PowerPoint Slides to Accompany

ESSENTIALS OF BUSINESS AND

ONLINE COMMERCE LAW
1st Edition
by Henry R. Cheeseman

Chapter 14
Negotiable Instruments and
Digital Banking
Slides developed by
Les Wiletzky

Copyright 2006 by Pearson Prentice-Hall. All rights reserved

Negotiable Instruments (1 of 2)

To qualify as a negotiable instrument

(commercial paper), the document must meet
certain requirements established by Revised
Article 3 (Negotiable Instruments) of the
Uniform Commercial Code (UCC)

Article of the UCC that establishes rules for the creation of,
transfer of, enforcement of, and liability on negotiable
instruments

Copyright 2006 by Pearson Prentice-Hall. All rights reserved.

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Negotiable Instruments (2 of 2)

If the requirements of Article 3 are met, a

transferee who qualifies as a holder in due
course takes the instrument free of many
defenses that can be asserted against the
original payee
In addition, the document is considered an
ordinary contract that is subject to contract
law

Copyright 2006 by Pearson Prentice-Hall. All rights reserved.

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Functions of Negotiable Instruments

Negotiable instruments serve the following

functions:

Substitute for money

Credit device
Record-keeping device

Most purchases by businesses and many

individuals are made by negotiable
instruments instead of cash

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Types of Negotiable Instruments

Instrument

Term that means

negotiable instrument
[UCC 3-104(b)]

Revised Article 3
recognizes four kinds
of instruments:
1. Drafts
2. Checks
3. Promissory Notes
4. Certificates of Deposit

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Drafts

A draft is a three-party instrument that is an

unconditional written order by one party that
orders the second party to pay money to a
third party

Drawer of a draft

Drawee of a draft

Payee of a draft

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Checks

A distinct form of draft drawn on a financial

institution and payable on demand

Drawer of a check
Drawee of a check
Payee of a check

Article 4 of the UCC establishes the rules and

principles that regulate bank deposit and
collection procedures

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Special Types of Checks

Bank Checks Checks for which the bank is

solely or primarily liable:

Certified Check

Cashiers Check

Travelers Check

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Promissory Notes

A two-party negotiable instrument that is an

unconditional written promise by one party to
pay money to another party

Maker of a note the party who makes the promise to

pay (borrower)
Payee of a note the party to whom the promise to pay is
made (lender)

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Certificates of Deposit (CD)

A two-party negotiable instrument that is a special form

of note created when a depositor deposits money at a
financial institution in exchange for the institutions
promise to pay back the amount of the deposit plus an
agreed-upon rate of interest upon the expiration of a set
time period agreed upon by the parties

Maker of the CD the bank (borrower)

Payer of the CD the depositor (lender)

Copyright 2006 by Pearson Prentice-Hall. All rights reserved.

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Summary: Types of Negotiable

Instruments (1 of 2)
Orders to
Pay

Party

Description of Party

Draft

Drawer
Drawee

Person who issues the draft

Person who owes money to the drawer; person who is ordered
to pay the draft and accepts the draft
Person to whom the draft is made payable

Payee
Check

Drawer
Drawee
Payee

Owner of a checking account at a financial institution; person

who issues the check
Financial institution where drawers checking account is
located; party who is ordered to pay the check
Person to whom the check is made payable

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Summary: Types of Negotiable

Instruments (2 of 2)
Promises to
Pay

Party

Description of Party

Promissory
Note

Maker
Payee

Party who issues the promissory note; usually the borrower

Party to whom the promissory note is made payable; usually the
lender

Certificate of
Deposit (CD)

Maker
Payee

Financial institution that issues the certificate of deposit

Party to whom the certificate of deposit is made payable;
usually the depositor

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According to UCC 3-104(a), a negotiable

instrument must:

Be in writing
Be signed by the maker or drawer
Be an unconditional promise or order to pay
State a fixed amount of money
Not require any undertaking in addition to the payment
of money
Be payable on demand or at a definite time
Be payable to order or to bearer

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Summary: Formal Requirements for a

Negotiable Instrument (1 of 4)
Requirement

Description

Writing

Writing must be permanent and portable. Oral or implied

instruments are nonnegotiable [UCC 3-104(d)].

Signed by maker or drawer Signature must appear on the face of the instrument. It
may be any mark intended by the signer to be his or her
signature. Signature may be by an authorized
representative [UCC 3-104(a)].
Unconditional promise or
order to pay

Instrument must be an unconditional promise or order to

pay [UCC 3-104(a)]. Permissible notations listed in UCC
3-106(a) do not affect instruments negotiability. If
payment is conditional on the performance of another
agreement, the instrument is nonnegotiable.

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Summary: Formal Requirements for a

Negotiable Instrument (2 of 4)
Requirement

Description

Fixed amount of money

Fixed amount: Amount required to discharge the

instrument must be on the face of the instrument [UCC 3104(a)]. Amount may include payment of interest,
discount, and costs of collection.
Revised Article 3 provides that variable interest rate notes
are negotiable instruments.
In money: Amount must be payable in U.S. or foreign
countrys currency. If payment is to made in goods,
services, or non-monetary items, the instrument is
nonnegotiable [UCC 3-104(a)].

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Summary: Formal Requirements for a

Negotiable Instrument (3 of 4)
Requirement

Description

Cannot require any

undertaking in addition to
the payment of money

A promise or order to pay cannot state any other

undertaking to do an act in addition to the payment of
money [UCC 3-104(a)(3)]. A promise or order to may
include authorization or power to protect collateral,
dispose of collateral, waive any law intended to protect
the obligee, and the like.

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Summary: Formal Requirements for a

Negotiable Instrument (4 of 4)
Requirement

Description

Payable on demand or at a Payable on demand: Payable at sight, upon presentation,

definite time
or when no time for payment is stated [UCC 3-108(a)].
Payable at a definite time: Payable at a definite date, or
before a stated date, a fixed period after a stated date, or
at a fixed period after sight [UCC 3-108(b)(c)].
Instrument payable only upon the occurrence of an
uncertain act or event is nonnegotiable.

Copyright 2006 by Pearson Prentice-Hall. All rights reserved.

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Nonnegotiable Contract

A promise or order to pay that does not meet

the requirements of a negotiable instrument
It is not subject to the provisions of UCC
Article 3
A nonnegotiable contract can be enforced
under normal contract law

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Transfer by Assignment or Negotiation

Transfer by Assignment
The transfer of rights under
a contract
It transfers the rights of the
transferor (assignor) to the
transferee (assignee)

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Transfer by Negotiation
The transfer of a negotiable
instrument by a person other
than the issuer
The person to whom the
instrument is transferred
becomes the holder
Negotiating order paper
Negotiating bearer paper
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Indorsement

The signature (and other directions) written

by or on behalf of the holder somewhere on
the instrument
The signature may:

Appear alone
Name an individual to whom the instrument is to
be paid, or
Be accompanied by other words

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Holder Versus Holder In Due Course

Holder
A person who is in
possession of a
negotiable instrument
that is drawn, issued,
or indorsed to him or
his order, or to bearer,
or in blank

Holder in Due Course

(HDC)
A person who takes a
negotiable instrument
for value, in good faith,
and without notice that
it is defective or is
overdue

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Requirements for HDC Status

To qualify as an HDC, the transferee must meet the

requirements established by the UCC
The person must be the holder of a negotiable
instrument that was taken:
1. For value
2. In good faith
3. Without notice that it is overdue, dishonored, or encumbered
in any way, and
4. Bearing no apparent evidence of forgery, alterations, or
irregularity [UCC 3-302]

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Holder in Due Course (HDC)

Maker or
Drawer

Negotiable
Instrument

Payee or
Bearer

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Negotiable
Instrument

Holder in
Due
Course
(HDC)

1.

Holder

2.

Takes a negotiable
instrument

3.

For value

4.

In good faith

5.

Without notice of
defect

6.

The instrument bears

no apparent evidence
of forgery, alterations,
or irregularity
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Real Defenses
Real Defenses
1. Minority
2. Extreme duress
3. Mental incapacity
4. Illegality
5. Discharge in bankruptcy
6. Fraud in the inception
7. Forgery
8. Material alteration
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Effect
Real defenses can be raised
against both holders and
holders in due course

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Personal Defenses
Personal Defenses
1. Breach of contract
2. Fraud in the inducement
3. Mental illness that makes a contract
voidable instead of void
4. Illegality of a contract that makes the
contract voidable instead of void
5. Ordinary duress or undue influence
6. Discharge of an instrument by payment
or cancellation

Effect
Personal defenses cannot
be raised against a holder in
due course

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HDC Status Eliminated with Respect to

Consumer Credit Transactions

The Federal Trade Commission (FTC) has adopted a

rule that eliminates HDC status with regard to
negotiable instruments that arise out of certain
consumer credit transactions
Sellers of goods and services are prevented from
separating the consumers duty to pay the credit and
the sellers duty to perform
Thus, both personal and real defenses can be raised
against an HDC

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The Bank Customer Relationship

Creditor Debtor Relationship
Created when a customer
deposits money into the bank
The customer is the creditor
and the bank is the debtor

Principal Agent Relationship

Created if the:

deposit is a check that the

bank must collect for the
customer or the
customer writes a check
against his or her account

The customer is the principal

and the bank is the agent

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The Collection Process

A bank is under duty to accept deposits into a

customers account

This includes collecting checks that are drawn

on other banks and made payable or indorsed
to the depositor

UCC Article 4 regulates the collection process

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The Check Collection Process

Drawer issues a check
to Payee drawn on
Country Bank

DRAWER
Drawer has a
checking account at
Country Bank

Payee deposits the

check in her account
at Metro Bank

Metro Bank sends

the check to City
Bank for collection

METRO
BANK

PAYEE

(Depository and
collecting bank)

COUNTRY
BANK
(Drawee and
payor bank)

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CITY
BANK
(Intermediary and
collecting bank)

City Bank sends the

check to Country
Bank for collection

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Electronic Fund Transfer Systems

Electronic fund transfer

systems (EFTS) are
supported by contracts
among and between
customers, banks, private
clearinghouses, and other
third parties

The most common forms of

EFTS are:

1. Automated Teller Machines

(ATM)
2. Point-of-Sale (POS) Terminals
3. Direct Deposits and Withdrawals
4. Paid-by-Internet

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Wire Transfers (1 of 2)

UCC Article 4A Fund Transfers governs

wholesale wire transfers:

Applies only to commercial electronic fund

transfers
Consumer fund transfers subject to the
Electronic Fund Transfer Act are not subject to
Article 4A

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Wire Transfers (2 of 2)

UCC Article 4A (continued)

Governs the rights and obligations between

parties to a fund transfer unless they have
entered into a contrary agreement
If a receiving bank mistakenly pays a greater
amount to the beneficiary than ordered, the
originator is liable for only the amount he or she
instructed to be paid

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