PART 1.

SALE AND LEASE OF GOODS

CHAPTER 1. BASIC CONCEPTS
I. Introduction
A. The Basics of Art. 1 (2001 version)
1. General article applicable to all the articles that follow unless stated otherwise
2. Basic principles
a. 1-103: how UCC is to be construed
b. 1-103(b): preserving the common law unless obviously changed by UCC
c. 1-304: good faith is to be imposed in all UCC transactions
d. 1-201: definition section explaining meaning of terms used in UCC
3. Controversial section 1-301
a. Parties are allowed to adopt by K the law of “any” jurisdiction and have it apply to
their disputes even if that jurisdiction has no obvious connection to the parties or the
matter at issue
b. No states have ever adopted this provision, instead most states have adopted 1-105(1):
i. when a transaction bears a reasonable relation to this state and also to another
state or nation, the parties may agree that the law either of this state or of such
other state or nation shall govern their rights and duties
B. The Basics of Art. 2 (pre-revision version)
1. Deals with transactions in goods
C. The Official Comments
1. Not enacted into law, but written by the drafters of UCC and appended thereto
2. Very persuasive, but in case when those comments are not favorable to you, you may
argue that in many jurisdictions they were not available to the legislature at the time it
adopted, so not part of the legislative history
II. Scope of Art. 2
A. Transactions in Goods
1. 2-102 Scope: Unless the context otherwise requires, Art. 2 applies to transactions in
goods; it does NOT apply to any transaction which although in the form of an
unconditional K to sell or present sale is intended to operate only as a security
transaction NOR does Art. 2 impair or repeal any statute regulating sales to consumers,
farmers or other specified class of buyers.
2. Transactions (2-106(1)): bigger than sale (passing of title from seller to buyer for a price)
a. Gift is not a transaction, but a transfer
3. Goods (2-105): all things (including specially manufactured goods) which are movable at
the time of identification to the K for sale
a. What is excluded: Money, Investment security, Things in action (health spa
membership)
b. What is included: Unborn young of animals, Growing crops, Other identified things
attached to realty to be severed from realty
4. Problem 1: Does Art. 2 apply?
a. Sale of insurance policy: X, thing in action (sale of K item), not a movable thing
b. Sale of real property: X, sale of house apart from the realty: O (2-107: if severed by
 the “seller”)
i. Sale of real property is not covered by Art. 2, but courts apply Art. 2 by analogy
c. Sale of building materials as “part of a construction project”: mixture of goods and
services -> Predominant purpose test (Perlmutter v. Beth David Hospital): when
service predominates and the transfer of personal property is but an incidental
feature of the transaction, the exacting warranty standards for imposing liability
without proof of fault will not be imported from the law of sales
i. illusory test, different outcome with similar fact patterns
d. Sale of standing timber or crops: O, things attached to realty and capable of
severance without material harm
e. Defective spinal plate given a patient in a hospital operating room: X (predominant
purpose test), false teeth by a dentist: X (services), injection of a drug into a patient’s
eye as part of operation: O
f. Sale of membership in a health spa: X, service
g. Sale of entire assets of a clothing store: 6-103 (bulk sale: if it is the sale of goods and
the business goes with it, then Art. 6 applies), if it is a bulk transfer sale, then Art. 2
applies
h. Sale of electricity: O (majority), X (minority)
5. Milau Associates v. North Avenue Development (Predominant Purpose Test)
a. Issue: Whether negligence or implied warranty of fitness for a particular purpose
applies to the defective sprinkler system installed by D?
b. Rule: Given the predominantly service-oriented character of the transaction, neither
UCC nor common law imply an undertaking to guard against economic loss stemming
from the non-negligent performance by D which has not contractually bound itself to
provide perfect results
6. Sale of Software
a. Majority: sale of software is sale of tangible goods, Art. 2 applies under the dominant
purpose test
b. Minority: (i) not goods b/c intangible and common law applies; (ii) software in a
package is goods, (iii) applies Art. 2 by analogy
c. 2R-103(k): excludes the sale of information
7. Analysts Intern. v. Recycled Paper (sale of software)
a. Issue: Whether UCC applies to the purchase of a computerized automatic
merchandise reordering system?
b. Rule: Where an agreement involves goods and services, a court must look to the
“essence or dominant factor” of the K to determine whether it was a K for goods
rather than services and is therefore governed by Art. 2.
8. Anthony Pools v. Sheehan (Gravamen Test: the ground of legal action)
a. Issue: Whether the Predominant Purpose Test should be applied to determine
whether the sale of the diving board, included in the transaction, carries an implied
warranty of merchantability under 2-314.
b. Rule (Gravamen Test): In a commercial transaction where consumer goods are sold,
which retain their character as consumer goods after completion of the performance
 promised to the consumer, and where monetary loss or personal injury is claimed to
have resulted from a defect in the consumer goods, UCC (implied warranties) apply to
the consumer goods, even if the transaction is predominately one for the rendering
of consumer services
i. What was that went wrong?
ii. Whether the gravamen of the action involves goods or services?
B. Merchants
1. Problem 2: 3rd year law student (not a merchant) sold her car to fellow student
a. Art 2 applies to all transaction in goods, but some provisions only applies to merchant
i. Portia is not a merchant, but Art. 2 applies b/c it is a sale of goods
ii. But implied warranty of merchantability does NOT apply b/c she is not a merchant
b. 2-104(1): merchant – person who deals in goods of the kind (regularly sells goods) or
otherwise by his occupation holds himself out as having knowledge or skill to the
practices or goods (routinely practice the transaction) involved in the transaction
i. OC2
a) statute of frauds, firm offers, confirmatory memoranda and modification:
almost every person in business would be deemed to be a merchant (having
knowledge or skill peculiar to the practices involved)
b) Implied warranty of merchantability (2-314): only if the seller is a merchant
w/r/t “goods” of that kind
2. Siemen v. Alden (sale of a used saw)
a. Issue: Whether one who is not in the business of selling a particular item, however
engages in an isolated transaction is subject to warranties of merchantability?
b. Rule: A person making an isolated sale of goods is not a merchant under Art. 2.
Warranty of merchantability is applicable only to a person who, in a professional
status, sells the particular kind of goods giving rise to the warranty
3. Problem 3: who is a merchant?
a. Quit teaching job on Friday and opened a hat store on Monday: O, “selling goods of
that kind”
i. Merchant b/c she regularly sells hats
b. Farmer selling his produce to a wholesaler: X, occasional sale is not enough to be a
merchant
i. Most courts say yes, but the common law says no although they sell crops for
leaving
III. Scope of Art. 2A: applies “true” leases of goods (Art. 2A is a copy of Art. 2)
A. True Lease (Art. 2A applies) v. Disguised Sale (Art. 2 applies)
1. 1-203 (lease distinguished from security interest)
a. Determined by the facts of each case
b. Not security interest merely b/c: subjection (c)
2. If it’s a true lease it comes w/in Art 2A. However, if a so-called “lease” does not pass the
tests described below, Art 2 and Art 9 are triggered instead b/c the lease will typically
then be a disguised sale on credit, w/ the “lessor’s” interest in reality being nothing
more than the reservation of a security interest.
 a. 1-201(37): if the lessee had the option to become the owner of the leased goods at
the end of the lease period for nominal or no consideration, a sale was effected
3. Bright-lines to help attorneys tell leases from secured transactions (1-203(b)(1) to (4))
a. If at the end of the lease period the lessee becomes the owner of the property for
little or no consideration, a secured transaction and not a lease has been created
b. If the K contains a clause that permits the lessee to terminate the lease at any time
and return the leased goods (so-called walk away test), a true lease has resulted.
Such a right of termination is not an attribute of a sale of goods
c. If the lease is for the entire economic life of the leased goods, w/ or w/o renewal, a
disguised sale has occurred
4. Why call “security interest?”
a. If it is a sale, the price should be paid, but in this transaction, the price is paid as
credit
b. Sale on credit is secured transaction -> triggers Art. 9
B. Problem 4: BIG Machines leased a computer to Helen’s Flower Shoppe for 5 yrs. The
machine was new and had cost BIG Machines $10,000. Helen promised to pay
$225/month as rent.
1. The lease provided that the lessee could terminate the lease at any time and return the
computer to the lessor: true lease b/c of the option to terminate the lease
2. Goods had no value at the end of 5 yrs: disguised sale b/c there is no economic life left
3. Rent is $150/month and the computer will be worth $3,500 after 5 yrs. Helen (lessee)
has the option to purchase the computer for $3,500 after 5 yrs: true lease b/c $3,500 is
not a nominal amount compared to the overall size of the transaction
4. The lease requires the lessee to renew this lease at the end of 5 yrs for another 5 yrs:
disguised sale b/c of no option to terminate
IV. International Sales
A. CISG (UN Convention on Ks for the International Sale of Goods)
1. Scope
a. covers only issues of K formation, rights and duties of the parties
b. excludes coverage of products liability issues, K validity (fraud, illegality, etc)
c. 76 member countries, but UK, JP, KR, TW not signed
B. Problem 5: Hegemony Enterprises, headquartered in NY, is about to sign a K for the
sale of men’s clothing to Cosas Americana, a retailer in Mexico City.
1. CISG applies? Yes b/c international sale of goods, and both are member countries
a. if the fact that the parties have their places of business in different States appears
from K (§1: Ks of sale of goods b/w parties whose places of business are in different
states, §2: excludes goods for personal/family use, by auction, stocks, ships,
electricity)
2. If Hegemony wants NY law apply, can the parties so stipulate in K and avoid CISG? Yes
(§6)
a. You can agree that NY law applies
3. If Hegemony were selling toys to Cosas Americana, would CISG apply? Probably yes b/c
the purchaser is not buying the toys for personal uses, but for resale (§2(a): excludes
 sale of goods bought for personal, family or household use if the seller knew/should
have known that before K)

CHAPTER 2. CONTRACT FORMATION

I. The Statute of Frauds
A. Common law: when a K fell within the Statute, all its terms and conditions had to be in
writing, or the K was not enforceable
B. 2-201: Formal Requirements; Statute of Frauds for the sale of goods for the price of $500
or more
1. A K must be in writing (quantity), signed by the party who denies the existence of the K
2. A K is enforceable even if a main term is omitted or misstated
a. The only term necessary is quantity: a K is not enforceable beyond the quantity of
goods shown in the writing (see problem 8)
3. 4 exceptions (not in writing, not mention quantity, not signed: OK)
a. Merchant confirmation letters (i) b/w merchants, (ii) if within a reasonable time a
writing in confirmation of the K and sufficient against the sender is received and (iii)
the party receiving it has reason to know its contents, are enforceable (iv) unless
written notice of objection within 10 days
b. Special manufacture: if the goods are to be specially manufactured for the buyer and
are not suitable for sale to others in the ordinary course of the seller’s business, and
the seller has made either a substantial beginning of their manufacture or
commitments for their procurement
c. Admission in legal proceedings: by the party against whom enforcement is sought
(but, K is not enforceable beyond the quantity admitted)
d. Part performance: w/r/t goods for which payment has been made and accepted or
which have been received and accepted
C. Problem 6: On Dec. 10th, Ross negotiated the purchase of 2 tons of ice with Scott via
phone. Scott wrote a memo on a memo pad describing the terms and scribbled his
initials on it. Ross sent a letter describing the terms to Scott on Dec. 14th. On Jan. 17th,
Scott phoned Ross and denied the existence of K
1. Memo pad note: yes, it satisfies 2-201(1) b/c in writing, states the quantity, signed by
the party against whom the enforcement is sought (initials of Scott -> 1-201(37):
signed – any symbol adopted with present intention to authenticate)
a. A letter “x” is a signature? – yes if there is an intent to authenticate
2. Legal effect of Dec. 14th letter: Dec. 14th letter satisfies the SOF under the merchant
exception b/c both parties are merchant, the letter is a writing in confirmation of the K
within a reasonable time, the party receiving the letter (Scott) knew the contents and
did not object within 10 days after he received the letter
3. What if Ross’ letter failed to mention the quantity: still binding K b/c the merchant
exception applies when the requirements of 2-201(1) are not satisfied
4. Even if the letter satisfies the SOF, is it conclusive as to the existence and terms of the
K? No, a writing that satisfies the SOF merely eliminates a SOF defense, but it does
NOT prove/establish the K terms
 a. You can still attack the terms of the K even after the SOF is satisfied!
5. Did Scott’s denial of the terms contained in Ross’s letter avoid the operation of 2-
201(2)? No, the written notice of objection to the contents was not given within 10
days from its receipt
6. What if Scott had “immediately” written Ross a letter correcting the quantity?: not a
sufficient notice of objection b/c the letter shows that there is some agreement b/w the
parties although certain terms are in dispute
a. This is not an objection to the “K”, but an objection to some terms
D. St. Ansgar Mills, Inc. v. Streit (corn sale: merchant written confirmation exception)
1. Issue: whether all relevant facts and circumstances, including trade usage, course of
performance and course of dealings, should be looked at to determine whether a
written confirmation was sent within a reasonable time under 2-201(2)? Yes
a. In fact, the farmer wanted to get out of the K b/c the grain price dropped (although
he did understand the K)
2. Rule: The reasonableness of conduct is determined by the facts and circumstances
existing at the time
E. Art. 2A-201
1. Amount of the lease must be at least $1,000 before a writing is required
2. The writing must describe the leased goods and the lease term
3. No merchant’s confirmation exception
F. No SOF for international sales under the CISG unless the country adopting the Convention
stipulates that its own SOF will apply
G. Problem 7: oral order of a huge water tank in the shape of a golf ball on a tee, price of
$30K, down payment check for $3K, signed by the city comptroller and marked “Tank”
on the memo line, tank was built, in the process of painting “City of Thebes” on the side
1. Does the check satisfy 2-201(1)? Yes, (i) K for the sale of good for the price of $500 or
more; (ii) some writing signed by the party against whom enforcement is sought (city
comptroller); (iii) quantity (“Tank” seems to mean 1 tank)
2. Tanks of America’s possible argument based on 2-201(3)(a) and 2-201(3)(c)
a. 2-201(3)(a): the tank was specially manufactured for the city and is not suitable for
sale to others b/c “City of Thebes” is painted on the side of it
i. Critical question is whether the seller can sell it easily (if there is no possibility of
lawsuit, what would you do with the tank?)
b. 2-201(3)(c): a partial payment has been made by the down payment check and
accepted
i. Is it enough payment? – yes b/c the good in this case is indivisible
3. City’s response to 2-201(3)(c) argument: it’s an indivisible K and there is only one object
of the K, when the payment made is less than the full amount, the K is not enforceable
under Williamson v. Martz
4. If the city had promised to sign a written K but had never gotten around to doing so, can
promissory estoppel or equitable estoppel be used to circumvent 2-201? – promissory
estoppel can be established by (i) the existence of an unambiguous K; (ii) reasonable
reliance on it; (iii) foreseeable detriment
 a. under 1-103(b) the common law cannot change the UCC, but can only supplant it: but
still viable argument as long as you’re in good faith
H. Problem 8: Tomorrow entered into a written joint venture K with Systems by which
Tomorrow promised to design and sell to Systems software non-exclusively. The K says
that the K would terminate after 2 yrs unless renewed. After 6 months, Systems faxed a
letter to Tomorrow stating that the K was at an end and declined to purchase any further
software.
1. Does 2-201(1) always require a specific quantity? – No, it says that “the K is not
enforceable beyond the quantity of goods shown in such writing.” The absence of a
quantity term was not fatal to the K under the SOF, but the K could fail for
indefiniteness if no reasonable basis for determining a breach or damages exists
a. This is non-exclusive dealing, so 2-306 does not apply
I. Statutes Facilitating Electronic Commerce
1. State level: Uniform Electronic Transactions Act (UETA)
2. Federal level: Electronic Signatures in Global and National Commerce Act (E-Sign) –
applies only in jurisdictions not adopting UETA
3. Basic thrust: to allow electronic records in most commercial transactions even if other
statutes requires a written signature
4. Common requirements
a. Where a consumer is involved, he must have agreed to electronic disclosures
i. Federal statute: the consumer must have agreed electronically to receive electronic
records or have confirmed this consent electronically
ii. UEETA: the consumer’s agreement to receive electronic communications must be
actual and not imposed unconscionably as part of the fine print in a written K
5. Sufficient notice requirement: what is sufficient?
II. The Parol Evidence Rule
A. 2-202 (Final Written Expression: Parol or Extrinsic Evidence): Terms w/r/t which the
confirmatory memoranda of the parties agree or which are otherwise set forth in a writing
intended by the parties as a final expression of their agreement w/r/t such terms as are
included therein may not be contradicted by evidence of any prior agreement or of a
contemporaneous oral agreement but may be explained or supplemented:
1. By course of performance, course of dealing, or usage of trade (even if there is a merger
clause), and
2. By evidence of consistent additional terms unless the court finds the writing to have
been intended also as a complete and exclusive statement of the terms of the
agreement (unless there is no merger clause)
3. OC3: consistent additional terms may be proved unless the court finds that the writing
was intended by both parties as a complete and exclusive statement of all the terms
i. If the additional terms are such that, if agreed upon, they would certainly have
been included in the document, then the evidence is barred (so, collateral matter
can be admitted)
4. Note: 2-202 does not exclude other common law exceptions to the parol evidence rule
B. Problem 9: K contains a merger clause, signed by both parties. Does 2-202 bar the
introduction of evidence of the following?
 1. An alleged preK agreement that Space Age would provide free flying lessons to the
president of Swinging Singles: admissible regardless of the merger clause b/c flying
lesson is a separate K from the sales K -> parol evidence rule does not apply at all
2. An alleged preK agreement that Swinging Singles could use the plane for 2 months, and
if they did not like it, they could return it for a full refund: not admissible b/c the preK
terms would have been included in the document if agreed upon
C. Columbia Nitrogen Corp. v. Royster Co. (extreme example of how to use extraordinary
trade usage)
1. Issue: whether a writing must be ambiguous in order for extrinsic evidence (like usage
of trade and course of dealings) to be admitted into evidence to interpret the writing?
No
2. Rule: 2-202 allows evidence of course of dealing or usage of trade to explain or
supplement terms intended by the parties as a final expression of their agreement. The
test of admissibility is not whether the K appears on its face to be complete in every
detail, but whether the proffered evidence of course of dealing and trade usage
reasonably can be construed as consistent with the express terms of the agreement. A
finding of ambiguity is not necessary for the admission of extrinsic evidence about the
usage of the trade and the parties' course of dealing.
3. Question: if the merger clause in the K had stated that it barred all evidence of usage of
trade and course of dealing, would the decision have been different? – maybe yes and
maybe no
a. Very hard to completely exclude trade usage
III. Offer and Acceptance
A. General Rules
1. 2-204 (Formation in General): A K for sale of goods may be made in ANY manner
sufficient to show agreement, including conduct by both parties which recognizes the
existence of such a K (practical construction, course of performance)
a. Even though one or more terms are left open, a K for sale does not fail for
indefiniteness if (i) the parties have intended to make a K and (ii) there is a
reasonably certain basis for giving an appropriate remedy (2-prong test)
2. 2-205 (Firm Offers): An offer by a merchant to buy or sell goods in a signed writing
which by its terms gives assurance that it will be held open is not revocable, for
lack of consideration, during the time stated or if no time is stated for a reasonable
time (which cannot exceed 3 months)
a. Any such term of assurance on a form supplied by the offeree must be separately
signed by the offeror
3. 2-206 (Offer and Acceptance in Formation of K): Unless otherwise unambiguously
indicated by the language or circumstances
a. An order or offer to buy goods for prompt/current shipment invites acceptance
either by a prompt promise to ship or by the prompt/current shipment of
conforming/non- conforming goods
b. Shipment of non-conforming goods is not an acceptance if the seller seasonably
notifies the buyer that the shipment is offered only as an accommodation to the
buyer
4. Problem 10: Mastervoice ordered 200 fuses from GE and GE immediately shipped
 defective fuses
a. At what moment was the K formed?
i. Under 2-206(1)(b), at the time of immediate shipment of the defective fuses (seller
didn’t notify the buyer that the shipment was offered only as an accommodation
to the buyer)
ii. K was formed and GE breached the K by offering defective fuses
b. Can GE say that there is no K b/c the shipment of defective goods did not comply
with Mastervoice’s offer? No, there is a K b/c the seller did not seasonably notify the
buyer under 2-206(1)(b)
c. What if GE shipped a very similar type of fuse with a cover note saying that “if not
suitable, we will take them back without charge.”
i. shipment of non-conforming goods and a seasonable notification by the seller
(counteroffer) -> so no acceptance, no K, no breach
5. Problem 11: Dreamer (buyer) and Posh (seller) agreed on a price for a car, Posh
promised to hold the car until the next day at noon, but Posh made a better deal with
another buyer before the next morning
a. Dreamers do not have a good cause of action b/c the offer by Posh (merchant) was
not in writing under 2-205
B. The Battle of the Forms
1. Common law rule
a. Mirror image rule & the last shot doctrine
2. The Original Version of 2-207
a. A definite and seasonable expression of acceptance operates as an acceptance EVEN
THOUGH it states terms additional to or different from those offered (acceptance
proposing diff/add terms), UNLESS acceptance is EXPRESSLY made conditional
on assent to the different terms (proviso clause: no acceptance –> counteroffer).
b. (when there is no proviso clause) The ADDITIONAL terms are construed as
PROPOSALS to the K. B/w merchants such terms become part of the K UNLESS
i. the offer expressly limits acceptance to its terms (prior objection)
ii. they materially alter it (OC: surprise or hardship)
iii. notification of objection to them has already been given or is given within a
reasonable time after notice of them is received (subsequent objection)
c. Conduct (including silence) by both parties which recognizes the existence of a K is
sufficient to establish a K for sale although the writings of the parties do not
otherwise establish a K. In such case, the terms of the particular K consist of
those terms on which the writings of the parties agree, together with any
supplementary terms incorporated under UCC.
3. Problem 12: Magic Carpet (buyer) had a long business relationship with Alibaba (seller),
Magic Carpet places an oral order, Alibaba provides its printed acknowledgment forms
disclaiming all warranties, Alibaba shipped a non-conforming carpet
a. Was a K formed b/w the parties? Yes. Under 2-207(1), Magic Carpet’s oral order is an
offer, Alibaba’s printed acknowledgment form is an acceptance even though it states
additional terms from those agreed upon b/c the acceptance was NOT
EXPRESSLY
 made conditional on assent to the additional terms (no proviso b/c it says that mere
silence can be an acceptance, acceptance should be made conditional on “express”
assent)
i. No proviso -> go to 2-207(2), not go to 2-207(3)
b. Was the disclaimer of warranties part of that K? No, under 2-207(2), both parties are
merchants, but the term negating standard warranties materially alters the K (OC:
exclusion of warranty is surprise & hardship)
4. Problem 13: seller sent a written offer, buyer accepted, enclosed a check and changed
the delivery date (different terms)
a. OC6: if no answer is received within a reasonable time after additional terms are
proposed, it is assumed that their inclusion has been assented to => thus, the seller
must send an answer objecting the changed delivery date in order to exclude the
changed delivery date from the K
5. Diamond Fruit Growers v. Krack Corp. (basic application of the rule with typical fact
pattern)
a. Facts: preliminary negotiation -> buyer sends purchase order -> seller sends
acknowledgment form (with express proviso)-> nobody reads the forms & goods are
shipped
b. Issue: whether Metal-Matic’s disclaimer of liability became part of the K when Krack
continued to purchase tubing after Metal-Matic refused to take out limitation of
liability from the K? No
c. Rule: an offeror must make a specific and unequivocal expression of assent, when the
offeree conditions its acceptance on assent to additional/different terms. If the
offeror does not give specific and unequivocal assent but the parties act as if they
have a K, the provisions of 2-207(3) apply to fill in the terms of the K
d. Question: what if you represent the seller? – how to disclaim warranties?
6. Problem 14: would the following clause in the seller’s acknowledgment to the buyer’s
order form be a material alteration under 2-207(2)(b)? : “Any disputes concerning this K
shall be subject to binding arbitration.”
a. Some courts says it’s a material alternation and some courts says not a material
alternation to K b/c no evidence of surprise or hardship to the buyer
b. What if the sale is an international sale of goods under CISG? : Material alteration to
K under Art. 19(3)
7. CISG Art. 19 (return to the common law mirror image rule)
a. A reply to an offer which purports to be an acceptance but contains additions,
limitations or other modifications is a rejection of the offer and constitutes a counter-
offer.
b. However, a reply to an offer which purports to be an acceptance but contains
additional or different terms which do not materially alter the terms of the offer
constitutes an acceptance, unless the offeror, without undue delay, objects orally to
the discrepancy or dispatches a notice to that effect. If he does not so object, the
terms of the K are the terms of the offer with the modifications contained in the
acceptance.
 c. Additional or different terms relating, among other things, to the price, payment,
quality and quantity of the goods, place and time of delivery, extent of one party's
liability to the other or the settlement of disputes are considered to alter the terms
of the offer materially.
8. Bayway Refining v. Oxygenated Markekting
a. Issue: Whether the party opposing the inclusion of an additional term under 2-
207(2)(b) bears the burden of proving that the term amounts to a material
alteration?
Yes
i. $464K is a material alteration b/c surprise & hardship
b. Rule: A material alteration is one that would result in surprise or hardship if
incorporated without express awareness by the other party.
9. Problem 15: purchase order of the buyer demanded 2-yr warranty, the seller’s
acknowledgment disclaimed all warranties, does the K include a warranty?
a. Under the knock-out rule, the conflicting terms on the warranties cancel each other
out, and gap-filler provisions of the UCC apply (so, warranty of merchantability is
implied under 2-314 if the seller is a merchant)
b. Under no distinction rule, the different terms by the seller (disclaimer of all
warranties) are not included in the K b/c they materially alter the K
10. Treatment of DIFFERENT terms
a. Minority: Different terms = additional terms (no need to distinguish)
b. Majority (Knock-out rule): conflicting terms cancel each other out, and gap-filler
provisions apply under OC6 of 2-207
11. Proviso clause of 2-207(1): unless acceptance is expressly made conditional on assent
to the additional/different terms
a. If the proviso clause is NOT used as part of the accepting form -> the purported
acceptance creates a K & go to 2-207(2) to determine its terms
b. If the proviso clause is put into the accepting document -> no K & go to 2-207(3) to
see what results from their dealings
12. Problem 16: buyer’s purchase order objects in advance (prior objection under 2-
207(2)(a)) to any different terms by seller, seller’s acknowledge form disclaims all
warranties (proviso)
a. Is there a K? proviso -> no K formed under 2-207(1) -> go to 2-207(3) -> there is a K
b/c the seller’s conduct (shipment) recognized the existence of a K although the
writings of the parties do not establish a K
b. Did the seller make a warranty as to the condition of the tables? Yes, (“not an
acceptance unless buyer assents to all changes), but a warranty of merchantability is
implied b/c the seller is a merchant w/r/t tables
c. Was there a K before the shipment? No b/c the proviso clause is put into the
accepting document -> no K & go to 2-207(3) -> no shipment yet
13. Leonard Pevar v. Evans Products (very nice summary of the law)
a. Issue: Whether a confirmatory memorandum that contains additional or differing
terms constitutes an acceptance under UCC? Yes
b. Rule
 i. If an oral agreement is reached b/w merchants, any additional or differing terms in
the seller’s acknowledgement will be treated as proposals and will become part of
the K unless 1) the offer expressly limit acceptance to the terms of the offer, 2)
they materially alter it, or 3) notification of objection to them has already been
given or is given within a reasonable time after notice of them is received. (2-
207(2))
ii. § 2-207 recognizes that a buyer and seller can enter into a K by one of 3 methods:
a) The parties may agree orally and thereafter send confirmatory memoranda: 2-
207(1)
b) The parties, without oral agreement, exchange writings which don’t contain
identical terms, but constitute a seasonable acceptance (no proviso): 2-207(1) -
> 2-207(2)
c) The conduct of the parties may recognize the existence of a contract, despite
the previous failure to agree orally or in writing: 2-207(3)
c. Question: if a seller frequently receives purchase orders triggering 2-207 rules, what
should he do in order to disclaim warranties?
i. Give the buyer 2 options: lower price with no warranty or higher price with
warranty
ii. Make the buyer’s P.O. not an offer (but how?)
iii. On-line sale (master K with all buyers): in advance, make the buyer agree to your
terms (no warranties) by K of adhesion
iv. Insurance!
14. Klocek v. Gateway (computer sales case)
a. Issue: Whether additional shrink-wrap terms such as duty to arbitrate that are
shipped with the goods become part of the K when the purchaser is not a merchant
and had no advance notice of the terms? No
b. Rule: Under 2-207 (2) in a K b/w a merchant and non-merchant, additional or
differing terms included in the seller’s acknowledgement are proposal for addition to
the K and do not become part of the K without express consent by the purchaser.
Mere silence or failure to object to the terms is insufficient to make the terms part of
the K.
i. ProCD case (7th Cir.)
a) 2-207 does not apply in case with only one form
b) By including the license with the software, the vendor proposed a K that the
buyer could accept by using the software after having an opportunity to read the
license
c) While the terms of the license were included within the package, its terms
afforded the purchaser an opportunity to review the product and its terms
before being bound.

CHAPTER 3. WARRANTIES
I. Overview: 2 Types of Warranties
A. Warranty of title (2-312)
B. Warranty of Quality
1. Express warranty(2-313): seller actually says something about the good
2. Implied warranty
 a. Merchantability (2-314): for ordinary purpose
b. Fitness for Particular Purpose (2-315)
II. The Warranty of Title
A. 2-312 (Warranty of Title): warrants that no one has better claim of ownership
1. The title conveyed shall be good, and its transfer rightful; and
2. The goods shall be delivered free from any security interest or other lien or
encumbrance of which the buyer at the time of contracting has no knowledge
B. Problem 18: Eddie stole a car and sold it to -> Sealed Lips which sold it to-> Duty who sold
it to-> Pirate who sued Duty for breach of warranty of good title
1. Duty argues that he thought he had good title: state of mind of seller is irrelevant under
2-312, the title was not good, so Duty is liable
2. Duty argues that he did have good title
a. under 2-403(1) (Shelter rule), you get whatever your seller had, a purchaser of goods
acquires all title which his transferor had -> thus, must look at the entire chain of
title, since Eddie had no good title, Duty’s title is not good either
3. What if Eddie had bought the car with a bad check?
a. under 2-403(1), a person with voidable title has power to transfer a good title to a
good faith purchaser for value, Eddie’s title was voidable, but he had power to
transfer a good title to a good faith purchaser for value. Thus Duty’s title is good
b. Voidable title: initially valid title, but voidable due to fraud, bad check, etc -> can pass
good title for value to a good faith purchaser
c. Had Eddie voided the title before he sold the car, Duty’s title would not have been
good
4. Any relief to Duty: under 2-607(5)(a), Duty may give Sealed Lips written notice of the
litigation, informing that it may come in and defend. If Sealed Lips does not do so, Duty
can sue Sealed Lips and Seale Lips will be bound by any fact determined in the current
litigation
C. Problem 19: Police impounded a wrong car that Boss bought from Croupier Motors, Boss
spent $400 to retrieve it and demands Croupier to pay the bill under 2-312
1. Croupier is NOT responsible for attorney’s fees b/c the title was good. Under 2-607(5),
Boss should have notified Croupier of the impounding so that Croupier took the case
instead of him
D. Problem 20: Is warranty present in each situation?
1. Sales K says “the product is sold ‘AS IS’ and seller makes no warranties, express or
implied.”
a. OC6 to 2-312: disclaimer of the warranty of title can only be excluded by specific
language or the circumstances which give the buyer reason to know that the person
selling does not claim title in himself or that he is purporting to sell only such right or
title as he or a 3rd person may have
b. The language is not specific enough under Moore -> the warranty of title is not
excluded if the buyer had no reason to know that the seller does not claim title in
himself (implied warranty may be disclaimed by “AS IS” language)
2. Seller sold a car to buyer 1 who returned it after failing to make the first payment. Does
the resale buyer get the benefit of a 2-312 warranty? (9-610: disposition of collateral
 after default)
a. OC5 to 2-312: Yes, seller was engaged in business of selling cars, so buyer would have
no reason to think otherwise. Unless properly excluded under subsection (2), the
resale includes the warranty of title
3. Buyer was offered an expensive watch in the men’s room at a bargain rate from a
stranger
a. From the circumstances, the buyer had the reason to know that the seller did not
claim title in himself -> no warranty of title
E. Moore v. Pro Team Corvette Sales, Inc. (Prof. says right decision with wrong reason)
1. Issue: Whether a disclaimer of warranty of title which expresses how the seller's liability
will be limited, rather than what title the seller purports to transfer, is sufficiently
specific to disclaim the implied warranty of title? No
2. Rule: under 2-312(2), a warranty of title may be excluded or modified by specific
language giving the purchaser reasons to know that the vendor is only selling what title
he possesses
a. The language expressing what the seller will not be liable for rather than what the
buyer is or is not receiving is not specific enough to exclude a warranty of title
b. Prof. says that courts are hostile to disclaimer of warranty of title
F. Warranty of title also includes
1. A warranty that there are no security interests (or other liens) on the goods other than
those of which the buyer knows (2-312(1)(b)); and
2. A warranty given by merchant sellers against claims based on patent infringement or
the like (2-312(3))
a. If seller specially manufactures goods based on buyer’s specification, the buyer
automatically makes a warranty to the seller that protects the seller from
infringement claims
III. Warranties of Quality
A. Express Warranties
1. 2-313 (Express Warranties by Affirmation, Promise, Description, Sample): created by
a. any affirmation of fact or promise made by the seller to the buyer related to the
goods and becomes part of the basis of the bargain
b. any description of the goods made part of the basis of the bargain
c. any sample or model made part of the basis of the bargain
d. note: basis of the bargain – plays some role in the buyer’s decision
i. specific reliance: once required by Uniform Sales Act, but most courts presume
reliance unless the seller shows no reliance (since the seller has the control in
making such affirmation)
ii. seller’s understanding of warranty is not required
iii. no need to use the words “warrant” or “guarantee”
iv. puffery, “improved,” “better” do not create warranty b/c they are not basis of the
bargain
2. Problem 21
a. “A-1” shape: no meaning in the industry (no trade usage), just puffery
i. If no general meaning to the buyer, just an opinion -> no express warranty
 ii. If the salesman has knowledge about used cars -> describing the goods -> express
warranty
b. “mint condition”: mint condition has a meaning of “like new” to most people, express
warranty
c. “bloom out, straighten up, fly right”: express warranty b/c seller describes the quality
of the goods
d. “do a good job in your chicken house”: mere puffing -> no express warranty
i. Question of fact: must look at the context b/c it is an oral statement (if written
statement, the judge will consider it)
e. “this is a great car, you’re gonna love it”: very vague expression -> mere
puffery/opinion, not describe the condition of the car -> no express warranty
f. Car salesman said “thoroughly inspected, mechanically in perfect condition.” Buyer
had it inspected independently and bought it: the salesman’s statement is an oral
representation related to the goods, but the buyer did not rely on his statement ->
the statement did not become part of the basis of the bargain -> no express warranty
i. Counterargument: the buyer relied on the statement, but wanted to make it more
clear by additional inspection
3. Problem 22:
a. Finest (in the store): O - description of the wallpaper, made part of the basis of the
bargain <-> puffing
b. Goes up easily: O – affirmation about the good made to alleviate the buyer’s
concerns and encourage them to buy it
c. Can be put on with any paste: O – affirmation of a fact made by the seller in response
to the buyer’s concerns about never putting up wall paper
d. Dries immediately: O – affirmation of a fact
e. Would look wonderful: X – just an opinion or puffery (no objective measurement)
f. Used by Mary Magic: O
i. OC7: the precise time when the statement was made is not material, key question
is whether the language is fairly to be regarded as part of the K. If the language is
used after closing of the deal, the warranty becomes a modification and need not
be supported by consideration if otherwise reasonable and in order
ii. that might have played some role in the buyer’s decision
g. any other express warranty? – sample under 2-313(1)(c) creates express warranty if
made part of the basis of the bargain
4. Problem 23: color-changing wig, ad says no color change, but never saw the ad before
the purchase (can argue in both ways)
a. No warranty: ad was not part of the bargain b/c he never saw the ad before his
purchase
b. Warranty: but courts would find express warranty even though there was no specific
reliance by the buyer, for public policy reasons under Winston Indus. (sellers are not
allowed to make these representation to the public and avoid liability just b/c one
particular buyer did not rely on it)
i. 3rd party beneficiary
 ii. Expectation of the public at large should be honored
B. Implied Warranties
1. Implied warranties are automatically part of the K unless the seller (or the
circumstance) does something affirmative to get rid of them
a. Implied as a matter of law
b. Seller’s intention irrelevant
2. Merchantability
a. 2-314: warranty of merchantability is implied if the seller is a merchant - goods must
be saleable and conform to the normal expectations of the parties
i. 2-314(2)(a) to (f): pass in the trade, fair average quality, uniformity, packaged,
labeled, conform to affirmation on the container or label
ii. 2-314(2)(c) goods to be merchantable must be at least fit for the “ordinary
purpose” for which such goods are used
b. Shaffer v. Victoria Station, Inc (wine glass broken)
i. Issue: Whether the container as well as the goods that are purchased must be fit
for the ordinary purchase for which the goods are to be used? Yes
ii. Rule: not adequately contained -> breach of merchantability even if the container
was not being sold
a) The product itself and the container in which it is supplied are purchased by the
user or consumer as an integrated whole. Where the container is itself
dangerous, the product is sold in a defective condition.
b) The product as well as the container must be fit for the ordinary purposes for
which the goods are used.
c) The sale of a glass of wine is subject to the strict liability provisions
iii. Questions (Is this transaction in good? Were they selling the drink?)
a) Would it be a defense that the seller was not negligent in handling of wine glass?
– warranty is absolute, non-negligence is not a defense
b) What if a free drink served by a casino to its patron contains chips of glass?
1. 2-314: the serving for value of food or drink to be consumed either on the
premises or elsewhere is a sale
2. “free” drink, but offered as an incentive to patrons to gamble and enhance
the casino’s business & the casino regularly serves the drinks as part of its
business (so the casino is a merchant w/r/t the drinks -> sale of drink -
> implied warranty O)
3. other courts might find no sale of goods b/c the buyer doesn’t pay for the drink
c. Problem 24:
i. Cigarettes that cause lung cancer merchantable if used over a period of yrs?: The
ordinary purpose of cigarettes is to be smoked -> merchantable
a) What if ads stated that the cigarettes were mild? : affirmative description of the
quality of the goods -> creates express warranty
b) Most courts said that cigarettes are merchantable, and come courts not
ii. Cop sold his car to neighbor telling it was a good car: the seller is not a merchant
as to the goods -> warranty of merchantability is not implied
 a) Should 2-314 be extended to all sellers including non-merchant?
d. Problem 25: Natty swerved car to avoid hitting deer and crashed into a tree. He got
injured and sued the car manufacturer for breach of warranty of merchantability
i. Manufacturer had to use reasonable care to design the car for the intended use:
car accidents are pretty common, it is foreseeable that a driver or passenger can
be injured by the objects within a car at accident -> manufacture breached the
warranty of merchantability
ii. 2nd collision problem: although can’t make perfectly safe cars, must not put
dangerous objects in the car
e. Daniell v. Ford Motor (locked inside the trunk of a car for 9 days)
i. Rule: An implied warranty of merchantability (fitness for an ordinary purpose) does
not apply when the buyer uses the product in a highly extraordinary way that is
outside the usual and ordinary purpose of the product. (the risk must be
foreseeable)
a) The purposes of an automobile trunk are to transport, stow and secure items
and to protect them from elements of the weather
b) Manufacture had no duty to design an internal release or opening mechanism
or to warn customers of the danger
ii. Q: Would the court have reached the same result if the plaintiff had been
accidentally trapped in the trunk or if the plaintiff had been a child?
a) National Highway Traffic Safety Administration has required that all automobiles
manufactured after Sep. 2001, have an interior release mechanism in the trunk
3. Fitness for a Particular Purpose (NO merchant requirement)
a. 2-315: where the seller at the time of contracting has reason to know (objective test)
any particular purpose for which the goods are required and that the buyer is relying
on the seller’s skill or judgment to select or furnish suitable goods, there is unless
excluded or modified, an implied warranty that the goods shall be fit for such
purpose
b. Problem 26: buyer bought a heater for a recreation room and seller knew well about
the room. The heater worked perfectly but insufficient capacity to heat the room
i. 2-314: No breach of implied warranty of merchantability b/c the heater worked
perfectly for its ordinary purpose of heating (merchantable)
ii. 2-315: No breach of implied warranty of fitness for a particular purpose b/c,
although the seller knew the particular purpose, the buyer did not rely on the
seller’s skill or judgment to select the heater. The buyer relied on the ad in
choosing the heater
a) Buyer would argue that seller had a reason to know the particular purpose and
the buyer expected seller to speak out
c. Problem 27: buyer bought a can of paint and painted walls, not enough paint, bought
another can from the same buyer telling him he was only half done, and finished the
painting
i. Offensive order: the paint is not fit for its ordinary purpose -> breach of implied
warranty of merchantability under 2-314
ii. Different color: the second can is not fit for its particular purpose b/c the seller
 should have had reason to know the particular purpose for buying the second can
of paint when the buyer told him the job was half done -> breach of implied
warranty of fitness for particular purpose under 2-315
d. Problem 28: new denture cracked on an olive pit in a martini (harmful substances in
food)
i. Foreign-natural test: denies liability if the object is a natural substance, as opposed
to a foreign object (Only CA & LA adopt this test)
ii. Reasonable expectation test (majority): permits recovery even where the
consumer is injured by a natural substance as long as the buyer’s reasonable
expectation is that it would have been removed (usage of trade)
iii. 2-314: is the seller of a merchant w/r/t olive? Not fit for its ordinary purpose?
iv. 2-315: the seller should have known that the buyer would eat the olive
e. Webster v. Blue Ship Tea Room (fish bones found in fish chowder)
i. Issue: Whether fish bones found in fish chowder that traditionally calls for bones
affects the chowders implied warranty of merchantability or fitness for a particular
purpose? No
ii. Rule: Hazardous bones or objects found in dishes that are part of traditional
recipes are reasonably anticipated by anyone who eats them -> no breach of
implied warranties of merchantability or fitness for a particular purpose.
iii. Q: This court adopted the reasonable expectation test
a) What if the plaintiff was from South Dakota and was on her first visit to New
England?
1. Recoverable: no reasonable expectation of fish bones in the soup
2. Non-recoverable: not mass production, human being makes it
b) What if the plaintiff consumed a can of chowder (not from a restaurant)?
1. Recoverable: people usually expect the manufacture to remove bones (mass
production)
2. Non-recoverable: ?
f. Problem 29: Carry bought a hair dye that contained alcohol, to which she was
allergic, only 0.5% of the population had this allergic reaction
i. Strict product liability (unreasonably dangerous defect): only 0.5% of the
population are allergic, but many people may get injured if it sells well
ii. Seller had better to put a test patch so that buyer can test if it is okay to use it
iii. What if the package says “alcohol free?” That would be a problem
C. Warranty Disclaimers and Limitations
1. Disclaiming Express Warranties
a. 2-316(1): disclaimer of an express warranty virtually impossible (don’t create express
warranty at all if you want to disclaim it!)
i. Words or conduct relevant to the creation of an express warranty and words or
conduct tending to negate or limit warranty shall be construed wherever
reasonable as consistent with each other; but subject to the parol evidence rule.
Negation or limitation is inoperative to the extent that such construction is
unreasonable
a) Warranty wins when attempting to get rid of it is unreasonable
 ii. OC4 to 2-313: a clause generally disclaiming “all warranties, express or implied”
cannot reduce the seller’s obligation w/r/t such description and therefore cannot
be given literal effect under 2-316.
iii. Express warranty is created by the seller voluntarily -> seller can’t take away
buyer’s expectation after creating it voluntarily
b. Bell Sports, Inc. v. Yarusso (motorcycle helmet)
i. Issue: Whether manufacturer’s disclaimer of warranty is valid when owner’s
manual contains inconsistent statements that have essential elements of a valid
express warranty? No
ii. Rule:
a) Textual representations in an owner’s manual that contain essential elements of
a valid express warranty cannot be disclaimed as a matter of law.
b) Language that is inconsistent with an express warranty will not be enforced in
order to protect a buyer from unexpected and unbargained language of a
disclaimer.
c) A claim for breach of warranty, express or implied, is distinct from a negligence
claim b/c negligence focuses on the manufacturer's conduct, whereas a breach
of warranty claim evaluates the product itself.
c. Problem 30: seller said MPG is b/w 30 and 35 or 40 to 45 (express warranty), but not
true, K says that:
i. This is the entire K, and there are no other matters agreed to by the parties that
are not contained herein: express warranty v. merger clause (inconsistent to each
other)
a) How to get around the parol evidence rule and get in the evidence (2-202: final
expression of agreement may not be contradicted -> “would certainly” test)?
1. “intended by the parties” under 2-202: you may attack that the buyer didn’t
intend it to be a final expression
2. You may also attack it for unconscionability, fraud
3. If extrinsic evidence is introduced, express warranty and merger clause
construed as consistent with each other -> if not possible, express warranty
wins
b) If parol evidence rule applies -> 2-202(b) does not applies b/c of merger clause -
> no extrinsic evidence admissible -> no express warranty
ii. There are no other express or implied warranties except those contained herein:
OC4 to 2-313 (a clause generally disclaiming “all warranties, express or implied”
cannot reduce the seller’s obligation w/r/t such description and therefore cannot
be given literal effect under 2-316) -> no disclaimer
iii. No salesperson has the authority to give express warranties other than those
contained herein:
a) Common sense argument: the salesperson is an agent of the seller
b) But, OC2 to 2-316: seller is protected against false allegations or oral warranties
by parol evidence and against unauthorized representation by the customary
“lack of authority” clauses -> disclaimer is valid
2. Disclaiming Implied Warranties
a. 2-316(2): to exclude or modify the implied warranty of merchantability (can be
disclaimed orally) or any part of it, the language must mention merchantability and in
case of a writing must be conspicuous, and to exclude or modify any implied warranty
of fitness (for particular purpose only, not for ordinary purpose) the exclusion must
be by a writing and conspicuous. Language to exclude all implied warranties of
fitness is sufficient if it states, for example, that “There are no warranties which
extend beyond the description on the face hereof.”
i. 1-201(1): conspicuous – a reasonable person should notice it (heading in capitals,
greater in size, contrasting type, symbols, etc)
b. 2-316(3): notwithstanding subjection (2)
i. Unless the circumstances indicate otherwise, all implied warranties are excluded
by expressions like “as is,” “with all faults” or other language which in common
understanding calls the buyer’s attention to the exclusion of warranties and makes
plain that there is no implied warranty; and
a) But, these languages can’t remove “express” warranty
ii. When the buyer before entering into the K has examined the goods or the sample
or model as fully as he desired or has refused to examine the goods, there is no
implied warranty w/r/t defects which an examination ought in the circumstances
to have revealed to him; and
a) Refusal to examine does not get rid of “express” warranty
iii. An implied warranty can also be excluded or modified by course of dealings or
course of performance or usage of trade
c. Cate v. Dover crop (lifts with disclaimer of implied warranty of merchantability)
i. Issue: Whether disclaimer of an implied warranty is enforceable when no efforts
are made to make the disclaimer conspicuous to reasonable person such as
larger/different color text? No
ii. Rule: A disclaimer contained in text undistinguished in typeface, size or color
within a form purporting to grant a warranty is not conspicuous, and is
unenforceable unless the buyer has actual knowledge of the disclaimer.
a) But the statute doesn’t mention about “actual” knowledge
iii. Concurrence (Spears): the legislature should prohibit all disclaimers of the implied
warranties of merchantability
iv. Dissent (Ray): the extent of a buyer’s knowledge of a disclaimer should be
irrelevant to a determination of its enforceability
d. Problem 31:
i. a statement buried in the fine print of a used car: “There are no express or implied
warranties that are part of this sale”
a) Are implied warranties disclaimed? No b/c a statement buried in “fine” print is
not CONSPICUOUS under 2-316
b) How to redraft the language to disclaim implied warranties?
1. Merchantability: mention “merchantability” and if in writing must be
conspicuous
2. Fitness: must be in writing and conspicuous (“As Is” “with all fault” language is
 okay)
c) Physical appearance of the clause: there should be a separate section titled
“DISCLAIMER”
1. 1-201(10): heading in capitals equal to or greater in size, in contrast type, font,
color to the surrounding text, larger type, contrasting type, font, color,
symbols, other marks
d) What if usage of trade permits the burial of warranty disclaimers in the fine print?
1. 2-316(3)(c): implied warranty can be excluded/modified by course of dealing,
course of performance or usage of trade, but the claimed trade usage does
not conform to public policy -> not effectively disclaim
ii. “AS IS” written with soap in large letters across the front windshield of the used car:
a) Effective disclaimer of implied warranty under 2-316(3)(a), but can’t disclaim
express warranty
b) If “AS IS” is consistent and reasonable with the express warranty, both
enforceable
1. If not, negation or limitation of express warranty is inoperative under 2-316(1)
c) Must “AS IS” be conspicuous? – must call the buyer’s attention to the exclusion
of warranties (2-316(3)(a))
iii. Seller asks buyer “would you like to examine the car?” and buyer says no:
a) Not effective disclaimer b/c there has to be a demand by the seller (strong
language that asks buyer to conduct an inspection under 2-316(3)(b))
1. OC8: not sufficient that the goods are available for inspection: you need (i)
demand by seller + (ii) had buyer taken up the demand, he should have found
certain defects
iv. Expensive watch offered by a stranger at a bargain price in a men’s room:
a) No implied warranty under 2-316(3)(c) (course of dealing): the seller is not a
merchant w/r/t the goods
e. Problem 32: buyer bought a new car relying on seller’s affirmation on superior
qualities, but actual written warranty is very limited
i. Is he bound by the written warranty’s terms? – seller made affirmation on the
quality of the car and buyer relied on it -> express warranty created
a) Limited warranty in the booklet is an offer for modification -> if the buyer does
not accept it, there is no modification (no limited warranty) -> original express
warranty is valid
f. Bowdoin v. Showell Growers, Inc. (post-disclaimer can’t be conspicuous)
i. Issue: Whether D effectively disclaimed the implied warranties of
fitness/merchantability w/r/t a high pressure spray rig that caused injuries to the
plaintiffs? No
ii. Rule: If a disclaimer was not presented to the purchaser before the sale, a court
will hold such a disclaimer ineffective b/c it did not form a part of the basis of
the bargain. This “basis of the bargain” rule protects purchasers from unexpected
and coercive disclaimers.
a) A disclaimer must be conspicuous before the sale, for only then will it be
 presumed that the disclaimer was part of the bargain.
g. Rinaldi v. Iomega Corp.
i. Issue: Whether seller's disclaimer of the implied warranty of merchantability was
"conspicuous," as required by 2-316(2), when the disclaimer was contained within
the packaging of the Zip drive product itself and not "discovered" by the purchaser
prior to the purchase? Yes
ii. Rule: Seller’s disclaimer was effective despite its physical placement inside the
packaging and satisfied the conspicuousness requirement of 2-316(2).
h. How to reconcile the above 2 cases?
i. Rinaldi court seems to say that the sale transaction is not complete until buyer has
a chance to review the additional terms that are inside the packaging and either
rejected or accepted them by using the product or returning it
3. Limitations on the Warranty (seller gives a warranty & wants to limit the scope of
liability)
a. 2-316(4): Remedies for breach of warranty can be limited in accordance with Art. 2
on liquidation or limitation of damages and on contractual modification of remedy
(2-718
& 719) -> distinguish from disclaimer
b. 2-719 (contractual modification or limitation of remedy): there is a warranty and
there is a breach, but you have contracted it away by limiting remedy
i. Subject to the provisions of subsections (2) and (3) of this section and of the
preceding section on liquidation and limitation of damages,
a) the agreement may provide for remedies in addition to or in substitution for
those provided Art. 2 and may limit or alter the measure of damages
recoverable under Art. 2, as by limiting the buyer's remedies to return of
the goods and repayment of the price or to repair and replacement of non-
conforming goods or parts; and
b) resort to a remedy as provided is optional unless the remedy is expressly agreed
to be exclusive, in which case it is the sole remedy.
ii. Where circumstances cause an exclusive or limited remedy to fail of its essential
purpose, remedy may be had as provided in UCC (gap fillers).
a) OC1: minimum adequate remedies must be available
iii. Consequential damages may be limited or excluded unless the limitation or
exclusion is unconscionable. Limitation of consequential damages for injury to the
person in the case of consumer goods is prima facie unconscionable but limitation
of damages where the loss is commercial is not.
a) Prima facie unconscionable: the burden of proof shifts to the seller to show that
it is not unconscionable from the circumstances and other evidence
iv. Note: most courts require any remedy limitation to be “conspicuous” in order to
be effective
c. Wilson Trading v. David Ferguson (sale of yarn, express warranty)
i. Issue: Whether one may sue for breach of an express warranty of merchantability
when latent defects are not reasonably discoverable until after the time limit in K,
but the seller is notified of these defects within a reasonable time after they were
or should have been discovered? Yes
 ii. Rule: The express warranty of merchantability includes latent defects.
a) Where an apparently fair and reasonable clause b/c of circumstances fails in its
purpose or operates to deprive either party of the substantial value of the
bargain, it must give way to the general remedy provisions of Art. 2.
b) No minimum adequate remedy -> no remedy at all -> fail of essential purpose ->
UCC gap fillers
d. Problem 33: Buyer bought a snowmobile ($1,200, consumer goods used for personal,
family, or household purposes), K provides for warranty of merchantability but limits
the remedy solely to “repair or replacement of defective parts” and denies any
consequential damages. 4 repairs for 4 weeks, then it blew up and was destroyed,
buyer injured (2-316(4), 2-302, 2-719, 2-715)
i. There is an express warranty (b/c the seller warranted that the vehicle was
merchantable) -> there is a breach (not fit for ordinary purpose) -> but remedy
limited
a) Seller may argue that the snowmobile is not a consumer good b/c the buyer
used it for business purpose, but buyer would argue that the snowmobile is
used for personal purpose
ii. Hospital expenses: consequential damages may be limited or excluded unless
unconscionable & limitation of consequential damages for injury to the person in
the case of consumer good is prima facie unconscionable (2-719(3)) -> recoverable
although the seller signed the K
a) Injury to the person includes hospital expenses?
iii. Camera: limitation of damages where the loss is commercial is not unconscionable
(2-719(3)) -> not recoverable
iv. Snowmobile: circumstances cause the limited remedy (repair or replacement of
defective parts) to fail of its essential purpose (2-719(2))-> buyer may seek to get
his money back for the snowmobile
v. Lost wage:
a) Incidental damages include expenses reasonably incurred in inspection, receipt,
transportation and care and custody of goods rightfully rejected, any
commercially reasonable charges, expenses or commissions in connection with
effecting cover and any other reasonable expense incident to the delay or other
breach (2-715(1))
b) Consequential damages include any loss resulting from general or particular
requirements and needs of which the seller at the time of contracting had
reason to know and which could not reasonably be prevented by cover or
otherwise; and injury to person or property proximately resulting from any
breach of warranty
vi. Rent of a snowmobile: consequential?
e. Other cases on validity of disclaimer of liability for consequential damages
i. Collins v. Uniroyal: “conspicuously” limiting the remedy for tire blowout to
repair/replacement
a) Natural reliance and reasonable expectation: seller’s ad says “If it only save your
 life once, it’s a bargain,” so buyer is far more likely to by tires in order to protect
himself than to assure a refund (limiting liability is patently unconscionable)
ii. Gladden v. Cadillac: no personal injury but car destroyed due to tire blowout
a) Warranty limitation is seriously lacking in clarity b/c buyer was presented with a
mélange of overlapping, variant, misleading, and contradictory provisions
(judicial extension)
iii. Andover Air v. Piper Aircraft: remedy limitation to repair/replacement
unconscionable where defective and inexpensive bracket caused $100,000 in
damages in an airplane crash
iv. NEC v. Nelson: disclaimer of liability for consequential damages not
unconscionable where a TV malfunctioned, burning down the buyer’s home but
causing no personal injury
f. Pierce v. Catalina Yachts (sailboat with limited warranty of repair)
i. Issue: Whether a disclaimer of consequential damages is valid when a party’s
limited remedy fails of its essential purpose? No
ii. Rule: When a limited remedy fails of its essential purpose, a party may pursue any
remedy provided by UCC including consequential damages.
a) 2-719(a): authorizes limited warranties, allowing parties entering into
commercial transactions to limit/alter the measure of damages recoverable
b) 2-719(b): when a limited remedy fails, the warranty’s limitation is nullified and
the buyer’s right to rely on any authorized remedy is restored
1. Limited warranty to repair fails of its essential purpose when the seller is
either unwilling or unable to conform the goods to the K
2. Example: (i) seller is unsuccessful in repairing/replacing regardless of
good/bad faith, or (ii) unreasonable delay in repair/replacement
c) 2-719(c): consequential damages may be limited or excluded unless
unconscionable
iii. Tension b/w 2-719(b) & (c): if a limited warranty fails of its essential
purpose, whether to apply 2-719(b) by restoring the buyer’s right to seek
consequential damages or apply 2-719(c) by enforcing the bar against
consequential damages unless unconscionable
a) 1st approach: (b) trumps (c) & all available remedies restored whether
unconscionable or not (if fails of essential purpose, don’t need to ask whether
unconscionable or not)
b) 2nd approach: case-by-case analysis
c) 3rd approach (majority): (b) and (c) are independent & the bar against
consequential damages enforced unless unconscionable (if fails of essential
purpose, still have to ask whether unconscionable or not)
D. Defenses in Warranty Actions
1. Notice: buyer loses all UCC rights if fails to give seller notice of the breach within a
reasonable time
a. 2-607(3)(a): where a tender has been accepted, buyer must within a reasonable time
after he discovers or should have discovered breach notify seller of breach or be
 barred from any remedy
i. OC4:
a) Content of notification: sufficient to let the seller know that the transaction is
still troublesome and must be watched
1. clear statement of all objections not required
2. claim for damages or any threatened litigation or other resort to a remedy
not required
b) reasonable time
1. merchant buyer – commercial standards
2. retail consumer: extended to defeat commercial bad faith
b. Problem 34: farmer showed samples of apples and said the bulk had less color and
were 1/5 smaller, delivered ones not as good as the sample and were 1/3 smaller,
without inspection buyer delivered the apples to commission merchant, 60 days later
farmer billed and buyer refused to pay
i. 2-313 express warranty was created by the sample and the statement and breached
ii. Course of dealing: always no inspection?
a) buyer should have inspected the apples and informed the famer right away so
that she could have a chance to cure (replace) them -> not reasonable to wait so
long b/c apples are perishable -> no remedy
c. Fitl v. Strek (baseball cards found worthless 2 yrs from purchase)
i. Issue: Is it reasonable for a buyer to notify a seller of a breach 2 yrs after sale when
a 3rd party investigation would be required to determine if breach occurred? (jury
question) Yes
a) Rule: The policies behind the notice requirement, to allow the seller to correct a
defect, to prepare for negotiation and litigation, and to protect against stale
claims at a time beyond which an investigation can be completed, were not
unfairly prejudiced by the lack of an earlier notice to the seller.
d. Problem 35: no notice of breach as to 1st late shipment, notice of breach as to 2nd
shipment but no intention to claim a breach expressed, filed a suit 3 months later
i. 1st shipment: no notice -> buyer lost all his UCC right for failure to give the seller a
notice
ii. 2nd shipment: notice after 18 days (may be commercially reasonable), but the letter
merely expressed the buyer’s dissatisfaction (disappointment, expenses and
inconvenience) without mentioning breach -> is this a proper notice under OC4?
a) if sufficient notice -> no remedy
b) if sufficient notice -> remedy
c) What if the buyer filed a suit without waiting 3 months? (Armco Steel v. Isaacson)
1. Majority: filing suit is not sufficient notice
2. Dissent: filing suit without prior notice is no hindrance to normal settlement
through negotiation
e. Problem 36: La Mancha (manufacturer) -> Carrasco Liquors (retailer) -> Quijano (buyer)
-> Sancho (guest) hospitalized for 8 months and thereafter sued La Mancha
i. Does Sancho have a cause of action against La Mancha?
 a) 2-607(3)(a): where a tender has been accepted buyer must within reasonable
time after he discovers or should have discover breach notify seller of breach or
be barred from remedy
1. OC5: the reason of this section does extend to requiring the beneficiary to
notify the seller that an injury has occurred
ii. If Quidano had been injured and he had given notice of breach to the retailer,
would that preserve his rights against the manufacturer?
a) Yes, “seller” refers only to the immediate seller who tendered the goods to
buyer. As long as buyer gives notice of the defect to his immediate seller, no
further notification to those distributors beyond the immediate seller is
required.
1. Privity
a. 2 types of privities
i. Vertical privity: how far back up the distribution chain the buyer can go (from
manufacturer to ultimate purchaser)
ii. Horizontal privity: to whom the retail seller is liable other than immediate
purchaser (from ultimate buyer to other people)
b. Problem 37: Hamilton Paint Co. (paint manufacturer) -> Girard Inst. Corp. (calculator
manufacturer) -> Leibnitz Dept. Store (retailer) -> Mr. Cayley (purchaser) -> Ms.
Cayley
-> children -> Mr. Gauss
i. If manufacturer had made express warranties, anyone can rely on it
a) If negligence could be proved, a tort action was possible
ii. If there was no express warranty, Mr. Cayley and other potential plaintiffs can rely
on a 3rd party beneficiary of the implied warranties made in sales b/w Hamilton
and Girard and b/w Girard and Leibnitz
iii. 2-318 (3rd Party Beneficiaries of Warranties Express or Implied: limitation of
“horizontal” privity)
a) Alternative A (adopted by OH): A seller’s warranty whether express or implied
extends to any natural person (not corporation) who is in the family or
household of his buyer or who is a guest in his home if it is reasonable to
expect (foreseeability) that such person may use, consume or be affected by
the goods and who is injured in person (not property damages) by breach of
the warranty. A seller may not exclude or limit the operation of this section.
b) Alternative B: A seller's warranty whether express or implied extends to any
natural person who may reasonably be expected to use, consume or be affected
by the goods and who is injured in person by breach of the warranty. A seller
may not exclude or limit the operation of this section.
c) Alternative C: A seller's warranty whether express or implied extends to any
person (corporation included) who may reasonably be expected to use,
consume or be affected by the goods and who is injured (not limited to personal
injury) by breach of the warranty. A seller may not exclude or limit the
operation of this section w/r/t injury to the person of an individual to whom
the warranty extends.
iv. Does 2-318 restrict the limits of vertical privity? Neutral w/r/t “vertical” privity
a) OC3 to 2-318: The first alternative expressly includes as beneficiaries within its
 provisions the family, household and guests of the purchaser. Beyond this,
the section in this form is neutral and is not intended to enlarge or restrict
the developing case law on whether the seller's warranties, given to his buyer
who resells, extend to other persons in the distributive chain.
b) Some courts held that no privity required for manufacturer’s breach of an
implied warranty, while other courts require it.
c. Reed v. City of Chicago (paper gown used for suicide)
i. Issue/rule: Whether a non-purchaser can recover for breach of warranty from the
manufacturer and designer of a gown that was specifically designed to be worn by
detainees when it is foreseeable that the detainee may attempt suicide? Yes
ii. IL adopts Alternative A: the prisoner was not a buyer or his family/household and
not covered by it b/c no privity
a) The court judicially extended it to Alternative C so that a 3rd party is covered
2. Note on Strict Products Liability (not on exam)
a. Restatement (2nd) of Torts 402A (Special Liability of Seller of Product for Physical
Harm to User or Consumer) – no privity, no notice required
i. One who sells any product in a defective condition unreasonably dangerous to the
user or consumer or to his property is subject to liability for physical harm thereby
caused to the ultimate user or consumer, or to his property, if
a) The seller is engaged in the business of selling such product, and
b) It is expected to and does reach the user or consumer without substantial change
in the condition in which it is sold
ii. The rule stated in subjection (1) applies although
a) The seller has exercised all possible care in the preparation and sale of his
product, and
b) The user or consumer has not bought the product from or entered into any
contractual relation with the seller
b. OH adopted strict product liability
c. East River v. Transamerica (ship turbine hurt itself, no harm to any other property or
people: purely economic loss)
i. Issue: Whether public policy requires manufacturers to be liable in tort to buyers in
a commercial transaction when a product malfunctions, injuring only the product
itself and causing only economic losses? No
ii. Rule: A manufacturer in a commercial transaction has no liability in tort for a
product malfunctioning and only causing damage to the product itself and other
economic losses.
d. Economic Loss Doctrine: precludes the application of tort theories to commercial
matters where the only injury is to the product itself (almost all states adopt this rule)
i. Courts have even denied tort recoveries in consumer suits
ii. Why contracts/commercial law is not utilized in this situation: SOL has run on all
but the tort claims
iii. Where the injury is not only to the product but to other property as well: most
courts will allow the tort theories to go forward
 iv. Distinctions b/w strict product liability and implied warranty suits
Strict Product Liability (Restatement 402A) Implied Warranty Suits (UCC)
Notice not required Notice required 2-607(3)(a)
Damages limited to those for physical injury Damages not limited to those for physical
injury
SOL imposed by state law for tort actions Governed by 2-725, differs significantly (4 yrs,
(starts to rune upon recognizing the defect) starts to run upon delivery)
Not affected by disclaimers or remedy May be limited by 2-316, 2-719
limitations
Privity not an issue Privity may be an issue
Product must contain a “defect” Warranty may be breached even if the
product is not defective (e.g.: perfectly
defect- free may breach express warranty or
implied warranty)
e. Problem 38: the axle on Python’s new car snapped in 2 while driving and the car ran
into Bystander, killing him.
i. Which is the best cause of action?
a) Negligence: hard to prove negligence
b) 402A strict product liability: best if the axle was defective (unreasonably
dangerous, no privity problem)
c) 2-314 implied warranty: privity may be an issue, may be limited by disclaimer
ii. Whom should you (Bystander’s attorney) sue?
a) The car manufacturer: deeper pocket & no privity required
E. UCC Warranties and the Magnuson-Moss Warranty – Federal Trade Commission
Improvement Act
1. Introduction:
a. Applies to all consumer products manufactured after July 4, 1975 covered by a
written warranty
b. Purpose: improve the adequacy of info available to consumers, prevent deception,
improve competition in the marketing of consumer products
2. 101 (definitions):
a. Consumer product: any tangible personal property distributed in commerce and
normally used for personal, family, or household purposes (including any such
property intended to be attached to or installed in any real property without regard
to whether it is so attached or installed)
b. Consumer: a buyer (other than for purposes of resale) of any consumer product, any
person to whom such product is transferred during the duration of an implied or
written warranty (or service contract) applicable to the product, and any other
person who is entitled by the terms of such warranty (or service contract) or under
applicable State law to enforce against the warrantor (or service contractor) the
obligations of the warranty (or service contract)
c. Supplier: any person engaged in the business of making a consumer product directly
or indirectly available to consumers
 d. Warrantor: any supplier or other person who gives or offers to give a written
warranty or who is or may be obligated under an implied warranty
e. Written warranty:
i. any written affirmation of fact or written promise made in connection with the sale
of a consumer product by a supplier to a buyer which relates to the nature of the
material or workmanship and affirms or promises that such material or
workmanship is defect free or will meet a specified level of performance over a
specified period of time, or
ii. any undertaking in writing in connection with the sale by supplier of a consumer
product to refund, repair, replace, or take other remedial action w/r/t such
product in the event that such product fails to meet the specifications set
forth in the undertaking (remedial promise),
iii. which written affirmation, promise, or undertaking becomes part of the basis of
the bargain b/w a supplier and a buyer for purposes other than resale of such
product
f. implied warranty: an implied warranty arising under State law (as modified by
sections 2308 and 2304(a) of this title) in connection with the sale by a supplier of a
consumer product
g. service contract: a K in writing to perform, over a fixed period of time or for a
specified duration, services relating to the maintenance or repair (or both) of a
consumer product
3. Problem 39: A corporation buys a company car, is it entitled to the protection of M-M?
Yes
a. 101(1): Consumer product - used for personal, family, or household purposes =>
actual usage of this particular product does not matter, “normal” usage only matters
b. 101(3): consumer - buyer does not need to be a consumer, buyer needs to buy a
consumer product
c. Thus, although this particular car is not used for personal purposes, it is protected by
M-M Act b/c a car is a consumer product normally used for personal purposes, and
the corporation is a consumer
4. Problem 40:
a. Seller said “I refuse to warrant my cars in any way.”
i. M-M protection? - No b/c no written warranty
a) 102(b)(2): M-M Act does not require suppliers to provide warranties, but once it
is given voluntarily, M-M Act governs
ii. UCC warranty? – implied warranty of merchantability under UCC 2-314 b/c the
seller is a merchant (should have mentioned “merchantability” in order to disclaim
it)
b. Seller said “I promise that this car has a sound engine that will last 5 yrs.”
i. M-M protection? - No b/c no written warranty
ii. UCC warranty? – Express warranty under UCC 2-313 and implied warranty of
merchantability under 2-314
c. Seller wrote “I guarantee that the only person to ever own this car was a little old
lady who only drove it to church every Sunday.” What if the car was owned by a
speedway
 racer?
i. M-M 101(6): not related to the nature of the material or workmanship -> No
protection
ii. UCC warranty: 2-313 express warranty & 2-314 implied warranty of merchantability
d. Seller pointed out 2 loose-leaf binders with written statement that “The Super Z Has
a Full Life-Time Guarantee.” (life-time of this vehicle? No. life-time of buyer? No –
construed broadly)
i. M-M 104(e): if a supplier designated a warranty applicable to a consumer product
as a “full (statement of duration)” warranty, then the warranty on such product
shall be deemed to incorporate at least the minimum requirements of this
section -> protected by M-M
ii. UCC warranty: 2-313 express warranty & 2-314 implied warranty of merchantability
e. 2 types of M-M warranties (M-M 103, 104, 105, 108)
i. Full warranty: conspicuously designate a “full (statement of duration) warranty” ->
gives consumers the choice to receive a full refund or replacement of a defective
product that is beyond repair
a) Consumer must be given the election to receive a refund or replacement
without charge of a product or part which is defective or malfunctions after a
reasonable number of attempts by the warrantor to correct such condition
ii. Limited warranty: anything other than full warranty
iii. Disclaimer/modification/limitation of implied warranty
a) Where a written warranty or service contract is given to the purchaser, implied
warranties may not be disclaimed or modified
b) Where an express “limited warranty” is given, implied warranties may be
limited to the duration of the written warranty of reasonable duration
c) Limitations on the duration of implied warranties in such a case are valid so
long as they are prominently displayed on the face of the warranty in clear and
unmistakable language and are not unconscionable
5. Problem 41: Conspicuous full 3-month warranty which guaranteed all the parts except
the tires as defect-free in lieu of all other warranties, express or implied. After 3
months, every part malfunctioned
a. Was the warranty disclaimer effective?
i. No b/c under M-M 108(a), once a written warranty has been given, implied
warranties cannot be disclaimed
ii. 108(a): no supplier may disclaim or modify any implied warranty to a consumer
w/r/t such consumer product if (1) such supplier makes any written warranty to
the consumer w/r/t such consumer product, or (2) at the time of sale or within 90
days thereafter, such supplier enters into a service K with the consumer which
applies to such consumer product
iii. 108(b): implied warranties may be limited in duration to the duration of a written
warranty of reasonable duration, if such limitation is conscionable and is set forth
in clear and unmistakable language and prominently displayed on the face of the
warranty
 b. Would it have been effective had seller offered only a “limited warranty?”
i. Yes, where a limited warranty is given, implied warranties may be limited to the
duration of the written warranty of reasonable duration
c. In an action based on 2-314, is attorney’s fee recoverable?
i. M-M 110(d)(1): consumer may bring suit for damages and other legal and
equitable relief (rescission, revocation of acceptance)
ii. M-M 110(d)(2): if consumer prevails, he may recover the aggregate amount of cost
and expenses determined by ct to have been reasonably incurred => allows the
recovery of attorney’s fees unless inappropriate
a) implied warranty of merchantability: not disclaimed b/c “merchantability” was
not mentioned
b) implied warranty of fitness: disclaimed b/c the disclaimer was in writing and
conspicuous
6. Ventura v. Ford Motor (Lemon car case – local dealership disclaimed all warranties)
a. P bought a new car from D and then sued for breach of warranty when it turned out
to be a lemon car case. Local dealership disclaimed all the warranties but made
service K which triggered M-M Act -> no privity requirement, disclaimer of implied
warranty is invalid
b. Held: If a supplier of consumer products provides a written limited warranty w/r/t the
goods to the consumer, it may not completely disclaim implied warranties. The M-M
Act §2304 specifically forbids it. The sales agreement promised that D would perform
any remedial action required by Ford’s warranty. This is a limited warranty, and D’s
disclaimer of implied warranty of merchantability and fitness was therefore invalid.
F. Warranties and Art. 2A
1. Introduction: the warranty rules for the lease of goods in Art. 2A are carbon copies of
Art. 2. Major difference is “finance lease”
2. Colonial Pacific Leasing Corp. v. McNatt Datronic Rental Corp. (hell or high water
clause)
a. Facts: P brought suit against equipment supplier, manufacturer and lessors (Ä) of
defective computer equipment it leased from Colonial and Datronic (Ä), seeking
rescission of the leases.
b. Held: A “hell or high water” clause does not insulate a lessor’s assignee from a claim
of fraud where an agency relationship can be established b/w the assignee and the
perpetrators of the alleged fraud. A finance lessor’s disclaimers of warranties are not
expressly prohibited. A contractual requirement that lessee make its rental payments
is also valid in the absence of fraud on finance lessor’s part. P agreed to pay the full
amt of the rental agreement to assignee/ lessors regardless of defect, damage or
unfitness of the equipment, and that the lessee agreed not to assert against the
assignee lessors defenses it could not assert against the original lessor. Thus, the
K precludes the lessee from asserting fraud of the original finance lessor as a
defense against the assignee lessor’s claim for payment. Also, there’s no evidence of
a relationship pursuant to which the alleged fraud of the supplier’s employers could
be imputed to the finance lessor so as to invalidate the Ks. Thus the “hell or high
water” clauses in the lease are viable.
3. Problem 42: Aurora manufactured a robot based on Tomorrow’s specification.
Bank bought the robot with express and implied warranties and leased it to
Tomorrow. The robot caused extensive damage to Tomorrow
a. Is this a “finance lease?” Yes, the bank is the lessor, Aurora is the supplier and
Tomorrow is the lessee (the lessee can have all the benefit of warranties directly
from Aurora)
i. 2A-103(1)(g): finance lease if a lease w/r/t which
a) the lessor does not select, manufacture, or supply the goods (bank didn’t’ select
or manufacture the robot),
b) the lessor acquires the goods or the right to possession and use of the goods in
connection with the lease, and (the bank bought the robot, but has no interest
in the robot now)
c) (i) the lessee receives a copy of K b/w the lessor and supplier, (ii) the lessee’s
approval of supply K b/w the lessor and supplier is a condition to effectiveness
of the lease K, (iii) the lessee receives an accurate/complete statement of
promises/warranties or (iv) the lessor informs the lessee in writing (a) of the
identity of supplier, (b) that the lessee is entitled to promises/warranties and (c)
that the lessee may communicate with supplier(Tomorrow has a copy of K
b/w the bank and Aurora, or etc)
ii. What if the bank does not want the lessee to know about the K b/w the bank and
Aurora? – the bank must inform Tomorrow at least (a) to (c) of 2A-103(1)(g)(C)
a) OC(g): parties can stipulate it is a finance lease in the K
b. Aurora: the supplier under 2A-103(1)(x)
c. Does Tomorrow have the benefit of whatever warranties Aurora gave to bank? Yes
i. 2A-209: the benefit of a supplier’s promises to the lessor under the supply K and of
all warranties, whether express or implied, extends to the lessee
d. Is bank responsible for breach of the implied warranty of merchantability? No b/c this
is a finance lease
i. 2A-212: “Except in a finance lease,” a warranty of merchantability is implied if the
lessor is a merchant w/r/t goods of that kind (no implied warranty of
merchantability in finance lease)
e. If bank told Tomorrow “We have investigated this robot, and I guarantee you it
will cause you no trouble,” must the lessor respond in a warranty lawsuit to a claim
for damages? Yes if the bank’s statement is part of the basis of the bargain b/c
express warranty has been created by the bank’s affirmation
i. 2A-210: express warranties by the lessor are created by any affirmation of
fact/promise & part of the basis of the bargain => express warranty by the bank
was created
ii. OC(g), 3rd paragraph, to 2A-103: if the lessor undertakes or performs other
functions, express warranties, covenants and the common law will protect the
lessee
f. The lease K b/w bank and Tomorrow states that the lessee had to pay the lessor even
if the goods did not work (“hell or high water” clause – the lessee binds itself to pay
the lessor no matter what happens in connection with the performance of the leased
 goods). After the robot ruins the lab, must Tomorrow pay bank? Yes b/c this is not
a consumer lease
i. 2A-407: In the case of a finance lease that is not a consumer lease, the lessee’s
promises under the lease K become irrevocable and independent upon the lessee’s
acceptance of the goods (not subject to cancellation, modification without the
consent of the party to whom the promise runs) -
g. Would we reach the same result if the lessee were a consumer? No b/c 2A-407
applies only to finance leases that are not consumer leases
G. Warranties in International Sales (the word “warranty” is never used, “conformity of goods”
are used instead)
1. Warranty of title: Art. 41
2. Express warranty liability: Art. 35(1) and (2)(c)
3. Implied warranties of merchantability and fitness for a particular purpose: Art. 35(2)(a)
& (b)
4. Disclaimer: Art. 6 (the parties may exclude the application of this Convention or subject
to Art. 12, derogate from or vary the effect of any of its provisions)

CHAPTER 4. TERMS OF THE CONTRACT

I. Filling in the Gaps
A. Introduction
1. UCC gives the courts statutory guidance by the gap-fillers (2-305 to 2-311) to save K
2. 2-311(1) & (3): good faith and commercial reasonableness
B. Problem 43: parties signed a written K for the delivery of 100 cases of motor oil, types to
be specified by buyer 1 week prior to the delivery date, the price of Type B is $30 but the
price of Type A to be set by seller at the time of delivery. 1 week prior to the delivery,
buyer revoked, in the past dealings, 50 ~ 65% was type A was $50 (but now jumped to
$125). What should the seller do?
1. 2-609: reasonable ground for insecurity -> in writing demand adequate assurance of
due performance and withhold performance
a. Mention the statute (2-609) in the writing, cite cases and demand assurance
b. Perform reasonably based on the course of dealings b/w the parties (not a business
decision)
2. 2-305 (Open Price Term): (1) The parties if they so intend can conclude a K for sale
even though the price is not settled. In such a case, the price is a reasonable price at the
time for delivery if
a. Nothing is said as to price; or
b. The price is left to be agreed by the parties and they fail to agree; or
c. The price is to be fixed in terms of some agreed market or other standard as set or
recorded by a 3rd person or agency and it is not so set or recorded
3. 2-311 (Options and Cooperation Respecting Performance): (1) An agreement for sale
which is otherwise sufficiently definite to be a K is not made invalid by the fact that it
leaves particulars of performance to be specified by one of the parties
4. 1-205 (Reasonable Time; Seasonableness)
 a. Whether a time for taking an action required by UCC is reasonable depends on the
nature, purpose, and circumstances of the action
b. An action is taken seasonably if it is taken at or within the time agreed or, if no time is
agreed, at or within a reasonable time
5. What if this were an international sale of goods under CISG?
a. Art. 65
i. If under the K the buyer is to specify the form, measurement or other feature of
the goods and he fails to make such specification either on the date agreed
upon or within a reasonable time after receipt of a request from the seller, the
seller may, without prejudice to any other rights he may have, make the
specification himself in accordance with the requirements of the buyer that may
be known to him
ii. If the seller makes the specification himself, he must inform the buyer of the
details thereof and must fix a reasonable time within which the buyer may make a
different specification. If, after receipt of such a communication, the buyer fails
to do so within the time so fixed, the specification made by the seller is binding.
b. So, seller may make the specification in accordance with the requirements of the
buyer and must inform the buyer of the details and fix a reasonable time within
which the buyer may make a different specification. (go ahead and specify)
6. What if buyer simply said “April fool!” and hung up? Is this a definite repudiation?
a. 2-610 (Anticipatory Repudiation): when either party repudiates the K, the aggrieved
party may
i. For a commercially reasonable time await performance by the repudiating party; or
ii. Resort to any remedy for breach even though he has notified the repudiating party
that he would await; and
iii. Suspend his own performance or proceed in accordance with Art. 2 on the seller’s
right to identify goods to the K notwithstanding breach or to salvage unfinished
goods
b. 2-611 (Retraction of Anticipatory Repudiation)
i. Until the repudiating party’s next performance is due he can retract his repudiation
unless the aggrieved party has since the repudiation cancelled or materially
changed his position or otherwise indicated that he considers the repudiation final
ii. Retraction may be by any method, but must include any assurance justifiably
demanded
iii. Retraction reinstate the repudiating party’s rights under the K with due excuse and
allowance to the aggrieved party for any delay occasioned by the repudiation
c. OC2 to 2-610: repudiation can result from action which reasonably indicates a
rejection of the continuing obligation => buyer’s words did not reasonably indicate a
rejection of the continuing obligation, not a definite repudiation
7. What action can the seller take to clear up buyer’s ambiguous statement?
a. 2-609 (Right to Adequate Assurance of Performance): (1) when reasonable grounds
for insecurity arise w/r/t the performance of either party, the other may in writing
demand adequate assurance of due performance and until he receives such
assurance may if commercially reasonable suspend any performance for which
he has not
 already received the agreed return
b. So, seller may in writing demand assurance of due performance and may suspend
any performance until he receives assurance from buyer
C. Landrum v. Devenport
1. Car purchase, negotiated for NASCAR limited edition car, selling price left blank, but
sticker price was 14 to 18k; wanted 22k, bought for price after objection and sued.
2. 1-207: purchase under protest; you buy, but you are reserving your rights for remedy
later.
3. 2-311: if there was intent for a K and a reasonably certain basis for giving an
appropriate remedy, then there is a K with the price to be filled in as reasonable.
4. Question: how might the buyer have used 1-308 if he was about to pay the higher price
the seller demanded at delivery?
a. 1-308 (Performance or Acceptance Under Reservation of Rights): A party that with
explicit reservation of rights performs or promises performance or assents to
performance in a manner demanded or offered by the other party does not thereby
prejudice the rights reserved. Such words as “without prejudice,” “under protest,” or
the like are sufficient (not subject to accord and satisfaction)
b. The buyer could have paid the higher price under protest, and reserved his rights (&
avoid waiver)
II. Unconscionability (not on exam)
A. 2-302 (Unconscionable K or Clause): (1) if a K is unconscionable, the court may refuse to
enforce the K, or it may enforce the remainder of the K without the unconscionable
clause, or it may so limit the application of any unconscionable clause as to avoid any
unconscionable result
B. Prof. Leff’s 2 types of unconscionability
1. Procedural unconscionability: unfair conduct in the formation of the K (adhesion K,
bargaining power)
2. Substantive unconscionability: unfairness in the terms of the resulting bargain (unfair
terms in K)
3. Both are required for a court can make a finding of 2-302 unconscionability
C. Questions
1. Is unconscionability defined in the code? No.
a. If asked, how would you define the meaning to a judge? OC1 to 2-302 (The basic test
is whether, in the light of the general commercial background and the commercial
needs of the particular trade or case, the clauses involved are so one-sided as to be
unconscionable under the circumstances existing at the time of the making the K)
2. Is the unconscionability issue one for the judge or the jury? Question of law b/c the
court needs to interpret the terms of the K (OC3: the commercial evidence referred
to in subsection (2) is for the court’s consideration, not the jury’s)
a. What is the policy reason for the Code’s drafters’ decision on this matter?
3. Is the 2-302(2) hearing mandatory as a technical step prior to a finding of
unconscionability? Yes (Haugen v. Ford Motor)
4. Would the answers to these questions change if this were a lease of goods to a
consumer?
 No, the same under 2A-108
a. 2A-108(4): mandatory attorney’s fee (not discretionary) not limited by the amount of
recovery
D. Problem 44: buyer told seller that he knew nothing about sailboats, seller offered $3,150
for a boat which was 3 times higher than market price and buyer signed a K without
comparison shopping. Does 2-302 permit buyer to avoid the sale? It depends, but
generally no b/c buyer could have done comparison shopping but he chose not to do so
1. Morris v. Capitol Furniture: buyer must show that she had an absence of a meaningful
choice when she entered into the K. the consumer was free to comparison shop w/r/t
the goods.
2. Jones v. Star Credit: under the circumstances, the sales agreement was unconscionable
III. Identification of the Goods
A. 2-501 (Insurable Interest in Goods; Manner of Identification of Goods) general policy
favoring early identification (as fast as possible)
1. Existing goods: when K is made if the sale of goods that already exist and are identified
(if the goods are there?)
2. Future goods: if the K is for the sale of future goods, when goods are shipped, marked
or otherwise designated by the seller as goods to which the K refers
3. Growing crops and unborn young:
a. Crops: when the crops are planted or otherwise become growing crops if the crops
are to be harvested in the next (1) 12 months or (2) normal harvest season
b. Unborn young: when the young are conceived if the unborn young are to be born
within 12 months after K
B. Problem 45: When identification per 2-501 has occurred?
1. Fisherman contracts to sell his entire catch for the coming season: when they’re caught
a. OC6: the product of lumbering, mining or fishing operation, though seasonal, is not
within the concept of “growing.” Identification under a K for all or part of the output
of such an operation can be effected early in the operation.
2. Seller contracted to sell the unborn calf of the elephant Nancy as soon as the calf was
born, the K was made when Nancy was 2 months pregnant. (gestation period of
elephant is 22 months!)
a. When conceived or delivered? Prof. has no answer b/c no case ever litigated
3. Farmer agreed to sell 1/2 of the grain he had stored in Rural Silo.
a. OC5: undivided shares in an identified fungible bulk, such as grain or oil, can be sold.
The mere making of the K with reference to an undivided share in an identified
fungible bulk is enough to effect an identification unless agreed otherwise
b. Fungible goods (dictionary definition): moveable perishable goods of a sort that may
be estimated by number or weight, such as grain, wine, etc
c. So, identification occurs on contracting
4. Seller contracted to sell 5,000 widgets to buyer and its warehouse contained 2 M
widgets, all alike – not an undivided share (Seller has the ability to identify the share for
the buyer)
a. 1-201(18): fungible goods means (i) goods of which any unit, by nature or usage of
trade, is the equivalent of any other like unit or (ii) goods that by agreement are
 treated as equivalent
b. So, identification occurs when the seller separate the share to be sold to the buyer
(ROL problem)
IV. Risk of Loss in the Absence of Breach
A. General Rules
1. 2-401(1): Who bears the risk of loss has nothing to do with who has technical title.
2. 2-509(1)(a): Presumption of shipment K (buyer bears ROL) (<-> destination K: seller
bears ROL)
3. 2-509(3): Absent contrary agreement,
a. where seller is a merchant, ROL passes to buyer on buyer’s actual receipt of the goods
b. where seller is not a merchant, ROL passes to buyer when seller tenders delivery
4. Problem 46: buyer bought a car from a car dealer and paid the full price, the car was
ready for pick up but buyer delayed pick up to the next day. The car was stolen that
night
a. Who had ROL?
i. Seller had ROL until buyer actually receives the goods b/c seller is a merchant
b. Might seller claim he was a bailee so that 2-509(2) applies? No, seller is not a bailee
b/c he still owns the good
i. 2-509(2): where the goods are held by a bailee to be delivered without being
moved,
ROL passes to buyer
a) On his receipt of possession/control of a negotiable document of title covering
the goods; or
b) On acknowledgment by the bailee of buyer’s right to possession of the goods; or
c) After his receipt of possession/control of a non-negotiable document of title or
other direction to deliver in a record
5. Problem 47: buyer bought a piano at a garage sale and was gonna take it the next day.
The piano was destroyed that night
a. Did ROL pass from seller to buyer? Yes, b/c seller was not a merchant, ROL passed to
the buyer on tender of delivery.
b. What if buyer never picked up the piano and it was destroyed 6 months after the sale?
i. 2-709(1)(a) (Action for the Price): when buyer fails to pay the price as it becomes
due, seller may recover, together with any incidental damages, the price of goods
accepted or of conforming goods lost or damaged within a commercially
reasonable time after ROL has passed to buyer
ii. Should ask if 6 months is a commercially reasonable time after ROL has passed to
buyer. If reasonable, seller can recover the price of piano. If unreasonable,
seller can’t.
6. Note: 2-509(3) applies only when 2-509(1) or (2) does not. The ROL rests on whoever
has control over the bailee
7. 2-509(1): where the K requires or authorizes the seller to ship the goods by carrier
a. If it does not require him to deliver them at a particular destination, the ROL passes
to the buyer when the goods are duly delivered to the carrier even though the
shipment is under reservation (shipment K), but
b. If it does require him to deliver them at a particular destination and the goods are
 there duly tendered while in the possession of the carrier, the ROL passes to the
buyer when the goods are there duly so tendered as to enable the buyer to take
delivery (destination K)
c. Transportation K: when the ROL passes depends on whether the K requires the seller
to deliver the goods at a particular destination
B. Delivery Terms
1. Introduction
a. Shipment K: seller need only get the goods to the carrier and then the buyer will take
the ROL
b. Destination K: goods must be delivered by the carrier before the ROL passes from
seller to buyer
c. OC5 to 2-503: it is presumed that Art. 2 is in favor of a shipment K where the K is
silent on the ROL
2. Types of delivery terms
a. C.I.F. (cost, insurance, freight), C. & F. (cost and freight): always shipment K (buyer
has the ROL b/c the cost includes insurance and the buyer paid for insurance)
b. F.A.S. (free along-side), ex-ship (off the ship): delivery terms used in connection with
ships
i. 2-319(2): unless otherwise agreed, the term F.A.S. vessel at a named port,
even though used only in connection with the stated price, is a delivery term under
which the seller must
a) at his own expense and risk deliver the goods alongside the vessel in the
manner usual in that port or on a dock designated and provided by the buyer,
and
b) obtain and tender a receipt for the goods in exchange for which the carrier is
under a duty to issue a bill of lading
ii. 2-322: Unless otherwise agreed, a term for delivery of goods ex-ship or in
equivalent language is not restricted to a particular ship and requires delivery from
a ship which has reached a place at the named port of destination where goods of
the kind are usually discharged.
a) the ROL does not pass to the buyer until the goods leave the ship’s tackle or are
otherwise properly unloaded
c. F.O.B. (free on board) + name of place : either shipment K or destination K, the ROL
passes to the buyer at the named place (price term in addition to ROL term)
i. 2-319(1): unless otherwise agreed, the term F.O.B. at a named place even though
used only in connection with the stated price, is a delivery term under which
a) when the term is F.O.B. the place of shipment (shipment K), the seller must at
that place ship the goods in the manner provided 2-504 and bear the expense
and risk of putting them into the possession of the carrier, or
b) When the term if F.O.B the place of destination (destination K), the seller must
at his own expense and risk transport the goods to that place and there tender
delivery of them in the manner provided in 2-503
3. Problem 48: Seller in NYC contracted to sell 80 boxes of clothing to buyer in Savannah,
GA. The delivery term was “$1,800 F.A.S. S.S. (steam ship) Seaworthy, NYC.”
Seller
 delivered the 80 boxes to the dock alongside the S.S. Seaworthy and received a bill of
lading from the ship as a receipt. Before the boxes could be loaded, the dock collapsed
and everything disappeared
a. Under 2-319(2) must buyer pay the $1,800 anyway? Under 2-319(2), buyer bears the
ROL b/c seller delivered the goods alongside the vessel and obtained a receipt
i. 2 prong test: 2-319(2) – the ROL passes when both (a) + (b) are satisfied
b. What if delivery term had been “Ex-ship S.S. Seaworthy, Savannah” and the boxes
had been properly unloaded just before the dock collapsed? – under 2-322(2), the
ROL passed to the buyer b/c the goods were properly unloaded from the ship
4. Problem 49: Seller in Detroit, MI contracted to sell and ship 50 automobiles to buyer in
Birmingham, AL. Lightning strikes, destroying the vehicles after the carrier has received
them but before they are loaded on board the railroad car. Who had the ROL if
a. The K said “F.O.B. Detroit (place of shipment)?”
i. 2-319(1)(a): seller must ship the goods at Detroit and bear the expense and risk of
putting them into the possession of the carrier
ii. B/c the carrier has received the vehicles, the ROL passed to the buyer
b. The K said “F.O.B. railroad cars Detroit?”
i. 2-319(1)(c): the seller must load the goods on board at his own expense and risk
ii. B/c the vehicles were not loaded on board the railroad car, the seller has the ROL
c. The K said “C.I.F. Birmingham?” – shipment K, but 2-320(2)(b) requires the seller
to load the goods
i. 2-320(2): seller at his own expense and risk to (i) put the goods into the possession
of carrier at the port of shipment (and obtain a bill of lading); (ii) load the goods
(and get receipt); (iii) get a certificate of insurance; (iv)) prepare an invoice and
other necessary documents; and (v) forward and tender with commercial
promptness all the documents
ii. Unless the seller did all the things above, the seller had the ROL
5. Problem 50: Dispatcher for seller finished loading 5 boxcars on board the cars of an
independent railroad carrier and seller agreed to sell 1 boxcar to buyer “F.O.B.
seller’s processing plant.” Dispatcher agreed to divert 1 of the 5 boxcars to buyer, but a
hurricane destroyed all 5 boxcars
a. OC2 to 2-509: where seller buys the goods afloat and later diverts the shipment to
the buyer, he must identify the goods to the K before the ROL can pass. To transfer
the risk it is enough that a proper shipment and a proper identification come to
apply to the same goods although, aside from special agreement, the risk will not
pass retroactively to the time of shipment in such a case.
b. There was no proper identification by the seller, the ROL stays with the seller (policy
prefers early identification, but you may argue in opposite way too!)
6. Cook Specialty Co. v. Schrlock (shipment K: whether the seller must ensure that the
carrier has sufficient insurance to cover a particular potential loss?)
a. Fact: FOB (free on board) seller places press brake on a carrier and received from the
carrier a certificate of insurance – goods were destroyed in transit. Carriers insurance
did not cover the lost product. Is the seller required to ensure that the carrier get full
 insurance coverage? No
b. Rule: §2-504 (shipment K) - Where the seller is required or authorized to send the
goods to the buyer and the K does not require him to deliver them at a particular
destination, then unless otherwise agreed he must put the goods in the possession
of such a carrier and make such a K for their transportation as may be reasonable
having regard to the nature of the goods and other circumstances of the case
c. Holding: K was reasonable under the UCC § 2-504(a). Reasonableness of shipper's
conduct in arranging shipment of goods is determined w/r/t mode of transfer
selected. Seller has no obligation to investigate amount and terms of insurance held
by carrier.
7. Rheinberg-Kellerei GmbH v. Vineyard Wine Co. (notification issue – buyer must be
informed of the shipment in sufficient time for him to take action to protect himself
from the risk of damage to or loss of the goods while in transit)
a. Facts: Shipment K and seller gets the goods to carrier – ship gets lost at sea. 2-504
failure to notify buyer or make proper K is a ground for rejection only if material delay
or loss ensures – must NOTIFY buyer. Here seller doesn’t notify buyer, he
instead notifies the broker, who also does not notify the buyer.
b. Rule: 2-509(1)(a) - where a K is a “shipment K,” ROL to buyer when the goods are
“duly delivered” to carrier. Before seller will be deemed to have “duly delivered” the
goods to carrier, seller must first fulfill certain duties owed to buyer. In the absence
of any agreement to the contrary, these responsibilities uner 2-504 include “prompt
notice.” “Prompt notice” is determined on a case-by-case basis. P’s failure to notify
D of the shipment until after the sailing of the ship and the ensuing loss was not
“prompt notice.” Thus, ROL did not pass to D upon the delivery of the wine to carrier
pursuant to 2-509(1)(a). P’s notification to its agent was insufficient b/c the info was
not passed along to D. Since D was never “promptly notified” within the time in
which its interest could have been protected by insurance or otherwise, D was
entitled to reject the shipment pursuant to the term of 2-504(c).
c. Public policy: Where the buyer, upon shipment by seller, assumes the perils involved
in carriage, he must have reasonable opportunity to guard against these risks by
independent arrangements with the carrier. Prompt notice under 2-504(c) must
be construed as taking into consideration the need of a buyer to be informed in
sufficient time for buyer to take action to protect himself from risk of damage to or
loss of the goods while in transit.
8. Problem 51: The University of Beijing in CN ordered video equipment from Applied
Tech. in San Jose, CA. If nothing is said about the subject, will this create a
shipment or a destination K?
i. CISG Art. 67
a) if the K of sale involves carriage of the goods and the seller is not bound to hand
them over at a particular place, the risk passes to the buyer when the goods are
handed over to the first carrier for transmission to the buyer in accordance with
the K of sale. If the seller is bound to hand the goods over to a carrier at a
particular place, the risk does not pass to the buyer until the goods are handed
 over to the carrier at that place. The fact that the seller is authorized to retain
documents controlling the disposition of the goods does not affect the passage
of the risk.
b) Nevertheless, the risk does not pass to the buyer until the goods are clearly
identified to the K, whether by markings on the goods, by shipping documents,
by notice given to the buyer or otherwise.
ii. CISG Art. 69
a) In case not within Art. 67 and 68, the risk passes to the buyer when he takes
over the goods or , if he does not do so in due time, from the time when the
goods are placed at his disposal and he commits a breach of K by failing to take
delivery
b) However, if the buyer is bound to take over the goods at a place other than a
place of business of the seller, the risk passes when delivery is due and the
buyer is aware of the fact that the goods are placed at his disposal at that place.
c) If the K relates to goods not then identified, the goods are considered not to be
placed at the disposal of the buyer until they are clearly identified to the K.
iii. If the seller is not bound to hand the goods over at a particular place (Art. 67), a
destination K is created and the seller bears the ROL.
b. If the parties had been negotiating for the purpose of this equipment but had not
gotten around to signing the K until the goods were already on board an airplane
crossing the Pacific Ocean, does the buyer have the ROL only from the moment of the
signing of the K or from the delivery of the equipment to the air carrier?
i. CISG Art. 68: The risk in respect of goods sold in transit passes to the buyer from
the time of the conclusion of the K. However, if the circumstances so indicate, the
risk is assumed by the buyer from the time the goods were handed over to the
carrier who issued the documents embodying the K of carriage. Nevertheless, if at
the time of the conclusion of the K of sale, the seller knew or ought to have known
that the goods had been lost or damaged and did not disclose this to the buyer,
the loss or damage is at the risk of the seller.
ii. Since the K was not concluded, we must look at if the circumstances show that the
risk is assumed by the buyer
9. Problem 52: Dime-A-Minute rented a new sports car to Joseph, who did not sign a
rental agreement. As he was leaving the rental car lot, the car was struck by a city bus
due to no fault of him. The sports car was totaled.
a. Did Joseph have the ROL?
i. 2A-219(1) Except in the case of a finance lease, ROL is retained by the lessor and
does not pass to the lessee. In case of a finance lease, ROL passes to the lessee
ii. 2A-219(2)(c): in any case not within (a) or (b) (i.e., if the parties agree otherwise),
the ROL passes to the lessee on the lessee’s receipt of the goods if the
lessor/supplier is a merchant
iii. This is not a finance lease b/c lessee can return the goods. So, the ROL remained in
the lessor
b. If he had signed a rental agreement making him responsible for the car, would that
agreement be valid?
 i. 2A-219(2)(c): Parties may agree otherwise unless unconscionable
ii. 1-302(1) Except otherwise provided, the effect of provisions of UCC may be varied
by agreement. But, good faith, diligence, reasonableness, care may not be
disclaimed by agreement. (parties may not disclaim “consionability” b/c
unconscionable K can’t be reasonable)
iii. 2A-108 (unconscionability): if unconscionable, not enforceable
10. Note: when either party is in breach, 2-510 (2A-220, CISG Art. 66 & 70) applies instead
of 2-509 (2A-219, CISG 67)

CHAPTER 5. PERFORMANCE OF THE CONTRACT

I. Introduction
A. 2-301 (General Obligation of Parties)
1. Seller’s basic obligation: to transfer and deliver (must tender conforming goods)
2. Buyer’s basic obligation: to pay in accordance with the K
B. Contemporaneous swap of money for the goods
1. 2-507(1): Tender (offer to perform) of delivery is a condition to the buyer’s duty to
accept the goods and, unless otherwise agreed, to his duty to pay for them. Tender
entitles the seller to acceptance of the goods and to payment according to the K
2. 2-511(1): Unless otherwise agreed, tender of payment is a condition to the seller’s duty
to tender and complete any delivery
3. Until somebody offers to perform, nobody is in breach unless parties agreed that
somebody comes first
4. If the parties did not intend a contemporaneous swap, 2-507(1) or 2-511(1) does not
apply
II. Installment Sales
A. Substantial performance rule: Seller is entitled to payment even where the tender of the
goods fails to conform exactly to the K as long as it “substantially” conforms
1. Never applied to single-delivery Ks b/w merchants b/c buyer does not have the same
bargaining position in installment sales
B. 2-612 (Installment K; Breach)
1. An “installment K” is one which requires or authorizes the delivery of goods in separate
lots to be separately accepted, even though the K contains a clause “each delivery is a
separate K” or its equivalent.
2. The buyer may reject any installment which is non-conforming if the non-conformity
substantially impairs the value of that installment and cannot be cured or if the non-
conformity is a defect in the required document; but if the non-conformity does not fall
within subsection (3) and the seller gives adequate assurance of its cure, the buyer
must accept that installment.
3. Whenever non-conformity or default w/r/t one or more installments substantially
impairs the value of the whole K, there is a breach of the whole K. But the aggrieved
party reinstates the K if he accepts a non-conforming installment without seasonably
notifying of cancellation or if he brings an action with respect only to past installments
or demands performance as to future installments.
C. Problem 53: Agreed to take 12 shipments of 20 statutes each over the coming yr. In 1st
shipment, 1 was broken and buyer promised to ship a replacement at once. In 2nd
shipment, 10 were broken.
1. Does 2-612 permit rejection for this reason?
a. 2-612(2): the 2nd shipment was non-conforming b/c the non-conformity substantially
impairs the value of that installment, but it can be cured by immediate replacement.
So, buyer must accept it.
2. If seller replaced the broken statutes within a week, but the 3rd shipment contained no
statutes at all, may buyer reject it? Yes
a. Buyer may reject it b/c there was no substantial performance at all (all the units were
completely non-conforming)
3. May buyer cancel the remainder of the K?
a. Yes b/c the non-conformity impairs the value of the whole K and there is a material
breach of the whole K. So, buyer must not accept a non-conforming installment with
seasonable notification of cancellation.
b. What if the court says that the value of the whole K is not impaired by the 3rd
installment? You will be in breach.
i. You may argue that repeated failure to tender conforming goods shows material
breach.
ii. You may settle with the seller so that no litigation is needed
iii. You may demand adequate assurance (if any further non-conforming goods, cancel
the K)
D. Cherwell-Ralli v. Rytman Grain (who was in breach of oral installment K? –> who
breached first?)
1. Facts: The K called for shipments according to weekly instructions from buyer, with
payments to be made within 10 days after delivery. Almost immediately buyer was
behind in its payments, and seller repeatedly called these arrearages to buyer's
attention but continued to make all shipments. Buyer had become concerned that
seller might not complete performance of K, b/c seller's plant might close and the
market price of the goods had come significantly to exceed K price. In a telephonic
conversation b/w buyer's president and seller's president, buyer was assured that
deliveries would continue if buyer would make the payments. Thereupon, buyer sent
seller a check in the amount of $ 9825.60 to cover shipments, but soon stopped
payment on this check b/c he was told by a truck driver that this shipment would be his
last load. He then asked for assurances. Buyer, conceding its indebtedness,
counterclaimed for damages arising out of seller's refusal to deliver remaining
installments under K.
2. Held: A party to sales K may not suspend its performance for which it has already
received the agreed return without reasonable grounds for insecurity as to remainder
of the other party’s performance.
3. 2-703(f): Aggrieved seller is expressly permitted, upon breach of a K as a whole, to
cancel the remainder of K "w/r/t whole undelivered balance." However, that was not
the case here.
III. The Perfect Tender Rule (2-601)
A. Definition: Seller must make a perfect tender, one that complied with all of the terms of
the K, and then show that buyer refused to take the goods (buyer can reject the whole
goods even if a very small part of them does not conform to the K)
B. 2-601 (Buyer’s Rights on Improper Delivery): Subject to 2-612 (Breach in Installment K) and
unless otherwise agreed under 2-718 and 2-719, if the goods or the tender of delivery fail
in any respect to conform to the K, the buyer may
1. Reject the whole; or
2. Accept the whole; or
3. Accept any commercial unit(s) and reject the rest
C. 2-105(6): Commercial unit – a unit of goods as by commercial usage is a single whole for
purposes of sale and division of which materially impairs its character or value on the
market or in use. May be a single Art. or a set of Art.s or a quantity or any other unit
treated in use or in the relevant market as a single whole
D. Problem 54: buyer signed a K with seller to buy 5 new cars to be delivered on Oct. 1. Upon
delivery, buyer test drove all and returned 2 b/c of audio system and carpeting in the
trunk. Seller offered to repair both defects but buyer refused to permit repair.
1. Does the common law doctrine de minimis no curat lex (“the law does not notice small
defects”) survive 2-601? If so, in spite of the tiny defects, the cars would be conforming.
Yes (the audio system and the carpeting in the trunk are minimal defects that can be
cured by the seller)
a. OC2 to 2-106: general policy requires exact performance by the seller, but 2-508
(seller’s cure of improper tender/delivery) and usage of trade permits commercial
leeways
b. D.P. Technology v. Sherwood Tool: Where goods specially manufactured, buyer not
in good faith in rejecting b/c of insubstantial delay in delivery
2. Seller has a right to cure in some circumstances
a. 2-508 (Cure by Seller of Improper Tender/Delivery; Replacement)
i. Where any tender/delivery by seller is rejected b/c non-conforming and the time
for performance has not yet expired, seller may seasonably notify buyer of his
intention to cure and may then within the K time, make a conforming delivery
ii. Where buyer rejects a non-conforming tender which seller had reasonable grounds
to believe would be acceptable with or without money allowance, seller may, if he
seasonably notifies the buyer, have a further reasonable time to substitute a
conforming tender.
b. Is this section of use to seller here? Yes, the seller may be given the opportunity to
cure the minor defects if the time for performance has not yet expired or if seller had
reasonable ground to believe the tender would be acceptable (Wilson v. Scampoli).
c. If usage of trade is to commonly correct small defects by car sellers, will seller
succeed if it argues that such correction is a usage of trade under 1-303(c) and thus
either the goods are conforming or b/c of this usage of trade, the parties have
impliedly agreed that 2-601 perfect tender is not required? Yes
i. 1-302: variation by agreement allowed
 i. 1-201(b)(3): agreement – distinguished from K, bargain of the parties in fact, as
found in their language or inferred from other circumstances, including course of
performance, course of dealings or usage of trade
IV. Cure
A. 2-508: if the seller has not made a perfect tender and the buyer has rejected the goods,
the seller has the right in some circumstances to cure the defective performance
B. Problem 55: Buyer ordered a new car for $22K to be delivered no later than Sept. 1. On
Aug. 15, the car was ready and buyer picked it up. 3 miles from the seller, the engine blew
up and was destroyed. Seller made the following responses: Does 2-508 require the buyer
to accept either of these cure offers?
1. Seller offered to take an engine out of a car of the same model and install it in the
original automobile: Under 2-508(1), this offer should be allowed b/c it is early tender,
but No under shaken faith doctrine.
a. Shaken Faith Doctrine: Once the faith is shaken, integrity is substantially impaired
and operation is fraught with apprehension. Any attempted cure is ineffective.
(Zabriskie Chevrolet v. Smith)
b. Things that do not work well at the start are not likely to work well in the future
unless the original defect is minor in nature.
2. Seller refused to refund the money and it claimed a right to give buyer a new car to be
delivered fresh from the factory on Aug. 20: Still no b/c cure is not possible in this case
a. 2-508(1): Where any tender/delivery by seller is rejected b/c non-conforming and the
time of performance has not yet expired, seller may be seasonably notify buyer of his
intention to cure and may then within the K time make a conforming delivery. (early
tender rule)
b. 2-508(2): Where the buyer rejects a non-conforming tender which the seller had
reasonable grounds to believe would be acceptable (e.g., better goods at the same
price) with or without money allowance the seller may if he seasonably notifies the
buyer have a further reasonable time to substitute a conforming tender (surprise
rejection rule)
C. Wilson v. Scampoli (TV set with a defect – usage of trade permits the seller opportunity to
determine if the defect is curable)
1. Facts: Buyer purchased a color television from seller. The TV had a reddish tinge that
the service representative could not adequately diagnose. Service rep. informed that
he would have to remove the chassis for further examination at the seller’s shop in
order to determine the cause of the red tinge. Buyer refused to allow the chassis to be
removed, asserting that she did not want it repaired, rather wanted a “brand new” set.
2. Held: Seller should be able to cure under 2-508(2), and can do so without subjecting
the buyer to any great inconvenience, risk or loss. Seller must have reasonable grounds
to believe that goods would be acceptable. Seller was denied access and a reasonable
opportunity to repair, buyer did not show breach of warranty entitling to a brand new
set or rescission. Removal of television chassis was at no inconvenience to buyer.
Since, seller had reasonable grounds to believe that the television would be
acceptable, they could invoke right to cure under section 2-508(2). Since seller was
denied the ability to
 determine the cause of the red tinge, thereby hindering his ability to cure the defect,
they were not in breach of any warranty nor did they have to furnish a brand new set.
3. Questions
a. The court is using the perfect tender rule in this case, since the buyer essentially
reject the televisions set (2-601)
b. 2-508(2) is relevant in this case.
c. Per section 2-711(3) buyer may hold on to the goods and re-sell them as an
aggrieved seller provided that rejection was valid.
V. Rejection and Acceptance
A. 2-602 (Manner and Effect of Rightful Rejection)
1. Rejection of goods must be within a reasonable time after the delivery or tender. It
is ineffective unless the buyer seasonably notifies the seller
2. Subject to 2-603 and 604
a. After rejection, any exercise of ownership by the buyer w/r/t any commercial unit is
wrongful as against the seller; and
b. If the buyer has before rejection taken physical possession of goods in which he does
not have a security interest under 2-711(3), he is under a duty after rejection to hold
them with reasonable care at the seller’s disposition for a time sufficient to permit
the seller to remove them; but
c. The buyer has no further obligations w/r/t goods rightfully rejected
3. The seller’s right w/r/t goods wrongfully rejected are governed by 2-703.
B. In summary:
1. When the seller makes a tender of the goods, the buyer must
a. Reject (2-602); or
b. Accept (2-606 and 2-607): failure to act results in a technical acceptance b/c rejection
must come within a reasonable period of time after delivery of the goods
c. You must distinguish rejection (possible if the goods/tender fail in any respect to
conform to the K) from revocation of acceptance (possible only if material
impairment)
2. 2-606 (What Constitutes Acceptance of Goods): acceptance of goods occurs when the
buyer (3-prong)
a. After a reasonable opportunity to inspect the goods signifies to the seller that the
goods are conforming or that he will take or retain them in spite of their non-
conformity (possession itself is not acceptance); or
b. Fails to make an effective rejection, but such acceptance does not occur until the
buyer has had a reasonable opportunity to inspect them; or
c. Does any act inconsistent with the seller ’s ownership (e.g., paint the goods, sell the
goods); but if such act is wrongful as against the seller, it is an acceptance only if
ratified by him
d. Acceptance of a part of any commercial unit is acceptance of that entire unit
3. 3 important things to notice
a. A buyer is entitled to a reasonable trial-use period to see if the goods conform
(reasonable opportunity to inspect: 2-513)
b. On acceptance, the burden of proof as to defects shifts to the buyer (2-607(4))
 c. Prior to acceptance, the seller must prove that a perfect tender was made under 2-
601
4. 5 Effects of acceptance: once accept
a. Must pay
b. Can’t reject (if accept knowing non-conformity, can’t revoke)
c. Must notify any breach
d. BOP as to defect shifts to buyer
e. 2-607(5): if buyer is sued by a 3rd party for which seller is answerable, he may notify
seller to defend or be bound by determined facts
5. 2-201(3)(c) (Statute of Frauds): w/r/t goods for which payment has been made and
accepted or which have been received and accepted -> no writing required
C. Problem 56: Buyer ordered 50 live lobsters “F.O.B. Portland.” Seller failed to notify
buyer of the date of the flight and the lobsters had been sitting for a day. 20 were dying
due to bad handling and damage in transit. Buyer wanted none of the lobsters.
1. Is the seller’s failure to notify buyer of the shipment a ground for rejection? Yes
a. 2-504 (Shipment by Seller): In shipment K, seller must . . . promptly notify the buyer
of the shipment
i. Failure to notify the buyer or to make a proper K is a ground for rejection only if
material delay or loss ensues.
b. F.O.B Portland (shipment K): ROL passed to the buyer in Portland (when seller loaded
the lobsters on board an airplane). Seller should have promptly notified the buyer of
the shipment. 20 of 50 were dying. So there is material loss -> ground for rejection O
2. May buyer reject b/c of the 20 defective lobsters (15 due to seller, 5 due to carrier)? Yes
a. 2-601 (perfect tender rule): buyer may reject the whole, accept the whole or accept
in part and reject the rest
b. 2-510(1): where a tender or delivery of goods so fails to conform to the K as to give a
right of rejection, the ROL remains on the seller until cure or acceptance
3. How quickly must buyer act if it wishes to reject? What technical steps is it required to
take?
a. 2-602(1): within a reasonable time after the delivery
b. 2-602(2)(b): hold them with reasonable care at the seller’s disposition for a time
sufficient to permit the seller to remove them
4. Must buyer reship the goods to buyer if the buyer offers to pay the freight? Yes
a. 2-603 (Merchant Buyer’s Duties as to Rightfully Rejected Goods)
i. Subject to 2-711(3), when the seller has no agent or place of business at the
market of rejection, a merchant buyer is under a duty after rejection of
goods in his possession or control to follow any reasonable instructions received
from the seller w/r/t the goods and in the absence of such instructions to make
reasonable efforts to sell them for the seller’s account if they are perishable or
threaten to decline in value speedily.
ii. What if there is no instruction? – good faith conduct
5. If buyer decides to keep 30 of the lobsters for resale, is this allowed?
a. 2-602(2)(a): after rejection any exercise of ownership by the buyer w/r/t any
 commercial unit is wrongful as against the seller
b. 2-606(2): acceptance of a part of any commercial unit is acceptance of that entire unit
c. Yes only if 30 lobsters are a commercial unit (single whole for purposes of sale and
division of which materially impairs its character or value on the market or in use)
according to the usage of trade. (You must ask your client how lobsters are sold.)
6. If buyer rejects the goods, must it give its reason in the notice of rejection? Yes in order
to justify rejection, buyer must state a particular defect
a. 2-605 (Waiver of Buyer’s Objections by Failure to Particularize)
i. The buyer’s failure to state in connection with rejection a particular defect which is
ascertainable by reasonable inspection precludes him from relying on the unstated
defect to justify rejection or to establish breach
a) where the seller could have cured it if stated seasonably; or
b) b/w merchants when the seller has after rejection made a request in writing for
a full and final written statement of all defects on which the buyer proposes to
rely
b. If the buyer does not state the reason for rejection, the seller could attempt to cure
the defect by shipping 20 new live lobsters
7. If buyer gives a valid notice of rejection within a reasonable period of time after the
lobsters are delivered, what should it then do with the lobsters?
a. 2-602(2): do not exercise ownership and hold them with reasonable care
D. Ramirez v. Autosport (camping car with a lot of problems)
1. Facts: P bought a camper from D and traded in their old van. The camper was found to
have many small defects and P decided not to accept delivery. After repairs were made,
P again refused delivery due to more defects. The next day D transferred title to P
without telling them. P then requested that the K be cancelled and to have their old
van back. However, D had already sold the old van and refused to cancel the K.
2. Issue: May buyers reject goods that do not completely conform to the contract? Yes
3. Held: Under the perfect tender rule, P had properly rejected tender of the van within a
reasonable time. Once P rejected the van, the burden shifted to D to prove that the
defects had been cured. B/c D had not done so within a reasonable time, P was entitled
to rescind or cancel the K
4. Questions
a. Did the D’s grounds for cure fit within 2-508? No
b. Is the court creating a right to cure outside 2-508? The court has huge presumption
in favor of “cure”
E. Problem 57: Buyer had a horse statue specially designed and manufactured by seller.
When put together, buyer was displeased with the appearance of the tail b/c the scale
model had had a different tail. Buyer removed the tail, substituted one of his own design,
and returned the original to seller along with a letter of rejection. Buyer painted the
rest of the horse black and used it extensively in advertising, but failed to attract new
business. After 3 months, buyer shipped it back to seller with a letter of rejection stating
that the problem with the tail made the horse unattractive and unusable.
1. Did buyer make a rejection or an acceptance?
 a. Buyer made a technical acceptance of the entire horse by accepting a part of a
commercial unit (2-606(2)) and painting the horse (exercise of ownership).
2. If the tail did not conform to the model, is that a ground for rejection?
a. Yes, the rejection of the whole commercial unit is allowed if the goods fail in any
respect to conform to the K (2-601)
3. If buyer had made a technical acceptance, does that fact preclude a suit for breach of
warranty?
a. 2-607(2): Acceptance of goods by the buyer precludes rejection of the goods
accepted, and if made with knowledge of a non-conformity cannot be revoked b/c
of it unless the acceptance was on the reasonable assumption that the non-
conformity would be seasonably cured but acceptance does not of itself impair any
other remedy provided by Art. 2 for non-conformity
b. No, buyer will be able to sue for breach of warranty. Acceptance only bars
subsequent rejection
4. What steps should buyer take to preserve his legal rights?
a. 2-607(3)(a): Where a tender has been accepted, (a) the buyer must within a
reasonable time after he discovers or should have discovered any breach notify the
seller of breach or be barred from any remedy
5. What reasons lie behind the notice requirement?
a. 2-508: give the seller an opportunity to cure
b. 2-515: seller may inspect/examine the goods after having been given notice so that
litigation or settlement will proceed smoothly.
F. Plateq Corp v. Machlett Lab (specially manufactures steel tank)
1. M ordered some special radiation-proof steel tanks from P. The K stipulated that the
tanks would be tested after installation. P had never made radiation-proof tanks before
and M had never designed them before. P encountered some difficulties and delays
with performance. M's engineer inspected the finished product at P's facility, noted a
few minor deficiencies, but said that M would pick up the tanks the next day. However,
instead, they canceled the K (without specifying why).
2. The Trial Court found for P.
a. The goods were substantially complete.
b. M had accepted the goods in accordance with 2-606(1)(a) by saying they would pick
them up.
c. M had not made an effective rejection under 2-606(1)(b).
d. M needed to be very specific about what the defect was, in order to give P an
opportunity to make a conforming tender under 2-508(2).
e. Under 2-608, once acceptance had occurred, M could only revoke acceptance by
showing substantial impairment of the goods' value.
3. The Appellate Court affirmed.
a. M unsuccessfully argued that their engineer's final examination of the goods showed
that the tanks were so incomplete and unsatisfactory that they were rightfully
entitled to conclude that P would never make a conforming tender.
VI. Revocation of Acceptance
A. 2 ways to disclaims the goods
1. Rejection
a. Standard for rejection: the goods fail in any respect
2. Revocation of acceptance:
a. buyer may recover the price of the goods as well as consequential damages
b. standards is more difficult to meet: the defect substantially impairs the value of the
goods
3. breach of warranty action: having made a technical acceptance, a buyer may bring a
breach of warranty action if a proper notice has been given
a. buyer may recover damages and still have the goods
B. 2-608 (Revocation of Acceptance in Whole or in Part)
1. The buyer may revoke his acceptance of a lot of commercial unit whose non-conformity
substantially impairs its value to him if he has accepted it (buyer has the BOP to show
why he accepted it)
a. on the reasonable assumption that its non-conformity would be cured and it has not
been seasonably cured; or
b. without discovery of such non-conformity if his acceptance was reasonably induced
either by the difficulty of discovery before acceptance or by the seller's assurances.
2. Revocation of acceptance must occur within a reasonable time after the buyer
discovers or should have discovered (objective test) the ground for it and before any
substantial change in condition of the goods which is not caused by their own
defects. It is not effective until the buyer notifies the seller of it. (notification
requirement)
3. A buyer who so revokes has the same rights and duties with regard to the goods
involved as if he had rejected them. (see 2-602)
C. Waddell v. L.VR.V. (RV with various problems): 7 months of 3 years, RV was broken down,
overheated engine. They wanted to tour country and live RV lifestyle.
1. 2-part test
a. subjective test (subjective value to the buyer): the value of conforming goods to the
plaintiff must first be determined
b. objective test (objective impairment): whether the nonconformity in fact
substantially impairs the value of the goods to the buyer, having in mind his
particular needs
D. Questions
1. Need the buyer return the goods to the seller when giving a notice of revocation of
acceptance? No
a. 2-711(3): On rightful rejection or justifiable revocation of acceptance, a buyer has a
security interest in goods in his possession or control for any payments made on their
price and any expenses reasonably incurred in their inspection, receipt,
transportation, care and custody (incidental expenses) and may hold such goods
and resell them in like manner as an aggrieved seller (2-706).
b. Mobile Home Sales v. Brown: when the buyer has a security interest in the goods
and the seller makes no request for their return, the buyer should not be
penalized by making tender back a prerequisite to revocation of acceptance
2. What if the buyer did not have a security interest in the car? No need to return
 a. 2-608(3): the buyer who revokes has the same rights and duties w/r/t the goods
involved as if he had rejected them.
b. 2-602(2)(b): if the buyer has before rejection taken physical possession of goods in
which he does not have a security interest under 2-711(3), he is under a duty after
rejection to hold them with reasonable care at the seller’s disposition for a time
sufficient to permit the seller to remove them
3. Should the court when allowing revocation make an allowance for the use the buyer got
from the car? Is the seller entitled to a setoff for the amount of benefits the purchaser
received? Yes (all the courts said yes except CT courts)
a. 1-103: unless displaced by the particular provisions, the principles of law and equity,
including the law merchant and the law relative to capacity to K, principal and agent,
estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, or other
validating or invalidating cause shall supplement its provisions.
b. Barco Auto v. House: the award of damages to the lessor should not have been offset
by a credit for the fair rental value of the automobile while it was in the lessor’s
possession.
c. Moor v. Howard Pontiac-American: the dealership was entitled to an offset of a fair
and reasonable use value of the automobile for the time that the purchasers made
use of the automobile
4. If the buyer keeps the car after revoking acceptance, may the buyer keep driving it
without negating the effectiveness of the revocation of acceptance? Probably yes (most
courts held that post-revocation/rejection use is acceptance. You should accept it and
sue for breach of warranty. But in mobile home or automobile cases, courts excused
post-revocation/rejection use.)
a. 2-606(1)(c): acceptance of goods occurs when the buyer does any act inconsistent
with the seller’s ownership; but if such act is wrongful against the seller, it is an
acceptance only if ratified by him
b. 2-602(2)(a): after rejection, any exercise of ownership by the buyer w/r/t any
commercial unit is wrongful as against the seller
c. 2-602(2)(b): if the buyer has before rejection taken physical possession of goods in
which he does not have a security interest, he is under a duty after rejection to hold
them with reasonable care at the seller’s disposition for a time sufficient to permit
the seller to remove them
d. Jurisdictions are split on this issue
i. Post-revocation use constitutes acceptance
ii. Post-revocation use is not acceptance, but seller could recover damages for this use
iii. In exceptional circumstances, post-revocation use is permissible
5. If your client needs to continue to use the goods following rejection/revocation, what
do you advise?
a. 2-714(Buyer’s Damages for Breach in Regard to Accepted Goods): can recover
damage, incidental and consequential damages in a proper case
b. Client may want to bring a breach of warranty action instead of rejection/revocation
so that it can continue to use the goods
E. Lemon Laws
1. Deals with consumer’s purchase of an automobile
2. A refund from D may be reduced by a reasonable allowance for the consumer’s use of
the vehicle in excess of the first 12K miles of operation and a reasonable allowance for
any damage not attributable to normal wear or improvements
F. Problem 58: The day after purchase of a new car, the right rear fender fell off.
1. May buyer use 2-608 (revocation of acceptance) or must she give seller a right to cure?
a. She may not revoke acceptance unless the non-conformity substantially impairs its
value to her (although 2-608 does not require the opportunity to cure, courts prefer
to give seller the opportunity to cure!)
2. The first time it rained, all the paint washed off the car. May she revoke now?
a. No b/c courts love “cure”
3. 2 weeks later, the engine quit and seller fixed it. Now, the car’s trunk will not open.
Must she permit them to fix it or can she revoke?
a. She can revoke b/c a lot of accumulated problems substantially impair the value of
the car
4. She had missed enough work and she is also concerned that the car is going to keep
breaking down. What do you advise? Is 2-609 (right to adequate assurance of
performance) of use to her?
a. Revoke acceptance and recover damages. 2-609 is of no use to her b/c all that the
seller can assure is that they will fix all the future problems. Seller can’t guarantee
that there will be no problem.
5. If she decides to revoke acceptance and if the court agrees that this is allowed, would it
also permit her to recover for the cost of rental car used as substitute transportation
while she was attempting to purchase a new car? (Some courts held that rental car
expense is consequential damage if it is reasonable. But you must be careful.)
a. McGinnis v. Wentworth Chevrolet: Cover remedy generally was not intended to
apply to a rental car. Rather the remedy was limited to situations where the buyer
purchased goods as an actual replacement for the agreed-upon goods. The buyer’s
rental expenses were not incidental damages.
6. If she goes out and buys a new car, can she make the first car dealer pay for it?
a. 2-712 (Cover; Buyer’s Procurement of Substitute Goods)
i. After a breach, a buyer may cover by making in good faith and without
unreasonable delay, any reasonable purchase of or K to purchase goods in
substitution for hose due from the seller.
ii. The buyer may recover from the seller as damages the difference b/w the cost of
the cover and the K price together with any incidental or consequential damages,
but less expenses saved in consequence of the seller’s breach
b. So, buyer may buy a new car and recover the difference b/w the cost of the cover and
the K price (But, note that courts are not sympathetic about the covering in car case.)
G. Problem 59: in Problem 58, the K explicitly limits the remedy for breach to repair or
replacement of defective parts. Is then the remedy of revocation is unavailable to the
buyer? No, the buyer may seek revocation b/c the limited remedy fails of its essential
purpose
 1. 2-719(2): where circumstances cause an exclusive or limited remedy to fail of its
essential purpose, remedy may be had as provided in this Act
2. Durfee v. Rod Baxter: where the exclusive remedy in the warranty failed of its essential
purpose and where the remaining defects were substantial enough to justify revocation
of acceptance, the buyer was entitled to look to the warrantor for relief
3. Andover Air v. Piper Aircraft:
H. Problem 60 (2-prong OR test): buyer ordered a computer model #740 and seller sent
#745, a newer and better model at the same price. Buyer liked it and sent a letter of
acceptance with a check in payment. However, when he began to use it, he was horrified
to learn that the computer was turned on by a hidden switch under the front panel. His
father had lost a finger when he reached under a machine to activate it and he had
witnessed the accident as a child. Buyer sent a notice of revocation of acceptance to
seller, stating the reason.
1. Does 2-608 permit him to revoke for this reason? Yes if the 2-prong test is satisfied
a. OC2: Revocation of acceptance is possible only where the non-conformity
substantially impairs the value of the goods to the buyer. For this purpose the test is
not what the seller had reason to know at the time of contracting; the question is
whether the non-conformity is such as will in fact cause a substantial impairment of
value to the buyer though the seller had no advance knowledge as to the buyer's
particular circumstances. (subjective test)
2. Is 2-508(2) relevant? Yes
a. 2-508(2): Where the buyer rejects a non-conforming tender which the seller had
reasonable grounds to believe would be acceptable with or without money
allowance, the seller may if he seasonably notifies the buyer have a further
reasonable time to substitute a conforming tender.
3. How would you advise seller to respond to buyer’s letter?
a. Seasonably notify buyer that seller will substitute the new model with the old model
within a reasonable time
I. Problem 61: After his car had broken down with the same defect 6 times, buyer decided to
revoke acceptance and return the car to the dealership that had been unable to repair it.
But, the dealership had gone bankrupt.
1. May he revoke acceptance against the manufacturer of the car which had covered its
product with a limited warranty?
a. Most courts say no b/c revocation is only against the seller (dealership here), but
other courts say yes. In M-M case, equitable remedy including revocation is allowed,
but M- M Act does not receive the same treatment among jurisdiction. M-M Act
provides arbitration clause too.
b. Fode v. Capital RV: buyer was entitled to revoke the sale b/c manufacturer’s lack of
responsibility for the defects was irrelevant. Buyer was not barred from revoking
acceptance despite seller’s disclaimer of warranties or limitation on a buyer’s
remedies
c. Gasque v. Mooers Motor: By continuing to use the car after giving notice of
revocation of acceptance, buyer failed to meet the statutory requirements for
revocation
d. M-M 110(d): allows a civil action against the warrantor that includes both legal and
 “equitable” relief (and revocation of acceptance, being a form of rescission, qualifies
as an equitable remedy)
J. Avoidance under CISG
1. Problem 62: retailer in Finland ordered 20 boxes of jeans from seller in NY, to
be delivered Sept. 1.
a. If the goods arrive on July 20, must buyer take them? No
i. Art. 52(1): If the seller delivers the goods before the date fixed, the buyer may take
delivery or refuse to take delivery
b. If the goods arrive on the appointed date, but there are only 18 boxes, must buyer
accept them?
i. Art. 35: less than quantity required by K – breach
ii. Art. 49: buyer may avoid K if fundamental breach
iii. Art. 25: fundamental breach – detriment, substantially deprive of what expect
iv. Art. 51: if the seller delivers only a part of the goods, Art. 46 to 50 applies. Buyer
may declare the K avoided only if fundamental breach
v. B/c it is not fundamental breach, buyer must accept 18 boxes
c. Can the buyer get the other 2 boxes?
i. Art. 46(2): buyer may require seller to remedy the lack of conformity by repair
d. If the buyer avoids the K, can the seller reinstate it by delivering the missing 2 boxes?
i. Art. 48(1): seller may, even after the date for delivery, remedy at his own expense
any failure to perform his obligation, if he can do so without unreasonable delay
and without causing the buyer unreasonable inconvenience or uncertainty of
reimbursement by the seller of expenses advanced by the buyer.
ii. Art. 48(2): if the seller requests the buyer to make known whether he will accept
performance and the buyer does not comply with the request within a reasonable
time, the seller may perform within the time indicated in his request.
e. If a flood causes water damage to the boxes before buyer to avoid the K, does this
affect its ability to do so?
i. Art. 82(1): the buyer loses the right to declare the K avoided or to require the seller
to deliver substitute goods if it is impossible for him to make restitution of the
goods substantially in the condition in which he received them
ii. Art. 82(2)(a): the preceding paragraph does not apply if the impossibility of making
restitution of the goods or of making restitution of the goods substantially in the
condition in which the buyer received them is not due to his act or omission
iii. Buyer lose the right to avoid the K if it is caused by his act or omission
2. Problem 63: Ambiance Hotel decided to have Buggies (carriage manufacturer) make
specially designed 10 horse carriages. Ambiance financed this transaction from Octopus
Bank and the finance lease K contains a “hell or high water” clause
a. If the carriages are delivered to the hotel and Ambiance rejects them b/c they are the
wrong color, must Ambiance pay the lease amounts to the bank?
i. 2A-407(1): In the case of a finance lease that is not a consumer lease, the lessee’s
promises under the lease K become irrevocable and independent upon the lessee’s
acceptance of the goods
 ii. Thus, Ambiance must pay the lease amount to the bank even if it rejects the
carriages
b. If the hotel accepts the carriages, but becomes upset when they constantly break
down, can it revoke its acceptance and refuse to pay the lessor? (Prof. says he’s in
confusion)
i. 2A-516(2): A lessee’s acceptance of goods precludes rejection of the goods
accepted. In the case of a finance lease, if made with knowledge of a
nonconformity, acceptance cannot be revoked b/c of it.
ii. OC1: subjection (2) precludes revocation if acceptance is made with knowledge of
nonconformity w/r/t the “lease” agreement, as opposed to the “supply”
agreement. (non-conformity of lease, not non-conformity of supply, precludes
revocation.)
VII. Risk of Loss: Breach
A. 2-510 (Effect of Breach on Risk of Loss)
1. Where a tender or delivery of goods so fails to conform to the K as to give a right of
rejection, the ROL remains on the seller until cure or acceptance
2. Where the buyer rightfully revokes acceptance, he may to the extent of any deficiency
in his effective insurance coverage treat the ROL as having rested on the seller from the
beginning
3. Where the buyer as to conforming goods already identified to the K for sale repudiates
or is otherwise in breach before ROL has passed to him, the seller may to the extent of
any deficiency in his effective insurance coverage treat the ROL as resting on the buyer
for a commercially reasonable time
4. 2-510(2) & (3): innocent party has the goods in his possession and the ROL is with the
other party
a. (2): seller is in breach, buyer has the goods, ROL is on the seller to the extent of any
deficiency of buyer’s insurance
b. (3): buyer is in breach, seller has the goods, ROL is on the buyer to the extent of any
deficiency of seller’s insurance
B. Jakowski v. Carole Chevrolet
1. Fact: The day after buyer took home a car bought from seller, seller informed buyer
that the car delivered to him lacked polymer coatings as agreed upon and seller
instructed buyer to return the car so that the coatings could be applied. Buyer
returned the auto to seller for application of the coatings, but the car was stolen from
seller's premises and was never recovered. Seller refused to provide a replacement for
buyer or to refund the purchase price.
2. Held: The car failed to conform to the requirements of the sales K, buyer never
accepted it, and the defect was never cured. Accordingly, ROL remained on the seller
and buyer was entitled to a refund of the purchase price that was paid to seller,
including the finance charges incurred by buyer.
3. No acceptance until buyer has a reasonable chance to inspect!
C. Problem 64: Museum ordered an Egyptian sphinx, an Old World gargoyle, and an Etruscan
statute of a centaur under separate Ks from Empusa, to be shipped “F.A.S. S.S. Titanic”
on or about April 9. Prior to April 9, museum cancelled the purchase of the centaur
statue.
Empusa discovered that the sphinx was a phony but shipped it by Titanic which foundered
and took the sphinx with it. Empusa also discovered that the gargoyle’s condition was such
that it could not survive the exposure to sea air, so sent it by air. Gargoyle arrived in good
condition and museum wrote a letter of acceptance. 1 week later, museum learned that
the gargoyle was not from the Old World (breach of express warranty) and sent a letter of
cancellation. Before Empusa could respond, the museum burned to the ground and the
centaur statue was stolen through no fault of Empusa. Both museum and Empusa were
fully insured
1. By shipping the other 2 objects, did Empusa waive its right to sue for repudiation of the
centaur statute?
a. 2-209(1): an agreement modifying a K needs no consideration to be binding
b. 2-106(3): “termination” occurs when either party pursuant to a power created by
agreement or law puts an end to the K otherwise than for its breach. On
“termination,” all obligations which are still executory on both sides are
discharged but any right based on prior breach or performance survives (to
terminate, both parties must agree. No agreement here)
c. 2-106(4): “cancellation” occurs when either party puts an end to the K for breach by
the other and its effect is the same as that of “termination” except that the cancelling
party also retains any remedy for breach of the whole K or any unperformed balance
d. There were 3 separate Ks. So, performing 2 Ks does not mean that seller waive its
right to sue for repudiation of a separate K. (courts are slow in recognizing waiver
when the party acted reasonably)
i. Museum may argue that Empusa waived its right to sue for repudiation when it
performed the rest 2 Ks.
2. Is 1-308 helpful to Empusa?
a. 1-308: A party that with explicit reservation of rights performs or promises
performance or assents to performance in a manner demanded or offered by the
other party does not thereby prejudice the rights reserved. Such words as “without
prejudice” “under protest” or the like are sufficient
b. Empusa protested the termination of K for the centaur statue, so the right to sue for
repudiation was reserved
3. What should it have done to use this section? Empusa should have protested “explicitly.”
4. Which party took the ROL on
a. The centaur: 2-510(3) – museum repudiated the K, but the ROL is on Empusa b/c it is
fully insured
b. The sphinx: 2-319(2) - F.A.S. S.S. Titanic – Empusa has the ROL although Empusa
would say that it duly delivered the goods to the carrier.
i. 2-510(1): the sphinx was not conforming, so ROL remains on the seller until cure or
acceptance
ii. 2-509(1): shipment K – ROL passes to the buyer when the goods are “duly (free of
breach)” delivered to the carrier. In this case, the goods were not duly delivered
to the carrier b/c it was not conforming -> 2-509(1) does not apply and 2-
510(1) governs
 c. The gargoyle: 2-510(2) – museum rightfully revokes acceptance for the reason of non-
conformity of the goods, so the ROL rested on Empusa to the extent of the deficiency
in museum’s insurance. But museum is fully insured, so ROL is on museum
5. When Empusa shipped the gargoyle by air instead of by sea, could museum have
treated this as an imperfect tender and rejected the gargoyle for that reason?
a. 2-614 (Substitute Performance): where the agreed manner of delivery becomes
commercially impracticable but a commercially reasonable substitute is available,
such substitute performance must be tendered and accepted
b. Museum must accept the gargoyle and cannot reject the good “for this reason.”
(conformity of the goods is a separate issue)
6. Museum’s insurance policy provided that (i) on payment of a claim, the insurance
company was subrogated to any claim its insured had against any other party; and (ii)
the policy should not be deemed to provide protection for any claim where the ROL
rested with another person. What is the effect of these provisions?
a. OC3 to 2-510: the deficiency means such deficiency in the insurance coverage as
exists without subrogation. This section merely distributes the ROL as stated and
is not intended to be disturbed by any subrogation of an insurer
b. Both insurance clauses are invalid and void b/c the insurance companies have the
premiums.
VIII. Impossibility of Performance
A. Introduction: courts have treated commercial impracticability as synonymous with
common law impossibility
1. 2-613 (Casualty to Identified Goods): Where the K requires for its performance goods
identified when the K is made, and the goods suffer casualty without fault of either
party before the ROL passes to the buyer, or in a proper case under a “no arrival, no
sale” term, then
a. If the loss is total, the K is avoided; and
b. If the loss is partial or the goods have so deteriorated as no longer to conform to the
K, the buyer may nevertheless demand inspection and at his option either treat the K
as avoided or accept the goods with due allowance from the K price for the
deterioration or the deficiency in quantity but without further right against the seller
2. 2-614 (Substituted Performance)
a. Where without fault of either party the agreed berthing, loading or unloading
facilities fail or an agreed type of carrier becomes unavailable or the agreed manner
or delivery otherwise becomes commercially impracticable but a commercially
reasonable substitute is available, such substitute performance must be accepted
b. If the agreed means or manner of payment fails b/c of domestic or foreign
governmental regulation, the seller may withhold or stop delivery unless the buyer
provides a means or manner of payment which is commercially a substantial
equivalent. If delivery has already been taken, payment by the means or in the
manner provided by the regulation discharges the buyer’s obligation unless the
regulation is discriminatory, oppressive or predatory
3. 2-615 (Excuse by Failure of Presupposed Conditions) except so far as a seller may have
 assumed a greater obligation and subject to the preceding section on substituted
performance:
a. Delay in delivery or non-delivery in whole or in part by a seller who complies with
paragraphs (b) and (c) is not a breach of his duty under a K for sale if performance as
agreed has been made impracticable by the occurrences of a contingency the non-
occurrence of which was a basic assumption on which the K was made or by
compliance in good faith with any applicable foreign or domestic governmental
regulation or order whether or not it later proves to be invalid
b. Where the causes mentioned in paragraph (a) affect only a part of the seller’s
capacity to perform, he must allocate production and deliveries among his customers
but may at his option include regular customers not then under K as well as his
own requirements for further manufacture. He may so allocate in any manner which
is fair and reasonable
c. The seller must notify the buyer seasonably that there will be delay or non-delivery
and, when allocation is required under paragraph (b), of the estimated quota thus
made available for the buyer
4. 2-616 (Procedure on Notice Claiming Excuse)
a. Where the buyer receives notification of a material or indefinite delay or an
allocation justified under the preceding section, he may by written notification to the
seller as to any delivery concerned, and when the prospective deficiency
substantially impairs the value of the whole K under the provision of Art. 2 relating
to breach of installment Ks, then also as to the whole
i. Terminate and thereby discharge any unexecuted portion of the K; or
ii. Modify the K by agreeing to take his available quota in substitution
b. If after receipt of such notification from the seller, the buyer fails so to modify the K
within a reasonable time not exceeding 30 days, the K lapses w/r/t any deliveries
affected
B. Problem 65: buyer ordered a sundial for $250 from seller that had 12 sundials. 9 were
smashed and 3 were slightly damaged due to an earthquake. Buyer, being informed of the
problem, insisted on looking over the 3 to select one possibly at a reduced price.
1. Is 2-613 or 2-615 relevant?
a. 2-613 is not relevant b/c the sundial was not required to be identified when the K
was made
b. 2-615 is relevant b/c the performance has been made impracticable by the
earthquake and the non-occurrence of earthquake was a basic assumption
2. Must seller let buyer pick out a sundial, and must it offer to let buyer purchase at a
reduced price, or can it simply cancel without fear of legal liability?
a. Seller must allocate production and deliveries among his customers under 2-615(b)
3. Test for impossibility of performance in international sales
a. CISG Art. 79
i. A party is not liable for a failure to perform any of his obligations if he proves that
the failure was due to an impediment beyond his control and that he could not
reasonably be expected to have taken the impediment into account at the time of
 the conclusion of the K or to have avoided or overcome it or its consequences
C. Problem 66: in Problem 65, when seller received buyer’s order, one of the sales persons
immediately put a red tag (“Hold for the buyer”) one of the sundials. Then the earthquake
occurred and only the marked sundial was destroyed. When buyer demanded his sundial,
will 2-613 excuse seller? No, seller must provide buyer with another sundial of the same
type
1. Valley Forge v. NY Dowel & Molding: the sale of a unique chattel comes within the
scope of 2-613, but fungible goods required more than just identification in the K.
There must have been a meeting of the minds by the parties as to the particular or
actual goods designated to be bought and sold.
2. No particular sundial is required and any other sundial of the same kind is enough in
this case. So 2-613 is not applicable b/c the goods were not required by K to be
identified when the K was made.
D. Arabian Score v. Lasma Arabian Ltd.:
1. Fact: The horse purchaser entered into an agreement to purchase an Arabian colt
named Score. The purchaser would pay the sellers $1M for the purchase of Score and
for the performance of promotional services. The K required the sellers to spend $
250,000 for the performance of those services, which consisted of advertising and
promoting Score, but shortly thereafter, Score died. The purchaser's complaint
sought recovery of the unspent portion of the $ 250,000 on the ground of
impossibility of performance of promoting Score, as well as seeking recovery under
the purchase agreement.
2. Held: Impossibility of performance exonerated the parties if the supervening event was
not reasonably foreseeable. Score's death was foreseeable and the commercial
frustration doctrine did not apply.
E. Problem 67: seller agreed to sell 27 utility companies 80M lbs of uranium over the next 20
yrs (at average price of $10/lb) when it actually owned only 15M lbs of uranium. The price
went up to $40/lb and seller announce that it would not honor its K for commercial
impracticability under 2-615 due to unforeseeable price rise.
1. How should the dispute be resolved? (courts held that under the “fixed” price K, you’re
bearing the risk of price increase in spited of the OC4!)
a. OC4 to 2-615: increased cost alone does not excuse performance unless the rise is
due to some unforeseen contingency which alters the essential nature of the
performance. A severe shortage of raw materials or of supplies due to a
contingency such as war, embargo, local crop failure, unforeseen shutdown of major
sources of supply or the like, is within the contemplation of this section (But,
usually rise in prices or deprivation of profit is NOT commercial impracticability)
b. OC5 to 2-615: there is no excuse unless the seller has employed all due measures to
assure himself that his source will not fail
c. Publicker Indus. V. Union Carbide: something less than a 100% cost increase had not
been held to make a seller’s performance impracticable. (but, 300% price rise here)
d. Seller has no way to get around the fixed price K here.
2. If you could advise seller on how to avoid this problem in the future, what would you
suggest?
 a. 2-305 (Open Price Term) the parties can conclude a K for sale even though the price is
not settled.
b. Parties can agree that the price is to be fixed in terms of some agreed market or
other standard as set by a 3rd party
F. LA Power v. Allegheny Ludlum:
1. Fact: Purchaser (P) had a supply K with supplier (D). D's costs went up and it asked P to
pay more than the K price. P refused and D would not give an assurance of
performance. P got the supplies from another supplier and sued D for its cover costs
and damages.
2. Held: The mere fact that performance under the K would have deprived D of its
anticipated profit and resulted in a loss on the K was not sufficient to show commercial
impracticability. D’s judgment as to events to occur in the future, even though
erroneous, was not a "mistake." It was not bad faith for P to refuse to renegotiate the K
with D. The issue of unconscionability determined without a hearing and the facts
surrounding the obtaining of a "cover," timeliness, mitigation of damages, good faith,
and costs could not be resolved on summary judgment.
3. Alcoa v. Essex: the court recognized a claim of commercial impracticability here. the
court found that it was not a “fixed” price K and reformed the K base on its own
formula (extraordinary case)

CHAPTER 6. REMEDIES
I. Special Remedies
A. Introduction
1. 2-703 ~ 710: seller’s remedies when the buyer is in breach
2. 2-711 ~ 717: buyer’s remedies when the seller is in breach
B. Remedies on Insolvency
1. Reclamation: when a party becomes insolvent while in possession of goods that have
been identified to the K, the other party may elect to forgo damages and try to get the
goods
2. 2-502 (Buyer’s Right to Goods on Seller’s Insolvency):
a. (1) Subject to subjections (2) and (3) and even though the goods have not been
shipped, a buyer who had paid a part or all of the price of goods in which he has a
special property under the provisions of the immediately preceding section may on
making and keeping good a tender of any unpaid portion of their price recover them
from the seller if:
i. (a) In the case of goods bought for personal, family, or household purposes, the
seller repudiates or fails to deliver as required by the K; or
ii. (b) In all cases, the seller becomes insolvent within 10 days after receipt of the first
installment on their price
b. (2) The buyer’s right to recover the goods under subjection (1)(a) vests upon
acquisition of a special property, even if the seller had not then repudiate or failed to
deliver
c. (3) If the identification creating his special property (identified goods) has been made
by the buyer he acquires the right to recover the goods only if they conform to the K
 for sale
d. Definition of insolvency
i. bankruptcy code: more liability than assets (bookkeeping test causes many problem)
ii. 1-201(23): failure to pay your debts when it is due
3. 2-702 (Seller’s Remedies on Discovery of Buyer’s Insolvency)
a. (1) Where the seller discovers the buyer to be insolvent, he may refuse delivery
except for cash including payment for all goods theretofore delivered under the K,
and stop delivery under 2-705
b. (2) Where the seller discovers that the buyer has received goods on credit while
insolvent, he may reclaim the goods upon demand made within 10 days after the
receipt, but if misrepresentation of solvency has been made to the particular seller in
writing within 3 months before delivery, the 10 day limitation does not apply. Except
as provided in this subsection, the seller may not base a right to reclaim goods on the
buyer’s fraudulent or innocent misrepresentation of solvency or of intent to pay
c. (3) The seller’s right to reclaim under subsection (2) is subject to the rights of a buyer
in ordinary course or other good faith purchaser under 2-403. Successful reclamation
of goods excludes all other remedies w/r/t them
C. Liquidated Damages
1. Common law
a. Liquidated damages clause in K was upheld only if the parties truly intended the
figure to be compensatory and had made in good faith an attempt to pre-
estimate the damages
b. If the liquidated figure was found to be a penalty amount to be forfeited in the event
of breach, the aggrieved party must prove actual damages
2. 2-718(1): same as the common law except that the validity of the liquidated damages
clause is to be tested against the actual harm caused by the breach
3. 2A-504: no longer refers to actual damages, allows a formula to be used to compute
damages, must be reasonable in light of the then anticipated harm caused by default
D. The Breaching Buyer’s Restitution
1. Problem 68: WV zoo official contracted to buy an elephant from DE zoo. The terms
were that WV zoo would deliver a black bear worth $300 as a down payment
and pay
$100/month for 20 months, at the end of which DE zoo would deliver the elephant. The
bear was tendered and accepted and WV zoo duly made its $100 payments for 15
months before it ran out of money. Can WV zoo recover the $1,500 it has paid and the
bear? Assuming the bear is still worth $300, calculate the amount that WV zoo is likely
to recover in restitution action
a. 2-718(2): buyer in breach is entitled to restitution of any amount by which the sum of
his payments exceeds (a) the amount to which the seller is entitled by virtue of terms
liquidating the seller’s damages in accordance with subsection (1) or (b) in the
absence of such terms, 20% of the value of the total performance for which the
buyer is obligated under the K or $500, whichever is smaller
i. Buyer’s restitution = sum of payment – liquidated damages (if liquidated damages
term is in K)
 ii. Buyer’s restitution = sum of payment – Smaller (20% of the K value or $500) (if no
liquidated damages)
b. 2-718(3): the buyer’s right to restitution is subject to offset to the extent that the
seller establishes (a) a right to recover damages under Art. 2 other than subsection
(1), and
(b) the amount or value of any benefits received by the buyer directly or indirectly by
reason of the K
c. 2-718(4): where a seller has received payment in goods their reasonable value or the
proceeds of their resale shall be treated as payments for the purposes of subsection
(2), but if the seller has notice of the buyer’s breach before reselling goods received
in part performance, his resale is subject to the conditions laid down in 2-706
d. So, the amount that WV zoo can recover is:
i. WV zoo’s payments ($300 + $1,500) – 20% of the value of the total performance
(0.2X$2,300 = $460) = $1,340
II. Seller’s Remedies
A. Introduction
1. Remedial principle (1-305(a))
a. Liberally administered
b. So that the aggrieved party may be put in as good a position as if the other party had
fully performed
c. Neither consequential or special nor penal damages may be had except as specifically
provided
2. 2-703 (Seller’s Remedies in General): Where the buyer wrongfully rejects or revokes
acceptance of goods or fails to make a payment due on or before delivery or repudiates
w/r/t a part or the whole, then w/r/t any goods directly affected and, if the breach is of
the whole K (2-612), then also w/r/t the whole undelivered balance, the aggrieved
seller may
a. Withhold delivery of such goods
b. Stop delivery by any bailee as provided in 2-705
c. Proceed under the next section respecting goods still unidentified to the K
d. Resell and recover damages as provided in 2-706
e. Recover damages for non-acceptance (2-708) or in a proper case the price (2-709)
f. Cancel
B. Accepted Goods
1. 2-709 (Action for the Price) together with any incidental damages, the price
a. Of goods accepted or of conforming goods lost or damaged within a commercially
reasonable time after ROL has passed to the buyer; and
b. Of goods identified to the K if the seller is unable after reasonable effort to resell
them at a reasonable price or the circumstances reasonably indicate that such effort
will be unavailing
2. Problem 69: seller sold a new car to buyer on credit who accepted the car and drove it
for a month. Buyer then sent a notice of revocation of acceptance for the reason that
the recent repainting of his garage clashed the color of the car. Buyer says that he
parked the car away from his garage and seller should come and get it, and he also
refused to make
 any more payments. 3 days after seller received the notice, the car disappeared.
a. May seller recover the price under 2-709?
i. Yes b/c the car was conforming goods and it was lost within a commercially
reasonable time after the ROL passed to buyer when he received the car (under 2-
709(1)(a))
a) The revocation is not valid b/c there was no substantial impairment of the value
caused by the seller’s breach
b. Who had the ROL?
i. 2-608(1): buyer may not revoke his acceptance b/c the non-conformity does not
substantially impairs its value to him
ii. 2-606(1) & 2-602(1): buyer failed to make an effective rejection b/c rejection must
be within a reasonable time after the delivery, but buyer drove the car for a month
and tried to revoke the acceptance for a ridiculous reason
iii. 2-510(3): Where the buyer as to conforming goods already identified to the K for
sale repudiates or is otherwise in breach before ROL has passed to him, the seller
may to the extent of any deficiency in his effective insurance coverage treat the
ROL as resting on the buyer for a commercially reasonable time
iv. So, the ROL rests on the buyer
c. Would it make a difference if buyer had rejected the goods for the same reason?
i. Then it is not a rightful rejection, so 2-703 governs. Seller may recover damages for
non-acceptance (2-708) or the price of the car (2-709)
C. Unaccepted Goods
1. When the buyer repudiates before delivery or rejects the goods
a. If the seller resells the goods: 2-706 (Seller’s Resale Including K for Resale)
i. If the resale price is higher than the K price, the seller take the surplus and there is
no damage
b. If no resale: damages measured under 2-708 (Seller’s Damages for Non-acceptance
or Repudiation)
c. Measure of damages
i. 2-706(1): K price - Resale price (when seller resells the goods)
ii. 2-708(1): K price - Market price (when seller cannot resell the goods)
iii. 2-708(2): Expected Profit (including reasonable overhead) (when seller is a lost
volume seller)
2. Problem 70: seller in Austin, TX contracted to sell 80 neon light fixtures to buyer in San
Antonio at $1,500 “F.O.B. Austin (shipment K)” to be shipped on Mar. 15. On Mar.
5, buyer called to cancel the deal but seller refuse to cancel and then seller posted a
notice on the bulletin board stating that 80 fixtures would be sold to a person making
the best offer. The 80 fixtures were sold to buyer 2 who offered $1,000, on Mar. 5,
open market price was $800, on Mar. 15, market price was $900 in Austin and $800 in
San Antonio.
a. Does the UCC permit seller to select goods from the warehouse after the buyer
repudiates?
i. 2-704(1)(a): an aggrieved seller may identify to the K conforming goods not already
identified if at the time he learned of the breach they are in his possession or
control
 ii. Seller can identify 80 fixtures after buyer’s repudiation as long as she notifies the
buyer (identification can occur after buyer’s breach in order to mitigate damages).
Here, there was no notice to the buyer, so identification was improper
b. Was the resale proper?
i. 2-706(1) (Seller’s Resale including K for Resale): seller may resell the goods but the
resale must be made in good faith and in a commercially reasonable manner
ii. Here, the resale was improper b/c no notice to the buyer under 2-706(3)
c. If seller’s damages are measured, what amount may she collect?
i. 2-708(1) (K price - market price) difference b/w the market price at the time and
place for tender (when the ROL passes to the buyer: F.O.B. Austin on Mar. 15)
and the unpaid K price together with any incidental damages less expenses
saved in consequence of the buyer’s breach => $1,500 - $900 – any saved
expenses = $600
– any saved expenses
ii. 2-706: K price – resale price= difference b/w the resale price ($1,000) and the K
price ($1,500) + incidental damages – any saved expenses = $500 + incidental
damages – saved expenses
d. Does seller have the choice b/w 2-706 (Resale) computation and 2-708 (Repudiation)
computation?
i. OC1 to 2-703: Art. 2 rejects any doctrine of election of remedy as a fundamental
policy, and thus the remedies are essentially cumulative in nature and include all of
the available remedies for breach. Whether the pursuit of one remedy bars
another depends entirely on the facts of the individual case
ii. No, if the seller did resale, the artificial formula under 2-708 is NOT allowed.
3. Problem 71: buyer ordered a pool at $2,000. Components cost $800 and assembly cost
$400. Buyer repudiated the K and current market price is $2,000. Seller is sure it can
find another buyer at that price if it resells the pool.
a. Does seller have damages? How are they measured (when there would have been 2
sales had there been no repudiation)?
i. 2-708(2): expected profit = list price – manufacturing cost (due allowance for
reasonably incurred costs and due credit for payments or proceeds of resale) =
$2,000 - $1,200 = $800
ii. The profit includes reasonable overhead which is fixed cost, not variable cost
b. Lost volume seller: if the law forces sellers to measure damages under 2-706 or 2-
708(1), they lose the profit they would have made from the resale (A lost volume
seller is a seller who has capacity to sell or produce goods in sufficiently large
quantities to meet the demands of all customers)
4. Teradyne v. Teledyne (lost volume seller): Seller sued buyer for damages suffered from
the breaking of a sales K. The court held that seller was entitled to recover from buyer
its expected profit under 2-718, including reasonable overhead, on the broken K. The
wages of the testers were not part of overhead and as a direct cost should have been
deducted from the K price. The seller was not required to mitigate damages by
acceptance of buyer's offer to purchase an alternative machine.
a. Damage is measured by expected profit including reasonable overhead cost (fixed cost)
 and variable costs should have been excluded
5. Questions
a. Exactly who qualifies as a “lost volume seller?” If a college student advertises his
guitar for sale and contracts to sell it to a caller, the caller then backs out, and the
student sells the guitar to someone else, can the student qualify as a lost volume
seller? No b/c the student has no unlimited inventory. Why does the court draw a
distinction b/w overhead costs and variable expenses (direct costs)? Which was
which here?
i. Overhead costs: include fixed cost such as ongoing expense of operating a business
(rent, wages, electricity, etc)
ii. Variable expenses: expenses that change in proportion to the activity of a business
b. 2-708(2) specifically requires a subtraction of the “proceeds of resale.” Doesn’t this
language always defeat the lost volume seller, who will typically have resold the
unaccepted goods?
i. Davis Chem. V. Diasonics: 2-708(2) requires that the proceeds from resale be
credited against the amount of damages awarded which, in most cases, would
result in the seller recovering nominal damages. In those cases in which the lost
volume seller was awarded its lost profit as damages, the courts have
circumvented this problem by concluding that this language only applies to
proceeds realized from the resale of uncompleted goods for scrap
ii. Courts have ignored proceeds of resale!
c. For a case requiring the seller to measure damages at no more than the lost profit
amount where the market price/K price differential under 2-708(1) would
overcompensate the seller
d. The lost volume concept also applies to lessors of goods (2A-529)
6. Problem 72: seller contracted to specially design and manufacture a computer for buyer
at $20K F.O.B. seller’s plant. When the computer was half done, buyer cancelled the
order. Now, the computer and its components are worth $5K and seller has heard that 3
other buyers might be enticed to buy it at $15K to $20K. It will cost seller $9K to
complete the computer
a. Should seller stop the manufacture of the computer and sell it for scrap or complete
the manufacture and then try to resell it?
i. 2-704(2): Where the goods are unfinished, an aggrieved seller may in the exercise
of reasonable commercial judgment for the purpose of avoiding loss and of
effective realization either complete the manufacture and wholly identify the
goods to the K or cease manufacture and resell for scrap or salvage value or
proceed in any other reasonable manner.
ii. If seller’s reasonable commercial judgment says that the 3 other buyers are likely
to buy the completed computer, it should complete the manufacture and resell it.
(it would be commercially reasonable for seller to contact the 3 other potential
buyers and ask if they would buy it, before it decides)
iii. It’s a business decision. You must ask the buyer if it wants to have the computer
completed or stopped
b. If seller completes the manufacture and then, after a good faith effort, is unable to
 find a new buyer, can it make buyer pay for the finished product?
i. 2-709(1)(b): seller may recover the price of goods identified to the K if the seller is
unable after reasonable effort to resell them at a reasonable price or the
circumstances reasonably indicate that such effort will be unavailing
ii. So, seller can recover from buyer the K price (assuming that the seller’s decision to
finish the good was commercially reasonable)
a) BOP of seller’s commercial unreasonableness is on BUYER (OC: presumption that
the seller behaved reasonably)
7. 2A-529 (Lessor’s Action for the Rent)
8. Problem 73: Lessee rented a computer from lessor and missed 2 lease payments in a
row. Lessor took the computer under lessee’s protest when the lease still had 1 yr to
run, with payments of $100/month. Lessor sued lessee for $1,200
a. Was lessor’s repossession valid? What remedy does lessee have if it was not?
i. 2A-525(2): After a default by the lessee . . . the lessor has the right to take
possession of the goods
ii. 2A-525(3): the lessor may proceed without judicial process if it can be done
without breach of the peace or the lessor ma proceed by action
iii. No, there was breach of the peace when the lessor took repossession of the
computer. So, it was not valid. Lessee’s remedy is?
b. Assuming there was no problem with the repossession, is lessor required to try to
mitigate damages by re-leasing the machine? No
i. OC2 to 2A-529: lessor will be able to recover as damages the present value of the
full rent due under 2A-528(2) which allows a lost profit recovery if necessary to put
the lessor in the position it would have been in had the lessee performed. Lessor
has no obligation to relet the goods for the benefit of lessee (unless otherwise
agreed).
c. Could lessor avoid any possible duty to mitigate by so stipulating in the lease
agreement? Yes
i. 1-302: parties may vary the provisions of the UCC by agreement
ii. 2A-503(1): the lease agreement may include rights and remedies for default in
addition to or in substitution for those provided in Art. 2 . . .
III. Buyer’s Remedies
A. 2-711 (Buyer’s Remedies in General; Buyer’s Security Interest in Rejected Goods)
1. The buyer may cancel and whether or not he has done so may in addition to recovering
so much of the price as has been paid
a. Cover and have damage under the next section as to all the goods affected whether
or not they have been identified to the K; or
i. you can’t get consequential damages that you could have reasonably covered
b. Recover damages for non-delivery as provided in 2-713
2. The buyer may also
a. If the goods have been identified, recover them as provided in 2-502; or
b. In a proper case, obtain specific performance or replevy the goods as provided in 2-
716
 3. Incidental damages is one type of consequential damages, but very specific: incidental
damages are damages necessary to ascertain if there is a breach
B. Accepted Goods
1. 2-607(3)(a): if a technical 2-606 acceptance of the goods has been made and is not later
revoked, the buyer may still use for breach of warranty (or other breach of K) if a notice
of the defect has been given to the seller within a reasonable time after the defect
should have been discovered
2. Problem 74: buyer (famous pianist) bought an electric piano with no written K and
found that he was going deaf due to a high-pitched whine from it. He destroyed the
piano (which ended his ability to revoke) and claimed damages including $3K for the
cost of the piano, $2K for doctor’s fee (incidental damage), $500 for expert (incidental
damage),
$750K for lost income for next 15 yrs (consequential damages), $1M for the value of his
hearing (consequential damages), and $5 for the axe used to destroy the piano. Seller
defended by (1) denying that it had warranted the piano in any way and (2) proving that
the whine was harmless to everybody in the world except the buyer.
a. What warranty, if any, did the seller breach? Does the company’s care in
manufacturing the piano or the freakishness of the injury keep the warranty from
being breached?
i. As the seller is a merchant, the warranty of merchantability is implied.
ii. Warranty is absolute, so non-negligence is not a defense. So, even if the piano is fit
for the ordinary purpose to everybody except the buyer, seller breaches the
implied warranty of merchantability to this particular buyer.
b. Which, if any, of buyer’s damages are recoverable under 2-714?
i. 2-714: damages for breach of warranty (difference at the time and place of
acceptance b/w the value of the goods accepted and the value they would have
had if they had been as warranted, unless special circumstances show proximate
damages of a different amount ) + incidental damages + consequential damages
ii. Damages for breach of warranty: $3K
c. Which, if any, of the items claimed are incidental damages under 2-715(1)?
i. 2-715(1): incidental damages - expenses reasonably incurred in inspection, receipt,
transportation and care and custody of goods rightfully rejected, any commercially
reasonable charges, expenses or commission in connection with effecting cover
and any other reasonable expense incident to the dealy or other breach
ii. $500 paid to the experts and $2K for doctor’s fee are incidental damage
d. The 2-715(2) test of consequential damages with its “reason to know” language is a
restatement of Hadley v. Baxendale. Is it relevant here?
i. 2-715(2): consequential damages – (a) any loss resulting from general or particular
requirements and needs of which the seller at the time of K had reason to know
and which could not reasonably be prevented by cover or otherwise; and (b) injury
to person or property proximately resulting from any breach of warranty
ii. No b/c consequential damages include injury to person or property proximately
resulting from any breach of warranty whether the seller had reason to know of it
or not. (in a breach of warranty action, foreseeability is not an issue)
 iii. $750K for the lost income and $1M for the value of hearing are consequential
damages
a) No double damages/no over-recovery
b) No recovery of the axe allowed
e. If you were the judge of both the fact and the law, what amount would you award
buyer, and why?
i. Damages for the breach of warranty + incidental damage + consequential damages
= $3K + $500 + $2K + $750K + $1M = $1,755,500
3. Problem 75: buyer bought a yo-yo cord for $1.5 which was defective. After eliminated
from the finals of the USA Yo-Yo Championship ($10K first prize), she refused to pay the
bill and filed suit against the seller for $50K consequential damages. Every expert
witness testified that buyer’s ability with the yo-yo was the greatest in the world. Seller
defended on 2 grounds: (1) merely knowing about the intended use of the yo-yo in the
competition was not enough to impose liability on him unless the parties had agreed to
put this risk on him (no tacit agreement test under OC); and (2) her damages were too
speculative.
a. Does the UCC permit buyer to refuse to pay the bill? Yes if she notifies the seller
i. 2-717: the buyer on notifying the seller of his intention to do so may deduct all or
any part of the damages resulting from any breach of the K from any part of the
price still due under the same K
b. If the buyer feels obligated to pay only part of the bill, what procedure should be
followed?
i. 3-311 (accord and satisfaction): buyer must prove that within 90 days after
payment of the instrument, she tendered repayment of the amount of the
instrument to seller. (send the seller payment in full check -> if seller cashes it, it
is satisfaction and dispute is over.)
c. Are the consequential damages for which buyer asked too speculative?
i. OC4 to 2-715: the BOP the extent of loss incurred by way of consequential damage
is on the buyer, but the section on liberal administration of remedies rejects any
doctrine of certainty which requires almost mathematical precision in the proof of
loss. Loss may be determined in any manner which is reasonable under the
circumstances.
ii. Wachtel v. National Alfalfa Journal: leading contender in canceled contest entitled
to value of the chance of winning
iii. The consequential damage may be $10K (the 1st prize in the contest), and $50K is
too much
d. Is knowledge of the possible consequential damages alone sufficient to impose
liability on a seller? Or is seller right in saying that the liability for consequential
damages attaches only if the seller has agreed (expressly or impliedly) to assume the
risk?
i. OC2 to 2-715: The “tacit agreement” test for the recovery of consequential
damages is rejected. Although the older rule at common law which made the seller
liable for all consequential damages of which he had “reason to know” in advance
is followed, the liberality of that rule is modified by refusing to permit recovery
 unless the buyer could not reasonably have prevented the loss by cover or
otherwise. Subparagraph (2) carries forward the provisions of the prior uniform
statutory provision as to consequential damages resulting from breach of
warranty, but modifies the rule by requiring first that the buyer attempt to
minimize his damages in good faith, either by cover or otherwise.
ii. Thus, the seller is liable for all consequential damages of which he had reason to
know in advance, but recovery is not allowed if buyer could reasonably have
prevented the loss by cover or otherwise. In this case, the loss could not have
prevented by buyer, so seller is liable for the loss.
e. May buyer recover her attorney fees as consequential damages? No unless specified
in the K or in other statutes
i. Equitable Lumber v. IPA Land: may be recovered if the K so provides, but any
specified amount must be valid as a liquidated damages provision
ii. Indiana Glass v. Indiana Michigan Power: not unless another statute so provides
iii. Cady v. Dick Loehr’s: trial court has discretion to award attorney fees as
consequential damages
iv. Modine Mfg. v. Noth East Indep. Sch. Dist.: no b/c such fees are penal in nature
and the Code does not authorize punitive damages
4. Problem 76: seller sold a moving truck to buyer. K limited the buyer’s remedy for
breach of warranty to replacement or repair and clearly disclaimed liability for
consequential damages. On 1st day, the truck proved incapable of climbing even small
hills, so buyer revoked, claimed a security interest under 2-711(3) and stored it at a
truck depot for resale, which charged it $50/day for storage
a. Must seller pay the storage charges, or is it protected by the disclaimer of
consequential damages?
i. 2-719(3): Consequential damages may be limited or excluded unless the limitation
or exclusion is unconscionable. Limitation of consequential damages for injury to
the person in the case of consumer goods is prima facie unconscionable but
limitation of damages where the loss is commercial is not.
ii. 2-715(1): Incidental damages resulting from the seller's breach include expenses
reasonably incurred in inspection, receipt, transportation and care and custody of
goods rightfully rejected, any commercially reasonable charges, expenses or
commissions in connection with effecting cover and any other reasonable expense
incident to the delay or other breach.
iii. The consequential damages can be excluded unless unconscionable. But, storage
charges for the custody of the truck rightfully rejected is incidental damage and
seller must pay it. (can’t excluded by the consequential damages disclaimer)
C. Unaccepted Goods
1. Buyer’s remedy: when no delivery, rejection or revocation of acceptance -> buyer may
a. recover the price and incidental/consequential damages; and
b. seek specific performance or replevin
2. 2-716 (Buyer’s Rights to Specific Performance or Replevin)
a. Specific performance may be decreed where the goods are unique or in other proper
 circumstances. (liberal administration of specific performance)
b. The decree for specific performance may include such terms and conditions as to
payment of the price, damages, or other relief as the court may deem just.
c. The buyer has a right of replevin for goods identified to the K if after reasonable
effort he is unable to effect cover for such goods or the circumstances reasonably
indicate that such effort will be unavailing or if the goods have been shipped under
reservation and satisfaction of the security interest in them has been made or
tendered. In the case of goods bought for personal, family, or household purposes,
the buyer's right of replevin vests upon acquisition of a special property, even if the
seller had not then repudiated or failed to deliver.
d. OC1: The present section continues in general prior policy as to specific performance
and injunction against breach. However, without intending to impair in any way the
exercise of the court's sound discretion in the matter, Art. 2 seeks to further a more
liberal attitude than some courts have shown in connection with the specific
performance of contracts of sale.
3. 2-712 (Cover; Buyer’s Procurement of Substitute Goods)
a. After a breach within the preceding section the buyer may “cover” by making in good
faith and without unreasonable delay any reasonable purchase of or K to purchase
goods in substitution for those due from the seller.
b. The buyer may recover from the seller as damages the difference b/w the cost of
cover and the K price together with any incidental or consequential damages defined
in 2-715, but less expenses saved in consequence of the seller's breach. (damage =
cost of cover – K price – saved expenses)
c. Failure of the buyer to effect cover within this Section does not bar him from any
other remedy.
4. Problem 77: buyer ordered a model 1 mobile home for $8K, delivery to be made on May
20. Buyer planned to spend an additional $500 to build a foundation that the mobile
home had to have for maximum utility. The price of trailers rose dramatically and on
May 10 seller informed buyer that the deal was off. Buyer shopped around and on Sept.
25 bought model 2 mobile home for $15K, but it did not require the foundation. Buyer
sued and seller defended by offering to show that (a) model 2 was selling for $10K up
to Sept. 5 and (b) model 2 always sells for $2K more than model 1. What damages can
buyer get under 2-712?
a. OC2: The test of proper cover is whether at the time and place the buyer acted in
good faith and in a reasonable manner, and it is immaterial that hindsight may later
prove that the method of cover used was not the cheapest or most effective. The
requirement that the buyer must cover “without unreasonable delay” is not intended
to limit the time necessary for him to look around and decide as to how he may best
effect cover. The test here is similar to that generally used in Art. 2 as to reasonable
time and seasonable action.
b. Buyer can recover the difference b/w the cost of the cover and the K price = $15K -
$8K = $7K
i. Buyer must show that the cover was reasonable to the extent that seller shows that
 the cover was beneficial to the buyer
5. Hughes Communications v. U.S.:
a. Fact: Plaintiff, aerospace contractor, sued the US government for breach of K and for
taking its property without just compensation. At the damages trial, P sought to
prove its increased costs in launching satellites on expendable launch vehicles,
rather than on the government's space shuttles, pursuant to the parties' launch
services agreement (LSA).
b. Held: In 8 of the 9 years duration of the LSA, the government had budgeted for more
shuttle launches than it was able to launch. Thus, technical obstacles, rather than
budget choices, prevented the government from launching more shuttles during the
LSA K period. Further, the government was acting in its proprietary capacity when it
entered into the LSA, and accordingly, the contractor's only claim against the
government was for breach of K
6. 2-715(2)(a): Consequential damages resulting from the seller's breach include (a) any
loss resulting from general or particular requirements and needs of which the seller at
the time of contracting had reason to know and which could not reasonably be
prevented by cover or otherwise
a. Although a buyer is not required to cover, if he fails to cover in an appropriate
situation, consequential damages that could have been avoided are denied
b. Financial inability is an excuse for non-cover
c. Practical test to gauge the reasonableness of the cover: Would the buyer have made
the same arrangements if there was no prospect of a successful suit against the
breaching seller?
7. 2-713 (Buyer’s Damages for Non-Delivery or Repudiation)
a. Subject to 2-723, the measure of damages for non-delivery or repudiation by the
seller is the difference b/w the market price at the time when the buyer learned of
the breach and the K price together with any incidental and consequential damages
provided in 2-715, but less expenses saved in consequence of the seller's breach (K
price – market price when learned of breach + incidental/consequential damages –
saved expenses)
b. Market price is to be determined as of the place for tender or, in cases of rejection
after arrival or revocation of acceptance, as of the place of arrival
8. Problem 78: A ordered wine form B for $1,000, to be delivered on Mar. 30. B ordered
the wine from C in CA “F.O.B. San Francisco (shipment K: buyer pays for shipping)” for
$750 (this price includes shipping cost b/c it is a shipment K), but C went bankrupt on
Mar. 25. B bought the same wine in its own city for $750 and delivered to A. On Mar.
25, the price of similar wine in San Francisco was $900 and the cost of transportation
would have been $100. (cover was better than the original K, so there was no damage
here)
a. Compute the damages due B for the failure to deliver the wine
i. Under 2-712: difference b/w the cost of cover and the K price = $750 - $750 = 0
ii. Under 2-713: difference b/w the market price at the time when the buyer learned
of the breach (San Francisco, Mar. 25) and the K price – expenses saved due to C’
 breach = $900 - $650 (K price solely for the wine) - $100 (transportation cost
saved)= $150
iii. OC5 to 2-713: The market or current price to be used in comparison with the K
price under this section is the price for goods of the same kind and in the same
branch of trade.
b. What role does the $100 transportation cost play in computing damages? Note the
definition of market price in 2-723
i. 2-723(2): If evidence of a price prevailing at the times or places described in Art. 2
is not readily available the price prevailing within any reasonable time before or
after the time described or at any other place which in commercial judgment or
under usage of trade would serve as a reasonable substitute for the one described
may be used, making any proper allowance for the cost of transporting the goods
to or from such other place.
ii. Transportation cost is included in the market price
9. Tongish v. Thomas: The buyer contracted with the seller to purchase a quantity of
sunflower seeds. When the seller notified the buyer that the seller would not continue
to supply the sunflower seeds, the buyer brought a breach of K action against the
seller. The buyer contended that the trial court applied the wrong measure of damages
and that the measure of damages should have been the difference b/w the market
price of the sunflower seeds and the K price under 2-713. The court held that: (1) 2-
713 provided the proper measure of damages in the case; and (2) although application
of 2- 713 might not reflect the actual loss to the buyer, it encouraged a more efficient
market and discouraged the breach of K.
a. Principle: put the innocent party to the position had there been no breach (no better
position)
b. Here, the farmer breached in bad faith, but overcompensation is sometimes allowed
to encourage the parties to keep K
c. KS Supreme Court affirmed this decision by adding that “If loss of actual profit would
be the measure of damages, it would enable seller to consider the K price as the
floor price, take advantage of rapidly escalating prices, ignore his contractual
obligation, and profitably sell to the highest bidder. Damages computed under 2-713
encourage honoring of K and market stability.”
10. CISG Art. 46(2): If the goods do not conform with the K, the buyer may require
delivery of substitute goods only if the lack of conformity constitutes a fundamental
breach of K and a request for substitute goods is made either in conjunction with
notice given under Art. 39 or within a reasonable time thereafter.
a. Art. 25: A breach of K committed by one of the parties is fundamental if it results in
such detriment to the other party as substantially to deprive him of what he is
entitled to expect under the K, unless the party in breach did not foresee and a
reasonable person of the same kind in the same circumstances would not have
foreseen such a result.
b. Restatement (2nd) of K 241: must consider the deprived benefit, adequate
compensation, forfeiture, likelihood of cure, good faith and fair dealing
11. Problem 79: seller of LA agreed to sell a vehicle to buyer of Australia, to be delivered
by Dec. 1. Due to problems with Customs, seller was not able to deliver and buyer sent
a letter proposing to move the delivery date to Feb. 1 (nachfrist: extension).
a. Is buyer bound to wait until that date before suing? Yes
i. Art. 47: (1) The buyer may fix an additional period of time of reasonable length for
performance by the seller of his obligations. (2) Unless the buyer has received
notice from the seller that he will not perform within the period so fixed, the
buyer may not, during that period, resort to any remedy for breach of K. However,
the buyer is not deprived thereby of any right he may have to claim damages for
delay in performance. (innocent party can extend)
ii. Buyer is bound to wait unless seller notifies that he will not perform within the
period so fixed
b. Is it bound to wait even if seller’s reply is “Go to hell!”?
i. No b/c clear repudiation
c. What if instead of buyer proposing the extension (Nachfrist), seller is the one to
propose a grace period? Can it be done?
i. Art. 48(1): Subject to Art. 49, the seller may, even after the date for delivery,
remedy at his own expense any failure to perform his obligations, if he can do so
without unreasonable delay and without causing the buyer unreasonable
inconvenience or uncertainty of reimbursement by the seller of expenses
advanced by the buyer. However, the buyer retains any right to claim damages
as provided for in this Convention (breaching party may extend)
ii. Art. 63: (1) The seller may fix an additional period of time of reasonable length for
performance by the buyer of his obligations. (2) Unless the seller has received
notice from the buyer that he will not perform within the period so fixed, the
seller may not, during that period, resort to any remedy for breach of K. However,
the seller is not deprived thereby of any right he may have to claim damages for
delay in performance.
iii. Seller may cure unless unreasonable but buyer retains any right to claim damages.
d. If the machine is delivered and then fails to work, can buyer force seller to fix it? Yes
i. Art. 46(3): If the goods do not conform with the K, the buyer may require the
seller to remedy the lack of conformity by repair, unless this is unreasonable
having regard to all the circumstances. A request for repair must be made either
in conjunction with notice given under Art. 39 or within a reasonable time
thereafter.
ii. Strong presumption in favor of specific performance
iii. Art. 28: If, in accordance with the provisions of this Convention, one party is
entitled to require performance of any obligation by the other party, a court is not
bound to enter a judgment for specific performance unless the court would do so
under its own law in respect of similar contracts of sale not governed by this
Convention.
e. Is this remedy available in American law? No this is involuntary servitude that is not
allowed in US
 i. 2-716(1): Specific performance may be decreed where the goods are unique or in
other proper circumstances.
IV. Anticipatory Repudiation
A. Common law rule
1. If one party to a K makes a definite repudiation of the K before the date set for
performance, the other party
a. could treat the repudiation as a breach and sue immediately
b. may ignore the repudiation and await the performance date to see if the repudiator
would retract the repudiation
i. As long as the innocent party had not changed position in reliance on the
repudiation, the repudiator was free to retract the repudiation, reinstate the K,
and perform as originally agreed
B. UCC approach
1. 2-610 (Anticipatory Repudiation): When either party repudiates the K w/r/t a
performance not yet due the loss of which will substantially impair the value of the K to
the other, the aggrieved party may
a. for a commercially reasonable time await performance by the repudiating party; or
b. resort to any remedy for breach (Section 2-703 or Section 2-711), even though he
has notified the repudiating party that he would await the latter's performance and
has urged retraction; and
c. in either case suspend his own performance or proceed in accordance with the
provisions of Art. 2 on the seller's right to identify goods to the K notwithstanding
breach or to salvage unfinished goods (Section 2-704).
d. This contradicts 2-713: damage is measured difference b/w the market price “at the
time when the buyer learned of the breach” and the K price
i. The drafters considered the case in which the innocent party learned of
repudiation after the breach
ii. So, in case of anticipatory repudiation, ignore 2-713
2. 2-611 (Retraction of Repudiation)
a. Until the repudiating party's next performance is due he can retract his repudiation
unless the aggrieved party has since the repudiation cancelled or materially changed
his position or otherwise indicated that he considers the repudiation final.
b. Retraction may be by any method which clearly indicates to the aggrieved party that
the repudiating party intends to perform, but must include any assurance justifiably
demanded under the provisions of Art. 2 (Section 2-609).
c. Retraction reinstates the repudiating party's rights under the K with due excuse and
allowance to the aggrieved party for any delay occasioned by the repudiation.
3. OC1 to 2-610:
a. A repudiation must be a definite refusal to perform
b. Mere equivocation is not enough
c. The equivocating party can be forced into performance or repudiation by 2-609
(Right to Adequate Assurance of Performance)
C. Problem 80: buyer ordered 1K lb of beef for $5K to be delivered on Oct. 8. Seller
 repudiated the K on July 10 when the price was $6K, buyer could have covered at $7K on
July 15 but decided to wait for the performance. On Oct. 8, the price was $8K. How much
can buyer recover?
1. Deciding not to cover is okay under 2-610
2. 2-713 is ignored and use 2-610 (commercially reasonable time – this may expire before
the date set for performance) in measuring damages
a. Damage = difference b/w the K price and the cover price at commercially reasonable
time
3. 2-723(1): If an action based on anticipatory repudiation comes to trial before the time
for performance w/r/t some or all of the goods, any damages based on market price
(Section 2-708 or Section 2-713) shall be determined according to the price of such
goods prevailing at the time when the aggrieved party learned of the repudiation.
4. Repudiation v. equivocation
a. Equivocation is unclear and doesn’t allow cover
i. So you must get adequate assurance in case of equivocation
V. The Statute of Limitations
A. 2-725 (Statute of Limitations in Ks for Sale)
1. An action for breach of any K for sale must be commenced within 4 yrs after the cause
of action has accrued. By the original agreement the parties may reduce the period of
limitation to not less than 1 yr but may not extend it.
2. A cause of action accrues when the breach occurs, regardless of the aggrieved party's
lack of knowledge of the breach. A breach of warranty occurs when tender of delivery
is made, except that where a warranty explicitly extends to future performance of the
goods and discovery of the breach must await the time of such performance, the cause
of action accrues when the breach is or should have been discovered.
3. Where an action commenced within the time limited by subsection (1) is so terminated
as to leave available a remedy by another action for the same breach such other action
may be commenced after the expiration of the time limited and within 6 months after
the termination of the 1st action unless the termination resulted from voluntary
discontinuance or from dismissal for failure or neglect to prosecute.
4. This section does not alter the law on tolling of the statute of limitations nor does it
apply to causes of action which have accrued before this Act becomes effective.
B. In summary
1. SOL under UCC is 4 yrs within which the normal commercial record is kept
2. SOL begins to run at the accrual of the cause of action (at the time of breach)
regardless of the aggrieved party’s lack of knowledge of the breach (when was the first
time the lawsuit could be filed)
a. When the cause of action accrues in case of breach of warranty?
i. 2-prong test: (i) tender of delivery ordinarily, and (ii) when the breach is or should
have been discovered in future performance cases
3. Parties may reduce the period to 1 yr, but may not extend it beyond 4 yrs (need not be
conspicuous)
4. SOL is an affirmative defense and is waived if not pleaded and proved
C. Problem 81: 4 yrs and 2 days after delivery of his new car, buyer had a flat tire and
changed it with the spare tire, which burst due to a manufacturing flaw. Has the SOL run?
1. Tire warranty: “These tires are merchantable.”
a. The breach of warranty occurred upon tender of delivery of the car. So, the SOL has
expired
2. What if this were a lease of goods? (always discovery rule)
a. 2A-506(2): A cause of action for default accrues when the act or omission on which
the default or breach of warranty is based is or should have been discovered by the
aggrieved party, or when the default occurs, whichever is later. A cause of action for
indemnity accrues when the act or omission on which the claim for indemnity is
based is or should have been discovered by the indemnified party, whichever is
later.
b. The cause of action accrued on the date of the tire burst, so the SOL has not lapsed
3. Tire warranty: “These tires have a lifetime guarantee.”
a. Kelleher v. Lumber: “lifetime guarantee” is an express warranty of future
performance (discovery rule applies)
b. 93 A.L.R.3d 690: a cause of action that accrued not at the time of the delivery of the
disposal unit, but at some future time during the unit's "lifetime," when the breach
was, or should have been, discovered
c. So, the SOL began to run at the time of the tire burst
4. Sales material: “Many tires are still on the road after 5 yrs.”
a. Jones & Laughlin Steel v. Johns-Manvville: a statement of future performance is
explicit if it does not arise by implication, but is instead “distinctly stated, plain in
language, clear, not ambiguous, express and unequivocal”
b. the language here is not explicit, so no guarantee of future performance, the SOL
began to run at tender of delivery of the car
5. If tire warranty says “These tires are warranted for 7 yrs from date of purchase (explicit
extension -> discovery rule applies),” and a tire first malfunctioned at the beginning of
the 3rd yr, when would the SOL expire?
a. Joswick v. Chesapeake Mobile Homes: Where no representations were made w/r/t
defects discovered after expiration of the stated warranty period, any action based
on the warranty had to be brought within 4 yrs of that expiration.
b. SOL expires 4 yrs from the date when the tire first malfunctioned (see Poli v.
DaimlerChrysler)
6. No express warranties, no warranty disclaimers: then warranty of merchantability is
implied
a. 4 yrs from the tender
D. Poli v. DaimlerChrysler: The buyer obtained a 7-year, 70,000-mile power train warranty
when he bought the car. He filed suit almost 6 yrs after the purchase date. The buyer's
Lemon Law claim failed to state a cause of action, as it only applied to defects identified
and reported within a statutorily specified period. However, the appellate court disagreed
with the trial court's finding that the power train warranty was an ordinary sales warranty,
such that the purchaser only had 4 yrs after delivery in which to bring an action. Such a
 finding meant that the buyer would be unable to enforce the warranty obligations for any
breach that occurred beyond or even near the end of that four-year period, even though
by its terms the warranty extended for as long as 7 yrs. The appellate court would not
construe 2-725(2) to lead to such an unreasonable result. The buyer's cause of action did
not accrue until the seller had refused to repair or replace the vehicle, rather than upon
the tender of delivery.
1. A statement of repair: if these tires don’t work, we will fix them -> when this warranty
starts to ticking?
a. First delivery?
b. First malfunction?
c. Prevailing rule: Most courts say that it’s not a warranty b/c it’s a separate service K
(not related to the good and not a basis of bargain) -> cannot be breached until
seller fails to repair
E. Problem 82: buyer bought a new car on Apr. 1, 2005 with a written warranty that “The
manufacturer will replace any part found to be defective in the 1st 5 yrs.” 3 yrs and 358
days later, steering wheel came off and it took 3 months for repair. On the same day,
steering wheel came off again and buyer was killed
1. When did the cause of action accrue w/r/t the defective steering wheel?
a. Standard Alliance v. Black Clawson: SOL begins to run at discovery of the defect
(not when seller abandoned repair after 6 months from the discovery)
b. Explicit extension of warranty: discovery rule applies
c. Thus, the cause of action accrued when the steering wheel came off for the first time
d. You may also argue that this is not a warranty at all under Poli case
2. Was the statute tolled during the 3 months that the car was in the shop? It depends on
jurisdiction
a. Gus’ Catering v. Menusoft: the SOL did not toll during the repair but ran from the
date of delivery
b. Highline Village v. Hersh Companies: SOL starts to run when a defect is discovered,
and the running of that period may be equitably tolled during the time that the seller
or contractor engages in repair efforts under an express or implied representation to
remedy the defect
3. If the manufacture sold it to the dealership and the dealership then resold the vehicle
to a consumer, when would the 4 yr period on the manufacturer’s implied warranty
start running?
a. Wilson v. Class: SOL starts running on the manufacturer’s delivery to the dealership
4. Would we reach the same result on an express warranty given by the manufacturer?
Should the courts draw a distinction as to when the cause of action accrues based on
whether the injury is to person or to property?
a. Prof: if the manufacture gave an express warranty, it’s given to the consumers. So,
in case of express warranty, SOL should start running on delivery to the consumers
i. c.f. implied warranty: M-M Act says that if there is a written statement, seller
can’t disclaim implied warranty
b. In re Hawaii Federal Asbestos Cases: warranty suit based on exposure to asbestos
 barred 4 yrs after delivery of product even if impossible to know of personal injury in
that period
c. Courts do not distinguish injury to person or to property

PART 2. PAYMENT
CHAPTER 7. NEGOTIABILITY
I. Introduction
A. Art. 3: negotiable instruments
B. Art. 4: bank deposits and collections
C. Art. 8: investment securities
D. Art. 4A: wire transfers of funds
II. Types of Negotiable Instruments
A. Many types of negotiable instruments
1. Money: technically a negotiable instrument
a. A dollar bill: bill of exchange
2. Investment securities: stocks and bonds
a. covered by Art. 8
3. 2 types of negotiable instruments covered by Art. 3
a. Note: written promise to pay money (promissory note: 2 party instrument b/w
maker/issuer and payee)
i. If created by a bank: certificate of deposit (CD)
a) 3-104(j): “Certificate of deposit” means an instrument containing an
acknowledgment by a bank that a sum of money has been received by the bank
and a promise by the bank to repay the sum of money. A certificate of deposit is
a note of the bank
ii. Investors is not able to reclaim the money until the CD matures
iii. IOU is not a promissory note, just acknowledgment of debt
b. Draft: written order by one person (drawer) to another (drawee), directing the latter
to pay money to a 3rd person (payee) (3 party instrument)
i. Check: draft written on a bank and payable on demand (drawee is a bank)
a) 3-104(f): “Check” means (i) a draft, other than a documentary draft, payable on
demand and drawn on a bank or (ii) a cashier's check or teller's check. An
instrument may be a check even though it is described on its face by another
term, such as “money order.”
b) bank’s customer is drawer, bank is drawee, the nominee is payee (who gets the
money)
ii. Cashier’s check: drawn by the bank on itself (bank is both drawer and drawee)
iii. Teller ’s check: drawn by one bank on another bank or made payable
through another bank
iv. Sales drafter: bank is neither drawer nor drawee
a) e.g.: to buyer, pay to the order of $5,000 to _(blank)_
4. Problem 83: buyer paid bank an amount required and bank issued the cashier’s check,
with seller being named as payee. What is the name that the Code gives to buyer in this
 situation?
a. 3-103(a)(15): remitter means a person who purchases an instrument from its issuer if
the instrument is payable to an identified person other than the purchaser
b. Seller: payee, buyer: remitter, bank: drawer & drawee
III. The Negotiability Concept
A. Introduction
1. Negotiable
a. technically negotiable (its form)
b. technically negotiated (transfer process) and reaches the hands of a purchaser (HDC:
HDC) for value who has no knowledge of problems with the transactions
c. the purchaser becomes super-plaintiff who can sue the parties to the instrument who
are not permitted to defend the lawsuit
i. not subject to any defenses arising from the underlying transaction
ii. parties to the paper have to pay it at maturity even if they have defenses arising
from the transaction
iii. promotes the desirability of buying negotiable instruments
d. D simply lose and pay up
2. 3-104(a): Except as provided in subsections (c) and (d), “negotiable instrument” means
an unconditional promise or order to pay a fixed amount of money, with or without
interest or other charges described in the promise or order, if it:
a. is payable to bearer or to order at the time it is issued or first comes into possession
of a holder;
b. is payable on demand or at a definite time; and
c. does not state any other undertaking or instruction by the person promising or
ordering payment to do any act in addition to the payment of money, but the
promise or order may contain (i) an undertaking or power to give, maintain, or
protect collateral to secure payment, (ii) an authorization or power to the holder to
confess judgment or realize on or dispose of collateral, or (iii) a waiver of the
benefit of any law intended for the advantage or protection of an obligor.
3. Non-negotiable instrument (mere K): Art. 3 does not apply, except by analogy
a. Transfer of non-negotiable instrument is assignment of a K right
b. Assignees of a K takes subject to all defenses arising from the underlying transaction
c. Courts are not in favor of extending Art. 3 by analogy to the situations in which the
deviation from the negotiability requirements is small (presumption against
negotiability)
B. Writing
1. Cannot be oral: both promise and order
2. Not need to be on paper
a. E.g.) court found a check on a cow
C. Signed
1. Both promise and order
2. Problem 84: branding iron that prints “X” – sign O
a. 1-201(b)(37): “Signed” includes using any symbol executed or adopted with present
 intention to adopt or accept a writing
3. Problem 85: sole proprietor of the Capitalist Company signs checks by writing
“Capitalist Company” but the checks are drawn on his personal checking account.
Can the bank treat the check as if he had signed his own name? Yes
a. 3-401(b): A signature may be made (i) manually or by means of a device or machine,
and (ii) by the use of any name, including a trade or assumed name, or by a word,
mark, or symbol executed or adopted by a person with present intention to
authenticate a writing
D. Unconditional Promise or Order
1. Necessary for negotiable paper to be circulated without question
2. 3-106 (Unconditional Promise or Order)
a. Except as provided in this section, for the purposes of Section 3-104(a), a promise or
order is unconditional unless it states (i) an express condition to payment, (ii) that the
promise or order is subject to or governed by another record, or (iii) that rights or
obligations w/r/t the promise or order are stated in another record. A reference to
another record does not of itself make the promise or order conditional
b. A promise or order is not made conditional (i) by a reference to another record for a
statement of rights w/r/t collateral, prepayment, or acceleration, or (ii) b/c payment
is limited to resort to a particular fund or source
c. If a promise or order requires, as a condition to payment, a countersignature by a
person whose specimen signature appears on the promise or order, the condition
does not make the promise or order conditional for the purposes of Section 3-104(a).
If the person whose specimen signature appears on an instrument fails to
countersign the instrument, the failure to countersign is a defense to the obligation
of the issuer, but the failure does not prevent a transferee of the instrument
from becoming a holder of the instrument.
d. If a promise or order at the time it is issued or first comes into possession of a holder
contains a statement, required by applicable statutory or administrative law, to the
effect that the rights of a holder or transferee are subject to claims or defenses that
the issuer could assert against the original payee, the promise or order is not thereby
made conditional for the purposes of Section 3-104(a); but if the promise or order is
an instrument, there cannot be a HDC of the instrument.
3. Implied Conditions
a. Even if it is possible to think up things that might happen to destroy the maker’s
liability on the instrument, negotiability is not destroyed unless the instrument makes
itself expressly conditional as to these matters
b. Triffin v. Dillabough: Appellant money order seller refused to pay the face value of
money orders that had been stolen from one of its agents. The court held that the
money orders were negotiable instruments even though appellant placed a legend on
the back of the orders providing that they would not be paid if stolen, holding that
the legend was simply a restatement of appellant's statutory defenses and that
the wording did not elevate the legend to a conditional promise to pay. Appellee
commercial discounter had the status of a HDC b/c he stood in the shoes of his
 assignor and, therefore, was entitled to recover the face amount of the money
orders from appellant.
4. Consideration Stated
a. 3-106 permits the instrument to mention the details of the underlying K without
destroying negotiability as long as payment of the note is not made subject to the
performance of that K
i. Perspective holder should never be required to investigate whether all is well with
the K
ii. Holder must be able to determine the negotiability of an instrument from within
its own 4 corners alone
iii. Mere reference to another record does not make the instrument conditional
iv. Section (b): Not conditional by (i) reference to another record for collateral,
prepayment or acceleration or (ii) limiting payment to a particular fund or source
v. Section (c) (traveler’s check): not on the exam
b. Problem 86: Are the following notes negotiable?
i. “(Date), I promise to pay bearer $500, subject to the K I signed with Honest John
today, (Signature)”: non-negotiable b/c the payment is subject to the performance
of the K
a) OC1 to 3-106: not negotiable if an instrument contains:
1. “This note is subject to a K of sale dated April 1, 1990 b/w payee and maker
of this note.”
2. “This note is subject to a loan and security agreement dated April 1, 1990
b/w payee and maker of this note.”
3. “Rights and obligations of the parties w/r/t this note are stated in an
agreement dated April 1, 1990 b/w payee and maker of this note.”
ii. “(Date), I promise to pay bearer $500 as per K I signed today with Honest John,
(Signature)”: negotiable
a) Old statute allowed “as per ” and “in accordance with”, but new statute
says nothing about it
b) 3-117: separate agreement affects only the parties thereto and not a
subsequent HDC
iii. “(Date), I promise to pay bearer $500 on Jan. 1, 2012. For rights as to prepayment
and acceleration, see the K signed Sep. 25, 2012, b/w the maker and the payee.
(Signature)”: negotiable
a) 3-106(b)(i): A promise or order is not made conditional (i) by a reference to
another record for a statement of rights w/r/t collateral, prepayment, or
acceleration
c. Problem 87: whenever it mails out a check, the Adhesion Insurance Company marks
it “Void After 90 Days.” Is such an instrument technically negotiable?
i. Technically, it is a condition, so not negotiable (but, universally accepted)
d. Problem 88: The promissory note contains “The collateral for this note is a security
interest in the maker’s art collection; for rights and duties on default, see the security
agreement signed this day creating the security interest.” Does this clause destroy
 negotiability? No
i. OC to 3-106(b)(i): statement of rights/obligations for collateral, prepayment,
acceleration does not prevent the note from being an instrument if the statement
is in the note itself
E. Fixed Amount of Money
1. Fixed amount: Nonnegotiable if the amount is not readily calculable
a. Problem 89: The promissory note says that the interest rate was “2% above the
prime rate as of the date of maturity,” which rate can be ascertained by reference to
financial publications. Negotiable!
i. 3-112 (Terms and Omissions Not Affecting Negotiability)
a) Unless otherwise provided in the instrument, (i) an instrument is not payable
with interest, and (ii) interest on an interest-bearing instrument is payable from
the date of the instrument.
b) Interest may be stated in an instrument as a fixed or variable amount of money
or it may be expressed as a fixed or variable rate or rates. The amount or rate of
interest may be stated or described in the instrument in any manner and may
require reference to information not contained in the instrument. If an
instrument provides for interest, but the amount of interest payable cannot be
ascertained from the description, interest is payable at the judgment rate in
effect at the place of payment of the instrument and at the time interest first
accrues.
2. Money: nonnegotiable if pay something other than money
a. 1-201(24): medium of exchange authorized or adopted by a domestic or foreign
government as a part of its currency (must be “official” currency -not limited to U.S.
currency)
b. 3-107: instrument payable in foreign currency is presumed to be payable in either
that currency or the U.S. dollar equivalent on the date due unless the instrument
limits payment to the foreign currency
c. Question: if an instrument states that it is payable only with French francs, is it
negotiable? Yes
F. Courier Without Luggage Requirement
1. Must not be burdened with anything other than the simple and clean unconditional
promise or order
a. Any additional promise make the note nonnegotiable b/c the note is conditioned on
the performance of the other promise
b. 3-104(a)(3): the promise or order may contain (i) an undertaking or power to give,
maintain, or protect collateral to secure payment, (ii) an authorization or power to
the holder to confess judgment or realize on or dispose of collateral, or (iii) a waiver
of the benefit of any law intended for the advantage or protection of an obligor
2. Problem 90: do the following clauses destroy negotiability?
a. “Maker agrees that signing this note also indicates acceptance of the K of the sale for
which it is given” – Yes, nonnegotiable b/c express condition -> this is a mere K
b. “Maker agrees and promises that if the holder of this note deems himself insecure at
 any time, he may so inform the maker, who will then supply additional collateral in an
amount and kind to be specified by the holder” – No, negotiable (exception 3-106(b)
(i))
c. “Maker agrees to let the holder select an attorney for the maker; at any time the
holder directs, said attorney is hereby given the authority to confess judgment
against the maker in any appropriate court” – No, negotiable (exception 3-106(b)(ii))
a) Confession of judgment or warrant of attorney provision: OH law clearly allows
it except in consumer law (but meritorious defense is allowed)
d. “On the front of the check: “By cashing this check, the payee agrees that the drawer
has made payment in full of the debt drawer owed payee as result of the purchase of
a 2012 Ford, made on January 24, 2012” – No, negotiable b/c additional undertaking
by the payee, not by the drawer
e. “Maker hereby grants the payee a security interest in the collateral described below”
– negotiable (creation of security interest is okay b/c it is about collateral)
3. Woodworth v. The Richmond Indiana Venture:
a. Fact: P executed a promissory note payable to Richmond for $655K and the note was
negotiated to D Signet Bank. The promissory note contained a term that if the maker
of the note failed to pay on time then the Partnership had the option to kick the
maker out and the maker would forfeit his partnership interest in addition to other
remedies in the Partnership agreement.
b. Held: This was more than recitation of security or an agreement to protect collateral.
This was forfeiture w/o resort to judicial process so the negotiability of the note was
destroyed. Since it was not negotiable, D Signet Bank couldn't claim HDC status and
was subject to ordinary K defenses Woodward had against Richmond. The forfeiture
was at the option of the partnership and not the holder and partnership could
exercise this even before the holder declared a default. Where doubt exists THE
PRESUMPTION IS AGAINST negotiability.
G. Payable on Demand or at a Definite Time
1. Must be able to tell when it comes due
a. But, no requirement that the instrument be dated
i. If the instrument does not state any time of payment, it is presumed to be payable
on demand
b. 3-108 (Payable on Demand or at a Definite Time)
i. A promise or order is “payable on demand” if it (i) states that it is payable on
demand or at sight, or otherwise indicates that it is payable at the will of the
holder, or (ii) does not state any time of payment.
ii. A promise or order is “payable at a definite time” if it is payable on elapse of a
definite period of time after sight or acceptance or at a fixed date or dates or at a
time or times readily ascertainable at the time the promise or order is issued,
subject to rights of (i) prepayment, (ii) acceleration, (iii) extension at the option of
the holder, or (iv) extension to a further definite time at the option of the maker or
acceptor or automatically upon or after a specified act or event.
iii. If an instrument, payable at a fixed date, is also payable upon demand made
before the fixed date, the instrument is payable on demand until the fixed date
and, if
 demand for payment is not made before that date, becomes payable at a definite
time on the fixed date.
c. 3-113 (Date of Instrument)
i. An instrument may be antedated or postdated. The date stated determines the
time of payment if the instrument is payable at a fixed period after date. Except as
provided in 4-401(c), an instrument payable on demand is not payable before the
date of the instrument
ii. If an instrument is undated, its date is the date of its issue or, in the case of an
unissued instrument, the date it first comes into possession of a holder
2. Problem 91: Do the following clauses destroy negotiability?
a. “Payable 30 days after sight”: negotiable b/c payable at definite time
b. “Payable in 11 successive monthly installments of $2,414.92 each and in a final
payment of $2,415.03 thereafter. The 1st installment being payable on the _ day of
20_, and the remaining installments on the same date of each month thereafter until
paid”: nonnegotiable b/c neither on demand nor definite time (when in doubt,
presumption against negotiability)
i. Barclays Bank v. Johnson: not a negotiable instrument in that it did not state
either that it was payable on demand or at a definite time
c. “Payable on Nov. 8, 2012, but the holder may demand payment at any time prior
thereto if he deems himself insecure”: negotiable b/c payable at definite time with
acceleration clause
d. “Payable when the sun comes up tomorrow”:
i. negotiable b/c payable at definite time (tomorrow)
ii. or you may argue that you don’t know when is tomorrow from the instrument
e. “Payable on Nov. 8, 2012, but if my potato crop fails that year, payment shall be
extended until Nov. 8 of the following year”: negotiable b/c maker’s extension is also
definite (3-108(b)(iv))
f. “Payable on Nov. 8, 2012, but the maker hereby reserves the option to extend the
time of payment until he can pay without serious financial hardship”: nonnegotiable
b/c no definite date
g. “Payable 120 days after my rich uncle Al dies (post-obituary notes)”: nonnegotiable
b/c not payable on demand and not at specific time
h. “Payable 100 yrs from today, but if my rich uncle Al dies before this note is due, it
shall become payable 10 days after distribution of his estate is made to his heirs”:
negotiable b/c payable at specific time with acceleration clause
i. Smith v. Gentilotti: the check’s negotiability was not affected by the fact it was
postdated 15 yrs
i. “Payable on my next birthday”:
i. nonnegotiable b/c the time is not certain from the face of the instrument
ii. you may argue that if you’re famous person, your birthday can easily looked up
even after you die
H. Payable to Bearer or to Order (words of negotiability)
1. 2 ways of establishing privity b/w the original creator of the paper and the later holder
 a. Bearer paper: Make the original promise or order payable to bearer (payable to the
holder of the paper and not to any specific person)
i. Privity passes with the physical delivery of the instrument
ii. Problem: too negotiable b/c stolen instrument is free of defense of theft
b. Order paper: Have the creator of the instrument make it payable to a specified
person or to whomever that person further ordered the paper paid
i. Must include the word “order”
ii. e.g.: pay to the order of John Smith: paid to John Smith or to whomever he orders
as his nominee
iii. Until John Smith makes some sort of order, the instrument cannot be validly
transferred
a) Usually in writing and signing
2. Words of negotiability: either bearer or order language necessary to be negotiable
a. Means of easily identifying K meant to be negotiable
3. 3-109 (Payable to Bearer or Order):
a. A promise or order is payable to bearer if it:
i. states that it is payable to bearer or to the order of bearer or otherwise indicates
that the person in possession of the promise or order is entitled to payment;
ii. does not state a payee; or
iii. states that it is payable to or to the order of cash or otherwise indicates that it is
not payable to an identified person.
b. A promise or order that is not payable to bearer is payable to order if it is payable (i)
to the order of an identified person or (ii) to an identified person or order. A promise
or order that is payable to order is payable to the identified person.
c. An instrument payable to bearer may become payable to an identified person if it is
specially indorsed pursuant to Section 3-205(a). An instrument payable to an
identified person may become payable to bearer if it is indorsed in blank pursuant to
Section 3-205(b).
4. Problem 92: Do the following clauses create bearer paper? (bearer paper is payable to
the bearer of the paper while order paper must include the word “order”)
a. “Pay to John Smith”: nonnegotiable b/c no words of negotiability (“Order or bearer”)
i. Sunrizon Homes v. American Guar: The sales K failed to meet the requirement
that a negotiable instrument be made payable to order or bearer
ii. Exception: checks are negotiable even if payable to a specific person (without
bearer or order language)
b. “Pay to the order of John Smith or bearer”: bearer paper
i. OC2 to 3-109: Sometimes the drawer will write the name of the payee “John Doe”
but will add the words “or bearer.” In that case the check is payable to bearer
c. “Pay to bearer”: bearer paper
d. “Pay to the order of Cash”: bearer instrument
e. “Pay to a Merry Christmas”: technically bearer b/c not payable to an identified person
i. Pay to anything (other than a specified person): bearer instrument
5. Problem 93: Do the following clauses create order or bearer paper, or do they make the
instrument nonnegotiable for failure to create either?
a. “Pay to the order of (blank)”: bearer paper until the blank is filled in b/c not payable
to an identified person
i. 3-115(b): Subject to subsection (c), if an incomplete instrument is an instrument
under 3-104, it may be enforced according to its terms if it is not completed, or
according to its terms as augmented by completion. If an incomplete instrument is
not an instrument under 3-104, but, after completion, the requirements of 3-104
are met, the instrument may be enforced according to its terms as augmented by
completion.
ii. OC3: In some cases the incomplete instrument does not meet the requirements of
3-104. An example is a check with the amount not filled in. The check cannot be
enforced until the amount is filled in. If the payee fills in an amount authorized by
the drawer the check meets the requirements of 3-104 and is enforceable as
completed. If the payee fills in an unauthorized amount there is an alteration of
the check and 3-407 applies.
b. “Pay to John Doe’s estate”: nonnegotiable b/c no order language (“Pay to John Doe’s
estate or order” creates order paper under 3-109(b)(ii))
i. 3-110(c)(2)(i): If an instrument is payable to a trust, an estate, or a person
described as trustee or representative of a trust or estate, the instrument is
payable to the trustee, the representative, or a successor of either, whether or
not the beneficiary or estate is also named
ii. Sirius v. Erickson: The note was not payable to bearer b/c it specifically identified
the person to whom payment was to be made, the company, and even though the
note was payable to an identified person, it was not payable to order b/c it lacked
the words of negotiability "to order" required under 3-109(2).
c. “Pay to the order of the President of U.S.”: order paper payable to whoever holds
that office
i. 3-110(c)(2)(iv): if an instrument is payable to an office or to a person described as
holding an office, the instrument is payable to the named person, the incumbent
of the office, or a successor to the incumbent.
d. The drawer of a check drew a line through the words “the order of” that were
printed on the check prior to the space for the payee’s name. Is the check, as
altered, negotiable? Still negotiable b/c check does not require the word “order”
i. 3-104(c): An order that meets all of the requirements of subsection (a), except
paragraph (1), and otherwise falls within the definition of “check” in subsection (f)
is a negotiable instrument and a check.
e. If the drawer of a check or the maker of a promissory note wants to destroy
negotiability, what should be done? Must conspicuously state in the instrument that
it is nonnegotiable.
i. 3-104(d): A promise or order other than a check is not an instrument if, at the time
it is issued or first comes into possession of a holder, it contains a conspicuous
statement, however expressed, to the effect that the promise or order is not
negotiable or is not an instrument governed by Art. 3
 f. Why would this ever be desirable?
I. Consumer Notes
1. Creation of a negotiable instrument deprives a maker of the usual K defenses
a. Many state consumer statutes forbid a seller/lessor to take a negotiable instrument
(other than a check) as part of a consumer sale/lease
i. But not destroy the negotiability: if a consumer note gets into the hands of a HDC,
the consumer unable to assert K defenses
b. Uniform Consumer Credit Code: preserves a consumer’s defenses even if the
instrument is owned by a HDC
2. FTC regulation requires that all promissory notes and Ks taken in consumer sales or
purchase money loans contain the notice that the holder is subject to all claims and
defenses
a. 9-403(d) and 9-404(d) automatically add the missing statement to all consumer
transactions
b. Question: does the required FTC language destroy negotiability?
i. 3-106(d): ordinarily it would defeat negotiability but 3-106(d) says it’s still
negotiable.

CHAPTER 8. NEGOTIATION
I. Some Technical
Terms
A. Parties
1. Promissory note (2 party instrument)
a. Maker: person who issues the instrument and promises to pay
i. Must pay the instrument (i) according to its terms at the time it was issues; or (ii) if
the issuer signed an incomplete instrument, according to its terms when
completed
b. Payee: person to whom the note is made payable
i. If payable to bearer: no specific payee, whoever has possession of the paper is
presumptively entitled to payment by the maker
2. Draft (3 party instrument)
a. Drawer: person who crates the draft and orders the drawee to pay
i. Upon dishonor of the draft by the drawee, drawer will pay the amount of the draft
b. Drawee: person to whom the drawer addresses the order of payment
i. Check: drawee is the bank at which the drawer has an account (payor bank)
c. Payee: person specified by the drawer as entitled to receive payment
i. If payable to bearer: no specific payee, any holder is entitled to payment from the
drawee
ii. If payable to the order of a specific person: that person is payee and may further
transfer (negotiate) the check
B. Negotiability v. Negotiation
1. Negotiability: form
a. Is an instrument negotiable = Is the instrument in the proper form to meet the
technical requirements of negotiability in 3-104(a)?
2. Negotiation: transfer (process)
 a. Has the instrument been negotiated? = Is the attempted transfer of the instrument
legally valid?
b. Negotiation is transfer made so that the current possessor can be a holder
II. Transfer and Negotiation
A. 3 states of negotiable instruments
1. Issuance (creation of the instrument and the first delivery by maker)
a. 3-105(a): the first delivery of an instrument by the maker or drawer, whether to a
holder or nonholder, for the purpose of giving rights on the instrument to any person
2. Transfer of the instrument
a. Legally significant movement of the paper b/w issuance and presentment
3. Presentment for payment
a. 3-501(a): a demand made by or on behalf of a PETE (i) to pay the instrument made to
the drawee or a party obliged to pay the instrument or, in the case of a note or
accepted draft payable at a bank, to the bank, or (ii) to accept a draft made to the
drawee.
B. 3-203(b): Transfer of an instrument, whether or not the transfer is a negotiation, vests in
the transferee any right of the transferor to enforce the instrument, including any right as
a HDC, but the transferee cannot acquire rights of a HDC by a transfer, directly or
indirectly, from a HDC if the transferee engaged in fraud or illegality affecting the
instrument.
1. If the physical transfer is done in such a manner as to make the transferee a technical
holder, then the transfer is called a negotiation
2. No one can become a HDC unless that person is first a holder, and becoming a holder is
tied up with proper negotiation
a. A proper negotiation confers holder status on the transferee with all the benefits
holder status carries
C. 3-201 (Negotiation)
1. “Negotiation” means a transfer of possession, whether voluntary or involuntary, of an
instrument by a person other than the issuer to a person who thereby becomes its
holder.
2. Except for negotiation by a remitter, if an instrument is payable to an identified person,
negotiation requires transfer of possession of the instrument and its indorsement by
the holder. If an instrument is payable to bearer, it may be negotiated by
transfer of possession alone.
3. Negotiation of order paper is accomplished by
a. The indorsement by the proper person (indorse) and
i. Indorsement: signature placed on an instrument by the payee or any later
transferees
b. The delivery of the instrument to the transferee (holder)
4. Negotiation of bearer paper needs no indorsement
a. Delivery to the transferee is all that is required for the transferee to qualify as a holder
III. Special and Blank Indorsement
A. Blank indorsement
1. Payee simply signs the back of the instrument
 2. Legal effect of converting the instrument into bearer paper (anyone in possession,
including a thief, is a HDC)
B. Special indorsement
1. If the payee wishes to preserve the order character, the original payee may specify a
new payee by writing “Pay to (name of new payee)” above the indorsement (no
need of “order” language, but you may include it)
2. Legal effect of making the instrument the sole property of the new payee, who becomes
a holder as soon as the instrument is delivered
a. Until the delivery, the original payee can strike out the special indorsement and do
anything with the instrument
3. Negotiability of an instrument is not affected by language written on the instrument
during the course of negotiation
C. Problem 94: Hansen paid Egger by writing out a Mechanical Bank check for $50. Egger
wrote his name on the back of the check (blank indorsement -> bearer paper) and Egger’s
wife brought the check to Cornucopia Grocery. The manager paid $50 to Egger’s wife and
wrote “Pay to Cornucopia Grocery” just above Egger’s signature. (special indorsement) The
check was delivered to Octopus Bank by Speed (check collection messenger) and Octopus
Bank stamped “Octopus Bank” on the back of the check. The check was forwarded to
Mechanical Bank.
1. To which parties should these labels be attached?
a. Drawer: Hansen
b. Drawee: Mechanical Bank
c. Payee: Egger
d. Depositary bank (4-105(2): the first bank to take an item even though it is also the
payor bank, unless the item is presented for immediate payment over the counter):
Octopus Bank
2. Did the following people qualify as holders?
a. Hansen: X (drawer)
b. Egger: holder b/c identified in the instrument and in possession
c. Egger’s wife: holder b/c in possession and the instrument was payable to the bearer
after Egger made blank indorsement on it
d. Manager of Grocery: holder (agent b/c in possession when it was payable to bearer)
e. Grocery: holder b/c the manager converted the blank indorsement into a special
indorsement by writing and was in possession through its agent
f. Speed: X b/c now special indorsement instrument and payable only to the specified
person
g. Octopus Bank: holder b/c it was the depositary bank
i. 4-205 (Depositary Bank Holder of Unindorsed Item): depositary bank is a holder if
the customer was a holder, whether indorsed or not
h. Mechanical Bank: X (drawee) – drawee is never a holder even if it gets possession b/c
the check was not transferred to them, but surrendered to them
3. If Egger had failed to indorse the check, but simply deposited it in his account with
Octopus Bank, would the bank have been a holder?
 a. 4-205: Yes, the depositary bank becomes the holder, whether or not the customer
indorse it
4. What was the legal effect of the language written on the check by the grocery store
manager?
a. Converted a blank indorsement to a special indorsement: making the instrument the
sole property of the new payee, who becomes a holder as soon as the instrument is
delivered
5. Which of the parties are properly called indorsers?
a. Egger & Octopus Bank
b. 3-204(a): “Indorsement” means a signature, other than that of a signer as maker,
drawer, or acceptor, that alone or accompanied by other words is made on an
instrument for the purpose of (i) negotiating the instrument, (ii) restricting payment
of the instrument, or (iii) incurring indorser's liability on the instrument, but
regardless of the intent of the signer, a signature and its accompanying words is an
indorsement unless the accompanying words, terms of the instrument, place of the
signature, or other circumstances unambiguously indicate that the signature was
made for a purpose other than indorsement. For the purpose of determining
whether a signature is made on an instrument, a paper affixed to the instrument is a
part of the instrument.
c. “Indorser” means a person who makes an indorsement (who write their names on
the check)
D. 3-110(d):
1. Payable to X or Y: If an instrument is payable to two or more persons alternatively, it is
payable to any of them and may be negotiated, discharged, or enforced by any or all of
them in possession of the instrument.
2. Payable to X and Y: If an instrument is payable to two or more persons not
alternatively, it is payable to all of them and may be negotiated, discharged, or
enforced only by all of them.
3. Payable to X and/or Y: If an instrument payable to two or more persons is ambiguous as
to whether it is payable to the persons alternatively, the instrument is payable to the
persons alternatively.
E. Problem 95:
1. A check was made payable to “Mary and Donald Colpitts.” Must both payees indorse it
in order to negotiate the instrument? Yes
2. “Mary or Donald Colpitts”: any or all may indorse it
3. “Mary Colpitts, Donald Colpitts”: the same as Mary or Donald Colpitts, and can be
indorsed by any or all of them
4.Stacked: ambiguous -> alternatively -> may be indorsed by any or all of them
Mary Colpitts
Donald Colpitts
Pay to the order of Façade Motor Company
a. Pelican National Bank v. Provident National Bank: ambiguous -> alternatively -> only
one may sign
F. Problem 96: Portia Moot received her paycheck made out to “Portia Mort” and took it to
 her bank to cash it. What steps should the bank take?
1. 3-204(d): If an instrument is payable to a holder under a name that is not the name of
the holder, indorsement may be made by the holder in the name stated in the
instrument or in the holder's name or both, but signature in both names may be
required by a person paying or taking the instrument for value or collection.
2. She can sign (i) her real name, (ii) the misspelled name, or (iii) both if required by the
bank
G. 3-301: A “person entitled to enforce (PETE)” an instrument means (i) the holder of the
instrument, (ii) a nonholder in possession of the instrument who has the rights of a
holder, or (iii) a person not in possession of the instrument who is entitled to enforce the
instrument pursuant to Section 3-309 or 3-418(d). A person may be a PETE the
instrument even though the person is not the owner of the instrument or is in wrongful
possession of the instrument
H. 1-201(21): “Holder” means:
1. the person in possession of a negotiable instrument that is payable either to bearer or
to an identified person that is the person in possession; or
2. the person in possession of a document of title if the goods are deliverable either to
bearer or to the order of the person in possession.
I. Problem 97: Desert Paradise initiated a scam in which hundreds of people signed
promissory notes. Desert Paradise, the payee on all these notes, sold them in bulk to
Octopus National Bank (ONB). Rather than indorsing its name hundreds of times on each
of the notes, Desert Paradise had its indorsement printed on a separate sheet of paper,
which it then folded into each promissory note without connecting it in any way other
than the fold. ONB demanded payment from the makers of the notes, claiming to be a
HDC, so as to take free of defenses of breach of K and fraud. Is ONB a holder?
1. 3-204(a): . . . For the purpose of determining whether a signature is made on an
instrument, a paper affixed to the instrument is a part of the instrument. (gluing,
pasting, stapling are okay, but wrapping around the noted is not okay)
a. OC1: The last sentence of subsection (a) is based on subsection (2) of former Section
3-202. An indorsement on an allonge is valid even though there is sufficient space on
the instrument for an indorsement.
2. Adams v. Madison Realty: the loose indorsement sheets accompanying defendant
bank's notes were not physically attached to the instruments in any way, and, thus,
patently failed to comply with the explicit Code prerequisite.
3. Lamson v. Commercial Credit: stapling is the modern equivalent of gluing or pasting
4. So, ONB is not a holder b/c the indorsement sheet is not sufficiently affixed to the
instrument
5. Mortgage case: at the closing of the mortgage, you must sign the mortgage document
AND the promissory note (bank may not foreclose unless it has the original promissory
note properly negotiated)
IV. Forgery of the Payee’s Name
A. Principle
1. If an instrument is payable to the order of a named payee, only that payee can become
 a holder upon getting possession of the instrument
2. Thereafter, no one can qualify as a holder until the payee indorses the instrument
a. Without the payee’s valid indorsement, no later transferee will have taken by a valid
negotiation of the instrument, which remains the payee’s property
b. Unauthorized signature (forgery or signature by non-agent) is not effective to
negotiate the instrument
i. Following a forgery of the payee’s name, no later transferee can qualify as a
holder
c. Forgery breaks the chain of HDC!
B. Problem 98: A check payable to Laura Lawyer and not indorsed was stolen. Thief forged
her name to the back of the check and transferred it to an innocent party, Gornucopia
Grocery, who tried to cash the check at the drawee bank. Can Laura retrieve the check?
1. 3-306: A person taking an instrument, other than a person having rights of a HDC, is
subject to a claim of a property or possessory right in the instrument or its proceeds,
including a claim to rescind a negotiation and to recover the instrument or its
proceeds. A person having rights of a HDC takes free of the claim to the instrument.
2. Cornucopia is not a holder b/c the check was fraudulently indorsed (transfer after
forgery is not a negotiation), so it took the instrument subject to the claim by Laura.
Laura can get her check back.
a. The thief will be the defendant in this case.
C. Problem 99: in Problem 98, after Laura signed her name to the back of the check, it was
blown out. Harry took it to Cornucopia and asked the manager to cash it, telling him that
he was Laura’s father, Lance Lawyer. Harry wrote Lance Lawyer under Laura’s
indorsement. Is Cornucopia a holder?
1. Once Laura singed the check (blank indorsement), the check became a bearer paper.
Anyone who takes the possession of it, including a thief, is a holder. Harry possessed
the check, so he was a holder and he transferred it to Cornucopia. So, Cornucopia is a
holder too.
2. So, the forgery is irrelevant after the check became a bearer paper
D. Problem 100: in Problem 98, Laura wrote “Pay to Lilly Lawyer” (her mother) and then
signed her own name, and the instrument was blown out to Harry. He indorsed “Lilly
Lawyer” under Laura’s name and transferred the check to Cornucopia. Is Cornucopia a
holder?
1. 3-205(a): If an indorsement is made by the holder of an instrument, whether payable
to an identified person or payable to bearer, and the indorsement identifies a person to
whom it makes the instrument payable, it is a "special indorsement." When specially
indorsed, an instrument becomes payable to the identified person and may be
negotiated only by the indorsement of that person. The principles stated in Section 3-
110 apply to special indorsements.
2. Laura made a special indorsement and the instrument became payable to Lilly and may
be negotiated only by Lilly. In other words, only the person identified in the instrument
(Lilly) can be a holder. Harry is not a holder and did forgery by signing Lilly’s name, so
the transfer to Cornucopia is not negotiation. Thus, Cornucopia is not a holder.
 E. Problem 101: in Problem 98, Laura simply wrote her name on the back of the check and
mailed the check to her mother who then wrote “Pay to Lilly Lawyer” above Laura’s
indorsement. Has the check now become order paper requiring the mother’s
indorsement for further negotiation?
1. 3-205(c): The holder may convert a blank indorsement that consists only of a signature
into a special indorsement by writing, above the signature of the indorser, words
identifying the person to whom the instrument is made payable.
2. Yes, Laura’s blank indorsement made the check a bearer paper. Lilly is a holder b/c
she has the possession of the check. Now, she converted the blank indorsement into a
special indorsement by her writing above Laura’s signature.

CHAPTER 9. HOLDERS IN DUE COURSE

I. Acquiring HDC Status
A. Introduction
1. HDC: super plaintiff, free of almost any defenses
a. Usually, payee cannot be a HDC b/c he is so closely involved in the transaction that he
has notice of the defects of the transaction
b. But, if a 3rd party is a payee who has no knowledge of the transaction, he can be a
HDC b/c he has no notice of the defects
2. 3-302(a): Subject to subsection (c) and Section 3-106(d), “HDC” means the holder of an
instrument if:
a. the instrument when issued or negotiated to the holder does not bear such apparent
evidence of forgery or alteration or is not otherwise so irregular or incomplete as to
call into question its authenticity; and (factual question)
b. the holder took the instrument (i) for value, (ii) in good faith, (iii) without notice that
the instrument is overdue or has been dishonored or that there is an uncured default
w/r/t payment of another instrument issued as part of the same series, (iv) without
notice that the instrument contains an unauthorized signature or has been altered,
(v) without notice of any claim to the instrument described in Section 3-306, and
(vi) without notice that any party has a defense or claim in recoupment
described in Section 3-305(a).
c. OC4: Normally, payee is so involved in the underlying transaction that he has notice
of problems affecting payment obligations and thus cannot be a HDC. But, payee can
qualify as a HDC in some rare situations
3. 3-302(c): Except to the extent a transferor or predecessor in interest has rights as a
HDC, a person does not acquire rights of a HDC of an instrument taken (i) by legal
process or by purchase in an execution, bankruptcy, or creditor's sale or similar
proceeding, (ii) by purchase as part of a bulk transaction (extraordinary sale of all
inventory) not in ordinary course of business of the transferor, or (iii) as the successor
in interest to an estate or other organization.
a. List of extraordinary transactions in which the transferee is statutorily denied HDC
status
b. In spite of this, federal agencies acquire HDC status as a matter of federal law when
 taking over failed financial institutions
B. Holder
1. In order to be a HDC, the possessor of the instrument must qualify as a holder
a. The instrument must be technically negotiable; and
b. Must have been technically negotiated into the hands of its current possessor
i. The named payee becomes a holder on issuance of the instrument without the
necessity of a negotiation
2. The drawee bank does not qualify as a holder (when it takes the check for payment)
a. b/c the process by which the drawee bank acquires the instrument is not a
negotiation, but a mere surrender for payment (presentment)
C. Value
1. Whether someone qualifies as a HDC is measured at the moment he gave value for the
instrument
a. Things that happen after value is given do not destroy HDC status once achieved
2. What is value? (broadly defined, but not same as consideration)
a. 3-303: An instrument is issued or transferred for value if:
i. the instrument is issued or transferred for a promise of performance, to the extent
the promise has been performed;
ii. the transferee acquires a security interest or other lien in the instrument other
than a lien obtained by judicial proceeding;
iii. the instrument is issued or transferred as payment of, or as security for, an
antecedent claim against any person, whether or not the claim is due;
iv. the instrument is issued or transferred in exchange for a negotiable instrument; or
v. the instrument is issued or transferred in exchange for the incurring of an
irrevocable obligation to a third party by the person taking the instrument
b. “Consideration” means any consideration sufficient to support a simple contract. The
drawer or maker of an instrument has a defense if the instrument is issued without
consideration. If an instrument is issued for a promise of performance, the issuer has
a defense to the extent performance of the promise is due and the promise has not
been performed. If an instrument is issued for value as stated in subsection (a), the
instrument is also issued for consideration.
c. Gift of an instrument will never create HDC status in the donee
d. Giving value is not the same thing as giving consideration
e. OC1 to 3-303: one gives value only to the extent that the holder has performed the
consideration or made some irrevocable commitment in connection with it
i. Unexecuted promise (even if it is sufficient consideration) is not value: a holder
may refuse to perform when problem arises and doesn’t need the extraordinary
status of holding in due course
3. Problem 102: Joe took his paycheck to the lawyer and indorsed it over to him in return
for his promise to represent Joe in his divorce action. Later that evening, Joe’s wife sent
the sheriff to seize his paycheck. Can the sheriff succeed in wresting the check from the
layer?
a. 3-306: A person taking an instrument, other than a person having rights of a HDC, is
 subject to a claim of a property or possessory right in the instrument or its proceeds,
including a claim to rescind a negotiation and to recover the instrument or its
proceeds. A person having rights of a HDC takes free of the claim to the instrument.
b. Carter & Grimsley v. Omni Trading: promise not yet performed -> no value -> not a
HDC
c. Unexecuted promise is not value, so the lawyer is not a HDC, subject to a claim of a
property right in the check. So the sheriff can wrest the check from the lawyer
i. if you’re a very famous divorce lawyer and retaining you as an attorney is itself
advantageous, you may argue that it is a retainer and you can keep it
4. Problem 103: Zach bought a car, signing a promissory note for $23K payable to seller.
Seller sold the note to Pierce for $22.8K. The car fell apart and Zach refused to pay.
a. Is Pierce a HDC for $23K or $22.8K?
i. Bankers Guar v. Fisher: discount is not taken out, HDC for the full amount
ii. Pierce is a HDC under 3-303(a)(4) for $23K b/c it have fully performed its part of
the deal (buying the note for $22.8K - court will not take the discount out)
b. If seller owed his mother $21K and gave her the note, the extra $2K being Mother’s
Day gift, would the mother be a HDC for the full amount?
i. No, b/c there was a antecedent debt, the mother is a HDC under 3-303(a)(3) only
for the consideration paid ($21K), but not for the extra $2K
5. Problem 104: Nodding wrote a $1K check (to be drawn on First Bank) payable to Tom,
Tom deposited it to his Last Bank (depositary bank) account after indorsing it. Last Bank
sent the check to First Bank for payment, but Nodding stopped payment so that the
check returned to Last Bank. Is Last Bank a HDC?
a. No b/c it has not given value for the check. (no withdrawal of money from the
account yet)
b. If Last Bank had permitted Tom to get money, it would be a HDC
i. 4-211: for purposes of determining its HDC status, a bank gives value whenever it
has a security interest in the instrument (i.e. if the bank out anything, if he took
the money out of the account)
6. Falls Church Bank v. Wesley Heights:
a. Issue: Can a depositary bank achieve the status of HDC of a negotiable paper
deposited with it by a customer?
b. Facts: X drew a check for $1,400, payable to the order of a Customer of Bank. The
Customer deposited the check in his account and was given a provisional credit. The
customer withdrew $140 from his account prior to the bank’s discovering that X had
stopped payment on the $1,400 check. When the check was returned to the bank
dishonored, the bank’s customer left no credits in his account on which to charge the
$140. The bank then made a demand on X for the amount. X refused.
c. Rule: A bank acquires a SI in items deposited with it to the extent that the provisional
credit given the customer on the item is withdrawn (4-210). For the purpose of
achieving the status of HDC, the depositary bank gives value to the extent that it
acquires a SI in the item in question (4-211). As a HDC as to $140, the Bank is a HDC
and its claim cannot be defeated.
 d. Note: Here, the customer had nothing in the account except $1,400-$140. If all they
gave was $140, then they’re only a holder to the extent of $140.
7. Problem 105: in Problem 104, Tom deposits the $1K check in his account which contains
$500. Then he withdraws $500. Is the bank a HDC for any amount?
a. 4-210(b): FIFO rule (First In, First Out)
i. No, the bank is not a HDC b/c the money was withdrawn from the preexisting
balance
b. What if he withdraws $750?
i. Then, the bank is a HDC only for $250 that has been taken out from his preexisting
money in the account
D. Good Faith and Notice (factual question)
1. To become a HDC, the owner of the instrument must be a bona fide purchaser who has
given value for the instrument in good faith
a. Good faith (both subjective and objective)
i. Subjective test: honesty in fact in the conduct or transaction concerned; and
ii. Objective test: observance of reasonable commercial standards of fair dealing
b. No notice: regarding problems with the instrument
2. General Investment v. Angelini:
a. Fact: Lustro agreed to do some work on Angelinis’ home. Angelini executed a note
that it would begin payments 60 days after the work was completed. Before Lustro
completed the work he sold the note at a discount to General Investment. But Lustro
never completed the work. Claiming to be a HDC, General Investment sued Angelini.
b. Rule: The more the holder knows about the underlying transaction, and particularly
the more he controls or participates or becomes involved in it, the less he fits the
role of a good faith purchaser for value. (You cannot close your eye to suspicious
circumstances to be in good faith)
c. Ordinarily where the note appears to be negotiable in form and regular on its face,
the holder is under no duty to inquire as to possible defenses, such as failure of
consideration, unless the circumstance of which he has knowledge rise to the level
that the failure to inquire reveals a deliberate desire on his part to evade knowledge
b/c of a belief or fear that investigation would disclose a defense arising from the
transaction. Once it appears that a defense exists against the payee, the person
claiming the rights of a HDC has the burden of establishing that he is in all respects
such a holder (3-308). Absence of inquiry under the circumstance amounts to an
intentional closing of the eyes and mind to any defect in or defenses to the transfer.
They could have demanded a certificate of completion. Thus, Gen Inv did not acquire
the note in good faith and therefore is not a HDC.
d. Held: Even though they gave value, they didn’t take in good faith [b/c they didn’t
observe reasonable commercial standards].
3. Problem 106: A corporate treasurer of Business Corporation used a corporate check to
pay his American Express bills every month for 2 yrs. BC sued AE in quasi-K for all the
money it had received and AE replied that it was a HDC. How should this be resolved?
AE is a HDC (although it is a payee) free of BC’s claims
 a. Hartford Accident v. American Express: AE is a HDC, free of BC’s claims b/c it had no
notice of BC’s claims and it had no duty to ask BC’s purposes in issuing checks
b. Grand Rapids v. MBNA: Bank has no duty of inquiry where it receives a check in
payment for a credit card account
c. Court says that it is very common for a company to reimburse individual’s expenses
4. Any Kind Checks v. Talcott:
a. Fact: An associate of the indorser persuaded the maker to issue the check to recover
a failed investment, as part of a scam perpetrated on the maker. The indorser
presented the check to the check cashing center, which paid it after unsuccessfully
trying to contact the maker. The maker stopped payment on the check.
b. Held: The center had to both be honest in fact and observe reasonable commercial
standards when cashing the check, to claim the status of a HDC. The check for $
10,000 cashed by someone identifying himself as a broker, was not the typical
transaction handled by the center, and reasonable commercial standards required
more care than its normal transaction. The fact that the center could not place a
holder on the check before releasing funds also required more careful verification of
the check. By releasing funds without verifying the check with its maker, the center
did not observe reasonable commercial standards and was not a HDC.
c. Note: $10K is unusual amount and the check cashing company should have been
more cautious in dealing with it
d. Question: Would a check cashing business be in good faith if it acquired a postdated
check before the date of the check? No (but Prof. thinks the OH decision is wrong b/c
people frequently cash postdated checks before the date)
i. Buckeye Check Cashing v. Camp: It was put on notice that the check might not be
good until the date on the check, and should have attempted to verify its validity in
a commercially reasonable manner
5. Winter & Hirsch v. Passarelli
a. Issue: Whether the defense of usury is available for use against P, who claims to be
HDC of the promissory note and therefore claim to have taken it free from the
defense of usury. Yes
b. Fact: P provided the money for the usurious loan before the loan was actually made.
P Winter & Hirsch gave money to Equitable, and Equitable gave money to Passarelli,
in exchange for a note. Winter & Hirsch claim to be a HDC. B/c it gave Equitable the
money before the note was executed, it was a co-originator of the loan and as such is
charged with knowledge of the terms of the loan, and therefore knew of the usurious
rate being charged.
c. Rule: Even if the note was seen prior to plaintiff giving Equitable $11K, then P also
says that the D had signed a note promising to repay $16K. As such it should have
asked why Equitable would sell a $16K note for $11K. We cannot permit parties to
intentionally keep themselves in ignorance of facts which, if known, would defeat
their unlawful purpose. When an instrument is so incomplete as to call its validity
into question, a purchaser of that instrument is on notice of the possibility of a
claim against it (3-302(a)(1) – so irregular or incomplete). Here, the incomplete part
was the
 principal sum of the loan extended to the D [the note didn’t say how much Equitable
had loaned to Passerelli (10K), only the amount (16K) Passarelli was obligated to pay,
and the amount of the discount (11K)]. By failing to include the principal amount
loaned to the borrower on the face of the loan K or note, a subsequent purchaser of
that K is able to say “I had no idea that usury was involved.” (usury -> illegality -> real
defense under 3-305(a)(1))
d. Question: Would the FTC HDC rule apply to the promissory note signed in this case if
the transaction had taken place after the effective date of that rule?
6. Problem 107: Fred wrote a check on Jan. 5, 2012, but mistakenly put down “2011” then
crossed out the last digit and wrote “2” above it. Can anyone become a HDC of this
instrument?
a. 3-302(a)(1)—the purchaser has notice of a claim or defense if the instrument is so
incomplete, bears such visible evidence of . .. alteration. .. .”
b. This would not seem to be “so incomplete”. This alteration would not call into
question the authenticity of the entire instrument. If cross out the amount, then it
might call that into question.
7. Problem 108: AFC was the payee on a promissory note singed by John. On its face, the
note calls for John to make 12 monthly interest payments before the note matures. AFC
sold the note at a discount to BTB. If the note has written on it, in big letters, a penciled
notation. “Missed Paying First Installment,” can BTB ever qualify as a HDC?
a. 3-304(b): W/r/t an instrument payable at a definite time the following rules apply:
i. If the principal is payable in installments and a due date has not been accelerated,
the instrument becomes overdue upon default under the instrument for
nonpayment of an installment, and the instrument remains overdue until the
default is cured.
ii. If the principal is not payable in installments and the due date has not been
accelerated, the instrument becomes overdue on the day after the due date.
iii. If a due date w/r/t principal has been accelerated, the instrument becomes
overdue on the day after the accelerated due date.
b. Unless the due date of principal has been accelerated, an instrument does not
become overdue if there is default in payment of interest but no default in payment
of principal.
c. OC2: the distinction made under former Art. 3 b/w defaults in payment of principal
and interest. Installment instruments and single payment instruments are treated
separately. If an installment is late, the instrument is overdue until the default is
cured.
d. The note was not overdue, so BTB had no notice on default
8. Problem 109: Dan wrote a check dated April 30 to Dr. Paine, which it fell to the floor
and lay until the end of August. Dr. Paine then indorsed the check over to his local
grocery store on August 31 and it bounced on Sept. 3 b/c Dan stopped payment. Is the
grocery store a HDC?
a. 3-304(a)(2): An instrument payable on demand becomes overdue at the earliest of
the following times: if the instrument is a check, 90 days after its date
b. The check was overdue when the grocery got possession of it, so it had sufficient
 notice of defect
9. Problem 110: Ellen bought a computer and wrote a promissory note to the seller, the
note stating “payable at Busy State Bank (bank pays the note when presented, and
expects reimbursement from the maker).” Head cashier promised not to pay the note
upon Ellen’s request, but forgot and paid by accident after 4 months. Can the bank
demand payment?
a. Forgotten Notice Doctrine: a holder is permitted to forget notice and become a HDC
if sufficient time passed b/w the notice and the acquisition of the instrument
b. 1-202(f):
c. OC25 to 1-201: a person has notice when he has received a notification of the fact in
question. But by the last sentence the act leaves open the time and circumstances
under which notice or notification may cease to be effective
10. Problem 111: GE bought some machinery from Tractors and executed a promissory
note payable to the order of Tractors for $2K which was sold without indorsement to
Friendly for $1.5K. GE refused to pay the note and Friendly decided to sue GE. On the
day before filing the lawsuit, Tractor specially indorsed the note over to Friendly. Is
Friendly a HDC?
a. 3-203(c): Unless otherwise agreed, if an instrument is transferred for value and the
transferee does not become a holder b/c of lack of indorsement by the transferor, the
transferee has a specifically enforceable right to the unqualified indorsement of the
transferor, but negotiation of the instrument does not occur until the indorsement is
made.
b. OC3: there is no negotiation of the instrument until the indorsement by the
transferor is made. Until that time the transferee does not become a holder, and if
earlier notice of a defense or claim is received, the transferee does not qualify as
a HDC under Section 3-302.
c. OC4: Case #4. Payee sold the note to Purchaser who took for value, in good faith and
without notice of the defense of Maker. Purchaser received possession of the note
but Payee neglected to indorse it. Purchaser became a PETE but did not become the
holder b/c of the missing indorsement. If Purchaser received notice of the defense of
Maker before obtaining the indorsement of Payee, Purchaser cannot become a
HDC b/c at the time notice was received the note had not been negotiated to
Purchaser. If indorsement by Payee was made after Purchaser received notice,
Purchaser had notice of the defense when it became the holder.
d. Ballengee v. New Mexico Fed. Sav.: the note was not negotiated b/c it had not been
indorsed
e. So, Friendly is not a HDC
11. Jones v. Approved Bancredit:
a. Fact: An agent for Dell, a home building contractor, presented Jones with documents.
Jones said she wanted to have her atty examine the documents first. Dell objected
and eventually Jones signed, among others, a note for $3, 250, which Dell
immediately sold to Bancredit for $2,250. A builder crashed a bulldozer into the
home, ultimately requiring the complete demolition of the structure. Dell (the
originally payee) closed
 its office. Bancredit sued Jones for the note. It turned out that Dell and Bancredit
were wholly owned subsidiaries of Homes, Inc. Homes Inc. and Bancredit had the
same officers and directors. Each transaction of Dell was approved in advance by
Bancredit.
b. Held: Bancredit was so involved in the transaction that it may not be treated as a
subsequent purchaser for value. It was more nearly an original party to the
transaction. Therefore, Bancredit should be denied HDC status.
c. Rule: Too-Closely Connected test (a method for denying HDC status, which also goes
to good faith)
i. Is the buyer-transferee the alter-ego of the seller-transferor? Do they have the
same officers, same personnel, same location?
ii. Who drafted the original promissory note?
iii. Is the buyer-transferee mentioned in the note?
iv. Does the seller transferor sell paper to other buyers, or is the buyer-transferee the
only market?
v. Did the buyer-transferee get involved in the transaction by which the note was
created? Did it, for instance, conduct a credit investigation of the maker?
vi. Did the buyer-transferee have some knowledge of the seller transferor’s poor past
performance of similar contracts?
d. Note: buyer-trasferee of the paper is too closely connected with the seller-transferor
to be permitted to obtain HDC status -> not acting in good faith, had notice of
underlying defenses, or same entity as the seller-transferor
12. Sullivan v. United Dealers Corp.
a. Issue: Whether United Dealers Corp (transferee), a finance company, was a HDC of a
promissory note executed and delivered by Sullivan (maker), in payment for building
material and labor furnished by Memorial Swift Homes, the payee of the note?
b. Fact: Sullivan executed a negotiable note for $18K to Memorial Swift. On the same
day, Memorial negotiated the note and assigned it to United Dealers. United in turn
negotiated the note to a Bank. Sullivan defaulted. The bank transferred the note back
to United for value. United sued Sullivan, who in turn claimed the defense that the
work was not done in a workmanlike manner and United is not a HDC.
c. Rule: Notice, in order to prevent one from being a HDC means notice at the time of
the taking or at the time the instrument is negotiated, and not notice arising
subsequently. The moment value is given for the instrument is decisive. The moment
value is given without notice, the status as a HDC generally is definitely and
irrevocably fixed. Under 3-302(f), to be effective, notice to a purchaser must be
received at such time and in such manner as to give a reasonable opportunity to act
on it. Here, there was no direct connection b/w the contractor and the finance
company. United had no notice and therefore was a HDC.
E. The Shelter Rule
1. Common law rule
a. Unqualified transfer of a chose in action (right to sue) places the transferee in the
transferor’s shoes and gives the transferee all the rights of the transferor
2. 3-203(b) (Shelter Rule): Transfer of an instrument, whether or not the transfer is a
 negotiation, vests in the transferee any right of the transferor to enforce the
instrument, including any right as a HDC, but the transferee cannot acquire rights of
a HDC by a transfer, directly or indirectly, from a HDC if the transferee engaged in
fraud or illegality affecting the instrument
a. To promote confidence in commercial transaction
3. Problem 112: Jack sold a car to Manny and received a promissory note for $2K made
payable to the order of Jack. Jack discounted the note with Alfred for $1.7K, who had
no knowledge of the underlying transaction. Alfred indorsed the note in blank and
gave it to his daughter Jessica as a birthday gift. Manny refused to pay the note due
to the problems in the car. Is Jessica a HDC?
a. Jack’s indorsement made the note a bearer paper
b. Alfred is a HDC, but Jessica is not a HDC b/c she paid no value for the note. But the
Shelter Rule gives her HDC rights b/c Alfred was a HDC
4. Problem 113: In Problem 112, if Jessica made a gift of the note to her husband Lorenzo,
Does he have HDC rights?
a. Lorenz is not a HDC b/c he did not pay a value, but he gets the rights of the HDC with
a claim against the maker. Although Jessica was not a HDC, she had HDC rights that
passed from Alfred (who was a HDC)
b. What if Lorenzo, prior to the gift, knows of Manny’s problems with the car?
i. Lorenz still gets the HDC right unless he is engaged in fraud or illegality (notice of
possible claims against the underlying transaction does not bar the application of
the Shelter Rule)
c. If Manny won’t pay, is Alfred liable to Lorenzo?
i. 3-305(a)(2): Except as otherwise provided in this section, the right to enforce the
obligation of a party to pay an instrument is subject to a defense of the obligor
stated in Art. 3 or a defense of the obligor that would be available if the PETE were
enforcing a right to payment under a simple K
a) Lorenzo is not a HDC b/c he paid no value, but he has a HDC right that Alfred
had had
5. Problem 114: Lorenzo sold the note for $1.8K to Portia who had no notice of problems
with the instrument. When she presented it to Manny for payment, he filed for
bankruptcy.
a. May she recover from Alfred?
i. 3-305(b): The right of a HDC to enforce the obligation of a party to pay the
instrument is subject to defenses of the obligor stated in subsection (a)(1), but is
not subject to defenses of the obligor stated in subsection (a)(2) or claims in
recoupment stated in subsection (a)(3) against a person other than the holder.
ii. Portia is a HDC in her own right b/c she paid a value and had no notice. Alfred is
liable as a prior indorser under 3-415
b. If Portia prevails and Alfred reacquires the instrument, does the shelter rule give him
Portia’s HDC rights?
i. Since he used to be a HDC, he gets that status back vis-à-vis parties prior to his first
holding.
 ii. Alfred retains his “original” HDC status, but he cannot improve his status by
Shelter Rule. He can go against prior indorser (Jack) and the drawer (Manny) only
c. Does Alfred reacquire his original HDC status when he gets the instrument back? Yes
d. Can he sue Jessica or Lorenzo? Will explore the liability of an indorser in the next
chapter
6. Reacquisition of an Instrument
a. NIL 121: on reacquisition, a holder is remitted to his former rights as regards all prior
parties
b. Thus, if one used to be a HDC, on reacquiring the instrument, he would get that
status back vis-à-vis parties prior to his first holding
c. 3-207: when a previous holder reacquires the instrument, he has the power to strike
the intervening indorsements
7. Triffin v. Somerset Valley Bank: The purchaser bought through assignment agreements
with check cashing companies’ 18 dishonored checks issued by the company. The
purchaser then filed suit to enforce the company's liability on the checks. The trial court
granted the purchaser's motion for summary judgment. On appeal, the company
argued the purchaser lacked standing to file suit against the company and summary
judgment was improperly granted. The appellate court determined it was evident the
purchaser had standing to sue the company b/c the purchaser was the assignee of the
18 checks, which he sought to have honored by the company, the drawer of the
checks. In addition, the appellate court concluded that summary judgment was
properly granted b/c there was no issue of material fact as to, inter alia, the status
of the checks as negotiable instruments. Moreover, the appellate court advised that
the company's failure to submit some factual evidence indicating that the facsimile
signature on the checks was forged or otherwise unauthorized, left unchallenged the
rebuttable presumption that a signature on an instrument was valid.
a. 3-308 (Proof of Signatures and Status as HDC)
II. Real and Personal Defenses/Claims
A. Defenses Against a HDC
1. 3-305:
a. Obligor: party to the instrument who is being sued by the holder of the instrument
i. Could be drawer, maker, someone who indorsed the instrument
ii. The person who owes the money
b. Defenses and claims in recoupment
i. Real defenses listed in 3-305(a)(1): can defeat the right of HDC (anybody is subject
to it)
a) Infancy of the obligor to the extent it is a defense to a simple K (at common law)
1. Infancy is always a defense if the common law says so (whether voidable or
void)
b) Duress, lack of legal capacity, or illegality of the transaction which, under other
law, nullifies the obligation of the obligor (can be a defense only when void, not
a defense when voidable)
1. Drunkenness won’t work typically
 2. Transaction with a plumber without license (IL case): not void unless statute
specifically says so (but Prof. says that illegality need not be mandated in
statute, courts decide)
3. Duress must be so severe that voids the K
4. Illegality
c) Fraud that induced the obligor to sign the instrument with neither knowledge
nor reasonable opportunity to learn of its character or its essential terms (fraud
in the factum)
d) Discharge of the obligor in insolvency proceedings
1. Bankruptcy
ii. Personal defenses listed in 3-305(a)(2): HDC is not subject to these defenses
(available against non HDC)
a) Defense of the obligor stated in another section of Art. 3
b) Defense of the obligor that would be available if the PETE were enforcing a
right to payment under a simple K (at common law)
iii. Recoupment listed in 3-305(a)(3): HDC is free of a claim in recoupment
a) Technically not a defense, simply a claim by subtraction process (but operates
as if it were a defense)
b) Legal ability to subtract from any payment due the amount the person trying to
collect the debt happens to owe the debtor
c) Claim must arise out of the same transaction
1. Problem 115: Stephen bought a sailboat from Jack, paying $500 down and signing a
$1,000 promissory note for the balance due. The sailboat went down in the storm and
it cost him $300 to have it restored. In the meantime, Jack gave the note to his father
as a birthday gift and the father presented it to Stephen for payment at maturity.
May Stephen assert his damages against the father?
a. Seller’s representation about “unsinkable boat” is not fraud under 3-305(a)(1), but
can be a personal defense under a simple K. So, the father, who is not a HDC, is
subject to the personal defense and recoupment. Stephen may subtract $300
from the payment due and only pay $700 to the father.
b. What if the boat never sank, but Jack’s dog bit Stephen on the leg one week after the
delivery of the sailboat and Stephen incurred $100 medical bills?
i. Zener v. Velde: maker’s claim to reduce the amount owing on the note
(recoupment) is not proper b/c the claim did not arise from the transaction that
gave rise to the promissory note
ii. the father’s claim is NOT subject to recoupment b/c it arose from a separate event
2. Federal Deposit Insurance v. Culver:
a. Fact: Culver signed a paper, which he thought was a receipt but turned out to be a
promissory note. Payee is Rexford State Bank
b. Issue: Was the FDIC a HDC? Yes, (FDIC is an exception to the rule that a buyer of bulk
notes can never be a HDC).
c. What was Culver’s defense? - Fraud in factum. “fraud that induced the obligor to sign
the instrument without knowledge or opportunity to learn . . .” If he were correct of
 meeting the test in 3-305(a)(1)(iii), then he would have prevailed and would not have
had to pay FDIC. He said he thought it was a receipt. He also said that he didn’t have
the opportunity to learn of the terms of the note b/c it was blank. This is real
defense. It was not reasonable for you to sign the instrument with all the blanks
there. He could have read it and seen that it was not a receipt.
d. Ort (1884): this case had better facts than Culver, suggesting he didn’t have the
opportunity to learn about it. someone approached Farmer, and told him what the
note was, but he didn’t have his glasses with him, so he had the agent to read it to
him. The agent said it was an agency K. The farmer protested at first, he didn’t have
his glasses, and even if he did, he couldn’t read that well. Farmer signed an
instrument. The court didn’t excuse him, b/c he did have enough opportunity to not
sign.
3. Problem 116: Simon told Rube that he was the owner of the Brooklyn Bridge and sold it
to him for $2M. Rube paid $20K down and signed a promissory note, payable to Simon,
for the rest. Simon negotiated the note to a finance company and Rube refused to pay
the note. Does Rube have a real defense of fraud?
a. Not a real defense b/c Rube knew that he was signing a promissory note. (This is
common law fraud, but not fraud under 3-305(a)(1) (Fraud that induced the obligor
to sign the instrument with neither knowledge nor reasonable opportunity to learn
of its character or its essential terms).
4. Problem 117: Thomas looked much older than his 17 yrs and signed a promissory note
for $800 payable to the order of Merry Music as payment for a piano. Merry Music,
unaware of Thomas’s age and indorsed the note over to bank for $725. Thomas refused
to pay and told the bank to come pick up the piano (disaffirming the sale). Who wins?
a. Bank is a HDC (good faith, no notice, gave value, valid negotiation) but subject to the
real defense of infancy if it were a good defense under state law
b. An infant who emancipated can disaffirm the sale.
5. Problem 118: Childe of age 17 received a check for $1,000 from his ER, indorsed the
check in blank and bought a car with it from Byron Auto Sales. Byron indorsed the
check on the back and cashed it at Crusader National Bank. Childe returned the car to
Byron Auto and informed CNB of his rescission of the K. CNB refused to return the
check to Childe and Childe filed a suit.
a. 3-306 (Claims to an Instrument): A person taking an instrument, other than a person
having rights of a HDC, is subject to a claim of a property or possessory right in the
instrument or its proceeds, including a claim to rescind a negotiation and to recover
the instrument or its proceeds. A person having rights of a HDC takes free of the
claim to the instrument.
b. 3-202:
i. Negotiation is effective even if obtained (i) from an infant, a corporation exceeding
its powers, or a person without capacity, (ii) by fraud, duress, or mistake, or (iii) in
breach of duty or as part of an illegal transaction.
ii. To the extent permitted by other law, negotiation may be rescinded or may be
subject to other remedies, but those remedies may not be asserted against a
subsequent HDC or a person paying the instrument in good faith and without
 knowledge of facts that are a basis for rescission or other remedy.
c. Since CNB paid a value for the note (as Byron Auto cashed the check at CNB), it is a
HDC. So, other remedies (including the order restraining CNB from presenting the
check to the drawee) may NOT be asserted against CNB
d. Difference b/w Defense (3-305) and Claim (3-306)
6. Mental Incapacity
a. Note signed by those who are mentally incompetent are void or voidable
b. If someone has been judicially declared incompetent, his instruments are more likely
to be declared void
7. Sea Air Support v. Herrmann: Hermann wrote a check for $10K payable to Ormbsy
House. Who’s the Plaintiff here? Casino. “Illegality of the transaction” b/c this was a
gambling debt. So this would be good even against a HDC. The Court concluded that
there was no HDC, b/c the casino was on notice. There were problems with value b/c it
was a promise for future value, which is not “value.”
a. Question: If Sea Air had been a HDC, would it have been able to enforce the check?
i. No b/c illegality of the transaction is a real defense against a HDC
ii. Gambling debts are void and unenforceable (illegal)
8. Kedzie v. Hodge: Appellee drawer gave a check to an unlicensed plumber as partial
payment of a work order. When the work was not completed, appellee ordered
payment stopped on the check. Nevertheless, the plumber obtained payment from
appellant. When appellant presented the check to appellee's bank, payment was
refused in accordance with the stop payment order. Appellant brought suit against
appellee alleging it was a HDC. Appellee asserted a defense under 3-305, claiming that
appellant was barred from collecting under the check based on the illegality of the
underlying transaction b/c the plumber was not licensed in accordance with state
statute. The trial court dismissed appellant's action and the appeals court affirmed. On
appeal, the court reversed and held that the plumber being unlicensed was not
dispositive of appellant's rights as a HDC to collect payment under the check.
a. Rule: Law that voids K
i. Void (majority) Kedzie v. Hodge
a) Illegality of the transaction. It is only when an obligation is made entirely null
and void under local law that the illegality exist as one of the real defenses
under
§3-305 to defeat a claim of a HDC; Not if it is merely voidable.
b) Defense is illegality b/c he was not a licensed plumber. Held, this is not the type
of illegality we’re looking at. It must be a law that makes the K void.
ii. Voidable (minority). defense of illegality is not limited to gambling and usury.
9. Problem 119: Elsie took loan from bank (PNB), which was evidenced by a promissory
note she had signed. She filed for bankruptcy and reported the bank loan too. The
bankruptcy proceeding culminated in the judge’s ordering that she be discharged from
all her scheduled debts. 2 yrs later, the note surfaced in the possession of another bank
(SSB), which claimed to be a HDC. Must Elsie pay?
a. Discharge in bankruptcy is a real defense and effective against HDC. Elsie does not
have to pay
 10. Discharge as a Real Defense
a. 3-302(b): discharge in bankruptcy is always a real defense, regardless of what the
subsequent holder knows or doesn’t know at the time of acquisition of the
instrument (real defense even without notice)
i. Any other discharge is not effective against a HDC unless that holder, at the time
of acquisition, knew of the discharge
a) Notice of discharge does not affect a HDC status
b) Discharge is not effective against a person with HDC rights without notice
ii. Ex) 4 sureties signed as indorsers on a promissory note and the current holder
decides to excuse one of them from future liability and draws a line through that
surety’s name, thus discharging him from all liability. Even a later HDC would know
that that surety is no longer liable and therefore could only enforce it against
other obligors
11. Problem 120: Malvolio bought a new car from Valentine Auto, signing a note for $18K.
Valentine discounted the note for $16.8K to Orsino Finance Company, which notified
Malvolio that he should make all future payment to them. Malvolio sent them a check
and asked for the note back, but a week later, received a note from Olivia Finance
Company saying that his note had been assigned to them. What should he do?
a. 3-601 (Discharge and Effect of Discharge)
i. The obligation of a party to pay the instrument is discharged as stated in Art. 3 or
by an act or agreement with the party which would discharge an obligation to pay
money under a simple contract.
ii. Discharge of the obligation of a party is not effective against a person acquiring
rights of a HDC of the instrument without notice of the discharge.
b. 3-602(b): a note is paid . . . only if the party obliged to pay has not received adequate
notification that the note has been transferred and that payment is to be made to
the transferee (not adopted by OH)
i. OC2 to 3-602: if a PETE transfers the instrument without giving notice to parties
obligated to pay the instrument and one of those parties subsequently makes a
payment to the transferor, the payment is effective even though it is not made to
the PETE
c. Malvolio have to pay Olivia b/c he didn’t get the note back from Orsino after sending
them the check, but he can sue Orsino for restitution (unjust enrichment)
B. A Special Note on Forgery
1. Whether forgery is a real defense or a personal defense? – Not a real defense
a. 3-401(a): A person is not liable on an instrument unless the person signed the
instrument
b. 3-403(a): Unauthorized signature is ineffective except as the signature of the
unauthorized signer in favor of a person who in good faith pays the instrument or
takes it for value
i. Unauthorized signature is effective only to make the forger liable
ii. You can ratify forged signature if you want and make yourself liable
c. If the forgery is of a name necessary to a valid negotiation, there can be no HDC
 following the forgery b/c no later transferee will qualify as a holder
2. Problem 121: Slick bought jewelry from John’s Jewelers and signed Money’s name to a
promissory note. Tenth National Bank (a HDC to whom John has negotiated the paper)
presented it to Money for payment. May Money refuse to pay?
a. The instrument has been validly negotiated as a promissory note signed by Slick (not
by Money)
b. So, TNB is a HDC as to Slick’s promissory note (not as to Money’s promissory note)
c. What is the key word that protects Money? 3-305(a)(2) says “obligor.” Money is not
an obligor b/c he’s not a party of the instrument (not signed)
3. Problem 122: Barbara bought a traveler’s check for $3K from ONB. The payee line on
the check was blank, but ONB had her sign a line on the check indicating the name of
the remitter. The check contained another blank for a countersignature, under which
was printed a statement that the bank would pay the traveler’s check only if the
remitter re- signed the check on this blank at the time of negotiation to the payee. A
thief stole the check and forged her sign on the countersignature line and
negotiated the check to Vegas Check-Cashing City. Barbra called ONB and told them
what happened and VCCC presented the check to ONB. Should ONB pay?
a. 3-104(i): “Traveler's check” means an instrument that (i) is payable on demand, (ii) is
drawn on or payable at or through a bank, (iii) is designated by the term “traveler's
check” or by a substantially similar term, and (iv) requires, as a condition to payment,
a countersignature by a person whose specimen signature appears on the
instrument.
b. 3-106(c): If a promise or order requires, as a condition to payment, a
countersignature by a person whose specimen signature appears on the promise or
order, the condition does not make the promise or order conditional for the
purposes of Section 3-104(a). If the person whose specimen signature appears on an
instrument fails to countersign the instrument, the failure to countersign is a
defense to the obligation of the issuer, but the failure does not prevent a
transferee of the instrument from becoming a holder of the instrument.
i. Official comment 2: failure to sign does not prevent the person from becoming a
holder. The specimen signature is there for the purpose of comparing the
signature.
c. Countersignature is not a name necessary to a valid negotiation, so negotiation
following the forgery was valid and the bank is a HDC.
i. Forgery of the remitter’s name is not a real defense, so cannot be raised against a
HDC (VCCC)
C. Procedural Issues
1. PETE:
a. Holder of the instrument (someone in possession pursuant to a valid negotiation)
includes
i. Someone who gets holder rights under the Shelter Rule
ii. Rightful owner of a lost instrument
iii. Defendant in a successful restitution action
b. HDC status become relevant only if a defense/claim to the instrument arises
i. Then the holder has the burden of establishing the position as a HDC
 ii. 3-308(b): If the validity of signatures is admitted or proved and there is compliance
with subsection (a), P producing the instrument is entitled to payment if P proves
entitlement to enforce the instrument under Section 3-301, unless D proves a
defense or claim in recoupment. If a defense or claim in recoupment is proved, the
right to payment of P is subject to the defense or claim, except to the extent P
proves that P has rights of a HDC which are not subject to the defense or claim.
c. Holder must take through a chain of indorsements that is free of forgeries affecting
the title
i. 3-308(a): In an action w/r/t an instrument, the authenticity of, and authority to
make, each signature on the instrument is admitted unless specifically denied in
the pleadings. If the validity of a signature is denied in the pleadings, the burden of
establishing validity is on the person claiming validity, but the signature is
presumed to be authentic and authorized unless the action is to enforce the
liability of the purported signer and the signer is dead or incompetent at the
time of trial of the issue of validity of the signature. If an action to enforce the
instrument is brought against a person as the undisclosed principal of a person
who signed the instrument as a party to the instrument, P has the burden of
establishing that D is liable on the instrument as a represented person under 3-
402(a).
a) Presumption that the signature is valid unless denied in the pleading
b) If denied, P must prove the signature is invalid
c) If P proves, the burden shifts to D to show a defense or claim in recoupment
d) If D shows, P is subject to the defense/claim unless he is a HDC
2. Virginia National Bank v. Holt
a. VNB had a note in its possession. Holts were the makers. Mrs. Holt claims she didn’t
sign it. But procedurally she didn’t meet the burden of proof. She did deny it but she
didn’t put on any proof to overcome the presumption of proof.
b. Rule:
i. 3-308 creates a presumption that a signature is genuine.
ii. The code determines not only substantive rights but also procedural rights.
c. Q: Would it have been sufficient to overcome the presumption if Mrs. Holt had taken
the stand and denied the signature? No, mere denial is not sufficient to establish that
the signature is not valid
i. Metropolitan Mortgage Fund v. Basiliko: Guarantors’ denial under oath that they
did not sign the notes and that they were not in any way involved in the business
on whose behalf the notes were given indicated that the presumption of validity of
the signatures was clearly overcome
ii. Freeman Check Casing v. State: D's evidence did not need to be sufficient to
require a directed verdict in its favor but it must have been enough to support its
denial by permitting a finding in its favor
iii. Bates v. Stallworth: Where appellee denied execution of an instrument appellant
sought to enforce and introduced some evidence to support his denial, appellant,
as the party claiming under the signature, bore the burden of establishing the
signature's effectiveness
D. Defenses Against a Non-HDC
1. 3-305
a. Except as otherwise provided in this section, the right to enforce the obligation of a
party to pay an instrument is subject to the following:
i. a defense of the obligor based on (i) infancy of the obligor to the extent it is a
defense to a simple contract, (ii) duress, lack of legal capacity, or illegality of the
transaction which, under other law, nullifies the obligation of the obligor, (iii)
fraud that induced the obligor to sign the instrument with neither knowledge nor
reasonable opportunity to learn of its character or its essential terms, or (iv)
discharge of the obligor in insolvency proceedings;
ii. a defense of the obligor stated in another section of Art. 3 or a defense of the
obligor that would be available if the PETE were enforcing a right to payment
under a simple K; and
iii. a claim in recoupment of the obligor against the original payee of the instrument
if the claim arose from the transaction that gave rise to the instrument; but the
claim of the obligor may be asserted against a transferee of the instrument only to
reduce the amount owing on the instrument at the time the action is brought.
b. The right of a HDC to enforce the obligation of a party to pay the instrument is
subject to defenses of the obligor stated in subsection (a)(1), but is not subject to
defenses of the obligor stated in subsection (a)(2) or claims in recoupment stated in
subsection (a)(3) against a person other than the holder.
2. 3-306: A person taking an instrument, other than a person having rights of a HDC, is
subject to a claim of a property or possessory right in the instrument or its proceeds,
including a claim to rescind a negotiation and to recover the instrument or its
proceeds. A person having rights of a HDC takes free of the claim to the instrument.
3. In summary:
a. All claims and both real and personal defenses may be asserted against anyone who
does not qualify as a HDC
b. Most common personal defenses: want of consideration, failure of consideration
4. Herzog Contracting v. McGowen
a. Issue: Whether solely on the basis that the notes are “clear and unambiguous” they
are enforceable regardless of what the parties actually intended?
b. Rule: The notes would be enforceable if enforcement was sought by a HDC, 3-305.
But Herzog was not a HDC. A holder of a promissory note who is not a HDC takes the
note subject to all defenses of any party which would be available in an action of
simple K, 3-305(b). One such defense is that the parties did not intend to create an
enforceable K.
c. Holding: court allows parole evidence to show it was a sham transaction, the note
was never intended to be enforced, so long as neither party was a HDC. The
question is whether to let in evidence that the note was fraudulent or a sham
transaction. They were allegedly trying to defraud the IRS.
d. Q: How would this case be decided under the Revision? Courts split on this issue
i. §3-105(b):“An instrument that is conditionally issued or is issued for a special
 purpose is binding on the maker or drawer, but failure of the condition or special
purpose to be fulfilled is a defense.
ii. §3-117: this contemplates admitting parole evidence, but it says that it’s subject
to applicable law. If state law allows it, then you could have a defense.
E. Jus Tertii
1. Rights of another (Jus Tertii) are available to other litigants only in special
circumstances
a. General prohibition against using jus tertii
i. 3-305(c): Except as stated in subsection (d) (surety), in an action to enforce the
obligation of a party to pay the instrument, the obligor may not assert against the
PETE a defense, claim in recoupment, or claim to the instrument (Section 3-306)
of another person, but the other person's claim to the instrument may be
asserted by the obligor if the other person is joined in the action and personally
asserts the claim against the PETE. An obligor is not obliged to pay the instrument
if the person seeking enforcement of the instrument does not have rights of a
HDC and the obligor proves that the instrument is a lost or stolen instrument.
b. Exceptions to the prohibition
i. Claims of another may always be asserted if that person joins the lawsuit
ii. 3-305(c) permits one jus tertii to be asserted against a non HDC
a) The instrument has been lost or stolen so that the current possessor is not the
true owner
iii. Accommodation parties are permitted to raise the defenses of their principals
(accommodated parties)
a) But, indorsers (even though they are treated as accommodation parties for
their former indorsers/maker) are not permitted to raise the defenses their
principals! (OC5 to 3-305)
c. 3-206(f) permits an obligor to refuse payment if doing so would violate the terms of
a restrictive indorsement
2. Problem 123: Craig signed a promissory note “I, Craig Covey, promise to pay to bearer
the sum of $5,000, on demand. I also promise to buy the bearer lunch on the date of
presentment.” The note was given to his uncle, who had loaned him the money for the
purchase. The uncle sold the note to Stonewall in return for a check for $4,500, which
was bounced. The next day the note was stolen from Stonewall’s office and later
surfaced in the hands of Jane, an innocent purchaser for value, who presented it to
Craig. The uncle and Stonewall had contacted Craig and asked him to refrain from
paying the instrument, respectively pointing to the bounced check and the stolen note.
a. Is Jane a HDC? No (But Art. 3 applies by analogy)
i. The instrument is NOT negotiable b/c it violates “Courier without Luggage”
requirement. Lunch thing is an additional promise -> nobody can be a HDC
b. If not, can Craig raise the suggested jus tertii against her?
i. Yes, if obligor (Craig) proves that the instrument is a lost or stolen instrument
(in order to prevent double payment), b/c Jane is not a HDC
c. If Craig wants to pay Jane, can his uncle stop him?
 i. 3-602(c): obligation is discharged even though payment is made with knowledge
of a claim under 3-306 (claim of property or possessory right against a non-HDC)
by another person
ii. It is safe for Craig to pay whomever court decides
F. Conclusion
1. Special statutes and rules (including FTC regulation) restrict the HDC doctrine in
consumer transactions
2. Q: If Art. 3 were amended to eliminate the concept of holding in due course,
commercial paper would legally resemble nothing more than simple Ks. Would we
then need Art. 3 at all?
a. Prof. doesn’t think that would happen

CHAPTER 10. THE NATURE OF LIABILITY

I. Introduction
A. 4 questions to be asked when a problem arises in connection with instruments
1. What negotiable instrument labels (drawer, payee, drawee, maker, indorser, guarantor,
etc) do the parties bear?
2. What causes of action (contractual obligation, warranty, conversion, suits “off the
instrument”) are available to each party?
3. What defenses are possible?
4. Can liability be passed to someone else?
B. Labels applied to the parties to notes/drafts
1. Promissory note
a. Maker/Payee/Indorser
2. Draft
a. Drawer/Drawee/Payee/Indorser
II. The Underlying Obligation
A. 3-204(a): indorsement means a signature, other than that of a signer as maker, drawer, or
acceptor, that alone or accompanied by other words is made on the instrument for the
purpose of (i) negotiating the instrument, (ii) restricting payment of the instrument, or (iii)
incurring indorser’s liability on the instrument, but regardless of the intent of the signer, a
signature and its accompanying words, terms of the instrument, place of the signature, or
other circumstances unambiguously indicate that the signature was made for a purpose
other than indorsement. For the purpose of determining whether a signature is made on
an instrument, a paper affixed is made on an instrument is a part of the instrument
B. May a party always bring suit on the underlying obligation? No
1. Problem 124: rentee gave a promissory note to rentor for the amount of rent to be due
3 months later. Rentor took the note and discounted it with a local bank. Then,
rentor brought suit against rentee for nonpayment of the rent. Can rentee defend?
a. Yes, b/c the underlying obligation is suspended until the instrument is dishonored
under 3-310(b)(2)
2. Common law doctrine of merger
a. Once an instrument was offered and accepted in satisfaction of an underlying
 obligation, the obligation merged with the instrument,
b. Until the instrument was dishonored, the underlying obligation was suspended
c. Discharging of the instrument (by payment, by bankruptcy, etc) discharges underlying
obligation
3. 3-310(a): if certified check, cashier’s check or teller’s check is taken, the obligation is
discharged to the same money amount
4. 3-310(b): Unless otherwise agreed and except as provided in subsection (a), if a note or
an uncertified check is taken for an obligation, the obligation is suspended to the same
extent the obligation would be discharged if an amount of money equal to the amount
of the instrument were taken, and the following rules apply:
a. In the case of an uncertified check, suspension of the obligation continues until
dishonor of the check or until it is paid or certified. Payment or certification of the
check results in discharge of the obligation to the extent of the amount of the check.
b. In the case of a note, suspension of the obligation continues until dishonor of the
note or until it is paid. Payment of the note results in discharge of the obligation
to the extent of the payment.
c. Except as provided in paragraph (4), if the check or note is dishonored and the
obligee of the obligation for which the instrument was taken is the PETE, the
obligee may enforce either the instrument or the obligation. In the case of an
instrument of a third person which is negotiated to the obligee by the obligor,
discharge of the obligor on the instrument also discharges the obligation.
d. Note:
i. 3-310(b)(1) & (2): actual payment of a check or a note discharges the underlying
obligation, but until then that obligation is suspended
ii. 3-310(b)(3): once the instrument is dishonored, the underlying K is divorced from
the instrument and separate causes of action then exist for both
5. Problem 125: In problem 124, rentee had paid her rent by a cashier’s check drawn by
bank. Rentor took the check down to bank to discover the bank had failed. Rentor
demanded the rent money to rentee. What should rentee tell rentor?
a. 3-310(a): Unless otherwise agreed, if a certified check, cashier's check, or teller's
check is taken for an obligation, the obligation is discharged to the same extent
discharge would result if an amount of money equal to the amount of the instrument
were taken in payment of the obligation. Discharge of the obligation does not affect
any liability that the obligor may have as an indorser of the instrument.
b. Acceptance of cashier’s check discharges the underlying obligation just as if she paid
in cash. (If it was an ordinary check and the bank failed, the obligation would still be
on rentee)
6. Problem 126: In problem 124, while the underlying obligation was suspended, rentor
tore up the note. May rentor now sue rentee for the rent?
a. 3-604(a): A PETE, with or without consideration, may discharge the obligation of a
party to pay the instrument (i) by an intentional voluntary act, such as surrender of
the instrument to the party, destruction, mutilation, or cancellation of the
instrument, cancellation or striking out of the party's signature, or the addition of
words to the
 instrument indicating discharge, or (ii) by agreeing not to sue or otherwise
renouncing rights against the party by a signed record.
b. 3-310(b)(4): If the PETE taken for an obligation is a person other than the obligee, the
obligee may not enforce the obligation to the extent the obligation is suspended. If
the obligee is the PETE but no longer has possession of it b/c it was lost, stolen, or
destroyed, the obligation may not be enforced to the extent of the amount payable
on the instrument, and to that extent the obligee's rights against the obligor are
limited to enforcement of the instrument.
c. 3-309(a): A person not in possession of an instrument is entitled to enforce the
instrument if:
i. the person seeking to enforce the instrument:
a) was entitled to enforce the instrument when loss of possession occurred; or
b) has directly or indirectly acquired ownership of the instrument from a person
who was entitled to enforce the instrument when loss of possession occurred;
ii. the loss of possession was not the result of a transfer by the person or a lawful
seizure; and
iii. the person cannot reasonably obtain possession of the instrument b/c the
instrument was destroyed, its whereabouts cannot be determined, or it is in the
wrongful possession of an unknown person or a person that cannot be found or is
not amenable to service of process.
d. Rentee may argue that the obligation was discharged when rentor intentionally
destroyed the instrument
e. But, rentor would argue that he did not intend to discharge the underlying
obligation, so there was no discharge. Further, he can enforce the instrument under
3-309(a)(3)
f. Prof: Courts have been kind to clerical error. But, rentor’s mistake is mistake of law.
Discharge on the instrument also discharges the underlying obligation under 3-310
7. Ward v. Federal Kemper Insurance
a. Fact: W changed vehicles which reduced his insurance premiums. Ins. Co sent him a
refund check of $12.50 which he received but never cashed (negotiated). Then, the
Ins Co. realized the refund should have been $4.50, and charged him the difference
($7.50), which he never paid. Later, W got in a wreck and Ins. Co declined to give
coverage b/c they cancelled his insurance policy
b. Rule: insurer may not cancel a policy for nonpayment of premium unless the
premium is in fact due
i. 3-408 “A check or other draft does not of itself operate as an assignment of funds
in the hands of the drawee available for its payment, and the drawee is not liable
on the instrument until the drawee accepts it.”
c. Holding: check is not payment, the money remained under Ins. Co.’s control and
therefore the cancellation of the policy was improper.
d. Note: the check has no effect on the underlying obligation (insurance policy) at all b/c
the underlying obligation is “liability off the instrument”
III. Liability on the Instrument (obligations of maker, indorser, surety, drawer, drawee)
A. Introduction: Liability on the instrument
 1. Promise implied in law (actual intent is irrelevant)
2. As soon as someone places a signature on a negotiable instrument, an implied
contractual obligation is automatically made promising to pay the instrument when it
mature
B. The Maker’s Obligation
1. Maker of a promissory note is absolutely liable on the instrument
2. 3-412: The issuer of a note (maker) or cashier's check (bank) or other draft drawn on
the drawer is obliged to pay the instrument (i) according to its terms at the time it was
issued or, if not issued, at the time it first came into possession of a holder (measuring
moment), or (ii) if the issuer signed an incomplete instrument, according to its terms
when completed, to the extent stated in 3-115 and 3-407. The obligation is owed to a
PETE or to an indorser who paid the instrument under 3-415.
3. If more than 1 maker, those who sign are presumed to be jointly and severally liable
a. But, they have a right to contribution from their co-makers if they are forced to pay
more than their share
b. 3-116: presumption of co-liability
4. Problem 127: Winkin, Blinkin and Nod signed a promissory note:
Oct. 1, 2010 $3,000
On or after 6 months from date, we promise to pay to the order of Grimms National
Bank, the sum of $3,000. We, along with all sureties and subsequent indorsers, waive
all rights to presentment, notice of dishonor, and protest, and all parties hereto agree
to any extension of time granted by the holder to the makers
GNB indorsed the note in blank and discounted it to Andersen Finance. When the note
matured, Andersen sued only Winkin, demanding entire amount. May he defend on the
basis that Andersen should have sued all 3 of them since the note contains the words
“we”? If Andersen wins, can Winkin sue Blinkin for $2,000? $1,000?
a. The waiver of benefit does not destroy negotiability: this instrument is perfectly
negotiable
b. 3-116
i. Except as otherwise provided in the instrument, two or more persons who have
the same liability on an instrument as makers, drawers, acceptors, indorsers who
indorse as joint payees, or anomalous indorsers are jointly and severally liable in
the capacity in which they sign.
ii. Except as provided in Section 3-419(f) or by agreement of the affected parties, a
party having joint and several liability who pays the instrument is entitled to
receive from any party having the same joint and several liability contribution in
accordance with applicable law.
iii. Discharge of one party having joint and several liability by a PETE does not affect
the right under subsection (b) of a party having the same joint and several liability
to receive contribution from the party discharged
c. Ghitter v. Edge: joint signatures are treated as several unless specified otherwise
d. W, B, and N signed together, so they are jointly and severally liable for the full
amount
 e. Andersen may sue Winkin for $3,000 b/c all 3 people are jointly and severally liable
f. If Andersen wins, Winkin can sue Blinkin for $1,000 and Nod for $1,000
(contribution)
i. What if N is insolvent? W can sue B for $1,500
g. “we” language does not destroy joint and several liability. But in common law, some
courts found otherwise
C. The Indorser’s Obligation
1. 3-204(a): Once the payee signs the back of the instrument, he automatically incurs the
obligation the law imposes on an indorser
a. Anyone who signs an instrument in an ambiguous capacity is conclusively presumed
to assume this liability
2. 3-415 (Obligation of Indorser)
a. Subject to subsections (b) to (e) and 3-419(d), if an instrument is dishonored, an
indorser is obliged to pay the amount due on the instrument (i) according to the
terms of the instrument at the time it was indorsed, or (ii) if the indorser indorsed an
incomplete instrument, according to its terms when completed, to the extent stated
in Sections 3-115 and 3-407. The obligation of the indorser is owed to a PETE or to a
subsequent indorser who paid the instrument under this section.
b. If an indorsement states that it is made “without recourse” or otherwise disclaims
liability of the indorser, the indorser is not liable under subsection (a) to pay the
instrument.
c. If notice of dishonor of an instrument is required by 3-503 and notice of dishonor
complying with that section is not given to an indorser, the liability of the
indorser under subsection (a) is discharged.
d. If a draft is accepted by a bank after an indorsement is made, the liability of the
indorser under subsection (a) is discharged.
e. If an indorser of a check is liable under subsection (a) and the check is not presented
for payment, or given to a depositary bank for collection, within 30 days after the
day the indorsement was made, the liability of the indorser under subsection (a) is
discharged.
f. Unlike the obligation of a maker, the indorser’s obligation is secondary in that there
are certain technical conditions to be met before suing the indorser (conditions
precedent):
i. The instrument must have first been presented to maker/drawee
ii. There must have been a dishonor by maker/drawee (dishonor of note/draft
occurs when maker/drawee refuses to pay)
iii. In certain circumstances, indorser must be given notice of dishonor
g. Indorser is not liable until the person primarily liable has dishonored the instrument
and indorser has been so notified
i. An Indorser is liable to subsequent indorsers, not to former indorsers
3. Problem 128: Billy wrote out a check payable to the order of Snow to pay for some
carnival equipment. Snow cashed the check at drug store, indorsing his name on the
back. Drug store then indorsed the check and deposited it in its account at JSB
 (depositary bank). JSB indorsed the check and presented it to the drawee bank, RNB,
which dishonored it b/c Billy had no money in his account, marking it “NSF (Not
Sufficient Funds”). The check was returned to JSB.
a. Drug store has suddenly gone out of business. Can JSB sue Snow and, if so, on what
theory?
i. 3-415(a): if an instrument is dishonored (by maker/drawee), an indorser is obliged
to pay the amount due on the instrument
ii. Snow is an indorser who is liable to PETE and a subsequent indorser who paid the
instrument, JSB (as a PETE & subsequent indorser who paid) can sue Snow for
indorser’s obligation
b. If JSB sues Snow, may he raise his defenses (say, that drug store had failed to pay
him any money when he indorsed it over to them), or is the indorser liability found
in 3-415 strict liability?
i. Snow can raise real defenses, but not personal defenses against JSB b/c JSB is a
HDC (3-415 liability is not strict liability, real/personal defenses may be raised
depending on HDC status)
c. If the bank does recover from Snow, will he have to pay the whole amount or do the
indorsers divide up the indorsement liability and share it proportionately?
i. 3-116: all the makers, drawers, acceptors, indorsers are jointly and severally liable
ii. Snow will have to pay JSB the whole amount, but he can sue the drawer (Billy) and
a former indorser (nobody here) for reimbursement of their shares
iii. Presumption: unless agreed on proportional liability, all the indorsers has full
liability
4. Problem 129: Charlie wanted to borrow $10K from PNB which demanded his note
indorsed by 4 responsible people. Lucy -> Schroeder -> Pig -> Patty signed the back of
the note and PNB loaned him money. When the note matured, Charlie was unable to
pay the note and PNB gave notice of dishonor to all 4 indorsers, but demanded
payment of Patty alone. She resisted, claiming she was liable at most for only 1/4 of
the amount ($2.5K).
a. Is she right? (3-116)
i. No, they are jointly and severally liable and PNB can sue any of them for the full
amount (she has right of contribution from other 3 indorsers)
b. If she pays $10K, can she sue Pig for the entire amount or only for part?
i. She can sue Pig only for his share (1/4 of $10K = 2.5K) for contribution
c. If she is sued, can she bring the other indorsers into the lawsuit? Yes, she can give
notice to them
i. 3-119 (Vouching in notice): In an action for breach of an obligation for which a 3rd
person is answerable over pursuant to Art. 3 or 4, D may give the 3rd person
notice of the litigation in a record, and the person notified may then give similar
notice to any other person who is answerable over. If the notice states (i) that the
person notified may come in and defend and (ii) that failure to do so will bind the
person notified in an action later brought by the person giving the notice as to any
determination of fact common to the 2 litigations, the person notified is so bound
 unless after seasonable receipt of the notice the person notified does come in and
defend.
d. If Charlie comes back into the chips, can Patty sue him? On what theory?
i. Under 3-412, the issuer(maker/drawee) of a note is obliged to pay an
instrument to an indorser who paid the instrument under 3-415
5. Co-Suretyship v. Sub-Suretyship
a. Common law presumption of sub-suretyship
i. Unless the sureties agreed otherwise, those signing later in time could get
complete reimbursement from those signing prior in time
b. 3-116 presumption of co-suretyship
i. If the sureties have agreed, expressly or impliedly, to share the liability, then they
are co-sureties and have a right of partial contribution from each other (jointly &
severally liable)
6. Indorsers v. Sureties
a. Whether the indorser intends it or not, 3-415 makes the indorser an unintentional
surety for the parties who have signed the instrument prior to the indorser
b. Anomalous indorsers (who are not in the chain of title but have indorsed the note)
are obviously sureties, any holder (whether HDC or not) should be able to notice
that
c. Indorsers are generally given all the rights given to voluntary sureties
(accommodation parties) except for Jus Tertii
i. Sureties may raise the defenses of their principals, but indorsers may not (OC5 to
3-305)
7. Qualified Indorsements
a. 3-415(b): By writing the words “without recourse” next to or above his name,
indorser can avoid incurring 3-415 obligation
b. Qualified indorsement operates to negotiate the instrument, but does not create
any contractual liability to pay the instrument
8. Problem 130: Melody bought a piano from Ivory, signing a promissory note payable to
Ivory for $3K. The day after delivery, Ivory discounted the note to Friendly Loan
Company for $2.7K, indorsing it on the back “Pay to the Friendly, Ivory (Without
Recourse).” Piano fell apart and Melody refused to pay the note. Friendly sued both
Melody and Ivory.
a. What is its cause of action against each?
i. Cause of action against Melody: Melody is maker, Ivory is payee & indorser,
Friendly is a HDC entitled to enforce the instrument. PETE must go after maker
first
ii. Cause of action against Ivory: indorser’s secondary liability if the note dishonored
by maker
b. What defenses can each defendant raise?
i. Melody’s defense:
a) Failure of consideration: not good against Friendly (HDC) b/c personal defense
ii. Ivory’s defense:
 a) Signed “without recourse” and disclaimed indorser liability
9. Practical Note
a. When a lawsuit is settled and the losing side send the winning party’s attorney a
check payable to the attorney and the winning party. Attorney should indorse the
check “without recourse” so that the check can be negotiated without incurring 3-
415 indorser obligation to the attorney
D. The Surety’s Obligation
1. Introduction
a. UCC treats all indorsers as sureties, so they has suretyship rights
b. 3 basic Ks involved with true surety setting
i. K1: Underlying obligation b/w the principal and creditor
ii. K2: Promise of the surety to back up the underlying obligation and see that the
creditor loses nothing as a result of accepting principal’s promise on the 1st K
iii. K3: Promise of the principal to reimburse the surety if the surety is forced to pay
off on the surety’s promise to the creditor
a) May be implied (in family matter) or may be spelled out in a document (in
professional surety)
c. Problem 131: Family hired Quickie to build a house for him, requiring Quickie to get
a performance and payment bond guaranteeing that Quickie would do the work and
pay its laborers and suppliers. Quickie got Big Bank to issue the bond, but he went
bankrupt halfway through the job and Family called on Big Bank to finish the work.
i. Identify 3 parties
a) Surety: Big Bank, principal: Quickie, creditor: Family
ii. Identify the 3 Ks
a) K1 b/w F and Q for Q to build a house for F and for F to pay Q when complete
b) K2 b/w Q and BB for Q to reimburse BB if BB is forced to pay off to F
c) K3 b/w BB and F for BB to back up Q’s underlying obligation
2. Surety’s remedial rights
a. Right of reimbursement (from principal)
b. Right of exoneration
c. Right of subrogation
d. Right of contribution (from co-sureties)
e. Strictissimi Juris
3. Right of exoneration
a. Equitable right: surety, at maturity, can compel principal to perform instead of
surety, so that the need for a later suit for reimbursement can be avoided
b. Basis for this right: implied duty that every principal owes to surety to perform at
the earliest moment and exonerate the surety from liability
4. Right of subrogation
a. Equitable assignment of creditor’s right: if surety is forced to pay off creditor, surety
steps into the shoes of creditor and is subrogated to whatever rights creditor had
against the principal
b. Creditor’s right might be better than surety’s reimbursement right: superior right on
 collateral, etc
5. Right of contribution
a. Right of partial reimbursement that co-sureties have against each other for
proportionate shares of the debt
6. Strictissimi Juris (Common Law Rule)
a. Common law rule: surety (particularly an uncompensated/voluntary surety) is a
favorite of the law, surety’s obligation is to be construed of the strictest law, and
surety prevails if possible
b. Restatement of Surety 128: An agreement b/w creditor and principal that changes
the 1st K in any detail operates to discharge and release the non-consenting surety
from further liability
i. b/c modification of the 1st K converts it into a new K to which the surety did not
consent (even the modification is beneficial to sureties)
ii. surety is discharged by a modification of the 1st K that benefits the surety by
lessening principal’s obligation
a) Merchants Nat’l Bank v. Blass: new note given by maker containing a higher
interest rate discharged surety on original note
b) First Nat’l City Bank v. Carbonaro: surety who agreed to back loan of $4,176
discharged when promissory note filled in with only $1,656 as the amount
c. If creditor releases principal debtor from liability on the 1st K or gives him a binding
extension of time to pay, surety is discharged unless (i) surety consents, or (ii)
creditor informs principal of the preservation of surety’s rights against principal
i. b/c by extending the time without surety’s consent, creditor prejudice surety’s
right of subrogation
ii. surety who dislikes this modified agreement can ignore it and exercise his usual
rights
iii. non-consenting surety is discharged only by a binding extension of time
d. 2nd K must be in writing to be enforceable under the Statute of Frauds
i. But, 3-419(b): negotiable instruments are not subject to SOF
7. The Accommodation Party (surety)/accommodated party (principal)
a. 3-419(a): accommodation party is a person who signs the instrument for the
purpose of incurring liability on the instrument without being a “direct beneficiary”
of the value given for the instrument
i. OC1: person who signs an instrument to benefit the accommodated party either
by signing at the time value is obtained by the accommodated party or later, and
who is not a direct beneficiary of the value obtained
b. 3-419(b): accommodation party may sign in any capacity (as maker, drawer,
acceptor, or indorser), but is obligated to pay the instrument in that capacity
i. If surety signs as a maker, he has the same liability as a maker
ii. If surety signs as an indorser, he is liable only in that capacity and has the rights of
an indorser (presentment, notice of dishonor, etc)
c. 3-419(c): anomalous indorser -> surety (accommodation party)
i. Accommodation party’s obligation is not affected by the fact that PETE had notice
 of accommodation
d. 3-419(f): accommodation party who pays is entitled to reimbursement from
accommodated party
i. But, accommodated party who pays is NOT entitled to contribution from
accommodation party (principal can’t sue surety for reimbursement while surety
can sue principal for it)
e. Problem 132: Consider the following promissory note
Front: Dec. 23, 2012
I, Mary Maker, promise to pay $4K to the order of Paul Payee on Dec. 25, 2014, with
interest of 8%/yr from date.
/s/ George Generous
/s/ Mary Maker
Back:
Pay to Ace Finance /s/ Paul Payee (special
indorsement)
Ace comes to you early in 2015 and tells you that the note is in default, but it failed
to give notice of dishonor to GG.
i. May GG establish his status as surety against a HDC? Yes
a) GG’s indorsement is anomalous indorsement under 3-205(d) -> there is notice
that the instrument is signed for accommodation under 3-419(c) -> Ace had a
notice that GG is an accommodation party, but can be a HDC in spite of the
notice of accommodation party
ii. May GG defend on the basis that he received no consideration for his
undertaking? No
a) 3-419(b): the obligation of an accommodation party may be enforced whether
or not he receives consideration for the accommodation
b) Even under common law suretyship, creditor will argue that consideration
(benefit to the promisor or detriment to promisee) is K1 that went through
iii. Is GG an accommodation maker or an accommodation indorser? Accommodation
maker (no right of notice)
a) 3-116(a): 2 or more persons who have the same liability on an instrument . . .
are jointly and severally liable in the capacity
b) Philadelphia Bond v. Highland: a signature in the lower right hand corner of an
instrument indicates an intent to sign as the maker of a note or the drawer of a
draft
f. Art. 3 applies only to accommodation parties who sign “the instrument.”
i. If accommodation party signs a “separate suretyship agreement” but not the note
itself, common law rules(e.g., Restatement of Suretyship and Guaranty), instead of
Art. 3, govern the result
g. 3-419(d): guarantor is surety who adds words of guaranty to his signature that
guarantees collection (must indicate unambiguously that he is guaranteeing
collection rather than payment)
i. Distinguish guarantor of payment (3-419(e)) from guarantor of collection (3-
 419(d))
ii. No further suretyship obligation created unless surety has specifically guaranteed
collection only, in which case guarantor is given extra protections under 3-419(d)
a) Guarantor is obliged to pay only if (i) execution of judgment against the other
party has been returned unsatisfied, (ii) the other party is insolvent or in an
insolvency proceeding, (iii) the other party cannot be served with process, or
(iv) it is otherwise apparent that payment cannot be obtained for the other
party
iii. Problem 133: In Problem 132, what if GG had written the word Guarantor after
his name?
a) If not unambiguous that GG is a guarantor of collection only -> he is a guarantor
of payment -> obliged to pay without prior resort to the accommodated party
b) Ace does not have to sue MM first, can go after GG directly (3-419(e))
h. Floor v. Melvin:
i. Fact: Melvin signed the back of the note: “For an in consideration of funds
advanced to Melco, Inc., we irrevocably guarantee Majorie Floor against loss by
reason of nonpayment of this note.” (guaranty of collection, not guaranty of
payment)
i. Issue: Must Majorie Floor sue Melco first, or can sue go directly after Melvin for
the money?
ii. Rule: There are two types of Ks guaranteeing negotiable instruments:
a) Ks guaranteeing the collection of notes: the guarantor promises to pay the debt
upon condition that the owner shall use the ordinary legal means to collect it
from the debtor with diligence but to no avail.
b) Ks guaranteeing the payments of notes: guarantor promises to pay the debt at
maturity if the principal debtor fails to, and upon maturity the guarantor must
be sued at once.
1. “I hereby guarantee this loan” = guarantee of payment, not collection.
2. “For value received I guarantee payment of the within note at maturity.” –
for payment
iii. Holding: Here, the terms of the guarantee are made conditional upon the
collection of the note, not payment b/c it is a guarantee against “loss”.
i. 3-419(f): Accommodation party who pays the instrument is entitled to enforce the
instrument against the accommodated party. An accommodated party who pays the
instrument has no right of recourse against, and is not entitled to contribution from,
an accommodation party
j. Problem 134: Mother borrowed $5K from ONB, signing a promissory note as maker
with the bank as payee, and had Portia indorse the note on the back before it is
presented to ONB
i. If mother is forced to pay this note when it matures, can she sue Portia, the
indorser?
a) No, M cannot sue P b/c M is a maker (primarily liable) and P is an indorser and
maker has no right of recourse against indorser under3-419(f)
 b) Normally, maker has no cause of action against indorsers, whose 3-415
obligation runs to “a PETE” or to indorser who paid
ii. If ONB recovers money from Portia at maturity, can Portia sue her mother, whose
maker’s obligation under 3-412 runs to indorser?
a) Yes, under 3-419(f), last sentence, an accommodated party that pays the
instrument has no right of recourse against, and is not entitled to contribution
from, an accommodation party
b) In this problem, the maker is actually the surety. But, 3-419(f) governs
iii. Portia made an anomalous indorsement for accommodation. She is a surety b/c
she is the first person to indorse the note in spite of the fact that she is not a
payee. So, ONB must have noticed that Portia is a surety.
a) If HDC has no reason to know that a party is a surety, the HDC will take free of
suretyship defense (discharge caused by tender of payment, extension,
material alteration, impairment of collateral, etc – 3-605(h))
8. Tender of Payment (3-603)
a. If tender of payment of an obligation to pay an instrument is made to a PETE, the
effect of tender is governed by principles of law applicable to tender of payment
under a simple K (i.e. common law).
b. If tender of payment of an obligation to pay an instrument is made to a PETE and the
tender is refused, there is discharge, to the extent of the amount of the tender, of
the obligation of an indorser or accommodation party having a right of recourse
w/r/t the obligation to which the tender relates. (principal’s tender discharge all the
secondary obligors, principal still liable, but not liable for the interest)
c. If tender of payment of an amount due on an instrument is made to a PETE, the
obligation of the obligor to pay interest after the due date on the amount tendered
is discharged. If presentment is required w/r/t an instrument and the obligor is able
and ready to pay on the due date at every place of payment stated in the
instrument, the obligor is deemed to have made tender of payment on the due date
to the PETE. (surety’s tender stops interest)
d. Problem 135: SP (maker) and OC(co-signer, anomalous indorser (one outside the
chain of title but signed), surety) co-signed a promissory note payable to the order
of RS, who loaned SP $10K. RS indorsed the note and sold it at a discount to AG
i. When the note matured, knowing that SP was in financial trouble, OC went to AG
and offered to pay the note, planning to seek reimbursement from SP. AG replied
“Let’s give poor SP a chance to pay it off himself.” (refusal of tender) 1 month
later, SP went bankrupt and AG demanded OC to pay the initial amount plus
interest. To what is he entitled?
a) 3-603(c): OC tendered to pay, so his obligation to pay interest is discharged and
AG is entitled to the principal only (surety’s tender stops the interest)
ii. On the due date, SP went to AG and offered to pay, but AG told him to pay next
month. 1 month later, SP went bankrupt. Can AG recover from OC? From RS, the
payee/indorse?
a) 3-603(b): SP tendered to pay and is refused, so indorser (OC)/accommodation
 party (RS)’s obligation has been discharged. AG’s only possible payor is now SP
who has gone bankrupt.
iii. Assume that on the maturity date, OC went to AG and offered to pay and was
refused. 1 month later, SP went bankrupt and OC filed for bankruptcy at the same
time. Is RS, the payee/indorser, liable to AG?
a) OC’s indorsement obligation runs to his subsequent indorsers (RS & AG) and
subsequent indorsers are entitled to reimbursement from prior indorsers
b) If SP (principal) tenders and is refused, all the secondary obligors are
discharged
c) If OC tenders and is refused, all his subsequent obligors (RS & AG) are
discharged
d) Thus, RS’s liability as an indorser was discharged when the payment was
tendered by OC and refused
9. Section 3-605: Strictissimi Juris Again (p. 1065 of the casebook)
a. In this section, the term "indorser" includes a drawer having the obligation described
in 3-414(d).
b. Discharge, under 3-604, of the obligation of a party to pay an instrument does not
discharge the obligation of an indorser or accommodation party having a right of
recourse against the discharged party. (discharge of the principal does not discharge
the surety)
c. If a PETE an instrument agrees, with or without consideration, to an extension of the
due date of the obligation of a party to pay the instrument, the extension
discharges an indorser or accommodation party having a right of recourse against
the party whose obligation is extended to the extent the indorser or
accommodation party proves that the extension caused loss to the indorser or
accommodation party w/r/t the right of recourse. (surety is discharged to the
extent of loss caused by extension)
d. If a PETE an instrument agrees, with or without consideration, to a material
modification of the obligation of a party other than an extension of the due date, the
modification discharges the obligation of an indorser or accommodation party
having a right of recourse against the person whose obligation is modified to the
extent the modification causes loss to the indorser or accommodation party w/r/t
the right of recourse. The loss suffered by the indorser or accommodation party as a
result of the modification is equal to the amount of the right of recourse unless the
person enforcing the instrument proves that no loss was caused by the modification
or that the loss caused by the modification was an amount less than the amount of
the right of recourse. (surety is discharged to the extent of loss caused by material
modification)
e. If the obligation of a party to pay an instrument is secured by an interest in collateral
and a PETE impairs the value of the interest in collateral, the obligation of an
indorser or accommodation party having a right of recourse against the obligor is
discharged to the extent of the impairment. The value of an interest in collateral is
impaired to the extent (i) the value of the interest is reduced to an amount less than
the amount of the right of recourse of the party asserting discharge, or (ii) the
 reduction in value of the interest causes an increase in the amount by which the
amount of the right of recourse exceeds the value of the interest. The burden of
proving impairment is on the party asserting discharge. (if surety is forced to pay,
surety is entitled to the bond to collateral. So, surety is discharged to the extent of
the loss caused by impairment of collateral)
f. If the obligation of a party is secured by an interest in collateral not provided by an
accommodation party and a PETE impairs the value of the interest in collateral, the
obligation of any party who is jointly and severally liable w/r/t the secured obligation
is discharged to the extent the impairment causes the party asserting discharge to
pay more than that party would have been obliged to pay, taking into account rights
of contribution, if impairment had not occurred. If the party asserting discharge is an
accommodation party not entitled to discharge under subsection (e), the party is
deemed to have a right to contribution based on joint and several liability rather
than a right to reimbursement. The burden of proving impairment is on the party
asserting discharge.
g. Under subsection (e) or (f), impairing value of an interest in collateral includes (i)
failure to obtain or maintain perfection or recordation of the interest in collateral,
(ii) release of collateral without substitution of collateral of equal value, (iii) failure
to perform a duty to preserve the value of collateral owed, under Art. 9 or other law,
to a debtor or surety or other person secondarily liable, or (iv) failure to comply with
applicable law in disposing of collateral. (impairment example)
h. An accommodation party is not discharged under subsection (c), (d), or (e) unless
the PETE knows of the accommodation or has notice under 3-419(c) that the
instrument was signed for accommodation.
i. A party is not discharged under this section if (i) the party asserting discharge
consents to the event or conduct that is the basis of the discharge, or (ii) the
instrument or a separate agreement of the party provides for waiver of discharge
under this section either specifically or by general language indicating that parties
waive defenses based on suretyship or impairment of collateral.
j. Note:
i. On paying off the creditor and thereby acquiring the negotiable instrument, the
surety is also entitled to that collateral
ii. 3-605(e), (f) and (g): non-consenting surety is discharged, up to the value of the
collateral, if the creditor (holder) fails to protect the collateral and if it is thereby
unavailable to pay the debt
k. Problem 136: Butch borrowed $10K from ONB, providing the inventory of his food
store stand as collateral and having Arnold sign the promissory note as guarantor.
ONB failed to file Art. 9 financing statement, so when Butch had financial difficulties,
other creditors prevailed over ONB’s attempt to claim the inventory (worth $6K).
What is the effect of ONB’s Art. 9 difficulties on Arnold’s liability?
i. Under 3-605(e), Arnold’s obligation is reduced by the worth of the inventory
($6K). By not perfecting the security interest, ONB has waived their rights to the
collateral (inventory), therefore, the agreement has changed and A is discharged
 the amount of the impairment
l. Chemical Bank v. Pic Motors
i. Fact: Bank agreed to lend money to Pic on the security of Pic’s inventory of cars as
collateral. Siegel personally guaranteed the loans in writing, and then sold his
interest in Pic to Robl, and resigned as director and president. Pic fell behind on
the payments. Bank made a demand, and then sued Pic and the guarantors. Siegel
defends that the deficiency was caused by the failure of the Bank to conduct
regular inspections of the business. No provision of the loan agreement or the
guaranty agreement obligated the Bank to conduct inspections.
ii. Held: Siegel was still liable.
m. Problem 137: G and M borrowed $10K from VFC, both signing a promissory note.
To secure the note, bank took a mortgage on M’s vineyard but failed to file its
mortgage in the proper place. (impairment of collateral) Before the note matured, M
filed for bankruptcy, and bankruptcy creditors were able to get the vineyard free and
clear of bank’s mortgage. (G & M are both principals)
i. Is G discharged in whole or in part by 3-605(e)? 3-605(f)?
a) G is not discharged by 3-605(e) b/c she is not an accommodation party (she is a
direct beneficiary: 3-419(a)), but G is discharged by 3-605(f).
b) G is discharged to the extent of Smaller (the value of vineyard or 50% of the
note amount) b/c G would have gained rights to M’s vineyard to the extent of
$5K after he paid $10K for the note. but still liable to pay $5K (casebook p.
1074, OC7 to 3-605)
ii. If M had not filed for bankruptcy but vineyard was still lost when the state seized
it b/c she hadn’t paid here taxes, is she discharged by the bank’s failure to perfect
its interest in the vineyard?
a) OC7 to 3-605: No, M is not discharged b/c she would have had to pay the taxes
anyway
n. Problem 138: P borrowed $75K from YNB and signed a promissory note together
with S as an accommodation maker (anomalous indorser). Is S discharged by any of
the following agreements b/w YNB and P?
i. When the note matured, P told YNB that he was thinking about bankruptcy and
YNB persuaded him to pay all he could ($5K) and signed an agreement with P
excusing him from having to pay the rest ($70K) of the debt. YNB then demanded
S to pay the amount still due. Does S owe it? Does the accord and satisfaction
agreement b/w YNB and P also bind S, or may YNB still seek complete
reimbursement from P?
a) 3-605(b): discharge of the principal’s obligation does not discharge the surety’s
obligation even though surety didn’t consent to principal’s discharge. Thus,
even though YNB discharged P, S is still liable for $70K. (Prof: this is to the
advantage of surety)
b) S has the right of reimbursement from P after S pays off $70K to YNB
ii. Assume that when the note matured, YNB granted extra 6 months to pay without
notifying S, and at the end of the 6 months, P filed for bankruptcy. Was S
 discharged by YNB’s action? Would your answer change depending on whether or
not P ever had the money to pay the note at any relevant period? Who has the
BOP? Could S, had he known of the extension agreement, have ignored it, paid
the note, and then sued P for reimbursement?
a) 3-605(c): Surety is discharged to the extent of loss caused by the extension,
thus, if P had any money to pay during the extension, S is discharged for that
amount of money b/c YNB could have been collected that amount of money
but for the extension (the mere fact that P had money does not necessarily
mean that he would have paid off the note -> S must prove that P would have
paid off but for the extension)
b) BOP: S has the BOP b/c that surety is discharged to the extent he proves that
the extension caused loss to him w/r/t the right of recourse under 3-605(c)
c) 3R-605(b)(3): S may ignore the extension and pay the note to YNB. But, if the
extension agreement does not preserve secondary obligor (S)’s recourse, S may
sue P for reimbursement after 6 months (nothing said in the current statute)
iii. Assume when the note was signed, YNB made P put up 100 shares of stock as
collateral. Before the note matured, YNB returned the stock to him in exchange
for a higher rate of interest. The original note contained a clause by which the
surety automatically agreed in advance to any impairment of the collateral. Has S
nonetheless been discharged? Who has the BOP?
a) 3-605(d): Surety is discharged to the extent of loss caused by material
modification, so, S is discharged to the extent of his loss caused by the higher
interest rate (loss caused by material modification). But S is not discharged to
the extent of his loss caused by impairment of the collateral b/c of the terms of
the original note (3-605(i): party is not discharged if he waives his defense)
b) Bank has the BOP both the modification and his loss (3-605(d) presumption of
BOP: burden shifts to the bank by the language – loss is equal to the amount of
the right of recourse unless PETE prove that no loss was caused by the
modification or the loss caused by the modification was an amount less than
the amount of the right of recourse))
iv. Is there a simple way that YNB could have avoided all these issues ab initio?
a) 3-605(i): secondary obligor is not discharged if he consents the release,
extension or modification (this does not destroy negotiability of the instrument)
b) Consent can be implied in case of surety (corporate officer)
c) Thus, YNB should get consent from S (secondary obligor)
o. London Leasing v. Interfina
i. Fact: The maker was a corporation and the indorser was its president. The maker
made and delivered to the payee a promissory note signed by the indorser as
president and personally indorsed by him. When the note was not paid on its due
date, the maker entered into letter agreements with the payee extending the time
for payment. The indorser signed the agreements only in his capacity as president.
ii. Held: There was no question that the maker was liable. In addition, the indorser
was liable even though the extension agreements were not signed by him in his
 personal capacity. Under 3-606(1)(a), an indorser was discharged by a maker's
agreement with a payee entered into without the indorser's consent to extend the
maker's time to pay a note. However, the indorser consented to the extension. He
applied for, negotiated, signed in his corporate capacity, and received the
agreements that extended the time for payment. The indorser's conduct far
exceeded mere knowledge or acquiescence and constituted consent.
p. 2002 revision to 3-605(f): . . . Unless the circumstances indicate otherwise, consent
by the principal obligor to an act that would lead to discharge under this section
constitutes consent to that act by the secondary obligor if the secondary obligor
controls the principal obligor or deals with PETE on behalf of the principal obligor
10. New Notes for Old
a. Problem 139: RL borrowed $5K from KL and gave his promissory note due June 8,
2012. RL had his daughter C sign as accommodation maker. Early in 2012, RL
defaulted on the installment payments and in return for mercy by KL, he signed a
new promissory note dated January 11, 2012, payable to KL Sep. 25, 2012, for the
same amount but with additional collateral. KL kept the first note as security for the
payment of the second. C never signed the second note.
i. Can the payee sue on the first note prior to Sep. 25, 2012?
a) 3-310(b)(2): Suspension of the underlying obligation (1st note) continues until
dishonor/payment of the 2nd note. Payment of the 2nd note results in discharge
of the obligation to the extent of the payment.
b) No, RL can’t sue b/c the underlying obligation (the first note) is suspended until
Sep. 25, 2012
ii. If RL does not pay the 2nd note when it matures, can KL sue on the 1st note, or has
it been paid and discharged by the 2nd note?
a) KL can enforce either note b/c upon default of the second note, underlying
obligation (1st note) is divorced from the 2nd note, and separate cause of
actions come to exist
iii. Assume that C can prove that the failure of KL to enforce its rights on the first
note caused her major damages in that RL’s financial situation deteriorated
drastically b/w Jan. 11 and Sep. 25. Is C still liable on the first note?
a) 3-605(c): C is discharged to the extent of the loss caused by the extension and
impairment of collateral (2nd note is working as an extension of 1st note, non-
consenting surety is discharged to the extent of the harm that he can prove)
b) C is not initially liable on the 2nd note b/c C didn’t sign it
b. Problem 140: SS was the surety on a promissory note that MM had given to DL
along with a pledge of 100 shares of TT stock to secure the loan for $800. Shortly
after receiving the loan, MM asked for the stock back, saying that he wanted to sell
it and buy other stock that he would repledge as collateral. DL gave him back the
stock, but MM didn’t provide other stock to DL. 1 week later, DL transferred the
note for value to HL, a bona fide purchaser. Assume that SS has been discharged
under 3-605(2) (impairment of collateral). Is he still liable to HL?
i. 3-601(b): discharge of the obligation of a party is not effective against a person
 acquiring rights of a HDC of the instrument w/o notice of the discharge
ii. 3-305(b): the right of a HDC is subject to real defenses
iii. 3-302(b): notice of discharge (other than discharge in bankruptcy) is not notice of
a defense, but effective against a person who became a HDC with notice of the
discharge
iv. Suretyship discharges are personal defenses (not a real defense) unless HDC had
notice of it, so they will not be effective against HL (HDC), without notice that you
had a suretyship defense
E. The Drawer’s Obligation
1. 3-414 (Obligation of Drawer)
a. This section does not apply to cashier's checks or other drafts drawn on the drawer.
b. If an unaccepted draft is dishonored, the drawer is obliged to pay the draft (i)
according to its terms at the time it was issued or, if not issued, at the time it first
came into possession of a holder, or (ii) if the drawer signed an incomplete
instrument, according to its terms when completed, to the extent stated in 3-115
and 3-407. The obligation is owed to a PETE the draft or to an indorser who paid the
draft under 3-415.
c. If a draft is accepted by a bank, the drawer is discharged, regardless of when or by
whom acceptance was obtained. (if draft is accepted, drawer is discharged)
d. If a draft is accepted and the acceptor is not a bank, the obligation of the drawer to
pay the draft if the draft is dishonored by the acceptor is the same as the obligation
of an indorser under 3-415(a) and (c). (sales draft)
e. If a draft states that it is drawn "without recourse" or otherwise disclaims liability of
the drawer to pay the draft, the drawer is not liable under subsection (b) to pay the
draft if the draft is not a check. A disclaimer of the liability stated in subsection (b) is
not effective if the draft is a check.
f. If (i) a check is not presented for payment or given to a depositary bank for collection
within 30 days after its date, (ii) the drawee suspends payments after expiration of
the 30-day period without paying the check, and (iii) b/c of the suspension of
payments, the drawer is deprived of funds maintained with the drawee to cover
payment of the check, the drawer to the extent deprived of funds may discharge its
obligation to pay the check by assigning to the PETE the check the rights of the
drawer against the drawee w/r/t the funds.
i. if check is not cashed in 30 days and drawee bank goes bankrupt during that time,
drawer is not liable: this is the only case when drawer becomes free
ii. Both indorsers and drawers have 2ndary liabilities unlike makers/drawee:
a) Both indorsers and drawers have the right of
1. presentment;
2. dishonor; and
3. notice of dishonor (indorsers only except for sales draft)
iii. C.f. 3-415(c): if notice of dishonor is required but not given to an indorser, the
liability of indorser is discharged
2. Secondary liability
 a. Drawer’s liability is secondary b/c the draft must first be presented to the drawee for
payment and dishonored by the drawee before the drawee has a legal obligation to
pay the instrument
3. Presentment and Dishonor
a. Presentment (3-501): demand for payment made to the maker/drawee of the
note/draft
i. Exhibition is required only if the presentee demands it
a) 3-501(b)(2): upon demand of the person to whom presentment is made, the
person making presentment must (i) exhibit the instrument, (ii) give reasonable
identification and, if presentment is made on behalf of another person,
reasonable evidence of authority to do so, and (iii) sign a receipt on the
instrument for any payment made or surrender the instrument if full payment
is made
ii. Failure to make presentment -> no dishonor -> cannot sue
a) Underlying obligation is merged into the note until the note is defaulted, so not
available as a cause of action
b) Technical argument against it based on the definition of presentment under 3-
502(a)(3) (dishonor of a note is governed if it is not paid on the day it becomes
payable)
1. But OC says the note must be paid to PETE (holder in possession of the note)
-> if you don’t have the note, you’re not PETE and you can’t sue
b. Dishonor: refusal of the presentee to pay (3-502)
c. Problem 141: AG paid off an old debt to RB by giving him a check drawn on PNB. RB
took the check to PNB which asked him to sign his name on the check, but RB
refused to sign. If PNB declines to pay the check, has a technical dishonor occurred?
i. 3-501(b)(3)(i): without dishonoring the instrument, the party to whom
presentment is made may return the instrument for lack of a necessary
indorsement
ii. 3-501(b)(2)(iii): upon demand of the person to whom presentment is made, the
person making presentment must sign a receipt on the instrument for any
payment made or surrender the instrument if full payment is made
iii. No, PNB may return the check for lack of necessary indorsement without
dishonoring it
iv. No sign -> no dishonor -> underlying obligation is still frozen
d. It is important to determine if there is a dishonor b/c drawer’s 3-414 obligation is
conditioned on a dishonor
i. Drawer cannot be sued on the underlying obligation that is suspended until
dishonor by 3-310
e. Problem 142: In Problem 141, when AG gave RB a check, RB negligently lost it
behind the sofa and didn’t find it for 8 months. PNB refused to pay it b/c it was
suspiciously old (4-404).
i. Is AG still liable on this check?
a) 4-404: Bank is not obligated to pay check more than 6 months old (but it may
 pay if wants)
b) 3-414(f): if drawee bank fails during the delay, drawer is discharged, but if
drawee bank does not fail, drawer is not discharged.
c) Thus, AG is still liable on this check b/c drawee bank does not fail
ii. Would he be liable if drawee bank had folded (failed) 5 months after the check
was written but before it was presented?
a) No, AG (drawer) is discharged if drawee bank failed during the delay
iii. If RB had indorsed the check the day after it was issued to him and then cashed it
at the corner drugstore and the drugstore mislaid it for 5 months before drawee
bank dishonored it, is RB still liable to the drugstore?
a) 3-415(e): If an indorser of a check is liable under subsection (a) and the check is
not presented for payment, or given to a depositary bank for collection, within
30 days after the day the indorsement was made, the liability of the indorser
under subsection (a) is discharged.
b) RB is discharged b/c the check was presented more than 30 days after his
indorsement
c) (if the check is not presented in 30 days, bank may dishonor it and indorsers are
off the hook)
f. Messing v. Bank of America
i. Thumbprint was found to be a to be reasonable identification
ii. Check was never dishonored b/c P failed to comply with terms of instrument for
presentment.
iii. ML court of appeals affirmed, noting that an agreement b/w bank and its
customer has no effect on the rights of the check’s presentor, though it does
insulate bank from a charge of wrongful dishonor, and that drawee bank may
require presenter to give a thumbprint
4. Notice of Dishonor
a. Indorsers are entitled to notice of dishonor while drawers are entitled to notice of
dishonor only if a non-bank acceptor refuses payment of the draft (3-414(d))
b. 3-503:
i. The obligation of an indorser stated in 3-415(a) and the obligation of a drawer
stated in 3-414(d) may not be enforced unless (i) the indorser or drawer is given
notice of dishonor of the instrument complying with this section or (ii) notice of
dishonor is excused under 3-504(b).
ii. Notice of dishonor may be given by any person; may be given by any commercially
reasonable means, including an oral, written, or electronic communication; and is
sufficient if it reasonably identifies the instrument and indicates that the
instrument has been dishonored or has not been paid or accepted. Return of an
instrument given to a bank for collection is sufficient notice of dishonor.
iii. Subject to 3-504(c), w/r/t an instrument taken for collection by a collecting bank,
notice of dishonor must be given (i) by the bank before midnight of the next
banking day following the banking day on which the bank receives notice of
dishonor of the instrument, or (ii) by any other person within 30 days following
 the day on which the person receives notice of dishonor. W/r/t any other
instrument, notice of dishonor must be given within 30 days following the day on
which dishonor occurs.
5. Protest (ritual done by notary or authorized officials for evidentiary purposes)
a. When an official (normally a notary public) makes a formal presentment of a draft to
the drawee, and upon dishonor, draws up, signs, and seals an official statement
(protest) of what happened
b. 3-505(b): A protest is a certificate of dishonor made by a US consul or vice consul, or
a notary public or other person authorized to administer oaths by the law of the
place where dishonor occurs. It may be made upon information satisfactory to that
person. The protest must identify the instrument and certify either that presentment
has been made or, if not made, the reason why it was not made, and that the
instrument has been dishonored by non-acceptance or nonpayment. The protest
may also certify that notice of dishonor has been given to some or all parties.
c. No longer required, but sometimes necessary to simplify proof (it used to be
required in international transaction)
6. Excuse
a. 3-504 (Excused Presentment and Notice of Dishonor)
i. Presentment for payment or acceptance of an instrument is excused if (i) the
person entitled to present the instrument cannot with reasonable diligence make
presentment, (ii) the maker or acceptor has repudiated an obligation to pay the
instrument or is dead or in insolvency proceedings, (iii) by the terms of the
instrument presentment is not necessary to enforce the obligation of indorsers or
the drawer, (iv) the drawer or indorser whose obligation is being enforced has
waived presentment or otherwise has no reason to expect or right to require that
the instrument be paid or accepted, or (v) the drawer instructed the drawee not
to pay or accept the draft or the drawee was not obligated to the drawer to pay
the draft.
ii. Notice of dishonor is excused if (i) by the terms of the instrument notice of
dishonor is not necessary to enforce the obligation of a party to pay the
instrument, or (ii) the party whose obligation is being enforced waived notice of
dishonor. A waiver of presentment is also a waiver of notice of dishonor.
iii. Delay in giving notice of dishonor is excused if the delay was caused by
circumstances beyond the control of the person giving the notice and the person
giving the notice exercised reasonable diligence after the cause of the delay
ceased to operate.
b. Problem 143: A promissory note says “All parties to this note hereby waive all rights
to presentment, notice of dishonor, and protest . . .” Is a clause like this buried in the
fine print on the front side of a note sufficient to deprive indorsers of their right to
notice of dishonor?
i. The waiver is effective under 3-504(a)(iv)
c. Problem 144: FF indorsed over to H a $50 check that he had won from DD. FF was
named as payee on the check. After giving the check to H, FF contacted DD and
 persuaded him to stop payment on the check. H held onto the check for 6 weeks and
took it to CNB and cashed it. CNB presented the check to the drawee bank which
dishonored it, whereupon CNB reclaimed its money from H.
i. Was FF discharged by the delay in presentment?
a) 3-415(e): Yes, if the check is not presented for payment within 30 days after
indorsement, the liability of indorser is discharged
ii. Was the presentment delay excused within the meaning of 3-504(a)(iv)?
a) Yes b/c the indorser (FF) has no reason to expect that the instrument be paid
under 3-504(a)(iv), thus presentment is excused (also drawer (DD) instructed
the drawee bank not to pay under 3-504(a)(v))
b) Harik v. Harik: SOL commenced at time of notice of dishonor b/c P had no way
of knowing that D placed a stop-payment order on the check
d. Makel Textiles v. Dolly Originals
i. Facts: Dolly borrowed $40K, paid down $30K, and made a note for 10K. It then
executed 5 notes for $2K each. One was deposited but returned for insufficient
funds. The notes were signed personally by Goldberg and Kushner.
ii. Holding: B/c Goldberg was the president and principal officer of Dolly, and signed
in that capacity as well as in a personal capacity, it was unnecessary to serve
Goldberg with notice of dishonor and nonpayment b/c failure to do so could not
injure or prejudice his rights in anyway. Formal notice of presentment and
dishonor to Mr. Goldberg would be merely a useless gesture of advising him of a
fact with which he was already aware. 3-504. He already knew that the notes
could not be and were not paid from any corporate funds. Regarding Kushner, he
signed only as an indorser, there is no proof of presentment and dishonor, nor
was there any activity or participation in the affairs of the corporation so as to
excuse presentment or notice of dishonor.
iii. Note: Goldberg was the president; he knew the corporation couldn’t pay it, so the
technical requirements of presentment wouldn’t have done any good.
F. The Drawee’s Obligation
1. Problem 145: Sam wrote an alimony check for $3K to his ex-wife Sue when his bank
balance at ONB greatly exceeded that amount. When Sue presented the check to ONB,
it refused to pay even though there was sufficient money in Sam’s account at ONB.
What should Sue do?
a. 3-408 (Drawee Not Liable on Unaccepted Draft): A check or other draft does not of
itself operate as an assignment of funds in the hands of the drawee available for its
payment, and the drawee is not liable on the instrument until the drawee accepts it.
b. 3-401(a): A person is not liable on an instrument unless (i) the person signed the
instrument, or (ii) the person is represented by an agent or representative who
signed the instrument and the signature is binding on the represented person under
3-402.
c. Thus, the bank is not liable on the check unless it accepts the check or signs the
check. Sue can’t sue the bank, she must contact Sam (drawer) for payment (but, the
bank is guilty of wrongful dishonor and the only person who can bring sue against
 the bank is the drawer (Sam))
2. Sales Draft Hypo: seller agrees to ship buyer 10,000 widgets at $20 each, “payment
against sight draft.” Seller will draw a draft on buyer payable on sight (when buyer first
sees it). Seller can discount the draft with seller’s bank, which will indorse the draft
over to collecting bank in buyer’s city, which will make a formal presentment to buyer-
drawee.
a. Seller is drawer, buyer is drawee
b. Payee can be anybody (highly likely to be a bank in seller’s town) to whom the
instrument is negotiated
3. The Non-Bank Acceptor (buyer in sales draft)
a. 3-409 (Acceptance of Draft; Certified Check)
i. “Acceptance” means the drawee's signed agreement to pay a draft as presented.
It must be written on the draft and may consist of the drawee's signature alone.
Acceptance may be made at any time and becomes effective when notification
pursuant to instructions is given or the accepted draft is delivered for the purpose
of giving rights on the acceptance to any person.
ii. A draft may be accepted although it has not been signed by the drawer, is
otherwise incomplete, is overdue, or has been dishonored.
iii. If a draft is payable at a fixed period after sight and the acceptor fails to date the
acceptance, the holder may complete the acceptance by supplying a date in good
faith.
iv. “Certified check” means a check accepted by the bank on which it is drawn.
Acceptance may be made as stated in subsection (a) or by a writing on the check
which indicates that the check is certified. The drawee of a check has no
obligation to certify the check, and refusal to certify is not dishonor of the check.
b. Norton v. Knapp
i. Fact: Drawee, Miles Knapp was presented with a sight draft to pay to the order of
Exchange Bank, $85.” On the back of it Knapp wrote “Kiss my foot. Miles Knapp.”
ii. Issue: How to construe the words “Kiss my foot.”? Held, this was a refusal.
iii. Holding: D intended by the use of the contemptuous and vulgar words to give
emphasis to his intention not to accept or have thing to do with the bill or the
plaintiff. They imply, and are understood to mean a contemptuous refusal to
comply with such request.
c. Time draft: must be presented twice, once for acceptance for the draft and once for
payment
i. Ex: Payable 60 days after sight. You have to present to start the running of the
time period. So there are 2 presentments.
To Betty Buyer
Sixty (60) days after sight, pay to the order of Scott Seller $10,000.
ii. 2 presentment
a) Presentment for acceptance: holder has to present the draft to start the
running of the time period
1. If drawee dishonored, she would not be liable on the instrument b/c she
 incurred no 3-413 liability
b) Presentment for payment: after 60 days, holder will make a 2nd presentment to
the drawee
1. If acceptor dishonors, she can be sued on her 3-413 obligation, or holder can
proceed, after giving notice of dishonor, against drawer and prior indorsers
on their K
iii. 3-502(b)(4): If a draft is payable on elapse of a period of time after sight or
acceptance, the draft is dishonored if presentment for acceptance is duly made
and the draft is not accepted on the day of presentment.
a) OC4: An unaccepted time draft differs from a time note. The maker of a note
knows that the note has been issued, but the drawee of a draft may not know
that a draft has been drawn on it. Thus, w/r/t drafts, presentment for payment
or acceptance is required.
1. (b)(3) applies to drafts payable on a date stated in the draft. Dishonor occurs
if presentment for payment is made and payment is not made on the day the
draft becomes payable or the day of presentment if presentment is made
after the due date. The holder of an unaccepted draft payable on a stated
date has the option of presenting the draft for acceptance before the day the
draft becomes payable to establish whether the drawee is willing to assume
liability by accepting. Under (b)(3)(ii) dishonor occurs when the draft is
presented and not accepted.
2. (b)(4) applies to unaccepted drafts payable on elapse of a period of time
after sight or acceptance. If the draft is payable 30 days after sight, the draft
must be presented for acceptance to start the running of the 30-day period.
Dishonor occurs if it is not accepted.
iv. 4 Types of Acceptance under UCC
a) Of offer (Art. 2)
b) Of goods (Art. 2)
c) Of draft (Art. 3)
d) Wire transfer (Art. 4)
4. Checks
a. 3-408: A check or other draft does not of itself operate as an assignment of funds in
the hands of the drawee available for its payment, and the drawee is not liable on
the instrument until the drawee accepts it.
b. Drawer’s writing of the check does not create any immediate rights in the checking
account funds and the drawee bank has no liability to the holder of the check until it
accepts it (Bank is not liable for a check unless it accept the check)
c. Galyen Petroleum v. Hixson
i. Fact: Galyen-payee presented checks to drawee bank, drawn on the account of
drawer. Bank refused despite having adequate funds in Hixson’s account. On 3
instances, the Bank refused to honor checks presented by Galyen, drawn on
Hixson’s acct. The bank setoff the amount in Hixson’s acct, against a loan, even
though it was not yet due. Hixson declared bankruptcy and was discharged.
 Galyen says bank unlawfully refused to honor his checks.
ii. Rule: a check or other draft does not of itself operate as an assignment of any
funds in the hands of the drawee, and the drawee is not liable on the instrument
until he accepts it (even if the bank should have accepted it). (3-408)
d. Common law rules
i. By special agreement, the drawer could work an immediate assignment of bank-
held funds so as to give the holder of the check a claim against the drawee bank
prior to acceptance -> create K obligation
5. Certification
a. Definition: drawee bank’s acceptance of a check
b. 3-409(d): “Certified check” means a check accepted by the bank on which it is
drawn. Acceptance may be made as stated in subsection (a) or by a writing on the
check which indicates that the check is certified. The drawee of a check has no
obligation to certify the check, and refusal to certify is not dishonor of the check.
i. Once certifying/accepting the check, the bank has the same obligation as maker
c. 3-413 (Obligation of Acceptor)
i. The acceptor of a draft is obliged to pay the draft (i) according to its terms at the
time it was accepted, even though the acceptance states that the draft is payable
“as originally drawn” or equivalent terms, (ii) if the acceptance varies the terms of
the draft, according to the terms of the draft as varied, or (iii) if the acceptance is
of a draft that is an incomplete instrument, according to its terms when
completed, to the extent stated in 3-115 and 3-407. The obligation is owed to a
PETE the draft/drawer/indorser who paid the draft under 3-414 or 3-415.
ii. If the certification of a check or other acceptance of a draft states the amount
certified or accepted, the obligation of the acceptor is that amount. If (i) the
certification or acceptance does not state an amount, (ii) the amount of the
instrument is subsequently raised, and (iii) the instrument is then negotiated to a
HDC, the obligation of the acceptor is the amount of the instrument at the time it
was taken by the HDC.
d. Problem 146: GG gave a check for $5K to church, and church did not want to cash
any checks it received until it has at least $20K. The church didn’t want contributors
to be able to back out and stop payment, so the church took GG’s check down to
drawee bank and asked to have it certified, a presentment for acceptance. The
drawee bank refused, saying that its practice was never to certify gift checks
i. Is that a dishonor so that the church should give GG notice of dishonor?
a) 3-409(d): No, drawee of a check has no obligation to certify the check and
refusal to certify is not dishonor of the check
ii. What should the church’s lawyer advise it to do now?
a) Cash the check right away. (if church presents checks for payment and bank
refuses, that would be dishonor)
iii. If the bank certified the check, but later refuses to pay it, could the church sue GG
on his drawer’s obligation?
a) 3-414(c): No, once a draft is accepted by a bank, the drawer is discharged,
 regardless of when or by whom acceptance was obtained. Once certifying the
check, the bank took the liability
b) Policy: payee gets a better defendant (bank) by certifying it
iv. Same result if GG had donated a certified check that the bank later dishonored?
a) OC3 to 3-414: Under subsection (c) the drawer is discharged of liability on a
draft accepted by a bank regardless of when acceptance was obtained. Holders
that have a bank obligation do not normally rely on the drawer to guarantee
the bank's solvency. A holder can obtain protection against the insolvency of a
bank acceptor by a specific guaranty of payment by the drawer or by obtaining
an indorsement by the drawer. 3-205(d).
b) Yes, drawer was discharged
G. Signature by an Agent
1. 3-402(a): agent’s authority to sign principal’s name may be real (express/implied) or
even apparent
2. Problem 147: F signed a promissory note payable to bank as an agent of B, when B
borrowed money from bank. But, F simply wrote his name “J. Pierpont Finch, Agent”
and failed to mention B’s name. Is B bound on this note?
a. 3-402(a): Yes, B (principal) is bound b/c agent may sign either his name or principal’s
name.
3. How can an agent avoid personal liability?: 3-402(b)(1)
a. Must name principal; AND
b. Unambiguously indicate that he is signing only in a representative capacity
c. Otherwise, agent is liable to HDC without notice that agent was not intended to be
liable
i. If HDC is not involved, agent may prove the original parties intention
4. Problem 148: In Problem 147, would F be liable to a HDC?
a. F would be liable to HDC without notice of the agency agreement and F cannot try to
prove otherwise. (But, F may prove that HDC had notice)
b. Would F be liable to the bank (non-HDC)? F would not be liable to the bank if he can
prove the original parties did not intend for the agent to incur liability
5. Mundaca Investment v. Febba
a. Fact: At the end of the note below the signature line, the name of each D was
typewritten beside the preprinted term “Borrower.” Following their signature, each
D handwrote the word “trustee.” But the trustee was not identified on the face of
the notes.
b. Rule: They do not indicate the name of the trust. So as to a HDC they would be
personally liable, but b/c the represented person (the trust) is not identified in the
instrument as required by 3-402(b)(1), this case fall under 3-402(b)(2). Thus they are
personally liable in two situations 1) to a HDC, 2) to any other party unless
defendants prove that the original parties did not intend them to be personally
liable.
6. Problem 149: President of Money Corp., John Smith, signed 3 corporate promissory
notes. Is he personally liable to HDC?
 a. John Smith (Money Corp. not mentioned): Yes, he is personally liable but can
introduce evidence against non-HDC
b. Money Corp., John Smith: Yes, he is liable b/c he didn’t state that he was signing as
an agent
c. Money Corp., John Smith, President: No, he is not liable b/c it is clear that he’s
signing in a representative capacity
7. Problem 150: Corporate checks of Francis Racing Stables had the words “Francis Racing
Stables” printed prominently in the upper left-hand corner of the checks, but the
president, Kit Fielding, simply signed his name and did not mention the name of the
company or agent/president. If the check is negotiated to a HDC and then dishonored
by the drawee bank, may HDC successfully impose personal liability on Fielding?
a. 3-402(c): In case of a check, if the check is payable from the company’s bank
account, representative is not personally liable even though he didn’t indicate his
representative status (as long as principal is named somewhere in the check –
check identifies the represented person)
8. Nichols v. Seale
a. Fact: Note was signed: “The Fashion Beauty Salon, Carl Nichols [typed], /s/ Carl
Nichols”. The Fashion Beauty salon was a dba, i.e., assumed name for Carls Fashion,
Inc.
b. Held: Use of an assumed name does “name the persons represented’ within the
meaning of the code. Extrinsic/parol evidence is admissible to identify the signer,
and when he is identified, the signature is effective. (usage of trade) Also, parole
evidence is admissible to show, as b/w the original parties, that the signer was not
personally obligated. The intent must be communicated to the other party.
c. Note:
i. Is using the dba sufficient disclosure of the principal. yes.
ii. Is the signature ambiguous as to the representative capacity. yes, but we’re not
dealing with a HDC, so he gets the opportunity to prove up the intent of the
parties, whether the original parties intend for him to be bound or not.
iii. TX supreme ct. reversed b/c the subjective intent should have been disclosed to
the other contracting party
IV. Other Theories of Liability
A. Legal relationship b/w bank and customer
1. Properly payable rule (4-401)
2. Wrongful dishonor rule (4-402)
B. Forgeries and alterations of negotiable instruments
1. Causes of action based on warranty and conversion

CHAPTER 11. BANKS AND THEIR CUSTOMERS

I. Introduction
A. Art. 4: Bank deposits and collections
1. 4-102(a): whenever Art. 3 conflict with Art. 4, Art. 4 prevails
a. 4-207 and 4-208 prevail over 3-416 and 3-417, if both applicable
 2. Terminology
a. Drawee bank: payor bank, paying bank
b. Depositary bank: first bank to which an item is transferred for collection
i. Includes payor bank
c. Collecting bank: any bank, except payor bank, in the collection process
i. Excludes payor bank
ii. Includes depositary bank
II. The Checking Account
A. 2 legal relationship w/r/t a checking account with a bank
1. Debtor/creditor: depositor is creditor, bank is debtor
2. Principal/agent: depositor is principal, bank is agent
B. “Properly Payable” Rule
1. 4-401 (When Bank May Charge Customer’s Account: Properly Payable Rule)
a. A bank may charge against the account of a customer an item that is properly
payable from the account even though the charge creates an overdraft. An item is
properly payable if it is authorized by the customer and is in accordance with any
agreement b/w the customer and bank.
b. A customer is not liable for the amount of an overdraft if the customer neither
signed the item (check) nor benefited from the proceeds of the item.
c. A bank may charge against the account of a customer a check that is otherwise
properly payable from the account, even though payment was made before the date
of the check, unless the customer has given notice to the bank of the postdating
describing the check with reasonable certainty. The notice is effective for the period
stated in 4-403(b) for stop-payment orders, and must be received at such time and in
such manner as to afford the bank a reasonable opportunity to act on it before the
bank takes any action w/r/t the check described in 4-303. If a bank charges against
the account of a customer a check before the date stated in the notice of postdating,
the bank is liable for damages for the loss resulting from its act. The loss may include
damages for dishonor of subsequent items under 4-402.
d. A bank that in good faith makes payment to a holder may charge the indicated
account of its customer according to:
i. the original terms of the altered item; or
ii. the terms of the completed item, even though the bank knows the item has been
completed unless the bank has notice that the completion was improper.
2. In summary:
a. Bank may pay out customer’s money only if it follows his orders exactly
b. If not, it must recredit the account
c. If properly payable, bank may charge even though it creates an overdraft
3. Problem 151: Portia gave her roommate a postdated check, dating one week later and
the roommate deposited the check in her own bank immediately, which presented it to
payor bank before the date of the check. Portia’s bank paid the check even though this
created an overdraft for which Portia was charged.
a. Was the check properly payable before its date?
 i. 4-401(c): Yes b/c the check was otherwise properly payable except the postdating
and Portia did not give notice to the bank of the postdating with reasonable
certainty (bank may pay even though it has notice from the check’s face unless the
notice is from the drawer)
b. If Portia had phoned the bank and warned it, would it have still been properly
payable?
i. No, if she gave notice to the bank with reasonable certainty
ii. If bank pays nonetheless, the bank is liable for the damages caused by this
4. Problem 152: Jack lost his checkbook and 1 month later, his bank (YNB) returned his
cancelled checks, including one payable to Shadbolt for $1K, to which Jack’s name was
forged as drawer. He notified YNB promptly.
a. Was this check properly payable?
i. 3-401: a person is not liable on an instrument unless he signs it
ii. 3-403: unauthorized signature
iii. No, the check is not properly payable b/c his signature was forged and not
authorized by the customer(OC1 to 4-401) (the check is properly payable from the
forger’s account)
b. If Jack had called YNB immediately on finding out that his checkbook was missing,
could the bank have made him stop payment on all those blank checks and also pay a
good hefty stop-payment fee on each one?
i. OC1 to 4-401: An item containing a forged drawer's signature or forged
indorsement is not properly payable. Concern has arisen whether a bank may
require a customer to execute a stop-payment order when the customer notifies
the bank of the loss of an unindorsed or specially indorsed check. Since such a
check cannot be properly payable from the customer's account, it is
inappropriate for a bank to require stop-payment order in such a case.
ii. Bank may not require Jack to make stop payment order or may not charge for a
stop-payment order b/c the check cannot be properly payable from Jack’s account
5. Problem 153: the Widow Douglas gave a check for $10.00 to Rogers in return for the
latter’s mowing her lawn. Harper stole the check, altered the amount to $1,000 and
forged Rogers’ signature to the back of the check. Harper presented the check for
payment to drawee bank (CSB), which paid him $1K. This reduced the balance in the
Widow Douglas’ account to zero and caused 4 other checks to bounce. The Widow
Douglas sued CSB.
a. The Widow Douglas’ argument: 4-401 says that bank may charge my account only
when the item is properly payable. On this check, I ordered bank to pay out $10 of
my funds to Rogers or his order. But since Rogers never signed it, he never ordered
it paid to anyone, and therefore bank did not pay in accordance with my
instructions and must recredit my account. Whatever payment it made was out of
the bank’s own funds
b. CSB’s argument: All we are require to do is make sure that the item is apparently
properly payable, that is, that it appears to contain the proper chain of
endorsements. We must also, of course, act in good faith, which we have done.
Mrs. Douglas paid Rogers, and if Rogers carelessly lost the check, why should that act
as a windfall to Mrs. Douglas? If Mrs. Douglas is permitted to win here, she will
have gotten a free lawn
 mowing job, and we will be out of $1K. In the alternative, even if we improperly
charged this account with the entire amount, surely 4-401(d)(2) permits us to take
$10 out of the account
c. Which argument would prevail if you were the judge? Mrs. Douglas would prevail
i. The bank did not follow drawer’s instruction to pay “Ben Rogers,” thus not in
accordance with the agreement b/w the customer and bank. (not a proper chain of
indorsement, the bank paid a wrong person the money)
ii. The bank does not have to pay $10 too until true “Ben Rogers” shows up
iii. What about 4-401(d)? – the thief is not a holder, so the bank should not have paid
anyway
6. Causes of action for bank’s wrongful paying out
a. Conversion: NO! Debtor (bank) cannot convert its “own” property (conversion is
misappropriation someone else’s fund)
b. Violation of “properly payable” rule under 4-401: OK
c. Breach of K or quasi-K: OK
7. Problem 154 (remotely created check): ONB recently paid a check drawn on a
customer’s account and there was no drawer’s signature on the check. Payee on the
check, as a telemarketing firm that had apparently called the bank’s customer, sold
him some product over the phone, had the customer read off the magnetically
encoded numbers at the bottom of his check, and then created the check. In lieu of
drawer’s signature, the check is stamped “drawer’s signature on file.” (pre-authorized
drafts) The customer now called and complained, apparently suffering from buyer’s
remorse, and wants the account recredited with the amount of the check. Is the payor
bank doing wrong when it honors them?
a. Banks are not required to investigate checks. And telemarketing companies are
sometimes authorized by customers to sign the checks as agents.
b. The “properly payable” rule would not apply when the customer initially authorizes a
check but then experiences "buyer's remorse" and subsequently tries to revoke the
authorization. If the depositary bank suspects "buyer's remorse," it may obtain from
its customer the express verifiable authorization of the check by the paying bank's
customer, required under the Federal Trade Commission's Telemarketing Sales
Rule, and use that authorization as a defense to the warranty claim.
8. Problem 155: Gulliver opened an account with SSB and used it for several yrs. When he
returned from a long sea voyage, a check that he had written and dated 8 yrs ago was
presented and paid against his account, creating an overdraft. Gulliver protested the
payment.
a. Will this argument succeed?
i. 4-404: Yes, the check is suspicious if it is more than 6 months old (trade usage not
to investigate usual checks would be effective)
ii. Granite Equip. v. Hempstead Bank: If bank wished to pay on a stale check, it could
do so in good faith
iii. Charles Ragusa v. Community State Bank: even if acting in good faith, the bank’s
payment of an obviously stale check demonstrated its lack of due care and
 prevented it from claiming the defense of good faith
b. Did the creation of an overdraft situation keep the check from being properly payable?
i. 4-401(a): No, bank may charge against the account if properly payable from the
account even though the charge creates an overdraft
c. Does the language of that section mean that a bank must pay overdrafts? No
i. 4-404: A bank is under no obligation to a customer having a checking account to
pay a check, other than a certified check, which is presented more than six months
after its date, but it MAY charge its customer's account for a payment made
thereafter in good faith.
ii. No, the bank MAY pay in spite of the overdraft
d. How quickly must Gulliver file suit?
i. 2 prong test under 3-118(c) - 3 yrs after dishonor or 10 yrs after the date of the
draft, whichever period expires first
ii. 4-111: 3 yrs from causes of action arise (the moment when you first could have
sued)
C. Wrongful Dishonor
1. 4-402 (Bank's Liability to Customer for Wrongful Dishonor, Time of Determining
Insufficient of Account)
a. Except as otherwise provided in Art. 4, a payor bank wrongfully dishonors an item if
it dishonors an item that is properly payable, but a bank may dishonor an item
that would create an overdraft unless it has agreed to pay the overdraft.
b. A payor bank is liable to its customer for damages proximately caused by the
wrongful dishonor of an item. Liability is limited to actual damages proved and
may include damages for an arrest or prosecution of the customer or other
consequential damages. Whether any consequential damages are proximately
caused by the wrongful dishonor is a question of fact to be determined in each case.
c. A payor bank's determination of the customer's account balance on which a decision
to dishonor for insufficiency of available funds is based may be made at any time b/w
the time the item is received by the payor bank and the time that the payor bank
returns the item or gives notice in lieu of return, and no more than one
determination need be made. If, at the election of the payor bank, a subsequent
balance determination is made for the purpose of reevaluating the bank's decision
to dishonor the item, the account balance at that time is determinative of whether a
dishonor for insufficiency of available funds is wrongful.
2. In summary, when a bank makes an improper payment from an account, this debit may
cause other checks written by the customer to be wrongfully dishonored. The customer
may recover all actual damages whenever the bank makes a wrongful dishonor of a
check that is properly payable from the account
3. Twin City Bank v. Isaacs (AK, 1984)
a. Fact: P’s checkbook was missing; two forged checks showed up; the bank put a freeze
on P’s account b/c P had once been convicted of a burglary. But someone else was
convicted for forging the checks. The account remained frozen for 4 years. Jury
awarded P 18K in compensatory, and 45K in punitive damages.
 b. Held: there is sufficient evidence to sustain damages for mental suffering, loss of
credit, and loss attributable to the inability to pursue the purchase of a home
(consequential damages).
4. Problem 156: Stella and Harry seek a divorce. To preserve Harry’s financial assets in the
status quo (to prevent fraudulent transfer of assets), Stella’s attorney sent a lis pendens
(notice of litigation) to the bank in which Harry maintained an account for the barber
shop he owned. The bank froze Harry’s account until the divorce matter was settled. 14
of the barber shop’s checks bounced and Harry’s ulcer acted up and put him in the
hospital. Harry filed suit against the bank, asking for $100K in damages. At trial, he
proved only the above facts but offered no evidence as to damages. Should the trial
judge grant the bank’s motion for a directed verdict?
a. 4-402(b): the bank’s liability is limited to the actual damages proved. Harry didn’t
prove any damages, so the motion for a directed verdict should be granted
b. Prof. says freezing account based on the only facts above is too conservative
5. Problem 157: When Archie received his paycheck from Nero, he walked it into the
drawee (NY MNB) and presented it. The teller refused to pay across-the-counter check
for the reason that Archie did not have his account with MNB.
a. Is this a wrongful dishonor?
i. Your Style v. Mid Town Bank: drawee bank’s failure to make full payment of
payroll checks maker issued to its EEs by imposition of a service charge was
contrary to the purpose of IL commercial code and thus illegal
ii. Buckley v. Trenton Savings: recovery is limited to actual damages when the
wrongful dishonor resulted from mistake, but recovery of consequential damages
is permitted where the dishonor was done willfully
iii. Yes b/c the check is properly payable and the bank refuses to pay it (wrongful
dishonor!)
a) What is practical advice for Archie? – Archie can’t sue the bank for wrongful
dishonor b/c only drawer can sue the drawee bank. Write a (threatening) letter
to your ER!
iv. Note: depositary bank is never required to accept checks unless it is drawee
(payor) bank, and so, depositary bank may impose fees in accepting other bank’s
checks
b. Could the bank solve this problem by putting a clause in the checking account
agreement stating that the customer would permit the bank to refuse to pay checks
presented across the counter unless the presenter had an account with the bank?
i. 4-103(a): Yes, b/c the effect of Art. 4 may be varied by agreement as long as
reasonable
D. Death or Incompetence of Customer
1. Common law rule: death or incompetence of a principal revokes the authority of an
agent to act used to play havoc with checking accounts
2. 4-405
a. A payor or collecting bank's authority to accept, pay, or collect an item or to account
for proceeds of its collection, if otherwise effective, is not rendered ineffective by
incompetence of a customer of either bank existing at the time the item is issued or
 its collection is undertaken if the bank does not know of an adjudication of
incompetence. Neither death nor incompetence of a customer revokes the authority
to accept, pay, collect, or account until the bank (i) knows of the fact of death or of
an adjudication of incompetence AND (ii) has reasonable opportunity to act on it.
b. Even with knowledge, a bank may for 10 days after the date of death pay or certify
checks drawn on or before that date unless ordered to stop payment by a person
claiming an interest in the account. (this section is for the purpose of probation after
death)
3. Problem 158: Howard dropped dead just after depositing the month’s bill payments in
the mailbox. His widow informed the payor bank of his death, by mentioning the mailed
checks and specifically asking to keep the account open to pay them. The bank manager
said that the bank would pay the checks for 9 more days. Howard’s crazy neighbor Nelly
called the bank and said that she was “sure to be an heir to the estate” and ordered the
bank to stop paying checks on Howard’s account.
a. Must the bank stop paying checks, or may it still continue to do so?
i. The bank must stop paying checks b/c 4-405 says a bank may not pay if “a person
claiming an interest in the account” orders to stop payment (even if the bank is
pretty sure that such claim is wrong)
b. If it returns checks, will it have made a dishonor? Yes
i. 3-502(b)(2): if a draft is payable on demand, the draft is dishonored if presentment
for payment is duly made to the drawee and the draft is not paid on the day of
presentment
c. Is it a wrongful dishonor so as to subject the bank to 4-402 damages?
i. No b/c the checks are not properly payable (4-401(a): properly payable if
authorized by the customer and in accordance with any agreement b/w customer
and bank)
E. Bank’s Right of Setoff
1. Common law lien (bank’s right of setoff/offset)
a. Bank could unilaterally debit the account of a depositor in order to pay a debt owed
to itself
b. One obligation (customer’s obligation to bank) is offset against another obligation
(bank’s obligation to customer)
i. But banks must be acting fairly in setoff customer’s account
c. Consumer who had a checking account with the same bank that issued him a credit
card might be the victim of a non-notification setoff on failing to make a payment
d. Fair Credit Billing Act prohibits non-notification setoff in customer credit card debts
2. Constitutional challenges to setoff right: has been rejected to date
a. Unconstitutional under Sniadach (garnishment without prior hearing held to violate
14th A): NO!
b. Setoff is a security interest, disclosure of which is required under federal Truth in
Lending Act and Uniform Consumer Credit Code: NO!
3. General accounts v. special accounts
a. General accounts (checking and savings accounts): may be setoff
 b. Special account (for a limited purpose): may not set off against it non-related debts
4. Walter v. National City Bank of Cleveland
a. Fact: R has a bank acct; R owed the bank on a 90-day promissory note that was not
yet due; W gets a judgment against R; W gets the court to issue a writ of
garnishment to the bank for them to pay W’s judgment; Bank get the garnishment
order and decided to set-off against the promissory note and then tells W that there
isn’t enough money in the account to satisfy the judgment; W sues the bank claiming
that the setoff was illegal
b. Rule:
i. Bank can setoff against matured obligations
ii. Banks can’t setoff against unmatured obligations
a) Exception: if the depositor is insolvent, then you can setoff even against
unmatured obligations – equity favors the bank since they hold the money
1. Exception to exception: if the bank created the debt, and made the loan
when the debtor was already insolvent, then the bank cannot use the money
and cannot setoff – here, equity does not favor the bank
b) If bankruptcy petition is filed, all the debts are stayed. Bank must freeze the
account, no setoff
5. Bankruptcy and setoff
a. Filing of a petition in bankruptcy creates an automatic stay against creditor collection
activity including setoff
b. Individuals injured by a violation of automatic stay may sue and recover actual
damages, including costs and attorneys fees, and punitive damages (sometimes)
c. Bank may apply to the bankruptcy court for relief from the stay, and on getting it
may exercise the right of setoff
d. Administrative freeze on a checking account is not the same as a setoff and does not
violate the automatic stay
i. Bank could freeze the account on learning of a bankruptcy, not allowing the
customer to reach the funds involved, but not taking the money for relief for itself
ii. Can preserve the status quo while the bankruptcy court is asked to straighten out
what is to become of the monies in the account
F. Customer’s Right to Stop Payment
1. Ordinary Checks
a. 4-403 (Customer’s Right to Stop Payment; Burden of Proof of Loss)
i. A customer or any person authorized to draw on the account if there is more than
one person may stop payment of any item drawn on the customer's account or
close the account by an order to the bank describing the item or account with
reasonable certainty received at a time and in a manner that affords the bank a
reasonable opportunity to act on it before any action by the bank w/r/t the item
described in 4-303. If the signature of more than one person is required to draw
on an account, any of these persons may stop payment or close the account.
ii. A stop-payment order is effective for 6 months, but it lapses after 14 calendar days
if the original order was oral and was not confirmed in a record within that period.
 A stop-payment order may be renewed for additional six-month periods by a
record given to the bank within a period during which the stop-payment order is
effective.
iii. The burden of establishing the fact and amount of loss resulting from the payment
of an item contrary to a stop-payment order or order to close an account is on the
customer. The loss from payment of an item contrary to a stop-payment order
may include damages for dishonor of subsequent items under 4-402.
iv. OC1 to 4-403: stopping payment or closing an account is a service which
depositors expect and are entitled to receive from banks. Inevitable occasional
losses should be borne by the banks
b. Parr v. Security National Bank
i. Fact: P ordered a stop payment, first orally, then in writing, and both times made
a 50-cent error in identifying the amount. P did give the correct date, check
number, of the check. Bank ended up paying the check.
ii. Rule: Stop payment order must identify the check with “Reasonable accuracy.”
iii. Held: P gave reasonable accuracy even if the amount was off by 50-cents. The
bank’s defense that it’s computer could only detect an exact match is untenable.
a) What if they just made a mistake? is that a defense to failure to do a stop
payment order? no, even if made by mistake or inadvertence (OC7).
c. Problem 159: Julio was tricked into buying a $50 refrigerator for $280 check. He
instructed the bank not to pay Juan the money by mentioning “Today – refrigerator
check” but the bank failed to stop payment. The bank refused to replace the money
in Julio’s account and Julio filed a suit against the bank, contending that the check
was not “properly payable” under 4-401. The complaint set out only the “facts” of
the stop-payment order and the payment in spite of it. How would you rule on each
of the following issues raised by the bank?
i. The stop payment order did not give enough info to be effective
a) No, Julio described the check with reasonable certainty b/c he mentioned
drawer’s name, payee’s name, date and the transaction and the bank was
afforded a reasonable opportunity to act on it (4-403(a))
b) OC5 to 4-403: describing the item must meet the standard of what info allows
the bank under the technology then existing to identify the item with
reasonable certainty
c) The bank may argue that the identification is not specific enough
ii. The K of deposit that Julio initially signed stated “Customer agrees that no oral
stop-payment order shall be effective; stop-payment orders must be in writing to
be effective”
a) 4-103(a): Art. 4 may be varied by agreement, but must be in good faith with
ordinary care
b) You can argue in both ways
1. No, you can’t K away good faith and ordinary care: hire Spanish translator for
your Spanish speaking customers
2. Yes, you can vary Art. 4 by agreement
iii. The K of deposit also contained this clause “Customer agrees that the bank shall
 not be liable if it mistakenly pays an item on which payment has been stopped”
a) OC 7 to 4-403: a payment in violation of an effective direction to stop payment
is an improper payment, even though made by mistake or inadvertence. Any
agreement to the contrary is invalid under 4-103(a) if the bank failed to
exercise ordinary care.
b) No, this clause is invalid
iv. The bank’s rules require that a stop-payment order be accompanied by a $15
stop-payment fee, and Julio failed to tender such a fee
a) OC 1 to 4-403: the inevitable occasional losses should be borne by the banks as
a cost of business of banking (opinions of Attorney General are in conflict)
b) Julio would argue that the bank must bear the cost of stop-payment as business
cost
c) The bank would argue that you can vary by agreement (but, can you make it a
condition precedent? – Prof. is very suspicious on it)
v. P’s complaint is defective in that it fails to allege any loss to P as a result of the
bank’s alleged wrongful payment, and P carries this burden under 4-403(c). P has
revoked his acceptance of refrigerator and avoided the sale on grounds of
unconscionability.
a) Cicci v. Lincoln Natl. Bank: the bank’s argument is persuasive
b) Thomas v. Marine Midland: to the contrary
c) Yes, 4-403(c) says that customer has the BOP of fact and loss (make sure to
prove loss in your complaint!)
d. 4-407(3): If a payor bank has paid an item in spite of the stop-payment order or after
the account has been closed, it is subrogated to the rights (3) of the drawer/maker
against the payee/holder of the item w/r/t the transaction out of which the item
arose
e. Problem 160: Thomas was unhappy about the color of his new car, so he placed an
oral stop-payment order (effective for 14 days under 4-403) on the check he had
written for the car. Negligently, the bank paid the check. Must the bank recredit the
account?
i. 4-407(2): If a payor bank has paid an item in spite of the stop-payment order or
after the account has been closed, it is subrogated to the rights (2) of the
payee/holder of the item against the drawer/maker either on the item or under
the transaction out of which the item arose
ii. The bank does not have to recredit the account before exercising its subrogation
rights (seller has a claim against Thomas b/c his revocation of acceptance is not
rightful: no breach of warranty, no ground for rejecting/revoking acceptance
here)
f. Canty v. Vermont National Bank
i. Fact: P handed his canceled IRS checks over to the IRS for inspection. The IRS re-
deposited the check, and the Bank paid them as second time, withdrawing the
funds from his account. Plaintiff moved for summary judgment. (clear violation of
“properly payable” rule v. subrogation rule)
 ii. Rule (4-407): if an item is not properly payable, the bank may not charge the
customer’s account and if it has done so, it must re-credit the acct under 4-401.
However, the bank may refuse to re-credit its customer’s acct after wrongful
payment of an item by subrogating itself to the rights of the presenter or the
improperly paid instrument.
iii. The IRS is unique because our account with them is never settled. Given the
purpose of avoiding unjust enrichment, the question is whether plaintiff depositor
actually suffered any loss by the admittedly improper payment.
iv. Held: P will have to prove his loss. The bank is not required to re-credit his
account before exercising its subrogation rights.
v. Note: the IRS was owed money by the depositor, and if they didn’t get it through
the payment of the checks, then they would have gotten it some other way, and
so the bank steps into the shoes of the IRS.
g. Problem 161: Rupert gave Maggie a $1K check as a birthday gift, and then submitted
to the bank a written stop-payment order on the check. In the meantime, Maggie
indorsed the check over to Computer City in payment for a $1K software package
and Computer City cashed the check at the bank. Rupert sued when the bank
refused to recredit his account, alleging a $1K loss b/c he had tried to revoke a gift
promise. Are either of these defenses by the bank good?
i. Computer City was a HDC and Rupert could not have refused to pay if it had
presented the check to him. Under 4-407, the bank is subrogated to the rights of
any HDC.
a) OC7 to 4-403: the payment can be stopped against a HDC, but the drawer
remains liable on the instrument to the HDC. If drawee pays, it becomes
subrogated to the rights of the HDC against the drawer. Any defenses available
against a HDC remain available to the drawer.
b) OC1 to 4-407: A defense frequently interposed by a bank in an action against it
for wrongful payment over a stop-payment order is that the drawer or maker
suffered no loss because it would have been liable to a HDC in any event. On
this argument some cases have held that payment cannot be stopped against a
HDC. Payment can be stopped, but if it is, the drawer or maker is liable and the
sound rule is that the bank is subrogated to the rights of the HDC
c) Yes, the bank is subrogated to the rights of the HDC (Computer City) against the
drawer (Rupert) and Rupert’s defense (revocation of gift) is not valid against
the HDC (Maggie is not a HDC b/c she did not pay value for the check)
ii. Computer City was a HDC and Rupert would eventually have had to pay Computer
City if the bank had been able to remember to stop payment. This being true,
Rupert has really suffered no loss by the wrongful payment.
a) 4-403(c): BOP of loss b/c of wrongful payment is on the customer
b) Seigel v. Merrill Lynch: bank is not liable in paying a HDC in spite of the stop-
payment order b/c the HDC would have been able to enforce the check against
the maker
c) Yes, Rupert can’t prove he’s suffering any loss due to the bank’s payment to
 Computer City. So, the bank would prevail
h. Problem 162: Same fact situation as in Problem 161, except that Maggie deposits
the check in her checking account with ONB. The next day, Maggie wrote a check
and cashed it at her bank, and ONB sent the check to the payor bank, CSB, which
negligently paid the check over the stop-payment order. Can CSB still use the above
2 defenses? Yes b/c ONB is a HDC (FIFO rule)
i. 4-221: In determining a HDC, a bank has given value to the extent it has a security
interest in an item, if the bank otherwise complies with the requirements of
Section 3-302 on what constitutes a HDC
ii. 4-201(a): A collecting bank has a security interest in an item and any
accompanying documents or the proceeds of, in case of an item deposited in an
account, to the extent to which credit given for the item has been withdrawn or
applied
iii. Thus, ONB is a HDC b/c it has given value for the check, and as a HDC, ONB is
entitled to recover against either the drawer (Rupert) or the indorser (Maggie)
2. Cashier’s, Teller’s, and Certified Checks
a. definitions
i. Cashier’s check: drawer = drawee = bank
ii. Teller’s check: drawer = bank 1, drawee = bank 2, bank 1 ≠ bank 2
iii. Certified check: check for which the bank verifies that sufficient funds exist in the
account to cover the check, and so certifies, at the time the check is written
b. OC4 to 4-403: a customer has no right to stop payment on a
certified/teller’s/cashier’s check
i. Once the check is certified, the payor bank is the primary obligor on the
instrument, and the drawer has no right to require the bank to breach its
acceptor’s K
c. Problem 163: Harry agreed to sell his sports car to Tom. Tom (remitter) purchased a
$15K cashier’s check payable to the order of Harry, and handed the check over to
Harry. When Tom went to pick up the car, he found it a worthless wreck and
demanded the bank not to pay the check. Should the bank do this?
i. 3-411 (Refusal to Pay Cashier’s Checks, Teller’s Checks, and Certified Checks)
a) In this section, “obligated bank” means the acceptor of a certified check or the
issuer of a cashier's check or teller's check bought from the issuer.
b) If the obligated bank wrongfully (i) refuses to pay a cashier's check or certified
check, (ii) stops payment of a teller's check, or (iii) refuses to pay a dishonored
teller's check, the person asserting the right to enforce the check is entitled to
compensation for expenses and loss of interest resulting from the nonpayment
and may recover consequential damages if the obligated bank refuses to pay
after receiving notice of particular circumstances giving rise to the damages.
c) Expenses or consequential damages under subsection (b) are not recoverable if
the refusal of the obligated bank to pay occurs because (i) the bank suspends
payments, (ii) the obligated bank asserts a claim or defense of the bank that it
has reasonable grounds to believe is available against the PETE, (iii) the
 obligated bank has a reasonable doubt whether the person demanding
payment is the PETE, or (iv) payment is prohibited by law.
ii. No, the bank may not refuse to pay b/c the purchaser of a cashier’s check has no
right to ask for stop payment (remitters can NOT stop payment on cashier’s
check)
iii. What can Tom do if the bank refuses to help him?
a) 3-202: negotiation is not effective if obtained by “fraud”
b) OC2 to 3-201: The remitter, although not a party to the check, is the owner of
the check until ownership is transferred to Seller by delivery. This transfer is a
negotiation because Seller becomes the holder of the check when Seller
obtains possession. In some cases Seller may have acted fraudulently in
obtaining possession of the check. In those cases Buyer may be entitled to
rescind the transfer to Seller because of the fraud and assert a claim of
ownership to the check under 3-306 against Seller or a subsequent transferee
of the check
c) Tom may rescind the K for fraud and assert a claim of ownership to the check
against Harry
d. Patriot Bank v. Navy Federal Credit Union
i. Fact: Plaintiff bank sued defendant credit union for refusing to honor a cashier's
check on presentment. The check was obtained by a credit union member who
gave the check as payment to a used car dealer and bank customer who deposited
the check into its account. The bank maintained that the used car dealer properly
indorsed the check when it wrote its account number and deposited the check.
ii. Held: The used car dealer wrote its account number in order to authenticate the
check for the purposes of deposit and the account number constituted an
indorsement. There was no need for the credit union to return the cashier's check
to the bank in order for the bank to guarantee the missing endorsement of its
customer. By submitting the check, the bank warranted it had credited the
dealer's account. The credit union had no defenses of its own to the payment of
the cashier's check. The credit union could not properly stop payment on the
cashier's check based on defenses of the member as remitter and refuse to honor
the check when it was presented after the bank guaranteed the missing
endorsement.
e. 3-312: stop payment on lost, destroyed, or stolen cashier’s/teller’s/certified checks
i. The person who lost possession files with the issuing bank a declaration of loss
ii. For 90 days after the date of the check: the issuing bank must pay it if it is
presented by a PETE
iii. After 90 days, the issuing bank should pay the amount of the check to the person
filing the declaration of loss
iv. If the check is presented after the issuing bank pays to the claimant, the claimant
must refund to the bank or the PETE
f. Problem 164: Portia purchases a cashier’s check from ONB payable to the order of
herself, signed her name to the back of the check and mailed it to her uncle. The
uncle denied receiving the check (a lie), and Portia filled out a declaration of loss
on
 Mar. 1. Having heard nothing during the next 90 days, ONB refunded the money to
Portia. Meantime, the uncle cashed the check at his local bank on May 25. Assuming
that the local bank qualifies as a HDC, what should ONB do when the local bank
presents the check on June 2?
i. 3-312(b)(2): Until the claim becomes enforceable, it has no legal effect and the
obligated bank may pay the check or, in the case of a teller's check, may permit
the drawee to pay the check. Payment to a PETE discharges all liability of the
obligated bank w/r/t the check.
ii. OC3 to 3-312: If the claim becomes enforceable and payment has not been made
to a PETE, the bank becomes obligated to pay the amount of the check to the
claimant. When the bank becomes obligated to pay the amount of the check to
the claimant, the bank is relieved of its obligation to pay the check. Thus, any PETE
including even a HDC, loses the right to enforce the check after a claim under
subsection (b) becomes enforceable.
iii. After 90 days, ONB is allowed to pay the check to Portia and ONB is relieved of its
obligation when it pay the money to Portia. The local bank may not go against
ONB, but it may go after Portia
a) Banks do not want to dishonor their own cashier’s checks b/c that will ruin their
reputation
g. 3-309 (Alternative to 3-312)
i. True owner of the check can go to court and judicially recreate it, having to post
bond or give other adequate protection for the entity that will then pay the
instrument
G. Mortgage Hypo: Harry arranged for a financing loan with RNB, which loaned him $200K
to buy a home. He signed 3 documents: (i) a mortgage K by which he (mortgagor) agreed
to repay the mortgage debt to the bank (mortgagee) or its assigns; (ii) a mortgage deed
which the bank would file in the real property records to create a lien on the property in
its favor; and (iii) a promissory note by which Harry agreed to pay the mortgage amount
to the order of RNB. 3 months later, RNB sold the mortgage to MIB by a K assigning the
mortgage to MIB which also took possession of the promissory note. MIB then sold the
note and mortgage to ST, which bundled the notes together to create the trust corpus
and then sold bonds, using the trust assets as collateral. As the mortgages matured, they
were transferred out of the trust and into the hands of the entity that would seek final
payment from the mortgagor and foreclose if he did not make this payment. Harry was
informed that he should make his monthly payment to a mortgage servicing company HA,
but he missed 6 payments in a row. Harry was then contacted by VFC, which claimed to
be the current owner of the mortgage. Assume that VFC can prove a regular chain of
mortgage assignment Ks, and that it has a photocopy of the original promissory note. The
back of the note is blank, never having been indorsed by the payee RNB.
1. Does Harry’s liability as the maker of a promissory note runt to VFC? No
a. Under 3-412, drawer is obligated to pay a PETE, and under 3-301, a PETE is a (i)
holder; (ii) person in possession of the note (shelter rule); or (iii) PETE under 3-309
(lost, destroyed note)
 b. VFC is not a holder b/c there is no indorsement by the payee, not covered by the
shelter rule b/c it is not in possession of the note, and not a PETE under 3-309 b/c it
cannot prove who was in possession of the note when the note disappeared, etc.
c. Thus, Harry’s liability does not runt to VFC
2. Is the copy of the promissory note valid against Harry? It turns out that no one can find
the original note, but this photocopy has been traveling with the mortgage K every
time it was assigned
a. 3-309: No, VFC must present the original note, otherwise, it must prove the terms of
the original note
3. Is Harry liable on the mortgage K?
a. Under 3-310(b)(2), the underlying obligation is suspended until the note is
defaulted/dishonored. Under 3-502(a)(3), if no presentment of the note, there is no
dishonor.
b. Thus, Harry is not liable on the mortgage K b/c it is suspended and the note is not
defaulted
4. What are the equities here? If Harry pays VFC, does that expose him to any risk? If a
court holds that VFC can’t foreclose, what should VFC now do? If you were the judge in
this case, how would you proceed?
a. Equities are strongly in favor of VFC, but Harry may be exposed to the risk that other
holder of the original note would show up and ask him to pay.
b. I would hold that Harry pay VFC the mortgage amount, and VFC would be liable
should the holder of the original note show up
H. Bank Statements
1. After deposit of a check, bank is required to return sufficient info about the check in
bank statement
a. 4-406(a): item number, amount, date of payment (safe harbor rule)
b. 4-406(b): when banks not physically return checks, must keep legible copies for 7 yrs
c. 4-406(c): customer must report alternation or forgery
d. For 7 yrs, payor bank must be able to furnish its customer with either the check itself
or a legible copy of it
2. Problem 165: Portia requested her bank copies of the 172 checks she had written
during the last yr. The bank tries to charge fee of $25 per copy. Can they do this? No
a. OC3 to 4-406(b): UCC does not regulate fees that banks charge their customers for
furnishing items or copies or other services covered by UCC, but under principles of
law such as unconscionability or good faith and fair dealing, courts have reviewed
fees and the bank's exercise of a discretion to set fees (the rule has not been settled,
but banks should not be too piggy)
b. $25 per copy is unconscionable
c. How quickly must the bank come up with the copies?
i. 4-406(b): in a reasonable time (depending on the bank’s system and the
customer’s needs)
d. What is Portia’s remedy if the bank neglects to produce the promised copies?
i. UCC does not specify sanctions for failure to retain or furnish the items or legible
 copies; this is left to other laws regulating banks. (specific performance)
3. 4-406(c): customer has a duty of examination for unauthorized signatures of the
drawer or any alterations on the check, and of prompt reporting if he should
reasonably have discovered the unauthorized payment
4. Problem 166: Joe opened a checking account with LSB, signed an account agreement
authorizing the bank to destroy the checks and return to him only a list of checks paid
from the account identified only by check #, amount, and date of payment. Joe was
bothered about (1) his records show that check 103 ($1204.00) was written for
$204.00 only and (2) he has written no more than 4 checks (check 105 was missing).
Does 4-406(c) require Joe to report all this to his bank?
a. Yes, Joe is required to report this to the bank (obligation to report alterations and
unauthorized signatures)
III. Bank Collection
A. Introduction (4-103)
1. may vary by agreement unless manifestly unreasonable (good faith, ordinary care, limit
damages)
2. FR regulations, operating circulars, clearing-house rules apply whether or not
specifically assented to by parties
3. Action constituting prima facie ordinary care
B. Funds Availability: How quickly the depositor can get back money from the bank in which
items are deposited? (not on the exam, but must know the terms)
1. Introduction: state/federal rules set outside time limits on the period that banks can
hold deposited funds
a. But not prohibits the depositary bank from allowing the customer earlier access to
the funds
2. Cash
a. 4-215(f): the next banking day, subject to the bank’s setoff right
b. 4-104(a)(3): banking day (testable question)– when the bank is open to the public
for carrying on substantially all of its banking functions (Saturday is not a banking
day!)
i. 4-108: bank may establish a cutoff hour in the early afternoon and pretend that
items received after that hour were received on the next banking day
3. Checks
a. Across the Counter Presentments: before the close of the business on the day of
presentment(3-502(b)(2))
b. “On Us” Items (depositary bank = drawee bank): as soon as your bank will let you
i. When do you have a legal right to draw checks? UCC – 2 days, EFAA – 1 day
a) If the depositary and payor banks are the same: 4-215(2)(e) – at the opening
of the 2nd banking day following receipt, unless dishonored
b) If dishonored: 4-202(a)(2) and 3-503(c) – you will be so notified
c) EFAA 603(a)(2)(E): next day availability
c. Transit Items (the depositary bank ≠ the payor (drawee) bank)
i. The depositary bank is called a collecting bank once it begins the process and acts
 as you agent (4-201(a))
ii. Problem 167: Prof. Chalk sent his son a $1K check for present who deposited the
check to his own bank unindorsed. The depositary bank stamped its own
indorsement on the back of the check and forwarded the check for collection.
But, Chalk stopped payment on the check and the depositary bank offset against
all of the son’s bank account to pay a debt the son owed it. When the check was
returned to the depositary bank, it threatened to sue Chalk under 3-414(b) and
Chalk responded that (i) bank is not a PETE b/c of no valid negotiation (no payee’s
signature). Chalk added that (ii) he had a defense of lack of consideration for his
drawer’s obligation.
a) 4-205: If a customer delivers an item to a depositary bank for collection:
1. the depositary bank becomes a holder of the item at the time it receives the
item for collection if the customer at the time of delivery was a holder of the
item, whether or not the customer indorses the item, and, if the bank
satisfies the other requirements of Section 3-302, it is a HDC; and
2. the depositary bank warrants to collecting banks, the payor bank or other
payor, and the drawer that the amount of the item was paid to the customer
or deposited to the customer's account.
b) As for the 1st argument: the depositary bank is a holder (b/c the son was a
holder) and thus a PETE under 3-301
c) As for the 2nd argument: failure of consideration is not a real defense, and not
valid against the bank that is a HDC
iii. Special rule for interbank collection presentments: 4-102(a)
a) No need to decide which checks to pay and which to dishonor before the close
of the business day
b) Provisional settlement by K: when exchanging checks each day, already
deposited each other’s accounts with the amounts of the presented checks
1. If decides to dishonor later, simply return the check and charge back
c) Clearing house rules: rules about provisional settlements and check exchanges
b/w banks
1. Clearinghouse rules are allowed to change the rules of UCC
d) Federal Reserve Bank: 1st intermediary bank b/w depositary bank and payor
bank, a bank for banks
e) Each bank has 2 banking days in which to pass the item on to the next bank: 4-
202(b)
f) Final settlement: if the payor bank pays the check, provisional settlements
along the check collection routine are said to firm up
g) 4-215(e): Subject to (i) applicable law stating a time for availability of funds
(superior command of federal law) and (ii) any right of the bank to apply the
credit to an obligation of the customer (bank’s own right of setoff), credit given
by a bank for an item in a customer's account becomes available for withdrawal
as of right:
1. if the bank has received a provisional settlement for the item, when the
 settlement becomes final and the bank has had a reasonable time to receive
return of the item and the item has not been received within that time;
(transit item rules)
2. if the bank is both the depositary bank and the payor bank, and the item is
finally paid, at the opening of the bank's second banking day following
receipt of the item. (“on us” items)
iv. Problem 168: ONB earns a lot of money off of the float period, so it wants the
float period to be as long as possible when it is collecting checks.
a) Is it okay to send the check on a circuitous route, much longer than is
necessary, in order to inflate the float?
1. 4-204: No, a collecting bank must send an item by a reasonably prompt
manner
b) If Mary deposits a check on May 1 and the check is drawn on a bank in another
state, so that by the fastest collection route, the check will pass through 2
intermediary banks before getting to the payor bank, and come back the same
route if dishonored, on what date in May must ONB allow Mary to withdraw
the money?
1. Under the final payment rules, the payor bank will have 2 banking days to
hold the check while it is considering whether or not to pay it
A. 4-215(e)(1):
B. If no dishonor: May 1 (ONB) -> May 3 (1st intermediary bank) -> May 5 (2nd
intermediary bank) -> May 7 (payor bank) -> May 9 (final settlement)
C. If dishonor: May 1(ONB) -> May 3 (1st intermediary bank) -> May 5 (2nd
intermediary bank) -> May 7 (payor bank) -> May 9 (decision to dishonor,
to the 2nd intermediary bank) -> May 11 (1st intermediary bank) -> May 13
(ONB)
d. The Federal Availability Rules (EFAA)
i. Next Day Availability of Special Items
a) There should be next banking day availability for items that are not likely to be
dishonored
1. Gov’t checks’ checks: issued by any branch of federal/state/local gov’t
2. Bank checks: on which a bank is primarily liable (cashier’s, teller’s and
certified checks)
3. Wire transfer: electronically sent payment orders of the sort covered by Art.
4A of UCC, and covered by Ch. 13
b) $100 Availability Rule: even for riskier checks, we ought to allow the customer
access to a small amount immediately
1. Give the customer $100 if aggregate of the day’s deposit – items already
requiring next day availability > $100
ii. Availability of Ordinary Checks
a) Local v. non-local: whether physically located in the same Fed check processing
region
1. Longer float period for nonlocal checks
b) Regulation CC 229.12: how fast you are allowed to make withdrawals based on
checks that you deposit in your own account drawn on other banks
1. Even if the rules require your bank to give you access to the deposited funds,
if a check is properly returned after you have taken out the money, you will
still be required to repay your own bank for the amount withdrawn
c) 3 rules
1. $100 Availability Rule allows you immediate access to the first $100
deposited in any one day, whether in cash or by check
2. If the depositary bank and the payor bank are local to one another, the
entire amount above $100 must be available for check writing purposes on
the second banking day following the date of deposit
A. If the customer wants to take out cash, he can only get to $400 of the
amount of the check on the 2nd banking day
3. The same rules apply for nonlocal checks, except that the period of
availability is on the 5th banking day following the day of deposit
d) Permanent Funds Availability: availability of different types of checks

e) A few escape valves

1. New Accounts: during the first 30 days of the existence of a new account,
there must be next-day availability for cash/wire deposits, for gov’t checks
and for bank-generated checks
A. If exceeds $5K, the depositary bank may put a hold on the amount that
exceeds $5K for up to 9 business days
B. UCC 4-415(e)(1) applies as to the time period for the availability of
local/nonlocal checks
C. No requirement of $100 next-day availability for new accounts
2. Large Checks: only the first $5K of a day’s deposit is subject to the normal
availability rules
A. The excess may be held for an additional reasonable period of time (5
business days for local checks, 6 business days for nonlocal checks)
 3. Redeposited Checks: normal availability rules are extended by an extra
reasonable period of time (with the same 5/6 business days presumption) in
case of redeposited checks, unless the announced reason for the return was
a missing indorsement or b/c the check was postdated, and the problems
have been cleared up at the time of redeposit
4. Repeated Overdrafts: normal availability rules are extended by an extra
reasonable period of time for 6 months after the account has been
repeatedly overdrawn
A. 2-prong test
i. If the account balance is negative (would have been negative if all
checks/charges had been paid) on 6 or more banking days within
preceding 6 months; OR
ii. If on 2 or more banking days within the preceding 6 months, the account
balance is negative (would have been negative if all checks/charges had
been paid) in the amount of $5K or more
5. The Reasonable Cause Exception: if the bank has “reasonable cause” to
believe that a check is uncollectible, it may ignore the usual rules, giving
notice (including reason and when the funds will be made available) to the
customer
A. Reasonable cause: facts which would cause a well-grounded belief in the
mid of a reasonable person
B. Example: check is being returned, check is stale, check kiting is suspected
C. For cashier’s, teller’s, certified checks, checks drawn on a FRB, checks
deposited at ATM
i. Must use the usual time periods plus a later reasonable time
6. Emergency Conditions: excuses compliance with the normal availability rules
due to emergencies beyond the bank’s control (4-109)
7. The Notice: Except in the new accounts situation, where a bank plans to take
advantage of either “large check,” “redeposited check,” “repeated
overdrafts,” or “reasonable cause” exceptions, the depositor must be
notified of the date the funds will be made available
A. Reliance on the model form of Notice of Exception to the usual availability
rules insulates the bank from any civil liability
8. Civil Liability: a bank that does not follow the statute/regulations by FRB can
be sued by the injured customer for his “actual” damages, punitive damages
($100 ~ $1K (in class action, lesser of $500K or 1% of the net worth of the
bank)), plus costs of suit and attorney’s fee
A. Federal or state court within 1 yr after the occurrence of the violation
C. Check Truncation
1. Introduction
a. Depositary bank simply keeps the deposited check and forwards only a description
of it to the payee bank through the bank collection process (4-110 & 4-209(b))
b. Banks are required to send certain info back to the customer and to give him the
 right to demand a legible copy of the check for 7 yrs after the statement was sent
out (4-406)
c. Creating an image of the check and sending it through bank channels: Check 21 Act
(not on exam)
2. Creating the Image and the Substitute Check
a. Reg. CC 229.2(ddd): banks (truncating banks – almost always depositary bank) have
the option (not duty) to create an image of the original check and pass it on if the
receiving bank agrees to that
i. If someone refuses to take the imaged version, a “reconverting bank” prints out a
paper version as a “substitute check”
ii. The reconverting bank must: Reg. CC 229.51(b)
a) Add all the indorsements that would have been placed on the original check
had it traveled the same route as the image
b) Identify the reconverting bank
c) Identify the truncating bank
3. Legal Equivalence (Sec. 4(b) – not on exam): the substitute check has the same legal
effect as the original (for ALL purposes)
a. No one can refuse to take the substitute check
b. Customers cannot insist on getting the original back
c. Problem 169: Sharon paid her state income taxes with a check, but the State
informed her that the taxes were still due. When she protested, the State demanded
to see the check, so she sent a copy of the check printed out by the bank to the State
which informed her that it was State policy to only accept the original cancelled
check as proof of payment. Now what should Sharon do?
i. A substitute check is legal equivalence if it satisfies the requirements of Section
4(b): accurately represents all of the info + bears the legend (sending the bank a
threatening letter)
4. Warranty Liability (Sec. 5): reconverting bank warrants that
a. The substitute check meets all the requirements for legal equivalence; and
b. No depositary bank, drawer, drawee or indorser will receive presentment or return
of the check (or any copy of it)
c. Problem 170: when the reconverting bank printed out the substitute check, the
account number was incorrectly listed as starting with an “8” when the original
started with a “3.” As a consequence, the wrong account was debited, causing other
checks to bounce. The payor bank recredited the account, now what?
i. Reg. CC 229.52 (Substitute check warranties)
a) Content and provision of substitute check warranties: A bank that transfers,
presents, or returns a substitute check (or a paper or electronic representation
of a substitute check) for which it receives consideration warrants to the parties
listed in paragraph (b) of this section that
1. The substitute check meets the requirements for legal equivalence described
in §229.51(a)(1)–(2); and
2. No depositary bank, drawee, drawer, or indorser will receive presentment or
 return of, or otherwise be charged for, the substitute check, the original
check, or a paper or electronic representation of the substitute check or
original check such that that person will be asked to make a payment based
on a check that it already has paid. (the original check is not floating around
and will not cause any problem!)
b) Warranty recipients: A bank makes the warranties described in paragraph (a) of
this section to the person to which the bank transfers, presents, or returns the
substitute check or a paper or electronic representation of such substitute
check and to any subsequent recipient, which could include a collecting or
returning bank, the depositary bank, the drawer, the drawee, the payee, the
depositor, and any indorser. These parties receive the warranties regardless of
whether they received the substitute check or a paper or electronic
representation of a substitute check.
ii. The warranty is breached b/c it is not legible. The account holder could sue the
payor bank for breach of the warranty of legal equivalence. The liability would
flow back to the reconverting bank, which can use Reg. J 210.5(a)(3) and (4) to sue
the truncating bank
5. Indemnity Liability (Sec. 6)
a. Reg. CC 229.53: indemnity liability against banks transferring the image or the
substitute check is created if doing so causes damages that could have been
prevented by use of the original check
i. Ex) if the drawer suffered a loss b/c it could not prove the forgery based on the
substitute check, the drawer would have an indemnity claim. But the drawer
would not have a substitute check warranty claim b/c the substitute check was the
legal equivalent of the original -> the amount of the drawer’s indemnity is limited
to the amount of the substitute check + interest and expenses
ii. Reg. CC 299.55(b)(1): all claims must be made within 120 days after the
transaction
iii. Check 21: SOL is 1 yr from the transaction
iv. Practice : destroy the original checks after 45 days
6. Expedited Recredit for Consumer (Sec. 7): consumer may get an expedited recredit
when he disputes the validity of the charge to the account
a. Sec. 7(a)(1): expedited recredit if the consumer asserts in good faith that (i) the bank
charged; (ii) the check was not properly charged or he has a warranty claim; (iii) he
suffered a loss; and (iv) the original check is necessary to determine the validity
b. Sec. 7(a)(2) : must recredit (i) no later than the end of the business day following the
business day when the bank determines the claim is valid, (ii) if not determined,
before the end of the 10th business day after the business day when the consumer
submitted the claim
c. Sec. 7(d): safeguard exceptions when the bank need not recredit
7. Expedited Recredit for Banks: a bank that is forced to recredit a consumer’s account
may seek indemnity from the bank that presented the check to it
a. All claims must be made within 120 days of the original transaction, must describe
 the reason
b. Within 10 days of the recredit claim, the indemnifying bank must recredit, return the
original check, or provide info
8. Lawsuits and Miscellaneous Provisions (Sec. 10)
a. Civil action is allowed for violations of the statute with an award of actual damages
(up to the amount of the check), plus costs and attorney’s fees
b. Notice of claims must be given within 30 days after a claimant discovers the grounds
for the claim
i. Otherwise, the amount of recovery is reduced by the amount that such prompt
notice would have provided
c. Federal or state courts – 1yr SOL
d. Rules of Check 21 may NOT varied by agreement except for the expedited recredit
b/w banks
e. Problem 171: Jeanie pay for her groceries with a check, the clerk scanned the check,
turning it into an electronic file, and then returned the check to her, telling that the
amount would be debited from her account.
i. This is neither Art. 4 nor Check 21 matter b/c the check was converted by a non-
bank. This is a creation of 1 transaction debit card
D. Final Payment
1. 4-302(a): following final payment, the payor bank is accountable for the amount of the
check: after the midnight deadline, it has lost the right to dishonor the check and must
pay it to the PETE
a. If properly payable: pay
b. If not: the payor bank may only rely on breach of presentment warranties (forgeries
and alterations) or common law restitution
c. Summary:
i. Deposit of a check in depositary : provisional settlement in your account (book
keeping entry) in 2 days - > depositary (collecting) bank sends the check to Federal
Reserve Bank: provisional settlement for the depositary bank (taking money from
payor bank account with FRB and put the money to depositary bank with FRB) in
2 days -> FRB sends the check to the payor bank in 2 days -> payor bank, by the
midnight deadline of the next banking day, decides whether to pay or return (final
payment or sending back the check)
a) If payor bank decides to return the check, it must give notice to depositary bank
-> the check bounces and you must pay back to depositary bank
ii. 3 causes of action after the payor bank already made a final payment,
a) Breach of presentment warranty (forgery, alteration) (4-302(b))
b) Defrauding (4-302(b))
c) Restitution (3-418): payment or acceptance by mistake by an innocent party can
be recovered
2. 4-302(b): The liability of a payor bank to pay an item pursuant to subsection (a) is
subject to defenses based on breach of a presentment warranty (4-208) or proof that
the person seeking enforcement of the liability presented or transferred the item for
 the purpose of defrauding the payor bank
a. Following the final payment, the payor bank bears the risk of any mistaken payment
not covered by one of these theories
3. 4-215(a): when does final payment occur? When the bank
a. Paid the item in cash;
b. Settled for the item without having a right to revoke the settlement under statute,
clearing-house rule, or agreement; or
i. Settle: to pay in cash, by clearing house settlement, in a charge or credit or by
remittance or otherwise as agreed. May be provisional or final (4-104(a)(11))
ii. Encompass all possible methods of making payment: wire transfer, netting of
outstanding accounts, tapping of an account, etc
c. Made a provisional settlement for the item and failed to revoke the settlement in the
time and manner permitted by statute, clearing-house rule, or agreement
i. If the check comes into the payor bank presented by another bank: the agreement
b/w 2 banks governs (e.g. presented items must be returned by 4 pm on the day
following the day of presentment)
ii. If the check is presented through a local clearinghouse: clearinghouse rule governs
iii. Absent such agreement: before expiration of the midnight deadline under 4-
104(a)(10) – midnight on its next banking day following the banking day on
which it received the relevant item or notice or from which the time for taking
action commences to run, whichever is later
a) Once the midnight deadline has expired, the check may not be dishonored and
returned
4. Final payment of a check destroys the check as a cause of action
a. All of the Art. 3 obligations (obligations of drawer, indorsers, and acceptor) are at
an end
b. Dishonor is no longer possible
c. Drawer and indorsers are off the hook
5. Problem 172: Sure made a presentment of a $12K check drawn on ONB at ONB. The
drawer’s account contained only $1K, but the teller misread it to be $100K. Right after
passing the money to Sure, the teller rechecked the account and snatched the money
out of Sure’s hands. Had the bank made final payment?
a. 4-215(a)(1): Yes, the bank has made final payment at the moment that the teller
passed the money to Sure (Chambers v. Miller)
6. Problem 173: Sally was the payee on a $1K check given to her by Joe. She and Joe both
banked at the same bank, ONB. Sally took the check to ONB and put $800 of the check
in her account and took the other $200 in cash across the counter (split deposit). 2
hours later, ONB discovered that Joe’s account was overdrawn. Can ONB dishonor the
whole check? $800 worth?
a. No dishonor is allowed b/c no partial final payment is possible, final payment for the
entire amount has been made
b. Kirby v. First & Merchant: payee cashed the whole check and deposited a part of the
cash into her account. No partial final payment is allowed.
7. Problem 174: In Problem 173, Sally asked for $1K cashier’s check drawn on ONB
payable to her order, and indorsed the check over to her creditor. ONB failed and
closed before the check could be presented and paid, so the creditor returned the
cashier’s check to her and demanded payment. Must she repay the creditor?
a. 3-310(a): No, payment by cashier’s check is the same as payment by cash! Sally’s
obligation to the creditor was discharged when the creditor took the cashier’s check
b. If she does repay the creditor, may she sue Joe either as drawer of the check (3-414)
or on the original obligation (3-310(b)(1))?
i. No, this check was finally paid and the underlying obligation was discharged!
8. Problem 175: what is the latest the payor bank can return a check before expiration of
its midnight deadline, assuming: the bank has established a cutoff hour of 2 pm, it is
not open on Saturdays and Sundays, Monday is a holiday, and FRB presents a check for
$1M on Friday at 4 pm?
a. The check is considered to have come in Tuesday morning. Thus, the payor bank
must return the check before Wednesday midnight.
b. Once the midnight deadline has passed for a check, the check may not be
dishonored and returned!
9. Rock Island Auction v. Empire Packing (Construing 4-302)
a. Fact: September 24, Rock received a check from Empire for $14K, September 24
Rock deposited check with First Bank, September 27 payor bank received item; Held
item until Oct 2. Oct 4, received by First Bank, Nov 7, Empire goes bankrupt, Rock
sues payor bank, b/c it held the check beyond the time limit fixed by 4-302
b. Held: the statute imposes liability for the amount of the item. 4-302 imposes liability
upon a payor bank for failing to act prior to its midnight deadline. 4-103(5) imposes
liability on a depositary bank or collecting bank for the same fault.
c. 4-303 places a greater liability on payor banks than 4-103 places on depositary or
collecting banks, b/c those banks are merely conduits, whereas the payor bank
knows whether or not there are sufficient funds available to pay the item.
d. Note: Customer said he would put the money in the bank. The bank tried to do him
a favor, but became strictly liable unless breach of warranty of presentment, fraud,
or restitution (innocent party)
10. Late return
a. Definition: return of a check on which the payor bank already made final payment –
not allowed
b. A payor bank that misses the midnight deadline is strictly liable for the amount of
the check involved
c. It is no defense that other parties, such as depositary bank, were negligent or did not
suffer a provable loss
d. Reg. CC 229.34: warranty of timely return for checks: if a bank is guilty of making a
late return, it has to respond in damages
e. Reg. CC 229.30(c)(1): payor bank is permitted to miss its midnight deadline as long as
it is able to return a check to the collecting bank “on or before the receiving bank’s
next banking day following the otherwise applicable deadline by the earlier of the
 close of that banking day or a cutoff hour of 2 pm or later set by the receiving bank
under 4-108”
i. Don’t send it back by mail, give it to a courier
ii. It is okay as long as the collecting bank receives the returned check the next
banking day after the payor’ bank’s midnight deadline
11. First National Bank v. Standard Bank
a. Fact: A person presented NB with checks amounting to $3.9 M, drawn on Standard,
and presented Standard with checks amounting $4M drawn on NB. The next day
each bank presented the other with the checks. Next day (Monday), NB opted not to
honor the checks, and returned all the check to Standard. Tuesday, Standard
received notice of this decision. Standard then attempted to dishonor its checks.
Stanford executives drove the checks to NB’s processing center. The checks were
received by NB at 3: 58pm, but NB did not credit Standard’s account.
b. Issue: Did Standard return the check in compliance with Reg CC, which provides that
the deadline is extended if the bank uses a “highly expeditious” means of
transportation.
c. Rule: Under the UCC, a paying bank may dishonor or revoke its provisional
settlement of a check before midnight on the next business day after it received the
check. 4-301. But Reg CC extends the deadline when a paying bank “expedites
delivery of a returned check.” Thus the bank need not regularly use a courier to
deliver the check.
d. Held: NB should have honored the checks Standard delivered in the amount of 3M.
12. Reg. CC 229.30(c)(1): the deadline is extended further if a paying bank uses a highly
expeditious means of transportation
a. Ex) a west coast bank may use this further extension to ship a returned check by air
courier directly to an east coast depositary bank even if the check arrives after the
close of the depositary bank’s banking day (now, banks can return checks by image!)
13. Problem 176: ONB has one central processing center where it makes all decisions
about whether to pay checks drawn on the branches. The canceled checks are returned
to the branches 2 days after the processing center decides to pay them. Is the
moment of presentment to the payor bank the moment of presentment to the
processing center or the moment when the check is returned to the individual branch?
a. Reg. CC 229.36(b): Receipt at bank office or processing center. A check is considered
received by the paying bank when it is received:
i. At a location to which delivery is requested by the paying bank;
ii. At an address of the bank associated with the routing number on the check,
whether in magnetic ink or in fractional form;
iii. At any branch or head office, if the bank is identified on the check by name
without address; or
iv. At a branch, head office, or other location consistent with the name and address
of the bank on the check if the bank is identified on the check by name and
address
b. Common law rule: The moment of presentment to the payor bank is when the check
 is returned to the processing center (agent of the paying bank)
c. But, if a bank designated different locations for the presentment, it requests
presentment of checks bearing a particular routing number only at the location
designated for receipt of collection checks bearing that routing number (Reg. CC
Commentary, p. 1747 supplementary)
E. Check Return: Regulation CC’s provisions designed to make the check collection
machinery operate very quickly to forward checks for collection and return them if
dishonored
1. The Federal Notice for Large Check Return (Reg. CC 229.33): checks of $2,500 or more
a. Payor bank must send a direct notice to the depositary bank (not through FRB) any
time it decides not to pay a check in the amount of the paying bank
i. Notice must include name and routing number of paying bank, name of payee,
amount, reason for return, date of indorsement of depositary bank, account
number of the depositor, branch where the item was first deposited, trace
number on the item of depositary bank
b. Fail to send notice -> payor bank becomes liable for actual damages
i. If not in good faith -> liable for consequential damages
c. Time limit: by 4 pm on the 2nd business day following the presentment to the paying
bank
d. Means: any reasonable means including physical return of check, writing, telephone,
Fedwire, telegraph
2. Expeditious return (Reg. CC 229.30): payor bank is required to return checks in a
manner that is as fast or faster than that which would be used to dispatch forward
collection were the depositary and payor banks reversed in function (the payor bank
may also return the check directly to the depositary bank, skipping intermediary
banks!)
a. Payor bank is deemed to act expeditiously if it returns the check in such a manner
that it would normally be received by the depositary bank not later than 4 pm on the
2nd business day following presentment to payor bank
b. This period can be extended to 4 business days if payor bank is non-local
3. Direct return to depositary bank is allowed: skipping over any collecting bank
F. Charge Back (highly testable!)
1. When a check is returned to depositary bank, depositary bank expects reimbursement
from its depositor no matter how many days elapsed since the check was first
deposited
a. 3 grounds for repayment
i. Initial K agreement signed when the account was opened
ii. Indorser’s obligation (3-415)
iii. Statutory right of charge back (4-214)
2. 4-214 (Right of Charge-back or Refund; Liability of Collecting Bank; Return of Item)
a. If a collecting bank has made provisional settlement with its customer for an item
and fails by reason of dishonor, suspension of payments by a bank, or otherwise to
receive settlement for the item which is or becomes final, the bank may revoke the
 settlement given by it, charge back the amount of any credit given for the item to its
customer's account, or obtain refund from its customer, whether or not it is able to
return the item, if by its midnight deadline or within a longer reasonable time after it
learns the facts it returns the item or sends notification of the facts. If the return or
notice is delayed beyond the bank's midnight deadline or a longer reasonable time
after it learns the facts, the bank may revoke the settlement, charge back the credit,
or obtain refund from its customer, but it is liable for any loss resulting from the
delay. These rights to revoke, charge back, and obtain refund terminate if and when
a settlement for the item received by the bank is or becomes final (if no final
payment, the depositary bank may revoke the provisional settlement and charge
back from depositor’s account)
b. A collecting bank returns an item when it is sent or delivered to the bank's customer
or transferor or pursuant to its instructions.
c. A depositary bank that is also the payor may charge back the amount of an item to
its customer's account or obtain refund in accordance with the section governing
return of an item received by a payor bank for credit on its books (Section 4-301).
d. The right to charge back is not affected by:
i. previous use of a credit given for the item; or
ii. failure by any bank to exercise ordinary care with respect to the item, but a bank
so failing remains liable.
e. A failure to charge back or claim refund does not affect other rights of the bank
against the customer or any other party.
f. If credit is given in dollars as the equivalent of the value of an item payable in foreign
money, the dollar amount of any charge-back or refund must be calculated on the
basis of the bank-offered spot rate for the foreign money prevailing on the day when
the person entitled to the charge-back or refund learns that it will not receive
payment in ordinary course.
3. Problem 177: Damon gave Pythias a $500 check drawn on BNB (drawee, payor bank),
which Pythias deposited in his account with DSB (depositary, collecting bank) on
Monday, July 8. On July 11, assuming that final payment had occurred, Pythias wrote
checks against the augmented balance. On July 10, the check reached BNB and was
marked NSF, and returned to DSB the next day. DSB took $500 out of Pythias’
account without notice, causing several other checks to bounce on July 15.
a. Can Pythias sue DSB under 4-402 for wrongful dishonor of these later checks?
i. 4-215(d): if provisional settlement does not become final, the item is not finally
paid
ii. 4-215(e)(1): Subject to (i) applicable law stating a time for availability of funds and
(ii) any right of the bank to apply the credit to an obligation of the customer,
credit given by a bank for an item in a customer's account becomes available for
withdrawal as of right:
a) if the bank has received a provisional settlement for the item, when the
settlement becomes final and the bank has had a reasonable time to receive
return of the item and the item has not been received within that time
 iii. No, the provisional settlement for the $500 check did not become final, and not
available for withdrawal. Later checks drawn on DSB would have caused overdraft
to Pythias’ account if had been paid, so DSB may refuse to pay the later checks (4-
402)
b. Since DSB has failed to give a proper charge-back notice, is it liable for the amount of
the item?
i. 4-214(a): If the return or notice is delayed beyond the bank's midnight deadline or
a longer reasonable time after it learns the facts, the bank may revoke the
settlement, charge back the credit, or obtain refund from its customer, but it is
liable for any loss resulting from the delay.
ii. No, DSB is only liable for the loss resulting from the delay
c. If it had given Pythias notice of dishonor, could DSB have recovered $500 even if it
had let Pythias withdraw all the money from his account prior to the return of the
check from the payor bank?
i. 4-214(d)(1): The right to charge back is not affected by: (1) previous use of a credit
given for the item
ii. Yes b/c DSB’s right of charge back is not affected by Pythias’ use of credit given for
the check -> Pythias must go against the drawer (Damon)!
d. Would your answer to the 1st question be the same if DSB were both the depositary
and the payor bank?
i. 4-215(e)(2): Subject to (i) applicable law stating a time for availability of funds and
(ii) any right of the bank to apply the credit to an obligation of the customer,
credit given by a bank for an item in a customer's account becomes available for
withdrawal as of right: (2) if the bank is both the depositary bank and the payor
bank, and the item is finally paid, at the opening of the bank's second banking day
(July 10) following receipt of the item (July 8).
ii. 4-302: if an item is presented to and received by a payor bank, the bank
is accountable for the amount of . . .
iii. Reg. CC 229.10(c)(vi): A depositary bank shall make funds deposited in an account
by check available for withdrawal not later than the business day (July 9) after the
banking day on which the funds are deposited (July 8) in the case of (iv) a check
deposited in a branch of the depositary bank and drawn on the same or another
branch of the same bank if both branches are located in the same state or the
same check processing region
iv. No, in case of “On US” item, DSB should have dishonored the $500 check by the
midnight of July 9 and charged back by the midnight deadline (July 10). So no
charge back is allowed b/c the deadline has lapsed.
e. If the check had been returned by BNB to DSB on Sept. 25, could DSB have still
charged back?
i. 4-214(a): these rights to revoke, charge back, and obtain refund terminate if and
when a settlement for an item received by the bank is or becomes final
ii. No, bank missed the deadline and made final payment, so, nobody has the right of
charge back
 f. Assume that when the check is first returned to DSB, the bank does not charge it
back against Pythias’ account, but instead again sends the check through for re-
presentment, hoping this time there will be money in the drawer’s account and the
check will be paid. If this hope proves fruitless and the check is returned by BNB a
second time, does 4-214 allow DSB to charge back, assuming that it does so
immediately on learning of the second return?
i. Notice to the customer is required if the bank wants to avoid damages
ii. If notice is provided to the customer, 2nd presentment is okay
g. Some courts impose punitive damages for wrongful charge back
4. Problem 178: Lew sold his vintage motorcycle on eBay for $6K and the buyer sent him
a cashier’s check for $10K (payable to his order), asking Lew to refund him a check for
the extra $4K. Lew did it promptly, sending the buyer a $4K personal check, and
depositing the larger cashier’s check in his bank account with BNB. The bank gave him
next day availability for the amount of the cashier’s check (1 day rule). 2 days later, the
cashier’s check was returned NSF by the bank on which it was drawn. Apparently, the
cashier’s check is a forgery. Is it too late for BNB to charge back the amount of the
check to Lew’s account?
a. No, the bank has the right of charge back. Lew’s remedy is against the seller
5. Valley Bank of Ronan v. Hughes
a. Fact: Swindlers promised the trustee a $3M commission for his aid in procuring
agricultural equipment and then proceeded to bilk him for hundreds of thousands of
dollars in advanced fees. The funds the trustee advanced were wired via the services
of a bank, resulting in a dispute over which party should bear the loss.
b. Held: The bank did not violate the UCC-defined duty of ordinary care in processing
the checks. Thus, the bank was entitled to summary judgment on the promissory
note executed by the trustee to satisfy the charge-back liability. Also, the bank bore
no liability on the wire transfer. Common law and equitable principles could be
used to supplement the UCC-defined duty of ordinary care w/r/t the bank's
representations about the check settlement process. Thus, the trustee's
counterclaims were not barred.
c. Cashier’s check can still be dishonored!
G. Undoing Final Payment
1. UCC rights off the instrument survive final payment, but the instrument itself is
canceled by final payment
a. All Art. 3 suits end
b. Payor bank, accountable for the check, must pay over the check’s amount to the
presenter
2. Whether payor bank may resist payment, using common law theories such as mistake
3. Problem 179: Shirker, who had a checking account at BNB, withdrew all the money in
the account and, by agreement with the bank, closed it. She then wrote a $5K check on
the account payable to Foxholer, who deposited the check in his own bank account with
a different bank. Shirker called up the vice president of BNB and said that a $5K
check would be presented against the closed-out account and told him to call her when
 it came in. The vice president did so when the check came in late in the banking day,
and Shirker promised to come down to the bank the next day, but never showed up. On
the 2nd banking day, BNB marked the check “Account closed” and returned it to the
depositary-presenting bank, which passed it on to Foxholer, the payee. Foxholer sued
the payor bank, claiming final payment had been made under 4-215(a)(3) in that the
provisional settlement had not been revoked within the time allowed by 4-301, so the
bank was accountable for the check under 4-302(a). Assume that Foxholer has not
breached one of the 4-208 presentment warranties. Foxholer should lose this suit, but
what defense UCC permits to BNB? Defense of 3-418 Fraud!
a. 4-302(b): the liability of a payor bank to pay an item pursuant to subsection (a) is
subject to defend based on breach of a presentment warranty (4-208) or proof that
the person seeking enforcement of the liability presented or transferred the item for
the purpose of defrauding the payor bank
b. 3-418 (payment or acceptance by mistake): if drawee pays a draft acting on
mistaken belief that payment had not been stopped, drawee may recover the
amount from the person to whom the payment was made.
4. Problem 180: the police department ordered new police radios and sent a check in
payment to Voice of Japan, but stopped payment by so notifying KNB b/c the radios
were not the correct size. Negligently, KNB paid the check, and then recredited the
account. Can KNB recover the amount of the check from Voice of Japan?
a. 3-418 & OC: if drawee pays a draft acting on mistaken belief that payment had not
been stopped, drawee may recover the amount from the person to whom the
payment was made. (protect innocent party)
b. Yes, KNB can recover b/c it acted on mistaken belief, even though it was negligent
c. 3-418(d) and 3-301(iii) give Voice of Japan the status of a PETE so as to enable it to
sue the police department on 3-414(b) obligation of the drawer of a draft (even if
the instrument does not exist any longer)
i. The police department may raise its breach of warranty defense which, if valid,
would enable it to prevail
H. Delays
1. Problem 181: A bank shredded 8,000 unprocessed checks (of worth $840K) by mistake.
For some checks, the bank would be a depositary or collecting bank (which are required
to take action before their midnight deadline following receipt, 4-202(b)), and
for others it would be the payer-drawee (which becomes absolutely accountable for a
check not returned before the expiration of the midnight deadline). Should the bank
just close down, or is there hope in 4-109(b)(Delays)?
a. 4-109(b): Delay by a collecting bank or payor bank beyond time limits prescribed or
permitted by this [Act] or by instructions is excused if (i) the delay is caused by
interruption of communication or computer facilities, suspension of payments by
another bank, war, emergency conditions, failure of equipment, or other
circumstances beyond the control of the bank , AND (ii) the bank exercises such
diligence as the circumstances require.
b. Prof. thinks that this is not the circumstance beyond the control of the bank (911
 attacks would satisfy this requirement)
I. Restrictive Indorsements and Banks
1. Chain of command theory (4-203): only the collecting bank’s transferor can give it
binding instructions and the collecting bank need not examine the item to see whether
other instructions or restrictions are contained in it
a. OC: it is unnecessary for an intermediary or collecting bank to determine whether its
transferor is “authorized” to give the instructions
b. 3-206(a): restrictive indorsement is not effective to prevent further transfer or
negotiation
i. There are only 2 exceptions under 3-206(c) in which restrictive indorsement is
effective against “depositary” bank
2. Problem 182: Nina indorsed her state welfare check “For deposit only, /s/ Nina Needy,”
and Max snatched her check. He wrote his name below Nina’s and took it to PNB
(depositary bank) and cashed it. PNB stamped its indorsement on the check and
forwarded it to ISB (intermediary bank), which indorsed the check and presented it to
the drawee, WPB (payor bank), which held the check past its midnight deadline. Nina
reported her loss to the state (drawer), but the check had been paid. Can she sue the
depositary, collecting and drawee banks in conversion, arguing that by paying in
violation of her express instruction, the banks converted her check? Or can the banks
use the chain of command sections to escape liability?
a. 3-206(c): If an instrument bears an indorsement (i) described in Section 4-201(b), or
(ii) in blank or to a particular bank using the words "for deposit," "for collection," or
other words indicating a purpose of having the instrument collected by a bank for
the indorser or for a particular account, the following rules apply:
i. A person, other than a bank, who purchases the instrument when so indorsed
converts the instrument unless the amount paid for the instrument is received by
the indorser or applied consistently with the indorsement.
ii. A depositary bank that purchases the instrument or takes it for collection when so
indorsed converts the instrument unless the amount paid by the bank w/r/t to the
instrument is received by the indorser or applied consistently with the
indorsement.
iii. A payor bank that is also the depositary bank or that takes the instrument for
immediate payment over the counter from a person other than a collecting bank
converts the instrument unless the proceeds of the instrument are received by
the indorser or applied consistently with the indorsement.
iv. Except as otherwise provided in paragraph (3), a payor bank or intermediary bank
may disregard the indorsement and is not liable if the proceeds of the instrument
are not received by the indorser or applied consistently with the indorsement.
b. Payor bank (WPB) and intermediary bank (ISB) are not liable, but depositary bank
(PNB) is liable
c. Soma v. Handrulis: all 3 banks (depositary, intermediary, payor) had converted the
check by paying it in obvious violation of a restricted indorsement -> 3-206(c) says
that only the depositary bank faces liability for noncompliance with the terms of a
 restrictive indorsement
J. Indorsement review
1. Blank v. special
a. Blank: sign the name only
b. Special: signature + “pay to XXX”
2. Qualified v. unqualified
a. Qualified: “without recourse”
3. Restrictive v. non-restrictive
a. Banks, other than depositary bank, don’t have to follow the restriction, but is still
good as to special indorsement
K. Priorities in the Bank Account: The Four Legals (what gets paid first?)
1. 4 Legals: notice (e.g., of a depositor’s death), stop-payment orders, service of legal
process (garnishment, etc), bank’s right of setoff – has priority over the payment of a
check
2. 4-303(a): Any knowledge, notice, or stop-payment order received by, legal process
served upon, or setoff exercised by a payor bank comes too late to terminate, suspend,
or modify the bank's right or duty to pay an item or to charge its customer's account
for the item if the knowledge, notice, stop-payment order, or legal process is received
or served and a reasonable time for the bank to act thereon expires or the setoff is
exercised after the earliest of the following:
a. the bank accepts or certifies the item;
b. the bank pays the item in cash;
c. the bank settles for the item without having a right to revoke the settlement under
statute, clearing-house rule, or agreement;
d. the bank becomes accountable for the amount of the item under Section 4-302
dealing with the payor bank's responsibility for late return of items (final payment);
or
e. w/r/t checks, a cutoff hour no earlier than one hour after the opening of the next
banking day after the banking day on which the bank received the check and no
later than the close of that next banking day or, if no cutoff hour is fixed, the close
of the next banking day after the banking day on which the bank received the check.
(if a checks comes in and this period has lapsed, the check wins over the 4 legal
events)
3. In summary, 4 legal events come too late (i) if the check has either been certified or the
bank has taken the steps that lead to final payment of the check, or (ii) they arrive after
the time periods described in (a)(5) (otherwise, four legals always win over checks)
4. Problem 183: Armstrong with $4,000 in his account, filed for bankruptcy on Oct. 5.
$3,000 check from another bank is returned on Oct. 10
Oct. 5 Balance $4,000 <- filed petition in bankruptcy
st
Oct. 6 1 Check -$1,000
---------
$3,000
nd
2 Check -$500
----------
 $2,500 <- Armstrong told Visor about
bankruptcy
4th Check -$500
-----------
$2,000 <- formal notice of bankruptcy
Home Improvement -$75
Loan ------------
$1,925
a. Does the filing of a petition in bankruptcy automatically freeze the account? No,
until the bank becomes aware of the filing for bankruptcy
i. Marin v. England: bank is protected until it had notice of the bankruptcy
proceeding
ii. Bankruptcy Reform Act 542(c): if no actual notice or knowledge, the bank may
transfer property of the estate in good faith
iii. BRA 549(a): the trustee may avoid a transfer of property of the estate (1) that
occurs after the commencement of the case; and (2)(A) that is authorized only
under 303(f) or 542(c); or that is not authorized under this title or by the court
b. At what moment did the bank have notice of bankruptcy?
i. 1-202(f): Notice, knowledge, or a notice or notification received by an organization
is effective for a particular transaction from the time it is brought to the attention
of the individual conducting that transaction and, in any event, from the time it
would have been brought to the individual's attention if the organization had
exercised due diligence. An organization exercises due diligence if it maintains
reasonable routines for communicating significant information to the person
conducting the transaction and there is reasonable compliance with the routines.
Due diligence does not require an individual acting for the organization to
communicate information unless the communication is part of the individual's
regular duties or the individual has reason to know of the transaction and that the
transaction would be materially affected by the information.
ii. Prof. thinks that, based on trade usage, the bank had notice of the bankruptcy
when Vivian heard it from Armstrong b/c she should call the bank and tell it (bank
should have notice + opportunity to act on it)
a) But this is a hot issue in litigation
c. Was the home improvement loan payment effective against the trustee?
i. BRA 553: No, setoff permitted on getting relief from the automatic stay of
362(a)(7). Before getting such relief, the account is frozen and the bank can’t
exercise its right of setoff
d. If you are the attorney representing the bank that presented the 3rd check, what
legal theory might attract your attention?
i. Final payment has been made b/c the check was returned after the midnight
deadline 4-302. ANB should have dishonored the check before the expiration of
the deadline
5. Problem 184: Thomas has $5,000 in his account at ESB. ESB received 5 checks from the
 bank across the street totaling $1,258 at 9:00 am and then 1 $4,986 check from FRB at
9:05 am. Should the bank dishonor the 1 big check or the 5 little ones? (3 little checks
are dated prior to the big check, 2 little checks are after)
a. 4-303(b): items may be accepted, paid, certified, or charged to the indicated account
of its customer in any order (OC: drawer would want “low to high,” but drawer
should have had sufficient funds when he wrote the checks, so, he has no complain
about the order in which the bank pays his checks)
b. Smith v. First Union Bank: banks are authorized to do just as they wish (“high to
low” payment is permitted – then bank may charge fees for each bounced check)

CHAPTER 12. WRONGDOING AND ERROR

I. Forgery of the Payee’s Name
A. Some Basic Ideas
1. Forgery of the payee (or special indorsee)’s name means that no valid negotiation takes
place, and therefore, no one taking the instrument thereafter can qualify as a holder
a. Problem 185: Portia received a $500 check signed by her grandmother and a Harry
stole the check. He forged Portia’s name to the back of the check, signed his own
name below hers, and deposited the check in the account he carried w/ CSB.
Before the check was presented, Portia had her grandmother stop payment on the
check, so it was dishonored and returned to CSB. By this time, Harry had
withdrawn the money and fled the jurisdiction. Is CSB a HDC? Can it enforce the
check against the grandmother per 3-414(b)? (the midnight deadline had passed)
i. The check was not properly payable either. CSB can go after Harry for (i) liability
of indorser, (ii) unjust enrichment (quasi-K), (iii) transfer warranty, (iv) right of
charge back (4-214), or (v) breach of K (deposit K w/ the bank)
ii. 3-201: "Negotiation" means a transfer of possession, whether voluntary or
involuntary, of an instrument by a person other than the issuer to a person who
thereby becomes its holder.
iii. After forgery of the payee (Portia)’s name, the negotiation is invalid, no once can be
a holder thereafter. So CSB is not a holder (no HDC), not a PETE (improper
indorsement, Portia’s sign is necessary for indorsement, no shelter rule applies
here)
b. W/o a valid indorsement by the payee, no later person can qualify as a holder:
i. no matter how many times the instrument is thereafter transferred,
ii. no matter how good the forgery appears to be,
iii. no matter how innocent the later takers or
iv. how much value they paid
v. the check is still the property of the payee, who could replevy it from the current
transferee
c. What if the instrument is a bearer paper?
i. Check made out to bearer, or payee indorsed the check in blank before stolen
ii. Anyone in possession of the check would be a holder, if otherwise qualifying, a HDC
2. PETE
 a. 3-301: "Person entitled to enforce" an instrument means (i) the holder of the
instrument, (ii) a nonholder in possession of the instrument who has the rights of a
holder (shelter rule), or (iii) a person not in possession of the instrument who is
entitled to enforce the instrument pursuant to 3-309 or 3-418(d). A person may be a
person entitled to enforce the instrument even though the person is not the owner
of the instrument or is in wrongful possession of the instrument.
i. Holder: someone who takes pursuant to a “valid negotiation”
ii. Non-holder in possession of the instrument who has the rights of a holder
b. Problem 186: In Problem 185, Portia gave her roommate Helen the check but forgot
to indorse it. Is Helen a holder? When Helen discovers that Portia forgot to indorse
the check, could she force Portia to do so?
i. Helen is NOT a holder b/c of lack of indorsement by Portia, but Helen is a PETE
(under the shelter rule) and may require Portia to indorse the check under 3-203(c)
– right of specific performance
ii. 3-203(c): Unless otherwise agreed, if an instrument is transferred for value and the
transferee does not become a holder b/c of lack of indorsement by the transferor,
the transferee has a specifically enforceable right to the “unqualified” indorsement
of the transferor, but negotiation of the instrument does not occur until the
indorsement is made.
iii. Negotiation (order paper: indorsement + delivery) does not occur until the
indorsement is made
c. PETE under 3-301(ii)
i. 3-203(b): Helen is a non-holder w/ the rights of a holder by the Shelter Rule
ii. 4-205: Depositary bank gets Portia’s holder rights in spite of the lack of payee
indorsement, if Portia deposited the check, unindorsed, in her bank account
d. PETE under 3-301(iii)
i. Someone who lost the instrument but has the right to go to court to recreate it
pursuant to 3-309
a) Ex: Portia’s cat chews up the check, so she is no longer a holder, but she is a PETE
ii. Person described in 3-418(d): even if the check is unavailable (lost, stolen,
destroyed), 3-418(d) and 3-301(iii) give the transferee the status of a PETE
B. Warranty Liability
1. Problem 187: Portia gave her landlord John (payee) a check and John fluttered it to the
floor, where it was discovered by Harry. Harry forged John’s name to the back of the
check and, pretending to be John, cashed the check at Tower Drug Store. TDS stamped
TDS under the forgery and deposited the check in its account at Merchants Bank. MB
presented the check to ONB, the drawee bank, and was paid. A week later, John told
Portia he had lost the check, and by this time, the check was returned to Portia by ONB
as part of her monthly bank statement. Portia showed it to John and he said the
signature on the back of the check was a forgery. She wrote him another check and
went to ONB.
a. Can she make ONB recredit her account? What is her theory?
i. Yes, Portia can make ONB recredit her account for violation of properly payable rule
b/c Portia ordered the bank to pay the money to John, not to Harry
 ii. Properly Payable Rule under 4-401(a): A bank may charge against the account of a
customer an item that is properly payable from that account even though the
charge creates an overdraft. An item is properly payable if it is authorized by the
customer and is in accordance w/ any agreement b/w the customer and bank.
b. ONB has made final payment on this check, and that ends its ability to dishonor the
check. However, 4-302(b) provides that final payment does not prevent warranty
liability from giving relief to the bank, specifically referring to 4-208. Which warranty
described therein was breached, and who breached it?
i. Presentment warranty (PETE warranty) under 4-208(a)(1) was breached by prior
transferors MB, TDS, Harry
ii. 4-302(b): The liability of a payor bank to pay an item pursuant to subsection (a) is
subject to defenses based on breach of a presentment warranty (Section 4-208) or
proof that the person seeking enforcement of the liability presented or transferred
the item for the purpose of defrauding the payor bank.
2. Art. 3 warranties v. Art. 4 warranties
a. Art. 3 warranties control until the check is taken for deposit, then Art. 4 warranties
take over
3. Difference b/w presentment and transfer
a. Issuance: creation of the instrument and its handing over to the 1st taker
i. No warranties made on issuance
b. Presentment: its final surrender to the drawee/maker for either acceptance
(certification) or payment
i. At that moment, presentment warranties are made by not only the entity physically
making presentment but also all prior transferors (drawee can choose Ds)
ii. 4-208 (a) (Presentment Warranty): transferor to drawee by person obtaining
payment/previous transferors
a) PETE warranty
b) Forgery is not alteration: alteration includes alteration of the amount
c) Not warrants that the signature is authorized, but warrants that the warrantor
had no knowledge
d) Remotely created item: warranty that the check was authorized by the drawer in
the amount
iii. 4-208(b): damages = amount the paid by the drawee – amount the drawee received
or is entitled to receive from drawer b/c of the payment (+ compensation for
expenses and loss of interest resulting from the breach)
iv. 4-208(c): preserves all the defenses
v. 4-208(e): cannot be disclaimed w/r/t checks, unless notice given within 30 days
after the reason to know (not actual knowledge), warrantor discharged to the
extent of loss caused by delay
vi. 4-208(f): cause of action accrues when has reason to know of the breach
c. Transfer (4-207): every other movement of the instrument for consideration b/w
issuance and presentment
i. Gives rise to the transfer warranties
 d. Off the instrument: warranty suits are suits off the instrument b/c they do not
require possession of the instrument as a prerequisite to suit
4. Problem 188: In Problem 187, ONB (drawee) successfully recaptured its money from
MB (collecting bank) under a theory of breach of a presentment warranty.
a. Can MB sue the drugstore using 4-208(a)?
i. NO, the warranty of presentment is made to the drawee (ONB), not to the
depositary bank (MB). Only the drawee can sue for presentment warranty under 4-
208(a)
b. How does MB get legal relief?
i. MB can sue the drugstore for breach of “transfer warranty” under 4-207(a) made by
customer or collecting bank to transferee (drawee bank cannot take advantage of 4-
207(a) transfer warranty)
ii. 4-207(a): A customer or collecting bank that transfers an item and receives a
settlement or other consideration warrants to the transferee and to any
subsequent collecting bank that:
a) the warrantor is a person entitled to enforce the item (PETE warranty);
b) all signatures (including drawer’s signature) on the item are authentic and
authorized (signature warranty);
c) the item has not been altered (no alteration warranty);
d) the item is not subject to a defense or claim in recoupment (3-305(a)) of any
party that can be asserted against the warrantor (free of defense/claim
warranty);
e) the warrantor has no knowledge of any insolvency proceeding commenced w/r/t
the maker or acceptor or, in the case of an unaccepted draft, the drawer (no
knowledge of bankruptcy warranty); and
f) w/r/t any remotely-created consumer item, that the person on whose account
the item is drawn authorized the issuance of the item in the amount for which
the item is drawn
iii. 4-207(b): if dishonored, customer/collecting bank must pay to
transferee/subsequent collecting bank in good faith (1) according to the terms of
the item at transfer or (2) if incomplete item, according to the terms as
completed.
Cannot disclaim by “without recourse” or otherwise
iv. 4-207(c): damages = loss suffered, not more than (amount of item + expenses + loss
of interest)
v. 4-207(d): cannot disclaim w/r/t checks. Unless notice within 30 days after reason to
know of the breach & ID, discharged
vi. 4-207(e): cause of action accrues when has reason to know of the breach
c. What warranties have been breached? Must MB give notice to the drugstore within
any given period of time?
i. The drug store breached 4-207(a)(1), (2) and (4) warranties (drug store can sue
Harry for the same transfer warranty)
ii. MB must give notice to the drugstore within 30 days after it has reason to know of
the breach & ID of warrantor (4-207(d))
d. If the drugstore refuses to pay, how quickly must suit be commenced?
i. 4-111: 3 yrs after the cause of action accrues
 5. Problem 189: In Problem 188, to what relief is the drug store entitled, assuming it can
find Harry in a solvent condition?
a. The drug store has the transfer warranty under 4-207 that passes the loss back to
wrongdoer (Harry)
6. Damages for breach of warranty
a. Same as 3-416(b): loss suffered as a result of the breach, but not more than the
amount of the instrument plus expenses and loss of interest incurred as a result of
the breach
b. Some courts allowed a payor bank to recover its attorney’s fees
c. OC6 to 3-416: attorney’s fees could be granted b/c they fit within “expenses . . .
incurred as a result of the breach”
d. But, so far no courts have allowed attorney’s fees as damages under revised Art. 3
and 4
C. Conversion Liability
1. Definition: civil action for misappropriation of another’s property (tort theory)
2. Problem 190: Your ER gives you your paycheck, drawn on ER’s bank, ONB. You take the
check to the bank and present it across the counter. But, ONB neither pays you nor
give the check back to you. Do they have the right to do that?
a. No, the bank must either pay the check or give the check back to you. This is common
law conversion(failure to pay or return it – stealing of a bearer instrument)
3. Problem 191: Wellborn was surreptitiously relieved of his wallet by Dodger. In the
wallet was a check made out to Wellborn, who had already indorsed it. Is Dodger
guilty of conversion?
a. If Wellborn made blank indorsement, the check became bearer paper and Dodger,
who had in possession of the check, can be a holder. If Wellborn made
special indorsement, the check can be validly negotiated only by the named
person, so Dodger cannot negotiate the check. In both cases, Dodger is guilty of
conversion under 3-420
4. 3-420 (Conversion of Instrument)
a. The law applicable to conversion of personal property applies to instruments. An
instrument is also converted if it is taken by transfer, other than a negotiation, from
a person not entitled to enforce the instrument or a bank makes or obtains payment
w/r/t the instrument for a person not entitled to enforce the instrument or receive
payment. An action for conversion of an instrument may not be brought by (i) the
issuer or acceptor of the instrument or (ii) a payee or indorsee who did not receive
delivery of the instrument either directly or through delivery to an agent or a co-
payee. (common law adoption + who cannot bring the suit (issuer/ accepter,
payee/indorser who did not receive the instrument)
b. In an action under subsection (a), the measure of liability is presumed to be the
amount payable on the instrument, but recovery may not exceed the amount of the
P's interest in the instrument.
c. A representative, other than a depositary bank, who has in good faith dealt w/ an
instrument or its proceeds on behalf of one who was not the person entitled to
 enforce the instrument is not liable in conversion to that person beyond the amount
of any proceeds that it has not paid out.
5. Who can sue for conversion?
a. For negotiable instruments, the holder is the owner of the instrument and is the
person w/ the property rights therein
i. Order instrument -> only the payee or a person who obtained the instrument by
negotiation from the payee can be the holder and has a sufficient property interest
to become the P
b. Since the instrument, once delivered, gives the payee these property rights, the
payee can take 4 different possible causes of action whenever the check is stolen,
his name is forged thereon, and the instrument is paid by the drawee bank
i. Conversion:
a) payee can sue drawee bank, or anyone taking the check after the forgery, in
conversion
b) if drawee is forced to pay payee, drawee will sue the check’s presenter for breach
of the presentment warranty that he was a PETE: 4-208(a)(1)
c) presenter can sue the transferor for breach of transfer warranties: 3-416(a)(1), (2)
& (4)
d) the loss will pass back up the chain until it reaches the forger or, if the forger has
departed for parts unknown, the 1st person to trust the forger
ii. Drawer’s Obligation:
a) Since the check is still the property of the payee, he can replevy it from its
current possessor (in order to be able to sue by getting a property interest in it),
cross off the forged indorsement, sign it, and present it to the drawee bank for
payment
b) If drawee dishonors it, payee may sue the drawer on the drawer’s obligation (3-
414(b)) or the underlying obligation
iii. Quasi-K: longer SOL than conversion
a) Some courts permit the quasi-contractual action by the payee for money
iv. Negligence: should have investigated whether the customer was a true payee
a) Most courts have not allowed either a common law negligence claim against
banks handling forged checks b/c Art. 3 preempts all common law theories
b) Minority decisions allowed the common law to supplement UCC
6. Problem 192: When Portia learned that the check she had given to her landlord had
been stolen from him, his name forged as payee, and paid by her bank, she sued her
bank in conversion.
a. Is she the proper P in this lawsuit? If not, who is?
i. No, Portia (issuer) cannot sue drawee bank in conversion, “payee (the landlord)”
can sue drawee bank, or anyone taking the check after the forgery, in conversion
under 3-420.
ii. 3-420(a): An action for conversion of an instrument may not be brought by (i) the
issuer or acceptor of the instrument or (ii) a payee or indorsee who did not receive
delivery of the instrument either directly or through delivery to an agent or a co-
payee.
 b. What relief does the law give her?
i. Portia (drawer) can sue the drawee bank for violation of properly payable rule (4-
401(a))
c. If the landlord (payee) decides to bring a 3-420 action, who is liable in such a suit?
i. Payee can sue for conversion the drawee and anyone taking the instrument after
forger, i.e., ONB, MB, the drugstore and Harry.
7. Problem 193: Tim mailed a check for $80K to ONB, the mortgagee, but it was stolen
from the mail by an unknown person, who forged ONB on the back and cashed it at
SHSB, which then collected it from the drawee bank.
a. Since ONB (payee) never received possession of the check, does it have sufficient
property rights therein to succeed in a conversion action against SHSB or the
drawee?
i. 3-420(a): No, ONB cannot sue in conversion b/c it never received delivery of the
instrument (no sufficient property right)
b. What can ONB do?
i. ONB (mortgagee) has a cause of action against Tim (mortgagor) b/c the underlying
obligation is not discharged
ii. 3-310(b): Unless otherwise agreed and except as provided in subsection (a), if a
note or an uncertified check is taken for an obligation, the obligation is suspended
to the same extent the obligation would be discharged if an amount of money
equal to the amount of the instrument were taken, and the following rules apply:
a) In the case of an uncertified check, suspension of the obligation continues until
dishonor of the check or until it is paid or certified. Payment or certification of
the check results in discharge of the obligation to the extent of the amount of
the check.
b) In the case of a note, suspension of the obligation continues until dishonor of the
note or until it is paid. Payment of the note results in discharge of the obligation
to the extent of the payment.
c) Except as provided in paragraph (4), if the check or note is dishonored and the
obligee of the obligation for which the instrument was taken is the person
entitled to enforce the instrument, the obligee may enforce either the
instrument or the obligation. In the case of an instrument of a third person
which is negotiated to the obligee by the obligor, discharge of the obligor on the
instrument also discharges the obligation.
d) If the person entitled to enforce the instrument taken for an obligation is a
person other than the obligee, the obligee may not enforce the obligation to
the extent the obligation is suspended. If the obligee is the person entitled to
enforce the instrument but no longer has possession of it b/c it was lost, stolen,
or destroyed, the obligation may not be enforced to the extent of the amount
payable on the instrument, and to that extent the obligee's rights against the
obligor are limited to enforcement of the instrument.
8. Leeds v. Chase Manhattan Bank
a. Fact: Atty received a check in a settlement case made “to the order of Client.” Above
this he type “Egnasko as atty for.” He endorsed the back and deposited it into his
Trust
 fund acct.
b. Hold: Although the check was not actually delivered to Client, it was delivered to
Egnasko as Client’s atty, w/ intent that title be transfer to Client, the payee.
Accordingly, Client is entitled to bring this action for conversion as one who “received
delivery of the instrument . . . through delivery to an agent . . .”under 3-420(a)
c. Prof: the court’s conclusion that 3-420(c) excuses the drawee bank from liability as a
representative is wrong (the drawee bank IS liable for conversion)
i. OC to 3-420 clearly refer the conversion liability of the drawee bank and there is
general agreement that only intermediary banks qualify as the sorts of
representatives, who are protected by 3-420(c).
9. Problem 194: drawer made the check out to “John and Mary Doe” in order to pay a
debt owed to them both. John got the check first, signed his name alone as
indorser, and deposited the check in his individual checking account. His bank
presented the check to the drawee bank and was paid.
a. Is a missing signature treated the same as a forged one?
i. Yes, missing indorsement -> conversion (if deposited in their joint account, no
conversion)
ii. 3-110(d): the check needs indorsements by both of them, and can be negotiated,
discharged and enforced by both payees
iii. 3-420(a): no proper negotiation b/c they both should have signed the instrument.
b. Has the presenting bank breached the warranty that it is a person entitled to enforce
the check?
i. Yes, the check can only be enforced by both of the payees (3-420(a) PETE
presentment warranty was breached)
c. Could Mary Doe sue the banks in conversion?
i. Yes, although payee who didn’t receive delivery of the instrument may not bring an
action for conversion under 3-420(a), she received delivery of the check through
delivery to a co-payee (John)
10. 3-206(c): payment in violation of the terms of a restrictive indorsement also gives rise
to a cause of action in conversion
II. Forgery of the Drawer’s Name
A. Basic rule (still the law!)
1. Price v. Neal (1762): Drawee who pays or accepts a draft takes the risk of a forged
drawer’s signature
2. Canal Bank v. Bank of Albany (1841): Drawee does not take the risk of a forged
indorser’s signature
B. Price v. Neal
1. Fact: Price had agreed w/ Sutton to accept and pay any drafts (bills of exchange) that
Sutton drew on Price. Sutton drew up 2 drafts on Price which were then negotiated to
Neale. Neale obtained payment from Price’s bankers. Subsequently, Price learned that
Sutton had not really singed the drafts and his name was forged to the instruments.
Price brought suit against Neale for “money had and received,” demanding a return
of the mistaken payment
 2. Rule:
a. If the drawee pays or accepts the draft, it cannot pass the risk of the drawer’s
signature being forged off onto prior good faith parties.
b. 4-208: everybody in the chain (warrantor) is making warranty to drawee
i. (a)(1): all the warrantors are PETEs of the forger’s obligation (not drawer’s
obligation)
ii. (a)(2): no alteration
iii. (a)(3): warranty of no knowledge of forgery (not warranty of no forgery)
iv. (a)(4): remotely created consumer item
c. In case of forger of drawer’s name, no warranty of presentment has been breached
under 4-208(a), no relief to drawee under 4-208(a)
C. Expansion of the rule of Price v. Neal
1. Expansion by judicial application: places on the drawee the risk of “any” mistaken
payment not covered by a presentment warranty, so that, for example, the bank’s
payment of a check drawn against insufficient funds is a legal fait accompli
2. UCC version of Price v. Neal rule
a. 4-302 (final payment statute): payor bank is accountable for an item that has been
finally paid
b. 3-418(c) (finality rule): Drawee bank cannot recover mistaken payment or payment
over forged drawer’s signature from a “Person who took the instrument in good
faith” or “in good faith changed position” OC 1
c. 3-418(b): finality rule also applies to the analogous situation of makers who have paid
notes on which their own signatures have been forged
3. Federal courts have applied the rule of Price v. Neal to checks drawn on the Federal
Treasury and paid through FRS (federal common law)
a. Government cannot recover its money from the banks that presented the checks if it
subsequently discovers that the checks are forgeries and not truly signed by the
appropriate federal official
4. Policy reasons for the finality rule
a. The drawee was guilty of neglect
b. Highly desirable to end the transaction
c. Drawee bank is the cheapest cost avoider for forgery of drawer’s name while
depositary bank is the cheapest cost avoider for forgery of payee’s name
D. Decibel Credit Union v. Pueblo Bank
1. Fact: Thief stole blank checks furnished by Decibel (drawee) to one of its customers
(drawer). The thief forged the signature of the customer on several checks. Each check
was cashed at Pueblo Bank (presenting bank). Pueblo processed all checks through the
Federal Reserve System to Decibel, and Decibel timely paid the checks
2. Hold: There were no presentment or transfer warranties made to Decibel by Pueblo by
returning the check to it through the Federal Reserve system
a. A transfer warranty as to the genuineness of the drawer’s signature does not apply
for the benefit of the drawee bank.
b. No breach of presentment warranty, breach of transfer warranty would have been
 possible (but not to payor bank), no restitution from innocent party
E. Problem 195: Harry stole Portia’s checkbook and wrote out one of her checks to himself
and signed her name to the drawer’s line. He cashed the check at the local drug store,
which passed it on to MB (depositary bank). MB presented the check to ONB (drawee)
and was paid. When Portia got this check back in her next monthly statement, she
immediately demanded that ONB replace the money in her account, saying that the
check was not properly payable w/o her valid signature (4-401(a)) and ONB recredited
her account. Who can ONB sue and under what theory?
1. ONB (drawer) can only sue Harry for the amount of the check under 3-418(a)
restitution. But ONB cannot sue MB and the drug store under 3-418(a) b/c they took
the check in good faith and for value (3-418(c)) (presentment warranty would not work
here)
2. 4-208(a): Presentment Warranty
3. 3-418 (Payment or Acceptance by Mistake)
a. Except as provided in subsection (c), if the drawee of a draft pays or accepts the draft
and the drawee acted on the mistaken belief that (i) payment of the draft had not
been stopped pursuant to 4-403 or (ii) the signature of the drawer of the draft was
authorized, the drawee may recover the amount of the draft from the person to
whom or for whose benefit payment was made or, in the case of acceptance, may
revoke the acceptance. Rights of the drawee under this subsection are not affected
by failure of the drawee to exercise ordinary care in paying or accepting the draft.
b. Except as provided in subsection (c), if an instrument has been paid or accepted by
mistake and the case is not covered by subsection (a), the person paying or accepting
may, to the extent permitted by the law governing mistake and restitution, (i)
recover the payment from the person to whom or for whose benefit payment was
made or
(ii) in the case of acceptance, may revoke the acceptance.
c. The remedies provided by subsection (a) or (b) may not be asserted against a person
who took the instrument in good faith and for value or who in good faith changed
position in reliance on the payment or acceptance. This subsection does not limit
remedies provided by 3-417 or 4-407.
d. Notwithstanding 4-215, if an instrument is paid or accepted by mistake and the payor
or acceptor recovers payment or revokes acceptance under subsection (a) or (b), the
instrument is deemed not to have been paid or accepted and is treated as
dishonored, and the person from whom payment is recovered has rights as a
person entitled to enforce the dishonored instrument.
F. Wachovia Bank v. Foster Bancshares (forgery of drawer’s name + alteration of payee’s
name)
1. Fact: A customer of the depositary bank deposited a check in her account. The actual
payee of the original check was not the customer, who disappeared w/ the money. In
the meantime, the issuing bank destroyed the original check. The issuing bank's suit
was based on the "presentment warranty."
2. Depositary bank argues: Alteration (payee’s name) & forgery of drawer’s name -> if
forged check is later altered, who takes liability? -> still Price v. Neale rules
a. Posner puts the BOP on depositary bank regarding copy of the image of the original
 check and forgery of drawer’s name: if depositary bank proves, no presentment
warranty problem b/c the forger is drawer of the forged check
3. Question
a. Court seems to think, if there had been no alteration, the drawee bank would have
lost the case. What happened to the presentment warranty in 4-208(a)(1) and why
wasn’t it discussed by Posner?
i. Assuming that there was no alteration of payee’s name, PETE issue would matter
G. Problem 196: In Problem 195, unhappy w/ being told that the depositary bank did not
violate 4-208(a)(3) (no knowledge of forgery warranty), ONB asks you if the depositary
bank violated 4-208(a)(1) (PETE warranty). Did it?
1. No, 3-403(a) says that the forgery acts as if the forger had signed his or her own name
instead of the forged name. The drawer of the check was Harry, and it was payable to
the order of Harry, properly indorsed by the payee, and properly negotiated by the
drugstore and the depositary bank. The depositary bank was a PETE and the payor bank
paid the draft of a non-customer payee.
2. Rule of Price v. Neal puts the risk squarely on the drawee: the drawee must know the
drawer’s signature as a mother must know her child
H. Problem 197: In Problem 154, a drawee bank paid a check w/ no drawer’s signature at all
b/c the check had been created over the telephone by the telemarketing payee. The
check was highly UNLIKELY to be properly payable from the drawer’s bank account under
4-401. Thus the drawee bank must replace the money in the drawer’s account unless the
subrogation rule of 4-407 can be brought into play to protect the bank. Having done so,
the bank wants to pass the liability back to the depositary bank. Can this be done, and if
so, under what theory?
1. No under Price v. Neal, but Yes under Reg. CC
2. Price v. Neal rule places the liability on the drawee bank: the drawee bank that has
made a mistaken payment must eat the loss unless 3-418 (Payment by Mistake -
restituion) applies
3. 2-208(a)(4) warranty may matter if the check is unauthorized
4. But, this is contrary to banking practices by which the drawee bank routinely returns
the preauthorized draft to the depositary bank, which debits the account of the
telemarketing payee
5. Federal Reserve’s solution (Reg. CC 229.2(fff)): remotely created checks create both
presentment and transfer warranties that these checks were authorized by the person
on whose account they are drawn in the amount specified
a. The return of the check to the depositary bank is allowed b/c the depositary bank is
in a better position to monitor the activities of the payee than is the payor bank
I. Federal Government
1. Federal courts have applied the rule of Price v. Neal to checks drawn on the Federal
Treasury and thereafter paid
a. If subsequently discovers forgery, gov’t cannot recover from the banks that
presented the checks
2. Bank’s practice
 a. Payor banks don’t recapture their drawers’ checks and have no opportunity to
compare drawers’ signature w/ the signature cards (bulk filing: no physical
examination if below a certain amount)
b. If a check forged and forger not found, payor banks recredit the drawers’ accounts
and look to their forgery insurance
3. Question: if drawer’s signature is forged, the loss is on the payor bank while if payee’s
name is forged, the loss falls on depositary bank. Is there a rational reason for the 2
different placements of liability?
a. The cheapest cost avoiders: payor banks keep drawer’s signature and can easily
found the forgery of drawers’ signature & depositary bank can easily look at payees’
signature
III. Validation of the Forgery
A. Introduction
1. 3-403(a) Escape Clause
a. Unless otherwise provided in Art. 3 or 4 & an unauthorized signature may be ratified
i. Under some circumstances, the forged signature will be treated as genuine
b. 3-401 (Signature)
c. 3-403 (Unauthorized Signature) – can be ratified
2. Problem 198: George learned that his wife Martha had been forging his name to
business checks received in his business on which he was the named payee, but said
nothing to her. 2 yrs later, he decided to recover the money by bringing a conversion
action against the banks that had paid money on the forged indorsement. Will his suit
succeed?
a. No, George ratified Martha’s forgery by not taking any action for 2 yrs although he
could have done something to prevent it
b. Johnson v. Johnson: Ratification requires intent to ratify plus full knowledge of all the
material facts.” It “may be express or implied, and intent may be inferred from the
failure to repudiate an unauthorized act, from inaction, or from conduct on the part
of the principal which is inconsistent w/ any other position than intent to adopt the
act.” Mere negligence cannot form the basis for ratification which necessarily
requires knowledge and intentional conduct
3. 3-402(a): ratification of supposed agency status can also occur, as where the non-agent
has apparent authority (agent has no actual authority but acts of principal create
apparent authority) due to the alleged principal’s actions or inactions (3 types of agency
– express, implied, apparent)
a. Fulka v. Florida Commecial Banks: payee estopped to bring conversion action where
she knew a business associate was forging her name to checks, but kept silent
b. Pre-UCC cases found apparent authority in an agent to cash the alleged principal’s
checks
c. But courts are slow to presume such authority
B. Common Law Validation
1. Hutzler v. Hertz Corp. (defalcating attorney – do something beyond what he was
authorized)
 a. Fact: Hutz settles w/ Hertz in a wrongful death claim. Hertz made the check payable
to “Hutz and Yudow, her attorney,” drawn on Manufacturer Hanover. Yudow signed
his own name and forges Hutz, and deposited the check into his personal account.
Then he closes the account and skips town. Hutz sues Hertz for underlying obligation
and payor bank for conversion.
b. Hold: Yudow must have had apparent authority, and if Hertz had paid in cash, they
would have been discharged of their obligation; w/ a check, there is suspension of
that obligation until cashed, here it was cashed. So even though he forged his
signature, and both signatures were required, she bears the loss b/c she selected the
agent.
i. If the attorney forged client’s signature, the same result as cash or bearer’s paper
(b/c the attorney could have taken cash or bearer’s paper on behalf of his client)
ii. The cheapest cost avoider is the client b/c she put trust on him (could’ve protected
herself better)
c. Question: Could P sue the drawee bank? What would be her cause of action?
i. 3-420(a): P could not sue the drawee bank here b/c she did not appeal, P could sue
her attorney for conversion
2. Problem 199: Drawer gave her check to payee, who lost it before he indorsed it. The
finder forged payee’s name to the back of the check and received payment from
drawee (ONB).
a. Is ONB liable to payee?
i. 3-420(a): Yes, ONB (drawee) is liable to payee for conversion
b. If ONB pays payee, is it also liable to drawer?
i. Drawer can’t sue drawee bank for conversion, but drawer could sue drawee bank
for violation of properly payable rule. But ONB is subrogated the right of payee
against drawer, so does not have to pay drawer (no damage to drawer, no unjust
enrichment)
ii. 4-401: properly payable rule
iii. 4-407: payor bank’s right to subrogation on improper payment (to prevent unjust
enrichment)
3. Double Liability Problem
a. Common law: it is always a defense to a negotiable instruments action to show that
the money got where it was supposed to go, and P has no damages
b. 4-407: successful conversion action by the payee destroys the drawer’s 4-401 not
properly payable suit against the drawee
4. 4 UCC sections that validate the wrongdoing in certain circumstances
a. 3-404: Impostor Rule
b. 3-405: EE Indorsement Rule
c. 3-406: Negligence Rule
d. 4-406: Bank Statement Rule
C. The Impostor Rule (3-404)
1. Imposter (Someone pretending to be someone else)
2. Validates the forgery of the payee’s name (and only the payee’s name) in some
 situations when drawer/maker has been duped by either an outsider or a trusted EE
into creating an instrument on which the name of payee is highly likely to be forged,
and it is proper to put the resulting liability on the drawer/maker rather than on non-
negligent parties, such as the indorsers or banks involved in collecting or paying the
check
3. 3-404 (Impostors; Fictitious Payees)
a. If an impostor, by use of the mails or otherwise, induces the issuer of an instrument
to issue the instrument to the impostor, or to a person acting in concert w/ the
impostor, by impersonating the payee of the instrument or a person authorized to
act for the payee, an indorsement of the instrument by any person in the name of
the payee is effective as the indorsement of the payee in favor of a person who, in
good faith, pays the instrument or takes it for value or for collection.
i. (imposter’s indorsement is effective in favor of good faith indorser, drawee or
collecting bank)
b. If (i) a person (issuer) whose intent determines to whom (payee) an instrument is
payable (3-110(a) or (b)) does not intend the person identified as payee to have any
interest in the instrument, or (ii) the person identified as payee of an instrument is a
fictitious person, the following rules apply until the instrument is negotiated by
special indorsement: (fictitious payee rule)
i. Any person in possession of the instrument is its holder.
ii. An indorsement by any person in the name of the payee stated in the instrument is
effective as the indorsement of the payee in favor of a person who, in good faith,
pays the instrument or takes it for value or for collection.
a) (unintended payee or fictitious payee -> any bearer is holder & anyone’s
indorsement is effective in favor of good faith indorser, drawee or collecting
bank)
c. Under subsection (a) or (b), an indorsement is made in the name of a payee if (i) it is
made in a name substantially similar to that of the payee or (ii) the instrument,
whether or not indorsed, is deposited in a depositary bank to an account in a name
substantially similar to that of the payee.
i. (substantially similar payee’s name is effective)
d. W/r/t an instrument to which subsection (a) or (b) applies, if a person paying the
instrument or taking it for value or for collection fails to exercise ordinary care in
paying or taking the instrument and that failure substantially contributes to loss
resulting from payment of the instrument, the person bearing the loss may recover
from the person failing to exercise ordinary care to the extent the failure to exercise
ordinary care contributed to the loss.
i. (comparative negligence: negligent indorser, drawee or collecting bank -> loss
allocated)
4. Problem 200: Sandra told Amy that she was Hilda Humane, the founder of Humane’s
Home for Homeless Dogs, and Amy gave her a $5K check payable to “Hilda Humane.”
Sandra signed “Hilda Humane” to the back of the check and cashed it at drawee bank. If
Amy discovers that there is no such thing as Humane’s Home for Homeless Dogs, can
she successfully demand that her account be recredited on the theory that the check
was cashed on an improper signature (not “properly payable”)?
 a. No, the payee is fictitious, thus Sandra’s signature of Hilda’s name is effective in favor
of the drawee bank if it paid in good faith, not improper signature.
b. But 3-404(d) says that if the drawee bank failed to exercise ordinary care, the loss is
allocated b/w the drawer and the drawee bank
i. To prove negligence of the bank, usage of trade may be looked at
c. 3-404(b): fictitious payee (the person who does not exist) -> indorsement is effective
5. Problem 201: Mrs. Heartstrong forged a letter and signature of her husband and sent it
to Methuselah Life Insurance Company, telling them to discontinue his life insurance
and send the cash surrender value by mail. She obtained the check, forged Mr.
Heartstrong’s name on the back, and cashed the check at SSB. SSB presented the
check to ONB (drawee), which cashed it. When Mr. Heartstrong sues the insurance
company and they call you, what would you advise?
a. ONB is off the hook b/c in good faith, the insurance company (drawer) takes the loss
under the impostor rule (the insurance company should have been more careful. but
she was his wife!)
b. 3-404(a): Mrs. Heartstrong impersonated Mr. Heartstrong -> effective as actual
indorsement of the husband in favor of good faith drawee (ONB) and depositary
bank (SSB)
6. 3-404(b): the person whose intent determines to whom an instrument is payable
(payee is determined by)
a. 3-110(a): determined by the intent of the person, whether or not authorized, signing
as, or in the name or behalf of, the issuer of the instrument
b. 3-110(b): if the signature of the issuer is made by automated means, the payee is
determined by the intent of the person who supplied the name or identification of
the payee, whether or not authorized to do so (secretary in Problem 203)
c. Generally means the person who signed the instrument, though for check-writing
machines, it means the person who supplied the name of the payee, whether or not
authorized to do so
7. Problem 202: The corporate treasurer of BC added fictitious EEs to the payroll and took
their checks each month for deposit into accounts opened under the phony names.
a. Are such checks properly payable from the account BC has w/ its bank?
i. Yes, the checks are properly payable b/c the treasurer was a holder and the
indorsement was effective under the fictitious payee rule
ii. 3-404(b)(ii): as the identified payees were fictitious, any person in possession of the
check is a holder and an indorsement by any person in the name of the payee is
effective in favor of a good faith drawee
b. Would the result be different if the treasurer padded the payroll w/ the names of real
former EEs and then did the same thing w/ these checks?
i. 3-404(b)(i): No, still properly payable b/c the treasurer did not intend the former
EEs to have any interest in the checks under the unintended payee rule (refer to
Case # 2 of OC2 to 3-404)
c. If the depositary banks that took these checks were negligent in allowing the
treasurer to open the accounts, would that change the result?
 i. 3-404(d): Yes, if the depositary banks had exercised ordinary care and requested
the ID, the loss would have been prevented. The loss should be allocated b/w BC
and depositary bank
8. Problem 203: Secretary informed Sam that he owed $1.5K to John on a debt (which is a
lie), so he wrote out a check to John. The Secretary forged John’s name to the check
and pocketed the proceeds.
a. Is this check properly payable from Sam’s account?
i. 3-110(a): issuer(Sam)’s intent controls -> payable to John
ii. No, the bank did not pay the check to the named payee John, and violated the
properly payable rule (3-404(a) or (b) do not apply b/c someone is not pretending
to be another person or the payee is not fictitious -> EE Indorsement Rule applies)
iii. what about 3-404(b)(i) unintended payee? – that does not apply b/c Sam did intend
to pay the money to John
b. Does it make any difference whether or not John is real or fictitious?
i. Yes, if John is fictitious, 3-404(b) applies and the check is properly payable (no relief
to Sam)
D. The EE Indorsement Rule
1. 3-405 (ER’s Responsibility for Fraudulent Indorsement by EE)
a. In this section:
i. "EE" includes an independent contractor and EE of an independent contractor
retained by the ER.
ii. "Fraudulent indorsement" means (i) in the case of an instrument payable to the ER,
a forged indorsement purporting to be that of the ER, or (ii) in the case of an
instrument w/r/t which the ER is the issuer, a forged indorsement purporting to be
that of the person identified as payee.
a) Applies either when ER is a drawer or a payee of the instrument
iii. "Responsibility" w/r/t instruments means authority (i) to sign or indorse
instruments on behalf of the ER, (ii) to process instruments received by the ER for
bookkeeping purposes, for deposit to an account, or for other disposition, (iii)
to prepare or process instruments for issue in the name of the ER, (iv) to
supply information determining the names or addresses of payees of instruments
to be issued in the name of the ER (secretary in Problem 203), (v) to control the
disposition of instruments to be issued in the name of the ER, or (vi) to act
otherwise w/r/t instruments in a responsible capacity. "Responsibility" does not
include authority that merely allows an EE to have access to instruments or
blank or incomplete instrument forms that are being stored or transported or
are part of incoming or outgoing mail, or similar access.
b. For the purpose of determining the rights and liabilities of a person who, in good
faith, pays an instrument or takes it for value or for collection, if an ER entrusted an
EE w/ responsibility w/r/t the instrument and the EE or a person acting in concert w/
the EE makes a fraudulent indorsement of the instrument, the indorsement is
effective as the indorsement of the person to whom the instrument is payable if it is
made in the name of that person. If the person paying the instrument or taking it for
value or for
 collection fails to exercise ordinary care in paying or taking the instrument and that
failure substantially contributes to loss resulting from the fraud, the person bearing
the loss may recover from the person failing to exercise ordinary care to the extent
the failure to exercise ordinary care contributed to the loss.
i. (EE’s indorsement is effective in favor of good faith indorser, drawee, collecting
bank, but loss allocated per contributory negligence)
c. Under subsection (b), an indorsement is made in the name of the person to whom an
instrument is payable if (i) it is made in a name substantially similar to the name of
that person or (ii) the instrument, whether or not indorsed, is deposited in a
depositary bank to an account in a name substantially similar to the name of that
person.
i. (substantially similar payee’s name is effective)
d. OC1: ER is in a far better position to avoid the loss by care in choosing EEs, in
supervising them, and in adopting other measures to prevent forged indorsements
on instruments “payable to ER” (when ER is payee) or fraud in issuance of
instruments in the name of ER (when ER is drawer). If the bank failed to exercise
ordinary care, (b) shift loss to the bank
2. Problem 204: Lucille, the head of the bookkeeping department of BC, was generally in
charge of the handling of checks although she had no authority to indorse the company
name on the checks. She forged the indorsement BC as payee on the back of a $800K
check payable to BC and negotiated it through an account she opened in that name at a
bank.
a. Does 3-405 make ER responsible for EE’s forgeries where ER is itself the payee (as
opposed to the issuer) of the instrument?
i. 3-405(a)(3)(ii): responsible w/r/t the instrument if process the checks for
bookkeeping purposes
ii. OC1: Yes, 3-405(b) applies when the instrument is payable to ER (as well as when
ER is drawer), so the indorsement by Lucille is effective as the indorsement by ER
iii. It does NOT matter if ER is issuer or payee of the instrument (different from
Impostor Rule)
b. Would that section reach a different result if the forgeries were done by Brad, who
had found a check payable to BC behind the computer he was repairing as part of his
job as an in-house computer maintenance specialist?
i. No, 3-405(b) does not apply b/c he is not an EE w/ responsibility w/r/t the
instrument (it is a normal forgery)
c. Read the cases in OC to 3-404 & 405
3. Note: Federal Commercial Paper Law
a. U.S.S.C. decisions preclude the use of 3-404(b) and 3-405 (no federal common law),
but 3-404(a) (Imposter Rule) has been adopted as a federal rule by lower federal
courts
b. OC4 to 3-102: If US is a party to an instrument, its rights and duties are governed by
federal common law in the absence of a specific federal statute or regulation. . . . In
most instances, courts have shown a willingness to adopt UCC rules in formulating
 federal common law on the subject
c. OC1 to 4-102: applicable federal law (e.g., Expedited Funds Availability Act and its
implementing Regulation CC) may supersede provisions of Art. 4. In some instances,
this law is alluded to in the statute. In other instances, although not referred to in
Art. 4, the provisions of the EFAA and Reg. CC control w/r/t checks
d. Art. 9 has been adopted by U.S.S.C as federal common law in US v. Kimbell Foods
4. Problem 205: Shopper left his checkbook lying on a department store counter, McGee
picked it up and wrote out a check for $100 payable to the order of John Doe (made up
name). Then he forged Shopper’s name to the drawer’s line, indorsed the check John
Doe and Fingers McGee, and deposited the check in his own account w/ FSB. FSB was
paid $100 by the drawee, ANB. (midnight deadline has passed and final payment has
been made) When Shopper complained to ANB about the forgery, the bank reluctantly
recredited his account. It now wants to pass the loss on to the presenting bank FSB,
claiming that it breached the warranty that it was a PETE b/c of the forged indorsement
of John Doe. Has that warranty been breached, or did FSB somehow become a holder?
(forgery of both drawer’s name and payee’s name)
a. Presentment warranty has not been breached and FSB became a holder
b. If drawer’s signature was forged, Price v. Neal rule applies and drawee bank takes
the loss
c. But, here in addition to the forgery of the drawer’s signature, other problems w/r/t
the check -> issuer, i.e., the person who wrote the check (McGee)’s intent controls ->
fictitious payee
d. 3-404(b)(ii): fictitious -> any person in possession of the check (McGee) is a holder
and indorsement by McGee is effective in favor of a good faith payor (FSB) unless
FSB failed to exercise ordinary care -> PETE warranty has NOT been breached b/c
McGee was a PETE (holder) -> now the forged signature of payee is validated -> then
Price v.
Neal rule governs now
e. Price v. Neal rule puts the loss on drawee bank when drawer’s signature was forged
E. The Negligence Rule
1. Doctrine of negligence
a. When a party’s own negligence substantially contributed to the creation of a forgery,
the person may be estopped to complain about the forgery
b. The same rule applies to the creation of alterations of the instrument
2. 3-406 (Negligence Contributing to Forged Signature or Alteration of Instrument)
a. A person whose failure to exercise ordinary care substantially contributes to an
alteration of an instrument or to the making of a forged signature on an instrument is
precluded from asserting the alteration or the forgery against a person who, in good
faith, pays the instrument or takes it for value or for collection.
i. (if drawer negligent, can’t assert forgery against good faith indorser, drawee,
collecting bank)
b. Under subsection (a), if the person asserting the preclusion fails to exercise ordinary
care in paying or taking the instrument and that failure substantially contributes to
loss, the loss is allocated b/w the person precluded and the person asserting the
 preclusion according to the extent to which the failure of each to exercise ordinary
care contributed to the loss.
i. (if indorser, drawee, collecting bank negligent too, loss allocated)
c. Under subsection (a), the burden of proving failure to exercise ordinary care is on the
person asserting the preclusion. Under subsection (b), the burden of proving failure
to exercise ordinary care is on the person precluded.
3. Problem 206: Is it enough negligence that a space was left on the amount line to which
a numeral could be added? Yes
a. Young v. Grote: drawer who so negligently draws an instrument as to facilitate its
material alteration is liable to drawee who pays the altered instrument in good faith
b. OC1 to 3-406: the Young v. Grote doctrine is expended to apply not only to drafts but
to all instruments. It includes in the protected class any “person who, in good faith,
pays the instrument or takes it for value or for collection.”
4. Defense v. Cause of Action
a. The doctrine of negligence can only be used as a defense (no separate affirmative
cause of action)
i. Affirmative negligence actions must be brought outside UCC and judged by
common law standards
b. OC1 to 3-406: 3-406 does not make the negligent party liable in tort for damages
resulting from the alteration. If the negligent party is estopped from asserting the
alteration the person taking the instrument is fully protected b/c the taker can treat
the instrument as having been issued in the altered form
5. Problem 207: AAA dealt w/ 2 customers named Plunkett Auto Sales, on in IL and the
other in AL. AAA sold a car for AL Plunkett but mistakenly mailed a check to IL Plunkett,
who cashed the check w/ his own bank PSS, which forwarded the check to the drawee
bank. The drawee bank dishonored the check at AAA’s stop payment request, IL
Plunkett skipped the state, and PSS was left holding the check. PSS sued AAA on its
drawer’s obligation under 3-414(b), AAA tried to raise the defense of mistake. Does 3-
406 apply?
a. Yes, AAA failed to exercise ordinary care in sending the check to the wrong customer,
and thus is precluded from asserting the forged indorsement against the drawee
bank.
b. Case No. 2, OC3: An insurance company draws a check to the order of Sarah Smith in
payment of a claim of a policyholder, Sarah Smith, who lives in AL. The insurance
company also has a policyholder w/ the same name who lives in IL. By mistake, the
insurance company mails the check to the IL Sarah Smith who indorses the check and
obtains payment. B/c the payee of the check is the AL Sarah Smith, the indorsement
by the IL Sarah Smith is a forged indorsement. 3-110(a). The trier of fact could find
that the insurance company failed to exercise ordinary care when it mailed the check
to the wrong person and that the failure substantially contributed to the making of
the forged indorsement. In that event the insurance company could be precluded
from asserting the forged indorsement against the drawee bank that honored the
check.
6. The Bank/First Citizens Bank v. Citizens and Associates
a. Facts: Drawer sued depository bank regarding checks it wrote to a third party who
 misdirected the checks into her personal account at the bank.
b. Rule: The drawer did not exercise ordinary care by negligent or careless business
practices when it issued checks w/o verification and delivered them to the forger, and
the bank failed to exercise ordinary care by accepting the checks and allowing them
to be deposited into the forger's personal account, and the bank's failure
substantially contributed to the drawer's loss. The drawer substantially contributed
to the forgery by negligently placing the checks at the forger's disposal, and this
negligence was a substantial factor in the forgery. As a result, the drawer
"substantially contributed" to the forgery under 3-406. The bank's failure to exercise
ordinary care was not the same as failing to take the checks in good faith, under 1-
201(19).
i. Branch manager has apparent authority!
7. Problem 208: Lucille, corporate treasurer of BC, had the authority to indorse the
corporate name to checks coming into BC. She took a number of checks, stamped the
corporate name as payee, then indorsed her own name below the corporate stamp and
deposited the checks in her personal account at BNB. Is it negligent for the depositary
bank to allow her to do this?
a. Yes, BNB had notice of the breach of fiduciary duty b/c the check was deposited to an
account other than BC’s account -> notice of claim by BC -> not HDC and subject to
BC’s claim (theft)
b. Ex 4 of OC3 to 3-405: EE’s duties include stamping ER’s unrestricted blank
indorsement on checks received by ER and depositing them in ER’s bank account.
After stamping ER’s unrestricted blank indorsement on a check, EE steals the check
and deposits it in EE’s personal bank account. 3-405 doesn’t apply b/c there is no
forged indorsement. EE is authorized by ER to indorse ER’s checks. The fraud by EE is
not the indorsement but rather the theft of the indorsed check. The issue is
determined under 3-307
c. 3-307(b)(2): if (i) an instrument is taken from a fiduciary for payment or collection or
for value, (ii) the taker has knowledge of the fiduciary status of the fiduciary, and (iii)
the represented person makes a claim to the instrument or its proceeds on the basis
that the transaction of the fiduciary is a breach of fiduciary duty, (2) in case of an
instrument payable to the represented person or the fiduciary as such, the taker has
notice of the breach of fiduciary duty if the instrument is (i) taken in payment of or as
security for a debt known by taker to be the personal debt of the fiduciary, (ii) taken
in a transaction known by the taker to be for the personal benefit of the fiduciary, or
(iii) deposited to an account other than an account of the fiduciary, as such, or an
account of the represented person
d. Al Sarena Mines v. Southtrust Bank: the depositary bank was liable for paying the
amounts of all of the checks forged b/c it did not act in a commercially reasonable
manner when it accepted the checks payable to the corporate payee for deposit into
a corporate EE’s personal account w/o verifying the checks w/ the corporate payee.
The corporate payee's negligence in not noticing the changes in its account under 3-
406 was not a defense in light of the depositary bank's failure to act in a
commercially reasonable manner as a matter of law.
 e. In re Lou Levy & Sons: D bank failed to meet its burden that it accepted 193 business
checks in a commercially reasonable manner pursuant to 3-406.
8. Problem 209: It was the practice of ONB to treat checks payable to the bank (bearer
instruments) as if they were payable to bearer b/c many check drawers made the same
assumption. Whenever BC wanted to put money into a special account for the payment
of taxes, it wrote a check payable to the order of ONB and, by use of a deposit slip w/
the tax account number on it, made the deposit. Lucille, the corporate treasurer of BC,
wrote out a check for $250K payable to the order of ONB, cooking the books so that it
appeared this amount was going into the tax account but in reality putting it into her
own personal account, using a deposit slip w/ her account number on it. When the
check cleared, Lucille disappeared w/ the money. BC protested to the bank, and when
the bank refused to recredit its account, used, arguing that these checks were not
properly payable under 4-401.
a. Was the bank negligent?
i. Majority of jurisdiction will hold that the bank was negligent (usage of trade
assuming such checks as bearer instruments was negligent)
ii. Olean Area Camp Fire Council v. Olean Dresser Clark Fed. Credit Union: negligence
of the grossest kind
iii. Trail Leasing v. Drovers First American Bank: bank is a HDC and takes free of
drawer’s defenses
b. If BC were found to be negligent in not better supervising Lucille, how does that
affect the result?
i. The loss will be apportioned according to negligence under 3-406(b)
9. Travelers Casualty v. Wells Fargo
a. Fact: A life insurance company had a checking account at D bank. An individual
forged a $287,651.23 check drawn on the account, and D brokerage firm opened an
account w/ it.
b. Rule: The bank could not be held liable for honoring a forged or otherwise
unauthorized check if the check was not forged or unauthorized. The insurer had
failed to prove that the check made out to the brokerage firm and deposited by the
individual had not been authorized by the company. However, the brokerage firm
violated its tort duty of care to the company and hence to the insurer. The
brokerage firm should have tried to find out from the company whether the check
had been authorized.
c. Note: Judge Posner’s cavalier assumption that a payor bank can by K avoid liability to
its customer for paying a check on which the drawer’s name is forged is
questionable
10. 3-307 (Notice of Breach of Fiduciary Duty)
a. In this section:
i. “Fiduciary” means an agent, trustee, partner, corporate officer or director, or other
representative owing a fiduciary duty w/r/t an instrument.
ii. “Represented person” means the principal, beneficiary, partnership, corporation,
or other person to whom the duty stated in paragraph (1) is owed.
 b. If (i) an instrument is taken from a fiduciary for payment or collection or for value,
(ii) the taker has knowledge of the fiduciary status of the fiduciary, and (iii) the
represented person makes a claim to the instrument or its proceeds on the basis
that the transaction of the fiduciary is a breach of fiduciary duty, the following
rules apply:
i. Notice of breach of fiduciary duty by the fiduciary is notice of the claim of the
represented person.
ii. In the case of an instrument payable to the represented person or the fiduciary as
such, the taker has notice of the breach of fiduciary duty if the instrument is (i)
taken in payment of or as security for a debt known by the taker to be the personal
debt of the fiduciary, (ii) taken in a transaction known by the taker to be for the
personal benefit of the fiduciary, or (iii) deposited to an account other than an
account of the fiduciary, as such, or an account of the represented person.
iii. If an instrument is issued by the represented person or the fiduciary as such, and
made payable to the fiduciary personally, the taker does not have notice of the
breach of fiduciary duty unless the taker knows of the breach of fiduciary duty.
iv. If an instrument is issued by the represented person or the fiduciary as such, to the
taker as payee, the taker has notice of the breach of fiduciary duty if the instrument
is (i) taken in payment of or as security for a debt known by the taker to
be the personal debt of the fiduciary, (ii) taken in a transaction known by the taker
to be for the personal benefit of the fiduciary, or (iii) deposited to an account other
than an account of the fiduciary, as such, or an account of the represented person.
11. Problem 210: When Edwin Dennis died, he left all of his property in trust to his minor
son, Patrick, whose guardianship was given over to Edwin’s sister, Mame, who was
named as trustee. A $10K CD changed after Edwin’s death so that it was payable to
“Mame Dennis, as guardian and trustee for Patrick Dennis, a minor.” Mame took the
CD down to BNB and pledged it as collateral for an $8K loan to her personally, and BNB
took possession of the CD and put it in its vault.
a. Can Patrick get the CD back from BNB w/o having to repay the loan, when he came
of age? Yes
i. 3-307(b)(2)(i): Yes, CD was payable to the represented person (Patrick) and was
taken as security for the fiduciary (Mame)’s personal debt -> BNB has notice of
breach of fiduciary duty -> notice of the claim of the represented person -> not a
HDC -> subject to a claim of property right of Patrick (3-306) (The bank should think
it very suspicious)
b. If Mame had used the Patrick Dennis Trust Account carried at BNB, on which she
was the named trustee, to write herself a check to pay her salary as trustee, would
that be a suspicious circumstance giving rise to a claim in Patrick’s favor to recover
the money? No
i. The check was issued by the fiduciary and made payable to the fiduciary personally
-> BNB has no notice of breach of fiduciary duty -> no notice of defense -> HDC ->
not subject to a claim of property right (paying salary to the fiduciary is not
suspicious)
 ii. 3-307(b)(3) and OC4: For example, Doe as President of Corporation writes a check
on Corporation's account to the order of Doe personally. The check is then
indorsed over to Bank as in Comment 3. In this case there is no notice of breach of
fiduciary duty b/c there is nothing unusual about the transaction. Corporation may
have owed Doe money for salary, reimbursement for expenses incurred for the
benefit of Corporation, or for any other reason. If Doe is authorized to write checks
on behalf of Corporation to pay debts of Corporation, the check is a normal way of
paying a debt owed to Doe. Bank may assume that Doe may use the instrument for
his personal benefit.
F. The Bank Statement Rule
1. 4-406 (Customer’s Duty to Discover and Report Unauthorized Signature or Alteration)
a. A bank that sends or makes available to a customer a statement of account showing
payment of items for the account shall either return or make available to the
customer the items paid or provide information in the statement of account
sufficient to allow the customer reasonably to identify the items paid. The statement
of account provides sufficient information if the item is described by item number,
amount, and date of payment. (bank statement should provide sufficient info)
b. If the items are not returned to the customer, the person retaining the items shall
either retain the items or, if the items are destroyed, maintain the capacity to
furnish legible copies of the items until the expiration of seven yrs after receipt of
the items. A customer may request an item from the bank that paid the item, and
that bank must provide in a reasonable time either the item or, if the item has been
destroyed or is not otherwise obtainable, a legible copy of the item. (safe harbor
rule)
c. If a bank sends or makes available a statement of account or items pursuant to
subsection (a), the customer must exercise “reasonable promptness” in examining
the statement or the items to determine whether any payment was not authorized
b/c of an alteration of an item or b/c a purported signature by or on behalf of the
customer (drawer) was not authorized. If, based on the statement or items
provided, the customer should reasonably have discovered the unauthorized
payment, the customer must promptly notify the bank of the relevant facts.
d. If the bank proves that the customer failed, w/r/t an item, to comply w/ the duties
imposed on the customer by subsection (c), the customer is precluded from
asserting against the bank:
i. the customer's unauthorized signature or any alteration on the item, if the bank
also proves that it suffered a loss by reason of the failure; and (bank must prove
loss for the 1st item & customer need not report the forgery within certain
period of time)
ii. the customer's unauthorized signature or alteration by the same wrongdoer on any
other item paid in good faith by the bank if the payment was made before the bank
received notice from the customer of the unauthorized signature or alteration and
after the customer had been afforded a reasonable period of time, not exceeding
30 days (grace period), in which to examine the item or statement of account and
 notify the bank.
a) same wrongdoer rule: If the customer fails to report the 1st forged check within
the grace period, he is precluded from recovering for any additional checks
forged by the same wrongdoer & paid after the grace period and before the
notice to the bank (bank need not prove loss)
e. If subsection (d) applies and the customer proves that the bank failed to exercise
ordinary care in paying the item and that the failure substantially contributed to loss,
the loss is allocated b/w the customer precluded and the bank asserting the
preclusion according to the extent to which the failure of the customer to comply w/
subsection (c) and the failure of the bank to exercise ordinary care contributed to
the loss. If the customer proves that the bank did not pay the item in good faith, the
preclusion under subsection (d) does not apply. (comparative fault rule)
f. W/o regard to care or lack of care of either the customer or the bank (no matter who
was negligent), a customer who does not within 1 yr after the statement or items
are made available to the customer (subsection (a)) discover and report the
customer's unauthorized signature on or any alteration on the item is precluded
from asserting against the bank the unauthorized signature or alteration. If there is a
preclusion under this subsection, the payor bank may not recover for breach of
warranty under 4-208 w/r/t the unauthorized signature or alteration to which the
preclusion applies. (nature of SOL, not technically SOL -> statute of repose)
g. In summary, customer must examine the bank statement or be estopped from
asserting unauthorized signatures or material alterations that could have been
discovered (extension of 3-406 Negligence Rule)
h. OC2:
i. (d)(1): applies to the unauthorized payment of the item to which the duty to report
under subsection (c) applies. If the bank proves that the customer "should
reasonably have discovered the unauthorized payment" and did not notify the
bank, the customer is precluded from asserting against the bank the alteration or
the customer's unauthorized signature if the bank proves that it suffered a loss as a
result of the failure of the customer to perform its subsection (c) duty.
ii. (d)(2): applies to cases in which the customer fails to report an unauthorized
signature or alteration w/r/t an item in breach of the subsection (c) duty and the
bank subsequently pays other items of the customer w/r/t which there is an
alteration or unauthorized signature of the customer and the same wrongdoer is
involved. If the payment of the subsequent items occurred after the customer has
had a reasonable time (not exceeding 30 days) to report w/r/t the first item and
before the bank received notice of the unauthorized signature or alteration of the
first item, the customer is precluded from asserting the alteration or unauthorized
signature w/r/t the subsequent items. (bank is not required to prove loss)
2. Problem 211: John tore out a blank check from the back of Rhonda’s checkbook. On
Mar. 25, this check ($500) cleared through Rhonda’s checking account w/ her name
forged thereto and was returned to Rhonda on April 1. She failed to balance her
checkbook until Aug. 1, when she discovered and reported the forgery.
 a. Must the bank recredit her account?
i. Yes, the bank must recredit under 4-406(d)(1) unless it proves there is loss in order
to avoid the liability! (as for the 1st item, customer need not report the forgery
within the grace period)
b. Would it help or hurt the bank’s position if John has also had an account at the bank
and had had $500 or more in this account at all times up until the end of July?
i. That would help the bank’s position b/c if Rhonda had reported the forgery earlier,
the bank would have been able to recover $500 from John’s account (now the bank
can prove that they suffered loss and can avoid the liability)
3. Problem 212: Lucille was secretary to Head, CEO of BC. Over 3 yrs, she stole 87 blank
corporate checks from Head’s checkbook, and took $378K out of the corporate
account before she was caught insolvent and went to jail.
a. How much, if anything, can it make its bank recredit? (ignore the issue of EE
indorsement rule)
i. First, w/r/t the checks older than 1 yr, BC takes all the loss. As for the remaining
checks, BC failed to report the forgeries within the grace period (not exceeding 30
days from the bank statement regarding the first forged check), so (d)(2) same
wrongdoer rule protects bank.
ii. 4-406(c): customer must promptly examine the bank statement and report any
unauthorized signature or alteration
iii. 4-406(d): if not, customer can’t raise unauthorized signature or alteration against
the bank for the payment made in good faith b/w 30 days from the receipt of the
bank statement and customer’s notice of forgery to the bank
iv. 4-406(e): if the bank was negligent too, the loss is allocated b/w the customer and
the bank
v. 4-406(f): After 1 yr from the statement, customer can’t assert the forgery against
the bank at all
b. What if all the forgeries happened during the last 6 months?
i. The 1st check: 4-406(d)(1) problem. The bank must prove the loss, otherwise BC
wins (BC need not report the forgery as for the 1st check within the grace
period)
ii. The checks cleared during the grace period: bank must prove the loss, otherwise
BC wins
iii. After the close of the grace period, BC can assert forgeries against the bank only if
it had reported the forgery of the 1st check within the grace period
4. Falk v. Northern Trust: good faith requirement in 4-406(f)
a. EE has been stealing checks for 13 yrs and her actions were suspicious
i. “good faith” clause was taken out of the code at that time – dissent: not necessary
any longer
ii. Majority: 4-406(f) requires that a bank act in good faith when paying the items on
the statement in order to claim the protection of the prerequisite of notice
requirement contained in that section
5. Problem 213: ONB did not examine checks less than $5K for forgeries (bulk filing) and
paid a series of $3.5K checks on which a customer’s signature as drawer was forged and
 sent them over a period of months to its customer as part of his monthly statement.
Customer negligently failed to report the forgeries until 7 months after the first one
was returned to him. When he did complain, the bank pointed to 4-406(c) and (d).
Customer replied that 4-406(e) requires the bank to share the loss since it did not
observe ordinary care. Who prevails here?
a. The bank will prevail. If bulk filing is the usage of trade in banking industry, it is the
exercise of ordinary care under UCC. But the customer may be able to show that the
bank was negligent in failing to notice the repeated forgeries over several months.
Then, the loss should be allocated b/w the customer and the bank
b. 4-103(c): Action/non-action approved by Art. 4 or FR regulations or operating
circulars is the exercise of ordinary care and, in the absence of special instructions,
house rules and the like or w/ a general banking usage not disapproved by Art. 4, is
prima facie the exercise of ordinary care
c. 3-103(a)(9): “ordinary care” in the case of a person engaged in business means
observance of reasonable commercial standards, prevailing in the area in which the
person is located, w/r/t the business in which the person is engaged. In the case of a
bank that takes an instrument for processing for collection or payment by automated
means, reasonable commercial standards do not require the bank to examine the
instrument if the failure to examine does not violate the bank’s prescribed procedure
and the bank’s procedures do not vary unreasonably from general banking usage not
disapproved by Art. 3 or 4.
6. Problem 214: When the law firm FF & M opened a checking account w/ ONB, the firm
members signed a deposit K, stating that they would report all irregularities in their
bank statements within 10 days of their receipt and failure to do so resulted in a waiver
of any problems w/ the statement. 2 yrs later, Ledger (FF & M’s bookkeeper) wrote 3
checks (each for $5K) to herself and forged FF & M signatures to the drawer’s line. 1st
check cleared through the bank in time to be returned w/ the bank statement that
arrived at the law office on Dec. 10. Ledger burned the statement and took off for parts
unknown. On Jan. 23, Amos (senior partner) notified ONB that he could not find the
December statement. When a duplicate was furnished to FF & M, they pointed out 1st
$5K check. By this time, the other 2 checks had cleared through FF & M’s account and
were ready to be sent out in the February statement. ONB declined to recredit FF &
M’s account w/ any of the $15K, pointing to the 10 day notice requirement in the
deposit K and to 4-406(d). FF & M sued under 4-401 properly payable rule and argued
that 4-103 invalidated the 10 day notice provision.
a. How should this come out? (shortening the period of time from 30 days to 10 days)
i. Many courts have allowed 14-day, 20-day, or 30-day period
ii. 4-103(a): Art. 4 may be varied by agreement unless manifestly unreasonable
iii. Thus, if the 10-day notice period is not manifestly unreasonable, FF & M is
precluded from asserting forgeries against ONB (But, White & Summers says that
10 days is unconscionably short! -> bank cannot prevail)
b. Would it make a difference if Ledger’s forgeries were very badly done?
i. 4-103(a): cannot disclaim a bank’s responsibility for its lack of good faith or failure
 to exercise ordinary care
ii. 4-406(e): bad forgeries -> ONB’s negligence or bad faith -> 4-406(d) preclusion not
applies -> FF & M is allowed to assert forgeries against ONB
7. Problem 215: In order to avoid the Price v. Neal liability, ONB added a clause to the
checking account agreement as follows: “Customer understands and agrees that the
bank is no longer examining checks written for amounts less than $5K, and also agrees
that if the drawer’s signature on such checks shall be unauthorized, the checks shall
nonetheless be properly payable from the bank account, w/ the customer having the
sole duty to pursue legal remedies against others.” Is this clause valid?
a. 4-103(a): cannot disclaim a bank’s responsibility for its lack of good faith or failure to
exercise ordinary care
b. 4-401(a): properly payable if authorized by customer and in accordance w/ any
agreement b/w customer and bank (2 prong test!)
i. OC1: an item containing a forged drawer’s signature or forged indorsement is NOT
properly payable
c. 3-103(a)(9): ordinary care
d. There is a dichotomy in the industry – who is the cheapest cost avoider? Bank!
i. Also 4-401(a) is a 2-prong test
8. Problem 216: Max let INB handle all his affairs as well as act as drawee of his checking
account. He signed all of his checks w/ a stamp when he first received this checkbook
and never examined the bank statements. His lawyer discovered that his bank account
was $4K short due to a check that had been stolen from Max and filled in to “Cash” for
$4K over 2 yrs ago. Lawyer, as Max’s agent, demanded that the account be replenished
w/ this amount and INB instantly complied. Then, INB demanded repayment from the
presenting bank FSB, charging breach of 4-208(a)(2) warranty of no alteration. What
result if FSB refuses and suit is brought?
a. The check was 2 yrs old (Max did not promptly examine the bank statement and
report)-> Max is precluded asserting unauthorized signature/alteration ->
nonetheless drawee (INB) recredited Max’s account -> so INB may not recover for
breach of presentment warranty from presenting bank (FSB) (4-406(f))
b. 4-406(f): if there is a preclusion under this subsection, the payor bank may not
recover for breach of warranty under 4-208 w/r/t the unauthorized signature or
alteration to which the preclusion applies
c. 4-208(c): If a drawee asserts a claim for breach of warranty under subsection (a)
based on an unauthorized indorsement of the draft or an alteration of the draft, the
warrantor may defend by proving that the indorsement is effective under 3-404 or
3-405 or the drawer is precluded under 3-406 or 4-406 from asserting against the
drawee the unauthorized indorsement or alteration
9. Problem 217: Balance (payroll clerk for TC) drew up 107 extra paychecks payable to
phony names. He signed the payee’s names to the back of every check and cashed
them at various local depositary banks over a period of 1 month. TC immediately
demanded that the money be recredited to its payroll account. The bank comes to you
for advice b/c TC is one of the bank’s largest depositors and the bank doesn’t want to
 lose it. If it recredits the account, can it sue the depositary banks for breach of
presentment warranties? No
a. If payor bank made proper payment in spite of the unauthorized signature of
drawer/alteration b/c these irregularities are validated by one of the 4 rules, payor
bank cannot ignore the validation and pass the loss on to innocent parties such as
presenting bank
b. 3-404(b)(ii): fictitious payees -> anyone in possession of the instrument is holder &
indorsement by anyone is effective in favor of a good faith payor (properly payable) -
> no violation of presentment warranty (4-208) by depositary banks (How about EE
Indorsement Rule?)
c. 4-208(c): the entity making presentment warranties may raise the various validation
rules to avoid warranty liability
IV. Material Alteration
A. 3-407 (alteration is NOT forgery!)
1. "Alteration" means (i) an unauthorized change in an instrument that purports to
modify in any respect the obligation of a party, or (ii) an unauthorized addition of
words or numbers or other change to an incomplete instrument relating to the
obligation of a party.
2. Except as provided in subsection (c), an alteration fraudulently made discharges a
party whose obligation is affected by the alteration unless that party assents or is
precluded from asserting the alteration. No other alteration discharges a party, and the
instrument may be enforced according to its original terms. (fraudulent alteration ->
“complete” discharge)
3. A payor bank or drawee paying a fraudulently altered instrument or a person taking it
for value, in good faith and w/o notice of the alteration, may enforce rights w/r/t the
instrument (i) according to its original terms, or (ii) in the case of an incomplete
instrument altered by unauthorized completion, according to its terms as completed.
(innocent later holder is not subject to the defense of discharge b/c discharge is a
personal defense)
B. Problem 218: Innocent borrowed $100 from MLC after he signed a promissory note for
$100 plus 8%/yr interest, payable to the order of MLC on demand. MLC altered the
amount to $9,500 (fraudulent alteration!) and discounted the paper for $100 to Schmidt
(self-employed commercial factor), who always bought MLC’s altered paper (not a HDC).
Schmidt presented the note to Innocent for payment. What legal defenses does Innocent
have?
1. 3-407: raising of the amount -> fraudulent alteration under 3-407(a)(i) -> Innocent is
“completely” discharged b/c he neither assented nor was precluded from asserting the
alteration
2. Policy: punitive! -> innocent later party take the instrument free of discharge
C. Problem 219: When writing out a check to Brown, Johnson simply signed his name to the
drawer’s line b/c he couldn’t remember how to spell Brown’s name or the exact amount
owed. The check was stolen and made out to “Cash” for $150, cleared through his
checking account the next week. Johnson brought suit against his bank, demanding that
 the bank recredit his account since the amount was not properly payable. He argues that
this was an alteration under 3-407 and he was discharged by the alteration. What reply
should the bank make?
1. Johnson is not discharged in spite of the fraudulent alteration b/c the check was
incomplete, drawer takes the loss w/r/t the innocent later party (negligence rule)
2. 3-115(c): if words or numbers are added to an incomplete instrument w/o authority of
the signer, there is an alteration of the incomplete instrument under 3-407
3. 3-407(c): drawee bank in good faith and w/o notice may enforce rights w/r/t the
instrument i) according to its original terms, or (ii) in the case of an incomplete
instrument altered by unauthorized completion, according to its terms as completed
a. OC2: if blanks are filled or an incomplete instrument is otherwise completed,
subsection (c) places the loss upon the party who left the instrument incomplete by
permitting enforcement in its completed form. This result is intended even though
the instrument was stolen from the issuer and completed after the theft
D. Problem 220: Goodheart, the owner and manager of the Goodheart Home for the Aged,
was the payee of a promissory note for $1K given him by Nephew for 3 months’ care
given to Nephew’s elderly aunt Molly. One day, Molly, who was not responsible for her
actions, changed the amount of the note to $1M.
1. Does this operate to discharge Nephew from his maker’s obligation under 3-407? No
a. Raising of the amount was not fraudulent in this case, so Nephew is not discharged
(unauthorized but not fraudulent b/c not intentional – spoliation by madding
stranger)
2. What would be the result if Molly had torn up and eaten the note?
a. 3-309 and OC: Goodheart is entitled to enforce the note if he can prove the terms of
the note b/c he was entitled to enforce the instrument when loss of possession
occurred
E. Problem 221: Smith mailed a check for $5.00 to his friend Rouge as a birthday gift. Rouge
raised the amount to $500.00 and cashed it at his own bank ONB, which then obtained
payment from the drawee bank. When Smith received the bank statement, he
immediately complained to the bank about the alteration of the check.
1. Assuming he was not negligent in writing the check, can Smith make the bank recredit
the account for $500.00 or only $495.00?
a. The drawee bank may recredit $495.00 only under 3-407(c)(i) (enforcing the original
terms)
b. 3-407: fraudulent alteration -> complete discharge
c. 4-401(d): bank that in good faith makes payment to a holder may charge (1) the
original amount or (2) the terms of the completed item unless no notice of improper
completion
d. 3-407(c): the drawee bank (if in good faith) may enforce the rights w/r/t the
instrument (i) according to the original terms or (ii) in the case of an incomplete
instrument altered by unauthorized completion, according to its terms as completed
(innocent later party takes the instrument free of discharge defense)
2. Is the bank w/o a remedy?
 a. 4-208(a): The drawee bank may sue the depositary bank (ONB) for breach of
presentment warranty (no alteration) under 4-208(a)(2)

CHAPTER 13. ELECTRONIC BANKING

I. Consumers and EFTs (EFTs)
A. Credit Cards (Regulation Z)
1. Basic Liability
a. Problem 222: Clark loaned his sister his bank charge card for $200 worth of
purchases, who has so far run up $1,800 in charges. ONB, the bank that issued the
card, says Clark is liable for all her charges until he can find her and reclaim his card.
i. Is he?
a) Yes, he is liable b/c he authorized his sister to use his card (If you loan your
credit card to somebody, authorize him to use the card continuously, notice
to the issuer of the card is not effective)
b) Martin v. American Express: giving the card to a 3rd party clearly establishes that
the 3rd party is authorized to use the card
c) Walker Bank v. Jones: a bank is justified in disregarding requests to cancel the
account b/c consumer does not surrender his card upon request
ii. If EFTA applies to the kind of credit card involved, what result?
a) Same result b/c not unauthorized EFT (Clark furnished his sister w/ the card) –
you can simply notify the bank to stop the card if it were a debit card
b) Reg. E 205.2(m): unauthorized EFT – EFT by a person other than the consumer
w/o actual authority and from which the consumer receives no benefit, except
1. By a person furnished the access device to the consumer’s account by the
consumer
2. W/ fraudulent intent by the consumer, or any person acting in concert w/ the
consumer
3. By the financial institution or its EEs
c) Why is there difference? (policy)
1. debit card draws money from your checking account, so it’s more serious
than credit card
b. Reg. Z 226.12: where the use is unauthorized, the cardholder’s liability is limited to
$50
i. Not liable for $50 if (1) card issuer has not notified the cardholder of the right, (2)
the card does not identify the user, and (3) the card issuer has not provided the
cardholder w/ a means of notifying the card issuer of the loss
ii. Major card companies waive this right of $50 and give cardholders a free ride for
completely unauthorized use
1. Asserting Defenses Against the Credit Card Issuer
a. Problem 223: Linda, resident of NJ, refused to pay her credit card bills (hotel bill in CA,
$80 suitcase that fell apart and the seller is bankrupt in NY, $25 art print from FL
that had never arrived and ONB included promotional literature in its last card bill),
charged w/ her bank credit card issued by ONB. Is she liable to ONB?
 i. Hotel bill: Linda is liable b/c the transaction occurred in CA (good faith attempt and
amount OK)
ii. Suitcase: Linda is liable unless she did not make a good faith attempt to resolve the
dispute w/ the seller -> automatic stay for bankrupt merchant -> so, Linda is not
required to contact the merchant and NOT liable (location and amount OK)
iii. Art print: Linda NOT liable b/c the seller obtained the order through a mail
solicitation made by the card issuer (location X, good faith attempt X, amount X,
but these limitations do not apply)
iv. Reg. Z 226.12(c): cardholder may assert against the card issuer all claims (other
than tort claims) and defenses arising out of the transaction and relating to the
failure to resolve the dispute. The card holder may withhold payment . . . only if
a) The cardholder has made a good faith attempt to resolve the dispute w/ the
person honoring the credit card (the merchant); AND
b) The amount exceeds $50 and the disputed transaction occurred in the same
state as the cardholder’s current designated address (or within 100 miles
from that address)
c) The above limitations do not apply if the merchant is (1) the card issuer; (2) is
controlled by the card issuer directly/indirectly; (3) is under the direct/indirect
control of a 3rd person that also directly/indirectly controls the card issuer; (4)
controls the card issuer directly/indirectly; (5) is a franchised dealer in the card
issuer’s products/services; (6) has obtained the order through a mail solicitation
made/participated in by the card issuer (ad by the card issuer)
2. Billing Errors
a. Reg. Z 226.13: if cardholder complains to the issuer of a billing error, the card issuer
must acknowledge within 30 days, good faith investigation , resolve within 90 days
(or 2 billing cycles)
i. During the interim, card issuer must not treat the disputed amount as overdue or
report it adversely
ii. Failure to honor -> issuer’s forfeiture of up to $50 + additional liability including
attorney’s fees
iii. This applies even when the bank is turned out to be right after investigation
B. Debit Cards (Regulation E; Official Commentary)
1. Problem 224: Electra’s ER informed her that all her paychecks would automatically be
deposited in the local bank of her choice. She chose ONB, her usual bank.
a. Could she have demanded a check and refused the EFT?
i. No, ER may require EEs to get EFT as long as it does not choose a particular
financial institution
ii. EFTA 913: no person may require a consumer to establish an account for receipt of
EFTs w/ a particular financial institution as a condition of employment or receipt of
a government benefit
b. ONB informed Electra that she could pay all her bills by phone (preauthorized EFT),
and she signed such K w/ her landlord, to whom ONB agreed to transfer $300/month
as rent. What details does ONB have to explain to her?
 i. EFTA 916(d)(2): civil liability
ii. Reg. E 205.7(b)(1): liability of consumer, telephone number and address, business
day, types of transfers and limitations, fees, documentation, stop payment, liability
of institution, confidentiality, error resolution, ATM fees
c. ONB’s computer malfunctioned and deducted $1,000 rent from Electra’s account and
credited it to an account designated “Computer Maintenance.” Several of her checks
bounced as a result. Is the deduction an EFT under Reg. E 205.3(b)?
i. Yes, this transaction was initiated by computer, so this is an EFT
ii. Definition: any transfer of funds initiated through an electronic terminal,
telephone, computer, magnetic tape for the purpose of ordering, including POS
transfers, ATM transfers, direct deposits/withdrawals of funds, transfers initiated
by telephone, transfers resulting from debit card transactions, whether or not
initiated through an electronic terminal
d. If so, is it also an “unauthorized EFT” under 205.2(m)?
i. No, EFT initiated by the financial institution is not an unauthorized ETF (205.2(m)(3))
-> It’s not unauthorized, but it’s nor authorized either, so consumer is not liable
even for $50,
e. Is the bank liable under 910? Under UCC 4-401(a)?
i. EFTA 910(a)(1): financial institution shall be liable to a consumer for all damages
proximately caused by the financial institution's failure to make an EFT, in
accordance w/ the terms and conditions of an account, in the correct amount or in
a timely manner when properly instructed to do so by the consumer . . . (yes)
ii. 4-401(a): properly payable rule (yes)
f. Are there common law theories that she might use?
i. Conversion? – No, you can’t convert your own money. The consumer loaned her
money to the bank when she made her account at the bank
g. What about the bounced checks?
i. 4-402: wrongful dishonor
h. ONB failed to pay Electra’s rent b/c the computer got backlogged. Can her landlord
evict her?
i. No, Electra’s obligation is suspended unless the landlord demanded payment by
other means in writing b/c the landlord agreed to EFT of the rent
ii. EFTA 912: if a system malfunction prevents an EFT initiated by a consumer to
another person, and such other person has agreed to accept payment by such
means, the consumer’s obligation is suspended until the malfunction is corrected,
unless such other person has subsequently, by written request, demanded
payment by other means
i. When she is evicted and sues ONB over 910, can the bank defend using 910(b)(1)?
i. The bank can’t defend using 910(b)(1) b/c technical malfunction is not beyond the
bank’s control, but it may defend using 910(b)(2) if Electra knew about the
technical malfunction at the time the transfer should have occurred
ii. 910(b)(1): no liability due to act of God or other circumstances beyond its control
iii. 910(b)(2): technical malfunction known to the consumer at the time he attempted
 to initiate an EFT, or in case of preauthorized transfer, at the time such
transfer should have occurred
iv. Blake v. Woodford Bank: bank is not excused b/c the circumstances beyond its
control (breakdown of posting machines) did not prevent it from timely performing
j. Electra had a dispute w/ her landlord, so she phoned ONB not to pay the next
month’s rent due to be transferred 4 days later. Is oral notice sufficient? Is her
notice timely?
i. Oral notice is sufficient, and 4 day notice is timely – bank can’t K away to require
written notice only b/c it is a federal law
ii. EFTA 907(a): a consumer may stop payment of a preauthorized EFT by notifying
the financial institution orally or in writing at any time up to 3 business days
preceding the scheduled date of such transfer (same under Reg. E 205.10(c))
k. If ONB fails to stop payment, what remedy does she have? What damages does she
have? Can she recover her attorney’s fees?
i. EFTA 910(c): all damages proximately caused by ONB’s failure to stop payment is
recoverable
ii. EFTA 915(a): actual damages + costs of the action + attorney’s fees (but, as for 910
involved, it is a battle ground)
l. If Linda in Problem 223 had made purchases w/ POS EFTs, would she be able to assert
her defenses against her bank under the EFTA?
i. No b/c she used her “debit” card at the merchant’s place, can’t use the defense for
“credit” card
2. Problem 225: Jane handled her bookstore’s financial affairs through a checking account
w/ ONB. If ONB grants the store an ability to pay its debts by EFTs, does EFTA apply?
a. NO b/c she is not a consumer, but a business woman
b. EFTA 903(2): account demand deposit account
c. Reg. E 205.2(b): demand deposit account = checking account
3. Problem 226: Arthur withdrew $50 from his checking account w/ his access card at
ATM. The ATM gave him $50 but it deducted $500 from his account, w/ no written
statement
a. At the end of the month, Arthur’s bank sent him a statement showing the status of
his account. Should it reflect this transaction? How?
i. EFTA 906(c): Yes, the bank must provide periodic statement including the amount,
date, type of transfer, identity of account, identity of 3rd party,
location/identification of electronic terminal
b. If Arthur does not examine this statement for 1 yr, does EFTA cause him problems?
i. EFTA 909(a): Yes, consumer must report within 60 days of transmittal of the
statement
ii. 4-406(f): customer must assert his claim within 1 yr after the statement are
available to him
c. If Arthur examines the statement promptly and discovers the error, what should he
do?
i. Reg. E 205.11(b): oral or written notice, within 60 days after the bank sent the
statement, identify consumer’s name and account number, indicate why he
believes an error exists, include the type, date, amount of the error
 d. The bank received Arthur’s notice on May 1. By what date need it act? Need it put
the money back in his account during its investigation?
i. EFTA 908(a): must investigate and report within 10 business days, conclude
investigation within 45 business days from notice
ii. EFTA 908(c): must provisionally recredit
iii. Reg. E 205.11(c): investigate and determine within 10 BUSINESS days of receiving
notice (may extend to 45 CALENDAR days from receipt of the notice if they provide
provisional recredit to customer’s account), report result within 3 business days
after completing investigation, correct the error within 1 business day after
determination
e. Who bears BOP as to whether ATM gave Arthur $50 or $500?
i. EFTA 909(b): financial institution to show EFT was authorized
ii. Gramore Stores v. Bankers Trust: BOP is on the depositor
f. What liability does the bank have simply b/c it never programmed the ATM to hand
out written statements?
i. EFTA 906(a): bank must provide written documentation of transfer including
amount, date, type of transfer, identity of account, identity of 3rd party,
location/identification of electronic terminal
ii. EFTA 916: liable for actual damage + automatic punitive damages + costs of the
action + reasonable attorney’s fee
g. If ATM had been so programmed but failed to give the statement to Arthur due to
mechanical failure, is this a defense?
i. EFTA 916(c): bank may show by preponderance of evidence that the violation was
not intentional and resulted from a bona fide error notwithstanding the
maintenance of procedures reasonably adapted to avoid such error
h. Is it a defense that ATM growled at Arthur when he walked up to it, so that he should
have known it wasn’t working, and thus he assumed the risk of error?
i. EFTA 910(b)(2): no liable if the error resulted from technical malfunction known to
consumer at the time he attempted to initiate an EFT
i. After receiving Arthur’s complaint, the bank’s investigation consisted solely of having a
computer printout made of the transaction and mailing it to Arthur. Does this
satisfy 908?
i. No, not good faith investigation
ii. EFTA 908(e): the consumer is entitled to treble damages if the bank (1) did not
provisionally recredit within 10 day or (2) knowingly and willfully concluded the
consumer’s account was not in error when such conclusion could not reasonably
have been drawn from available evidence
4. EFTA 909 (Consumer liability for unauthorized transfers); Reg. E 205.6:
a. Consumer’s normal liability is $50
b. If consumer does not report within 2 business days, the liability goes up to $500
c. If consumer does not report within 60 days, he is liable for the amount used b/w the
end of 60 day period and notice
5. Problem 227: Scrooge owned a bank credit card issued by DNB, w/ which he maintained
 a checking account. The mail contained a letter assigning him a PIN and explaining that
by inserting his credit card in ATM and punching in the PIN, he could receive immediate
cash withdrawals from his account
a. Has DNB violated EFTA?
i. No b/c bank is not liable until Scrooge uses the PIN
ii. EFTA 911: no person may issue to a consumer any card, code, or other means of
access to such consumer’s account for the purpose of initiating an EFT w/o
request/application or as a renewal/substitution of other means of access (same
under Reg. E 205.5)
iii. Truth in Lending Act forbids to mail customers unsolicited “credit” card; but it is
allowed to mail customers unsolicited “debit” card as long as not validating it
b. Scrooge threw the PIN letter in the wastebasket, and Bob stole Scrooge’s card and
extracted $100 from ATM. Is Scrooge liable for this withdrawal?
i. No, he is not liable b/c it’s not an accepted card
ii. EFTA 909(a): a consumer is liable for an unauthorized EFT only if the used card was
an accepted card and the issuer of the card/code has provided a means (PIN)
whereby the user can be identified as the person authorized to use it, such as by
signature, photograph, fingerprint, electronic/mechanical confirmation
iii. EFTA 903(1): accepted card – card/code/other means of access to a consumer’s
account for initiating EFTs when the consumer requested and received, signed,
used or authorized another to use
iv. Reg. E 205.6: consumer is liable only if the card was accepted and the bank
provided a means to identify the consumer
6. Problem 228 (final exam!): Carl once loaned Nancy and authorized her to make small
withdrawals, and later Nancy stole his card and took $500 from his account w/ ONB on
April 30. Rather than notify the bank, Carl tried to track her down. On May 5, she used
the card to remove $800 and left the state. Carl slumped into a depression so severe
that he could not leave his bed. On May 31, ONB sent Carl the usual bank statement.
On June 10, Nancy returned to the state and took $3,000.
a. no notice within 2 business days -> Carl’s liability goes up to $500 from $50 -> but
within 60 days from receipt of bank statement -> Carl would have been liable for the
unauthorized transfer b/w the end of the 60 day period and notice to the bank if he
had notified the bank after 60 days from the receipt of banks statement (but, here,
he will be liable only for $500 if he reports now)
b. Reg. E 205.6: he owes $500 and no more – unlimited liability for the transaction after
60 days until he reports
c. unauthorized transfer w/ accepted card + means to identify the consumer provided
by the bank
7. Problem 229: A person stuck a gun in Armstrong’s back and ordered him to withdraw
the maximum amount from ATM w/ his debit card.
a. Is this an “unauthorized” EFT, so that his liability is limited to $50? Yes, it is an
unauthorized transfer
i. 12 C.F.R. 205, EFT-2 Q2-28: An EFT at an ATM is an unauthorized transfer if the
 consumer has been induced by force to initiate the transfer
b. If Armstrong lost his wallet and it contained his debit card, on which he had
negligently written his PIN, would his liability for unauthorized use increase?
i. Q6-6.5: he is NOT liable for any amount more than permissible under Reg. E
(consumer’s negligence cannot be used as the basis for imposing greater liability)
II. Wire Transfers (when consumers are not involved)
A. Introduction
1. Reg. J 12 C.F.R. 210: resolve disputes internal to transfers through the Federal Reserve
System (in accordance w/ Art. 4)
2. Fedwire: FRS’s wire transfer mechanism
3. CHIPS (Clearing house Interbank Payments System): all of the wire transfers in the
“world (not in US)” run through CHIPS
4. Bank’s risk
a. Receiving bank allows its non-bank customer immediate access to the funds even
though settlement will not occur until the end of the day
b. If settlement never happens, the receiving bank will be unable to recapture the funds
c. Daylight overdraft: limit of the amount of exposure by imposing a debit cap
5. ACH (Automated Clearinghouse): mechanism for the electronic transfer of recurring
debits and credits b/w participants
6. Body of EFT law: EFTA, Reg. J, Art. 4A
7. NACHA (National Automated Clearing House Association): allowed consequential
damages -> so bankers prefer UCC b/c they prefer moneyback guarantee to
consequential damages
B. Scope of Art. 4A
1. 4A-103(a)(1): wholesale wire transfers, including any payment order, transmitted orally,
electronically or in writing (not deals w/ payment instructions)
a. Payment order: pushes funds of sender to beneficiary
i. requires an electronic credit, not debit
ii. electronic debit is likely be covered by Operating Letters of the FRB or private
agreements
b. Payment instructions: such as checks, involve the efforts of the payee to pull funds
from payor’s bank account into the bank account of the payee
2. Problem 230: Big Department Store pays its EEs by ETF through ACH to their bank
accounts throughout the country. Every Friday, it receives weekly receipts from its
thousands of retail stores by instructing BDS’s bank to transfer to itself all the monies
the retail outlets had deposited in their Friday Receipts accounts.
a. Are the payroll ACH transfers payment orders?
i. Yes b/c they are making payment
b. Are the Friday remittances?
i. No, they are capturing payment
ii. 4A-103(a)(1): “Payment order” means an instruction of a sender to a receiving
bank, transmitted orally, electronically, or in writing, to pay, or to cause another
bank to pay, a fixed or determinable amount of money to a beneficiary if:
 a) the instruction does not state a condition to payment to the beneficiary
other than time of payment,
b) the receiving bank is to be reimbursed by debiting an account of, or
otherwise receiving payment from, the sender, and
c) the instruction is transmitted by the sender directly to the receiving bank or
to an agent, funds-transfer system, or communication system for transmittal to
the receiving bank.
iii. OC4 to 4A-10: In a credit transfer the instruction to pay is given by the person
making payment. In a debit transfer the instruction to pay is given by the person
receiving payment.
iv. Federal regulations
a) FRB issues their own internal rules (operating letters)
b) Reg. J almost identical w/ Art. 4A
3. Problem 231: Sheridan (NY) agreed to buy the Mesalia Journal (OH) from Jefferson, and
instructed his bank (NY MNB) to wire $1M to Jefferson’s bank (MCB). The bank did so
through Fedwire, having FRB of NY (NY Fed) debit this amount from NY MNB’s account
w/ it and crediting the same amount to itself. NY Fed used Fedwire to transfer the $1M
to the account it carried w/ Cincy Fed. Since MCB did not have an account w/ Cincy Fed,
Cincy Fed transferred the money to the account of LESB which credited the $1M into
the account that MCB carried w/ it. MCB, in turn, placed the money into Jefferson’s
account. All this happened in one day.
a. Look at 4A-103, 104, 105 and put the appropriate labels on the parties
i. Originator: sender of the 1st payment order in a funds transfer – Sheridan (one
who starts it all, could be an individual)
ii. Originator’s bank: (1) receiving bank to which the payment order of the originator
is issues if the originator is not a bank or (2) or the originator if the originator is a
bank – NY MNB (first receiving bank)
iii. Sender: person giving the instruction to the receiving bank – everybody except
Jefferson and MCB (anyone who gives a payment order)
iv. Intermediary bank: receiving bank other than the originator’s bank or beneficiary’s
bank – N.Y. Fed, Cincy Fed, LESB (exclude the first and the last banks)
v. Receiving bank: bank to which the sender’s instruction is addressed – all of the
banks, i.e., NY MNB, N.Y. Fed, Cincy Fed, LESB, MCB
vi. Beneficiary: person to be paid by the beneficiary’s bank – Jefferson (the person
who is going to get the money)
vii. Beneficiary’s bank: bank identified in a payment order in which an account of the
beneficiary is to be credited pursuant to the order or which otherwise is to make
payment to the beneficiary if the order does not provide for payment to an
account
– MCB (last bank) – acceptance/rejection of the payment order, notify the
beneficiary
b. At what exact moment does Jefferson have a legal right to the money?
i. Jefferson has a legal right to the money on the payment date of the order
ii. 4A-404(a): payment is due on the payment date of the order, but if acceptance
 occurs on the payment date after the close of the funds-transfer business day of the
bank, payment is due on the next funds-transfer business day
c. Must MCB notify Jefferson that the money is in this account? Yes
i. 4A-404(b): if a payment order instructs payment to an account of the beneficiary,
the bank is obligated to notify the beneficiary of receipt of the order before
midnight of the next funds-transfer business day following the payment date
d. Can MCB impose a charge against Jefferson for its actions in accepting the funds
transfer?
i. Yes, but the amount is minimal in practice (usage of trade: originator pays all the
charges)
ii. 4A-406(c): amount of originator’s order = originator’s payment – charges of
receiving banks
iii. OC5: charges of receiving banks in a funds transfer normally are nominal
e. MCB believed that Jefferson owed it $40K on a loan it made to him last yr, so it told
him that it was allowing him access to only $960K. He protested, telling the bank that
he had repaid the entire loan 2 weeks ago (which was true) and that he needed the
$40K to pay off the newspaper’s creditors so that the sale to Sheridan could go
through. Does the bank have a right of setoff for legitimate debts that its customer
owes it? Yes
i. 4A-502(c)(1): the bank may credit the beneficiary’s account and set off against an
obligation owed by the beneficiary to the bank
f. If the newspaper sale collapses b/c Jefferson failed to pay off the creditors, what
damages can he recover from MCB?
i. He can get consequential damages b/c he warned the bank
ii. 4A-404(a): beneficiary may recover consequential damages resulting from the
refusal to pay to the extent the bank had notice of the damages unless the bank
proves reasonable doubt
4. Funds availability
a. Most funds transfers are completed on the day that the sender gives the originating
payment order
b. In ACH transfers, funds become available to the beneficiary on the day after the
transfer is completed
c. Expedited Funds Availability Act requires next-business day availability for wire
transfers
C. Acceptance of Payment Orders
1. Introduction
a. If a receiving bank makes a technical acceptance of a payment order, it cannot
change its mind and reverse the acceptance
b. No right of charge-back simply b/c a bank fails to receive payment
c. If the receiving bank does not want to make an acceptance, it must reject the
payment order
2. 4A-212
a. Art. 4A never requires any bank to make an acceptance of a payment order
 b. A bank is always free to reject the payment order unless it has a separate agreement
otherwise
c. If the bank makes an agreement to accept a payment order and then wrongfully
refuses to do so, the law of Ks, not Art. 4A, governs its liability
3. 4A-209(d)
a. If the payment order specifies a payment date, no acceptance can occur until that
date even if the banks have made provisional settlements
b. How to make acceptance
i. Receiving bank (other than the beneficiary’s bank): executing the payment order
(passing it on)
ii. Beneficiary’s bank
a) Payment of the amount of the order to the beneficiary
b) Notification to the beneficiary that the amount is available for withdrawal
c) Receipt itself of full payment order
d) Failure of the beneficiary’s bank to reject the payment order within the time
limits under 4A-209(b)(3) – not will be tested
1. opening of the next funds-transfer business day following the order’s
payment date if beneficiary’s bank has received payment or the sender’s
account is fully covered by a withdrawable credit balance, unless the
beneficiary’s bank rejects order before that time
2. within one hour of that time, or within one hour after the opening of the
sender’s next business day if the sender was not immediately available to
receive rejection
4. OC2 to 4A-502
a. Before acceptance, any credit in the beneficiary’s account is provisional only
5. 4A-404(a)
a. A beneficiary’s bank can avoid liability to the beneficiary by delaying acceptance of
the payment order (typically saying nothing to the beneficiary until payment is
received)
b. Once acceptance occurs, the beneficiary has a right to the funds
c. If the beneficiary’s bank accepts the payment order and fails to make payment to the
beneficiary, it is liable to the beneficiary for the amount of the payment (plus
interest) and for any consequential damages
6. Problem 232: During the great bank collapse of 2018, wire transfer completion became
a major concern. If ONB receives a payment order from a bank whose financial status is
either shaky or unknown, how can it protect itself from liability to its customers in the
event that the sender fails to forward the funds (or settle at the end of the business
day)?
a. They can wait until the money actually comes to your bank and then accept or reject.
But, if the payment order came through to you, even though you don’t receive the
money, you may treat the money as if it is in your account b/c Federal Reserve Bank
approved it.
b. 4A-403 (Payment by Sender to Receiving Bank)
c. 4A-405(e)(Payment by Beneficiary’s Bank to Beneficiary): doomsday rule
d. 4A-209 (Acceptance of Payment Order)
 e. OC8 to 4A-209
7. Problem 233: ONB made its customers sign an agreement providing that even though
the bank had informed them that they were the beneficiaries of a wire transfer, no
acceptance was final unless the bank itself actually received the funds. Any withdrawal
of the funds prior to the bank’s receipt was merely a loan by ONB to its customers, to be
repaid either by receipt of the funds or, failing that, by customer repayment. Is this
agreement enforceable?
a. Void as a matter of public policy. If the bank lets the money out to the customer, it
cannot recover from its customer even if the sender does not pay the order (4A-
405(c)).
b. 4A-209(b)(1): a beneficiary’s bank accepts a payment order when the bank (i) pays
the beneficiary as stated in 4A-405(a) or 4A-405(b), or (ii) notifies the
beneficiary of receipt of the order or that the account of the beneficiary has been
credited w/r/t the order unless the notice indicates that the bank is rejecting the
order or that funds w/r/t the order may not be withdrawn or used until receipt
of payment from the sender of the order
D. Transmission Errors: who bears the loss?
1. Grain Traders v. Citibank:
a. Grain trader (originator) wants to sue one of the collecting banks
b. No cause of action from originator against intermediary bank -> it must sue the
originator bank
c. ROL in this transaction was to be borne by P as the originator of the action, as it was
P's choice of the intermediary bank that led to the loss.
d. All that is allowed is money back guarantee, but they were no longer in business here
2. Most courts have ruled that common law theories are preempted in wire transfer cases
by the statutory scheme of Art. 4A
a. If Art. 4A does not specifically address certain issues, courts will look at common law
3. OC to 4A-203 (Unenforceability of Certain Verified Payment Orders): if the customer can
prove that the person committing the fraud did not obtain the confidential info from an
agent or former agent of the customer or from a source controlled by the customer, the
loss is shifted to the bank
4. Problem 234: Saul agreed to buy Betty’s business from her for $1M, the deal to be off
unless he made payment of this amount to her account (12345) at MB on Sept. 25. On
Sept. 24, Saul ordered his bank, ONB, to wire $1M from his account w/ ONB to Betty,
Account #12345, at MB, w/ a payment date of the next day. ONB executed this payment
order by issuing an identical payment order to MB, but mistakenly gave the account # as
12346, though it correctly identified Betty by name. MB notified Harry, the holder of
Account #12346, that $1M had been deposited in his account and was available for
withdrawal as of Sept. 25. Harry, delighted, withdrew the money and lit out for parts
unknown. When Betty didn’t receive the money, she phoned Saul on Sept. 26 and told
him that the deal was off and that she was selling the business to her brother.
Saul, furious, sued his bank. Who bears what liability here?
a. MB (beneficiary’s bank) is not liable and may ignore the account holder’s name
 b. ONB (originator bank) is liable and it must go after Harry in order to recover the
money (common law restitution) – the entity that made a mistake is liable
c. 4A-305: ONB is liable to Saul for his expenses, the $1M and interest, but not for
consequential damages unless a written agreement b/w Saul and ONB provides that
the bank will bear this greater loss
i. In certain circumstances, the bank may have to pay Saul’s attorneys’ fees
d. 4A-304: Saul has a duty to discover and report the problem within 90 days after his
bank sends him notification of the payment or be responsible for whatever loss the
bank can prove it suffered b/c of his dealy in reporting
5. Usage of trade
a. Banks look only at the account # and ignore the actual name
b. 4A-207: beneficiary’s bank may ignore the name specified in the payment order and
deal only on the basis of the given account #, unless it was actually aware of the
discrepancy
i. TME Enterprises v. Norwest Corp.: if the beneficiary’s bank was actually aware of
the discrepancy of account holder’s name, it is responsible for seeing that the
correct beneficiary gets the funds
6. 4A-204(a): any time a bank does not properly execute the payment order, the
originator must be made whole, including interest
a. But bank is not liable for any consequential damages unless a written agreement w/
the originator
b. OC2: money-back guarantee
7. Corfan Banco v. Ocean Bank:
a. Fact: Originator bank transferred an incorrect payment order bearing wrong account
number, and beneficiary bank identified the error and sent the money to the right
account.
b. Hold: Under the plain meaning of the statute, bank should not have accepted the
order referring to a nonexistent account number.
8. Problem 235: In Problem 234, Saul is the one that gave his bank the incorrect account
number, though he correctly listed the beneficiary’s name. What result?
a. Saul is not obliged to pay unless he had notice that ONB would make the payment on
the basis of the beneficiary’s bank account number
b. 4A-207(c) and OC3: a non-bank originator who made a wrong payment order is not
obliged to pay its order unless the originator’s bank proves that originator, before
acceptance of his order, had noticed that payment of a payment order issued by the
originator might be made by the beneficiary’s bank on the basis of identifying or bank
account number even if it identifies a person different from the named beneficiary
(but if the originator is a bank, the bank is obliged to pay!)
9. Bank of America v. Sanati:
a. Fact: D told P bank to send the interest, and P erroneously transferred the principal.
b. Hold: P won. The bank was entitled to restitution from Ds despite its negligence
under general principles of mistake and unjust enrichment.
10. Problem 236: Business Corporation paid all of its bills by funds transfers through ONB.
 These 2 entities signed an agreement providing that funds transfers could be made only
if the originator included in the payment order a secret code number, which would
change daily according to the number assigned by a computer program accessed by
both the corporation and the bank (security procedure). John, BC EE in charge of
approving its payment orders, revealed his job details to Mary (computer hacker) who
accessed BC’s files, issue phony payment orders of worth $830,756, and have ONB
execute them.
a. Can BC demand that ONB recredit its account for the amount she stole?
i. The bank followed the security procedure. The originator granted access by a 3rd
party through its EE, and thus is at fault.
ii. 4A-201: security procedure
iii. 4A-202(b): once the security procedure has been established, a payment order
received by the receiving bank is effective as the order of the customer, whether or
not authorized if (1) the security procedure is a commercially reasonable and (2)
the bank proves that it accepted the payment order in good faith and in
compliance w/ the security procedure
iv. OC5 to 4A-203: customer bears BOP that he is not at fault. If customer proves, the
loss is shifted to the bank
b. How long does BC have in which to demand a recredit of its account?
i. 4A-505: 1yr after BC received the notification reasonably identifying the order
ii. Regatos v. North Fork Bank: 1 yr period cannot be modified by an agreement
11. Problem 237: In Problem 236, the security procedure b/w the parties says “if the
amount transferred was above $500K, the secret code had to begin w/ the letter “A,”
but the secret code itself did not tell senders this. Mary didn’t know about it and
failed to put the “A” in front of the secret code when transferring $830,756 to her bank
account. ONB accepted the payment order anyway when it made the funds transfer
to Mary’s bank. Now what?
a. Now the bank did not follow the security procedure, so it loses
b. 4A-205(a)(1): if an accepted payment order by a security procedure has an error in
(1) beneficiary; (2) amount (greater than); or (3) duplicate transfer,
i. Sender is not obliged to pay if he proves that he complied w/ the security
procedure and the error would have been detected if the receiving bank had also
complied it
ii. Sender is not obliged to pay and the receiving bank is entitled to recover from the
beneficiary in case of (1) and (3)
iii. Sender is not obliged to pay to the extent of excess amount and receiving bank is
entitled to recover from the beneficiary the excess amount
E. Conclusion
1. 4A-303: Art. 4A tends to place liability for erroneous payment orders on the entity that
made the mistake.
2. 4A-501(a): rights and obligations of a party to a funds transfer may be varied by
agreement of the affected party
a. But, throughout Art. 4A, sections restrict the right of the parties to change UCC rules
by agreement
i. Ex) right of a beneficiary to receive payment and damages under 4A-404(c)
 3. Bank protection
a. OC2 to 4A-305:
b. In case of bank insolvency, banks that have accepted payment orders but not
received payment must bear the loss unless a funds transfer system has adopted a
plan for loss- sharing and the plan fails
i. In such case, the payment is undone even though acceptance had occurred under
4A-405(e) doomsday rule

CHAPTER 14. INVESTMENT SECURITIES

I. Introduction (covered some terms and skipped the rest of the part – not heavily tested)
A. Art. 8 on investment securities
1. Certificated securities: stocks and bonds (physical pieces of paper)
2. Uncertificated securities: non-paper, registration of the investors’ interest at the
issuer’s headquarters or some other central location (description of rights, no physical
paper)
3. Security entitlements: rights of investors in security account
II. Terminology
A. Sale of security
1. If the registered owner sells the security -> he (transferor) indorses the instrument, by
writing either on it or on a separate paper, over to the new owner -> the instrument is
presented to the transfer agent (EE of the corporation or separate entity)
a. The registered owner may simply indorse the instrument in blank, naming no
transferee (when selling the security through a broker to unknown purchaser)
b. It is common for registered owners who wish to sell their securities on the market to
indorse them over to their brokers, who then register the security in the brokers’
names (street name securities)
i. Broker submits the security to the transfer agent so that the records can be
changed to switch the registered ownership from the broker to the purchaser
ii. Beneficial owner of the security has a security entitlement in a securities account
held w/ a security intermediary (who one instructs by giving an entitlement order
(8-102(a)), in which all these terms are defined in 8-501(a))
a) In today’s world, actual certificate may be held only by a clearing corporation
and rights therein are passed down to lower tiers of owners by bookkeeping
entries
b) If you become holder of security entitlement, and it is held by security
intermediary, your broker is security intermediary and original clearing corp. is
broker’s security intermediary
III. Security Entitlements (Part 5 of Art. 8)
A. Place physical paper in a holding company, bank accounts concerning it are created, and
info regarding rights are put onto computer
B. Problem 244: Goldbury, an investor, told his broker, BB & B, to buy him 100 shares of
Utopia, Ltd. Stock. BB & B placed the order by having this number of shares transferred to
the account it carried w/ Clearing Corp. BB & B then marked its books to reflect that
Goldbury owned 100 shares of Utopia, Ltd.
1. Using the definitions in 8-102, answer the questions:
 a. entitlement holder: person identified in the records of a securities intermediary as
the person having a security entitlement against the securities intermediary -
Goldbury
b. securities intermediary: a clearing corporation or a person, including a bank or broker,
that in the ordinary course of its business maintains securities accounts for others
and is acting in that capacity – CC and BB & B
c. security entitlement: rights and property interest of an entitlement holder w/r/t a
financial asset – the 100 shares of Utopia that Goldbury has on BB & B’s book (8-
102(17))
d. who has a securities account under 8-501(a): account to which a financial asset is or
may be credited in accordance w/ an agreement under which the person maintaining
the account undertakes to treat the person for whom the account is maintained as
entitled to exercise the rights that comprise the financial asset – Goldbury has one w/
BB & B, and BB & B has one w/ CC
2. if the former owner of the 100 shares Goldbury purchased claims that they were stolen
from her and somehow traces them to the account BB & B has w/ CC, will she succeed
in reclaiming the stock?
a. 8-502 (Assertion of Adverse Claim): an action based on an adverse claim to a financial
asset, whether framed in conversion, replevin, constructive trust, equitable lien, or
other theory, may not be asserted against a person who acquires a security
entitlement under 8-501 for value and w/o notice of the adverse claim (equivalent to
HDC)
b. Whatever theory to try to get it back will NOT work against “person who acquire the
security entitlement for value w/o notice of the adverse claim (commerce depends
on these things not being claimed once good faith people have a hold)
i. Exception: current stock holder participated in collusion or fraud
c. No, the former owner cannot succeed in reclaiming the stock from Goldbury who
acquired a security entitlement for value and w/o notice from an entitlement holder.
Everyone else has shelter under the protected person (Goldbury). She has to go
against the thief (only exception is collusion and fraud) b/c Goldbury
d. 8-510(b) shelter rule for stock and bond
3. BB & B has many creditors itself. Can a creditor of BB & B seize the rights Goldbury has
in the 100 shares of Utopia stock if BB & B does not pay its debts to that creditor?
a. No, not seizeable interest by its own creditors b/c security intermediaries have no
property rights in securities they hold for entitlement holders
b. 8-503(a): to the extent necessary for a securities intermediary to satisfy all security
entitlements w/r/t a particular financial asset, all interests in that asset held by the
securities intermediary are held by the securities intermediary for the entitlement
holders, are not property of the securities intermediary, and are not subject to claims
of creditors of the securities intermediary, except as otherwise provided in 8-511
c. 8-511:
i. If a securities intermediary does not have sufficient interests in a particular
financial assets to satisfy both its obligations to entitlement holders and its
obligations to a creditor, the claims of entitlement holders have priority over
the claims of the
 creditors
ii. a claim of a creditor of a securities intermediary has priority over claims of the
securities intermediary’s entitlement holders if the creditor has control over the
financial asset
iii. if a clearing corporation does not have sufficient financial assets to satisfy both its
obligations to entitlement holders and its obligations to a creditor, claim of the
creditor has priority over the claims of entitlement holders
d. Nathan v. First Concord Securities: although P’s securities were not ordinarily subject
to the claims of its creditors, D properly obtained control of the securities and thus
has a perfected SI
4. BB & B became insolvent. . . . Does that mean that he gets the entire 50 shares?
a. No, they share in proportion (pro rata). They get 25 each.
b. 8-503(b): the time when the entitlement holder acquired the security entitlement is
not relevant in determining the property interest.
C. Powers v. American Express:
1. Under 8-507(b), a securities intermediary is liable to an entitlement holder for any
damages caused by the improper transfer
2. A security intermediary, like AmEx, which transfers funds pursuant to an “ineffective
entitlement order” is liable to an “entitlement holder” for any damages caused by
improper transfer

PART 3. PAYMENT IN DOCUMENTED SALES

CHAPTER 15. DOCUMENTS OF TITLE
I. Introduction
A. Art. 7 (documents of title: 48 states including OH have adopted the new version of Art. 7)
1. Definition: pieces of paper issued for the purpose of actually representing title to goods
(1-201(16))
a. 7-106 (Control of Electronic Document of Title)
i. System must establish the person as the person to which the electronic document
was issues/transferred
ii. “single” entity
2. 2 primary types of documents of title
a. Bills of lading (1-201(6)): document of title evidencing the receipt of goods for
shipment issued by a person engaged in the business of directly/indirectly
transporting/forwarding goods
b. Warehouse receipts (1-201(42)): document of title issued by a person engaged in the
business of storing goods for hire
3. 7-403 (Obligation of Warehouseman or Carrier to Deliver; Excuse) 7-403(c) is the most
important!
a. A bailee shall deliver the goods to a person entitled under a document of title if the
person complies w/ (b) and (c), unless and to the extent that the bailee establishes
any of the following:
i. delivery of the goods to a person whose receipt was rightful as against the claimant;
 ii. damage to or delay, loss, or destruction of the goods for which the bailee is not
liable;
iii. previous sale or other disposition of the goods in lawful enforcement of a lien or on
a warehouse's lawful termination of storage;
iv. the exercise by a seller of its right to stop delivery pursuant to 2-705 or by a lessor
of its right to stop delivery pursuant to 2A-526;
v. a diversion, reconsignment, or other disposition pursuant to 7-303;
vi. release, satisfaction, or any other personal defense against the claimant; or
vii. any other lawful excuse
b. A person claiming goods covered by a document of title shall satisfy the bailee's lien
if the bailee so requests or if the bailee is prohibited by law from delivering the goods
until the charges are paid.
c. Unless a person claiming the goods is a person against which the document of title
does not confer a right under 7-503(a):
i. the person claiming under a document shall surrender possession or control of any
outstanding negotiable document covering the goods for cancellation or indication
of partial deliveries; and
ii. the bailee shall cancel the document or conspicuously indicate in the document the
partial delivery or the bailee is liable to any person to which the document is duly
negotiated.
d. Note: person claiming the goods must surrender the negotiable document of title for
cancellation in order to receive the goods (only way to get the goods stored under
negotiable document)
i. If the document has been lost, the holder can get the goods only by procuring a
court order directing the bailee to turn over the goods
ii. Negotiable document becomes goods
a) If not negotiable, it does not represent the title of the good. It’s just a receipt,
not good collateral.
4. 7-601 (Lost and Missing Documents)
a. If a document has been lost, stolen or destroyed, a court may order delivery of the
goods or issuance of a substitute document and the bailee may w/o liability to any
person comply w/ such order. If the document was negotiable the claimant must
post security approved by the court to indemnify any person who may suffer loss as
a result of non-surrender of the document. If the document was not negotiable, such
security may be required at the discretion of the court. The court may also in its
discretion order payment of the bailee's reasonable costs and counsel fees.
b. A bailee who w/o court order delivers goods to a person claiming under a missing
negotiable document is liable to any person injured thereby, and if the delivery is not
in good faith becomes liable for conversion. Delivery in good faith is not conversion if
made in accordance w/ a filed classification or tariff or, where no classification or
tariff is filed, if the claimant posts security w/ the bailee in an amount at least
double the value of the goods at the time of posting to indemnify any person
injured by the delivery who files a notice of claim within one yr after the delivery.
 5. Negotiability of documents of title
a. Depends on whether they contain order or bearer language (7-104)
b. Bailee can demand only the surrender of “negotiable” paper
i. only negotiable documents of title truly represent absolute ownership of the goods
ii. non-negotiable paper simply evidences the K b/w the bailor and the bailee
II. Warehouse Receipts
A. 3 roles of warehouse receipt
1. Receipt for the goods
2. K for storage
3. If negotiable, a physical embodiment of the concept of title to the goods
B. Basic Bailment Law
1. Bailee’s duty to proper delivery
a. Bailee is required to make proper delivery of the goods to the bailor when the
bailment ends or is to be responsible for nondelivery
b. 7-403(1): excuses for nondelivery
c. Unauthorized delivery is conversion
d. 7-404 (No Liability for Good Faith Delivery Pursuant to Receipt or Bill): A bailee who
in good faith including observance of reasonable commercial standards has received
goods and delivered or otherwise disposed of them according to the terms of the
document of title or pursuant to Art. 7 is not liable therefor. This rule applies even
though the person from whom he received the goods had no authority to procure
the document or to dispose of the goods and even though the person to
whom he delivered the goods had no authority to receive them.
e. Bailee is absolutely liable for misdelivering cargo, unless his mistake as to the person
entitled to receive the goods was induced by the bailor
i. breach of K, tort conversion
ii. Equitable defenses to allegations of misdelivery are disfavored
iii. Prima facie case of negligence -> BOP is on bailee
2. P&G v. Lawrence American
a. Fact: P brought an action against D based upon the nondelivery of the merchandise
for which it issued its warehouse receipts.
b. Hold: The holder of the warehouse receipt was entitled to recover for the full value
of the merchandise.
c. Standard is reasonable care: self-contradictory for a warehouseman simultaneously
to assert due care and total lack of knowledge of what happened
3. 7-203 (Liability for Non-Receipt or Misdescription): A party to or purchaser for value in
good faith of a document of title other than a bill of lading relying in either case upon
the description therein of the goods may recover from the issuer damages caused by
the non-receipt or misdescription of the goods, except to the extent that the
document conspicuously indicates that the issuer does not know whether any part
or all of the goods in fact were received or conform to the description, as where the
description is in terms of marks or labels or kind, quantity or condition, or the receipt
or description is qualified by “contents, condition and quality unknown”, “said to
contain” or the like, if
 such indication be true, or the party or purchaser otherwise has notice.
a. Warehouse company that issues a warehouse receipt is liable to good faith holders
even if it never received the goods
b. It is also liable if the goods are incorrectly described
4. 7-207: warehouse is required to keep goods separate unless they are fungible
5. 7-205: If the goods are fungible, a buyer in the ordinary course of business can
purchase the goods and get good title even though there is an outstanding negotiable
warehouse receipt
6. 7-204 (Duty of Care; Contractual Limitation of Warehouseman's Liability)
a. A warehouseman is liable for damages for loss of or injury to the goods caused by his
failure to exercise such care in regard to them as a reasonably careful man would
exercise under like circumstances but unless otherwise agreed he is not liable for
damages which could not have been avoided by the exercise of such care.
b. Damages may be limited by a term in the warehouse receipt or storage agreement
limiting the amount of liability in case of loss or damage, and setting forth a specific
liability per Art. or item, or value per unit of weight, beyond which the
warehouseman shall not be liable; provided, however, that such liability may on
written request of the bailor at the time of signing such storage agreement or
within a reasonable time after receipt of the warehouse receipt be increased on
part or all of the goods thereunder, in which event increased rates may be
charged based on such increased valuation, but that no such increase shall be
permitted contrary to a lawful limitation of liability contained in the
warehouseman's tariff, if any. No such limitation is effective w/r/t the
warehouseman's liability for conversion to his own use.
c. Reasonable provisions as to the time and manner of presenting claims and instituting
actions based on the bailment may be included in the warehouse receipt or tariff.
d. This section does not impair or repeal ... any statute which imposes a higher
responsibility upon the warehouseman or invalidates contractual limitations which
would be permissible under Art. 7
7. Dunfee v. Blue Rock Van & Storage
a. Fact: A storage warehouse customer brought suit in negligence against a storage
company for loss of her goods by fire.
b. Hold: The customer could not claim surprise or prejudice after she admitted
knowledge of the limitation of liability and purchased extra, additional insurance
coverage to protect against loss over the limited amount stated on the warehouse
receipt. Also, the court upheld the language employed in the receipt and K b/c it
complied w/ 7-204(2) and the customer clearly understood its significance when she
bought extra, additional insurance.
c. Questions
i. Riot destroyed the warehouse. Can they enforce the limitation of liability (7-204)?
Yes
ii. Would the court have reached the same result if Ms. Dunfee had not known of the
limitation of liability, it being buried in the fine print on the receipt? Yes
a) Keefe v. Bekins Van & Storage: limitation effective even though not called to
 customer’s attention
b) Jasphy v. Osinsky: limitation of liability to 1 dollar held unconscionable
iii. Could the bailee depend on a clause in the receipt that completely disclaimed
liability for its own negligence? No
a) Variation by agreement b/w parties is allowed unless unconscionable
b) Typically, you can’t disclaim your own negligence
iv. If the bailee here were a carrier that had issued a bill of lading, would we reach a
different result?
a) 7-309: “reasonably careful man” standard
b) Downstate Medical v. Purolator Courier: May limit liability in ordinary
negligence, but not in gross negligence or recklessness
C. Bailee’s Lien (statutory lien created by Art. 7; consensual SI)
1. Possessory lien
a. All bailees (including warehousemen and carriers) are given a statutory lien in the
bailed goods to the extent of the charges for storage and expenses incident to the
bailment K (e.g., expenses necessary to preserve the goods)
b. 7-209 & 210: warehouse lien
c. 7-306 & 308: carriers lien
d. Bailess’s liens are possessory liens only
i. If voluntarily surrenders the goods (or wrongfully refuses to surrender them), bailee
loses its lien
e. If bailor does not pay the bailee’s charges, bailee may foreclose its lien by
public/private sale in a “commercially reasonable manner”
2. Constitutional (due process) attacks on bailee lien enforcement
a. Flagg Bros v. Brooks: the sale is not properly attributable to the State b/c there is no
state action -> no violation of due process
b. Svendsen v. Smith’s Moving: 7-210 is unconstitutional as a matter of NY state
constitutional law
i. Amendment of NY 7-210 and creation of new 7-211 by adding both notice and a
court hearing to the lien enforcement procedure
D. Delivery Orders: order by bailor address to bailee telling him to deliver the goods to
somebody (similar to checks or drafts except that delivery orders are drawn on bailee
instead of banks)
1. If goods are stored under a nonnegotiable warehouse receipt, bailee can deliver the
goods w/o requiring surrender of the warehouse receipt
a. Nonnegotiable warehouse forms: “delivery can be made on detached written
authority w/o the return of this receipt”
b. If bailor wants the order delivered, he sends a letter (delivery order) to the bailee,
explaining to whom the goods are to be delivered
c. You can store goods in bulk under a nonnegotiable warehouse receipt and break
them up into smaller units by separate delivery orders
2. Negotiable v. nonnegotiable (delivery order can be negotiable/nonnegotiable although
its underlying warehouse receipt is always nonnegotiable)
 a. Negotiable: if it directs bailee to deliver the goods to someone “or his order” or “to
bearer”
b. Nonnegotiable: otherwise
3. Delivery order imposes no liability on the bailee until he accepts the order
a. Bailee who refuses to accept a delivery order may be in breach of the bailment K,
and if so, is liable to the bailor
b. 7-502(1)(d): In the case of a delivery order the bailee's obligation accrues only upon
acceptance and the obligation acquired by the holder is that the issuer and any
indorser will procure the acceptance of the bailee
4. ROL (goods to be delivered w/o being moved): depends on how a seller of bailed goods
makes tender to the buyer under Art. 2
a. Negotiable document of title
i. 2-509(2)(a) (warehouse receipts, not bills of lading): where the goods are held by a
bailee to be delivered w/o being moved, ROL passes to buyer on his receipt of
possession or control of a negotiable document of title covering the goods
ii. 2-503(4)(a) (Manner of Seller’s Tender of Delivery): Where goods are in the
possession of a bailee and are to be delivered w/o being moved: tender requires
that the seller either tender a negotiable document of title covering such goods or
procure acknowledgment by the bailee of the buyer's right to possession of the
goods
iii. 2-510: if the goods do not conform to the K, ROL remains on seller until cure or
acceptance
b. Nonnegotiable document of title
i. 2-509(2)(c): After his receipt of possession or control of nonnegotiable document of
title or other written direction to deliver (delivery order) in a record, as provided in
2-503(4)(b)
ii. 2-503(4)(b): Where goods are in the possession of a bailee and are to be delivered
w/o being moved: tender to the buyer of a nonnegotiable document of title or of a
written direction to the bailee to deliver is sufficient tender unless the buyer
seasonably objects, and receipt by the bailee of notification of the buyer's rights
fixes those rights as against the bailee and all third persons; but ROL of the goods
and of any failure by the bailee to honor the nonnegotiable document of title or
to obey the direction remains on the seller until the buyer has had a reasonable
time to present the document or direction, and a refusal by the bailee to honor
the document or to obey the direction defeats the tender.
iii. In summary, if the goods conform to the K, ROL passes to buyer after his receipt of a
nonnegotiable document of title or other written direction to deliver under 2-
503(4)(b)
c. No documents
i. 2-509(2)(b): ROL shifts to buyer on the bailee’s acknowledgement of buyer ’s right
to possession
5. Problem 245: Fred, a farmer, took 2 truckloads of this cotton to Rural Warehouse for
storage. He stored 1st truckload of 80 bales under a negotiable warehouse receipt
issued
 by Rural. For 2nd truckload of 80 bales, he obtained a nonnegotiable warehouse receipt.
Fred took the documents to Harold, a commodity merchant, who bought both the
negotiable/nonnegotiable receipts. Harold asked that Fred divide the 80 bales
represented by the nonnegotiable receipt into 2 equal lots so that he could resell them
more easily. Fred wrote out 2 delivery orders addressed to Rural, each requiring the
warehouse to turn over 40 bales to “Harold or order.” Harold sold one of the delivery
orders to another commodity merchant Sue, endorsing on the back of the delivery
order “Deliver to Sue or order, (signed) Harold.” Sue phoned Rural and said that she
was the owner of 40 bales of Fred’s cotton under a delivery order. The warehouse
agent agreed that Sue could pick up the bales the next day. That night lightning struck
the warehouse and all the cotton burned. Who took the ROL as to each segment of the
cotton?
a. 80 bales of cotton stored under the negotiable warehouse receipt
i. 2-509(2)(a): whoever in possession of the document of title has ROL
ii. ROL shifted to Harold (buyer) when he obtained the negotiable warehouse receipt
from Fred
b. 80 bales of cotton stored under the nonnegotiable warehouse receipt & negotiable
delivery order & sold to Harold
a) 2-503(4)(b): ROL is on Fred (seller) b/c buyer has not had a reasonable time to
present the (non-negotiable) document of title or delivery order
b) 2-509(2)(a): not apply here b/c delivery order is not “negotiable document of
title” mentioned in this section. Rather, it is covered by negotiable delivery order
mentioned in 2-509(2)(c)
E. Terminology: The Issuer
1. Issuer: the person primarily liable on the document of title
a. Bailee is almost always the person who issues the document
b. Issuer = bailee except for delivery order
c. Bailor is the issuer for delivery order
2. Question: who were the issuers in Problem 245?
a. Issuer of warehouse receipts: bailee (Rural Warehouse)
b. Issuer of delivery orders: bailor (Fred)
III. Bills of Lading
A. Introduction (Payment against Document)
1. Definition: documents issued upon the receipt of goods for transportation by carriers
2. Negotiable or nonnegotiable depending on “order or bearer” language
3. 3 roles: receipt for the goods, K of transportation, tangible evidence of ownership of
the bailed goods
B. Federal Law
1. Art. 7 does not apply (except by analogy) to bill of ladings issued for goods that are to
leave the state
2. Federal Bills of Lading Act (almost the same as Art. 7), Shipping Act, Intercoastal
Shipping Act, Carriage of Goods by Sea Act, etc
C. The Basic Idea
1. Shipper (original owner, bailor) of the goods turns them over to the carrier for
 transportation
2. Carrier (issuer) issues a bill of lading to the shipper
a. If the bill is negotiable, carrier (issuer) will not turn over the goods at the destination
until the negotiable bill of lading is surrendered
i. Shipper must send the bill of lading to the person who is to receive the goods
(normally the buyer) before the latter can get possession of the goods
ii. Shipper will not surrender the bill of lading to the buyer until the latter has paid for
the goods (requiring payment against documents)
iii. As soon as buyer pays seller, buyer gets possession of the negotiable bill of lading
and can claim the goods from the carrier
b. If carrier delivers the goods to the buyer w/o demanding surrender of an outstanding
negotiable bill of lading, the carrier has converted the goods and is liable to the
holder of the negotiable bill
D. Form
1. Negotiable
a. Consign: send or hand over goods to another
i. Consignment: K by which send the goods to somebody
ii. Consignor: bailor, frequently seller, shipper
iii. Consignee: entity listed on the bill of lading as the person to get the goods,
frequently buyer
b. Negotiable bill of lading = order bill of lading (b/c of goods are consigned to the
“order of XXX”)
c. Consignor = shipper, consignee = buyer, carrier = issuer = bailee
2. Nonnegotiable
a. Also called straight bill of lading b/c the goods are delivered straight to the consignee
whether or not the nonnegotiable bill is surrendered
3. Shipment under reservation (of title):
a. Frequently the consignor consigns the goods to itself to make it clear that the
consigner is at all times the owner of the goods
i. When buyer pays, seller indorses a negotiable bill over to buyer or, if nonnegotiable
bill is used, issues a delivery order to the carrier telling it to deliver the goods to
buyer
ii. Seller has a SI in the goods until purchase price is paid
iii. Buyer has equitable interest even though the legal title is in the seller
b. 2-509 (1)(a): ROL passes to buyer when the goods are duly delivered to the carrier
even though the shipment is under reservation
c. 2-505 (Seller's Shipment Under Reservation)
i. Where the seller has identified goods to the K by or before shipment:
a) his procurement of a negotiable bill of lading to his own order or otherwise
reserves in him a SI in the goods. His procurement of the bill to the order of a
financing agency or of the buyer indicates in addition only the seller's expectation
of transferring that interest to the person named;
b) a nonnegotiable bill of lading to himself or his nominee reserves possession of
the goods as security but except in a case of conditional delivery (2-
507(2)) a
 nonnegotiable bill of lading naming the buyer as consignee reserves no SI even
though the seller retains possession of the bill of lading.
ii. When shipment by the seller w/ reservation of a SI is in violation of the K for sale it
constitutes an improper K for transportation within the preceding section but
impairs neither the rights given to the buyer by shipment and identification of the
goods to the K nor the seller's powers as a holder of a negotiable document.
4. Problem 246: Homer, of South Bend, IN, the inventor of the 3 dimensional widget,
contracted to sell 5,000 widgets to Ned in Evansville, IN. Homer delivered the goods to
the Overnight Trucking Company, consigning the goods to himself but writing “Notify
Ned on arrival” on the straight bill of lading. Homer mailed the original bill to his cousin
Wilbur, who lived in Evansville, along w/ a delivery order signed by himself and
addressed to Overnight telling it to deliver the goods to Ned. Homer’s cover letter to
Wilbur stated that Wilbur should take the delivery order down to Ned at the store and
turn it over to Ned only if Ned paid Wilbur cash for the goods. Wilbur did present the
delivery order as Homer directed, but Ned was short of funds and could not pay.
Wilbur, confused, mailed all the documents back to Homer w/ a letter saying Ned
would not pay. Meanwhile, the goods arrived at Evansville, and John, Overnight’s truck
driver, had to decide what to do w/ the widgets. Reading the bill of lading, he
discovered that the consignee lived in South Bend and had no address in Evansville.
Then, John noticed that he was to notify Ned, which did have an Evansville address, so
he delivered the widgets to Ned.
a. Was the carrier’s delivery to Ned improper?
i. Yes, “notify to Ned” means to notify, not to deliver, John should have asked
consignor, it’s misdelivery (breach of K and conversion)
ii. 7-303 (Diversion; Reconsignment; Change of Instructions)
a) Unless the bill of lading otherwise provides, the carrier may deliver the goods to
a person or destination other than that stated in the bill or may otherwise
dispose of the goods on instructions from
1. the holder of a negotiable bill; or
2. the consignor on a non-negotiable bill notwithstanding contrary instructions
from the consignee; or
3. the consignee on a non-negotiable bill in the absence of contrary instructions
from the consignor, if the goods have arrived at the billed destination or if the
consignee is in possession of the bill; or
4. the consignee on a non-negotiable bill if he is entitled as against the
consignor to dispose of them.
b) Unless such instructions are noted on a negotiable bill of lading, a person to
whom the bill is duly negotiated can hold the bailee according to the original
terms.
b. If the widgets were destroyed in an auto accident prior to Ned’s refusal to pay, who
would have had the ROL if the K was “F.O.B. truck South Bend”?
i. F.O.B. truck South Bend: ROL passes to the buyer when the goods are duly
delivered to the carrier (2-509(1)(a)) -> ROL was on the buyer b/c it’s a shipment K
even though the shipment was under reservation
ii. 2-509(1): Where the K requires or authorizes the seller to ship the goods by carrier
 a) if it does not require him to deliver them at a particular destination, the ROL
passes to the buyer when the goods are duly delivered to the carrier even though
the shipment is under reservation (2-505); but
b) if it does require him to deliver them at a particular destination and the goods
are there duly tendered while in the possession of the carrier, the ROL passes to
the buyer when the goods are there duly so tendered as to enable the buyer to
take delivery.
iii. 7-309(1): A carrier who issues a bill of lading whether negotiable or non-negotiable
must exercise the degree of care in relation to the goods which a reasonably careful
man would exercise under like circumstances. This subsection does not repeal or
change any law or rule of law which imposes liability upon a common carrier for
damages not caused by its negligence.
c. Would the result w/r/t the ROL or proper delivery change if the bill of lading had
been an order bill (negotiable)?
i. If the bill of lading had been negotiable, the delivery would have been improper b/c
John delivered the goods w/o demanding the surrender of the negotiable bill of
lading
ii. Further, the ROL passes to the buyer on his receipt of the negotiable bill of lading,
so ROL would have been on the seller in this case
iii. 7-403(3): Unless the person claiming is one against whom the document confers no
right under 7-503(1), he must surrender for cancellation or notation of partial
deliveries any outstanding negotiable document covering the goods, and the bailee
must cancel the document or conspicuously note the partial delivery thereon or be
liable to any person to whom the document is duly negotiated
iv. 2-509(b)(ROL in the Absence of Breach): Where the goods are held by a bailee to be
delivered w/o being moved, the ROL passes to the buyer
1. on his receipt of a negotiable document of title covering the goods; or
2. on acknowledgment by the bailee of the buyer's right to possession of the
goods; or
3. after his receipt of a non-negotiable document of title or other written
direction to deliver, as provided in 2-503(4)(b).
5. Problem 247: Blue Skies Air Lines was about to deliver a shipment of frozen fish to the
buyer to whom it was consigned under a straight airbill (nonnegotiable) when the
phone rang. The seller-consignor was on the phone, and she forbade the delivery,
telling Blue Skies to return the fish to her, since she had learned that the buyer is a
bum. If Blue Skies returns the goods to the seller, is it risking liability to the buyer? Yes
a. Seller may stop delivery if buyer is to be insolvent -> stopping delivery b/c “buyer is a
bum” would be improper stoppage (hot issue in litigation), so if the carrier obeys the
unjustified order to stop, he may also be liable to the buyer.
b. The bill of lading is nonnegotiable, so the carrier may deliver the goods to a person
other than that stated in the bill on instructions from the consignor on a
nonnegotiable bill notwithstanding contrary instructions from the consignee
c. 2-705 (Seller's Stoppage of Delivery in Transit or Otherwise)
 i. The seller may stop delivery of goods in the possession of a carrier or other bailee
when he discovers the buyer to be insolvent (2-702) and may stop delivery of
carload, truckload, planeload or larger shipments of express or freight when the
buyer repudiates or fails to make a payment due before delivery or if for any other
reason the seller has a right to withhold or reclaim the goods.
ii. As against such buyer the seller may stop delivery until
a) receipt of the goods by the buyer; or
b) acknowledgment to the buyer by any bailee of the goods except a carrier that
the bailee holds the goods for the buyer; or
c) such acknowledgment to the buyer by a carrier by reshipment or as
warehouseman; or
d) negotiation to the buyer of any negotiable document of title covering the goods.
iii. a) To stop delivery the seller must so notify as to enable the bailee by reasonable
diligence to prevent delivery of the goods.
b) After such notification the bailee must hold and deliver the goods according to
the directions of the seller but the seller is liable to the bailee for any ensuing
charges or damages.
c) If a negotiable document of title has been issued for goods the bailee is not
obliged to obey a notification to stop until surrender of the document.
d) A carrier who has issued a non-negotiable bill of lading is not obliged to obey a
notification to stop received from a person other than the consignor.
d. OC1: Improper stoppage is a breach by the seller if it effectively interferes w/ the
buyer's right to due tender under the section on manner of tender of delivery.
However, if the bailee obeys an unjustified order to stop he may also be liable to the
buyer. The measure of his obligation is dependent on the provisions of the
Documents of Title Art. (Section 7-303). Subsection 3(b) therefore gives him a right
of indemnity as against the seller in such a case.
e. 7-303 hierarchy: holder of negotiable bill -> consignor on a nonnegotiable bill ->
consignee on a nonnegotiable bill (carrier MAY deliver here)
6. Problem 248: Jane, a southern IA, stored 1,000 pumpkins w/ the Pumpkin Warehouse,
located in Des Moines, taking a negotiable warehouse receipt for 500 and a
nonnegotiable receipt for the other 500. She also contracted to sell 700 other pumpkins
to Peter, Sioux City, IA. The terms of the K required her to ship Peter 700 stemless
pumpkins “F.O.B. railroad car Fort Madison, IA (shipment K).” Jane loaded 700
pumpkins on board an IA Pacific Railroad car, at Fort Madison, IA, w/o cutting off the
stems. She received a negotiable bill of lading consigned to her own order and made a
proper K for carriage of the pumpkins to Sioux City. She sold the 1,000 warehouse
pumpkins to Mom’s Pies of Cedar Rapids. She indorsed the negotiable warehouse
receipt over to Mom’s Pies for the 1st 500 stored pumpkins and gave them a
nonnegotiable delivery order for the other 500 stored pumpkins. Before Mom’s Pies
could contact the warehouse, the IA Pacific Railroad train carrying the pumpkins
passed through Des Moines and derailed due to the negligence of the train’s
engineer. The train ran off the track and went through the center of the Pumpkin
Warehouse, destroying all 1,700
 pumpkins. The railroad, of course, going to be liable to whoever took the ROL as to the
pumpkins. Where is the ROL placed for each of the pumpkins transactions
a. 500 pumpkins stored under negotiable warehouse receipt: (goods sold w/o being
moved – 2-509(2))
i. ROL passed to buyer (Mom’s Pies) upon receipt of the negotiable receipt
b. 500 pumpkins stored under nonnegotiable warehouse receipt & nonnegotiable
delivery order:
i. 2-503(4)(b): ROL on the seller until buyer presents nonnegotiable documents and
gets the goods
c. 700 pumpkins transferred under negotiable bill of lading:
i. 2-509(1) applies: ROL passed to buyer when the goods are duly delivered to the
carrier
ii. But, not cut off the stems -> non conforming -> not duly delivered to the carrier ->
ROL remains on seller until cure
d. 2-503(4): Where goods are in the possession of a bailee and are to be delivered w/o
being moved:
i. tender requires that the seller either tender a negotiable document of title covering
such goods or procure acknowledgment by the bailee of the buyer's right to
possession of the goods; but
ii. tender to the buyer of a nonnegotiable document of title or of a written direction to
the bailee to deliver is sufficient tender unless the buyer seasonably objects, and
receipt by the bailee of notification of the buyer's rights fixes those rights as against
the bailee and all third persons; but ROL of the goods and of any failure by the
bailee to honor the nonnegotiable document of title or to obey the direction
remains on the seller until the buyer has had a reasonable time to present the
document or direction, and a refusal by the bailee to honor the document or to
obey the direction defeats the tender.
e. 2-509(2): Where the goods are held by a bailee to be delivered w/o being moved, the
ROL passes to the buyer
i. on his receipt of a negotiable document of title covering the goods; or
ii. on acknowledgment by the bailee of the buyer's right to possession of the goods; or
iii. after his receipt of a non-negotiable document of title or other written direction to
deliver, as provided in 2-503(4)(b).
f. 2-510(1): Where a tender or delivery of goods so fails to conform to the K as to give a
right of rejection the risk of their loss remains on the seller until cure or acceptance.
g. 2-601: if goods fail to conform to K, accept the whole, reject the whole, or accept any
commercial units
h. 2-319(1): Unless otherwise agreed the term F.O.B. (which means "free on board") at a
named place, even though used only in connection w/ the stated price, is a delivery
term under which (a) when the term is F.O.B. the place of shipment, the seller must
at that place ship the goods in the manner provided in Art. 2 (2-504) and bear
the expense and risk of putting them into the possession of the carrier;
E. Misdescription
1. Is the carrier liable for wrong information (misdescription) on the bill of lading if the
shipper furnished the carrier w/ the information?
a. To guard against possible liability for resulting misdescription, the carrier normally
states “SHIPPER’S WEIGHT, LOAD, AND COUNT” on the bill of lading in order to
indicate that the carrier makes no warranties as to these matters
2. 7-301 (Liability for Non-receipt or Misdescription; "Said to Contain"; "Shipper's Load and
Count"; Improper Handling)
a. A consignee of a non-negotiable bill who has given value in good faith or a holder to
whom a negotiable bill has been duly negotiated relying in either case upon the
description therein of the goods, or upon the date therein shown, may recover from
the issuer damages caused by the misdating of the bill or the non-receipt or
misdescription of the goods, except to the extent that the document indicates that
the issuer does not know whether any part or all of the goods in fact were
received or conform to the description, as where the description is in terms of marks
or labels or kind, quantity, or condition or the receipt or description is qualified by
"contents or condition of contents of packages unknown", "said to contain",
"shipper's weight, load and count" or the like, if such indication be true. (exculpatory
languages)
b. When goods are loaded by an issuer who is a common carrier, the issuer must count
the packages of goods if package freight and ascertain the kind and quantity if bulk
freight. In such cases "shipper's weight, load and count" or other words indicating
that the description was made by the shipper are ineffective except as to freight
concealed by packages.
c. When bulk freight is loaded by a shipper who makes available to the issuer adequate
facilities for weighing such freight, an issuer who is a common carrier must ascertain
the kind and quantity within a reasonable time after receiving the written request of
the shipper to do so. In such cases "shipper's weight" or other words of like purport
are ineffective.
d. The issuer may by inserting in the bill the words "shipper's weight, load and count" or
other words of like purport indicate that the goods were loaded by the shipper; and if
such statement be true the issuer shall not be liable for damages caused by the
improper loading. But their omission does not imply liability for such damages.
e. The shipper shall be deemed to have guaranteed to the issuer the accuracy at the
time of shipment of the description, marks, labels, number, kind, quantity,
condition and weight, as furnished by him; and the shipper shall indemnify the issuer
against damage caused by inaccuracies in such particulars. The right of the issuer to
such indemnity shall in no way limit his responsibility and liability under the K of
carriage to any person other than the shipper.
3. Federal Bills of Lading Act §22: If a bill of lading has been issued by a carrier, the carrier
is liable to (a) the owner of the goods covered by a straight bill subject to existing right
of stoppage in transit or (b) the holder of an order bill, for damages caused by the
misdescription or failure to correspond w/ the misdescription
4. GAC Commercial v. Wilson: `
a. Fact: The corporation entered into an accounts receivable financing arrangement w/
 a pulp and paper company. The paper company forwarded copies of its invoices and
bills of lading to the corporation, which then advanced funds to the company. The
company did not repay the loans and later went bankrupt. There were no shipments.
b. Rule: The Federal Bills of Lading Act applied to the 60 interstate shipments. There was
no liability on the railroad as a carrier b/c there were no goods actually shipped, and
therefore there was no owner who could assert a claim against the railroad. An
owner could not be assigned to non-existent goods. The corporation could not assert
claims on the bills of lading for the 2 intrastate shipments b/c it was not a
consignee. The corporation could not circumvent the restrictions of the Act by
filing common law negligence claims.
c. Empty car, fraud, no exculpatory language on the bill of lading
i. Straight bill of lading (nonnegotiable) is not a good security risk b/c it is a mere K
and parties may change the underlying K
d. Under FBLA 22, where a straight bill of lading is involved, GAC is not protected b/c
there are no goods, and hence there can be no owner
i. But 7-301 gives protection on a straight bill to the consignee
ii. 7-102(1)(b): “Consignee” means the person named in a bill to whom or to whose
order the bill promises delivery
e. Both FBLA and 7-301 protect holders by due negotiation of order bills
i. Both acts allow the carrier to disclaim liability under certain circumstances
5. Problem 249: Harry asked Phillip to make out some phony negotiable bills of lading
representing nonexistent shipments by Harry to a buyer in CA. Harry discounted the bill
to ONB and left town. When ONB sued the railroad, the latter defended on the grounds
that the phony bills contain the words “Shipper’s weight, load, and count.” Is this
defense good?
a. No, issuer is liable unless the bill indicate the issuer does not know and that
indication is true
b. 7-301(d) & OC3 to 7-301: “shipper’s weigh, load, and count” language makes the
issuer (carrier) not liable for damages caused by the improper loading (if the goods
were really loaded by shipper)
IV. Due Negotiation
A. The Basic Concept
1. Bona fide purchaser of negotiable documents of title
a. Holder to whom a negotiable document of title has been duly negotiated (7-502): 7-
502 holder
b. Only applies to negotiable documents, excludes nonnegotiable warehouse
receipts/straight bills of lading
c. Holders of nonnegotiable documents of title get no special rights (7-504)
2. Negotiation of a negotiable document of title
a. Indorsement & delivery are necessary: 7-501(1) ~(3)
b. Indorsement of a nonnegotiable document neither makes it negotiable nor adds to
the transferee’s right: 7-501(5)
3. 7-501(4): A negotiable document of title is "duly negotiated" when it is negotiated in the
 manner stated in this section to a holder who purchases it in good faith w/o notice of
any defense against or claim to it on the part of any person and for value, unless it is
established that the negotiation is not in the regular course of business or financing or
involves receiving the document in settlement or payment of a money obligation.
4. Cleveland v. McNabb
a. Issue: was the document duly negotiated when they didn’t check the record?
i. No b/c they had reason to know
b. But courts are split on this issue
i. Commodity Credit Corp. was denied 7-502 holder status b/c it had reason to know
ii. R.E. Huntly Cotton v. Fields: access to information sufficient to put transferees on
notice of claims is immaterial unless D had actual knowledge of facts and
circumstances that would amount to bad faith
5. 7-501 Regular Course of Business or Financing
a. OC1: 2 aspects – person making the transfer & the nature of the transaction itself
b. Is the transferor a person w/ whom it is reasonable to deal as having full powers?
i. Holder whose possession appears, commercially, to be in order is a person in the
trade
c. Is the transaction one which is normally proper to pass full rights w/o inquiry, even
though the transferor himself may not have such rights to pass and even though he
may be acting in breach of duty?
6. 7-502 (Rights Acquired by Due Negotiation)
a. Subject to the following section and to the provisions of 7-205 on fungible goods, a
holder to whom a negotiable document of title has been duly negotiated acquires
thereby:
i. title to the document;
ii. title to the goods;
iii. all rights accruing under the law of agency or estoppel, including rights to goods
delivered to the bailee after the document was issued; and (feeding bill of lading)
iv. the direct obligation of the issuer to hold or deliver the goods according to the
terms of the document free of any defense or claim by him except those arising
under the terms of the document or under Art. 7. In the case of a delivery order
the bailee's obligation accrues only upon acceptance and the obligation acquired
by the holder is that the issuer and any indorser will procure the acceptance of the
bailee
b. Subject to 7-503, title and rights so acquired are not defeated by any stoppage of the
goods represented by the document or by surrender of such goods by the bailee, and
are not impaired even if
i. Any person has been deprived of possession of a negotiable tangible document or
control of a negotiable electronic document by misrepresentation, fraud, accident,
mistake, duress, loss, theft, or conversion; or
ii. A previous sale or other transfer of the goods or document has been made to a 3rd
person
7. Problem 250: Warehouse issues a negotiable warehouse receipt to “bearer ”
which covered 40 drums of oil. The bailor, Bonanza Petroleum, pledged the receipt to
ONB as
 collateral for a $5K loan. While in ONB’s possession, the receipt was stolen by the bank’s
credit manager Claude, who gave it to Al, a disreputable oil products salesman (Al is in
the business). Al presented the receipt at the warehouse, the new agent on duty
delivered the drums to him and returned the receipt to AL. Al sold the drums through
his business and pledged the receipt to ANB as collateral for a $5K loan. When both
banks make demand on the warehouse for the goods, does the warehouse have any
defenses?
a. As for ONB: the document is a bearer paper, so Al is a 7-502 holder.
Warehouse delivered the goods to the bearer of the warehouse receipt, which is
commercially reasonable. So, warehouse is not liable
b. As for ANB: returning the negotiable warehouse receipt to Al was not commercially
reasonable. So, bailee (warehouse) is liable to ANB (7-502 holder) under 7-403(c)(2)
c. 7-403(c)(2): unless a person claiming the goods is a 7-503 holder, the bailee must
cancel the document or bailee is liable to any person to which the document is duly
negotiated
d. 7-404 (No Liability for Good Faith Delivery Pursuant to Receipt or Bill): A bailee who
in good faith including observance of reasonable commercial standards has
received goods and delivered or otherwise disposed of them according to the
terms of the document of title or pursuant to Art. 7 is not liable therefor. This
rule applies even though the person from whom he received the goods had no
authority to procure the document or to dispose of the goods and even though
the person to whom he delivered the goods had no authority to receive them.
B. The 7-503(a) Owner
1. Entrusting Rule
a. 2-403(2): Any entrusting of possession of goods to a merchant who deals in goods of
that kind gives him power to transfer all rights of the entruster to a buyer in ordinary
course of business
b. 2-403(3): “Entrusting” includes any delivery and any acquiescence in retention of
possession regardless of any condition expressed b/w the parties to the delivery or
acquiescence and regardless of whether the procurement of the entrusting or the
possessor’s disposition of the goods have been such as to be larcenous under the
criminal law
2. Problem 251: Albert took his antique grandfather clock down to the Antique Clock Store
to be cleaned. The proprietor assured him it would be ready on Friday. On Thursday,
Betty made the proprietor an offer he couldn’t refuse, so he sold her the clock. Albert
was furious and consults you.
a. Can he replevy the clock from Betty?
i. No b/c Albert entrusted the clock to the merchant who deals w/ this kinds
a) But, here is a factual question: if Betty bought the clock in the course of ordinary
business
ii. Sutton v. Snider: if the owner entrusted the goods to the merchant who dealt in
goods of that kind, the merchant had the legal authority to sell the goods to the
buyer in the ordinary course of business
b. Can he sue the proprietor? Using what theory?
 i. Yes, he can sue the proprietor based on unjust enrichment, conversion, breach of K
c. If the proprietor had stored the clock in a warehouse, received a negotiable
warehouse receipt therefore, and pledged the receipt to LNB in return for a loan,
could Albert retrieve the clock from the warehouse?
i. No, The warehouse receipt confers right in the clock against Albert b/c Albert had a
property interest in the clock before issuance of the warehouse receipt but Albert
entrusted the clock to the store w/ apparent authority to sell it (he does NOT
qualify as 7-503 owner b/c he entrusted the goods to the merchant!)
ii. 7-403(c): the person claiming the goods (Albert) is a person against which the
document of title does not confer a right under 7-503(a) -> 7-403(c) does not apply
iii. 7-502: title and rights acquired by due negotiation are not defeated by any
stoppage of the goods represented by the document of title even if the due
negotiation constituted a breach of duty
iv. 7-503(a): a document of title confers no right in goods against a person that before
issuance of the document had a legal interest . . . in the goods and did not deliver or
entrust the goods to the bailor (proprietor) w/ actual/apparent authority to sell
3. Real defenses against 7-502 holder
a. 7-403(a): proper delivery to a superior claimant, nonnegligent destruction of the
goods, sale to enforce bailee’s lien, any other lawful excuse
b. Superior claimant: 7-503(1) owner who had a legal interest or perfected SI in the
goods prior to the bailee’s issuance of a document of title and who was in no way
responsible for the creation of a situation permitting a negotiable document of title
to come into existence
c. 7-503(a): A document of title confers no right in goods against a person that before
issuance of the document had a legal interest or a perfected SI in the goods and that
did not:
i. deliver or entrust the goods or any document of title covering the goods to the
bailor or the bailor's nominee with:
a) actual or apparent authority to ship, store, or sell;
b) power to obtain delivery under 7-403; or
c) power of disposition under 2-403, 2A-304(2), 2A-305(2), 9-320, or 9-321(c) or
other statute or rule of law; or
ii. acquiesce in the procurement by the bailor or its nominee of any document
d. In summary, if the owner of goods entrusts them (or documents covering them) or
delivers diem to anyone so that that person has the “apparent” authority to deal w/
the goods, the owner is estopped to assert ownership against a subsequent 7-502
holder
e. Where the owner has entrusted and is thus estopped, ownership becomes a
“personal” defense and unassertable against a 7-502 holder
f. But when the owner of the goods has had them stolen by someone other than his
agent, the owner is the very person 7-503(a) was meant to protect
i. 7-503(a) owner has a superior right to the goods even against a 7-502 holder
ii. Ownership is a real defense, and the true owner can force the bailee to turn over
 the goods to 7-503(a) owner w/o surrendering the negotiable document
g. Policy: one of 2 innocent parties must bear a loss
i. If the owner has been even slightly at fault by permitting someone else to have the
goods (and therefore apparent authority to ship or store them) or the documents,
he should bear the loss
ii. If the owner has had the goods stolen by someone not permitted to hold onto the
goods, the owner should be able to trace the goods and recover them even if they
are found in the possession of a bailee
4. Agricredit Acceptance v. Hendrix
a. Fact: Ds cotton merchants filed a motion for summary judgment on P's claim seeking
foreclosure of its SI in the cotton, a writ of possession against anyone in possession of
the cotton, and a finding of conversion and an award of damages against the cotton
merchants, among other things.
b. Hold: A genuine issue of fact existed concerning the merchants' notice of P's claims to
the cotton. In any case, 7-503 expressly provided that EWRs conferred no rights in the
goods covered by the EWRs against SIs existing and perfected prior to the issuance of
the EWR where there had been no entrustment or acquiescence on the part of the
secured party. Lastly, P did not entrust the cotton.
C. Other Transfers
1. 7-504 (Rights Acquired in Absence of Due Negotiation; Effect of Diversion; Stoppage of
Delivery)
a. A transferee of a document of title, whether negotiable or nonnegotiable, to which
the document has been delivered but not duly negotiated, acquires the title and
rights that its transferor had or had actual authority to convey (Shelter Rule)
b. In the case of a transfer of a nonnegotiable document of title, until but not after the
bailee receives notice of the transfer, the rights of the transferee may be defeated:
i. by those creditors of the transferor which could treat the transfer as void under 2-
402 or 2A-308;
ii. by a buyer from the transferor in ordinary course of business if the bailee has
delivered the goods to the buyer or received notification of the buyer's rights;
iii. by a lessee from the transferor in ordinary course of business if the bailee has
delivered the goods to the lessee or received notification of the lessee's rights; or
iv. as against the bailee, by good-faith dealings of the bailee w/ the transferor.
c. A diversion or other change of shipping instructions by the consignor in a
nonnegotiable bill of lading which causes the bailee not to deliver the goods to the
consignee defeats the consignee's title to the goods if the goods have been delivered
to a buyer in ordinary course of business or a lessee in ordinary course of business
and, in any event, defeats the consignee's rights against the bailee
d. Delivery of the goods pursuant to a nonnegotiable document of title may be stopped
by a seller under 2-705 or a lessor under 2A-526, subject to the requirements of due
notification in those sections. A bailee that honors the seller's or lessor's instructions
is entitled to be indemnified by the seller or lessor against any resulting loss or
expense
 2. 7-505: the indorser of a document of title does not make any K that the bailee will
honor the document
3. 7-507 (Warranties on Negotiation or Delivery of Document of Title) If a person
negotiates or delivers a document of title (no need to be negotiable!) for value,
otherwise than as a mere intermediary under 7-508, unless otherwise agreed, the
transferor, in addition to any warranty (Art. 2 warranties) made in selling or leasing the
goods, warrants to its immediate purchaser only that:
a. the document is genuine;
b. the transferor does not have knowledge of any fact that would impair the
document's validity or worth; and
c. the negotiation or delivery is rightful and fully effective w/r/t the title to the
document and the goods it represents.
d. Note: A transferor also makes Art. 2 warranties since a sale of goods is involved
4. Shelter Rules in UCC: 2-403, 3-203(b), 8-301, 7-504(a)
5. Problem 252: The shipping agent for KCMC wrongfully took for himself 90 bales of
cotton that had come under his control and stored them in the Rural Warehouse, which
issued to him a negotiable warehouse receipt. He took this receipt to ONB and
indorsed it over to ONB as security for a loan. KCMC discovered the bales were
missing and the shipping agent was arrested. Shortly thereafter, ONB sold the
warehouse receipt to ANB, which bought the document w/ full knowledge of the above
facts. Both ANB and KCMC made a demand on Rural Warehouse for the cotton. Result?
a. ANB is not a 7-502 holder b/c it had a notice of defense/claim by KCMC, but it gets
rights of 7-502 holder from ONB
b. 7-603 (Conflicting Claims; Interpleader): If more than one person claims title to or
possession of the goods, the bailee is excused from delivery until the bailee has a
reasonable time to ascertain the validity of the adverse claims or to commence an
action for interpleader. The bailee may assert an interpleader either in defending an
action for nondelivery of the goods or by original action.
c. Warehouse may hold delivery until the validity of the adverse claims is ascertained
d. What about KCMC? – their agent delivered the goods, so are not protected
V. Collection Through Banks
A. Payment Against Documents
1. 2-503(5)(b): where the K requires the seller to deliver documents, (b) tender through
customary banking channels is sufficient and dishonor of a draft accompanying the
document constitutes non-acceptance or rejection
2. Where seller and buyer are separated by great distances, seller has an agent (typically a
bank) in the buyer’s city who could present the bill of lading covering the goods to the
buyer but not turn it over to the buyer until cash was paid for the goods
a. Seller (drawer) draws 3-104(e) draft (instruction of payment to the payee (whomever
the seller nominates)) on the buyer (drawee) and attaches it to the bill of lading
3. 3-104(e) draft is combined w/ other papers for delivery to the buyer (bill of lading, sale
invoice, inspection certificate) and indorsed over to the seller’s local bank for collection
4. Eventually, a bank in buyer’s vicinity makes presentment of the draft to the buyer, and
 the buyer must either pay or dishonor
a. Buyer cannot get the documents (especially the bill of lading) until payment, so the
seller is protected from having to trust a buyer in an arm’s length transaction
b. If the buyer dishonors, the seller is notified by the collecting bank and gives
instructions to the bank as to what to do w/ the goods
c. The bank can claim the goods from the carrier b/c it has the bill of lading
5. 4-104(a)(6): “Documentary draft” means a draft to be presented for acceptance or
payment if specified documents, certificated securities (8-102) or instructions for
uncertificated securities (8-102), or other certificates, statements, or the like are to be
received by the drawee or other payor before acceptance or payment of the draft
a. Normal rules for negotiable instruments in Art. 3 and 4 apply
b. Special rules: 4-202(a)(2) – after dishonor, a collecting bank need not return a
documentary draft to its transferor
6. Trade acceptance
a. Under some Ks, it is enough that buyer accept the draft and incur the obligation of
an acceptor (3-413), thus becoming primarily liable on the draft
i. Buyer accepts by writing his signature on the draft
b. Time draft (as opposed to sight draft): require payment in 30, 60 or 90 days after sight
c. 4-212 (Presentment by Notice of Item Not Payable By, Through, or At Bank; Liability
of Drawer or Indorser)
i. Unless otherwise instructed, a collecting bank may present an item not payable by,
through, or at a bank by sending to the party to accept or pay a record providing
notice that the bank holds the item for acceptance or payment. The notice must be
sent in time to be received on or before the day when presentment is due and the
bank must meet any requirement of the party to accept or pay under 3-501 by the
close of the bank's next banking day after it knows of the requirement.
ii. If presentment is made by notice and payment, acceptance, or request for
compliance w/ a requirement under 3-501 is not received by the close of business
on the day after maturity or, in the case of demand items, by the close of business
on the third banking day after notice was sent, the presenting bank may treat the
item as dishonored and charge any drawer or indorser by sending it notice of the
facts.
7. Problem 253: Seller in Dallas signed a sales K to sell 1 ton of tennis balls to Buyer in IN,
“FOB truck in Dallas (shipment K)” $800 to be paid by a 60-day time draft on Buyer.
Seller drew a draft as follows:
To: Beth Buyer
60 days after sight pay to the order of Sam Seller $800.
(signed) Sam Seller
Seller took the tennis balls down to the Texas Trucking Company and asked for a
negotiable bill of lading consigned to his own order, w/ the instructions “notify Buyer on
arrival.” The trucking company issued the negotiable (“order”) bill to Seller.
Seller took the bill of lading, the invoice describing the goods, and the draft on Buyer
down to his local bank LSNB and indorsed both the draft and the bill of lading over to
 LSNB, which then forwarded the draft and the documents to the ISHB for collection.
ISHB called Buyer and Buyer wrote her name diagonally on the draft (which ISHB
dated and kept), and received the other documents.
2-514 (When Documents Deliverable on Acceptance; When on Payment): Unless
otherwise agreed documents against which a draft is drawn are to be delivered to the
drawee on acceptance of the draft if it is payable more than three days after
presentment; otherwise, only on payment
2 days later, the trucking company showed up w/ the goods and notified Buyer of their
arrival. Buyer went down to the truck depot and surrendered the bill of lading,
whereupon she received the tennis balls.
a. Can Buyer inspect the goods? If so, when?
i. 2-513(1): Not until she accepts the draft (she can after accepting the draft)
b. If the tennis balls are defective, can Buyer reject or revoke her acceptance and refuse
to pay?
i. Yes , within a reasonable time after delivery under 2-602(1)
c. If the cartons are empty, can Buyer sue the trucking company, since the bill of lading
states that the goods shipped are “ONE TON TENNIS BALL”?
i. 7-301: Yes b/c the trucking company did not include exculpatory language, they, in
turn, get indemnification from seller
d. Can Buyer sue the collecting bank b/c the documents did not conform to the goods
shipped? No
i. 7-508 (Warranties of Collecting Bank as to Documents of Title): A collecting bank or
other intermediary known to be entrusted w/ documents of title on behalf of
another or w/ collection of a draft or other claim against delivery of documents
warrants by the delivery of the documents only its own good faith and authority
even if the collecting bank or other intermediary has purchased or made advances
against the claim or draft to be collected

CHAPTER 16. LETTERS OF CREDIT

I. Introduction
A. 2 primary sources for the law relating to LOCs
1. Art. 5 of UCC & Uniform Customs and Practice for Documentary Credit (UCP 600)
a. UCP is not significantly different from Art. 5
2. Relationship of Art. 5 to UCP
a. OC2 to 5-103: When UCP is adopted but conflict w/ Art. 5 and except where variation
is prohibited, UCP terms are permissible contractual modifications under 1-302 and 5-
103(c).
i. Normally, Art. 5 should not be considered to conflict w/ practice except when a
rule explicitly stated in UCP or other practice is different from a rule explicitly
stated in Art. 5
II. The Basic Problem
A. Documentary credit
1. Bank that issues the letter of credit (LOC) to the seller is in effect the buyer/consignee
 here
2. Applicant (actual buyer) may pledge assets as collateral in order to have the LOC issued
in favor of the seller (beneficiary/consignor)
3. Confirmer: seller’s local bank may confirm the LOC issued by the issuer bank and
becomes liable in the same fashion as the issuer
a. Issuer becomes the customer of the confirmer and gets reimbursement from it

B. Standby LOC (similar to surety obligation)

1. Issued by a bank to be honored only if there is default in an unrelated K
a. Only requires certificate of default of underlying K
2. Beneficiary is not required to produce any other documents along w/ its draft against
the LOC
3. Beneficiary just gives a written notice of breach
C. Problem 254: US Army wanted to put a penalty clause in a K buying uniforms from Khaki
Clothing, but common law prohibits such clause. So, it required Khaki to get a standby LOC
in favor of Army in which ONB promised to pay a huge penalty sum to Army if Khaki does
not deliver the uniforms on time. Is this allowed?
1. Yes, if you don’t call it “penalty clause”
2. Balboa v. Costal Bank: allowed b/c underlying K is independent from the LOC
3. Telenois v. Village of Schaumburg: clear penalty clause-> invalid
4. 5-103(d)(independence principle): independence of underlying obligation – judged only
by the LOC (cannot bring any facts about underlying obligations)
III. Definitions and Scope of Art. 5
A. Who can issue a LOC?
 1. 5-102(a)(9): “Issuer” means a bank or other person that issues a LOC, but does not
include an individual who makes an engagement for personal, family, or household
purposes
B. Formal requirements
1. 5-104: A LOC, confirmation, advice, transfer, amendment, or cancellation may be issued
in any form that is a record and is authenticated (i) by a signature or (ii) in accordance
w/ the agreement of the parties or the standard practice referred to in 5-108(e)
2. OC3: electronically generated LOCs are clearly allowed
C. Terms (5-102 & 5-108)
1. Clean credits: LOCs not requiring the presentation of documents
2. Beneficiary: person who under the terms of a LOC is entitled to have its complying
presentation honored, including a person to whom drawing rights have been
transferred under a transferable LOC
3. Applicant: person at whose request or for whose account a LOC is issued, including a
person who requests an issuer to issue a LOC on behalf of another if the person making
the request undertakes an obligation to reimburse the issuer
4. Adviser: person who, at the request of the issuer, a confirmer, or another adviser,
notifies or requests another adviser to notify the beneficiary that a LOC has been
issued, confirmed, or amended
5. Confirmer: a nominated person who undertakes, at the request or w/ the consent of
the issuer, to honor a presentation under a LOC issued by another
6. 5-107 (Confirmer, Nominated Person, and Adviser)
a. A confirmer is directly obligated on a LOC and has the rights and obligations of an
issuer to the extent of its confirmation. The confirmer also has rights against and
obligations to the issuer as if the issuer were an applicant and the confirmer had
issued the LOC at the request and for the account of the issuer.
b. A nominated person who is not a confirmer is not obligated to honor or otherwise
give value for a presentation.
c. A person requested to advise may decline to act as an adviser. An adviser that is not
a confirmer is not obligated to honor or give value for a presentation. An
adviser undertakes to the issuer and to the beneficiary accurately to advise the
terms of the LOC, confirmation, amendment, or advice received by that person and
undertakes to the beneficiary to check the apparent authenticity of the request to
advise. Even if the advice is inaccurate, the LOC, confirmation, or amendment is
enforceable as issued.
d. A person who notifies a transferee beneficiary of the terms of a LOC, confirmation,
amendment, or advice has the rights and obligations of an adviser under subsection
(c). The terms in the notice to the transferee beneficiary may differ from the terms in
any notice to the transferor beneficiary to the extent permitted by the LOC,
confirmation, amendment, or advice received by the person who so notifies
7. 5-102(a)(10): “LOC” means a definite undertaking that satisfies the requirements of 5-
104 by an issuer to a beneficiary at the request or for the account of an applicant or, in
the case of a financial institution, to itself or for its own account, to honor a
documentary presentation by payment or delivery of an item of value.
 8. 5-106(a): a LOC is presumed to be irrevocable unless so provided
a. OC1: revocable LOC offers unhappy possibilities for misleading the parties who deal
w/ them
b. 2-325: in sale of goods Ks, a clause requiring a LOC means an “irrevocable” LOC
IV. The Issuer – Duties and Rights
A. 5-108 (Issuer's Rights and Obligations)
1. Except as otherwise provided in 5-109 (fraud), an issuer shall honor a presentation that,
as determined by the standard practice referred to in subsection (e), appears on its face
strictly to comply w/ the terms and conditions of the LOC. Except as otherwise provided
in 5-113 (successor) and unless otherwise agreed w/ the applicant, an issuer shall
dishonor a presentation that does not appear so to comply.
2. An issuer has a reasonable time after presentation, but not beyond the end of the
seventh business day of the issuer after the day of its receipt of documents:
a. to honor,
b. if the LOC provides for honor to be completed more than seven business days after
presentation, to accept a draft or incur a deferred obligation, or
c. to give notice to the presenter of discrepancies in the presentation.
3. Except as otherwise provided in subsection (d), an issuer is precluded from asserting as
a basis for dishonor any discrepancy if timely notice is not given, or any discrepancy not
stated in the notice if timely notice is given. (estoppel, waiver)
4. Failure to give the notice specified in subsection (b) or to mention fraud, forgery, or
expiration in the notice does not preclude the issuer from asserting as a basis for
dishonor fraud or forgery as described in 5-109(a) (fraud) or expiration of the LOC
before presentation. (even if you didn’t give notice, you can use fraud or expiration of
the letter)
5. An issuer shall observe standard practice of financial institutions that regularly issue
LOCs. Determination of the issuer's observance of the standard practice is a matter of
interpretation for the court. The court shall offer the parties a reasonable opportunity
to present evidence of the standard practice.
6. An issuer is not responsible for:
a. the performance or nonperformance of the underlying contract, arrangement, or
transaction, (independence principle)
b. an act or omission of others, or
c. observance or knowledge of the usage of a particular trade other than the standard
practice referred to in subsection (e)
7. If an undertaking constituting a LOC under 5-102(a)(10) contains nondocumentary
conditions, an issuer shall disregard the nondocumentary conditions and treat them as
if they were not stated.
8. An issuer that has dishonored a presentation shall return the documents or hold them
at the disposal of, and send advice to that effect to, the presenter.
9. An issuer that has honored a presentation as permitted or required by Art 5.:
(reimbursement from applicant)
a. is entitled to be reimbursed by the applicant in immediately available funds not later
than the date of its payment of funds; (if issuer honored a presentation that should
 have been dishonored, the issuer cannot get reimbursement from the applicant)
b. takes the documents free of claims of the beneficiary or presenter;
c. is precluded from asserting a right of recourse on a draft under 3-414 (drawer) and 3-
415 (indorser);
d. except as otherwise provided in 5-110 (warranty) and 5-117 (subrogation), is
precluded from restitution of money paid or other value given by mistake to the
extent the mistake concerns discrepancies in the documents or tender which are
apparent on the face of the presentation; (duty of issuer to make sure strict
compliance) and
e. is discharged to the extent of its performance under the LOC unless the issuer
honored a presentation in which a required signature of a beneficiary was forged.
10. Note: if the issuer honors a draft that it should have dishonored, the issuer may not
seek reimbursement from its applicant
a. An issuer in this predicament has a potential remedy in the warranty 5-110
B. Problem 255: At the request of its applicant GCC, LNB issued a LOC to LSC, obligating itself
to pay drafts drawn against it, reflecting steel shipped to GCC under “Invoice #0046.” 2
weeks after the LOC was issued, buyer and seller changed the shipment dates on the
underlying K and issued a new invoice “Invoice #0060.” LSC shipped the steel to GCC as
agreed and was disturbed to learn that buyer had filed for bankruptcy 2 days later.
However, it was assured by the terms of the LOC. On Friday, Mar. 27, it submitted a draft
to LNB, accompanied by Invoice #0060, and was turned down for payment on April 1.
1. Label the parties
a. Issuer: LNB
b. Beneficiary: LSC
c. Applicant: GCC
2. What is the effect of the bank holding onto the presented draft until April 1?
a. 5-108(b): issuer may hold the presented draft for a reasonable time not exceeding 7
business days
3. Remembering the doctrine of de minimis non curat lex, LSC attorney argued that it
substantially complied w/ the LOC, so the bank was guilty of wrongful dishonor and out
to respond in damages under 5-111. Is this right?
a. No, beneficiary must strictly comply w/ the terms of the LOC (the bank is not
supposed to be involved w/ the underlying transaction), LNB need not pay to LSC
b. Dubose Steel v. Branch Banking & Trust: although applicant and beneficiary agreed
to a change in order, issuer was not informed of change, so not liable on the LOC
when beneficiary presented invoices that did not comply w/ the terms of the LOC
4. Does the seller have any other remedy?
a. 2-702(b): where buyer has received goods on credit while insolvent, seller may
reclaim the goods upon demand made within 10 days after buyer’s receipt of the
goods
b. Bankruptcy Code 546(c): seller may reclaim the goods by demanding in writing within
45 days after buyer’s receipt of the goods
5. What should LSC have done to avoid all this?
a. 5-106(b): should have obtained consent from the issuer bank when buyer and seller
 made a change to the K (should have got amendment to the LOC!)
6. UCP 600 does not have the strict compliance rule: data in a document need not be
identical to, but must not conflict with, data in the LOC
C. Voest-Alpine v. Bank of CN
1. Fact
a. The price dropped after making the K, buyer wants out of the K
b. There are clerical errors and typos and issuer bank refused to honor the LOC due to
the errors
2. Hold: Issuer was supposed to file a timely notice of rejection w/ the reasons. The spirit
of the agreement was of importance rather than any technical misspellings or slight
errors in the LOC. Therefore, the court held in favor of P.
a. Mirror image rule rejected by the court
b. Flagship test rejected by the court: they merely recognize that variance b/w
documents specified an documents submitted is not fatal if there is no possibility that
the documents could mislead the paying bank to its detriment
c. ROL test rejected by the court: no ostensible harm to applicant
d. Court adopted UCP 500 test: consistency b/w the LOC and the document presented
to the issuer
3. Note
a. This case was decided under UCP 500 (strict compliance requirement is less markedly
pronounced than UCC). Under UCC, would the court have reached the same result?
Yes
i. 5-103(d): rights and obligations of an issuer to beneficiary/nominated person are
independent of the existence, performance, nonperformance of a K out of which
the LOC arises
ii. 5-108(a): issuer shall honor a presentation that appears on its face “strictly” to
comply w/ the terms and conditions of the LOC
iii. OC3 to 5-102: issuer’s obligation to honor in “strict compliance in accordance w/
standard practice” were changed to “reasonable compliance” by use of the “fair
dealing” standard
iv. OC1 to 5-108: standard of strict compliance governs the issuer’s obligation to the
beneficiary/applicant. The documents themselves must appear on their face
strictly to comply and other terms of the LOC must be strictly complied with
b. As to the waiver issue, see 5-108(c)
c. Banks issuing LOCs do not charge a great deal and therefore should be exposed to a
minimum risk (commercial reasonableness is important!)
4. Problem 256: Assume in Problem 255 that the LOC has required that the bill of lading
be given not to GCC (applicant) but to LNB. Assume that LSC has completely complied
w/ all of the terms of the credit, but LNB, knowing of applicant’s bankruptcy, wrongfully
refuses to pay the credit as agreed.
a. Must LSC resell the steel involved in this transaction immediately, or may it wait,
hoping LNB will change its mind and pay what it owes?
i. 5-111(a): Beneficiary (LSC) need not take action to mitigate damages (it may recover
 the amount that is subject of the dishonor and incidental damages, but not
consequential damages)
ii. Policy: independence principle – parties are not supposed to be involved w/ the
underlying transaction
b. If it does resell, does that reduce the amount it can claim as damages from LNB?
i. 5-111(a): Yes, if beneficiary mitigates damages by resale, the recovery from the
issuer must be reduced by the amount of damages avoided
5. Problem 257: At the request of its applicant, ONB issued an irrevocable LOC to
beneficiary Crook. The credit’s terms required a bill of lading showing that the goods
were loaded on board the S.S. Titanic by April 1, 2014. Crook drew up a phony bill of
lading and presented it along w/ a draft on the bank to the issuer and ONB paid the
draft.
a. Can ONB collect from its applicant? Yes
i. Policy reasons:
a) Argument: risk should be on the applicant b/c applicant chose to do the
business w/ that beneficiary
b) Counter argument: risk should be on the issuer (bank w/ expertise & money)
ii. 5-108(a): issuer shall honor presentation if it appears to strictly comply w/ the
terms of the LOC
iii. 5-108(i): issuer that has honored a presentation is entitled to be reimbursed by
the applicant
iv. 5-110 (Warranties)
a) If its presentation is honored, the beneficiary warrants:
1. To the issuer, any other person to whom presentation is made and the
applicant that there is no fraud or forgery of the kind described in 5-109(a);
and
2. To the applicant that the drawing does not violate any agreement b/w the
applicant and the beneficiary or any other agreement intended by them to be
augmented by the LOC
b) The warranties in (a) are in addition to warranties arising under Art. 3, 4, 7 and
8 b/c of the presentation or transfer of documents covered
v. 5-111: if issuer wrongfully dishonors, it is subject to liability
vi. 5-117: issuer that honors a beneficiary’s presentation is subrogated to the rights of
the beneficiary and of the applicant
b. Could the applicant use the 5-110 warranties to sue the beneficiary?
i. Yes, beneficiary breached the warranty of 5-110 (no fraud/forgery + no violation of
underlying K) to applicant
6. Problem 258: LT hired WCC to build a new company headquarters, requiring a standby
LOC of $80K to be paid if WCC failed to keep to the required schedule for completion of
the building. At WCC’s request, LNB issued such a credit in favor of LT, payable according
to the terms of the credit “on (i) default by WCC in meeting the attached completion
schedule (nondocumentary condition) and (ii) the beneficiary’s presentation of an
affidavit to that effect along w/ a draft drawn on us for $80K (documentary condition).”
WCC dutifully performed its contractual duties, but LT sent the required draft and
 affidavit to LNB, wrongfully asserting that WCC had missed timely completion of a part
of the project. LNB paid the draft w/o investigating the truth of the assertions in the
affidavit and now seeks reimbursement from applicant WCC.
a. Can WCC resist paying under the theory that LNB did not verify the default as the
LOC required?
i. No, WCC’s default is a non-documentary condition, so the issuer shall disregard
non-documentary conditions in a LOC
a) Policy reason: risk is on the applicant, issuer only need examine documents
(independence principle)
ii. 5-108(g): If an undertaking constituting a LOC under 5-102(a)(10) contains
nondocumentary conditions, an issuer shall disregard the nondocumentary
conditions and treat them as if they were not stated.
iii. OC9: where the nondocumentary conditions are central and fundamental to the
issuer’s obligation, their inclusion may remove the undertaking from the scope of
Art. 5 entirely. Even though nondocumentary conditions must be disregarded in
determining compliance of a presentation, an issuer that has promised its
applicant that it will honor only on the occurrence of those nondoocumentary
conditions may have liability to its applicant for disregarding the conditions
iv. White & Summers: where the documents commit the issuer to assess facts and
events outside the documents presented, they disable the independence principle
and topple the wall that separates presented documents from beneficiary-
applicant disputes
b. If WCC has gone bankrupts since the bank honored the draft, can LNB (issuer) pursue
LT (beneficiary) to get its money back?
i. Yes, LT breached 5-110(a)(1) warranty (no fraud/forgery warranty) to LNB, and LNB
is NOT precluded from restitution b/c issuer’s dishonor was not caused by mistake
concerning apparent discrepancies of the documents
ii. 5-108(i)(4): An issuer that has honored a presentation is precluded from restitution
of money paid or other value given by mistake to the extent the mistake concerns
discrepancies in the documents or tender which are apparent on the face of the
presentation
a) Policy reason: to respect beneficiary’s reliance on the final payment
iii. 5-110(a)(1): if its presentation is honored, beneficiary warrants to the
issuer/applicant that there is no fraud or forgery
c. How quickly must it act?
i. 5-115: within 1 yr after expiration date of the relevant LOC or 1 yr after the claim
for relief/cause of action accrues, whichever occurs later (a claim for relief/cause of
action accrues when the breach occurs, regardless of the aggrieved party’s lack of
knowledge of the breach)
V. Fraud
A. Sztejn v. J. Henry Schroder Bank
1. Fact: P (maker of a LOC) sought to restrain the payment of drafts under a LOC. P argued
that the documents accompanying the drafts were fraudulent. D collecting bank argued
 it was only concerned w/ the documents, and on its face, they conformed to the
requirements of the LOC.
2. Hold: D was not a HDC, but was a mere agent for collection. Where the seller's fraud
had been called to a bank's attention, before the drafts and documents had been
presented for payment, the principle of the independence of the bank's obligation
under the LOC should not be extended to protect an unscrupulous seller. When the
issuer of a LOC knew that a document, although correct in form, was false or illegal,
it could not be called upon to recognize such a document as complying w/ the terms of
a LOC.
B. Is Sztejn still good law? Yes, Sztejn has been codified in 5-109
1. 5-109 (Fraud and Forgery)
a. If a presentation is made that appears on its face strictly to comply w/ the terms and
conditions of the LOC, but a required document is forged or materially fraudulent, or
honor of the presentation would facilitate a material fraud by the beneficiary on the
issuer or applicant:
i. the issuer shall honor the presentation, if honor is demanded by (i) a nominated
person who has given value in good faith and w/o notice of forgery or material
fraud, (ii) a confirmer who has honored its confirmation in good faith, (iii) a HDC of
a draft drawn under the LOC which was taken after acceptance by the issuer or
nominated person, or (iv) an assignee of the issuer's or nominated person's
deferred obligation that was taken for value and w/o notice of forgery or material
fraud after the obligation was incurred by the issuer or nominated person; and
(where innocent parties involve, issuer shall honor)
ii. the issuer, acting in good faith, may honor or dishonor the presentation in any
other case (may honor or dishonor where the presentation is made by non-
innocent beneficiary)
b. If an applicant claims that a required document is forged or materially fraudulent or
that honor of the presentation would facilitate a material fraud by the beneficiary on
the issuer or applicant, a court of competent jurisdiction may temporarily or
permanently enjoin the issuer from honoring a presentation or grant similar relief
against the issuer or other persons only if the court finds that:
i. the relief is not prohibited under the law applicable to an accepted draft or
deferred obligation incurred by the issuer;
ii. a beneficiary, issuer, or nominated person who may be adversely affected is
adequately protected against loss that it may suffer b/c the relief is granted;
iii. all of the conditions to entitle a person to the relief under the State law have been
met; and
iv. on the basis of the information submitted to the court, the applicant is more likely
than not to succeed under its claim of forgery or material fraud and the person
demanding honor does not qualify for protection under subsection (a)(1)
2. Mid-America Tire v. PTZ: the LOC is independent of the underlying K unless a fraud is so
extensive as to vitiate the entire transaction
3. 5-109(a)(1): if the draft is held by a HDC, issuer of LOC is not allowed to allege the
defense of fraud
 C. Problem 259: Just as ONB was about to honor a draft drawn on it by the beneficiary of its
LOC, the applicant called and demanded that ONB dishonor the draft b/c the beneficiary
was guilty of “out-and-out fraud” on the underlying transaction b/w them. The documents
presented along w/ the draft exactly match the terms of the credit, and ONB officials are
sure that there is no fraud in the documents.
1. What should ONB do?
a. Under 5-109(a)(2), Issuer may honor or dishonor the presentation if it is in good faith
b/c the presentation is made by beneficiary (innocent parties listed in 5-109(a)(1) are
not involved here)
i. Then how should ONB decide whether to honor or not? Business decision – if
issuer wrongfully dishonors, issuer is subject to liability under 5-111
b. 5-108: issuer shall honor a presentation that appears on its face strictly to comply w/
the terms and conditions of the LOC
c. 5-109(a): If a presentation is made that appears on its face strictly to comply w/ the
terms and conditions of the LOC, but honor of the presentation would facilitate a
material fraud by the beneficiary on the applicant, (1) the issuer shall honor the
presentation if honor is demanded by a nominated person , confirmer, HDC or
assignee of issuer or nominated person’s deferred obligation (for value, in good faith,
w/o notice); and (2) issuer, acting in good faith, may honor or dishonor the
presentation in any other case
d. Emery-Waterhouse v. Rhode Island Hosp. Trust Natl. Bank: punitive damages of
$1,397K awarded against beneficiary who fraudulently drew against a LOC
2. If ONB dishonors the draft and this causes the beneficiary to lose millions of dollars on
the underlying transaction, is ONB ever liable for more than the amount of the LOC?
a. 5-111: the amount that is the subject of the dishonor + incidental damages (but not
consequential damages) + reasonable attorney’s fees and other expenses of litigation
3. If the issuer bank honors the draft, applicant has 2 causes of action against the
beneficiary: underlying obligation and 5-110(a)(2) warranty
D. Intrinsic Values v. Superintendencia De Administratcion
1. Fact: The agency entered into a K w/ the corporation, which the latter breached. A
Guatemalan court issued an injunction barring payment on LOCs issued for the
corporation's benefit.
2. Hold: Honoring payment would facilitate a material fraud by the corporation. Payment
on the LOC was properly enjoined to effectuate the Guatemala injunction.
3. Note: in deciding the liability of an issuer who refuses to honor a credit, courts have
placed great emphasis on the real reason the issuer wants out
a. If the applicant is bankrupt (no reimbursement by the applicant to the issuer): courts
will stretch to hold the issuer liable
i. b/c fear of applicant insolvency was the very reason the seller wanted a LOC in the
beginning
b. if honoring will violate 5-108: issuer’s conduct is more likely to receive favorable
treatment from the court
VI. Assignment
A. Beneficiary of a LOC can assign proceeds of a LOC
1. But can’t assign beneficiary’s drawing rights or documents presented by the beneficiary
B. Problem 260: ONB issued a $50K LOC to GG of NY, payable to GG on presentation of a
draft and certain documents demonstrating shipment of clothing to OW, the bank’s
applicant. GG needed money to finance its operations, so it borrowed $30K from MSB,
giving MSB a SI in the proceeds of the LOC, and assigning the right to those proceeds
to MSB, which promptly notified ONB of the assignment. GG had trouble filling the OW
order, so those 2 parties agreed to lower the amount shipped and the price to $10K
worth of clothing, and the LOC was amended (by ONB) to reflect this lower amount.
When the clothing was shipped and the draft presented under the LOC, ONB was only
willing to pay $10K to MSB. What are MSB’s rights here?
1. Assignee’s right has been be changed by the original parties agreement to amend the
LOC, so MSB is entitled to $10K only (the collateral is not worth $30K and GG still owes
the deficiency to MSB)
2. 5-114 (Assignment of Proceeds)
a. In this section, “proceeds of a LOC” means the cash, check, accepted draft, or other
item of value paid or delivered upon honor or giving of value by the issuer or any
nominated person under the LOC. The term does not include a beneficiary's drawing
rights or documents presented by the beneficiary.
b. A beneficiary may assign its right to part or all of the proceeds of a LOC. The
beneficiary may do so before presentation as a present assignment of its right to
receive proceeds contingent upon its compliance w/ the terms and conditions of the
LOC.
c. An issuer or nominated person need not recognize an assignment of proceeds of a
LOC until it consents to the assignment.
d. An issuer or nominated person has no obligation to give or withhold its consent to an
assignment of proceeds of a LOC, but consent may not be unreasonably withheld if
the assignee possesses and exhibits the LOC and presentation of the LOC is a
condition to honor.
e. Rights of a transferee beneficiary or nominated person are independent of the
beneficiary's assignment of the proceeds of a LOC and are superior to the assignee's
right to the proceeds.
f. Neither the rights recognized by this section b/w an assignee and an issuer,
transferee beneficiary, or nominated person nor the issuer's or nominated person's
payment of proceeds to an assignee or a third person affect the rights b/w the
assignee and any person other than the issuer, transferee beneficiary, or nominated
person. The mode of creating and perfecting a SI in or granting an assignment of a
beneficiary's rights to proceeds is governed by Art. 9 or other law. Against persons
other than the issuer, transferee beneficiary, or nominated person, the rights and
obligations arising upon the creation of a SI or other assignment of a beneficiary's
right to proceeds and its perfection are governed by Art. 9 or other law.
3. 5-106 (Issuance, Amendment, Cancellation, and Duration)
a. A LOC is issued and becomes enforceable according to its terms against the issuer
 when the issuer sends or otherwise transmits it to the person requested to advise or
to the beneficiary. A LOC is revocable only if it so provides.
b. After a LOC is issued, rights and obligations of a beneficiary, applicant, confirmer, and
issuer are not affected by an amendment or cancellation to which that person has
not consented except to the extent the LOC provides that it is revocable or that the
issuer may amend or cancel the LOC w/o that consent.
c. If there is no stated expiration date or other provision that determines its duration, a
LOC expires one yr after its stated date of issuance or, if none is stated, after the date
on which it is issued.
d. A LOC that states that it is perpetual expires 5 yrs after its stated date of issuance, or
if none is stated, after the date on which it is issued.
4. OC2 to 5-106: When there is a partial transfer, both the original beneficiary and the
transferee beneficiary have an interest in performance of the LOC and each expects
that its rights will not be altered by amendment unless it consents
VII. Subrogation
A. Principal - (K1) - Creditor – (K2) - Surety – (K3) - Principal:
1. subrogation gives surety who paid (K2) the right of creditor (K1) against principal (which
is likely to be a better right against principal (K3))
B. 5-117 (Subrogation of Issuer, Applicant, and Nominated Person)
1. An issuer that honors a beneficiary's presentation is subrogated to the rights of the
beneficiary to the same extent as if the issuer were a secondary obligor of the
underlying obligation owed to the beneficiary and of the applicant to the same extent
as if the issuer were the secondary obligor of the underlying obligation owed to the
applicant.
2. An applicant that reimburses an issuer is subrogated to the rights of the issuer against
any beneficiary, presenter, or nominated person to the same extent as if the applicant
were the secondary obligor of the obligations owed to the issuer and has the rights of
subrogation of the issuer to the rights of the beneficiary stated in subsection (a).
3. A nominated person who pays or gives value against a draft or demand presented
under a LOC is subrogated to the rights of:
a. the issuer against the applicant to the same extent as if the nominated person were a
secondary obligor of the obligation owed to the issuer by the applicant;
b. the beneficiary to the same extent as if the nominated person were a secondary
obligor of the underlying obligation owed to the beneficiary; and
c. the applicant to same extent as if the nominated person were a secondary obligor of
the underlying obligation owed to the applicant.
4. Notwithstanding any agreement or term to the contrary, the rights of subrogation
stated in subsections (a) and (b) do not arise until the issuer honors the LOC or
otherwise pays and the rights in subsection (c) do not arise until the nominated person
pays or otherwise gives value. Until then, the issuer, nominated person, and the
applicant do not derive under this section present or prospective rights forming the
basis of a claim, defense, or excuse.
C. Problem 261: Scrooge was the sole shareholder of S & M, a corporation that sold coal. In
early 2009, the corporation signed a $2M K to buy mineral rights in a new coal tract in PA
 from Frederick Bean, the owner of the land, agreeing that he would allow S & M to mine
the coal in the summer of 2009, sell it to others, and then pay $2M to Bean. In the
meantime, S & M signed a promissory note for this amount payable to Bean, guaranteed
personally by Scrooge, due June 1, 2010. Bean also required S & M to get a standby LOC in
his favor for the amount of $2M payable if the corporation defaulted on its promissory
note. The corporation had DNB issue such a LOC, w/ Bean as the beneficiary. The
transaction went as planned until the market for coal collapsed after S & M had mined
the Bean tract and found itself unable to sell that coal at a profit. When the promissory
note was not paid when it came due in 2010, Bean drew a draft on DNB under the LOC.
DNB has this draft in hand and calls you. S & M has just filed for bankruptcy, and has no
assets
1. Must DNB pay the LOC?
a. Yes if the presentation strictly complies w/ the terms of the LOC (bankruptcy of
applicant cannot be the reason to dishonor)
2. If it does so, can it subrogate itself to Bean (beneficiary)’s rights against Scrooge
(applicant)?
a. 5-117(a): Yes, issuer that honors a beneficiary’s presentation is subrogated to the
rights of the beneficiary and of the applicant
3. Can it go after Scrooge before it pays Bean’s draft?
a. 5-117(d): No, the rights of subrogation do not arise until the issuer honors the LOC

PART 4. SECURED TRANSACTIONS

CHAPTER 17. INTRODUCDTION TO SECURED TRANSACTIONS
I. Basic definitions
A. Terms
1. Unsecured creditor: creditor who has no interest in the collateral
B. Lien: interest in the debtor’s property given by the law to protect a creditor
1. Consensual lien: debtor voluntarily grants such an interest
a. Mortgage: consensual lien taken in the debtor’s real property (Art. 9 does not apply)
i. Must file the mortgage in real property record
b. Personal property lien (SI): consensual lien in personal property or fixtures (governed
by Art. 9)
2. Judicial lien: involuntary lien arising from judicial proceedings (not self-executing)
a. Creditor sues, recovers judgment, sends sheriff out to seize D’s property
3. Statutory lien: involuntary lien imposed by a statute or the common law in favor of
certain creditors
a. Liens given to landlords, to artisans repairing personal property, a host of others
(ostlers, innkeepers, attorneys)
b. Examples
i. mechanic’s lien: statutory lien in favor of those who perform construction work
ii. federal tax lien: statutory lien that reaches all of the taxpayer’s property
iii. artisan’s lien: when you have your car fixed at garage
C. Hierarchy of creditors under prior statutes
1. Bona fide purchaser (BFP) in the ordinary course of business
 2. Creditors w/ perfected SIs (before the filing of the bankruptcy)
a. Beat out the bankruptcy trustee & judicial lien creditor
b. Win over non-BFPs: general creditors including
i. creditors w/o perfected SIs
ii. creditors whose SIs were perfected later in time
iii. creditors w/ no SIs at all (general creditors: corner grocer, family doctor, etc)
3. Bankruptcy trustee
a. represents all of the bankrupt’s unsecured creditors
b. §544(a) of BC (strong arm clause): as of the date of the filing of the bankruptcy
petition, the trustee is conclusively presumed to occupy the legal position of a judicial
lien creditor who has levied on all of the bankrupt’s property
i. Fictitious status of judicial lien holder
4. Secured creditors whose SIs are unperfected at the moment of the filing of the
bankruptcy petition
a. lose the right to claim the collateral
b. If a creditor’s claim to the property survives the attack of the bankruptcy trustee, the
creditor’s SI (lien) is said to be perfected
5. General creditors
D. How is a creditor’s SI perfected?
1. Depends on the nature of the collateral, technical steps required by the statutes or the
courts
II. Bankruptcy (federal law)
A. Bankruptcy Reform Act of 1978 (Bankruptcy Code: BC)
1. Ch. 7: straight bankruptcy (pure liquidation proceeding)
a. Vast majority of bankruptcies
b. Over 90% filed by individuals
2. Ch. 11: reorganization proceeding for business
3. Ch. 12: reorganization proceeding for farmers
4. Ch. 13: debt repayment plan for individuals
B. Sketch of proceedings in straight bankruptcy
1. BC §301 Voluntary Bankruptcy – debtor files a petition w/ bankruptcy court
a. Debtor files lists (schedules) showing assets and creditors (some property is
exempted and returned to the bankrupt)
2. BC §303 Involuntary Bankruptcy – creditors file a petition. Debtor is forced into
bankruptcy (Ch 7 & 11 proceedings). If debtor has less than 12 creditors, then 1 creditor
can file the petition. If more than 12, then 3 need to file.
a. BC §362 Automatic Stay (debtor’s best friend) – Once petition is filed, anyone
attempting to collect on a debt must cease.
3. BC §341 Meeting – the 1st meeting creditors are summoned to where they elect a
trustee to gather up debtor’s property, sell it, and represent the creditors’
interests in the distribution proceeding. If other people claim the property, trustee
may have to litigate the issue
4. Overall Goal to Obtain a Discharge of Debt – Bankrupt then petitions bankruptcy judge
 for a discharge (forgiveness) of all scheduled debts so that bankrupt’s life can be
resumed financially unburdened. W/ some exceptions, bankrupts usually receive a
discharge from most (not all) debts.
a. See BC §522 Exemptions – debtor can claim these for self
5. Trustee’s Goal to Make the Estate BIG – When trustee gathers the estate’s property, he
either can surrender the encumbered collateral to the secured creditors, or he can elect
to sell it, perfected creditors get their debts paid off 1st from the proceeds.
Unencumbered assets are also sold to pay for the proceeding, and, from whatever is
left, the general creditors are paid off last.
a. Validity (perfection) of SI is a matter of State law. If the SI is finally determined to be
unperfected, the interest is destroyed, and the creditor becomes a general creditor.
b. Note: In most bankruptcies the unsecured creditors receive NOTHING!
6. BC §547 Preferences – many payments made by an insolvent debtor to an existing
creditor w/in 90 days of the filing date are void as preferences. Trustee can recover the
payment from the preferred creditor.
a. E.g. On Jan. 1, A owed B, C, and D $1,000 each. On May 1, A paid B $1,000 and next
day filed a voluntary petition in bankruptcy. Trustee can recover payment made to B
for fairness to C and D.
III. Pre-code Security Devices
A. Benedict v. Ratner (USSC, 1925)(NO longer good law)
1. Facts: Hub Carpet received several loans from D. D in return got a lien (assignment) on
all past and future accounts receivable. Unless the lien was foreclosed upon, all
indications of ownership in the accounts were to be retained by Hub. No records of the
lien were made. Hub soon thereafter filed for bankruptcy. P, the bankruptcy trustee,
filed an action to void the lien as a “preferential transfer.” The problem was that the
debtor had ownership of the collateral.
2. Reasoning: Bankruptcy allows a trustee to void pre-filing fraudulent transfers (this is
determined by state law). Here, NY law declared as fraudulent a lien on an unrecorded
SI in property, when the transferor retained apparent possession. (fraudulent
concealment of lien)
3. Rule: When a person files for bankruptcy and then gives a lien on accounts to a creditor
but retains ownership of the goods, the lien is voidable in bankruptcy.
4. NOTE:
a. The holding in Ratner did NOT survive the enactment of Art. 9.
i. 9-205 & OC2: a FS should be filed to give notice to ALL other creditors (and the rest
of the world) that the property is encumbered by a lien.
ii. 2-402: creditor of the seller may treat a sale or an identification of goods to a K for
sale as void if as against him a retention of possession by the seller is fraudulent
except in good faith and current course of trade by a merchant-seller for a
commercially reasonable time after a sale or identification is not fraudulent
b. This case was about the secret lien that other creditors do not know about, which
was not enforced by the court in order to prevent other creditors from being hurt
c. The court indicated methods by which the lien would have survived the trustee’s
 attack.
i. Creditor is required to police the debtor’s conduct (record the mortgage, pay over
collections to the creditor, etc)
5. Methods to get around the problems in Ratner are as follows:
a. Permit creditor to have physical possession of the property (pledge) when the
collateral is tangible
B. Pledge (Hypothecation)
1. Pledgor (debtor) gives physical possession of the collateral to pledge (creditor) until the
debt is paid
a. No need to file a FS b/c no secret lien problem
2. Possession perfects the creditor’s interest in the collateral even against the bankruptcy
trustee
3. 2 drawbacks
a. Only tangible (physical & easily stored) objects can be pledged
b. For some types of collateral (e.g., machines used in manufacturing), debtor needs to
keep possession -> need non-possessory SI
C. Chattel Mortgage
1. Mortgage given by mortgagor (debtor) to the mortgagee (creditor)
2. Recorded in a designated place and indexed under the name of the debtor so that other
potential creditors could check and see whether the collateral was encumbered
D. Conditional Sale
1. Problem 262: John sold Nancy a used car for $900, to be paid off in 3 payments of $300
each, by an oral K. Nancy missed the 2nd payment and John repossessed the car. Nancy
sued John for conversion. Who should win?
a. Nancy wins b/c 2-702(2) does not apply here (Nancy is not insolvent). John has to
have a SI in order to repossess. Otherwise, it is a conversion. Don’t repossess w/o a
valid SI
b. 2-702(2): where the seller discovers that the buyer has received goods on credit
while insolvent he may reclaim the goods upon demand made within 10 days
after the receipt, but if misrepresentation of solvency has been made to the
particular seller in writing within 3 months before delivery, the 10 day limitation
does not apply. Except as provided in this subsection, the seller may not base a right
to reclaim goods on the buyer’s fraudulent or innocent misrepresentation or
solvency or of intent to pay
2. 3 circumstances when the unpaid seller may repossess
a. When 2-702 (seller’s right to reclaim) applies
b. When buyer has specifically granted seller a SI in the object sold
c. When seller (judgment creditor, judicial creditor, lien creditor) sues, recovers
judgment, and has the sheriff seize the property as part of the execution of the
seller’s judgment
3. Chattel mortgage
a. Prior to UCC, seller could take a chattel mortgage in the property sold and file to
record the interest
4. Conditional sale
a. Buyer got possession of the property but seller reserved full and complete title to it
 until buyer paid in full
b. In many states, seller’s title was treated as nothing more than an unperfected SI
c. 9-202 (Title to Collateral Immaterial) Art. 9 applies whether title to collateral is in the
secured party or the debtor
d. In most states, seller’s interest in conditional sale had to be filed to be perfected
5. Effect of seller’s retention of title
a. 2-401(1): Any retention or reservation by the seller of the title (property) in goods
shipped or delivered to the buyer is limited in effect to a reservation of a SI
b. 1-201(37): Unless a consignment is intended as security, reservation of title
thereunder is not a “SI”, but a consignment in any event is subject to the provisions
on consignment sales (2-326).
E. Trust Receipt (codified Uniform Trust Receipts Act): typically done in automobile sales
(repealed)
1. Car dealer asks bank to buy cars from manufacturer
2. Bank turns them over to dealer after
a. Bank filed a notice in the appropriate place announcing its intention to engage in
trust receipt financing w/ this particular dealer; and
b. Dealer signed a trust receipt (thereby becoming a trustee, bank was called an
entruster), acknowledging receipt of the vehicles and granting bank a SI therein
3. As the cars were sold, bank’s interest was paid off, and when paid in full, the trust
receipt was cancelled
4. Problems
a. Sale out of trust: dealer did not remit the proceeds of the car sales as required by the
agreement, which often happened if the bank failed to police the debtor’s activities
F. Factor’s Lien (repealed)
1. Originally meaning of “factor” – any selling agent (wholesaler or retailer) who helped
finance the principal’s business
2. Current meaning – financing entity who loaned money against inventory the
manufacturer put up as collateral
3. When a factor was granted a lien (a SI) in the inventory, this SI had to be filed, in order
to be perfected
4. Drawback
a. Not a floating lien – not extend to new additions to the inventory (after-acquired
property)
b. New SA and a filing of the SI for the after-acquired property necessary
G. Field Warehousing
1. When the collateral is too big to be conveniently left in the creditor’s possession, debtor
stores the goods in a warehouse and the warehouse company issue a negotiable
warehouse receipt made out to bearer.
2. Warehouse receipt takes the place of the goods
3. Receipt is pledged to the creditor in return for the loan of money
a. Possession of a negotiable document of title (warehouse receipt or bill of lading)
perfected the creditor’s SI
 4. Field warehouse: if the goods are too bulky to move easily, field warehouseman goes to
the goods, stakes them out in some way, issues a warehouse receipt therefor, and
guards them
a. Even the debtor is not supposed to be able to get to the goods
H. Art. 9 replaced all these devices w/ new rules

CHAPTER 18. THE SCOPE OF ARTICLE 9

I. SI Defined
A. 1-203 (Lease Distinguished from SI)
1. Whether a transaction in the form of a lease creates a lease or SI is determined by the
facts of each case.
2. A transaction in the form of a lease creates a SI if the consideration that the lessee is to
pay the lessor for the right to possession and use of the goods is an obligation for the
term of the lease and is not subject to termination by the lessee, and: (1) the original
term of the lease is equal to or greater than the remaining economic life of the goods;
(2) the lessee is bound to renew the lease for the remaining economic life of the goods
or is bound to become the owner of the goods; (3) the lessee has an option to renew
the lease for the remaining economic life of the goods for no additional consideration
or for nominal additional consideration upon compliance w/ the lease agreement; or
(4) the lessee has an option to become the owner of the goods for no additional
consideration or for nominal additional consideration upon compliance w/ the lease
agreement.
3. A transaction in the form of a lease does not create a SI merely b/c: (1) the present
value of the consideration the lessee is obligated to pay the lessor for the right to
possession and use of the goods is substantially equal to or is greater than the fair
market value of the goods at the time the lease is entered into; (2) the lessee assumes
ROL of the goods;
(3) the lessee agrees to pay, w/r/t the goods, taxes, insurance, filing, recording, or
registration fees, or service or maintenance costs; (4) the lessee has an option to renew
the lease or to become the owner of the goods; (5) the lessee has an option to renew
the lease for a fixed rent that is equal to or greater than the reasonably predictable fair
market rent for the use of the goods for the term of the renewal at the time the option
is to be performed; or (6) the lessee has an option to become the owner of the goods
for a fixed price that is equal to or greater than the reasonably predictable fair market
value of the goods at the time the option is to be performed.
4. Additional consideration is nominal if it is less than the lessee's reasonably predictable
cost of performing under the lease agreement if the option is not exercised. Additional
consideration is not nominal if: (1) when the option to renew the lease is granted to the
lessee, the rent is stated to be the fair market rent for the use of the goods for the term
of the renewal determined at the time the option is to be performed; or (2) when the
option to become the owner of the goods is granted to the lessee, the price is stated to
be the fair market value of the goods determined at the time the option is to be
performed.
5. The "remaining economic life of the goods" and "reasonably predictable" fair market
rent, fair market value, or cost of performing under the lease agreement must be
 determined w/ reference to the facts and circumstances at the time the transaction is
entered into.
B. 9-109(a)[General scope of Art. 9] Except as otherwise provided in subsections (c) and (d)
(exemptions), Art. 9 applies to:
1. a transaction, regardless of its form (even if it is called conditional sale!), that creates a
SI in personal property or fixtures by K;
2. an agricultural lien;
3. a sale of accounts, chattel paper, payment intangibles, or promissory notes;
4. a consignment;
5. a SI arising under 2-401 (title), 2-505 (goods being shipped), 2-711(3) (possessory SI), or
2A-508(5) (corresponding to 2-711(3)), as provided in 9-110; and
6. a SI arising under 4-210 or 5-118
C. 9-109(b): Art. 9 does not apply to mortgage (but applies to promissory notes)
D. Problem 263: A state statue gives someone doing repairs a possessory artisan’s lien on
the property repaired. Baker took his car into Mack’s Garage for repair but couldn’t pay
the full bill, and Mack wouldn’t let him have the car back.
1. Is Mack’s artisan’s lien an Art. 9 SI?
a. No, this is a statutory artisan’s lien and Art. 9 does not apply to statutory liens
b. 9-109(d)(2): Art. 9 does not apply to a lien, other than an agricultural lien, given by
statute or other rule of law for services or materials
2. If, prior to the repair work, Baker signed a statement giving Mack’s Garage a right to
repossess the car if the bill wasn’t paid, does this agreement create a SI under UCC?
a. Yes, it is consensual now
b. 9-109(a)(1): Art. 9 applies to a transaction, regardless of its form, that creates a SI in
personal property or fixtures by K
E. Problem 264: Farmer Brown’s Fresh Vegetables Roadside Stand sold all of its accounts
receivable to NFC, which notified the customers that henceforth all payments should be
made directly to NFC. (Note that this is not a loan from the finance company to the farmer
w/ the accounts put up as collateral; it is an outright sale. If it were a loan, and if the
collectible accounts exceeded the amount of the loan, the excess would be returned to
Farmer Brown; in an actual sale, NFC can keep the surplus. If it were a loan, NFC would
have to return the surplus to Farmer Brown. See 9-608(b)).
1. Is this sale nonetheless an Art. 9 “SI”? Yes
a. 9-109(a)(3): Art. 9 applies to a sale of accounts, chattel paper, payment intangibles,
or promissory notes
2. If so, even though Farmer Brown has no further obligations to NFC, he would of
necessity be termed an Art. 9 “debtor.”
a. 9-102(a)(28)(B): “debtor” means a seller of accounts, chattel paper, payment
intangibles, or promissory notes
3. Then NFC would have to file an Art. 9 FS to perfect its interest against later parties. Why
would UCC drafters have brought an outright sale of accounts (and chattel paper,
payment intangibles, and promissory notes) under the coverage of Art. 9?
a. To prevent secret liens like in Ratner. Interests in accounts are hard to discover w/o
 public notice procedure b/c Farmer (debtor) seems to be the real owner of the
goods, but there is no public record to show the lien by the secured party (NFC -
creditor) -> exactly an Art. 9 matter
4. If a business transaction w/ no apparent loan or collateral may still fall within Art. 9, the
creditor had better have taken whatever steps Art. 9 requires for perfection
II. Consignments
A. True consignment
1. Marketing procedure by which the owner of the goods (consignor) sends (consigns)
them to a retailer (consignee) for sale to the public
2. Consignee is the selling agent or a bailee w/ the ability to sell the bailor’s goods, and
does not buy the goods (no sale)
3. If consignee cannot sell them, they are returned to consignor
B. Advantage to consignor
1. Consignor retains control over the terms of the retail sale
2. At common law, there is no requirement that the consignor file a notice anywhere
announcing that a consignment is going on
a. At common law, consignors were able to reclaim the consigned goods from the
inventory of the consignee over the objections of the consignee’s other creditors
C. Problem
1. Retailer appears to be the unfettered owner of goods in inventory that actually belong
to consignor
2. Retailer’s creditors cannot check whether some or all of the inventory is actually held
on consignment
a. In a true consignment, consignee’s creditors can’t seize the consigned inventory
D. Disguised consignments (Art. 9 applies)
1. Sales on credit (i.e., secured transactions)
2. To escape the filing requirements
3. If the retailer must pay for the goods whether or not able to resell them, this is not a
true consignment, but the creation of a SI in goods
4. If a SI s intended, not a true consignment
a. 9-102(a)(20)(D): “Consignment” means a transaction, regardless of its form, in which
a person delivers goods to a merchant for the purpose of sale and the transaction
does not create a SI that secures an obligation
E. Some true consignments (under 9-102(a)(20)) governed by Art. 9 while others outside UCC
1. 9-102(a)(20): "Consignment" means a transaction, regardless of its form, in which a
person delivers goods to a merchant for the purpose of sale and:
a. the merchant:
i. deals in goods of that kind under a name other than the name of the person
making delivery;
ii. is not an auctioneer; and
iii. is not generally known by its creditors to be substantially engaged in selling the
goods of others; (Art. 9 governs)
b. w/r/t each delivery, aggregate value of the goods is $1,000 or more at the time of
 delivery;
c. the goods are not consumer goods immediately before delivery; and
d. the transaction does not create a SI that secures an obligation.
2. Pawn shop: pawn shop sales are not governed by Art. 9 b/c it is generally known to be
engaged in selling the goods of others (although pawn shop sale is a true consignment)
a. Not governed by Art. 9, but by the common law rules
F. Problem 265: Antiques R Us was the largest antiques store in the city, well known as a
place where antique dealers could hire out space and exhibit their wares, w/ the store
handling the sales and taking a commission on each one and returning to the dealers
items that remained unsold. When the store takes out a loan from ONB and uses as
collateral “all its property,” will the bank’s SI reach the items in the store that belong to
the dealers if the dealers have never taken the steps required of consignors under Art. 9?
1. No b/c ARU is generally known to be substantially engaged in selling the goods of others
(so, consignor doesn’t have to take Art. 9 steps)
2. 9-102(a)(20)(A)(iii): "Consignment" means a transaction, regardless of its form, in which
a person delivers goods to a merchant for the purpose of sale and the merchant is not
generally known by its creditors to be substantially engaged in selling the goods of
others;
G. In re Fabers
1. Facts: P, a dealer in oriental carpets, delivered carpets to D, a carpet retailer.
Agreement provided that the carpets remained the property of P until sold, and
that the funds received from any sale was also the P’s property. While the carpets
were in D’s possession, D filed for bankruptcy.
2. Rule: A consignor of goods may be unable to reclaim his goods upon the consignee’s
bankruptcy.
3. Outcome: P admittedly did not file any type of Art 9 FS. Also, D was not generally known
by its creditors to sell goods on consignment. Therefore, the carpets were subject to the
claims of D’s creditors, who had perfected their SIs, and were beyond the reach of P to
reclaim.
H. Problem 266: When Luke, an artisan who handcrafted his wares, finished creating a large
jeweled sword, he took it down to WOW, a large gun and weapon dealer, which mostly
sold items that it either manufactured itself or bought from other dealers around the
globe. The sword was appraised as being worth over $25K. Luke asked WOW to sell the
sword for him. Is this an Art. 9 consignment so that Luke needs to take Art. 9 steps to
protect himself from WOW’s other creditors who have an interest in the store’s inventory?
1. Yes, Luke would need to file b/c WOW is a merchant not generally known as a consignor
III. Leases EXAM QUESTION GOOD FIRST PARAGRAPH
A SECURITY INTEREST ATTACHES WHEN YOU HAVE THESE
THREE THINGS THAT OCCUR.
1. AN AGREEMENT
2. VALUE PASSES
 3. THE DEBTOR OBTAINS RIGHTS IN THE COLLATEROL OR
THE POWER TO TRANSFER RIGHTS IN THE COLLATERAL.
REPEAT IT EXACTLY LIKE THIS. PAGE 829
FILING, PROTECTING, WHOLE WORLD ON NOTICE TO CLAIM
TO THAT COLLATERAL.

DIFFERENCE BETWEEN LEASE AND SALE

B. Problem 267: BIG Machines leased a duplicating machine to Connie’s Print Shop. The lease
was for 5 yrs, and the rental payments over this period exactly equaled the current market
price of the machine (this factor is not determinative under 1-203(c)). The lease K further
provided that at the end of the 5 yrs, Connie might purchase the machine outright by
paying BIG $5. BIG did not file an Art. 9 FS. Thereafter, Connie borrowed money from
ONB and signed a SA w/ the bank granting it an interest in all of Connie’s “equipment.”
ONB duly perfected its SI by filing a FS in the appropriate place. When Connie failed to
repay the loan, ONB seized all the equipment, including the duplicating machine. In the
lawsuit ONB v. BIG, who gets the machine?
1. ONB gets the machine b/c the lease is a disguised SI (the lessee can become the owner
for little consideration at the end of the lease period) governed by Art. 9 but the
secured party (BIG) did not file an Art. 9 FS
C. 1-203 (true lease v. disguised sale)
1. If at the end of the lease period, the lessee becomes the owner of the property for little
or no consideration, a secured transaction and not a lease (nominal consideration test –
1-203(b)(3))
2. If the K contains a clause that permits the lessee to terminate the lease at any time and
return the leased goods, a true lease (1-203(b))
3. If the lease is for the entire economic life of the leased goods, w/ or w/o renewal, a
disguised sale (junk pile test – 1-203(b)(1))
D. Problem 268: BC leased a massive copier from Copies for a 5 yr period. At the outset of
the lease, the copier had a fair market value of $300K and a predicted 10 yr useful life.
Over the course of the 5 yr lease, the rental payments would total to $330K. The lease
provides that BC has the option to become the owner of the copier at the end of the 5 yr
period by paying Copies $10K.
1. Is this a true lease?
a. Yes b/c the lease is not for the entire economic life of the copier and the lessee needs
to pay a substantial amount ($10K) to be the owner at the end of the lease period
i. You may argue that $10K is not a significant amount compared to the market value
($300K) of the copier
2. Would we reach a different result if the copier’s useful life were only 5 yrs?
a. Yes, this would be a disguised sale (creation of SI governed by Art. 9)
E. In re Architectural Millwork of Virginia
 1. Facts: Before filing bankruptcy, Architectural, the debtor and the D, entered into a truck
leasing agreement w/ Associates, P. The agreement was for the lease of a truck w/ a
final adjustment clause that required the sale of the truck at the end of lease.
Agreement determined the residual value of the truck to be $9,625. D also entered
into a 2nd agreement regarding a forklift w/ the option to buy it for $1 after all
scheduled payments were made (looks like a disguised sale!). D filed bankruptcy and P
filed suit in hopes that Court would require D to pay for the purchase of the truck.
(consumer transaction is regulated by the federal government)
2. Rule: A lease agreement is intended as a SA where it gives lessee an option to become
owner of the property for nominal consideration upon completion of the lease term
and is intended as a true lease where the consideration is not nominal.
3. Outcome:
a. Forklift agreement should be a SA. Truck agreement is less clear. The final
adjustment clause in the K for the truck was simply an option for D to purchase the
truck at the end of the lease.
b. D was obligated to pay full value of consideration under the lease. But, although an
option was created to purchase the truck for the residual value ($9,625), this
purchase would not be considered nominal value given that the full cost of the
truck was
$38,500. Thus, the transaction fails as a SI and the truck agreement was a true lease.
F. 9-505(b) [Effect of FS under subsection (a)] filing or compliance is not of itself a factor in
determining whether the collateral secures an obligation.
IV. Other Transactions
A. Problem 269: When Mercy Hospital’s administrators decided to build a new addition, they
hired a general contractor named Crash Construction and required it to get a surety to
guarantee the performance of the construction job and the payment of all the workers
and material suppliers to avoid a mechanic’s lien on the hospital. Standard Surety issued
such a performance and payment bond covering Crash’s obligation to Mercy Hospital. To
finance the construction, Crash borrowed money from ONB and gave as collateral the
right to collect the progress payments from Mercy Hospital as they came due. ONB duly
filed an Art. 9 FS. Halfway through the job, Crash went bankrupt, and Standard Surety had
to finish and pay off the EEs and suppliers. At this point, by virtue of the common
law right to subrogation, Standard Surety claimed a superior right to unpaid monies
retained by Mercy Hospital, which were to be paid to Crash. ONB also claimed this fund,
pointed to its filed SI, and stated that Standard Surety’s subrogation right was only an
unfiled Art. 9 SI. Who should win?
Mercy Hospital (Creditor) – Crash (Principal/Art. 9 debtor to ONB) – Standard Surety (surety:
common law right of subrogation against Mercy Hospital)
ONB (Art. 9 creditor to Crash) COMMON LAW AND EQUITABLE OUTSIDE OF TITLE 9. YOU
CAN FILE MULTIPLE FINANCING AT MANY PLACES.

1. Surety (Standard Surety) wins b/c it has superior rights against the contractor’s secured
creditors (ONB), common law equitable right of subrogation trumps Art. 9. (this is no
more an issue – settled)
 2. New Mexico State Highway and Transp. Dept. v. Gulf Ins. Co.: a surety that issued
performance and payment bonds and then satisfied claims against the contractor by
paying laborers and materialmen has superior rights as against the contractor’s secured
creditors to final progress payments and regained funds held by the project owner
V. Exclusions from Art. 9 (subsections (c) and (d))
A. 9-109(c): [Extent to which Art. does not apply] Art. 9 does not apply to the extent that:
1. a statute, regulation, or treaty of the US preempts Art. 9 (ship mortgages, aircraft titles,
patents and copyrights, railroad equipment interstate commercial vehicles)
2. another statute of this State expressly governs the creation, perfection, priority, or
enforcement of a SI created by this State or a governmental unit of this State;
(automobiles)
3. a statute of another State, a foreign country, or a governmental unit of another State or
a foreign country, other than a statute generally applicable to SIs, expressly governs
creation, perfection, priority, or enforcement of a SI created by the State, country, or
governmental unit; or
4. the rights of a transferee beneficiary or nominated person under a LOC are
independent and superior under 5-114
B. 9-109(d): [Inapplicability of Art.] Art. 9 does not apply to:
1. a landlord's lien, other than an agricultural lien;
2. a lien, other than an agricultural lien, given by statute or other rule of law for services
or materials, but 9-333 applies w/r/t priority of the lien; (artisan’s liens for goods to
be repaired & mechanic’s liens for real property and supply materials)
3. an assignment of a claim for wages, salary, or other compensation of an EE;
4. a sale of accounts, chattel paper, payment intangibles, or promissory notes as part of a
sale of the business out of which they arose;
5. an assignment of accounts, chattel paper, payment intangibles, or promissory notes
which is for the purpose of collection only;
6. an assignment of a right to payment under a K to an assignee that is also obligated to
perform under the K;
7. an assignment of a single account, payment intangible, or promissory note to an
assignee in full or partial satisfaction of a preexisting indebtedness;
8. a transfer of an interest in or an assignment of a claim under a policy of insurance,
other than an assignment by or to a health-care provider of a health-care-insurance
receivable and any subsequent assignment of the right to payment, but 9-315 and
9-322 apply w/r/t proceeds and priorities in proceeds;
9. an assignment of a right represented by a judgment, other than a judgment taken on a
right to payment that was collateral; (handled by the common law or other statute)
10. a right of recoupment or set-off, but:
a. 9-340 applies w/r/t the effectiveness of rights of recoupment or set-off against
deposit accounts; and
b. 9-404 applies w/r/t defenses or claims of an account debtor;
11. the creation or transfer of an interest in or lien on real property, including a lease or
rents thereunder, except to the extent that provision is made for:
 a. liens on real property in 9-203 and 9-308;
b. fixtures in 9-334;
c. fixture filings in 9-501, 9-502, 9-512, 9-516, and 9-519; and
d. SAs covering personal and real property in 9-604;
12. an assignment of a claim arising in tort, other than a commercial tort claim, but 9-315
and 9-322 apply w/r/t proceeds and priorities in proceeds; or
13. an assignment of a deposit account (i.e. checking account) in a consumer transaction,
but 9-315 and 9-322 apply w/r/t proceeds and priorities in proceeds.
C. Federal Statutes
1. UCC applies to the extent that the federal statute does not answer the problem
presented
2. Most federal statutes (except IRC) do not cover the field and are supplemented by Art.
9
3. US v. Kimbell Foods (USSC 1979): as a matter of federal law, the relative priority of
private consensual liens arising in favor of US is to be decided under non-discriminatory
state law unless a federal statute clearly provides otherwise
4. Ship mortgages, aircraft titles, patents and copyrights, railroad equipment, and some
interstate commercial vehicles are, in part, governed by federal statutes
5. Certain federal statutes may void some SIs
a. Truth in Lending Act 125 destroys any SI taken in a consumer’s home as part of a
credit transaction if the credit seller does not notify the consumer of a 3-day right to
rescind the K
6. Philko Aviation v. Shacket (USSC 1983)
a. Facts: Ps purchased an airplane from Smith. Ps did not record their purchase w/ the
FAA as required by law. Smith gave possession of the aircraft to Ps and subsequently
entered into a fraudulent transaction wherein he sold the aircraft to D who recorded
the sale w/ the FAA.
b. Rule: One who purchases an airplane but does not record the sale w/ the FAA will
have inferior title to a subsequent purchaser. (same applies for trains and RR system)
c. Outcome: All transfers of aircraft must be registered w/ the FAA to have priority over
subsequent purchasers for value. Congress intended the FAA to serve as a central
clearing-house for all transactions involving transfers of aircraft and all state
regulations to the contrary in this field are preempted. Here, Ps did not record their
transaction w/ the FAA. D had superior title to the aircraft than Ps b/c he recorded
the transaction w/ the FAA.
d. Note: retrial – second purchaser still lost b/c of failure to investigate suspicious
circumstances
D. Landlord’s Lien and Other Statutory Liens
1. 9-109(d)(1) & (2) exclude statutory liens from Art. 9
2. Problem 270: When Christopher opened his bookshop, he signed a lease agreement
providing that all of the inventory would be subject to a lien in the landlord’s favor and
could be seized and sold if he defaulted in the rent payments. Is the landlord’s lien
required to be perfected under Art. 9?
 a. Yes b/c this lien is a consensual lien arising out of K. Art. 9 applies to a transaction,
regardless of its form, that creates a SI in personal property by K
E. Wage Assignments
1. 9-109(d)(3): Art. 9 does not apply to an assignment of a claim for wages, salary, or other
compensation of an EE
a. Some states absolutely prohibit the assignment of future wages
b. some permit them in limited circumstances if ER consents
c. some states require the consent of both ER and the spouse
2. Problem 271: Carl was an independent insurance agent who sold policies for many
companies, though his primary sales were the life and automobile policies of MIA. In
order to float a loan to buy a car, Carl gave the lending bank a SI in “all present and
future commissions earned or to be earned” from MIA. Does Art. 9 cover this
assignment?
a. Yes b/c he is an independent contractor (≠ EE) and commissions ≠ wages
F. Non-Financing Assignments
1. 9-109(d)(4) ~ (7) exclude all assignments of a non-financing nature (transfers of
accounts, chattel paper, payment intangibles, and promissory notes) in bulk sale b/c
deception of later parties is small
2. Problem 272: When Bean sold her lucrative art business to Gabriel, she sold not only all
the tangible assets but her outstanding accounts receivable as well. (this is a bulk sale)
a. Must the buyer take the steps required by Art. 9 of a secured party? No
i. 9-102(a)(72)(D): “secured party” means a person to which accounts, chattel paper,
payment intangibles, or promissory notes have been sold
ii. 9-109(d)(4): Art. 9 does not apply to a sale of accounts, chattel paper, payment
intangibles, or promissory notes as part of a sale of the business out of which they
arose (otherwise, sale of accounts is typically covered by Art. 9)
b. If Bean received a commission to paint the portrait of the city’s mayor but decided
she was too busy to perform the task and transferred the job (w/ the right to the
payment for it) to another artist, must the new artist take Art. 9 steps? No
i. 9-109(d)(6): Art. 9 does not apply to an assignment of a right to payment under a K
to an assignee that is also obligated to perform under the K (also delegation of a
duty of performance)
c. When one of Bean’s clients refused to pay for a delivered painting, Bean sold the
account to Trash Collection Agency. Must Trash comply w/ Art. 9? No
i. 9-109(d)(5): Art. 9 does not apply to an assignment of accounts, chattel paper,
payment intangibles, or promissory notes which is for the purpose of collection
only
d. Presented by her art supplies store for payment of her outstanding tab, Bean
transferred to the store the money due her from a client whose portrait she had
painted the month before. Must the art supplies store take Art. 9 steps? No
i. 9-109(d)(7): Art. 9 does not apply to an assignment of a single account, payment
intangible, or promissory note to an assignee in full or partial satisfaction of a
preexisting indebtedness
G. Real Estate
1. Except for fixtures, real estate SIs are not covered by Art. 9
 2. What happens when the paperwork creating them (mortgage itself and promissory
note the debtor signs) is used as security when the mortgagee itself seeks a loan?
(Then Art. 9 applies)
3. Problem 273: LLC needed to borrow money and ONB agreed to loan it the requisite
amount, taking into ONB’s possession as collateral the real property mortgages and
accompanying promissory notes given to LLC by its borrowers. Need ONB do anything
either in the real property recording office or under Art. 9 to protect its interest in this
collateral?
a. Art. 9 does NOT apply to creation of the real property mortgage, but DOES apply to
the transfer of the promissory note
b. 2 ways to perfect a SI in promissory notes
i. Filing a FS for the mortgage record; OR
ii. Taking possession of the promissory note
a) Security follows the debt – if you take possession of the promissory note, you
don’t have to perfect SI for the mortgage record
c. 9-109(d)(11): Art. 9 does not apply to a right of recoupment or set-off, but 9-340
applies w/r/t the effectiveness of rights of recoupment or set-off against deposit
accounts and 9-404 applies w/r/t defenses or claims of an account debtor
d. 9-109(b): [SI in secured obligation] the application of Art. 9 to a SI in a secured
obligation is not affected by the fact that the obligation is itself secured by a
transaction or interest to which Art. 9 does not apply
e. OC7 to 9-109: O borrows $10K from M and secures its repayment obligation,
evidenced by a promissory note, by granting to M a mortgage on O’s land. Art. 9 does
not apply to the creation of the real property mortgage. However, if M sells the
promissory note to X or gives a SI in the note to secure M’s own obligation to X, Art. 9
applies to the SI thereby created in favor of X
f. 9-203(g): [Lien securing right to payment] The attachment of a SI in a right to payment
or performance secured by a SI or other lien on personal or real property is also
attachment of a SI in the SI, mortgage, or other lien
g. 9-308(e): [Lien securing right to payment] Perfection of a SI in a right to payment or
performance also perfects a SI in a SI, mortgage, or other lien on personal or real
property securing the right
H. Other Exclusions
1. Problem 274: ONB issues Connie a credit card. As collateral for the credit card debts,
ONB took a SI in all items she purchased using the card, as well as in her personal
checking account w/ ONB. (this is PMSI)
a. Does Art. 9 apply to ONB’s rights in this account? No
i. 9-109(d)(13): Art. 9 does not apply to an assignment of a deposit account in a
consumer transaction, but 9-315 and 9-322 apply w/r/t proceeds and priorities in
proceeds
b. Would Art. 9 apply if she used her consumer bank account as collateral for a business
loan?
i. Yes b/c 9-109(d)(13) is only for consumer transaction (Art. 9 applies to business
 transactions)

CHAPTER 19. THE CREATION OF A SECURITY INTEREST

CLASSIFYING THE COLLATERAL EASIER QUESTIONS.
I. Classifying the Collateral: determined by debtor’s announced use of the collateral
A. 9-102(a)(12): “Collateral” means the property subject to SI or agricultural lien. The term
includes:
1. Proceeds to which a SI attaches;
2. Accounts, chattel paper, payment intangibles, and promissory notes that have been
sold; and
3. Goods that are the subject of a consignment
B. Goods (9-102(a)(44)): all things that are movable when a SI attaches. The term includes (i)
fixtures, (ii) standing timber that is to be cut and removed under a conveyance or K for
sale,
(iii) the unborn young of animals, (iv) crops grown, growing, or to be grown, even if the
crops are produced on trees, vines, or bushes, and (v) manufactured homes. The term also
includes a computer program embedded in goods and any supporting information
provided in connection w/ a transaction relating to the program if (i) the program is
associated w/ the goods in such a manner that it customarily is considered part of the
goods, or (ii) by becoming the owner of the goods, a person acquires a right to use
the program in connection w/ the goods. The term does not include a computer
program embedded in goods that consist solely of the medium in which the program is
embedded. The term also does not include accounts, chattel paper, commercial tort
claims, deposit accounts, documents, general intangibles, instruments, investment
property, LOC rights, LOCs, money, or oil, gas, or other minerals before extraction.
1. Consumer goods(9-102(a)(23)): goods that are used or bought for use primarily for
personal, family, or household purposes.
2. Equipment (9-102(a)(33)): goods other than inventory, farm products, or consumer
goods
a. Catchall category for any goods that do not fit into the other 3 goods categories
b. Ex) a person engaging in farming operation uses his daughter’s phony as collateral –
this is equipment!
i. buyers in the ordinary course of business takes inventory free of SI, while buyers in
the ordinary course of business takes equipment subject to SI
ii. so, when in doubt, take all the steps to perfect your SI
3. Farm Products (9-102(a)(34)): goods, other than standing timber, w/r/t which the
debtor is engaged in a farming operation and which are:
a. crops grown, growing, or to be grown, including:
i. crops produced on trees, vines, and bushes; and
ii. aquatic goods (fish) produced in aquacultural operations;
b. livestock, born or unborn, including aquatic goods produced in aquacultural
operations;
c. supplies used or produced in a farming operation; or
d. products of crops or livestock in their unmanufactured states (raw milk is a farm
 product, processed milk is not)
4. Inventory (9-102(a)(48)): goods, other than farm products, which:
a. are leased by a person as lessor;
b. are held by a person for sale or lease or to be furnished under a K of service;
c. are furnished by a person under a K of service; or
d. consist of raw materials, work in process, or materials used or consumed in a business
C. Quasi-Tangible Property (pieces of paper used as collateral) DO NOT SAY QUASI-
TANGIBLE PROPERTY
1. Instruments (9-102(a)(47) & 3-104): a negotiable instrument or any other writing that
evidences a right to the payment of a monetary obligation, is not itself a SA or lease,
and is of a type that in ordinary course of business is transferred by delivery w/ any
necessary indorsement or assignment. The term does not include (i) investment
property, (ii) LOCs, or (iii) writings that evidence a right to payment arising out of the
use of a credit or charge card or information contained on or for use w/ the card.
a. Non-negotiable instruments also qualify as instruments here
2. Investment Property (stock and bonds and rights to accounts containing the same) (9-
102(a)(49)): a security, whether certificated or uncertificated, security entitlement,
securities account, commodity contract, or commodity account.
3. Documents (warehouse receipts and bills of lading) (9-102(a)(30) & 1-201(15)): a
document of title or a receipt of the type described in 7-201(2)
a. "Document of title" includes bill of lading, dock warrant, dock receipt, warehouse
receipt or order for the delivery of goods, and also any other document which in the
regular course of business or financing is treated as adequately evidencing that the
person in possession of it is entitled to receive, hold and dispose of the document
and the goods it covers. To be a document of title a document must purport to be
issued by or addressed to a bailee and purport to cover goods in the bailee's
possession which are either identified or are fungible portions of an identified mass.
4. Chattel Paper (9-102(a)(11)): a record or records that evidence both a monetary
obligation and a SI in specific goods, a SI in specific goods and software used in the
goods, a SI in specific goods and license of software used in the goods, a lease of
specific goods, or a lease of specific goods and license of software used in the
goods. In this paragraph, "monetary obligation" means a monetary obligation secured
by the goods or owed under a lease of the goods and includes a monetary obligation
w/r/t software used in the goods. The term does not include (i) charters or other Ks
involving the use or hire of a vessel or (ii) records that evidence a right to payment
arising out of the use of a credit or charge card or information contained on or for use
w/ the card. If a transaction is evidenced by records that include an instrument or
series of instruments, the group of records taken together constitutes chattel paper
D. Intangible Property (property having no significant physical form) DO NOT SAY
INTANGIBLE PROPERTY ON EXAM
1. Accounts (9-102(a)(2)): means a right to payment of a monetary obligation, whether or
not earned by performance, (i) for property that has been or is to be sold, leased,
licensed, assigned, or otherwise disposed of, (ii) for services rendered or to be
rendered,
 (iii) for a policy of insurance issued or to be issued, (iv) for a secondary obligation
incurred or to be incurred, (v) for energy provided or to be provided, (vi) for the use or
hire of a vessel under a charter or other contract, (vii) arising out of the use of a credit
or charge card or information contained on or for use w/ the card, or (viii) as winnings
in a lottery or other game of chance operated or sponsored by a State, governmental
unit of a State, or person licensed or authorized to operate the game by a State or
governmental unit of a State. The term includes health-care-insurance receivables. The
term does not include (i) rights to payment evidenced by chattel paper or an
instrument, (ii) commercial tort claims, (iii) deposit accounts, (iv) investment property,
(v) LOC rights or LOCs, or (vi) rights to payment for money or funds advanced or sold,
other than rights arising out of the use of a credit or charge card or information
contained on or for use w/ the card.
a. Health-Care-Insurance-Receivables (9-102)(a)(46)): an interest in or claim under a
policy of insurance which is a right to payment of a monetary obligation for health-
care goods or services provided.
b. Outright loans of money is NOT account
2. Commercial Torts Claims (9-102(a)(13)): "Commercial tort claim" means a claim arising
in tort w/r/t which:
a. the claimant is an organization; or
b. the claimant is an individual and the claim:
i. arose in the course of the claimant's business or profession; and
ii. does not include damages arising out of personal injury to or the death of an
individual.
3. Deposit Accounts (9-102(a)(29)): a demand, time, savings, passbook, or similar account
maintained w/ a bank. The term does not include investment property or accounts
evidenced by an instrument.
4. LOCs Rights (9-102(a)(51)): a right to payment or performance under a LOC, whether or
not the beneficiary has demanded or is at the time entitled to demand payment or
performance. The term does not include the right of a beneficiary to demand payment
or performance under a LOC.
5. General Intangibles (9-102(a)(42)): any personal property, including things in action,
other than accounts, chattel paper, commercial tort claims, deposit accounts,
documents, goods, instruments, investment property, LOC rights, LOCs, money, and oil,
gas, or other minerals before extraction. The term includes payment intangibles and
software.
a. Catchall category for all intangible collateral not falling into another category
b. Include a right to sue someone, which does not ripe to judgment
c. Payment Intangibles (9-102(a)(61)): a general intangible under which the account
debtor's principal obligation is a monetary obligation. (loans!)
E. Problem 275: classify the items of collateral
1. A professional pianist’s piano: equipment
2. Cattle fattened by a farmer for sale: farm product
3. Famer’s tractor: equipment
4. Famer’s chickens: farm product
 5. Manure from the dairy herd: farm product
6. A mobile home: consumer good
a. You may argue that it is real property!
7. A right to sue someone for breach of K: general intangibles
8. A right to sue someone for negligence arising out of an automobile accident: excluded
from UCC
a. 9-109(d)(12): Art. 9 does not apply to an assignment of a claim arising in tort (other
than a commercial tort claim)
9. A right to sue a corporation for wooing away a trusted EE: commercial torts claim
10. A SI in a lawsuit P has already won and that has been reduced to a settlement
agreement: payment intangible
a. OC15 to 9-109: once a claim arising in tort has been settled and reduced to a
contractual obligation to pay, the right to payment becomes a payment intangible
and ceases to be a claim arising in tort
11. Pencils and other stationery supplies used by Wal-Mart or a similar large retailer in its
credit offices: inventory (includes items consumed in the course of ordinary business)
a. OC4(a) to 9-102: goods are inventory if they leased by a lessor or held by a person for
sale or lease
12. A liquor license: general intangible CHATTEL PAPER SECURITY INTERST AND
INSTRUMENT
13. A right to return of a security deposit held by a landlord: general intangible
14. A newspaper carrier’s right to payments for papers already delivered: account
15. A newspaper carrier’s right to payments for papers to be delivered in the future:
account
16. Curtains bought by a lawyer for the law office: equipment
17. What if after purchasing the curtains the lawyer decides to use them at home? Do
they become consumer goods?
a. No, it remains to be equipment. We must look at the time at which the SI attached
(the secured party is not required to police what happens to the collateral)
b. 9-507(b): a FS is not rendered ineffective if, after the FS is filed, the information
provided in the FS becomes seriously misleading under 9-506
18. Aunt Augusta loaned her nephew $5K w/ an oral agreement he would repay the
money the following yr. If she wants to use this agreement as collateral: payment
intangible
F. In re Troupe (tractor is a consumer good) A PMSI MONEY LEANT SO THAT PURCHASER
CAN OBTAIN CERTAIN GOODS DIFFERENT THAN A FLOATING LIEN. PMSI SACRED COW
UNDER UCC. THEY ARE FAVORED. THEY ARE SO FAVORED THAT SOME PMSIs ARE
TREATED AS ALREADY PERFECTED. MONEY IS LEANT SO THAT DEBTOR CAN OBTAIN NEW
GOODS.
1. Facts: Debtor bought the tractor w/ a PMSI by seller, telling that it was for personal use
even though it would be used in his land to fill ditches. Debtor filed for bankruptcy. The
debtors' tax returns indicated that the tractor was used 100% for business purposes.
However, the SA that the debtors signed reflected that it was a "personal" rather than a
"commercial" transaction.
2. Rule: The secured party is entitled to rely on what the debtor says at the time of the
 transaction in regards to what the collateral will be used for.
3. Hold: A debtor who made representations in a SA regarding the intended use of the
collateral should be bound by those representations. Further, the classification of the
collateral, for purposes of perfection of the SI, was determined when the SI attached.
The later use of the collateral for other purpose was irrelevant in determining whether
the SI was perfected.
4. Questions:
a. What will be the result where a car buyer tells the seller he wants the car for personal
family use, but is lying and really plans to resell it on this own lot? Perfect on the
certificate of title. Lien title
b. Some creditors contemplating a loan require that the debtor fill out an application
that explains the intended use of the collateral. Is this legally wise from the creditor’s
point of view?
G. Problem 276: Many of patients of Mercy Hospital are members of various health plans,
and when they come in for treatment they sign paperwork authorizing the hospital to
seek payment from their health insurance coverage provider. The hospital always has
a large number of such receivables in the process of collection. When the hospital
borrows money, can it use the monies due it from the various health plans as collateral?
1. Yes, this is a health-care-insurance receivable
2. 9-109(d)(8): Art. 9 does not apply to a transfer of an interest in or an assignment of a
claim under a policy of insurance, but, Art. 9 applies to an assignment by or to a health-
care provider of a health-care-insurance receivable and any subsequent assignment of
the right to payment
H. Problem 277: Passport Credit Card Company issued millions of credit cards internationally,
sending them to cardholders, who then used them in millions of transactions w/
merchants. The merchants would then send the resulting paperwork to PCCC for
reimbursement (minus PCCC’s fee). When PCCC needs to borrow money, can it use
these credit card transactions as collateral? (Remember that the outright sale of such
property by PCCC is also an Art. 9 transaction, 9-109(a)(3))
1. Yes it is a credit card receivable
2. 9-102(a)(2): “Account” means a right to payment of a monetary obligation (vii) arising
out of the use of a credit or charge card or information contained on or for use w/ the
card
I. Problem 278: classify the collateral items
1. Milk in the hands of the farmer: farm product
2. Milk in the hands of the grocery store: inventory
3. Milk in the hands of the grocery store’s customer who is buying for consumption:
consumer goods
4. Milk in the hands of the restaurant’s customer who is buying for consumption:
consumer goods
a. OC 4(a) to 9-102: The classes of goods are mutually exclusive. For example, the same
property cannot simultaneously be both equipment and inventory. In borderline
cases-a physician's car or a farmer's truck that might be either consumer goods or
 equipment-the principal use to which the property is put is determinative. Goods can
fall into different classes at different times. For example, a radio may be inventory in
the hands of a dealer and consumer goods in the hands of a consumer. As under
former Art. 9, goods are “equipment” if they do not fall into another category.
5. A certificate of deposit issued by a bank: instrument (writing evidencing a right to the
payment of a monetary obligation)
a. 3-104(j): “Certificate of deposit” means an instrument containing an
acknowledgment by a bank that a sum of money has been received by the bank and
a promise by the bank to repay the sum of money. A certificate of deposit is a note
of the bank
6. An airbill issued by an airline as a receipt for frozen shrimp shipped by air: document
a. 1-201(a)(6): “Airbill” means a document serving for air transportation as a bill of
lading does for marine or rail transportation, and includes an air consignment note
or air waybill
7. The receipt given to a farmer by a silo operator when the farmer stored grain there:
document
8. Rare coins bought by a hobbyist for addition to his collection: consumer good
9. A tax refund: general intangible
10. A debenture bond issued by a corporation: investment property
a. 8-102(a)(15): “Security,” except as otherwise provided in 8-103, means an obligation
of an issuer or a share, participation, or other interest in an issuer or in property or
an enterprise of an issuer:
i. which is represented by a security certificate in bearer or registered form, or the
transfer of which may be registered upon books maintained for that purpose by or
on behalf of the issuer;
ii. which is one of a class or series or by its terms is divisible into a class or series of
shares, participations, interests, or obligations; and
iii. which:
a) is, or is of a type, dealt in or traded on securities exchanges or securities markets;
or
b) is a medium for investment and by its terms expressly provides that it is a
security governed by Art. 9.
11. A right to 100 shares of stock recorded on the books of the debtor’s stockbroker:
investment property (security entitlement)
a. 8-102(a)(17): “Security entitlement” means the rights and property interest of an
entitlement holder w/r/t a financial asset specified in Part 5.
12. The checking account you have down at your bank: deposit account
13. A computer program: general intangibles (if sold separately)
14. The monthly rental obligations owed to a landlord, who wants to use these obligations
as collateral for a loan: payment intangible/account/excluded from Art. 9?
a. 9-109(d)(11): Art. 9 does not apply to the creation or transfer of an interest in or lien
on real property, including a lease or rents thereunder . . .
15. The promissory notes signed for the tenants to pay their rent: instrument
a. 9-109(b): the application of Art. 9 to a SI in a secured obligation is not affected by the
 fact that the obligation is itself secured by a transaction or interest to which Art. 9
does not apply
J. Morgan County Feeders v. McCormick
1. Facts: Allen owned cattle subject to a perfected SI for MC Feeders, principally for
recreational cattle drives on his ranch. He entered into a K w/ D to sell D 56 head of
cattle. The agreement granted D a perfected SI in the cattle. MC Feeders seized them
before delivery to D.
2. Hold: The cattle are “inventory” or “equipment” but NOT “farm products.”
3. Inventory vs. Equipme
4. nt (in business/retail context)
a. Goods are equipment: if they are fixed assets or have a relatively long period of use.
b. Goods are inventory: even if they are not for sale, if they are used up or consumed in
a short period of time to produce an end product.
K. Problem 279: Sam acquired one of Elvis Presley’s guitars for investment and kept it for yrs.
If Sam uses the guitar as collateral for a loan needed to run his law practice, how is the
guitar classified? Equipment
1. No inventory b/c he does not sell it in the ordinary course of business (OC4a)
2. No consumer goods b/c he does not play the guitar (not used for personal, family,
household purposes)
L. Chattel Paper (9-102(a)(11)) and Artificial Construct
1. Records evidencing both a monetary obligation (secured by goods or owed under a
lease of goods) and a SI.
2. If you run an automobile dealership, purchasers sign promissory notes and a SA: this is
chattel paper
3. Problem 280: How would you categorize the car lease Ks that Dime-A-Minute Rental
Cars uses as collateral when it borrows money from a bank? Chattel paper
a. Can the electronic version of paperwork be used as collateral? Yes
i. 9-102(a)(31) & OC5(b): electronic chattel paper means chattel paper evidenced by a
record consisting of information stored in an electronic medium
b. Art. 9 provides that a secured party will be protected as to such electronic chattel
paper if it has “control” over the paper, but given that there is no actual writing, how
could this possibly be done?
i. 9-105 (Control of Electronic Chattel Paper): A secured party has control of electronic
chattel paper if the records comprising the chattel paper are created, stored, and
assigned in such a manner that:
a) a single authoritative copy of the record or records exists which is unique,
identifiable and, except as otherwise provided in paragraphs (4), (5), and (6),
unalterable;
b) the authoritative copy identifies the secured party as the assignee of the record
or records;
c) the authoritative copy is communicated to and maintained by the secured party
or its designated custodian;
d) copies or revisions that add or change an identified assignee of the authoritative
 copy can be made only w/ the participation of the secured party;
e) each copy of the authoritative copy and any copy of a copy is readily identifiable
as a copy that is not the authoritative copy; and
f) any revision of the authoritative copy is readily identifiable as an
authorized/unauthorized revision.
4. Problem 281: Montana has enacted a statute giving unpaid crop dusters a lien on the
crops of the farmer (Montana Statutes 71-3-901). This, of course, is a statutory lien
(since it arises by statute and is not created by the consent of the debtor). Is this
nonetheless an Art. 9 transaction requiring compliance w/ the usual Art. 9 rules?
a. Yes b/c agricultural liens are covered by Art. 9 although it is not a consensual lien.
b. 9-102(a)(5): agricultural lien means an interest, other than a SI, in farm products . . .
c. 9-109(a)(2): Art. 9 applies to an agricultural lien
d. 9-109(d)(2): Art. 9 does not apply to a lien, other than an agricultural lien, given by
statute or other rule of law for services or materials, but 9-333 applies w/r/t priority
of the lien
II. Technical Validity of the Forms
A. 2 Documents Involved w/ an Art. 9 SI
1. SA (SA)
a. K b/w the debtor and the creditor by which the debtor grants to the creditor (secured
party) a SI in the collateral (you may put it all the things you care about in the K)
b. 9-102(a)(73): “SA” means an agreement that creates or provides for a SI
c. Purpose: create property rights b/w the debtor and the creditor
2. FS (FS)
a. Notice that is filed in the place specified in 9-501 (public record under secretary of
state office typically) and indexed under the debtor’s name in order to give later
creditors an awareness that the collateral is encumbered
b. Purpose: crate property rights in the creditor against most of the rest of the world
3. 9-502(a): [Sufficiency of FS] Subject to subsection (b), a FS is sufficient only if it:
a. provides the name of the debtor;
b. provides the name of the secured party or a representative of the secured party; and
c. indicates the collateral covered by the FS.
4. 9-509(a): [Person entitled to file record] A person may file an initial FS, amendment
that adds collateral covered by a FS, or amendment that adds a debtor to a FS only if:
a. the debtor authorizes the filing in an authenticated record or pursuant to subsection
(b) or (c); or
b. the person holds an agricultural lien that has become effective at the time of filing
and the FS covers only collateral in which the person holds an agricultural lien.
5. 9-509(b):[SA as authorization] By authenticating or becoming bound as debtor by a SA,
a debtor or new debtor authorizes the filing of an initial FS, and an amendment,
covering:
a. the collateral described in the SA; and
b. property that becomes collateral under 9-315(a)(2), whether or not SA expressly
covers proceeds.
6. 9-521:
 a. [Initial FS form] A filing office that accepts written records may not refuse to accept a
written initial FS in the following form and format except for a reason set forth in 9-
516(b):
b. [Amendment form] A filing office that accepts written records may not refuse to
accept a written record in the following form and format except for a reason set
forth in 9-516(b):
B. The SA
1. If the collateral is in the possession of the secured party (pledge), no written SA is
required by law
a. Where the property is to leave the creditor’s control, 9-203 becomes relevant
2. 9-203 (Very Important Provision)
a. [Attachment] A SI attaches to collateral when it becomes enforceable against the
debtor w/r/t the collateral, unless an agreement expressly postpones the time of
attachment
b. [Enforceability] Except as otherwise provided in subsections (c) through (i), a SI is
enforceable against the debtor and third parties w/r/t the collateral only if :
i. value has been given;
ii. the debtor has rights in the collateral or the power to transfer rights in the collateral
to a secured party; and
iii. one of the following conditions is met:
a) the debtor has authenticated a SA that provides a description of the collateral
and, if the SI covers timber to be cut, a description of the land concerned;
(nature of Statute of Fraud)
b) the collateral is not a certificated security and is in the possession of the secured
party under 9-313 pursuant to the debtor's SA (can be oral agreement);
c) the collateral is a certificated security in registered form and the security
certificate has been delivered to the secured party under 8-301 pursuant to the
debtor's SA; or
d) the collateral is deposit accounts, electronic chattel paper, investment property,
or LOC rights, and the secured party has control under 9-104, 9-105, 9-106, or 9-
107 pursuant to the debtor's SA.
c. [Other UCC provisions] Subsection (b) is subject to 4-210 on the SI of a collecting
bank, 5-118 on the SI of a LOC issuer or nominated person, 9-110 on a SI arising
under Art. 2 or 2A, and 9-206 on SIs in investment property.
d. [When person becomes bound by another person's SA] A person becomes bound as
debtor by a SA entered into by another person if, by operation of law other than Art.
9 or by K:
i. the SA becomes effective to create a SI in the person's property; or
ii. the person becomes generally obligated for the obligations of the other person,
including the obligation secured under the SA, and acquires or succeeds to all or
substantially all of the assets of the other person.
e. [Effect of new debtor becoming bound] If a new debtor becomes bound as debtor by
a SA entered into by another person:
 i. the agreement satisfies subsection (b)(3) w/r/t existing or after-acquired property of
the new debtor to the extent the property is described in the agreement; and
ii. another agreement is not necessary to make a SI in the property enforceable.
f. [Proceeds and supporting obligations] The attachment of a SI in collateral gives the
secured party the rights to proceeds provided by 9-315 and is also attachment of a SI
in a supporting obligation for the collateral.
g. [Lien securing right to payment] The attachment of a SI in a right to payment or
performance secured by a SI or other lien on personal or real property is also
attachment of a SI in the SI, mortgage, or other lien.
h. [Security entitlement carried in securities account.] The attachment of a SI in a
securities account is also attachment of a SI in the security entitlements carried in the
securities account.
i. [Commodity Ks carried in commodity account] The attachment of a SI in a commodity
account is also attachment of a SI in the commodity Ks carried in the commodity
account.
3. Where the collateral is not in the secured party’s possession or control, 9-203 SA must:
a. Be authenticated by the debtor; and
i. “authenticate” defined in 9-102(a)(7): sign or execute, adopt a symbol, encrypt or
similarly process a record, w/ the present intent to identify the person or
adopt/accept a record
b. Described the collateral
4. Note
a. No particular form or words necessary
b. Need not call itself a SA
5. Admissibility of parol evidence to establish the security nature of apparently absolute
transactions
a. OC3 to 9-203: a debtor may show by parol evidence that a transfer purporting to be
absolute was in fact for security
6. Problem 282: When Bean bought a new computer on credit from Centerboro Office
Supply, the store made him sign a “Conditional Sale K,” by which he agreed that title to
the computer would remain w/ the store until he had fully paid for his purchase. The K
described the computer, but did not mention a SI. Does the K qualify as a SA under 9-
203?
a. Yes if the debtor (Bean) authenticates the agreement by signing it (it can be a SA even
if the agreement is not called SA)
b. 1-201(b)(35): "SI" means an interest in personal property or fixtures which secures
payment or performance of an obligation. "SI" includes any interest of a consignor
and a buyer of accounts, chattel paper, a payment intangible, or a promissory note
in a transaction that is subject to Art. 9. "SI" does not include the special property
interest of a buyer of goods on identification of those goods to a K for sale under 2-
505, the right of a seller or lessor of goods under Art. 2 or 2A to retain or acquire
possession of the goods is not a "SI", but a seller or lessor may also acquire a "SI" by
complying w/ Art. 9. The retention or reservation of title by a seller of goods
notwithstanding
 shipment or delivery to the buyer under 2-401 is limited in effect to a reservation of a
"SI." Whether a transaction in the form of a lease creates a "SI" is determined
pursuant to 1-203.
C. The Financing Statement (UCC-1) does not have to be signed as long as SA is signed.
Sufficiency of financing statement. Debtor’s name, debtor’s address, creditor’s name,
creditor, an adequate description of the collateral, has to be authenticated by the debtor,
if it is a fixture filing it has to describe the real estate,
1. Filed by the creditor (secured party) to perfect e creditor’s right
2. 9-502(a)
a. Need be signed by no one
i. Though the debtor must have authenticated it
ii. Signing a SA by the debtor authenticates a FS (9-509)
b. Must identify the parties (debtor, secured party) and collateral
3. 9-502(b): if realty interests are involved (timber, fixture, minerals to be extracted from
the ground)
a. Must describe the realty and the record owner of the realty (if not the obligor)
b. Indicate that it be filed in the real property records
4. 9-516 (What Constitutes Filing; Effect of Filing)
a. [What constitutes filing] Except as otherwise provided in subsection (b),
communication of a record to a filing office and tender of the filing fee or acceptance
of the record by the filing office constitutes filing.
b. [Refusal to accept record; filing does not occur] Filing does not occur w/r/t a record
that a filing office refuses to accept b/c:
i. the record is not communicated by a method or medium of communication
authorized by the filing office;
ii. an amount equal to or greater than the applicable filing fee is not tendered;
iii. the filing office is unable to index the record b/c:
a) in the case of an initial FS, the record does not provide a name for the debtor;
b) in the case of an amendment or correction statement, the record:
1. does not identify the initial FS as required by 9-512 or 9-518, as applicable; or
2. identifies an initial FS whose effectiveness has lapsed under 9-515;
c) in the case of an initial FS that provides the name of a debtor identified as an
individual or an amendment that provides a name of a debtor identified as an
individual which was not previously provided in the FS to which the record
relates, the record does not identify the debtor's last name; or
d) in the case of a record filed [or recorded] in the filing office described in 9-
501(a)(1), the record does not provide a sufficient description of the real property
to which it relates;
iv. in the case of an initial FS or an amendment that adds a secured party of record, the
record does not provide a name and mailing address for the secured party of
record;
v. in the case of an initial FS or an amendment that provides a name of a debtor which
was not previously provided in the FS to which the amendment relates, the record
does not:
 a) provide a mailing address for the debtor;
b) indicate whether the debtor is an individual or an organization; or
c) if the FS indicates that the debtor is an organization, provide:
1. a type of organization for the debtor;
2. a jurisdiction of organization for the debtor; or
3. an organizational identification number for the debtor or indicate that the
debtor has none;
vi. in the case of an assignment reflected in an initial FS under 9-514(a) or an
amendment filed under 9-514(b), the record does not provide a name and mailing
address for the assignee; or
vii. in the case of a continuation statement, the record is not filed within the six-month
period prescribed by 9-515(d).
c. [Rules applicable to subsection (b)] For purposes of subsection (b):
i. a record does not provide information if the filing office is unable to read or
decipher the information; and
ii. a record that does not indicate that it is an amendment or identify an initial FS to
which it relates, as required by 9-512, 9-514, or 9-518, is an initial FS.
d. [Refusal to accept record; record effective as filed record] A record that is
communicated to the filing office w/ tender of the filing fee, but which the filing
office refuses to accept for a reason other than one set forth in subsection (b), is
effective as a filed record except as against a purchaser of the collateral which
gives value in reasonable reliance upon the absence of the record from the files.
e. Note (p. 805):
i. if the filing office does not take the FS not containing these things, the FS is effective
nonetheless
ii. FS does not typically contain many details of the underlying transaction
D. The Debtor’s Identity
1. Problem 283: Harry Fellini ran a movie theater called “Fellini’s Art Theater.” B/c he
was the sole proprietor, that was a trade name. He gave a SI in the business’s
equipment to SFC. The FS calls for a listing of the “debtor’s name.”
a. Should the parties use the business name or individual name?
i. They should use the individual’s name (should check proper documents) under 9-
503(c) – debtor’s trade name insufficient
ii. 9-503 (Name of Debtor and Secured Party)
a) [Sufficiency of debtor's name] A FS sufficiently provides the name of the debtor:
1. if the debtor is a registered organization, only if the FS provides the name of
the debtor indicated on the public record of the debtor's jurisdiction of
organization which shows the debtor to have been organized;
2. if the debtor is a decedent's estate, only if the FS provides the name of the
decedent and indicates that the debtor is an estate;
3. if the debtor is a trust or a trustee acting w/r/t property held in trust, only if
the FS:
A. provides the name specified for the trust in its organic documents or, if no
 name is specified, provides the name of the settlor and additional
information sufficient to distinguish the debtor from other trusts having
one or more of the same settlors; and
B. indicates, in the debtor's name or otherwise, that the debtor is a trust or is
a trustee acting w/r/t property held in trust; and
4. in other cases:
A. if the debtor has a name, only if it provides the individual or organizational
name of the debtor; and
B. if the debtor does not have a name, only if it provides the names of the
partners, members, associates, or other persons comprising the debtor.
b) [Additional debtor-related information] A FS that provides the name of the
debtor in accordance w/ subsection (a) is not rendered ineffective by the absence
of:
1. a trade name or other name of the debtor; or
2. unless required under subsection (a)(4)(B), names of partners, members,
associates, or other persons comprising the debtor.
c) [Debtor's trade name insufficient] A FS that provides only the debtor's trade
name does not sufficiently provide the name of the debtor.
d) [Representative capacity] Failure to indicate the representative capacity of a
secured party or representative of a secured party does not affect the sufficiency
of a FS.
e) [Multiple debtors and secured parties.] A FS may provide the name of more than
one debtor and the name of more than one secured party.
b. If the theater were run as a partnership, would the partnership’s name be used as the
debtor’s name? Yes
i. 9-503(a)(4)(A): a FS sufficiently provides the name of the debtor if the debtor has a
name, only if it provides the individual or organizational name of the debtor
ii. OC2: “organization” includes corporations, partnerships of all kinds, business trusts,
etc
2. Problem 284: The debtor’s correct name was “Michael A. Erwin,” but the FS listed him
as “Mike Erwin.” 9-506(a) excuses “minor errors unless seriously misleading.”
a. Is the secured party okay here?
i. Yes if the search yields the correct results
ii. 9-506(c) search engine test: if a search of the records of the filing office under the
debtor’s correct name, using the filing office’s standard search logic, if any, would
disclose a FS that fails sufficiently to provide the name of the debtor in accordance
w/ 9-503(a), the name provided does not make the FS seriously misleading
b. If you are the attorney for the creditor and you lose on this one, what can you do to
avoid this problem in the future?
i. File the FS in multiple names (all the possible names w/ extra fees)
ii. Make sure to check if there are any other names used by the debtor in other FSs
c. If the debtor mistakenly tells you his legal name is “Michael Atwood Erwin,” but his
birth certificate actually lists his name as “Michael Edward Erwin,” would the FS be all
right?
 i. Search engine test!
3. Problem 285: Barbara Song borrowed $50K from ONB in order to start a business called
“Barb’s Interiors.” ONB and Song signed a SA showing her as the debtor and giving ONB
an interest in the inventory and equipment. ONB duly filed a FS, but Song married and
changed her name to Barbara Dancer. She borrowed another $50K from NFC,
which loaned her the money after searching the records under “Dancer,” and finding
no prior encumbrances on the business’s inventory and equipment. Did ONB lose its SI
b/c it failed to refile when her name changed?
a. Yes, the FS remains effective only for the inventory/equipment acquired by Barbara
before or within 4 months after the change (for the inventory/equipment acquired by
Barbara thereafter, ONB should file an amendment)
b. 9-507(c)[Change in debtor's name] If a debtor so changes its name that a filed FS
becomes seriously misleading under 9-506:
i. the FS is effective to perfect a SI in collateral acquired by the debtor before, or
within 4 months after, the change; and
ii. the FS is not effective to perfect a SI in collateral acquired by the debtor more than
4 months after the change, unless an amendment to the FS which renders the FS
not seriously misleading is filed within 4 months after the change.
c. OC4: FS, unless amended to provide the debtor’s new correct name, is effective only
to perfect a SI in collateral acquired by the debtor before, or within 4 months after
the change
4. Problem 286: LNB filed a FS in the proper place to perfect its SI in the accounts
receivable of the American Electronics Store. When AES ran into financial difficulty, its
assets were sold to a Voice of Japan, which moved into the same retail location.
a. Must LNB refile to keep its SI perfected in (1) the accounts actually transferred by AES
to VoJ or (2) accounts thereafter acquired by VoJ?
i. No, the FS remains effective after the sale
ii. 9-507(a): [Disposition] A filed FS remains effective w/r/t collateral that is sold,
exchanged, leased, licensed, or otherwise disposed of and in which a SI or
agricultural lien continues, even if the secured party knows of or consents to the
disposition
iii. OC3: As a consequence of the disposition, the collateral may be owned by a person
other than the debtor against whom the FS was filed. Under subsection (a), the
secured party remains perfected even if it does not correct the public record.
b. Do we get the same result if AES merges w/ VoJ and the new entity is called “Voice of
Electronics”?
i. Yes, VoE becomes bound as debtor b/c the SA becomes effective to create a SI in
VoE’s property (VoE now the new debtor of the record)
ii. But if seriously misleading as to the new debtor’s name, have to refile within 4
months from the merger
iii. 9-102(a)(56): “New debtor” means a person that becomes bound as debtor under 9-
203(d) by a SA previously entered into by another person
iv. 9-203(d): [When person becomes bound by another person's SA] A person becomes
bound as debtor by a SA entered into by another person if, by operation of law
other
 than Art. 9 or by K:
a) the SA becomes effective to create a SI in the person's property; or
b) the person becomes generally obligated for the obligations of the other person,
including the obligation secured under the SA, and acquires or succeeds to all or
substantially all of the assets of the other person.
v. 9-203(e): [Effect of new debtor becoming bound] If a new debtor becomes bound as
debtor by a SA entered into by another person:
a) the agreement satisfies subsection (b)(3) w/r/t existing or after-acquired property
of the new debtor to the extent the property is described in the agreement; and
b) another agreement
vi. OC7 to 9-203:
a) if a new debtor becomes bound as debtor by a SA entered into by another
person, the SA satisfies the requirement of (b)(3) as to the existing and after-
acquired property of the new debtor to the extent the property is described in
the agreement.
b) Persons who become bound are limited to those who both become primarily
liable for the original debtor’s obligations and succeed to (or acquire) its assets.
(sureties, secondary obligors, persons who become obligated through veil
piercing are excluded)
vii. 9-508 (Effectiveness of FS If New Debtor Becomes Bound by SA)
a) [FS naming original debtor] Except as otherwise provided in this section, a filed FS
naming an original debtor is effective to perfect a SI in collateral in which a new
debtor has or acquires rights to the extent that the FS would have been effective
had the original debtor acquired rights in the collateral.
b) FS becoming seriously misleading] If the difference b/w the name of the original
debtor and that of the new debtor causes a filed FS that is effective under
subsection (a) to be seriously misleading under 9-506:
1. the FS is effective to perfect a SI in collateral acquired by the new debtor
before, and within 4 months after, the new debtor becomes bound under 9-
203(d); and
2. the FS is not effective to perfect a SI in collateral acquired by the new debtor
more than 4 months after the new debtor becomes bound under 9-203(d)
unless an initial FS providing the name of the new debtor is filed before the
expiration of that time.
c) [When not applicable] This does not apply to collateral as to which a filed FS
remains effective against the new debtor under 9-507(a).
c. What if the debtor remains the same, but LNB assigns its interest in the debtor’s
accounts to ONB? Need the records be changed?
i. When the creditor has changed, amendment is not required, but it is wise for the
new debtor to file an amendment
ii. 9-310(c): [Assignment of perfected SI] If a secured party assigns a perfected SI or
agricultural lien, a filing under Art. 9 is not required to continue the perfected status
of the SI against creditors of and transferees from the original debtor.
iii. 9-511 (Secured Party of Record)
 a) [Secured party of record] A secured party of record w/r/t a FS is a person whose
name is provided as the name of the secured party or a representative of the
secured party in an initial FS that has been filed. If an initial FS is filed under 9-
514(a), the assignee named in the initial FS is the secured party of record w/r/t
the FS.
b) [Amendment naming secured party of record] If an amendment of a FS which
provides the name of a person as a secured party or a representative of a secured
party is filed, the person named in the amendment is a secured party of record. If
an amendment is filed under 9-514(b), the assignee named in the amendment is a
secured party of record.
c) [Amendment deleting secured party of record] A person remains a secured party
of record until the filing of an amendment of the FS which deletes the person.
d. Is ONB’s interest superior to that of LNB’s creditors? Consider that the transfer of the
SI from LNB to ONB is itself the transfer of an account or chattel paper
i. No unless ONB perfect its SI by filing
ii. Ex 2 of OC4 to 9-310: Dealer creates a SI in specific equipment in favor of
Lender. After Lender perfects the SI in the equipment by filing, Lender assigns the
chattel paper to X. The SI in the equipment, in X’s hands and w/o further steps on
X’s part, continues perfected against Dealer’s transferees and creditors. However,
regardless of whether Lender made the assignment to secure Lender’s obligation
to X or whether the assignment was an outright sale of the chattel paper, the
assignment creates a SI in the chattel paper in favor of X. Accordingly, X must take
whatever steps may be required for perfection in order to be protected against
Lender’s transferees and creditors w/r/t the chattel paper
5. Problem 287: When Robin found he could not get a loan unless he had collateral, he
got permission from his foster brother, Richard, to use Richard’s yacht as collateral.
a. Should the lender make both sign the SA (only Robin signed the promissory note)?
i. Yes, the debtor (Richard) must authenticate the SA
b. Which of these parties is the debtor and which the “obligor”?
i. Debtor is Richard (has an interest in the collateral), obligor is Robin (has to sign SA)
ii. 9-102(a)(28)(A): “Debtor” means:
a) A person having an interest, other than a SI or other lien, in the collateral,
whether or not the person is an obligor;
b) A seller of accounts, chattel paper, payment intangibles, or promissory notes; or
c) A consignee
iii. 9-102(a)(59): "Obligor" means a person that, w/r/t an obligation secured by a SI in or
an agricultural lien on the collateral, (i) owes payment or other performance of the
obligation, (ii) has provided property other than the collateral to secure payment or
other performance of the obligation, or (iii) is otherwise accountable in whole or in
part for payment or other performance of the obligation. The term does not include
issuers or nominated persons under a LOC.
c. Under whose name should the FS be filed?
i. Debtor’s name (Richard) should be used in the FS b/c that is who creditors care most
 about
E. Description of the Collateral
1. Problem 288: Peter signed a SA and FS in favor of TFC, giving the company a SI in “all
personal property debtor now owns or ever owns or even hopes to own b/w now and
the end of the world or his death, whichever occurs first.”
a. Does this perfect an interest in his guitar?
i. No, it does not reasonably identify the collateral (supergeneric description is
sufficient in FS, but not sufficient in SA)
ii. 9-108 (Sufficiency of Description in SA)
a) [Sufficiency of description] Except as otherwise provided in subsections (c), (d),
and (e), a description of personal or real property is sufficient, whether or not it is
specific, if it reasonably identifies what is described.
b) [Examples of reasonable identification] Except as otherwise provided in
subsection (d), a description of collateral reasonably identifies the collateral if it
identifies the collateral by:
1. specific listing;
2. category;
3. except as otherwise provided in subsection (e), a type of collateral defined in
UCC;
4. quantity;
5. computational or allocational formula or procedure; or
6. except as otherwise provided in subsection (c), any other method, if the
identity of the collateral is objectively determinable.
c) [Supergeneric description not sufficient in SA] A description of collateral as "all
the debtor's assets" or "all the debtor's personal property" or using words of
similar import does not reasonably identify the collateral. (but supergeneric
description is sufficient in FS)
d) [Investment property] Except as otherwise provided in subsection (e), a
description of a security entitlement, securities account, or commodity account is
sufficient if it describes:
1. the collateral by those terms or as investment property; or
2. the underlying financial asset or commodity contract.
e) [When description by type insufficient] A description only by type of collateral
defined in UCC is an insufficient description of:
1. a commercial tort claim; or
2. in a consumer transaction, consumer goods, a security entitlement, a securities
account, or a commodity account.
iii. 9-504 (Indication of Collateral): A FS sufficiently indicates the collateral that it covers
if the FS provides:
a) a description of the collateral pursuant to 9-108; or
b) an indication that the FS covers all assets or all personal property.
b. Why would the drafters have drawn this distinction b/w the description in the SA and
that in the FS?
 i. SA is a K b/w 2 parties and must be more specific
2. In re Grabowski
a. SA must contain a reasonable identification of the property covered, and blanket
agreements, covering all the debtor’s assets, are generally not sufficient. The ID of
the collateral must be objectively determinable, and a description by category, or
type of collateral, is permitted.
b. FS, however, may contain a broader description per 9-504 allowing a FS that “covers
all assets of all personal property.” All that is required is that subsequent creditor be
notified that a lien may exist, and that further inquiry is needed to disclose the
complete state of affairs.
3. Problem 289: Polly owned a clothing store that was doing quite well, so she decided to
open branches all over the state. She borrowed money to do so from LSB, which took a
SI (according to the filed FS) in “all inventory, accounts receivable, equipment,
instrument, general intangibles, and personal property.” The bank also made her pledge
her extensive collection of jewelry to the bank. A yr later, she asked to have the jewelry
back so that she could wear it to a social occasion, and the bank gave it to her.
Before she could return it to the bank, another creditor seized it by judicial process.
a. Is LSB’s interest in the jewelry perfected by the filed FS?
i. You may argue that the jewelry is categorized as consumer good and covered by “all
personal property” in the FS.
ii. But, the other creditor may argue that the jewelry is not covered by the FS b/c the
bank perfected its SI in the jewelry by taking possession of it, not by filing, and lost
the perfection by abandoning the possession -> if you meant to include everything,
you’d better list it in a FA
4. Debtors are allowed to use future as well as current property as collateral for a credit
extension (floating lien)
a. Creditor’s lien will attach to new property w/o the signing of any further paperwork
b. 9-204(a): [After-acquired collateral] Except as otherwise provided in subsection (b), a
SA may create or provide for a SI in after-acquired collateral
c. 9-204(b): [When after-acquired property clause not effective] consumer goods, other
than an accession (fixture to other property, e.g., tires to a car), or a commercial tort
claim
5. Problem 290: The SA and the FS both described the collateral as “inventory.”
a. Does this limit the SI to existing inventory only, or does the SI extend to replacement
for the original collateral?
i. The courts split in this issue.
a) Argument 1: Typically, if you want to include after-acquired inventory, you
explicitly say so.
b) Argument 2: But the word “inventory” turns over constantly as a matter of
common sense and the rule to collateral in 9-204(a) may apply to inventory.
b. If the SA had said “inventory now owned or after-acquired,” but the FS had simply
mentioned “inventory,” does this perfect a SI in after-acquired inventory?
i. Yes, the fact that the FS simply mentioned “inventory” w/o further description does
 not mean that a SI on the after-acquired inventory will not be perfected
ii. OC3 to 9-108: whether a description in a SA is sufficient to include after-acquired
collateral if the agreement does not explicitly so provide is one of K interpretation
and is not susceptible to a statutory rule
iii. OC2 to 9-502: a FS is effective to cover after-acquired property of the type indicated
and to perfect w/r/t future advances under SAs, regardless of whether after-
acquired property or future advances are mentioned in the FS and even if not in
the contemplation of the parties at the time the FS was authorized to be filed
6. OC2 to 9-108: test adopted by the courts in faulty description problem
a. Whether the description does the job assigned to it, i.e., make possible the
identification of the thing described
b. Notice filing: the description in the FS must be sufficient to alert the searcher to the
necessity for further inquiry
7. Problem 291: The FS’s description said “Various Equipment, see attached list.” No list
was attached. Is the statement sufficient to perfect a SI in the debtor’s equipment?
a. You can argue in either way
i. Yes, even if there is no attached list, FS is meant to include all the equipment owned
by the debtor
ii. No, this does not put a reasonable person on notice as to the identity of the collateral
8. Problem 292: The SA stated that the collateral was “machinery, equipment, furniture
and fixture.” To this list the FS added “inventory and accounts receivable.” The parties
are all willing to testify that the loan was intended to be secured by inventory and
accounts receivable as well as by the items listed in the SA. Other creditors object. Does
the secured party’s interest reach inventory and accounts receivable?
a. No, the secured party’s interest will not reach inventory and accounts receivable b/c
they are not described in the SA (violation of Statute of Fraud)
b. 9-203(b): a SI is enforceable against the debtor and 3rd parties w/r/t to the collateral
only if . . . (nature of Statute of Fraud)
9. Problem 293: ONB is planning to make a loan to LT and wants to take a SI in all of the
equipment of the debtor. LT’s most important piece of equipment is the very
expensive Abacus-12. Should the SA be drafted to say that the debtor grants a SI in “the
Abacus-12 plus all other equipment,” “all equipment, particularly the Abacus-12,” or
simply “all equipment”?
a. “all equipment” would be enough to reasonably identify what is described. But, “all
equipment, including but not limited to the Abacus-12” would be better.
10. Problem 294: The SA stated that the tractor buyer granted a SI to “ ,” but
the seller forgot to fill in his name. The seller later filed a FS showing he had a secured
interest in the buyer’s tractor.
a. Is the purported document w/ the blank a 9-203 SA?
i. Yes, SA need be signed by the debtor (not by the secured party) under 9-203. But,
Prof. thinks that you should fill in the creditor’s name too!
b. What about the FS?
i. No, FS must provide both of the debtor’s name and the secured party’s name
 c. What about both?
SECURITY INTERST ATTACHES WHEN
1. AN AGREEMENT
2. VALUE PASSES
3. DEBTOR OBTAINS RIGHTS TO THE COLLATERAL

ii. In some jurisdictions: FScannot operate as a SA when there is no language granting a

SI to a creditor
iii. In other jurisdictions: As FS contains a description of the collateral signed by the
debtor, it may serve as SA
11. Note: A wise creditor will:
a. Make sure all the forms are correctly filled out in all particulars;
b. Check the debtor’s technical legal name now and in the immediate past and make
sure it is correctly listed on all the documents;
c. Refile if the debtor’s name changes in any way;
d. Describe the collateral as accurately and completely as possible in all documents; and
e. Inquire into the source of the debtor’s title to ensure that the former owner’s
creditors have no valid claims
III. Attachment of the SI
A. Definitions and steps of attachment
1. Attachment: process by which the SI in favor of the creditor becomes effective against
the debtor (steps that must be taken by the creditor)
2. Perfection: process by which the creditor’s SI becomes effective against most of the rest
of the world
a. OH case: As long as there is an attachment, the creditor can repossess against the
debtor even though there is no perfection (no notice against the rest of the world)
3. Steps for attachment (to be enforceable against the debtor & 3rd parties)
a. A SA must be signed
b. The creditor must give value; and
c. The debtor must have some rights in the collateral
4. 9-203 (Attachment and Enforceability of SI; Proceeds; Supporting Obligations; Formal
Requisites)
a. [Attachment] A SI attaches to collateral when it becomes enforceable against the
debtor w/r/t the collateral, unless an agreement expressly postpones the time of
attachment.
b. [Enforceability] Except as otherwise provided in subsections (c) through (i), a SI is
enforceable against the debtor and third parties w/r/t the collateral only if : (3
requirements)
i. value has been given;
ii. the debtor has rights in the collateral or the power to transfer rights in the collateral
to a secured party; and
iii. one of the following conditions is met: (there must be a written SA or pledge)
a) the debtor has authenticated a SA that provides a description of the collateral and,
 if the SI covers timber to be cut, a description of the land concerned;
b) the collateral is not a certificated security and is in the possession of the secured
party under 9-313 pursuant to the debtor's SA;
c) the collateral is a certificated security in registered form and the security
certificate has been delivered to the secured party under 8-301 pursuant to the
debtor's SA; or
d) the collateral is deposit accounts, electronic chattel paper, investment property,
or LOC rights, and the secured party has control under 9-104, 9-105, 9-106, or 9-
107 pursuant to debtor's SA.
c. [Other UCC provisions] Subsection (b) is subject to 4-210 on the SI of a collecting
bank, 5-118 on the SI of a LOC issuer or nominated person, 9-110 on a SI arising
under Art. 2 or 2A, and 9-206 on SIs in investment property.
d. [When person becomes bound by another person's SA] A person becomes bound as
debtor by a SA entered into by another person if, by operation of law other than Art.
9 or by K:
i. the SA becomes effective to create a SI in the person's property; or
ii. the person becomes generally obligated for the obligations of the other person,
including the obligation secured under the SA, and acquires or succeeds to all or
substantially all of the assets of the other person.
e. [Effect of new debtor becoming bound] If a new debtor becomes bound as debtor by
a SA entered into by another person:
i. the agreement satisfies subsection (b)(3) w/r/t existing or after-acquired property of
the new debtor to the extent the property is described in the agreement; and
ii. another agreement is not necessary to make a SI in the property enforceable.
f. [Proceeds and supporting obligations] The attachment of a SI in collateral gives the
secured party the rights to proceeds provided by 9-315 and is also attachment of a SI
in a supporting obligation for the collateral.
g. [Lien securing right to payment] The attachment of a SI in a right to payment or
performance secured by a SI or other lien on personal or real property is also
attachment of a SI in the SI, mortgage, or other lien.
h. [Security entitlement carried in securities account] The attachment of a SI in a
securities account is also attachment of a SI in the security entitlements carried in the
securities account.
i. [Commodity Ks carried in commodity account] The attachment of a SI in a commodity
account is also attachment of a SI in the commodity Ks carried in the commodity
account.
5. 9-204 (After-Acquired Property; Future Advances)
a. [After-acquired collateral] Except as otherwise provided in subsection (b), a SA may
create or provide for a SI in after-acquired collateral.
b. [When after-acquired property clause not effective] A SI does not attach under a
term constituting an after-acquired property clause to:
i. consumer goods, other than an accession when given as additional security, unless
the debtor acquires rights in them within 10 days after the secured party gives
value;
 or
ii. a commercial tort claim.
c. [Future advances and other value] A SA may provide that collateral secures, or that
accounts, chattel paper, payment intangibles, or promissory notes are sold in
connection with, future advances or other value, whether or not the advances or
value are given pursuant to commitment.
B. Border State Bank of Greenbush v. Bagley Livestock Exchange
1. Fact: P bank contends that Ds, a livestock exchange and a farmer, converted the bank's
perfected SI in calves. The farmer sought indemnity from an individual w/ whom he had
an agreement, and the court awarded the individual damages on the individual's
counterclaim.
a. debtor has possession of the cattle, but has no title in it
2. Issue: Whether the bank's SI attached to the calves sold under the cattle-sharing
agreement
3. Hold: It was logical that the farmer would have an interest in the individual continuing
to care for his cattle located on the individual's farm. Mere possession of collateral does
not give you an interest in collateral – but you don’t have to have a title, a right in
collateral is enough
C. Problem 295: Roy borrowed $35K from ONB in order to open his shop named Gabriel’s
Trumpets. On Jan. 6, he signed a SA w/ ONB, giving ONB an interest in all “existing and
after- acquired inventory in the store,” and received the money. On Jan. 6, his inventory
consisted of 4 guitars and a pitch pipe. Roy had a K w/ TTMC to sell him 40 trumpets,
which he paid for in advance of the delivery date (Mar. 30). On Mar. 15, TTMC packaged
the 40 trumpets and marked them “For Shipment to Gabriel’s Trumpet Store,” and shipped
them to Gabriel on Mar. 30, who received them that day and displayed them in the store.
1. On what day or days did the bank’s SI attach (that is, become effective) to the guitars,
pitch pipe, and trumpets?
a. Bank’s SI attaches when Roy had rights in the collateral, i.e., Jan. 6 for the guitar and
pitch pipe, and Mar. 15 when the trumpets were identified by packaging
b. The other party may argue that the SI is attached to the inventory “in the store” ->
accidental postponed attachment
c. 9-203(a): a SI attaches to collateral when it becomes enforceable against the debtor
w/r/t the collateral, unless an agreement expressly postpones the time of attachment
d. 2-501: the buyer obtains a special property and an insurable interest in goods by
identification of existing goods (footnote 2 on p. 194 of the casebook)
2. Does your answer change if ONB filed a proper FS covering Gabriel’s inventory on Jan. 7?
a. No, attachment date remains the same (but perfection is delayed until Jan. 7)
3. Can a FS be filed before the SA is signed? Attached? Yes
a. 9-502(d): a FS may be filed before a SA is made or a SI otherwise attaches
b. You can “file” before attachment, but filing before attachment is not perfection
4. Why would a creditor wish to file a FS before the SI had attached?
a. To get priority over other secured creditors. While the trumpets attachment and
perfection occurred on Mar. 15, ONB has priority over other creditors who
perfected
 their SI after Jan. 7
b. 9-322(a)(1): conflicting perfected SIs and agricultural liens rank according to priority
in time of filing or perfection. Priority dates from the earlier of the time a filing
covering the collateral is first made or the SI or agricultural lien is first perfected, if
there is no period thereafter when there is neither filing nor perfection (first-to-file-
or-perfect rule, whichever earlier)
5. If ONB did not advance any money until Mar. 31, and if ONB did not make
any commitment to advance any money until that date, when did the SI attach?
a. It attached on Mar. 31 when the “value” was given (9-203(b)(1))
b. 9-102(a)(68): “pursuant to commitment” means pursuant to secured party’s
obligation, whether or not a subsequent event of default or other event not within
the secured party’s control has relieved or may relieve the secured party from its
obligation
D. In re Howell Enterprises
1. Facts: Bar Schwartz wanted to buy rice from Howell using a commercial LOC. Howell
would not accept the commercial letter as payment for the rice. Tradax would accept
the LOC but Bar Schwartz did not want to buy the rice from Tradax. Howell and Tradax
came up w/ a plan that Tradax would sell its rice to Bar Schwartz under Howell’s name.
Howell had borrowed $2.1M from FNB and granted a SI in all accounts receivable. On
Feb. 27, 1987 a K was signed in the name of Howell under which rice would be sold by
Tradax to Bar Schwartz and the payment was a commercial LOC. Howell and Tradax
were used interchangeably. Howell listed the Bar Schwartz transaction as an account
receivable on its books w/ a corresponding and equivalent account payable to
Tradax. Tradax documented the transaction on its books as a sale to Howell but did not
invoice Howell for a sale. Howell was named as the beneficiary for the LOC issued.
Howell presented the LOC to FNB and it was understood that Howell would transfer
the proceeds to Tradax when the LOC matured. Prior to the letter maturing Howell
filed for Chapter 11. FNB came forward to claim its perfected SI in Howell’s
accounts receivable and the Bar Schwartz LOC was swept into bankruptcy.
2. Issue: Is the LOC an account receivable? Whether FNB’s undisputed SI can reach
that particular line item in Howell’s account receivable identified as the Bar
Schwartz account?
3. Rule (9-203): a SI cannot attach unless the debtor has rights in the collateral. Mere
possession of LOC is insufficient to establish a right to collateral upon which to base a
SI.
4. Hold: Howell did not own and could not legitimately encumber any interest in the Bar
Schwartz account regardless of the bookkeeping procedure it chose. There is no reason
based solely on an undisclosed but legal argument to require Tradax to pay twice w/ no
hope of recompense for the same barge of rice by permitting FNB to execute its SI on
the Bar Schwartz account. FNB has shown no detrimental reliance on Howell’s
accounting error. Tradax wins.

CHAPTER 20. PERFECTION OF THE SI

I. Introduction
TYPES OF PERFECTION
1. TAKE POSSESSION
2. FILE A FINANCING STATEMENT AND FILE A UCC1 FINANCING ALL UCC1S ARE FINANCING
STATEMENT. NOT ALL FINANCING STATEMENTS ARE UCC1.
3. AUTOMATIC PERFECTION – GET THE SECURITY INTEREST TO ATTACH. PMSI IN
CONSUMER GOODS. EQUIPMENT 20 DAYS
4. TAKE CONTROL GET A CONTROL AGREEMENT.
CENTRALLY SUFFICIENT TO PERFECT THE SECURITY INTEREST
B. 9-308 (When SI or Agricultural Lien is Perfected; Continuity of Perfection)
1. [Perfection of SI] Except as otherwise provided in this and 9-309, a SI is perfected if it
has attached and all of the applicable requirements for perfection in 9-310 through 9-
316 have been satisfied. A SI is perfected when it attaches if the applicable
requirements are satisfied before the SI attaches.
2. [Perfection of agricultural lien] An agricultural lien is perfected if it has become effective
and all of the applicable requirements for perfection in 9-310 have been satisfied. An
agricultural lien is perfected when it becomes effective if the applicable requirements
are satisfied before the agricultural lien becomes effective.
3. [Continuous perfection; perfection by different methods] A SI or agricultural lien is
perfected continuously if it is originally perfected by one method under Art. 9 and is
later perfected by another method under Art. 9, w/o an intermediate period when
it was unperfected. (You can switch the method of perfection as long as there is no
gap)
4. [Supporting obligation] Perfection of a SI in collateral also perfects a SI in a supporting
obligation (e.g., surety’s obligation) for the collateral.
5. [Lien securing right to payment] Perfection of a SI in a right to payment (e.g.,
promissory note) or performance also perfects a SI in a SI, mortgage, or other lien on
personal or real property securing the right. (perfection of a promissory note perfects
the mortgage even if you don’t perfect the mortgage)
6. [Security entitlement carried in securities account] Perfection of a SI in a securities
account also perfects a SI in the security entitlements carried in the securities account.
7. [Commodity K carried in commodity account] Perfection of a SI in a commodity account
also perfects a SI in the commodity Ks carried in the commodity account.
C. Perfection
1. If a SI is perfected, it is senior to most later creditor interests, including that of the
trustee in bankruptcy
2. A SI must first attach before perfection is possible
3. 4 Means of perfection
a. Filing a FS in the appropriate place (9-310(a))
b. Pledge for tangible collateral (goods, instruments, documents, chattel paper):
creditor’s taking physical possession of the collateral (9-310(b)(6))
c. Automatic perfection w/o filing or possession (9-309))
d. Achieving control of the collateral
II. Perfection by Possession (Pledge)
A. 9-313 (When Possession by or Delivery to Secured Party Perfects SI w/o Filing – only
tangible things)
1. [Perfection by possession or delivery] Except as otherwise provided in subsection (b), a
secured party may perfect a SI in negotiable documents, goods, instruments, money, or
tangible chattel paper by taking possession of the collateral. A secured party may
perfect a SI in certificated securities by taking delivery of the certificated securities
under 8-301.
2. [Goods covered by certificate of title] W/r/t goods covered by a certificate of title
issued by this State, a secured party may perfect a SI in the goods by taking
possession of the goods only in the circumstances described in 9-316(d).
3. [Collateral in possession of person other than debtor] W/r/t collateral other than
certificated securities and goods covered by a document, a secured party takes
possession of collateral in the possession of a person other than the debtor, the
secured party, or a lessee of the collateral from the debtor in the ordinary course of
the debtor's business, when:
a. the person in possession authenticates a record acknowledging that it holds
possession of the collateral for the secured party's benefit; or
b. the person takes possession of the collateral after having authenticated a record
acknowledging that it will hold possession of collateral for the secured party's
benefit.
4. [Time of perfection by possession; continuation of perfection] If perfection of a SI
depends upon possession of the collateral by a secured party, perfection occurs no
earlier than the time the secured party takes possession and continues only while the
secured party retains possession.
5. [Time of perfection by delivery; continuation of perfection] A SI in a certificated security
in registered form is perfected by delivery when delivery of the certificated security
occurs under 8-301 and remains perfected by delivery until the debtor obtains
possession of the security certificate
6. [Acknowledgment not required] A person in possession of collateral is not required to
acknowledge that it holds possession for a secured party's benefit.
7. [Effectiveness of acknowledgment; no duties or confirmation] If a person acknowledges
that it holds possession for the secured party's benefit:
a. the acknowledgment is effective under subsection (c) or 8-301(a), even if the
acknowledgment violates the rights of a debtor; and
b. unless the person otherwise agrees or law other than Art. 9 otherwise provides, the
person does not owe any duty to the secured party and is not required to confirm
the acknowledgment to another person.
8. [Secured party's delivery to person other than debtor] A secured party having
possession of collateral does not relinquish possession by delivering the collateral to a
person other than the debtor or a lessee of the collateral from the debtor in the
ordinary course of the debtor's business if the person was instructed before the
delivery or is instructed contemporaneously w/ the delivery:
a. to hold possession of the collateral for the secured party's benefit; or
b. to redeliver the collateral to the secured party.
9. [Effect of delivery under subsection (h); no duties or confirmation] A secured party does
 not relinquish possession, even if a delivery under subsection (h) violates the rights of a
debtor. A person to which collateral is delivered under subsection (h) does not owe any
duty to the secured party and is not required to confirm the delivery to another person
unless the person otherwise agrees or law other than Art. 9 otherwise provides.
10. OC2:
a. Goods, instruments, tangible negotiable documents, money, tangible chattel paper:
perfection by taking of possession
b. Accounts, commercial tort claims, deposit accounts, investment property, LOC rights,
LOCs, oil, gas, minerals before extraction: not by possession
c. Accounts, payment intangible (property not ordinarily represented by any writing
whose delivery operates to transfer the right to payment): perfection only by filing
d. Certain assignments of accounts or payment intangibles which are out of the
ordinary course of financing: filing exempted
e. Sales of payment intangibles: automatic perfection
B. Problem 296: Gracie owns The White Star of England, a famous large diamond currently
on display at the Astor Museum in NY. Brown has agreed to buy the diamond from
Gracie, and she has made a substantial down payment, w/ an agreement to make 3 more
payments before she gets possession. Gracie and Brown have signed the purchase
agreement, which contains a clause granting him a SI in his own diamond until she has
made all the required payments. Can he perfect a SI in the diamond by simply notifying
the Astor museum of the sale and telling the museum to hold it for his benefit until she
makes payment in full, thus creating an escrow arrangement in which possession is held
by the escrow agent?
1. Yes, authentication can be oral
2. 9-313(c): secured party takes possession of collateral in the possession of other person
in the ordinary course of the debtor’s business under the possessor’s acknowledgment
in an authenticated record
C. 7-403(3)
1. When the collateral is too large to be possessed by the secured party -> store the goods
in a warehouse and get a negotiable warehouse receipt
2. Warehouseman cannot surrender the goods unless the recipient turns over any
outstanding warehouse receipt
3. 9-312(c):
a. a SI in the good may be perfected by perfecting a SI in the document
b. a SI perfected in the document has priority over any SI that becomes perfected in the
goods by another method during that time
D. Problem 297: Kiddie Delight, a manufacturer of toys, wanted to borrow money and use it
inventory of toys as collateral. It called up Fred’s Field Warehouse Company, and Fred’s
came to the plant, put the inventory in a locked room, and posted a sign on the door
saying “Contents of Room Under Control of Fred’s Field Warehouse.” Fred’s then issued
a negotiable warehouse receipt deliverable to the order of Kiddie Delight. Fred’s hired
Mort Menial, the Kiddie Delight janitor, as its local warehouse custodian (Mort was paid
$1/week by Fred’s to mind the goods; he continued to receive his normal paycheck
from Kiddie Delight). Kiddie Delight pledged the warehouse receipt to MSB in return for a
loan. Kiddie
 Delight went bankrupt shortly thereafter.
1. By having possession of this document, did MSB have a perfected SI in the inventory?
a. No, MSB has a perfected SI in the warehouse receipt. But the secured party’s agent
(Mort) is so closely connected to the debtor (Kiddie) that Kiddie retained effective
possession of the inventory, and Mort’s taking possession of the inventory is not
sufficient for perfection (Kiddie Delight must be unable to get to the goods in the
warehouse!)
b. 9-312(c): SI in the goods covered by negotiable document may be perfected by
perfecting SI in the document
c. OC3 to 9-313:
i. The fact of dual agency (both as an agent of the secured party and as an agent of
the debtor) is not of itself inconsistent w/ the secured party’s having taken
possession.
ii. A court may determine that a person in possession is so closely connected to or
controlled by the debtor that the debtor has retained effective possession.
iii. If so, the person’s taking possession would not constitute the secured party’s taking
possession and would not be sufficient for perfection
2. Assume that warehouse receipt is validly issued and effective. If MSB and Kiddie Delight
signed a written SA covering the warehouse receipt and the inventory it represented
and if MSB gave Kiddie Delight the money, does MSB have a perfected SI in the
warehouse receipt even before MSB gets possession of it?
a. Yes, MSB has a 20-day period from the day of attachment even w/o filing or taking
possession (temporary perfection – grace period)
b. 9-312(e): temporary perfection for SI in negotiable documents or instruments for 20
days w/o filing or taking of possession or control
3. If Kiddie Delight (prior to bankruptcy) wanted to get the warehouse receipt back from
the bank in order to present it to the warehouseman, get the goods, clean them, return
them to the field warehouse, and get back the receipt for
rehypothecation(REATACHMENT) to MSB, will MSB lose its perfection by turning the
document over to the debtor?
a. No, the secured party may allow the debtor to have access to the goods to deal w/
them for sale or exchange w/o losing perfection (surrender for a temporary/limited
purpose)
b. 9-312(f): a perfected SI in a negotiable document or goods in possession of a bailee
(other than issuer of the negotiable document) remains perfected for 20 days if the
secured party makes available to the debtor the goods or documents for sale,
exchange, or processing preliminary to the sale or exchange
4. If MSB loses its perfection, who would you advise it to sue? The warehouse!
a. 7-204(1): a warehouse is liable for damages for loss of or injury to the goods caused
by its failure to exercise care w/r/t the goods that a reasonably careful person would
exercise under similar circumstances.
E. Problem 298: Karate was a self-defense training school. It pledged 36 of the promissory
notes given it by its customers to NFC in return for a loan. The parties signed a SA and NFC
took possession of the notes. 1 month later, Karate’s president, Arnold Sun, asked NFC to
 let him have back one of the notes so that he could present it to the customer for
payment (Art. 3 presentment). NFC gave him the note on April 6. Sun put it in his desk at
the school and forgot about it. On Oct. 12, Karate went bankrupt.
1. Does NFC have a perfected SI in any or all of the promissory notes?
a. No, after 20-day period, NFC lost perfection b/c of no filing or no possession
b. 9-312(g): perfected SI in instrument remains perfected for 20 days for presentment
c. 9-312(h): after 20-day period, perfection depends upon compliance w/ Art. 9
2. Would NFC have protected itself by filing a FS as to the promissory notes? Yes
a. 9-312(a): SI in chattel paper, negotiable documents, instruments, investment
property may be perfected by filing
F. 5-118: the issuer of a LOC always has a SI in bills of lading presented under the LOC until
the issuer is reimbursed by its customer (applicant)
III. Automatic Perfection
A. Meaning
1. The secured party need only make sure that its SI has attached and perfection is
thereby accomplished w/o the need for any further steps
a. All you have to do for perfection is attachment (e.g., by signing SA, and no further
steps required)
B. Purchase Money Security Interest (PMSI) in Consumer Goods
1. 9-309(1) (SI Perfected Upon Attachment)The following SIs are perfected when they
attach: a PMSI in consumer goods, except as otherwise provided in 9-311(b) w/r/t
consumer goods that are subject to a statute or treaty described in 9-311(a)
2. Reason: consumer goods are unlikely to be used as collateral twice and there are rarely
any later creditors to protect
a. If filing is required for PMSI for every consumer sale, there would be too many filings
3. Exception: motor vehicles requires notation of the lien interest on the certificate of title
(9-311(a)(2))
4. 9-103(a) definitions
a. PM collateral: goods or software that secures a PM obligation incurred w/r/t that
collateral
b. PM obligation: obligation of an obligor incurred as all or part of the price of the
collateral or for value given to enable the debtor to acquire rights in or the use of the
collateral if the value is in fact so used
i. loan of money or sale of goods by which the creditor gets the debtor able to
purchase the goods
5. Granted to sellers/lenders willing to extend credit permitted the debtor to acquire the
collateral
a. Superior equity in the collateral vis-à-vis other creditors, afforded w/ special
considerations by UCC
6. Problem 299: Bilko Siding put aluminum siding on Mr. and Mrs. Brown’s home. They
signed a K on Aug. 4, giving Bilko a SI in all their currently owned consumer goods plus
those acquired in the future. On Sept. 25, the Browns went to FFC and borrowed $80
for the stated purpose of buying a sewing machine. They signed a SA w/ FFC, granting it
a SI
 in the machine. FFC did not file a FS. The Browns bought the machine on Oct. 11. They
filed for bankruptcy on Oct. 12. Bilko, FFC and their trustee all claim the machine.
a. Did Bilko’s SI attach to the sewing machine? No
i. 9-204(b): SI does not attach under a term constituting an after-acquired property
clause to consumer goods unless the debtor acquires right in them within 10 days
after the secured party gives value
ii. In re Johnson: creditor’s SI in “all consumer goods” held totally invalid b/c the after-
acquired property clause is overbroad, unconscionable, and unfair as it had an in
terrorem effect on consumers
b. What did the bankruptcy judge mean in In re Johnson?
i. protect consumer’s basic need as to the consumer goods
c. Why would Bilko want a SI in a used sewing machine (w/ little resale value)?
i. To force the consumer to pay by any means by making them
inconvenient/uncomfortable w/o the hostage value collateral (wedding rings, baby
cribs, etc.)
d. Was the loan agreement a PMSI even though FFC was a lender and not the seller of
the machine?
i. Yes, lender, as well as seller, can be a PM creditor
ii. 9-103(a)(2): “obligation incurred . . . for value given to enable the debtor to acquire
the right in . . . the collateral”
e. Would it have been a PMSI if the Browns had used the $80 to pay a liquor bill and
had used $80 from their savings account to buy the sewing machine?
i. No, the value must be in fact so used (9-103(a)(2))
f. How can FFC protect themselves from the debtor’s misuse of the funds advanced?
i. By making the check payable to the consumer AND the sewing machine company
ii. 3-110(d): if an instrument is payable to 2 or more persons not alternatively, it may
be negotiated only by all of them
g. Assuming the $80 was used for the announced purpose, who gets the sewing
machine?
i. FFC b/c they (as a PM creditor) have a perfected PMSI in the sewing machine by
signing a SA (no filing of FS required to perfect PMSI). Equipment then file.
7. Bankruptcy Code 522(f): debtor is permitted in bankruptcy to avoid non-possessory, non-
PMSI in consumer goods
a. Issue: if a PM transaction has later been renegotiated and either consolidated w/
other debts or new money loaned, does it retain its PM character so as to escape
avoidance under BC 522(f)?
b. Congress wanted to condemn hostage value collateral
i. Refinancing problem: is PMSI transformed to non-PMSI by refinancing?
a) Automatic transformation (all or nothing) rule: PMSI is automatically transformed
into a non-PMSI when the proceeds of the renewal note are used to satisfy the
original note
b) Dual status rule: a lien may be partially PMSI and partially non-PMSI, and PM
aspect of a lien is not automatically destroyed by refinancing or consolidation w/
 other debt (BOP on creditor)
8. In re Short
a. Facts: P entered into a retail installment K to buy bedroom furniture. The K to pay
the debt, which granted a SI in the furniture, was assigned to D on date of signing. P
executed a note w/ D which consolidated the furniture debt w/ other debts. The
note listed the collateral as a continued PM interest in the bedroom furniture as well
as some other household items owned by P. There was no indication that D had a
PMSI in these other items. P then filed bankruptcy and moved to avoid D’s lien on all
the furniture, contending that the refinancing destroyed the PM character of the lien
and therefore the lien should be exempt from creditor process pursuant to BC
§522(f).
b. Hold: PMSI retains its character when the debt is consolidated w/ other obligations
and thus is not subject to avoidance under BC §522(f). §522(f) allows a debtor to
avoid the a lien on property that would otherwise be exempt if such a lien is a
nonpossessory, non-PMSI in consumer goods.
c. “dual status” approach: if collateral secures both a PMSI and a non-PMSI, so long as
the interests can be separated, a consolidation should not destroy the initial
character of the interests.
d. The Fed BC §522 Exemptions: when you go into bankruptcy and put all your assets in
you can take out individual assets. §522(f) allows debtor or trustee to set aside a SI in
non-PMSI for the creditor, but this cannot be done w/ a PMSI.
e. Notes
i. Why would Congress have enacted 522(f), which permits the debtor to avoid non-
possessory, non-PMSI in certain items? What policy is at work to restrict the use of
such collateral in lending? Note that Bilko in Problem 299 attempted to do this. B/c
most used consumer goods have little resale value, why would creditors want the
debtor to use them as collateral?
ii. Both FTC and FRB have issued regulations forbidding creditors from taking non-
possessory SI in household goods unless they are PMSI.
iii. The 1999 revision of Art. 9 now provides that in non-consumer goods cases, the
“dual status” rule prevails, and creates methods of allocating the payments so as
to ascertain what portion of the PM debt survives.
9. 9-103(e): [Application of payment in non-consumer-goods transaction] In a transaction
other than a consumer-goods transaction, if the extent to which a SI is a PMSI depends
on the application of a payment to a particular obligation, the payment must be
applied:
a. in accordance w/ any reasonable method of application to which the parties agree;
b. in the absence of the parties' agreement to a reasonable method, in accordance w/
any intention of the obligor manifested at or before the time of payment; or
c. in the absence of an agreement to a reasonable method and a timely manifestation
of the obligor's intention, in the following order:
i. to obligations that are not secured; and
ii. if more than one obligation is secured, to obligations secured by PMSIs in the order
in which those obligations were incurred.
10. 9-103(f): [No loss of status of PMSI in non-consumer-goods transaction] In a
transaction other than a consumer-goods transaction, a PMSI does not lose its status as
such, even if:
a. the PM collateral also secures an obligation that is not a PM obligation;
b. collateral that is not PM collateral also secures the PM obligation; or
c. the PM obligation has been renewed, refinanced, consolidated, or restructured.
11. 9-103(g): [Burden of proof in non-consumer-goods transaction] In a transaction other
than a consumer-goods transaction, a secured party claiming a PMSI has the burden of
establishing the extent to which the SI is a PMSI
12. Problem 300: Façade Motors decided to buy an expensive Oriental rug for its main
office. It selected one from the stock of Treasures of Persia which let FM take the rug
back to the office to try it out to see if it wanted to buy the rug. All of the equipment of
FM was covered by a perfected floating lien in favor of ONB.
a. As soon as FM gets possession of the rug (and before it decides whether it wants to
buy it) does ONB’s lien attach?
i. No, the sale of the rug is a “sale on approval,” so the rug is not subject to the claims
of FM’s creditor ONB until acceptance
ii. 2-326(1): Unless otherwise agreed, if delivered goods may be returned by the buyer
even though they conform to the K, the transaction is
a) A “sale on approval” if the goods are delivered primarily for use; and
b) A “sale or return” if the goods are delivered primarily for resale
iii. 2-326(2): Goods held on approval are not subject to the claims of the buyer’s
creditors until acceptance; goods held on sale or return are subject to such claims
while in the buyer’s possession
b. FM decided to purchase the rug, so it signed a K to do so w/ Treasures of Persia,
making a down payment at the time it did so. To finance the rest of the installment
payments, FM borrowed the necessary amount from NSL, giving it a SI in the rug.
Does NSL’s SI qualify as the PM kind?
i. No, FM acquired the rug on unsecured credit and subsequently created the SI to
secure the purchase price -> no close nexus b/w the acquisition of the rug and the
secured obligation
a) You may argue in other way (as in the next case)
ii. OC3: PMSI requires a close nexus b/w the acquisition of collateral and the secured
obligation. Thus, a SI does not qualify as a PMSI if a debtor acquires property on
unsecured credit and subsequently creates the SI to secure the purchase price
13. GE Capital Commercial Automotive Finance v. Spartan Motors
a. Rule: A PMSI status may be obtained even where debtor first obtains the property
and is later reimbursed by the purported PMSI creditor.
b. Outcome:
i. A perfected PMSI is an exception to the general 1st-in-time, 1st-in-right rule of
competing SIs and has super-priority over a prior SI in the same property. The PMSI
must meet the definition of a SI in 9-103: “(a) taken or retained by the seller of the
collateral to secure all or part of its price; or (b) taken by a person who by making
 advances or incurring an obligation gives value to enable debtor to acquire rights in
or the use of such collateral if such value is in fact so used.”
c. GMAC reimbursements to D/dealer were made 6 and 2 days after the respective
purchases, and such post-purchase reimbursement was common both in the trade
and in D’s dealings w/ its financiers. Here there’s no dispute that it was custom in the
trade and in D’s dealings w/ its financiers to reimburse the debtor following delivery
of the merchandise and title.
d. Note: figure out what was the intent of the parties and how closely related is the
subsequent advance to the purchase. Look at the transaction and ask whether this
was in furtherance of the purchase or separate and apart from it
C. Certain Accounts and Other Intangibles
1. 9-309(2) (SI Perfected Upon Attachment): an assignment of accounts or payment
intangibles which does not by itself or in conjunction w/ other assignments to the same
assignee transfer a significant part of the assignor's outstanding accounts or payment
intangibles
a. if it is not a transfer of a significant part, attachment w/o filing is sufficient for
perfection
b. OC4
i. Purpose: to save from ex post facto invalidation casual or isolated assignments
(which no one would think of filing)
ii. Any person who regularly takes assignments of any debtor’s accounts or payment
intangibles should file
2. 3 Tests
a. Significant part (percentage) test
b. Casual or isolated transaction (Official Comment) test
c. Both insignificant and ignorant (Gilmore) test
3. In re Wood
a. Facts: P loaned D $10K and took as SI a lien on D’s contingency interest in 2 cases he
was handling. D filed BK. P sued to enforce his SI
b. Rule: Distinguishing fact in determining whether an assignee of accounts receivable is
required to file for perfection would be whether assignee was involved in commercial
lending or regularly took assignment of accounts. If yes, assignee must file a FS.
i. 2 prong tests
a) Significnat part; AND
b) Casual isolated & not routine
ii. Attorney should be familiar w/ the importance of perfecting SI by filing and is
excluded from the members of the class protected under 9-309(1)(e) (Prof. thinks
this case is wrong)
c. Outcome: 9-302 exempts from the general filing requirements to perfect a SI in
accounts receivable in those situations where the assignment of such accounts do not
consitute a significant part of the accounts of the assignor. No filing is necessary
for isolated or casual assignments, where neither party may be aware of or have
reason to suspect the applicability of Art 9.
 d. Note:
i. The “percentage” test is subjective. Analyze the amount of assignment given to the
assignee. The other test, “the casual and isolated” test requires the court to
examine the circumstances surrounding the transaction, including the status of the
assignee, to determine whether the assignment was in fact “casual and isolated.”
ii. Automatic perfection seems to allow secret liens (remember this was a policy that
the idea of perfection attempts to remove). Automatic Perfection is therefore only
available on an extremely limited basis. Accordingly, many states have capped the
amount of money that a consumer good can cost for automatic perfection.
4. 9-309(3)~(14) (SI Perfected Upon Attachment):
a. a sale of a payment intangible;
b. a sale of a promissory note;
c. a SI created by the assignment of a health-care-insurance receivable to the provider
of the health-care goods or services;
d. a SI arising under 2-401, 2-505, 2-711(3), or 2A-508(5), until the debtor obtains
possession of the collateral;
e. a SI of a collecting bank arising under 4-210;
f. a SI of an issuer or nominated person arising under 5-118;
g. a SI arising in the delivery of a financial asset under 9-206(c);
h. a SI in investment property created by a broker or securities intermediary;
i. a SI in a commodity K or a commodity account created by a commodity intermediary;
j. an assignment for the benefit of all creditors of the transferor and subsequent
transfers by the assignee thereunder;
k. a SI created by an assignment of a beneficial interest in a decedent's estate; and
l. a sale by an individual of an account that is a right to payment of winnings in a lottery
or other game of chance
5. Problem 301: ONB sold all the promissory notes it was holding in its value to LNB. (The
sale of promissory notes is an Art. 9 transaction, w/ the seller being the “debtor” and
the buyer the “secured party” under 9-109(a)(3)). Must LNB file a FS or make sure it has
possession in order to perfect its SI in the notes?
a. No, sale of promissory note is automatically perfected when it attaches (9-309(4)).
6. Transfer of debts “w/ recourse” or “w/o recourse”
a. Automatic perfection rules for the sale of some types of debt apply only if a true sale
is taking place
i. In doubtful cases, file a FS or take possession of the promissory notes for perfection
b. W/ recourse
i. original seller must make up the deficiency if the underlying obligor does not make
full payment of the debts sold
ii. looks more like merely a loan than an outright sale b/c the seller of the debt keeps
any of the indicia of ownership -> buyer is arguably not automatically perfected
c. W/o recourse
i. buyer of the debt assumes both the risk that the debt won’t be paid and gets any
surplus if more is collected than the selling price -> automatic perfection
 7. Problem 302: When NFC loaned $20K to Portia to enable her to expand her law
practice, she gave NFC a SI in her accounts receivable which NFC promptly perfected by
fling a FS in the appropriate place. One of these accounts has a surety, the mother of
the client, who promised Portia that she would pay the debt if the client did not. What
must NFC do to perfect its interest in the surety obligation of the mother? (same rule
for automatic perfection extends to LOCs that support the original transaction)
a. NFC does not have to do anything b/c a SI is automatically perfected against the
surety’s supporting obligation once it attaches to the collateral
b. 9-203(f): [Proceeds and supporting obligations] the attachment of a SI in collateral
gives the secured party the rights to proceeds provided by 9-315 and is also
attachment of a SI in a supporting obligation for the collateral
c. 9-308(d): [Supporting obligation] perfection of a SI in collateral also perfects a SI in a
supporting obligation for the collateral
d. 9-102(a)(77): “supporting obligation” means a LOC right or secondary obligation that
supports the payment or performance of an account, chattel paper, a document, a
general intangible, an instrument, or investment property
e. 9-102(a)(71): “secondary obligor” means an obligor to the extent that
i. The obligor’s obligation is secondary; or
ii. The obligor has a right of recourse w/r/t an obligation secured by collateral against
the debtor, another obligor, or property of either
IV. Perfection by Filing
A. The Mechanic of Filing
1. Except for the transactions listed in 9-310, the filing of a FS is the exclusive method of
perfection of the creditor’s SI
2. Central filing in the office of the Secretary of State for almost all FS
a. 9-501: Local county filing only for matters having to do w/ realty (minerals to be
extracted from the earth, timber or fixture)
3. Problem 303: Hamlet Corp. borrowed $100K from EFC and gave it a SI in HC’s
equipment. The parties properly filed out a FS and Shakespeare was mentioned on
the FS as the president of HC. EFC gave the FS and the filing fee to a clerk at the
Secretary of State’s Office. The clerk indexed the FS under “Shakespeare” instead of
“Hamlet.” 1 yr later, another finance company loaned HC more money, taking a SI in
the same equipment. Since priority of creditors depends on order of filing (9-322(a)
(1)), did EFC “file” first, or did it bear the risk of clerical error? MANUFACTURED 30
YEARS.
a. EFC filed its FS first b/c the indexing error does not affect the filing (as long as other
creditors do something)
b. 9-516(a): [What constitutes filing] Except as otherwise provided in subsection (b),
communication of a record to a filing office and tender of the filing fee or acceptance
of the record by the filing office constitutes filing.
c. 9-517: The failure of the filing office to index a record correctly does not affect the
effectiveness of the filed record.
d. OC2 to 9-517 (Effectiveness of Mis-Indexed Records): the risk of filing-office error is
imposed on those who search the files rather than on those who file
 e. In re Butler’s Tire & Battery: creditor not protected where creditor’s error caused
filing official’s mistake
f. Whichever creditor loses should sue the state for negligence.
i. Some states have set aside a fund from the filing fees w/ which to pay judgments
against the filing officer
B. Other Filings
1. Duration and Effectiveness of FS
a. 9-102(a)(67): FS is effective for 5 yrs
i. It lapses unless a continuation statement is filed within 6 months before the
expiration
b. 9-102(a)(53): Public finance transaction and manufactured home transactions
effective for 30 yrs
2. 9-515 (Duration and Effectiveness of FS; Effect of Lapsed FS)
a. [5-yr effectiveness] Except as otherwise provided in subsections (b), (e), (f), and (g), a
filed FS is effective for a period of 5 yrs after the date of filing.
b. [Public-finance or manufactured-home transaction] Except as otherwise provided in
subsections (e), (f), and (g), an initial FS filed in connection w/ a public-finance
transaction or manufactured-home transaction is effective for a period of 30 yrs after
the date of filing if it indicates that it is filed in connection w/ a public-finance
transaction or manufactured-home transaction.
c. [Lapse and continuation of FS] The effectiveness of a filed FS lapses on the expiration
of the period of its effectiveness unless before the lapse a continuation statement is
filed pursuant to subsection (d). Upon lapse, a FS ceases to be effective and any SI or
agricultural lien that was perfected by the FS becomes unperfected, unless the SI is
perfected otherwise. If the SI or agricultural lien becomes unperfected upon lapse, it
is deemed never to have been perfected as against a purchaser of the collateral for
value.
d. [When continuation statement may be filed] A continuation statement may be filed
only within 6 months before the expiration of the 5-yr period specified in subsection
(a) or the 30-yr period specified in subsection (b), whichever is applicable.
e. [Effect of filing continuation statement] Except as otherwise provided in 9-510, upon
timely filing of a continuation statement, the effectiveness of the initial FS continues
for a period of 5 yrs commencing on the day on which the FS would have become
ineffective in the absence of the filing. Upon the expiration of the 5-yr period, the FS
lapses in the same manner as provided in subsection (c), unless, before the lapse,
another continuation statement is filed pursuant to subsection (d). Succeeding
continuation statements may be filed in the same manner to continue the
effectiveness of the initial FS.
f. [Transmitting utility FS] If a debtor is a transmitting utility and a filed FS so indicates,
the FS is effective until a termination statement is filed.
g. [Record of mortgage as FS] A record of a mortgage that is effective as a FS filed as a
fixture filing under 9-502(c) remains effective as a FS filed as a fixture filing until the
mortgage is released or satisfied of record or its effectiveness otherwise terminates
 as to the real property.
3. Assignment of SI
a. 2 creditors MAY(not compulsory) file an assignment statement
b. 9-512: The procedure to be followed when the debtor and the secured party want to
free some of the collateral from coverage under a filed FS
c. 9-514 (Assignment of Powers of Secured Party of Record)
i. [Assignment reflected on initial FS] Except as otherwise provided in subsection (c),
an initial FS may reflect an assignment of all of the secured party's power to
authorize an amendment to the FS by providing the name and mailing address of
the assignee as the name and address of the secured party.
ii. [Assignment of filed FS] Except as otherwise provided in subsection (c), a secured
party of record may assign of record all or part of its power to authorize an
amendment to a FS by filing in the filing office an amendment of the FS which:
a) identifies, by its file number, the initial FS to which it relates;
b) provides the name of the assignor; and
c) provides the name and mailing address of the assignee.
iii. [Assignment of record of mortgage] An assignment of record of a SI in a fixture
covered by a record of a mortgage which is effective as a FS filed as a fixture filing
under 9-502(c) may be made only by an assignment of record of the mortgage in the
manner provided by law of this State other than UCC.
4. Problem 304: ONB had a SI in the equipment of WCC for which it filed a FS in the
proper place on May 1, 2009. ANB took a SI in the same collateral and filed its FS on
May 2, 2009 in the same place
a. How long is a FS effective?
i. 5 yrs under 9-515(a) (expires on May 1, 2014)
b. If ONB files a continuation statement on May 1, 2013, is its perfected position
continued?
i. No, this is a premature renewal (should file a CS b/w Nov. 1, 2013 and May 1, 2014)
ii. 9-515(d): A CS may be filed only within 6 months before the expiration of the 5-yr or
30-yr period
iii. 9-510(c): A CS that is not filed within the 6-month period is ineffective
c. If ONB never files a CS at all, after May 1, 2020, does it nonetheless retain its priority
over ANB (who, after all, always thought of itself as junior to ONB’s prior filing and
would get a windfall if it suddenly prevails)? No
i. ONB’s SI is deemed to have never been perfected as against a purchaser of the
collateral for value
a) Is junior secured party is a purchaser of the collateral for value? Yes
1. 1-201(b)(29) & (30): purchase include taking SI!
ii. 9-515(c): Upon lapse, a FS ceases to be effective and a SI becomes unperfected as if
it has never been perfected as against a purchaser of the collateral for value
d. If ONB fails to file a CS in time, so that its perfection lapses, but a week later it files
another FS, is it still senior to ANB?
i. No if ANB files a CS in time (there is a gap period)
 e. Is an attorney who fails to file a CS guilty of malpractice? Yes
i. Even if the attorney warned the client to file a CS, he is liable unless he himself
should have filed it
ii. Barnes v. Turner: the lawyer breached his duty at the time the 5-yr period of
effectiveness for the FS expired, when he failed to inform the client of the renewal
requirement or renew the statement
5. Problem 305: When Portia paid off her debt to LNB, which had loaned her $3K to buy a
computer for her law office and taken a PMSI therein, for which it had duly filed a FS,
she wanted LNB to clear up the records down at the filing office.
a. Does she have this right? Yes
i. 9-513(a)(1): a secured party shall cause the secured party of record for a FS to file a
termination statement for the FS if the FS covers consumer goods and there is no
obligation secured by the collateral and no commitment to make an advance, incur
an obligation or otherwise give value. 9-625 DAMAGES
b. What can she do if they stiff-arm her?
i. She may file an amendment to the FS on her own and file for damages (punitive
damages in addition to actual damages)
ii. 9-509(d)(2): A person may file an amendment (other than an amendment that adds
collateral or a debtor) only if the amendment is a TS for a FS
iii. 9-625(b) & (e)(4): damages in the amount of any loss caused by noncompliance &
$500 (per wrongful filing)
6. Open drawer concept of file searches
a. Later searchers are given absolutely everything related to the original FS so that they
have complete info
b. Definition of FS includes an original filing and all related amendments
c. 9-522(a): filing office must maintain all filings until at least 1 yr after the filing has
lapsed
d. 9-519(g): removal of a debtor’s name from the index is prohibited until 1 yr after
complete lapse
e. Note: effectiveness of the termination cannot be ascertained from the public record
i. It needs to have been properly authorized to be effective
7. Problem 306: Andrew filed 42 phony FS in the public records showing that all of Sam’s
assets were security for various nonexistent loans in favor of Andrew, the secured party
of the record. What can Sam do to clear up these clouds on this title to his property
(which the common law would have regarded as defamation)?
a. Sam must send an authenticated demand to Andrew. If Andrew does not send a TS,
Sam may authorize the filing of a TS. He may also file a correction statement.
Otherwise, he could resort to traditional judicial recourse. He could recover damages
under 9-625.
b. 9-513(c): within 20 days after a secured party receives an authenticated demand
from a debtor, the secured party shall send to the debtor a TS for the FS or file
the TS if there is no obligation secured by the collateral
c. OC3 to 9-513: the putative secured party is deemed to have received a notification,
 and if a TS is not forthcoming, the debtor may authorize the filing of a TS
d. 9-518 (Claim Concerning Inaccurate or Wrongfully Filed Record)
i. [Correction statement] A person may file in the filing office a correction statement
w/r/t a record indexed there under the person's name if the person believes that
the record is inaccurate or was wrongfully filed.
ii. [Alternative A][Sufficiency of correction statement] A correction statement must:
a) identify the record to which it relates by the file number assigned to the initial FS
to which the record relates;
b) indicate that it is a correction statement; and
c) provide the basis for the person's belief that the record is inaccurate and indicate
the manner in which the person believes the record should be amended to cure
any inaccuracy or provide the basis for the person's belief that the record was
wrongfully filed.
iii. [Alternative B][Sufficiency of correction statement] A correction statement must:
a) identify the record to which it relates by:
1. the file number assigned to the initial FS to which the record relates; and
2. if the correction statement relates to a record filed [or recorded] in a filing
office described in 9-501(a)(1), the date [and time] that the initial FS was
filed [or recorded] and the information specified in 9-502(b);
b) indicate that it is a correction statement; and
c) provide the basis for the person's belief that the record is inaccurate and indicate
the manner in which the person believes the record should be amended to cure
any inaccuracy or provide the basis for the person's belief that the record was
wrongfully filed.
iv. [Record not affected by correction statement] The filing of a correction statement
does not affect the effectiveness of an initial FS or other filed record.
e. OC3 to 9-518 (Resort to Other Law): A summary judicial procedure for correcting the
public record and criminal penalties are likely to be more effective
f. 9-625(b): damages in the amount of any loss caused by noncompliance
g. 9-625(e)(3) & (4): $500
V. Perfection by Control
A. 9-314(a): a SI in investment property, deposit accounts, LOC rights, or electronic chattel
paper may be perfected by control of the collateral under 9-104, 9-105, 9-106, or 9-107.
B. Control: the secured party has taken the steps described in these sections so it is obvious
to anyone investigating the state of the collateral that the secured party has right therein

CHAPTER 21. MULTISTATE TRANSACTIONS

I. General Choice of Law Rules
A. 9-301 (Law Governing Perfection and Priority of SI)
1. Domicile approach: looks to the law of the debtor’s location as the state in which the
steps for perfection need to be taken
2. While collateral is located in a jurisdiction, the local law of that jurisdiction governs
perfection, the effect of perfection or non-perfection, and the priority of a possessory SI
 in that collateral (if pledged)
3. If the collateral has physical form (negotiable documents, goods, instruments, money,
or tangible chattel paper), the law of the jurisdiction in which the collateral is located
will govern issues involving priority and other Art. 9 matters (effect of perfection)
a. Perfection of a SI in the goods by filing a fixture filing
b. Perfection of a SI in timber to be cut
c. The effect of perfection or non-perfection and the priority of a non-possessory SI in
the collateral
B. Problem 307: Mary lived in a home she owned in WY, and wanted to buy a large
sailboat in OH, planning to keep the boat there after the purchase. OH law provides that
whenever a consumer has paid more than 75% of a debt secured by consumer
goods (except automobiles), the creditor’s SI automatically is stripped from the consumer
goods, but WY has no such rule.
1. If a creditor loans Mary money to buy the sailboat and takes a SI in it, where should he
file the FS?
a. As the debtor lives in WY, the WY law determines perfection (OH law only governs
the effect of perfection and the priority of a non-possessory SI)
2. When Mary has paid 75% of the debt, will the creditor’s SI still be attached to the boat?
a. No. Since the boat has physical form, the OH law governs issues involving effect of
perfection. Thus, upon payment of 75% of the debt, the SI is stripped
C. Special choice of law rules for certain kinds of collateral: the law where the collateral is
located
1. Minerals to be extracted from the ground: 9-301(4)
2. Agricultural liens: 9-302
3. Goods covered by a certificate of title: 9-303
4. Deposit accounts: 9-304
5. Investment property: 9-305
6. LOC rights: 9-306
D. Problem 308: Peripatetic Corp. was organized under DE law, but has its large retail store
outlet in NJ. PC as really a husband-and-wife type of business, and they did all the corp.
paperwork at their home in ML (where they also kept the corp. records). Their corp.
stationery used their home address.
1. When PC borrows money against its accounts receivable, in what state should the FS be
filed?
a. DE b/c PC is a corporation organized under the DE law (9-307(e))
b. 9-307(b) (debtor’s location: general rules)
i. A debtor who is an individual is located at the individual’s principal residence
ii. A debtor that is an organization and has only one place of business is located at its
place of business
iii. A debtor that is an organization and has more than one place of business is located
at its chief executive office
c. 9-307(e): a registered organization that is organized under the law of a State is
located in that State
 2. If PC was registered in the Republic of Jahala, a Pacific island nation, where should the
FS be filed?
a. If Jahala has a system similar to Art 9 for filing of non-possessory SI in public records,
Jahala law must be complied with. If not, filing should be in D.C.
b. 9-307(c): subsection (b) applies only if a debtor’s residence, place of business, or
chief executive office, as applicable, is located in a jurisdiction whose law generally
requires information concerning the existence of a non-possessory SI to be made
generally available in filing, recording, or registration system as a condition or
result of a SI’s obtaining priority over the rights of a lien creditor w/r/t the collateral.
If (b) does not apply, the debtor is located in D.C.
E. Principal place of business
1. “Frequent and notorious” to “probable potential creditors”
2. “factual” principal place of business
3. An occasional use or occupation of a place for business purpose is NOT sufficient to
constitute it as a place of business
F. Problem 309: Factory, Factory & Money is a legal partnership that has its only place of
business in IL, where ONB, which has a SI in the accounts receivable of the firm, had filed
its FS.
1. If FFM makes a permanent move to D.C., on Jan. 1, 2013, does the bank lose its
perfection or does it have a grace period in which to refile in the new jurisdiction?
a. 4 months from Jan. 1, 2013 (grace period – general rule)
b. 9-316(a): SI perfected pursuant to the law of the jurisdiction remains perfected until
the earliest of
i. The time perfection would have ceased under the law of that jurisdiction
ii. The expiration of 4 months after a change of the debtor’s location to another
jurisdiction, or
iii. The expiration of 1 yr after a transfer of collateral to a person that thereby become a
debtor and is located in another jurisdiction
2. If FFM merges w/ a law firm in D.C., w/ the new D.C. firm assuming all the debts of the
former one, is the time period the same?
a. 1 yr from Jan. 1, 2013 (9-316(a)(3) – new debtor exception)
G. Problem 310: Suppose that FFM had 2 creditors before its permanent move to D.C., both
of which had a perfected SI in the firm’s accounts receivable – ONB, which had filed its FS
first, and LNB, which had filed second, both creditors filing in IL early in 2012. When the
move occurred on Jan. 1, 2013, LNB promptly filed in D.C. before the end of March of
2012, but ONB files in D.C. only in September. Will ONB retain its priority over LNB?
1. No, ONB’s SI is deemed never to have been perfected (LNB now has priority over ONB)
2. 9-316(b): If a SI becomes perfected under the law of the other jurisdiction before the
earliest time or event, it remains perfected thereafter. If the SI does not become
perfected under the law of the other jurisdiction before the earliest time or event, it
becomes unperfected and is deemed never to have been perfected as against a
purchaser of the collateral for value
3. OC3: The SI becomes unperfected prospectively and, as against purchasers for value,
 including buyers and secured parties, but not as against donee or lien creditors,
retroactively
II. Certificates of Title
A. Good faith purchaser buying from someone w/ voidable title
1. 2-403(1): A purchaser of goods acquires all title which his transferor had or had power
to transfer except that a purchaser of a limited interest acquires rights only to the
extent of the interest purchased. A person w/ voidable title has power to transfer a
good title to a good faith purchaser for value. When goods have been delivered under a
transaction of purchase the purchaser has such power even though
a. the transferor was deceived as to the identity of the purchaser, or
b. the delivery was in exchange for a check which is later dishonored, or
c. it was agreed that the transaction was to be a "cash sale", or
d. the delivery was procured through fraud punishable as larcenous under the criminal
law
2. Another way to protect automobile owners: certificate of title
a. In some jurisdictions, certificate of title is required for boats or motorcycles
B. Problem 311: Saylor was a trucker who lived and worked in MI. He went to PA and
purchased a truck on credit from Ringer Truck City. B/c IN charged less for licenses and
other registration fees, Saylor told the dealership that he lived in IN and that the truck
would be domiciled there. He gave RTC the address of his sister, who live in IN. IN law
requires that lien interests be noted on the certificate of title, a step that RTC duly took
when it procured the IN certificate. When Saylor went bankrupt 1 yr later, the trustee in
bankruptcy argued that RTC was unperfected as it had not gotten a MI certificate of title
and had its lien interest noted thereon, as MI law required. RTC argued that it was
entitled to believe the debtor when he told the company that he lived in IN. How should
this come out?
1. RTC wins b/c 9-303 applies even if there is no relationship b/w IN and the truck or Saylor
2. 9-303(a): This section applies to goods covered by a certificate of title, even if there is
no other relationship b/w the jurisdiction under whose certificate of title the goods
are covered and the goods or the debtor
a. Policy: no matter where it is from, it is okay as long as there is only one certificate of
title
C. Meetzger v. Americredit Financial Services
1. Fact: A third person purchased a car in NY. The holder financed the purchase and the
NY certificate of title issued to the person reflected the holder's SI in the car. The
person later moved to GA and, by a clerical error, a GA certificate of title was issued not
reflecting the holder's SI in the car. The person later transferred the car to an
automobile dealer and, eventually, the buyer purchased it. After the buyer registered
the car, the holder located it, repossessed it, and sold it at auction.
2. Hold: The buyer took the car free of the SI pursuant to 9-337. Although the holder's SI in
the car remained perfected at the time that the buyer purchased the car, that SI could
not be enforced against the buyer, a good faith purchaser as defined in 9-337(1), since
the SI was not properly reflected on the GA certificate of title.
D. Problem 312: On May 10, Holly, a resident of TX, bought a new car on credit while on
vacation in OK, from NCS. OK law required lien interests to be noted on the certificate of
title as a condition of perfection, which NCS did on May 12. On May 14, Holly drove the
car to TX and that same day she reregistered the car there and a received a TX certificate
w/o surrendering the OK certificate (though TX law required to turn in the old certificate
before a new one should have been issued). TX required lien interests to be noted on the
certificate of title as a condition of perfection, but the TX certificate showed no liens
of any kind thereon. On May 26, Holly sold the cart to her neighbor William, who paid in
full value w/o knowledge of NCS’s interest. On May 28, learning of sale to William, NCS
repossessed the car.
1. Assuming that her resale of the car was a “default” so as to entitle NCS to repossess,
decide which of them is entitled to the car.
a. William takes car free of NCS’s lien b/c he had no knowledge of the SI under 9-337
i. But, car dealership will argue that William must have had knowledge of the SI in the
car although the certificate of title did not reflect it (b/c he is her neighbor!)
b. 9-303(a): 9-303 applies even if there is no relationship b/w IN and the truck or Saylor
c. OC6 to 9-303: it is assumed that the certificate-of-title statutes to which they apply
have no relation–back provisions (provisions under which perfection is deemed to
occur at a time earlier than when the perfection steps actually are taken)
d. 9-316(d): a SI in goods covered by a certificate of title which is perfected by any
method under the law of another jurisdiction when the goods become covered by a
certificate of title from this State remains perfected until the SI would have become
unperfected under the law of the other jurisdiction had the goods not becomes so
covered (even though the certificate of title in this State ceases to exist, the original
creditors are protected)
e. 9-316(e): A SI described in subsection (d) becomes unperfected as against a
purchaser of the goods for value and is deemed never to have been perfected
as against a purchaser of the goods for value if the applicable requirements for
perfection under 9-311(b) or 9-313 are not satisfied before the earlier of: (exception
to (d) – when we don’t protect prior creditors)
i. the time the SI would have become unperfected under the law of the other
jurisdiction had the goods not become covered by a certificate of title from this
State; or
ii. the expiration of 4 months after the goods had become so covered.
f. OC5 to 9-316:
g. 9-337 (Priority of SI in Goods Covered by Certificate of Title) If, while a SI in goods is
perfected by any method under the law of another jurisdiction, this State issues a
certificate of title that does not show that the goods are subject to the SI or contain a
statement that they may be subject to SIs not shown on the certificate:
i. a buyer (not purchasers) of the goods, other than a person in the business of selling
goods of that kind (dealers), takes free of the SI if the buyer gives value and receives
delivery of the goods after issuance of the certificate and w/o knowledge of the SI;
and
ii. the SI is subordinate to a conflicting SI in the goods that attaches, and is perfected
 under 9-311(b), after issuance of the certificate and w/o the conflicting
secured party's knowledge of the SI. (when value was given later, creditors still
protected)
h. OC to 9-337: a buyer can take free of, and the holder of a conflicting SI can
acquire priority over, a SI perfected in another jurisdiction if such SI is not
reflected in the certificate of title in this State
2. Note that 9-337 favors nonbusiness buyers; a used car lot buying an out-of-state
vehicle is not entitled to the same protection. Why would the drafters have made
this distinction?
a. A more sophisticated business buyer is likely to know the rules
E. Problem 313: Armstrong bought a yacht in State A that did not use certificates of title
for boats and that required filing for perfection in such collateral, which step the
financing bank ONB duly took. He moved to State B that required all SI on boats to be
noted on certificates of title issued by State B, but he never took the trouble to get such
a certificate.
1. Does ONB’s perfection in State B last as long as its filed FS is still effective or for only
4 months?
a. ONB’s perfection in State B lasts only for 4 months after his move to State B (ONB
need get certificate of title in State B)
b. 9-316(a): must be perfected in 4 months from relocation unless it is merge (in
that case 1 yr)
2. Suppose that Armstrong starts in State B and ONB’s interest is duly noted on State
B’s certificate. Then he moved to State A that has no certificates of title at all, ONB
never files there, and he never re-registers the yacht. Now what result?
a. No problem at all (ONB’s original perfection remains good until a new one is
issued) b. 9-303:
c. OC:
 CHAPTER 22. PRIORITY
Multiple security interests on the same collateral.
I. Simple Disputes
A. 9-317 (Interests That Take Priority over or Take Free of SI or Agricultural Lien)
1. [Conflicting SIs and rights of lien creditors] A SI or agricultural lien is subordinate to
the rights of:
a. a person entitled to priority under 9-322; and (first-to-file-or-perfect)
b. except as otherwise provided in subsection (e), a person that becomes a lien
creditor before the earlier of the time:
i. the SI or agricultural lien is perfected; or
ii. one of the conditions specified in 9-203(b)(3) is met and a FS covering the
collateral is filed. (not important)
2. [Buyers that receive delivery] Except as otherwise provided in subsection (e), a
buyer, other than a secured party, of tangible chattel paper, documents, goods,
instruments, or a security certificate takes free of a SI or agricultural lien if the buyer
gives value and receives delivery of the collateral w/o knowledge of the SI or
agricultural lien and before it is perfected.
3. [Lessees that receive delivery] Except as otherwise provided in subsection (e), a lessee
of goods takes free of a SI or agricultural lien if the lessee gives value and receives
delivery of the collateral w/o knowledge of the SI or agricultural lien and before it is
perfected.
4. [Licensees and buyers of certain collateral] A licensee of a general intangible or a buyer,
other than a secured party, of accounts, electronic chattel paper, general intangibles, or
investment property other than a certificated security takes free of a SI if the licensee
or buyer gives value w/o knowledge of the SI and before it is perfected.
5. [PMSI] Except as otherwise provided in 9-320 and 9-321, if a person files a FS w/r/t a
PMSI before or within 20 days after the debtor receives delivery of the collateral, the SI
takes priority over the rights of a buyer, lessee, or lien creditor which arise b/w the time
the SI attaches and the time of filing.
B. Problem 314: Epstein’s Bookstore borrowed $10K from ONB, signing a SA giving ONB a
floating (existing and future assets) covers existing and after acquired lien over its
inventory. ONB never got around to filing the FS. Martin’s Travel Service was unpaid
creditor of EB that sued on the debt and recovered a judgment against EB. It then had the
sheriff levy on the inventory. A FLOATING LIEN IS DIFFERENT FROM A PMSI. PMSI ENABLES
DEBTOR TO ACQUIRE GOODS. PMSI CAN BE ACCOMPLISHED FROM SELLING THE GOODS
OR FROM SOMEONE GOING TO A BANK. BANK IS NOT THE SELLER BUT IT IS A PURCHASE
MONEY LOAN. LOAN THAT ALLOWS DEBTOR TO PURCHASE THE GOODS.
FOUR CREDITORS
1. JAN. 4, 2011 – THEN A FLOATING LIEN ON INVENTORY
2. JAN. 4, 2012 – THEN SECOND TAKES A FLOATING LIEN
3. JAN. 4, 2013 – THIRD FLOATING LIEN
4. JAN. 4, 2014 – PMSI LIEN
CODE FAVORS PMSI TO ENCOURAGE COMMERCE. IF YOU DON’T ALLOW PEOPLE TO
 BUY NEW GOODS. THIS CREDITOR CAN GET PROTECTED AS TO MONEY IT IS LOANING.
THE PMSI AS TO THOSE ITEMS IS NOW NUMBER 1 AS TO PRIORITY.
1. STATUTORY LIENS – FEDERAL TAX LIEN.
2. COMMON LAW LIENS – ARTISAN’S LIEN.
3. JUDICIAL LIEN – LIEN THAT ARISES BECAUSE OF A JUDGMENT. JUDGEMENT
CREDITOR – LEVIED EXECUTION AGAINST THE COLLATERAL.
4. CONSENSUAL – ARISE FROM AGREEMENT.
PERFECTION
5. Does ONB (SELF HELP OR JUDICIAL REPOSSESION) d first b/c a lien creditor (due to the
levy) has priority over unperfected SI
a. 9-317(a)(2): A SI is subordinate to a person that becomes a lien creditor before the SI
is perfected
b. 9-102(a)(52): "Lien creditor" means:
i. a creditor that has acquired a lien on the property involved by attachment, levy, or
the like; (judicial creditor)
ii. an assignee for benefit of creditors from the time of assignment; (state proceeding
– private bankruptcy like thing)
 iii. a trustee in bankruptcy from the date of the filing of the petition; or (has a status of
judicial lien creditor under strong arm clause of Federal Bankruptcy Code)
iv. a receiver in equity from the time of appointment
6. If, instead of a judgment creditor’s seizing the goods, EB had filed a bankruptcy petition
while ONB’s lien was still unperfected, what result?
a. The trustee in bankruptcy will have priority over ONB’s unperfected SI
C. Problem 315: CTA used its accounts receivable as collateral for a loan from MSB which
failed to file the FS. 6 months later, CTA needed another loan and applied for one from
BNB, which searched the files, discovered that there were no FS recorded for CTA as
debtor, and took a SI in CTA’s accounts receivable. BNB did file a FS in the proper place.
Which bank has the superior interest in the collateral?
PERFECTED ALWAYS WINS AGAINST UNPERFECTED. BUT FILED IN COURT BEFORE HAD
POSSESSION.
1. BNB’s perfected SI has priority over MSB’s unperfected SI
2. 9-322(a)(2): A perfected SI or agricultural lien has priority over a conflicting unperfected
SI or agricultural lien
3. OC3 to 9-317: the SI given priority under 9-322 take priority in general even over a
perfected SI
D. 9-322 (Priorities Among Conflicting SIs in Some Collateral)
1. (a)(1): (first-to-file-or-perfect rule) conflicting perfected SIs and agricultural liens rank
according to priority in time of filing or perfection GENERAL RULE, FIRST TO PERFECT
WINS.
2. (a)(2): perfected SI has priority over unperfected SI
3. (a)(3): first SI to attach or become effective has priority over unperfected SI
E. Problem 316: Jay ran a clothing store and needed money. He went to 2 banks, FNB and
SSB, and asked each to loan him money using his inventory as collateral. They each made
him sign a SA. FNB filed its FS first, on Sept. 25 but did not loan Jay any money (nor did it
make any commitment to do so) until Nov. 10. On Oct. 2, SSB loaned Jay the money and
filed its FS. Jay paid neither bank.
1. Did both banks have a perfected SI, assuming they filed in the proper place? That is, is it
possible for 2 creditors to have perfected SI in the same collateral? Yes
2. Remembering that attachment is a prerequisite to perfection (9-308), and that
attachment cannot occur until the creditor gives value, decide which bank has the
superior right to the inventory?
a. FNB (filed first although not perfected) has the superior right to the inventory over
SSB b/c FNB filed first (SSB perfected later)
i. This is why FSs are often filed before attached
b. Ex 1 in OC4 to 9-322: On Feb. 1, A files a FS covering a certain item of Debtor’s
equipment. On March 1, B filed a FS covering the same equipment. On April 1, B
makes a loan to Debtor and obtains a SI in the equipment. On May 1, A makes a loan
to Debtor and obtains a SI in the same collateral. A has priority even though B’s loan
was made earlier and was perfected when made. It makes no difference whether A
knew of B’s SI when A made its advance (first-to-file-or-perfect)
 3. If SSB had knowledge of the transaction b/w Jay and FNB at the time it perfected, does
that affect its priority? No (courts are clear on that we don’t have to ask who knew
what)
a. St. Paul Mercury Ins. V. Merchants & Marine Bank: the company’s knowledge of the
contractor’s assignment to the insurer was irrelevant for determining priority of
claims
F. Problem 317: When FNB took a perfected SI in the inventory of Jay’s clothing store, the SA
provided that the inventory would secure not only the current loan “but all future
advances of whatever kind (future advances clause).” 6 months later, FNB loaned Jay an
additional
$10K and had him sign a new promissory note for that amount. Do the existing filed FS
and SA need to be altered in any way, or are they sufficient as is to protect FNB?
1. They are sufficient to protect FNB as it is
2.9-204(c): SA may provide that collateral secures, or that accounts, chattel paper,
payment intangibles, or promissory notes are sold in connection with, future advances
or other value, whether or not the advances or value are given pursuant to
commitment (protects future advance clause and expand collateral to future debts)
file continuance within 6 months.
3. OC5: parties are free to agree that a SI secures any obligation whatsoever
G. Problem 318: (Spent FS problem) Assume in Problem 317 that after FNB made Jay the first
loan and filed its FS, he then borrowed more money from SSB, using the same inventory as
collateral, and this lender also filed a FS in the correct place. Jay then paid off the loan to
FNB completely, but FNB never filed a termination statement. 1 month later, FNB loaned
Jay more money. The parties signed a new SA, but no new FS was filed. FNB’s attorney
reasoned that the earlier FS would protect the later loan’s priority, even though this loan
was not contemplated when the first FS was filed.
1. Is this right? SSB would prefer that the court rule that the first FS was “spent” when the
underlying debt was paid off, and could not be used to give a top priority to a later
uncontemplated loan.
a. Yes, by the future advance clause, you can extend new value and use an existing FS to
perfect that agreement, whether the original loan was paid off or not.
a. 9-323(a): for purposes of determining the priority of a perfected SI under 9-322(a)(1),
perfection of the SI dates from the time an advance is made to the extent that the SI
secures an advance that:
FILE TO PERFECT.
i. Is made while the SI is perfected only;
a) Under 9-309 when it attaches; or
b) Temporarily under 9-312(e), (f), or (g); and
ii. Is not made pursuant to a commitment entered into before or while the SI is
perfected by a method other than under 9-309 or 9-312(e), (f) or (g)
b. Ex 1 of OC3 to 9-323: On Feb. 1, A makes an advance secured by machinery in
Debtor’s possession and files a FS. On March 1, B makes an advance secured by
the same machinery and files a FS. On April 1, A makes a further advance, under the
original SA, against the same machinery. A was the first to file and so, under the
first-to-file-or- perfect rule of 9-322(a)(1), A’s SI has priority over B’s, both as to the
Feb. 1 and as to the April 1 advance. It makes no difference whether A knows of
B’s intervening
 advance when A makes second advance. As long as A was the first to file or perfect, A
would have priority w/r/t both advances if either A or B had perfected by taking
possession of the collateral. Likewise, A would have priority if A’s April 1 advance was
not made under the original agreement w/ Debtor, but was under a new agreement.
c. OC2 to 9-502: A FS is effective to cover after-acquired property of the type indicated
and to perfect w/r/t future advances under SA, regardless of whether after-acquired
property or future advances are mentioned in the FS and even if not in the
contemplation of the parties at the time the FS was authorized to be filed
2. Often a SA will have in it a clause stating that the collateral protects not only this loan,
but all future advances as well (9-204(c)). If such a future advance clause had not been
in the original SA that Jay signed w/ FNB, does that affect the answer at all? No
a. OC2 to 9-502: A FS is effective to encompass transaction under a SA not in existence
and not contemplated at the time the notice was filed, if the indication of collateral in
the FS is sufficient to cover the collateral
H. Problem 319: Phillip pledged his valuable stamp collection to CNB in return for a loan (he
gave CNB an oral SI in the collateral; no FS was signed -> but CNB perfected its SI by
possession). CNB put the stamp collection in its vault. Phillip later borrowed money from
his father Filbert and gave him a signed SA in the same stamp collection. The father filed a
FS in the proper place.
1. Who has priority b/w CNB and the father?
a. CNB b/c it perfected SI by possession before father perfected his SI by filing (first-to-
file-or-perfect)
2. If Phillip goes to CNB and takes the collection home so that he can add new stamp but
does then return it, does the answer change? Yes
a. 9-313(d): [Time of perfection by possession; continuation of perfection] If perfection
of a SI depends upon possession of the collateral by a secured party, perfection
occurs no earlier than the time the secured party takes possession and continues
only while the secured party retains possession
3. At common law, the pledge could return the collateral to the pledgor for a “temporary
and limited purpose” w/o losing its perfection. Has this doctrine survived the
enactment of UCC? No
4. Is 9-312(f) relevant?
a. No b/c CNB is not a bailee
b. 9-312(f): [Temporary perfection: goods or documents made available to debtor]
A perfected SI in a negotiable document or goods in possession of a bailee, other
than one that has issued a negotiable document for the goods, remains perfected
for 20 days w/o filing if the secured party makes available to the debtor the
goods or documents representing the goods for the purpose of:
i. ultimate sale or exchange; or
ii. loading, unloading, storing, shipping, transshipping, manufacturing, processing, or
otherwise dealing w/ them in a manner preliminary to their sale or exchange.
5. If CNB makes Phillip sign a SA and then turns the collection over to him but never files a
FS, who wins?
 a. Father wins
b. 9-308(c):[Continuous perfection; perfection by different methods] A SI or agricultural
lien is perfected continuously if it is originally perfected by one method under Art. 9
and is later perfected by another method under Art. 9, w/o an intermediate period
when it was unperfected.
6. What should CNB have done?
a. They should have filed a FS before turning over possession of the collateral and it will
also need a written SA before that time
I. Future Advance Clauses
1. 9-204(c): [Future advances and other value] A SA may provide that collateral secures, or
that accounts, chattel paper, payment intangibles, or promissory notes are sold in
connection with, future advances or other value, whether or not the advances or value
are given pursuant to commitment.
2. But not a dragnet clause (a clause purporting to expand the SI to cover “unrelated”
obligations owed by the debtor to the creditor)
a. Courts (and Gilmore) used a test based on the intention of the parties; and the later
obligation be related, similar, or of the same class as the original transaction, but
b. OC5 to 9-204: determining the obligations secured by collateral is solely a matter of
construing the parties’ agreement (intention)
i. Rejects other tests, such as whether a future advance or other subsequently
incurred obligation was of the same or a similar type or class as earlier advances
and obligations secured by the collateral
J. Problem 320: Poll decided to go into the cattle business and borrowed $65K from BNB to
finance part of the purchase of the initial herd. Poll signed a SA using the cattle as
collateral for this “and all other obligations now or hereafter owed to BNB.” A FS
covering this transaction was filed in the appropriate place. 2 yrs later Poll received a
charge card from BNB and used it to finance a trip to Australia to look over cattle
ranching there. When he failed to pay the credit card bill, BNB repossessed the cattle
(even though his payments on the cattle purchase loan were current).
1. Did BNB’s SI in the cattle encompass the credit card obligation?
a. Yes b/c the credit card obligation incurred w/r/t his business trip related to the
original transaction
2. Would it make a difference if he had gone to Australia in search of the perfect wave for
surfing?
a. Yes that would have been a consumer use unrelated to the original transaction (cattle
business)
i. You may argue that, based on OC5 to 9-204, same or similar class test does not work
any longer
b. In re Johnson: consumer goods held not to secure future advances of a business
nature in spite of dragnet clause
c. Kimbell Foods v. Republic Natl. Bank: The true intention of the parties is really the
sole and controlling factor in determining whether future advances were covered by
the original agreement or would have to be perfected
 K. In re Wollin
1. Issue: the enforceability of "dragnet clauses" in SAs that provided future advances and
antecedent debts would also be secured.
2. Hold: The future transaction must be "so related to" the primary loan that the consent
of the debtor to its inclusion may be inferred. The court declined to adopt a per se test
based on the status of the loans as PM transactions. The court could not find future
advances for credit card charges sufficiently related to vehicle loans. As to antecedent
loans, the court adopted the "specific reference" standard. The antecedent debts were
not specifically referenced, as such, the vehicles did not secure them.
L. Problem 321: Aware of difficulties w/ cross-collateralization clauses, rancher Poll was
always careful to keep his consumer obligations (from his Visa card, using the objects
purchased as collateral) w/ a different bank than the one that financed his ranching
operations (w/ a traditional loan using his cattle as collateral). Both banks had him sign
SAs that provided that the collateral nominated for each debt would also protect “any
and all debts, now existing or after-acquired” owed to the same creditor. Poll was
therefore distressed to learn that when the 2 banks merged, the new bank’s loan officer
now insisted that his cattle also protect the debts he owed on his Visa card. Is that right?
1. No (can get around OC5 test by showing “parties’ intention to protect his consumer
debts by his cattle” since no same class test is accepted any longer)
II. Purchase Money Security Interests
A. The Basic Rule
1. 9-103: PMSI; Application of Payments; Burden of Establishing
a. [Definitions] In this section:
i. "PM collateral" means goods or software that secures a PM obligation incurred
w/r/t that collateral; and
ii. "PM obligation" means an obligation of an obligor incurred as all or part of the price
of the collateral or for value given to enable the debtor to acquire rights in or the
use of the collateral if the value is in fact so used.
b. [PMSI in goods] A SI in goods is a PMSI:
i. to the extent that the goods are PM collateral w/r/t that SI;
ii. if the SI is in inventory that is or was PM collateral, also to the extent that the SI
secures a PM obligation incurred w/r/t other inventory in which the secured party
holds or held a PMSI; and
iii. also to the extent that the SI secures a PM obligation incurred w/r/t software in
which the secured party holds or held a PMSI.
c. [PMSI in software] A SI in software is a PMSI to the extent that the SI also secures a
PM obligation incurred w/r/t goods in which the secured party holds or held a PMSI
if:
i. the debtor acquired its interest in the software in an integrated transaction in which
it acquired an interest in the goods; and
ii. the debtor acquired its interest in the software for the principal purpose of using
the software in the goods.
d. [Consignor's inventory PMSI] The SI of a consignor in goods that are the subject of a
 consignment is a PMSI in inventory.
e. [Application of payment in non-consumer-goods transaction] In a transaction other
than a consumer-goods transaction, if the extent to which a SI is a PMSI depends on
the application of a payment to a particular obligation, the payment must be applied:
i. in accordance w/ any reasonable method of application to which the parties agree;
ii. in the absence of the parties' agreement to a reasonable method, in accordance w/
any intention of the obligor manifested at or before the time of payment; or
iii. in the absence of an agreement to a reasonable method and a timely manifestation
of the obligor's intention, in the following order:
a) to obligations that are not secured; and
b) if more than one obligation is secured, to obligations secured by PMSIs in the
order in which those obligations were incurred.
f. [No loss of status of PMSI in non-consumer-goods transaction] In a transaction other
than a consumer-goods transaction, a PMSI does not lose its status as such, even if:
i. the PM collateral also secures an obligation that is not a PM obligation;
ii. collateral that is not PM collateral also secures the PM obligation; or
iii. the PM obligation has been renewed, refinanced, consolidated, or restructured.
g. [Burden of proof in non-consumer-goods transaction] In a transaction other than a
consumer-goods transaction, a secured party claiming a PMSI has the burden of
establishing the extent to which the SI is a PMSI.
h. [Non-consumer-goods transactions; no inference] The limitation of the rules in
subsections (e), (f), and (g) to transactions other than consumer-goods transactions is
intended to leave to the court the determination of the proper rules in consumer-
goods transactions. The court may not infer from that limitation the nature of the
proper rule in consumer-goods transactions and may continue to apply established
approaches.
2. 9-309(1): where the collateral is consumer goods, no further steps are required for a
PMSI therein to prevail over prior or later interests
a. All other PMSIs must be perfected during a 20-day grace period following the buyer’s
possession of the goods in order to take advantage of a relation-back of priority to
that date
i. 9-317(e): [PMSI] Except as otherwise provided in 9-320 and 9-321, if a person files a
FS w/r/t a PMSI before or within 20 days after the debtor receives delivery of the
collateral, the SI takes priority over the rights of a buyer, lessee, or lien creditor
which arise b/w the time the SI attaches and the time of filing. (super priority of
PMSI w/ filed FS within 20 days from receipt of goods)
ii. 9-324(a): [General rule: PM priority] Except as otherwise provided in subsection (g),
a perfected PMSI in goods other than inventory or livestock has priority over a
conflicting SI in the same goods, and, except as otherwise provided in 9-327, a
perfected SI in its identifiable proceeds also has priority, if the PMSI is perfected
when the debtor receives possession of the collateral or within 20 days thereafter.
3. Problem 322: When Paramount Homes finished building its newest fancy apartment
complex, it had to furnish the clubhouse, so it made $2K worth of credit purchases at
 Sophy’s Interiors and signed a SA in favor of the seller. The agreement was signed on
June 8; the goods were delivered that same day. PH failed to mention that all of its
equipment was designated as collateral on an existing SA and FS in favor of SNB. This
agreement contained an “after-acquired property” clause, which stated that later
similar collateral coming into the buyer’s estate would automatically fall under SNB’s
SI. (9- 204(a)). The policy of Sophy’s Interiors was not to file FSs for its credit furniture
sales
a. Why might it have such a policy? Is it wise here?
i. The policy reflects the furniture’s usual use (consumer goods: no filing is necessary
for perfection). It’s not wise and Sophy’s should at least ask buyers the intended use
of the goods
b. On June 10, which creditor will have priority in the furniture?
i. Sophy’s will have priority since it is protected for 20 days from the delivery (Here,
the furniture is NOT consumer goods, but equipment due to its business purpose)
c. On June 30?
i. SNB’s prior SI will have priority after June 28 (20 days from the delivery)
4. Galleon Industries v. Lewyn Machinery
a. Fact: The financier had a SI in all existing and acquired factory equipment. The
supplier ordered the equipment from the manufacturer to be shipped to the
supplier and delivered to the factory after cash payment. The manufacturer
shipped the equipment to the factory. The supplier demanded cash payment from
the factory. The factory failed to pay the supplier and the financier. The financier
foreclosed under its SI on all of the factory's equipment.
b. Hold: The supplier lacked the necessary possession to maintain the action, b/c 2-401
were subject to 9-204(3) SIs. The supplier's remedy had been to file a SI under 9-202
to obtain priority under 9-312(4). B/c the financier had a valid lien on after acquired
equipment, financier wins.
5. Problem 323: Video Wonder, an electronics store, had granted a floating lien over its
inventory and equipment to LNB, which perfected its SI by filing a FS in the appropriate
place. Needing a guard dog for the store, VW bought a German shepherd, Fang, from
Agatha for $1.2K. VW agreed to send her $100/month until the dog was paid for, at
which time she agreed in writing to sign over Fang’s papers. Agatha and VW agreed that
the store would not get any title to Fang until all the payments had been made. When
VW stopped making payments to all creditors 2 months later, LNB seized all of the
store’s assets, including Fang.
a. Is there any hope for Agatha? Can she argue that LNB’s SI only attached to VW’s
equity in the dog, or that until VW had paid the entire debt, it had no property
interest to which LNB’s floating lien could attach?
i. No. The dog to the video store was “equipment” and Agatha failed to file a FS. So,
she is unperfected secured creditor going against a perfected secured creditor (LNB)
that has the right to take Fang. (although sense of equity is on her)
6. Problem 324: Hart Farm Equipment leased a construction backhoe to Farmer Bean for a
6-month period w/ the understanding that FB would be given the option to purchase
the backhoe at any time during that period, and, in fact, the lease at one point called
this a
 “sale on approval.” FB’s equipment was already subject to a perfected floating lien in
favor of ONB. 3 months after the delivery of the backhoe, FB agreed to buy the
backhoe, and HFE filed its FS the next day, claiming its PMSI. Who wins in the priority
battle b/w HFE and ONB?
a. HFE wins b/c the equipment does not become collateral until FB decides to buy it. So,
HFE has time (20 days from the day of acceptance) to file a FS.
b. 2-326(2): Goods held on approval are not subject to the claims of the buyer’s
creditors until acceptance
c. OC3 to 9-324: when a person takes possession of goods as lessee under a lease K and
then exercises an option to purchase the goods from the lessor on secured credit,
creditors of the lessee generally take subject to the lease K; filing a FS against the
lessee is unnecessary to protect the lessor’s leasehold or residual interest. Once the
lease is converted to a SI, filing a FS is necessary to protect the seller’s SI. Accordingly,
the 20-day period in subsection (a) does not commence until the goods become
“collateral” i.e., until they are subject to a SI.
B. Inventory and Livestock
1. Inventory financier has a perfected interest (floating lien) over the mass of changing
goods available for sale by the debtor to others
a. If the debtor buys new inventory and gives the seller a PMSI, the original financier is
hurt if
i. It does not know of the PMSI but thinks all the inventory is collateral in which it has
priority; and
ii. The PMSI is held to prevail over the already perfected interest in after-acquired
inventory
b. Prior creditor is alerted by 9-324(b) notice: must watch out for itself and cannot
complain if the PM creditor prevails as to the inventory covered by the notice
2. 9-324(b): [Inventory PM priority] Subject to subsection (c) and except as otherwise
provided in subsection (g), a perfected PMSI in inventory has priority over a conflicting
SI in the (i) same inventory, has priority over a conflicting SI in (ii) chattel paper or an
instrument constituting proceeds of the inventory and in (iii) proceeds of the chattel
paper, if so provided in 9-330, and, except as otherwise provided in 9-327, also has
priority in (iv) identifiable cash proceeds of the inventory to the extent the identifiable
cash proceeds are received on or before the delivery of the inventory to a buyer, if:
a. the PMSI is perfected when the debtor receives possession of the inventory;
b. the PM secured party sends an authenticated notification to the holder of the
conflicting SI;
c. the holder of the conflicting SI receives the notification within 5 yrs before the
debtor receives possession of the inventory; and
d. the notification states that the person sending the notification has or expects to
acquire a PMSI in inventory of the debtor and describes the inventory.
3. Problem 325: Merchants Credit Association held a perfected SI in the inventory of
Harold’s Clothing Store. HCS contracted to buy $4K worth of new clothes for resale
from Madame Belinda’s Fashions, which took a PMSI in the clothes on Dec. 10, the
date of
 sale. MBF wrote MCA on Dec. 11 and informed them of the sale. MCA protested but did
nothing. MBF filed on Dec. 11; the goods were delivered to the store on Dec. 12.
a. Who has priority?
i. MBF (PM creditor) has priority b/c it (a) perfected before HCS possessed the goods;
and (b) gave authenticated notice to MCA (inventory creditor) within 5 yrs before
HCS gets possession
ii. Policy: notice inventory creditors so that they accelerate the clause (same issue
comes up w/ SI in crops)
b. If the notice was received on Dec. 11, is it sufficient to permit MBF to keep selling
goods to HCS for an indefinite period thereafter or only for this one transaction?
i. Notice is valid for 5 yrs, so MBF can keep selling and financing inventory for 5 yrs.
ii. 9-324(b)(3): A PMSI in inventory has priority over a conflicting SI in the same
inventory if: (3) the holder of the conflicting SI receives the notification within 5 yrs
before the debtor receives possession of the inventory
4. Kunkel v. Sprague National Bank
a. Facts: D, the bank, made several loans to the Morkens, w/ a perfected SI in the
inventory, farm products, equipment and A/R. Morkens purchased a head of cattle in
1990 from Hoxie, w/ a loan agreement and promissory note granting Hoxie a PMSI in
the cattle. Hoxie did not file a FS but instead perfected its SI by taking possession of
the cattle. The Morken filed Ch 11 bankruptcy. Hoxie then sold the cattle and, after
deducting the amounts owed Hoxie for care and feeding, $550K remained.
b. Hold: The sale and delivery of the cattle by Hoxie to Morken granted Morken “rights
in the collateral” b/c Hoxie had constructively delivered the cattle to Morken and had
possession of the cattle on Morken’s behalf, Morken had title to and owned the
cattle, Hoxie merely retained a SI in the cattle as bailee, and Morken had rights
in the collateral sufficient for D’s SI to attach. Thus, D had a perfected SI in the
cattle. However, Hoxie’s PMSI had superiority over D’s interest. The notice
requirement is triggered by actual and not constructive possession of the inventory;
thus, notification was timely. Hoxie’s SI has priority.
c. Note
i. This case continue to be good law even after the 1999 revision
ii. OC5 to 9-324: if the debtor never received possession, the 5-yr period never begins,
and the PMSI has priority even if notification is not given
iii. 9-324(d): the superpriority procedure for gaining a PMSI in inventory is extended to
a PMSI in the debtor’s livestock
5. Problem 326: Hans Racing Equipment bought much of its inventory from Standard Auto
Wholesales, which always took a PMSI in the goods sold to HRE and which filed a FS on
the same day. HRE also borrowed money from MDNB to finance the purchase of
inventory from wholesalers, part of which was used to pay off SAW. MDNB filed a FS,
claiming a SI in HRE’s inventory. On March 28, HRE contracted to buy $3K in goods from
SAW, making a down payment of $1.5K and giving SAW a PMSI in the goods for the rest.
On that same day, HRE borrowed the $1.5K down payment from MDNB and also gave
MDNB a PMSI in the same goods. Both creditors knew of the other, so they both sent
 written notice to each other. The goods were delivered to HRE on April 2. Which
creditor has proirity?
a. The seller (SAW)’s PMSI is favored over the lender (MDNB)’s PMSI
b. 9-324(g):[Conflicting PMSIs] If more than one SI qualifies for priority in the same
collateral under subsection (a), (b), (d), or (f):
i. a SI securing an obligation incurred as all or part of the price of the collateral has
priority over a SI securing an obligation incurred for value given to enable the
debtor to acquire rights in or the use of collateral; and
ii. in all other cases, 9-322(a) applies to the qualifying SIs.
c. OC13: priority to PMSI securing the price of collateral (i.e., created in favor of the
seller) over PMSI that secure enabling loans
i. The first-to-file-or-perfect rule of 9-322 applies to multiple PMSIs securing enabling
loans
6. Consignments
a. 9-103(d):[Consignor's inventory PMSI] The SI of a consignor in goods that are the
subject of a consignment is a PMSI in inventory.
i. Like PMSI, the consignor must give notice to inventory financier in order to have
priority
b. Ex 3 in OC3 to 9-319: SP1 obtains a SI in all Debtor’s existing and after-acquired
inventory and perfects its SI w/ a proper filing. Then SP2 delivers goods to Debtor in a
transaction constituting a “consignment” and files a proper FS but does not send
notification to SP1. Accordingly, SP2’s SI is junior to SP1’s SI under 9-322(a). Under 9-
319(a), Debtor is deemed to have the consignor’s rights and title, so that SP1’s SI
attaches to SP2’s ownership interest in the goods. Thereafter, Debtor grants a SI in
the goods to SP3 and SP3 perfects by fling. B/c SP2’s perfected SI is senior to SP3’s
under 9-322(a), 9-319(b) applies. Other law determines Debtor’s rights and title to
the goods insofar as SP3 is concerned, and SP3’s SI attaches to those right
7. Problem 327: (Definition of Consignment in 9-102(a)(20)) Barbara was asked by Tim,
owner of Isle’s Fine Art Works, if he could exhibit and sell some of her pottery. She gave
him 5 of her favorite pieces. The next day, she learned that ONB, which had a perfected
floating lien on the store’s inventory, had foreclosed and seized everything in the store,
including her pottery. Can ONB do this to her?
a. Yes, Barbara is a consignor w/ PMSI in her pottery and she should have filed a FS and
given notice to ONB (inventory financier) before Tim took possession.
III. Control and Priority
A. Control over Investment Property
1. Investment property (9-102(a)(49))
a. A security, whether certificated or uncertificated, security entitlement, securities
account, commodity K or commodity account
2. 2 ways of perfecting SI in investment property
a. Filing of a FS; and/or
b. Taking of control over the investment property
i. Secured party who has control has priority over one who has merely filed (9-328(1))
3. Control (8-106): (control is means of gaining perfection of SI in intangibles)
a. generally one has control over a certificated security by taking delivery of it along w/
any necessary indorsements
b. for uncertificated securities, delivery is artificially defined in 8-301(b) as making sure
that the secured party is registered as the stock owner in the records of the issuing
corporation
c. in the context of indirect holding, control requires that the secured party take steps
to make sure that it can reach the rights of the debtor in the event that it needs to
foreclose
4. Problem 328: Mr. Goldbury instructed his stockbroker BB&B to buy 100 shares of
Utopia, Ltd. Stock and place it in his account at BB&B. BB&B bought the shares and
kept them in the account it held at Clearing Corporation but marked its records to
indicate that Mr. Goldbury was really the owner of this number of shares of the stock.
In this case, Art. 8 would deem Mr. Goldbury an entitlement holder who has a
securities entitlement in a security account w/ a securities intermediary (8-102, 8-
501(a)). Mr. Goldbury went to ONB and asked to borrow money using the above 100
shares as collateral.
a. Which of the possible methods is the safest way of perfecting (i.e., getting control
over the securities entitlement) ONB’s SI?
i. ONB can perfect its SI by getting control over the 100 shares, either by becoming the
entitlement holder of the share or by getting consent of security intermediary
(BB&B) that it will comply w/ ONB’s entitlement order w/o further consent by Mr.
Goldbury
ii. 8-106(d): A purchaser has "control" of a security entitlement if:
a) the purchaser becomes the entitlement holder; or
b) the securities intermediary has agreed that it will comply w/ entitlement orders
originated by the purchaser w/o further consent by the entitlement holder, or
c) another person has control of the security entitlement on behalf of the purchaser
or, having previously acquired control of the security entitlement, acknowledges
that it has control on behalf of the purchaser.
iii. OC4: 3 means to obtain control of a security entitlement – purchaser has control if
a) it is the entitlement holder, whether it holds through the same intermediary that
the debtor used or has the securities position transferred to its own intermediary
b) the securities intermediary has agreed to act on entitlement orders originated by
the purchaser if no further consent by the entitlement holder is required (even
though the original entitlement holder remains as the entitlement holder)
c) another person (other than the debtor) has control and the person acknowledges
that it has control on the purchaser’s behalf
1. parallels the delivery of certificated securities and uncertificated securities
b. if another creditor also gets control over the rights to the 100 shares, which has
priority?
i. Whoever gets control first will gets priority
ii. 9-328(2): Except as otherwise provided in paragraphs (3) and (4), conflicting SIs held
by secured parties each of which has control under 9-106 rank according to priority
in time of:
 a) if the collateral is a security, obtaining control;
b) if the collateral is a security entitlement carried in a securities account and:
1. if the secured party obtained control under 8-106(d)(1), the secured party's
becoming the person for which the securities account is maintained;
2. if the secured party obtained control under 8-106(d)(2), the securities
intermediary's agreement to comply w/ the secured party's entitlement orders
w/r/t security entitlements carried or to be carried in the securities account; or
3. if the secured party obtained control through another person under 8-106(d)
(3), the time on which priority would be based under this paragraph if the
other person were the secured party; or
c) if the collateral is a commodity K carried w/ a commodity intermediary, the
satisfaction of the requirement for control specified in 9-106(b)(2) w/r/t
commodity Ks carried or to be carried w/ the commodity intermediary.
c. If Mr. Goldbury borrows money from BB&B after ONB has control and grants BB&B a
SI in all stock held in his account w/ them, is BB&B’s SI superior to ONB’s?
i. Yes, stock brokers are preferred in this situation
ii. 9-328(3): A SI held by a securities intermediary in a security entitlement or a
securities account maintained w/ the securities intermediary has priority over a
conflicting SI held by another secured party.
iii. Ex. 5 of OC4: both of BB&B and ONB have control, so the general control priority
rule of 9-328(1) does not apply. A SI held by a securities intermediary in positions
of its own customer has priority over a conflicting SI of an external lender.
B. Control over Deposit Accounts
1. Art. 9 allows a perfected SI in bank accounts by a creditor obtaining control over the
account
a. Consumer accounts may not be used as collateral for consumer debts, but could be
so used for non-consumer debts
b. 9-104 (Control of Deposit Account)
i. [Requirements for control] A secured party has control of a deposit account if:
a) the secured party is the bank w/ which the deposit account is maintained;
b) the debtor, secured party, and bank have agreed in an authenticated record that
the bank will comply w/ instructions originated by the secured party directing
disposition of the funds in the deposit account w/o further consent by the debtor;
or
c) the secured party becomes the bank's customer w/r/t the deposit account.
ii. [Debtor's right to direct disposition] A secured party that has satisfied subsection (a)
has control, even if the debtor retains the right to direct the disposition of funds
from the deposit account.
2. Problem 329: Computer World desires to borrow money from Investment Bank of
America, which will grant it a revolving line of credit, secured in part by the bank
account that CW maintains at LNB.
a. How can IBoA perfect its SI in this bank account and which of the methods of control
in 9-104 would be the safest form of security?
 i. IBoA can perfect by (1) getting LNB to agree in an authenticated record that it will
comply w/ IBoA’s instructions, or (2) changing the account name to IBoA’s name ((2)
is safer)
b. If CW later borrows money from LNB and grants LNB a SI in the account carried
there, would LNB have priority over IBoA?
i. Yes, LNB’s SI has priority over IBoA’s conflicting SI unless IBoA perfects its SI by
becoming LNB’s customer w/r/t the deposit account
ii. 9-327(3): Except as otherwise provided in paragraph (4), a SI held by the bank w/
which the deposit account is maintained has priority over a conflicting SI held by
another secured party
iii. 9-327(4): A SI perfected by control under 9-104(a)(3) (becoming the bank’s
customer w/r/t the deposit account) has priority over a SI held by the bank w/
which the deposit account is maintained.
C. Control over LOCs Rights
1. Bank is persuaded by an applicant and issues a LOC to beneficiary to whom payment is
to be made, specifying the circumstances under which the bank will honor drafts drawn
on it by the beneficiary
a. 9-312(b)(2): SI in a LOC right may be perfected only by control under 9-314
b. 9-107 (Control of LOC Right): A secured party has control of a LOC right to the extent
of any right to payment or performance by the issuer or any nominated person if the
issuer or nominated person has consented to an assignment of proceeds of the LOC
under 5-114(c) or otherwise applicable law or practice
c. 5-114(b) ~ (d)(Assignment of Proceeds):
2. Problem 330: Computer World agreed to sell 10,000 computers to Football University
for the sum of $25K, w/ FU agreeing to obtain a LOC for this amount in favor of the
seller. Shortly thereafter, CW received a LOC from ONB naming CW as the
beneficiary and stating that it would honor drafts drawn on ONB in favor of CW for the
amount of $25K on presentation of an invoice showing shipment of the computers to
FU by Sept. 25 of that yr. CW comes to you in Feb. of the same yr w/ the following
problem. It needs to borrow $10K from some lender in order to finance the
construction of the computers by the required deadline. It wants to use the LOC as
collateral for this loan.
a. How can the new lender obtain a perfected interest in the rights represented by the
LOC?
i. New lender can have control of the LOC right if ONB agrees to the assignment of the
proceeds of the LOC by ONB to lender (bank is not required to do so, but if not, it
would be unreasonable)
b. When CW asked ONB if it would agree to an assignment of the proceeds of the LOC
to CW’s lender, ONB refused, pointing to clauses in the LOC that provided a number
of things: (1) the right of CW to draw drafts on ONB was not transferable; and (2) the
LOC specifically forbade the beneficiary (CW) the right to make an assignment of the
proceeds of the LOC and voided the LOC if the beneficiary made such an assignment
w/o ONB’s consent. What can CW tell potential lenders who might be willing to loan
it money if the LOC rights could be used as collateral? (Remember that the obligation
 from FU to CW is an account)
i. The terms forbidding assignment is void under 9-409 and CW can transfer the LOC
right to the new lenders
a) You can perfect a SI in underlying account
ii. 5-114 (Assignment of Proceeds)
a) In this section, "proceeds of a LOC" means the cash, check, accepted draft, or
other item of value paid or delivered upon honor or giving of value by the issuer
or any nominated person under the LOC. The term does not include a
beneficiary's drawing rights or documents presented by the beneficiary.
b) beneficiary may assign its right to part or all of the proceeds of a LOC. The
beneficiary may do so before presentation as a present assignment of its right to
receive proceeds contingent upon its compliance w/ the terms and conditions of
the LOC.
c) An issuer or nominated person need not recognize an assignment of proceeds of
a LOC until it consents to the assignment.
d) An issuer or nominated person has no obligation to give or withhold its consent
to an assignment of proceeds of a LOC, but consent may not be
unreasonably withheld if the assignee possesses and exhibits the LOC and
presentation of the LOC is a condition to honor.
e) Rights of a transferee beneficiary or nominated person are independent of the
beneficiary's assignment of the proceeds of a LOC and are superior to the
assignee's right to the proceeds.
f) Neither the rights recognized by this section b/w an assignee and an issuer,
transferee beneficiary, or nominated person nor the issuer's or nominated
person's payment of proceeds to an assignee or a third person affect the rights
b/w the assignee and any person other than the issuer, transferee beneficiary, or
nominated person. The mode of creating and perfecting a SI in or granting an
assignment of a beneficiary's rights to proceeds is governed by Art. 9 or other
law. Against persons other than the issuer, transferee beneficiary, or nominated
person, the rights and obligations arising upon the creation of a SI or other
assignment of a beneficiary's right to proceeds and its perfection are governed by
Article 9 or other law.
iii. 9-308(d): [Supporting obligation] Perfection of a SI in collateral also perfects a SI in a
supporting obligation for the collateral
iv. 9-102(a)(77): “Supporting obligation” means a LOC right or secondary obligation
that supports the payment or performance of an account, chattel paper, a
document, a general intangible, an instrument, or investment property
v. 9-409 (Restrictions on Assignment of LOC Rights Ineffective)
a) [Term or law restricting assignment generally ineffective] A term in a LOC or a
rule of law, statute, regulation, custom, or practice applicable to the LOC which
prohibits, restricts, or requires the consent of an applicant, issuer, or nominated
person to a beneficiary's assignment of or creation of a SI in a LOC right is
ineffective to the extent that the term or rule of law, statute, regulation, custom,
 or practice:
1. would impair the creation, attachment, or perfection of a SI in the LOC right; or
2. provides that the creation, attachment, or perfection of the SI may give rise to
a default, breach, right of recoupment, claim, defense, termination, right of
termination, or remedy under the LOC right.
b) [Limitation on ineffectiveness under subsection (a)] To the extent that a term in a
LOC is ineffective under subsection (a) but would be effective under law other
than Art. 9 or a custom or practice applicable to the LOC, to the transfer of a
right to draw or otherwise demand performance under the LOC, or to the
assignment of a right to proceeds of the LOC, the creation, attachment, or
perfection of a SI in the LOC right:
1. is not enforceable against the applicant, issuer, nominated person, or
transferee beneficiary;
2. imposes no duties or obligations on the applicant, issuer, nominated person, or
transferee beneficiary; and
3. does not require the applicant, issuer, nominated person, or transferee
beneficiary to recognize the SI, pay or render performance to the secured
party, or accept payment or other performance from the secured party.
IV. Buyers
A. Art. 9 Golden Rule and Exceptions
1. 9-201(a): Except as otherwise provided by UCC, a SA is effective according to its terms
b/w the parties, against purchasers of the collateral and against creditors
a. Golden Rule: sale of collateral does not destroy a SI in the collateral
2. 9-320(a): buyer in ordinary course of (debtor’s) business takes free of a SI created by
buyer’s seller even if the SI is perfected and buyer knows of its existence
a. But pawnbrokers or farm products buyers are excluded
3. 9-320(b): good faith consumer of consumer goods from consumer before the filing of a
FS takes free of SI (even if the SI is perfected by any method other than filing)
4. 9-317(b): buyer, other than a secured party, of tangible chattel paper, document,
goods, instruments, or a security certificate takes free of SI if buyer gives value and
receives delivery of the collateral w/o knowledge of the SI and before it is perfected
5. 9-315(a)(1): a SI continues in collateral not withstanding sale, lease, license, exchange,
or other disposition thereof unless the secured party authorized the disposition free of
the SI . . .
6. Exception to the exceptions
a. 9-320(e): 9-320(a) & (b) do not affect the SI in goods in possession by the secured
party
7. Problem 331: Betty bought a TV set from Distortion TV, a retail store. 1 month later
Distortion went bankrupt, and ONB asked Betty to turn over the set, for the reason that
ONB had perfected SI in all of Distortion’s inventory.
a. What should Betty tell ONB’s flunky?
i. She bought the TV set in the ordinary course of Distortion’s business, so takes it free
of ONB’s SI.
 b. Would it matter if Betty had know that ONB had s perfected SI in Distortion’s
invention? No
i. Mere knowledge of the existence of SI doesn’t matter unless she knew the sale
violated the SA
a) Policy: otherwise, no one would buy inventory (even ONB would want you to buy
it!)
ii. OC3 to 9-320: buyer takes free if she merely knows that a SI covers the goods, but
takes subject if she knows, in addition, that the sale violates a term in an agreement
w/ the secured party
c. Would it matter if she bought at a “Liquidation Sale” and was informed by the store’s
owner that the store planned to file a bankruptcy petition the following week?
i. No, even if she knew about the imminence of bankruptcy, she takes free of SI
d. What if Betty had put the TV on “layaway” and had paid 50% of the price but
permitted Distortion to keep the TV (she signed a K obligating herself to pay the
balance), then it went bankrupt?
i. She may recover the goods from Distortion if Distortion went insolvent within 10
days after her payment of the 1st installment
ii. 2-502(1)(b) (Buyer’s Right to Goods on Seller’s Insolvency): even though the goods
have not been shipped, a buyer who has paid a part or all of the price may recover
them from the seller if seller becomes insolvent within 10 days after receipt of the
first installment of their price
iii. BC 507(a)(7) (list of unsecured creditors to get paid next): gives layaway buyers a
priority payment up to the amount of $900 per individual
8. International Harvester Co. v. Glendenning
a. Fact: Appellants alleged that they were the holder of a duly perfected SI in 3 new
tractors, appellee had wrongfully purchased the tractors subject to the SI, appellee
was not a buyer in due course, did not act in a commercially responsible manner, and
did not act honestly.
b. Issue: Whether appellee was a buyer of the tractors in the ordinary course of
business.
c. Hold: The evidence conclusively established that appellee was not a purchaser in the
ordinary course of business. The evidence demonstrated a definite pattern of lies,
deceit, dishonesty and bad faith.
d. Note
i. 1-304 imposes a “good faith” requirement
a) Some say that good faith is a condition precedent to any protection under the UCC
ii. Bad faith can alter the usual Art. 9 priorities
9. Problem 332: Deering Milliken was a textile manufacturer that routinely sold textiles on
credit to Mill Fabrics, a firm that finished the textiles into dyed and patterned fabrics. It
was Mill’s practice to resell the fabrics to Tanbro Fabrics, a wholesaler. While the
textiles were still in Deering’s warehouse, Mill contracted to buy them from Deering,
signing a SA to that effect and giving Deering a FS, which it duly filed. In turn, Mill sold
the textiles to Tanbro, which paid Mill for them, but delayed taking delivery for a few
weeks, so that the fabrics remained in Deering’s possession. Deals of this kind were
common in the
 textile industry, and all parties knew of the others’ interest. Unfortunately, Mill became
insolvent and never paid Deering for the textiles, and Deering therefore refused to
deliver them to Tanbro. The latter sued. Who should prevail?
a. SI was created by Mill (buyer’s seller) in favor of Deering and Tanbro is a BOCB ->
exception under 9-320(e): Deering would win b/c it has possession of the goods
b. 9-320(e): [Possessory SI not affected] Subsections (a) and (b) (BOCB & Buyer of
consumer goods) do not affect a SI in goods in the possession of the secured party
under 9-313
c. OC8: BOCB is prevented from taking free of SI if collateral is in the possession of the
secured party
10. 1-201(a)(9) Definition of “Buyer in the ordinary course of business”
a. Must be a buyer in the ordinary course of seller’s business (buying seller’s inventory
in routine way)
b. Not buy in bulk (not buy an entire inventoried business) and not take the interest as
security for or in total/partial satisfaction of a preexisting debt (must give some form
of “new” value)
c. Buys from one in the business of selling goods of that kind (e.g., cars from a car
dealer, i.e., inventory)
d. Buys in good faith and w/o knowledge that this purchase is in violation of others’
ownership rights or SIs
e. Not buy farm products from a person engaged in farming operations
f. Seller’s creditor must part w/ possession
g. Competing SI must be one “created by buyer’s seller”
11. Problem 333: ONB had a perfected SI in all cars on Smiles Motor’s lot. Smiles owed
$5K in past due insurance premiums to its insurance agent Howard Teeth, who bought
a new car from Smiles. Smiles first gave Howard a check for $5K, but Howard endorsed
it back over to Smiles for a new car. Is Howard a 1-201(a)(9) “buyer in the ordinary
course of business” so as to take free of ONB’s SI?
a. No, he takes subject to ONB’s SI. This is a sham transaction and Howard took the SI
for satisfaction of Smiles’ preexisting debt to him (no “new” value given here, just
cancellation of old debt)
12. First Nat’l Bank and Trust v. Ford Motor Credit Co. (double financing)
a. Fact: The company entered into an inventory financing agreement w/ the dealer.
The dealer gave the company a PMSI in all vehicles then owned and thereafter
acquired, and in all proceeds from the sale thereof. The bank had a SI in 2 cars in
the dealer’s inventory
b. Hold: The bank was not a buyer, but a financier of the buyers. As such, it was not
covered under 9-307(1), which allowed a buyer in ordinary course to take free of the
company's SI in the inventory. The company’s SI continued in the 2 vehicles and in the
proceeds.
13. Problem 334: Arthur bought a new car on credit from Lorri’s Car City, which took a
PMSI in the car, perfecting same by notation of its lien interest on the certificate of
title, as required by state law. He was a used car dealer by profession, but he had
purchased the
 car for his private use. Nonetheless, he frequently parked the car on his lot, and one day
sold it for cash to Ann, a customer. Arthur did not mention to her that it was his
personal car. When everyone learned what had happened, Ann sued Lorri’s Car City,
demanding that it release the title. What result?
a. Ann takes the car free of SI. Ann qualifies as BOCB b/c she purchased the car in good
faith w/o knowledge of the SI (she bought the car in a routine manner of purchasing
a car).
14. Problem 335: Wonder Spa pledged 50 of its promissory notes to the CSBTC in return
for a loan. CSBTC took possession of the notes. WS asked to have 10 of them back for
presentment to the makers for payment, and the bank duly turned them over, which
WS sold (discounted) to ONB, a bona fide purchaser w/o knowledge of CSBTC’s
interest. This resale was in direct violation of the spa’s agreement w/ CSBTC.
a. Which bank is entitled to the instrument?
i. CSBTC’s SI remains perfected for 20 days when it returned the notes to WS for
presentment (or sale). But ONB is a HDC that takes priority over CSBTC’s SI unless
CSBTC has real defense
ii. 9-312(g):[Temporary perfection: delivery of security certificate or instrument to
debtor] A perfected SI in a certificated security or instrument remains perfected for
20 days w/o filing if the secured party delivers the security certificate or instrument
to the debtor for the purpose of:
a) ultimate sale or exchange; or
b) presentation, collection, enforcement, renewal, or registration of transfer
iii. 9-331 (Priority of Rights of Purchasers of Instruments, Documents, and Securities
under Other Articles; Priority of Interests in Financial Assets and Security
Entitlements under Art. 8)
a) [Rights under Art. 3, 7, and 8 not limited] Art. 9 does not limit the rights of a
holder in due course of a negotiable instrument, a holder to which a negotiable
document of title has been duly negotiated, or a protected purchaser of a
security. These holders or purchasers take priority over an earlier SI, even if
perfected, to the extent provided in Art. 3, 7, and 8.
b) [Protection under Article 8] Art. 9 does not limit the rights of or impose liability on
a person to the extent that the person is protected against the assertion of a
claim under Art. 8.
c) [Filing not notice] Filing under Art. 9 does not constitute notice of a claim or
defense to the holders, or purchasers, or persons described in subsections (a) and
(b).
b. Is ONB one of the parties protected by 9-331?
i. Yes, ONB is a HDC b/c it is in good faith purchaser for value
ii. 3-302: Holder in Due Course
iii. 3-305: Defenses and Claims in Recoupment
15. 9-320(b): only covers sale of consumer goods by a consumer to a consumer
a. Buyer takes free of seller’s creditor’s SI only if buyer is both ignorant of it and there
is no FS on file
16. Problem 336: Andy bought a stereo receiver on credit from VOJ, an electronics store,
giving it a PMSI in the receiver. VOJ did not file a FS. 6 months later, when Andy still
owed VOJ $300, he held a garage sale and sold the receiver to Nancy for $200 cash.
If Andy stops making payments to VOJ, can it repossess the receiver from Nancy? No
a. OC5 to 9-320: VOJ has a perfected SI in the receiver even though it did not file b/c it
is a PMSI in consumer goods under 9-309(1). But, Nancy takes free of a SI
(automatically perfected w/o filing) under 9-302(b) b/c she bought (1) w/o
knowledge of the SI; (2) for value; (3) primarily for her own personal, family, or
household purposes, and (4) before a FS is filed
b. Thus, even though a PMSI in consumer goods is automatically perfected on
attachment (w/o filing a FS), it is wise to file a FS just in case
17. Problem 337: RFC had a perfected (filed) SI in the equipment of WTIC (the company
sold ice cream to children from trucks that traveled through the city’s neighborhoods).
Bill, the owner of WTIC, sold Frank one of the machines the company owned, for cash.
When WTIC failed to make its payments, RFC repossessed all equipment. When Frank
refused to turn over the ice cream machine, RFC sued him for conversion (a tort that
does not require scienter or guilty knowledge for its commission)
a. Does he lose?
i. Yes, Frank is NOT buyer in the ordinary course of WTIC’s business b/c WTIC sells ice
cream (inventory), not ice cream machine (equipment) as business (9-320(a)). In
addition, it was not a consumer to consumer sale (9-320(b)). So, Frank takes subject
RFC’s SI.
ii. 9-201(c): in case of conflict b/w Art. 9 and other law, other law controls
iii. 9-401(b): [Agreement does not prevent transfer] An agreement b/w the debtor and
secured party which prohibits a transfer of the debtor’s rights in collateral or makes
the transfer a default does not prevent the transfer from taking effect.
iv. Production Credit Assn. v. Nowatzski: Transferee takes subject to creditor’s right of
possession. Conversion when transferee refuses to surrender the collateral to
creditor
b. Would we get a different result if RFC’s interest were unperfected at the time of the
sale?
i. Yes, if RFC’s SI were not perfected, Frank takes free of RFC’s SI b/c he is a good faith
purchaser
ii. 9-317(b): [Buyers that receive delivery] a buyer, other than a secured party, of
tangible chattel paper, document, goods, instruments, or a security certificate takes
free of a SI if the buyer gives value and receives delivery of the collateral w/o
knowledge of the SI before it is perfected
c. Would we get a different result if RFC knew and approved of the sale?
i. Yes, if secured party (RFC) authorized the sale, its SI discontinues and Frank wins
ii. 9-315(a)(1): SI continues in collateral notwithstanding sale, lease, license, exchange,
or other disposition unless the secured party authorized the disposition free of the
SI
18. Problem 338: Paul was a rock singer to whom ONB loaned $8K so he could buy stereo
 equipment for his road show. On April 2, he purchased the equipment and on April 10,
ONB filed its FS in the proper place. However, in the interim, on April 8, Paul sold the
equipment to Used Stereo Heaven, which bought w/ no knowledge of ONB’s PMSI.
Which party has the superior claim to the equipment?
a. As ONB filed a FS on 4/10 (within 20 days after debtor’s receipt of delivery), ONB’s
PMSI takes priority over USH(buyer)’s rights which arose on 4/8 (b/w 4/2 and 4/22)
b. 2-403(2): if the secured party entrusts collateral to a merchant who deals in goods of
that kind and the merchant sells the collateral to a BOCB, SI discontinues
c. 9-201: SA is effective according to its terms b/w the parties against purchasers of the
collateral and against creditors
d. 9-317(e):[PMSI] Except as otherwise provided in 9-320 and 9-321, if a person files a
FS w/r/t a PMSI before or within 20 days after the debtor receives delivery of the
collateral, the SI takes priority over the rights of a buyer, lessee, or lien creditor
which arise b/w the time the SI attaches and the time of filing
19. Problem 339: When Farmer Bean borrowed a large amount of money from FFFC, he
was required to sign a SA by which he promised not to sell the crop that was the
collateral for the loan w/o the written consent of FFFC. Nonetheless, every yr, he sold
the crop to the same buyer and remitted the proceeds to FFFC w/o getting its written
consent.
a. Does the buyer take free of FFFC’s SI under 9-320(a)?
i. No, 9-320(a) excludes a person buying farm products from a person engaged in
farming operations. Even if he is a buyer in the ordinary course of business w/o
knowledge of SI, he takes subject to SI b/c he is a buyer of farm products (but
special protection to farmers by FSA!)
b. If FFFC never protested what was going on yr after yr as the SA was violated, can it
be said to have waived its SI? Can a SI be waived?
i. Yes, SI discontinues if the secured party authorized the disposition of collateral free
of SI under 9-315(a)(1). In addition, under 2-403(2), if the secured party entrusts
collateral to a merchant who deals in goods of that kind and the merchant sells the
collateral to a BOCB, SI discontinues (course of performance can change the express
terms – waiver)
20. Clovis National Bank v. Thomas (waiver)
a. Facts: The bank would advance monies to Bunch, to buy young cattle which he would
raise and then sell, taking a SI in the cattle as collateral for the loans. The SA provided
that Bunch would not dispose of the cattle w/o getting the bank’s approval.
Nonetheless, Bunch regularly sold the cattle w/o notifying P. P knew of this but
allowed it to continue b/c it was common practice. At one point, certain cattle
purchased by Bunch received the brand of his son, who refused to turn any monies
over to the bank. Son eventually sold the 90 cattle and received $7,700 for them. The
bank sued the cattle broker/auctioneer who bought the cattle from Bunch’s son, for
conversion.
b. Rule: The general rule is that when an auctioneer sells property on behalf of
someone who was not in fact legally authorized to convey title, the auctioneer is
liable to any
 true owner or mortgagee, regardless of whether he had actual or constructive
knowledge of that person’s interest. However, when a mortgagee under a chattel
mortgage allows the mortgagor to retain possession of the property and sell the
same at will, the mortgagee waives his lien as against 3rd parties. The bank waived it
rights through the course of dealing.
c. Outcome: This is precisely the case here. P was admittedly aware of Bunch’s habit of
selling the cattle w/o its consent. Consequently, it waived any rights it might have had
against 3rd parties, such as those of D. D cannot be held liable for conversion when P
consented to the sale of the cattle. By consenting to the sale of cattle, w/o P taking
any actions himself but rather permitting the debtor to sell the cattle solely, P waived
his rights in the collateral/cattle.
d. Note
i. NM legislature amended UCC to provide that course of dealing or trade usage could
not have the effect of waiving a SI in farm product (but “course of performance”
can!)
21. 9-320(a)’s exclusion of buyers of farm products
a. To encourage financial institutions to loan money to farmers by allowing lenders to
follow the collateral into innocent buyers
b. But farmers routinely ignore the SA’s requirement of written consent, so
i. Some courts found a waiver of the SI as in Clovis
ii. Other courts developed a conditional consent test: waiver is ineffective unless the
condition under which it was made was complied with
iii. Still other courts, noting that bank’s waiver is really nothing more than the
acceptance of a fait accompli, did not permit such a course of dealing to override
the express selling prohibition of SA
c. Many states enacted a statute creating a system whereby a buyer of farm products
would take free of SI of farmer’s creditor if the buyer satisfies certain requirements
d. Now a federal statute (Food Security Act)replaced state statutes and completely
preempted the farm products exclusion
i. Relevant procedure on p. 919 of casebook: if buyers follow the payment
instructions under 1631, they take free of the bank’s SI
22. Problem 340: Farmer Bean borrowed money from ONB which had him sign a SA
covering his crops. The SA forbade him to sell his crops w/o the written consent of ONB.
It also required him to give ONB a list of potential buyers of the crop. The list was of the
5 buyers to whom he had sold his crop in the past. ONB sent a written notice complying
w/ 1631(e)(1) to each of the listed buyers, telling them that all payments for FB’s crops
should be by check made payable to ONB. One buyer not on the list was Rural Silo, a
grain merchant that contracted to buy all of FB’s 2015 wheat crop. RS knew that FB had
borrowed money from ONB and that ONB had filed a FS to perfect its SI (the state had
not created an FSA central filing system). It bought the crop from FB and paid him cash
for it.
a. Is RS, which after all knew all about ONB’s SI, a buyer in the ordinary course defined
in 1631(c)(1)?
i. Yes, buyer’s knowledge of SI does not affect his BCOB status
 ii. 1631(c)(1): Notwithstanding 9-320(a), the term “buyer in the ordinary course of
business” means a person who, in the ordinary course of business, buys farm
products from a person engaged in farming operations who is in the business of
selling farm products.
b. Does RS take free of ONB’s SI?
i. Yes b/c RS is a BCOB
ii. 1631(d): Except as provided in subsection (e) and notwithstanding any other
provision of Federal, State, or local law, a buyer who in the ordinary course of
business buys a farm product from a seller engaged in farming operations shall take
free of a SI created by the seller, even though the SI is perfected; and the buyer
knows of the existence of such interest.
c. Does ONB have any other remedy here?
i. ONB has a perfected SI in the proceeds from the sale (9-315(a)(2))
ii. ONB also has a remedy under 1631(h)(3), but the fine will be paid to the
government, not to ONB
iii. 1631(h)(3): A person violating paragraph (2) shall be fined $5,000 or 15 per centum
of the value or benefit received for such farm product described in the SA,
whichever is greater.
23. Farm Credit Bank v. F & A Dairy
a. Fact: The dairy refused to pay the bank the money it collected from a farm for milk
sales for 4 months. The farm had previously sold its milk to another dairy that had
agreed to pay the bank monthly payments.
b. Hold: The bank had an effective perfected SI covering the sale of the farm's milk to
the dairy. The bank was entitled to receive all proceeds from the sale of the farm's
milk b/c it had a perfected SI and gave proper notice to the dairy under 7 U.S.C.S.
§1631(e). The bank also informed the dairy of any payment obligations as conditions
for waiver under §1631(e) b/c the bank demanded payment in lieu of receiving
the milk. The bank was entitled to immediate possession of the farm's milk proceeds
and the dairy should have given the proceeds to the bank b/c the farm was in default
of its loan.
c. UCC is preempted by FSA
24. Problem 341: Mr. and Mrs. Halyard purchased a large sailboat (consumer goods) w/
money borrowed from the BNB, which took a SI therein and promptly filed a FS in the
proper place (although the SI would have been automatically perfected w/o filing). The
Halyards sold the boat to Oil Slick Boat Sales, a used boat concern, telling OSBS of BNB’s
SI and of the necessity of making monthly payments to BNB. OSBS turned around and
resold the boat to Mr. and Mrs. Blink, innocent people who paid in full value for the
boating believing OSBS had clear title. When BNB did not receive its usual monthly
payment, it investigated, found the boat, and repossessed it.
a. Has the Blinks’ property been converted or don’t they fit into 9-320(a)?
i. The Blinks are not BOCB (so not protected) b/c the SI was created not by the buyer’s
(the Blinks) seller (OSBS), but by Halyards.
b. What does “created by the buyer’s seller” mean in 9-320(a)?
i. It means that the original buyer can defeat the SI if he sells it to an innocent party.
 c. Does 2-403 entrusting rule help the Blinks?
i. No b/c Blinks only gets rights of the entruster (Halyard) and Halyard’s right was
subject to BNB’s perfected SI
ii. 2-403(2): Any entrusting of possession of goods to a merchant who deals in goods of
that kind gives him power to transfer all rights of the entruster to a buyer in
ordinary course of business
d. What is 2-403’s relationship w/ Art. 9?
i. 2-403(4): rights of other purchasers of goods and of lien creditors are governed by
Art. 9
e. The “created by the buyer’s seller” language will often cause trouble for buyers
buying goods from a used merchandise dealer. Why would the drafters have
favored the original creditor in this situation over a buyer in the ordinary course?
i. Creditor’s point of view: consumer goods sold to consumer
ii. No difference from the viewpoint of Blinks
f. If the Blinks lose this lawsuit, whom should they sue, and what is their theory?
i. They can sue OSBS under 2-312 (Warranty of Title: shall be delivered free of SI not
known to buyer)
g. Can OSBS use the same theory against the Halyards?
i. No b/c OSBS knew about the SI
V. Leases
A. 2A-103(1)(j): unless the context clearly indicates otherwise, lease includes a sublease
B. Problem 342: The Highbid Construction Company gave a SI to ONB in all of its construction
equipment “now owned or after-acquired.” ONB filed a FS in the proper place. 2 yrs later
Highbid was in the middle of an enormous construction project at Football University
when a number of its key EEs quit, leaving it very short-staffed. To avoid breach of K, it
became necessary to farm out the project to someone else, though Highbid had never
done this before. Highbid reached an agreement w/ Newcomer Construction Company,
one of its subcontractors on the FU job, by which Highbid would lease all of its
construction equipment to Newcomer for the length of the FU project so that
Newcomer could finish the job for Highbid. Is the lessee subject to ONB’s existing SI in the
equipment?
1. Yes, Highbid is not in the business of leasing its equipments to other contractors, so this
lease K is not in the ordinary course of business and is not protected under 9-321(c).
Thus, the lessee is subject to ONB’s existing SI in the equipment.
2. 2A-307 (Priority of Liens Arising by Attachment or Levy on, SI in, and Other Claims to
Goods)
a. Except as otherwise provided in 2A-306, a creditor of a lessee takes subject to the
lease K.
b. Except as otherwise provided in subsection (3) and in 2A-306 and 2A-308, a creditor
of a lessor takes subject to the lease K unless the creditor holds a lien that attached
to the goods before the lease K became enforceable.
c. Except as otherwise provided in 9-317, 9-321, and 9-323, a lessee takes a leasehold
interest subject to a SI held by a creditor of the lessor.
3. 9-321(c): [Rights of lessee in ordinary course of business] A lessee in ordinary course of
 business takes its leasehold interest free of a SI in the goods created by the lessor, even
if the SI is perfected and the lessee knows of its existence
C. Problem 343: When FU project was completed, the lease described in Problem 342
ended, and the machinery was returned by the lessee to Highbid. Highbid paid off all of
its loans in full and free all of its assets from the SIs that had encumbered them.
Highbid’s lawyer advised the company that for both tax and accounting reasons it would
be better if Highbid leased the new grading machine that it had recently purchased
rather than owning it outright. To accomplish this, Highbid’s attorney worked out a
deal by which ONB would purchase the grading machine from Highbid and then lease it
back to Highbid. The term of the lease was exactly equal to the useful life of the grading
machine. (sale on lease-back) 2 months after this arrangement had come into being,
HIghbid needed to borrow some money. ONB refused to advance further funds, so
Highbid sought a loan from ANB, offering the grading machine as collateral. He was able
to produce a bill of sale showing that Highbid had purchased the grading machine a mere
3 months ago when it was involved in the FU
K. He did not tell ANB about the subsequent sale and leaseback arrangement that Highbid
had w/ ONB. After ANB checked the public records and found no evidence of SI in the
grading machine, it had Highbid sign the necessary Art. 9 documents and a promissory
note, loaned the money, and filed its FS in the appropriate place.
When Highbid defaulted on its lease payments, ONB repossessed the grading machine, at
which point ANB claimed the superior interest therein. ANB’s attorney argued that ONB
was a party to fraud in that the sale and leaseback helped Highbid create the false
appearance of assets.
1. How does this come out?
a. ANB wins. ONB had a disguised SI (not a lease) b/c it was leased to Highbid for the
useful life of the goods. ONB should have filed a FS to retain priority. Since ANB filed
first, ANB wins.
b. 2A-307(1): creditor of a lessee takes subject to the lease K unless lien attached before
lease K
c. 2A-308(3): creditor of a seller may treat a sale/identification of goods to a K for sale
as void if as against the creditor retention of possession by the seller is fraudulent,
but retention of possession of the goods pursuant to a lease K entered into by
seller as lessee and buyer as lessor in connection w/ the sale/identification of the
goods is not fraudulent if buyer bought for value and in good faith (sale and
lease-back not fraudulent if in good faith)
d. 1-203 (Lease Distinguished from SI)
2. Would you reach the same result if the lease agreement b/w Highbid and ONB
provided the lessee w/ a right of termination at any time?
a. No, then ONB would win b/c this would be a true lease and creditor (ANB) of a lessee
(Highbid) takes subject to the lease K
VI. Article 2 Claimants
A. Problem 344: Jack was a traveling salesman. He needed new luggage to carry his samples
and bought a set from Alligator Fashions, which reserved a SI therein and filed a FS. 1
month later, Jack sold all of his samples and the luggage to Mark who paid cash. Jack
told Mark
 that the luggage was genuine alligator (lie). When Mark discovered the truth, he revoked
his acceptance of the goods pursuant to 2-608 and claimed a SI in the goods (2-711(3)). On
learning of Jack’s resale to Mark and of the latter’s revocation of acceptance, AF decided
to call the loan and repossess the luggage. Who is entitled to luggage?
1. Mark is entitled to luggage b/c a SI arising under 2-711(3) has priority over a conflicting
SI created by the debtor until the debtor obtains possession of the goods under 9-
110(d).
a. 9-320 does not protect Mark b/c he is not a buyer in ordinary course of business
since Jack usually sells samples, not luggage
b. Art. 2 claimants win as long as they perfect by possession
2. 2-711(3): On rightful rejection or justifiable revocation of acceptance, buyer has a SI in
goods in his possession or control for any payments made on their price and nay
expenses reasonably incurred in their inspection, receipt, transportation, care and
custody and may hold such goods and resell them in like manner as an aggrieved seller
(2-706)
3. 9-110 (SI Arising under Art. 2 or 2A): A SI arising under 2-401, 2-505, 2-711(3), or 2A-
508(5) is subject to Art. 9. However, until the debtor obtains possession of the goods:
a. the SI is enforceable, even if 9-203(b)(3) has not been satisfied;
b. filing is not required to perfect the SI;
c. the rights of the secured party after default by the debtor are governed by Art. 2 or
2A; and
d. the SI has priority over a conflicting SI created by the debtor.
B. Rights of Unpaid Seller
1. If seller gets a SA covering the item sold, a PMSI (9-103) arises and 9-324(a) & (b)
handles priority
2. If seller extends credit to buyer but fails to reserve a SI, 2-702 applies
3. If buyer gets the goods and pays w/ a check that is then dishonored, seller’s rights are
governed by 2-403, 2-507 and 2-511, not by 2-702
4. Problem 345: Guy was a successful author who decided to self-publish his latest book
and market it directly to retailers. He received an order for 200 copies from Cowskin
Book Chain, and he shipped off the books immediately, along w/ an invoice for their
price. 2 days later he learned that Cowskin was hopelessly insolvent and unable to pay
any creditors.
a. What can he do?
i. Guy may stop delivery of goods in the possession of a carrier (2-705) or reclaim the
books upon a demand made within 10 days after Cowskin’s receipt of the books
ii. 2-702(2) (Seller’s Remedies on Discovery of Buyer’s Insolvency): where seller
discovers that buyer has received goods on credit while insolvent, seller may
reclaim the goods upon demand made within 10 days after the receipt, but if
misrepresentation of solvency has been made to the particular seller in writing
within 3 months before delivery, the ten day limitation does not apply. Except as
provided in this subjection, seller may not base a right to reclaim goods on buyer’s
fraudulent or innocent misrepresentation of solvency or of intent to pay
b. Suppose that 2 weeks before he shipped the books, Cowskin had sent him a letter
 lying about its financial condition. Now how long does he have to make his
reclamation demand?
i. Guy may reclaim the books within a reasonable time (SOL applies) b/c 10 day
limitation does not apply as Cowskin misrepresented its solvency in writing within 3
months before delivery
c. If he gets the books back, can he sue Cowskin for the wasted shipping cost? No
i. 2-702(3): Successful reclamation of goods excludes all other remedies w/r/t them.
d. If Cowskin’s inventory was subject to a perfected SI in favor of a bank, which thereby
had a floating lien on the inventory, could he still reclaim the books?
i. No, Guy (who has a SI in this own books)’s right to reclaim is subject to the rights of
good-faith purchaser (the bank: inventory financier)
ii. 2-702(3): The seller's right to reclaim under subsection (2) is subject to the rights of
a buyer in ordinary course of business or other good-faith purchaser for value under
2-403.
iii. 2-403(1): A purchaser of goods acquires all title which his transferor had or had
power to transfer except that a purchaser of a limited interest acquires rights only
to the extent of the interest purchased. A person w/ voidable title has power to
transfer a good title to a good faith purchaser for value. When goods have been
delivered under a transaction of purchase the purchaser has such power even
though
a) the transferor was deceived as to the identity of the purchaser, or
b) the delivery was in exchange for a check which is later dishonored, or
c) it was agreed that the transaction was to be a "cash sale", or
d) the delivery was procured through fraud punishable as larcenous under the
criminal law
e. Note that the definition of a purchaser in 1-201(a)(29) and (30) includes any
voluntary transferee, which would encompass secured parties. What should Guy
have done?
i. He should have claimed a PMSI in the books and perfect and notify the inventory
financier of his interest before shipping the goods
ii. 9-324(b): [Inventory PM priority] Subject to subsection (c) and except as otherwise
provided in subsection (g), a perfected PMSI in inventory has priority over a
conflicting SI in the same inventory, has priority over a conflicting SI in chattel paper
or an instrument constituting proceeds of the inventory and in proceeds of the
chattel paper, if so provided in 9-330, and, except as otherwise provided in 9-327,
also has priority in identifiable cash proceeds of the inventory to the extent the
identifiable cash proceeds are received on or before the delivery of the inventory to
a buyer, if:
a) the PMSI is perfected when the debtor receives possession of the inventory;
b) the PM secured party sends an authenticated notification to the holder of the
conflicting SI;
c) the holder of the conflicting SI receives the notification within 5 yrs before the
debtor receives possession of the inventory; and
 d) the notification states that the person sending the notification has or expects to
acquire a PMSI in inventory of the debtor and describes the inventory.
5. If buyer had filed a bankruptcy petition shortly before receiving the books, seller might
recover the books from the bankruptcy trustee
a. BC 546(c)
i. Except as provided in subsection (d) and in 507(c), and subject to the prior rights
of a holder of a SI in such goods or the proceeds thereof, the rights and powers of
the trustee under sections 544(a) (strong arm clause), 545, 547, and 549 are
subject to the right of a seller of goods that has sold goods to the debtor, in the
ordinary course of such seller’s business, to reclaim such goods if the debtor has
received such goods while insolvent, within 45 days before the date of the
commencement of a case under this title, but such seller may not reclaim such
goods unless such seller demands in writing reclamation of such goods
a) not later than 45 days after the date of receipt of such goods by the debtor; or
b) not later than 20 days after the date of commencement of the case, if the 45-day
period expires after the commencement of the case.
ii. If a seller of goods fails to provide notice in the manner described in paragraph (1),
the seller still may assert the rights contained in 503(b)(9).
6. In re Arlco
a. Lender, who held a perfected SI in substantially all of debtor's assets, was a good
faith purchaser for value. Thus P's interest as a reclaiming seller was subject to
lender's rights as a good faith purchaser.
b. Note
i. 2-702(3) protects good faith purchaser and BOCB
ii. What happened to the surplus?
a) No surplus b/c inventory financier eats up all the loss
7. Problem 346: ONB held a perfected SI in all the cattle owned by Family Farms of IW.
When it became obvious that the farm was failing financially, ONB decided to pull the
plug. Before it did so, it wanted to make sure that the cattle were well fed, so ONB
called Cow Chow, and encouraged it to make another delivery of cattle feed to FF, even
though it had not been paid for its last 2 deliveries. ONB did not mention that it was
about to foreclose on the fattened cattle, which it did as soon as they had consumed
most of the new delivery (for which CC billed FF in the amount of $10K). CC was an
unsecured creditor (PM security creditor), which ONB well knew. Is ONB required to
give CC any of the money it realizes from the foreclosure sale?
a. Yes, ONB did not act in good faith b/c they tricked Cow Chow (fraud)
b. 1-103(b): unless displaced by UCC, the common law supplements UCC
c. 1-304: obligation of good faith
VII. Statutory Lien Holders
A. Repair person in the ordinary course of business
1. Frequently has priority over previously perfected “consensual” SI
2. 9-333 (Priority of Certain Liens Arising by Operation of Law)
a. ["Possessory lien"] In this section, "possessory lien" means an interest, other than a
 SI or an agricultural lien:
i. which secures payment or performance of an obligation for services or materials
furnished w/r/t goods by a person in the ordinary course of the person's
business;
ii. which is created by statute or rule of law in favor of the person; and
iii. whose effectiveness depends on the person's possession of the goods.
b. [Priority of possessory lien] A possessory lien on goods has priority over a SI in the
goods unless the lien is created by a statute that expressly provides otherwise.
3. OC to 9-333:
a. “possessory” lien: common law and statutory liens whose effectiveness depends on
the lienor’s possession of goods w/r/t which the lienor provided services or
furnished material in the ordinary course of its business
b. possessory lien has priority over a SI unless the possessory lien is created by a
statute that expressly provides otherwise
4. Problem 347: RFC had a perfected SI in Hattie Mobile’s car (RFC’s lien was noted on
the certificate of title as required by state law). The car broke down and Hattie had it
towed to Mike’s Greasepit Garage, where it was repaired. State law gave a possessory
artisan’s lien to repair persons. The garage told Hattie it was claiming such a lien, but
when she pleaded w/ the manager, he let her drive the car to work after she assured
him that she would return the car to the garage for storage every night. Repossession
found out about this practice and, deeming itself insecure (1-309), accelerated the
amount due and repossessed the car from Hattie.
a. Which creditor has the superior interest in the car under 9-333?
i. RFC has the superior interest b/c the garage lost its “possessory” lien once it
returned the possession of the car to Hattie
ii. Forrest Cate Ford v. Fryar: repairman has to retain possession in order to maintain
the priority of statutory lien over preexisting SI
b. If the car had been in Mike’s possession when the conflict arose, would it matter
under 9-333 that the finance company never gave its consent to the repairs?
i. No, consent by the creditor is irrelevant under 9-333
ii. Williamsport Natl. Bank v. Shrey: The common law repairman's lien given by rule
of law has priority over a prior SI, even if perfected, regardless of whether or not
consent for the repairs was given by the holder of the SI.
c. Once Mike’s released the car to Hattie, did its lien reattach whenever she returned it
to the garage?
i. Courts are evenly split on this issue
ii. In re Borden: the artisan’s lien holder’s consent is merely a conditional consent to
debtor’s temporary use of the equipment w/ an agreement to him, so he did not
lose artisan’s lien
d. What if the garage’s charges are unconscionably high?
i. No artisan’s lien allowed unless lienor furnished services or materials in the
ordinary course of his business (i.e., in good faith)
VIII. Fixtures
A. Art. 9 special rules for creation and perfection of a fixture
 1. 9-109(a): Art. 9 applies to (1) any transaction that creates a SI in personal property or
fixture
2. 9-501(a)(1)(B): fixture filings have to be made in the real property records
3. 9-102(a)(41): “Fixtures” mean goods that have become so related to particular real
property that an interest in them arises under real property law
4. 9-334(a): A SI does not exist under Art. 9 in ordinary building materials incorporated
into an improvement on land (not fixtures)
B. Pre-Code state law tests for fixtures
1. Pure annexation test: measured by the difficulty of removal
2. Intention of the parties test: Teaff v. Hewitt
3. Trade fixtures: items of personal property necessary to the conduct of the tenant’s
business but not permanently affixed to the realty
a. UCC courts treat a trade fixture as equipment and not as a true fixture
4. Assembled industrial plant doctrine: all items connected w/ the operation of a going
business are fixtures (PA courts)
C. George v. Commercial Credit Corp. (mobile home that moved only once: fixture)
1. Fact: The property owner lived in a mobile home, which was subject to a mortgage held
by the secured creditor. The property owner filed for bankruptcy protection.
2. Hold: Wis. Stat. and decisional law increasingly recognized a distinction b/w mobile and
motor homes. A mobile home was realty if it was physically annexed to realty, if it was
adapted to the realty's use, and if the person annexing it intended to make a permanent
accession to the freehold. In light of these factors, the property owner's mobile home
was a fixture and had the nature of real property.
D. 9-334 (Priority of SIs in Fixtures and Crops)
1. [SI in fixtures under Art. 9] A SI under Art. 9 may be created in goods that are fixtures or
may continue in goods that become fixtures. A SI does not exist under Art. 9 in ordinary
building materials incorporated into an improvement on land.
2. [SI in fixtures under real-property law] Art. 9 does not prevent creation of an
encumbrance upon fixtures under real property law.
3. [General rule: subordination of SI in fixtures] In cases not governed by subsections (d)
through (h), a SI in fixtures is subordinate to a conflicting interest of an encumbrancer
(mortgagee) or owner (landlord) of the related real property other than the debtor
4. [Fixtures PM priority] Except as otherwise provided in subsection (h), a perfected SI in
fixtures has priority over a conflicting interest of an encumbrancer or owner of the real
property if the debtor has an interest of record in or is in possession of the real
property and:
a. the SI is a PMSI;
b. the interest of the encumbrancer or owner arises before the goods become fixtures;
and
c. the SI is perfected by a fixture filing (in the real property records) before the goods
become fixtures or within 20 days thereafter.
5. [Priority of SI in fixtures over interests in real property] A perfected SI in fixtures has
priority over a conflicting interest of an encumbrancer or owner of the real property if:
 a. the debtor has an interest of record in the real property or is in possession of the real
property and the SI:
i. is perfected by a fixture filing before the interest of the encumbrancer or owner is
of record; and
ii. has priority over any conflicting interest of a predecessor in title of the
encumbrancer or owner;
b. before the goods become fixtures, the SI is perfected by any method permitted by
Art. 9 (okay if not perfected by fixture filing) and the fixtures are readily removable:
i. factory or office machines;
ii. equipment that is not primarily used or leased for use in the operation of the real
property; or
iii. replacements of domestic appliances that are consumer goods;
c. the conflicting interest is a lien on the real property obtained by legal or equitable
proceedings after the SI was perfected by any method permitted by Art. 9; or
d. the SI is:
i. created in a manufactured home in a manufactured-home transaction; and
ii. perfected pursuant to a statute described in 9-311(a)(2).
6. [Priority based on consent, disclaimer, or right to remove] A SI in fixtures, whether or
not perfected, has priority over a conflicting interest of an encumbrancer or owner of
the real property if:
a. the encumbrancer or owner has, in an authenticated record, consented to the SI or
disclaimed an interest in the goods as fixtures; or
b. the debtor has a right to remove the goods as against the encumbrancer or owner.
7. [Continuation of paragraph (f)(2) priority] The priority of the SI under paragraph (f)(2)
continues for a reasonable time if the debtor's right to remove the goods as against the
encumbrancer or owner terminates.
8. [Priority of construction mortgage] A mortgage is a construction mortgage to the
extent that it secures an obligation incurred for the construction of an improvement
on land, including the acquisition cost of the land, if a recorded record of the
mortgage so indicates. Except as otherwise provided in subsections (e) and (f), a SI
in fixtures is subordinate to a construction mortgage if a record of the mortgage is
recorded before the goods become fixtures and the goods become fixtures before the
completion of the construction. A mortgage has this priority to the same extent as a
construction mortgage to the extent that it is given to refinance a construction
mortgage. (top dog priority given to construction mortgagee)
9. [Priority of SI in crops] A perfected SI in crops growing on real property has priority over
a conflicting interest of an encumbrancer or owner of the real property if the debtor
has an interest of record in or is in possession of the real property.
10. [Subsection (i) prevails] Subsection (i) prevails over any inconsistent provisions of
other statutes
E. Problem 348: Monopoly Railway went to ONB and asked to borrow money, using as part
of the collateral its extensive network of railroad track (rails and ties), which winds
through 12 western states. The track is installed in a total 117 counties. Must it file a FS in
each one?
 1. No, MR is a “transmitting utility” so it must file a FS in at least one county in each of the
12 western states (transmitting utility equipment is a fixture and need to be filed in 1
location in each state)
2. 9-501(b): [Filing office for transmitting utilities] The office in which to file a FS to perfect
a SI in collateral, including fixtures, of a transmitting utility is the office of [ ]. The FS also
constitutes a fixture filing as to the collateral indicated in the FS which is or is to
become fixtures.
3. 9-102(a)(80):"Transmitting utility" means a person primarily engaged in the business of:
a. operating a railroad, subway, street railway, or trolley bus;
b. transmitting communications electrically, electromagnetically, or by light;
c. transmitting goods by pipeline or sewer; or
d. transmitting or producing and transmitting electricity, steam, gas, or water.
F. Problem 349: Simon decided to erect an apartment building on a vacant lot he owned, so
he borrowed $4M from CSB, to which he mortgaged the real estate “and all
appurtenances or things affixed thereto, now present or after-acquired.” Simon and
CSB signed the mortgage, which contained a legal description of the realty, and the
mortgage was filed in the real property recorder’s office.
1. Is the mortgage effective as a FS?
a. Yes, the mortgage is effective as a FS filed as a fixture filing (adequately describing
fixture)
b. 9-502(c):[Record of mortgage as FS] A record of a mortgage is effective, from the
date of recording, as a FS filed as a fixture filing or as a FS covering as-extracted
collateral or timber to be cut only if:
i. the record indicates the goods or accounts that it covers;
ii. the goods are or are to become fixtures related to the real property described in the
record or the collateral is related to the real property described in the record and is
as-extracted collateral or timber to be cut;
iii. the record satisfies the requirements for a FS in this section other than an indication
that it is to be filed in the real property records; and
iv. the record is [duly] recorded
2. During construction of the apartment building, Simon bought a furnace on credit from
Blast Home Supplies, giving Blast a SI in the furnace that described the real estate.
Where should Blast file its FS?
a. Blast should file its FS in the office designated for filing mortgages on the real
property, or w/ the court clerk of the superior court in any county of the state
b. 9-501(1)(B): filing office is the office designated for the filing or recording of a
mortgage on the related real property if the FS is filed as a fixture filing and the
collateral is goods that are or are to become fixtures
c. 9-501(2): the office of the clerk of the superior court of any county of this state
3. Is there a technical sentence that needs to be in this FS?
a. Yes, a FS filed as a fixture filing must indicate that it is to be filed w/ the real property
records
b. 9-502(b)(2): FS that is filed as a fixture filing and covers goods that are or are to
 become fixtures must indicate that it is to be filed [for record] in the real property
records
4. Why would the drafters have added such a requirement?
a. So that the clerks are aware
5. If Blast files a proper FS in the right place before the furnace is installed, will Blast
prevail over CSB?
a. No, the furnace was bought on credit from Blast as equipment for his apartment
complex to be converted to a fixture upon installment after he entered into a
construction mortgage w/ CSB who filed first. B/c a construction mortgage who files
first reasonably expects to have its priority in the improvement built using the
mortgagee’s advances, a later filing by a PM creditor will be subordinate. B/c the
furnace is a good that will become a fixture within the construction period of the
construction mortgage, construction mortgage has super priority even over PMSI
b. 9-334(d): [Fixtures PM priority] Except as otherwise provided in subsection (h), a
perfected SI in fixtures has priority over a conflicting interest of an encumbrancer or
owner of the real property if the debtor has an interest of record in or is in
possession of the real property and:
i. the SI is a PMSI;
ii. the interest of the encumbrancer or owner arises before the goods become
fixtures; and
iii. the SI is perfected by a fixture filing before the goods become fixtures or within 20
days thereafter.
c. 9-334(h): [Priority of construction mortgage] A mortgage is a construction mortgage
to the extent that it secures an obligation incurred for the construction of an
improvement on land, including the acquisition cost of the land, if a recorded record
of the mortgage so indicates. Except as otherwise provided in subsections (e) and (f),
a SI in fixtures is subordinate to a construction mortgage if a record of the mortgage
is recorded before the goods become fixtures and the goods become fixtures before
the completion of the construction. A mortgage has this priority to the same extent
as a construction mortgage to the extent that it is given to refinance a construction
mortgage
d. OC11: priority is given to the construction mortgage recorded before the filing of the
PMSI in fixtures. A refinancing of a construction mortgage has the same priority as
the construction mortgage itself. This applies only to goods that become fixtures
during the construction period leading to the completion of the improvements
6. If CBS’s interest is not perfected, will Blast prevail?
a. Yes if Blast properly perfected its SI as a fixture filing
b. 9-334(e)(1): a perfected SI in fixtures has priority over a conflicting interest of an
encumbrancer or owner of the real property if the debtor has an interest of record in
the real property or is in possession of the real property and the SI (A) is perfected by
a fixture filing before the interest of the encumbrancer or owner is of record; and (B)
has priority over any conflicting interest of a predecessor in title of the encumbrancer
or owner
7. What can Blast do to ensure itself of priority?
a. Blast may K w/ CSB for the voluntary subordination of the furnace under 9-339 or
may ask for CSB’s consent to Blast’s SI and obtain an authenticated record of this
consent under 9-334(f)(1)
b. 9-334(f)(1): A SI in fixtures, whether or not perfected, has priority over a conflicting
interest of an encumbrancer or owner of the real property if the encumbrancer or
owner has, in an authenticated record, consented to the SI or disclaimed an interest
in the goods as fixtures
c. 9-339 (Priority Subject to Subordination): Art. 9 does not preclude subordination by
agreement by a person entitled to priority
8. Problem 350: Would your answer to Problem 349’s priority disputes change if the
object in question were a refrigerator?
i. Yes b/c refrigerator is readily removable and not primarily used in the operation of
the apartment building (9-334(e)(2)(B))
b. What if it were a computer that Simon purchased for use in his office (which is
located in the apartment building)?
i. The computer is an office machine under 9-334(e)(2)(A) (some states would consider
the computer a fixture under the industrial plant doctrine)
ii. 9-334(e)(2): A perfected SI in fixtures has priority over a conflicting interest of an
encumbrancer or owner of the real property if, before the goods become fixtures,
the SI is perfected by any method permitted by Art. 9 and the fixtures are readily
removable:
a) factory or office machines;
b) equipment that is not primarily used or leased for use in the operation of the real
property; or
c) replacements of domestic appliances that are consumer goods;
iii. 9-334(f)(2): A SI in fixtures, whether or not perfected, has priority over a conflicting
interest of an encumbrancer or owner of the real property if the debtor has a right
to remove the goods as against the encumbrancer or owner
iv. OC8 (exception to the usual first-to-file-or-perfect rule in (e)(2)): priority is given to
the holders of SI in readily removable goods, nor primarily used in the operation of
the real property
9. Lewiston Bottled Gas v. Key Bank of Maine
a. Fact: The bank held a mortgage on real estate that covered after-acquired fixtures.
The property owner constructed a hotel on the property and bought 90 heating and
air-conditioning units from the gas company in exchange for a PMSI in the units. The
SI was recorded under the corporate entity that constructed and ran the hotel. The
bank gave 2nd mortgage and subsequently foreclosed on both mortgages.
b. Hold: The units were physically annexed to the real estate as the personal and real
property were united in the carrying out of a common enterprise. The SI could not be
considered against the bank b/c the bank was not a party to it and was unaware of it.
The units were subject to the mortgages and that 1st mortgage took priority over the
SI as it was not properly perfected due to the improper recording.
10. Problem 351: Simon failed to pay his attorney, Susan, so she sued him, recovered
judgment, and levied on the apartment building and its contents.
a. Will Simon’s creditors holding SIs in the fixture prevail if they have perfected by
fixture filings?
i. Yes, Simon’s creditor’s perfected SIs in fixtures have priority over Susan’s subsequent
judgment lien (judicial lien creditors are not protected in fixture unless they check
the real property records)
ii. 9-334(e)(3): A perfected SI in fixtures has priority over a conflicting interest of an
encumbrancer or owner of the real property if the conflicting interest is a lien on the
real property obtained by legal or equitable proceedings (judicial lien) after the SI
was perfected by any method permitted by Art. 9
b. What if those creditors filed FSs in all the correct places except the real estate
records?
i. Does not matter
ii. OC9 to 9-334: a perfected fixture SI takes priority over a subsequent judgment lien
even if no evidence of the SI appears in the relevant real property records
11. Problem 352: After the building was complete, Tuesday moved in. Not liking the
refrigerator Simon had installed, she had him remove it, and she bought another
refrigerator on time from Easy Credit Department Store, which reserved a SI therein but
never filed a FS (b/c it is a PMSI in consumer goods that is automatically perfected).
Assume state real property laws permit CSB’s after-acquired property mortgage to reach
fixtures installed by lessees. (If they do not, ECDS will always prevail. 9-334(f)(2)). Will
ECDS be entitled to priority if it is forced to repossess?
a. Yes, ECSD has priority over the construction mortgage b/c ECSD’s PMSI was
automatically perfected (replacement of domestic appliance that is consumer goods)
b. 3-334(e)(2)(C): A perfected SI in fixtures has priority over a conflicting interest of an
encumbrancer or owner of the real property if, before the goods become fixtures, the
SI is perfected by any method permitted by Art. 9 and the fixtures are readily
removable replacements of domestic appliances that are consumer goods
c. OC8: (e)(2) is limited to readily removable “replacements” of domestic appliances
(not “original installations”) which are consumer goods. A secured party financing
occasional replacements of domestic appliances in noncommercial, owner-occupied
contexts need not concern itself w/ real-property descriptions or records
12. Problem 353: Assume Tuesday in Problem 353 bought a trash compactor on credit
from ECDS and installed it on May 5. ECDS comes to you on May 7.
a. Is it entitled to automatic perfection of its SI in consumer goods here?
i. No b/c (although the SI is in consumer goods) a SI in fixtures must be perfected by a
fixture filing
a) 3-334(e)(2)(C) does not apply b/c it is not replacement (but original)
ii. OC3 to 9-309: A fixture filing is required for priority over conflicting interests in
fixtures to the extent provided in 9-334 except 9-334(e)(2)
b. Suppose it has a FS indicating the debtor is Tuesday. Should the statement contain
Simon’s name too? Why?
i. Yes, the FS must provide Simon’s name b/c Tuesday (debtor - tenant) does not have
 an interest of record in the real property.
ii. 9-502(b)(4): to be sufficient, a FS which is filed as a fixture filing and covers goods
that are or are to become fixtures, must provide the name of a record owner if the
debtor does not have an interest of record in the real property
c. Will ECDS prevail over CSB if it filed on May 10?
i. Yes b/c the SI is perfected (May 10) within 20 days after trash compactor became
fixture(May 5)
ii. 9-334(d): A perfected SI in fixtures has priority over a conflicting interest of an
encumbrancer or owner of the real property if the debtor has an interest of record
in or is in possession of the real property and
a) The SI is a PMSI;
b) The interest of the encumbrancer or owner arises before the goods become
fixtures; and
c) The SI is perfected by a fixture filing before the goods become fixtures or within
20 days thereafter
d. Will it prevail over Simon’s landlord’s lien?
i. ??
13. Problem 354: Assume that Blast Home Supplies held a perfected SI in Simon’s furnace
and that this interest was entitled to priority over CSB, the real estate mortgagee.
a. If Simon defaults on his payments, what liability does Blast have to CSB if removal
(repossession) of the furnace will do $1K damage to the building’s structure and if to
replace it Simon (or CSB) will have to spend $8K?
i. If Blast removes the furnace, it must reimburse only the injury ($1K) caused by the
removal. But it need not reimburse for diminution in value of the real property ($8K)
caused by the absence of the furnace removed or by any necessity of replacing it
ii. 9-604(c): [Removal of fixture] (W/o breaching the peace) if a secured party holding a
SI in fixture has priority over all owners and encumbrancers of the real property, the
secured party, after default, may remove the collateral from the real property
iii. 9-604(d): [Injury caused by removal] A secured party that removes collateral shall
promptly reimburse any encumbrancer or owner of the real property, other than the
debtor, for the cost of repair of any physical injury caused by the removal. The
secured party need not reimburse the encumbrancer or owner for any diminution in
value of the real property caused by the absence of the goods removed or by any
necessity of replacing them. A person entitled to reimbursement may refuse
permission to remove until the secured party gives adequate assurance for the
performance of the obligation to reimburse.
iv. OC3: A secured party whose SI in fixture has priority over owners and
encumbrancers of the real property may remove the collateral from the real
property. However, the secured party must reimburse any owner (other than the
debtor) or encumbrancer for the cost of reparing any physical injury caused by the
removal
b. What are CSB’s rights?
i. 9-604(d): CSB may refuse permission to remove the furnace until Blast gives
adequate assurance for the reimbursement of $1K
 c. Is Blast liable to Simon for the damage to the building caused by the furnace’s
removal?
i. No, Blast need not reimburse Simon b/c he is the debtor (9-604(d) excludes debtor
from reimbursement b/c he is the one who caused the problem)
14. Maplewood Bank & Trust v. Sears, Roebuck & Co.
a. Fact: P was the holder of 1st PM mortgage owned by the homeowners. D department
store filed a FS and executed a SI, which covered a new kitchen installed in the
mortgaged premises at the request of the homeowners. When the homeowners
defaulted in the payments due, P filed a complaint for foreclosure. D sought a
declaration that it was entitled to priority over P.
b. Hold: D's SI was limited to the fixtures and did not extend to the realty. Adopting D's
approach would be a modification of long-established fundamental property rights of
PM mortgagees and was not implied from 9-313.
i. OC3 to 9-604: this case has been overruled. Fixture financier is protected, i.e.,
extends to the realty
c. Note: What could Sears do if 9-604 had been the law when the case was decided?

i. Creditor who is repossessing a fixture is bound by all the usual repossession rules
15. Problem 355: Farmer Bean had filed a mortgage on his home in favor of RSB. The
mortgage stated that it extended to the realty and all things “growing on, or attached
thereto, now in existence or in the future.” When FB borrowed money to plant this yr’s
crop, he gave a SI in the crop to Seeds, the PM lender. If the latter files its FS in
the appropriate place, will it prevail over RSB’s mortgage lien?
a. Yes, Seeds prevails b/c they have a perfected SI in crops
b. 9-334(i): A perfected SI in crops growing on real property has priority over a
conflicting interest of an encumbrancer or owner of the real property if the debtor
has an interest of record in or is in possession of the real property
c. OC12: when crops are encumbered by both a mortgage and an Art. 9 SI, the SI has
priority
16. Problem 356: When FB bought a doublewide trailer from Traveling Homes, for $100K,
he had it towed to a vacant lot on his farm. The doublewide was then placed on a
foundation that had been built on the vacant log, attached to various utilities for
electricity and water, and FB built a fancy deck that he extended out the front door of
the trailer. If you are the attorney representing the bank that loaned FB the money
to buy the doublewide, what steps should be taken to perfect its PMSI in the
collateral: a real estate mortgage, a fixture filing under Art. 9, or notation of the bank’s
interest on a certificate of title issued for the doublewide?
a. No agreement as to this question (file everywhere!)
b. 9-334(e)(4): A perfected SI in fixtures has priority over a conflicting interest of an
encumbrancer or owner of the real property if the SI is (i) created in a manufactured
home in a manufactured-home transaction and (ii) perfected pursuant to a statute
described in 9-311(a)(2)
c. 9-311(a)(2): FS is not effective to perfect a SI in property subject to any certificate-of-
 title statute covering automobiles, trailer, mobile homes, boats, farm tractors, or the
like
d. In re Kroskie: certificate of title controls
e. In re Gregory: real property laws trump Art. 9 rules
IX. Accessions And Commingling
A. Accessions
1. When goods are affixed to other goods (as opposed to realty), an accession occurs (e.g.,
stereo system to automobile)
2. 9-335 (Accessions)
a. [Creation of SI in accession] A SI may be created in an accession and continues in
collateral that becomes an accession.
b. [Perfection of SI] If a SI is perfected when the collateral becomes an accession, the SI
remains perfected in the collateral.
c. [Priority of SI] Except as otherwise provided in subsection (d), the other provisions of
this part determine the priority of a SI in an accession.
d. [Compliance w/ certificate-of-title statute] A SI in an accession is subordinate to a SI
in the whole which is perfected by compliance w/ the requirements of a certificate-
of-title statute under 9-311(b).
e. [Removal of accession after default] After default, subject to Part 6, a secured party
may remove an accession from other goods if the SI in the accession has priority over
the claims of every person having an interest in the whole.
f. [Reimbursement following removal] A secured party that removes an accession from
other goods under subsection (e) shall promptly reimburse any holder of a SI or other
lien on, or owner of, the whole or of the other goods, other than the debtor, for the
cost of repair of any physical injury to the whole or the other goods. The secured
party need not reimburse the holder or owner for any diminution in value of the
whole or the other goods caused by the absence of the accession removed or by any
necessity for replacing it. A person entitled to reimbursement may refuse permission
to remove until the secured party gives adequate assurance for the performance
of the obligation to reimburse.
B. Commingling
1. When goods are so combined w/ other goods that they cannot be recovered
2. 9-336 (Commingled Goods)
a. ["Commingled goods"] In this section, "commingled goods" means goods that are
physically united w/ other goods in such a manner that their identity is lost in a
product or mass.
b. [No SI in commingled goods as such] A SI does not exist in commingled goods as
such. However, a SI may attach to a product or mass that results when goods
become commingled goods.
c. [Attachment of SI to product or mass] If collateral becomes commingled goods, a SI
attaches to the product or mass.
d. [Perfection of SI] If a SI in collateral is perfected before the collateral becomes
commingled goods, the SI that attaches to the product or mass under subsection (c)
 is perfected.
e. [Priority of SI] Except as otherwise provided in subsection (f), the other provisions of
this part determine the priority of a SI that attaches to the product or mass under
subsection (c).
f. [Conflicting SIs in product or mass] If more than one SI attaches to the product or
mass under subsection (c), the following rules determine priority:
i. A SI that is perfected under subsection (d) has priority over a SI that is unperfected
at the time the collateral becomes commingled goods.
ii. If more than one SI is perfected under subsection (d), the SIs rank equally in
proportion to the value of the collateral at the time it became commingled goods.
C. Problem 357: Victor was a traveling salesman. He owned a Honda in which the Salesman’s
Credit Union held a perfected SI, which was duly noted on the certificate of title. He
purchased a fancy GPS from WorldView, which claimed a PMSI in the GPS and filed a FS in
the appropriate place before the system was installed in the Honda. Will the credit union
or WorldView have priority in the GPS?
1. WordView’s SI in GPS is subordinate to Union’s perfected SI in the Honda if it is an
accession. But, GPS is readily removable from a car, so no accession (But, OC uses tires
as an example of accession)
2. 9-335(d): A SI in accession is subordinate to a SI in the whole which is perfected by
compliance w/ the requirements of a certificate-of-title statue under 9-311(b)
3. OC7: SP1 has a perfected SI in Debtor’s existing and after-acquired baked goods and SP2
has a perfected SI in Debtor’s flour. When the flour is processed into cakes, SP2
acquires a perfected SI in the cakes. If SP1 filed against the baked goods before SP2
filed against the flour, SP1 will enjoy priority in the cakes. But if SP2 filed against the
flour before SP1 filed against the baked goods, SP2 will enjoy priority in the cakes to the
extent of its SI
4. Paccar Financial Corp. v. Les Schwab Tire Centers of Montana: easily removable items
are not accessions
X. Federal Priorities for Debts and Taxes
A. The Federal Priority Statute (not on the exam)
1. Grant of pre-bankruptcy priority for all federal claims no matter how they arise
a. Paid first when a debtor becomes insolvent
2. Courts have subordinated the federal claim to an earlier lien (judicial, statutory, and
consensual) if the lien is choate (fixed)
a. Gorden v. Campbell: a lien is choate (and therefore superior to the federal interest) if
the lien is definite in at least 3 respects (1) the identity of the lienor; (2) the amount
of the lien; and (3) the property to which it attaches
b. US v. Gilbert Assocs., : a lien is inchoate (and thereby lost to a federal claim) where
the lien claimant had neither title nor possession
c. Gilmore: A security arrangement claiming a floating lien on after-acquired property or
claiming a priority for future advances is inchoate and inferior to the federal claim
B. Tax Liens – Basic Priority
1. Federal tax liens
a. Arises upon assessment and covers all of the taxpayer’s property (no filing needed)
 b. Secret lien: no one knows of the assessment except the IRS, nevertheless tax lien
binds the property
c. Government wins out over all parties claiming an interest in the property except “any
purchaser, holder of a SI, mechanic’s lienor, or judgment creditor.”
d. Must be filed in the place designated under state law
2. US v. Estate of Romani (skip)
a. The federal priority statute did not give preference to tax liens over the prior
perfected judgment lien, where the priority statute did not supersede the federal Tax
Lien Act in the adjudication of federal tax claims. Under the Act, the tax liens were
not valid as against the earlier judgment lien.
C. Tax Liens and After-Acquired Property
1. Problem 358: ONB had a perfected SI in the inventory, accounts receivable, instruments
and chattel paper of an automobile dealership named Smiles Motors, to which ONB
made periodic loans. Smiles Motors failed to pay its federal taxes, and the IRS filed a tax
lien in the proper place on Oct. 1. On Nov. 1 and Dec. 1, new shipments of cars arrived
at Smiles’s lot, and all during the yr Smiles continued to sell cars on credit, generating
chattel paper and accounts receivable.
a. Does the filing of the tax lien cut off ONB’s floating lien in whole or in part?
i. For the new cars that arrived at Smiles’s lot by Nov. 15, ONB’s SI takes priority over
the filed federal tax lien. For the new cars that arrives at Smiles’s lot after Nov. 15,
the filed federal tax lien takes priority over ONB’s SI
ii. IRC 6323(c): commercial financing security is permitted to fall under an existing
perfected security arrangement and take priority over a filed federal tax lien if the
new collateral is acquired by the taxpayer-debtor in the 45 days following the tax
lien filing
b. Is this issue in any case was affected by ONB’s knowledge of the tax lien filing?
i. Yes, secured party must not have known of the tax lien when making the loan
ii. 6323(c)(2)(A): loan has to be made w/o knowledge of the tax lien filing, but lender’s
later discovery of the tax lien filing does not affects the priority of its floating lien
during the 45-day period
2. 9-323(b): 45-day rule in which advances made by a perfected Art. 9 creditor prevail over
the intervening interest of a judicial lien creditor
3. Plymouth Savings Bank. US IRS
a. Fact: P bank and D IRS each claimed a lien on an amount owed by a 3rd party to the
lienee as payment for lienee's services.
b. Hold: Under the Federal Tax Lien Act, 26 U.S.C.S. §§ 6321, 6323(c), the amount owed
was a K right acquired by the lienee within 45 days of the tax lien filing, the time limit
set out in the statute for lien priority based on property acquired after the tax lien
filing. The K right, even if conditional, was therefore qualified property covered by the
P's SI and protected by statute from the federal tax lien b/c the proceeds of those
rights, like the rights themselves, are considered to have been acquired at the time
the K was made.
4. Problem 359: 6 months after the IRS filed a tax lien against her, Charlene bought a fire
 extinguisher system for her horse stables on credit from King Protection Enterprises,
which reserved a PMSI in itself and perfected it. Is the IRS’s lien superior to King’s PMSI?
a. No, federal tax lien does not beat out PMSI perfected under state law (in spite of filing)
b. In re Specialty Contarcting & Supply, : Bank's perfected PMSI entitled to priority over
previously filed federal tax lien
D. Tax Liens and Future Advances
1. IRC 6323(d): protects future advances made w/o knowledge of the tax lien in the 45
days after its filing if the advance is collateralized by a perfected SI in existing property
of the taxpayer
2. Problem 360: Marie owned a hat factory. She financed her business through a series of
loans from RSB pursuant to an agreement by which she gave RSB a SI in all of the
factory’s equipment, and RSB agreed to loan her money from time to time “as it thinks
prudent.” (no commitment) A FS covering the equipment was filed in the proper place.
On Aug. 1, she owed RSB $1.5K. The equipment consisted of 2 machines: the Habsburg
Hat Blocker (worth $7K) and the Hubuenot Felt Press (worth $5K). On that date, US
filed a federal tax lien against all of her property. On Aug. 31, RSB loaned her another
$10K.
a. Assuming RSB did not know of the tax lien on Aug. 31, does RSB or US have priority in
the equipment, and to what amount?
i. RSB wins for $11.5K (whole amount)
b. What if RSB did know?
i. Then, they will lose for $10K (loan made after RSB knew about the tax lien)
c. Assume there is no tax lien, but on Aug. 15 Louis paid Marie $5K cash for the
Huguenot Felt Press, and on Aug. 31 RSB loaned her $10K. Does the purchase cut off
RSB’s SI? (it depends)
i. Louis is a buyer of goods other than a BOCB, and takes free of RSB’s SI for $10K if
RSB didn’t know of the purchase (i.e., $10K was loaned before RSB knew of the
purchase
& 45 days after purchase)
ii. 9-323(d): [Buyer of goods] Except as otherwise provided in subsection (e), a buyer of
goods other than a buyer in ordinary course of business takes free of a SI to the
extent that it secures advances made after the earlier of:
a) the time the secured party acquires knowledge of the buyer's purchase; or
b) 45 days after the purchase.
iii. 9-323(e): [Advances made pursuant to commitment: priority of buyer of goods]
Subsection (d) does not apply if the advance is made pursuant to a commitment
entered into w/o knowledge of the buyer's purchase and before the expiration of
the 45-day period.
iv. 9-102(a)(68):"Pursuant to commitment", w/r/t an advance made or other value
given by a secured party, means pursuant to the secured party's obligation, whether
or not a subsequent event of default or other event not within the secured party's
control has relieved or may relieve the secured party from its obligation.
d. Does it matter whether or not RSB knew of the sale prior to the Aug. 31 loan?
i. Yes, Louis takes free of RSB’s SI made after RSB’s knowledge of the sale, so if RSB
knew of the sale prior to Aug. 31 loan, Louise takes free of Aug. 31 loan
 e. Instead of buying the machine, assume that Dupes is another creditor of Marie. On
Aug. 15, he levied execution on the felt press pursuant to a judgment (judicial lien). If
he did this w/ full knowledge of RSB’s SI and if w/ notice of his levy RSB still loans
Marie the $10K on Aug. 31, does Dupes or RSB have the superior interest in the felt
press as to the future advance?
i. RSB has the superior interest b/c it made the $10K advance (Aug. 31) less than 45
days (Sept. 14) after Dupes became a lien creditor (Aug. 15)
ii. 9-323(b): [Lien creditor] Except as otherwise provided in subsection (c), a SI is
subordinate to the rights of a person that becomes a lien creditor to the extent that
the SI secures an advance made more than 45 days after the person becomes a lien
creditor unless the advance is made:
a) w/o knowledge of the lien; or
b) pursuant to a commitment entered into w/o knowledge of the lien
f. If RSB did not know of the levy by Dupes on Aug. 15 but loaned Marie an additional
$5K on Oct. 15, who would have priority as to this advance?
i. RSB still has the superior interest levy b/c they had no knowledge of the lien
(although RSB’s SI secures an advance made (Oct. 15) more than 45 days after he
became a lien creditor (Aug. 15))

CHAPTER 23 BANKRUPTCY AND ARTICLE 9

I. The Trustee’s Status
A. Automatic stay at the time of filing of bankruptcy petition
1. Debtor gets exempted property back
2. Secured parties may sell the collateral or get money from the trustee who sold the
collateral
B. Rights of trustee in bankruptcy in resisting or attacking creditors’ claims
1. Moore v. Bay: trustee gets the right of hypothetical creditor represented b/c trustee’s
claim is not limited to the amount of the actual creditor’s claim but rather is the size of
the entire estate
2. BC 544(a) Strong Arm Clause: hypothetical judicial lien creditor who acquires a lien on
all of the debtor’s property as of the moment of the filing of a bankruptcy petition
a. As to personal property ((1) & (2)): wipes out unperfected interests
b. As to real property ((3)): BFP protected
3. 9-317(a)(2): such a lien creditor can avoid unperfected SI
4. BC 558: benefit of whatever defenses the debtor would have had against the creditor’s
claim (e.g., SOF, SOL)
5. BC 544(b): rights and position of any unsecured creditor who has a claim against the
estate
C. Problem 361: Lew Sun opened a restaurant and had many unsecured creditors (food
sellers, linen services, EEs, etc). On April 17, he applied to ISB for a loan of $10K, signing a
SA in favor of ISB, securing the loan by an interest in Sun’s equipment. On April 18, 1 hr
before ISB filed the FS, Sun filed a bankruptcy petition in the federal court.
1. If no new general creditors came into existence b/w the loan on April 17 and the petition
 filing on April 18, can the trustee avoid ISB’s SI under BC544(a)?
a. Yes b/c ISB’s SI was not perfected as of the filing of the bankruptcy petition and the
trustee in bankruptcy may avoid unsecured SI (regardless of whether there are real
creditors or not)
2. What result if ISB had filed its FS 2 seconds before the bankruptcy petition was filed?
a. As ISB’s SI was perfected as of the filing of the bankruptcy petition, the trustee may
not avoid ISB’s SI (no gaps b/w attachment and perfection! File before attachment to
avoid gaps!)
3. If ISB had had a PMSI, would the filing of the bankruptcy petition have cut off the usual
20-day grace period?
a. No, the rights of the trustee are subject to UCC that permits the 20-day grace period
for PMSI (automatic stay does not cut off 20-day grace period)
b. BC 546(b)(1): The rights and powers of the trustee under 544, 545, or 549 are subject
to any generally applicable law that
i. Permits perfection of an interest in property to be effective against an entity that
acquires rights in such property before the date of such perfection; or
ii. Provides for the maintenance or continuation of perfection of an interest in property
to be effective against an entity that acquires rights in such property before the date
on which action is taken to effect such maintenance or continuation
II. Preferences
A. BC 547 (p. 976 of casebook): trustee can avoid preferential transfers if the debtor was
insolvent at the time of transfer, which is presumed in the 90-day period (or 1 yr-period if
transferee is an insider)
1. Definition of preference: a transfer (including the creation of a SI in the debtor’s
property) made or suffered by the bankrupt to pay or secure a pre-existing debt within
the 90-day period preceding the filing of the bankruptcy petition, which has the effect
of giving the transferee (creditor) a greater payment than the creditor would get under
the usual bankruptcy distribution
2. If the creation of a SI is deemed preferential, the trustee can cancel it, turning the
preferred creditor into an unsecured one
3. Policy: if you’re a creditor and know that the debtor is going down, you may force the
debtor to pay early. Preference rule discourages this kind of practice
4. BC 547(b) & (d): Trustee may avoid any transfer of an interest of the debtor in property
a. To or for the benefit of a creditor;
b. For old debts owed by the debtor before such transfer
c. Made while the debtor was insolvent
d. Made
i. Within 90 days before the filing date of the petition; or
ii. b/w 90 days and 1 yr before the filing date of the petition if such creditor was an
insider
e. enabling such creditor to receive more than he would receive under usual bankruptcy
distribution
f. made to a surety to secure reimbursement of the surety
 5. BC 547(c): Trustee may NOT avoid a transfer
a. Intended (subjective) to be a contemporaneous exchange for new value given to the
creditor; and in fact (objective) a substantially contemporaneous exchange
b. In payment of a debt incurred in the ordinary course of business or financial affairs
made according to ordinary business terms
c. That creates a PMSI that secures new value and perfected on or before 30 days after
the debtor’s receipt of possession of the property
d. Subsequent advance (creditor gave new value to debtor after the transfer)
e. Floating liens in inventory, receivable, or their proceeds
f. Statutory liens
g. Domestic support obligations
h. Consumer debts
B. Problem 362: On June 8, BC borrowed $80K from ONB and gave ONB a SI in its equipment
(worth $100K). On July 18, ONB filed a valid FS in the proper place. The next day, BC filed
its bankruptcy petition.
1. Can the trustee destroy ONB’s secured position and turn it into a general creditor under
the theory that the delayed perfection is a preference?
a. Yes b/c ONB’s perfection was within 90 days from BC’s filing of bankruptcy petition,
trustee can destroy ONB’s secured position (regardless of the fact that ONB’s loan
was also made within 90 days from BC’s filing of bankruptcy petition)
2. If ONB had perfected on June 8 but the debtor made some extraordinary payments to
ONB in the 90-day period before the filing of the petition, could the trustee use 547 to
make ONB pay that money back into the estate?
a. No, ONB is a fully secured creditor and does not get more nor improves their position
by the extraordinary payment. This is not a preference (this is why banks are always
over-secured)
b. Payments to fully secured creditors are never preferential b/c no improvement in
position!
3. Assume that ONB had perfected on June 8 but that the collateral was only worth $60K
(the debt was still $80K, so ONB is undersecured). Would routine payments made to
service this debt be preferential?
a. No, routine payment made in the ordinary course of business is not avoided by trustee
b. 547(c)(2): Trustee may not avoid a transfer to the extent that such transfer was in
payment of a debt incurred by the debtor in the ordinary course of business or
financial affairs of the debtor and the transferee, and such transfer was
i. Made in the ordinary course of business or financial affairs of the debtor and the
transferee; or
ii. Made according to ordinary business terms
C. Problem 363: On Nov. 1, PNB loaned Kermit $1K to buy a banjo (consumer goods:
automatic perfection w/o filing) he wanted for his nightclub act, making him sign a SA and
a FS. He bought the banjo on Nov. 15, and PNB filed the FS on Dec. 5. Kermit filed his
bankruptcy petition the next day.
1. Is the transfer of the SI in this banjo a preference?
 a. No, b/c PNB’s SI secures new value given at signing of the SA describing the banjo as
collateral, and was perfected within 30 days after Kermit received possession of the
banjo (PMSI perfected within 30 days after the debtor receives possession is
protected)
b. 547(c)(3): Trustee may not avoid a transfer that creates a SI in property acquired by
the debtor
i. To the extent such SI secures new value that was
a) Given at or after the signing of a SA that contains a description of such property
as collateral;
b) Given by or on behalf of the secured party under such agreement
c) Given to enable the debtor to acquire such property; and
d) In fact used by the debtor to acquire such property; and
ii. That is perfected on or before 30 days after the debtor receives possession of such
property
2. If PNB’s SI was not of the PM variety but was simply a floating lien covering all after-
acquired equipment, what result using the same dates?
a. Trustee can avoid PNB’s SI b/c it is preferential (there is a gap b/w attachment and
perfection)
b. 547(e)(2): a transfer is made
i. At the time such transfer takes effect b/w transferor and transferee, if such transfer
is perfected at, or within 30 days after, such time, except as provided in (c)(3)(B);
ii. At the time such transfer is perfected, if such transfer is perfected after such 30
days; or
iii. Immediately before the filing date of the petition, if such transfer is not perfected at
the later of
a) The commencement of the case; or
b) 30 days after such transfer takes effect b/w transferor and transferee
D. Problem 364: In early 2013 John borrowed $1K from BWB; it was a signature loan (i.e., no
collateral). On Sept. 25, 2013, John made a $500 payment to BWB (not in the ordinary
course – this is a preference & debtor is presumed to be insolvent during the 90 days
preceding the filing of the bankruptcy petition under 547(f)), but on Oct. 4, he borrowed
$300 more from BWB, giving it a SI in his sword collection. BWB never filed a FS, and John
filed a bankruptcy petition on Nov. 8, 2013. How much, if anything, can his bankruptcy
trustee recover from BWB?
1. $200 (the amount of preference – improvement of BWB’s position during the 90-day
period)
2. 544(a)(2): The trustee shall have, as of the commencement of the case, and w/o regard
to any knowledge of the trustee or of any creditor, the rights and powers of, or may
avoid any transfer of property of the debtor or any obligation incurred by the debtor
that is voidable by a creditor that extends credit to the debtor at the time of the
commencement of the case, and obtains, at such time and w/r/t such credit, an
execution against the debtor that is returned unsatisfied at such time, whether or not
such a creditor exists;
 3. 547(c)(4): trustee may not avoid a transfer to or for the benefit of a creditor, to the
extent that, after such transfer, such creditor gave new value to or for the benefit of
the debtor
a. Not secured by an otherwise unavoidable SI; and
b. On account of which new value the debtor did not make an otherwise unavoidable
transfer to or for the benefit of such creditor
E. Moment of Transfer
1. Real property other than fixtures (547(e)(1)(A)): when a bona fide purchaser could no
longer prevail over the creditor (moment of the filing in the real property records)
2. Personal property and fixtures (547(e)(1)(B)): when a judicial lien creditor could not
achieve priority over the creditor (moment of perfection under 9-317)
3. Federal grace period under 547(e)(2)(A): 30-day break from the moment of attachment
a. If perfection is accomplished during this 30-day period, a relation back occurs to
protect the transfer from the trustee’s attack (even if the state law does not give a
grace period)
III.The Floating Lien in Bankruptcy
A. 547(c)(5) Test
1. Compare the debt/collateral ratio at 2 points:
a. 90 days before the filing of petition (or the 1st date within that period where a debt
was owed if the loan was made within the 90-day period); and
b. The date of the filing of petition
2. If creditor’s position has improved within this period, there is a preference to the extent
of the improvement
B. Problem 365: LNB had a perfected SI in the inventory of the Epstein bookstore, which
owed LNB $20K. On Mar. 1, the inventory was worth $8K. On May 28, when Epstein
filed for bankruptcy, the inventory was worth $20K b/c the store had purchased
several new shipments for cash in the interim.
1. Rule (547(c)(5)): did the creditor improve its position during the 90-day period? If they
did, the improvement is preferential
2. What can the trustee do about LNB’s claim?
a. Trustee can avoid $12K ($20K - $8K) b/c the inventory has increased $12K during the
90-day period
3. What if LNB first loaned Epstein $20K on May 1, when the inventory was worth $12K?
a. Trustee can avoid $8K, otherwise ONB gets $8K more than it was entitled to when it
first loaned Epstein (if a loan was made during the preference period, that is the
measuring moment)
C. In re Smith’s Home Furnishings: Presumption is that the payments are routine, not
preferential. Trustee has the BOP showing that the payments are preferential
IV. Fraudulent Transfers
A. BC 548 or 544(b)
1. Trustee can avoid any transfer (including creation of Art. 9 SI) that is fraudulent (even if
the 90-day period has lapsed?)
a. Badge of fraud
i. Transfer to friends, family, your attorney
 ii. Burden shifts to debtor to show the transfer is not fraudulent
2. 2 types of fraudulent transfers
a. Where the transferee from an insolvent debtor does not give “reasonable equivalent
value in exchange” (nominal consideration is fraud even if everybody is in good faith)
b. Where the transferor and the transferee have the “actual intent to defraud” the
debtor’s creditors
B. Problem 366: When Arnold retired as an international diplomat, he was much in debt. He
decided to make money by writing his memoirs. He gave a SI in the right to receive royalty
payments from his publisher to his wife as collateral for “the many debts I owe her” and
she filed a FS in the proper place 5 months before Arnold filed his bankruptcy petition. Can
the trustee avoid this SI?
1. Yes, trustee may avoid any transfer of the debtor in property made within 2 yrs (BC
548(a)(1)) before the filing date of bankruptcy petition if such transfer was made w/
actual intent to defraud
2. Common law: one of the badges of fraud was a voluntary transfer made by the debtor
to a family member
V. Nonconsensual Liens and the Trustee
A. Judicial lien
1. BC 547(b): all judicial liens acquired by a creditor within the 90 days preceding the
bankruptcy filing if taken while the bankrupt was insolvent is preferential
B. Statutory liens
1. BC 545: statutory liens are effective against the trustee if
a. They would be good against a BFP; and
b. They do not arise only on insolvency

CHAPTER 24. PROCEEDS

I. The Meaning of Proceeds
A. 9-102(a)(64): “Proceeds," except as used in 9-609(b), means the following property:
1. whatever is acquired upon the sale, lease, license, exchange, or other disposition of
collateral;
2. whatever is collected on, or distributed on account of, collateral;
3. rights arising out of collateral;
4. to the extent of the value of collateral, claims arising out of the loss, nonconformity, or
interference w/ the use of, defects or infringement of rights in, or damage to, the
collateral; or
5. to the extent of the value of collateral and to the extent payable to the debtor or the
secured party, insurance payable by reason of the loss or nonconformity of, defects or
infringement of rights in, or damage to, the collateral
6. note: 9-102(a)(9): “cash proceeds” means proceeds that are money, checks, deposit
accounts, etc
B. Priority Rules for Proceeds
1. 9-315 (Secured Party’s Rights on Disposition of Collateral and in Proceeds)
a. [Disposition of collateral: continuation of SI or agricultural lien; proceeds] Except as
 otherwise provided in Art. 9 and in 2-403(2): (Golden rule)
i. a SI or agricultural lien continues in collateral notwithstanding sale, lease, license,
exchange, or other disposition thereof unless the secured party authorized the
disposition free of the SI or agricultural lien; and
ii. a SI attaches to any identifiable proceeds of collateral. (common law of tracing)
b. [When commingled proceeds identifiable] Proceeds that are commingled w/ other
property are identifiable proceeds:
i. if the proceeds are goods, to the extent provided by 9-336; and
ii. if the proceeds are not goods, to the extent that the secured party identifies the
proceeds by a method of tracing, including application of equitable principles, that is
permitted under law other than Art. 9 w/r/t commingled property of the type
involved.
c. [Perfection of SI in proceeds] A SI in proceeds is a perfected SI if the SI in the original
collateral was perfected. (automatic perfection in proceeds)
d. [Continuation of perfection] A perfected SI in proceeds becomes unperfected on the
21st day after the SI attaches to the proceeds unless:
i. the following conditions are satisfied:
a) a filed FS covers the original collateral;
b) the proceeds are collateral in which a SI may be perfected by filing in the office in
which the FS has been filed; and
c) the proceeds are not acquired w/ cash proceeds;
ii. the proceeds are identifiable cash proceeds; or
iii. the SI in the proceeds is perfected other than under subsection (c) when the SI
attaches to the proceeds or within 20 days thereafter.
e. [When perfected SI in proceeds becomes unperfected] If a filed FS covers original
collateral, a SI in proceeds which remains perfected under subsection (d)(1) becomes
unperfected at the later of:
i. when the effectiveness of the filed FS lapses under 9-515 or is terminated under 9-
513; or
ii. the 21st day after the SI attaches to the proceeds.
C. Problem 367: When Rosetta bought a new car from Champollion Motors, she traded in
her 5-yr-old car, made a $200 down payment with her check, and signed a promissory
note for the balance payable to the dealership. RNB had a perfected SI in CM’s inventory.
1. Does that SI continue in the car once it is delivered to Rosetta?
a. No b/c it’s a sale in the ordinary course of business
b. 9-320(a): BOCB takes free of a SI created by buyer’s seller, even if the SI is perfected
and buyer knows of its existence
2. Under 9-315(a), RNB’s SI will continue in proceeds, as defined in subsection (1). What
are the proceeds of the car sale?
a. The proceeds are the 5-yr-old car, the $200 down payment check, and the promissory
note
b. 9-315(a): SI continues in collateral notwithstanding sale, lease, license, exchange, or
other disposition thereof unless the secured party authorized the disposition free of
 the SI and SI attaches to any identifiable proceeds of collateral.
3. Is the attachment of the creditor’s SI in the proceeds automatic, or must they be
claimed in the original SA?
a. It is an automatic perfection (SA doesn’t have to say a word about it)
b. 9-203(f): the attachment of a SI in collateral gives the secured party the rights to
proceeds provided by 9-315 and is also attachment of a SI in a supporting obligation
for the collateral
D. Farmers Cooperative Elevator Co. v. Union State Bank (commingling)
1. Facts: As collateral for a loan, bank perfected a SI from the farmers/debtors, covering all
accounts arising from sale or other dispostion of their milk products. The farmers were
selling milk to Land. In return for waiver of its lien, bank executed an assignment
whereby Land would pay bank $4,333/mo from the farmer’s milk proceeds. After
the farmers switched dairies and began selling their milk to F&A, in Aug 1988, P
notified F&A on Aug 22 of its assignment and SI and demanded payments in
accordance w/ the assignment but F&A refused to pay bank for months of Aug thru
Nov.
2. Rule: A buyer of farm products takes them subject to a SI created by the seller where he
receives written notice of this interest from the secured party w/in 1 yr before the sale
of the products.
3. Outcome: F &A received proper notice, thus purchased the products subject to the SI.
E. Art. 9 and Insurance (skip)
1. Art. 9 does not apply to SI in insurance policy, but applies to insurance payments that
qualify as proceeds
a. 9-109(d)(8): Art. 9 does not apply to a transfer of an interest in or an assignment of a
claim under a policy of insurance, other than an assignment by or to a health-care
provider of a health-care-insurance-receivable and any subsequent assignment of the
right to payment, but 9-315 and 9-322 apply w/r/t proceeds and priorities in
proceeds
b. Examples
i. if the collateral is a car destroyed in a traffic mishap and the car owner receives
compensation from an insurance company, the insurance money is proceeds, and
any SI in the car attaches to these monies
c. if the car owner sells the car and deposits the money in a bank account, the account
is proceeds, and the car money can be traced into the bank account and tapped by
the unpaid secured creditor
2. 9-315(a)(2): SI attaches to any identifiable proceeds of collateral
3. 9-315(b)(2): proceeds that are commingled w/ other property are identifiable proceeds
if the proceeds are not goods, to the extent that the secured party identifies the
proceeds by a method of tracing, including application of equitable principles, that is
permitted under law other than Art. 9 w/r/t commingled property of the type involved
F. Problem 368: Farmers’ Friend Credit Association loaned Farmer Bean money secured by
his crops. In 2011, the federal government paid FB not to grow any crop that yr. Is the
government payment the “proceeds” of the crop?
1. No unless the SA described the government payment as collateral
a. Courts split: sometimes proceeds, account, or general intangible
 2. In re Weyland: government agreements, including the dairy termination program
agreement, are general intangibles, and the bank’s SI is limited strictly to the property
or collateral described in its agreement. Any doubts about the SA are to be
construed against the drafting party (the bank)
II. Priorities in Proceeds
A. Problem 369: The Aquarius Auto Audio Shop sold and installed stereo systems in cars. Its
inventory was financed by CMB, which had a perfected SI in present and after-acquired
inventory. When AAAS sold the systems, it sometimes was paid cash, sometimes extended
credit w/o singed Ks, and sometimes made credit customers sign Ks promising payment
and granting AAAS a SI in the systems. When AAAS needed further financing, it took a
later loan from CFC, granting a SI in its accounts receivable and its chattel paper. CFC
knew all about the prior loan and inventory SI of CMB at the time it filed its FS in the
proper place. AAAS defaulted on both loans, and both secured parties claimed the
accounts and chattel paper (only CMB claimed the inventory). CMB’s major theory was
that the accounts and chattel paper were proceeds of the inventory. The chattel paper
was in CFC’s possession; it had not yet collected any of the accounts receivable.
1. Who should prevail?
a. Inventory: CMB prevails b/c CFC does not claim the inventory
b. Chattel paper: CFC prevails b/c purchaser (purchaser includes secured party) of
chattel paper has priority over SI in the chattel paper claimed as proceeds of
inventory
c. Accounts receivable: CMB prevails b/c it filed first (proceeds of accounts have the
same priority as inventory, so must look at who filed or perfected first)
i. Inventory financier v. account financier (not the generation of account)
d. 9-315: SI attaches to any identifiable proceeds of collateral
e. 9-330(a): purchaser of chattel paper has priority over a SI in the chattel paper which
is claimed merely as proceeds of inventory subject to SI if
i. In good faith and in the ordinary course of (chattel paper) purchaser’s business,
purchaser gives new value and takes possession of the chattel paper or obtains
control of the chattel paper under 9-105; and
ii. The chattel paper does not indicate that it has been assigned to an identified
assignee other than purchaser (no evidence showing someone else owns the chattel
paper)
f. 9-322(a): [general priority rules among conflicting Sis]
i. Priority in time of filing or perfection
ii. Perfected SI has priority over a conflicting unperfected SI
iii. First SI to attach or become effective has priority if conflicting SIs are unperfected
g. 9-322(b): [time of perfection: proceeds and supporting obligations]
i. The time of filing or perfection as to a SI in collateral is also the time of filing or
perfection as to a SI in proceeds
ii. The time of filing or perfection as to a SI in collateral supported by a supporting
obligation is also the time of fling or perfection as to a SI in the supporting obligation
2. What result where the accounts receivable financier filed first?
a. CFC wins under the first-to-file-or-perfect rule
B. Problem 370: Shadrach Heating and Air Conditioning borrowed $15K from MMFA in order
 to purchase a new furnace for its own home office. When one of its clients needed an
identical furnace in a hurry, SNAC sold it its own new furnace. The $17K check it received
in payment was put into SHAC’s checking account (balance prior to this deposit: $81) w/
ASB. Thereafter, SHAC made one further deposit of $5K, followed a week later by a
withdrawal of $5,040.
1. Are proceeds from the furnace sale still in the bank accounts?
a. Yes, any payments are presumed to be from funds other than funds in which another
had a legally recognized interest
i. presumed that the money is taken out of funds other than the proceeds
ii. Art. 4 FIFO rule has never been cited in Art. 9 issue (malpractice!)
b. Universal CIT Credit Corp. v. Farmers Bank: in tracing commingled funds it is
presumed that any payments made were from other than funds in which another
had a legally recognized interest (common law presumption of lowest intermediate
balance rule)
c. 9-315(b): tracing of identifiable proceeds is permitted
d. OC3 to 9-315: when proceeds commingled w/ other property are identifiable
proceeds, the use of whatever methods of tracing permitted by other law is allowed
2. If SHAC defaults on its loan repayment to MMFA and also on an unsecured promissory
note currently held by ASB, can ASB exercise its common law right of setoff and pay
itself out of the checking account, or is its setoff right junior to MMFA’s SI in the
proceeds?
a. ASB’s set-off right wins (right of recoupment process)
b. 9-340 (Effectiveness of Right of Recoupment or Set-off Against Deposit Account)
i. [Exercise of recoupment or set-off] Except as otherwise provided in subsection (c), a
bank w/ which a deposit account is maintained may exercise any right of
recoupment or set-off against a secured party that holds a SI in the deposit account.
ii. [Recoupment or setoff not affected by SI] Except as otherwise provided in
subsection (c), the application of Art. 9 to a SI in a deposit account does not
affect a right of recoupment or set-off of the secured party as to a deposit
account maintained w/ the secured party.
iii. [When set-off ineffective] The exercise by a bank of a set-off against a deposit
account is ineffective against a secured party that holds a SI in the deposit account
which is perfected by control under 9-104(a)(3), if the set-off is based on a claim
against the debtor.
3. What can a creditor claiming an interest in proceeds do to protect itself from setoff by
debtor’s bank?
a. If the creditor can put the account in their name pursuant to SA, he will win over
ASB’s set-off right (it is when creditor can win: by control!)
C. HCC Credit Corp. v. Springs Valley Bank U & Trust Co.
1. Fact: Debtor sold equipment and used the proceeds to pay off promissory notes, 3 of
which were not yet due, held by D bank. P secured creditor filed suit, seeking to recover
proceeds from the sale of the property in which it held a SI. D's loan officer agreed
debtor's payment was extraordinary and constituted the largest ever made on any debt
owed by debtor to D.
 2. Hold: The payment was not in the ordinary course of debtor's business, and D was not
protected in keeping these proceeds under 9-306 OC2(c), which allowed a recipient of a
payment made in the ordinary course by a debtor to take such payment free and clear
of any claim that a secured party had in the payment as proceeds. P had a binding and
enforceable SA against debtor, debtor understood the purpose and effect of the SA,
and P's SI was valid and perfected as to equipment and proceeds from the sale of
that equipment. D bank was aware of this SA and SI.
3. Note
a. The court states that revised Art. 9 has a section more explicitly protecting the
transferee in the ordinary course in this situation
b. Would this case have come out differently under 9-332(b) and its OCs?
i. 9-332(b): A transferee of funds from a deposit account takes the funds free of a SI in
the deposit account unless the transferee acts in collusion w/ debtor in violating the
rights of secured party
D. Problem 371: ONB loaned $200K to Big Department Store and took a SI in its inventory
“now owned or after-acquired,” which it perfected by filing a FS on July 5. ANB loaned
$100K to Total Store, and took a SI in its inventory “now owned or after-acquired,” which
it perfected by filing a FS on Sept. 25. W/o the consent of either creditor, the 2 retailers
merged the following yr, when the inventories of both were worth $300K. The new entity
was named Total Department Store. Which bank has priority?
1. Seriously misleading name change -> must refile within 4 months
2. Original SI remains perfected in the old inventory as to new debtor, but not in after-
acquired inventory unless the new debtor signs
3. If the collateral is identifiable, can trace
4. 9-102(a)(56): “New debtor” means a person that becomes bound as debtor under 9-
203(d) by a SA previously entered into by another person
5. 9-203(d): A person becomes bound as debtor by a SA entered into by another person if,
by operation of law other than Art. 9 or by K:
a. the SA becomes effective to create a SI in the person's property; or
b. the person becomes generally obligated for the obligations of the other person,
including the obligation secured under the SA, and acquires or succeeds to all or
substantially all of the assets of the other person
6. 9-203(e): If a new debtor becomes bound as debtor by a SA entered into by another
person:
a. the agreement satisfies subsection (b)(3) w/r/t existing or after-acquired property of
the new debtor to the extent the property is described in the agreement; and
b. another agreement is not necessary to make a SI in the property enforceable
7. 9-508 (Effectiveness of FS If New Debtor Becomes Bound by SA)
a. [FS naming original debtor] Except as otherwise provided in this section, a filed FS
naming an original debtor is effective to perfect a SI in collateral in which a new
debtor has or acquires rights to the extent that the FS would have been effective
had the original debtor acquired rights in the collateral.
b. [FS becoming seriously misleading] If the difference b/w the name of the original
 debtor and that of the new debtor causes a filed FS that is effective under subsection
(a) to be seriously misleading under 9-506:
i. the FS is effective to perfect a SI in collateral acquired by the new debtor before,
and within 4 months after, the new debtor becomes bound under 9-203(d); and
ii. the FS is not effective to perfect a SI in collateral acquired by the new debtor more
than 4 months after the new debtor becomes bound under 9-203(d) unless an initial
FS providing the name of the new debtor is filed before the expiration of that time.
c. [When section not applicable] This section does not apply to collateral as to which a
filed FS remains effective against the new debtor under 9-507(a).
8. OCs to 9-508:
9. 9-325 (Priority of SI in Transferred Collateral)
a. [Subordination of SI in transferred collateral] Except as otherwise provided in
subsection (b), a SI created by a debtor is subordinate to a SI in the same collateral
created by another person if:
i. the debtor acquired the collateral subject to the SI created by the other person;
ii. the SI created by the other person was perfected when the debtor acquired the
collateral; and
iii. there is no period thereafter when the SI is unperfected.
b. [Limitation of subsection (a) subordination] Subsection (a) subordinates a SI only if
the SI:
i. otherwise would have priority solely under 9-322(a) or 9-324; or
ii. arose solely under 2-711(3) or 2A-508(5).
10. 9-326 (Priority of SIs Created by New Debtor)
a. [Subordination of SI created by new debtor] Subject to subsection (b), a SI created
by a new debtor which is perfected by a filed FS that is effective solely under 9-508
in collateral in which a new debtor has or acquires rights is subordinate to a SI in the
same collateral which is perfected other than by a filed FS that is effective solely
under 9-508.
b. [Priority under other provisions; multiple original debtors] The other provisions of
this part determine the priority among conflicting SIs in the same collateral
perfected by filed FSs that are effective solely under 9-508. However, if the SAs to
which a new debtor became bound as debtor were not entered into by the same
original debtor, the conflicting SIs rank according to priority in time of the new
debtor's having become bound.
11. OCs to 9-326
E. 9-315(d):[Continuation of perfection] A perfected SI in proceeds becomes unperfected on
the 21st day after the SI attaches to the proceeds unless:
1. the following conditions are satisfied:
a. a filed FS covers the original collateral;
b. the proceeds are collateral in which a SI may be perfected by filing in the office in
which the FS has been filed; and
c. the proceeds are not acquired w/ cash proceeds;
2. the proceeds are identifiable cash proceeds; or
 3. the SI in the proceeds is perfected other than under subsection (c) when the SI
attaches to the proceeds or within 20 days thereafter.
F. Problem 372 (important!): On Aug. 2, when the filed FS in favor of the LNB covered “all
business machines,” the debtor engaged in the transactions listed below. Decide for each
transaction if LNB should take action before Aug. 22 or if the FS is sufficient as filed:
1. The debtor traded a computer for another computer: FS sufficient as filed b/c floating
lien over all equipment: 9-315(d)(1)(B)
2. The debtor traded another computer for a painting to be hung in the office: FS
sufficient as filed b/c floating lien over all equipment: 9-315(d)(1)(B)
a. Do business machines include painting? – no, but painting is collateral in which a SI
may be perfected by filing in the office in which the FS has been filed
3. The debtor traded a duplicating machine for a used car (and state law requires a lien
interest in a vehicle to be noted on the certificate of title as the sole means of
perfection): must note lien on certificate of title within 20 days
4. The debtor sold a calculator to a friend for cash and that same day used the cash to
buy a painting: must file a new FS b/c the painting was acquired w/ identifiable cash
proceed (9-315(d)(1)(C))
a. If cash proceeds turned into something new, this is 2nd generation proceed and need
refilling
b. If they keeps the cash, this is identifiable cash proceeds and no need of new filing
5. The debtor sold an adding machine for $500 and put the cash in a bank account at a
different bank; on Aug. 2 that bank exercised its right of setoff against the account.
a. The bank wins unless LNB becomes the bank’s customer w/r/t the account.
b. 9-340(c): The exercise by a bank of a set-off against a deposit account is ineffective
against a secured party that holds a SI in the deposit account which is perfected by
control under 9-104(a)(3)
6. The debtor sold a coffee maker for $200 and gave the money to a Salvation Army
volunteer that day
a. Transferee of money takes free of a SI unless the transferee acts in collusion w/ the
debtor
b. Transferees are protected as long as in good faith
c. 9-332(a): [Transferee of money] A transferee of money takes the money free of a SI
unless the transferee acts in collusion w/ the debtor in violating the rights of the
secured party
G. Problem 373: Balboa Bank & Trust floor-planned the inventory of Erickson Motors and
perfected its SI in the inventory (and proceeds) by fling in the proper place. (9-311(d))
Erickson sold a car to Smith, who paid $1K down and signed a K obligating him to pay
$25K more (chattel paper). The car dealership assigned this K to the CFC, which took
possession of the K and notified Smith to make future payments to CFC. Smith made no
payments at all b/c the car had serious mechanical difficulties, and eventually the parties
cancelled the transaction and the car was returned to Erickson on Sept. 11. On Sept. 12, a
representative of CFC came to the dealership and took possession of the car, claiming it
was proceeds from the K of purchase, which CFC still had. Balboa Bank objected and
 claimed a superior interest in the car, asserting its priority in the inventory of the
dealership. Who prevails here?
1. CFC (purchaser of the chattel paper that perfected by possession) prevails even if their
SI in the proceeds of the chattel paper (car) is unperfected (even if the goods is
returned to the inventory)
2. 9-330(c): [Chattel paper purchaser's priority in proceeds] Except as otherwise provided
in 9-327, a purchaser having priority in chattel paper under subsection (a) or (b) also
has priority in proceeds of the chattel paper to the extent that:
a. Section 9-322 provides for priority in the proceeds; or
b. the proceeds consist of the specific goods covered by the chattel paper or cash
proceeds of the specific goods, even if the purchaser's SI in the proceeds is
unperfected.
3. OC9: returned and repossessed goods may constitute proceeds of chattel paper
4. OC10: If BCOB rightfully returned the goods, the rights of SP1 (SI holder in inventory:
Balboa Bank) and SP2 (purchaser of chattel paper: CFC) is subject to BCOB’s claims and
defenses unless BCOB has waived its defenses as against assignees of the chattel
paper. Assuming that SP1’s SI is perfected by filing in the same office where a filing
would be made against the chattel paper, SP1’s SI would remain perfected beyond the
20-day period of automatic perfection. B/c Dealer’s newly reacquired interest in the
returned goods is proceeds of the chattel paper, SP2’s SI also attaches in the goods as
proceeds. If SP2 had perfected its SI in the chattel paper only by possession, SP2’s SI is
unperfected after the 20-day period. Nevertheless, SP2’s unperfected SI is senior to
SP1’s SI under 9-330(c).

CHAPTER 25. DEFAULT

I. Introduction
A. Part 6 governs “Default” (Each segment in Art. 9 is called “Part”)
1. 9-625 (Remedies for Secured Party’s Failure to Comply w/ Art. 9: Very Important!)
a. [Judicial orders concerning noncompliance] If it is established that a secured party is
not proceeding in accordance w/ Art. 9, a court may order or restrain collection,
enforcement, or disposition of collateral on appropriate terms and conditions. (you
can go to court and get a court order)
b. [Damages for noncompliance] Subject to subsections (c), (d), and (f), a person is liable
for damages in the amount of any loss caused by a failure to comply w/ Art. 9. Loss
caused by a failure to comply may include loss resulting from the debtor's inability to
obtain, or increased costs of, alternative financing.
c. [Persons entitled to recover damages; statutory damages in consumer-goods
transaction] Except as otherwise provided in 9-628:
i. a person that, at the time of the failure, was a debtor, was an obligor, or held a SI in
or other lien on the collateral may recover damages under subsection (b) for its loss;
and
ii. if the collateral is consumer goods, a person that was a debtor or a secondary
obligor at the time a secured party failed to comply w/ Part 6 may recover for that
failure in
 any event an amount not less than the credit service charge (interest) plus 10
percent of the principal amount of the obligation or the time-price differential
(finance charge) plus 10 percent of the cash price.
d. [Recovery when deficiency eliminated or reduced] A debtor whose deficiency is
eliminated under 9-626 may recover damages for the loss of any surplus. However, a
debtor or secondary obligor whose deficiency is eliminated or reduced under 9-626
may not otherwise recover under subsection (b) for noncompliance w/ the provisions
of this part relating to collection, enforcement, disposition, or acceptance.
e. [Statutory damages: noncompliance w/ specified provisions] In addition to any
damages recoverable under subsection (b), the debtor, consumer obligor, or person
named as a debtor in a filed record, as applicable, may recover $500 in each case
from a person that:
i. fails to comply w/ 9-208;
ii. fails to comply w/ 9-209;
iii. files a record that the person is not entitled to file under 9-509(a);
iv. fails to cause the secured party of record to file or send a termination statement as
required by 9-513(a) or (c);
v. fails to comply w/ 9-616(b)(1) and whose failure is part of a pattern, or consistent
w/ a practice, of noncompliance; or
vi. fails to comply w/ 9-616(b)(2).
f. [Statutory damages: noncompliance w/ 9-210] A debtor or consumer obligor may
recover damages under subsection (b) and, in addition, $500 in each case from a
person that, w/o reasonable cause, fails to comply w/ a request under 9-210. A
recipient of a request under 9-210 which never claimed an interest in the collateral
or obligations that are the subject of a request under that section has a
reasonable excuse for failure to comply w/ the request within the meaning of this
subsection.
g. [Limitation of SI: noncompliance w/ 9-210] If a secured party fails to comply w/ a
request regarding a list of collateral or a statement of account under 9-210, the
secured party may claim a SI only as shown in the list or statement included in the
request as against a person that is reasonably misled by the failure.
II. Pre-default Duties of the Secured Party
A. 9-207 (Rights and Duties of Secured Party Having Possession or Control of Collateral)
(Gist: a secured party in possession of the collateral needs to take reasonable care over
it)
1. [Duty of care when secured party in possession] Except as otherwise provided in
subsection (d), a secured party shall use reasonable care in the custody and
preservation of collateral in the secured party’s possession. In the case of chattel
paper or an instrument, reasonable care includes taking necessary steps to preserve
rights (making presentment, giving dishonor, etc) against prior parties unless otherwise
agreed.
2. [Expenses, risks, duties, and rights when secured party in possession] Except as
otherwise provided in subsection (d), if a secured party has possession of collateral:
a. reasonable expenses, including the cost of insurance and payment of taxes or other
charges, incurred in the custody, preservation, use, or operation of the collateral are
chargeable to the debtor and are secured by the collateral;
 - The risk of accidental loss or damage is on the debtor to the extent of a deficiency
in any effective insurance coverage;
- Where collateral is in possession of creditor, risk of accidental loss or damage is on
the debtor.
b. secured party shall keep the collateral identifiable, but fungible collateral may be
commingled; and
c. the secured party may use or operate the collateral:
i. for the purpose of preserving the collateral or its value;
ii. as permitted by an order of a court having competent jurisdiction; or
iii. except in the case of consumer goods, in the manner and to the extent agreed by
the debtor.
3. [Duties and rights when secured party in possession or control] Except as otherwise
provided in subsection (d), a secured party having possession of collateral or control of
collateral under 9-104, 9-105, 9-106, or 9-107:
a. may hold as additional security any proceeds, except money or funds, received from
the collateral;
b. shall apply money or funds received from the collateral to reduce the secured
obligation, unless remitted to the debtor; and
c. may create a SI in the collateral.
B. Problem 374: Andy was the owner of 100 shares of Titanic Telephone, which he
pledged MCNB as collateral for a $10K loan. At the time of the pledge, the stock was
selling for
$100/share. The SA was oral and MCNB filed no FS
1. If the stock began to fall in value and if on Nov. 4, when it was selling at $80/share,
Andy called MCNB and told the bank to sell, is the bank responsible if it does not and
the stock bottoms out at $1.5/share?
a. No, Andy should bear the loss. Reasonable care does not mean they have to obey
instructions of the customer
i. MCNB may sell the stock but has no duty to sell the stock.
ii. But, Andy may argue that he told the bank to sell and the bank did not use
reasonable care
b. 9-207(b)(2): if a secured party has possession of collateral, the risk of accidental loss
or damage is on the debtor to the extent of a deficiency in any effective insurance
coverage
c. 9-207(b)(4)(A): the secured party MAY use or operate the collateral for the purpose
of preserving the collateral or its value
d. Layne v. Bank One: the bank had no duty to sell the stock at a certain time b/c the
debtor never asked the bank to sell the stock
2. Would it help MCNB’s position if the pledge agreement contained a clause saying that
MCNB was not responsible for its own negligence in dealing w/ the stock?
a. No, they have to take reasonable care. Art. 1 does not allow them to disclaim liability
b. 1-103(a)(2): UCC must be liberally construed and applied to promote its underlying
purposes and policies, which are to permit the continued expansion of commercial
practices through custom, usage, and agreement of the parties
 c. Brodheim v. Chase Bank: parties may, by agreement, determine the standards by
which the performance of such obligations was to be measured if such standards
were not manifestly unreasonable
3. MCNB held, as pledge, Andy’s stocks in 5 different companies and one of these, LF,
offered a stock split option that had to be exercised by Dec. 31, so Andy asked MCNB
how many shares of LF it held. MCNB replied it possessed 50 shares (this was a typo, it
actually held 150). Andy tendered 50 shares of equivalent stock to MCNB in exchange
for a return of 50 shares of LF, on which he then exercised the stock option, which
proved very profitable. On Jan. 3, Andy learned that he owned 100 more shares that
MCNB held, but it was too late.
a. Does Andy have a cause of action against MCNB under 9-207?
i. Yes, Andy may recover actual damage (loss)
b. Under 9-210? (better cause of action)
i. Yes, Andy may recover actual damage + statutory damage of $500 (9-625(f)). The
secured party has a duty to comply w/ the debtor’s request regarding a list of
collateral and approve or correct a list of collateral made by the debtor.
ii. 9-210(b): A secured party shall comply w/ a request within 14 days after receiving
request for (1) accounting and (2) list of collateral or statement or account (9-201
notice)
c. What damages can he recover?
i. 9-625(b): damages in the amount of any loss caused by a failure to comply w/ Art. 9
ii. 9-625(f): additional $500 (punitive damage)
C. Problem 375: Mazie borrowed $2K from MBSB and as collateral, pledged to MBSB her
stamp collection (valued at $2K). MBSB was destroyed in an earthquake and the stamp
collection went w/ it. MBSB was fully insured by a policy w/ GIC, which paid MBSB $2K for
the loss of the stamp collection. GIC then notified Mazie that she should pay $2K debt to
them, using the doctrine of subrogation to step into the shoes of MBSB. Need she pay?
1. No, she does NOT have to pay, MBSB was fully insured and there was no deficiency
(insurance company’s business is to take this kind of risks. They are the cheapest cost
avoider)
2. 9-207(b)(2): the risk of accidental loss/damage is on the debtor “to the extent of a
deficiency in any effective insurance coverage”
III.Default
A. 9-601
1. [Rights of secured party after default] After default, a secured party has the rights
provided in Part 6 and, except as otherwise provided in 9-602, those provided by
agreement of the parties. A secured party:
a. may reduce a claim to judgment, foreclose, or otherwise enforce the claim, SI, or
agricultural lien by any available judicial procedure; and
b. if the collateral is documents (warehouse receipt, bill of lading), may proceed either
as to the documents or as to the goods they cover.
2. [Rights and duties of secured party in possession or control] A secured party in
possession or control of collateral under 9-104, 9-105, 9-106, or 9-107 has the rights
 and duties provided in 9-207.
3. [Rights cumulative; simultaneous exercise] The rights under subsections (a) and (b) are
cumulative and may be exercised simultaneously.
B. State Bank of Piper v. A-Way
1. Fact: Bank had a SI in grain and proceeds of the sale of grain. D, warehouseman listed
the number of bushels he held, 5,141.20. The bank confused this number w/ their
value, and moved to have D pay them $5,141.20. Complying w/ the court order, D
sold the bushels and only paid bank the $5141.20. Bank later realized its error and
brought action to enforce its SI in the remaining proceeds. D claims res judicata and
doctrine of merger.
2. Rule (9-601): A Secured creditor’s effort to collect its debt through the judicial process
will not operate to destroy his SI in relation to the debtor or affect his priority w/r/t
third parties.
3. Hold: Here, even though the notes merged into the judgment precluding further action
on the notes, that merger did not preclude P from bringing this action to enforce its SI
in the grain. The SI in the grain was separate and apart from the SI in the notes under
the SA.
C. Definition of default
1. Introduction
a. No definition in UCC
i. The only judicially recognized form of default: failure to pay the debt on time
b. Agreement must fill in the blanks
i. Parties may specifically define “default” as “failure to perform any of the terms of
the agreement” as well as “failure to pay on time”
c. If creditor repossesses through inadvertence, mistake, or deliberate bad faith, he is
guilty of conversion and breach of K -> have to pay all damages caused thereby
d. Acceleration clause (1-309): A party may accelerate payment or performance only if
that party in good faith believes that the prospect of payment or performance is
impaired
i. Good faith is presumed
ii. Person challenging it has BOP lack of good faith
2. Problem 376: Bankruptcy bought a mobile home from Nervous Motors and signed a
PM SA in favor of the seller that contained an acceleration clause. Which of the
following events is sufficient to trigger the proper use of the clause?
a. A very bad financial quarter for Nervous: N
b. A serious drop in the state of economy: N
c. Knowledge that Bankruptcy had been talking to a lawyer: depends on what the
attorney was talking about
i. If they are thinking of divorcing, then more likely to be yes
ii. Send them 2-609 request for adequate assurance if your client gets nervous
d. A report (which simple investigation would show to be false) that Bankruptcy have
failed to pay their grocery bills for the last 2 months: depends on what kind of report
it is
i. If you repossess, but have no right to -> guilty of conversion (intentional tort, punitive
 damage b/c it is taking someone’s property w/o justification)
e. An anonymous phone calls that states Bankruptcy are getting ready to move the
mobile home to Mexico: Yes b/c it would definitely at least investigate
f. The confiscation of the mobile home and the arrest of Bankruptcy for possessing
marijuana: Y
i. Objective-reasonable person test v. purely subjective test
ii. Court awarded punitive damages for a bad faith acceleration
g. Can you call a demand promissory note?
i. Yes no good faith test for demand instruments (1-308 OC) b/c demand instruments
do not need any reason or justification
ii. Courts protect the debtor whenever the secured party’s insecurity is unwarranted
iii. “The courts stretch to protect the debtor whenever the secured party’s “insecurity” is
unwarranted. For particularly outrageous conduct on the part of the creditor,
punitive damages are favored.”
iv. Conversion is the cause of action.
3. Klingbiel v. Commercial Credit Corp.
a. Fact: 4 days before Purchaser’s first monthly payments was due, Seller [who had a
PMSI in the car], w/o demand, notice, or communication, repossessed the car. Seller
claims that under the K they had a right to accelerate if they felt themselves
unsecured.
b. Hold: Here the SA stated that “Purchaser agrees in the case of acceleration to pay the
amount to the Seller, upon demand, or at the election of the Seller, to deliver the
vehicle to the Seller.” The K explicitly states that the Purchaser is entitled to demand
before repossession occurs. Punitive damages are awarded.
c. Note:
i. debtor’s “right to notice” before repossession by the secured party v. “upon
demand”
a) acceleration clause: can repossess w/o notice
b) K terms: secured party must demand before repossession (this clause is
malpractice)
ii. if the creditor wants to repossess, do they have to give notice to the debtor BEFORE
they repossess?
a) NO, b/c if you tell them you’re going to repossess, debtors will hide the collateral
4. Guzman v. Western State Bank: bank pursued its foreclosure remedy under the guise of
a state attachment procedure that was clearly unconstitutional, P sues the bank under
the Civil Rights Act and recovered $10K in actual damages and $30K in punitive
damages
5. Problem 377: Natty bought a car w/ money borrowed from CDFC which perfected its
interest in the car. The SA provided that “time was of the essence” and the acceptance
by CDFC of late payments was not a waiver of its right to repossess. Natty always paid
10 to 15 days late. CDFC sent a man out who took the car using a duplicate set of keys
from the parking lot of the factory where Natty worked.
a. Has a default occurred?
i. No b/c Time is of the Essence clause & Anti-Waiver clause of Time is of the Essence
 clause have been waived by CDFC’s acceptance of late payments
ii. 2-208(1): any course of performance accepted or acquiesced in w/o objection shall
be relevant to determine the meaning of the agreement
iii. Gilmore: Courts pay little attention to clauses which appear to say that meaningful
acts are meaningless and the secured party can blow out hot or cold as he chooses
b. If CDFC’s conduct has waived the right to repossess if Natty is late, what can it do to
reinstate the “time is of the essence” clause?
i. It may retract the waiver by reasonable notification by calling Natty and tell him no
more late payments (but pass for the prior late payments) -> put the clause back to
effect
ii. 2-209(5): a party who has made a waiver affecting an executory portion of the K may
retract the waiver by reasonable notification received by the other party that strict
performance will be required of any term waived, unless the retraction would be
unjust in view of a material change of position in reliance on the waiver
6. Note: Credit Insurance and Default
a. At the time you take a loan on your car, frequently creditor will make you pay a
premium for credit insurance to protect them from your non-payment of the debt
b. When the debtor has died, become ill or disabled and credit insurance should pay
the debt, the secured creditor must look first to the credit insurance before
repossessing
IV. Repossession and Resale
A. 9-609 (Secured party’s Right to Take Possession after Default)
1. [Possession; rendering equipment unusable; disposition on debtor's premises] After
default, a secured party:
a. may take possession of the collateral; and
b. w/o removal, may render equipment unusable and dispose of collateral on a debtor's
premises under 9-610
2. [Judicial and nonjudicial process] A secured party may proceed under subsection (a):
a. pursuant to judicial process; or
b. w/o judicial process, if it proceeds w/o breach of the peace.
3. [Assembly of collateral] If so agreed, and in any event after default, a secured party may
require the debtor to assemble the collateral and make it available to the secured party
at a place to be designated by the secured party which is reasonably convenient to both
parties.
4. Note:
a. The secured party may skip judicial processes and repossess the collateral on
debtor’s default w/o a “breach of peace”
5. Examples
a. Invite the faulting buyer to a friendly conference and repossess the car upon his
arrival: o.k.
b. Pick up the car on the street wherever it may be parked: o.k.
c. Break into an empty house when the SA allows: not o.k.
B. Williamson v. Fowler Toyota
1. Fact: Gilmore bought a Chevette giving Seller a PMSI. Gilmore stopped making
 payments. Seller declared default and hired an independent contractor to repossess it
by cutting the locked gates.
2. Issue: Whether a creditor is liable for the trespass and the resulting damages caused by
an independent contractor employed by the creditor to repossess the secured
collateral. Yes
3. Hold: Creditor is liable for any breach of the peace by the independent contractor. The
independent contractor’s wanton and reckless disregard of the property right of
another may be imputed to ER and exemplary damages awarded
4. Note: the court cites the Restatement of Torts 188 (conversion is torts) – the use of
force, such as breaking or removing a padlock does not comport w/ concepts of
reasonableness and peaceableness, and therefore a violation of the prohibition in the
UCC
C. Problem 378: Don was in charge of repossession for Carmen Motors, and the dealership
told him to pick up the cars owned by 4 debtors (Escamillo, Micaela, Zuniga, and Morales)
b/c they had missed payments.
1. Is Carmen Motors required to give the debtors notice that they are in default before
repossessing?
a. 9-609: No, notice of default before repossession is NOT required (you can always
break into the collateral as long as no breach of peace)
2. Don found Escamillo’s car parked in his driveway at 2 a.m.; he broke a car window, hot-
wired the car, and drove it away. Has a breach of the peach occurred? No, b/c no
confrontation
a. Giles v. 1st VA Credit Services: the repossession that occurred w/o confrontation did
not breach the beach
3. What if Escamillo heard the window break, rushed out, and began yelling? May Don
continue the repossession, or must he quit?
a. Don must quit repossession b/c there is potential for violence
4. If he goes away, may he try again later that night?
a. No, the passage of time b/w the 1st attempt and the 2nd attempt is too short and
there is still potential for violence
b. Wade v. Ford Motor: the potential for violence has been substantially reduced during
the 1 month b/w the first attempt and the successful attempt.
c. Griffith v. Valley of the Sun: repossessor liable in negligence for act of debtor’s
neighbor who used a shotgun to shoot a bystander during repossession melee
5. Don showed up at Michaela’s house accompanied by his brother (an off-duty sheriff
who was wearing his sheriff’s uniform) and told her that he was repossessing the car.
Has a breach of the peach occurred?
a. Yes, OC says the show of authority is constructive force, and thus breach of the peace
b. Stone Mach v. Kessler: constructive force also constitutes a breach of the peace
c. First & Farmer’s Bank v. Henderson: $75K punitive damages
6. Don broke into Zuniga’s garage through the use of the services of a locksmith, w/ garage
lock and door undamaged. The K provided that the secured party had the right to enter
the debtor’s premises to remove the property. Does the repossession comply w/ 9-609?
 a. No, debtor may not waive/vary 9-609
b. 9-602(6): debtor/obligor may not waive or vary the rules in 9-609 to the extent that it
impose upon a secured party that takes possession of collateral w/o judicial process
the duty to do so w/o breach of the peace
c. Policy reason: right of neighbors to be free of this kind of situation cannot be waived
by the debtor
7. Don phoned Morales and said that the car was being recalled b/c of an unsafe engine
mount. Morales brought the car and Don repossessed the car. Is the repossession valid?
a. Most courts (except AL) say YES b/c certain amount of trickery is allowed as long as it
is peaceful
b. Cox v. Galigher Motors: no breach of the peace
c. Ford Motor v. Byrd: 9-503 does not permit repossession through trickery, w/o
debtor’s knowledge
D. Hilliman v. Cobado (constructive breach of peace)
1. Fact: K provided a SI in cattle, and gave lender the right to enter the premises
peaceably. Lender, along w/ two deputy sheriffs came to debtor’s house, and despite
pleas not to do so, went to the barn and began loading the cattle into his truck.
Another sheriff arrived and informed Lender that if he left w/ the cattle he would be
arrested for stealing property. He did and he was.
2. Rule: Repossession should be strictly confined to situation when the repossession may
be accomplished peaceably. No physical confrontation required (constructive force by
accompanying deputy sheriffs is sufficient breach of peace).
E. Problem 379: ONB financed Mary’s purchase of a new car, in which it perfected its SI. The
loan agreement provided that on default ONB had all the rights listed in Part 6 of Art. 9
and the parties agreed ONB would not be liable for conversion or otherwise if there were
other items in the car at the time it was repossessed. Mary missed a payment and ONB
took the car in the dead of night from its parking place in front of her home. She
protested the next day, claiming that her golf clubs were in the trunk which was not found
by ONB. When she sued, ONB defended on the basis of the SA’s exculpatory clause.
1. Is it valid?
a. In drafting a SA, you may include an exculpatory clause and if the repossessor
behaves well, the court will be sympathetic to the creditor (but, the result is not
predictable)
2. If ONB finds the clubs and returns them promptly on her demand, is ONB guilty of
conversion? No
F. Bankruptcy Code 362 (federal matter): If the debtor files a petition in bankruptcy, an
automatic stay of any creditor collection activity is created
1. No formal court notice is required for the automatic stay
2. In effect from the moment of the filing
3. Creditor’s action taken w/o knowledge must be undone
4. Violation is contempt of court: willful violation -> actual damages including costs and
attorney’s fees + punitive damages
G. Problem 380: Wonder Spa gave ANB a SI in its accounts receivable (money owed and to be
owed by customers) and chattel paper in return for a loan. When Wonder Spa missed 2
payments in a row, ANB notified the spa’s customers that future payments should be
made directly to ANB.
1. Does ANB have this right?
a. Yes, this is the typical way to repossess the accounts receivable
b. 9-607 (Collection and Enforcement by Secured Party)
i. [Collection and enforcement generally.] If so agreed, and in any event after default,
a secured party:
a) may notify an account debtor or other person obligated on collateral to make
payment or otherwise render performance to or for the benefit of the secured
party;
b) may take any proceeds to which the secured party is entitled under 9-315;
c) may enforce the obligations of an account debtor or other person obligated on
collateral and exercise the rights of the debtor w/r/t the obligation of the account
debtor or other person obligated on collateral to make payment or otherwise
render performance to the debtor, and w/r/t any property that secures the
obligations of the account debtor or other person obligated on the collateral;
d) if it holds a SI in a deposit account perfected by control under 9-104(a)(1), may
apply the balance of the deposit account to the obligation secured by the deposit
account; and
e) if it holds a SI in a deposit account perfected by control under 9-104(a)(2) or (3),
may instruct the bank to pay the balance of the deposit account to or for the
benefit of the secured party.
ii. [Nonjudicial enforcement of mortgage] If necessary to enable a secured party to
exercise under subsection (a)(3) the right of a debtor to enforce a mortgage
nonjudicially, the secured party may record in the office in which a record of the
mortgage is recorded:
a) a copy of the SA that creates or provides for a SI in the obligation secured by the
mortgage; and the secured party's sworn affidavit in recordable form stating that:
1. a default has occurred; and
2. the secured party is entitled to enforce the mortgage nonjudicially.
iii. [Commercially reasonable collection and enforcement] A secured party shall
proceed in a commercially reasonable manner if the secured party:
a) undertakes to collect from or enforce an obligation of an account debtor or other
person obligated on collateral; and
b) is entitled to charge back uncollected collateral or otherwise to full or limited
recourse against the debtor or a secondary obligor.
iv. [Expenses of collection and enforcement] A secured party may deduct from the
collections made pursuant to subsection (c) reasonable expenses of collection and
enforcement, including reasonable attorney's fees and legal expenses incurred by
the secured party.
v. [Duties to secured party not affected] This section does not determine whether an
account debtor, bank, or other person obligated on collateral owes a duty to a
secured party.
 c. 9-406(c): [Proof of assignment] if requested by account debtor, assignee (secured
party) shall furnish reasonable proof of assignment (a copy of SA), otherwise, account
debtor may pay to the assignor (debtor to secured party)
2. If the spa stops opening its doors, need its former customers keep paying ANB? (The spa
K did not mention the possibility that the K would be assigned)
a. No, former customers may raise their defenses arising from the underlying spa K
unless they waived (In consumer transaction, ANB can’t be a HDC b/c they are
regarded to have had notice)
b. 9-404(a): [Assignee's rights subject to terms, claims, and defenses; exceptions] Unless
an account debtor has made an enforceable agreement not to assert defenses or
claims, and subject to subsections (b) through (e), the rights of an assignee are
subject to:
c. all terms of the agreement b/w the account debtor and assignor and any defense or
claim in recoupment arising from the transaction that gave rise to the K; and
d. any other defense or claim of the account debtor against the assignor which accrues
before the account debtor receives a notification of the assignment authenticated by
the assignor or the assignee.
e. Unico v. Owen: The ability of customers to raise defenses against the finance
company is bound up in the law of negotiable instruments
H. Strict Foreclosure: after repossession, secured party keeps the collateral and give up
further remedy
1. Strict foreclosure is done in 2 situations
a. If the debtor has no money
b. If the value of collateral is more than the debt
2. If repossessing creditor resell the collateral instead of keeping it, he may sue the debtor
for any deficiency (difference b/w the debt and the resale price) or return the surplus to
the debtor
I. 9-610 (Disposition of Collateral After Default)
1. After default, a secured party may dispose of the collateral in any commercially
reasonable manner
2. Every aspect of a disposition of collateral (method, manner, time, place, other terms)
must be commercially reasonable
3. Drafters encourages private sales b/c private sales would create more money
4. Purchase by secured party allowed at a public disposition or at a private disposition only
if the collateral is customarily sold on a recognized market or subject of widely
distributed standard price quotation
5. Warranties on disposition
6. Disclaimer of warranties
7. Record sufficient to disclaim warranties: “there is no warranty relating to title,
possession, quiet enjoyment, or the like in this disposition”
8. Note: if a bank repossesses a car, a warranty of merchantability is not implied b/c the
bank is not a merchant of cars
a. If a car dealership repossesses a car, a warranty of merchantability is implied
J. Notice of Resale (9-611(c))
1. Secured party must give the debtor notice of the time and place of the sale
2. Reasons: debtor may elect to use 9-623 right of redemption, or can enter bids at the
sale to bring a fair price for the collateral
3. 9-610(b): every aspect of a disposition of collateral, including the method, manner,
time, place, and other terms must be commercially reasonable
4. 9-611(d): (b) does not apply (no notice required), if the collateral (no worry about fair
price)
a. Is perishable
b. Declines speedily in value
c. Is customarily sold on a recognized market
5. 9-611(e) grace period
a. Not later than 20 days or earlier than 30 days before the notification date
K. Problem 381: After NLC had repossessed Brown’s car, it decided to advertise it for bids in a
local newspaper.
1. Is this a private or a public sale?
a. Public sale if advertisement + public access to the sale
b. If the ad says “send your bids to our office” and the bids are not disclosed, this is a
private sale
c. OC7 to 9-610:
i. public disposition
a) one at which the price is determined after the public has had a meaningful
opportunity for competitive bidding
b) secured party may buy at the public disposition
c) debtor is entitled to notification of the time and place of a pubic disposition
ii. private disposition: debtor is entitled to notification of the time after which a private
disposition or other intended disposition is to be made
2. How much in advance of the resale must she be given notice? Reasonable time
a. 9-611: notification before disposition of collateral
b. 9-612: question of fact, 10-day is reasonable in other than a consumer transaction
i. In consumer transaction? – Art. 9 exempts consumer transaction, but OH version
does not (same rule applies to consumer transactions in OH)
3. What should the notice say?
a. Use the safe harbor forms in 9-613 (in most of transactions) & 614 (in consumer
transaction)
b. 9-613 (notice to non-consumer debtor): debtor/secured party, collateral, method of
disposition, debtor is entitled to an accounting of the unpaid indebtedness and the
charge for an accounting, time/place of public disposition or time of any other
disposition
c. 9-614 (notice to consumer debtor): 9-613 + liability for a deficiency, telephone
number from which the amount to be paid to redeem the collateral is available,
telephone number or mailing address from which additional info is available
4. After the resale, NLC sent her a statement saying that the amount she now owed was
 $3,200. What are her rights here?
a. 9-616: secured party must send an explanation after disposition
b. 9-625(c): may recover damages for any loss caused by a failure to comply w/ Art. 9 &
for consumer debtor, the minimum amount of recovery is (credit service charge +
10% of the principal amount of the obligation) or (time-price differential + 10 % of
the cash price)
c. 9-625(e): statutory damage of $500 is recoverable
5. The price obtained at the resale seems suspiciously low to her. How relevant is that?
a. It might be suspicious, but it is not determinative
b. 9-627(a): the fact that a greater mount could have been obtained by a collection,
enforcement, disposition, or acceptance at a different time or in a different method
from that selected by the secured party is not of itself sufficient to preclude the
secured party from establishing that the collection, enforcement, disposition, or
acceptance was made in a commercially reasonable manner
c. BOP for commercial reasonableness is still on the creditor
6. She suspects that the reason the sale brought so little is that the only bidder was NLC
itself. Can they do that?
a. NLC may purchase the car, but if Brown proves that the amount of proceeds is
significantly low, the deficiency must be recalculated based on 9-615(f) formula
b. 9-610(c): secured party may purchase collateral (1) at a public disposition, or (2) at a
private disposition only if the collateral is of a kind that is customarily sold on a
recognized market or the subject of widely distributed standard price quotations
c. 9-615(f): the surplus/deficiency is calculated based on the amount of proceeds that
would have been realized in a disposition to a transferee other than the secured
party if (1) the transferee is the secured party and (2) the amount of proceeds is
significantly below
d. 9-626(a)(5) (non-consumer transaction): if deficiency/surplus is calculated under 9-
615(f), debtor/obligor has the burden of establishing that the amount of proceeds is
significantly below
7. If she succeeds in reducing the amount she owes, can she also get actual damages for
the harm they have caused her?
a. 9-625(d): No, she may only recover damages for the loss of any surplus, but may not
recover for NLC’s noncompliance
L. Problem 382: ANB agreed to loan Miller $80K if they (1) got a surety, (2) signed an
agreement giving ANB a SI in the restaurant equipment and inventory, and (3) pledged to
ANB additional collateral having a value of $20K or more. Miller got Stuhldreher to sign as
surety; they signed the SA; and they borrowed $20 worth of stock from Layden, which was
registered in Layden’s name at the time it was pledged to ANB (i.e., ANB took possession
of the stock), but ANB had it reregistered in ANB’s name so that it could be sold easily in
the event of default. ANB, however, filed its FS (FS) in the appropriate office. Miller
borrowed another $5K from NCU, which also took a SI in the restaurant’s equipment (2
creditors have SIs in it), and filed a FS. Millers missed 2 payments on the loan, ANB
repossessed the assets and sent a written notice to Miller, telling him that the stock
would be sold on the open
market (no specific date given) and the restaurant equipment would be sold at public
auction on Dec. 1 at his offices. Crowley phoned Stuhldreher and told him the same thing.
He sent a written notice to Layden, but the letter came back marked “Moved – No
Forwarding Address.” If asked, Miller would have supplied Crowley w/ Layden’s new
address. Crowley sold the stock for $10K (current selling price) on the open market, and
auctioned off the restaurant equipment on Dec. 1 for $500 (only one bid was received –
Crowley himself was the bidder; he later resold the equipment to other restaurant for
$10K). Crowley turned over the proceeds from the 2 sales ($10.5K) to ANB, which then
brought suit against Miller and Stuhldreher for the deficiency.
1. Is a surety entitled to a notice under 9-611? That is, is he a debtor?
a. Surety is not debtor, but second obligor, so entitled to a notice under 9-611
b. 9-102(a)(28)(A): “Debtor” means a person having an interest, other than a SI or other
lien, in the collateral, whether or not the person is an obligor
c. 9-102(a)(71): “Second obligor” means an obligor to the extent that (A) the obligor’s
obligation is secondary; or (B) the obligor has a right of recourse w/r/t an obligation
secured by collateral against the debtor, another obligor, or property of either
d. 9-611(c): debtor & second obligor are entitled to a notice of disposition
2. Was Layden a debtor too?
a. Yes, Layden is a debtor b/c he has an ownership interest in the stock
b. OC2a to 9-102: debtor is a person who may have a stake in the proper enforcement
of a SI by virtue of non-lien property interest (ownership interest) in the collateral
3. Does the oral notice to Stuhldreher satisfy 9-611(b)?
a. No, the secured party needs to send an authenticated notification and an oral notice
cannot be sent authenticated
b. 1-201(b)(36): “Send" in connection w/ a writing, record, or notice means: (A) to
deposit in the mail or deliver for transmission by any other usual means of
communication w/ postage or cost of transmission provided for and properly
addressed and, in the case of an instrument, to an address specified thereon or
otherwise agreed, or if there be none to any address reasonable under the
circumstances; or (B) in any other way to cause to be received any record or notice
within the time it would have arrived if properly sent.
c. 9-102(a)(7): "Authenticate" means: (A) to sign; or (B) to execute or otherwise adopt a
symbol, or encrypt or similarly process a record in whole or in part, w/ the present
intent of the authenticating person to identify the person and adopt or accept a
record.
d. OC5 to 9-611: notification of disposition must be “authenticated”
4. Were any parties entitled to notice of the stock sale?
a. No, stock is customarily sold on a recognized market so subsection (b) does not apply
b. 9-611(d): subsection (b) does not apply if the collateral is perishable or threatens to
decline speedily in value or is of a type customarily sold on a recognized market
5. How about the sale of the equipment?
a. Must send notification to Miller (debtor), Stuhldreher (secondary obligor), Layden
(debtor), NCU (other secured party)
 b. 9-611(c): debtor, secondary obligor, (if not consumer goods) person from which the
secured party has received an authenticated notification of a claim of an interest in
the collateral and other secured party
6. If no notice was sent to NCU before the equipment was sold, did Crowley himself take
free of its SI when he bought the equipment at the foreclosure sale?
a. Crowley is not a good-faith transferee, so he takes the equipment subject to NCU’s SI
(Typically buyers take free of SI)
b. 9-617 (Rights of Transferee of Collateral)
i. [Effects of disposition] A secured party's disposition of collateral after default:
a) transfers to a transferee for value all of the debtor's rights in the collateral;
b) discharges the SI under which the disposition is made; and
c) discharges any subordinate SI or other subordinate lien [other than liens created
under [cite acts or statutes providing for liens, if any, that are not to be
discharged]].
ii. [Rights of good-faith transferee] A transferee that acts in good faith takes free of the
rights and interests described in subsection (a), even if the secured party fails to
comply w/ Art 9. or the requirements of any judicial proceeding.
iii. [Rights of other transferee] If a transferee does not take free of the rights and
interests described in subsection (a), the transferee takes the collateral subject to:
a) the debtor's rights in the collateral;
b) the SI or agricultural lien under which the disposition is made; and
c) any other SI or other lien.
7. Did the buyer from Crowley take free of its SI?
a. If the buyer was in good faith, he takes the equipment free of NUC’s SI
b. 2-403(1): A purchaser of goods acquires all title which his transferor had or had
power to transfer except that a purchaser of a limited interest acquires rights only
to the extent of the interest purchased. A person w/ voidable title has power to
transfer a good title to a good faith purchaser for value. When goods have been
delivered under a transaction of purchase the purchaser has such power even
though
i. the transferor was deceived as to the identity of the purchaser, or
ii. the delivery was in exchange for a check which is later dishonored, or
iii. it was agreed that the transaction was to be a "cash sale", or
iv. the delivery was procured through fraud punishable as larcenous under the criminal
law.
8. Is the notice sent to Mr. Miller sufficient as to Mrs. Miller? No
a. Tauber v. Johnson: Notice to husband does not satisfy notice to wife
9. Does 9-611 require the creditor to whom a notice is returned by the post office to take
further steps to notify the debtor?
a. OC6 to 9-611: Art. 9 leaves it to judicial resolution (some courts required second try)
b. Panora State Bank v. Dickinson: second try is not required
10. If the restaurant equipment is also named as collateral in a junior filed FS, must the
bank notify that secured party of the resale?
a. Yes, the bank must notify the junior party so that they can protect themselves
 b. 9-611(c)(3)(B): must notify other secured party that held a SI in the collateral
perfected by the filing of a FS
c. 9-611(e): if secured party requests info on FS and receives no response, no
notification is required
11. Who has BOP as to the commercial reasonableness of the sales? ANB (secured party)
a. 9-626(a)(2): secured party has the burden of establishing that the collection,
enforcement, disposition or acceptance was conducted in accordance w/ this part
12. If Crowley had given the equipment sale no publicity, has a public sale occurred, and if
so, was it commercially reasonable?
a. OC7 to 9-610: no meaningful opportunity for competitive bidding -> no public sale
13. When a secured party repossesses goods and sells them at a foreclosure sale, will this
give rise to Art. 2 warranties being made to the purchaser at the sale?
a. Yes, unless disclaimed/modified
b. 2-312: in a K for sale, there is a warranty of good title, rightful transfer, free from any
SI
c. 9-610(d): K for sale, lease, license, disposition includes warranties relating to title,
possession, quiet enjoyment, and the like which by operation of law accompany a
voluntary disposition of property of the kind subject to the K
d. 9-610(e): secured party may disclaim/modify warranties (1) in an effective manner or
(2) by communicating to the purchaser a record evidencing the K for disposition and
including an express disclaimer/modification of the warranties
M. R & J TN v. Blankenship-Melton
1. Fact: The guarantor never received actual notice of the sale.
2. Hold: 9-611(b) did not require the creditor to prove that the guarantor actually received
the notice. However the notice was insufficient as it was not sent in a reasonable
manner as required by 9-611 b/c the creditor sent the notice and then conducted
the sale 10 days later w/o any indication as to if the notice actually reached the
guarantor. The sale was not held in good faith or in a commercially reasonable manner
as required by 1-203 and 9-610(b) b/c in addition to inadequate notice, the creditor
failed to offer a reasonable explanation as to why he waited more than 7 months to
conduct the sale and allowed his relatives to continue using the collateral, which
caused them to depreciate faster. Also the creditor never advertised the sale in a
public newspaper, utilized an experienced auctioneer, or used an independent
appraiser.
a. The notice of resale is intended to afford the debtor a reasonable opportunity (1) to
avoid a sale altogether by discharging the debt and redeeming the collateral or (2) in
case of sale, to see that the collateral brings a fair price
b. 9-624 (Waiver): debtor or secondary obligor may waive the right to notification only
by an agreement after default (not before default!)
N. Problem 383: BSB held a perfected SI in the logging equipment of BOTC. When BOTC
defaulted on its loan payment, BSB repossessed the equipment and the sale was held the
next day in the middle of a snowstorm. The equipment sold for very little (there was only 1
bidder, and he complained that it was hard to know the condition of the equipment b/c it
was so dirty, being covered w/ mud from the backwoods). BSB sued BOTC for the amount
 still due.
1. Was the notice period too short? Yes, the notice period must be reasonable
a. 9-612: reasonable time – 10-day period is sufficient for non-consumer transaction
2. Is the secured party required to wash the collateral prior to sale?
a. Cases say equipment must be cleaned up in spite of 9-610(a) (b/c it’s commercially
reasonable)
b. 9-610(a): secured party may sell the collateral “in its present condition”
3. Did it violate 9-610(b) to conduct the sale in the snowstorm?
a. Yes, the secured party must dispose of the equipment in a commercially reasonable
way
O. Problem 384: How should you draft a clause in the SA waiving the debtor’s rights when
the creditor seizes the collateral and resells it?
1. 9-602: debtor/obligor may not waive or vary the rues listed in 9-602
2. Can guarantors (as opposed to the primary debtor) waive these rights? Yes
a. OC4 to 9-602: secondary obligor (assuming that they were debtors) can waive these
rights
P. Problem 385: Façade Motors granted a SI in its inventory to ONB (senior secured party),
which duly perfected by filing a FS in the proper place. Subsequently, FM granted an
identical SI to NFC (junior secured party) to get short-term credit. When FM failed to repay
the second debt, NFC repossessed the inventory and sold it.
1. Must it somehow account to ONB for the proceeds of the resale?
a. No, the collateral was sold subject to the senior SI of ONB (which affected the sale
price), so NFC need not account to ONB for the proceeds of the resale. But, ONB is
entitled to notice of resale to protect its interest
b. 9-615(g)(3): not obligated to account to or pay the holder of the SI or other lien for
any surplus
2. Does the buyer at the resale take free of the SI of the senior creditor?
a. No, the buyer takes subject to the SI of ONB unless he received cash in good faith and
w/o knowledge of ONB’s SI
b. 9-608: Application of Proceeds of Collection or Enforcement
i. Order of payment
a) reasonable expenses of collection (attorney’s fees + legal expenses)
b) obligations secured by the SI
c) obligation secured by subordinate SI
c. OC5 to 9-608: the application of proceeds does not affect the priority of a SI in
collateral which is senior to the interest of the secured party who is collecting or
enforcing collateral under 9-607
d. 9-615(g)[Cash proceeds received by junior secured party]: A secured party that
receives cash proceeds of a disposition in good faith and w/o knowledge that the
receipt violates the rights of the holder of a SI or other lien that is not subordinate to
the SI or agricultural lien under which the disposition is made:
i. takes the cash proceeds free of the SI or other lien;
ii. is not obligated to apply the proceeds of the disposition to the satisfaction of
 obligations secured by the SI or other lien; and
iii. is not obligated to account to or pay the holder of the SI or other lien for any surplus
e. OC5 to 9-610
i. the exercise of the right to dispose of collateral by a secured party whose SI is
subordinate to that of another secured party does not of itself constitute a
conversion or otherwise give rise to liability in favor of the holder of the senior SI
ii. b/c the disposition by a junior would not cut off a senior’s SI, the junior’s receipt of
the cash proceeds would not violate the rights of the senior
iii. the holder of a junior SI normally must notify the senior secured party of an
impending disposition
f. 9-617 (Rights of Transferee of Collateral)
g. 2-312 (Warranty of Title): may be excluded or modified only by specific language or
by circumstances which give the buyer reason to know that the person selling does
not claim title in himself . . . (buyer of the collateral would usually know about SI
from the public record)
i. 9-610(d) & (e)
Q.Penalties for Noncompliance: what happens to deficiency when resale does not comply w/
Art. 9?
1. Minor jurisdiction: debtor must prove the damages resulting from noncompliance
2. Absolute bar rule (about 30% of jurisdictions including OH): failure to comply results in a
forfeiture of the creditor’s right to collect a deficiency (the amount owed – the amount
realized at the foreclosure sale)
3. Rebuttable presumption rule (most jurisdictions): a deficiency is allowed, but the
creditor may overcome a rebuttable presumption that had the rules been followed
there would have been no deficiency and the creditor may pursue the debtor for the
amount still due only if the creditor could overcome this presumption by adequate
proof (BOP is on the secured party who did not comply w/ Art. 9)
R. Problem 386: FM repossessed the car that Portia used in her law practice (not a consumer
transaction) but failed to send her any notice of the foreclosure sale, which brought only
half the amount she still owed on the car.
1. May it still sue her for the deficiency?
a. 9-626(a): Yes, (in an action arising from a non-consumer transaction) FM need not
prove its compliance w/ the UCC unless Portia places its compliance in issue. If Portia
raises the issue, FM has BOP and if it fails to prove, Portia’s liability is limited to
(secured obligation + expenses + attorney’s fees) – greater (proceeds of the
collection, proceeds that would have been realized had FM proceeded in accordance
w/ the UCC)
b. 9-626(a)(4): rebuttable presumption rule in non-consumer transactions (not adopted
by OH)
i. In OH, absolute bar rule applies even in consumer transactions
2. What are Portia’s rights?
a. 9-625: damages in the amount of any loss caused by noncompliance (including loss
resulting from Portia’s inability to obtain, or increased costs of, alternative financing)
3. What if Portia has purchased the car for her personal use?
 a. 9-626(b): 9-626(a) does not apply. Courts will determine the proper rules in
consumer transaction
S. Coxall v. Clover Commercial Corp. (consumer transaction case: absolute bar -> rebuttable
presumption)
1. Fact: The debtors never made monthly payments after experiencing mechanical
difficulties w/ the car soon after purchase. The secured party took possession of the
vehicle and sent a notice of disposition. The secured party repurchased the car for
$1.5K.
2. Hold: The secured party failed to provide reasonable notice and did not provide any
evidence as to the commercial reasonableness of the sale. While the rebuttable
presumption rule applies to non-consumer transaction, NY has applied the absolute bar
rule to consumer transaction. Here, the secured party cannot recover for any deficiency
whether the absolute bar rule applies or the rebuttable presumption rule applies b/c
they introduce no evidence of “the amount of proceeds that would have been realized
had it proceeded in accordance w/ UCC.
V. Redemption and Strict Foreclosure
A. Right of Redemption
1. Right of the defaulting debtor to recover the collateral by curing the default
2. Courts will not permit anything to “clog the equity of redemption” (even if the K forbids
it!)
B. Problem 387: When Paul borrowed $2K from LSB, LSB made him sign an agreement giving
it a SI in his private yacht. He failed to make a payment on due and the next day LSB
repossessed the yacht. Paul tendered a payment in cash but LSB refused to take the
money, based on an acceleration clause in the SA that made the entire amount due if a
payment was missed. LSB demanded the total unpaid balance.
1. Need Paul pay off everything? Yes
a. 9-623 (Right to Redeem Collateral)
i. [Persons that may redeem] A debtor, any secondary obligor, or any other secured
party or lien holder may redeem collateral
ii. [Requirements for redemption] To redeem collateral, a person shall tender:
a) fulfillment of all obligations secured by the collateral; and
b) the reasonable expenses and attorney's fees described in 9-615(a)(1)
iii. [When redemption may occur] A redemption may occur at any time before a
secured party:
a) has collected collateral under 9-607;
b) has disposed of collateral or entered into a K for its disposition under 9-610; or
c) has accepted collateral in full or partial satisfaction of the obligation it secures
under 9-622.
b. OC2 to 9-623: If the entire balance of a secured obligation has been accelerated, it
would be necessary to tender the entire balance
2. First Natl. Bank v. DiDomenico: misdescription of the redemption rights bars any action
for the deficiency
3. In OH, no right of acceleration allowed
C. Strict Foreclosure
1. Occurs when the creditor repossesses the collateral and simply keeps it in satisfaction
of the debt
2. No deficiency is sought
3. The debtor (or other creditors having junior SI) may not be pleased w/ strict foreclosure
4. 9-620 (Acceptance of Collateral in Full or Partial Satisfaction of Obligation; Compulsory
Disposition of Collateral)
a. [Conditions to acceptance in satisfaction] Except as otherwise provided in subsection
(g), a secured party may accept collateral in full or partial satisfaction of the
obligation it secures only if:
i. the debtor consents to the acceptance under subsection (c);
ii. the secured party does not receive, within the time set forth in subsection (d), a
notification of objection to the proposal authenticated by:
a) a person to which the secured party was required to send a proposal under 9-
621; or
b) any other person, other than the debtor, holding an interest in the collateral
subordinate to the SI that is the subject of the proposal;
iii. if the collateral is consumer goods, the collateral is not in the possession of the
debtor when the debtor consents to the acceptance; and
iv. subsection (e) does not require the secured party to dispose of the collateral or the
debtor waives the requirement pursuant to 9-624
b. [Purported acceptance ineffective] A purported or apparent acceptance of collateral
under this section is ineffective unless:
i. the secured party consents to the acceptance in an authenticated record or sends a
proposal to the debtor; and
ii. the conditions of subsection (a) are met
c. [Debtor's consent] For purposes of this section:
i. a debtor consents to an acceptance of collateral in partial satisfaction of the
obligation it secures only if the debtor agrees to the terms of acceptance in a record
authenticated after default; and
ii. a debtor consents to an acceptance of collateral in full satisfaction of the obligation
it secures only if the debtor agrees to the terms of the acceptance in a record
authenticated after default or the secured party:
a) sends to the debtor after default a proposal that is unconditional or subject only
to a condition that collateral not in the possession of the secured party be
preserved or maintained;
b) in the proposal, proposes to accept collateral in full satisfaction of obligation it
secures; and
c) does not receive a notification of objection authenticated by the debtor within 20
days after the proposal is sent
d. [Effectiveness of notification] To be effective under subsection (a)(2), a notification of
objection must be received by the secured party:
i. in the case of a person to which the proposal was sent pursuant to 9-621, within 20
days after notification was sent to that person; and
 ii. in other cases:
a) within 20 days after the last notification was sent pursuant to 9-621; or
b) if notification was not sent, before the debtor consents to the acceptance under
subsection (c).
e. [Mandatory disposition of consumer goods] A secured party that has taken
possession of collateral shall dispose of the collateral pursuant to 9-610 within the
time specified in subsection (f) if:
i. 60 percent of the cash price has been paid in the case of a PMSI in consumer goods;
or
ii. 60 percent of the principal amount of the obligation secured has been paid in the
case of a non-PMSI in consumer goods.
f. [Compliance w/ mandatory disposition requirement] To comply w/ subsection (e),
the secured party shall dispose of the collateral:
i. within 90 days after taking possession; or
ii. within any longer period to which the debtor and all secondary obligors have agreed
in an agreement to that effect entered into and authenticated after default.
g. [No partial satisfaction in consumer transaction] In a consumer transaction, a secured
party may not accept collateral in partial satisfaction of the obligation it secures.
5. 9-622 (Effect of Acceptance of Collateral)
a. [Effect of acceptance] A secured party's acceptance of collateral in full or partial
satisfaction of the obligation it secures:
i. discharges the obligation to the extent consented to by the debtor;
ii. transfers to the secured party all of a debtor's rights in the collateral;
iii. discharges the SI or agricultural lien that is the subject of the debtor's consent and
any subordinate SI or other subordinate lien; and
iv. terminates any other subordinate interest
b. [Discharge of subordinate interest notwithstanding noncompliance] A subordinate
interest is discharged or terminated under subsection (a), even if the secured party
fails to comply w/ Art. 9.
D. Problem 388: AAI sold Dudley a $5K painting and Dudley paid $1K down and agreed to pay
over $1K/month thereafter. The finance charge was $151.20; the annual percentage
rate was 18%. The K contained a clause saying that in the event of default, AAI could
repossess the painting and keep it w/o reselling it or, at its option, could resell it and sue
for deficiency. Dudley missed the last payment and AAI, w/o notice, sent one of its
agents to take the painting. Dudley immediately tendered $1K to AAI and demanded
the painting but AAI refused (the painting is now worth $7K). 4 months later Dudley filed
suit.
1. May he get the painting back?
a. 9-625(a): Yes, he may file an equitable action so that the court may restrain
collection, enforcement, disposition of the collateral
2. What is the basis of his cause of action, and to what relief is he entitled?
a. Paintings are consumer goods, so strict foreclosure is forbidden if the debtor has paid
off more than 60% of the debt. AAI must dispose of the painting within 90 days after
repossession. Dudley is entitled to damages in the amount of any loss caused by AAI’s
 noncompliance
b. 9-620(e): [Mandatory Disposition of Consumer Goods] secured party must dispose of
the collateral if 60% has been paid
i. Policy: debtor has paid a significant portion & doesn’t know how long the secured
party will keep the collateral. (eventually, the secured party will sell the collateral!)
ii. In OH Revised Code 1317, 60% rule does not apply
c. 9-620(f): secured party must dispose of the collateral within 90 days from
repossession or longer period agreed
d. 9-625(b): damages in the amount of any loss caused by noncompliance
e. 9-625(c): debtor, obligor, secured party, secondary obligor (if consumer goods)
3. If Dudley had made only one payment and then defaulted, causing AAI to repossess,
could AAI have sent him a proposal that it would keep the painting and forgive half the
remaining debt only? No
a. 9-620(g): in a consumer transaction, a secured party may not accept collateral in
partial satisfaction of the obligation
E. Problem 389: When RFC declared a default and repossessed all the office equipment of
attorney Portia, as allowed by the SA, RFC then did nothing w/ the collateral except let it
sit in a storage room for 17 months. It conducted a resale w/ appropriate notices and
then sued Portia for the deficiency. She defended by arguing that RFC had constructively
elected strict foreclosure by doing nothing for such a long period of time and had
forfeited any right to a deficiency. Is this correct? No
1. OC5 to 9-620: [No Constructive Strict Foreclosure] a mere delay in collection or
disposition of collateral does not constitute a “constructive” strict foreclosure. Instead,
delay is a factor relating to whether the secured party acted in a commercially
reasonable manner
F. Reeves v. Foutz & Tanner,
1. Fact: Ps pawned valuable jewelry w/ D. When Ps defaulted on their loans, D notified Ps
that it intended to retain the collateral pursuant to 9-505(2), and Ps did not object. D
then moved the jewelry into its normal sale inventory, and since the jewelry was worth
considerably more than the loans, D was left w/ a substantial surplus upon its sale,
which was not returned to Ps
2. Issue: whether a secured party who sends a notice of intent to retain collateral, in
conformance w/ 9-620 may sell the collateral in its regular course of business w/o
complying w/ 9-610? No
3. Hold: Where a secured party intended to sell collateral in the regular course of business,
rather than use the collateral for its personal use for the immediately foreseeable
future, an accounting for a surplus on the collateral's sale pursuant to 9-504 was
required. (You may not keep the goods for strict foreclosure if you elected to resell the
collateral)
4. Question: Is this case right? Does the court mean that any time the creditor elects to
use 9-620, that creditor is forbidden the right to resell the collateral? After this
decision, and assuming the court would reach the same result under the revision of
Art. 9, can it be said that 9-620 is a dead letter in New Mexico?
a. Prof. says that the problem w/ the NM court is that few creditors who elect strict
foreclosure will keep the collateral for ever (most of them will sell it eventually!)