1. Chapter 14 Negotiable Instruments and Digital Banking
PowerPoint Slides to Accompany ESSENTIALS OF BUSINESS AND ONLINE COMMERCE LAW 1st Edition by Henry R. Cheeseman
Chapter 14
Negotiable Instruments and Digital Banking
Slides developed by
Les Wiletzky

2. Negotiable Instruments (1 of 2)
To qualify as a negotiable instrument (commercial paper), the document must meet certain requirements established by Revised Article 3 (Negotiable Instruments) of the Uniform Commercial Code (UCC)
Article of the UCC that establishes rules for the creation of, transfer of, enforcement of, and liability on negotiable instruments

3. Negotiable Instruments (2 of 2)
If the requirements of Article 3 are met, a transferee who qualifies as a holder in due course takes the instrument free of many defenses that can be asserted against the original payee
In addition, the document is considered an ordinary contract that is subject to contract law

4. Functions of Negotiable Instruments
Negotiable instruments serve the following functions:
Substitute for money
Credit device
Record-keeping device
Most purchases by businesses and many individuals are made by negotiable instruments instead of cash

5. Types of Negotiable Instruments
Term that means negotiable instrument [UCC 3-104(b)]
Revised Article 3 recognizes four kinds of instruments:
1. Drafts
2. Checks
3. Promissory Notes
4. Certificates of Deposit

6. Drafts
A draft is a three-party instrument that is an unconditional written order by one party that orders the second party to pay money to a third party
Drawer of a draft
Drawee of a draft
Payee of a draft

7. Checks
A distinct form of draft drawn on a financial institution and payable on demand
Drawer of a check
Drawee of a check
Payee of a check
Article 4 of the UCC establishes the rules and principles that regulate bank deposit and collection procedures

8. Special Types of Checks
Bank Checks – Checks for which the bank is solely or primarily liable:
Certified Check
Cashier’s Check
Traveler’s Check

9. Promissory Notes
A two-party negotiable instrument that is an unconditional written promise by one party to pay money to another party
Maker of a note – the party who makes the promise to pay (borrower)
Payee of a note – the party to whom the promise to pay is made (lender)

10. Certificates of Deposit (CD)
A two-party negotiable instrument that is a special form of note created when a depositor deposits money at a financial institution in exchange for the institution’s promise to pay back the amount of the deposit plus an agreed-upon rate of interest upon the expiration of a set time period agreed upon by the parties
Maker of the CD – the bank (borrower)
Payer of the CD – the depositor (lender)

11. Summary: Types of Negotiable Instruments (1 of 2)
Orders to Pay
Party
Description of Party
Draft
Drawer
Drawee
Payee
Person who issues the draft
Person who owes money to the drawer; person who is ordered to pay the draft and accepts the draft
Person to whom the draft is made payable
Check
Owner of a checking account at a financial institution; person who issues the check
Financial institution where drawer’s checking account is located; party who is ordered to pay the check
Person to whom the check is made payable

12. Summary: Types of Negotiable Instruments (2 of 2)
Promises to Pay
Party
Description of Party
Promissory Note
Maker
Payee
Party who issues the promissory note; usually the borrower
Party to whom the promissory note is made payable; usually the lender
Certificate of Deposit (CD)
Financial institution that issues the certificate of deposit
Party to whom the certificate of deposit is made payable; usually the depositor

13. According to UCC 3-104(a), a negotiable instrument must:
Be in writing
Be signed by the maker or drawer
Be an unconditional promise or order to pay
State a fixed amount of money
Not require any undertaking in addition to the payment of money
Be payable on demand or at a definite time
Be payable to order or to bearer

14. Summary: Formal Requirements for a Negotiable Instrument (1 of 4)
Description
Writing
Writing must be permanent and portable. Oral or implied instruments are nonnegotiable [UCC 3-104(d)].
Signed by maker or drawer
Signature must appear on the face of the instrument. It may be any mark intended by the signer to be his or her signature. Signature may be by an authorized representative [UCC 3-104(a)].
Unconditional promise or order to pay
Instrument must be an unconditional promise or order to pay [UCC 3-104(a)]. Permissible notations listed in UCC 3-106(a) do not affect instrument’s negotiability. If payment is conditional on the performance of another agreement, the instrument is nonnegotiable.

15. Summary: Formal Requirements for a Negotiable Instrument (2 of 4)
Description
Fixed amount of money
Fixed amount: Amount required to discharge the instrument must be on the face of the instrument [UCC 3-104(a)]. Amount may include payment of interest, discount, and costs of collection.
Revised Article 3 provides that variable interest rate notes are negotiable instruments.
In money: Amount must be payable in U.S. or foreign country’s currency. If payment is to made in goods, services, or non-monetary items, the instrument is nonnegotiable [UCC 3-104(a)].

16. Summary: Formal Requirements for a Negotiable Instrument (3 of 4)
Description
Cannot require any undertaking in addition to the payment of money
A promise or order to pay cannot state any other undertaking to do an act in addition to the payment of money [UCC 3-104(a)(3)]. A promise or order to may include authorization or power to protect collateral, dispose of collateral, waive any law intended to protect the obligee, and the like.

17. Summary: Formal Requirements for a Negotiable Instrument (4 of 4)
Description
Payable on demand or at a definite time
Payable on demand: Payable at sight, upon presentation, or when no time for payment is stated [UCC 3-108(a)].
Payable at a definite time: Payable at a definite date, or before a stated date, a fixed period after a stated date, or at a fixed period after sight [UCC 3-108(b)(c)].
Instrument payable only upon the occurrence of an uncertain act or event is nonnegotiable.

18. Nonnegotiable Contract
A promise or order to pay that does not meet the requirements of a negotiable instrument
It is not subject to the provisions of UCC Article 3
A nonnegotiable contract can be enforced under normal contract law

19. Transfer by Assignment or Negotiation
The transfer of rights under a contract
It transfers the rights of the transferor (assignor) to the transferee (assignee)
Transfer by Negotiation
The transfer of a negotiable instrument by a person other than the issuer
The person to whom the instrument is transferred becomes the holder
Negotiating order paper
Negotiating bearer paper

20. Indorsement
The signature (and other directions) written by or on behalf of the holder somewhere on the instrument
The signature may:
Appear alone
Name an individual to whom the instrument is to be paid, or
Be accompanied by other words

21. Holder Versus Holder In Due Course
A person who is in possession of a negotiable instrument that is drawn, issued, or indorsed to him or his order, or to bearer, or in blank
Holder in Due Course (HDC)
A person who takes a negotiable instrument for value, in good faith, and without notice that it is defective or is overdue

22. Requirements for HDC Status
To qualify as an HDC, the transferee must meet the requirements established by the UCC
The person must be the holder of a negotiable instrument that was taken:
For value
In good faith
Without notice that it is overdue, dishonored, or encumbered in any way, and
Bearing no apparent evidence of forgery, alterations, or irregularity [UCC 3-302]

23. Holder in Due Course (HDC)
Negotiable Instrument
Negotiable Instrument
Holder in Due Course (HDC)
Maker or Drawer
Payee or Bearer
Holder
Takes a negotiable instrument
For value
In good faith
Without notice of defect
The instrument bears no apparent evidence of forgery, alterations, or irregularity

24. Real Defenses Real Defenses Effect Minority Extreme duress
Mental incapacity
Illegality
Discharge in bankruptcy
Fraud in the inception
Forgery
Material alteration
Real defenses can be raised against both holders and holders in due course

25. Personal Defenses Personal Defenses Effect Breach of contract
Fraud in the inducement
Mental illness that makes a contract voidable instead of void
Illegality of a contract that makes the contract voidable instead of void
Ordinary duress or undue influence
Discharge of an instrument by payment or cancellation
Personal defenses cannot be raised against a holder in due course

26. HDC Status Eliminated with Respect to Consumer Credit Transactions
The Federal Trade Commission (FTC) has adopted a rule that eliminates HDC status with regard to negotiable instruments that arise out of certain consumer credit transactions
Sellers of goods and services are prevented from separating the consumer’s duty to pay the credit and the seller’s duty to perform
Thus, both personal and real defenses can be raised against an HDC

27. The Bank – Customer Relationship
Creditor – Debtor Relationship
Created when a customer deposits money into the bank
The customer is the creditor and the bank is the debtor
Principal – Agent Relationship
Created if the:
deposit is a check that the bank must collect for the customer or the
customer writes a check against his or her account
The customer is the principal and the bank is the agent

28. The Collection Process
A bank is under duty to accept deposits into a customer’s account
This includes collecting checks that are drawn on other banks and made payable or indorsed to the depositor
UCC Article 4 regulates the collection process

29. The Check Collection Process
Metro Bank sends the check to City Bank for collection
Drawer issues a check to Payee drawn on Country Bank
Payee deposits the check in her account at Metro Bank
METRO BANK
CITY BANK
DRAWER
PAYEE
Drawer has a checking account at Country Bank
(Depository and collecting bank)
(Intermediary and collecting bank)
COUNTRY BANK
City Bank sends the check to Country Bank for collection
(Drawee and payor bank)

30. Electronic Fund Transfer Systems
Electronic fund transfer systems (EFTS) are supported by contracts among and between customers, banks, private clearinghouses, and other third parties
The most common forms of EFTS are:
1. Automated Teller Machines (ATM)
2. Point-of-Sale (POS) Terminals
3. Direct Deposits and Withdrawals
4. Paid-by-Internet

31. Wire Transfers (1 of 2)
UCC Article 4A – Fund Transfers governs wholesale wire transfers:
Applies only to commercial electronic fund transfers
Consumer fund transfers subject to the Electronic Fund Transfer Act are not subject to Article 4A

32. Wire Transfers (2 of 2) UCC Article 4A (continued)
Governs the rights and obligations between parties to a fund transfer unless they have entered into a contrary agreement
If a receiving bank mistakenly pays a greater amount to the beneficiary than ordered, the originator is liable for only the amount he or she instructed to be paid