Lesson 37: Commercial Paper (Article 3)

In the realm of contracts law, the Uniform Commercial Code (UCC) plays a significant role. One of its key articles is Article 3, which governs commercial paper. Commercial paper includes negotiable instruments such as checks, promissory notes, and drafts.

Overview of Commercial Paper

Commercial paper refers to various types of negotiable instruments, which are financial documents guaranteeing the payment of a specific amount of money, either on demand or at a set time. The primary types of commercial paper include:

  • Drafts (or Bills of Exchange): An order by one party to another to pay a specified amount to a third party.
  • Checks: A specific type of draft drawn on a bank and payable on demand.
  • Promissory Notes: A promise by one party to pay a specified amount to another party.

Key Definitions

Understanding Article 3 requires familiarity with several key terms:

  • Drawer: The person who writes or creates a draft or check.
  • Drawee: The person or entity (often a bank) directed to pay the money specified in a draft or check.
  • Payee: The person or entity entitled to receive the payment.
  • Indorser: A person who signs the back of a negotiable instrument, thereby transferring their rights to another party.
  • Holder in Due Course: A party who has acquired a negotiable instrument in good faith and for value, and thus has certain protections under UCC Article 3.

Negotiability and Endorsements

For a document to be considered a negotiable instrument under Article 3, it must meet specific requirements:

  • It must be in writing and signed by the maker or drawer.
  • It must contain an unconditional promise or order to pay a fixed amount of money.
  • It must be payable on demand or at a definite time.
  • It must be payable to order or to bearer.
Note: Endorsements play a critical role in the negotiation of commercial paper. They can be either blank (just a signature, making it payable to bearer) or special (specifying a new payee).

Types of Endorsements

There are different types of endorsements that affect how the instrument can be negotiated:

  • Blank Endorsement: The endorser signs the instrument without specifying a payee, making it a bearer instrument.
  • Special Endorsement: The endorser signs and names a specific person as the new payee.
  • Restrictive Endorsement: The endorser adds restrictions on how the instrument may be used, such as "for deposit only."
  • Qualified Endorsement: The endorser includes words like "without recourse," limiting their liability if the instrument is not paid.
graph TD A["Drawer"] -->|Creates| B["Draft"] B -->|Presented to| C["Drawee"] C -->|Pays| D["Payee"]

Holder in Due Course

One of the most important concepts in Article 3 is the Holder in Due Course (HDC). An HDC has certain protections that make it difficult for other parties to assert defenses against them. To qualify as an HDC, a holder must:

  • Take the instrument for value.
  • Take it in good faith.
  • Take it without notice of any defect or claim against it.
Important: Being a Holder in Due Course provides significant advantages, such as immunity from certain defenses that could be raised against previous holders.

Defenses Against Holders in Due Course

Even though a Holder in Due Course (HDC) enjoys certain protections, there are real defenses and personal defenses that can be asserted against them:

  • Real Defenses: These are valid against all holders, including HDCs. They include:
    • Forgery
    • Fraud in the factum
    • Alteration of the instrument
    • Incapacity
    • Illegality
    • Duress
    • Discharge in bankruptcy
  • Personal Defenses: These are valid only against holders who are not HDCs. They include:
    • Lack of consideration
    • Non-delivery of the instrument
    • Unauthorized completion
    • Payment to a prior holder

Liabilities in Commercial Paper

The parties involved in commercial paper transactions have different types of liabilities:

  • Primary Liability: The maker of a promissory note or the acceptor of a draft is primarily liable. They have an unconditional obligation to pay the instrument.
  • Secondary Liability: Drawers and indorsers have secondary liability, meaning they are only obligated to pay if the primary liable party defaults. To enforce secondary liability, the holder must:
    • Present the instrument for payment or acceptance.
    • Provide notice of dishonor to the secondary parties.

Discharge of Commercial Paper

Discharge refers to the release of parties from liability on the instrument. Discharge can occur through various methods:

  • Payment: Full payment by the party primarily liable discharges the instrument.
  • Cancellation: Intentional cancellation of the instrument by the holder (e.g., tearing it up).
  • Renunciation: The holder may renounce rights against any party in writing or by surrendering the instrument.
graph TD E[Holder] -->|Presents| F[Promissory Note] F -->|Payment| G[Maker] F -->|If dishonored| H[Indorser] H -->|Notice of Dishonor| I[Drawer]

Practical Applications

Understanding Article 3 is crucial for navigating the complexities of commercial transactions. Practical applications include:

  • Using checks and drafts in daily financial transactions.
  • Understanding the rights and obligations of parties in promissory notes.
  • Recognizing the importance of endorsements and the protections for Holders in Due Course.

For additional reading on topics related to contract law, please refer to our articles on:

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