Larry London (LL) buys a computer with his new store credit card at Greatest Get (GG). GG immediately sells the right to receive monthly payments from LL to a finance company, Friendly Finance (FF). Unfortunately for LL, the computer stops working three months after he purchased it. As GG won't return his calls regarding his broken PC, LL stops making payments. Long story short, all stakeholders (LL, GG, and FF) are fed up with each other's behavior; they all lawyer up.

I am acting as FF's Lawyer

consider whether the parties have a negotiable instrument. If so, what kind? What defenses might there be on that instrument?

Reference:

NEGOTIABLE INSTRUMENTS

With graduation looming, Chaz needs to rent an apartment and buy a car. Responding to an online ad, he finds the perfect place to rent. True, it is more expensive than he had planned, but he will surely get a raise soon. With nervous hands, he writes out a big check for three month's rent (first month, last month, and security deposit). Then he goes to Trustie Car Lot to buy a used car. He cannot afford the entire purchase price, so he makes a down payment and signs a promissory note for the balance due.

With growing excitement, Chaz loads all his worldly possessions into his car and heads over to his new apartment. When he arrives, though, his key does not work and a stranger answers his knock. It turns out that someone else is living in his apartment. Chaz has been scammedthe person he gave his check to had no right to the apartment. Stunned, Chaz goes to a friend's place where he can crash for a few days. But his car will not start. With his head in his hands, Chaz tries to remember what he learned about negotiable instruments in his business law class.

When he arrives, his key does not work and a stranger answers his knock.

Let's take the rent check first. When Chaz's bank paid the scammer on the check, it became a holder in due course. Chaz has no valid defenses against the bank. So that rent money is just gone, unless Chaz can recover from the thief (not likely). But he has better luck with the car. Because Trustie still holds the promissory note, it is not a holder in due course. If the car is defective, Chaz will not have to pay back the full amount of the Trustie loan. What is the difference, you ask? Read on to save yourself from Chaz's mistakes.

15-1 NEGOTIABLE INSTRUMENTS

This chapter is about negotiable instruments, which are a type of commercial paper.

15-1aCommercial Paper

As Chaz learned, the law of commercial paper is important to anyone who writes checks or borrows money. Historically speaking, however, commercial paper is a relatively new development. In early human history, people lived on whatever they could hunt, grow, or make for themselves. Imagine what your life would be like if you had to subsist only on what you could make yourself. Over time, people improved their standard of living by bartering for goods and services that other people could provide more efficiently. But traders needed a method for keeping track of who owed how much to whom. That was the role of currency. Many items have been used for currency over the years, including silver, gold, copper, and cowrie shells. These currencies have two disadvantagesthey are easy to steal and difficult to carry.

Paper currency weighs less than gold or silver, but it is even easier to steal. As a result, money had to be kept in a safe place, and banks developed to meet that need. However, money in a vault is not very useful unless it can be readily spent. Society needed a system for transferring paper funds easily. Commercial paper is that system. If done right, it acts as a substitute for currency.

15-1bTypes of Negotiable Instruments

There are two kinds of commercial paper: negotiable and non-negotiable instruments.

Article 3 of the Uniform Commercial Code (UCC) covers only negotiable instruments; non-negotiable instruments are governed by ordinary contract law.

There are also two categories of negotiable instruments: notes and drafts. Anote(also called apromissory note) is your promise that you will pay money. A promissory note is used in virtually every loan transaction, whether the borrower is paying for a multimillion-dollar company, a television, or college tuition. When Krystal borrows money from the government to pay her college tuition, she signs a note stating, "I promise to pay to the Department of Education all loan amounts disbursed under the terms of this Promissory Note, plus interest and other charges and fees that may become due as provided in this Promissory Note." She is themakerbecause she is the one who has made the promise. The Department of Education is called thepayeebecause it expects to be paid.

Note

The maker of the instrument promises to pay a specific amount of money. Also called a promissory note.

Maker

The issuer of a promissory note

Payee

Someone who is owed money under the terms of an instrument

Adraftis an order directing someone else to pay money for you. Acheckis the most common form of a draftit is an order telling a bank to pay money. In a draft, three people are involved: thedrawerorders thedraweeto pay money to the payee. Now before you slam the book shut in despair, let us sort out the players. Suppose that Madison Keys wins the River Oaks Club Open. River Oaks writes her a check for $500,000. This check is simply an order by River Oaks (the drawer) to its bank (the drawee) to pay money to Keys (the payee). The terms make sense if you remember that, when you take money out of your account, youdrawit out. Therefore, when you write a check, you are the drawer, and the bank is the drawee. The person to whom you make out the check is being paid, so she is called the payee.

Draft

The drawer of this instrument orders someone else to pay money.

Check

The most common form of a draft; it is an order telling a bank to pay money.

Drawer

The person who issues a draft

Drawee

The person who pays a draft. In the case of a check, the bank is the drawee.

In this note, Romeo is the maker and Juliet is the payee.

The following table illustrates the difference between notes and drafts. Even courts sometimes confuse the termsdrawer(the person who signs a check) andmaker(someone who signs a promissory note).Issueris an all-purpose term that means both maker and drawer.

Issuer

The maker of a promissory note or the drawer of a draft

Who PaysWho PlaysNoteYou make a promise that you will pay.Two people are involved: maker and payee.DraftYou order someone else to pay.Three people are involved: drawer, drawee, and payee.

15-1cNegotiation

Negotiable instruments are meant to act as a substitute for currencythat is, to be freely transferable in the marketplace, just as currency is. To meet that goal, an instrument must comply with this fundamental rule of commercial paper:

The possessor of a piece of commercial paper has an unconditional right to be paid, so long as(1)the paper isnegotiable,(2)it has beennegotiatedto the possessor,(3)the possessor is aholder in due course, and(4)the issuer cannot claim a valid defense.

In the following sections, we explain all of these important terms.

Negotiable

In the opening scenario, Chaz has given a promissory note to Trustie Car Lot. So long as Trustie keeps the note, Chaz's obligation to pay is contingent upon the validity of the underlying contract. If the car is defective, then Chaz is not liable to Trustie for the full amount of the note. However, Trustie does not want to keep the note. It needs the cashnowso that it can buy more cars to sell to other customers. Reggie's Finance Co. is happy to buy Chaz's promissory note from Trustie, but the price Reggie is willing to pay depends upon whether the note is negotiable.

The transferee ofnegotiablecommercial paper hasmorerights than the person who made the original contract. With negotiable commercial paper, the transferee's rights areunconditional: He is entitled to be paid the full amount of the note, regardless of the relationship between the original parties. If the promissory note is a negotiable instrument, Chaz must pay the full amount to its subsequent holders, no matter what complaints he might have against Trustie.

The rules are different for the transferee ofnon-negotiable commercial paper: His rights are the sameno more, no lessas the person who made the original contract.That is to say, they areconditional. If, for some reason, the original party loses his right to be paid, so does the transferee. The value of non-negotiable commercial paper is greatly reduced because the transferee cannot be absolutely sure what his rights are or whether he will be paid at all.