Commercial Paper Outline

Professor Kilborn Spring 2003

Introduction Commercial Paper: any piece of paper or document that evidences an obligation to make a payment. The National Commissioners of Uniform State a! created the Uniform Commercial Code "UCC#. The UCC is not la!. $t becomes la! only !hen adopted by each state. %very state has adopted most of the UCC. ouisiana& for the last '( years& has adhered to the UCC& but not articles ( and ("a#& and has made some changes to the adopted la!s. ouisiana)s version of the UCC is contained in Title '* + the commercial la!. The citations !ithin Title '* correspond to the UCC number. Chapter 1 Checking ccounts as the Paradigm Pa!ment S!stem ssignment 1 "he #asic Checking $elationship and the #ank%s $ight to Pa! Checks Terminology: $ssuer,-ra!er: person !ho !rites the check. commonly called dra!er because uses a check to dra! money out of a bank account. Payor /ank,-ra!ee: the bank from !hom the money is dra!n. if hear the !ord 0payor&1 it refers to the bank and not the person !riting the check. Payee: person to !hom a check is !ritten -epositary: bank into !hich the payee makes a deposit. !herever the payee puts the check $ntermediary: the 2ederal 3eserve /ank. bank through !hich the check passes to be presented to the payor bank for ultimate payment. $n a small to!n,area& there !ill be either one intermediary bank& or none. Collecting /ank: any bank that handles an item for collection other than the payor bank. 4enerally& 5ob of the 2ed. 3eserve. Presenting bank: 6ny bank that presents an item for acceptance or payment. The payor bank is not itself a presenting bank. The relationship bet!een the dra!er and the payor is governed by several things: an account agreement& UCC arts 7 and 8 "section 898*' in particular#& federal la!& and other banking regulations. $n addition& in its agreement& the parties can alter the UCC rules. 2ederal la! largely regulates ho! banks do business !ith other banks. $t regulates the business of being a bank rather than the relationship bet!een the bank and the dra!er.

/ank)s 3ight to Pay Proper for a /ank to Pay: "'# : 898*' + proper for bank to charge a customer)s account for any item that is properly payable. $t is properly payable if the customer has authori;ed payment. "(# <ost common !ay for customer to authori;e payment is by !riting a check. "7# Payment to thieves is not authori;ed + item containing a forged endorsement or signature is not properly payable. =>%3-362T ":898*' ? :898*(# "'# Payor bank may pay NS2 check& but does not have to. ook to agreement. ST=P P6@<%NT ":898*7# "'# Timely and adeAuate notice to payor bank. bank must have reasonable opportunity to act on it. "(# %ven if the bank stops payment& check !riter remains responsible to the payee on the underlying obligation. "7# Britten order effective for C months. oral order effective for '8 days. "8# UCC suspends the payee)s right to pursue customer on underlying obligation !hen payee accepts the customer)s check but suspension ends if check is dishonored. -36B%3)S -%6TD =3 $NC=<P%T%NC% ":898*E# "'# /ank is entitled to pay until 0kno!s of fact of death or ad5udication of incompetence1 and has reasonable time to act. "(# -oesn)t automatically revoke authority to pay& collect& or account for items. "7# /UT bank can honor checks until '* days after death of person unless ordered to stop payment by person claiming an interest in the account. ":898*E"b##. 3emedies for =verpayment: 3e9credit customer)s account :898*(. conseAuential damages !hen charge leads to dishonored checks. :898*F. 1

 This obligation is limited by subrogation of the bank to the rights of the payee. 6rticle 8: /ank may N=T enter into an agreement that disclaims responsibility for the follo!ing: "'# $ts o!n lack of good faith. "(# $ts o!n failure to eGercise ordinary care. "7# No agreements limiting damages for such lack or failure /ank and customer may agree on reasonable standards by !hich to measure bank)s responsibilities. : 89 '*7"a#. Problem Set ' 1. Tertiuss wife wrote a $1,500 check when the joint account only contained $50 and was not protected by overdraft. The bank honored the check and seeks reimbursement from Tertius. a. s Tertius liable for the check! & '('01)a* + 6 bank may charge against the account of a customer an item that is properly payable from the account even though the charge creates an overdraft. 6n item is properly payable if it is authori;ed by the customer and is in accordance !ith any agreement bet!een the customer and the bank. & '('01Comment 1 9 6n item dra!n for more than the amount of a customer)s account may be properly payable. Thus& a bank may charge the customer)s account for an item even though payment results in an overdraft. 6n item containing a forged dra!er)s signature or forged indorsement is not properly payable. Tertius is liable for the check even though it !ould create an overdraft. $f a check is properly payable& the bank !ill pay it. 6 check is properly payable !hen it is authori;ed by the customer. $f it is a 5oint account& both husband and !ife are 5ointly and severally accountable. Therefore& Tertius is accountable for the checks his !ife issues. b. f Tertius and his wife are estran"ed and she used the funds to buy a plane ticket to #ondon for pleasure, would the answer be different! & '('01)b* + 6 customer is not liable for the amount of an overdraft if the customer neither signed the item nor benefited from the proceeds of the item. H This provision does not eGist in ouisiana. So& in ouisiana& !hether you benefit or not& you are liable. &'('01 Comment 2 + Subsection "b# adopts the vie! that if there is more than one customer !ho can dra! on an account& the non9signing customer is not liable for an overdraft unless that person benefits from the proceeds of the item. $f Tertius did not sign the check and did not benefit from it& then he cannot be charged for overdraft. 0Customer1 is interpreted to individually in this section. !e don)t do that for 8*8"a#. 0/enefit1 is a more ambiguous term + may argue that because are husband and !ife& a benefit for her is a benefit for him. This argument may !ork better in other cases than this one. The intent of the statute probably applies here. /ecause 898*'"b# !as not adopted by ouisiana& Tertius !ould be liable here !hether or not he en5oyed any benefit. $. %ustomer of bank wrote $&00 check. 'ank received the check for payment on (onday, )anuary $$, but the check was dated *ebruary 1 and made out to a realtor co. The banks check processin" system does not e+amine the dates on checks, and it automatically processed the check. %ustomer had sent the 'ank a letter in ,eptember of last year askin" the bank not to cash any of the checks made to the realtor co. until the indicated dates. -as the bank acted properly! & 3(113)a* + 6n instrument may be antedated or postdated. The date stated determines the time of payment if the instrument is payable at a fiGed period after date. %Gcept as provided in : 898*'"c#& an instrument payable on demand is not payable before the date of the instrument.

& '('01)c* + 6 bank may charge against the account of a customer a check that is other!ise properly payable from the account& even though payment !as made before the date of the check& unless the customer has given notice to the bank of the postdating describing the check !ith reasonable certainty. The notice is effective for the period stated in : 898*7"b# for stop9payment orders& and must be received at such time and in such manner as to afford the bank a reasonable opportunity to act on it before the bank takes any action !ith respect to the check described in : 897*7. $f a bank charges against the account of a customer a check before the date stated in the notice of postdating& the bank is liable for damages for the loss resulting from its act. The loss may include damages for dishonor of subseAuent items under : 898*(. & '('01 Comment 3 + Subsection "c# is added because automated check collection system cannot accommodate postdated checks. 6 customer !ishing to postdate a check must notify the payor bank of its postdating in time to allo! the bank to act on the customer)s notice before the bank has to commit itself to pay the check. $f the bank fails to act on the customer)s timely notice& it may be liable for damages for the resulting loss !hich may include damages for dishonor of subseAuent items. & '('03)b* + 6 stop9payment order is effective for C months& but it lapses after '8 calendar days if the original order !as oral and !as not confirmed in !riting !ithin that period. 6 stop9payment order may be rene!ed for additional siG9month periods by a !riting given to the bank !ithin a period during !hich the stop9payment order is effective. & '('03 Comment + + 6 stop payment order is effective after the order& !hether !ritten or oral& is received by the bank and the bank has a reasonable opportunity to act on it. $f there is !ritten confirmation !ithin the '8 days& the siG month period dates from the giving of the oral order. 6 ne! stop9 payment order may be given after a siG9month eGpires& but such a notice takes effect from the date given. Bhen a stop9payment order eGpires& it is as if the order had never been given& and the payor bank may pay the item in good faith even though a stop9payment order had once been given. The bank should not have paid the check before the post9date. it !as therefore& not properly payable. $f a customer gives notice to the bank !ith 0reasonable certainty&1 the bank must abide by that reAuest for up to C months& rene!able indefinitely. To determine !hat is reasonably sufficient time to give the bank notice& should ask the bank because may differ depending on the bank)s technology. Customer)s notice may not be reasonable if she merely asked that her rent check be postdated. should probably help to identify check by party payable to& amount& and any other identifiable features. /ecause the customer properly reAuested honoring of the post9date& the bank is liable for any damage that results from the improperly paid check "if there is no damage& there is no cause of action#. $n this case& there !ill be no damage if no other check comes through until 2ebruary. The bank !ill 5ust give customer overdraft protection for I days "until 2ebruary#. .. 'ank paid check in contravention of a written stop payment order. The check was written in e+chan"e for cookin" e/uipment, but when purchaser "ot home with e/uipment, he decided it was too bi". 0hen seller of e/uipment refused to take back the e/uipment, purchaser issued stop payment order on his check, identifyin" the check number, account number, and date of the check. 1 clerk at the bank, however, incorrectly entered the information and as a result, the system did not reco"ni2e the check when it was cashed the ne+t day. (ust the bank recredit the purchasers bank account! f so, will the bank bear the final loss! & '('01)a* + see above & '('03)a* , )b* + see "b# above. 6 customer or any person authori;ed to dra! on the account if there is more than one person may stop payment of any item dra!n on the customer)s account or close the account by an order to the bank describing the item or account !ith reasonable certainty received at a time and in a manner that affords the bank a reasonable opportunity to act on it before any action by the bank !ith respect to the item described in : 897*7. $f the signature of more than one person is reAuired to dra! on an account& any of these persons may stop payment or close the account. & '('0-)2* , )3* + $f a payor bank has paid an item over a stop9payment order& after an account has been closed& or other!ise under circumstances giving a basis for ob5ection by the dra!er or maker& to prevent un5ust enrichment and only to the eGtent necessary to prevent loss to the bank by reason of its payment of the item& the payor bank is subrogated to the rights: 3

"(# of the payee or any other holder of the item against the dra!er or maker either on the item or under the transaction out of !hich the item arose. and "7# of the dra!er or maker against the payee or any other holder of the item !ith respect to the transaction out of !hich the item arose. & '('0- Comments 2 , 3 + Paragraph ( subrogates the bank to the rights of the payee or other holder against the dra!er or maker either on the item or under the transaction out of !hich it arose. $t may !ell be that the payee is not a holder in due course but still has good rights against the dra!er. These may be on the check but also may not be as& for eGample& !here the dra!er buys goods from the payee and the goods are partially defective so that the payee is not entitled to the full price& but the goods are still !orth a portion of the contract price. $f the dra!er retains the goods& it is obligated to pay a part of the agreed price. $f the bank has paid the check it should be subrogated to this claim of the payee against the dra!er. Paragraph 7 subrogates the bank to the rights of the dra!er or maker against the payee or other holder !ith respect to the transaction out of !hich the item arose. $f& for eGample& the payee !as a fraudulent salesman inducing the dra!er to issue a check for defective securities& and the bank pays the check over a stop9payment order but reimburses the dra!er for such payment& the bank should have a basis for getting the money back from the fraudulent salesman. Customer must give the bank reasonable time to do !hat he asked them to do. $f the bank had reasonable time& the fault is on the bank)s head. /ecause the stop9payment order !as on the right form and !as !ithin a reasonable time& the bank here is at fault. Stop payment orders are addressed in the agreement bet!een the bank and the customer& not the UCC. The check !as not properly payable& and the bank should credit the customer)s account. Do!ever& the bank is subrogated to the rights of the check recipient. $t can therefore argue that 3. 0hat would have happened if the bank complied with the stop4payment order and refused to honor the check! %ould e/uipment seller force purchaser to pay for the e/uipment! &3(310)b* + $f a note or an uncertified check is taken for an obligation& the obligation is suspended to the same eGtent the obligation !ould be discharged if an amount of money eAual to the amount of the instrument !ere taken& and the follo!ing rules apply: "'# $n case of an uncertified check& suspension of the obligation continues until dishonor of the check or until it is paid or certified. Payment or certification of the check results in discharge of the obligation to the eGtent of the amount of the check. "7# $f the check or note is dishonored and the obligee of the obligation for !hich the instrument !as taken is the person entitled to enforce the instrument& the obligee may enforce either the instrument or the obligation. $n the case of an instrument of a 7 rd person !hich is negotiated to the obligee by the obligor& discharge of the obligor on the instrument also discharges the obligation. &3(310 Comment 3 + $f the check or note is dishonored& the seller may sue on either the dishonored instrument or the contract of sale if the seller has possession of the instrument and is the person entitled to enforce it. $f the right to enforce the instrument is held by somebody other than the seller& the seller can)t enforce the right to payment of the price under the sales contract because that right is represented by the instrument !hich is enforceable by somebody else. Thus& if the seller sold the note or the check to a holder and has not reacAuired it after dishonor& the only right that survives is the right to enforce the instrument. The seller can force the buyer to pay. 6s soon as the check is dishonored& the payee can enforce the check or sue on the obligation. $t is easier to sue on the check 9 merely put buyer on the stand and ask him !hether it is his signature on the check. $f he says yes& then case closed. 6ll signatures are deemed valid unless proven other!ise. Bhether seller !ill recover& !ill depend on !hether buyer has money. Bhat if buyer doesn)t have money& can seller sue the bankJ The payee cannot sue the bank& because has no right to. The only thing that reAuires the bank to pay is the agreement bet!een the buyer and the bank. The buyer can force the bank to pay& but seller cannot not because she is not privy to the contract bet!een the buyer and the bank. 5. 5ld 6resident of corporation re"ains control of the business from dau"hter and son4in4law. 'ut, based on the account a"reement, the bank refuses to "ive president access to funds of businesss bank account because the si"nature card for the business refers only to dau"hter and son4in4law, not president. 'ank re/uests the consent of dau"hter and son4in4law before si"nature card is chan"ed. 4

%an president force bank to release the funds without providin" a letter of consent from dau"hter and son4in4law! & '(103)a* + The effect of the provisions of this 6rticle may be varied by agreement& but the parties to the agreement cannot disclaim a bank)s responsibility for its lack of good faith or failure to eGercise ordinary care or limit the measure of damages for the lack or failure. Do!ever& the parties may determine by agreement the standards by !hich the bank)s responsibility is to be measured if those standards are not manifestly unreasonable. &'(103 Comment 2 + The agreements may not disclaim a bank)s responsibility for its o!n lack of good faith or failure to eGercise ordinary care and may not limit the measure of damages for the lack or failure& but his subsection like : '9'*("7# approves the practice of parties determining by agreement the standards manifestly are unreasonable& the agreement controls. =!ners of items and other interested parties are not affected by agreements under this subsection unless they are parties to the agreement or are bound by adoption& ratification& estoppel& or the like. 6ccount agreement governs unless something overrides it. Do!ever& if the agreement violates reAuired care or good faith& it is overridden. Dere& the bank is not acting negligently or in bad faith. The agreement here overrides la!. ssignment 2. #ank%s Obligation to Pa! The /ank must pay if funds are available. /hen funds are a0ailable. '. Time of %valuation + bank is free to determine !hether an account has sufficient money at any time 0b,t time item is received and payor bank returns.1 9 $f ordered to pay and there is money in the account& the bank must pay. - =nly has to check one time. $f it checks more than once& it is bound by the second amount if different. (. 6vailability of 2unds + -epositary - Bhen an account holder deposits money& the bank does not have to make that money available immediately. - 3eg. C.C. deadlines by !hich the depositary must make funds available to customer upon deposit of check. Do!ever& !ith modern technology& these rules may be obsolete. 1on Cash 2ithdra2al from a 3ocal check 9 K'** on the first business day after the bankin" day on !hich funds !ere deposited. 3emainder no later than ( nd business day. 1on Cash 2ithdra2al from 1on(local check 9 K'** 'st day after deposit. 3emainder -ay E. Cash 2ithdra2al on 3ocal check 9 K'** day '. K8** day (. 3emainder -ay 7 Cash 2ithdra2al on 1on(local check 9 K'** day'. K8** day E. 3emainder day C. L %Gceptions: "a# '**M of o! 3isk items are available on the ' st business day. Can probably !ithdra! amount of deposit as soon as deposit made. "'# 0=n9us1 items: checks deposited or cashed at the bank on !hich they !ere dra!n. "(# Cashier)s Check: /oth payable by and !ritten by the bank. "7# Treasury checksJ "b# 6T< deposits: (nd business day unless 0on9us1 or treasury check. "c# $f a check is over KE***& then 3eg. CC does not apply. "3eg. CC :((I.'7#. "d# Bhen the check actually clears& funds must be made available even if it is before schedule. 4eneral Terms: - /usiness -ay 9 calendar days& eGcept Saturday& Sunday& and federal holidays "3eg. CC : ((I.(#. - /anking -ay 9 business day on !hich the bank is open for carryin" on substantially all of its bankin" functions. "3eg. CC : ((I.("f##. Bhat does this mean Saturday isJ ocal Check 9 check dra!n on a bank that is a member of your regional 2ederal 3eserve System. - Non9 ocal Check + 6ny check dra!n on a bank located outside the check processing region of the bank at !hich the check is deposited. Brongful -ishonor: /ank breaches agreement and refuses to pay a properly payable check. 5

 Customer entitled to all damages proGimately caused by !rongful dishonor. iability is limited to actual damages and may include damages for an arrest or prosecution of the customer or other conseAuential damages. ": 898*("b##. <iscellaneous: Check is stale after C months& but the bank may still honor it in 42 and in observance of reasonable commercial standards of fair dealing. 6ll funds must be made available !hen the check clears. :89('E. Check Niting - 2orm of bank fraud - =pen 6ccount at /ank ' and !rite a check for '.7 million and deposits it at /ank (. =pens account at /ank ( and !rites check for '.8 million and deposits at /ank '. 6t some point take the money out of one account. The /ank that allo!s this is left holding the bag. "2irst National /ank v. Colonial /ank#. Problem Set 2 1. 'ank honored check that was 7 months old. 8rawer thinks that the check was too stale to honor. %an drawer contest the banks honor! & '('0' + 6 bank is under no obligation to a customer having a checking account to pay a check& other than a certified check& !hich is presented more than C months after its date& but it may charge its customer)s account for a payment made thereafter in good faith. & '('0' Comment + /ank is given the option to pay a stale "over C months old# check because it may be in a position to kno! that the dra!er !ants payment made. Certified checks are eGcluded because they are primary obligations of the certifying bank. The customer)s account !as presumably charged !hen the check !as certified. & 1(201)14* + 04ood faith1 means honesty in fact in the conduct or transaction concerned. "This definition does not apply to 6rt. 8#. & 3(103)a*)'* + 04ood faith1 means honesty in fact and the observance of reasonable commercial standards of fair dealing. & 3(103 Comment ' + This definition of good faith only applies to 6rticles 7 and 8 and is consistent !ith 6rticles (& (6& 8& and 86. 4ood faith is concerned !ith fairness of conduct rather than the care !ith !hich an act is performed. The check is stale because it is over C months old. The bank can choose !hether or not to honor it. The bank has the right to pay a stale check but isn)t obligated to pay it. Do!ever& the bank can only honor the check in good faith. There is nothing here to suggest that the bank !as dishonest. -oes it fit in 0reasonable commercial standards of fair dealingJ1 Nilborn doesn)t think its unfair& but it may depend on the 5udge& !ho could think an inAuiry !as necessary after C months. $. The followin" checks were deposited in a -ouston branch of %ountry'ank (onday, (arch 1. %ountry bank is open for substantially all of its operations 9 days a week. 0ithdraws are made by check. a. %ustomer wants to withdraw cash a"ainst a deposited $7,000 check written by 1rchie on his ,eattle bank account. The check is non9local and it is a cash !ithdra!. Therefore& according to the 3eg. CC& the bank must make K'** on the business day after the banking day on !hich the funds !ere deposited. Therefore& K'** should be made available on Tuesday& <arch (. Do!ever& the bank is not reAuired to make any more money available until the fifth business day from the banking day on !hich the funds !ere available. Therefore& on <onday& the eighth of the neGt !eek& the bank must make K8** available. The fifth day is Saturday& but because neither Saturday nor Sunday is a business day& the funds !ill not be available until <onday& !hich is the E th business day. =n Tuesday& <arch ninth& the K8&E** !ill be available. /ecause the deposit !as over KE&***& anything over KE&*** !ill not be available until the deposit clears. The day it does& the remaining K(&*** !ill become available.

b. %ustomer deposits $1,000 cashiers check drawn on a ,eattle bank. The check was ori"inally payable to :iverfront Tools but was properly indorsed from the corp. to %arl. $eg5 CC &224510)c*)1*)0* , )0ii* + 6 depositary bank shall make funds deposited in an account by check available for !ithdra!al not later than the business day after the banking day on !hich the funds are deposited& in the case of "'# a cashier)s& certified& or teller)s check deposited + $n an account held by a payee of the check. in person to an employee of the depositary bank. and !ith a special deposit slip or deposit envelope& if such or envelope is reAuired by the depositary bank under paragraph "c#"7# of this section& and "(# 6 check deposited in a branch of the depositary bank and dra!n on the same state or the same check processing region. $eg5 CC & 224512)b*)'* + 6 depositary bank shall make funds deposited in an account by a check available for !ithdra!al not later than the (nd business day on !hich funds are deposited& in the case of 9 6 check dra!n on a 2ederal 3eserve /ank or 2ederal Dome oan /ank. a check dra!n by a state or unit of general local government. or a cashier)s& certified& or teller)s check. if any check referred to in this paragraph is a local check that is not governed by the availability reAuirements of ((I.'*. $eg5 CC & 224512)c*)1*)ii* + 6 depositary bank shall make funds deposited in an account by a check available for !ithdra!al not later than the Eth business day follo!ing the banking day on !hich funds are deposited& in the case of + a check dra!n on a 2ederal 3eserve /ank or 2ederal Dome oan /ank. a check dra!n by a state or unit of general local government. a cashier)s& certified& or teller)s check. or a check deposited in a branch of the depositary bank and dra!n on the same or another branch of the same bank& if any check referred to in this paragraph is a nonlocal check that is not governed by the availability reAuirements of ((I.'*. 6 cashier)s check is a lo!9risk item& but it !as indorsed by a 7 rd person. $t is treated as a non9local item. Therefore& K'** !ill be available on the first day& and the remainder on the E th day. c. %ustomer deposits $1000 check from the ;, Treasury at a -ouston branch %ountry'ank 1T( . $eg5 CC 224510)c*)1*)i* + 6 depositary bank shall make funds deposited in an account by check available for !ithdra!al not later than the business day after the banking day on !hich the funds !ere deposited& in the case of + a check dra!n on the Treasury of the United States and deposited in an account held by a payee of the check. $eg5 CC 224512)b*)'* + see above $eg5 CC 224512)c*)1*)ii* + see above %ven though the Treasury check !as deposited in an 6T<& checks dra!n on the gov)t are considered so secure that the funds !ill be available on the neGt business day "' st#. d. %ustomer deposits $1,000 drawn on the ,tate of (ichi"an with a bank teller. $eg5 CC 224510)c*)1*)i0* , )0ii* $eg5 CC 224512)c*)1*)ii* + $f it is dra!n on a state other than !here the bank sits& it is treated as a non9local check. So& -ay '& day E. .. %heck dated )an. $$ was drawn on customers account on )an. $. in the amount of $300 payable to <(1%, a finance co. associated with <(. The account at the time contained only $100 because the bank had wron"fully honored a postdated check the day before. The bank therefore dishonored the check and char"ed the customer $$5 fee for issuin" a check a"ainst insufficient funds. 5n )an. $&, the customers car was repossessed, and a $$,000 in cash was deposited into the account. The funds from that deposit would have been available in time to cover the postdated check. 8oes the bank have si"nificant liability! 7

&'('02)b* + 6 payor bank is liable to its customer for damages proGimately caused by the !rongful dishonor of an item. iability is limited to actual damages proved and may include damages for an arrest or prosecution of the customer or other conseAuential damages. Bhether any conseAuential damages are proGimately caused by the !rongful dishonor is a Auestion of fact to be determined in each case. :898*( comment 7 + Bhether the dishonor is the proGimate cause is a factual determination that must be made on a case9by9case basis. The bank is liable for all damages proGimately caused by the !rongful dishonor of the check. -amages in this case !ould be include the K(E NS2 fee& K8** to car dealer& damages resulting from repossessment of car& and reputation damage if in ne!spaper. Do!ever& depending on the 5urisdiction& it is iffy !hether could get emotional damages. "<ost courts are reluctant to give $$%-#. 3. <enerally, bank decides whether to honor a check by the account balance at the close of the bankin" day that the check was presented. 0hen bank mana"er saw a certain check was on the bounce list because of insufficient funds at the close of the previous bankin" day, he rechecked the customers account in order to check the accuracy of the software pro"ram. -e noticed a cash deposit made on the previous day, available that day, that would cover the check. 'ank mana"er wants to know that practices are okay. &'('02)c* + 6 payor bank)s determination of the customer)s account balance on !hich a decision to dishonor for insufficiency of available funds is based may be made at any time bet!een the time the item is received by the payor bank and the time that the payor bank returns the item or gives notice in lieu of return& and no more than one determination need be made. $f& at the election of the payor bank& a subseAuent balance determination is made for the purpose of reevaluating the bank)s decision to dishonor the item& the account balance at that time is determinative of !hether a dishonor for insufficiency of available funds is !rongful. 3eg. CC :((I.'*"a#"'# + 6 bank shall make funds deposited in an account by cash available for !ithdra!al not later than the business day after the banking day on !hich the cash is deposited& if the deposit is made in person to an employee of the depositary bank. The bank can check the balance at any time and it only has to check once. $n this manner& the statute is very fleGible. $t doesn)t matter for !hat reasons the account is checked. if he looked at the account and sa! sufficient funds& he cannot bounce the check. $f the account is checked again& the bank must go !ith the (nd time. The banker !ouldn)t have a problem if had 5ust checked it once& but because found sufficient funds on (nd check& must honor the check. 5. ,everal branch banks received checks drawn on nonlocal banks that the payor banks eventually refused to honor. Those branches have lost a substantial amount of money on those checks in cases in which the customer withdrew funds and closed their accounts before %ountry'ank learned that the checks would not be honored. This mostly occurs with recently opened accounts or accounts on which overdrafts have been fre/uent. s there anythin" the banks can do! %an the banks e+tend to 9 business days the hold that the bank puts on all nonlocal checks deposited at the problem banks! $eg5 CC &224513 9 too long to !rite Countrybank cannot make the blanket rule that it !ants to& but it can change its current procedure a little. 2or the ne! accounts& do not have to honor until I days& checks over the amount of KE&***. 6lso& for repeated overdraft& if in the last C months& it has been repeatedly overdra!n& the deadline may be eGtended. The hold may only apply in specific circumstances. there cannot be a blanket rule. She cannot across the board say all non9local checks !ill be held eGtra days. ssignment 3. Collection of Checks Check Clearing Process - /egins !hen the dra!er gives a check to the payee in eGchange for !hatever. Payee accepts the check because has confidence that !ill get paid. 6 check is an order to the bank to pay by the dra!er. - $ 0ays of 5btainin" payment a* Presentment "'# Payee goes directly to the payor bank and receives money from a teller. 8

"(# 4iven that the check is dra!n on the payor bank& !here the payee has gone& or !here the payee has an account& that check is called an 0on9us1 item. $t is easy for the payor bank to deal !ith that check + it only has to access its o!n information. The bank has until midnight the neGt banking day to determine if it !ill honor the check. b* Indirect Clearance S!stem "'# Payee takes check and deposits in depositary bank. The depositary bank becomes the customer)s agent in obtaining payment. "The depositary bank and the payor bank may be different branches of the same bank.# "(# There are 7 steps that are common to indirect payment method: "a# Pa!ee 6epositar! #ank. Bhen the payee deposits the check& generally& the depositary bank !ill provisionally credit the payee)s account& but !ill not provide access yet 5 &'(201)a*5 That credit is sub5ect to revocation on timely dishonor by payor. &'(21'5 That deposit begins the banking day deadline. 6 deposit is deemed to occur on a banking day only if made by the cut9off hour + no earlier than ( in the afternoon. "b# 6epositar! #ank Collecting #ank. "'# <$C3: The depositary bank sends checks to an off9site processing region. Number at the bottom of the check is a <$C3 line + magnetic line. 'st ( numbers are the region and subregion "the ;ip code of the bank#. The (nd four numbers is the bank. The rest of the numbers is your bank account. 6t end& last number is a check sum digit. $f you get checks back& you !ill see that another number has been added at the end in same <$C3 ink. They are encoding the amount of the check on the check. 6fter that& <$C3 line is fed into a machine. The machine !ill sort according to routing number. "(# Collecting /ank: /anks can either have multilateral or bilateral agreements as to ho! checks !ill be presented. $f ( banks have a significant relationship "or in a small to!n#& may have a bilateral agreement that permits each to send checks directly to the other !ithout the use of an intermediary. $f not& the 2ederal 3eserve System acts as a collection intermediary bank for all banks. /anks may also have clearinghouse agreements to trade checks more efficiently. 6 courier physically transports to 2ederal 3eserve or Clearinghouse on the day of the deposit. The clearinghouse gives the checks to the payor bank as presentment for payment. The collecting bank and the payee can demand payment. 6t the payor bank& the checks are once again fed into a machine. The computer determines ho! much is available in the accounts and determine if !ill cover the amount of the check. $f it !ill& it happens automatically. The collecting bank makes the credits and debits to accounts. 6 number of checks may be randomly selected for signature checks. "c# $eturn to 6epositar! #ank. $f the bank is going to dishonor the check and doesn)t send it Auickly& the payor bank !ill be liable for the amount of the check. The payor bank& if it !ants to dishonor& must do so under ( timelines: "'# 7CC 8idnight deadline: Payor bank must return the check by sending it back to the collecting or presenting bank by mail or other!ise before midnight of the business day after the banking day on !hich presentment !as made. "(# $eg5 CC deadline 9 &224530 "a# 2 da! 9 ' da! $ule: Payor bank must send check so that it !ould be received no later than 8 pm on the (nd business day after the banking day of presentment to the payor for local checks and 8th business day for non9local checks. 9 $f the bank misses the UCC midnight deadline& 3eg. CC says that if can still comply !ith (,8 day rule& the UCC rule !ill be suspended. This essentially adds an eGtra day to UCC midnight deadline. $f the payor bank uses a highly eGpeditious means of getting checks back& deadline is entirely !aived. "b# :or2ard Collection: The payor bank may use the same process of sending checks as if !ere sending as a depositary bank to the collecting bank. %ssentially& the payor bank !ill put a <$C3 line taped to bottom and !ill reverse <$C3 line to go back to depositary bank !ithin a couple of hours. "c# 6ishonor of 3arge Checks5 $f payor bank !ants to dishonor check for (&E** or more& the bank must provide notice of nonpayment to the depositary bank by 8 p.m. on the (nd business day follo!ing the banking day on !hich the check !as presented. Notice should be provided by any reasonable means. "7# -ifference bet!een UCC and 3eg. CC: "a# UCC is concerned !ith !hen the check is sent. 3eg. CC is concerned !ith !hen depositary bank should receive check. 9

"b# UCC reAuires check be returned by mail. 3eg. CC permits for!ard collection as !ell as other appropriately eGpeditious means. "c# 3eg. CC altered the midnight deadline and permits payor bank to defer return until neGt day if payor selects an appropriately eGpeditious mode of return that !ould result in faster delivery than the UCC deadline. "d# Payor bank must meet UCC and 3eg. CC& but if bank misses midnight deadline& the 3eg. CC permits an eGtension of one day. "3eg. CC trumps state la!#. Problem Set 7: 1. %ustomer deposited a check for $1000 at 'ulstrode in 'oston on (onday at . p.m., drawn on another 'ulstrode branch in %onnecticut. tems received after $ p.m. were treated as received the ne+t day. 'oston 'ulstrode "ave customer a provisional credit for the check and forwarded the check to =ew -aven, %onn. on 0ed. mornin". =ew -aven dishonored the check on Thur. afternoon, returnin" it by courier to 'oston. t reached 'oston 'ulstode before midni"ht on Thurs. 5n *riday, the bank called customer to inform him that provisional credit was revoked. 8id bank act promptly enou"h for a dishonor to occur! &'(10')a*)10* 0<idnight deadline1 !ith respect to a bank is midnight on its neGt banking day follo!ing the banking day on !hich it receives the relevant item or notice or from !hich the time for taking action commences to run& !hichever is later. &'(10- 6 branch or separate office of a bank is a separate bank for the purpose of computing the time !ithin !hich and determining the place at or to !hich action may be taken or notices or orders shall be given under this 6rticle and under 6rticle 7. &'(10; )a* 2or purposes of allo!ing time to process items& prove balances& and make the necessary entries on its books to determine its position for the day& a bank may fiG an afternoon hour of ( p.m. or later as a cutoff hour for the handling of money and items and the making of entries on its books. "b# 6n item or deposit of money received on any day after a cutoff hour so fiGed or after the close of the banking day may be treated as being received at the opening of the neGt business day. &'(301)a* $f a payor bank settles for a demand item other than a documentary draft presented other!ise than for immediate payment over the counter before midnight of the banking day of receipt& the payor bank may revoke the settlement and recover the settlement if& before it has made final payment and before its midnight deadline& it "'# returns the item. or "(# sends !ritten notice of dishonor or nonpayment if the item is unavailable for return. &'(302)a* $f an item is presented to and received by a payor bank& the bank is accountable for the amount of: "'# a demand item& other than a documentary draft& !hether properly payable or not& if the bank& in any case in !hich it is not also the depositary bank& retains the item beyond midnight of the banking day of receipt !ithout settling for it or& !hether or not it is also the depositary bank& does not pay or return the item or send notice of dishonor until after its midnight deadline. or "(# any other properly payable item unless& !ithin the time allo!ed for acceptance or payment of that item& the bank either accepts or pays the item or returns it and accompanying documents. $f this is an on9us item& it !ould have been an automatic transfer for the bank simply looks at an account of its o!n. Do!ever& different branches are treated as separate banks for purposes of this rule. 6ccording to the UCC& the bank must dishonor by the day after presentment. The check !as presented on Bed. morning& so it had until midnight Thursday to dishonor the check. 2or purposes of presentment& the ( o)clock banking day cut9off hour applies. The payor bank did dishonor because reached on day after presentment by midnight. /y courier is sending and is sufficient. 6s soon as the check is in the hands of the courier& the UCC is satisfied. 3eg CC "must meet both UCC and 3eg. CC#. 3eg. CC has the ( day , 8 day rule. /y 8:** the payor bank had to deliver the check to the depositary bank ( days after presentment if local and 8 days if nonlocal. /oth the 3eg CC and the UCC say that dishonor is sending back to. $n fact& the 3eg. CC only reAuires a sending. there is no reAuirement that it actually get there. $t does& ho!ever& reAuire that it be sent in such a !ay that it normally !ould be received before the ( or 8 days after presentment. 6s long as the Conn. bank sends the check back so that it !ould normally get back before 8 pm on 2riday& okay. $n this case& the bank fulfilled its reAuirements to dishonor. 10

K'** !ould have to be available on the first day follo!ing& !hich is Bed. $f a cash !ithdra!& then K8** !ould have to be available on Thursday& and the rest on 2riday. /ut& if a check& then K'** on Bed. and the rest on the neGt day. The provisional credit may be properly revoked by /ulstrode. $. %ustomer deposited $10,000 check written by %.#. %.#.s account only contained $100 at the time of deposit. 1 hold was placed on customers account while bank called %.#. to see whether she would deposit funds to cover the check. a. #ater that mornin", customer attempted to cash a check for total balance of account 4 $1$,000, includin" the funds from %.#.s check. Teller refused to cash the check because of the hold on the account. %.#. leaves town indefinitely for work. 'ank doesnt think it can "et the funds from her> what should it do! &'(21')c* + 6 depositary bank that is also the payor may charge back the amount of an item to its customer)s account or obtain refund in accordance !ith the section governing return of an item received by a payor bank for credit on its books. &'(21<)a* + 6n item is finally paid by a payor bank !hen the bank has first done any of the follo!ing: "'# paid the item in cash. "(# settled for the item !ithout having a right to revoke the settlement under statute& clearing9house rule& or agreement. or "7# made a provisional settlement for the item and failed to revoke the settlement in the time and manner permitted by statute& clearing9house rule& or agreement. &'(301)b* + $f a demand item is received by a payor bank for credit on its books& it may return the item or send notice of dishonor and may revoke any credit given or recover the amount thereof !ithdra!n by its customer& if it acts !ithin the time limit and in the manner specified in subsection "a#. 6n 0on9us1 item. The bank doesn)t have to give customer anything. /ut neGt day& must give K'** if available. The bank has until midnight on 2riday to decide !hether it !ants to dishonor the check and sent it back according to the UCC. /anker probably gave the customer a '*N provisional credit !hen he deposited it. $t may be revoked anytime before midnight of the neGt day unless any of the 7 things happened in 897*'"a#. None of these 7 things happened. The bank may rescind the provisional settlement. b. 'ank allowed customer to cash %.#.s check when first presented. 0here would that leave the bank! Bhen the bank pays the item in cash& it is finally paid and not a provisional settlement. :89('E"a#. Therefore& the bank cannot revoke payment to the customer. /ut could still go after customer for un5ust enrichment. c. 'ank ne"lected to place a hold on the funds because thou"ht computer would do that automatically. 1s a result, teller permits customer to close out his account, includin" the amount of %.#.s check. 0hat is the banks situation! The bank did not pay cash for the item + they gave him cash for his account. Therefore& it is not final payment& but a provisional settlement that can be revoked if done before the midnight deadline on the date of receipt "Thurs#. $t must also return the check or put a notice of dishonor before the midnight deadline on 2riday. The bank can recover in court under the UCC. Using the UCC is easier and less timely than arguing un5ust enrichment. .. %ustomer is runnin" a check4kitin" scheme throu"h *=' and %olonial banks. 5n Tuesday, *ebruary11, *irst =ational presents 1.5 million of checks to %olonial for payment. %olonial thinks somethin" is amiss but does not dishonor the checks on Tuesday or 0ednesday because customer tells %olonial that everythin" fine. Thursday mornin", %olonial discovers customers misconduct and attempted to dishonor the checks. 5n Thursday mornin", what could %olonial have done! &'(21<)a*)3* 6n item is finally paid by a payor bank !hen the bank has first done any of the follo!ing: made a provisional settlement for the item and failed to revoke the settlement in the time and manner permitted by statute& clearing9house rule& or agreement.

11

$eg5 CC &224530)c*)1* The deadline for return or notice of nonpayment is eGtended to the time of dispatch of such return or notice of nonpayment !here a paying bank uses a means of delivery that !ould ordinarily result in receipt by the bank to !hich it is sent + on or before the receiving bank)s neGt banking day follo!ing the other!ise applicable deadline& for all deadlines . . . this deadline is eGtended further if a paying bank uses a highly eGpeditious means of transportation& even if this means of transportation !ould ordinarily result in delivery after the receiving bank)s neGt banking day. UCC <idnight deadline is clear and cannot be !aived under the UCC. Do!ever& under the 3eg. CC& the midnight deadline is !aived if the bank uses a 0highly eGpeditious means of transportation.1 They could use a speedy courier to get the check to the bank as fast as can. =vernight courier is probably a highly eGpeditious means of transportation. 3. %ustomer deposited a $$,500 check from ).'. on (onday, ,ept. & drawn on Town'ank in #.1. 'ank "ave customer a provisional credit on the date of deposit and forwarded check throu"h *ed. :eserve in 8allas. ;nder ordinary circumstances, that would "et the check to Town'ank late Tuesday ni"ht ?durin" Town'anks 0ed. bankin" day@. 1t .A00 p.m. on *riday afternoon, ,eptember 1., 'ank received electronic notice of nonpayment from Town'ank. 'ank withdrew provisional credit and notified customer mail. 5n (onday mornin", ,ept. 19, a check in the amount of $$,000 was presented a"ainst customers account, which 'ank dishonored for insufficient funds. 'ank received the ).'. check by mail from Town'ank on 0ed. mornin" on the 1Bth of ,ept. in an envelope dated (onday. 8id Town'ank meet the midni"ht deadline! The return and notice re/uirements of :e". %%! s there anythin" else you need to ask 'ank! &1(201)3;* + 0Send1 in connection !ith any !riting or notice means to deposit in the mail or deliver for transmission by any other usual means of communication !ith postage or cost of transmission provided for and properly addressed and in the case of an instrument to an address specified thereon or other!ise agreed& or if there be none to any address reasonable under the circumstances. The receipt of any !riting or notice !ithin the time at !hich it !ould have arrived if properly sent has the effect of a proper sending. &'(21')a* $f a collecting bank has made provisional settlement !ith its customer for an item and fails by reason of dishonor& suspension of payments by a bank& or other!ise to receive settlement for the item !hich is or becomes final& the bank may revoke the settlement given by it& charge back the amount of any credit given for the item to its customer)s account& or obtain refund from its customer& !hether or not it is able to return the item& if by its midnight deadline or !ithin a longer reasonable time after it learns the facts it returns the item or sends notification of the facts. $f the return or notice is delayed beyond the bank) midnight deadline or a longer reasonable time after it learns the facts& the bank may revoke the settlement& charge back the credit& or obtain refund from its customer& but it is liable for any loss resulting from the delay. These rights to revoke& charge back& and obtain refund terminate if and !hen a settlement for the item received by the bank is or becomes final. &'(21<)d* + The right to charge back is not affected by: "'# previous use of a credit given for the item. or "(# failure by any bank to eGercise ordinary care !ith respect to the item& but a bank so failing remains liable. &'(301)d*)2* 6n item is returned: !hen it is sent or delivered to the bank)s customer or transferor or pursuant to instructions. $eg5 CC &22453')b* %ach paying bank that gives notice of nonpayment !arrants to the transferee bank& to any subseAuent transferee bank& to any subseAuent transferee bank& to the depositary bank& and to the o!ner of the check that + "'# the paying bank or in the case of a check payable by a bank and payable through another bank& the bank by !hich the check is payable& returned or !ill return the check !ithin its deadline. "(# $t is authori;ed to send the notice& and "7# The check has not been materially altered. These !arranties are not made !ith respect to checks dra!n on a state or a unit of general local government that are not payable through or at a bank. $eg5 CC &22453')d* -amages for breach of these !arranties shall not eGceed the consideration received by the bank that presents or transfers a check or returned check& plus interest compensation and eGpenses related to the check or returned check& if any. $eg5 CC &22453; iability of bank. 12

ssignment 21. 1egotiable Instruments iAuidity: iAuidity is a measure of ho! Auickly and easily an asset can be turned into money. The effectiveness of a payment system is gauged by ho! liAuid its assets are. <eans that paper !ill certainly be made into money. iAuid assets are stocks and bonds& and negotiable instruments "things !ith a recogni;ed market and could certainly and readily turn into money#. Pure liAuidity is a dollar bill. The barter system is also liAuid. - 6n eGample of inliAuidity: machinery. Seller must find a buyer& dicker about the price& test the item& etc. $t can be turned into money& but it is a harder& longer process. - 6 check is liAuid. Bithout the la!& a check !ould be a piece of paper the holder thinks he could get money for. This 0probably1 reduces liAuidity. Today& !e generally vie! checks as paper money. 3eAuirements for instrument to be negotiable: :79'*8 9 "'# 7nconditional + = There must be no suspensive or resolutory conditions !hatsoever. 2or eGample& cannot say that the instrument is sub5ect to or governed by the terms of another agreement. @ou can make a reference to another document but cannot be governed by another document. 6 N is a conditional promise to pay and therefore is not negotiable instrument. There are a fe! eGceptions. "'# 6 promissory note can refer to another loan agreement or security agreement if all saying is that !ill pay it and it stipulates that the agreement has security. "(# The obligation to pay on promissory note can be accelerated. "7# $f the holder gets eGtra rights& that)s okay. "8# 6 note can reAuirement payment come only from a specific source. That seems to condition payment& but people have deemed that not to be a condition for reasons the Prof. doesn)t understand. "(# /ritten promise or order to pa! <ust be tangible document that promises or orders payment. 6 promise is eGemplified in the promissory note: $ promise to pay. 6n order is a check. )3* "o bearer or order ( Bays to be /earer: "'# Put the !ord 0bearer1 on the payment line 9 meaning anyone holding the check can cash it& or "(# <ake it payable to no one "blank# or cash. ( Bays to make it an =rder: "'# <ake payment 0to the order of1 and then name the payee& or "(# $ promise to pay a particular person or order. 0Pay to Oason Nilborn or order1. $t is not an instrument if it says 0Pay to Oason Nilborn1. "a# This reAuirement is suspended for checks. $f you scratch off the !ords& it is still a negotiable instrument. )'* fi>ed amount 6s long as it is calculated at any given moment "determinable#& it is fiGed. Cannot say that !ill pay E*M of proceeds of sale of business because you don)t kno! ho! much the business !ill make. therefore& its not fiGed. The UCC allo!s a floating interest rate. $/=3 is the ondon %Gchange 3ate determined daily based on interest that banks charge each other for overnight loans. "E# Of mone! + <oney is any legal currency& foreign or domestic Cannot be non9monetary& because the system is designed to increase liAuidity. "C# t a definite time 6 fiGed or determinable time. This date can be accelerated + that doesn)t affect negotiability. $f there is no date& then payable on demand. )-* /ith no e>traneous undertakings5 Cannot obligate the debtor to do something other than monetary such as perform a service. 7 eGceptions: 13

"'# 6 note can contain a provision promising to take care of security "collateral#& "(# Can allo! holder to confess 5udgment "make it easier to sue on the note# or -ispose of collateral. "7# /orro!er !aives la!s intended for his benefit or protection. $f it doesn)t meet one of the negotiability reAuirements& it 5ust means that it !on)t be applied under the UCC. They are still obligations that can be enforced& but by contract la!& not UCC. 6 check is a negotiable instrument& as is a promissory note. Ns are not negotiable because are a conditional promise to pay.

Problem Set (' 1. 'ank wants to sell a corporate bond in a standard form. ,ee p". 31$ for bond. s this bond a ne"otiable instrument! 6 bond is a promise to pay issued by a corporation& but is it negotiableJ To be negotiable& it must use the proper language or as Prof. says& the magic !ords. $t does not to bearer or order. $t is not a negotiable instrument& but still an enforceable obligation. $s a check more liAuid than a bondJ The liAuidity of a bond depends on the solvency of the debtor. it is the same for a check. $n fact& a bond may be more liAuid than a check. Negotiability doesn)t necessarily increase liAuidity. $. s the promissory note in 1ssi"nment 15 a ne"otiable instrument! The note is unconditional. the acceleration clause is no problem. Prepayment is okay even though makes definite time a little less definite because it is not a problem for the holder + its 5ust a right. The promise to pay attorney)s fees is an eGtraneous undertaking. $t is an eGtraneous promise to pay. There may also be an argument that the promise to pay attorney)s fees is a conditional promise to pay. Do!ever& it may be closely associated !ith the enforcement of the note. Baiver of rights is probably okay. 6s a general rule& they are acceptable. Barranty of use of funds !ill be used only for commercial purposes. Note is still payable even if the funds !ere used for personal use. $t seems like an eGtraneous promise + but the reAuirements for negotiability are vague,unclear and an argument could be made that it is not.

.. 1re home mort"a"e notes on the standard form of the =ational (ort"a"e 1ssoc. and the *ederal -ome #oan (ort"a"e %orp, which contain provisions "ivin" holder ri"hts of prepayment, re/uire notice of prepayment, and refer to security a"reements, ne"otiable instruments! Under :79'*C& the promise to pay is not unconditional !hen it refers to another document that stipulates rights the holder !ill have. %Gception is in 79'*C"b# + promise to order is not conditional !ith respect to collateral& prepayment& or acceleration. Therefore& there is no problem !ith the provision giving the holder a right of acceleration. Notice of prepayment could be an eGtraneous undertaking. The argument could go either !ay. $f it is an eGtraneous undertaking& the notes are not negotiable. 3. 'anks 1T( deposits included a $1$,000 check where drawer crossed out the printed words Cto order ofD and wrote in Conly to.D %heck was cashed at 5vco 8ru"s. 5vco 8ru"s deposited the check at 'ank. s the check valid and what should 'ank do! The check is negotiable because there is an eGception for checks in that do not have to stipulate 0to bearer1 or 0to order.1 Changing the !ords on a check& has no effect + cannot make a check non9 negotiable. -oes the bank have to pay itJ The bank is reAuired to pay a check if there is enough funds and it is properly payable. There is an account agreement that obligates the bank to the dra!er. The collecting bank has no right against the payor bank. only the dra!er does. The bank could refuse to honor it before midnight deadline and it does not have to give a reason. 6s long as customer satisfied& bank under no liability. $mproper discharge could lead to conseAuential damages. E. :, receives a white dress shirt with writin" that says, C6ay to the order of the nternal :evenue ,ervice $150,000.D ,enders si"nature was written below with the name of a bank and account numbers. The bank refused to honor the shirt4check, claimin" that it only honored checks written on its supplied forms. s the shirt a valid instrument the bank must honor! &3(103)a*)+* + 0=rder1 means a !ritten instruction to pay money signed by the person giving the instruction. The instruction may be addressed to any person& including the person giving the instruction& 14

or to one or more persons 5ointly or in the alternative but not in succession. 6n authori;ation to pay is not an order unless the person authori;ed to pay is also instructed to pay. &3(10')e* + 6n instrument is a 0note1 if it is a promise and is a 0draft1 if it is an order. $f an instrument falls !ithin the definition of both 0note1 and 0draft&1 a person entitled to enforce the instrument may treat it as either. &3(10')f* + 0Check1 means "i# a draft& other than a documentary draft& payable on demand and dra!n on a bank or "ii# a cashier)s check or teller)s check. 6n instrument may be a check even though it is described on its face by another term& such as 0money order.1 &3('0; + 6 check or other draft does not of itself operate as an assignment of funds in the hands of the dra!ee available for its payment& and the dra!ee is not liable on the instrument until the dra!ee accepts it. The shirt is a valid instrument because it meets all the reAuirements of a negotiable instrument. There is no reAuirement that it be on paper + only that it be tangible. That there is no date on !hich it is payable is not fatal to negotiability. Bhen no date or time listed& it is payable on demand. Do!ever& if the account agreement says that only honor checks supplied by bank& the agreement !ould trump this rule& and the bank could dishonor the check9shirt. -oes the $3S have any right to get paid from the bankJ No& payee has no right to sue on the check. the only person !ith the right to enforce a check is the dra!er. Payee only gets rights against the bank if bank accepts the check or holds it beyond the midnight deadline. ssignment 22. "ransfer , ?nforcement of 1egotiable Instruments $e@uirements of "ransfer of 1egotiable Instrument: <ust be a holder to negotiate an instrument 1egotiation 9 :79(*'"a# + transfer of possession by person other than original issuer that causes the transferee to become a holder. $nstruments are negotiated by passing bearer paper or indorsing blank& specially& or restrictively. Aolder 9 :797*'"i# + "'# must have possession of the instrument "!ritten promise,order# and "(# <ust be entitled to enforce the instrument. a# $f an instrument is not properly negotiated& the recipient has only possession& but is not entitled to enforce& and is therefore not a holder. b# There can only be one holder at a time. $f a check is made payable to ( people& only the both together can negotiate the instrument. Bould have to deposit in a 5oint account. $f check is payable to G or y& either can negotiate check alternatively. Bhether entitled to enforce an instrument depends on !hether bearer paper or order paper. a# #earer paper + 6nyone in possession can enforce it + even a thief. Thief& though properly enforcing& could still be liable in conversion and criminal theft. 2or bearer paper& negotiation means that you give it to someone else or someone take it from you. b# Order paper + =nly that person named in instrument can enforce it until that person indorses it over to someone else "negotiates it#. 2or order paper& negotiation means indorsing to someone else. "'# $ndorsements + 8 kinds - #lank + holder 5ust signs the back of the check. 6ny person !ho comes into possession becomes the holder for the check becomes bearer paper. ::79(*E"b#& 79'*I"c#. "=rder paper can become bearer paper through blank indorsement#. - Special + identifies a person to !hom the instrument is paid. 0Pay to /ob1 !ritten above ,s,. This remains order paper and only /ob is the holder. "/earer paper can become order paper !ith special indorsement#. - $estricti0e + adds protection. The only allo!ed is 0for deposit only1 above ,s,& meaning that only a bank can be holder. Bhen depositing checks into bank& do not have to endorse. /anks !ill ask you to because !ant you to have indorser liability. nomalous + rare. made by a person !ho is not the holder. not negotiated. anomalous indorser becomes a guarantor of the instrument. :79C*E. ?nforcement and Collection of Instruments 3ight to enforce an instrument a# Dolder has the legal right to enforce the instrument. 15

b# Therefore& if bearer paper& possessor has right of enforcement. c# $f order paper& only the person in payee line or special indorsement may enforce. Presentment and dishonor a# Dolder has ( rights: Presentment and Negotiation "'# Negotiate instrument as a money substitute& like payment. "(# To Present instrument for payment& obligor or payor bank may honor and pay or dishonor and return. - Dolder has a legal right to enforce the instrument. - Check P assume honored until prompt dishonor - Note P dishonored unless specific steps are taken to honor -efenses to %nforcement a# 6s long as the person entitled to enforce is not a D$-C defenses allo!ed. b# <ost common defense: failure of consideration

3iabilit! on an Instrument No party is liable on an instrument unless they signed the instrument. 6gency la!: representative !ho signs is not personally liable. : 798*(. <ust be clear that in agency capacity. Parties !ho have signed are liable: a# $ssuer: unconditionally liable. :798'(. b# -ra!ee: directly liable !hen accepts the drafts. ::798*Q& 798'7. c# -ra!er: Same liability as indorser. Not liable until dishonored. dishonored upon acceptance. :79 8'8. iable for reimbursement and on underlying obligation. d# $ndorser: iable only !hen instrument is dishonored and given 7* day notice of dishonor. -ischarged upon acceptance. :798'E. iable for reimbursemnet. 9 $f indorser signs 0!ithout recourse&1 then are not liable as indorsers& but other !arranties are not !aived. ?ffect of Instrument on 7nderl!ing Obligation Near9Cash $nstruments + cash eAuivalent. =bligation is discharged immediately !hen obligee accepts,takes the instrument and presumed paid. :797'*"a#. a# cashier)s check b# teller)s check c# certified check =rdinary $nstrument + suspends underlying obligation until honored. $f dishonored& the obligation is reinstated. a# check + obligation suspended and eGtinguished !hen payor bank honors. $f not honored& obligation still eGists. :797'*"b#. ccord and Satisfaction &3(311 Brite a check for some portion of the obligation that they think you o!e them. @ou sign and put 0in full payment.1 @ou hope that they look at the instrument and 5ust accept it in full satisfaction of obligation as informal settlement. $f they accept it& that is accord and satisfaction. Cannot be used as a trap for the un!ary. 7 reAuirements: "'# There must have been a bona fide dispute "(# <ust be a conspicuous legend saying in full payment for all obligations bet!een the parties "7# Payee must accept& cash& and not refund !ithin I* days. Payee has I* days to send the money back and go for all of the disputed payment. 42 is reAuired under 6rt. 7 + creditor may not scratch out the legend and cash. <ust take as stands or send back. Problem Set (( '. Tom operates a check4cashin" business as TE5. -is normal practice re/uires the customers to si"n the top end of the reverse of the check. -e doesnt not allow parties to cash checks when they are not the named payee. -is clerks e+amine drivers licenses to ensure proper identity. *inally, clerks stamp the top end of the reverse side of the check with a rubber stamp that states CTE5. a. Tom wants to know if his procedures e+pose him to any undue risks. 16

&3('01)b* + 6 signature may be made "i# manually or by means of a device or machine& and "ii# by the use of any name& including a trade or assumed name& or by a !ork& mark& or symbol eGecuted or adopted by a person !ith present intention to authenticate a !riting. Comment 2 9 Parol evidence is admissible to identify the signer& and !hen the signer is identified& the signature is effective. Signatures are blank endorsements. therefore& the checks are no! essentially cash. 6nyone of TomR) clerks could cash the checks and be entitled to enforce it. $t !ould be better to use a special endorsement. Bould be a good idea if Tom got a stamp that said 0Pay to TN=1 !ith a line underneath it for customer)s signature. Bould be safer even to pay to Tom& unless inconvenient for business purposes. TN= could also be liable if the check bounces because his name is an indorsement. Tom could have indorser liability. b. Tom wants to know what additional risks he would face if he be"an acceptin" . rd party checks that have been indorsed by the named payee. f the check appears to have been specially indorsed by the named payee and is submitted for cashin" by the person to whom the named payee indorsed the check, what risk does Tom face in cashin" the check! &3('1<)a* Sub5ect to certain eGceptions& if an instrument is dishonored& an indorser is obliged to pay the amount due on the instrument. The obligation of the indorser is o!ed to a person entitled to enforce the instrument or to a subseAuent indorser !ho paid the instrument. &3('1+)a* + 6 person !ho transfers an instrument for consideration !arrants to the transferee and& if the transfer is by indorsement& to any subseAuent transferee that: "'# the !arrantor is a person entitled to enforce the instrument. "(# all signatures on the instrument are authentic and authori;ed. "7# the instrument has not been altered. "8# the instrument is not sub5ect to a defense or claim in recoupment of any party !hich can be asserted against the !arrantor. and "E# the !arrantor has no kno!ledge of any insolvency proceeding commenced !ith respect to the maker or acceptor& or& in the case of an unaccepted draft& the dra!er. &'('1-)a* + $f an unaccepted draft is presented to the dra!ee for payment or acceptance and the dra!ee pays or accepts the draft& "i# the person obtaining payment or acceptance& at the time of presentment& and "ii# a previous transferor of the draft& at the time of transfer& !arrant to the dra!ee making payment or accepting the draft in good faith that: "'# the !arrantor is& or !as& at the time the !arrantor transferred the draft& a person entitled to enforce the draft or authori;ed to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft. "(# the draft has not been altered. and "7# the !arrantor has no kno!ledge that the signature of the dra!er of the draft is unauthori;ed. &3('20)a* + The la! applicable to conversion of personal property applies to instruments. 6n instrument is also converted if it is taken by transfer& other than a negotiation& from a person not entitled to enforce the instrument or receive payment. 6n action for conversion of an instrument may not be brought by "i# the issuer or acceptor of the instrument or "ii# a payee or indorsee !ho did not receive delivery of the instrument either directly or through delivery to an agent or a co9payee. The specially indorsed named payee has indorser liability& so Tom could get the amount of the check back from the named payee. The person primarily liable is the dra!er and Tom kno!s !hat bank the check !as dra!n on and the address of the dra!er. The problem !ith 7 rd party checks is that TN= has no !ay of kno!ing if signatures are valid& particularly the signature of the original payee. /ecause on order paper& a thief !ho forges a person)s signature& the check !as improperly cashed because the thief !as not holder. =nly if payee signs his name is it a signature. if someone !rites his name& there is no signature. /ecause the thief !as not a holder& TN= !ill not be a holder. $n addition& by signing it "or stamping it#& TN= acAuires indorser !arranties& and may have to pay for the loss. $t is not a good idea for TN= to accept 7 rd party checks. (. f the :, cant make the bank pay the check, can the :, sue the ta+ payer on the shirt4check! @es. The $3S can sue the dra!er of the check& the taGpayer& because he is primarily liable on the check. $t is not difficult to !in its case against the dra!er + must merely sho! that it is his signature on the check. $f it)s a negotiable instrument& and valid signature& case closed& particularly if the $3S is a holder 17

in due course because then !on)t be able to argue defenses. $f the shirt9check !as not a negotiable instrument& then it !ould be a simple N to pay money& !hich cannot prove liability based on signature alone. $3S could also sue taGpayer on the underlying obligation of taG debt. =nce a check is dishonored& the obligation is no longer suspended. <ay be best to sue !ith alternative claims. The claim on the instrument should be the first count because much easier to prove. /ecause suing on the underlying obligation is more complicated& it should be second. 7. #andlord and tenant have dispute over space leased. #andlord received a check from tenant for F of disputed amount, includin" a notation on the check that it constituted Cfull payment for all past4due rent.D n the past, landlord has a practice of drawin" a line throu"h such a notation as rejection of the tenants position and depositin" the check. 0hat do you think of her practice! $f situation meets the 7 reAuirements of accord and satisfaction& then dra!ing a line through the full payment language accomplishes nothing. The obligation is probably satisfied if the check is not returned !ithin I* days. =nce the check is cashed& the burden is on the person !ho accepted the check to sho! that it did not meet the 7 reAuirements of accord and satisfaction. andlord could make arguments based on the first ( elements by saying that dispute !as ambiguous& there !as no settlement negotiation. 6lthough she could make these arguments& it is better not to have to. Therefore& the landlord should take and accept the settlement or re5ect it altogether. 8. Tom wants to know who he can sue in the followin" circumstancesA a. %heck written by drawer and payable to payee. %heck bears indorsement that purports to be the si"nature of payee. 'ut check was actually cashed by a thief who mu""ed payee, takin" his wallet and drivers license also. 0hen drawer heard of the attack on payee, she stopped payment on the check, so it was returned to Tom. Tom is not a holder and thus cannot enforce any rights on the check. The thief cannot indorse the check to TN=& only the payee could have. %ven if a signature looks eGactly like that of the payee& it is not the payee)s signature or indorsement. $f you !rite someone else)s name& it is still your signature. TN= cannot sue anyone on that check. Their only relief !ould be to sue the thief for conversion + not for indorsement. b. %heck written by drawer as C6ay to the order of bearer.D 6aul brou"ht check to TE5. %lerk simply paid 6aul cash for the check and took possession of it without obtainin" any indorsement at all. 'ank dishonored the check. TN= is holder here because it is bearer paper. To transfer bearer paper& may merely pass possession. 6s holder& TN= could sue the dra!er !ho is primarily liable. $t could not sue Paul& ho!ever& because he did not indorse it and therefore& does not have indorser liability. There is no cause of action against Paul. c. %heck written by drawer to 6aul. There are $ si"natures on the back of the checkA first ?at the top@ states, D6ay to Tom (ae, GsG 6aul 6ayeeD and below that a si"nature by (artin %hu22elwit. The check was dishonored because drawer closed account. 0ho can Tom sue! f Tom sues (artin, can (artin recover from anyone else! $f Tom <ae and TN= are vie!ed as the same entity "sole proprietorship#& then TN= is holder. /ecause Paul signed the check& he has indorser liability. <artin is an anomalous indorser& and as such is a guarantor of the check. Therefore& TN= could sue dra!er& as primarily liable party& Paul& or <artin. <artin& to recoup !hat he pays to TN=& has rights against Paul. De could also sue dra!er for payment by subrogation& !hich !ill discuss later. E. %hambers wrote a $.,300 check to purchase stereo system from ,tore. ,tereo would not work and %hambers could not return because ,tore "oin" out of business. %hambers told bank to stop payment on check, but check was already paid. %hambers came in to look at check and saw there was no indorsement by ,tore, only a stamp by depositary bank. %hambers insisted that 'ank acted improperly 18

in payin" check because depositary bank was not holder because ,tore did not indorse. 'ank wants to know if acted improperly. Bhen depositing a check in a bank& no indorsement is necessary to make the bank the holder. :89(*E. Therefore& /ank acted properly. C. 'ook4dealer re/uires %ustomer to pay him once a month for all books bou"ht in the precedin" month. %ustomers purchases totaled $1$,000 durin" last $ weeks. 'ook4dealer asked customer for immediate payment due to abnormally lar"e amount of purchases. 'ook4dealer received check for $1$,000 drawn on .rd ,tate 'ank and si"ned by that bank in the lower ri"ht4hand corner. n lower left4hand corner, it lists customer as Cremitter.D 'ook4dealer has heard ne"ative news about the bank, and wonders if bein" had. $f one accepts a cashier)s check& the obligation is eGtinguished. :797'*. $n that case& the only means of recovery is against the bank. The bank fills the shoes of the purchaser of cashier)s check. $f book9 dealer is !orried about the solvency of the bank& it may lose the K'(&*** because cannot go after customer for there is no longer liability on the underlying obligation. Customer is probably not pulling a fast one because paid bank for cashier)s check. /ut still risky if don)t think bank good for it. 03emitter1 + person !ho asked for cashier)s check and paid for it. ssignment 23. Aolders in 6ue Course D$-C status implements the idea that enhancing the ability of the transferees to enforce instruments enhances the liAuidity of negotiable instruments by enhancing attractiveness of negotiable instruments as investments. AI6C Status ' $e@uirements &3(302 <ust be the Dolder of the instrument + possession& properly negotiated and negotiable - /earer paper + take possession - =rder paper + take possession via proper indorsement 2or >alue - 6nything of value + including a future promise but only after future promise has been performed. &3(303 4ood 2aith - ouisiana does not go by :'9(*7)s definition of good faith as honesty in fact. Bill use the Civil Code definition instead + not bad faith. $t)s a 0you kno! it !hen you see it1 standard + ambiguous and more fleGible in a. - %Gample of /2: Payee negotiates all instruments that payors give him directly through to a bank that is financing his operation. /ank gives payee the money. Payee and bank have insulated bank from liability of the payor. Payor must call the payee if his purchased item is broken and payee !ill say call the bank. /ut bank is D$-C& so no obligation to payor. Some courts do not think this is fair dealing. Bithout Notice of 8 Specific Problems &3(302)a* - =verdue& dishonored& or principal payment default "default on principle& not interest#. - Unauthori;ed ,s, or has been altered or forged. - 6nother claim on the instrument - 6nother party& such as the maker& has a defense. <ost common: failure of consideration. - Notice is not kno!ledge. $f based on all kno!n facts and circumstances at the time& should have tipped off to one of the above& have notice. &1(201)2<*)c* d0antages of AI6C Status %nforce the instrument free of personal defenses to payment of maker + failure of consideration& redhibition - Not immune from 8 3eal -efenses &3(30<)a*)1*5 These 8 defenses are considered so fundamentally important that not even a D$-C is immune from them. The 0real1 defenses render the instrument an absolute nullity and therefore void. "'# $nfancy + minor !ho has no capacity under state la! "(# $llegality + but only if that illegality renders the instrument absolutely null. Under the UCC& duress and lack of legal capacity fall into this category. 19

 $n a.& duress and lack of capacity are merely relatively null and are not defenses that can be asserted against a D$-C. Prostitution !ould fit under illegality in a. "7# 2raud in the 2actum "not in the inducement# + maker of the note defrauded as to the very nature of the instrument. "not !here signer is talked into signing#. <ust have been so defrauded that didn)t kno! and couldn)t have reasonably kno!n that taking on an obligation to pay. "8# 2ederal discharge in /ankruptcy. 2ederal bankruptcy la! preempts state la! and is therefore assertable. Shelter Principle &3(203)b* - 6llo!s the buyer to stop into the shoes of the seller. - 6llo!s a purchaser !ho fails to obtain its o!n D$-C status& i.e.& does not meet four reAuirements to assert any D$-C rights that the seller had before the sale. Pa!ment , 6ischarge =nly payment to the Dolder eGtinguishes the obligation. - $t is important to pay attention to !hom your holder is. $f you pay the !rong person& the obligation is not eGtinguished. Partial payment should not bar D$-C status. -ischarge - -ischarge is effective against a person !ho became the D$-C !ith notice of discharge. Do!ever& D$-C that took !ithout kno!ledge of discharge + discharge is not binding. - $f payee negotiates the instrument to someone else& the payments must be made to that ne! holder or the obligation is not getting discharged. Important 3imit on AI6C Status Can never become a D$-C by acAuiring the note issued by a consumer transaction under federal regulation. Problem Set (7 '. 'ank is thinkin" of ac/uirin" some promissory notes. =one are due in the ne+t 5 years, but in each, the borrower has missed one or more of the scheduled payments. The seller of the notes has not responded to the defaults. 1ssumin" they are ne"otiable in form and the current seller is holder of the notes and that the 'ank is properly indorsed the notes, will the borrowers missed payments prevent 'ank from becomin" a holder in due course! ,ome of the notes call for monthly payments that are part principle and part interest, while others call for monthly payments of interest only. &3(30')b* and )c* + Bith respect to an instrument payable at a definite time& the follo!ing rules apply: "'# $f the principle is payable in installments and a due date has not been accelerated& the instrument becomes overdue upon default under the instrument for nonpayment of an installment& and the instrument remains overdue until the default is cured. "(# $f the principal is not payable in installments and the due date has not been accelerated& the instrument becomes overdue on the day after the due date. "7# $f a due date !ith respect to principal has been accelerated& the instrument becomes overdue on the day after the accelerated due date. Unless the due date of principle has been accelerated& an instrument does not become overdue if there is default in payment of interest but no default in payment of principal. Unless accelerated& !hich not here& an instrument does not become overdue if there is a default in payment of interest + but does if there is default in payment of principal. Notes that are merely defaults of monthly interest payments do not prevent holder in due course status. Do!ever& defaults on payments of both principal and interest& give holder notice of overdue. $n that case& /ank !ould not be a holder in due course. =verdue means that payment of principle !as not met. (. %ustomer is in dispute with 'ank over a $$( promissory note that %ustomer issued to 'ank$ in connection with a mort"a"e. %ustomer paid off 'ank$ with a lump sum payment, and later received a call from 'ank to direct payment to it for 'ank had purchased the promissory note. Hven thou"h %ustomer told 'ank that already paid to 'ank$, 'ank said didnt matter because purchased the note $ weeks before %ustomer paid it. s %ustomer liable to 'ank$ on a note he has already paid! &3(+01)b* + -ischarge of the obligation of a party is not effective against a person acAuiring rights of a holder in due course of the instrument !ithout notice of the discharge. 20

Payment to a person !ho is not entitled to enforce the instrument is not effective payment and does not eGtinguish the obligation to pay. Customer must pay the person entitled to enforce the instrument. Unfortunately& there is no reasonable !ay Customer could have protected himself if /ank( !as trying to pull a fast one on him. Customer should pay off notes face9to9face. $t doesn)t matter !hether /ank is a holder in due course or not. =nly thing customer could do !ould be to sue /ank( for un5ust enrichment + but eGpensive. Customer could also argue that !as not a negotiable instrument if the promise to pay !as conditional or some such. $f so& a different set of rules !ould apply. 7. Tom cashed a travelers check. t was issued by 'ank and payable to Cbearer,D but re/uired a countersi"nature from )ane as a condition to payment. t turns up that the customer had stolen the check from )ane and for"ed her countersi"nature. 'ank refused to honor the check because )ane notified 'ank that it was stolen. 0hy cant Tom rely on holder in due course status to enforce the check a"ainst 'ank! 6 traveler)s check is a negotiable instrument despite reAuirement of counter9signature. $f payable to bearer& then anyone !ho possesses the check is a holder. Therefore& the thief !as a holder. Prof. thinks that issuer should be able to raise the defense of failure to countersign. Nonetheless& if Tom is a holder in due course& the issuer is not able to assert that defense. Tom is a holder in due course because he is a holder& took the instrument for value& took in good faith& and !as una!are of notice of problems. Tom should be able to get money from /ank Bhether or not Tom sues depends on !hether it is !ork it. Traveler)s checks !ill not be tested on the eGam. 8. %ustomer issued check for $10,000 payable to *latiron. 'ecause customers account did not hold $10,000 on day the check was presented, 'ank dishonored it. 1 few days later, customer sent 'ank a stop4payment order on the check. 1 few months later, *latiron walked into branch of 'ank and asked teller to e+chan"e customers check for cashiers check. 'ecause customers account has sufficient funds at the time, the teller complied. (inutes later, the tellers supervisor noticed that payment had been stopped for the check. 'ank called *latiron and told it that would dishonor its cashiers check. 0hat does the 'ank do! /ank is liable for cashier)s checks it issues. $t can raise the defense that !as a mistake& but this is a personal defense& not a real defense& and so can only be raised if 2latiron is not a D$-C. The dishonored check !as not value in eGchange for cashier)s check& may not have taken it in good faith& and had notice of dishonored + so not a D$-C. E. n e+chan"e for specially dyed uniforms, %lym paid Ienn with a ne"otiable promissory note in the amount of $.,000, payable to Ienn in e/ual monthly installments over $ years. 'ank bou"ht the note from Ienn for $$,B00. Ienn added a special indorsementA C6ay to 'ank GsG Ienn.D 'ank wanted to donate the note to 00*> it did so with the indorsementA C6ay to 00*, 0ithout :ecourse, 'ank, by GsG 'ank (ana"er, I6.D Ienn did not dye the uniforms well and %lym refuses to pay the note. %lyms lawyer says 00* cannot force %lym to pay because it is not a holder in due course. s this true! &3(203)b* 9 Transfer of an instrument& !hether or not the transfer is a negotiation& vests in the transferee any right of the transferor to enforce the instrument& including any right as a holder in due course& but the transferee cannot acAuire rights of a holder in due course by a transfer& directly or indirectly& from a holder in due course if the transferee engaged in fraud or illegality affecting the instrument. BB2 is not a D$-C because received the note by donation. Do!ever& under the Shelter principle& it can assert the rights of /ank !ho !as a D$-C. So& Clym cannot assert the defense of faulty merchandise against BB2. C. ' wrote % a check for $1,500 and then stopped payment because chan"ed mind about purchase. % indorsed check and deposited in own bank. 's bank, 'ank1, dishonored the check based on the stop4 payment re/uest. 0hat can %s bank do to recover the funds it credited to %s account! 6ccording to :89('8& a collecting bank may revoke provisional settlements and give the check back to C. So /ank !ill suffer no loss at all. C)s bank could also sue / as D$-C and avoid his defense of lack of consideration& though no real good reason !hy should. 21

F. (a""ie si"ns promissory note for $.,000 to buy furniture. ,he was obli"ed to make monthly payments over . years. 1fter 9 payments, (a""ie wants to stop payin" because the furniture never arrived. 'ank says her obli"ation to pay is absolute and should brin" any problem with furniture to dealer. 8ealer will not return calls, and (a""ie wants to know if she can stop payments. The note does not contain the standard *T% le"end that prevents the bank from obtainin" holder in due course status. 8oes that mean the bank is a holder in due course! $f 2TC legend is there& bank cannot be a D$-C. $f it is not there& it can. >ery fu;;y on this + ask Nilborn. SSIB18?1" '. $ISK O: 3OSS I1 CA?CKI1B SCS"?8 "A? # SIC :$ 8?/O$K 4eneral 3ule: Person in the best position to avoid the loss !ill bear that loss. 6nother ob5ective may be to allocate the loss to the party best able to spread it over persons and over time. Indorser 3iabilit! &3('1< %very indorser guarantees payment to all subseAuent parties acAuiring the check for the value of the check $2 6N- =N @ $2 the check is dishonored. %nforcement by any holder against any indorser P Chain of iability - <ust be dishonored in 7* days - if indorser puts 0!ithout recourse1 !ith indorsement& he escapes liability. - <ust have notice of dishonor Payor /ank cannot enforce indorser liability b,c it !ould obtain the instrument only if it paid the instrument. $ndorser iability is not available !hen dra!ee pays the instrument. -ra!er does not incur indorser liability because it doesn)t indorse the instrument "ransfer /arranties &3('1+ and &'(20 6nyone !ho transfers an instrument !arrants to subseAuent transferees& including banks "N=T the Payor /ank# that: "'# Proper indorsements "meaning had the right to enforce#+ b,c everyone breaches this !hen a forgery& gets passed back all the !ay to the one !ho relied on the forgery thief. "(# 6uthori;ed signatures "7# No alternations + amount& maturity date& completion& or parties "8# No defenses or claims in recoupment "E# No kno!ledge of insolvent dra!er %nforced against all transferors Presenting bank seeks to pass loss back up the chain of liability "indorser liability also comes into play here#. Notice of breach of !arranty must be given to !arrantor !ithin 7* days after claimant has reason to kno! of breach and the identity of the !arrantor. 2ailure to give notice to the !arrantor !ithin this period discharges the !arrantor to the eGtent of any loss caused by delay in giving notice. =nly a transferee !ho takes the instrument in good faith is entitled to recover for breach of the transfer !arranty. &3('1+)b*5 Note: 6rt. 7 applies to individuals or anyone and 6rt. 8 applies to banks. Presentment /arranties 6nyone !ho takes a check and transfers it or presents it to payor bank& !arrants to the payor bank certain presentment !arranties. They run only to the payor bank. &3('1- and &'(20; Bhen Payor /ank honors a forged check& it can rely on the presentment !arranties to recover from anyone !ho transferred or presented the check. =ther!ise that bank bears the loss because check not properly payable. 7 presentment !arranties: "'# $ndorsements are proper "(# No alterations. "7# No kno!ledge of unauthori;ed signature + this is actual kno!ledge. 3eAuires 42 in paying or accepting the instrument to utili;e. P Presenters for payment make only presentment !arranties& but prior transferors may make both transfer and presentment !arranties. P $f anyone acts in /2 in the chain& then the rule is interpreted against them. 22

2orged -ra!er)s Signature - No party is liable on an instrument unless his signature appears on the instrument. :798*'. $f the signature !as forged by a person unauthori;ed to sign the dra!er)s signature& the signature is 0ineffective1 as the signature of the dra!er. :798*7"a#. The signature does& ho!ever& operate as the signature of the unauthori;ed signer. - Payor bank cannot charge dra!er)s account b,c check is not properly payable. :898*'"a#. 6n item is only properly payable !hen authori;ed by the customer. :898'*"a#. Do!ever& under :898*F"(#& payor bank may be subrogated to the rights of the payee if it paid the payee and therefore can sue the dra!er. The depositary bank may also be subrogated. oss is generally passed to the person !ho dealt !ith the forger. $f the payor bank honors the check !ith the forged signature& the payor bank should bear the loss b,c it !as most likely to discover that the signature !as forged. Payor /ank bears the loss + last solvent person to deal !ith thief. 2orged $ndorsements - 6 payor bank that pays an instrument bearing a forged indorsement cannot charge the dra!er)s account because the check is not properly payable. - The payor bank !ill be able to shift liability to the presenter& b,c the presenter !as not a person entitled to enforce the instrument and thus breached a presenter)s !arranty. The presenter in turn !ill be able to impose liability on prior transferors& as their transfers !ere in violation of the transfer !arranty that all signatures !ere authentic and authori;ed and that the !arrantor !as a person entitled to enforce the instrument. This chain of shifting losses should end !ith the transferor !ho took from the forger. That individual may seek recovery from the forger. Conversion - &3('20: 6n instrument that is converted if it is taken by transfer& other than negotiation& from a person not entitled to enforce the instrument or a bank makes or obtains payment !ith respect to the instrument for a person not entitled to enforce the instrument or receive payment. 6n action for conversion of an instrument may not be brought by "i# the issuer or acceptor of the instrument or "ii# a payee or indorsee !ho did not receive delivery of the instrument either directly or through delivery to an agent or a co9 payee. - 6n instrument that has been paid over a forged indorsement has been converted by the payor. - Payee of a stolen check is barred from enforcing the underlying obligation. - $nstead of pursuing the thief& pursue !ho purchased the check from the thief: depositary bank or payor bank "not intermediary#. &3('20 - Payee)s right to pursue the Payor bank for conversion creates tension !ith the dra!er)s right to prevent improperly payable checks from being paid. - Subrogation + payor bank gets subrogated to the rights of the payee once it pays the item and can charge dra!er)s account 5ust as though property payable. &'('06lteration - Change in relevant aspect of the check as originally !ritten. &3('0-)c* - There are !arranties against alternation& so again& check passes back. a# Payor bank can only charge the dra!er)s account for the original amount of the check b# Payor bank can pursue others for breach of presentment !arranties &'(20; - 6ddition to incomplete check + dra!er bears the loss. best position to avoid it. &3('0HHHCannot Baive Barranties !ith respect to checks. ::798'C"c#& 798'F"e#HHH Problem Set 8 1. 8rawer wrote a $.00 check to 6ayee for doctors visit. 'ank honored the check. %heck bears a blank indorsement by 6ayee, followed by indorsements of Hdward and 'ank$. 6ayee, however, claims that he never received the check. 0ill had stolen the check and "iven it to Hdward as payment for debts. 'ank a"reed to recredit drawers account. 'ank doesnt want to bear the loss for the check> what should it do! $. 0hat could 'ank$ have done if 'ank had noticed the for"ed indorsement and dishonored the check!

23

&'(20- + 6 customer or collecting bank that transfers an item and receives a settlement or other consideration !arrants to the transferee and to any subseAuent collecting bank that: "transfer !arranties#. .. 1n unknown person stole a check from drawers checkbook and for"ed her si"nature. #yd"ate, tricked by the for"er, a"reed to cash the check. 0hen #yd"ate tried to deposit the check, his bank forwarded to 'ank$ for collection. 'efore doin" so, the 'ank included a le"end as part of its indorsementA C0ithout recourse and without any warranty whatsoever.D The payor bank dishonored the check and returned to the collectin" bank. %ollectin" bank wants to know if can recover from depositary bank or the for"er. &3('1')b* + $f an unaccepted draft is dishonored& the dra!er is obliged to pay the draft "i# according to its terms at the time it !as issued or if not issued& at the time it first cam into possession of a holder& or "ii# if the dra!er signed an incompleted instrument& according o its terms !hen completed& to the eGtent stated in :79''E and 798*F. &3('1;)a* + %Gcept as other!ise provided& if the dra!ee of a draft pays or accepts the draft and the dra!ee acted on the mistaken belief that "i# payment of the draft had not been stopped or "ii# the signature of the dra!er of the draft !as authori;ed& the dra!ee may recover the amount of the draft from the person to !hom or for !hose benefit payment !as made or& in the case of acceptance& may revoke acceptance. 3ights of the dra!ee under this section are not affected by the failure of the dra!ee to eGercise ordinary care in paying or accepting the draft. 3. 0hat ri"hts would the payor bank in the /uestion above have if it honored the check, but then recredited drawers account when the fraud was discovered! &3('1;)c* + %Gception to :8'Q"a# + see problem 7. The remedy in "a# cannot be asserted against a person !ho took the instrument in good faith and for value or !ho in good faith changed position in reliance on the payment or acceptance. 5. %ustomer carries si"ned checks in her wallet. 0hen she left the wallet in a restaurant, one of the checks was taken, completed for the amount of $1,000 and cashed at 'ank, and honored by payor bank without anyone noticin" the problem. %ustomer claims the check should not have been honored. 6ayor bank does not want to bear the loss J what should it do! &3('0-)c* + 6 payor bank or dra!ee paying a fraudulently altered instrument or a person taking it for value& in good faith and !ithout notice of the alteration& may enforce rights !ith respect to the instrument "i# according to its original terms& or "ii# in the case of an incomplete instrument altered by unauthori;ed completion& according to its terms as completed. &'('01)d* + 6 bank that in good faith makes payment to a holder may charge the indicated account of its customer according to: "'# the original terms of the altered item. or "(# the terms of the completed item& even though the bank kno!s the item has been completed unless the bank has notice that the completion !as improper. 9. %ustomer wrote check to supplier for $1,000. The check was altered durin" collection process to indicate an amount of $10,000. %ustomers bank did not notice the alteration and honored the check for the full amount. 'ank thinks it can only hold %ustomer to $1,000 but wants to recover other $&,000. SSIB18?1" <. $ISK O: 3OSS I1 "A? CA?CKI1B SCS"?8 SP?CI 3 $73?S Beneral $ule &3('0+ 3ule: 06 person !hose failure to eGercise ordinary care substantially contributes to an alteration of an instrument or to the making of a forged signature on an instrument is precluded from asserting the alteration or the forgery against a person& !ho& in good faith& pays the instrument or takes it for value or for collection.1 $f a dra!er negligently allo!s someone to use her checkbook& she cannot claim that the thief)s signature !as not proper. The bank must act !ith ordinary care as !ell& or !ill have a contributory negligence situation. $f this occurs& the bank !ill cause some of the liability. =rdinary care 9 industry practice 24

Statement $e0ie2 $ule &'('0+ /ank customers have a duty to revie! their bank statements reasonably promptly "about 7* days#. There are ( important rules in :898*C: "'# $f bank gives statements and customer fails to reasonably promptly revie! that statement& then any fraud perpetrated after 7* days is on the dra!er for any subseAuent frauds by the same defrauder. 6s soon as first fraudulent check appears& have a duty to report. 2ollo!ing fraudulent acts are on your o!n head if do not. "(# $f don)t catch fraud !ithin ' year& regardless of ho! careful you are& you are liable for any fraud appearing on statement after ' year. $f donRt notify !ithin ' year& there is an absolute bar to recovery. $esponsible ?mplo!ee $ule $f responsible employee indorses& the employer !ill be precluded from a claim against the payor bank. :898*E $f a responsible employee forges by stealing employer)s indorsement or forging checks& the employer is precluded from claiming that indorsement !as invalid. The loss is on he !ho hired the defrauder. Imposter $ule $f someone dupes the dra!er into issuing a check because they are impersonating someone else& then the dra!er is precluded from claiming that not a proper indorsement. The dra!er is in the best position to avoid loss& so pin it on him& but only if payor bank honors check. Problem Set E 1. %ustomer left check on seat of airplane. 0hat if . rd party takes the check, for"es his indorsement, and cashes it! $f Customer)s failure to act !ith ordinary care substantially facilitated the forgery& he cannot make a claim against the depositary bank for !rongful conversion. :798*C. /ut :798*C may not apply because of the !ord 0signature.1 $ don)t understand this. $. n the followin" situations, would employer be liable! f so, what should he do to limit liability! a@ Hmployee, who has no check writin" authority, makes out one of employers blank checks to himself and for"es employers si"nature as drawer. Hmployee then indorses the check and deposits it. Hmployee then withdraws funds from his account and disappears. b@ 6erson claims to be a supplier to whom employer owes money. Hmployer issues a check in the name the person claims to be. 6erson then indorses check in payees name, cashes it, and runs off. c@ ,ame as in ?a@, but instead of writin" the check to himself, Hmployee writes it to (adeline, intendin" to "ive the check to a friend. The friend for"es (adelines indorsement and cashes the check. d@ ,ame as in ?c@ but Hmployee makes check out to a wholly fictitious character. 6inker indorses the check in the name of the fictitious person and deposits it in an account that 6inker maintains in the fictitious name. e@ ,ame as in ?c@ but Hmployee is the person in Hmployers office responsible for issuin" checks. f@ 6inker stole the check and used Hmployers facsimile si"nature machine to si"n the check. Hmployers account a"reement stated that any si"nature suin" that machine would be treated as authori2ed by Hmployer.

.. %ustomer has been the victim of a len"thy for"ery scheme by his accounts payable clerk. The clerk for"ed checks on the account for 1B months before bein" cau"ht, stealin" a total of $1.5,000. 'ank thinks that it has no obli"ation to return the funds to %ustomers account because %ustomer never noticed any of the for"eries on his statement. 'ut the bank doesnt want to hurt its relationship with %ustomer and is considerin" payin" anyway. 'ank wants to know how it can miti"ate the banks e+posure to le"al liability in the future and the possibility that the losses will occur in the first place J but nothin" too costly. CA P"?$ 2. O"A?$ CO1S78?$ P C8?1" SCS"?8S ssignment +. "he Credit Card S!stem 25

$ssuer9Cardholder 3elationship: Participants + cardholder& issuer& merchant& and merchant bank 3egulations + T$ 6 and 3eg. S. T$ 6 "Truth in ending 6ct# is only applicable in consumer transactions. Collection by Payee '. <echanics of Collection <erchant agreement !ith net!ork. <erchant takes on significant credit card responsibility "pay a fee to allo! consumers to use credit cards#. They do this intending to dra! more business. a# >isa and <asterCard are not banks. They are net!orks that eGist to encourage people to use credit cards. They make money by allo!ing members to use services for a fee. <erchant bank gives merchant provisional credit (. 2inality of Payment $ssuing bank)s obligation to pay does not become final at the time of the initial payment Cardholder has the right to !ithhold on basis of any defense it can assert against the merchant. T$ 6 :'F*"a#. Cardholder pays balance and must make 42 attempt to obtain satisfactory resolution of disagreement '** mile rule + Cardholder cannot !ithhold payment of transaction that occurs more than '** miles from Cardholder)s billing address. Transaction must be over KE*. Problem Set C 1. 'ank receives letter from bank cardholder, describin" a $375 mountain bike cardholder purchased usin" bank visa card. The letter e+plained that the bike was defective and asked bank to refund the cost of the bike as char"ed on the card. The letter enclosed payment for the remainder of the bill. s the cardholder entitled to a refund! 0hat is cardholder entitled to! "I3 &1-0 briefly: "a# 6 card issuer to a consumer credit plan is sub5ect to all claims "other than tort# and defenses arising out of any transaction in !hich the credit card !as used if "'# the obligor has made a good faith attempt to obtain satisfactory resolution of a disagreement or problem relative to the transaction from the person honoring the credit card. "(# the amount of the initial transaction eGceeds KE*& and "7# place !here the initial transaction occurred !as in the same State as the cardholder& or !ithin '** miles from his address. The reAuirements of "(# and "7# are not necessary if the person honoring the credit card "6# is the same person as the card issuer& "/# is controlled by the card issuer& "C# is under direct or indirect common control !ith the card issuer& "-# is a franchised dealer in the card issuer)s products or services& or "%# has obtained the order for such transaction through a mail solicitation made by or participated in by the card issuer in !hich the cardholder is solicited to enter into such transaction by using the credit card issued by the card issuer. $eg5 D &22+512)c* + "'# 4eneral rule + !hen a person !ho honors a credit card fails to resolve satisfactorily a dispute as to property or services purchased !ith the card in a consumer credit transaction& the cardholder may assert against the issuer all claims "other than tort# and defenses arising out of the transaction and relating to the failure to resolve the dispute. The cardholder may !ithhold payment up to the amount of the credit outstanding for the property or services and any finance or other charges imposed on that amount. "(# The card issuer cannot report the amount !ithheld as delinAuent until dispute settled or 5udgment rendered. "7# These rights only apply if "i# the cardholder may a 42 attempt to resolve the dispute !ith the person honoring the card. and "ii# eGceeds KE* and is in same state or !ithin '** miles. Cardholder may not have a refund from the bank& but he can !ithhold payment. To get a refund& he must go through the merchant. She can assert any defenses she has against the merchant to the bank& eGcept !hen it comes to payment. @ou have 7* days to reverse payment !ith the merchant. $t)s a very simple matter. Transaction must be !ithin state living or '** miles and the cost of the item charged must eGceed KE*. $f not& cannot !ithhold. <ay !ithhold payment if 7 rules apply: "'# charge for disputed item eGceeds KE* 26

"(# cardholder made a 42 attempt to settle it !ith the merchant "7# $f merchant refuses& merchant must be !ithin '** miles or !ithin state of consumer)s residence. "This is a serious problem !ith charges made by telephone#. To determine !hether cardholder is entitled to !ithhold payment& it is necessary to kno! !here consumer lives in relation to bike shop. $f the locality reAuirements are not met& the bank doesn)t have to honor the cardholder)s reAuest. $. -ow can 'ank respond to cardholders defenses! $f the defense presented to the issuer is valid and the issuer removes charge from cardholder)s account& the issuer& through its agreement !ith merchant bank& generally allo!s the issuer to charge back the merchant bank the price of the bike. The merchant bank !ill then do the same to the merchant. Then& !hen the merchant eats the loss& it !ill !ant the bike back. $ssuer is not likely to ever take the loss. .. 'ank concerned over clients filin" for bankruptcy due to consumer complaints about new line of computers. 'ank has provided clients processin" of mail4order credit card sales. n the last . months, those sales were $150,000. 8oes the 'anks relationship put it at risk! $f the product does not !ork& the consumers may !ithhold payment. -ue to the courts !illingness to to fudge the '** mile rule in order to protect customers& the rule may be interpreted as the closest brick and mortar store or !here the telephone operator is located. The N bet!een the issuer and the merchant bank says that issuer can charge the loss to the merchant. /ut b,c the merchant is threatened !ith bankruptcy& the issuer is left taking the hit b,c it cannot take money from the merchant due to the bankruptcy. 3. %omputer services company owes $10,000 to suppliers. f he does not pay within the ne+t week, they will stop shippin" "oods to him which would kill his business. %ompany is considerin" usin" the (aster%ard to pay the suppliers $10,000 to reduce the amount he owes for past shipments. %o. thinks it can dispute the char"es and defer payment to the issuer indefinitely. "I3 &10')1* + This subchapter does not apply to . . . credit transactions involving eGtensions of credit primarily for business& commercial& or agricultural purposes& or to gov)t or gov)tal agencies or instrumentalities& or to organi;ations. The right to dispute charges does not apply to business charges. %ven if he passed this eGception& there must be a good faith attempt too resolve the disagreement. /ut because most banks do not ask !hether you have attempted to resolve the issue& this plan may !ork in practicality eGcept that issuer bank !ill Auickly charge back to merchant bank. merchant bank !ill charge back to supplier. $f did& !ould probably only buy himself a !eek or so and !ould look pretty obviously like fraud. De could put it on credit and 5ust not pay it for a !hile + credit cards are essentially high interest loans. 5. 'ank, as ac/uirer that clears credit card transactions for customer, bounced several checks of customers. %ustomer thinks checks should have been easily covered by funds deposited into his account in the form of credit card receivables. 'ank said it adopted a new policy that a hold is placed on credit card deposits for 35 days after date deposited to protect a"ainst the possibility that 'ank will have to "ive back funds to issuers if cardholders challen"e any relevant transactions. :89('E"e# does not apply because credit card receivables are not 0items1 and are eGcluded from 6rticle 8. Under 3eg. CC& general funds availability rules may help but because credit card receivables are not included !ithin the definition of 0check1 in 3eg. CC ((I.("k#& it is not applicable. So& neither article 8 nor the 3eg. CC help the customer. Customer could go to court and argue that 8E days is unreasonable by saying that other banks do not !ait that long. The customer)s other option is to change banks. ssignment -. ?rror , :raud in Credit(Card "ransactions %rror: -efined 9 appears on a credit card statement and does not reflect an actual transaction To challenge billing error cardholder must provide !ritten notice to the issuer !ithin 90 days after the date on !hich creditor sent the statement. $f not& then lose right to complain or contest. Thereafter& the creditor must respond in .0 days and resolve the claim !ithin $ billin" cycles. KE* penalty to cardholder for failure to follo! procedure. 27

 $ncluded in error is !here there is a problem !ith the merchant as to the product. 6lthough it is not really a billing error to say that he didn)t uphold his end of the deal& it is included in error nonetheless. :raud "I3 &133 + cardholder liability is limited to KE* maG regardless of lack of care and even if the cardholder fails to notify the issuer. Do!ever& to get liability belo! KE*& should notify. $f can catch before use& avoid liability altogether. Upon notification& the card issuer loses right to hold the consumer accountable for any charges after that. There is no statute of limitations for asserting anything under T$ 6. Courts have implied a private right to action. 6gency la! + businesses issuing credit cards to employees a#/usiness cannot pass the loss on to its employees !hen they N out of T$ 6 protection. 6uthori;ed users + if actual& implied& or apparent authority are authori;ed user. T$ 6 :'*7"o#. a# 6pparent authority + agent b,c someone has led a 7rd party to kno! that agent. $t thus reAuires the cardholder make a manifestation to the card issuer. $t may be possible that if do not revie! statements& are manifesting that !hatever is on card is okay !ith you. 6lthough this interpretation runs counter to the T$ 6)s notion of protecting consumers& it may be possible to argue& particularly if you allo! to go on for long time. b# $mplied authority + parent gives child his credit card to use Problem Set F 1. %onsumer lost his credit card which has a $$0,000 limit one week a"o. ,hould he be worried! "I3 &133 + "a#"'# 6 cardholder is liable for the unauthori;ed use of a credit card only if 9 the card is an accepted credit card& the liability is not in eGcess of KE*& the issuer gives adeAuate notice to cardholder of potential liability& issuer has provided cardholder !ith a description of ho! issuer should be notified of loss or theft of card& the unauthori;ed use occurs before the card issuer has been notified of unauthori;ed use or possible use& and the issuer has provided a method !hereby the user of such card can be identified as the person authori;ed to use it. Consumer must !orry about potential liability due to unauthori;ed use that occurred prior to his notification of the card)s disappearance. Do!ever& he can only be liable for KE* maGimum. $f the fraud occurred over mail order& the merchant bears the loss. if face9to9face& then issuer bears the loss. '** mile rule doesn)t apply to unauthori;ed transactions. $. %onsumer is about to sell books by mail order. -e is worried about acceptin" payment by credit card because the cardholder wont be si"nin" slips. 8oes that mean that the cardholders will have "reater ri"ht to "et out of the transactions! No& !hether or not they sign slips doesn)t matter + it only matters !hether authori;ed or not. The real issue is !hether can figure out if authori;ed or not. Signature on the slip is not authori;ation + its 5ust proof of !ho you are and helpful in proving and detecting fraud. ack of signatures does not give cardholders greater ability to get out of transactions. .. %onsumer purchased airline tickets several weeks before the airline stopped flyin" and went bankrupt. %onsumer purchased the tickets on his (aster%ard> can he "et a refund! 0hat do you need to know to answer %onsumers /uestion! This is an authori;ed transaction. ( !ays to avoid billing charge: "'# Could say that it is billing error because airline never supplied services. Consumer has C* days from sending of statement& not receipt& to give notice& so must act relatively Auickly. Bhat do you need to kno! to ans!er the AuestionJ Bhen statement !as sent,receivedJ "(# Under T$ 6 :'F*& he may have a claim against issuer if !ithin '** mile rule. Need to kno! if has already paid for the tickets. if so& cannot do. 3. 'ank has pro"ram that provides credit cards for small businesses at low costs. ,mall business must si"n an a"reement acceptin" responsibility for any unauthori2ed char"es that are made with a stolen card. 1n employer is complainin" that a thief stole . of 5 cards that issued to employees. 'y time called to report, thief had char"ed $500 on each of the cards. Hmployer plans on deductin" the amount from each of the employees paychecks. Hmployer wants to make sure this is okay. f employer cannot char"e to employees, she wants the bank to bear the loss. 28

"I3 &13< + 6 card issuer and a business or organi;ation that provides credit cards to '* or more of its employees may by contract agree to liability of the business or other organi;ation !ith respect to unauthori;ed use of such credit cards& but under no circumstances can the business or issuer impose liability upon any employee !ith respect to unauthori;ed use. 6lthough a business may !aive its KE* maGimum liability& it must issue at least '* cards to its employees in order to do so and cannot pass on the loss to employees. %ven if it !as possible for the business to pass on liability to employees& it could not eGceed KE* a card. The bank is responsible for unauthori;ed charges. 5. 'erties diners card was refused by a merchant who asked 'ertie if would speak on the phone to a representative of the issuer. The issuer advised 'ertie that the card was not honored because of 'erties failure to pay the last . months bills that totaled $3,500. The problem arose because issuer erroneously entered a $30 char"e as $3,000 on the 1st unpaid statement. 'ertie has not received the last . statements bGc he failed to "ive issuer his new address when he moved. n a"reement with issuer says that if dont contest in accordance with federal procedure, are liable. %an 'ertie "et the char"e removed! The charge !as authori;ed& even if the actual amount charged is !rong. Dis defense to payment to assert against the issuer under :'F' doesn)t eGist. :'C' is the billing error section. De has C* days from the time they transmitted the statement to send in a challenge. De !aited too long. Do!ever& he may have an action in un5ust enrichment. C. Hmployers ne"li"ence allowed credit card to be taken by employee and card was used to obtain a $1,000 cash advance from issuer bank. That bank was not able to recover the funds from the thief and is tryin" to obtain payment from Hmployer because it was his fault. s Hmployer obli"ated to pay! 0hat is the banks best ar"ument! There is no eAuivalent to UCC 798*C "ordinary care,negligence rule# in T$ 6. Therefore& Client cannot be liable for more than KE* maG. for the unauthori;ed use of his credit card. Do!ever& the bank may argue that it !as mislead to think the employee had apparent authority& and therefore authori;ed. ssignment ;. 6ebit Cards %2T6 ::I*'9I(* and 3eg. % 3eplaces paper check !ith an electronic impulse that directs the bank to transfer funds to customer or a 7 rd party& !hich Aualifies as an electronic funds transfer. Pa!ment 2ith a 6ebit Card '. %stablishing the -ebit Card 3elationship + ( procedural reAuirements %2T6 :I'' + Customer must reAuest a debit card from bank. $f bank sends a card unsolicited& it must be in an invalidated condition. $f bank sends invalidated card to customer& customer must contact bank to validate. 3eg. % + -isclosure reAuirement + bank must provide the customer !ith a detailed up9front disclosure of the terms and conditions that !ill govern the use of the card. (. Transferring 2unds !ith a -ebit Card Point of Sale Transactions "P=S# + merchant receives almost automatic 6CD transaction from your account %2T6 :I*C"a# + reAuires that customers be provided !ith !ritten documentation of every transaction they initiate 7. Collection by Payee + merchant must have a N !ith bank or net!ork that processes debit card transactions P$N9based -ebit Cards + - Terminal transmits signal to Payro /ank over phone line. $f P$N matches P$N for designated account and funds are available& the Payor /ank honors the reAuest. %9message sent back to merchant over the phone line. - Payor /ank)s obligation to pay becomes final at the moment it transmits message back to the merchant. - Payee)s risk of non9payment is limited to insolvency of the payor bank or failure in processing system. 29

P$N9less -ebit Cards - =n9line authori;ation !hile customer at terminal but does not clear and settle transaction immediately. 6uthori;ation of the transaction at terminal& !hich confirms availability of funds in account to cover the reAuested transaction. - <erchant obtains payment the same !ay as in a credit card transaction + over the neGt fe! days. - 2rom a consumer perspective& payment is final at time of transaction and no T$ 69based rights to challenge payment later.

?rror , :raud in 6ebit Card "ransactions 3isk of nonpayment is less in a debit card transaction b,c the consumer cannot stop payment + too fast. 15 ?rror $f merchant believes it receives authori;ation !hen in fact it !as not communicating !ith the payor bank + P=S net!ork rules ordinarily protect the merchant and pass the loss back to the payor bank. $f payor bank sends signal committing to make payment& then charges the !rong account + Payor /ank !ould have to recredit the incorrectly charged account and then could charge correct account and pursue customer for deficiency. Consumer has C* days to notify orally or by !riting of error. Payor bank may reAuire !ritten notice after oral notice is given. %2T6 :I*Q. 6fter receiving notice& the payor bank may provisionally recredit the consumer)s account !ithin '* days. The payor bank shall investigate the matter no longer than 8E days after notice. -uring this pendency& consumer has full use of funds provisionally credited. %2T6 :I*Q. "$f bank provisionally credits account& it doesn)t have to abide by previously noted day reAuirements#. $f payor bank determines that an error did occur& it has no more than ' business day after that determination to correct the error. %2T6 :I*Q. 6n eGplanation of its findings must be mailed or delivered to the consumer !ithin 7 days of investigation)s conclusion. Consumer can get treble damages under certain circumstances in !hich the bank did not act in 42. :I*Q. 25 :raud <ost serious risk of loss in the debit card conteGt is the risk from false authori;ations: debit card transactions that the consumer in fact has not authori;ed. <erchant entitled to payment b,c bank in much better position to maintain the system for authori;ation of !ithdra!als. Customer + there are 7 rules the bank can use to impose liability on customer !hen his card is lost or stolen. :I*I"a#. - /ank can hold the customer liable for up to KE* of unauthori;ed transactions that occur before bank kno!s of consumer)s loss of the card. "/anks can N to take on more liability& but cannot N to give more liability to consumer#. - 2ault9based notice rule + allo!s the bank to charge consumer for losses if consumer does not promptly notify the bank after discovery of lost card. a# Up to KE** paid after ( days after loss,fraud "not ( days after discovers loss# and fails to notify. b# So + notify the bank !ithin ( days of discovering the loss. - Customer has 90 days to revie! statements. a# $f he fails to report unauthori;ed transaction !,in C* days of statement& he is liable for any subseAuent transactions. "Some state la!s limit this liability. a. does not#. b# No maGimum limit. c# >isa and <C issued debit cards have limited liability to KE* like T$ 6 Problem Set Q 1. %lient left his debit card with his 6 = on an airplane. 0hat should he do! ,hould he be worried! $f Client calls the bank immediately& he !ill probably not be liable for anything. $f it has been already used& then he !ould liable up to KE*. $f he !aits ( days before notifying the bank& he could be liable up to KE**. $f he fails to report the transaction !ithin C* days& he is liable for any subseAuent transactions sub5ect to no maGimum limit "unless >isa or <C !hich do not abide by C* day or KE** rule#. Negligence rules under 798*C that apply to checks& do not apply to debit cards. 30

$. <rocer is considerin" acceptin" 6 =4based debit cards in hopes that funds would be credited more /uickly, thereby brin"in" in more interest income and will save on bad4check e+penses. -owever, <rocer is still skeptical. 8oes he face any si"nificant risks of loss if he accepts debit cards! 0hat if system messes up and he sells thin"s to people with no money in their accounts! -ebit cards are the ultimate payment system for merchants. Payment is final at the moment of transaction. 6nd upon finality& the risk of loss is on the payor bank for any fraudulent items. 6lthough the payor bank may be able to pass the loss to the consumer& it !ill not pass the loss to the merchant. Net!ork rules allocate loss. Bhy does the bank agree to assume risk rather than pass it to the merchantJ /ecause the banks !ant lots of money flo!ing through and its much less eGpensive to process electronic messages rather than checks. $n addition& the risk of forgery or fraud is negligible because debit cards are very difficult to forge. The merchant !ill take the loss for fraudulent debit transactions if it accepts these transactions !hile its computer is do!n. .. 1rchie, with his bank card, purchased a printin" press which is defective and wants to withhold payment. 'ank told him that he could not challen"e the transaction. -is card is a (% with both credit and debit features. -e thinks the clerk at the shop erroneously processed the transaction as a debit card transaction rather than a credit card transaction. %an 1rchie "et his money back from the bank! ?:" &403)11* + 0unauthori;ed electronic fund transfer1 + an electronic transfer initiated by a person other than the consumer !ithout actual authority to initiate transfer and from !hich the consumer receives no benefit. $t does not include a transfer initiated by a person other than the consumer !ho !as furnished !ith the card& code& or other means of access by such consumer& unless the consumer has notified the bank that transfers by such other person are no longer authori;ed& it !as initiated !ith fraudulent intent by the consumer& or constitutes an error committed by a financial institution. Under %2T6& it probably !on)t be considered an unauthori;ed electronic fund transfer because it !as given by 6rchie to the clerk and 6rchie benefited from it. /ut because he intended credit card& T$ 6 may apply + see :'F* + 0The credit card is used as a method of payment.1 De should have looked at !hat he !as signing and !ould have recogni;ed that clerk used debit instead of credit. 3. 1rchie, in reviewin" his statement that he receives at the first of every month, noticed several unauthori2ed transactions that "o back over a year and total $.,000 4 $$50 on the 15 th of every month. -e has just remembered that the card was taken from him in a mu""in" 1 year a"o on (arch 1 and he for"ot to do anythin" about it. *or how much is 1rchie responsible! $f 6rchie has reported the card stolen to the bank upon notice& he could only be liable for up to KE* if the card had already been used. 6fter lost or stolen for ( days "not ( days after discovery# and failure to notify bank& 6rchie !ould be liable up to KE**. De is liable for all fraud that occurs after C* days that don)t revie!. So& 6rchie is liable for KE* off the bat. (nd part + liable for K(** for a total of K(E*. iable for K(E* in 6pril. So& far a total of KE** !hich is the maG he can pay. so& 6rchie is not liable for <ay 'E K(E* payment. That payment !as !ithin C* days of 'st statement that reflected fraud "statement !ould have been on 6pril '#. 2or the Oune payments and everything after& he is fully liable. So& 6rchie !ill only be refunded K(E* from the <ay 'E charge& and is responsible for everything else. 5. %lient reported lost debit card and $1,000 of unauthori2ed char"es on same day learned card was lost J (onday, (arch 1. 10 days later on (arch 11, %lient "ot a notice from his supplier that because check bounced, was cancelin" E. The bank had bounced the check on (arch & because it had not yet determined how to respond to %lients claim. 8oes client have a ri"ht to complain about banks dishonor of check! The bank has '* days to investigate claim and see if the transaction !as unauthori;ed. The bank 0may1 provisionally credit a claimant)s account + but doesn)t have to. $f it had& the bank !ould not be sub5ect to the '* day rule& but !ould have 8E days to investigate. The check bounced Q days after reported it missing. This is okay. Client has no right to complain about the dishonor. Client should complain to the bank and hope they change it& but no la! helps. Compared to check + check system presumes check is improper and investigation follo!s. Payment of a forged check is not properly payable& investigate later. The opposite is true for debit card transaction. 9. 0ould the answer in problem 5 be different if %lients card was a (aster(oney debit card! 6ssuming this is a <asterCard& then yes& it !ould be different. <asterCard reAuires the bank to give the money back provisionally !ithin E days. Through the <asterCard net!ork agreement& the consumer has 31

greater protection. $f bank has agreed to recredit !ithin E days& is incorporated into rule. The dishonor !ould be !rongful. ssignment 4. utomated Clearinghouse Pa!ments

Benerall! -efined: 6CD + a nation!ide computeri;ed net!ork that is counterpart to the checking system. $t is used to electronically transfer funds bet!een accounts at 6merican financial institutions. To the eGtent that they involve consumer accounts& it is governed by %2T6 and 3eg. %. 2or transfers bet!een business accounts& it is governed by UCC art. 86. The net!ork is generally governed by N6TCD6 "National 6utomated Clearing Douse 6ssociation + a non9profit assoc. of 7C clearing houses#. N6TCD6 are not la!. they are 5ust rules agreed upon among financial institutions. a# /anking day + $n N6TCD6& a banking day is a day on !hich a substantial part of business is done. So& Saturday could Aualify. The most common 6CD transaction is direct deposit of paychecks. Can also directly !ithdra! recurrent fees + like gym fees and bills and mortgage payments. "erminolog! =riginator + party that makes entry "or communication# that initiates transaction. =riginating -epository 2inancial $nstitution "=-2$# + financial institution of the originator. 6utomated Clearing Douse operator "6CD =perator# + party that carries the communication "and funds# from the =-2$ to the 3-2$. This is normally the local 2ederal 3eserve. $f banks are far apart& !ill be an originating 6CD operator and a receiving 6CD operator. 3eceiving -epositary 2inancial $nstitution "3-2$# + financial institution of the recipient 3eceiver + part to !hich the entry is directed. :inalit!. 6ishonor , Stop Pa!ment -ishonor 9 6CD entries can be dishonored for lack of funds& particularly if it is an automatic !ithdra!al. N6CD6 has same sort of payment dishonor rules as 3eg. CC. <ust provide notice of dishonor !ithin of the (nd day. Stop payment + Stop payment can be sent in ( circumstances. "'# Consumers having money !ithdra!n are the only ones !ith a significant right to stop payment. To stop payment of a !ithdra!al& consumer need only give oral notice 7 banking days before the settlement date. /ank can reAuire !ritten notice follo!9up !ithin '8 banking days. ?rror $f an erroneous credit& or particularly debit entry& is made& consumers have a very specific right to get money back. N6TCD6 reAuires the consumer check his statement !ithin E regular days + this is most rigorous revie! rule !e have yet encountered. The bank must then recredit promptly. The definition of 0promptly1 is ambiguous& but Nilborn thinks ( or 7 days is enough. Problem Set I: '. Kou have the internet bill paid by automatic deduction from your bank account which you a"reed to when you si"ned up for service. a@ 8etermine what type of 1%- entry ?credit or debit@ is most likely to be involved. 1 "CA &1251520 + 6 credit entry is one for the transfer of money to the account of a receiver. 6 debit entry is for the !ithdra!al of money from the transaction account or general ledger account of a receiver. 6ll entries are deemed 0items1 !ithin meaning of UCC art. 8 and that article shall apply eGcept !here the application is inconsistent !ith these rules. Bhen you authori;e money to be taken out& it is a debit payment. @ou could make it a credit entry by initiating the payment transaction& i.e.& click button authori;ing !ithdra!al or direct bank to make payments against account. b@ Kou live in %hica"o and internet provider is in ,eattle. 0ho are the most likely parties to the transaction and the roles they would play under applicable =1%-1 rules! 32

The internet provider is the originator because it started the transaction by sending through reAuest to debit account. /ank in Seattle is the =-2. 2rom there& send to local federal reserve bank as originating 6CD operator. Bhen going across ( federal reserve regions& the local federal reserve !ill send to depositary)s local federal reserve as 6CD. So& from the Seattle federal reserve& the entry !ill go to the Chicago federal reserve& !hich !ill be called the receiving 6CD operator. The Chicago reserve !ill send the entry to your bank. The 3-2$ "your bank# !ill check to see that properly authori;ed. c@ 1ssumin" that the ne+t payment is due (onday, 1pril 1, what would you need to do to cancel that payment, and what is the latest date on which you could act to do so in a timely manner! 1 CA &-5' "relevant parts# + 3eceiver may stop the payment of a debit entry by providing either verbal or !ritten notice to the 3-2$ at least 7 /anking days before the settlement date "date of scheduled transfer#. 6ny 3-2$ may honor a stop payment order received !ithin the 79banking9day limit& and if it does& the 3-2$ has no resulting liability or responsibility to any other person having an interest in the entry. The 3-2$ may reAuire !ritten confirmation of a verbal stop payment order be made !ithin '8 days of a verbal stop payment order& provided that the 3-2$ notifies the 3eceiver of this reAuirement and provides an address to !hich confirmation should be sent at the time the verbal order is provided. $f the 3-2$ reAuires !ritten notice& the verbal stop payment order !ill cease to be binding after '8 days. 6 receiver may !ithdra! a stop payment order by providing !ritten notice to the 3-2$. 6 stop payment order !ill remain in effect "'# for C months from the date of the stop payment order& "(# until payment of the debit entry has been stopped& or "7# until the receiver !ithdra!s the stop payment order& !hichever occurs earliest. 1 CA sub& 1351511 + /anking day: any day on !hich the -2$ is open to the public during any part of the day for carrying on substantially all of its banking functions. 2or 6CD operator& it is any day on !hich it is operated. 6 credit entry cannot be stopped. Bith debit entry& you& as a consumer& do have a right to stop payment !ithin 7 days of settlement date. Bhen must notify if payment on <ondayJ -o not count Sunday. $f the bank is open on Saturdays& even until noon& Saturday !ould count. Counting Saturday& Thursday is the earliest day that could be the deadline for stopping payment. $f bank is not open on Saturday& it !ould be Bednesday. Notice can be given orally unless you have agreed other!ise by N. (. Kou pay your credit4card bill throu"h an nternet billin" payment service offered by your bank, throu"h which you can direct your bank to pay bills throu"h 1%- transfers. ;sin" that service, you direct a transfer to pay a $7,000 credit card bill in its entirety. 0hat if you chan"e your mind the ne+t day J is there anythin" you can do to stop payment! 1 CA & 25< To correct an erroneous entry previously initiated to a receiver)s account& an originator may initiate a reversing entry. The reversing entry is transmitted to the 3eceiving 6CD =perator in enough time that 3-2$ may be made available to the entry by midnight of the E th banking day follo!ing the Settlement date of the erroneous entry. 6n erroneous entry: "'# a duplication of an entry& "(# entries not intended& and "7# entries !ith different dollar amount. =riginator must notify the 3eceiver of the reversing entry !ith a reason no later than the Settlement date of the reversing entry. %ach =-2$ that initiates a reversing entry shall indemnify participating parties from and against all claim& demand& loss& or eGpense& including attorney)s fees that result from the reversing entry. This is a credit entry because pushing money& so there is no stop payment right. =nce originating bank receives order& cannot stop. $ts more acceptable to have stop payment !ith a check because it is not as instantaneous + it takes several days to a month for your bank to get order to pay. Bith 6CD& the order is received immediately. 33

7. ;sin" the same system as in L$, you pay your monthly mort"a"e payment. t has a settlement date of 1pril 1, but you receive a notice of late fee because not processed until 1pril $. The notice advises you that the co. takes $ days to process 1%- payments and thus all mort"a"e payments must be transmitted $ days in advance of the date the mort"a"e is due. s there anythin" you can do about this! 1 CA sub& '5'5' + 6 3eceiver must credit the =riginator !ith the amount of an entry credited to the 3eceiver)s account as of the Settlement -ate. . . N6CD6 rules reAuire receiver give credit to originator on the settlement date. $t is generally sent and received on the settlement date. The mortgage co. is reAuired to give credit. /ut mortgage co. could argue that it is not bound by N6TCD6 rules. %very participating bank agrees to comply !ith N6CD6 and it only bind banks that are members. $t does not bind the originator or the receiver unless they have agreed to be bound by N6CD6 in N "!hich is possible because the receiver)s bank has an interest in reAuiring the receiver follo!s N6CD6 rules. So& look to the N b,t the receiver bank and the receiver. 8. Kour bank mistakenly honors a check that is not properly payable from your bank account, which has the effect of depletin" the funds in your account. 1s a result, the re"ularly scheduled debit entry to pay your car payment is returned unpaid by your bank. %ar lender repossesses your car, which causes you to incur a variety of e+penses. s your bank liable for those losses! 1 CA &<51 6n 3-2$ may return an entry for any reason eGcept if it returns it simply because it is a credit& debit& or particular type of credit or debit. 3eturn entries must be received by the 3-2$)s 6CD =perator in enough time that it be made available to the =-2$ no later than the opening of business on the ( nd banking day after the Settlement date of the original entry. $f it)s a credit entry being returned& it must be transmitted by the 3-2$ to its 6CD =perator prior to the time the 3-2$ accepts the credit entry unless the 3eceiver does not have an account !ith the 3-2$& the receiver)s account has been closed& or the 3-2$ is not permitted by la! to receive credits for the receiver. The 3-2$ must transmit the return entry to the 6CD =perator by midnight of the banking day after the banking day of receipt by the 3-2$ from the 3eceiver. 6n =-2$ must accept return entries if done in accordance !ith the above. 2or more rules on return entries& see pg. 'QF9QQ of teGt. The 3-2$ may not be separate from the receiver& particularly if receiver is a bank that takes mortgages in that case are bound automatically by N6CD6. $f a finance co.& maybe bound because members of N6CD6 and are a 3-2$. See !hat Curt has on this. E. 0hen you check bank statement, you find a debit entry for $$,100 to cover a mort"a"e payment to 'ank. 'ut you do not own a home. a@ -ow /uickly must your bank return the $$,100 to your account! 1 CA &-5+ $ecei0er%s $ight to $ecredit 2or all consumer entries& an 3-2$ must promptly credit the amount of a debit entry if "'# the 3eceiver sends or delivers to the 3-2$ a !ritten affidavit that debit entry !as not authori;ed by the 3eceiver& and "(# this affidavit is sent or delivered to the 3-2$ !ithin 'E days from the date the 3-2$ sends statement to the receiver. 2or more on re9crediting& see pgs. 'I79'IC in teGt. 6s long as you revie! your statement and notify bank in !riting of error !ithin 'E days of date statement !as mailed& you are okay under N6CD6 and %2T6. /ank !ill reAuire you file an affidavit and must recredit after file 0promptly.1 b@ 1fter the bank returns the money, will it be able to recover from any other party! 0ould your answer be different if the funds had been stolen by check! The bank !ill be able to recover from the =-2$ if had been fraudulent check& The payor bank couldn)t recover from anyone else. /ecause if payor pays fraudulent check& it bears the risk of loss unless can push it off on you. Check !ith Curt on this. 34

C. %lient wants to know the advanta"es and disadvanta"es he would face in acceptin" 1%- payments at his "rocery store ?presumably 656 entries, as compared to checks and debit cards. P=P + point of purchase "more generally called P=S 9 point of sale#. The first Auestion is if 6CD practical to grocer. The only !ay it could !ork is if customers brought checkbooks !ith them and some !ay to s!ipe. %Gpense: 6CD is cheap. There are no transaction fees or per transaction fee as !ould !ith checks& debit cards& or credit cards. Checks are a pain for merchants& and 6CD is more cost efficient + about same as debit. Speed + The speed in !hich the grocer !ill get money in 6CD is the same as debit. Credit reAuires sending slips but still get money pretty Auickly !ithin days. <uch faster than checks. Stability of payment + Customer has less ability to stop payment or assert defense or stop payment. Credit allo!s to assert defenses. Bith check& customer can stop payment before clears. Do!ever& debit great for finality. ike debit& 6CD checks in real time + kno! !hether enough money or not. 2raud + no chance of fraud on debit card. $t)s a lot higher for credit cards and checks. Check losses !ill be borne by payor bank and credit as !ell. 6CD is not great given logistical problems. Credit cards great for merchants but T$ 6 makes a little harder. -ebit cards are best from merchant)s perspective. CA P"?$ 3. O"A?$ #7SI1?SS P C8?1" SCS"?8S ssignment 10. "he /ire "ransfer S!stem Bire transfer payments are attractive to businesses b,c they offer almost instantaneous payment at the time of the transaction. <ost made through net!ork UCC 6rt. 86 governs + only credit transfers. Ao2 It /orks: '. $nitiating the Bire Transfer + 2rom =riginator)s /ank P /eneficiary)s /ank =)s /ank must do ( things: "'# Notifies /)s /ank "(# 2or!ard Payment P $f does not send timely& could have to pay interest %ach step& from the = to /)s /ank is a separate payment order Systems "'# /ilateral System "SB$2T# + =)s /ank sends message directly to /)s /ank "(# CD$PS + System that allo!s a large T of banks to send all messages to central clearinghouse that can aggregate and net out all participant)s transfers. "7# 2%-B$3% + dominant b,t US banks. =)s bank sends message to the 2ed. 3eserve bank. 2ed. 3eserve eGecutes payment "pymt order T(# P /)s /ank. /)s /ank is then reAuired to pay /. 6utomatically accepted + no cancellation. "a# -aylight overdrafts allo!ed. 3eg. O reAuires banks to take care of at the end of the day. (. Completing the 2unds Transfer: 2rom the /)s /ank P / /)s /ank technically has the right to re5ect payment order. ::869('*. 869(*( cmt. Q. - $f re5ects& must do so Auickly. =nce /)s bank accepts the payment order& it becomes obligated to pay /. <oment transfer received P /)s bank obligated. 6ischarge of the O%s obligation 8698*C a payment made by !ire transfer satisfied the underlying obligation of = at the moment /)s bank accepts payment order. So + obligation is eGtinguished upon acceptance :inalit! of Pa!ment %Gtremely limited time to stop payment. rapid transaction. 3easonable time for bank to act is difficult b,c hours or even minutes is the time frame for these transactions. 35

 =nly time can cancel "'# /)s /ank has not notified or paid the / "(# /)s /ank has not received full payment "7# =pening ' hour after neGt funds transfer day after payment date. Problem Set '* '. ' owes = $100,000 on promissory note that was due 1pril 1. 5n (onday, (arch .0, ' asked his bank, <ride, to send a wire transfer to =s account at %heeryble 'ank. <ride sent tele+ to %heeryble e+ecutin" 's re/uest on Tuesday, (arch .1, callin" for payment to = on 1pril 1. 6ursuant to a pree+istin" a"reement between <ride and %heeryble, %heeryble was entitled to obtain payment from <rides account at %heeryble. 1t the time the account contained more than enou"h funds to cover the promissory note. The order was misplaced by %heeryble and so %heeryble neither accepted nor rejected the order and did not notify = that the payment had come in by wire. 5n *riday, 1pril ., <ride was closed and *8 % was appointed receiver to supervise the closin" of its affairs. <ride withdrew all funds late Thursday afternoon, no funds remained in the <ride account at %heeryble. a@ t is 1pril 9 and = has not been paid. %an he pursue ' for payment! f not, is he entitled to payment from %heeryble! 6s in a check& the obligation is suspended !hen the originator initiates the !ire transfer. $t is eGtinguished by performance as soon as the beneficiary)s bank "Cheeryble# accepts payment. The obligation then shifts to the /eneficiary)s /ank. Bhen it says that Cheeryble didn)t do anything to accept or re5ect the payment order& it simply means that Cheeryble didn)t do anything affirmatively + it doesn)t mean that Cheeryble didn)t accept the order. /eneficiary)s /ank doesn)t have to give notice to /eneficiary though likely to. Dad C notified N that the money had come in& that !ould be one !ay of accepting the payment order& and C !ould then be obligated. 6cceptance by Cheeryble !as automatic and by default by the opening of the 0neGt funds9 transfer business day1 after it receives the payment order unless it re5ects it before then. :869 (*I"b#"7#. 0NeGt funds9transfer business day1 + day follo!ing the payment day or order "!hich !as 6pril '& so !ould be the opening of 6pril (#. =n the opening of 6pril (& that payment !as accepted if "'# at the time& the amount of the sender)s order is fully covered by a !ithdra!able credit balance or "(# the bank has other!ise received full payment from the sender& unless the order !as re5ected before that time or is re5ected !ithin "i# one hour after that time& or "ii# one hour after the opening of the neGt business day of the sender follo!ing the payment date if that time is later. 4ride is the sender to Cheeryble. Thursday morning& 4ride had sufficient funds in its account !hich !as taken out Thursday afternoon. Thus& because there !as money on hand at the opening of the business day& Cheeryble automatically accepted unless it re5ected. /ecause Cheeryble accepted& it is bound to the beneficiary to pay and / is off the hook as his obligation is eGtinguished. b@ -ow would the answer differ if %heeryble had rejected the order immediately after %heeryble received it! ?1ssume rejection was proper.@ /ank has right to re5ect payment order if reasonable even if sufficient funds. Unless Cheeryble and 4ride have agreed that Cheeryble !ill accept certain payment orders& then nothing in 86 reAuires Cheeryble to accept. The only person !ho !ill have a complaint is someone !ho had an agreement !ith the bank that refuses to payout the !ire transfer. c@ -ow would answer differ if the payment to %heeryble had been made by *edwire instead of throu"h an a"reement that %heeryble debit <rides account with %heeryble! 2edBire is a system operated by the 2ederal 3eserve System. The 2ed. in each district has an account that is o!ned by every bank regulated !ithin its district. Bhen bank transfers from 2ed. Bire& the 2ederal 3eserve credits receivers and debits payor)s accounts !ith the 2ed 3eserve. 6s long as there is enough money in the ( accounts& payment is automatic and instantaneous. 6ns!er !ould change: Bith 2edBire& payment order !ould have been immediately accepted& rather than a couple of days later. Payment !ould have been received on the day sent. $f sent 7,7'& !ould have been received 7,7'.

36

(. 'anks *ed. :eserve account is declinin" as the day "oes on due to only out"oin" wires. The balance is down to $. (illion. 'ank has received a re/uest to send out a wire for $5 million. 'ank wants to know if it can send out a wire for more than in its *ederal :eserve account. 2ed 3eserve allo!s daylight overdrafts& and different banks have different limits. 2ed 3eserve imposes a fee for every daylight overdraft + something like .(FM of overdraft amount. /ank !ill probably be okay if pays because credits and incoming !ires generally come at end of day. Bhat happens if the account doesn)t get replenishedJ /ook suggests that 2ed 3eserve reAuires /ank to make a deposit of money to put in account. /ank !ill likely dra! that amount from another account. 2ed 3eserve allo!s banks to do this to avoid hindering the process of making transfers. iAuidity is enhanced and business is facilitated. 7. 'ertie tells bank to send payment to Threepwoods bank for $350,000. 'erties bank sends order that late that ni"ht by means of a bilateral a"reement with Threepwoods bank. Threepwoods bank received order but has not acted on it yet ?ne+t mornin"@. 'ertie wants to issue a stop payment on the wire when he discovered the item he purchased was worth only $75,000. %an 'ertie have the wire canceled! $f receiving bank hasn)t accepted yet& you can give an order to stop payment. :869('' allo!s you to forcibly stop a !ire& but must do it Auickly before receiving bank has accepted it. $t is important that the bank has not informed Threep!ood that it received the !ire because if did so !ould constitute accpetance. @ou !ould have to call sending bank "/ertie)s bank# for ' st stop payment order. This must be done today because the initial order is automatically accepted at the opening of the funds transfer day after the payment order !as sent. Bould ans!er be different if it !as 2ed!ireJ @es& its automatic& so there is no possibility of canceling payment order. 8. Carol submitted wire transfer re/uest to transfer $750,000 from her checkin" account ?which earned no interest@ to another banks account ?which earned interest at BM annum@. 'ank ne"lected to send wire and can only send it tomorrow mornin". 0hat dama"es can %arol seek a"ainst the bank J will dama"es e+ceed the interest that 'ens bank can earn by investin" the funds until it transfers them! ?1ssume no a"reement between %arol and 'ank@. UCC 869E*C"b# permits consumers to get interest from the bank. The amount is determined by multiplying the applicable 2ederal 2unds rate by the amount that is payable. The product is then multiplied by the number of days for !hich interest is payable "7CE#. The 2ederal 2unds rate is the average of that published by the 2ed 3eserve of N@ for each of the days for !hich interest is payable divided by 7C*. Carol !ill !ant the bank to pay the applicable QM annum interest for the amount she has lost. Do!ever& under the UCC& interest o!ed by banks is calculated according to 2ederal 2unds rate !hich is substantially less than !hat Carol !ould seek. E. 'ank received a payment order from :ealtors, an account holder at the 'ank on 1pril 9 to transfer $500,000 to an account of )asmine also at the same bank. 'ank immediately made the appropriate debit and credit. )asmine had funds wired to an account in her name in (e+ico. 'ank just received an order from :ealtors cancelin" )asmines payment order. The ori"inal payment order stated that transition date was 1pril 9 and payment date was 1pril B. 'ank doesnt think it can "et the money back from )asmine. 8oes 'ank have to return the funds to the account of :ealtors! 7CC &' (204)d* + 6 payment order issued to the originator)s bank cannot be accepted until payment date if the originator)s bank is also the beneficiary)s bank or the eGecution date if the bank is not the beneficiary)s bank. $f the originator)s bank eGecutes the originator)s payment order before the eGecution date or pays the beneficiary of the originator)s payment order before the payment date and the payment order is subseAuently canceled& the bank may recover from the beneficiary any payment received to the eGtent allo!ed by la! governing mistake and restitution. Bhere the originator bank and the beneficiary bank are the same& a payment order cannot be accepted until payment date. The improper acceptance can be canceled if !ithin a reasonable time. 3ealtor must get money back + only from !hom. Can try to get money back from Oasmine& but is likely that the loss !ill fall on the bank. Note: 6 very different rule for checks: /ank can pay checks !henever it !ants regardless of post date& unless properly notified. C. :*T sold %6T tools worth $350,000. Their E re/uired payment with a cashiers check from 0ells *ar"o. %6T attempted to wire funds to an account of :*T at 'ank. :*T had accepted payment by transfers into that account in several earlier E, but has not been usin" that account for several months. %6Ts bank accepted %6Ts payment order and e+ecuted the transfer to :*Ts bank. 'ank notified :*T that 37

received funds for it. 'efore :*T was able to reach %6T to complain, 'ank was closed that afternoon and *8 % was appointed receiver. :eceiver told :*T that it would be able to retain very little from his account. 8oes :*T have a claim a"ainst %6T and does %6T have any remedy! 8698*C"b# + $f N specifically called for another form of payment& the beneficiary must complain and cannot take any of the money. $f accept money then cannot complain about it later. CPT has already paid but !ill have to pay again. Do! can it get back at least one of those paymentsJ CPT& if it pays 32T)s obligation& !ill be subrogated to 32T)s rights against /ank on the money already paid. :8698*C. Summary of 6ssignment '' + $f bank eGecutes order improperly . . . /anks bear no libility for !ire transfer errors unless specifically make themselves liable by agreement. 6ssignemnt '( -on)t mind international issus: 5ust kno! generally and kno! !here to look. 2raud: 3uel: !ire transfer fraud is treated like check fraud. $f send unauthori;ed !ire& the originator)s bank is responsible. The originator is not. Bhether unaturhoi;ed depends on la! of agency. Bhether apparetn implied or actual authroity to send !ire. %ach state is slightly differnet. /ut no ma5or surprises state to staet. 3uel(: Certain unath. Transfers can be deemed autho if the sepcial securites sysetem is follo!ed. $f agreed to impletn a comemrcially reasonable procedure and foll!os procedurea and originator unable to sho! that source of fradu !as not related to the orignator. The& the originator !ill bear liability. =riginator)s bank !ill !ant to have a realtively sophistticated security system to detect unauth transfers ssignment 11. ?rror in /ire("ransfer "ransactions 3ecovering from Parties in the System Principle: each party bears the responsibility for its o!n errors. Parties !ho participate after error have no obligation to discover or correct an error that one party made in an earlier transaction. =riginator)s %rror 3esponsible for its communication of the order. 6n erroneous payment order may "'# $s misplaced or lost& "(# $dentify the !rong account,person& "7# <ess up the amount of the payment order. /anks can rely on the T indicated on the order and deposit K into that account. Brong account T 9 /)s bank can rely on the T & even if does not match name& as long as it $-)s an eGisting account T. :869(*F. Senders ? receivers can agree on error detection systems + though rare. %rrors in the System + =)s /ank Sent too much 8698*("d# = /ank is liable for the correct amount of its order and must return the eGcess debits to the sender !ith interest on the funds from the date on !hich it initially paid out the funds. Can seek to cancel a duplicate or eGcessive order under :869(''. /eneficiary may give back by agreement& or if not& have a claim of un5ust enrichment. Sent $nadeAuate 2unds :8697*7"b# =)s /ank is only responsible for !hat the actual amount the bank sends. =)s /ank may correct and send the rest of the K due& but = remains only liable for !hat !as sent first =)s bank must refund any K collected from =)s account for (nd !ire and must pay interest on it. Sent late or not at all ate funds :8697*E + /ank must pay interest for timely improperly held /ank does not send at all + must compensate = for losses and eGpenses in the transaction "refund money charged for !ire transfer#. 38

ConseAuential damages are N=T allo!ed UN %SS the parties have an eGpress !ritten agreement. :8697*E"c#. Party !ho has no right to receive funds + restitution and mistake are the only recovery. $f sent to !rong beneficiary :86 doesn)t say very much about this. @ou can recover& but it must be under state la! "such as un5ust enrichment or restitution#.

/ank Statement 3ule :8697*8 + generally imposes a duty of ordinary care to revie! statements = must complain !ithin I* days of the error in order to recover from a bank error = cannot challenge a debit from the account for a !ire transaction after ' year from the date that the = received notice "receipt of statement#. $f bank sends ( payments out of =)s account !hen should be only '& =. !ill al!ays get the eGtra payment back. /ut if don)t revie! statement& lose ability to get interest on the money that bank mistakenly debited. Problem Set '' '. %lient asked 'ank to send )ames a $500,000 payment. The order identified )ames by name and account number as 00$1.1. 'ank debited clients account and sent payment order directly to )amess 'ank in %hica"o. )ames 'ank deposited the funds in its account L 00$1.1. -owever, this was not )ames account, but belon"ed to another. a# %an client recover the funds from his bankJ /anks may and al!ays !ill rely on T& and if originator gets number !rong& then person !ho causes the mistake !ill bear the burden. /ut this is an eGceptional situation. Need to kno! if /ank provided notice to Client that if he gives bank name and number& that bank !ill rely only on number. ook to the account agreement for this. $f Client had notice& he !ould be responsible for !iring the !rong T& and !on)t be able to get money back. $f he didn)t receive notice and says had no idea that bank !ould rely on number& then shouldn)t have been sent. b@ f client cannot recover the funds from his bank, does he have any way to recover the money! Under :869(*F"d#& if the beneficiary)s bank rightfully pays the person identified by number and that person !as not the correct beneficiary& the amount paid may recover under state la! if the = is obliged to pay its payment order. $f the = is not a bank and is not obliged to pay its payment order& the =)s bank has the right to recover. Client should call the person the money !as mistakenly given to and tell him give back the KE**&*** !as mistakenly deposited to his account. Bhat if that person refusesJ 86 doesn)t give any right to the client& so client !ould have to seek reimbursement under state la! theories of restitution and mistake "probably under un5ust enrichment#.

c@ 0ould the answer chan"e if )amess 'ank reco"ni2ed the discrepancy before it accepted the payment order! $f Oames)s /ank recogni;es that the name and account number identify ( different people& then it cannot be accepted and the payment order dies. Oames)s /ank should give notice to =)s bank. (. 'all send 'ank an email re/uestin" a wire transfer for $100,000 to #on"s account at ,='. 'ank accidentally duplicated the transaction and sent $ transfers. 'all complained that day. 'ank called ,=' who told 'ank that it had already notified #on", but that she had not yet removed the e+cess money. a@ %an 'ank force ,=' to send the e+tra payment back to 'ank! Dave both orders been accepted or is there time to dishonorJ /oth have been accepted because notified the beneficiary under :869(*I"b#. Nothing can force SN/ to return the funds because after payment order is accepted& cancellation is not effective. The banks must agree. $f SN/ doesn)t agree& under :869(''"c#"(# he may be able to sue under state la!. &' (211. $f a payment order is accepted by the beneficiary)s bank& cancellation is not effective unless the order !as issued in eGecution of unauthori;ed payment order or b,c of mistake by sender !hich resulted in the issuance of a payment order "i# that is a duplicate of a payment order previously issued by the sender& "ii# that orders payment to a beneficiary not entitled to receive 39

payment from the =& or "iii# that orders payment in an amount greater than the amount the beneficiary)s bank is entitled to receive from the =. b@ f not, can 'ank recover the e+cess funds from #on"! 0hat if 'all in fact owes #on" $1million! /ank may get money back from ong through un5ust enrichment + but it !ill depend on the relationship b,t ong and /all. $f /all really o!ed ong K(**&***& then most likely that bank could not get back. f 'ank has no ri"ht to recover the e+cess funds from ,=' or #on", can it retain all funds that it debited from 'alls account to pay for the orders! No. Can only debit sender for amount she sent.

c@

7. 'ank wants customers to waive any ri"ht to any type of recovery from the bank for failure to e+ecute a customers wire transfer payment order due to computer failure. 0ould such an a"reement be enforceable! /ank cannot N out of paying interest. :8697*E"f#. /ank also cannot N out of incidental damages. :869 7*E. /ank is not liable for conseAuential damages unless they agree to be held to conseAuential damages. /ank could probably have attorney)s fees !aived at least in a suit for damages in something other than interest and incidental damages !hich cannot N out of. 8. %lient authori2ed a wire transfer for $50,000, but the 'ank sent $500,000 by mistake. The bank mailed a notification to client, but it was lost in the mail and wasnt received until 1. months later. %an client force the bank to recredit the funds from the transfer! f so, is client entitled to interest! &' (<0< + $f receiving bank has received payment from its customer !ith respect to payment order issued in the name of the customer as sender and accepted by the bank& and the customer received notification reasonably identifying the order& the customer is precluded from asserting that the bank is not entitled to retain the payment unless the customer notifies the bank of the customer)s ob5ection to the payment !ithin ' year after notification !as received by the customer. -id client receive notificationJ 6 person received notification !hen it is properly delivered at his address or !hen he has actual notice. De could say that he is not precluded until ' year after he received the notice. Client should not be precluded from getting money back because bank is the one !ho made the error. Client may also get interest if the bank is reAuired to give the money back. E. %lients account was substantially depleted as a result of the banks accident in L3. The bank had dishonored several checks written by client in the last few weeks. These bounced checks caused client to suffer bounced check fees and more serious claims of default under a"reements that client had with the payees of the checks. %an client pass the costs of solvin" those problems back to the bank as conse/uences of the banks incorrect actions! <ust ask !hat is the cause of these problems. $f it is improper handling of !ire transfers& then the bank is not responsible for conseAuential damages unless agreed to in !ritten N. /ut if problems are due to !rongful dishonor of check& then go to :898*( !hich says bank is liable for conseAuential damages for !rongful dishonor of check. Nilborn doesn)t kno! !hat the ans!er is and says you must argue both. ssignment 12. :raud and S!stem :ailure in /ire("ransfer "ransactions 2raud 3ules 4eneral 3ule = is not liable for the unauthori;ed !ire transfers. generally& =)s bank takes the hit a! of 6gency $f fraudfeasor had apparent authority + defrauded customer is liable. $f no authority + customer is not liable -eemed 6uthori;ed + Some !ire transfers are deemed authori;ed = and =)s /ank must implement a security system $f =)s bank can prove that 'st follo!ed procedure and = cannot prove security breach !as from a source not controlled by = + deemed authori;ed. H =)s /ank is generally !illing to eat fraud losses

40

Choice of a! 3ules 9 :869E*F '. /,t sender and receiving banks + la! of receiving bank applies in a dispute (. /,t /)s bank and / + /)s bank)s la! applies 7. /,t = and / + la! of O. in !hich /)s bank is located. These rules apply !hen parties do not have a choice of la! provision in their Ns. The la! governing /)s bank governs in all disputes eGcept those b,t the = and its bank. Problem Set '( '. 'ank is marketin" a new security system for wire transfers. %ustomer did not want it. %ustomer wants a"reement statin" that 'ank is authori2ed to act on any written instruction that appears to reflects her si"nature as provided to the bank. 8oes this proposed a"reement e+pose the 'ank to any si"nificant risks! Under :869(*'& the proposal of signature comparison is not good enough to follo! the rule that the bank can deem received transfers as authori;ed. 6 security procedure does not include a comparison of signatures + it is easy to forge someone else)s signature. /ank should not agree to this procedure. The security procedure really should involve a pass!ord or a callback. 6lthough the procedure !ould not create any eGtraordinary risk& !ould not get the benefit of the commercially reasonable procedure in !hich could pass back loss to customer. (. Threepwood defrauded 'ertie in a sales transaction by claimin" the item was Canti/ueD when it was manufactured 10 years a"o. Threepwoods bank has notified Threepwood of the incomin" transfer, but Threepwood has not yet withdrawn the funds. 0ould Threepwoods fraud enable 'ertie to keep the beneficiarys bank from payin" the funds to Threepwood! 4eneral rule + !hen the beneficiary !as notified about the transfer& it !as accepted and the underlying obligation !as discharged. Under :869(''"c#& can cancel if it is payment order by mistake and the beneficiary is not entitled to funds. This may not be a mistake. $t is unlikely that fraud !ill allo! you to cancel the payment order. 6rt. 86 doesn)t mention fraud eGcept to say that if fraud bet!een = and =)s bank& = !ill not recover anything. The fraud !as independent of the !ire transfer& and /ertie must pay. This is fraud in the inducement !hich is only a defense in the credit card system. /ertie must sue Threep!ood under state la! for fraud. The person !ho could best avoid the loss !ill bear the loss. 7. 'ank su""ested %ustomer start usin" wire transfers to make business payments because safer and more certain than mailin" checks. 'ank wants to install e/uipment that would allow %ustomer to contact the 'ank by internet thus minimi2in" the potential for mistakes. 'ank tells %ustomer that no reason to fear unauthori2ed orders because %ustomer will be the only one with a password. %ustomer wonders if should do it. $f the bank follo!s the commercially reasonable security process& thin it is protected from its potential mistakes. Customer !ould have to prove that the security breach occurred and it !as no !ay related to the customer. $f anything goes !rong !ith his pass!ord& customer runs serious risk that bank !ill pass back loss to him. Can the bank !aive the above rule and agree to take the lossJ @es& under :869(*7"a#"'# in order to encourage customers and banks to enter into security agreements even if the customer is leery. There may be an argument that the pass!ord is not commercially reasonable because may be easy to find out. @ou could dra! a parallel to the signature problem. 8. %lient wonders at safety of receivin" payment by wire transfer. -e is hesitant to transfer his property based on the banks advise that it received the purchase price by wire transfer. De is not absolutely safe& but close. =nce the bank receives the !ire& the transaction is final and it is then the bank)s obligation to pay the beneficiary. 8698*E"d#& 0the credit is provisional until actual payment is make to the beneficiary bank . . . .1 / has to have received notice of this for it to stand + probably !as given a pamphlet !ith that information. $f this transfer !as by 2ed!ire or Chips + don)t allo! for provisional credits. they !ant transfers to be final. Dis bank could also b,c bankrupt b,8 it passes the funds to his account. So& this poses a risk because once the transfer !as accepted& the originator)s obligation !as discharged. %ustomer listed incorrect account number when issuin" a wire transfer J a mistake which neither bank noticed. 0hat if 5s bank is in (anhattan and 's bank is located in #ondon. The wire transfer was mistakenly sent to -arthouse who lives in (unich. Hn"land has adopted the ;=% T:1# (odel and <ermany has no wire transfer law, but instead relies on customary principles of a"ency law. %an 41

E.

%ustomer recover the funds from the 's bank! 8oes it matter whether %ustomer sues 's bank in =K or #ondon! Customer has a better chance in ondon than it does in N@. Under :869E*F& receiving bank governs& !hich is /)s bank in ondon. So& the <odel la! !ill apply to this dispute. -oes it matter !here you sueJ No& /)s bank)s la! !ill apply !herever sue. The real Auestion is !hich court !ill be more favorable to youJ N@ 5udges !ill be biased in favor of their o!n la! "under 86# !hereas a ondon 5udge is less inclined to look at 86. Therefore& ondon !ill give more room to argue that should have seen that should have been identified by name. Court pick is probably more important than choice of la!. Chapter 13. 3etters of Credit. "he #asics #etter from a financial institution promisin" to pay a stated sum of money upon the receipt of specified documents J way of enhancin" credit4worthiness of the buyer. %ommon in international sales. UCC art. E "if domestic# and UCP "if international# + Uniform Customs and Practices for Customary -ocuments. UCP only governs if incorporated into =C by reference. UCC applies automatically to domestic =Cs regardless of their reference !ithin the =C. The Transaction in a =C $ssuing bank issues a =C to the seller. $ssuing bank commits to pay price upon proof that seller shipped the goods. $ssuer charges the applicant a small fee and puts a hold on the funds in anticipation of the =C being honored. $ssuing bank may find a 1ominated #ank& usually !here the seller is located& !ho !ill process payment. The nominated bank may also be an d0ising #ank that eGplains the terms to the seller. Confirming #ank is the same as the nominated bank but it agrees to be personally liable. Seller ships goods and !rites letter to nominating bank "letter called documentary draft#brings documents and draft to the nominated,confirming bank. Nominated bank compares docs to the =C and pays the seller upon confirmation that docs strictly comply !ith =C& sub5ect to reimbursement !hen sends all original docs to issuing bank. $f docs do not strictly comply& bank can dishonor the =C or call issuer to inAuire if !illing to !aive reAuirements. Bithout !aiver& then dishonor. /ank has F days as per UCP to determine compliance of the documents& and after that is precluded from claiming non9compliance and must honor the draft. UCP ''"a#"i# + if electronic message is sent& adeAuate to transact. if mail sent& that item has no effect. Nominated or Confirming /ank)s =bligation %ompletely ministerial J just compare for e+act compliance and that is it. Independence principle + =C transaction is completely independent from the underlying transaction. =nly thing that matters is !hether or not documents conform. Underlying obligation is $33% %>6NT Caveat: $f bank is a!are of material fraud& then can dishonor based on that fraud. iability of -ifferent Players in the System 6dvising /ank + only gives information Confirming /ank Pays 6grees to be personally liable Das the right to immediate reimbursement Nominated /ank Pays /ut no agreement of personal liability Problem Set '7

42

'. 'ank has issued #5% which provides payment for "oods shipped Cfrom the end of *ebruary 1&&B.D ,he received a draft includin" an invoice for "oods shipped on *eb. $1, 1&&B. The #5% incorporates the ;%6 by reference. 8oes the draft comply with the #5%! 7CP &'- + The !ords to& until& till& from& and !ords of similar import are understood to include the date mentioned. The !ord 0after1 eGcludes the date mentioned. The terms 0first half1 and 0second half1 of a month shall refer to the 'st to the 'Eth and the 'Cth to the last day of the month. 0/eginning&1 0<iddle&1 and 0end1 of a month refer to the 'st to the '*th& the ''th to the (*th& and the ('st to the last day of such month& all dates inclusive. 2ebruary (' is defined as part of the end of the month and so complies. 02rom the end1 means from the ('st to the last day of the month. $n case of doubt& may !ant to ask applicant if okay. (. 'ookseller shipped books overseas. 0hen he submitted a draft on the #5%, the confirmin" bank told him it was not obli"ated to pay because the issuin" bank closed. Thus, the confirmin" bank ar"ued it would not be reimbursed and the #5% was unenforceable due to lack of consideration. 'ookseller wants to know what can do to "et payment! /ecause the confirming bank is in fact the confirming bank& it is personally liable on the =C. UCC :E9'*E. 7. 'ank misfiled a draft presented on a #5% and thus failed to respond to it. The beneficiary presented the draft on )an. 5, 1&&B, and 'ank did nothin" until beneficiary wrote in early *eb. demandin" payment. The #5% called for payment based on shipment of 100 cases of #lano Hstado wine at a price of Caround $130 per case.D The draft seeks payment of $1$0 per case. s 'ank re/uired to pay on the #5%! 06round1 in the UCP means !ithin a '*M difference. /ut does the UCP applyJ $t does not apply be default. if =C says UCP applies& then it does. '*M of K'8* is K'8.**. The difference here is greater than K'8 and so does not comply. /ank has only F banking days to dishonor an =C. /ecause this is one month later& can no longer point out discrepancies + lose the right to dishonor on that basis. $f neither honor nor dishonor !ithin F days& the result is automatic dishonor& but the bank is liable to pay damages for. So& the result is that the bank !ill pay the =C because it !rongfully dishonored& !hether or not the documents complied. 6pplicant !ill not be reAuired to pay. <aterial fraud is a problem that can be raised outside the F day period. 8. 'ank received an authenticated electronic mail messa"e from 6,' re/uestin" 'ank advise the beneficiary of the issuance of the #5%, and if willin", also serve as a confirmin" bank. 'ank confirmed the #5% and had ori"inal delivered to beneficiary. 'ank honored a draft on the #5% in the amount of $500,000. 0hen 'ank sou"ht reimbursement from 6,', it learned that #5% should have been for $50,000, not $500,000. 6,' made a typo"raphical error. 'ank notices that it received a written copy of correct #5% in the mail the day after 'ank delivered the #5% to the beneficiary. 8oes 6,' have to reimburse 'ank for payment of #5%! 6ccording to the UCP& /ank is reAuired to rely only on electronic message and not anything sent after. UCP :''"a#"'#. UCC is similar to the UCP here. The =C is the one sent electronically as long as it meets !hatever security measures /ank has in place. the mailed =C is considered a copy. The /ank must be reimbursed. This follo!s the general rule that in sophisticated commercial dealings& the person responsible for the error bears responsibility for that error. There may be litigation on this dispute if the =C does not refer to the UCP. E. 'ank issues a #5% for %ustomer to pay for shipment of toys from T(% in -on" Eon". %ustomer is dissatisfied with the toys and wants 'ank to reject the draft that has been presented to 'ank under the #5%. T(% submitted draft with appropriate docs to the 'ank of -on" Eon", who paid T(% and submitted the draft to 'ank. %an 'ank reject the draft bGc it was presented to her after the #5% e+pired and by a bank other than advisin" bank with which 'ank had never done business! 6s long as the docs are presented before the eGpiration date& they are okay. %Gpiration is not measured from !hen issuing bank receives the documents and there is no time limit for the bank to ask for reimbursement. %Gpiration only deals !ith !hen beneficiary must ask for payment. 6dvising bank !as Dang Seng /ank& but Dong Nong /ank paid. DS probably gave the =C over to DN. Bhether or not an =C can be negotiated doesn)t matter. ook to see if =C contains a restriction on !ho may perform. $f says credit available at any bank& then DS could transfer it. /ut if it says only DS& then cannot give it to another bank. $f it says 0freely negotiable1 or 0performance by any bank1& then anyone can pay. This is relatively rare& because issuing bank likes to kno! !ho dealing !ith. $f documents strictly comply !ith =C& then Dong Nong /ank must be reimbursed. 2unny that no rule that nominated persons get reimbursed but obviously they have to. 43

C. 'ank and %ustomer established special procedures fro drafts submitted under #5% issued to customers re"ular suppliers. They a"reed that 'ank would provide same day service on drafts for less than $$5,000 submitted on desi"nated CH+press 8raftD #5%s. They also a"reed that 'ank would not be obli"ated to review any of the documents smutted with these drafts, and 'ank a"reed to reduce its normal processin" fee by 50M on those drafts. 1 $$0,000 draft was submitted on an CH+press 8raftD #5%. *ollowin" its normal practice, 'ank honored draft within hours and without lookin" at underlyin" documents. %ustomer noticed that documents did not include the bill of ladin" called for by the #5% and found that the supplier did not in fact ship the "oods but was insolvent. %ustomer refuses to reimburse 'ank for the draft. 'ank wants to know if it has a ri"ht to payment by %ustomer. The agreement !as perfectly legitimate. Parties may vary their art. E duties and rights by agreement. 4ood faith and ordinary care cannot be !aived& but if customer !ants to do it this !ay& okay. 6pplicant is taking on risk but allo!ed to. ssignment 1'. 3etters of Credit d0anced "opics %rror and 2raud in =C Transactions /rongful Aonor :E9'*Q + issuer honors the draft despite the beneficiary)s failure to present the reAuired documents and lack of !aiver. $ssuing /ank has no right to recover funds from the applicant b,c improper use of funds and strict compliance standard. 3emedy for the issuing bank + Subrogation. :E9''F"a# $f the issuing bank pays the applicant)s obligation& it is subrogated to the rights of the beneficiary against the applicant on the underlying transaction. The bank steps into the shoes of the seller and goes after the applicant. $f the !rongful honor !as proper payment& bank can usually get money. $ssuer responsible to the applicant for damages resulting from the breach + incidental& not conseAuential damages. /rongful 6ishonor + issuer dishonors the draft even though documents presented !ere correct. -ishonor is only proper !hen docs don)t strictly comply& presented after eGpiration& or material fraud. /eneficiary can sue for specific performance + incidental damages not conseAuential "interest& attys fees#. /eneficiary has no duty to mitigate damages. :E9'''. 2raud :E9'*I + ( kinds: Someone forges /eneficiary)s ,s, on the docs and bank pays applicant is still liable. almost never occurs /eneficiary& !ho has not shipped goods& forges docs and says supplies !ere shipped. The bank can honor any draft it !ants that complies. /ank can only pay in 42 "honesty in fact#. /uyer then can sue the seller for fraud. The bank can dishonor draft if forged or materially fraudulent. <aterial fraud is difficult test to meet "stra! and camel dung#. /uyer can try to en5oin the bank from paying !hen it kno!s of material fraud. =nly time !hen independence principle does not have to apply. /ank must be very certain it is material fraud. $f it is !rong& !ill be liable for !rongful dishonor. 6ssigning =Cs : E9''8 4eneral rule + cannot assign a =C unless =C specifically allo!s it. Can assign the right to collect payment on the letter 3ight to perform is not assignable unless =C eGpressly allo!s. Problem Set '8 1. ,=' failed to make timely response to a draft on a $1$,000 #5% issued by *,'. The draft did not comply with the re/uirements of the #5%. a# 2S/ received a K'(&*** deposit from the applicant at the time that 2S/ issued the =C. $f 2S/ is forced to pay K'(&*** to the beneficiary& can 2S/ keep the K'(&*** to reimburse itselfJ 44

The price term in the docs said that wine was worth $1$0 a case and #5% said Cabout $130 a case.D 1Gb allows for 10M difference. ;nder N5410B?a@, you "et reimbursed for a properly presented doc. -ere, the docs dont comply. The 'ank cannot "o to the applicant because did not honor the draft correctly. 'ut, the 'ank could "et paid throu"h subro"ation to the ri"hts of the seller. 'ut how is subro"ation "oin" to help when buyer hasnt accepted the shipment! ,ubro"ation doesnt help issuer unless beneficiary has performed and applicant has accepted performance. 1s lon" as applicant accepts the wine, 'ank can be subro"ated to the ri"hts of the sellerGbeneficiary a"ainst the buyer and may keep the $1$,000 deposit. 'uyer may have a defense to payment by a breach of E bGc wron" wine sent. ,o, the buyer still may not have to pay. 'ut 'ank does not have to pay because may not be subro"ated if applicant returns the wine. (ay dishonor and say prospective unjust enrichment. b@ ,ame facts, but *,' did not take a deposit from the applicant. %an *,' recover the $1$,000 from the applicant! Same analysis eGcept that bank !ill probably sue to get the K'(&*** back. The basis of the suit !ill be the N b,c the bank subrogated to the seller)s rights. /ank !ill argue as seller& it did not get paid. $. 'ank issued a #5% for $1 million to :*T. 10 days a"o, 'ank received a documentary draft on the #5%, which appeared to contain all the re/uisite docs. 'ank did not process the draft timely and when it called applicant, the applicant told 'ank that that #5% must be for"ed because she beneficiary said would be submittin" a draft tomorrow. (ust 'ank honor the #5%! 0ould the answer chan"e if the #5% was issued by a 'ank branch outside the ;,! 6lthough /ank has F days to dishonor the check and failure to do so is automatic !rongful dishonor& the only defense that may be properly asserted after the F day term is material fraud. /ank can al!ays not pay and assert a forgery defense. $f the =C !as issued outside the US& the UCP !ould apply because all branches of banks are separate and individual entities and the la! of the issuer bank applies. The UCP does not contain this eGplicit eGception as does the UCC in :E9'*Q"b#. So& this issue may be up in the air. /ut the /ank probably should not have to pay because thieves don)t sue in court to steal money. .. 'ank wants to know what its responsibility will be if it receives a presentation drawin" on one of the #5%s that is totally for"ed and 'ank doesnt reali2e it and thus honors the #5%. 0ill bank be able to obtain reimbursement from its customer and is bank liable to honor a later le"itimate draft! The /ank may have to pay ( times. $f the first !as forged& then the obligation !as not discharged and bank !ill have to pay again !hen properly presented. 2orgery losses are most likely to be borne by the applicant. $t only falls on the /ank if the bank kno!s that forged and then the /ank has no right to payment. /ank should seek reimbursement on the first forged draft + bank probably took a deposit and should hold on to it. $t !ill be difficult to collect on the ( nd payment if have to pay ( times. 3. 5n *riday, %ustomer receives a shipment that should have been 3 barrels of e+pensive indi"o ink, but instead the barrels contained ordinary printers ink which has only O the value of indi"o ink. %ustomer obtained a $75,000 #5% to pay the shipper and 'ank found all docs to be in order. The banker told %ustomer it would honor the #5% (onday mornin". 0hat do you advise! -oes this rise to material fraudJ $f had said that sent empty boGes& clearly !ould. The real restriction on the bank is !hether the payment is in good faith. Could make an argument in Customer)s behalf that !ould be bad faith for bank to pay. /ank !ould then argue that bank did according to applicant)s !ishes on docs. $t is unlikely that the bank can be forced to pay& even if told. This probably doesn)t arise to the level of material fraud. 3emember& it is a very strict test. $f it !as material fraud& the bank could not pay it. 6nything Customer could do to prevent bank from payingJ Could get a court in5unction. /ut because over the !eekend& impossible to do this. Therefore& Customer must sue the ink co. for noncompliance !ith N. 5. ,ame facts as above, but assume the documentary draft and supportin" docs were presented to the issuer by the 'ank of -on" Eon" and that nobody at that bank had any reason to doubt the le"itimacy of those documents or the underlyin" transaction. 6ns!er does not change because if nominated person has already paid and had no kno!ledge of fraud& then the issuer is obligated to reimburse the nominated and so on do!n the line to applicant. $t)s important !ho banks chose as nominating bank& particularly if !orried about fraud. This system really doesn)t take fraud seriously + the =C is completely independent. 45

9. #5% issued to T(% as beneficiary. 'ank received draft on the #5% by -on" Eon" Toys and included all proper docs. t also included a piece of paper si"ned by 6res. 5f T(% transferrin" the #5% and all ri"hts under it to -on" Eon" Toys. a@ s 'ank obli"ated to honor the documentary draft! ,hould it! Cannot assign the right to performance. The assignment is void. Dong Nong !ill have to sue to get its toys back. b@ 0ould the answer chan"ed if -on" Eon" Toys ac/uired the #5% due to a mer"er with T(%! $f the transfer is incident to a merger& then it is essentially as if there has been no transfer. The =C !ould be validly presented by Dong Nong Toys. CA P"?$ '5 "A? #O$$O/?$%S O#3IB "IO1 ssignment 1<. Promissor! 1otes , Interest $ates Promissory Note& 4enerally Primary credit instrument in business and commercial transactions. <ortgage notes& student loans& and business loans. Promissory note is an independent obligation& novation occurs !ith it "a N to pay money#. =ld defenses may be lost. 3ates <aGimum la!ful rate + cannot be eGceeded + need to put provision in note to make sure in the document& other!ise have usury problems. Prime rate + average of prime rates of several industrial N@ banks& determined by each institution& and should be determined !ithin the note. /anks generally base their prime rates on the lo!est rate that give to biggest and best customers because so lo! risk. <ight use $/=3 " ondon $nterbank =ffice 3ate# as the prime. Prime rate is affected by the 2ederal 2unds rate. :ederal :unds rate + rate that the 2ed. sets and charges to institutions for overnight loans. Changes to it affect other interest rates including prime rates. :i>ed interest rate + Specific set rate you have for the remainder of your obligation. $nsurance companies like fiGed rate obligations + steady income. Eariable interest rates + $nterest set at a floating rate !hich is usually determined by using a prime rate plus some. /anks like to lend at variable rates& 5ust in case rates rise& b,c they !ould lose money if they have to pay others more interest on money than they are making on their loans. /enchmark rate U certain M "or basis points# - /enchmark !ill usually be the banks prime rate& $/=3& or the 2ed. 2unds rate - ' /asis point V .*'M "'** /P V 'M#. /ank !ants a variable interest rate b,c they think interest rates may rise in the near future& so they don)t !ant to be stuck !ith fiGed interest rates. $ns. Cos. may think rates are likely to fall later and they favor fiGed interest rates. 6llocation of Payments 6morti;ation + per month payment due on the note& combines interest and principal. %arly in the note most of the payment !ill be interest and less !ill be principal& later eGactly the opposite occurs as your balance falls. Some notes allo! you to pay the !hole amount early& but some !ill have prepayment penalties !hich help the bank make up for interest payments they should have gotten if you had fulfilled the !hole note as eGpected. /orro!er in a fiGed rate position may !ant to repay the entire balance if interest rates begin falling. %ven !ith prepayment penalties they may save themselves money over the long run. %G: 7* year note !ould save a good amount. Choice of a! may be provided in the note to make things easier in case of litigation. -efault + <ost notes contain a long list of acts constituting default because there is no 5urisprudential definition of default. =ne event of default: borro!er shall at al times maintain an %/$T-6 level + gross earnings before a number of eGpenses& such as interest& taGes& depreciation& amorti;ation of costs. 46

$nterest 3ate S!aps Digh risk investors bet that interest rates are going do!n. They buy a fiGed interest rate and o!e the banks a variable rate. ssignment 1+ 7sur! Usury& 4enerally This is the eGcessive charge of interest + usually determined by the la!s of a state. They penali;e lenders for scre!ing consumers. Usury is generally not applicable to: /usiness loans Dome <ortgage loans + they are federally eGempted Credit cards issued by national banks + they incorporate in states !ith no usury provisions so they can stick you good Usury does not apply to loan sharks,1pay day loans.1 Usury controls the legitimate market only "longer term loans#. 7 Usury Problems >ariable rate notes may float above the maGimum rate. This problem is easily solved by making sure the promissory note has a provision !hich states that the rate charged shall never be in eGcess of the maGimum la!ful rate. arge loans involve fees aside from interest. @ou pay these fees in order to get reduced interest rate or some other benefit. This problem is solved by providing that the fees are considered interest. Note must define !hat !ill be interest for purposes of the note and cannot eGceed maGimum la!ful rate. Usury may also apply to points& charges& and fees paid. $f loan pays off very early& may have paid more interest rather than little by little. $f borro!er pre9pays a note it may be usurious so make certain you have a provision !hich says if this happens it !as mistake and the eGcess !ill be refunded. 7 3easons Usury 3arely 6pplies Statutes narro!ly restrict their application. a. permits a maG. of '(M& eGcept for banks and commercial loans. "So regulate pay day loansJ# <any states eGempt common loans& such as pay day loans& from usury& but not banks as does a. 2ederal la! related to home loan financing preempts state la!. Therefore& home mortgage notes are not sub5ect to state usury limitations. National /anking 6ct !as interpreted to mean that any federally chartered bank can charge any rate that could charge in the state in !hich it is organi;ed. This also applies to state chartered banks. $f chartered in -ela!are& !here no usury restrictions& can transport that limitation to any state !here do business. "Can distinguish federally chartered by 0N.6.1 To establish a violation of usury la!: oan of money or forbearance of debt 6n agreement b,t parties that the principal shall be repayable absolutely. The eGaction of a greater amount of interest or profit than is allo!ed by la! Presence of an intention to evade the la! at the inception of the transaction. /ank)s Penalties <ust refund all interest to borro!er& return triple interest that taken& or give entire principal as a gift. Problem Set 'C '. 'ank uses fi+ed rate loans that vary between & and 13M and between $1 million and $B million. 1re these loans usurious! 47

The bank is entitled to charge interest at a progressive rate. 6s a business loan& it can go up to the maGimum la!ful rate. $n a.& !hich eGempts bank loans& there is no maGimum. (. 'ank has offered a variable interest rate at prime plus 1.5M for %lients medical clinic. 6rime is currently 7M. The loans calls for the lesser of ?a@ the (a+ rate, or ?b@ 1F M above the prime rate. a@ 0hat the ma+imum lawful rate would be if the auction rate for $9 week Treasury bills rose to BM, 11M, 1.M, and 15M! T9/ills are auctioned !eekly to allo! individual investors to buy. The auction rate is the amount of interest that buyers demand. <ust multiply the auction rate by ( and round to the nearest Auarter percent. J 4et notes from Curt. b@ 1ssumin" auction rates stays at 5M below 6rime :ate, at what rate would interest accrue! %ould client contest that rate as usurious! Then prime rate !ould be '7&'C&'Q& and (*M. The rates !ould thus be '8.E& 'F.E& 'I.E& and ('.EM. None of these !ould be usurious. <aGimum rate is so high that this is unlikely to eGceed. c@ f the interest would not be usurious, can you think of any other way that client could si"n the 6romissory =ote and still be in a position to avoid any le"al obli"ation to pay interest at that hi"h rate! 0ould bankruptcy help! Not likely to escape individual liability here. To the eGtent that he cannot pay the obligation& bankruptcy !ill help& but all other assets !ill be liable to !hat o!es.

7. 'ank is desi"nin" a new loan product for potential small business borrowers. 'orrower makes an up4 front interest payment of $M of the loan at the time of the application. f the application is rejected, the money is refunded. f the loan closes, the $M is applied a"ainst interest accruin" durin" the first $ months of the loan. f the bank accepts the application, but the customer fails to close the loan or repay it, the 'ank retains the $M fee. s there a problem with this arran"ement! There is no problem in the money being refunded. $f the loan closes& that is fine too assuming that the loan is not paid off immediately. $f it doesn)t close& its not interest but a fee. Courts !ill probably still consider it interest. 6dvise client to make it a fee because if call interest is sub5ect to usury. 8. 1 note just like that in problem $ but borrower asks 'ank to remove warranty of commercial use lan"ua"e because borrower is not sure want he wants to do with the money. 0hats wron" with the borrowers re/uest! /ank should keep the language b,c it makes a difference !hat the funds are used for to apply the maGimum interest rate. The rate differs if it is a consumer loan or business loan. ssignment 1-. 3ate Pa!ment , Prepa!ment $f borro!er pays late& the lender has 7 responses: '. 6ccelerate the payment term of the note UCC :'9(*7 %ntire balance is due immediately on demand 3are for lender b,c they !ant to get the interest payments The only restriction on acceleration: 42 (. -efault rate of interest Substantially higher rate of interest !hich accrues not to the entire principal& but only on outstanding balance. 7. ate 2ees Punitive + to punish you and scare you into paying Non9Punitive + /ank incurs administrative costs !hen you pay late @ou are essentially paying the bank for foregone interest due to your holding its money. =ther!ise& you !ould have an interest free mini9loan. Courts sometimes don)t buy the administrative costs argument of lenders. ate 2ees are not enforceable if: The late fees look like liAuidated damages. "Courts are not likely to see as such in commercial situations b,c supposedly sophisticated borro!er#. Could be usurious if note doesn)t provide that they are included in the administrative costs of the loan. State statutes may restrict amount that can be charged as late fee - Usually protects consumers& not businesses 48

Some states have no restrictions in order to attract business "N@#

Prepayment enders are generally happy to get prepayment from consumers because they are relative high risk. 2rom businesses though& banks may not !ant to get prepayments because vie! loans as investments. Thus& they impose a prepayment penalty for commercial loans. Courts are less likely to challenge a prepayment penalty than late fee problems because so rarely apply to consumer loans. %arlyle 1partments v. 1 < - P sued in state court and - removed to 2ed. under diversity. State la! applied. %ven though 2ed. courts are located& they have no po!er to determine !hat state la! is. 2ed. cts. Can only speculate and must look to state courts and legislature. 2ederal courts cannot say !hat state la! should be. Do! the ender Protects $tself The note includes a provision for a prepayment penalty called 0yield maintenance payment1 This allo!s prepayment but reAuires the borro!er to pay a fee eAual to !hat the bank !ould have been paid reduced by !hat it can gain in a lo! risk investment ook at T9bill rates or something to determine !hat the bank can no! get on the principal and subtract that from yield that should have come to get payment amount penalty The bank is protecting itself by mitigating damages& and both sides can !in Problem Set 'F 1. %lient is liable on the te+ts e+emplar promissory note with a monthly payment of $$0,000. -ow much would it cost him to stop makin" payments on the note for a while. 1ssume that the ma+imum lawful rate applicable to the promissory not is 1BM per annum. a@ 0hat could the lender do if client stopped payin" for . months! %ould he cure the default by makin" . late payments! $f do not payments or communicate !ith the lender& that is enough for the bank to accelerate in good faith. The lender is less likely to accelerate if making some attempt to pay + even a little. $f doesn)t accelerate !ould have to sue for each payment. Could cure by paying late fees& but if accelerates& in trouble. b@ The note includes a fi+ed late char"e of 3M. nterest accrues under the note at 10M per year. 8oes that mean he actually saves money if he can hold out on makin" a late payment for more than 3G10 of a year! 1ssumin" the lender never accelerates, what would client owe if he mana"ed to defer makin" any sin"le payment for 9 mos.! De !ould o!e a total payment of WWWWWWW. =verdue principal of K(*&*** U '*M interest. 6lso has to pay default interest of 'QM on the amount that is overdue as !ell as a 8M late fee. $. %lients promissory note includes standard provisions e+cept that this one allows partial prepayments and does note re/uire any prepayment fee for prepayments made less than 5 years before maturity of the note. %lient made a total of 3 payments on his re"ular payment date last month ?. prepayments@. %lient was not assessed a prepayment fee because note is due in 3 years. 'ut client didnt make a payment for this month and plans to skip the $ months as well. -e was surprised to find himself in default. a@ 0hat is the basis for the lenders complaint! s the lender correct! Prepayments are applied to the last payments !ould have to make. So& client must still make regular payments. b@ f the lender is correct, what benefit will 'ill "et from makin" the prepayments! Client !ill pay less interest because paid off eGtra on outstanding amount.

.. 'ank is concerned that prepayment fees imposed on promissory note are invalidated as unlawful penalties. 8oes it matter whether 'ank uses a fi+ed M prepayment fee rather than a yield4maintenance prepayment fee! 8ont worry about usury.

49

2iGed M 2ee 9 Under historical theory& a N cannot provide for a penalty + if it looks like liAuidated damages. This theory has fallen by the !ayside. $n a consumer transaction& may run into it& but not likely in a commercial transaction. @ield9maintenance + less likely bank !ould get a !indfall. 6lso& bank covers the loss if the payments are loss via yield maintenance. @ield may be the best because the fiGed may not be enforceable and !ill make no money. 3. %ustomer called bank wantin" to rene"otiate the interest rate to 7M. nterest rates had fallen in the 5 years since customer si"ned the note. %ustomer threatened to prepay the note and take her business elsewhere if 'ank did not a"ree. 'ank thinks note barred prepayment. The market rate for a similar note is only 7M. 0hat are customers ri"hts under the note! s there anythin" 'ank can put in notes to avoid similar problems in the future! $f customer prepays& she !ill pay EM of outstanding balance as a penalty. $s it a good idea to prepayJ She !ould save 7M over 'E years + 8EM. 8EM 9 EM V 8*M savings. $f prepays !ould come out ahead. The bank could have saved by using yield maintenance. CA P"?$ <. C$?6I" ?1A 1C?8?1" ssignment 1;. Credit ?nhancement b! Buarant! 4uaranty,Suretyship& 4enerally Suretyship is governed by state la! $f concerned about borro!er)s ability to pay& lender can reAuire a personal guaranty that !ould allo! lender to recover from guarantor if borro!er cannot pay. This allo!s lender to recover but also acts an incentive to make shareholders pay off business loans. 4uarantor has no defenses& the bank can sue them directly& immediately after default ( types 0=f collection1 + bank is forced to eGhaust all remedies before pursuing the guaranty 0=f payment1 + normal one after default by borro!er set according to the agreement& bank can proceed to get money from 4uaranty. Problem Set 'Q '. %lient is the "uarantor of a lar"e loan from 'ank to ((%. ((% has just closed its doors after liti"ation with 'ank and has no assets to pay 'ank or any other creditor. 'ank spent $300,000 in le"al fees pursuin" ((%. %lient thinks 'ank cannot collect those le"al fees from him under the "uaranty N1. of the Te+t <uaranty ?<uarantor a"rees to pay reasonable attys fees and all other costs and e+penses incurred by #ender in enforcin" this "uaranty or in any action or proceedin" arisin" out of, or relatin" to, this "uaranty, includin" but not limited to bankruptcy proceedin"s@. Client is !rong. 06rising out of1 and 0related to1 are broad and include an action to go after debt. Under : ( of sample guaranty agreement& indebtedness is defined to include costs& eGpenses& and atty)s fees. The eGpansive language encompasses any eGpense the creditor incurs to get its money back. (. %*' issued $$0 million to )affe nc., a business operated by )affe and Hckert. )affe runs the day to day affairs and Hckert provided the capital. %*' took a continuin" "uaranty from Hckert. )affe ran out of the country after "ettin" cau"ht for embe22lin". Hckert wrote bank sayin" that terminated the continuin" "uaranty and abjure any further liability. %*' has $$ million still outstandin" on the loan with 1.M interest. %*' also issued #5%s backin" up $10 million of short4term commercial paper that )affe, nc. issued $ months a"o. The #5%s mature ne+t week. 'ank doesnt think )affe nc. can make either payment. 'ank wants to know if the notice by Hckert limits the banks ability to pursue Hckert for the commercial paper or accruin" interest. $ndebtedness is principle and any interest on that principal. 6lthough gave notice of termination of guaranty& he still has to pay the interest on the principal that he guaranteed because is indebtedness. $s the =C future indebtedness or indebtednessJ The =C is current indebtedness because of its contingent definition: 0$ might o!e you& and you might o!e me.1 7. %lient has business called 50- in which client is sole shareholder. %lient has "uaranteed 50-s 1.$ million line of credit with 'ank. 50-s net monthly income has decreased from $$0,000 to only $$,000. =ow 50- owes bank entire 1.$ million. 50- has only $10,000 on hand and its current obli"ations 50

include a $10,000 monthly payment due to 'ank and $B,000 in overdue bills from suppliers. %lient doesnt mind if loses business as lon" as he can keep the rest of his assets. 0hat should he do! 6 guaranty is more than a simple collateral interest in the business + all of his personal assets are on the line including his other business and future earnings. Bhat if he filed for bankruptcyJ Then& the primary obligation is discharged& but can still come after him. 4uaranty survives bankruptcy. =ne !ay to avoid this is to declare bankruptcy himself& but he has too many other assets to make that !orth!hile. De should go the bank and try to !ork something out. /ank may agree to reduce monthly payments. $f cannot pay suppliers& business !ill fail and !on)t be able to pay off the rest of the loan. /ank doesn)t !ant that and often agree to restructure loans in order to avoid dealing !ith bankruptcy. This is often very successful. 8. 'ank read that one of his borrowers, (6, was hit with major tort jud"ment. 'ank knows that (6 cannot pay it and is worried about the banks $$50,000 loan to (6 for which bank has no collateral but does have a personal "uarantor who is the ownerGoperator of (6. 'ank believes that tort jud"ment is default because it constitutes a Cmaterial adverse chan"eD in (6s financial situation. /ank should not !orry about being paid. 6s tortfeasor& only the corp. is liable. the tort victim cannot go after o!ner of corp. /ut because the o!ner is a guarantor& the bank can. $f <P in default& then /ank can sue the guarantor or the primary obligor at its discretion. $t !ill not matter if corp. goes into bankruptcy. bankruptcy has no effect on guaranty. The /ank)s position is very secure. E. 'ank lends to a chain store that speciali2es in bri"ht red clothin". 'usiness has been operated as a sole proprietorship owned by Ienn. 'ecause Ienn is very wealthy, 'ank has considered the relationship a safe one thou"h unsecured. Ienn found out that H61 listed his red dye as to+ic. Ienn believes it is safe, but decides to incorporate in case of envtal liability. Ienn would like to transfer the loan to the new entity and is willin" to issue a "uaranty of the loan himself. 'ank wants to know what to do. 6 !in,!in situation for the bank. 6s a corp. and !ith >enn as guarantor& /ank could still go after >enn)s personal assets as it could !hen business !as a sole proprietorship. $f the corp. is sued by the %P6& /ank is in an even better position because %P6 could only go after corp. and not >enn& !hereas !hen a sole proprietorship& %P6 could have gone after >enn. 4uaranty gives nonconsensual guarantors the shaft + it is good for lenders. ssignment 14. Protections for Buarantors 3ights of the Surety,4uarantor a"ainst the Borrower/Principal Obligor: '. Performance + $f refuses to pay& can sue and force the borro!er to pay the creditor. Pretty !orthless. (. 3eimbursement + if surety is forced to pay lender& he can then go after the borro!er for reimbursement. CC 7*8F and 7*8I 7. Subrogation + 4uarantor is subrogated to the rights that the lender has against the principal borro!er after they pay off the debt. <ay include some kind of collateral that has been pledged and can no! be sei;ed& or a lien on some property that can be foreclosed. -efenses that may be asserted by surety a"ainst the creditor '. $mpairment of Collateral + $f a creditor does something that materially affects the status of the collateral that may result in harm to the surety after subrogation& this defense can be asserted. Could be a partial reduction or full defense depending on impairment and the value of collateral. %G: <aybe the lender didn)t secure procedurally an interest in the collateral so that a lien or privilege is not able to be eGecuted& or another creditor is no! first in line b,c of a mistake. (. <aterial modification of underlying obligation !ithout surety)s kno!ledge + $f the creditor grants an eGtension that increases the debt b,c interest piles up& or b,c the assets of borro!er b,c depleted. Surety may assert this and it could reduce the amount they o!e to lender to the eGtent that affected by change. "6 non9commercial surety is !holly discharged#. $n a.& if the principle obligor is released even partially& the bank cannot go after the remainder from the guarantor "though it can in other states# because eGtinction of the principle obligation& eGtinguishes the suretyship altogether. 7. Creditor releases the borro!er + $n a.& if creditor releases the borro!er the surety is released as !ell. $n common la!& subrogation to creditor)s rights b,c of subrogation protects the surety from release. They can then proceed against borro!er. 51

$n a. and other states& there may be suretyship !aivers. a. has

Suretyship defenses in conteGt of 6rticle 7 6nomalous indorser is a guarantor. Such an indorser has suretyship defenses under 79C*E. not adopted this article& but it isn)t necessary due to suretyship articles. Baiver of -efenses Suretyship defenses can be !aived by guarantor. This is relatively common. 6rt. 7*8* + surety can agree to modify its rights /ank !ants guarantor to !aive rights because of the !ay bankruptcy la! used to be but isn)t anymore. $t doesn)t make any sense that bank !ants guarantor to !aive rights against the obligor. Problem Set 'I

'. %lient sold co. to a new investor, %ompo. %ompo called client to tell him that he would not make loan payment due to 'ank. %lient is the "uaranty under that loan. %lient thinks best course is to pay off loans with his personal assets and try to save the business. 0ill that plan work! Client !aived right of subrogation and reimbursement. /ut only if there is a special security device is subrogation necessary. Client still has the right to force Compo to pay. Could sell off assets of company to make payments. /ut can he effectively do that since he sold the co.J No!& Compo is the only one !ho can sell the assets. Bhen negotiating deal !ith Compo& should have negotiated a security interest in assets. (. 'ank is ne"otiatin" with a "uarantor. <uarantor wants provision statin" that has no ri"ht of subro"ation and waives any ri"ht to enforce any remedy #ender has a"ainst borrower to be removed from a"reement and replaced with the followin", C<uarantors shall be entitled to ri"hts of reimbursement and subro"ation, but only to the e+tent of payments actually made to #ender under this <uaranty.D 'ank wants to know what to do. Subrogation rights may only be used for full payment and this language goes against that rule. So& the bank may not like this. $nclude language that have right to subrogation& but provided there is full payment. 7. Ienns business, which earlier, has been sued by H61 for $75 million. 'ank is concerned and has decided to release the borrower for 75M of the amount of its loan to the business. %an it cut that deal with the borrower and then turn around and sue the "uarantor for the remainin" $5M! a! avoids any possibility of putting us in this dilemma. $n a.& cannot go after guarantor if agree to release obligor. $f outside a.& 79C*E applies and creditors can still go after guarantor for difference. 8. n future cases, can 'ank proceed with a reverse structure in which bank would make the loan directly to the entrepreneur and take a "uaranty from the operatin" company! -ow does this approach chan"e the credit risks and le"al risks! $t is more difficult to monitor the financial activity of an individual rather than a business because business has financial records that can refer to. -epending on the amount of the loan& this is probably important to /ank. /ut it really doesn)t matter + they are both on the line. There is no real difference bet!een a guarantor of payment and obligor if guarantor !aives rights.

E. %lient and former - owned a business for which - obtained a loan that client "uaranteed. n the divorce, the business was assi"ned to -, alon" with responsibility for the loan. %lient received notice form 'ank that it a"reed to modify the loan accordin" to -s re/uest to increase the interest rate from BM to a floatin" rate of prime plus .M. ?6rime is currently 7.5M@. n return, the bank a"reed to for"o takin" action in response to -s failure to make a number of past4due payments that total $.$,000. The bank seeks %lients consent and a reaffirmation of her "uaranty. The bank will pursue its remedies a"ainst %lient if she does not a"ree. $f she consents& there is no defense to payment because clearly a modification. Then& if the bank !ere to go for!ard& she could be on the hook for pre9modification only. $f noncommercial& then off the hook entirely. So& she is still liable for difference. $f she doesn)t consent& the bank !ill foreclose against D. Then& if D cannot pay& she !ill be liable. 6 significant do!nside. 52

Das ( options: 3e9negotiation + bank may be !illing to release part of the guaranty and that might be a better option to refusing altogether. =3 2ile for bankruptcy + could limit bank)s potential claim. "/ut she may not be a candidate for bankruptcy#. ssignment 20. "hird Part! Credit ?nhancement Standb! 3OC Standby =C $f commercial borro!er cannot find a guarantor to enhance his credit !orthiness and he has no other security interest& he can get a bank to guaranty repayment of loan to a different bank. Distorically this !as illegal. Same =C rules apply as earlier discussed + including independence principle. %G: Tabasco !ants to ship to Peru and needs financing for that. Bants to take out a loan but no local bank has enough lending capacity. Chase <anhattan !ill !ant a co9signer and not one from an individual. Can go to Ne! $beria /ank and ask them to co9sign. $f do& !ill issue a standby =C to Chase <anhattan as beneficiary. That =C says if Tabasco defaults under the credit agreement& upon presentation of affidavit by Chase <anhattan attesting to default& Ne! $beria /ank agrees to pay the loan. $t is essentially a guaranty but in the form of an =C. Clean Standby =C + doesn)t reAuire document at all for payment. =nly need beneficiary to sho! up and demand. This is very rare. Normally& =Cs are payment devices and are paid. Standby =Cs are credit enhancements and rarely get paid. /ank guarantors do not have suretyship defenses of art. E. /ut does have right against obligor of reimbursement and subrogation. Problem Set (* '. 'ookseller is considerin" a"reement with supplier that re/uires bookseller to maintain a clean standby #5% from a bank that is satisfactory to seller. 'ank wants possession of a %8 from bookseller. 'ookseller wants to know if okay. /ank is asking for C- as collateral and this is perfectly okay. /ookseller should 5ust do it + the risk is there but not likely that standby =C is called. 5. 'ank issued a standby #5% for the benefit of 'ank$. The #5% was to back up obli"ation of #yd"ate to repay loan for construction. 'ut 'ank did not take collateral to reimburse it if forced to pay on #5%. 'ank$ took a lien on the buildin" to secure obli"ation to repay. #yd"ates financial affairs have collapsed, and he cannot pay. 'ank$ presented a draft on the #5% to 'ank who then issued 'ank$ a check for the full amount of the loan. 'ank seeks reimbursement from #yd"ate. t assumed it would be subro"ated to 'ank$s lien. 1 state statute however re/uires mort"a"e creditors to release liens whenever they receive full payment of their loans. -ence, 'ank $ released the lien the day after it received payment from 'ank. a@ -as 'ank lost its ri"ht to use the lien to pursue #yd"ate! $f done according to state la!& then cannot subrogate that right. /ank has lost the right to use the lien. b@ 0hat is 'ank had acted as a "uarantor instead of issuin" a #5%! 1ssume that the "uaranty included a defeasance provision. Could not argue that /ank( impaired collateral because a surety defense and cannot use under =C. There is very little practical difference bet!een guaranty and =C 9 5ust the actor and the surety defenses. Das only a right of reimbursement.

53

8ini #ar $e0ie2 '. These are presentment !arranties. "'# entitled to enforce "proper indorsements#& "(# no alteration& and "7# authori;ed signatures. (. "'# a holder& "(# take for value& "7# good faith& "8# no notice of defenses or claims that overdue or dishonored& or in principal payment default& unauthori;ed signature& another claim& that maker has a defense. 7. Three are no defense to payment eGcept 8 real defenses. 2raud in factum& discharge in factum& infancy& and illegality. $n a.& lack of capacity and duress are not real defenses. 03eal1 defenses are those absolutely null. $f void& a real defense. 8. -efinition: transfer an instrument to another to make them a holder& or allo! them to enforce rights on the instrument. /earer paper + simple transfer of possession. order paper reAuires indorsement and transfer of possession. E. /lank indorsement + sign name that all Special indorsement + 0Pay to someone else1 signed Oohn -oe /lank indorsement makes the instrument bearer paper. 6nyone !ith possession is holder. Special indorsement makes it order paper + only indorsee can be holder. C. 4uarantee of Collection + can only go after guarantor !hen principal obligor in default. <ust go after obligor first and reAuires 5udgment or declaration of insolvency + some form of proof =f Payment + can go after guarantor !ithout looking to obligor Presumption is in bank)s favor + if 5ust say guarantee& then a guarantee of payment. F. <ust be dishonored and must have proper notice of dishonored. 6 note is dishonored automatically if not paid !ithin a day of presentment. Unlike a check !hich is not honored if dishonored. Notice must be !ithin 7* days of dishonor. Q. Unconditional !ritten promise or order to pay money at a fiGed amount payable to bearer or order upon demand or at a definite time !ith no eGtraneous undertakings. I. $& Oohn Oones& promise to pay to the order of Sam Smith K'** on Sept. 'E& (**'. <ake sure put in magic !ords + 0to the order of1 or 0to Sam Smith or order.1 6nd make sure say 0promise.1 '*. No& b,c /etty is 6nn)s agent. 6s long as signature is authori;ed& then okay. 2orgery is unauthori;ed + !ithout actual& apparent& or implied authority under agency la!. $f given permission to sign& then authori;ed. 6uthority to do so does not need to be in !riting + eGpress oral or !ritten is fine. ''. J '(. %ither may negotiate check because in alternative. Bhoever negotiates it could enforce it. $f said 0and1 then both must sign to negotiate& but 0or1 makes it alternative. '7 6 + eGtraneous undertaking. %ither !ay non9negotiable. / + can have alternative payees C + Non9negotiable. Upon death is putting a condition other!ise !en die still payable from estate. <ust be unconditional. - + Non9Negotiable. Can make reference to another document but cannot be governed by another document. 0in accordance !ith1 could mean that governed by or sub5ect to another agreement. Can come to o!n conclusion about !hat means + may need more testimony to determine. $f need testimony& infers that non9negotiable. % + 6cceleration clause does not affect definite date reAuirement. 6n eGception to the definite time reAuirement. Still negotiable even though time is not so definite. 2 + Still negotiable. 6s long as note clear that recovery is restricted to particular fund& okay. 6nother eGception to conditional reAuirement. 4 + Non9negotiable. No definite time. D + if undated& still payable at a definite time + payable on demand. /ut here says ' year after date& but leaves out date& so not payable on demand. $t is payable at a definite time + only reAuires that can be determined + even if do by parol evidence. Can sho! !hen signed note. '8. =n first check& 6l still liable because /ob authori;ed under agency la!. /ut on 7** and '***& 6l !as negligent in giving /ob the checkbook and may have failed to eGercise ordinary care. /ank statement revie! principle + have ( statement periods to notice fraudulent activity. Then later fraud& by same !rongdoer is on you. 2irst fraud is not on you until one year has passed. This rule does not preclude him yet + only precluded from future but not 'st (. $f a year passes& then liable for all forgeries in that year. '*** a forgery the 7** may have been under apparent authority. <ay be an unauthori;ed alteration + did !ithout authority. $ts an unauthori;ed alteration. 6l can assert against bank& but failed to eGercise ordinary care. 54