COMMERCIAL PAPER - Loyola University New Orleans



COMMERCIAL PAPER

SULC; Fall 2001; Professor Barbre; Scott G. Yarnell

Texts: Commercial Paper and Banking; Hawkland; 1995;

Commercial and Debtor-Creditor Law: Selected Statutes; Westbury;

PROMISSORY NOTES

Documents

Note is a promise to pay.

Draft is an order to pay. Most common form is a check. A certificate of deposit is a promissory type note.

Order form is much harder to negotiate. The document usually states “Pay to the order of”.

Bearer form is much easier to negotiate.

Labels of parties

Definitions from Art 1-201 and Art 3-103.

Maker/Issuer - person who is signing the note and making the promise. In checks, this person would be called the Drawer and not maker.

Payee/Holder - person who lawfully holds the note.

Indorser - person who signed the back of the instrument prior to transferring it to another person.

Indorsee - person who acquires the instrument from a payee or subsequent holder and is now known as the holder.

Transferor - person who transferred an instrument without signing or indorsing it.

CONCEPT OF NEGOTIABILITY

3-104 provides that a negotiable instrument must have the following to be negotiable:

It must be in writing;

It must be signed by the maker or drawer;

It must contain a promise or order;

The promise or order to pay must be unconditional;

The promise or order to pay must be to pay money, and the instrument must not contain any other undertaking or instruction;

The money promised or ordered must be fixed;

The money promised must be payable on demand or at a definite time; and

Except for checks, the instrument must be payable to order or to bearer.

Three important results depend upon negotiability:

1. Article 3 is limited to negotiable instruments. If the instrument is missing an element then it is nonnegotiable and is regulated by contract law outside the scope of Article 3.

2. The concept of HIDC attends negotiable instruments, but not other contracts.

3. HIDC has some procedural advantages that are not available to assignees of simple contracts.

A note has to be indorsed and transferred for negotiation to have occurred.

Writing and Signature

Part of 3-104.

A writing includes printing, typewriting or any other intentional reduction to tangible form.

A signature includes any symbol executed or adopted by a party with present intention to authenticate a writing.

Signature is not the same as subscription.

Unconditional Promises

3_104. Negotiable Instrument.

(a) Except as provided in subsections (c) and (d), “negotiable instrument” means an unconditional promise....

3_106. Unconditional Promise or Order.

(a) Except as provided in this section, for the purposes of Section 3_104(a), 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 with respect to the promise or order are stated in another writing. A reference to another writing does not of itself make the promise or order conditional.

(b) A promise or order is not made conditional (i) by a reference to another writing for a statement of rights with respect to collateral, prepayment, or acceleration, or (ii) because payment is limited to resort to a particular fund or source.

(c) If a promise or order requires, as a condition to payment, a countersignature by a person whose specimen signature appears on the promise or order, the condition does not make the promise or order conditional for the purposes of Section 3_104(a). If the person whose specimen signature appears on an instrument fails to countersign the instrument, the failure to countersign is a defense to the obligation of the issuer, but the failure does not prevent a transferee of the instrument from becoming a holder of the instrument.

(d) If a promise or order at the time it is issued or first comes into possession of a holder contains a statement, required by applicable statutory or administrative law, to the effect that the rights of a holder or transferee are subject to claims or defenses that the issuer could assert against the original payee, the promise or order is not thereby made conditional for the purposes of Section 3_104(a); but if the promise or order is an instrument, there cannot be a holder in due course of the instrument.

An implied condition is not fatal, but an express condition is fatal. A promise to pay is not the same as acknowledgment of debt. An IOU is an acknowledgment and not a promissory note.

Phrases such as “as per”, “in accordance with” and “pursuant to” are said not to destroy negotiability, but phrases such as “subject to” or “governed by” do destroy negotiability.

Money

Money means a medium of exchange authorized or adopted by a domestic or foreign government and includes a monetary unit of account established by an intergovernmental organization or by agreement between two or more nations.

Test of money is does it have the sanction of the particular government?

Variable interest rate does not affect negotiability.

3_107. Instrument Payable in Foreign Money.

Unless the instrument otherwise provides, an instrument that states the amount payable in foreign money may be paid in the foreign money or in an equivalent amount in dollars calculated by using the current bank_offered spot rate at the place of payment for the purchase of dollars on the day on which the instrument is paid.

Is the term referring to foreign money, like francs or lira, that is used by one country or multiple countries? Francs is the term used in France and Switzerland. Could be a complication.

Fixed Amount

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....

Interest is allowed.

3_112. Interest.

(a) Unless otherwise provided in the instrument, (i) an instrument is not payable with interest, and (ii) interest on an interest_bearing instrument is payable from the date of the instrument.

(b) Interest may be stated in an instrument as a fixed or variable amount of money or it may be expressed as a fixed or variable rate or rates. The amount or rate of interest may be stated or described in the instrument in any manner and may require reference to information not contained in the instrument. If an instrument provides for interest, but the amount of interest payable cannot be ascertained from the description, interest is payable at the judgment rate in effect at the place of payment of the instrument and at the time interest first accrues.

Payable on Demand or at a Definite Time

3-104a2: Payable on demand or at a definite time.

3_108. Payable on Demand or at Definite Time.

(a) A promise or order is “payable on demand” if it (i) states that it is payable on demand or at sight, or otherwise indicates that it is payable at the will of the holder, or (ii) does not state any time of payment.

(b) A promise or order is “payable at a definite time” if it is payable on elapse of a definite period of time after sight or acceptance or at a fixed date or dates or at a time or times readily ascertainable at the time the promise or order is issued, subject to rights of (i) prepayment, (ii) acceleration, (iii) extension at the option of the holder, or (iv) extension to a further definite time at the option of the maker or acceptor or automatically upon or after a specified act or event.

(c) If an instrument, payable at a fixed date, is also payable upon demand made before the fixed date, the instrument is payable on demand until the fixed date and, if demand for payment is not made before that date, becomes payable at a definite time on the fixed date.

Note states a fixed payable time and then has an extension date which does not specify a fixed time. Does this destroy negotiability? No.

Does a prepay clause destroy negotiability? No, even though the time due period is destroyed if paid early.

Person with little bargaining power that goes to a bank will usually always have to sign a “demand” note because the bank will be able to move quickly to recover if things go wrong. Doesn’t always work. Normally, the bank doesn’t demand the note because it wants the interest on the note.

Rule of 78 is used by banks to calculate interest.

Extension clauses are valid and do not destroy the negotiability. See 3-108(b).

Acceleration clauses are valid and do not destroy the negotiability. This is a compromise between a fixed time note and a demand note. 3-108(b).

Acceleration clauses are usually inserted at the request of the lender to protect itself in case borrower runs into trouble. 3 different type of notes in this area:

1. demand clause - notes that are payable on demand;

2. default clause - gives the option to accelerate upon the happening of a specific event; and

3. insecurity clause - note payable if the holder deems himself to be insecure.

Good faith is an element in default clauses.

Post-obit loan is a loan that becomes due upon the death of a person.

Words of Negotiability

3_109. Payable to Bearer or to Order.

(a) A promise or order is payable to bearer if it:

(1) states that it is payable to bearer or to the order of bearer or otherwise indicates that the person in possession of the promise or order is entitled to payment;

(2) does not state a payee; or

(3) states that it is payable to or to the order of cash or otherwise indicates that it is not payable to an identified person.

(b) A promise or order that is not payable to bearer is payable to order if it is payable (i) to the order of an identified person or (ii) to an identified person or order. A promise or order that is payable to order is payable to the identified person.

(c) An instrument payable to bearer may become payable to an identified person if it is specially indorsed pursuant to Section 3_205(a). An instrument payable to an identified person may become payable to bearer if it is indorsed in blank pursuant to Section 3_205(b).

Is the note in bearer or order form? This will dictate how to look at the other things in order to determine how to negotiate.

“Payable to order of John Smith or bearer” - bearer form and negotiable. 3-109(a).

“Pay to bearer” - bearer note that is negotiable and payable to however has it in their possession. 3-109(a).

“Pay to order of cash” - bearer form and negotiable. 3-109(a).

“Pay to order of John Smith” - order form and negotiable. 3-109(b)(ii).

“Pay to John Doe” - is it negotiable? No if in a note. Yes if a check per 3-104(c). Why? A check is an instrument that is negotiable even though it lacks all the formal requirements for negotiability of a promissory note.

3-104(d): A promise or order other than a check is not an instrument if, at the time it is issued or first comes into possession of a holder, it contains a conspicuous statement, however expressed, to the effect that the promise or order is not negotiable or is not an instrument governed by this Article.

This means that if want the instrument to be non-negotiable then can insert language stating this in the contract. But this does not apply to checks.

LIABILITY OF THE PARTIES

Obligations of the Parties

Can be liable either as a maker or indorser.

Makers obligation: revealed on the face of the note; is a primary and unconditional obligation; but can be defensible.

Indorsers obligation: not revealed on the face of the note; is a secondary and conditional obligation.

Unconditional: obligation to pay accrues without any activity on the part of the holder.

Conditional: obligation to pay accrues after certain conditions are satisfied.

The Maker

Maker is unconditionally obliged to pay the note according to its tenor.

Presentment nor notice of dishonor is a condition to the makers liability.

Presentment waiver is usually in the note.

3_401. Signature.

(a) A person is not liable on an instrument unless (i) the person signed the instrument, or (ii) the person is represented by an agent or representative who signed the instrument and the signature is binding on the represented person under Section 3_402.

(b) A signature may be made (i) manually or by means of a device or machine, and (ii) by the use of any name, including a trade or assumed name, or by a word, mark, or symbol executed or adopted by a person with present intention to authenticate a writing.

3_402. Signature by Representative.

(a) If a person acting, or purporting to act, as a representative signs an instrument by signing either the name of the represented person or the name of the signer, the represented person is bound by the signature to the same extent the represented person would be bound if the signature were on a simple contract. If the represented person is bound, the signature of the representative is the “authorized signature of the represented person” and the represented person is liable on the instrument, whether or not identified in the instrument.

(b) If a representative signs the name of the representative to an instrument and the signature is an authorized signature of the represented person, the following rules apply:

(1) If the form of the signature shows unambiguously that the signature is made on behalf of the represented person who is identified in the instrument, the representative is not liable on the instrument.

(2) Subject to subsection (c), if (i) the form of the signature does not show unambiguously that the signature is made in a representative capacity or (ii) the represented person is not identified in the instrument, the representative is liable on the instrument to a holder in due course that took the instrument without notice that the representative was not intended to be liable on the instrument. With respect to any other person, the representative is liable on the instrument unless the representative proves that the original parties did not intend the representative to be liable on the instrument.

(c) If a representative signs the name of the representative as drawer of a check without indication of the representative status and the check is payable from an account of the represented person who is identified on the check, the signer is not liable on the check if the signature is an authorized signature of the represented person.

3_403. Unauthorized Signature.

(a) Unless otherwise provided in this Article or Article 4, an unauthorized signature is ineffective except as the signature of the unauthorized signer in favor of a person who in good faith pays the instrument or takes it for value. An unauthorized signature may be ratified for all purposes of this Article.

(b) If the signature of more than one person is required to constitute the authorized signature of an organization, the signature of the organization is unauthorized if one of the required signatures is lacking.

(c) The civil or criminal liability of a person who makes an unauthorized signature is not affected by any provision of this Article which makes the unauthorized signature effective for the purposes of this Article.

The Indorser

See 3-204, 3-205, 3-206, 3-415, and 3-503.

Allonge: Refers to a page that is attached to a note when the note runs out of places for indorsements.

Blank indorsement: just sign the back of the note. Can be negotiated by anyone after this type of indorsement.

Special indorsement: indorser signs it and make it payable to an identified person, i.e., “pay to” or “pay to the order of”. This limits negotiation.

Qualified indorsement: “Without recourse s/Paul”. Incurs no liability.

Unqualified indorsement: “s/Paul”. Incurs secondary or conditional liability.

Anomalous indorsement: someone who is not a holder indorses the note. This is a good indication that the person is probably an accommodation indorser.

Problems arise when indorser wants to be qualified, but fails to use the magic words “without recourse” which then means can parole evidence be used to prove. In Louisiana, if want to use parole evidence of an agreement other than the note, the agreement must be in writing.

Examples:

1. “Pay John Jones, s/Payee” - special (identifies who is a holder), qualified, non-restrictive.

2. “For deposit only in XYZ Bank, s/Payee” - special (identifies the bank), unqualified, restrictive (3-206(c)).

3. “For deposit only, s/Payee” - blank, unqualified, and restrictive.

4. “Without recourse, s/Payee” - blank, qualified (restricts liability), and non-restrictive.

5. “s/Payee” - blank, unqualified, and non-restrictive.

6. “Pay John Jones, without recourse on me, s/Payee” - special, qualified, non-restrictive.

Indorser not liable unless gets notice of dishonor.

Certificate of Protest: an affidavit executed which is self-proving of presentment and notice of dishonor. No longer required by the code, but still may use it.

Warranty

2 types of warranty: presentment (3-417) and transfer (3-416).

Warranty principles come from property law.

Warrant that the note is good and all is in good faith.

One way to get around the non-liability of a qualified indorser who is in bad faith. Remember, Louisiana uses a different definition for “good faith” than the UCC.

Warranty against non-authentic and non-authorized signatures.

Can indicate that transfer is without warranty on the note when indorsed. Example is “without recourse and warranty, s/paul”.

Accommodation Parties

An accommodation party is one who is asked to sign on a note. Also called surety.

Defenses to Liability

Claims and Defenses

Holder in Due Course

Rights of Parties Who Are Not HIDC

METHODS OF ULTIMATE PAYMENT

Article 4 of UCC.

Cash

Checks

Relationship Between the Drawer and Payee or Successor to Payee

Relationship Between the Drawer and Drawee-Payor

Relationship Between the Payor and its Successor, Including the Depositary Bank and the Drawee-Payee

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