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Payment Systems
University of South Carolina School of Law
Lacy, Philip T.

Payment Systems
Spring 2008 – Lacy
January 8, 2008
Subject matter of the course:
Articles 3 (Negotiable Instruments) and 4 (Bank Deposits and Collections)
Also Article 5 (Letters of Credit)
In South Carolina:
Currently there are only two states in the country that have not enacted revisions to Articles 3 and 4 that were promulgated in 1990
SC and NY
A SC bill has been pre-filed that would enact both the 1990 revised versions of Articles 3 and 4 plus additional revisions in 2002
The effective date might be January 1, 2009
We will study Revised Article 3 and 4 because that will be what all states use
On SC bar may be asked how the revisions have affected the resolution of the issues that have been addressed in the SC cases
Vocabulary is tough
Nature of the transactions may also be difficult
Be able to diagram the transactions
Chapter One – Negotiability and Holders in Due Course
A. Introduction
B. Concept of Negotiability – What is a negotiable instrument?
See §3-104(a): Except as provided in (c) and (d), “negotiable instrument” means an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order, if it…”
In §3-103(a) there is an extensive list of definitions used in Article 3
“Order” to pay is defined in §3-103(a)(8) as “a written instruction to pay money signed by the person giving the instruction…”
“Promise” to pay is defined in §3-103(a)(12) as “a written undertaking to pay money signed by the person undertaking to pay…”
What does a negotiable instrument look like? See §3-104
See §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
Ex. Promissory Note (two-party instrument)
A promise in writing to pay money in a fixed amount signed by the promisor
“I promise to pay to order of John Paul 1,000 on 12/31/08.” Signed by Smith
John Paul is the “payee” on the instrument 
Smith is the “maker” on the instrument
For a writing to be an instrument, the promisor order has to be either to pay to the name of a named party (order paper) or has to be to pay to bearer (bearer paper)
An instrument is a “draft” if it is an order; most common form is a check
Ex. Check
“Pay to order of John Paul $1,000.” Signed by Smith
The person who signs the check (Smith) is the “drawer” of the draft
The person on whom the draft is drawn (Bank) is the “drawee”
John Paul is the “payee”
See illustration in notes
A check is simply a form of a draft (drawn on a bank)
Certificates of Deposit
Ex. Promissory Note
Seller sells goods to a Buyer on credit; B doesn’t execute a promissory note to S; the time for payment comes and goes and at this point S will have to sue B to establish the existence of the K and B’s breach (time consuming); sue on the K
Suppose that instead of an oral promise, B executes a promissory note; once the instrument has been issued (B, the maker of the note, signs and delivers it to the seller), the obligation is reified into that paper
B’s liability on the contract is suspended until the note is either paid or dishonored
Suppose B fails to pay the note; if S were selling on the contract he has substantial burdens of proof—but here if S received the transfer of the promissory note, S will be a “holder” as defined in §1-201(b)(21)
S has met burden of proof by presenting the note
Suppose S sells the note; S can transfer the promissory note to a transferee “for value”
One type of transfer is particularly advantageous; a holder of an instrument like S can transfer his status as a “holder” and his rights to the transferee; if B has executed a promissory note “payable to bearer,” all S has to do to negotiate this note (with the result that the transferee is a “holder”) is to “deliver” the note
“Bearer paper” can be negotiated by delivery alone
But if the note says “I promise to pay to Seller,” this instrument is “order paper” and S can negotiate the order paper to a transferee so that T will be a holder, but to do that there must be “possession” PLUS “indorsement”
If S signs the back of the note and then delivers it, then the transferee will be a holder and has a right to payment (created by B and originally issued to S)
Suppose B realizes he has a right to revoke acceptance of the goods because of breach of warranty or some other defense; if S simply sues on an oral promise, B can raise these defenses
If instead of an oral promise, B issues a promissory note, S is a “holder” and may qualify as a “holder in due course” (didn’t know anything was wrong with the goods and acted in due course); even though S is a “holder,” B can raise his warranty defenses if S attempts to collect on the note from B
If S transfers this promissory note by negotiation and if S indorses and delivers the note, the transferee will be a “holder”
The question is whether the transferee qualifies as a “holder in due course”
See §3-302(a)
Gives value; takes in good faith and without notice of a defense, etc.
If the transferee is a HDC and sues B, B cannot raise the same defenses that he could have asserted against S even if S were a holder and that B could have asserted upon an oral contract against a mere assignee
See §3-305(a) and (b) and §3-306
What is B’s remedy? He must pay the note and then sue S for breach of the K
Many courts have said you can’t use a promissory note in a consumer transaction and even if you do you can’t have a holder in due course
January 10, 2008
Merger Doctrine
Why does merger facilitate the transfer of rights to payment?
Hypo: Assume S on 1/10 sells goods to B who promises to pay $10,000 for the goods on or before 3/1
Seller has a valuable right; his right to payment is an account and if he wants to transfer this account there is a market for it under Article 9
Assume on 1/20 S assigns the right to payment to A; then on 1/30 S assigns the same account receivable to B—who pays value and has no knowledge of the prior assignment; what happens when 3/1 comes along and B is supposed to pay?
Common law problem was that there was no way to set up notice for assignments; against this backdrop of law, what’s the market for the transfer of rights to payment? The buyers of the streams of value will pay only if they are assured a right to enfo

·         Claims of Ownership – arise between the owner of the instrument and subsequent transferees, e.g., between the payee and subsequent takes of the instrument
·         Ordinary Defenses
o   Subsection (b) of §3-305 is a limitation on subsection (a). The right of a holder in due course to enforce and instrument is subject to the defenses stated in subsection (a)(1)—the so called “real” defenses—but is NOT subject to the “ordinary” defenses stated in subsection (a)(2) or claims in recoupment described in subsection (a)(3).
·         Real Defenses
·         Claims in Recoupment
·         See §3-305; §3-306 and §3-302
Hypo: Assume that a B purchases goods from S and pays with a $10,000 note due within 2 months; S then endorses and transfers possession of the promissory note to a third party (H); because H received a transfer of an instrument (and we assume that this instrument said that it was payable to the order of Seller) and it was indorsed, H becomes a “holder”
Suppose the goods are defective and B has all kinds of claims against S; the note becomes due and H demands payment from B but B refuses to pay the instrument because of the defective goods
If H is not only a holder but also a holder in due course, then H will take free of the so-called “personal defenses” that B has against S—even though B may be justified in not paying Seller because the goods were defective, because the goods have been transferred to a holder in due course, the HDC gets to enforce the note against B and B is left with a contract action against S but has to pay H
It is clear that S will be able to sell his right to payment at a higher price and people will be willing to buy the note at a lower price if they don’t have to worry about the underlying transaction
Who is entitled to enforce a negotiable instrument?
See §3-301
Under SC current law you must be a “holder” but revised Article 3 changes this:
A “holder” of the instrument under §3-301(i) is entitled to enforce the instrument against the maker
An instrument is typically negotiated to a holder
The other category of people who can enforce negotiable instruments under (ii) are “non-holders” who have possession of the instrument with the rights of a holder
An instrument can also be transferred to a non-holder and if the transfer is effective the transferee has the right to enforce
Who is a “holder”?
See §1-201(b)(21): Holder means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession
But when does a person become a holder?