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Payment Systems
South Texas College of Law Houston
East, W. David

Payment Systems—Prof. David East—Fall 2012
 
Chapter 1: What is a Negotiable Instrument
 
·         What is a Negotiable Instrument?
o   A negotiable instrument is a cross between a contract and money
o   Primary Difference from ordinary K right: An assignee of an ordinary K right takes subject to all defenses to which his assignor took subject
§  A HIDC of a negotiable instrument takes instrument free from virtually all defenses [1] o   Other Differences: Simpler to plead and prove case on a negotiable instrument [2] ·         Governing Law
o   UCC—Basic law governing negotiable instruments is contained in Articles 3 and 4 of UCC.  In 2002, ALI and National Conference of Commissioners on Uniform State Laws proposed several amendments to Articles 3 &4.  However, until enacted by particular state, these amendments will not be law in that state [2] §  Coverage of Article 3: Governs writings meeting requirements of UCC [§3-104(a)] ·         UCC §3-102 specifically excludes from scope of Article 3 the following writings that otherwise may qualify as negotiable instruments: (1) Investment securities governed by Article 8, (2) money, and (3) Payment orders governed by Article 4A [§3-102(a)] [2] §  Coverage of Article 4: Governs bank collection process
·         Limited to Items
·         Any promise or order to pay money handled by a bank for collection or payment is an item whether or not promise or order would qualify as negotiable instrument under Article 3 [§4-104(a)(9)] ·         “Item” does not include payment orders governed by Article 4A or debit and credit card slips [2] §  Article 4 prevails over Article 3: When results reached under an applicable provision of Article 4 conflict with results of Article 3, Article 4 controls
·         Types of Negotiable Instruments
o   Article 3 NI are classified into 2 categories: Notes and Drafts [3-6] §  Notes—Promise by one party (maker) to pay to anther party (payee) a sum of money; usual purpose of note is to evidence debt; note thus primarily serve a credit rather than payment function  [3] §  COD’s—Note issued by bank; defined as “an acknowledgement by bank of receipt of money together with engagement by bank to repay money [3-104(j)]; COD’s are means by which banks raise money and depositors assure themselves of a good return on their money [3-4] §  Drafts—Sometimes known as bill of exchange, is 3-party instrument by which Drawer (person who typically signs draft in lower right corner) orders Drawee (person named in draft to whom order is directed) to pay payee; usually payment instruments by which Drawer makes payment to payee [4] §  Checks—Drafts drawn on Banks (either Drawee Bank or Payor Bank) and payable on demand; because all checks are drafts, unless Code specifically provides otherwise, checks are governed by same rules that govern drafts [4] [3-104(f)] §  Bank Checks Including Cashier’s, Teller’s, and Certified Checks—Bank checks treated differently than ordinary checks for several purposes including: (1) ability of issuing bank to refuse payment; (2) the loss or destruction of bank check; (3) the effect of taking bank check on underlying obligation; and (4) the SOL on bringing action against issuing bank [4] §  Traveler’s Check—To be such, check must require, as condition to payment, a counter signature by person whose specimen signature appears on instrument [3-104(i)]; HIDC does not take subject to risk that traveler’s check was stolen and countersignature forged [3-106, official comment 2] [4-5] §  Personal Money Order—Draft sold by Drawee to person who typically does not have account with drawee; it is, in effect, a single-transaction checking account; if Drawee is bank, personal money order is check; if non-bank, personal money order is draft; drawee bank not liable on personal money order because bank has not signed order [5] §  Time Drafts—Draft payable at definite time [5] §  Sight Drafts—Draft payable on demand [5] §  Documentary Draft—Draft, whether payable at definite time or demand, which is accompanied by letter containing instructions that draft is not to be paid unless holder presents to drawee certain designated documents [5] §  Banker’s Acceptance—Draft drawn on and accepted by bank; by accepted, bank becomes liable to pay draft [3-413(a)] [5] §  Trade Acceptances—Draft drawn on and accepted by person other than bank [5] §  Payable Through Items—Bank through which item is payable, having no right to pay item, is collecting bank and not payor bank [4-106(a), comment 1] §  Payable at Items—Article 4 provides 2 alternative provisions that a state may adopt as to manner in which instruments payable at bank are to be treated; 1st treats “payable at” item as check [4-106(b), Alt. A]; 2nd payable at item treated as though it is “payable through” designated bank [4-106(b), Alt. B] [5-6] §  Remotely Created Consumer Item—Item drawn on consumer account, which is not created by payor bank and does not bear handwritten signature purporting to be signature of drawer [Rev. 3-103(a)(16)] [6] ·         Requirements for Negotiability
o   Only writing complying with 3-104(a) requirements = NI under Article 3 [3-104, Official Comment 1]; Negotiability determined solely by reference to 4 corners of instrument; separate agreement cannot affect negotiability of instrument [6-7] o   1.) Signed Writing—As long as signer intends for it to be her signature, she may use any name, word, or mark as signature including fictitious name, trade name, or signer’s first name; may be in form of printing, handwriting, typing, or even imprinting of thumbprint [1-201, official comment 39; 3-401(b); 3-401, Official comment 2] [7] o   2.) Unconditional Promise or Order—Promise or order that is expressly conditioned upon happening of specified event is not unconditional; promise or order is regarded as unconditional if promise or order is subject only to implied or constructive condition [3-106(a), comment 1]; promise or order not unconditional if it states that promise or order is subject to, or governed by, another writing or if rights of parties are stated in another writing [3-106(a)(ii & iii)]; instrument that merely refers to existence of another writing may be negotiable [3-106(a)]; instrument may retain negotiability while referring to another writing for rights as to collateral, acceleration, or prepayment [3-106(b)(i)] [8-9] o   3.) Principal Sum Must Be Payable in Fixed Amount of Money—Instrument no payable in fixed amount if terms used in instrument express sum payable or any component thereof are ambiguous or if reference must be made to outside source or writing to determine principal amount; instrument and other charges do not have to be payable in fixed amount [3-112, comment 1]; virtually any type of provision for payment of interest is permissible; instrument may state obligation to pay interest as fixed or variable amount of money or as fixed or variable rate or rates; amount or rate of interest may be stated or described in instrument in any manner and may require reference to information not contained in instrument [3-112(b), comment 1]; provisions for attorneys’ fees and costs incurred in collection of instrument are permissible “other charges” even though they do not specify a particular sum; provisions for prepayment penalties, late payment penalties, or other penalties, discounts, or rebates are also permissible “other charges”; duty to pay taxes or to pay to insure collateral are probably not permissible other charges and therefore their inclusion will defeat an instrument’s negotiability; an instrument is not negotiable unless it is payable in money [3-104(a)] [9-11] o   4.) Must be Payable to Bearer or Order—An instrument that is payable to bearer may take one of several forms: (a) state that it is payable “to bearer”; (b) use language indicating that person in possession of it is entitled to payment, e.g., to “holder,” to “cash,” or to the “order of cash”; or (c) does not name a payee, e.g., “pay to order of ________” [3-109(a)]; Instrument is payable to order if it is payable to the “order of [an identified person]” or to an “[identified person] or order” [3-109(b), comment 2]; instruments containing following designations are payable to bearer: (a) “bearer or order,” (b) “order of bearer,” (c) “John Doe or bearer,” or (d) “order of cash” [3-109(a), comment 2]; however, check that meets all requirements of 3-104(a), except for not being made payable to “order” or “bearer,” is negotiable instrument governed by Article 3 [3-104(c)] [11-12] o   5.) Must be Payable On Demand or At a Definite Time—Promise or order payable on demand if it states that it is (a) payable on demand, on presentation, or at sight; (b) otherwise indicates that it is payable at will of holder; or (c) fails to state when payment is due [3-108(a)]; Instrument otherwise payable on demand remains payable on demand even if it is postdated or antedated [3-113(a)]; promise or order payable at definite time if it is payable (a) at fixed date; (b) a definite period after stated date, or; (c) on “elapse of definite period of time after sight or acceptance [3-108(b)]; Instrument payable at definite time as long as date is readily ascertainable at time promise or order is issued even if date is not specified in instrument; a note or draft payable a fixed period “after date” that does not state date is incomplete instrument; once note or draft is completed by addition of date, instrument becomes payable at definite time; instrument that is otherwise payable at definite time remains so even if time of payment is subject to acceleration; any type of acceleration clause is permissible [3-108(b)(ii)]; Instrument that is subject to prepayment by obligor remains payable at definite

n connected with issuer [3-110(b)] §  Two or More Payees—An instrument payable to two or more persons is payable to them either jointly or in the alternative
·         Jointly—If an instrument is payable jointly, all payee must participate in any negotiation, discharge, or enforcement of instrument [3-110(d), comment 4] ·         Alternative—An instrument in alternative may be negotiated, discharged or enforced by any payee who is in possession of instrument [3-110(d), comment 4]; instruments payable “to P or R,” “to P and R in the alternative,” or “to P/R” (“/” means either/or) are payable to P or R in the alternative
·         Ambiguous—When it is unclear whether instrument is payable alternatively or jointly, e.g., “to P and/or R,” instrument is deemed payable in the alternative [3-110(d)] o   Depositary Bank’s Status as Holder—If customer delivers an item to DB for collection, whether or not customer indorses item, DB becomes holder of item at time it receives the item if the customer, at time of delivery, was holder of item [4-205(1), comment] ·         Value—An instrument is issued or transferred for value when it is taken for the following:
o   Promise of Performance—Instrument is issued or transferred for a promise of performance, to extent promise has been performed; any promise that would constitute consideration under K law constitutes “promise of performance” under Article 3 [3-303(a)(1)]; when holder has only partially performed agreed-on consideration, holder has rights of HIDC to extent of fraction of amount payable under instrument equal to value of partial performance divided by value of promised performance [3-302(d)] o   Security Interest or Lien—A holder takes for value to extent that she acquires SI in, or other lien on, instrument other than lien obtained by judicial proceeding
§  SI in Instrument—Holder may acquire a SI in, or a lien on, an instrument in 2 ways: Voluntary transfer by debtor, usually an Article 9 SI [3-303(a)(2), Comment 3]; or a SI that collecting bank automatically acquires under 4-210(a); A collecting bank acquires a SI in an item and any accompanying documents or proceeds of either item or documents; collecting bank acquires SI only to extent that bank allows customer to use funds; a collecting bank also acquires a SI when it applies item in part or in full in payment of debt owed to it by its customer [4-210(a)(1)]; If credit given for item is available for withdrawal as matter of right, collecting bank has SI in item whether or not credit drawn on or there is right of charge back [4-210(a)(2)]; When bank makes advance against item, SI arises whether or not item is deposited into customer’s account [4-210(a)]; when credits given for several items deposited at one time, or pursuant to single agreement, are withdrawn or applied in part, bank’s SI applies to all items [4-210(b)]; Credits first given are deemed to be first drawn on [4-210(b)]; Thus, when items are not deposited simultaneously, the SI attaches to the items in order in which they were deposited
§  Lien on Instrument—A person who has a lien on an instrument by operation of law takes the instrument for value; most typical type of lien is a CL or statutory banker’s lien [3-303(a)(2), comment 3]; In contrast, a lien acquired by judicial process, e.g., attachment, garnishment, or execution, does not constitute value [3-303(a)(2), comment 3] §  Value only to extent of amount owed—A lienholder or SP takes instrument for value only to extent of amount owed on underlying debt [3-302(e)] o   For Antecedent Claim—Instrument is issued or transferred as payment of, or as security for, an antecedent claim against any person, whether or not claim is due
o   NI or Irrevocable Commitment—An instrument is taken for value if it is issued or transferred in exchange for NI or for incurring of an irrevocable commitment to a 3P by person taking instrument [3-303(a)]