Business Law Question

For your Final Paper, assume the following scenario: You are the manager of Acme Fireworks, a fireworks retailer who sells fireworks, and produces fireworks displays with ground display fireworks and large aerial display fireworks. The company started in the owner’s garage 2 years ago and now has 15 employees who you manage. The company started as a sole proprietorship, and the owner has never changed the entity. The owner has informed you that the company has received inquiries from several large businesses wondering if the company could create several fireworks displays on a regular basis. The owner told the inquirers that the company could fill such display orders, and a price per display was agreed upon. It was discussed that most of the cost for a fireworks display is for skilled labor, insurance, and the actual service of setting off the fireworks. No other details were discussed. The owner is anticipating that new employees will need to be hired, but he is worried that if the large orders for fireworks displays do not continue, the company will not have the funds to pay the new employees. The owner is now considering changing the business entity, but he does not know what entity to form or how to form it.

In your paper, the owner has asked you to do the following:

• Analyze if the contracts with the businesses will be governed by common law or the Uniform Commercial Code (UCC).
• Explain why.
• Analyze whether the owner formed a contract with the businesses.
• Apply the five essential elements of an enforceable contract.
• Explain the potential personal liability to Acme Fireworks if a spectator is injured by a stray firework from a fireworks display.
• Discuss the different employment types and relationships relevant to agency law.
• Analyze the advantages and disadvantages of each type specific to Acme Fireworks.
• Explain why Acme Fireworks should not operate as a sole proprietorship.
• Recommend a new business entity.
• Provide rationale to support your recommendation.
• For each task, be sure to analyze the relevant law, apply the facts to the law, and make a conclusion.

Must be eight to 10 double-spaced pages in length (not including title and references pages) and formatted according to APA Style.

Must address the topic of the paper with critical thought. That is, describe what your response is to the content, either positive or negative, and defend your position. If multiple options, alternatives, and/or positions are present and are being rejected, you must also defend the reasons for rejecting an option.

Must use at least five credible and/or scholarly sources, two of which must be from the University of Arizona Global Campus Library, in addition to the course text.

(Rogers, S., & Seaquist, G. (2023). Essentials of business law (2nd ed.). The University of Arizona Global Campus.) Chapters Attached.

9
Warranties and Remedies
for Breach
Viktoria Korobova / iStock / Getty Images Plus
Learning Outcomes
After studying this chapter, you will be able to
• Explain the concept of implied warranties and distinguish implied from express warranties.
• Discuss the requirements for disclaiming warranties under the UCC.
• List three examples of buyers’ remedies for breach of the sales contract.
• List three examples of sellers’ remedies for breach of the sales contract.
© 2023 The University of Arizona Global Campus. All rights reserved. Not for resale or redistribution.
Section 9.1
Warranties
This chapter begins with an explanation of warranties, provided by Article 2 of the UCC with
regard to goods. A warranty is an assurance that the goods will meet certain requirements.
The UCC provides four specific types of warranties covering goods under sales contracts:
• warranty of title
• implied warranty of merchantability
• warranty of fitness for a particular purpose
• express warranties
These warranties offer buyers important protection covering purchases of goods and are
important to both merchant and consumer buyers.
Sales contracts are as susceptible to breach as any other contract. The common law of contracts provides a variety of remedies to parties who suffer a breach of contract, as we have
seen in Chapter 6. The UCC also provides remedies to buyers and sellers who suffer a breach
of contract. As usual, the UCC makes some modifications to the common law of contracts in
order that the remedies allowed to buyers and sellers reflect the economic realities of doing
business and fostering commerce.
9.1 Warranties
Suppose that you entered into a contract to purchase a new Tesla automobile. After you drove
the car for a few months, the battery lost the capacity to recharge. You returned the car to the
dealer and demanded that they replace the costly battery. Looking through the paperwork
you received from Tesla, you read the following:
Battery and Drive Unit Limited Warranty
The Battery and Drive Unit in your vehicle are covered for a period of:
• Model S/Model X: 8 years or 150,000
miles, whichever comes first, with minimum 70% retention of Battery capacity
over the warranty period.
This is an example of a warranty provided by the
manufacturer of goods. You may be surprised to
learn that if the manufacturer did not provide a
warranty, you would nevertheless receive warranties through Article 2 of the UCC, which provides
four types of warranties that offer buyers important
protection covering purchases of goods. Warranties are important to both merchant and consumer
buyers because they provide a guarantee about the
quality of the goods.
typhoonski / Getty Images Editorial RF
Tesla provides a warranty for its
cars. Even if the company did not,
consumers would receive warranties
through Article 2 of the UCC.
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Warranties
Section 9.1
All warranties are either express or implied. As discussed in Chapter 4 related to contracts,
express means oral or written, so an express warranty is one that is written down. The foregoing example given by Tesla is express because it is written and accompanies the sales contract. There are also implied warranties, or warranties that are not oral or written, that
come with the product even though they are not mentioned by the seller. Next we will discuss
these types of warranties covered under the UCC.
Warranty of Title and Against Infringements (§ 2-312)
The warranty of title is an example of an implied warranty because in every contract for the
sale of goods, every seller guarantees to every buyer that the seller owns the goods, the goods
are not stolen, the transfer is legal, and there are no liens or encumbrances against the title to
the goods being sold.
Example 9.1. Breach of implied warranty of title. Antonio purchases a new Honda automobile and finances the car. Honda places a lien on Antonio’s title, which is a notice to anyone
that Antonio owes money on the car. Antonio then sells the car to Kendra. Antonio takes his
title and artfully erases the information that shows Honda’s lien, so Kendra thinks she is getting a car that is free from any encumbrances.
Antonio has committed fraud and has also breached the warranty of title, which guarantees
that goods are sold free from any liens.
The warranty of title is an implied warranty that automatically attaches to every sale made. It
can, however, be disclaimed through specific language giving the buyer notice that the seller
does not claim title to the goods sold or that they are only transferring whatever ownership
right they have in the property.
Example 9.2. Susan, after breaking up with her boyfriend, wants to sell a ring he gave her as a
gift. Margaret agrees to buy the ring for $100. Susan believes that her ex-boyfriend purchased
the ring from a jeweler, but she also knows that he had purchased items from street peddlers
of questionable repute in the past. In order to cover herself against a possible future suit for
breach of warranty of title from Margaret, she draws up a sales contract that reads as follows:
In consideration of $100, I hereby sell all of my interest, if any, in a gold ring
with a small opal to Margaret Smith. I sell the ring AS IS and make no express
or implied warranties of any kind to the buyer. In particular, I make no warranty of title to the buyer.
As long as Susan sells the ring to Margaret in good faith, Margaret will not be able to sue her in
the future for breach of warranty if the ring turns out to be worthless or stolen. In order for a
warranty to be waived, the language waiving it must be conspicuous—it must stand out from
the written contract by being larger, darker, or of a different color. A waiver of warranty that
does not stand out from the text of a contract will not be enforced.
If the seller is a merchant who regularly deals in goods of the kind being sold, the seller also
makes a warranty against infringement to the buyer, through which the seller warrants that
the goods are delivered free of any copyright, patent, or trademark infringement.
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Warranties
Section 9.1
Example 9.3. Breach of the warranty of title. Big Box Store buys 100 copies of Lady Gaga’s
latest CD from Music Wholesale Inc. Music Wholesale automatically guarantees that the CDs
were manufactured under a proper license. If they turn out to be counterfeits that infringe
copyright, Music Wholesale will be liable for breach of warranty.
Every sale made by a merchant who deals in goods of the kind being sold, whether new or
used, gives an implied warranty that the goods are merchantable—or fit for their ordinary
purpose. Note that this warranty automatically comes with goods when they are purchased
unless the seller disclaims them.
Example 9.4. Acme Hardware Store sells a hammer to Stephanie. Acme is guaranteeing that
the hammer is fit for pounding in nails and other normal things for which people use hammers. Acme is not guaranteeing that the hammer will serve as an impromptu car jack.
No statement needs to be made by the merchant; it is implied and automatic (although it can
be excluded or modified by express language).
It is not necessary for the buyer to show that the seller knowingly or negligently sold faulty,
mislabeled, or otherwise nonconforming goods in order to sue for breach of the warranty of
merchantability. Merchants are strictly liable for breach of the warranty whether or not they
were aware that the goods were not merchantable at the time that they sold them.
Implied Warranty of Fitness for a
Particular Purpose (§ 2-315)
The implied warranty of fitness for a particular
purpose is unusual, because it requires that the
buyer and seller discuss the goods. Suppose that
Francisca suffers from severe allergies and needs
to be careful when selecting makeup. She goes into
Rawpixel / iStock / Getty Images Plus
a store and explains this to the makeup artist, who
If
a
customer
asks whether a loaf of
recommends a particular brand. Francisca applies
the makeup and suffers a severe allergic reaction, bread is gluten free and the store
for which she is hospitalized. Since Francisca and owner assures the customer it is, then
the seller had a dialogue about a particular purpose the owner is liable under the implied
for the goods, and the seller sold the goods knowing warranty of fitness for a particular
that Francisca was relying on their judgment, this is purpose if the bread contains
a breach of the warranty. When a buyer explains to gluten and the customer has an
a seller that they need a product for a special reason adverse reaction.
and the seller selects a product in response, the seller gives a warranty of fitness for a particular purpose. This warranty arises because the seller (merchant as well as nonmerchant) sells
goods to a buyer guaranteeing that the goods are suitable for the specific purpose for which
the buyer intends to use them. In order for the warranty to arise, two tests must be met.
• The seller must be aware that the buyer is purchasing the goods with a particular
use in mind.
• The buyer must rely on the seller’s superior skill and judgment in selecting goods
appropriate to the seller’s specific intended use.
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Warranties
Section 9.1
Consider the following example.
Example 9.5. Implied warranty of fitness for a particular purpose. Buyer, a novice angler,
tells Seller, the owner of a sporting goods store, that he needs a rod and reel for fly-fishing and
asks her to recommend a good model. Seller, who is new to the trade and unfamiliar with flyfishing, recommends an excellent deep-sea fishing rod and reel set that is inappropriate for
fly-fishing. Seller is liable for breach of warranty since Seller knew Buyer’s purpose and Buyer
was entitled to rely on Seller’s presumed expertise.
In the Media:
Product Liability Claims as a Result of COVID-19
According to The National Law Review, a prestigious legal publication, attorneys need to be
on the watch for breaches of various warranties arising out of COVID-19 treatments. The
Review states that attorneys are considering the many ways that persons infected with the
virus will be able to bring lawsuits for damages. Of particular applicability to this chapter is
using breach of the implied warranty of merchantability or implied warranty of fitness for
a particular purpose in these lawsuits (Price et al., 2020). For example, if a particular type
of medicine did not lessen a person’s symptoms, that could be a breach of the warranty of
merchantability, or if someone died from taking a drug that did not undergo the usual rigors
of testing that other drugs normally were subjected to, that could be a breach of implied
warranty of fitness for a particular purpose.
Questions to Consider
1.
2.
3.
Do you think that lawyers are wrong in pursuing cases based on a pandemic?
Product liability lawsuits normally relate to products. What theory could lawyers
sue under for death or injury resulting from contracting COVID-19 or a similar
affliction?
Warranties also normally relate to tangible products. How could one argue that
contracting a virus is a breach of a warranty?
Express Warranties (§ 2-313)
An express warranty arises when the seller has, with words, made representations about the
quality and capability of particular goods. Express warranties can arise through statements
of fact, such as “This car will last for 10 years,” or a description contained in paperwork that
comes with a purchase, or they can arise from models that represent the quality of the goods.
For the warranty to arise, the statements, descriptions, samples, or models must have been
made available to the buyer at a time when the buyer might have relied on such information
in agreeing to enter into the contract. Representations about the goods are binding whether
they are made orally, in writing, or by showing a sample or model before the buyer agrees to
purchase the goods.
An affirmation of fact must be specific and cannot be a mere opinion.
© 2023 The University of Arizona Global Campus. All rights reserved. Not for resale or redistribution.
Section 9.1
Warranties
Beyond the Book: Driver Who Relied on Extended Car
Warranty Says Company Refused to Pay for Repairs
Watch: https://www.youtube.com/watch?v=1AQ7zJB0hq8
While learning about warranties can provide assurance that consumer protection really
exists, sometimes in reality, theories and laws are unhelpful. Additionally, if you have ever
been the subject of a robocaller asking you to buy an extended warranty for your car, you
know that not only are these calls annoying, but the warranties promised might not be worth
the payment of extended coverage. Watch this video about a customer who paid $3,000 for
extended warranties from CarShield and American Auto Shield that did not cover repairs
after all.
Questions to Consider
1.
2.
3.
What do the advertisements say about coverage? What type of warranty is given by
the advertisements?
What is the problem with the product, according to the video? What complaints do
consumers have?
What advice does the video have about entering into these contracts?
Example 9.6. Express warranty. “This car gets an average of 35 miles per gallon” is an affirmation of fact that gives rise to an express warranty. “This car gets great mileage” is not a
statement of fact but is an opinion or “puffing” and thus does not create a warranty.
Example 9.7. Express warranty. “This elliptical exercise machine is guaranteed for
3 years” creates a warranty. “This thing will last forever” is puffery and not an affirmation,
and thus there is no warranty created. The display of a model or sample to a buyer can also
constitute an express warranty in some situations.
Example 9.8. Express warranty example based on a sample. Brianna, a budding rock star,
goes to Wally’s Piano Shop. The salesperson encourages her to try out a floor model of a
hybrid digital piano with a grand acoustic system but missing the pedal soft spot that she
wishes to experience. Nevertheless, the piano is so amazing that she purchases it with the
added pedals. When it arrives, she is disappointed to discover that it tends to make buzzing
noises when the power cord is jogged. This will clearly not do for Brianna, who has many
upcoming concerts with her band. Is Wally’s Piano Shop in breach of warranty? The answer
is yes, because by using the model, the store was guaranteeing that the piano Brianna bought
would perform in the same manner. The model did not buzz when Brianna played it, but the
one she bought does, which is not the same level of performance.
Disclaimer of Warranties (§ 2-316)
Generally speaking, sellers can waive the warranties on products they sell. The warranty of
merchantability, however, can only be excluded by language that specifically mentions the
word “merchantability,” and the disclaimer must be conspicuous. In addition, an exclusion of
the warranty of fitness for a particular purpose must be in writing and conspicuous. Implied
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Remedies
Section 9.2
warranties can be disclaimed by a clear statement that the warranties are excluded. Selling
goods “as is” or “with all faults” generally disclaims all implied warranties. But note that the
specific requirements for waiving implied warranties can vary among the states, and many
states prohibit a disclaimer in the sale of consumer goods.
Example 9.9. Disclaimer of warranties. Big Box Store sells an exercise bike with a written contract that disclaims all warranties. Buyer (who is out of shape but only weighs
140 pounds) is injured when he sits on the bike and it collapses. In many states, Big Box can
still be held liable for breach of warranty.
Most states also allow clauses that limit remedies for breach of warranty. Remedies are the
compensation a buyer or seller can collect from the liable party for breaches of warranty. Suppose Seller contracts to supply Buyer with a cement mixer and the contract states that Buyer’s
remedies in the case of malfunction or defect are limited to repair of the mixer by Seller. The
cement mixer breaks down almost immediately and discharges a load of wet cement in the
parking lot, damaging five of Buyer’s fleet vehicles. Buyer has over $50,000 in damage to his
property, but he will not be able to collect it from Seller because of the limitations of remedies
clause in the contract. In the next section, we turn to remedies.
9.2 Remedies
Sales contracts are as susceptible to breach as any other contract. The common law of contracts provides a variety of remedies to parties who suffer a breach of contract, as discussed
in Chapter 6. The UCC also provides remedies to buyers and sellers who suffer a breach of
contract. As usual, the UCC makes some modifications to the common law of contracts in
order that the remedies allowed to buyers and sellers reflect the economic realities of doing
business and fostering commerce. In this section we look at remedies, which apply to both
buyers and sellers in a sales contract.
Buyers’ Remedies for Breach
When a seller breaches the sales contract, the buyer
can pursue a number of remedies to compensate
for the breach. These include the right to reject
nonconforming goods, or goods that are not as
ordered, thereby giving the buyer the right to sue
for damages and, under certain circumstances, the
right to sue for specific performance.
Right to Reject Nonconforming Goods
(§ 2-601)
FG Trade / E+ / Getty Images Plus
If a shipment of plants arrives
damaged and moldy, the buyer can
keep them and sue for damages or
reject the nonconforming goods.
When a seller tenders delivery to a buyer of nonconforming goods, the buyer may keep them
and sue for damages under the contract or, in certain cases, reject the goods and either sue
for damages or cancel the contract at the buyer’s option. The options available to the buyer
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Remedies
Section 9.2
depend in part on whether the contract is for a single delivery or a contract requiring the
seller to ship the goods in separate installments. When the contract requires only a single
delivery by the seller and the seller tenders nonconforming goods, the buyer may reject the
whole shipment, accept the whole shipment, or accept any separate part of the shipment and
reject the rest.
Example 9.10. Buyer’s duty to follow seller’s instructions. A buyer purchased 100 crates
of live, potted plants, which arrived in broken containers with clear signs of fungus. The buyer
notified the seller that he was rejecting the shipment. The seller responded requesting that
the buyer move and store the goods in a covered warehouse until the seller could arrange to
have the goods picked up. In such a case, the seller would be responsible for all costs to the
buyer, but the buyer, as a merchant, must follow reasonable instructions of the seller, despite
the goods being nonconforming. As merchants engaged in business, both the seller and buyer
are expected to act to preserve each other’s interests as much as possible.
When the nonconforming goods are shipped as part of an installment contract that requires
or allows goods to be tendered in a series of separate shipments, the buyer’s right to reject
the contract is more limited. A buyer can reject a nonconforming delivery if the nonconformity materially impairs the value of that installment and cannot be cured. In other words, a
buyer who allows a seller to ship goods in installments will not be able to refuse the shipment
unless the buyer first informs the seller that the goods are nonconforming, gives the seller the
opportunity to cure the defect within a reasonable time, and can show that the nonconformity
lessens the value of the goods. This may seem to give an unfair advantage to the seller, but it
is yet another example of the UCC’s pragmatism in recognizing the practical realities of doing
business. Minor nonconformities in sales contracts, particularly between merchants dealing
in high volumes and repeat sales, are inevitable. The code seeks to encourage commerce and
prevent waste by ensuring that parties that collaborate with one another on an ongoing basis
can’t reject shipments for inconsequential nonconformities without first giving the breaching
party the opportunity to cure the breach.
Example 9.11. Installment contracts. A buyer orders 1,000 one-pound cans of coffee from
a seller to be delivered in installments of 100 cans per month for 10 months. During the third
month of the contract, the seller ships 90 cans of coffee. The buyer cannot reject the shipment,
since this is an installment sale, without first giving the seller the opportunity to cure the
defect within a commercially reasonable time (e.g., by sending the missing 10 cans of coffee
within a few days of being notified that the shipment was nonconforming).
Right to Sue for Damages (§ 2-713)
As with the common law of contracts, buyers who suffer a breach of contract may sue for the
difference between the original contract price minus the market price at the time the buyer
learned of the breach.
Example 9.12. Rights of buyer when nonconforming goods are delivered. A buyer orders
100 laptop computers from Arctic Computing in August for shipment by October 1, in time
for the Christmas rush. Due to the COVID-19 pandemic and the short supply of computer
chips, the seller fails to ship until March of the next year. When the laptops finally arrive,
the buyer can reject the shipment due to the seller’s failure to ship them on time and can
sue the seller for damages. Or the buyer could cancel the contract and purchase substitute
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Remedies
Section 9.2
goods. Damages are tied to the “market price at the time the buyer learned of the breach”
(UCC § 2-713, 1951), which is in all likelihood the time the buyer will cancel and seek substitute goods in the marketplace, and therefore the difference in price between the two is the
damages calculation.
Example 9.13. How damages are determined. One hundred laptop computers were ordered
at a cost of $1,200 each. The total original contract price was $120,000. The buyer learns of
the breach on October 15, when the cost of laptops is $1,250 each, or a total of $125,000.
The buyer would have to pay an additional $5,000 to buy substitute goods and therefore is
entitled to that amount in damages.
Right to Cover (Obtain Substitute Goods) (§ 2-712)
If the buyer does not receive the goods or rightfully rejects nonconforming goods, the buyer
has the right to cancel the contract. The buyer can then go out into the marketplace and try to
find substitute goods, or cover.
If the buyer chooses to do so, they may then sue the seller for the difference between what the
buyer would have paid the seller for the goods under the contract and what the buyer now
needs to pay a substitute supplier for the goods. In the previous example, the buyer could
have obtained the laptops from another supplier when the seller failed to ship the computers
on a timely basis. The buyer could then sue the seller for the difference between the contract
price and the higher price paid to the substitute supplier.
Right to Specific Performance (§ 2-716)
A court has the power to grant specific performance to the buyer under the UCC when the
goods in question are unique or “in other proper circumstances” (UCC § 2-716, 1951) in
which mere money damages would not properly compensate the buyer for their loss.
Example 9.14. When specific performance is an appropriate remedy. A buyer agreed to
purchase two airplanes from a seller for $870,000. The seller breached the contract, and the
buyer sued for specific performance, arguing that the planes were unique because of their
condition and asking price. Since the ability to cover is virtually impossible, the buyer is entitled to specific performance, and the court would order the transfer of the planes to the buyer
upon payment.
When a buyer breaches the sales contract, the seller has a number of remedies available to
them in seeking compensation for their loss. These include the right to withhold goods, the
right to recover shipped goods, and the right to force the buyer to accept shipped goods under
certain circumstances.
Right to Withhold Goods (§ 2-705)
The seller can withhold delivery of the goods to the buyer until payment is made.
Example 9.15. A buyer orders 100 hover balls and agrees to pay using PayPal. Until the seller
receives payment, the seller has no obligation to make the goods available to the buyer.
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Chapter Summary
Right to Recover Goods (§ 2-702)
Sometimes, however, the seller starts the goods in motion to the buyer even when the seller
has not received payment. This may occur by placing the goods on a common carrier. Section 2-702 gives the seller the right to recover the goods from the third party prior to their
delivery.
Example 9.16. When seller learns buyer is insolvent and goods are in transit. A buyer
in Ohio buys goods from a seller in Indiana and agrees to have the goods delivered via Red
Ball Express. If, after the goods are in transit but before Red Ball Express delivers them to the
buyer, the seller learns that the buyer is insolvent, the seller can recover the goods from the
common carrier (Red Ball Express).
Sellers’ Damages for Breach (§§ 2-708–2-711)
When a buyer breaches the sales contract, the seller can recover lost profits from the buyer
or, alternatively, the difference between the contract price and the market price, or the contract price and the resale price (the latter is the price at which the seller is able to resell the
goods to another buyer after a good faith effort to sell the goods). The seller is also entitled to
recover incidental damages and consequential damages from the buyer, such as the cost
of shipment, storage, and restocking.
Example 9.17. When buyer wrongfully refuses to accept goods. A seller ships to a buyer
100 widgets pursuant to a valid sales contract. When the goods arrive, the buyer wrongfully
refuses to accept them. The seller can sue the buyer for lost profits under the contract and for
the costs of storing the goods, shipping them back, and restocking them once they arrive at
the seller’s plant.
Chapter Summary
The UCC provides for a number of warranties, both express and implied, that may accompany
a sale of goods transaction. The seller’s guarantees that there is valid title to the goods and
that the goods are merchantable are implied warranties that do not need to be specifically
stated by the seller. The guarantee of fitness of the goods for a particular purpose is also
implied, but this warranty requires that the seller know what use the buyer intends and that
the buyer relies on the seller’s superior knowledge of the goods. It is obviously important for
both parties to be aware of the legal ramifications of any representations regarding the title
or function of the goods, but they must equally pay careful attention to the language of the
contract so as to be aware of disclaimers and limitations.
As with any contract, sale of goods contracts can be breached on either side, and the UCC has
a number of provisions dealing with remedies for breach. Buyers can reject nonconforming
goods, sue for damages, and in cases of unique subject matter, alternatively sue for specific
performance of the contract. If the buyer breaches, the possible remedies for a seller include
the right to withhold goods or to recover goods that were already shipped or monetary damages. An astute seller or buyer should know when they make the contract what remedies are
available to them should things go wrong.
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Chapter Summary
Focus on Ethics:
Limiting the Implied Warranty of Merchantability
On one hand, the UCC provides for the implied warranty of merchantability. On the other,
it allows sellers to easily disclaim the warranty or limit the damages the seller owes if the
product is defective. Let us look at two examples of how this may play out in the real world.
• Suppose you are buying a used car from Big Al’s Auto Dealership. The car, a 2021
Toyota, is sold with either a 1-year warranty for an extra $1,000 or “as is” for the list
price. You buy the car “as is,” since you are a cash-strapped college student and every
dollar counts. As you are driving away from the dealership, the accelerator pedal
sticks and you crash into a highway barrier, wrecking the car.
• Suppose Net One, a cable television and internet service provider, is buying cable
from Cable Co. to install for an upgrade to its system. The contract provides that
remedies are limited to replacement and repair. Net One spends over $1 million
installing the cable, which turns out to be defective. Net One loses an estimated
$7.5 million in business during the period that the cable is being replaced.
Questions to Consider
1.
2.
3.
How would Big Al’s Auto and Cable Co. argue that its lack of liability is not only legal
but ethical?
Does it have an effect with regard to the fairness of the transaction that you as
the cash-strapped college student had a choice to pay more for a warranty on the
used car?
What if Net One shows that all the cable manufacturers use remedy limitations,
and thus they had no choice in the matter, that they could not bargain for a better
deal because there was no other supplier to bargain with? Note that Net One is a
big company, complete with attorneys, which puts it at a distinct disadvantage in
attempting to argue any kind of unconscionability claim. Does that mean that the
law is giving the sellers an unfair advantage?
Case Study: Bigelow v. Agway Inc.
506 F.2d 551 (2d Cir. 1974)
Facts: Bigelow was a dairy farmer who grew and baled his own hay. Kemin, a chemical
manufacturer, made a chemical preparation called Hay Savor, which was sold by Agway Inc.
Hay Savor’s purpose is to retard mold in baled hay, enabling it to be baled earlier when it
has a higher moisture content, which is more nutritious. Advertising literature for Hay Savor
stated that moisture levels should be 25% or below. Bigelow bought Hay Savor and spraying
equipment from Agway.
(continued on next page)
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Chapter Summary
Case Study: Bigelow v. Agway Inc. (continued)
Representatives from Kemin (Mr. Nelson) and Agway
(Mr. Newton) visited the Bigelow farm when the hay lay
drying in the fields. Nelson stated that even though the
hay had over 30% moisture and the normal safe level
for baling would be 25% or below, it would be safe for
baling if Hay Savor was used. Bigelow thought the hay
was too green, but relying on Nelson’s statement, he
went ahead and baled the hay and stored it in his barn.
Unfortunately, it turned out that the hay was indeed
too wet, and as a result of the heat generated by mold,
spontaneous combustion occurred. The hay and barn
were destroyed in the ensuing fire.
Bigelow sued the sellers of Hay Savor, alleging among
other things breach of warranty of merchantability and
warranty of fitness for a particular purpose.
Issue: Could a jury find that the warranty was made and
breached?
roundhill / Getty Images Plus
Even though an Agway
representative assured
Bigelow that it would be safe
to use Hay Savor, spontaneous
combustion occurred and
destroyed a barn. Was a
warranty of merchantability
made and breached?
Discussion: The court said there was no evidence that Hay Savor would not have performed
properly and safely had the hay been below the advertised 25% moisture level. Thus, the
warranty of merchantability could not have been breached.
With regard to the warranty of fitness for a particular purpose, the representation of Nelson
was made after the sale of the Hay Savor, and therefore Bigelow could not have been relying
on it when he made the purchase. The visit by Nelson and Newton was a different story,
however. If the language or samples or models are considered part of the contract, then the
contract was modified under 2-209, and the warranty became a modification to the original
contract.
Bigelow had testified that he treated and baled the hay in its condition because of what
Nelson told him. He thought the hay was too green, but the court decided that a jury could
infer he had relied on Nelson’s statements and thus possibly find that a warranty of fitness
for a particular purpose had been violated.
Holding: The court found that Mr. Bigelow relied on Nelson’s expertise and remanded the
case for a new trial so that the jury could consider Agway’s liability in light of this court’s
finding that an implied warranty of fitness was made by Agway’s representatives.
Questions to Consider
1.
2.
3.
4.
Why did the court find there was no breach of the warranty of merchantability?
The farmer was very experienced when it came to baling hay. Why would he have
been entitled to rely on Nelson’s opinion that it was safe to bale the hay?
How was a warranty for fitness of a particular purpose created here?
Why is UCC Section 2-209 relevant in this case?
© 2023 The University of Arizona Global Campus. All rights reserved. Not for resale or redistribution.
Chapter Summary
Case Study: Soaper v. Hope Industries, Inc.
309 S.C. 438,424 S.E.2d 493 (Sup. Ct. South Car. 1992)
Facts: Soaper purchased a color film–processing machine from Hope Industries to use in
a fast photo business, which he made known to Hope Industries. The machine repeatedly
malfunctioned, and Soaper sued Hope for breach of express warranty, breach of the implied
warranty of merchantability, and breach of the implied warranty of fitness for a particular
purpose. Hope argued that the goods were fit for their ordinary use. Soaper argued that the
goods were defective for their intended use in his fast photo business.
Issue: Does a purchaser establish a warranty of fitness for a particular purpose when goods,
purchased solely for their ordinary purpose, are found to be unfit for any and all purposes?
Discussion: When a product is purchased for a particular purpose, the question is whether
that same product must also be fit for other purposes, including ordinary purposes.
Holding: When a product is purchased for a particular purpose it, must also be usable for
its ordinary purchase. The warranties of merchantability and implied fitness for a particular
purpose merge.
Questions to Consider
1.
2.
3.
When Soaper purchased the machine, did he make known the particular purpose he
intended for its use?
If Soaper did not clearly articulate a particular use for the machine, what was
the court’s reasoning for finding that there was a breach of the implied warranty
of fitness for a particular purpose? What does this teach you about the court’s
interpretation? Is it a lenient or strict interpretation of the UCC?
The jury awarded the plaintiff the full value of the machine. What would have been
your decision if you had sat on the jury? Why?
Critical Thinking Questions
1. How do express and implied warranties differ?
2. Try reading the packaging of various products. Do they contain warranties? Do they
disclaim or limit warranties?
3. How much attention do you pay to warranties when you purchase a product? Does it
matter what the product is or how much it cost? If you do not particularly notice warranties, why not?
Hypothetical Case Problems
Case 1. A buyer orders an AM/FM stereo receiver, an amplifier, a record player, a CD player,
and speakers from the same retailer. The system is not sold as a set, and the separate components are listed separately on the bill. When the components are delivered, the buyer notices
that the system works perfectly, but the CD player is a different brand than that which he had
ordered.
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Chapter Summary
A. Can the buyer return the CD player and demand that it be exchanged but keep the
rest of the system after paying for it? Why?
B. Can the buyer reject the shipment and cancel the contract?
C. If the buyer returns the CD player and is informed that the one he had ordered is no
longer sold by the seller, what legal remedies are available to him?
D. Is the buyer entitled to reimbursement for the incidental expense of shipping the
nonconforming CD player back to the seller?
Case 2. In describing a new sculpture by a new artist, the owner of an art gallery makes the
following statement to a prospective buyer:
This wonderful sculpture by Jeff Oops, Brass Bedpan Over City Landscape, represents a poignant example of humanity’s struggle to triumph over existentialist despair. It is also the best social commentary on the evils of globalization ever to have been conceived by a brilliant young artist. And it is a bargain
at $25,000.
A. Assume that a buyer purchases the sculpture in question for the asking price. Does
the statement made by the seller constitute an express warranty as to the sculpture’s value? Why?
B. If most rational art critics would consider the work a worthless piece of junk, is
the seller guilty of breach of an express or implied warranty based on the above
statement?
C. Which of the following statements made by the seller about the sculpture would
constitute express warranties?
• If you purchase the sculpture and are displeased by it after 90 days, you may
return it to us for a full refund.
• This sculpture is not only art but a valuable antique as well, since the bedpan used
by the artist once belonged to the emperor Napoleon.
• This sculpture will appreciate at a minimum of 10% per year over the next 10
years.
D. If the bedpan had been stolen from a college fraternity house, where it had been
used as a punch bowl, placed atop a 5-year-old’s crayon drawing of a city landscape,
and then sold to the unsuspecting art gallery owner as an original work by Jeff Oops,
will the gallery owner be in breach of an implied warranty if they sell it in good faith
to a buyer? Explain.
Case 3. A buyer orders a truckload of Florida oranges from the owner of a Florida orange
grove. Under the terms of the agreement, the seller is to ship the oranges to the buyer FOB
seller’s plant, with payment due on delivery. After the goods are placed in the hands of the
carrier, but before they are delivered to the buyer, the seller learns that the buyer has filed for
bankruptcy and will be unable to pay for the shipment if it is delivered.
A. What can the seller do under the circumstances to protect their rights?
B. If the goods had been shipped on credit and actually delivered to the insolvent buyer,
what would the seller’s remedies be under the contract?
C. If the buyer is solvent but refuses to accept the goods upon delivery, claiming to have
found a cheaper supplier, what can the seller do?
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Chapter Summary
Case 4. A buyer, wishing to buy a Christmas gift for her husband, visits a computer store and
asks the salesperson to recommend a laser printer. She tells the salesperson that the printer
must print at a minimum of 12 pages per minute at a minimum resolution of 1,200 dots per
inch and must have a duty cycle of at least 10,000 copies per month. The salesperson recommends a low-end printer on sale that week but fails to mention that it prints at a speed of only
8 pages per minute and is rated for not more than 5,000 copies per month.
A. Has the salesperson breached any express warranty?
B. Has the salesperson breached any implied warranty? Explain.
C. If the salesperson demonstrates a color printer that meets all of the seller’s requirements but then sells her a cheaper monochrome laser printer instead, have they
breached any warranty?
Key Terms
consequential damages The costs
incurred in a breach of contract lawsuit to
find and purchase substitute goods, such as
mileage, lodging, and traveling expenses.
cover The name given to the process
wherein the seller of goods breaches the
contract and the buyer must then find
substitute goods.
express warranty A statement that comes
with a product either orally or in writing
that promises the goods will perform in a
certain manner.
implied warranty Either an implied
warranty of fitness for a particular purpose
or an implied warranty of merchantability.
“Implied” means that the warranty comes
with the product without an oral or written
statement.
incidental damages Minor costs incurred
by the injured party as a result of the other’s
breach of contract.
merchantable Pertaining to goods that are
fit for the usual or normal purpose.
nonconforming goods Goods that are
not what the buyer ordered, either because
they are defective or do not meet the
specifications of the buyer’s order.
remedies The compensation a buyer or
seller can collect from the liable party for
breaches of warranty.
warranty A guarantee that goods will meet
certain standards.
warranty of fitness for a particular
purpose A warranty that the goods are
suitable for a specific use intended by the
buyer. Such use must be known to the
seller at the time of sale, and the buyer
must be relying on the seller’s expertise in
recommending the goods for the purpose
indicated.
warranty of title A guarantee that goods
are sold free from any liens.
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10
Commercial Paper
AndreyPopov/ iStock/ Getty Images
Learning Outcomes
After studying this chapter, you will be able to
• Explain the significance of negotiable versus nonnegotiable commercial paper.
• Name the parties to notes and the parties to drafts.
• Define and distinguish between notes, drafts, checks, and certificates of deposit.
• Define the term “holder in due course” and explain the significance of this status.
• Explain the characteristics of negotiable instruments.
• Explain the difference between blank, special, and restrictive indorsements.
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Money has been used as a medium of exchange for more than 4,000 years. The exchange of
hard currency for goods and services facilitates commerce, but there are many circumstances
in which doing business on a cash basis is inconvenient or impossible.
Consider the sale of an office building for $50 million. In hundred-dollar bills, the payment
would take up about the same space as 25 boxed washing machines. It is unlikely either buyer
or seller would want to lug that around or that a bank would want to count it out. And of
course, there would be major security issues with such a large cash transaction.
One way to avoid the problems of transferring large sums of money is to deal on a credit basis:
The buyer could give the seller a promise that the seller could collect at the seller’s convenience. While much business is carried out on a credit basis, most sellers prefer something
more substantial than a simple promise that may or may not be paid upon demand. The solution is often commercial paper, which is a substitute for money that takes the form of drafts
and notes. Commercial papers function in place of cash and facilitate business transactions.
They are transferable, can easily be exchanged for cash, and serve as credit.
Notes and drafts are the subject of Article 3 of the Uniform Commercial Code. The idea behind
Article 3 of the UCC is the desire to make commercial paper flow through commerce with the
same ease as cash. In order to accomplish that feat, the rules governing commercial paper
give special protection to parties who accept it in the regular course of business so that it is
readily acceptable as a substitute for cash.
Beyond the Book:
Is Cryptocurrency the Future of Money?
Watch: https://www.youtube.com/watch?v=cJ9YvnGYvoM
The U.S. financial system has long been based on the use of paper as an exchange of currency.
The underpinnings of that system may be changing with the introduction of new types of
money such as cryptocurrency and Bitcoin. This video is an explanation of digital currencies
as compared to commercial paper, most notably negotiable instruments.
Questions to Consider
1.
2.
3.
One of the purposes of money is the ease of exchanging currency for the purchase of
goods. What did you observe in this video about the ease of using Bitcoin?
Why does Bitcoin have value? What is its value based on?
As of 2022, are there any government regulations regarding Bitcoin?
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Requirements for Commercial Paper
Section 10.1
10.1 Requirements for Commercial Paper
Commercial paper consists of two types of written
instruments: drafts and notes. Each will be examined in the discussion that follows.
Drafts and notes can be either negotiable or nonnegotiable. To be negotiable, the paper must meet
all of the criteria set out in UCC Section 3-104. All
negotiable instruments must:
1. Be in writing. Notes and drafts can be in
YinYang/ iStock/ Getty Images
any form, but checks must be on the form
Checks
must
be
on
the form required
required by a bank.
by
the
bank.
2. Be signed by the maker or drawer (the person writing the instrument). A signature is
simply any mark that the maker or drawer intends to represent a signature.
An X, initials, or a full autograph can all qualify.
3. Contain an unconditional promise to pay a sum certain in money. “I will pay $50,000
for the yacht Aurealis” is a sum certain, is in money recognized by a country, and is
unconditional. The promise to pay “if Aurealis wins the race” or in cigarettes contains a condition and is not payable in a currency recognized by a country and so
would make the paper nonnegotiable.
4. Contain no other promise, order, or obligation not specifically authorized by the UCC.
In other words, the promise to pay must be unconditional.
5. Be payable on demand or at a specific time. “I promise to pay $50,000 on June 1,
2024” qualifies. So does “I promise to pay $50,000 to Sierra when she wants it,”
which is a demand term. But “I promise to pay $50,000 to Sierra when she finally
graduates from college” is not, because Sierra’s graduation date is uncertain (e.g.,
what if she flunks Business Law?!).
6. Be payable to order or bearer. Commercial paper is either bearer paper or order paper.
To be order paper, the instrument must use the words “order” or “bearer,” unless it
is a check. Checks do not need the words “order” or “bearer” to be negotiable. To be
bearer paper, the instrument must use the words “bearer” or “cash” or be payable to a
specific person.
If an instrument does not meet all of the above criteria, it is not a negotiable instrument.
What is the importance of being negotiable? Both negotiable and nonnegotiable commercial
paper may flow through commerce. The problem with nonnegotiable paper is that it is subject to defenses; meaning the maker or drawer can refuse to pay. No one wants to hold paper
for which they cannot receive cash. On the other hand, most negotiable commercial paper is
not subject to defenses, meaning that the likelihood of payment is much greater. Thinking of
negotiable instruments as payable and nonnegotiable instruments as not payable is a simple
way to understand the difference between the two.
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Requirements for Commercial Paper
Section 10.1
An instrument may fail to meet the requirements for a negotiable instrument and still be
legally binding as a contract, and many people might accept it as payment. But they would be
taking a chance because it would not give the protection that a negotiable instrument provides. Consider the following instruments. Do they meet the requirements of negotiability?
1.
July 13, 2022
To: Jay Baldauf
I.O.U $50 (fifty dollars)
2.
July 13, 2022
To: First Bank of Bullion
Pay to the Order of: Ken Ansley
Three (3) ounces of gold
3.
Pay to the order of: Frank Barral
One hundred and xx/100 dollars when he completes the upcoming
July 13, 2022
$100.00
New York Marathon.
First Bank of Tampa
Memo: Go, Frank!
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Parties to Commercial Paper
Section 10.2
All of the above documents could be enforceable as part of a valid contract. None of the samples, however, meets the requirements for a negotiable instrument. Sample 1 is a simple IOU
that does not contain an unconditional promise to pay (it purports to owe the money but
does not say “I promise to pay” and therefore makes no specific promise as to its repayment);
furthermore, it is not payable to the order of Jay Baldauf or to bearer. Sample 2 is not payable
in money; gold, while valuable, is not legal tender. It need not necessarily be in dollars, but it
must be in a currency recognized by a country (a note payable in yen, euros, pounds, or pesos
is negotiable, but one payable in gold, silver, or any other commodity is not). Sample 3 is not
negotiable because it contains a conditional (not unconditional) promise to pay. Each of the
above instruments is nonnegotiable commercial paper that is subject to defenses and therefore does not give any special protection to parties who accept them in the regular course of
business.
10.2 Parties to Commercial Paper
Before we go much further, it is probably a good idea to define who is who when it comes to
commercial paper. See Tables 10.1 and 10.2.
Table 10.1: Notes—Two-party paper
Note
Maker
Payee
A promise by the maker to pay
the payee
The person (or company) who
promises to pay
The person who is being paid
Table 10.2: Drafts—Three-party paper
Draft
Drawer
Drawee
Payee
An order by the drawer
to the drawee to pay
the payee
The party ordering
the drawee (usually a
bank) to pay the payee
The bank
The person being paid
Example of parties to a note: Mikki enrolls in college and borrows money from the bank
for her tuition. She signs a note payable to the bank. Mikki is the maker and the bank is the
payee.
Example of parties to a draft: Dawn writes a check to Carrollton Jewelry for $45. Dawn
is the drawer; Carrollton is the payee; and Dawn’s bank, which is paying Carrollton, is the
drawee.
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Section 10.3
Types of Commercial Paper
Other parties of significance in commercial transactions are as follows.
Guarantor
Accommodation party
Acceptor
Indorser
Indorsee
A person who signs a note or draft on its face guaranteeing payment in case the
note or draft is dishonored when it is presented for payment. The guarantor is
liable to the payee of a note or draft for its face value if the maker or drawee fails
to pay the note when the payee properly demands payment. The liability of a
guarantor is primary to that of indorsers (signers) or accommodation parties.
A person who indorses (signs) a note or draft that is not made payable to them
in order to guarantee payment if the note or draft is dishonored when presented
for payment. An accommodation party has secondary liability and cannot
be made to pay on the note unless the principal parties (maker, drawer, and
drawee) have all refused payment.
A drawee of a draft who binds themself to pay the payee the face value of the
draft when it is presented for payment by signing as acceptor on the face of the
draft. A payee who obtains good faith acceptance of the draft by the drawee
receives a guarantee from them that the draft will be paid when it is properly
presented for payment.
The person who signs their name on the back of a note or draft naming them as
payee in order to obtain payment on it or negotiate it to a third party. (Please
note that “indorse” and “endorse” are synonymous. “Indorse” is used here and
throughout this chapter because it is the preferred legal term and the one used
by the UCC.)
The person to whom a negotiable instrument is indorsed as the new payee.
10.3 Types of Commercial Paper
For the purposes of our discussion, we’ll focus on these types of negotiable instruments: notes,
which includes notes and certificates of deposit; and drafts, which include drafts and checks.
Note
A note is an unconditional promise to pay a sum certain in money to a named payee (or to
bearer) that is payable on a specific date or on demand. The person or company who writes a
note is called the maker, and the person to whom the note is made payable is the payee. Notes
are used when a person wishes to borrow money from, say, a bank. The bank loans the money
and has the borrower sign a promissory note. The note is a promise to pay the bank back
with interest over a set number of years. The following example is typical.
Example 10.1. Robert wants to buy Aretha’s car for $5,000 but only has $1,000 available in
cash. He asks her if she’d be willing to accept a note for the balance payable over a period of
3 years at 10% interest. Aretha agrees and turns over the car in exchange for $1,000 in cash
and the following negotiable instrument.
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Types of Commercial Paper
Section 10.3
PROMISSORY NOTE
November 1, 2022
For good and valuable consideration received, the undersigned promises
to pay to the order of Aretha Jones the sum of $4,000.00 (Four thousand dollars) with
interest at a rate of 10%, payable in equal, consecutive monthly payments of $129.07
(One hundred and tweny-nine and 07/100 dollars) over the next 36 months with the
first payment due on December 1, 2022. In the event that the undersigned fails to
make any payment within 10 days of the date that it is due, the entire balance will be
due at the option of any holder of this instrument.
Upon default, the maker will pay all reasonable costs of collection, including court costs and reasonable attorneys’ fees.
Loan principle: $4,000.00
Annual interest rate: 10%
Interest charges: $646.52
Total Payments: $4,646.52
In the above example, Aretha is the payee of the note, while Robert is the maker. Once Robert
signs the note, Aretha will be able to negotiate it by indorsing it to a third party. Once the note
is indorsed and delivered to the third party, that party becomes the note’s holder and can in
turn negotiate the note to yet another person or keep the note and be entitled to payment
from Robert under its terms. Aretha can, of course, choose to keep the note and collect the
payments from Robert for the entire term.
Draft
A draft is an unconditional written, signed order by a drawer to a drawee to pay a sum certain in money to a named payee or to bearer. Unlike the maker of a note, who promises to pay
the payee, the drawer of a draft orders a third party—the drawee—to make the payment to
the payee. If the drawee refuses to pay the draft to the payee, the drawee may be liable to the
drawer if there were sufficient funds in the account and the draft appeared to be proper. A
check is a form of draft in which the drawee is a bank. The drawer opens up an account at the
bank and deposits money. The drawer then writes a check that orders the bank (drawee) to
pay the payee.
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Section 10.3
Types of Commercial Paper
The following example illustrates a simple draft. Note that none of the parties here is a bank
or large company, although they could be.
May 18, 2022
TO: Danielle Drawee
Pay to the order of Pam Payee $100.00 (One hundred dollars)
In this example, Danielle is the drawee (the person ordered to pay), Don is the drawer (the
person who writes the draft and orders the drawee to pay), and Pam is the payee. The draft
meets all of the requirements for negotiability: It is in writing, is signed by the drawer, contains an unconditional order to pay a sum certain in money, contains no other promises, and
is payable on demand, since no specific date for payment is specified. If Pam Payee takes this
draft from Don, she will be able to freely negotiate it. Naturally, both Pam and anyone else to
whom she negotiates the draft are likely to want some assurance that the drawee will honor
the draft when it is presented for payment. Pam can get such an assurance by taking the note
to the bank and asking the bank to certify the check. What this tells the holder of the check is
that when they take it to the bank, the bank will pay.
May 18, 2022
TO: Danielle Drawee
Pay to the order of Pam Payee $100.00 (One hundred dollars)
Accepted: Danielle Drawee
Even if Danielle is under no obligation to Don to accept the draft, once she signs as acceptor,
her obligation to pay the draft when it is presented will be absolute.
Check
A check is simply a draft in which the drawee is a bank. The drawer of a check is a person or
company who has an account in a bank against which they are authorized to draw checks. If
a payee of a check wants to ensure that there will be enough funds in the account on which
the check is drawn to guarantee its payment, the payee can demand that the drawer have the
check certified by the bank. A certified check is the equivalent of a draft that has been accepted
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Holder in Due Course
Section 10.4
by the drawee. Section 3-411 of the UCC specifically refers to certification of a check by a
bank as acceptance of the check; when a bank certifies a check, it guarantees that there will
be sufficient funds in the drawer’s account for the check to be honored when it is presented
for payment.
May 18, 2022
Pay to the Order of Pam Payee
One hundred and xx/100 —————————————————–Dollars
$100.00
State Bank
One Financial Lane
Anytown, USA 12345-6789
Memo: ________________________
1235 : 678901234 : 0001
The preceding sample contains all necessary information for the bank to pay the payee $100
from Don Drawer’s account. It should be noted that checks are a formal contract that must be
printed on a particular form before the bank will accept them. While other types of negotiable
paper such as notes can be written on a coconut and still be valid, checks must be on the preprinted form required by the bank.
Certificate of Deposit
A certificate of deposit (CD) is a note issued by banks and credit unions. The only significant
difference between a CD and a note is that CDs are issued by banks and notes can be issued
by any company or individual.
10.4 Holder in Due Course
A holder in due course is a person who has given value for an instrument, in good faith,
without notice of outstanding claims or other defects. The UCC gives special protection to
such people.
Example 10.2. Daniel hires Catherine to paint his house. After she completes the job, he lacks
the cash to pay, so he writes a note that reads, “I promise to pay to the order of Catherine
$3,000.” He signs his name and gives the note to Catherine. Catherine is buying Holden’s car,
and as payment she now writes on Daniel’s note “Pay to the order of Holden” and gives Holden
the note. Holden is a holder in due course.
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Holder in Due Course
Section 10.4
Holders in due course are in a very strong position when they accept a negotiable instrument
in that they take the instrument free from all personal defenses that any party might have to
payment of the instrument. In many circumstances, a holder in due course receives greater
rights and protection in taking negotiable instruments than the original holder of the instrument possessed. In most instances, holders in due course are entitled to payment of negotiable instruments in their possession, regardless of defects that these may possess.
Example 10.3. Daniel now discovers that the paint on his house is blistering and peeling
because Catherine used the wrong type for an exterior. Even though this is a breach of contract between Daniel and Catherine, he still has to pay Holden the $3,000.
Section 3-302 of the UCC lists the requirements for a person to become a holder in due course.
In order to qualify for the special status of holder in due course, a person must take a negotiable instrument:
1. For value. Taking the instrument for value means that some consideration was given
by the holder in order to receive the instrument, such as the car Holden gave to
Catherine.
2. In good faith. The requirement of good faith is met as long as the holder acted in
a just and ethical manner in obtaining the instrument (e.g., if the holder takes an
instrument under circumstances that should make her suspicious as to the validity
of the instrument, the good faith requirement will not be met).
3. Without notice that it is overdue or has been dishonored or of any defense against or
claim to it on the part of any person. Finally, the holder must also take the instrument
without the knowledge that it has been dishonored or is overdue or that there are
claims that can be asserted against it by third parties; this requirement can be seen as
an extension of the good faith requirement.
Section 3-305 of the UCC outlines the rights of a
holder in due course. In essence, a holder in due
course takes a negotiable instrument free from all
claims and defenses between the maker and the
payee or the drawer and payee. The only defenses
that can be successfully asserted against a holder in
due course occur between the maker and the payee
or the drawer and the payee and include incapacity, duress, illegality, forgery, and misrepresentation. With these exceptions—all of which are real
defenses that make the original execution of the
instrument void—no other defense may be asserted
against a holder in due course. Consider the following circumstances.
South_agency / E+/ Getty Images
If Catherine, the housepainter, indorses
Daniel’s note for $3,000 over to Holden
in payment for his car, Holden becomes
a holder in due course.
Example 10.4. Seller, a jeweler, sells Buyer a counterfeit Rolex watch for $7,500 (the watch is
an illegal import worth $20). Buyer pays by check, and the jeweler cashes the check.
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Characteristics of Negotiable Instruments
Section 10.5
Example 10.5. Tania finds a paycheck on the lectern after class, where the absentminded
professor left it after indorsing it in blank. (Obviously, this was not a business law professor!)
Tania takes the check and asks a friend to cash it for her, telling him the truth as to how she
came to possess the instrument. Tania’s friend then negotiates the check to his local grocer,
who is unaware that the paycheck was acquired through larceny.
Example 10.6. An armed robber forces Jin to execute a check at gunpoint.
Example 10.7. Sharlene tricks William into signing a note for $250,000, telling him it’s a petition to save polar bears and other endangered species. William, who trusts Sharlene implicitly, signs the note where she indicates a place for his signature. Sharlene then negotiates the
note to a group of innocent investors and leaves the country.
Example 10.8. Slick, an upscale day care center operator, dreams up the brilliant idea of having the children in his care sign notes for $250,000 each, payable in 20 years. (Slick figures
that chances are good that most of his kids will be independently wealthy in their mid-20s,
and he would like to assure himself a cozy retirement at their expense.) Several of the children who signed the notes in fact become quite wealthy, and Slick negotiates those notes
19 years later to innocent third parties.
In Examples 10.4 and 10.5, the bank and the grocer are holders in due course, since each
acquired the instrument for value, in good faith, and without knowledge that there were any
defenses or claims against it. As such, both the grocer and the bank are entitled to payment
under the instrument, and the buyer of the counterfeit Rolex as well as the professor will
have to bear the loss. (They can, of course, sue the jewelry store owner for fraud and Tania for
conversion, respectively, assuming these individuals can be found.)
In Examples 10.6, 10.7, and 10.8, however, Jin, William, and the persons who executed the
notes as children will all have valid defenses, even against holders in due course. A check or
note issued under duress is void and of no legal effect; since such an instrument is invalid at
its inception, even a holder in due course cannot obtain good title to it. Likewise, if a maker or
drawer is tricked into executing a negotiable instrument without their knowledge or consent,
the instrument is void and can never have any effect, even in the hands of a holder in due
course. The notes in Example 10.8 are executed by children of tender years and void at the
inception; they will be unenforceable even in the hands of a holder in due course.
10.5 Characteristics of Negotiable Instruments
Negotiable instruments, whether they are notes, drafts, checks, or CDs, can be characterized
as either a bearer or order paper. An order paper is a negotiable instrument that is payable
to the order of a specific person or company. A check that reads “Pay to the order of Alice Z.
López” is an order instrument, since the drawer is ordering the bank to pay Alice the sum
named in the check.
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Section 10.6
Negotiation and Indorsers’ Liability
A bearer paper, or bearer instrument, on the other
hand, is one that is made payable to cash or bearer.
The most common example of a bearer paper is a
check that is made out to cash: “Pay to the order of
cash” means pay to anyone who is in possession of
the instrument. “Pay to the order of bearer” would
be another example of a bearer instrument. Anytime a specific payee cannot be determined from the
words used by the drawer or maker to identify the
payee, it is assumed that a bearer paper is intended,
and the instrument becomes a bearer paper. Thus, a
check payable “to the order of 100 rabid raccoons”
is a bearer paper, since no specific payee can be
identified. Despite what a shocked bank teller might
think if such a check were presented for collection,
it is very much valid and as a bearer paper is payable to anyone who has it in their possession.
monkeybusinessimages / iStock / Getty Images
An order paper is a negotiable
instrument that is payable to the order
of a specific person or company, while
a bearer instrument is one that is
made payable to “cash” or “bearer.”
An instrument that sufficiently identifies a specific person or group of people as payees is
deemed an order paper, even if it does not specifically name them. A check made out as follows would be an order paper: “Pay to the order of the owner of a black Nissan 240 SX NY
license plate 1234 ABC.” Once the instrument is executed, it is payable only to the owner of
the automobile in question, who will be entitled to demand payment after proving that they
own such a car. It is possible to trace the payee of such an instrument to only one person, since
there could not be two black Nissan 240 SX automobiles in New York with the same license
plate number. If the car is registered to two people, such as a husband and wife, then the check
would be payable to both of them jointly.
Despite the fact that there is some room for creativity in the drafting of negotiable instruments with regard to the identification of payees, it is never a good idea to express one’s
creativity in drafting such instruments. At the very least, drafting a negotiable instrument in
an unusual manner—or for that matter, on an unusual object (such as the negotiable coconut
previously alluded to)—will cause problems for the payee when they try to cash or further
negotiate the check. At worst, litigation may be necessary to be able to enforce the validity
of the negotiable instrument. Also, keep in mind that there is generally no obligation for parties with whom we do business to accept our checks or other negotiable instruments; they
are free to demand cash from us, if they wish. Therefore, while your corner grocer may willingly accept your check that states “Pay to the order of cash,” “Pay to the order of bearer,” or
perhaps even “Pay to the order of anybody,” the grocer is unlikely to accept a check that reads
“Pay to the order of life, the universe, and everything,” no matter how much you argue.
10.6 Negotiation and Indorsers’ Liability
Negotiable instruments are freely transferable. This means that sellers will accept them
because they can be easily converted to cash. The vast majority of checks, drafts, notes, and
certificates of deposit are paid when properly presented to drawees or makers. On the rare
occasion that an instrument is presented and payment refused, the parties involved in writing
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Negotiation and Indorsers’ Liability
and transferring the instrument have liability. Makers, drawees, acceptors, and guarantors are primarily liable or “first in line” for payment of negotiable
instruments. If, however, they are unable or unwilling to pay it when it is properly presented for payment by the payee, there are others who are secondarily liable for paying the instrument. Drawers are
secondarily liable, meaning these individuals pay
only if the one with primary liability does not. They
can be called upon to pay if the drawee refuses to pay
(or dishonors) the draft or check when it is properly
presented for payment. Likewise, indorsers are also
secondarily liable if an instrument is dishonored.
Section 10.6
Pgiam/iStock/Getty Images
“Pay to the order of the Internal
Revenue Service” is an order
instrument, since the bank is ordered
to pay whatever amount is named in
the check to a specific payee—in this
case, a government agency.
Example 10.9. Tania is buying Devan’s café. Tania
gives Devan a check for $25,000. At this point, Tania
as drawer is not primarily liable to Devan; Devan
must present the check to the bank (or drawee). But if the bank dishonors (refuses to cash) the
check, Devan has the right to demand the $25,000 from Tania. Note that if Devan is nervous
over Tania’s duty to pay, he may prefer to specify payment in the form of a cashier’s check, a
special type of draft whose payment is guaranteed by the bank, or an electronic bank transfer.
The holder of a negotiable instrument—for example, a payee—can transfer its ownership to
another person or company by indorsing the back of the instrument and delivering it to the
person to whom it is indorsed. The indorsement of a negotiable instrument followed by its
delivery to the person to whom it is indorsed is termed negotiation—the formal name given
to the legal transfer of ownership from one holder to another. For an order instrument (one
payable to the order of a person or company) to be duly negotiated, indorsement followed by
delivery to the indorsee is necessary. A bearer instrument (one that is payable to cash, to the
order of cash, or to bearer or that otherwise fails to mention a specifically identifiable payee)
is negotiated simply by delivery to anyone; it does not need an indorsement.
Indorsers are basically anyone who has signed the instrument, other than the issuer or acceptor. Indorsers can be secondarily liable to those who follow them in the chain of transfer, but
not to those who came before them.
Example 10.10. Tania gives the check for $25,000 to Devan. Devan writes on the back “Pay to
Brittany,” signs his name, and gives the check to Brittany in payment for her Porsche automobile. Brittany now signs her name and gives the check to her landlord. If Tania now refuses to
pay the landlord, the landlord could demand that Devan or Brittany pay. If Brittany pays, she
cannot hold Devan liable, because he was a previous indorser.
Types of Indorsements (§§ 3-204–3-205)
Indorsements may be blank, special, or restrictive. A blank indorsement specifies no specific
indorsee and can consist of a simple signature on the back of the negotiable instrument. A
special indorsement is one that specifies to whose order an instrument is payable. A restrictive
indorsement is one that is conditional, purports to prohibit further transfer of the instrument,
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Section 10.6
Negotiation and Indorsers’ Liability
or includes the words “for collection,” “pay any bank,” “for deposit” or any similar term that
states the instrument is negotiated to a bank for the purpose of deposit.
Section 3-206 of the UCC clearly states that restrictive indorsements do not prevent an instrument from being further negotiated. However, a person to whom an instrument is negotiated
under a restrictive indorsement must comply with the indorsement if they are to qualify for
holder in due course status. If the bank or individual to whom a negotiable instrument is
restrictively indorsed does not treat the instrument consistently with the indorsement, it will
be liable to the indorser for any damages that result. Consider the following example.
Example 10.11. Dan restrictively indorses his paycheck as follows: “For deposit only into
State Bank A/C 1234567.” He then signs his name. On the way to the bank, he is mugged
by Thelma, who later takes the check and cashes it at her bank—First Bank of Erehwon.
Despite the restrictive indorsement, the bank teller pays the thief the face value of the check.
Assuming that the thief then leaves the state and cannot be found, First Bank of Erehwon will
have to reimburse Dan the full amount of the check, because it failed to honor the restrictive
indorsement.
The following examples illustrate restrictive, special, and blank indorsements made on a
check originally payable to Lisa Wong.
Restrictive Endorsement
For deposit only into
Fourth National Bank A/C
123-4567
Special Endorsement
Blank Endorsement
Pay to the order
of John Smith
Liability of Indorsers (§§ 3-415, 3-501)
Indorsers of negotiable instruments are secondarily liable for payment of the instrument if
the drawee or maker does not pay. For example, suppose Mark makes a note that says on its
face, “I promise to pay Pam $10,000 on August 15, 2023.” Pam then indorses the note and
negotiates it to Harry. On August 15, 2023, Harry presents the note to Mark for payment. If
Mark pays, then that is the end of the transaction. But if Mark refuses to pay, he has dishonored the note. Harry can then turn to Pam, who as an indorser is secondarily liable. He would
tell her that he presented the note to Mark, who refused to pay. This in effect is giving Pam
notice that Mark dishonored the instrument. Once notice of dishonor is given to Pam, Harry
can then seek payment from her since she is secondarily liable.
If a bank refuses to pay a check when it is presented for payment, then the payee must notify
the drawer and all indorsers before the payee can demand payment of the instrument from
them. A bank must notify its customer of dishonor by midnight of the day in which the dishonor occurs; all other persons must give notice of dishonor by midnight of the third day
following the dishonor (§ 3-508). Under Section 3-508, notice of dishonor by a bank or other
individual may be given in any reasonable format, including orally or in writing. If notification
is made by mail, the notice is deemed effective as of the time that the letter is mailed.
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Negotiation and Indorsers’ Liability
Section 10.6
Warranties of Presentment and Transfer (§ 3-417)
The following warranties are made by every transferor of negotiable instruments to the transferee upon negotiation of the instrument under UCC Section 3-417(1).
1. They have good title to the instrument or are authorized to transfer the instrument
on behalf of one who has good title to it.
2. They have no knowledge that the signatures of the maker or drawer are unauthorized (a holder in due course does not make this warrantee to a maker, drawee, or
acceptor of a draft).
3. The instrument has not been materially altered (a holder in due course does not
make this warrantee to the maker of a note or drawer of a draft, drawee, or acceptor
of a draft).
In addition to the above warranties by all transferors, any person who transfers a negotiable
instrument and receives consideration for the transfer also warrants the following under Section 3-417(2).
1. They have good title to the instrument or are authorized to obtain payment or
acceptance on behalf of one who has good title.
2. All signatures are genuine or authorized.
3. The instrument has not been materially altered.
4. There is no valid defense from any party against them.
5. They have no knowledge of any insolvency proceeding instituted with respect to the
maker, acceptor, or drawer of an unaccepted instrument. An insolvency proceeding is
a legal action taken by a creditor against a person or business debtor because they are
not paying their debts as they become due.
Section 3-417(3) provides that a transferor may limit the warranty liability specified under
Section 3-4172(2) by transferring the instrument “without recourse.” By transferring an
instrument “without recourse,” no warranties are made as to the transferor’s title, the genuineness of signatures, material alterations, or defenses by third parties affecting the instrument.
Example 10.12. Anna writes a check for $300 to Rahul, paying him back for money he loaned
her last week. Rahul alters the amount to read $1,300 and uses the check to pay for a scooter
he is buying from Carolina. Carolina deposits the check. When Anna discovers her account has
been debited $1,300, she brings it to the attention of the bank, which credits $1,000 back to
her account. Carolina must reimburse the bank for the $1,000, but she has the right to collect
from Rahul.
The warranties of presentment and transfer are implied warranties made by all transferors
of negotiable instruments. Dishonor of an instrument when it is presented for payment to a
maker or drawee can give rise to a lawsuit against them for breach of contract and against
indorsers for breach of one of the previously discussed warranties. For example, if the instrument is dishonored for a fraudulent signature, that would be a breach of the warranty of
good title.
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Chapter Summary
Chapter Summary
The use of commercial paper has been critical to modern commerce, enabling large transfers of money to be made in ways that would hardly be possible through the use of hard
currency like cash. There are several different kinds of commercial paper, including notes,
drafts, checks, and certificates of deposit, but all include certain requirements. They must
(a) be written and signed by the maker, (b) contain an unconditional promise to pay a definite
amount of money, and (c) be payable at a specific time or on demand. A key feature of commercial paper is that these instruments can be negotiated, or transferred readily to different
parties, and the law sometimes gives a transferee who qualifies as a holder in due course
additional protection. Because of the common nature of commercial paper transactions, it
is important that businesspersons understand the rights and risks attendant in using commercial paper. As is so often the case with the law, an awareness of what can go wrong should
enable people to better structure their business to ensure it more often goes right.
Focus on Ethics:
Should Banks Be Liable for Forged Checks?
Banks are often held liable for paying out on forged checks, a rule that was originally based
on the idea that banks had a relationship with their account holders and either could
recognize an invalid signature or had the ability to compare it with a signature on record
when the check was presented. Years ago, customers were known to the tellers at their local
bank, and they often did their banking in person. Banks do have some defenses available
to them under certain circumstances. For example, bank customers are required to inspect
their checks to make sure they are valid. In addition, bank customers must guard their
checkbook from falling into the hands of a thief. In either case, the bank could argue that it is
not liable even if the signature on the check was forged.
Today check processing is often done by machine, and many transactions are done
electronically, through online banking and ATMs or the use of debit cards; yet banks are still
liable for paying out in the same way they have previously been. This practice will continue
until new laws are drafted to make way for electronic signatures.
Questions to Consider
1.
2.
3.
4.
Does it still make sense for banks to presume liability when it comes to forgeries?
Do you think a bank should be able to protect itself by having an account holder sign
an agreement not to hold the bank liable for such mechanized transactions?
If Daria writes a check for $100 to Barry, who alters it to read $10,000, couldn’t we
say that Daria is as much at fault as the bank, since she chose to do business with a
crook? Could she have protected herself in this situation?
What are the advantages or disadvantages to society of a law that holds the bank
responsible (assuming the forger cannot be found or does not have the funds to
cover the loss)?
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Chapter Summary
Case Study: CadleRock v. Esperanza Architecture
500 P.3d 402 (Colo. App. 2021)
Facts: WestStart Bank loaned $500,000 to Esperanza Architecture through a revolving line
of credit. The next year the borrowers requested an increase in the loan from $500,000 to
$750,000. The bank agreed, and the parties signed a change of terms agreement to increase
the loan amount. The bank then transferred the revolving line of credit to a third party,
eventually ending with CadleRock. The borrowers defaulted on the loan and stopped making
payments. CadleRock sued the borrowers for the past due amounts.
Issue: Is a revolving line of credit a negotiable instrument, thereby making CadleRock a
holder in due course?
Discussion: A credit line agreement is a loan from a bank up to a certain amount of money
on which the customer can draw cash. The customer then has the obligation to repay the
loan. The customer can draw up to the maximum amount or take smaller draws. Therefore,
the amount that the customer owes on such a loan varies, depending on how much they
draw and how much they pay back. In order for an instrument to be a negotiable instrument,
it must be payable for a specific amount of money. Since the credit agreement does not reflect
a promise or order to pay a “fixed amount,” it is not a negotiable instrument.
Holding: Under the UCC, in order to be a negotiable instrument, the instrument must meet
the “fixed amount of money requirement.” This agreement fluctuates depending on how
much the borrowers take out from the account, and it is also subject to finance charges,
which also changes the amount owed. Since it is not a negotiable instrument, the defenses
normally available do not apply. The agreement could not be enforced.
Questions to Consider
1.
2.
3.
Was the paper involved in this case commercial paper?
Was the paper involved in this case negotiable or nonnegotiable?
What difference does it make whether or not the document is negotiable?
Case Study: Atlantic National Trust, LLC v. McNamee
984 So. 2d 375 (Ala. 2007)
Facts: McNamee borrowed $150,000 from South Trust Bank (which later became Wachovia)
and signed a promissory note. Wachovia gave McNamee a copy of the promissory note
that day, but Wachovia eventually lost the original. A few months before the note matured,
allowing for demand of repayment of the note, Wachovia assigned it to Atlantic National
Trust, LLC (Atlantic), by using a copy Wachovia had of the promissory note. When the note
became due, Atlantic demanded that McNamee repay the remaining balance plus interest,
but McNamee refused, arguing that Wachovia had no right to assign the note to Atlantic
because Wachovia had lost the original. Atlantic sued McNamee in a federal court. According
(continued on next page)
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Chapter Summary
Case Study: Atlantic National Trust, LLC v. McNamee
(continued)
to McNamee, the plain language of the relevant section of Alabama’s UCC prevented Atlantic
from having any right to enforce the copy of the note because Atlantic did not possess the
original at the time it was lost. That statute (§7-3-309) says in part: “A person not in the
possession of an instrument is entitled to enforce the instrument if the person was in the
possession of the instrument and entitled to enforce it when the loss of the possession
occurred.” Before rendering a decision, the federal court sent the case to the Alabama
Supreme Court, asking it to provide an answer to the legal question interpreting Alabama’s
UCC, since there was no precedent on the matter.
Issue: (a) Under the Alabama version of the UCC, can an assignee of a promissory note
enforce the note that was lost before it has been assigned? (b) Can a party that was entitled
to enforce this promissory note assign its rights to enforce the note after it was lost?
Discussion: In interpreting the specific UCC section in question, the court noted that though
the UCC does not specifically allow the assignment of the right to enforce a lost promissory
note, it also does not prohibit it. Furthermore, the court concluded that when the UCC does
not address an issue, the principles of common law should be used instead. Under Alabama
common law, “a valid assignment gives the assignee the same rights, benefits, and remedies
that the assignor possesses” (Nissan Motor Corp. v. Ross, 1997). So the court concluded that,
since the original note was genuine, the fact of the loss of the original does not make the note
unenforceable by either the maker of the note, Wachovia, or the assignee, Atlantic.
Holding: The Supreme Court of Alabama answered yes to both certified questions.
Questions to Consider
1.
2.
3.
4.
5.
Since McNamee gave a promissory note to Wachovia and later refused to repay the
remaining balance, why wasn’t Wachovia a party to this lawsuit?
What was McNamee’s argument supporting his refusal to repay the note?
What questions did the federal court want the Supreme Court of Alabama to
answer?
Why did the Alabama Supreme Court answer the questions the way it did? Do you
think that the answers of the Alabama Supreme Court would be different if there
was a dispute about the authenticity of the original promissory note?
Imagine that Wachovia did not make a copy of the note. Do you think it would be
legally right for McNamee to refuse the repayment of borrowed money because
there was no written proof of his debt? Even if it was legally permissible, do you
think it would be ethical? Would it be ethical for McNamee to escape paying back a
loan he acknowledged receiving?
Critical Thinking Questions
1. Commercial paper is intended to make business easier. Give three examples of how it
does so.
2. Reflect back on when you last paid a bill. Did you write a check? Or did you use an
alternative form of payment such as PayPal? Do you think that rules regarding negotiable instruments will soon be outdated and replaced by a new set of guidelines?
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Chapter Summary
Hypothetical Case Problems
Case 1. A seller offers a used car to a buyer, telling him that it is 3 years old, has 12,000 miles
on the odometer, and is in perfect mechanical condition. In fact, the car is 8 years old and has
over 100,000 miles on it, but the odometer has been tampered with to show 12,000 miles,
and the engine burns oil. The buyer buys the car based on the seller’s fraudulent misrepresentations and issues a check for $10,000. The seller then indorses the buyer’s check over to
a car wholesaler in return for 10 used cars. The wholesaler, who is unaware of seller’s shady
business practices, further indorses and negotiates the check to his bank.
A. Is the used car seller a holder of the check?
B. Is the used car seller a holder in due course of the check?
C. Is the wholesaler to whom the seller negotiates the check a holder in due course of
the instrument?
D. Is the wholesaler’s bank a holder in due course of the instrument?
E. If the buyer stops payment on the check after the seller has transferred the instrument to the wholesaler, will he have a valid defense against the wholesaler to refuse
payment of the check?
F. Would the buyer have a valid defense to refuse payment to the original seller?
Case 2. The following instrument is presented for payment at State Bank, where Mr. Tai C.
Chang has a checking account (#1-234567). The instrument is drafted on what appears to be
a yellow legal pad, and all items except for Tai’s signature are typewritten. The signature is
genuine.
September 1, 2022
Pay to the order of Alejandra Patiño $200.00 (Two hundred dollars and no/100)
To: State Bank, 123 Main Street, Anytown, OH 11111
Account Number: 1-234567
A. Is the instrument negotiable or nonnegotiable?
B. What type of paper is it?
C. If the instrument had been written on balsa wood, would the holder be able to cash
it at a bank?
D. Assuming the instrument is valid, is it an order or bearer paper? Explain.
E. Assume Alejandra indorses the instrument by signing her name on the back, without
adding any additional language. What type of indorsement would that be? Would the
instrument now be an order or bearer paper?
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Chapter Summary
Case 3. Examine the following instrument and answer the questions that follow.
May 18, 2022
Two years from today, the undersigned promises to pay Upinder Singh $10,000
(Ten thousand dollars) with interest thereon at a rate of seven percent per year.
Payment Guaranteed:
A. Is the instrument involved negotiable? Why?
B. What type of instrument is it?
C. Who are the various parties to the instrument?
Key Terms
acceptor A drawee of a draft who binds
themself to pay the payee the face value of
the draft when it is presented for payment
by signing as acceptor on the face of the
draft. A payee who obtains good faith
acceptance of the draft by the drawee
receives a guarantee from them that the
draft will be paid when it is properly
presented for payment.
accommodation party A person who
indorses a note or draft that is not made
payable to them in order to guarantee
payment if the note or draft is dishonored
when presented for payment. An
accommodation party has secondary
liability and cannot be made to pay on the
note unless the principal parties (maker,
drawer, and drawee) have all refused
payment.
bearer instrument An instrument that is
made payable to cash or bearer. Also called
bearer paper.
cashier’s check A check drawn by a bank
on itself.
certificate of deposit (CD) A note issued
by a bank.
check A draft in which the drawee is a bank.
commercial paper A medium of exchange
in the form of a note or a draft governed by
UCC Articles 3 and 4.
draft An unconditional written, signed
order by a drawer for a drawee to pay a sum
certain in money to the order of a named
payee or to bearer.
drawee The person or organization that is
directed to pay a draft.
drawer The person who makes or executes
a draft. Also called maker.
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Chapter Summary
guarantor A person who signs a note or
draft on its face guaranteeing payment in
case the note or draft is dishonored when
presented for payment.
holder in due course A person who has
given value for an instrument, in good faith,
without notice of outstanding claims or
other defects.
indorsee The person to whom a negotiable
instrument is indorsed as the new payee.
indorser The person who transfers a
note or draft by signing the back of the
instrument in order to obtain payment or
negotiate to a third party.
maker The person who makes or executes
a note. Also called drawer.
negotiation A transfer of commercial paper
from one person to another for value.
note A form of commercial paper in which
a maker promises to pay a sum certain to a
payee.
order paper A negotiable instrument with
the words “pay to the order of.”
payee The person to whom a note or draft
is made payable.
promissory note An unconditional written
promise to pay money; an IOU.
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Unit 4
Property, Employment,
and Business Organizations
This chapter begins with a discussion of property law. Property can take many forms, from real
property, which includes land and things attached to the land, to intellectual property, to personal
property. Business transactions often focus on property, whether it is leasing an office building,
selling products (personal property), or preventing infringement of a trademark (intangible
property). Chapter 11 will examine the three major types of property: personal property, which
includes goods under the UCC; intellectual property, which encompasses copyrights, patents, and
trademarks; and real property, which is land and all things attached to the land.
Business relationships and organizations are also critical to understanding the modern commercial
environment. In today’s complex business world, understanding employment relationships is important
for managers. There are many different forms an employment relationship can take, each with its own
characteristics. Managing employees within the boundaries of the law without violating discrimination
laws, which are complicated and ubiquitous, is the topic of Chapter 12. Chapter 13 will look at the
different types of business organizations, ranging from the ancient and simple sole proprietorships and
partnerships to the much newer and more complex forms that can exist only through statute, such as
corporations.
CHAPTER 11: Property: Personal, Intellectual, and Real
CHAPTER 12: Employment Law, Discrimination, and Privacy
CHAPTER 13: Business Organizations
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11
Property:
Personal, Intellectual, and Real
Tttuna | iStock Unreleased / Getty Images
Learning Outcomes
After studying this chapter, you will be able to
• Distinguish between personal, intellectual, and real property.
• Explain how personal property is acquired.
• Discuss the definition and significance of bailments.
• Describe the types of intellectual property and how they operate in cyberspace.
• Define different types of tenancies in real property.
• Discuss the concept of eminent domain.
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Section 11.1
Personal Property
The concept of property and ownership is one that has long been important in both society
in general and law in particular. English philosopher and political theorist John Locke saw it
as “the reason why men enter into society,” and Walter Lippmann, the American journalist,
described it as “the only dependable foundation of personal liberty” (as cited in Jeffrey, 2014).
Some have gone so far as to say that the main reason for law is to protect property rights. Even
if one does not subscribe to such a narrow purpose, there is no doubt that the law is much
concerned with property and rights of ownership.
Property can be defined as the right of an individual to exclusively possess, use, and dispose of
anything that is capable of being owned. Broadly speaking, property can be divided into three
separate types: personal property, intellectual property, and real property. In the materials
that follow, we will explore these different types and their characteristics.
Because modern business often involves all three types of property, a basic understanding
of property law is essential for business students. A company will protect its name, logo, and
advertising slogans through intellectual property law. The company’s factory, whether owned
or leased, is governed by the law of real property. The goods the company manufactures are
personal property of the business. One way or another, property law is unavoidable for almost
any business.
11.1 Personal Property
Personal property consists of tangible and intangible goods, as discussed in Chapter 2. Tangible personal property is the same as goods under Article 2 of the UCC and encompasses
ownership interests in things that have a physical existence and are able to be moved, or
carried, from place to place. Most property falls into this category: a car, wallet, photograph,
shirt, pen, and phone are all common examples of tangible personal property. Intangible
personal property, on the other hand, is personal property that by its very nature does not
have a physical existence but is merely a right that can be owned, as opposed to a real, tangible object. Common examples of intangible property include stocks and bonds.
Acquiring Ownership Over Personal Property
This section discusses the ways people acquire an ownership interest in personal property.
The sale and purchase of personal property is governed by the Uniform Commercial Code. In
both your personal and professional life, you will buy and sell goods, whether it be acquiring
new furniture for your apartment or business supplies for your company. How to buy and sell
goods is an important concept to under…