Commercial Paper Outline Professor KilbornSpring 2003

Introduction• Commercial Paper: any piece of paper or document that evidences an obligation to make a payment.• The National Commissioners of Uniform State Law created the Uniform Commercial Code (UCC). The

UCC is not law. It becomes law only when adopted by each state. Every state has adopted most of the UCC.

• Louisiana, for the last 12 years, has adhered to the UCC, but not articles 2 and 2(a), and has made some changes to the adopted laws. Louisiana’s version of the UCC is contained in Title 10 – the commercial law. The citations within Title 10 correspond to the UCC number.

Chapter 1 – Checking Accounts as the Paradigm Payment SystemAssignment 1 – The Basic Checking Relationship and the Bank’s Right to Pay Checks

Terminology:• Issuer/Drawer: person who writes the check; commonly called drawer because uses a check to draw

money out of a bank account.• Payor Bank/Drawee: the bank from whom the money is drawn; if hear the word “payor,” it refers to the

bank and not the person writing the check.• Payee: person to whom a check is written• Depositary: bank into which the payee makes a deposit; wherever the payee puts the check• Intermediary: the Federal Reserve Bank; bank through which the check passes to be presented to the

payor bank for ultimate payment. In a small town/area, there will be either one intermediary bank, or none.• Collecting Bank: any bank that handles an item for collection other than the payor bank. Generally, job of

the Fed. Reserve.• Presenting bank: Any bank that presents an item for acceptance or payment. The payor bank is not itself

a presenting bank.

- The relationship between the drawer and the payor is governed by several things: an account agreement, UCC arts 3 and 4 (section 4-401 in particular), federal law, and other banking regulations. In addition, in its agreement, the parties can alter the UCC rules.

- Federal law largely regulates how banks do business with other banks. It regulates the business of being a bank rather than the relationship between the bank and the drawer.

Bank’s Right to Pay• Proper for a Bank to Pay:

(1) § 4-401 – proper for bank to charge a customer’s account for any item that is properly payable. It is properly payable if the customer has authorized payment.

(2) Most common way for customer to authorize payment is by writing a check.(3) Payment to thieves is not authorized – item containing a forged endorsement or signature is not

properly payable.• OVERDRAFT (§4-401 & §4-402)

(1) Payor bank may pay NSF check, but does not have to. Look to agreement.• STOP PAYMENT (§4-403)

(1) Timely and adequate notice to payor bank; bank must have reasonable opportunity to act on it.(2) Even if the bank stops payment, check writer remains responsible to the payee on the

underlying obligation.(3) Written order effective for 6 months; oral order effective for 14 days.(4) UCC suspends the payee’s right to pursue customer on underlying obligation when payee

accepts the customer’s check but suspension ends if check is dishonored.• DRAWER’S DEATH OR INCOMPETENCE (§4-405)

(1) Bank is entitled to pay until “knows of fact of death or adjudication of incompetence” and has reasonable time to act.

(2) Doesn’t automatically revoke authority to pay, collect, or account for items.(3) BUT bank can honor checks until 10 days after death of person unless ordered to stop payment

by person claiming an interest in the account. (§4-405(b)).

Remedies for Overpayment:• Re-credit customer’s account §4-402; consequential damages when charge leads to dishonored checks. §4-407.

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• This obligation is limited by subrogation of the bank to the rights of the payee.

Article 4:Bank may NOT enter into an agreement that disclaims responsibility for the following:(1) Its own lack of good faith.(2) Its own failure to exercise ordinary care.(3) No agreements limiting damages for such lack or failureBank and customer may agree on reasonable standards by which to measure bank’s responsibilities. § 4-103(a).

Problem Set 1

1. Tertius’s 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. Is Tertius liable for the check?

§ 4-401(a) – A 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. An item is properly payable if it is authorized by the customer and is in accordance with any agreement between the customer and the bank.

§ 4-401Comment 1 - An item drawn 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. An item containing a forged drawer’s signature or forged indorsement is not properly payable.

Tertius is liable for the check even though it would create an overdraft. If a check is properly payable, the bank will pay it. A check is properly payable when it is authorized by the customer. If it is a joint account, both husband and wife are jointly and severally accountable. Therefore, Tertius is accountable for the checks his wife issues.

b. If Tertius and his wife are estranged and she used the funds to buy a plane ticket to London for pleasure, would the answer be different?

§ 4-401(b) – A 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.* This provision does not exist in Louisiana. So, in Louisiana, whether you benefit or not, you are liable.

§4-401 Comment 2 – Subsection (b) adopts the view that if there is more than one customer who can draw on an account, the non-signing customer is not liable for an overdraft unless that person benefits from the proceeds of the item.

If Tertius did not sign the check and did not benefit from it, then he cannot be charged for overdraft. “Customer” is interpreted to individually in this section; we don’t do that for 404(a). “Benefit” is a more ambiguous term – may argue that because are husband and wife, a benefit for her is a benefit for him. This argument may work better in other cases than this one. The intent of the statute probably applies here. Because 4-401(b) was not adopted by Louisiana, Tertius would be liable here whether or not he enjoyed any benefit.

2. Customer of bank wrote $900 check. Bank received the check for payment on Monday, January 22, but the check was dated February 1 and made out to a realtor co. The bank’s check processing system does not examine the dates on checks, and it automatically processed the check. Customer had sent the Bank a letter in September of last year asking the bank not to cash any of the checks made to the realtor co. until the indicated dates. Has the bank acted properly?

§ 3-113(a) – An instrument may be antedated or postdated. The date stated determines the time of payment if the instrument is payable at a fixed period after date. Except as provided in § 4-401(c), an instrument payable on demand is not payable before the date of the instrument.

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§ 4-401(c) – A bank may charge against the account of a customer a check that is otherwise properly payable from the account, even though payment was made before the date of the check, unless the customer has given notice to the bank of the postdating describing the check with reasonable certainty. The notice is effective for the period stated in § 4-403(b) for stop-payment 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 with respect to the check described in § 4-303. If 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 subsequent items under § 4-402.

§ 4-401 Comment 3 – Subsection (c) is added because automated check collection system cannot accommodate postdated checks. A customer wishing to postdate a check must notify the payor bank of its postdating in time to allow the bank to act on the customer’s notice before the bank has to commit itself to pay the check. If the bank fails to act on the customer’s timely notice, it may be liable for damages for the resulting loss which may include damages for dishonor of subsequent items.

§ 4-403(b) – A stop-payment order is effective for 6 months, but it lapses after 14 calendar days if the original order was oral and was not confirmed in writing within that period. A stop-payment order may be renewed for additional six-month periods by a writing given to the bank within a period during which the stop-payment order is effective.

§ 4-403 Comment 6 – A stop payment order is effective after the order, whether written or oral, is received by the bank and the bank has a reasonable opportunity to act on it. If there is written confirmation within the 14 days, the six month period dates from the giving of the oral order. A new stop-payment order may be given after a six-month expires, but such a notice takes effect from the date given. When a stop-payment order expires, it is as if the order had never been given, and the payor bank may pay the item in good faith even though a stop-payment order had once been given.

The bank should not have paid the check before the post-date; it was therefore, not properly payable. If a customer gives notice to the bank with “reasonable certainty,” the bank must abide by that request for up to 6 months, renewable indefinitely. To determine what 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. Because the customer properly requested honoring of the post-date, 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). In this case, there will be no damage if no other check comes through until February. The bank will just give customer overdraft protection for 9 days (until February).

3. Bank paid check in contravention of a written stop payment order. The check was written in exchange for cooking equipment, but when purchaser got home with equipment, he decided it was too big. When seller of equipment refused to take back the equipment, purchaser issued stop payment order on his check, identifying the check number, account number, and date of the check. A clerk at the bank, however, incorrectly entered the information and as a result, the system did not recognize the check when it was cashed the next day. Must the bank recredit the purchaser’s bank account? If so, will the bank bear the final loss?

§ 4-401(a) – see above

§ 4-403(a) & (b) – see (b) above; A customer or any person authorized to draw on the account if there is more than one person may stop payment of any item drawn on the customer’s account or close the account by an order to the bank describing the item or account with 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 with respect to the item described in § 4-303. If the signature of more than one person is required to draw on an account, any of these persons may stop payment or close the account.

§ 4-407(2) & (3) – If a payor bank has paid an item over a stop-payment order, after an account has been closed, or otherwise under circumstances giving a basis for objection by the drawer or maker, to prevent unjust enrichment and only to the extent necessary to prevent loss to the bank by reason of its payment of the item, the payor bank is subrogated to the rights:

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(2) of the payee or any other holder of the item against the drawer or maker either on the item or under the transaction out of which the item arose; and

(3) of the drawer or maker against the payee or any other holder of the item with respect to the transaction out of which the item arose.

§ 4-407 Comments 2 & 3 – Paragraph 2 subrogates the bank to the rights of the payee or other holder against the drawer or maker either on the item or under the transaction out of which it arose. It may well be that the payee is not a holder in due course but still has good rights against the drawer. These may be on the check but also may not be as, for example, where the drawer 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 worth a portion of the contract price. If the drawer retains the goods, it is obligated to pay a part of the agreed price. If the bank has paid the check it should be subrogated to this claim of the payee against the drawer. Paragraph 3 subrogates the bank to the rights of the drawer or maker against the payee or other holder with respect to the transaction out of which the item arose. If, for example, the payee was a fraudulent salesman inducing the drawer to issue a check for defective securities, and the bank pays the check over a stop-payment order but reimburses the drawer 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 what he asked them to do. If the bank had reasonable time, the fault is on the bank’s head. Because the stop-payment order was on the right form and was within a reasonable time, the bank here is at fault. Stop payment orders are addressed in the agreement between the bank and the customer, not the UCC. The check was not properly payable, and the bank should credit the customer’s account.However, the bank is subrogated to the rights of the check recipient. It can therefore argue that

4. What would have happened if the bank complied with the stop-payment order and refused to honor the check? Could equipment seller force purchaser to pay for the equipment?

§3-310(b) – If a note or an uncertified check is taken for an obligation, the obligation is suspended to the same extent the obligation would be discharged if an amount of money equal to the amount of the instrument were taken, and the following rules apply:(1) In 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 extent of the amount of the check.

(3) If the check or note is dishonored and the obligee of the obligation for which the instrument was taken is the person entitled to enforce the instrument, the obligee may enforce either the instrument or the obligation. In the case of an instrument of a 3rd person which is negotiated to the obligee by the obligor, discharge of the obligor on the instrument also discharges the obligation.

§3-310 Comment 3 – If 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. If 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 which is enforceable by somebody else. Thus, if the seller sold the note or the check to a holder and has not reacquired it after dishonor, the only right that survives is the right to enforce the instrument.

The seller can force the buyer to pay. As soon as the check is dishonored, the payee can enforce the check or sue on the obligation. It is easier to sue on the check - merely put buyer on the stand and ask him whether it is his signature on the check. If he says yes, then case closed. All signatures are deemed valid unless proven otherwise. Whether seller will recover, will depend on whether buyer has money.What if buyer doesn’t have money, can seller sue the bank? The payee cannot sue the bank, because has no right to. The only thing that requires the bank to pay is the agreement between 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 between the buyer and the bank.

5. Old President of corporation regains control of the business from daughter and son-in-law. But, based on the account agreement, the bank refuses to give president access to funds of business’s bank account because the signature card for the business refers only to daughter and son-in-law, not president. Bank requests the consent of daughter and son-in-law before signature card is changed. Can

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president force bank to release the funds without providing a letter of consent from daughter and son-in-law?

§ 4-103(a) – The effect of the provisions of this Article 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 exercise ordinary care or limit the measure of damages for the lack or failure. However, the parties may determine by agreement the standards by which the bank’s responsibility is to be measured if those standards are not manifestly unreasonable.

§4-103 Comment 2 – The agreements may not disclaim a bank’s responsibility for its own lack of good faith or failure to exercise ordinary care and may not limit the measure of damages for the lack or failure, but his subsection like § 1-102(3) approves the practice of parties determining by agreement the standards manifestly are unreasonable, the agreement controls. Owners 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.

Account agreement governs unless something overrides it. However, if the agreement violates required care or good faith, it is overridden. Here, the bank is not acting negligently or in bad faith. The agreement here overrides law.

Assignment 2: Bank’s Obligation to Pay

The Bank must pay if funds are available.

When funds are available:1. Time of Evaluation – bank is free to determine whether an account has sufficient money at any time “b/t

time item is received and payor bank returns.”- If ordered to pay and there is money in the account, the bank must pay.- Only has to check one time. If it checks more than once, it is bound by the second amount if

different.2. Availability of Funds – Depositary

- When an account holder deposits money, the bank does not have to make that money available immediately.

- Reg. C.C. deadlines by which the depositary must make funds available to customer upon deposit of check. However, with modern technology, these rules may be obsolete.• Non Cash withdrawal from a Local check - $100 on the first business day after the banking day

on which funds were deposited. Remainder no later than 2nd business day.• Non Cash withdrawal from Non-local check - $100 1st day after deposit. Remainder Day 5.• Cash withdrawal on Local check - $100 day 1; $400 day 2; Remainder Day 3• Cash withdrawal on Non-local check - $100 day1; $400 day 5; Remainder day 6.► Exceptions:

(a) 100% of Low Risk items are available on the 1st business day. Can probably withdraw amount of deposit as soon as deposit made.(1) “On-us” items: checks deposited or cashed at the bank on which they were drawn.(2) Cashier’s Check: Both payable by and written by the bank.(3) Treasury checks?

(b) ATM deposits: 2nd business day unless “on-us” or treasury check.(c) If a check is over $5000, then Reg. CC does not apply. (Reg. CC §229.13). (d) When the check actually clears, funds must be made available even if it is before schedule.

General Terms:- Business Day - calendar days, except Saturday, Sunday, and federal holidays (Reg. CC § 229.2).- Banking Day - business day on which the bank is open for carrying on substantially all of its banking

functions. (Reg. CC § 229.2(f)). What does this mean Saturday is?- Local Check - check drawn on a bank that is a member of your regional Federal Reserve System. - Non-Local Check – Any check drawn on a bank located outside the check processing region of the bank

at which the check is deposited.

Wrongful Dishonor:• Bank breaches agreement and refuses to pay a properly payable check.

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• Customer entitled to all damages proximately caused by wrongful dishonor. Liability is limited to actual damages and may include damages for an arrest or prosecution of the customer or other consequential damages. (§ 4-402(b)).

Miscellaneous:• Check is stale after 6 months, but the bank may still honor it in GF and in observance of reasonable

commercial standards of fair dealing.• All funds must be made available when the check clears. §4-215.• Check Kiting

-Form of bank fraud-Open Account at Bank 1 and write a check for 1.3 million and deposits it at Bank 2. Opens account at

Bank 2 and writes check for 1.4 million and deposits at Bank 1. At some point take the money out of one account. The Bank that allows this is left holding the bag. (First National Bank v. Colonial Bank).

Problem Set 2

1. Bank honored check that was 7 months old. Drawer thinks that the check was too stale to honor. Can drawer contest the bank’s honor?

§ 4-404 – A bank is under no obligation to a customer having a checking account to pay a check, other than a certified check, which is presented more than 6 months after its date, but it may charge its customer’s account for a payment made thereafter in good faith.

§ 4-404 Comment – Bank is given the option to pay a stale (over 6 months old) check because it may be in a position to know that the drawer wants payment made. Certified checks are excluded because they are primary obligations of the certifying bank. The customer’s account was presumably charged when the check was certified.

§ 1-201(19) – “Good faith” means honesty in fact in the conduct or transaction concerned. (This definition does not apply to Art. 4).

§ 3-103(a)(4) – “Good faith” means honesty in fact and the observance of reasonable commercial standards of fair dealing.

§ 3-103 Comment 4 – This definition of good faith only applies to Articles 3 and 4 and is consistent with Articles 2, 2A, 4, and 4A. Good faith is concerned with fairness of conduct rather than the care with which an act is performed.

The check is stale because it is over 6 months old. The bank can choose whether or not to honor it. The bank has the right to pay a stale check but isn’t obligated to pay it. However, the bank can only honor the check in good faith. There is nothing here to suggest that the bank was dishonest. Does it fit in “reasonable commercial standards of fair dealing?” Kilborn doesn’t think its unfair, but it may depend on the judge, who could think an inquiry was necessary after 6 months.

2. The following checks were deposited in a Houston branch of CountryBank Monday, March 1. Country bank is open for substantially all of its operations 6 days a week. Withdraws are made by check.

a. Customer wants to withdraw cash against a deposited $7,000 check written by Archie on his Seattle bank account.

The check is non-local and it is a cash withdraw. Therefore, according to the Reg. CC, the bank must make $100 on the business day after the banking day on which the funds were deposited. Therefore, $100 should be made available on Tuesday, March 2. However, the bank is not required to make any more money available until the fifth business day from the banking day on which the funds were available. Therefore, on Monday, the eighth of the next week, the bank must make $400 available. The fifth day is Saturday, but because neither Saturday nor Sunday is a business day, the funds will not be available until Monday, which is the 5th business day. On Tuesday, March ninth, the $4,500 will be available. Because the deposit was over $5,000, anything over $5,000 will not be available until the deposit clears. The day it does, the remaining $2,000 will become available.

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b. Customer deposits $1,000 cashier’s check drawn on a Seattle bank. The check was originally payable to Riverfront Tools but was properly indorsed from the corp. to Carl.

Reg. CC §229.10(c)(1)(v) & (vii) – A depositary bank shall make funds deposited in an account by check available for withdrawal not later than the business day after the banking day on which the funds are deposited, in the case of (1) a cashier’s, certified, or teller’s check deposited – In an account held by a payee of the check; in person to an employee of the depositary bank; and with a special deposit slip or deposit envelope, if such or envelope is required by the depositary bank under paragraph (c)(3) of this section, and (2) A check deposited in a branch of the depositary bank and drawn on the same state or the same check processing region.

Reg. CC § 229.12(b)(4) – A depositary bank shall make funds deposited in an account by a check available for withdrawal not later than the 2nd business day on which funds are deposited, in the case of - A check drawn on a Federal Reserve Bank or Federal Home Loan Bank; a check drawn 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 requirements of 229.10.

Reg. CC § 229.12(c)(1)(ii) – A depositary bank shall make funds deposited in an account by a check available for withdrawal not later than the 5th business day following the banking day on which funds are deposited, in the case of – a check drawn on a Federal Reserve Bank or Federal Home Loan Bank; a check drawn 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 drawn 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 requirements of 229.10.

A cashier’s check is a low-risk item, but it was indorsed by a 3rd person. It is treated as a non-local item. Therefore, $100 will be available on the first day, and the remainder on the 5 th day.

c. Customer deposits $1000 check from the US Treasury at a Houston branch CountryBank ATM.

Reg. CC 229.10(c)(1)(i) – A depositary bank shall make funds deposited in an account by check available for withdrawal not later than the business day after the banking day on which the funds were deposited, in the case of – a check drawn on the Treasury of the United States and deposited in an account held by a payee of the check.

Reg. CC 229.12(b)(4) – see above

Reg. CC 229.12(c)(1)(ii) – see above

Even though the Treasury check was deposited in an ATM, checks drawn on the gov’t are considered so secure that the funds will be available on the next business day (1st).

d. Customer deposits $1,000 drawn on the State of Michigan with a bank teller.

Reg. CC 229.10(c)(1)(iv) & (vii) –

Reg. CC 229.12(c)(1)(ii) –

If it is drawn on a state other than where the bank sits, it is treated as a non-local check. So, Day 1, day 5.

3. Check dated Jan. 22 was drawn on customer’s account on Jan. 23 in the amount of $400 payable to GMAC, a finance co. associated with GM. The account at the time contained only $100 because the bank had wrongfully honored a postdated check the day before. The bank therefore dishonored the check and charged the customer $25 fee for issuing a check against insufficient funds. On Jan. 29, the customer’s car was repossessed, and a $2,000 in cash was deposited into the account. The funds from that deposit would have been available in time to cover the postdated check. Does the bank have significant liability?

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§4-402(b) – A payor bank is liable to its customer for damages proximately caused by the wrongful dishonor of an item. Liability is limited to actual damages proved and may include damages for an arrest or prosecution of the customer or other consequential damages. Whether any consequential damages are proximately caused by the wrongful dishonor is a question of fact to be determined in each case.

§4-402 comment 3 – Whether the dishonor is the proximate cause is a factual determination that must be made on a case-by-case basis.

The bank is liable for all damages proximately caused by the wrongful dishonor of the check. Damages in this case would be include the $25 NSF fee, $400 to car dealer, damages resulting from repossessment of car, and reputation damage if in newspaper. However, depending on the jurisdiction, it is iffy whether could get emotional damages. (Most courts are reluctant to give IIED).

4. Generally, bank decides whether to honor a check by the account balance at the close of the banking day that the check was presented. When bank manager saw a certain check was on the bounce list because of insufficient funds at the close of the previous banking day, he rechecked the customer’s account in order to check the accuracy of the software program. He noticed a cash deposit made on the previous day, available that day, that would cover the check. Bank manager wants to know that practices are okay.

§4-402(c) – A payor bank’s determination of the customer’s account balance on which a decision to dishonor for insufficiency of available funds is based may be made at any time between 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. If, at the election of the payor bank, a subsequent 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 whether a dishonor for insufficiency of available funds is wrongful.

Reg. CC §229.10(a)(1) – A bank shall make funds deposited in an account by cash available for withdrawal not later than the business day after the banking day on which 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. In this manner, the statute is very flexible. It doesn’t matter for what reasons the account is checked; if he looked at the account and saw sufficient funds, he cannot bounce the check. If the account is checked again, the bank must go with the 2nd time. The banker wouldn’t have a problem if had just checked it once, but because found sufficient funds on 2nd check, must honor the check.

5. Several 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 CountryBank learned that the checks would not be honored. This mostly occurs with recently opened accounts or accounts on which overdrafts have been frequent. Is there anything the banks can do? Can the banks extend to 6 business days the hold that the bank puts on all nonlocal checks deposited at the problem banks?

Reg. CC §229.13 - too long to write

Countrybank cannot make the blanket rule that it wants to, but it can change its current procedure a little. For the new accounts, do not have to honor until 9 days, checks over the amount of $5,000. Also, for repeated overdraft, if in the last 6 months, it has been repeatedly overdrawn, the deadline may be extended. The hold may only apply in specific circumstances; there cannot be a blanket rule. She cannot across the board say all non-local checks will be held extra days.

Assignment 3: Collection of Checks

Check Clearing Process- Begins when the drawer gives a check to the payee in exchange for whatever. Payee accepts the check

because has confidence that will get paid. A check is an order to the bank to pay by the drawer.- 2 Ways of Obtaining payment

a) Presentment (1) Payee goes directly to the payor bank and receives money from a teller.

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(2) Given that the check is drawn on the payor bank, where the payee has gone, or where the payee has an account, that check is called an “on-us” item. It is easy for the payor bank to deal with that check – it only has to access its own information. The bank has until midnight the next banking day to determine if it will honor the check.

b) Indirect Clearance System (1) 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.)

(2) There are 3 steps that are common to indirect payment method:(a) Payee – Depositary Bank. When the payee deposits the check, generally, the depositary

bank will provisionally credit the payee’s account, but will not provide access yet. §4-201(a). That credit is subject to revocation on timely dishonor by payor. §4-214. That deposit begins the banking day deadline. A deposit is deemed to occur on a banking day only if made by the cut-off hour – no earlier than 2 in the afternoon.

(b) Depositary Bank – Collecting Bank. (1) MICR : The depositary bank sends checks to an off-site processing region. Number at

the bottom of the check is a MICR line – magnetic line. 1st 2 numbers are the region and subregion (the zip code of the bank). The 2nd four numbers is the bank. The rest of the numbers is your bank account. At end, last number is a check sum digit. If you get checks back, you will see that another number has been added at the end in same MICR ink. They are encoding the amount of the check on the check. After that, MICR line is fed into a machine. The machine will sort according to routing number.

(2) Collecting Bank : Banks can either have multilateral or bilateral agreements as to how checks will be presented. If 2 banks have a significant relationship (or in a small town), may have a bilateral agreement that permits each to send checks directly to the other without the use of an intermediary. If not, the Federal Reserve System acts as a collection intermediary bank for all banks. Banks may also have clearinghouse agreements to trade checks more efficiently. A courier physically transports to Federal Reserve 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. At the payor bank, the checks are once again fed into a machine. The computer determines how much is available in the accounts and determine if will cover the amount of the check. If it will, it happens automatically. The collecting bank makes the credits and debits to accounts. A number of checks may be randomly selected for signature checks.

(c) Return to Depositary Bank. If the bank is going to dishonor the check and doesn’t send it quickly, the payor bank will be liable for the amount of the check. The payor bank, if it wants to dishonor, must do so under 2 timelines:(1) UCC Midnight deadline : Payor bank must return the check by sending it back to the

collecting or presenting bank by mail or otherwise before midnight of the business day after the banking day on which presentment was made.

(2) Reg. CC deadline - §229.30(a) 2 day / 4 day Rule: Payor bank must send check so that it would be received no

later than 4 pm on the 2nd business day after the banking day of presentment to the payor for local checks and 4th business day for non-local checks. - If the bank misses the UCC midnight deadline, Reg. CC says that if can still

comply with 2/4 day rule, the UCC rule will be suspended. This essentially adds an extra day to UCC midnight deadline. If the payor bank uses a highly expeditious means of getting checks back, deadline is entirely waived.

(b) Forward Collection: The payor bank may use the same process of sending checks as if were sending as a depositary bank to the collecting bank. Essentially, the payor bank will put a MICR line taped to bottom and will reverse MICR line to go back to depositary bank within a couple of hours.

(c) Dishonor of Large Checks. If payor bank wants to dishonor check for 2,500 or more, the bank must provide notice of nonpayment to the depositary bank by 4 p.m. on the 2nd business day following the banking day on which the check was presented. Notice should be provided by any reasonable means.

(3) Difference between UCC and Reg. CC:(a) UCC is concerned with when the check is sent; Reg. CC is concerned with when

depositary bank should receive check.

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(b) UCC requires check be returned by mail; Reg. CC permits forward collection as well as other appropriately expeditious means.

(c) Reg. CC altered the midnight deadline and permits payor bank to defer return until next day if payor selects an appropriately expeditious mode of return that would result in faster delivery than the UCC deadline.

(d) Payor bank must meet UCC and Reg. CC, but if bank misses midnight deadline, the Reg. CC permits an extension of one day. (Reg. CC trumps state law).

Problem Set 3:

1. Customer deposited a check for $1000 at Bulstrode in Boston on Monday at 3 p.m., drawn on another Bulstrode branch in Connecticut. Items received after 2 p.m. were treated as received the next day. Boston Bulstrode gave customer a provisional credit for the check and forwarded the check to New Haven, Conn. on Wed. morning. New Haven dishonored the check on Thur. afternoon, returning it by courier to Boston. It reached Boston Bulstode before midnight on Thurs. On Friday, the bank called customer to inform him that provisional credit was revoked. Did bank act promptly enough for a dishonor to occur?

§4-104(a)(10) – “Midnight deadline” with respect to a bank is midnight on its next banking day following the banking day on which it receives the relevant item or notice or from which the time for taking action commences to run, whichever is later.

§4-107 – A branch or separate office of a bank is a separate bank for the purpose of computing the time within which and determining the place at or to which action may be taken or notices or orders shall be given under this Article and under Article 3.

§4-108 – (a) For purposes of allowing time to process items, prove balances, and make the necessary entries on its books to determine its position for the day, a bank may fix an afternoon hour of 2 p.m. or later as a cutoff hour for the handling of money and items and the making of entries on its books. (b) An item or deposit of money received on any day after a cutoff hour so fixed or after the close of the banking day may be treated as being received at the opening of the next business day.

§4-301(a) – If a payor bank settles for a demand item other than a documentary draft presented otherwise 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 (1) returns the item; or (2) sends written notice of dishonor or nonpayment if the item is unavailable for return.

§4-302(a) – If an item is presented to and received by a payor bank, the bank is accountable for the amount of: (1) a demand item, other than a documentary draft, whether properly payable or not, if the bank, in any case in which it is not also the depositary bank, retains the item beyond midnight of the banking day of receipt without settling for it or, whether 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 (2) any other properly payable item unless, within the time allowed for acceptance or payment of that item, the bank either accepts or pays the item or returns it and accompanying documents.

If this is an on-us item, it would have been an automatic transfer for the bank simply looks at an account of its own. However, different branches are treated as separate banks for purposes of this rule. According to the UCC, the bank must dishonor by the day after presentment. The check was presented on Wed. morning, so it had until midnight Thursday to dishonor the check. For purposes of presentment, the 2 o’clock banking day cut-off hour applies. The payor bank did dishonor because reached on day after presentment by midnight. By courier is sending and is sufficient. As soon as the check is in the hands of the courier, the UCC is satisfied.Reg CC (must meet both UCC and Reg. CC). Reg. CC has the 2 day / 4 day rule. By 4:00 the payor bank had to deliver the check to the depositary bank 2 days after presentment if local and 4 days if nonlocal. Both the Reg CC and the UCC say that dishonor is sending back to. In fact, the Reg. CC only requires a sending; there is no requirement that it actually get there. It does, however, require that it be sent in such a way that it normally would be received before the 2 or 4 days after presentment. As long as the Conn. bank sends the check back so that it would normally get back before 4 pm on Friday, okay. In this case, the bank fulfilled its requirements to dishonor.

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$100 would have to be available on the first day following, which is Wed. If a cash withdraw, then $400 would have to be available on Thursday, and the rest on Friday. But, if a check, then $100 on Wed. and the rest on the next day. The provisional credit may be properly revoked by Bulstrode.

2. Customer deposited $10,000 check written by C.L. C.L.’s account only contained $100 at the time of deposit. A hold was placed on customer’s account while bank called C.L. to see whether she would deposit funds to cover the check.a. Later that morning, customer attempted to cash a check for total balance of account - $12,000,

including the funds from C.L.’s check. Teller refused to cash the check because of the hold on the account. C.L. leaves town indefinitely for work. Bank doesn’t think it can get the funds from her; what should it do?

§4-214(c) – A 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 with the section governing return of an item received by a payor bank for credit on its books.

§4-215(a) – An item is finally paid by a payor bank when the bank has first done any of the following: (1) paid the item in cash; (2) settled for the item without having a right to revoke the settlement under statute, clearing-house rule, or agreement; or (3) made a provisional settlement for the item and failed to revoke the settlement in the time and manner permitted by statute, clearing-house rule, or agreement.

§4-301(b) – If 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 withdrawn by its customer, if it acts within the time limit and in the manner specified in subsection (a).

An “on-us” item. The bank doesn’t have to give customer anything. But next day, must give $100 if available. The bank has until midnight on Friday to decide whether it wants to dishonor the check and sent it back according to the UCC. Banker probably gave the customer a 10K provisional credit when he deposited it. It may be revoked anytime before midnight of the next day unless any of the 3 things happened in 4-301(a). None of these 3 things happened. The bank may rescind the provisional settlement.

b. Bank allowed customer to cash C.L.’s check when first presented. Where would that leave the bank?

When the bank pays the item in cash, it is finally paid and not a provisional settlement. §4-215(a). Therefore, the bank cannot revoke payment to the customer. But could still go after customer for unjust enrichment.

c. Bank neglected to place a hold on the funds because thought computer would do that automatically. As a result, teller permits customer to close out his account, including the amount of C.L.’s check. What is the bank’s 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). It must also return the check or put a notice of dishonor before the midnight deadline on Friday. The bank can recover in court under the UCC. Using the UCC is easier and less timely than arguing unjust enrichment.

3. Customer is running a check-kiting scheme through FNB and Colonial banks. On Tuesday, February11, First National presents 1.5 million of checks to Colonial for payment. Colonial thinks something is amiss but does not dishonor the checks on Tuesday or Wednesday because customer tells Colonial that everything fine. Thursday morning, Colonial discovers customer’s misconduct and attempted to dishonor the checks. On Thursday morning, what could Colonial have done?

§4-215(a)(3) – An item is finally paid by a payor bank when the bank has first done any of the following: made a provisional settlement for the item and failed to revoke the settlement in the time and manner permitted by statute, clearing-house rule, or agreement.

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Reg. CC §229.30(c)(1) – The deadline for return or notice of nonpayment is extended to the time of dispatch of such return or notice of nonpayment where a paying bank uses a means of delivery that would ordinarily result in receipt by the bank to which it is sent – on or before the receiving bank’s next banking day following the otherwise applicable deadline, for all deadlines . . . this deadline is extended further if a paying bank uses a highly expeditious means of transportation, even if this means of transportation would ordinarily result in delivery after the receiving bank’s next banking day.

UCC Midnight deadline is clear and cannot be waived under the UCC. However, under the Reg. CC, the midnight deadline is waived if the bank uses a “highly expeditious means of transportation.” They could use a speedy courier to get the check to the bank as fast as can. Overnight courier is probably a highly expeditious means of transportation.

4. Customer deposited a $2,500 check from J.B. on Monday, Sept. 9 drawn on TownBank in L.A. Bank gave customer a provisional credit on the date of deposit and forwarded check through Fed. Reserve in Dallas. Under ordinary circumstances, that would get the check to TownBank late Tuesday night (during TownBank’s Wed. banking day). At 3:00 p.m. on Friday afternoon, September 13, Bank received electronic notice of nonpayment from TownBank. Bank withdrew provisional credit and notified customer mail. On Monday morning, Sept. 16, a check in the amount of $2,000 was presented against customer’s account, which Bank dishonored for insufficient funds. Bank received the J.B. check by mail from TownBank on Wed. morning on the 18th of Sept. in an envelope dated Monday. Did TownBank meet the midnight deadline? The return and notice requirements of Reg. CC? Is there anything else you need to ask Bank?

§1-201(38) – “Send” in connection with any writing or notice means to deposit in the mail or deliver for transmission by any other usual means of communication with postage or cost of transmission provided for and properly addressed and in the case of an instrument to an address specified thereon or otherwise agreed, or if there be none to any address reasonable under the circumstances. The receipt of any writing or notice within the time at which it would have arrived if properly sent has the effect of a proper sending.

§4-214(a) – If a collecting bank has made provisional settlement with its customer for an item and fails by reason of dishonor, suspension of payments by a bank, or otherwise to receive settlement for the item which 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, whether or not it is able to return the item, if by its midnight deadline or within a longer reasonable time after it learns the facts it returns the item or sends notification of the facts. If 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 when a settlement for the item received by the bank is or becomes final.

§4-215(d) – The right to charge back is not affected by: (1) previous use of a credit given for the item; or (2) failure by any bank to exercise ordinary care with respect to the item, but a bank so failing remains liable.

§4-301(d)(2) – An item is returned: when it is sent or delivered to the bank’s customer or transferor or pursuant to instructions.

Reg. CC §229.34(b) – Each paying bank that gives notice of nonpayment warrants to the transferee bank, to any subsequent transferee bank, to any subsequent transferee bank, to the depositary bank, and to the owner of the check that – (1) the paying bank or in the case of a check payable by a bank and payable through another bank, the bank by which the check is payable, returned or will return the check within its deadline; (2) It is authorized to send the notice, and (3) The check has not been materially altered. These warranties are not made with respect to checks drawn on a state or a unit of general local government that are not payable through or at a bank.

Reg. CC §229.34(d) – Damages for breach of these warranties shall not exceed the consideration received by the bank that presents or transfers a check or returned check, plus interest compensation and expenses related to the check or returned check, if any.

Reg. CC §229.38 – Liability of bank.

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Assignment 21: Negotiable Instruments

Liquidity:- Liquidity is a measure of how quickly and easily an asset can be turned into money. The effectiveness of

a payment system is gauged by how liquid its assets are. Means that paper will certainly be made into money.

- Liquid assets are stocks and bonds, and negotiable instruments (things with a recognized market and could certainly and readily turn into money). Pure liquidity is a dollar bill. The barter system is also liquid.

- An example of inliquidity: machinery. Seller must find a buyer, dicker about the price, test the item, etc. It can be turned into money, but it is a harder, longer process.

- A check is liquid. Without the law, a check would be a piece of paper the holder thinks he could get money for. This “probably” reduces liquidity. Today, we generally view checks as paper money.

Requirements for instrument to be negotiable:§3-104 - (1) Unconditional –

• There must be no suspensive or resolutory conditions whatsoever. For example, cannot say that the instrument is subject to or governed by the terms of another agreement.

• You can make a reference to another document but cannot be governed by another document. • A K is a conditional promise to pay and therefore is not negotiable instrument.• There are a few exceptions.

(1) A promissory note can refer to another loan agreement or security agreement if all saying is that will pay it and it stipulates that the agreement has security.

(2) The obligation to pay on promissory note can be accelerated. (3) If the holder gets extra rights, that’s okay. (4) A note can requirement 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.

(2) Written promise or order to pay • Must be tangible document that promises or orders payment.• A promise is exemplified in the promissory note: I promise to pay. • An order is a check.

(3) To bearer or order• 2 Ways to be Bearer:

(1) Put the word “bearer” on the payment line - meaning anyone holding the check can cash it, or (2) Make it payable to no one (blank) or cash.

• 2 Ways to make it an Order:(1) Make payment “to the order of” and then name the payee, or (2) I promise to pay a particular person or order. “Pay to Jason Kilborn or order”. It is not an

instrument if it says “Pay to Jason Kilborn”. (a) This requirement is suspended for checks. If you scratch off the words, it is still a

negotiable instrument.(4) A fixed amount

• As long as it is calculated at any given moment (determinable), it is fixed. • Cannot say that will pay 50% of proceeds of sale of business because you don’t know how much the

business will make; therefore, its not fixed. • The UCC allows a floating interest rate. LIBOR is the London Exchange Rate determined daily based

on interest that banks charge each other for overnight loans. (5) Of money –

• Money is any legal currency, foreign or domestic• Cannot be non-monetary, because the system is designed to increase liquidity.

(6) At a definite time • A fixed or determinable time.• This date can be accelerated – that doesn’t affect negotiability. • If there is no date, then payable on demand.

(7) With no extraneous undertakings.• Cannot obligate the debtor to do something other than monetary such as perform a service. • 3 exceptions:

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(1) A note can contain a provision promising to take care of security (collateral), (2) Can allow holder to confess judgment (make it easier to sue on the note) or Dispose of

collateral. (3) Borrower waives laws intended for his benefit or protection.

If it doesn’t meet one of the negotiability requirements, it just means that it won’t be applied under the UCC. They are still obligations that can be enforced, but by contract law, not UCC. A check is a negotiable instrument, as is a promissory note.

Ks are not negotiable because are a conditional promise to pay.

Problem Set 21

1. Bank wants to sell a corporate bond in a standard form. See pg. 412 for bond. Is this bond a negotiable instrument?A bond is a promise to pay issued by a corporation, but is it negotiable? To be negotiable, it must use the proper language or as Prof. says, the magic words. It does not to bearer or order. It is not a negotiable instrument, but still an enforceable obligation.Is a check more liquid than a bond? The liquidity of a bond depends on the solvency of the debtor; it is the same for a check. In fact, a bond may be more liquid than a check. Negotiability doesn’t necessarily increase liquidity.

2. Is the promissory note in Assignment 15 a negotiable 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 just a right. The promise to pay attorney’s fees is an extraneous undertaking. It is an extraneous promise to pay. There may also be an argument that the promise to pay attorney’s fees is a conditional promise to pay. However, it may be closely associated with the enforcement of the note.Waiver of rights is probably okay. As a general rule, they are acceptable.Warranty of use of funds will be used only for commercial purposes. Note is still payable even if the funds were used for personal use. It seems like an extraneous promise – but the requirements for negotiability are vague/unclear and an argument could be made that it is not.

3. Are home mortgage notes on the standard form of the National Mortgage Assoc. and the Federal Home Loan Mortgage Corp, which contain provisions giving holder rights of prepayment, require notice of prepayment, and refer to security agreements, negotiable instruments?Under §3-106, the promise to pay is not unconditional when it refers to another document that stipulates rights the holder will have. Exception is in 3-106(b) – promise to order is not conditional with respect to collateral, prepayment, or acceleration. Therefore, there is no problem with the provision giving the holder a right of acceleration. Notice of prepayment could be an extraneous undertaking. The argument could go either way. If it is an extraneous undertaking, the notes are not negotiable.

4. Bank’s ATM deposits included a $12,000 check where drawer crossed out the printed words “to order of” and wrote in “only to.” Check was cashed at Ovco Drugs. Ovco Drugs deposited the check at Bank. Is the check valid and what should Bank do?The check is negotiable because there is an exception for checks in that do not have to stipulate “to bearer” or “to order.” Changing the words on a check, has no effect – cannot make a check non-negotiable.Does the bank have to pay it? The bank is required 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 drawer. The collecting bank has no right against the payor bank; only the drawer does. The bank could refuse to honor it before midnight deadline and it does not have to give a reason. As long as customer satisfied, bank under no liability. Improper discharge could lead to consequential damages.

5. IRS receives a white dress shirt with writing that says, “Pay to the order of the Internal Revenue Service $150,000.” Sender’s signature was written below with the name of a bank and account numbers. The bank refused to honor the shirt-check, claiming that it only honored checks written on its supplied forms. Is the shirt a valid instrument the bank must honor?

§3-103(a)(6) – “Order” means a written 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,

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or to one or more persons jointly or in the alternative but not in succession. An authorization to pay is not an order unless the person authorized to pay is also instructed to pay.

§3-104(e) – An instrument is a “note” if it is a promise and is a “draft” if it is an order. If an instrument falls within the definition of both “note” and “draft,” a person entitled to enforce the instrument may treat it as either.

§3-104(f) – “Check” means (i) a draft, other than a documentary draft, payable on demand and drawn on a bank or (ii) a cashier’s check or teller’s check. An instrument may be a check even though it is described on its face by another term, such as “money order.”

§3-408 – A check or other draft does not of itself operate as an assignment of funds in the hands of the drawee available for its payment, and the drawee is not liable on the instrument until the drawee accepts it.

The shirt is a valid instrument because it meets all the requirements of a negotiable instrument. There is no requirement that it be on paper – only that it be tangible. That there is no date on which it is payable is not fatal to negotiability. When no date or time listed, it is payable on demand.However, if the account agreement says that only honor checks supplied by bank, the agreement would trump this rule, and the bank could dishonor the check-shirt.Does the IRS have any right to get paid from the bank? No, payee has no right to sue on the check; the only person with the right to enforce a check is the drawer. Payee only gets rights against the bank if bank accepts the check or holds it beyond the midnight deadline.

Assignment 22: Transfer & Enforcement of Negotiable Instruments

Requirements of Transfer of Negotiable Instrument:Must be a holder to negotiate an instrument• Negotiation - §3-201(a) – transfer of possession by person other than original issuer that causes the

transferee to become a holder.Instruments are negotiated by passing bearer paper or indorsing blank, specially, or restrictively.

• Holder - §3-301(i) – (1) must have possession of the instrument (written promise/order) and (2) Must be entitled to enforce the instrument.a) If 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. If a check is made payable to 2 people, only the both

together can negotiate the instrument. Would have to deposit in a joint account. If check is payable to x or y, either can negotiate check alternatively.

• Whether entitled to enforce an instrument depends on whether bearer paper or order paper.a) Bearer paper – Anyone in possession can enforce it – even a thief. Thief, though properly

enforcing, could still be liable in conversion and criminal theft. For bearer paper, negotiation means that you give it to someone else or someone take it from you.

b) Order paper – Only that person named in instrument can enforce it until that person indorses it over to someone else (negotiates it). For order paper, negotiation means indorsing to someone else.(1) Indorsements – 4 kinds

- Blank – holder just signs the back of the check. Any person who comes into possession becomes the holder for the check becomes bearer paper. §§3-205(b), 3-109(c). (Order paper can become bearer paper through blank indorsement).

- Special – identifies a person to whom the instrument is paid. “Pay to Bob” written above /s/. This remains order paper and only Bob is the holder. (Bearer paper can become order paper with special indorsement).

- Restrictive – adds protection. The only allowed is “for deposit only” above /s/, meaning that only a bank can be holder. When depositing checks into bank, do not have to endorse. Banks will ask you to because want you to have indorser liability.

- Anomalous – rare; made by a person who is not the holder; not negotiated; anomalous indorser becomes a guarantor of the instrument. §3-605.

Enforcement and Collection of Instruments• Right to enforce an instrument

a) Holder has the legal right to enforce the instrument.

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b) Therefore, if bearer paper, possessor has right of enforcement. c) If order paper, only the person in payee line or special indorsement may enforce.

• Presentment and dishonora) Holder has 2 rights: Presentment and Negotiation

(1) Negotiate instrument as a money substitute, like payment.(2) To Present instrument for payment, obligor or payor bank may honor and pay or dishonor and

return.- Holder has a legal right to enforce the instrument.- Check → assume honored until prompt dishonor- Note → dishonored unless specific steps are taken to honor

• Defenses to Enforcementa) As long as the person entitled to enforce is not a HIDC defenses allowed.b) Most common defense: failure of consideration

Liability on an Instrument• No party is liable on an instrument unless they signed the instrument.• Agency law: representative who signs is not personally liable. § 3-402. Must be clear that in agency capacity.• Parties who have signed are liable:

a) Issuer: unconditionally liable. §3-412.b) Drawee: directly liable when accepts the drafts. §§3-408, 3-413.c) Drawer: Same liability as indorser. Not liable until dishonored; dishonored upon acceptance. §3-

414. Liable for reimbursement and on underlying obligation.d) Indorser: Liable only when instrument is dishonored and given 30 day notice of dishonor.

Discharged upon acceptance. §3-415. Liable for reimbursemnet.- If indorser signs “without recourse,” then are not liable as indorsers, but other warranties are not waived.

Effect of Instrument on Underlying Obligation• Near-Cash Instruments – cash equivalent. Obligation is discharged immediately when obligee

accepts/takes the instrument and presumed paid. §3-310(a).a) cashier’s checkb) teller’s checkc) certified check

• Ordinary Instrument – suspends underlying obligation until honored. If dishonored, the obligation is reinstated.a) check – obligation suspended and extinguished when payor bank honors. If not honored, obligation

still exists. §3-310(b).

Accord and Satisfaction §3-311• Write a check for some portion of the obligation that they think you owe them. You sign and put “in full

payment.” You hope that they look at the instrument and just accept it in full satisfaction of obligation as informal settlement. If they accept it, that is accord and satisfaction.

• Cannot be used as a trap for the unwary.• 3 requirements:

(1) There must have been a bona fide dispute(2) Must be a conspicuous legend saying in full payment for all obligations between the parties(3) Payee must accept, cash, and not refund within 90 days. Payee has 90 days to send the money

back and go for all of the disputed payment.• GF is required under Art. 3 – creditor may not scratch out the legend and cash. Must take as stands or

send back.

Problem Set 22

1. Tom operates a check-cashing business as TKO. His normal practice requires the customers to sign the top end of the reverse of the check. He doesn’t not allow parties to cash checks when they are not the named payee. His clerks examine driver’s licenses to ensure proper identity. Finally, clerks stamp the top end of the reverse side of the check with a rubber stamp that states “TKO.

a. Tom wants to know if his procedures expose him to any undue risks.

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§3-401(b) – A 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 work, mark, or symbol executed or adopted by a person with present intention to authenticate a writing.Comment 2 - Parol evidence is admissible to identify the signer, and when the signer is identified, the signature is effective.

Signatures are blank endorsements; therefore, the checks are now essentially cash. Anyone of Tom'’ clerks could cash the checks and be entitled to enforce it. It would be better to use a special endorsement. Would be a good idea if Tom got a stamp that said “Pay to TKO” with a line underneath it for customer’s signature. Would be safer even to pay to Tom, unless inconvenient for business purposes.TKO 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 began accepting 3rd party checks that have been indorsed by the named payee. If the check appears to have been specially indorsed by the named payee and is submitted for cashing by the person to whom the named payee indorsed the check, what risk does Tom face in cashing the check?

§3-415(a) Subject to certain exceptions, if an instrument is dishonored, an indorser is obliged to pay the amount due on the instrument. The obligation of the indorser is owed to a person entitled to enforce the instrument or to a subsequent indorser who paid the instrument.

§3-416(a) – A person who transfers an instrument for consideration warrants to the transferee and, if the transfer is by indorsement, to any subsequent transferee that: (1) the warrantor is a person entitled to enforce the instrument; (2) all signatures on the instrument are authentic and authorized; (3) the instrument has not been altered; (4) the instrument is not subject to a defense or claim in recoupment of any party which can be asserted against the warrantor; and (5) the warrantor has no knowledge of any insolvency proceeding commenced with respect to the maker or acceptor, or, in the case of an unaccepted draft, the drawer.

§4-417(a) – If an unaccepted draft is presented to the drawee for payment or acceptance and the drawee 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, warrant to the drawee making payment or accepting the draft in good faith that: (1) the warrantor is, or was, at the time the warrantor transferred the draft, a person entitled to enforce the draft or authorized to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft; (2) the draft has not been altered; and (3) the warrantor has no knowledge that the signature of the drawer of the draft is unauthorized.

§3-420(a) – The law applicable to conversion of personal property applies to instruments. An 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. An 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 who did not receive delivery of the instrument either directly or through delivery to an agent or a co-payee.

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 drawer and Tom knows what bank the check was drawn on and the address of the drawer. The problem with 3rd party checks is that TKO has no way of knowing if signatures are valid, particularly the signature of the original payee. Because on order paper, a thief who forges a person’s signature, the check was improperly cashed because the thief was not holder. Only if payee signs his name is it a signature; if someone writes his name, there is no signature. Because the thief was not a holder, TKO will not be a holder. In addition, by signing it (or stamping it), TKO acquires indorser warranties, and may have to pay for the loss. It is not a good idea for TKO to accept 3rd party checks.

2. If the IRS can’t make the bank pay the check, can the IRS sue the tax payer on the shirt-check?

Yes. The IRS can sue the drawer of the check, the taxpayer, because he is primarily liable on the check. It is not difficult to win its case against the drawer – must merely show that it is his signature on the check. If it’s a negotiable instrument, and valid signature, case closed, particularly if the IRS is a holder

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in due course because then won’t be able to argue defenses. If the shirt-check was not a negotiable instrument, then it would be a simple K to pay money, which cannot prove liability based on signature alone.IRS could also sue taxpayer on the underlying obligation of tax debt. Once a check is dishonored, the obligation is no longer suspended.May be best to sue with alternative claims. The claim on the instrument should be the first count because much easier to prove. Because suing on the underlying obligation is more complicated, it should be second.

3. Landlord and tenant have dispute over space leased. Landlord received a check from tenant for ½ of disputed amount, including a notation on the check that it constituted “full payment for all past-due rent.” In the past, landlord has a practice of drawing a line through such a notation as rejection of the tenant’s position and depositing the check. What do you think of her practice?

If situation meets the 3 requirements of accord and satisfaction, then drawing a line through the full payment language accomplishes nothing. The obligation is probably satisfied if the check is not returned within 90 days. Once the check is cashed, the burden is on the person who accepted the check to show that it did not meet the 3 requirements of accord and satisfaction. Landlord could make arguments based on the first 2 elements by saying that dispute was ambiguous, there was no settlement negotiation. Although she could make these arguments, it is better not to have to. Therefore, the landlord should take and accept the settlement or reject it altogether.

4. Tom wants to know who he can sue in the following circumstances:

a. Check written by drawer and payable to payee. Check bears indorsement that purports to be the signature of payee. But check was actually cashed by a thief who mugged payee, taking his wallet and driver’s license also. When 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 TKO, only the payee could have. Even if a signature looks exactly like that of the payee, it is not the payee’s signature or indorsement. If you write someone else’s name, it is still your signature. TKO cannot sue anyone on that check. Their only relief would be to sue the thief for conversion – not for indorsement.

b. Check written by drawer as “Pay to the order of bearer.” Paul brought check to TKO. Clerk simply paid Paul cash for the check and took possession of it without obtaining any indorsement at all. Bank dishonored the check.

TKO is holder here because it is bearer paper. To transfer bearer paper, may merely pass possession. As holder, TKO could sue the drawer who is primarily liable. It could not sue Paul, however, because he did not indorse it and therefore, does not have indorser liability. There is no cause of action against Paul.

c. Check written by drawer to Paul. There are 2 signatures on the back of the check: first (at the top) states, ”Pay to Tom Mae, /s/ Paul Payee” and below that a signature by Martin Chuzzelwit. The check was dishonored because drawer closed account. Who can Tom sue? If Tom sues Martin, can Martin recover from anyone else?

If Tom Mae and TKO are viewed as the same entity (sole proprietorship), then TKO is holder. Because Paul signed the check, he has indorser liability. Martin is an anomalous indorser, and as such is a guarantor of the check. Therefore, TKO could sue drawer, as primarily liable party, Paul, or Martin.Martin, to recoup what he pays to TKO, has rights against Paul. He could also sue drawer for payment by subrogation, which will discuss later.

5. Chambers wrote a $3,400 check to purchase stereo system from Store. Stereo would not work and Chambers could not return because Store going out of business. Chambers told bank to stop payment on check, but check was already paid. Chambers came in to look at check and saw there was no indorsement by Store, only a stamp by depositary bank. Chambers insisted that Bank acted improperly

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in paying check because depositary bank was not holder because Store did not indorse. Bank wants to know if acted improperly.

When depositing a check in a bank, no indorsement is necessary to make the bank the holder. §4-205. Therefore, Bank acted properly.

6. Book-dealer requires Customer to pay him once a month for all books bought in the preceding month. Customer’s purchases totaled $12,000 during last 2 weeks. Book-dealer asked customer for immediate payment due to abnormally large amount of purchases. Book-dealer received check for $12,000 drawn on 3rd State Bank and signed by that bank in the lower right-hand corner. In lower left-hand corner, it lists customer as “remitter.” Book-dealer has heard negative news about the bank, and wonders if being had.

If one accepts a cashier’s check, the obligation is extinguished. §3-310. In that case, the only means of recovery is against the bank. The bank fills the shoes of the purchaser of cashier’s check. If book-dealer is worried about the solvency of the bank, it may lose the $12,000 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. But still risky if don’t think bank good for it.“Remitter” – person who asked for cashier’s check and paid for it.

Assignment 23: Holders in Due Course

HIDC status implements the idea that enhancing the ability of the transferees to enforce instruments enhances the liquidity of negotiable instruments by enhancing attractiveness of negotiable instruments as investments.

HIDC Status – 4 Requirements §3-302 • Must be the Holder of the instrument – possession, properly negotiated and negotiable

- Bearer paper – take possession- Order paper – take possession via proper indorsement

• For Value- Anything of value – including a future promise but only after future promise has been performed.

§3-303• Good Faith

- Louisiana does not go by §1-203’s definition of good faith as honesty in fact. Will use the Civil Code definition instead – not bad faith. It’s a “you know it when you see it” standard – ambiguous and more flexible in La.

- Example of BF: Payee negotiates all instruments that payors give him directly through to a bank that is financing his operation. Bank 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 will say call the bank. But bank is HIDC, so no obligation to payor. Some courts do not think this is fair dealing.

• Without Notice of 4 Specific Problems §3-302(a)- Overdue, dishonored, or principal payment default (default on principle, not interest).- Unauthorized /s/ or has been altered or forged.- Another claim on the instrument- Another party, such as the maker, has a defense. Most common: failure of consideration.- Notice is not knowledge. If based on all known facts and circumstances at the time, should have

tipped off to one of the above, have notice. §1-201(25)(c)

Advantages of HIDC Status• Enforce the instrument free of personal defenses to payment of maker – failure of consideration,

redhibition- Not immune from 4 Real Defenses §3-305(a)(1). These 4 defenses are considered so

fundamentally important that not even a HIDC is immune from them. The “real” defenses render the instrument an absolute nullity and therefore void.

(1) Infancy – minor who has no capacity under state law(2) Illegality – but only if that illegality renders the instrument absolutely null.

• Under the UCC, duress and lack of legal capacity fall into this category.

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• In La., duress and lack of capacity are merely relatively null and are not defenses that can be asserted against a HIDC. Prostitution would fit under illegality in La.

(3) Fraud in the Factum (not in the inducement) – maker of the note defrauded as to the very nature of the instrument. (not where signer is talked into signing). Must have been so defrauded that didn’t know and couldn’t have reasonably known that taking on an obligation to pay.

(4) Federal discharge in Bankruptcy . Federal bankruptcy law preempts state law and is therefore assertable.

• Shelter Principle §3-203(b)- Allows the buyer to stop into the shoes of the seller.- Allows a purchaser who fails to obtain its own HIDC status, i.e., does not meet four requirements

to assert any HIDC rights that the seller had before the sale.

Payment & Discharge• Only payment to the Holder extinguishes the obligation.

- It is important to pay attention to whom your holder is. If you pay the wrong person, the obligation is not extinguished.

• Partial payment should not bar HIDC status.• Discharge

- Discharge is effective against a person who became the HIDC with notice of discharge. However, HIDC that took without knowledge of discharge – discharge is not binding.

- If payee negotiates the instrument to someone else, the payments must be made to that new holder or the obligation is not getting discharged.

Important Limit on HIDC Status• Can never become a HIDC by acquiring the note issued by a consumer transaction under federal

regulation.

Problem Set 23

1. Bank is thinking of acquiring some promissory notes. None are due in the next 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. Assuming they are negotiable in form and the current seller is holder of the notes and that the Bank is properly indorsed the notes, will the borrower’s missed payments prevent Bank from becoming a holder in due course? Some of the notes call for monthly payments that are part principle and part interest, while others call for monthly payments of interest only.

§3-304(b) and (c) – With respect to an instrument payable at a definite time, the following rules apply: (1) If 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. (2) If 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. (3) If a due date with 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, which 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. However, defaults on payments of both principal and interest, give holder notice of overdue. In that case, Bank would not be a holder in due course. Overdue means that payment of principle was not met.

2. Customer is in dispute with Bank over a $2M promissory note that Customer issued to Bank2 in connection with a mortgage. Customer paid off Bank2 with a lump sum payment, and later received a call from Bank to direct payment to it for Bank had purchased the promissory note. Even though Customer told Bank that already paid to Bank2, Bank said didn’t matter because purchased the note 2 weeks before Customer paid it. Is Customer liable to Bank2 on a note he has already paid?

§3-601(b) – Discharge of the obligation of a party is not effective against a person acquiring rights of a holder in due course of the instrument without notice of the discharge.

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Payment to a person who is not entitled to enforce the instrument is not effective payment and does not extinguish the obligation to pay. Customer must pay the person entitled to enforce the instrument. Unfortunately, there is no reasonable way Customer could have protected himself if Bank2 was trying to pull a fast one on him. Customer should pay off notes face-to-face. It doesn’t matter whether Bank is a holder in due course or not.Only thing customer could do would be to sue Bank2 for unjust enrichment – but expensive. Customer could also argue that was not a negotiable instrument if the promise to pay was conditional or some such. If so, a different set of rules would apply.

3. Tom cashed a traveler’s check. It was issued by Bank and payable to “bearer,” but required a countersignature from Jane as a condition to payment. It turns up that the customer had stolen the check from Jane and forged her countersignature. Bank refused to honor the check because Jane notified Bank that it was stolen. Why can’t Tom rely on holder in due course status to enforce the check against Bank?

A traveler’s check is a negotiable instrument despite requirement of counter-signature. If payable to bearer, then anyone who possesses the check is a holder. Therefore, the thief was 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 was unaware of notice of problems. Tom should be able to get money from Bank Whether or not Tom sues depends on whether it is work it. Traveler’s checks will not be tested on the exam.

4. Customer issued check for $10,000 payable to Flatiron. Because customer’s account did not hold $10,000 on day the check was presented, Bank dishonored it. A few days later, customer sent Bank a stop-payment order on the check. A few months later, Flatiron walked into branch of Bank and asked teller to exchange customer’s check for cashier’s check. Because customer’s account has sufficient funds at the time, the teller complied. Minutes later, the teller’s supervisor noticed that payment had been stopped for the check. Bank called Flatiron and told it that would dishonor its cashier’s check. What does the Bank do?

Bank is liable for cashier’s checks it issues. It can raise the defense that was a mistake, but this is a personal defense, not a real defense, and so can only be raised if Flatiron is not a HIDC. The dishonored check was not value in exchange for cashier’s check, may not have taken it in good faith, and had notice of dishonored – so not a HIDC.

5. In exchange for specially dyed uniforms, Clym paid Venn with a negotiable promissory note in the amount of $3,000, payable to Venn in equal monthly installments over 2 years. Bank bought the note from Venn for $2,800. Venn added a special indorsement: “Pay to Bank /s/ Venn.” Bank wanted to donate the note to WWF; it did so with the indorsement: “Pay to WWF, Without Recourse, Bank, by /s/ Bank Manager, VP.” Venn did not dye the uniforms well and Clym refuses to pay the note. Clym’s lawyer says WWF cannot force Clym to pay because it is not a holder in due course. Is this true?

§3-203(b) - Transfer of an instrument, whether 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 acquire 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.

WWF is not a HIDC because received the note by donation. However, under the Shelter principle, it can assert the rights of Bank who was a HIDC. So, Clym cannot assert the defense of faulty merchandise against WWF.

6. B wrote C a check for $1,500 and then stopped payment because changed mind about purchase. C indorsed check and deposited in own bank. B’s bank, Bank1, dishonored the check based on the stop-payment request. What can C’s bank do to recover the funds it credited to C’s account?

According to §4-214, a collecting bank may revoke provisional settlements and give the check back to C. So Bank will suffer no loss at all. C’s bank could also sue B as HIDC and avoid his defense of lack of consideration, though no real good reason why should.

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7. Maggie signs promissory note for $3,000 to buy furniture. She was obliged to make monthly payments over 3 years. After 6 payments, Maggie wants to stop paying because the furniture never arrived. Bank says her obligation to pay is absolute and should bring any problem with furniture to dealer. Dealer will not return calls, and Maggie wants to know if she can stop payments. The note does not contain the standard FTC legend that prevents the bank from obtaining holder in due course status. Does that mean the bank is a holder in due course?

If FTC legend is there, bank cannot be a HIDC. If it is not there, it can. Very fuzzy on this – ask Kilborn.

ASSIGNMENT 4: RISK OF LOSS IN CHECKING SYSTEM – THE BASIC FRAMEWORK

General Rule: Person in the best position to avoid the loss will bear that loss. Another objective may be to allocate the loss to the party best able to spread it over persons and over time.

Indorser Liability §3-415• Every indorser guarantees payment to all subsequent parties acquiring the check for the value of the

check IF AND ONLY IF the check is dishonored.• Enforcement by any holder against any indorser → Chain of Liability

- Must be dishonored in 30 days- if indorser puts “without recourse” with indorsement, he escapes liability.- Must have notice of dishonor

• Payor Bank cannot enforce indorser liability b/c it would obtain the instrument only if it paid the instrument. Indorser Liability is not available when drawee pays the instrument.

• Drawer does not incur indorser liability because it doesn’t indorse the instrument

Transfer Warranties §3-416 and §4-207• Anyone who transfers an instrument warrants to subsequent transferees, including banks (NOT the

Payor Bank) that:(1) Proper indorsements (meaning had the right to enforce)– b/c everyone breaches this when a

forgery, gets passed back all the way to the one who relied on the forgery thief.(2) Authorized signatures(3) No alternations – amount, maturity date, completion, or parties(4) No defenses or claims in recoupment(5) No knowledge of insolvent drawer

• Enforced 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 warranty must be given to warrantor within 30 days after claimant has reason to

know of breach and the identity of the warrantor. Failure to give notice to the warrantor within this period discharges the warrantor to the extent of any loss caused by delay in giving notice.

• Only a transferee who takes the instrument in good faith is entitled to recover for breach of the transfer warranty. §3-416(b).

Note: Art. 3 applies to individuals or anyone and Art. 4 applies to banks.

Presentment Warranties• Anyone who takes a check and transfers it or presents it to payor bank, warrants to the payor bank

certain presentment warranties. They run only to the payor bank. §3-417 and §4-208• When Payor Bank honors a forged check, it can rely on the presentment warranties to recover from

anyone who transferred or presented the check. Otherwise that bank bears the loss because check not properly payable.

• 3 presentment warranties:(1) Indorsements are proper(2) No alterations.(3) No knowledge of unauthorized signature – this is actual knowledge.

• Requires GF in paying or accepting the instrument to utilize.

→ Presenters for payment make only presentment warranties, but prior transferors may make both transfer and presentment warranties.

→ If anyone acts in BF in the chain, then the rule is interpreted against them.

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Forged Drawer’s Signature- No party is liable on an instrument unless his signature appears on the instrument. §3-401. If the

signature was forged by a person unauthorized to sign the drawer’s signature, the signature is “ineffective” as the signature of the drawer. §3-403(a). The signature does, however, operate as the signature of the unauthorized signer.

- Payor bank cannot charge drawer’s account b/c check is not properly payable. §4-401(a). An item is only properly payable when authorized by the customer. §4-410(a). However, under §4-407(2), payor bank may be subrogated to the rights of the payee if it paid the payee and therefore can sue the drawer. The depositary bank may also be subrogated.

- Loss is generally passed to the person who dealt with the forger. If the payor bank honors the check with the forged signature, the payor bank should bear the loss b/c it was most likely to discover that the signature was forged. Payor Bank bears the loss – last solvent person to deal with thief.

Forged Indorsements- A payor bank that pays an instrument bearing a forged indorsement cannot charge the drawer’s account

because the check is not properly payable.- The payor bank will be able to shift liability to the presenter, b/c the presenter was not a person entitled

to enforce the instrument and thus breached a presenter’s warranty. The presenter in turn will be able to impose liability on prior transferors, as their transfers were in violation of the transfer warranty that all signatures were authentic and authorized and that the warrantor was a person entitled to enforce the instrument. This chain of shifting losses should end with the transferor who took from the forger. That individual may seek recovery from the forger.

Conversion- §3-420: An 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 with respect to the instrument for a person not entitled to enforce the instrument or receive payment. An 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 who did not receive delivery of the instrument either directly or through delivery to an agent or a co-payee.

- An 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.- Instead of pursuing the thief, pursue who purchased the check from the thief: depositary bank or payor

bank (not intermediary). §3-420- Payee’s right to pursue the Payor bank for conversion creates tension with the drawer’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 drawer’s account just as though property payable. §4-407

Alteration- Change in relevant aspect of the check as originally written. §3-407(c)- There are warranties against alternation, so again, check passes back.

a) Payor bank can only charge the drawer’s account for the original amount of the checkb) Payor bank can pursue others for breach of presentment warranties §4-208

- Addition to incomplete check – drawer bears the loss; best position to avoid it. §3-407

***Cannot Waive Warranties with respect to checks. §§3-416(c), 3-417(e)***

Problem Set 4

1. Drawer wrote a $300 check to Payee for doctor’s visit. Bank honored the check. Check bears a blank indorsement by Payee, followed by indorsements of Edward and Bank2. Payee, however, claims that he never received the check. Will had stolen the check and given it to Edward as payment for debts. Bank agreed to recredit drawer’s account. Bank doesn’t want to bear the loss for the check; what should it do?

2. What could Bank2 have done if Bank had noticed the forged indorsement and dishonored the check?

§4-207 – A customer or collecting bank that transfers an item and receives a settlement or other consideration warrants to the transferee and to any subsequent collecting bank that: (transfer warranties).

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3. An unknown person stole a check from drawer’s checkbook and forged her signature. Lydgate, tricked by the forger, agreed to cash the check. When Lydgate tried to deposit the check, his bank forwarded to Bank2 for collection. Before doing so, the Bank included a legend as part of its indorsement: “Without recourse and without any warranty whatsoever.” The payor bank dishonored the check and returned to the collecting bank. Collecting bank wants to know if can recover from depositary bank or the forger.

§3-414(b) – If an unaccepted draft is dishonored, the drawer is obliged to pay the draft (i) according to its terms at the time it was issued or if not issued, at the time it first cam into possession of a holder, or (ii) if the drawer signed an incompleted instrument, according o its terms when completed, to the extent stated in §3-115 and 3-407.

§3-418(a) – Except as otherwise provided, if the drawee of a draft pays or accepts the draft and the drawee acted on the mistaken belief that (i) payment of the draft had not been stopped or (ii) the signature of the drawer of the draft was authorized, the drawee may recover the amount of the draft from the person to whom or for whose benefit payment was made or, in the case of acceptance, may revoke acceptance. Rights of the drawee under this section are not affected by the failure of the drawee to exercise ordinary care in paying or accepting the draft.

4. What rights would the payor bank in the question above have if it honored the check, but then recredited drawer’s account when the fraud was discovered?

§3-418(c) – Exception to §418(a) – see problem 3. The remedy in (a) cannot be asserted against a person who took the instrument in good faith and for value or who in good faith changed position in reliance on the payment or acceptance.

5. Customer carries signed checks in her wallet. When she left the wallet in a restaurant, one of the checks was taken, completed for the amount of $1,000 and cashed at Bank, and honored by payor bank without anyone noticing the problem. Customer claims the check should not have been honored. Payor bank does not want to bear the loss – what should it do?

§3-407(c) – A payor bank or drawee paying a fraudulently altered instrument or a person taking it for value, in good faith and without notice of the alteration, may enforce rights with respect to the instrument (i) according to its original terms, or (ii) in the case of an incomplete instrument altered by unauthorized completion, according to its terms as completed.

§4-401(d) – A bank that in good faith makes payment to a holder may charge the indicated account of its customer according to: (1) the original terms of the altered item; or (2) the terms of the completed item, even though the bank knows the item has been completed unless the bank has notice that the completion was improper.

6. Customer wrote check to supplier for $1,000. The check was altered during collection process to indicate an amount of $10,000. Customer’s bank did not notice the alteration and honored the check for the full amount. Bank thinks it can only hold Customer to $1,000 but wants to recover other $9,000.

ASSIGNMENT 5: RISK OF LOSS IN THE CHECKING SYSTEM – SPECIAL RULES

General Rule §3-406• Rule: “A person whose failure to exercise 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, who, in good faith, pays the instrument or takes it for value or for collection.”

• If a drawer negligently allows someone to use her checkbook, she cannot claim that the thief’s signature was not proper.

• The bank must act with ordinary care as well, or will have a contributory negligence situation. If this occurs, the bank will cause some of the liability.

• Ordinary care - industry practice

Statement Review Rule §4-406• Bank customers have a duty to review their bank statements reasonably promptly (about 30 days).

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• There are 2 important rules in §4-406: (1) If bank gives statements and customer fails to reasonably promptly review that statement,

then any fraud perpetrated after 30 days is on the drawer for any subsequent frauds by the same defrauder. As soon as first fraudulent check appears, have a duty to report. Following fraudulent acts are on your own head if do not.

(2) If don’t catch fraud within 1 year, regardless of how careful you are, you are liable for any fraud appearing on statement after 1 year. If don't notify within 1 year, there is an absolute bar to recovery.

Responsible Employee Rule • If responsible employee indorses, the employer will be precluded from a claim against the payor

bank. §4-405• If a responsible employee forges by stealing employer’s indorsement or forging checks, the employer

is precluded from claiming that indorsement was invalid.• The loss is on he who hired the defrauder.

Imposter Rule• If someone dupes the drawer into issuing a check because they are impersonating someone else,

then the drawer is precluded from claiming that not a proper indorsement. • The drawer is in the best position to avoid loss, so pin it on him, but only if payor bank honors check.

Problem Set 5

1. Customer left check on seat of airplane. What if 3rd party takes the check, forges his indorsement, and cashes it? If Customer’s failure to act with ordinary care substantially facilitated the forgery, he cannot make a claim against the depositary bank for wrongful conversion. §3-406. But §3-406 may not apply because of the word “signature.” I don’t understand this.

2. In the following situations, would employer be liable? If so, what should he do to limit liability?a) Employee, who has no check writing authority, makes out one of employer’s blank checks to himself

and forges employer’s signature as drawer. Employee then indorses the check and deposits it. Employee then withdraws funds from his account and disappears.

b) Person claims to be a supplier to whom employer owes money. Employer issues a check in the name the person claims to be. Person then indorses check in payee’s name, cashes it, and runs off.

c) Same as in (a), but instead of writing the check to himself, Employee writes it to Madeline, intending to give the check to a friend. The friend forges Madeline’s indorsement and cashes the check.

d) Same as in (c) but Employee makes check out to a wholly fictitious character. Pinker indorses the check in the name of the fictitious person and deposits it in an account that Pinker maintains in the fictitious name.

e) Same as in (c) but Employee is the person in Employer’s office responsible for issuing checks.f) Pinker stole the check and used Employer’s facsimile signature machine to sign the check.

Employer’s account agreement stated that any signature suing that machine would be treated as authorized by Employer.

3. Customer has been the victim of a lengthy forgery scheme by his accounts payable clerk. The clerk forged checks on the account for 18 months before being caught, stealing a total of $135,000. Bank thinks that it has no obligation to return the funds to Customer’s account because Customer never noticed any of the forgeries on his statement. But the bank doesn’t want to hurt its relationship with Customer and is considering paying anyway. Bank wants to know how it can mitigate the bank’s exposure to legal liability in the future and the possibility that the losses will occur in the first place – but nothing too costly.

CHAPTER 2: OTHER CONSUMER PAYMENT SYSTEMS

Assignment 6: The Credit Card System

Issuer-Cardholder Relationship:• Participants – cardholder, issuer, merchant, and merchant bank

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• Regulations – TILA and Reg. Z. TILA (Truth in Lending Act) is only applicable in consumer transactions.

Collection by Payee1. Mechanics of Collection

Merchant agreement with network. Merchant takes on significant credit card responsibility (pay a fee to allow consumers to use credit cards). They do this intending to draw more business.a) Visa and MasterCard are not banks. They are networks that exist to encourage people to use credit cards. They make money by allowing members to use services for a fee.

Merchant bank gives merchant provisional credit2. Finality of Payment

Issuing bank’s obligation to pay does not become final at the time of the initial payment Cardholder has the right to withhold on basis of any defense it can assert against the merchant.

TILA §170(a). Cardholder pays balance and must make GF attempt to obtain satisfactory resolution of

disagreement 100 mile rule – Cardholder cannot withhold payment of transaction that occurs more than 100

miles from Cardholder’s billing address. Transaction must be over $50.

Problem Set 6

1. Bank receives letter from bank cardholder, describing a $475 mountain bike cardholder purchased using bank visa card. The letter explained that the bike was defective and asked bank to refund the cost of the bike as charged on the card. The letter enclosed payment for the remainder of the bill. Is the cardholder entitled to a refund? What is cardholder entitled to?

TILA §170 briefly: (a) A card issuer to a consumer credit plan is subject to all claims (other than tort) and defenses arising out of any transaction in which the credit card was used if (1) 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; (2) the amount of the initial transaction exceeds $50, and (3) place where the initial transaction occurred was in the same State as the cardholder, or within 100 miles from his address. The requirements of (2) and (3) are not necessary if the person honoring the credit card (A) is the same person as the card issuer, (B) is controlled by the card issuer, (C) is under direct or indirect common control with the card issuer, (D) is a franchised dealer in the card issuer’s products or services, or (E) has obtained the order for such transaction through a mail solicitation made by or participated in by the card issuer in which the cardholder is solicited to enter into such transaction by using the credit card issued by the card issuer.

Reg. Z §226.12(c) – (1) General rule – when a person who honors a credit card fails to resolve satisfactorily a dispute as to property or services purchased with 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 withhold payment up to the amount of the credit outstanding for the property or services and any finance or other charges imposed on that amount.(2) The card issuer cannot report the amount withheld as delinquent until dispute settled or judgment rendered.(3) These rights only apply if (i) the cardholder may a GF attempt to resolve the dispute with the person honoring the card; and (ii) exceeds $50 and is in same state or within 100 miles.

Cardholder may not have a refund from the bank, but he can withhold payment. To get a refund, he must go through the merchant. She can assert any defenses she has against the merchant to the bank, except when it comes to payment. You have 30 days to reverse payment with the merchant. It’s a very simple matter. Transaction must be within state living or 100 miles and the cost of the item charged must exceed $50. If not, cannot withhold.May withhold payment if 3 rules apply:(1) charge for disputed item exceeds $50(2) cardholder made a GF attempt to settle it with the merchant(3) If merchant refuses, merchant must be within 100 miles or within state of consumer’s residence.

(This is a serious problem with charges made by telephone).

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To determine whether cardholder is entitled to withhold payment, it is necessary to know where consumer lives in relation to bike shop. If the locality requirements are not met, the bank doesn’t have to honor the cardholder’s request.

2. How can Bank respond to cardholder’s defenses? If the defense presented to the issuer is valid and the issuer removes charge from cardholder’s account, the issuer, through its agreement with merchant bank, generally allows the issuer to charge back the merchant bank the price of the bike. The merchant bank will then do the same to the merchant. Then, when the merchant eats the loss, it will want the bike back. Issuer is not likely to ever take the loss.

3. Bank concerned over client’s filing for bankruptcy due to consumer complaints about new line of computers. Bank has provided client’s processing of mail-order credit card sales. In the last 3 months, those sales were $150,000. Does the Bank’s relationship put it at risk?If the product does not work, the consumers may withhold payment. Due to the courts willingness to to fudge the 100 mile rule in order to protect customers, the rule may be interpreted as the closest brick and mortar store or where the telephone operator is located. The K between the issuer and the merchant bank says that issuer can charge the loss to the merchant. But b/c the merchant is threatened with bankruptcy, the issuer is left taking the hit b/c it cannot take money from the merchant due to the bankruptcy.

4. Computer services company owes $10,000 to suppliers. If he does not pay within the next week, they will stop shipping goods to him which would kill his business. Company is considering using the MasterCard to pay the suppliers $10,000 to reduce the amount he owes for past shipments. Co. thinks it can dispute the charges and defer payment to the issuer indefinitely.

TILA §104(1) – This subchapter does not apply to . . . credit transactions involving extensions of credit primarily for business, commercial, or agricultural purposes, or to gov’t or gov’tal agencies or instrumentalities, or to organizations.

The right to dispute charges does not apply to business charges. Even if he passed this exception, there must be a good faith attempt too resolve the disagreement. But because most banks do not ask whether you have attempted to resolve the issue, this plan may work in practicality except that issuer bank will quickly charge back to merchant bank; merchant bank will charge back to supplier. If did, would probably only buy himself a week or so and would look pretty obviously like fraud. He could put it on credit and just not pay it for a while – credit cards are essentially high interest loans.

5. Bank, as acquirer that clears credit card transactions for customer, bounced several checks of customer’s. Customer thinks checks should have been easily covered by funds deposited into his account in the form of credit card receivables. Bank said it adopted a new policy that a hold is placed on credit card deposits for 45 days after date deposited to protect against the possibility that Bank will have to give back funds to issuers if cardholders challenge any relevant transactions. §4-215(e) does not apply because credit card receivables are not “items” and are excluded from Article 4. Under Reg. CC, general funds availability rules may help but because credit card receivables are not included within the definition of “check” in Reg. CC 229.2(k), it is not applicable. So, neither article 4 nor the Reg. CC help the customer. Customer could go to court and argue that 45 days is unreasonable by saying that other banks do not wait that long. The customer’s other option is to change banks.

Assignment 7: Error & Fraud in Credit-Card Transactions

Error:Defined - appears on a credit card statement and does not reflect an actual transactionTo challenge billing error cardholder must provide written notice to the issuer within 60 days after the

date on which creditor sent the statement. If not, then lose right to complain or contest.Thereafter, the creditor must respond in 30 days and resolve the claim within 2 billing cycles.$50 penalty to cardholder for failure to follow procedure.Included in error is where there is a problem with the merchant as to the product. Although 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.

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FraudTILA §133 – cardholder liability is limited to $50 max regardless of lack of care and even if the

cardholder fails to notify the issuer. However, to get liability below $50, should notify. If 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 TILA. Courts have implied a private right to

action.Agency law – businesses issuing credit cards to employees

a)Business cannot pass the loss on to its employees when they K out of TILA protection.Authorized users – if actual, implied, or apparent authority are authorized user. TILA §103(o).

a) Apparent authority – agent b/c someone has led a 3rd party to know that agent. It thus requires the cardholder make a manifestation to the card issuer. It may be possible that if do not review statements, are manifesting that whatever is on card is okay with you. Although this interpretation runs counter to the TILA’s notion of protecting consumers, it may be possible to argue, particularly if you allow to go on for long time.

b) Implied authority – parent gives child his credit card to use

Problem Set 7

1. Consumer lost his credit card which has a $20,000 limit one week ago. Should he be worried?

TILA §133 – (a)(1) A cardholder is liable for the unauthorized use of a credit card only if - the card is an accepted credit card, the liability is not in excess of $50, the issuer gives adequate notice to cardholder of potential liability, issuer has provided cardholder with a description of how issuer should be notified of loss or theft of card, the unauthorized use occurs before the card issuer has been notified of unauthorized use or possible use, and the issuer has provided a method whereby the user of such card can be identified as the person authorized to use it.

Consumer must worry about potential liability due to unauthorized use that occurred prior to his notification of the card’s disappearance. However, he can only be liable for $50 maximum. If the fraud occurred over mail order, the merchant bears the loss; if face-to-face, then issuer bears the loss. 100 mile rule doesn’t apply to unauthorized transactions.

2. Consumer is about to sell books by mail order. He is worried about accepting payment by credit card because the cardholder won’t be signing slips. Does that mean that the cardholders will have greater right to get out of the transactions?No, whether or not they sign slips doesn’t matter – it only matters whether authorized or not. The real issue is whether can figure out if authorized or not. Signature on the slip is not authorization – its just proof of who you are and helpful in proving and detecting fraud. Lack of signatures does not give cardholders greater ability to get out of transactions.

3. Consumer purchased airline tickets several weeks before the airline stopped flying and went bankrupt. Consumer purchased the tickets on his MasterCard; can he get a refund? What do you need to know to answer Consumer’s question?This is an authorized transaction. 2 ways to avoid billing charge: (1) Could say that it is billing error because airline never supplied services. Consumer has 60 days from sending of statement, not receipt, to give notice, so must act relatively quickly. What do you need to know to answer the question? When statement was sent/received? (2) Under TILA §170, he may have a claim against issuer if within 100 mile rule. Need to know if has already paid for the tickets; if so, cannot do.

4. Bank has program that provides credit cards for small businesses at low costs. Small business must sign an agreement accepting responsibility for any unauthorized charges that are made with a stolen card. An employer is complaining that a thief stole 3 of 5 cards that issued to employees. By time called to report, thief had charged $500 on each of the cards. Employer plans on deducting the amount from each of the employee’s paychecks. Employer wants to make sure this is okay. If employer cannot charge to employees, she wants the bank to bear the loss.

TILA §135 – A card issuer and a business or organization that provides credit cards to 10 or more of its employees may by contract agree to liability of the business or other organization with respect to unauthorized use of such credit cards, but under no circumstances can the business or issuer impose liability upon any employee with respect to unauthorized use.

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Although a business may waive its $50 maximum liability, it must issue at least 10 cards to its employees in order to do so and cannot pass on the loss to employees. Even if it was possible for the business to pass on liability to employees, it could not exceed $50 a card. The bank is responsible for unauthorized charges.

5. Bertie’s diner’s card was refused by a merchant who asked Bertie if would speak on the phone to a representative of the issuer. The issuer advised Bertie that the card was not honored because of Bertie’s failure to pay the last 3 months’ bills that totaled $4,500. The problem arose because issuer erroneously entered a $40 charge as $4,000 on the 1st unpaid statement. Bertie has not received the last 3 statements b/c he failed to give issuer his new address when he moved. In agreement with issuer says that if don’t contest in accordance with federal procedure, are liable. Can Bertie get the charge removed?The charge was authorized, even if the actual amount charged is wrong. His defense to payment to assert against the issuer under §171 doesn’t exist. §161 is the billing error section. He has 60 days from the time they transmitted the statement to send in a challenge. He waited too long. However, he may have an action in unjust enrichment.

6. Employer’s negligence 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 trying to obtain payment from Employer because it was his fault. Is Employer obligated to pay? What is the bank’s best argument?There is no equivalent to UCC 3-406 (ordinary care/negligence rule) in TILA. Therefore, Client cannot be liable for more than $50 max. for the unauthorized use of his credit card. However, the bank may argue that it was mislead to think the employee had apparent authority, and therefore authorized.

Assignment 8: Debit Cards

EFTA §§901-920 and Reg. E

Replaces paper check with an electronic impulse that directs the bank to transfer funds to customer or a 3rd party, which qualifies as an electronic funds transfer.

Payment with a Debit Card1. Establishing the Debit Card Relationship – 2 procedural requirements

EFTA §911 – Customer must request a debit card from bank. If bank sends a card unsolicited, it must be in an invalidated condition. If bank sends invalidated card to customer, customer must contact bank to validate.

Reg. E – Disclosure requirement – bank must provide the customer with a detailed up-front disclosure of the terms and conditions that will govern the use of the card.

2. Transferring Funds with a Debit Card Point of Sale Transactions (POS) – merchant receives almost automatic ACH transaction from

your account EFTA §906(a) – requires that customers be provided with written documentation of every

transaction they initiate3. Collection by Payee – merchant must have a K with bank or network that processes debit card

transactions PIN-based Debit Cards –

- Terminal transmits signal to Payro Bank over phone line. If PIN matches PIN for designated account and funds are available, the Payor Bank honors the request. E-message sent back to merchant over the phone line.

- Payor Bank’s obligation to pay becomes final at the moment it transmits message back to the merchant.

- Payee’s risk of non-payment is limited to insolvency of the payor bank or failure in processing system.

PIN-less Debit Cards- On-line authorization while customer at terminal but does not clear and settle transaction

immediately. Authorization of the transaction at terminal, which confirms availability of funds in account to cover the requested transaction.

- Merchant obtains payment the same way as in a credit card transaction – over the next few days.

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- From a consumer perspective, payment is final at time of transaction and no TILA-based rights to challenge payment later.

Error & Fraud in Debit Card TransactionsRisk of nonpayment is less in a debit card transaction b/c the consumer cannot stop payment – too fast.

1. Error If merchant believes it receives authorization when in fact it was not communicating with the payor

bank – POS network rules ordinarily protect the merchant and pass the loss back to the payor bank.

If payor bank sends signal committing to make payment, then charges the wrong account – Payor Bank would have to recredit the incorrectly charged account and then could charge correct account and pursue customer for deficiency.

Consumer has 60 days to notify orally or by writing of error. Payor bank may require written notice after oral notice is given. EFTA §908.

After receiving notice, the payor bank may provisionally recredit the consumer’s account within 10 days. The payor bank shall investigate the matter no longer than 45 days after notice. During this pendency, consumer has full use of funds provisionally credited. EFTA §908. (If bank provisionally credits account, it doesn’t have to abide by previously noted day requirements).

If payor bank determines that an error did occur, it has no more than 1 business day after that determination to correct the error. EFTA §908. An explanation of its findings must be mailed or delivered to the consumer within 3 days of investigation’s conclusion.

Consumer can get treble damages under certain circumstances in which the bank did not act in GF. §908.

2. Fraud Most serious risk of loss in the debit card context is the risk from false authorizations: debit card

transactions that the consumer in fact has not authorized. Merchant entitled to payment b/c bank in much better position to maintain the system for

authorization of withdrawals. Customer – there are 3 rules the bank can use to impose liability on customer when his card is lost

or stolen. §909(a).- Bank can hold the customer liable for up to $50 of unauthorized transactions that occur

before bank knows of consumer’s loss of the card. (Banks can K to take on more liability, but cannot K to give more liability to consumer).

- Fault-based notice rule – allows the bank to charge consumer for losses if consumer does not promptly notify the bank after discovery of lost card.

a) Up to $500 paid after 2 days after loss/fraud (not 2 days after discovers loss) and fails to notify.b) So – notify the bank within 2 days of discovering the loss.

- Customer has 60 days to review statements.a) If he fails to report unauthorized transaction w/in 60 days of statement, he is liable

for any subsequent transactions. (Some state laws limit this liability; La. does not).b) No maximum limit.c) Visa and MC issued debit cards have limited liability to $50 like TILA

Problem Set 8

1. Client left his debit card with his PIN on an airplane. What should he do? Should he be worried?If Client calls the bank immediately, he will probably not be liable for anything. If it has been already used, then he would liable up to $50. If he waits 2 days before notifying the bank, he could be liable up to $500. If he fails to report the transaction within 60 days, he is liable for any subsequent transactions subject to no maximum limit (unless Visa or MC which do not abide by 60 day or $500 rule).Negligence rules under 3-406 that apply to checks, do not apply to debit cards.

2. Grocer is considering accepting PIN-based debit cards in hopes that funds would be credited more quickly, thereby bringing in more interest income and will save on bad-check expenses. However, Grocer is still skeptical. Does he face any significant risks of loss if he accepts debit cards? What if system messes up and he sells things to people with no money in their accounts?Debit cards are the ultimate payment system for merchants. Payment is final at the moment of transaction. And upon finality, the risk of loss is on the payor bank for any fraudulent items. Although

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the payor bank may be able to pass the loss to the consumer, it will not pass the loss to the merchant. Network rules allocate loss. Why does the bank agree to assume risk rather than pass it to the merchant? Because the banks want lots of money flowing through and its much less expensive to process electronic messages rather than checks. In addition, the risk of forgery or fraud is negligible because debit cards are very difficult to forge. The merchant will take the loss for fraudulent debit transactions if it accepts these transactions while its computer is down.

3. Archie, with his bank card, purchased a printing press which is defective and wants to withhold payment. Bank told him that he could not challenge the transaction. His card is a MC with both credit and debit features. He thinks the clerk at the shop erroneously processed the transaction as a debit card transaction rather than a credit card transaction. Can Archie get his money back from the bank?

EFTA §903(11) – “unauthorized electronic fund transfer” – an electronic transfer initiated by a person other than the consumer without actual authority to initiate transfer and from which the consumer receives no benefit. It does not include a transfer initiated by a person other than the consumer who was furnished with 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 authorized, it was initiated with fraudulent intent by the consumer, or constitutes an error committed by a financial institution.

Under EFTA, it probably won’t be considered an unauthorized electronic fund transfer because it was given by Archie to the clerk and Archie benefited from it. But because he intended credit card, TILA may apply – see §170 – “The credit card is used as a method of payment.” He should have looked at what he was signing and would have recognized that clerk used debit instead of credit.

4. Archie, in reviewing his statement that he receives at the first of every month, noticed several unauthorized transactions that go back over a year and total $3,000 - $250 on the 15 th of every month. He has just remembered that the card was taken from him in a mugging 1 year ago on March 1 and he forgot to do anything about it. For how much is Archie responsible? If Archie has reported the card stolen to the bank upon notice, he could only be liable for up to $50 if the card had already been used. After lost or stolen for 2 days (not 2 days after discovery) and failure to notify bank, Archie would be liable up to $500. He is liable for all fraud that occurs after 60 days that don’t review. So, Archie is liable for $50 off the bat. 2nd part – liable for $200 for a total of $250. Liable for $250 in April. So, far a total of $500 which is the max he can pay; so, Archie is not liable for May 15 $250 payment. That payment was within 60 days of 1st statement that reflected fraud (statement would have been on April 1). For the June payments and everything after, he is fully liable. So, Archie will only be refunded $250 from the May 15 charge, and is responsible for everything else.

5. Client reported lost debit card and $1,000 of unauthorized charges on same day learned card was lost – Monday, March 1. 10 days later on March 11, Client got a notice from his supplier that because check bounced, was canceling K. The bank had bounced the check on March 9 because it had not yet determined how to respond to Client’s claim. Does client have a right to complain about bank’s dishonor of check?The bank has 10 days to investigate claim and see if the transaction was unauthorized. The bank “may” provisionally credit a claimant’s account – but doesn’t have to. If it had, the bank would not be subject to the 10 day rule, but would have 45 days to investigate. The check bounced 8 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 law helps.Compared to check – check system presumes check is improper and investigation follows. Payment of a forged check is not properly payable, investigate later. The opposite is true for debit card transaction.

6. Would the answer in problem 5 be different if Client’s card was a MasterMoney debit card?Assuming this is a MasterCard, then yes, it would be different. MasterCard requires the bank to give the money back provisionally within 5 days. Through the MasterCard network agreement, the consumer has greater protection. If bank has agreed to recredit within 5 days, is incorporated into rule. The dishonor would be wrongful.

Assignment 9: Automated Clearinghouse Payments

Generally Defined: ACH – a nationwide computerized network that is counterpart to the checking system. It is

used to electronically transfer funds between accounts at American financial institutions.

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To the extent that they involve consumer accounts, it is governed by EFTA and Reg. E. For transfers between business accounts, it is governed by UCC art. 4A. The network is generally governed by NATCHA (National Automated Clearing House Association – a non-profit assoc. of 36 clearing houses). NATCHA are not law; they are just rules agreed upon among financial institutions.a) Banking day – In NATCHA, a banking day is a day on which a substantial part of business is done. So, Saturday could qualify.

The most common ACH transaction is direct deposit of paychecks. Can also directly withdraw recurrent fees – like gym fees and bills and mortgage payments.

Terminology Originator – party that makes entry (or communication) that initiates transaction. Originating Depository Financial Institution (ODFI) – financial institution of the originator. Automated Clearing House operator (ACH Operator) – party that carries the communication (and funds)

from the ODFI to the RDFI. This is normally the local Federal Reserve. If banks are far apart, will be an originating ACH operator and a receiving ACH operator.

Receiving Depositary Financial Institution (RDFI) – financial institution of the recipient Receiver – part to which the entry is directed.

Finality: Dishonor & Stop Payment Dishonor - ACH entries can be dishonored for lack of funds, particularly if it is an automatic withdrawal.

NACHA has same sort of payment dishonor rules as Reg. CC. Must provide notice of dishonor within of the 2nd day.

Stop payment – Stop payment can be sent in 2 circumstances. (1) Consumers having money withdrawn are the only ones with a significant right to stop payment. To

stop payment of a withdrawal, consumer need only give oral notice 3 banking days before the settlement date. Bank can require written notice follow-up within 14 banking days.

Error If an erroneous credit, or particularly debit entry, is made, consumers have a very specific right to get

money back. NATCHA requires the consumer check his statement within 5 regular days – this is most rigorous review rule we have yet encountered. The bank must then recredit promptly. The definition of “promptly” is ambiguous, but Kilborn thinks 2 or 3 days is enough.

Problem Set 9:

1. You have the internet bill paid by automatic deduction from your bank account which you agreed to when you signed up for service.a) Determine what type of ACH entry (credit or debit) is most likely to be involved.

NATCHA §12.1.20 – A credit entry is one for the transfer of money to the account of a receiver. A debit entry is for the withdrawal of money from the transaction account or general ledger account of a receiver. All entries are deemed “items” within meaning of UCC art. 4 and that article shall apply except where the application is inconsistent with these rules.

When you authorize money to be taken out, it is a debit payment. You could make it a credit entry by initiating the payment transaction, i.e., click button authorizing withdrawal or direct bank to make payments against account.

b) You live in Chicago and internet provider is in Seattle. Who are the most likely parties to the transaction and the roles they would play under applicable NACHA rules?

The internet provider is the originator because it started the transaction by sending through request to debit account. Bank in Seattle is the ODF. From there, send to local federal reserve bank as originating ACH operator. When going across 2 federal reserve regions, the local federal reserve will send to depositary’s local federal reserve as ACH. So, from the Seattle federal reserve, the entry will go to the Chicago federal reserve, which will be called the receiving ACH operator. The Chicago reserve will send the entry to your bank. The RDFI (your bank) will check to see that properly authorized.

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c) Assuming that the next payment is due Monday, April 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?

NACHA §7.4 (relevant parts) – • Receiver may stop the payment of a debit entry by providing either verbal or written notice to the

RDFI at least 3 Banking days before the settlement date (date of scheduled transfer). • Any RDFI may honor a stop payment order received within the 3-banking-day limit, and if it does,

the RDFI has no resulting liability or responsibility to any other person having an interest in the entry.

• The RDFI may require written confirmation of a verbal stop payment order be made within 14 days of a verbal stop payment order, provided that the RDFI notifies the Receiver of this requirement and provides an address to which confirmation should be sent at the time the verbal order is provided.

• If the RDFI requires written notice, the verbal stop payment order will cease to be binding after 14 days.

• A receiver may withdraw a stop payment order by providing written notice to the RDFI. • A stop payment order will remain in effect (1) for 6 months from the date of the stop payment

order, (2) until payment of the debit entry has been stopped, or (3) until the receiver withdraws the stop payment order, whichever occurs earliest.

NACHA sub§ 13.1.11 – Banking day: any day on which the DFI is open to the public during any part of the day for carrying on substantially all of its banking functions. For ACH operator, it is any day on which it is operated.

A credit entry cannot be stopped. With debit entry, you, as a consumer, do have a right to stop payment within 3 days of settlement date. When must notify if payment on Monday? Do not count Sunday. If the bank is open on Saturdays, even until noon, Saturday would count. Counting Saturday, Thursday is the earliest day that could be the deadline for stopping payment. If bank is not open on Saturday, it would be Wednesday. Notice can be given orally unless you have agreed otherwise by K.

2. You pay your credit-card bill through an Internet billing payment service offered by your bank, through which you can direct your bank to pay bills through ACH transfers. Using that service, you direct a transfer to pay a $7,000 credit card bill in its entirety. What if you change your mind the next day – is there anything you can do to stop payment?

NACHA § 2.5 – 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 Receiving ACH Operator in enough time that RDFI may be made available to the entry by midnight of the 5th banking day following the Settlement date of the erroneous entry.

An erroneous entry: (1) a duplication of an entry, (2) entries not intended, and (3) entries with different dollar amount.

Originator must notify the Receiver of the reversing entry with a reason no later than the Settlement date of the reversing entry.

Each ODFI that initiates a reversing entry shall indemnify participating parties from and against all claim, demand, loss, or expense, 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. Once originating bank receives order, cannot stop. Its more acceptable to have stop payment with a check because it is not as instantaneous – it takes several days to a month for your bank to get order to pay. With ACH, the order is received immediately.

3. Using the same system as in #2, you pay your monthly mortgage payment. It has a settlement date of April 1, but you receive a notice of late fee because not processed until April 2. The notice advises you that the co. takes 2 days to process ACH payments and thus all mortgage payments must be transmitted 2 days in advance of the date the mortgage is due. Is there anything you can do about this?

NACHA sub§ 4.4.4 – A Receiver must credit the Originator with the amount of an entry credited to the Receiver’s account as of the Settlement Date. . .

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NACHA rules require receiver give credit to originator on the settlement date. It is generally sent and received on the settlement date. The mortgage co. is required to give credit. But mortgage co. could argue that it is not bound by NATCHA rules. Every participating bank agrees to comply with NACHA and it only bind banks that are members. It does not bind the originator or the receiver unless they have agreed to be bound by NACHA in K (which is possible because the receiver’s bank has an interest in requiring the receiver follows NACHA rules. So, look to the K b/t the receiver bank and the receiver.

4. Your bank mistakenly honors a check that is not properly payable from your bank account, which has the effect of depleting the funds in your account. As a result, the regularly scheduled debit entry to pay your car payment is returned unpaid by your bank. Car lender repossesses your car, which causes you to incur a variety of expenses. Is your bank liable for those losses?

NACHA §5.1 An RDFI may return an entry for any reason except if it returns it simply because it is a credit, debit,

or particular type of credit or debit. Return entries must be received by the RDFI’s ACH Operator in enough time that it be made

available to the ODFI no later than the opening of business on the 2nd banking day after the Settlement date of the original entry.

If it’s a credit entry being returned, it must be transmitted by the RDFI to its ACH Operator prior to the time the RDFI accepts the credit entry unless the Receiver does not have an account with the RDFI, the receiver’s account has been closed, or the RDFI is not permitted by law to receive credits for the receiver.

The RDFI must transmit the return entry to the ACH Operator by midnight of the banking day after the banking day of receipt by the RDFI from the Receiver.

An ODFI must accept return entries if done in accordance with the above. For more rules on return entries, see pg. 187-88 of text.

The RDFI may not be separate from the receiver, particularly if receiver is a bank that takes mortgages in that case are bound automatically by NACHA. If a finance co., maybe bound because members of NACHA and are a RDFI. See what Curt has on this.

5. When you check bank statement, you find a debit entry for $2,100 to cover a mortgage payment to Bank. But you do not own a home.a) How quickly must your bank return the $2,100 to your account?

NACHA §7.6 Receiver’s Right to Recredit For all consumer entries, an RDFI must promptly credit the amount of a debit entry if (1) the

Receiver sends or delivers to the RDFI a written affidavit that debit entry was not authorized by the Receiver, and (2) this affidavit is sent or delivered to the RDFI within 15 days from the date the RDFI sends statement to the receiver.

For more on re-crediting, see pgs. 193-196 in text.

As long as you review your statement and notify bank in writing of error within 15 days of date statement was mailed, you are okay under NACHA and EFTA. Bank will require you file an affidavit and must recredit after file “promptly.”

b) After the bank returns the money, will it be able to recover from any other party? Would your answer be different if the funds had been stolen by check?The bank will be able to recover from the ODFI if had been fraudulent check, The payor bank couldn’t recover from anyone else. Because if payor pays fraudulent check, it bears the risk of loss unless can push it off on you. Check with Curt on this.

6. Client wants to know the advantages and disadvantages he would face in accepting ACH payments at his grocery store (presumably POP entries, as compared to checks and debit cards. POP – point of purchase (more generally called POS - point of sale). The first question is if ACH

practical to grocer. The only way it could work is if customers brought checkbooks with them and some way to swipe.

Expense: ACH is cheap. There are no transaction fees or per transaction fee as would with checks, debit cards, or credit cards. Checks are a pain for merchants, and ACH is more cost efficient – about same as debit.

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Speed – The speed in which the grocer will get money in ACH is the same as debit. Credit requires sending slips but still get money pretty quickly within days. Much faster than checks.

Stability of payment – Customer has less ability to stop payment or assert defense or stop payment. Credit allows to assert defenses. With check, customer can stop payment before clears. However, debit great for finality. Like debit, ACH checks in real time – know whether enough money or not.

Fraud – no chance of fraud on debit card. It’s a lot higher for credit cards and checks. Check losses will be borne by payor bank and credit as well.

ACH is not great given logistical problems. Credit cards great for merchants but TILA makes a little harder. Debit cards are best from merchant’s perspective.

CHAPTER 3: OTHER BUSINESS PAYMENT SYSTEMS

Assignment 10: The Wire Transfer System

Wire transfer payments are attractive to businesses b/c they offer almost instantaneous payment at the time of the transaction.Most made through networkUCC Art. 4A governs – only credit transfers.

How It Works:1. Initiating the Wire Transfer – From Originator’s Bank → Beneficiary’s Bank

O’s Bank must do 2 things:(1) Notifies B’s Bank(2) Forward Payment

→ If does not send timely, could have to pay interest Each step, from the O to B’s Bank is a separate payment order Systems

(1) Bilateral System (SWIFT) – O’s Bank sends message directly to B’s Bank(2) CHIPS – System that allows a large # of banks to send all messages to central

clearinghouse that can aggregate and net out all participant’s transfers.(3) FEDWIRE – dominant b/t US banks; O’s bank sends message to the Fed. Reserve bank.

Fed. Reserve executes payment (pymt order #2) → B’s Bank. B’s Bank is then required to pay B. Automatically accepted – no cancellation.

(a) Daylight overdrafts allowed; Reg. J requires banks to take care of at the end of the day.

2. Completing the Funds Transfer: From the B’s Bank → B B’s Bank technically has the right to reject payment order. §§4A-210. 4A-202 cmt. 8.

- If rejects, must do so quickly. Once B’s bank accepts the payment order, it becomes obligated to pay B. Moment transfer received → B’s bank obligated.

Discharge of the O’s obligation 4A-406 a payment made by wire transfer satisfied the underlying obligation of O at the moment B’s

bank accepts payment order. So – obligation is extinguished upon acceptance

Finality of Payment Extremely limited time to stop payment; rapid transaction. Reasonable time for bank to act is difficult b/c hours or even minutes is the time frame for these

transactions. Only time can cancel

(1) B’s Bank has not notified or paid the B(2) B’s Bank has not received full payment(3) Opening 1 hour after next funds transfer day after payment date.

Problem Set 10

1. B owes N $100,000 on promissory note that was due April 1. On Monday, March 30, B asked his bank, Gride, to send a wire transfer to N’s account at Cheeryble Bank. Gride sent telex to Cheeryble executing B’s request on Tuesday, March 31, calling for payment to N on April 1. Pursuant to a preexisting agreement between Gride and Cheeryble, Cheeryble was entitled to obtain payment from Gride’s

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account at Cheeryble. At the time the account contained more than enough funds to cover the promissory note. The order was misplaced by Cheeryble and so Cheeryble neither accepted nor rejected the order and did not notify N that the payment had come in by wire. On Friday, April 3, Gride was closed and FDIC was appointed receiver to supervise the closing of its affairs. Gride withdrew all funds late Thursday afternoon, no funds remained in the Gride account at Cheeryble.a) It is April 6 and N has not been paid. Can he pursue B for payment? If not, is he entitled to payment

from Cheeryble? As in a check, the obligation is suspended when the originator initiates the wire transfer. It is

extinguished by performance as soon as the beneficiary’s bank (Cheeryble) accepts payment. The obligation then shifts to the Beneficiary’s Bank.

When it says that Cheeryble didn’t do anything to accept or reject the payment order, it simply means that Cheeryble didn’t do anything affirmatively – it doesn’t mean that Cheeryble didn’t accept the order.

Beneficiary’s Bank doesn’t have to give notice to Beneficiary though likely to. Had C notified N that the money had come in, that would be one way of accepting the payment order, and C would then be obligated.

Acceptance by Cheeryble was automatic and by default by the opening of the “next funds-transfer business day” after it receives the payment order unless it rejects it before then. §4A-209(b)(3).

“Next funds-transfer business day” – day following the payment day or order (which was April 1, so would be the opening of April 2).

On the opening of April 2, that payment was accepted if (1) at the time, the amount of the sender’s order is fully covered by a withdrawable credit balance or (2) the bank has otherwise received full payment from the sender, unless the order was rejected before that time or is rejected within (i) one hour after that time, or (ii) one hour after the opening of the next business day of the sender following the payment date if that time is later. Gride is the sender to Cheeryble. Thursday morning, Gride had sufficient funds in its account which was taken out Thursday afternoon. Thus, because there was money on hand at the opening of the business day, Cheeryble automatically accepted unless it rejected. Because Cheeryble accepted, it is bound to the beneficiary to pay and B is off the hook as his obligation is extinguished.

b) How would the answer differ if Cheeryble had rejected the order immediately after Cheeryble received it? (Assume rejection was proper.)Bank has right to reject payment order if reasonable even if sufficient funds. Unless Cheeryble and Gride have agreed that Cheeryble will accept certain payment orders, then nothing in 4A requires Cheeryble to accept. The only person who will have a complaint is someone who had an agreement with the bank that refuses to payout the wire transfer.

c) How would answer differ if the payment to Cheeryble had been made by Fedwire instead of through an agreement that Cheeryble debit Gride’s account with Cheeryble? FedWire is a system operated by the Federal Reserve System. The Fed. in each district has an

account that is owned by every bank regulated within its district. When bank transfers from Fed. Wire, the Federal Reserve credits receivers and debits payor’s accounts with the Fed Reserve. As long as there is enough money in the 2 accounts, payment is automatic and instantaneous.

Answer would change: With FedWire, payment order would have been immediately accepted, rather than a couple of days later. Payment would have been received on the day sent. If sent 3/31, would have been received 3/31.

2. Bank’s Fed. Reserve account is declining as the day goes on due to only outgoing wires. The balance is down to $3 Million. Bank has received a request to send out a wire for $5 million. Bank wants to know if it can send out a wire for more than in its Federal Reserve account.Fed Reserve allows daylight overdrafts, and different banks have different limits. Fed Reserve imposes a fee for every daylight overdraft – something like .27% of overdraft amount. Bank will probably be okay if pays because credits and incoming wires generally come at end of day. What happens if the account doesn’t get replenished? Book suggests that Fed Reserve requires Bank to make a deposit of money to put in account. Bank will likely draw that amount from another account. Fed Reserve allows banks to do this to avoid hindering the process of making transfers. Liquidity is enhanced and business is facilitated.

3. Bertie tells bank to send payment to Threepwood’s bank for $450,000. Bertie’s bank sends order that late that night by means of a bilateral agreement with Threepwood’s bank. Threepwood’s bank received

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order but has not acted on it yet (next morning). Bertie wants to issue a stop payment on the wire when he discovered the item he purchased was worth only $75,000. Can Bertie have the wire canceled?If receiving bank hasn’t accepted yet, you can give an order to stop payment. §4A-211 allows you to forcibly stop a wire, but must do it quickly before receiving bank has accepted it. It is important that the bank has not informed Threepwood that it received the wire because if did so would constitute accpetance. You would have to call sending bank (Bertie’s bank) for 1st 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 was sent. Would answer be different if it was Fedwire? Yes, its automatic, so there is no possibility of canceling payment order.

4. Carol submitted wire transfer request to transfer $750,000 from her checking account (which earned no interest) to another bank’s account (which earned interest at 8% annum). Bank neglected to send wire and can only send it tomorrow morning. What damages can Carol seek against the bank – will damages exceed the interest that Ben’s bank can earn by investing the funds until it transfers them? (Assume no agreement between Carol and Bank).UCC 4A-506(b) permits consumers to get interest from the bank. The amount is determined by multiplying the applicable Federal Funds rate by the amount that is payable. The product is then multiplied by the number of days for which interest is payable (365). The Federal Funds rate is the average of that published by the Fed Reserve of NY for each of the days for which interest is payable divided by 360.Carol will want the bank to pay the applicable 8% annum interest for the amount she has lost. However, under the UCC, interest owed by banks is calculated according to Federal Funds rate which is substantially less than what Carol would seek.

5. Bank received a payment order from Realtors, an account holder at the Bank on April 6 to transfer $500,000 to an account of Jasmine also at the same bank. Bank immediately made the appropriate debit and credit. Jasmine had funds wired to an account in her name in Mexico. Bank just received an order from Realtors canceling Jasmine’s payment order. The original payment order stated that transition date was April 6 and payment date was April 8. Bank doesn’t think it can get the money back from Jasmine. Does Bank have to return the funds to the account of Realtors?

UCC §4A-209(d) – A 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 execution date if the bank is not the beneficiary’s bank. If the originator’s bank executes the originator’s payment order before the execution date or pays the beneficiary of the originator’s payment order before the payment date and the payment order is subsequently canceled, the bank may recover from the beneficiary any payment received to the extent allowed by law governing mistake and restitution.

Where 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 within a reasonable time. Realtor must get money back – only from whom. Can try to get money back from Jasmine, but is likely that the loss will fall on the bank.Note: A very different rule for checks: Bank can pay checks whenever it wants regardless of post date, unless properly notified.

6. RFT sold CPT tools worth $450,000. Their K required payment with a cashier’s check from Wells Fargo. CPT attempted to wire funds to an account of RFT at Bank. RFT had accepted payment by transfers into that account in several earlier K, but has not been using that account for several months. CPT’s bank accepted CPT’s payment order and executed the transfer to RFT’s bank. Bank notified RFT that received funds for it. Before RFT was able to reach CPT to complain, Bank was closed that afternoon and FDIC was appointed receiver. Receiver told RFT that it would be able to retain very little from his account. Does RFT have a claim against CPT and does CPT have any remedy?4A-406(b) – If K specifically called for another form of payment, the beneficiary must complain and cannot take any of the money. If accept money then cannot complain about it later. CPT has already paid but will have to pay again. How can it get back at least one of those payments? CPT, if it pays RFT’s obligation, will be subrogated to RFT’s rights against Bank on the money already paid. §4A-406.

Summary of Assignment 11 – If bank executes order improperly . . . Banks bear no libility for wire transfer errors unless specifically make themselves liable by agreement.

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Assignemnt 12

Don’t mind international issus: just know generally and know where to look.

Fraud:Ruel: wire transfer fraud is treated like check fraud. If send unauthorized wire, the originator’s bank is responsible. The originator is not.Whether unaturhoized depends on law of agency. Whether apparetn implied or actual authroity to send wire. Each state is slightly differnet. But no major surprises state to staet.Ruel2: Certain unath. Transfers can be deemed autho if the sepcial securites sysetem is followed. If agreed to impletn a comemrcially reasonable procedure and follwos procedurea and originator unable to show that source of fradu was not related to the orignator. The, the originator will bear liability.Originator’s bank will want to have a realtively sophistticated security system to detect unauth transfers

Assignment 11: Error in Wire-Transfer Transactions

Recovering from Parties in the SystemPrinciple: each party bears the responsibility for its own errors. Parties who participate after error have no

obligation to discover or correct an error that one party made in an earlier transaction.

Originator’s Error Responsible for its communication of the order. An erroneous payment order may

(1) Is misplaced or lost, (2) Identify the wrong account/person,(3) Mess up the amount of the payment order.

Banks can rely on the # indicated on the order and deposit $ into that account. Wrong account # - B’s bank can rely on the # , even if does not match name, as long as it ID’s an

existing account #. §4A-207. Senders & receivers can agree on error detection systems – though rare.

Errors in the System – O’s Bank Sent too much 4A-402(d)

O Bank is liable for the correct amount of its order and must return the excess debits to the sender with interest on the funds from the date on which it initially paid out the funds.

Can seek to cancel a duplicate or excessive order under §4A-211. Beneficiary may give back by agreement, or if not, have a claim of unjust enrichment.

Sent Inadequate Funds §4A-303(b) O’s Bank is only responsible for what the actual amount the bank sends. O’s Bank may correct and send the rest of the $ due, but O remains only liable for what was

sent first O’s bank must refund any $ collected from O’s account for 2nd wire and must pay interest on

it. Sent late or not at all

Late funds §4A-305 – Bank must pay interest for timely improperly held Bank does not send at all – must compensate O for losses and expenses in the transaction

(refund money charged for wire transfer). Consequential damages are NOT allowed UNLESS the parties have an express written

agreement. §4A-305(c). Party who has no right to receive funds – restitution and mistake are the only recovery.

If sent to wrong beneficiary §4A doesn’t say very much about this. You can recover, but it must be under state law

(such as unjust enrichment or restitution).

Bank Statement Rule §4A-304 – generally imposes a duty of ordinary care to review statements O must complain within 90 days of the error in order to recover from a bank error O cannot challenge a debit from the account for a wire transaction after 1 year from the date that the

O received notice (receipt of statement).

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If bank sends 2 payments out of O’s account when should be only 1, O. will always get the extra payment back. But if don’t review statement, lose ability to get interest on the money that bank mistakenly debited.

Problem Set 11

1. Client asked Bank to send James a $500,000 payment. The order identified James by name and account number as 002131. Bank debited client’s account and sent payment order directly to James’s Bank in Chicago. James’ Bank deposited the funds in its account # 002131. However, this was not James’ account, but belonged to another.a) Can client recover the funds from his bank?

Banks may and always will rely on #, and if originator gets number wrong, then person who causes the mistake will bear the burden. But this is an exceptional situation. Need to know if Bank provided notice to Client that if he gives bank name and number, that bank will rely only on number. Look to the account agreement for this. If Client had notice, he would be responsible for wiring the wrong #, and won’t be able to get money back. If he didn’t receive notice and says had no idea that bank would rely on number, then shouldn’t have been sent.

b) If client cannot recover the funds from his bank, does he have any way to recover the money?Under §4A-207(d), if the beneficiary’s bank rightfully pays the person identified by number and that person was not the correct beneficiary, the amount paid may recover under state law if the O is obliged to pay its payment order. If the O is not a bank and is not obliged to pay its payment order, the O’s bank has the right to recover. Client should call the person the money was mistakenly given to and tell him give back the $500,000 was mistakenly deposited to his account. What if that person refuses? 4A doesn’t give any right to the client, so client would have to seek reimbursement under state law theories of restitution and mistake (probably under unjust enrichment).

c) Would the answer change if James’s Bank recognized the discrepancy before it accepted the payment order?If James’s Bank recognizes that the name and account number identify 2 different people, then it cannot be accepted and the payment order dies. James’s Bank should give notice to O’s bank.

2. Ball send Bank an email requesting a wire transfer for $100,000 to Long’s account at SNB. Bank accidentally duplicated the transaction and sent 2 transfers. Ball complained that day. Bank called SNB who told Bank that it had already notified Long, but that she had not yet removed the excess money.a) Can Bank force SNB to send the extra payment back to Bank?

Have both orders been accepted or is there time to dishonor? Both have been accepted because notified the beneficiary under §4A-209(b).Nothing can force SNB to return the funds because after payment order is accepted, cancellation is not effective. The banks must agree. If SNB doesn’t agree, under §4A-211(c)(2) he may be able to sue under state law.

§4A-211: If a payment order is accepted by the beneficiary’s bank, cancellation is not effective unless the order was issued in execution of unauthorized payment order or b/c of mistake by sender which 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 payment from the O, or (iii) that orders payment in an amount greater than the amount the beneficiary’s bank is entitled to receive from the O.

b) If not, can Bank recover the excess funds from Long? What if Ball in fact owes Long $1million?Bank may get money back from Long through unjust enrichment – but it will depend on the relationship b/t Long and Ball. If Ball really owed Long $200,000, then most likely that bank could not get back.

c) If Bank has no right to recover the excess funds from SNB or Long, can it retain all funds that it debited from Ball’s account to pay for the orders?No. Can only debit sender for amount she sent.

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3. Bank wants customers to waive any right to any type of recovery from the bank for failure to execute a customer’s wire transfer payment order due to computer failure. Would such an agreement be enforceable?Bank cannot K out of paying interest. §4A-305(f). Bank also cannot K out of incidental damages. §4A-305. Bank is not liable for consequential damages unless they agree to be held to consequential damages. Bank could probably have attorney’s fees waived at least in a suit for damages in something other than interest and incidental damages which cannot K out of.

4. Client authorized a wire transfer for $50,000, but the Bank sent $500,000 by mistake. The bank mailed a

notification to client, but it was lost in the mail and wasn’t received until 13 months later. Can client force the bank to recredit the funds from the transfer? If so, is client entitled to interest?

§4A-505 – If receiving bank has received payment from its customer with 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 objection to the payment within 1 year after notification was received by the customer.

Did client receive notification? A person received notification when it is properly delivered at his address or when he has actual notice. He could say that he is not precluded until 1 year after he received the notice. Client should not be precluded from getting money back because bank is the one who made the error. Client may also get interest if the bank is required to give the money back.

5. Client’s account was substantially depleted as a result of the bank’s accident in #4. 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 agreements that client had with the payees of the checks. Can client pass the costs of solving those problems back to the bank as consequences of the bank’s incorrect actions?Must ask what is the cause of these problems. If it is improper handling of wire transfers, then the bank is not responsible for consequential damages unless agreed to in written K. But if problems are due to wrongful dishonor of check, then go to §4-402 which says bank is liable for consequential damages for wrongful dishonor of check. Kilborn doesn’t know what the answer is and says you must argue both.

Assignment 12: Fraud and System Failure in Wire-Transfer Transactions

Fraud Rules General Rule

O is not liable for the unauthorized wire transfers; generally, O’s bank takes the hit Law of Agency

If fraudfeasor had apparent authority – defrauded customer is liable. If no authority – customer is not liable

Deemed Authorized – Some wire transfers are deemed authorized O and O’s Bank must implement a security system If O’s bank can prove that 1st followed procedure and O cannot prove security breach was

from a source not controlled by O – deemed authorized.* O’s Bank is generally willing to eat fraud losses

Choice of Law Rules - §4A-5071. B/t sender and receiving banks – law of receiving bank applies in a dispute2. B/t B’s bank and B – B’s bank’s law applies3. B/t O and B – law of J. in which B’s bank is located.

These rules apply when parties do not have a choice of law provision in their Ks. The law governing B’s bank governs in all disputes except those b/t the O and its bank.

Problem Set 12

1. Bank is marketing a new security system for wire transfers. Customer did not want it. Customer wants agreement stating that Bank is authorized to act on any written instruction that appears to reflects her signature as provided to the bank. Does this proposed agreement expose the Bank to any significant risks?

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Under §4A-201, the proposal of signature comparison is not good enough to follow the rule that the bank can deem received transfers as authorized. A security procedure does not include a comparison of signatures – it is easy to forge someone else’s signature. Bank should not agree to this procedure. The security procedure really should involve a password or a callback. Although the procedure would not create any extraordinary risk, would not get the benefit of the commercially reasonable procedure in which could pass back loss to customer.

2. Threepwood defrauded Bertie in a sales transaction by claiming the item was “antique” when it was manufactured 10 years ago. Threepwood’s bank has notified Threepwood of the incoming transfer, but Threepwood has not yet withdrawn the funds. Would Threepwood’s fraud enable Bertie to keep the beneficiary’s bank from paying the funds to Threepwood?General rule – when the beneficiary was notified about the transfer, it was accepted and the underlying obligation was discharged. Under §4A-211(c), can cancel if it is payment order by mistake and the beneficiary is not entitled to funds. This may not be a mistake. It is unlikely that fraud will allow you to cancel the payment order. Art. 4A doesn’t mention fraud except to say that if fraud between O and O’s bank, O will not recover anything. The fraud was independent of the wire transfer, and Bertie must pay. This is fraud in the inducement which is only a defense in the credit card system. Bertie must sue Threepwood under state law for fraud. The person who could best avoid the loss will bear the loss.

3. Bank suggested Customer start using wire transfers to make business payments because safer and more certain than mailing checks. Bank wants to install equipment that would allow Customer to contact the Bank by internet thus minimizing the potential for mistakes. Bank tells Customer that no reason to fear unauthorized orders because Customer will be the only one with a password. Customer wonders if should do it.If the bank follows the commercially reasonable security process, thin it is protected from its potential mistakes. Customer would have to prove that the security breach occurred and it was no way related to the customer. If anything goes wrong with his password, customer runs serious risk that bank will pass back loss to him. Can the bank waive the above rule and agree to take the loss? Yes, under §4A-203(a)(1) 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 password is not commercially reasonable because may be easy to find out. You could draw a parallel to the signature problem.

4. Client wonders at safety of receiving payment by wire transfer. He is hesitant to transfer his property based on the bank’s advise that it received the purchase price by wire transfer.He is not absolutely safe, but close. Once the bank receives the wire, the transaction is final and it is then the bank’s obligation to pay the beneficiary. 4A-405(d), “the credit is provisional until actual payment is make to the beneficiary bank . . . .” B has to have received notice of this for it to stand – probably was given a pamphlet with that information. If this transfer was by Fedwire or Chips – don’t allow for provisional credits; they want transfers to be final. His bank could also b/c bankrupt b/4 it passes the funds to his account. So, this poses a risk because once the transfer was accepted, the originator’s obligation was discharged.

5. Customer listed incorrect account number when issuing a wire transfer – a mistake which neither bank noticed. What if O’s bank is in Manhattan and B’s bank is located in London. The wire transfer was mistakenly sent to Harthouse who lives in Munich. England has adopted the UNCITRAL Model and Germany has no wire transfer law, but instead relies on customary principles of agency law. Can Customer recover the funds from the B’s bank? Does it matter whether Customer sues B’s bank in NY or London?Customer has a better chance in London than it does in NY. Under §4A-507, receiving bank governs, which is B’s bank in London. So, the Model law will apply to this dispute. Does it matter where you sue? No, B’s bank’s law will apply wherever sue. The real question is which court will be more favorable to you? NY judges will be biased in favor of their own law (under 4A) whereas a London judge is less inclined to look at 4A. Therefore, London will 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 law.

Chapter 13: Letters of Credit: The Basics

Letter from a financial institution promising to pay a stated sum of money upon the receipt of specified documents – way of enhancing credit-worthiness of the buyer. Common in international sales.

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UCC art. 5 (if domestic) and UCP (if international) – Uniform Customs and Practices for Customary Documents. UCP only governs if incorporated into LOC by reference. UCC applies automatically to domestic LOCs regardless of their reference within the LOC.

The Transaction in a LOC Issuing bank issues a LOC to the seller. Issuing bank commits to pay price upon proof that seller

shipped the goods. Issuer charges the applicant a small fee and puts a hold on the funds in anticipation of the

LOC being honored. Issuing bank may find a Nominated Bank, usually where the seller is located, who will process

payment. The nominated bank may also be an Advising Bank that explains the terms to the seller. Confirming Bank is the same as the nominated bank but it agrees to be personally liable.

Seller ships goods and writes letter to nominating bank (letter called documentary draft)brings documents and draft to the nominated/confirming bank.

Nominated bank compares docs to the LOC and pays the seller upon confirmation that docs strictly comply with LOC, subject to reimbursement when sends all original docs to issuing bank. If docs do not strictly comply, bank can dishonor the LOC or call issuer to inquire if willing to waive requirements. Without waiver, then dishonor.

Bank has 7 days as per UCP to determine compliance of the documents, and after that is precluded from claiming non-compliance and must honor the draft.

UCP 11(a)(i) – if electronic message is sent, adequate to transact; if mail sent, that item has no effect.

Nominated or Confirming Bank’s Obligation Completely ministerial – just compare for exact compliance and that is it. Independence principle –

LOC transaction is completely independent from the underlying transaction. Only thing that matters is whether or not documents conform. Underlying obligation is IRRELEVANT Caveat: If bank is aware of material fraud, then can dishonor based on that fraud.

Liability of Different Players in the System Advising Bank – only gives information Confirming Bank

Pays Agrees to be personally liable Has the right to immediate reimbursement

Nominated Bank Pays But no agreement of personal liability

Problem Set 13

1. Bank has issued LOC which provides payment for goods shipped “from the end of February 1998.” She received a draft including an invoice for goods shipped on Feb. 21, 1998. The LOC incorporates the UCP by reference. Does the draft comply with the LOC?

UCP §47 – The words to, until, till, from, and words of similar import are understood to include the date mentioned. The word “after” excludes the date mentioned. The terms “first half” and “second half” of a month shall refer to the 1st to the 15th and the 16th to the last day of the month. “Beginning,” “Middle,” and “end” of a month refer to the 1st to the 10th, the 11th to the 20th, and the 21st to the last day of such month, all dates inclusive.

February 21 is defined as part of the end of the month and so complies. “From the end” means from the 21st to the last day of the month. In case of doubt, may want to ask applicant if okay.

2. Bookseller shipped books overseas. When he submitted a draft on the LOC, the confirming bank told him it was not obligated to pay because the issuing bank closed. Thus, the confirming bank argued it would not be reimbursed and the LOC was unenforceable due to lack of consideration. Bookseller wants to know what can do to get payment?

Because the confirming bank is in fact the confirming bank, it is personally liable on the LOC. UCC §5-105.

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3. Bank misfiled a draft presented on a LOC and thus failed to respond to it. The beneficiary presented the draft on Jan. 5, 1998, and Bank did nothing until beneficiary wrote in early Feb. demanding payment. The LOC called for payment based on shipment of 100 cases of Llano Estado wine at a price of “around $140 per case.” The draft seeks payment of $120 per case. Is Bank required to pay on the LOC? “Around” in the UCP means within a 10% difference. But does the UCP apply? It does not apply be default; if LOC says UCP applies, then it does. 10% of $140 is $14.00. The difference here is greater than $14 and so does not comply.Bank has only 7 banking days to dishonor an LOC. Because this is one month later, can no longer point out discrepancies – lose the right to dishonor on that basis. If neither honor nor dishonor within 7 days, the result is automatic dishonor, but the bank is liable to pay damages for. So, the result is that the bank will pay the LOC because it wrongfully dishonored, whether or not the documents complied. Applicant will not be required to pay. Material fraud is a problem that can be raised outside the 7 day period.

4. Bank received an authenticated electronic mail message from PSB requesting Bank advise the beneficiary of the issuance of the LOC, and if willing, also serve as a confirming bank. Bank confirmed the LOC and had original delivered to beneficiary. Bank honored a draft on the LOC in the amount of $500,000. When Bank sought reimbursement from PSB, it learned that LOC should have been for $50,000, not $500,000. PSB made a typographical error. Bank notices that it received a written copy of correct LOC in the mail the day after Bank delivered the LOC to the beneficiary. Does PSB have to reimburse Bank for payment of LOC?According to the UCP, Bank is required to rely only on electronic message and not anything sent after. UCP §11(a)(1). UCC is similar to the UCP here. The LOC is the one sent electronically as long as it meets whatever security measures Bank has in place; the mailed LOC is considered a copy. The Bank must be reimbursed. This follows 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 LOC does not refer to the UCP.

5. Bank issues a LOC for Customer to pay for shipment of toys from TMC in Hong Kong. Customer is dissatisfied with the toys and wants Bank to reject the draft that has been presented to Bank under the LOC. TMC submitted draft with appropriate docs to the Bank of Hong Kong, who paid TMC and submitted the draft to Bank. Can Bank reject the draft b/c it was presented to her after the LOC expired and by a bank other than advising bank with which Bank had never done business? As long as the docs are presented before the expiration date, they are okay. Expiration is not measured from when issuing bank receives the documents and there is no time limit for the bank to ask for reimbursement. Expiration only deals with when beneficiary must ask for payment.Advising bank was Hang Seng Bank, but Hong Kong Bank paid. HS probably gave the LOC over to HK. Whether or not an LOC can be negotiated doesn’t matter. Look to see if LOC contains a restriction on who may perform. If says credit available at any bank, then HS could transfer it. But if it says only HS, then cannot give it to another bank. If it says “freely negotiable” or “performance by any bank”, then anyone can pay. This is relatively rare, because issuing bank likes to know who dealing with. If documents strictly comply with LOC, then Hong Kong Bank must be reimbursed. Funny that no rule that nominated persons get reimbursed but obviously they have to.

6. Bank and Customer established special procedures fro drafts submitted under LOC issued to customer’s regular suppliers. They agreed that Bank would provide same day service on drafts for less than $25,000 submitted on designated “Express Draft” LOCs. They also agreed that Bank would not be obligated to review any of the documents smutted with these drafts, and Bank agreed to reduce its normal processing fee by 50% on those drafts. A $20,000 draft was submitted on an “Express Draft” LOC. Following its normal practice, Bank honored draft within hours and without looking at underlying documents. Customer noticed that documents did not include the bill of lading called for by the LOC and found that the supplier did not in fact ship the goods but was insolvent. Customer refuses to reimburse Bank for the draft. Bank wants to know if it has a right to payment by Customer.The agreement was perfectly legitimate. Parties may vary their art. 5 duties and rights by agreement. Good faith and ordinary care cannot be waived, but if customer wants to do it this way, okay. Applicant is taking on risk but allowed to.

Assignment 14: Letters of Credit – Advanced Topics

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Error and Fraud in LOC Transactions Wrongful Honor §5-108 – issuer honors the draft despite the beneficiary’s failure to present the

required documents and lack of waiver. Issuing Bank has no right to recover funds from the applicant b/c improper use of funds and

strict compliance standard. Remedy for the issuing bank – Subrogation. §5-117(a) If 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. If the wrongful honor was proper payment, bank can usually get money.

Issuer responsible to the applicant for damages resulting from the breach – incidental, not consequential damages.

Wrongful Dishonor – issuer dishonors the draft even though documents presented were correct. Dishonor is only proper when docs don’t strictly comply, presented after expiration, or

material fraud. Beneficiary can sue for specific performance – incidental damages not consequential

(interest, attys fees). Beneficiary has no duty to mitigate damages. §5-111.

Fraud §5-109 – 2 kinds: Someone forges Beneficiary’s /s/ on the docs and bank pays applicant is still liable; almost never

occurs Beneficiary, who has not shipped goods, forges docs and says supplies were shipped.

The bank can honor any draft it wants that complies. Bank can only pay in GF (honesty in fact). Buyer then can sue the seller for fraud.

The bank can dishonor draft if forged or materially fraudulent. Material fraud is difficult test to meet (straw and camel dung). Buyer can try to enjoin the bank from paying when it knows of material fraud. Only time when independence principle does not have to apply. Bank must be very certain it is material fraud. If it is wrong, will be liable for wrongful

dishonor.

Assigning LOCs § 5-114 General rule – cannot assign a LOC unless LOC specifically allows it. Can assign the right to collect payment on the letter Right to perform is not assignable unless LOC expressly allows.

Problem Set 14

1. SNB failed to make timely response to a draft on a $12,000 LOC issued by FSB. The draft did not comply with the requirements of the LOC.a) FSB received a $12,000 deposit from the applicant at the time that FSB issued the LOC. If FSB is

forced to pay $12,000 to the beneficiary, can FSB keep the $12,000 to reimburse itself?The price term in the docs said that wine was worth $120 a case and LOC said “about $140 a case.” A/b allows for 10% difference.Under §5-108(a), you get reimbursed for a properly presented doc. Here, the docs don’t comply. The Bank cannot go to the applicant because did not honor the draft correctly. But, the Bank could get paid through subrogation to the rights of the seller. But how is subrogation going to help when buyer hasn’t accepted the shipment? Subrogation doesn’t help issuer unless beneficiary has performed and applicant has accepted performance. As long as applicant accepts the wine, Bank can be subrogated to the rights of the seller/beneficiary against the buyer and may keep the $12,000 deposit. Buyer may have a defense to payment by a breach of K b/c wrong wine sent. So, the buyer still may not have to pay.But Bank does not have to pay because may not be subrogated if applicant returns the wine. May dishonor and say prospective unjust enrichment.

b) Same facts, but FSB did not take a deposit from the applicant. Can FSB recover the $12,000 from the applicant?Same analysis except that bank will probably sue to get the $12,000 back. The basis of the suit will be the K b/c the bank subrogated to the seller’s rights. Bank will argue as seller, it did not get paid.

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2. Bank issued a LOC for $1 million to RFT. 10 days ago, Bank received a documentary draft on the LOC, which appeared to contain all the requisite docs. Bank did not process the draft timely and when it called applicant, the applicant told Bank that that LOC must be forged because she beneficiary said would be submitting a draft tomorrow. Must Bank honor the LOC? Would the answer change if the LOC was issued by a Bank branch outside the US?Although Bank has 7 days to dishonor the check and failure to do so is automatic wrongful dishonor, the only defense that may be properly asserted after the 7 day term is material fraud. Bank can always not pay and assert a forgery defense.If the LOC was issued outside the US, the UCP would apply because all branches of banks are separate and individual entities and the law of the issuer bank applies. The UCP does not contain this explicit exception as does the UCC in §5-108(b). So, this issue may be up in the air. But the Bank probably should not have to pay because thieves don’t sue in court to steal money.

3. Bank wants to know what its responsibility will be if it receives a presentation drawing on one of the LOCs that is totally forged and Bank doesn’t realize it and thus honors the LOC. Will bank be able to obtain reimbursement from its customer and is bank liable to honor a later legitimate draft?The Bank may have to pay 2 times. If the first was forged, then the obligation was not discharged and bank will have to pay again when properly presented. Forgery losses are most likely to be borne by the applicant. It only falls on the Bank if the bank knows that forged and then the Bank has no right to payment. Bank should seek reimbursement on the first forged draft – bank probably took a deposit and should hold on to it. It will be difficult to collect on the 2nd payment if have to pay 2 times.

4. On Friday, Customer receives a shipment that should have been 4 barrels of expensive indigo ink, but instead the barrels contained ordinary printer’s ink which has only ¼ the value of indigo ink. Customer obtained a $75,000 LOC to pay the shipper and Bank found all docs to be in order. The banker told Customer it would honor the LOC Monday morning. What do you advise?Does this rise to material fraud? If had said that sent empty boxes, clearly would. The real restriction on the bank is whether the payment is in good faith. Could make an argument in Customer’s behalf that would be bad faith for bank to pay. Bank would then argue that bank did according to applicant’s wishes on docs. It is unlikely that the bank can be forced to pay, even if told. This probably doesn’t arise to the level of material fraud. Remember, it is a very strict test. If it was material fraud, the bank could not pay it.Anything Customer could do to prevent bank from paying? Could get a court injunction. But because over the weekend, impossible to do this. Therefore, Customer must sue the ink co. for noncompliance with K.

5. Same facts as above, but assume the documentary draft and supporting docs were presented to the issuer by the Bank of Hong Kong and that nobody at that bank had any reason to doubt the legitimacy of those documents or the underlying transaction.Answer does not change because if nominated person has already paid and had no knowledge of fraud, then the issuer is obligated to reimburse the nominated and so on down the line to applicant. It’s important who banks chose as nominating bank, particularly if worried about fraud. This system really doesn’t take fraud seriously – the LOC is completely independent.

6. LOC issued to TMC as beneficiary. Bank received draft on the LOC by Hong Kong Toys and included all proper docs. It also included a piece of paper signed by Pres. Of TMC transferring the LOC and all rights under it to Hong Kong Toys.a) Is Bank obligated to honor the documentary draft? Should it?

Cannot assign the right to performance. The assignment is void. Hong Kong will have to sue to get its toys back.

b) Would the answer changed if Hong Kong Toys acquired the LOC due to a merger with TMC?If the transfer is incident to a merger, then it is essentially as if there has been no transfer. The LOC would be validly presented by Hong Kong Toys.

CHAPTER 4. THE BORROWER’S OBLIGATION

Assignment 15: Promissory Notes & Interest Rates

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Promissory Note, Generally Primary credit instrument in business and commercial transactions. Mortgage notes, student loans,

and business loans. Promissory note is an independent obligation, novation occurs with it (a K to pay money). Old

defenses may be lost.

Rates Maximum lawful rate – cannot be exceeded – need to put provision in note to make sure in the

document, otherwise have usury problems. Prime rate – average of prime rates of several industrial NY banks, determined by each institution,

and should be determined within the note. Banks generally base their prime rates on the lowest rate that give to biggest and best customers because so low risk. Might use LIBOR (London Interbank Office Rate) as the prime. Prime rate is affected by the Federal Funds rate.

Federal Funds rate – rate that the Fed. sets and charges to institutions for overnight loans. Changes to it affect other interest rates including prime rates.

Fixed interest rate – Specific set rate you have for the remainder of your obligation. Insurance companies like fixed rate obligations – steady income.

Variable interest rates – Interest set at a floating rate which is usually determined by using a prime rate plus some. Banks like to lend at variable rates, just in case rates rise, b/c they would lose money if they have to pay others more interest on money than they are making on their loans.

Benchmark rate + certain % (or basis points)- Benchmark will usually be the banks prime rate, LIBOR, or the Fed. Funds rate- 1 Basis point = .01% (100 BP = 1%).

Bank wants a variable interest rate b/c they think interest rates may rise in the near future, so they don’t want to be stuck with fixed interest rates.

Ins. Cos. may think rates are likely to fall later and they favor fixed interest rates.

Allocation of Payments Amortization – per month payment due on the note, combines interest and principal. Early in the

note most of the payment will be interest and less will be principal, later exactly the opposite occurs as your balance falls.

Some notes allow you to pay the whole amount early, but some will have prepayment penalties which help the bank make up for interest payments they should have gotten if you had fulfilled the whole note as expected.

Borrower in a fixed rate position may want to repay the entire balance if interest rates begin falling. Even with prepayment penalties they may save themselves money over the long run. Ex: 30 year note would save a good amount.

Choice of Law may be provided in the note to make things easier in case of litigation. Default – Most notes contain a long list of acts constituting default because there is no jurisprudential

definition of default. One event of default: borrower shall at al times maintain an EBITDA level – gross earnings

before a number of expenses, such as interest, taxes, depreciation, amortization of costs.

Interest Rate Swaps High risk investors bet that interest rates are going down. They buy a fixed interest rate and owe the

banks a variable rate.

Assignment 16 – Usury

Usury, Generally This is the excessive charge of interest – usually determined by the laws of a state. They penalize

lenders for screwing consumers. Usury is generally not applicable to:

Business loans Home Mortgage loans – they are federally exempted Credit cards issued by national banks – they incorporate in states with no usury provisions

so they can stick you good Usury does not apply to loan sharks/”pay day loans.” Usury controls the legitimate market only

(longer term loans).

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3 Usury Problems Variable rate notes may float above the maximum rate.

This problem is easily solved by making sure the promissory note has a provision which states that the rate charged shall never be in excess of the maximum lawful rate.

Large loans involve fees aside from interest. You 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 what will be interest for purposes of the note and cannot exceed maximum lawful rate. Usury may also apply to points, charges, and fees paid.

If loan pays off very early, may have paid more interest rather than little by little. If borrower pre-pays a note it may be usurious so make certain you have a provision which

says if this happens it was mistake and the excess will be refunded.

3 Reasons Usury Rarely Applies Statutes narrowly restrict their application.

La. permits a max. of 12%, except for banks and commercial loans. (So regulate pay day loans?)

Many states exempt common loans, such as pay day loans, from usury, but not banks as does La.

Federal law related to home loan financing preempts state law. Therefore, home mortgage notes are not subject to state usury limitations.

National Banking Act was interpreted to mean that any federally chartered bank can charge any rate that could charge in the state in which it is organized. This also applies to state chartered banks. If chartered in Delaware, where no usury restrictions, can transport that limitation to any state where do business. (Can distinguish federally chartered by “N.A.”

To establish a violation of usury law: Loan of money or forbearance of debt An agreement b/t parties that the principal shall be repayable absolutely. The exaction of a greater amount of interest or profit than is allowed by law Presence of an intention to evade the law at the inception of the transaction.

Bank’s Penalties Must refund all interest to borrower, return triple interest that taken, or give entire principal as a gift.

Problem Set 16

1. Bank uses fixed rate loans that vary between 9 and 14% and between $1 million and $8 million. Are these loans usurious?The bank is entitled to charge interest at a progressive rate. As a business loan, it can go up to the maximum lawful rate. In La., which exempts bank loans, there is no maximum.

2. Bank has offered a variable interest rate at prime plus 1.5% for Client’s medical clinic. Prime is currently 7%. The loans calls for the lesser of (a) the Max rate, or (b) 1½ % above the prime rate.a) What the maximum lawful rate would be if the auction rate for 26 week Treasury bills rose to 8%,

11%, 13%, and 15%?T-Bills are auctioned weekly to allow individual investors to buy. The auction rate is the amount of interest that buyers demand. Must multiply the auction rate by 2 and round to the nearest quarter percent. ? Get notes from Curt.

b) Assuming auction rates stays at 5% below Prime Rate, at what rate would interest accrue? Could client contest that rate as usurious?Then prime rate would be 13,16,18, and 20%. The rates would thus be 14.5, 17.5, 19.5, and 21.5%. None of these would be usurious. Maximum rate is so high that this is unlikely to exceed.

c) If the interest would not be usurious, can you think of any other way that client could sign the Promissory Note and still be in a position to avoid any legal obligation to pay interest at that high rate? Would bankruptcy help?Not likely to escape individual liability here. To the extent that he cannot pay the obligation, bankruptcy will help, but all other assets will be liable to what owes.

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3. Bank is designing a new loan product for potential small business borrowers. Borrower makes an up-front interest payment of 2% of the loan at the time of the application. If the application is rejected, the money is refunded. If the loan closes, the 2% is applied against interest accruing during the first 2 months of the loan. If the bank accepts the application, but the customer fails to close the loan or repay it, the Bank retains the 2% fee. Is there a problem with this arrangement?There is no problem in the money being refunded. If the loan closes, that is fine too assuming that the loan is not paid off immediately. If it doesn’t close, its not interest but a fee. Courts will probably still consider it interest. Advise client to make it a fee because if call interest is subject to usury.

4. A note just like that in problem 2 but borrower asks Bank to remove warranty of commercial use language because borrower is not sure want he wants to do with the money. What’s wrong with the borrower’s request?Bank should keep the language b/c it makes a difference what the funds are used for to apply the maximum interest rate. The rate differs if it is a consumer loan or business loan.

Assignment 17: Late Payment & Prepayment

If borrower pays late, the lender has 3 responses:1. Accelerate the payment term of the note UCC §1-203

Entire balance is due immediately on demand Rare for lender b/c they want to get the interest payments The only restriction on acceleration: GF

2. Default rate of interest Substantially higher rate of interest which accrues not to the entire principal, but only on

outstanding balance.3. Late Fees

Punitive – to punish you and scare you into paying Non-Punitive – Bank incurs administrative costs when you pay late You are essentially paying the bank for foregone interest due to your holding its money.

Otherwise, you would have an interest free mini-loan. Courts sometimes don’t buy the administrative costs argument of lenders. Late Fees are not enforceable if:

The late fees look like liquidated damages. (Courts are not likely to see as such in commercial situations b/c supposedly sophisticated borrower).

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- Some states have no restrictions in order to attract business (NY)

Prepayment Lenders are generally happy to get prepayment from consumers because they are relative high risk.

From businesses though, banks may not want to get prepayments because view 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.

Carlyle Apartments v. AIG- P sued in state court and D removed to Fed. under diversity. State law applied. Even though Fed.

courts are located, they have no power to determine what state law is. Fed. cts. Can only speculate and must look to state courts and legislature. Federal courts cannot say what state law should be.

How the Lender Protects ItselfThe note includes a provision for a prepayment penalty called “yield maintenance payment”

This allows prepayment but requires the borrower to pay a fee equal to what the bank would have been paid reduced by what it can gain in a low risk investment

Look at T-bill rates or something to determine what the bank can now 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 win

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Problem Set 17

1. Client is liable on the text’s exemplar promissory note with a monthly payment of $20,000. How much would it cost him to stop making payments on the note for a while. Assume that the maximum lawful rate applicable to the promissory not is 18% per annum.a) What could the lender do if client stopped paying for 3 months? Could he cure the default by making

3 late payments? If do not payments or communicate with 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. If doesn’t accelerate would have to sue for each payment. Could cure by paying late fees, but if accelerates, in trouble.

b) The note includes a fixed late charge of 4%. Interest accrues under the note at 10% per year. Does that mean he actually saves money if he can hold out on making a late payment for more than 4/10 of a year? Assuming the lender never accelerates, what would client owe if he managed to defer making any single payment for 6 mos.?He would owe a total payment of _______. Overdue principal of $20,000 + 10% interest. Also has to pay default interest of 18% on the amount that is overdue as well as a 4% late fee.

2. Client’s promissory note includes standard provisions except that this one allows partial prepayments and does note require any prepayment fee for prepayments made less than 5 years before maturity of the note. Client made a total of 4 payments on his regular payment date last month (3 prepayments). Client was not assessed a prepayment fee because note is due in 4 years. But client didn’t make a payment for this month and plans to skip the 2 months as well. He was surprised to find himself in default.a) What is the basis for the lender’s complaint? Is the lender correct?

Prepayments are applied to the last payments would have to make. So, client must still make regular payments.

b) If the lender is correct, what benefit will Bill get from making the prepayments?Client will pay less interest because paid off extra on outstanding amount.

3. Bank is concerned that prepayment fees imposed on promissory note are invalidated as unlawful penalties. Does it matter whether Bank uses a fixed % prepayment fee rather than a yield-maintenance prepayment fee? Don’t worry about usury.Fixed % Fee - Under historical theory, a K cannot provide for a penalty – if it looks like liquidated damages. This theory has fallen by the wayside. In a consumer transaction, may run into it, but not likely in a commercial transaction.Yield-maintenance – less likely bank would get a windfall. Also, bank covers the loss if the payments are loss via yield maintenance. Yield may be the best because the fixed may not be enforceable and will make no money.

4. Customer called bank wanting to renegotiate the interest rate to 7%. Interest rates had fallen in the 5 years since customer signed the note. Customer threatened to prepay the note and take her business elsewhere if Bank did not agree. Bank thinks note barred prepayment. The market rate for a similar note is only 7%. What are customer’s rights under the note? Is there anything Bank can put in notes to avoid similar problems in the future?If customer prepays, she will pay 5% of outstanding balance as a penalty. Is it a good idea to prepay? She would save 3% over 15 years – 45%. 45% - 5% = 40% savings. If prepays would come out ahead. The bank could have saved by using yield maintenance.

CHAPTER 5: CREDIT ENHANCEMENT

Assignment 18: Credit Enhancement by Guaranty

Guaranty/Suretyship, Generally Suretyship is governed by state law If concerned about borrower’s ability to pay, lender can require a personal guaranty that would allow

lender to recover from guarantor if borrower cannot pay. This allows lender to recover but also acts an incentive to make shareholders pay off business loans.

Guarantor has no defenses, the bank can sue them directly, immediately after default

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2 types “Of collection” – bank is forced to exhaust all remedies before pursuing the guaranty “Of payment” – normal one after default by borrower set according to the agreement, bank can

proceed to get money from Guaranty.

Problem Set 18

1. Client is the guarantor of a large loan from Bank to MMC. MMC has just closed its doors after litigation with Bank and has no assets to pay Bank or any other creditor. Bank spent $400,000 in legal fees pursuing MMC. Client thinks Bank cannot collect those legal fees from him under the guaranty §13 of the Text Guaranty (Guarantor agrees to pay reasonable atty’s fees and all other costs and expenses incurred by Lender in enforcing this guaranty or in any action or proceeding arising out of, or relating to, this guaranty, including but not limited to bankruptcy proceedings).Client is wrong. “Arising out of” and “related to” are broad and include an action to go after debt. Under § 2 of sample guaranty agreement, indebtedness is defined to include costs, expenses, and atty’s fees. The expansive language encompasses any expense the creditor incurs to get its money back.

2. CFB issued $20 million to Jaffe Inc., a business operated by Jaffe and Eckert. Jaffe runs the day to day affairs and Eckert provided the capital. CFB took a continuing guaranty from Eckert. Jaffe ran out of the country after getting caught for embezzling. Eckert wrote bank saying that terminated the continuing guaranty and abjure any further liability. CFB has $2 million still outstanding on the loan with 13% interest. CFB also issued LOCs backing up $10 million of short-term commercial paper that Jaffe, Inc. issued 2 months ago. The LOCs mature next week. Bank doesn’t think Jaffe Inc. can make either payment. Bank wants to know if the notice by Eckert limits the bank’s ability to pursue Eckert for the commercial paper or accruing interest.Indebtedness is principle and any interest on that principal. Although gave notice of termination of guaranty, he still has to pay the interest on the principal that he guaranteed because is indebtedness. Is the LOC future indebtedness or indebtedness? The LOC is current indebtedness because of its contingent definition: “I might owe you, and you might owe me.”

3. Client has business called OWH in which client is sole shareholder. Client has guaranteed OWH’s 1.2 million line of credit with Bank. OWH’s net monthly income has decreased from $20,000 to only $2,000. Now OWH owes bank entire 1.2 million. OWH has only $10,000 on hand and its current obligations include a $10,000 monthly payment due to Bank and $8,000 in overdue bills from suppliers. Client doesn’t mind if loses business as long as he can keep the rest of his assets. What should he do?A 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.What if he filed for bankruptcy? Then, the primary obligation is discharged, but can still come after him. Guaranty survives bankruptcy. One way to avoid this is to declare bankruptcy himself, but he has too many other assets to make that worthwhile.He should go the bank and try to work something out. Bank may agree to reduce monthly payments. If cannot pay suppliers, business will fail and won’t be able to pay off the rest of the loan. Bank doesn’t want that and often agree to restructure loans in order to avoid dealing with bankruptcy. This is often very successful.

4. Bank read that one of his borrowers, MP, was hit with major tort judgment. Bank knows that MP cannot pay it and is worried about the bank’s $250,000 loan to MP for which bank has no collateral but does have a personal guarantor who is the owner/operator of MP. Bank believes that tort judgment is default because it constitutes a “material adverse change” in MP’s financial situation. Bank should not worry about being paid. As tortfeasor, only the corp. is liable; the tort victim cannot go after owner of corp. But because the owner is a guarantor, the bank can. If MP in default, then Bank can sue the guarantor or the primary obligor at its discretion. It will not matter if corp. goes into bankruptcy; bankruptcy has no effect on guaranty. The Bank’s position is very secure.

5. Bank lends to a chain store that specializes in bright red clothing. Business has been operated as a sole proprietorship owned by Venn. Because Venn is very wealthy, Bank has considered the relationship a safe one though unsecured. Venn found out that EPA listed his red dye as toxic. Venn believes it is safe, but decides to incorporate in case of env’tal liability. Venn would like to transfer the loan to the new entity and is willing to issue a guaranty of the loan himself. Bank wants to know what to do.A win/win situation for the bank. As a corp. and with Venn as guarantor, Bank could still go after Venn’s personal assets as it could when business was a sole proprietorship. If the corp. is sued by the EPA,

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Bank is in an even better position because EPA could only go after corp. and not Venn, whereas when a sole proprietorship, EPA could have gone after Venn. Guaranty gives nonconsensual guarantors the shaft – it is good for lenders.

Assignment 19: Protections for Guarantors

Rights of the Surety/Guarantor against the Borrower/Principal Obligor : 1. Performance – If refuses to pay, can sue and force the borrower to pay the creditor. Pretty

worthless.2. Reimbursement – if surety is forced to pay lender, he can then go after the borrower for

reimbursement. CC 3047 and 30493. Subrogation – Guarantor is subrogated to the rights that the lender has against the principal

borrower after they pay off the debt. May include some kind of collateral that has been pledged and can now be seized, or a lien on some property that can be foreclosed.

Defenses that may be asserted by surety against the creditor 1. Impairment of Collateral – If 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. Ex: Maybe the lender didn’t secure procedurally an interest in the collateral so that a lien or

privilege is not able to be executed, or another creditor is now first in line b/c of a mistake.2. Material modification of underlying obligation without surety’s knowledge – If the creditor grants an

extension that increases the debt b/c interest piles up, or b/c the assets of borrower b/c depleted. Surety may assert this and it could reduce the amount they owe to lender to the extent that

affected by change. (A non-commercial surety is wholly discharged). In La., 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 extinction of the principle obligation, extinguishes the suretyship altogether.

3. Creditor releases the borrower – In La., if creditor releases the borrower the surety is released as well. In common law, subrogation to creditor’s rights b/c of subrogation protects the surety from release. They can then proceed against borrower.

In La. and other states, there may be suretyship waivers.

Suretyship defenses in context of Article 3 Anomalous indorser is a guarantor. Such an indorser has suretyship defenses under 3-605. La. has

not adopted this article, but it isn’t necessary due to suretyship articles.

Waiver of Defenses Suretyship defenses can be waived by guarantor. This is relatively common. Art. 3040 – surety can agree to modify its rights Bank wants guarantor to waive rights because of the way bankruptcy law used to be but isn’t

anymore. It doesn’t make any sense that bank wants guarantor to waive rights against the obligor.

Problem Set 19

1. Client sold co. to a new investor, Compo. Compo called client to tell him that he would not make loan payment due to Bank. Client is the guaranty under that loan. Client thinks best course is to pay off loans with his personal assets and try to save the business. Will that plan work?Client waived right of subrogation and reimbursement. But 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. But can he effectively do that since he sold the co.? Now, Compo is the only one who can sell the assets. When negotiating deal with Compo, should have negotiated a security interest in assets.

2. Bank is negotiating with a guarantor. Guarantor wants provision stating that has no right of subrogation and waives any right to enforce any remedy Lender has against borrower to be removed from agreement and replaced with the following, “Guarantors shall be entitled to rights of reimbursement and subrogation, but only to the extent of payments actually made to Lender under this Guaranty.” Bank wants to know what to do.

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Subrogation rights may only be used for full payment and this language goes against that rule. So, the bank may not like this. Include language that have right to subrogation, but provided there is full payment.

3. Venn’s business, which earlier, has been sued by EPA for $75 million. Bank is concerned and has decided to release the borrower for 75% of the amount of its loan to the business. Can it cut that deal with the borrower and then turn around and sue the guarantor for the remaining 25%?Law avoids any possibility of putting us in this dilemma. In La., cannot go after guarantor if agree to release obligor. If outside La., 3-605 applies and creditors can still go after guarantor for difference.

4. In future cases, can Bank proceed with a reverse structure in which bank would make the loan directly to the entrepreneur and take a guaranty from the operating company? How does this approach change the credit risks and legal risks?It is more difficult to monitor the financial activity of an individual rather than a business because business has financial records that can refer to. Depending on the amount of the loan, this is probably important to Bank. But it really doesn’t matter – they are both on the line. There is no real difference between a guarantor of payment and obligor if guarantor waives rights.

5. Client and former H owned a business for which H obtained a loan that client guaranteed. In the divorce, the business was assigned to H, along with responsibility for the loan. Client received notice form Bank that it agreed to modify the loan according to H’s request to increase the interest rate from 8% to a floating rate of prime plus 3%. (Prime is currently 7.5%). In return, the bank agreed to forgo taking action in response to H’s failure to make a number of past-due payments that total $32,000. The bank seeks Client’s consent and a reaffirmation of her guaranty. The bank will pursue its remedies against Client if she does not agree.If she consents, there is no defense to payment because clearly a modification. Then, if the bank were to go forward, she could be on the hook for pre-modification only. If noncommercial, then off the hook entirely. So, she is still liable for difference.If she doesn’t consent, the bank will foreclose against H. Then, if H cannot pay, she will be liable. A significant downside.Has 2 options: Re-negotiation – bank may be willing to release part of the guaranty and that might be a better option to refusing altogether. OR File for bankruptcy – could limit bank’s potential claim. (But she may not be a candidate for bankruptcy).

Assignment 20: Third Party Credit Enhancement – Standby LOC

Standby LOC If commercial borrower cannot find a guarantor to enhance his credit worthiness and he has no other

security interest, he can get a bank to guaranty repayment of loan to a different bank. Historically this was illegal. Same LOC rules apply as earlier discussed – including independence principle. Ex: Tabasco wants to ship to Peru and needs financing for that. Wants to take out a loan but no

local bank has enough lending capacity. Chase Manhattan will want a co-signer and not one from an individual. Can go to New Iberia Bank and ask them to co-sign. If do, will issue a standby LOC to Chase Manhattan as beneficiary. That LOC says if Tabasco defaults under the credit agreement, upon presentation of affidavit by Chase Manhattan attesting to default, New Iberia Bank agrees to pay the loan. It is essentially a guaranty but in the form of an LOC.

Clean Standby LOC – doesn’t require document at all for payment. Only need beneficiary to show up and demand. This is very rare.

Normally, LOCs are payment devices and are paid. Standby LOCs are credit enhancements and rarely get paid.

Bank guarantors do not have suretyship defenses of art. 5. But does have right against obligor of reimbursement and subrogation.

Problem Set 20

1. Bookseller is considering agreement with supplier that requires bookseller to maintain a clean standby LOC from a bank that is satisfactory to seller. Bank wants possession of a CD from bookseller. Bookseller wants to know if okay.Bank is asking for CD as collateral and this is perfectly okay. Bookseller should just do it – the risk is there but not likely that standby LOC is called.

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5. Bank issued a standby LOC for the benefit of Bank2. The LOC was to back up obligation of Lydgate to repay loan for construction. But Bank did not take collateral to reimburse it if forced to pay on LOC. Bank2 took a lien on the building to secure obligation to repay. Lydgate’s financial affairs have collapsed, and he cannot pay. Bank2 presented a draft on the LOC to Bank who then issued Bank2 a check for the full amount of the loan. Bank seeks reimbursement from Lydgate. It assumed it would be subrogated to Bank2’s lien. A state statute however requires mortgage creditors to release liens whenever they receive full payment of their loans. Hence, Bank 2 released the lien the day after it received payment from Bank.a) Has Bank lost its right to use the lien to pursue Lydgate?

If done according to state law, then cannot subrogate that right. Bank has lost the right to use the lien.

b) What is Bank had acted as a guarantor instead of issuing a LOC? Assume that the guaranty included a defeasance provision.Could not argue that Bank2 impaired collateral because a surety defense and cannot use under LOC. There is very little practical difference between guaranty and LOC - just the actor and the surety defenses. Has only a right of reimbursement.

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Mini Bar Review

1. These are presentment warranties. (1) entitled to enforce (proper indorsements), (2) no alteration, and (3) authorized signatures.

2. (1) a holder, (2) take for value, (3) good faith, (4) no notice of defenses or claims that overdue or dishonored, or in principal payment default, unauthorized signature, another claim, that maker has a defense.

3. Three are no defense to payment except 4 real defenses. Fraud in factum, discharge in factum, infancy, and illegality. In La., lack of capacity and duress are not real defenses. “Real” defenses are those absolutely null. If void, a real defense.

4. Definition: transfer an instrument to another to make them a holder, or allow them to enforce rights on the instrument. Bearer paper – simple transfer of possession; order paper requires indorsement and transfer of possession.

5. Blank indorsement – sign name that allSpecial indorsement – “Pay to someone else” signed John DoeBlank indorsement makes the instrument bearer paper. Anyone with possession is holder.Special indorsement makes it order paper – only indorsee can be holder.

6. Guarantee of Collection – can only go after guarantor when principal obligor in default. Must go after obligor first and requires judgment or declaration of insolvency – some form of proofOf Payment – can go after guarantor without looking to obligorPresumption is in bank’s favor – if just say guarantee, then a guarantee of payment.

7. Must be dishonored and must have proper notice of dishonored. A note is dishonored automatically if not paid within a day of presentment. Unlike a check which is not honored if dishonored. Notice must be within 30 days of dishonor.

8. Unconditional written promise or order to pay money at a fixed amount payable to bearer or order upon demand or at a definite time with no extraneous undertakings.

9. I, John Jones, promise to pay to the order of Sam Smith $100 on Sept. 15, 2001. Make sure put in magic words – “to the order of” or “to Sam Smith or order.” And make sure say “promise.”

10. No, b/c Betty is Ann’s agent. As long as signature is authorized, then okay. Forgery is unauthorized – without actual, apparent, or implied authority under agency law. If given permission to sign, then authorized. Authority to do so does not need to be in writing – express oral or written is fine.

11. ?12. Either may negotiate check because in alternative. Whoever negotiates it could enforce it. If said “and”

then both must sign to negotiate, but “or” makes it alternative.13A – extraneous undertaking. Either way non-negotiable.B – can have alternative payeesC – Non-negotiable. Upon death is putting a condition otherwise wen die still payable from estate. Must be unconditional.D – Non-Negotiable. Can make reference to another document but cannot be governed by another document. “in accordance with” could mean that governed by or subject to another agreement. Can come to own conclusion about what means – may need more testimony to determine. If need testimony, infers that non-negotiable. E – Acceleration clause does not affect definite date requirement. An exception to the definite time requirement. Still negotiable even though time is not so definite.F – Still negotiable. As long as note clear that recovery is restricted to particular fund, okay. Another exception to conditional requirement.G – Non-negotiable. No definite time.H – if undated, still payable at a definite time – payable on demand. But here says 1 year after date, but leaves out date, so not payable on demand. It is payable at a definite time – only requires that can be determined – even if do by parol evidence. Can show when signed note. 14. On first check, Al still liable because Bob authorized under agency law. But on 300 and 1000, Al was negligent in giving Bob the checkbook and may have failed to exercise ordinary care. Bank statement review principle – have 2 statement periods to notice fraudulent activity. Then later fraud, by same wrongdoer is on you. First fraud is not on you until one year has passed. This rule does not preclude him yet – only precluded from future but not 1st 2. If a year passes, then liable for all forgeries in that year. 1000 a forgery the 300 may have been under apparent authority. May be an unauthorized alteration – did without authority. Its an unauthorized alteration. Al can assert against bank, but failed to exercise ordinary care.

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