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PAYMENT SYSTEMS
1) INTRODUCTION: PAYMENT SYSTEMS GENERALLY a) Payments systems transfer value without using cash payments between buyers and sellers b) The law of payment systems is a risk allocation device c) Common characteristics of all payment systems i) Underlying transaction between buyer and seller ii) Buyer creates a claim based on the law of contracts with a third party payor (usually the buyer's bank) by opening up a checking account or using a credit card iii) Buyer transfers the claim to the seller by using a check or credit card to make payment iv) Seller collects payment from the buyer's bank through the check collection system or the credit card system d) Payment Systems i) Checks ii) Credit Cards iii) Debit Cards iv) Wire Transfers v) Promissory Notes vi) Negotiable Instruments vii) Letters of Credit 2) CHECKS a) Payor Bank's Obligation to Pay Checks UCC 4-401 i) When the Bank May Debit the Customer's Account (1) Bank may debit the customer's account when it pays any item that is properly payable even if it creates an overdraft (a) McGuire v. Bank One (i) Bank paid an overdraft on the customers account. (ii) Bank is presumed to exercise ordinary care b/c it complied w/ 4-401. (iii) A check creating an unusually large overdraft is still properly payable. (2) "Properly payable" means authorized by the customer and in accordance with any bank/customer agreement (a) Authorized (i) Authorized means signed by the customer(s) (ii) If two or more customers can draw on the account, the non-signing party is not liable for an overdraft unless that party benefits from proceeds of the check (b) Agreement UCC 4-103 (i) General Rule: Article 4 can be varied by agreement (ii) Exception: bank cannot contract away its duty of good faith or its duty to exercise reasonable care (iii) Duties: Parties can determine the standards of good faith and ordinary care so long as such standards are not manifestly unreasonable (3) Post-Dated Checks UCC 4-401 (a) General Rule: A bank may debit the account of a customer before the payment date of the check if it is otherwise properly payable (RationaleMICR Line processingno humans) (b) Exception: Bank receives notice from the customer describing the check with reasonable certainty and within a reasonable time for the bank to act (c) If customer notifies bank about post-dating and bank still pays before the date, bank is liable for all damages and for subsequent damages resulting from other wrongful dishonors (4) Stale Checks UCC 4-404 (a) General Rule: Bank has no obligation to debit the customer's account to pay a check that is six months old (b) Exception: Bank may debit a customer's account to pay a check that is six months old if the bank acts in good faith (Rationalebank might know if customer wants it paid) UCC 4-104 (i) Honesty in fact (ii) Observance of reasonable commercial standards of fair dealing

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ii) 1. Common banking practice is to consult with the banking customer Comments 2. Depends on the location of the bank and the local standards in that area When the Bank Must Debit The Customer's Account (1) Bank must debit customer's account when the check is properly payable and there are sufficient funds in the account (2) Time for determining sufficient funds UCC 4-402 (a) Bank has to determine if there are sufficient funds only once between the time it receives the check and the time the check bounces (b) If bank makes second determination, that determination controls whether sufficient funds exist (3) NOTE: Bank can pay checks in any order it wishes UCC 4-303 Stop Payment Orders: Bank Must Not Debit Customer's Account UCC 4-403 (1) Any customer on an account (if more than one) has the right to stop payment. (e.g., if George and Kristen have a joint account and George writes and signs a check, Kristen can stop payment on that check even though she did not write or sign it). (2) Requirements (a) Written or oral notice (i) Written notice is effective for six months (ii) Oral notice is effective for 14 days (b) Describing the check with reasonable certainty (c) Given within a reasonable time so that the bank can act (3) Stop payment orders can be renewed after they expire (4) Once totally expired, bank may debit the customer's account and pay if done in good faith Banks Right of Subrogation UCC 4-407 (1) General Rule: Article 4 remedy for wrongfully paying an item the bank should not have is to recredit the customer's account (2) When bank pays an item it should not have (e.g., over a valid stop payment order; after account is closed, etc.) and unjust enrichment results (e.g., customer gets the goods for free; payee gets the money from customer without giving customer the goods or giving the customer defective goods), the bank is subrogated to the rights of the party who was unjustly enriched (3) Example: Customer pays Merchant $1,000 for a TV. The TV is defective and costs $400 to repair. (Breach of Warranty). Over a valid stop payment order, Bank pays Merchant $1,000. Bank must recredit Customer's account, but in doing so, customer receives a free TV worth $600 (cost minus repair). Bank is subrogated to the rights of Merchant and could thus recover the $600 from Customer. Bank is still out $400. Thus, Bank is subrogated to the rights of Customer against Merchant for the $400 cost to repair the defect. In effect, subrogation means that bank need not recredit account at all if unjust enrichment results. (4) McIntyre v. Harris Bank (a) Bennett gave McIntyre a $2,000 check to pay for roofing materials to fix her roof. (b) McIntyre gave Bennett a $2,000 check and told her to cash it if he didnt fix her roof. (c) McIntyre cashed Bennetts check and stopped payment on his check. (d) McIntyre never fixed Bennetts roof and she cashed his check over the stop payment order. (e) Although normally McIntyre would be entitled to have the bank refund his account, the Bank was allowed to keep the $2,000 to prevent unjust enrichment. Wrongful Dishonor UCC 4-402 (1) A bank wrongfully dishonors a check if the check was properly payable and there were sufficient funds to cover the amount of the check (2) Bank does not wrongfully dishonor a check if it dishonors a check that creates an overdraft (3) Bank is liable for proximately caused damages, actual damages proved, and consequential damages Funds Availability for Deposited Checks Expedited Funds Availability Act (EFAA); Reg. CC, Art. 4 (1) Introduction (a) General UCC Rule: Bank does not have to make funds available until bank receives

iii)

iv)

v)

vi)

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payment for the item (settlement) (b) Exception: EFAA and Reg. CC supercede conflicting local law (c) EFAA and Reg. CC provide maximum time limitbanks can make funds available earlier than the rules (d) Depositary bank has right to chargeback if it makes funds available before the limits and the check is returned unpaid (2) Definitions Reg. CC (a) Business days: weekdays not including holidays (b) Banking days: business days when banks conduct their business (3) Funds Availability Schedule: Reg. CC 229 (a) Next-Day Availability: No Risk Items (i) In-person cash deposit directly to teller in your own account (ii) Deposit of US government check (Treasury Check) in your name (iii) Deposit of state or local government check in your name from the same state as bank (iv) In-person deposit of cashier's, certified, or tellers' check in your name and in your account (v) Deposit of "on-us" item (vi) $100 of the aggregate amount of all checks (not counting next-day availability checks) in any one banking day (e.g., $1000 teller check, $500 in nonlocal checks; $1100 would be available next day ($1000 teller check and $100 aggregate of other checks) 1. Withdraw in cash: balance after $100 available on the fifth day 2. Nonlocal check deposited and withdrawn by check: balance after $100 available on the fifth day 3. Local check withdrawn by cash: $400 after the $100 available on the second day; balance available on the third day 4. Nonlocal state or local government check: balance after $100 available on the fifth day (b) Second-Day Availability: Low Risk Items (i) Local checks (ii) Local third party cashier's check (iii) U.S. Treasury check and state/local government checks signed over to 3rd person (iv) ATM deposits at ATM owned or controlled by depositary bank (c) Five-Day Availability: Higher Risk Items (i) Funds from a deposit of a nonlocal check must be made available on the fifth business day following the banking day of the deposit (ii) Nonlocal third party cashier's check (iii) ATM deposits at ATM not owned or controlled by depositary bank (4) Extension of Availability Schedule for Highly Risky Items: Exceptions (a) New Account Deposits (open for 30 days or less) (b) Amounts over $5000 (UCC 4-215 applies for amounts over $5000) (c) Redeposited Checks (d) Deposits into "repeatedly overdrawn" account (e) Deposits where there is "reasonable cause to doubt collectibility" (case-by-case determination) b) Check Collection System i) Introduction (1) Forward Collection (a) Presentment process where the check is turned into cash (b) All checks go through this process (c) Governed by UCC Art. 4 (2) Return Process (a) Process whereby dishonored checks are returned (b) Only dishonored checks go through this process (c) Governed by UCC Art. 4; EFAA; Regs. CC and J ii) Definitions UCC 4-105 (1) Payor Bank: bank that is the drawee of a draft (2) Depositary Bank: first bank in the chain even if it is also the payor bank unless item is

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presented for payment over the counter by the payor bank (3) Collecting Bank: bank that handles an item for collection except the payor bank. Depository bank that is not the payor bank is a collecting bank (4) Intermediary Bank: bank where an item is transferred during the collection process except the depository and payor bank (5) Presenting Bank: any bank presenting an item except a payor bank (6) Midnight deadline: midnight of the next banking day after a bank receives the check UCC 4-104 (7) End of Banking Day: 2 P.M. or later so the bank can (1) process (2) prove balances and (3) make entries. If deposited after cutoff, treated as deposited on the morning of the next banking day. UCC 4-108 (8) Branches: Each branch of a bank is separate bank for deadline purposes UCC 4-107 iii) Forward Collection (1) Depositary bank receives item and gives provisional credit for the deposit by midnight of the banking day it receives the item (unless it's an "on-us" item) (2) Collecting banks must use "ordinary care" in collecting the item UCC 4-202 (a) Collecting banks are "agents" of the customer during the collection process (b) Agency relationship terminates when the item is finally paidthen, depositary bank becomes debtor of the customer (because it owes the customer the amount of the check) (3) "Ordinary care" means forwarding the check for collection before its midnight deadline UCC 4-202 (4) If the check is dishonored, depositary bank can revoke settlement, chargeback the amount of the item, or obtain a refund from the customer UCC 4-214 (a) Must return the item by its midnight deadline or a reasonable time after it learns of the facts or (b) Notifies the customer of the facts if the item cannot be returned (c) If the depositary bank is the payor bank also, it must meet its midnight deadline (5) Liability for Depositary Bank's Failure to Meet Requirements (a) Loses ability to revoke settlement (b) Loses chargeback right iv) Return Process (1) Payor bank must settle by midnight of the banking day it receives the item for payment (2) "Settle" means to give provisional credit or pay (3) Final Payment: UCC 4-215 (a) Payor bank pays item in cash or (b) Fails to revoke settlement before its midnight deadline (4) Dishonor (a) Payor bank has ability to dishonor an item if (i) It is a demand item (ii) Not presented for immediate payment (iii) Returned before midnight deadline and before final payment (b) Payor Bank must "send" dishonored check before its midnight deadline UCC 1-201; 4-104 (c) Bank must comply with expeditious return requirements Reg. CC 229 (i) 2-day test for local checks (ii) 4-day test for nonlocal checks (iii) forward collection test: send the check the same way it was presented (d) Bank must give notice of dishonor for return of checks exceeding $2500 (5) Liability for Payor Bank's Failure to Meet Requirements (a) Payor bank is "accountable" for the amount of the item if it does not meet the return process requirements UCC 4-302 (b) Payor bank loses ability to revoke settlement (c) Payor Bank warrants that returned item is returned expeditiously Reg. CC 229 v) Encoding Warranties UCC 4-209; Reg CC 229 (1) Person who encodes information on an item warrants to (1) subsequent collecting banks and (2) payor bank that encoded information is correct (2) If customer of bank is the encoder, than the customer's bank also makes the warranty (3) If information is incorrect, encoder is liable to the payor bank

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(4) NOTE: Reg CC only applies to banks and warrants that the MICR line is correct c) General Risk of Loss Rules i) Nonpayment (1) Indorser Liability for Payment UCC 3-415 (a) Each party that indorses a check implies that it will be liable for the amount of the check (b) Applies only when check is dishonored (c) Owed to person entitled to enforce the item and subsequent indorser who paid the instrument (d) Transferee must deposit or present the check w/in 30 days of the indorsement (e) Transferee must give prompt notice of the dishonor to the indorser (i) Banks must give notice w/in midnight of the banking day on which it learns of the dishonor (ii) Other parties must give notice w/in 30 days (f) Can be disclaimed by stating "without recourse" (2) Drawer Liability UCC 3-414 (a) Drawer of the check is liable if the bank dishonors it ii) Forgeries (1) Forged Drawer's Signature (a) If Payor bank Pays the Check (i) Payor Bank bears the risk of loss for honoring a check with a forged drawer's name because payor bank is deemed to know the signatures of its customers. Price v. Neal (ii) Payor bank may not charge the drawers account. (iii) Remedies limited to mistake and presentment warranty (very limited) (b) If Payor Bank Dishonors the Check (i) Presenting Banks bear the risk of loss for dishonored checks with forged drawer's name (ii) Usually, the loss is passed on to the earliest solvent party that dealt with the thief (2) Forged Indorsements (a) Presentment Warranties UCC 4-208 (i) Transferors of check make warranties to the payor bank that 1. Transferor is entitled to enforce the item 2. There are no alterations, and 3. The transferor does not actually know that the drawer's signature is forged (ii) Only payor banks can assert this warranty (b) Transfer Warranties UCC 4-207; 3-416 (i) Customer or collecting banks that transfer items and receive settlement or consideration warrant that 1. Transferor is entitled to enforce the item 2. Signatures on the item are authentic and authorized 3. There are no alterations on the item 4. The item is not subject to a defense or recoupment 5. Transferor has no knowledge of the drawer's insolvency (ii) Applies to all transferees in the chain except the payor bank (c) If payor bank dishonors the check (i) Presenting bank bears the risk of loss for dishonored check with forged indorsement (ii) May pursue transfer warranty vs. an earlier party (d) If the payor bank honors the check (i) Payor Bank bears the risk of loss for honored checks with forged indorsements (ii) Bank may not charge the drawers account. (iii) Payor bank may recover from collecting bank for breach of presentment warranty (e) Conversion UCC 3-420 (i) Instruments (checks) are personal property (ii) At common law, conversion was aimed at scoundrel (iii) Under Article 3, bank can be liable if 1. Payor bank pays on the instrument 2. Payment made to a person not entitled to enforce the instrument

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(3) Payment by Mistake: UCC 3-418 (a) If payor bank pays under mistaken belief that drawer's signature was authorized, payor bank can recover from the person who benefited from the payment (b) Exception: Person took in good faith and for value iii) Alterations (1) Incomplete Checks Later Completed UCC 3-407 (a) Payor bank can pay the full amount of the check as written (b) Payor bank can charge the drawer for the amount (c) Rationale: drawer should've done a better job completing the check (2) Terms of the Check have been changed UCC 3-407; 4-401 (a) Drawer can only be charged according to the check's original terms (b) Payor bank can sue under presentment warranty to recover the balance UCC 4-208 d) Exceptions to the General Risk of Loss Rules: Where one party is in a better position to prevent loss i) Negligence UCC 3-406 (1) General Negligence (Bank's Burden of Proof) (a) Failure to exercise ordinary care (b) Substantially contributes to alteration or forgery (c) Effect: legitimizes any forgery (2) Comparative Negligence (Customer's Burden of Proof) (a) Bank must also exercise ordinary care in payment (b) Bank can share the loss if there was an obvious forgery (c) Plaintiff bears burden of proving comparative negligence ii) Bank Statement Rule UCC 4-406 (1) Banks are not required to issue statement but do so to avoid liability. Statement includes (a) Copies of the checks or (b) Sufficient information so the customer can identify the check (2) Customer must exercise reasonable promptness to examine and determine any unauthorized activity (3) If customer does not act reasonably prompt, customer cannot assert against the bank (a) any unauthorized signatures or alterations (b) subsequent forgeries by the same wrongdoer (4) One Year Rule: If customer waits one year to report forgeries, customer is liable for all forgeries during that year iii) Employee Fraud UCC 3-405 (1) General Rule: Employers are not responsible for employee fraud if they exercise ordinary care (2) Ordinary care means safeguarding checks Comment (3) Exception: If the employee has check-writing authority, employer can be liable for the amount of the check iv) Imposters UCC 3-404 (1) If imposter induces drawer to issue an instrument, the forgery is deemed properly payable (2) Risk of loss shifts to the drawer (3) Rationale: drawer dealing with the imposter is in the best position to prevent fraud 3) CREDIT CARDS a) Introduction i) Governed by Truth in Lending Act and Regulation Z ii) Applies to Consumer Transactions and Some Business Transactions iii) Parties (1) CardholderConsumer who makes the purchase with the credit card (2) Issuing BankBank that issues the credit card to the cardholder (3) MerchantThe Seller (4) Merchant's BankBank which merchant maintains its account iv) TILA governs relationship between cardholder and issuing bank b) General Rules i) Credit Cardany card or credit device existing for the purpose of obtaining something on credit TILA 103(k).

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(1) Bank cannot issue credit card unless it has been requested by the consumer. TILA 132. (2) Bank must give clear and conspicuous disclosure of rules regarding credit card once issued. Regulation Z 226.5. ii) Billing Errors (1) General Rule: Item that appears on a credit-card statement that does not reflect an actual transaction on the account (2) Specific Billing Errors TILA 161(b): (a) Statement contains transaction that did not occur or was for the wrong amount (b) Statement contains transaction that cardholder requested additional clarification about (c) Statement contains charge for goods or services not accepted by the cardholder or were not delivered to cardholder (d) Statement dies not reflect payment made by or credit issued to the cardholder (e) Computation error or something similar iii) Authorized Charge (1) A use is authorized when the user has actual or apparent authority to use the card (a) Actual usewhen the user has actual authority to use the credit card when the cardholder expressly or impliedly gives the user authority to use the card (hand over credit card and say go buy that thing) (b) Apparent authoritycardholder gives the impression to third parties that the user is authorized to use the card (hand over credit card to brother and say go buy that thing. Merchant calls to confirm that you gave authority. You say yes. A week later, forgetting to take back the card from your brother, he makes another purchase at the same place. Youre liable because you gave the merchant the appearance that your brother was authorized). (2) In a dispute, issuing bank has the burden to prove the charge was authorized TILA 133. iv) Unauthorized Charges (Fraud) (1) Use by a person who has no actual, implied, or apparent authority and (2) Cardholder receives no benefit from the transaction TILA 103(o). (3) NOTE: Apply this when card is stolen, lost, counterfeited, or never received by consumer c) Resolving Billing Errors i) Consumer's Responsibility TILA 161(a) (1) Must notify the issuing bank in writing of the billing error (2) Within 60 Days (3) Indicating the name and account number (4) Stating what the believed error is and why (5) stating the amount of the billing error (6) Must be sent to the address specified for billing disputes ii) Bank's Obligation TILA 161(a) (1) Bank must acknowledge in writing (2) Within 30 days after customer's notice (3) Must correct within two 2 complete billing cycles or (4) Must send documentation and evidence that the bill is correct (5) Interest does not accrue until the customer is actually required to pay (6) Bank cannot accuse customer of bad credit while the dispute is pending iii) Remedy for Billing Error TILA 170 (1) Holder gets a refund if follows the resolution procedures (2) NOTE: Remedy under 170 is withholding payment but if bill has been paid, only recourse is billing error refund d) Cardholder Liability for Unauthorized Use i) Cardholder is only liable for unauthorized use IF: (1) The card was "accepted" (a) cardholder requested or applied for and received card (b) signed or (c) used or authorized another person to use the card to obtain credit (2) The Issuing Bank gave the cardholder notice of liability and a place to call and (3) Card has a signature line (so the merchant can identify the cardholder) ii) Liability cannot exceed the lesser of (1) $50 or

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(2) The value of goods or services obtained from the unauthorized use iii) The Bank Statement Rule appliescustomer must review his bank statement iv) Network RulesAllocates losses between issuing bank, merchant bank, and merchant (1) Bank loses for face to face transactions (2) Merchant loses for remote transactions (internet and telephone transactions) e) Cardholder's Right to Refuse Payment: Underlying Obligation Between Merchant and Customer i) Cardholder can refuse payment of credit card bill for a purchase if (1) Customer made a good faith effort to resolve the dispute with the merchant (2) The purchase is more the $50 and (3) The purchase was made within the same state as the address on the card or within 100 miles of that address if the purchase was made out of state ii) The amount of the claim or defense that the customer can assert against the issuing bank cannot exceed the amount of outstanding credit f) Damages TILA 161(3) & TILA 130 i) If Bank fails to follow error correcting procedures, bank forfeits (1) $50 for each billing error and (2) Can be liable for actual damages g) Small Businesses TILA 135 i) Generally, TILA does not apply to businesses ii) Exceptions (1) Banks cannot send credit cards to businesses TILA 132 (2) Business cannot be liable more than $50 TILA 135 (3) Businesses can be liable for fraud TILA 134 iii) If a bank issues credit cards to a business with ten or more employees, bank and business can agree that the business will take the loss of unauthorized charges but liability cannot exceed $50 for each employee TILA 135 iv) Rationale: Protect really small businesses and treat them like consumers 4) DEBIT CARDS a) Introduction i) Governed by Electronic Funds Transfer Act (EFTA) and Regulation E ii) Applies to consumer electronic funds transfers EFTA 902 iii) Process (1) Buyer and seller transact and buyer used debit card (2) Buyer has an open account with his bank (3) Buyer and bank have relationship whereby bank will pay seller directly out of buyers account (4) Seller obtains payment by two methods (see below) iv) Methods of Collecting Payment (1) Pin Based (a) Who? Mac, PLUC, NYCE, (b) How? Buyer types PIN # into terminal at sellers location, bank verifies, and payment is approved and final (c) Cost? Low cost to merchant (2) PIN-less (a) Who? VISA and MasterCard (b) How? Buyer swipes card using these networks, bank authorizes charge and puts hold on accountPayment is final. Money then collected by merchant through network (c) Cost? High cost to merchant b) General Rules i) Electronic funds transfer Defined EFTA 903(6) (1) Any transfer (2) Initiated through an electronic terminal, phone, or computer (3) To order a bank to debit or credit an account ii) Statement of Transfer: Two are Required EFTA 906 (1) Statement at the time of transfer and (2) Periodic (monthly) statement iii) Types (1) Point of sale transfers (used at merchants location) (2) ATM transfers

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(3) Direct deposits or automatic payments c) Dispute Resolution EFTA 908 i) If error believed, customer must (1) Notify bank within 60 days of receiving documentation of error (2) Notification can be oral or in writing ii) Bank must either (1) Investigation within 10 days and recredit customers account on the 11th day (if there was an error) or (2) Give customer provisional credit within 10 days and finish the investigation within 45 days (3) 45-day limit can be extended for point of sale transactions or foreign transactions iii) If there was no error, bank must provide customer an explanation within three days after conclusion of the investigation d) Customer Liability for Fraud or Unauthorized Use EFTA 909 i) Unauthorized EFT defined EFTA 903(11) (1) Transfer initiated by a person (2) Without actual authority to initiate the transfer and (3) Consumer receives no benefit from the transfer (4) Exceptions: (a) Customer furnishes card (b) Customer engages in fraud or (c) Financial institution commits error ii) Conditions to Consumer Liability for Unauthorized Transfer (1) Card must be accepted (received and activated) (2) Issuer provides means to identify the consumer (PIN or signature) (3) Bank must provide liability disclosures Reg. E. 205.6(a) iii) Liability of Consumer for Unauthorized Transfer (Once conditions are met) (1) If customer notifies bank immediately, customer is liable for nom more than $50 (2) If customer waits more than (2) days after learning of the loss, customer can be liable up to $500 (3) Bank Statement Rule for EFTs: If customer waits more than (60) days after bank sends the first bank statement indicating unauthorized transaction, liability is unlimited for all losses after the 60th day (4) Limitation on liability apply whether or not the customer was negligent (5) Extenuating circumstances may be asserted to extend the time limits. Examples: (a) Extended travel (b) Hospitalization 5) WIRE TRANSFERS a) Introduction i) Governed by Article 4A of the UCC. UCC 4A-102 ii) Applies to Business to Business transactionsconsumer transactions excluded UCC 4A108 iii) Involves huge amounts of money iv) Allows for instantaneous payment v) Parties and Process (1) Payment Order #1: Originator (Buyer, Payor, and Sender) starts the funds transfer and sends payment order to originators bank (a) Oral or in person (b) Written (c) Email (2) Payment Order # 2: Originators Bank: (Only One in the process, can be sender, receiving bank) receives payment order and sends second payment order to receiving bank (a) SWIFT (b) CHIPS (c) Fedwire (3) Receiving Bank (can be beneficiarys bank): receives payment order (4) Beneficiarys Bank: bank that pays the beneficiary (5) Beneficiary (Seller, Payee) receives payment

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b) General Rules i) Funds Transfer Defined: UCC 4A-104 (1) Series of transactions from the originators payment order to the acceptance by the beneficiarys bank ii) Payment Order Defined UCC 4A-103 (1) Instruction of a sender to a receiving bank to pay or cause another bank to pay a sum of money to the beneficiary Requirements. Three requirements: (a) Unconditional (b) Reimbursed by sender (c) Transmitted directly to receiving bank (2) Payment orders can be oral, written, or electronic iii) Originators Obligation (1) Beneficiary cannot recover from the originator if the originators obligation is discharged (2) Originators obligation is discharged when payment is made UCC 4A-406 (3) Payment is made when the payment order is accepted by the beneficiary bank UCC 4A-406 (4) Acceptance (a) By Beneficiary Bank UCC 4A-209 (i) When payment is made to beneficiary (ii) When beneficiary bank notifies beneficiary that account has been credited (iii) When beneficiary bank receives entire amount of senders order or (iv) One hour after the opening of the next funds transfer business day after payment date if the sender had enough money to cover the payment at that time (b) By Other Banks UCC 4A-209 (i) Acceptance occurs when the payment order is executed (ii) Executed means another payment order follows the first (e.g. A give payment order to Bank B (originators bank). Bank B gives payment order to Bank C (Beneficiarys bank). Bank A would have executed by giving the payment order to Bank C.) (5) Rejection UCC 4A-210 (a) Does not discharge the originators obligation (b) Banco de la Provincia: Bank has discretion to reject payment order but (c) Discretion to reject payment order is not absolute iv) Effect of Acceptance by Beneficiarys Bank UCC 4A-404 (1) Beneficiarys Bank is obligated to pay the amount of the order to the beneficiary once payment order is accepted v) Stopping Payment of Wire Transfers UCC 4A-211 (1) Oral, written, or email notice of cancellation and (2) Received before acceptance of a payment order within a reasonable time in order for the bank to act (3) Fedwire transactions cannot be stopped (they are instantaneous) vi) Damages (Loss of the Use of Funds) (1) Bank is liable for interest if (a) Sender doesnt send notice of rejection and (b) Account does not bear interest at statutory rate c) Errors in Wire Transfer Transactions i) General Rules (1) Each party bears responsibility from its own mistakes (2) Mistake by Internet Service Provider or Funds Transfer System (except Fedwire) is deemed a mistake by the party using the ISP or FTS UCC 4A-206 (3) Later parties in the transaction do not have an obligation to discover or correct errors by earlier parties to the transaction ii) Misdescription (1) Where beneficiarys name is correct but the account number does not exist UCC 4A207 (a) No person has rights of beneficiary and thus no acceptance can occur (b) Since no acceptance can occur, sender need not pay UCC 4A-402 (c) Policy: Big players in the wire transfer system should not how to process orders (2) Where beneficiarys name is correct but the account number belongs to another person

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(a) If beneficiarys bank does not actually know (UCC 1-201) the name and account number refer to different people, beneficiarys bank can rely on the number (b) If beneficiary bank pays according to the account number and the holder of the account is not the beneficiary, the payment order is deemed accepted (c) Because it is deemed accepted, sender must pay UCC 4A-402 (d) If Beneficiarys bank knows the number and name do not match, sender need not pay and beneficiary bank must pay (3) Originators Obligation for Wrong Account Number on Payment Order (a) If the originator is a bank, originator must pay the order UCC 4A-407 (b) If the originator is not a bank, originator must pay only if originator had notice (knew or had reason to know UCC 1-201) that the beneficiary bank would rely on the account number iii) Mistakes by Receiving Banks (1) Duplicate Payment Orders (a) If Receiving Bank sends duplicate payment orders to beneficiarys bank and beneficiary banks accepts (b) Payment order cannot be cancelled (c) Sender must pay (d) Beneficiary bank must pay the full amount of the order to the beneficiary (2) Cancellation of Duplicate Payment Orders UCC 4A-211 (a) If the accepted payment order was the result of a UCC 4A-211(c)(2) mistake (i) Duplicate of previous order (ii) Wrong beneficiary or (iii) Greater in the amount beneficiary was entitled to receive (b) Then the payment order can be cancelled only if (i) Receiving bank agrees and (ii) Funds Transfer System allows for cancellation d) Fraud and System Failure in Wire Transactions i) General Rules (1) Customer is liable for the amount of the payment order that was authorized (2) Exception: Use of security procedure can make unauthorized payments authorized ii) Customers Liability (1) Customer is liable for fraud if security procedure is commercially reasonable and (2) Bank can show that it complied with the security procedure iii) Banks Liability (1) Loss from fraud can shift back to the bank (2) Customer must show that the fraudulent payment order was not performed by someone under the customers control UCC 4A-203 6) PROMISSORY NOTES a) Introduction i) Terms: In cases of deferred compensation, parties have a written agreement describing the time when payment must be made and amount of compensation for delay. ii) Form: Law requires no particular form for the transaction (but usually written) b) General Rules i) Novation (1) Extinguishment of an obligation by the substitution of a new one. (2) Novation may not be presumed (3) Novation determined by the intent of the parties based on the facts and circumstances (4) Promissory notes may contain a clause that it is the final agreement of the parties and may not be altered. ii) Determining the Amount of Compensation (1) Fixed and Variable Interest Rates (a) Fixed Rate Note (i) Parties agree to a specific interest rate at the time of the borrowing. (ii) Interest accrues at the fixed rate on the principal balance of the note. (b) Variable Rate Note (i) Interest accrues at a floating rate based on an objectively determinable reference rate

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(c) Interest Rate Swaps (i) Lender enters into an interest rate swap w/ a 3rd party (aka the swap partner). (ii) Lender swaps the fixed rate payments of its borrower for variable rate payments the swap partner pays. c) Usury i) The Basic Concept (1) State laws establish interest rate ceilings for various types of loans. (2) Penalties include forfeiting interest, penalties, forfeiting unpaid balance, and criminal sanctions (3) Elements (a) Express or implied loan. (b) Understanding that money loan will be repaid. (c) Interest rate is greater than maximum lawful rate. (d) Intent (i) Corrupt intent (Schnee v. Plemmons) or (ii) General intent to charge more than the maximum lawful rate. (4) Usury is a defense to non-payment. ii) Typical Usury Problems (1) Exceptions (a) Home mortgage loan. (b) Credit cards. (2) Corporations (Trapp) (a) Corporations may not assert usury as a defense. (b) Exception: If corporate guarantor used the loan to pay personal obligations. (c) Good Faith Exception: Lender may assert good faith. (3) If the interest rate changes in the future and it goes above the maximum lawful rate. (4) Charges upon issuance of loan. d) Late Payment and Prepayment i) Late Payment (1) Acceleration: Balance becomes due and payable immediately. (2) Cure: Borrower pays late fees or the principal if loan accelerated. (3) Default Rate: Interest rate higher than ordinary rate but may not be usurious. (4) Late Charges: May not be enforceable if they are liquidated damages (a) grossly in excess of actual damages or (b) susceptible of definite measure (c) Burden is on party asserting that the charge is a penalty (d) Policy: commercial borrowers should know what they are doing ii) Prepayment (1) Fixed Amount Prepayment Fee (a) Borrower may prepay but at a fixed fee. (2) Yield Maintenance Prepayment Fee (a) Borrower may prepay but pays the difference in interest between the Notes interest rate and the interest rate on a Treasury Note for the same year (Carlyle Apts.). (b) Attempt by lender to approximate actual damages. 7) NEGOTIABLE INSTRUMENTS a) Introduction i) Device to facilitate transfer of value ii) Paper is the value: negotiable document must be paper iii) Negotiability is a system of enhancing liquidity (ease with which assets can be sold) iv) Two types of Negotiable Instruments: NOTES & DRAFTS v) If the instrument is negotiable, Article 3 applies (Form over substance) vi) If the instrument is not negotiable, common law rules apply b) Requirements for Negotiability i) Unconditional UCC 3-106 (1) Conditional IF (a) States express condition to the payment of money (b) Subject to or governed by other writings (c) Rights or obligations specified in another writing

13
(2) Exceptions (a) References another writing for a statement of rights with respect to collateral, prepayment, or acceleration (b) Instrument states that payment must come from a particular source ii) Promise or Order (1) Promise is an undertaking to pay money (NOTE) UCC 3-103 (2) Order is an instruction to pay money (DRAFT, CHECK) iii) In Writing (1) Paper only (2) Impossible to have electronic negotiable instrument iv) For a Fixed Amount of Money (1) With or Without Interest (2) Variable interest Rates are OK UCC 3-104; 3-112(b) v) Payable to Bearer or to Order UCC 3-109 (1) Payable to Bearer is payable to unspecified person (2) Payable to order is payable to a specified person vi) Payable on Demand or at a Definite Time UCC 3-108 (1) On Demand: payable at the will of the holder (2) Definite Time: elapse of a definite time subject to the rights of (a) Prepayment (b) Acceleration (c) Extension by holder or (d) Extension by maker to a further definite time vii) Does not State other Undertaking in Addition to the Payment of Money (1) Forbids maker from doing something non-monetary (2) Waivers of liability, etc. are other undertakings c) Transfer & Enforcement i) Liability on Instruments (1) Indorsers of a Note or Draft (a) Person is liable on an instrument only if signed by that person UCC 3-401(a) (b) Signature by representative UCC 3-401 (i) Principal is liable if would be liable under agency law (ii) Representative might be liable if you cant tell whether signature is by representative for another party or for himself (c) Indorser liability conditioned on dishonor UCC 3-415 (d) NOTE: If instrument is not signed, liability can attach under warranty liability (2) Issuer of a Note UCC 3-412 (a) Issuer is absolutely liable (b) Liable to a person entitled to enforce the instrument (3) Drawees of a Draft UCC 3-408; 3-413 (a) Drawee liability is conditioned upon acceptance of the draft (b) Once accepted, drawee is liable to a person entitled to enforce the draft (4) Drawer of a Draft UCC 3-414 (a) Drawer liability is conditioned upon dishonor of the draft (b) Once dishonored, drawer is liable to a person entitled to enforce the draft ii) Person Entitled to Enforce an Instrument UCC 3-301 (1) Holder (2) Non-holder in possession with rights of a holder or (3) No possession and 3-309 (lost instrument) or 3-418 (payment by mistake) iii) Holder UCC 1-201(20) (1) General (a) Person becomes a holder by negotiation (b) Possession of instrument payable to bearer is a holder (i) Even if someone steals bearer paper, that person is still a holder (c) Possession by the identified person on an instrument is a holder (2) Types of Indorsements UCC 3-205 (a) Special (i) Identifies the person to whom the instrument is payable (/s/ George A. Bibikos Payable to Kristen R. Opdenhoff)

14
(ii) Effect: Only the named party can negotiate the instrument (Here, Kristen) (b) Blank (i) Names no one (/s/ George A. Bibikos) (ii) Effect: Becomes bearer paper and anyone in possession can be a holder (c) Anomalous (i) Indorsement by person who was not a holder when signed (ii) Effect: indorser acts as a guarantor and can be liable under indorsement theory (d) Restrictive UCC 3-206 (i) General Rule: restrictive indorsements have no effect (ii) Exception: for deposit only or for collection (iii) NOTE: If bank cashes check for deposit only bank can be liable to the payee under conversion theory UCC 3-420 (Check payable to the order of George A. Bibikos. /s/ George A. Bibikos for deposit only. Kristen takes check and First Union cashes itbank is liable to George). (3) Suing on the Instrument of Underlying Obligation (a) Holder can sue on the instrument or underlying obligation (b) Instrument UCC 3-308 (i) Indorsement theory; warranties (c) Underlying Obligation UCC 3-310 (i) Issuance of check suspends the obligation until dishonor (ii) Once check is accepted and then dishonored, holder can sue under both theories (4) Accord & Satisfaction UCC 3-311 (a) Instrument is tendered as full satisfaction of a bona fide disputed claim (b) Payor conspicuously notifies the payee that it intends the instrument to constitute full satisfaction of the claim (PAID IN FULL) (c) Payee successfully obtains payment (d) Exception for Businesses UCC 3-311(c)(1) (i) Business can require disputed claim to be sent to a designated place (submit disputes to claims department) (ii) If payor does not send to this place, there can be no accord & satisfaction (iii) If, within 90 days, the business sends money back, then there is no accord & satisfaction (5) Bank Rules UCC 4-205 (a) If customer was a holder, bank becomes a holder (b) Bank does not have to indorse (c) Rationale: facilitates easy collections by banks d) Holder in Due Course (HDC) UCC 3-302 i) Elements (1) Holder (2) Takes instrument for value and in good faith (a) For value UCC 3-303 (i) Promise of performance (ii) Security interest or lien (b) Good faith UCC 3-103(a) (i) Honesty in fact (subjective) (ii) Observance of reasonable commercial standards of fair dealing (objective) (3) Without notice that (a) Payment is overdue (b) Instrument is dishonored (c) Uncured default in payment (d) Instrument has unauthorized signature (e) Instrument has been altered (f) There are any claims to the instrument or any defenses to payment (i) Obligor is discharged UCC 3-602 1. when obligor is paid or 2. when obligor is released (guaranteed by another) (ii) Notice of discharge is not notice of a claim or defense and does not destroy HDC status (iii) If HDC takes with notice of discharge, HDC cant get paid from the discharged

15
obligor (but hes still a HDC) (4) Appearance of instrument UCC 3-302 (a) Instrument cannot appear forged (b) Instrument cannot appear incomplete Effect: When the person required to pay on the instrument says he aint gonna pay the HDC (1) If not HDC, person takes instrument subject to all claims and defenses (a) Exception: Shelter Principle UCC 3-203 (i) Transferee gets all the rights of the transferor (ii) If HDC transfers to transferee, transferee has rights of HDC (iii) Transferee can take free of personal defenses (see below) (iv) NOTE: If transferee engages in fraud or illegality, cannot get rights of HDC (2) If HDC, HDC takes free of personal defenses (a) Article 3 defenses (b) Contract defenses (c) Claims in recoupment (3) HDC takes subject to Real Defenses: (a) Infancy (b) Duress (c) Lack of capacity (d) Illegality (e.g., usury, gambling debts, etc.) (e) Fraud in the factum (i) Signer must have had no reasonable opportunity to discover the true nature of the note (ii) Examples: signer was blind, could not speak or read English, etc. (f) Discharge in bankruptcy Overdue Instrument UCC 3-304: (1) Instrument becomes overdue on the earliest of the following times: (a) day after the day demand is duly made (b) if the instrument is a check, 90 days after its date or (c) if not a check, after an unreasonable period of time in light of instrument and usage of trade (2) If instrument payable at definite time (a) If instrument is payable in installments and due date has not been accelerated (i) Instrument is overdue upon default and (ii) Instrument remains overdue until cured (b) If not an installment & due date not accelerated, instrument is overdue the day after the due date (c) If due date has been accelerated, instrument is overdue the day after the acceleration day (3) Default in payment of interest, not principal, does not make the instrument overdue unless the due date of the principal has been accelerated Banks as HDC: When do they give Value? UCC 4-211 (1) Bank gives value to the extent it has a security interest in an item (2) Banks has security interest if depositor has right to withdraw (a) Can be credit given by the bank or (b) Credit available for immediate withdraw Consumer Notes (1) FTC legend must be on a consumer note (2) The legend must state that any holder is subject to all claims and defenses (3) No one can become a HDC of consumer credit contracts (4) If there is no legend (a) No good faith (b) Buyer of note had reason to know that there should be a legend (notice requirement)

ii)

iii)

iv)

v)

8) LETTERS OF CREDIT a) Introduction i) Three Contracts: (1) Sales contract between the buyer and seller (2) Letter of credit between buyers bank and seller

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(3) Bill of lading contract between seller and carrier (4) NOTE: All contracts are independent of each other ii) Two Types of LOCs (1) Documentary LOC (2) Standby LOC (for domestic sales) that act as guarantees iii) Parties (1) Buyer (Applicant) (2) Buyers Bank (Issuer) (3) Sellers Bank (Confirmer or Advisor) (4) Seller (Beneficiary) iv) Governing Law (1) UCC Article 4 (2) UCP International Standards & Practices v) Process (1) Buyer tells bank to issue a letter of credit to seller (2) Buyers bank presents that to the seller or sellers bank (3) Seller or his bank turns over documents to buyers bank (4) If documents comply, bank pays (5) Buyer reimburses buyers bank Issuing Letter of Credit UCC 5-104 i) Can be issued in any form that is a record and authenticated by signature or other means ii) Can be an email UCP art. 11(a)(i) (1) If Email is the first LOC sent, email is the operative credit instrument and no mail confirmation should be sent (2) Any mail documentation has no effect iii) No consideration is needed to issue LOC UCC 5-105 Obligation of Issuer UCC 5-108; UCP art. 14(d) i) Issuer must honor a presentation that on its face strictly complies with the letter of credit ii) Unless otherwise agreed, issuer must dishonor a presentation that does not strictly comply iii) Issuer has reasonable time after presentation but no later than 7 business days to (1) Honor the presentment (2) Accept and defer the obligation if the LOC is for more than 7 days or (3) Give notice to the presenter that there are discrepancies in the presentation UCP arts. 39(a), 47(a) (a) "About" "approximately" "circa" or similar words used to describe the amount of credit or quantity of goods are construed as 10% more or less than the amount stated (b) The words "to" "until" "till" "from" and similar words will be understood to incorporate the date mentioned (c) The terms "beginning" "middle" or "end" of a month shall be interpreted as 1st to the 10th, (beginning) 11th to the 20th (middle), and the 21st to the last day of such month (end) respectively, all dates inclusive. iv) If Issuer does not comply with time limit, issuer cannot not raise discrepancies as a defense to honor v) UCC Exception to time limit: Issuer suspects fraud or forgery Obligation of Confirmer and Advisor UCC 5-107 i) Confirmer is directly obligated on a the LOC ii) Advisor merely advises the beneficiary and is not directly liable on the LOC Problems with Letters of Credit i) Nonperformance ii) Wrongful Honor UCC 5-108; 5-111 (1) If issuer should not have honored, issuer has no right to reimbursement (2) Applicant (buyer) gets damages iii) Fraud (1) Forgery (2) Fraud in the transaction Rights of Subrogation UCC 5-117 i) Issuer is subrogated to rights of beneficiary as if it was a secondary obligor

b)

c)

d) e)

f)