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

Code Structure

Definitions: the definitions in § 1.102 apply to a transaction to the extent that it is governed by another chapter of the UCC, i.e., the definitions in § 1.201 apply unless a particular chapter/article provides for a chapter-specific definition.

Supplemented by CL, Equity, etc.: § 1.103 title is liberally construed- provides that unless displaced by the particular provisions of the UCC, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, or other laws shall supplement the UCC. For example, federal or state laws on evidence will, but there are some overriding UCC presumptions.

“Notice:” § 1.202(a) provides that a person has “notice” of a fact if the person

1) Has actual knowledge of it;

2) Has received a notice or notification of it; or

3) From all the facts and circumstances known, has reason to know that it exists.

“Knowledge:” § 1.202(b) provides that “knowledge” means actual knowledge.

Variation by Agreement for the UCC and Chapter 3 (but not Chapter 4) § 1.302:

1) In general, the effect of the provisions of the UCC

2) may be varied by agreement.

EXCEPTION: the obligations of good faith, diligence, reasonableness, and care prescribed by the UCC may not be disclaimed by agreement. But the parties, by agreement, may determine the standards by which the performance of those obligations is to be measured if those standards are not manifestly unreasonable (i.e., unreasonable on its face).

REASONABLE TIME BY AGREEMENT: whenever the UCC requires an action to be taken within a reasonable time, a time that is not manifestly unreasonable may be fixed by agreement.

Obligation of Good Faith- 1.304- every K imposes obligation fo GF in performance and enforcement.

Option to Accelerate at Will- 1.309: allows an oblige to accelerate a det obligation at will when he deems himself insecure. Acceleration is permissible only if the oblige in GF believes that the prospect of pmt or performance is impaired.

Negotiable Instruments- Ch 3

SM 3.102- applies to negotiable instruments, doesn’t apply to money pmt orders, or securities.

Negotiable Instrument § 3.104(a)

1) An unconditional promise or order to pay a fixed amount of money,

2) W/ or w/o interest or other charges described in the promise or order, if it’s—

a) Payable to bearer or to order at the time issued or first comes into possession of a holder;

b) Is payable on demand or at a definite time; and

c) Does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain:

(1) An undertaking or power to give, maintain, or protect collateral to secure pmt;

(2) An authorization or power to the holder to confess judgment or realize on or dispose of collateral; or

(3) A waiver of benefit of any law intended for advantage or protection of an obligor.

3.103 Defs

INSTRUMENT: “instrument” means a negotiable instrument.

CHECKS: a check is an instrument and is an order to the bank to pay a payee. To have a check or a draft, you must have an order.

PROMISSORY NOTE: a promissory note is an instrument and a promise.


(1) A written instrument to pay money signed by the person giving the instruction;’

(2) The instruction may be addressed to any person,

(3) including the person giving the instruction, or to

(4) one or more persons jointly or in the alternative but not in succession, but an

(5) authorization to pay is not an order

(6) unless the person authorized to pay is also instructed to pay.


(1) A written undertaking to pay money signed by the person undertaking to pay, but

(2) An acknowledgement of an obligation by the obligor is not a promise

(3) Unless the obligor also undertakes to pay the obligation.

EAST SAYS FOUR CONCEPTS: § 3.104(a) gives four concepts for negotiable instruments.

Demand Draft § 3.104(k) (Texas non-uniform)

1) A writing that is not signed by the customer

2) Created by a third party under the purported authority of the customer

3) For the purpose of charging the customer’s account with a bank, but a

4) Demand draft does not include a check drawn by a fiduciary;

5) A demand draft may contain any or all of the following:

a) Customer’s printed or typewritten name or account number;

b) A notation that the customer authorized the draft; and

c) The statement “no signature required,” “authorization on file,” “signature on file,” or words to that effect.

EFFECT: b/c the demand draft is created with the authority of the person identified as the drawer, that drawer will by the issuer. The draft will be issued to its creator; thus the deposit by the creator at a bank is a transfer. Further, to have a draft, there must be an order.

EXAMPLE: an instrument created by a telemarketer to pay itself for goods or services delivered to the customer. It will be in the form of a draft and have the customer’s account number and other routing and processing information magnetically encoded so that it can be deposited at a bank and processed and collected through the banking system.

Checking Accounts


Bank: a person engaged in the business of banking and includes a savings bank, S&L association, credit union, and trust company.

Check: means a (i) 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.”

Note vs. Draft: 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.

Drawer/Issuer: a person who signs or is identified in a draft as a person ordering payment.

Drawee/Payor Bank: a person (bank) ordered in a draft to make payment.

Payee: the person to whom the check is issued (usually the seller).

Depository Bank: the first bank to take an item even if it is also the payor bank, unless the item is presented for immediate payment over the counter.

Intermediary Bank: a bank to which an item is transferred in course of collection except the depository or payor bank (e.g., Fed Reserve Bank in Dallas).

HYPO: If CJ writes a check to AM to buy a book, that check is “drawn” on CJ’s account at Rocky Mountain Bank. That makes Rocky Mountain the “drawee” or the “payor bank.” Cliff, the person that directs the payment by writing the check, is the “drawer” or “issuer.” AM, the person to whom the check is written, is the “payee.” Assuming that AM does not have an account at Rocky Mountain Bank, the process of collecting on the check will involve one or more intermediaries between the payee and the payor bank. For example, Archie is most likely to deposit the check in his account, at Colorado National Bank. That makes Colorado National the “depository bank.” Finally, if other banks (e.g., Federal Reserve Bank in Denver) handle the check before it gets from the depository bank to the payor bank, all of those banks—intermediaries between the depository bank and the payor bank—are “intermediary banks.”

Regulation of the Checking Relationships: a checking account basically is a two-step arrangement between the bank and the customer, under which the customer deposits money with the bank and the bank then disposes of the money in accordance with the customer’s directions.

1) Agreement: many of the terms of that arrangement appear in the written K between the customer and the bank, which typically consists of a brief signature card that incorporates by reference a relatively length set of rules formulated by the bank that govern its accounts.

2) Federal and State Laws: in addition to that K, state and federal laws provide a variety of rules, many of which govern the rights of the parties even if they are contrary to the arrangements that the parties themselves select in their K.

a) Federal: the federal-law rules are in the form of federal statutes (principally the Expedited Funds Availability Act) or rules promulgated by the Board of Governors of the Federal Reserve. § 4.103(b) reflects the Code’s recognition of federal preemption.

b) State: the state-law rules generally appear in the UCC. Articles 3 and 4 provide a variety of rules that affect checking accounts and check transactions. Article 4A relates to wire transfers; article 5 relates to letters of credit; article 7 relates to documents of title; and article 8 relates to securities.

(1) Article 3: governs negotiable instruments.

(2) Article 4: governs the day-to-day functioning of the checking system (“Bank Deposits and Collections”).

CHAPTER 4 TRUMPS: § 3.102(b) provides that if there is a conflict between articles 3 and 4, article 4 governs (in fact, if article 3 and 9 (secured credit) conflict, 9 governs as well).

Customer as creditor of the bank—Checking Relationship: In the checking system, the transaction payor, or drawer/issuer (i.e., the person that writes the check) establishes that claim by opening a checking account.

1) For a checking account, the customer/depositor goes to the bank and

2) deposits money into a checking account, which creates a demand deposit account (DDA),

3) making the customer a creditor of the bank, and the bank becomes a debtor

4) b/c the bank is now indebted to customer to pay that money back the funds on deposit;

5) the account is a demand deposit b/c the customer is entitled to the money on demand

6) provided the timing for funds availability has been satisfied.

EFFECT: when a customer issues a check, the order mandates the bank to discharge part of its debt to the customer by paying a third person.

Effect of Issuing an Instrument on an underlying obligation § 3.310

1) When an uncertified check or note is issued to satisfy an obligation, e.g., sale of goods,

2) 3.310(b) shows that two obligations emerge—

3) the underlying obligation and the obligation that the check be honored,

4) And upon issuance of the check, the underlying obligation is suspended to the

5) Same extent the obligation would be discharged if an amount of money equal to the

6) Amount of the instrument were taken, and

a) [SUSPENSION] The suspension continues until dishonor of the check or until it is paid or certified, and upon payment of the check or certification thereof, the underlying obligation is discharged to the extent of the amount of the check; and

b) [DISHONORED AND OBLIGEE HAS POSSESSION AND ENFORCEMENT] If the check or note is dishonored then the payee of the check, provided he is entitled to enforcement of the instrument and has possession of the instrument, may enforce either the instrument or the underlying obligation (breach of K);

c) [OBLIGEE NOT RIGHT TO ENFORCE INSTRUMENT] But if the right to enforce the instrument is held by somebody other than the seller (obligee), the seller can’t enforce the right to payment of the price under the sales K b/c that right is represented by the instrument enforceable by somebody else. Thus, if the seller/obligee sold the note or the check to a holder and has not reacquired after it after dishonor, the only right that survives is the right to enforce the instrument. What that means is that even though the suspension of the underlying obligation may end upon dishonor, the obligation is not revived to sue for breach of K for example when the obligee does not have the right of enforcement of the instrument. (Come back and fill in the second part of 3.310(b)(4)!)

TYPICAL: the typical case is that in which a buyer pays for goods or services by giving the seller the buyer’s personal check, or in which the buyer signs a note for the purchase price. The underlying obligation, which is suspended, to pay for the goods arises under 2.607(a) that if goods have been accepted, the buyer is obligated to pay for the goods.

HYPO: BL issued a check payable to CL for 1500 for cooking equipment from First State Bank of Matacora. BL is saying discharge 1500 of your debt to me by paying CL. CL will ML take the check and deposit it in her own bank, i.e., the depository bank, which will send the check back to the payee bank, First State bank, for payment. When CL deposits the check, 3.310(b)(1) operates to suspend her right to sue for breach of K until the uncertified check is paid or certified. BL does not want the equipment anymore b/c it was slightly larger than he had understood. CL has refused to take back the equipment. This is a sale of goods. Remorse is not a defense for a K obligation; so, he’s obligated whether happy or not, but what is a defense? If he had ordered it and never delivered, than that is failure of consideration, but what if delivered and it’s the wrong size? Is he obligated by 2.607? Sort out the article 2 and article 3 and 4 stuff.

Drawer Liability UCC § 3.414(b)

1) If an item is dishonored, the drawer is obligated to pay the draft per its terms when issued to

2) a person entitled to enforce the draft, or an endorser held liable for endorser liability.

EFFECT: this is the provision triggered under 3.310(b) that when a check issued for an obligation, the obligation suspended until check honored or dishonored, and if dishonored, the obligee can sue on either the check or the obligation. This section, 3.414(b) provides the basis for the obligee to recover on the terms of the dishonored check.

ADVANTAGE TO SUING ON THE INSTRUMENT: sue on the instrument b/c under 3.308(b) if the validity of signatures is admitted or proved, a π producing the instrument is entitled to payment if he is a person entitled to enforce (e.g., a holder), unless ∆ proves a defense or claim in recoupment. If a defense or claim in recoupment is proved, π can still recover π can prove he has rights of a holder in due course (subject of course to the ∆ then coming

honor” of subsequent items under § 4.402.

POLICY: this rule is necessary b/c the automated check collection system cannot accommodate postdated checks. A check is usually paid upon presentment w/o respect to the date of the check.

HISTORY: under the former law, if a payor bank paid a postdated check before its stated date, it could not charge the customer’s account b/c the check was not “properly payable.” Hence, the bank might have been liable for wrongfully dishonoring subsequent checks of the drawer that would have been paid had the postdated check not been prematurely paid.

Problem 1.2: BD is a senior VP at First State Bank of Matacora, which is owned by his father-in-law. He calls you one Monday afternoon to ask you about a problem. BD explains that this problem relates to a 900 dollar check drawn by his customer Jasmine Ball, which BD’s bank received for payment on Monday, January 22. The check was payable to Matacora Realtors and dated Feb 1 of the current year. B/c his bank’s new automated check-processing system does not examine dates and b/c Ball’s account at that time contained 1k, the system paid the check and deducted 900 form Ball’s account. Upon further examination, it appears that Ball sent the bank a letter in September of last year. The letter identified Ball’s account by number and explained that she would be paying her rent for the next year by postdated checks until the indicated dates. The bank never responded to the letter. Has BD’s bank acted improperly?

Under the former law, the bank acted improperly.

Is it permissible for someone to accept a post-dated check? Yes. But the bank has a problem making sure it can find these (see comic book).

But currently, the bank acted improperly only if Ball failed to comply with 4.401(c). Under 4.401(c), the customer must give notice of the post-dating and describing the check with reasonable certainty—here, in her letter, she gave her account number, but not a check number.

What more could she have given the bank besides an account number for reasonably certain notice? The future dates, identify the payee, and most critically, the amount of the future check.

Why? B/c the automated check collection system identifies three fields in the micro-line of magnetic ink: (1) the payor bank’s routing number, (2) the account number and the item number (i.e., check number), and (3) the amount of the check. She should have put one these indicators where the bank could set its system to pull the checks and not pay them until postdate. Without that, here it’s hard to conclude she complied with 4.401(c) “reasonable certainty.”

Assuming she did comply, than as to time, this was a four-month old notice, but the notice is still effective b/c six months has not passed. And, further assuming she did comply, the bank should have pulled the check and it only has a narrow window of time to dishonor the check before the midnight deadline. If bank dishonored in time, than Matacora Realty could re-deposit the check on Feb 1, which is the post-date.

Customer’s Right to Stop Payment; Burden of Proof of Loss § 4.403

1) A customer (or any person authorized to draw on the account) may

2) stop payment (or close the account) by a written order to the bank,

3) dated, and signed, describing the item or account w/ reasonable certainty

4) received at a time and in a manner that affords the bank a reasonable opportunity

5) to act on it before any action by the bank with respect to the item,

6) and if the signature of more than one person is required to draw on an account,

7) Any of those persons may stop payment or close the account.

EFFECT: A payment in violation of an effective direction to stop payment is an improper payment, even though it is made by mistake or inadvertence. This is termed a “wrongful payment over a stop-payment order.”

EFFECTIVE PERIOD OF TIME: in Texas, a stop-payment order is effective for six months and is binding on the bank only if it is in writing,[2] dates, and signed and describes the item with certainty (there is no Texas case on what constitutes “certainty” versus “reasonable certainty,” but ML need all three things, or two of three, recognized on the micro-line in the check collection system). A stop-payment order may be renewed for additional 6-month periods by a writing given to the bank within a period during which the stop-payment order is effective.

BURDEN ON CUSTOMER TO PROVE LOSS: the burden of establishing the (1) fact and (2) amount of loss resulting from the payment of an item contrary to a stop payment order or order to close an account is on the customer. The loss from payment of an item contrary to a stop payment order may include damages for dishonor of subsequent items under § 4.402.

EXCEPTION: a payee or indorsee has no right to stop payment. The sole exception to this rule is § 4.405 on payment after notice of death, by which any person claiming an interest in the account can stop payment.

EXCEPTION: the customer has no obligation to explain why he or she is issuing a stop-order b/c it’s a right of the customer, period.

[1] Customer means a person having an account with a bank or for whom a bank has agreed to collect items, including a bank that maintains an account at another bank.

[2] The official UCC § 4.403(b) provides that oral stop-payment orders are binding, but only for 14 days, unless the customer provides a written order within the first 14 days, whereupon the six-month term is triggered. Texas, however, does not recognize oral stop-payment orders as binding. But a bank may take the risk as a business judgment to voluntarily abide by an oral stop-payment order from a good customer.