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REG - Notes Chapter 6
Commercial Paper
Commercial paper is promissory notes (CD’s) or drafts (checks)
The commercial paper laws arose, in part, to provide a convenient and safe substitute for cash

Article 3 – governs any type of note or draft (check or installment note)

- not warehouse receipts, bills of lading, stocks and bonds

Step 1: identify the type of paper

A note – is a two party commercial paper. It is a promise by one party (the maker) to pay money to another
party (the payee)

Certificate of deposit (a bank promissory note) – A CD is a negotiable instrument issued by a bank that
acknowledges receipt of money and promises to repay at a future date

Drafts – is a three party commercial paper. It is an order by one person (the drawer) to another person (the
drawee) demanding that the drawee pay money to a third person (the payee)

Checks – drawee must be a bank and be payable on demand

Trade acceptances – draft drawn by seller ordering the buyer to pay

Demand note/draft – an instrument payable on demand

Time note/draft – an instrument payable at a future date

Step 2: is the instrument negotiable

To be a negotiable instrument, the instrument must:

• Be in writing
• Be signed my the maker (note) or drawer (draft)
- UCC is liberal on what constitutes a signature, could be an X or a scribble as long as you wrote it
• Contain an unconditional promise (note) or order (draft) to pay
- not negotiable if on the front it states payment is conditional (“subject to” or “contingent upon”)
• Be a fixed amount of money only
- on the face of the instrument and be a specifically ascertainable amount (its not uncertain if its payable
with interest, with stated disc/prem or with cost of legal fees)
• Be payable on demand or at a definite time
- Checks don’t have to be dates, but it should
- Notes may have to be dated if the notes says payable after 90 or 180 days
• Be payable to order or to bearer, with the exception of checks, and
- Unless it’s a check, it must state order or bearer (“pay to the order of John”)
- an instrument payable to bearer, is payable to anyone who possesses it
• Contain no undertaking or instruction not authorized by the UCC
- certain authorized promises will not destroy negotiability such as, collateral, promises to pay legal
fees, waivers of the right to a jury trial, promises to pay prepayment penalty, interest, pay off early

Type written terms control over pre-printed terms. Hand written terms control over both

Words controls figures. Pay five dollars and 5,000 is construed as an order to pay 5 dollars

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If an instrument is not negotiable there can be no holder in due course and the holder in due course rule cannot
apply. Thus, transferees of the instrument will take the instrument subject to any defense against payment that a
party might have

Step 3: Does the holder qualify as an HDC?

The process by which commercial paper is transferred is called “negotiation”, and the persons whom the UCC
seeks to protect are holders in due course (HDC’s) and most transferees of holders in due course

The first step in becoming an HDC is becoming a holder. A holder can be thought of as a person with good title
to the commercial paper

Bearer paper is negotiated by delivering the instrument to a transferee

Order paper (commercial paper payable to specific person) requires delivery to that person and the payee’s
endorsement (signature)

Special endorsement – names a particular person as endorsee and always makes the instrument order paper

The UCC treats the forgery as the genuine signature of the forger. Thus, transferees are holders of the forger’s

Endorsers are secondarily liable (guarantors) (must pay) if primary party defaults

Without recourse means there is no guarantee of payment by the endorser. The without recourse endorser still
has warranty liability

Restrictive endorsement generally have no effect on negotiability

Types of endorsements
• Blank = mere signature of holder; converts to bearer
• Special = pay to specific person; converts to order
• Restrictive = only, or “for deposit” or “for collection”; restrictive order
• Qualified = without recourse; bearer

Becoming a holder in due course (HDC) – has superior rights to transferor

Article 3 limits the defenses that can be raised against an HDC
A holder will take commercial paper in due course to the extent that he takes the paper with all these:
• Is negotiable
• For value
- An executory promise (a promise to give value in the future) is not value
- Value need not be equivalent to face value
• In good faith, and
• Without notice of any defenses to or claims of ownership on the instruments
- purchase without knowledge that the instrument is overdue, dishonoured, or any claim against
If all these are not met, the holder is a mere assignee of transferor and has no better rights than the original

The shelter doctrine – A holder through a HDC

Article 3 provides that most subsequent transferees of an HDC can “succeed to” or “take shelter in” the rights
of an HDC. So even though the transferee himself might not qualify as an HDC, he can claim the rights of an
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Step 4: Does the maker/drawer have a real or personal defense

Holder in due course rule – is a negotiable instrument is negotiated to a holder in due course, the HDC takes
free from personal defenses and claims and is subject to only real defenses (FAIDS2)

If the holder does not have the rights of an HDC, the maker or drawer can successfully assert any defense

Real defenses – may be asserted against both HDC and non-HDC transferees FAIDS2
• Forgery
• Fraud in execution
• Alteration of instrument
• Adjudicated insanity
• Infancy
• Illegality
• Duress
• Discharge in bankruptcy
• Surety defenses
• Statue of limitations

Personal defenses can’t be raised against an HDC or their assignees (shelter doctrine)
- such as: fraud in the inducement, failure of consideration, theft of instrument after signed, breach of
contract, mistake, impossibility, unauthorized completion (giving a party an instrument with the amount
left blank) That’s different then material alteration (changing the amount written on the instrument
without permission)

Liability of the parties

• Note/CD
- Primary liable – maker
- Secondary liable – endorsers
• Draft/check
- Primary liable – Drawee (if they accept)
- Secondary liable – Drawer + endorsers

An endorser can be liable in two separate ways

• Contract liability– by endorsing the instrument he becomes secondarily liable (negates if without recourse)
• Warranty liability – any person who transfers an instrument for consideration makes the five warranties
listed below (exists even if the transferor does not sign or signs without recourse)
- Transferor is entitled to enforce the instrument
- All signatures are genuine or authorized
- The instrument has not been materially altered
- No defense of any party is good against the transferor, and
- The transferor has no knowledge of any insolvency proceeding against the maker, acceptor, or drawer
of an unaccepted instrument

General rule – real defense for the innocent party whose name was forged
Forger is always liable

Forgery of drawers name – the drawee is liable upon acceptance for negligence (should have known the
signature was forged)

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Forgery of the payees name – does not usually pass good title

If a maker or drawer issues an instrument to an imposter, any resulting forgery of the payee’s name will be

Secured Transactions
Secured transactions – debt secured by collateral

Security interest – right of creditor to repossess upon default

• Effective between creditor and debtor as soon upon attachment.
• Effective against third parties upon perfection (a form of notice that the creditor has security interest in the
collateral and gives the creditor superior rights to collateral compared to certain third parties

When a debtor pledges collateral to multiple parties creditor protects themselves from third parties by “perfect”
security interest

Purchase money security interest (PMSI) – has priority over all other types of security interests in the same
collateral, if the PMSI is properly perfected. A PMSI arises when:
• A creditor sells the collateral to the debtor on credit, retaining a security interest, or
• The creditor advances funds used by the debtor to purchase the collateral

Types of collateral
• Consumer goods – personal use goods
• Inventory – goods held for sale or lease
• Equipment – goods that do not fit into another category

3 requisites for attachment (creditor vs. debtor)

• Parties must have an agreement creating the security interest by:
- An authenticated record (written agreement) of the security agreement by the debtor, or
- Creditor takes possession or control of the collateral
• Value must be given to the debtor
• Debtor must have rights in the collateral (debtor owns/has possession of the collateral)

Authenticated record – signed and approved by debtor

Perfection of the security interest (creditors vs. third parties)

Perfection of a security interest cannot be completed until it has been attached (but can occur at the same time)
There are 5 methods of perfection:
1. Filing – give notice by filing a financing statement, authenticated by debtor, which contains:
- name and mailing address of debtor and secured party
- indication of the collateral covered by the financing statement, and
- if the collateral is real property, there is a description of that real property
2. Taking possession (oral agreement ok) – this is similar to when a pawn shop takes an item in exchange
- must use reasonable care is storing and preserving the collateral
3. Perfection by control – for investment property
- Certificated stocks and bond securities – must take possession
- Uncertificated securities – must have owner notify the issuer to reregister the securities in the name of
the secured party
- Securities accounts – owner of the account must contact the broker and instruct the broker that the
secured party no has whatever right
4. Automatic perfection – PMSI in consumer (personal) goods only
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- security interest can be perfected by attachment in consumer goods without any added requirements
5. Temporary perfection
- 20 day period for proceeds
- 4 months grace period for interstate shipments (protected in new state until end of grace period)

There can be conflicting interests in collateral. Between creditor and debtors; between creditors with a security
interest in the same collateral. The priority ranking is:
1. Buyer in the ordinary course of business (HDC’s and the like)
- even if the buyer has knowledge of the security interest
2. Holder of a properly perfected PMSI in the collateral
- exception: second hand consumer purchase without notice (did not file) would take free of PMSI
- PMSI in inventory – to have priority must be perfect before debtor gets possession and notice must be
given to other perfected parties in same collateral
- PMSI in equipment – has priority is filed anytime within 20 days of the debtor getting possession of
the collateral
3. Holder of a perfected security interest (and judicial lienholders once the lien has attached)
- Two creditors both perfected but neither PMSI, first to file or perfect gets priority (so the party with
the earliest date of the two categories gets priority).
- Dates of attachment are irrelevant
4. Holder of an unperfected security interest
- If there are two unperfected security interests in the same collateral, first to attach has priority
5. The Debtor

Rights on defaults
Self-help – secured party may take possession of collateral without judicial process if the breach is not

Replevin Action – judicial action seeking the transfer of personal property

After default or repossession, the secured party may sell or lease the collateral. Once the collateral is sold, all
subordinate claims are wiped out and there is no right of redemption by subordinate security interest holders or
the debtor

Proceeds of the sale are distributed in the following order:

• Expenses of repossession
• Satisfaction if the debt of the creditor
• Satisfaction of other creditors with security interests
• Any surplus is paid to the debtor

A secured party may keep the collateral un full or partial satisfaction of the debt
• Exception: in consumer goods cases where the debtor has paid at least 60% of the loan, the secured party
must sell the collateral within 90 days after repossession, unless the debtor waives this right

Real Property (Land)

Fee simple – absolute ownership of all rights in the land
Life estate – last as long as the life of a person

Future interests – an estate that does not entitle the holder to current possession, but may give the owner
possession in the future

Nonpossessory interests – intangible real property

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• Easements – limited right to use the land of another
• License – privilege to go upon the land of another (watch a concert)
• Profit – right to enter land and take a substance from the land (soil, timber, minerals)

Concurrent estates – any estate in land can be held concurrently by several persons.
• These co-tenants have the right to enjoyement and possession of the jointly owned land
• Because each co-tenant has rights to the whole land, their interests in the land is “undivided”

Joint tenancy
Right of survivorship – In a joint tenancy, when one joint tenant dies, the property passes to the surviving joint
tenants by operation of law. A joint tenant cannot change this by a provision in his or her will

4 unities are required to create joint tenancy: TTIP

• Unity of time – interests vest at the same time
• Unity of title – interests must be acquired by the same instrument
• Unity of interest – interests must be of the same type and duration
• Unity of possession – interests must give identical rights to enjoyment

While a joint tenant is alive, he/she may transfer his or her interest without the permission of the other joint
tenants. The transferee become a tenant in common with no right of survivorship.

Tenancy in common – concurrent estate with no right of survivorship

• When a tenant in common dies, her interest passes to her heirs or the persons named in the will

Tenancy by the entirety – joint tenancy between spouses, with right of survivorship

Landlord and tenant

Leasehold estate – a possessory estate that entitles the tenant, rather than the owner, to exclusive possession of
the land

Tenancy for years – tenancy expires at the end of the stated period without notice to either party

Periodic tenancies – continue until terminated by notice

Tenancy at will – may terminate the tenancy at anytime without notice

Absent specific restrictions in the lease, a tenant may engage in any lawful activity on the premises.

Assignments by tenants – original tenant transfers all of their interest to the new tenant
• The new tenant is liable to the landlord (for rent)

Sublease – Sublessee is liable to the original lessee but not to the landlord, to the sublessor

A landlord may assign or sell his interest in the property

• If a lease prohibits assignment, you could still sublease and visa versa (play on words)

Transfer of real property – conveyancing (transfer tile through sale or gift)

To be an enforceable contract for the sale of land – must be in writing and signed by purchaser, contain a
description of the property, the parties, the price, the manner of payment

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Deeds – must be in writing and signed by the grantor, identify the property, identify the parties, and show
intention to transfer realty (price is not required). Must be delivered to be effective (not necessarily physical)

Recording – similar to perfecting – protects buyer from subsequent 3rd parties

• Recordation not essential between grantor and grantee
• Recording gives constructive notice to the world of purchaser’s interest
Types of recording acts determines who will keep property where a grantor conveys the same property to more
than one grantee
• Notice statutes – subsequent BFP (bona fide purchaser) prevails over a prior grantee who failed to record
• Race notice statutes – subsequent BFP is protects only if she records before prior grantee records and has
no notice of a prior transfer
• Race statutes – first to record wins

A standard insurance policy insures only a good record title as of the policy’s date

Recording rules apply to all interests in real property. Thus, a subsequent purchaser who records generally will
not be subject to a prior, unrecorded mortgage that he/she is not aware of.

Mortgage – debt secured by real property

A mortgage is created by a written mortgage deed (like a financing statement)

Required items of a valid mortgage:

• Delivery
• Description of the property
• Names of the parties
• Words of grant or conveyance
• Mortgagor’s signature
• Mortgagors acknowledgement

Whether it’s a deed, lease or mortgage it must contain a description of the premises

RESPA is a federal act that requires that certain disclosures be made when a debtor agrees to give a mortgage
on the debtors property

Deficiency – if the sale does not bring a sum sufficient to satisfy the debt for which the mortgage was given,
some states allow the mortgage to bring a deficiency action against the mortgagor to recover the deficiency, but
some state do not allow such an action

Assuming a mortgage – if a buyer assumes an existing mortgage of a seller, the buyer has agree to be liable for
this mortgage. The seller (old mortgagor) is also liable.

Buying subject to an existing mortgage – the buyer is not liable for the existing mortgage. However, buyer runs
the risk of foreclosure if the seller does not pay the mortgage and defaults

A prior recorded mortgage has priority over a second mortgage. So upon default, the first mortgage must be
paid in full before the second mortgage can get anything

The mortgagor has an equitable right of redemption until the foreclosure sale is held and may have a statutory
right to redeem the property after the sales as well (if the state statue permits)

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Surety – one who is liable for the debt or obligation of another

To make a document of title negotiable, its terms goods are to be delivered to bearer or to the order of a named

Essential terms of a warehouse receipt

• Who is to receive the goods
• Description of the goods and the number of the receipt must be included
• The date the receipt was issued
• Where the goods are being stored
• The fees and storage rates must be stated
• Signed by the warehouseman or agent must be included