Fall 2014
Professor Gary Sullivan
Payment Systems and Other Financial Transactions, 5th Edition (Aspen Casebook)
Ronald J. Mann, Brand: Aspen Publishers
CHAPTER 6: NEGOTIABILITY
ASSIGNMENT 22: NEGOTIABLE INSTRUMENTS
A. Negotiability and Liquidity
Overview
i. Liquidity is central to financial transactions
a. Liquidity generally refers to the ease with which an asset can be sold at a price that reflects the asset’s economic value
i. Example:
1. Shares on NY Stock Exchange is one of the most liquid of all assets
2. Partnership interest in a 2 person general partnership is very illiquid
b. Liquidity is useful for payment obligations
i. If a payment obligation is highly liquid, the payee can easily sell the obligation and thus convert it to cash
c. Many businesses prefer to have immediate cash, even if they have to sell their payment obligations at a discount
i. Liquidity allows businesses to shift financial risks to 3rd parties
ii. This has allowed businesses to pop up that specialized in bearing the financial risks that operating businesses want to trade for cash!
a. Specialization can lead to administration of those obligations that is cheaper and more effective
iii. The NI is the oldest device besides money for enhancing liquidity
a. (1) NI offer an easy way to verify a party’s power to transfer an enforceable interest in the instrument
i. All relevant info. appears on two sides of the instrument
1. This means that the only thing a purchaser of a NI needs to do to determine that the purported seller can transfer a right to enforce the instrument is look at the instrument and verify the identity of the party with whom it is dealing
b. (2) Second liquidity-enhancing feature of a NI arises from a defense-stripping rule that makes a NI more valuable in the hands of a purchaser than it was in the hands of the payee that sold it!
i. Upon compliance with this rule, a transfer of a NI strips away most of the defenses to payment that the payor could have asserted against the original payee
1. A purchaser that becomes a “holder in due course” takes the instrument free from all personal defenses
a. These rules make NI a more attractive investment, which makes the NI more liquid
iv. The subject of the negotiability system is a piece of paper that evidences the payment obligation
a. This is central
v. The evidence of a transfer takes the form of physical signatures (indorsements) on the instrument
a. And a holder-in-due-course status can be attained only by a person who possesses the instrument!
In-Class Notes:
A. Negotiable instrument — two main types: drafts and notes
. Draft:
1. 3-party transaction that involves an instruction (order) to pay
2. Parties: Drawer (issues order and gives instrument to payee), payee, and drawee (must make payment in accordance with the order);
3. Most common draft: check (the drawee is a bank)
a. Note:
1. 2-party transaction
2. Parties: Maker and payee
1. A note is not an order; it’s a promise to pay (maker – borrower; payee – lender)
3. Common example of notes: loans (bank is the payee (it is owed money)) whereas in the check context, the banks OWES money pursuant to a customer’s instructions
4. Another example: CDs; the customer is the lender and the bank is the maker
B. Negotiability is important because an assignee can become a “holder in due course”
. A writes check to B and B endorses it to C, making C a holder in due course
1. Later, A and B have a dispute over money owed, but they now
actions
i. The result is as if W had paid R directly, except that the bank draft expedited the payment transaction
g. Terms:
i. M Bank is the drawer or issuer b/c it directed payment
ii. W is the remitter b/c he caused the draft to be issued – b/c there is an understanding that W will remit the draft to payee R
iii. R is the payee – person to whom payment is to be made
iv. B Bank is the drawee – the person directed to make payment
iv. Foundation of negotiability is a physical object: the negotiable instrument
a. Article 3 uses a two-stage framework to set out the rules for determining whether any particular obligation is negotiable
i. (1) General definition of NI
1. UCC § 3-104(a)
ii. (2) Contained in an array of provisions scattered throughout Article 1 and other provisions in Part 1, Article 3
1. Which provide detailed definitions of many of the terms that appear in UCC § 3-104
v. UCC § 3-104 sets forth 7 requirements for negotiability
a. An obligation that satisfies all 7 requirements is a NI or simply an instrument
i. UCC § 3-104(b)
1. “Instrument” means NI
