or accelerated payment.91 If the reference provides that either the promise or order or rights or obligations with respect to the promise or order are subject to that other writing, however, payment is conditional and the instrument is nonnegotiable.92 So, too, negotiability will be destroyed if the separate agreement provides terms for or governs the fulfillment of the promise or order in the negotiable instrument.93

An instructive case explaining these principles is Jackson v. Luellen Farms, Inc.94 The court acknowledged the rule that a note that is secured by a security interest in collateral (a mortgage) is negotiable where the note states that rights and obligations with respect to the collateral are either stated in or governed by the security agreement; a reference to the security does not strip the note of its negotiability. Such a note is non-negotiable, however, where, as in this case, the note provides that all agreements and covenants in the mortgage securing the note apply to the note. The court explained, There is a significant difference in a note stating that it is secured by a mortgage from one which provides, the terms of said mortgage are by this reference made a part hereof.A reference in a note to an extrinsic agreement does not destroy negotiability unless the reference actually makes the note subject to the terms of that agreement. (citations omitted)

Some instruments, such as travelers checks, may require, as a condition to payment, the countersignature of a person whose signature already appears on the instrument. Such a requirement, however, does not destroy the negotiability of a writing that otherwise satisfies the requirements of Section 3-104. In addition, certain statements that may govern the transaction between the original parties to the instrument do not affect its negotiability. For instance, an undertaking to give, maintain, or protect collateral will not destroy negotiability.95 Similarly, an authorization to the holder to confess judgment or realize on or dispose of collateral will not destroy the unconditional nature of the instrument.96 Finally, an instrument may remain unconditional even though it contains a waiver of the benefit of any law intended to protect an obligor.97

Although the rules of conditionality purport to clarify when an instrument is negotiable, some ambiguities remain. Assume, for instance, that Jones signs a note that reads, I, Jones, promise to pay to the order of Smith, $100 in accordance with the contract we have executed this date. If the in accordance clause is intended to refer solely to the origin of the note, the promise is unconditional and the note is negotiable. If, however, the clause implies that the promise will only be fulfilled in accordance with the terms of the underlying contract, then the clause states a condition and the note is nonnegotiable. Nevertheless, there is no easy way to determine the intent of the parties merely by looking at the instrument.

The current version addresses instruments which contain statements required by statute or administrative law. Such statements typically provide that a holder or transferee is subject to the issuers claims or defenses against the payee (see, e.g., the Holder Rule under 16 C.F.R. 433.2(a), discussed above 20.01[6]). Under the current version, these conditions do not render the promise or order conditional, and it is otherwise governed by the provisions of Article 3 except that a cannot become a holder in due course of the instrument.98

Practical Hint:The 2002 Revision adds a definition of Record, meaning information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.99 Adding a definition of Record was done in order to facilitate electronic communications.100 The current version was further amended in the 2002 Revision to substitute this defined term, Record, for the word writing in several sections, including Code Section 3-106. Accordingly, under the current version, Section 3-106, as amended in the 2002 Revision, a promise or order is unconditional unless it is subject to or governed by another record (instead of another writing) and is not made conditional by reference to another record (instead of another writing).101

[d] Reference to Fund From Which Payment Is to Be Made Will No Longer Destroy NegotiabilityPrior versions of Article 3 adhered to the rule that a promise or order was not unconditional if the instrument stated that it was to be paid only out of a particular fund or from a particular source.102 The rationale for the restriction was that the instrument will not move smoothly through the stream of commerce if satisfaction of the obligation is contingent on the existence and sufficiency of the particular fund. Negotiability was considered to be contingent on the obligors full credit standing behind the promise to pay. Nevertheless, the determination of whether an instrument was, in fact, payable from a limited fund could be difficult. The prior version of Article 3 added to the confusion by also permitting an instrument to state that a particular account or fund was to be debited, if that statement was merely one of expectation, not of limitation.103 Assume, for instance, a note that recites, I, Jones, promise to pay on June 1, 1989, to the order of Smith, $100, payable from my bank account #123-456 at First National Bank. While a holder seeking negotiability might have argued that this language constitutes only a statement of a particular account to be debited under Article 3, Jones was equally likely to prevail on an argument that the language constituted a limitation on the source of payment under Pre-Revision Section 3-105(2)(b). Thus, the certainty assumed to flow from the requirements of negotiability was not always borne out in fact.

The current version of Article 3 reverses the limitation of fund rule and leaves the desirability of taking such an instrument to market forces. This result seems appropriate. Should a holder be willing to accept the risk that a limited fund will be depleted prior to payment, leaving the holder with no recourse against other resources of the drawer or maker, there seems no good commercial reason to interfere with that judgment. After all, the holder presumably will have purchased the note for a price that reflects the increased risk. Thus, currently Section 3-106(b) specifically provides that a promise or order is not made conditional by the fact that payment is limited to resorting to a particular fund or source.104 This change, however, does throw some doubt on the vitality of the traditional explanation for rigid requirements of negotiability. If market forces are capable of pricing and either accepting or rejecting instruments that a payable from a limited fund, then why are they not similarly capable of pricing instruments that are similarly risky because, for instance, they bear express statements of conditionality of payment or that are payable at times that are relatively indefinite?

Even prior to the change in legal doctrine, there were additional permissible limitations on the source of payment. One exception occurred where the instrument is limited to payment out of a particular fund or the proceeds of a particular source, if the instrument is issued by a government or governmental agency or unit.105 The purpose of this provision was to permit governments and governmental agencies to draw checks or to issue other short-term commercial paper in which payment is limited to a particular fund or source of revenue.106 Governments frequently pay for capital projects by issuing debt in the form of bonds that are payable solely from a specific revenue source, such as an electric utility or a water system. The government unit exception to the limited fund rule permitted such bonds to retain their negotiability.

The third exception to the rule that a promise or order was conditional if the instrument stated that it is to be paid only out of a particular fund or source applied where the instrument is li


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