UCC 3 & 9A Negotiable Instruments Secured Transactions Class 5

UCC 3 & 9AUCC 3 & 9A•Negotiable Instruments•Secured Transactions

Class 5

Borrowing MoneyBorrowing Money• Most businesses rely on credit to buy

supplies or equipment. The business will use – Negotiable instruments (sometimes called

commercial paper) or– Secured transactions

• Both are governed by the Uniform Commercial Code

Negotiable InstrumentsNegotiable Instruments

• A contract to pay money• A negotiable instrument is used as

– A substitute for money– A loan of money

• Money is not a negotiable instrument• Article 3 of the UCC (RCW 62A.3) applies

PurposePurpose• UCC 3 is designed to facilitate

commerce – to make pieces of paper into something that is almost as reliable and transferable as money.

FoundationFoundation• The fundamental rule of negotiable

instruments:– The possessor of a piece of commercial

paper has an unconditional right to be paid, as long as• The paper is negotiable• It has been negotiated to the possessor• The possessor is a holder in due course• The issuer cannot claim any of a limited

number of “real” defenses

TypesTypes• Four specific types of negotiable

instruments– Notes (promissory notes)– Certificates of Deposit – Drafts – Checks

Promissory NotePromissory Note• A promise to pay money, whereby the

maker signs the instrument, promising to pay money to the payee.

• The note can be collectable either on a specific date in the future (time note) or at any time the payee decides to collect (demand note).

Certificate of DepositCertificate of Deposit

• If a note is made by a bank, it is called a certificate of deposit.

Draft and ChecksDraft and Checks• A draft is a three-party instrument in

which the drawer orders the drawee to pay money to the payee.

NegotiabilityNegotiability• Six requirements – Must be

– In writing– Signed by the maker or drawing– An unconditional promise or order to pay– For a stated fixed amount of money– Payable on demand or at a definite time – Payable to bearer or order

TransferTransfer• Transfer creates a holder, who at the

very least receives the rights of a previous possessor.

The HolderThe Holder• A holder of a negotiable instrument is a

person who – Has bearer paper (payable to bearer)– Has order paper (payable to the order of a

specific person) which is properly endorsed• A holder takes the instrument subject

to all of the defenses that could have been brought against the original payee.

Holder in Due CourseHolder in Due Course

• A holder in due course has an automatic right to receive payment for a negotiable instrument – this may even be more than the previous possessor.

• A holder in due course takes free of most claims against payment.

• The holder in due course is exempt from defenses that could have been made against the original payee.

Holder in Due CourseHolder in Due Course

• There are 5 requirements that must be satisfied to be a holder in due course

– Must be a holder– Of a negotiable instrument– Who took for value– In good faith– Without notice of any outstanding claims

or other defects

Taking for ValueTaking for Value• Holder can take value by:

– Performing the instrument’s promise – Acquiring a security interest or other lien in

the instrument– Taking instrument in payment for an

antecedent debt– Giving a negotiable instrument as payment– Giving irrevocable commitment as

payment

Good FaithGood Faith• The holder must meet both of these

tests:– Subjective test. Did the holder believe the

transaction was honest in fact?– Objective test. Did the transaction appear

to be commercially reasonable?• Only applies to holder, not the transferor

Taking Without NoticeTaking Without Notice

• Holder is on notice that an instrument has an outstanding claim or defect if there is reason to know:– Instrument is overdue– Instrument has been dishonored– Actual knowledge or any suspicious event– That a claim or defense exists– Instrument is altered forged or incomplete

Holder through an HDCHolder through an HDC

• Shelter Rule– A transferor of an instrument passes on all

of his rights. When a holder in due course transfers an instrument, the recipient acquires all the same rights – even if he is not a holder in due course himself.

• Limitations on the shelter principle if new holder engaged in fraud or illegality.

Payment ProcessPayment Process• Presentment – holder demands

payment from one who is obligated to pay– Must exhibit the instrument– Show identification– Surrender the instrument (if paid in full) or

give a receipt (if only partially paid)

Payment ProcessPayment Process• Dishonor – The maker or drawee

refuses to pay• Notice of Dishonor – Given to those

who are secondarily liable (i.e., check stamped “insufficient funds”)

LiabilityLiability• There are two kinds of liability

associated with negotiable instruments:– Signature liability– Warranty liability

The Basic RulesThe Basic Rules

• The culprit is always liable– If a forger signs someone else’s name to an

instrument, that signature counts as the forger’s signature, not as that of the person whose signature was forged

• The drawee bank is liable if it pays a check on which the drawer’s name is forged

• In other cases, a person who first acquires an instrument from a culprit is liable to anyone else who pays value for it.

Transfer WarrantiesTransfer Warranties

• A person who transfers an instrument warrants that:– She is a holder of the instrument– All signatures are authentic and authorized– The instrument has not been altered– No defense can be asserted against her– The issuer is solvent

Presentment WarrantiesPresentment Warranties

• Anyone who presents a check warrants that– He is a holder– The check has not be altered– He has no reason to believe the drawer’s

signature is forged

• Anyone who presents a promissory note for payment warrants only that he is a holder of the instrument

DefensesDefenses• Universal (or real) and personal

defenses are valid against any ordinary holder

• Only real defenses can be used against a holder in due course

Real DefensesReal Defenses• Forgery• Bankruptcy• Minority • Alteration• Mental incapacity• Duress• Illegality• Fraud in the execution

Personal DefensesPersonal Defenses

• Breach of contract• Lack of consideration• Prior Payment• Unauthorized completion• Fraud in the inducement

Consumer PaperConsumer Paper• Notes labeled “consumer paper”

(consumer credit contracts) are not negotiable instruments because they are nonnegotiable.– A holder (even an HDC) has the same

rights as the person who made the contract

DischargeDischarge• Discharge from the obligation or from

liability occurs in one of 5 ways– Proper payment– Agreement– Cancellation– Certification– Alteration

AmbiguitiesAmbiguities• UCC favors negotiability. In interpreting

negotiable instruments, courts should construe the paper so that – Words take precedence over numbers– Handwritten terms prevail over typed and

printed terms– Typed terms win over printed terms

The Bank’s DutiesThe Bank’s Duties• A bank must pay a check if it is

authorized by the customer and complies with the terms of the checking account agreement.

• If a bank wrongfully dishonors an authorized check, it is liable to the customer for all actual and consequential damages.

Secured TransactionsSecured Transactions

• Article 9A of the UCC governs secured transactions.

• In a secured transaction, the debtor’s promise to pay is “secured” by something of value that the creditor can seize if the debtor fails to make good on his or her promise to pay.

• The valued property is “collateral”

PurposePurpose• UCC 9A addresses the creditor’s two

concerns– Can the collateral be seized if the debtor

defaults?– Will the creditor have priority over other

creditors with rights to the same property?

The PropertyThe Property• Article 9A applies to any transaction

intended to create a security interest in personal property or fixtures. This could include– Goods– Inventory– Negotiable instruments– Investment property– Other intangible property

AttachmentAttachment

• “Attachment” is the UCC’s term for describing the enforceability of the creditor’s right to seize collateral. Three steps are required:– The creditor must have a signed security

agreement and– Must have given something of value– The debtor must have rights in the

collateral

Security AgreementSecurity Agreement

• The security agreement must contain a description of the collateral and must be signed by the debtor.

PerfectionPerfection• In order for a creditor to have priority

over other creditors, the creditor must have a perfected security interest. This requires:– Possession of the collateral or– Filing of a financing statement or– Giving money for the purchase of

consumer goods (purchase money security interest)

PossessionPossession• The secured party may take possession

of the goods (this may or may not be in conjunction with filing).– Must use reasonable care in the custody

and preservation of the collateral

FilingFiling• The most common way of perfecting

– File financing statement with appropriate state agency

• Financing statement provides– Name of debtor– Name of secured party– Identification of collateral

Purchase MoneyPurchase Money• A purchase money security interest is

the interest taken by the person who sells the collateral or by the person who advances the money so the debtor can by the collateral.

• This interest is perfected automatically, without filing.

Buyer of Secured GoodsBuyer of Secured Goods

• A buyer in the ordinary course of business has the highest right to the goods.

PriorityPriority• The general order of priority among

creditors and buyers is:– Buyer in the ordinary course of business– Perfected purchase money security interest– Perfected security interest– Lien creditors – Unperfected security interests– General creditors

DefaultDefault• If the debtor defaults, the secured

party may take possession of the collateral without any court order– The secured party may sell or otherwise

dispose of the collateral in any commercially reasonable manner

– May retain the collateral as satisfaction of the debt

TerminationTermination• Once the debt is paid in full, the

secured party must complete a termination statement– Document indicating that secured party no

longer claims an interest in the collateral.

BankruptcyBankruptcy• Federal law• Purposes:

– Rehabilitation of the debtor– Liquidation

• Fairly divide debtor’s assets

Common OptionsCommon OptionsChapter 7 - Liquidation of all existing

assets

Chapter 11 - Business reorganization

Chapter 13 – Individual reorganization

ProcessProcess• Petition

– Voluntary (by debtor)– Involuntary (by creditors)

• Trustee is appointed to gather and distribute assets

• Meeting of creditors• Payment of Claims• Discharge• www.uscourts.gov/bkforms/index.html