Wednesday, November 25, 2015

Thanksgiving and the UCC!


Thanksgiving has always been my favorite Holiday.  One of the reasons this is so is because it transcends any particular belief or religious system, and focuses instead upon something that is universal—gratitude.  Obstacles are an inevitable reality of life, and everyone who has ever accomplished anything of value has experienced this reality.  In the face of adversity and everything that goes with it however, there is always a place for gratitude.  This may require a shift in perspective, and the utilization of the intellect to overcome feelings, but this is doable and, I submit, necessary.
This blog is certainly not the place to discuss what I am personally grateful for, but on this point, I will say that I start everyday focusing on precisely that.  In the context of this blog, I am grateful to have an avenue through which to communicate and promote a legitimate business.  I am also grateful for the knowledge gained in this process, both as to the substantive content of certain Code sections, as well as the knowledge gained through the discipline of the writing process.  These blogs are challenging which creates a pathway toward personal improvement.
 I am grateful for the opportunities that the Uniform Commercial Code has created for me throughout my lifetime.  Through the Uniform Commercial Code I had the privilege of knowing and working with some of the finest legal minds in history, who taught me as a student and from whom I continued to learn as a professor.  After twenty-one years out of the legal world—working with abused, neglected and incarcerated minors in California—the Uniform Commercial Code opened the door to my return to teaching law.   The change from Los Angeles County Central Juvenile Hall to the Stetson University College of Law was so dramatic it was humorous.  This after all, was the first group of students in twenty years who weren’t sentenced to be with me—although a couple of them felt like they were.
The teaching led to the rewrite of The Uniform Commercial Code Made Easy which has been extremely helpful at all levels of my dealings with the legal community. I believe the manner in which the book presents the UCC was instrumental in providing me the opportunity to teach the UCC in one day for CLE credit to bar associations throughout the United States, as well as the consulting opportunities which have followed. Of equal significance, the UCC has opened doors for me to present programs on children at risk to bar associations and staff in residential and correctional facilities.  On March 18, 2016, for example, I have the great opportunity to present to the Missouri Juvenile Justice Association and attorneys and judges who work with the full spectrum of children at risk, the day after a UCC presentation for members of the Missouri Bar Association.
I am also grateful that I had the opportunity to be educated which made the UCC experience possible.  Being given a shot at life is all anyone can ask for.  When I witnessed the incredible obstacles and barriers faced by children with no money, little food and no hope, I understood in a whole new way how fortunate I was to be born into a home where I was offered the opportunity to go to college and then law school.  Within this context, the biggest blessing that I had was the absolute, rock solid belief that life is very important and that the best investment I could make was to invest my full energy and resources into improving my mind and improving myself as a person.
We all have the opportunity everyday to create our reality. I submit that a reality that incorporates gratitude as a cornerstone principle will create a better life.  In an earlier post I presented the concept of the reactionary mind and how to overcome automatic reactions that the brain has to certain events and input presented by life.  This discussion offers a very practical example of the application of some of those principles:
Each time your brain reacts negatively—to anything—respond by thinking of something you are grateful for. 
It’s all physics.
In 2007 I was doing a presentation in Irvine California.  The room I had been given was right next to the elevator, which had a very loud ring each time someone exited—which seemed to be very often.  Initially I was furious each time the elevator opened and deprived me of sleep.  I could feel my blood pressure rise and of course the corresponding anger.  After suffering through this experience for several hours, I had a breakthrough. I decided that each time I heard the elevator bell, instead of being angry, I would be grateful I could hear! ……………It worked.
                                          Happy Thanksgiving

Thursday, November 19, 2015

What are the Goods?


As of this writing, most of Articles 1 and 3 have been completed, and while there are other sections which could be discussed in Article 3, I am confident that anyone who understands the posts to date will be able to analyze those sections.  Going forward, I will be combining posts from Articles 2, 7, and 9.  Article 2 deals with sales of goods; Article 7 deals with movement and storage of goods via documents of title; and Article 9 deals with secured financing, and while there are many types of non goods collateral, Article 9 has many provisions which deal with the secured financing of goods at the wholesale and retail level. 
At the outset, it must be noted that although Article 2 deals with sales, the scope of Article 2 applies to ‘transactions in goods’:
Unless the context otherwise requires, this Article applies to transactions in goods; it does not apply to any transaction which although in the form of an unconditional contract to sell or present sale is intended to operate only as a security transaction nor does this Article impair or repeal any statute regulating sales to consumers, farmers or other specified classes of buyers.
                                      
                                                                                    Section 2-102
Most of the time, the applicability of Article 2 will be very straightforward—the transaction involved will be a typical sale of goods and Article 2 will apply.  In some situations however, the transaction involved will be a combination of a sale and a service requiring further analysis to determine whether or not a particular combined transaction is within the scope of Article 2.
            Before addressing the scope issue as it relates to mixed transactions, a more basic question must be addressed; namely, what are ‘goods’, the essential ingredient of Article 2. Goods are defined under Section 1-205 as follows:
(1)  "Goods" means all things (including specially manufactured goods) which are movable at the time of identification to the contract for sale other than the money in which the price is to be paid, investment securities (Article 8) and things in action. "Goods" also includes the unborn young of animals and growing crops and other identified things attached to realty as described in the section on goods to be severed from realty (Section 2-107).
Goods, therefore, are tangible personal property which are ‘movable’ at the time of identification to the contract for sale.  Note that when money is used as a payment mechanism, it is excluded from the definition of goods.  If however, money is being sold as a commodity, it will come within the definition of goods.  This point is specifically addressed in comment 1 to Section 2-105 which states as follows:
Goods is intended to cover the sale of money when money is being treated as a commodity but not to include it when money is the medium of payment.
In order for an interest in goods to pass, the goods must be ‘existing and identified’:
Goods must be both existing and identified before any interest in them can pass. Goods which are not both existing and identified are "future" goods. A purported present sale of future goods or of any interest therein operates as a contract to sell.                     Section 2-105(2)
Several exceptions/qualifications to this general rule are contained in Section 2-107 which is cross referenced in Section 2-105(1).  Section 2-107(1) states as follows:
A contract for the sale of minerals or the like (including oil and gas) or a structure or its materials to be removed from realty is a contract for the sale of goods within this Article if they are to be severed by the seller but until severance a purported present sale thereof which is not effective as a transfer of an interest in land is effective only as a contract to sell.
There are three situations contemplated by Section 2-107(1):
1.    Sale of minerals ‘or the like’, specifically including oil and gas;
2.    Sale of a structure to be moved from realty;
3.    Sale of the materials of a structure to be removed from realty.
In order for a sale of the foregoing to be within Article 2, severance of those items must be undertaken by the seller.  Further, until severance, there can be no present sale of those items unless there is an accompanying transfer of the real estate interest.  Absent such a real estate transfer, any contract for the sale of the items listed will be treated’ only as a contract to sell’.
            The foregoing is consistent with basic real estate law. Oil, gas and mineral rights generally are treated as part of the real estate on which they are located.  Hence, absent a sale of the land, there is no sale of these goods.  This is also consistent with Article 9 which characterizes oil, gas and mineral rights as ‘as extracted collateral’, which is defined under Section 9-102(a)(6) as follows:
                         "As-extracted collateral" means:
(A) oil, gas, or other minerals that are subject to a security interest that:
(i) is created by a debtor having an interest in the minerals before extraction; and
(ii) attaches to the minerals as extracted; or
(B) ….
While the oil, minerals and gas are in the ground, they are treated as real estate.  Upon extraction they become goods, and hence within the scope of a secured transaction under Article 9.
            The scenario contemplated by Section 2-107(1) is to be distinguished from the situation where the goods involved are attached to realty but are capable of removal without ‘material harm’ to the realty:       
A contract for the sale apart from the land of growing crops or other things attached to realty and capable of severance without material harm thereto but not described in subsection (1) or of timber to be cut is a contract for the sale of goods within this Article whether the subject matter is to be severed by the buyer or by the seller even though it forms part of the realty at the time of contracting, and the parties can by identification effect a present sale before severance.
 In the situation contemplated by Section 2-107(2), severance can be made by either party, and the parties can conduct a present sale of those goods before severance by identification of the goods involved.
           

Thursday, November 12, 2015

Imposters, Fictitious Payees & Effective Indorsements


The basic rule regarding liability on an instrument is expressed in Section 3-401: if a person does not sign the instrument, he or she is not liable on the instrument.  In addition to this basic rule, Section 3-401(a) also provides the first exception to the general rule by providing that a party can be liable on an instrument by an agent’s signature.  It was noted in our discussion of Section 3-402 that the principal in such a situation can be held liable on an instrument even if not specifically named by the agent, assuming that the authority did in fact exist.  Another exception to the general rule was discussed in connection with Section 3-406.  In that situation, a person whose negligence ‘substantially contributed’ to the forgery will be precluded from asserting the forgery against a ‘person who, in good faith, pays the instrument or takes it for value or for collection’.  Hence, liability can be established without the signature having been made.
            This post will discuss a different scenario pertaining to signatures which is activated by the imposter and fictitious payee rules of Section 3-404.  Section 3-404(a) states as follows:
If an impostor, by use of the mails or otherwise, induces the issuer of an instrument to issue the instrument to the impostor, or to a person acting in concert with the impostor, by impersonating the payee of the instrument or a person authorized to act for the payee, an indorsement of the instrument by any person in the name of the payee is effective as the indorsement of the payee in favor of a person who, in good faith, pays the instrument or takes it for value or for collection.
Section 3-406(a) envisions two situations: 
                     Situation # 1:
1.    An imposter;
2.    An issuer who has been ‘induced by the imposter’—by the mails or otherwise-- to issue the instrument to the imposter;
      Situation # 2:
1.    An imposter induces the issuer to issue the instrument to:
·      A person acting in concert with the imposter who impersonates the payee of the instrument; or
·      A person acting in concert with the imposter who impersonates a person authorized to act for the payee.
Examples of the application are relatively simple and straightforward.  In situation # 1, the imposter is simply pretending to be someone he or she is not. The issuer has bought into the scheme and issues an instrument to the imposter.  In situation #2, the accomplice of the imposter is pretending to be the intended payee or someone authorized to act for the payee.
Section 3-406(a) goes on to state that if an instrument so issued is subsequently indorsed ‘by any person’ in the name of the payee to a person ‘who, in good faith, pays the instrument or takes it for value or collection’, such indorsement is ‘effective as that of the payee’.  Assume for example that Imposter induced Issuer to deliver a check for $25,000.00 to the Imposter who claimed to be Fred Jones.  The Imposter’s signature as ‘Fred Jones’ is effective as that of Fred Jones as regards a person who in good faith paid the instrument or took it for value or for collection.  As such, the drawer is liable on his or her drawer’s contract, at least initially. [Exception to be discussed below.]
  The signature in the foregoing example is ‘effective’ even though Fred Jones does not exist. Similarly, if Imposter induced Issuer to deliver a $25,000.00 check payable to Fred Jones to someone pretending to be Fred Jones, or someone authorized to act for Fred Jones, a subsequent indorsement in the name of Fred Jones is effective as that of Fred Jones  to a person who in good faith paid the instrument or took it for value or collection.
Note that the language states that the indorsement ‘by any person in the name of the payee is effective as the indorsement of the payee in favor of someone who pays in good faith or has taken the instrument for value or collection’.  Therefore, if the Imposter or his colleague loses the check and someone else picks it up and indorses ‘Fred Jones’ that too will be considered an effective indorsement to someone who in good faith paid the instrument or took it for value or collection.
The policy of section 3-404(a) is simple: it was the drawer of the check that got duped into issuing the check.  Therefore, the drawer will not be relieved of liability on the check to a person who in good faith paid the instrument or took it for value or consideration.  This is analogous to the rule discussed in the last post, and consistent with the general policy of the Uniform Commercial Code in placing responsibility on parties whose culpable conduct set the series of transactions in motion.
Section 3-404(b) applies to cases dealing with not just fictitious payees, but also instruments issued to existing payees that the issuer does not intend to have any interest in the instrument.  That section also states certain rules with regard to such an instrument prior to any special indorsement on the instrument:
(b) If (i) a person whose intent determines to whom an instrument is payable (Section 3-110(a) or (b)) does not intend the person identified as payee to have any interest in the instrument, or (ii) the person identified as payee of an instrument is a fictitious person, the following rules apply until the instrument is negotiated by special indorsement:
(1) Any person in possession of the instrument is its holder.
(2) An indorsement by any person in the name of the payee stated in the instrument is effective as the indorsement of the payee in favor of a person who, in good faith, pays the instrument or takes it for value or for collection.

It is interesting to note that in such a situation, an indorsement in the name of the payee ‘substantially similar’ to that of the payee will be effective and further, if such an instrument is taken to a depository bank and deposited in an account in a name ‘substantially similar’ to the payee, it will be treated as an effective indorsement.  The latter is true even if the instrument has not been indorsed:
(c) Under subsection (a) or (b), an indorsement is made in the name of a payee if (i) it is made in a name substantially similar to that of the payee or (ii) the instrument, whether or not indorsed, is deposited in a depositary bank to an account in a name substantially similar to that of the payee.
            As stated in Section 3-404(a), the effectiveness of the Impostor’s indorsement is in favor of a ‘person who, in good faith, pays the instrument or takes it for value or collection.’  As discussed in a previous post, good faith under Article 3 means ‘honesty in fact and the observance of  reasonable commercial standards of fair dealing’ either via Section 3-103(a)(6) for those states that have not enacted the amended definition of good faith or via 1-201(b)(20) for those that have. The exception is New York who has neither enacted the amended definition of good faith or the amendments to Article 3.
            As was also discussed, the use of the words ‘reasonable commercial standards of fair dealing’ are intended to focus on the fairness of conduct, not the commercial reasonableness of conduct.  The absence of commercial reasonableness in conduct in the Imposter/Fictitious Payee situation has been addressed in Section 3-404(d):
(d) With respect to an instrument to which subsection (a) or (b) applies, if a person paying the instrument or taking it for value or for collection fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss resulting from payment of the instrument, the person bearing the loss may recover from the person failing to exercise ordinary care to the extent the failure to exercise ordinary care contributed to the loss.
Therefore, the broad statement dealing with the effectiveness of the indorsement under Section 3-404(a) is limited not only by the good faith requirement, but also by a requirement to exercise ordinary care in paying the instrument or taking it for value or collection.  Ordinary care was discussed in detail in the previous post, but it clearly requires the ‘observance of reasonable commercial standards’ in addition to the commercial fairness requirement of good faith.

Thursday, November 5, 2015

Commercial Reasonableness Strikes Again

The matter of the altered check in the Stephen’s Boats/East Dade Bank/Harold stolen check scenario seems relatively straightforward on its face:  Harold stole Jerry’s $850.00 paycheck; raised it to $8,500; crossed out Jerry’s restrictive indorsement; forged Jerry’s signature and received $8,500.00.  As discussed in the memorandum [October 15, 2015 post], East Dade, as the depository bank must see that the proceeds from the check are   ‘received by the indorser or applied consistently with the indorsement per Section 3-206(c)(2).  Neither happened, and hence the East Dade is liable for conversion.
The bank’s liability for conversion however, does not end the inquiry. Section 3-406 provides an opportunity for the bank to produce evidence showing that Stephen or Jerry ‘failed to exercise ordinary care’ which contributed to the alteration. If proven, Section 3-406(a) can be used to preclude the culpable party from asserting the alteration.  That section states as follows:
(a) A person whose failure to exercise ordinary care substantially contributes to an alteration of an instrument or to the making of a forged signature on an instrument is precluded from asserting the alteration or the forgery against a person who, in good faith, pays the instrument or takes it for value or for collection.
                  Ordinary care’ is a defined term:
"Ordinary care" in the case of a person engaged in business means observance of reasonable commercial standards, prevailing in the area in which the person is located, with respect to the business in which the person is engaged. In the case of a bank that takes an instrument for processing for collection or payment by automated means, reasonable commercial standards do not require the bank to examine the instrument if the failure to examine does not violate the bank's prescribed procedures and the bank's procedures do not vary unreasonably from general banking usage not disapproved by this Article or Article 4.  Section 3-103(a)(9).
The first sentence to Section 3-103(a)(9) explicitly requires ‘the observance of reasonable commercial standards’.  However, it is also explicitly clear that these standards are not universal; rather, they are to be judged by business practices ‘prevailing in the area in which the person is located’.  Therefore, what might be required to satisfy ‘reasonable commercial standards’ in San Francisco might be substantially different than those required in Bakersfield.
The second sentence to Section 3-109(a)(3) excuses a bank from examining an instrument if three criteria are met:
1.    The bank is processing checks via electronic means [automated];
2.    The processing of the item in question, through automated means, does not violate the prescribed procedures of the bank;
3.    The procedures utilized by the bank ‘do not vary unreasonably from general banking usage’ and are not disapproved by Article3 or Article 4.
     In order for a person to invoke Section 3-406, it must be prepared to demonstrate that it took the instrument for value. In good faith, and in accordance with reasonable commercial standards [per Sections 3-406(a) and 3-103(a)(9).  If activated, and the bank does not meet that burden, it will not be entitled to assert the defense of Section 3-406(a) against any person who was negligent within that section, regardless of a ‘substantial contribution’ or lack thereof.
      The question of ‘commercially reasonable behavior’ by a person who pays the instrument or who takes it for value or for collection can arise in a variety of ways. On the one hand, it could be something as narrow as the procedures used in cashing a check over the counter.  On the other continuum, it might involve a requirement by the bank to undertake an affirmative duty to follow the terms of a customer/bank agreement. Or, as indicated by the court, it might involve a requirement to inquire further which has been activated by the particular facts of the case.  Such was the situation in Apcoa, Inc. v. Fidelity National Bank 506 F.2d 158 (11th Cir., 1990) 12 UCC Reptr. 158 (1990). 
      Before presenting the summary of the facts, I would like bring up a point concerning human behavior, and questions often raised by students.  I believe that you will see that commercial behavior of certain bank personnel in Apcoa is so far out of line with commercial reasonableness, that you might ask ‘How can this happen?’  It happens because all of the scenarios are played out by humans.  For example, personal relationships may form that, consciously or unconsciously, eliminate the scrutiny which should accompany every transaction.  Institutionally, the bank failed by not having appropriate procedures in place which would have made the embezzlements far less likely.
      In Apcoa , plaintiff  was in the business of managing parking facilities throughout the United States.  Apcoa’s home office was in Cleveland Ohio with field offices in Atlanta.  Primary payment activities, such as payroll, were conducted through the main office in Cleveland and the Cleveland banks.  Banking arrangements were maintained with several Atlanta banks as well, with the primary purpose of these arrangements to facilitate the transfer of funds from Atlanta to the home office.  Payroll and other business expenses were paid from the Cleveland banks.
      In the summer of 1982, Apcoa’s regional manager and vice president decided to change banks due to dissatisfaction with C & S Bank of Atlanta and changed Apcoa's Atlanta banking accounts to Fidelity National Bank. In June of 1982, an account was opened at Fidelity which was to be used for petty cash expenses in the Atlanta offices.  In August of 1982, two more accounts were opened, the purpose of which were to act as depositories for proceeds from the business.
      In connection with the opening of these accounts, corporate resolution papers, including a Designation and Authorization Form, were sent from Apcoa to Fidelity.  Among other things, the Designation and Authorization form stated under what circumstances items could be properly withdrawn from the Apcoa account, and the procedure to be followed for opening Apcoa accounts.  All authorized signatures were individuals who were located at the Cleveland office.
      Despite the foregoing, probably fired Doris Moore, opened an account at Fidelity entitled: ‘Apcoa—Special Account’. in September of 1982.   In May of 1983, another account was opened by the embezzler Dolly Ison entitled:  Dolly Ison for Apcoa.  Before it ended, Dolly had netted about $260,000.  Doris allowed Dolly to deposit parking lot revenues into the two illegal accounts, despite knowing that this was in contravention of the agreement between Fidelity and Apcoa.
      At the trial court, Fidelity attempted to use Section 3-406 [pre-2002 amendment, but identical for the point being raised here], apparently asserting negligence on the part of Apcoa in allowing the scheme to take place.  Before entertaining any theories against Apcoa, the court addressed the behavior of the bank.  If that behavior was   not commercially reasonable, the inquiry ends there.
      The trial court concluded that the behavior of Fidelity was commercially unreasonable as a matter of law.  In affirming the trial court, the 11th Circuit Court of Appeals stated as follows:
Fidelity first asserts that the district court erred in finding their conduct commercially unreasonable as a matter of law. Applying the general principles associated with the defense of commercial reasonableness, this Court must disagree. After careful consideration of the undisputed facts and circumstances that occurred in connection with the two accounts used for the embezzlement, we hold that Fidelity cannot avail itself of this defense as a matter of law. The district court correctly noted that Fidelity was responsible for three acts which provided the system for the embezzlement scheme: (1) the opening of the unauthorized accounts, (2) the deposit of checks payable to Apcoa into these accounts, (3) the acceptance of checks written on these accounts on the single signature of Dolly Ison.6Additionally the district court noted that if Fidelity had prevented any of the above acts, the embezzlement scheme would have been stopped.
Fidelity's conduct was not in accordance with reasonable commercial standards where a reasonable person would have been on notice of some impropriety appearing from the form of the instrument and its endorsements or from knowledge of the facts outside the instrument itself. Trust Company Bank, 266 S.E.2d at 258.
            The case is important for several reasons.  First, it underscores the importance of the agreement between the bank and the customer, particularly in the commercial context.  This in turn activates Section 4-103 which deals with agreements between a bank and its customer.  Both of which activate everything discussed in connection with the definition of ‘Agreement’ under Article 1
Second, and in connection with the foregoing, it underscores the need to have procedures in place which make the execution of the scheme much less likely to get launched.  If for example, Doris had been required to execute a check list, and one of the terms was a directive to follow all agreements between the bank and the customer, it might have been enough to show Doris there was a downside in opening accounts like the ones in Apcoa.
Third, the final comment of the court quoted above indicates that bank employees are accountable for facts ‘outside the instrument itself.’  This language opens many possibilities, particularly in discovery.  How far ‘outside’ the instrument can one go?  Are the outside facts limited to commercial matters? Could this include personal matters which might be interfering with a person’s ability to perform? A creative advocate could use the court’s language very effectively.