Transfer and Negotiation

As noted on several occasions, the primary purpose of this blog is to teach the basic meaning and operational structure of the Uniform Commercial Code, while creating a foundation for anyone reading it to take their knowledge base to higher levels.  The goal is to create a basic structure for the whole UCC before March 1, 2016.  Having never used this format before—linear as it is—I am creating a new product which is being unrolled as it is being created.

By way of review—we learned some very basic concepts under Article 1.  These include the policies and principles which guide courts and practitioners in the interpretation and application of the Uniform Commercial Code.  The pervasive and importance of course of performance, course of dealing and trade usage was emphasized as a foundation for all agreements, and the interpretation of the same, under the Uniform Commercial Code.  The application of a standard of ‘good faith’ in all commercial transactions was also emphasized as a cornerstone principle under the UCC.  That stated, the law of the various jurisdictions is not consistent on what is required, as a matter of law, to act in good faith.

Also discussed was the importance of the ‘merchant’ definition under Article 2, particularly in connection with the reply doctrine of Section 2-201(2).  Also presented was the concept of utilizing a comprehensive approach to Uniform Commercial Code transactions, both as to multiplicity of Articles in all transactions under the Code, and the activation of numerous sections within the primary Article.

From this basic introduction, focus was directed to Article 3.  Commercial transactions involve payment mechanisms.  Promissory notes, checks, and commercial drafts are among the most common devices used.  The initial focus was to create an understanding of the elements which need to be in place to make an instrument ‘negotiable’ in form. Part of this included what terms cannot be contained in the writing, such as making a would-be instrument ‘subject to’ another writing.  And of course, the reason this is so important concerns the transfer of the instrument.  If negotiable in form, a ‘holder in due course’ can be created.  If the instrument is taken under prescribed circumstances, the transferee will take the instrument free of all personal defenses which the obligor might have had against the original payee.

In this blog, I will fill in some statutory provisions which apply in the transfer of negotiable instruments.  The next post will contain a discussion of several cases designed to supplement the posts to date, and to stimulate thought as certain sections are applied in a set of concrete facts.  Going forward, I will begin to integrate other Articles, basically seeking to navigate through Code sections in a logical sequence as a UCC core is being formed.  I expect to move to Articles 2 and 9 while completing the balance of Article 3. 

Part 2 of Article 3 governs matters dealing with ‘negotiation, transfer and indorsement’ of an instrument, all of which are necessary to create holder in due course status.  Statutory provisions which are activated in the transfer process will be discussed below.

As noted previously, the first element of becoming a holder in due course is becoming a ‘holder’.  A holder of an instrument is defined under Section 1-201(b)(21)(A) as:

the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession.  Section 1-201(b)(21)(A)

Therefore, when George is in possession of the promissory note from Alan and Stephen payable ‘to the order of George’ or ‘payable to bearer’, George would be the holder of the instrument.  The first delivery of the note to George by Alan and Stephen is an ‘issue’ of the instrument:

 

"Issue" means the first delivery of an instrument by the maker or drawer, whether to a holder or nonholder, for the purpose of giving rights on the instrument to any person.  Section 3-105(a).

The person obligated on the note is maker of the note:

"Maker" means a person who signs or is identified in a note as a person undertaking  to pay.  Section 3-103(7)

The precise liability of the maker of a note derives from Section 3-412 and the maker’s status as the issuer of the note:

"Issuer" applies to issued and unissued instruments and means a maker or   drawer of an instrument. Section 3-105(c)

      

The issuer of a note …is obliged to pay the instrument (i) according to its terms time at the it was issued….The obligation is owed to a person entitled to enforce the instrument or to an indorser who paid the instrument under Section 3-415. 

Section 3-412

The liability of a maker, indorser or any other party named in an instrument, does not vest until the party signs the instrument, or it is signed on his or her behalf by an authorized representative:

(a) A person is not liable on an instrument unless (i) the person signed the instrument, or (ii) the person is represented by an agent or representative who signed the instrument and the signature is binding on the represented person under Section 3-402.                           Section 3-401

George wants to sell the instrument to South Dade Bank at a discount so that he can get some capital.  If George properly indorses and delivers the instrument to South Dade, the latter will become a ‘holder’ and the instrument will be negotiated: 

"Negotiation" means a transfer of possession, whether voluntary or     involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder.  Section 3-201(a)

Note that under this definition the first delivery of the note to George would not be a ‘negotiation’’ since it was delivered to George by the issuer.  Subsequent transfers however, would qualify as a negotiation if the instrument was properly indorsed and delivered.  The following illustrates these concepts in the transaction among Stephen, Alan, George and the Bank.

The transfer referenced in the definition of negotiation is contained under Section 3-203(a)

(a)  An instrument is transferred when it is delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument.

The transferee acquires the rights of his or her transferor regardless of whether or not there is a negotiation:

Transfer of an instrument, whether or not the transfer is a negotiation, vests in the transferee any right of the transferor to enforce the instrument, including any right as a holder in due course, but the transferee cannot acquire rights of a holder in due course by a transfer, directly or indirectly, affecting the instrument. Section 3-203(b)

This section, in all its simplicity, packs a lot of power on many levels.  We will take a look at Section 3-203(b) in connection with the case discussed below.

          TRIFFIN v DILLABOUGH   448 Pa.Super. 72 (1996) 670 A.2d 684 provides an excellent factual backdrop from which to view many of the concepts and provisions that have been discussed.  I highly recommend a full read of this case for anyone learning the law of negotiable instruments.  Although cites are sometimes very general, the overall opinion is excellent. The case involved incomplete American Express money orders which had been stolen, transferred, presented and cashed.  The money orders had all been stamped with a preprinted signature of the chairman of American Express.

           

           The stolen money orders were presented to Chuckie Enterprise, Inc. [Chuckie’s], who was in the business of cashing checks on December 11, 1990. The third money order was presented on February 25, 1991.  In each instance, the money orders were completed and indorsed. Identification was checked and all appeared in order. The money orders were passed through the usual bank collection channels and were presented for payment at United Bank of Grand Junction, Colorado. American Express, having noted on its "fraud log" that the money orders were stolen, returned the money orders marked "Reported . Lost or Stolen — Do Not Redeposit." American Express refused to pay the amounts of the money orders.

Triffin, a commercial discounter, purchased the dishonored money orders  for cash from Chuckie's and took an assignment of all Chuckie's rights, claims and interests in the money orders. On July 16, 1992, Triffin filed a complaint against American Express and the individual defendants.  Trifrin’s case was dismissed below and was up on appeal.

As you can see, this case offers the opportunity to discuss whether the incomplete money orders would  or would not be treated as a negotiable instrument.  This is important as it raises the possibility that Chuckie’s was a holder in due course.  If Chuckie’s is found to be a holder in due course the question becomes does Triffin assume that status even though he knew the money orders had been dishonored at the time he purchased them.  Clearly, if he had purchased the money orders independently, the notice of dishonor would have been notice of a defense and precluded him from taking ‘without notice’, and hence no HDC status.

The court found the instrument to be negotiable in form per Section 3-115:

"Incomplete instrument" means a signed writing, whether or not issued by the signer, the contents of which show at the time of signing that it is incomplete but that the signer intended it to be completed by the addition of words or numbers.  Section 3-115(a)

The court found that the preprinted signature was made with the requisite ‘present intent’ to authenticate required by Section 1-201(37).

In connection with Section 3-115 and the unauthorized completion the court cited Section 3-407:

A payor bank or drawee paying a fraudulently altered instrument or a person taking it for value, in good faith and without notice of the alteration, may enforce rights with respect to the instrument (i) according to its original terms, or (ii) in the case of an incomplete instrument altered by unauthorized completion, according to its terms as completed. Section 3-407(c).

The court concluded that Chuckie’s acquired the rights of a holder in due course when it cashed the money orders.  The court further concluded that Triffin did acquire the holder in due course rights of Chuckie’s even though it had knowledge of the dishonor.  The court based its decision on the general law of assignment, and is in fact the required result under Section 3-203(b) discussed above.