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Flashcards in Ch 7 Commercial Paper Deck (25):

To be a negotiable instrument within Article 3, the instrument must:

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  1. be in writing
  2. be signed by the maker (note) or drawer (draft)
  3. contain an unconditional promise (note) or order (draft) to pay
  4. be for a fixed amount of money only
  5. be payable on demand or at a definite time
  6. be payable to order or to bearer, with the exception of checks
  7. contain no additional undertaking or instruction not authorized by the UCC


What distinguishes a check from other drafts under Article 3?

A check is a draft (i.e., negotiable three-party paper) drawn on a bank and payable on demand.

  • drawee must be a bank
  • must be payable on demand
  • to be negotiable, a check does NOT have to be payable to order or a bearer


If bearer paper is negotiated by delivery alone, how is order paper negotiated?

By delivery and proper endorsement


Once signed (endorsed) in blank, the negotiable instrument turns into:

Bearer paper, negotiable by delivery alone.


Once an instrument is issued as bearer paper, will it always remain bearer paper?

Not necessarily. The last endorsement controls. If the last endorsement is blank, the instrument is bearer paper. If the last endorsement names a new payee (a "special" endorsement), the instrument is an order instrument.


What are some examples that do NOT destroy negotiability that examiners often like to test?

  • the instrument may be paid off early (acceleration clause)
  • the instrument includes a promise to maintain collateral or a statement indicating the instrument is secured
  • a promise to pay collection costs


What is a qualified endorsement?

A qualified endorsement includes the words "without recourse." This releases the endorser from contract liability (no guarantee of payment), but the endorser may still be liable if the endorser breaches any warranties.


What are some permissible conditions that do not destroy the "unconditional promise" requirement to be a negotiable instrument?

permissible conditions:

  • subject to implied conditions (implied in the law or that consideration was given)
  • states its consideration (the instrument was given in exchange for a car)
  • refers to the transaction out of which the instrument arose
  • limits payment to a particular source or fund


Does something on the back of paper determine if instrument is negotiable?

NO! Only the front can determine negotiability. 


Nothing on the back can create or destroy negotiability.


How many parties are there for a Note? A Draft?

  • Note: Two parties
    • A maker promises to pay a payee (or bearer)
    • promise to pay
  • Draft: Three parties
    • A drawer orders a drawee to pay a payee
    • order to pay


List  the"real defenses" that may be asserted against both HDC and non-HDC transferees.

Real defenses means that maker/drawer does not have to pay anymore.

If negotiable instrument is a HDC, the HDC takes free from personal defenses, and only subject to real defenses.


All are voidable, unless adjudicated insanity, illegality, duress

  1. Fraud in the execution - where a person is tricked into signing something that he does not know is a negotiable instrument (ex: thinks it is a fan's autograph book)
  2. Forgery
  3. Adjudicated insanity - void
  4. Material Altercation
  5. Infancy (aka minority)
  6. Illegality - void
  7. Duress - void
  8. Discharge in bankruptcy
  9. Suretyship defenses
  10. Statute of limitations


Personal defenses cannot be raised against who?

An HDC or their assignees


List personal defenses

  • May be viewed as all defenses, except for real defenses (FAIDS)
  • personal defenses includes unauthorized completion (occurs when issuer leaves part of an instrument blank and a later holder in the missing info, either without authority or beyond the authority granted)
  • includes every defense available in ordinary contract actions
    • fraud in inducement
    • failure ( or lack of) of consideration
    • theft of an instrument after it was signed
    • breach of contract/warranty
    • mistake
    • impossibility
    • failure of a condition precedent
    • unconscionability
    • unauthorized completion


How does the UCC define a holder in due course?

A holder in due course is a holder (i.e., a person in possession of the instrument with good title to it) who takes the negotiable instrument (refer to step 2)

  • Step 1: become a holder
    • proper negotiation
  • Step 2: obtain the paper "in due course"
    1. for value (not a gift)
    2. in good faith
    3. without notice of any defenses to or claims of ownership
    4. instrument is negotiable


What are the attributes of a draft under Article 3 of UCC?

A draft is three-party commercial paper. It is an order by one person (the drawer) to another person (the drawee - usually a merchant or a bank) demanding that the drawee pay money to a 3rd person (the payee)


What is required to become a holder of:

  1. bearer paper
  2. order paper

  1. bearer paper: requires only delivery
  2. order paper: requires delivery and endorsement


Signing without recourse means what?

  • Signing without recourse negates contract liability on the instrument. Contract liability is the promise to pay upon dishonor. 


When is the drawer of a draft liable?

The drawer of a draft is secondarily liable.

The drawer is liable only after

  1. the draft is presented to the drawee,
  2. the draft is dishonored, and
  3. the drawer is given notice of dishonor.


What is the shelter doctrine?

Most subsequent transferees of an HDC can "succeed to" or "Take shelter in" the rights of the HDC, which means that even though the transferee himself might not qualify as an HDC, he can claim the rights of an HDC who held the commercial paper before him.


When a maker signs a negotiable promissory note and when the note is negotiated to a holder in due course (or when an HDC transfers the note to a holder to whom the shelter doctrine applies), the maker must pay the note when due according to its terms when the maker signed unless:

the maker has a real defense


While an exectory promise (i.e., one that has not yet been fulfilled) constitutes contract consideration, an executory promise does not constitute, what?

alue for purposes of ascertaining if a holder is an HDC. 


An endorsement that includes the words "without recourse" is what kind of endorsement?



Each endorsement has what 3 qualities?

  1. Special or Blank
  • special: ones that names a particular person as the endorsee and always makes the instrument order paper (draft)
    • requires both signature and delivery
  • blank: does not name a special endorsee and makes the instrument bearer paper (note)
    • requires only delivery

2. Restrictive or Unrestrictive

  • restrictive: any other language that contains conditions
  • does not destroy negotiability
  • ex: pay paula payee only if she has moved my lawn

3. Qualified or unqualified

  • endorsement includes the words, "without recourse," which means there is no guarantee of payment by the endorser. Thus, there is no contract liability, but there is still warranty liability.


*Note: the last endorsement always governs negotiability (whether instrument is "bearer" paper, or "order" paper).



Explain the "On demand or at a definite time" requirement to be a negotiable instrument.

Do events not certain to happen destroy negotiability?

Do events certain to happen, but uncertain as to time destroy negotiability?

Do acceleration clauses destroy negotiability?

Do extension clauses destroy negotiability?

Do undated, posted, and antedated instruments destroy negotiability?

Do events not certain to happen destroy negotiability?

  • Yes, ex: payable when I am able to obtain a loan

Do events certain to happen, but uncertain as to time destroy negotiability?

  • Yes, ex: Payable when Tim dies

Do acceleration clauses destroy negotiability?

  • No, ex: payable on March 16, 2015, accelerated by the death of my Uncle Tim
  • because the latest date for payment is known

Do extension clauses destroy negotiability?

  • No, because the latest date that payment will be due can be determined from the face of the instrument

Do undated, posted, and antedated instruments destroy negotiability?

  • No, an undated instrument is payable on demand


What kind of transactions preclude (destroy) HDC's status?

  1. purchased at a judicial sale
  2. acquired in taking over an estate
  3. purchased as part of a bulk transaction not in the regular course of the transferor's business