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Payment Systems
South Texas College of Law Houston
Hague, David R.

Payment Systems
Fall 2014 – Professor Hague
Part I – Building Blocks
Types of Negotiable Instruments
Two basic types of negotiable instruments, § 3-104(a)
–          Promise = note = two-party transaction where maker promises payee payment, §§ 3-104(e), 3-103(a)(7)
–          Order = draft = instruction to have another party pay on your behalf: drawer orders drawee to pay payee
o    Check = a draft payable on demand and drawn on a bank, § 2-104(f)
Promissory notes
–          If it’s a promissory note, it’s either a—
o    Regular note, or
o    Certificate of deposit (CD)
Order drafts
–          If it’s an order draft, it’s a check; the check is either a—
o    Regular check
o    Cashier’s check
o    Teller’s check, or
o    Certified check
Elements of Negotiability: Definition of Negotiable Instrument
Concept of negotiability
–          The Derivative Title Doctrine, § 2-403(1) – a purchaser of goods acquires all title which his transferor had or had power to transfer
o    A transferee of goods gets title only as good as his transferor had
o    This does NOT apply to money because it would interfere with commerce; since we want negotiable instruments to function like money, this doctrine cannot apply to negotiable instruments either
–          The negotiability concept – a commodity is negotiable if and to the extent that a transferee can obtain title superior to that of his transferor
Elements of a negotiable instrument, § 3-104(a)
1.                   Writing
2.                   Signed by maker or drawer
a.       “Signed” includes using a symbol executed or adopted with present intention to adopt or accept a writing
3.                   Contains unconditional promise or order
a.       Cannot contain an express condition to payment, but can expressly recite an implied condition
                                                              i.      Non-negotiable: “I promise to pay $50k to the order of X if he conveys title to Y.”
1.       Non-negotiable because contains an express condition to payment
2.       Look for words like if, unless, subject to, governed by, or void after
                                                            ii.      Negotiable: “In consideration of his promise to convey Y to me, I promise to pay $50k to the order of X.”
1.       Negotiable because the promise to convey title is an implied condition of the maker’s promise to pay, and the note expressly recites that implied condition. But the note does not make the performance of the promise an express condition of the promise to pay.
2.       Notes:
a.       Referral in the instrument to a separate document (i.e., “per the settlement agreement”) doesn’t destroy negotiability
b.       Inclusion in the instrument of a security agreement doesn’t destroy negotiability, § 3-106(b)
4.                   To pay a fixed amount of money, with or without interest
a.       “Fixed amount”
                                                              i.      If there’s any question as to whether it’s a fixed amount of money, it’s non-negotiable
                                                            ii.      Interest rate may fluctuate as long as the initial fixed amount does not, § 3-112(b)
1.       If the amount of interest payable can’t be ascertained from the description, interest is payable at the judgment rate in effect at the place of payment of the instrument and at the time interest first accrues (depends on jurisdiction)
b.       Contradictory terms
                                                              i.      If an instrument contains contradictory terms, typewritten terms prevail over printed terms, handwritten terms prevail over both, and words prevail over numbers, § 3-114
1.       Handwritten > typewritten > printed
2.       Words > numbers
5.                   Payable on demand or at a definite time
a.       Exceptions to this requirement that do not destroy negotiability:
                                                              i.      Acceleration clauses
                                                            ii.      Extensions of time at the option of the HOLDER
b.       If the indicated time on the instrument requires the reader to look to some extrinsic document in order to determine the definite time, it’s not payable at a definite time and is thus non-negotiable
6.                   Contains words of negotiability (bearer or order)
a.       “Payable to Bearer or to Order”
                                                              i.      Order instrument, § 3-109(b)—
1.       An instrument payable to order is payable to an identified person
a.       “Pay to Order of John Smith”
b.       Exception: “Pay to John Smith” would be acceptable only if it was on a check, § 3-104(c)
2.       An instrument payable to bearer is payable to the person in possession of the promise or order
a.       “Pay to bearer” or “pay to the order of cash” or “pay to a Merry Christmas” or “pay to order of ______”
b.       If there’s wording indicating instrument could be order paper OR bearer paper, bearer paper trumps if it states “bearer”
7.                   Does not state any other promise or instruction, except:
a.       To give, maintain, or protect collateral
b.       Authorization to confess judgment or to collect collateral, or
c.       Waiver of rights designed to protect obligor
Steps to determine initial negotiability
1.                   Does it have all elements required to be a n/i? § 3-104(a)
2.                   Is it order paper or bearer paper? § 3-109
3.                   To whom is the instrument payable? § 3-110
Exceptions, § 3-104(a)(3)
–          You can put “non-negotiable” on virtually anything and effectively make it non-negotiable EXCEPT checks
–          FTC notice – intended to abolish the HDC doctrine in certain cases like credit sales in goods and services; if the transaction is covered by the FTC regulation, then the FTC notice in the instrument negates the HDC doctrine and K law applies
o    Even if the note doesn’t include the FTC notice in these situations, it’s still considered as automatically added and still applies, § 3-305(e)
Process of Negotiation: How to Negotiate an Instrument
Bearer instruments
–          Delivery (possession)
Order instruments
–          Proper party must indorse
–          Delivery
*When negotiating to bank, if you’re the bank’s customer and a holder and you forget to indorse, you can give check to bank and they’ll be considered the holder
Part II – The Holder in Due Course Doctrine
Acquiring HDC Status
HDC requirements
1.                   Must be a holder holding a n/i;
2.                   Must have taken for value;
a.       Not the same as consideration; an unperformed promise can be consideration but NOT value; value must be a performed promise (party must be giving up something)
b.       Bank can become HDC by giving value in the form of a provisional credit, i.e., customer deposits check, bank puts provisional credit in full or partial amount of check in customer’s account until check clears
3.                   Must have taken in good faith; and
a.       Objective standard: honesty in fact and observance of reasonable commercial standards and fair dealing
4.                   Must have taken it without notice of any problems that might be associated with the instrument on its face or the transaction that gave rise to the instrument
a.       Notice can be imputed by actual knowledge, word-of-mouth, or inquiry notice (reason to know based on surrounding circumstances)
Effect of becoming a HDC
–          HDC takes instrument free of Art. 3 defenses and ordinary K defenses, and takes subject only to real defenses specified in Code
Notice requirement
–          Notice of breach of fiduciary duty
o    Can’t qualify as HDC is taking instrument from fiduciary with knowledge that fiduciary is in breach of its fiduciary duties with respect to the instrument
o    Examples:
§  Fiduciary deposits check into his own account
§  Fiduciary uses instrument as security on his own loan
§  Fiduciary negotiates instrument to another to pay a personal debt
–          Late or dishonored instruments
o    Can’t qualify as HDC if instrument is late or dishonored and purchaser acquired instrument with reason to know it’s late or dishonored
o    Examples:
§  Instrument with definite fixed payment date – if principal amount overdue, that prevents HDC status (but interest is ok) because it should alert a potential HDC and put him on notice
§  Checks – checks always become overdue 90 days after issuance, so if potential HDC receives check after 90 days he is on notice and can’t acquire HDC status
o    No indorsement
§  Transferee can’t become a holder until order paper has been transferred and indorsed; if transferee learns of a potential claim or defense before transferor indorses, it constitutes earlier notice of a defense or claim, which prevents transferee from acquiring HDC status
§  Examples:
·         X has check payable to X. X transfers check to Y but forgets to indorse. Y he

signed the same instrument as the principal; and
o    He can show he’s not a direct beneficiary of the value given for the instrument
–          Conditional liability – if accommodation party adds words to the signature line indicating he’s guaranteeing collection, he is liable only after holder first pursues the principal and is unable to collect, which must be evidenced by—
o    An execution of judgment being returned unsatisfied;
o    Proof principal has filed for bankruptcy;
o    Proof principal can’t be served with process; or
o    Proof that payment can’t be obtained from principal
Accommodated party vs. accommodation party
–          Accommodated party – has no right of recourse against accommodation party if accommodated party pays the instrument
–          Accommodation party – entitled to full reimbursement from accommodated party if accommodation party pays the instrument, and accommodation party is entitled to enforce the instrument against the accommodated party
Accommodation Party & Suretyship Defenses
Tender of payment by accommodation party or an indorser
–          If, at maturity, the accommodation party or an indorser tenders payment to the holder of the instrument, and the holder refuses to accept it, the accommodation party or indorser is still liable for the full amount but is not liable for any interest going forward
Tender of payment by principal or accommodated party
–          If payment tendered by principal or by any party against whom the indorser has a right of recourse, and payment is refused, the accommodation party or indorser is completely discharged of their obligation on the instrument
o    Indorser who has a right of recourse = if there’s a p/n signed by maker and by accommodation party, and indorser signed back, indorser has right of recourse
Impairment of collateral
–          If holder impairs collateral, any secondary obligor who would have had a right to the collateral if forced to pay on the instrument is discharged up to the amount of the impairment of the collateral
Releases, time extensions, and modifications
–          If there’s an agreement to release the principal, extend the loan, or modify the loan in some respect, the agreement has the same effect on the secondary obligor unless the agreement specifies otherwise
–          If secondary obligor can show that he suffered a loss as a result of the release, extension, or modification, he will be discharged to the extent of the loss
Drawers on the Instrument
Drawer’s liability
–          Drawer promises to pay PETE
o    But the promise is conditioned on drawer first being accorded technical rights of presentment and notice of dishonor
–          PETE has 30 days to present
o    If PETE does not present, drawer still has liability
§  The only way drawer will be discharged of liability is if PETE presents to bank after 30 days but bank has gone insolvent, causing drawer to lose his money
–          PETE has 30 days to give notice of dishonor to drawer
o    If PETE does not give notice, drawer still has liability
Drawee Liability
Drawee’s liability
–          Bank as drawee
o    Incurs no UCC liability until it certifies (accepts) the check
o    Once drawee certifies check, drawee takes on primary liability of the check and no matter who procures that certification (acceptance), drawer and all indorsers are immediately discharged from all liability the second the bank certifies the check
–          Non-bank as drawee
o    Incurs liability upon acceptance
§  Acceptance = drawee’s signed agreement to pay a draft as presented; by accepting a draft, drawee incurs obligation of an acceptor