Friday, July 31, 2015

Notice—Who Has Reason to Know?


As we have discussed, Article 3 favors the movement of negotiable instruments through the protections given to a holder in due course.  This policy is reflected in the interpretation of the ‘good faith’ requirement which has historically interpreted good faith via a subjective test.  A pure heart and empty head has been sufficient to establish ‘good faith’.  Moreover, there are many cases that stand for the proposition that someone purchasing a negotiable instrument is under no duty to investigate circumstances which might raise suspicions.  As discussed in the last post, even under the amended definition of ‘good faith’, the observance of reasonable commercial standards of fair dealing’ can logically be interpreted as not requiring commercially reasonable conduct in the transaction, just a commercial standard of fairness in the conduct.
            Once good faith is in place, the next inquiry concerns ‘notice’ of a claim or defense by the would be holder in due course.  This assumes, of course, that the instrument ‘does not bear such apparent evidence of forgery or alteration or is not otherwise as irregular or incomplete as to call into question its authenticity’ per Section 3-302(1). Notice is a very pervasive concept throughout the Uniform Commercial Code, as indicated by its inclusion in Article 1.  Although this post will focus on ‘notice’ for purposes of holder in due course status, I want to point out some examples of the reach of the concept throughout the UCC.  The following are illustrative; there are many more sections which require notice throughout the Code:
1.    Notice of defective goods under Article 2:  Sections 2-602; 2-607;
2.    Duty to notify of excused performance under Article 2A: Section 2A-405(c);
3.    Notice of dishonor under Article 3: Section 3-503;
4.    Customers duty to notify his or her bank of an unauthorized payment under Section 4-406;
5.    Notice of rejection of a payment order under Article 4A: Section 4A-210;
6.    Notice of any discrepancies in the presentation of a letter of credit under Article 5: Section 5-108;
7.    Notice required of a warehouse to enforce a warehouse lien under Article 7: Section 7-210;
8.    Notice of disposition of collateral under Article 9: Section 2-611
The amended version of Article 1 addresses the pervasive element of notice in Section 1-202.  Section 1-202(a) defines notice as follows:
(a)                  Subject to subsection (f), a person has "notice" of a fact if the person: (1) has actual knowledge of it; (2) has received a notice or notification of it; or (3) from all the facts and circumstances known to the person at the time in question, has reason to know that it exists.
Subsection (a)(1) is obvious on its face—if you’ know’ of something, you have notice of it.  As stated in Section 1-202(b):  "Knowledge" means actual knowledge. "Knows" has a corresponding meaning.
            The second manner in which a person will be deemed to have notice of a fact is if the person ‘has received a notice or notification of it’ per Section 1-202(a)(2).
  Section 1-202(e)(2) tells us that
…[A] person “receives” a notice or notification when:
it is duly delivered in a form reasonable under the circumstances at the place of business through which the contract was made or at another location held out by that person as the place for receipt of such communication.
In determining whether or not notice was given, it is irrelevant whether the person to whom the notice is sent actually receives it:
(d) A person "notifies" or "gives" a notice or notification to another person by taking such steps as may be reasonably required to inform the other person in ordinary course, whether or not the other person actually comes to know of it. [Emphasis added]   Section 1-202(d)
 Notice, knowledge, or a notice or notification received by an organization is effective for a particular transaction from the time it is brought to the attention of the individual conducting that transaction and, in any event, from the time it would have been brought to the individual's attention if the organization had exercised due diligence….Section 1-202(f).
The foregoing sections deal with very specific manners in which notice can be effectively given as well as when it is received.
 It is the third method in which notice can be received that is the focus of this post.  That method is contained in Section 1-202(a)(3):
…[A] person has “notice” of a fact if the person:
from all the facts and circumstances known to the person at the time in question has reason to know that it exists.  Section 1-202(a)(3)
Once again we are presented with a question that is very similar to the one discussed under good faith: Does the language of Section 1-202(a)(3) require the application of a subjective standard or an objective standard in making the determination as to whether a person has ‘reason to know’? 
            As always, before looking at case law or commentaries on the subject, focus must be directed to the precise language of the statute. The following discussion is based solely upon my pure reading of the section. Feel free and encouraged to offer any thoughts.
Precise language in question.
…[A] person has “notice” of a fact if the person:
from all the facts and circumstances known to the person at the time in question has reason to know that it exists.  Section 1-202(a)(3)
The first step is to understand what the Uniform Commercial Code means by the word ‘’person’.  Checking definitions is an essential step until one knows the meaning of the words very well.  Person is defined under Section 1-201(b)(27) as follows:
 "Person" means an individual, corporation, business trust, estate, trust, partnership, limited liability company, association, joint venture, government, governmental subdivision, agency, or instrumentality, public corporation, or any other legal or commercial entity.
The expanded definition immediately opens your mind and creates expansion of the manner in which you will read the statutory provisions on notice.  Instinctively, consistent with the post on the reactionary mind, most people would simply think ‘person’ as in a human being.
Once an understanding of ‘person’ is in place, we turn to the first clause, speaking to facts and circumstances. As to these facts and circumstances the statute speaks in terms of actual knowledge.  Therefore, the party to whom notice is being imputed must have actual knowledge of certain relevant facts and circumstances. This actual knowledge creates the groundwork for the remainder of the section for once these facts and circumstances are in place, facts which may be unclear are brought into play at that point, and the question becomes: Based on this knowledge, do you have ‘
Which brings up the basic question once again as to whether this is an objective analysis or subjective analysis?   Stated otherwise: Once certain facts and circumstances are known to an individual, what would a reasonable person be conclude as to the facts in play? That is your standard ‘objective test’.  Alternatively, should the standard be based upon one person’s honest interpretation of a factual situation regardless of where it falls on the spectrum? 
There are of course great arguments that can be made for either interpretation.  Which once again takes us back to Article 1.  If you are trying to make an argument in either direction, the starting point is Section 1-103(a) where you extract purposes and policies that are consistent with your interpretation.  You then line up your facts and process them through those purposes and policies to guide the court to the desired, and correct result. 



For those reading, I will be in Chicago next week. I am doing a presentation in Chicago which focuses on the implementation of systems designed to elevate the plane of existence.  I have prepared a short handout for that presentation, and as of now, it is my intention to post it next week. I do so not to promote my work, but to share some ideas with anyone who has taken the time to read this work.

Friday, July 24, 2015

Good Faith: Commercial Reasonableness or Fairness?


At this point it has been established that the amended definition of good faith requires the observance of ‘reasonable commercial standards of fair dealing in the trade’ in addition to ‘honesty in fact’. Many have assumed that this requires that persons involved in UCC transactions act honestly and in a commercially reasonable manner.  As the court in the Any Kind Check Cashing case noted:
To the old, subjective good faith, "honesty in fact" standard, the legislature added an objective component—the "pure heart of the holder must now be accompanied by reasoning that assures conduct comporting with reasonable commercial standards of fair dealing." Maine Family Fed. Credit Union v. Sun Life Assurance Co. of Canada, 727 A.2d 335, 342 (Me.1999). No longer may a holder of an instrument act with "a pure heart and an empty head and still obtain holder in due course status. Any Kind Checks Inc. v Talcott 830 So. 2d 160 (4th District Court of Appeals, FL, 2002).at 165
This post will examine the meaning of compliance with the ‘observance of reasonable commercial standards of fair dealing in the trade’.
            The basic question in this analysis is simple: Does the ‘observance of reasonable commercial standards of fair dealing in the trade’ require commercial reasonableness in the conduct involved?  A quick reading might indicate an affirmative answer to this question.  However, a detailed reading of this clause, coupled with the comments and the opinions of experts in the field, create the possibility that even under the amended definition a strong argument can be made that complying with the amended definition does not require that a party act in a commercially reasonable manner as regards to the substantive transaction, but simply that the person behave in a manner which would be considered to comply with a commercial standard of fairness.
 In other words, if someone is ‘honest’ and ‘fair’ in a commercially reasonable way, is the standard of good faith complied with even though the conduct as to the substance of the transaction was not commercially reasonable?   The comments to Section 1-201(b)(20) state:
Although “fair dealing” is a broad term that must be defined in context, it is clear that it is concerned with the fairness of the conduct rather than the care with which an act is performed.  This is an entirely different concept that whether a party exercised ordinary care in conducting a transaction.
The suggested analysis is supported by the text of the statute, and the comment, and also by Professors James White and Robert Summers in their excellent treatise on the Uniform Commercial Code,* in which the authors state:
Before one concludes that the banks described in the preceding paragraphs are not in good faith, return to the definition.  A bank that fails to follow commercial standards is not in good faith only if it deviates from commercial standards of “fair dealing”.  Deviating from such standards on the side of generosity and gullibility does not render one’s act in bad faith.  So beware, good faith does not require general conformity to “reasonable commercial standards” but only to “reasonable commercial standards of fair dealing.” [cite] The issue is one of “unfairness” not of “negligence”      White and Summers, Uniform Commercial Code, Hornbook Series 5th Edition at 523 (2010)
The question arises therefore as to whether the amendment is meaningful as regards to the actual level of performance required on the issue of good faith.  It appears from the text, the comments and recognized UCC experts that commercial reasonableness in the conduct involved is not required.  Just fairness.  This challenges the statement in Any Kind Check Cashing noted earlier where the court stated:
 

No longer may a holder of an instrument act with "a pure heart and an empty head and still obtain holder in due course status. Any Kind Checks Inc. v Talcott 830 So. 2d 160 (4th District Court of Appeals, FL, 2002).at 165
In fact, it appears as though a pure heart and empty head will fit the bill as long as the pure heart and empty headed person is commercially fair.
The conclusion that commercial reasonableness is not required is further supported by explicit reference in other Code sections to a requirement of commercial reasonableness. For example, when a secured creditor disposes of collateral under Section 9-610(b) there is a requirement that every aspect of the disposition must be ‘commercially reasonable’.  When a seller disposes of goods under Section 2-704, he or she is required to exercise ‘reasonable commercial judgment’.  Clearly, if the drafters were looking for commercial reasonableness, they would have explicitly said so.
 

Thursday, July 16, 2015

Good Faith: Impact of Amended Definition Under Article 3


In the last post TRIFFIN v DILLABOUGH, 448 Pa.Super. 72, 670 A.2d 684(1996) was discussed in connection with the holder in due course doctrine.  That case stood for the proposition that the transferee of a negotiable instrument from a holder in due course will acquire those rights even if the transferee has knowledge of a defense to the instrument at the time of transfer.  This result, as noted, is supported by Section 3-203(a). 
On several occasions, the importance of the different definitions of good faith among the various jurisdictions has been emphasized.  In the majority of jurisdictions, the amended definition of good faith has been enacted in Article 1.  Prior to the amendment, good faith simply required honesty in fact per Section 1-201(b)(19).  Under this definition, the inquiry is whether or not an individual acted with a ‘pure heart’.  There was no requirement to act in accordance with reasonable commercial standards.  The amended definition of good faith under Article 1 requires ‘honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade’.
Prior to the adoption of the amended version of good faith under Article 1, the 1990 amendments to Article 3 incorporated the ‘the observance of reasonable commercial standards of fair dealing’ in its definition of good faith.  In those states that adopted the amended version of Article 1, the Article 3 definition under Section 3-103(a)(4) was deleted as unnecessary since the Article 1 definition applies throughout the UCC.
In the abstract, the distinction may not appear to be important.  However, as noted in cases in which then new standard has been applied, the different standards have an enormous impact in the real world.  New York stands alone as the only state that has not adopted Article 3 and additionally has not adopted the amended definition of good faith in Article 1.  As noted in an earlier post, the New York legislature recently enacted many of the changes in the amended version of Article 1, but specifically declined to enact the amended definition of good faith.  Hence, in the state of New York, there is no requirement for the observance of reasonable commercial standards of fair dealing in establishing good faith under Article 3.  Given the unique importance of New York in the commercial world, this distinction is extremely important and should be considered when doing business in the state of New York.
The amended definition and its impact under Section 3-302 has been discussed in a number of cases.  Illustrative of the opinions in these cases, and the impact of the amended definition of good faith on holder in due course status is the case of Any Kind Checks Inc. v Talcott 830 So. 2d 160 (4th District Court of Appeals, FL, 2002).  The legal question presented in Any Kind was whether the check cashing business was a holder in due course thereby cutting off personal defenses of Talcott on the checks involved. The question of whether or not Any Kind acted in good faith was the determinative question on this issue.
The facts in brief involved the issue of a $10,000 check by Talcott which was fraudulently induced by the payee, a Mr. Guarino.  Talcott subsequently stopped payment on the check which was cashed by Any Kind.  There were no written procedures in place at Any Kind by which a determination to pay or not pay a check over $2,000.  The trial court found that Any Kind did not act in good faith and was therefore not a holder in due course. Any Kind appealed.


In discussing the issue the court of appeals noted:
The good faith requirement of the holder in due course doctrine "has been the source of an ancient and continuing dispute." WHITE & SUMMERS, UNIFORM COMMERCIAL CODE § 17-6 (4th ed.1995). On the one hand, [s]hould the courts apply a so-called objective test, and ask whether a reasonably prudent person, behaving the way the alleged holder in due course behaved, would have been acting in good faith? Or should the courts instead apply a subjective test and examine the person's actual behavior, however stupid and irrespective of the reaction a reasonably prudent person would have had in the same circumstance? The legal establishment has steered a crooked course through this debate.    Any Kind at 164
The court noted that if the ‘honesty in fact’ standard was applied, Any Kind would have holder in due course status ‘since Any Kind's employees were pure of heart, that they acted without knowledge of Guarino's wrongdoing.’ Any Kind at 165
The court went on to note:
To the old, subjective good faith, "honesty in fact" standard, the legislature added an objective component—the "pure heart of the holder must now be accompanied by reasoning that assures conduct comporting with reasonable commercial standards of fair dealing." Maine Family Fed. Credit Union v. Sun Life Assurance Co. of Canada, 727 A.2d 335, 342 (Me.1999). No longer may a holder of an instrument act with "a pure heart and an empty head and still obtain holder in due course status." Id.  Any Kind at 165
The court found that while the conduct of Any Kind may have complied with the good faith standard under the old definition of good faith, it did not comply with the amended definition which requires the observance of reasonable commercial standards of fair dealing.  This was primarily based on the nature of the check cashing business and the difference between standard transactions in that industry and the $10,000 check which was the subject of the dispute.  In this regard, the court stated:
The size of the check, in the context of the check cashing business, was a proper factor to consider under the objective standard of good faith in deciding whether Any Kind was a holder in due course. Any Kind at 167
The court concluded that:
[B]y adopting changes to the "good faith" standard in the holder in due course doctrine, the legislature "necessarily must have concluded that the addition of the objective requirement to the definition of `good faith' serves an important goal. The paramount necessity of unquestioned negotiability has given way, at least in part to the desire for reasonable commercial fairness in negotiable transactions." Any Kind at 168
Any Kind is illustrative of case law which has emerged since the amendment to the definition of good faith.  It remains to be seen what is required under ‘commercial standards of fair dealing’; however one thing is clear: honesty in fact is no longer enough to satisfy the obligation of good faith.  This scenario offers an excellent drafting opportunity to minimize exposure.  Businesses can, by reason of Section 1-302, set standards for what constitutes ‘reasonable commercial standards of fair dealing’ and as long as those standards are not ‘manifestly unreasonable’ they will be upheld.