Ma Bar Essay - Secured Transaction/commercial Paper

Front 1

What is the scope of Article 9 of the UCC?

Back 1

Article 9 applies to CONSENSUAL security interests in personalty or fixtures.

Note: When the collateral is real estate, apply the law of MORTGAGES. By contrast, when the collateral is personalty or fixtures, apply ARTICLE 9.

In general, personalty equals GOODS. Remember that Article 9 applies only to voluntary or consensual collateralizations. Thus, it does not apply to STATUTORY OR MECHANIC’S LIENS.

Front 2

Giorgio Armani borrows $2 million from Bank. He grants Bank a security interest in his business equipment. Are we within the scope of Article 9?

Back 2

YES. Why? This is A VOLUNTARY TRANSFER of a security interest in debtor’s GOODS.

Front 3

Who are the cast of characters in Article 9?

Back 3

i. debtor: ENTITY WHO OWES THE MONEY
ii. secured party/secured creditor: ENTITY WHO LENDS THE $
iii. security agreement: PARTIES’ CONTRACT OR RECORD
iv. security interest: RIGHT CREDITOR HAS IN PERSONALTY OR FIXTURES
v. collateral: PERSONALTY OR FIXTURES THAT CREDITOR CAN LOOK TO FOR SATISFACTION.

Front 4

What are the types of collateral covered in Article 9?

Back 4

TANGIBLE COLLATERAL:
a. consumer goods: those items used for personal or familial purposes, such as a home dining room set, blender, oven, refrigerator, car; or
b. equipment: items used in business, such as Macy’s cash registers, Mrs. Field’s cookie ovens, Le Cirque restaurant’s china, Dr. Dentist’s dental chair, Armani’s sewing machines; or
c. inventory: goods held for sale or lease, such as Circuit City’s stock of stereos, Nordstrom’s spring clothing line or Ethan Allen’s furniture line; or
d. farm products: crops, livestock and supplies used in farming operations, such as eggs, corn and cows in possession of a farmer.
e. fixtures: items annexed to realty, such as lighting fixtures, sprinkler systems, furnaces.

INTANGIBLE OR SEMI-INTANGIBLE COLLATERAL:
-patents, trademarks, copyrights
-stocks, bonds, mutual funds
-proceeds from sale of collateral
-accounts (i.e. right to payment for goods/services)
-promissory notes & drafts

Front 5

How does one classify tangible collateral?

Back 5

The key for purposes of classifying tangible collateral: primary use in the hands of THE DEBTOR.

GOLF CLUBS IN YOUR HANDS = CONSUMER GOODS
IN THE HANDS OF TIGER WOODS = Equipment
IN THE HANDS OF GOLF PRO STORE = INVENTORY

Front 6

What are the important intangible collaterals?

Back 6

-PATENT AND TM RIGHTS, COPYRIGHTS;
-STOCKS, BONDS, AND MUTUAL FUNDS;
-PROCEEDS RECEIVED ON SALE OF COLLATERAL ACCOUNTS;
– RIGHT TO PAYMENT FOR GOODS/SERVICES
-PROMISSORY NOTES DRAFTS

Front 7

How does one create an enforceable security interest?

Back 7

ATTACHMENT which means creating an enforceable security interest.

Front 8

How does one attach?

Back 8

The three requirements for attachment: remember “VCR”
i. VALUE must be given by creditor. For example, Bank lends $50,000 to Debtor. Bank has extended value.
ii. a CONTRACT, called the security agreement, must evidence the secured transaction unless the secured party has taken possession of the collateral.
iii. RIGHTS in the collateral: Debtor must have rights in the collateral.

Front 9

Can we substitute something for the contract? If we need a written contract, what are the requirements?

Back 9

If the secured party is in possession of the collateral, there is no need for A RECORD.

By contrast, if the debtor is in possession of the collateral, WE NEED A RECORD.

The record must:
a. BE AUTHENTICATED BY THE DEBTOR (SIGNED OR ELECTRONICALLY MARKED) and
b. REASONABLY IDENTIFY THE COLLATERAL

Front 10

Mick Jagger lends $20,000 to Keith Richards, who gives Mick a security interest in the Brooklyn Bridge. Can Mick look to the Brooklyn Bridge for satisfaction of the debt when Keith fails to pay?

Back 10

NO – DEBTOR DOES NOT HAVE RIGHTS IN THE COLLATERAL – THIS IS THE COMBINATION OF THE MICK JAGGER RULE (“CAN’T ALWAYS GET WHAT YOU NEED”) AND THE KEITH RICHARDS RULE (“I CAN’T GET NO SATISFACTION.”)

Front 11

Can I get a security interest in items that are acquired after the contract is signed?

Back 11

Yes - “after-acquired collateral clauses” are enforceable.

Front 12

Secured Party lends $500,000 to Staples Stores, taking a security interest “in all of Staples’ inventory, whether now held or hereafter acquired.” What kind of clause is this? Is it enforceable?

Back 12

This sort of clause is called: AN AFTER ACQUIRED COLLATERAL CLAUSE It is: ENFORCEABLE!

Front 13

What is perfection?

Back 13

Perfection is best understood as a PUBLICITY DEVICE.

PERFECTION = PUBLICITY It is something that the secured party does to put the world on RECORD or CONTSTRUCTIVE notice of the secured party’s existence. Proper perfection helps to protect the secured party from competing creditors.

Front 14

Diana Ross lends $300,000 to Smokey Robinson, taking a security interest in Smokey’s vintage album collection. Diana attaches (meaning that she has complied with the VCR requirements. She extended VALUE, executed a valid CONTRACT or security agreement and Smokey has RIGHTS in the album collection.). What does Diana do to protect her interest?

Back 14

To protect herself from subsequent creditors who might stake a claim to the album collection, Diana promptly and properly PERFECTS HER INTEREST.

Front 15

Diana Ross lends $300,000 to Smokey Robinson, taking a security interest in Smokey’s vintage album collection. Diana attaches (meaning that she has complied with the VCR requirements. She extended VALUE, executed a valid CONTRACT or security agreement and Smokey has RIGHTS in the album collection.). She perfects her interest. Later, suppose that Smokey, in need of quick cash, borrows $100,000 from The Temptations, granting them a security interest in the same album collection. What happens if Smokey defaults?

Back 15

If Smokey defaults, DIANA defeats THE TEMPTATIONS meaning that she has FIRST PRIORITY in the album collection.

THE CREDITOR WHO PERFECTS FIRST IS SUPREME.

Front 16

How do I perfect my interest?

Back 16

A. By the secured party’s taking possession of the collateral

B. Automatic perfection for purchase money security interests (PMSIs) in consumer goods.

C. the secured party FILES NOTICE of the security interest in the public records: Proper filing puts the world of potentially competing creditors on RECORD or CONSTRUCTIVE notice of the filer’s claim.

Front 17

Siegfried and Roy borrow $5,000 from Cher, granting Cher a security interest in their famous pig, Babe. Cher properly attaches and then takes possession of the pig until the debt is repaid. What must Cher do to perfect?

Back 17

NOTHING Cher’s taking possession equals PERFECTION. CHER = PERFECTION – “BABE, I’VE GOT YOU BABE.”

Front 18

Tell me about PMSIs?

Back 18

Automatic perfection for purchase money security interests (PMSIs) in consumer goods.

To encourage lending to consumers, PMSIs in consumer goods are perfected automatically, upon attachment.

Front 19

But, what IS a PMSI?

Back 19

It is a security interest that enables the debtor to purchase the goods.

Front 20

Ethan Allen extends $6,000 in value to enable Debtor to acquire a new bedroom set. Ethan Allen takes as collateral a security interest in the bedroom set. What does Ethan Allen have?

Back 20

It has: A PMSI
Upon attachment, PERFECTION IS AUTOMATIC

THE PMSI IS THE FAVORITE CHILD OF ARTICLE 9

Front 21

So, I want to file my notice of my security interest. What do I do?

Back 21

The security agreement could be filed, but rarely is.

Instead, the document typically filed is called a FINANCING STATEMENT (UCC-1). It is a very simple document whose only purpose is to provide interested parties with sufficient information to make FOLLOWUP INQUIRIES.

Article 9 aims to encourage ELECTRONIC FILING, and is “MEDIA NEUTRAL.”

Front 22

What are the requisite contents of a financing statement?

Back 22

Our buzzwords: SIMPLE AND SPARSE
The financing statement need only contain:
1) DEBTOR’S NAME AND ADDRESS
2) SECURED CREDITOR’S NAME AND ADDRESS and
3) A DESCRIPTION OF THE COLLATERAL

In the financing statement, super-generic descriptions of the collateral (such as “all of Debtor’s assets”) are PERMISSIBLE.

Front 23

Where is the financing statement filed?

Back 23

Filing is done centrally, with the state Secretary of State, in the state where DEBTOR IS LOCATED
- If debtor is an individual, he or she is located: IN HER STATE OF PRINCIPLE RESIDENCE.
- If debtor is a registered organization (i.e., a corporation, a limited liability company or a limited partnership), it is located: UNDER WHOSE LAWS IT IS ORGANIZED.
- The exception to central filing: If the collateral is TIMBER, MINERALS or FIXTURES, file LOCALLY, in the county where THE UNDERLYING REALTY IS LOCATED.

Front 24

What’s the most important part of secured transactions?

Back 24

Priority – if there are more than one secured party, who gets to take first? The basic concept: Priority is the purpose of collateralization, and the secured party seeks to SUBORDINATE, not to SHARE. This is a piggish norm. Each claimant is entitled to satisfaction IN FULL before a subordinated claimant is entitled to take.

Front 25

Who are the cast of characters of priority?

Back 25

AUPie – Attached Unperfected Creditor
LC – Lien Creditor
PAC – Perfected Attached Creditor
NOCie – Non-Ordinary Course Buyer
BIOC – Buyer in Ordinary Course
GUC – General Unsecured Creditor

Front 26

What’s an AUPie, Attached Unperfected Creditor?

Back 26

AUPie (Attached Unperfected Creditor): This is the Article 9 creditor who creates an enforceable security interest, i.e., it attaches, but either never bothers to perfect or tries to perfect but botches the effort, perhaps by filing in the wrong place.

Front 27

What is a lien creditor?

Back 27

LC (lien creditor): This is the general unsecured creditor who goes to court to get a judicial lien on the collateral.

Front 28

What is a perfected attached creditor (PAC)?

Back 28

PAC (Perfected Attached Creditor): This is the Article 9 creditor who succeeds in attaining perfection.

Front 29

What is a non-ordinary course buyer?

Back 29

NOCie (Non-Ordinary Course Buyer): This is someone who purchases the collateral outside the ordinary stream of commerce. For example, Steven Tyler buys a guitar from his auto mechanic.

Front 30

What is a buyer in ordinary course (BIOC)?

Back 30

BIOC (Buyer in Ordinary Course): This is someone who purchases the collateral from a merchant’s inventory. For example, Steven Tyler buys a guitar from Sam Ash Guitar Store.

Front 31

What is a general unsecured creditor?

Back 31

GUC (General Unsecured Creditor): This is the lender who never bothered to take collateral. For example, Jared lends the Subway Sandwich Co. $50,000, and, believing it to be a good credit risk, takes no collateral to back up his extension of value. – SUPREME LOSER IN ANY ARTICLE 9 SITUATION

JARED LOANS $50K TO SUBWAY WITH NO SECURITY INTEREST – SUPREME LOSER

Front 32

In a nutshell, how do the characters rank?

Back 32

Rank:
1. BIOC [buyer in ordinary course]
2. PAC [perfected attached creditor]
3. LC [lien creditor]
4. NOCie [non-ordinary course buyer]
5. AUPie [attached unperfected creditor]
6. GUC [general unsecured creditor]

Front 33

Who wins between AUPie vs. the World?

Back 33

AUPie’s interest is enforceable as against THE DEBTOR , and AUPie will defeat any subsequent AUPie as well as any GUC.

AUPie will lose to PAC, to LC, and to ANY BUYER without knowledge of the security interest.

Front 34

What about PAC v. the World?

Back 34

PAC defeats all, except:
i. the PAC who filed first;
ii. certain PMSI-holders;
iii. the BIOC.

Front 35

What happens when there are two PACs, who wins?

Back 35

The PAC who filed first: PAC vs. PAC: The Rule: FIRST IN TIME, FIRST IN RIGHT

Front 36

Calista Flockhart extends $10,000 in value to Robert Downey, Jr., taking a security interest in Robert’s Rolex watch. Calista perfects properly on Jan. 10, 2003. Later, Barry White extends $5,000 in value to Robert, taking a security interest in the same watch. Barry perfects properly on Feb. 1, 2003. Who has first priority in the watch?

Back 36

Calista – she filed first. RULE: First in time, first in right. Note that for purposes of determining priority, Article 9 gives special effect to filing. It allows for early filing, even at the onset of loan negotiations. If an early filer subsequently attaches, she is allowed the benefit of her early filing. Priority will relate back to the early filing date.

Front 37

Suppose now that on Jan. 1, Calista begins negotiating with Robert about lending him $10,000. On Jan. 1, Calista files a financing statement covering Robert’s Rolex. The negotiations continue. Later, Barry lends Robert $10,000, and on Feb. 1, Barry perfects a security interest in the Rolex. On March 1, Calista and Robert finally reach an agreement and Calista lends him the $10,000 and Robert signs an appropriate security agreement granting Calista a security interest in the Rolex. Who has first priority in the watch?

Back 37

CALISTA Why? SHE FILED FIRST, AS SHE’S ALLOWED TO DO, AND SHE SUBSEQUENTLY ATTACHED. NOW, HAVING ATTACHED, HER ATTACHMENT IS RELATED BACK TO THE EARLIER FILING DATE.

Front 38

What about when a PAC v. PMSI? First question, when does this arise? Who is an AACF?

Back 38

Here, the relevant priority contest is between the after-acquired collateral financier (AACF) and the holder of a purchase-money security interest (PMSI).

First, who is an AACF? A secured creditor who takes as collateral a security interest “in all of Debtor’s [business equipment, for example, or inventory, for example], whether now held or hereafter acquired.”

When you’ve got an after-acquired collateral clause, you’ve got an AACF.

Front 39

What about when a PAC v. PMSI? Okay, so we know about the AACF, what’s a PMSI again?

Back 39

Second, what is a PMSI? A security interest that enables the debtor to purchase the goods. In other words, it is an extension of value by a lender who takes as collateral a security interest in the very item that its loan enables the debtor to acquire.

Front 40

Debtor purchases a $4,000 stereo system on credit from The Wiz, granting The Wiz a security interest in the stereo system. What interest does the Wiz have in the stereo?

Back 40

The Wiz has a PMSI.

Front 41

Debtor borrows $4,000 from Bank to purchase a stereo system, granting Bank a security interest in the stereo system. What interest does Bank have in the stereo?

Back 41

Bank has PMSI.

Front 42

What about when a PAC v. PMSI? How does an AACF collide with the PMSI?

Back 42

a. The AACF v. the PMSI-holder when the collateral is equipment b. The AACF v. the PMSI-holder when the collateral is inventory

Front 43

On March 1, Macy’s borrows $2 million from Bank, granting Bank a security interest “in all of Macy’s business equipment, whether now held or hereafter acquired.” Bank properly perfects its interest. Bank is what? Later, on August 1, Macy’s buys 10 new cash registers on credit from Office Depot, granting Office Depot a security interest in the new cash registers. Office Depot is what? The collateral is classified as what? How can Office Depot achieve first priority in the 10 new cash registers?

Back 43

Bank is an AAFC
Office Depot is a PMSI holder
The collateral is classified as equipment
All that Office Depot must do is FILE PROPERLY within 20 DAYS after Macy’s takes possession of the cash registers.

Front 44

On Oct. 1, Macy’s borrows $2 million from Bank, granting Bank a security interest “in all of Macy’s inventory, whether now held or hereafter acquired.” Bank properly perfects its interest. Bank is what? Later, on Jan. 1, Macy’s acquires Armani’s spring line of clothing on credit, granting Armani a security interest in the line. Armani is what? The collateral is classified as what? How can Armani achieve first priority in the Armani spring line?

Back 44

Bank is AAFC PAC. Armani is PMSI HOLDER. The collateral is classified as INVENTORY.
Armani must do two things:
1. Armani must FILE PROPERLY before debtor Macy’s takes possession AND
2. Armani must NOTIFY BANK before debtor Macy’s takes possession.

Front 45

Why do we require these steps when we’re talking about inventory?

Back 45

The reason for these additional safeguards when the collateral is inventory: TO PREVENT DEBTOR FROM COMMITTING FRAUD (insofar as debtor might otherwise entice the AACF into extending additional value to it on the basis of the new acquisition of inventory, failing to mention that the new inventory is already encumbered on behalf of the PMSI lender).

Front 46

What about PAC vs. BIOC?

Back 46

General rule: PAC loses to BIOC. A buyer in the ordinary course of business takes free of a perfected security interest in seller’s inventory.

Front 47

Bank has a perfected security interest in Nordstrom’s inventory. When Mrs. Jones buys a suit or handbag from Nordstrom’s, what happens?

Back 47

Mrs. Jones can rest assured that she has good title to the merchandise. The reasons for this rule: TO PROMOTE COMMERCE AND CONSUMERISM AND TO HONOR BUYER’S REASONABLE EXPECTATIONS.

Front 48

What is default?

Back 48

Default: DEBTOR IS IN BREACH, TYPICALLY FOR FAILURE TO PAY (LOOK TO SECURITY AGREEMENT)

Front 49

Once debtor has defaulted what does Article 9 say a creditor can do?

Back 49

A. Self-help repossession
B. Repossession by judicial action
C. Strict Foreclosure
D. Sale
E. Action for deficiency judgment

Front 50

What is self-help repossession, when is it permissible?

Back 50

Self-help repossession is permissible, so long as CREDITOR DOES NOT BREACH THE PEACE.
A breach of the peace occurs when the secured party’s actions are LIKELY TO CAUSE VIOLENCE.

* Thus, the relevant question is not whether or not an actual fight broke out, but whether the secured party did something provocative or likely to cause violence.

* A repossession made over any protest by the debtor, however mild the protest, constitutes a breach of the peace. For that matter, if the repossessor misuses the color of law, by for example impersonating a law enforcement officer, he or she has used CONSTRUCTIVE FORCE and therefore has breached the peace.

Front 51

What are the penalties for a creditor’s misconduct?

Back 51

Civil and criminal penalties attach to creditor’s misconduct.

Front 52

What special rules about collateral in a debtor’s home? What about outside the home?

Back 52

Repossession when the collateral is in debtor’s home: THE HOME ENJOYS A ZONE OF PRIVACY. SP may not enter debtor’s home without VOLUNTARY AND CONTEMPORANEOUS CONSENT.

Repossession when the collateral is outside the home: MORE LEEWAY SP may take the collateral so long as there is no DEBTOR OBJECTION.

Front 53

What if I don’t want to chance self-help repossession, what can I do?

Back 53

If the secured party chooses not to resort to self-help repossession, he or she may MAY GO TO COURT TO OBTAIN COURT TO OBTAIN A JUDICIAL WRIT, ordering the sheriff to obtain possession of the collateral and deliver it to the secured party.

Front 54

What is strict foreclosure?

Back 54

Strict foreclosure occurs when the secured party retains the collateral IN FULL SATISFACTION OF THE OUTSTANDING DEBT. In other words, the creditor lawfully retains the collateral and the debt in turn is canceled.

Front 55

Janet Jackson borrows $50,000 from Bank, granting Bank a security interest in Janet’s yacht. Thereafter, she defaults, still owing Bank $44,000. Bank lawfully repossesses the yacht and properly accomplishes strict foreclosure. What does this mean?

Back 55

Bank RETAINS the yacht and the debt is DISCHARGED.

Front 56

How do I strictly foreclose?

Back 56

How to strictly foreclose: To accomplish strict foreclosure, the secured party must send a written proposal to retain the collateral in satisfaction of the debt.

Front 57

To whom is the written proposal for strict foreclosure sent?

Back 57

a. When the collateral is consumer goods, the notice is sent to THE DEBTOR AND ANY SECONDARY OBLIGORS. A secondary obligor is A GUARANTOR OF THE UNDERLYING DEBT.

b. When the collateral is not consumer goods, the notice is sent to THE DEBTOR and OTHER SECURED PARTIES who have told the foreclosing creditor of their security interest in the collateral, as well as PERFECTED SECURED PARTIES, AND SECONDARY OBLIGORS.

Front 58

Donny is the debtor. Marie promises that if Donny cannot pay, she will pay. What is Marie?

Back 58

Marie is THE SECONDARY OBLIGOR.

Front 59

What happens if any of the notified parties objects? When can they object?

Back 59

If any of the notified parties objects within 20 days after the notice is sent, strict foreclosure will not be allowed. Instead, the collateral must be disposed of by sale.

******* RULE – DON’T HAVE TO OBJECT FOR CAUSE, CAN OBJECT FOR ANY OLD REASON

Front 60

**What special rules apply if we’re talking about a consumer good?

Back 60

Consumer goods and the 60% rule: If the collateral is consumer goods and the debtor has paid 60% of the loan in the event of a non-PMSI or 60% of the cash price in the event of a PMSI, strict foreclosure is not allowed. Instead, the secured party must sell the collateral within 90 days or be liable in conversion.

Front 61

Prince purchases a $30,000 little red Corvette on credit from Chevrolet. Chevrolet takes a security interest in the car. Chevrolet has A PMSI IN A CONSUMER GOOD After repaying $18,000, Prince defaults. May Chevrolet strictly foreclose?

Back 61

NO, BECAUSE PRINCE HAS ALREADY REPAID 60% OF THE CASH PRICE. WHY IS THIS JUST? BECAUSE WE DON’T WANT TO AWARD CREDITORS A WINDFALL – ALL THE PRINCIPAL AND ALSO THE COLLATERAL ITSELF.

Front 62

Can the secured party sell the collateral?

Back 62

The secured party may sell the collateral and apply the sale proceeds to the debt. The secured party chooses whether the sale will be public (i.e., a public auction) or private.

Front 63

What are the general rules for selling the collateral?

Back 63

Two governing guideposts:
i. Every aspect of the sale must be: COMMERCIALLY REASONABLE.
ii. Prior to the sale, reasonable notice must be sent.

Front 64

How do we know if notice is reasonable? Is there a shortcut?

Back 64

Notice must be commercially reasonable.

Article 9 provides standard notice forms which, if used, are presumptively COMMERCIALLY REASONABLE.

Front 65

Who do I have to send notice to?

Back 65

a. if the collateral is consumer goods, notice must be sent to DEBTOR AND ANY SECONDARY OBLIGORS.
b. with all other types of collateral, notice must be sent to DEBTOR and those secured parties who have advised the foreclosing creditor of their security interest, as well as PERFECTED SECURED PARTIES AND SECONDARY OBLIGORS.

Front 66

What must the notice contain?

Back 66

The content of the notice depends on the type of sale. If disposition is by public sale, the notice must state THE TIME AND PLACE OF SALE. If disposition is by private sale, the notice must state the time after which the sale will be made. For example, “Please be advised that after Feb. 1, 2003, Secured Party will sell the following collateral . . . .”

Front 67

Are there any special notice rules for consumer goods?

Back 67

d. For consumer goods, additional consumer-protective provisions are mandatory, including HOW ANY DEFICIENCY WILL BE CALCULATED and HOW DEBTOR CAN REDEEM THE COLLATERAL

Front 68

How much advance notice is required?

Back 68

There is no bright line. The standard is one of COMMERCIAL REASONABLENESS. However, in a nonconsumer transaction, notice is deemed sent within a reasonable time if it is sent 10 DAYS OR MORE before the time of sale.

Front 69

May the secured party buy at sale?

Back 69

At a public sale, YES
At a private sale, absent external market checks, NO.

Why not? TOO MUCH POTENTIAL FOR UNREGULATED SELF-DEALING.

Front 70

What if I don’t get as much from the sale of the item as the loan was for, can I get the remainder?

Back 70

Yes – this is a deficiency judgment

Front 71

Suppose that the outstanding debt is $100,000, and that the sale of the collateral nets only $60,000 for the secured party. What can the secured party do?

Back 71

Seek a deficiency judgment against the debtor.

Note: If a secured party sells collateral at a low price to an insider buyer, the price that AN INDEPENDENT 3D PARTY WOULD HAVE PAID, rather than the actual amount paid, is the price that will be used in calculating the deficiency. TO AVOID FRAUD/COLLUSION

Front 72

Can the Debtor get his property back?

Back 72

Possibly – the debtor has a limited right of redemption
i. The debtor’s right to redeem the collateral is cut off once the secured party has RESOLD THE COLLATERAL or completed a STRICT FORECLOSURE.
ii. To redeem, the debtor must pay the amount owed plus: ACCRUED INTEREST AND SECURED PARTY’S REASONABLE EXPENSES INCLUDING ATTORNEY’S FEES.
iii. If the security agreement contains an acceleration clause (which permits the creditor to declare the full balance due in the event of default), to redeem the debtor must: PAY OFF ENTIRE UNPAID BALANCE & ACCRUED INTEREST + SECURED PARTIES REASONABLE EXPENSES INCLUDING ATTORNEY’S FEES.

Front 73

**What is the effect when a negotiable instrument is duly negotiated to a holder in due course?

Back 73

Holder in due course takes the instrument free of all claims to it, free of personal defenses, and subject only to real defenses.

BRIGHT LINE RULE

Front 74

What questions do we ask in commercial paper?

Back 74

I. When is the given writing a negotiable instrument as opposed to a mere contract? (NEGOTIABLE INSTRUMENT = ARTICLE 3; IF CONTRACT, CONTRACT LAW) II. In a commercial paper fact pattern, on what theories might the defendant get sued? A. Contract or Signature Liability B. Warranty or Transfer Liability III. How is a negotiable instrument duly negotiated, meaning, what makes the transfer proper? IV. How does a transferee qualify as a holder in due course (HDC)? V. What are claims and personal defenses (which the HDC takes free of) and what are real defenses (which the HDC is subject to)?

Front 75

What are the types of negotiable instrument?

Back 75

I. TYPES OF NEGOTIABLE INSTRUMENTS: A. THE PROMISSORY NOTE B. THE DRAFT WE ARE DEALING WITH WRITINGS CALLING FOR THE PAYMENT OF MONEY

Front 76

What does a promissory note look like?

Back 76

I promise to pay to the order of Britney Spears FIFTY THOUSAND DOLLARS. /s/Justin Timberlake

Front 77

What distinguishes a promissory note? Who are the parties to a promissory note?

Back 77

Think of the promissory note as: THE PROMISE MAKER.
It contains: AN AFFIRMATIVE PROMISE TO PAY and not just a mere IOU.

Two parties: The promisor is called THE MAKER. The promisee is called the PAYEE.

Front 78

What distinguishes a draft? Who are the parties to a draft?

Back 78

Think of the draft as: THE COMMANDER.
It contains: AN ORDER OR COMMAND.

Thus, a check is a DRAFT because it contains A COMMAND OR ORDER.

Three parties: The drawer gives THE ORDER. The drawee is ordered to do THE PAYING (THE BANK). The payee is the beneficiary of THE ORDER (THE ENTITY WHO COLLECTS.)

Front 79

Who else might be a party to the draft or promissory note?

Back 79

The Indorser: Appears in the context of promissory notes and checks. The indorser SIGNS ON THE BACK.

Front 80

How to tell whether the writing is a negotiable instrument (i.e., a promissory note or draft) or just a contract?

Back 80

To qualify as a negotiable instrument, we need:
i) a writing;
ii) payable to order or to bearer;
iii) signed by the maker or drawer;
iv) reciting a sum certain;
v) containing an unconditional promise or order, and no additional promises or orders;
vi) payable on demand or at a definite time; and
vii) payable in currency.

Front 81

Do you have a mnemonic to remember what elements are required for a negotiable instrument?

Back 81

[WOSSUPP]

W: WRITING
O: ORDER (PAYABLE TO)
S: SIGNED BY MAKER OR DRAWER
S: SUM CERTAIN
U: UNCONDITIONAL
P: PAYABLE ON DEMAND OR AT DEFINITE TIME
P: PAYABLE IN CURRENCY

Front 82

Who has to sign the different instruments? What qualifies as a signature?

Back 82

The instrument must be signed by the maker if it is a PROMISSORY NOTE or by the drawer if it is a DRAFT.

Any authentication, found anywhere on the instrument, qualifies. For example, the authentication could be initials, some defining mark, or a nickname, found in the margins or anywhere else on the paper. This is not a formal standard.

Front 83

What about the language of the instrument? What does it have to contain?

Back 83

The instrument must contain an UNCONDITIONAL promise to qualify as a PROMISSORY NOTE or unconditional order to qualify as a DRAFT.

By contrast, “conditional” = A CONTRACT.

Front 84

What are some ways that an instrument can be conditional?

Back 84

a. The express condition = A CONTRACT.
b. “Governed by” or “subject to” = A CONTRACT.

If the instrument endeavors to be “governed by” or “subject to” the terms of some other agreement or states that rights or obligations with respect to the promise or order are contained in another writing, it is NON-NEGOTIABLE.
The rationale is that the holder of a negotiable instrument should not be required to examine another document to determine rights with respect to payment.
c. Compare reference to another document – not necessarily conditional (e.g. this note is secured by a security interest in collateral described in a separate security agreement)
d. Also not deemed conditional if it limits method of payment (i.e. still negotiable, e.g. “I promise to pay from the funds I realize from my next wheat crop”)

Front 85

What if the instrument refers to another document? Does that make it conditional?

Back 85

Merely referring to another writing does not of itself make the promise or order conditional.

Further, a promise or order is not CONDITIONAL simply because it refers to another writing for a statement of rights with respect to collateral, prepayment or acceleration.

Front 86

The writing recites “I promise to pay if the Mets win the World Series.” Is this instrument negotiable?

Back 86

The writing is A CONTRACT AND NOT A NEGOTIOTIABLE regardless of whether the Mets win.

Front 87

“This note is secured by a security interest in collateral described in a security agreement dated April 1, 2003, between payee and maker. Rights and duties with respect to the collateral are stated in the security agreement”. Is this negotiable?

Back 87

NEGOTIABLE. Merely referring to another writing does not of itself make the promise or order conditional. Further, a promise or order is not CONDITIONAL simply because it refers to another writing for a statement of rights with respect to collateral, prepayment or acceleration.

Front 88

What about if the instrument limits payments to a particular source or fund?

Back 88

NEGOTIABLE. The instrument will NOT be deemed conditional merely because it limits payment to a particular source or fund.

Front 89

“I promise to pay from the funds I realize from my next wheat crop.” Is this negotiable?

Back 89

This is: NEGOTIABLE.

Front 90

What about the sum? What’s required about the sum on the instrument?

Back 90

To be negotiable, the instrument must state a sum certain or fixed amount, meaning a specifically ascertainable sum.

In other words, you must be able to calculate how much is to be paid, either from WHAT WRITING SAYS or FROM REFERENCE TO AN OUTSIDE SOURCE.

Front 91

“$75,000 principal amount plus interest from date at 10%.” Is this negotiable?

Back 91

This is NEGOTIABLE because you can calculate the amount from the face of the note.

Front 92

“$75,000 principal amount plus interest.” Is this negotiable?

Back 92

This is NEGOTIABLE because when the instrument states that it is payable with interest, but does not state how much interest, the judgment rate (the rate on a court judgment), which is set by state statute and therefore fixed, will be applied.

Front 93

Does the amount of interest on the instrument need to be fixed, since you said we needed a sum certain?

Back 93

While the amount of principal due under the instrument must be fixed, it is not necessary that the amount of interest be fixed. Thus, a variable interest rate or indexed interest rate is PERMISSIBLE.

The interest rate need not be determinable from the face of the instrument; calculation of the interest rate may require reference to information not contained in the instrument.

Front 94

$75,000 principal amount plus interest at 3% above the prime rate, adjusted every six months based on then prevailing bank rates in New York City. Is this negotiable?

Back 94

Yes. While the amount of principal due under the instrument must be fixed, it is not necessary that the amount of interest be fixed.

Thus, a variable interest rate or indexed interest rate is PERMISSIBLE. The interest rate need not be determinable from the face of the instrument; calculation of the interest rate may require reference to information not contained in the instrument.

Front 95

Can I have my note payable in monopoly money? Rolexes?

Back 95

No. To be negotiable, the sum certain must be payable in currency. Currency means MONEY. Money includes FOREIGN CURRENCY. Money does NOT mean GOODS.

Front 96

If the writing recites: “I promise to pay by remitting my business equipment,” or “an ounce of gold” or “ten shirts,” or “$5,000 or a Rolex watch.” Is this negotiable?

Back 96

No. It is NON-NEGOTIABLE. The sum certain must be payable in currency alone.

Front 97

Can I give something in addition to the currency?

Back 97

No. To be negotiable, the writing must not contain any additional promises or orders. Remember, two’s a crowd.

Front 98

If the writing recites “I promise to pay $5,000 and give you my vintage Beatles album collection.” Is this negotiable?

Back 98

No. It is NON-NEGOTIABLE. To be negotiable, the writing must not contain any additional promises or orders.

Front 99

What about timing? What requirements are there here?

Back 99

To be negotiable, the instrument must be payable on demand or at a definite time.

Front 100

What does it mean if an instrument is “on demand?”

Back 100

An instrument is payable on demand when it specifically states that it is payable “ON DEMAND” or “AT SIGHT” or “ON PRESENTATION.” If the instrument is silent as to the time of payment, it is still NEGOTIABLE, and payable on demand.

Front 101

What does it mean if an instrument is payable at a definite time?

Back 101

An instrument is payable at a definite time if, by its terms, it is payable ON OR BEFORE A STATED DATE or AT A FIXED PERIOD AFTER A STATED DATE.

Front 102

“On or before Feb. 1, 2003” “90 days after Feb. 1, 2003” “On Feb. 1, 2003, but this becomes immediately due and payable if prior to that time the Giants win the Super Bowl.” Are these negotiable? What about: “Payable when my first grandchild is born”

Back 102

The first three are negotiable. Note that Acceleration clauses are permissible, and do not destroy negotiability. By contrast: “Payable when my first grandchild is born” NON-NEGOTIABLE, because this future event is not linked to a date certain.

Front 103

Who does an instrument have to be payable to in order to be negotiable?

Back 103

To be negotiable, the writing must be payable to order or to bearer.

Front 104

How does one make a payable to order note or draft negotiable?

Back 104

Payable to Order: To be negotiable, the note or draft must use the word “ORDER” or the word “ASSIGNS” in connection with the payee’s name.

Front 105

“Pay to the order of Andy Garcia.” “Pay to the assigns of Andy Garcia.” “Pay to Andy Garcia or his order.” Are these proper?

Back 105

Yes – these are all payable to the order of Andy Garcia.

Front 106

What does it mean to be payable to bearer?

Back 106

Payable to Bearer: If the instrument is not payable to order, then to be negotiable it must be payable to bearer, meaning that it is payable to anyone who has it.

Front 107

“Pay to bearer.” “Pay to the order of bearer.” “Pay to Andy Garcia or bearer.” “Pay to cash.” “Pay to the order of cash.” Are these proper?

Back 107

These are all payable to bearer instruments.

Front 108

“Pay to Andy Garcia” Is this proper?

Back 108

No! It is NOT NEGOTIABLE. Instead, it is just a CONTRACT. Why? IT DOES NOT CONTAIN THE WORD ORDER, ASSIGNS OR BEARER. BY STATUTE FOR CHECKS ONLY – NOT NECESSARY TO USE THE MAGIC WORDS.

Front 109

IN A COMMERCIAL PAPER HYPOTHETICAL, HOW DOES THE DEFENDANT GET SUED?

Back 109

THE TWO THEORIES:
A. CONTRACT OR SIGNATURE LIABILITY
B. WARRANTY OR TRANSFER LIABILITY

Front 110

What is the basic concept behind contract or signature liability?

Back 110

Here, our defendant signed the negotiable instrument. Remember: When you sign it, you promise to pay it, and that’s how you get sued.

Front 111

Who signed the instrument? Can the maker of a promissory note be sued?

Back 111

The maker, merely by signing his name to the instrument, enters into a CONTRACT, whereby he agrees to pay the instrument. If he fails to pay, HE CAN BE SUED.

Front 112

Who signed the instrument? Can the indorser be sued?

Back 112

The indorser: an indorser signs his name ON THE BACK OF THE INSTRUMENT. He is considered secondarily liable for the instrument - after the drawee or maker.

Front 113

Emeril uses his Food Channel paycheck to purchase a meal at Manhattan’s “21 Club” restaurant. The restaurant requires Emeril’s indorsement on the back of the check. If Emeril does not honor this promise can he be sued?

Back 113

By signing the back of the check, Emeril promises: THAT IF THE CHECK BOUNCES AND HE IS GIVEN NOTICE OF THAT FACT, HE WILL PAY. If Emeril does not honor this promise, HE CAN BE SUED.

Front 114

Who signed the instrument? Can the drawer be sued?

Back 114

The drawer: the party WHO SIGNS THE CHECK. The drawer can be sued, but has secondary liability. If the check is accepted by a bank, the drawer is discharged and cannot be held liable if the bank fails to pay.

Front 115

You purchase groceries and write a check to pay for them. Who are you in this situation? What happens if the check bounces?

Back 115

You are THE DRAWER. By signing the check, you promise that if it bounces, and you are notified, YOU WILL PAY. If you fail to do so, YOU CAN BE SUED.

Front 116

Who signed the check? Can the drawee be sued?

Back 116

The drawee: THE PARTY WHO PAYS THE DRAFT. Typically, this is THE BANK. Note: The drawee does NOT SIGN. Therefore, it is not liable. (Remember that this is signature liability.)

Front 117

Are there special words I can use on my check to avoid liability? Who can use these words?

Back 117

“Without recourse” is a term of art used by INDORSERS and DRAWERS. It represents A DISCLAIMER OF LIABILITY. “WITHOUT RECOURSE” PASSES TITLE BUT NOT SIGNATURE LIABILITY.

Front 118

Johnny Damon indorses his paycheck by signing “without recourse Johnny Damon.” What is the effect of this additional language?

Back 118

“Without recourse” is a term of art used by INDORSERS and DRAWERS.

It represents A DISCLAIMER OF LIABILITY. Thus, Cheryl Tiegs IS NOT LIABLE FOR THE PURPOSES OF SIGNATURE LIABILITY. “WITHOUT RECOURSE” PASSES TITLE BUT NOT SIGNATURE LIABILITY.

Front 119

What is warranty or transfer liability?

Back 119

The basic context: Think of this as seller’s liability for selling a defective instrument.

Front 120

Who can be sued for breach of warranty in commercial paper?

Back 120

Any transferor who SELLS the negotiable instrument. Thus, if our transferor is not a DONOR he can be sued.

Front 121

What determines who is entitled to sue the defendant for breach of warranty?

Back 121

It depends on whether the defendant indorsed the instrument or not.

Front 122

Okay, so who is entitled to sue if the defendant indorsed the document?

Back 122

If defendant indorsed the instrument (i.e., signed on the back), any plaintiff IN POSSESSION OF THE INSTRUMENT may sue. When defendant indorses, warranties run with the instrument.

Front 123

Gwyneth indorses her paycheck from Paramount Studios and remits the check to her agent, for services rendered. Her agent in turn remits the check to Stylist for his services. The check bounces. May Stylist sue Gwyneth?

Back 123

YES Gwyneth was not a DONOR and she INDORSED the check.

Front 124

Who is entitled to sue if the defendant did not indorse the back of the instrument?

Back 124

If defendant did not indorse the instrument, then only the defendant’s IMMEDIATE TRANSFEREE may sue. The warranties will not run with the instrument.

Front 125

Will, who never indorses his paycheck from NBC, remits the check to his agent for services rendered. His agent in turn remits to Stylist. The check bounces. May Stylist sue Will?

Back 125

NO. Will did not indorse the check.

Front 126

What are the warranties made by the defendant?

Back 126

i. Defendant promises: THAT HE HAS GOOD TITLE ON THE INSTRUMENT
ii. Defendant promises THAT ALL SIGNATURES ON THE INSTRUMENT ARE GENUINE AND AUTHORIZED. Thus, FORGERY is a breach of warranty.
iii. Defendant promises that the instrument NOT BEEN MATERIALLY ALTERED. When the facts tell you that the instrument has been tampered with, IT IS DEFECTIVE.
iv. Defendant promises that there is no defense or claim good against the defendant, meaning that the instrument is enforceable.
v. Defendant promises that she has no knowledge of any BANKRUPTCY or INSOLVENCY PROCEEDING against the maker or drawer.

Front 127

What does duly negotiated mean? What is the effect of proper transfer?

Back 127

Due negotiation or “duly negotiated” means that there has been a proper transfer of the instrument. If the instrument has been properly transferred, the transferee is a holder and may be eligible to be HOLDER IN DUE COURSE. By contrast, if the instrument has been improperly transferred, the transferee is not a holder and cannot qualify as a holder in due course.

Front 128

How is a payable to order instrument negotiated?

Back 128

When the instrument is payable to the order of a specific payee, it is negotiated by DELIVERY OF THE INSTRUMENT TO THAT PAYEE. Any further negotiation requires that the payee INDORSE THE INSTRUMENT and DELIVER IT TO THE TRANSFEREE. The indorsement must be authorized and valid.

Front 129

Paula Abdul loses her paycheck, payable to her order. Simon finds it, signs Paula’s name on the back and cashes it at Randy’s Music Shop. Is Randy a holder?

Back 129

NO This is a bad transfer. Why? The instrument was payable to order, and therefore the payee (Paula Abdul) had to INDORSE IT. He never did. Thus, Randy can never be a HOLDER IN DUE COURSE.

Front 130

How is a payable to bearer instrument negotiated?

Back 130

If the instrument is payable to bearer, INDORSEMENT is not required.

Front 131

Paula Abdul loses her paycheck, payable to bearer. Simon finds it and cashes it at Randy’s Music Shop. Is Randy a holder?

Back 131

YES. INDORSEMENT IS NOT REQUIRED WHEN PAYABLE TO BEARER.

Front 132

What are the types of indorsements?

Back 132

Special or Blank; and
Restrictive or Unrestrictive

Front 133

What is meant by a special endorsement? What effect does it have?

Back 133

The special indorsement is one that names a particular person as “indorsee.” The indorsee MUST SIGN in order for the instrument to be further negotiated.

Front 134

Bobby Donnell indorses his paycheck, “Pay to Helen Gamble, /s/ Bobby Donnell.” Helen is THE INDORSEE. Helen loses the check. Jimmy finds it, signs Helen’s name on the back and cashes it at Gullible Grocery. Is Gullible Grocery a holder?

Back 134

NO This is a bad transfer. Helen never indorsed the check.

Front 135

What is meant by a blank endorsement? What is its effect?

Back 135

The blank indorsement is one that DOES NOT NAME A SPECIFIC INDORSEE. It may be negotiated by DELIVERY ALONE.

Front 136

Bobby Donnell indorses his paycheck by signing his name on the back and delivers it to Elinor, who loses it. Jimmy finds it and cashes it at Gullible Grocery. Is Gullible Grocery a holder?

Back 136

YES This is a good transfer.

Front 137

What is a restrictive indorsement?

Back 137

The restrictive indorsement CONTAINS A CONDITION.

Front 138

Bobby Donnell indorses his check, “For deposit only, Bobby Donnell.” Lucy steals the check from Bobby and cashes it at Stupid Bank. Is Bank a holder? What, if any, are Bobby’s rights?

Back 138

No. BOBBY RECOVERS FROM BANK IN CONVERSION.

Front 139

How does one qualify for holder in due course status?

Back 139

A holder in due course (HDC) is a holder who takes the instrument:
1. for value; and
2. in good faith; and
3. without notice that it is overdue or has been dishonored or is subject to any defense or claim.

Front 140

What does it mean to take an instrument for value?

Back 140

For Value: The holder must GIVE VALUE FOR the instrument. Note that giving value does NOT mean giving CONSIDERATION, which is a CONTRACT principle.

Front 141

How are value and consideration different?

Back 141

Consideration and value differ in two important ways:
A. A mere promise is not value.
B. Old value is good value.

Front 142

Mike Piazza indorses and delivers his paycheck to Roger Clemens. In return, Roger promises not to pitch at Mike’s head for the next year. Is this value?

Back 142

NO A promise isn’t enough. Thus, Roger could never qualify as A HOLDER IN DUE COURSE.

Front 143

Carrie indorses and delivers her paycheck to Aidan, to pay him for the furniture that he made for her last year. Has Aidan given value?

Back 143

YES, past value can qualify for value. Thus, Aidan could qualify as a HOLDER IN DUE COURSE if the remaining elements are met.

Front 144

What is meant by good faith in holder in due course?

Back 144

In Good Faith: Good faith means honesty in fact (this is a SUBJECTIVE test, sometimes referred to as the rule of the pure heart and the empty head) and the observance of reasonable commercial standards of fair dealing (an OBJECTIVE test).

Front 145

What does it mean to take without notice?

Back 145

Without Notice: The holder must acquire the instrument without notice that it is overdue, has been dishonored or is subject to any defense or claim.

The notice requirement imposes an OBJECTIVE test. It asks, did the holder KNOW OR HAVE REASON TO KNOW OF THE PROBLEM?

Front 146

So, what does it mean to take notice that an instrument is overdue?

Back 146

Notice that the instrument is overdue: i.e., that it should already have been paid. If the holder has notice or reason to know that the instrument should already have been paid, he or she is not a HOLDER IN DUE COURSE.
i. Payable at definite time - HDC
ii. Principal in arrears – non-HDC (ie. Overdue)
iii. Interest in arrears – still an HDC

Front 147

The instrument recites that it is payable on Jan. 1, 2003. Holder buys the instrument on Jan. 5, 2003. Is the holder a Holder in Due Course?

Back 147

Holder is not a HOLDER IN DUE COURSE. She bought too late.

Front 148

What if I know that a payment or more of the principal is in arrears, can I still be a holder in due course?

Back 148

If holder had notice that a payment or more of principal is in arrears, he or she cannot qualify as an HDC.

Front 149

What if I know that one or more payments of interest only are in arrears?

Back 149

If holder takes with notice that one or more payments of interest are in arrears, he can nonetheless qualify as an HDC.

Front 150

How might a holder have notice that there are defenses or claims against the instrument’s enforcement?

Back 150

i. when the appearance of the instrument gives notice:
ii. notice that obligation of any party is voidable.
iii. notice of a competing claim to the negotiable instrument.
iv. notice that fiduciary has negotiated the instrument in breach of his or her fiduciary duty.

Front 151

The instrument is stamped on its face “PAID” or “VOID.” Nonetheless, Phoebe buys it. Is she a holder in due course?

Back 151

Phoebe cannot be a HOLDER IN DUE COURSE.

Why not? THE FACE OF THE INSTRUMENT SHOULD HAVE TOLD HER THAT SOMETHING IS WRONG.

Front 152

Aidan sells a chair to Charlotte. He misrepresents to her that it is an antique. Charlotte signs and delivers to Aidan a negotiable note for $4,000 for the chair. Aidan indorses the note and sells the note to Samantha. What is Charlotte’s obligation to pay? Is Samantha a holder in due course?

Back 152

First, as between Aidan and Charlotte, Charlotte’s obligation to pay is VOIDABLE. Charlotte has a defense to enforcement of her promise to pay because Aidan defrauded Charlotte. Second, could Samantha qualify as a holder in due course? YES, if she did not have notice or reason to know of Charlotte’s defense.

Front 153

How might one have notice of a competing claim to the negotiable instrument?

Back 153

If the instrument is lost by or stolen from the true owner, the transferee could still qualify as a holder in due course if the instrument has been properly transferred and the transferee did not have notice or reason to know of the theft or loss.

Front 154

Larry steals a negotiable instrument from Carrie and sells it to Dave. Carrie discovers the theft and confronts Dave. Who is entitled to the negotiable instrument?

Back 154

Dave, if the instrument was PROPERLY TRANSFERRED, and Dave did not have NOTICE or reason to know of the theft.

Front 155

How might one dealing with a fiduciary lose holder in due course status?

Back 155

With notice that fiduciary has negotiated the instrument in breach of his or her fiduciary duty.

Front 156

Brad Pitt buys a speedboat for his personal use. He pays Dealer by indorsing and delivering to Dealer a check payable to the Brad Pitt Fan Club. Could Dealer qualify as a holder in due course?

Back 156

YES, if Dealer did not actually know of the breach. This is the only time that the standard is one of ACTUAL KNOWLEDGE.

Front 157

What’s the standard for determining if the holder knew of the breach of fiduciary duty for determining holder in due course status?

Back 157

Actual knowledge. This is the only time that the standard is one of actual knowledge.

Front 158

What is the shelter rule with respect to holder in due course status?

Back 158

The basic principle: A transferee acquires whatever rights her TRANSEROR had.

In other words, the transferee TAKES SHELTER in the status of her transferor. This rule allows the transferee “to step into the shoes” of the HDC, even though she otherwise clearly fails to meet the requirements of due course holding.

Thus, transferee has all the rights of an HDC even though transferee is a DONEE or OTHERWISE FAILS TO MEET THE REQUIREMENTS OF DUE COURSE HOLDING.

Front 159

Napoleon, a holder in due course of a negotiable instrument, makes a gift of the instrument to Pedro. Is Pedro a holder in due course?

Back 159

Pedro is a mere DONEE. Even though he doesn’t deserve it, Pedro qualifies as a HOLDER IN DUE COURSE because of THE SHELTER RULE.

Front 160

What are the benefits of holder in due course status?

Back 160

The rule: A holder in due course (and subsequent transferees who take “shelter” in that status) takes the instrument free from CLAIMS, free from PERSONAL DEFENSES and subject only to REAL DEFENSES.

Front 161

What does it mean that a holder in due course takes free from claims?

Back 161

A claim is a right to a negotiable instrument because of SUPERIOR OWNERSHIP. If a negotiable instrument is duly negotiated to a holder in due course, the holder in due course defeats the superior owner.

Front 162

What does it mean that a holder in due course takes free from personal defenses?

Back 162

The Holder in Due Course takes free from personal defenses: Personal defenses include every defense available in ORDINARY CONTRACT ACTIONS, such as: LACK OF CONSIDERATION, UNCONSCIONABILITY, WAIVER, ESTOPPEL, FRAUD IN THE INDUCEMENT

Front 163

What does it mean that a Holder in Due Course takes subject to real defenses?

Back 163

The Holder in Due Course takes subject to real defenses: To remember, think of MAD FIFI4
MA: MATERIAL ALTERATION
D: DURESS
FIF: FRAUD IN THE FACTUM
I: INCAPACITY
I: INFANCY
I: ILLEGALITY
I: INSOLVENCY

Front 164

How is material alteration a defense? How does it work?

Back 164

“Material alteration” as a real defense: A material alteration is a change in THE TERMS OF THE INSTRUMENT. However, if maker was negligent, he is ESTOPPED from raising material alteration as a defense. Negligence includes leaving blanks or leaving wide spaces on the check.

Front 165

Maker writes a check for $100. Payee changes the amount to $2,100, then sells it to an HDC. What is the Maker liable for? What if he left huge spaces when writing the instrument?

Back 165

Maker is liable only for $100.

However, if maker was negligent, he is ESTOPPED from raising material alteration as a defense. Negligence includes leaving blanks or leaving wide spaces on the check.

Front 166

What’s the difference between “real” fraud and personal fraud?

Back 166

“Real” fraud, known as fraud in the factum, is assertable against an HDC. “Real” fraud means that there has been A MISREPRESENTATION ABOUT THE INSTRUMENT. By contrast, personal fraud, meaning fraud in the inducement, is a personal defense. It is INEFFECTIVE against an HDC.

Front 167

Luciano, who cannot read English, signs a promissory note after his lawyer tells him that it is a credit application. Is the note enforceable in the hands of an HDC?

Back 167

Even in the hands of an HDC, the note NOT ENFORCEABLE. There has been “real” fraud, a misrepresentation about the instrument, which is a defense even against an HDC.

Front 168

Frank Sinatra sells Ava Gardner a ring, telling her that it contains diamonds that date back to the 17th Century. After paying for the ring by check, Ava discovers that it is a fake. If the check is now held by an HDC, can Ava’s defense be asserted against the holder?

Back 168

Ava’s defense cannot be asserted. Why not? THE FRAUD DEFENSE IS PERSONAL ONLY! Unlike Luciano, in the example above, here Ava knew that she was signing a negotiable instrument. In the hands of a HOLDER IN DUE COURSE, the instrument is enforceable.

Front 169

What is the fundamental rule of commercial paper?

Back 169

The bright-line rule: When a negotiable instrument is duly negotiated to a holder in due course, the holder in due course takes the instrument free of all claims to it, free of personal defenses and subject only to real defenses.

Front 170

Tony Soprano steals a negotiable instrument from Carrie Bradshaw and sells it to Arlis Michaels. Carrie discovers the theft and confronts Arlis. Who is entitled to the negotiable instrument?

Back 170

The answer: Arlis, if the instrument was duly negotiated and Arlis can qualify as a holder in due course.