CASE NOTES

Applicability. —

The UCC applies to rights flowing from the transfer of negotiable instruments, even if secured by real estate mortgages. In re Valentine, 146 Bankr. 945, 1991 Bankr. LEXIS 2139 (Bankr. E.D. Va. 1991) (decided under prior law).

OFFICIAL COMMENT

1. Former Article 3 had no provision affirmatively stating its scope.  Former Section 3-103 was a limitation on scope. In revised Article 3, Section 3-102  states that Article 3 applies to “negotiable instruments,” defined in Section 3-104.  Section 3-104(b) also defines the term “instrument” as a synonym for “negotiable instrument.”  In most places Article 3 uses the shorter term “instrument.”  This follows the convention used in former Article 3.
2. The reference in former Section 3-103(1) to “documents of title” is omitted as superfluous because these documents contain no promise to pay money.  The definition of “payment order” in Section 4A-103 (a)(1)(iii) excludes drafts which are governed by Article 3. Section 3-102(a) makes clear that a payment order governed by Article 4A is not governed by Article 3.  Thus, Article 3 and Article 4A are mutually exclusive.
3. Although the terms of Article 3 apply to transactions by Federal Reserve Banks, federal preemption would make ineffective any Article 3 provision that conflicts with federal law.  The activities of the Federal Reserve Banks are governed by  regulations of the Federal Reserve Board and by operating circulars issued by the Reserve Banks themselves. In some instances, the operating circulars are issued pursuant to a Federal Reserve Board regulation.  In other cases, the Reserve Bank issues the operating circular under its own authority under the Federal Reserve Act, subject to review by the Federal Reserve Board.  Section 3-102(c) states that Federal Reserve Board regulations and operating circulars of the Federal Reserve Banks supersede any inconsistent provision of Article 3 to the extent of the inconsistency. Federal Reserve Board regulations, being valid exercises of regulatory authority pursuant to a federal statute, take precedence over state law if there is an inconsistency.  Childs v. Federal Reserve Bank of Dallas, 719 F.2d 812 (5th Cir. 1983), reh. den. 724 F.2d 127 (5th Cir. 1984).Section 3-102(c) treats operating circulars as having the same effect whether issued under the Reserve Bank’s own authority or under a Federal Reserve Board regulation.  Federal statutes may also preempt article 3.  For example, the Expedited Funds Availability Act, 12 U.S.C. § 4001 et seq., provides that the Act and the regulations issued pursuant to the Act supersede any inconsistent provisions of the UCC.  12 U.S.C. § 4007 (b).
4. In Clearfield Trust Co. v. United States, 318 U.S. 363 (1943), the Court held that if the United States is 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 United States v. Kimbell Foods, Inc., 440 U.S. 715 (1979), the Court stated a three-pronged test to ascertain whether the federal common-law rule should follow the state rule.  In most instances courts under the Kimbell test have shown a willingness to adopt UCC rules in formulating federal common law on the subject.  In Kimbell the Court adopted the priorities rules of Article 9.
5. In 1989 the United Nations Commission on International Trade Law completed a Convention on International Bills of Exchange and International Promissory Notes.  If the United States becomes a party to this Convention, the Convention will preempt state law with respect to international bills and notes governed by the Convention.  Thus, an international bill of exchange or promissory note that meets the definition of instrument in Section 3-104 will not be governed by Article 3 if it is governed by the Convention.

Article 8 states in Section 8-102(1)(c) that “A writing that is a certificated security is governed by this Article and not by Article 3, even though it also meets the requirement of that Article.” Section 3-102(a) conforms to this provision. With respect to some promises or orders to pay money, there may be a question whether the promise or order is an instrument under Section 3-104(a) or a certificated security under Section 8-102(a). Whether a writing is covered by Article 3 or Article 8 has important consequences. Among other things, under Section 8-207, the issuer of a certificated security may treat the registered owner as the owner for all purposes until the presentment for registration of a transfer. The issuer of a negotiable instrument, on the other hand, may discharge its obligation to pay the instrument only by paying a person entitled to enforce under Section 3-301. There are also important consequences to an indorser. An indorser of a security does not undertake the issuer’s obligation or make any warranty that the issuer will honor the underlying obligation, while an indorser of a negotiable instrument becomes secondarily liable on the underlying obligation.

Ordinarily the distinction between instruments and certificated securities in non-bearer form should be relatively clear. A certificated security under Article 8 must be in a registered form (Section 8-102(1)(a)(i)) so that it can be registered on the issuer’s records. By contrast, registration plays no part in Article 3. The distinction between an instrument and a certificated security in bearer form may be somewhat more difficult and will generally lie in the economic functions of the two writings. Ordinarily, negotiable instruments under Article 3 will be separate and distinct instruments, while certificated securities under Article 8 will be either one of a class or series or by their terms divisible into a class or series (Section 8-102(1)(a)(iii). Thus, a promissory note in bearer form could come under either Article 3 if it were simply an individual note, or under Article 8 if it were one of a series of notes or divisible into a series. An additional distinction is whether the instrument is of the type commonly dealt in on securities exchanges or markets or commonly recognized as a medium for investment (Section 8-102(1)(a)(ii)). Thus, a check written in bearer form (i.e., a check made payable to “cash”) would not be a certificated security within Article 8 of the Uniform Commercial Code.

Occasionally, a particular writing may fit the definition of both a negotiable instrument under Article 3 and of an investment security under Article 8. In such cases, the instrument is subject exclusively to the requirements of Article 8. Section 8-102(1)(c) and Section 3-102(a).

CASE NOTES

“Good faith.” —

Trial court erred in finding that a debtor did not act in good faith when she presented a check marked “payment in full” to a bank teller for the amount the debtor believed was owed, and thus the subject mortgage was discharged pursuant to an accord and satisfaction under § 8.3A-311 . Johnston v. First Union Nat'l Bank, 271 Va. 239 , 624 S.E.2d 10, 2006 Va. LEXIS 18 (2006).

Cashier’s check was tendered by a homeowner in good faith to settle a disputed claim with a plumbing company because: (1) the owner submitted the check to the plumbing company’s business address; (2) the check was clearly marked “Paid in Full,” and a letter accompanying the check indicated that the owner was submitting the check in full satisfaction of the plumbing company’s claim for work done on the owner’s house; and (3) there were no claims that the check was submitted fraudulently. Helton v. Phillip A. Glick Plumbing, Inc., 277 Va. 352 , 672 S.E.2d 842, 2009 Va. LEXIS 27 (2009).

Party to an instrument connotes a person who has signed the instrument. —

Where a guarantor, who was equally liable for duties owed by a buyer to a seller under an asset purchase agreement, did not sign a nonnegotiated promissory note for the deferred purchase price for the assets, the guarantor was not a party to the note; thus, the four-year limitations period of § 8.2-725 applied to claims against him. Bizmark, Inc. v. Indus. Gas & Supply Co., 358 F. Supp. 2d 518, 2005 U.S. Dist. LEXIS 3112 (W.D. Va. 2005), dismissed in part, No. 2:04cv00109, 2005 U.S. Dist. LEXIS 26707 (W.D. Va. Nov. 4, 2005).

Chapter 7 debtor, as accommodation party to instrument, was liable on promissory note in her capacity as maker under Virginia law, and liability she assumed when she executed note created valid antecedent debt that trustee could not avoid under Bankruptcy Code or Virginia law. As forbearance agreement transfers made by debtor to bank were given to secure valid, non-avoidable antecedent debt, debtor received reasonably equivalent value and thus, trustee could not avoid transfers. Tavenner v. Wells Fargo Bank, N.A. (In re Ferguson), No. 11-32141-KRH, No. APN 13-03067-KRH, 2014 Bankr. LEXIS 1046 (Bankr. E.D. Va. Mar. 18, 2014).

Successor not holder in due course. —

Note executed by debtor was not negotiable under Virginia law. Thus, Virginia law would not classify the successor in interest as a holder in due course. Resolution Trust Corp. v. Maplewood Invs., 31 F.3d 1276, 1994 U.S. App. LEXIS 19485 (4th Cir. 1994).

CIRCUIT COURT OPINIONS

Good faith. —

Electrical contractor acted in good faith and did not violate reasonable commercial standards when it marked check for payment of security company’s invoice as payment “in full” and security company negotiated that check, even though the electrical contractor withheld the amount the electrical contractor had been charged for liquidated damages from payment it made. Omni Alarm Sys. v. MCI Elec. Co., 58 Va. Cir. 264, 2002 Va. Cir. LEXIS 146 (Warren County Feb. 26, 2002).

Good faith dispute. —

Term “bona fide dispute,” in the context of a claim of accord and satisfaction, means that a party in good faith, without fraud or deceit, calls into question the validity or existence of, or questions the truth or validity of, or calls into doubt the other party’s claim; an act is deemed to be done in “good faith,” within the meaning of subdivision (a)(4) of this section, if it is done honestly. Baughman v. Automated Horizons, Inc., 61 Va. Cir. 67, 2003 Va. Cir. LEXIS 10 (Roanoke Jan. 17, 2003).

Editor’s note.

The Revision of Uniform Commercial Commentary Article 1 — General Provisions, drafted by the National Conference of Commissioners on Uniform State Laws of The American Law Institute, and approved by the American Bar Association on February 12, 2002, made conforming amendments to other articles of the UCC and the commentary thereto. The affected portions of the Official Comment to this section have been set out below with the appropriate amendments.

OFFICIAL COMMENT

1. Subsection (a) defines some common terms used throughout the Article that were not defined by former Article 3 and adds the definitions of “order” and “promise” found in former Section 3-102(1)(b) and (c).
2. The definition of “order” includes an instruction given by the signer to itself.  The most common example of this kind of order is a cashier’s check: a draft with respect to which the drawer and the drawee are the same bank or branches of the same bank.  Former Section 3-118(a) treated a cashier’s check as a note.  It stated “a draft drawn on the drawer is effective as a note.”  Although it is technically more correct to treat a cashier’s check as a promise by the issuing bank to pay rather than an order to pay, a cashier’s check is in the form of a check and it is normally referred to as a check. Thus, revised Article 3 follows banking practice in referring to a cashier’s check as both a draft and a check rather than a note.  Some insurance companies also follow the practice of issuing drafts in which the drawer draws on itself and makes the draft payable at or through a bank. These instruments are also treated as drafts. The obligation of the drawer of a cashier’s check or other draft drawn on the drawer is stated in Section 3-412.
3. The last sentence of subsection (a)(9) is intended to make it clear that an I.O.U. or other written acknowledgement of indebtedness is not a note unless there is also an undertaking to pay the obligation.
4. Subsection  (a)(7) is a definition of ordinary care which is applicable not only to Article 3 but to Article 4 as well. See Section 4-104(c).  The general rule is stated in the first sentence of subsection (a)(7) and it applies both to banks and to persons engaged in businesses  other than banking. Ordinary care means observance of reasonable commercial standards of the relevant business prevailing in the area in which the person is located.  The second sentence of Subsection (a)(7) is a particular rule limited to the duty of a bank to examine an instrument taken by a bank for processing for collection or payment by automated means.  This particular rule applies primarily to Section 4-406 and it is discussed in Comment 4 to that section. Nothing in Section 3-103(a)(7) is intended to prevent a customer from proving that the procedures followed by a bank are unreasonable, arbitrary, or unfair.
5. In subsection (c) reference is made to a new definition of “bank” in amended Article 4.

An order may be addressed to more than one person as drawee either jointly or in the alternative. The authorization of alternative drawees follows former Section 3-102(1)(b) and recognizes the practice of drawers, such as corporations issuing dividend checks, who for commercial convenience name a number of drawees, usually in different parts of the country. Section 3-501(b)(1) provides that presentment may be made to any one of multiple drawees. Drawees in succession are not permitted because the holder should not be required to make more than one presentment. Dishonor by any drawee named in the draft entitles the holder to rights of recourse against the drawer or indorsers.

CASE NOTES

Editor’s note.

Many of the cases annotated below were decided under former §§ 8.3-104, 8.3-106, and 8.3-112.

Negotiable instrument could not also be account or general intangible. —

Where a note was a negotiable instrument under former § 8.3-104 and, therefore, an instrument under § 8.9A-102 (47), it could not also be an account or general intangible subject to the notice requirements of § 8.9A-406 . Lambert v. Barker, 232 Va. 21 , 348 S.E.2d 214, 3 Va. Law Rep. 462, 1986 Va. LEXIS 221 (1986).

Notes not negotiable where not due until various conditions satisfied. —

Notes were not negotiable instruments where they incorporated by reference an agreement setting forth various conditions which had to be satisfied before the debt evidenced by the notes became due and payable. Salomonsky v. Kelly, 232 Va. 261 , 349 S.E.2d 358, 3 Va. Law Rep. 997, 1986 Va. LEXIS 253 (1986).

Where no time for payment is stated in the note, it is a demand note under the UCC, and not a time instrument. Guth v. Hamlet Assocs., 230 Va. 64 , 334 S.E.2d 558, 1985 Va. LEXIS 252 (1985).

Instrument requiring reference to outside source not negotiable. —

The drafters of the Uniform Commercial Code (UCC) adopted criteria of negotiability intended to exclude an instrument which requires reference to any source outside the instrument itself in order to ascertain the amount due, subject only to the exceptions specifically provided for by the UCC. Taylor v. Roeder, 234 Va. 99 , 360 S.E.2d 191, 4 Va. Law Rep. 485, 1987 Va. LEXIS 251 (1987).

Subsection (1) (c) of former § 8.3-104 (see now subdivision (a) (2)) controlled where face of each note involved showed with exactness the amount payable, including interest, the number of installments required, and the amount of each installment and reference to no other document was required to ascertain the payment terms of the notes, or the amount required to satisfy the debt. Accordingly, neither subdivision (1) (b) of former § 8.3-104 (see now subsection (a)) or former § 8.3-105 (2) (a) (see now § 8.3A-106 (a) (ii)) was implicated, since the clause in question was merely an acceleration clause. Marriott v. Harris, 235 Va. 199 , 368 S.E.2d 225, 4 Va. Law Rep. 2357, 1988 Va. LEXIS 67 (1988).

A note providing for a variable rate of interest not ascertainable from the face of the note is not a negotiable instrument. Taylor v. Roeder, 234 Va. 99 , 360 S.E.2d 191, 4 Va. Law Rep. 485, 1987 Va. LEXIS 251 (1987).

“Note” construed under former N.I.L. —

See Rector v. Hancock, 127 Va. 101 , 102 S.E. 663 , 1920 Va. LEXIS 37 (1920).

As non-recourse obligation, note lacked negotiability because it did not constitute an unconditional promise to pay a fixed amount of money. Apartment Inv. & Mgt. v. National Loan Investors, 258 Va. 322 , 518 S.E.2d 627, 1999 Va. LEXIS 98 (1999).

A promissory note is rendered conditional when it provides that the borrower will not be liable personally for payment in the event of default and limits recourse for payment to certain tangible property or other collateral. Apartment Inv. & Mgt. v. National Loan Investors, 258 Va. 322 , 518 S.E.2d 627, 1999 Va. LEXIS 98 (1999).

Assignee not holder in due course. —

Since note was not a negotiable instrument, assignee of noteholder and security agreement could not assert any right that a holder in due course may have had to rely on under federal statutory provision allowing transfer of assets and liabilities without prior written consent. Apartment Inv. & Mgt. v. National Loan Investors, 258 Va. 322 , 518 S.E.2d 627, 1999 Va. LEXIS 98 (1999).

Writing held not note. —

Where loan was due Aug. 20, and on Aug. 5 borrower and credit union agreed to postpone due date, and the parties memorialized their agreement in language typed on credit union’s stationery, subscribed by borrower and witnessed by credit union representative, the writing dated Aug. 5 was not a “note” as defined in former § 8.3-104(2) (d) (see now subsection (e)), nor was it an “instrument” within the contemplation of former § 8.3-805, but it was merely a consensual postponement of the due date of the existing debt rather than a new or refinanced loan. CUNA Mut. Ins. Soc'y v. Norman, 237 Va. 33 , 375 S.E.2d 724, 5 Va. Law Rep. 1375, 1989 Va. LEXIS 22 (1989).

Holder allowed to foreclose on deed of trust. —

Virginia law allowed a holder to foreclose on a deed of trust because, inter alia, the mortgage note was a negotiable instrument under § 8.3A-104 , both the note and the deed of trust demonstrated that the parties intended to allow the loan to be freely transferred, the note was endorsed in blank, the note was currently in the holder’s hands, there was no alteration to the note or deed of trust at any time, and the owner was in default on his obligations. Bernardo v. Nat'l City Real Estate Servs., LLC, 435 Fed. Appx. 240, 2011 U.S. App. LEXIS 10812 (4th Cir. 2011).

Negotiability is not affected by a statement that collateral has been given to secure obligations, either on the instrument or otherwise, of an obligor on the instrument, and an order or promise is not made conditional by the fact that the instrument states that it is secured. This rule was the majority rule even before the adoption of the Uniform Commercial Code. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

Law of place of negotiation governs. —

In ascertaining what the rights attaching to a negotiation of a negotiable instrument are, the courts are to apply the law, not of the place of payment, but of the place where the negotiation occurred. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

Transferability of notes determined by principles unique to negotiable instruments. —

Where the notes in dispute are negotiable instruments, the transferability of such notes, as well as the rights flowing from such transfers, are to be determined by the legal principles unique to negotiable instruments. This is so, though the notes are secured by a real estate mortgage. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

Successor not holder in due course. —

Note executed by debtor was not negotiable under Virginia law. Thus, Virginia law would not classify the successor in interest as a holder in due course. Resolution Trust Corp. v. Maplewood Invs., 31 F.3d 1276, 1994 U.S. App. LEXIS 19485 (4th Cir. 1994).

Liability on promissory note. —

Chapter 7 debtor, as accommodation party to instrument, was liable on promissory note in her capacity as maker under Virginia law, and liability she assumed when she executed note created valid antecedent debt that trustee could not avoid under Bankruptcy Code or Virginia law. As forbearance agreement transfers made by debtor to bank were given to secure valid, non-avoidable antecedent debt, debtor received reasonably equivalent value and thus, trustee could not avoid transfers. Tavenner v. Wells Fargo Bank, N.A. (In re Ferguson), No. 11-32141-KRH, No. APN 13-03067-KRH, 2014 Bankr. LEXIS 1046 (Bankr. E.D. Va. Mar. 18, 2014).

CIRCUIT COURT OPINIONS

Swap agreement not negotiable instrument. —

Swap agreement was not payable to bearer or order and included many other undertakings by the borrowers and the other parties to the swap agreement; because the swap agreement was not a negotiable instrument under § 8.3A-104 , the court sustained the lender’s demurrer as to any allegations regarding the covenant of good faith and fair dealing. Best Med. Int'l v. Wells Fargo, 82 Va. Cir. 502, 2011 Va. Cir. LEXIS 63 (Fairfax County Apr. 27, 2011).

Settlement agreements not negotiable instruments. —

A plea in bar based on accord and satisfaction was overruled where the localities in the relator’s Virginia Fraud Against Taxpayers Act, § 8.01-216.1 et seq., action were not named parties in the Multidistrict Litigation and had not signed the settlement agreements, and the settlement agreements were not negotiable instruments. Commonwealth ex rel. McShane v. Reichl, 104 Va. Cir. 55, 2019 Va. Cir. LEXIS 1193 (Norfolk Dec. 10, 2019).

No negotiable instrument. —

Repayment contract could not be a negotiable instrument under subsection (a) of § 8.3A-104 because it only gave information about the loan and repayment and failed to include an undertaking to pay the obligation and thus contained no promise. Faison v. Hughson, 80 Va. Cir. 96, 2010 Va. Cir. LEXIS 20 (Roanoke Jan. 22, 2010).

OFFICIAL COMMENT

1. The definition of “negotiable instrument” defines the scope of Article 3 since Section 3-102 states:  “This Article applies to negotiable instruments.”  The definition in Section 3-104(a) incorporates other definitions in Article 3. An instrument is either a “promise,” defined in Section 3-103(a)(9), or “order,” defined in Section 3-103(a)(6).  A promise is a written undertaking to pay money signed by the person undertaking to pay.  An order is a written instruction to pay money signed by the person giving the instruction. Thus, the term “negotiable instrument” is limited to a signed writing that orders or promises payment of money. “Money” is defined in Section 1-201 (24) and is not limited to United States dollars.  It also includes a medium of exchange established by a foreign government or monetary units of account established by an intergovernmental organization or by agreement between two or more nations.  Five other requirements are stated in Section 3-104(a):  First, the promise or order must be  “unconditional.” The quoted term is explained in Section 3-106.  Second, the amount of money must be “a fixed amount * * * with or without interest or other charges described in the promise or order.”  Section 3-112(b) relates to “interest.”  Third, the promise or order must be “payable to bearer or to  order.”  The quoted phrase is explained in Section 3-109.  An exception to this requirement is stated in subsection (c).  Fourth, the promise or order must be payable “on demand or at a definite time.” The quoted phrase is explained in Section 3-108.  Fifth, the promise or order may 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” with three exceptions.  The quoted phrase is based on the first sentence of N.I.L. Section 5 which is the precursor of “no other promise, order, obligation or power given by the maker or drawer” appearing in former Section 3-104(1)(b).  The words “instruction” and “undertaking” are used instead of “order” and “promise” that are used in the N.I.L. formulation because the latter words are defined terms that include only orders or promises to pay money.  The three exceptions stated in Section 3-104(a)(3) are based on and are intended to have the same meaning as former Section 3-112(1)(b), (c), (d), and (e), as well as N.I.L. § 5(1), (2), and (3).  Subsection (b) states that “instrument” means a “negotiable instrument.”  This follows former Section 3-102(1)(e) which treated the two terms as synonymous.
2. Unless subsection (c) applies, the effect of subsection (a)(1) and Section 3-102(a) is to exclude from Article 3 any promise or order that is not payable to bearer or to order. There is no provision in revised Article 3 that is comparable to former Section 3-805.  The Comment to former Section 3-805 states that the typical example of a writing covered by that section is a check reading “Pay John Doe.” Such a check was governed by former Article 3, but there could not be a holder in due course of the check.  Under Section 3-104(c) such a check is governed by revised Article 3 and there can be a holder in due course of the check.  But subsection (c) applies only to checks. The Comment to former Section 3-805 does not state any example other than the check to illustrate that section.  Subsection (c) is based on the belief that it is good policy to treat checks, which are payment instruments, as negotiable instruments whether or not they contain the words “to the order of.”  These words are almost always pre-printed on the check form.  Occasionally the drawer of a check may strike out these words before issuing the check.  In the past some credit unions used check forms that did not contain the quoted words.  Such check forms may still be in use, but they are no longer common. Absence of the quoted words can easily be overlooked and should not affect the rights of holders who may pay money or give credit for a check without being aware that it is not in the conventional form.
3. Subsection (d) allows exclusion from Article 3 of a writing that would otherwise be an instrument under subsection (a) by a statement to the effect that the writing is not negotiable or is not governed by Article 3.  For example, a promissory note can be stamped with the legend NOT NEGOTIABLE.  The effect under subsection (d) is not only to negate the possibility of a holder in due course, but to prevent the writing from being a negotiable instrument for any purpose. Subsection (d) does not, however, apply to a check.  If a writing is excluded from Article 3 by subsection (d), a court could, nevertheless, apply Article 3 principles to it by analogy as stated in Comment 2.
4. Instruments are divided into two general categories: drafts and notes.  A draft is an instrument that is an order. A note is an instrument that is a promise.  Section 3-104(e).  The term “bill of exchange” is not used in Article 3.  It is generally understood to be a synonym for the term “draft.” Subsections (f) through (j) define particular instruments that fall within the categories of draft and note.  The term “draft,” defined in subsection (e), includes a “check” which is defined in subsection (f).  “Check” includes a share draft drawn on a credit union payable through a bank because the definition of bank (Section 4-104) includes credit unions.  However, a draft drawn on an insurance payable through a bank is not a check because it is not drawn on a bank.  “Money orders” are sold both by banks and non-banks. They vary in form and their form determines how they are treated in Article 3.  The most common form of money order sold by banks is that of an ordinary check drawn by the purchaser except that the amount is machine impressed.  That kind of money order is a check under Article 3 and is subject to a stop order by the purchaser-drawer as in the case of ordinary checks.  The seller bank is the drawee and has no obligation to a holder to pay the money order. If a money order falls within the definition of a teller’s check, the rules applicable to teller’s checks apply.  Postal money orders are subject to federal law.  “Teller’s check” is separately defined in subsection (h).  A teller’s check is always drawn by a bank and is usually drawn on another bank. In some cases a teller’s check is drawn on a nonbank but is made payable at or through a bank.  Article 3 treats both types of teller’s checks identically, and both are included in the definition of “check.”  A cashier’s check, defined in subsection (g), is also included in the definition of “check.” Traveller’s checks are issued both by banks and nonbanks and may be in the form of a note or draft. Subsection (i) states the essential characteristics of a traveler’s check.  The requirement that the instrument be ‘drawn on or payable at or through a bank’ may be satisfied without words on the instrument that identify a bank as drawee or paying agent so long as the instrument bears an appropriate routing number that identifies a bank as paying agent.

Total exclusion from Article 3 of other promises or orders that are not payable to bearer or to order serves a useful purpose. It provides a simple device to clearly exclude a writing that does not fit the pattern of typical negotiable instruments and which is not intended to be a negotiable instrument. If a writing could be an instrument despite the absence of “to order” or “to bearer” language and a dispute arises with respect to the writing, it might be argued that the writing is a negotiable instrument because the other requirements of subsection (a) are somehow met. Even if the argument is eventually found to be without merit it can be used as a litigation ploy. Words making a promise or order payable to bearer or to order are the most distinguishing feature of a negotiable instrument and such words are frequently referred to as “words of negotiability.” Article 3 is not meant to apply to contracts for the sale of goods or services or the sale or lease of real property or similar writings that may contain a promise to pay money. The use of words of negotiability in such contracts would be an aberration. Absence of the words precludes any argument that such contracts might be negotiable instruments.

An order or promise that is excluded from Article 3 because of the requirements of Section 3-104(a) may nevertheless be similar to a negotiable instrument in many respects. Although such a writing cannot be made a negotiable instrument within Article 3 by contract or conduct of its parties, nothing in Section 3-104 or in Section 3-102 is intended to mean that in a particular case involving such a writing a court could not arrive at a result similar to the result that would follow if the writing were a negotiable instrument. For example, a court might find that the obligor with respect to a promise that does not fall within Section 3-104(a) is precluded from asserting a defense against a bona fide purchaser. The preclusion could be based on estoppel or ordinary principles of contract. It does not depend upon the law of negotiable instruments. An example is stated in the paragraph following Case #2 in Comment 4 to Section 3-302.

Moreover, consistent with the principle stated in Section 1-102(2)(b), the immediate parties to an order or promise that is not an instrument may provide by agreement that one or more of the provisions of Article 3 determine their rights and obligations under the writing. Upholding the parties’ choice is not inconsistent with Article 3. Such an agreement may bind a transferee of the writing if the transferee has notice of it or the agreement of it arises from usage of trade and the agreement does not violate other law or public policy. An example of such an agreement is a provision that a transferee of the writing has the rights of a holder in due course stated in Article 3 if the transferee took rights under the writing in good faith, for value, and without notice of a claim or defense.

Even without an agreement of the parties to an order or promise that is not an instrument, it may be appropriate, consistent with the principles stated in Section 1-102(2), for a court to apply one or more provisions of Article 3 to the writing by analogy, taking into account the expectations of the parties and the differences between the writing and an instrument governed by Article 3. Whether such application is appropriate depends upon the facts of each case.

The definitions in Regulation CC § 229.2 of the terms “check,” “cashier’s check,” “teller’s check,” and “traveler’s check” are different from the definitions of those terms in Article 3.

Certificates of deposit are treated in former Article 3 as a separate type of instrument. In revised Article 3, Section 3-104(j) treats them as notes.

OFFICIAL COMMENT

1. Under former Section 3-102(1)(a) “issue” was defined as the first delivery to a “holder or a remitter” but the term “remitter” was neither defined nor otherwise used.  In revised Article 3, Section 3-105(a) defines “issue” more broadly to include the first delivery to anyone by the drawer or maker for the purpose of giving rights to anyone on the instrument.  “Delivery” with respect to instruments is defined in Section 1-201 (14) as meaning “voluntary transfer of possession.”
2. Subsection (b) continues the rule that nonissuance, conditional issuance or issuance for a special purpose is a defense of the maker or the drawer of an instrument.  Thus, the defense can be asserted against a person other than a holder in due course. The same rule applies to non-issuance of an incomplete instrument later completed.
3. Subsection (c) defines “issuer” to include the signer of an unissued instrument for convenience of reference in the statute.

CASE NOTES

Editor’s note.

The cases annotated below were decided under former § 8.3-105.

Notes not negotiable where not due until various conditions satisfied. —

Notes were not negotiable instruments where they incorporated by reference an agreement setting forth various conditions which had to be satisfied before the debt evidenced by the notes became due and payable. Salomonsky v. Kelly, 232 Va. 261 , 349 S.E.2d 358, 3 Va. Law Rep. 997, 1986 Va. LEXIS 253 (1986).

Form of acceptance held not to destroy negotiability. —

Acceptance which read: “This note is hereby accepted this 20th day of June, 1974, pursuant to Paragraph 4 of the Contract of Settlement dated the 10th day of June, 1974, as to terms and amount” did not destroy the negotiability of the note. McLean Bank v. Nelson, 232 Va. 420 , 350 S.E.2d 651, 3 Va. Law Rep. 1423, 1986 Va. LEXIS 274 (1986).

Negotiability is not affected by a statement that collateral has been given to secure obligations, either on the instrument or otherwise, of an obligor on the instrument, and an order or promise is not made conditional by the fact that the instrument states that it is secured. This rule was the majority rule even before the adoption of the Uniform Commercial Code. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

Law of place of negotiation governs. —

In ascertaining what the rights attaching to a negotiation of a negotiable instrument are, the courts are to apply the law, not of the place of payment, but of the place where the negotiation occurred. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

Transferability of notes determined by principles unique to negotiable instruments. —

Where the notes in dispute are negotiable instruments, the transferability of such notes, as well as the rights flowing from such transfers, are to be determined by the legal principles unique to negotiable instruments. This is so, though the notes are secured by a real estate mortgage. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

Subsection (1) (c) of former § 8.3-104 (see now § 8.3A-104 (a) (2)) controlled where face of each note involved showed with exactness the amount payable, including interest, the number of installments required, and the amount of each installment. Reference to no other document was required to ascertain the payment terms of the notes, or the amount required to satisfy the debt. Accordingly, neither former § 8.3-104(1) (b) (see now § 8.3A-104 (a) ) or subsection (2) (a) of former § 8.3-105 (see now subdivision (a) (ii)) was implicated, since the clause in question was merely an acceleration clause. Marriott v. Harris, 235 Va. 199 , 368 S.E.2d 225, 4 Va. Law Rep. 2357, 1988 Va. LEXIS 67 (1988).

OFFICIAL COMMENT

1. This provision replaces former Section 3-105.  Its purpose is to define when a promise or order fulfills the requirement in Section 3-104(a) that it be an “unconditional” promise or order to pay. Under Section 3-106(a) a promise or order is deemed to be unconditional unless one of the two tests of the subsection make the promise or order conditional.  If the promise or order states an express condition to payment, the promise or order is not an instrument.  For example, a promise states, “I promise to pay $100,000 to the order of John Doe if he conveys title to Blackacre to me.”  The promise is not an instrument because there is an express condition to payment. However, suppose a promise states, “In consideration of John Doe’s promise to convey title to Blackacre I promise to pay $100,000 to the order of John Doe.”  That promise can be an instrument if Section 3-104 is otherwise satisfied. Although the recital of the executory promise to Doe to convey Blackacre might be read as an implied condition that the promise be performed, the condition is not an express condition as required by Section 3-106(a)(i).  This result is consistent with former Section 3-105(1)(a) and (b).  Former Section 3-105(1)(b) is not repeated in Section 3-106 because it is not necessary.  It is an example of an implied condition.  Former Section 3-105(1)(d), (e), and (f) and the first clause of former Section 3-105(1)(c) are other examples of implied conditions.  They are not repeated in Section 3-106 because they are not necessary.  The law is not changed.
2. Subsection (c) applies to traveler’s checks or other instruments that may require a countersignature.  Although the requirement of a countersignature is a condition to the obligation to pay, traveler’s checks are treated in the commercial world as money substitutes and therefore should be governed by Article 3.  The first sentence of subsection (c) allows a traveler’s check to meet the definition of instrument by stating that the countersignature condition does not make it conditional for the purposes of Section 3-104.  The second sentence states the effects of a failure to meet the condition. Suppose a thief steals a traveler’s check and cashes it by skillfully imitating the specimen signature so that the countersignature appears to be authentic.  The countersignature is for the purpose of identification of the owner of the instrument.  It is not an indorsement. Subsection (c) provides that the failure of the owner to countersign does not prevent a transferee from becoming a holder. Thus, the merchant or bank that cashed the traveler’s check becomes a holder when the traveler’s check is taken. The forged countersignature is a defense to the obligation of the issuer to pay the instrument, and is included in defenses under Section 3-305(a)(2).  These defenses may not be asserted against a holder in due course.  Whether a holder has notice of the defense is a factual question.  If the countersignature is a very bad forgery, there may be notice.  But if the merchant or bank cashed a traveler’s check and the countersignature appeared to be similar to the specimen signature, there might not be notice that the countersignature was forged.  Thus, the merchant or bank could be a holder in due course.
3. Subsection (d) concerns the effect of a statement to the effect that the rights of a holder or transferee are subject to the claims and defenses that the issuer could assert against the original payee.  The subsection applies only if the statement is required by Statutory or administrative law. The prime example is the Federal Trade Commission Rule (16 C.F.R. Part 433) preserving consumers’ claims and defenses in consumer credit sales.  The intent of the FTC rule is to make it impossible for there to be a holder in due course of a note bearing the FTC legend and undoubtedly that is the result. But, under former Article 3, the legend may also have had the unintended effect of making the note conditional, thus excluding the note from former Article 3 altogether. Subsection (d) is designed to make it possible to preclude the possibility of a holder in due course without excluding the instrument from Article 3.  Most of the provisions of Article 3 are not affected by the holder-in-due-course doctrine and there is no reason why Article 3 should not apply to a note bearing the FTC legend if the holder-in-due-course rights are not involved.  Under subsection (d) the statement does not make the note conditional. If the note otherwise meets the requirements of Section 3-104(a) it is a negotiable instrument for all purposes except that there cannot be a holder in due course of the note.  No particular form of legend or statement is required by subsection (d).  The form of a particular legend or statement may be determined by the other statute or administrative law. For example, the FTC legend required in a note taken by the seller in a consumer sale of goods or services is tailored to that particular transaction and therefore uses language that is somewhat different from that stated in subsection (d), but the difference in expression does not affect the essential similarity of the message conveyed.  The effect of the FTC legend is to make the rights of a holder or transferee subject to claims or defenses that the issuer could assert against the original payee of the note.

Section 3-106(a)(ii) and (iii) carry forward the substance of former Section 3-105(2)(a). The only change is the use of “writing” instead of “agreement” and a broadening of the language that can result in conditionality. For example, a promissory note is not an instrument defined by Section 3-104 if it contains any of the following statements: 1. “This note is subject to a contract of sale dated April 1, 1990 between the payee and the maker of this note.” 2. “This note is subject to a loan and security agreement dated April 1, 1990 between the payee and maker of this note.” 3. “Rights and obligations of the parties with respect to this note are stated in an agreement dated April 1, 1990 between the payee and maker of this note.” It is not relevant whether any condition to payment is or is not stated in the writing to which reference is made. The rationale is that the holder of a negotiable instrument should not be required to examine another document to determine rights with respect to payment. But subsection (b)(i) permits reference to a separate writing for information with respect to collateral, prepayment, or acceleration.

Many notes issued in commercial transactions are secured by collateral, are subject to acceleration in the event of default, or are subject to prepayment, or acceleration does not prevent the note from being an instrument if the statement is in the note itself. See Section 3-104(a)(3) and Section 3-108(b). In some cases it may be convenient not to include a statement concerning collateral, prepayment or acceleration in the note, but rather to refer to an accompanying loan agreement, security agreement, or mortgage for that statement. Subsection (b)(i) allows a reference to the appropriate writing for a statement of these rights. For example, a note would not be made conditional by the following statement: “This note is secured by a security interest in collateral described in a security agreement dated April 1, 1990 between the payee and maker of this note. Rights and obligations with respect to collateral are [stated in] [governed by] the security agreement.” The bracketed words are alternatives, either of which complies.

Subsection (b)(ii) addresses the issues covered by former Section 3-105(1)(f), (g), and (h) and Section 3-105(2)(b). Under Section 3-106(a) a promise or order is not made conditional because payment is limited to payment from a particular source or fund. This reverses the results of former Section 3-105(2)(b). There is no cogent reason why the general credit of a legal entity must be pledged to have a negotiable instrument. Market forces determine the marketability of instrument of this kind. If potential buyers don’t want promises or orders that are payable only from a particular source or fund, they won’t take them, but Article 3 should apply.

CASE NOTES

Instrument requiring reference to outside source not negotiable. —

The drafters of the Uniform Commercial Code (UCC) adopted criteria of negotiability intended to exclude an instrument which requires reference to any source outside the instrument itself in order to ascertain the amount due, subject only to the exceptions specifically provided for by the UCC. Taylor v. Roeder, 234 Va. 99 , 360 S.E.2d 191, 4 Va. Law Rep. 485, 1987 Va. LEXIS 251 (1987) (decided under former § 8.3-107).

OFFICIAL COMMENT

The definition of instrument in Section 3-104 requires that the promise or order be payable in “money.” That term is defined in Section 1-201 (24) and is not limited to United States dollars. Section 3-107 states that an instrument payable in foreign money may be paid in dollars if the instrument does not prohibit it. It also states a conversion rate which applies in the absence of a different conversion rate stated in the instrument. The reference in former Section 3-107(1) to instruments payable in “currency” or “current funds” has been dropped as superfluous.

CASE NOTES

Editor’s note.

Some of the cases annotated below were decided under former § 8.3-108.

Where no time for payment is stated in the note, it is a demand note under the UCC, and not a time instrument. Guth v. Hamlet Assocs., 230 Va. 64 , 334 S.E.2d 558, 1985 Va. LEXIS 252 (1985).

Error in date note was payable made it demand note. —

As a promissory note provided that the first payment was due on a date prior to its execution, this error in the date it was payable made it a demand note under subsection (a) of § 8.3A-108 . Gowin v. Granite Depot, LLC, 272 Va. 246 , 634 S.E.2d 714, 2006 Va. LEXIS 90 (2006).

An instrument which is a demand note is payable at once. Harris & Harris v. Tabler, 232 Va. 75 , 348 S.E.2d 241, 3 Va. Law Rep. 529, 1986 Va. LEXIS 230 (1986).

Note not due where no demand was made. —

As promissory note representing a member’s capital contribution to a limited liability company (LLC) was a demand note under § 8.3A-108(a) , neither the LLC nor its manager had made a demand for payment, and the note had not been outstanding for an unreasonable period of time, the LLC had no authority under § 13.1-1027 and the articles of organization to remove him as a member for failing to make a required contribution. Gowin v. Granite Depot, LLC, 272 Va. 246 , 634 S.E.2d 714, 2006 Va. LEXIS 90 (2006).

A demand note “matures” on the day of its execution. Harris & Harris v. Tabler, 232 Va. 75 , 348 S.E.2d 241, 3 Va. Law Rep. 529, 1986 Va. LEXIS 230 (1986).

Oral agreement not to call demand note contradicts nature of instrument. —

When the original promissory note and all subsequent modifications clearly stated that the written documents were the “final, complete and entire agreement” between the parties, any oral agreements not to call a demand note for a certain time frame or until a specified event contradict the very nature of a demand instrument. Thus, in that action on the promissory note, the loan terms were controlled by the written instruments, executed by both parties. Dominion Bank v. Moore, 688 F. Supp. 1084, 1988 U.S. Dist. LEXIS 7764 (W.D. Va. 1988).

Calling of demand note not bad faith or misconduct. —

Bank’s request for additional collateral after two previous modifications, a history of delinquent payments, and bank’s calling of the demand note did not constitute bad faith or misconduct on the part of the bank. Dominion Bank v. Moore, 688 F. Supp. 1084, 1988 U.S. Dist. LEXIS 7764 (W.D. Va. 1988).

Statute of limitations barred enforcement of notes. —

Where a husband acknowledged that he never made any payment on two of three notes representing debts given by his parents to go towards the marital home, and never paid a third note off in full, the circuit court accurately analyzed the several notes and correctly applied the appropriate statutes of limitation to find them unenforceable and not marital debts. Garrett v. Garrett, 2004 Va. App. LEXIS 513 (Va. Ct. App. Nov. 2, 2004).

OFFICIAL COMMENT

This section is a restatement of former Section 3-108 and Section 3-109. Subsection (b) broadens former Section 3-109 somewhat by providing that a definite time includes a time readily ascertainable at the time the promise or order is issued. Subsection (b)(iii) and (iv) restates former Section 3-109(1)(d). It adopts the generally accepted rule that a clause providing for extension at the option of the holder, even without a time limit, does not effect negotiability since the holder is given only a right which the holder would have without the clause. If the extension is to be at the option of the maker or the acceptor or is to be automatic, a definite time limit must be stated or the time of payment remains uncertain and the order or promise is not a negotiable instrument. If a definite time limit is stated, the effect upon certainty of time of payment is the same as if the instrument were made payable at the ultimate date with a term providing for acceleration.

OFFICIAL COMMENT

1. Under Section 3-104(a), a promise or order cannot be an instrument unless the instrument is payable to bearer or to order when it is issued or unless Section 3-104(c) applies. The terms “payable to bearer” and “payable to order” are defined in Section 3-109.  The quoted terms are also relevant in determining how an instrument is negotiated.  If the instrument is payable to bearer it can be negotiated by delivery alone.  Section 3-201(b).  An instrument that is payable to an identified person cannot be negotiated without the indorsement of the identified person.  Section 3-201(b). An instrument payable to order is payable to an identified person.  Section 3-109(b). Thus, an instrument payable to order requires the indorsement of the person to whose order the instrument is payable.
2. Subsection (a) states when an instrument is payable to bearer.  An instrument is payable to bearer if it states  that it is payable to bearer, but some instruments use ambiguous terms.  For example, check forms usually have the words “to the order of” printed at the beginning of the line to be filled in for the name of the payee. If the drawer writes in the word “bearer” or “cash,” the check reads “to the order of bearer” or “to the order of cash.”  In each case the check is payable to bearer.  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.  Subsection (a).  Under subsection (b), if an instrument is payable to bearer it can’t be payable to order. This is different from former Section 3-110(3).  An instrument that purports to be payable both to order and bearer states contradictory terms.  A transferee of the instrument should be able to rely on the bearer term and acquire rights as a holder without obtaining the indorsement of the identified payee.  An instrument is also payable to the bearer if it does not state a payee. Instruments that do not state a payee are in most cases incomplete instruments.  In some cases the drawer of a check may deliver or mail it to the person to be paid without filling in the line for the name of the payee.  Under subsection (a) the check is payable to bearer when it is sent or delivered.  It is also an incomplete instrument.  This case is discussed in Comment 2 to Section 3-115.  Subsection (a)(3) contains the words “otherwise indicates that it is not payable to an identified person.”    The quoted words are meant to cover uncommon cases in which an instrument indicates that it is not meant to be payable to a specific person.  Such an instrument is treated like a check payable to “cash.” The quoted words are not meant to apply to an instrument stating that it is payable to an identified person such as “ABC Corporation” if ABC Corporation is a nonexistant company. Although the holder of the check cannot be the nonexistant company, the instrument is not payable to bearer. Negotiation of such an instrument is governed by Section 3-404(b).

CASE NOTES

To whom payable. —

Because the promissory note was payable to both debtor’s former father-in-law and mother-in-law, not one or the other alternatively, the note was payable to both and could only be negotiated, discharged, or enforced by both of them; subsection (d) of § 8.3A-110 . Because their rights to payment arose from the promissory note, they could only enforce those rights by obtaining a joint judgment. In re Forster, 465 Bankr. 97, 2012 Bankr. LEXIS 5 (Bankr. W.D. Va. 2012).

Court rejected creditor’s affirmative defense to trustee’s preferential transfer claim, that the payments were made by an affiliate of the project owner, as debtor had a contractual right to payment from the affiliate, subject to any offsets by the affiliate, and had rights as a payee on the joint check under § 8.3A-110 . In re Lansdowne Constr., LLC, No. 18-11754-BFK, No. 19-01056-BFK, 2020 Bankr. LEXIS 461 (Bankr. E.D. Va. Feb. 21, 2020).

OFFICIAL COMMENT

1. Section 3-110 states rules for determining the identity of the person to whom an instrument is initially payable if the instrument is payable to an identified person.  This issue usually arises in a dispute over the validity of an indorsement in the name of the payee. Subsection (a) states the general rule that the person to whom an instrument is payable is 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.”  “Issuer” means the maker or drawer of the instrument.  Section 3-105(c).  If X signs a check as  drawer of a check on X’s account, the intent of X controls.  If X, as President of Corporation, signs a check as President in behalf of Corporation as drawer, the intent of X controls.  If X forges Y’s signature as drawer of a check, the intent of X also controls.  Under Section 3-103(a)(3), Y is referred to as the drawer of the check because the signing of Y’s name identifies Y as the drawer.  But since Y’s signature was forged Y has no liability as drawer (Section 3-403(a)) unless some other provision of Article 3 or Article 4 makes Y liable.  Since X, even though unauthorized, signed in the name of the Y as issuer, the intent of X determines to whom the check is payable.
2. Subsection (c) allows the payee to be identified in any way including the various ways stated.  Subsection (c)(1) relates to the instruments payable to bank accounts.  In some cases the account might be identified by name and number, and the name and number might refer to different persons.  For example, a check is payable to “X Corporation Account No. 12345 in Bank of Podunk.”  Under the last sentence of subsection (c)(1), this check is payable to X Corporation and can be negotiated by X Corporation even if Account No. 12345 is some other person’s account or the check is not deposited in that account.  In other cases the payee is identified by an account number and the name of the owner of the account is not stated.  For example, Debtor pays Creditor by issuing a check drawn on Payor Bank.  The check is payable to a bank account owned by Creditor but identified only by number.  Under the first sentence of subsection (c)(1) the check is payable to the Creditor and, under Section 1-201 (20), Creditor becomes the holder when check is delivered.  Under Section 3-201(b), further negotiation of the check requires the indorsement of Creditor.  But under Section 4-205(a), if the check is taken by a depositary bank for collection, the bank may become a holder without the indorsement. Under Section 3-102(b), provisions of Article 4 prevail over those of Article 3.  The depositary bank warrants that the amount of the check was credited to the payee’s account.
3. Subsection (c)(2) replaces former Section 3-117 and subsections (1)(e), (f), and (g) of former Section 3-110. This provision merely determines who can deal with an instrument as a holder.  It does not determine ownership of the instrument or its proceeds.  Subsection (c)(2)(i) covers trusts and estates.  If the instrument is payable to the trust or estate or to the trustee or representative of the trust or estate, the instrument is payable to the trustee or representative or any successor.  Under subsection (c)(2)(ii), if the instrument states that it is payable to Doe, President of X Corporation, either Doe or X Corporation can be holder of the instrument. Subsection (c)(2)(iii) concerns informal organizations that are not legal entities such as unincorporated clubs and the like.  Any representative of the members of the organization can act as holder.  Subsection (c)(2)(iv) applies principally to instruments payable to public offices such as a check payable to County Tax Collector.
4. Subsection (d) replaces former Section 3-116.  An instrument payable to X or Y is governed by the first sentence of subsection (d).  And instrument payable to X and Y is governed by the second sentence of subsection (d).  If an instrument is payable to X or Y, either is the payee and if either is in possession that person is the holder and the person entitled to enforce the instrument.  Section 3-301.  If an instrument is payable to X and Y, neither X nor Y acting alone is the person to whom the instrument is payable. Neither person, acting alone, can be the holder of the instrument. The instrument is “payable to an identified person.”  The “identified person” is X and Y acting jointly.  Section 3-109(b) and Section 1-102(5)(a). Thus, under Section 1-201 (20) X or Y, acting alone, cannot be the holder or the person entitled to enforce or negotiate the instrument because neither, acting alone, is the identified person stated in the instrument.

In the case of a check payable to “John Smith,” since there are many people in the world named “John Smith” it is not possible to identify the payee of the check unless there is some further identification or the intention of the drawer is determined. Name alone is sufficient under subsection (a), but the intention of the drawer determines which John Smith is the person to whom the check is payable. The same issue is presented in cases of misdescriptions of the payee. The drawer intends to pay a person known to the drawer as John Smith. In fact, the person’s name is James Smith or John Jones, or some other entirely different name. If the check identifies the payee as John Smith, it is nevertheless payable to the person intended by the drawer. That person may indorse the check in either the name John Smith or the person’s correct name or in both names. Section 3-204(d). The intent of the drawer is also controlling in fictitious payee cases. Section 3-404(b). The last sentence of subsection (a) refers to the rare cases in which the signature of an organization requires more than one signature and the persons signing on behalf of the organization do not all intend the same person as payee. Any person intended by a signer for the organization is the payee and an indorsement by that person is an effective indorsement.

Subsection (b) recognizes the fact that in a large number of cases there is no human signer of an instrument because the instrument, usually a check, is produced by automated means such as a check-writing machine. In that case the relevant intent is that of the person who supplied the name of the payee. In most cases that person is an employee of the drawer, but in some cases the person could be an outsider who is committing a fraud by introducing names of payees of checks into the system that produces the checks. A check-writing machine is likely to be operated by means of a computer in which is stored information as to the name and address of the payee and the amount of the check. Access to the computer may allow production of fraudulent checks without knowledge of the organization that is the issuer of the check. Section 3-404(b) is also concerned with this issue. See Case #4 in Comment 2 to Section 3-404.

The third sentence of subsection (d) is directed to cases in which it is not clear whether an instrument is payable to multiple payees alternatively. In the case of ambiguity persons dealing with the instrument should be able to rely on the indorsement a single payee. For example, an instrument payable to X and/or Y is treated like an instrument payable to X or Y.

OFFICIAL COMMENT

If an instrument is payable at a bank in the United States, Section 3-501(b)(1) states that presentment must be made at the place of payment, i.e. the bank. The place of presentment of a check is governed by Regulation CC § 229.36.

CASE NOTES

1988 amendment not retroactive. —

Under Virginia law, the 1988 amendment to § 8.3-106 (see now this section) would appear not to apply retroactively, leaving the note involved in the instant case nonnegotiable because of its interest provision. Resolution Trust Corp. v. Maplewood Invs., 31 F.3d 1276, 1994 U.S. App. LEXIS 19485 (4th Cir. 1994).

State’s retroactivity principles followed. —

Although creating a federal common-law rule of decision in the instant case would be acting in conformity with present Virginia law, nevertheless such an action would disregard that state’s retroactivity principles and, to that extent, disrupt commercial relationships predicated on state law and engaged in by individuals in reliance upon that law. Resolution Trust Corp. v. Maplewood Invs., 31 F.3d 1276, 1994 U.S. App. LEXIS 19485 (4th Cir. 1994).

A note providing for a variable rate of interest not ascertainable from the face of the note is not a negotiable instrument. Taylor v. Roeder, 234 Va. 99 , 360 S.E.2d 191, 4 Va. Law Rep. 485, 1987 Va. LEXIS 251 (1987) (decided under former § 8.3-107).

“Sum certain” found. —

Because the note issued in the instant case by defendant refers to an established rate of a named financial institution, under the law in effect since 1988, it does contain a sum certain and would be considered a negotiable instrument. Resolution Trust Corp. v. Maplewood Invs., 31 F.3d 1276, 1994 U.S. App. LEXIS 19485 (4th Cir. 1994).

OFFICIAL COMMENT

1. Under Section 3-104(a) the requirement of a “fixed amount” applies only to principal.  The amount of interest payable is that described in the instrument.  If the description of interest in the instrument does not allow for the amount of interest to be ascertained, interest is payable at the judgement rate.  Hence, if an instrument calls for interest, the amount of interest will always be determinable. If a variable rate of interest is prescribed, the amount of interest is ascertainable by reference to the formula or index described or referred to in the instrument.  The last sentence of subsection (b) replaces subsection (d) of the former Section 3-118.
2. The purpose of subsection (b) is to clarify the meaning of “interest” in the introductory clause of Section 3-104(a). It is not intended to validate a provision for interest in an instrument if that provision violates other law.

OFFICIAL COMMENT

This section replaces former Section 3-114. Subsections (1) and (3) of former Section 3-114 are deleted as unnecessary. Section 3-113 (a) is based in part on subsection (2) of former Section 3-114. The rule that a demand instrument is not payable before the date of the instrument is subject to Section 4-401(c) which allows the payor bank to pay a postdated check unless the drawer has notified the bank of the postdating pursuant to a procedure prescribed in that subsection. With respect to an undated instrument, the date is the date of issue.

OFFICIAL COMMENT

Section 3-114 replaces subsections (b) and (c) of former Section 3-118.

OFFICIAL COMMENT

1. This section generally carries forward the rules set out in former Section 3-115.  The term “incomplete instrument” applies both to an “instrument,” i.e. a writing meeting all the requirements of Section 3-104, and to a writing intended to be an instrument that is signed but lacks some element of an instrument.  The test in both cases is whether the contents show that it is incomplete and that the signer intended that additional words or numbers be added.
2. If an incomplete instrument meets the requirements of Section 3-104  and is not completed it may be enforced in accordance with its terms.  Suppose, in the following two cases, that a note delivered to the payee is incomplete soley because a space on the pre-printed note form for the due date is not filled in:
3. In some cases the incomplete instrument does not meet the requirements of Section 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 Section 3-104 and is enforceable as completed.  If the payee fills in an unauthorized amount there is an alteration of the check and Section 3-407 applies.
4. Section 3-302(a)(1) also bears on the problem of incomplete instruments.  Under that section a person cannot be a holder in due course of the instrument if it is so incomplete as to call into question its validity.  Subsection (d) of Section 3-115 is based on the last clause of subsection (2) of the former Section 3-115.

Case #1. If the incomplete instrument is never completed, the note is payable on demand. Section 3-108(a)(ii). However, if the payee and the maker agreed to a due date, the maker may have a defense under Section 3-117 if the demand for payment is made before the due date agreed to by the parties.

Case #2. If the payee completes the note by filling in the due date agreed to by the parties, the note is payable on the due date stated. However, if the due date filled in was not the date agreed to by the parties there is an alteration of the note. Section 3-407 governs the case.

Suppose Debtor pays Creditor by giving Creditor a check on which the space for the name of the payee is left blank. The check is an instrument but it is incomplete. The check is enforceable in its incomplete form and it is payable to the bearer because it does not state a payee. Section 3-109(a)(2). Thus, Creditor is a holder of the check. Normally in this kind of case Creditor would simply fill in the space with Creditor’s name. When that occurs the check becomes payable to the Creditor.

OFFICIAL COMMENT

1. Subsection (a) replaces subsection (e) of former Section 3-118.  Subsection (b) states contribution rights of parties with joint and several liability by referring to applicable law. But subsection (b) is subject to Section 3-419(e).  If one of the parties with joint and several liability is an accommodation party and the other is the accommodated party, Section 3-419(e) applies.  Subsection (c) deals with discharge.  The discharge of a jointly and severally liable obligor does not affect the right of other obligors to seek contribution from the discharged obligor.
2. Indorsers normally do not have joint and several liability. Rather, an earlier indorser has liability to a later indorser. But indorsers can have joint and several liability in two cases. If an instrument is payable to two payees jointly, both payees must indorse.  The indorsement is a joint indorsement and the indorsers have joint and several liability and subsection (b) applies.  The other case is that of two or more anomolous indorsers. The term is defined in Section 3-205(d).  An anomolous indorsement normally indicates that the indorser signed as an accommodation party.  If more than one accommodation party indorses a note as an accommodation to the maker, the indorsers have a joint and several liability and subsection (b) applies.

CASE NOTES

The negotiability of the instrument must turn only on what is within the four corners of the instrument itself. Just as separate agreements cannot destroy an instrument’s negotiability, neither can they create negotiability. Bankers Trust v. 236 Beltway Inv., 865 F. Supp. 1186, 1994 U.S. Dist. LEXIS 14029 (E.D. Va. 1994) (decided under former § 8.3-119).

OFFICIAL COMMENT

1. The separate agreement might be a security agreement or mortgage or it might be an agreement that contradicts the terms of the instrument.  For example, a person may be induced to sign an instrument under an agreement that the signer will not be liable on the instrument unless certain conditions are met.  Suppose X requested credit from Creditor who is willing to give the credit only if an acceptable accommodation party will sign the note of X as co-maker.  Y agrees to sign as co-maker on the condition that the Creditor also obtain the signature of Z as co-maker.  Creditor agrees and Y signs as co-maker with X.  Creditor fails to obtain the signature of Z on the note. Under Section 3-412 and 3-419(b), Y is obliged to pay the note, but Section 3-117 applies.  In this case, the agreement modifies the terms of the note by stating a condition to the obligation of Y to pay the note. This case is essentially similar to a case in which the maker of a note is induced to sign the note by fraud of the holder.  Although the agreement that Y not be liable on the note unless Z also signs may not have been fraudulently made, a subsequent attempt by Creditor to require Y to pay the note in violation of the agreement is a bad faith act.  Section 3-117, in treating the agreement as a defense, allows Y to assert the agreement against the Creditor, but the defense would not be good against a subsequent holder in due course of the note that took it without notice of the agreement. If there cannot be a holder in due course because of § 3-106(d), a subsequent holder that took the note in good faith, for value and without knowledge of the agreement would not be able to enforce the liability of Y.  This result is consistent with the risk that a holder not in due course takes with respect to fraud in inducing issuance of an instrument.
2. The effect of merger of integration clauses to the effect that a writing is intended to be the complete and exclusive statement of the terms of the agreement or that the agreement is not subject to conditions is left to the supplementary law of the jurisdiction pursuant to Section 1-103.  Thus, in the case discussed in Comment 1, whether Y is permitted to prove the condition to Y’s obligation to pay the note is determined by that law.  Moreover, nothing in this section is intended to validate an agreement which is fraudulent or void as against public policy, as in the case of a note given to deceive a bank examiner.

CASE NOTES

Applicability. —

Given that § 8.3A-118 casts a broad net to encompass both negotiable and non-negotiable notes, the court believed it appropriate to apply the statute of limitations for notes to an obligation akin to a note although not titled as such, rather than applying § 8.01-246 . Hutchinson v. First Cmty. Bank (In re Hutchinson), No. 18-71619, No. 19-07036, 2020 Bankr. LEXIS 250 (Bankr. W.D. Va. Jan. 30, 2020).

Presumption of payment not superseded. —

Where bank refused payment on savings certificate because it had no record of the certificate and, under the common law presumption of payment, asserted that payment of the debt was presumed since more than 20 years had elapsed since the debt matured for payment, and where appellants contended that the presumption is tantamount to a statute of limitations, and, therefore, was superseded by the statute of limitations for redemption of instruments established by this section, the court held that the common law presumption of payment is not, and does not create, a statute of limitations. It is a presumption of fact, a rule of evidence which, like any rebuttable presumption, fails when sufficient contradictory evidence is introduced. Therefore, it was not abolished by the adoption of this section. Wool v. Nationsbank, 248 Va. 384 , 448 S.E.2d 613, 1994 Va. LEXIS 131 (1994).

Commencement of statute of limitations for installment payments. —

Where a buyer and seller were parties to a nonnegotiable promissory note that evidenced the remaining deferred purchase price on a sale of assets that was to be paid in 60 installments, the seller could await the failure to perform as to each installment payment before pursuing a remedy. Thus, only those claims for amounts covered by installments due more than six years prior to the filing of the seller’s action on the note were barred by the six-year limitations period. Bizmark, Inc. v. Indus. Gas & Supply Co., 358 F. Supp. 2d 518, 2005 U.S. Dist. LEXIS 3112 (W.D. Va. 2005), dismissed in part, No. 2:04cv00109, 2005 U.S. Dist. LEXIS 26707 (W.D. Va. Nov. 4, 2005).

Collection action not time-barred. —

If a note for purchase of his employer’s stock was treated as a negotiable instrument, a suit to collect on the note was not time-barred under the six year limitations period of subsection (a) of § 8.3A-118 , even though by its language the note was due by a certain date or when the borrower was terminated because the plain language of a severance agreement stated that the note did not mature when the borrower was terminated and that the borrower was not released from his personal obligation to repay the note. Meijer v. Thompson, 655 F. Supp. 2d 607, 2009 U.S. Dist. LEXIS 81634 (E.D. Va. 2009).

Circuit court’s order as to the unenforceability of promissory notes upheld. —

Circuit court properly held that where a husband’s parents loaned money to purchase and/or improve the parties’ three marital residences, but either no payments were made or the loans were not paid in full, the debts were unenforceable as being barred by the statute of limitations; thus, the debts could not be considered part of the marital debt. Garrett v. Garrett, 2004 Va. App. LEXIS 513 (Va. Ct. App. Nov. 2, 2004).

Bankruptcy claims. —

Where a debtor limited liability company (LLC) sought to disallow a former member’s claims, most of the LLC’s objections were overruled because, inter alia, the obligation underlying one note was not barred by the statute of limitations since payment had not been accelerated nor had the note become due. In re Virginia Broadband, LLC, 521 Bankr. 539, 2014 Bankr. LEXIS 4638 (Bankr. W.D. Va. 2014), aff'd, 538 Bankr. 253, 2015 U.S. Dist. LEXIS 122638 (W.D. Va. 2015).

CIRCUIT COURT OPINIONS

Enforceability. —

Where a husband’s parents loaned money to purchase and/or improve the parties’ three marital residences, but either no payments were made or the loans were not paid in full, the debts were unenforceable as being barred by the statute of limitations of § 8.3A-118(a) , (b); as a result, the debts could not be considered part of the marital debt. Garrett v. Garrett, 63 Va. Cir. 399, 2003 Va. Cir. LEXIS 216 (Fairfax County Nov. 13, 2003), aff'd, No. 0155-04-4, 2004 Va. App. LEXIS 513 (Va. Ct. App. Nov. 2, 2004).

OFFICIAL COMMENT

1. Section 3-118 differs from former Section 3-122, which states when a cause of action accrues on an instrument. Section 3-118 does not define when a cause of action accrues. Accrual of a cause of action is stated in other sections of Article 3 such as those that state the various obligations of parties to an instrument.  The only purpose of Section 3-118 is to define the time within which an action to enforce an obligation, duty, or right arising under Article 3 must be commenced.  Section 3-118 does not attempt to state all rules with respect to a statute of limitations.  For example, the circumstances under which the running of a limitations period may be tolled is left to other law  pursuant to Section 1-103.
2. The first six subsections apply to actions to enforce an obligation of any party to an instrument to pay the instrument. This changes present law in that indorsers who may become liable on an instrument after issue are subject to a period of limitations running from the same date as that of the maker or drawer.  Subsections (a) and (b) apply to notes. If the note is payable at a definite time, a six-year limitations period starts at the due date of the note, subject to prior acceleration.  If the note is payable on demand, there are two limitations periods.  Although a note payable on demand could theoretically be called a day after it was issued, the normal expectation of the parties is that the note will remain outstanding until there is some reason to call it.  If the law provides that the limitations period does not start until demand is made, the cause of action to enforce it may never be barred.  On the other hand, if the limitations period starts when demand for payment may be made, i.e. at any time after the note was issued, the payee of a note on which interest or portions of principle are being paid could lose the right to enforce the note even though it was treated as a continuing obligation by the parties.  Some demand notes are not enforced because the payee has forgiven the debt.  This is particularly true in family and other noncommercial transactions.  A demand note found after death of the payee may be presented for payment many years after it was issued. The maker may be a relative and it may be difficult to determine whether the note represents a real or forgiven debt. Subsection (b) is designed to bar notes that no longer represent a claim to payment and to require reasonably prompt action to enforce notes on which there is default.  If a demand for payment is made to the maker, a six-year limitations period starts to run when demand is made.  The second sentence of subsection (b) bars an action to enforce a demand note if no demand has been made on the note and no payment of interest or principal has been made for a continuous period of 10 years. This covers the case of a note that does not bear interest or a case in which interest due on the note has not been paid.  This kind of case is likely to be a family transaction in which a failure to demand payment may indicate that the holder did not intend to enforce the obligation but neglected to destroy the note.  A limitation period that bars stale claims in this kind of case is appropriate if the period is relatively long.
3. Subsection (c) applies primarily to personal uncertified checks.  Checks are payment instruments rather than credit instruments. The limitations period expires three years after the date of dishonor or 10 years after the date of the check, whichever is earlier. Teller’s checks, cashier’s checks, certified checks, and traveler’s checks are treated differently under subsection (d) because they are commonly treated as cash equivalents.  A great delay in presenting a cashier’s check for payment in most cases will occur because the check was mislaid during that period.  The person to whom traveler’s checks are issued may hold them indefinitely as a safe form of cash for use in an emergency.  There is no compelling reason for barring the claim of the owner of the cashier’s check or traveler’s check. Under subsection (d) the claim is never barred because the three-year limitations period does not start to run until demand for payment is made.  The limitations period in subsection (d) in effect applies only to cases in which there is a dispute about the legitimacy of the claim of the person demanding payment.
4. Subsection (e) covers certificates of deposit.  The limitations period of six years doesn’t start to run until the depositor demands payment. Most certificates of deposit are payable on demand even if they state a due date.  The effect of a demand for payment before maturity is usually that the bank will pay, but that a penalty will be assessed against the depositor in the form of a reduction in the amount of interest that is paid.  Subsection (e) also provides for cases in which the bank has no obligation to pay until the due date.  In that case the limitations period doesn’t start to run until there is a demand for payment in effect and the due date has passed.
5. Subsection (f) applies to accepted drafts other than certified checks.  When a draft is accepted it is in effect turned into a note of the acceptor.  In almost all cases the acceptor will agree to pay at a definite time.  Subsection (f) states that in that case the six-year limitations periods starts to run on the due date.  In the rare case in which the obligation of the acceptor is payable on demand, the six-year limitations period starts to run at the date of the acceptance.
6. Subsection (g) covers warranty and conversion cases and other actions to enforce obligations or rights arising under Article 3. A three-year period is stated and subsection (g) follows general law in stating that the period runs from the time the cause of action accrues.  Since the traditional term “cause of action” may have been replaced in some states by “claim for relief” or some equivalent term, the words “cause of action” have been bracketed to indicate that the words may be replaced by an appropriate substitute to conform to local practice.

OFFICIAL COMMENT

This section is a restatement of former Section 3-803.

CASE NOTES

Editor’s note.

Some of the cases annotated below were decided under former § 8.3-202.

Alteration of terms “due negotiation” and “holder in due course.” —

The U.C.C. does not permit the sort of alteration of the inviolable terms “due negotiation” and “holder in due course” found in a provision included in promissory notes which attempted to equate a “holder” with a mere possessor, to make “due negotiation” synonymous with delivery accompanied only by assignment, and to convert the meaning of “holder in due course” to one who possesses order paper by assignment. Becker v. National Bank & Trust Co., 222 Va. 716 , 284 S.E.2d 793, 1981 Va. LEXIS 365 (1981).

Meaning of “negotiation” under former N.I.L. —

See National Bank v. American Bank & Trust Co., 163 Va. 710 , 177 S.E. 229 , 1934 Va. LEXIS 211 (1934).

A transfer of an order instrument without a necessary indorsement is not a negotiation. Strickler v. Marx, 246 Va. 384 , 436 S.E.2d 447, 10 Va. Law Rep. 443, 1993 Va. LEXIS 137 (1993) (decision under former § 8.3-301).

State law where check negotiated applied. —

Check was negotiated in Illinois since the delivery of the check occurred when seller’s bank in Illinois received the check and deposited it in seller’s account and that was when the transferee bank became the holder; therefore, the negotiation of the check in Illinois, required the substantive law of Illinois to be applied to the issue of whether there was a valid accord and satisfaction. Western Branch Holding Co. v. Trans Mktg. Houston, Inc., 722 F. Supp. 1339, 1989 U.S. Dist. LEXIS 12297 (E.D. Va. 1989).

Instruments endorsed in blank. —

Bankruptcy court granted a bank’s motion for summary judgment on a Chapter 13 debtor’s claim that the bank did not have standing to enforce a note and deed of trust on real property the debtor owned because it did not hold the note. The bank submitted an affidavit that stated that it had possession of the note, a copy of the note the bank attached to its affidavit showed that the note was endorsed in blank, and the note and affidavit established that the bank obtained lawful possession of the note under §§ 8.3A-201(b) and 8.3A-205(b) and was entitled under § 8.3A-301 to enforce the note. Allen v. Chase Home Mortg. Group (In re Allen), No. 10-20094-BFK, No. 12-01062, 2012 Bankr. LEXIS 3565 (Bankr. E.D. Va. Aug. 1, 2012).

OFFICIAL COMMENT

1. Subsections (a) and (b) are based in part on subsection (1) of the former Section 3-202.  A person can become holder of an instrument when the instrument is issued to that person, or the status of holder can arise as the result of an event that occurs after issuance.  “Negotiation” is the term used in Article 3 to describe this post-issuance event.  Normally, negotiation occurs as the result of a voluntary transfer of possession of an instrument by a holder to another person who becomes the holder as a result of the transfer. Negotiation always requires a change in possession of the instrument because nobody can be a holder without possessing the instrument, either directly or through an agent.  But in some cases the transfer of possession is involuntary and in some cases the person transferring possession is not a holder.  In defining “negotiation” former Section 3-202(1) used the word “transfer,” an undefined term, and “delivery,” defined in Section 1-201 (14) to mean voluntary change of possession. Instead, subsections (a) and (b) used the term “transfer of possession” and, subsection (a) states that negotiation can occur by an involuntary transfer of possession.  For example, if an instrument is payable to bearer and it is stolen by Thief or is found by Finder, Thief or Finder becomes the holder of the instrument when possession is obtained.  In this case there is an involuntary transfer of possession that results in negotiation to Thief or Finder.
2. In most cases negotiation occurs by a transfer of possession by a holder or a remitter.  Remitter transactions usually involve a cashier’s or teller’s check.  For example, Buyer buys goods from the Seller and pays for them with a cashier’s check of Bank that Buyer buys from Bank.  The check is issued by Bank when it is delivered to Buyer, regardless of whether the check is payable to Buyer or to Seller.  Section 3-105(a).  If the check is payable to Buyer, negotiation to Seller is done by delivery of the check to Seller after it is indorsed by Buyer.  It is more common, however, that the check when issued will be payable to Seller.  In that case Buyer is referred to as the “remitter.”  Section 3-103(a)(11).  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 Section 3-306 against Seller or a subsequent transferee of the check.  Section 3-202(b) provides for rescission of negotiation, and that provision applies to rescission by a remitter as well as by holder.
3. Other sections of Article 3 may modify the the rule stated in the first sentence of the subsection (b).  See for example, Sections 3-404, 3-405, and 3-406.

OFFICIAL COMMENT

1. This section is based on former Section 3-207.  Subsection (2) of former Section 3-207 prohibited rescission of a negotiation against holders in due course.  Subsection (b) of Section 3-202 extends this protection to payor banks.
2. Subsection (a) applies even though the lack of capacity or the illegality, is of a character which goes to the essence of the transaction and makes it entirely void.  It is inherent in the character of negotiable instruments that any person in possession of an instrument which by its terms is payable to that person or to bearer is a holder and may be dealt with by anyone as a holder.  The principle finds its most extreme application in the well settled rule that a holder in due course may take the instrument even from a thief and be protected against the claim of the rightful owner.  The policy of subsection (a) is that any person to whom an instrument is negotiated is a holder until the instrument has been recovered from that person’s possession.  The remedy of a person with a claim to an instrument is to recover the instrument by replevin or otherwise; to impound it or to enjoin its enforcement, collection, or negotiation; to recover its proceeds from the holder; or to intervene in any action brought by the holder against the obligor.  As provided in Section 3-305(c), the claim of the claimant is not a defense to the obligor unless the claimant defends the action.
3. There can be no rescission or other remedy against a holder in due course or a person who pays in good faith and without notice, even though the prior negotiation may have been fraudulent or illegal in its essence and entirely void. As against any other party the claimant may have any remedy permitted by law.  This section is not intended to specify what that remedy may be, or to prevent any court from imposing conditions or limitation such as prompt action or return of the consideration received.  All such questions are left to the law of the particular jurisdiction.  Section 3-202 gives no right that would not otherwise exist.  The section is intended to mean that any remedies afforded by other law are cut off only by a holder in due course.

CASE NOTES

A transferee may become a holder of order paper only by negotiation, that is, by indorsement and delivery, and the indorsement must be by or on behalf of a person who is himself a holder. Strickler v. Marx, 246 Va. 384 , 436 S.E.2d 447, 10 Va. Law Rep. 443, 1993 Va. LEXIS 137 (1993) (decision under former § 8.3-301).

Six year statute of limitations applicable. —

Under Virginia law, an assignee of an instrument acquires any right of the assignor to enforce that instrument, and therefore, the plaintiff was entitled to the six year statute of limitations afforded to the Resolution Trust Corporation under the Federal Institutions Reform, Recovery and Enforcement Act. National Enters., Inc. v. Moore, 948 F. Supp. 567, 1996 U.S. Dist. LEXIS 18685 (E.D. Va. 1996).

Liability of accommodation indorser under former N.I.L. —

See Dunnington v. Bank of Crewe, 144 Va. 36 , 131 S.E. 221 , 1926 Va. LEXIS 229 (1926) (decided under prior law).

Rights to transfer. —

Plaintiff homeowners’ argument that “given the splitting, selling, and trading of pieces of the promissory note on the secondary market, the Deed of Trust was split from the note and was unenforceable” by defendant financial institutions was rejected because it contradicted the terms of the Deed of Trust and subsection B of § 8.3A-203 , which provided that transfer of an instrument, whether or not the transfer was a negotiation, vested in the transferee any right of the transferor to enforce the instrument, including any right as a holder in due course, and the Deed of Trust stated that the note or a partial interest in the note (together with the Deed of Trust) could be sold one or more times without prior notice to the homeowners. Tapia v. United States Bank, N.A., 718 F. Supp. 2d 689, 2010 U.S. Dist. LEXIS 62448 (E.D. Va. 2010).

CIRCUIT COURT OPINIONS

Partial assignment. —

Assignor of an overwhelming majority of a promissory note could not sue on the note in its own name where although the assignor had retained a small beneficial interest and the rights arising out of that interest, pursuant to the allonge the assignor could not assert an interest in the percentage of the note that was assigned to the assignee. Walnut St. Fin., L.L.C. v. Ferguson Holdings, L.L.C., 107 Va. Cir. 257, 2021 Va. Cir. LEXIS 37 (Fairfax County Feb. 19, 2021).

OFFICIAL COMMENT

1. Section 3-203 is based on former Section 3-201 which stated that a transferee received such rights as the transferor had. The former section was confusing because some rights of the transferor are not vested in the transferee unless the transfer is a negotiation. For example, a transferee that did not become the holder could not negotiate the instrument, a right that the transferor had.  Former Section 3-201 did not define “transfer.”  Subsection (a) defines transfer by limiting it to cases in which possession of the instrument is delivered for the purpose of giving to the person receiving delivery the right to enforce the instrument.
2. Subsection (b) states that transfer vests in the transferee any right of the transferor to enforce the instrument “including any right as a holder in due course.” If the transferee is not a holder because the transferor did not indorse; the transferee is nevertheless a person entitled to enforce the instrument under Section 3-301 if the transferor was a holder at the time of transfer.  Although the transferee is not a holder, under subsection (b) the transferee obtained the rights of the transferor as holder. Because the transferee’s rights are derivative of the transferor’s rights, those rights must be proved.  Because the transferee is not a holder, there is no presumption under Section 3-308 that the transferee, by producing the instrument, is entitled to payment.  The instrument, by its terms, is not payable to the transferee and the transferee must account for possession of the unindorsed instrument by proving the transaction through which the transferee acquired it.  Proof of a transfer to the transferee by a holder is proof that the transferee has aquired the rights of a holder. At that point the transferee is entitled to the presumption under Section 3-308.
3. Subsection (c) applies only to a transfer for value.  It applies only if the instrument is payable to order or specially indorsed to the transferor.  The transferee acquires, in the absence of a contrary agreement, the specifically enforceable right to the indorsement of the transferor.  Unless otherwise agreed, it is a right to the general indorsement of the transferor with full liability as indorser, rather than to an indorsement without recourse.  The question may arise if the transferee has paid in advance and the indorsement is omitted fraudulently or through oversight. A transferor who is willing to indorse only without recourse or unwilling to indorse at all should make those intentions clear before transfer. The agreement of the transferee to take less than an unqualified indorsement need not be an express one, and the understanding may be implied from conduct, from past practice, or from the circumstances of the transaction. Subsection (c) provides that there is no negotiation of the instrument until the endorsement 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 holder in due course under Section 3-302.
4. The operation of Section 3-203 is illustrated by the following cases.  In each case Payee, by fraud, induced Maker to issue a note to Payee.  The fraud is a defense to the obligation of Maker to pay the note under Section 3-305(a)(2).
5. Subsection (d) restates former Section 3-202(3).  The cause of action on an instrument cannot be split.  Any indorsement which purports to convey to any party less than the entire amount of the instrument is not effective for negotiation. This is true of either “Pay A one-half,” or “Pay A two-thirds and B one-third.”  Neither A nor B becomes a holder.  On the other hand, an indorsement reading merely “Pay A and B” is effective, since it transfers the entire cause of action to A and B as tenants in common.  An indorsement purporting to convey less than the entire instrument does, however, operate as a partial assignment of the cause of action.  Subsection (d) makes no attempt to state the legal effect of such assignment, which is left to other law.  A partial assignee of an instrument has rights only to the extent the applicable law gives rights, either at law or in equity, to a partial assignee.

Although transfer of an instrument might mean in a particular case that title to the instrument passes to the transferee, that result does not follow in all cases. The right to enforce an instrument and ownership of the instrument are two different concepts. A thief who steals a check payable to bearer becomes the holder of the check and a person entitled to enforce it, but does not become the owner of the check. If the thief transfers the check to a purchaser the transferee obtains the right to enforce the check. If the purchaser is not a holder in due course, the owner’s claim to the check may be asserted against the purchaser. Ownership rights in instruments may be determined by the principles of the law of property, independent of Article 3, which do not depend upon whether the instrument was transferred under Section 3-203. Moreover, a person who has an ownership right in an instrument might not be a person entitled to enforce the instrument. For example, suppose X is the owner and holder of an instrument payable to X. X sells the instrument to Y but is unable to deliver immediate possession to Y. Instead, X signs a document conveying all of X’s right, title, and interest in the instrument to Y. Although the document may be effective to give Y a claim to ownership of the instrument, Y is not a person entitled to enforce the instrument until Y obtains possession of the instrument. No transfer of the instrument occurs under Section 3-203(a) until it is delivered to Y.

An instrument is a reified right to payment. The right is represented by the instrument itself. The right to payment is transferred by delivery of possession of the instrument “by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument.” The quoted phrase excludes issue of an instrument, defined in Section 3-105, and cases in which a delivery of possession is for some purpose other than the transfer of the right to enforce. For example, if a check is presented for payment by delivering the check to the drawee, no transfer of the check to the drawee occurs because there is no intent to give the drawee the right to enforce the check.

Under subsection (b) a holder in due course that transfers an instrument transfers those rights as a holder in due course to the purchaser. The policy is to assure the holder in due course a free market for the instrument. There is one exception to this rule stated in the concluding clause of subsection (b). A person who is party to fraud or illegality affecting the instrument is not permitted to wash the instrument clean by passing it into the hands of a holder in due course and then repurchasing it.

Case #1. Payee negotiated the note to X who took as a holder in due course. After the instrument became overdue X negotiated the note to Y who had notice of the fraud. Y succeeds to X’s rights as a holder in due course and takes free of Maker’s defense of fraud.

Case #2. Payee negotiated the note to X who took as a holder in due course. Payee then repurchased the note from X. Payee does not succeed to X’s rights as a holder in due course and is subject to Maker’s defense of fraud.

Case #3. Payee negotiated the note to X who took as a holder in due course. X sold the note to Purchaser who received possession. The note, however, was indorsed to X and X failed to indorse it. Purchaser is a person entitled to enforce the instrument under Section 3-301 and succeeds to the rights of X as holder in due course. Purchaser is not a holder, however, and under Section 3-308 Purchaser will have to prove the transaction with X under which the rights of X as holder in due course were acquired.

Case #4. Payee sold the note to Purchaser who took for value, in good faith and without notice of the defense of the Maker. Purchaser received possession of the note but payee neglected to indorse it. Purchaser became a person entitled to enforce the instrument but did not become the holder because of the missing indorsement. If Purchaser received notice of the defense of Maker before obtaining the indorsement of Payee, Purchaser cannot become a holder in due course because 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.

CASE NOTES

Clerical error on draft in favor of one constituent of consolidated bank and indorsement by consolidated bank in its own name under former N.I.L. —

See First Wis. Nat'l Bank v. People's Nat'l Bank, 136 Va. 276 , 118 S.E. 82 , 1923 Va. LEXIS 86 (1923) (decided under former § 8.3-203).

The writing provision sanctions only the addition of indorsements to an instrument. Bankers Trust v. 236 Beltway Inv., 865 F. Supp. 1186, 1994 U.S. Dist. LEXIS 14029 (E.D. Va. 1994) (decided under former § 8.3-202).

OFFICIAL COMMENT

1. Subsection (a) is a definition of “indorsement,” a term which was not defined in former Article 3.  Indorsement is defined in terms of the purpose of the signature.  If a blank or special indorsement is made to give rights as a holder to a transferee the indorsement is made for the purpose of negotiating the instrument. Subsection (a)(i).  If the holder of a check has an account in the drawee bank and wants to be sure that payment of the check will be made by credit to the holder’s account, the holder can indorse the check by signing the holder’s name with the accompanying words “for deposit only” before presenting the check for payment to the drawee bank.  In that case the purpose of the quoted words is to restrict payment of the instrument.  Subsection (a)(ii).  If X wants to guarantee payment of a note signed by Y as maker, X can do so by signing X’s name to the back of the note as an indorsement.  This indorsement is known as an anomolous indorsement (Section 3-205(d)) and is made for the purpose of incurring indorser’s liability on the note.  Subsection (a)(iii). In some cases an indorsement may serve more than one purpose.  For example, if the holder of a check deposits it to the holder’s account in a depositary bank for collection and indorses the check by signing holder’s name with the accompanying words “for deposit only” the purpose of the indorsement is both to negotiate the check to the depositary bank and to restrict payment of the check.
2. Assume that Payee indorses a note to Creditor as security for a debt.  Under subsection (b) of Section 3-203 Creditor takes Payee’s rights to enforce or transfer the instrument subject to the limitations imposed by Article 9.  Subsection (c) of Section 3-204 makes clear that the Payee’s indorsement to Creditor, even though it mentions creation of a security interest, is an unqualified indorsement that gives to Creditor the right to enforce the note as its holder.
3. Subsection (d) is a restatement of former Section 3-203. Section 3-110 (a) states that an instrument is payable to the person intended by the person signing as or in the name or behalf of the issuer even if that person is identified by a name that is not the true name of the person.  In some cases the name used in the instrument is a misspelling of the correct name and in some cases the two names may be entirely different.  The payee may indorse in the name used in the instrument, in the payee’s correct name, or in both.  In each case the indorsement is effective.  But because an indorsement in a name different from that used in the instrument may raise a question about its validity and an indorsement in a name that is not the correct name of the payee may raise a problem of identifying the indorser, the accepted commercial practice is to indorse in both names.  Subsection (d) allows a person paying or taking the instrument for value or collection to require indorsement in both names.

The but clause of the first sentence of subsection (a) elaborates on former Section 3-402. In some cases it may not be clear whether a signature was meant to be that of the indorser, a party to the instrument in some other capacity such as drawer, maker or acceptor, or a person who was not signing as a party. The general rule is that a signature is an indorsement if the instrument does not indicate an unambiguous intent of the signer not to sign as as an indorser. Intent may be determined by words accompanying the signature, the place of the signature, or other circumstances. For example, suppose a depositary bank gives cash for a check properly indorsed by the payee. The bank requires the payee’s employee to sign the back of the check as evidence that the employee received the cash. If the signature consists only of the initials of the employee it is not reasonable to assume that it was meant to be an indorsement. If there was a full signature but accompanying words indicated that it was meant as a receipt for the cash given for the check, it is not an indorsement. If the signature is not qualified in any way and appears in the place normally used for indorsements, it may be an indorsement even though the signer intended the signature to be a receipt. To take another example, suppose the drawee of a draft signs the draft on the back in the space usually used for indorsements. No words accompany the signature. Since the drawee has no reason to sign a draft unless the intent is to accept the draft, the signature is effective as an acceptance. Custom and usage may be used to determine intent. For example, by long-established custom and usage, a signature in the lower right hand corner of an instrument indicates an intent to sign as the maker of the note or the drawer of a draft. Any similar clear indication of an intent to sign in some other capacity or for some other purpose may establish that a signature is not an indorsement. For example, if the owner of a traveler’s check countersigns the check in the process of negotiating it, the countersignature is not an indorsement. The countersignature is a condition to the issuer’s obligation to pay and its purpose is to provide a means of verifying the identity of the person negotiating the travel’s check by allowing comparison of the specimen signature and the countersignature. The countersignature is not necessary for negotiation and the signer does not incur indorser’s liability. See Comment 2 to Section 3-106.

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.

CASE NOTES

Blank endorsement. —

Because a note was endorsed in blank, it was enforceable by whoever possessed it pursuant to subsection (b) of § 8.3A-205 . It was possessed by a bank when the bank attempted to foreclose on the property; therefore, once the homeowner defaulted on the property, Virginia law straightforwardly allowed the bank to take the actions that it did. Horvath v. Bank of N.Y., N.A., 641 F.3d 617, 2011 U.S. App. LEXIS 10152 (4th Cir. 2011).

Bankruptcy court granted a bank’s motion for summary judgment on a Chapter 13 debtor’s claim that the bank did not have standing to enforce a note and deed of trust on real property the debtor owned because it did not hold the note. The bank submitted an affidavit that stated that it had possession of the note, a copy of the note the bank attached to its affidavit showed that the note was endorsed in blank, and the note and affidavit established that the bank obtained lawful possession of the note under §§ 8.3A-201(b) and 8.3A-205(b) and was entitled under § 8.3A-301 to enforce the note. Allen v. Chase Home Mortg. Group (In re Allen), No. 10-20094-BFK, No. 12-01062, 2012 Bankr. LEXIS 3565 (Bankr. E.D. Va. Aug. 1, 2012).

According to Virginia law, when endorsed in blank, an instrument became payable to bearer and may be negotiated by transfer of possession alone until specially endorsed, and once in possession of an instrument, the holder was entitled to enforce it; thus, defendant, as a holder in possession of the note, had the authority to foreclose on the property in accordance with Virginia law. Wolf v. Fannie Mae, 512 Fed. Appx. 336, 2013 U.S. App. LEXIS 4300 (4th Cir. 2013).

Debtors failed to prove that movant lacked standing to seek stay relief, as the note attached to its motion was a bearer instrument and, under Virginia law, an instrument endorsed in blank was payable to bearer and could be negotiated by transfer of possession alone. Further, a notice of transfer of proof of claim to the movant was filed in bankruptcy court, debtors were served with notice of the assignment of claim to movant more than a year before the stay relief motion was filed, and the claim was deemed allowed because debtors filed no objection. In re Blackburn, No. 12-34299-KRH, 2017 Bankr. LEXIS 1053 (Bankr. E.D. Va. Apr. 17, 2017).

Special indorsement under former N.I.L. —

See Fleshman v. Bibb, 118 Va. 582 , 88 S.E. 64 , 1916 Va. LEXIS 41 (1916) (decided under former § 8.3-204).

Holder to foreclose on a deed of trust. —

Virginia law allowed a holder to foreclose on a deed of trust because, inter alia, the mortgage note was a negotiable instrument under § 8.3A-104 , both the note and the deed of trust demonstrated that the parties intended to allow the loan to be freely transferred, the note was endorsed in blank, the note was currently in the holder’s hands, there was no alteration to the note or deed of trust at any time, and the owner was in default on his obligations. Bernardo v. Nat'l City Real Estate Servs., LLC, 435 Fed. Appx. 240, 2011 U.S. App. LEXIS 10812 (4th Cir. 2011).

OFFICIAL COMMENT

1. Subsection (a) is based on subsection (1) of the former Section 3-204. It states the test of a special indorsement to be whether the indorsement identifies a person to whom the instrument is payable. Section 3-110 states rules for identifying the payee of an instrument. Section 3-205(a) incorporates the principles stated in Section 3-110 in identifying an indorsee. The language of Section 3-110 refers to language used by the issuer of the instrument. When that section is used with respect to an indorsement, Section 3-110 must be read as referring to the language used by the indorser.
2. Subsection (b) is based on subsection (2) of former Section 3-204.  An indorsement made by the holder is either a special or blank indorsement.  If the indorsement is made by a holder and is not a special indorsement, it is a blank indorsement.  For example, the holder of an instrument, intending to make a special indorsement, writes the words “Pay to the order of” without completing the indorsement by writing the name of the indorsee.  The holder’s signature appears under the quoted words.  The indorsement is not a special indorsement because it does not identify a person to whom it makes the instrument payable.  Since it is not a special indorsement it is a blank indorsement and the instrument is payable to bearer. The result is analogous to that of a check in which the name of the payee is left blank by the drawer.  In that case the check is payable to bearer. See the last paragraphs of Comment 2 to Section 3-115.
3. The only effect of an “anomalous indorsement,” defined in subsection (d), is to make the signer liable on the instrument as an indorser.  Such an indorsement is normally made by an accommodation party.  Section 3-419.

A blank indorsement is usually the signature of the indorser on the back of the instrument without other words. Subsection (c) is based on subsection (3) of former Section 3-204. A “restrictive indorsement” described in Section 3-206 can be either a blank indorsement or a special indorsement. “Pay to T, in trust for B” is a restrictive indorsement. It is also a special indorsement because it identifies T as the person to whom the instrument is payable. “For deposit only” followed by the signature of the payee of a check is a restrictive indorsement. It is also a blank indorsement because it does not identify the person to whom the instrument is payable.

CASE NOTES

Indorsement that imposed limitation on payee held restrictive. —

Indorsement that stated, “by endorsing this check, the payee agrees to record a first lien in favor of bank” was conditional and restrictive because it imposed a limitation on the payee. Fairfax Bank & Trust Co. v. Crestar Bank, 247 Va. 356 , 442 S.E.2d 651, 10 Va. Law Rep. 1178, 1994 Va. LEXIS 52 (1994).

OFFICIAL COMMENT

1. This section replaces former Sections 3-205 and 3-206 and clarifies the law of restrictive indorsements.
2. Subsection (a) provides that an indorsement that purports to limit further transfer or negotiation is ineffective to prevent further transfer or negotiation.  If a payee indorses “Pay A only,” A may negotiate the instrument to subsequent holders who may ignore the restriction on the indorsement. Subsection (b) provides that an indorsement that states a condition to the right of a holder to receive payment is ineffective to condition payment.  Thus if a payee indorses “Pay A if A ships goods complying with our contract,” the right of A to enforce the instrument is not affected by the condition.  In the case of a note, the obligation of the maker to pay A is not affected by the indorsement.  In the case of a check, the drawee can pay A without regard to the condition, and if the check is dishonored the drawer is liable to pay A. If the check was negotiated by the payee to A in return for a promise to perform a contract and the promise was not kept, the payee would have a defense or counterclaim against A if the check were dishonored and A sued the payee as indorser, but the payee would have that defense or counterclaim whether or not the condition to the right of A was expressed in the indorsement.  Former Section 3-206 treated a conditional indorsement like indorsements for deposit or collection.  In revised Article 3, Section 3-206(b) rejects that approach and makes the conditional indorsement ineffective with respect to parties other than the indorser and indorsee.  Since the indorsements referred to in subsections (a) and (b) are not effective as restrictive indorsements, they are no longer described as restrictive indorsements.
3. The great majority of restrictive indorsements are those that fall within subsection (c) which continues previous law. The depositary bank or the payor bank, if it takes the check for immediate payment over the counter, must act consistently with the indorsement, but an intermediary bank or payor bank that takes the check from a collecting bank is not affected by the indorsement.  Any other person is also bound by the indorsement.  For example, suppose a check is payable to X, who indorses in blank but writes above the signature the words “For deposit only.”  The check is stolen and is cashed at a grocery store by the thief.  The grocery store indorses the check and deposits it in Depositary Bank.  The account of the grocery store is credited and the check is forwarded to Payor Bank which pays the check. Under Subsection (c), the grocery store and Depositary Bank are converters of the check because X did not receive the amount paid for the check.  Payor Bank and intermediary bank in the collection process are not liable to X. This Article does not displace the law of waiver as it may apply to restrictive indorsements.  The circumstances under which a restrictive indorsement may be waived by the person who made it is not determined by this Article.
4. Subsection (d) replaces subsection (4) of former Section 3-206.  Suppose Payee indorses a check “Pay to T in trust for B.”  T indorses in blank and delivers it to (a) Holder for value; (b) Depositary Bank for collection; or (c) Payor Bank for payment.  In each case these takers can safely pay T so long as they have no notice under Section 3-307 of any breach of fiduciary duty that T may be committing. For example, under subsection (a) of Section 3-307 these takers have notice of a breach of trust if the check was taken in any transaction known by the taker to be for T’s personal benefit.  Subsequent transferees of the check from Holder or Depositary Bank are not affected by the restriction unless they have knowledge that T dealt with the check in breach of trust.
5. Subsection (f) allows a restrictive indorsement to be used as a defense by a person obliged to pay the instrument if that person would be liable for paying in violation of the indorsement.

OFFICIAL COMMENT

Section 3-207 restates former Section 3-208. Reacquisition refers to cases in which a former holder reacquires the instrument either by negotiation from the present holder or by a transfer other than negotiation. If the reacquisition is by negotiation, the former holder reacquires the status of holder. Although Section 3-207 allows the holder to cancel all indorsements made after the holder first acquired holder status, cancellation is not necessary. Status of holder is not affected by whether or not cancellation is made. But if the reacquisition is not the result of negotiation the former holder can obtain holder status only by striking the former holder’s indorsement and any subsequent indorsements. The latter case is an exception to the general rule that if an instrument is payable to an identified person, the indorsement of that person is necessary to allow a subsequent transferee to obtain the status of holder. Reacquisition without indorsement by the person to whom the instrument is payable is illustrated by two examples:

Case #1. X, a former holder, buys the instrument from Y, the present holder. Y delivers the instrument to X but fails to indorse it. Negotiation does not occur because the transfer of possession did not result in X’s becoming holder. Section 3-201(a). The instrument by its terms is payable to Y, not to X. But X can obtain the status of holder by striking X’s indorsement and all subsequent indorsements. When these indorsements are struck, the instrument by its terms is payable either to X or to bearer, depending on how X originally became holder. In either case X becomes holder. Section 1-201 (20).

Case #2. X, the holder of an instrument payable to X, negotiates it to Y by special indorsement. The negotiation is part of an underlying transaction between X and Y. The underlying transaction is rescinded by agreement of X and Y, and Y returns the instrument without Y’s indorsement. The analysis is the same as that in Case #1. X can obtain holder status by cancelling X’s indorsement to Y.

In Case #1 and Case #2, X acquired ownership of the instrument after reacquisition, but X’s title was clouded because the instrument by its terms was not payable to X. Normally, X can remedy the problem by obtaining Y’s indorsement, but in some cases X may not be able to conveniently obtain that indorsement. Section 3-207 is a rule of convenience which relieves X of the burden of obtaining an indorsement that serves no substantive purpose. The effect of cancellation of any indorsement under Section 3-207 is to nullify it. Thus, the person whose indorsement is cancelled is relieved of indorser’s liability. Since cancellation is notice of discharge, discharge is effective even with respect to the rights of a holder in due course. Sections 3-601 and 3-604.

CASE NOTES

Blank endorsement. —

Bankruptcy court granted a bank’s motion for summary judgment on a Chapter 13 debtor’s claim that the bank did not have standing to enforce a note and deed of trust on real property the debtor owned because it did not hold the note. The bank submitted an affidavit that stated that it had possession of the note, a copy of the note the bank attached to its affidavit showed that the note was endorsed in blank, and the note and affidavit established that the bank obtained lawful possession of the note under §§ 8.3A-201(b) and 8.3A-205(b) and was entitled under § 8.3A-301 to enforce the note. Allen v. Chase Home Mortg. Group (In re Allen), No. 10-20094-BFK, No. 12-01062, 2012 Bankr. LEXIS 3565 (Bankr. E.D. Va. Aug. 1, 2012).

According to Virginia law, when endorsed in blank, an instrument became payable to bearer and may be negotiated by transfer of possession alone until specially endorsed, and once in possession of an instrument, the holder was entitled to enforce it; thus, defendant, as a holder in possession of the note, had the authority to foreclose on the property in accordance with Virginia law. Wolf v. Fannie Mae, 512 Fed. Appx. 336, 2013 U.S. App. LEXIS 4300 (4th Cir. 2013).

Enforcement of note not allowed. —

Bankruptcy court disallowed a claim pursuant to 11 U.S.C.S. § 502(b)(1) that sought payment of a note signed by a Virginia corporation before it declared Chapter 11 bankruptcy because the claimant did not establish that it made a loan to the corporation or had rights as a holder under § 8.3A-301 that allowed it to enforce the note. The claimant failed to comply with Fed. R. Bankr. P. 3001 when it filed its claim because it did not provide the original note or a duplicate, and it engaged in inequitable conduct when it violated the court’s order that it retain counsel to represent it that would have justified a decision under 11 U.S.C.S. § 510 to subordinate its claim to other claims filed against the corporation’s bankruptcy estate, even if the claim could have been paid. Commonwealth Biotechnologies, Inc. v. Fornova Pharmworld, Inc. (In re Commonwealth Biotechnologies, Inc.), No. 11-30381-KRH, No. 12-03038, 2012 Bankr. LEXIS 5127 (Bankr. E.D. Va. Nov. 1, 2012).

OFFICIAL COMMENT

This section replaces former Section 3-301 that stated the rights of a holder. The rights stated in former Section 3-301 to transfer, negotiate, enforce, or discharge an instrument are stated in other sections of Article 3. In revised Article 3, Section 3-301 defines “person entitled to enforce” an instrument. The definition recognizes that enforcement is not limited to holders. The quoted phrase includes a person enforcing a lost or stolen instrument. Section 3-309. It also includes a person in possession of an instrument who is not the holder. A nonholder in possession of an instrument includes a person that acquired rights of a holder by subrogation or under Section 3-203(a). It also includes any other person who under applicable law is a successor to the holder or otherwise acquires the holder’s rights.

CASE NOTES

Editor’s note.

Some of the cases annotated below were decided under former § 8.3-302.

The Uniform Commercial Code divides the purchasers of negotiable paper into two categories, and it fixes the rights of a purchaser by his classification within those categories. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

The two categories are “holder in due course” and one not a “holder in due course”. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

The Uniform Commercial Code provides a simple test for ascertaining within which category a purchaser of a negotiable paper falls. To be a “holder in due course,” one must have acquired the negotiable instrument before maturity and before default. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

An assignee may become a holder in due course provided the assignor properly negotiates the note by indorsement and delivery. Virginia law only prevents one who takes a note by “mere assignment and not through indorsement” from becoming a holder in due course. Bankers Trust v. 236 Beltway Inv., 865 F. Supp. 1186, 1994 U.S. Dist. LEXIS 14029 (E.D. Va. 1994) (decided under former § 8.3-302).

Alteration of terms “due negotiation” and “holder in due course”. —

The U.C.C. does not permit the sort of alteration of the inviolable terms “due negotiation” and “holder in due course” found in a provision included in promissory notes which attempted to equate a “holder” with a mere possessor, to make “due negotiation” synonymous with delivery accompanied only by assignment, and to convert the meaning of “holder in due course” to one who possesses order paper by assignment. Becker v. National Bank & Trust Co., 222 Va. 716 , 284 S.E.2d 793, 1981 Va. LEXIS 365 (1981).

The reason for the differentiation between rights acquired by one under an assignment before maturity and one after maturity was long recognized before the adoption of either the Negotiable Instruments Act or the Uniform Commercial Code. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

State’s retroactivity principles followed. —

Although creating a federal common-law rule of decision in the instant case would be acting in conformity with present Virginia law, nevertheless such an action would disregard that state’s retroactivity principles and, to that extent, disrupt commercial relationships predicated on state law and engaged in by individuals in reliance upon that law. Resolution Trust Corp. v. Maplewood Invs., 31 F.3d 1276, 1994 U.S. App. LEXIS 19485 (4th Cir. 1994).

Good faith does not encompass a concept of negligence; the test is a subjective one. An act is deemed to be done in good faith, within the meaning of the UCC, if it is done honestly, whether or not it is performed negligently. Under this test, good faith is determined by looking to the mind of the particular holder who asserts that he is a holder in due course, and not by focusing on what the state of mind of a reasonably prudent person should have been. Lawton v. Walker, 231 Va. 247 , 343 S.E.2d 335, 1986 Va. LEXIS 186 (1986).

Evidence was insufficient to raise an inference of lack of good faith on the part of a purchaser of a promissory note, where the transaction was his “first try” at the business of purchasing commercial paper, he stated he was unaware of any “problems” with the note, he thought the transaction for which the note was given was “a straight cash sale,” without interest. Lawton v. Walker, 231 Va. 247 , 343 S.E.2d 335, 1986 Va. LEXIS 186 (1986).

Successor not holder in due course. —

Note executed by debtor was not negotiable under Virginia law. Thus, Virginia law would not classify the successor in interest as a holder in due course. Resolution Trust Corp. v. Maplewood Invs., 31 F.3d 1276, 1994 U.S. App. LEXIS 19485 (4th Cir. 1994).

Assignee not holder in due course. —

Note was not a negotiable instrument because it did not constitute an unconditional promise to pay a fixed amount of money; therefore, assignee of noteholder and security agreement could not assert any right that a holder in due course may have had to rely on under federal statutory provision allowing transfer of assets and liabilities without prior written consent. Apartment Inv. & Mgt. v. National Loan Investors, 258 Va. 322 , 518 S.E.2d 627, 1999 Va. LEXIS 98 (1999).

Status as holder in due course not affected by “in bulk” transaction. —

Where the purchaser answered affirmatively on cross-examination to the question calling for the legal conclusion whether he purchased the instrument “in bulk,” but the evidence as a whole showed clearly that the purchaser was not taking over the seller’s entire assets in bulk under unusual circumstances indicating he was the seller’s successor in interest, the purchaser’s status as holder in due course was not affected by the nature of the transfer. Lawton v. Walker, 231 Va. 247 , 343 S.E.2d 335, 1986 Va. LEXIS 186 (1986).

Car dealer as holder in due course of bank check. —

Car dealer, which conditioned immediate possession of vehicle and transfer of title on payment being made in cash or by a “bank check,” was a holder in due course of the check delivered to it, and was not subject to personal defenses to the instrument, because it had not “dealt” with the drawer bank within the meaning of former § 8.3-305(2) (see now § 8.3A-305 (a) ). Village Motors, Inc. v. American Fed. Sav. & Loan Ass'n, 231 Va. 408 , 345 S.E.2d 288, 1986 Va. LEXIS 206 (1986).

Investigation by purchasers of note provided actual notice of claims. —

The purchasers of an interest in a promissory note were not holders in due course where, before purchasing the note, one of the purchasers made an investigation into the various parties’ interests in the note which provided him with actual notice of claims against the instrument. Brantley v. Karas, 220 Va. 489 , 260 S.E.2d 189, 1979 Va. LEXIS 288 (1979).

Payment or security for antecedent claim constitutes value. —

An instrument taken in payment of or as security for an antecedent claim is taken for value. Elkins Energy Corp. v. Central Supply Co., 21 Bankr. 481, 1982 Bankr. LEXIS 4157 (Bankr. W.D. Va. 1982).

Review of finding of notice of claim. —

A trial judge’s determination that a purchaser had actual knowledge of a claim against a note cannot be disturbed if reasonable persons might differ as to the conclusions of fact established by the evidence. Brantley v. Karas, 220 Va. 489 , 260 S.E.2d 189, 1979 Va. LEXIS 288 (1979).

What constituted holder in due course under former N.I.L. —

See Colona v. Parksley Nat'l Bank, 120 Va. 812 , 92 S.E. 979 , 1917 Va. LEXIS 162 (1917); Fleshman v. Bibb, 118 Va. 582 , 88 S.E. 64 , 1916 Va. LEXIS 41 (1916); Fourth Nat'l Bank v. Bragg, 127 Va. 47 , 102 S.E. 64 9, 1920 Va. LEXIS 31 (1920); Stevens v. Clintwood Drug Co., 155 Va. 353 , 154 S.E. 515 , 1930 Va. LEXIS 168 (1930); Andrews & Stone v. Fidelity Loan & Trust Co., 103 Va. 196 , 48 S.E. 884 , 1904 Va. LEXIS 27 (1904); Catron v. Bostic, 123 Va. 355 , 96 S.E. 845 , 1918 Va. LEXIS 37 (1918); Moore v. Potomac Sav. Bank, 160 Va. 597 , 169 S.E. 922 , 1933 Va. LEXIS 241 (1933); City Nat'l Bank v. Hundley, 112 Va. 51 , 70 S.E. 494 , 1911 Va. LEXIS 51 (1911); Crum v. Hanna, 140 Va. 366 , 125 S.E. 219 , 1924 Va. LEXIS 177 (1924); Duncan v. Carson, 127 Va. 306 , 103 S.E. 665 , 1920 Va. LEXIS 52 (1920); Ratcliffe v. Costello, 117 Va. 563 , 85 S.E. 469 , 1915 Va. LEXIS 72 (1915).

OFFICIAL COMMENT

1. Subsection (a)(1) is a return to the N.I.L. rule that the taker of an irregular or incomplete instrument is not a person the law should protect against defenses of the obligor or claims of prior owners.  This reflects a policy choice against extending the holder in due course doctrine to an instrument that is so incomplete or irregular “as to call into question its authenticity.”  The term “authenticity” is used to make it clear that the irregularity or incompleteness must indicate that the instrument may not be what it purports to be. Persons who purchase or pay such instruments should do so at their own risk. Under subsection (1) of former Section 3-304, irregularity or incompleteness gave a purchaser notice of a claim or defense.  But it was not clear from that provision whether the claim or defense had to be related to the irregularity or incomplete aspect of the instrument.  This ambiguity is not present in subsection (a)(1).
2. Subsection (a)(2) restates subsection (1) of former Section 3-302.  Section 3-305(a) makes a distinction between defenses to the obligation to pay an instrument and claims in recoupment by the maker or the drawer that may be asserted to reduce the amount payable on the instrument.  Because of this distinction, which was not made in former Article 3, the reference in subsection (a)(2)(vi) is to both a defense and a claim in recoupment.  Notice of forgery or alteration is stated separately because forgery and alteration are not technically defenses under subsection (a) of Section 3-305.
3. Discharge is also separately treated in the first sentence of subsection (b).  Except for discharge in an insolvency proceeding, which is specifically stated to be a real defense in Section 3-305(a)(1), discharge is not expressed in Article 3 as a defense and is not included in Section 3-305(a)(2). Discharge is effective against anybody except a person having rights of a holder in due course who took the instrument without notice of the discharge.  Notice of discharge does not disqualify a person from becoming a holder in due course.  For example, a check certified after it is negotiated by the payee may subsequently be negotiated to a holder.  If the holder had notice that the certification occurred after negotiation by the payee, the holder necessarily had notice of the discharge of the payee as indorser.  Section 3-415(d).   Notice of that discharge does not prevent the holder from becoming a holder in due course, but the discharge is effective against the holder.  Section 3-601(b). Notice of a defense under Section 3-305(a)(1) of a maker, drawer or acceptor based on a bankruptcy discharge is different. There is no reason to give holder in due course status to a person with notice of that defense.  The second sentence of subsection (b) is from former Section 3-304(5).
4. Professor Britton in his treatise Bills and Notes 309 (1961) stated:  “A substantial number of decisions before the [N.I.L.] indicates that at common law there was nothing in the position of payee as such which made it impossible for him to be a holder in due course.” The courts were divided, however, about whether the payee of an instrument could be the holder in due course under N.I.L..  Some courts read N.I.L. § 52(4) to mean that a person could be a holder in due course only if the instrument was “negotiated” to that person. N.I.L. § 30 stated that “an instrument is negotiated when it is transferred from one person to another in such manner as to constitute the transferee the holder thereof.”  Normally, an instrument is “issued” to the payee; it is not transferred to the payee.  N.I.L. § 191 defined “issue” as the “first delivery of the instrument * * * to a person who takes it as a holder.”  Thus, some courts concluded that the payee never could be a holder in due course.  Other courts concluded that there was no evidence that the N.I.L. was intended to change the common law rule that the payee could be a holder in due course.  Professor Britton states on p. 318: “The typical situations which raise the [issue] are those where the defense of a maker is interposed because of fraud by a [maker who is] principal debtor * * * against a surety co-maker, or where the defense of fraud by a purchasing remitter is interposed by the drawer of the instrument against the good faith purchasing payee.”
5. Subsection (c) is based on former Section 3-302(3).  Like former Section 3-302(3), subsection (c) is intended to state existing case law.  It covers a few situations in which the purchaser takes an instrument under unusual circumstances. The purchaser is treated as a successor in interest to the prior holder and can acquire no better rights.   But if the prior holder was a holder in due course, the purchaser obtains rights of a holder in due course.
6. Subsection (d) and (e) clarify two matters not specifically addressed by former Article 3:
7. There is a large body of state statutory and case law restricting the use of the holder in due course doctrine in consumer transactions as well as some business transactions that raise similar issues.  Subsection (g) subordinates Article 3 to that law and any other similar law that may evolve in the future.  Section 3-106(d) also relates to statutory or administrative law intended to restrict use of the holder-in-due-course doctrine.  See Comment 3 to Section 3-106.

Former Section 3-302(2) stated: “A payee may be a holder in due course.” This provision was intended to resolve the split of authority under the N.I.L.. It made clear that there was no intent to change the common law rule that allowed a payee to become a holder in due course. See Comment 2 to former Section 3-302. But there was no need to put subsection (2) in former Section 3-302 because the split in authority under N.I.L. was caused by the particular wording of N.I.L. § 52(4). The troublesome language in that section was not repeated in former Article 3 nor is it repeated in revised Article 3. Former Section 3-302(2) has been omitted in revised Article 3 because it is surplusage and may be misleading. The payee of an instrument can be a holder in due course, but use of the holder-in-due-course doctrine by the payee of an instrument is not the normal situation.

The primary importance of the concept of holder in due course is with respect to assertion of defenses or claims in recoupment (Section 3-305) and of claims to the instrument (Section 3-306). The holder-in-due-course doctrine assumes the following cases as typical. Obligor issues a note or check to Obligee. Obligor is the maker of the note or drawer of the check. Obligee is the payee. Obligor has some defense to Obligor’s obligation to pay the instrument. For example, Obligor issued the instrument for goods that Obligee promised to deliver. Obligee never delivered the goods. The failure of Obligee to deliver the goods is a defense. Section 3-303(b). Although Obligor has a defense against Obligee, if the instrument is negotiated to Holder and the requirements of subsection (a) are met, Holder may enforce the instrument against Obligor free of the defense. Section 3-305(b). In the typical case the holder in due course is not the payee of the instrument. Rather, the holder in due course is an immediate or remote transferee of the payee. If Obligor in our example is the only obligor on the check or note, the holder-in-due-course doctrine is irrelevant in determining rights between Obligor and Obligee with respect to the instrument.

But in a small percentage of cases it is appropriate to allow the payee of an instrument to assert rights as a holder in due course. The cases are like those referred to in the quotation from Professor Britton referred to above, or other cases in which conduct of some third party is the basis of the defense of the issuer of the instrument. The following are examples:

Case #1. Buyer pays for goods bought from Seller by giving to Seller a cashier’s check bought from Bank. Bank has a defense to its obligation to pay the check because Buyer bought the check from Bank with a check known to be drawn on an account with insufficient funds to cover the check. If Bank issued the check to Buyer as payee and Buyer endorsed it over to Seller, it is clear that Seller can be a holder in due course taking free of the defense if Seller had no notice of the defense. Seller is a transferee of the check. There is no good reason why Seller’s position should be any different if Bank drew the check to the order of Seller as payee. In that case, when Buyer took delivery of the check from Bank, Buyer became the owner of the check even though Buyer was not the holder. Buyer was a remitter. Section 3-103(a)(11). At that point nobody was the holder. When Buyer delivered the check to Seller, ownership of the check was transferred to Seller who also became the holder. This is a negotiation. Section 3-201. The rights of seller should not be affected by the fact that in one case the negotiation to Seller was by a holder and in the other case the negotiation was by a remitter. Moreover, it should be irrelevant whether Bank delivered the check to Buyer and Buyer delivered it to Seller or whether Bank delivered it directly to Seller. In either case Seller can be holder in due course that takes free of Bank’s defense.

Case #2. X fraudulently induces Y to join X in a spurious venture to purchase a business. The purchase is to be financed by a bank loan for part of the price. Bank lends money to X and Y by deposit in a joint account of X and Y who sign a note payable to Bank for the amount of the loan. X then withdraws the money from the joint account and absconds. Bank acted in good faith and without notice of the fraud of X against Y. Bank is payee of the note executed by Y, but its right to enforce the note against Y should not be affected by the fact that Y was induced to execute the note by the fraud of X. Bank can be a holder in due course that takes free of the defense of Y. Case #2 is similar to Case #1. In each case the payee of the instrument has given value to the the person committing the fraud in exchange for the obligation of the person against whom the fraud was committed. In each case the payee was not party to the fraud and had no notice of it.

Suppose in Case #2 that the note does not meet the requirements of Section 3-104(a) and thus is not a negotiable instrument covered by Article 3. In that case, Bank cannot be a holder in due course but the result should be the same. Bank’s rights are determined by general principles of contract law. Restatement Second, Contracts § 164(2) governs the case. If Y is induced to enter into a contract with Bank by fraudulent misrepresentation by X, the contract is voidable by Y unless Bank “in good faith and without reason to know of the misrepresentation either gives value or relies materially on the transaction.” Comment e to § 164(2) states:

“This is the same principle that protects an innocent person who purchases goods or commercial paper in good faith, without notice and for value from one who obtained them from the original owner by misrepresentation. See Uniform Commercial Code § 2-403(1), 3-305. In the cases that fall within [§ 164(2)], however, the innocent person deals directly with the recipient of the misrepresentation, which is made by one not a party to the contract.”

The same result follows in Case #2 if Y had been induced to sign the note as an accommodation party (Section 3-419). If Y signs as co-maker of a note for the benefit of X, Y is a surety with respect of the obligation of X to pay the note but is liable as maker of the note to pay Bank. Section 3-419(b). If Bank is a holder in due course, the fraud of X cannot be asserted against Bank under Section 3-305(b). But the result is the same without resort to holder-in-due-course doctrine. If the note is not a negotiable instrument governed by Article 3, general rules of suretyship apply. Restatement, Security § 119 states that the surety (Y) cannot assert a defense against the creditor (Bank) based on the fraud of the principal (X) if the creditor “without knowledge of the fraud * * * extended credit to the principal on the security of the surety’s promise * * *.” The underlying principle of § 119 is the same as that of § 164(2) of Restatement Second, Contracts.

Case #3. Corporation draws a check payable to Bank. The check is given to an officer of Corporation who is instructed to deliver it to Bank in payment of a debt owed by Corporation to Bank. Instead, the officer, intending to defraud Corporation, delivers the check to Bank in payment of officer’s personal debt, or the check is delivered to Bank for deposit to the officer’s personal account. If Bank obtains payment of the check, Bank has received funds of Corporation which have been used for the personal benefit of the officer. Corporation in this case will assert a claim to the proceeds of the check against Bank. If Bank was a holder in due course of the check it took the check free of the Corporation’s claim. Section 3-306. The issue in this case is whether Bank had notice of the claim when it took the check. If Bank knew that the officer was a fiduciary with respect to the check, the issue is governed by Section 3-307.

Case #4. Employer, who owed money to X, signed a blank check and delivered it to Secretary with instructions to complete the check by typing in X’s name and the amount owed to X. Secretary fraudulently completed the check by typing in the name of Y, a creditor to whom the Secretary owed money. Secretary then delivered the check to Y in payment of Secretary’s debt. Y obtained payment of the check. This case is similar to Case #3. Since Secretary was authorized to complete the check, Employer is bound by Secretary’s act in making the check payable to Y. The drawee bank properly paid the check. Y received funds of the employer which were used for the personal benefit of Secretary. Employer asserts a claim to these funds against Y. If Y is a holder in due course, Y takes free of the claim. Whether Y is a holder in due course depends upon whether Y had notice of Employer’s claim.

Subsection (c) applies to a purchaser in an execution sale or sale in bankruptcy. It applies equally to an attaching creditor or any other person who acquires the instrument by legal process or to a representative, such as an executor, administrator, receiver, or assignee for the benefit of creditors, who takes the instrument as part of an estate. Subsection (c) applies to bulk purchases lying outside of the ordinary course of business of the seller. For example, it applies to the purchase by one bank of a substantial part of the paper held by another bank which is threatened with insolvency and seeking to liquidate its assets. Subsection (c) would also apply when a new partnership takes over for value all of the assets of an old one after a new member has entered the firm, or to a reorganized or consolidated corporation taking over the assets of a predecessor.

In the absence of controlling state law to the contrary, subsection (c) applies to a sale by a state bank commissioner of the assets of an insolvent bank. However, subsection (c) may be preempted by federal law if the Federal Deposit Insurance Corporation takes over an insolvent bank. Under the governing federal law, the FDIC and similar financial institution insurers are given holder in due course status and that status is also acquired by their assignees under the shelter doctrine.

Case #5. Payee negotiates a $1,000 note to Holder who agrees to pay $900 for it. After paying $500, Holder learns that Payee defrauded Maker in the transaction giving rise to the note. Under subsection (d) Holder may assert rights as a holder in due course to the extent of $555.55 ($500 ÷ $900 = .555 s $1,000 = $555.55). This formula rewards holder with a ratable portion of the bargained for profit.

Case #6. Payee negotiates a note of Maker for $1,000 to Holder as security for payment of Payee’s debt to Holder of $600. Maker has a defense which is good against Payee but of which Holder has no notice. Subsection (e) applies. Holder may assert rights as a holder in due course only to the extent of $600. Payee does not get the benefit of the holder-in-due-course status of Holder. With respect to $400 of the note, Maker may assert any rights that Maker has against Payee. A different result follows if the payee of a note negotiated it to a person who took it as a holder in due course and that person pledged the note as security for a debt. Because the defense cannot be asserted against the pledgor, the pledgee can assert rights as a holder in due course for the full amount of the note for the benefit of both the pledgor and pledgee.

CASE NOTES

Editor’s note.

The cases annotated below were decided under former § 8.3-408.

Draft mistakenly issued by insurer without consideration. —

Where an insurer mistakenly issued a draft where there was no coverage for the insured’s claim under his policy, the insurer had no underlying obligation to the insured, and the draft was without consideration. Therefore the insurer could not be required to honor the draft under former § 8.3-802 (see now § 8.3A-310 ), since, under this section, want or failure of consideration is a defense as against any person not having the rights of a holder in due course. Criterion Ins. Co. v. Fulgham, 219 Va. 294 , 247 S.E.2d 404, 1978 Va. LEXIS 191 (1978).

Original defense unavailable as to succeeding note where maker learns of defense. —

A defense to an original note of want of consideration would be unavailable to the maker of a succeeding note made in satisfaction of the original obligation, if the maker had knowledge of the defense at the time of execution of the succeeding note. Whether on a ground of estoppel or waiver, the maker cannot raise a defense to a note that has been satisfied by his own action. Elkins Energy Corp. v. Central Supply Co., 21 Bankr. 481, 1982 Bankr. LEXIS 4157 (Bankr. W.D. Va. 1982).

Consideration under former N.I.L. —

Matthews v. Crockett, 82 Va. 394 , 1886 Va. LEXIS 49 (1886); Jones v. Degge, 84 Va. 685 , 5 S.E. 799 , 1888 Va. LEXIS 129 (1888); Loftus v. Maloney, 89 Va. 576 , 16 S.E. 749 , 1893 Va. LEXIS 77 (1893); Reid v. Windsor, 111 Va. 825 , 69 S.E. 1101 , 1911 Va. LEXIS 36 (1911); Murphy's Hotel Co. v. Herndon, 120 Va. 505 , 91 S.E. 634 , 1917 Va. LEXIS 137 (1917); Bernard-Smith Co. v. Bernard, 124 Va. 518 , 98 S.E. 677 , 1919 Va. LEXIS 143 (1919); Wheeler v. Wardell, 173 Va. 168 , 3 S.E.2d 377, 1939 Va. LEXIS 184 (1939); Trevillian v. Bullock, 185 Va. 958 , 40 S.E.2d 920, 1947 Va. LEXIS 233 (1947).

OFFICIAL COMMENT

1. Subsection (a) is a restatement of former Section 3-303 and subsection (b) replaces former Section 3-408.  The distinction between value and consideration in Article 3 is a very fine one. Whether an instrument is taken for value is relevant to the issue of whether a holder is a holder in due course. If an instrument is not issued for consideration the issuer has a defense to the obligation to pay the instrument. Consideration is defined in subsection (b) as “any consideration sufficient to support a simple contract.”  The definition of value in Section 1-201 (44), which doesn’t apply to Article 3, includes “any consideration sufficient to support a simple contract.”  Thus, outside Article 3, anything that is consideration is also value.  A different rule applies in Article 3.  Subsection (b) of Section 3-303 states that if an instrument is issued for value it is also issued for consideration.
2. Subsection (a), which defines value, has primary importance in cases in which the issue is whether the holder of an instrument is a holder in due course and particularly to cases in which the issuer of the instrument has a defense to the instrument.  Suppose Buyer and Seller signed a contract on April 1 for the sale of goods to be delivered on May 1. Payment of 50% of the price of the goods was due upon signing of the contract.  On April 1 Buyer delivered to Seller a check in the amount due under the contract.  The check was drawn by X to Buyer as payee and was indorsed to Seller.  When the check was presented for payment to the drawee on April 2, it was dishonored because X had stopped payment.  At that time Seller had not taken any action to perform the contract with buyer.  If X has a defense on the check, the defense can be asserted against Seller who is not a holder in due course because Seller did not give value for the check. Subsection (a)(1).  The policy basis for subsection (a)(1) is that the holder who gives an executory promise of performance will not suffer an out-of-pocket loss to the extent the executory promise is unperformed at the time the holder learns of the dishonor of the instrument. When Seller took delivery of the check on April 1, Buyer’s obligation to pay 50% of the price on that date was suspended, but when the check was dishonored on April 2 the obligation revived.  Section 3-310(b).  If payment for goods is due at or before delivery and the Buyer fails to make the payment, the Seller is excused from performing the promise to deliver the goods.  Section 2-703. Thus, Seller is protected from an out-of-pocket loss even if the check is not enforceable. Holder-in-due-course status is not necessary to protect Seller.
3. Subsection (a)(2) equates value with the obtaining of a security interest or a nonjudicial lien in the instrument. The term “security interest” covers Article 9 cases in which an instrument is taken as collateral as well as bank collection cases in which a bank acquires a security interest under Section 4-210.  The acquisition of a common-law or statutory banker’s lien is also value under subsection (a)(2).  An attaching creditor or other person who acquires a lien by judicial proceedings does not give value for the purposes of subsection (a)(2).
4. Subsection (a)(3) follows former Section 3-303(b) in providing that the holder takes for value if the instrument is taken in payment of or as security for an antecedent claim, even though there is no extension of time or other concession, and whether or not the claim is due.  Subsection (a)(3) applies to any claim against any person; there is no requirement that the claim arise out of contract.  In particular the provision is intended to apply to an instrument given in payment of or as security for the debt of a third person, even though no concession is made in return.
5. Subsection (a)(4) and (5) restate former Section 3-303(c). They state generally recognized exceptions to the rule that an executory promise is not value.  A negotiable instrument is value because it carries the possibility of negotiation to a holder in due course, after which the party who gives it is obliged to pay.  The same reasoning applies to any irrevocable commitment to a third person, such as a letter of credit issued when an instrument is taken.

Case #1. X owes Y $1,000. The debt is not represented by a note. Later X issues a note to Y for the debt. Under subsection (a)(3) X’s note is issued for value. Under subsection (b) the note is also issued for consideration whether or not, under contract law, Y is deemed to have given consideration for the note.

Case #2. X issues a check to Y in consideration of Y’s promise to perform services in the future. Although the executory promise is consideration for issuance of the check it is value only to the extent the promise is performed. Subsection (a)(1).

Case #3. X issues a note to Y in consideration of Y’s promise to perform services. If at the due date of the note Y’s performance is not yet due, Y may enforce the note because it was issued for consideration. But if at the due date of the note, Y’s performance is due and has not been performed, X has a defense. Subsection (b).

OFFICIAL COMMENT

1. To be a holder in due course, one must take without notice that an instrument is overdue.  Section 3-302(a)(2)(iii). Section 3-304 replaces subsection (3) of former Section 3-304.  For the sake of clarity it treats demand and time instruments separately.  Subsection (a) applies to demand instruments.  A check becomes stale after 90 days.
2. Subsections (b) and (c) cover time instruments.  They follow the distinction made under former Article 3 between defaults in payment of principal and interest.  In subsection (b) installment instruments and single payment instruments are treated separately.  If an installment is late, the instrument is overdue until the default is cured.

Under former Section 3-304(3)(c), a holder that took a demand note had notice that it was overdue if it was taken “more than a reasonable length of time after its issue.” In substitution for this test, subsection (a)(3) requires the trier of fact to look at both the circumstances of the particular case and the nature of the instrument and trade usage. Whether a demand note is stale may vary a great deal depending upon the facts of the particular case.

CASE NOTES

Voidable transactions. —

Virginia law deems that a conflict of interest such as a breach of faith or fiduciary duty by officers of the trustee makes a transaction voidable by the plaintiff-debtor, not void, thus rendering that defense useless against a holder in due course. Resolution Trust Corp. v. Maplewood Invs., 31 F.3d 1276, 1994 U.S. App. LEXIS 19485 (4th Cir. 1994).

A mere business relationship with assignor is not a badge of fraud which denies one the status of holder in due course. White v. Gilliam, 244 Va. 113 , 419 S.E.2d 247, 8 Va. Law Rep. 3288, 1992 Va. LEXIS 74 (1992) (decided under former § 8.3-305).

Failure of consideration under former N.I.L. —

See Brenard Mfg. Co. v. Brown, 120 Va. 757 , 92 S.E. 850 , 1917 Va. LEXIS 156 (1917); Bernard-Smith Co. v. Bernard, 124 Va. 518 , 98 S.E. 677 , 1919 Va. LEXIS 143 (1919) (decided under former § 8.3-306).

When instrument subject to original defenses under former N.I.L. —

See Aragon Coffee Co. v. Rogers, 105 Va. 51 , 52 S.E. 843 (1906); Elkhart State Bank v. Bristol Broom Co., 143 Va. 1 , 129 S.E. 371 , 8 A.C. 623 (1925) (decided under former § 8.3-306).

CIRCUIT COURT OPINIONS

Contractual limitations not a bar. —

Because the buyers’ recoupment plea arose from the same contract and transaction in the owners’ complaint, prohibiting the buyers from asserting the plea might allow the owners to enjoy the benefits of the transaction without meeting its obligations; therefore, the contractual limitation on warranties and representations did not bar the plea. Rosenbloom v. Integrated Sec. Sys., 73 Va. Cir. 71, 2007 Va. Cir. LEXIS 91 (Fairfax County June 21, 2007).

OFFICIAL COMMENT

1. Subsection (a) states the defenses to the obligation of a party to pay the instrument.  Subsection (a)(1) states the “real defenses” that may be asserted against any person entitled to enforce the instrument.
2. Subsection (a)(2) states other defenses that, pursuant to subsection (b), are cut off by a holder in due course.  These defenses comprise those specifically stated in Article 3 and those based on common law contract principles.  Article 3 defenses are nonissuance of the instrument, conditional issuance, and issuance for a special purpose (Section 3-105(b)); failure to countersign a traveler’s check (Section 3-106(c)); modification of the obligation by separate agreement (Section 3-117); payment that violates a restrictive indorsement (Section 3-206(f)); instruments issued without consideration or for which promised performance has not been given (Section 3-303(b)), and breach of warranty when a draft is accepted (Section 3-417(b)).  The most prevalent common law defenses are fraud, misrepresentation or mistake in the issuance of the instrument.  In most cases the holder in due course will be an immediate or remote transferee of the payee of the instrument.  In most cases the holder-in-due-course doctrine is irrelevant if defenses are being asserted against the payee of the instrument, but in a small number of cases the payee of the instrument may be a holder in due course. Those cases are discussed in Comment 4 to Section 3-302.
3. Subsection (a)(3) is concerned with claims in recoupment which can be illustrated by the following example.  Buyer issues a note to the order of Seller in exchange for a promise of Seller to deliver specified equipment.  If Seller fails to deliver the equipment or delivers equipment that is rightfully rejected, Buyer has a defense to the note because the performance that was the consideration for the note was not rendered.  Section 3-303(b).  This defense is included in Section 3-305(a)(2).  That defense can always be asserted against Seller.  This result is the same as that reached under former Section 3-408.
4. Subsection (c) concerns claims and defenses of a person other than the obligor on the instrument.  It applies principally to cases in which an obligation is paid with the instrument of a third person.  For example, Buyer buys goods from Seller and negotiates to Seller a cashier’s check issued by Bank in payment of the price. Shortly after delivering the check to Seller, Buyer learns that Seller had defrauded Buyer in the sale transaction.  Seller may enforce the check against Bank even though Seller is not a holder in due course. Bank has no defense to its obligation to pay the check and it may not assert defenses, claims in recoupment, or claims to the instrument of Buyer, except to the extent permitted by the but clause of the first sentence of subsection (c).  Buyer may have a claim to the instrument under Section 3-306 based on a right to rescind the negotiation to Seller because of Seller’s fraud. Section 3-202(b) and Comment 2 to Section 3-201.  Bank cannot assert that claim unless Buyer is joined in the action in which Seller is trying to enforce payment of the check. In that case Bank may pay the amount of the check into court and the court will decide whether that amount belongs to Buyer or Seller.  The last sentence of subsection (c) allows the issuer of an instrument such as a cashier’s check to refuse payment in the rare case in which the issuer can prove that the instrument is a lost or stolen instrument and the person seeking enforcement does not have rights of a holder in due course.
5. Subsection (d) applies to instruments signed for accommodation (Section 3-419) and this subsection equates the obligation of the accommodation party to that of the accommodated party. The accommodation party can assert whatever defense or claim the accommodated party had against the person enforcing the instrument. The only exceptions are discharge in bankruptcy, infancy and lack of capacity.  The same rule does not apply to an indorsement by a holder of the instrument in negotiating the instrument.  The indorser, as transferor, makes a warranty to the indorsee, as transferee, that no defense or claim in recoupment is good against the indorser.  Section 3-416(a)(4).  Thus, if the indorsee sues the indorser because of a dishonor of the instrument, the indorser may not assert the defense or claim in recoupment of the maker or drawer against the indorsee.

Subsection (a)(1)(i) allows assertion of the defense of infancy against a holder in due course, even though the effect of the defense is to render the instrument voidable but not void. The policy is one of protection of the infant even at the expense of occasional loss to an innocent purchaser. No attempt is made to state when infancy is available as a defense or the conditions under which it may be asserted. In some jurisdictions it is held that an infant cannot rescind the transaction or set up the defense unless the holder is restored to the position held before the instrument was taken which, in the case of a holder in due course, is normally impossible. In other states an infant who has misrepresented age may be estopped to assert infancy. Such questions are left to other law, as an integral part of the policy of each state as to the protection of infants.

Subsection (a)(1)(ii) covers mental incompetence, guardianship, ultra vires acts or lack of corporate capacity to do business, or any other incapacity apart from infancy. Such incapacity is largely statutory. Its existence and effect is left to the law of each state. If under the state law the effect is to render the obligation of the instrument entirely null and void, the defense may be asserted against a holder in due course. If the effect is merely to render the obligation voidable at the election of the obligor, the defense is cut off.

Duress, which is also covered by subsection (a)(ii), is a matter of degree. An instrument signed at the point of a gun is void, even in the hands of a holder in due course. One signed under threat to prosecute the son of the maker for theft may be merely voidable, so that the defense is cut off. Illegality is most frequently a matter of gambling or usury, but may arise in other forms under a variety of statutes. The statutes differ in their provisions and the interpretations given them. They are primarily a matter of local concern and local policy. All such matters are therefore left to the local law. If under that law the effect of the duress or the illegality is to make the obligation entirely null and void, the defense may be asserted against a holder in due course. Otherwise it is cut off.

Subsection (a)(1)(iii) refers to “real” or “essential” fraud, sometimes called fraud in the essence or fraud in the factum, as effective against a holder in due course. The common illustration is that of the maker who is tricked into signing a note in the belief that it is merely a receipt or some other document. The theory of the defense is that the signature on the instrument is ineffective because the signer did not intend to sign such an instrument at all. Under this provision the defense extends to an instrument signed with knowledge that it is a negotiable instrument, but without knowledge of its essential terms. The test of defense is that of excusable ignorance of the contents of the writing signed. The party must not only have been in ignorance, but must also have had no reasonable opportunity to obtain knowledge. In determining what is a reasonable opportunity all relevant factors are to be taken into account, including intelligence, education, business experience, and ability to read or understand English of the signer. Also relevant is the nature of the representations that were made, whether the signer had good reason to rely on the representations or to have confidence in the person making them, the presence or absence of any third person who might read or explain the instrument to the signer, or any other possibility of obtaining independent information, and the apparent necessity, or lack of it, for acting without delay. Unless the misrepresentation meets this test, the defense is cut off by a holder in due course.

Subsection (a)(1)(iv) states specifically that the defense of discharge in insolvency proceedings is not cut off when the instrument is purchased by a holder in due course. “Insolvency proceedings” is defined in Section 1-201 (22) and it includes bankruptcy whether or not the debtor is insolvent. Subsection (2)(e) of former Section 3-305 is omitted. The substance of that provision is stated in Section 3-601(b).

Assume Buyer issues a note to Seller in payment of the price of goods that Seller fraudulently promises to deliver but which are never delivered. Seller negotiates the note to Holder who has no notice of the fraud. If Holder is a holder in due course, Holder is not subject to Buyer’s defense of fraud. But in some cases an original party to the instrument is a holder in due course. For example, Buyer fraudulently induces Bank to issue a cashier’s check to the order of Seller. The check is delivered by Bank to Seller, who has no notice of the fraud. Seller can be a holder in due course and take the check free of Bank’s defense of fraud. This case is discussed as Case #1 in Comment 4 to Section 3-302. Former Section 3-305 stated that a holder in due course takes free of defenses of “any party to the instrument with whom the holder has not dealt.” The meaning of this language was not at all clear and if read literally could have produced the wrong result. In the hypothetical case, it could be argued that Seller “dealt” with Bank because Bank delivered the check to Seller. But it is clear that Seller should take free of Bank’s defense against Buyer regardless of whether Seller took delivery of the check from Buyer of Bank. The quoted language is not included in Section 3-305. It is not necessary. If Buyer issues an instrument to Seller and Buyer has a defense against Seller, that defense can obviously be asserted. Buyer and Seller are the only people involved. The holder-in-due-course doctrine has no relevance. The doctrine applies only to cases in which more than two parties are involved. Its essence is that the holder in due course does not have to suffer the consequences of the defense of an obligor on the instrument that arose from an occurrence with a third party.

But suppose Seller delivered the promised equipment and it was accepted by Buyer. The equipment, however, was defective. Buyer retained the equipment and incurred expenses with respect to its repair. In this case, Buyer does not have a defense under Section 3-303(b). Seller delivered the equipment and the equipment was accepted. Under Article 2, Buyer is obliged to pay the price of the equipment which is represented by the note. But Buyer may have a claim against Seller for breach of warranty. If Buyer has a warranty claim, the claim may be asserted against Seller as a counterclaim or as a claim in recoupment to reduce the amount owing on the note. It is not relevant whether Seller is or is not a holder in due course of the note or whether Seller knew or had notice that Buyer had the warranty claim. It is obvious that holder-in-due-course doctrine cannot be used to allow Seller to cut off a warranty claim that Buyer has against Seller. Subsection (b) specifically covers this point by stating that a holder in due course is not subject to a “claim in recoupment * * * against a person other than the holder.”

Suppose Seller negotiates the note to Holder. If Holder had notice of Buyer’s warranty claim at the time the note was negotiated to Holder, Holder is not a holder in due course (Section 3-302(a)(2)(iv)) and Buyer may assert the claim against Holder (Section 3-305(a)(3)) but only as a claim in recoupment, i.e. to reduce the amount owed on the note. If the warranty claim is $1,000 and the unpaid note is $10,000, Buyer owes $9,000 to Holder. If the warranty claim is more than the unpaid amount of the note, Buyer owes nothing to the Holder, but Buyer cannot recover the unpaid amount of the warranty claim from Holder. If Buyer had already partially paid the note, Buyer is not entitled to recover the amounts paid. The claim can be used only as an offset to amounts owing on the note. If holder had no notice of Buyer’s claim and otherwise qualifies as a holder in due course, Buyer may not assert the claim against Holder. Section 3-305(b).

The result under Section 3-305 is consistent with the result reached under former Article 3, but the rules for reaching the result are stated differently. Under former Article 3 Buyer could assert rights against Holder only if Holder was not a holder in due course, and Holder’s status depended upon whether Holder had notice of a defense by Buyer. Courts have held that Holder had that notice if Holder had notice of Buyer’s warranty claim. The rationale under former Article 3 was “failure of consideration.” This rationale does not distinguish between cases in which the seller fails to perform and those in which the buyer accepts the performance of seller but makes a claim against the seller because the performance is faulty. The term “failure of consideration” is subject to varying interpretations and is not used in Article 3. The use of the term “claim in recoupment” in Section 3-305 (a)(3) is a more precise statement of the nature of Buyer’s right against Holder. The use of the term does not change the law because the treatment of a defense under subsection (a)(2) and a claim in recoupment under subsection (a)(3) is essentially the same.

Under former Article 3, case law was divided on the issue of the extent to which an obligor on a note could assert against a transferee who is not a holder in due course a debt or other claim that the obligor had against the original payee of the instrument. Some courts limited claims to those that arose in the transaction that gave rise to the note. This is the approach taken in Section 3-305(a)(3). Other courts allowed the obligor on the note to use any debt or other claim, no matter how unrelated to the note, to offset the amount owed on the note. Under current judicial authority and non-UCC statutory law, there will be many cases in which a transferee of a note arising from a sale transaction will not qualify as a holder in due course. For example, applicable law may require the use of a note to which there cannot be a holder in due course. See Section 3-106(d) and Comment 3 to Section 3-106. It is reasonable to provide that the buyer should not be denied the right to assert claims arising out of the sale transaction. Subsection (a)(3) is based on the belief that it is not reasonable to require the transferee to bear the risk that wholly unrelated claims may also be asserted. The determination of whether a claim arose from the transaction that gave rise to the instrument is determined by law other than this Article and thus may vary as local law varies.

CASE NOTES

Editor’s note.

The cases annotated below were decided under former § 8.3-306.

The Uniform Commercial Code made little real change in the rights of one not a holder in due course under the old law merchant, which was to the effect that one not a holder in due course got by transfer only such title as his transferor had and, if some other person had legal or equitable title, such title would not be divested by the transfer. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

One who takes notes with knowledge that they are past due and in default takes nothing but the actual right and title of his assignor and he takes subject to any claim based on breach of trust or duty or any other reason including a constructive trust or other equity against the instrument or its proceeds in favor of any person. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

The taker of notes is charged with knowledge of the law as it fixed his rights under his assignment. The law specifically denies him any right to assume, when he took his assignment, that there were no equities or other claims of rights against the instrument or its proceeds. Capital Investors Co. v. Executors of Estate of Morrison, 484 F.2d 1157, 1973 U.S. App. LEXIS 7924 (4th Cir. 1973).

OFFICIAL COMMENT

This section expands on the reference to “claims to” the instrument mentioned in former Sections 3-305 and 3-306. Claims covered by the section include not only claims to ownership but also any other claim of a property of possessory right. It includes the claim to a lien or the claim of a person in rightful possession of an instrument who was wrongfully deprived of possession. Also included is a claim based on Section 3-202(b) for rescission of a negotiation of the instrument by the claimant. Claims to an instrument under Section 3-306 are different from claims in recoupment referred to in Section 3-305(a)(3).

OFFICIAL COMMENT

1. This section states rules for determining when a person who has taken an instrument from a fiduciary has notice of a breach of fiduciary duty that occurs as a result of the transaction with the fiduciary. Former Section 3-304(2) and (4)(e) related to this issue, but those provisions were unclear in their meaning. Section 3-307 is intended to clarify the law by stating rules that comprehensively cover the issue of when the taker of an instrument has notice of breach of a fiduciary duty and thus notice of a claim to the instrument or its proceeds.
2. Subsection (a) defines the terms “fiduciary” and “represented person” and the introductory paragraph of subsection (b) describes the transaction to which the section applies. The basic scenario is one in which the fiduciary in effect embezzles money of the represented person by applying the proceeds of an instrument that belongs to the represented person to the personal use of the fiduciary. The person dealing with the fiduciary may be a depositary bank that takes the instrument for collection or a bank or other person that pays value for the instrument. The section also covers a transaction in which an instrument is presented for payment to a payor bank that pays the instrument by giving value to the fiduciary. Subsections (b)(2), (3), and (4) state rules for determining when the person dealing with the fiduciary has notice of breach of fiduciary duty. Subsection (b)(1) states that notice of breach of fiduciary duty is notice of the represented person’s claim to the instrument or its proceeds.
3. Subsection (b)(2) applies to instruments payable to the represented person or the fiduciary as such. For example, a check payable to Corporation is indorsed in the name of Corporation by Doe as its President. Doe gives the check to Bank as partial repayment of a personal loan that Bank had made to Doe. The check was indorsed either in blank or to Bank. Bank collects the check and applies the proceeds to reduce the amount owed on Doe’s loan. If the person acting for Bank in the transaction knows that Doe is a fiduciary and that the check is being used to pay a personal obligation of Doe, subsection (b)(2) applies. If Corporation has a claim to the proceeds of the check because the use of the check by Doe was a breach of fiduciary duty, Bank has notice of the claim and did not take the check as a holder in due course. The same result follows if Doe had indorsed the check to himself before giving it to Bank. Subsection (b)(2) follows Uniform Fiduciaries Act § 4 in providing that if the instrument is payable to the fiduciary, as such, or to the represented person, the taker has notice of a claim if the instrument is negotiated for the fiduciary’s personal debt. If fiduciary funds are deposited to a personal account of the fiduciary or to an account that is not an account of the represented person or of the fiduciary, as such, there is a split of authority concerning whether the bank is on notice of a breach of fiduciary duty. Subsection (b)(2)(iii) states that the bank is given notice of breach of fiduciary duty because of the deposit. The Uniform Fiduciaries Act § 9 states that the bank is not on notice unless it has knowledge of facts that makes its receipt of the deposit an act of bad faith.
4. Subsection (b)(3) is based on Uniform Fiduciaries Act § 6 and applies when the instrument is drawn by the represented person or the fiduciary as such to the fiduciary personally. The term “personally” is used as it is used in the Uniform Fiduciaries Act to mean that the instrument is payable to the payee as an individual and not as a fiduciary. 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 because 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.
5. Subsection (b)(4) can be illustrated by as hypothetical case. Corporation draws a check payable to an organization. X, an officer or employee of Corporation, delivers the check to a person acting for the organization. The person signing the check on behalf of Corporation is X or another person. If the person acting for the organization in the transaction knows that X is a fiduciary, the organization is on notice of a claim by Corporation if it takes the instrument under the same circumstances stated in subsection (b)(2). If the organization is a bank and the check is taken in repayment of a personal loan of the bank to X, the case is like the case discussed in Comment 3. It is unusual for Corporation, the represented person, to pay a personal debt of Doe by issuing a check to the bank. It is more likely that the use of the check by Doe reflects an unlawful use of the proceeds of the check. The same analysis applies if the check is made payable to an organization in payment of goods or services. If the person acting for the organization knew of the fiduciary status of X and that the goods or services were for X’s personal benefit, the organization is on notice of a claim by Corporation to the proceeds of the check. See the discussion in the last paragraph of Comment 2.

Under Section 3-306, a person taking an instrument is subject to a claim to the instrument or its proceeds, unless the taker has rights of a holder in due course. Under Section 3-302(a)(2)(v), the taker cannot be a holder in due course if the instrument was taken with notice of a claim under Section 3-306. Section 3-307 applies to cases in which a represented person is asserting a claim because a breach of fiduciary duty resulted in a misapplication of the proceeds of an instrument. The claim of the represented person is a claim described in Section 3-306. Section 3-307 states rules for determining when a person taking an instrument has notice of the claim which will prevent assertion of rights as a holder in due course. It also states rules for determining when a payor bank pays an instrument with notice of breach of fiduciary duty.

Section 3-307(b) applies only if the person dealing with the fiduciary “has knowledge of the fiduciary status of the fiduciary.” Notice which does not amount to knowledge is not enough to cause Section 3-307 to apply. “Knowledge” is defined in Section 1-201 (25). In most cases, the “taker” referred to in Section 3-307 will be a bank or other organization. Knowledge of an organization is determined by the rules stated in Section 1-201 (27). In many cases, the individual who receives and processes an instrument on behalf of the organization that is the taker of the instrument “for payment or collection or for value” is a clerk who has no knowledge of any fiduciary status of the person from whom the instrument is received. In such cases, Section 3-307 doesn’t apply because, under Section 1-201(27), knowledge of the organization is determined by the knowledge of the “individual conducting that transaction,” i.e. the clerk who receives and processes the instrument. Furthermore, paragraphs (2) and (4) each require that the person acting for the organization have knowledge of facts that indicate a breach of fiduciary duty. In the case of an instrument taken for deposit to an account, the knowledge is found in the fact that the deposit is made to an account other than that of the represented person or a fiduciary account for benefit of that person. In other cases the person acting for the organization must know that the instrument is taken in payment or as security for a personal debt of the fiduciary or for the personal benefit of the fiduciary. For example, if the instrument is being used to buy goods or services, the person acting for the organization must know that the goods or services are for the personal benefit of the fiduciary. The requirement that the taker have knowledge rather than notice is meant to limit Section 3-307 to relatively uncommon cases in which the person who deals with the fiduciary knows all the relevant facts: the fiduciary status and that the proceeds of the instrument are being used for the personal debt or benefit of the fiduciary or are being paid to an account that is not an account of the represented person or of the fiduciary, as such. Mere notice of these facts is not enough to put the taker on notice of the breach of fiduciary duty and does not give rise to any duty of investigation by the taker.

The rationale of subsection (b)(2) is that it is not normal for an instrument payable to the represented person or the fiduciary, as such, to be used for the personal benefit of the fiduciary. It is likely that such use reflects an unlawful use of the proceeds of the instrument. If the fiduciary is entitled to compensation from the represented person for services rendered or for expenses incurred by the fiduciary the normal mode of payment is by a check drawn on the fiduciary account to the order of the fiduciary.

CASE NOTES

Editor’s note.

The cases below were annotated under former § 8.3-307.

The holder has the benefit of a presumption of consideration. Humble Oil & Ref. Co. v. Copley, 213 Va. 449 , 192 S.E.2d 735, 1972 Va. LEXIS 383 (1972).

The defendant has the burden of establishing his defense by a preponderance of the evidence. Humble Oil & Ref. Co. v. Copley, 213 Va. 449 , 192 S.E.2d 735, 1972 Va. LEXIS 383 (1972).

Debtor has burden of showing want of consideration. —

The burden of establishing defense of partial want or failure of consideration on a note is on the debtor. Elkins Energy Corp. v. Central Supply Co., 21 Bankr. 481, 1982 Bankr. LEXIS 4157 (Bankr. W.D. Va. 1982).

Basis of section’s presumption. —

The presumption is based upon the fact that in the normal course of events forged or unauthorized signatures are very uncommon, and that evidence of such is usually within the defendant’s control or more accessible to him. Virginia Nat'l Bank v. Holt, 216 Va. 500 , 219 S.E.2d 881, 1975 Va. LEXIS 321 (1975).

Effect of presumption on plaintiff. —

The effect of the presumption in this section is to eliminate any requirement that plaintiff prove a signature is authentic until some evidence is introduced which would support a finding that the signature is forged or unauthorized. Virginia Nat'l Bank v. Holt, 216 Va. 500 , 219 S.E.2d 881, 1975 Va. LEXIS 321 (1975).

A forgery or an unauthorized signature may not be shown by merely demonstrating plaintiff’s apparent lack of evidence on that issue. Virginia Nat'l Bank v. Holt, 216 Va. 500 , 219 S.E.2d 881, 1975 Va. LEXIS 321 (1975).

Party denying a signature must make some sufficient showing of the grounds for the denial before the plaintiff is put to his proof. Virginia Nat'l Bank v. Holt, 216 Va. 500 , 219 S.E.2d 881, 1975 Va. LEXIS 321 (1975).

Where the effectiveness of a signature on a negotiable instrument is put in issue by a specific denial, the signature is presumed to be genuine or authorized, and the party claiming under the signature is not put to his proof until the party making the denial has produced some evidence which would support a finding that the signature is forged or unauthorized. First Nat'l Bank v. Roy N. Ford Co., 219 Va. 942 , 252 S.E.2d 354, 1979 Va. LEXIS 193 (1979).

Summary judgment possible even if state of mind in dispute. —

To allow a maker to automatically defeat a holder’s summary judgment motion by the presentation of evidence of nothing more than the holder’s possible knowledge or the maker’s or drawer’s drinking, psychological or marital problems would not only be contrary to the law but would subject innumerable transactions to a level of scrutiny that would have a chilling effect on the transferability of commercial paper, contrary to the general intent of the drafters of Article 3 of the UCC, thus, summary judgment will be granted against debtor who claimed purchaser of instrument should have known of debtor’s alleged alcohol and psychological problems. Schultz v. Wills, 126 Bankr. 489, 1991 Bankr. LEXIS 442 (Bankr. E.D. Va. 1991).

Original defense unavailable as to succeeding note where maker learns of defense. —

A defense to an original note of want of consideration would be unavailable to the maker of a succeeding note made in satisfaction of the original obligation, if the maker had knowledge of the defense at the time of execution of the succeeding note. Whether on a ground of estoppel or waiver, the maker cannot raise a defense to a note that has been satisfied by his own action. Elkins Energy Corp. v. Central Supply Co., 21 Bankr. 481, 1982 Bankr. LEXIS 4157 (Bankr. W.D. Va. 1982).

OFFICIAL COMMENT

1. Section 3-308 is a modification of former Section 3-307. The first two sentences of subsection (a) are a restatement of former Section 3-307(1). The purpose of the requirement of a specific denial in the pleadings is to give the plaintiff notice of the defendant’s claim of forgery or lack of authority as to the particular signature, and to afford the plaintiff an opportunity to investigate and obtain evidence. If local rules of pleading permit, the denial may be on information and belief, or it may be a denial of knowledge or information sufficient to form a belief. It need not be under oath unless the local statutes or rules require verification. In the absence of such specific denial the signature stands admitted, and is not in issue. Nothing in this section is intended, however, to prevent amendment of the pleading in a proper case.
2. Subsection (b) restates former Section 3-307(2) and (3). Once signatures are proved or admitted a holder, by mere production of the instrument, proves “entitlement to enforce the instrument” because under Section 3-301 a holder is a person entitled to enforce the instrument. Any other person in possession of an instrument may recover only if that person has the rights of a holder. Section 3-301. That person must prove a transfer giving that person such rights under Section 3-203(b) or that such rights were obtained by subrogation or succession.

The question of the burden of establishing the signature arises only when it has been put in issue by specific denial. “Burden of establishing” is defined in Section 1-201 . The burden is on the party claiming under the signature, but the signature is presumed to be authentic and authorized except as stated in the second sentence of subsection (a). “Presumed” is defined in Section 1-201 and means that until some evidence is introduced which would support a finding that the signature is forged or unauthorized, the plaintiff is not required to prove that it is valid. The presumption rests upon the fact that in ordinary experience forged or authorized signatures are very uncommon, and normally any evidence is within the control of, or more accessible to, the defendant. The defendant is therefore required to make some sufficient showing of the grounds for the denial before the plaintiff is required to introduce evidence. The defendant’s evidence need not be sufficient to require a directed verdict, but it must be enough to support the denial by permitting a finding in the defendant’s favor. Until introduction of such evidence the presumption requires a finding for the plaintiff. Once such evidence is introduced the burden of establishing the signature by a preponderance of the total evidence is on the plaintiff. The presumption does not arise if the action is to enforce the obligation of a purported signer who has died or become incompetent before the evidence is required, and so is disabled from obtaining or introducing it. “Action” is defined in Section 1-201 and includes a claim asserted against the estate of a deceased or an incompetent.

The last sentence of subsection (a) is a new provision that is necessary to take into account Section 3-402(a) that allows an undisclosed principal to be liable on an instrument signed by an authorized representative. In that case the person enforcing the instrument must prove that the undisclosed principal is liable.

If a plaintiff producing the instrument proves entitlement to enforce the instrument, either as a holder or a person with rights of a holder, the plaintiff is entitled to recovery unless the defendant proves a defense or claim in recoupment. Until proof of a defense or claim in recoupment is made, the issue as to whether the plaintiff has rights of a holder in due course does not arise. In the absence of a defense or claim in recoupment, any person entitled to enforce the instrument is entitled to recover. If a defense or claim in recoupment is proved, the plaintiff may seek to cut off the defense or claim in recoupment by proving that the plaintiff is a holder in due course or that the plaintiff has rights of a holder in due course under Section 3-203(b) or by subrogation or succession. All elements of Section 3-302(a) must be proved.

Nothing in this section is intended to say that the plaintiff must necessarily prove rights as a holder in due course. The plaintiff may elect to introduce no further evidence, in which case a verdict may be directed for the plaintiff or the defendant, or the issue of the defense or claim in recoupment may be left to the trier of fact, according to the weight and sufficiency of the defendant’s evidence. The plaintiff may elect to rebut the defense or claim in recoupment by proof to the contrary, in which case a verdict may be directed for either party or the issue may be for the trier of fact. Subsection (b) means only that if the plaintiff claims the rights of a holder in due course against the defense or claim in recoupment, the plaintiff has the burden of proof on that issue.

CASE NOTES

Enforcement not precluded. —

Fact that a bankruptcy trustee did not have an original promissory note did not preclude enforcement of it under § 8.3A-309 where it was undisputed that the trustee had a copy of the note; however, final judgment was withheld since it was unclear whether or not adequate protection had been provided. Peyton v. Nat'l Home Buyer Realty, Inc. (In re Forde), No. 01-12296-SSM, No. 03-1283, 2004 Bankr. LEXIS 2361 (Bankr. E.D. Va. May 11, 2004).

CIRCUIT COURT OPINIONS

Enforcement not precluded. —

Bank was in violation of § 8.3A-309 , which provided that lost negotiable instruments were only enforceable by persons who were in possession of the instrument when it was lost, because the bank conceded that it was not in possession of the promissory note a mortgagor executed and that a prior holder lost the note, but the bank’s violation of § 8.3A-309 did not extinguish the mortgagor’s debt obligation; the deed of trust remained valid and enforceable through foreclosure, and the bank’s violation of § 8.3A-309 had no effect on its right to foreclose under the deed of trust pursuant to § 55-59.1.Benkahla v. White, 82 Va. Cir. 116, 2011 Va. Cir. LEXIS 2 (Fairfax County Jan. 18, 2011).

Violation of § 8.3A-309 does not extinguish a borrowers debt obligation, it merely precludes the creditor from enforcing a security as a negotiable instrument under the Virginia Uniform Commercial Code, and a violation of § 8.3A-309 , by itself, has no effect on a creditors foreclosure action under Virginia’s foreclosure laws; enforcement of a promissory note and enforcement of a security instrument are separate and distinct remedies governed by different laws, and a creditor’s foreclosure on a security property is governed by Virginia’s foreclosure statute, § 55-59.1, and not by Virginia’s Uniform Commercial Code. Benkahla v. White, 82 Va. Cir. 116, 2011 Va. Cir. LEXIS 2 (Fairfax County Jan. 18, 2011).

OFFICIAL COMMENT

Section 3-309 is a modification of former Section 3-804. The rights stated are those of “a person entitled to enforce the instrument” at the time of loss rather than those of an “owner” as in former Section 3-804. Under subsection (b), judgment to enforce the instrument cannot be given unless the court finds that the defendant will be adequately protected against a claim to the instrument by a holder that may appear at some later time. The court is given discretion in determining how adequate protection is to be assured. Former Section 3-804 allowed the court to “require security indemnifying the defendant against loss.” Under Section 3-309 adequate protection is a flexible concept. For example, there is substantial risk that a holder in due course may make a demand for payment if the instrument was payable to bearer when it was lost or stolen. On the other hand if the instrument was payable to the person who lost the instrument and that person did not indorse the instrument, no other person could be a holder of the instrument. In some cases there is risk of loss only if there is doubt about whether the facts alleged by the person who lost the instrument are true. Thus, the type of adequate protection that is reasonable in the circumstances may depend on the degree of certainty about the facts in the case.

CASE NOTES

Editor’s note.

The cases annotated below were decided under former § 8.3-802.

Application to note executed before effective date of UCC. —

Where a note antedated the effective date of the Uniform Commercial Code but the transactions and the events which precipitated the demand for payment and made the note actionable occurred after the adoption of the Code, with respect to those transactions and events subsection (1) (b) of former § 8.3-802 (see now subsection (b)) was applicable. Humble Oil & Ref. Co. v. Copley, 213 Va. 449 , 192 S.E.2d 735, 1972 Va. LEXIS 383 (1972).

This section does not limit defenses available to the drawer in actions on commercial paper taken for underlying obligations. Criterion Ins. Co. v. Fulgham, 219 Va. 294 , 247 S.E.2d 404, 1978 Va. LEXIS 191 (1978).

No automatic right of recovery upon dishonor. —

The second sentence of subsection (1) (b) of former § 8.3-802 (see now subsection (b)) merely afforded the holder a choice of remedies, not an automatic right of recovery, if the commercial instrument was dishonored. Criterion Ins. Co. v. Fulgham, 219 Va. 294 , 247 S.E.2d 404, 1978 Va. LEXIS 191 (1978).

Insurer not required to honor draft mistakenly issued. —

Where an insurer mistakenly issued a draft where there was no coverage for the insured’s claim under his policy, the insurer had no underlying obligation to the insured, and the draft was without consideration. Therefore the insurer could not be required to honor the draft under former § 8.3-802, since, under former § 8.3-408 (see now § 8.3A-303 (b) ), want or failure of consideration was a defense as against any person not having the rights of a holder in due course. Criterion Ins. Co. v. Fulgham, 219 Va. 294 , 247 S.E.2d 404, 1978 Va. LEXIS 191 (1978).

OFFICIAL COMMENT

1. Section 3-310 is a modification of former Section 3-802. As a practical matter, application of former Section 3-802 was limited to cases in which a check or a note was given for an obligation. Subsections (a) and (b) of Section 3-310 are therefore stated in terms of checks and notes in the interests of clarity.  Subsection (c) covers the rare cases in which some other instrument is given to pay an obligation.
2. Subsection (a) deals with the case in which a certified check, cashier’s check or teller’s check is given in payment of an obligation.  In that case the obligation is discharged unless there is an agreement to the contrary.  Subsection (a) drops the exception in former Section 3-802 for cases in which there is a right of recourse on the instrument against the obligor.  Under former Section 3-802(1)(a) the obligation was not discharged if there was a right of recourse on the instrument against the obligor.  Subsection (a) changes this result.  The underlying obligation is discharged, but any right of recourse on the instrument is preserved.
3. Subsection (b) concerns cases in which an uncertified check or a note is taken for an obligation.  The typical case is that in which a buyer pays for goods or services by giving the seller the buyer’s personal check, or in which the buyer signs a note for the purchase price.  Subsection (b) also applies to the uncommon cases in which a check or note of a third person is given in payment of the obligation.  Subsection (b) preserves the rule under former Section 3-802(1)(b) that the buyer’s obligation to pay the price is suspended, but subsection (b) spells out the effect more precisely.  If the check or note is dishonored, the seller may sue on either the dishonored instrument or the contract of sale if the seller has possession of the instrument and is the person entitled to enforce it.  If the right to enforce the instrument is held by somebody other than the seller, the seller can’t enforce the right to payment of the price under the sales contract because that right is represented by the instrument which is enforceable by somebody else.  Thus, if the seller sold the note or the check to a holder and has not reacquired it after dishonor, the only right that survives is the right to enforce the instrument.
4. There was uncertainty concerning the applicability of former Section 3-802 to the case in which the check given for the obligation was stolen from the payee, the payee’s signature was forged, and the forger obtained payment.  The last sentence of subsection (b)(4) addresses this issue.  If the payor bank pays a holder, the drawer is discharged on the underlying obligation because the check was paid.  Subsection (b)(1).  If the payor bank pays a person not entitled to enforce the instrument, as in the hypothetical case, the suspension of the underlying obligation continues because the check has not been paid.  Section 3-602(a).  The payee’s cause of action is against the depositary bank or payor bank in conversion under Section 3-420 or against the drawer under Section 3-309.  In the latter case, the drawer’s obligation under Section 3-414(b) is triggered by dishonor which occurs because the check is unpaid.  Presentment for payment to the drawee is excused under Section 3-504(a)(i) and, under Section 3-502(e), dishonor occurs without presentment if the check is not paid. The payee cannot merely ignore the instrument and sue the drawer on the underlying contract.  This would impose on the drawer the risk that the check when stolen was indorsed in blank or to bearer.
5. Subsection (c) deals with rare cases in which other instruments are taken for obligations.  If a bank is the obligor on the instrument, subsection (a) applies and the obligation is discharged. In any other case subsection (b) applies.

The last sentence of subsection (b)(3) applies to cases in which an instrument of another person is indorsed over to the obligee in payment of the obligation. For example, Buyer delivers an uncertified personal check of X payable to the order of Buyer to Seller in payment of the price of goods. Buyer indorses the check over to Seller. Buyer is liable on the check as indorser. If Seller neglects to present the check for payment or to deposit it for collection within 30 days of the indorsement, Buyer’s liability as indorser is discharged. Section 3-415(e). Under the last sentence of Section 3-310(b)(3) Buyer is also discharged on the obligation to pay for the goods.

A similar analysis applies with respect to lost instruments that have not been paid. If a creditor takes a check of the debtor in payment of an obligation, the obligation is suspended under the introductory paragraph of subsection (b). If the creditor then loses the check, what are the creditor’s rights? The creditor can request the debtor to issue a new check and in many cases, the debtor will issue a replacement check after stopping payment on the lost check. In that case both the debtor and creditor are protected. But the debtor is not obliged to issue a new check. If the debtor refuses to issue a replacement check, the last sentence of subsection (b)(4) applies. The creditor may not enforce the obligation of debtor for which the check was taken. The creditor may assert only rights on the check. The creditor can proceed under Section 3-309 to enforce the obligation of the debtor, as drawer, to pay the check.

CASE NOTES

Conspicuous statement. —

Trial court’s judgment was not clearly erroneous since a contractor’s letters and a statement on its payoff check were “conspicuous” and presented a prima facie case of an accord and satisfaction. Gelles & Sons Gen. Contr., Inc. v. Jeffrey Stack, Inc., 264 Va. 285 , 569 S.E.2d 406, 2002 Va. LEXIS 99 (2002).

Statement on check made in good faith. —

Trial court erred in finding that a debtor did not act in good faith, as defined in § 8.3A-103 when she presented a check marked “payment in full” to a bank teller for the amount the debtor believed was owed, and thus the subject mortgage was discharged pursuant to an accord and satisfaction. Johnston v. First Union Nat'l Bank, 271 Va. 239 , 624 S.E.2d 10, 2006 Va. LEXIS 18 (2006).

No accord and satisfaction where no consideration given. —

An accord and satisfaction did not occur on two claims for sales commissions for which defendant former employer offered no payment; the former employer failed to offer any consideration in exchange for plaintiff’s alleged agreement to discharge these claims by accord and satisfaction, and no reasonable person would have considered the check to be tendered in full satisfaction of the two sale commissions claims. Brucato v. Ezenia! Inc., 351 F. Supp. 2d 464, 2004 U.S. Dist. LEXIS 26231 (E.D. Va. 2004).

Accord and satisfaction where two claims are in dispute. —

Where a debtor offers payment for one or more undisputed claims, such payment does not operate to discharge by accord and satisfaction other explicitly disputed claims arising out of separate and distinct transactions. Brucato v. Ezenia! Inc., 351 F. Supp. 2d 464, 2004 U.S. Dist. LEXIS 26231 (E.D. Va. 2004).

Where a debtor offers an amount less than that demanded and denies the remainder, and a reasonable person would have understood the offer to be tendered as full satisfaction of the disputed claim, the claim is discharged when the claimant accepts and negotiates the instrument in payment for the lesser sum. Brucato v. Ezenia! Inc., 351 F. Supp. 2d 464, 2004 U.S. Dist. LEXIS 26231 (E.D. Va. 2004).

Accord and satisfaction found. —

Homeowner was entitled to a final judgment in the homeowner’s favor because the homeowner proved an accord and satisfaction by use of an instrument as the homeowner, who was acting in good faith, submitted a check marked “Paid in Full” to a plumbing company that performed work on the homeowner’s house, along with a letter explaining why the homeowner was not paying disputed portions of the bill, and the plumbing company deposited the check after placing a line through the notation and writing “No” and “Balance Due $1,686.51” on the check. Helton v. Phillip A. Glick Plumbing, Inc., 277 Va. 352 , 672 S.E.2d 842, 2009 Va. LEXIS 27 (2009).

CIRCUIT COURT OPINIONS

Statement on check. —

Electrical contractor’s check marked payment “in full” was sufficient to make the check a full satisfaction check and security company’s negotiation on that check meant the electrical contractor had no further obligation even though the security company marked through the “in full” notation and put “Amount in dispute” beside it. Omni Alarm Sys. v. MCI Elec. Co., 58 Va. Cir. 264, 2002 Va. Cir. LEXIS 146 (Warren County Feb. 26, 2002).

If an alleged accord and satisfaction involves a check, the cancelled check can be used to prove the statement that the check is tendered as full satisfaction of the claim, and because the payee can be reasonably expected to examine the check (a relatively small piece of paper), almost any statement on the face of the check should be noticed and is therefore conspicuous. Chittum v. Anthony, 56 Va. Cir. 536, 2001 Va. Cir. LEXIS 319 (Spotsylvania County Nov. 26, 2001).

Bona fide dispute. —

The pleader of accord and satisfaction must establish that the claim was unliquidated or subject to a bona fide dispute and the person against whom a claim is made must have an honest basis for disputing the amount of the bill. Chittum v. Anthony, 56 Va. Cir. 536, 2001 Va. Cir. LEXIS 319 (Spotsylvania County Nov. 26, 2001).

Term “bona fide dispute,” in the context of a claim of accord and satisfaction, means that a party in good faith, without fraud or deceit, calls into question the validity or existence of or calls into doubt the other party’s claim; an act is deemed to be done in good faith, within the meaning of the Uniform Commercial Code, if it is done honestly. Baughman v. Automated Horizons, Inc., 61 Va. Cir. 67, 2003 Va. Cir. LEXIS 10 (Roanoke Jan. 17, 2003).

No accord and satisfaction. —

As the amount the maker of a promissory note owed to the bearer was not subject to a “bona fide dispute,” the holder’s negotiation of a check for less than the amount due, tendered in “full and final payment,” did not create an accord and satisfaction. Baughman v. Automated Horizons, Inc., 61 Va. Cir. 67, 2003 Va. Cir. LEXIS 10 (Roanoke Jan. 17, 2003).

A plea in bar based on accord and satisfaction was overruled where the localities in the relator’s Virginia Fraud Against Taxpayers Act, § 8.01-216.1 et seq., action were not named parties in the Multidistrict Litigation and had not signed the settlement agreements, and the settlement agreements were not negotiable instruments. Commonwealth ex rel. McShane v. Reichl, 104 Va. Cir. 55, 2019 Va. Cir. LEXIS 1193 (Norfolk Dec. 10, 2019).

Statute inapplicable. —

Court denied builder’s plea in bar that the matters in the customer’s motion for judgment were resolved by accord and satisfaction as it was unclear whether all the customer’s claims were barred; § 8.3A-311 did not apply to this accord and satisfaction claim as the builder did not tender a negotiable instrument as satisfaction of the claim. Gilmore v. Fifield, 61 Va. Cir. 481, 2003 Va. Cir. LEXIS 226 (Loudoun County Apr. 22, 2003).

OFFICIAL COMMENT

1. This section deals with an informal method of dispute resolution carried out by use of a negotiable instrument.  In the typical case there is a dispute concerning the amount that is owed on a claim.
2. Comment d. to Restatement of Contracts, Section 281 discusses the full satisfaction check and the applicable common law rule.  In a case like Case #1, the buyer can propose a settlement of the disputed bill by a clear notation on the check indicating that the check is tendered as full satisfaction of the bill.  Under the common law rule the seller, by obtaining payment of the check accepts the offer of compromise by the buyer.  The result is the same if the seller adds a notation to the check indicating that the check is accepted under protest or in only partial satisfaction of the claim. Under the common law rule the seller can refuse the check or can accept it subject to the condition stated by the buyer, but the seller can’t accept the check and refuse to be bound by the condition.  The rule applies only to an unliquidated claim or a claim disputed in good faith by the buyer.  The dispute in the courts was whether Section 1-207 changed the common law rule.  The Restatement states that section “need not be read as changing this well-established rule.”
3. As part of the revision of Article 3, Section 1-207 has been amended to add subsection (2) stating that Section 1-207 “does not apply to an accord and satisfaction.”  Because of that amendment and revised Article 3, Section 3-311 governs full satisfaction checks. Section 3-311 follows the common law rule with some minor variations to reflect modern business conditions.  In cases covered by Section 3-311 there will often be an individual on one side of the dispute and a business organization on the other.  This section is not designed to favor either the individual or the business organization.  In Case #1 the person seeking the accord and satisfaction is an individual.  In Case #2 the person seeking the accord and satisfaction is an insurance company.  Section 3-311 is based on a belief that the common law rule produces a fair result and that informal dispute resolution by full satisfaction checks should be encouraged.
4. Subsection (a) states three requirements for application of Section 3-311.  “Good faith” in subsection (a)(i) is defined in Section 3-103(a)(4) as not only honesty in fact, but the observance of reasonable commercial standards of fair dealing.  The meaning of “fair dealing” will depend upon the facts in the particular case.  For example, suppose an insurer tenders a check in settlement of a claim for personal injury in an accident clearly covered by the insurance policy.  The claimant is necessitous and the amount of the check is very small in relationship to the extent of the injury and the amount recoverable under the policy.  If the trier of fact determines that the insurer was taking unfair advantage of the claimant, an accord and satisfaction would not result from payment of the check because of the absence of good faith by the insurer in making the tender.  Another example of lack of good faith is found in the practice of some business debtors in routinely printing full satisfaction language on their check stocks so that all or a large part of the debts of the debtor are paid by checks bearing the full satisfaction language, whether or not there is any dispute with the creditor.  Under such a practice the claimant cannot be sure whether a tender in full satisfaction is or is not being made.  Use of a check on which full satisfaction language was affixed routinely pursuant to such a business practice may prevent an accord and satisfaction on the ground that the check was not tendered in good faith under subsection (a)(i).
5. Subsection (c)(1) is a limitation on subsection (b) in cases in which the claimant is an organization.  It is designed to protect the claimant against inadvertent accord and satisfaction.  If the claimant is an organization payment of the check might be obtained without notice to the personnel of the organization concerned with the disputed claim.  Some business organizations have claims against very large numbers of customers.  Examples are department stores, public utilities and the like.  These claims are normally paid by checks sent by customers to a designated office at which clerks employed by the claimant or a bank acting for the claimant process the checks and record the amounts paid.  If the processing office is not designed to deal with communications extraneous to recording the amount of the check and the account number of the customer, payment of a full satisfaction check can easily be obtained without knowledge by the claimant of the existence of the full satisfaction statement.  This is particularly true if the statement is written on the reverse side of the check in the area in which indorsements are usually written. Normally, the clerks of the claimant have no reason to look at the reverse side of checks.  Indorsement by the claimant normally is done by mechanical means or there may be no indorsement at all.  Section 4-205(a).  Subsection (c)(1) allows the claimant to protect itself by advising customers by a conspicuous statement that communications regarding disputed debts must be sent to a particular person, office, or place.  The statement must be given to the customer within a reasonable time before the tender is made.  This requirement is designed to assure that the customer has reasonable notice that the full satisfaction check must be sent to a particular place.  The reasonable time requirement could be satisfied by a notice on the billing statement sent to the customer.  If the full satisfaction check is sent to the designated destination and the check is paid, the claim is discharged.  If the claimant proves that the check was not received at the designated destination the claim is not discharged unless subsection (d) applies.
6. Subsection (c)(2) is also designed to prevent inadvertent accord and satisfaction.  It can be used by a claimant other than an organization or by a claimant as an alternative to subsection (c)(1). Some organizations may be reluctant to use subsection (c)(1) because it may result in confusion of customers that causes checks to be routinely sent to the special designated person, office, or place.  Thus, much of the benefit of rapid processing of checks may be lost.  An organization that chooses not to send a notice complying with subsection (c)(1)(i) may prevent an inadvertent accord and satisfaction by complying with subsection (c)(2).  If the claimant discovers that it has obtained payment of a full satisfaction check, it may prevent an accord and satisfaction if, within 90 days of the payment of the check, the claimant tenders repayment of the amount of the check to the person against whom the claim is asserted.
7. Subsection (c) is subject to subsection (d).  If a person against whom a claim is asserted proves that the claimant obtained payment of a check known to have been tendered in full satisfaction of the claim by “the claimant or an agent of the claimant having direct responsibility with respect to the disputed obligation,” the claim is discharged even if (i) the check was not sent to the person, office, or place required by a notice complying with subsection (c)(1), or (ii) the claimant tendered repayment of the amount of the check in compliance with subsection (c)(2).
8. In some cases the disputed claim may have been assigned to a finance company or bank as part of a financing arrangement with respect to accounts receivable.  If the account debtor was notified of the assignment, the claimant is the assignee of the account receivable and the “agent of the claimant” in subsection (d) refers to an agent of the assignee.

Case #1. The claim is for the price of goods or services sold to a consumer who asserts that he or she is not obliged to pay the full price for which the consumer was billed because of a defect or breach of warranty with respect to the goods or services.

Case #2. A claim is made on an insurance policy. The insurance company alleges that it is not liable under the policy for the amount of the claim.

In either case the person against whom the claim is asserted may attempt an accord and satisfaction of the disputed claim by tendering a check to the claimant for some amount less than the full amount claimed by the claimant. A statement will be included on the check or in a communication accompanying the check to the effect that the check is offered as full payment or full satisfaction of the claim. Frequently, there is also a statement to the effect that obtaining payment of the check is an agreement by the claimant to a settlement of the dispute for the amount tendered. Before enactment of revised Article 3, the case law was in conflict over the question of whether obtaining payment of the check had the effect of an agreement to the settlement proposed by the debtor. This issue was governed by a common law rule, but some courts hold that the common law was modified by former Section 1-207 which they interpreted as applying to full settlement checks.

Section 3-311 does not apply to cases in which the debt is a liquidated amount and not subject to a bona fide dispute. Subsection (a)(ii). Other law applies to cases in which a debtor is seeking discharge of such a debt by paying less than the amount owed. For the purpose of subsection (a)(iii) obtaining acceptance of a check is considered to be obtaining payment of the check.

The person seeking the accord and satisfaction must prove that the requirements of subsection (a) are met. If that person also proves that the statement required by subsection (b) was given, the claim is discharged unless subsection (c) applies. Normally the statement required by subsection (b) is written on the check. Thus, the canceled check can be used to prove the statement as well as the fact that the claimant obtained payment of the check. Subsection (b) requires a “conspicuous” statement that the instrument was tendered in full satisfaction of the claim. “Conspicuous” is defined in Section 1-201 (10). The statement is conspicuous if “it is so written that a reasonable person against whom it is to operate ought to have noticed it.” If the claimant can reasonably be expected to examine the check, almost any statement on the check should be noticed and is therefore conspicuous. In cases in which the claimant is an individual the claimant will receive the check and will normally indorse it. Since the statement concerning tender in full satisfaction normally will appear above the space provided for the claimant’s indorsement of the check, the claimant “ought to have noticed” the statement.

A claimant knows that a check was tendered in full satisfaction of a claim when the claimant “has actual knowledge” of that fact. Section 1-201 (25). Under Section 1-201 (27), if the claimant is an organization, it has knowledge that a check was tendered in full satisfaction of the claim when that fact is

“brought to the attention of the individual conducting that transaction, and in any event when it would have been brought to his 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 such communication is part of his regular duties or unless he has reason to know of the transaction and that the transaction would be materially affected by the information.”

With respect to an attempted accord and satisfaction the “individual conducting that transaction” is an employee or other agent of the organization having direct responsibility with respect to the dispute. For example, if the check and communication are received by a collection agency acting for the claimant to collect the disputed claim, obtaining payment of the check will result in an accord and satisfaction even if the claimant gave notice, pursuant to subsection (c)(1), that full satisfaction checks be sent to some other office. Similarly, if a customer asserting a claim for breach of warranty with respect to defective goods purchased in a retail outlet of a large chain store delivers the full satisfaction check to the manager of the retail outlet at which the goods were purchased, obtaining payment of the check will also result in an accord and satisfaction. On the other hand, if the check is mailed to the chief executive officer of the chain store subsection (d) would probably not be satisfied. The chief executive officer of a large corporation may have general responsibility for operations of the company, but does not normally have direct responsibility for resolving a small disputed bill to a customer. A check for a relatively small amount mailed to a high executive officer of a large organization is not likely to receive the executive’s personal attention. Rather, the check would normally be routinely sent to the appropriate office for deposit and credit to the customer’s account. If the check does receive the personal attention of the high executive officer and the officer is aware of the full-satisfaction language, collection of the check will result in an accord and satisfaction because subsection (d) applies. In this case the officer has assumed direct responsibility with respect to the disputed transaction.

If a full satisfaction check is sent to a lock box or other office processing checks sent to the claimant, it is irrelevant whether the clerk processing the check did or did not see the statement that the check was tendered as full satisfaction of the claim. Knowledge of the clerk is not imputed to the organization because the clerk has no responsibility with respect to an accord and satisfaction. Moreover, there is no failure of “due diligence” under Section 1-201 (27) if the claimant does not require its clerks to look for full satisfaction statements on checks or accompanying communications. Nor is there any duty of the claimant to assign that duty to its clerks. Section 3-311(c) is intended to allow a claimant to avoid an inadvertent accord and satisfaction by complying with either subsection (c)(1) or (2) without burdening the check-processing operation with extraneous and wasteful additional duties.

CASE NOTES

Discharge. —

As a “lost” cashier’s check was not presented until long after a replacement check was enforceable, defendant bank was obligated to pay the amount of the check to a claimant, discharging all liability of the bank pursuant to § 8.3A-312 . As the bank’s liability was fully discharged and it later refused to honor the original check, the claimant was to pay plaintiffs if they were in fact holders in due course of such check, not the bank, in accordance with § 8.3A-312(c) . Willis v. Wells Fargo Bank, N.A., No. 2:11cv193, 2012 U.S. Dist. LEXIS 3662 (E.D. Va. Jan. 11, 2012).

OFFICIAL COMMENT

1. This section applies to cases in which a cashier’s check, teller’s check, or certified check is lost, destroyed, or stolen. In one typical case a customer of a bank closes his or her account and takes a cashier’s check or teller’s check of the bank as payment of the amount of the account. The customer may be moving to a new area and the check is to be used to open a bank account in that area. In such a case the check will normally be payable to the customer. In another typical case a cashier’s check or teller’s check is bought from a bank for the purpose of paying some obligation of the buyer of the check. In such a case the check may be made payable to the customer and then negotiated to the creditor by indorsement. But often, the payee of the check is the creditor. In the latter case the customer is a remitter. The section covers loss of the check by either the remitter or the payee. The section also covers loss of a certified check by either the drawer or the payee.
2. A claim to the amount of a lost, destroyed, or stolen cashier’s check, teller’s check, or certified check may be made under subsection (b) if the following requirements of that subsection are met. First, a claim may be asserted only by the drawer or payee of a certified check or the remitter or payee of a cashier’s check or teller’s check. An indorsee of a check is not covered because the indorsee is not an original party to the check or a remitter. Limitation to an original party or a remitter gives the obligated bank the ability to determine, at the time it becomes obligated on the check, the identity of the person or persons who can assert a claim with respect to the check. The bank is not faced with having to determine the rights of some person who was not a party to the check at that time or with whom the bank had not dealt. If a cashier’s check is issued to the order of the person who purchased it from the bank and that person indorses it over to a third person who loses the check, the third person may assert rights to enforce the check under Section 3-309 but has no rights under Section 3-312.
3. A claim asserted under subsection (b) does not have any legal effect, however, until the date it becomes enforceable, which cannot be earlier than 90 days after the date of a cashier’s check or teller’s check or 90 days after the date of acceptance of a certified check. Thus, if a lost check is presented for payment within the 90-day period, the bank may pay a person entitled to enforce the check without regard to the claim and is discharged of all liability with respect to the check. This ensures the continued utility of cashier’s checks, teller’s checks, and certified checks as cash equivalents. Virtually all such checks are presented for payment within 90 days.
4. The following cases illustrate the operation of Section 3-312:

Under Section 3-309 a person seeking to enforce a lost, destroyed, or stolen cashier’s check or teller’s check may be required by the court to give adequate protection to the issuing bank against loss that might occur by reason of the claim by another person to enforce the check. This might require the posting of an expensive bond for the amount of the check. Moreover, Section 3-309 applies only to a person entitled to enforce the check. It does not apply to a remitter of a cashier’s check or a teller’s check or to the drawer of a certified check. Section 3-312 applies to both. The purpose of Section 3-312 is to offer a person who loses such a check a means of getting refund of the amount of the check within a reasonable period of time without the expense of posting a bond and with full protection of the obligated bank.

Second, the claim must be asserted by a communication to the obligated bank describing the check with reasonable certainty and requesting payment of the amount of the check. “Obligated bank” is described in subsection (a)(4). Third, the communication must be received in time to allow the obligated bank to act on the claim before the check is paid, and the claimant must provide reasonable identification if requested. Subsections (b)(iii) and (iv). Fourth, the communication must contain or be accompanied by a declaration of loss described in subsection (b). This declaration is an affidavit or other writing made under penalty of perjury alleging the loss, destruction, or theft of the check and stating that the declarer is a person entitled to assert a claim, i.e. the drawer or payee of a certified check or the remitter or payee of a cashier’s check or teller’s check.

A claimant who delivers a declaration of loss makes a warranty of the truth of the statements made in the declaration. The warranty is made to the obligated bank and anybody who has a right to enforce the check. If the declaration of loss falsely alleges loss of a cashier’s check that did not in fact occur, a holder of the check who was unable to obtain payment because subsection (b)(3) and (4) caused the obligated bank to dishonor the check would have a cause of action against the declarer for breach of warranty.

The obligated bank may not impose additional requirements on the claimant to assert a claim under subsection (b). For example, the obligated bank may not require the posting of a bond or other form of security. Section 3-312(b) states the procedure for asserting claims covered by the section. Thus, procedures that may be stated in other law for stating claims to property do not apply and are displaced within the meaning of Section 1-103.

If the claim becomes enforceable and payment has not been made to a person entitled to enforce the check, the bank becomes obligated to pay the amount of the check to the claimant. Subsection (b)(4). 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. Subsection (b)(3). Thus, any person entitled to enforce the check, including even a holder in due course, loses the right to enforce the check after a claim under subsection (b) becomes enforceable.

If the obligated bank pays the claimant under subsection (b)(4), the bank is discharged of all liability with respect to the check. The only exception is the unlikely case in which the obligated bank subsequently incurs liability under Section 4-302(a)(1) with respect to the check. For example, Obligated Bank is the issuer of a cashier’s check and, after a claim becomes enforceable, it pays the claimant under subsection (b)(4). Later the check is presented to Obligated Bank for payment over the counter. Under subsection (b)(3), Obligated Bank is not obliged to pay the check and may dishonor the check by returning it to the person who presented it for payment. But the normal rules of check collection are not affected by Section 3-312. If Obligated Bank retains the check beyond midnight of the day of presentment without settling for it, it becomes accountable for the amount of the check under Section 4-302(a)(1) even though it had no obligation to pay the check.

An obligated bank that pays the amount of a check to a claimant under subsection (b)(4) is discharged of all liability on the check so long as the assertion of the claim meets the requirements of subsection (b) discussed in Comment 2. This is important in cases of fraudulent declarations of loss. For example, if the claimant falsely alleges a loss that in fact did not occur, the bank, subject to Section 1-203 , may rely on the declaration of loss. On the other hand, a claim may be asserted only by a person described in subsection (b)(i). Thus, the bank is discharged under subsection (a)(4) only if it pays such a person. Although it is highly unlikely, it is possible that more than one person could assert a claim under subsection (b) to the amount of a check. Such a case could occur if one of the claimants makes a false declaration of loss. The obligated bank is not required to determine whether a claimant who complies with subsection (b) is acting wrongfully. The bank may utilize procedures outside this Article, such as interpleader, under which the conflicting claims may be adjudicated.

Although it is unlikely that a lost check would be presented for payment after the claimant was paid by the bank under subsection (b)(4), it is possible for it to happen. Suppose the declaration of loss by the claimant fraudulently alleged a loss that in fact did not occur. If the claimant negotiated the check, presentment for payment would occur shortly after negotiation in almost all cases. Thus, a fraudulent declaration of loss is not likely to occur unless the check is negotiated after the 90-day period has already expired or shortly before expiration. In such a case the holder of the check, who may not have noticed the date of the check, is not entitled to payment from the obligated bank if the check is presented for payment after the claim becomes enforceable. Subsection (b)(3). The remedy of the holder who is denied payment in that case is an action against the claimant under subsection (c) if the holder is a holder in due course, or for breach of warranty under subsection (b). The holder would also have common law remedies against the claimant under the law of restitution or fraud.

Case #1. Obligated Bank (OB) certified a check drawn by its customer, Drawer (D), payable to Payee (P). Two days after the check was certified, D lost the check and then asserted a claim pursuant to subsection (b). The check had not been presented for payment when D’s claim became enforceable 90 days after the check was certified. Under subsection (b)(4), at the time D’s claim became enforceable OB became obliged to pay D the amount of the check. If the check is later presented for payment, OB may refuse to pay the check and has no obligation to anyone to pay the check. Any obligation owed by D to P, for which the check was intended as payment, is unaffected because the check was never delivered to P.

Case #2. Obligated Bank (OB) issued a teller’s check to Remitter (R) payable to Payee (P). R delivered the check to P in payment of an obligation. P lost the check and then asserted a claim pursuant to subsection (b). To carry out P’s order, OB issued an order pursuant to Section 4-403(a) to the drawee of the teller’s check to stop payment of the check effective on the 90th day after the date of the teller’s check. The check was not presented for payment. On the 90th day after the date of the teller’s check P’s claim becomes enforceable and OB becomes obliged to pay P the amount of the check. As in case #1, OB has no further liability with respect to the check to anyone. When R delivered the check to P, R’s underlying obligation to P was discharged under Section 3-310. Thus, R suffered no loss. Since P received the amount of the check, P also suffered no loss except with respect to the delay in receiving the amount of the check.

Case #3. Obligated Bank (OB) is sued a cashier’s check to its customer, Payee (P). Two days after issue, the check was stolen from P who then asserted a claim pursuant to subsection (b). Ten days after issue, the check was deposited by X in an account in Depositary Bank (DB). X had found the check and forged the indorsement of P. DB promptly presented the check to OB and obtained payment on behalf of X. On the 90th day after the date of the check P’s claim becomes enforceable and P is entitled to receive the amount of the check from OB. Subsection (b)(4). Although the check was presented for payment before P’s claim became enforceable, OB is not discharged. Because of the forged indorsement X was not a holder and neither was DB. Thus, neither is a person entitled to enforce the check (Section 3-301) and OB is not discharged under Section 3-602(a). Thus, under subsection (b)(4), because OB did not pay a person entitled to enforce the check, OB must pay P. OB’s remedy is against DB for breach of warranty under Section 4-208(a)(1). As an alternative to the remedy under Section 3-312, P could recover from DB for conversion under Section 3-420(a).

Case #4. Obligated Bank (OB) issued a cashier’s check to its customer, Payee (P). P made an unrestricted blank indorsement of the check and mailed the check to P’s bank for deposit to P’s account. The check was never received by P’s bank. When P discovered the loss, P asserted a claim pursuant to subsection (b). X found the check and deposited it in X’s account in Depositary Bank (DB) after indorsing the check. DB presented the check for payment before the end of the 90-day period after its date. OB paid the check. Because of the unrestricted blank endorsement by P, X became a holder of the check. DB also became a holder. Since the check was paid before P’s claim became enforceable and payment was made to a person entitled to enforce the check, OB is discharged of all liability with respect to the check. Subsection (b)(2). Thus, P is not entitled to payment from OB. Subsection (b)(4) doesn’t apply.

Case #5. Obligated Bank (OB) issued a cashier’s check to its customer, Payee (P). P made an unrestricted blank indorsement of the check and mailed the check to P’s bank for deposit to P’s account. The check was never received by P’s bank. When P discovered the loss, P asserted a claim pursuant to subsection (b). At the end of the 90-day period after the date of the check, OB paid the amount of the check to P under subsection (b)(4). X then found the check and deposited it to X’s account in Depositary Bank (DB). DB presented the check to OB for payment. OB is not obliged to pay the check. Subsection (b)(4). If OB dishonors the check, DB’s remedy is to charge back to X’s account. Section 4-214(a). Although P, as an indorser, would normally have liability to DB under Section 3-415(a) because the check was dishonored, P is released from that liability under Section 3-415(e) because collection of the check was initiated more than 30 days after the indorsement. DB has a remedy only against X. A depositary bank that takes a cashier’s check that cannot be presented for payment before expiration of the 90-day period after its date is on notice that the check might not be paid because of the possibility of a claim asserted under subsection (b) which would excuse the issuer of the check from paying the check. Thus, the depositary bank cannot safely release funds with respect to the check until it has assurance that the check has been paid. DB cannot be a holder in due course of the check because it took the check when the check was overdue. Section 3-304(a)(2). Thus, DB has no action against P under subsection (c).

Case #6. Obligated Bank (OB) issued a cashier’s check payable to bearer and delivered it to its customer, Remitter (R). R held the check for 90 days and then wrongfully asserted a claim to the amount of the check under subsection (b). The declaration of loss fraudulently stated that the check was lost. R received payment from OB under subsection (b)(4). R then negotiated the check to X for value. X presented the check to OB for payment. Although OB, under subsection (b)(2), was not obliged to pay the check, OB paid X by mistake. OB’s teller did not notice that the check was more than 90 days old and was not aware that OB was not obliged to pay the check. If X took the check in good faith, OB may not recover from X. Section 3-418(c). OB’s remedy is to recover from R for fraud or for breach of warranty in making a false declaration of loss. Subsection (b).

CASE NOTES

Liability. —

Clause (i) of § 19.2-271.2 did not apply because the husband was not the victim of the offense; the husband did not rely on defendant’s deceit, as he testified that he had no knowledge that defendant had written the check, he was not defrauded, and he parted with nothing of value because the bank had earlier closed the account from which defendant wrote the check. Lindsey v. Commonwealth, 2007 Va. App. LEXIS 480 (Va. Ct. App. Dec. 27, 2007).

OFFICIAL COMMENT

1. Obligation on an instrument depends on a signature that is binding on the obligor.  The signature may be made by the obligor personally or by an agent authorized to act for the obligor.  Signature by agents is covered by Section 3-402.  It is not necessary that the name of the obligor appear on the instrument, so long as there is a signature that binds the obligor.  Signature includes an indorsement.
2. A signature may be handwritten, typed, printed or made in any other manner.  It need not be subscribed, and may appear in the body of the instrument, as in the case of “I, John Doe, promise to pay * * *” without any other signature.  It may be made by mark, or even by thumb-print.  It may be made in any name, including any trade name or assumed name, however false and fictitious, which is adopted for the purpose.  Parol evidence is admissible to identify the signer, and when the signer is identified the signature is effective.  Indorsement in a name other than that of the indorser is governed by Section 3-204(d).

This section is not intended to affect any other law requiring a signature by mark to be witnessed, or any signature to be otherwise authenticated, or requiring any form of proof.

OFFICIAL COMMENT

1. Subsection (a) states when the represented person is bound on an instrument if the instrument is signed by a representative.  If under the law of agency the represented person would be bound by the act of the representative in signing either the name of the represented person or that of the representative, the signature is the authorized signature of the represented person.  Former Section 3-401(1) stated that “no person is liable on an instrument unless his signature appears thereon.”  This was interpreted as meaning that an undisclosed principal is not liable on an instrument. This interpretation provided an exception to ordinary agency law that binds an undisclosed principal on a simple contract.
2. Subsection (b) concerns the question of when an agent who signs an instrument on behalf of a principal is bound on the instrument.  The approach followed by former Section 3-403 was to specify the form of signature that imposed or avoided liability.  This approach was unsatisfactory.  There are many ways in which there can be ambiguity about a signature.  It is better to state a general rule. Subsection (b)(1) states that if the form of the signature unambiguously shows that it is made on behalf of an identified represented person (for example, “P, by A, Treasurer”) the agent is not liable. This is a workable standard for a court to apply. Subsection (b)(2) partly changes former Section 3-403(2).  Subsection (b)(2) relates to cases in which the agent signs on behalf of a principal but the form of the signature does not fall within subsection (b)(1).  The following cases are illustrative.  In each case John Doe is the authorized agent of Richard Roe and John Doe signs a note on behalf of Richard Roe.  In each case the intention of the original parties to the instrument is that Roe is to be liable on the instrument but Doe is not to be liable.
3. Subsection (c) is directed at the check cases.  It states that if the check identifies the represented person the agent who signs on the signature line does not have to indicate agency status. Virtually all checks used today are in personalized form which identify the person on whose account the check is drawn.  In this case, nobody is deceived into thinking that the person signing the check is meant to be liable.  This subsection is meant to overrule cases decided under former Article 3 such as Griffin v. Ellinger, 538 S.W.2d 97 (Texas 1976).

It is questionable whether this exception was justified by the language of former Article 3 and there is no apparent policy justification for it. The exception is rejected by subsection (a) which returns to ordinary rules of agency. If P, the principal, authorized A, the agent, to borrow money on P’s behalf and A signed A’s name to a note without disclosing that the signature was on behalf of P, A is liable on the instrument. But if the person entitled to enforce the note can also prove that P authorized A to sign on P’s behalf, why shouldn’t P also be liable on the instrument? To recognize the liability of P takes nothing away from the utility of negotiable instruments. Furthermore, imposing liability on P has the merit of making it impossible to have an instrument on which nobody is liable even though it was authorized by P. That result could occur under former Section 3-401(1) if an authorized agent signed “as agent” but the note did not identify the principal. If the dispute was between the agent and the payee of the note, the agent could escape liability on the note by proving that the agent and the payee did not intend that the agent be liable on the note when the note was issued. Former Section 3-403(2)(b). Under the prevailing interpretation of former Section 3-401(1), the principal was not liable on the note under former Section 3-401(1) because the principal’s name did not appear on the note. Thus, nobody was liable on the note even though all parties knew that the note was signed by the agent on behalf of the principal. Under Section 3-402(a) the principal would be liable on the note.

Case #1. Doe signs “John Doe” without indicating in the note that Doe is signing as agent. The note does not identify Richard Roe as the represented person.

Case #2. Doe signs “John Doe, Agent” but the note does not identify Richard Roe as the represented person.

Case #3. The name “Richard Roe” is written on the note and immediately below that name Doe signs “John Doe” without indicating that Doe signed as agent.

In each case Doe is liable on the instrument to a holder in due course without notice that Doe was not intended to be liable. In none of the cases does Doe’s signature unambiguously show that Doe was signing as agent for an identified principal. A holder in due course should be able to resolve any ambiguity against Doe.

But the situation is different if a holder in due course is not involved. In each case Roe is liable on the note. Subsection (a). If the original parties to the note did not intend that Doe also be liable, imposing liability on Doe is a windfall to the person enforcing the note. Under subsection (b)(2) Doe is prima facie liable because his signature appears on the note and the form of the signature does not unambiguously refute personal liability. But Doe can escape liability by proving that the original parties did not intend that he be liable on the note. This is a change from former Section 3-403(2)(a).

A number of cases under former Article 3 involved situations in which an agent signed the agent’s name to a note, without qualification and without naming the person represented, intending to bind the principal but not the agent. The agent attempted to prove that the other party had the same intention. Some of these cases involved mistake, and in some there was evidence that the agent may have been deceived into signing in that manner. In some of the cases the court refused to allow proof of the intention of the parties and imposed liability on the agent based on former Section 3-403(2)(a) even though both parties to the instrument may have intended that the agent not be liable. Subsection (b)(2) changes the result of those cases, and is consistent with Section 3-117 which allows oral or written agreements to modify or nullify apparent obligations on the instrument.

Former Section 3-403 spoke of the represented person being “named” in the instrument. Section 3-402 speaks of the represented person being “identified” in the instrument. This change in terminology is intended to reject decisions under former Section 3-403(2) requiring that the instrument state the legal name of the represented person.

CASE NOTES

Failure to assert defense of forgery within the 21-day period in no way prejudiced the bank or caused its loss where reliance on the forged signature was complete at the time of the forgery. Pate v. Southern Bank & Trust Co., 214 Va. 596 , 203 S.E.2d 126, 1974 Va. LEXIS 185 (1974) (decided under former § 8.3-404).

OFFICIAL COMMENT

1. “Unauthorized” signature is defined in Section 1-201 (43) as one that includes a forgery as well as a signature made by one exceeding actual or apparent authority.  Former Section 3-404(1) stated that an unauthorized signature was inoperative as the signature of the person whose name was signed unless that person “is precluded from denying it.”  Under former Section 3-406 if negligence by the person whose name was signed contributed to an unauthorized signature, that person “is precluded from asserting the * * * lack of authority.” Both of these sections were applied to cases in which a forged signature appeared on an instrument and the person asserting rights on the instrument alleged that the negligence of the purported signer contributed to the forgery.  Since the standards for liability between the  two sections differ, the overlap between the sections caused confusion.  Section 3-403(a) deals with the problem by removing the preclusion language that appeared in former Section 3-404.
2. The except clause of the first sentence of subsection (a) states the generally accepted rule that the unauthorized signature, while it is wholly inoperative as that of the person whose name is signed, is effective to impose liability upon the signer or to transfer any rights that the signer may have in the instrument.  The signer’s liability is not in damages for breach of warranty of authority, but is full liability on the instrument in the capacity in which the signer signed.  It is, however, limited to parties who take or pay the instrument in good faith; and one who knows that the signature is unauthorized cannot recover from the signer on the instrument.
3. The last sentence of subsection (a) allows an unauthorized signature to be ratified.  Ratification is a retroactive adoption of the unauthorized signature by the person whose name is signed and may be found from conduct as well as from express statements.  For example, it may be found from the retention of benefits received in the transaction with knowledge of the unauthorized signature.  Although the forger is not an agent, ratification is governed by the rules and principles applicable to ratification of unauthorized acts of an agent.
4. Subsection (b) clarifies the meaning of “unauthorized” in cases in which an instrument contains less than all of the signatures that are required as authority to pay a check. Judicial authority was split on the issue whether the one-year notice period under former Section 4-406(4) (now Section 4-406(f)) barred a customer’s suit against a payor bank that paid a check containing less than all of the signatures required by the customer to authorize payment of the check. Some cases took the view that if a customer required that a check contain the signatures of both A and B to authorize payment and only A signed, there was no unauthorized signature within the meaning of that term in former Section 4-406(4) because A’s signature was neither unauthorized nor forged. The other cases correctly pointed out that it was the customer’s signature at issue and not that of A; hence, the customer’s signature was unauthorized if all signatures required to authorize payment of the check were not on the check. Subsection (b) follows the latter line of cases.  The same analysis applies if A forged the signature of B.  Because the forgery is not effective as a signature of B, the required signature of B is lacking.

Ratification is effective for all purposes of this Article. The unauthorized signature becomes valid so far as its effect as a signature is concerned. Although the ratification may relieve the signer of liability on the instrument, it does not of itself relieve the signer of liability to the person whose name is signed. It does not in any way affect the criminal law. No policy of the criminal law prevents a person whose name is forged to assume liability to others on the instrument by ratifying the forgery, but the ratification cannot affect the rights of the state. While the ratification may be taken into account with other relevant facts in determining punishment, it does not relieve the signer of criminal liability.

Subsection (b) refers to “the authorized signature of an organization.” The definition of “organization” in Section 1-201 (28) is very broad. It covers not only commercial entities but also “two or more persons having a joint or common interest.” Hence subsection (b) would apply when a husband and wife are both required to sign an instrument.

CASE NOTES

Comparative negligence applies. —

Pursuant to this section and § 8.3A-405 , as between the drawer and the depository bank, the concept of comparative negligence is employed to determine liability to the person sustaining the loss based upon the premise that all participants in the process have a duty to exercise ordinary care in the drawing and handling of checks. Gina Chin & Assocs. v. First Union Bank, 260 Va. 533 , 537 S.E.2d 573, 2000 Va. LEXIS 150 (2000).

Double forgery situations. —

See Gina Chin & Assocs. v. First Union Bank, 256 Va. 59 , 500 S.E.2d 516, 1998 Va. LEXIS 98 (1998).

OFFICIAL COMMENT

1. Under former Article 3, the impostor cases were governed by former Section 3-405(1)(a) and the fictitious payee cases were governed by Section 3-405(1)(b).  Section 3-404 replaces former Section 3-405(1)(a) and (b) and modifies the previous law in some respects. Former Section 3-405 was read by some courts to require that the indorsement be in the exact name of the named payee.  Revised Article 3 rejects this result. Section 3-404(c) requires only that the indorsement be made in a name “substantially similar” to that of the payee. Subsection (c) also recognizes the fact that checks may be deposited without indorsement.  Section 4-205(a).
2. Subsection (b) is based in part on former Section 3-405(1)(b) and in part on N.I.L. § 9(3).  It covers cases in which an instrument is payable to a fictitious or nonexisting person and to cases in which the payee is a real person but the drawer or maker does not intend the payee to have any interest in the instrument. Subsection (b) applies to any instrument, but its primary importance is with respect to checks of corporations and other organizations.  It also applies to forged check cases.  The following cases illustrate subsection (b):
3. In cases governed by subsection (a) the dispute will normally be between the drawer of the check that was obtained by the impostor and the drawee bank that paid it.  The drawer is precluded from obtaining recredit of the drawer’s account by arguing that the check was paid on a forged indorsement so long as the drawee bank acted in good faith in paying the check.  Cases governed by subsection (b) are illustrated by Cases #1 through #5 in Comment 2.  In Cases #1, #2, and #3 there is no forgery of the check, thus the drawer of the check takes the loss if there is no lack of good faith by the banks involved. Cases #4 and #5 are forged check cases.  Depositary Bank is entitled to retain the proceeds of the check if it didn’t know about the forgery. Under Section 3-418 the drawee bank is not entitled to recover from Depositary Bank on the basis of payment by mistake because Depositary Bank took the check in good faith and gave value for the check when the credit given for the check was withdrawn.  And there is no breach of warranty under Section 3-417(a)(1) or (3) or 4-208(a)(1) or (3). Unless Section 3-406 applies the loss is taken by the drawee bank if a forged check is paid, and that is the result in Case #5.  In Case #4 the loss is taken by Corporation, the drawer, because an agreement between Corporation and the drawee bank allowed the bank to debit Corporation’s account despite the unauthorized use of the check-writing machine.

Subsection (a) changes the former law in a case in which the impostor is impersonating an agent. Under former Section 3-405(1)(a), if Impostor impersonated Smith and induced the drawer to draw a check to the order of Smith, Impostor could negotiate the check. If Impostor impersonated Smith, the president of Smith Corporation, and the check was payable to the order of Smith Corporation, the section did not apply. See the last paragraph of Comment 2 to former Section 3-405. In revised Article 3, Section 3-404(a) gives Impostor the power to negotiate the check in both cases.

Case #1. Treasurer is authorized to draw checks in behalf of Corporation. Treasurer fraudulently draws a check of Corporation payable to Supplier Co., a non-existent company. Subsection (b) applies because Supplier Co. is a fictitious person and because Treasurer did not intend Supplier Co. to have any interest in the check. Under subsection (b)(1) Treasurer, as the person in possession of the check, becomes the holder of the check. Treasurer indorses the check in the name “Supplier Co.” and deposits it in Depositary Bank. Under subsection (b)(2) and (c)(i), the indorsement is effective to make Depositary Bank the holder and therefore a person entitled to enforce the instrument. Section 3-301.

Case #2. Same facts as Case #1 except that Supplier Co. is an actual company that does business with Corporation. If Treasurer intended to steal the check when the check was drawn, the result in Case #2 is the same as the result in Case #1. Subsection (b) applies because Treasurer did not intend Supplier Co. to have any interest in the check. It does not make any difference whether Supplier Co. was or was not a creditor of Corporation when the check was drawn. If Treasurer did not decide to steal the check until after the check was drawn, the case is covered by Section 3-405 rather than Section 3-404(b), but the result is the same. See Case #6 in Comment 3 to Section 3-405.

Case #3. Checks of Corporation must be signed by two officers. President and Treasurer both sign a check of Corporation payable to Supplier Co., a company that does business with Corporation from time to time but to which Corporation does not owe any money. Treasurer knows that no money is owed to Supplier Co. and does not intend that Supplier Co. have any interest in the check. President believes that money is owed to Supplier Co. Treasurer obtains possession of the check after it is signed. Subsection (b) applies because Treasurer is “a person whose intent determines to whom an instrument is payable” and Treasurer does not intend Supplier Co. to have any interest in the check. Treasurer becomes the holder of the check and may negotiate it by indorsing it in the name “Supplier Co.”

Case #4. Checks of Corporation are signed by a check-writing machine. Names of payees of checks produced by the machine are determined by information entered into the computer that operates the machine. Thief, a person who is not an employee or other agent of Corporation, obtains access to the computer and causes the check-writing machine to produce a check payable to Supplier Co., a non-existent company. Subsection (b)(ii) applies. Thief then obtains possession of the check. At that point Thief becomes the holder of the check because Thief is the person in possession of the instrument. Subsection (b)(1). Under Section 3-301 Thief, as holder, is the “person entitled to enforce the instrument” even though Thief does not have title to the check and is in wrongful possession of it. Thief indorses the check in the name “Supplier Co.” and deposits it in an account in Depositary Bank which Thief opened in the name “Supplier Co.” Depositary Bank takes the check in good faith and credits the “Supplier Co.” account. Under subsection (b)(2) and (c)(i), the indorsement is effective. Depositary Bank becomes the holder and the person entitled to enforce the check. The check is presented to the drawee bank for payment and payment is made. Thief then withdraws the credit to the account. Although the check was issued without authority given by Corporation, the drawee bank is entitled to pay the check and charge Corporation’s account if there was an agreement with Corporation allowing the bank to debit Corporation’s account for payment of checks produced by the check-writing machine whether or not authorized. The indorsement is also effective if Supplier Co. is a real person. In that case subsection (b)(i) applies. Under Section 3-110(b) Thief is the person whose intent determines to whom the check is payable, and Thief did not intend Supplier Co. to have any interest in the check. When the drawee bank pays the check, there is no breach of warranty under Section 3-417(a)(1) or 4-208(a)(1) because Depositary Bank was a person entitled to enforce the check when it was forwarded for payment.

Case #5. Thief, who is not an employee or agent of Corporation, steals check forms of Corporation. John Doe is president of Corporation and is authorized to sign checks on behalf of Corporation as drawer. Thief draws a check in the name of Corporation as drawer by forging the signature of Doe. Thief makes the check payable to the order of Supplier Co. with the intention of stealing it. Whether Supplier Co. is a fictitious person or a real person, Thief becomes the holder of the check and the person entitled to enforce it. The analysis is the same as that in Case #4. Thief deposits the check in an account in Depositary Bank which Thief opened in the name “Supplier Co.” Thief either indorses the check in a name other than “Supplier Co.” or does not indorse the check at all. Under Section 4-205(a) a depositary bank may become holder of a check deposited to the account of a customer if the customer was a holder, whether or not the customer indorses. Subsection (c)(ii) treats deposit to an account in a name substantially similar to that of the payee as the equivalent of indorsement in the name of the payee. Thus, the deposit is an effective indorsement of the check. Depositary Bank becomes the holder of the check and the person entitled to enforce the check. If the check is paid by the drawee bank, there is no breach of warranty under Section 3-417(a)(1) or 4-208(a)(1) because Depositary Bank was a person entitled to enforce the check when it was forwarded for payment and, unless Depositary Bank knew about the forgery of Doe’s signature, there is no breach of warranty under Section 3-417(a)(3) or 4-208(a)(3). Because the check was a forged check the drawee bank is not entitled to charge Corporation’s account unless Section 3-406 or Section 4-406 applies.

If a check payable to an impostor, fictitious payee, or payee not intended to have an interest in the check is paid, the effect of subsections (a) and (b) is to place the loss on the drawer of the check rather than on the drawee or the Depositary Bank that took the check for collection. Cases governed by subsection (a) always involve fraud, and fraud is almost always involved in cases governed by subsection (b). The drawer is in the best position to avoid the fraud and thus should take the loss. This is true in Case #1, Case #2, and Case #3. But in some cases the person taking the check might have detected the fraud and thus have prevented the loss by the exercise of ordinary care. In those cases, if that person failed to exercise ordinary care, it is reasonable that that person bear loss to the extent the failure contributed to the loss. Subsection (d) is intended to reach that result. It allows the person who suffers loss as a result of payment of the check to recover from the person who failed to exercise ordinary care. In Case #1, Case #2, and Case #3, the person suffering the loss is Corporation, the drawer of the check. In each case the most likely defendant is the depositary bank that took the check and failed to exercise ordinary care. In those cases, the drawer has a cause of action against the offending bank to recover a portion of the loss. The amount of loss to be allocated to each party is left to the trier of fact. Ordinary care is defined in Section 3-103(a)(7). An example of the type of conduct by a depositary bank that could give rise to recovery under subsection (d) is discussed in Comment 4 to Section 3-405. That comment addresses the last sentence of Section 3-405(b) which is similar to Section 3-404(d).

In Case #1, Case #2, and Case #3, there was no forgery of the drawer’s signature. But cases involving checks payable to a fictitious payee or a payee not intended to have an interest in the check are often forged check cases as well. Examples are Case #4 and Case #5. Normally, the loss in forged check cases is on the drawee bank that paid the check. Case #5 is an example. In Case #4 the risk with respect to the forgery is shifted to the drawer because of the agreement between the drawer and the drawee bank. The doctrine that prevents a drawee bank from recovering payment with respect to a forged check if the payment was made to a person who took the check for value and in good faith is incorporated into Section 3-418 and Sections 3-417(a)(3) and 4-208(a)(3). This doctrine is based on the assumption that the depositary bank normally has no way of detecting the forgery because the drawer is not that bank’s customer. On the other hand, the drawee bank, at least in some cases, may be able to detect the forgery by comparing the signature on the check with the specimen signature that the drawee has on file. But in some forged check cases the depositary bank is in a position to detect the fraud. Those cases typically involve a check payable to a fictitious payee or a payee not intended to have an interest in the check. Subsection (d) applies to those cases. If the depositary bank failed to exercise ordinary care and the failure substantially contributed to the loss, the drawer in Case #4 or the drawee bank in Case #5 has a cause of action against the depositary bank under subsection (d). Comment 4 to Section 3-405 can be used as a guide to the type of conduct that could give rise to recovery under Section 3-404(d).

CASE NOTES

Double forgery situations. —

See Gina Chin & Assocs. v. First Union Bank, 256 Va. 59 , 500 S.E.2d 516, 1998 Va. LEXIS 98 (1998).

CIRCUIT COURT OPINIONS

Conversion found. —

Because a company president’s wife, as the company’s bookkeeper, lacked any authority over some 7 checks payable to the president individually, her forgery of said checks defeated any argument that there was an effective negotiation of said checks, as the wife was not the president’s employee. Further, the depository bank failed in its burden of showing that the payee failed to exercise ordinary care, and that such failure substantially contributed to the making of the forged signature. Fax Connection, Inc. v. Chevy Chase Bank, F.S.B., 73 Va. Cir. 263, 2007 Va. Cir. LEXIS 72 (Fairfax County Apr. 16, 2007).

Conversion not found. —

Because a company president’s wife, who also served as the company’s bookkeeper, was entrusted with the responsibility over some 59 checks that were allegedly forged and placed in her personal account, the circuit court found that said checks were effectively negotiated, and not converted, and that the depository bank acted in good faith, exercising ordinary care in honoring said checks presented to it by the bookkeeper. Thus, the bank could not be liable to the company and its president for the same. Fax Connection, Inc. v. Chevy Chase Bank, F.S.B., 73 Va. Cir. 263, 2007 Va. Cir. LEXIS 72 (Fairfax County Apr. 16, 2007).

OFFICIAL COMMENT

1. Section 3-405 is addressed to fraudulent indorsements made by an employee with respect to instruments with respect to which the employer has given responsibility to the employee. It covers two categories of fraudulent indorsements: indorsements made in the name of the employer to instruments payable to the employer and indorsements made in the name of payees of instruments issued by the employer.  This section applies to instruments generally but normally the instrument will be a check.  Section 3-405 adopts the principle that the risk of loss for fraudulent indorsements by employees who are entrusted with responsibility with respect to checks should fall on the employer rather than the bank that takes the check or pays it, if the bank was not negligent in the transaction. Section 3-405 is based on the belief that the employer is in a far better position to avoid the loss by care in choosing employees, in supervising them, and in adopting other measures to prevent forged indorsements on instruments payable to the employer or fraud in the issuance of instruments in the name of the employer.  If the bank failed to exercise ordinary care, subsection (b) allows the employer to shift loss to the bank to the extent the bank’s failure to exercise ordinary care contributed to the loss.  “Ordinary care” is defined in Section 3-103(a)(7).  The provision applies regardless of whether the employer is negligent.
2. With respect to cases governed by former Section 3-405(1)(c), Section 3-405 is more favorable to employers in one respect.  The bank was entitled to the preclusion provided by former Section 3-405(1)(c) if it took the check in good faith.  The fact that the bank acted negligently did not shift the loss to the bank so long as the bank acted in good faith. Under revised section 3-405 the loss may be recovered from the bank to the extent the failure of the bank to exercise ordinary care contributed to the loss.
3. Section 3-404(b) and Section 3-405 both apply to cases of employee fraud.  Section 3-404(b) is not limited to cases of employee fraud, but most of the cases to which it applies will be cases of employee fraud.  The following cases illustrate the application of Section 3-405.  In each case it is assumed that the bank that took the check acted in good faith and was not negligent.
4. The last sentence of subsection (b) is similar to subsection (d) of Section 3-404 which is discussed in Comment 3 to Section 3-404.  In Case #5, Case #6, or Case #7 the depositary bank may have failed to exercise ordinary care when it allowed the employee to open an account in the name “Supplier Co.”, to deposit checks payable to “Supplier Co.” in that account, or to withdraw funds from that account that were proceeds of checks payable to Supplier Co.  Failure to exercise ordinary care is to be determined in the context of all the facts relating to the bank’s conduct with respect to the bank’s collection of the check.  If the trier of fact finds that there was such a failure and that the failure substantially contributed to loss, it could find the depositary bank liable to the extent the failure contributed to the loss.  The last sentence of subsection (b) can be illustrated by an example.  Suppose in Case #5 that the check is not payable to an obscure “Supplier Co.” but rather to a well-known national corporation.  In addition, the check is for a very large amount of money.  Before depositing the check, Employee opens an account in Depositary Bank in the name of the corporation and states to the person conducting the transaction for the bank that Employee is manager of a new office being opened by the corporation.  Depositary Bank opens the account without requiring Employee to produce any resolutions of the corporation’s board of directors or other evidence of authorization of Employee to act for the corporation.  A few days later, the check is deposited, the account is credited, and the check is presented for payment. After Depositary Bank receives payment, it allows Employee to withdraw the credit by a wire transfer to an account in a bank in a foreign country.  The trier of fact could find that Depositary Bank did not exercise ordinary care and that the failure to exercise ordinary care contributed to the loss suffered by Employer. The trier of fact could allow recovery by Employer from Depositary Bank for all or part of the loss suffered by Employer.

The first category of cases governed by Section 3-405 are those involving indorsements made in the name of payees of instruments issued by the employer. In this category, Section 3-405 includes cases that were covered by former Section 3-405(1)(c). The scope of Section 3-405 in revised Article 3 is, however, somewhat wider. It covers some cases not covered by former Section 3-405(1)(c) in which the entrusted employee makes a forged indorsement to a check drawn by the employer. An example is Case #6 in Comment 3. Moreover, a larger group of employees is included in revised Section 3-405. The key provision is the definition of “responsibility” in subsection (a)(1) which identifies the kind of responsibility delegated to an employee which will cause the employer to take responsibility for the fraudulent acts of that employee. An employer can insure this risk by employee fidelity bonds.

The second category of cases governed by Section 3-405 — fraudulent indorsements of the name of the employer to instruments payable to the employer — were covered in former Article 3 by Section 3-406. Under former Section 3-406, the employer took the loss only if negligence of the employer could be proved. Under revised Article 3, Section 3-406 need not be used with respect to forgeries of the employer’s indorsement. Section 3-405 imposes the loss on the employer without proof of negligence.

Case #1. Janitor, an employee of Employer, steals a check for a very large amount payable to Employer after finding it on a desk in one of Employer’s offices. Janitor forges Employer’s indorsement on the check and obtains payment. Since Janitor was not entrusted with “responsibility” with respect to the check, Section 3-405 does not apply. Section 3-406 might apply to this case. The issue would be whether Employer was negligent in safeguarding the check. If not, Employer could assert that the indorsement was forged and bring an action for conversion against the depositary or payor bank under Section 3-420.

Case #2. X is Treasurer of Corporation and is authorized to write checks on behalf of Corporation by signing X’s name as Treasurer. X draws a check in the name of Corporation and signs X’s name as Treasurer. The check is made payable to X. X then indorses the check and obtains payment. Assume that Corporation did not owe any money to X and did not authorize X to write the check. Although the writing of the check was not authorized, Corporation is bound as drawer of the check because X had authority to sign checks on behalf of Corporation. This result follows from agency law and Section 3-402(a). Section 3-405 does not apply in this case because there is no forged indorsement. X was payee of the check so the indorsement is valid. Section 3-110(a).

Case #3. The duties of Employee, a bookkeeper, include posting the amounts of checks payable to Employer to the accounts of the drawers of the checks. Employee steals a check payable to Employer which was entrusted to Employee and forges Employer’s indorsement. The check is deposited by employee to an account in Depositary Bank which Employee opened in the same name as Employer, and the check is honored by the drawee bank. The indorsement is effective as Employer’s indorsement because Employee’s duties include processing checks for bookkeeping purposes. Thus, Employee is entrusted with “responsibility” with respect to the check. Neither Depositary Bank nor the drawee bank is liable to Employer for conversion of the check. The same result follows if Employee deposited the check in the account in Depositary Bank without indorsement. Section 4-205(a). Under subsection (c) deposit in a depositary bank in an account in a name substantially similar to that of Employer is the equivalent of an indorsement in the name of Employer.

Case #4. Employee’s duties include stamping Employer’s unrestricted blank indorsement on checks received by Employer and depositing them in Employer’s bank account. After stamping Employer’s unrestricted blank indorsement on a check, Employee steals the check and deposits it in Employee’s personal bank account. Section 3-405 doesn’t apply because there is no forged indorsement. Employee is authorized by Employer to indorse Employer’s checks. The fraud by Employee is not the indorsement but rather the theft of the indorsed check. Whether Employer has a cause of action against the bank in which the check was deposited is determined by whether the bank had notice of the breach of fiduciary duty by Employee. The issue is determined under Section 3-307.

Case #5. The computer that controls Employer’s check-writing machine was programmed to cause a check to be issued to Supplier Co. to which money was owed by Employer. The address of Supplier Co. was included in the information in the computer. Employee is an accounts payable clerk whose duties include entering information into the computer. Employee fraudulently changed the address of Supplier Co. in the computer data bank to an address of Employee. The check was subsequently produced by the check-writing machine and mailed to the address that Employee had entered into the computer. Employee obtained possession of the check, indorsed it in the name of Supplier Co., and deposited it to an account in Depositary Bank which Employee opened in the name “Supplier Co.” The check was honored by the drawee bank. The indorsement is effective under Section 3-405(b) because Employee’s duties allowed Employee to supply information determining the address of payee of the check. An employee that is entrusted with duties that enable the employee to determine the address to which a check is to be sent controls the disposition of the check and facilitates forgery of the indorsement. The employer is held responsible. The drawee may debit the account of Employer for the amount of the check. There is no breach of warranty by Depositary Bank under Section 3-417(a)(1) or 4-208(a)(1).

Case #6. Treasurer is authorized to draw checks in behalf of Corporation. Treasurer draws a check of Corporation payable to “Supplier Co.”, a company that sold goods to Corporation. The check was issued to pay the price of these goods. At the time the check was signed Treasurer had no intention of stealing the check. Later, Treasurer stole the check, indorsed it in the name “Supplier Co.” and obtained payment by depositing it to an account in Depositary Bank which Treasurer opened in the name “Supplier Co.”. The indorsement is effective under Section 3-405(b). Section 3-404(b) does not apply to this case.

Case #7. Checks of Corporation are signed by Treasurer in behalf of Corporation as drawer. Clerk’s duties include the preparation of checks for issue by Corporation. Clerk prepares a check payable to the order of Supplier Co. for Treasurer’s signature. Clerk fraudulently informs Treasurer that the check is needed to pay a debt owed to Supplier Co., a company that does business with Corporation. No money is owed to Supplier Co. and Clerk intends to steal the check. Treasurer signs it and returns it to Clerk for mailing. Clerk does not indorse the check but deposits it to an account in Depositary Bank which Clerk opened in the name “Supplier Co.”. The check is honored by the drawee bank. Section 3-404(b)(i) does not apply to this case because Clerk, under Section 3-110(a), is not the person whose intent determines to whom the check is payable. But Section 3-405 does apply and it treats the deposit by Clerk as an effective indorsement by Clerk because Clerk was entrusted with responsibility with respect to the check. If Supplier Co. is a fictitious person Section 3-404(b)(ii) applies. But the result is the same. Clerk’s deposit is treated as an effective indorsement of the check whether Supplier Co. is a fictitious or a real person or whether money was or was not owing to Supplier Co. The drawee bank may debit the account of Corporation for the amount of the check and there is no breach of warranty by Depositary Bank under Section 3-417(1)(a).

CASE NOTES

Failure to exercise ordinary care in drawing check not established. —

A district court’s finding that the drawer of a check had not failed to exercise ordinary care in preparing the check was not clearly erroneous where the only evidence submitted by the warrantor bank in support of its burden of proving that the drawer had failed to exercise ordinary care was the check itself and where the district court physically examined the check, including the just less than one-half inch of open space in the numerical portion of the check and the one inch of open space in the written portion of the check and, based upon this physical examination, found that the drawer had filled in the open spaces in the numerical and written portions of the check sufficiently such that “any alteration that was made was obvious.” HSBC Bank USA v. F&M Bank-Northern Va., 246 F.3d 335, 2001 U.S. App. LEXIS 5588 (4th Cir. 2001).

CIRCUIT COURT OPINIONS

Conversion found. —

Because a company president’s wife, as the company’s bookkeeper, lacked any authority over some 7 checks payable to the president individually, her forgery of said checks defeated any argument that there was an effective negotiation of said checks, as the wife was not the president’s employee. Further, the depository bank failed in its burden of showing that the payee failed to exercise ordinary care, and that such failure substantially contributed to the making of the forged signature. Fax Connection, Inc. v. Chevy Chase Bank, F.S.B., 73 Va. Cir. 263, 2007 Va. Cir. LEXIS 72 (Fairfax County Apr. 16, 2007).

OFFICIAL COMMENT

1. Section 3-406(a) is based on former Section 3-406.  With respect to alteration, Section 3-406 adopts the doctrine of Young v. Grote, 4 Bing. 253 (1827), which held that a drawer who so negligently draws an instrument as to facilitate its material alteration is liable to a drawee who pays the altered instrument in good faith.  Under Section 3-406 the doctrine is expanded 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.”  Section 3-406 rejects decisions holding that the maker of a note owes no duty of care to the holder because at the time the instrument is issued there is no contract between them. By issuing the instrument and “setting it afloat upon a sea of strangers” the maker or drawer voluntarily enters into a relation with later holders which justifies imposition of a duty of care.  In this respect an instrument so negligently drawn as to facilitate alteration does not differ in principle from an instrument containing blanks which may be filled. Under Section 3-407 a person paying an altered instrument or taking it for value, in good faith and without notice of the alteration may enforce rights with respect to the instrument according to its original terms.  If negligence of the obligor substantially contributes to an alteration, this section gives the holder or the payor the alternative right to treat the altered instrument as though it had been issued in the altered form.
2. Section 3-406 applies equally to a failure to exercise ordinary care that substantially contributes to the making of a forged signature on an instrument.  Section 3-406 refers to “forged signature” rather than “unauthorized signature” that appeared in former Section 3-406 because it more accurately describes the scope of the provision.  Unauthorized signature is a broader concept that includes not only forgery but also the signature of an agent which does not bind the principal under the law of agency.  The agency cases are resolved independently under agency law.  Section 3-406 is not necessary in those cases.
3. The following cases illustrate the kind of conduct that can be the basis of a preclusion under Section 3-406(a):
4. Subsection (b) differs from former Section 3-406 in that it adopts a concept of comparative negligence.  If the person precluded under subsection (a) proves that the person asserting the preclusion failed to exercise ordinary care and that failure substantially contributed to the loss, the loss may be allocated between the two parties on a comparative negligence basis.  In the case of a forged indorsement the litigation is usually between the payee of the check and the depositary bank that took the check of collection.  An example is a case like Case #1 of Comment 3 to Section 3-405.  If the trier of fact finds that Employer failed to exercise ordinary care in safeguarding the check and that the failure substantially contributed to the making of the forged indorsement, subsection (a) of Section 3-406 applies.  If Employer brings an action for conversion against the depositary bank that took the checks from the forger, the depositary bank could assert the preclusion under subsection (a).  But suppose the forger opened an account in the depositary bank in a name identical to that of the employer, the payee of the check, and then deposited the check in the account.  Subsection (b) may apply.  There may be an issue whether the depositary bank should have been alerted to possible fraud when a new account was opened for a corporation shortly before a very large check payable to a payee with the same name is deposited. Circumstances surrounding the opening of the account may have suggested that the corporation to which the check was payable may not be the same as the corporation for which the account was opened. If the trier of fact finds that collecting the check under these circumstances was a failure to exercise ordinary care, it could allocate the loss between the depositary bank and Employer, the payee.

No attempt is made to define particular conduct that will constitute “failure to exercise ordinary care [that] substantially contributes to an alteration.” Rather, “ordinary care” is defined in Section 3-103(a)(7) in general terms. The question is left to the court or the jury for decision in the light of the circumstances in the particular case including reasonable commercial standards that may apply.

Section 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 because the taker can treat the instrument as having been issued in the altered form.

The “substantially contributes” test of former Section 3-406 is continued in this section in preference to a “direct and proximate cause” test. The “substantially contributes” test is meant to be less stringent than a “direct and proximate cause” test. Under the less stringent test the preclusion should be easier to establish. Conduct “substantially contributes” to a material alteration or forged signature if it is a contributing cause of the alteration or signature and a substantial factor in bringing it about. The analysis of “substantially contributes” in former Section 3-406 by the court in Thompson Maple Products v. Citizens National Bank of Corry , 234 A.2d 32 (Pa.Super.Ct.1967), states what is intended by the use of the same words in revised Section 3-406(b). Since Section 3-404(d) and Section 3-405(b) also use the words “substantially contributes” the analysis of these words also applies to those provisions.

Case #1. Employer signs checks drawn on Employer’s account by use of a rubber stamp of Employer’s signature. Employer keeps the rubber stamp along with Employer’s personalized blank check forms in an unlocked desk drawer. An unauthorized person fraudulently uses the check forms to write checks on Employer’s account. The checks are signed by use of the rubber stamp. If Employer demands that Employer’s account in the drawee bank be recredited because the forged check was not properly payable, the drawee bank may defend by asserting that Employer is precluded from asserting the forgery. The trier of fact could find that Employer failed to exercise ordinary care to safeguard the rubber stamp and the check forms and that the failure substantially contributed to the forgery of Employer’s signature by the unauthorized use of the rubber stamp.

Case #2. 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 Alabama. The insurance company also has a policyholder with the same name who lives in Illinois. By mistake, the insurance company mails the check to the Illinois Sarah Smith who indorses the check and obtains payment. Because the payee of the check is the Alabama Sarah Smith, the indorsement by the Illinois Sarah Smith is a forged indorsement. Section 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.

Case #3. A company writes a check for $10. The figure “10” and the word “ten” are typewritten in the appropriate spaces on the check form. A large blank space is left after the figure and the word. The payee of the check, using a typewriter with a typeface similar to that used on the check, writes the word “thousand” after the word “ten” and a comma and three zeros after the figure “10”. The drawee bank in good faith pays $10,000 when the check is presented for payment and debits the account of the drawer in that amount. The trier of fact could find that the drawer failed to exercise ordinary care in writing the check and that the failure substantially contributed to the alteration. In that case the drawer is precluded from asserting the alteration against the drawee if the check was paid in good faith.

CASE NOTES

Editor’s note.

Some of the cases annotated below were decided under former § 8.3-407.

Subsection 2(a) of former § 8.3-407 (see now subsection (b)) was derived from various sections of the Uniform Negotiable Instruments Law and was essentially identical to provisions in force in virtually every state. Business Bank v. Plank, 710 F. Supp. 619, 1989 U.S. Dist. LEXIS 4259 (E.D. Va. 1989).

Only an actual fraud requirement accords with the overall purpose of the entire alteration provision in this section. Business Bank v. Plank, 710 F. Supp. 619, 1989 U.S. Dist. LEXIS 4259 (E.D. Va. 1989).

Filling in blanks under former N.I.L. —

See Frank & Adler v. Lilienfeld, 74 Va. (33 Gratt.) 377, 1880 Va. LEXIS 49 (1880); Brown v. Thomas, 120 Va. 763 , 92 S.E. 977 , 1917 Va. LEXIS 157 (1917); State Bank v. Payne, 156 Va. 837 , 159 S.E. 163 , 1931 Va. LEXIS 237 (1931); Allen v. Rouseville Cooperage Co., 157 Va. 355 , 161 S.E. 50 , 1931 Va. LEXIS 326 (1931).

Forging irregular indorser’s name as maker under former N.I.L. —

See Shepherd v. Mortgage Sec. Corp., 139 Va. 274 , 123 S.E. 553 , 1924 Va. LEXIS 105 (1924).

Careless or innocent misrepresentation. —

Subsection 2(b) of former § 8.3-407 (see now subsection (b)) establishes that an obligor on a note is not discharged where the alteration, whether or not material, results from careless or innocent misrepresentation, i.e., constructive fraud. Business Bank v. Plank, 710 F. Supp. 619, 1989 U.S. Dist. LEXIS 4259 (E.D. Va. 1989).

Burden of proof. —

Defendant failed to offer any evidence from which reasonable fact finder could conclude that check was altered as opposed to counterfeited, so defendant could not carry its burden of proving that plaintiff breached its warranty of presentment under § 8.4-207.2 , and its claim failed. Defendant presented no witnesses who could testify regarding defendant’s receipt of the check, meaning that no one could offer evidence regarding the condition of the check when it was presented for payment, and more importantly, defendant could not present the original check, having destroyed it after making a digital copy. Chevy Chase Bank, F.S.B. v. Wachovia Bank, N.A., 208 Fed. Appx. 232, 2006 U.S. App. LEXIS 29944 (4th Cir. 2006).

OFFICIAL COMMENT

1. This provision restates former Section 3-407.  Former Section 3-407 defined a “material” alteration as any alteration that changes the contract of the parties in any respect.  Revised Section 3-407 refers to such a change as an alteration.  As under subsection (2) of former Section 3-407, discharge because of alteration occurs only in the case of an alteration fraudulently made.  There is no discharge if a blank is filled in the honest belief that it is authorized or if a change is made with a benevolent motive such as a desire to give the obligor the benefit of a lower interest rate. Changes favorable to the obligor are unlikely to be made with any fraudulent intent, but if such an intent is found the alteration may operate as a discharge.
2. Under subsection (c) a person paying a fraudulently altered instrument or taking it for value, in good faith and without notice of the alteration, is not affected by a discharge under subsection (b).  The person paying or taking the instrument may assert rights with respect to the instrument according to its original terms or, in the case of an incomplete instrument that is altered by unauthorized completion, according to its terms as completed.  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.

Discharge is a personal defense of the party whose obligation is modified and anyone whose obligation is not affected is not discharged. But if an alteration discharges a party there is also discharge of any party having a right of recourse against the discharged party because the obligation of the party with the right recourse is affected by the alteration. Assent to the alteration given before or after it is made will prevent the party from asserting the discharge. The phrase “or is precluded from asserting the alteration” in subsection (b) recognizes the possibility of an estoppel or other ground barring the defense which does not rest on assent.

CASE NOTES

Delivery of check becomes promise to make a gift. —

Because check did not operate as an assignment of funds, mere delivery of the check did not place the gift beyond the donor’s power of revocation and the check simply became an unenforceable promise to make a gift. Woo v. Smart, 247 Va. 365 , 442 S.E.2d 690, 10 Va. Law Rep. 1184, 1994 Va. LEXIS 51 (1994).

Check as assignment under former N.I.L. —

See National Mechanics' Bank v. Schmely Nat'l Bank, 136 Va. 33 , 116 S.E. 380 , 1923 Va. LEXIS 66 (1923) (decided under former § 8.3-409).

OFFICIAL COMMENT

1. This section is a restatement of former section 3-409(1). Subsection (2) of former Section 3-409 is deleted as misleading and superfluous.  Comment 3 says of subsection (2):  “It is intended to make it clear that this section does not in any way affect any liability which may arise apart from the instrument.”  In reality subsection (2) did not make anything clear and was a source of confusion.  If all it meant was that a bank that has not certified a check may engage in other conduct that might make it liable to a holder, it stated the obvious and was superfluous.  Section 1-103 is adequate to cover those cases.
2. Liability with respect to drafts may arise under other law.  For example, Section 4-302 imposes liability on a payor bank for late return of an item.

OFFICIAL COMMENT

1. The first three subsections of Section 3-409 are a restatement of former Section 3-410.  Subsection (d) adds a definition of certified check which is a type of accepted draft.
2. Subsection (a) states the generally recognized rule that the mere signature of the drawee on the instrument is a sufficient acceptance.  Customarily the signature is written vertically across the face of the instrument, but since the drawee has no reason to sign for any other purpose a signature in any other place, even on the back of the instrument, is sufficient.  It need not be accompanied by such words as “Accepted,” “Certified,” or “Good.”  It must not, however, bear any words indicating an intent to refuse to honor the draft.  The last sentence of subsection (a) states the generally recognized rule that an acceptance written on the draft takes effect when the drawee notifies the holder or gives notice according to instructions.
3. The purpose of subsection (c) is to provide a definite date of payment if none appears on the instrument.  An undated acceptance of a draft payable “thirty days after sight” is incomplete.  Unless the acceptor writes in a different date the holder is authorized to complete the acceptance according to the terms of the draft by supplying a date of acceptance. Any date supplied by the holder is effective if made in good faith.
4. The last sentence of subsection (d) states the generally recognized rule that in the absence of agreement a bank is under no obligation to certify a check.  A check is a demand instrument calling for payment rather than acceptance.  The bank may be liable for breach of any agreement with the drawer, the holder, or any other person by which it undertakes to certify.  Its liability is not on the instrument, since the drawee is not so liable until acceptance. Section 3-408.  Any liability is for breach of the separate agreement.

OFFICIAL COMMENT

1. This section is a restatement of former Section 3-412.  It applies to conditional acceptances, acceptances for part of the amount, acceptances to pay at a different time from that required by the draft, or to the acceptance of less than all of the drawees.  It applies to any other engagement changing the essential terms of the draft.  If the drawee makes a varied acceptance the holder may either reject it or assent to it.  The holder may reject by insisting on acceptance of the draft as presented.  Refusal by the drawee to accept the draft as presented is dishonor.  In that event the drawee is not bound by the varied acceptance and is entitled to have it canceled.
2. Under subsection (b) an acceptance does not vary from the terms of the draft if it provides for payment at any particular bank or place in the United States unless the acceptance states that the draft is to be paid only at such bank or place.  Section 3-501(b)(1) states that if an instrument is payable at a bank in the United States presentment must be made at the place of payment (Section 3-111) which in this case is at the designated bank.

If the holder assents to the varied acceptance, the drawee’s obligation as acceptor is according to the terms of the varied acceptance. Under subsection (c) the effect of the holder’s assent is to discharge any drawer or indorser who does not also assent. The assent of the drawer or indorser must be affirmatively expressed. Mere failure to object within a reasonable time is not assent which will prevent the discharge.

OFFICIAL COMMENT

1. In some cases a creditor may require that the debt be paid by an obligation of a bank.  The debtor may comply by obtaining certification of the debtor’s check, but more frequently the debtor buys from a bank a cashier’s check or teller’s check payable to the creditor.  The check is taken by the creditor as a cash equivalent on the assumption that the bank will pay the check.  Sometimes, the debtor wants to retract payment by inducing the obligated bank not to pay. The typical case involves a dispute between the parties to the transaction in which the check is given in payment.  In the case of a certified check or cashier’s check, the bank can safely pay the holder of the check despite notice that there may be an adverse claim to the check (Section 3-602).  It is also clear that the bank that sells a teller’s check has no duty to order the bank on which it is drawn not to pay it. A debtor using any of these types of checks has no right to stop payment.  Nevertheless, some banks will refuse payment as an accommodation to a customer.  Section 3-411 is designed to discourage this practice.
2. The term “obligated bank” refers to the issuer of the cashier’s check or teller’s check and the acceptor of the certified check.  If the obligated bank wrongfully refuses to pay, it is liable to pay for expenses and loss of interest resulting from the refusal to pay.  There is no express provision for attorney’s fees, but attorney’s fees are not meant to be necessarily excluded.  They could be granted because they fit within the language “expenses * * * resulting from the nonpayment.”  In addition the bank may be liable to pay consequential damages if it has notice of the particular circumstances giving rise to the damages.
3. Subsection (c) provides that expenses or consequential damages are not recoverable if the refusal to pay is because of the reasons stated.  The purpose is to limit that recovery to cases in which the bank refuses to pay even though its obligation to pay is clear and it is able to pay.  Subsection (b) applies only if the refusal to honor the check is wrongful.  If the bank is not obliged to pay there is no recovery.  The bank may assert any claim or defense that it has, but normally the bank would not have a claim or defense. In the usual case it is a remitter that is asserting a claim to the check on the basis of a rescission of negotiation to the payee under Section 3-202.  See Comment 2 to Section 3-201.  The bank can assert that claim if there is compliance with Section 3-305(c), but the bank is not protected from damages under subsection (b) if the claim of the remitter is not upheld.  In that case, the bank is insulated from damages only if payment is enjoined under Section 3-602(b)(1). Subsection (c)(iii) refers to cases in which the bank may have a reasonable doubt about the identity of the person demanding payment. For example, a cashier’s check is payable to “Supplier Co.”  The person in possession of the check presents it for payment over the counter and claims to be an officer of Supplier Co.  The bank may refuse payment until it has been given adequate proof that the presentment in fact is being made for Supplier Co., the person entitled to enforce the check.

CASE NOTES

General law of contracts compared to Uniform Commercial Code. —

Under the general law of contracts, if an obligor has received no notice that his debt has been assigned and is in fact unaware of the assignment, he may, with impunity, pay his original creditor, and his payment will be a complete defense against the claim of an assignee who failed to give him notice of the assignment; however, under the law of negotiable instruments the makers are bound by their contract to make payment to the holder, and a holder in due course takes the instrument free from the maker’s defense that he has made payment to the original payee, if he lacks notice of the payment and has not dealt with the maker. Taylor v. Roeder, 234 Va. 99 , 360 S.E.2d 191, 4 Va. Law Rep. 485, 1987 Va. LEXIS 251 (1987) (decided under former § 8.3-413).

Signatory bound in absence of fraud, duress, or mutual mistake. —

In the absence of fraud, duress, or mutual mistake, an individual having the capacity to understand a written document who signs it after reading it, or who signs it without reading it, is bound by the signature. First Nat'l Exch. Bank v. Johnson, 233 Va. 254 , 355 S.E.2d 326, 3 Va. Law Rep. 2337, 1987 Va. LEXIS 193 (1987) (decided under former § 8.3-413).

Issuer obligated to pay. —

Where a note is a negotiable instrument within the meaning of the UCC, the issuer of such note, under this section, is obligated to pay the instrument according to its terms at the time it was issued. Lanasa v. Willey, 251 Va. 231 , 467 S.E.2d 786, 1996 Va. LEXIS 38 (1996).

OFFICIAL COMMENT

1. The obligations of the maker, acceptor, drawer, and indorser are stated in four separate sections.  Section 3-412 states the obligation of the maker of a note and is consistent with former Section 3-413(1).  Section 3-412 also applies to the issuer of a cashier’s check or other draft drawn on the drawer.  Under former Section 3-118(a), since a cashier’s check or other draft drawn on the drawer was “effective as a note,” the drawer was liable under former Section 3-413(1) as a maker.  Under Sections 3-103(a)(6) and 3-104(f) a cashier’s check or other draft drawn on the drawer is treated as a draft to reflect common commercial usage, but the liability of the drawer is stated by Section 3-412 as being the same as that of the maker of a note rather than that of the drawer of a draft.  Thus, Section 3-412 does not in substance change former law.
2. Under Section 3-105(b) nonissuance of either a complete or incomplete instrument is a defense by a maker or drawer against a person that is not a holder in due course.
3. The obligation of the maker may be modified in the case of alteration if, under Section 3-406, the maker is precluded from asserting the alteration.

OFFICIAL COMMENT

Subsection (a) is consistent with former Section 3-413(1). Subsection (b) has primary importance with respect to certified checks. It protects the holder in due course of a certified check that was altered after certification and before negotiation to the holder in due course. A bank can avoid liability for the altered amount by stating on the check the amount the bank agrees to pay. The subsection applies to other accepted drafts as well.

CASE NOTES

Subsection (2) of former § 8.3-413 (see now § 8.3A-412 ) applied only to drafts and not to notes. Nevertheless, where the parties used this language in a note, an ambiguity requiring resolution was thereby created. Thus, the trial court correctly heard parol evidence, without objection, to determine the true meaning the parties intended by this language. Bankers Credit Serv. of Vermont, Inc. v. Dorsch, 231 Va. 273 , 343 S.E.2d 339, 1986 Va. LEXIS 189 (1986) (decided under former § 8.3-413).

OFFICIAL COMMENT

1. Subsection (a) excludes cashier’s checks because the obligation of the issuer of a cashier’s check is stated in Section 3-412.
2. Subsection (b) states the obligation of the drawer on an unaccepted draft.  It replaces former  Section 3-413(2).  The requirement under former Article 3 of notice of dishonor or protest has been eliminated.  Under revised Article 3, notice of dishonor is necessary only with respect to indorser’s liability.  The liability of the drawer of an unaccepted draft is treated as a primary liability. Under former Section 3-102(1)(d) the term “secondary party” was used to refer to a drawer or indorser.  The quoted term is not used in revised Article 3.  The effect of a draft drawn without recourse is stated in subsection (e).
3. Under subsection (c) the drawer is discharged of liability on a draft accepted by a bank regardless of when acceptance was obtained.  This changes former Section 3-411(1) which provided that the drawer is discharged only if the holder obtains acceptance.  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.  Section 3-205(d).
4. Subsection (d) states the liability of the drawer if a draft is accepted by a drawee other than a bank and the acceptor dishonors.  The drawer of an unaccepted draft is the only party liable on the instrument.  The drawee has no liability on the draft.  Section 3-408.  When the draft is accepted, the obligations change.  The drawee, as acceptor, becomes primarily liable and the drawer’s liability is that of a person secondarily liable as a guarantor of payment.  The drawer’s liability is identical to that of an indorser, and subsection (d) states the drawer’s liability that way.  The drawer is liable to pay the person entitled to enforce the draft or any indorser that pays pursuant to Section 3-415. The drawer in this case is discharged if notice of dishonor is required by Section 3-503 and is not given in compliance with that section.  A drawer that pays has a right of recourse against the acceptor.  Section 3-413(a).
5. Subsection (e) does not permit the drawer of a check to avoid liability under subsection (b) by drawing the check without recourse.  There is no legitimate purpose served by issuing a check on which nobody is liable.  Drawing without recourse is effective to disclaim liability of the drawer if the draft is not a check.  Suppose, in a documentary sale, Seller draws a draft on Buyer for the price of goods shipped to Buyer.  The draft is payable upon delivery to the drawee of an order bill of lading covering the goods.  Seller delivers the draft with the bill of lading to Finance Company that is named as payee of the draft.  If Seller draws without recourse Finance Company takes the risk that Buyer will dishonor.  If Buyer dishonors, Finance Company has no recourse against Seller but it can obtain reimbursement by selling the goods which it controls through the bill of lading.
6. Subsection (f) is derived from former Section 3-502(1)(b). It is designed to protect the drawer of a check against loss resulting from suspension of payments by the drawee bank when the holder of the check delays collection of the check.  For example, X writes a check payable to Y for $1,000.  The check is covered by funds in X’s account in the drawee bank.  Y delays initiation of collection of the check for more than 30 days after the date of the check.  The drawee bank suspends payments after the 30-day period and before the check is presented for payment.  If the $1,000 of funds in X’s account have not been withdrawn, X has a claim for those funds against the drawee bank and, if subsection (e) were not in effect, X would be liable to Y on the check because the check was dishonored.  Section 3-502(e).  If the suspension of payments by the drawee bank will result in payment to X of less than the full amount of the $1,000 in the account or if there is a significant delay in payment to X, X will suffer a loss which would not have been suffered if Y had promptly initiated collection of the check.  In most cases, X will not suffer any loss because of the existence of federal bank deposit insurance that covers accounts up to $100,000. Thus, subsection (e) has relatively little importance. There might be some cases, however, in which the account is not fully insured because it exceeds $100,000 or because the account doesn’t qualify for deposit insurance.  Subsection (f) retains the phrase “deprived of funds maintained with the drawee” appearing in former Section 3-502(1)(b).  The quoted phrase applies if the suspension of payments by the drawee prevents the drawer from receiving the benefit of funds which would have paid the check if the holder had been timely in initiating collection.  Thus, any significant delay in obtaining full payment of the funds is a deprivation of funds.  The drawer can discharge drawer’s liability by assigning rights against the drawee with respect to the funds to the holder.

CASE NOTES

Editor’s note.

The cases annotated below were decided under former § 8.3-414.

Agreement among endorsers as to liability under former N.I.L. —

See Colona v. Parksley Nat'l Bank, 120 Va. 812 , 92 S.E. 979 , 1917 Va. LEXIS 162 (1917).

The contract of an indorser under subsection (1) of former § 8.3-414 (see now this section) did not run to a drawee bank. That contract could be enforced by a drawee bank only if it dishonored a check; and if the bank dishonored the check, it suffered no loss. Kirby v. First & Merchants Nat'l Bank, 210 Va. 88 , 168 S.E.2d 273, 1969 Va. LEXIS 202 (1969).

The rule that a drawee who mistakenly pays a check has recourse only against the drawer was firmly established before adoption of the Uniform Commercial Code. Kirby v. First & Merchants Nat'l Bank, 210 Va. 88 , 168 S.E.2d 273, 1969 Va. LEXIS 202 (1969).

The drawer of a check, and not the holder who receives payment, is primarily responsible for the drawing out of funds from a bank. An overdraft is an act by reason of which the drawer and not the holder obtains money from the bank on his check. The holder, therefore, in the absence of fraud or express understanding for repayment, has no concern with the question whether the drawer has funds in the bank to meet the check. The bank is estopped, as against him, from claiming that by its acceptance an overdraft occurred. A mere mistake is not sufficient to enable it to recover from him. Banks cannot always guard against fraud, but can guard against mistakes. It is therefore the general rule, sustained by almost universal authority, that a payment in the ordinary course of business of a check by a bank on which it is drawn under the mistaken belief that the drawer has funds in the bank subject to check, is not such a payment under a mistake of fact as will permit the bank to recover the money so paid from the recipient of such payment. To permit the bank to repudiate the payment would destroy the certainty which must pertain to commercial transactions if they are to remain useful to the business public. Otherwise no one would ever know when he can safely receive payment of a check. Kirby v. First & Merchants Nat'l Bank, 210 Va. 88 , 168 S.E.2d 273, 1969 Va. LEXIS 202 (1969).

By use of the language “loan repayment guaranteed,” one agrees to pay the obligation when due without resort to the maker. In contrast, the liability of an ordinary indorser is expressly dependent upon dishonor, unless the endorsement otherwise specifies. Guth v. Hamlet Assocs., 230 Va. 64 , 334 S.E.2d 558, 1985 Va. LEXIS 252 (1985).

OFFICIAL COMMENT

1. Subsections (a) and (b) restate the substance of former Section 3-414(1).  Subsection (2) of former Section 3-414 has been dropped because it is superfluous.  Although notice of dishonor is not mentioned in subsection (a), it must be given in some cases to charge an indorser.  It is covered in subsection (c).  Regulation CC § 229.35(b) provides that a bank handling a check for collection or return is liable to a bank that subsequently handles the check to the extent the latter bank does not receive payment for the check.  This liability applies whether or not the bank incurring the liability indorsed the check.
2. Section 3-503 states when notice of dishonor is required and how it must be given.  If required notice of dishonor is not given in compliance with Section 3-503, subsection (c) of Section 3-415 states that the effect is to discharge the indorser’s obligation.
3. Subsection (d) is similar in effect to Section 3-414(c) if the draft is accepted by a bank after the indorsement is made.  See Comment 3 to Section 3-414.  If a draft is accepted by a bank before the indorsement is made, the indorser incurs the obligation stated in subsection (a).
4. Subsection (e) modified former Sections 3-503(2)(b) and 3-502(1)(a) by stating a 30-day rather than a seven-day period, and stating it as an absolute rather than a presumptive period.

CASE NOTES

By endorsing a check, regardless of the fact that it lacked a drawer’s signature and was irregular on its face, appellant accorded the instrument legal efficacy as between the endorser and transferee because he warranted that he had good title to the instrument and that it had not been materially altered. On its face, the check had a sufficient appearance of genuineness that it possibly could “operate to the injury of another.” The check was of sufficient apparent legal efficacy to support the trial court’s finding that appellant was guilty of forgery and uttering. Muhammad v. Commonwealth, 13 Va. App. 194, 409 S.E.2d 818, 8 Va. Law Rep. 1044, 1991 Va. App. LEXIS 265 (1991) (decided under former § 8.3-417).

OFFICIAL COMMENT

1. Subsection (a) is taken from subsection (2) of former Section 3-417.  Subsections (3) and (4) of former Section 3-417 are deleted.  Warranties under subsection (a) in favor of the immediate transferee apply to all persons who transfer an instrument for consideration whether or not the transfer is accompanied by indorsement.  Any consideration sufficient to support a simple contract will support those warranties.  If there is an indorsement the warranty runs with the instrument and the remote holder may sue the indorser-warrantor directly and thus avoid a multiplicity of suits.
2. Since the purpose of transfer (Section 3-203(a)) is to give the transferee the right to enforce the instrument, subsection (a)(1) is a warranty that the transferor is a person entitled to enforce the instrument, (Section 3-301). Under Section 3-203(b) transfer gives the transferee any right of the transferor to enforce the instrument.  Subsection (a)(1) is in effect a warranty that there are no unauthorized or missing indorsements that prevent the transferor from making the transferee a person entitled to enforce the instrument.
3. The rationale of subsection (a)(4) is that the transferee does not undertake to buy an instrument that is not enforceable in whole or in part, unless there is a contrary agreement.  Even if the transferee takes as a holder in due course who takes free of the defense or claim in recoupment, the warranty gives the transferee the option of proceeding against the transferor rather than litigating with the obligor on the instrument the issue of the holder-in-due-course status of the transferee.  Subsection (3) of former Section 3-417 which limits this warranty is deleted.  The rationale is that while the purpose of a “no recourse” indorsement is to avoid a guaranty of payment, the indorsement does not clearly indicate an intent to disclaim warranties.
4. Under subsection (a)(5) the transferor does not warrant against difficulties of collection, impairment of the credit of the obligor or even insolvency.  The transferee is expected to determine such questions before taking the obligation.  If insolvency proceedings as defined in Section 1-201 (22) have been instituted against the party who is expected to pay and the transferor knows it, the concealment of that fact amounts to a fraud upon the transferee, and the warranty against knowledge of such proceedings is provided accordingly.
5. Transfer warranties may be disclaimed with respect to any instrument except a check.  Between the immediate parties disclaimer may be made by agreement.  In the case of an indorser, disclaimer of transferor’s liability, to be effective, must appear in the indorsement with words such as “without warranties” or some other specific reference to warranties.  But in the case of a check, subsection (c) of Section 3-416 provides that transfer warranties cannot be disclaimed at all.  In the check collection process the banking system relies on these warranties.
6. Subsection (b) states the measure of damages for breach of warranty.  There is no express provision for attorney’s fees, but attorney’s fees are not meant to be necessarily excluded. They could be granted because they fit within the phrase “expenses * * * incurred as a result of the breach.”  The intention is to leave to other state law the issue as to when attorney’s fees are recoverable.
7. Since the traditional term “cause of action” may have been replaced in some states by “claim for relief” or some equivalent term, the words “cause of action” in subsection (d) have been bracketed to indicate that the words may be replaced by an appropriate substitute to conform to local practice.

CASE NOTES

Editor’s note.

The cases annotated below were decided under former § 8.3-417.

No warranty of sufficient funds on deposit. —

The warranties set forth in subsection (1) of former § 8.3-417 (see now this section) and former § 8.4-207(1) do not include a warranty that the drawer of a check has sufficient funds on deposit to cover the check. Kirby v. First & Merchants Nat'l Bank, 210 Va. 88 , 168 S.E.2d 273, 1969 Va. LEXIS 202 (1969).

The rule that a drawee who mistakenly pays a check has recourse only against the drawer was firmly established before adoption of the Uniform Commercial Code. Kirby v. First & Merchants Nat'l Bank, 210 Va. 88 , 168 S.E.2d 273, 1969 Va. LEXIS 202 (1969).

The drawer of a check, and not the holder who receives payment, is primarily responsible for the drawing out of funds from a bank. An overdraft is an act by reason of which the drawer and not the holder obtains money from the bank on his check. The holder therefore in the absence of fraud or express understanding for repayment, has no concern with the question whether the drawer has funds in the bank to meet the check. The bank is estopped, as against him, from claiming that by its acceptance an overdraft occurred. A mere mistake is not sufficient to enable it to recover from him. Banks cannot always guard against fraud, but can guard against mistakes. It is therefore the general rule, sustained by almost universal authority, that a payment in the ordinary course of business of a check by a bank on which it is drawn under the mistaken belief that the drawer has funds in the bank subject to check is not such a payment under a mistake of fact as will permit the bank to recover the money so paid from the recipient of such payment. To permit the bank to repudiate the payment would destroy the certainty which must pertain to commercial transactions if they are to remain useful to the business public. Otherwise no one would ever know when he can safely receive payment of a check. Kirby v. First & Merchants Nat'l Bank, 210 Va. 88 , 168 S.E.2d 273, 1969 Va. LEXIS 202 (1969).

OFFICIAL COMMENT

1. This section replaces subsection (1) of former Section 3-417.  The former provision was difficult to understand because it purported to state in one subsection all warranties given to any person paying any instrument.  The result was a provision  replete with exceptions that could not be readily understood except after close scrutiny of the language.  In revised Section 3-417, presentment warranties made to drawees of uncertified checks and other unaccepted drafts are stated in subsection (a).  All other presentment warranties are stated in subsection (d).
2. Subsection (a) states three warranties.  Subsection (a)(1) in effect is a warranty that there are no unauthorized or missing indorsements.  “Person entitled to enforce” is defined in Section 3-301.  Subsection (a)(2) is a warranty that there is no alteration. Subsection (a)(3) is a warranty of no knowledge that there is a forged drawer’s signature. Subsection (a) states that the warranties are made to the drawee and subsection (b) and (c) identify the drawee as the person entitled to recover for breach of warranty.  There is no warranty made to the drawer under subsection (a) when presentment is made to the drawee.  Warranty to the drawer is governed by subsection (d) and that applies only when presentment for payment is made to the drawer with respect to a dishonored draft.  In Sun ’N Sand, Inc. v. United California Bank, 582 P.2d 920 (Cal.1978), the court held that under former Section 3-417(1) a warranty was made to the drawer of a check when the check was presented to the drawee for payment. The result in that case is rejected.
3. Subsection (a)(1) retains the rule that the drawee does not admit the authenticity of indorsements and subsection (a)(3) retains the rule of Price v. Neal, 3 Burr. 1354 (1762), that the drawee takes the risk that the drawer’s signature is unauthorized unless the person presenting the draft has knowledge that the drawer’s signature is unauthorized.  Under subsection (a)(3) the warranty of no knowledge that the drawer’s signature is unauthorized is also given by prior transferors of the draft.
4. Subsection (d) applies to presentment for payment in all cases not covered by subsection (a).  It applies to presentment of notes and accepted drafts to any party obliged to pay the instrument, including an indorser, and to presentment of dishonored drafts if made to the drawer or an indorser.  In cases covered by subsection (d), there is only one warranty and it is the same as that stated in subsection (a)(1).  There are no warranties comparable to subsections (a)(2) and (a)(3) because they are appropriate only in the case of presentment to the drawee of an unaccepted draft. With respect to presentment of an accepted draft to the acceptor, there is no warranty with respect to alteration or knowledge that the signature of the drawer is unauthorized.  Those warranties were made to the drawee when the draft was presented for acceptance (Section 3-417(a)(2) and (3)) and breach of that warranty is a defense to the obligation of the drawee as acceptor to pay the draft.  If the drawee pays the accepted draft the drawee may recover the payment from any warrantor who was in breach of warranty when the draft was accepted.  Section 3-417(b). Thus, there is no necessity for these warranties to be repeated when the accepted draft is presented for payment.  Former Section 3-417(1)(b)(iii) and (c)(iii) are not included in revised Section 3-417 because they are unnecessary.  Former Section 3-417(1)(c)(iv) is not included because it is also unnecessary.  The acceptor should know what the terms of the draft were at the time acceptance was made.
5. The measure of damages for breach of warranty under subsection (a) is stated in subsection (b).  There is no express provision for attorney’s fees, but attorney’s fees are not meant to be necessarily excluded.  They could be granted because they fit within the language “expenses * * * resulting from the breach.”  Subsection (b) provides that the right of the drawee to recover for breach of warranty is not affected by a failure of the drawee to exercise ordinary care in paying the draft.  This provision follows the result reached under former Article 3 in Hartford Accident & Indemnity Co. v. First Pennsylvania Bank, 859 F.2d 295 (3d Cir. 1988).
6. Subsection (c) applies to checks and other unaccepted drafts.  It gives to the warrantor the benefit of rights that the drawee has against the drawer under Section 3-404, 3-405, 3-406, or 4-406.  If the drawer’s conduct contributed to a loss from forgery or alteration, the drawee should not be allowed to shift the loss from the drawer to the warrantor.
7. The first sentence of subsection (e) recognizes that checks are normally paid by automated means and that payor banks rely on warranties in making payment.  Thus, it is not appropriate to allow disclaimer of warranties appearing on checks that normally will not be examined by the payor bank. The second sentence requires a breach of warranty claim to be asserted within 30 days after the drawee learns of the breach and the identity of the warrantor.
8. Since the traditional term “cause of action” may have been replaced in some states by “claim for relief” or some equivalent term, the words “cause of action” in subsection (f) have been bracketed to indicate that the words may be replaced  by an appropriate substitute to conform to local practice.

If presentment is made to the drawer or maker, there is no necessity for a warranty concerning the signature of that person or with respect to alteration. If presentment is made to an indorser, the indorser had itself warranted authenticity of signatures and that the instrument was not altered. Section 3-416(a)(2) and (3).

CASE NOTES

Recovery not warranted. —

Bank was not entitled to recover $ 20,000 from a former husband due to the bank mistakenly honoring the former wife’s withdrawals because the bank confirmed receipt of the former husband’s stop payment order over a month before honoring the withdrawals, and there was no ground for disturbing the bankruptcy court’s “plausible” finding that the former husband did not benefit from the bank’s distributions made in contravention of the former husband’s order. Rusnack v. Cardinal Bank, N.A., 695 Fed. Appx. 704, 2017 U.S. App. LEXIS 13409 (4th Cir. 2017).

OFFICIAL COMMENT

1. This section covers payment or acceptance by mistake and replaces former Section 3-418.  Under former Article 3, the remedy of a drawee that paid or accepted a draft by mistake was based on the law of mistake and restitution, but that remedy was not specifically stated. It was provided by Section 1-103.  Former Section 3-418 was simply a limitation on the unstated remedy under the law of mistake and restitution. Under revised Article 3, Section 3-418 specifically states the right of restitution in subsections (a) and (b).  Subsection (a) allows restitution in the two most common cases in which the problem is presented:  payment or acceptance of forged checks and checks on which the drawer has stopped payment.  If the drawee acted under a mistaken belief that the check was not forged or had not been stopped, the drawee is entitled to recover the funds paid or to revoke the acceptance whether or not the drawee acted negligently.  But in each case, by virtue of subsection (c), the drawee loses the remedy if the person receiving payment or acceptance was a person who took the check in good faith and for value or who in good faith changed position in reliance on the payment or acceptance.  Subsection (a) and (c) are consistent with former Section 3-418 and the rule of Price v. Neal. The result in the two cases covered by subsection (a) is that the drawee in most cases will not have a remedy against the person paid because there is usually a person who took the check in good faith and for value or who in good faith changed position in reliance on the payment or acceptance.
2. If a check has been paid by mistake and the payee receiving payment did not give value for the check or did not change position in reliance on the payment, the drawee bank is entitled to recover the amount of the check under subsection (a) regardless of how the check was paid. The drawee bank normally pays a check by a credit to an account of the collecting bank that presents the check for payment.  The payee of the check normally receives the payment by a credit to the payee’s account in the depositary bank.  But in some cases the payee of the check may have received payment directly from the drawee bank by presenting the check for payment over the counter. In those cases the payee is entitled to receive cash, but the payee may prefer another form of payment such as a cashier’s check or teller’s check issued by the drawee bank.  Suppose Seller contracted to sell goods to Buyer.  The contract provided for immediate payment by Buyer and delivery of the goods 20 days after payment.  Buyer paid by mailing a check for $10,000 drawn on Bank payable to Seller.  The next day Buyer gave a stop payment order to Bank with respect to the check Buyer had mailed to Seller.  A few days later Seller presented Buyer’s check to Bank for payment over the counter and requested a cashier’s check as payment. Bank issued and delivered a cashier’s check for $10,000 payable to Seller.  The teller failed to discover Buyer’s stop order. The next day Bank discovered the mistake and immediately advised Seller of the facts.  Seller refused to return the cashier’s check and did not deliver any goods to Buyer.
3. Subsection (b) covers cases of payment or acceptance by mistake that are not covered by subsection (a).  It directs courts to deal with those cases under the law governing mistake and restitution. Perhaps the most important class of cases that falls under subsection (b), because it is not covered by subsection (a), is that of payment by the drawee bank of a check with respect to which the bank has no duty to the drawer to pay either because the drawer has no account with the bank or because available funds in the drawer’s account are not sufficient to cover the amount of the check. With respect to such a case, under Restatement of Restitution § 29, if the bank paid because of a mistaken belief that there were available funds in the drawer’s account sufficient to cover the amount  of the check, the bank is entitled to restitution.  But § 29 is subject to Restatement of Restitution § 33 which denies restitution if the holder of the check receiving payment paid value in good faith for the check and had no reason to know that the check was paid by mistake when payment was received.
4. The right of the drawee to recover a payment or to revoke an acceptance under Section 3-418 is not affected by the rules under Article 4 that determine when an item is paid.  Even though a payor bank may have paid an item under Section 4-215, it may have a right to recover the payment under Section 3-418.  National Savings & Trust Co. v. Park Corp., 722 F.2d 1303 (6th Cir.1983), cert. denied, 466 U.S. 939 (1984), correctly states the law on the issue under former Article 3. Revised Article 3 does not change the previous law.

Under Section 4-215, Buyer’s check was paid by Bank at the time it delivered its cashier’s check to Seller. See Comment 3 to Section 4-215. Bank is obliged to pay the cashier’s check and has no defense to that obligation. The cashier’s check was issued for consideration because it was issued in payment of Buyer’s check. Although Bank has no defense on its cashier’s check it may have a right to recover $10,000, the amount of Buyer’s check, from Seller under Section 3-418(a). Bank paid Buyer’s check by mistake. Seller did not give value for Buyer’s check because the promise to deliver goods to Buyer was never performed. Section 3-303(a)(1). And, on these facts, Seller did not change position in reliance on the payment of Buyer’s check. Thus, the first sentence of Section 3-418(c) does not apply and Seller is obliged to return $10,000 to Bank. Bank is obliged to pay the cashier’s check but it has a counterclaim against Seller based on its rights under Section 3-418(a). This claim can be asserted against Seller, but it cannot be asserted against some other person with rights of a holder in due course of the cashier’s check. A person without rights of a holder in due course of the cashier’s check would take subject to Bank’s claim against Seller because it is a claim in recoupment. Section 3-305(a)(3).

If Bank recovers from Seller under Section 3-418(a), the payment of Buyer’s check is treated as unpaid and dishonored. Section 3-418(d). One consequence is that Seller may enforce Buyer’s obligation as drawer to pay the check. Section 3-414. Another consequence is that Seller’s rights against Buyer on the contract of sale are also preserved. Under Section 3-310(b) Buyer’s obligation to pay for the goods was suspended when Seller took Buyer’s check and remains suspended until the check is either dishonored or paid. Under Section 3-310(b)(2) the obligation is discharged when the check is paid. Since Section 3-418(d) treats Buyer’s check as unpaid and dishonored, Buyer’s obligation is not discharged and suspension of the obligation terminates. Under Section 3-310(b)(3), Seller may enforce either the contract of sale or the check subject to defenses and claims of Buyer.

If Seller had released the goods to Buyer before learning about the stop order, Bank would have no recovery against Seller under Section 3-418(a) because Seller in that case gave value for Buyer’s check. Section 3-418(c). In this case Bank’s sole remedy is under Section 4-407 by subrogation.

The result in some cases is clear. For example, suppose Father gives Daughter a check for $10,000 as a birthday gift. The check is drawn on Bank in which both Father and Daughter have accounts. Daughter deposits the check in her account in Bank. An employee of Bank, acting under the belief that there were available funds in Father’s account to cover the check, caused Daughter’s account to be credited for $10,000. In fact, Father’s account was overdrawn and Father did not have overdraft privileges. Since Daughter received the check gratuitously there is clear unjust enrichment if she is allowed to keep the $10,000 and Bank is unable to obtain reimbursement from father. Thus, Bank should be permitted to reverse the credit to Daughter’s account. But this case is not typical. In most cases the remedy of restitution will not be available because the person receiving payment of the check will have given value for it in good faith.

In some cases, however, it may not be clear whether a drawee bank should have a right of restitution. For example, a check-kiting scheme may involve a large number of checks drawn on a number of different banks in which the drawer’s credit balances are based on uncollected funds represented by fraudulently drawn checks. No attempt is made in Section 3-418 to state rules for determining the conflicting claims of the various banks that may be victimized by such a scheme. Rather, such cases are better resolved on the basis of general principles of law and the particular facts presented in the litigation.

CASE NOTES

Right of irregular indorser against prior irregular indorser under former N.I.L. —

See Mann v. Bradshaw, 136 Va. 351 , 118 S.E. 326 , 1923 Va. LEXIS 90 (1923) (decided under prior law).

Obligation of guarantor indistinguishable from that of comaker. —

Where a guarantor has guaranteed payment of a note, his obligation is indistinguishable from that of a comaker, since he is deemed to have waived any right of presentment and protest. In re Johnson, 552 F.2d 1072, 1977 U.S. App. LEXIS 13974 (4th Cir. 1977) (decided under former § 8.3-416).

By use of the language “loan repayment guaranteed,” one agrees to pay the obligation when due without resort to the maker. In contrast, the liability of an ordinary indorser is expressly dependent upon dishonor, unless the endorsement otherwise specifies. Guth v. Hamlet Assocs., 230 Va. 64 , 334 S.E.2d 558, 1985 Va. LEXIS 252 (1985) (decided under former § 8.3-416).

Validity of contracted debt. —

Chapter 7 trustee could not rely on voluntary conveyance statute to attack validity of contracted debt as fraudulent conveyance. Even if it could be construed to apply to obligation incurred by debtor, more specific language applicable to accomodation party in Virginia Code would override general provisions in voluntary conveyance statute. Tavenner v. Wells Fargo Bank, N.A. (In re Ferguson), No. 11-32141-KRH, No. APN 13-03067-KRH, 2014 Bankr. LEXIS 1046 (Bankr. E.D. Va. Mar. 18, 2014).

Liability of maker. —

Chapter 7 debtor, as accommodation party to instrument, was liable on promissory note in her capacity as maker under Virginia law, and liability she assumed when she executed note created valid antecedent debt that trustee could not avoid under Bankruptcy Code or Virginia law. As forbearance agreement transfers made by debtor to bank were given to secure valid, non-avoidable antecedent debt, debtor received reasonably equivalent value and thus, trustee could not avoid transfers. Tavenner v. Wells Fargo Bank, N.A. (In re Ferguson), No. 11-32141-KRH, No. APN 13-03067-KRH, 2014 Bankr. LEXIS 1046 (Bankr. E.D. Va. Mar. 18, 2014).

CIRCUIT COURT OPINIONS

Liability of accommodated party. —

In father’s suit against defendants to recover damages arising from defendants’ alleged failure to satisfy a promissory note on which the father had acted as co-maker so that defendants could qualify for a loan, the court granted the father’s motion for judgment where the father signed the note without being a direct beneficiary of the instrument; thus, the father was an accommodation party, and was entitled to reimbursement from defendants, the accommodated party. Smith v. Mathis, 65 Va. Cir. 467, 2004 Va. Cir. LEXIS 276 (Roanoke County Sept. 13, 2004).

OFFICIAL COMMENT

1. Section 3-419 replaces former Sections 3-415 and 3-416. An accommodation party is a 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.  An accommodation party will usually be a co-maker or anomalous indorser.  Subsection (a) distinguished between direct and indirect benefit.  For example, if X cosigns a note of Corporation that is given for a loan to Corporation, X is an accommodation party if no part of the loan was paid to X or for X’s direct benefit.  This is true even though X may receive indirect benefit from the loan because X is employed by Corporation or is a stockholder of Corporation, or even if X is the sole stockholder so long as Corporation and X are recognized as separate entities.
2. It does not matter whether an accommodation party signs gratuitously either at the time the instrument is issued or after the instrument is in the possession of a holder. Subsection (b) of Section 3-419 takes the view stated in Comment 3 to former Section 3-415 that there need be no consideration running to the accommodation party: “The obligation of the accommodation party is supported by any consideration for which the instrument is taken before it is due. Subsection (2) is intended to change occasional decisions holding that there is no sufficient consideration where an accommodation  party signs a note after it is in the hands of a holder who has given value. The [accommodation] party is liable to the holder in such a case even though there is no extension of time or other concession.”
3. As stated in Comment 1, whether a person is an accommodation party is a question of fact.  But it is almost always the case that a co-maker who signs with words of guaranty after the signature is an accommodation party.  The same is true of an anomalous indorser.  In either case a person taking the instrument is put on notice of the accommodation status of the co-maker or indorser.  This is relevant to Section 3-605(h).  But, under subsection (c), signing with words of guaranty or as an anomalous indorser also creates a presumption that the signer is an accommodation party.  A party challenging accommodation party status would have to rebut this presumption by producing evidence that the signer was in fact a direct beneficiary of the value given for the instrument.
4. Subsection (b) states that an accommodation party is liable on the instrument in the capacity in which the party signed the instrument.  In most cases that capacity will be either that of a maker or indorser of a note.  But subsection (d) provides a limitation on subsection (b).  If the signature of the accommodation party is accompanied by words indicating unambiguously that the party is guaranteeing collection rather that payment of the instrument, liability is limited to that stated in subsection (d), which is based on former Section 3-416(2).
5. Subsection (e) restates subsection (5) of present Section 3-415.  Since the accommodation party that pays the instrument is entitled to enforce the instrument against the accommodated party, the accommodation party also obtains rights to any security interest or other collateral that secures payment of the instrument.

Former Article 3 was confusing because the obligation of a guarantor was covered both in Section 3-415 and in Section 3-416. The latter section suggested that a signature accompanied by words of guaranty created an obligation distinct from that of an accommodation party. Revised Article 3 eliminates that confusion by stating in Section 3-419 the obligation of a person who uses words of guaranty. Portions of former Section 3-416 are preserved. Former Section 3-416(2) is reflected in Section 3-419(d) and former Section 3-416(4) is reflected in Section 3-419(c).

CASE NOTES

This section clearly contemplates that payees eligible to sue may have little or no interest in a multiple payee check, and that a conversion claim may be maintained even where delivery is made to a payee with no actual interest in the check. Stefano v. First Union Nat'l Bank, 981 F. Supp. 417, 1997 U.S. Dist. LEXIS 16784 (E.D. Va. 1997).

Constructive delivery. —

Although plaintiff did not personally receive delivery of any of the checks, each was delivered to a an agent of the co-payee of the checks; the principle of constructive delivery compels the conclusion that the requisite delivery occurred. Stefano v. First Union Nat'l Bank, 981 F. Supp. 417, 1997 U.S. Dist. LEXIS 16784 (E.D. Va. 1997).

Agency relationship existed between a debtor and a creditor when the debtor received a check written to the creditor to satisfy a judgment and the debtor converted the funds for his own use by forging the creditor’s signature. Clause (ii) of subsection (a) did not apply; thus, the debt was nondischargeable under 11 U.S.C.S. § 523(a)(4). Hess v. Waterholter (In re Waterholter), No. 05-30247-DOT, No. 05-03044-DOT, 2006 Bankr. LEXIS 303 (Bankr. E.D. Va. Jan. 4, 2006).

Action for conversion found. —

Where a bank accepted checks for deposit to a partnership account without a co-payee’s endorsement, it provided an action for conversion under this section, displacing the common law. Stefano v. First Union Nat'l Bank, 981 F. Supp. 417, 1997 U.S. Dist. LEXIS 16784 (E.D. Va. 1997).

Conversion not found. —

In a former employee’s suit against his former employer, alleging conversion of instruments, in violation of § 8.3A-420 , based on the employer’s demand that he divest his company stock upon termination, the employee failed to establish a required element of this cause of action because one of the conditions of the employee’s buying the employer’s stock was that he would have to sell it back if he were terminated and thus, the divestment would not be wrongful. Inman v. Klockner-Pentaplast of Am., Inc., 467 F. Supp. 2d 642, 2006 U.S. Dist. LEXIS 93620 (W.D. Va. 2006).

CIRCUIT COURT OPINIONS

Conversion found. —

Because a company president’s wife, as the company’s bookkeeper, lacked any authority over some 7 checks payable to the president individually, her forgery of said checks defeated any argument that there was an effective negotiation of said checks, as the wife was not the president’s employee. Further, the depository bank failed in its burden of showing that the payee failed to exercise ordinary care, and that such failure substantially contributed to the making of the forged signature. Fax Connection, Inc. v. Chevy Chase Bank, F.S.B., 73 Va. Cir. 263, 2007 Va. Cir. LEXIS 72 (Fairfax County Apr. 16, 2007).

Conversion not found. —

Judgment was entered in favor of an executrix on a conversion claim as: (1) the relationship between a decedent and a bank was one of creditor and debtor, (2) the decedent instructed a bank to close a payable on death account and to issue a check to her, (3) the bank issued a check to the decedent and the few days that passed before the check was issued were legally insignificant, (4) the executrix properly negotiated to the decedent’s estate, issued a check from the estate account as executrix to herself as sole beneficiary, and negotiated the check as the payee, and (5) the funds passed under the decedent’s will and were not a gift. Pleasant v. Haynes, 70 Va. Cir. 396, 2006 Va. Cir. LEXIS 56 (Roanoke Apr. 25, 2006).

Because a company president’s wife, who also served as the company’s bookkeeper, was entrusted with the responsibility over some 59 checks that were allegedly forged and placed in her personal account, the circuit court found that said checks were effectively negotiated, and not converted, and the depository bank acted in good faith, exercising ordinary care in honoring said checks presented to it by the bookkeeper. Thus, the bank could not be liable to the company and its president for the same. Fax Connection, Inc. v. Chevy Chase Bank, F.S.B., 73 Va. Cir. 263, 2007 Va. Cir. LEXIS 72 (Fairfax County Apr. 16, 2007).

OFFICIAL COMMENT

1. Section 3-420 is a modification of former Section 3-419. The first sentence of Section 3-420(a) states a general rule that the law of conversion applicable to personal property also applies to instruments.  Paragraphs (a) and (b) of former Section 3-419(1) are deleted as inappropriate in cases of noncash items that may be delivered for acceptance or payment in collection letters that contain varying instructions as to what to do in the event of nonpayment on the day of delivery. It is better to allow such cases to be governed by the general law of conversion that would address the issue of when, under the circumstances prevailing, the presenter’s right to possession has been denied.  The second sentence of Section 3-420(a) states that an instrument is converted if it is taken by transfer other than a negotiation from a person not entitled to enforce the instrument or taken for collection or payment from a person not entitled to enforce the instrument or receive payment.  This covers cases in which a depositary or payor bank takes an instrument bearing a forged indorsement.  It also covers cases in which an instrument is payable to two persons and the two persons are not alternative payees, e.g., a check payable to John and Jane Doe.  Under Section 3-110(d) the check can be negotiated or enforced only by both persons acting jointly. Thus, neither payee acting without the consent of the other, is a person entitled to enforce the instrument.  If John indorses the check and Jane does not, the indorsement is not effective to allow negotiation of the check.  If Depositary Bank takes the check for deposit to John’s account, Depositary Bank is liable to Jane for conversion of the check if she did not consent to the transaction. John, acting alone, is not the person entitled to enforce the check because John is not the holder of the check.  Section 3-110(d) and Comment 4 to Section 3-110.  Depositary Bank does not get any greater rights under Section 4-205(1). If it acted for John as its customer, it did not become holder of the check under that provision because John, its customer, was not a holder.
2. Subsection (2) of former Section 3-419 is amended because it is not clear why the former law distinguished between the liability of the drawee and that of other converters.  Why should there be a conclusive presumption that the liability is face amount if a drawee refuses to pay or return an instrument or makes payment on a forged indorsement, while the liability of a maker who does the same thing is only presumed to be the face amount?  Moreover, it was not clear under former Section 3-419(2) what face amount meant.  If a note for $10,000 is payable in a year at 10% interest, it is common to refer to $10,000 as the face amount, but if the note is converted the loss to the owner also includes the loss of interest.  In revised Article 3, Section 3-420(b), by referring to “amount payable on the instrument,” allows the full amount due under the instrument to be recovered.
3. Subsection (3) of former Section 3-419 drew criticism from the courts, that saw no reason why a depositary bank should have the defense stated in the subsection.  See Knesz v. Central Jersey Bank & Trust Co., 477 A.2d 806 (N.J.1984).  The depositary bank is ultimately liable in the case of a forged indorsement check because of its warranty to the payor bank under Section 4-208(a)(1) and it is usually the most convenient defendant in cases involving multiple checks drawn on different banks.  There is no basis for requiring the owner of the check to bring multiple actions against the various payor banks and to require those banks to assert warranty rights against the depositary bank.  In revised Article 3, the defense provided by Section 3-420(c) is limited to collecting banks other than the depositary bank.  If suit is brought against both the payor bank and the depositary bank, the owner, of course, is entitled to but one recovery.

Under former Article 3, the cases were divided on the issue of whether the drawer of a check with a forged indorsement can assert rights against a depositary bank that took the check. The last sentence of Section 3-420(a) resolves the conflict by following the rule stated in Stone & Webster Engineering Corp. v. First National Bank & Trust Co., 184 N.E.2d 358 (Mass.1962). There is no reason why a drawer should have an action in conversion. The check represents an obligation of the drawer rather than property of the drawer. The drawer has an adequate remedy against the payor bank for recredit of the drawer’s account for unauthorized payment of the check.

There was also a split of authority under former Article 3 on the issue of whether a payee who never received the instrument is a proper plaintiff in a conversion action. The typical case was one in which a check was stolen from the drawer or in which the check was mailed to an address different from that of the payee and was stolen after it arrived at that address. The thief forged the indorsement of the payee and obtained payment by depositing the check to an account in a depositary bank. The issue was whether the payee could bring an action in conversion against the depositary bank or the drawee bank. In revised Article 3, under the last sentence of Section 3-420(a), the payee has no conversion action because the check was never delivered to the payee. Until delivery, the payee does not have any interest in the check. The payee never became the holder of the check nor a person entitled to enforce the check. Section 3-301. Nor is the payee injured by the fraud. Normally the drawer of a check intends to pay an obligation owed to the payee. But if the check is never delivered to the payee, the obligation owed to the payee is not affected. If the check falls into the hands of a thief who obtains payment after forging the signature of the payee as an indorsement, the obligation owed to the payee continues to exist after the thief receives payment. Since the payee’s right to enforce the underlying obligation is unaffected by the fraud of the thief, there is no reason to give any additional remedy to the payee. The drawer of the check has no conversion remedy, but the drawee is not entitled to charge the drawer’s account when the drawee wrongfully honored the check. The remedy of the drawee is against the depositary bank for breach of warranty under Section 3-417(a)(1) or 4-208(a)(1). The loss will fall on the person who gave value to the thief for the check.

The situation is different if the check is delivered to the payee. If the check is taken for an obligation owed to the payee, the last sentence of Section 3-310(b)(4) provides that the obligation may not be enforced to the extent of the amount of the check. The payee’s rights are restricted to enforcement of the payee’s rights in the instrument. In this event the payee is injured by the theft and has a cause of action for conversion.

The payee receives delivery when the check comes into the payee’s possession, as for example when it is put into the payee’s mailbox. Delivery to an agent is delivery to the payee. If a check is payable to more than one payee, delivery to one of the payees is deemed to be delivery to all of the payees. Occasionally, the person asserting a conversion cause of action is an indorsee rather than the original payee. If the check is stolen before the check can be delivered to the indorsee and the indorsee’s indorsement is forged, the analysis is similar. For example, a check is payable to the order of A. A indorses it to B and puts it into an envelope addressed to B. The envelope is never deliverd to B. Rather, Thief steals the envelope, forges B’s indorsement to the check and obtains payment. Because the check was never delivered to B, the indorsee, B has no cause of action for conversion, but A does have such an action. A is the owner of the check. B never obtained rights in the check. If A intended to negotiate the check to B in payment of an obligation, that obligation was not affected by the conduct of Thief. B can enforce that obligation. Thief stole A’s property not B’s.

The “but” clause in subsection (b) addresses the problem of conversion actions in multiple payee checks. Section 3-110(d) states that an instrument cannot be enforced unless all payees join in the action. But an action for conversion might be brought by a payee having no interest or a limited interest in the proceeds of the check. This clause prevents such a plaintiff from receiving a windfall. An example is a check payable to a building contractor and a supplier of building material. The check is not payable to the payees alternatively. Section 3-110(d). The check is delivered to the contractor by the owner of the building. Suppose the contractor forges supplier’s signature as an indorsement of the check and receives the entire proceeds of the check. The supplier should not, without qualification, be able to recover the entire amount of the check from the bank that converted the check. Depending upon the contract between the contractor and the supplier, the amount of the check may be due entirely to the contractor, in which case there should be no recovery, entirely to the supplier, in which case recovery should be for the entire amount, or part may be due to one and the rest to the other, in which case recovery should be limited to the amount due to the supplier.

OFFICIAL COMMENT

Subsection (a) defines presentment. Subsection (b)(1) states the place and manner of presentment. Electronic presentment is authorized. The communication of the demand for payment or acceptance is effective when received. Subsection (b)(2) restates former Section 3-505. Subsection (b)(2)(i) allows the person to whom presentment is made to require exhibition of the instrument, unless the parties have agreed otherwise as in an electronic presentment agreement. Former Section 3-507(3) is the antecedent of subsection (b)(3)(i). Since a payor must decide whether to pay or accept on the day of presentment, subsection (b)(4) allows the payor to set a cut-off hour for receipt of instruments presented.

OFFICIAL COMMENT

1. Section 3-415 provides that an indorser is obliged to pay an instrument if the instrument is dishonored and is discharged if the indorser is entitled to notice of dishonor and notice is not given. Under Section 3-414, the drawer is obliged to pay an unaccepted draft if it is dishonored. The drawer, however, is not entitled to notice of dishonor except to the extent required in a case governed by Section 3-414(d). Part 5 tells when an instrument is dishonored (Section 3-502) and what it means to give notice of dishonor (Section 3-503). Often dishonor does not occur until presentment (Section 3-501), and frequently presentment and notice of dishonor are excused (Section 3-504).
2. In the great majority of cases presentment and notice of dishonor are waived with respect to notes. In most cases a formal demand for payment to the maker of the note is not contemplated. Rather, the maker is expected to send payment to the holder of the note on the date or dates on which payment is due. If payment is not made when due, the holder usually makes a demand for payment, but in the normal case in which presentment is waived, demand is irrelevant and the holder can proceed against indorsers when payment is not received. Under former Article 3, in the small minority of cases in which presentment and dishonor were not waived with respect to notes, the indorser was discharged from liability (former Section 3-502(1)(a)) unless the holder made presentment to the maker on the exact day and note was due (former Section 3-503(1)(c)) and gave notice of dishonor to the indorser before midnight of the third business day after dishonor (former Section 3-508(2)). These provisions are omitted from Revised Article 3 as inconsistent with practice which seldom involves face-to-face dealings.
3. Subsection (a) applies to notes. Subsection (a)(1) applies to notes payable on demand. Dishonor requires presentment, and dishonor occurs if payment is not made on the day of presentment. There is no change from previous Article 3. Subsection (a)(2) applies to notes payable at a definite time if the note is payable at or through a bank or, by its terms, presentment is required. Dishonor requires presentment, and dishonor occurs if payment is not made on the due date or the day of presentment if presentment is made after the due date. Subsection (a)(3) applies to all other notes. If the note is not paid on its due date it is dishonored. This allows holders to collect notes in ways that make sense commercially without having to be concerned about a formal presentment on a given day.
4. Subsection (b) applies to unaccepted drafts other than documentary drafts. Subsection (b)(1) applies to checks. Except for checks presented for immediate payment over the counter, which are covered by subsection (b)(2), dishonor occurs according to rules stated in Article 4. When a check is presented for payment through the check-collection system, the drawee bank normally makes settlement for the amount of the check to the presenting bank. Under Section 4-301 the drawee bank may recover this settlement if it returns the check within its midnight deadline (Section 4-104). In that case the check is not paid and dishonor occurs under Section 3-502(b)(1). If the drawee bank does not return the check or give notice of dishonor or nonpayment within the midnight deadline, the settlement becomes final payment of the check. Section 4-215. Thus, no dishonor occurs regardless of whether the check is retained or is returned after the midnight deadline. In some cases the drawee bank might not settle for the check when it is received. Under Section 4-302 if the drawee bank is not also the depositary bank and retains the check without settling for it beyond midnight of the day it is presented for payment, the bank becomes “accountable” for the amount of the check, i.e. it is obliged to pay the amount of the check. If the drawee bank is also the depositary bank, the bank is accountable for the amount of the check if the bank does not pay the check or return it or send notice of dishonor within the midnight deadline. In all cases in which the drawee bank becomes accountable, the check has not been paid and, under Section 3-502(b)(1), the check is dishonored. The fact that the bank is obliged to pay the check does not mean that the check has been paid. When a check is presented for payment, the person presenting the check is entitled to payment not just the obligation of the drawee to pay. Until that payment is made, the check is dishonored. To say that the drawee bank is obliged to pay the check necessarily means that the check has not been paid. If the check is eventually paid, the drawee bank no longer is accountable.
5. Subsection (c) gives drawees an extended period to pay documentary drafts because of the time that may be needed to examine the documents. The period prescribed is that given by Section 5-112 in cases in which a letter of credit is involved.
6. Subsection (d) governs accepted drafts. If the acceptor’s obligation is to pay on demand the rule, stated in subsection (d)(1), is the same as for that of a demand note stated in subsection (a)(1). If the acceptor’s obligation is to pay at a definite time the rule, stated in subsection (d)(2), is the same as that of a time note payable at a bank stated in subsection (b)(2).
7. Subsection (e) is a limitation on subsection (a)(1) and (2), subsection (b), subsection (c), and subsection (d). Each of those provisions states dishonor as occurring after presentment. If presentment is excused under Section 3-504, dishonor occurs under those provisions without presentment if the instrument is not duly accepted or paid.
8. Under subsection (b)(3)(ii) and (4) if a draft is presented for acceptance and the draft is not accepted on the day of presentment, there is dishonor. But after dishonor, the holder may consent to late acceptance. In that case, under subsection (f), the late acceptance cures the dishonor. The draft is treated as never having been dishonored. If the draft is subsequently presented for payment and payment is refused dishonor occurs at that time.

Subsection (b)(2) applies to demand drafts other than those governed by subsection (b)(1). It covers checks presented for immediate payment over the counter and demand drafts other than checks. Dishonor occurs if presentment for payment is made and payment is not made on the day of presentment.

Subsection (b)(3) and (4) applies to time drafts. 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, with respect to drafts, presentment for payment or acceptance is required. Subsection (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 subsection (b)(3)(ii) dishonor occurs when the draft is presented and not accepted. Subsection (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. The rules in subsection (b)(3) and (4) follow former Section 3-501(1)(a).

OFFICIAL COMMENT

1. Subsection (a) is consistent with former Section 3-501(2)(a), but notice of dishonor is no longer relevant to the liability of a drawer except for the case of a draft accepted by an acceptor other than a bank. Comments 2 and 4 to Section 3-414. There is no reason why drawers should be discharged on instruments they draw until payment or acceptance. They are entitled to have the instrument presented to the drawee and dishonored (Section 3-414(b)) before they are liable to pay, but no notice of dishonor need be made to them as a condition of liability. Subsection (b), which states how notice of dishonor is given, is based on former Section 3-508(3).
2. Subsection (c) replaces former Section 3-508(2). It differs from that section in that it provides a 30-day period for a person other than a collecting bank to give notice of dishonor rather than the three-day period allowed in former Article 3. Delay in giving notice of dishonor may be excused under Section 3-504(c).

OFFICIAL COMMENT

Section 3-504 is largely a restatement of former Section 3-511. Subsection (4) of former Section 3-511 is replaced by Section 3-502(f).

CASE NOTES

Letter of credit card holder erroneously admitted into evidence. —

Trial court erroneously admitted into evidence a letter written by the holder of the credit card who did not testify at the trial; the letter was a personal letter written to a credit card center about problems the cardholder was having regarding erroneous debits to his credit card account; the personal letter to a bank card center failed to qualify as a stamp or writing “of the drawee, payor bank or presenting bank,” according to paragraph (b) of former § 8.3-510 (see now subdivision (2)); moreover, the letter was not “any book or record of the drawee, payor bank, or any collecting bank kept in the usual course of business,” within the meaning of paragraph (c) of former § 8.3-510 (see now subdivision (3)) since the letter was not an “entry” in any bank’s records and it was merely incorporated by reference in one of a “batch” of documents gathered together by a credit card center to justify a “charge-back.” Mika v. Planters Bank & Trust Co., 241 Va. 415 , 404 S.E.2d 222, 7 Va. Law Rep. 2246, 1991 Va. LEXIS 48 (1991) (decided under former § 8.3-510).

OFFICIAL COMMENT

Protest is no longer mandatory and must be requested by the holder. Even if requested, protest is not a condition to the liability of indorsers or drawers. Protest is a service provided by the banking system to establish that dishonor has occurred. Like other services provided by the banking system, it will be available if market incentives, interbank agreements, or governmental regulations require it, but liabilities of parties no longer rest on it. Protest may be a requirement for liability on international drafts governed by foreign law which this Article cannot affect.

CASE NOTES

Editor’s note.

Some of the cases annotated below were decided under former § 8.3-601.

Instrument is not discharged. —

The Uniform Commercial Code provides for the discharge of parties to the instrument, not for the discharge of the instrument itself. In re Worley, 251 F. Supp. 725, 1966 U.S. Dist. LEXIS 6917 (W.D. Va. 1966).

Reacquisition of note by co-maker discharged all other parties. —

Where party, who as a co-maker had no right of action or recourse on the note, reacquired it in his own right by assignment from the bank, all other parties to the note were discharged by operation of law. Roark v. Hicks, 234 Va. 470 , 362 S.E.2d 711, 4 Va. Law Rep. 1318, 1987 Va. LEXIS 277 (1987).

Discharge of person secondarily liable under former N.I.L. —

See Cape Charles Bank, Inc. v. Farmers Mut. Exch., 120 Va. 771 , 92 S.E. 918 , 1917 Va. LEXIS 158 (1917); Colona v. Parksley Nat'l Bank, 120 Va. 812 , 92 S.E. 979 , 1917 Va. LEXIS 162 (1917); Dunnington v. Bank of Crewe, 144 Va. 36 , 131 S.E. 221 , 1926 Va. LEXIS 229 (1926); Harris v. Citizens Bank & Trust Co., 172 Va. 111 , 200 S.E. 652 , 1939 Va. LEXIS 225 (1939); Cawley v. Hanes, 173 Va. 381 , 4 S.E.2d 376, 1939 Va. LEXIS 206 (1939).

Discharge did not displace defense of double recovery. —

Trial court erred in denying the alleged debtor the opportunity to conduct discovery regarding the alleged debtor’s defense of double recovery in a case where the alleged creditor settled another action involving the assignment of loans to a trust, including the alleged debtor’s loan, with another entity and the alleged debtor sought to assert the defense in the current action of double recovery; the alleged debtor sought not to assert that the alleged debtor’s loan, on which the alleged debtor was a guarantor, had been discharged, but instead raised the defense of double recovery, the statute involving discharge, § 8.3A-601 , did not in any event displace the defense of double recovery, and the trial court affected the alleged debtor’s substantial rights in not allowing discovery to determine if the double recovery defense could be established. Nizan v. Wells Fargo Bank Minn. N.A., 274 Va. 481 , 650 S.E.2d 497, 2007 Va. LEXIS 117 (2007).

OFFICIAL COMMENT

Subsection (a) replaces subsections (1) and (2) of former Section 3-601. Subsection (b) restates former Section 3-602. Notice of discharge is not treated as notice of a defense that prevents holder in due course status. Section 3-302(b). Discharge is effective against a holder in due course only if the holder had notice of the discharge when holder in due course status was acquired. For example, if an instrument bearing a canceled indorsement is taken by a holder, the holder has notice that the indorser has been discharged. Thus, the discharge is effective against the holder even if the holder is a holder in due course.

CASE NOTES

Payment to an authorized agent of the holder will also satisfy the requirement of payment to the holder, resulting in discharge. But the burden of proving an agency relationship rests on the party claiming payment as a defense. Lambert v. Barker, 232 Va. 21 , 348 S.E.2d 214, 3 Va. Law Rep. 462, 1986 Va. LEXIS 221 (1986) (decided under former § 8.3-603).

And no notice is required for protection of payor. —

Because payment in satisfaction of the instrument must be made to a party in possession in order to discharge the payor’s liability, no notice is required for the protection of the payor. Rather, the payor may protect himself by demanding production of the instrument and refusing payment to any party not in possession unless in an action on the obligation the owner proves his ownership. Lambert v. Barker, 232 Va. 21 , 348 S.E.2d 214, 3 Va. Law Rep. 462, 1986 Va. LEXIS 221 (1986) (decided under former § 8.3-603).

Discharge of liability. —

The liability of any party to a negotiable instrument is discharged to the extent of his payment or satisfaction to the holder. Sackadorf v. JLM Group Ltd. Partnership, 250 Va. 321 , 462 S.E.2d 64, 12 Va. Law Rep. 210, 1995 Va. LEXIS 105 (1995) (decided under former § 8.3-603).

OFFICIAL COMMENT

This section replaces former Section 3-603(1). The phrase “claim to the instrument” in subsection (a) means, by reference to Section 3-306, a claim of ownership or possession and not a claim in recoupment. Subsection (b)(1)(ii) is added to conform to Section 3-411. Section 3-411 is intended to discourage an obligated bank from refusing payment of a cashier’s check, certified check or dishonored teller’s check at the request of a claimant to the check who provided the bank with indemnity against loss. See Comment 1 to Section 3-411. An obligated bank that refuses payment under those circumstances not only remains liable on the check but may also be liable to the holder of the check for consequential damages. Section 3-602(b)(1)(ii) and Section 3-411, read together, change the rule of former Section 3-603(1) with respect to the obligation of the obligated bank on the check. Payment to the holder of a cashier’s check, teller’s check, or certified check discharges the obligation of the obligated bank on the check to both the holder and the claimant even though indemnity has been given by the person asserting the claim. If the obligated bank pays the check in violation of an agreement with the claimant in connection with the indemnity agreement, any liability that the bank may have for violation of the agreement is not governed by Article 3, but is left to other law. This section continues the rule that the obligor is not discharged on the instrument if payment is made in violation of an injunction against payment. See Section 3-411(c)(iv).

CASE NOTES

Discharge of person secondarily liable under former N.I.L. —

See Cape Charles Bank, Inc. v. Farmers Mut. Exch., 120 Va. 771 , 92 S.E. 918 , 1917 Va. LEXIS 158 (1917); Colona v. Parksley Nat'l Bank, 120 Va. 812 , 92 S.E. 979 , 1917 Va. LEXIS 162 (1917); Dunnington v. Bank of Crewe, 144 Va. 36 , 131 S.E. 221 , 1926 Va. LEXIS 229 (1926); Harris v. Citizens Bank & Trust Co., 172 Va. 111 , 200 S.E. 652 , 1939 Va. LEXIS 225 (1939); Cawley v. Hanes, 173 Va. 381 , 4 S.E.2d 376, 1939 Va. LEXIS 206 (1939) (decided under prior law).

CIRCUIT COURT OPINIONS

Payment of stock satisfactory under settlement agreement. —

Debtors’ motion to set aside a confession of judgment was granted where it presented an adequate defense that the meaning of the term “proceeds” in a settlement agreement with the creditor was ambiguous and did not define what was meant by the same, but the tender of stock proceeds was just as good as tendering cash to satisfy the obligations under the note. Ali v. TeleScience Int'l, Inc., 64 Va. Cir. 60, 2004 Va. Cir. LEXIS 16 (Fairfax County Feb. 5, 2004).

OFFICIAL COMMENT

Section 3-603 replaces former Section 3-604. Subsection (a) generally incorporates the law of tender of payment applicable to simple contracts. Subsections (b) and (c) state particular rules. Subsection (b) replaces former Section 3-604(2). Under subsection (b) refusal of a tender of payment discharges any indorser or accommodation party having a right of recourse against the party making the tender. Subsection (c) replaces former Section 3-604(1) and (3).

CASE NOTES

Editor’s note.

The cases annotated below were decided under former § 8.3-605.

The UCC approaches discharge from the standpoint of discharge of parties on the instrument rather than discharge of the instrument itself. Payne v. Payne, 219 Va. 12 , 245 S.E.2d 133, 1978 Va. LEXIS 152 (1978).

Under the law as it existed before enactment of the Uniform Commercial Code, the presumption was that destruction of a negotiable instrument was done intentionally to cancel the instrument. The burden of proof was on the party alleging that the apparent cancellation was made unintentionally or under mistake, or without authority. As the Uniform Commercial Code is silent on the burden of proof, preexisting law governs and the burden presumably remains on the person suing on a negotiable instrument to rebut the presumption arising from the destruction of the original. Sweeney v. First Va. Bank, 224 Va. 579 , 299 S.E.2d 858, 1983 Va. LEXIS 164 (1983).

“Renounce” means to announce one’s abandonment of the ownership of, to abandon something possessed, as to renounce a title or a claim. First Nat'l Bank v. Cobler, 215 Va. 852 , 213 S.E.2d 800, 1975 Va. LEXIS 237 (1975).

To “surrender” is to relinquish; to deliver into lawful custody; to give up completely in favor of another. First Nat'l Bank v. Cobler, 215 Va. 852 , 213 S.E.2d 800, 1975 Va. LEXIS 237 (1975).

Under subsection (1)(b) of former § 8.3-605 (see now subsection (a)), the holder of a negotiable instrument “may” discharge the obligor by “surrender” to him of the instrument. The term “surrender” connotes an intention upon redelivery to relinquish the note and abandon the ownership thereof. Mere delivery does not by itself result in discharge. Sweeney v. First Va. Bank, 224 Va. 579 , 299 S.E.2d 858, 1983 Va. LEXIS 164 (1983).

Renunciation may be made effective at a future date. First Nat'l Bank v. Cobler, 215 Va. 852 , 213 S.E.2d 800, 1975 Va. LEXIS 237 (1975).

Accommodated party not discharged by payment by accommodation maker. —

Where an accommodation maker, who was liable to a holder, made payment of the note to the holder, and the note was marked “paid” by the bank, this endorsement on the face of the note discharged the accommodation maker who paid the note, but it did not have the effect of discharging the accommodated party’s obligation to the accommodation maker since such discharge was not apparent on the face of the instrument. Nor did delivery of the instrument by the bank to the accommodation maker effect discharge of the accommodated party’s obligation to the accommodation maker. Payne v. Payne, 219 Va. 12 , 245 S.E.2d 133, 1978 Va. LEXIS 152 (1978).

The Uniform Commercial Code does not govern nonnegotiable indemnifying bonds. However, redelivery of a nonnegotiable bond to the obligors does not discharge the bond if the evidence establishes that there was no intention by the obligee to discharge. Mere possession of a nonnegotiable document should not be given dispositive significance. Sweeney v. First Va. Bank, 224 Va. 579 , 299 S.E.2d 858, 1983 Va. LEXIS 164 (1983).

A 1979 note was not cancelled when it was stamped “PAID BY RENEWAL,” as the requirements of this section were not met. Gullette v. FDIC, 231 Va. 486 , 344 S.E.2d 920, 1986 Va. LEXIS 217 (1986).

Presumption that burning was intentional cancellation under former N.I.L. —

See Jones v. Coleman, 121 Va. 86 , 92 S.E. 910 , 1917 Va. LEXIS 11 (1917).

OFFICIAL COMMENT

Section 3-604 replaces former Section 3-605.

OFFICIAL COMMENT

1. Section 3-605, which replaces former Section 3-606, can be illustrated by an example. Bank lends $10,000 to Borrower who signs a note under which Borrower is obliged to pay $10,000 to Bank on a due date stated in the note. Bank insists, however, that Accommodation Party also become liable to pay the note. Accommodation Party can incur this liability by signing the note as a co-maker or by indorsing the note. In either case the note is signed for accommodation and Borrower is the accommodated party. Rights and obligations of Accommodation Party in this case are stated in Section 3-419. Suppose that after the note is signed, Bank agrees to a modification of the rights and obligations between Bank and Borrower. For example, Bank agrees that Borrower may pay the note at some date after the due date, or that Borrower may discharge Borrower’s $10,000 obligation to pay the note by paying Bank $3,000, or that Bank releases collateral given by Borrower to secure the note. Under the law of suretyship Borrower is usually referred to as the principal debtor and Accommodation Party is referred to as the surety. Under that law, the surety can be discharged under certain circumstances if changes of this kind are made by Bank, the creditor, without the consent of Accommodation Party, the surety. Rights of the surety to discharge in such cases are commonly referred to as suretyship defenses. Section 3-605 is concerned with this kind of problem in the context of a negotiable instrument to which the principal debtor and the surety are parties. But Section 3-605 has a wider scope. It also applies to indorsers who are not accommodation parties. Unless an indorser signs without recourse, the indorser’s liability under Section 3-415(a) is that of a guarantor of a payment. If Bank in our hypothetical case indorsed the note and transferred it to Second Bank, Bank has rights given to an indorser under Section 3-605 if it is Second Bank that modifies rights and obligations of Borrower. Both accommodation parties and indorsers will be referred to in these Comments as sureties. The scope of Section 3-605 is also widened by subsection (e) which deals with rights of a non-accommodation party co-maker when collateral is impaired.
2. The importance of suretyship defenses is greatly diminished by the fact that they can be waived. The waiver is usually made by a provision in the note or other writing that represents the obligation of the principal debtor. It is standard practice to include a waiver of suretyship defenses in notes given to financial institutions or other commercial creditors. Section 3-605(i) allows waiver. Thus, Section 3-605 applies to the occasional case in which the creditor did not include a waiver clause in the instrument or in which the creditor did not obtain the permission of the surety to take the action that triggers the suretyship defense.
3. Subsection (b) addresses the effect of discharge under Section 3-604 of the principal debtor. In the hypothetical case stated in Comment 1, release of Borrower by Bank does not release Accommodation Party. As a practical matter, Bank will not gratuitously release Borrower. Discharge of Borrower normally would be part of a settlement with Borrower if Borrower is insolvent or in financial difficulty. If Borrower is unable to pay all creditors, it may be prudent for Bank to take partial payment, but Borrower will normally insist on a release of the obligation. If Bank takes $3,000 and releases Borrower from the $10,000 debt, Accommodation Party is not injured. To the extent of the payment Accommodation Party’s obligation to Bank is reduced. The release of Borrower by Bank does not affect the right of Accommodation Party to obtain reimbursement from Borrower if Accommodation Party pays Bank. Section 3-419(e). Subsection (b) is designed to allow a creditor to settle with the principal debtor without risk of losing rights against sureties. Settlement is in the interest of sureties as well as the creditor. Subsection (b) changes the law stated in former Section 3-606 but the change relates largely to formalities rather than substance. Under former Section 3-606, Bank could settle with and release Borrower without releasing Accommodation Party, but to accomplish that result Bank had to either obtain the consent of Accommodation Party or make an express reservation of rights against Accommodation Party at the time it released Borrower. The reservation of rights was made in the agreement between Bank and Borrower by which the release of Borrower was made. There was no requirement in former Section 3-606 that any notice be given to Accommodation Party. The reservation of rights doctrine is abolished in Section 3-605 with respect to rights on instruments.
4. Subsection (c) relates to extensions of the due date of the instrument. In most cases an extension of time to pay a note is a benefit to both the principal debtor and sureties having recourse against the principal debtor. In relatively few cases the extension may cause loss if deterioration of the financial condition of the principal debtor reduces the amount that the surety will be able to recover on its right of recourse when default occurs. Former Section 3-606(1)(a) did not take into account the presence or absence of loss to the surety. For example, suppose the instrument is an installment note and the principal debtor is temporarily short of funds to pay a monthly installment. The payee agrees to extend the due date of the installment for a month or two to allow the debtor to pay when funds are available. Under former Section 3-606 surety was discharged if consent was not given unless the payee expressly reserved rights against the surety. It did not matter that the extension of time was a trivial change in the guaranteed obligation and that there was no evidence that the surety suffered any loss because of the extension. Wilmington Trust Co. v. Gesullo,  29 U.C.C. Rep. 144 (Del.Super.Ct. 1980). Under subsection (c) an extension of time results in discharge only to the extent the surety proves that the extension caused loss. For example, if the extension is for a long period the surety might be able to prove that during the period of extension the principal debtor became insolvent, thus reducing the value of the right of recourse of the surety. By putting the burden on the surety to prove loss, subsection (c) more accurately reflects what the parties would have done by agreement, and it facilitates workouts.
5. Former Section 3-606 applied to extensions of the due date of a note but not to other modifications of the obligation of the principal debtor. There was no apparent reason why former Section 3-606 did not follow general suretyship law in covering both. Under Section 3-605(d) a material modification of the obligation of the principal debtor, other than an extension of the due date, will result in discharge of the surety to the extent the modification caused loss to the surety with respect to the right of recourse. The loss caused by the modification is deemed to be the entire amount of the right of recourse unless the person seeking enforcement of the instrument proves that no loss occurred or that the loss was less than the full amount of the right of recourse. In the absence of that proof, the surety is completely discharged. The rationale for having different rules with respect to loss for extensions of the due date and other modifications is that extensions are likely to be beneficial to the surety and they are often made. Other modifications are less common and they may very well be detrimental to the surety. Modification of the obligation of the principal debtor without permission of the surety is unreasonable unless the modification is benign. Subsection (d) puts the burden on the person seeking enforcement of the instrument to prove the extent to which loss was not caused by the modification.
6. Subsection (e) deals with discharge of sureties by impairment of collateral. It generally conforms to former Section 3-606(1)(b). Subsection (g) states common examples of what is meant by impairment. By using the term “includes,” it allows a court to find impairment in other cases as well. There is extensive case law on impairment of collateral. The surety is discharged to the extent the surety proves that impairment was caused by a person entitled to enforce the instrument. For example, suppose the payee of a secured note fails to perfect the security interest. The collateral is owned by the principal debtor who subsequently files in bankruptcy. As a result of the failure to perfect, the security interest is not enforceable in bankruptcy. If the payee obtains payment from the surety, the surety is subrogated to the payee’s security interest in the collateral. In this case the value of the security interest is impaired completely because the security interest is unenforceable. If the value of the collateral is as much or more than the amount of the note there is a complete discharge.
7. Subsection (f) is illustrated by the following case. X and Y sign a note for $1,000 as co-makers. Neither is an accommodation party. X grants a security interest in X’s property to secure the note. The collateral is worth more than $1,000. Payee fails to perfect the security interest in X’s property before X files in bankruptcy. As a result the security interest is not enforceable in bankruptcy. Had Payee perfected the security interest, Y could have paid the note and gained rights to X’s collateral by subrogation. If the security interest had been perfected, Y could have realized on the collateral to the extent of $500 to satisfy its right of contribution against X. Payee’s failure to perfect deprived Y of the benefit of the collateral. Subsection (f) discharges Y to the extent of its loss. If there are no assets in the bankruptcy for unsecured claims, the loss is $500, the amount of Y’s contribution claim against X which now has a zero value. If some amount is payable on unsecured claims, the loss is  reduced by the amount receivable by Y. The same result follows if Y is an accommodation party but Payee has no knowledge of the accommodation or notice under Section 3-419(c). In that event Y is not discharged under subsection (e), but subsection (f) applies because X and Y are jointly and severally liable on the note. Under subsection (f), Y is treated as a co-maker with a right of contribution rather than an accommodation party with a right of reimbursement. Y is discharged to the extent of $500. If Y is the principal debtor and X is the accommodation party subsection (f) doesn’t apply. Y, as principal debtor, is not injured by the impairment of collateral because Y would have been obliged to reimburse X for the entire $1,000  even if Payee had obtained payment from sale of the collateral.
8. Subsection (i)  is a continuation of former law which allowed suretyship defenses to be waived.

In some states a real property grantee who assumes the obligation of the grantor as maker of a note secured by the real property becomes by operation of law a principal debtor and the grantor becomes a surety. The meager case authority was split on whether former Section 3-606 applied to release the grantor if the holder released or extended the obligation of the grantee. Revised Article 3 takes no position on the effect of the release of the grantee in this case. Section 3-605(e) does not apply because the holder has not discharged the obligation of a “party,” a term defined in Section 3-103(a)(8) as “party to an instrument.” The assuming grantee is not a party to the instrument.