Commercial Paper, Bank Deposits, and Collections
a. Essence of the course
i. About making payments for goods, services, etc.
1. The way payments are made
2. This used to be primarily negotiable instruments law
ii. Negotiable Instruments Law
i. 1896 America borrowed from English statute
ii. The only statutory law involved negotiable instruments
1. NIL – negotiable instruments law. This is old terminology
2. Every state had adopted this old statute
iii. Mid-twentieth century
1. Development of the UCC by this time
a. Article 3 replaced old NIL
b. 1952 Articles 3 and 4 were promulgated
c. Article 4 – collection and deposit of checks
d. By end of 1960s, all the states had adopted Original
Articles 3 and 4, except for Louisiana, which waited until
1973 to adopt them
i. The Louisiana version changed a lot of the UCC
ii. So remember two things about La. law:
1. Any case prior to 1974 is based on NIL, not
2. After 1974, our statutory law was
significantly different from other states
iv. 1990 Revision
1. ALI and National Commissioners did completely new version of
Articles 3 and 4 – “The Revision”
2. Louisiana was one of the first states to adopt The Revision!
a. Louisiana did not tinker with the UCC articles of 1990
nearly as much as originally
b. There are minor differences
c. No blockbuster cases since the Revision
v. 2002 Amendments to Articles 3 and 4
1. Done by ALI and National Commissioners. Not a complete
2. Most states have not adopted these amendments
a. Louisiana has not
b. Our statute book includes these amendments in the “official
text” of the UCC without explaining that most states have
not adopted the new amendments
vi. Revised Version of Article 1
1. By ALI/Commissioners
2. Article 1 – general provisions applicable to the UCC generally
a. Definitions, etc.
3. Half the states had adopted Revised Article 1, including Louisiana
a. New version as adopted in Louisiana in 2006 is in “the
handout.” Old version is in the class supplement. The
revised UCC version is in the green statute book.
b. Louisiana’s major change was changing the definition of
“good faith” in Revised Article 1.
c. *Our day to day document is primarily “the supplement”
because the Article 1 references in most of the cases are to
the old Article 1
vii. Article 4A adopted by all the states addresses wire transfers
viii. Federal Law
1. Expedited Funds Availability Act in 1987
c. Recommended Treatises
i. White and Summers UCC
ii. Miller and Harrell, Modern Payment Systems
1. Payment law
i. Modified open book
1. Can bring the supplement, the statutory book, and the handout on
2. Free to write notes in these materials
ii. Format – same as prior years
1. Short answer Part I
2. Essay Part II
Negotiability and Holders in Due Course
i. “The big idea” – the assignability of debt
1. The ability to transfer a debt owed to you to a different person, for
2. The idea that debts are not personal, but are a form of property that
can be bought and sold like other property
a. At early common law if you didn’t pay your debt, you went
to jail. Debts were personal.
b. Later on, at common law, debts became a type of property
i. This led to a huge wealth-producing concept in
western civilization. Created the groundwork for
the modern credit economy.
ii. Assuring the fluidity of passing negotiable instruments became a key
iii. After the 18th century, the commercial world became vastly different
1. A owes a debt to B. B assigns the debt to C.
2. This creates 3 relationships
a. A-B. The debt.
b. B-C. Assignment of debt.
c. A-C. Obligor’s relationship to the new obligee.
3. Even where A’s debt is evidenced by a negotiable instrument, as far
as A and B are concerned, we are really only concerned with
4. However, where the debt is evidenced by a negotiable instrument,
NIL defines B-C and A-C’s relationships.
a. What is necessary for the transfer from B to C to be
b. What rights does C acquire against A, and in particular,
what effect does the original A-B contract have on C’s
i. NIL differs from contract law here
ii. Contract law rule is that the assignee, C, only steps
into the shoes of B, the assignor. But NIL says that
C as holder in due course may have vastly superior
rights against A, more than B would have had
1. All negotiable instruments are either one of two types: promises
and orders. Both are to pay money.
a. A promise to pay money is a note, or promissory note.
b. An order to pay money is a draft, the most common of
which is a check.
2. A promissory note
a. A two party instrument
i. A maker
ii. A payee
iii. There may also be one or more indorsers, a holder,
and/or a person entitled to enforce (PETE)
3. A draft (check)
a. A three party instrument
i. A drawer
1. Person making the order to pay
ii. A drawee
1. Person to whom the order to pay is directed
iii. A payee
1. The person to whom payment is to be made
by the drawee
iv. There may be one or more indorsers, a holder,
and/or a PETE
1. The rules of NIL were originally meant to create a free market.
But these rules don’t make as much sense in the 21st Century.
2. Still, the basic rules of NIL have been retained.
b. Merger Doctrine
1. When a negotiable instrument is given in payment for an
underlying debt, the debt is merged into the instrument. The
underlying debt and the instrument are no longer separate.
2. 5 key terms
a. Issue, UCC 3-105 – the first delivery of an instrument by
the maker or drawer, whether to a holder or nonholder, for
the purpose of giving someone rights on the instrument.
b. Negotiation, 3-201 – a transfer of possession, whether
voluntary or involuntary, of an instrument by someone
other than the issuer to someone who becomes a holder of
the instrument by virtue of the transfer.
c. Holder, 1-201(20) – with respect to a negotiable
instrument, means the person in possession of the
instrument, if the instrument is payable to bearer, or if the
instrument is payable to an indentified person, the holder is
the identified person who is in possession.
i. Instruments payable to bearer and to order are
ii. To be a holder, you have to have possession of the
d. Transfer of an Instrument, 3-203 – Instrument is transferred
when delivered by a person other than the issuer for the
purpose of giving the person receiving delivery the right to
enforce the instrument.
i. Delivery, 1-201(14) – voluntary transfer of
e. PETE, 3-301 – (i) the holder or alternatively (ii) a
nonholder in possession who has the rights of a holder, or
(iii) someone without possession but the right to enforce
under special rules (lost instruments and instruments that
have been dishonored).
ii. Negotiation and Transfer
a. Original Article 3 gave the holder the right of enforcement,
which sounded like you had to be a holder to enforce
i. The 1990 Revision included 3-301 to show that a
nonholder may be able to enforce.
ii. The Revision made a distinction: Negotiation that
creates a holder vs. other changes of possession that
don’t involve negotiation but may still create the
right of enforcement in the transferee.
b. Case #1, page 5
i. John signs a note and delivers it to Rachel. Payable
to bearer of the note.
1. This first delivery means there has been an
issue of the note to Rachel. Same in Case
2. It is payable to bearer, so Rachel is a holder.
Bearer just means the person in possession.
3. This is not a transfer or negotiation because
it was made by the issuer.
4. The instrument is Bearer paper.
ii. Rachel loses the note, and Peter finds it and takes
1. There has been negotiation of the note to
Peter, because transfer of possession has
been made, though involuntary.
2. Peter is a holder because instrument is
payable to bearer. He becomes the bearer by
possessing, so he is a holder. Same result if
Peter had stolen the instrument (involuntary
transfer of possession). As a holder, he may
enforce the instrument against John. This
isn’t the right to keep the instrument; he’s
not a holder in due course. Therefore, Peter
is vulnerable to adverse claims in possession
by Rachel. But until she brings such a
claim, Peter is a holder and may enforce.
c. Case #2
i. John signs a note and delivers it to Rachel, payable
to the order of Rachel.
1. There was issuance.
2. Also, the note is payable to a certain person,
and that certain person possesses it, so she is
3. The instrument is Order paper.
ii. Rachel sells the instrument to Peter, but she does
not indorse the note.
1. There was a voluntary transfer of
possession, but no negotiation because there
was no indorsement by the holder, Rachel.
The instrument was payable to Rachel, so
Rachel would have had to indorse the note
to Peter for the note to be negotiated to him.
2. However, since the transaction was
voluntary, with Rachel’s intention to make
Peter the owner of the instrument, there has
been the transfer of an instrument. Because
the purpose in giving to Peter was to give
him the right of enforcement.
3. Peter is now a PETE, a nonholder in
possession who under the “shelter rule” of
3-203(b) has the rights of his transferor,
Rachel. Peter is a nonholder in possession
with a former holder’s rights, making him a
a. The difference matters because there
is only a transfer and not a
negotiation, under 3-308(b). If the
validity of signatures is admitted or
proved, the plaintiff producing the
instrument is entitled to payment if
he proves that he or she is a PETE,
unless the defendant can then prove a
defense or claim in recoupment.
b. If the plaintiff establishes he is a
PETE, he gets a directed verdict,
unless the defendant can prove a
defense or a claim in recoupment
(counterclaim). If the defendant
proves the defense, the plaintiff must
prove he is a holder in due course.
a. Problem 1, Page 7
i. Mark signs a note and delivers it to Patricia for
value; she in turn delivers to Theresa for Value. The
note is made payable to the order of Patricia.
Theresa wants to enforce the note. She introduces
the note and rests. Mark asks for a directed verdict.
1. If Patricia indorses the note to Theresa,
Theresa is a holder. Patricia was a PETE
because the note was payable to her, she
then endorsed it to Theresa, making Theresa
a holder and therefore a PETE. SHE
actually gets the directed verdict.
2. However, if Patricia delivered the note to
Theresa intended to pass ownership to
Theresa, but failing to indorse the
instrument, then Mark gets the directed
verdict. Because Theresa must prove the
transaction by which she obtained the
instrument from Patricia. There has been no
negotiation, so Theresa is only proven to be
a PETE if she proves transfer of an
ii. This problem shows that the “magic status” of a
holder is superior
b. Problem 2, Page 7
i. Pete fraudulently induced Maria to issue a note
payable to Pete. Pete indorsed and delivered to
Helen who had no notice of any defenses on the
instrument. Maria discovered she had been
defrauded and notified Helen of the fraud, stating
she would refuse payment. Helen gave the note to
David, telling him the circumstances. David may
recover from Maria free of the defense of fraud
because of the shelter rule.
ii. When Helen took the note, she became a holder in
due course: there was negotiation because the note
was indorsed to her by Peter, so she was a holder.
iii. However, when Helen gives the note to David,
David does not become a holder in due course
because he’s not a holder. Not a holder because
Helen did not indorse it. (Couldn’t be “in due
course” because instrument taken after maturity and
not for value, as well as the fact that he had actual
knowledge of the defense that Maria has.) BUT,
since Helen delivered with the intention of
transferring rights in the note, there was a transfer
1. Transfer vests in the transferee any right to
enforce the instrument, including any right
of a holder in due course. David is not a
holder in due course, but has the rights of a
holder in due course. This is the shelter
2. Most types of fraud would not be an
effective defense where there is a transfer.
3. If David sues Maria on the note, he must
establish that he’s a PETE (meaning that the
note was delivered such that there was a
transfer) and establish that Helen was a
holder in due course, to prove that David
obtained derivative rights from Helen.
4. The justification for shelter doctrine is to
ensure the free market in negotiable
a. However, if the transferee engaged
in fraud or illegality he cannot
receive the rights of a holder in due
a. The debt is merged into the instrument
b. One of the results of merger is that, traditionally, only
payment to the holder of the instrument will discharge the
obligation on the instrument and the underlying debt
a. Payment incurs when made by or on behalf of a party
obliged to pay the instrument to a person entitled to enforce
i. As long as obligor pays a PETE, the obligation is
ii. This is different from the traditional rule. The
obligor can pay a PETE (doesn’t have to be a
holder), and there will be discharge.
iii. The policy is that the obligor does not have to get
bogged down in the dispute of who is the owner of
b. “The dark side” of the rule: real estate
i. Example – Debtor borrowed money to buy home
and granted Bank a mortgage. Bank negotiated
mortgage to Assignee. Neither Bank nor Assignee
notified Debtor of Assignment. Bank did not notify
Debtor, fraudulently, continuing to collect
payments. Assignee then notified Debtor of default.
Bank then closes shop.
1. The Assignee is the holder of the note
because the Bank no longer has possession
of the note. Since the Bank indorsed the
note, there was negotiation to Assignee, who
is a holder, and therefore by definition a
2. Debtor’s payments did not discharge the
obligation because they were not made to a
ii. ALI through the 3d Restatement of Mortgages
created a rule to fix this, but the UCC did not also
fix the problem initially. The Restatement provided
that if Debtor in mortgage situation paid before
notice of the assignment, discharge would still
iii. Of course, in 99% of cases there is no problem
because payment to the bank is payment to the
assignee’s agent. Additionally, the assignee usually
gives the debtor notice, so there is no problem with
paying a non-PETE.
iv. Lambert v. Barker - A sells a house to B. A agrees
to finance the transaction: “pay me a note and give
me, A, a mortgage over the house.” B pays with
note and mortgage on the note to secure the
obligation to pay. A then negotiates the note and
mortgage as security for loan that C is making to A.
1. C doesn’t feel the need to notify B of the
negotiation because C won’t have to collect
from B unless A defaults on note to C.
2. Let’s say B’s lawyer contacts A, wanting to
pay off the debt. A responds that A has lost
the note. B’s lawyer says, no problem, and
pays the remainder of the debt to A. Then A
absconds (runs off). Therefore, A defaults to
C on A’s obligation to C. C contacts B
demanding payment because C is the holder.
3. The UCC result was that since B paid a nonholder of the instrument (A), there was no
discharge for B. B would have to either pay
the instrument the second time, to C, or have
the property seized by C.
a. Also B’s attorney would be liable for
malpractice, because when A said A
lost the note, B’s lawyer should have
required some security before B paid
A. Even if A still did have
possession of the note, if B didn’t
obtain the note back with a notation
that it was paid, then B is vulnerable
to A giving the note to a holder in
due course and C could still collect
from B if C did not have knowledge.
i. This means never pay a note
unless you can obtain the
instrument marked “paid.”
To ensure that the note
cannot be subsequently
negotiated to a holder in due
ii. Or demand some sort of
iii. To do otherwise is
malpractice, if representing a
v. The 2002 amendment to UCC 3-602, however,
solves this problem. A “broad reversal” of the
traditional rule. Not limited to either mortgage
notes or even to consumer transactions.
1. Louisiana, as most states, has not adopted
this amendment. So it doesn’t help very
much in the real world.
2. The New Rule: A notice paid to a person
that was formerly entitled to enforce the
note discharges the debt only if at the time
of payment, the party obliged to pay has not
received adequate notice that the note has
been transferred and that payment is to be
made to the transferee. Upon request, the
Transferee must furnish reasonable proof of
transfer of the note to the Maker.
3. Hypo: Maker issues a note payable to order
of Payee, which Payee indorses and delivers
a. Neither Payee nor Transferee
notified Maker of the transfer and
Maker made payments to Payee
before receiving notice of transfer.
Therefore, Transferee must credit the
Maker for the payments made to
Payee. (Statute does not address
whether Payee is then liable to
Transferee for the payments – but
under unjust enrichment, Payee
would probably have to pay the
Transferee.) This is the operation of
the new rule working effectively to
protect a consumer debtor.
b. However, if Transferee had notified
Maker via adequate notification of
the transfer of the instrument, the
Maker may be an unsophisticated
person not familiar with Transferee.
Not having heard from Payee of the
transfer, Maker calls Payee, who
says that Payee is the agent for
i. This is the blind spot in the
statute: the statute requires
for Maker to contact
Transferee and for Transferee
to furnish proof of the
transfer. In this hypo, Maker
should have contacted the
Transferee, not contact the
ii. So under both the new and
old law, a Payee/Transferor
can defraud a gullible Maker
of a note.
i. Indorsement – 3-204(a)
1. A signature on an instrument that is not a signature of a maker,
drawer, or acceptor [drawee that accepts the check] that negotiates
the instrument, restricts payment of the instrument, or incurs the
indorser’s liability. If you sign on the back, it’s an indorsement
(because makers sign on the front). A paper affixed to the
instrument is part of the instrument (allonge – an archaic concept).
2. Special v. Blank Indorsements
a. If a note is payable to Rachel, who wants to negotiate to
Peter. Rachel could turn the check over and sign, putting
“pay to the order of Peter.” At this point the instrument has
been negotiated to Peter and can be indorsed only by his
signature. This is a special indorsement (3-205(a)).
b. However, if Rachel merely signs her name on the back, this
is a blank indorsement, and the instrument is payable to
i. Blank indorsements are usually the way that
instruments become payable to bearer (“bearer
ii. No additional indorsement is required for
negotiation, unless Peter takes the note and writes
“pay to Tom” and signs his name. Then the
instrument is converted back to order paper through
a special indorsement. Peter could also merely
write the words “pay to Tom” above Rachel’s
signature to specially indorse. This latter approach
is preferable because Peter’s name will not appear
on the instrument; therefore, he will not become
liable on the instrument.
d. Holder in Due Course Doctrine
i. The single most important part of NIL
1. Defined – someone who is a holder in due course takes the
instrument free of any adverse claims of ownership and takes it
free of most defenses to pay the instrument
a. Defenses that would ordinarily be available to a contract
obligor are not able to be used against a holder in due
b. This is different from contract law, where the assignee has
no greater right than the assignor.
2. UCC 3-302 Definition
a. Must be a holder of the instrument
i. Very important and often overlooked
ii. See definition of “holder”
b. The instrument when negotiated or issued to holder does
not bear such apparent evidence of forgery or alteration or
is not otherwise so irregular or incomplete as to call into
question its authenticity.
i. Nothing about the document would excite suspicion
c. Holder took the instrument
i. For value
ii. In good faith
iii. Without notice of defenses to the instrument
3. Remarkable doctrine
a. Radical departure from ancient rule of contract law, that
assignee of contract only steps into shoes of assignor, and
assumes assignor’s rights
b. Common scenario - LP
i. Mark is one of 20 limited partners in which Parker
is the general partner.
ii. Each partner contributes 100k in cash and gives
Parker a note for 50k payable on demand.
iii. Parker would hold onto the notes and make a call on
the notes in the future when needed.
iv. Agreement was that upon receipt of money from
each partner, Parker would return the note to the
v. Notes were payable to order of LP.
vi. Parker indorsed all the notes to the bank and gave to
the bank, though Parker had fraudulent intentions,
which the bank was not aware of.
vii. Parker sold the notes to bank, took the money and
viii. Who bears the loss?
1. Mark bears the loss under the UCC
2. The fraud would be an ordinary defense, and
since the bank took the note in good faith
and for value, and without notice of the
defense, the bank is a holder in due course
and can force payment of the note by Mark
c. Two parties deal with a crook in this above hypo. Policy
question is, who should bear the loss?
i. Assignee who pays the assignor takes into account
the possibility of the obligor having a defense to
1. The assignee is taking the risk of not being
paid – a credit risk
a. So by paying 85% of face value of
the note, the assignee assumes it will
make a profit, even though some
obligors will be insolvent
b. Assignee/bank would also adjust the
price if it believed that obligor might
have a defense of fraud
d. Maker’s concerns
i. A maker may not be aware he is dealing with a
ii. May not be aware of the holder in due course
iii. Defenses available against the payee may not be
available if payee assigns the instrument to
iv. The revisers considered amending the law to require
every negotiable instrument to explain the holder in
due course doctrine, to protect the makers of notes.
1. Suggested a “legend” describing consumer
2. But this suggestion was rejected
ii. Rights of the Holder in Due Course
1. Claims of Ownership
a. The least significant in the “real world”
b. Miller v. Race and Rhodes v. Peacock – seminal 18th
century cases by Lord Mansfield
i. Miller v. Race
1. Promissory note payable to Finney or bearer.
Stolen from Finney and then sold to
2. The innkeeper was a bona fide purchaser
and took free of any claims of ownership.
ii. Rhodes v. Peacock
1. Bill of exchange (modernly, a draft),
indorsed in blank, given to bona fide
2. Same holding as in Miller v. Race
c. UCC 3-306 A person having rights of a holder in due
course takes free of a claim to the instrument.
i. Claim to the instrument – a property claim
(ownership or possessory)
d. Basically, if someone is a holder in due course, they get to
keep ownership of the instrument if the original possessor
of the note sues to receive the instrument “back” from the
current holder in due course
i. If not a holder in due course, previous possessor can
sue to rescind negotiation of the note to the current
ii. See example, pp. 12-13
e. Hypo – (Draft, not a note)
i. Drawer (John) writes $100 check to the order of
ii. Peter steals check from Rachel and forges Rachel’s
iii. Peter then goes to Corner Grocery and gives the
Grocery the check as payment for items. Corner
Grocery is a bona fide purchaser of the note for
value, in this hypo. No notice of any claim Rachel
may have to the instrument.
iv. Rachel sues the Grocery to obtain ownership of the
v. Grocery is not a holder because of the forgery of
1. 3-201(b) the check could only be negotiated
with Rachel’s indorsement.
2. 3-403(a) the forgery by Peter is “ineffective”
as her signature. Since her indorsement is
necessary for negotiation, no negotiation
took place; and therefore, while the Grocery
may have been a bona fide purchaser, it is
not a holder.
3. 3-203(b) Grocery only received rights of
Peter, the transferor (shelter doctrine); Peter
had no rights as a thief, therefore as a
transferee, the Grocery took the draft subject
to Rachel’s claim of ownership.
4. The result would have been different if the
check was blankly indorsed by Rachel.
Example, Rachel just signs the check, then
there would be negotiation to Peter
(involuntary transfer) and Grocer could be a
holder in due course.
2. Ordinary Defenses
a. AKA “personal defenses,” available to drawer or maker.
b. 3-305 Right to enforce is subject to:
i. (a)(1) A defense of the obligor based on … (real
ii. (a)(2)A defense stated in another section of this
chapter… (ordinary defenses)
iii. (a)(3) and a claim in recoupment.
c. 3-305(b) – However, right of holder in due course not
subject to defenses in (a)(2) and (a)(3)
d. Types of ordinary defenses
i. Error, misrepresentation, fraud in the inducement,
failure of consideration. These are ordinary
ii. Those created by Article 3 itself:
1. 3-303(b) Instrument issued without
2. 3-117 Agreements by original parties (issuer
and payee) that modify, supplement, or
nullify the obligation reflected on the face of
a. Example: Child tells parent needs
$5k. Parent gives it; child says it
doesn’t know if it will be able to pay
back. Parent says fine, but wants
child to sign a promissory note
payable to order of parent.
b. The La. 3-117 is different from UCC.
It requires a “separate written
agreement” to modify the original
i. Reflects our laws on
ii. So only written agreements
can modify the terms of the
e. Ordinary defenses may not be raised against a holder in due
3. Real Defenses
a. Real defenses may be raised against a holder in due course
b. Types listed in 3-305(a)(1)
i. Infancy of the obligor to the extent it is a defense to
a simple contract
ii. Duress, lack of legal capacity, or illegality of the
transaction which legally nullifies the obligation of
iii. Fraud that induced the obligor to sign the
instrument with neither knowledge nor reasonable
opportunity to learn of its character or its essential
1. Hypo: Guy going door to door sells you
aluminum siding. Says if you agree to pay
10k, you’ll be the model house in the
neighborhood and get a 1k credit for every
other neighbor that orders aluminum siding.
You sign paperwork that does not reflect the
oral discussion – it is actually a negotiable
promissory note and mortgage on the house.
Guy then negotiates the note to a finance
company. Aluminum siding is never
installed. It’s a complete fraud. But under
3-305, the defense of fraud is not available
against the holder in due course, because
there was a “reasonable opportunity to learn
of its character or its essential terms”
through reading the documents.
2. **The fraud that is a “real defense” is fraud
in factum, or essential fraud. Some sort of
excusable ignorance (which does not include
failing to read what you sign).
a. Fraud in the factum would be signing
a promissory note when you thought
you were signing an autograph book.
iv. Discharge of the obligor in insolvency proceedings
c. Real defenses are very rare
i. Holmes and I play poker. Holmes wins and I write
him a check. He negotiates the check to X.
Gambling is an unlawful cause; there is no action to
enforce the debt. This would have been a historical
“real defense” available against X, a holder in due
course. [Illegality of the transaction]
ii. Usury – an unlawfully high rate of interest being
charged. Small number of states declared usurious
debts to be void.
4. Claims in Recoupment
a. 3-305(a)(3) [the right to enforce an instrument is subject to]
a claim in recoupment of the obligor against the original
payee of the instrument if the claim arose from the
transaction that gave rise to the instrument; but the claim of
the obligor may be asserted against a transferee of the
instrument only to reduce the amount owing on the
instrument at the time the action is brought.
i. See Comment 3 hypo: Buyer and Seller. Buyer
pays with promissory notes. Seller delivers the
goods. Buyer later discovers the goods were
defective, so there is a claim for breach of warranty.
The claim in recoupment is the buyer’s claim that
can offset the seller’s claim to receive payment for
the goods. Like a counterclaim.
ii. The Revision tells us that the claim in recoupment
is available against holders, but not against holders
in due course.
b. Merchant sold goods to Plumber, who gave a 10k note to
pay for goods. Merchant immediately negotiated note to
Finance Co. A month later, Plumber does work for
Merchant; Plumber’s bill for the work was 8k. Plumber
refused to pay the 10k note because Merchant had not paid
its 8k and because some of the goods sold were defective,
causing damages of 4k.
i. Plumber potentially has a claim for breach of
warranty for the 4k loss. This would clearly be a
claim of recoupment.
ii. The 8k is not a claim in recoupment because it did
not arise from the transaction giving rise to the
iii. The 4k claim in recoupment may be asserted as a
defense to payment of the 10k to Finance Co.., as a
holder. However, if a holder in due course, the
claim in recoupment may not be asserted as a
c. The claim in recoupment asserted against the transfereeholder may only be asserted as a shield, not a sword.
i. Example, if the damages to Plumber were 20k, this
would only zero out the 10k note; Finance Co. as a
transferee-holder would not owe Plumber any
ii. However, if there was no negotiation of the note,
and the payee—Merchant—still held the note, the
claim in recoupment could be used not just to
reduce the debt but also to bring suit for the excess
e. Formal Requirements of Negotiable Instruments
1. The rules are clear cut. There is virtually no litigation over
negotiability any more.
2. “Magic words” in the document make an instrument negotiable.
And the document has to avoid saying anything that the statute
3. But the bar examiners love asking questions about negotiability.
See supplement, page 80.
4. 3-102 – Chapter 3 of UCC only applies to negotiable instruments.
Not to money, payment orders, or securities.
5. The drafters wanted to broaden the definition of “negotiable
instrument,” and others wanted to narrow the definition.
ii. Definition – 3-104
1. (a) Aside from special rules in (c) and (d), 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:
a. Payable to bearer or to order at the time it is issued or first
comes into possession of a holder
b. Is payable by demand or at a definite time; and
c. Does not state any other undertaking or instruction by
person promising or ordering payment to do any act in
addition to the payment of money, but the order or promise
i. An undertaking or power to give, maintain, or
protect collateral to secure payment
ii. An authorization or power to the holder to confess
judgment or realize on or dispose of collateral, or
iii. A waiver of the benefit of any law intended for the
advantage or protection of an obligor.
2. (b) “Instrument” means a negotiable instrument.
3. (c) An order meeting all the requirements of (a) except for being
payable to bearer or to order is a negotiable instrument and a
check. A check is a draft made on a bank and payable upon
a. This is just so that I can’t erase “payable to order of” on a
check to make it nonnegotiable.
b. The reason is that bank collections require all checks drawn
on banks to be negotiable instruments.
4. (d) Any promise or order other than a check is not negotiable if it
conspicuously states that the instrument is not negotiable or is not
governed by UCC Chapter 3.
a. But this doesn’t work for checks, just as in (c).
iii. Taylor v. Roeder
a. Involved deeds of trust (mortgages on immovables); given
to secure notes.
b. Only if Prewitt is a holder in due course, because the notes
are negotiable instruments, is he allowed to recover on the
c. The interest rate could not be determined from the face of
the document because it was set at the Chase Manhattan
a. This was not a negotiable instrument because the statute at
the time required the instrument to be a promise to pay a
“sum certain in money”
b. The amount payable must be determinable from the
instrument itself without reference to any outside source
c. The note saying that the interest rate was 3% above a nonfixed amount does not satisfy the sum certain requirement
i. This was in spite of the fact that the Chase
Manhattan Prime rate could have been ascertained
by a phone call
ii. This was the Four Corners rule. The comments
insisted that the computation of the sum could only
be made by reference to the numbers and figures in
the note itself.
3. Many cases at the time followed the position of this case.
a. Some read the statute more broadly, like the dissent in this
b. Dissent: The variable instrument rate creates a balance
between interest rate of borrower and lender in credit
markets where the rate is fluctuating
i. The lender does not want to be tied down for a long
period of time at a fixed rate.
ii. The borrower does not want it to be open ended, so
he agrees to some amount of fluctuation, but to have
an anchor on how high the rate will go.
c. The courts required negotiable instruments to be “couriers
4. Before the Revision, Louisiana and several states amended the
statute to bring about the dissent result: requiring only a fixed
amount of money, with or without interest described in the
5. 3-112(b) now specifically sanctions variable instrument rate notes.
iv. Summary of Requirements
a. Reduced to tangible form
a. By the person ordering or undertaking payment
3. Unconditional promise or order to pay
4. Fixed amount of money
5. Payable to bearer or to order at time of issuance or when first
coming into possession of a holder
6. Payable on demand or at a definite time
7. 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 (with three listed exceptions)
f. Requirements for Holder in Due Course (HIDC)
i. Defined, 3-302
1. The holder of an instrument, if:
a. The instrument does not bear apparent evidence of forgery
or alteration or is not otherwise so irregular or incomplete
as to call into question its authenticity; and
b. The holder took instrument:
i. For value
ii. In good faith
iii. Without notice that instrument is overdue or has
been dishonored or that there is an uncured default
with respect to payment of another instrument
issued as part of the same series
iv. Without notice that the instrument contains an
unauthorized signature or has been altered
v. Without notice of any claim to the instrument
described in 3-306 (property and possessory claims)
vi. And without notice that any party has a defense or
claim in recoupment described in 3-305(a).
2. In shorthand, that holder took the instrument without apparent
evidence of forgery or alteration and for value, in good faith, and
without notice of any claims or defenses.
ii. Good Faith and Notice
a. Used to be defined as subjective honesty under old NIL
b. Now good faith and no notice of any defenses to payment
are both required
c. While separate requirements, they are both clearly linked
with one another
i. If you have notice of a claim, then you probably
cannot take the instrument in good faith
ii. However, there are situations where a person may
have acted in good faith and be deemed to have
notice of a claim or defense
2. Kaw Valley State Bank v. Riddle
i. Co-Mac sold equipment to Riddle and Riddle gave
a note for payment
ii. Co-Mac than negotiated the note to Kaw Valley, as
it did with all its notes for years
iii. Riddle never got the equipment. Consideration for
the note was never delivered.
iv. A receiver had been appointed to take over CoMac’s business immediately before Kaw Valley
notified Riddle that it had the note.
1. The receiver is a state law analog to
v. Kaw Valley now sues to collect on the note from
i. The fact that Riddle never got the equipment is a
defense to payment, but an ordinary defense (failure
ii. Cannot be asserted against a HIDC.
iii. Question is whether Kaw Valley is a HIDC: was
the bank in good faith and did it have notice of the
c. Good Faith
i. Subjective honesty standard; honesty in fact in the
transaction concerned or conduct concerned
1. Also described as “pure (white) heart, empty
2. In other words, even if you are negligent/not
reasonable, if subjectively honest, you met
the GF standard under the old law
a. This standard has changed since this
ii. Court holds that Kaw Valley was honest and did not
have knowledge of the material problem with the
iii. 1990 Revision
1. Occurred after this case (1976)
2. Article 3, drafters in 3-103(a)(4) adopted an
Article 3 definition of good faith.
3. Previously, there was only one definition,
the one in the general rules of Article 1.
4. The Revision changed the standard from
mere honesty in fact to “honesty in fact and
observance of reasonable commercial
standards of fair dealing.”
5. When Louisiana adopted the Revision in
1992, the legislature chose not to adopt the
new definition of good faith. The fair
dealing component was not added so that,
from the standpoint of Louisiana law, the
definition continued to be the “honesty in
fact” standard of this case.
a. However, in 2006, the La.
Legislature adopted revised Article 1
of the UCC, 1-201(b)(20). This
definition is the same as the UCC:
“honesty in fact and the observance
of reasonable commercial standards
of fair dealing.”
i. Kaw Valley was aware of the fact that Co-Mac
frequently delivered equipment to its customers and
at the time of negotiation, the equipment had not
ii. Also Kaw Valley and Co-Mac had a long-term
relationship with each other
iii. Co-Mac had been paying the note for a period of
time following negotiation of the note. Why didn’t
this tip Kaw Valley off to something being amiss
with the note?
1. Legal answer: Test the good faith at the
time of negotiation, and not thereafter. This
is because if things that the holder learns
after the holder buys the note could defeat
their HIDC status, then that HIDC status
wouldn’t mean much at all.
2. Practical answer: Co-Mac was guaranteeing
payment of the notes. This practice is called
selling notes “with recourse” meaning that if
Riddle wasn’t paying the notes that had been
negotiated to Kaw Valley, Kaw Valley can
require Co-Mac to pay the notes.
a. Note, in these kinds of dealings
between dealers in heavy equipment,
they get in squabbles all the time
over things like repairs.
iv. Objective standard
1. This is where Kaw Valley lost the case; it
had notice of the defense, and therefore not
a. Had constructive notice
2. Four different circumstances where courts
have found that a holder has notice of a
a. (1) Holder had information from the
transferor or obligor which disclosed
existence of a defense.
i. Example, at time of
negotiation, Riddle told Kaw
Valley that it never received
ii. Note that “knows” or
“knowledge” in the UCC
means actual, subjective
b. (2) Where the defense appears in an
accompanying document delivered
to the holder with the note
c. (3) Information appears in the
written instrument indicating
existence of a defense
i. Example, the note itself bears
obvious forgery or something
along those lines
d. (4) Knowledge of the business
practices of the transferor or when so
closely aligned with the transferor
that the transferor may be considered
an agent of the holder and the
transferee is charged with the actions
and knowledge of the transferor
i. This is the hard one
ii. May come from having a
close relationship between
transferor and transferee
iii. May also come from simple
knowledge of transferor’s
i. After Riddle proved the defense, the burden shifted
to Kaw Valley to prove its HIDC status
ii. Kaw Valley did not meet its burden of proof that it
did not have notice of the defense.
1. Kaw Valley had notice because they had
notice of Co-Mac’s business practice;
because Kaw Valley and Co-Mac had so
many transactions between them that they
must know of the defense.
2. Knowledge of Co-Mac is imputed to the
principal, Kaw Valley, assuming that there is
an agency relationship. Co-Mac was the
agent for collection, in collecting payments
from Riddle and sending these to Kaw
3. Ultimately, the court recognizes a legal
fiction based upon policy choices. Simply
because they’ve had a series of ongoing
business practices doesn’t necessarily mean
knowledge on Kaw Valley’s part of any
particular practices of Co-Mac. Further, it
does not mean there is an actual agency
relationship. But the court’s reasoning
simply justifies the conclusion that where
there is this longstanding relationship, that
the doctrine of negotiability should not exist
3. UCC: Good Faith and Notice
a. Good Faith, 1-201(19) = honesty in fact in the conduct or
transaction concerned (+now, observance of reasonable
commercial standards of fair dealing).
i. (25) A person has notice of a fact when:
1. Actual knowledge of it,
2. Received notice or notification of it, or
3. From all facts and circumstances known to
him at the time in question he has reason to
know that it exists.
ii. (26)-(28) elaborate
1. “Receives notice” is defined as
a. Either by being brought to his
b. It is delivered to the place of
business through which the contract
was made or at any other place held
out by him as the place for receipt of
2. Notice to organizations: look through the
eyes of the person acting on behalf of the
a. Organization must exercise due
diligence to not have notice
b. Due diligence is then defined here:
c. Notice, knowledge, or a notice or
notification received by an
organization is effective for a
particular transaction from the time it
is brought to the attention of the
individual conducting that
transaction and, in any event, from
the time it would have been brought
to the individual's attention if the
organization had exercised due
diligence. An organization exercises
due diligence if it maintains
reasonable routines for
information to the person conducting
the transaction and there is
reasonable compliance with the
routines. Due diligence does not
require an individual acting for the
organization to communicate
information unless the
communication is part of the
individual's regular duties or the
individual has reason to know of the
transaction and that the transaction
would be materially affected by the
a. Problem 1, Page 32
i. U.S. Treasury Bills stolen from Morgan Bank.
Morgan sends notice of lost securities, describing
the stolen bills, to bankers throughout the country.
Third Bank receives notice and notes this in its lost
securities file. Third Bank then makes loans and
takes collateral, including two of the stolen bills.
The officer of Third Bank who approved the loan
was not aware that the bills were stolen, but never
checked the file either.
ii. Third Bank is not a HIDC because they had notice.
This illustrates due diligence – the officer should
have known that the bank had a “lost securities” file
and should have looked this up. This is why
maintenance of reasonable routines is good.
b. Problem 2
i. Fazarri was induced by Wade to sign a promissory
note payable to Wade. After discovering the fraud,
Fazarri notified local banks and even spoke
personally to the cashier of Odessa Bank about the
fraud. Cashier later on forgot about the
conversation with Fazarri and purchased the note.
ii. One of the classic problems of NIL prior to the
1. Odessa Bank would have lost because there
was actual notice given.
2. Under the old law, there was no distinction
between good faith and notice and both
would be subject to the “honesty” standard
as opposed to constructive knowledge under
the current UCC.
3. If the test is honesty, as opposed to
reasonable belief, there is an argument that a
holder who honestly has forgotten
something that they previously knew could
be acting without notice.
4. This doctrine of “forgotten notice” is pretty
much gone now. The basic point is that,
today, if you are Odessa Bank, you have to
prove under 3-308 that you are a HIDC.
5. The New Prong of “Good Faith”: Reasonable Commercial
Standards of Fair Dealing--Maine Family Fed. Credit Union v. Sun
Life Assurance Co.
i. Expedited Funds Availability
1. Traditional practice is for banks to hold onto
money as long as they can and deny paying
money to the customer
a. If customer deposits check, the bank
sends it on to the drawee bank
b. If the drawee bank dishonors and the
drawer does not have enough money,
the bank never gets money on the
check. If it allowed the customer to
make a withdrawal, the bank would
be out of money and have no way to
acquire the funds to offset having
had to pay the withdrawal to
2. Citizens started complaining that banks were
holding onto funds for too long
3. Congress passed a law saying that banks
must make the money available to customers
on a pre-determined schedule, fine tuned by
4. So under federal law there are strict
deadlines; have to let the customer withdraw
the deposit even though the bank has not
gotten payment from the drawee bank
5. Understand that when you “cash a check,”
the depositary bank is actually buying the
negotiable instrument with the expectation
that the depositary bank will be able to then
collect on the note from the drawee bank.
i. Life insurance policyholder died and the three
beneficiary children had checks written to them by
Sun Life Insurance Company
ii. The checks were all drawn by Sun Life on Chase
iii. Sun Life gave the checks to its agent, so that agent
could give the checks to payee beneficiaries
iv. Agent gave to the beneficiaries, but suggested a
“deal” for them
1. Instead of depositing the checks in their
account, they can deposit them in the agent’s
investing account with “HER Inc.”
2. Each beneficiary indorsed in blank and gave
to the agent
3. The agent and another life insurance agent
took the money and ran! Deposited with
Maine Credit Union and the Credit Union
paid the agents for the checks (cashed them).
v. The payees became disappointed with their
decision, notified Sun Life of the fraud and asked to
issue a stop payment notice to Chase Manhattan.
Sun Life does this. When Credit Union presents the
checks, Chase Manhattan denies them.
vi. Unusually, the CU is able to get some of the money
back from one of the crooks.
1. 4-214(a) says that in these circumstances
where depositary bank does not receive
payment and it allowed its customer to
withdraw the amount, the bank is entitled to
2. However, CU is still out by $40k
i. CU sues Sun Life under 3-414(b). Where a check is
dishonored, the drawer of the check has made a
contract to pay it, and Sun Life as drawer is
potentially responsible for paying the check.
ii. CU also sued one of the beneficiaries who indorsed
the check before giving it to the other agent under
3-415(a). He upon dishonor of the check has made
a contract to pay as an indorser.
iii. Under 3-306 the beneficiary claims that he can
rescind negotiation of the check and make a claim
to the instrument or its proceeds. Because the
beneficiary has that right, Sun Life can assert that
claim as a defense to payment to the CU. (3305(c)).
d. Issue: If the CU is a HIDC, then the beneficiary’s claim of
ownership is ineffective.
i. CU says it gave value for the check, it was in GF
when dealing with the agents, and had no notice of
any fraud and therefore it’s a HIDC.
ii. Trial Court said CU not in GF because did not
reasonably observe commercial standards of fair
iii. Jury held the CU was not in GF and therefore not a
i. The jury was justified and could have rationally
believed that the CU was not in GF
1. It is permissible under CU’s internal policies
and Regulation CC to conclude that CU
should have waited longer to give the funds
to the agents
2. Allowing immediate withdrawal of the
funds was not reasonable/fair dealing
because the check was drawn on an out of
state bank and was a large amount of money
– should have waited several days until
ii. This is problematic for depositary banks and has the
potential to undercut protections available to HIDC
1. This case diminishes protection available to
a HIDC and calls into question whether the
drafters of Article 3 really thought through
adding the second objective component of
f. Good Faith Analysis
i. Honesty in Fact – disposed of easily. Obviously the
CU was acting honestly. There’s no way that the
typical depositary would have any knowledge of
claims of remote persons. Could not have known
what the agents told the beneficiaries to whom the
checks were issued.
ii. Reasonable Commercial Standards of Fair Dealing
1. The federal regulation says that the bank has
to pay the person making a withdrawal and
depositing a check by a certain date. So this
seems to suggest that it would be okay for
the depositary bank to pay the money to the
depositor (the life insurance agents) fairly
quickly. This suggests that a bank in CU’s
position should be able to have HIDC status
if it has to pay out its own money
immediately. Because the federal regulation
requires payment immediately, according to
a certain schedule.
2. There were plenty of cases at the time that
said that doing what the CU did does not
prevent GF, under the honesty in fact
standard, though. Not dishonest to allow a
customer to draw against uncollected funds.
3. The court legitimately has a gripe with the
drafters of the statute. They have given little
guidance as to what “fair dealing” means!
a. 3-103 cmt. 4 – Fair dealing is not the
same as “ordinary care.” Dealing
carefully is not what is meant.
Dealing fairly is the issue. Fairness
of conduct, not care of conduct.
b. Commercial standards in each case
are directed to different aspects of
commercial conduct. But this is not
clear to us who don’t know what the
drafters had in mind.
c. The comments do not define fair
dealing or how it relates to being a
4. Good faith purchase v. performance in
Restatement (Second) of Contracts
a. When addressing a good faith
purchase, the only relevant issue is
b. When addressing a good faith
performance, then the component of
fair dealing was intended to restate
that parties should not be allowed to
take unfair advantage of one another
i. Something more than mere
honesty is required when
performing a contract
c. However, the drafters of Article 3
apparently did not address the
Restatement view in the comments
to Article 3. If they had, then this
case may have come out differently.
5. The UCC does not state to whom the duty of
fairness is owed
a. So the court develops a two prong
i. Whether conduct comported
with industry or commercial
standards applicable to the
ii. If so, whether those standards
were reasonable standards
intended to result in fair
b. Standard the CU observed is that
someone depositing a check should
be allowed immediate access.
However, if large amount or drawn
on out of state bank, the CU had the
discretion to withhold access for up
to 9 days. However, neither
regulations of Regulation CC nor the
CU’s internal policies required the
CU to withhold access. Expert
testimony showed that the practice in
the state was to allow immediate
access to funds.
c. CU is saying it followed standard
procedures and its own procedures,
therefore they were engaged in fair
dealing. The risk of non-payment of
a check like this was virtually zero.
This was a one in a million case
where the payees of the checks had
1. The jury was allowed to take into account
the amount of the check, the location of
payor bank, and the fact that under federal
law the CU would be permitted to place a
longer hold on the check
2. The jury was justified in its conclusion;
rationally could conclude that fair dealing
required a hold on the uncollected funds for
a reasonable period of time and that in
giving value under these circumstances, the
CU did not act according to commercial
standards that were reasonably structured to
result in fair dealing.
g. This case is problematic for banks
i. Between a rock and a hard place
ii. The Expedited Funds Availability Act was meant to
allow banks to make funds available more quickly
iii. But this decision actually gives the banks the
incentive to hold onto money as long as they can,
which bucks the purpose of the federal law!
iv. Plus, customers will get very, very angry when they
can’t get their money immediately.
v. This case shows that drafters did not think it
through or should have explained that for HIDC,
fair dealing has little to do with purchase; and that
honesty is the crucial test.
h. Note 1, Page 42
i. Many of these cases have been decided the same
way. But some cases make clear that fair dealing
means not taking advantage of someone.
1. La. did not initially adopt 3-103(a)(4) new
definition of GF
2. But in 2006, we amended 1-201(b)(20) in
Article 1 to include the new definition of
GF, so La. law now also adopts this 2 part
definition of GF. So the potential for this
kind of case exists in Louisiana, as well.
iii. Overdue or Irregular Instruments
1. 3-302(a)(1) – “the instrument . . . does not bear such apparent
evidence of forgery or alteration or is not otherwise so irregular or
incomplete as to call into question its authenticity…”
2. Problem, p.43: Irregularity of Instruments
a. Maker signed note for 10k to Payee. Should have been
payable in 20k. Payee brought this to Maker’s attention.
Maker told Payee to change the number. Payee did and the
alteration was done crudely.
b. Payee sold note to Holder. Holder demanded payment
from Maker; Maker refused, claiming that Maker never
received goods from Payee.
c. Held: No one can become a HIDC of the instrument
because the instrument bears “apparent evidence of
alteration” that “calls into question its authenticity.”
i. Note that in this case, there was no defense of
alteration, because Maker told the Payee that the
Payee could erase the number and write a new one
in. Normally, the alteration would be valid and
enforceable against the Maker.
ii. Here, however, the Maker has a separate defense,
failure of consideration. But the fact that there has
been some alteration does not suggest to someone
taking the instrument that there is no consideration.
1. This was the problem under the old statute.
2. However, the 1990 Revision resolves the
problem against the holder by saying that if
an instrument is “irregular,” the irregularity
prevents anyone from being a HIDC of the
3. Overdue Instruments
a. 3-304 Overdue Instrument
i. (a) Instruments payable on demand. Becomes
overdue at the earliest of the following:
1. (1) On the day after demand for payment is
2. (2) If instrument is a check, 90 days after its
a. This is one of many rules regarding
checks and the passage of time
b. If more than 90 days have passed
since date of check, no one can
thereafter be a HIDC. But this does
not mean that the check is no longer
3. (3) If the instrument is not a check, when the
instrument (mainly promissory notes) has
been outstanding for a period of time after
its date which is unreasonably long under
the circumstances in light of the nature of
the instrument and usage of the trade.
ii. (b) Instruments payable at a definite time
1. (1) If principal is payable in installments and
due date has not been accelerated, the
instrument becomes overdue upon default
under the instrument for nonpayment of an
installment, and the instrument remains
overdue until the default is cured.
2. (2) If principal is not payable in installments
and due date has not been accelerated, the
instrument becomes overdue on day after
3. (3) If a due date with respect to principal has
been accelerated, the instrument becomes
overdue on the day after the accelerated due
iii. (c) Unless the due date of principal has been
accelerated, an instrument does not become overdue
if there is default in payment of interest but no
default in payment of principal.
b. Problems, Page 45. Problem 1.
i. Buyer is concerned about unrecorded liens on
property he is buying from Seller. Buyer is
suspicious that Seller may have given lien rights to
someone, liens that don’t have to be recorded.
Buyer gets promissory note from Seller to protect
ii. Note was executed by Seller on March 25 and due
75 days later. Note indorsed without recourse to
Plaintiff on Sept. 1 for consideration. Seller refused
to pay the plaintiff.
iii. Plaintiff is not a HIDC, because he took with notice
of the fact that the instrument was overdue.
iv. This is a 3-117 ordinary defense: agreement that
modifies the agreement on face of the instrument.
$6500 is face of instrument, but parties made
separate agreement that Seller’s liability was limited
to those amounts expended by Buyer, which is
$4244 in this case. Therefore, plaintiff as holder
can only sue to receive $4244.
1. In Louisiana, this separate agreement would
have to be in writing to be enforceable at all,
along with the primary promissory note.
2. **Note that the $3,067 is not relevant. This
is what the Plaintiff paid Buyer for the
instrument, meaning that the instrument was
taken by Plaintiff for value. But this does
not limit the amount Plaintiff as holder can
recover. Remember this for exam!
c. Problem 2
i. Payee sold house to Maker. Maker did promissory
note in payment. Payee had to go off to war, so
asked Banker to collect payments on the note.
Later, Maker fell in default and Banker, also with
financial difficulties, sold the note to Purchaser for
value. Purchaser knew that four payments had not
been made, but had no knowledge of the
circumstances under which Banker had taken the
note. Payee gets back and sues to receive
ownership of the instrument.
ii. Purchaser cannot be a HIDC. He had notice that the
instrument was overdue; he knew that several
installments had not been paid.
1. 3-304(b)(1) The principal was payable in
installments, and the Maker was in default
on certain payments and the default was
never cured. Therefore, the instrument was
2. If you have notice that the instrument is
overdue, then you cannot become a HIDC.
iv. Negotiability in Consumer Transactions
1. Universal C.I.T. Credit Corp. v. Ingel
i. This case is not the law anywhere anymore
ii. It is a historical relic. 1964 case: the most recent
state supreme court opinion where a court applied
the HIDC doctrine in a consumer transaction.
iii. In this case, the sale of aluminum siding was
i. Common scheme
ii. $1,890 paid in installments for aluminum siding.
iii. The note was negotiated to a consumer finance
iv. The siding proved to be junk
v. Plaintiff holder is suing the homeowners for
i. The plaintiffs want to use evidence from BBB
records that the payee aluminum siders had been
known to make false representations
ii. Wanted to introduce the credit company’s letter
written to the plaintiffs. Simply says that the
company still requires payment.
iii. Wanted to introduce evidence of misrepresentation.
iv. The court excluded the evidence, saying that the
consumers had the burden of showing that the credit
company was not a HIDC.
d. This case shows that the old rule was that a credit
company’s role was simply financing, that they had nothing
to do with the underlying transaction involved.
i. Even if the dealer’s conduct was outrageous, the
credit company could still require payment on the
ii. The rationale was that the consumers should have to
pay the HIDC, the credit company; and then if the
consumers got a bad deal, just sue the dealer.
1. If the dealer is solvent, then this is a fair
2. However, in reality, often the dealer is either
insolvent or has disappeared. Leaving the
consumers with having to pay the note and
having no remedy against the fraudulent
dealer. (=this case).
2. Change to the Modern Rule
a. The self-evident truth was that a credit company is in a
much better position to monitor the conduct of companies it
i. The finance company is in a better position to
address the risk of a fraudulent dealer by adjusting
how much it will pay for an instrument written to
ii. Dean Rosenthal – the case against applying HIDC
doctrine to consumer transactions.
1. The drafters of the UCC “punted” the issue
for fear that selling the UCC to the states
might become difficult.
2. It fell to courts and legislatures to address
the need for consumer protection.
b. The legislative response
i. UCC took a neutral response, 3-302(g): This
Section is subject to any law limiting status as a
HIDC in particular classes of transactions.
1. The drafters did not take any specific
position, but to acknowledge that the HIDC
doctrine has eroded in certain areas and may
continue to be eroded in the future.
2. Extrinsic laws in states will be recognized.
ii. Most states have some legislation that limits HIDC
doctrine in consumer cases.
1. Louisiana used to, but not anymore.
2. E.g. having additional requirements for a
note to be negotiable.
iii. UCCC (Uniform Consumer Credit Code) prohibited
the use of negotiable instruments in consumer credit
transactions and stated that even if a negotiable
instrument is used in violation of the statute, they
take the instrument still subject to obligor’s
defenses. Only a handful of states have adopted
iv. The FTC Rules: Nationwide Approach
1. Provides the “holder rule”
2. Their jurisdiction is over sellers, not lenders
a. Define the transaction as one entered
into for personal, family, or
i. Sales of goods or services
iii. *NOT business reasons, such
as buying a computer for use
in home office
b. Did not include credit cards
3. Required consumer credit transactions to
have a legend that stated that the instrument
is taken subject to all claims and defenses
4. 3-106(d) The legend does not affect
negotiability, but simply means that the
person taking the instrument cannot become
HIDC. The legend as required by federal
law just means that no one can become a
HIDC of the instrument.
v. So UCC 3-106(d) clarified that the legend simply
meant that the no one could be HIDC.
3. Purchase Money Loans
i. Two different types of transactions exist:
1. Assigned Paper: Buyer gives note to seller.
Seller sells note to finance company (like
2. Purchase Money Loan: Financer lends
money to buyer and gets a promissory note
from buyer. Buyer then takes the loaned
money and pays the seller.
a. To avoid collusion between financer
and seller, FTC had to devise a rule.
ii. Example is buying car. Technically, getting loan
from GMAC and using the proceeds to pay GM for
b. FTC rule requires that when (1) the seller refers the buyer
to a financer or (2) the financer/seller are affiliated by
contract/business arrangement; then the contract between
lender and buyer must contain the same legend stating that
the note to financer is subject to claims or defenses.
i. “Business arrangement”
1. What does it mean? Ambiguous.
2. UCCC is much more explicit: the lender in
a purchase money situation is subject to
buyer’s claims or defenses against the seller.
ii. FTC’s power applies to sellers. Not lenders.
1. Creates an issue. If lender did not include
the notice, what should happen if the lender
does not include the legend?
2. Gonzales v. Old Kent Mortgage Co.
a. An ingenious solution for the
problem, though the court had
absolutely no authority.
b. Court treats a case as if the legend
was there. A “virtual legend.” Treat
the contract as if it did have the
legend. This solves the problem in
purchase money loans of the financer
not having the legend on the
c. The UCC thought this case was
great, so they added a comment to
iii. 3-305. UCC Article 3 amendment: If extrinsic law
requires a legend, even if the instrument does not
have the notice, it is treated as if it did.
1. But this amendment has not been adopted
hardly anywhere. La. has not adopted it.
2. This amendment would apply to both
assigned paper and purchase money
transactions. So if federal law would require
the notice, if a state adopted this
amendment, in a regular old assigned paper
transaction, no financer would be able to
take the instrument as a HIDC, if the
underlying transaction was a consumer
3. However, in reality, the financer will usually
be aware that the underlying transaction was
a consumer transaction. So they probably
could not qualify as HIDC, regardless of the
existence of the legend. Still, the FTC
requirement of the legend has been
v. Payee as Holder in Due Course
a. Usually, a payee would not need to be a HIDC because the
payee is a party to the underlying transaction with the
b. If the issuer has a claim or defense, the payee will have
notice, if not actual knowledge.
c. But there are unusual cases in which the payee may be able
to assert rights as HIDC; to take free of some claim or
defense because the defense arises out of a relationship
between the issuer and a third person.
d. Example, fraud perpetrated upon issuer by someone other
i. Example, fraud perpetrated by agent of the issuer.
A company is the issuer, and its agent acts
a. In two party cases, where there is no third party, a seller
cannot claim he is a HIDC and take free of a claim in
recoupment on the basis that the seller did not know that
the goods were defective.
i. The seller has reason to know of the defects in
goods and takes note subject to the claim.
b. There can only be HIDC when there are three parties
c. Comment 4, 3-302.
vi. Transactions with Fiduciaries
1. Smith v. Olympic Bank
a. Pre-revision case [Original Article 3]
i. The minor child is beneficiary of grandpa’s life
ii. Child’s father is appointed by the court as guardian
for purposes of receiving and managing the
proceeds of the policy
iii. Check made payable to “dad, guardian of child, a
iv. Dad was told to open a guardianship account with
the bank and deposit the check
v. Attorney even talked to bank about the minor
child’s funds being deposited
vi. Dad deposited the check in a personal account and
thereafter spent almost all of the money
vii. After all this, a new guardian was appointed, and he
sues both dad and the bank
i. Issue: is the bank a HIDC?
1. Takes free of the claim of breach of
fiduciary only if HIDC
2. Court says under the old UCC, the bank had
notice of the claim of breach of fiduciary
1. When the bank knowingly allowed dad to
deposit the check in his personal account,
that put the bank on notice of the claim
d. Prior to 1990, the law was not uniform
i. Many cases came out like this one
ii. However, Knox and others reached opposite
iii. Explanation of opposing views:
1. Equities of individual cases are very
a. For example, one similar case
involved the dad depositing the
money in personal account to pay for
his five kids, instead of the one kid
for whom the check was supposed to
2. Drafters adopted the Olympic Bank
2. UCC 3-307. Notice of Breach of Fiduciary Duty.
i. (a) Defines fiduciary (agent, trustee, corporate
officer/director, etc.) and “represented person”
(principal, beneficiary, corporation, etc.)
1. A fiduciary must only use the proceeds or
money not for personal benefit but for the
beneficial owner of the assets
2. The beneficial owner has a claim against the
fiduciary for not acting in the best interests
of the rightful owner
3. Once a check is negotiated to a bank, this
general fiduciary substantive law becomes
4. This statute defines whether someone taking
an instrument has notice of the claim of
breach of fiduciary duty, such that he cannot
be a HIDC.
ii. (b) If (i) an instrument is taken from a fiduciary for
payment or collection for value, (ii) the taker has
knowledge [actual subjective knowledge] of the
fiduciary status of fiduciary, and (iii) the
represented person makes a claim to the instrument
or its proceeds on basis of breach of fiduciary duty,
the following rules apply:
1. (1) Notice of breach of fiduciary duty by the
fiduciary is notice of the claim of the
2. (2) If instrument is payable to represented
person or fiduciary as such, the taker has
notice of the breach of fiduciary duty if
instrument (i) is taken in payment of or as
security for a debt known by the taker to be
the personal debt of the fiduciary; (ii) is
taken in transaction known by the taker to be
for the personal benefit of the fiduciary; or
(iii) is deposited to an account other than an
account of the fiduciary, as such, or an
account of the represented person.
3. (3) If an instrument is issued by the
represented person, or the fiduciary as such,
and made payable to fiduciary personally,
the taker does not have notice of breach
unless taker knows of the breach.
4. (4) If an instrument is issued by the
represented person or the fiduciary as such,
to taker as payee, taker has notice of breach
if (i) taken in payment of debt known by the
taker to be a personal debt of fiduciary, (ii)
taken in transaction known by the taker to be
for fiduciary’s personal benefit, or (iii)
deposited to account other than account of
the fiduciary, as such, or an account of the
i. “Knowledge” of fiduciary status
1. Remember that UCC defines knowledge as
“actual, subjective knowledge.”
2. Therefore, there’s no notice of the claim if
the holder does not actually know that they
were dealing with a fiduciary.
3. In Olympic Bank case, not only did the
check itself reflect dad’s status as a
fiduciary, but also the attorney called the
bank and notified the bank that the dad was
a fiduciary with regard to the check being
deposited in the personal account.
ii. (b) (i) through (iii)
1. Olympic Bank took the instrument for
2. The taker had knowledge of fiduciary status
3. The represented person (the child, through
another attorney) has made a claim to the
proceeds on the basis that the transaction
[deposit of the check to personal account],
was a breach of fiduciary duty
a. The statute is structured such that
deemed notice is based upon (1) who
issued the instrument and (2) to
whom the instrument was made
b. These two questions are the essence
2. (b)(2) [Olympic Bank case]. When
instrument is payable to represented person
(to the kid) or to the fiduciary as such (to
dad, on kid’s behalf):
a. Payment of a debt that taker knows
is personal debt of fiduciary
b. Transaction is known to be for
fiduciary’s personal benefit
c. Deposit to account other than an
account of represented person or
fiduciary as such
i. This is the Olympic Bank
ii. Bank would have had to
require that the check be
deposited in a guardianship
account or in an account in
iii. Controversial. Some states
rejected this portion of the
statute. In conflict with
Uniform Fiduciaries Act
(UFA), which La. has
3. Problem, page 66
a. Guardian deposited check in Bank 1 in personal account,
only until he could get guardianship account opened.
b. Then opened guardianship account in Bank 2. Put funds in
it. Then withdrew from Bank 2 and misappropriated funds.
c. Held: Bank 1’s breach was not proximate cause of the loss
and therefore not liable.
d. Prof.: A good result.
e. Problem: if guardianship account opened at Bank 1, Bank
1 would have clearly been a HIDC, even if the fiduciary
later withdrew and used for personal benefit. Because bank
has no duty to monitor use of funds after the deposit is
i. Statute only imposes a duty upon the holder/bank at
the threshold level: time of deposit. The bank has
no way of monitoring what fiduciary later does with
the deposited funds.
ii. Therefore, in this above mentioned case, there was
technically a violation of the statute by Bank 1.
BUT no harm because transferred funds to
guardianship account at Bank 2, and from the
guardianship account, the funds were withdrawn.
Ingenious use of proximate cause to give Bank 1
4. Problem, Page 67
a. Person issuing the instrument is the fiduciary himself, in
the following situations.
b. In each case, Little Corp. is in a small city with checking
account in Bank. Agreement between Little and Bank is
that Bank may honor checks drawn on the account if signed
in name of Little by either President or Treasurer. President
was involved in the following transactions. In each case in
which President issues the check, she does so in breach of
fiduciary duty. Little Corp. brings an action against each
taker on basis of breach of fiduciary duty.
c. Case #1
i. President’s personal credit card was used to pay for
auto rentals, restaurants, hotel rooms. All charges
incurred for President’s personal benefit and not
related to Little’s business. President wrote check
on Little’s checking account and sent to Issuer of
credit card to pay credit card charges.
ii. This is (b)(4), instrument issued by fiduciary, to
taker as payee.
iii. Credit card company should not be found to be on
notice – this is the right result.
iv. Applying the statute (3-307):
1. Little is represented person. President is a
2. Credit Card company is not liable unless it
has knowledge of fiduciary status and
knowledge that the check is taken in
payment of a personal debt known by the
taker to be a personal debt.
3. “Knowledge” under Art. 1 is actual
knowledge. In the case of an organization,
determine this by the person conducting the
a. Credit card company clerk is
primarily involved in looking to see
amount of check and credits it to
appropriate account. That’s all the
clerk is concerned with.
b. Would have to show that clerk had
knowledge of President’s fiduciary
status. So if the clerk noticed that
the check was written upon Little’s
account, signed by President, the
clerk may have had knowledge of
c. However, there is nothing indicating
to the clerk that would make her
have knowledge that these charges
were a personal debt. The charges
may have been for a business
d. Case #2
i. President buys expensive rug from merchant with
check written on Little’s account.
ii. Same result. However, the fact that transaction was
face to face may cut more in favor of merchant
having knowledge of fiduciary status, because they
saw President write the check on behalf of the
iii. However, still hard to prove that the merchant knew
that this was a personal debt under 3-307(b)(4).
iv. If the rug had been delivered to President’s house,
that may have been a stronger case.
v. Note that the comments to the statute indicate that
holder in due course status should be liberally
construed in these fiduciary breach cases.
e. Case #3
i. President went to clothier’s store and ordered
several custom made dresses for herself. Wrote
check on Little’s account. Clothier asked why
Little’s check was being used. She replied that the
dresses were being given by Little, as a grateful
employer, for her years of service.
ii. Tougher case, but jury might find that Little wins.
iii. Knowledge of fiduciary status? Obviously yes.
iv. Actual knowledge that this was a personal debt of
the President? Maybe not. But could any
reasonable person think that this was an actual
business transaction? The clothier raised the
question to begin with, so perhaps he did have
actual knowledge that she was buying these for
herself in breach of fiduciary duty.
1. Businesses do not pay bonuses to employees
buy handing over the credit card and saying,
“Go buy yourself something nice.”
f. Case #4
i. President wrote $1,000 check drawn on Little’s
account payable to herself. She indorsed, deposited
at bank account in her personal account. Gave it to
a teller who knew that she was Little’s president.
ii. (b)(3) If an instrument is issued by the fiduciary as
such and made payable to fiduciary personally, the
taker does not have notice of breach unless taker
knows of the breach.
iii. The teller does not have knowledge of the breach.
Therefore, Bank wins.
1. How can this be?
2. In a small LLC, it would be common for a
corporate officer to sign his/her own payroll
check. This does not necessarily incite
3. In the same way, a trustee might sign his
own check on a trust account to receive his
fee. So there would not necessarily be
actual knowledge of fiduciary breach by the
4. (b)(3) transactions are normal; therefore,
knowledge of the fact that there is a breach
is the standard.
a. Holder must have given value for the instrument to be a
b. The justification is that HIDC doctrine gives the person
substantial rights against the obligor on the instrument. In
order to attain these special rights, you should pay for it.
c. Avoid having the person receiving the interest get a
d. Statute: 3-303 Value and Consideration
i. (a) An instrument is issued or transferred for value
in five cases:
1. (1) Instrument is issued or transferred for
promise of performance, to the extent the
promise has been performed
2. (2) Transferee acquires a security interest or
other lien in the instrument, other than a
3. (3) Instrument is issued or transferred as
payment of, or as security for, an antecedent
claim against any person, whether or not the
claim is due
4. (4) Instrument is issued or transferred in
exchange for a negotiable instrument
5. (5) Instrument is issued or transferred for the
incurring of an irrevocable obligation to a
third party by the person taking the
ii. (b) “Consideration” means any consideration
sufficient to support a simple contract. If an
instrument is issued for value, it is issued for
consideration (but not necessarily vice versa).
e. Problems, page 68
i. $1,000 from maker to payee. Fraud. Goods never
delivered to maker from payee. In each case, payee
negotiated to holder who had no notice of fraud or
failure of consideration.
ii. Problem 1
1. Payee negotiates to holder, in consideration
of holder’s agreement to perform services
for payee. Before holder is obligated to
begin performance, note falls due. Holder
demands payment from maker. Maker
claims defense of fraud on the instrument.
2. The holder gave consideration, but not
value. (a)(1) says that there is no value
given unless the promise is performed.
a. The rationale is that when holder
learns of the defense, he is not out
anything; all he has done is make a
promise. Whenever maker asserts
his defense to payment, then holder
is relieved of obligation to perform
his promise to payee (because of
failure of consideration under
iii. Problem 2
1. Payee negotiates note to holder, who pays
$900 in cash. Holder has clearly given
value and therefore holder will get the entire
$1,000 of the note by maker.
2. Payee negotiates note to holder, who pays
$600 cash for the note and promises to pay
the payee an additional $300 in 60 days.
After paying the $600, holder learned of the
fraud and paid no more. Holder has given
for value; but only to the extent of
performing promise to pay. The $300 has
not yet been performed. How much can
holder recover from maker?
a. $666.67 (2/3 of the $1,000 note).
b. This is because of a separate rule, 3302(d): If under 3-303(a)(1), the
promised performance that is
consideration is partially performed,
the holder can assert holder in due
course status only as a fraction of the
performance it has given.
c. The holder is a HIDC only on 2/3 of
the $1,000 instrument because holder
only has give 2/3 value for the
instrument through only performing
2/3 of the promised performance
made to the payee.
d. “Partial HIDC.”
e. HOWEVER, La. law is a little
different here: 303(a)(1) – …to the
extent promise has been performed,
or the holder has in good faith
changed his position in reliance on
the instrument, in which case he is
deemed to have given full value for
the instrument. Intended to protect
some transferees who have only
rendered partial performance.
i. This is murky law because
what sort of change in
reliance is anticipated is
ii. This is inconsistent with
303(d), that says you only
become holder on a pro rata
amount of that which you
iii. What the La. legislature
meant has not yet surfaced.
But this language is
iv. Problem 3
1. Payee was indebted to holder on past due
loan. To avoid holder suing payee, payee
negotiated the maker’s note to holder as
collateral for the payment of the loan holder
made to payee.
2. Holder demands payment from maker.
3. Holder did give value under (a)(3):
instrument was taken as security for an
antecedent debt of the payee.
4. The problem with this result is that arguably
holder has not done anything: he was an
unpaid creditor before, and he is an unpaid
creditor now. Why does he suddenly get to
sue maker? However, the statute adopts the
NIL common law policy that perhaps
through the holder taking the note as
security for payee’s debt, this may lead
holder to not sue payee on the debt. And
this is value under the statute.
2. Rights of Depositary Bank in Deposited Check
i. Involves Article 4, Bank Deposits and Collections
ii. Important because HIDC status most commonly
involves the right of depositary banks
b. Check Collection under Article 4: How it works
i. Drawer issues check to payee (customer), who
deposits the check in the depositary bank.
ii. Check drawn by drawer is drawn upon the drawee
iii. What happens?
1. Depositary bank gives the payee (customer)
a provisional credit for his bank account.
This is a book-keeping entry.
2. Depositary bank then forwards to drawee
(payor) bank for payment.
a. If payor bank pays the check, then
the provisional credit becomes final,
and payee/customer gets access to
b. However, in certain cases, payor
bank may dishonor the check
because (1) NSF to pay the check or
(2) drawer issued stop payment
i. Check is returned to
depositary bank. So it will
revoke the provisional credit
to payee (customer) and
returns the check to the
ii. Customer is once again the
holder and can assert its
rights against the drawer
3. Depositary bank may choose to not revoke
the provisional credit, but may charge it
back under 4-214a, meaning that depositary
bank remains the holder.
iv. Depositary bank almost never has any rights against
the drawee. So depositary will sue the drawer. If
the drawer has a defense, the issue then becomes
has the depositary bank given value to payee, so as
to become HIDC, not subject to drawer’s defense.
c. Giving of Value
i. Giving the provisional credit by the depositary bank
is not giving value because it is revocable.
ii. However, acquiring a security interest in the
instrument constitutes giving value:
1. 4-210 explains three ways a security interest
may be created:
a. When the check is deposited, to the
extent that the resulting credit is
withdrawn or applied
b. Check deposited and depositor given
unrestricted right to withdraw the
c. Bank makes a loan or cash payment
based on the check.
2. These special rules only complement the
general rules in Article 3
d. Problem, page 70
i. Addresses the problem of how to determine whether
value has been given; the order in which credits are
ii. 4-210(b) Credits first given are first withdrawn
1. Depositor has account at Depositary Bank
2. See chart page 71
a. Nov. 1 - 4k balance
b. Nov. 2 - 5k deposit by check
c. On what date was the 5k credit
d. The Nov. 2 check was not paid
because drawer issued a stop
payment order on the check. (Claim
is failure of consideration.)
e. Depositary bank sues the drawer
3. The Nov. 3 4k withdrawal is considered to
be withdrawal of the original balance.
4. The Nov. 5 withdrawal of 5k represents the
withdrawal based on the Nov. 2 check.
5. So Nov. 5 is when there is a withdrawal of
the credit given based on the Nov. 2 check.
Because this withdrawal occurred before
bank received notice of the dishonor on the
check (which occurred on Nov. 6), the Bank
is a HIDC. Obtained the check for value.
iv. The policy is to protect those who have an out-ofpocket loss. So if a Bank has given out of its
pocket, then it has given value.
1. Is this what occurred under these facts?
2. On Nov. 6, the bank still had 6k in this
account. The bank had a statutory right to
withdraw any credit it had given to depositor
based on the check, and therefore could have
taken the 5k amount of dishonored check
out of the 6k balance – remove the credit,
reduce the account down to 1k, making the
bank whole. This would mean that the bank
would have no out-of-pocket loss. Further,
even if the customer’s account balance had
been 0k, the bank could have sued depositor
for the 5k. But still, the UCC says that the
bank has given value.
a. However, this is not very likely to
happen in the commercial world.
Because a Bank does not want to
purchase the right to sue the drawer
of a check.
b. Arguably, in this hypo, this creates a
windfall to depositary bank because
bank could both sue drawer and
revoke the credit from customer.
c. The policy is to encourage banks to
continue the common practice of
allowing customers to write checks
on their bank accounts based on
funds that have not yet actually been
received by the bank.
v. **This particular problem is unrealistic: the
numbers are all round and match up evenly. In the
typical checking account, this would not occur.
1. Banks often only because HIDC for a
portion of the check: the portion of the
proceeds for which they have allowed
3. Article 9 Security Interest as Value
a. UCC 3-303(a)(2) says that when the transferee acquires a
security interest or other lien in the instrument (other than
judicial lien), the transferee has given value
i. Whereas Article 9 of UCC specifically addresses
security interests broadly, pertaining to movable
b. Bowling Green, Inc. v. State Street Bank & Trust Co.
1. Very influential case
2. Early in development of the law under the
3. Federal First Circuit
1. SBA made a loan by $15,306 check to
2. Bowling Green then negotiated the check to
Bowl-Mar to buy bowling equipment
a. Conditional sales contract. The
$15,306 was a down payment to
b. Bowl-Mar then deposited the check
in State Street Bank’s account.
3. Immediately after the deposit, there was a
$5,024 overdraft. The Bank first reduced
the overdraft by this amount.
4. Bank then learned that Bowl-Mar went
bankrupt. Bank then applied $10,047 of the
check to other loans that Bowl-Mar owed to
5. Bowl-Mar never delivered the equipment.
6. Bowling Green sues the Bank: claiming that
the Bank was holding the check as trustee
for Bowling Green. Asserting a property
right in the check under 3-306. If the Bank
is HIDC, then there can be no such property
iii. Statute, 4-210
1. First Issue
a. The $5,024 is not at issue. Parties
agree that value was given because
bank reduced the customer’s
overdraft by this amount.
b. Under 4-210, this was an application
of the proceeds.
i. (a)(1) says that bank acquires
a security interest when item
is deposited, to extent that
item has been withdrawn or
ii. In this case, there was no
withdrawal, but there has
been an application—the
bank applied $5,024 to
reduce the customer’s
c. Having this security interest = value,
even if the application could
subsequently be reversed. This used
to be highly controversial.
2. The Post-Bankruptcy Application of
$10,047 to Other Loans
a. Argument that Bank knew of BowlMor’s bankruptcy, therefore knew
that they wouldn’t deliver equipment
to Bowling Green. Argument is that
the Bank therefore had notice of
Bowling Green’s defense…
b. Bank must have given full value at
the time check was received to be a
iv. Floating Lien
1. The bank had a floating lien on Bowl-Mor’s
a. This is a security interest in the
chattel paper and proceeds thereof
b. Under Article 9 lingo, a conditional
sale contract like the one between
Bowling Green and Bowl-Mor is
chattel paper. The check, therefore,
given to Bowl-Mor, constituted
proceeds of the chattel paper. This
means that the Bank had a security
interest in the check, from the
moment that it came into BowlMor’s hands.
2. When Bank became holder of the check, it
became a HIDC because it had already
given value by virtue of the Art. 9 security
interest obtained upon receiving the check.
3. The floating lien is an arrangement where
the secured party has a continuous security
interest in a stream of collateral (e.g.
inventory). The Bank had a floating lien
over all Bowl-Mor’s chattel paper.
4. This opinion is critical because it read the
UCC 3-303 broadly to say that when a bank
acquires a security interest under Article 9 or
outside the UCC altogether (including setoff
or banker’s lien), the bank has given value.
v. Banker’s Lien
1. Common law possessory right in a check by
virtue of customer giving check to the bank
and having pre-existing debts owed to the
1. Bank and customer have account. Once
check is deposited and the bank collects, this
represents a debt owed by the bank to its
2. If customer then owes debt to the bank by
obtaining a loan from the bank, the bank can
set off the amount deposited on the check
(which is really the debt owed by bank to
the customer) against the customer’s debt to
3. This is called “compensation under the La.
a. The old law was that there was no
compensation unless the bank and
customer had an express agreement
b. Now, La. R.S. 6:316, banks have
general right of compensation (set
off) and bank also has a security
interest by law in any checks that a
customer deposits. This statute
makes Louisiana have the same
common law rule regarding set-off
and banker’s lien.
c. Bowling Green--how could bank have become a holder
without showing that Bowl-Mor indorsed the check?
i. Old Article 4-205 stated then when customer
deposited, then the bank had the right to supply the
indorsement. But here this did not happen. How
could the court then say that the bank became
holder of the check? This was very controversial.
ii. The Revision sides with this court by providing
under New 4-205 that where the customer is a
holder, the depositary bank automatically becomes a
holder, even if the customer does not indorse the
check to the bank.
d. Section 4-205 states that a depositary bank receiving a
check for collection becomes a holder when it receives the
check if the customer was then a holder, regardless of
whether the check is indorsed by the customer.
Liability of Parties to Negotiable Instruments
a. Liability of Maker
i. Liability of Parties in General
1. Several types of liability at issue in NIL
a. Liability on the underlying transaction between maker and
b. Liability of a party on the instrument itself
i. This is contract liability assumed by a party by
becoming a party to the instrument
ii. The only way you can become liable on an
instrument is by signing it
c. Liability based on implied warranties imposed by statute
ii. Liability of Maker
1. Simplest of rules of contract liability under Article 3: 3-412
a. A person signing a promissory note makes a contract to pay
the instrument according to its terms at the time it was
b. This is “primary liability,” in the sense that the person
enforcing the instrument does not have to make any attempt
to recover from anyone else
a. Movie company rounded up 20 investors for new motion
picture. Each agreed to contribute $1 million. Company
gets bank financing, and persuades all investors to sign
single negotiable promissory note payable to the company
for $20 million, which company showed to banks to induce
financing. Some of the investors wish to now withdraw
from the commitment to invest. To induce them to not
back out, the company warns them that any one signer of
the note can be sued for the full $20 million.
b. Is the movie company correct in saying that one investor
can be sued for the entire amount?
i. YES. 3-412 and 3-116, the investor is the issuer
who is primarily liable.
ii. Under 3-116, where multiple parties sign an
instrument in the same capacity, they become
jointly and severally liable on the instrument. Any
one or more of them can be sued for the full
amount. (Same as solidary liability in Louisiana.)
c. What rights does investor have against the other persons?
i. Contribution. $1 million from each person.
ii. Under 3-116, the amount of contribution that may
be recovered is stated by extrinsic law of the states.
But all the states have the rule of contribution.
d. Important point is that a solvent co-obligor may have to pay
the entire note. This is important to explain to any client
who is thinking about co-signing a note.
b. Drawers, Drawees, and Acceptors
i. Problem, page 82
1. Facts: Drawer signs and delivers check for $1k to payee in
payment for goods purchased. Check drawn on drawee bank.
a. Payee presents check to drawee and drawee dishonors
because drawer stopped payment.
i. Drawee is not liable on the check to payee because
drawee did not accept under 3-408. A draft is not
an assignment of funds from drawer to payee.
1. Because bank has not accepted by not
signing, not liable.
ii. Drawer is liable to payee because upon dishonor of
the check, the drawer can be made to pay the payee
b. Payee presents check to drawee for payment, and drawee
dishonors even though no stop payment order had been
received and drawer had sufficient funds in account to pay
i. Drawee not liable to payee. Drawer becomes liable
to payee upon dishonor.
ii. Drawee may be liable to drawer for wrongful
c. Payee presented check to drawee for acceptance; drawee
certified the check. Payee presented certified check for
payment. Drawee dishonored check because after
certifying, received stop payment order from drawer.
i. Drawee is now liable to payee for accepting the
check, under 3-414(b).
ii. Drawer is now not any longer liable to payee. The
effect of the drawee accepting the check through
certifying discharges the drawer’s obligation to
d. Drawee refuses to certify check when payee presents the
check, even though drawer had sufficient funds.
i. Bank had no obligation to certify the check.
ii. A bank has no obligation to certify a check; the
refusal to certify a check is not dishonor.
1. When a draft is issued, no one is primarily responsible/liable on the
draft at that point
a. The drawee is simply the person to whom the order to pay
is being made
i. The drawee’s responsibility is to the drawer to act in
accordance with their contract
b. Upon dishonor of the draft, though, the drawer has an
obligation to pay a PETE/holder. But this is secondary
liability. Because the condition is dishonor by the drawee
that triggers the drawer’s liability to the payee.
i. However, a drawer may draw a draft “without
recourse,” which under 3-414 means that drawer is
not liable to payee under (e). But this cannot be
done for a check under (e). Therefore, drawer
writing a check cannot write “without recourse” on
the check. A drawer using a check will always be
liable to payee when check is dishonored by
2. Types of drafts
a. Seller may make draft upon buyer
i. Documentary draft
ii. Often times the draft would have to be accompanied
by a bill of lading showing that the seller has
delivered the goods
i. Virtually everything we will discuss that is a draft is
a. Draft can be accepted, which means under 3-409(a) that
that the drawee has signed the draft
i. Acceptance: Signed agreement to pay a draft as
presented; may consists of drawee’s signature alone
ii. **Do not confuse acceptance of a check with
payment of the check. Acceptance is a technical
term, referring only to some transaction by which
the drawee undertakes the obligation to pay the
instrument by virtue of drawee’s signature on the
instrument. This is not the same as drawee paying
the instrument to payee.
b. Certification or other Acceptance
i. Certification, This is a type of acceptance, 3-413
ii. The effect of acceptance is to make the drawee
liable. Upon acceptance, drawee becomes obligated
to pay instrument’s terms at that time. Drawee then
becomes primarily liable.
c. When drawee accepts, the drawer is discharged from the
obligation to pay the instrument.
d. In practice, commercial entities want the promise of a bank;
not just a drawer’s draft ordering a bank to pay. This is
why cashier’s or teller’s checks have meant that banks
don’t in practice certify checks at all any more. It is much
more convenient for banks to issue a check themselves,
rather than certifying/accepting a drawer’s check.
4. Time Draft
a. Presented first to drawee for acceptance, and then after the
passage of some prescribed period of time, the draft is to be
re-presented to drawee for payment.
b. Often used in connection with letters of credit issued by a
c. Not payable on demand; payable only on the elapse of
some period of time after the drawee’s acceptance.
d. The refusal of drawee to accept a time draft is dishonor;
whereas with other normal checks, refusal to accept a
regular demand draft is not dishonor.
iii. Problem page 85
1. Seller contracted to sell real property to buyer for $150k, payable
on settlement date by certified check. Buyer arrived with
uncertified check drawn on drawee. Seller refused to accept it; “I
wanted a certified check from a bank.” Buyer got seller to call
drawee bank to ask about buyer’s bank account balance; bank
teller said there were sufficient funds. Teller also told seller that
funds would be there when check was presented; teller then faxed
in writing that bank would put holds on the funds so that they
would be there. Later on, when seller presents the check for
payment, drawee dishonors because of insufficient funds in
account. Bank teller was mistaken as to the account balance.
2. To certify the check, the bank would have had to sign it; therefore,
the fax was not an acceptance of the draft. There was no
acceptance; therefore, drawee is not liable to seller.
3. This is the Harrington v. MacNab case:
a. How else could drawee bank be held liable, outside of
b. There’s no consideration for bank’s promise to pay, so there
is no general contract obligation payment.
c. However, seller could not sue the bank in tort, the court
said, e.g. negligent misrepresentation.
i. The case could have been argued either way on this
point. But this particular court found that it would
not be appropriate to recognize a cause of action
ii. This factual scenario doesn’t happen any more,
because tellers are told to never discuss any
information about the balance in a customer’s
account, let alone say that they will put a hold on a
d. Holmes didn’t address this, but what about promissory
estoppel/detrimental reliance as a form of recovery?!
c. Liability of Indorser
i. UCC 3-415
1. Just like a drawer, an indorser of an instrument makes a contract to
pay the instrument according to its terms at the time of
indorsement. But like the drawer, the indorser’s liability is
secondary. It is owed only upon dishonor of the instrument;
conditional liability, just like with the drawer.
2. (b) By indorsing “without recourse,” (which is possible for any
instrument including a check), the indorser can disclaim liability to
pay the instrument.
a. This is a good practice, highly recommended to us as
attorneys, by the professor.
b. Any time you indorse an instrument for purpose of transfer,
for example a settlement check or loan closing check,
should probably indorse without recourse.
c. This insures that the indorser cannot be made thereafter to
pay the instrument as an indorser.
3. Multiple Indorsers
a. The obligation is owed to a PETE or subsequent indorser
who paid the instrument
i. On back of instrument, there are three successive
indorsements (A B and C).
ii. Therefore, if C paid the instrument, he could seek
payment from either B or A. If B paid the
instrument, he could seek payment from A. If A
pays the instrument, he can seek payment from
iii. Any one of them can sue either the drawer of the
instrument or maker if it’s a note.
c. Different rules apply where multiple indorsers indorse as
co-payees, or where there are multiple indorsements by
sureties (aka accommodation parties).
ii. Problem, page 85
1. #1 - Employer sent Peter his paycheck, drawn on Bank One. Peter
indorsed in blank and deposited the check in Bank Two. Bank
Two gave immediate credit in account and Peter withdrew before
Bank Two learned that Bank One had dishonored the check
because employer was insolvent.
a. When Peter indorsed and deposited in his account, he
thought he was just indorsing for purpose of collecting.
b. But by indorsing, he has legally guaranteed payment of the
check. Therefore, Peter is liable to Bank Two if Bank Two
chooses not to proceed against the insolvent employer.
2. #2 – Seller sold real property to buyer. Financed $25,000 of the
$100,000 purchase price. Seller was willing to finance $20,000
himself. At closing, buyer executed the 20k note and a second
mortgage securing payment of the 20k to seller. Investor third
party purchased the note from seller for 15 cash. Seller indorsed in
blank and assigned mortgage to investor. Buyer defaulted in
payments on the note. Under states that have this particular law,
investor could not sue buyer. Can investor sue seller?
a. Seller is liable for full amount of the note to investor
because seller is an indorser.
b. Seller should have negotiated for “without recourse.”
c. Problem once again shows that indorsers are often not
aware that they are liable by indorsing an instrument.
i. Particular hardship in this case because not only
must seller pay on the note that he should have been
receiving, but also under this particular state’s antideficiency law he is not able to sue the buyer!
iii. Dishonor and Notice of Dishonor
1. See text and 3-502—3-504
2. Practically speaking, this is rarely an issue for indorser liability
a. Banks that have remedies against an indorser often have
other more efficient remedies under Article 4
d. Liability of Transferor
i. Transfer Warranties
a. A person who transfers an instrument for consideration
warrants to the transferee, and if the transfer is by
indorsement, to any subsequent transferee:
i. The warrantor is a PETE
ii. All signatures on the instrument are authentic and
iii. The instrument has not been altered
iv. The instrument is not subject to a claim or defense
of recoupment that can be asserted against
v. Warrantor has no knowledge of insolvency
proceeding commenced with respect to maker or
acceptor, or in case of unaccepted draft, the drawer.
b. (b) If there is breach of transfer warranty, the warrantor is
liable for damages equal to an amount equal to the loss
suffered as a result of the breach, but not more than the
amount of the instrument plus expenses and loss of interest
incurred as a result of the breach.
2. Problem, page 87
a. Maker signed and delivered note to payee. Payee, who
fraudulently induced maker to issue the note, indorsed
without recourse and sold to Holder. Holder presented the
note to maker. Maker refused to pay because of fraud.
i. Holder has rights against payee as transferor. Under
3-416(a)(4) the instrument was subject to a defense
against warrantor, therefore the
payee/indorser/transferor violated warranty.
ii. A without recourse warranty only disclaims the
basic indorser contract liability. Writing “without
recourse” only negated the payee’s liability as
indorser, under 3-416(c). But writing “without
recourse” does not negate the transferor’s liability
as warrantor of transfer warranties.
iii. Transferor would have had to write “without
warranties” to disclaim the transfer warranties.
1. However, under (c), the transfer warranties
cannot be disclaimed with respect to checks.
ii. More to come much later.
e. Cashier’s Checks and Teller’s Checks
i. Use in Payment of Obligations
a. Prior to 1990, there was very little statutory law about
cashier’s and teller’s checks.
b. Therefore, for decades courts had to grapple with whether
checks issued by banks should be treated differently from
checks issued by individuals. The case decisions were
c. 3-104(f) “Check” is a draft payable on demand and drawn
on a bank; it includes cashier’s and teller’s checks.
d. Cashier’s check is a check in which the drawer and drawee
are the same bank. A draft drawn by a bank upon itself.
i. Imposes the same liability upon issuer of a cashier’s
check as the maker of a note. Primary liability
exists upon the bank issuing the cashier’s check.
e. Teller’s check is a draft drawn by a bank upon another
i. This is often used by smaller banks or credit unions,
in small communities, in which the drawee is often
a federal reserve or bigger bank.
ii. The drawee bank has no liability generally until the
bank accepts it.
iii. The drawer is liable in the same way that any other
drawer is. Secondary liability; only liable if the
check is dishonored by drawee.
iv. The drawer bank of the check can stop payment like
any other drawer by issuing a stop payment order
upon the drawee bank. 4-403.
2. UCC 3-310
a. (a) Fundamental difference between an uncertified check
and certified cashier’s and teller’s checks (“c/t check”):
when c/t check is taken for payment of an obligation, this
discharges the obligation the same as if the obligee had
i. When someone agrees to take a c/t check, they
agree they are giving up other rights against the
person giving the check.
b. (b) Uncertified check simply suspends the underlying
obligation until either payment or dishonor (if subsequently
paid, obligation is discharged, if dishonored, then the
suspension is lifted). At that point obligor can be sued on
underlying obligation or upon the instrument.
3. Problem, page 90
a. Seller contracted to sell goods to buyer with payment by
cashier’s check. Buyer purchased the cashier’s check for
10k from bank made payable to seller. Before delivering
the check to seller, buyer found out that seller intended to
not comply with the contract. Buyer asked bank to return
the money buyer paid to issue the check, but bank delayed.
Is buyer, the remitter, a PETE?
b. 3-103(11) Remitter – a person purchasing an instrument
from its issuer if the instrument is payable to an identified
person other than the purchaser. (Practically speaking, this
is a c/t check).
i. A fundamental reason for buyer being a remitter in
paying seller, is that the buyer does not have to
indorse a check, which would incur personal
liability. C/T check allows the person purchasing
the check to avoid liability on the instrument.
ii. The seller’s reason is to have a reliable indication
that it will get payment, rather than just a check
written by the buyer; get a bank on the hook, the
promise of a bank to pay.
c. The prevailing view is that buyer is not a PETE. But there
are new comments to 3-301 that say that a remitter is a
i. Why this change in the comments to say something
ii. Buyer obviously is not a holder; there was no
negotiation of the instrument to him. He could only
be a nonholder in possession of the instrument with
the rights of the transferor. Perhaps, the comments
are trying to say that the buyer is entitled to a refund
on the check. Just an indication to the courts that
because the bank has debited customer’s account for
the cashier’s check, the bank has no excuse for not
taking the check back and re-crediting the
iii. We could have reached this same result through
theory of unjust enrichment.
ii. Payment With Notice of an Adverse Claim
1. Right to Stop Payment
i. Often a dispute arises after check is given to seller.
Buyer wants to insure that seller does not end up
with his money.
ii. UCC 4-403(a) A payor bank wrongfully dishonors
an item if it dishonors an item that is properly
payable, but a bank may dishonor an item that
would create an overdraft unless it has agreed to
pay the overdraft.
iii. “Customer” is a person with an account at the bank
b. The Right: 4-403(a) A customer may stop payment of any
item (check) drawn on customer’s account by order to bank
describing the item with reasonable certainty in time for the
bank to act.
i. The customer has a broad right. As long as he
describes the item and gives reasonable time to the
bank to act.
ii. Page 91
1. Problem 1 – Buyer got cashier’s check
payable to seller from Bank A. Bank A
debited buyer’s account for the amount of
the check, and Buyer delivered check to
seller; seller did not deliver goods. Buyer
suspected fraud, so he demanded seller give
check back; seller refused. Buyer contacted
Bank A to stop payment on the check.
Under the statute, there is no right to stop
payment because the buyer is a customer of
Bank A, but the draft was not drawn on his
account; the bank drew the draft on the
bank’s own account. Therefore, the buyer
has no right to stop payment on a cashier’s
a. The 1990 Revision made it clear that
the person buying a cashier’s check
has no right to stop payment.
b. The bank that issued the check may
decline to pay, but this is not because
of a stop payment order.
2. Problem 2 – Same, except Bank A issued
teller’s check drawn on Bank B payable to
order of seller. Buyer ordered Bank B to
a. Once more, the check was not drawn
on buyer’s account, so buyer has no
right to stop payment.
b. On the other hand, Bank A can stop
payment on the check because Bank
A is the customer of Bank B and the
check was drawn upon Bank A’s
account with Bank B. But Bank A is
not obliged to stop payment on
buyer’s behalf; Bank A may do so.
2. Issuing Bank Refuses/Delays Payment
a. Issue: What happens when the bank issuing the check
refuses to make payment?
b. Problem p.92
i. Seller wants cashier’s check from buyer. Buyer got
cashier’s check from Bank payable to order of seller
and delivered to Buyer. Buyer gave check to seller
but then experienced “buyer’s remorse” and asked
seller to call off the deal; seller refused. Buyer
demanded that Bank not pay the check (“Just do
it!”), promising to reimburse it for any litigation
expenses if Seller pressed claim against Bank.
ii. Should the Bank go ahead and pay the Seller on the
check, or comply with Buyer’s demand?
1. 3-411 governs the Bank’s exposure:
compensation for expenses of litigation
(comments say this includes attorney’s fees),
interest, and losses, as well as consequential
(special) damages, as long as the Bank is on
notice of the circumstances giving rise to
2. 3-411 makes a Bank liable for refusing to
pay a cashier’s check to a PETE, the Seller
in this case.
3. Therefore, the Bank should pay the
instrument to Seller and should not listen to
Buyer’s demands just in the interest of
maintaining good relations with its
c. The policy in 3-411 is meant to discourage banks from
refusing to pay cashier’s checks
d. 3-411 Discussion
i. Assume instead that the Buyer does not have
buyer’s remorse, but rather believes he has been
defrauded, and demands that the Bank not pay the
check to Seller.
1. This should not make a difference because
of the merger doctrine.
2. 3-602(a) An instrument is paid to the extent
payment is made by or on behalf of a party
obliged to pay to a person entitled to
enforce. To the extent of payment,
obligation to pay is discharged even though
payment is made with the knowledge of a
claim to the instrument by another person.
a. The fact that the buyer may say he
has been defrauded, and has an
extrinsic legal right to have the
transaction rescinded is irrelevant.
b. The bank does not have to get
involved in the dispute between the
Buyer/customer and the Seller.
c. The Buyer cannot force the bank to
become the referee.
3. The bank has no way of knowing whether
the Buyer/customer is telling the truth.
4. Thus, the rule is that the bank does not have
to take the risk; as long as the bank pays a
PETE, the bank receives a discharge of the
obligation to pay.
a. The Seller is a holder and has
possession; therefore, he is a PETE.
b. Bank receives discharge through
paying the Seller.
ii. Buyer’s Recourse
1. What can buyer do when he believes he has
been defrauded by seller, after having
purchased a cashier’s check made payable to
2. 3-602(b) The obligation to pay is not
discharged if a claim is enforceable against
the person receiving payment and payment
is made with knowledge by the payor that
payment is prohibited by injunction of a
a. So the buyer’s recourse is to get a
court injunction that forbids the bank
b. If the bank has (actual) knowledge of
the injunction and pays anyway, the
bank will be liable to the customer.
Buyer needs to ensure that bank has
been served with the injunction so
that the bank will have actual
3. If it’s not a c/t check, 3-602(b)(ii): “in the
case of an instrument other than a cashier's
check, teller's check, or certified check, the
party making payment accepted, from the
person having a claim to the instrument,
indemnity against loss resulting from refusal
to pay the person entitled to enforce the
instrument.” This is saying that if the party
making payment [bank] previously accepted
from the buyer indemnity against loss
resulting from refusal to pay the PETE, the
obligation is not discharged by paying the
seller, if the buyer had a claim to the
iii. Regardless of the law, banks often refuse to pay the
seller because they want to maintain the goodwill of
1. Therefore, seller will sue the bank to receive
payment from the bank.
2. Bank would want to then third-party sue the
buyer to bring him into the lawsuit.
3. 3-305(c) In an action to enforce obligation
to pay the instrument, the obligor may not
assert a defense, claim in recoupment, or
claim to the instrument of another person…
a. In general, someone obligated on the
instrument cannot assert the rights of
a third person to resist payment of
b. This is the doctrine of jus tertii –
cannot assert rights of third persons.
4. 305(c) continued “, but the other person’s
claim to the instrument may be asserted by
the obligor if the other person is joined in
the action and personally asserts the claim
against the PETE.
a. So if the buyer is joined in the action
and asserts his claim to the
instrument, the bank can also assert
this right against the seller/PETE.
b. The court can then decide on the
merits whether the buyer is correct in
iv. Therefore, if bank does refuse to pay the
PETE/seller, the bank should join the buyer in the
action to be able to assert the buyer’s claim to the
3. Issuing Bank’s Right to Raise Own Claims or Defenses
a. Pre-Revision Law
i. Cases were split
ii. The majority rule was the cash equivalents theory –
a bank as obligor on a c/t check is absolutely liable.
No defenses at all were available.
iii. This was because of a perceived need to enhance
the commercial viability of these instruments.
iv. The cash equivalent theory was problematic—it had
no basis in statute. It was a common law theory
developed by the courts
b. Revised Law
i. 3-411(c) Expenses or consequential damages are
not recoverable if the refusal of obligated bank to
pay occurs because:
1. Bank suspends payments
2. Obligated bank asserts a claim or defense of
the bank that it has reasonable grounds to
believe is available against the PETE
3. Obligated bank has reasonable doubt
whether person demanding payment is the
4. Payment is prohibited by law;
5. or R.S. 10:3-312 is applicable (re: lost c/t
ii. Key in on #2 – If obligated bank has reasonable
grounds to believe it has its own claim or defense
against the PETE, the bank can refuse to pay the c/t
c. Page 99 problem
i. Rolando/buyer gets certified check from Bank One.
Pays Bank One with a check drawn on Bank Two.
Rolando delivered check to Parsons/seller. Bank
One dishonored the certified cashier’s check
because Rolando’s check drawn on Bank Two had
been returned by Bank Two for insufficient funds.
ii. In other words, fraud or failure of consideration
between Bank One and Rolando existed (because
Rolando’s check in payment of cashier’s check
iii. Issue: What is reasonable grounds to believe that
Bank One’s defense (fraud in the inducement or
failure of consideration) is “available against the
holder”? Because Parsons may very well be a
iv. The State Street case, res nova opinion, concluded
that the Bank could raise the defense and still be
free of sanctions, even if it turned out that Parsons
was a HIDC. Professor thinks that this is right
1. The statutory language is ambiguous. But
from a policy perspective it makes sense that
“reasonable grounds to believe the defense
is available” allows the Bank to not be liable
to Parsons because Bank has its own defense
on the instrument.
2. The Bank has no way of knowing whether
the holder is a HIDC when the Bank refuses
to pay the check, so the Bank should be able
to raise the defense, even if the merits of the
case later show that the holder was a HIDC.
4. Lost Instruments
a. Lost Instruments Under Section 3-309
1. A PETE includes a person who lost the
instrument but has rights of enforcement
Instrument may be lost, stolen, or destroyed
UCC 3-309 (a) addresses standing
(b) addresses burden of proof
(a) A person not in possession of an
instrument is entitled to enforce the
a. (i) The person was in possession of
the instrument and entitled to enforce
when the loss of possession
b. (ii) Loss of possession was not result
of transfer or lawful seizure, and
c. (iii) Person cannot reasonably obtain
possession of the instrument because
it was destroyed, its whereabouts
cannot be determined, or it is in the
wrongful possession of an unknown
person or a person that cannot be
found or is not amenable to service
2. (b) A person seeking enforcement under (a)
must prove the terms of the instrument and
the person’s right to enforce the instrument.
The court may not enter judgment for the
person seeking enforcement unless it finds
that the person required to pay the
instrument is adequately protected against
loss that might occur by reason of a claim by
another person to enforce the instrument.
Adequate protection may be provided by
any reasonable means.
iii. Problem, Page 100
1. Illustrated a glitch in the statute
2. Maker borrowed 100k from bank and
evidenced its loan by note payable to order
of bank. Bank failed, so FDIC acquired the
note when it became receiver for bank.
FDIC sold note in a batch of several hundred
notes to Pooler. Later FDIC disclosed to
Pooler that it lost the original note before
sale and that possession of the note had
never been delivered to Pooler. Pooler
brings suit against Maker under 3-309 on a
3. The problem is that Pooler was never in
possession of the note under 3-309(a)(i). In
order to bring an action under the statute, the
claimant must have been in possession of
the note at time loss of possession occurred.
It was the FDIC and not Pooler that was in
possession at the time the note was lost.
4. The case held that the plain words of the
statute did not allow Pooler to have a right
5. Statute was amended to say you have to
prove one of two things: either in
possession at time it was lost, or acquired
ownership from a person that was entitled to
enforce at the time possession was lost. But
this 2002 Amendment has not been adopted
by many states.
b. Lost Cashier’s, Teller’s or Certified Checks Under Section
1. Stiff burden of proof: prove terms of the
instrument and how the claimant became a
PETE. If that proof is made, the court
cannot enter judgment unless the person
required to pay is adequately protected
against loss that might occur by a HIDC
showing up and demanding payment.
2. So the threat of double liability is the
ultimate problem with a lost instrument; the
obligated person who pays someone
claiming to have lost the instrument may
have to pay a second time to a HIDC.
3. Diaz v. MHTC
a. Pre-1990 law not every state took the
same approach to what constituted
i. This is why we currently
have 3-312 which deals
exclusively with c/t checks
i. Plaintiff/payee had two
cashier’s checks and lost
them. Asked for money from
the obligated bank.
ii. Obligated bank required a
bond in twice the face value
of the checks. The plaintiff
could not afford to post this
c. Court: Has no discretion, but must
enforce the statute providing that
security shall be required in not less
than twice the amount allegedly due
under the instrument. Plaintiff had
to post the bond or she could recover
d. Tough result because the state did
not have a statute of limitations for
cashier’s checks; therefore, there was
no law addressing how long security
had to remain posted. The security
would have to remain posted forever.
1. Applies only to c/t checks, certified checks,
and in Louisiana, money orders. 3-312 is a
more desirable alternative than 3-309 on
general lost checks. But you can choose
which one to proceed under if you have a c/t
2. (a) Definitions
a. Check means c/t check
c. Declaration of loss
d. Obligated bank
3. (b) A claimant may assert a claim to the
amount of a check by a communication to
the obligated bank describing the check with
reasonable certainty and requesting payment
of the amount of the check, if (i) the
claimant is drawer or payee of certified
check or the remitter or payee of a c/t check
or money order, (ii) the communication has
a declaration of loss, (iii) communication is
received at a time and manner affording the
bank a reasonable time to act on it before the
check is paid, and (iv) claimant provides
reasonable identification if requested by the
obligated bank. If a claim is asserted in
compliance with this Subsection, the
following rules apply:
a. (1) The claim becomes enforceable
at later of time that claim is asserted
or 90th day following date of the
b. (2) Until claim becomes enforceable,
it has no legal effect and obligated
bank may pay the check. Payment to
a PETE discharges all liability.
c. (3) If the claim becomes enforceable
before the check is presented for
payment, the obligated bank is not
obliged to pay the check.
d. (4) When claim becomes
enforceable, the obligated bank
becomes obliged to pay the amount
of the check if payment has not been
made to a PETE. Payment to the
claimant discharges liability.
4. (c) If after bank pays the claim, and check is
presented by person who has rights of
HIDC, the claimant has to either refund
payment to obligated bank or pay amount of
check to the HIDC.
iii. Problems, page 103
1. Background: Claimant purchases cashier’s
check on January 2.
2. (#1) Thief stole claimant’s purse containing
the check. Check had not been indorsed by
claimant. Claimant asked for stop payment,
but First Bank said that she would have to
come in and fill out a declaration of loss,
and she could get her money 90 days after
date of check. If she wanted money
immediately, had to file a bond. January 6,
she signed the form asserting a claim,
including declaration of loss under 3-312.
Thief indorsed forged claimant’s signature
and deposited at Second Bank on January 8.
Check was promptly presented to First Bank
for payment. Thief ran off with the
proceeds. Claimant 90 days from date of
check demanded payment from First Bank.
a. Claimant has standing under the
b. Proceeding under 3-309, the court
would have to find that First Bank is
adequately protected against multiple
liability. The court could “freeze”
the funds—put them in a restricted
account until the statute of
limitations ran on the instrument (3118). Or require the posting of a
bond. This is why 3-312 was added.
c. Thief could not become a holder of
the instrument because he forged the
indorsement. Therefore, payment of
the check to the thief did not
discharge First Bank. Because
neither Thief nor Second Bank was a
PETE. Therefore, 90 days runs, and
then Claimant may demand payment.
d. If First Bank pays to thief and then
claimant also, what rights does First
Bank have against Second Bank?
i. First Bank can recover from
Second Bank. Because of
(Chapter 5). 3-417
ii. Then Second Bank will have
to pursue Thief for breach of
3. (#2) Change facts above. Claimant indorsed
the check by writing her name on the back;
mailed the check to sister. But Thief stole
check from the mail and deposited it at
Second Bank. By January 10, Claimant
realized something happened to check.
Went to First Bank and requested stop
payment; instead was told to do declaration
of loss. 90 days Claimant sought payment
on the check.
a. The problem is that Claimant
indorsed the check, it became bearer
paper, so it became negotiated by
involuntary transfer of possession to
Thief. Thus Thief became a
holder/PETE, and when he deposited
with Second Bank, the Bank became
b. During the 90 day period, the
payment to the PETE/thief
discharged First Bank’s obligation to
c. Thus the loss falls on Claimant. She
should not have indorsed the check
before placing it in the mail.
4. (#3) Change facts again. Check deposited
by Thief in Second Bank on May 10.
Second Bank promptly presented check for
payment by First Bank. At time of
presentment for payment, First Bank had
already paid the Claimant because 90 days
had elapsed since date of the check. First
Bank dishonors the check when Second
Bank presents it.
a. Does Second Bank have rights
against First Bank or Claimant?
b. No rights. Because under (b)(3) if
claim becomes enforceable before
presentment, the bank is not obliged
to pay the check. And payment to
claimant after it becomes enforceable
discharged First Bank’s liability.
c. Therefore, after 90 days, claim
became enforceable and obligated
bank had to pay claimant. And this
payment discharged First Bank’s
liability, such that not liable to pay
Thief later on.
d. Note that under 3-312(c) if Second
Bank was a HIDC, then this would
complicate things. But here, Second
Bank is not HIDC because the
instrument was overdue at the time
that the instrument was negotiated to
Second Bank (a check is overdue
after 90 days).
e. However, Claimant has potential
indorser’s liability to Second Bank.
i. But under 3-415(e) unless
check is either deposited with
depositary bank or presented
to drawee bank within 30
days of indorsement, the
indorser’s liability is
ii. Here, it was long over 30
days, so her liability as an
indorser was discharged also.
f. Accommodation Parties
i. Liability of Accommodation Party and Rights Against Accommodated
1. Accommodated Party is Individual
i. Practically speaking, while an accommodation party
can be anyone who signs an instrument in any
capacity, for the most part accommodation party
issues arise in the context of promissory notes.
ii. Every state has a general law of suretyship
applicable outside of the law of negotiable
instruments. See La. Civ. Code arts. 3041-3062 (be
familiar with these). This presents the problem that
general suretyship law is not the same as Article 3
b. Problem, page 104
i. Bank would lend Son 25k only if Mom cosigned
note. Mom did so by signing lower right hand
corner on face of note. Bank then advanced the
money. Proceeds used in Son’s business. Son
defaulted; Bank asked Mom to pay. Mom estranged
ii. Mom is a co-maker on the note; therefore she is
solidarily bound (jointly and severally liable) for the
whole thing (3-116). 3-419(b) she is liable in the
capacity in which she signs, even as an
accommodation party, even though she has received
no direct benefit (did not receive any of the funds).
Nothing requires proceeding against the Son first.
iii. If she pays, she has the right to demand
reimbursement (the entire amount) from Son.
1. Ordinarily several obligors receive only
contribution from each other.
2. But here she gets reimbursement under 3419(e).
iv. Son has no right of recourse against the Mom
because accommodated party under 3-419(e) has no
right of action against the accommodation party.
v. This problem demonstrates that a solvent
accommodation party will probably be called upon
to pay first.
1. Mom was lending her credit for the benefit
of her son.
c. Problem, page 106
i. Bob/Ted borrow money from Bank to set up
business. Bob’s parents and B/T’s wives are
required to cosign by the bank. Ted defaulted.
Bank demanded payment from the parents.
ii. They signed as makers because they signed on the
front of the note, as opposed to the back, in which
case they would be indorsers.
1. Regardless of how you sign, you can still be
an accommodation party, as long as you sign
for the purpose of incurring liability, without
being a direct beneficiary of the value given.
2. Under 3-419(b), an accommodation party
can sign as maker, drawer, acceptor, or
a. A maker, for example, can still be a
b. It’s not true that only an indorser can
be a surety.
i. Still some courts don’t realize
ii. The confusion comes from
the fact that indorser liability
is only secondary (triggered
by dishonor of the instrument
by another party).
c. A co-maker of a note can be a surety.
iii. The nature of co-maker’s obligation is to pay the
instrument voluntarily. Makers and co-makers are
iv. UCC 3-419(b) Basic rule is that an accommodation
party is obliged to pay the instrument in the
capacity in which the accommodation party signs.
It doesn’t matter whether the accommodation party
receives consideration for being an accommodation
1. The contract liability on the instrument is
the same as any other party signing the
instrument in the same capacity. If
accommodated party is maker, liability is the
same as any other maker.
2. So what is the difference between
accommodated party-maker and just pure
maker? As accommodation party, there may
be the benefit of special defenses, as long as
the person seeking to enforce the instrument
has notice of accommodation party status.
3-419(c): Person signing an instrument is
presumed to be an accommodation party,
and there is notice of their status if there is
an anomalous indorsement or words
indicating that the signer is a surety or
a. In other words, except for some
special defenses available under
UCC 3-605 (not in Louisiana
statute), contract liability is not
affected by the fact that person
taking the instrument had notice that
you signed as an accommodation
b. Anomalous indorser – this
constitutes notice to person enforcing
that you are signing as an
i. 3-205(d) Anomalous indorser
– an indorsement by someone
other than a holder of the
instrument. Therefore, an
indorsement by someone who
signs solely for the purpose
of incurring liability. Not a
holder; signature is not
necessary for negotiation, so
the only reason to sign is to
ii. When there are ordinary
serial indorsements, as
among each other, an
indorser is liable to a
subsequent indorser. They
are liable in the order in
which they sign.
iii. If indorser indorses
anomalously, they are jointly
and severally liable. Among
themselves, they have rights
c. A holder has notice of
accommodation party status if he has
actual knowledge or constructive
notice through words on the
instrument indicating the party’s
d. Under common law and many state
statutes, before creditor can pursue a
surety, he must exhaust all rights
against principal obligor. This used
to be Louisiana law. Called
“discussion.” Usually waived by
suretyship agreements. In Louisiana,
the obligor does not have to pursue
the principal obligor first.
v. 3-419(d) If signature of party to an instrument is
accompanied by words indicating unambiguously
that the party is guaranteeing collection rather than
payment of the obligation of another party to the
instrument, the signer is obliged to pay the amount
due to PETE only if (i) execution of judgment
against other party has been returned unsatisfied,
(ii) other party is insolvent, (iii) other party cannot
be served with process, or (iv) it is otherwise
apparent that payment cannot be obtained from the
1. So Parents and spouses should have
indicated unambiguously that they were
only guaranteeing collection, on the face of
the instrument. Absent putting such
unambiguous language, in signing the note
they are primarily liable, though they still
have certain suretyship defenses.
vi. If accommodated party pays, can’t get anything
from accommodation party.
vii. If accommodation party pays, he can get full
reimbursement from any accommodated party(ies).
viii. If this was a community property state, the spouses
would not be indirect beneficiaries; they would be
direct beneficiaries so they would be co-owners of
the business and therefore may become
ix. Assuming separate property state, there are four
1. If parents pay, how much can they recover
from spouses, the other accommodation
parties? The right of contribution (25%
each) among each other. Accommodation
parties can recover contribution among each
2. However, if one accommodation party is
insolvent, then the remaining three are each
liable for 1/3.
2. Accommodated Party is Business Organization
a. Problem, page 106–07
i. X owned 50% of stock of Corporation and also was
President. Y and Z were officers who owned 25%.
Corporation needed a loan and the note was signed:
By X, President
2. By signing first as representative, the
president was not incurring personal
3. But here, X also signed in his individual
capacity. Intended to impose liability on
ii. The loan was used entirely for corporate purposes.
X paid the bank the entire 10k balance upon default.
iii. Issue: Is X treated separately from Corporation as a
distinct person, or are they indistinguishable, such
that payment of the loan proceeds to Corporation
was payment to X, such that X was a direct
1. There is no indication that we should pierce
the corporate veil under these facts.
Therefore, X should be treated as an
accommodation party. If we pierced the
veil, then X would not be an accommodation
party; he would be treated the same as the
Corporation, the maker of the note.
2. X only receives an indirect benefit by being
a 50% shareholder; therefore he is treated as
an accommodation party and can get
reimbursement from the Corporation based
on having paid the debt.
b. Plein v. Lackey
1. Corporation purchased property and in
payment gave a promissory note for 75k and
a mortgage securing payment (deed of trust)
2. Signed by corporate officers, representatives
of the corporation. Also signed by the
President and his wife, individually. This
made President and wife jointly and
severally liable because they are co-makers.
3. President paid off the note and so President
received the mortgage note.
4. President argues that he as holder of the note
and assignee of the mortgage has a first
mortgage on the property. Wants to
foreclose on the property and apply the
proceeds to satisfy the note. He argues that
as an accommodation party he can now
pursue the accommodated party.
ii. Issue: Is the President an accommodation party
subrogated to the seller’s rights? Or is he a
principal debtor, in which case the debt has been
iii. Court: President was an accommodation party
1. Only an indirect beneficiary; received no
direct benefit of the proceeds of the
2. Common law rationale that the bank would
not have issued credit but for the President’s
signature on the instrument
iv. Under 3-419(e) when President paid the note, he
now has the right to enforce it against the
ii. Suretyship Defenses
a. Sureties are extended certain rights and privileges that other
obligors in the same position do not enjoy
i. Sureties are in a favored position in the law
ii. Historically, surety was gratuitous
iii. When surety gives a helping hand without
compensation, this is favored
iv. The trade-off is that the law will give special rights
b. For example, the obligee must exhaust its rights against the
obligor before pursuing the surety. This is no longer the
law, unless the surety unambiguously indicates that his
signature is only guaranteeing collection of the instrument.
c. Suretyship law has historically extended some special
defenses to sureties
i. The defenses arise out of transactions between the
accommodated party/obligor and the creditor. The
surety does not consent to these transactions.
ii. Four categories:
1. Creditor discharges or releases the principal
obligor from the obligation entirely (3-604)
2. An extension of time to pay
3. Other modifications of the principal debt;
for example, an increase in the interest rate
4. Release of collateral
iii. The surety who hasn’t consented may have his
risk/burden increased by these transactions
1. Surety sometimes can raise these changes as
a defense to payment
d. The revision of UCC 3-605 and Restatement of Suretyship
had some conflicting rules
e. Modern: 3-605 was rewritten to make it consistent with the
Restatement, making the rules even more complicated
i. Louisiana has not adopted 3-605
ii. Louisiana addresses the issue in the Civil Code
2. In modern commercial transactions, these defenses often mean
nothing because they are almost always waived in agreements
3. Civil Code
a. Art. 3059 – The extinction of the principal obligation
extinguishes the suretyship.
i. If the obligation on the instrument terminates, the
surety is always immediately released.
ii. This results from the nature of accommodation. If
the principal debtor is released, the surety is
b. Types of suretyship
i. Legal suretyship – not an issue in negotiable
ii. Commercial suretyship, Art. 3052 – One in which:
1. The surety is engaged in a surety business
2. Principal obligor or surety is a business
3. The principal obligation arises out of a
commercial transaction of the principal
4. The suretyship arises out of a commercial
transaction of the surety
iii. Ordinary suretyship, Art. 3044 – One that is neither
commercial nor legal.
iv. Commercial suretyship is defined very broadly, but
it does not include any requirement that the surety
c. Modification of the Principal Obligation (Art. 3062)
i. Modification or amendment of the principal
obligation, or impairment of real security held for it,
by the creditor in any material manner and without
consent of the surety, has the following effects:
1. For ordinary suretyship, the suretyship is
extinguished. Regardless of whether there is
any harm/risk to the surety.
a. For example, parent guarantees
child’s student loan. If there was no
waiver in the agreement, and the
principal obligation is changed, the
parent is discharged.
2. A commercial suretyship is extinguished to
the extent that the surety is prejudiced by the
creditor’s action, unless the principal
obligation is one other than for the payment
of money [never true for negotiable
instruments—this situation exists in
construction contracts], and the surety
should have contemplated that the creditor
might take such action in the ordinary
course of performance of the obligation.
The creditor has the burden of proving that
the surety has not been prejudiced or that the
extent of the prejudice is less than the full
amount of the surety’s obligation.
a. Once the surety has established a
modification or impairment of
collateral, unless the creditor proves
no prejudice or prejudice less than
the full amount of the debt, the
surety is off the hook entirely.
iii. Accommodation Party Raising Defenses of Accommodated Party
1. Jus tertii – one obliged to pay the instrument cannot usually raise
defenses of third parties unless they are joined in the lawsuit
2. But there is an exception in 3-305(d):
a. If the action is against an accommodation party, there is no
necessity of joining the accommodated party in the action,
and the accommodation party may assert any defense or
claim of the accommodated party to payment, except for
the defenses of discharge in insolvency proceedings,
infancy, and lack of legal capacity.
b. So an accommodation party can raise accommodated
party’s defenses generally, without necessity of joinder of
the accommodated party.
g. Signatures by Representatives
i. Liability of Agent on Notes
a. The issue is often litigated whether the representative who
signs an instrument is liable on the instrument
2. Statute: 3-401
a. One cannot be liable on the instrument unless that person
signs the instrument or the person is represented by an
agent who signs the instrument and the signature is binding
on the represented person under 3-402.
b. Signature is defined broadly to include a mark with the
present intention to authenticate a writing
3. Signature by Representative: 3-402
a. (a) Liability of the Principal
i. The statute is doing nothing more than
incorporating by reference the state law of
ii. If person acting as representative signs instrument
by signing either name of principal or name of
signer, the represented person is bound by the
signature under extrinsic state law of agency. If
represented person is bound, the signature of the
representative is the “authorized signature of the
represented person” and the represented person is
liable on the instrument, whether or not identified in
b. (b) Liability of the Representative
i. If representative signs the name of representative to
the instrument and the signature is an authorized
signature of the represented person, the following
1. If the representative signs and he does not
have the agency power to bind the purported
represented party, then we get to 3-403,
which states that the signatures binds no one
but the representative.
ii. (1) If the form of the signature shows
unambiguously that the signature is made on behalf
of the represented person who is identified in the
instrument, the representative is not liable on the
iii. (2) Subject to special rules on checks in (c), if (i)
the form of the signatures does not show
unambiguously that the signature is made in a
representative capacity, or (ii) the represented
person is not identified in the instrument, the
representative is liable on the instrument to a HIDC
that took the instrument without notice that the
representative was not intended to be liable on the
instrument. With respect to any other person, the
representative is liable on the instrument unless the
representative proves that the original parties did
not intend the representative to be liable on the
4. Page 114, Problems
a. Treasurer is authorized to pay promissory notes on behalf
of New Corp.
b. #1 – She does not want to incur personal liability in signing
the promissory notes, that will evidence bank loans and
credit made to the company. How should she sign the
notes, to gain full protection from liability under 3-402(b)?
Write “New Corp., Inc., by Carolyn Park, Treasurer.”
i. This format will ensure that she will not incur
personal liability, even to a HIDC.
ii. She has (i) named the represented party and (ii)
unambiguously shown that she is acting on behalf
of the represented person. It is unambiguous by
using the longstanding custom of the word “by”
showing that she is acting for someone else.
c. #2 – Are the following signatures “ambiguous”?
i. New Corp. Inc., by Carolyn Park
1. No indication of capacity as “treasurer”
2. But the comments indicate that this is still
ii. New Corp.. Inc., Carolyn Park, Treasurer
1. Comments indicate this is unambiguous,
even without the word “by” because the
corporate capacity of “treasurer” is indicated
iii. Carolyn Park, Treasurer
iv. New Corp Inc., Carolyn Park
v. Any deviation from the customary form will be
treated harshly by the courts. So just use “by” and
indicate the person’s corporate capacity.
d. #3 – Carolyn signs a note authorized by New Corp. merely
by writing her name, “Carolyn Park.”
1. This scenario is fairly common:
a. Agent signs a form piece of paper,
and then corporation says it will later
fill in the rest of the blank form. And
eventually the instrument is given to
a third party, and only the agent’s
name is on the note.
ii. The modern law varies from the pre-1990 law.
1. The original law would have been that New
Corp. would not have been liable. Under the
common law, New Corp. would not have
been liable unless it would have been named
in the instrument.
2. Modernly, under 3-402(a) the represented
person, New Corp. is liable even though not
3. Carolyn’s Liability
a. If the person seeking payment is a
HIDC, then Carolyn is definitely
liable on the instrument because her
signature did not indicate
unambiguously that she was signing
in a representative capacity.
b. If not a HIDC, then Carolyn can
defend by showing that under (b)(2)
there was an understanding between
the original parties that the
representative would not be liable on
c. The generally rule is that if either she
doesn’t indicate her representative
capacity unambiguously or the
represented person is not identified,
or both, then the agent is liable when
signing the instrument.
i. Carolyn neither indicated her
representative capacity nor
identified the represented
ii. So her only hope is under the
ending language of (b)(2),
proving that she and the
payee originally agreed that
she would not be personally
iii. Prior to 1990 if she had
signed in this fashion, she
would be liable to anyone
and would not have been able
to avoid liability.
iv. Now, Carolyn would in effect
have to prove a modification
of what was shown on the
face of the instrument. This
is a 3-305/3-117 ordinary
defense not applicable to a
HIDC. In Louisiana, such a
counterletter, would have to
be in writing to be
enforceable. So Carolyn
would have to prove using
written evidence, to avoid
liability by showing that she
and original payee agreed
that she would not be
e. #4 – In order to evidence loan obligation to New Corp.,
Carolyn signs in front of note unambiguously to name
represented person. However, on back she signs as
“Carolyn Park.” The usual reason one signs on the back is
to guarantee payment as an indorser. It would make no
sense for her to sign as an issuer/representative of principal
unless she intended to be personally liable.
i. This was an anomalous indorsement, which is
presumed to be for accommodation. But she can
defend, again, under (b)(2) by proving intent
between the original parties that she would not be
personally liable (as long as the person seeking to
enforce is not a HIDC).
ii. Liability of Agent on Checks
a. 3-402(c) If a representative signs the name of the
representative as drawer of a check without indication of
the representative status and the check is payable from an
account of the represented person who is identified on the
check, the signer is not liable on the check if the signature
is an authorized signature of the represented person
[signing with authority].
b. The rule of signatures of representatives is different for
i. Different from the old rule:
1. Old Rule:
a. If you neither named the principal
nor indicated signing as
representative, you were liable
b. These indications had to appear next
to the signature on the check.
c. Having the represented person’s
name in the upper left hand corner of
the check was not sufficient to
“identify” the represented person.
ii. So the reason for the new rule is to allow the
representative to sign a check without having to
rewrite the company’s name beneath the signature
line. If the company’s name is indicated elsewhere
on the check, this is sufficient for the representative
to not be personally liable.
2. Triffin v. Ameripay
i. Outsourcing of payroll function to third parties
ii. The payroll company performed the payroll
function for various employers/companies. The
payroll company in this case opened an account
upon which the payroll company could draw funds
to pay the employer’s employees.
iii. The payroll company issued checks; some
employees cashed the checks and the checks were
dishonored for insufficient funds. Plaintiff is in the
business of purchasing dishonored checks and
seeking to enforce them against drawers of the
iv. Plaintiff’s theory is that the payroll company is the
drawer of the checks and is liable
i. The name on the check determines the status.
Payroll company was only acting as agent of the
ii. The employer is actually the drawer of the check;
only the employer is liable.
iii. Even though payroll company opened the account,
it opened the account on behalf of the employer to
pay funds that the employer sent to the account.
1. Therefore, under 3-402(c) because the
represented person is identified on the
check, the payroll company is not personally
liable on the check, even though the payroll
company’s name is on the account.
3. Other issues:
a. Where the name of identified represented person is not the
exact name of the company
i. Subsection (c) is not clear as to what it means to
“identify” the represented person
ii. Where Comfort Plus Inc. is actual name, the court
said “Comfort Plus” is sufficient to “identify” the
iii. Don’t have to reproduce the exact legal name. Only
have to identify the represented person.
b. Use of trade names
i. If XYZ’s trade name was ABC, and “ABC”
appeared on the check.
ii. One court held that “ABC” was sufficient to
“identify.” But this is more arguable, where the
trade name linguistically bears little relation to the
company’s actual name.
iii. It’s better for a company that uses checks to have
the actual name and “d/b/a [trade name]”
h. Accord and Satisfaction
1. Falls underneath “compromise” in the Louisiana Obligations
2. The process by which disputed debts/obligations can be settled
3. Common law: accord is the agreement to settle the disputed debt,
and the satisfaction is the performance of the agreement.
1. Use of checks as settlement mechanisms has long been widespread
2. The person tendering payment will put a legend on the back of the
check indicating “paid in full,” such that the payee’s accepting
payment under the check extinguishes the underlying claim.
3. Common areas of use
a. Insurance companies
4. Previous law
a. In Article 1, 1-207 provided seemingly that the settlement
could be avoided by writing “under protest,” “without
prejudice” or the like and scratching out the “paid in full”
language, and then cashing the check.
b. The new statute makes it plain that 1-207 does not apply to
accord and satisfaction. Payee cannot now unilaterally
modify the check to avoid a settlement.
iii. Statute: 3-311
1. (a) If person against whom a claim is asserted proves that (i)
person in good faith tendered an instrument to claimant in full
satisfaction of the claim, (ii) the amount of the claim was
unliquidated or subject to a bona fide dispute, and (iii) the claimant
obtained payment of the instrument, the following rules apply:
2. (b) Unless (c) applies, the claim is discharged if the person against
whom the claim is asserted proves that the instrument or an
accompanying written communication contained a conspicuous
statement to the effect that the instrument was tendered in full
satisfaction of the claim.
3. (c) Subject to (d), a claim is not discharged under (b) if either of
the following applies:
a. (1) The claimant, if an organization, proves that (i) within a
reasonable time before the tender, the claimant sent a
conspicuous statement stating that accord and satisfaction
instruments should be sent to a designated person, office, or
place, and (ii) the instrument or accompanying
communication was not received by that designated person,
office, or place.
i. This addresses the concern of a large retailer that is
not able to carefully visually examine all the
thousands of checks it receives every day, to look
for accord and satisfaction language on checks.
ii. Allows organizations to designate a specified office
or person to whom such instruments should be sent.
b. (2) The claimant, whether or not an organization, proves
that within 90 days after payment, the claimant tendered
repayment of the amount.
i. Allows an escape hatch for those who receive a
settlement by mistake. If you cash the check, you
can repay within 90 days to avoid a binding
settlement. Then you are still a claimant; the payor
does not receive a discharge.
ii. This led to concern from consumer groups who
were concerned that (c)(2) was too big-guy
company friendly…so they added (d).
4. (d) Notwithstanding (c), if claimant or his agent having direct
responsibility with respect to the disputed obligation has actual
knowledge of instrument issued in full satisfaction, then that
a. If payment is made to someone on claimant’s behalf that
has “direct responsibility” for the obligation, as long as that
person has actual knowledge of the full satisfaction, then
the claim is discharged although (c) would otherwise apply.
5. Most litigation is over the basic question of whether or not the
language is “conspicuous.”
Payment Systems: Checks and Credit Cards
a. Check Collection
1. U.S. is the only country in which checks are the most commonly
used noncash method of payment
2. Finally the volume of checks processed in the new millennium has
begun to subside
3. Still, billions of checks remain in circulation
a. Mountains of checks are physically transported every day
—Apocalypse Now reference in the casebook!
4. Article 4 is the backbone of our focus now.
ii. Article 4: Check Deposits and Collections
1. As opposed to Article 3
a. Article 4 did not have a pre-UCC counterpart; there was
some common law, but no comprehensive framework.
Whereas Article 3 had the benefit of NIL.
2. The drafter (a lawyer)’s approach to writing Article 4 was not to
use theory, but actual intimate knowledge of how check collection
works, what banks actually do. Article 4 was drafted to codify
“best practices” of the mid-twentieth century.
a. A criticism has been that it is a banker’s statute. That it is
b. The law was designed to fit the transactions. Not designed
to force the transactions to fit the statutes.
3. Effect of computerization
a. Revision of 1990 brought Article 4 up to date
b. Federal law plays a much bigger role in this area than it did
prior to 1987, when Congress passed the Expedited Funds
i. Congress in the Act delegated plenary power to the
Federal Reserve Board to make changes governing
ii. Therefore the Fed can preempt state law in the area
of check collections where it believes this is
iii. So Article 4 has been adopted by the states, but
federal law makes some modifications to these
rules, which we will address later
4. The Process
a. 4-104 and 4-105 are the primary definitions sections
i. Drawer issues check to payee. Payee deposits in
depositary bank (“collecting bank”). Usually, the
depositary bank would issue a provisional credit to
the payee’s account. Now we are concerned with
what happens after depositary bank takes the check.
ii. Depositary acts as payee’s agent for obtaining
payment of that check from the drawee bank
1. The depositary could do that through
sending the check directly to payor bank,
but this is not what commonly occurs.
2. More typically, the check passes through at
least one, often more than one,
3. DrawerPayeeDepositary Bank
(Collecting, Presenting)Drawee Bank
iii. The two intermediary banks are also collecting
banks. The intermediary, collecting bank that
actually presents the check for payment to the payor
bank is the “presenting bank.”
iv. Each intermediary will give a provisional credit to
the bank the check is received from. This is
v. When intermediary #1 receives from collecting
bank, it gives provisional credit. When
intermediary #2 receives from #1, it gives #1 a
provisional credit as settlement. When #2 presents
check for payment to payor, the payor will give
intermediary #2 a provisional credit.
1. All these credits are provisional only,
subject to revocation (4-214) if the check is
vi. Why Intermediary Banks?
1. Depositary may be small, local bank that
sends check to its regional federal reserve
bank. That regional federal reserve might
send to regional federal reserve for the
drawer. Then that bank presents to the bank
upon which the check is drawn.
iii. Time Check Is Paid by Payor Bank
1. The Midnight Deadline
i. Provisional credit/settlement is ordinarily to be
given on the day the check is received by payor
ii. Payor bank must then make a decision about
whether to pay the check or dishonor it.
1. If bank does not dishonor in a timely
fashion, then under the statute, the
provisional credit statutorily becomes final,
no longer subject to revocation. Under 4215, the payor bank is deemed to have paid
a. Important terminology: A check can
be paid only by the payor bank. Any
bank can settle for a check by giving
its customer a provisional credit, but
only the payor bank can pay a check.
i. This is different from a
depositary bank giving value
for a check deposited by a
customer. This is buying, or
“paying for” a check,
differing from “paying” a
check, which is only by the
b. If bank dishonors in a timely fashion,
it can revoke the credit given to
presenting bank by returning the
iii. If properly revoked, then each bank in the chain will
revoke the provisional credit given to previous
intermediary banks, and last intermediary will
revoke credit given to depositary bank, who will
ordinarily revoke the credit given to payee.
1. So the timely dishonor by payor bank means
that the check goes all the way back to
payee, who then pursues action against the
drawer of the check. But this is dependent
upon the payor bank’s compliance with 4301.
1. Payor bank that settles for item (other than
one presented over the counter) before
midnight of day of receipt can revoke the
settlement and recover settlement if before it
has made final payment and before midnight
a. Returns the item; or
b. Sends written notice of dishonor or
nonpayment if item is unavailable
2. Problems, page 124 #1: Drawer on Bank A
pays check to payee, who deposits in Bank
B. Bank B gives provisional credit and
presents to Bank A. Bank A gets the check
in a bundle Monday morning. Bank A
provisionally settles by sending Bank B a
Fedwire for total amount of the cash letter
with all the checks in the bundle. Checks in
the bundle went through Bank A’s readersorter computer on Monday afternoon.
a. (a) Reader-sorter picked out the
check because account balance was
insufficient to pay. On Tuesday,
Bank A reviewed the
customer/drawer’s account and
found that there was still insufficient
funds. Bank A decided to dishonor
and sent to check return office on
Tuesday afternoon. Check not
returned until 3 a.m. on Wednesday
morning by courier that left the bank
at that time, because of a mix-up.
Check arrived at Bank B on
Wednesday afternoon. On Thursday
Bank B revoked the provisional
account in payee’s account and
returned check to payee on Friday.
i. Midnight Deadline – 4104(a)(10) is midnight on the
next banking day following
the banking day on which
bank receives the relevant
item. “Banking day” is the
part of the day the bank is
open to carry on substantially
all of its banking functions.
ii. Since receipt was on
Monday, the midnight
deadline is end of day
Tuesday. Thus, Bank A
missed its midnight deadline.
iii. Under 4-301(a) revocation of
the settlement made on the
day of receipt (Monday) may
only be made if the check (1)
is returned [sent [deposited in
mail or delivered] or
delivered to customer or
transferor physically] or (2)
when the check is not
available, giving written
iv. The bank was not sent until
given to the courier at 3 a.m.,
which was after the midnight
deadline. Therefore, the bank
is “accountable” for the
check under 4-215. Check is
deemed finally paid. Bank A
is liable for face amount of
the check regardless of
whether the payee has
suffered any loss as result of
the late return—strict
liability. This “strict
liability” is because the payor
bank must act in a timely
fashion, or else the depositary
bank cannot know if it’s safe
to allow the payee/customer
to withdraw the money.
b. (b) Check selected for visual
inspection because of large amount.
After inspection, Bank A decided to
pay and drawer’s account debited at
1:00 p.m. on Tuesday. Check sent to
filing clerk who was supposed to
mail with other canceled checks at
end of month. Bank A then learned
that mistake was made—the drawer
had insufficient funds. But courier
had already left and file clerk left,
couldn’t find the check. Check was
found at 9 pm and put in the mail at
10 pm, addressed to presenting bank,
Bank B, where it arrived on Friday.
i. Bank revoked the settlement
timely because it was “sent,”
or placed in the mail, before
the midnight deadline.
ii. Putting check in the mail at
10 pm was a “return of the
check” under 4-301(a)(1).
iii. Therefore, bank is not
accountable on the check; no
iv. Banks know that they just
have to get the checks
physically out of the bank in
some way that meets the
definition of “send,” by the
v. The time of receipt is
important, but not under state
law, rather under Regulation
vi. The filing clerk is a red
herring. Under original law,
payment of the check
required a payor bank to
complete its “process of
posting” the check to the
drawer’s account. In the
1990 Revision, this “process
of posting” was eliminated as
c. (c) Coming back to this later.
3. Problem #2, page 125
a. Drawer drew a Check on account
with Bank payable to Payee. Payee
deposited its account, which was also
with Bank, on Monday. (Bank is
both payor and depositary bank.)
Bank gave Payee a provisional
settlement on Tuesday. Wednesday
morning Bank discovered that
Drawer’s account was insufficient; in
the afternoon erased the credit from
Payee’s account and returned check
b. The credit was not properly revoked;
Bank is liable for the amount of the
c. The problem is the statute’s wording
of 4-302(a)(1)—if the bank, in any
case in which it is not also the
depositary bank, retains the item
beyond midnight of the banking day
without provisionally settling for it,
or, whether or not it is also the
depositary bank, does not pay or
return the item or send notice of
dishonor until after the midnight
d. Carefully read, the statute gives two
separate deadlines: (1) where payor
bank is not also the depositary bank,
the payor bank must settle
provisionally by midnight on the day
of receipt. (2) In all cases, whether
or not the payor bank is also the
depositary bank, the bank must
return or send notice of dishonor by
the true midnight deadline, midnight
of the banking day following day of
e. Thus in this problem, the failure to
provisionally settle until Tuesday
does not matter; because the bank is
both payor and depositary. But the
bank is still subject to the midnight
deadline; the bank waited until
Wednesday to do this, missing the
c. Blake v. Woodford Bank
1. K+K, drawer, sent 2 checks to Blake, payee,
who deposited at Morristown bank. Dec. 3
and Dec. 17 check. The Dec. 3 check was
dishonored, but Blake still said to send the
Dec. 17 check.
2. The checks arrived at Woodford, payor
bank, for presentment on Dec. 24 and were
returned on Dec. 27.
1. Dec. 25 is Christmas, not a banking day.
Therefore, the midnight deadline was
midnight, end of day Dec. 26.
2. Woodford missed its midnight deadline.
3. The only thing Woodford can do is raise a
force majeure defense to full liability on the
amount of the check: 4-108(2), Interruption
of communication facilities, suspension of
payments by another bank, war, emergency
conditions, or other circumstances beyond
the control of the bank provided it exercises
such diligence as the circumstances require.
4. Woodford alleges that under this statute it is
excused because of the heavy workload of
Christmas and two of the check posting
machines had broken down; additionally a
key bookkeeper of the bank was ill and thus
not present at the bank.
5. Held: It was foreseeable that there would be
an increased number of checks on Christmas
and that machines might break down and
people get sick. Therefore, the bank did not
exercise due diligence as required under the
statute; the failure to meet the midnight
deadline is not excused.
iii. Purpose of Midnight Deadline
1. Because the drawee/payor bank is not
personally liable on an instrument until
certifying the check, there has to be some
deadline, or else the payor bank will wait
indeterminably to choose whether or not to
accept the check.
2. The deadline that has been selected is
midnight of next day; in effect gives banks a
two-day turnaround in processing checks.
a. Some argue that this is too bank
b. It costs the customer a day’s interest.
For a big business like Wal-Mart this
could be serious revenue foregone by
giving payor banks a two-day rather
than one-day turnaround.
iv. Other Force Majeure Cases
1. Breakdown of an armored car was not a
2. However, in another case, a computer
breakdown was a force majeure. This case
is an anomaly because the vast majority of
cases will not excuse banks. Computer
failure is ubiquitous and will never excuse
v. Re-presentment of Check
1. The Dec. 3 had already been dishonored
once and returned by Woodford on a timely
2. Woodford argues that it should at least avoid
liability on the Dec. 3 check that was represented because it already discharged its
obligation to dishonor the check once, in a
3. Leaderbrand, Kansas Supreme Court—held
that re-presentment of check did not require
bank to meet midnight deadline.
a. KSC got it wrong because of
misinterpretation of the law.
b. Time draft is one that by its terms
must be presented initially for
acceptance by drawee, who signs,
and then after the lapse of a
prescribed period of time, the check
is presented a second time for
i. The first presentment is really
a contract to pay. The second
presentment is when the
timelines start running.
ii. KSC was looking at the rules
on time drafts when it
addressed a re-presented
iii. The rules applicable to time
drafts have nothing to do
with checks and representment of checks.
4. All courts now recognize that Leaderbrand
was wrong and that a re-presented check
must still be timely dishonored.
a. It’s very common for dishonored
checks to be re-presented, and many
times they are paid the second time.
b. This is because laypersons deposit a
check in their account and then
immediately draw a check on their
account, not realizing that the funds
deposited won’t be immediately
available. Therefore, often when the
check is re-presented, the customer’s
deposit will have cleared and
therefore the re-presented check will
c. Also, the depositary bank has no way
of knowing of a check’s dishonor
without this rule. Depositaries never
receive notice of payment; they only
receive notice of dishonor. The
depositary bank infers honor of the
check when it has not received
notice of dishonor by the time it
expects notice to come. This is the
importance of the midnight deadline;
it allows the depositary bank to
assume at some point that the check
it presented to the payor bank has
been honored by the payor bank.
d. Settlement by End of First Day of Receipt
i. Almost always, banks in practice do provisionally
settle by midnight on the first day, as is required by
ii. Only one case of record, Hanna, in which payor
bank was held liable for failing to settle
provisionally on the first day.
1. It’s not even clear from the court’s opinion
how the bank failed to settle.
2. Court only said that payor bank had
presented no admissible evidence of
settlement. So perhaps it was just a failure
2. What Is a Payor Bank?
a. 4-302(a) says that presentment to payor bank starts the
running of the midnight deadline period.
b. 4-107: A branch or separate office of a bank is a separate
bank for the purpose of computing the time within which
and determining the place at or to which action may be
taken or notices or orders shall be given under this Article
and under Article 3.
i. The comments to this statute admit that this statute
is not specific. The courts must resolve the issues
based upon the facts of each case.
c. Problems, page 139
i. #1 Bank has 20 branches in large city and a large
processing center to which all checks drawn on any
bank are automatically routed. The Check is
received by the Center at noon on Day 1 and run
through computers; more than 5k, so delivered to
Branch at 8 a.m. on Day 2. Branch decides to
dishonor and sends back to Center at 5 p.m. On
Day 3, Center dispatched check to motor courier.
1. The processing center and banks are not
treated as separate banks. Given the way
that they function.
2. Deadline started running when the Center
received the check; so it should have
dispatched by end of Day 2, and was not.
Thus bank is fully liable.
ii. #2 – Bank has 100 branches; processing centers in
Eastern area and Western area of city. Check drawn
on Eastern branch and deposited in account at
Western branch on Day 1. Delivered to Eastern
Center on Day 3. Delivered to Eastern Branch on
Day 4. Eastern Branch decides to dishonor and
returns to Eastern Center on Day 4. Eastern Center
dispatches at 11 p.m. on Day 4, where it arrived to
Western Center on Day 5.
1. Eastern and Western branches are treated as
2. Thus, when Eastern Center received check
on Day 3 is when deadlines started running.
Check was put in the mail from Eastern
Center an hour before midnight on Day 4, so
the deadline was met.
3. Check Kiting
i. Open accounts in several banks, in one account
having only a nominal amount of funds
ii. Write a check on the nominal account and then
draw on account at another bank to deposit that
amount at the other bank
iii. The reason it is called “kiting” is that the checks
iv. The scheme involves seeing how many banks you
can make withdrawals from before the bank will not
allow you to withdraw when the bank learns that the
check deposit in that bank has been dishonored
b. First National Bank in Harvey v. Colonial Bank
1. Check kiting between related entities
2. The entities were essentially the same
entities; same shareholders and directors
3. There are competing equities involved in the
application of the midnight deadline in a
check kiting situation
4. Kiting is an attractive scam because
depositary banks are required to make the
funds available quickly under federal law.
Thus federal law makes kiting possible,
notwithstanding computers that could
normally discover kiting schemes.
1. World Commodities and Shelly are the
related companies. The transactions occur
all on the same day.
2. World is the drawer of 13 checks ($1.5
million) drawn on Colonial, paid to Shelly,
who deposits the checks at FN
3. Shelly draws 17 checks ($1.5 million) on
FN, giving them in payment to World as
payee, who deposits at Colonial
4. So both FN and Colonial are the depositary
and payor banks, respectively, because each
related entity (Shelly and World) has a role
as drawer and as payee
iii. Facts—Detecting the Kiting Scheme
1. FN realized that it might be the potential
victim of a kite; an officer of the bank froze
Shelly’s account with FN. On Wednesday,
FN decided to dishonor the checks presented
by Colonial. They dishonored the checks by
sending notice by Fedwire (Fed’s
communication system) that Colonial
received during the day. The reason for the
return originally was “uncollected funds”
but was changed to “refer to maker” (refer to
a. Regulation CC requires that in cases
where payor bank dishonors check of
$2,500 or more, direct notice of
dishonor is required to be sent to the
depositary bank no later than 4 p.m.
local time for depositary on second
business day following the
presentment of the check. If payor
bank fails to do this, it is liable for
depositary’s actual losses, if any (not
liability on face value of check)
b. Here, therefore, FN did both
necessary things: under Regulation
CC [giving the requisite notice] and
under the UCC/state law [dishonored
the checks and returned before
2. Colonial now had to decide about what to do
with the 13 checks drawn on it by its
customer. To avoid liability it must return
them by midnight that day—the midnight
deadline. Therefore, only had from 2:45 to
12:00 to decide. Colonial asked its
customer/drawer what was going on. The
customer/drawer/kiter lied and said that the
checks were good and would be paid when
3. Colonial waited until Thursday to return the
checks—after the midnight deadline
4. FN sues Colonial for violation of the
midnight deadline, arguing that Colonial is
now accountable for the face amount of the
iv. Cause of Action
1. Colonial’s liability under 4-302(a)—failure
to take timely action requires in
accountability on the amount of the checks
a. Colonial’s defense is that when FN
returned the checks drawn on it, FN
knew or strongly suspected a kite.
That FN is trying to get out before
the kite crashes. FN will get a
b. Colonial argues for relief from strict
liability of 4-302(a) because of these
2. So issue is potential bad faith of FN
1. It does not make any difference whether FN
suspected a kite
2. Article 4-109 establishes a defense for payor
bank based on force majeure. But the
statute does not suggest that the defense
should be extended based upon the
depositary’s suspicions about a kite.
3. A separate statute, 4-103(e) makes a bank
liable when it fails to exercise ordinary care
in handling a check, but only to the extent
that the item could have been collected in
the observance of ordinary care. Recovery
is reduced by the amount that would have
been uncollectible. In other words, this is
liability on account of negligence.
a. The defense is that strict liability is
not fair where the customer is telling
Colonial one thing and that Colonial
should be excused because it
exercised ordinary care
b. But the court focuses on the fact that
the role of the payor bank in check
collection is crucial. The whole
system would break down if banks
were allowed to delay these
4. Court upholds the strict requirement of the
vi. Good Faith?
1. The UCC imposes a duty of good faith in
the performance or enforcement of every
contract or duty within the UCC
2. Colonial alleges that it is bad faith for FN to
not disclose its suspicions of kiting to
Colonial. That FN’s return of the checks
indicating “refer to maker,” or “ask the
customer about it,” was not sufficient to
disclose the kite. That the overriding
obligation of good faith required FN to
disclose the suspected kite.
3. Held: FN was not in bad faith; it did not
have an obligation to disclose the suspected
a. A depositary bank that suspects a
kite does not have a duty to disclose
suspicions to the payor.
b. The depositary may both return
checks drawn on it as payor and seek
to collect checks drawn on another
c. There is a dissenting view in Oregon;
but that is the only jurisdiction taking
the view that FN was in bad faith.
4. Banks are competitors. They are not
fiduciaries. Thus FN had no general duty of
disclosure. FN’s decision to return the
checks drawn on it and still pursue
collection of deposits from Colonial was a
business decision that a bank is allowed to
c. Good Faith?
i. Observance of reasonable commercial standards of
fair dealing. This definition has been added to the
previous definition of merely “honesty in fact.”
ii. Perhaps this is why Oregon courts have held that a
bank in FN’s position would have been in bad faith.
iii. It might not be “fair dealing” for FN to act the way
d. UCC 4-302(b)
i. Text: The liability of a payor bank to pay an item
[because of failure to meet the midnight deadline] is
subject to defenses based on breach of a
presentment warranty or proof that the person
seeking enforcement of the liability presented or
transferred the item for the purpose of defrauding
the payor bank.
1. Comment says that in a check kiting
scheme, the payor bank should not be liable.
2. So if the payee or presenter of the check is
perpetrating fraud, the payor bank should
not be liable.
3. The above case held differently because
a. The purpose of the comment is to
ensure that the check kiter will not
be able to enforce payment of the
b. But in the case, FN was not
operating a check kiting scheme.
Therefore Colonial may not raise an
affirmative defense to payment of
the check to FN because FN did not
defraud Colonial; FN was only
caught up in the check kiting
ii. This is an affirmative defense to the midnight
deadline rule of liability
4. Effect of Regulation CC on the Midnight Deadline
a. Regulation CC
i. 12 CFR pt. 229, Section 229.30(c)
ii. Why federal law got involved
1. It used to be that the depositary bank would
not allow the depositor to withdraw the
funds deposited until at least week, allowing
the depositary to present the check to the
payor bank and collect, and thus finally
credit the depositor’s account for that
2. Depositors squealed to the government
about banks waiting so long to make funds
a. The banks’ answer was that this was
necessary to protect them.
b. The check often passed through an
intermediary bank (“forward
collection”)—moving the check
through intermediary to the payor
c. The checks would be machineprocessed and not be seen by a
human being until payor bank
received, and even then only under
d. But when checks were dishonored,
this was handled manually because
each bank involved in the process
must physically erase the credit
given to the transferor, all the way
back to the depositary bank, who
will erase the provisional credit
given the customer
e. Therefore, depositary bank had to
protect itself by waiting sufficient
time to make sure that the check was
3. In 1987, Congress passed the Expedited
Funds Availability Act, requiring depositary
banks to make funds available according to
federal deadlines—as set by the Federal
iii. Under midnight deadline, as long as bank gets the
check in the mail before the midnight deadline, it
may avoid final payment of the check. But the mail
is slow, so the transferor bank may not receive the
dishonored check for several days.
1. The midnight deadline rules under the UCC
have only focused on the time of dispatch
into the mail, without considering how long
it would take for notice of dishonored items
to get to the transferor bank.
2. This is why Regulation CC changes the
UCC midnight deadline. It focuses on time
of receipt by the bank of notice of
iv. The Text:
1. Extension of deadline. The deadline for
return or notice of nonpayment under the
UCC is extended to the time of dispatch of
such return or notice of nonpayment where a
paying bank uses a means of delivery that
would ordinarily result in receipt by the
bank to which it is sent
a. (1) On or before the receiving bank’s
next banking day following the UCC
midnight deadline; this deadline is
extended further if a paying bank
uses a highly expeditious means of
transportation, even if this means of
transportation would ordinarily result
in delivery after the receiving bank’s
next banking day
i. The “highly expeditious”
exception is not often used.
An example would be the
payor bank paying Fedex to
pay for the fastest method of
b. Oak Brook Bank v. Northern Trust Co.
1. Judge Posner—leading jurist wrote the
a. Checks were drawn by unidentified
check kiter on Northern. Deposited
in Oak Brook and presented for
payment to Northern on Feb. 11.
Did not decide to dishonor until Feb.
13, after the UCC midnight deadline
had expired. But notified Oak Brook
of nonpayment by telephone on Feb.
13, complying with Regulation CC.
b. Evening of Feb. 13, Northern puts
the checks into transport.
a. Regulation CC extends the deadline
for return to the time of dispatch, as
long as payor bank uses a means of
delivery that ordinarily would result
in receipt by the transferor bank’s
next banking day.
b. Therefore, Regulation CC’s focus is
different from the UCC midnight
deadline rule. UCC only requires
sending, or putting notice in the mail
by midnight deadline. Regulation
CC requires sending the notice by a
means in which the receiving bank
will receive the notice by the end of
the receiving bank’s next banking
day after the midnight deadline.
ii. “Banking Day”
1. This is a federal reserve bank. In light of
such a bank’s functions, which are primarily
check processing, the banking day is 24
hours per day.
2. The statutory standard is the time of the day
during which a bank is carrying on
substantially all of its banking functions.
Which is all day and night for federal
3. In this case, Regulation CC was met because
the notice was sent by the end of the second
4. The comment to 4-104 says that under the
definition of “banking day,” the part of a
business day when a bank is open for only
limited functions, e.g. to receive deposits
and cash checks, but with loan, bookkeeping
and other departments closed, is not part of a
“banking day.” Regulation CC adopts a
5. Federal Reserve banks exist primarily to
process checks—so this is its primary
a. The plaintiff wants the court to
separate the bank’s daily activities to
find that at the time the bank
received the notice, the banking day
b. The court refuses to do this. It
would be impractical for payor banks
to monitor internal operations of
returning banks in order to make sure
that sending a check by courier at a
given hour on a given day would be
within the returning bank’s “banking
c. Posner is suggesting that the Fed.
Reserve Board goofed in drafting
this rule in tying the “banking day”
standard to a subjective
should have just adopted a “midnight
of the next banking day” standard.
6. This case is ultimately limited only to
Federal Reserve banks. This leaves open the
possibility of a fact-specific inquiry in other
types of banks as to whether it is carrying
substantially all of its main functions at time
of receiving notice.
c. Regulation CC speeds up the check payment process by
authorizing the payor bank to pay directly to the depositary
bank or to return the check to a “Regulation CC returning
i. A “returning bank” is defined in Regulation CC as a
bank that undertakes return of the check in an
ii. A returning bank does not even have to be one that
was involved in the forwarding process at all
iii. Practically, the regional Federal Reserve banks
predominate the “returning bank” function
1. These banks get paid fees for performing
iv. Right of Collecting Bank to Revoke Settlement on Dishonored Check
1. Statute: 4-214(a)
a. If a collecting bank has made provisional settlement with
customer, the bank may revoke the settlement, charge back
the credit, or retain refund from customer, if by its midnight
deadline or within a longer reasonable time after it learns
the facts it returns the item or sends other notification of
i. Depositary’s Remedies
1. If depositary bank receives notice of
dishonor of check, it has several options.
Proceed against customer based on
customer’s indorsement; proceed against
customer on breach of transfer warranty;
bring action against drawer of check. But
banks rarely pursue these remedies.
2. If it hasn’t allowed the customer to
withdraw the proceeds, all the depositary
bank has to do is erase the provisional
credit. If customer has withdrawn the
proceeds, the bank may obtain a refund from
the customer under this statute.
3. Only when the depositary cannot take these
steps will it have to sue the drawer.
ii. If return or notice is delayed until after the bank’s
midnight deadline or a longer reasonable time after
learning of the facts, the bank may revoke
settlement, obtain refund, or charge back credit but
is liable for any loss resulting from the delay.
iii. These rights terminate when a settlement for the
item received by the bank is final.
2. Essex Construction Corp. v. Industrial Bank
i. Payor bank notifies depositary of dishonor of check
drawn by drawer because drawer stopped payment
ii. Depositary gave notice to customer through mailing
written notice before the midnight deadline, but the
customer did not receive the mailed written notice
until several days later, and customer wrote checks
against the funds it thought were available.
iii. Therefore, customer wants to sue for its loss in
writing checks on funds it thought were available.
iv. Customer argues that timely notice of dishonor was
i. Notice of dishonor was mailed by the bank’s
midnight deadline. This is sufficient. All
depositary bank had to do was mail the check or
notice by the midnight deadline.
ii. Court notes that even if the deadline were missed,
the depositary bank would only be liable for loss
resulting from the delay; bank could still revoke the
credit under the statute. 4-103(e)
c. This case illustrates the problem with the midnight deadline
—the mail is slow. This is why Regulation CC and Ex.
Funds Av. Act attempt to speed up notice of revocation of
d. Once final payment occurs, a collecting/depositary bank
loses its ability to revoke the provisional settlement or
charge back provisional funds. 4-215(d). Final payment
by the payor bank means that provisional credits given by
collecting banks become final.
i. 4-214(a), toward the end: If the return or notice is
delayed beyond midnight deadline or longer
reasonable time after learning the facts, the bank
may revoke the settlement, charge back the credit,
or obtain refund from its customer, but it is liable
for any loss resulting from the delay. These rights
to revoke, charge back, and obtain refund terminate
if and when a settlement for the item received by the
bank is or becomes final
ii. Example of Bank Being Liable for Damages:
1. March 1 drawer on payor bank gives payee a
check. Payee deposits at depositary bank.
The drawer’s account has sufficient funds at
the time. However, the teller at depositary
bank loses the check, where it sits for 3
weeks, until teller finds it.
2. The check is then presented to payor. On
March 15, drawer went bankrupt. Payor
bank timely dishonors because of
nonsufficient funds and sends notice to
depositary bank, who then timely notifies
payee of dishonor and revokes the
3. Result: Depositary bank can revoke the
settlement. The return of the check was
a. However, depositary was negligent
in forwarding check to payor bank.
This does not prevent the bank from
revoking the settlement. 4-214(d).
But a bank failing to exercise
ordinary care is liable under 4214(d).
b. Under 4-103(e), the bank obviously
failed to exercise ordinary care
through not timely presenting the
check for payment. The bank is
liable to the customer for damages;
damages would consist of not being
able to recover from the drawer
because he is bankrupt and there is
an automatic stay. Customer will sue
the depositary bank to prove that had
the bank acted timely, sufficient
funds would have been in drawer’s
account, and customer would have
received payment on the check.
3. Duties of Collecting Banks (4-202)
a. Exercise of ordinary care in presenting an item, sending
notice of dishonor, settling for an item when the bank
receives final settlement, and notifying its transferor of any
loss or delay in transit within a reasonable time after
b. There is a midnight deadline for these actions.
c. However, taking proper action within a reasonably longer
time may constitute ordinary care, but bank has burden of
d. 4-103(e) If a collecting bank does not exercise ordinary
care, its liability is limited to whatever actual damage the
party claiming injury can establish.
v. Check Encoding
a. Magnetic Ink Character Recognition (MICR) technology
i. Paved the way to the automation of check collection
ii. Once the check is received by the depositary bank, a
human being is not likely to view the check again
until it’s the drawer looking at his monthly
iii. Allows the check to be mechanically routed based
on federal reserve district number, account number
of drawer, and the check number and bank number
b. The problem is the amount of the check is not in the MICR
line; it cannot be. It must be added at the end of the MICR
line either by the payee, depositary, or some other
collecting bank. Usually added by the depositary, unless
the payee is some large merchant like Wal-Mart that can
add the amount.
c. This leads to underencoding (less than face amount of
check) and overencoding (more than face amount of check)
i. Courts came up with common law solutions for
ii. The payor bank pays what is encoded, not the face
amount. A human being will only examine the
check if they need to verify a signature by sight to
iii. 4-209 was the solution
1. It imposes a warranty that the information
encoded is accurate.
2. Statute: 4-209
a. (a) A person who encodes information on or with respect to
an item after issue warrants to any subsequent collecting
bank and to the payor bank that the information is correctly
encoded. If the customer of a depositary bank encodes, that
bank also makes this warranty.
b. (c) A person to whom warranties are made under this
Section and who took the item in good faith may recover
from the warrantor as damages for breach of warranty an
amount equal to the loss suffered as a result of breach, plus
expenses and loss of interest incurred as result of the
3. Problem, page 159
a. Drayton (drawer) drew on Park Co. (payee/customer), who
deposited in Bank 2 (depositary), who forwarded to Bank 1
(payor). Check arrived to payor on May 1. 10k check.
b. (a) Depositary misencoded for 1k and on May 1 payor sent
wire transfer for 1k as provisional settlement. Debited
drawer’s account for 1k. When depositary only received 1k
settlement for check, it reduced credit in customer’s
account to 1k. When customer learned about this, it was
unhappy and complained that it did not get credit for 10k.
i. Stipulation: Payor is accountable for 10k face value
of the check because it did not meet its midnight
ii. What we need to know is how much was in
drawer’s account. If drawer has 10k in account, no
problem because payor who underpaid the face
value of the check can just debit the remaining 9k
from drawer’s account. Payor has suffered no loss.
Because payor suffers no loss, even though there
was a breach of warranty by depositary, payor may
not recover anything from depositary. This is
because the encoding warranty under the UCC is
only strict liability (liability without fault) if there
has been loss; not absolute liability, which would
allow recovery even absent loss.
iii. If there were not sufficient funds in drawer’s
account, then payor would have an action for
damages against depositary for depositary’s breach
of warranty that the information was correctly
iv. So underencoding is a breach of warranty but is not
likely to create an actual right for damages.
c. (b) Overencoding. Check misencoded for 100k. Payor sent
wire transfer for 100k.
i. (i) Drawer had more than 100k in account and
payor debited for 100k.
1. Drawer has right to recover 90k from payor.
But payor bank can then recover 90k from
depositary bank because depositary bank
breached its encoding warranty and payor
has suffered loss as a result.
ii. (ii) On May 2, payor bank discovered drawer had
only 25k in the account and dishonored the check
before midnight deadline. Drawer may have rights
against payor bank for wrongful dishonor.
1. If drawer recovers such damages, then payor
bank can recover damages from depositary.
4. First Union National Bank v. Bank One, N.A.
i. Drawer issues check for over 500k. Payee deposits
in depositary bank’s account. Depositary
misencodes for $0.00!
ii. Depositary sends to Intermediary Bank, who settles
for $0, who forward to Payor, who settles with
Intermediary for $0.
iii. Payor is the first to discover the error. Payor then
pays intermediary the actual face amount of the
check (about 500k).
1. The intermediary bank claimed it was
confused about what to do with the 500k
settlement it received. Stuck it in a suspense
account—parked the money for months
2. Depositary asked for payment, and payor
paid the amount a second time to the
3. Therefore, under 4-215(d), the depositary is
suing intermediary to recover on payor’s
i. Ignores Section 4-209 altogether and uses common
law principles that developed before the Revision.
ii. Issue: What is the intermediary liable for?
1. Held: The face amount, NOT the MICR
2. The intermediary is liable for the face
amount of the check.
a. The intermediary argues that the
depositary bank should be estopped
because depositary bank made the
b. Court says no because the
intermediary has suffered no loss; it
would receive a windfall if it does
not have to pay the face amount
vi. Electronic Presentment
1. Under UCC
a. Article 4A Generally
i. **Article 4A is in the big green statute book
ii. Very complex statute
i. Old meaning--The cost cutting measures that banks
use through obtaining agreement from customer;
example, sending customer a statement without
returning the physical checks themselves
ii. Radical Truncation—AKA electronic presentment
1. Check never leaves possession of depositary
bank; depositary bank only forwards
electronic information for the purpose of
presentment to have the check paid by payor
2. Banks, retailers, etc. all agree to radical
truncation, which is the use of electronic
3. In 1990, the UCC allowed electronic
presentment under 3-501. Includes the
ability to present a check for payment in
4. Allows presentment notice, rather than
having to present the check itself
iii. Mandatory electronic presentment has not occurred
2. Under Federal Law: “The Check 21 Act”
a. Check Clearing for the 21st Century Act (2003)
b. The feds have never required electronic presentment. It is
left up to the banking industry to decide. Electronic
presentment is still a matter of agreement
c. Check 21 allows the use of electronic presentment and
return of checks without electronic truncation agreement
among banks. It creates the substitute check, which is a
paper reproduction of an electronic image of the original
check, which is the legal equivalent of the original check
for all purposes.
d. Note that electronic presentment can proceed without the
creation or transfer of a substitute check—a substitute
check is useful only when an individual or bank prefers to
create or receive a paper check.
e. Substitute Check
i. This is the chief creation of the Act
ii. As long as the requirements are met, the bank does
not have a choice, it must accept the substitute
iii. A bank converts the information to paper form,
which is a substitute check, which the payor bank
iv. This saves the expense of forwarding the physical
check through the process.
v. This does not resolve the basic issue of how long it
will take until the substitute check becomes
obsolete, and we move into a regime of full
vii. Funds Availability and Regulation CC
a. Traditionally, the depositary banks had long hold periods
on deposited checks because the return of dishonored
checks has been traditionally slow, having to go through the
return process of going through returning banks. So
depositary banks would not allow customers to withdraw
on checks for around two weeks to protect the banks in
case the checks proved uncollectible.
i. The forwarding process is much faster than the
1. MICR is available to speed up check
forwarding; but there is no automated
system for returning checks
b. Additionally, depositary banks had the incentive to keep
funds longer because they could accrue interest. In effect,
an interest free loan from the customer. The bank’s use of
the money to accrue interest was called the “float.”
i. In many cases, banks were withholding payment for
deposited checks for which they had already
received payment. But the banks were able to hold
onto funds because the holding periods were
c. The Electronic Funds Availability Act (EFAA) and Reg. CC
attempt to solve these problems and create shorter holding
periods, making funds available to customers more quickly
2. Funds Availability
a. Page 84, Funds Availability Schedule under Regulation CC
i. Most banks just make deposits available the next
day because of the complexity of the Schedule
ii. The schedule in brief:
1. For low risk deposits, next day
2. For local check, not later than second day
after banking day of deposit
3. For nonlocal check, not later than fifth
business day following banking day of
4. But customer may withdraw up to $100 on
next banking day after deposit of either local
or nonlocal checks.
3. Check Collection and Return
a. Under Regulation CC, provisional settlements made by
collecting banks are made final.
i. This does not mean that there is final payment of the
ii. This simply means that when the payor bank
dishonors a check, that instead of revoking a
provisional settlement made by the payor bank, the
payor may recover the amount of the check from a
bank to which the check is returned.
iii. That amount can be recovered only when the bank
physically receives the check.
1. The payor can return the check to any bank
that acts as a returning bank.
a. The returning bank does not have to
be one that was involved in the
2. This gives the payor bank the incentive to
return the check as quick as possible to get it
back to the depositary
3. If payor returns the check to any bank other
than the depositary and recovers the
settlement, than the returning bank can
recover the settlement from the depositary
b. If the payor returns the check directly back to the
depositary, the credits given by the intermediary banks will
expire at some point.
c. Regulation CC’s Important Points:
i. Payor bank that dishonors a check of $2,500 or
more must, in addition to meeting the midnight
deadline, must give direct notice to the depositary
bank no later than 4 pm local time of the depositary
bank on the second business day following
1. The notice can be in writing, by phone,
Fedwire, fax, in person, whatever
ii. A bank that fails to comply with a duty imposed by
the Regulation has liability for actual loss [not strict
liability as under the midnight deadline]
b. Credit and Debit Cards
i. Liability for Unauthorized Use of Cards
1. Credit Cards
a. Section 1643, Truth in Lending Act
i. A cardholder shall be liable for the unauthorized use
of a credit card only if:
1. (A) Card is an accepted card
2. (B) Liability is not in excess of $50
3. (C) Card issuer gives adequate notice to the
cardholder of the potential liability
4. (D) Card issuer has provided cardholder
with description of means by which issuer
may be notified of loss or theft
5. (E) The unauthorized use occurs before the
card issuer has been notified that an
unauthorized use has occurred or may occur
as the result of the loss, theft, or otherwise;
6. (F) Card issuer has provided a method
whereby the user of such card can be
identified as person authorized to use it
[signature on back of card]
b. Problems, page 177
i. #1—Oscar paid for meal at restaurant. Waiter
copied information on card by a device that he
concealed in his belt and sold this information to an
enterprise that fraudulently produced replica cards.
These cards were used to make purchases at retail
establishments. Oscar protested to paying the
charges that appeared on his monthly statement.
1. Under 1643(A), it’s not an accepted credit
card because it’s a counterfeit card.
Therefore, the statute does not apply to
counterfeit cards at all. Thus, Oscar has
2. The credit card issuers can protect
themselves by monitoring credit card
charges and then refusing to honor the card
under suspicious circumstances, e.g.
purchases made in certain locations or over
ii. #2—Oscar is absent minded. Obtained card from
Bank A but forgot to sign the back. He used it only
a couple times by buying gas; this mechanism did
not search for presence of a signature. The card was
stolen, but he never noticed and he did not open his
mail which contained statements showing many
fraudulent purchases. Bank A demanded payment
of $5,000 for purchases made on the card, some as
long as three months after disappearance of the
card, all of which were noted on Bank A’s
1. Oscar is only liable for $50 under the
2. He would have been liable for zero if he had
notified the bank of the loss of the card
before the unauthorized uses had occurred.
c. Through the statute, Congress forces the credit card
industry to internalize these losses.
i. The industry must absorb the loss, as opposed to the
ii. With only a $50 limit of liability, why are people so
worried about loss of credit cards?
1. They don’t know about the $50 limit.
2. Have to report loss to get a new card.
3. Don’t want the hassle of having to prove
that the use was unauthorized.
iii. The credit card industry has had no problem in
absorbing the losses; it continues to thrive
2. Debit Cards
i. Banks make money because of receiving interest on
ii. Card issuers of credit cards make their money off
fees that they charge the merchants to accept such
iii. Unauthorized use of debit cards is not governed by
the Truth in Lending Act, but by the Electronic
Funds Transfer Act (EFTA)
b. EFTA Rules: See problem below.
c. Problem, Page 179
i. How would Oscar, Supra,’s case have been different
if it was a debit card and after 2 days he learns of
1. If you don’t report within 2 days after you
should have learned or learned of the loss,
you are liable for $500.
2. If you report within 2 days, then $50 is the
3. There is no limit if there is failure to report
within 60 days of transmittal of a statement.
a. But the card issuer (bank) has the
burden of loss of proving actual
damage beyond 60 days.
ii. The debit card holder is held to a higher standard
because the unauthorized use of a debit card holder
is more likely to occur through the card holder’s
negligence—because to use a debit card, you need a
1. But this rationale might break down because
we don’t have to use our PIN’s to use debit
cards in certain situations.
iii. Now the federal legislation says that the function
that the card holder elects (debit or credit) is what
governs, for dual use (debit or credit) cards.
3. When Is Use Authorized?
a. Statute, Section 1602: when the user lacks actual, implied,
or apparent authority to make a purchase with the card.
b. Minskoff v. AMEX
1. M hires Ms. B as her office manager; and B
proceeds to steal M blind.
2. B applied for a corporate card in her own
name from AMEX and began using the
corporate card for various personal
3. B upgraded her corporate card and M’s
corporate card to Platinum status
4. How did she accomplish this?
a. It is not clear from the record
whether the invitation to upgrade
was directed personally to M or not
b. The invitation was sent to M’s
personal home address; how did Ms.
B get it? [I smell an affair…]
5. Her actions were eventually discovered
many months letter, after Ms. B had used
forged checks to pay for the monthly
statements sent to the business
6. AMEX counterclaims, asserting that M is
not allowed to get anything back. M sued
claiming that this was unauthorized use, so
its liability is limited to $50.
7. AMEX contends that the use was authorized
under agency law principle of apparent
1. Apparent authority cannot be established by
the manifestations of the agent; it is the
principal’s manifestations to the third party
that lead to the third party’s reasonable
belief that the agent had authority, which
creates apparent authority
2. M was grossly negligent in never examining
a single credit card billing statement; there
were no internal controls set up; only Ms. B
ever looked at the billing statements.
3. The simplest auditing of the company’s
records would have disclosed the fraud
4. This gross negligence established apparent
authority of Ms. B; therefore the use was
a. However, the initial use of the card
up until the first billing statement
was sent were not authorized
because M was not grossly negligent
up until that point
5. Court finds within 4-406 that the customer
has a duty to look at a bank statement to
detect any forged items; the customer then
has a duty to promptly report such forged
items to the bank
a. If the customer does not timely
report, it cannot assert the forgery
against the bank
b. The policy underlying this statute is
related to the present case; M was in
a much superior position to be able
to determine if the charges were
c. It is much easier for the cardholder
to determine if a charge made on the
account was legitimate, authorized,
as opposed to the card issuer
(AMEX), who has no way of
knowing that use was unauthorized
d. But what does this have to do with
the law of agency? The court is
really imposing the loss on M not
because of apparent authority, but
really because of M’s negligence.
The Truth in Lending Act (TILA)
asks whether there was apparent
authority of the user, not whether the
cardholder was negligent in allowing
use. Therefore, the court’s analysis
is not correct.
e. Apparent authority is based on
contract principles; but agency by
estoppel has a tort basis. The court
is really using agency by estoppel;
saying that because M was negligent
in not detecting the fraud, M will be
estopped from pleading that Ms. B’s
use of the card was unauthorized.
iii. Thus in cases of serial fraud by the employee, the
loss can be passed upon the employer if the
employer does not examine the card statements it
receives. This is often the case because the person
conducting the fraud is the person to whom the
employer’s financial affairs are delegated.
c. Problem, page 187
i. Wife married Husband and she opened a credit card
account with Bank, requesting card issued to her
and duplicate card to Husband in his name. Upon
divorce, wife notified bank that she would no longer
pay for husband’s charges on the card. Credit card
agreement provided that account could be closed by
returning all cards. Bank immediately revoked both
cards and gave numerous notifications to both
parties of revocation and requests that the cards be
returned. Both Wife and Husband continued to
make purchases. Wife contended that for charges
made by Husband after her notification to the Bank,
her liability should be limited to $50; the card
should be treated as a lost or stolen card since she
had no power to compel the Husband to return the
1. Wife is the cardholder for purposes of the
statute; because the account is issued in her
name. This is important because
unauthorized use is by someone other than
the cardholder; Husband is not a cardholder.
2. Wife certainly had notified the bank upon
divorce that Husband was no longer
authorized to make purchases; but she is
arguing that this makes it as though the card
was either lost or stolen.
ii. This is Walker Bank v. Jones
1. The court stated that the TILA focuses on
whether or not there is actual or implied, or
apparent authority. As long as the Husband
had a card with his name on it, this created
apparent authority for him to use the card.
As long as the Husband’s name was on the
card, he had apparent authority to make
purchases with the card.
a. The court focuses on apparent
authority from the perspective of the
merchant who honors the card.
b. The statute does not make it clear
whether the apparent authority is
from the perspective of the person
honoring the card or from the
perspective of the issuer of the card
c. The dissent obviously viewed it that
the statute means apparent authority
from the perspective of the issuer;
and in this case, the bank could not
reasonably believe that the Husband
had authority to use the card because
Wife notified the bank that Husband
was no longer authorized
2. This is largely unresolved: is apparent
authority from the merchant’s perspective, or
the card issuer’s perspective? The dissent
views the purpose of the statute as focusing
on whether there has been notification
between the cardholder and card issuer.
Therefore, the focus should be upon the card
issuer’s belief or lack thereof in authority.
4. Assertion of Cardholder Defenses
a. Issue: To what extent may the cardholder raise its defenses
against the merchant from whom goods were purchased
against the card issuer, to avoid payment of the card
charges to the issuer?
b. Legislation—Fair Credit Billing Act, Section 1666i
i. Congress decided that under limited circumstances,
the cardholder should be able to assert defenses
arising out of the underlying transaction against the
issuer of the card
ii. Conditions for raising defenses:
1. Cardholder (obligor) must make good faith
attempt to obtain satisfactory resolution of
the disagreement with the party that honored
2. Amount of underlying transaction must
a. This requirement is probably that for
de minimis amounts, it’s not so much
an extension of credit as it is a
substitute for the cardholder paying
b. In this era that the statute was
drafted, ATM/debit cards did not
3. Place where initial transaction occurred
must be same state as mailing address
provided by cardholder to issuer or within
100 miles of such address
a. The reason for this is that a merchant
or other person honoring the card
that is a great distance from the
buyer’s residence would not want to
accept a card if the merchant knew
that the cardholder could assert a
defense and then the merchant would
be left with an unsecured claim
against the purchaser who lives
many miles away.
iii. 2 and 3 supra as conditions do not apply in certain
1. Honorer of card is the same as the issuer, is
under control of the card issuer, etc.
c. Problem, page 189
i. California tourist buys syrup in Maine and pays
with Visa card issued by SD bank. Tourist believed
she had been defrauded. First called the seller to try
and resolve; but seller said what was mailed was
what she purchased and there would be no refund.
Tourist then does not want to have to pay Visa.
ii. Under the statute, the amount exceeds $50, but the
initial transaction was neither within the
cardholder’s home state nor within 100 miles of her
mailing address. Therefore, the tourist cannot raise
her defense against the issuing bank.
d. The statute only governs rights between cardholder and
card issuer. As between card issuer and person honoring
the card, this is governed by the system rules of Visa,
e. Citibank (South Dakota) v. Mincks
1. Case law interpreting Section 1666i has
been hard to come by
2. This is the first authoritative, reported
appellate opinion involving two previously
unaddressed issues in the case law
1. Mary applies for a credit card and gets one
issued in her and her husband, Chuck's,
name. She uses the card for personal
purchases pretty much exclusively. Her
husband uses the card to buy some sort of
stupid postcards for his business. They never
come. He makes several attempts to get the
postcards and they never get back to him.
Several months later he finds that the
company went out of business
2. Mary tries to get her money back by getting
it back from CitiBank who declines to do so
because she didn't do it within 60 days and
because it was for a business purchase.
iii. First Issue: Section 1666i allows consumer to, in
some circumstances, get his/her money back from
the card issuer. This only applies when a card has
been issued under an "open end consumer credit
plan". The purchase made by Chuck was clearly for
his business. However, the card was issued as an
"open end consumer credit plan". What controls?
The specific transaction or is it the "overall
purpose" of the card's issue?
1. The "overall purpose" test was used by the
Court and, therefore, it held that Mary's card
was an "open end..." card.
2. Holmes likes this decision.
iv. Second, more technical, issue:
1. Relationship between cardholder defense
rule in 1666i and the separate billing error
provision in 1666a.
2. The billing error rule gives the consumer the
right to request correction of a billing error
within 60 days of the incorrect statement.
a. CitiBank attempted to use this as a
defense because Mary didn't try to
get any sort of redress until months
after the 60 day time period.
b. Court determines that these
provisions of 1666a are entirely
separate and have no effect on
Mary's ability to assert the defense of
non-delivery under Section 1666i
c. Further, these provisions exist for
i. 1666a billing provisions is to
"call off the dogs" when there
is an error as to the bill and
the consumer notices the
v. Court says that the Mincks are entitled to assert
their defenses. Their failure to give notice within 60
days had no relevance to this issue.
f. Note 1 following CitiBank
i. Limitations on 1666i - The statute offers no
guidance as to where, in fact, an "initial transaction"
occurs. As is commonly the case today, people order
things over the phone/internet. The statute was
drafted when credit card transactions were done in
ii. In a non face-to-face transaction, the transaction
occurs where "acceptance" of the contract takes
place. The "last act necessary to complete the
contract" is where the contract is complete and,
thus, where the location is for purposes of 1666i.
1. Often they're just going to come down on
the side of the consumer-purchaser. Seems
like courts will have to do a bit of stretching
on the doctrine of offer/acceptance in order
to reach this result.
5. Internet Fraud
a. In cases of e-fraud, the seller is the one who bears the loss.
If someone gets your credit card info and uses it to make a
fraudulent order over the internet, the merchant is the one
who "eats" it. How can seller protect itself?
i. Ship solely to home address
ii. Require telephone confirmation for large
Payment Systems: Electronic Transfers
a. Electronic Funds Transfers
i. The Basic Transaction Covered By Article 4A
a. Article 4A deals with whole sale wire transfers –
substantial amounts; not the Electronic Funds Transfer Act
which deals with small credit card and debit card and other
small wire transfers.
b. Wire transfers account for far more in dollar volume than
either checks or credit cards. While 98% of volume of
transactions are through credit cards and checks. 85% of
value is through wire transfers. Average value of wire
transfer is several million dollars.
c. Two important things to understand about wire transfers –
why do they account for 85% of value?
d. Wire transfer system gives you advantage of instantaneous
payment for substantial amounts of money on which you
don’t have to pay much. Charge to make a wire transfer is
simply on the amount it takes to complete the transaction.
e. One of the truly astonishing things – article 4A of UCC was
not promulgated until 1989. All states adopted it by 1996.
Thus astonishing for a system that handles such large
amounts of money, there were no governing laws until mid
1990s. Before that had to be handled through common law
processes. The world is much simpler now that we have
article 4A. But 4A does require some close attention.
2. The Concept of Funds Transfer
a. Funds transfers under Article 4A—accomplished by one or
more payment orders, as defined in the statute, that are
made to a bank.
b. Bank is defined in the statute: broader than a commercial
bank, but it also includes several other institutions.
c. Section 108 excludes consumer transfers made under the
federal Electronic Funds Transfer Act (EFTA) that we
discussed in the context of debit cards. The debit card is
therefore not subject to these rules. We're talking about
transactions that take place among banks and banks alone.
a. 4A-103 and 104 are the main provisions
b. When we talk about funds transfers (wire transfers), we are
dealing with two basic concepts: 1) the sending of payment
orders as defined in 4A-103 and 2) by those payment orders
the effecting of a funds transfer under 4A-104.
c. 103(a)(1) payment order – Payment order means an
instruction of a sender to a receiving bank, transmitted
orally, electronically, or in writing, to pay, or to cause
another bank to pay, a fixed or determinable amount of
money to a beneficiary if:
i. The instruction does not state a condition to
payment to the beneficiary other than time of
ii. The receiving bank is to be reimbursed by debiting
an account of, or otherwise receiving payment from,
the sender, and
iii. The instruction is transmitted by the sender directly
to the receiving bank or to an agent, fund-transfer
system, or communication system for transmittal to
the receiving bank.
d. 103 (a)(2) beneficiary – the person to be paid by the
e. 103(a)(3) beneficiary’s bank – the bank identified in a
payment order in which an account of the beneficiary is to
be credited pursuant to the order or which otherwise is to
make payment to the beneficiary if the order does not
provide for payment to an account.
f. 103(a)(4) receiving bank – the bank to which the sender’s
instruction is addressed.
g. 103(a)(5) sender – the person giving the instruction to the
h. 103(b) and (c) tell us that if more than one payment is to be
made, each is a separate payment order and that a payment
order is issued when it is sent to the receiving bank.
i. 104(a) funds transfer – means a series of transactions,
beginning with the originator’s payment order, made for the
purpose of making payment to the beneficiary of the order.
The term includes any payment order issued by the
originator’s bank or an intermediary bank intended to carry
out the originator’s payment order. A funds transfer is
completed by acceptance by the beneficiary’s bank of a
payment order for the benefit of the beneficiary of the
originator’s payment order.
j. 104(b) intermediary bank – a receiving bank other than the
originator’s bank or the beneficiary’s bank.
k. 104(c) originator – the sender of the first payment order in
a funds transfer.
l. 104(d) originator’s bank – (i) the receiving bank to which
the payment order of the originator is issued if the
originator is not a bank, or (ii) the originator if the
originator is a bank.
4. 4A-104, Comment 1 Hypotheticals
i. X wants to pay Y several million dollars and wishes
to do so via a wire transfer.
ii. X is the originator; Y is the beneficiary.
b. Case 1
i. Bank A has accounts both for X and for Y. Thus X
as the sender of payment order instructs bank A to
credit the account of Y. For purposes the statute, X
is sender of payment order and originator of funds
transfer. Bank A, bank to whom instruction has
been sent, is the receiving bank of the payment
order and also the originator’s bank of funds
transfer as well as beneficiary’s bank. Thus when
bank A notifies Y that the funds have been credited
to its account or made available to it…the funds
transfer is complete. One bank, one payment order
ii. Called a book transfer because it’s all on the books
of the same bank.
iii. Is the least common because most often the
originator and the receiver of the transfer will not
have the same bank.
c. Case 2
i. X and Y do not have accounts in same bank. X’s
account is with Bank A and Y’s account is with
Bank B. We assume that A and B have a
contractual arrangement. So Bank A (under X’s
instruction) is going to wire 1 million to bank B for
Y. With respect to this payment order, X is the
sender, Bank A is the receiving bank, and Y is the
beneficiary. Bank A carries out X’s order by
instructing Bank B to pay 1 million to Y’s account.
For this payment order, Bank A is the sender of
payment order, Bank B is the receiving bank and Y
is the beneficiary. In the funds transfer, X is the
originator, Bank A is the originator’s bank, and
Bank B is the beneficiary’s bank.
When Bank A executed X’s order, X incurred an
obligation to pay Bank A the amount of the order.
When Bank B accepts the payment order issued to it
by Bank A, Bank B incurs an obligation to Y to pay
the amount of the order, and Bank A incurs an
obligation to pay Bank B.
Funds transfer is completed when bank B notified Y
of availability funds.
Two bank, two payment order transfer.
This scenario is possible because Banks A and B
have a contractual arrangement.
d. Case 3
i. What happens when Banks A and B don’t have
accounts with each other? The intermediary bank
ii. Bank C is the receiving bank of A’s order and the
intermediary bank as to the funds transfer. Section
104 defines intermediary bank as any receiving
bank other than the receiving bank or beneficiary’s
iii. X needs to pay 1 million to Y and does so by wire
transfer. Three bank, three payment order funds
transfer. A is X’s bank and B is Y’s bank. In this
case, Bank A may not be able to move the funds
directly to Bank B because A and B may not have
any relationship with one another. In order for
funds transfers to work, the bank receiving the
funds transfer must be able to debit the account of
sender and credit account of person they are sending
payment order to. Need direct contractual
relationship as in #2 above. In many instances, A
and B may not have an existing relationship…thus
unless both are parties to a funds transfer system
(fedwire and chips)…then basically they will have
to find a correspondent bank that they can use…
bank that has relationship with originator’s bank
and beneficiary’s bank.
iv. X gives payment order to bank A to wire funds to Y.
X is sender of payment order and originator of
funds transfer. Bank A as is receiving bank of
payment order, originator’s bank of funds transfer,
and sender of second payment order. Bank C is
receiving bank of payment order and intermediary
of funds transfer and then sender of third payment
order. Bank B is receiving bank of Bank C’s
payment order and beneficiary bank of funds
transfer. Y is beneficiary. The funds transfer is
completed when bank B notifies Y of availability of
funds. (Note: in crediting Y’s account, Bank B was
not sending a payment order).
e. These Scenarios Generally
i. In each of the three cases there is a transaction that
could be completed within a matter of minutes.
Even the most complicated orders will only take a
few hours at most. High Speed is the "first
imperative under 4A". Secondly, a transfer which
can be accomplished using fairly little money.
1. The fees that banks charge are not based
upon a percentage of what's transferred.
Rather, they're made based upon mechanical
function and with a modest amount of
money for profit.
2. Because of the speed involved, these funds
transfers are often deemed superior to even
cashier's checks. There does remain the
possibility that you could get "stiffed" even
if the funds are in your account.
5. Article 4A does not apply to consumer electronic funds transfers
such as point of sale transactions, ATM transactions, direct deposit
and preauthorized debits, wire transfers like those of western union
(because western union is not a bank).
6. In Summary
a. Article 4A and wire transfers mean high speed, low cost,
b. The downside is that there is a huge risk because of the
often enormous amounts of money involved. If things go
awry, then it becomes a problem.
c. The comments indicate that the law is a deliberate decision
to make funds transfer a particular form of payment
governed by unique rules.
ii. Payment Orders
a. A funds transfer is one or more payment orders
b. If there is no payment order, there can be no funds transfer
under Article 4A.
c. Payment order – an instruction of sender to a receiving
bank, transmitted orally, electronically, or in writing to pay
or cause another bank to pay a fixed or determinable
amount of money to a beneficiary if:
i. the instruction does not state a condition to payment
to the beneficiary other than time of payment,
ii. the receiving bank is to be reimbursed by debiting
an account of, or otherwise receiving payment, from
the sender, and
iii. the instruction is transmitted by the sender directly
to the receiving bank or to an agent, funds-transfer
system, or communication system for transmittal to
the receiving bank.
2. Trustmark Insurance Co. v. Bank One
i. Trustmark has accounts at Bank One.
ii. Trustmark gives an instruction to Bank One that at
any point in time when the amount in a certain
account exceeds a 10k balance, that Bank One
should transfer everything in excess of 10k to an
interest-bearing account that Trustmark held in a
iii. For the first time ever, in Sept. 1996, the balance
rose above 10k, but Bank One did nothing, and the
balance in the account continued to grow until Dec.
1997, when the Bank One finally transferred the
funds. There was over 19M in the account at this
b. Breach of Contract
i. Bank One claims that its agreement with Trustmark
would prevent any substantial recovery under
breach of contract theory.
ii. There are rules governing receiving banks’ delay in
issuing a payment order. Article 4A significantly
limits the receiving bank’s liability for delay,
though. However, Article 4A does entitle the sender
the amount of lost interest resulting from the delay
or failure. This is the basis of Trustmark’s claim:
lost interest resulting from the receiving bank’s
delay in issuing a payment order.
iii. The claim here is for over 500k in interest lost as a
result of Bank One’s delay in issuing a payment
c. Payment Order?
i. Article 4A states that to be a payment order, the
instruction may not state a condition to payment to
the beneficiary other than time of payment.
ii. Ordinarily, payment orders are given to be paid
1. However, as long as the payment order is to
pay at a fixed time in the future, there is no
2. However, in this case, the time of payment
is determinable, but not specifically stated.
iii. Held: This is not a payment order because
Trustmark’s instruction required Bank One to
constantly monitor the account.
1. This was more than a condition stating the
time of payment.
2. There was a condition requiring
responsibilities than go beyond Article 4A
a. The obligation to make an ongoing
inquiry into the account balance
removes the transfer from the
definition of a payment order.
3. Because there was no payment order, there
can be no recovery under Article 4A.
a. This does not preclude a potential
breach of contract claim of
Trustmark because of Bank One’s
failure to comply with their mutual
iii. Acceptance of Payment Orders
a. A receiving bank other than beneficiary’s bank accepts a
payment order when it issues a payment order itself
pursuant to instructions given in sender’s payment order.
b. A beneficiary’s bank accepts by paying the beneficiary
pursuant to the rules in 4A-405(a): crediting the
beneficiary’s account and advising the beneficiary that the
funds are present and available for withdrawal.
2. Problem, page 203
a. There is an ambiguity in the statute. There are three
methods by which payment can occur: (4A-405(a))
i. Beneficiary is notified of right to withdraw
ii. Bank lawfully applies the credit to a debt of the
iii. When the funds are otherwise made available to the
beneficiary by the bank—ambiguous.
b. Beneficiary’s Bank (BB) received payment order and
credited B’s account. BB notified B that credit had been
received but said nothing about availability. But B was
given immediate access at time account was credited. Was
payment made at the time of the credit or at the time of
i. The originator’s liability is discharged when
payment is made. This is why in this case the issue
of when payment was made is important.
ii. Held: Payment occurred as soon as the beneficiary
had access to the funds, even though the bank had
not given the beneficiary notice at that time.
iii. Once the account is credited, payment occurs, even
if the beneficiary bank has not given notice to the
iv. Receiver Finality
1. Aleo Int’l Ltd. v. Citibank
i. Many obligees view funds transfers as an optimal
method of payment
i. Aleo instructed Citibank to send an amount to x in a
Germany Bank. Citibank issued a payment order to
ii. Germany Bank credited the amount of the payment
to x at 3:59 a.m. on October 14.
1. At this point, Germany Bank accepted
Citibank’s payment order.
2. Aleo however, changed its mind and
instructed Citibank to stop the transfer,
which Citibank refused to do. Now Aleo
c. Held: Once acceptance has occurred, the transfer may not
i. Beneficiary was paid by the bank, so acceptance
ii. Germany Bank credited at 3:59 a.m.; this was
iii. The attempt to cancel the payment order occurred
later on, so it was ineffective.
iv. Therefore, Citibank cannot be liable for refusing to
stop the transfer.
2. Cancellation of Payment Order, 4A-211
a. Ordinarily can only occur before acceptance of a payment
b. Once acceptance has occurred, the statute allows
cancellation of payment order to beneficiary’s bank only in
four defined circumstances:
i. 1) Payment order was unauthorized
ii. 2) Duplicate of previous payment order
iii. 3) Payment to wrong beneficiary
iv. 4) Payment was made in the wrong amount.
c. “Buyer’s remorse” is not sufficient to cancel, once
acceptance has occurred. That was the Aleo case.
i. Even when cancellation may occur, the
beneficiary’s bank must consent.
ii. Rarely will the beneficiary bank consent to the
funds being taken away from its customer, the
beneficiary. Because this would be a bad customer
3. Absorption of Loss
a. When one bank becomes insolvent, who bears the loss?
b. With the exceptions of transfers in the Fedwire system
(where there is immediate credit), all that is involved is a
series of bank credits made by the banks taking part in the
transfer. At the end of the day, all these “net out.” What
happens if during the course of the day, one bank becomes
insolvent and thus cannot settle?
c. If beneficiary’s bank does not receive a settlement in this
case, the beneficiary’s bank eats the loss. May not recover
the funds back from the beneficiary.
v. The “Money-Back Guarantee”
a. *A bedrock principle in Article 4A
2. Grain Traders, Inc. v. Citibank
i. First authoritative opinion discussing the MB
ii. 2d Cir.
b. Obligation of Sender:
i. To make payment to bank to which order is sent
ii. However, obligation is excused if funds transfer is
1. Receiving bank must then refund to sender
i. GT (originator) BCN (originator’s bank)
Citibank (intermediary bank) BCIL
(intermediary bank) Extrader (beneficiary’s
bank) Kraemer (beneficiary).
1. Unless the parties to a funds transfer all have
accounts with each other, there are
2. This involves debiting and crediting banks
among banks that have mutual agreements.
ii. GT owes Kraemer a bunch of money; so does a
funds transfer. GT instructs BCN to make payment
iii. This involves BCN debiting GT’s account and
crediting Citibank’s account, etc., down the line to
iv. BCN accepted GT’s payment order by issuing a
payment order to Citibank. Citibank accepted by
sending payment order to BCIL. But after this, we
don’t know what happened. But we do know that
Kraemer never got the money.
v. Presumably BCIL never issued a payment order to
Extrader because of Extrader’s precarious financial
vi. GT asks BCN to ask Citibank to return the money.
vii. After several unsuccessful efforts to get through to
BCIL, a message was received saying that BCIL’s
account could be debited to reverse the series of
payment orders. However, Citibank did not debit
BCIL’s account and return the money to BCN.
viii. Citibank asserts that BCIL had exceeded its credit
limitations. Citibank refused to undo the payment
order from BCN; claimed that BCIL had an
insufficient balance in its account so it couldn’t
return the money to BCN.
ix. BCIL owed Citibank money and in light of BCIL’s
financial distress, Citibank determined that it was
unlikely to get paid. So Citibank froze BCIL’s
account and refuses to return the money to BCN.
x. Therefore, GT is out of its money paid to BCN.
Citibank has the money now in its account. It
appears that Citibank is getting a windfall.
xi. GT still owes Kraemer the money.
xii. GT sues Citibank.
d. Statute: 4A-402
i. Under the MB Guarantee, GT’s action is strictly
against its receiving bank, BCN.
ii. The sender cannot sue a receiving bank with which
the sender is not in privity.
iii. The funds transfer was not completed, therefore,
under 4A-402(c), GT’s obligation to pay BCN is
excused and therefore under (d), GT is entitled to a
refund (the MB Guarantee) from BCN.
iv. The MB Guarantee Defined
1. The statute makes no provision for a sender
to seek refund from any bank other than the
receiving bank of that sender’s payment
2. The MB Guarantee is that if the funds
transfer is not completed, the sender can
receive its money back from the receiving
bank to which the payment order was sent.
3. 4A-402(d) “If the sender of a payment order
pays the order and was not obliged to pay all
or part of the amount paid [because the
funds transfer was never completed], the
bank receiving payment is obliged to refund
payment to the extent the sender was not
obliged to pay.” This is the MB Guarantee.
3. Policy Behind the MB Guarantee
a. Effect an orderly unraveling of a funds transfer in the event
that it is not completed
b. Provides a predictable scheme by only making receiving
banks liable to the sender with whom the receiving bank is
4. Article 4A-402(e)
a. Provides a narrow exception to the MB Guarantee: when
the originator instructed the sender to use a certain
intermediary bank that becomes insolvent.
b. Originator instructs Bank A to use Bank C to pay B with
account in Bank B.
i. Bank C is an intermediary that is insolvent, so it
fails to complete the transfer.
ii. The ordinary MB Guarantee would be that the
originator would get its money back from Bank A.
And Bank A would be left holding the bag because
it can’t get its money back from Bank C.
iii. This would be unfair in this case because the
originator instructed Bank A to use C as an
iv. Therefore, the exception to the MB Guarantee is
that Bank A may recover from the originator, and
the originator is subrogated to Bank A’s right to
recover from Bank C.
5. Common Law
a. Common law principles should not be integrated into the
MB Guarantee statutes
b. The official comment expresses that the statute is intended
to be the exclusive authority for addressing rights and
c. This comment begs the judiciary to ignore common law
principles outside of Article 4A.
vi. Erroneous Execution of Payment Orders
1. Sending Bank’s Errors
a. General Article 4A principle is that the sender is liable for
its own errors.
b. Problem, page 214
i. OriginatorOriginator’s BankIntermediary
ii. Because OB has no relationship with BB, OB needs
IB to complete the funds transfer.
iii. Case #1. OB executed the payment order by
instructing IB to pay BB 100k for the account of a
certain beneficiary. However, IB mistakenly
instructed BB to pay 100k for the wrong
beneficiary. This can easily occur by mistyping one
digit, thus sending the money to the wrong
1. a) IB did execute the payment order of OB.
Because execution occurs when a bank
sends a payment order intended to carry out
the order it received from a sender.
2. b) The funds transfer was not completed;
this is the MB Guarantee. The wrong
beneficiary was paid, so the transfer was
not completed. O’s obligation to pay OB is
3. c) IB, therefore, is not entitled to payment
from OB. Because the funds transfer was
not completed, OB’s obligation to pay IB is
4. d) BB is entitled to payment from IB.
Because the BB accepted the payment order,
it is entitled to payment under 4A-402(b).
5. e) IB may be entitled to recover from the
mistaken beneficiary. Under 4A-303(c),
when the executing bank issues an order to
the wrong beneficiary, the sender of the
erroneous order may recover to the extent
allowed by the state law governing mistake
a. The IB made the error, so it bears the
loss, unless state law of restitution
changes this result.
iv. Case #2 – OB mistakenly instructed IB to pay too
1. Under 4A-303(a), O is obligated to pay OB
100k, not the greater amount that OB
mistakenly ordered IB to pay.
2. OB who made the error is then allowed to
pursue the beneficiary for the excess
amount, under state law governing mistake
2. Discharge-for-Value Rule
a. Hypothetical: the originator’s bank sends the payment
order to the beneficiary’s bank, but to pay the wrong
beneficiary. However, if by happenstance the wrong
beneficiary happens to be a creditor of the originator, if the
amount is in excess of $100k, the creditor may keep the
money in certain situations.
b. Two different rules:
i. Mistake of Fact
1. The more restrictive rule.
2. Under the common law, this meant that to
keep the payment, the person receiving
payment would have to show change in
position; detrimental reliance.
3. For example, show cancelation of a
mortgage, delivery of goods, etc.., in
reliance on receiving the originator’s money.
4. If no reliance was shown, the creditor/wrong
beneficiary would have to return the money
to the originator.
ii. Discharge-for-value Rule
1. Creditor has no duty to make restitution as
long as the creditor can show that (1) he had
no notice of the mistake and that (2) the
creditor was in good faith (made no false
2. Article 4A adopts this rule as the majority
c. In Re Calumet Farms
i. Note: This scenario—where the wrong beneficiary
will actually be an obligee of the originator’s
obligation to pay—is very uncommon. The more
common situation is where someone is overpaid and
wants to keep the excess amount.
1. Originator owes $1 million; instructs First
National (FN) Bank to make a payment on
2. The money was sent to the correct account
of the correct beneficiary, but FN added a
zero, sending a higher amount in its payment
order to the next bank in the chain.
3. FN now brings an action to recover the
overpayment from the beneficiary.
1. The discharge-for-value rule applies.
2. Issue: When does notification of the
mistake to the beneficiary occur?
3. Restatement on Restitution: the creditor
who receives a benefit in discharge of the
debt is under no duty to make restitution,
although the discharge was given by
mistake, if the creditor was in good faith and
had no notice of the mistake.
4. There must have been a discharge of
Calumet’s debt on the beneficiary’s books,
which did not occur until after the
beneficiary had been notified of the error.
a. Thus the discharge came after the
beneficiary received notice, and the
beneficiary must return the
b. Therefore, FN is entitled to
i. Note that FN incorrectly sent
an order for an overly high
amount; so it could only
recover from Calumet the
amount for which it sent an
overpayment order. FN can
only recover the amount of
the originator’s payment
order from the originator
iv. 4A-406(a)(1) – The originator’s obligation to the
beneficiary is discharged whenever the beneficiary’s
bank accepts the payment order sent to it.
1. Under this standard, if the correct amount
was sent, at the instant the beneficiary’s
account was credited, the originator’s
obligation would have been discharged.
2. However, the statute specifically says that
the discharge is made to the extent of the
amount specified in the originator’s payment
3. In a case of overpayment, like this case, the
payment of the originator’s debt only occurs
to the extent of the intended payment
amount. Therefore, the over-amount has not
been “paid” under the statute at the time that
the beneficiary receives the funds.
4. Because the discharge for an overpayment
only occurs at the time that the beneficiary
applies it to the originator’s account,
therefore in this case, the discharge did not
occur until after the beneficiary had notice
of the overpayment; therefore, there was no
discharge-for-value. The beneficiary had
notice of the overpayment and thus must
make restitution for the overpayment to the
vii. Failure of Receiving Bank to Execute Payment Order
1. Evra Corp. v. Swiss Bank Corp.
i. Originator needed to pay a certain amount of money
to beneficiary by a certain date in order for the
originator to keep its charter to use the beneficiary’s
ii. Originator issued a payment order to his bank, who
issued payment order to intermediary bank, who
issued an order to Swiss Bank (intermediary).
iii. Swiss Bank received the order but did not execute
the order to the beneficiary’s bank.
1. Ordinarily the result of this would be the
Money Back Guarantee.
2. But the issue is that because Swiss Bank
made a late payment, beneficiary did not
receive the money on time and canceled the
originator’s ship charter.
b. Issue: Can Swiss Bank be liable for consequential damages
of the originator (the economic losses in not obtaining the
charter from the beneficiary)?
c. Held: Swiss Bank did not have a reason to know of the
importance of the ship charter and the potential for
consequential damages; they were not foreseeable, so Swiss
Bank was not liable for consequential damages under
i. Judge Posner’s opinion
ii. This opinion was written without the benefit of the
2. Article 4A Extent of Liability
i. A receiving bank only has to execute a payment
order to the extent it has obliged itself to do so by
ii. If it does not comply with the agreement, it is liable
as expressed in the agreement or in accordance with
iii. The receiving bank will be in privity with the
originator’s bank; this will be the applicable
agreement governing the receiving bank’s duty to
execute a payment order.
iv. The parties have freedom of contract and can
contract their liability in most cases.
v. An originator will never be in privity with an
intermediary bank. Thus there will not be an
agreement between the originator and intermediary,
so the intermediary owes no duty to the originator.
1. Therefore, the result in the case above will
not exist today.
2. Because an intermediary owes no duty to the
originator of the funds transfer, there can be
no recovery for damages, much less
vi. However, the originator’s bank is in privity with the
originator. Thus there is the possibility of the
originator’s bank failing to execute a payment order
issued by the originator, and the bank may have a
duty by virtue of contract with the originator and
may be liable for failure to execute the payment
order. The extent of liability is expressed in 4A305(d).
i. If a receiving bank fails to execute a payment order
that it was obliged by express agreement to execute,
the bank is liable to the sender for its expenses in
the transaction and for incidental expenses and
interest losses resulting from the failure to execute.
Additional damages, including consequential
damages, are recoverable to the extent provided in
an express written agreement of the receiving bank,
but are not otherwise recoverable.
ii. Incidental expense may be the cost of issuing a new
payment order; only incidental expenses and
interest losses are recoverable by the originator, and
only if there is a duty to execute the payment order
provided in an express agreement.
iii. The statute “hard-heartedly” denies consequential
damages to the originator, except if an express
written agreement provides for them.
1. The policy behind this rule is that the banks
convinced the statute drafters that high
damage costs would prohibit high speed and
low cost that are pillars of the electronic
funds transfer system.
2. The originator is in the best position to
monitor the progress of the transfer. The
originator can pick up the phone and call to
make sure that the process is moving along.
a. Evra Redux
i. The case demonstrates this
point—the originator did not
monitor the transfer.
ii. Twice, the originator waited
until the day before the
payment was due to initiate
the funds transfer. The
originator was clearly in the
best position to manage the
viii. Fraudulent Payment Orders
a. The drafting was a contentious process as to whether the
customer or the bank should bear the loss where the
originator purports to be the customer but is a crook and
initiates a funds transfer. In these situations, fraudulent
originator orders payment to his own bank account or that
of an accomplice.
b. Agency Law
i. The initial determination of whether the transfer
was authorized is a matter of agency law. Ask
whether the person was authorized by the sender to
make the transfer.
ii. 4A-202(a) – A payment order received by receiving
bank is the authorized order of the person identified
as sender if that person authorized the order or is
otherwise bound under the law of agency.
iii. But this doesn’t add much—because crooks will not
be authorized under the law of agency.
c. Guiding Concerns:
i. Whether the bank made available to its customer a
commercially reasonable security procedure
ii. Whether the bank complied with the security
iii. If these two requirements are met, the bank will
ordinarily not be liable.
d. A bank cannot claim that a mere signature comparison
constitutes a security procedure.
e. 4A-202(b) – If customer and bank have agreed on security
procedure, a payment order received by bank is effective as
the order of the customer whether or not authorized, if (i)
the security procedure is commercially reasonable and (ii)
bank proves that it accepted the payment order in good
faith and in compliance with the security procedure and any
written agreement between customer and bank.
i. Exception, allowing allocation of loss to the bank:
4A-203(a)(2) If a payment order is effective,
receiving bank is not entitled to enforce or retain
payment if customer proves that the order was not
caused directly or indirectly by a person (i) with
duties to act for the customer with respect to
payment orders or the security procedure, or (ii)
who obtained access to transmitting facilities of the
customer, or who obtained, from a source controlled
by the customer and without authority of the
receiving bank, information facilitating breach of
the security procedure.
2. Problems, page 220
i. Fraudulent transfer; customer did not authorize.
ii. Need to know whether there was a security
procedure that was commercially reasonable and
whether the bank followed it. If not, then the bank
is liable to the customer.
iii. If commercially reasonable procedure was followed
by the bank, the loss falls on the customer, unless
the customer can invoke the 4A-203 exception…
1. …That no one connected with the customer
provided the information to the crook who
i. “Cyber Caper”—international fraud by Russian
grad student who penetrated a security system so
sophisticated that industry experts said what he did
was “almost impossible.”
ii. Same answer was problem #1. Procedure was
commercially reasonable and was followed, so
customer would bear the loss.
iii. However, if the customer invokes the exception,
proving that the crook did not obtain the
information from a source associated with the
customer, the bank would bear the loss.
1. **The comments to 4A-203(a)(2) are
helpful in interpreting the somewhat
2. Simple theft of information
a. E.g. the Russian is an expert lockpicker, goes to customer’s offices
and rummages through the code
book, using it to make fraudulent
b. The statute is ambiguous on this fact
c. Cmt. 5 – Indicates that the loss shifts
to the bank if the customer can prove
that the crook did not obtain the
information from an agent of the
3. The statute may be fairly interpreted to say
that if there is simple theft, without a
voluntary action by an agent of the
customer, the exception applies and the
customer can shift the loss to the bank.
iv. Another criticism of the exception is that it requires
the customer to prove a negative—that none of the
customer’s employees or other agents was
responsible for the disclosure of the information.
1. For Wal-Mart as a customer, it is impossible
to prove that none of its thousands of
employees was responsible!
2. The comments to the statute indicate a belief
that ultimately “the truth will come out.”
The crook will eventually be caught through
criminal investigations. Thus it’s not as
much of a burden as customers claim to
prove what is required by the statute.
c. Commercial Reasonableness
i. 4A-202(c) – Question of law determined by
considering the wishes of the customer expressed to
the bank, the circumstances of the customer known
to the bank, including the size/type/frequency of
payment orders normally issued by the customer to
the bank, alternative security procedures offered to
the customer, and security procedures in general use
by customers and receiving banks similarly situated.
ii. …However, if the bank offers a customer a
procedure that’s reasonable, and customer refuses
and chooses a different one, the one selected by the
customer will be deemed to be commercially
ix. Incorrectly Identified Beneficiary
1. Statute: 4A-207
a. *One of the most common issues under Article 4A
b. Problem, page 221
i. Thief impersonated Investor by ordering a payment
to the account of Investor.
ii. The account number in the order was xyz.
iii. Payment order was made to OB, which executed
payment order to BB, who credited the account
bearing number xyz. Xyz was actually the account
of Coin Dealer.
iv. Who bears the loss?
1. Under 4A-207(b), the beneficiary’s bank
may rely upon the account number as long
as it has no actual knowledge of the
a. Thus in this case the BB is not liable.
b. This is an automated system, and the
bank is not required to compare the
account number with the name of the
listed beneficiary. It is economically
not feasible to require the bank to
perform this comparison.
c. This leaves the originator with a
possible cause of action in
restitution. Originator bears the loss,
unless under (d)(1), originator can
recover under restitution from the
Coin Dealer—the incorrect
2. If the beneficiary’s bank has knowledge of
the discrepancy between name and account
number or simply pays the named person
rather than the account number, then the
beneficiary bank bears the loss.
a. If a bank has knowledge of the
discrepancy, it has the duty to clarify.
b. Therefore, if bank knows of
discrepancy and pays someone not
entitled to payment, acceptance
cannot occur. Beneficiary bank
could not accept the payment order
sent to it. And effectively, BB has
just given its money away to Coin
i. This leaves the possibility of
BB recovering under
restitution from Coin Dealer,
or to recover from Thief—
which is unlikely because he
v. (c) addresses customer concerns:
1. For the originator to bear the loss, the bank
must notify the originator that in the case of
a discrepancy between name and account
number, the beneficiary bank will be entitled
to rely upon the account number.
2. Thus the originator’s bank must provide
some sort of notice to the originator of the
practice of relying upon the account number,
to make the originator liable for the loss.
i. (a) Subject to (b), if payment order received by
beneficiary’s bank contains name or bank account
number referring to a nonexistent or unidentifiable
person, no person has rights as a beneficiary and
acceptance cannot occur
1. Error in the statute—“or” should say “and.”
ii. (b) If a payment order received by beneficiary’s
bank identifies the beneficiary both by name and
account number and the name and number identify
1. (1) Except as in (c), if the beneficiary’s bank
does not know that the name and number
refer to different persons, it may rely on the
2. (2) If beneficiary’s bank pays the person
identified by name or knows that the name
and number identify different persons, no
person has rights as beneficiary except the
person entitled to receive payment from the
originator. If no person has rights as
beneficiary, acceptance cannot occur.
iii. (c) If a payment order in (b) is accepted, the
originator’s payment order described the beneficiary
inconsistently by name and number, and
beneficiary’s bank pays the person identified by
number under (b)(1):
1. (1) If originator is a bank, originator must
pay its order.
2. (2) If originator is not a bank and proves that
person identified by number was not entitled
to receive payment, originator not obliged
to pay unless originator’s bank proves that
originator had notice—before acceptance of
its order—of a policy that someone will be
paid based on account number even if
inconsistent with the named beneficiary.
iv. (d) In a case under (b)(1), if beneficiary’s bank
rightfully pays the person bearing the number and
that person was the wrong beneficiary, the amount
paid may be recovered from that person under law
governing mistake and restitution as follows:
1. (1) If originator is obliged to pay its
payment order under (c), originator may
2. (2) If originator is not a bank and is not
obliged to pay its payment order,
originator’s bank may recover.
2. Corfan Banco Asuncion Paraguay v. Ocean Bank
i. This case results from a drafting error in 4A-207
ii. The account number identified no one
iii. Statute: 4A-207(a)
1. Subject to (b), if name, bank account
number, or other identification refers to a
nonexistent or unidentifiable person or
account, no person has rights as a
beneficiary and acceptance cannot occur.
i. OB to IB to BB to B is the transaction.
ii. B was described by name, but also by an account
number that did not exist.
iii. BB noticed the discrepancy. Could not pay anyone
because the account number did not exist. But BB
then contacted the named B and verified the correct
iv. OB then discovers its mistake and sends a duplicate
payment order in exactly the same amount, this time
with the correct account number. Therefore, B has
been paid twice.
v. OB sues BB to recover the amount of duplicate
i. Court applies the literal language of the statute and
finds that acceptance could not occur, so BB must
refund the money to OB.
ii. Statute says that if any item of identification (name,
number, etc.) does not exist, then acceptance cannot
1. Court applies this literally. Can’t get to (b)
because (b) only applies if the name and
number refer to different persons.
2. The account number in this case identified
no one. Therefore, acceptance could not
3. Statute should be amended under (b) to say
that acceptance may occur if name and
account number do not refer to the same
x. Bank-Customer Agreement
1. Regatos v. North Fork Bank
i. Two basic rules:
1. 4A-204 in the case of an unauthorized
payment order entitles the customer to a
a. The bank “shall” make the refund.
b. Customer must exercise ordinary
care to notice the error and notify the
bank within a reasonable time.
2. 4A-505 If the customer fails to notify the
bank within one year of the facts, then the
bank is not obligated to refund the payment.
i. Two fraudulent payments orders
ii. Bank did not comply with its own security
procedure, which was itself “ludicrously deficient”
1. The comparison of a signature alone is not a
procedure at all. Bank was supposed to
compare the signature and made a phone
2. Bank did not make a phone call.
iii. But customer did not notify the bank until a couple
months after the fraudulent orders; customer had
agreed to not receive his bank statements until later
than normal. But when customer did receive the
statement, he notified the bank promptly.
i. Customer takes the position that 4A-505 is a
mandatory rule trumping a bank-customer
agreement, so he has a full year to notify the bank
of the fraudulent payment order.
ii. The bank takes the position that the bank-customer
contract requires the customer to notify the bank
within 15 days.
1. Agreement: the customer must exercise
reasonable care in examining bank
statements, including for unauthorized
signatures must notify the bank no later than
15 days after the bank statement is first
made available to the customer.
iii. Article 4A-501(a)—The parties may vary their
rights and obligations by agreement, except as
otherwise provided in Article 4A.
1. So the bank argues that this provision
provides a general freedom of contract.
a. Specific provisions say that they are
b. 4A-505 says nothing suggesting that
it is not alterable by agreement.
i. Argues that 4A-505 and 4A-204 are in pari materia.
ii. 4A-505 states a fundamental right of a customer to
be refunded, when there has been an unauthorized
payment order, if it notifies the bank within one
iii. The 15 day window in the contract is trumped by
i. Article 4A represents carefully crafted compromise
between customers and banks
ii. 4A-505 should be viewed as merely a default rule
because it does not contain language saying that the
one-year period is unalterable by agreement.
iii. Still, maybe the failure to tie together 4A-505
nonvariable was a drafting error.
2. Rule of Reason
a. Some courts take the viewpoint that while 4A-505’s oneyear period is alterable by agreement, there is a rule of
reasonableness governing a bank-customer agreement
giving a customer a time period lesser than one year
i. This is foreshadowing of the next chapter—the loss
can be imposed upon the customer if the customer
does not examine his statement and report a forgery
within a certain amount of time.
b. Case law has addressed not whether the one year period can
be altered by agreement, but by how much the period can
c. Jurisprudential rule: The one year can be shortened but
must be reasonable.
i. 10 days would not be reasonable.
ii. 60 days might be reasonable.
iii. The lower court in Regatos has used this approach
to reach the same result used in the appellate court:
bank could vary the one-year period by agreement,
but 15 days was unreasonable.
Fraud, Forgery, and Alteration
i. Allocation of Loss Between Customer and Payor Bank
i. *******This is the meat of the course.
ii. Check fraud is a huge problem.
iii. Think Wal-Mart just filling out the check for you as
a “debit card” –type transaction; the crook does the
transaction without leaving information on the
iv. ***It is CRUCIAL that we learn these rules.
b. Forged Checks
1. Drawer has check that Thief steals, and
Thief forges Drawer’s signature.
2. Thief passes the check to a Payee, who
deposits with Depositary, who forwards the
check to Payor/Drawee for payment.
3. We are concerned with Drawer/Payor
1. Thief’s forgery is “ineffective” as the
signature of the Drawer. The check does not
represent Drawer’s order under 3-403(a).
Thus check is not properly payable under 4401(a) because not “authorized by the
2. Payor Bank must re-credit the amount to
c. Forged Indorsements
1. Drawer issues check to Payee. Thief steals
check from Payee.
2. Thief forges Payee’s indorsement on check
and deposits with Depositary, which
presents check for payment to
1. The general result is the same as with forged
checks: the Thief’s forgery is ineffective
as the signature of the Payee.
2. The Payor was authorized to pay based on
Drawer’s signature, which did not occur.
3. The check was not properly payable and
thus Payor Bank must re-credit Drawer’s
account for amount of the check.
d. General Rule: The customer/drawer is protected from
forgery. When forgery occurs, the payor bank has to recredit the customer’s account after the thief’s fraud is
i. However, there are exceptions, which we explore
ii. The payor may be able to reallocate some of the
loss to the customer under these exceptions.
2. Negligence of Customer Contributing to Forgery
a. Statute: 3-406(a)
i. The statute imposes a duty of ordinary care on the
ii. Summary of text: A person whose failure to
exercise ordinary care substantially contributes to
an alteration of an instrument or to the making of a
forged signature on an instrument is precluded from
asserting the alteration or forgery against the bank
iii. Therefore, the loss because of a forgery can be
shifted to the customer if (1) the customer did not
use ordinary care and (2) this failure substantially
contributed to the making of the forgery.
1. Thompson Maple Products’ ordinary care
analysis is incorporated into this statute
b. Thompson Maple Products v. Citizens Nat. Bank
1. Plaintiff purchases timber from local
businesses, uses local truck haulers to bring
the timber to plaintiff’s mill
2. When logs were delivered by haulers, the
plaintiff’s employee was supposed to fill out
scaling slip—give original to bookkeeper
and give copy to the truck hauler.
3. However, the plaintiff rarely ever followed
these internal procedures. In actuality,
plaintiff’s employee gave slips to the hauler,
who then brought the slips to the
4. The fraudster was a truck hauler who would
get blank slips and fill them out to himself,
bring them to the bookkeeper, and have a
check written, and volunteer to bring the
checks to the timber owner. Fraudster then
would forge payee’s signature (forged
indorsements) and deposit them at the bank,
have them paid to himself.
1. Thompson is precluded from asserting the
forged indorsements against the bank
because of the customer’s failure to exercise
ordinary care that contributed substantially
to the loss.
2. “Substantially contributes”—there must be a
showing that the customer’s negligence
made it easier for the forger to commit the
fraud. Customer is precluded from pleading
the forgery because its negligence made it
easier for the fraudster to commit the
iii. Ordinary Care
1. Making blank slips available to truckers and
not using sequentially numbered slips, in
addition to allowing truckers to bring the
slips to the bookkeeping office—in totality,
all these acts constituted a failure to exercise
2. In this case, the negligence of customer is
related to the payee’s indorsement. This is a
rare case; usually if the payee’s indorsement
is forged, the customer’s negligence will not
contribute. Usually, the customer-drawer’s
negligence will lead to a forged check, not a
c. Modern Cases
i. There has been some shift away from the strictness
of the UCC. One case found that the negligence
was not “proximately related” to the forgery, so the
bank would still be liable. This “proximately
related” standard of causation is pre-UCC standard.
The actual UCC standard of “substantially
contributes” only requires that the negligence make
it easier for the forgery to occur.
ii. Where insurance company had two insureds named
John Doe in different states and mailed check to the
wrong John Doe, this substantially contributed to
the ability of a forgery to occur, and the customer
was precluded from shifting loss to the bank.
d. Problems, Page 239
i. 3-406(b) creates an exception to the exception.
Despite the rule of customer negligence, (b)
provides that if the bank fails to exercise ordinary
care and that failure substantially contributes to the
loss, the loss is allocated between the customer and
the bank in a sort of comparative negligence
ii. #1 – In the Thompson Maple Products case, the
checks were “on us” checks. In other words, the
drawee bank was the bank in which the fraudster
deposited the check. Drawee/payor bank and
depositary bank were the same bank. Normally, the
payees of the checks might not have a reason to
transfer the checks to the fraudster. The payees
would normally deposit these checks in their own
1. This might raise at least some curiosity of
the bank as to why the farmers would have
paid the hauler for services by negotiating
the check from the plaintiff to the hauler. In
most instances, check would be deposited in
payee’s account, and payee would make a
separate check payable to the truck hauler.
2. This suggests possible lack of ordinary care
on the bank’s part. Therefore, there would
be comparative fault applied between bank
and customer; each would bear part of the
loss from the forgery.
a. Note that the statute does not give
any indications of how to allocate
percentages of fault.
iii. #2 – In this hypo, these are not “on us” checks; the
fraudster deposits the check in his own depositary
bank. Assume that the checks to the timber
companies were made to corporate payees, and
indorsements of these companies would ordinarily
be printed and “look official.” The fraudster made
crude indorsements, so the customer/drawer may
have an argument that the payor/drawee bank
failure to exercise ordinary care in not questioning
the appearance of the indorsement.
1. But in this case, the fraudster had no account
with the payor bank, so the payor bank
would have no reason to be familiar with the
2. Held: the drawee bank had no duty to
examine a check to determine irregularities
with regard to indorsements.
a. The drawee bank pays by automation
and never looks at an indorsement of
b. Further, the depositary bank warrants
that the indorsements are valid, so
the drawee/payor has no duty to look
at the indorsements. Payor can pass
the loss back to the depositary bank.
The depositary bank would thus be
liable in such a case for breach of its
presentment warranty—foreclosing a
need for a negligence analysis with
respect to the depositary bank. The
next case discusses the potential
liability of a depositary bank in this
e. Halifax Corp. v. Wachovia Bank
1. The fraudster had access to the signature
stamp for the President of the company;
would stamp the checks, fill out the
remainder of the checks by hand, and either
deposit these checks in her account or cash
2. The depositary bank never raised any
questions at all about these activities. Even
though the depositary bank knew that this
fraudster could not have the salary, as an
employee, necessary to be payee of this
many successive checks from the employercompany.
1. These were forged checks because the
fraudster’s act of stamping was
2. Perhaps the drawee bank was negligent.
However, the customer-drawer company
failed to report any of the forgeries to the
drawee/payor bank until the one year cutoff
in 4-406(f) had accrued.
a. Therefore, if the customer recovers
anything, it has to find a way of
shifting the loss to the depositary
b. Depositary banks make no
guarantees with regard to the
c. Legal doctrine: 3-406 is broader
than relationship between drawer and
drawee. It implicitly does create an
affirmative cause of action for the
drawer against the depositary whose
negligence contributed to the loss.
d. This Court: Rejects the legal
doctrine and finds that 3-406 does
not create a cause of action against
the depositary bank.
e. Professor’s observation: the law is
still evolving, and the White &
Summers’ legal doctrine is highly
persuasive. But in this case, the
court’s finding makes sense because
a depositary bank has no duty to
discover a forged signature of the
drawer, because depositary is only
concerned with its customer, the
3. Failure of Customer to Report Forgery
i. It is easier for a customer to detect forgeries than it
is for a payor bank to detect, thus 4-406 imposes a
duty on the customer to report forged checks to the
ii. As the volume of checks has grown, banks have
stopped doing sight review to verify signatures.
iii. 4-406 was originally designed to codify the duty of
the customer/drawer to examine bank statements
with reasonable promptness, and if the customer
discovered forgeries or unauthorized checks, to
report this to the bank on a timely basis
1. Under original 4-406, if the customer could
show that the bank was negligent, the bank
was contributorily negligent and would bear
the entire loss. However, now, this is only
2. Traditionally, to shift the loss, the customer
would argue that the failure of the bank to
perform sight review of check signatures
was negligence that should cause the bank to
bear the loss.
iv. Banks shifted from sight review of all checks to
payment by machine with no human examination
1. Customers then argued that in eliminating
sight review, this was elimination of a
traditional service and lack of ordinary care
2. Early cases were deeply divided. Medford
held that failure to perform sight review was
negligence as a matter of law.
3. The banking industry put major efforts into
this litigation and later cases adopted the
Hand Formula—if cost of sight review
outweighed the benefit, it was not
negligence as a matter of law.
a. The 1990 Revision adopted these
cases. New definition of ordinary
b. “Ordinary Care,” 3-103(a)(7): in the case of a person
engaged in business, means observance of reasonable
commercial standards prevailing in the area in which the
person is located, with respect to the business in which the
person is engaged. In the case of a bank that takes an
instrument for processing for collection or payment by
automated means, reasonable commercial standards do not
require the bank to examine the instrument if the failure to
examine does not violate the bank’s prescribed procedures
and the bank’s procedures do not vary unreasonably from
general banking usage not disapproved by this Chapter or
i. Comment acknowledges the banking industry’s
position that sight review is very costly.
ii. The costs of sight review outweigh the benefits—
often sight review does not catch forged checks,
c. Espresso Roma Corp. v. Bank of America
1. Employee fraud—classic inside job. Steals
blank checks from employer, prints out
blank checks from computer and forges
signatures. Removes forged checks from
bank statement that were mailed to the
2. More than $330,000 stolen over one and a
3. There was a lack of internal controls
4. The bank abandoned all sight review of
ii. Held: The bank established sufficient evidence that
it exercised ordinary care.
iii. 4-406 discussion
1. Where the customer does not report on a
timely basis, the customer eats the loss
2. However under (e), if the bank did not
exercise ordinary care and this contributed
to the loss, the loss is apportioned between
the bank and its customer
3. The bank’s procedures were reasonable
because other similarly-sized large banks in
that geographical area had abandoned sight
4. These cases almost always come down to
trials with “dueling experts.” The customer
and banking expert will each state what he
believes to be standard banking usage.
a. The bank’s expert testified that for
similar banks in northern California,
no similar bank used sight review.
b. The court found that this provided a
prima facie case that the bank’s
procedures were reasonable.
c. The customer’s expert testimony was
not persuasive because it focused on
other types of banks in the same
iv. Additionally, even if failure to do sight review was
negligent, in this case, it did not contribute to the
v. 3-103 Comment 5 states that a customer may prove
that the rules followed by a particular bank are
unreasonable, arbitrary, or unfair.
1. This comment addresses the some concern
that banks could get together, in collusion,
and follow the same practices; to essentially
collectively set the benchmark for ordinary
2. This comment just states that even though a
practice is general banking usage, the
customer can introduce evidence that the
usage followed is unreasonable, arbitrary, or
unfair—and therefore a lack of ordinary care
3. However, one court found that the language
of the statute trumped the comment.
d. Time Limitations
i. 4-406(f) If a customer does not report a forgery
within one year after the statement is made
available, the customer cannot raise the forgery
against the bank, regardless of lack of ordinary care
by bank and/or customer.
ii. 4-406(e) states that if the bank pays the instrument
in bad faith, the bank bears the loss.
1. This addresses the situation where the forger
has inside help from the bank.
e. Bank Statements
i. Some banks no longer mail canceled checks to their
ii. The customer’s duty to report forgery is triggered
by the bank’s sending a statement of account. This
raises the question of how much information about
the check the bank must provide in order for the
customer’s duty to report to be triggered.
iii. There is no duty to report; therefore, if the bank
does not return the checks, this just means that the
customer’s duty to report is not triggered.
iv. However, if check number, amount of check and
date are provided, the customer has significant
information, and the duty to report is triggered. As
of now, there is no requirement of returning an
image of a check to the customer to trigger the duty
f. Agency Law Issue
i. The customer cannot satisfy his duty to report,
when the forger is the one authorized by the
customer to oversee financial matters.
ii. As a matter of agency law, if authority is delegated
to a forger to receive bank statements, and that
person takes advantage of that authority, the
customer is bound by apparent authority.
iii. Therefore, if the customer hires a crook, this is the
customer’s “tough luck.” The duty to report is not
excused by virtue of hiring a crook. “Duty of
supervision” is not an issue.
g. Problems, page 249
i. Agreement between Bank and Company, its
customer, is that Bank may pay checks drawn on
account only if signed by CFO—Hardy and deputy
ii. #1 – Olsen signed his name, but Hardy did not.
Even though there was no forgery, under 3-403(b),
the signature was unauthorized. If more than one
signature is required on a check by virtue of bankcustomer agreement, if a signature is missing, the
check is unauthorized.
iii. #2 – Olsen fraudulently wrote 3 checks on
Company’s account payable to Olsen. He forged
Hardy’s signature. Under Bank’s procedures, it did
no sight review for checks less than $2,500. Fraud
was discovered by Company in June. Olsen was
then insolvent. Company notified bank on June 7,
immediately after discovery of the fraud.
1. (a) First check for $1,000 paid on Jan. 2 and
returned on Jan. 4.
a. The starting point is 4-406(c): The
customer must exercise reasonable
promptness in examining the
statement. If customer should have
reasonably have discovered the
unauthorized payment, the customer
must promptly notify the bank of the
relevant facts. This is the basic duty
of the customer.
b. “Reasonable promptness” is not
defined. The 30 day period of (d) is
not part of (c). Whether there is an
excuse for the delay is the starting
point of the analysis—consider all
the facts and circumstances if there
is a delay in reporting. If there were
extenuating circumstances, the
customer does not violate the duty by
not reporting immediately. We only
reach (d) if the customer does not
meet his duty in (c).
c. 4-406(d) – If the customer failed to
comply with the duty imposed, the
customer may not assert: (1) the
customer’s unauthorized signature or
any alteration if the bank also proves
that it suffered a loss by reason of the
failure; and [may not assert] (2)
customer’s unauthorized signature or
alteration by the same wrongdoer on
any other item paid in good faith by
the bank if payment was made before
the bank received notice from
customer and after customer was
afforded a reasonable time, not
exceeding 30 days, in which to
examine the item and notify the
d. (d)(1) refers to the rare occasion
where there is one isolated forgery,
and also refers to the first check (in a
series of forgeries) that is apparent in
the first statement. (d)(2) refers to
the checks after the first check in a
e. (d)(1) says that for the one-time
forgery or the first check returned in
a forgery, the customer bears the loss
if the customer unreasonably delayed
under (c) and the bank suffered a
loss under (d)(1). In this case, there
is no way that the customer complied
with its duty under (c); it delayed 6
months between receiving notice of
the first check and notifying the
bank. However, under (d)(1), the
bank must prove that it suffered a
loss by reason of the customer’s
failure to give notice of the forgery.
Therefore, under (d)(1), the bank
will probably still be liable for the
amount of the check.
i. In effect, the statute requires
but-for causation: but-for the
delay in reporting, that the
bank could have recovered
the check from the forger.
ii. This has nothing to do with
contributing to the forgery;
only negligence in failing to
report the forgery.
iii. In this case, it will be
difficult for the bank to carry
its burden of proof that it
could have recovered from
the forger, but for the
Because even if customer had
given timely notice, the bank
suing the thief would not
have allowed recovery
because the thief went
2. (b) Second check in amount of $2,000 paid
on Feb. 20 and returned on Mar. 3.
a. Under (d)(2), there was a 30 day
window for the customer to report
this forgery. This was the second
check in a series of forgeries, so (d)
(2) applies. January 4 was the day
that the statement was made
available to the customer, so this is
the date that the 30 days start ticking.
b. Note that the statute says, for
forgeries by the same wrongdoer, the
time to discover and report the
forgery is a reasonable time not to
exceed 30 days. However, banks
usually allow the full 30 days.
c. When the bank paid the second
check on Feb. 20, the 30 days had
expired. Therefore, after 30 days
from January 4, the loss
presumptively shifts to the customer.
The bank does not have to prove its
d. However, if under (e), the customer
can show that the bank failed to
exercise ordinary care and that this
negligence contributed to the loss,
the customer can introduce
comparative fault between the
customer and the bank. In this case,
the bank’s policy is to not sight
examine any check below $2,500. It
would be a fact inquiry as to whether
this policy is reasonable. This is the
Espresso Roma issue redux.
3. (c) Third check for $5,000 paid by Bank on
Feb. 28. Before check was paid, employee
examined check but failed to detect the
forgery. Returned on Mar. 3.
a. The question becomes how good the
forgery was. If under (e) the clerk
did not make an adequate inspection,
then perhaps some of the loss can be
shifted back to the bank.
b. But otherwise, under (d)(2), more
than 30 days have passed since Jan.
4, so the customer is presumptively
liable on the amount of the check.
h. 4-406(f) One-year statute of limitations
i. There is a one-year statutory cutoff for the customer
to report a forgery. One year from the date that the
statement is made available to the customer.
ii. The one year runs from any given check for any
given statement. Thereafter, negligence on either
party’s part is irrelevant. The customer is precluded
from raising the fact of the forgery against the bank.
iii. This only applies to the customer’s unauthorized
signature or alterations of the check—it does not
apply to forged indorsements. 4-111 provides the
statute of limitations for forged indorsements: 3
i. Fraud Prevention Measures
i. Banks have other fraud filters, instead of sight
inspection, to guard against forgery losses.
Sequencing of checks, unusually large amounts, and
software that monitors account activity are all fraud
ii. Banks also insure against forgery losses.
4. Validity of Contractual “Cutdown” Clauses
a. National Title Ins. Co. Agency v. First Union Nat. Bank
i. Issue: Under what circumstances may bankcustomer agreements cut down reporting times for
1. Freedom of contract. 4-103 allows varying
by the agreement the provisions of Article 4,
except for (1) disclaiming a bank’s
responsibility of good faith, (2) disclaiming
responsibility for failure to exercise ordinary
care, and (3) limiting the measure of
damages for lack of this failure.
1. Bank-customer agreement purported to
absolve the liability of bank if customer did
not report a forgery within 60 days.
2. Customer did not report forgeries within 60
days of the date that checks were returned.
1. Held: The one-year period could be varied
a. This agreement vastly cut down the
statutory 365-day period to 60 days.
b. This substantially reduces the bank’s
risk of paying forged checks.
c. But the court sees this as a freedom
of contract issue.
d. 4-103 seems to allow the
modification. The shortening of the
one-year period does not disclaim
bank’s good faith obligation, or its
duty to use ordinary care, or its
liability for damages resulting from
lack of ordinary care.
iv. Another court upheld a 20 day cutdown.
1. This is the judicial trend—banks usually win
in these disputes.
2. Article 4 is basically a series of default
3. This raises the question of how much the
agreement can shorten the time period for
ii. Right of Payor Bank to Recover Mistaken Payment of Check
1. Forged Checks
a. Price v. Neal
i. Old English case from 1762. Lord Mansfield.
**Be able to recognize this case by name.
1. The law of restitution prevents a party from
being unjustly enriched.
iii. In this case, the drawee believed that drawer’s
signature was authorized; but in fact it had been
1. Common law of restitution suggested that
drawee could get the money back.
2. Held: drawee could not obtain the money
3. The rationale was that as between the person
paid and the drawee, the drawee is in a
better position to be familiar with the
drawer’s signature. It was incumbent upon
the drawee to know the drawer’s signature.
(Clearly this rationale has no value in
modern banking transactions.)
4. However, the modern statute retains the
holding of this case.
iv. Rationale for modern rule
1. The need for a bright-line rule as to who will
bear the loss between drawee and payee, in
the case of a forged check.
b. Statute: 3-418
1. (a) The drawee may recover from the payee
under a theory of restitution, but subject to
2. (c) The remedy may not be asserted against
a person who took the instrument in good
faith and for value or who in good faith
changed his position in reliance on the
payment or acceptance. However, the
presentment warranties (3-417 and 4-208—
parallel provisions) are still available to the
ii. 3-417 Presentment Warranties for Unaccepted
1. (a) If the drawee pays, the person obtaining
payment and person presenting for payment
a. (1) the warrantor was a PETE;
b. (2) the draft was not altered
c. (3) the warrantor had no knowledge
that signature of drawer was
c. Problem, page 257
i. Employee forged check payable to herself, using
this check to buy groceries. The grocery store
usually cashed third party payroll checks, which this
check appeared to be. The forgery was well done.
Grocery store deposited, depositary presented, and
payor bank paid.
1. (a) Payor bank may not demand that
depositary bank reimburse for the amount of
the check. This is the rule of Price v. Neal.
Under 3-418, the possibility of recovery in
restitution is cut off because the depositary
has changed its position in reliance on the
a. Additionally, there is no remedy for
suing in presentment warranty.
Because depositary only warranted
under 3-417 that it had no knowledge
that the signature was unauthorized.
Therefore, the payor cannot push the
loss to the depositary.
b. Also, the depositary makes a
warranty that he was a PETE. Both
the grocery store and depositary
bank were PETEs. Even though the
employee forged the employer’s
signature, this is treated under the
statute as if he had signed his own
name; therefore the employee has
become liable on the check. A
forged check is not an absolute
nullity; it may be negotiated. This is
a fundamental difference between a
forged check and a forged
indorsement. Thus because the
check was able to be negotiated, the
grocer and then the depositary
became PETEs/holders. Therefore,
there was no breach of transfer
warranties by grocer and depositary.
So payor has no right to recover on a
breach of transfer warranty theory
from either grocer or depositary.
2. (b) When Payor learned of forgery, it
demanded that Grocer pay, on the theory
that Grocer dealt with the crook, so Grocer
should bear the loss.
a. Grocer is not liable, just like
depositary bank was not.
b. The presentment warranty is made
by prior transferors, not just the
presenter. But here, the grocer did
not breach its warranty. It was a
holder, and therefore a PETE.
c. The grocer only makes the
presentment warranty that it does not
have knowledge of a
d. The transfer warranties, however,
also warrant that transferor is a
PETE and that all signatures are
authentic and authorized. This is a
broader warranty than the
presentment warranty—which is
merely that there is no knowledge of
an unauthorized signature. Still, the
Grocer did not breach its transfer
warranty. The payor is not a
transferee. When the depositary
bank presents the check to payor,
depositary does not “transfer” to
payor, but rather seeks payment.
Therefore, payor does not get the
benefit of transfer warranties—only
of presentment warranties.
e. Notably, Grocer did breach the
transfer warranty in a technical sense
because it warranted that previous
signatures were authorized—and the
employee’s signature was not
authorized. However, this technical
breach gives rise to no action
because the transferee, depositary
bank, has suffered no loss in this
case. To recover from a warrantor, a
plaintiff must show proof of actual
d. The rule of Price v. Neal was argued against by banks when
Articles 3 and 4 were drafted but the rule was adopted
because it gives payor banks an incentive to be vigilant
about forgeries, and because the common law was settled
for 250 years.
2. Forged Indorsement
i. **Big difference from forged checks
ii. **Very important for rest of the course.
b. Problem, page 258
i. Drawer issues check to Payee. Thief steals check
and forges Payee’s indorsement. Payee sells check
to Customer, who takes in good faith and without
notice of forgery and deposits at Depositary Bank.
Depositary presents for payment to Payor; Payor
pays. Customer withdraws amount of the check
ii. As between Drawer and Payor, Payor will have to
re-credit Drawer’s account like we learned at
beginning of the chapter. But can Payor shift loss
to either Customer or Depositary?—Yes!
Warranties are the key.
iii. Customer and Depositary have breached transfer
warranties. They both warranted that they were
PETEs; they were not PETEs because the forgery of
the indorsement prevents future transfers of the
instrument. Payor can recover from either
Customer or Depositary.
iv. Depositary could recover from Customer if Payor
sues Customer. Because Customer breached its
transfer warranty to Depositary.
i. Forged indorsements are treated radically different
from forged checks under warranties. The warranty
is that the transferor is a PETE; but neither
Customer nor Depositary was a PETE because of
the forgery. Because of the forged indorsements,
there could be no negotiation of the check to
ii. Common Law
1. Rule was that collecting banks were not
liable. Therefore, collecting banks
guaranteed prior indorsements. Prior
2. In the face of this custom of guaranteeing
indorsements, the UCC drafters just imposed
a warranty—the presentment warranty is
placed on the presenting bank and prior
transferors that they are PETEs.
3. The presentment warranty is made by the
depositary. If the payor sues the depositary,
the depositary may pass the loss back onto
the customer because of customer’s breach
of transfer warranty. Additionally, the
customer breached its presentment warranty
iii. Forged indorsements usually result in the loss being
passed back to the person who dealt with the forger.
This leaves the person who dealt with the forger
having to pursue the forger for recovery.
iv. This is why business establishments and depositary
banks are hesitant to accept from customers checks
that contain indorsements to the customer;
depositary cannot determine whether the previous
indorsements were forged or not.
v. Justification for treating forged indorsements
differently from forged checks
1. White & Summers argue strongly that there
is no justification.
2. But common law precedent is essentially the
3. However, one rationale is that the transferee
dealing with the forger is able to require
identification from the forger to determine
the validity of forger’s signature.
3. Remotely Created Checks
i. Checks created by telemarketers with consent of
ii. If the telemarketers was guilty of fraud, the UCC
placed the loss on the depositary.
b. Now, Regulation CC imposes a warranty…
i. The majority rule in many states is to follow the
Restatement of Restitution, which recognizes a
cause of action to recover the payment.
ii. Overdrafts are problematic. The equities are not
clear cut. No bank in its right mind would pay a
forged check or a check with a forged indorsement
on which payment has been stopped. It would have
to be a mistake for a payor bank to pay such a
check. However, banks pay checks that create
overdrafts all the time. They do this as a short-term
extension of credit to the customer, if the customer
is trustworthy, rather than having the check bounce.
iii. Therefore, the bank may pay the check in hopes that
the drawer will later put enough funds in the
account. Then later the drawer may not put money
in the account, so the payor bank may want to
recover under 3-418, that it paid the check by
mistake and is entitled to restitution.
b. So the payor bank who pays an overdraft may sue under
restitution, but again under 3-418(c), no right of restitution
may be asserted against a person who took the check in
good faith and for value or who in good faith changed
position in reliance on payment of the check.
iii. Conversion Actions Regarding Checks Bearing Forged Indorsement
1. Action by Payee
i. Example: Drawer issues check to Payee. Thief
steals and forges Payee’s indorsement. Deposits
with Depositary, who obtains payment of the check
from Payor. What are the rights of the payee?
Because the payee has not received payment of
obligation, now that check has been stolen.
ii. The ordinary rule is that the drawer does not receive
discharge on obligation to payee until the check is
accepted by payor bank. Upon dishonor of the
check, the drawer can be liable on the check itself
or on the underlying obligation to payee. However,
under the above example, 3-310(b)(4), the payee
cannot sue on the underlying obligation because it is
suspended. The payee may only sue the drawer
under 3-309, the rules regarding lost, stolen, or
destroyed instruments. Payee will have the burden
of proving the terms of the instrument, etc.
iii. If Payee can get Drawer to stop payment and give
Payee another one, then problem is solved.
However, this requires cooperation from the
Drawer. Additionally, usually the check will
already have been paid.
iv. Therefore, Payee may try to shift the loss to Payor
or Depositary, on the theory that they have
converted the check. A theory of tort liability.
v. Conversion: the unwarranted exercise of dominion
over the property of another. The theory is that
when payor pays the check or depositary takes it,
this is dominion over the check without the payee’s
1. The Louisiana version of the statute is a bit
longer because our adoption of the Revision
includes the fact that we don’t have the
common law tort of conversion.
a. Under the UCC, the payee has no
right to obtain a substitute check
from the drawer. However, the
Louisiana statute (3-420(e)) states
that the owner of an instrument may
obtain a substitute check. There
have been no cases on this point, but
this Louisiana provision, that nothing
in the statute should prevent payee
from obtaining substitute check from
drawer, is seemingly in conflict with
the statute that the payee’s only
remedy can be to sue the drawer
under 3-309 for a lost check.
vi. Problem, page 261
1. Walks through the rules
2. Company sells products online and by mail
order. Thief, former employee, steals cash
and checks payable to company from
buyers. Thief forges indorsements to
himself. Deposits checks. Various payor
banks on which checks were drawn pay the
checks. Depositary allowed Thief to
withdraw the funds before forgeries were
3. Company as payee wants to pursue remedies
to recover these checks.
4. Thief was a converter, and depositary was a
converter because took without negotiation
of the checks. Because there could be no
negotiation, since the indorsements were
forged. The payor banks are also converters
because they have made payment with
respect to an instrument to a person not
entitled to enforce.
5. Rights of Payee
a. Sue the drawer. But not a good
remedy because payee has to prove
the terms of the checks to be able to
recover from these companies that
wrote the checks to payee. Also,
these drawers of the checks are
spread out all over the company—
would require a multitude of
b. Sue payor banks for conversion. But
they are also as diffuse as the
drawers, requiring a multitude of
lawsuits. If payee did recover from
payors, payor banks could shift the
loss back to depositary banks
because of depositaries’ breaches of
c. Best remedy is sue the depositary.
The one bank the dealt with all the
checks. The depositary is a
converter because it took the check
in a transfer other than negotiation
from a non-PETE.
b. Delivery of Check to Payee
i. Statute: 3-420(b) An action for conversion cannot
be brought by a payee who did not receive delivery
of an instrument.
1. Prior to 1990 Revision, this was not clear.
2. Conversion is a property principle—the
unwarranted exercise of dominion over
someone else’s property. If payee never
receives delivery, it has never become his
property. Additionally, if payee never
received a check, the underlying obligation
was not suspended—therefore, the payee has
a clear action on the obligation against the
drawer. There is no need for a conversion
action against one of the banks.
3. Rule: If payee has not received delivery of
the check personally, through a co-payee, or
through an agent, there can be no
conversion action by the payee.
c. Liability of Depositary Bank as Agent for Collection
1. Original Article 3 recognized a right of
action to sue a depositary; also said that
representatives, including depositary banks,
would only be liable if they still had check
proceeds in their possession.
2. This rule did not make any sense; the payee
would just sue payor, who would then sue
depositary. Therefore, the depositary would
ultimately be liable regardless of whether it
still possessed the check proceeds.
ii. Rule: only applies to representatives other than
depositary banks. A collecting bank through whom
the check passes is not liable in conversion, unless
the collecting bank still holds onto the proceeds.
This applies to collecting banks other than
depositaries. But the depositary bank is liable in
conversion, regardless of whether it still has the
d. Unauthorized Indorsement
1. Check indorsed by company and deposited.
Under 3-110(d), in which cases should bank
have demanded signature before taking
2. #1 – Check payable to “company
company2.” Only one signature is needed.
If there is any ambiguity as to whether check
is payable alternatively or not, it is deemed
to be paid in the alternative; thus only one
indorsement is needed.
3. #2 – “Company / company2.” Paid in the
4. #3 – “Company-company2.” The hyphen is
also ambiguous and thus payable in the
alternative, so that only one signature is
ii. Courts addressed what the drawer intended, by
looking at the way the check was written out. But
this was a recipe for confusion—depositary could
not determine intention of drawer, with regard to
how many indorsements were needed.
iii. Thus now there is a safe harbor: if it is ambiguous,
the depositary is protected; a single authorized
indorsement is enough under 3-110(d). Thus the
depositary would not be liable for conversion.
e. Forgery by Entrusted Employee of Payee
1. This addresses the relevance of the payee’s
behavior to payee’s ability to recover for
2. Cooper v. Union Bank, pre-Revision Case
a. Lawyer hired former client to be
employee was known to have been a
compulsive gambler who went
through bankruptcy; she stole checks
payable to lawyer and expertly
forged indorsements. Deposited at
her bank, which was the same bank
as the employer-lawyer’s bank.
Payee lawyer sued bank for
b. The issue is the payee lawyer’s
negligence—failure to exercise
ordinary care that substantially
contributed to the forgery. This
could be raised by the depositary
bank as a defense.
c. Lawyer made no effort to oversee
this known gambler. But bank
would have burden of proving the
lack of care. Should there be a more
direct way of allowing the bank to
defend rather than requiring bank to
prove payee’s negligence? Yes.
ii. Statute, 3-405
1. In certain types of employee fraud, the loss
should be imposed upon the employer
without the need to show actual negligence.
2. Where employer has delegated to employee
certain types of responsibility with regard to
financial affairs, there can be avoidance of
3. (a) Responsibility means authority to
sign/indorse instruments, process
instruments, prepare instruments for issue,
4. If this responsibility is delegated to
employee who then forges employer’s
signature, that signature is effective as
indorsement of the employer. So under (b),
the depositary would avoid liability, unless
the depositary also was negligent, in which
the loss will be apportioned between the
depositary and the payee-employer.
iii. Sidenote: The employee depositing the check in her
own account is less plausible than employee
cashing the check. Because in the latter case it
might make sense that the employee might be
cashing the check to give the petty cash to the
employer. Whereas with a deposit, why would an
employer indorse a check payable to it over to the
employee for deposit in the employee’s account?
Therefore, perhaps in the case of employee
depositing the check, this is negligence of the bank
in accepting the deposit, such that under 3-405(b),
some of the loss can be allocated to the depositary.
2. Action by Drawer
a. Stone & Webster v. First National Bank
1. Res nova addressing ability of drawer to sue
2. Employee forged indorsements and
deposited checks in employee’s bank.
3. Issue: Under Article 3, could the drawer sue
the depositary bank for conversion?
1. Held: No action was available to drawer.
The drawer’s rights were exclusively against
the payor/drawee bank.
2. Analysis of opinion
a. However, if drawer successfully
imposes loss on payor bank, payor
can then recover from depositary;
thus it may make sense to allow the
drawer an action against the
b. But the court says that this makes
sense only if it is absolute that the
drawer will be able to recover from
the payor bank. And in many cases,
the payor can defend against such an
action based upon the drawer’s lack
of care under 4-406.
c. Thus drawer should be able to sue
payor; then if there is recovery,
payor sues depositary on breach of
presentment warranty basis.
b. 3-420, Statute
i. (b) An action for conversion may not be brought by
the drawer or issuer.
ii. Rule on presentment warranty is that if a payor
voluntarily re-credits the drawer’s account, and then
sues depositary, the depositary is allowed to assert
against the payor the 3-404—3-406 defenses.
iv. Impostors and Fictitious Payees
1. Intent of Issuer
a. Generally, 3-110(a)
i. Rules regarding identification of a payee
1. Requires more than looking at the name on
an instrument. Because several people may
have the same name!
ii. Rule: The intent of the person issuing the
instrument, whether or not authorized, determines
who the payee is. The identity of the payee is
determined by the intent of the issuer.
1. Note that the identity of the payee can be
determined by the forger of a check under
this rule. Because the intent of the issuer
“whether or not authorized” is what
determines the identity of the payee.
2. Determination of intent is difficult when
there is an impostor as a payee—when the
person to whom the check is written is
someone other than whom he claims to be.
This is difficult because the issuer intended
to deal with someone else, but also
apparently in some way intended to deal
with the actual person “standing before
a. Statute: 3-404(a)
i. If an impostor induces the issuer of an instrument to
issue the instrument to the impostor by
impersonating the payee of an instrument or by
impersonating a person authorized to act for the
payee, an indorsement by any person in the name of
the payee is effective as that of the payee in favor of
a person who in good faith takes the instrument for
value or collection.
ii. Problem, page 273
1. Pauley fraudulently induces Martini to write
a check to Herman by convincing Martini
that Pauley was Herman. Pauley then
indorses, with Herman’s name, the check to
himself. Pauley deposits the check. Martini
claims that payor bank cannot debit his
account because Herman’s indorsement was
2. This is the classic impostor rule: because
Pauley obtained the check fraudulently,
Martini is the fool and should bear the loss.
3. An indorsement by any person in the name
of the payee is effective in favor of persons
who in good faith take the instrument for
value or for collection. The depositary acted
in good faith. The check is properly
4. The indorsement is valid.
iii. Problem #2
1. Pauley induced Martini to write a check to
the chair of the Red Cross, claiming he was
chair of the Red Cross. Pauley then
indorsed as the chair of the Red Cross and as
2. Pauley forged the indorsement by writing
Red Cross as an indorsement.
3. Bank must re-credit Martini’s account
because there was no impersonation. This is
not fraud covered by the statute. The fraud
was the representation that Pauley was an
agent of the Red Cross—not that he was any
one other than Pauley.
4. If Pauley had claimed to be Herman, the
chair of the Red Cross, the result would be
5. Here Pauley claimed to be no one other than
Pauley. A false representation of one’s
status as an agent is not covered by 3-404—
the bank has to re-credit the account in this
iv. The critical element is impersonation—claiming to
be someone other than who you are. If the
fraudulent character impersonates a payee, the
fraudster’s indorsement in the name of the
impersonated payee is effective as the indorsement
of that impersonated payee. Thus payor bank does
not bear the loss.
b. 3-404(c)—a minor discrepancy does not matter.
Discrepancy between name on the check and how it is
indorsed. An indorsement is made in the name of a payee
if made in name substantially similar to that of payee, or
whether or not indorsed, deposited in a depositary bank to
an account in a name substantially similar to that of payee.
i. Example, payee is Blue County Red Cross.
Signature is Red Cross of Blue County—this is
c. 3-404(d) However, if there is comparative fault of payor
and/or depositary bank, loss can be allocated to banks.
3. Fictitious Payees
a. Statute, 3-404(b)
i. This addresses instance where the employee forges
the indorsement of a payee other than the employer.
ii. If (i) a person whose intent determines to whom an
instrument is payable does not intend the person
identified as payee to have any interest in the
instrument, or (ii) the person identified as payee of
an instrument is a fictitious person, the following
rules apply until the instrument is negotiated by a
iii. (1) Any person in possession of the instrument is its
iv. (2) An indorsement by any person in the name of
the payee stated in the instrument is effective as the
indorsement of the payee in favor of a person who
in good faith pays the instrument or takes it for
value or collection.
i. Treasurer has authority to sign checks for Employer.
Treasurer, to defraud, includes checks payable to
part-time employees who aren’t actually owed
anything. Treasurer then, when signing those
checks with authority, indorses the names of the
employees and deposits the checks. Employer
bears the loss.
1. As to the checks payable to the part-time
employee payees, the Treasurer’s intention
controls—and the Treasurer did not intend
the payees to have any interest in the checks.
Therefore, Treasurer’s signature is effective
as their indorsements.
2. Because they were payable to fictitious
payees, the statute makes the instruments
valid if anyone signs the names of the
3. The result is the same whether (i) Treasurer
writes checks payable to ex-employees who
are not technically fictitious but whom the
Treasurer does not intend to have rights
under the instruments, or (ii) Treasurer
writes checks to fictitious payees.”
a. A payee is “fictitious” not just if
there is no one else in the world with
that name (which would be highly
unlikely), but if the person is made
up by the forger.
c. The effect of the fictitious payee rule of 3-404(b) is to shift
the loss from the depositary to the payor bank.
d. Because the signature of the fraudster is effective as the
signature of the named, fictitious payee, this is not a forged
v. Payroll Padding
1. Payroll padding is yet another type of employee fraud scheme.
a. Same hypo as above, except checks are signed by not only
Treasurer but also another officer. (This only means that
the instrument is payable to any person intended by either
of the officers.)
b. The Treasurer did not prepare the checks; someone else
prepared them. This person, Clerk, included some checks
payable to part-time employees who did no work. They are
actual persons not owed any money. Clerk gets Treasurer’s
signature, pulls out the employees’ checks, indorses them,
deposits them in Clerk’s account.
c. Now the problem is that the Treasurer’s intention under 3404(b) is what determines who the checks are payable to.
The Treasurer intended that the payees of the check receive
the funds—this would be the part-time employees.
i. Therefore, 3-404(b) does not work—these are not
fictitious persons, and Treasurer as signer intended
for these employees to get the money. Therefore,
this would be a forged indorsement and checks
would not be properly payable. But this makes no
sense as a policy matter
ii. Statute: 3-405.
3. Statute, 3-405
a. Forged indorsements where the employer as drawer has
validly issued them.
b. (a)(3) the clerk was entrusted with responsibility to
determine the payees of the checks to be issued in the name
i. This statute does not apply if an employee merely
has access. He must have responsibility as an agent
of the employer.
ii. Because the clerk has responsibility, (b) provides
c. (b) If an employee entrusted with “responsibility” over an
instrument makes a fraudulent indorsement, the
indorsement is effective if made in the name of the payee.
i. ***In this case, the statute speaks of an indorsement
made either by an employee or someone acting in
concert with the employee. Applies strictly to these
indorsements—not just anyone making the
vi. The Double Forgery
1. Gina Chin & Assoc. v. First Union Bank
i. The 1990 Revision addressed what to do with
checks that are both forged and bearing a forged
i. Employee of Employer forged name of one of the
authorized officers on a series of checks. Made
them payable to creditors of Employer.
ii. Then Employee forged the creditors’ indorsements.
This was done with the assistance of a Bank teller.
Checks were deposited with Bank and later
presented to Payors, who paid the checks.
iii. Employer sues in negligence against Bank
i. Pre-1990, courts would say that the forged check
trumps the forged indorsement—the forged check
was the principal infirmity. Therefore, courts would
impose the loss on the payor bank.
ii. Current Law, 3-404(b) If the person forging the
check does not intend the named payee to have any
interest in the check (which applies to these facts),
the person’s indorsement is effective in favor of
persons who in good faith pay the instrument or
take it for value or collection.
1. Even for a person who forges a check, his
signature determines the intent of who the
payee will be. Here, the Employee clearly
did not intend to give the listed payees
(creditors) rights under the instrument.
2. Therefore, the indorsement is effective.
Still, it is a forged check—so the loss falls
upon the payor bank.
iii. 3-404(d) states that if the person taking the check
fails to exercise ordinary care, the person bearing
the loss may recover from the taker, to the extent
that the negligence contributed to the loss.
1. Thus the drawer can sue the depositary in a
double forgery case.
2. But why does drawer need to sue
depositary? Because the payor is liable on
this forged check.
3. The comments indicate that the payor bears
the loss, and if the depositary is negligent,
payor may be able to shift loss to the
depositary. But it doesn’t make sense to
allow the drawer to bypass the payor and sue
d. Summary: For double forgery, treat as forged check, not
i. Yes, the indorsement is “effective” as that of the
payee, protecting depositary/collecting banks from
liability for transfer/presentment warranties.
ii. But, the payor bank is still liable because it is still a
iii. Note, that under 3-404(d), the payor may be able to
shift some of the loss back to the depositary bank
under a comparative negligence analysis.
vii. Allocation of Loss by Contract
1. Statute, 4-103
a. Provisions of this chapter may be varied by agreement, but
agreement cannot disclaim bank’s responsibility for its lack
of good faith or failure to exercise ordinary care or limit the
measure of damages for lack of failure
2. Jefferson Parish School Board v. First Commerce Corp.
i. Unknown person counterfeited checks.
ii. The Bank had drafted an agreement purporting to
absolve it of liability for checks bearing signatures
that appeared to resemble facsimile specimens on
file with the bank.
iii. The signatures at issue did resemble the specimens
on file with the bank.
iv. No employee of the school board was implicated.
i. Held: The agreement between bank and school
board was valid under 4-103 to vary the terms of the
1. 4-103 allows freedom of contract between
bank and its customer.
ii. This is perhaps the most looming issue in forgery
law—how can far can a bank go in overturning the
UCC’s provisions of who bears the loss in forgery
iii. Here the court says that the drawee can contract out
of the Price v. Neal rule that the drawee/payor bank
is liable for forgeries.
c. Freedom of Contract
i. Arguably, parties should be able to adapt in this
ii. However, how is the customer to protect itself from
forgeries, if the customer agrees to absolve the
payor bank from responsibility for any check whose
signatures resembles the one on file?
1. If customer does not sign an agreement, the
bank will refuse to do business with him.
2. Such an agreement is a massive reallocation
3. The banks have won most of these cases
under the freedom of contract banner.
4. However, one case has held that banks
should not be allowed to alter the basic
structure of Articles 3 and 4.
a. Courts might recognize that banks at least have a duty to
disclose—that when there is a boilerplate clause in the
contract, the bank must bring it to customer’s attention that
customer will be liable for forgeries
b. For example (and by analogy), in one case, bank said that it
did not have to stop payment unless customer on stop
payment order reported the exact amount of the check.
Held: if the bank wanted to enforce this provision, bank
should have explained the provision to the customer.
i. Complete Instruments
a. **Common errors on the exam in this subject matter.
b. Alteration is far less common than forgery, but still exists.
2. HSBC Bank v. F&M
i. Authorized employee delivered check payable to
payee. Payee altered the amount of the check
without authorization of drawer.
ii. Check was deposited at payee’s account with
depositary; payor paid the altered amount. Draweremployer’s account debited for the higher-thanauthorized amount.
b. Statute, 3-407
i. (a) Alteration means (i) an unauthorized change in
an instrument purporting to modify a party’s
obligation, or (ii) an unauthorized addition of words
or numbers or other change to an incomplete
instrument relating to the obligation of a party.
ii. (b) Except as in (c), an alteration fraudulently made
discharges a party whose obligation is affected by
the alteration unless that party assents or is
precluded from asserting the alteration. No other
alteration discharges a party, and the instrument
may be enforced according to its original terms.
1. Routinely misread by students.
iii. (c) A payor/drawee paying a fraudulently altered
instrument or a person taking it for value in good
faith and without notice of alteration, may enforce
rights with respect to the instrument (i) according to
its original terms, or (ii) in the case of an
incomplete instrument altered by unauthorized
completion, according to its terms as completed.
i. Absent negligence on drawer’s part, payor can
charge the drawer’s account only for the original
amount and may recover the over-amount from
depositary bank on basis of its breach of
presentment warranty under 3-417: breached the
warranty that the instrument has not been altered.
ii. Depositary can then turn and recover the same
amount from the payee, who altered the instrument,
on basis of payee’s breach of transfer warranty
under 3-416, of the warranty that instrument has
not been altered.
iii. The alteration cannot change the obligation of the
issuer/drawer, unless the lack of ordinary care
contributed to the alteration, or the drawer has not
reported the alteration in a timely fashion.
iv. 3-407(b) is the key: where an alteration is made
with fraudulent intent, it discharges the drawer’s
obligation entirely, but subject to (c). (c) tells us
that the discharge is not effective against a payor or
drawee or one who pays the instrument in good
faith, or transfers for value, in good faith, and
without notice of the alteration.
1. The discharge can only be raised against the
alterer, or other persons who did not give
value, were in bad faith, or had notice of the
2. Therefore, the drawer will still have to pay
the original, unaltered amount, to a person
who takes the instrument in good faith, for
value, and without notice of the alteration.
i. Payor can charge drawer’s account on the original
amount on the instrument.
ii. But because presenter of check warrants that check
has not been altered, payor can recover its loss
under 3-417(b) (interest and expenses--business
losses) from the depositary, who will then sue for
same amount from the payee for breach of transfer
3. Alteration involving added numbers/words
a. Sometimes drawer might leave extra spaces for a fraudster
to add extra zeroes. And leave extra space on word line for
fraudster to add extra words like “thousand”!
b. 3-406 may apply in this case—lack of care contributing to
c. Then payor bank may be able to raise this defense against
its customer, with the possibility of comparative negligence
on payor bank’s part.
4. Alteration of Certified Checks
a. Pre-certification alteration
i. Payor certifies the check after there has been an
ii. 3-413(a): Accepter of draft is obliged to pay
according to terms at time of acceptance, even
though the acceptance states that the draft is
payable as originally drawn.
iii. Therefore, a payor bank’s stipulation that it accepts
the check to pay it only in the value at time of
original issuance—this stipulation is ineffective.
The payor’s acceptance discharges the drawer. The
payor must pay the amount at time of acceptance.
b. Post-certification alteration
i. This is alteration after the payor accepts the check.
ii. 3-413(b): If certification/acceptance states the
amount accepted, the obligation of acceptor is that
amount. If amount is not stated, if the amount is
thereafter altered to a higher amount and HIDC
takes the instrument, the obligation of acceptor is
the amount of the instrument at time taken by the
1. So basically if the payor accepts and puts the
accepted amount, and thereafter there is
alteration, payor will only have to pay the
2. However, if the payor’s acceptance does not
state the amount of acceptance, this is
negligent, and the payor will have to pay the
amount thereafter altered.
a. However, this higher amount must
only be paid to a HIDC. Therefore,
there would have to be no apparent
evidence of the alteration for the
subsequent taker to be a HIDC.
ii. Incomplete Instruments
1. Statute, 3-115
a. Incomplete Instrument defined: (a) A signed writing whose
contents show that signer intends for the instrument to be
later completed by words or numbers.
i. Example, person preparing check for company
leaves some space on the check. This does not
mean the check is incomplete!!! Because the
instrument is only incomplete if there is evidence
that the contents of the signed writing show an
intention that the signer wanted the instrument to be
a. A owes B money. A sends check payable to B, but leaving
the amount blank. A tells B to fill in the amount of debt
that is owed.
b. If B determines that $10 is owed, and B writes in “$10,”
this is fine. Done with A’s authorization. B was A’s agent,
for purpose of adding the amount of the check to the
instrument that A provided. This is not an alteration.
Alteration requires an unauthorized addition to an
c. However, if B writes in $10,000, this is not authorized.
This is an alteration under 3-115 and 3-407.
d. 3-407(c): The instrument can be enforced according to its
terms as completed, as long as it’s a payor or person taking
for value in good faith and without notice of the alteration.
3. Why the difference in rules for complete v. incomplete
a. For a complete instrument, the issuer is liable only for the
original amount, unless the issuer is negligent.
b. For an incomplete instrument, the same result is reached
without addressing actual negligence. The check is left
completely empty, making an alteration easy. The loss
should be imposed on the party that foolishly created an
incomplete instrument. The issuer is treated as
conclusively bound for the entire amount.
c. Restrictive Indorsements
1. The purpose of a restrictive indorsement is to restrict payment of
2. Some restrictive indorsements are enforceable, such as “for deposit
only” or listing a certain account to which the funds must be
3. Others are not enforceable: 3-206(a) indorsements restricting
payment to a particular person (e.g. “Pay to John Doe only”), and
3-206(b) indorsements that attempt to prohibit payment unless a
stated condition is satisfied.
ii. Statute, 3-206
1. (a) An indorsement that purports to limit payment to a particular
person or otherwise prohibiting further transfer or negotiation of
the instrument is not effective to prevent further transfer or
negotiation of the instrument.
2. (b) An indorsement stating a condition to the right of the indorsee
to receive payment does not affect the right of indorsee to enforce.
3. (c) An instrument bearing an indorsement (i) to “pay any bank”, or
(ii) indorsed in blank or to a particular bank using words such as
“for deposit,” “for collection,” or other words indicating a purpose
of having the instrument collected by a bank for the indorser or for
a particular account, the following rules apply:
a. (1) A person, other than a bank, who purchases the
instrument when so indorsed converts the instrument unless
the amount paid for the instrument is received by the
indorser or applied consistently with the indorsement.
b. (2) A depositary bank that purchases the instrument or takes
it for collection when so indorsed converts the instrument
unless the amount paid by the bank with respect to the
instrument is received by the indorser or applied
consistently with the indorsement.
c. (3) A payor bank that is also the depositary bank or that
takes the instrument for immediate payment over the
counter from a person other than a collecting bank converts
the instrument unless the proceeds of the instrument are
received by the indorser or applied consistently with the
d. (4) Except as otherwise provided in Paragraph (3), a payor
bank or intermediary bank may disregard the indorsement
and is not liable if the proceeds of the instrument are not
received by the indorser or applied consistently with the
4. Problem, page 294
a. Peter, payee of 10k check indorsed and mailed to Bank One
where he had an account. Thief stole and indorsed Peter’s
name, depositing in his account at Bank Two. Payor pays
the check. What are Peter’s rights against Bank Two and
Payor Bank if Peter’s indorsements were as follows:
b. #1 - For deposit only
i. Peter has action against Bank2, depositary, for
conversion. Bank2 was put on notice by the
restrictive indorsement that the check could only be
deposited in an account of Peter’s.
ii. The proceeds were made not available to Peter.
iii. The payor is not liable because it is not an “on us”
c. #2 – Pay to Bank One for Account No. xyzabc
i. Special indorsement but also restrictive.
ii. Same result. The indorsement specifies that it is to
go into that account. Therefore, depositary bank is
liable for conversion because proceeds were paid
neither to Peter nor to the specified account.
d. #3 – Peter
For deposit only
i. Here is it unclear whether “for deposit only” was
written by Peter or Thief.
ii. If it is ambiguous and depositary cannot tell which
person indorsed, then depositary might argue that it
has the right to treat this as an indorsement by Thief
and therefore is not liable for conversion.
iii. Majority Rule: depositary must deposit the check in
account of payee. If depositary deposits funds in
account of anyone other than payee, depositary does
this at its peril—the customary assumption is that
restrictive indorsements are for the benefit of payee.
iv. 3-206(c)(2) states that the depositary bank must
make the payment available to the indorser or apply
the payment consistently with the indorsement.
1. This does not clearly state that in this
situation, the payment must be made
available to the payee.
2. However, the majority rule (e.g. State of
Qatar v. First American Bank) interprets the
statute as requiring payment to the payee.
3. However, there are some courts that find if a
particular account is not specified, the check
may be deposited in anyone’s account—the
check just must be deposited, as opposed to
4. Schulingkamp v. Carter—Louisiana case
recently addressed case just like this one.
Louisiana First Circuit sided with the
majority rule. However, case went up to
LASC, who reversed without opinion. The
case has been remanded by the trial court.
5. Problem, page 298
a. Situation in which the indorsement indicates that the
instrument is being negotiated to the indorsee.
b. Peter, payee of check of 10k drawn on Payor, gave check to
Faith, legal guardian of Ward. Peter told Faith that the
check was a contribution to defray Ward’s nursing home
expenses. Peter indorsed:
Pay to Faith as Guardian for Ward
Faith indorses by signing her name and deposits the check
in her personal account in Depositary. Faith also had a
fiduciary account as guardian for Ward in the same bank.
Pursuant to her instructions, Depositary credited Faith’s
personal account for 10k and obtained payment from Payor.
Faith withdrew the 10k. Ward sues Faith for breach of
fiduciary duty, and he also sues Depositary and Payor.
c. 3-206(d)—Except for an indorsement covered by (c), if the
indorsement bears words to the effect that payment is to be
made to the indorsee as agent, trustee, or fiduciary for the
benefit of the indorser or another person, the following
i. (1) Unless there is notice of breach of fiduciary duty
as provided in 3-307, a person who purchase the
instrument from indorsee or takes the instrument for
collection or payment for value may do so without
regard to whether the indorsee violates a fiduciary
duty to the indorser.
ii. (2) A subsequent transferee of the instrument or
person who pays the instrument is neither given
notice nor otherwise affected by the restriction in
the indorsement unless the transferee or payor
knows that the fiduciary dealt with the instrument or
its proceeds in breach of fiduciary duty.
d. The Payor is not liable; the Depositary bank is liable.
i. Where the Depositary had knowledge of Faith’s
fiduciary status, because the proceeds were
deposited in the account of someone other than the
represented person, Depositary is liable.
e. Peter’s indorsement is restrictive under 3-206 because it
gives notice that the proceeds should be paid to Faith in her
fiduciary capacity, on behalf of Ward.
i. By paying Faith, Depositary is doing what the
indorsement instructs it to do. Depositary has no
duty to monitor what Faith does with the funds.
ii. But here, Depositary seemingly has notice of Faith’s
breach of fiduciary duty. Because the check was
deposited in a personal account, Depositary was on
notice of the breach of fiduciary duty, and is
therefore liable to Ward.
iii. Payor is not liable because it had no knowledge of
Faith’s breach of fiduciary duty.
The Bank-Customer Relationship
i. 4-401 et seq.
1. 4-401(a) defines what makes a check properly payable.
a. A bank may charge against an account of a customer an
item that is properly payable from that account, even
though the charge creates an overdraft. An item is properly
payable if it is authorized by the customer and is in
accordance with any agreement between the customer and
b. The comments address a common cause for customer
dissatisfaction with banks: imposition of fees for stopping
i. A forged check or check bearing forged
indorsement is not properly payable. Therefore, if
customer advises the bank that such a check should
not be paid because of forgery, then the bank is not
entitled to demand payment from its customer for
ii. Comment says that it is inappropriate for a bank to
require a stop payment fee in such a circumstance.
iii. Remember Holmes’ war story that if you advise the
bank that this is the law, they probably won’t charge
you a fee to stop payment order for potential forged
2. 4-402(a)—A payor bank wrongfully dishonors an item if it
dishonors an item that is properly payable, but a bank may
dishonor an item that would create an overdraft unless it has
agreed to pay the overdraft.
3. 4-404—A bank is under no obligation to a customer having a
checking account to pay a check, other than a certified check,
which is presented more than 6 months after its date, but it may
charge its customer’s account for a payment made thereafter in
a. Addresses “stale” checks.
b. If a check is presented that is more than 6 months old, the
payor bank has the discretion to dishonor.
c. This is different from what makes a check overdue—90
days after its date. This is the separate issue of
“irregularity” that would prevent a taker from becoming a
HIDC of an instrument.
4. Additionally, federal regulations have the effect of creating
agreements between banks and customers, even if banks and
customers do not actually include these provisions in their
5. 4-103(a) provides that the provisions of Article 4 may be changed
by agreements between the parties. Except that the bank cannot
disclaim its duty of good faith, or limit liability or damages for
failing to exercise ordinary care.
b. Stop-Payment Orders
i. Proving Loss Under 4-403(c)
1. Statute, 4-403
a. (a) A customer or any person authorized to draw on the
account may stop payment on any item drawn on the
account, or close the account, by an order to the bank
describing the item or account with reasonable certainty
received at a time and in a manner that affords the bank a
reasonable opportunity to act on it before any action by the
bank with respect to the item. If the signature of more than
one person is required to draw on an account, any of these
persons may stop payment or close the account.
b. Problems, page 301
i. #1—Remitter of cashier’s check asks Bank to stop
payment because remitter believes she has been
defrauded by Payee of the check.
1. Bank does not have to stop payment because
the check is not drawn on the remitter’s
ii. #2—Payee learns that paycheck has been stolen
from his wallet.
1. Bank does not have to stop payment because
the check is not drawn on the payee’s
account. It is drawn on the drawer’s
account. Payee should ask drawer to stop
iii. #3—Baker and Able are partners, but their
agreement with the bank is that both signatures are
required to sign any partnership check. Both signed
a check payable to Payton. Now, Baker wants to
1. Bank must stop payment because where the
signature of more than one person is
required, any person who may draw upon
the account can stop payment.
iv. #4—Husband and Wife have joint account in Bank.
Wife disapproved of some checks that Husband
wrote on the account and ordered Bank to close the
1. Bank must stop payment because the statute
says that any person authorized to draw on
the account may order a stopping of
payment or cancel the account.
a. The burden of establishing the fact and amount of loss
resulting from the payment of an item contrary to a stoppayment order or order to close an account is on the
i. Comment says that a stop payment order is a
service that customers expect from banks. This is
inconvenient for banks, but banks must bear this
expense as a cost of banking.
ii. Another comment states that a payment in violation
of an effective stop payment order is an improper
payment, even if made by mistake or inadvertence.
iii. It is difficult to reconcile these comments with 4403(c)’s placing the burden of establishing loss
from wrongful payment upon the customer.
b. Minority Rule: Loss under subsection (c) means nothing
other than the debiting of the account. Bank is absolutely
obliged to re-credit customer’s account, without the need
for an inquiry into the underlying transaction. Bank could
then subrogate to customer’s right to recover payment from
the non-customer party to the transaction, if customer has
such a right to which bank could subrogate.
c. Majority Rule: Loss is more than just the debiting of the
account. The customer must prove that he did not owe the
money. Burden of establishing that customer had a defense
to payment of the check.
i. No Louisiana cases have addressed this.
ii. In such a state, the bank will force the customer to
sue it. As long as the bank knows that the law will
place the burden of proof on the customer, the bank
will not re-credit the account.
iii. This viewpoint is based on the fact that most stoppayment orders result from buyer’s remorse and not
a legitimate defense to payment.
iv. Dunnigan v. First Bank
a. Overpayment by wire transfer.
Payment for coins. Then another
payment by two checks for gold
coins. Drawer then instructs stop
b. Bank fails to stop payment on one of
a. No loss was proven because there
was no defense to payment of the
check. The drawer merely having a
counterclaim did not constitute loss.
b. The customer must prove that he was
not liable to payee on the check.
3. Dissent: Even though there was technically
no defense to payment of the check itself,
there was a claim in recoupment, a claim
against the payee. Thus drawer should have
been able to recover damages for failure to
a. Prof. thinks this is correct.
b. Under the statute (subsection (c)),
subsequent transactions can be taken
into effect—what happens after the
issuance of the check is relevant.
Thus transactions occurring prior to
issuance of the check should also be
3. Last sentence of (c): The loss from payment can also include
damages for dishonor of subsequent checks.
a. Thus if bank fails to stop payment and as a result,
subsequent checks bounce, the damages recoverable can
include damages for dishonor.
ii. Operational Issues
a. 4-403(b) makes it clear that customer can stop payment
2. Problems, page 310
a. #1—Customers ordered stop payment on check #292 for
1k. Order was given in time, but customer ordered
payment on the wrong check number, #293. Therefore,
bank paid the check because its computer did not recognize
the check number supplied by the customer.
i. Held: Bank was liable for wrongful payment.
ii. Bank could have programmed its computer to stop
payment on the basis of either amount or check
number. If bank can do this, this is what it is
required to do.
iii. Generally, customers win these cases even if they
supplied an error, but only if the order reasonably
identifies the check.
iv. The comment indicates that it is not appropriate for
the statute to set in stone a set of information that
the customer must provide. Banks have to be
flexible and adapt to changes in technology.
b. #2—Same as previous, except on bank’s stop payment
order form, there is a clause saying that the customer must
inform of the exact amount of the item, the number of the
check, and the account number. Clause then says that if
this information is not provided, the bank will not be
responsible for failure to stop payment.
i. The cases are split as to whether such a provision is
ii. White & Summers say that the clause should be in
conspicuous text and should explain why adequate
information is needed.
c. #3—Bank induces customer to sign stop-payment order
form, with a clause in which the customer agrees to hold
the bank harmless for all expenses and costs incurred by the
customer on account of refusing payment; and further
agreeing not to hold the bank liable on account of payment
through inadvertence, accident or oversight; or if by reason
of payment other items drawn by the customer are returned
i. The first part is okay; the customer may be required
to indemnify the bank for stopping payment.
ii. The second part is not okay: 4-103 does not allow
the bank to disclaim its liability for negligence,
which this clause attempts to do.
iii. The third clause is also an attempt to disclaim
liability for negligence, which the bank may not do.
d. #4—It would seem that the drawee may charge a fee for
processing a stop-payment order. But some courts have
held that this is not allowed. But Professor says that bank
should be allowed to charge stop payment fee—because
customer just has buyer’s remorse.
3. Postdated Checks
a. 4-401(c) allows a customer to postdate a check. The
customer has to file a notice of postdating similar to a stop
payment order. This is because the bank’s machines cannot
read a notation that says the check should not be paid till a
c. Wrongful Dishonor
1. (a) A bank wrongfully dishonors an item that is properly payable.
a. UCC: A payor bank is liable to its customer for damages
proximately caused by the wrongful dishonor of an item.
Liability is limited to actual damages proved and may
include damages for an arrest or prosecution of the
customer or other consequential damages. Whether any
consequential damages are proximately caused by the
wrongful dishonor is a question of fact to be determined in
i. Loucks v. Albuquerque National Bank
a. Partnership opened an account with
the bank. One of the partners was in
default, so bank set off this amount
against deposited funds. This
resulted in checks bouncing.
b. Partners sued the payor bank.
a. Held in favor of compensatory
belief, but not punitive.
3. Wrongful Dishonor: A creditor is not
entitled to partnership’s assets—only
entitled to partner’s share of profits. The
checks were properly payable.
ii. The customer must establish some actual loss.
1. The common law rule was that if a bank
dishonors a business’ check, the business is
entitled to damages automatically, without
having to prove anything more than the
dishonor of the check. A strict liability rule.
The “trader rule.” The trader has been
defamed, and therefore substantial damages
may be awarded based on defamation per se.
2. The Revision: the trader rule is dead. The
customer must offer evidence of actual loss.
But they don’t have to be quantified
3. More than mere nominal damages are
awardable. They must be compensatory and
cannot be harsh.
4. Evidence of malice on wanton disregard was
not enough in this case to allow punitive
b. Louisiana Version: A payor bank is liable to its customer
for damages proximately caused by the wrongful dishonor
of an item.
i. The damages are not limited to actual loss in our
ii. Louisiana originally had the trader rule.
1. The legislative comments to our statute
indicated that the extra language of 4-402
was not adopted because the Legislature
intended to maintain the trader rule, under
CC Art. 2315.
iii. However, in our adoption of the Revision, the
Legislature initially adopted the full uniform text,
but then one year later amended the statute to
shorten it to its present form. However, no
commentary was provided as to why the Legislature
made this deletion.
iv. Given the history, Professor thinks that the
Legislature intended to keep the trader rule.
3. The person having an account with the bank is the customer. Only
the person with the account is allowed to recover damages for
ii. Liability to Customer
1. Question of whether shareholders, officers, or directors should be
allowed to sue where the corporation’s check is dishonored.
2. Some courts under a veil-piercing theory have allowed the
organization’s constituents to recover for wrongful dishonor.
3. The furthest extension has been one court holding that a guarantor
of an obligation of the organization may have a right to sue for
4. However, some cases have held that insiders have no right of
5. One Louisiana case: shareholders of corporation had no right of
iii. Damages Recoverable
1. The cases have divided over whether emotional distress damages
are awardable. Courts are reluctant.
2. Whether punitive damages are recoverable is a matter of extrinsic