UCC 3 & 4 Outline
Fall 2000

© 2000 Matt Kaser

  1. Negotiability
    1. Requirements of Negotiablity (§3-104(a))
      1. Be signed & written by the maker or drawer (§1-201(39); §3-401(b));
      2. Contains an unconditional promise or order to pay a certain sum(§3-106; §3-103; Triffin v. Dillabough, 716 A.2d 605 (1998));
        1. Exceptions negating unconditionally,
          1. Express language §3-106(a)(i)
          2. Order subject to or governed by another writing. §3-106(a)(ii) & (iii).
        2. Promises are not made conditional because
          1. Collateral is referenced; or
          2. Payment is limited to a particular fund or account.
        3. Fixed amount of money,
          1. that an instrument reference amounts outside the instrument does not destroy negotiably, provided that the interest is ascertainable by reference to a formula or index.
          2. The fixed amount applies only to the principal.
        4. If the issuer promises or undertakes any act in addition to payment of the money that is not authourized by the code, negotiably is destroyed. The code authourizes,
          1. An undertaking to provide collateral to secure payment
          2. Admit default
          3. A waiver of law intended to protect an obligor.
      3. Be payable upon demand or at a definite time; and
        1. A holder of an instrument must be able to tell when the note becomes due. Otherwise the instrument is non-negotiable, but there is no requirement that the instrument be dated. § 3-108.
          1. The due date must be readily ascertainable at the time the promise or order is issued, either by date, or upon demand.
          2. If the option belongs to the holder, the holder is in control, even if a later date is specified.
          3. An extension of time to a specific date at the option of the maker or upon a specified act or event.
        2. An undated instrument that specifies no time is payable upon demand of the holder. § 3-113.
      4. By payable to the order or bearer (§3-109)
        1. The obligation must travel with the instrument. This can be done with the "magic words" of "payable to bearer" or "order" or other similar phrases (as a practical matter don't modify the terms).
        2. If a specific person is named, only that person can cash the note.
        3. If an entity or organization can be identified by a person, that person is the person which may negotiate the note, e.g. the estate is represented by an administrator. §3-110(c); §1-201(28).
        4. If no person is specified, or to the order of cash, it is bearer paper, payable to anyone.
        5. If it had characteristics of both order or bearer, it's bearer (i.e. "John Doe or bearer" is payable to bearer).
        6. A special exception applies to checks where the words "the order of" are omitted. These are still negotiable instruments. §3-104(c). This exception applies because the checks are scanned by machine, not by human eyes.
    2. Types of Negotiable Instruments (§3-104(e))
      1. Notes
        1. A payer's written promise to pay money to the payee.
        2. Examples: Certificate of deposits.
      2. Drafts
        1. A written order by the drawer to the drawee another directing them to pay money to a payer.
        2. Examples: Cashier's check.(here, the "purchaser" is known as the "remitter" §3-103(a)(11); Problem 82).
    3. Policy: We are concerned with the form of the language.
  2. Negotiation
    1. Negotiation is concerned with the form of the transfer of the instrument.
    2. Life of an instrument
      1. Issue (Birth) (§3-105)
        1. Makes of note makes promise
        2. Drawer of draft orders payment
      2. Transfer (3-201; 3-205)
        1. Selling the instrument by someone other than the issuer or presenter of the instrument.
        2. Sending for collection (i.e. depositing a check)
      3. Presentment (death) (3-501)
        1. Obligation demanded
        2. Narrow defination
    3. Transfer & Negotiation
      1. Negotiation (3-201)
      2. Transfer of possession
        1. voluntary or involuntary
        2. By a person other than issueer
        3. To a person who becomes it's holder
          1. holder
            1. Payee or later person
            2. possessing the instrument; and
            3. Entitled to payment
        4. Bearer paper - the person who possesses the paper
        5. Order paper - the person who holds the note and is identifed as the proper holder.
    4. Indorsements
      1. A blank indorsement on the back of the check can merely be their signature. §3-205(b)
      2. A special indorsment on the back of the check can be limited, e.g. on back, "pay to John Clute /s/ payee" §3-205(a).
      3. A depositary bank can be a holder regardless of their customer's signature. The basis being that there is a special relationship between customers and their banks. §4-205(1). Depository banks have a security interest in a note and accompanying documents. §4-210. Therefore, value is given for the negotiation of notes.
      4. In the revised Article 3, a person entitled to enforce the instrument can sue on the instrument. §3-301. Although this is generally a holder, it may also include certain entities.
      5. To qualify as a holder, a person must, (§1-201(20)).
        1. Be in possession of the instrument and for non-bearer instruments,
        2. Be the person identified in the instrument.
      6. The number of endorsements depends on the joining language in the "payable to" verbiage. See Problem 94 (6th Edition); (rick knight-simplot soil builders case).
      7. The indorsement must be physically affixed to the instrument itself. §3-203(a).
    5. Forgery of the Payee's Name
      1. Any unauthorized indorsement of the payee's name or any special indorsee's name is not a valid negotiation and gives subsequent transferees no legal rights, as an HDC or otherwise, regardless of how far removed they are from that transaction. §3-205(a).
      2. If the indorsement is made, absent limitations, the note becomes bearer paper and is negotiable by anyone who comes into possession of the note. §3-201(b).
      3. A holder may convert a blank endorsement into a special indorsement by including language indicating the negotiator. §3-205(c).
  3. Holder in Due Course
    1. A holder in due course (HDC) is one who, (§3-302(a))
      1. Takes the instrument which does not appear to be forged
      2. The holder took the instrument
        1. For value (§3-303)
          1. Consideration is not enough. Rather, there must be an agreed performance that has been performed.
          2. Examples include the acquisition of a security interest, exchange of other instruments, paying off an underlying debt, taking of an obligation or in satisfaction of a promise.
          3. To promise to do something, does not constitute "for value." Sea Air Support, Inc. v. Hermann, 613 P.2d 413 (Nev. 1980).
          4. A bank acts as a HDC even though they act as an agent when they give value for the instrument to the extent that value has been given. §4-210; §4-211.
        2. Good faith(§3-302(a)(2)(ii))
          1. Defined: "honesty in fact in the conduct of the transaction concerned." §1-201(19). This test from Article 3 encompasses both this subjective standard and an objective standard which requires the "observance of reasonably commercial standards of fair dealings." §3-103(4).
          2. The holder is under no duty to inquire as to possible defenses, unless the circumstances indicate that there is a purpose not to inquire.
          3. If a fiduciary breaches a duty, and the debt is applied to the fiduciary's personal account, the principal is imputed knowledge of the breach of the duty. §3-307.
        3. Without notice of defenses or problems with the note
          1. Notice may come from the instrument itself or other sources.
          2. It may be difficult at times to distinguish between good faith and notice because they are often intertwined.
          3. Types of notice that will prevent HDC status,
            1. The instrument bears apparent evidence of forgery, alteration so as to raise questions regarding its authenticity. §3-302(a)(1).
            2. Notice that the instrument has been dishonoured. §3-302(a)(2)(iii).
            3. Notice that the instrument has an unauthorized signature or has been altered. §3-302(a)(2)(iv).
            4. Facial challenges, such as incorrect dates may not qualify as a problem, whereas a notation that notice that an installment or interest payments have been missed may qualify as notice, and may negate HDC status. Problems 104 & 105; §3-302(a)(iii); §3-304(c).
            5. An instrument is overdue 90 days after issuance. §3-304(a)(2).
          4. The inquiry of whether an entity has HDC status is when the instrument is negotiated.
            1. If the subsequent purchasers know nothing about the transaction, they get the protection. If they know about the transaction, they usually don't get HDC protection.
            2. Courts draw a distinction between knowing about the transaction, and knowing about the defenses.
        4. Not blocked by other law.
    2. Establishing HDC Status. §3-308.
      1. The plaintiff has the burden to establish that they are a holder of the note and is entitled to enforce.
      2. If the defendant raises a defense, the burden is on the plaintiff that they are an HDC. Once HDC status is determined, the defense is revisited to determine whether it is real or personal.
      3. The burden is a preponderance of the evidence.
    3. The Shelter Rule
      1. The transferee has the same rights as the transferor. §3-203(b).
      2. Use only if HDC status is unavailable to the holder of the instrument.
      3. The string of rights is "chainlike," viz. if someone had HDC rights in the past, those rights transfer on to all subsequent transferees.
      4. If the instrument is reacquired by a prior holder, the holder is in the position they were in when the first acquired the instrument.
    4. Real and Personal Defenses
      1. A person holding an instrument, other than an HDC, must take subject to other instruments. §3-306.
      2. Immune from defenses from parties with whom they have not dealt with, but still subject to defenses from the immediate transferor, regardless of HDC status. §3-305(d).
        1. HDC's must take subject to Real Defenses. (§3-305(a)(1)).
          1. Discharge in Insolvency
          2. Fraud
          3. State Law Defenses
          4. Forged Signature. §3-401; 3-403. The signature is admitted, unless specifically denied in the pleadings. §3-308(a). If denied, the plaintiff-holder has the burden of showing the signature is valid, but presume that the signature is valid until the defendant makes a sufficient showing.
          5. Discharge in bankruptcy
          6. Lack of capacity.
            1. Even if an infant negotiates an instrument, later holders can still negotiate the instrument. §3-202.
        2. HDC's need not listen to personal defenses, but non-HDC's must take subject to personal defenses. §3-305(a)(2)
          1. Any defense under a simple contract
            1. Failure to countersign a travelers' check. §3-106(c)
            2. Modification of an obligation §3-117
            3. No consideration §3-303(b)
            4. Breach of warranty. §3-417(b).
          2. Claim in Recoupment
            1. The obligor may raise a claim in recoupment against the original payee of the instrument if the claim arose from the transaction that gave rise to the instrument. §3-305(a)(3).
            2. The recoupment can only reduce the amount owing on the instrument.
            3. This defense usually arises in a breach of warranty situation where the buyer has accepted the goods, and is thus responsible for the price of the goods, but has a breach of warranty claim against eh seller and wants to reduce the amount owing because of the breach of warranty claim.
    5. Policy
      1. In third party actions, we do not pay attention to personal defenses.
      2. Because we want people to utilize negotiable instruments, we give banks extra privileges and allow them to be a holder without a signature.
  4. The Nature of Liability
    1. The underlying obligation
      1. The underlying obligation is merged into the negotiable instrument when the instrument is used to pay the underlying obligation. §3-310.
      2. The obligation to pay the underlying obligation is suspended during the merger. §3-310(b). If the note is one where a bank becomes obligated, the issuance of the note becomes discharge unless there is an agreement to the contrary. §3-310(a).
      3. The destruction of the note by the holder has discharged the note. §3-604. If the note has been destroyed, the obligation is suspended until the note has can be honored. §3-310(b)(4). The suspension can end, and the person seeking enforcement of a destroyed note if a court can be satisfied that the obligation existed and the note is reconstructed. §3-309.
    2. Liability on the Instrument
      1. A maker of a note is obligated to pay the instrument on the terms at the time the note was issued. §3-412.
      2. Multiple makers of a note are jointly and severally liable. A party who pays more than their proportionate share may seek contribution from co-makers. §3-116.
      3. Indorsers are obligated to pay the amount due on the instrument if the note is dishonored. §3-415. However, the maker of the note is primarily liable on the note and the subsequent indorsers are secondarily liable.
      4. Indorsers on the check that are listed prior to the payee are termed an anomalous indorser. Anomalous indorsements modify the rule in §3-415 insofar as joint and several liability is imposed. §3-116(a). These third parties must be notified of the action, or be bound by the result in an action. §3-119.
    3. Surety's Obligation
      1. When a surety exists, there are three contracts,
        1. Underlying obligation between the principal and the creditor
        2. Promise of the surety to back up the obligation
        3. Promise of the principal to reimburse the surety of the surety is forced to pay off the obligation.
      2. If the principal dishonors the note, the surety (as an accommodation party) may seek either exoneration, reimbursement or subrogation. §3-419.
        1. Exoneration. Once the obligation matures, the surety can compel the debtor to perform.
        2. Reimbursement. If the surety pays the creditor, the surety can recover the entirety of the paid amount. §3-419(e).
        3. Contribution. If the surety pays, the surety can assume the rights of the creditor against the debtor. §3-419(e).
      3. An accommodation maker receives extra protection if the language of the instrument unambiguously indicates that the signature is done to guarantee the note. The guarantor is entitled to reimbursement from the maker if the payee either is unable or simply can't get the full amount from the maker. §3-419. The emphasis is on guaranteeing collection of the debt, not simply a garden variety guarantor. Therefore, the magic words, "collection guarantor" ought be used Problem 130.
      4. Discharge of Accommodation Parties
        1. Tender of Payment. §3-603.
          1. If the surety tenders payment to someone entitled to enforce the instrument, and the money is accepted, the surety is entitled to enforce the instrument against the maker.
          2. If the maker tenders payment to someone entitled to enforce the instrument, and tender is refused, the surety's obligation is discharged, to the extent of the tendered amount. Likewise, if tender is refused, the obligation of the surety to pay interest is discharged.
        2. Under common law and §3-605(e), (f), & (g), the nonconsenting surety is sometimes discharged up to the value of the collateral, if the creditor fails to protect the collateral and is thereby unavailable to pay the debt.
        3. Under §3-604, a holder of a note may discharge the obligation of the party to discharge the obligation of the party by an intentional voluntary act. This does not affect the rights of an indorser or an accommodation party. §3-605(b).
        4. If an extension to pay the obligation is given, the accommodation party is discharged to the extent that the extension caused the accommodation impaired the right of recourse (i.e. caused harm to the accommodation party). §3-605(c). Usually an extension of time will not harm the accommodation party. Nor does the failure to timely present, absent an agreement, discharge the surety.
        5. Material modifications other than an extension of time, discharges the accommodation party to the extent that the accommodation party caused harm. §3-605(d).
      5. New Notes for Old
        1. The underlying obligation as represented by a first note is suspended when a second note is issued, and remains suspended until the second note is dishonoured or paid. §3-310(b)(2).
        2. The obligation of an accommodation party on an underlying note is discharged to the extent that this party can show harm. §3-605(c).
      6. Impairment of collateral
        1. First, we must determine the status of the party seeking discharge
          1. Indorsers and accommodation parties are discharged to the extent of the impairment. §3-605(e). Examples,
            1. Under-secured: Collateral- Ai = discharge
            2. Over-secured: Note - Ai = discharge
          2. Multiple makers and accommodation parties, who fail to identify their status, are discharged to the extent the impairment affects their right of contribution. §3-605(f). Examples: (Note/Parties) - Ai = discharge.
      7. The Drawer's Obligation
        1. The drawer of a draft has an obligation to pay the draft, if the draft has been dishonored on it's terms or of the drawer signed an incomplete instrument. §3-414(a). Accordingly, the drawer is secondarily liable and the maker is primarily liable. The obligation is owed to someone entitled to enforce the instrument or to an indorser who paid the draft. The drawer is discharged when the bank's acceptance. §3-414(c).
        2. Presentment
          1. Presentment is the demand for payment made to the maker of the note or, to accept a draft. §3-501.
            1. Under presentment for payment, the presenter wants the money.
            2. Under presentment for acceptance, the presenter wants the drawee to make the acceptor's contract (i.e. become primarily liable on the draft). §3-502(b).
          2. An indorser is discharged by an untimely presentment (i.e. within 30 days), while a drawer is not discharged. §3-414(e). Presentment is waived by a drawer or indorser who has no reason to expect that the instrument would be paid or accepted. §3-504(a)(iv).
        3. Notice of Dishonour
          1. Dishonour occurs when the instrument is appropriately presented and is not accepted or paid. §3-503.
          2. Notice of dishonour must be given very quickly for it to be effective. §3-504.
          3. Notice of dishonoured is waived if presentment is waived.
          4. Drawer does not always have right to notice of dishonour
            1. If the draft has been accepted by a nonbank, drawer is entitled to notice of dishonour. §3-414(d); §3-503.
            2. If the draft has been accepted by a bank, drawer is discharged so notice of dishonor is not applicable. §3-414(c).
            3. If the draft has not been accepted, drawer is not entitled to notice of dishonour. §3-414(b); §3-503.
          5. Indorser usually has the right to notice of dishonour
            1. Indorser's obligation under §3-415 may not be enforced unless notice of dishonour is given. §3-503.
            2. Notice of dishonour may be "excused" in certain circumstances under §3-504(b).
            3. An indorser may "waive" the right to get notice of dishonour. §3-504(d).
        4. Determining when presentment for acceptance is timely,
          1. Demand draft. There is no right to present the draft for acceptance. §3-502(b)(2). If a drawee refuses to accept when a demand draft is presented for acceptance, the refusal is not a dishonour. Instead, the presenter should make a demand for payment, and that refusal is a dishonour.
          2. Time draft. The draft is due on a particular date. §3-502(b)(3). The right to present for acceptance is optional. If desired, the presentment must be done prior to the due date. If the drawee refuses to accept presentment, the refusal is treated as a dishonour.
          3. Sight + time draft. The draft is due a specified time after sight (presentment for acceptance). You must present the draft for acceptance to start the time running. If the drawee refuses to accept it, then dishonour occurs.
      8. The Drawee's Obligation
        1. A drawee is not liable on an instrument unless the drawee has signed the instrument. §3-401; §3-408.
        2. If the drawee dishonours the instrument, the drawer may have a cause of action against the drawee under a contract or under wrongful dishonour.
      9. Certification
        1. The drawee bank's acceptance of a check is certification.
        2. There is no difference between acceptance by a non-bank and a bank. §3-409(d); §3-411; §3-413.
      10. Signature by an Agent (§3-402(a))
        1. The agent must unequivocally state that they are and authourized representative of the signer, with such terms as "authourized signature of the represented person."
        2. The principal is bound by the signature of the agent, whether or not identified as the agent.
        3. To avoid liability, the agent is to name the principal and indicate that they are signing in a representative capacity.
  5. Banks and their Customers
    1. Overview
      1. Article 4 is inextricable intertwined with Article 3. When a conflict occurs, Article 4 controls. §4-102(a).
      2. Terminology.
        1. The drawer is the person who makes the note.
        2. The payee is the one who is listed on the face of the note.
        3. The depository bank is the first bank to take an item even though it is also the payor bank, unless the item is presented for immediate payment over the counter. §4-105(2).
        4. Intermediary banks are banks to which an item is transferred in course of collection except the depositary or payor bank §4-105(4).
        5. Presenting banks are banks presenting an item except a payor bank. §4-105(6).
        6. The drawee/payor bank is one handling an item for collection. The payor bank is the drawee of a draft. §4-105(3); (5).
      3. A bank may fulfill multiple roles. The terminology depends on who's suing whom.
    2. The checking account
      1. Properly Payable Rule.
        1. The bank must pay out the customer's money only if it exactly follows the customer's orders. §4-401(a).
        2. A customer is not liable for the amount of the overdraft if the customer did not sign or benefitted from the proceeds of the action. §4-401(b). This applies mostly in circumstances where several people are properly authourized to draw on the account.
        3. In the case of post-dated checks, the bank is not liable and the note is properly payable, unless the bank has notice in advance. §4-401(c).
        4. In the case of fraudulently altered notes, a bank that acts in good faith may charge the account according to the original terms or on the terms of the completed note, unless the bank has notice that the completion was improper. §4-401(d).
        5. Checks over six months old are not obligated to be paid by a bank, but a bank may charge it's customer's account for the payment. §4-404.
        6. The statute of limitations is three years after the bank's action. §4-111.
      2. Wrongful Dishonour
        1. When a bank makes an improper payment from an account, the customer may recover actual damages from the dishonour. §4-402.
        2. Mental suffering and punitive damages are a possibility under §4-402. Strictly speaking, it is a matter of state law and is measured akin to a defamation action. Twin City Banks v. Isaacs, 672 S.W.2d 651 (Ark. 1984).
        3. A drawee bank may not impose conditions (i.e. bank fingerprinting requirements) above and beyond giving reasonable identification to negotiate the note. §3-501(b)(2).
      3. Death or Incompetence of Customer
        1. A drawee bank is not liable for the payment of a check before it has notice of the death or incompetence of the drawer. §4-405(a).
        2. A bank may pay or certify checks for ten (10) days after it has notice, unless a person who has an interest in the account places a hold order on the account. §4-405(b).
      4. Bank's Right of Setoff
        1. The code does not establish a right of setoff, but at common law, a right of setoff existed. Setoff is the right of a bank to pay itself from a customer's account. This is available only in a general account.
        2. This is a preference to banks that once the obligation is mature the bank can exercise it's right of setoff. If it's not mature, the bank must show intervening insolvency.
      5. Customer's Right to Stop Payment
        1. Anyone with access to an account may issue a stop payment order. §4-403(a). The customer must describe the account with certainty (account no., check number, date or name).
        2. A stop payment order is effective for six months. An oral stop payment order is effective for 14 calendar days. These may be renewed for additional six-month terms. §4-403(b).
        3. A payment in violation of a stop payment order subjects the payor bank for damages. The customer has the responsibility to establish the amount of loss. §4-403(c).
        4. If the payor bank has mistakenly paid an improper note, the payor is subrogated to the rights of an HDC, the payee, other holder or the drawer. §4-407.
        5. A payor bank can likewise step into the shoes of the maker against the holder or payee of a note. This is to protect banks and makers in the case of fraudulent transactions where the bank can get the money back, to the extent that the maker can prove loss. §4-407(3).
      6. Bank Statements
        1. A bank must return "sufficient information" in a bank statement showing which checks have been paid or make available the canceled checks. §4-406(a). This information, which is the "safe harbour" rule, includes at a minimum, must include item number, amount and date of payment.
        2. If the items are not returned, the bank must possess the notes for at least seven years or a legible copy. §4-406(b).
        3. If the bank sends a statement, the customer must be prompt in determining errors or unauthourized signatures, and communicating with the bank. §4-406(c).
    3. Bank Collection
      1. Funds Availability
        1. Cash
          1. Cash which is deposited in an account can be removed the following banking day. §4-215(f). A banking day is when the bank is open to the public for carrying on substantially all of it's banking functions. §4-104(a)(3). Federal law does not count weekends or holidays.
          2. The bank can "cut off" it's banking day as early as 2pm. §4-108. If presented after the cut off time, it is treated as received during the next banking day.
        2. Checks
          1. For over the counter presentments, the bank is required to make a decision that same day regarding the note. §3-502 (b)(2).
          2. The money is available for removal the at the opening of the second banking day following receipt of the item. §4-215(e)(2). Under the Expedited Funds Availability Act (EFAA) (12 USC 4001-4010), same-bank checks ("on us" notes) are available for withdrawal on the following day after day of deposit. EFAA §603(a)(2)(E).
          3. Under the midnight deadline rule, the bank must pay or dishonour a note by the midnight of the next banking day following the banking day of receipt. §4-301; §4-302. If it has done neither, it must pay the instrument.
          4. Depository banks do not need a customer's signature for the note to become a holder. §4-205.
          5. A bank may decide to honour notes on an overdrawn account in any order. §4-303(a).
      2. Final Payment
        1. Final payment occurs when the drawee bank takes action (or fails to take action). §4-215. This can occur when the bank pays the item in cash, settles the item or does nothing by it's Midnight deadline.
        2. The payor bank can no longer dishonour the item.
        3. This establishes the rights of others
          1. Settlements can no longer be revoked.
          2. Charge backs no longer possible.
          3. Obligations on the item are "dead."
        4. This time frame can be delayed if the delay is caused by the interruption of communications and the bank exercises reasonable diligence in taking action. §4-109.
      3. Check Return
        1. Under the EFAA, depositary banks are required to allow customers quick access to funds represented by deposited checks.
        2. For checks of $2,500 or more, payor banks are required to send direct notice to the depositary bank at any time they decide to dishonour the instrument. Reg. CC § 229.33.
          1. The notice must include the name, routing number of paying bank, name of payee, amount, reason for return, and other information.
          2. This notice must be given and received by 4:00 (local time) on the second business day following the banking day on which the check was presented to the paying bank.
        3. This does not vary the midnight rule, but the midnight rule may be excused, if the manner of informing the depositary bank is as expeditiously as possible.
      4. Charge Back
        1. If a drawee bank dishonors the note, and returns it to the depositary bank, the depositary bank will expect reimbursement regardless of the time elapsed since the check was first deposited.
        2. Under the concept of charge back, the depositary bank has the right to remove the "deposited" funds from it's customer's account until final payment. §4-214(a).
        3. If the depositary bank fails to give adequate notice to the customer, the depositary bank is liable for any loss resulting from any delay.
      5. Undoing Final Payment
        1. Creates a separate cause of action after final payment has been made.
        2. If the drawee bank that accepted a draft by mistake, the bank could recover, buy not from one who took the instrument in good faith, and for value or in good faith changed position in reliance. §3-418.
      6. Restrictive Indorsements and Banks
        1. Only the collecting bank's transferor can give it binding instructions and the collecting bank need not examine the document to see of other instructions or restricts are contained on it. §4-203.
        2. Only the depository bank faces liability for conversion because of the non-compliance with the terms of the restrictive indorsement. §3-206. This is because the teller is the one most likely to ascertain whether such an endorsement existed.
      7. Priorities in the Bank Account: The Four Legals
        1. Addresses the issue of who gets paid first when one of four events happens, notice, stop payment, service of legal process and the bank's right of setoff.
        2. If final payment has been made, it's too late for the bank to take action. §4-303(a). If final payment has not been made, the bank still needs reasonable time to react.
  6. Wrongdoing and Error
    1. Forgery of the Payee's Name
      1. Warranty Liability
        1. Arises when someone has handled an instrument, although they didn't sign the instrument.
        2. Direct transferee get the benefit of these warranties regardless of the signature on the instrument, while remote transferees don't necessarily get the warranties benefit if an indorser's signature is missing, depending on whether Art. 3 or Art. 4 applies.
        3. Transfer Warranties
          1. Immediate transferee: Any person who transfers an instrument for consideration makes the transfer warranties to their immediate transferee.
          2. Remote (Subsequent) Transferees.
            1. Article 3: If the transferor signs the instrument, the warranties are also given to subsequent transferees. §3-416.
            2. Article 4: a signature is not needed for the warranties to be given the subsequent transferees. §4-207.
          3. A subsequent transferees are the plaintiffs in any actions and any prior transferees could be the defendants.
          4. Transfer Warranties (warranties of good title) arise because the warrantor indicates that they are a person entitled to enforce the instrument, that the signatures are authentic and have not been altered, there are no defenses or claims in recoupment on the instrument and that the warrantor has no knowledge of any insolvency proceedings commenced with respect to the maker or drawer. §3-416(a).
          5. The holder of the note must give thirty (30) days notice after the holder has reason to know of the breach. §4-207(d). The statute of limitations on such a suit is three (3) years. §4-111.
        4. Presentment Warranties
          1. A person who presents an instrument makes presentments warranties to the drawee being asked to pay or accept the instrument. §3-417(a); §4-408(a).
          2. Only the drawee can be a plaintiff while anyone in the chain can be a defendant.
          3. The payee warrants to the drawee that the warrantor that they are entitled to enforce the draft, the draft has not been altered and that they have no knowledge that the signature of the drawer of the draft is unauthourized.
          4. A drawer has no cause of action under a warranty theory, but they do have one for wrongful payment.
          5. Under §3-417(d), there are other presentment warranties. These arise for instruments other than drafts. The bar exam questions focus on promissary notes, which are specifically included under this subpart. When presenting to the maker, the holder warrants that title is good. The warranties in §3-417(a) do not apply because the maker is in the best position not to pay a note which would otherwise be protected in (d).
          6. Under §3-417(d)(i), if the note is dishonoured by the drawee, the immediate preceding holder, obtains presentment warranties, for lack of good title.
          7. Signatures are not required for those after the check is deposited in order to impose transfer warranties.
        5. Conversion
          1. Defined: Civil liability for the misappropriation of another's property. §3-420.
          2. Only the person who's rights are affected may sue for conversion. In other words, only the payee can be the holder, and thus, a plaintiff in a conversion action.
            1. The issuer of a draft cannot be a plaintiff, because they have no further interests in the note. The remedy is to have the maker's bank recredit their account and make them whole. §4-401.
            2. The action in conversation arises only when the note has been delivered to the payee.
            3. The cause of action accrues when the actual conversion occurs, not when it is discovered.
            4. Violation of a restrictive indorsement also gives rise to a cause of action in conversion. §3-206(c).
          3. Subsequent holders of non-bearer notes are subject to a suit in conversation as they were not entitled to enforce the instrument because they lacked good title. Intermediary Banks, however, are immune from liability, unless they still have proceeds in-hand. §3-420(c).
    2. Validation of the Forged Indorsement
      1. The Impostor Rule
        1. In certain circumstances, a forged indorsement of the payee is deemed to be valid. §3-404
          1. If the impostor induces the maker of the instrument to make the instrument to them, and they are impersonating that person, the indorsement of the payee is valid. §3-404(a).
          2. If the issuer does not intend for the named payee to receive the money, the (forged) indorsement of the payee is likewise valid. §3-404(b). (Evil Drawer rule).
          3. If a fictitious person is named, again, the note is valid. §3-404(b).
        2. In all these situations, title is good because the signature has been validated.
      2. The Employee Indorsement Rule
        1. For employees, a forged indorsement of the payee is deemed to be validated if: (§3-405)
          1. The forger is an Entrusted Employee; or
          2. Checks payable to employer; or
          3. Checks issued by employer.
        2. Policy: if the employer makes a bad choice in selecting employees, they are in a better position to take appropriate action. Official Comment No. 1.
      3. The Bank Statement Rule
        1. The customer has the duty to examine the bank statement or be estopped from asserting unauthorized signatures or material alterations that could have been discovered. §4-406(c) & (d). The customer must have a reasonable time (30 days) to report the loss from date of receipt of statement. Official Comment 2.
        2. If the customer failed to examine the statement and the bank failed to exercise ordinary care in paying the item, the loss is allocated between the customer and bank. §4-406(e). The inquiry is whether the failure of the bank contributed to the loss.
          1. I.e. the customer may be negligent, but the bank may have paid a not properly payable note. The bank cannot claim the non-reading of the statement as a defense.
          2. For exam purposes, where serial wrongdoing is involved, add thirty (30) days after the date of the (first) statement. Any checks prior to that date, must be recredited. All checks written afterwards, the bank prevails.
        3. The statute of limitation is one year, without reference to the negligence of the bank or other entities. §4-406(f).
    3. Alteration
      1. Defined: an unauthorized change in an instrument that purports to modify the obligation or the unauthorized addition of words or number to an incomplete instrument. §3-407(a).
      2. An alteration discharges a party whose obligation is affected by the alteration. §3-407(b). A payor bank or drawee, taking value, in good faith and without notice, may enforce the note on the original terms, or the terms as completed, in the case of an uncomplete instrument. §3-407(c).
  7. Electronic Banking
    1. The Electric Fund Transfer Act
      1. Generally
        1. Applies only to consumer transactions
        2. Geared towards the protection of consumers engaging in electronic fund transfers.
      2. Credit Cards
        1. If the use of the card was authorized, the consumer must pay the resulting bills. Reg. E. §205.6(a)
        2. If the use of the card was unauthorized, the cardholder's liability is limited to $50, or what has been charged before the cardholder notifies the issuer for the amount of loss. If the cardholder notifies the issuer of the loss prior to use, the consumer does not end up paying. Reg. E. §205.6(b).
      3. Defenses Against Credit Card Issuer
        1. When a buyer and seller have a dispute relating to a consumer goods transaction, the cardholder may assert all claims and defenses against the card issuer pertaining to the claims. Reg. Z. §226.12(c)(1).
        2. During this process, if the cardholder withholds payment, the issuer cannot report the delinquent amount. Reg. Z. § 226.12(c)(2).
        3. This applies only if the parties have made a good faith attempt to resolve the dispute and the claim or defense exceeds $50.00. Reg. Z. §226.12(c)(3).
      4. Billing Errors
        1. If the cardholder complains to the issuer of a billing error, the card issuer must acknowledge the complaint within thirty (30) days, conduct a good faith investigation and resolve the difficulty within ninety (90) days of the complaint. Reg. Z. §226.13.
    2. Wire Transfers
      1. Scope of Article 4A
        1. Concerned with wholesale wire transfers, including "payment orders," which pushes the funds out of the account of the sender and into the bank account of the payee.
      2. Acceptance of Payment Orders
        1. The receiving, or beneficiary, bank makes a technical acceptance of the payment order when it receives the funds. §4A-405(d). If the bank does not want to make the acceptance, it must reject the payment order.
        2. Where the payment order specifies a payment date, a receiving bank makes acceptance when,
          1. payment of the amount of the order to the beneficiary
          2. notification to the beneficiary that the amount is available for withdrawal
          3. receipt itself of full payment of the order
          4. failure of the beneficiary bank to reject the payment order within §4A-209(b)(3) time limits.
      3. Transmission Errors
        1. General rule: loss follows on the person making the error.