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.