NEGOTIABLE INSTRUMENTS LAW “acknowledgment by a bank that a sum of money has been name of the new holder of the
of money has been name of the new holder of the bond. (3)
Atty. Rene Alexis P. Villarente, MBA
Ateneo de Davao University
INTERNATIONAL AND LOCAL TERMINOLOGIES
I. SECTION 1 and allied Sections
1. Extension Clauses. The reverse of an acceleration clause is an extension
clause, which allows the date of maturity to be extended into the future.
To keep the instrument negotiable, the interval of the extension must be
specified if the right to extend is given to the maker of the instrument. If,
on the other hand, the holder of the instrument can extend it, the maturity
date does not have to be specified. (1)
Extension Clauses. The reverse of an acceleration clause is
an extension clause, which allows the date of maturity to be
extended into the future. To keep the instrument negotiable,
the interval of the extension must be specified if maker or
drawer of the instrument is given the right to extend it. If,
however, the holder of the instrument can extend it, the
maturity date does not have to be specified. (4)
2. Drafts. A draft, which is a three-party instrument, is an unconditional
written order by one party (the drawer) that orders a second party (the
drawee) to pay money to a third party (the payee). A draft can be either a
time draft or a sight draft. A time draft is payable to a designated future
date. A sight draft is payable on sight. A sight draft is also called a demand
draft. (2)
Bank Drafts. A bank draft is a check drawn by one bank on
another bank. Banks customarily keep a portion of their
funds on deposit with other banks. A bank, then, may draw a
check on these funds as freely as any corporation may draw
checks. (3)
Draft Usage. Businesses often use drafts to pay for
merchandise ordered, especially when the buyer and the
seller are in different states. Drafts may be payable “at sight”
(i.e., on demand), or they may be “time drafts” (i.e., they are
payable at a future date). (6)
3. Trade acceptance. A trade acceptance is a sight draft that arises when
credit is extended with the sale of goods. In this type of draft, the seller is
both the drawer and payee. The buyer to whom credit is extended is the
drawee. Even though only two actual parties are involved, it is considered
a three-party instrument because three legal positions are involved. (2)
Trade Acceptances. A trade acceptance is a type of draft that
is frequently used in the sale of goods. In a trade acceptance,
the seller of the goods is both the drawer and the payee. (4)
Often, a seller of goods will send a draft to the buyer for
acceptance. If the buyer accepts, he or she has agreed to pay
any holder who makes proper presentation. Such a draft is
called a trade acceptance. (6)
4. Certificates of Deposit. A certificate of deposit is a special form of note
that is created when a depositor deposits money at a financial institution
in exchange for the institution’s promise to pay back the amount of the
deposit plus an agreed-upon rate of interest upon the expiration of a set
time period agreed upon by the parties. (2)
The UCC defines a certificate of deposit (DC) as an
date is commonly called stale check. A bank acts in good faith may pay it.
received by the bank and a promise by the bank to repay the
sum of money”. Normally the money is repaid with interest.
The UCC classifies a certificate of deposit as a note even
though it does not contain the word promise. A CD is to a draft
because it does not contain an order to pay. (3)
A certificate of deposit is an instrument used by a bank
evidencing a debt owed to a depositor. These instruments
commonly call for the bank to pay to a proper presenter the
amount deposited plus interest at a stated future date.
Although regularly thought of as a type of special savings
account, certificates of deposit are really credit instruments.
They recognize money “borrowed” by the bank from its
depositor (6)
A certificate of deposit is a promise made by a bank to pay a
payee a certain amount of money at a future time. The UCC
defines a certificate of deposit as ‘an instrument containing
an acknowledgment by a bank that a sum of money has been
received by the bank and a promise by the bank to repay the
sum of money. A certificate of deposit is a note of the bank’.
(7)
5. Permanency and portable. Permanency requirement is a requirement
of negotiable instruments that says they must be in a permanent state,
such as written on ordinary paper. Portability requirement is a
requirement of negotiable instruments that says they must be able to be
easily transported between areas. (2)
6. Nonnegotiable Contract. If a promise or order to pay does not meet one
of the previously discussed requirements of negotiability, it is a
nonnegotiable contract. As such, it is not subject to the provisions of UCC
Article 3 (NIL). The contract, however, is not rendered either
nontransferable or nonenforceable. A nonnegotiable contract can be
enforced under normal contract law. If the maker or drawer of a
nonnegotiable contract fails to pay it, the holder of the contract can sue the
nonperforming party for breach of contract. (2)
7. Law Merchant. In England prior to about A.D. 1400, all disputes between
merchants were settled on the spot by special courts set up by the
merchants. The rules applied by these courts became known as the law
merchant. (3)
8. Bond. A bond is a written contractual obligation, usually under seal,
generally issued by a corporation, a municipality, or a government, that
contains a promise to pay a sum certain at a fixed or determinable future
time. In addition to the promise to pay, it will generally contain certain
other conditions and stipulations. A bond issued by a corporation is
generally secured by a deed of trust on the property of the corporation. A
bond may be a coupon bond or a registered bond. (3)
9. Coupon Bond. A coupon bond is so called because the interest payments
that will become due on the bond are represented by detachable individual
coupons to be presented for payment when due. Coupon bonds and the
individual coupons are usually payable to the bearer, as a result, they can
be negotiated by delivery. There is no registration of the original purchaser
or any subsequent holder of the bond. (3)
10. Registered bond. A registered bond is a bond payable to a named
person. The bond is recorded under that name by the organization issuing
it to guard against its loss or destruction. When a registered bond is sold,
a record of the transfer to the new bondholder must be made under the
11. Collateral Note. A collateral note is a note secured by personal
property. The collateral usually consists of stock, bonds, or other written
evidences of debt, or a security interest in tangible personal property given
by the debtor to the payee-creditor. (3)
12. Debentures. An unsecured bond or note issued by a business firm is
called debentures. A debenture, like any other bond, is nothing more or
less than a promissory note, usually under seal. It may be embellished with
gold-colored edges, but this does not in any way indicate its value. A
debenture is usually negotiable in form. (3)
13. Certified check. A certified check is an ordinary check accepted by an
official of the drawee bank. The official accepts it by writing across the face
of the check the word certified, or some similar word, and signing it. Either
the drawer or the holder may have a check certified. The certification of
the check by the bank has the same effect as an acceptance. It makes the
bank liable for the payment of the check and binds it by the warranties
made by an acceptor. A certification obtained by a holder releases the
drawer from liability. (3)
A certified check is a check that has been drawn by a
depositor and then accepted by the bank on which it is drawn.
(4)
A certified check is one that has been accepted by the drawee
bank. In other words, the bank has assumed primary liability
and agreed to pay the check upon a later presentment. (6)
Certified check: A check accepted by the bank on which it is
drawn (7)
14. Cashier’s Check. A check that a bank draws on its won funds and that
the cashier or some other responsible official of the bank signs is called a
cashier’s check. It is accepted for payment when issued and delivered.
Such a check may be used by a bank in paying its own obligations, or it may
be used by anyone else who wishes to remit money in some form other
than cash or a personal check. (3)
When a bank draws a check on itself, the check is called a
cashier’s check and is a negotiable instrument on issue. (4)
Cashier’s check means a draft with respect to which a drawer
and drawee are the same bank or branches of the same bank.
(6)
Cashier’s check means a draft with respect to which a drawer
and drawee are the same bank or branches of the same bank.
(7)
15. Voucher Checks. A voucher check is a check with a voucher attached.
The voucher lists the items of an invoice for which the check is the means
of payment. In business the drawer of the check customarily writes on the
check such words as In full of account, For invoice NO. 1622, or similar
notations. These notations make the checks excellent receipts when the
returned to the drawer. (3)
16. Bad Check. A bad check is a check that the holder sends to the drawee
bank and the bank refuses to pay, normally for insufficient funds. Usually
these statutes state that if the check is not made good within a specific
period, such as ten days, a presumption arises that the drawer originally
issued the check with the intent to defraud. (3)
17. Stale Check. A check that is presented more than six months after its
However, unless the check is certified, the bank is not required to pay it. (3)
Stale Check. If a check is not presented to a bank within six
months of its date, the check is considered a stale check. (7)
18. Teller’s Check is usually drawn by a bank on another bank; when drawn
on a nonblank, it is payable at or through a bank. (4)
Teller’s check means a draft drawn by a bank (i) on another
bank, or (ii) payable at or through a bank. (6)
Teller’s check is similar to a cashier’s check in that both the
drawer and the drawee are banks. However, a teller’s check
is different because it is a check that is drawn by one bank
and usually drawn on another bank. In other words, bank A
is the drawer while bank B is the drawee. (7)
19. Traveler’s Check is an instrument that is payable on demand, drawn on
or payable at a bank and designated as a traveler’s check. (4)
Traveler’s Check means an instrument that (i) is payable on
demand, (ii) is drawn on or payable at or through a bank, (iii)
is designated by the term “traveler’s check” or by a
substantially similar term, and (iv) requires as a condition to
payment, a countersignature by a person whose specimen
signature appears on the instrument. (6)
Traveler’s Check An instrument that (i) is payable on demand,
(ii) is drawn on or payable at or through a bank, (iii) is
designated by the term “traveler’s check” or by a
substantially similar term, and (iv) requires as a condition to
payment, a countersignature by a person whose specimen
signature appears on the instrument. (7)
20. Fixed Amount of Money Requirement. A holder of a negotiable
instrument must know how much money is to be received when the
instrument is paid. The amount is commonly specified exactly, which
makes the determination simple, but this is not necessary to satisfy the
fixed amount of money requirement. (6)
Sum certain in money. Negotiable instruments must promise
or order that payment be made in a national currency. For
example, US dollars, English pounds, euros, and Japanese yen
all satisfy the currency requirement. Bushels of apples, gold,
shares of stock, diamonds and rare gems, and the lie, are not
currencies. While promises to pay in apples or gold or stock
may form a perfectly enforceable contract, the resulting
instrument is not a negotiable instrument. (7)
21. Demand Instruments. The payee (or subsequent holder) can demand
actual payment at any time. The UCC (Uniform Commercial Code) defines
an instrument “payable on demand” as one that ‘(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’. With a time
instrument, payment can be made only at a specific time designated in the
future. The UCC requires that an ‘instrument payable at a definite time’
have a time easily determined from the document itself. (7)
22. Discharge of liability on instrument. When a party’s liability for a
negotiable instrument is terminated, this party’s liability has been
discharged. In other words, the party is released from liability. Discharged
can occur through a variety of ways. (7)
Discharge through payment and tender payment, discharged
1
 by cancellation or renunciation, discharge by reacquisition,
discharge by impairment of recourse, discharge by
impairment of collateral. (7)
Discharge by impairment of recourse. A right to recourse is
the ability of a party to seek reimbursement. If the holder has
in some way impaired the endorsers’ ability to seek recourse
from any of these parties, the endorser is not liable on the
instrument. (7)
Discharge by impairment of collateral. If a party posts
collateral to ensure his performance of the negotiable
instrument and the holder of the collateral impairs the value
of the collateral, the party to the instrument is discharged
from the instrument to the extent of the damage to the
collateral. (7)
23. The Truth-In-Savings Act. In an effort to allow consumers to be better
informed, Congress (US) passed the Truth-in-Savings Act (TISA) in 1991.
TISA requires that depositary institutions disclose, in great detail, the terms
and conditions of their accounts. Depositary institutions include
commercial banks, savings banks, credit unions and savings and loan
associations. (7)
II. SECTIONS 14, 15 and 16/INDORSEMENT
1. Unqualified indorsement. An indorsement whereby the indorser
promises to pay the holder or any subsequent indorser the amount of the
instrument if the maker, drawer, or acceptor defaults on it. (2)
2. Red Light Doctrine. A holder cannot qualify as a holder in due course if
he or she has notice that the instrument contains an unauthorized
signature or has been altered or that there is any adverse claim against or
defense to its payment. This rule is common referred to as the red light
doctrine. (2) (Section 52 (d))
3. Trailing Edge. Banks required that an indorsement on a check be on the
back and within one and a half inches of the trailing edge. The trailing edge
is the left side of a check when looking at it from the front. If the indorser’s
signature appears elsewhere and it cannot be determined in what capacity
the signature is made, it will be considered an indorsement. (3)
4. Allonge. An allonge is a paper so firmly attached to an instrument as to
become a part of it. If a party does not wish to be liable as an indorser, the
instrument can be assigned by a written assignment on a separate piece of
paper. (3)
If there is no room on the instrument, the indorsement can
be written on a separate piece of paper, called an allonge
(pronounced uh-lohnj). The allonge must be “so firmly
affixed (to the instrument) as to become a part thereof”. Pins
or paper clips will not suffice. Most courts hold that staples
are sufficient. (4)
If there is no room on the instrument or if all the room has
been taken by previous endorsements, an allonge may be
attached. An allonge is simply an additional piece of paper
with the endorsements. It must be firmly attached. (7)
5. Blank Indorsement. As the name indicates, a blank indorsement is one
having no words other than the name of the indorser. If the instrument is
a bearer paper, it remains bearer paper when a blank indorsement is made.
(3)
A blank indorsement specifies no particular indorsee and can
consist of a mere signature. (4)
A blank indorsement does not specify the party to whom the
instrument is to be paid. The normal form of a blank
indorsement is a mere signature by the holder. Such an
indorsement makes the instrument bearer paper. (6)
A blank endorsement is simply the payee’s or last endorsee’s
signature, nothing else. The effect of this unqualified, blank
endorsement is that it turns the previous order paper into
bearer paper. An instrument with an unqualified, blank
endorsement may now be negotiated by delivery only. (7)
6. Special Indorsement. A special indorsement designates the particular
person to whom payment should be made. After making such an
indorsement, the paper is order paper, whether or not it was originally so
payable or was originally payable to bearer (Warning! This is contrary to
our law [section 40] read this part with caution see Plate II). (3)
A special indorsement identifies the person to whom the
indorser intends to make the instrument payable. (4)
A special indorsement specifies the party to whom the
instrument is to be paid or to whose order it is to be paid.
This means that a special indorsement makes (or leaves) the
instrument payable “to order”. (6)
A special endorsement is the endorser’s signature along with
a name endorsee. Note that in an endorsement, the words
of negotiability, to order of, are not needed. The instrument
remains negotiable. The effect of this kind of endorsement is
that it keeps order paper as order paper and thus continues
to require an endorsement and delivery for further
negotiation. (7)
7. Qualified Indorsement. A qualified indorsement has the effect of
qualifying, thus limiting, the liability of the indorser. This type of
indorsement is usually used when the payee of an instrument is merely
collecting the funds of another. (3)
An indorser who does not wish to be liable on an instrument
can use a qualified indorsement to disclaim this liability. The
notation “without recourse” is commonly used to create a
qualified indorsement. (4)
Qualified endorsements. As with unqualified endorsements,
there are two versions of qualified endorsements: blank
qualified endorsements and special qualified
endorsements. What makes them qualified is the addition of
the words without recourse. When negotiable instruments
are passed from one party to another, the person transferring
the instrument is guaranteeing certain aspects of the
instrument by virtue of his or her signature. Endorsing the
instrument with the restrictive endorsement without
recourse states that the endorser does not intend to be
bound to this guarantee. (7)
8. Restrictive Indorsement. A restrictive indorsement is an indorsement
that attempts to prevent the use of the instrument for anything except the
stated use. The indorsement may state that the indorsee holds the paper
for a special purpose or as an agent or trustee for another or it may impose
a condition that must occur before payment. (3)
A restrictive indorsement requires the indorsee to comply
with certain instructions regarding the funds involved but
does not prohibit further negotiation of the instrument.
(Warning! This is contrary to our law [section 37] and
Natividad Gempesaw vs. Court of Appeals G.R. No. 92244,
February 9, 1993 read this part with caution) (4)
A restrictive indorsement purports to prohibit any further
negotiation of the instrument, contains a condition restricting
any further negotiation, contains words that indicate it is to
be deposited or collected, such as “for deposit”, “for
collection”, or “pay any bank,” or it has some other
restriction specified as to its use. (6)
Restrictive endorsements attempt to either limit the
transferability of the instrument or control the manner of
payment under the instrument. Such an endorsement does
not succeed in its attempt. No type of endorsement can
prohibit further transfer; in other words, once an instrument
is negotiable, it remains negotiable. (Warning! This is
contrary to our law [section 37] and Natividad Gempesaw vs.
Court of Appeals G.R. No. 92244, February 9, 1993 read this
part with caution) (7)
Conditional Indorsements. When payment depends on the
occurrence of some event specified in the indorsement, the
instrument has a conditional indorsement. (4)
Conditional endorsement. The endorser can
put a condition on payment (one that if it were
on face of the instrument would destroy
negotiability, but it does not affect negotiability
here). However, it does not affect the ability of
the instrument to be further negotiated. (7)
Indorsement for Deposit or Collection. A common type of
restrictive indorsement make the indorsee (almost always a
bank) a collecting agent of the indorser. (4)
The most comment restrictive endorsement is
the endorsement for deposit or collection
only. Signing the back of a check with an
unqualified blank endorsement and the adding
“for deposit only” turns that endorsement into
a blank restrictive endorsement. The check
cannot be cashed; it can only be deposited into
an account – any account. (7)
Trust Indorsement. Indorsements to person who are to hold
or use the funds for the benefit of the indorser or a third party
are called trust indorsements (also known as agency
indorsements). (4)
Trust Indorsement. This kind of endorsement
is used when the instrument is being
transferred to an agent or trustee for the
benefit of either the endorser or a third party.
(7)
9. Incomplete or inchoate bill. This is a bill lacking in some material
particular. (5)
10. Bills in a set. It is common for bills from abroad to be drawn in sets of
two, three or more “parts” (copies), three being the most usual number.
The object is to avoid delays which would arise, say from the loss of the sole
copy of the bill. The rules relating to these bills, labeled as a rule, “First of
Exchange (second and third of same tenor being unpaid)”, which avoids
duplication of liability, of payment, and so on. (5)
11. Transfer. Negotiable instruments are intended to “flow” through the
commercial world. In order to “flow”, the instrument needs to be
transferred from person to person. The form these transfers take
determines the rights that can be asserted by each person gaining
possession of the negotiable instrument. (6)
12. Negotiation. Obviously, something more is needed to protect the
possessor of the commercial paper and to facilitate the free flow of
commercial paper through commercial channels. That “something more”
is provided by the UCC, and it is known as negotiation. (6)
Negotiation. When the rights to a negotiable instrument are
transferred from one party to another, such a transfer is
called negotiation. In understanding the rules on negotiation,
it is important to understand that the rules are slightly
different depending on whether the instrument is an order
instrument or a bearer instrument. Bearer paper requires
only delivery of the instrument to the holder by the payee. In
contrasts, order paper requires delivery and an endorsement.
(7)
III. FORGERY AND MATERIAL ALTERATION
1. Unauthorized Signatures. People are not normally liable to pay on
negotiable instruments unless their signatures appear on the instrument.
Hence, an unauthorized signature is wholly inoperative and will not bind he
person whose name is forged. There are exceptions to this rule. If the
person whose unauthorized signature was used ratifies that signature or is
in some way precluded from denying it, then the unauthorized signature is
operative. (1)
An unauthorized signature is one made without any
authority, expressed or implied, and it includes a forgery. An
unauthorized signature is wholly inoperative against the
person whose name was signed unless that person later
ratifies the signing. (6)
2. Imposter Rule. An imposter is one who, by use of the mails, telephone,
or personal appearance, induces a maker or drawer to issue an instrument
in the name of an impersonated payee. The maker or drawer honestly
believes that the imposter is actually the named payee and issues the
instrument to the imposter. Since the maker or drawer did issue and intend
the imposter to receive the instrument, the indorsement by the imposter
is not treated as unauthorized when the instrument is transferred to an
innocent party. (1)
For purposes of the imposter rule, an imposter is one who
impersonates a payee and induces the maker or drawer to
issue an instrument in the payee’s name and give the
instrument to the imposter. If the imposter forges the
indorsement of the named payee, the drawer or maker is
liable on the instrument to any person who, in good faith,
pays the instrument or takes it for value or for collection. This
rule is called the imposter rule. (2)
An imposter is one who, by her or his personal appearance or
use of the mail, telephone, or other communication, induces
a maker or drawer to issue an instrument in the name of
impersonated payee. If the drawer or maker believes the
imposter to be the named payee at the time of issue, the
indorsement of the imposter is not treated as unauthorized
2
 when the instrument is transferred to an innocent party. (4)
Under the UCC’s imposter rule, if a maker or drawer issues a
negotiable instrument to an imposter, the imposter’s
endorsement will be effective. The court considers the intent
of the drawer or maker when issuing the instrument. (7)
3. Fictitious Payee Rule. The so-called fictitious payee rule deals with an
instrument issued in the name of a payee with intention that the payee
have no interest in the instrument. The payee need not be fictitious (that
is, the payee may be a real person). The determining factor is that the
maker or drawer, or another party who has supplied the payee’s name to
the maker or drawer, intends that the payee not be the party to receive the
proceeds when payment is made on the instrument. (1) (Also PNB vs.
Rodriguez, G.R. No. 170325, September 26, 2008)
A drawer or maker is liable on a forged or unauthorized
indorsement under the fictitious payee rule. This rule applies
when a person signing as or on behalf of a drawer or maker
intends the named payee to have no interest in the
instrument or the person identified as the payee is a fictitious
person. (2)
An unauthorized indorsement will also be effective when a
person causes an instrument to be used to a payee who will
have no interest in the instrument. In this situation, the payee
is referred to as a fictitious payee. (4)
4. Material Alteration. The UCC defines a material alteration as “an
unauthorized change in an instrument that purports to modify in any
respect the obligation of a party, or an unauthorized addition of words or
numbers or other change to an incomplete instrument relating to the
obligation of a party” (UCC, 3-407)
IV. RIGHTS AND LIABILITIES OF PARTIES
1. Shelter Principle. A person who does not qualify as a holder in due
course but who derives his or her title through a holder in due course can
acquire the rights and privileges of a holder in due course. If a holder was a
party to fraud or illegality affecting the instrument, or if, as a prior holder,
he or she had notice of a claim or defense against an instrument, that
holder is not allowed to improve his or her status by repurchasing from a
later holder in due course. (1)
Holder Through a Holder in Due Course. The first holder in
due course brings into operation all the protections that the
law has placed around negotiable instruments. When these
protections once accrue, they are not easily lost.
Consequently a subsequent holder, known as a holder
through a holder in due course, may benefit from them even
though not a holder in due course. (3)
Holder by Due Negotiation. When a document is negotiated
to a person who purchases the instrument in good faith and
the purchaser takes the document without notice of any
defense against or claims to the goods or the document, the
instrument has been duly negotiated. This makes the
recipient of the document a holder by due negotiation
(HDN), a preferred and protected status in the area of
documents of title. (6)
Generally, if an item is transferred from one person to
another, the transferee acquires all the rights that the
transferor had in the item. This idea is called the shelter
principle. Therefore, following the shelter principle, even if a
holder cannot attain holder in due course status, the holder
can acquire the rights and privileges of a holder in due course
if the item is being transferred from a holder in due course.
(7)
Shelter Rule. It is basic rule at common law that whenever
property is transferred, the transferee acquires at least
whatever rights the transferor had in that property. Because
a negotiable instrument is a type of property, this principle
applies to the transfer of an instrument. Thus, it is possible
to acquire the rights of a holder in due course without
actually becoming one. This can be done by “taking shelter”
in the holder in due course rights of one’s transferor. The
rights one acquires by the shelter rule are no different from
true holder in due course rights. The shelter rule assures the
holder in due course of a free market for the instrument. (8)
Party to the Fraud Exception. There is an
important exception to the shelter rule. This
rule cannot confer holder in due course
protection to one who is involved in any fraud
or illegality with respect to the instrument. (8)
2. Wrongful Dishonor. If the bank does not honor a check when there are
sufficient funds in a drawer’s account to pay a properly payable check, it is
liable for wrongful dishonor. The payer bank is liable to the drawer for
damages proximately caused by the wrongful dishonor as well as for
consequential damages, damages caused by criminal prosecution, and
such. (2)
If a bank wrongfully fails to pay a check – wrongfully
dishonoring the check – the bank may be liable to the
customer for damages. The UCC clearly states that banks can
be held liable, but it does not cite a specific theory for
recovery. Therefore, someone whose check was dishonored
need prove only that the dishonoring was wrongful, and he
or she will be entitled to recovery. (7)
Under the properly payable rule, a bank has a duty to pay
checks from customer’s account as long as the check is
“properly payable”. In other words, the check must be
authorized by the drawer and must not violate the agreement
between the bank and the customer. (7)
Duties of the bank. Remember that the drawee bank makes
no promise to third parties to pay items. The promise to pay
a check is in the contract between the customer-drawer and
the bank. As part of this contract the bank promises to pay
items that are properly payable. Most of the controversies
in this regard arise either from the bank paying an item that
is not properly payable or failing to pay an item that is
properly payable. (8)
3. Jus Tertii. The contract of the obligor is to pay the holder. The doctrine
of jus tertii concerns claims and defenses of a person other than the
obligor. Under the doctrine, the rights of a third party cannot be used even
against a mere holder. (8)
4. The Collection Process. Payor bank, the bank where the drawer has a
checking account and on which the check is drawn. Depositary bank, the
bank where the payee or holder has an account. Collecting bank, the
depositary bank and other banks in the collection process (other than the
payor bank). Intermediary bank, a bank in the collection process that is
not the depositary bank.(2)
Designation of Banks Involved in the Collection Process. The
first bank to receive a check for payment is the depositary
bank. The bank on which the check is drawn (the drawee
bank) is called the payor bank. Any bank except the payor
bank that handles a check during some phase of the
collection process is a collecting bank. Any bank except the
payor bank or the depository bank to which an item is
transferred in the course of this collection process is called an
intermediary bank. (4)
Types of Banks Involved in Check Collection. The check
collection process is established by Article 4 of the UCC.
Section 4-105 of the UCC defines the four types of banks that
may be involved in the check collection process. Depository
bank the first bank accepting a check for payment. Payor
bank the bank ultimately responsible for granting funds for
the check. Collecting bank a bank, other than the payor bank,
handling the check at any point from the time the check is
deposited to the time it reaches the payor bank.
Intermediary bank, a bank receiving a transferred check
during the collection process [excluding the first bank
(depositary) and the last bank (payor)]. (7)
Presenting bank is any bank presenting an
item. (8)
5. Good Faith. Good faith is defined as “honesty in fact in the transaction.”
This requirement is actually measured by a negative test. The holder acted
with good faith if bad faith is not present. (6)
Taking Instrument in Good Faith. Historically there has some
debate about whether good faith had an objective or
subjective definition. Looking at good faith in an objective
sense means considering what the reasonable holder would
have done. However, other courts look at good faith in a
subjective sense by asking whether the holder acted honestly
when taking the instrument. To look at good faith in a
subjective sense means considering the holder’s actual
behavior. (7)
The UCC’s definition of good faith is somewhere in the middle
of the subjective and objective standard. The UCC defines
good faith as “honesty in fact and the observance of
reasonable commercial standards of fair dealing” [UCC, 3-
103(a)(4)] (7)
6. “On Us” checks. If the drawer and the payer or holder have accounts at
the same bank, the depositary bank is also the payer bank. The check is
called an “on us” item it is presented for payment by the payee or holder.
In this case, the bank has until the opening of business on the second
banking day following the receipt of the check to dishonor it. If it fails to
do so, the check is considered paid. The payee or holder can withdraw the
funds at this time [UCC, 4-215(e) (2), note no parallel provision in the NIL].
(2)
7. “On Them” checks. If the drawer and the payee or holder have accounts
at different banks, the payor and depository bank are not the same bank.
In this case, the check is called an “on them” item. (2)
8. Electronic fund transfer system (EFTS). Electronic fund transfer is a
transfer of money made with the use of an electronic terminal, a telephone,
a computer, or magnetic tape. Automatic payments, direct deposits, and
other fund transfers are now made electronically; no physical transfers of
cash, checks, or other negotiable instruments are involved. Electronic fund
transfer transactions eliminate the float time that the drawer of a check
currently enjoys by retaining the use of funds during the period between
the check’s issuance and final payment. (1)
Electronic payment and collection system that are facilitated
by computers and other electronic technology. (2)
An electronic fund transfer (EFT) is a transfer of money made
by the use of an electronic terminal, a telephone, a computer,
or magnetic tape. (4)
Recent technological advances have provided banking with a
new method of doing business and with a new type of service.
This new method of doing business is the electronic funds
transfer (EFT), which allows for computerization of checking
accounts and for theoretically faster, more accurate banking
transactions. (6)
9. Automated Teller Machines. A major Electronic Fund Transfer Systems
development involved the automated teller machine (ATM), also called a
customer-bank communications terminal or remote service unit.(1)
An electronic fund transfer system at a convenient location
that is connected on-line to the bank’s computers; customers
use ATMs to withdraw cash from bank accounts, cash checks,
make deposits, and make payments owned to the bank. (2)
Automated Teller Machines (ATMs), machines connected to
a bank’s computer, are located in convenient places so that
customers may conduct banking transactions without
actually going into a bank. Customers may withdraw and
deposit money, as well as check the balance of their savings
and checking accounts. (7)
10. Point-of-Sale Systems. Point-of-sale systems allow consumers to
transfer funds to merchants to pay for purchases. On-line terminals are
located at checkout counters in, for example, grocery stores. Instead of
receiving cash or a check from the customer, the checkout person inserts
the customer’s card into a terminal, which reads the data encoded on the
card. The computer at the customer’s bank verifies that card and that there
are enough funds in the customer’s account to cover the purchase. After
the payment is made, the customer’s account is debited for the amount of
the purchase. (1)
Point-of-sale (POS) terminal is a terminal at a merchant’s
checkout counter that is connected on-line to the bank’s
computers; a debit card or credit card ca be used to make
purchases at POS terminals. (2)
Point of Sale (POS) Transactions. The first method is the
point-of-sale (POS) transaction, involving the use of a POS
terminal and a “debit” card. In a POS transaction, the
customer presents the merchant with a debit card, the
merchant imprints the card and has the customer sign, and
the funds are transferred from the customer’s account to the
merchant’s account. The transaction is similar in format to
the use of a credit card, but there should be no delay in
receiving the money from the sale for the merchant. (6)
A point of sale system allows customers to directly transfer
funds from a banking account to a merchant.
11. Pay-by-Telephone System. This allows the customer to access the
institution’s computer system by telephone and direct a transfer of funds.
3
(1)
Payment-by-Telephone or Pay-by-Computer System. Many
banks permit customers to pay bills from their bank accounts
by use of a telephone or a personal computer. (2)
Telephonic Transactions. If the bank is a participant in a
network, the customer may be able to authorize payments to
predetermined accounts by phone. Here, the customer calls
the bank and, using the buttons or a touch-tone phone, can
designate preselected “payees” who will be paid an amount
determined by punching in the amount of the “electronic
check” so that the funds are automatically transferred. (6)
12. The Bank Statement Rule. The customer must exercise reasonable care
in examining the bank statement or items to discover an unauthorized
signature or alteration and must notify the bank promptly of any
irregularities. This duty, called the bank statement duty, arises when the
bank complies with its duty to send or make the bank statement available
to the customer. The bank must either return or make the item paid
available to the customer or provide information to allow the customer to
reasonably identify the items paid. (8)
Check Truncation. A system of shortening the trip a check
makes from the payee to the drawee bank and then to the
drawer is called check truncation. Many banks no longer
return canceled checks to their customers with the monthly
statement. Instead, the form of the statement to customers
has been revised to list the check numbers. As before, the
dollar amount of the checks is shown, but the transactions
are now printed in numerical order. The customer can easily
reconcile the amount without having the canceled checks.
However, banks must be able to supply legible copies of the
checks at the customers’ request for seven years. This is a
type of check truncation. (3)
Substitute checks. To further facilitate electronic
presentment, in 2004 Congress passed the Check Clearing for
the 21st Century Act (also known as Check 21 or the Check
Truncation Act). Check 21 allows banks to forgo sending
original checks as part of the collection or return process and
instead send a truncated version. In place of the original
paper check, a bank may send (1) a substitute check or (2),
by agreement, an electronic image of the check along with
data from the magnetic ink character recognition (MICR) line
on the original check. (7)
13. Uncured Default. A purchaser who has reason to know that any part of
the principal is overdue, that an uncured default exists in payment of an
instrument in the same series, or that acceleration of the instrument has
been made has notice that the instrument is overdue. (3)
14. Digital Cash. New forms of electronic payments (e-payments) have the
potential to replace physical cash – coins and paper currency – with virtual
cash in the form of electronic impulses. This is the unique promise of digital
cash, which consists of funds stored on microchips and other computer
devices. (4)
15. E-money. Today, various forms of electronic money, or e-money, are
emerging. The simplest kind of e-money system uses stored-value cards.
These are plastic cards embossed with magnetic strips containing
magnetically encoded data. (4)
E-Money and Online Banking. Digital cash: Money stored
electronically on microchips, magnetic strips, or other
computer media. Stored-value cards: Plastic cards that
contain magnetic strips, similar to those on credit cards or
ATM cards, containing data regarding the value of the card.
(7)
16. Smart cards. Another form of e-money is the smart card. Smart cards
are plastic cards containing computer microchips that can hold more
information than a magnetic strip. (4)
Smart cards: Cards that are the same size as regular check
and ATM cards but that contain microchips, instead of a
magnetic strip, for storing larger amounts of data. (7)
17. Clearing house. An association of banks and financial institutions that
“clears” items between banks. (6)
18. Debit/ATM Cards. The bank customer inserts his or her card in the
machine, enters his or per personal identification number (PIN), and selects
a transaction. The customer can make a deposit, a withdrawal, a transfer
from one account to another, a payment, or a number of other banking
transactions. (6)
19. Preauthorized Transactions. There are preauthorized automatic
payments and preauthorized direct deposits. In both cases, regular
amounts are deducted from, or added to, customer’s account balance on
designated dates to ensure that payment (or credit) is received without any
worries about forgetting to send in the check or drive to the bank to make
the deposit. (6)
Direct deposits and withdrawals. A direct deposit or
withdrawal is a preauthorized action performed on a
customer’s account through an electronic terminal. (7)
20. Money Laundering. The false reporting of income from criminal activity
as income from legitimate business. (9)
NOTE:
Q: What is a collecting bank then? How do we answer this question if
asked?
Suggested Answer:
(a) An indorser with liabilities (Section 17 PCHC Rules; Associated
Bank vs CA, 1996 Latest is Metro Bank vs BA Finance
Corporation G.R. No. 179952, December 4, 2009
(b) A holder with rights (Bank of the Philippine Islands vs
Gregorio C. Roxas, G.R. 157833, October 15, 2007)
(c) Agent for purposes of collection (Section 4-205 of the U.S.
Uniform Commercial Code; Far East Bank vs Gold Palace, G.R.
No.168274, August 20, 2008)