Commercial Paper

Question 2

What is a draft?

Answer 2

A commercial paper involving three parties- a drawer; a payee and a drawee

A drawer orders a sum to be paid to a payee by the drawee

May be payable on demand or in the future

Note: If a draft that is otherwise negotiable states: “Pay to XYZ Corporation.” This statement destroys negotiability because the draft is NOT payable “to the order or” XYZ Corporation

Question 3

What is a promissory note?

Answer 3

A promise to pay a specific amount

Two parties involved - maker and a payee

Can reference other transactions without harming the instrument’s negotiability

Example: Bank Certificate of Deposit (CD)

Question 4

What is a draft?

Answer 4

A commercial paper involving three parties- a drawer; a payee and a drawee

A drawer orders a sum to be paid to a payee by the drawee

May be payable on demand or in the future

Question 5

What is required to maintain the negotiability of a commercial paper?

Answer 5

1. Must be in writing
2. Signed by drawer/maker
3. Be without conditions for payment (other than limitations on payment sources). Must contain an Unconditional promise or order to pay
4. Amount of money must be stated (fixed amount) - also must be payable in money and nothing else but money
5. Payable to order or bearer, unless it is a check
6. Be payable on demand or at a definite time

These requirements must be present on the face (front) of the instrument. Instruments that do not comply with these provisions are nonnegotiable and are transferable only by assignment

Question 6

What is a trade acceptance?

Answer 6

A Trade Acceptance is a draft drawn by a seller ordering a buyer to pay

Seller extends credit to Buyer

Buyer agrees to pay Seller - Buyer has primary liability

Seller is both Drawer and Payee - Seller has Secondary Liability

Question 7

What is the difference between a post-dated check and a negotiable time draft?

Answer 7

A check is payable on demand; even if post-dated.

A negotiable time draft is not payable until the date designated for payment.

Question 8

What characteristics will cancel the negotiability of a commercial paper?

Answer 8

An additional promise is stated in addition to the promise to pay (like the option to purchase Real Estate)

The promise to pay occurs after some action by another party or an event; it cancels negotiability

Cannot allow for an alternative such as payment or some other action by the maker

Note: a stated amount of payment plus a stated % of interest is OK

Note: The key to determining if the promise/order is conditional is, does the language in the instrument make the actual payment subject to some event?

Question 9

What are the major types of endorsements on commercial paper?

Answer 9

Blank endorsement - Doesn’t name a new payee; transforms into a bearer paper (from order paper). Or if an endorsement does not specify any endorsee, the endorsement converts order paper into bearer paper

Note: If the last or only endorsement on instrument is a blank endorsement, any holder may convert that bearer paper into order paper by writing “Pay to X” above that blank endorsement

Special endorsement - Names a new payee; transforms into an order paper. This occurs when endorsement indicates a specific person to whom the instrument is being negotiated

1. Note the words “pay to the order of” are not required on back as endorsements - instrument only needs to be payable to order or to bear on “front only”
2. If instrument is NOT payable to order or bearer on it face; it CANNOT be turned into a negotiable instrument by using these words in an endorsement on the back

Restrictive endorsement - Adds restrictions; doesn’t stop further negotiation

Valid restrictions are:

1. “for deposit only”
2. “pay any bank”
3. “pay smith for jones”

Qualified endorsement - Payment not guaranteed; without recourse added to endorsement.

Without recourse means no guarantee of payment - disclaiming liability

Question 10

What are the major types of endorsements on commercial paper?

Answer 10

Blank - Doesn’t name a new payee; transforms into a bearer paper (from bearer paper)

Note: If the last or only endorsement on instrument is a blank endorsement, any holder may convert that bearer paper into order paper by writing “Pay to X” above that blank endorsement

Special - Names a new payee; transforms into an order paper.

1. Note the words “pay to the order of” are not required on back as endorsements - instrument only needs to be payable to order or to bear on “front only”
2. If instrument is NOT payable to order or bearer on it face; it CANNOT be turned into a negotiable instrument by using these words in an endorsement on the back

Restrictive - Adds restrictions; doesn’t stop further negotiation

Valid restrictions are:

1. “for deposit only”
2. “pay any bank”
3. “pay smith for jones”

Qualified - Payment not guaranteed; without recourse added to endorsement.

Without recourse means no guarantee of payment

Question 11

Define primary liability with respect to a contract.

Answer 11

Primary liable parties are the parties first expected to pay on the instrument

First in line to pay on the note/draft

Maker of a Promissory Note has primary liability and must pay according to terms of the note

With a Check; no party has Primary Liability

Exception: Drawee (your bank) is primarily liable to pay if they certify – i.e. promise to pay.

Note: There is no obligation for the drawee (your bank) to accept. In order for the bank to be liable, they have to accept

Question 12

If endorsed; within what amount of time must a check be presented for payment in order to hold the ENDORSER liable?

Answer 12

Within 7 days

Question 13

Define primary liability with respect to a contract.

Answer 13

First in line to pay on the note/draft

Maker of a Promissory Note has primary liability and must pay according to terms of the note

With a Check; no party has Primary Liability

Exception: Drawee (your bank) is primarily liable to pay if they certify – i.e. promise to pay

Question 14

Define secondary liability with respect to contract liability

Answer 14

Secondary liable parties are liable ONLY after presentment and notice of dishonor

Drawers are Secondarily Liable if Drawee fails to pay a Draft

Endorsers (the payee) are secondarily liable

Holder in due course can hold Endorser liable

Exception: Endorsed ‘Without Recourse’

Question 15

Define contract liability.

Answer 15

Guarantees payment of a liability - applies to any party who signs negotiable instrument and can include a maker, drawer, acceptor or a draft, or endorser

Question 16

When does warranty liability occur?

Answer 16

Occurs when you negotiate commercial paper

By signing; you warrant to all future parties

By not signing; you warrant to current party only

Question 17

What are the REAL defenses against a holder in due course (HDC); which will WIN?

Answer 17

A holder in due course takes an instrument subject to Real Defenses (WIN vs. HDC)

1. Material alterations to the instrument - partially a real defense:
   a. If dollar amount was altered, then HDC can collect according to original terms; a non-HDC collects nothing
   b. If an instrument was incomplete originally and then completed without authorization, HDC can enforce it as completed; a non-HDC collects nothing
2. Forgery
3. Bankruptcy - if the maker declares BK, HDC loses the right to collect on the note
4. Maker not competent to Contract
   a. Insanity
   b. Illegal
   c. Infant (minority) - if a minor can disaffirm a contract; then its a real defense for a negotiable instrument
5. Fraud in the execution
   a. Victim didn’t know contract was Executed

Note: If victim knew a contract was made, but there were misrepresentations (i.e. fraud in the inducement), HDC beats this defense

6. VOID contract as adjudicated by state - HDC losses

Question 18

What are the personal defenses against a holder in due course (HDC) which will LOSE?

Answer 18

An HDC takes an instrument free of Personal Defenses (LOSE vs. HDC)

1. Lack of consideration/value given
2. Breach of contract/warranty
3. Prior payment
4. Unauthorized completion
5. Duplicate payments
6. Non-delivery - occurs when bearer instrument is lost or stolen
7. Fraud (in the inducement only) - they know they made a contract, but did so b/c of some misrepresentation

HDC > Fraud in the Inducement claims

8. Voidable contracts
   a. Voidable due to illegality or insanity - HDC wins
   b. Void contract as adjudicated by state - HDC losses

Question 19

What are the requirements for a holder to be a holder in due course?

Answer 19

1. Holding a negotiable instrument
2. Taking instrument in Good Faith - Even if you buy a stolen note and you don’t know that it’s stolen; you’re still an HDC
3. Having no knowledge of defenses against instrument; i.e. problems with the instrument
4. Giving a present value for the instrument (a future value doesn’t count)
5. Takes as a satisfaction of a previous debt
6. Gives another negotiable instrument
7. Acquires a security interest in the instrument (i.e. the holder takes possession of the instrument as collateral for another debt)

Question 20

What is required to negotiate Bearer Paper?

Answer 20

Bearer paper is a negotiable instrument that is payable to any party (i.e. “Pay to cash”)

1. Transferred by delivery alone
2. Holder only needs possession of the instrument
3. Subsequent parties may require endorsements (even though UCC does not) for identification
4. Holder may, in any event, endorse it if they choose to do so

Question 21

What warranties does a person (transferor) who negotiates a negotiable document of title for value makes to an immediate purchaser?

Answer 21

They (the transferor) make the following warranties:

1. Negotiation by the transferor is rightful and fully effective with respect to the goods it represents
2. The transferor has no knowledge of any facts that would impair the document’s validity or worth
3. The document & signatures are genuine
4. Good title
5. No defense is good against them
6. No insolvency proceeding against the issuer
7. No material alteration
8. No knowledge of bankruptcy proceedings

Question 22

What warranties does a person (transferor) who negotiates a negotiable document of title for value makes to an immediate purchaser?

Answer 22

They (the transferor) make the following warranties:

1. Negotiation by the transferor is rightful and fully effective with respect to the goods it represents
2. The transferor has no knowledge of any facts that would impair the document’s validity or worth
3. The document & signatures are genuine
4. Good title
5. No defense is good against them
6. No insolvency proceeding against the issuer

Question 23

What items are NOT commercial paper, but usually follow the same rules?

Answer 23

The following ARE NOT commercial paper, but usually follow the same rules:

1. Investment securities (stock & bonds)
2. Documents of Title (warehouse receipts & bills of lading)

Question 24

What is a warehouse receipt?

Document of Title

Answer 24

Warehouse receipts are issued by a warehouse acknowledging receipt and storage of goods specified in the document (need not be bonded & licensed)

a. Must state if goods are to be delivered to Bearer, to a specified party, or to the Order of a specified party
b. Must state location of the warehouse

Question 25

What is a bill of lading?

Document of Title

Answer 25

Bills of lading are documents issued by a carrier acknowledging receipt of goods & a contract for transportation