chapter ii - law.gmu.edu

NEGOTIABILITY: THE DOCTRINE AND ITS APPLICATION IN U.S. COMMERCIAL LAW

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CHAPTER II

REQUISITES OF NEGOTIABILITY: IS THE INSTRUMENT NEGOTIABLE?

If we are to create a genre of promise upon which to bestow the attributes of negotiability, how can suchpromises be identified?

The tests of negotiability embodied in Part 1 of UCC Article 3 reflect, in large part, the case law develop-ment of several hundred years. Negotiability was available to certain types of instruments containing specificlanguage. In some sense, the decision as to what language was necessary, what permissible, and what impermis-sible depended upon the purpose of the instrument and its reception by the market. The tests codified in the NIL,the original Article 3 and its revision reflect an ecclectic combination of formality and utility. In part, suchimprecision is necessary because of the type of instruments to be governed differs considerably. The case lawreflected in the statutes reflects, in part, an instrument intended to circulate as currency (a simple draft or bill ofexchange or note); in part, checks; and, in part, intracate promises to pay which are undergirded by extensiveassurances of repayment.

The United Kingdom Bills of Exchange Act and the U.S. Uniform Negotiable Instruments Law, modeledlargely on the British Act, both adopted a test which contained elements of formality. Comparative law providesa most useful insight into the nature of negotiability at this juncture. Compared to the system used in the civiliancountries, the U.S. and U.K. tests appear almost functional. For an interesting compromise between the twosystems, it would be useful to examine the work of the United Nations Commission on International Trade Lawas embodied in the Convention on International Bills of Exchange and International Promissory Notes.

The approach taken in Article 3 is to delimit its scope by means of positive and negative requirementsembodied in the definition of a negotiable instrument. As a result, the initial analytical step in any probleminvolving Article 3 is in determining whether the instrument at issue is negotiable; an exercise which is definitionalin character.

In applying these rules, it is necessary to determine which provisions are mandatory, which are permissible,and which are impermissible. While this determination is usually easy with respect to simple promises or ordersused in a currency-like fashion, it is much less so with respect to more complex promises. In order to resolve theissues involved in such undertakings in a principled fashion, it is necessary to understand the reason for theparticular statutory requirement. In this process, it is inevitable that its soundness is assessed as well. As a result,it is sometimes necessary to determine whether certain requirments are wisely specified with great precision andwhether the definitional requirements should be applied formally or with respect to their purpose. As the de-mands for instruments change from time to time, these questions can become most pressing.

A. NEGOTIABLE INSTRUMENTS: A DEFINITIONAL EXERCISE

1. Signed Writings

a.) Is it necessary that a negotiable instrument be in writing?

CHAPTER 2: REQUISITES OF NEGOTIABILITY - IS THE INSTRUMENT NEGOTIABLE?

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(1) Is an oral undertaking otherwise negotiable enforceable? Could it be enforceable under principlesof estoppel?

(2) If the above undertaking were recorded on tape would it be enforceable?

(3) If the undertaking was contained on a computer disk would it be enforceable?

(4) If something were to satisfy the business records exception, would it qualify as a writing? Is thisrequirment, then, simply evidentiary?

(5) Is there an element of permanance? In 17 Bank Security Report 2 (1988), checks were reported tobe turning up in Chicago which dissolved within hours of the time they were deposited and before theywere microfilmed.

b.) Is it necessary that a negotiable instrument be signed?

(1) Is a letterhead a signature?(2) The printed name on a check?

c.) Should the provisions regarding a signed writing be liberally or strictly construed?

2. Payable to Order or to Bearer

a.) Is the following undertaking negotiable?

b.) The following instrument was the subject of litigation in Lincoln First Bank v. Bank of New York (InRe Levine), 23 Bankr. 410 (Bankr. S.D.N.Y. 1982), aff�d, 24 Bankr. 804 (Bankr. S.D.N.Y. 1982):

�Know all men by these presents, that Morris M. Levine and Barbara R. Levine ... hereinafterdesignated as the obligor, does hereby acknowledge the obligor to be justly indebted to David Mykoff andJoan Mykoff ... hereinafter designated as the obligee, in the sum of FIFTY FOUR THOUSAND dollars... which sum said obligor does hereby covenant to pay the said obligee, and the executors, administra-tors, successors or assigns of the obligee, on September 2nd, 1977, with interest thereon to be computedfrom the date hereof at the rate of eight (8%) per centum per annum and to be paid on the 2nd day ofOctober, 1976, next ensuing and monthly thereafter.�

Pay to _____________________________ $3,000.00

Three Thousand and xx/100 dollars

Bank TenSomewhere

John Doe

52-221-764-32


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In analyzing the priority to be given this bond in an insolvency proceeding, it was necessary to determinewhether or not it was supported by consideration. Since it was given in exchange for an antecedent debt,the consideration would not support it unless it were determined to be negotiable. The court�s conclusionthat it was not negotiable is as explained as follows:

Is the Bond A Negotiable Instrument?

If the bond in question were a negotiable instrument, the lack of legal consideration supporting it would notaffect Bankers Trust�s secured status as assignee of the mortgage. New York�s Uniform Commercial Code(U.C.C.) Section 3-408 states in pertinent part: § 3-408.

Consideration

�Want or failure of consideration is a defense as against any person not having the rights of a holder in due course(Section 3-305), except that no consideration is necessary for an instrument or obligation thereon given in pay-ment of or as security for an antecedent obligation of any kind.�

The use of the word �instrument� in the statute means a negotiable instrument, N.Y.U.C.C. Section 3-102(1)(e).Thus, an antecedent debt is sufficient consideration for the execution of a negotiable instrument, even if theholder of the instrument does not have the rights of a holder in due course. Here, the assignee does not have therights of a holder in due course 2 and therefore would ordinarily be subject to the defense of want or failure ofconsideration (N.Y.U.C.C. Section 3-306(c)); however, if the bond is a negotiable instrument, N.Y.U.C.C. Sec-tion 3-408 would resolve any problem regarding the consideration.3 In light of the foregoing, it is crucial todetermine the character of the mortgage bond which was endorsed over and assigned to Bankers Trust.

A negotiable instrument is one that meets the standards set out in N.Y.U.C.C. Section 3-104. 4 It is section 3-104(1)(d) that is of concern here; a writing, to be negotiable, must �be payable to order or to bearer� (seeN.Y.U.C.C. Section 3-110 and Section 3-111). The mortgage bond in question does not contain such language,5

and therefore cannot be a negotiable instrument. 6 In the case of In re Deveson�s Estate, 158 Misc. 868, 287N.Y.S. 98 (Surr.Ct.1936), the court addressed the issue of whether an ordinary mortgage bond, payable to theobligee, his executors, administrators, or assigns, accompanied by real estate security, is a negotiable instrument.(This language is identical to that used in the subject mortgage bond). Citing the former Negotiable InstrumentsLaw, Section 20(4) (now incorporated in the N.Y.U.C.C.), which was in accord with the U.C.C. requirementthat the instrument be payable to order or bearer, the court concluded, �(t)hus, by statute, a mortgage bond, as inthe instant case, becomes nonnegotiable.� 287 N.Y.S. at 101. In Enoch v. Brandon, 249 N.Y. 263, 265-6, 164N.E. 45, 46 (1928) the court stated:

�True, to become negotiable an instrument need not follow any precise language ... But it �must conform� tothe definition specified in Section 20. (Section 20 of the N.I.L., now U.C.C. Section 3-104). In the face of acommand so explicit we must adhere to the design of the Legislature .... We turn, therefore, to the more seriousquestion. The statute deals with the form of the instrument-with what a mere inspection of its face shoulddisclose. It must contain an unconditional promise to pay a fixed sum, on demand, or at a fixed or determinablefuture time, to order or to bearer. Only if it fulfills these requirements is it negotiable.�

The fact that the Mykoffs endorsed the bond with the words �payable to the order of Bankers TrustCompany without recourse� does not change the inherent character of the bond. �(N)o intention, no agreement,may make negotiable an instrument which the statute declares to be non-negotiable.� Enoch v. Brandon, 164N.E. at 46. See also, Felin Associates, Inc. v. Rogers, 38 A.D.2d 6, 326 N.Y.S.2d 413 (Sup.Ct.A.D. 1st Dept.


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1971). Accordingly, it must be concluded that the subject mortgage bond is not a negotiable instrument, and thatN.Y.U.C.C. Section 3-408 cannot operate to excuse the lack of legal consideration. The bond which the Levinesexecuted and gave to the Mykoffs, evidencing their promise to pay an antecedent debt is unenforceable, andtherefore the accompanying mortgage falls with it. Since the assignee, Bankers Trust, holds an unenforceablebond and mortgage (its position can be no better than that of its assignor), its claim is rendered unsecured.

Note that the decision was governed by the original Section 3-104 and 3-110.

Do you agree with the court?

c.) If an instrument lacks order/bearer language, but is otherwise negotiable, is it enforceable? See formerSection 3-805.

3. Promise or Order

a.) "Pay to Bearer" Is this an order?

b.) Is this undertaking negotiable? Why?

"Waterville, Kans., Dec. 31, 1924."G.W. Shearer, Waterville Kans.,:I owe you $4683.34, money advanced on'Shearer Cottage Camp' Colorado Springs, Colo.

Mrs. Rena Shearer.

c.) Is this language negotiable? Why?

�You are hereby irrevocably authorized to pay to the order of Tom Jones $10,000.� /s/ Sam Shoe

d.) Is there an operative legal difference between a promise and an order? What if the drawer is the payee?the drawee? Is it a draft or a note? What difference does it make?

B. MANDATORY, PERMISSIBLE & IMPERMISSIBLE PROVISIONS IN NEGOTIABLE INSTRU-MENTS

In order to determine whether an instrument is negotiable, all necessary provisions must be present and noimpermissible provisions may be present. While the rules are reasonably clear, some are less easily applied.

1. What are the mandatory requirments for negotiability?

2. Is consideration necessary for an instrument to be negotiable?

3. a.) Is this instrument negotiable? Why?


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Dear Sirs,

As an inducement to you to extend credit to and to otherwise deal with Thomas C. Creasy, Jr. and/or MargaretW. Creasy (hereinafter called Borrower), and in consideration thereof, the undersigned hereby absolutely and uncon-ditionally guarantees to you and your successors and assigns the due and punctual payment of any and all notes,drafts, debts, obligations and liabilities, primary or secondary (whether by way of endorsement or otherwise), ofborrower, at any time, now or hereafter, incurred with or held by you, together with interest, as and when the samebecome due and payable, whether by acceleration or otherwise, in accordance with the terms of any such notes,drafts, debts, obligations or liabilities or agreements evidencing any such indebtedness, obligation or liability includ-ing all renewals, extensions and modifications thereof.

The undersigned is your debtor for all indebtedness, obligations and liabilities for which this Guaranty is made,and you shall also at all times have a lien on all stocks, bonds and other securities of the undersigned at any time inyour possession and the same shall at your option be held, administered and disposed of as collateral to any suchindebtedness, obligation or liability of the borrower, and you shall also at all times have the right of setoff against anydeposit account of the undersigned with you in the same manner and to the same extent that the right of setoff mayexist against the Borrower.

It is understood that any such notes, drafts, debts, obligations and liabilities may be accepted or created by orwith you at any time and from time to time without notice to the undersigned and the undersigned hereby expresslywaives presentment, demand, protest,and notice of dishonor of any such notes, drafts, debts, obligations and liabili-ties or any other evidence of any such indebtedness, obligation or liability.

You may receive and accept from time to time any securities or other property as a collateral to any such notes,drafts, debts, obligations and liabilities, and may surrender, compromise, exchange and release absolutely the same orany part thereof at any time without notice to the undersigned and without in any manner affecting the obligation andliability of the undersigned hereby created.

This obligation and liability on the part of the undersigned shall be a primary and not a secondary obligationand liability, payable immediately upon demand without recourse first having been had by you against the Borroweror any person, firm or corporation; ...

The aggregate amount of the principal of all indebtedness, obligations and liabilities at any one time outstand-ing for which the undersigned shall be liable as herein set forth shall not exceed the sum of $35,000.00.

This agreement shall inure to the benefit of you, your successors and assigns, and the owners and holders ofany of the indebtedness, obligations and liabilities hereby guaranteed, and shall remain in force until a written noticerevoking it has been received by you; but such revocation shall not release the undersigned from liability to you, yoursuccessors or assigns, or the owners and holders of any of the indebtedness obligations and liabilities herebyguaranteed, for any indebtedness, obligation or liability of the Borrower which is hereby guaranteed and then inexistence or from any renewals or extensions thereof in whole or in part, whether such renewals or extensions are madebefore or after such revocation.1

SIGNATURES: THOMAS C. CREASY, JR./ MARGARET W. CREASY


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b.) The following decision was rendered under prior Section 3-106. Is this decision sound? Is the rule sound andis it continued? Review the current code to determine its application.

Taylor V. Roeder234 Va. 99, 360 S.E.2d 191 (1987)

Opinion by: Russell

In the second case, Richard L. Saslaw and oth-ers, on December 31, 1979, borrowed $22,450 fromVMC evidenced by a 12-month note secured by deedof trust on Fairfax County land. This note also boreinterest at �3% over Chase Manhattan Prime adjustedmonthly.� Interest was to be payable quarterly begin-ning April 1, 1980.� In November 1980, Virender andBarbara Puri entered into a contract to purchase fromSaslaw, et al., the land subject to the last-mentioneddeed of trust. The Puris designated the same FrederickTaylor, Jr., as their settlement attorney. Taylor�s titleexamination revealed VMC�s deed of trust. Tayloragain requested a pay-off figure from VMC. At settle-ment, Saslaw objected to the figure, communicated withVMC and received VMC�s agreement to an adjustedfigure. Taylor paid the adjusted amount to VMC. Again,Taylor failed to receive the cancelled Saslaw note, andthe Saslaw deed of trust was not released.

Cecil Pruitt, Jr., was a trustee of a tax-exemptemployee�s pension fund. He invested some of thepension fund�s assets with VMC, receiving as collat-eral pledges of certain secured notes that VMC held.The Saslaw note was pledged and delivered to him onJanuary 25, 1980; the Olde Towne note was pledgedand delivered to him on September 12, 1980. No noticewas given to the makers, or to Taylor, that the noteshad been transferred, and all payments on both noteswere made to and accepted by VMC.

VMC received and deposited in its account suffi-cient funds to pay both notes in full, but never informedPruitt of the payments and made no request of him forreturn of the original notes. In February 1982, VMCdefaulted on its obligation to Pruitt for which both noteshad been pledged as collateral. In May 1982, VMCfiled a bankruptcy petition in federal court.

The dispositive question in this case is whether anote providing for a variable rate of interest, notascertainable from the face of the note, is a negotiableinstrument. We conclude that it is not.

The facts are undisputed. VMC Mortgage Com-pany (VMC) was a mortgage lender in Northern Vir-ginia. In the conduct of its business, it borrowed fundsfrom investors, pledging as security the notes securedby deeds of trust which it had obtained from its bor-rowers. Two of these transactions became the subjectof this suit. Because they involve similar facts and thesame question of law, they were consolidated for trialbelow and are consolidated in a single record here pur-suant to former Rule 5:23.

In the first case, Olde Towne Investment Corpo-ration of Virginia, Inc., on September 11, 1979, borrowed$18,000 from VMC, evidenced by a 60-day note se-cured by a deed of trust on land in Fairfax County. Thenote provided for interest at �three percent (3.00%)over Chase Manhattan Prime to be adjusted monthly.�The note provided for renewal �at the same rate ofinterest at the option of the makers up to a maximum ofsix (6) months in sixty (60) day increments with thepayment of an additional fee of two (2) points.� Thenote was renewed and extended to November 11, 1980,by a written extension agreement signed by OldeTowne and by VMC.

In May 1981, Frederick R. Taylor Jr., as trusteefor himself and other parties, entered into a contract tobuy from Olde Towne the land in Fairfax County se-curing the $18,000 loan. Taylor�s title examination re-vealed the VMC deed of trust. He requested the pay-off figures from VMC and forwarded to VMC the fundsVMC said were due. He never received the cancelledOlde Towne note, and the deed of trust was not re-leased.


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Learning that the properties securing both noteshad been sold, Pruitt demanded payments from the re-spective original makers as well as the new owners ofthe properties, contending that he was a holder in duecourse. The makers and new owners took the positionthat they had paid the notes in full. Pruitt caused Will-iam F. Roeder, Jr., to qualify as a substituted trusteeunder both deeds of trust and directed him to foreclosethem. Taylor and the Puris filed separate bills of com-plaint against Roeder, trustee, seeking to enjoin the fore-closure sales. The chancellor entered a temporary in-junction to preserve the status quo and heard the con-solidated cases ore tenus. By letter opinion incorpo-rated into a final decree entered February 3, 1984, thechancellor found for the defendant and dissolved theinjunctions. We granted the complainants an appeal.The parties have agreed on the record that foreclosurewill be withheld while the case is pending in this court.

Under the general law of contracts, if an obligorhas received no notice that his debt has been assignedand is in fact unaware of the assignment, he may, withimpunity, pay his original creditor and thus extinguishthe obligation. His payment will be a complete defenseagainst the claim of an assignee who failed to give himnotice of the assignment. Evans v. Joyner, 195 Va. 85,88, 77 S.E.2d 420, 422 (1953).

Under the law of negotiable instruments, contin-ued in effect under the Uniform Commercial Code, therule is different: The makers are bound by their con-tract to make payment to the holder. See Trustees ofInternal Imp. Fund v. Lewis, 34 Fla. 424, 428, 16 So.325, 326-327 (1894); Hobgood v. Sylvester, 242 Or.162, 167, 408 P.2d 925, 927 (1965); Perkins v. Hall,123 W.Va. 707, 716, 17 S.E.2d 795, 801 (1941); Code8.3-413. Further, a holder in due course takes the in-strument free from the maker�s defense that he hasmade payment to the original payee, if he lacks noticeof the payment and has not dealt with the maker. Code8.3-305. Thus, the question whether the notes in thiscase were negotiable is crucial.

Code 8.3-104(1) provides, in pertinent part:

Any writing to be a negotiable instrument within thistitle must . . . (b) contain an unconditional promise ororder to pay a sum certain in money . . .

The meaning of �sum certain� is clarified by Code 8.3-106:

(1) The sum payable is a sum certain even though it isto be paid(a) with stated interest or by stated installments; or(b) with stated different rates of interest before andafter default or a specified date; or(c) with a stated discount or addition if paid before orafter the date fixed for payment; or(d) with exchange or less exchange, whether at a fixedrate or at the current rate; or(e) with costs of collection or an attorney�s fee or bothupon default.(2) Nothing in this section shall validate any term whichis otherwise illegal.

Official Comment 1, which follows, states in part:

It is sufficient [to establish negotiability] that at anytime of payment the holder is able to determine theamount then payable from the instrument itself with anynecessary computation . . . The computation must beone which can be made from the instrument itself with-out reference to any outside source, and this sectiondoes not make negotiable a note payable with interest�at the current rate.� Code 8.3-107 provides an ex-plicit exception to the �four corners� rule laid down aboveby providing for the negotiability of instruments pay-able in foreign currency.

We conclude that the drafters of the UniformCommercial Code adopted criteria of negotiability in-tended to exclude an instrument which requires refer-ence to any source outside the instrument itself in orderto ascertain the amount due, subject only to the excep-tions specifically provided for by the U.C.C. SeeSalomonsky v. Kelly, 232 Va. 261, 264, 349 S.E.2d 358,360 (1986).

The appellee points to the Official Comment toCode 8.3-104. Comment 1 states that by providing cri-teria for negotiability �within this Article,� (adopted inVirginia as �within this title�) 8.3-104(1) �leaves openthe possibility that some writings may be made nego-tiable by other statutes or by judicial decision.� TheComment continues: �The same is true as to any new


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type of paper which commercial practice may developin the future.� The appellee urges us to create, by judi-cial decision, just such an exception in favor of vari-able-interest notes.

Appellants concede that variable-interest loanshave become a familiar device in the mortgage lendingindustry. Their popularity arose when lending institu-tions, committed to long-term loans at fixed rates ofinterest to their borrowers, were in turn required to bor-row short-term funds at high rates during periods ofrapid inflation. Variable rates protected lenders whenrates rose and benefitted borrowers when rates de-clined. They suffer, however, from the disadvantagethat the amount required to satisfy the debt cannot beascertained without reference to an extrinsic source - -in this case the varying prime rate charged by ChaseManhattan Bank. Although that rate may readily beascertained from published sources, it cannot be foundwithin the �four corners� of the note.

Other courts confronted with similar questionshave reached differing results. See e.g., A. Alport &Son v. Hotel Evans, Inc., 65 Misc.2d 374, 376-377,317 N.Y.S.2d 937 939-940 (1970) (note bearing inter-est at �bank rates� not negotiable under U.C.C.);Woodhouse, Drake and Carey, Ltd. v. Anderson, 61Misc.2d 951, 307 N.Y.S.2d 113 (1970) (note providingfor interest at �8 1/2%� or at the maximum legal rate�was not usurious. Inferentially, the note was nego-tiable.); Farmers Production Credit Ass�n v. Arena,145 Vt. 20, 23, 481 A.2d 1064, 1065 (1984) (variable-interest note not negotiable under U.C.C.).

The U.C.C. introduced a degree of clarity intothe law of commercial transactions which permits it tobe applied by laymen daily to countless transactionswithout resort to judicial interpretation. The relativepredictability of results made possible by that clarityconstitutes the overriding benefit arising from its adop-tion. In our view, that factor makes it imperative thatwhen change is thought desirable, the change shouldbe made by statutory amendment, not through litigationand judicial interpretation.1

1 In 1981 the legislature of Tennessee amended its ver-sion of U.C.C. 3-106 to provide that variable interest noteswill be negotiable. Tenn. Code Ann. 47-3-106(1)(f) and (g).

Accordingly, we decline the appellee�s invitationto create an exception, by judicial interpretation, in fa-vor of instruments providing for a variable rate of inter-est not ascertainable from the instrument itself.

In an alternative argument, the appellee contendsthat even if the notes are not negotiable, they are nev-ertheless �symbolic instruments� which ought to be paidaccording to their express terms. Those terms includethe maker�s promises to pay �to VMC Mortgage Com-pany or order,� and in the event of default, to makeaccelerated payment �at the option of the holder.� Theemphasized language, appellee contends, makes clearthat the makers undertook an obligation to pay any partywho held the notes as a result of a transfer from VMC.Assuming the abstract correctness of that argument, itdoes not follow that the makers undertook the furtherobligation of making a monthly canvass of all inhabit-ants of the earth in order to ascertain who the holdermight be. In the absence of notice to the makers thattheir debt had been assigned, they were entitled to theprotection of the rule in Evan v. Joyner in making goodfaith payment to the original payee of these nonnego-tiable notes.

Accordingly, we will reverse that decree and re-mand the case to the trial court for entry of a perma-nent injunction against foreclosure.

Reversed and remanded.

DISSENT: COMPTON, J., dissenting.

The majority views the Uniform Commercial Codeas inflexible, requiring legislative action to adapt tochanging commercial practices. This overlooks a ba-sic purpose of the Code, flexibility and adaptability ofconstruction to meet developing commercial usage.

According to Code 8.1-102(1), the UCC �shallbe liberally construed and applied to promote its under-lying purposes and policies.� One of such underlyingpurposes and policies is �to permit the continued ex-pansion of commercial practices through custom, us-age and agreement of the parties.� 8.1-102(2)(b). Com-ment 1 to this section sets out clearly the intention ofthe drafters:


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�This act is drawn to provide flexibility so that, since itis intended to be a semipermanent piece of legislation,it will provide its own machinery for expansion of com-mercial practices. It is intended to make it possible forthe law embodied in this Act to be developed by thecourts in light of unforeseen and new circumstancesand practices. However, the proper construction ofthe Act requires that its interpretation and applicationbe limited to its reason.�

The majority�s rigid interpretation defeats the pur-pose of the code. Nowhere in the UCC is �sum cer-tain� defined. This absence must be interpreted in lightof the expectation that commercial law continue toevolve. The 8.3-106 exceptions could not have beenintended as the exclusive list of �safe-harbors,� as thedrafters anticipated �unforeseen� changes in commer-cial practices. Instead, those exceptions represented,at the time of drafting, recognized conditions of pay-ment which did not impair negotiability in the judge-ment of businessmen. To limit exceptions to those ex-isting at that time would frustrate the �continued ex-pansion of commercial practices� by freezing the Codein time and requiring additional legislation whenever�unforeseen and new circumstances and practices�evolve, regardless of �custom, usage, and agreementof the parties.�

�The rule requiring certainty in commercial paperwas a rule of commerce before it was a rule of law. Itrequires commercial, not mathematical, certainty. Anuncertainty which does not impair the function of nego-tiable instruments in the judgement of businessmen oughtnot to be regarded by the courts . . . The whole ques-tion is, do [the provisions] render the instruments souncertain as to destroy their fitness to pass current inthe business world?� Cudahy Packing Co. v. StateNational Bank of St. Louis, 134 F. 538, 542, 545 (8thCir. 1904).

Instruments providing that loan interest may beadjusted over the life of the loan routinely pass withincreasing frequency in this state and many other asnegotiable instruments. This Court should recognizethis custom and usage, as the commercial market has,and hold these instruments to be negotiable.

The majority focuses on the requirement found inComment 1 to 8.3-106 that a negotiable instrument beself-contained, understood without reference to an out-side source. Our cases have interpreted this to meanthat reference to terms in another agreement whichmaterially affect the instrument renders it nonnegotiable.See e.g., McLean Bank v. Nelson, Adm�r, 232 Va.420, 350 S.E.2d 651 (1986) (where note was accepted�pursuant� to a separate agreement, reference consid-ered surplusage and the note negotiable); Salomonskyv. Kelly, 232 Va. 261, 349 S.E.2d 358 (1986) (whereprincipal sum payable �as set forth� in a separate agree-ment, all the essential terms did not appear on the faceof the instrument and the note was nonnegotiable).

The commercial market requires a self-containedinstrument for negotiability so that a stranger to the origi-nal transaction will be fully apprised of its terms andwill not be disadvantaged by terms not ascertainablefrom the instrument itself. For example, interest pay-able at the �current rate� leaves a holder subject toclaims that the current rate was established by one bankrather than another and would disadvantage a strangerto the original transaction.

The rate which is stated in the notes in this case,however, does not similarly disadvantage a stranger tothe original agreement. Anyone coming into posses-sion could immediately ascertain the terms of the notes;interest payable at three percent above the prime rateestablished by the Chase Manhattan Bank of New YorkCity. This is a third-party objective standard which isrecognized as such by the commercial market. Therate can be determined by a telephone call to the bankor from published lists obtained on request. Associ-ated East Mortgage Co. v. Highland Park, Inc., 172Conn. 395, 406, 374 A.2d 1070, 1076 (1977); see Con-stitution Bank and Trust Company v. Robinson, 179Conn. 232, 425 A.2d 1268 (1979).

Accordingly, I believe these notes are negotiableunder the Code and I would affirm the decision below.


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c.) The following is a sample of a variable rate provision:

ADJUSTABLE RATE NOTE

THIS NOTE CONTAINS A PROVISION ALLOWING FOR CHANGES IN MY INTEREST RATE.IF MY INTEREST RATE INCREASES, MY MONTHLY PAYMENTS WILL BE HIGHER. IF MYINTEREST RATE DECREASES, MY MONTHLY PAYMENTS WILL BE LOWER.. . .

2. INTEREST

Interest will be charged on that part of principal which has not been paid beginning on the date I receiveprincipal and continuing until the full amount of principal has been paid. Beginning on the date I receiveprincipal, I will pay interest at a yearly rate of 10% . The interest rate that I will pay will change inaccordance with Section 4 of this Note. The interest rate required by this Section and Section 4 of thisNote is the rate I will pay both before and after any default described in Section 7(B) of this Note.

3. PAYMENTS(A) Time and Place of Payments

I will pay principal and interest by making payments every month. I will make my monthly payments onthe 1st day of each month beginning on Jan. 1, 1990.I will make these payments every month untilI have paid all of the principal and interest and any other charges described below that I may owe underthis Note. My monthly payments will be applied to interest before principal. If on ________, _______Istill owe amounts under this Note, I will pay those amounts in full on that date, which is called the�maturity date.� I will make my monthly payments at above address or at a different place if requiredby the Note Holder.

(B) Amount of My Initial Monthly PaymentsMy initial monthly payments will be in the amount of U.S. $_____________. This amount may changeto reflect changes in the interest rate that I must pay. The Note Holder will determine my monthlypayments in accordance with Section 4 of this Note.

4. INTEREST RATE AND MONTHLY PAYMENT CHANGES(A) Change Dates

The interest rate I will pay may change on the 1st of Jan. , 1991, and on that day of the monthevery six months thereafter. Each date on which my interest rate could change is called a �ChangeDate.�

(B) The IndexBeginning with the first Change Date, my interest rate will be based on an �Index.� The Index is theweekly average yield on United States Treasury securities adjusted to a constant maturity of 5years, as made available by the Federal Reserve Board. The most recent Index figure available as of 45days before each Change Date is called the �Current Index.�

If the Index is no longer available, the Note Holder will choose a new index which is based upon compa-rable information. The Note Holder will give me notice of its choice.


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(C) Calculation of ChangesBefore each Change Date, the Note Holder will calculate my new interest rate by adding two percent-age points ( 2 % ) to the Current Index. The sum will be my new interest rate in full the principal I amexpected to owe on the Change Date in substantially equal payments by the maturity date at my newinterest rate. The result of this calculation will be the new amount of my monthly payment.

(D) Effective Date of ChangesMy new interest rate will be become effective on each Change Date. I will pay the amount of my newmonthly payment beginning on the first monthly payment date after the Change Date until the amount ofmy monthly payment changes again.

(E) Notice of ChangesThe Note Holder will mail or deliver to me a notice before each Change Date. The notice will advise meof

(i) the new interest rate on my loan as of the Change Date;(ii) the amount of my monthly payment following the Change Date;(iii) any additional matters which the Note Holder is required to disclose; and(iv) the title and telephone number of a person who will answer any question I may

have regarding the notice.

d.) Does this language render an undertaking non-negotiable?

�with interest at the current rate�

�with interest�

�with interest at the highest lawful rate after maturity� 2

e.) Is this instrucment payable to order or bearer or both?

Richmond, VA.

I promise to pay to the order of bearer the sum of $10,000.

/s/John Doe

· to the order of TOM TANK or the bearer?

· to the order of Tom Tank and BEARER?

· to ____________ or order?

f) Assuming that the instrument is payable to order as issued but indorsed by the payee, �pay to Tom Doe�,does it lose its negotiability through the failure of the payee/indorser to include �order/bearer� language in theindorsement?


41

g.) Is the following undertaking negotiable?

What about these undertakings?· �I promise to pay to the order of Tom Tank or the bearer the sum of $10,000�, /s/ Sam Shoe· �I promise to pay to the order of Tom Tank and bearer the sum of $10,000,� /s/ Sam Shoe

4. a.) Is consideration necessary in order to enforce a negotiable instrument? Should it be? Why?

b.) Is this requirement of a fixed amount of money mandatory or permissive?

c.) Can a negotiable instrument be payable in gold? Why?

d.) Can an instrument be payable in ECU�s? in SDR�s?

e.) In his article on the U.N. Convention on International Bills and Notes, Professor Spanoglesuggests that, among other things, such an instrument must contain a date and must name the payee,U.N. Convention on International Bills and Notes, 25 U.C.C. L.J. 99, (1992). Do you agree?Are there any other requirements? See Appendix L.

Enoch v. Brandon249 N.Y. 263; 164 N.E. 45

ANDREWS, J.

The question before us is whether certain bondsare negotiable instruments. If so, the purchaser in duecourse from a thief may retain them.

The Manitoba Power Company issued a series ofbonds. It promised to pay the bearer of each on No-vember 1, 1941, a certain sum at a certain place, withinterest. They are said to be �all equally secured by

and entitled to the benefits and subject to the provi-sions� of a trust mortgage. They may be redeemed at105 per cent and interest at certain dates. The obligormust create a sinking fund to provide for their purchaseor redemption and the principal may become due inadvance of maturity in case of default under the mort-gage; all as provided in the mortgage �to which refer-ence is hereby made for a description of the property

THE 1ST BANK AND TRUST COMPANY

No. Arlington, Virginia $ 10,000.00

This certifies that there have been deposited with THE 1ST BANK AND TRUST

COMPANY, the sum of Ten Thousand Dollars payable to John Doe incurrent funds with interest (for the actual number of days from date to maturity ona 360-day year basis) at the rate of __ per cent per annum upon the 1st day of July 19 90 upon surrender of this certificate.

Joe SchmoeAuthorized Signature


42

mortgaged and pledged, the nature and extent of thesecurity, the rights of the holders of the bonds with re-spect thereto, the manner in which notice may be givento such holders, and the terms and conditions uponwhich said bonds are issued and secured.� The bondsmay be registered in the usual way and except whereregistered �they are to be treated as negotiable and allpersons are invited by the Company to act accordingly.�

At times this last provision might aid in the construc-tion of doubtful clauses contained in the instrument be-fore the court. It at least shows that the parties in-tended to omit anything that might impair negotiability.But no such statement will make negotiable a bond notin the form provided by our statute. Whether the resultwas or was not fortunate it is too late to argue that theLegislature did not refer to bonds in its all inclusive defi-nitions of negotiable paper. True, to become negotiablean instrument need not follow any precise language.(Negotiable Instruments Law [Cons. Laws, ch. 38],sec. 29.) But it �must conform� to the definition speci-fied in section 20. In the face of a command so explicitwe must adhere to the design of the Legislature (Amer.Nat. Bank v. Sommerville, 191 Cal. 364.) At times con-tract rights may be enforced or some theory of estop-pel adopted, but no intention, no agreement, may makenegotiable an instrument which the statute declares tobe non-negotiable.

We turn, therefore, to the more serious question. Thestatute deals with the form of the instrument -- withwhat a mere inspection of its face should disclose. Itmust contain an unconditional promise to pay a fixedsum, on demand, or at a fixed or determinable futuretime, to order or to bearer. Only if it fulfills these re-quirements is it negotiable. If it does, no collateral agree-ment affects its character.

If in the bond or note anything appears requiring ref-erence to another document to determine whether infact the unconditional promise to pay a fixed sum at afuture date is modified or subject to some contingency,then the promise is no longer unconditional. What thatdocument may provide is immaterial. Reference to thepaper itself said to be negotiable determines its charac-ter. (Old Colony Trust Company v. Stumpel, 247 N.Y.538.)

Provisions other than those required by section 20may be contained in a bond or note without impairingits negotiability. There may be included, among otherthings, a statement of the transaction giving rise to theinstrument (sec. 22) or a statement as to collateral se-curity. (Sec. 24.) And it may refer to a trust mortgage,or to an agreement as to the collateral which fixes theremedies of the parties with respect thereto. (ChelseaBank v. Warner, 202 App. Div. 499.)

The rule itself is not a difficult one. The trouble, asoften happens, lies in its application to particular facts.There is no infallible test as to whether there is a modi-fication of the promise. Because of differences in thewords used, or in the arrangement of paragraphs, sen-tences or clauses, each instrument must be interpretedby itself. Only then may we solve the question as to itscharacter.

Three cases in this State will serve as an illustration.In McClelland v. Norfolk Southern R.R. Co. (110 N.Y.469) the bond itself showed that the promise to paywas a conditional one. It was to become payable uponthe terms and with the effect mentioned in the trustmortgage. In Hibbs v. Brown (190 N.Y. 167) the pre-cise form of the bond involved does not appear in theprinted case and exceptions. It did, however, contain aclause referring �to the deed of trust for a statement ofthe rights of the bondholders and of the securities andproperty securing the payment of the bonds,� and wesaid that this clause had only to do with procedure un-der the trust indenture. In Old Colony Trust Companyv. Stumpel (247 N.Y. 538) the note stated that it was�subject to the terms� of a conditional sales agreement.Here by no possibility did the clause relate to security.Necessarily it had to do with the terms of payment.

Do then the references in these particular bonds tothe trust mortgage modify the promise to pay; do theysubject it to some possible condition or contingencydescribed elsewhere, or do they merely determine therights and remedies of the holder under the mortgage?We must consider the instrument as a whole, not wrest-ing any one phrase from its context and concentratingour attention upon it alone. Further, where the meaningis doubtful, we must adopt the construction most favor-able to the bondholder.


43

tain. He would see that the bonds were to be issuednot only upon the general credit of the corporation, butupon the faith of some collateral mortgage. To it hemust go if further knowledge as to this security is de-sired. Some minor matters are also to be considered.There is the possibility of the acceleration of the datewhen the bonds are due if there is default under themortgage. Such a possibility does not make them non-negotiable. (Higgins v. Hocking Valley Ry. Co., 188App. Div. 684; Chicago Railway Equipment Companyv. Merchants� Bank, 136 U.S. 268, 284; Mackintosh v.Gibbs, 81 N.J.L. 577; Schmidt v. Pegg, 172 Mich. 159;White v. Hatcher, 135 Tenn. 609.) A note is payable ata determinable future time if payable on or before afixed date. (Sec. 23.) And in one case acceleration ofpayment in case of default is expressly recognized.(Sec. 21.) The same thing is true of the privilege giventhe obligor to redeem at 105 per cent before the bondsbecame due. That does not limit its absolute promise topay on November 1, 1941. The bonds are payable tobearer or if registered to the registered holder. This doesnot affect their negotiability. (Dickerman v. NorthernTrust Company, 176 U.S. 181.) Nor does the provisionrequiring the obligor to create a sinking fund.

The judgment of the Appellate Division should be re-versed and that of the Trial Term affirmed, with costsin this court and in the Appellate Division.

CARDOZO, Ch. J., CRANE, LEHMAN,KELLOGG and O�BRIEN, JJ., concur; POUND, J.,dissents.Judgment accordingly.

The bonds are part of an issue of $7,500,000, �allequally secured by and entitled to the benefits and sub-ject to the provisions� of the trust mortgage. Then,speaking of possible redemption, of acceleration of pay-ment, of a sinking fund and of notice, it continues �all asprovided� in the trust mortgage �to which reference ishereby made for a description of the property mort-gaged and pledged, the nature and extent of the secu-rity, the rights of the holders of the bonds with respectthereto, the manner in which notice may be given tosuch holders, and the terms and conditions under whichsaid bonds are issued and secured.�

We hold that here there is no modification of the prom-ise to pay, made in explicit terms. The provisions allhave to do with the trust mortgage. They refer to therights conferred by it upon the bondholders and limitand explain those rights. They are so linked togetheras to indicate that the obligor was speaking solely ofthe security. A purchaser scanning the bonds wouldhave the same thought. It would never occur to himthat when November 1, 1941, arrived, because of some-thing contained in the mortgage he might be unable tocollect the amount due him. He would interpret thestatement that the bonds were secured by and entitledto the benefits and subject to the provisions of the mort-gage, as meaning that a foreclosure or other relief mightbe had thereunder only subject to its provisions. Hewould see that reference to it is also made to determinethe terms and conditions under which the bonds areissued and secured. Again it would mean to him as itmeans to us, that only by turning to the mortgage mighthe discover the precise nature of the lien he is to ob-

QUESTIONS

1.) In U.S. v. Farrington, 172 F. Supp. 797 (C.D. Mass. 1959), the court held that the following clauserendered a note conditional notwithstanding the absence of any provision in the loan agreement that wouldcompromise the negotiability of the note:

�... having deposited with this obligation as collateral security,

Assigned Government ContractsThis note evidences a borrowing made under and is subject to the terms of loan agreement dated Jan. 3, 1952between the undersigned and the payee thereof and should the market value of the same, in the judgment of theholder or holders hereof, decline, we promise to furnish satisfactory additional collateral on demand.


44

Can this decision be reconciled with Enoch?

2.) The mortgage bond in Lincoln First Bank v. Bank of New York, supra, contained the following clause:

�IT IS HEREBY EXPRESSLY AGREED, that the said principal sum shall at the option of the obligee becomedue on the happening of any default or event by which, under the terms of the mortgage securing this bond, saidprincipal sum may or shall become due and payable; also, that all of the covenants, conditions and agreementscontained in said mortgage are hereby made part of this instrument.�

Does this language affect the negotiability of the instrument?

3.) Does the following clause affect negotiability?

a. This note with interest is secured by a mortgage on real estate of even date herewith, made bythe maker hereof in favor of the said payee, and shall be construed and enforced according to the laws of theState of Florida. The terms of said mortgage are by this reference made a part hereof.3

b. �Reference is made to the Purchase and Security Agreement for additional rights of the holderhereof.�2d

c. �This promised payment for ownership in Casper project when/if option is exercised for 2ndhalf...�2e

d. A check, on the memorandum line;

�JUST TO HOLD FOR THE SECURITY OF FUTURE BUSINESS�2f

4.) Are either of the following clauses negotiable?

a.

"No. ____ $5,000.00 February , 19___ after date; for value received, I promise to pay to the order of Mellow Music,Inc., Five thousand and no/100-------- Dollars Payable at From Cigarette Commissions, of, _____________ withinterest thereon at the rate of ______ per cent, per annum from _______ until fully paid. Interests payable semi-annually. The maker and endorser of this note fruther agree to waive demand, notice of non-payment and protest,and in case suit shall be brought for the collection hereof, or the same has to be collected upon demand of anattorney, to pay reasonable attorney's fees for making such collection. Deferred interest payments to bear interestfrom maturity at ___ per cent, per annum, payable semi-annually.

Lester Siegel Pres. (Seal)Due On Demand 19 __

Lester Seigal d/b/a Jester Rest. (Seal)

b Without regard to the foregoing, payments of principal on January 1, 1987, and June 1, 1987, willbe made from the proceeds, if any, of the sale of kangaroo belts under that agreement between maker and the TieMe Kangaroo Down Belt Company, Ltd. Any amounts not paid shall accumulate to the next payment dateprovided, however, that the balance shall be paid in full on January 1, 1988, from the general revenue of the makerand not limited to any particular fund.4


45

5.) If an instrument which otherwise complies with Section 3-104 contains the following clause--�This in-strument is not negotiable�--would it be commercial paper under prior Article 3? Same result under revision?

Cheltenham National Bank v. Snelling326 A. 2d 557 (Pa. Super. 1974)

HOFFMAN, Judge:

This appeal is from an order of the Court of Com-mon Pleas of Montgomery County dismissing appellant�spetition to open and set aside a confessed judgment.We must determine whether a clause allowing judg-ment to be confessed �at any time� renders the instru-ment nonnegotiable; if so, we must determine whetherprinciples of equitable estoppel preclude the appellantfrom asserting defenses against the appellee, the presentholder of the instrument. The complex facts of this casemay be summarized as follows: On August 14, 1969,Goodway Copy Centers, Inc. (�Goodway�) and appel-lant entered into a franchise arrangement wherebyGoodway promised to locate, establish, equip and man-age 100 copy centers within a period of seven years. Inreturn, appellant agreed to purchase the centers as com-pleted. Shortly thereafter, appellant transferred all hisright in this venture to International Development Corp.(�IDC�), of which appellant was the sole shareholder.Goodway was represented in these negotiations by Mr.Donald Wolk.

In December, 1969, Mr. Wolk applied toCheltenham National Bank (�Cheltenham�) for a loan.Appellant did not participate in any negotiations. Ap-pellant testified that Mr. Wolk told him that Cheltenhamwould require a promissory note as a prerequisite togranting the loan. On February 27, 1970, appellant ex-ecuted a demand note to the order of Goodway in theamount of $150,000.1

Cheltenham was aware that the purpose of theloan was to enable Goodway to purchase five copycenters. Cheltenham never saw the master agreementbetween appellant and Goodway but did possess a copyof Goodway�s prospectus and appellant�s financial state-ment. On March 24, 1970, Goodway assignedappellant�s note to Cheltenham and the bank approvedthe loan application. $132,000 was deposited into aGoodway account and $18,000 was deposited into ac-counts held by IDC.

Appellant paid the interest on the loan for the firstyear. In March, 1971, Cheltenham demanded thatGoodway make a principal payment on the loan, and onJuly 20, 1971, made the same demand of appellant. Inlate November, 1971, there was a meeting attended byappellant, Mr. Wolk, and Mr. Monroe Long, Presidentof Cheltenham. Mr. Long testified that a repaymentschedule was agreed to at that meeting. Appellant�stestimony is in conflict, but a letter from appellant toMr. Long, dated December 15, 1971, states: �I feel con-fident that a substantial payment can be made some-time prior to the end of December.� In March, 1972,appellant pledged almost 19,000 shares of Snelling &Snelling stock to Cheltenham as collateral. No paymentsof principal were ever made. Eventually, Goodway soldall of its business other than the venture with appellantto another firm. The completed centers that appellanthad purchased from Goodway during the interim wereclosed by an Internal Revenue Service levy. In August,1972, appellant filed suit against Goodway in FederalDistrict Court. On April 6, 1973, Cheltenham confessedjudgment on the promissory note assigned to it byGoodway. On May 16, 1973, appellant filed a Petitionto Open Judgment. Appellee filed an Answer to thisPetition and extensive depositions were taken and tran-scribed. On December 31, 1973, the lower court heardoral arguments. On the basis of the depositions, briefs,and argument, the court denied appellant�s Petition toOpen Judgment on the grounds that Cheltenham wasthe holder in due course of a negotiable instrument andalternatively, �(e)ven if the plaintiff were not a holder indue course of the note, by reason of defendant�s con-duct and actions he has estopped himself from assert-ing any defenses he may have as to Goodway CopyCenters, Inc. against this plaintiff.� This appeal is takenfrom the denial of said petition.


46

In its Petition to Open and Set Aside ConfessedJudgment, appellant asserts that Goodway procured theMaster Agreement by fraudulent misrepresentations andthat Goodway was in breach of said agreement. Thesedefenses are �personal� and will not prevail against aholder in due course.2 Appellant contends, however, thatCheltenham cannot be a holder in due course becausethe instrument assigned to it contained a clause autho-rizing confession of judgment �at any time�, and wastherefore a nonnegotiable note. Thus, appellant claimsthat Cheltenham is merely an assignee whose rightsrise no higher than those of its assignor.

The Uniform Commercial Code, section 3�112,provides that �(1) the negotiability of an instrument isnot affected by . . . (d) a term authorizing a confessionof judgment on the instrument if it is not paid whendue.� (Emphasis added). Thus, a confession of judg-ment clause is authorized by the Code Only if the in-strument is not paid when due. If the clause allows judg-ment to be confessed at a time prior to a default, theclause renders the instrument nonnegotiable. Fundsfor Business Growth, Inc. v. Maraldo, 443 Pa. 281,278 A.2d 922 (1971), involved a confession of judg-ment clause in a nonnegotiable note. The Court statedat 283, 278 A.2d at 923: �Appellee had recorded thenote on January 20, 1961, immediately after its execu-tion on January 19, 1961, so that judgment was con-fessed against all parties prior to any default. . . . Sec-tion 3�112(1) (d)(12A P.S.) provides that negotiabilityis not affected by a term in the instrument that permitsconfession of judgment if it is not paid when due. Thishas been held to mean that a note which authorizesconfession of judgment at any time before or aftermaturity, as is the case here, is a nonnegotiable instru-ment.� The instrument in question provides in pertinentpart: �And to secure the payment of said amount wehereby authorize, . . . any Attorney of any Court ofRecord to appear for us in such Court, . . . At any timebefore or after maturity and confess a judgment . . .�(Emphasis added).

Appellee argues that the instrument is negotiablebecause it is a demand note and is thus immediatelydue and payable after its making. Appellee asserts,therefore, that the words �before maturity� are meresurplusage and have no effect on negotiability. How-ever, the crucial language in the instrument is the words

�at any time.� The significance of these words is thatconfession of judgment is authorized whether or not adefault has occurred. Under appellee�s interpretation,Cheltenham could have confessed judgment immedi-ately upon receiving the instrument without ever de-manding payment.3 Holding the note negotiable underthis interpretation is at odds with both the language ofSection 3-- 112(1)(d) and applicable precedent.

In Smith v. Lenchner, 204 Pa.Super. 500, 205 A.2d626 (1964), this Court held that a demand note having aconfession of judgment clause authorizing confessionat any time was nonnegotiable: �Prior to the enactmentof the Code, a note containing a warrant of attorney toconfess judgment at any time was held to be a non-negotiable instrument . . . . This rule was applied to ademand note . . . . The same result has been reached incases subsequent to the enactment of the Code.� 204Pa.Super. at 505, 205 A.2d at 629. Under the law ofthis Commonwealth, the note assigned to Cheltenhamwas nonnegotiable and Cheltenham took it subject toany defenses appellant could assert against Goodway.

In order to successfully petition to open a con-fessed judgment, one must act promptly and aver a meri-torious defense, Wenger v. Ziegler, 424 Pa. 268, 226A.2d 653 (1967); however, �(a) petition to open judg-ment is addressed to the sound discretion of the courtand is an appeal to the court�s equitable powers.�Wenger, supra, at 273, 226 A.2d at 655. Courts havealways recognized that equitable estoppel may bar ameritorious defense even in contract-assignment cases.See, e.g., Northwestern National Bank v. Common-wealth, 345 Pa. 192, 27 A.2d 20 (1942). Therefore,even though the note is nonnegotiable, if the facts war-rant an equitable estoppel, appellant is precluded fromasserting defenses against an assignee.

The essential elements of an equitable estoppelas related to the party claiming the estoppel are: (1)lack of knowledge and of the means of knowledge ofthe truth as to the facts in question; (2) reliance uponthe conduct of the party estopped; and (3) action basedthereon of such a character as to change his positionprejudicially. United States National Bank inJohnstown v. Drabish, 187 Pa.Super. 169, 144 A.2d640 (1958).


47

The record reveals that Cheltenham was unawareat the time it assumed the note that Goodway may haveprocured its contract with appellant by means of fraudu-lent misrepresentation or that Goodway may have beenin breach of contract. Cheltenham was merely a lenderwho assumed a promissory note in return for approvinga loan; it was not a Contract assignee. In fact,Cheltenham never saw the contract between appellantand Goodway until after judgment had been confessed.It is true that Cheltenham was aware of the purpose ofthe loan and knew that an arrangement betweenGoodway and appellant existed. Section 3�304(4)(b)of the Code provides, however, that: �(4) Knowledgeof the following facts does not of itself give the pur-chaser notice of a defense or claim . . . (b) that it wasissued or negotiated in return for an executory promiseor accompanied by a separate agreement, unless thepurchaser has notice that a defense or claim has arisenfrom the same terms thereof.� (Emphasis added). Therewas no reason for Cheltenham to be put on notice ofany defenses from the mere fact of the separate agree-ment. The Bank had a copy of Goodway�s prospectusand a copy of appellant�s financial statement.Cheltenham was also aware of Mr. Snelling�s personalreputation in the business community. On that basis,consistent with its policies, Cheltenham loaned Goodwayand IDC $150,000 and received appellant�s promissorynote in return. The second element of equitable estop-pel is reliance. The facts show that Cheltenham begandemanding principal payments as early as March 1971.Letters from appellant to Cheltenham dated August 4,1971, and December 15, 1971, contain promises fromappellant to institute a schedule in order to repay theloan in full.4 Cheltenham relied on these letters to fore-bear from confessing judgment at those times. TheMarch, 1972 pledge of Snelling & Snelling stock in-duced further reliance on the part of Cheltenham. TheBank could reasonably view appellant�s conduct as in-dicative of a bona fide intent to repay.

In United States National Bank in Johnstownv. Drabish, supra, a petition to open judgment wasdenied. The facts presented in this case are similar: thenote was given for the purpose of raising money; thebank was only a lender and not a contract assignee;

and the bank was unaware of any possible defensesthat the maker could assert against the original holderof the instrument. These facts distinguish the presentcase from those decisions which granted petitions toopen judgment. For example, in Fidelity Trust Co. v.Gardiner, 191 Pa.Super. 17, 155 A.2d 405 (1959), theentire factual situation was permeated with fraud. Theappellant had been dealing with an imposter and therewas sufficient evidence to put the bank-assignee onnotice of that fact. See also, Bittner v. McGrath, 186Pa.Super. 477, 142 A.2d 323 (1958) (Plaintiff clearlyaware of the existence of defenses against his assignor);Standard Furnace Co., Inc. v. Roth, 102 Pa.Super.341, 156 A. 600 (1931) (Bank a contract assignee aswell as a lender). There are no circumstances in thepresent case which would have imposed a duty onCheltenham to make further inquiries. Cheltenhamwaited more than three years from the time it obtainedthe note until it confessed judgment. This delay has re-sulted in a prejudicial change in Cheltenham�s position.At the time judgment was finally confessed, Goodwayhad sold all of its assets, IDC was virtually inactive,and the Snelling & Snelling stock pledged as collateralwas considerably reduced in value. The difficulty ofobtaining repayment is self-evident from the state ofaffairs existing at the time judgment was confessed.

We hold that the note in question is nonnegotiable,but that appellant is barred by principles of equitableestoppel from asserting any defenses he may have.Therefore, the order of the court below is affirmed.

1 Under the Uniform Commercial Code, �Instrumentspayable on demand include those payable at sight or onpresentation and those in which no time for payment isstated.� 12A P.S. Section 3�108. A demand note isdue and payable immediately at the option of the holder.Master Homecraft Co. v. Zimmerman, 208 Pa.Super.401, 222 A.2d 440 (1966).

2 Under 12A P.S. Section 3�305, a holder in due coursetakes the instrument free from all �personal� defensesof any party to the instrument with whom he has notdealt, but takes the instrument subject to five specifi-cally delineated �real� defenses. 12A P.S. Section 3�306 provides that if one is not a holder in due course, he


48

takes the instrument subject to, Inter alia, all contractdefenses and the defenses of want or failure of consid-eration.

3 The official comment to Section 3�112(1)(d) states:�The use of judgment notes is confined to two or threestates, and in others the judgment clauses are madeillegal or ineffective either by special statutes or by de-cision.� Thus, close judicial scrutiny is essential.

4 On August 4, 1971, appellant wrote to Mr. Long: �Thiswill acknowledge receipt of your recent letter concern-ing the $150,000 loan to International DevelopmentCorporation. �Wehave been remiss in setting up a definite repaymentplan covering the reduction of the principal, and I ap-preciate your consideration and understanding in thismatter.

�We will institute, beginning with the month of Au-gust, a regular repayment schedule which will con-tinue on a monthly basis until such time as the en-tire loan is repayed. This amount will fluctuate from

time to time depending on the availability of funds atthat particular time.� (Emphasis added).

The December 15, 1971 letter states in pertinent part:�As a follow-up to our meeting of several weeks agobetween yourself, Mr. Wolk and I, at which time wefelt strongly that some type of payment could be madeon the principal on the outstanding loan to InternationalDevelopment Corporation . . . . �As the situationnow exists, I feel confident that a substantial pay-ment can be made sometime prior to the end of De-cember. While this deviates somewhat from our origi-nal commitment, I would feel that you would be in aposition to go along with this slight delay of severalweeks.� (Emphasis added).

QUESTIONS

1. Va. Statute 8.01-433.1 (1992) provides:

No judgement shall be confessed upon a note, bond, or other evidence of debt pursuant to a confession ofjudgement provision contained therein which does not contain a statement typed in boldface print of not less thaneight point type on its face:

IMPORTANT NOTICE

THIS INSTRUMENT CONTAINS A CONFESSION OF JUDGEMENT PROVISION WHICH CONSTI-TUTES A WAIVER OF IMPORTANT RIGHTS YOU MAY HAVE AS A DEBTOR AND ALLOWS THECREDITOR TO OBTAIN A JUDGEMENT AGAINST YOU WITHOUT ANY FURTHER NOTICE.

This Section shall only apply to notes, bonds, or other evidences of debt containingconfession of judgement provisions entered into after January 1, 1993.

Does the absence of this provision affect the negotiability of a note containing a confession of judgement clausesubject to Virginia law?

2. Are confession of judgment clauses permissible in any type of commercial paper? Which? Shouldthey be? See H. Ward Classen, Robert K. Rowell, & James C. Wine, A Survey of the Legality of ConfessedJudgement Clauses in Commercial Transactions, 47 The Business Lawyer 729 (1992).


49

3. When did the note in the Cheltenham case become due? Can a demand note containing a proconfesso clause ever be negotiable? Is the absence of a provision stating when a judgment clause can beconfessed the same as an express provision permitting confession �as of any term�?

4. Does the current Article 3 resolve this issue?

5. Company X , a U.S. company, agreed to purchase exchange currencies with Company Y, a Swisscompany. As part of this arrangement, Company X transferred U.S. $6.9 million into Company Y's accounts infulfillment of it undertaking. Company Y, however, had been declared insolvent. What law governs? See Koreag,Controles el Revision S.A. v. Refco F/S Associates, Inc. 961 F.2d 341 (2nd Cir. 1992).

Schekter v. Michael184 So. 2d 641 (Fla. 1966)

DREW, Justice.This petition for certiorari, based on a question

certified to us by the District Court of Appeal, ThirdDistrict, is directed to a decision of that court datedJune 15, 1965 and reported as Michael v. Schekter in176 So.2d 581. The respondent executed a note for$8000.00 payable to Charles Donner but with the duedate left blank. Thereafter the note was assigned topetitioner who made demand for payment. This wasrefused and petitioner brought suit. Respondent inter-posed defenses based on an alleged parol agreementby which the note was not to mature until some indefi-nite time in the future determined by certain other ven-tures of the maker and payee. The petitioner movedfor summary judgment which was granted. The respon-dent appealed to the District Court of Appeal whichreversed the trial judge and certified the case to us aspassing upon a question of great public interest.

The question posed is:

�Whether a promissory note which is blank as todue date becomes, by application of Sec. 674.09(2),F.S., a demand note thereby barring the admission intoevidence of a contemporaneous parol agreement whichwould vary the demand character of the instrument?�

The law is a part of every contract made in thisState. Therefore, when this note was executed and de-livered (April 19, 1960) the provisions of Section 674.09,Florida Statutes 1959, F.S.A., became as much a partof the note as if it had been written on the face of it.This was tantamount to stamping across the face ofthe note �No time for payment appearing hereon, thisnote is payable on demand.�

It is said that this is a case of first impression inFlorida. In view of the plain, unambiguous language ofthe statute, this is understandable. The New Hamp-shire Supreme Court in Merrimack River SavingsBank v. Higgins, 89 N.H. 154, 195 A. 369 (1937), inconstruing this identical Section taken from N.I.L.,correctly disposed of the question in this terse observa-tion: �The statute states no exceptions or qualificationsto the demandable character of such an instrument, andno policy is perceived by which any are implied by it.The law is intended to be a fully developed codification,of static fixation. It seeks definiteness and complete-ness, avoiding uncertainty and elasticity.� (Emphasissupplied.)

If a person executes and delivers a promissorynote in which no time for payment is expressed, he ischarged with knowledge it is payable on demand. Thedecision of the District Court is quashed and the causeis remanded to that court for entry of a judgment af-firming the summary judgment of the trial court.

THORNAL, C.J., and THOMAS, O�CONNELL,CALDWELL and HOBSON (Ret.), JJ., concur.

ERVIN, J., dissents with opinion.

Editor�s Note: Fla. Stat. 674.09(1959) was based onSection 7 of the Uniform Negotiable Instrument Law,the predecessor statute to U.C.C. Article 3, which pro-vided that �an instrument is payable on demand...inwhich no time for payment is expressed....�


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QUESTIONS

1. Should the parol evidence rule apply to the question of whether an instrument is negotiable? Did theinstrument in Schekter contain an integration clause? Is such a clause necessary for application of the parolevidence rule? What is the effect of 3-117?

2. Is the requirement that a note be payable on demand or at a definite time mandatory?

3. Assume a note contains the following clause:

�Payee may accelerate at will at which point the full balance shall be due and owing.�

Is the note negotiable?

Assume that the payee accelerates in order to damage maker�s credit and force maker into bankruptcyso as to have access to the maker�s property even though maker is not in default. Does this use of the clauseaffect the negotiability of the note?5

4. Is the following undertaking negotiable? If not, can it be rendered so?

I promise to pay the sum of $5,000.00 payable upon the death of Y (Y being a specific person).

/s/ MAKER

5. The United Nations Commission on International Trade Law (UNCITRAL) has drafted a Conventionon International Negotiable Bills of Exchange and International Promissory Notes. The text of that Conventionmerits careful examination for the comparative insights it provides into the Article 3 system. For a summary ofthis Convention, see Appendix B.

NoteFor a helpful treatment of legal analysis by one of the leading drafters of the UCC, Professor Karl Llewellyn, seeAppendix C. His remarks should be most useful in enabling you to discern between sound and unsound argumentand between strong and weak argument. Are they the same? What is a technically perfect case? Why doesn�tLlewellyn think it is enough?

ENDNOTES

2d. See, First Federal Sav. & Loan Asso. v. Gump & Ayers Real Estate, Inc., 771 P.2d 1096, 105 UtahAdv. Rep. 27, 8 U.C.C. Rep. Serv.2d (Callaghan) 720.

2e. See, Northwestern Nat. Bank v. Shuster,307 N.W.2d 767, 32 U.C.C. Rep. Serv. (Callaghan) 585(Minn. 1981).

2f. See, Carador v. Sana Travel Service, Ltd., 700 F.Supp 787, 8 U.C.C. Rep Serv.2d (Callaghan) 752(S.D.N.Y. 1988).

1. See Branch Banking & Trust Co. v. Creasy, 301 N.C. 441, 269 S.E. 2d 117 (1980).


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2. See Universal C.I.T. Credit Corp. v. Ingel,347 Mass. 119, 196 N.E. 2d 847 (1964).

3. See Holly Hills Acres, Ltd. v. Charter Bankof Gainesville, 314 So. 2d 209 (Fla. Dist. Ct. App.1975).

4. See Rothenberg v. Mellow Music, Inc., 291So. 2d 234 (Fla. Dist. Ct. App. 1974)

5. See Opinion of the Attrney Gerneral of Iowa,No. 65-7, July 9, 1965, 3 U.C.C. Rep. Serv. 183.

6. Manhattan Co. v. Morgan, 242 N.Y. 38, 150N.E. 594 (1926).

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