CHAPTER 20 Negotiable Instruments
20.01 Introduction to Article 3 of the Uniform Commercial Code
[1] Recent Developments in the Law of Negotiable Instruments [2]
Scope of Article 3 [3] Nature of a Negotiable Instrument [4] Use of
a Negotiable Instrument in an Accord and Satisfaction [5] Relevance
of Article 3 to Writings Not Meeting Requisites of Negotiability
[6] Caveats With Respect to the Organization of This Chapter
20.02 The Requirements of a Negotiable Instrument [1] The Types
of Writings That May Constitute Negotiable Instruments [2] A
Negotiable Instrument Must Be Signed by the Maker or DrawerWhat
Constitutes a Signature? [3] A Negotiable Instrument Must Contain a
Promise or Order to PayWhat Constitutes a Promise or Order to Pay?
[a] Promise to Pay [b] Order to Pay [i] An Order Is a Direction and
Must Be More Than an Authorization or Request [ii] An Order Must
Identify the Person to Pay [c] Instruments Payable at a Bank [4]
The Promise or Order to Pay Must Be Unconditional [a] In General
[b] Implied and Constructive Conditions Do Not Destroy
Negotiability [c] Statement of Consideration or Reference to
Underlying Transaction or Agreement Does Not Destroy Negotiability
[d] Reference to Fund From Which Payment Is to Be Made Will No
Longer Destroy Negotiability [5] A Negotiable Instrument Must Be
Payable for a Sum Certain or for a Fixed Amount [a] In General [b]
Effect of Interest Rates [c] Other Clauses Affecting Amount Payable
[6] A Negotiable Instrument Must Be Payable in Money [a] In General
[b] Foreign Currency [7] A Negotiable Instrument Must Be Payable on
Demand or at a Definite Time [a] In General [b] On Demand Defined
[c] Definite Time Defined [8] A Negotiable Instrument Must Be
Payable to Order or to Bearer [a] In General [b] Order Paper
Defined [i] What Constitutes Payable to Order? [ii] To Whom May an
Order Instrument Be Made Payable? [c] Bearer Paper Defined [9] A
Negotiable Instrument Must Contain No Other Promise, Order,
Obligation or Power [a] In General [b] Omissions Not Affecting
Negotiability [c] Terms Not Affecting Negotiability [i] References
in an Instrument to Collateral Do Not Affect Negotiability [ii] A
Promise or Power to Maintain or Protect Collateral or to Give
Additional Collateral Does Not Affect Negotiability [iii]
Confession of Judgment Clauses Do Not Affect Negotiability Provided
They Are Legal Under Non-Code State or Federal Law [iv] Inclusion
in an Instrument of a Term Purporting to Waive the Benefit of Any
Law Does Not Destroy Negotiability [v] Negotiability Is Not
Affected by a Provision in Draft That Cashing or Indorsing of Same
Is an Acknowledgement of Full Satisfaction of the Obligation
Represented by the Draft [vi] Clauses Providing for Choice of Law,
Venue, Jury Waivers, and Arbitration Are Enforceable and Do Not
Affect or Destroy Negotiability [vii] Information in the Memo
Portion of an Instrument Does Not Affect Negotiability [10] Rules
of Construction for Ambiguous Instruments
20.03 The Holder of an Instrument [1] Distinctions Among
Possessors of Instruments [2] Becoming a Holder [a] What
Constitutes Possession of the Instrument? [b] Transfer and
Negotiation of Bearer and Order Instruments [3] Rights of a Holder
[a] The Right to Negotiate the Instrument [b] The Right to Secure a
Discharge of the Instrument [c] The Right to Enforce Payment of the
Instrument [i] A Holder Has Important Procedural Advantages Over an
Ordinary Transferee or a Claimant Suing on the Underlying Claim [A]
A Holder Need Only Bring Action on the Instrument Itself [B]
Production of the Instrument Containing the Signature of the
Obligor Gives the Plaintiff-Holder a Prima Facie Right to Recovery
[ii] A Comparison Between the Procedures in an Action on an
Instrument and in an Action on the Underlying Obligation [4] Rights
of a Non-Holder [a] Lost or Stolen Instruments [b] The Shelter
Principle [i] Scope of the Principle [ii] Limitations on the
Shelter Principle
20.04 The Holder in Due Course. [1] In General [2] A Holder in
Due Course Must Be a Holder.
20.05 A Holder in Due Course Must Take an Instrument for Value
[1] A Holder Takes an Instrument for Value Only to the Extent That
the Agreed Consideration Has Been Performed [2] A Holder Takes an
Instrument for Value if the Holder Acquires a Security Interest in
or Lien on the Instrument [3] A Holder Who Takes an Instrument in
Payment of or as Security for an Antecedent Claim Takes for Value.
[4] A Holder Takes for Value When Negotiable Instruments Are
Exchanged [5] A Holder Who Makes an Irrevocable Commitment to a
Third Person Takes for Value.
20.06 A Holder in Due Course Must Take an Instrument in Good
Faith
20.07 Notice as an Element of Holder in Due Course Status [1]
The Importance and Definition of Notice [2] Notice Within An
Organization [3] When Is An Instrument Overdue? [4] Purchasers Who
Take With Notice That the Instrument Has Been Dishonored Cannot Be
Holders in Due Course [5] Purchasers Who Take With Notice of a
Defense or Claim to the Instrument Cannot Be Holders in Due Course
[a] Defense or Claim Defined [b] Voidability or Discharge of
Obligation on Instrument [c] Breach of Duty by Fiduciary [d]
Knowledge That Does Not Constitute Notice of a Defense or Claim [e]
Notice in New York and the Doctrine of Forgotten Notice [6]
Purchasers Who Take Instruments Bearing Irregularity Cannot Be
Holders in Due Course
20.08 Additional Issues Affecting Holder in Due Course Status
[1] Transfers Not in the Ordinary Course of Business That Prevent a
Purchaser From Being a Holder in Due Course [2] The Payee as a
Holder in Due Course
20.09 Causes of Action and Statutes of Limitation [1]
Pre-Revision Provisions [2] Current Provisions
20.10 Rights of a Holder in Due Course [1] Assertion of Claims
and Defenses Against a Holder in Due Course [a] In General [b] A
Holder in Due Course Takes Free of All Claims [c] A Holder in Due
Course Takes Free of Most Defenses Asserted Against Parties Other
Than the Holder [d] Real Defenses That Can Be Asserted Against a
Holder in Due Course [i] Infancy of the Obligor [ii] Incapacity,
Duress, and Illegality as a Defense [iii] Usury as a Defense [iv]
Fraud in the Factum as a Defense Against a Holder in Due Course [A]
Defense of Fraud in the Factum as a Vehicle for Consumer Protection
[v] Discharge as a Defense Against a Holder in Due Course [2]
Assertion of Claims and Defenses Against One Not a Holder in Due
Course [a] One Who Is Not a Holder in Due Course Takes an
Instrument Subject to the Defense of Want or Failure of
Consideration [i] What Constitutes Want of Consideration or Failure
of Consideration? [ii] Pleading and Proof Required in Assertion of
Defense [iii] No Consideration Is Necessary Where the Instrument Is
Taken in Satisfaction of an Antecedent Debt [b] One Who Is Not a
Holder in Due Course Takes an Instrument Subject to the Defense of
Nonperformance of Conditions Precedent [i] Conditions Precedent to
the Obligation on the Instrument [ii] Conditions Precedent to the
Underlying Obligation [A] Express Conditions Precedent [B] Implied
or Constructive Conditions Precedent [iii] Admissibility of Parol
Evidence in Proof of Conditions Precedent [c] One Who Is Not a
Holder in Due Course Takes an Instrument Subject to the Defense of
Breach of a Condition as to Delivery [i] Nondelivery [ii] Delivery
for a Special Purpose [iii] Conditional Delivery [iv] Admissibility
of Parol Evidence [d] One Who Is Not a Holder in Due Course Takes
an Instrument Subject to the Defense That It Was Acquired by or
Through Theft [e] One Who Is Not a Holder in Due Course Takes an
Instrument Subject to Restrictive Indorsements [f] One Who Is Not a
Holder in Due Course Takes an Instrument Subject to the Defense
That It Has Been Altered [i] Alteration in General [A] Effect of
Alteration [B] Pleading and Proof [ii] The Nature of the Alteration
[iii] The Alteration Must Be Fraudulent [iv] When the Defense Is
Barred [A] Assent to an Alteration Will Bar Assertion of It as a
Defense [g] Jus Tertii [i] Denial of Claims Based on Rights of
Others [ii] Interpretative Difficulties in Section 3-305(c) [A]
Claims vs. Defenses [B] Section 3-305(c) Is Not Confined to the
Claims and Defenses of Third Parties to the Instrument [iii] Jus
Tertii Arguments May Be Used to Attack the Plaintiffs Status
20.11 Signatures and Forgeries [1] Necessity of Signature for
Liability to Attach [2] What Constitutes a Signature? [3] Whose
Signature Is It? [a] Liability for Unauthorized Signatures [i]
Ratification of Unauthorized Signatures [ii] Preclusion to Deny
Authorization [b] Liability for Signature by an Authorized
Representative [i] A Signature May Be Made by an Authorized
Representative [ii] Failure Both to Indicate Representative
Capacity and Name Principal [A] Personal Liability of Principal and
Representative [B] The Use of Parol Evidence to Disestablish
Signers Personal Liability [iii] Liability of Representative Where
Principal Is Named [iv] Signature on Behalf of an Organization [4]
Burden of Proof Regarding Signatures [a] Specific Denial Required
to Place Authenticity of Signature in Issue [i] Effect of Failure
to Deny Specifically [b] Burden of Establishing Genuineness Is on
the Party Claiming Under the Signature [i] Presumption of
Genuineness [ii] Plaintiffs Burden of Establishing Defined [5]
Capacity in Which Signature Is Made [a] A Signature Is Presumed to
Be an Indorsement [b] Parol Evidence Is Inadmissible to Explain the
Intended Liability of the Signer [6] Liability for Unauthorized
Signature Caused by Negligence [a] Effect of Negligence [b]
Substantial Contribution and Proximate Cause [c] Comparative
Negligence Standard and Burden of Proof [d] Availability of Defense
to Depositary Bank [e] Imposter Rule and Fictitious Payee
RuleIntroduction [i] Scope of Imposter Rule [ii] The Fictitious
Payee Doctrine [iii] The Consequences of Negligence
20.12 Liability of the Maker or Issuer [1] The Maker or Issuers
Obligation [a] The Maker or Issuer Promises to Pay According to the
Terms of the Instrument as Issued [b] The Maker of Issuers
Liability Is Primary [c] A Note is a Contract; Makers Obligation Is
Subject to Contract Law
20.13 Liability of the Acceptor or Payor (Drawee) [1] Drawee as
Acceptor [a] The Nature of a Draft [b] The Acceptors Obligation [2]
Acceptance [a] What Constitutes Acceptance? [b] Personal Money
Orders [c] Certified Checks; Certification as Acceptance [d]
Refusal to Pay Instruments on Which Bank Is Obligated [e] When
Acceptance Becomes Effective [3] Acceptance at Variance With Terms
of Draft [a] Disclaiming the Obligation [b] Modifying the
Obligation [c] Acceptance Varying Place of Payment [4] Finality of
Payment or Acceptance Rule [a] Mistaken Payment and Restitution [b]
What Constitutes Payment Under the Final Payment Rule? [c] Change
of Position in Reliance on Payment or Acceptance [d] Negligence of
the Holder Does Not Preclude Application of the Finality of Payment
Rule
20.14 Liability of the Drawer [1] The Drawers Obligation [a]
Conditions Precedent to the Drawers Obligation [b] Disclaiming
Liability
20.15 Liability of the Indorser [1] Definition of an Indorsement
[a] Elements Necessary to Constitute an Indorsement [b] Types of
Indorsement [i] Special Indorsement [ii] Blank Indorsement [iii]
Anomalous Indorsement [iv] Restrictive Indorsement [2] The
Indorsers Obligation [a] The Indorsers Contract [b] Conditions
Precedent to the Indorsers Obligation [c] Varying the Indorsers
Contractual Obligation [i] Disclaiming the Indorsers Contractual
Obligation [ii] Modifying the Indorsers Contractual Obligation
[iii] Admissibility of Parol Evidence to Establish Indorsers
Contract [d] To Whom Does the Indorsers Obligation Run? [e] In What
Order Are Indorsers Liable?
20.16 Liability of the Surety [1] The Nature of a Suretyship
Relationship [a] In General [b] Suretyship and Negotiable
Instruments [2] Accommodation Parties [a] Definition of
Accommodation Party [b] Establishing Accommodation Status [i]
Admissibility of Parol Evidence [ii] Receipt of Benefit [c] To Whom
Does the Accommodation Partys Obligation Run? [d] The Accommodation
Partys Obligation Under the New York State Variation [e] Defenses
Available to Accommodation Parties [i] Failure of Consideration Not
a Defense [ii] Discharge or Release of Accommodated Party [iii]
Extension of Time of Payment [iv] Modification of Accommodated
Partys Agreement [v] Impairment of Collateral [f] Consent to, and
Waiver of Discharge [g] The Accommodation Partys Right of
Subrogation [3] Guarantors [a] In General [b] To Whom Does a
Guarantors Obligation Run? [c] A Guaranty Is Not Rendered
Unenforceable Because It Violates a Statute of Frauds [d]
Guarantees in Consumer Transactions
20.17 Warranty Liability [1] In General [a] Contractual and
Warranty Liability Distinguished [b] The Nature of Warranty
Liability [i] Varying Warranty LiabilityModifications and
Disclaimers [c] Accrual of Cause of Action [i] A Cause of Action
for Breach of Warranty Accrues When the Instrument Is Transferred
or Presented [ii] Statute of Limitations [d] Damages for Breach of
Warranty [2] Transfer Warranties [a] Against Whom Are the
Warranties Imposed? [i] There Must Be a Transfer of the Instrument
[ii] The Transfer Must Be for Consideration [b] To Whom Do the
Warranties Run? [i] Transfers With and Without Indorsements [c] The
Specific Transfer Warranties [i] Person Entitled to Enforce [ii]
All Signatures Are Authentic and Authorized [iii] No Alteration
[iv] No Defense Good Against Transferor [v] No Knowledge of Any
Insolvency Proceeding [vi] Warranty as to Remotely-Created Consumer
Item under 2002 Revision [3] Presentment Warranties [a] Against
Whom Are the Warranties Imposed? [b] To Whom Do the Warranties Run?
[c] The Specific Presentment Warranties [i] The Presentment
Warranties Operate in Conjunction With the Finality of Payment Rule
of Section 3-418 [ii] Person Entitled to Enforce [A] In General [B]
Title to Bearer Instruments and Order Instruments [iii] Authorized
Signatures [A] The Basic Warranty [B] Exceptions to the Basic
Warranty [iv] No Alterations [A] The Basic Warranty [B] Exceptions
to the Basic Warranty [v] Right to Assert Drawees Defenses [d]
Third Party Actions and Vouching-In
20.18 Conversion Liability and Forged Indorsements [1] In
General [2] Incorporation of Common Law [3] Conversion by Payment
on a Forged Indorsement [a] Introduction [i] Payee vs. Drawer [ii]
Drawer vs. Drawee Bank [iii] Drawee Bank vs. Collecting Banks [iv]
Payee vs. Drawee Bank [v] Drawer vs. Depositary Bank [vi] Payee vs.
Collecting Bank [A] The Scope of Pre-Revision Section 3-419(3) [B]
Reasonable Commercial Standards [C] Representative [D] Proceeds
20.01 Introduction to Article 3 of the Uniform Commercial
Code*
[1] Recent Developments in the Law of Negotiable Instruments
Article 3 of the Uniform Commercial Code (herein referred to as
the Code) concerns the payment mechanisms through which commercial
transactions are most commonly financednegotiable instruments.
Negotiable instruments or commercial paper, specifically drafts and
checks, have long played an important role in commerce as
representing one of several payment systems. Checks and drafts are
used as a means for one person to make payment of funds to another
person.1 Certain principles with respect to application of the Code
must be recognized. The Code is a codification of the principles of
the law merchant; it sets forth liabilities that are different than
existed at common law.2 Where the Code provides for the situation
in which the Code codifies the law on a subject, a common law claim
cannot be asserted, as it is supplanted by the Code.3
Notwithstanding recent inroads made possible by technological
advances in electronic payment systems, commercial suppliers of
goods and services typically perform their obligations in return
for the drafts, such as checks, and notes governed by Article 3.
The provisions of this Article constitute a comprehensive
codification of the rights and duties of the parties to negotiable
instruments.4
Nevertheless, the law of negotiable instruments has recently
been the subject of substantial changes on two fronts. Developments
in the use of credit cards, electronic funds transfers, and check
collection led to substantial debate about the need for a more
comprehensive codification of the law of payment systems, including
credit cards and electronic funds transfers. Early attempts to
create a Payments Code, however, met substantial opposition.5 In
response, the American Law Institute and the National Conference of
Commissioners on Uniform State Laws adopted a comprehensive
Revision to Article 3 and amendments to Article 4, which governs
the check collection process.6 The current version of Article 3
retains the basic concepts and structure of prior law, but takes
account of certain technological developments and purports to
clarify ambiguous terminology and resolve interpretive conflicts
among the courts.7 Other revisions, however, are substantive, and
dramatically alter the law of negotiable instruments. (Indeed,
Article 3 itself has been renamed Negotiable Instruments.). This
1990 revision and amendments effected by N.C.C.U.S.L have been
recognized by the courts as having resulted in significant
substantive revisions.8 At the same time, one also must not lose
sight of the fact that many provisions from the Pre-Revision
version are carried forward in the current version without any
substantive changes. To the extent a particular provision remains
the same under the successor or parallel section in the revised
Code, case law interpretations based upon the Code provision will
continue to provide precedent for construing the revised Code
section.9
Further amendments to Uniform Commercial Code Articles 3 and 4
were drafted by N.C.C.U.S.L. as approved and recommended for
enactment by the states at the N.C.C.U.S.L. annual conference
meeting on July 26-August 2, 2002. Unlike the 1990 Official Text,
the 2002 Amendments (referred to in this chapter as the 2002
Revision) affect significantly more modest revisions to Articles 3
and 4, and changes to the law. Topics that are addressed in the
2002 Revision cover transferring lost instruments; payment and
discharge; tele-phonically generated checks; suretyship; electronic
communications; consumer notes and United Nations Convention on
International Bills of Exchange and International Promissory
Notes.10 The more significant and substantial revisions effected by
the 2002 Revision are, as to suretyship rights, to wit: the
respective rights and liabilities of the parties to an instrument
when certain parties are released by the person entitled to enforce
an instrument or such person agrees to a change in the obligations
of the principal obligor on the instrument (the entire current
version of Code 3-605, Discharge of Indorsers and Accommodation
Parties, has been deleted, and in substitution therefore, a new
section has been added). Also, in connection with the revisions in
the 2002 Revision, certain definitions were added.11 Two notable
changes are that the definition of Good Faith has been deleted from
Article 3 (in that an exact definition was added to the 2001
revisions to Article 1) and that a new definition of a term used in
several sections in the 2002 Revision, Record, has been added to
Article 1, in 1-201(33a). This chapter, therefore, discusses both
the law of the pre-Revision version of Article 3, the modifications
and clarifications of that law under the Revision, and the 2002
Revision. Citations to the Revision will be designated by section
number alone. Citations to pre-Revision sections will be designated
as pre-Revision Section 3-xxx in text and Pre-Revision UCC 3-xxx in
footnotes. Reference to the 2002 Revisions will be designated as
UCC 3-xxx (2002 Revision) in text and footnotes.
In addition, substantial portions of payments law are now
governed by federal, rather than state law. The Expedited Funds
Availability Act12 and Regulation CC of the Federal Reserve Board13
may pre-empt state law that governs the check collection process.
Although most of the effects of these federal enactments limit the
range of Article 4 of the Code, they also have implications for
Article 3 provisions, such as the scope of the warranty made by a
bank that transfers or presents a check for payment. Section
3-102(c) recognizes the increasing influence of federal law by
providing: Regulations of the Board of Governors of the Federal
Reserve System and operating circulars of the Federal Reserve Banks
supersede any inconsistent provision of this Article to the extent
of the inconsistency.
Adoption of the 1990 Amendments, the Revision, by the various
states occurred over a period of several years. As a result, courts
continue to hear disputes concerning transactions that occurredwhen
the prior version of Article 3 was in effect. Courts in this
position must decide what effect to give to the revised version
where it varies from the prior version. This raises the question as
to the prospective effect of the current version. Some courts have
considered that substantive changes in the current version of
Article 3 reflect a desire to clarify prior ambiguities or to make
commercial law consistent with commercial practice. These courts
have used the language of revised Article 3 to interpret provisions
of the version in effect when the transaction in dispute arose. In
Amberboy v. Societe de Banque PriveeAmberboy v. Societe de Banque
Privee,14 for instance, the Texas Supreme Court determined that a
note bearing a variable interest rate could satisfy the conditions
of negotiability, notwithstanding explicit rejection of that
position in a comment to the pre-Revision Code. The Court noted
that the revised version of the Code (which had not been adopted in
Texas) made such notes negotiable. The Court concluded that its
interpretation was consistent with the Codes objective of
reflecting modern commercial practices. Similarly, a New Jersey
court concluded that an amendment to that states version of the
Code adding the current version Article 3 was curative in nature
and thus could be given retroactive effect with respect to notes
bearing variable interest rates.15
Numerous appeals courts have recognized the general proposition
that unless it is otherwise manifestly intended by the legislature,
or expressly provided in the statute, a new law does not have
retroactive effect.16
In an Illinois case that addressed the same issue, however, an
appellate court determined that revised provisions that made such
instruments negotiable were substantive in nature and thus could
only apply prospectively. In Johnson v. Johnson,17 the court
concluded:
While we believe that the 1992 amendment has no retroactivity,
at least one State (New Jersey) has adopted a contrary view. Where
the note was executed in 1989, the trial held in 1990, and the New
Jersey U.C.C. amended in 1992, the New Jersey court determined that
the amendment was curative, embracing the expectations of the
parties. With remarkable casuistry, the New Jersey court suggests
that as an exception to the non-retroactivity rule the amendment
attempts to improve a statutory scheme and bring the law into
harmony with the expectations of the parties and the law in the
commercial marketplace. Applying such retroactivity does just the
opposite. It is generally unfair and makes the parties unsure of
the bargain they have struck. The New Jersey court has contorted
the rules of statutory construction to meet the exigencies of
current leading practices. In Illinois, we do not so bend.
Had our General Assembly desired, it could have designated that
the amendment be given retroactive application. Had the American
Law Institute which promulgated the uniform act had such a desire,
retroactivity could have been included in the comment.
The Minnesota Supreme Court has adopted a view more similar to
that of the Illinois appellate court. In deciding which parties
were properly the subject of a conversion suit for a check bearing
a forged indorsement, the court presumed that the legislature
intended an amendment to effect a statutory change. Thus, in
considering whether a depositary bank could be liable for
conversion in a Pre-Revision transaction, the existence of the
amendment imposing liability indicated that such institutions were
previously exempt from liability. The current version of Article 3
was not be given any retroactive effect.18 A federal bankruptcy
court similarly refused to give retroactive effect to a provision
that was interpreted as expanding the conditions under which a
forged indorsement by a faithless employee would be
effective.19
The Pre-Revision will continue to apply to any case where the
events or transactions upon which a claim or suit is based occurred
prior to adoption of the revised Code in that state,
notwithstanding that the current version may be in effect at the
time a lawsuit is commenced or a decision rendered by a court.20
The revised Code is prospective and will apply where the
transactions occurred after its adoption.21 However, a Minnesota
appellate case22 recognized that if an amendment to a statute seeks
only to clarify the intent of the old statute, then the new statute
may be applied retroactively [citations omitted]. We rely upon the
amended UCC to the extent that it serves merely to clarify usages
and practices previously recognized. Finally, as recognized in a
Washington appellate case,23 [S]tatutes are presumed to apply
prospectively only [citations omitted]. An exception is recognized
if the statute is remedial in nature, and retroactive application
would further its remedial purpose [a law] is deemed remedial and
applied retroactively when it relates to practice, procedure or
remedies, and does not affect a substantive or vested right.24
Another important concept concerns whether the provisions of the
Code displace other rules of law (statutory and case law). In
Travelers Cas. & Sur. Co. of Am. v. Manufacturers Life Ins.
Co.,25 the court stated the general rule of interpretation that
there will be a displacement under circumstances where the Code
articulates a loss distribution scheme that applies to fact
patterns that are involved in the case. In other words, if a loss
distributive scheme is available under the [Code] for a particular
fact pattern, then related common law claims must be dismissed.
(citations omitted)
Finally, 42 states and the District of Columbia have also
adopted the Uniform Electronic Transactions Act, or UETA. This Act
is designed to facilitate the use of electronic commerce by making
electronic records and signatures legally equivalent to writings
and written, or manually-signed, signatures. The UETA interacts
with Article 3 insofar as instruments may be created and executed
electronically. For instance, the Proposed 2002 Revision
substitutes the term record for writing.26 A record is defined in
corresponding revisions to Article 1 of the Uniform Commercial Code
as information that is inscribed on a tangible medium or that is
stored in an electronic or other medium and is retrievable in
perceivable form.27 Other provisions in the Proposed 2002 Revision
adopt from UETA the definition of an electronic signature as an
electronic sound, symbol, or process attached to or logically
associated with a record and executed or adopted by a person with
the intent to sign the record.28 The federal Electronic Signatures
in Global and National Commerce Act,29 however, does not apply to
instruments governed by Article 3. Section 7003(a)(3) specifically
exempts records governed by Article 3 from coverage of the federal
provisions.
[2] Scope of Article 3
Generally, Article 3 is concerned only with negotiable
instruments. Most importantly, Article 3 does not apply to money,30
although much of the law of negotiable instruments has the purpose
and effect of transforming instruments into money substitutes. It
also does not apply to electronic funds transfers governed by
Article 4A or to securities, which are governed by Article 8.31 Nor
does it apply to consumer electronic fund transfers such as credit
card, debit card, or ATM card transactions. In addition, if there
is any conflict between the provisions of Article 3 and those of
Article 4, which deals with Bank Deposits and Collections, or
Article 9, which deals with Secured Transactions, the provisions of
Article 3 are subordinate.32
The Code establishes several requirements that must be satisfied
for a writing to qualify as a negotiable instrument. These
requirements will be discussed in detail later in this chapter.33
If an instrument is negotiable, the holder may qualify as a holder
in due course, a status that provides rights far more substantial
than those available to an obligee or assignee under a simple
contract. For instance, a party with holder in due course status
may take the instrument free from defenses to payment that could be
asserted against a mere assignee of a common law contract right.34
It is in part for this reason that negotiable instruments are
considered money substitutes. As in the case of a negotiable
instrument, a transferor of money can give a good faith transferee
better title than the transferor had.35 If the requirements of
negotiability under the Code are not satisfied, however, the
obligee under the instrument has only the rights of an obligee or
assignee under a contract. As noted above, to the extent that
Article 3 involves transactions governed by the Federal Reserve
System, such as the collection and return of checks, the Code is
superseded by federal law and regulations. This may be true even if
no Federal Reserve Bank participates in the transaction. For
instance, the Expedited Funds Availability Act36 confers broad
authority on the Federal Reserve System to regulate check
collection nationwide, even if the instrument at issue never passes
through a Federal Reserve Bank.
[3] Nature of a Negotiable Instrument
A negotiable instrument usually has a dual nature. It is
foremost an independent and unqualified promise to pay a fixed
amount of money on demand or at some definite time in the future to
either the bearer of the instrument or to the order of some person
named in the instrument.37 In addition, the instrument will often
serve as written evidence of some underlying obligation for which
the instrument was given. This is not always the case, however, as
where the instrument is given as a gift. Where the instrument is
issued to satisfy an underlying obligation, that obligation is
integrated or merged into the instrument. The legal effect of this
merger is that the requirements to pay the instrument and to make
payment on the underlying obligation rise or fall in concert. While
the instrument is outstanding, for instance, the underlying
obligation is suspended and the obligee cannot bring an action to
enforce it unless the instrument is subsequently dishonored.38
Thus, an obligee who accepted a draft from an obligor within the
statutory period for receiving compensation from the obligor could
not claim that the period had been exceeded, even though the
proceeds of the draft were not available to the obligee until after
the end of the period.39 Additionally, payment of the instrument
constitutes a discharge on the underlying obligation.40 (It is
important to note, however, that payment is a specialized term that
requires payment on behalf of the obligor on the instrument and
payment to a person entitled to enforce the instrument.)41 This
suggests both the value of negotiable instruments as payment
devices and their ready acceptance in the commercial world as
substitutes for cash transactions.
[4] Use of a Negotiable Instrument in an Accord and
Satisfaction
Prior to the current version of Article 3, courts divided over
the issue of whether a negotiable instrument could effect an accord
and satisfaction when tendered and taken in an amount less than an
alleged debt. First, one must define an accord and satisfaction. It
is a contractual method by which a debt or claim can be discharged.
The accord is the agreement between the parties, while the
satisfaction is the execution or performance of the agreement.42 A
federal district court43 observed that an accord and satisfaction
must contain the elements of a normal contract; these are an offer,
acceptance, and consideration. A Texas appellate court44 recognized
that no separate consideration is necessary for the accord and
satisfaction; specifically, for the satisfaction. The consideration
supporting the accord and satisfaction is the good faith dispute as
to liability on either a liquidated or unliquidated claim [which is
what] furnishes sufficient consideration for an accord and
satisfaction. Some courts resolved the issue through Section 1-207
of the Code, which permits a party to take a check, but explicitly
to reserve rights when depositing the check, thereby avoidingany
claim of accord and satisfaction. The current version of Article 3
addresses the issue directly. Section 1-207(2) provides that the
authorization for a reservation of rights does not apply to an
accord and satisfaction.45 Section 3-311 now governs checks that
purport to be in full satisfaction of a debt.
Section 3-311 relieves a person who offers an instrument in
payment of an obligation of further liability when four conditions
are met. First, the party offering the instrument must have a
good-faith belief that the instrument fully satisfies the claim.
Second, the amount of the claim must be unliquidated or subject to
a good-faith dispute. Third, the claimant must obtain payment of
the instrument. If these conditions are satisfied, the underlying
claim will be discharged if, fourth, the instrument or an
accompanying writing contained a conspicuous statement that it was
tendered in full satisfaction of the debt.46
Each of these four elements are explained and discussed in
numerous cases. As indicated in an Illinois case,47 when the
criteria of the section are satisfied there is an accord and
satisfaction if there is a bona fide dispute and the creditor
cashes the check, notwithstanding that the creditor protests that
he does not accept the amount in full satisfaction. The creditor
must either accept the payment with the condition or refuse. An
Indiana court48 described 3-311 as providing a bright-line rule
that the cashing of a check that is clearly marked full
satisfaction check (and where the other conditions of 3-311 are
met) operates as an accord and satisfaction. An endorsement of a
full satisfaction check that purports to reserve the
payee/creditors rights against the drawer/debtor is not effective
to prevent the accord and satisfaction and discharge of the debtor
on the underlying obligation.
The tender of the accord and satisfaction check must be made in
good faith.49 Addressing the conspicuous requirement, a Virginia
appellate case50 provides a useful explanation of the definition of
conspicuous as provided in Section 1-201(10). It means a term that
a reasonable person should notice. It is a physical attribute that
is involved; the focus of the inquiry is the manner in which the
statement is displayed, as no specific language is required. It is
the province of the court to decide if a statement meets the
requirement and is conspicuous. The debtor sent the creditor a
letter that described the deficiencies of the creditors work. The
final paragraph of the letter stated JSI stands by its final
amounts as stated on the latest correspondence dated December 8,
2000. Enclosed, please find a check in the amount of $13,580.00
representing final payment on the contract. This statement, the
court held, satisfied the conspicuous statementthat the check is
tendered in full satisfaction.
Practical Hint:Although it is not necessary to use any
particular word or phrase, in that UCC Section 3-311(b) provides
what is required is a conspicuous statement to the effect that the
instrument is tendered as a full satisfaction (emphasis added), use
of the phrase in full and final payment or payment in full
satisfaction is preferable and recommended so that there will be no
fact question for a court to determine as to the drawers intention.
A drawer-obligor who wants to more specifically describe the
transaction can certainly do so but should accomplish that goal by
adding additional language to one of the recognized phrases, in
lieu of substituting other language. It is also recommended that
the accord and satisfaction language be placed on the instrument
and that the obligor not rely only on language in an accompanying
letter, although the statute permits the language to be in a
written communication that accompanies the instrument. It is a much
clearer expression of intent if the language is on the instrument,
and there can be no question as to whether the letter was received
or not. The obligor can place the requisite language in both the
letter and the instrument, if the obligor desires to send an
accompanying letter. Finally, an obligor is encouraged to emphasize
the language that tenders the check in full settlement, in a manner
that satisfies the conspicuous definition, and not rely upon the
determination of the court whether the language was or was not, as
a fact determination, conspicuous.
Exceptions to this discharge rule are made in two cases. No
discharge results if the claimant is an organization (defined in
Section 1-201(28) to include corporations, governments, or other
legal or commercial entities) that sent a conspicuous statement to
the person against whom the claim is asserted, indicating that
communications concerning disputes, including an accord and
satisfaction, are to be sent to a particular person, office or
place and that the instrument or communication was not received by
that person, office, or place.51 Note that this rule requires
receipt by the person, office or place, not simply the sending of
the instrument to the designated person or location. In addition,
no discharge results if the claimant tenders repayment of the
amount of the instrument within 90 days of receiving payment as
long as the claimant is not an organization that provided a
statement about the proper person or location for receipt of
communications concerning disputes.52 Finally, discharge results,
notwithstanding the exceptions that would otherwise apply, if the
claimant knew, within a reasonable time before collection of the
instrument was initiated, that the instrument was tendered in full
satisfaction of the claim. Thus, if a clerk in the organization who
is not authorized to receive notices concerning disputes receives a
check with a notation in full payment, the clerks failure to notice
the notation and deposit of the check will not result in a
discharge. Instead, the statement and 90-day provisions would be
triggered. If, however, an agent of the organization who has been
communicating with the alleged debtor receives such a check,
notices the notation, and deposits the check, the claim is
discharged.53
[5] Relevance of Article 3 to Writings Not Meeting Requisites of
Negotiability
For the most part, writings that fail to satisfy the
requirements of Section 3-104 cannot be negotiable instruments
within the meaning of Article 3, which does not apply.54 Such a
writing, though valid, will merely have the effect of a common-law
contract.55 Nevertheless, some writings that do not meet the formal
requisites of negotiability are statutorily deemed negotiable
instruments.56 It is common, for instance, for legislation
authorizing the issuance of bonds by the state or its political
subdivisions to declare such bonds to be negotiable instruments.
Other writings may bear elements of negotiability by judicial
decision, contract or custom.57 Another important principle
recognized by the courts is that negotiability of an instrument is
dependent upon the form of the instrument and is to be determined
by what appears on the face of the instrument. The determination of
whether a note is negotiable is based upon the relevant law, not
upon the intention of the parties (whether they intended it to be
negotiable) or whether the instrument contains a statement that it
is negotiable.58
Although Section 8-105(1) provides that certificated
securities59 governed by Article 8 of the Uniform Commercial Code
are negotiable instruments, they are governed by the provisions of
Article 8, rather than of Article 3.60 Nevertheless, Article 8
largely incorporates Article 3 rules that define the rights and
powers of parties to a negotiable instrument. Perhaps the most
important distinction is the lack of necessity for an Article 8
security to satisfy the requirements concerning the form of an
instrument that are found in Section 3-104.
Prior to its current version, Article 3 provided that a writing
that was nonnegotiable by virtue of not being payable to order or
bearer could still be subject to Article 3 if, by its own terms,
the writing did not preclude transfer.61 Nevertheless, there could
be no holder in due course of such an instrument. Thus, a writing
that purported to be a check in every way other than that it was
payable to X rather than to the order of X would be governed by
those provisions of Article 3 other than those that grant special
rights or powers to a holder in due course. Currently, Article 3
excludes nonnegotiable instruments from its coverage altogether,
but includes some writings that previously did not satisfy the
requirements of negotiability. The scope provision, Section 3-102,
restricts the applicability of Article 3 to negotiable instruments,
a phrase that excludes writings in the form Pay to X.62
Nevertheless, the definition of a negotiable instrument, includes a
document that otherwise qualifies as a check but that is payable to
X rather than to the order of X.63 Thus, a person in possession of
such a check may be a holder and, if he or she otherwise satisfies
the requirements, may be a holder in due course. The exception is
justified because transferees of instruments that otherwise qualify
as checks are unlikely to examine the document to ensure that it
includes the usual to the order of language, and would be surprised
to discover that a document otherwise in the form of a check failed
the test of negotiability.64
Pre-Code cases permitted parties to some documents to obtain the
benefits of negotiability, even with respect to documents that did
not satisfy the formal requisites of negotiable instruments.65 Some
cases decided under the Code have followed this line. For instance,
a party to a writing that did not qualify as a negotiable
instrument could be estopped by its conduct from asserting a
defense against a bona fide purchaser. In First State Bank at
Gallup v. Clark,66 the court found that a note that failed to
satisfy the Codes requirements of negotiability could, under
contract law, retain the elements of negotiability as between the
parties involved in the transaction. Thus, where the maker of a
nonnegotiable note expressly permitted pledge of the note by the
payee as collateral for a loan, the court found the maker estopped
from asserting defenses to payment against the pledgee. The
doctrine of negotiability by estoppel was adopted very early in New
York and accepted fairly generally under the Negotiable Instruments
Law.67 While these cases suggest that an obligor will be estopped
from denying negotiability against third parties only where the
obligor has, by negligence or fraud, induced such parties to
believe they had purchased negotiable instruments, other cases
suggest that a contractual waiver of defenses against third-party
purchasers estops the obligor from future assertion of such
defenses.68 Comment 2 to Section 3-104 continues this policy by
providing that a court could confer the benefits of negotiability
through principles of estoppel or contract, even though the law of
negotiable instruments did not apply.
Although parties may not contractually transform a nonnegotiable
instrument into a negotiable one, substantial case law supports the
conclusion that parties can contractually agree that a writing will
have the same legal effect as a negotiable instrument. Early case
law in New York recognized, at least in dicta, the creation of
negotiable instruments by contract outside of the Negotiable
Instruments Law.69 These cases suggested that as long as such
contractual negotiability would not directly contravene provisions
of the Negotiable Instruments Law, as for example where the statute
merely enumerated requirements for negotiability without explicitly
denying negotiability in their absence, an instrument might be made
negotiable by contract without having satisfied all of the
statutory requirements. In Cho v. Kacy Chi,70 the court makes it
clear that although an instrument is not negotiable for failure to
satisfy the elements of UCC 3-104(a), and is therefore not subject
to the provisions of the Code (not subject to the law on negotiable
instruments), that does not render the instrument unenforceable.
The court enforced the instrument to the extent of the legal
consideration given for the document.
Practical Hint:This is an important point. An instrument does
not have to be negotiable to be enforceable against the maker, in
accordance with general contract principles, since an instrument is
a contract.71 A non-negotiable instrument is still enforceable,
although lacking negotiability, as certain rights are not obtained
by a holder, such as the ability to quality as a holder in due
course.
The current version clarifies the effect of legends on
instruments. An instrument which is nonnegotiable due to a failure
to comply with the requirements of negotiability cannot be made
negotiable by placing appropriate legends or statements in the
instrument.72 However, the placement of legends or statements such
as not negotiable on an otherwise fully negotiable instrument will
be given effect and the instrument will not be negotiable for any
purpose.73
Some scope for contractual negotiability appears to remain under
the Code. In the words of the New York State Law Revision
Commission: It would appear that negotiability by contract is still
limited although not forbidden, by Bank of Manhattan v. Morgan, 243
N.Y. 28 (1926) and Enoch v. Brandon, 249 N.Y. 263, 164 N.E. 45
(1928).74
The form of contractual provision necessary to create
negotiability by agreement, however, remains unclear. In Manhattan
Co. v. Morgan, Judge Cardozo indicated that it was insufficient for
a contract to provide, without more, that the maker may treat the
bearer as the absolute owner for all purposes and shall not be
affected by any notice to the contrary.75 While such a provision
serves to protect a maker who, with notice of an adverse claim,
pays the holder, it does not, according to Cardozo, adequately
protect future holderspresumably because the maker is not required
by such language to treat the bearer as absolute owner for all
purposes.
One early commentator opined that to create negotiability by
stipulation the parties must show their clear intention not to
conform to the act, but to make the instrument involved negotiable
in spite of the clear prohibition of these sections.76 Professor
Beutel thus recommended insertion of a rather detailedcontractual
provision to make it clear that the parties had, in fact,
contracted to create the rights available to the holder of a
negotiable instrument.
The limited case law in this area seems to support Beutels
recommendation of a detailed contractual provision to reflect the
parties intent to confer the benefits of negotiability. In Morgan
Brothers v. Dayton Coal & Iron Co.,77 an elaborate provision
waiving rights between the issuer and the original or any
intermediate holder, inserted in what would otherwise have been
nonnegotiable corporate debentures, was deemed sufficient to permit
recovery by a subsequent innocent holder of the bonds.78 In one
case, however, a Pennsylvania court suggested that an otherwise
nonnegotiable instrument could be rendered negotiable by the mere
inclusion of the words This note shall be negotiable printed in the
body of the note.79
The limits of any attempt to create negotiability by contract
are evident in Becker v. National Bank and Trust Co.80 In Becker,
the payee of notes transferred those documents to a third party to
secure performance of certain obligations. The transfer was
accompanied by an assignment, but there was no negotiation
sufficient to make the transferee a holder. The transferee
subsequently retransferred the notes to the Bank. Each note bore a
legend permitting the payee or its assignees to assign or negotiate
this Note. The bank claimed that this legend transformed it into a
holder in due course, not subject to the defense of fraud in the
underlying transaction because the parties had contracted for
assignment to take place without losing the benefits of
negotiability. The Virginia Supreme Court disagreed. The Court held
that any attempt to change the effects of assignment into those of
negotiation was an alteration of the legal concepts or definitions
of negotiation and holder in due course, an attempt barred by the
Official Comment to Section 1-102. Thus, the bank was entitled
solely to its status and rights as an assignee.
Comment 2 to pre-Revision Section 3-104 indicated that new types
of commercial paper which commercial practice may develop in the
future may create a custom of negotiability notwithstanding failure
to satisfy the formal requisites of Article 3 instruments. Like
negotiability by estoppel, the doctrine of customary negotiability
received early judicial recognition by Judge Cardozo in Manhattan
Co. v. Morgan.81 Nevertheless, the doctrine appears to assume the
existence of a substantial tradition within the trade of treating a
writing as negotiable. Cardozo was therefore unwilling to consider
a note to be negotiable by custom where its form had only come into
general use in the same year as the transaction that gave rise to
the controversy at issue. Other cases, however, refused to
recognize any possibility of creating negotiability through
custom.82
Comment 2 to Section 3-104 contains an oblique appeal to the
development of negotiability by custom. It indicates that it may be
appropriate, consistent with the principles stated in Section
1-102(2), for a court to apply one or more provisions of Article 3
to the writing by analogy, taking into account the expectations of
the parties and the differences between the writing and an
instrument governed by Article 3. That Section indicates that Code
provisions are to be interpreted, (b) to permit the continued
expansion of commercial practices through custom, usage and
agreement of the parties.83 Hence, development of a customary use
of negotiable-like instruments could be enforced by a court
notwithstanding the failure of the writings at issue to satisfy the
technical requirements of negotiability. In addition to a court
applying an Article 3 provision by analogy, notably, as also stated
in Comment 2, parties to a contract may choose to include
provisions from Article 3 in an instrument to determine their
respective rights and obligations.
Conversely, instruments that satisfy the requirements of
negotiability may lose the benefits of that characterization by
virtue of other principles of law. Thus, the Federal Trade
Commission has, by regulation, required that language be inserted
in notes arising out of certain consumer transactions in order to
preclude holders of those notes from asserting the rights of
holders in due course.84 In addition to the Federal Trade
Commission Rules, there are other federal statutes that in specific
types of loans contain provisions providing certain consumer
protection and limiting holder in due course status.85 Further,
state statutes outside of the Code contain provisions limiting
holder in due course status and rights in consumer
transactions.86
[6] Caveats With Respect to the Organization of This Chapter
It is important to recognize that the Code is a highly
integrated statute, and Article 3 in particular has many of the
features of a jigsaw puzzle. The importance of a specific provision
becomes clear only when one considers its relationship to
complementary provisions. This is particularly true with respect to
the law of negotiable instruments. The common situation of
fraudulent checks, for instance, may involve all of the various
theories of liability discussed in this chapter. The defrauded bank
may seek to impose liability on the drawer of the check under a
contract theory. Failing that, the bank may seek to shift the loss
to a prior transferee through a warranty theory. The payee of a
stolen check, on the other hand, may seek recovery on a conversion
theory. To ensure that all possible actions have been considered in
any given fact situation, the reader should make liberal use of the
cross-references found in this chapter. These statements are
recognized in Merrill Lynch Pierce Fenner & Smith, Inc. v.
Fakih.87 The court acknowledged that the Code is a highly
integrated body of statutes and then remarked that its provisions
must be carefully read as such. Fair and just application of the
UCC rarely involves reference to only one or a few of its
provisions in isolation.
20.02 The Requirements of a Negotiable Instrument*
The current version of Article 3 of the Uniform Commercial Code
applies exclusively to negotiable instruments.1 Section 3-104(b)
defines instrument, as used in Article 3, to mean negotiable
instrument. The requirements of negotiability have evolved over a
substantial period of time and are currently codified in Section
3-104(a). These requirements bear substantial study since they are
highly technical, and courts, mindful of the power that accompanies
holder in due course status, are often persuaded to deny a claimant
those powers by finding that the instrument in question was
nonnegotiable.
One might infer that bright lines separate negotiable from
nonnegotiable instruments. After all, if the requirements of
negotiability were intended to permit transferees of such paper to
recognize immediately whether they had substantial rights against
makers or drawers, regardless of defenses those parties might have
against the payee, then clear distinctions would seem necessary.
While the history and justification for negotiable instruments law
certainly suggests that parties to them be able to discern readily
the nature of the document in front of them, the fact is that the
Code requirements leave substantial room for ambiguity. We will
concentrate on the potential for ambiguity and its resolution
throughout the following discussion.
The requirements for an instrument to be negotiable are set
forth in Section 3-104:
(a) Except as provided in subsections (c) and (d), negotiable
instrument means an unconditional promise or order to pay a fixed
amount of money, with or without interest or other charges
described in the promise or order, if it:
(1) is payable to bearer or to order at the time it is issued or
first comes into possession of a holder;
(2) is payable on demand or at a definite time; and
(3) 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, but the promise or order may contain (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
Notably, money does not qualify as a negotiable instrument.3 Nor
do securities that are governed by Article 8 of the Code.4 In
determining whether there has been compliance with the requisites
of negotiability, it is important to recognize that the original
drafters of the Code argued for strict compliance with the
requirements of negotiability. Thus, doubtful cases should be
resolved against negotiability.5 While this principle has not been
explicitly endorsed or rejected in the current version of Article
3, it is sensible if one is concerned that a party who qualifies as
a holder in due course, a status that can only be attained by
holding a negotiable instrument, can cut off defenses of innocent
parties who would otherwise be able to avoid liability on the
instrument.6
In Qui Ngo v. Park,7 the court observed that courts require
strict compliance with the requisites for negotiability provided in
the Code section that defines a negotiable instrument. Courts, the
court held, are encouragedto strictly interpret the definitional
requirements to the extent that in doubtful cases the [courts]
decision should be against negotiability. (citation omitted)
Article 3 also permits the issuer of a writing that otherwise
qualifies as an instrument to remove it from coverage of the UCC by
including a conspicuous statement that the promise or order is not
negotiable. This right, however, does not apply to a check.8
[1] The Types of Writings That May Constitute Negotiable
Instruments
Although Section 3-104 no longer specifically refers to the need
for a writing and that it be signed, 9 a promise and order that
falls within that provision is defined as a written instruction or
written undertaking.10 Additionally, the Official Comment to
Section 3-104 provides that a promise within the section is a
written undertaking and an order is a written instruction. Section
1-201(46) defines written or writing to include printing,
typewriting or any other intentional reduction to tangible form.11
There is no requirement that the writing be permanent or indelible
and an instrument written in lead pencil or other erasable form is
sufficient.12 The writing need not be on paper and one court has
heldthat an oral contract was reduced to tangible form and
qualified as a writing when the contract was tape recorded.13 In
Bank Leumi Trust Co. v. Bank of Mid-Jersey,14 the court noted that
UCC 3-104 does not require that a check be written on a customary
bank form or on paper. There is also no question that a writing
includes duplicated instruments of any sort.15 The advent of
electronic funds transfer promises to generate questions of the
scope of a writing.
Some writings take particular forms, several of which have been
specified in Article 3. In Transcontinental Holding Ltd. v. First
Banks, Inc.,16 the court set forth the substance of Section
3-104(a) (400.3-104 R.S.Mo. (2009)) and then observed that The UCC
recognizes four basic types of negotiable instruments: notes,
drafts, checks, and certificates of deposit. To be a negotiable
instrument, the writing must meet certain statutorily-defined
requirements, at the heart of which is an unconditional promise or
order to pay a fixed amount of money.
An instrument is a note if it is a promise.17 A check, for
instance, is a draft that is payable on demand and is drawn on a
bank.18 A check may be a negotiable instrument even if it is not
payable to bearer or order, as long as it meets all the other
requirements of negotiability.19 This exception to the general rule
that an instrument must be payable to order or bearer was created
to address the concern that someone in possession of a pre-printed
check forms that lacked language of order (as was the case with
numerous drafts drawn by credit unions) could otherwise be misled
into believing he or she was in possession of an instrument, and
would be surprised to discover that he or she did not have a
holders rights due to the technical omission of words of
negotiability. Thus, a check that is drawn payable to X will retain
its status as a negotiable instrument, although a note with the
same language will fail the test of negotiability. In McMullen Oil
Co. v. Crysen Ref., Inc.,20 the court appropriately observed that a
check involves three parties: (1) drawer who writes the check, (2)
the payee, to whose order the check is made out, and (3) the drawee
or payor bank, the bank which has the drawers checking account from
which the check is to be paid. It is also important to recognize
that while a check is an order to pay money, the check does not
constitute an assignment of funds in the hands of the drawee.21 In
Lenares v. Miano,22 the court explained the differences between a
check and note, which are, although fairly obvious, nevertheless
worthy to quote. The court observed that while checks and notes
have many similarities and perform substantially like functions in
many commercial transactions [however] the basic difference between
the two classes of paper is that a draft or check is an order to
pay money, whereas a note is a promise or undertaking to pay
money.
A tellers check is a draft drawn by a bank either on another
bank or payable through or at a bank.23 Tellers checks are
typically used by a savings bank or savings and loan association
that maintains an account with and draws checks on a commercial
bank. A teller check may also be referred to as an official check.
A cashiers check is a draft on which the same bank serves as drawer
and drawee.24 Typically, a bank will issue such an instrument after
it has received funds in return for which the cashiers check is
issued. The bank will typically not allow a withdrawal against the
deposited funds, as they are held to secure the cashiers check. A
travelers check is an instrument that is payable on demand, is
drawn on or payable at or through a bank, is designated by the
phrase travelers check or its equivalent, and requires, as a
condition to payment, a countersignature by a person whose specimen
signature appears on the instrument.25 Note that in order to be a
negotiable instrument, a promise or order must be unconditional.
The fact that a countersignature is required as a condition to
payment of a travelers check, however, does not render the writing
conditional for purposes of defining a negotiable instrument.26 A
share draft is drawn on the drawers account at a credit union. A
share draft may not contain the word order, but has been
interpreted by courts to fall within the category of negotiable
instruments. For purposes of Articles 3 and 4, such a document
functions exactly like a check.27 A certificate of deposit is an
instrument that contains an acknowledgement by a bank that a sum of
money has been received by the bank and a promise to repay the sum
of money. A certificate of deposit is a note of the bank that
issues it.28 A money order is effectively a check and may be sold
by banks and nonbanks.29
Two common situations have developed where a party may issue
what has come to be recognized as pre-authorized drafts or
telechecks In the first variation, a consumer, to whom a vendor is
providing goods or services, agrees with the vendor that the vendor
can prepare drafts drawn on the consumers account. The consumer
provides the vendor with his or her account number, and the vendor
prepares drafts on the consumers account and deposits them at the
vendors bank for collection. The second variation involves the
preparation of checks by telemarketers who have purportedly sold
goods through a telephone order in the name of the purchaser as a
means of obtaining payment for the goods sold. The draft may have a
stamp on it in the place where the signature usually is found,
stating authorization on file, verbally authorized by your
depositor, or such similar notation. The liability of the parties
under these instruments, as for instance where the consumer claims
not to have given an authorization, is not provided for directly in
the Code.
Several states, including Wisconsin, California, Colorado,
Hawaii, Idaho, New Hampshire, North Dakota, Oregon, Texas, Utah,
West Virginia, and Nebraska, have addressed this situation by
amending 3-104, defining a negotiable instrument, to incorporate a
new definition of a Demand draft30 and providing in the warranty
sections under Articles 3 and 4 that the person creating the demand
draft warrants that it was created with the authority of the person
who is identified as the drawer.31 Similarly N.C.C.U.S.L. also
addressed the situation by amending section 3-104 to incorporate a
new definition of Remotely-created consumer item (which is,
essentially, the same as a demand draft under the above identified
states) in the 2002 Revision to Articles 3 and 4.
Numerous documents or writings may appear to be similar to an
instrument but are not negotiable instruments.32 A withdrawal slip
is not an instrument when it contains a statement that it is
nonnegotiable.33
[2] A Negotiable Instrument Must Be Signed by the Maker or
DrawerWhat Constitutes a Signature?
The current version of Article 3 (section 3104) omits the
requirement, contained in earlier versions, that instruments be
signed by a maker or drawer. Thus, one might initially argue that a
promise or order that had been completed, except for the signature
of a drawer or maker, still qualified as an instrument. As noted
previously (see above 20.02[1]) the requirements that an instrument
be written and signed are contained in the definitions of Order and
Promise. Nevertheless, Article 3 retains the rule that no one is
obligated on an instrument unless he or she signed it, or a
representative signed it in a manner that binds the principal.34 As
a result, even if a writing that contained a signature did
constitute an instrument, no party could have a maker or drawers
liability. Presumably, however, if some party subsequently signed
the instrument as an indorser, that party would have an indorsers
liability to subsequent transferees.
A signature may be made either manually or by means of a device
or machine, such as a check writing machine that imprints the maker
or drawers name. The drawer or maker may use any name,35 including
a trade or assumed name, or a word, mark, or symbol executed or
adopted by a person. The key requirementis that whatever name is
used and however the signature is affixed to the instrument, the
signer have a present intention to authenticate the writing.36
Thus, a signature may be typed, even if the rest of the
instrument is hand written; or the signature may take the form of a
symbol rather than the signers proper name. Virtually any form of
printing, stamping or writing, on any part of the instrument, may
constitute a signature. Moreover, objective intent governs, and
where the issue is whether the instrument is negotiable, only the
intent evidenced by the instrument itself is relevant.37 In the
proper context, however, even a preprinted letterhead may
constitute a signature, such as where the paper that contains the
letterhead contains words of negotiability that appear to have been
written with the intent to bind the party whose name appears on the
document.38 Alternatively, a preprinted signature may render an
instrument negotiable when combined with another indicium of intent
to authenticate, as where a preprinted check is completed with an
inscription written by a check writer.39 Courts have recognized the
validity of facsimile signatures when they are authorized in
account documentation (account rules and regulations governing an
account).40
A signature need not be subscribed but may appear in the body of
the instrument.41 For example, a note may read, I, X, promise to
pay without any further signature by X. The instrument must be
viewed as a whole to determine whether the inclusion of the name
constitutes a signature. Thus, if the instrument was typewritten,
contained no signature line, but the name was handwritten, a court
might conclude that the handwriting evidenced an intention to
authenticate the writing. Such a finding would justify the courts
interpreting the document as a signed negotiable instrument. If, on
the other hand, both the text of the instrument and the purported
makers name were typewritten, and there was a signature line left
blank, the court might conclude that there was no intention to
authenticate the writing.42
While there may be a variety of signatures on an instrument, the
vital signature is that of the drawer of a draft or maker of a
note. An instrument signed only by parties other than drawers or
makers has been held not to satisfy the requirements of
negotiability.43
[3] A Negotiable Instrument Must Contain a Promise or Order to
PayWhat Constitutes a Promise or Order to Pay?
A negotiable instrument must contain a promise or order to
pay.44 An instrument that simply acknowledges an obligation or is
an authorization or request is not negotiable.45
[a] Promise to PayA promise is an undertaking to pay and must be
more than an acknowledgment of an obligation.46 In a Delaware
appellate case,47 a document provided I Robert Harrison owe Peter
Jacob $ 25,000. This document, the court held, is an acknowledgment
of a debt; although one could imply that it is a promise to pay, it
does not satisfy revised section 3-103(a)(9) that requires the
promise to be an undertaking to pay. The court further stated that
[S]uch an undertaking to pay does not exist on the face of the
documenttherefore [the UCC] does not apply. Thus, an I.O.U. would
not be a negotiable instrument.48 Similarly, a statement that I
borrowed from H. Jones the sum of five hundred dollars with four
percent interest; the borrowed money ought to be paid within four
months from the above date would not constitute a promise to pay
within the meaning of Article 3. Nevertheless, the breadth of the
definition leaves unclear the effect of such language as I agree to
pay, I am obligated to pay and I intend to pay. In an Alabama
appellate case,49 wire transfer instructions and cash withdrawal
slips were held not to be instruments (UCC 3-104(b)) because they
were not undertakings or instructions to pay money. The policy of
requiring strict compliance with the formal requisites of
negotiability would seem to dictate that in questionable cases the
courts should lean toward holding such instruments
nonnegotiable.
Further, such cases as In re Nellis50 would be rejected under
the Code. There the court held that a statement that a person had
borrowed $2,000 which is subject to and payable on demand indicated
a promise to pay. The court looked to the whole writing to discern
its true nature. Under Article 3, the result would be different
since the promise must stand on its own as an obligation to pay.
The mere implication of a promise derived from a reading of the
instrument as a whole should not be enough to confer
negotiability.
[b] Order to Pay[i] An Order Is a Direction and Must Be More
Than an Authorization or RequestAn order to pay is defined by the
Code as a written instruction to pay.51 It must be more than an
authorization or request to make payment.52 Occasionally, the
distinction between a direction to pay and an authorization or
request may not be clear. The drafters of the Code have suggested
how the niceties of language may generate disparate legal results.
The Official Comments to the prior version of Article 3 suggested
that words of courtesy appearing before the direction, such as
please pay, do not render the direction a request;53 but precatory
language such as I wish you would pay will not qualify as an
order.54 The instruction to pay may be to the person giving the
order, as is the case with a cashiers check.55
[ii] An Order Must Identify the Person to PayThe prior version
of the Code stated that the person who is ordered to pay must be
identified with reasonable certainty.56 The current version adds
rules which concern identifying the payee of an instrument, and so
modifies the prior Code requirement that the payee be identified
with reasonable certainty. Under the current version, intent of the
issuer57 controls as to the identity of the payee.58
Where the payee designation is one of a common name, such as
John Smith, the drawers intention as to which John Smith is the
payee will determine the person to whom the check is payable.59
This rule also applies where there is an inaccurate description60
or a fictitious payee.61 In the case of a forgery of the drawers
signature, the intent of the person making the unauthorized
signature, not the purported drawer, controls since the person
making the forged signature is the drawer and the person whose
signature is forged is not liable on the instrument.62 Where a
signature is made by automated means such as a check-writing
machine or computer, the payee is determined by the intent of the
person who supplied the name or identification of the payee,
whether or not authorized to do so.63 The person whose intent
controls will usually be an employee of the drawer but may be a
stranger committing a fraud through improper use of the automated
system.64
Editors Note:These principles are also discussed below; see
20.02[8]b][i].
An order may be addressed to two or more persons jointly or in
the alternative.65 This recognizes the corporate practice of
providing for a number of drawees across the country when issuing
dividend checks.66 Drawees in succession are not permitted,
however, because that would require a holder of the instrument to
make presentment to each drawee before having recourse against the
drawer and indorsers.67
[c] Instruments Payable at a BankIn one instance, the Code
provides that an instrument which promises the payment of money may
operate as an order instrument. Under Alternative A of Section
4-106, a note or acceptance payable at a bank that is identified in
the item is treated as the equivalent of a draft (order instrument)
drawn on the bank. Thus, the bank must make payment out of the
account of the maker or acceptor when the instrument falls due and
the Article 4 timing deadlines apply.68 In those states that have
adopted Alternative B of Section 4-106, the fact than an instrument
is made payable at a bank operates only to designate the bank as a
collecting bank and requires the bank to present the item for
payment. The banks only function is to notify the maker or acceptor
that the instrument has been presented and to ask for
instructions.69
[4] The Promise or Order to Pay Must Be Unconditional
[a] In GeneralIn order for an instrument to be negotiable, the
promise or order to pay must be unconditional.70 A negotiable
instrument is designed to circulate in a manner that permits the
holder to determine all the terms of payment from the face of the
writing. It is this feature that has provided the analogy that
instruments are like a courier without luggage. The assumption is
that avoiding the need to examine obligations and terms outside the
writing will facilitate commercial use of the instrument.71 For
this reason, the conditional or unconditional character of a
promise or order must be determined by what is expressed in the
instrument.72 Thus, a mere allegation that a promise or order was
intended to be conditional will not be permitted to change the
obligors legally unconditional promise to pay.73 Nor will a
memorandum on the instrument, intended to facilitate the drawers
own purposes, constitute a condition that destroys
negotiability.74
To some extent, all instruments are subject to conditional
promises. For instance, payment is to be made only when the
maturity date arrives, and only upon production and surrender of
the instrument properly indorsed. Unconditional, as used in Section
3-104, has a more narrow meaning. Unconditional is intended to
exclude instruments not commercially acceptable because they do not
state an absolute obligation, but an obligation contingent upon the
occurrence of an event foreign to the instrument and the law
applicable to it. Negotiable instruments law attempts to permit
ready determination of cases that fall within and without this
category. Section 3-106 purports to simplify the test of
unconditionality by omitting many of the specific tests included in
the priorversion of Article 3. Instead, that provision presumes
that a promise or order is unconditional unless it states (i) an
express condition to payment, (ii) that the promise or order is
subject to or governed by another writing, or (iii) that rights or
obligations of the maker or drawer are stated in another writing.
The intent is to ensure that a transferee of the writing is able to
determine the conditions of payment from the instrument itself.
Mere reference to another writing alone will not render the promise
or order unconditional.75
[b] Implied and Constructive Conditions Do Not Destroy
NegotiabilityThe Official Comment to Section 3-106 indicates that
the omission of specific examples of implied conditions contained
in Section Pre-Revision 3-105(1) is not intended to change the
law.76 Rather, the intent is to continue the understanding that the
presumption of unconditionality is not rebutted by an implied
condition.77 A condition may be defined as operative fact, one on
which the existence of some particular legal relation depends.78 An
implied condition is a condition which is supplied by the court in
order to give effect to the presumed intent of the parties.79 A
constructive condition, on the other hand, operates by reason of
law apart from any expressed or implied intention of the parties.80
Thus, a recital on an instrument that it was given in return for an
executory promise could give rise to an implied condition that the
instrument is not to be paid if the promise is not performed.81 The
presumption of Section 3-106 ensures that such a condition does not
impair the negotiability of the instrument.82
A bankruptcy court83 addressed the issue of whether a note was
conditional. The notes provided that The entire unpaid principal
balance shall be due and payable in full upon completion of the
project being financed by the funds secured by this note; or at any
time either evidenced in writing by both parties, or within three
(3) years of the execution of this note. The court found that the
notes were unconditional promises to pay. The court reasoned that
while completion of the project is a conditional event, and is
beyond the control of the holder, the amount due is not contingent
upon only that event. There is another event; if the project is
never completed, the amount of the notes are still due at any time
either evidenced in writing or within three years of the execution
of this note. This latter language makes the notes unconditional on
their face. In other words, there are two independent events that
trigger payment: the notes are due within three years regardless of
whether or not the project is completed, the statement that the
notes are due upon completion of the project only provides one
possible time when the balance may be demanded.
An example of an express condition to payment (conditional
language) that will render a note non-negotiable can be found in a
federal district case.84 The note, in which CDL is the maker,
stated that The 10/1/08 payment will be made unless there are
business or regulatory changesincluding code editswhich causes CDL
to become insolvent. The court denominated this provision as the
conditional clause.
The words upon acceptance on a draft generally do not indicate a
conditional promise to pay because it is only a restatement of an
implied or constructive condition of any draft which must be
accepted to charge the drawee.85 In certain cases, the words upon
acceptance may refer to an agreement by the payee to specific
conditions precedent rather than to the liability of the drawee.
Even in these cases, however, if the term is merely intended to
indicate that the payee accepts the instrument in full satisfaction
of the underlying obligation, the negotiability of the instrument
is not impaired.86
[c] Statement of Consideration or Reference to Underlying
Transaction or Agreement Does Not Destroy NegotiabilityA statement
of the consideration for which the instrument was given will not
destroy the negotiability of an instrument.87 It does not matter
whether the consideration stated has been performed or is merely
promised.88 The negotiability of an instrument is also not affected
by the omission of the statement of any consideration.89
A negotiable instrument may refer to the transaction that gave
rise to the issuance of the instrument.90 Similarly, it may refer
to another writing for a statement of rights with respect to issues
governing collateral, prepayment, or accelerated payment.91 If the
reference provides that either the promise or order or rights or
obligations with respect to the promise or order are subject to
that other writing, however, payment is conditional and the
instrument is nonnegotiable.92 So, too, negotiability will be
destroyed if the separate agreement provides terms for or governs
the fulfillment of the promise or order in the negotiable
instrument.93
An instructive case explaining these principles is Jackson v.
Luellen Farms, Inc.94 The court acknowledged the rule that a note
that is secured by a security interest in collateral (a mortgage)
is negotiable where the note states that rights and obligations
with respect to the collateral are either stated in or governed by
the security agreement; a reference to the security does not strip
the note of its negotiability. Such a note is non-negotiable,
however, where, as in this case, the note provides that all
agreements and covenants in the mortgage securing the note apply to
the note. The court explained, There is a significant difference in
a note stating that it is secured by a mortgage from one which
provides, the terms of said mortgage are by this reference made a
part hereof.A reference in a note to an extrinsic agreement does
not destroy negotiability unless the reference actually makes the
note subject to the terms of that agreement. (citations
omitted)
Some instruments, such as travelers checks, may require, as a
condition to payment, the countersignature of a person whose
signature already appears on the instrument. Such a requirement,
however, does not destroy the negotiability of a writing that
otherwise satisfies the requirements of Section 3-104. In addition,
certain statements that may govern the transaction between the
original parties to the instrument do not affect its negotiability.
For instance, an undertaking to give, maintain, or protect
collateral will not destroy negotiability.95 Similarly, an
authorization to the holder to confess judgment or realize on or
dispose of collateral will not destroy the unconditional nature of
the instrument.96 Finally, an instrument may remain unconditional
even though it contains a waiver of the benefit of any law intended
to protect an obligor.97
Although the rules of conditionality purport to clarify when an
instrument is negotiable, some ambiguities remain. Assume, for
instance, that Jones signs a note that reads, I, Jones, promise to
pay to the order of Smith, $100 in accordance with the contract we
have executed this date. If the in accordance clause is intended to
refer solely to the origin of the note, the promise is
unconditional and the note is negotiable. If, however, the clause
implies that the promise will only be fulfilled in accordance with
the terms of the underlying contract, then the clause states a
condition and the note is nonnegotiable. Nevertheless, there is no
easy way to determine the intent of the parties merely by looking
at the instrument.
The current version addresses instruments which contain
statements required by statute or administrative law. Such
statements typically provide that a holder or transferee is subject
to the issuers claims or defenses against the payee (see, e.g., the
Holder Rule under 16 C.F.R. 433.2(a), discussed above 20.01[6]).
Under the current version, these conditions do not render the
promise or order conditional, and it is otherwise governed by the
provisions of Article 3 except that a cannot become a holder in due
course of the instrument.98
Practical Hint:The 2002 Revision adds a definition of Record,
meaning information that is inscribed on a tangible medium or that
is stored in an electronic or other medium and is retrievable in
perceivable form.99 Adding a definition of Record was done in order
to facilitate electronic communications.100 The current version was
further amended in the 2002 Revision to substitute this defined
term, Record, for the word writing in several sections, including
Code Section 3-106. Accordingly, under the current version, Section
3-106, as amended in the 2002 Revision, a promise or order is
unconditional unless it is subject to or governed by another record
(instead of another writing) and is not made conditional by
reference to another record (instead of another writing).101
[d] Reference to Fund From Which Payment Is to Be Made Will No
Longer Destroy NegotiabilityPrior versions of Article 3 adhered to
the rule that a promise or order was not unconditional if the
instrument stated that it was to be paid only out of a particular
fund or from a particular source.102 The rationale for the
restriction was that the instrument will not move smoothly through
the stream of commerce if satisfaction of the obligation is
contingent on the existence and sufficiency of the particular fund.
Negotiability was considered to be contingent on the obligors full
credit standing behind the promise to pay. Nevertheless, the
determination of whether an instrument was, in fact, payable from a
limited fund could be difficult. The prior version of Article 3
added to the confusion by also permitting an instrument to state
that a particular account or fund was to be debited, if that
statement was merely one of expectation, not of limitation.103
Assume, for instance, a note that recites, I, Jones, promise to pay
on June 1, 1989, to the order of Smith, $100, payable from my bank
account #123-456 at First National Bank. While a holder seeking
negotiability might have argued that this language constitutes only
a statement of a particular account to be debited under Article 3,
Jones was equally likely to prevail on an argument that the
language constituted a limitation on the source of payment under
Pre-Revision Section 3-105(2)(b). Thus, the certainty assumed to
flow from the requirements of negotiability was not always borne
out in fact.
The current version of Article 3 reverses the limitation of fund
rule and leaves the desirability of taking such an instrument to
market forces. This result seems appropriate. Should a holder be
willing to accept the risk that a limited fund will be depleted
prior to payment, leaving the holder with no recourse against other
resources of the drawer or maker, there seems no good commercial
reason to interfere with that judgment. After all, the holder
presumably will have purchased the note for a price that reflects
the increased risk. Thus, currently Section 3-106(b) specifically
provides that a promise or order is not made conditional by the
fact that payment is limited to resorting to a particular fund or
source.104 This change, however, does throw some doubt on the
vitality of the traditional explanation for rigid requirements of
negotiability. If market forces are capable of pricing and either
accepting or rejecting instruments that a payable from a limited
fund, then why are they not similarly capable of pricing
instruments that are similarly risky because, for instance, they
bear express statements of conditionality of payment or that are
payable at times that are relatively indefinite?
Even prior to the change in legal doctrine, there were
additional permissible limitations on the source of payment. One
exception occurred where the instrument is limited to payment out
of a particular fund or the proceeds of a particular source, if the
instrument is issued by a government or governmental agency or
unit.105 The purpose of this provision was to permit governments
and governmental agencies to draw checks or to issue other
short-term commercial paper in which payment is limited to a
particular fund or source of revenue.106 Governments frequently pay
for capital projects by issuing debt in the form of bonds that are
payable solely from a specific revenue source, such as an electric
utility or a water system. The government unit exception to the
limited fund rule permitted such bonds to retain their
negotiability.
The third exception to the rule that a promise or order was
conditional if the instrument stated that it is to be paid only out
of a particular fund or source applied where the instrument is
li