with
ABA
Business Law Section
Committee
on Cyberspace Law
I. Introduction: Description of Project on Negotiability and Electronic Commerce
II. Application of Principles of Negotiability in Traditional and Emerging Transfer and Payment Systems
A. [describe work of ECP Subcommittee in cataloging examples of transfer and payment systems posted on World Wide Web site]
B. [describe preparation of Report based
on analysis of examples provided by members and proposed media neutral
language for recognizing electronic equivalent of negotiability by contract
and by statute]
A.
What is negotiability? - a working definition for the purposes
of this Project
1. Paper merges with abstract rights
2. Use of form invokes legal rules simplifying
transfer of ownership
3. Use of form cuts off spectrum of defenses
and competing claims by operation of law
4. Use of form invokes procedural advantages,
including factual presumptions, in litigation after default
5. Use of form invokes loss allocation
system without risk pooling that encourages use of decentralized, party-controlled
risk management policies
B. Template for contributions to this Web site - please organize submissions along the following lines; if a particular section is not applicable to a given transfer or payment system, please note that but do not omit the subsection. All submissions must be submitted to Jane Winn at jwinn@mail.smu.edu.
2. How is the right transferred? What is the source of law governing the mechanics of transfer? Is the abstract right merged with a physical representation?
3. How are competing claims of ownership and contractual defenses handled? What is the source of law governing the enforceability of such claims and defenses when the rights have been transferred to third parties?
4. How are the rights enforced in the hands of 3rd parties? What is the source of law governing such enforcement?
5. How are risks of fraud and error allocated? For payment devices, how is risk of nonpayment allocated? What is the source of law governing such loss allocation rules? How much power to parties have over their own risk management policies?
C. Existing Transfer and Payment Systems Incorporating Principles of Negotiability
1. What is it? written contract - order or promise to pay to order or bearer with date and sum certain containing no forbidden terms
2. How is the right transferred? What is
the source of law governing the mechanics of transfer?
Merger rule - paper and right merge
Negotiate - bearer negotiable by transfer
of possession, order paper by endorsement of holder; creates another holder
Transfer - voluntary surrender of possession
that does not meet all the requirements of negotiation
Person entitled to enforce & Shelter-
a transferee who is not a holder may still be entitled to enforce the instrument
and may shelter under the rights of the transferor
3. How are competing claims of ownership
and contractual defenses handled? What is the source of law governing the
enforceability of such claims and defenses when the rights have been transferred
to third parties?
HDC takes free of claims and personal
defenses, but not real defenses nor defect in title due to forged necessary
indorsement; FTC rule protects consumers from HDC
4. How are the rights enforced in the hands
of 3rd parties? What is the source of law governing such enforcement?
Presumption of genuine signatures
5. How are risks of fraud and error allocated?
How are risks of nonpayment allocated? What is the source of law governing
such loss allocation rules? How much power to parties have over their own
risk management policies?
Warranty liability covers downstream transferees
from risk of defect in title, forgery
Indorser's contract protects downstream
transferees from risk of nonpayment
Contributory negligence for alternation
or forgery, imposter, employee defalcation, bank statement rules
2.
Negotiable Documents
3.
Certificated Securities under UCC 8
4.
Good Faith Secured Party under UCC 9
5.
FDIC as HDC
6.
Leasing - Hell or High Water provisions under UCC 2A
7.
Contractual Waiver of Defenses under Common Law
8. ??
Robert
Charles Clark, Abstract Rights versus Paper Rights under Article 9 of the
Uniform Commercial Code, 84 Yale L. J. 445 (1975)
Paper rights, which include promissory
notes, stock certificates, warehouse receipts and chattel paper, are property
rights that have been "concretized" in paper. These correspond to abstract
rights include accounts, unembodied shareholder interests, interests in
inventory or goods. This article analyzes the varying treatment under Article
9 of the priority of the interest of secured parties in these abstract
rights that are wrongfully converted by the debtor into a paper right and
then pledges the paper right to an innocent third party. In addition, this
article discusses the evolution of the tendency to suppress abstraction
in commercial law. In a society in which all rights are abstract (i.e.,
no paper or filing system), then nonpossessory rights will be difficult
to establish and police. Paperizing rights can the terms of the right less
ambiguous, and making a paper the unique embodiment of an abstract right
can reduce fraud. The next step is the creation of a central recording
or filing system in which the paper right, a copy of it or notice of it
is kept. Such a recording system can substantially reduce fraud and error.
Robert
D. Cooter and Edward L. Rubin, A Theory of Loss Allocation for Consumer
Payments, 66 Tex. L. Rev. 63 (1987)
Legislation governing payment systems
used by consumers adopts a variety of different approaches, some of which
are mutually inconsistent. These different legislative approaches can be
analyzed in terms of whether they promote economic efficiency. Markets
in which consumers are present are inefficient if information asymmetries
and disproportionate negotiating costs suffered by consumers but not businesses.
Loss allocation rules should be designed in light of these market failures.
Loss allocation rules include loss spreading, which permits economic actors
to manage risk by creating a portfolio of risky assets that as an aggregate
has a risk profile that the actor can accept from a large number of assets
that each have risk profiles that individually are not acceptable to the
actor; loss reduction rules create incentives for parties to minimize losses
through precaution or innovation; and loss imposition rules enforce the
assignment of liability to the party most able to manage risks according
to the first two principles. If the object of regulation is to promote
the economic efficiency of payment systems, then consumer liability for
the amount of invalid checks paid by banks should mimic the consumer liability
limits for invalid credit card payments.
Walter
A. Effross, Putting the Cards Before the Purse?: Distinctions, Differences,
and Dilemmas in the Regulation of Stored Value Card Systems, 65 UMKC L.Rev.
319 (1997).
The article discusses the different types and features of stored value
cards; examines the underlying tensions concerning the timing and extent
of regulation in this area; reviews the legislative history and relevant
provisions of the Electronic Fund Transfer
Act and Regulation E; analyzes the revisions proposed by the Federal Reserve
Board of Governors in May 1996 to apply Regulation E to stored value systems;
evaluates the responses submitted to the Board pursuant to its request
for comment; analyzes the conclusions of the FDIC, and the financial community's
response, concerning the insurability of funds held by depository institutions
in exchange for stored value cards; reviews the recommendations of the
Office of the Comptroller of the Currency on consumer disclosures in this
context; and suggests principles and practices to develop a more effective
set of regulatory classifications of stored value card systems.
David
Frisch and Henry D. Gabriel, Much Ado About Nothing: Achieving Essential
Negotiability in an Electronic Environment, 31 Idaho L. Rev. 747 (1995)
At the time that negotiable instruments
law emerged, the common law of assignments prohibited assignments of contract
rights; this prohibition continued generally until the 19th
century. Under modern contract law, there is no longer any such prohibition.
When compared to assignees of contract rights, holders of negotiable instruments
still generally enjoy more simple enforcement procedures, and other advantages,
such as the exclusive right to receive payments from the debtor, that make
payment more certain. However, many of these advantages can be reproduced
for assignees of contract rights by using provisions such as waivers of
defenses, and the initial hostility of the common law to such drafting
techniques is now gone. Given that even the transferee of a negotiable
instrument may take subject to competing claims of ownership if a necessary
indorsement has been forged, filing systems designed to support electronic
commerce modeled after Article 9 filing offices might be adequate to protect
assignees of contract rights in the future without negotiability.
Grant
Gilmore, The Commercial Doctrine of Good Faith Purchase, 63 Yale L. J.
1057 (1954)
Grant
Gilmore, Formalism and the Law of Negotiable Instruments, 13 Creighton
L. Rev. 441 (1979)
Grant
Gilmore, The Good Faith Purchase Idea and the Uniform Commercial Code:
Confessions of a Repentant Draftsman, 15 Ga. L. Rev. 605 (1981)
Grant
Gilmore, On Statutory Obsolesence, 39 Colo. L. Rev. 461 (1967)
Codification projects inevitably look
backward and fail to predict what the future will hold. Some bodies of
commercial law were well enough established with the creation at the turn
of the century of the Uniform Law Commission to become the subject of individual
statutes, such as the Uniform Sales Act. Once sales law was codified, it
failed to take account of long-term contractual arrangements, such as requirements
contracts, until the case law on sales was revisited with the drafting
of the UCC fifty years later. Although the UCC tries to be flexible and
ambiguous, it is inevitable that the same rigidities will become apparent
with the UCC as new commercial practices develop.
Ronald
J. Mann, Searching for Negotiability in Payment and Credit Systems, 44
U.C.L.A. 951 (1997)
Charles W. Mooney, Jr., Beyond Negotiability: A New Model for Transfers and Pledge of Interests in Securities Controlled by Intermediaries 12 Cardozo L. Rev. 305 (1990)
James
A. Newell and Michael R. Gordon, Electronic Commerce and Negotiable Instruments
(Electronic Promissory Notes) 31 Idaho L. Rev. 819 (1995)
Henry
H. Perritt, Jr. Legal and Technological Infrastructures for Electronic
Payment Systems, 22 Rutgers Computer & Tech. L. J. 1 (1996)
Marie
T. Reilly, The FDIC as Holder in Due Course: Some Law and Economics, 1992
Colum. Bus. L. Rev. 165
The FDIC has 3 legal bases for its federal
HDC status: D'Oench Duhume, 12 USC § 823(e) and federal common law.
FDIC immunity from defenses of bank customer arises in the when FDIC as
receiver takes over a failed bank, and serves to lower the cost to the
FDIC (and possibly the taxpayer) of a successful disposition of the assets
of the failed bank. Federal HDC status for the FDIC is economically efficient
if the losses imposed on the failed bank's customers are losses that the
customers could more easily have avoided before the bank's failure than
the FDIC could have taken account of them after the bank's failure.
James
Steven Rogers, The Irrelevance of Negotiable Instruments Concepts in the
Law of Check-Based Payment Systems, 65 Tex. L. Rev. 929 (1987)
It is often wrongly assumed that the modern
check collection system requires the following three effects of applying
negotiable instruments law: standardization of the rights and obligations
of the parties to a check; the reification of the payment obligation in
a piece of paper; and the ability of certain transferees to take the check
free from certain claims or defenses that other parties to the check might
raise. While negotiability helps explain a payment system based on bank
notes, it does not help explain a payment system based on instructions
to withdraw funds from deposit accounts. The check collection system is
based on legal principles, such as provisional settlements that firm up
and banks acting as agents for their depositors, that offer a complete
explanation of the operation of the check collection system and its loss
allocation rules without reference to negotiability.
James Steven Rogers, The Myth of Negotiability, 31 Boston College L. Rev. 265 (1990)
James
Steven Rogers, Negotiability as a System of Title Recognition, 48 Ohio
State L. Rev. 197 (1987)
It is a common misperception among lawyers
that negotiable instruments law deals with a unique form of property, whose
salient characteristic is its value to strangers who qualify as holders
in due course because they can cut off the claims and defenses of other
innocent parties in the event of an unexpected loss. This overlooks the
importance of negotiability as a system of title recognition; any system
of title recognition will favor those who comply with its terms over those
who do not. Negotiability effectively creates a "last in time, first in
right" rule to resolve disputes, except when there is a forged necessary
indorsement. As a result, negotiability creates less certainty in commercial
transactions than is commonly assumed. A recording system would permit
parties to discover competing claims of ownership prior to purchasing the
asset, and so reduce the number of times losses must be allocated between
innocents.
James
Steven Rogers, Policy Perspectives on Revised U.C.C. Article 8, 43 U.C.L.A.
1431 (1996)
Hal
S. Scott, The Risk Fixers, 91 Harv. L. Rev. 737 (1978)
Albert
J. Rosenthal, Negotiability - Who Needs It? 71 Colum. L. Rev 375 (1971)
Holder in due course allocates losses
between two innocents; the problem arises because the wrongdoer cannot
be made to bear the losses he or she caused. Given that splitting the difference
has not historically been an option, the apparent inequity of the result
is justified by reference to the need to protect the buyer's reasonable
expectations in order to promote the growth of markets and commerce. Law
professors emphasize the remarkable nature of HDC to spark the interest
of law students in what would otherwise be a dull course; HDC doctrines
can be especially unfair when applied to consumers. Negotiability doctrines
fail to take account of the realities of the modern check collection system.
Jane
K. Winn, Couriers Without Luggage: Negotiable Instruments and Digital
Signatures, 49 S. Carolina L. Rev. 900 (1998) www.smu.edu/~jwinn/ecourier.htm
While the origins of negotiable instruments
can be traced back to the late medieval period, and digital signatures
created using public key cryptography were not invented until the 1970s
and are only coming into widespread commercial use in the late 1990s, they
share certain common features. Both are techniques that can be used
to solve certain predictable problems encountered by parties to commercial
transactions. Negotiable instruments law is characterized by a high
degree of formalism and encourages parties to take responsibility for the
fraud and error risks associated with commercial transactions. The
ABA Digital Signature Guidelines, published in 1996, propose that the regulation
of digital signatures might usefully be analogized to negotiable instruments.
While this analogy is very suggestive of certain features negotiable instruments
and digital signatures share, ultimately it is a flawed analogy.
The structure of negotiable instruments law reflectes centuries of commercial
practice, while there are not yet any large-scale applications for digital
signatures. Legislating rigid loss allocation rules for digital signatures
is premature at this time, because there is not yet any significant commercial
experience with this technology to indicate whether such a loss allocation
system makes sense.
Jane
K. Winn, Open Systems, Free Markets and the Regulation of Internet Commerce,
72 Tulane L. Rev. 1 (1998) www.smu.edu/~jwinn/esig.htm
While conducting business over the Internet
raises many novel issues of commercial practice, it is not clear that the
appropriate legislative response should be new laws designed to promote
Internet electronic commerce. One of the most hotly debated issues
regarding the regulation of Internet commerce is the question of what would
be the online equivalent of a signature. Technology specific legislation
designed to promote the use of public key cryptography has been vigorously
promoted in many quarters, but upon careful examination, can be seen to
suffer from serious shortcomings. A technology-neutral approach to
Internet commerce legislation is preferable because it permits parties
to commercial transactions to make up their own minds about what new business
practices make sense for Internet commerce. If any special legislation
is needed to promote sound business practices in Internet commerce at this
early stage in its development, it would be technology-neutral consumer
protection legislation, not protections for technology developers and promoters
before the risks associated with their products have become apparent.