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Notes Chapter 6 REG
Notes Chapter 6 REG
Notes Chapter 6 REG
http://www.cpa-cfa.org
Commercial Paper
Commercial paper is promissory notes (CDs) or drafts (checks)
The commercial paper laws arose, in part, to provide a convenient and safe substitute for cash
Article 3 governs any type of note or draft (check or installment note)
- not warehouse receipts, bills of lading, stocks and bonds
Step 1: identify the type of paper
A note is a two party commercial paper. It is a promise by one party (the maker) to pay money to another
party (the payee)
Certificate of deposit (a bank promissory note) A CD is a negotiable instrument issued by a bank that
acknowledges receipt of money and promises to repay at a future date
Drafts is a three party commercial paper. It is an order by one person (the drawer) to another person (the
drawee) demanding that the drawee pay money to a third person (the payee)
Checks drawee must be a bank and be payable on demand
Trade acceptances draft drawn by seller ordering the buyer to pay
Demand note/draft an instrument payable on demand
Time note/draft an instrument payable at a future date
Step 2: is the instrument negotiable
To be a negotiable instrument, the instrument must:
Be in writing
If an instrument is not negotiable there can be no holder in due course and the holder in due course rule cannot
apply. Thus, transferees of the instrument will take the instrument subject to any defense against payment that a
party might have
Step 3: Does the holder qualify as an HDC?
The process by which commercial paper is transferred is called negotiation, and the persons whom the UCC
seeks to protect are holders in due course (HDCs) and most transferees of holders in due course
The first step in becoming an HDC is becoming a holder. A holder can be thought of as a person with good title
to the commercial paper
Bearer paper is negotiated by delivering the instrument to a transferee
Order paper (commercial paper payable to specific person) requires delivery to that person and the payees
endorsement (signature)
Special endorsement names a particular person as endorsee and always makes the instrument order paper
The UCC treats the forgery as the genuine signature of the forger. Thus, transferees are holders of the forgers
instrument
Endorsers are secondarily liable (guarantors) (must pay) if primary party defaults
Without recourse means there is no guarantee of payment by the endorser. The without recourse endorser still
has warranty liability
Restrictive endorsement generally have no effect on negotiability
Types of endorsements
Is negotiable
For value
- An executory promise (a promise to give value in the future) is not value
- Value need not be equivalent to face value
Forgery
Fraud in execution
Alteration of instrument
Adjudicated insanity
Infancy
Illegality
Duress
Discharge in bankruptcy
Surety defenses
Statue of limitations
Personal defenses cant be raised against an HDC or their assignees (shelter doctrine)
- such as: fraud in the inducement, failure of consideration, theft of instrument after signed, breach of
contract, mistake, impossibility, unauthorized completion (giving a party an instrument with the amount
left blank) Thats different then material alteration (changing the amount written on the instrument
without permission)
Liability of the parties
Note/CD
- Primary liable maker
- Secondary liable endorsers
Draft/check
- Primary liable Drawee (if they accept)
- Secondary liable Drawer + endorsers
An endorser can be liable in two separate ways
Contract liability by endorsing the instrument he becomes secondarily liable (negates if without
recourse)
Warranty liability any person who transfers an instrument for consideration makes the five warranties
listed below (exists even if the transferor does not sign or signs without recourse)
- Transferor is entitled to enforce the instrument
- All signatures are genuine or authorized
- The instrument has not been materially altered
- No defense of any party is good against the transferor, and
- The transferor has no knowledge of any insolvency proceeding against the maker, acceptor, or drawer
of an unaccepted instrument
Forgery
General rule real defense for the innocent party whose name was forged
Forger is always liable
Forgery of drawers name the drawee is liable upon acceptance for negligence (should have known the
signature was forged)
Forgery of the payees name does not usually pass good title
If a maker or drawer issues an instrument to an imposter, any resulting forgery of the payees name will be
effective
Secured Transactions
Secured transactions debt secured by collateral
Security interest right of creditor to repossess upon default
Effective against third parties upon perfection (a form of notice that the creditor has security interest in
the collateral and gives the creditor superior rights to collateral compared to certain third parties
When a debtor pledges collateral to multiple parties creditor protects themselves from third parties by perfect
security interest
Purchase money security interest (PMSI) has priority over all other types of security interests in the same
collateral, if the PMSI is properly perfected. A PMSI arises when:
A creditor sells the collateral to the debtor on credit, retaining a security interest, or
The creditor advances funds used by the debtor to purchase the collateral
Types of collateral
Debtor must have rights in the collateral (debtor owns/has possession of the collateral)
Authenticated record signed and approved by debtor
Perfection of the security interest (creditors vs. third parties)
Perfection of a security interest cannot be completed until it has been attached (but can occur at the same time)
There are 5 methods of perfection:
1. Filing give notice by filing a financing statement, authenticated by debtor, which contains:
- name and mailing address of debtor and secured party
- indication of the collateral covered by the financing statement, and
- if the collateral is real property, there is a description of that real property
2. Taking possession (oral agreement ok) this is similar to when a pawn shop takes an item in exchange
- must use reasonable care is storing and preserving the collateral
3. Perfection by control for investment property
- Certificated stocks and bond securities must take possession
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- Uncertificated securities must have owner notify the issuer to reregister the securities in the name of
the secured party
- Securities accounts owner of the account must contact the broker and instruct the broker that the
secured party no has whatever right
4. Automatic perfection PMSI in consumer (personal) goods only
- security interest can be perfected by attachment in consumer goods without any added requirements
5. Temporary perfection
- 20 day period for proceeds
- 4 months grace period for interstate shipments (protected in new state until end of grace period)
There can be conflicting interests in collateral. Between creditor and debtors; between creditors with a security
interest in the same collateral. The priority ranking is:
1. Buyer in the ordinary course of business (HDCs and the like)
- even if the buyer has knowledge of the security interest
2. Holder of a properly perfected PMSI in the collateral
- exception: second hand consumer purchase without notice (did not file) would take free of PMSI
- PMSI in inventory to have priority must be perfect before debtor gets possession and notice must be
given to other perfected parties in same collateral
- PMSI in equipment has priority is filed anytime within 20 days of the debtor getting possession of
the collateral
3. Holder of a perfected security interest (and judicial lienholders once the lien has attached)
- Two creditors both perfected but neither PMSI, first to file or perfect gets priority (so the party with
the earliest date of the two categories gets priority).
- Dates of attachment are irrelevant
4. Holder of an unperfected security interest
- If there are two unperfected security interests in the same collateral, first to attach has priority
5. The Debtor
Rights on defaults
Self-help secured party may take possession of collateral without judicial process if the breach is not
breached
Replevin Action judicial action seeking the transfer of personal property
After default or repossession, the secured party may sell or lease the collateral. Once the collateral is sold, all
subordinate claims are wiped out and there is no right of redemption by subordinate security interest holders or
the debtor
Proceeds of the sale are distributed in the following order:
Expenses of repossession
Exception: in consumer goods cases where the debtor has paid at least 60% of the loan, the secured
party must sell the collateral within 90 days after repossession, unless the debtor waives this right
Future interests an estate that does not entitle the holder to current possession, but may give the owner
possession in the future
Nonpossessory interests intangible real property
Profit right to enter land and take a substance from the land (soil, timber, minerals)
Concurrent estates any estate in land can be held concurrently by several persons.
These co-tenants have the right to enjoyement and possession of the jointly owned land
Because each co-tenant has rights to the whole land, their interests in the land is undivided
Joint tenancy
Right of survivorship In a joint tenancy, when one joint tenant dies, the property passes to the surviving joint
tenants by operation of law. A joint tenant cannot change this by a provision in his or her will
4 unities are required to create joint tenancy: TTIP
When a tenant in common dies, her interest passes to her heirs or the persons named in the will
Tenancy by the entirety joint tenancy between spouses, with right of survivorship
Landlord and tenant
Leasehold estate a possessory estate that entitles the tenant, rather than the owner, to exclusive possession of
the land
Tenancy for years tenancy expires at the end of the stated period without notice to either party
Periodic tenancies continue until terminated by notice
Tenancy at will may terminate the tenancy at anytime without notice
Absent specific restrictions in the lease, a tenant may engage in any lawful activity on the premises.
Assignments by tenants original tenant transfers all of their interest to the new tenant
If a lease prohibits assignment, you could still sublease and visa versa (play on words)
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Notice statutes subsequent BFP (bona fide purchaser) prevails over a prior grantee who failed to
record
Race notice statutes subsequent BFP is protects only if she records before prior grantee records and
has no notice of a prior transfer
Delivery
Mortgagors signature
Mortgagors acknowledgement
Whether its a deed, lease or mortgage it must contain a description of the premises
RESPA is a federal act that requires that certain disclosures be made when a debtor agrees to give a mortgage
on the debtors property
Deficiency if the sale does not bring a sum sufficient to satisfy the debt for which the mortgage was given,
some states allow the mortgage to bring a deficiency action against the mortgagor to recover the deficiency, but
some state do not allow such an action
Assuming a mortgage if a buyer assumes an existing mortgage of a seller, the buyer has agree to be liable for
this mortgage. The seller (old mortgagor) is also liable.
Buying subject to an existing mortgage the buyer is not liable for the existing mortgage. However, buyer runs
the risk of foreclosure if the seller does not pay the mortgage and defaults
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A prior recorded mortgage has priority over a second mortgage. So upon default, the first mortgage must be
paid in full before the second mortgage can get anything
The mortgagor has an equitable right of redemption until the foreclosure sale is held and may have a statutory
right to redeem the property after the sales as well (if the state statue permits)
Additional
Surety one who is liable for the debt or obligation of another
To make a document of title negotiable, its terms goods are to be delivered to bearer or to the order of a named
person
Essential terms of a warehouse receipt
Description of the goods and the number of the receipt must be included