H 4011 Session 109 (1991-1992)
H 4011 General Bill, By Hayes and Wilkins
A Bill to amend the Code of Laws of South Carolina, 1976, by adding Chapter 2A
to Title 36 so as to make general provisions to the Uniform Commercial Code
regarding leases and to provide for the formation, construction, effect,
performance, and default of a lease contract; and to amend Sections 36-1-105,
36-1-201(37), and 36-9-113, relating to other provisions of the Uniform
Commercial Code, so as to revise these provisions to conform them to the above
provisions of Chapter 2A; and by adding Chapter 4A to Title 36 so as to make
general provisions to the Uniform Commercial Code on fund transfers including
the issuance, acceptance, and payment of payment orders.
05/21/91 House Introduced and read first time HJ-120
05/21/91 House Referred to Committee on Judiciary HJ-120
05/07/92 House Committee report: Favorable Judiciary HJ-54
05/20/92 House Objection by Rep. Carnell, Felder, Baker,
Haskins, Bruce, Clyborne, HJ-97
05/20/92 House Objection by Rep. Rogers, Waites, McElveen, Rama
& Hodges HJ-97
05/21/92 House Objection withdrawn by Rep. Rama, Baker, Haskins,
Bruce, Carnell, Clyborne & Felder HJ-54
05/21/92 House Objection by Rep. Scott & Delleney HJ-54
06/02/92 House Objection withdrawn by Rep. Rogers, Waites,
Hodges & Delleney HJ-54
06/03/92 House Debate adjourned HJ-106
06/04/92 House Debate adjourned HJ-28
Indicates Matter Stricken
Indicates New Matter
COMMITTEE REPORT
May 7, 1992
H. 4011
Introduced by REPS. Hayes and Wilkins
S. Printed 5/7/92--H.
Read the first time May 21, 1991.
THE COMMITTEE ON JUDICIARY
To whom was referred a Bill (H. 4011), to amend the Code of Laws
of South Carolina, 1976, by adding Chapter 2A to Title 36 so as to make
general provisions to the Uniform Commercial Code regarding leases,
etc., respectfully
REPORT:
That they have duly and carefully considered the same, and
recommend that the same do pass:
DAVID H. WILKINS, for Committee.
A BILL
TO AMEND THE CODE OF LAWS OF SOUTH CAROLINA, 1976,
BY ADDING CHAPTER 2A TO TITLE 36 SO AS TO MAKE
GENERAL PROVISIONS TO THE UNIFORM COMMERCIAL
CODE REGARDING LEASES AND TO PROVIDE FOR THE
FORMATION, CONSTRUCTION, EFFECT, PERFORMANCE, AND
DEFAULT OF A LEASE CONTRACT; AND TO AMEND SECTIONS
36-1-105, 36-1-201(37), AND 36-9-113, RELATING TO OTHER
PROVISIONS OF THE UNIFORM COMMERCIAL CODE, SO AS TO
REVISE THESE PROVISIONS TO CONFORM THEM TO THE
ABOVE PROVISIONS OF CHAPTER 2A; AND BY ADDING
CHAPTER 4A TO TITLE 36 SO AS TO MAKE GENERAL
PROVISIONS TO THE UNIFORM COMMERCIAL CODE ON FUND
TRANSFERS INCLUDING THE ISSUANCE, ACCEPTANCE, AND
PAYMENT OF PAYMENT ORDERS.
Be it enacted by the General Assembly of the State of South Carolina:
SECTION 1. Title 36 of the 1976 Code is amended by adding:
"CHAPTER 2A
Commercial Code - Leases
________
Introduction
Article 2A of the Uniform Commercial Code, along with Conforming
Amendments to Articles 1 and 9, is presented, upon the recommendation
of the Permanent Editorial Board for the Uniform Commercial Code, by
the National Conference for Commissioners on Uniform State Laws and
the American Law Institute. It represents a major development in
commercial law, addressing a type of business transaction, the leasing
of personal property, that has long existed. Under present law,
transactions of this type are governed partly by common law principles
relating to personal property, partly by principles relating to real estate
leases, and partly by reference to Articles 2 and 9 of the Uniform
Commercial Code, dealing with Sales and Secured Transactions
respectively. The legal rules and concepts derived from these sources
imperfectly fit a transaction that involves personal property rather than
realty, and a lease rather than either a sale or a security interest as such.
A statute directly addressing the personal property lease is therefore
appropriate.
Such a statute has become especially appropriate with the
exponential expansion of the number and scale of personal property
lease transactions. Article 2A will apply to transactions involving
billions of dollars annually. It will apply to consumer's rental of
automobiles or do-it-yourself equipment, on the one hand, and to leases
of such items as commercial aircraft (to the extent not preempted by
federal law) and industrial machinery, on the other. The text recognizes
the differences between consumer and business leasing, while resting
upon concepts that apply generally to any personal property lease
transactions.
The final product represents an important undertaking of the
Conference and the Institute. It has proceeded, following
recommendations by the Conference's Study Committee in 1981,
through preparation and review by the Conference's Drafting Committee
first of a proposed free-standing Uniform Personal Property Leasing Act,
which was approved by the Conference, and later of Article 2A, which
proceeded through the Permanent Editorial Board, the Executive
Committee of the Conference, the Conference, and the Council of the
Institute and the Annual Meeting of the members of the Institute.
Carrying the text through these several stages has required coordination
of somewhat different procedures, and continued patience and mutual
forbearance. At the same time, the text has been subjected to analysis
and criticism from many points of view and thereby steadily improved.
The resulting product borrows from both Articles 2 and 9. These
existing Articles of the Uniform Commercial Code have certain
imperfections revealed by the long experience since their adoption.
Article 2A cannot overcome those imperfections but seeks to minimize
their significance as applied to leases. More fundamentally, there is
important conceptual dissonance between Article 2 and Article 9. The
formulation of Article 2A takes Articles 2 and 9 as they are for the time
being and hence has required careful adjustment to this dissonance.
________
PART 1. GENERAL PROVISIONS
Section 36-2A-101. SHORT TITLE.
This chapter may be cited as the Uniform
Commercial Code - Leases.
OFFICIAL COMMENT
Rationale for Codification: There are several reasons for
codifying the law with respect to leases of goods. An analysis of the
case law as it applies to leases of goods suggests at least three significant
issues to be resolved by codification. First, what is a lease? It is
necessary to define lease to determine whether a transaction creates a
lease or a security interest disguised as a lease. If the transaction creates
a security interest disguised as a lease, the lessor will be required to file
a financing statement or take other action to perfect its interest in the
goods against third parties. There is no such requirement with respect
to leases. Yet the distinction between a lease and a security interest
disguised as a lease is not clear. Second, will the lessor be deemed to
have made warranties to the lessee? If the transaction is a sale the
express and implied warranties of Article 2 of the Uniform Commercial
Code apply. However, the warranty law with respect to leases is
uncertain. Third, what remedies are available to the lessor upon the
lessee's default? If the transaction is a security interest disguised as a
lease, the answer is stated in Part 5 of the Article on Secured
Transactions (Article 9). There is no clear answer with respect to leases.
There are reasons to codify the law with respect to leases of goods
in addition to those suggested by a review of the reported cases. The
answer to this important question should not be limited to the issues
raised in these cases. Is it not also proper to determine the remedies
available to the lessee upon the lessor's default? It is, but that issue is
not reached through a review of the reported cases. This is only one of
the many issues presented in structuring, negotiating and documenting
a lease of goods.
Statutory Analogue: After it was decided to proceed with the
codification project, the drafting committee of the National Conference
of Commissioners on Uniform State Laws looked for a statutory
analogue, gradually narrowing the focus to the Article on Sales (Article
2) and the Article on Secured Transactions (Article 9). A review of the
literature with respect to the sale of goods reveals that Article 2 is
predicated upon certain assumptions: Parties to the sales transaction
frequently are without counsel; the agreement of the parties often is oral
or evidenced by scant writings; obligations between the parties are
bilateral; applicable law is influenced by the need to preserve freedom
of contract. A review of the literature with respect to personal property
security law reveals that Article 9 is predicated upon very different
assumptions: Parties to a secured transaction regularly are represented
by counsel; the agreement of the parties frequently is reduced to a
writing, extensive in scope; the obligations between the parties are
essentially unilateral; and applicable law seriously limits freedom of
contract.
The lease is closer in spirit and form to the sale of goods than to the
creation of a security interest. While parties to a lease are sometimes
represented by counsel and their agreement is often reduced to a writing,
the obligations of the parties are bilateral and the common law of leasing
is dominated by the need to preserve freedom of contract. Thus the
drafting committee concluded that Article 2 was the appropriate
statutory analogue.
Issues: The drafting committee then identified and resolved
several issues critical to codification:
Scope: The scope of the Article was limited to leases
(Section 2A-102). There was no need to include leases intended as
security, i.e., security interests disguised as leases, as they are
adequately treated in Article 9. Further, even if leases intended as
security were included, the need to preserve the distinction would
remain, as policy suggests treatment significantly different from that
accorded leases.
Definition of Lease: Lease was defined to exclude
leases intended as security (Section 2A-103(1)(j)). Given the
litigation to date a revised definition of security interest was
suggested for inclusion in the Act. (Section 1-201(37)). This
revision sharpens the distinction between leases and security
interests disguised as leases.
Filing: The lessor was not required to file a financing
statement against the lessee or take any other action to protect the
lessor's interest in the goods (Section 2A-301). The refined
definition of security interest will more clearly signal the need to file
to potential lessors of goods. Those lessors who are concerned will
file a protective financing statement (Section 9-408).
Warranties: All of the express and implied warranties
of the Article on Sales (Article 2) were included (Sections 2A-210
through 2A-216), revised to reflect differences in lease transactions.
The lease of goods is sufficiently similar to the sale of goods to
justify this decision. Further, many courts have reached the same
decision.
Certificate of Title Laws: Many leasing transactions
involve goods subject to certificate of title statutes. To avoid conflict
with those statutes, this Article is subject to them
(Section 2A-104(1)(a)).
Consumer Leases: Many leasing transactions involve
parties subject to consumer protection statutes or decisions. To
avoid conflict with those laws this Article is subject to them to the
extent provided in (Section 2A-104(1)(c) and (2)). Further, certain
consumer protections have been incorporated in the Article.
Finance Leases: Certain leasing transactions substitute
the supplier of the goods for the lessor as the party responsible to the
lessee with respect to warranties and the like. The definition of
finance lease (Section 2A-103(1)(g)) was developed to describe these
transactions. Various sections of the Article implement the
substitution of the supplier for the lessor, including Sections 2A-209
and 2A-407. No attempt was made to fashion a special rule where
the finance lessor is an affiliate of the supplier of goods; this is to be
developed by the courts, case by case.
Sale and Leaseback: Sale and leaseback transactions are
becoming increasingly common. A number of state statutes treat
transactions where possession is retained by the seller as fraudulent
per se or prima facie fraudulent. That position is not in accord with
modern practice and thus is changed by the Article "if the
buyer bought for value and in good faith" (Section 2A-308(3)).
Remedies: The Article has not only provided for lessor's
remedies upon default by the lessee (Sections 2A-523 through
2A-531), but also for lessee's remedies upon default by the lessor
(Sections 2A-508 through 2A-522). This is a significant departure
from Article 9, which provides remedies only for the secured party
upon default by the debtor. This difference is compelled by the
bilateral nature of the obligations between the parties to a lease.
Damages: Many leasing transactions are predicated on
the parties' ability to stipulate an appropriate measure of damages in
the event of default. The rule with respect to sales of goods (Section
2-718) is not sufficiently flexible to accommodate this practice.
Consistent with the common law emphasis upon freedom to contract,
the Article has created a revised rule that allows greater flexibility
with respect to leases of goods (Section 2A-504(1)).
History: This Article is a revision of the Uniform Personal
Property Leasing Act, which was approved by the National Conference
of Commissioners on Uniform State Laws in August, 1985. However,
it was believed that the subject matter of the Uniform Personal Property
Leasing Act would be better treated as an Article of this Act. Thus,
although the Conference promulgated the Uniform Personal Property
Leasing Act as a Uniform Law, activity was held in abeyance to allow
time to restate the Uniform Personal Property Leasing Act as Article 2A.
In August, 1986 the Conference approved and recommended this
Article (including conforming amendments to Article 1 and Article 9)
for promulgation as an amendment to this Act. In December, 1986 the
Council of the American Law Institute approved and recommended this
Article (including conforming amendments to Article 1 and Article 9),
with official comments, for promulgation as an amendment to this Act.
In March, 1987 the Permanent Editorial Board for the Uniform
Commercial Code approved and recommended this Article (including
conforming amendments to Article 1 and Article 9), with official
comments, for promulgation as an amendment to this Act. In May, 1987
the American Law Institute approved and recommended this Article
(including conforming amendments to Article 1 and Article 9), with
official comments, for promulgation as an amendment to this Act. In
August, 1987 the Conference confirmed its approval of the final text of
this Article.
Upon its initial promulgation, Article 2A was rapidly enacted in
several states, was introduced in a number of other states, and underwent
bar association, law revision commission and legislative study in still
further states. In that process debate emerged, principally sparked by the
study of Article 2A by the California Bar Association, California's
non-uniform amendments to Article 2A, and Articles appearing in a
symposium on Article 2A published after its promulgation in the
Alabama Law Review. The debate chiefly centered on whether Article
2A had struck the proper balance or was clear enough concerning the
ability of a lessor to grant a security interest in its leasehold interest and
in the residual, priority between a secured party and the lessee, and the
lessor's remedy structure under Article 2A.
This debate over issues on which reasonable minds could and did
differ began to affect the enactment effort for Article 2A in a deleterious
manner. Consequently, the Standby Committee for Article 2A,
composed predominantly of the former members of the drafting
committee, reviewed the legislative actions and studies in the various
states, and opened a dialogue with the principal proponents of the
non-uniform amendments. Negotiations were conducted in conjunction
with, and were facilitated by, a study of the uniform Article and the
non-uniform Amendments by the New York Law Revision Commission.
Ultimately, a consensus was reached, which has been approved by the
membership of the Conference, the Permanent Editorial Board, and the
Council of the Institute. Rapid and uniform enactment of Article 2A is
expected as a result of the completed amendments. The Article 2A
experience reaffirms the essential viability of the procedures of the
Conference and the Institute for creating and updating uniform state law
in the commercial law area.
Relationship of Article 2A to Other Articles: The Article on
Sales provided a useful point of reference for codifying the law of
leases. Many of the provisions of that Article were carried over,
changed to reflect differences in style, leasing terminology or leasing
practices. Thus, the official comments to those sections of Article 2
whose provisions were carried over are incorporated by reference in
Article 2A, as well; further, any case law interpreting those provisions
should be viewed as persuasive but not binding on a court when
deciding a similar issue with respect to leases. Any change in the
sequence that has been made when carrying over a provision from
Article 2 should be viewed as a matter of style, not substance. This is
not to suggest that in other instances Article 2A did not also incorporate
substantially revised provisions of Article 2, Article 9 or otherwise
where the revision was driven by a concern over the substance; but for
the lack of a mandate, the drafting committee might well have made the
same or a similar change in the statutory analogue. Those sections in
Article 2A include Sections 2A-104, 2A-105, 2A-106, 2A-108(2) and
(4), 2A-109(2), 2A-208, 2A-214(2) and (3)(a), 2A-216, 2A-303,
2A-306, 2A-503, 2A-504(3)(b), 2A-506(2), and 2A-515. For lack of
relevance or significance not all of the provisions of Article 2 were
incorporated in Article 2A.
This codification was greatly influenced by the fundamental tenet of
the common law as it has developed with respect to leases of goods:
freedom of the parties to contract. Note that, like all other Articles of
this Act, the principles of construction and interpretation contained in
Article 1 are applicable throughout Article 2A (Section 2A-103(4)).
These principles include the ability of the parties to vary the effect of the
provisions of Article 2A, subject to certain limitations including those
that relate to the obligations of good faith, diligence, reasonableness and
care (Section 1-102(3)). Consistent with those principles no negative
inference is to be drawn by the episodic use of the phrase "unless
otherwise agreed" in certain provisions of Article 2A. Section
1-102(4). Indeed, the contrary is true, as the general rule in the Act,
including this Article, is that the effect of the Act's provisions may be
varied by agreement. Section 1-102(3). This conclusion follows even
where the statutory analogue contains the phrase and the correlative
provision in Article 2A does not.
Section 36-2A-102. SCOPE.
This chapter applies to any transaction, regardless of form, that
creates a lease.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-102(1). Throughout this
Article, unless otherwise stated, references to "Section" are
to other sections of this Act.
Changes: Substantially revised.
Purposes: This Article governs transactions as diverse as the
lease of a hand tool to an individual for a few hours and the leveraged
lease of a complex line of industrial equipment to a multi-national
organization for a number of years.
To achieve that end it was necessary to provide that this Article
applies to any transaction, regardless of form, that creates a lease. Since
lease is defined as a transfer of an interest in goods (Section
2A-103(1)(j)) and goods is defined to include fixtures (Section
2A-103(1)(h)), application is limited to the extent the transaction relates
to goods, including fixtures. Further, since the definition of lease does
not include a sale (Section 2-106(1)) or retention or creation of a
security interest (Section 1-201(37)), application is further limited; sales
and security interests are governed by other Articles of this Act.
Finally, in recognition of the diversity of the transactions to be
governed, the sophistication of many of the parties to these transactions,
and the common law tradition as it applies to the bailment for hire or
lease, freedom of contract has been preserved. DeKoven, Proceedings
After Default by the Lessee Under a True Lease of Equipment, in 1C P.
Coogan, W. Hogan, D. Vagts, Secured Transactions Under the
Uniform Commercial Code, Section 29B.02[2] (1986). Thus,
despite the extensive regulatory scheme established by this Article, the
parties to a lease will be able to create private rules to govern their
transaction. Sections 2A-103(4) and 1-102(3). However, there are
special rules in this Article governing consumer leases, as well as other
state and federal statutes, that may further limit freedom of contract with
respect to consumer leases.
A court may apply this Article by analogy to any transaction,
regardless of form, that creates a lease of personal property other than
goods, taking into account the expressed intentions of the parties to the
transaction and any differences between a lease of goods and a lease of
other property. Such application has precedent as the provisions of the
Article on Sales (Article 2) have been applied by analogy to leases of
goods. E.g., Hawkland, The Impact of the Uniform
Commercial Code on Equipment Leasing, 1972 Ill. L.F. 446;
Murray, Under the Spreading Analogy of Article 2 of the Uniform
Commercial Code, 39 Fordham L. Rev. 447 (1971). Whether such
application would be appropriate for other bailments of personal
property, gratuitous or for hire, should be determined by the facts of
each case. See Mieske v. Bartell Drug Co., 92 Wash. 2d 40,
46-48, 593 P.2d 1308, 1312 (1979).
Further, parties to a transaction creating a lease of personal property
other than goods, or a bailment of personal property may provide by
agreement that this Article applies. Upholding the parties' choice is
consistent with the spirit of this Article.
Cross References: Sections 1-102(3), 1-201(37), Article 2,
esp. Section 2-106(1), and Sections 2A-103(1)(h), 2A-103(1)(j) and
2A-103(4).
Definitional Cross Reference: "Lease". Section
2A-103(1)(j).
Section 36-2A-103. DEFINITIONS AND INDEX OF
DEFINITIONS.
(1) In this chapter unless the context otherwise requires:
(a) `Buyer in ordinary course of business' means a person who in
good faith and without knowledge that the sale to him is in violation of
the ownership rights or security interest or leasehold interest of a third
party in the goods, buys in ordinary course from a person in the business
of selling goods of that kind but does not include a pawnbroker.
`Buying' may be for cash or by exchange of other property or on secured
or unsecured credit and includes receiving goods or documents of title
under a pre-existing contract for sale but does not include a transfer in
bulk or as security for or in total or partial satisfaction of a money debt.
(b) `Cancellation' occurs when either party puts an end to the lease
contract for default by the other party.
(c) `Commercial unit' means such a unit of goods as by commercial
usage is a single whole for purposes of lease and division of which
materially impairs its character or value on the market or in use. A
commercial unit may be a single chapter, as a machine, or a set of
chapters, as a suite of furniture or a line of machinery, or a quantity, as
a gross or carload, or any other unit treated in use or in the relevant
market as a single whole.
(d) `Conforming' goods or performance under a lease contract means
goods or performance that are in accordance with the obligations under
the lease contract.
(e) `Consumer lease' means a lease that a lessor regularly engaged
in the business of leasing or selling makes to a lessee who is an
individual and who takes under the lease primarily for a personal,
family, or household purpose, if the total payments to be made under the
lease contract, excluding payments for options to renew or buy, do not
exceed twenty-five thousand dollars.
(f) `Fault' means wrongful act, omission, breach, or default.
(g) `Finance lease' means a lease with respect to which:
(i) the lessor does not select, manufacture, or supply the goods;
(ii) the lessor acquires the goods or the right to possession and
use of the goods in connection with the lease; and
(iii) one of the following occurs:
(A) the lessee receives a copy of the contract by which the
lessor acquired the goods or the right to possession and use of the goods
before signing the lease contract;
(B) the lessee's approval of the contract by which the lessor
acquired the goods or the right to possession and use of the goods is a
condition to effectiveness of the lease contract;
(C) the lessee, before signing the lease contract, receives an
accurate and complete statement designating the promises and
warranties, and any disclaimers of warranties, limitations or
modifications of remedies, or liquidated damages, including those of a
third party, such as the manufacturer of the goods, provided to the lessor
by the person supplying the goods in connection with or as part of the
contract by which the lessor acquired the goods or the right to
possession and use of the goods; or
(D) if the lease is not a consumer lease, the lessor, before the
lessee signs the lease contract, informs the lessee in writing (i) of the
identity of the person supplying the goods to the lessor, unless the lessee
has selected that person and directed the lessor to acquire the goods or
the right to possession and use of the goods from that person, (ii) that the
lessee is entitled under this chapter to the promises and warranties,
including those of any third party, provided to the lessor by the person
supplying the goods in connection with or as part of the contract by
which the lessor acquired the goods or the right to possession and use of
the goods, and (iii) that the lessee may communicate with the person
supplying the goods to the lessor and receive an accurate and complete
statement of those promises and warranties, including any disclaimers
and limitations of them or of remedies.
(h) `Goods' means all things that are movable at the time of
identification to the lease contract, or are fixtures (Section 36-2A-309),
but the term does not include money, documents, instruments, accounts,
chattel paper, general intangibles, or minerals or the like, including oil
and gas, before extraction. The term also includes the unborn young of
animals.
(i) `Installment lease contract' means a lease contract that authorizes
or requires the delivery of goods in separate lots to be separately
accepted, even though the lease contract contains a clause "each
delivery is a separate lease" or its equivalent.
(j) `Lease' means a transfer of the right to possession and use of
goods for a term in return for consideration, but a sale, including a sale
on approval or a sale or return, or retention or creation of a security
interest is not a lease. Unless the context clearly indicates otherwise, the
term includes a sublease.
(k) `Lease agreement' means the bargain, with respect to the lease,
of the lessor and the lessee in fact as found in their language or by
implication from other circumstances including course of dealing or
usage of trade or course of performance as provided in this chapter.
Unless the context clearly indicates otherwise, the term includes a
sublease agreement.
(l) `Lease contract' means the total legal obligation that results from
the lease agreement as affected by this chapter and any other applicable
rules of law. Unless the context clearly indicates otherwise, the term
includes a sublease contract.
(m) `Leasehold interest' means the interest of the lessor or the lessee
under a lease contract.
(n) `Lessee' means a person who acquires the right to possession and
use of goods under a lease. Unless the context clearly indicates
otherwise, the term includes a sublessee.
(o) `Lessee in ordinary course of business' means a person who in
good faith and without knowledge that the lease to him is in violation of
the ownership rights or security interest or leasehold interest of a third
party in the goods leases in ordinary course from a person in the
business of selling or leasing goods of that kind but does not include a
pawnbroker. `Leasing' may be for cash or by exchange of other property
or on secured or unsecured credit and includes receiving goods or
documents of title under a pre-existing lease contract but does not
include a transfer in bulk or as security for or in total or partial
satisfaction of a money debt.
(p) `Lessor' means a person who transfers the right to possession and
use of goods under a lease. Unless the context clearly indicates
otherwise, the term includes a sublessor.
(q) `Lessor's residual interest' means the lessor's interest in the goods
after expiration, termination, or cancellation of the lease contract.
(r) `Lien' means a charge against or interest in goods to secure
payment of a debt or performance of an obligation, but the term does not
include a security interest.
(s) `Lot' means a parcel or a single article that is the subject matter
of a separate lease or delivery, whether or not it is sufficient to perform
the lease contract.
(t) `Merchant lessee' means a lessee that is a merchant with respect
to goods of the kind subject to the lease.
(u) `Present value' means the amount as of a date certain of one or
more sums payable in the future, discounted to the date certain. The
discount is determined by the interest rate specified by the parties if the
rate was not manifestly unreasonable at the time the transaction was
entered into; otherwise, the discount is determined by a commercially
reasonable rate that takes into account the facts and circumstances of
each case at the time the transaction was entered into.
(v) `Purchase' includes taking by sale, lease, mortgage, security
interest, pledge, gift, or any other voluntary transaction creating an
interest in goods.
(w) `Sublease' means a lease of goods the right to possession and use
of which was acquired by the lessor as a lessee under an existing lease.
(x) `Supplier' means a person from whom a lessor buys or leases
goods to be leased under a finance lease.
(y) `Supply contract' means a contract under which a lessor buys or
leases goods to be leased.
(z) `Termination' occurs when either party pursuant to a power
created by agreement or law puts an end to the lease contract otherwise
than for default.
(2) Other definitions applying to this chapter and the sections in
which they appear are:
`Accessions'. Section 36-2A-310(1).
`Construction mortgage'. Section 36-2A-309(1)(d).
`Encumbrance'. Section 36-2A-309(1)(e).
`Fixtures'. Section 36-2A-309(1)(a).
`Fixture filing'. Section 36-2A-309(1)(b).
`Purchase money lease'. Section 36-2A-309(1)(c).
(3) The following definitions in other chapters apply to this chapter:
`Account'. Section 36-9-106.
`Between merchants'. Section 36-2-104(3).
`Buyer'. Section 36-2-103(1)(a).
`Chattel paper'. Section 36-9-105(1)(b).
`Consumer goods'. Section 36-9-109(1).
`Document'. Section 36-9-105(1)(f).
`Entrusting'. Section 36-2-403(3).
`General intangibles'. Section 36-9-106.
`Good faith'. Section 36-2-103(1)(b).
`Instrument'. Section 36-9-105(1)(i).
`Merchant'. Section 36-2-104(1).
`Mortgage'. Section 36-9-105(1)(j).
`Pursuant to commitment'. Section 36-9-105(1)(k).
`Receipt'. Section 36-2-103(1)(c).
`Sale'. Section 36-2-106(1).
`Sale on approval'. Section 36-2-326.
`Sale or return'. Section 36-2-326.
`Seller'. Section 36-2-103(1)(d).
(4) In addition, Chapter 1 contains general definitions and principles
of construction and interpretation applicable throughout this chapter.
OFFICIAL COMMENT
(a) "Buyer in ordinary course of business". Section
1-201(9).
(b) "Cancellation". Section 2-106(4). The effect of
a cancellation is provided in Section 2A-505(1).
(c) "Commercial unit". Section 2-105(6).
(d) "Conforming". Section 2-106(2).
(e) "Consumer lease". New. This Article includes a
subset of rules that applies only to consumer leases. Sections 2A-106,
2A-108(2), 2A-108(4), 2A-109(2), 2A-221, 2A-309, 2A-406, 2A-407,
2A-504(3)(b), and 2A-516(3)(b).
For a transaction to qualify as a consumer lease it must first qualify
as a lease. Section 2A-103(1)(j). Note that this Article regulates the
transactional elements of a lease, including a consumer lease; consumer
protection statutes, present and future, and existing consumer protection
decisions are unaffected by this Article. Section 2A-104(1)(c) and (2).
Of course, Article 2A as state law also is subject to federal consumer
protection law.
This definition is modeled after the definition of consumer lease in
the Consumer Leasing Act, 15 U.S.C. Section 1667 (1982), and in the
Unif. Consumer Credit Code Section 1.301(14), 7A U.L.A. 43 (1974).
However, this definition of consumer lease differs from its models in
several respects: the lessor can be a person regularly engaged either in
the business of leasing or of selling goods, the lease need not be for a
term exceeding four months, a lease primarily for an agricultural
purpose is not covered, and whether there should be a limitation by
dollar amount and its amount is left up to the individual states.
This definition focuses on the parties as well as the transaction. If a
lease is within this definition, the lessor must be regularly engaged in the
business of leasing or selling, and the lessee must be an individual not
an organization; note that a lease to two or more individuals having a
common interest through marriage or the like is not excluded as a lease
to an organization under Section 1-201(28). The lessee must take the
interest primarily for a personal, family or household purpose. If
required by the enacting state, total payments under the lease contract,
excluding payments for options to renew or buy, cannot exceed the
figure designated.
(f) "Fault". Section 1-201(16).
(g) "Finance Lease". New. This Article includes a
subset of rules that applies only to finance leases. Sections 2A-209,
2A-211(2), 2A-212(1), 2A-213, 2A-219(1), 2A-220(1)(a), 2A-221,
2A-405(c), 2A-407, 2A-516(2) and 2A-517(1)(a) and (2).
For a transaction to qualify as a finance lease it must first qualify as
a lease. Section 2A-103(1)(j). Unless the lessor is comfortable that the
transaction will qualify as a finance lease, the lease agreement should
include provisions giving the lessor the benefits created by the subset of
rules applicable to the transaction that qualifies as a finance lease under
this Article.
A finance lease is the product of a three party transaction. The
supplier manufactures or supplies the goods pursuant to the lessee's
specification, perhaps even pursuant to a purchase order, sales
agreement or lease agreement between the supplier and the lessee. After
the prospective finance lease is negotiated, a purchase order, sales
agreement, or lease agreement is entered into by the lessor (as buyer or
prime lessee) or an existing order, agreement or lease is assigned by the
lessee to the lessor, and the lessor and the lessee then enter into a lease
or sublease of the goods. Due to the limited function usually performed
by the lessor, the lessee looks almost entirely to the supplier for
representations, covenants and warranties. If a manufacturer's warranty
carries through, the lessee may also look to that. Yet, this definition
does not restrict the lessor's function solely to the supply of funds; if the
lessor undertakes or performs other functions, express warranties,
covenants and the common law will protect the lessee.
This definition focuses on the transaction, not the status of the
parties; to avoid confusion it is important to note that in other contexts,
e.g., tax and accounting, the term finance lease has been used to connote
different types of lease transactions, including leases that are disguised
secured transactions. M. Rice, Equipment Financing, 62-71
(1981). A lessor who is a merchant with respect to goods of the kind
subject to the lease may be a lessor under a finance lease. Many leases
that are leases back to the seller of goods (Section 2A-308(3)) will be
finance leases. This conclusion is easily demonstrated by a hypothetical.
Assume that B has bought goods from C pursuant to a sales contract.
After delivery to and acceptance of the goods by B, B negotiates to sell
the goods to A and simultaneously to lease the goods back from A, on
terms and conditions that, we assume, will qualify the transaction as a
lease. Section 2A-103(1)(j). In documenting the sale and lease back, B
assigns the original sales contract between B, as buyer, and C, as seller,
to A. A review of these facts leads to the conclusion that the lease from
A to B qualifies as a finance lease, as all three conditions of the
definition are satisfied. Subparagraph (i) is satisfied as A, the lessor, had
nothing to do with the selection, manufacture, or supply of the
equipment. Subparagraph (ii) is satisfied as A, the lessor, bought the
equipment at the same time that A leased the equipment to B, which
certainly is in connection with the lease. Finally, subparagraph (iii) (A)
is satisfied as A entered into the sales contract with B at the same time
that A leased the equipment back to B. B, the lessee, will have received
a copy of the sales contract in a timely fashion.
Subsection (i) requires the lessor to remain outside the selection,
manufacture and supply of the goods; that is the rationale for releasing
the lessor from most of its traditional liability. The lessor is not
prohibited from possession, maintenance or operation of the goods, as
policy does not require such prohibition. To insure the lessee's reliance
on the supplier, and not on the lessor, subsection (ii) requires that the
goods (where the lessor is the buyer of the goods) or that the right to
possession and use of the goods (where the lessor is the prime lessee and
the sublessor of the goods) be acquired in connection with the lease (or
sublease) to qualify as a finance lease. The scope of the phrase "in
connection with" is to be developed by the courts, case by case.
Finally, as the lessee generally relies almost entirely upon the supplier
for representations and covenants, and upon the supplier or a
manufacturer, or both, for warranties with respect to the goods,
subsection (iii) requires that one of the following occur: (A) the lessee
receive a copy of the supply contract before signing the lease contract;
(B) the lessee's approval of the supply contract is a condition to the
effectiveness of the lease contract; (C) the lessee receive a statement
describing the promises and warranties and any limitations relevant to
the lessee before signing the lease contract; or (D) before signing the
lease contract and except in a consumer lease, the lessee receive a
writing identifying the supplier (unless the supplier was selected and
required by the lessee) and the rights of the lessee under Section 2A-209,
and advising the lessee a statement of promises and warranties is
available from the supplier. Thus, even where oral supply orders or
computer placed supply orders are compelled by custom and usage the
transaction may still qualify as a finance lease if the lessee approves the
supply contract before the lease contract is effective and such approval
was a condition to the effectiveness of the lease contract. Moreover,
where the lessor does not want the lessee to see the entire supply
contract, including price information, the lessee may be provided with
a separate statement of the terms of the supply contract relevant to the
lessee; promises between the supplier and the lessor that do not affect
the lessee need not be included. The statement can be a restatement of
those terms or a copy of portions of the supply contract with the relevant
terms clearly designated. Any implied warranties need not be
designated, but a disclaimer or modification of remedy must be
designated. A copy of any manufacturer's warranty is sufficient if that
is the warranty provided. However, a copy of any Regulation M
disclosure given pursuant to 12 C.F.R. Section 213.4(g) concerning
warranties in itself is not sufficient since those disclosures need only
briefly identify express warranties and need not include any disclaimer
of warranty.
If a transaction does not qualify as a finance lease, the parties may
achieve the same result by agreement; no negative implications are to be
drawn if the transaction does not qualify. Further, absent the application
of special rules (fraud, duress, and the like), a lease that qualifies as a
finance lease and is assigned by the lessor or the lessee to a third party
does not lose its status as a finance lease under this Article. Finally, this
Article creates no special rule where the lessor is an affiliate of the
supplier; whether the transaction qualifies as a finance lease will be
determined by the facts of each case.
(h) "Goods". Section 9-105(1)(h). See Section
2A-103(3) for reference to the definition of "Account",
"Chattel paper", "Document", "General
intangibles" and "Instrument". See Section 2A-217
for determination of the time and manner of identification.
(i) "Installment lease contract". Section 2-612(1).
(j) "Lease". New. There are several reasons to codify
the law with respect to leases of goods. An analysis of the case law as
it applies to leases of goods suggests at least several significant issues
to be resolved by codification. First and foremost is the definition of a
lease. It is necessary to define lease to determine whether a transaction
creates a lease or a security interest disguised as a lease. If the
transaction creates a security interest disguised as a lease, the transaction
will be governed by the Article on Secured Transactions (Article 9) and
the lessor will be required to file a financing statement or take other
action to perfect its interest in the goods against third parties. There is
no such requirement with respect to leases under the common law and,
except with respect to leases of fixtures (Section 2A-309), this Article
imposes no such requirement. Yet the distinction between a lease and
a security interest disguised as a lease is not clear from the case law at
the time of the promulgation of this Article. DeKoven, Leases of
Equipment: Puritan Leasing Company v. August, A Dangerous
Decision, 12 U.S.F. L. Rev. 257 (1978).
At common law a lease of personal property is a bailment for hire.
While there are several definitions of bailment for hire, all require a
thing to be let and a price for the letting. Thus, in modern terms and as
provided in this definition, a lease is created when the lessee agrees to
furnish consideration for the right to the possession and use of goods
over a specified period of time. Mooney, Personal Property
Leasing: A Challenge, 36 Bus. Law. 1605, 1607 (1981). Further,
a lease is neither a sale (Section 2-106(1)) nor a retention or creation of
a security interest (Section 1-201(37)). Due to extensive litigation to
distinguish true leases from security interests, an amendment to Section
1-201(37) has been promulgated with this Article to create a sharper
distinction.
This section as well as Section 1-201(37) must be examined to
determine whether the transaction in question creates a lease or a
security interest. The following hypotheticals indicate the perimeters of
the issue. Assume that A has purchased a number of copying machines,
new, for $1,000 each; the machines have an estimated useful economic
life of three years. A advertises that the machines are available to rent
for a minimum of one month and that the monthly rental is $100.00. A
intends to enter into leases where A provides all maintenance, without
charge to the lessee. Further, the lessee will rent the machine, month to
month, with no obligation to renew. At the end of the lease term the
lessee will be obligated to return the machine to A's place of business.
This transaction qualifies as a lease under the first half of the definition,
for the transaction includes a transfer by A to a prospective lessee of
possession and use of the machine for a stated term, month to month.
The machines are goods (Section 2A-103(1)(h)). The lessee is obligated
to pay consideration in return, $100.00 for each month of the term.
However, the second half of the definition provides that a sale or a
security interest is not a lease. Since there is no passing of title, there is
no sale. Sections 2A-103(3) and 2-106(1). Under pre-Act security law
this transaction would have created a bailment for hire or a true lease
and not a conditional sale. Da Rocha v. Macomber, 330 Mass.
611, 614-15, 116 N.E.2d 139, 142 (1953). Under Section 1-201(37), as
amended with the promulgation of this Article, the same result would
follow. While the lessee is obligated to pay rent for the one month term
of the lease, one of the other four conditions of the second paragraph of
Section 1-201(37) must be met and none is. The term of the lease is one
month and the economic life of the machine is 36 months; thus,
subparagraph (a) of Section 1-201(37) is not now satisfied. Considering
the amount of the monthly rent, absent economic duress or coercion, the
lessee is not bound either to renew the lease for the remaining economic
life of the goods or to become the owner. If the lessee did lease the
machine for 36 months, the lessee would have paid the lessor $3,600 for
a machine that could have been purchased for $1,000; thus,
subparagraph (b) of Section 1-201(37) is not satisfied. Finally, there are
no options; thus, subparagraphs (c) and (d) of Section 1-201(37) are not
satisfied. This transaction creates a lease, not a security interest.
However, with each renewal of the lease the facts and circumstances at
the time of each renewal must be examined to determine if that
conclusion remains accurate, as it is possible that a transaction that first
creates a lease, later creates a security interest.
Assume that the facts are changed and that A requires each lessee to
lease the goods for 36 months, with no right to terminate. Under pre-Act
security law this transaction would have created a conditional sale, and
not a bailment for hire or true lease. Hervey v. Rhode Island
Locomotive Works, 93 U.S. 664, 672-73 (1876). Under this
subsection, and Section 1-201(37), as amended with the inclusion of this
Article in the Act, the same result would follow. The lessee's obligation
for the term is not subject to termination by the lessee and the term is
equal to the economic life of the machine.
Between these extremes there are many transactions that can be
created. Some of the transactions have not been properly categorized by
the courts in applying the 1978 and earlier Official Texts of Section
1-201(37). This subsection, together with Section 1-201(37), as
amended with the promulgation of this Article, draws a brighter line,
which should create a clearer signal to the professional lessor and lessee.
(k) "Lease agreement". This definition is derived from
the first sentence of Section 1-201(3). Because the definition of lease is
broad enough to cover future transfers, lease agreement includes an
agreement contemplating a current or subsequent transfer. Thus it was
not necessary to make an express reference to an agreement for the
future lease of goods (Section 2-106(1)). This concept is also
incorporated in the definition of lease contract. Note that the definition
of lease does not include transactions in ordinary building materials that
are incorporated into an improvement on land. Section 2A-309(2).
The provisions of this Article, if applicable, determine whether a
lease agreement has legal consequences; otherwise the law of bailments
and other applicable law determine the same. Sections 2A-103(4) and
1-103.
(l) "Lease contract". This definition is derived from the
definition of contract in Section 1-201(11). Note that a lease contract
may be for the future lease of goods, since this notion is included in the
definition of lease.
(m) "Leasehold interest". New.
(n) "Lessee". New.
(o) "Lessee in ordinary course of business". Section
1-201(9).
(p) "Lessor". New.
(q) "Lessor's residual interest". New.
(r) "Lien". New. This term is used in Section 2A-307
(Priority of Liens Arising by Attachment or Levy on, Security Interests
in, and Other Claims to Goods).
(s) "Lot". Section 2-105(5).
(t) "Merchant lessee". New. This term is used in
Section 2A-511 (Merchant Lessee's Duties as to Rightfully Rejected
Goods). A person may satisfy the requirement of dealing in goods of the
kind subject to the lease as lessor, lessee, seller, or buyer.
(u) "Present value". New. Authorities agree that present
value should be used to determine fairly the damages payable by the
lessor or the lessee on default. E.g., Taylor v. Commercial
Credit Equip. Corp., 170 Ga. App. 322, 316 S.E.2d 788 (Ct. App.
1984). Present value is defined to mean an amount that represents the
discounted value as of a date certain of one or more sums payable in the
future. This is a function of the economic principle that a dollar today
is more valuable to the holder than a dollar payable in two years. While
there is no question as to the principle, reasonable people would differ
as to the rate of discount to apply in determining the value of that future
dollar today. To minimize litigation, this Article allows the parties to
specify the discount or interest rate, if the rate was not manifestly
unreasonable at the time the transaction was entered into. In all other
cases, the interest rate will be a commercially reasonable rate that takes
into account the facts and circumstances of each case, as of the time the
transaction was entered into.
(v) "Purchase". Section 1-201(32). This definition
omits the reference to lien contained in the definition of purchase in
Article 1 (Section 1-201(32)). This should not be construed to exclude
consensual liens from the definition of purchase in this Article; the
exclusion was mandated by the scope of the definition of lien in
Section 2A-103(1)(r). Further, the definition of purchaser in this Article
adds a reference to lease; as purchase is defined in Section 1-201(32) to
include any other voluntary transaction creating an interest in property,
this addition is not substantive.
(w) "Sublease". New.
(x) "Supplier". New.
(y) "Supply contract". New.
(z) "Termination". Section 2-106(3). The effect of a
termination is provided in Section 2A-505(2).
Section 36-2A-104. LEASES SUBJECT TO OTHER LAW.
(1) A lease, although subject to this chapter, is also subject to any
applicable:
(a) certificate of title statute of this State: (list any certificate of
title statutes covering automobiles, trailers, mobile homes, boats, farm
tractors, and the like);
(b) certificate of title statute of another jurisdiction (Section
36-2A-105); or
(c) consumer protection statute of this State, or final consumer
protection decision of a court of this State existing on the effective date
of this chapter.
(2) In case of conflict between this chapter, other than Sections
36-2A-105, 36-2A-304(3), and 36-2A-305(3), and a statute or decision
referred to in subsection (1), the statute or decision controls.
(3) Failure to comply with an applicable law has only the effect
specified therein.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 9-203(4) and 9-302(3)(b) and
(c).
Changes: Substantially revised.
Purposes: 1. This Article creates a comprehensive scheme for
the regulation of transactions that create leases. Section 2A-102. Thus,
the Article supersedes all prior legislation dealing with leases, except to
the extent set forth in this Section.
2. Subsection (1) states the general rule that a lease, although
governed by the scheme of this Article, also may be governed by certain
other applicable laws. This may occur in the case of a consumer lease.
Section 2A-103(1)(e). Those laws may be state statutes existing prior
to enactment of Article 2A or passed afterward. In this case, it is
desirable for this Article to specify which statute controls. Or the law
may be a pre-existing consumer protection decision. This Article
preserves such decisions. Or the law may be a statute of the United
States. Such a law controls without any statement in this Article under
applicable principles of preemption.
An illustration of a statute of the United States that governs
consumer leases is the Consumer Leasing Act, 15 U.S.C.
Sections 1667-1667(e) (1982) and its implementing regulation,
Regulation M, 12 C.F.R. Section 213 (1986); the statute mandates
disclosures of certain lease terms, delimits the liability of a lessee in
leasing personal property, and regulates the advertising of lease terms.
An illustration of a state statute that governs consumer leases and which
if adopted in the enacting state prevails over this Article is the Unif.
Consumer Credit Code, which includes many provisions similar to those
of the Consumer Leasing Act, e.g, Unif. Consumer Credit Code
Sections 3.202, 3.209, 3.401, 7A U.L.A. 108-09, 115, 125 (1974), as
well as provisions in addition to those of the Consumer Leasing Act,
e.g., Unif. Consumer Credit Code Sections 5.109-.111, 7A U.L.A.
171-76 (1974) (the right to cure a default). Such statutes may define
consumer lease so as to govern transactions within and without the
definition of consumer lease under this Article.
3. Under subsection (2), subject to certain limited exclusions, in case
of conflict a statute or a decision described in subsection (1) prevails
over this Article. For example, a provision like Unif. Consumer Credit
Code Section 5.112, 7A U.L.A. 176 (1974), limiting self-help
repossession, prevails over Section 2A-525(3). A consumer protection
decision rendered after the effective date of this Article may supplement
its provisions. For example, in relation to Article 9 a court might
conclude that an acceleration clause may not be enforced against an
individual debtor after late payments have been accepted unless a prior
notice of default is given. To the extent the decision establishes a
general principle applicable to transactions other than secured
transactions, it may supplement Section 2A-502.
4. Consumer protection in lease transactions is primarily left to other
law. However, several provisions of this Article do contain special rules
that may not be varied by agreement in the case of a consumer lease.
E.g., Sections 2A-106, 2A-108, and 2A-109(2). Were that not so, the
ability of the parties to govern their relationship by agreement together
with the position of the lessor in a consumer lease too often could result
in a one-sided lease agreement.
5. In construing this provision the reference to statute should be
deemed to include applicable regulations. A consumer protection
decision is "final" on the effective date of this Article if it is
not subject to appeal on that date or, if subject to appeal, is not later
reversed on appeal. Of course, such a decision can be overruled by a
later decision or superseded by a later statute.
Cross References: Sections 2A-103(1)(e), 2A-106, 2A-108,
2A-109(2) and 2A-525(3).
Definitional Cross Reference: "Lease". Section
2A-103(1)(j).
Section 36-2A-105. TERRITORIAL APPLICATION OF
CHAPTER TO GOODS COVERED BY CERTIFICATE OF TITLE. Subject to the provisions of Sections 36-2A-304(3) and
36-2A-305(3), with respect to goods covered by a certificate of title
issued under a statute of this State or of another jurisdiction, compliance
and the effect of compliance or noncompliance with a certificate of title
statute are governed by the law (including the conflict of laws rules) of
the jurisdiction issuing the certificate until the earlier of (a) surrender of
the certificate, or (b) four months after the goods are removed from that
jurisdiction and thereafter until a new certificate of title is issued by
another jurisdiction.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-103(2)(a) and (b).
Changes: Substantially revised. The provisions of the last
sentence of Section 9-103(2)(b) have not been incorporated as it is
superfluous in this context. The provisions of Section 9-103(2)(d) have
not been incorporated because the problems dealt with are adequately
addressed by this section and Sections 2A-304(3) and 305(3).
Purposes: The new certificate referred to in (b) must be
permanent, not temporary. Generally, the lessor or creditor whose
interest is indicated on the most recently issued certificate of title will
prevail over interests indicated on certificates issued previously by other
jurisdictions. This provision reflects a policy that it is reasonable to
require holders of interests in goods covered by a certificate of title to
police the goods or risk losing their interests when a new certificate of
title is issued by another jurisdiction.
Cross References: Sections 2A-304(3), 2A-305(3),
9-103(2)(b) and 9-103(2)(d).
Definitional Cross Reference: "Goods". Section
2A-103(1)(h).
Section 36-2A-106. LIMITATION ON POWER OF PARTIES TO
CONSUMER LEASE TO CHOOSE APPLICABLE LAW AND
JUDICIAL FORUM.
(1) If the law chosen by the parties to a consumer lease is that of a
jurisdiction other than a jurisdiction in which the lessee resides at the
time the lease agreement becomes enforceable or within 30 days
thereafter or in which the goods are to be used, the choice is not
enforceable.
(2) If the judicial forum chosen by the parties to a consumer lease is
a forum that would not otherwise have jurisdiction over the lessee, the
choice is not enforceable.
OFFICIAL COMMENT
Uniform Statutory Source: Unif. Consumer Credit Code
Section 1.201(8), 7A U.L.A. 36 (1974).
Changes: Substantially revised.
Purposes: There is a real danger that a lessor may induce a
consumer lessee to agree that the applicable law will be a jurisdiction
that has little effective consumer protection, or to agree that the
applicable forum will be a forum that is inconvenient for the lessee in
the event of litigation. As a result, this section invalidates these choice
of law or forum clauses, except where the law chosen is that of the state
of the consumer's residence or where the goods will be kept, or the
forum chosen is one that otherwise would have jurisdiction over the
lessee.
Subsection (1) limits potentially abusive choice of law clauses in
consumer leases. The 30-day rule in subsection (1) was suggested by
Section 9-103(1)(c). This section has no effect on choice of law clauses
in leases that are not consumer leases. Such clauses would be governed
by other law.
Subsection (2) prevents enforcement of potentially abusive
jurisdictional consent clauses in consumer leases. By using the term
judicial forum, this section does not limit selection of a nonjudicial
forum, such as arbitration. This section has no effect on choice of forum
clauses in leases that are not consumer leases; such clauses are, as a
matter of current law, "prima facie valid". The Bremen
v. Zapata Off-Shore Co., 407 U.S. 1, 10 (1972). Such clauses
would be governed by other law, including the Model Choice of Forum
Act (1968).
Cross Reference: Section 9-103(1)(c).
Definitional Cross Reference:
"Consumer lease". Section 2A-103(1)(e).
"Lease agreement". Section 2A-103(1)(k).
"Lessee". Section 2A-103(1)(n).
"Goods". Section 2A-103(1)(h).
"Party". Section 1-201(29).
Section 36-2A-107. WAIVER OR RENUNCIATION OF CLAIM
OR RIGHT AFTER DEFAULT.
Any claim or right arising out of an alleged default or breach of
warranty may be discharged in whole or in part without consideration by
a written waiver or renunciation signed and delivered by the aggrieved
party.
OFFICIAL COMMENT
Uniform Statutory Source: Section 1-107.
Changes: Revised to reflect leasing practices and terminology.
This clause is used throughout the official comments to this Article to
indicate the scope of change in the provisions of the Uniform Statutory
Source included in the section; these changes range from one extreme,
e.g., a significant difference in practice (a warranty as to
merchantability is not implied in a finance lease (Section 2A-212)) to the
other extreme, e.g., a modest difference in style or terminology
(the transaction governed is a lease not a sale (Section 2A-203)).
Cross References: Sections 2A-203 and 2A-212.
Definitional Cross References:
"Aggrieved party". Section 1-201(2).
"Delivery". Section 1-201(14).
"Rights". Section 1-201(36).
"Signed". Section 1-201(39).
"Written". Section 1-201(46).
Section 36-2A-108. UNCONSCIONABILITY.
(1) If the court as a matter of law finds a lease contract or any
clause of a lease contract to have been unconscionable at the time it was
made the court may refuse to enforce the lease contract, or it may
enforce the remainder of the lease contract without the unconscionable
clause, or it may so limit the application of any unconscionable clause
as to avoid any unconscionable result.
(2) With respect to a consumer lease, if the court as a matter of
law finds that a lease contract or any clause of a lease contract has been
induced by unconscionable conduct or that unconscionable conduct has
occurred in the collection of a claim arising from a lease contract, the
court may grant appropriate relief.
(3) Before making a finding of unconscionability under
subsection (1) or (2), the court, on its own motion or that of a party, shall
afford the parties a reasonable opportunity to present evidence as to the
setting, purpose, and effect of the lease contract or clause, or of the
conduct.
(4) In an action in which the lessee claims unconscionability with
respect to a consumer lease:
(a) If the court finds unconscionability under subsection (1) or
(2), the court shall award reasonable attorney's fees to the lessee.
(b) If the court does not find unconscionability and the lessee
claiming unconscionability has brought or maintained an action he knew
to be groundless, the court shall award reasonable attorney's fees to the
party against whom the claim is made.
(c) In determining attorney's fees, the amount of the recovery on
behalf of the claimant under subsections (1) and (2) is not controlling.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-302 and Unif. Consumer
Credit Code Section 5.108, 7A U.L.A. 167-69 (1974).
Changes: Subsection (1) is taken almost verbatim from the
provisions of Section 2-302(1). Subsection (2) is suggested by the
provisions of Unif. Consumer Credit Code Section 5.108(1), (2), 7A
U.L.A. 167 (1974). Subsection (3), taken from the provisions of Section
2-302(2), has been expanded to cover unconscionable conduct. Unif.
Consumer Credit Code Section 5.108(3), 7A U.L.A. 167 (1974). The
provision for the award of attorney's fees to consumers, subsection (4),
covers unconscionability under subsection (1) as well as (2). Subsection
(4) is modeled on the provisions of Unif. Consumer Credit Code
Section 5.108(6), 7A U.L.A. 169 (1974).
Purposes: Subsections (1) and (3) of this section apply the
concept of unconscionability reflected in the provisions of Section 2-302
to leases. See Dillman & Assocs. v. Capitol Leasing
Co., 110 Ill. App. 3d 335, 342, 442 N.E.2d 311, 316 (App. Ct.
1982). Subsection (3) omits the adjective "commercial"
found in subsection 2-302(2) because subsection (3) is concerned with
all leases and the relevant standard of conduct is determined by the
context.
The balance of the section is modeled on the provisions of Unif.
Consumer Credit Code Section 5.108, 7A U.L.A. 167-69 (1974). Thus
subsection (2) recognizes that a consumer lease or a clause in a
consumer lease may not itself be unconscionable but that the agreement
would never have been entered into if unconscionable means had not
been employed to induce the consumer to agree. To make a statement
to induce the consumer to lease the goods, in the expectation of invoking
an integration clause in the lease to exclude the statement's admissibility
in a subsequent dispute, may be unconscionable. Subsection (2) also
provides a consumer remedy for unconscionable conduct, such as using
or threatening to use force or violence, in the collection of a claim
arising from a lease contract. These provisions are not exclusive. The
remedies of this section are in addition to remedies otherwise available
for the same conduct under other law, for example, an action in tort for
abusive debt collection or under another statute of this State for such
conduct. The reference to appropriate relief in subsection (2) is intended
to foster liberal administration of this remedy. Sections 2A-103(4) and
1-106(1).
Subsection (4) authorizes an award of reasonable attorney's fees if
the court finds unconscionability with respect to a consumer lease under
subsections (1) or (2). Provision is also made for recovery by the party
against whom the claim was made if the court does not find
unconscionability and does find that the consumer knew the action to be
groundless. Further, subsection (4)(b) is independent of, and thus will
not override, a term in the lease agreement that provides for the payment
of attorney's fees.
Cross References: Sections 1-106(1), 2-302 and 2A-103(4).
Definitional Cross Reference:
"Action". Section 1-201(1).
"Consumer lease". Section 2A-103(1)(e).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Party". Section 1-201(29).
Section 36-2A-109. OPTION TO ACCELERATE AT WILL.
(1) A term providing that one party or his successor in interest may
accelerate payment or performance or require collateral or additional
collateral `at will' or `when he deems himself insecure' or in words of
similar import must be construed to mean that he has power to do so
only if he in good faith believes that the prospect of payment or
performance is impaired.
(2) With respect to a consumer lease, the burden of establishing
good faith under subsection (1) is on the party who exercised the power;
otherwise the burden of establishing lack of good faith is on the party
against whom the power has been exercised.
OFFICIAL COMMENT
Uniform Statutory Source: Section 1-208 and Unif. Consumer
Credit Code Section 5.109(2), 7A U.L.A. 171 (1974).
Purposes: Subsection (1) reflects modest changes in style to
the provisions of the first sentence of Section 1-208.
Subsection (2), however, reflects a significant change in the
provisions of the second sentence of Section 1-208 by creating a new
rule with respect to a consumer lease. A lease provision allowing
acceleration at the will of the lessor or when the lessor deems itself
insecure is of critical importance to the lessee. In a consumer lease it is
a provision that is not usually agreed to by the parties but is usually
mandated by the lessor. Therefore, where its invocation depends not on
specific criteria but on the discretion of the lessor, its use should be
regulated to prevent abuse. Subsection (1) imposes a duty of good faith
upon its exercise. Subsection (2) shifts the burden of establishing good
faith to the lessor in the case of a consumer lease, but not otherwise.
Cross Reference: Section 1-208.
Definitional Cross Reference:
"Burden of establishing". Section 1-201(8).
"Consumer lease". Section 2A-103(1)(e).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Party". Section 1-201(29).
"Term". Section 1-201(42).
PART 2. FORMATION AND CONSTRUCTION OF
LEASE CONTRACT
Section 36-2A-201. STATUTE OF FRAUDS.
(1) A lease contract is not enforceable by way of action or defense
unless:
(a) the total payments to be made under the lease contract,
excluding payments for options to renew or buy, are less than $1,000;
or
(b) there is a writing, signed by the party against whom
enforcement is sought or by that party's authorized agent, sufficient to
indicate that a lease contract has been made between the parties and to
describe the goods leased and the lease term.
(2) Any description of leased goods or of the lease term is sufficient
and satisfies subsection (1)(b), whether or not it is specific, if it
reasonably identifies what is described.
(3) A writing is not insufficient because it omits or incorrectly states
a term agreed upon, but the lease contract is not enforceable under
subsection (1)(b) beyond the lease term and the quantity of goods shown
in the writing.
(4) A lease contract that does not satisfy the requirements of
subsection (1), but which is valid in other respects, is enforceable:
(a) if the goods are to be specially manufactured or obtained for
the lessee and are not suitable for lease or sale to others in the ordinary
course of the lessor's business, and the lessor, before notice of
repudiation is received and under circumstances that reasonably indicate
that the goods are for the lessee, has made either a substantial beginning
of their manufacture or commitments for their procurement;
(b) if the party against whom enforcement is sought admits in that
party's pleading, testimony or otherwise in court that a lease contract
was made, but the lease contract is not enforceable under this provision
beyond the quantity of goods admitted; or
(c) with respect to goods that have been received and accepted by
the lessee.
(5) The lease term under a lease contract referred to in subsection (4)
is:
(a) the term so specified if there is a writing signed by the party
against whom enforcement is sought or by that party's authorized agent
specifying the lease term;
(b) the term so admitted if the party against whom enforcement
is sought admits in that party's pleading, testimony, or otherwise in court
a lease term; or
(c) a reasonable lease term.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-201, 9-203(1) and 9-110.
Changes: This section is modeled on Section 2-201, with
changes to reflect the differences between a lease contract and a contract
for the sale of goods. In particular, subsection (1)(b) adds a requirement
that the writing "describe the goods leased and the lease
term", borrowing that concept, with revisions, from the provisions
of Section 9-203(1)(a). Subsection (2), relying on the statutory analogue
in Section 9-110, sets forth the minimum criterion for satisfying that
requirement.
Purposes: The changes in this section conform the provisions
of Section 2-201 to custom and usage in lease transactions. Section
2-201(2), stating a special rule between merchants, was not included in
this section as the number of such transactions involving leases, as
opposed to sales, was thought to be modest. Subsection (4) creates no
exception for transactions where payment has been made and accepted.
This represents a departure from the analogue, Section 2-201(3)(c). The
rationale for the departure is grounded in the distinction between sales
and leases. Unlike a buyer in a sales transaction, the lessee does not
tender payment in full for goods delivered, but only payment of rent for
one or more months. It was decided that, as a matter of policy, this act
of payment is not a sufficient substitute for the required memorandum.
Subsection (5) was needed to establish the criteria for supplying the
lease term if it is omitted, as the lease contract may still be enforceable
under subsection (4).
Cross References:
Sections 2-201, 9-110 and 9-203(1)(a).
Definitional Cross References:
"Action". Section 1-201(1).
"Agreed". Section 1-201(3).
"Buying". Section 2A-103(1)(a).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notice". Section 1-201(25).
"Party". Section 1-201(29).
"Sale". Section 2-106(1).
"Signed". Section 1-201(39).
"Term". Section 1-201(42).
"Writing". Section 1-201(46).
Section 36-2A-202. FINAL WRITTEN EXPRESSION: PAROL
OR EXTRINSIC EVIDENCE.
Terms with respect to which the confirmatory memoranda of the
parties agree or which are set forth in a writing intended by the parties
as a final expression of their agreement with respect to such terms may
not be contradicted by evidence of any prior agreement or of a
contemporaneous oral agreement but may be explained or supplemented:
(a) by course of dealing or usage of trade or by course of
performance; and
(b) by evidence of consistent additional terms unless the court
finds the writing to have been intended also as a complete and exclusive
statement of the terms of the agreement.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-202.
Definitional Cross References:
"Agreement". Section 1-201(3).
"Course of dealing". Section 1-205.
"Party". Section 1-201(29).
"Term". Section 1-201(42).
"Usage of trade". Section 1-205.
"Writing". Section 1-201(46).
Section 36-2A-203. SEALS INOPERATIVE.
The affixing of a seal to a writing evidencing a lease contract or an
offer to enter into a lease contract does not render the writing a sealed
instrument and the law with respect to sealed instruments does not apply
to the lease contract or offer.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-203.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Lease contract". Section 2A-103(1)(l).
"Writing". Section 1-201(46).
Section 36-2A-204. FORMATION IN GENERAL.
(1) A lease contract may be made in any manner sufficient to show
agreement, including conduct by both parties which recognizes the
existence of a lease contract.
(2) An agreement sufficient to constitute a lease contract may be
found although the moment of its making is undetermined.
(3) Although one or more terms are left open, a lease contract does
not fail for indefiniteness if the parties have intended to make a lease
contract and there is a reasonably certain basis for giving an appropriate
remedy.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-204.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Agreement". Section 1-201(3).
"Lease contract". Section 2A-103(1)(l).
"Party". Section 1-201(29).
"Remedy". Section 1-201(34).
"Term". Section 1-201(42).
Section 36-2A-205. FIRM OFFERS.
An offer by a merchant to lease goods to or from another person in
a signed writing that by its terms gives assurance it will be held open is
not revocable, for lack of consideration, during the time stated or, if no
time is stated, for a reasonable time, but in no event may the period of
irrevocability exceed three months. Any term of assurance on a form
supplied by the offeree must be separately signed by the offeror.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-205.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Merchant". Section 2-104(1).
"Person". Section 1-201(30).
"Reasonable time". Section 1-204(1) and (2).
"Signed". Section 1-201(39).
"Term". Section 1-201(42).
"Writing". Section 1-201(46).
Section 36-2A-206. OFFER AND ACCEPTANCE IN
FORMATION OF LEASE CONTRACT.
(1) Unless otherwise unambiguously indicated by the language or
circumstances, an offer to make a lease contract must be construed as
inviting acceptance in any manner and by any medium reasonable in the
circumstances.
(2) If beginning a requested performance is a reasonable mode of
acceptance, an offeror who is not notified of acceptance within a
reasonable time may treat the offer as having lapsed before acceptance.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-206(1)(a) and (2).
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Lease contract". Section 2A-103(1)(l).
"Notifies". Section 1-201(26).
"Reasonable time". Section 1-204(1) and (2).
Section 36-2A-207. COURSE OF PERFORMANCE OR
PRACTICAL CONSTRUCTION.
(1) If a lease contract involves repeated occasions for performance
by either party with knowledge of the nature of the performance and
opportunity for objection to it by the other, any course of performance
accepted or acquiesced in without objection is relevant to determine the
meaning of the lease agreement.
(2) The express terms of a lease agreement and any course of
performance, as well as any course of dealing and usage of trade, must
be construed whenever reasonable as consistent with each other. If that
construction is unreasonable, express terms control course of
performance, course of performance controls both course of dealing and
usage of trade, and course of dealing controls usage of trade.
(3) Subject to the provisions of Section 36-2A-208 on modification
and waiver, course of performance is relevant to show a waiver or
modification of any term inconsistent with the course of performance.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-208 and 1-205(4).
Changes: Revised to reflect leasing practices and terminology,
except that subsection (2) was further revised to make the subsection
parallel the provisions of Section 1-205(4) by adding that course of
dealing controls usage of trade.
Purposes: The section should be read in conjunction with
Section 2A-208. In particular, although a specific term may control over
course of performance as a matter of lease construction under subsection
(2), subsection (3) allows the same course of dealing to show a waiver
or modification, if Section 2A-208 is satisfied.
Cross References: Sections 1-205(4), 2-208 and 2A-208.
Definitional Cross References:
"Course of dealing". Section 1-205.
"Knowledge". Section 1-201(25).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Party". Section 1-201(29).
"Term". Section 1-201(42).
"Usage of trade". Section 1-205.
Section 36-2A-208. MODIFICATION, RESCISSION AND
WAIVER.
(1) An agreement modifying a lease contract needs no consideration
to be binding.
(2) A signed lease agreement that excludes modification or
rescission except by a signed writing may not be modified or rescinded
otherwise, but, such a requirement on a form supplied by a merchant
must be separately signed by the other party, except as between
merchants.
(3) Although an attempt at modification or rescission does not
satisfy the requirements of subsection (2), it may operate as a waiver.
(4) A party who has made a waiver affecting an executory portion
of a lease contract may retract the waiver by reasonable notification
received by the other party that strict performance will be required of
any term waived, unless the retraction would be unjust in view of a
material change of position in reliance on the waiver.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-209.
Changes: Revised to reflect leasing practices and terminology,
except that the provisions of subsection 2-209(3) were omitted.
Purposes: Section 2-209(3) provides that "the
requirements of the statute of frauds section of this Article (Section
2-201) must be satisfied if the contract as modified is within its
provisions." This provision was not incorporated as it is unfair to
allow an oral modification to make the entire lease contract
unenforceable, e.g. if the modification takes it a few dollars over the
dollar limit. At the same time, the problem could not be solved by
providing that the lease contract would still be enforceable in its
pre-modification state (if it then satisfied the statute of frauds) since in
some cases that might be worse than no enforcement at all. Resolution
of the issue is left to the courts based on the facts of each case.
Cross References: Sections 2-201 and 2-209.
Definitional Cross References:
"Agreement". Section 1-201(3).
"Between merchants". Section 2-104(3).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Merchant". Section 2-104(1).
"Notification". Section 1-201(26).
"Party". Section 1-201(29).
"Signed". Section 1-201(39).
"Term". Section 1-201(42).
"Writing". Section 1-201(46).
Section 36-2A-209. LESSEE UNDER FINANCE LEASE AS
BENEFICIARY OF SUPPLY CONTRACT.
(1) The benefit of a supplier's promises to the lessor under the
supply contract and of all warranties, whether express or implied,
including those of any third party provided in connection with or as part
of the supply contract, extends to the lessee to the extent of the lessee's
leasehold interest under a finance lease related to the supply contract,
but is subject to the terms of the warranty and of the supply contract and
all defenses or claims arising therefrom.
(2) The extension of the benefit of a supplier's promises and of
warranties to the lessee (Section 36-2A-209(1)) does not: (i) modify the
rights and obligations of the parties to the supply contract, whether
arising from it or otherwise, or (ii) impose any duty or liability under the
supply contract on the lessee.
(3) Any modification or rescission of the supply contract by the
supplier and the lessor is effective between the supplier and the lessee
unless, before the modification or rescission, the supplier has received
notice that the lessee has entered into a finance lease related to the
supply contract. If the modification or rescission is effective between
the supplier and the lessee, the lessor is deemed to have assumed, in
addition to the obligations of the lessor to the lessee under the lease
contract, promises of the supplier to the lessor and warranties that were
so modified or rescinded as they existed and were available to the lessee
before modification or rescission.
(4) In addition to the extension of the benefit of the supplier's
promises and of warranties to the lessee under subsection (1), the lessee
retains all rights that the lessee may have against the supplier which
arise from an agreement between the lessee and the supplier or under
other law.
OFFICIAL COMMENT
Uniform Statutory Source: None.
Changes: This section is modeled on Section 9-318, the
Restatement (Second) of Contracts Section 302-315 (1981), and leasing
practices. See Earman Oil Co. v. Burroughs Corp., 625 F.2d
1291, 1296-97 (5th Cir. 1980).
Purposes: 1. The function performed by the lessor in a finance
lease is extremely limited. Section 2A-103(1)(g). The lessee looks to
the supplier of the goods for warranties and the like or, in some cases as
to warranties, to the manufacturer if a warranty made by that person is
passed on. That expectation is reflected in subsection (1), which is
self-executing. As a matter of policy, the operation of this provision
may not be excluded, modified or limited; however, an exclusion,
modification, or limitation of any term of the supply contract or
warranty, including any with respect to rights and remedies, and any
defense or claim such as a statute of limitations, effective against the
lessor as the acquiring party under the supply contract, is also effective
against the lessee as the beneficiary designated under this provision. For
example, the supplier is not precluded from excluding or modifying an
express or implied warranty under a supply contract. Sections 2-312(2)
and 2-316, or Section 2A-214. Further, the supplier is not precluded
from limiting the rights and remedies of the lessor and from liquidating
damages. Sections 2-718 and 2-719 or Sections 2A-503 and 2A-504.
If the supply contract excludes or modifies warranties, limits remedies
, or liquidates damages with respect to the lessor, such provisions are
enforceable against the lessee as beneficiary. Thus, only selective
discrimination against the beneficiaries designated under this section is
precluded, i.e., exclusion of the supplier's liability to the lessee with
respect to warranties made to the lessor. This section does not affect the
development of other law with respect to products liability.
2. Enforcement of this benefit is by action. Sections 2A-103(4) and
1-106(2).
3. The benefit extended by these provisions is not without a price,
as this Article also provides in the case of a finance lease that is not a
consumer lease that the lessee's promises to the lessor under the lease
contract become irrevocable and independent upon the lessee's
acceptance of the goods. Section 2A-407.
4. Subsection (2) limits the effect of subsection (1) on the supplier
and the lessor by preserving, notwithstanding the transfer of the benefits
of the supply contract to the lessee, all of the supplier's and the lessor's
rights and obligations with respect to each other and others; it further
absolves the lessee of any duties with respect to the supply contract that
might have been inferred from the extension of the benefits thereof.
5. Subsections (2) and (3) also deal with difficult issues related to
modification or rescission of the supply contract. Subsection (2) states
a rule that determines the impact of the statutory extension of benefit
contained in subsection (1) upon the relationship of the parties to the
supply contract and, in a limited respect, upon the lessee. This statutory
extension of benefit, like that contained in Sections 2A-216 and 2-318,
is not a modification of the supply contract by the parties. Thus,
subsection (3) states the rules that apply to a modification or rescission
of the supply contract by the parties. Subsection (3) provides that a
modification or rescission is not effective between the supplier and the
lessee if, before the modification or rescission occurs, the supplier
received notice that the lessee has entered into the finance lease. On the
other hand, if the modification or rescission is effective, then to the
extent of the modification or rescission of the benefit or warranty, the
lessor by statutory dictate assumes an obligation to provide to the lessee
that which the lessee would otherwise lose. For example, assume a
reduction in an express warranty from four years to one year. No
prejudice to the lessee may occur if the goods perform as agreed. If,
however, there is a breach of the express warranty after one year and
before four years pass, the lessor is liable. A remedy for any prejudice
to the lessee because of the bifurcation of the lessee's recourse resulting
from the action of the supplier and the lessor is left to resolution by the
courts based on the facts of each case.
6. Subsection (4) makes it clear that the rights granted to the lessee
by this section do not displace any rights the lessee otherwise may have
against the supplier.
Cross References: Sections 2A-103(1)(g), 2A-407 and
9-318.
Definitional Cross References:
"Action". Section 1-201(1).
"Finance lease". Section 2A-103(1)(g).
"Leasehold interest". Section 2A-103(1)(m).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notice". Section 1-201(25).
"Party". Section 1-201(29).
"Rights". Section 1-201(36).
"Supplier". Section 2A-103(1)(x).
"Supply contract". Section 2A-103(1)(y).
"Term". Section 1-201(42).
Section 36-2A-210. EXPRESS WARRANTIES.
(1) Express warranties by the lessor are created as follows:
(a) Any affirmation of fact or promise made by the lessor to the
lessee which relates to the goods and becomes part of the basis of the
bargain creates an express warranty that the goods will conform to the
affirmation or promise.
(b) Any description of the goods which is made part of the basis
of the bargain creates an express warranty that the goods will conform
to the description.
(c) Any sample or model that is made part of the basis of the
bargain creates an express warranty that the whole of the goods will
conform to the sample or model.
(2) It is not necessary to the creation of an express warranty that the
lessor use formal words, such as `warrant' or `guarantee,' or that the
lessor have a specific intention to make a warranty, but an affirmation
merely of the value of the goods or a statement purporting to be merely
the lessor's opinion or commendation of the goods does not create a
warranty.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-313.
Changes: Revised to reflect leasing practices and terminology.
Purposes: All of the express and implied warranties of the
Article on Sales (Article 2) are included in this Article, revised to reflect
the differences between a sale of goods and a lease of goods. Sections
2A-210 through 2A-216. The lease of goods is sufficiently similar to the
sale of goods to justify this decision. Hawkland, The Impact of the
Uniform Commercial Code on Equipment Leasing, 1972 Ill. L.F.
446, 459-60. Many state and federal courts have reached the same
conclusion.
Value of the goods, as used in subsection (2), includes rental value.
Cross References: Article 2, esp. Section 2-313, and
Sections 2A-210 through 2A-216.
Definitional Cross References:
"Conforming". Section 2A-103(1)(d).
"Goods". Section 2A-103(1)(h).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Value". Section 1-201(44).
Section 36-2A-211. WARRANTIES AGAINST INTERFERENCE
AND AGAINST INFRINGEMENT; LESSEE'S OBLIGATION
AGAINST INFRINGEMENT.
(1) There is in a lease contract a warranty that for the lease term no
person holds a claim to or interest in the goods that arose from an act or
omission of the lessor, other than a claim by way of infringement or the
like, which will interfere with the lessee's enjoyment of its leasehold
interest.
(2) Except in a finance lease there is in a lease contract by a lessor
who is a merchant regularly dealing in goods of the kind a warranty that
the goods are delivered free of the rightful claim of any person by way
of infringement or the like.
(3) A lessee who furnishes specifications to a lessor or a supplier
shall hold the lessor and the supplier harmless against any claim by way
of infringement or the like that arises out of compliance with the
specifications.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-312.
Changes: This section is modeled on the provisions of Section
2-312, with modifications to reflect the limited interest transferred by a
lease contract and the total interest transferred by a sale. Section
2-312(2), which is omitted here, is incorporated in Section 2A-214. The
warranty of quiet possession was abolished with respect to sales of
goods. Section 2-312 official comment 1. Section 2A-211(1) reinstates
the warranty of quiet possession with respect to leases. Inherent in the
nature of the limited interest transferred by the lease - the right to
possession and use of the goods - is the need of the lessee for protection
greater than that afforded to the buyer. Since the scope of the protection
is limited to claims or interests that arose from acts or omissions of the
lessor, the lessor will be in position to evaluate the potential cost,
certainly a far better position than that enjoyed by the lessee. Further,
to the extent the market will allow, the lessor can attempt to pass on the
anticipated additional cost to the lessee in the guise of higher rent.
Purposes: General language was chosen for subsection (1) that
expresses the essence of the lessee's expectation: with an exception for
infringement and the like, no person holding a claim or interest that
arose from an act or omission of the lessor will be able to interfere with
the lessee's use and enjoyment of the goods for the lease term.
Subsection (2), like other similar provisions in later sections, excludes
the finance lessor from extending this warranty; with few exceptions
(Sections 2A-210 and 2A-211(1)), the lessee under a finance lease is to
look to the supplier for warranties and the like or, in some cases as to
warranties, to the manufacturer if a warranty made by that person is
passed on. Subsections (2) and (3) are derived from Section 2-312(3).
These subsections, as well as the analogue, should be construed so that
applicable principles of law and equity supplement their provisions.
Sections 2A-103(4) and 1-103.
Cross References: Sections 2-312, 2-312(1), 2-312(2), 2-312
official comment 1, 2A-210, 2A-211(1) and 2A-214.
Definitional Cross References:
"Delivery". Section 1-201(14).
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Leasehold interest". Section 2A-103(1)(m).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Merchant". Section 2-104(1).
"Person". Section 1-201(30).
"Supplier". Section 2A-103(1)(x).
Section 36-2A-212. IMPLIED WARRANTY OF
MERCHANTABILITY.
(1) Except in a finance lease, a warranty that the goods will be
merchantable is implied in a lease contract if the lessor is a merchant
with respect to goods of that kind.
(2) Goods to be merchantable must at least:
(a) pass without objection in the trade under the description in the
lease agreement;
(b) in the case of fungible goods, be of fair average quality within
the description;
(c) be fit for the ordinary purposes for which goods of that type
are used;
(d) run, within the variation permitted by the lease agreement, of
even kind, quality, and quantity within each unit and among all units
involved;
(e) be adequately contained, packaged, and labeled as the lease
agreement may require; and
(f) conform to any promises or affirmations of fact made on the
container or label.
(3) Other implied warranties may arise from course of dealing or
usage of trade.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-314.
Changes: Revised to reflect leasing practices and terminology.
E.g., Glenn Dick Equip. Co. v. Galey Constr., Inc., 97 Idaho
216, 225, 541 P.2d 1184, 1193 (1975) (implied warranty of
merchantability (Article 2) extends to lease transactions).
Definitional Cross References:
"Conforming". Section 2A-103(1)(d).
"Course of dealing". Section 1-205.
"Finance lease". Section 2A-103(1)(g).
"Fungible". Section 1-201(17).
"Goods". Section 2A-103(1)(h).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessor". Section 2A-103(1)(p).
"Merchant". Section 2-104(1).
"Usage of trade". Section 1-205.
Section 36-2A-213. IMPLIED WARRANTY OF FITNESS FOR
PARTICULAR PURPOSE.
Except in a finance lease, if the lessor at the time the lease contract
is made has reason to know of any particular purpose for which the
goods are required and that the lessee is relying on the lessor's skill or
judgment to select or furnish suitable goods, there is in the lease contract
an implied warranty that the goods will be fit for that purpose.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-315.
Changes: Revised to reflect leasing practices and terminology.
E.g., All-States Leasing Co. v. Bass, 96 Idaho 873,
879, 538 P.2d 1177, 1183 (1975) (implied warranty of fitness for a
particular purpose (Article 2) extends to lease transactions).
Definitional Cross References:
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Knows". Section 1-201(25).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
Section 36-2A-214. EXCLUSION OR MODIFICATION OF
WARRANTIES.
(1) Words or conduct relevant to the creation of an express warranty
and words or conduct tending to negate or limit a warranty must be
construed wherever reasonable as consistent with each other; but,
subject to the provisions of Section 36-2A-202 on parol or extrinsic
evidence, negation or limitation is inoperative to the extent that the
construction is unreasonable.
(2) Subject to subsection (3), to exclude or modify the implied
warranty of merchantability or any part of it the language must mention
`merchantability', be in writing, and be conspicuous. Subject to
subsection (3), to exclude or modify any implied warranty of fitness the
exclusion must be in writing and be conspicuous. Language to exclude
all implied warranties of fitness is sufficient if it is in writing, is
conspicuous and states, for example, `There is no warranty that the
goods will be fit for a particular purpose'.
(3) Notwithstanding subsection (2), but subject to subsection (4),
(a) unless the circumstances indicate otherwise, all implied
warranties are excluded by expressions like `as is', or `with all faults', or
by other language that in common understanding calls the lessee's
attention to the exclusion of warranties and makes plain that there is no
implied warranty, if in writing and conspicuous;
(b) if the lessee before entering into the lease contract has
examined the goods or the sample or model as fully as desired or has
refused to examine the goods, there is no implied warranty with regard
to defects that an examination ought in the circumstances to have
revealed; and
(c) an implied warranty may also be excluded or modified by
course of dealing, course of performance, or usage of trade.
(4) To exclude or modify a warranty against interference or against
infringement (Section 36-2A-211) or any part of it, the language must
be specific, be in writing, and be conspicuous, unless the circumstances,
including course of performance, course of dealing, or usage of trade,
give the lessee reason to know that the goods are being leased subject to
a claim or interest of any person.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-316 and 2-312(2).
Changes: Subsection (2) requires that a disclaimer of the
warranty of merchantability be conspicuous and in writing as is the case
for a disclaimer of the warranty of fitness; this is contrary to the rule
stated in Section 2-316(2) with respect to the disclaimer of the warranty
of merchantability. This section also provides that to exclude or modify
the implied warranty of merchantability, fitness or against interference
or infringement the language must be in writing and conspicuous. There
are, however, exceptions to the rule. E.g., course of dealing, course of
performance, or usage of trade may exclude or modify an implied
warranty. Section 2A-214(3)(c). The analogue of Section 2-312(2) has
been moved to subsection (4) of this section for a more unified treatment
of disclaimers; there is no policy with respect to leases of goods that
would justify continuing certain distinctions found in the Article on
Sales (Article 2) regarding the treatment of the disclaimer of various
warranties. Compare Sections 2-312(2) and 2-316(2). Finally, the
example of a disclaimer of the implied warranty of fitness stated in
subsection (2) differs from the analogue stated in Section 2-316(2); this
example should promote a better understanding of the effect of the
disclaimer.
Purposes: These changes were made to reflect leasing
practices. E.g., FMC Finance Corp. v. Murphree, 632 F.2d 413,
418 (5th Cir. 1980) (disclaimer of implied warranty under lease
transactions must be conspicuous and in writing). The omission of the
provisions of Section 2-316(4) was not substantive. Sections 2A-503
and 2A-504.
Cross References: Article 2, esp. Sections 2-312(2) and
2-316, and Sections 2A-503 and 2A-504.
Definitional Cross References:
"Conspicuous". Section 1-201(10).
"Course of dealing". Section 1-205.
"Fault". Section 2A-103(1)(f).
"Goods". Section 2A-103(1)(h).
"Knows". Section 1-201(25).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Person". Section 1-201(30).
"Usage of trade". Section 1-205.
"Writing". Section 1-201(46).
Section 36-2A-215. CUMULATION AND CONFLICT OF
WARRANTIES EXPRESS OR IMPLIED.
Warranties, whether express or implied, must be construed as
consistent with each other and as cumulative, but if that construction is
unreasonable, the intention of the parties determines which warranty is
dominant. In ascertaining that intention the following rules apply:
(a) Exact or technical specifications displace an inconsistent sample
or model or general language of description.
(b) A sample from an existing bulk displaces inconsistent general
language of description.
(c) Express warranties displace inconsistent implied warranties other
than an implied warranty of fitness for a particular purpose.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-317.
Definitional Cross Reference:
"Party". Section 1-201(29).
36-2A-216. THIRD-PARTY BENEFICIARIES OF EXPRESS AND
IMPLIED WARRANTIES.
A warranty to or for the benefit of a lessee under this chapter,
whether express or implied, extends to any natural person who may
reasonably be expected to use, consume, or be affected by the goods and
who is injured in person by breach of the warranty. This section does
not displace principles of law and equity that extend a warranty to or for
the benefit of a lessee to other persons. The operation of this section
may not be excluded, modified, or limited, but an exclusion,
modification, or limitation of the warranty, including any with respect
to rights and remedies, effective against the lessee is also effective
against the beneficiary designated under this section.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-318.
Changes: The provisions of Section 2-318 have been included
in this section, modified in two respects: first, to reflect leasing practice,
including the special practices of the lessor under a finance lease;
second, to reflect and thus codify elements of the official comment to
Section 2-318 with respect to the effect of disclaimers and limitations of
remedies against third parties.
Purposes: This section is based on later additions to Section
2-318 and is more favorable to the injured person.
The last sentence does not preclude the lessor from excluding or
modifying an express or implied warranty under a lease. Section
2A-214. Further, that sentence does not preclude the lessor from
limiting the rights and remedies of the lessee and from liquidating
damages. Sections 2A-503 and 2A-504. If the lease excludes or
modifies warranties, limits remedies for breach, or liquidates damages
with respect to the lessee, such provisions are enforceable against the
beneficiaries designated under this section. However, this last sentence
forbids selective discrimination against the beneficiaries designated
under this section, i.e., exclusion of the lessor's liability to the
beneficiaries with respect to warranties made by the lessor to the lessee.
Other law, including the Article on Sales
(Article 2), may apply in determining the extent to which a warranty to
or for the benefit of the lessor extends to the lessee and third parties.
This is in part a function of whether the lessor has bought or leased the
goods.
This Article does not purport to change the development of the
relationship of the common law, with respect to products liability,
including strict liability in tort (as restated in Restatement (Second) of
Torts, 402A (1965)), to the provisions of this Act. Compare
Cline v. Prowler Indus. of Maryland, 418 A.2d 968 (Del. 1980)
and Hawkins Constr. Co. v. Matthews Co., 190 Neb.
546, 209 N.W.2d 643 (1973) with Dippel v. Sciano, 37
Wis. 2d 443, 155 N.W.2d 55 (1967).
Cross References: Article 2, esp. Section 2-318, and
Sections 2A-214, 2A-503 and 2A-504.
Definitional Cross References:
"Goods". Section 2A-103(1)(h).
"Lessee". Section 2A-103(1)(n).
"Person". Section 1-201(30).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
Section 36-2A-217. IDENTIFICATION. Identification of goods
as goods to which a lease contract refers may be made at any time and
in any manner explicitly agreed to by the parties. In the absence of
explicit agreement, identification occurs:
(a) when the lease contract is made if it is for goods that are existing
and identified;
(b) when the goods are shipped, marked, or otherwise designated by
the lessor as goods to which the lease contract refers, if the lease
contract is for goods that are not existing and identified; or
(c) when the young are conceived, if the lease contract is for a lease
of unborn young of animals.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-501.
Changes: This section, together with Section 2A-218, is
derived from the provisions of Section 2-501, with changes to reflect
lease terminology; however, this section omits as irrelevant to leasing
practice the treatment of special property.
Purposes: With respect to subsection (b) there is a certain
amount of ambiguity in the reference to when goods are designated, e.g.,
when the lessor is both selling and leasing goods to the same
lessee/buyer and has marked goods for delivery but has not
distinguished between those related to the lease contract and those
related to the sales contract. As in Section 2-501(1)(b), this issue has
been left to be resolved by the courts, case by case.
Cross References: Sections 2-501 and 2A-218.
Definitional Cross References:
"Agreement". Section 1-201(3).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Lessor". Section 2A-103(1)(p).
"Party". Section 1-201(29).
Section 36-2A-218. INSURANCE AND PROCEEDS.
(1) A lessee obtains an insurable interest when existing goods are
identified to the lease contract even though the goods identified are
nonconforming and the lessee has an option to reject them.
(2) If a lessee has an insurable interest only by reason of the lessor's
identification of the goods, the lessor, until default or insolvency or
notification to the lessee that identification is final, may substitute other
goods for those identified.
(3) Notwithstanding a lessee's insurable interest under subsections
(1) and (2), the lessor retains an insurable interest until an option to buy
has been exercised by the lessee and risk of loss has passed to the lessee.
(4) Nothing in this section impairs any insurable interest recognized
under any other statute or rule of law.
(5) The parties by agreement may determine that one or more parties
have an obligation to obtain and pay for insurance covering the goods
and by agreement may determine the beneficiary of the proceeds of the
insurance.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-501.
Changes: This section, together with Section 2A-217, is
derived from the provisions of Section 2-501, with changes and
additions to reflect leasing practices and terminology.
Purposes: Subsection (2) states a rule allowing substitution of
goods by the lessor under certain circumstances, until default or
insolvency of the lessor, or until notification to the lessee that
identification is final. Subsection (3) states a rule regarding the lessor's
insurable interest that, by virtue of the difference between a sale and a
lease, necessarily is different from the rule stated in Section 2-501(2)
regarding the seller's insurable interest. For this purpose the option to
buy shall be deemed to have been exercised by the lessee when the
resulting sale is closed, not when the lessee gives notice to the lessor.
Further, subsection (5) is new and reflects the common practice of
shifting the responsibility and cost of insuring the goods between the
parties to the lease transaction.
Cross References: Sections 2-501, 2-501(2) and 2A-217.
Definitional Cross References:
"Agreement". Section 1-201(3).
"Buying". Section 2A-103(1)(a).
"Conforming". Section 2A-103(1)(d).
"Goods". Section 2A-103(1)(h).
"Insolvent". Section 1-201(23).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notification". Section 1-201(26).
"Party". Section 1-201(29).
Section 36-2A-219. RISK OF LOSS.
(1) Except in the case of a finance lease, risk of loss is retained by
the lessor and does not pass to the lessee. In the case of a finance lease,
risk of loss passes to the lessee.
(2) Subject to the provisions of this chapter on the effect of default
on risk of loss (Section 36-2A-220), if risk of loss is to pass to the lessee
and the time of passage is not stated, the following rules apply:
(a) If the lease contract requires or authorizes the goods to be
shipped by carrier
(i) and it does not require delivery at a particular destination,
the risk of loss passes to the lessee when the goods are duly delivered to
the carrier; but
(ii) if it does require delivery at a particular destination and the
goods are there duly tendered while in the possession of the carrier, the
risk of loss passes to the lessee when the goods are there duly so
tendered as to enable the lessee to take delivery.
(b) If the goods are held by a bailee to be delivered without being
moved, the risk of loss passes to the lessee on acknowledgment by the
bailee of the lessee's right to possession of the goods.
(c) In any case not within subsection (a) or (b), the risk of loss
passes to the lessee on the lessee's receipt of the goods if the lessor, or,
in the case of a finance lease, the supplier, is a merchant; otherwise the
risk passes to the lessee on tender of delivery.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-509(1) through (3).
Changes: Subsection (1) is new. The introduction to
subsection (2) is new, but subparagraph (a) incorporates the provisions
of Section 2-509(1); subparagraph (b) incorporates the provisions of
Section 2-509(2) only in part, reflecting current practice in lease
transactions.
Purposes: Subsection (1) states rules related to retention or
passage of risk of loss consistent with current practice in lease
transactions. The provisions of subsection (4) of Section 2-509 are not
incorporated as they are not necessary. This section does not deal with
responsibility for loss caused by the wrongful act of either the lessor or
the lessee.
Cross References: Sections 2-509(1), 2-509(2) and 2-509(4).
Definitional Cross References:
"Delivery". Section 1-201(14).
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Merchant". Section 2-104(1).
"Receipt". Section 2-103(1)(c).
"Rights". Section 1-201(36).
"Supplier". Section 2A-103(1)(x).
Section 36-2A-220. EFFECT OF DEFAULT ON RISK OF LOSS.
(1) Where risk of loss is to pass to the lessee and the time of passage
is not stated:
(a) If a tender or delivery of goods so fails to conform to the
lease contract as to give a right of rejection, the risk of their loss remains
with the lessor, or, in the case of a finance lease, the supplier, until cure
or acceptance.
(b) If the lessee rightfully revokes acceptance, he may treat the
risk of loss as having remained with the lessor from the beginning to the
extent of any deficiency in his effective insurance coverage.
(2) Whether or not risk of loss is to pass to the lessee, if the lessee
as to conforming goods already identified to a lease contract repudiates
or is otherwise in default under the lease contract, the lessor, or, in the
case of a finance lease, the supplier, to the extent of any deficiency in his
effective insurance coverage may treat the risk of loss as resting on the
lessee for a commercially reasonable time.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-510.
Changes: Revised to reflect leasing practices and terminology.
The rule in Section (1)(b) does not allow the lessee under a finance lease
to treat the risk of loss as having remained with the supplier from the
beginning. This is appropriate given the limited circumstances under
which the lessee under a finance lease is allowed to revoke acceptance.
Section 2A-517 and Section 2A-516 official comment.
Definitional Cross References:
"Conforming". Section 2A-103(1)(d).
"Delivery". Section 1-201(14).
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Reasonable time". Section 1-204(1) and (2).
"Rights". Section 1-201(36).
"Supplier". Section 2A-103(1)(x).
Section 36-2A-221. CASUALTY TO IDENTIFIED GOODS.
If a lease contract requires goods identified when the lease contract
is made, and the goods suffer casualty without fault of the lessee, the
lessor or the supplier before delivery, or the goods suffer casualty before
risk of loss passes to the lessee pursuant to the lease agreement or
Section 36-2A-219, then:
(a) if the loss is total, the lease contract is avoided; and
(b) if the loss is partial or the goods have so deteriorated as to no
longer conform to the lease contract, the lessee may nevertheless
demand inspection and at his option either treat the lease contract as
avoided or, except in a finance lease that is not a consumer lease, accept
the goods with due allowance from the rent payable for the balance of
the lease term for the deterioration or the deficiency in quantity but
without further right against the lessor.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-613.
Changes: Revised to reflect leasing practices and terminology.
Purposes: Due to the vagaries of determining the amount of
due allowance (Section 2-613(b)), no attempt was made in subsection
(b) to treat a problem unique to lease contracts and installment sales
contracts: determining how to recapture the allowance, e.g., application
to the first or last rent payments or allocation, pro rata, to all rent
payments.
Cross References: Section 2-613.
Definitional Cross References:
"Conforming". Section 2A-103(1)(d).
"Consumer lease". Section 2A-103(1)(e).
"Delivery". Section 1-201(14).
"Fault". Section 2A-103(1)(f).
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Rights". Section 1-201(36).
"Supplier". Section 2A-103(1)(x).
PART 3. EFFECT OF LEASE CONTRACT
Section 36-2A-301. ENFORCEABILITY OF LEASE CONTRACT.
Except as otherwise provided in this chapter, a lease contract is
effective and enforceable according to its terms between the parties,
against purchasers of the goods, and against creditors of the parties.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-201.
Changes: The first sentence of Section 9-201 was incorporated,
modified to reflect leasing terminology. The second sentence of Section
9-201 was eliminated as not relevant to leasing practices.
Purposes: 1. This section establishes a general rule regarding
the validity and enforceability of a lease contract. The lease contract is
effective and enforceable between the parties and against third parties.
Exceptions to this general rule arise where there is a specific rule to the
contrary in this Article. Enforceability is, thus, dependent upon the lease
contract meeting the requirements of the Statute of Frauds provisions of
Section 2A-201. Enforceability is also a function of the lease contract
conforming to the principles of construction and interpretation contained
in the Article on General Provisions (Article 1). Section 2A-103(4).
2. The effectiveness or enforceability of the lease contract is not
dependent upon the lease contract or any financing statement or the like
being filed or recorded; however, the priority of the interest of a lessor
of fixtures with respect to the interests of certain third parties in such
fixtures is subject to the provisions of the Article on Secured
Transactions (Article 9). Section 2A-309. Prior to the adoption of this
Article filing or recording was not required with respect to leases, only
leases intended as security. The definition of security interest, as
amended concurrently with the adoption of this Article, more clearly
delineates leases and leases intended as security and thus signals the
need to file. Section 1-201(37). Those lessors who are concerned about
whether the transaction creates a lease or a security interest will continue
to file a protective financing statement. Section 9-408. Coogan,
Leasing and the Uniform Commercial Code, in Equipment
Leasing-Leveraged Leasing 681, 744-46 (2d ed. 1980).
3. Hypothetical:
(a) In construing this section it is important to recognize its
relationship to other sections in this Article. This is best demonstrated
by reference to a hypothetical. Assume that on February 1 A, a
manufacturer of combines and other farm equipment, leased a fleet of
six combines to B, a corporation engaged in the business of farming, for
a 12 month term. Under the lease agreement between A and B, A agreed
to defer B's payment of the first two months' rent to April 1. On March
1 B recognized that it would need only four combines and thus
subleased two combines to C for an 11 month term.
(b) This hypothetical raises a number of issues that are answered
by the sections contained in this part. Since lease is defined to include
sublease (Section 2A-103(1)(j) and (w)), this section provides that the
prime lease between A and B and the sublease between B and C are
enforceable in accordance with their terms, except as otherwise provided
in this Article; that exception, in this case, is one of considerable scope.
(c) The separation of ownership, which is in A, and possession,
which is in B with respect to four combines and which is in C with
respect to two combines, is not relevant. Section 2A-302. A's interest
in the six combines cannot be challenged simply because A parted with
possession to B, who in turn parted with possession of some of the
combines to C. Yet it is important to note that by the terms of Section
2A-302 this conclusion is subject to change if otherwise provided in this
Article.
(d) B's entering the sublease with C raises an issue that is treated
by this part. In a dispute over the leased combines A may challenge B's
right to sublease. The rule is permissive as to transfers of interests
under a lease contract, including subleases. Section 2A-303(2).
However, the rule has two significant qualifications. If the prime lease
contract between A and B prohibits B from subleasing the combines, or
makes such a sublease an event of default, Section 2A-303(2) applies;
thus, while B's interest under the prime lease may be transferred under
the sublease to C, A may have a remedy pursuant to Section 2A-303(5).
Absent a prohibition or default provision in the prime lease contract A
might be able to argue that the sublease to C materially increases A's
risk; thus, while B's interest under the prime lease may be transferred
under the sublease to C, A may have a remedy pursuant to
Section 2A-303(5). Section 2A-303(5)(b)(ii).
(e) Resolution of this issue is also a function of the section dealing
with the sublease of goods by a prime lessee (Section 2A-305).
Subsection (1) of Section 2A-305, which is subject to the rules of
Section 2A-303 stated above, provides that C takes subject to the interest
of A under the prime lease between A and B. However, there are two
exceptions. First, if B is a merchant (Sections 2A-103(3) and 2-104(1))
dealing in goods of that kind and C is a sublessee in the ordinary course
of business (Sections 2A-103(1)(o) and 2A-103(1)(n)), C takes free of
the prime lease between A and B. Second, if B has rejected the six
combines under the prime lease with A, and B disposes of the goods by
sublease to C, C takes free of the prime lease if C can establish good
faith. Section 2A-511(4).
(f) If the facts of this hypothetical are expanded and we assume that
the prime lease obligated B to maintain the combines, an additional issue
may be presented. Prior to entering the sublease, B, in satisfaction of its
maintenance covenant, brought the two combines that it desired to
sublease to a local independent dealer of A's. The dealer did the
requested work for B. C inspected the combines on the dealer's lot after
the work was completed. C signed the sublease with B two days later.
C, however, was prevented from taking delivery of the two combines as
B refused to pay the dealer's invoice for the repairs. The dealer
furnished the repair service to B in the ordinary course of the dealer's
business. If under applicable law the dealer has a lien on repaired goods
in the dealer's possession, the dealer's lien will take priority over B's and
C's interests, and also should take priority over A's interest, depending
upon the terms of the lease contract and the applicable law.
Section 2A-306.
(g) Now assume that C is in financial straits and one of C's creditors
obtains a judgment against C. If the creditor levies on C's subleasehold
interest in the two combines, who will prevail? Unless the levying
creditor also holds a lien covered by Section 2A-306, discussed above,
the judgment creditor will take its interest subject to B's rights under the
sublease and A's rights under the prime lease. Section 2A-307(1). The
hypothetical becomes more complicated if we assume that B is in
financial straits and B's creditor holds the judgment. Here the judgment
creditor takes subject to the sublease unless the lien attached to the two
combines before the sublease contract became enforceable. Section
2A-307(2)(a). However, B's judgment creditor cannot prime A's interest
in the goods because, with respect to A, the judgment creditor is a
creditor of B in its capacity as lessee under the prime lease between A
and B. Thus, here the judgment creditor's interest is subject to the lease
between A and B. Section 2A-307(1).
(h) Finally, assume that on April 1 B is unable to pay A the deferred
rent then due under the prime lease, but that C is current in its payments
under the sublease from B. What effect will B's default under the prime
lease between A and B have on C's rights under the sublease between B
and C? Section 2A-301 provides that a lease contract is effective against
the creditors of either party. Since a lease contract includes a sublease
contract (Section 2A-103(1)(l)), the sublease contract between B and C
arguably could be enforceable against A, a prime lessor who has
extended unsecured credit to B, the prime lessee/sublessor, if the
sublease contract meets the requirements of Section 2A-201. However,
the rule stated in Section 2A-301 is subject to other provisions in this
Article. Under Section 2A-305, C, as sublessee, would take subject to
the prime lease contract in most cases. Thus, B's default under the prime
lease will in most cases lead to A's recovery of the goods from C.
Section 2A-523. A and C could provide otherwise by agreement.
Section 2A-311. C's recourse will be to assert a claim for damages
against B. Sections 2A-211(1) and 2A-508.
4. Relationship Between Sections:
(a) As the analysis of the hypothetical demonstrates, Part 3 of the
Article focuses on issues that relate to the enforceability of the lease
contract (Sections 2A-301, 2A-302 and 2A-303) and to the priority of
various claims to the goods subject to the lease contract (Sections
2A-304, 2A-305, 2A-306, 2A-307, 2A-308, 2A-309, 2A-310, and
2A-311).
(b) This section states a general rule of enforceability, which is
subject to specific rules to the contrary stated elsewhere in the Article.
Section 2A-302 negates any notion that the separation of title and
possession is fraudulent as a rule of law. Finally, Section 2A-303 states
rules with respect to the transfer of the lessor's interest (as well as the
residual interest in the goods) or the lessee's interest under the lease
contract. Qualifications are imposed as a function of various issues,
including whether the transfer is the creation or enforcement of a
security interest or one that is material to the other party to the lease
contract. In addition, a system of rules is created to deal with the rights
and duties among assignor, assignee and the other party to the lease
contract.
(c) Sections 2A-304 and 2A-305 are twins that deal with good faith
transferees of goods subject to the lease contract. Section 2A-304
creates a set of rules with respect to transfers by the lessor of goods
subject to a lease contract; the transferee considered is a subsequent
lessee of the goods. The priority dispute covered here is between the
subsequent lessee and the original lessee of the goods (or persons
claiming through the original lessee). Section 2A-305 creates a set of
rules with respect to transfers by the lessee of goods subject to a lease
contract; the transferees considered are buyers of the goods or sublessees
of the goods. The priority dispute covered here is between the transferee
and the lessor of the goods (or persons claiming through the lessor).
(d) Section 2A-306 creates a rule with respect to priority disputes
between holders of liens for services or materials furnished with respect
to goods subject to a lease contract and the lessor or the lessee under that
contract. Section 2A-307 creates a rule with respect to priority disputes
between the lessee and creditors of the lessor and priority disputes
between the lessor and creditors of the lessee.
(e) Section 2A-308 creates a series of rules relating to allegedly
fraudulent transfers and preferences. The most significant rule is that set
forth in subsection (3) which validates sale-leaseback transactions if the
buyer-lessor can establish that he or she bought for value and in good
faith.
(f) Sections 2A-309 and 2A-310 create a series of rules with respect
to priority disputes between various third parties and a lessor of fixtures
or accessions, respectively, with respect thereto.
(g) Finally, Section 2A-311 allows parties to alter the statutory
priorities by agreement.
Cross References: Article 1, especially Section 1-201(37),
and Sections 2-104(1), 2A-103(1)(j), 2A-103(1)(l), 2A-103(1)(n),
2A-103(1)(o) and 2A-103(1)(w), 2A-103(3), 2A-103(4), 2A-201,
2A-301 through 2A-303, 2A-303(2), 2A-303(5), 2A-304 through
2A-307, 2A-307(1), 2A-307(2)(a), 2A-308 through 2A-311, 2A-508,
2A-511(4), 2A-523, Article 9, especially Sections 9-201 and 9-408.
Definitional Cross References:
"Creditor". Section 1-201(12).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Party". Section 1-201(29).
"Purchaser". Section 1-201(33).
"Term". Section 1-201(42).
Section 36-2A-302. TITLE TO AND POSSESSION OF GOODS.
Except as otherwise provided in this chapter, each provision of this
chapter applies whether the lessor or a third party has title to the goods,
and whether the lessor, the lessee, or a third party has possession of the
goods, notwithstanding any statute or rule of law that possession or the
absence of possession is fraudulent.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-202.
Changes: Section 9-202 was modified to reflect leasing
terminology and to clarify the law of leases with respect to fraudulent
conveyances or transfers.
Purposes: The separation of ownership and possession of
goods between the lessor and the lessee (or a third party) has created
problems under certain fraudulent conveyance statutes. See,
e.g., In re Ludlum Enters., 510 F.2d 996 (5th Cir.
1975); Suburbia Fed. Sav. & Loan Ass'n v. Bel-Air
Conditioning Co., 385 So. 2d 1151 (Fla. Dist. Ct. App. 1980). This
section provides, among other things, that separation of ownership and
possession per se does not affect the enforceability of
the lease contract. Sections 2A-301 and 2A-308.
Cross References: Sections 2A-301, 2A-308 and 9-202.
Definitional Cross References:
"Goods". Section 2A-103(1)(h).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
Section 36-2A-303. ALIENABILITY OF PARTY'S INTEREST
UNDER LEASE CONTRACT OR OF LESSOR'S RESIDUAL
INTEREST IN GOODS; DELEGATION OF PERFORMANCE;
TRANSFER OF RIGHTS.
(1) As used in this section, `creation of a security interest'
includes the sale of a lease contract that is subject to Article 9, Secured
Transactions, by reason of Section 36-9-102(1)(b).
(2) Except as provided in subsections (3) and (4), a provision in
a lease agreement which (i) prohibits the voluntary or involuntary
transfer, including a transfer by sale, sublease, creation, or enforcement
of a security interest, or attachment, levy, or other judicial process, of an
interest of a party under the lease contract or of the lessor's residual
interest in the goods, or (ii) makes such a transfer an event of default,
gives rise to the rights and remedies provided in subsection (5), but a
transfer that is prohibited or is an event of default under the lease
agreement is otherwise effective.
(3) A provision in a lease agreement which (i) prohibits the
creation or enforcement of a security interest in an interest of a party
under the lease contract or in the lessor's residual interest in the goods,
or (ii) makes such a transfer an event of default, is not enforceable
unless, and then only to the extent that, there is an actual transfer by the
lessee of the lessee's right of possession or use of the goods in violation
of the provision or an actual delegation of a material performance of
either party to the lease contract in violation of the provision. Neither
the granting nor the enforcement of a security interest in (i) the lessor's
interest under the lease contract or (ii) the lessor's residual interest in the
goods is a transfer that materially impairs the prospect of obtaining
return performance by, materially changes the duty of, or materially
increases the burden or risk imposed on, the lessee within the purview
of subsection (5) unless, and then only to the extent that, there is an
actual delegation of a material performance of the lessor.
(4) A provision in a lease agreement which (i) prohibits a transfer
of a right to damages for default with respect to the whole lease contract
or of a right to payment arising out of the transferor's due performance
of the transferor's entire obligation, or (ii) makes such a transfer an event
of default, is not enforceable, and such a transfer is not a transfer that
materially impairs the prospect of obtaining return performance by,
materially changes the duty of, or materially increases the burden or risk
imposed on, the other party to the lease contract within the purview of
subsection (5).
(5) Subject to subsections (3) and (4):
(a) if a transfer is made which is made an event of default under
a lease agreement, the party to the lease contract not making the transfer,
unless that party waives the default or otherwise agrees, has the rights
and remedies described in Section 36-2A-501(2);
(b) if paragraph (a) is not applicable and if a transfer is made that
is prohibited under a lease agreement or materially impairs the prospect
of obtaining return performance by, materially changes the duty of, or
materially increases the burden or risk imposed on, the other party to the
lease contract, unless the party not making the transfer agrees at any
time to the transfer in the lease contract or otherwise, then, except as
limited by contract, (i) the transferor is liable to the party not making the
transfer for damages caused by the transfer to the extent that the
damages could not reasonably be prevented by the party not making the
transfer and (ii) a court having jurisdiction may grant other appropriate
relief, including cancellation of the lease contract or an injunction
against the transfer.
(6) A transfer of `the lease' or of `all my rights under the lease', or
a transfer in similar general terms, is a transfer of rights and, unless the
language or the circumstances, as in a transfer for security, indicate the
contrary, the transfer is a delegation of duties by the transferor to the
transferee. Acceptance by the transferee constitutes a promise by the
transferee to perform those duties. The promise is enforceable by either
the transferor or the other party to the lease contract.
(7) Unless otherwise agreed by the lessor and the lessee, a
delegation of performance does not relieve the transferor as against the
other party of any duty to perform or of any liability for default.
(8) In a consumer lease, to prohibit the transfer of an interest of
a party under the lease contract or to make a transfer an event of default,
the language must be specific, by a writing, and conspicuous.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-210 and 9-311.
Changes: The provisions of Sections 2-210 and 9-311 were
incorporated in this section, with substantial modifications to reflect
leasing terminology and practice and to harmonize the principles of the
respective provisions, i.e. limitations on delegation of performance on
the one hand and alienability of rights on the other. In addition, unlike
Section 2-210 which deals only with voluntary transfers, this section
deals with involuntary as well as voluntary transfers. Moreover, the
principle of Section 9-318(4) denying effectiveness to contractual terms
prohibiting assignments of receivables due and to become due also is
implemented.
Purposes: 1. Subsection (2) states a rule, consistent with
Section 9-311, that voluntary and involuntary transfers of an interest of
a party under the lease contract or of the lessor's residual interest,
including by way of the creation or enforcement of a security interest,
are effective, notwithstanding a provision in the lease agreement
prohibiting the transfer or making the transfer an event of default.
Although the transfers are effective, the provision in the lease agreement
is nevertheless enforceable, but only as provided in subsection (5).
Under subsection (5) the prejudiced party is limited to the remedies on
"default under the lease contract" in this Article and, except
as limited by this Article, as provided in the lease agreement, if the
transfer has been made an event of default. Section 2A-501(2). Usually,
there will be a specific provision to this effect or a general provision
making a breach of a covenant an event of default. In those cases where
the transfer is prohibited, but not made an event of default, the
prejudiced party may recover damages; or, if the damage remedy would
be ineffective adequately to protect that party, the court can order
cancellation of the lease contract or enjoin the transfer. This rule that
such provisions generally are enforceable is subject to subsections (3)
and (4), which make such provisions unenforceable in certain instances.
2. The first such instance is described in subsection (3). A provision
in a lease agreement which prohibits the creation or enforcement of a
security interest, including sales of lease contracts subject to Article 9
(Sections 9-102(1)(b) and 9-104(f)), or makes it an event of default is
generally not enforceable, reflecting the policy of Section 9-318(4).
However, that policy gives way to the doctrine stated in Section
2-210(2), which gives one party to a contract the right to protect itself
against an actual delegation (but not just a provision under which
delegation might later occur) of a material performance by the other
party. Accordingly, such a provision in a lease agreement is enforceable
when the transfer delegates a material performance. Generally, as
expressly provided in subsection (6), a transfer for security is not a
delegation of duties. However, inasmuch as the creation of a security
interest includes the sale of a lease contract, if there are then
unperformed duties on the part of the lessor/seller, there could be a
delegation of duties in the sale, and, if such a delegation actually takes
place and is of a material performance, a provision in a lease agreement
prohibiting it or making it an event of default would be enforceable,
giving rise to the rights and remedies stated in subsection (5). The
statute does not define "material." The parties may set
standards to determine its meaning. The term is intended to exclude
delegations of matters such as accounting to a professional accountant
and the performance of, as opposed to the responsibility for,
maintenance duties to a person in the maintenance service industry.
3. For similar reasons, the lessor is entitled to protect its residual
interest in the goods by prohibiting anyone but the lessee from
possessing or using them. Accordingly, under subsection (3) if there is
an actual transfer by the lessee of its right of possession or use of the
goods in violation of a provision in the lease agreement, such a
provision likewise is enforceable, giving rise to the rights and remedies
stated in subsection (5). A transfer of the lessee's right of possession or
use of the goods resulting from the enforcement of a security interest
granted by the lessee in its leasehold interest is a "transfer by the
lessee" under this subsection.
4. Finally, subsection (3) protects against a claim that the creation
or enforcement of a security interest in the lessor's interest under the
lease contract or in the residual interest is a transfer that materially
impairs the prospect of obtaining return performance by, materially
changes the duty of, or materially increases the burden or risk imposed
on the lessee so as to give rise to the rights and remedies stated in
subsection (5), unless the transfer involves an actual delegation of a
material performance of the lessor.
5. While it is not likely that a transfer by the lessor of its right to
payment under the lease contract would impair at a future time the
ability of the lessee to obtain the performance due the lessee under the
lease contract from the lessor, if under the circumstances reasonable
grounds for insecurity as to receiving that performance arise, the lessee
may employ the provision of this Article for demanding adequate
assurance of due performance and has the remedy provided in that
circumstance. Section 2A-401.
6. Sections 9-206 and 9-318(1) through (3) also are relevant.
Section 9-206 sanctions an agreement by a lessee not to assert certain
types of claims or defenses against the lessor's assignee. Section
9-318(1) through (3) deal with, among other things, the other party's
rights against the assignee where Section 9-206(1) does not apply. Since
the definition of contract under Section 1-201(11) includes a lease
agreement, the definition of account debtor under Section 9-105(1)(a)
includes a lessee of goods. As a result, Section 9-206 applies to lease
agreements, and there is no need to restate those sections in this Article.
The reference to "defenses or claims arising out of a sale"
in Section 9-318(1) should be interpreted broadly to include defenses or
claims arising out of a lease inasmuch as that section codifies the
common law rule with respect to contracts, including lease contracts.
7. Subsection (4) is based upon Section 2-210(2) and Section
9-318(4). It makes unenforceable a prohibition against transfers of
certain rights to payment or a provision making the transfer an event of
default. It also provides that such transfers do not materially impair the
prospect of obtaining return performance by, materially change the duty
of, or materially increase the burden or risk imposed on, the other party
to the lease contract so as to give rise to the rights and remedies stated
in subsection (5). Accordingly, a transfer of a right to payment cannot
be prohibited or made an event of default, or be one that materially
impairs performance, changes duties or increases risk, if the right is
already due or will become due without further performance being
required by the party to receive payment. Thus, a lessor can transfer the
right to future payments under the lease contract, including by way of a
grant of a security interest, and the transfer will not give rise to the rights
and remedies stated in subsection (5) if the lessor has no remaining
performance under the lease contract. The mere fact that the lessor is
obligated to allow the lessee to remain in possession and to use the
goods as long as the lessee is not in default does not mean that there is
"remaining performance" on the part of the lessor.
Likewise, the fact that the lessor has potential liability under a
"non-operating" lease contract for breaches of warranty does
not mean that there is "remaining performance." In contrast,
the lessor would have "remaining performance" under a
lease contract requiring the lessor to regularly maintain and service the
goods or to provide "upgrades" of the equipment on a
periodic basis in order to avoid obsolescence. The basic distinction is
between a mere potential duty to respond which is not "remaining
performance," and an affirmative duty to render stipulated
performance. Although the distinction may be difficult to draw in some
cases, it is instructive to focus on the difference between
"operating" and "non-operating" leases as
generally understood in the marketplace. Even if there is
"remaining performance" under a lease contract, a transfer
for security of a right to payment that is made an event of default or that
is in violation of a prohibition against transfer does not give rise to the
rights and remedies under subsection (5) if it does not constitute an
actual delegation of a material performance under subsection (3).
8. The application of either the rule of subsection (3) or the rule of
subsection (4) to the grant by the lessor of a security interest in the
lessor's right to future payment under the lease contract may produce the
same result. Both subsections generally protect security transfers by the
lessor in particular because the creation by the lessor of a security
interest or the enforcement of that interest generally will not prejudice
the lessee's rights if it does not result in a delegation of the lessor's
duties. To the contrary, the receipt of loan proceeds or relief from the
enforcement of an antecedent debt normally should enhance the lessor's
ability to perform its duties under the lease contract. Nevertheless, there
are circumstances where relief might be justified. For example, if
ownership of the goods is transferred pursuant to enforcement of a
security interest to a party whose ownership would prevent the lessee
from continuing to possess the goods, relief might be warranted. See 49
U.S.C. Section 1401(a) and (b) which places limitations on the operation
of aircraft in the United States based on the citizenship or corporate
qualification of the registrant.
9. Relief on the ground of material prejudice when the lease
agreement does not prohibit the transfer or make it an event of default
should be afforded only in extreme circumstances, considering the fact
that the party asserting material prejudice did not insist upon a provision
in the lease agreement that would protect against such a transfer.
10. Subsection (5) implements the rule of subsection (2). Subsection
(2) provides that, even though a transfer is effective, a provision in the
lease agreement prohibiting it or making it an event of default may be
enforceable as provided in subsection (5). See Brummond v. First
National Bank of Clovis, 656 P.2d 884, 35 U.C.C. Rep. Serv.
(Callaghan) 1311 (N. Mex. 1983), stating the analogous rule for Section
9-311. If the transfer prohibited by the lease agreement is made an event
of default, then, under subsection 5(a), unless the default is waived or
there is an agreement otherwise, the aggrieved party has the rights and
remedies referred to in Section 2A-501(2), viz. those in this Article and,
except as limited in the Article, those provided in the lease agreement.
In the unlikely circumstance that the lease agreement prohibits the
transfer without making a violation of the prohibition an event of default
or, even if there is no prohibition against the transfer, and the transfer is
one that materially impairs performance, changes duties, or increases
risk (for example, a sublease or assignment to a party using the goods
improperly or for an illegal purpose), then subsection 5(b) is applicable.
In that circumstance, unless the party aggrieved by the transfer has
otherwise agreed in the lease contract, such as by assenting to a
particular transfer or to transfers in general, or agrees in some other
manner, the aggrieved party has the right to recover damages from the
transferor and a court may, in appropriate circumstances, grant other
relief, such as cancellation of the lease contract or an injunction against
the transfer.
11. If a transfer gives rise to the rights and remedies provided in
subsection (5), the transferee as an alternative may propose, and the
other party may accept, adequate cure or compensation for past defaults
and adequate assurance of future due performance under the lease
contract. Subsection (5) does not preclude any other relief that may be
available to a party to the lease contract aggrieved by a transfer subject
to an enforceable prohibition, such as an action for interference with
contractual relations.
12. Subsection (8) requires that a provision in a consumer lease
prohibiting a transfer, or making it an event of default, must be specific,
written and conspicuous. See Section 1-201(10). This assists in
protecting a consumer lessee against surprise assertions of default.
13. Subsection (6) is taken almost verbatim from the provisions of
Section 2-210(4). The subsection states a rule of construction that
distinguishes a commercial assignment, which substitutes the assignee
for the assignor as to rights and duties, and an assignment for security or
financing assignment, which substitutes the assignee for the assignor
only as to rights. Note that the assignment for security or financing
assignment is a subset of all security interests. Security interest is
defined to include "any interest of a buyer of ... chattel
paper". Section 1-201(37). Chattel paper is defined to include a
lease. Section 9-105(1)(b). Thus, a buyer of leases is the holder of a
security interest in the leases. That conclusion should not influence this
issue, as the policy is quite different. Whether a buyer of leases is the
holder of a commercial assignment, or an assignment for security or
financing assignment should be determined by the language of the
assignment or the circumstances of the assignment.
Cross References: Sections 1-201(11), 1-201(37), 2-210,
2A-401, 9-102(1)(b), 9-104(f), 9-105(1)(a), 9-206, and 9-318.
Definitional Cross References:
"Agreed" and "Agreement". Section
1-201(3).
"Conspicuous". Section 1-201(10).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Lessor's residual interest". Section 2A-103(1)(q).
"Notice". Section 1-201(25).
"Party". Section 1-201(29).
"Person". Section 1-201(30).
"Reasonable time". Section 1-204(1) and (2).
"Rights". Section 1-201(36).
"Term". Section 1-201(42).
"Writing". Section 1-201(46).
Section 36-2A-304. SUBSEQUENT LEASE OF GOODS BY
LESSOR.
(1) Subject to Section 36-2A-303, a subsequent lessee from a lessor
of goods under an existing lease contract obtains, to the extent of the
leasehold interest transferred, the leasehold interest in the goods that the
lessor had or had power to transfer, and except as provided in subsection
(2) and Section 36-2A-527(4), takes subject to the existing lease
contract. A lessor with voidable title has power to transfer a good
leasehold interest to a good faith subsequent lessee for value, but only
to the extent set forth in the preceding sentence. If goods have been
delivered under a transaction of purchase, the lessor has that power even
though:
(a) the lessor's transferor was deceived as to the identity of the
lessor;
(b) the delivery was in exchange for a check which is later
dishonored;
(c) it was agreed that the transaction was to be a `cash sale'; or
(d) the delivery was procured through fraud punishable as
larcenous under the criminal law.
(2) A subsequent lessee in the ordinary course of business from a
lessor who is a merchant dealing in goods of that kind to whom the
goods were entrusted by the existing lessee of that lessor before the
interest of the subsequent lessee became enforceable against that lessor
obtains, to the extent of the leasehold interest transferred, all of that
lessor's and the existing lessee's rights to the goods, and takes free of the
existing lease contract.
(3) A subsequent lessee from the lessor of goods that are subject to
an existing lease contract and are covered by a certificate of title issued
under a statute of this State or of another jurisdiction takes no greater
rights than those provided both by this section and by the certificate of
title statute.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-403.
Changes: While Section 2-403 was used as a model for this
section, the provisions of Section 2-403 were significantly revised to
reflect leasing practices and to integrate this Article with certificate of
title statutes.
Purposes: 1. This section must be read in conjunction with, as
it is subject to, the provisions of Section 2A-303, which govern
voluntary and involuntary transfers of rights and duties under a lease
contract, including the lessor's residual interest in the goods.
2. This section must also be read in conjunction with Section 2-403.
This section and Section 2A-305 are derived from Section 2-403, which
states a unified policy on good faith purchases of goods. Given the
scope of the definition of purchaser (Section 1-201(33)), a person who
bought goods to lease as well as a person who bought goods subject to
an existing lease from a lessor will take pursuant to Section 2-403.
Further, a person who leases such goods from the person who bought
them should also be protected under Section 2-403, first because the
lessee's rights are derivative and second because the definition of
purchaser should be interpreted to include one who takes by lease; no
negative implication should be drawn from the inclusion of lease in the
definition of purchase in this Article. Section 2A-103(1)(v).
3. There are hypotheticals that relate to an entrustee's unauthorized
lease of entrusted goods to a third party that are outside the provisions
of Sections 2-403, 2A-304 and 2A-305. Consider a sale of goods by M,
a merchant, to B, a buyer. After paying for the goods B allows M to
retain possession of the goods as B is short of storage. Before B calls
for the goods M leases the goods to L, a lessee. This transaction is not
governed by Section 2-403(2) as L is not a buyer in the ordinary course
of business. Section 1-201(9). Further, this transaction is not governed
by Section 2A-304(2) as B is not an existing lessee. Finally, this
transaction is not governed by Section 2A-305(2) as B is not M's lessor.
Section 2A-307(2) resolves the potential dispute between B, M and L.
By virtue of B's entrustment of the goods to M and M's lease of the
goods to L, B has a cause of action against M under the common law.
Sections 2A-103(4) and 1-103. See, e.g., Restatement (Second) of Torts
Sections 222A-243. Thus, B is a creditor of M. Sections 2A-103(4) and
1-201(12). Section 2A-307(2) provides that B, as M's creditor, takes
subject to M's lease to L. Thus, if L does not default under the lease, L's
enjoyment and possession of the goods should be undisturbed.
However, B is not without recourse. B's action should result in a
judgment against M providing, among other things, a turnover of all
proceeds arising from M's lease to L, as well as a transfer of all of M's
right, title and interest as lessor under M's lease to L, including M's
residual interest in the goods. Section 2A-103(1)(q).
4. Subsection (1) states a rule with respect to the leasehold interest
obtained by a subsequent lessee from a lessor of goods under an existing
lease contract. The interest will include such leasehold interest as the
lessor has in the goods as well as the leasehold interest that the lessor
had the power to transfer. Thus, the subsequent lessee obtains
unimpaired all rights acquired under the law of agency, apparent agency,
ownership or other estoppel, whether based upon statutory provisions or
upon case law principles. Sections 2A-103(4) and 1-103. In general, the
subsequent lessee takes subject to the existing lease contract, including
the existing lessee's rights thereunder. Furthermore, the subsequent
lease contract is, of course, limited by its own terms, and the subsequent
lessee takes only to the extent of the leasehold interest transferred
thereunder.
5. Subsection (1) further provides that a lessor with voidable title has
power to transfer a good leasehold interest to a good faith subsequent
lessee for value. In addition, subsections (1)(a) through (d) provide
specifically for the protection of the good faith subsequent lessee for
value in a number of specific situations which have been troublesome
under prior law.
6. The position of an existing lessee who entrusts leased goods to its
lessor is not distinguishable from the position of other entrusters. Thus,
subsection (2) provides that the subsequent lessee in the ordinary course
of business takes free of the existing lease contract between the lessor
entrustee and the lessee entruster, if the lessor is a merchant dealing in
goods of that kind. Further, the subsequent lessee obtains all of the
lessor entrustee's and the lessee entruster's rights to the goods, but only
to the extent of the leasehold interest transferred by the lessor entrustee.
Thus, the lessor entrustee retains the residual interest in the goods.
Section 2A-103(1)(q). However, entrustment by the existing lessee must
have occurred before the interest of the subsequent lessee became
enforceable against the lessor. Entrusting is defined in Section 2-403(3)
and that definition applies here. Section 2A-103(3).
7. Subsection (3) states a rule with respect to a transfer of goods
from a lessor to a subsequent lessee where the goods are subject to an
existing lease and covered by a certificate of title. The subsequent
lessee's rights are no greater than those provided by this section and the
applicable certificate of title statute, including any applicable case law
construing such statute. Where the relationship between the certificate
of title statute and Section 2-403, the statutory analogue to this section,
has been construed by a court, that construction is incorporated here.
Sections 2A-103(4) and 1-102(1) and (2). The better rule is that the
certificate of title statutes are in harmony with Section 2-403 and thus
would be in harmony with this section. E.g., Atwood
Chevrolet-Olds v. Aberdeen Mun. School Dist., 431 So.2d 926, 928
(Miss. 1983); Godfrey v. Gilsdorf, 476 P.2d 3, 6, 86 Nev. 714,
718 (1970); Martin v. Nager, 192 N.J. Super. 189, 197-98, 469
A.2d 519, 523 (Super. Ct. Ch. Div. 1983). Where the certificate of title
statute is silent on this issue of transfer, this section will control.
Cross References: Sections 1-102, 1-103, 1-201(33), 2-403,
2A-103(1)(v), 2A-103(3), 2A-103(4), 2A-303 and 2A-305.
Definitional Cross References:
"Agreed". Section 1-201(3).
"Delivery". Section 1-201(14).
"Entrusting". Section 2-403(3).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Leasehold interest". Section 2A-103(1)(m).
"Lessee". Section 2A-103(1)(n).
"Lessee in the ordinary course of business". Section
2A-103(1)(o).
"Lessor". Section 2A-103(1)(p).
"Merchant". Section 2-104(1).
"Purchase". Section 2A-103(1)(v).
"Rights". Section 1-201(36).
"Value". Section 1-201(44).
Section 36-2A-305. SALE OR SUBLEASE OF GOODS BY
LESSEE.
(1) Subject to the provisions of Section 36-2A-303, a buyer or
sublessee from the lessee of goods under an existing lease contract
obtains, to the extent of the interest transferred, the leasehold interest in
the goods that the lessee had or had power to transfer, and except as
provided in subsection (2) and Section 36-2A-511(4), takes subject to
the existing lease contract. A lessee with a voidable leasehold interest
has power to transfer a good leasehold interest to a good faith buyer for
value or a good faith sublessee for value, but only to the extent set forth
in the preceding sentence. When goods have been delivered under a
transaction of lease the lessee has that power even though:
(a) the lessor was deceived as to the identity of the lessee;
(b) the delivery was in exchange for a check which is later
dishonored; or
(c) the delivery was procured through fraud punishable as
larcenous under the criminal law.
(2) A buyer in the ordinary course of business or a sublessee in the
ordinary course of business from a lessee who is a merchant dealing in
goods of that kind to whom the goods were entrusted by the lessor
obtains, to the extent of the interest transferred, all of the lessor's and
lessee's rights to the goods, and takes free of the existing lease contract.
(3) A buyer or sublessee from the lessee of goods that are subject to
an existing lease contract and are covered by a certificate of title issued
under a statute of this State or of another jurisdiction takes no greater
rights than those provided both by this section and by the certificate of
title statute.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-403.
Changes: While Section 2-403 was used as a model for this
section, the provisions of Section 2-403 were significantly revised to
reflect leasing practice and to integrate this Article with certificate of
title statutes.
Purposes: This section, a companion to Section 2A-304, states
the rule with respect to the leasehold interest obtained by a buyer or
sublessee from a lessee of goods under an existing lease contract. Cf.
Section 2A-304 official comment. Note that this provision is consistent
with existing case law, which prohibits the bailee's transfer of title to a
good faith purchaser for value under Section 2-403(1). Rohweder
v. Aberdeen Product. Credit Ass'n, 765 F.2d 109 (8th Cir. 1985).
Subsection (2) is also consistent with existing case law.
American Standard Credit, Inc. v. National Cement Co., 643
F.2d 248, 269-70 (5th Cir. 1981); but cf. Exxon
Co., U.S.A. v. TLW Computer Indus., 37 U.C.C. Rep. Serv.
(Callaghan) 1052, 1057-58 (D. Mass. 1983). Unlike Section 2A-304(2),
this subsection does not contain any requirement with respect to the time
that the goods were entrusted to the merchant. In Section 2A-304(2) the
competition is between two customers of the merchant lessor; the time
of entrusting was added as a criterion to create additional protection to
the customer who was first in time: the existing lessee. In subsection
(2) the equities between the competing interests were viewed as
balanced.
There appears to be some overlap between Section 2-403(2) and
Section 2A-305(2) with respect to a buyer in the ordinary course of
business. However, an examination of this Article's definition of buyer
in the ordinary course of business (Section 2A-103(1)(a)) makes clear
that this reference was necessary to treat entrusting in the context of a
lease.
Subsection (3) states a rule of construction with respect to a transfer
of goods from a lessee to a buyer or sublessee, where the goods are
subject to an existing lease and covered by a certificate of title. Cf.
Section 2A-304 official comment.
Cross References: Sections 2-403, 2A-103(1)(a), 2A-304
and 2A-305(2).
Definitional Cross References:
"Buyer". Section 2-103(1)(a).
"Buyer in the ordinary course of business". Section
2A-103(1)(a).
"Delivery". Section 1-201(14).
"Entrusting". Section 2-403(3).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Leasehold interest." Section 2A-103(1)(m).
"Lessee". Section 2A-103(1)(n).
"Lessee in the ordinary course of business". Section
2A-103(1)(o).
"Lessor". Section 2A-103(1)(p).
"Merchant". Section 2-104(1).
"Rights". Section 1-201(36).
"Sale". Section 2-106(1).
"Sublease". Section 2A-103(1)(w).
"Value". Section 1-201(44).
Section 36-2A-306. PRIORITY OF CERTAIN LIENS ARISING
BY OPERATION OF LAW.
If a person in the ordinary course of his business furnishes services
or materials with respect to goods subject to a lease contract, a lien upon
those goods in the possession of that person given by statute or rule of
law for those materials or services takes priority over any interest of the
lessor or lessee under the lease contract or this chapter unless the lien is
created by statute and the statute provides otherwise or unless the lien
is created by rule of law and it provides otherwise.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-310.
Changes: The approach reflected in the provisions of Section
9-310 was included, but revised to conform to leasing terminology and
to expand the exception to the special priority granted to protected liens
to cover liens created by rule of law as well as those created by statute.
Purposes: This section should be interpreted to allow a
qualified lessor or a qualified lessee to be the competing lienholder if the
statute or rule of law so provides. The reference to statute includes
applicable regulations and cases; these sources must be reviewed in
resolving a priority dispute under this section.
Cross Reference: Section 9-310.
Definitional Cross References:
"Goods". Section 2A-103(1)(h).
"Lease Contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Lien". Section 2A-103(1)(r).
"Person". Section 1-201(30).
Section 36-2A-307. PRIORITY OF LIENS ARISING BY
ATTACHMENT OR LEVY ON, SECURITY INTERESTS IN, AND
OTHER CLAIMS TO GOODS.
(1) Except as otherwise provided in Section 36-2A-306, a creditor
of a lessee takes subject to the lease contract.
(2) Except as otherwise provided in subsections (3) and (4) and
in Sections 36-2A-306 and 36-2A-308, a creditor of a lessor takes
subject to the lease contract unless:
(a) the creditor holds a lien that attached to the goods before the
lease contract became enforceable,
(b) the creditor holds a security interest in the goods and the
lessee did not give value and receive delivery of the goods without
knowledge of the security interest; or
(c) the creditor holds a security interest in the goods which was
perfected (Section 36-9-303) before the lease contract became
enforceable.
(3) A lessee in the ordinary course of business takes the leasehold
interest free of a security interest in the goods created by the lessor even
though the security interest is perfected (Section 36-9-303) and the
lessee knows of its existence.
(4) A lessee other than a lessee in the ordinary course of business
takes the leasehold interest free of a security interest to the extent that it
secures future advances made after the secured party acquires
knowledge of the lease or more than forty-five days after the lease
contract becomes enforceable, whichever first occurs, unless the future
advances are made pursuant to a commitment entered into without
knowledge of the lease and before the expiration of the forty-five-day
period.
OFFICIAL COMMENT
Uniform Statutory Source: None for subsection (1). Subsection (2)
is derived from Section 9-301, and subsections (3) and (4) are derived
from Section 9-307(1) and (3), respectively.
Changes: The provisions of Sections 9-301 and 9-307(1) and
(3) were incorporated, and modified to reflect leasing terminology and
the basic concepts reflected in this Article.
Purposes: 1. Subsection (1) states a general rule of priority
that a creditor of the lessee takes subject to the lease contract. The term
lessee (Section 2A-103(1)(n)) includes sublessee. Therefore, this
subsection not only covers disputes between the prime lessor and a
creditor of the prime lessee but also disputes between the prime lessor,
or the sublessor, and a creditor of the sublessee. Section 2A-301 official
comment 3(g). Further, by using the term creditor (Section 1-201(12)),
this subsection will cover disputes with a general creditor, a secured
creditor, a lien creditor and any representative of creditors. Section
2A-103(4).
2. Subsection (2) states a general rule of priority that a creditor of a
lessor takes subject to the lease contract. Note the discussion above with
regard to the scope of these rules. Section 2A-301 official comment
3(g). Thus, the section will not only cover disputes between the prime
lessee and a creditor of the prime lessor but also disputes between the
prime lessee, or the sublessee, and a creditor of the sublessor.
3. To take priority over the lease contract, and the interests derived
therefrom, the creditor must come within one of three exceptions stated
within the rule. First, subsection (2)(a) provides that where the creditor
holds a lien (Section 2A-103(1)(r)) that attached before the lease
contract became enforceable (Section 2A-301), the creditor does not
take subject to the lease. Second, subsection (2)(b) provides that when
the creditor holds a security interest (Section 1-201(37)) , whether or not
perfected, the creditor has priority over a lessee who did not give value
(Section 1-201(44)) and receive delivery of the goods without
knowledge (Section 1-201(25)) of the security interest. As to other
lessees, under subsection (2)(c) a secured creditor holding a perfected
security interest before the time the lease contract became enforceable
(Section 2A-301) does not take subject to the lease. With respect to this
provision, the lessee in these circumstances is treated like a buyer so that
perfection of a purchase money security interest does not relate back
(Section 9-301).
4. The rules of this section operate in favor of whichever party to the
lease contract may enforce it, even if one party perhaps may not, e.g.,
under Section 2A-201(1)(b).
5. The rules stated in subsections (2)(b) and (c), and the rule in
subsection (3), are best understood by reviewing a hypothetical.
Assume that a merchant engaged in the business of selling and leasing
musical instruments obtained possession of a truck load of musical
instruments on deferred payment terms from a supplier of musical
instruments on January 6. To secure payment of such credit the
merchant granted the supplier a security interest in the instruments; the
security interest was perfected by filing on January 15. The merchant,
as lessor, entered into a lease to an individual of one of the musical
instruments supplied by the supplier; the lease became enforceable on
January 10. Under subsection (2)(b) the lessee will prevail (assuming
the lessee qualifies thereunder) unless subsection (c) provides otherwise.
Under the rule stated in subsection (2)(c) a priority dispute between the
supplier, as the lessor's secured creditor, and the lessee would be
determined by ascertaining on January 10 (the day the lease became
enforceable) the validity and perfected status of the security interest in
the musical instrument and the enforceability of the lease contract by the
lessee. Nothing more appearing, under the rule stated in subsection
(2)(c), the supplier's security interest in the musical instrument would
not have priority over the lease contract. Moreover, subsection (2) states
that its rules are subject to the rules of subsections (3) and (4). Under
this hypothetical the lessee should qualify as a "lessee in the
ordinary course of business". Section 2A-103(1)(o). Subsection
(3) also makes clear that the lessee in the ordinary course of business
will win even if he or she knows of the existence of the supplier's
security interest.
6. Subsections (3) and (4), which are modeled on the provisions of
Section 9-307(1) and (3), respectively, state two exceptions to the
priority rule stated in subsection (2) with respect to a creditor who holds
a security interest. The lessee in the ordinary course of business will be
treated in the same fashion as the buyer in the ordinary course of
business, given a priority dispute with a secured creditor over goods
subject to a lease contract.
Cross References: Sections 1-201(12), 1-201(25), 1-201(37),
1-201(44), 2A-103(1)(n), 2A-103(1)(o), 2A-103(1)(r), 2A-103(4),
2A-201(1)(b), 2A-301 official comment 3(g), Article 9, especially
Sections 9-301, 9-307(1) and 9-307(3) .
Definitional Cross References:
"Creditor". Section 1-201(12).
"Goods". Section 2A-103(1)(h).
"Knowledge" and "Knows". Section
1-201(25).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Leasehold interest". Section 2A-103(1)(m).
"Lessee". Section 2A-103(1)(n).
"Lessee in the ordinary course of business". Section
2A-103(1)(o).
"Lessor". Section 2A-103(1)(p).
"Lien". Section 2A-103(1)(r).
"Party". Section 1-201(29).
"Pursuant to commitment". Section 2A-103(3).
"Security interest". Section 1-201(37).
Section 36-2A-308. SPECIAL RIGHTS OF CREDITORS.
(1) A creditor of a lessor in possession of goods subject to a lease
contract may treat the lease contract as void if as against the creditor
retention of possession by the lessor is fraudulent under any statute or
rule of law, but retention of possession in good faith and current course
of trade by the lessor for a commercially reasonable time after the lease
contract becomes enforceable is not fraudulent.
(2) Nothing in this chapter impairs the rights of creditors of a lessor
if the lease contract (a) becomes enforceable, not in current course of
trade but in satisfaction of or as security for a pre-existing claim for
money, security, or the like, and (b) is made under circumstances which
under any statute or rule of law apart from this chapter would constitute
the transaction a fraudulent transfer or voidable preference.
(3) A creditor of a seller may treat a sale or an identification of
goods to a contract for sale as void if as against the creditor retention of
possession by the seller is fraudulent under any statute or rule of law, but
retention of possession of the goods pursuant to a lease contract entered
into by the seller as lessee and the buyer as lessor in connection with the
sale or identification of the goods is not fraudulent if the buyer bought
for value and in good faith.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-402(2) and (3)(b).
Changes: Rephrased and new material added to conform to
leasing terminology and practice.
Purposes: Subsection (1) states a general rule of avoidance
where the lessor has retained possession of goods if such retention is
fraudulent under any statute or rule of law. However, the subsection
creates an exception under certain circumstances for retention of
possession of goods for a commercially reasonable time after the lease
contract becomes enforceable.
Subsection (2) also preserves the possibility of an attack on the lease
by creditors of the lessor if the lease was made in satisfaction of or as
security for a pre-existing claim, and would constitute a fraudulent
transfer or voidable preference under other law.
Finally, subsection (3) states a new rule with respect to
sale-leaseback transactions, i.e., transactions where the seller sells goods
to a buyer but possession of the goods is retained by the seller pursuant
to a lease contract between the buyer as lessor and the seller as lessee.
Notwithstanding any statute or rule of law that would treat such
retention as fraud, whether per se, prima facie, or otherwise, the
retention is not fraudulent if the buyer bought for value (Section
1-201(44)) and in good faith (Sections 1-201(19) and 2-103(1)(b)).
Section 2A-103(3) and (4). This provision overrides Section 2-402(2)
to the extent it would otherwise apply to a sale-leaseback transaction.
Cross References: Sections 1-201(19), 1-201(44), 2-402(2)
and 2A-103(4).
Definitional Cross References:
"Buyer". Section 2-103(1)(a).
"Contract". Section 1-201(11).
"Creditor". Section 1-201(12).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Money". Section 1-201(24).
"Reasonable time". Section 1-204(1) and (2).
"Rights". Section 1-201(36).
"Sale". Section 2-106(1).
"Seller". Section 2-103(1)(d).
"Value". Section 1-201(44).
Section 36-2A-309. LESSOR'S AND LESSEE'S RIGHTS WHEN
GOODS BECOME FIXTURES.
(1) In this section:
(a) goods are `fixtures' when they become so related to particular
real estate that an interest in them arises under real estate law;
(b) a `fixture filing' is the filing, in the office where a
mortgage on the real estate would be filed or recorded, of a financing
statement covering goods that are or are to become fixtures and
conforming to the requirements of Section 36-9-402(5);
(c) a lease is a `purchase money lease' unless the lessee has
possession or use of the goods or the right to possession or use of the
goods before the lease agreement is enforceable;
(d) a mortgage is a `construction mortgage' to the extent it
secures an obligation incurred for the construction of an improvement
on land including the acquisition cost of the land, if the recorded writing
so indicates; and
(e) `encumbrance' includes real estate mortgages and other liens
on real estate and all other rights in real estate that are not ownership
interests.
(2) Under this chapter a lease may be of goods that are fixtures or
may continue in goods that become fixtures, but no lease exists under
this chapter of ordinary building materials incorporated into an
improvement on land.
(3) This chapter does not prevent creation of a lease of fixtures
pursuant to real estate law.
(4) The perfected interest of a lessor of fixtures has priority over
a conflicting interest of an encumbrancer or owner of the real estate if:
(a) the lease is a purchase money lease, the conflicting interest of
the encumbrancer or owner arises before the goods become fixtures, the
interest of the lessor is perfected by a fixture filing before the goods
become fixtures or within ten days thereafter, and the lessee has an
interest of record in the real estate or is in possession of the real estate;
or
(b) the interest of the lessor is perfected by a fixture filing
before the interest of the encumbrancer or owner is of record, the lessor's
interest has priority over any conflicting interest of a predecessor in title
of the encumbrancer or owner, and the lessee has an interest of record
in the real estate or is in possession of the real estate.
(5) The interest of a lessor of fixtures, whether or not perfected,
has priority over the conflicting interest of an encumbrancer or owner of
the real estate if:
(a) the fixtures are readily removable factory or office machines,
readily removable equipment that is not primarily used or leased for use
in the operation of the real estate, or readily removable replacements of
domestic appliances that are goods subject to a consumer lease, and
before the goods become fixtures the lease contract is enforceable; or
(b) the conflicting interest is a lien on the real estate obtained
by legal or equitable proceedings after the lease contract is enforceable;
or
(c) the encumbrancer or owner has consented in writing to the
lease or has disclaimed an interest in the goods as fixtures; or
(d) the lessee has a right to remove the goods as against the
encumbrancer or owner. If the lessee's right to remove terminates, the
priority of the interest of the lessor continues for a reasonable time.
(6) Notwithstanding subsection (4)(a) but otherwise subject to
subsections (4) and (5), the interest of a lessor of fixtures, including the
lessor's residual interest, is subordinate to the conflicting interest of an
encumbrancer of the real estate under a construction mortgage recorded
before the goods become fixtures if the goods become fixtures before the
completion of the construction. To the extent given to refinance a
construction mortgage, the conflicting interest of an encumbrancer of the
real estate under a mortgage has this priority to the same extent as the
encumbrancer of the real estate under the construction mortgage.
(7) In cases not within the preceding subsections, priority between
the interest of a lessor of fixtures, including the lessor's residual interest,
and the conflicting interest of an encumbrancer or owner of the real
estate who is not the lessee is determined by the priority rules governing
conflicting interests in real estate.
(8) If the interest of a lessor of fixtures, including the lessor's
residual interest, has priority over all conflicting interests of all owners
and encumbrancers of the real estate, the lessor or the lessee may (i) on
default, expiration, termination, or cancellation of the lease agreement
but subject to the lease agreement and this chapter, or (ii) if necessary
to enforce other rights and remedies of the lessor or lessee under this
chapter, remove the goods from the real estate, free and clear of all
conflicting interests of all owners and encumbrancers of the real estate,
but the lessor or lessee must reimburse any encumbrancer or owner of
the real estate who is not the lessee and who has not otherwise agreed
for the cost of repair of any physical injury, but not for any diminution
in value of the real estate caused by the absence of the goods removed
or by any necessity of replacing them. A person entitled to
reimbursement may refuse permission to remove until the party seeking
removal gives adequate security for the performance of this obligation.
(9) Even though the lease agreement does not create a security
interest, the interest of a lessor of fixtures, including the lessor's residual
interest, is perfected by filing a financing statement as a fixture filing for
leased goods that are or are to become fixtures in accordance with the
relevant provisions of the Chapter on Secured Transactions (Chapter 9).
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-313.
Changes: Revised to reflect leasing terminology and to add
new material.
Purposes: 1. While Section 9-313 provided a model for this
section, certain provisions were substantially revised.
2. Section 2A-309(1)(c), which is new, defines purchase money
lease to exclude leases where the lessee had possession or use of the
goods or the right thereof before the lease agreement became
enforceable. This term is used in subsection (4)(a) as one of the
conditions that must be satisfied to obtain priority over the conflicting
interest of an encumbrancer or owner of the real estate.
3. Section 2A-309(4), which states one of several priority rules
found in this section, deletes reference to office machines and the like
(Section 9-313(4)(c)) as well as certain liens (Section 9-313(4)(d)).
However, these items are included in subsection (5), another priority
rule that is more permissive than the rule found in subsection (4) as it
applies whether or not the interest of the lessor is perfected. In addition,
subsection (5)(a) expands the scope of the provisions of Section
9-313(4)(c) to include readily removable equipment not primarily used
or leased for use in the operation of real estate; the qualifier is intended
to exclude from the expanded rule equipment integral to the operation
of real estate, e.g., heating and air conditioning equipment.
4. The rule stated in subsection (7) is more liberal than the rule
stated in Section 9-313(7) in that issues of priority not otherwise
resolved in this subsection are left for resolution by the priority rules
governing conflicting interests in real estate, as opposed to the Section
9-313(7) automatic subordination of the security interest in fixtures.
Note that, for the purpose of this section, where the interest of an
encumbrancer or owner of the real estate is paramount to the interest of
the lessor, the latter term includes the residual interest of the lessor.
5. The rule stated in subsection (8) is more liberal than the rule
stated in Section 9-313(8) in that the right of removal is extended to both
the lessor and the lessee and the occasion for removal includes
expiration, termination or cancellation of the lease agreement, and
enforcement of rights and remedies under this Article, as well as default.
The new language also provides that upon removal the goods are free
and clear of conflicting interests of owners and encumbrancers of the
real estate.
6. Finally, subsection (9) provides a mechanism for the lessor of
fixtures to perfect its interest by filing a financing statement under the
provisions of the Article on Secured Transactions (Article 9), even
though the lease agreement does not create a security interest. Section
1-201(37). The relevant provisions of Article 9 must be interpreted
permissively to give effect to this mechanism as it implicitly expands the
scope of Article 9 so that its filing provisions apply to transactions that
create a lease of fixtures, even though the lease agreement does not
create a security interest. This mechanism is similar to that provided in
Section 2-326(3)(c) for the seller of goods on consignment, even though
the consignment is not "intended as security". Section
1-201(37). Given the lack of litigation with respect to the mechanism
created for consignment sales, this new mechanism should prove
effective.
Cross References: Sections 1-201(37), 2A-309(1)(c),
2A-309(4), Article 9, especially Sections 9-313, 9-313(4)(c),
9-313(4)(d), 9-313(7), 9-313(8) and 9-408.
Definitional Cross References:
"Agreed". Section 1-201(3).
"Cancellation". Section 2A-103(1)(b).
"Conforming". Section 2A-103(1)(d).
"Consumer lease". Section 2A-103(1)(e).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Lien". Section 2A-103(1)(r).
"Mortgage". Section 9-105(1)(j).
"Party". Section 1-201(29).
"Person". Section 1-201(30).
"Reasonable time". Section 1-204(1) and (2).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
"Security interest". Section 1-201(37).
"Termination". Section 2A-103(1)(z).
"Value". Section 1-201(44).
"Writing". Section 1-201(46).
Section 36-2A-310. LESSOR'S AND LESSEE'S RIGHTS WHEN
GOODS BECOME ACCESSIONS.
(1) Goods are `accessions' when they are installed in or affixed to
other goods.
(2) The interest of a lessor or a lessee under a lease contract entered
into before the goods became accessions is superior to all interests in the
whole except as stated in subsection (4).
(3) The interest of a lessor or a lessee under a lease contract entered
into at the time or after the goods became accessions is superior to all
subsequently acquired interests in the whole except as stated in
subsection (4) but is subordinate to interests in the whole existing at the
time the lease contract was made unless the holders of such interests in
the whole have in writing consented to the lease or disclaimed an
interest in the goods as part of the whole.
(4) The interest of a lessor or a lessee under a lease contract
described in subsection (2) or (3) is subordinate to the interest of
(a) a buyer in the ordinary course of business or a lessee in the
ordinary course of business of any interest in the whole acquired after
the goods became accessions; or
(b) a creditor with a security interest in the whole perfected before
the lease contract was made to the extent that the creditor makes
subsequent advances without knowledge of the lease contract.
(5) When under subsections (2) or (3) and (4) a lessor or a lessee of
accessions holds an interest that is superior to all interests in the whole,
the lessor or the lessee may (a) on default, expiration, termination, or
cancellation of the lease contract by the other party but subject to the
provisions of the lease contract and this chapter, or (b) if necessary to
enforce his other rights and remedies under this chapter, remove the
goods from the whole, free and clear of all interests in the whole, but he
must reimburse any holder of an interest in the whole who is not the
lessee and who has not otherwise agreed for the cost of repair of any
physical injury but not for any diminution in value of the whole caused
by the absence of the goods removed or by any necessity for replacing
them. A person entitled to reimbursement may refuse permission to
remove until the party seeking removal gives adequate security for the
performance of this obligation.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-314.
Changes: Revised to reflect leasing terminology and to add
new material.
Purposes: Subsections (1) and (2) restate the provisions of
subsection (1) of Section 9-314 to clarify the definition of accession and
to add leasing terminology to the priority rule that applies when the lease
is entered into before the goods become accessions. Subsection (3)
restates the provisions of subsection (2) of Section 9-314 to add leasing
terminology to the priority rule that applies when the lease is entered
into on or after the goods become accessions. Unlike the rule with
respect to security interests, the lease is merely subordinate, not invalid.
Subsection (4) creates two exceptions to the priority rules stated in
subsections (2) and (3). Subsection (4) deletes the special priority rule
found in the provisions of Section 9-314(3)(b) as the interests of the
lessor and lessee are entitled to greater protection.
Finally, subsection (5) is modeled on the provisions of Section
9-314(4) with respect to removal of accessions, restated to reflect the
parallel changes in Section 2A-309(8).
Neither this section nor Section 9-314 governs where the accession
to the goods is not subject to the interest of a lessor or a lessee under a
lease contract and is not subject to the interest of a secured party under
a security agreement. This issue is to be resolved by the courts, case by
case.
Cross References: Sections 2A-309(8), 9-314(1), 9-314(2),
9-314(3)(b), 9-314(4).
Definitional Cross References:
"Agreed". Section 1-201(3).
"Buyer in the ordinary course of business". Section
2A-103(1)(a).
"Cancellation". Section 2A-103(1)(b).
"Creditor". Section 1-201(12).
"Goods". Section 2A-103(1)(h).
"Holder". Section 1-201(20).
"Knowledge". Section 1-201(25).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessee in the ordinary course of business". Section
2A-103(1)(o).
"Lessor". Section 2A-103(1)(p).
"Party". Section 1-201(29).
"Person". Section 1-201(30).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
"Security interest". Section 1-201(37).
"Termination". Section 2A-103(1)(z).
"Value". Section 1-201(44).
"Writing". Section 1-201(46).
Section 36-2A-311. PRIORITY SUBJECT TO SUBORDINATION.
Nothing in this chapter prevents subordination by agreement by any
person entitled to priority.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-316.
Purposes: The several preceding sections deal with questions
of priority. This section is inserted to make it entirely clear that a person
entitled to priority may effectively agree to subordinate the claim. Only
the person entitled to priority may make such an agreement: the rights
of such a person cannot be adversely affected by an agreement to which
that person is not a party.
Cross References: Sections 1-102 and 2A-304 through
2A-310.
Definitional Cross References:
"Agreement". Section 1-201(3).
"Person". Section 1-201(30).
PART 4. PERFORMANCE OF LEASE
CONTRACT:
REPUDIATED, SUBSTITUTED AND EXCUSED
Section 36-2A-401. INSECURITY: ADEQUATE ASSURANCE
OF PERFORMANCE.
(1) A lease contract imposes an obligation on each party that the
other's expectation of receiving due performance will not be impaired.
(2) If reasonable grounds for insecurity arise with respect to the
performance of either party, the insecure party may demand in writing
adequate assurance of due performance. Until the insecure party
receives that assurance, if commercially reasonable the insecure party
may suspend any performance for which he has not already received the
agreed return.
(3) A repudiation of the lease contract occurs if assurance of due
performance adequate under the circumstances of the particular case is
not provided to the insecure party within a reasonable time, not to
exceed thirty days after receipt of a demand by the other party.
(4) Between merchants, the reasonableness of grounds for insecurity
and the adequacy of any assurance offered must be determined
according to commercial standards.
(5) Acceptance of any nonconforming delivery or payment does not
prejudice the aggrieved party's right to demand adequate assurance of
future performance.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-609.
Changes: Revised to reflect leasing practices and terminology.
Note that in the analogue to subsection (3) (Section 2-609(4)), the
adjective "justified" modifies demand. The adjective was
deleted here as unnecessary, implying no substantive change.
Definitional Cross References:
"Aggrieved party". Section 1-201(2).
"Agreed". Section 1-201(3).
"Between merchants". Section 2-104(3).
"Conforming". Section 2A-103(1)(d).
"Delivery". Section 1-201(14).
"Lease contract". Section 2A-103(1)(l).
"Party". Section 1-201(29).
"Reasonable time". Section 1-204(1) and (2).
"Receipt". Section 2-103(1)(c).
"Rights". Section 1-201(36).
"Writing". Section 1-201(46).
Section 36-2A-402. ANTICIPATORY REPUDIATION. If either
party repudiates a lease contract with respect to a performance not yet
due under the lease contract, the loss of which performance will
substantially impair the value of the lease contract to the other, the
aggrieved party may:
(a) for a commercially reasonable time, await retraction of
repudiation and performance by the repudiating party;
(b) make demand pursuant to Section 36-2A-401 and await assurance
of future performance adequate under the circumstances of the particular
case; or
(c) resort to any right or remedy upon default under the lease contract
or this chapter, even though the aggrieved party has notified the
repudiating party that the aggrieved party would await the repudiating
party's performance and assurance and has urged retraction. In addition,
whether or not the aggrieved party is pursuing one of the foregoing
remedies, the aggrieved party may suspend performance or, if the
aggrieved party is the lessor, proceed in accordance with the provisions
of this chapter on the lessor's right to identify goods to the lease contract
notwithstanding default or to salvage unfinished goods (Section
36-2A-524).
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-610.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Aggrieved party". Section 1-201(2).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Lessor". Section 2A-103(1)(p).
"Notifies". Section 1-201(26).
"Party". Section 1-201(29).
"Reasonable time". Section 1-204(1) and (2).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
"Value". Section 1-201(44).
Section 36-2A-403. RETRACTION OF ANTICIPATORY
REPUDIATION.
(1) Until the repudiating party's next performance is due, the
repudiating party can retract the repudiation unless, since the
repudiation, the aggrieved party has canceled the lease contract or
materially changed the aggrieved party's position or otherwise indicated
that the aggrieved party considers the repudiation final.
(2) Retraction may be by any method that clearly indicates to the
aggrieved party that the repudiating party intends to perform under the
lease contract and includes any assurance demanded under Section
36-2A-401.
(3) Retraction reinstates a repudiating party's rights under a lease
contract with due excuse and allowance to the aggrieved party for any
delay occasioned by the repudiation.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-611.
Changes: Revised to reflect leasing practices and terminology.
Note that in the analogue to subsection (2) (Section 2-611(2)) the
adjective "justifiably" modifies demanded. The adjective
was deleted here (as it was in Section 2A-401) as unnecessary, implying
no substantive change.
Definitional Cross References:
"Aggrieved party". Section 1-201(2).
"Cancellation". Section 2A-103(1)(b).
"Lease contract". Section 2A-103(1)(l).
"Party". Section 1-201(29).
"Rights". Section 1-201(36).
Section 36-2A-404. SUBSTITUTED PERFORMANCE.
(1) If without fault of the lessee, the lessor and the supplier, the
agreed berthing, loading, or unloading facilities fail or the agreed type
of carrier becomes unavailable or the agreed manner of delivery
otherwise becomes commercially impracticable, but a commercially
reasonable substitute is available, the substitute performance must be
tendered and accepted.
(2) If the agreed means or manner of payment fails because of
domestic or foreign governmental regulation:
(a) the lessor may withhold or stop delivery or cause the supplier
to withhold or stop delivery unless the lessee provides a means or
manner of payment that is commercially a substantial equivalent; and
(b) if delivery has already been taken, payment by the means or
in the manner provided by the regulation discharges the lessee's
obligation unless the regulation is discriminatory, oppressive, or
predatory.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-614.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Agreed". Section 1-201(3).
"Delivery". Section 1-201(14).
"Fault". Section 2A-103(1)(f).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Supplier". Section 2A-103(1)(x).
Section 36-2A-405. EXCUSED PERFORMANCE. Subject to
Section 36-2A-404 on substituted performance, the following rules
apply:
(a) Delay in delivery or nondelivery in whole or in part by a lessor
or a supplier who complies with paragraphs (b) and (c) is not a default
under the lease contract if performance as agreed has been made
impracticable by the occurrence of a contingency the nonoccurrence of
which was a basic assumption on which the lease contract was made or
by compliance in good faith with any applicable foreign or domestic
governmental regulation or order, whether or not the regulation or order
later proves to be invalid.
(b) If the causes mentioned in paragraph (a) affect only part of the
lessor's or the supplier's capacity to perform, he shall allocate production
and deliveries among his customers but at his option may include regular
customers not then under contract for sale or lease as well as his own
requirements for further manufacture. He may so allocate in any manner
that is fair and reasonable.
(c) The lessor seasonably shall notify the lessee and in the case of a
finance lease the supplier seasonably shall notify the lessor and the
lessee, if known, that there will be delay or nondelivery and, if
allocation is required under paragraph (b), of the estimated quota thus
made available for the lessee.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-615.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Agreed". Section 1-201(3).
"Contract". Section 1-201(11).
"Delivery". Section 1-201(14).
"Finance lease". Section 2A-103(1)(g).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Knows". Section 1-201(25).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notifies". Section 1-201(26).
"Sale". Section 2-106(1).
"Seasonably". Section 1-204(3).
"Supplier". Section 2A-103(1)(x).
Section 36-2A-406. PROCEDURE ON EXCUSED
PERFORMANCE.
(1) If the lessee receives notification of a material or indefinite delay
or an allocation justified under Section 36-2A-405, the lessee may by
written notification to the lessor as to any goods involved, and with
respect to all of the goods if under an installment lease contract the value
of the whole lease contract is substantially impaired (Section
36-2A-510):
(a) terminate the lease contract (Section 36-2A-505(2)); or
(b) except in a finance lease that is not a consumer lease, modify
the lease contract by accepting the available quota in substitution, with
due allowance from the rent payable for the balance of the lease term for
the deficiency but without further right against the lessor.
(2) If, after receipt of a notification from the lessor under Section
36-2A-405, the lessee fails so to modify the lease agreement within a
reasonable time not exceeding 30 days, the lease contract lapses with
respect to any deliveries affected.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-616(1) and (2).
Changes: Revised to reflect leasing practices and terminology.
Note that subsection 1(a) allows the lessee under a lease, including a
finance lease, the right to terminate the lease for excused performance
(Sections 2A-404 and 2A-405). However, subsection 1(b), which allows
the lessee the right to modify the lease for excused performance,
excludes a finance lease that is not a consumer lease. This exclusion is
compelled by the same policy that led to codification of provisions with
respect to irrevocable promises. Section 2A-407.
Definitional Cross References:
"Consumer lease". Section 2A-103(1)(e).
"Delivery". Section 1-201(14).
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Installment lease contract". Section 2A-103(1)(i).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notice". Section 1-201(25).
"Reasonable time". Section 1-204(1) and (2).
"Receipt". Section 2-103(1)(c).
"Rights". Section 1-201(36).
"Termination". Section 2A-103(1)(z).
"Value". Section 1-201(44).
"Written". Section 1-201(46).
Section 36-2A-407. IRREVOCABLE PROMISES: FINANCE
LEASES.
(1) In the case of a finance lease that is not a consumer lease the
lessee's promises under the lease contract become irrevocable and
independent upon the lessee's acceptance of the goods.
(2) A promise that has become irrevocable and independent under
subsection (1):
(a) is effective and enforceable between the parties, and by or
against third parties including assignees of the parties; and
(b) is not subject to cancellation, termination, modification,
repudiation, excuse, or substitution without the consent of the party to
whom the promise runs.
(3) This section does not affect the validity under any other law of
a covenant in any lease contract making the lessee's promises
irrevocable and independent upon the lessee's acceptance of the goods.
OFFICIAL COMMENT
Uniform Statutory Source: None.
Purposes: 1. This section extends the benefits of the classic
"hell or high water" clause to a finance lease that is not a
consumer lease. This section is self-executing; no special provision
need be added to the contract. This section makes covenants in a
finance lease irrevocable and independent due to the function of the
finance lessor in a three party relationship: the lessee is looking to the
supplier to perform the essential covenants and warranties. Section
2A-209. Thus, upon the lessee's acceptance of the goods the lessee's
promises to the lessor under the lease contract become irrevocable and
independent. The provisions of this section remain subject to the
obligation of good faith (Sections 2A-103(4) and 1-203), and the lessee's
revocation of acceptance (Section 2A-517).
2. The section requires the lessee to perform even if the lessor's
performance after the lessee's acceptance is not in accordance with the
lease contract; the lessee may, however, have and pursue a cause of
action against the lessor, e.g., breach of certain limited warranties
(Sections 2A-210 and 2A-211(1)). This is appropriate because the
benefit of the supplier's promises and warranties to the lessor under the
supply contract and, in some cases, the warranty of a manufacturer who
is not the supplier, is extended to the lessee under the finance lease.
Section 2A-209. Despite this balance, this section excludes a finance
lease that is a consumer lease. That a consumer be obligated to pay
notwithstanding defective goods or the like is a principle that is not
tenable under case law (Unico v. Owen, 50 N.J. 101, 232 A.2d
405 (1967)), state statute (Unif. Consumer Credit Code
Section 3.403-.405, 7A U.L.A. 126-31 (1974), or federal statute (15
U.S.C. Section 1666i (1982)).
3. The relationship of the three parties to a transaction that qualifies
as a finance lease is best demonstrated by a hypothetical. A, the
potential lessor, has been contacted by B, the potential lessee, to discuss
the lease of an expensive line of equipment that B has recently placed an
order for with C, the manufacturer of such goods. The negotiation is
completed and A, as lessor, and B, as lessee, sign a lease of the line of
equipment for a 60-month term. B, as buyer, assigns the purchase order
with C to A. If this transaction creates a lease (Section 2A-103(1)(j)),
this transaction should qualify as a finance lease. Section 2A-103(1)(g).
4. The line of equipment is delivered by C to B's place of business.
After installation by C and testing by B, B accepts the goods by signing
a certificate of delivery and acceptance, a copy of which is sent by B to
A and C. One year later the line of equipment malfunctions and B falls
behind in its manufacturing schedule.
5. Under this Article, because the lease is a finance lease, no
warranty of fitness or merchantability is extended by A to B. Sections
2A-212(1) and 2A-213. Absent an express provision in the lease
agreement, application of Section 2A-210 or Section 2A-211(1), or
application of the principles of law and equity, including the law with
respect to fraud, duress, or the like (Sections 2A-103(4) and 1-103), B
has no claim against A. B's obligation to pay rent to A continues as the
obligation became irrevocable and independent when B accepted the
line of equipment (Section 2A-407(1)). B has no right of set-off with
respect to any part of the rent still due under the lease. Section
2A-508(6). However, B may have another remedy. Despite the lack of
privity between B and C (the purchase order with C having been
assigned by B to A), B may have a claim against C. Section 2A-209(1).
6. This section does not address whether a "hell or high
water" clause, i.e., a clause that is to the effect of this section, is
enforceable if included in a finance lease that is a consumer lease or a
lease that is not a finance lease. That issue will continue to be
determined by the facts of each case and other law which this section
does not affect. Sections 2A-104, 2A-103(4), 9-206 and 9-318.
However, with respect to finance leases that are not consumer leases
courts have enforced "hell or high water" clauses. In re
O.P.M. Leasing Servs., 21 Bankr. 993, 1006 (Bankr. S.D.N.Y.
1982).
7. Subsection (2) further provides that a promise that has become
irrevocable and independent under subsection (1) is enforceable not only
between the parties but also against third parties. Thus, the finance lease
can be transferred or assigned without disturbing enforceability.
Further, subsection (2) also provides that the promise cannot, among
other things, be cancelled or terminated without the consent of the
lessor.
Cross References: Sections 1-103, 1-203, 2A-103(1)(g),
2A-103(1)(j), 2A-103(4), 2A-104, 2A-209, 2A-209(1), 2A-210,
2A-211(1), 2A-212(1), 2A-213, 2A-517(1)(b), 9-206 and 9-318.
Definitional Cross References:
"Cancellation". Section 2A-103(1)(b).
"Consumer lease". Section 2A-103(1)(e).
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Party". Section 1-201(29).
"Termination". Section 2A-103(1)(z).
PART 5. DEFAULT
A. IN GENERAL
Section 36-2A-501. DEFAULT: PROCEDURE.
(1) Whether the lessor or the lessee is in default under a lease
contract is determined by the lease agreement and this chapter.
(2) If the lessor or the lessee is in default under the lease contract,
the party seeking enforcement has rights and remedies as provided in
this chapter and, except as limited by this chapter, as provided in the
lease agreement.
(3) If the lessor or the lessee is in default under the lease contract,
the party seeking enforcement may reduce the party's claim to judgment,
or otherwise enforce the lease contract by self-help or any available
judicial procedure or nonjudicial procedure, including administrative
proceeding, arbitration, or the like, in accordance with this chapter.
(4) Except as otherwise provided in Section 36-1-106(1) or this
chapter or the lease agreement, the rights and remedies referred to in
subsections (2) and (3) are cumulative.
(5) If the lease agreement covers both real property and goods, the
party seeking enforcement may proceed under this Part as to the goods,
or under other applicable law as to both the real property and the goods
in accordance with that party's rights and remedies in respect of the real
property, in which case this Part does not apply.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-501.
Changes: Substantially revised.
Purposes: 1. Subsection (1) is new and represents a departure
from the Article on Secured Transactions (Article 9) as the subsection
makes clear that whether a party to the lease agreement is in default is
determined by this Article as well as the agreement. Sections 2A-508
and 2A-523. It further departs from Article 9 in recognizing the
potential default of either party, a function of the bilateral nature of the
obligations between the parties to the lease contract.
2. Subsection (2) is a version of the first sentence of Section
9-501(1), revised to reflect leasing terminology.
3. Subsection (3), an expansive version of the second sentence of
Section 9-501(1), lists the procedures that may be followed by the party
seeking enforcement; in effect, the scope of the procedures listed in
subsection (3) is consistent with the scope of the procedures available to
the foreclosing secured party.
4. Subsection (4) establishes that the parties' rights and remedies are
cumulative. DeKoven, Leases of Equipment: Puritan Leasing
Company v. August, A Dangerous Decision, 12 U.S.F. L. Rev. 257,
276-80 (1978). Cumulation, and largely unrestricted selection, of
remedies is allowed in furtherance of the general policy of the
Commercial Code, stated in Section 1-106, that remedies be liberally
administered to put the aggrieved party in as good a position as if the
other party had fully performed. Therefore, cumulation of, or selection
among, remedies is available to the extent necessary to put the aggrieved
party in as good a position as it would have been in had there been full
performance. However, cumulation of, or selection among, remedies is
not available to the extent that the cumulation or selection would put the
aggrieved party in a better position than it would have been in had there
been full performance by the other party.
5. Section 9-501(3), which, among other things, states that certain
rules, to the extent they give rights to the debtor and impose duties on
the secured party, may not be waived or varied, was not incorporated in
this Article. Given the significance of freedom of contract in the
development of the common law as it applies to bailments for hire and
the lessee's lack of an equity of redemption, there was no reason to
impose that restraint.
Cross References: Sections 1-106, 2A-508, 2A-523, Article
9, especially Sections 9-501(1) and 9-501(3).
Definitional Cross References:
"Goods". Section 2A-103(1)(h).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Party". Section 1-201(29).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
Section 36-2A-502. NOTICE AFTER DEFAULT. Except as
otherwise provided in this chapter or the lease agreement, the lessor or
lessee in default under the lease contract is not entitled to notice of
default or notice of enforcement from the other party to the lease
agreement.
OFFICIAL COMMENT
Uniform Statutory Source: None.
Purposes: This section makes clear that absent agreement to the
contrary or provision in this Article to the contrary, e.g., Section
2A-516(3)(a), the party in default is not entitled to notice of default or
enforcement. While a review of Part 5 of Article 9 leads to the same
conclusion with respect to giving notice of default to the debtor, it is
never stated. Although Article 9 requires notice of disposition and strict
foreclosure, the different scheme of lessors' and lessees' rights and
remedies developed under the common law, and codified by this Article,
generally does not require notice of enforcement; furthermore, such
notice is not mandated by due process requirements. However, certain
sections of this Article do require notice. E.g., Section 2A-517(2).
Cross References: Sections 2A-516(3)(a), 2A-517(2), and
Article 9, esp. Part 5.
Definitional Cross References:
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notice". Section 1-201(25).
"Party". Section 1-201(29).
Section 36-2A-503. MODIFICATION OR IMPAIRMENT OF
RIGHTS AND REMEDIES.
(1) Except as otherwise provided in this chapter, the lease agreement
may include rights and remedies for default in addition to or in
substitution for those provided in this chapter and may limit or alter the
measure of damages recoverable under this chapter.
(2) Resort to a remedy provided under this chapter or in the lease
agreement is optional unless the remedy is expressly agreed to be
exclusive. If circumstances cause an exclusive or limited remedy to fail
of its essential purpose, or provision for an exclusive remedy is
unconscionable, a remedy may be had as provided in this chapter.
(3) Consequential damages may be liquidated under Section
36-2A-504, or may otherwise be limited, altered, or excluded unless the
limitation, alteration, or exclusion is unconscionable. Limitation,
alteration, or exclusion of consequential damages for injury to the person
in the case of consumer goods is prima facie unconscionable but
limitation, alteration, or exclusion of damages where the loss is
commercial is not prima facie unconscionable.
(4) Rights and remedies on default by the lessor or the lessee with
respect to any obligation or promise collateral or ancillary to the lease
contract are not impaired by this chapter.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-719 and 2-701.
Changes: Rewritten to reflect lease terminology and to clarify
the relationship between this section and Section 2A-504.
Purposes: 1. A significant purpose of this Part is to provide
rights and remedies for those parties to a lease who fail to provide them
by agreement or whose rights and remedies fail of their essential purpose
or are unenforceable. However, it is important to note that this implies
no restriction on freedom to contract. Sections 2A-103(4) and 1-102(3).
Thus, subsection (1), a revised version of the provisions of Section
2-719(1), allows the parties to the lease agreement freedom to provide
for rights and remedies in addition to or in substitution for those
provided in this Article and to alter or limit the measure of damages
recoverable under this Article. Except to the extent otherwise provided
in this Article (e.g., Sections 2A-105, 106 and 108(1) and (2)), this Part
shall be construed neither to restrict the parties' ability to provide for
rights and remedies or to limit or alter the measure of damages by
agreement, nor to imply disapproval of rights and remedy schemes other
than those set forth in this Part.
2. Subsection (2) makes explicit with respect to this Article what is
implicit in Section 2-719 with respect to the Article on Sales (Article 2):
if an exclusive remedy is held to be unconscionable, remedies under this
Article are available. Section 2-719 official comment 1.
3. Subsection (3), a revision of Section 2-719(3), makes clear that
consequential damages may also be liquidated. Section 2A-504(1).
4. Subsection (4) is a revision of the provisions of Section 2-701.
This subsection leaves the treatment of default with respect to
obligations or promises collateral or ancillary to the lease contract to
other law. Sections 2A-103(4) and 1-103. An example of such an
obligation would be that of the lessor to the secured creditor which has
provided the funds to leverage the lessor's lease transaction; an example
of such a promise would be that of the lessee, as seller, to the lessor, as
buyer, in a sale-leaseback transaction.
Cross References: Sections 1-102(3), 1-103, Article 2,
especially Sections 2-701, 2-719, 2-719(1), 2-719(3), 2-719 official
comment 1, and Sections 2A-103(4), 2A-105, 2A-106, 2A-108(1),
2A-108(2), and 2A-504 .
Definitional Cross References:
"Agreed". Section 1-201(3).
"Consumer goods". Section 9-109(1).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Person". Section 1-201(30).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
Section 36-2A-504. LIQUIDATION OF DAMAGES.
(1) Damages payable by either party for default, or any other act or
omission, including indemnity for loss or diminution of anticipated tax
benefits or loss or damage to lessor's residual interest, may be liquidated
in the lease agreement but only at an amount or by a formula that is
reasonable in light of the then anticipated harm caused by the default or
other act or omission.
(2) If the lease agreement provides for liquidation of damages, and
such provision does not comply with subsection (1), or such provision
is an exclusive or limited remedy that circumstances cause to fail of its
essential purpose, a remedy may be had as provided in this chapter.
(3) If the lessor justifiably withholds or stops delivery of goods
because of the lessee's default or insolvency (Section 36-2A-525 or
36-2A-526), the lessee is entitled to restitution of any amount by which
the sum of his payments exceeds:
(a) the amount to which the lessor is entitled by virtue of terms
liquidating the lessor's damages in accordance with subsection (1); or
(b) in the absence of those terms, twenty percent of the then
present value of the total rent the lessee was obligated to pay for the
balance of the lease term, or, in the case of a consumer lease, the lesser
of such amount or five hundred dollars.
(4) A lessee's right to restitution under subsection (3) is subject to
offset to the extent the lessor establishes:
(a) a right to recover damages under the provisions of this chapter
other than subsection (1); and
(b) the amount or value of any benefits received by the lessee
directly or indirectly by reason of the lease contract.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-718(1), (2), (3) and 2-719(2).
Changes: Substantially rewritten.
Purposes: Many leasing transactions are predicated on the
parties' ability to agree to an appropriate amount of damages or formula
for damages in the event of default or other act or omission. The rule
with respect to sales of goods (Section 2-718) may not be sufficiently
flexible to accommodate this practice. Thus, consistent with the
common law emphasis upon freedom to contract with respect to
bailments for hire, this section has created a revised rule that allows
greater flexibility with respect to leases of goods.
Subsection (1), a significantly modified version of the provisions of
Section 2-718(1), provides for liquidation of damages in the lease
agreement at an amount or by a formula. Section 2-718(1) does not by
its express terms include liquidation by a formula; this change was
compelled by modern leasing practice. Subsection (1), in a further
expansion of Section 2-718(1), provides for liquidation of damages for
default as well as any other act or omission.
A liquidated damages formula that is common in leasing practice
provides that the sum of lease payments past due, accelerated future
lease payments, and the lessor's estimated residual interest, less the net
proceeds of disposition (whether by sale or re-lease) of the leased goods
is the lessor's damages. Tax indemnities, costs, interest and attorney's
fees are also added to determine the lessor's damages. Another common
liquidated damages formula utilizes a periodic depreciation allocation
as a credit to the aforesaid amount in mitigation of a lessor's damages.
A third formula provides for a fixed number of periodic payments as a
means of liquidating damages. Stipulated loss or stipulated damage
schedules are also common. Whether these formulae are enforceable
will be determined in the context of each case by applying a standard of
reasonableness in light of the harm anticipated when the formula was
agreed to. Whether the inclusion of these formulae will affect the
classification of the transaction as a lease or a security interest is to be
determined by the facts of each case. Section 1-201(37). E.g., In re
Noack, 44 Bankr. 172, 174-75 (Bankr. E.D. Wis. 1984).
This section does not incorporate two other tests that under sales law
determine enforceability of liquidated damages, i.e., difficulties of proof
of loss and inconvenience or nonfeasibility of otherwise obtaining an
adequate remedy. The ability to liquidate damages is critical to modern
leasing practice; given the parties' freedom to contract at common law,
the policy behind retaining these two additional requirements here was
thought to be outweighed. Further, given the expansion of subsection
(1) to enable the parties to liquidate the amount payable with respect to
an indemnity for loss or diminution of anticipated tax benefits resulted
in another change: the last sentence of Section 2-718(1), providing that
a term fixing unreasonably large liquidated damages is void as a penalty,
was also not incorporated. The impact of local, state and federal tax
laws on a leasing transaction can result in an amount payable with
respect to the tax indemnity many times greater than the original
purchase price of the goods. By deleting the reference to unreasonably
large liquidated damages the parties are free to negotiate a formula,
restrained by the rule of reasonableness in this section. These changes
should invite the parties to liquidate damages. Peters, Remedies for
Breach of Contracts Relating to the Sale of Goods Under the Uniform
Commercial Code: A Roadmap for Article Two, 73 Yale L.J. 199,
278 (1963).
Subsection (2), a revised version of Section 2-719(2), provides that
if the liquidated damages provision is not enforceable or fails of its
essential purpose, remedy may be had as provided in this Article.
Subsection (3)(b) of this section differs from subsection (2)(b) of
Section 2-718; in the absence of a valid liquidated damages amount or
formula the lessor is permitted to retain 20 percent of the present value
of the total rent payable under the lease. The alternative limitation of
$500 contained in Section 2-718 is deleted as unrealistically low with
respect to a lease other than a consumer lease.
Cross References: Sections 1-201(37), 2-718, 2-718(1),
2-718(2)(b) and 2-719(2).
Definitional Cross References:
"Consumer lease". Section 2A-103(1)(e).
"Delivery". Section 1-201(14).
"Goods". Section 2A-103(1)(h).
"Insolvent". Section 1-201(23).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Lessor's residual interest". Section 2A-103(1)(q).
"Party". Section 1-201(29).
"Present value". Section 2A-103(1)(u).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
"Term". Section 1-201(42).
"Value". Section 1-201(44).
Section 36-2A-505. CANCELLATION AND TERMINATION
AND EFFECT OF CANCELLATION, TERMINATION,
RESCISSION, OR FRAUD ON RIGHTS AND REMEDIES.
(1) On cancellation of the lease contract, all obligations that are
still executory on both sides are discharged, but any right based on prior
default or performance survives, and the canceling party also retains any
remedy for default of the whole lease contract or any unperformed
balance.
(2) On termination of the lease contract, all obligations that are
still executory on both sides are discharged but any right based on prior
default or performance survives.
(3) Unless the contrary intention clearly appears, expressions of
`cancellation', `rescission', or the like of the lease contract may not be
construed as a renunciation or discharge of any claim in damages for an
antecedent default.
(4) Rights and remedies for material misrepresentation or fraud
include all rights and remedies available under this chapter for default.
(5) Neither rescission nor a claim for rescission of the lease
contract nor rejection or return of the goods may bar or be deemed
inconsistent with a claim for damages or other right or remedy.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-106(3) and (4), 2-720 and
2-721.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Cancellation". Section 2A-103(1)(b).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Party". Section 1-201(29).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
"Termination". Section 2A-103(1)(z).
Section 36-2A-506. STATUTE OF LIMITATIONS.
(1) An action for default under a lease contract, including breach
of warranty or indemnity, must be commenced within four years after
the cause of action accrued. By the original lease contract the parties
may reduce the period of limitation to not less than one year.
(2) A cause of action for default accrues when the act or omission
on which the default or breach of warranty is based is or should have
been discovered by the aggrieved party, or when the default occurs,
whichever is later. A cause of action for indemnity accrues when the act
or omission on which the claim for indemnity is based is or should have
been discovered by the indemnified party, whichever is later.
(3) If an action commenced within the time limited by subsection
(1) is so terminated as to leave available a remedy by another action for
the same default or breach of warranty or indemnity, the other action
may be commenced after the expiration of the time limited and within
six months after the termination of the first action unless the termination
resulted from voluntary discontinuance or from dismissal for failure or
neglect to prosecute.
(4) This section does not alter the law on tolling of the statute of
limitations nor does it apply to causes of action that have accrued before
this chapter becomes effective.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-725.
Changes: Substantially rewritten.
Purposes: Subsection (1) does not incorporate the limitation
found in Section 2-725(1) prohibiting the parties from extending the
period of limitation. Breach of warranty and indemnity claims often
arise in a lease transaction; with the passage of time such claims often
diminish or are eliminated. To encourage the parties to commence
litigation under these circumstances makes little sense.
Subsection (2) states two rules for determining when a cause of
action accrues. With respect to default, the rule of Section 2-725(2) is
not incorporated in favor of a more liberal rule of the later of the date
when the default occurs or when the act or omission on which it is based
is or should have been discovered. With respect to indemnity, a
similarly liberal rule is adopted.
Cross References: Sections 2-725(1) and 2-725(2).
Definitional Cross References:
"Action". Section 1-201(1).
"Aggrieved party". Section 1-201(2).
"Lease contract". Section 2A-103(1)(l).
"Party". Section 1-201(29).
"Remedy". Section 1-201(34).
"Termination". Section 2A-103(1)(z).
Section 36-2A-507. PROOF OF MARKET RENT: TIME AND
PLACE.
(1) Damages based on market rent (Section 36-2A-519 or
36-2A-528) are determined according to the rent for the use of the goods
concerned for a lease term identical to the remaining lease term of the
original lease agreement and prevailing at the times specified in Sections
36-2A-519 and 36-2A-528.
(2) If evidence of rent for the use of the goods concerned for a
lease term identical to the remaining lease term of the original lease
agreement and prevailing at the times or places described in this chapter
is not readily available, the rent prevailing within any reasonable time
before or after the time described or at any other place or for a different
lease term which in commercial judgment or under usage of trade would
serve as a reasonable substitute for the one described may be used,
making any proper allowance for the difference, including the cost of
transporting the goods to or from the other place.
(3) Evidence of a relevant rent prevailing at a time or place or for
a lease term other than the one described in this chapter offered by one
party is not admissible unless and until he has given the other party
notice the court finds sufficient to prevent unfair surprise.
(4) If the prevailing rent or value of any goods regularly leased in
any established market is in issue, reports in official publications or
trade journals or in newspapers or periodicals of general circulation
published as the reports of that market are admissible in evidence. The
circumstances of the preparation of the report may be shown to affect its
weight but not its admissibility.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-723 and 2-724.
Changes: Revised to reflect leasing practices and terminology.
Sections 2A-519 and 2A-528 specify the times as of which market rent
is to be determined.
Definitional Cross References:
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease agreement". Section 2A-103(1)(k).
"Notice". Section 1-201(25).
"Party". Section 1-201(29).
"Reasonable time". Section 1-204(1) and (2).
"Usage of trade". Section 1-205.
"Value". Section 1-201(44).
B. DEFAULT BY LESSOR
Section 36-2A-508. LESSEE'S REMEDIES.
(1) If a lessor fails to deliver the goods in conformi ty to the
lease contract (Section 36-2A-509) or repudiates the lease contract
(Section 36-2A-402), or a lessee rightfully rejects the goods (Section
36-2A-509) or justifiably revokes acceptance of the goods (Section
36-2A-517), then with respect to any goods involved, and with respect
to all of the goods if under an installment lease contract the value of the
whole lease contract is substantially impaired (Section 36-2A-510), the
lessor is in default under the lease contract and the lessee may:
(a) cancel the lease contract (Section 36-2A-505(1));
(b) recover so much of the rent and security as has been paid
and is just under the circumstances;
(c) cover and recover damages as to all goods affected whether
or not they have been identified to the lease contract (Sections
36-2A-518 and 36-2A-520), or recover damages for nondelivery
(Sections 36-2A-519 and 36-2A-520);
(d) exercise any other rights or pursue any other remedies
provided in the lease contract.
(2) If a lessor fails to deliver the goods in conformity to the lease
contract or repudiates the lease contract, the lessee may also:
(a) if the goods have been identified, recover them (Section
36-2A-522); or
(b) in a proper case, obtain specific performance or replevy the
goods (Section 36-2A-521).
(3) If a lessor is otherwise in default under a lease contract, the
lessee may exercise the rights and pursue the remedies provided in the
lease contract, which may include a right to cancel the lease, and in
Section 36-2A-519(3).
(4) If a lessor has breached a warranty, whether express or
implied, the lessee may recover damages (Section 36-2A-519(4)).
(5) On rightful rejection or justifiable revocation of acceptance,
a lessee has a security interest in goods in the lessee's possession or
control for any rent and security that has been paid and any expenses
reasonably incurred in their inspection, receipt, transportation, and care
and custody and may hold those goods and dispose of them in good faith
and in a commercially reasonable manner, subject to Section
36-2A-527(5).
(6) Subject to the provisions of Section 36-2A-407, a lessee, on
notifying the lessor of the lessee's intention to do so, may deduct all or
any part of the damages resulting from any default under the lease
contract from any part of the rent still due under the same lease contract.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-711 and 2-717.
Changes: Substantially rewritten.
Purposes: 1. This section is an index to Sections 2A-509
through 522 which set out the lessee's rights and remedies after the
lessor's default. The lessor and the lessee can agree to modify the rights
and remedies available under this Article; they can, among other things,
provide that for defaults other than those specified in subsection (1) the
lessee can exercise the rights and remedies referred to in subsection (1);
and they can create a new scheme of rights and remedies triggered by
the occurrence of the default. Sections 2A-103(4) and 1-102(3).
2. Subsection (1), a substantially rewritten version of the provisions
of Section 2-711(1), lists three cumulative remedies of the lessee where
the lessor has failed to deliver conforming goods or has repudiated the
contract, or the lessee has rightfully rejected or justifiably revoked.
Sections 2A-501(2) and (4). Subsection (1) also allows the lessee to
exercise any contractual remedy. This Article rejects any general
doctrine of election of remedy. To determine if one remedy bars another
in a particular case is a function of whether the lessee has been put in as
good a position as if the lessor had fully performed the lease agreement.
Use of multiple remedies is barred only if the effect is to put the lessee
in a better position than it would have been in had the lessor fully
performed under the lease. Sections 2A-103(4), 2A-501(4), and
1-106(1). Subsection (1)(b), in recognition that no bright line can be
created that would operate fairly in all installment lease cases and in
recognition of the fact that a lessee may be able to cancel the lease
(revoke acceptance of the goods) after the goods have been in use for
some period of time, does not require that all lease payments made by
the lessee under the lease be returned upon cancellation. Rather, only
such portion as is just of the rent and security payments made may be
recovered. If a defect in the goods is discovered immediately upon
tender to the lessee and the goods are rejected immediately, then the
lessee should recover all payments made. If, however, for example, a
36-month equipment lease is terminated in the 12th month because the
lessor has materially breached the contract by failing to perform its
maintenance obligations, it may be just to return only a small part or
none of the rental payments already made.
3. Subsection (2), a version of the provisions of Section 2-711(2)
revised to reflect leasing terminology, lists two alternative remedies for
the recovery of the goods by the lessee; however, each of these remedies
is cumulative with respect to those listed in subsection (1).
4. Subsection (3) is new. It covers defaults which do not deprive the
lessee of the goods and which are not so serious as to justify rejection or
revocation of acceptance under subsection (1). It also covers defaults
for which the lessee could have rejected or revoked acceptance of the
goods but elects not to do so and retains the goods. In either case, a
lessee which retains the goods is entitled to recover damages as stated
in Section 2A-519(3). That measure of damages is "the loss
resulting in the ordinary course of events from the lessor's default as
determined in any manner that is reasonable together with incidental and
consequential damages, less expenses saved in consequence of the
lessor's breach."
5. Subsection (1)(d) and subsection (3) recognize that the lease
agreement may provide rights and remedies in addition to or different
from those which Article 2A provides. In particular, subsection (3)
provides that the lease agreement may give the remedy of cancellation
of the lease for defaults by the lessor that would not otherwise be
material defaults which would justify cancellation under subsection (1).
If there is a right to cancel, there is, of course, a right to reject or revoke
acceptance of the goods.
6. Subsection (4) is new and merely adds to the completeness of the
index by including a reference to the lessee's recovery of damages upon
the lessor's breach of warranty; such breach may not rise to the level of
a default by the lessor justifying revocation of acceptance. If the lessee
properly rejects or revokes acceptance of the goods because of a breach
of warranty, the rights and remedies are those provided in subsection (1)
rather than those in Section 2A-519(4).
7. Subsection (5), a revised version of the provisions of Section
2-711(3), recognizes, on rightful rejection or justifiable revocation, the
lessee's security interest in goods in its possession and control. Section
9-113, which recognized security interests arising under the Article on
Sales (Article 2), was amended with the adoption of this Article to
reflect the security interests arising under this Article. Pursuant to
Section 2A-511(4), a purchaser who purchases goods from the lessee in
good faith takes free of any rights of the lessor, or in the case of a
finance lease the supplier. Such goods, however, must have been
rightfully rejected and disposed of pursuant to Section 2A-511 or
2A-512. However, Section 2A-517(5) provides that the lessee will have
the same rights and duties with respect to goods where acceptance has
been revoked as with respect to goods rejected. Thus, Section
2A-511(4) will apply to the lessee's disposition of such goods.
8. Pursuant to Section 2A-527(5), the lessee must account to the
lessor for the excess proceeds of such disposition, after satisfaction of
the claim secured by the lessee's security interest.
9. Subsection (6), a slightly revised version of the provisions of
Section 2-717, sanctions a right of set-off by the lessee, subject to the
rule of Section 2A-407 with respect to irrevocable promises in a finance
lease that is not a consumer lease, and further subject to an enforceable
"hell or high water" clause in the lease agreement. Section
2A-407 official comment. No attempt is made to state how the set-off
should occur; this is to be determined by the facts of each case.
10. There is no special treatment of the finance lease in this
section. Absent supplemental principles of law and equity to the
contrary, in the case of most finance leases, following the lessee's
acceptance of the goods the lessee will have no rights or remedies
against the lessor, because the lessor's obligations to the lessee are
minimal. Sections 2A-210 and 2A-211(1). Since the lessee will look to
the supplier for performance, this is appropriate. Section 2A-209.
Cross References: Sections 1-102(3), 1-103, 1-106(1),
Article 2, especially Sections 2-711, 2-717 and Sections 2A-103(4),
2A-209, 2A-210, 2A-211(1), 2A-407, 2A-501(2), 2A-501(4), 2A-509
through 2A-522, 2A-511(3), 2A-517(5), 2A-527(5) and Section 9-113.
Definitional Cross References:
"Conforming". Section 2A-103(1)(d).
"Delivery". Section 1-201(14).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Goods". Section 2A-103(1)(h).
"Installment lease contract". Section 2A-103(1)(i).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notifies". Section 1-201(26).
"Receipt". Section 2-103(1)(c).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
"Security interest". Section 1-201(37).
"Value". Section 1-201(44).
Section 36-2A-509. LESSEE'S RIGHTS ON IMPROPER
DELIVERY; RIGHTFUL REJECTION.
(1) Subject to the provisions of Section 36-2A-510 on default in
installment lease contracts, if the goods or the tender or delivery fail in
any respect to conform to the lease contract, the lessee may reject or
accept the goods or accept any commercial unit or units and reject the
rest of the goods.
(2) Rejection of goods is ineffective unless it is within a reasonable
time after tender or delivery of the goods and the lessee seasonably
notifies the lessor.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-601 and 2-602(1).
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Commercial unit". Section 2A-103(1)(c).
"Conforming". Section 2A-103(1)(d).
"Delivery". Section 1-201(14).
"Goods". Section 2A-103(1)(h).
"Installment lease contract". Section 2A-103(1)(i).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notifies". Section 1-201(26).
"Reasonable time". Section 1-204(1) and (2).
"Rights". Section 1-201(36).
"Seasonably". Section 1-204(3).
Section 36-2A-510. INSTALLMENT LEASE CONTRACTS:
REJECTION AND DEFAULT.
(1) Under an installment lease contract a lessee may reject any
delivery that is nonconforming if the nonconformity substantially
impairs the value of that delivery and cannot be cured or the
nonconformity is a defect in the required documents; but if the
nonconformity does not fall within subsection (2) and the lessor or the
supplier gives adequate assurance of its cure, the lessee must accept that
delivery.
(2) Whenever nonconformity or default with respect to one or more
deliveries substantially impairs the value of the installment lease
contract as a whole there is a default with respect to the whole. But, the
aggrieved party reinstates the installment lease contract as a whole if the
aggrieved party accepts a nonconforming delivery without seasonably
notifying of cancellation or brings an action with respect only to past
deliveries or demands performance as to future deliveries.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-612.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Action". Section 1-201(1)
"Aggrieved party". Section 1-201(2).
"Cancellation". Section 2A-103(1)(b).
"Conforming". Section 2A-103(1)(d).
"Delivery". Section 1-201(14).
"Installment lease contract". Section 2A-103(1)(i).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notifies". Section 1-201(26).
"Seasonably". Section 1-204(3).
"Supplier". Section 2A-103(1)(x).
"Value". Section 1-201(44).
Section 36-2A-511. MERCHANT LESSEE'S DUTIES AS TO
RIGHTFULLY REJECTED GOODS.
(1) Subject to any security interest of a lessee (Section
36-2A-508(5)), if a lessor or a supplier has no agent or place of business
at the market of rejection, a merchant lessee, after rejection of goods in
his possession or control, shall follow any reasonable instructions
received from the lessor or the supplier with respect to the goods. In the
absence of those instructions, a merchant lessee shall make reasonable
efforts to sell, lease, or otherwise dispose of the goods for the lessor's
account if they threaten to decline in value speedily. Instructions are not
reasonable if on demand indemnity for expenses is not forthcoming.
(2) If a merchant lessee (subsection (1)) or any other lessee (Section
36-2A-512) disposes of goods, he is entitled to reimbursement either
from the lessor or the supplier or out of the proceeds for reasonable
expenses of caring for and disposing of the goods and, if the expenses
include no disposition commission, to such commission as is usual in the
trade, or if there is none, to a reasonable sum not exceeding 10 percent
of the gross proceeds.
(3) In complying with this section or Section 36-2A-512, the lessee
is held only to good faith. Good faith conduct hereunder is neither
acceptance or conversion nor the basis of an action for damages.
(4) A purchaser who purchases in good faith from a lessee pursuant
to this section or Section 36-2A-512 takes the goods free of any rights
of the lessor and the supplier even though the lessee fails to comply with
one or more of the requirements of this chapter.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-603 and 2-706(5).
Changes: Revised to reflect leasing practices and terminology.
This section, by its terms, applies to merchants as well as others. Thus,
in construing the section it is important to note that under this Act the
term good faith is defined differently for merchants (Section
2-103(1)(b)) than for others (Section 1-201(19)). Section 2A-103(3) and
(4).
Definitional Cross References:
"Action". Section 1-201(1).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Merchant lessee". Section 2A-103(1)(t).
"Purchaser". Section 1-201(33).
"Rights". Section 1-201(36).
"Security interest". Section 1-201(37).
"Supplier". Section 2A-103(1)(x).
"Value". Section 1-201(44).
Section 36-2A-512. LESSEE'S DUTIES AS TO RIGHTFULLY
REJECTED GOODS.
(1) Except as otherwise provided with respect to goods that threaten
to decline in value speedily (Section 36-2A-511) and subject to any
security interest of a lessee (Section 36-2A-508(5)):
(a) the lessee, after rejection of goods in the lessee's possession,
shall hold them with reasonable care at the lessor's or the supplier's
disposition for a reasonable time after the lessee's seasonable notification
of rejection;
(b) if the lessor or the supplier gives no instructions within a
reasonable time after notification of rejection, the lessee may store the
rejected goods for the lessor's or the supplier's account or ship them to
the lessor or the supplier or dispose of them for the lessor's or the
supplier's account with reimbursement in the manner provided in Section
36-2A-511; but
(c) the lessee has no further obligations with regard to goods
rightfully rejected.
(2) Action by the lessee pursuant to subsection (1) is not acceptance
or conversion.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-602(2)(b) and (c) and 2-604.
Changes: Substantially rewritten.
Purposes: The introduction to subsection (1) references goods
that threaten to decline in value speedily and not perishables, the
reference in Section 2-604, the statutory analogue. This is a change in
style, not substance, as the first phrase includes the second.
Subparagraphs (a) and (c) are revised versions of the provisions of
Section 2-602(2)(b) and (c). Subparagraph (a) states the rule with
respect to the lessee's treatment of goods in its possession following
rejection; subparagraph (b) states the rule regarding such goods if the
lessor or supplier then fails to give instructions to the lessee. If the
lessee performs in a fashion consistent with subparagraphs (a) and (b),
subparagraph (c) exonerates the lessee.
Cross References: Sections 2-602(2)(b), 2-602(2)(c) and
2-604.
Definitional Cross References:
"Action". Section 1-201(1).
"Goods". Section 2A-103(1)(h).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notification". Section 1-201(26).
"Reasonable time". Section 1-204(1) and (2).
"Seasonably". Section 1-204(3).
"Security interest". Section 1-201(37).
"Supplier". Section 2A-103(1)(x).
"Value". Section 1-201(44).
Section 36-2A-513. CURE BY LESSOR OF IMPROPER TENDER
OR DELIVERY; REPLACEMENT.
(1) If any tender or delivery by the lessor or the supplier is rejected
because nonconforming and the time for performance has not yet
expired, the lessor or the supplier may seasonably notify the lessee of the
lessor's or the supplier's intention to cure and may then make a
conforming delivery within the time provided in the lease contract.
(2) If the lessee rejects a nonconforming tender that the lessor or the
supplier had reasonable grounds to believe would be acceptable with or
without money allowance, the lessor or the supplier may have a further
reasonable time to substitute a conforming tender if he seasonably
notifies the lessee.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-508.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Conforming". Section 2A-103(1)(d).
"Delivery". Section 1-201(14).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Money". Section 1-201(24).
"Notifies". Section 1-201(26).
"Reasonable time". Section 1-204(1) and (2).
"Seasonably". Section 1-204(3).
"Supplier". Section 2A-103(1)(x).
Section 36-2A-514. WAIVER OF LESSEE'S OBJECTIONS.
(1) In rejecting goods, a lessee's failure to state a particular defect
that is ascertainable by reasonable inspection precludes the lessee from
relying on the defect to justify rejection or to establish default:
(a) if, stated seasonably, the lessor or the supplier could have
cured it (Section 36-2A-513); or
(b) between merchants if the lessor or the supplier after
rejection has made a request in writing for a full and final written
statement of all defects on which the lessee proposes to rely.
(2) A lessee's failure to reserve rights when paying rent or other
consideration against documents precludes recovery of the payment for
defects apparent on the face of the documents.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-605.
Changes: Revised to reflect leasing practices and terminology.
Purposes: The principles applicable to the commercial practice
of payment against documents (subsection 2) are explained in official
comment 4 to Section 2-605, the statutory analogue to this section.
Cross Reference: Section 2-605 official comment 4.
Definitional Cross References:
"Between merchants". Section 2-104(3).
"Goods". Section 2A-103(1)(h).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Rights". Section 1-201(36).
"Seasonably". Section 1-204(3).
"Supplier". Section 2A-103(1)(x).
"Writing". Section 1-201(46).
Section 36-2A-515. ACCEPTANCE OF GOODS.
(1) Acceptance of goods occurs after the lessee has had a
reasonable opportunity to inspect the goods and
(a) the lessee signifies or acts with respect to the goods in a
manner that signifies to the lessor or the supplier that the goods are
conforming or that the lessee will take or retain them in spite of their
nonconformity; or
(b) the lessee fails to make an effective rejection of the goods
(Section 36-2A-509(2)).
(2) Acceptance of a part of any commercial unit is acceptance of
that entire unit.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-606.
Changes: The provisions of Section 2-606(1)(a) were
substantially rewritten to provide that the lessee's conduct may signify
acceptance. Further, the provisions of Section 2-606(1)(c) were not
incorporated as irrelevant given the lessee's possession and use of the
leased goods.
Cross References: Sections 2-606(1)(a) and 2-606(1)(c).
Definitional Cross References:
"Commercial unit". Section 2A-103(1)(c).
"Conforming". Section 2A-103(1)(d).
"Goods". Section 2A-103(1)(h).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Supplier". Section 2A-103(1)(x).
Section 36-2A-516. EFFECT OF ACCEPTANCE OF GOODS;
NOTICE OF DEFAULT; BURDEN OF ESTABLISHING DEFAULT
AFTER ACCEPTANCE; NOTICE OF CLAIM OR LITIGATION TO
PERSON ANSWERABLE OVER.
(1) A lessee must pay rent for any goods accepted in accordance
with the lease contract, with due allowance for goods rightfully rejected
or not delivered.
(2) A lessee's acceptance of goods precludes rejection of the
goods accepted. In the case of a finance lease, if made with knowledge
of a nonconformity, acceptance cannot be revoked because of it. In any
other case, if made with knowledge of a nonconformity, acceptance
cannot be revoked because of it unless the acceptance was on the
reasonable assumption that the nonconformity would be seasonably
cured. Acceptance does not of itself impair any other remedy provided
by this chapter or the lease agreement for nonconformity.
(3) If a tender has been accepted:
(a) within a reasonable time after the lessee discovers or should
have discovered any default, the lessee shall notify the lessor and the
supplier, if any, or be barred from any remedy against the party not
notified;
(b) except in the case of a consumer lease, within a reasonable
time after the lessee receives notice of litigation for infringement or the
like (Section 36-2A-211) the lessee shall notify the lessor or be barred
from any remedy over for liability established by the litigation; and
(c) the burden is on the lessee to establish any default.
(4) If a lessee is sued for breach of a warranty or other obligation
for which a lessor or a supplier is answerable over the following apply:
(a) The lessee may give the lessor or the supplier, or both, written
notice of the litigation. If the notice states that the person notified may
come in and defend and that if the person notified does not do so that
person will be bound in any action against that person by the lessee by
any determination of fact common to the two litigations, then unless the
person notified after seasonable receipt of the notice does come in and
defend that person is so bound.
(b) The lessor or the supplier may demand in writing that the
lessee turn over control of the litigation including settlement if the claim
is one for infringement or the like (Section 36-2A-211) or else be barred
from any remedy over. If the demand states that the lessor or the
supplier agrees to bear all expense and to satisfy any adverse judgment,
then unless the lessee after seasonable receipt of the demand does turn
over control the lessee is so barred.
(5) Subsections (3) and (4) apply to any obligation of a lessee to
hold the lessor or the supplier harmless against infringement or the like
(Section 36-2A-211).
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-607.
Changes: Substantially revised.
Purposes: 1. Subsection (2) creates a special rule for finance
leases, precluding revocation if acceptance is made with knowledge of
nonconformity with respect to the lease agreement, as opposed to the
supply agreement; this is not inequitable as the lessee has a direct claim
against the supplier. Section 2A-209(1). Revocation of acceptance of
a finance lease is permitted if the lessee's acceptance was without
discovery of the nonconformity (with respect to the lease agreement, not
the supply agreement) and was reasonably induced by the lessor's
assurances. Section 2A-517(1)(b). Absent exclusion or modification,
the lessor under a finance lease makes certain warranties to the lessee.
Sections 2A-210 and 2A-211(1). Revocation of acceptance is not
prohibited even after the lessee's promise has become irrevocable and
independent. Section 2A-407 official comment. Where the finance
lease creates a security interest, the rule may be to the contrary.
General Elec. Credit Corp. of Tennessee v. Ger-Beck Mach.
Co., 806 F.2d 1207 (3rd Cir. 1986).
2. Subsection (3)(a) requires the lessee to give notice of default,
within a reasonable time after the lessee discovered or should have
discovered the default. In a finance lease, notice may be given either
to the supplier, the lessor, or both, but remedy is barred against the party
not notified. In a finance lease, the lessor is usually not liable for defects
in the goods and the essential notice is to the supplier. While notice to
the finance lessor will often not give any additional rights to the lessee,
it would be good practice to give the notice since the finance lessor has
an interest in the goods. Subsection (3)(a) does not use the term finance
lease, but the definition of supplier is a person from whom a lessor buys
or leases goods to be leased under a finance lease. Section
2A-103(1)(x). Therefore, there can be a "supplier" only in
a finance lease. Subsection (4) applies similar notice rules as to lessors
and suppliers if a lessee is sued for a breach of warranty or other
obligation for which a lessor or supplier is answerable over.
3. Subsection (3)(b) requires the lessee to give the lessor notice of
litigation for infringement or the like. There is an exception created in
the case of a consumer lease. While such an exception was considered
for a finance lease, it was not created because it was not necessary - the
lessor in a finance lease does not give a warranty against infringement.
Section 2A-211(2). Even though not required under subsection (3)(b),
the lessee who takes under a finance lease should consider giving notice
of litigation for infringement or the like to the supplier, because the
lessee obtains the benefit of the suppliers' promises subject to the
suppliers' defenses or claims. Sections 2A-209(1) and 2-607(3)(b).
Cross References: Sections 2-607(3)(b), 2A-103(1)(x),
2A-209(1), 2A-210, 2A-211(1), 2A-211(2), 2A-407 official comment
and 2A-517(1)(b).
Definitional Cross References:
"Action". Section 1-201(1).
"Agreement". Section 1-201(3).
"Burden of establishing". Section 1-201(8).
"Conforming". Section 2A-103(1)(d).
"Consumer lease". Section 2A-103(1)(e).
"Delivery". Section 1-201(14).
"Discover". Section 1-201(25).
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Knowledge". Section 1-201(25).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notice". Section 1-201(25).
"Notifies". Section 1-201(26).
"Person". Section 1-201(30).
"Reasonable time". Section 1-204(1) and (2).
"Receipt". Section 2-103(1)(c).
"Remedy". Section 1-201(34).
"Seasonably". Section 1-204(3).
"Supplier". Section 2A-103(1)(x).
"Written". Section 1-201(46).
Section 36-2A-517. REVOCATION OF ACCEPTANCE OF
GOODS.
(1) A lessee may revoke acceptance of a lot or commercial unit
whose nonconformity substantially impairs its value to the lessee if the
lessee has accepted it:
(a) except in the case of a finance lease, on the reasonable
assumption that its nonconformity would be cured and it has not been
seasonably cured; or
(b) without discovery of the nonconformity if the lessee's
acceptance was reasonably induced either by the lessor's assurances or,
except in the case of a finance lease, by the difficulty of discovery
before acceptance.
(2) Except in the case of a finance lease that is not a consumer
lease, a lessee may revoke acceptance of a lot or commercial unit if the
lessor defaults under the lease contract and the default substantially
impairs the value of that lot or commercial unit to the lessee.
(3) If the lease agreement so provides, the lessee may revoke
acceptance of a lot or commercial unit because of other defaults by the
lessor.
(4) Revocation of acceptance must occur within a reasonable time
after the lessee discovers or should have discovered the ground for it and
before any substantial change in condition of the goods which is not
caused by the nonconformity. Revocation is not effective until the
lessee notifies the lessor.
(5) A lessee who so revokes has the same rights and duties with
regard to the goods involved as if the lessee had rejected them.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-608.
Changes: Revised to reflect leasing practices and terminology.
Note that in the case of a finance lease the lessee retains a limited right
to revoke acceptance. Sections 2A-517(1)(b) and 2A-516 official
comment. New subsections (2) and (3) added.
Purposes: 1. The section states the situations under which the
lessee may return the goods to the lessor and cancel the lease.
Subsection (2) recognizes that the lessor may have continuing
obligations under the lease and that a default as to those obligations may
be sufficiently material to justify revocation of acceptance of the leased
items and cancellation of the lease by the lessee. For example, a failure
by the lessor to fulfill its obligation to maintain leased equipment or to
supply other goods which are necessary for the operation of the leased
equipment may justify revocation of acceptance and cancellation of the
lease.
2. Subsection (3) specifically provides that the lease agreement may
provide that the lessee can revoke acceptance for defaults by the lessor
which in the absence of such an agreement might not be considered
sufficiently serious to justify revocation. That is, the parties are free to
contract on the question of what defaults are so material that the lessee
can cancel the lease.
Cross Reference: Section 2A-516 official comment.
Definitional Cross References:
"Commercial unit". Section 2A-103(1)(c).
"Conforming". Section 2A-103(1)(d).
"Discover". Section 1-201(25).
"Finance lease". Section 2A-103(1)(g).
"Goods". Section 2A-103(1)(h).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Lot". Section 2A-103(1)(s).
"Notifies." Section 1-201(26).
"Reasonable time". Section 1-204(1) and (2).
"Rights". Section 1-201(36).
"Seasonably". Section 1-204(3).
"Value". Section 1-201(44).
Section 36-2A-518. COVER; SUBSTITUTE GOODS.
(1) After a default by a lessor under the lease contract of the type
described in Section 36-2A-508(1), or, if agreed, after other default by
the lessor, the lessee may cover by making any purchase or lease of or
contract to purchase or lease goods in substitution for those due from the
lessor.
(2) Except as otherwise provided with respect to damages liquidated
in the lease agreement (Section 36-2A-504) or otherwise determined
pursuant to agreement of the parties (Sections 36-1-102(3) and
36-2A-503), if a lessee's cover is by a lease agreement substantially
similar to the original lease agreement and the new lease agreement is
made in good faith and in a commercially reasonable manner, the lessee
may recover from the lessor as damages (i) the present value, as of the
date of the commencement of the term of the new lease agreement, of
the rent under the new lease agreement applicable to that period of the
new lease term which is comparable to the then remaining term of the
original lease agreement minus the present value as of the same date of
the total rent for the then remaining lease term of the original lease
agreement, and (ii) any incidental or consequential damages, less
expenses saved in consequence of the lessor's default.
(3) If a lessee's cover is by lease agreement that for any reason does
not qualify for treatment under subsection (2), or is by purchase or
otherwise, the lessee may recover from the lessor as if the lessee had
elected not to cover and Section 36-2A-519 governs.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-712.
Changes: Substantially revised.
Purposes: 1. Subsection (1) allows the lessee to take action to
fix its damages after default by the lessor. Such action may consist of
the lease of goods. The decision to cover is a function of commercial
judgment, not a statutory mandate replete with sanctions for failure to
comply. Cf. Section 9-507.
2. Subsection (2) states a rule for determining the amount of lessee's
damages provided that there is no agreement to the contrary. The
lessee's damages will be established using the new lease agreement as
a measure if the following three criteria are met: (i) the lessee's cover is
by lease agreement, (ii) the lease agreement is substantially similar to the
original lease agreement, and (iii) such cover was effected in good faith,
and in a commercially reasonable manner. Thus, the lessee will be
entitled to recover from the lessor the present value, as of the date of
commencement of the term of the new lease agreement, of the rent
under the new lease agreement applicable to that period which is
comparable to the then remaining term of the original lease agreement
less the present value of the rent reserved for the remaining term under
the original lease, together with incidental or consequential damages less
expenses saved in consequence of the lessor's default. Consequential
damages may include loss suffered by the lessee because of deprivation
of the use of the goods during the period between the default and the
acquisition of the goods under the new lease agreement. If the lessee's
cover does not satisfy the criteria of subsection (2), Section 2A-519
governs.
3. Two of the three criteria to be met by the lessee are familiar, but
the concept of the new lease agreement being substantially similar to the
original lease agreement is not. Given the many variables facing a party
who intends to lease goods and the rapidity of change in the market
place, the policy decision was made not to draft with specificity. It was
thought unwise to seek to establish certainty at the cost of fairness.
Thus, the decision of whether the new lease agreement is substantially
similar to the original will be determined case by case.
4. While the section does not draw a bright line, it is possible to
describe some of the factors that should be considered in finding that a
new lease agreement is substantially similar to the original. First, the
goods subject to the new lease agreement should be examined. For
example, in a lease of computer equipment the new lease might be for
more modern equipment. However, it may be that at the time of the
lessor's breach it was not possible to obtain the same type of goods in the
market place. Because the lessee's remedy under Section 2A-519 is
intended to place the lessee in essentially the same position as if he had
covered, if goods similar to those to have been delivered under the
original lease are not available, then the computer equipment in this
hypothetical should qualify as a commercially reasonable substitute. See
Section 2-712(1).
5. Second, the various elements of the new lease agreement should
also be examined. Those elements include the presence or absence of
options to purchase or release; the lessor's representations, warranties
and covenants to the lessee, as well as those to be provided by the lessee
to the lessor; and the services, if any, to be provided by the lessor or by
the lessee. All of these factors allocate cost and risk between the lessor
and the lessee and thus affect the amount of rent to be paid. If the
differences between the original lease and the new lease can be easily
valued, it would be appropriate for a court to adjust the difference in
rental to take account of the difference between the two leases, find that
the new lease is substantially similar to the old lease, and award cover
damages under this section. If, for example, the new lease requires the
lessor to insure the goods in the hands of the lessee, while the original
lease required the lessee to insure, the usual cost of such insurance could
be deducted from the rent due under the new lease before determining
the difference in rental between the two leases.
6. Having examined the goods and the agreement, the test to be
applied is whether, in light of these comparisons, the new lease
agreement is substantially similar to the original lease agreement. These
findings should not be made with scientific precision, as they are a
function of economics, nor should they be made independently with
respect to the goods and each element of the agreement, as it is
important that a sense of commercial judgment pervade the finding. To
establish the new lease as a proper measure of damage under subsection
(2), these factors, taken as a whole, must result in a finding that the new
lease agreement is substantially similar to the original.
7. A new lease can be substantially similar to the original lease even
though its term extends beyond the remaining term of the original lease,
so long as both (a) the lease terms are commercially comparable (e.g.,
it is highly unlikely that a one-month rental and a five-year lease would
reflect similar commercial realities), and (b) the court can fairly
apportion a part of the rental payments under the new lease to that part
of the term of the new lease which is comparable to the remaining lease
term under the original lease. Also, the lease term of the new lease may
be comparable to the term of the original lease even though the
beginning and ending dates of the two leases are not the same. For
example, a two-month lease of agricultural equipment for the months of
August and September may be comparable to a two-month lease running
from the 15th of August to the 15th of October if in the particular
location two-month leases beginning on August 15th are basically
interchangeable with two-month leases beginning August 1st. Similarly,
the term of a one-year truck lease beginning on the 15th of January may
be comparable to the term of a one-year truck lease beginning January
2d. If the lease terms are found to be comparable, the court may base
cover damages on the entire difference between the costs under the two
leases.
Cross References: Sections 2-712(1), 2A-519 and 9-507.
Definitional Cross References:
"Agreement". Section 1-201(3).
"Contract". Section 1-201(11).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(l)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Party". Section 1-201(29).
"Present value". Section 2A-103(1)(u).
"Purchase". Section 2A-103(1)(v).
Section 36-2A-519. LESSEE'S DAMAGES FOR NONDELIVERY,
REPUDIATION, DEFAULT, AND BREACH OF WARRANTY IN
REGARD TO ACCEPTED GOODS.
(1) Except as otherwise provided with respect to damages liquidated
in the lease agreement (Section 36-2A-504) or otherwise determined
pursuant to agreement of the parties ( Sections 36-1-102(3) and
36-2A-503), if a lessee elects not to cover or a lessee elects to cover and
the cover is by lease agreement that for any reason does not qualify for
treatment under Section 36-2A-518(2), or is by purchase or otherwise,
the measure of damages for nondelivery or repudiation by the lessor or
for rejection or revocation of acceptance by the lessee is the present
value, as of the date of the default, of the then market rent minus the
present value as of the same date of the original rent, computed for the
remaining lease term of the original lease agreement, together with
incidental and consequential damages, less expenses saved in
consequence of the lessor's default.
(2) Market rent is to be determined as of the place for tender or, in
cases of rejection after arrival or revocation of acceptance, as of the
place of arrival.
(3) Except as otherwise agreed, if the lessee has accepted goods and
given notification (Section 36-2A-516(3)), the measure of damages for
nonconforming tender or delivery or other default by a lessor is the loss
resulting in the ordinary course of events from the lessor's default as
determined in any manner that is reasonable together with incidental and
consequential damages, less expenses saved in consequence of the
lessor's default.
(4) Except as otherwise agreed, the measure of damages for breach
of warranty is the present value at the time and place of acceptance of
the difference between the value of the use of the goods accepted and
the value if they had been as warranted for the lease term, unless special
circumstances show proximate damages of a different amount, together
with incidental and consequential damages, less expenses saved in
consequence of the lessor's default or breach of warranty.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-713 and 2-714.
Changes: Substantially revised.
Purposes: 1. Subsection (1), a revised version of the
provisions of Section 2-713(1), states the basic rule governing the
measure of lessee's damages for non-delivery or repudiation by the
lessor or for rightful rejection or revocation of acceptance by the lessee.
This measure will apply, absent agreement to the contrary, if the lessee
does not cover or if the cover does not qualify under Section 2A-518.
There is no sanction for cover that does not qualify.
2. The measure of damage is the present value, as of the date of
default, of the market rent for the remaining term of the lease less the
present value of the original rent for the remaining term of the lease,
plus incidental and consequential damages less expenses saved in
consequence of the default. Note that the reference in Section
2A-519(1) is to the date of default not to the date of an event of default.
An event of default under a lease agreement becomes a default under a
lease agreement only after the expiration of any relevant period of grace
and compliance with any notice requirements under this Article and the
lease agreement. American Bar Foundation, Commentaries on
Indentures, Section 5-1, at 216-217 (1971). Section 2A-501(1).
This conclusion is also a function of whether, as a matter of fact or law,
the event of default has been waived, suspended or cured. Sections
2A-103(4) and 1-103.
3. Subsection (2), a revised version of the provisions of Section
2-713(2), states the rule with respect to determining market rent.
4. Subsection (3), a revised version of the provisions of Section
2-714(1) and (3), states the measure of damages where goods have been
accepted and acceptance is not revoked. The subsection applies both to
defaults which occur at the inception of the lease and to defaults which
occur subsequently, such as failure to comply with an obligation to
maintain the leased goods. The measure in essence is the loss, in the
ordinary course of events, flowing from the default.
5. Subsection (4), a revised version of the provisions of Section
2-714(2), states the measure of damages for breach of warranty. The
measure in essence is the present value of the difference between the
value of the goods accepted and of the goods if they had been as
warranted.
6. Subsections (1), (3) and (4) specifically state that the parties may
by contract vary the damages rules stated in those subsections.
Cross References: Sections 2-713(1), 2-713(2), 2-714 and
Section 2A-518.
Definitional Cross References:
"Conforming". Section 2A-103(1)(d).
"Delivery". Section 1-201(14).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease agreement". Section 2A-103(1)(k).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notification". Section 1-201(26).
"Present value". Section 2A-103(1)(u).
"Value". Section 1-201(44).
Section 36-2A-520. LESSEE'S INCIDENTAL AND
CONSEQUENTIAL DAMAGES.
(1) Incidental damages resulting from a lessor's default include
expenses reasonably incurred in inspection, receipt, transportation, and
care and custody of goods rightfully rejected or goods the acceptance of
which is justifiably revoked, any commercially reasonable charges,
expenses or commissions in connection with effecting cover, and any
other reasonable expense incident to the default.
(2) Consequential damages resulting from a lessor's default
include:
(a) any loss resulting from general or particular requirements and
needs of which the lessor at the time of contracting had reason to know
and which could not reasonably be prevented by cover or otherwise; and
(b) injury to person or property proximately resulting from any
breach of warranty.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-715.
Changes: Revised to reflect leasing terminology and practices.
Purposes: Subsection (1), a revised version of the provisions
of Section 2-715(1), lists some examples of incidental damages resulting
from a lessor's default; the list is not exhaustive. Subsection (1) makes
clear that it applies not only to rightful rejection, but also to justifiable
revocation.
Subsection (2), a revised version of the provisions of Section
2-715(2), lists some examples of consequential damages resulting from
a lessor's default; the list is not exhaustive.
Cross References: Section 2-715.
Definitional Cross References:
"Goods". Section 2A-103(1)(h).
"Knows". Section 1-201(25).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Person". Section 1-201(30).
"Receipt". Section 2-103(1)(c).
Section 36-2A-521. LESSEE'S RIGHT TO SPECIFIC
PERFORMANCE OR REPLEVIN.
(1) Specific performance may be decreed if the goods are unique
or in other proper circumstances.
(2) A decree for specific performance may include any terms and
conditions as to payment of the rent, damages, or other relief that the
court deems just.
(3) A lessee has a right of replevin, detinue, sequestration, claim
and delivery, or the like for goods identified to the lease contract if after
reasonable effort the lessee is unable to effect cover for those goods or
the circumstances reasonably indicate that the effort will be unavailing.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-716.
Changes: Revised to reflect leasing practices and terminology,
and to expand the reference to the right of replevin in subsection (3) to
include other similar rights of the lessee.
Definitional Cross References:
"Delivery". Section 1-201(14).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Rights". Section 1-201(36).
"Term". Section 1-201(42).
Section 36-2A-522. LESSEE'S RIGHT TO GOODS ON LESSOR'S
INSOLVENCY.
(1) Subject to subsection (2) and even though the goods have not
been shipped, a lessee who has paid a part or all of the rent and security
for goods identified to a lease contract (Section 36-2A-217) on making
and keeping good a tender of any unpaid portion of the rent and security
due under the lease contract may recover the goods identified from the
lessor if the lessor becomes insolvent within 10 days after receipt of the
first installment of rent and security.
(2) A lessee acquires the right to recover goods identified to a lease
contract only if they conform to the lease contract.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-502.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Conforming". Section 2A-103(1)(d).
"Goods". Section 2A-103(1)(h).
"Insolvent". Section 1-201(23).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Receipt". Section 2-103(1)(c).
"Rights". Section 1-201(36).
C. DEFAULT BY LESSEE
Section 36-2A-523. LESSOR'S REMEDIES.
(1) If a lessee wrongfully rejects or revokes acceptance of goods
or fails to make a payment when due or repudiates with respect to a part
or the whole, then, with respect to any goods involved, and with respect
to all of the goods if under an installment lease contract the value of the
whole lease contract is substantially impaired (Section 36-2A-510), the
lessee is in default under the lease contract and the lessor may:
(a) cancel the lease contract (Section 36-2A-505(1));
(b) proceed respecting goods not identified to the lease
contract (Section 36-2A-524);
(c) withhold delivery of the goods and take possession of goods
previously delivered (Section 36-2A-525);
(d) stop delivery of the goods by any bailee (Section
36-2A-526);
(e) dispose of the goods and recover damages (Section
36-2A-527), or retain the goods and recover damages (Section
36-2A-528), or in a proper case recover rent (Section 36-2A-529);
(f) exercise any other rights or pursue any other remedies
provided in the lease contract.
(2) If a lessor does not fully exercise a right or obtain a remedy
to which the lessor is entitled under subsection (1), the lessor may
recover the loss resulting in the ordinary course of events from the
lessee's default as determined in any reasonable manner, together with
incidental damages, less expenses saved in consequence of the lessee's
default.
(3) If a lessee is otherwise in default under a lease contract, the
lessor may exercise the rights and pursue the remedies provided in the
lease contract , which may include a right to cancel the lease. In
addition, unless otherwise provided in the lease contract:
(a) if the default substantially impairs the value of the lease
contract to the lessor, the lessor may exercise the rights and pursue the
remedies provided in subsections (1) or (2); or
(b) if the default does not substantially impair the value of the
lease contract to the lessor, the lessor may recover as provided in
subsection (2).
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-703.
Changes: Substantially revised.
Purposes: 1. Subsection (1) is an index to Sections 2A-524
through 2A-531 and states that the remedies provided in those sections
are available for the defaults referred to in subsection (1): wrongful
rejection or revocation of acceptance, failure to make a payment when
due, or repudiation. In addition, remedies provided in the lease contract
are available. Subsection (2) sets out a remedy if the lessor does not
pursue to completion a right or actually obtain a remedy available under
subsection (1), and subsection (3) sets out statutory remedies for defaults
not specifically referred to in subsection (1). Subsection (3) provides
that, if any default by the lessee other than those specifically referred to
in subsection (1) is material, the lessor can exercise the remedies
provided in subsection (1) or (2); otherwise the available remedy is as
provided in subsection (3). A lessor who has brought an action seeking
or has nonjudicially pursued one or more of the remedies available under
subsection (1) may amend so as to claim or may nonjudicially pursue a
remedy under subsection (2) unless the right or remedy first chosen has
been pursued to an extent actually inconsistent with the new course of
action. The intent of the provision is to reject the doctrine of election of
remedies and to permit an alteration of course by the lessor unless such
alteration would actually have an effect on the lessee that would be
unreasonable under the circumstances. Further, the lessor may pursue
remedies under both subsections (1) and (2) unless doing so would put
the lessor in a better position than it would have been in had the lessee
fully performed.
2. The lessor and the lessee can agree to modify the rights and
remedies available under the Article; they can, among other things,
provide that for defaults other than those specified in subsection (1) the
lessor can exercise the rights and remedies referred to in subsection (1),
whether or not the default would otherwise be held to substantially
impair the value of the lease contract to the lessor; they can also create
a new scheme of rights and remedies triggered by the occurrence of the
default. Sections 2A-103(4) and 1-102(3).
3. Subsection (1), a substantially rewritten version of Section 2-703,
lists various cumulative remedies of the lessor where the lessee
wrongfully rejects or revokes acceptance, fails to make a payment when
due, or repudiates. Section 2A-501(2) and (4). The subsection also
allows the lessor to exercise any contractual remedy.
4. This Article rejects any general doctrine of election of remedy.
Whether, in a particular case, one remedy bars another, is a function of
whether lessor has been put in as good a position as if the lessee had
fully performed the lease contract. Multiple remedies are barred only if
the effect is to put the lessor in a better position than it would have been
in had the lessee fully performed under the lease. Sections 2A-103(4),
2A-501(4), and 1-106(1).
5. Hypothetical: To better understand the application of
subparagraphs (a) through (e), it is useful to review a hypothetical.
Assume that A is a merchant in the business of selling and leasing new
bicycles of various types. B is about to engage in the business of
subleasing bicycles to summer residents of and visitors to an island
resort. A, as lessor, has agreed to lease 60 bicycles to B. While there is
one master lease, deliveries and terms are staggered. 20 bicycles are to
be delivered by A to B's island location on June 1; the term of the lease
of these bicycles is four months. 20 bicycles are to be delivered by A to
B's island location on July 1; the term of the lease of these bicycles is
three months. Finally, 20 bicycles are to be delivered by A to B's island
location on August 1; the term of the lease of these bicycles is two
months. B is obligated to pay rent to A on the 15th day of each month
during the term for the lease. Rent is $50 per month, per bicycle. B has
no option to purchase or release and must return the bicycles to A at the
end of the term, in good condition, reasonable wear and tear excepted.
Since the retail price of each bicycle is $400 and bicycles used in the
retail rental business have a useful economic life of 36 months, this
transaction creates a lease. Sections 2A-103(1)(j) and 1-201(37).
6. A's current inventory of bicycles is not large. Thus, upon signing
the lease with B in February, A agreed to purchase 60 new bicycles from
A's principal manufacturer, with special instructions to drop ship the
bicycles to B's island location in accordance with the delivery schedule
set forth in the lease.
7. The first shipment of 20 bicycles was received by B on May 21.
B inspected the bicycles, accepted the same as conforming to the lease
and signed a receipt of delivery and acceptance. However, due to poor
weather that summer, business was terrible and B was unable to pay the
rent due on June 15. Pursuant to the lease A sent B notice of default and
proceeded to enforce his rights and remedies against B.
8. A's counsel first advised A that under Section 2A-510(2) and the
terms of the lease B's failure to pay was a default with respect to the
whole. Thus, to minimize A's continued exposure, A was advised to
take possession of the bicycles. If A had possession of the goods A
could refuse to deliver. Section 2A-525(1). However, the facts here are
different. With respect to the bicycles in B's possession, A has the right
to take possession of the bicycles, without breach of the peace. Section
2A-525(2). If B refuses to allow A access to the bicycles, A can proceed
by action, including replevin or injunctive relief.
9. With respect to the 40 bicycles that have not been delivered, this
Article provides various alternatives. First, assume that 20 of the
remaining 40 bicycles have been manufactured and delivered by the
manufacturer to a carrier for shipment to B. Given the size of the
shipment, the carrier was using a small truck for the delivery and the
truck had not yet reached the island ferry when the manufacturer (at the
request of A) instructed the carrier to divert the shipment to A's place of
business. A's right to stop delivery is recognized under these
circumstances. Section 2A-526(1). Second, assume that the 20
remaining bicycles were in the process of manufacture when B
defaulted. A retains the right (as between A as lessor and B as lessee)
to exercise reasonable commercial judgment whether to complete
manufacture or to dispose of the unfinished goods for scrap. Since A is
not the manufacturer and A has a binding contract to buy the bicycles,
A elected to allow the manufacturer to complete the manufacture of the
bicycles, but instructed the manufacturer to deliver the completed
bicycles to A's place of business. Section 2A-524(2).
10. Thus, so far A has elected to exercise the remedies referred to in
subparagraphs (b) through (d) in subsection (1). None of these remedies
bars any of the others because A's election and enforcement merely
resulted in A's possession of the bicycles. Had B performed A would
have recovered possession of the bicycles. Thus A is in the process of
obtaining the benefit of his bargain. Note that A could exercise any
other rights or pursue any other remedies provided in the lease contract
(Section 2A-523(1)(f)), or elect to recover his loss due to the lessee's
default under Section 2A-523(2).
11. A's counsel next would determine what action, if any, should be
taken with respect to the goods. As stated in subparagraph (e) and as
discussed fully in Section 2A-527(1) the lessor may, but has no
obligation to, dispose of the goods by a substantially similar lease
(indeed, the lessor has no obligation whatsoever to dispose of the goods
at all) and recover damages based on that action, but lessor will not be
able to recover damages which put it in a better position than
performance would have done, nor will it be able to recover damages for
losses which it could have reasonably avoided. In this case, since A is
in the business of leasing and selling bicycles, A will probably inventory
the 60 bicycles for its retail trade.
12. A's counsel then will determine which of the various means of
ascertaining A's damages against B are available. Subparagraph (e)
catalogues each relevant section. First, under Section 2A-527(2) the
amount of A's claim is computed by comparing the original lease
between A and B with any subsequent lease of the bicycles but only if
the subsequent lease is substantially similar to the original lease contract.
While the section does not define this term, the official comment does
establish some parameters. If, however, A elects to lease the bicycles to
his retail trade, it is unlikely that the resulting lease will be substantially
similar to the original, as leases to retail customers are considerably
different from leases to wholesale customers like B. If, however, the
leases were substantially similar, the damage claim is for accrued and
unpaid rent to the beginning of the new lease, plus the present value as
of the same date, of the rent reserved under the original lease for the
balance of its term less the present value as of the same date of the rent
reserved under the replacement lease for a term comparable to the
balance of the term of the original lease, together with incidental
damages less expenses saved in consequence of the lessee's default.
13. If the new lease is not substantially similar or if A elects to sell
the bicycles or to hold the bicycles, damages are computed under
Section 2A-528 or 2A-529.
14. If A elects to pursue his claim under Section 2A-528(1) the
damage rule is the same as that stated in Section 2A-527(2) except that
damages are measured from default if the lessee never took possession
of the goods or from the time when the lessor did or could have regained
possession and that the standard of comparison is not the rent reserved
under a substantially similar lease entered into by the lessor but a market
rent, as defined in Section 2A-507. Further, if the facts of this
hypothetical were more elaborate A may be able to establish that the
measure of damage under subsection (1) is inadequate to put him in the
same position that B's performance would have, in which case A can
claim the present value of his lost profits.
15. Yet another alternative for computing A's damage claim
against B which will be available in some situations is recovery of the
present value, as of entry of judgment, of the rent for the then remaining
lease term under Section 2A-529. However, this formulation is not
available if the goods have been repossessed or tendered back to A. For
the 20 bicycles repossessed and the remaining 40 bicycles, A will be
able to recover the present value of the rent only if A is unable to
dispose of them, or circumstances indicate the effort will be unavailing.
If A has prevailed in an action for the rent, at any time up to collection
of a judgment by A against B, A might dispose of the bicycles. In such
case A's claim for damages against B is governed by Section 2A-527 or
2A-528. Section 2A-529(3). The resulting recalculation of claim should
reduce the amount recoverable by A against B and the lessor is required
to cause an appropriate credit to be entered against the earlier judgment.
However, the nature of the post-judgment proceedings to resolve this
issue, and the sanctions for a failure to comply, if any, will be
determined by other law.
16. Finally, if the lease agreement had so provided pursuant to
subparagraph (f), A's claim against B would not be determined under
any of these statutory formulae, but pursuant to a liquidated damages
clause. Section 2A-504(1).
17. These various methods of computing A's damage claim against
B are alternatives subject to Section 2A-501(4). However, the pursuit
of any one of these alternatives is not a bar to, nor has it been barred by,
A's earlier action to obtain possession of the 60 bicycles. These
formulae, which vary as a function of an overt or implied mitigation of
damage theory, focus on allowing A a recovery of the benefit of his
bargain with B. Had B performed, A would have received the rent as
well as the return of the 60 bicycles at the end of the term.
18. Finally, A's counsel should also advise A of his right to cancel
the lease contract under subparagraph (a). Section 2A-505(1).
Cancellation will discharge all existing obligations but preserve A's
rights and remedies.
19. Subsection (2) recognizes that a lessor who is entitled to exercise
the rights or to obtain a remedy granted by subsection (1) may choose
not to do so. In such cases, the lessor can recover damages as provided
in subsection (2). For example, for non-payment of rent, the lessor may
decide not to take possession of the goods and cancel the lease, but
rather to merely sue for the unpaid rent as it comes due plus lost interest
or other damages "determined in any reasonable manner."
Subsection (2) also negates any loss of alternative rights and remedies
by reason of having invoked or commenced the exercise or pursuit of
any one or more rights or remedies.
20. Subsection (3) allows the lessor access to a remedy scheme
provided in this Article as well as that contained in the lease contract if
the lessee is in default for reasons other than those stated in subsection
(1). Note that the reference to this Article includes supplementary
principles of law and equity, e.g., fraud, misrepresentation and duress.
Sections 2A-103(4) and 1-103.
21. There is no special treatment of the finance lease in this section.
Absent supplementary principles of law to the contrary, in most cases
the supplier will have no rights or remedies against the defaulting lessee.
Section 2A-209(2)(ii). Given that the supplier will look to the lessor for
payment, this is appropriate. However, there is a specific exception to
this rule with respect to the right to identify goods to the lease contract.
Section 2A-524(2). The parties are free to create a different result in a
particular case. Sections 2A-103(4) and 1-102(3).
Cross References: Sections 1-102(3), 1-103, 1-106(1),
1-201(37), 2-703, 2A-103(1)(j), 2A-103(4), 2A-209(2)(ii), 2A-501(4),
2A-504(1), 2A-505(1), 2A-507, 2A-510(2), 2A-524 through 2A-531,
2A-524(2), 2A-525(1), 2A-525(2), 2A-526(1), 2A-527(1), 2A-527(2),
2A-528(1) and 2A-529(3).
Definitional Cross References:
"Delivery". Section 1-201(14).
"Goods". Section 2A-103(1)(h).
"Installment lease contract". Section 2A-103(1)(i).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
"Value". Section 1-201(44).
Section 36-2A-524. LESSOR'S RIGHT TO IDENTIFY GOODS TO
LEASE CONTRACT.
(1) After default by the lessee under the lease contract of the type
described in Section 36-2A-523(1) or Section 36-2A-523(3)(a) or, if
agreed, after other default by the lessee, the lessor may:
(a) identify to the lease contract conforming goods not already
identified if at the time the lessor learned of the default they were in the
lessor's or the supplier's possession or control; and
(b) dispose of goods (Section 36-2A-527(1)) that
demonstrably have been intended for the particular lease contract even
though those goods are unfinished.
(2) If the goods are unfinished, in the exercise of reasonable
commercial judgment for the purposes of avoiding loss and of effective
realization, an aggrieved lessor or the supplier may either complete
manufacture and wholly identify the goods to the lease contract or cease
manufacture and lease, sell, or otherwise dispose of the goods for scrap
or salvage value or proceed in any other reasonable manner.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-704.
Changes: Revised to reflect leasing practices and terminology.
Purposes: The remedies provided by this section are available
to the lessor (i) if there has been a default by the lessee which falls
within Section 2A-523(1) or 2A-523(3)(a), or (ii) if there has been any
other default for which the lease contract gives the lessor the remedies
provided by this section. Under "(ii)", the lease contract
may give the lessor the remedies of identification and disposition
provided by this section in various ways. For example, a lease provision
might specifically refer to the remedies of identification and disposition,
or it might refer to this section by number (i.e., 2A-524), or it might do
so by a more general reference such as "all rights and remedies
provided by Article 2A for default by the lessee."
Definitional Cross References:
"Aggrieved party". Section 1-201(2).
"Conforming". Section 2A-103(1)(d).
"Goods". Section 2A-103(1)(h).
"Learn". Section 1-201(25).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Lessor". Section 2A-103(1)(p).
"Rights". Section 1-201(36).
"Supplier". Section 2A-103(1)(x).
"Value". Section 1-201(44).
Section 36-2A-525. LESSOR'S RIGHT TO POSSESSION OF
GOODS.
(1) If a lessor discovers the lessee to be insolvent, the lessor may
refuse to deliver the goods.
(2) After a default by the lessee under the lease contract of the
type described in Section 36-2A-523(1) or 36-2A-523(3)(a) or, if agreed,
after other default by the lessee, the lessor has the right to take
possession of the goods. If the lease contract so provides, the lessor may
require the lessee to assemble the goods and make them available to the
lessor at a place to be designated by the lessor which is reasonably
convenient to both parties. Without removal, the lessor may render
unusable any goods employed in trade or business, and may dispose of
goods on the lessee's premises (Section 36-2A-527).
(3) The lessor may proceed under subsection (2) without judicial
process if it can be done without breach of the peace or the lessor may
proceed by action.
OFFICIAL COMMENT
Uniform Statutory Source: Sections 2-702(1) and 9-503.
Changes: Substantially revised.
Purposes: 1. Subsection (1), a revised version of the
provisions of Section 2-702(1), allows the lessor to refuse to deliver
goods if the lessee is insolvent. Note that the provisions of Section
2-702(2), granting the unpaid seller certain rights of reclamation, were
not incorporated in this section. Subsection (2) made this unnecessary.
2. Subsection (2), a revised version of the provisions of Section
9-503, allows the lessor, on a Section 2A-523(1) or 2A-523(3)(a) default
by the lessee, the right to take possession of or reclaim the goods. Also,
the lessor can contract for the right to take possession of the goods for
other defaults by the lessee. Therefore, since the lessee's insolvency is
an event of default in a standard lease agreement, subsection (2) is the
functional equivalent of Section 2-702(2). Further, subsection (2)
sanctions the classic crate and delivery clause obligating the lessee to
assemble the goods and to make them available to the lessor. Finally,
the lessor may leave the goods in place, render them unusable (if they
are goods employed in trade or business), and dispose of them on the
lessee's premises.
3. Subsection (3), a revised version of the provisions of Section
9-503, allows the lessor to proceed under subsection (2) without judicial
process, absent breach of the peace, or by action. Sections 2A-501(3),
2A-103(4) and 1-201(1). In the appropriate case action includes
injunctive relief. Clark Equip. Co. v. Armstrong Equip. Co.,
431 F.2d 54 (5th Cir. 1970), cert. denied, 402 U.S. 909
(1971). This Section, as well as a number of other Sections in this Part,
are included in the Article to codify the lessor's common law right to
protect the lessor's reversionary interest in the goods. Section
2A-103(1)(q). These Sections are intended to supplement and not
displace principles of law and equity with respect to the protection of
such interest. Sections 2A-103(4) and 1-103. Such principles apply in
many instances, e.g., loss or damage to goods if risk of loss passes to the
lessee, failure of the lessee to return goods to the lessor in the condition
stipulated in the lease, and refusal of the lessee to return goods to the
lessor after termination or cancellation of the lease. See also Section
2A-532.
Cross References: Sections 1-106(2), 2-702(1), 2-702(2),
2A-103(4), 2A-501(3), 2A-532 and 9-503.
Definitional Cross References:
"Action". Section 1-201(1).
"Delivery". Section 1-201(14).
"Discover". Section 1-201(25).
"Goods". Section 2A-103(1)(h).
"Insolvent". Section 1-201(23).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Party". Section 1-201(29).
"Rights". Section 1-201(36).
Section 36-2A-526. LESSOR'S STOPPAGE OF DELIVERY IN
TRANSIT OR OTHERWISE.
(1) A lessor may stop delivery of goods in the possession of a carrier
or other bailee if the lessor discovers the lessee to be insolvent and may
stop delivery of carload, truckload, planeload, or larger shipments of
express or freight if the lessee repudiates or fails to make a payment due
before delivery, whether for rent, security or otherwise under the lease
contract, or for any other reason the lessor has a right to withhold or take
possession of the goods.
(2) In pursuing its remedies under subsection (1), the lessor may stop
delivery until
(a) receipt of the goods by the lessee;
(b) acknowledgment to the lessee by any bailee of the goods,
except a carrier, that the bailee holds the goods for the lessee; or
(c) such an acknowledgment to the lessee by a carrier via
reshipment or as warehouseman.
(3)(a) To stop delivery, a lessor shall so notify as to enable the bailee
by reasonable diligence to prevent delivery of the goods.
(b) After notification, the bailee shall hold and deliver the goods
according to the directions of the lessor, but the lessor is liable to the
bailee for any ensuing charges or damages.
(c) A carrier who has issued a nonnegotiable bill of lading is not
obliged to obey a notification to stop received from a person other than
the consignor.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-705.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Bill of lading". Section 1-201(6).
"Delivery". Section 1-201(14).
"Discover". Section 1-201(25).
"Goods". Section 2A-103(1)(h).
"Insolvent". Section 1-201(23).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Notifies" and "Notification". Section
1-201(26).
"Person". Section 1-201(30).
"Receipt". Section 2-103(1)(c).
"Remedy". Section 1-201(34).
"Rights". Section 1-201(36).
Section 36-2A-527. LESSOR'S RIGHTS TO DISPOSE OF
GOODS.
(1) After a default by a lessee under the lease contract of the type
described in Section 36-2A-523(1) or 36-2A-523(3)(a) or after the lessor
refuses to deliver or takes possession of goods (Section 36-2A-525 or
36-2A-526), or, if agreed, after other default by a lessee, the lessor may
dispose of the goods concerned or the undelivered balance thereof by
lease, sale, or otherwise.
(2) Except as otherwise provided with respect to damages liquidated
in the lease agreement (Section 36-2A-504) or otherwise determined
pursuant to agreement of the parties (Sections 36-1-102(3) and
36-2A-503), if the disposition is by lease agreement substantially similar
to the original lease agreement and the new lease agreement is made in
good faith and in a commercially reasonable manner, the lessor may
recover from the lessee as damages (i) accrued and unpaid rent as of the
date of the commencement of the term of the new lease agreement, (ii)
the present value, as of the same date, of the total rent for the then
remaining lease term of the original lease agreement minus the present
value, as of the same date, of the rent under the new lease agreement
applicable to that period of the new lease term which is comparable to
the then remaining term of the original lease agreement, and (iii) any
incidental damages allowed under Section 36-2A-530, less expenses
saved in consequence of the lessee's default.
(3) If the lessor's disposition is by lease agreement that for any
reason does not qualify for treatment under subsection (2), or is by sale
or otherwise, the lessor may recover from the lessee as if the lessor had
elected not to dispose of the goods and Section 36-2A-528 governs.
(4) A subsequent buyer or lessee who buys or leases from the lessor
in good faith for value as a result of a disposition under this section takes
the goods free of the original lease contract and any rights of the original
lessee even though the lessor fails to comply with one or more of the
requirements of this chapter.
(5) The lessor is not accountable to the lessee for any profit made on
any disposition. A lessee who has rightfully rejected or justifiably
revoked acceptance shall account to the lessor for any excess over the
amount of the lessee's security interest (Section 36-2A-508(5)).
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-706(1), (5) and (6).
Changes: Substantially revised.
Purposes: 1. Subsection (1), a revised version of the first
sentence of subsection 2-706(1), allows the lessor the right to dispose of
goods after a statutory or other material default by the lessee (even if the
goods remain in the lessee's possession - Section 2A-525(2)), after the
lessor refuses to deliver or takes possession of the goods, or, if agreed,
after other contractual default. The lessor's decision to exercise this
right is a function of a commercial judgment, not a statutory mandate
replete with sanctions for failure to comply. Cf. Section 9-507. As the
owner of the goods, in the case of a lessor, or as the prime lessee of the
goods, in the case of a sublessor, compulsory disposition of the goods
is inconsistent with the nature of the interest held by the lessor or the
sublessor and is not necessary because the interest held by the lessee or
the sublessee is not protected by a right of redemption under the
common law or this Article. Subsection 2A-527(5).
2. The rule for determining the measure of damages recoverable by
the lessor against the lessee is a function of several variables. If the
lessor has elected to effect disposition under subsection (1) and such
disposition is by lease that qualifies under subsection (2), the measure
of damages set forth in subsection (2) will apply, absent agreement to
the contrary. Sections 2A-504, 2A-103(4) and 1-102(3).
3. The lessor's damages will be established using the new lease
agreement as a measure if the following three criteria are satisfied: (i)
the lessor disposed of the goods by lease, (ii) the lease agreement is
substantially similar to the original lease agreement, and (iii) such
disposition was in good faith, and in a commercially reasonable manner.
Thus, the lessor will be entitled to recover from the lessee the accrued
and unpaid rent as of the date of commencement of the term of the new
lease, and the present value, as of the same date , of the rent under the
original lease for the then remaining term less the present value as of the
same date of the rent under the new lease agreement applicable to the
period of the new lease comparable to the remaining term under the
original lease, together with incidental damages less expenses saved in
consequence of the lessee's default. If the lessor's disposition does not
satisfy the criteria of subsection (2), the lessor may calculate its claim
against the lessee pursuant to Section 2A-528. Section 2A-523(1)(e).
4. Two of the three criteria to be met by the lessor are familiar, but
the concept of the new lease agreement that is substantially similar to the
original lease agreement is not. Given the many variables facing a party
who intends to lease goods and the rapidity of change in the market
place, the policy decision was made not to draft with specificity. It was
thought unwise to seek to establish certainty at the cost of fairness. The
decision of whether the new lease agreement is substantially similar to
the original will be determined case by case.
5. While the section does not draw a bright line, it is possible to
describe some of the factors that should be considered in a finding that
a new lease agreement is substantially similar to the original. The
various elements of the new lease agreement should be examined.
Those elements include the options to purchase or release; the lessor's
representations, warranties and covenants to the lessee as well as those
to be provided by the lessee to the lessor; and the services, if any, to be
provided by the lessor or by the lessee. All of these factors allocate cost
and risk between the lessor and the lessee and thus affect the amount of
rent to be paid. These findings should not be made with scientific
precision, as they are a function of economics, nor should they be made
independently, as it is important that a sense of commercial judgment
pervade the finding. See Section 2A-507(2). To establish the new lease
as a proper measure of damage under subsection (2), these various
factors, taken as a whole, must result in a finding that the new lease
agreement is substantially similar to the original. If the differences
between the original lease and the new lease can be easily valued, it
would be appropriate for a court to find that the new lease is
substantially similar to the old lease, adjust the difference in the rent
between the two leases to take account of the differences, and award
damages under this section. If, for example, the new lease requires the
lessor to insure the goods in the hands of the lessee, while the original
lease required the lessee to insure, the usual cost of such insurance could
be deducted from rent due under the new lease before the difference in
rental between the two leases is determined.
6. The following hypothetical illustrates the difficulty of providing
a bright line. Assume that A buys a jumbo tractor for $1 million and
then leases the tractor to B for a term of 36 months. The tractor is
delivered to and is accepted by B on May 1. On June 1 B fails to pay
the monthly rent to A. B returns the tractor to A, who immediately
releases the tractor to C for a term identical to the term remaining under
the lease between A and B. All terms and conditions under the lease
between A and C are identical to those under the original lease between
A and B, except that C does not provide any property damage or other
insurance coverage, and B agreed to provide complete coverage.
Coverage is expensive and difficult to obtain. It is a question of fact
whether it is so difficult to adjust the recovery to take account of the
difference between the two leases as to insurance that the second lease
is not substantially similar to the original.
7. A new lease can be substantially similar to the original lease even
though its term extends beyond the remaining term of the original lease,
so long as both (a) the lease terms are commercially comparable (e.g.,
it is highly unlikely that a one-month rental and a five-year lease would
reflect similar realities), and (b) the court can fairly apportion a part of
the rental payments under the new lease to that part of the term of the
new lease which is comparable to the remaining lease term under the
original lease. Also, the lease term of the new lease may be comparable
to the remaining term of the original lease even though the beginning
and ending dates of the two leases are not the same. For example, a
two-month lease of agricultural equipment for the months of August and
September may be comparable to a two-month lease running from the
15th of August to the 15th of October if in the particular location
two-month leases beginning on August 15th are basically
interchangeable with two-month leases beginning August 1st. Similarly,
the term of a one-year truck lease beginning on the 15th of January may
be comparable to the term of a one-year truck lease beginning January
2d. If the lease terms are found to be comparable, the court may base
cover damages on the entire difference between the costs under the two
leases.
8. Subsection (3), which is new, provides that if the lessor's
disposition is by lease that does not qualify under subsection (2), or is
by sale or otherwise, Section 2A-528 governs.
9. Subsection (4), a revised version of subsection 2-706(5), applies
to protect a subsequent buyer or lessee who buys or leases from the
lessor in good faith and for value, pursuant to a disposition under this
section. Note that by its terms, the rule in subsection 2A-304(1), which
provides that the subsequent lessee takes subject to the original lease
contract, is controlled by the rule stated in this subsection.
10. Subsection (5), a revised version of subsection 2-706(6),
provides that the lessor is not accountable to the lessee for any profit
made by the lessor on a disposition. This rule follows from the
fundamental premise of the bailment for hire that the lessee under a lease
of goods has no equity of redemption to protect.
Cross References: Sections 1-102(3), 2-706(1), 2-706(5),
2-706(6), 2A-103(4), 2A-304(1), 2A-504, 2A-507(2), 2A-523(1)(e),
2A-525(2), 2A-527(5), 2A-528 and 9-507.
Definitional Cross References:
"Buyer" and "Buying". Section 2-103(1)(a).
"Delivery". Section 1-201(14).
"Good faith". Sections 1-201(19) and 2-103(1)(b).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Present value". Section 2A-103(1)(u).
"Rights". Section 1-201(36).
"Sale". Section 2-106(1).
"Security interest". Section 1-201(37).
"Value". Section 1-201(44).
Section 36-2A-528. LESSOR'S DAMAGES FOR
NONACCEPTANCE, FAILURE TO PAY, REPUDIATION, OR
OTHER DEFAULT.
(1) Except as otherwise provided with respect to damages liquidated
in the lease agreement (Section 36-2A-504) or otherwise determined
pursuant to agreement of the parties (Sections 36-1-102(3) and
36-2A-503), if a lessor elects to retain the goods or a lessor elects to
dispose of the goods and the disposition is by lease agreement that for
any reason does not qualify for treatment under Section 36-2A-527(2),
or is by sale or otherwise, the lessor may recover from the lessee as
damages for a default of the type described in Section 36-2A-523(1) or
36-2A-523(3)(a), or, if agreed, for other default of the lessee, (i) accrued
and unpaid rent as of the date of default if the lessee has never taken
possession of the goods, or, if the lessee has taken possession of the
goods, as of the date the lessor repossesses the goods or an earlier date
on which the lessee makes a tender of the goods to the lessor, (ii) the
present value as of the date determined under clause (i) of the total rent
for the then remaining lease term of the original lease agreement minus
the present value as of the same date of the market rent at the place
where the goods are located computed for the same lease term, and (iii)
any incidental damages allowed under Section 36-2A-530, less expenses
saved in consequence of the lessee's default.
(2) If the measure of damages provided in subsection (1) is
inadequate to put a lessor in as good a position as performance would
have, the measure of damages is the present value of the profit,
including reasonable overhead, the lessor would have made from full
performance by the lessee, together with any incidental damages allowed
under Section 36-2A-530, due allowance for costs reasonably incurred
and due credit for payments or proceeds of disposition.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-708.
Changes: Substantially revised.
Purposes: 1. Subsection (1), a substantially revised version of
Section 2-708(1), states the basic rule governing the measure of lessor's
damages for a default described in Section 2A-523(1) or (3)(a), and, if
agreed, for a contractual default. This measure will apply if the lessor
elects to retain the goods (whether undelivered, returned by the lessee,
or repossessed by the lessor after acceptance and default by the lessee)
or if the lessor's disposition does not qualify under subsection
2A-527(2). Section 2A-527(3). Note that under some of these
conditions, the lessor may recover damages from the lessee pursuant to
the rule set forth in Section 2A-529. There is no sanction for disposition
that does not qualify under subsection 2A-527(2). Application of the
rule set forth in this section is subject to agreement to the contrary.
Sections 2A-504, 2A-103(4) and 1-102(3).
2. If the lessee has never taken possession of the goods, the measure
of damage is the accrued and unpaid rent as of the date of default
together with the present value, as of the date of default, of the original
rent for the remaining term of the lease less the present value as of the
same date of market rent, and incidental damages, less expenses saved
in consequence of the default. Note that the reference in Section
2A-528(1)(i) and (ii) is to the date of default not to the date of an event
of default. An event of default under a lease agreement becomes a
default under a lease agreement only after the expiration of any relevant
period of grace and compliance with any notice requirements under this
Article and the lease agreement. American Bar Foundation,
Commentaries on Indentures, Section 5-1, at 216-217 (1971).
Section 2A-501(1). This conclusion is also a function of whether, as a
matter of fact or law, the event of default has been waived, suspended
or cured. Sections 2A-103(4) and 1-103. If the lessee has taken
possession of the goods, the measure of damages is the accrued and
unpaid rent as of the earlier of the time the lessor repossesses the goods
or the time the lessee tenders the goods to the lessor plus the difference
between the present value, as of the same time, of the rent under the
lease for the remaining lease term and the present value, as of the same
time, of the market rent.
3. Market rent will be computed pursuant to Section 2A-507.
4. Subsection (2), a somewhat revised version of the provisions of
subsection 2-708(2), states a measure of damages which applies if the
measure of damages in subsection (1) is inadequate to put the lessor in
as good a position as performance would have. The measure of damage
is the lessor's profit, including overhead, together with incidental
damages, with allowance for costs reasonably incurred and credit for
payments or proceeds of disposition. In determining the amount of due
credit with respect to proceeds of disposition a proper value should be
attributed to the lessor's residual interest in the goods. Sections
2A-103(1)(q) and 2A-507(4).
5. In calculating profit, a court should include any expected
appreciation of the goods, e.g. the foal of a leased brood mare. Because
this subsection is intended to give the lessor the benefit of the bargain,
a court should consider any reasonable benefit or profit expected by the
lessor from the performance of the lease agreement. See
Honeywell, Inc. v. Lithonia Lighting, Inc., 317 F. Supp. 406,
413 (N.D. Ga. 1970); Locks v. Wade, 36 N.J. Super. 128, 131,
114 A.2d 875, 877 (Super. Ct. App. Div. 1955). Further, in calculating
profit the concept of present value must be given effect. Taylor v.
Commercial Credit Equip. Corp., 170 Ga. App. 322, 316 S.E.2d
788 (Ct. App. 1984). See generally Section
2A-103(1)(u).
Cross References: Sections 1-102(3), 2-708, 2A-103(1)(u),
2A-402, 2A-504, 2A-507, 2A-527(2) and 2A-529.
Definitional Cross References:
"Agreement". Section 1-201(3).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease agreement". Section 2A-103(1)(k).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Party". Section 1-201(29).
"Present value". Section 2A-103(1)(u).
"Sale". Section 2-106(1).
Section 36-2A-529. LESSOR'S ACTION FOR THE RENT.
(1) After default by the lessee under the lease contract of the type
described in Section 36-2A-523(1) or 36-2A-523(3)(a) or, if agreed,
after other default by the lessee, if the lessor complies with subsection
(2), the lessor may recover from the lessee as damages:
(a) for goods accepted by the lessee and not repossessed by or
tendered to the lessor, and for conforming goods lost or damaged within
a commercially reasonable time after risk of loss passes to the lessee
(Section 36-2A-219), (i) accrued and unpaid rent as of the date of entry
of judgment in favor of the lessor, (ii) the present value as of the same
date of the rent for the then remaining lease term of the lease agreement,
and (iii) any incidental damages allowed under Section 36-2A-530, less
expenses saved in consequence of the lessee's default; and
(b) for goods identified to the lease contract if the lessor is unable
after reasonable effort to dispose of them at a reasonable price or the
circumstances reasonably indicate that effort will be unavailing, (i)
accrued and unpaid rent as of the date of entry of judgment in favor of
the lessor, (ii) the present value as of the same date of the rent for the
then remaining lease term of the lease agreement, and (iii) any incidental
damages allowed under Section 36-2A-530, less expenses saved in
consequence of the lessee's default.
(2) Except as provided in subsection (3), the lessor shall hold for the
lessee for the remaining lease term of the lease agreement any goods that
have been identified to the lease contract and are in the lessor's control.
(3) The lessor may dispose of the goods at any time before collection
of the judgment for damages obtained pursuant to subsection (1). If the
disposition is before the end of the remaining lease term of the lease
agreement, the lessor's recovery against the lessee for damages is
governed by Section 36-2A-527 or Section 36-2A-528, and the lessor
will cause an appropriate credit to be provided against a judgment for
damages to the extent that the amount of the judgment exceeds the
recovery available pursuant to Section 36-2A-527 or 36-2A-528.
(4) Payment of the judgment for damages obtained pursuant to
subsection (1) entitles the lessee to the use and possession of the goods
not then disposed of for the remaining lease term of and in accordance
with the lease agreement.
(5) After default by the lessee under the lease contract of the type
described in Section 36-2A-523(1) or Section 36-2A-523(3)(a) or, if
agreed, after other default by the lessee, a lessor who is held not entitled
to rent under this section must nevertheless be awarded damages for
nonacceptance under Section 36-2A-527 or Section 36-2A-528.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-709.
Changes: Substantially revised.
Purposes: 1. Absent a lease contract provision to the contrary,
an action for the full unpaid rent (discounted to present value as of the
time of entry of judgment as to rent due after that time) is available as
to goods not lost or damaged only if the lessee retains possession of the
goods or the lessor is or apparently will be unable to dispose of them at
a reasonable price after reasonable effort. There is no general right in
a lessor to recover the full rent from the lessee upon holding the goods
for the lessee. If the lessee tenders goods back to the lessor, and the
lessor refuses to accept the tender, the lessor will be limited to the
damages it would have suffered had it taken back the goods. The rule
in Article 2 that the seller can recover the price of accepted goods is
rejected here. In a lease, the lessor always has a residual interest in the
goods which the lessor usually realizes upon at the end of a lease term
by either sale or a new lease. Therefore, it is not a substantial imposition
on the lessor to require it to take back and dispose of the goods if the
lessee chooses to tender them back before the end of the lease term: the
lessor will merely do earlier what it would have done anyway, sell or
relet the goods. Further, the lessee will frequently encounter substantial
difficulties if the lessee attempts to sublet the goods for the remainder of
the lease term. In contrast to the buyer who owns the entire interest in
goods and can easily dispose of them, the lessee is selling only the right
to use the goods under the terms of the lease and the sublessee must
assume a relationship with the lessor. In that situation, it is usually more
efficient to eliminate the original lessee as a middleman by allowing the
lessee to return the goods to the lessor who can then redispose of them.
2. In some situations even where possession of the goods is
reacquired, a lessor will be able to recover as damages the present value
of the full rent due, not under this section, but under 2A-528(2) which
allows a lost profit recovery if necessary to put the lessor in the position
it would have been in had the lessee performed. Following is an
example of such a case. A is a lessor of construction equipment and
maintains a substantial inventory. B leases from A a backhoe for a
period of two weeks at a rental of $1,000. After three days, B returns
the backhoe and refuses to pay the rent. A has five backhoes in
inventory, including the one returned by B. During the next 11 days
after the return by B of the backhoe, A rents no more than three
backhoes at any one time and, therefore, always has two on hand. If B
had kept the backhoe for the full rental period, A would have earned the
full rental on that backhoe, plus the rental on the other backhoes it
actually did rent during that period. Getting this backhoe back before
the end of the lease term did not enable A to make any leases it would
not otherwise have made. The only way to put A in the position it
would have been in had the lessee fully performed is to give the lessor
the full rentals. A realized no savings at all because the backhoe was
returned early and might even have incurred additional expense if it was
paying for parking space for equipment in inventory. A has no
obligation to relet the backhoe for the benefit of B rather than leasing
that backhoe or any other in inventory for its own benefit. Further, it is
probably not reasonable to expect A to dispose of the backhoe by sale
when it is returned in an effort to reduce damages suffered by B.
Ordinarily, the loss of a two-week rental would not require A to reduce
the size of its backhoe inventory. Whether A would similarly be entitled
to full rentals as lost profit in a one-year lease of a backhoe is a question
of fact: in any event the lessor, subject to mitigation of damages rules,
is entitled to be put in as good a position as it would have been had the
lessee fully performed the lease contract.
3. Under subsection (2) a lessor who is able and elects to sue for the
rent due under a lease must hold goods not lost or damaged for the
lessee. Subsection (3) creates an exception to the subsection (2)
requirement . If the lessor disposes of those goods prior to collection of
the judgment (whether as a matter of law or agreement), the lessor's
recovery is governed by the measure of damages in Section 2A-527 if
the disposition is by lease that is substantially similar to the original
lease, or otherwise by the measure of damages in Section 2A-528.
Section 2A-523 official comment .
4. Subsection (4), which is new, further reinforces the requisites of
Subsection (2). In the event the judgment for damages obtained by the
lessor against the lessee pursuant to subsection (1) is satisfied, the lessee
regains the right to use and possession of the remaining goods for the
balance of the original lease term; a partial satisfaction of the judgment
creates no right in the lessee to use and possession of the goods.
5. The relationship between subsections (2) and (4) is important to
understand. Subsection (2) requires the lessor to hold for the lessee
identified goods in the lessor's possession. Absent agreement to the
contrary, whether in the lease or otherwise, under most circumstances
the requirement that the lessor hold the goods for the lessee for the term
will mean that the lessor is not allowed to use them. Sections 2A-103(4)
and 1-203. Further, the lessor's use of the goods could be viewed as a
disposition of the goods that would bar the lessor from recovery under
this section, remitting the lessor to the two preceding sections for a
determination of the lessor's claim for damages against the lessee.
6. Subsection (5), the analogue of subsection 2-709(3), further
reinforces the thrust of subsection (3) by stating that a lessor who is held
not entitled to rent under this section has not elected a remedy; the lessor
must be awarded damages under Sections 2A-527 and 2A-528. This is
a function of two significant policies of this Article - that resort to a
remedy is optional, unless expressly agreed to be exclusive (Section
2A-503(2)) and that rights and remedies provided in this Article
generally are cumulative. (Section 2A-501(2) and (4)).
Cross References: Sections 1-203, 2-709, 2-709(3),
2A-103(4), 2A-501(2), 2A-501(4), 2A-503(2), 2A-504, 2A-523(1)(e),
2A-525(2), 2A-527, 2A-528 and 2A-529(2).
Definitional Cross References:
"Action". Section 1-201(1).
"Conforming". Section 2A-103(1)(d).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Lease agreement". Section 2A-103(1)(k).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Present value". Section 2A-103(1)(u).
"Reasonable time". Section 1-204(1) and (2).
Section 36-2A-530. LESSOR'S INCIDENTAL DAMAGES. Incidental damages to an aggrieved lessor include any commercially
reasonable charges, expenses, or commissions incurred in stopping
delivery, in the transportation, care and custody of goods after the
lessee's default, in connection with return or disposition of the goods, or
otherwise resulting from the default.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-710.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Aggrieved party". Section 1-201(2).
"Delivery". Section 1-201(14).
"Goods". Section 2A-103(1)(h).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
Section 36-2A-531. STANDING TO SUE THIRD PARTIES FOR
INJURY TO GOODS.
(1) If a third party so deals with goods that have been identified
to a lease contract as to cause actionable injury to a party to the lease
contract (a) the lessor has a right of action against the third party, and (b)
the lessee also has a right of action against the third party if the lessee:
(i) has a security interest in the goods;
(ii) has an insurable interest in the goods; or
(iii) bears the risk of loss under the lease contract or has since
the injury assumed that risk as against the lessor and the goods have
been converted or destroyed.
(2) If at the time of the injury the party plaintiff did not bear the risk
of loss as against the other party to the lease contract and there is no
arrangement between them for disposition of the recovery, his suit or
settlement, subject to his own interest, is as a fiduciary for the other
party to the lease contract.
(3) Either party with the consent of the other may sue for the benefit
of whom it may concern.
OFFICIAL COMMENT
Uniform Statutory Source: Section 2-722.
Changes: Revised to reflect leasing practices and terminology.
Definitional Cross References:
"Action". Section 1-201(1).
"Goods". Section 2A-103(1)(h).
"Lease contract". Section 2A-103(1)(l).
"Lessee". Section 2A-103(1)(n).
"Lessor". Section 2A-103(1)(p).
"Party". Section 1-201(29).
"Rights". Section 1-201(36).
"Security interest". Section 1-201(37).
Section 36-2A-532. LESSOR'S RIGHTS TO RESIDUAL
INTEREST.
In addition to any other recovery permitted by this chapter or other
law, the lessor may recover from the lessee an amount that will fully
compensate the lessor for any loss of or damage to the lessor's residual
interest in the goods caused by the default of the lessee."
OFFICIAL COMMENT
Uniform Statutory Source: None.
Purposes: This section recognizes the right of the lessor to
recover under this Article (as well as under other law) from the lessee
for failure to comply with the lease obligations as to the condition of
leased goods when returned to the lessor, for failure to return the goods
at the end of the lease, or for any other default which causes loss or
injury to the lessor's residual interest in the goods.
SECTION 2. Section 36-1-105 of the 1976 Code, as last amended by
Act 494 of 1988, is further amended to read:
"Section 36-1-105. TERRITORIAL APPLICATION OF THE
TITLE; PARTIES' POWER TO CHOOSE APPLICABLE LAW.
(1) Except as provided in this section, when a transaction bears a
reasonable relation to this State and also to another state or nation the
parties may agree that the law either of this State or of another state or
nation shall govern their rights and duties. Failing an agreement this
title applies to transactions bearing an appropriate relation to this State.
(2) Where one of the following provisions of this title specifies the
applicable law, that provision governs and a contrary agreement is
effective only to the extent permitted by the law (including the conflict
of laws rules) so specified:
Rights of seller's creditors against sold goods. Section
36-2-402.
Applicability of the Chapter on Leases.
Sections 36-2A-105 and 36-2A-106.
Applicability of the Chapter on Bank Deposits and
Collections. Section 36-4-102.
Bulk transfers subject to the Chapter on Bulk Transfers.
Section 36-6-102.
Applicability of the Chapter on Investment Securities. Section
36-8-106.
Perfection provisions of the Chapter on Secured
Transactions. Section 36-9-103."
OFFICIAL COMMENT
Uniform Statutory Source: Section 1-105, 1978 Official Text of the
Act.
Changes: Subsection (2) is amended to reference two sections
of the Article on Leases (Article 2A), which is being promulgated at the
same time as this amendment.
SECTION 3. Section 36-1-201(37) of the 1976 Code, as last amended
by Act 494 of 1988, is further amended to read:
"(37) `Security interest' means an interest in personal property
or fixtures which secures payment or performance of an obligation. The
retention or reservation of title by a seller of goods notwithstanding
shipment or delivery to the buyer (Section 36-2-401) is limited in effect
to a reservation of a `security interest'. The term also includes any
interest of a buyer of accounts or chattel paper which is subject to
Chapter 9. The special property interest of a buyer of goods on
identification of the those goods to a contract for sale
under Section 36-2-401 is not a `security interest', but a buyer
also may also acquire a `security interest' by complying
with Chapter 9. Unless a lease or consignment is intended as
security, reservation of title under a lease or consignment is not a
`security interest', but a consignment is in any event is
subject to the provisions on consignment sales (Section 36-2-326).
Whether a lease is intended as security is to be determined by the
facts of each case; however, (a) the inclusion of an option to purchase
does not of itself make the lease one intended for security, and (b) an
agreement that upon compliance with the terms of the lease the lessee
shall become or has the option to become the owner of the property for
no additional consideration or for a nominal consideration does make the
lease one intended for security.
(A) Whether a transaction creates a lease or security interest is
determined by the facts of each case; however, a transaction creates a
security interest if the consideration the lessee is to pay the lessor for the
right to possession and use of the goods is an obligation for the term of
the lease not subject to termination by the lessee, and
(1) the original term of the lease is equal to or greater than the
remaining economic life of the goods,
(2) the lessee is bound to renew the lease for the remaining
economic life of the goods or is bound to become the owner of the
goods,
(3) the lessee has an option to renew the lease for the
remaining economic life of the goods for no additional consideration or
nominal additional consideration upon compliance with the lease
agreement, or
(4) the lessee has an option to become the owner of the goods
for no additional consideration or nominal additional consideration upon
compliance with the lease agreement.
(B) A transaction does not create a security interest merely
because it provides that
(1) the present value of the consideration the lessee is
obligated to pay the lessor for the right to possession and use of the
goods is substantially equal to or is greater than the fair market value of
the goods at the time the lease is entered into, (2) the
lessee assumes risk of loss of the goods, or agrees to pay taxes,
insurance, filing, recording, or registration fees, or service or
maintenance costs with respect to the goods,
(3) the lessee has an option to renew the lease or to become
the owner of the goods,
(4) the lessee has an option to renew the lease for a fixed rent
that is equal to or greater than the reasonably predictable fair market rent
for the use of the goods for the term of the renewal at the time the option
is to be performed, or
(5) the lessee has an option to become the owner of the goods
for a fixed price that is equal to or greater than the reasonably
predictable fair market value of the goods at the time the option is to be
performed.
For purposes of this subsection (37):
Additional consideration is not nominal if (i) when the option to
renew the lease is granted to the lessee the rent is stated to be the fair
market rent for the use of the goods for the term of the renewal
determined at the time the option is to be performed, or (ii) when the
option to become the owner of the goods is granted to the lessee the
price is stated to be the fair market value of the goods determined at the
time the option is to be performed. Additional consideration is nominal
if it is less than the lessee's reasonably predictable cost of performing
under the lease agreement if the option is not exercised;
`Reasonably predictable' and `remaining economic life of the
goods' are to be determined with reference to the facts and circumstances
at the time the transaction is entered into; and
`Present value' means the amount as of a date certain of one or
more sums payable in the future, discounted to the date certain. The
discount is determined by the interest rate specified by the parties if the
rate is not manifestly unreasonable at the time the transaction is entered
into; otherwise, the discount is determined by a commercially reasonable
rate that takes into account the facts and circumstances of each case at
the time the transaction was entered into."
OFFICIAL COMMENT
Uniform Statutory Source: Section 1-201(37), 1978 Official Text
of the Act.
Changes: Substantially revised.
Purposes: This amendment to Section 1-201(37) is being
promulgated at the same time that the Article on Leases (Article 2A) is
being promulgated as an amendment to this Act.
One of the reasons it was decided to codify the law with respect to
leases was to resolve an issue that has created considerable confusion in
the courts: what is a lease? The confusion exists, in part, due to the last
two sentences of the definition of security interest in the 1978 Official
Text of the Act. Section 1-201(37). The confusion is compounded by
the rather considerable change in the federal, state and local tax laws and
accounting rules as they relate to leases of goods. The answer is
important because the definition of lease determines not only the rights
and remedies of the parties to the lease but also those of third parties.
If a transaction creates a lease and not a security interest, the lessee's
interest in the goods is limited to its leasehold estate; the residual interest
in the goods belongs to the lessor. This has significant implications to
the lessee's creditors. "On common law theory, the lessor, since
he has not parted with title, is entitled to full protection against the
lessee's creditors and trustee in bankruptcy...." 1 G. Gilmore,
Security Interests in Personal Property Section 3.6, at 76 (l965).
Under pre-Act chattel security law there was generally no
requirement that the lessor file the lease, a financing statement, or the
like, to enforce the lease agreement against the lessee or any third party;
the Article on Secured Transactions (Article 9) did not change the
common law in that respect. Coogan, Leasing and the Uniform
Commercial Code, in Equipment Leasing - Leveraged Leasing
681, 700 n.25, 729 n.80 (2d ed. 1980). The Article on Leases
(Article 2A) has not changed the law in that respect, except for leases of
fixtures. Section 2A-309. An examination of the common law will not
provide an adequate answer to the question of what is a lease. The
definition of security interest in Section 1-201(37) of the 1978 Official
Text of the Act provides that the Article on Secured Transactions
(Article 9) governs security interests disguised as leases, i.e., leases
intended as security; however, the definition is vague and outmoded.
Lease is defined in Article 2A as a transfer of the right to possession
and use of goods for a term, in return for consideration. Section
2A-103(1)(j). The definition continues by stating that the retention or
creation of a security interest is not a lease. Thus, the task of sharpening
the line between true leases and security interests disguised as leases
continues to be a function of this section.
The first paragraph of this definition is a revised version of the first
five sentences of the 1978 Official Text of Section 1-201(37). The
changes are modest in that they make a style change in the fourth
sentence and delete the reference to lease in the fifth sentence. The
balance of this definition is new, although it preserves elements of the
last two sentences of the prior definition. The focus of the changes was
to draw a sharper line between leases and security interests disguised as
leases to create greater certainty in commercial transactions.
Prior to this amendment, Section 1-201(37) provided that whether a
lease was intended as security (i.e., a security interest disguised as a
lease) was to be determined from the facts of each case; however, (a) the
inclusion of an option to purchase did not itself make the lease one
intended for security, and (b) an agreement that upon compliance with
the terms of the lease the lessee would become, or had the option to
become, the owner of the property for no additional consideration, or for
a nominal consideration, did make the lease one intended for security.
Reference to the intent of the parties to create a lease or security
interest has led to unfortunate results. In discovering intent, courts have
relied upon factors that were thought to be more consistent with sales or
loans than leases. Most of these criteria, however, are as applicable to
true leases as to security interests. Examples include the typical net
lease provisions, a purported lessor's lack of storage facilities or its
character as a financing party rather than a dealer in goods.
Accordingly, amended Section 1-201(37) deletes all reference to the
parties' intent.
The second paragraph of the new definition is taken from Section
1(2) of the Uniform Conditional Sales Act (act withdrawn 1943),
modified to reflect current leasing practice. Thus, reference to the case
law prior to this Act will provide a useful source of precedent. Gilmore,
Security Law, Formalism and Article 9, 47 Neb. L. Rev. 659,
671 (1968). Whether a transaction creates a lease or a security interest
continues to be determined by the facts of each case. The second
paragraph further provides that a transaction creates a security interest
if the lessee has an obligation to continue paying consideration for the
term of the lease, if the obligation is not terminable by the lessee (thus
correcting early statutory gloss, e.g. In re Royer's Bakery, Inc.,
1 U.C.C. Rep. Serv. (Callaghan) 342 (Bankr. E.D. Pa. 1963)) and if one
of four additional tests is met. The first of these four tests, subparagraph
(a), is that the original lease term is equal to or greater than the
remaining economic life of the goods. The second of these tests,
subparagraph (b), is that the lessee is either bound to renew the lease for
the remaining economic life of the goods or to become the owner of the
goods. In re Gehrke Enters., 1 Bankr. 647, 651-52 (Bankr.
W.D. Wis. 1979). The third of these tests, subparagraph (c), is whether
the lessee has an option to renew the lease for the remaining economic
life of the goods for no additional consideration or for nominal
additional consideration, which is defined later in this section. In re
Celeryvale Transp., 44 Bankr. 1007, 1014-15 (Bankr. E.D. Tenn.
1984). The fourth of these tests, subparagraph (d), is whether the lessee
has an option to become the owner of the goods for no additional
consideration or for nominal additional consideration. All of these tests
focus on economics, not the intent of the parties. In re Berge,
32 Bankr. 370, 371-73 (Bankr. W.D. Wis. 1983).
The focus on economics is reinforced by the next paragraph, which
is new. It states that a transaction does not create a security interest
merely because the transaction has certain characteristics listed therein.
Subparagraph (a) has no statutory derivative; it states that a full payout
lease does not per se create a security interest. Rushton v. Shea,
419 F. Supp. 1349, 1365 (D. Del. 1976). Subparagraph (b) provides the
same regarding the provisions of the typical net lease. Compare
All-States Leasing Co. v. Ochs, 42 Or. App. 319, 600 P.2d 899
(Ct. App. 1979) with In re Tillery, 571 F.2d 1361 (5th Cir.
1978). Subparagraph (c) restates and expands the provisions of former
Section 1-201(37) to make clear that the option can be to buy or renew.
Subparagraphs (d) and (e) treat fixed price options and provide that fair
market value must be determined at the time the transaction is entered
into. Compare Arnold Mach. Co. v. Balls, 624 P.2d 678 (Utah
1981) with Aoki v. Shepherd Mach. Co., 665 F.2d 941 (9th Cir.
1982).
The relationship of the second paragraph of this subsection to the
third paragraph of this subsection deserves to be explored. The fixed
price purchase option provides a useful example. A fixed price purchase
option in a lease does not of itself create a security interest. This is
particularly true if the fixed price is equal to or greater than the
reasonably predictable fair market value of the goods at the time the
option is to be performed. A security interest is created only if the
option price is nominal and the conditions stated in the introduction to
the second paragraph of this subsection are met. There is a set of
purchase options whose fixed price is less than fair market value but
greater than nominal that must be determined on the facts of each case
to ascertain whether the transaction in which the option is included
creates a lease or a security interest.
It was possible to provide for various other permutations and
combinations with respect to options to purchase and renew. For
example, this section could have stated a rule to govern the facts of
In re Marhoefer Packing Co., 674 F.2d 1139 (7th Cir. 1982).
This was not done because it would unnecessarily complicate the
definition. Further development of this rule is left to the courts.
The fourth paragraph provides definitions and rules of construction.
SECTION 4. Section 36-9-113 of the 1976 Code, as last amended by
Act 494 of 1988, is further amended to read:
"Section 36-9-113. SECURITY INTERESTS ARISING
UNDER CHAPTER ON SALES OR UNDER CHAPTER ON LEASES.
A security interest arising solely under the Chapter on Sales (Chapter
2) or the Chapter on Leases (Chapter 2A) is subject to the
provisions of this chapter except that to the extent that and so long as the
debtor does not have or does not lawfully obtain possession of the goods
(a) no security agreement is necessary to make the security interest
enforceable; and
(b) no filing is required to perfect the security interest;
and
(c) the rights of the secured party on default by the debtor are
governed (i) by the Chapter on Sales (Chapter 2) in the case
of a security interest arising solely under such Chapter or (ii) by the
Chapter on Leases (Chapter 2A) in the case of a security interest arising
solely under such Chapter.
OFFICIAL COMMENT
Uniform Statutory Source: Section 9-113, 1978 Official Text of the
Act.
Changes: This section is amended to include security interests
arising under the Article on Leases (Article 2A), which is being
promulgated at the same time as this amendment. Section 2A-508(5).
After the effective date of the amendment to this section all references
in the Act to Section 9-113 will be deemed to refer to this section, as
amended. E.g., Sections 9-203(1) and 9-302(1)(f).
Cross Reference: Article 2A, esp. Section 2A-508(5).
Definitional Cross References:
"Agreement". Section 1-201(3).
"Goods". Section 2A-103(1)(h).
"Lease". Section 2A-103(1)(j).
"Party". Section 1-201(29).
"Rights". Section 1-201(36).
"Sale". Section 2-106(1).
"Security interest". Section 1-201(37).
CHAPTER 5. Title 36 of the 1976 Code is amended by adding:
"CHAPTER 4A.
UNIFORM COMMERCIAL CODE - FUNDS
TRANSFERS
--------
Introduction
The National Conference of Commissioners on Uniform State laws
and The American Law Institute have approved a new Article 4A to the
Uniform Commercial Code. Comments that follow each of the sections
of the statute are intended as official comments. They explain in detail
the purpose and meaning of the various sections and the policy
considerations on which they are based.
Description of transaction covered by Article 4A.
There are a number of mechanisms for making payments through the
banking system. Most of these mechanisms are covered in whole or part
by state or federal statutes. In terms of number of transactions,
payments made by check or credit card are the most common payment
methods. Payment by check is covered by Articles 3 and 4 of the UCC
and some aspects of payment by credit card are covered by federal law.
In recent years electronic funds transfers have been increasingly
common in consumer transactions. For example, in some cases a retail
customer can pay for purchases by use of an access or debit card inserted
in a terminal at the retail store that allows the bank account of the
customer to be instantly debited. Some aspects of these point-of-sale
transactions and other consumer payments that are effected
electronically are covered by a federal statute, the Electronic Fund
Transfer Act (EFTA). If any part of a funds transfer is covered by
EFTA, the entire funds transfer is excluded from Article 4A.
Another type of payment, commonly referred to as a wholesale wire
transfer, is the primary focus of Article 4A. Payments that are covered
by Article 4A are overwhelmingly between business or financial
institutions. The dollar volume of payments made by wire transfer far
exceeds the dollar volume of payments made by other means. The
volume of payments by wire transfer over the two principal wire
payment systems -- the Federal Reserve wire transfer network (Fedwire)
and the New York Clearing House Interbank Payments Systems
(CHIPS) -- exceeds one trillion dollars per day. Most payments carried
out by use of automated clearing houses are consumer payments covered
by EFTA and therefore not covered by Article 4A. There is, however,
a significant volume of non-consumer ACH payments that closely
resemble wholesale wire transfers. These payments are also covered by
Article 4A.
There is some resemblance between payments made by wire transfer
and payments made by other means such as paper-based checks and
credit cards or electronically-based consumer payments, but there are
also many differences. Article 4A excludes from its coverage these
other payment mechanisms. Article 4A follows a policy of treating the
transaction that it covers -- a "funds transfer" -- as a unique
method of payment that is governed by unique principles of law that
address the operational and policy issues presented by this kind of
payment.
The funds transfer that is covered by Article 4A is not a complex
transaction and can be illustrated by the following example which is
used throughout the Prefatory Note as a basis for discussion. X, a
debtor, wants to pay an obligation owed to Y. Instead of delivering to
Y a negotiable instrument such as a check or some other writing such as
a credit card slip that enables Y to obtain payment from a bank, X
transmits an instruction to X's bank to credit a sum of money to the bank
account of Y. In most cases X's bank and Y's bank are different banks.
X's bank may carry out X's instruction by instructing Y's bank to credit
Y's account in the amount that X requested. The instruction that X
issues to its bank is a "payment order." X is the
"sender" of the payment order and X's bank is the
"receiving bank" with respect to X's order. Y is the
"beneficiary" of X's order. When X's bank issues an
instruction to Y's bank to carry out X's payment order, X's bank
"executes" X's order. The instruction of X's bank to Y's
bank is also a payment order. With respect to that order, X's bank is the
sender, Y's bank is the receiving bank, and Y is the beneficiary. The
entire series of transactions by which X pays Y is known as the
"funds transfer." With respect to the funds transfer, X is the
"originator," X's bank is the "originator's bank,"
Y is the "beneficiary" and Y's bank is the
"beneficiary's bank." In more complex transactions there are
one or more additional banks known as "intermediary
banks" between X's bank and Y's bank. In the funds transfer the
instruction contained in the payment order of X to its bank is carried out
by a series of payment orders by each bank in the transmission chain to
the next bank in the chain until Y's bank receives a payment order to
make the credit to Y's account. In most cases, the payment order of each
bank to the next bank in the chain is transmitted electronically, and often
the payment order of X to its bank is also transmitted electronically, but
the means of transmission does not have any legal significance. A
payment order may be transmitted by any means, and in some cases the
payment order is transmitted by a slow means such as first class mail.
To reflect this fact, the broader term "funds transfer" rather
than the narrower term "wire transfer" is used in Article 4A
to describe the overall payment transaction.
Funds transfers are divided into two categories determined by
whether the instruction to pay is given by the person making payment or
the person receiving payment. If the instruction is given by the person
making the payment, the transfer is commonly referred to as a
"credit transfer." If the instruction is given by the person
receiving payment, the transfer is commonly referred to as a "debit
transfer." Article 4A governs credit transfers and excludes debit
transfers.
Why is Article 4A needed?
There is no comprehensive body of law that defines the rights and
obligations that arise from wire transfers. Some aspects of wire transfers
are governed by rules of the principal transfer systems. Transfers made
by Fedwire are governed by Federal Reserve Regulation J and transfers
over CHIPS are governed by the CHIPS rules. Transfers made by means
of automated clearing houses are governed by uniform rules adopted by
various associations of banks in various parts of the nation or by Federal
Reserve rules or operating circulars. But the various funds transfer
system rules apply to only limited aspects of wire transfer transactions.
The resolution of the many issues that are not covered by funds transfer
system rules depends on contracts of the parties, to the extent that they
exist, or principles of law applicable to other payment mechanisms that
might be applied by analogy. The result is a great deal of uncertainty.
There is no consensus about the juridical nature of a wire transfer and
consequently of the rights and obligations that are created. Article 4A
is intended to provide the comprehensive body of law that we do not
have today.
Characteristics of a funds transfer.
There are a number of characteristics of funds transfers covered by
Article 4A that have influenced the drafting of the statute. The typical
funds transfer involves a large amount of money. Multimillion dollar
transactions are commonplace. The originator of the transfer and the
beneficiary are typically sophisticated business or financial
organizations. High speed is another predominant characteristic. Most
funds transfers are completed on the same day, even in complex
transactions in which there are several intermediary banks in the
transmission chain. A funds transfer is a highly efficient substitute for
payments made by the delivery of paper instruments. Another
characteristic is extremely low cost. A transfer that involves many
millions of dollars can be made for a price of a few dollars. Price does
not normally vary very much or at all with the amount of the transfer.
This system of pricing may not be feasible if the bank is exposed to very
large liabilities in connection with the transaction. The pricing system
assumes that the price reflects primarily the cost of the mechanical
operation performed by the bank, but in fact, a bank may have more or
less potential liability with respect to a funds transfer depending upon
the amount of the transfer. Risk of loss to banks carrying out a funds
transfer may arise from a variety of causes. In some funds transfers,
there may be extensions of very large amounts of credit for short periods
of time by the banks that carry out a funds transfer. If a payment order
is issued to the beneficiary's bank, it is normal for the bank to release
funds to the beneficiary immediately. Sometimes, payment to the
beneficiary's bank by the bank that issued the order to the beneficiary's
bank is delayed until the end of the day. If that payment is not received
because of the insolvency of the bank that is obliged to pay, the
beneficiary's bank may suffer a loss. There is also risk of loss if a bank
fails to execute the payment order of a customer, or if the order is
executed late. There also may be an error in the payment order issued
by a bank that is executing the payment order of its customer. For
example, the error might relate to the amount to be paid or to the identity
of the person to be paid. Because the dollar amounts involved in funds
transfers are so large, the risk of loss if something goes wrong in a
transaction may also be very large. A major policy issue in the drafting
of Article 4A is that of determining how risk of loss is to be allocated
given the price structure in the industry.
Concept of acceptance and effect of acceptance
by the beneficiary's bank.
Rights and obligations under Article 4A arise as the result of
"acceptance" of a payment order by the bank to which the
order is addressed. Section 4A-209. The effect of acceptance varies
depending upon whether the payment order is issued to the beneficiary's
bank or to a bank other than the beneficiary's bank. Acceptance by the
beneficiary's bank is particularly important because it defines when the
beneficiary's bank becomes obligated to the beneficiary to pay the
amount of the payment order. Although Article 4A follows convention
in using the term "funds transfer" to identify the payment
from X to Y that is described above, no money or property right of X is
actually transferred to Y. X pays Y by causing Y's bank to become
indebted to Y in the amount of the payment. This debt arises when Y's
bank accepts the payment order that X's bank issued to Y's bank to
execute X's order. If the funds transfer was carried out by use of one or
more intermediary banks between X's bank and Y's bank, Y's bank
becomes indebted to Y when Y's bank accepts the payment order issued
to it by an intermediary bank. The funds transfer is completed when this
debt is incurred. Acceptance, the event that determines when the debt
of Y's bank to Y arises, occurs (i) when Y's bank pays Y or notifies Y of
receipt of the payment order, or (ii) when Y's bank receives payment
from the bank that issued a payment order to Y's bank.
The only obligation of the beneficiary's bank that results from
acceptance of a payment order is to pay the amount of the order to the
beneficiary. No obligation is owed to either the sender of the payment
order accepted by the beneficiary's bank or to the originator of the funds
transfer. The obligation created by acceptance by the beneficiary's bank
is for the benefit of the beneficiary. The purpose of the sender's
payment order is to effect payment by the originator to the beneficiary
and that purpose is achieved when the beneficiary's bank accepts the
payment order. Section 4A-405 states rules for determining when the
obligation of the beneficiary's bank to the beneficiary has been paid.
Acceptance by a bank other than the beneficiary's bank.
In the funds transfer described above, what is the obligation of X's
bank when it receives X's payment order? Funds transfers by a bank on
behalf of its customer are made pursuant to an agreement or arrangement
that may or may not be reduced to a formal document signed by the
parties. It is probably true that in most cases there is either no express
agreement or the agreement addresses only some aspects of the
transaction. Substantial risk is involved in funds transfers and a bank
may not be willing to give this service to all customers, and may not be
willing to offer it to any customer unless certain safeguards against loss
such as security procedures are in effect. Funds transfers often involve
the giving of credit by the receiving bank to the customer, and that also
may involve an agreement. These considerations are reflected in Article
4A by the principle that, in the absence of a contrary agreement, a
receiving bank does not incur liability with respect to a payment order
until it accepts it. If X and X's bank in the hypothetical case had an
agreement that obliged the bank to act on X's payment orders and the
bank failed to comply with the agreement, the bank can be held liable
for breach of the agreement. But apart from any obligation arising by
agreement, the bank does not incur any liability with respect to X's
payment order until the bank accepts the order. X's payment order is
treated by Article 4A as a request by X to the bank to take action that
will cause X's payment order to be carried out. That request can be
accepted by X's bank by "executing" X's payment order.
Execution occurs when X's bank sends a payment order to Y's bank
intended by X's bank to carry out the payment order of X. X's bank
could also execute X's payment order by issuing a payment order to an
intermediary bank instructing the intermediary bank to instruct Y's bank
to make the credit to Y's account. In that case execution and acceptance
of X's order occur when the payment order of X's bank is sent to the
intermediary bank. When X's bank executes X's payment order the bank
is entitled to receive payment from X and may debit an authorized
account of X. If X's bank does not execute X's order and the amount of
the order is covered by a withdrawable credit balance in X's authorized
account, the bank must pay X interest on the money represented by X's
order unless X is given prompt notice of rejection of the order. Section
4A-210(b).
Bank error in funds transfers.
If a bank, other than the beneficiary's bank, accepts a payment order,
the obligations and liabilities are owed to the originator of the funds
transfer. Assume in the example stated above, that X's bank executes
X's payment order by issuing a payment order to an intermediary bank
that executes the order of X's bank by issuing a payment order to Y's
bank. The obligations of X's bank with respect to execution are owed
to X. The obligations of the intermediary bank with respect to execution
are also owed to X. Section 4A-302 states standards with respect to the
time and manner of execution of payment orders. Section 4A-305 states
the measure of damages for improper execution. It also states that a
receiving bank is liable for damages if it fails to execute a payment order
that it was obliged by express agreement to execute. In each case
consequential damages are not recoverable unless an express agreement
of the receiving bank provides for them. The policy basis for this
limitation is discussed in Comment 2 to Section 4A-305.
Error in the consummation of a funds transfer is not uncommon.
There may be a discrepancy in the amount that the originator orders to
be paid to the beneficiary and the amount that the beneficiary's bank is
ordered to pay. For example, if the originator's payment order instructs
payment of $100,000 and the payment order of the originator's bank
instructs payment of $1,000,000, the originator's bank is entitled to
receive only $100,000 from the originator and has the burden of
recovering the additional $900,000 paid to the beneficiary by mistake.
In some cases the originator's bank or an intermediary bank instructs
payment to a beneficiary other than the beneficiary stated in the
originator's payment order. If the wrong beneficiary is paid the bank
that issued the erroneous payment order is not entitled to receive
payment of the payment order that it executed and has the burden of
recovering the mistaken payment. The originator is not obliged to pay
its payment order. Section 4A-303 and Section 4A-207 state rules for
determining the rights and obligations of the various parties to the funds
transfer in these cases and in other typical cases in which error is made. Pursuant to Section 4A-402(c) the originator is excused from the
obligation to pay the originator's bank if the funds transfer is not
completed, i.e. payment by the originator to the beneficiary is not made.
Payment by the originator to the beneficiary occurs when the
beneficiary's bank accepts a payment order for the benefit of the
beneficiary of the originator's payment order. Section 4A-406. If for
any reason that acceptance does not occur, the originator is not required
to pay the payment order that it issued or, if it already paid, is entitled to
refund of the payment with interest. This "money-back
guarantee" is an important protection of the originator of a funds
transfer. The same rule applies to any other sender in the funds transfer.
Each sender's obligation to pay is excused if the beneficiary's bank does
not accept a payment order for the benefit of the beneficiary of that
sender's order. There is an important exception to this rule. It is
common practice for the originator of a funds transfer to designate the
intermediary bank or banks through which the funds transfer is to be
routed. The originator's bank is required by Section 4A-302 to follow
the instruction of the originator with respect to intermediary banks. If
the originator's bank sends a payment order to the intermediary bank
designated in the originator's order and the intermediary bank causes the
funds transfer to miscarry by failing to execute the payment order or by
instructing payment to the wrong beneficiary, the originator's bank is not
required to pay its payment order and if it has already paid it is entitled
to recover payment from the intermediary bank. This remedy is
normally adequate, but if the originator's bank already paid its order and
the intermediary bank has suspended payments or is not permitted by
law to refund payment, the originator's bank will suffer a loss. Since the
originator required the originator's bank to use the failed intermediary
bank, Section 4A-402(e) provides that in this case the originator is
obliged to pay its payment order and has a claim against the
intermediary bank for the amount of the order. The same principle
applies to any other sender that designates a subsequent intermediary
bank.
Unauthorized payment orders.
An important issue addressed in Section 4A-202 and Section 4A-203
is how the risk of loss from unauthorized payment orders is to be
allocated. In a large percentage of cases, the payment order of the
originator of the funds transfer is transmitted electronically to the
originator's bank. In these cases it may not be possible for the bank to
know whether the electronic message has been authorized by its
customer. To ensure that no unauthorized person is transmitting
messages to the bank, the normal practice is to establish security
procedures that usually involve the use of codes or identifying numbers
or words. If the bank accepts a payment order that purports to be that of
its customer after verifying its authenticity by complying with a security
procedure agreed to by the customer and the bank, the customer is bound
to pay the order even if it was not authorized. But there is an important
limitation on this rule. The bank is entitled to payment in the case of an
unauthorized order only if the court finds that the security procedure was
a commercially reasonable method of providing security against
unauthorized payment orders. The customer can also avoid liability if
it can prove that the unauthorized order was not initiated by an employee
or other agent of the customer having access to confidential security
information or by a person who obtained that information from a source
controlled by the customer. The policy issues are discussed in the
comments following Section 4A-203. If the bank accepts an
unauthorized payment order without verifying it in compliance with a
security procedure, the loss falls on the bank.
Security procedures are also important in cases of error in the
transmission of payment orders. There may be an error by the sender in
the amount of the order, or a sender may transmit a payment order and
then erroneously transmit a duplicate of the order. Normally, the sender
is bound by the payment order even if it is issued by mistake. But in
some cases an error of this kind can be detected by a security procedure.
Although the receiving bank is not obliged to provide a security
procedure for the detection of error, if such a procedure is agreed to by
the bank Section 4A-205 provides that if the error is not detected
because the receiving bank does not comply with the procedure, any
resulting loss is borne by the bank failing to comply with the security
procedure.
Insolvency losses.
Some payment orders do not involve the granting of credit to the
sender by the receiving bank. In those cases, the receiving bank accepts
the sender's order at the same time the bank receives payment of the
order. This is true of a transfer of funds by Fedwire or of cases in which
the receiving bank can debit a funded account of the sender. But in
some cases the granting of credit is the norm. This is true of a payment
order over CHIPS. In a CHIPS transaction the receiving bank usually
will accept the order before receiving payment from the sending bank.
Payment is delayed until the end of the day when settlement is made
through the Federal Reserve System. If the receiving bank is an
intermediary bank, it will accept by issuing a payment order to another
bank and the intermediary bank is obliged to pay that payment order. If
the receiving bank is the beneficiary's bank, the bank usually will accept
by releasing funds to the beneficiary before the bank has received
payment. If a sending bank suspends payments before settling its
liabilities at the end of the day, the financial stability of banks that are
net creditors of the insolvent bank may also be put into jeopardy,
because the dollar volume of funds transfers between the banks may be
extremely large. With respect to two banks that are dealing with each
other in a series of transactions in which each bank is sometimes a
receiving bank and sometimes a sender, the risk of insolvency can be
managed if amounts payable as a sender and amounts receivable as a
receiving bank are roughly equal. But if these amounts are significantly
out of balance, a net creditor bank may have a very significant credit risk
during the day before settlement occurs. The Federal Reserve System
and the banking community are greatly concerned with this risk, and
various measures have been instituted to reduce this credit exposure.
Article 4A also addresses this problem. A receiving bank can always
avoid this risk by delaying acceptance of a payment order until after the
bank has received payment. For example, if the beneficiary's bank
credits the beneficiary's account it can avoid acceptance by not notifying
the beneficiary of the receipt of the order or by notifying the beneficiary
that the credit may not be withdrawn until the beneficiary's bank
receives payment. But if the beneficiary's bank releases funds to the
beneficiary before receiving settlement, the result in a funds transfer
other than a transfer by means of an automated clearing house or similar
provisional settlement system is that the beneficiary's bank may not
recover the funds if it fails to receive settlement. This rule encourages
the banking system to impose credit limitations on banks that issue
payment orders. These limitations are already in effect. CHIPS has also
proposed a loss-sharing plan to be adopted for implementation in the
second half of 1990 under which CHIPS participants will be required to
provide funds necessary to complete settlement of the obligations of one
or more participants that are unable to meet settlement obligations.
Under this plan, it will be a virtual certainty that there will be settlement
on CHIPS in the event of failure by a single bank. Section 4A-403(b)
and (c) are also addressed to reducing risks of insolvency. Under these
provisions the amount owed by a failed bank with respect to payment
orders it issued is the net amount owing after setting off amounts owed
to the failed bank with respect to payment orders it received. This rule
allows credit exposure to be managed by limitations on the net debit
position of a bank.
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PART 1
SUBJECT MATTER AND DEFINITIONS
Section 36-4A-101. SHORT TITLE.
This chapter may be cited as Uniform Commercial Code--Funds
Transfers.
Section 36-4A-102. SUBJECT MATTER.
Except as otherwise provided in Section 36-4A-108, this chapter
applies to funds transfers defined in Section 36-4A-104.
OFFICIAL COMMENT
Article 4A governs a specialized method of payment referred to in
the Article as a funds transfer but also commonly referred to in the
commercial community as a wholesale wire transfer. A funds transfer
is made by means of one or more payment orders. The scope of Article
4A is determined by the definitions of "payment order" and
"funds transfer" found in Section 4A-103 and Section
4A-104.
The funds transfer governed by Article 4A is in large part a product
of recent and developing technological changes. Before this Article was
drafted there was no comprehensive body of law -- statutory or judicial
-- that defined the juridical nature of a funds transfer or the rights and
obligations flowing from payment orders. Judicial authority with respect
to funds transfers is sparse, undeveloped and not uniform. Judges have
had to resolve disputes by referring to general principles of common law
or equity, or they have sought guidance in statutes such as Article 4
which are applicable to other payment methods. But attempts to define
rights and obligations in funds transfers by general principles or by
analogy to rights and obligations in negotiable instrument law or the law
of check collection have not been satisfactory.
In the drafting of Article 4A, a deliberate decision was made to write
on a clean slate and to treat a funds transfer as a unique method of
payment to be governed by unique rules that address the particular issues
raised by this method of payment. A deliberate decision was also made
to use precise and detailed rules to assign responsibility, define
behavioral norms, allocate risks and establish limits on liability, rather
than to rely on broadly stated, flexible principles. In the drafting of
these rules, a critical consideration was that the various parties to funds
transfers need to be able to predict risk with certainty, to insure against
risk, to adjust operational and security procedures, and to price funds
transfer services appropriately. This consideration is particularly
important given the very large amounts of money that are involved in
funds transfers.
Funds transfers involve competing interests -- those of the banks that
provide funds transfer services and the commercial and financial
organizations that use the services, as well as the public interest. These
competing interests were represented in the drafting process and they
were thoroughly considered. The rules that emerged represent a careful
and delicate balancing of those interests and are intended to be the
exclusive means of determining the rights, duties and liabilities of the
affected parties in any situation covered by particular provisions of the
Article. Consequently, resort to principles of law or equity outside of
Article 4A is not appropriate to create rights, duties and liabilities
inconsistent with those stated in this Article.
Section 36-4A-103. PAYMENT ORDER - DEFINITIONS.
(a) In this chapter:
(1) `Payment order' means an instruction of a sender to a
receiving bank, transmitted orally, electronically, or in writing, to pay,
or to cause another bank to pay, a fixed or determinable amount of
money to a beneficiary if:
(i) the instruction does not state a condition to payment to
the beneficiary other than time of payment,
(ii) the receiving bank is to be reimbursed by debiting an
account of, or otherwise receiving payment from, the sender, and
(iii) the instruction is transmitted by the sender directly to
the receiving bank or to an agent, funds-transfer system, or
communication system for transmittal to the receiving bank.
(2) `Beneficiary' means the person to be paid by the
beneficiary's bank.
(3) `Beneficiary's bank' means the bank identified in a
payment order in which an account of the beneficiary is to be credited
pursuant to the order or which otherwise is to make payment to the
beneficiary if the order does not provide for payment to an account.
(4) `Receiving bank' means the bank to which the sender's
instruction is addressed.
(5) `Sender' means the person giving the instruction to the
receiving bank.
(b) If an instruction complying with subsection (a)(1) is to make
more than one payment to a beneficiary, the instruction is a separate
payment order with respect to each payment.
(c) A payment order is issued when it is sent to the receiving bank.
OFFICIAL COMMENT
This section is discussed in the Comment following Section 4A-104.
Section 36-4A-104. FUNDS TRANSFER - DEFINITIONS.
In this chapter:
(a) `Funds transfer' means the series of transactions, beginning with
the originator's payment order, made for the purpose of making payment
to the beneficiary of the order. The term includes any payment order
issued by the originator's bank or an intermediary bank intended to carry
out the originator's payment order. A funds transfer is completed by
acceptance by the beneficiary's bank of a payment order for the benefit
of the beneficiary of the originator's payment order.
(b) `Intermediary bank' means a receiving bank other than the
originator's bank or the beneficiary's bank.
(c) `Originator' means the sender of the first payment order in a
funds transfer.
(d) `Originator's bank' means (i) the receiving bank to which the
payment order of the originator is issued if the originator is not a bank,
or (ii) the originator if the originator is a bank.
OFFICIAL COMMENT
1. Article 4A governs a method of payment in which the person
making payment (the "originator") directly transmits an
instruction to a bank either to make payment to the person receiving
payment (the "beneficiary") or to instruct some other bank
to make payment to the beneficiary. The payment from the originator
to the beneficiary occurs when the bank that is to pay the beneficiary
becomes obligated to pay the beneficiary. There are two basic
definitions: "Payment order" stated in Section 4A-103 and
"Funds transfer" stated in Section 4A-104. These
definitions, other related definitions, and the scope of Article 4A can
best be understood in the context of specific fact situations. Consider
the following cases:
Case #1. X, which has an account in Bank A, instructs that
bank to pay $1,000,000 to Y's account in Bank A. Bank A carries out
X's instruction by making a credit of $1,000,000 to Y's account and
notifying Y that the credit is available for immediate withdrawal. The
instruction by X to Bank A is a "payment order" which was
issued when it was sent to Bank A. Section 4A-103(a)(1) and (c). X is
the "sender" of the payment order and Bank A is the
"receiving bank." Section 4A-103(a)(5) and (a)(4). Y is the
"beneficiary" of the payment order and Bank A is the
"beneficiary's bank." Section 4A-103(a)(2) and (a)(3).
When Bank A notified Y of receipt of the payment order, Bank A
"accepted" the payment order. Section 4A-209(b)(1). When
Bank A accepted the order it incurred an obligation to Y to pay the
amount of the order. Section 4A-404(a). When Bank A accepted X's
order, X incurred an obligation to pay Bank A the amount of the order.
Section 4A-402(b). Payment from X to Bank A would normally be
made by a debit to X's account in Bank A. Section 4A-403(a)(3). At the
time Bank A incurred the obligation to pay Y, payment of $1,000,000
by X to Y was also made. Section 4A-406(a). Bank A paid Y when it
gave notice to Y of a withdrawable credit of $1,000,000 to Y's account.
Section 4A-405(a). The overall transaction, which comprises the acts of
X and Bank A, in which the payment by X to Y is accomplished is
referred to as the "funds transfer." Section 4A-104(a). In
this case only one payment order was involved in the funds transfer. A
one-payment-order funds transfer is usually referred to as a "book
transfer" because the payment is accomplished by the receiving
bank's debiting the account of the sender and crediting the account of the
beneficiary in the same bank. X, in addition to being the sender of the
payment order to Bank A, is the "originator" of the funds
transfer. Section 4A-104(c). Bank A is the "originator's
bank" in the funds transfer as well as the beneficiary's bank.
Section 4A-104(d).
Case #2. Assume the same facts as in Case #1 except that
X instructs Bank A to pay $1,000,000 to Y's account in Bank B. With
respect to this payment order, X is the sender, Y is the beneficiary, and
Bank A is the receiving bank. Bank A carries out X's order by
instructing Bank B to pay $1,000,000 to Y's account. This instruction
is a payment order in which Bank A is the sender, Bank B is the
receiving bank, and Y is the beneficiary. When Bank A issued its
payment order to Bank B, Bank A "executed" X's order.
Section 4A-301(a). In the funds transfer, X is the originator, Bank A is
the originator's bank, and Bank B is the beneficiary's bank. When Bank
A executed X's order, X incurred an obligation to pay Bank A the
amount of the order. Section 4A-402(c). When Bank B accepts the
payment order issued to it by Bank A, Bank B incurs an obligation to Y
to pay the amount of the order (Section 4A-404 (a)) and Bank A incurs
an obligation to pay Bank B. Section 4A-402(b). Acceptance by Bank
B also results in payment of $1,000,000 by X to Y. Section 4A-406(a).
In this case two payment orders are involved in the funds transfer.
Case #3. Assume the same facts as in Case #2 except that
Bank A does not execute X's payment order by issuing a payment order
to Bank B. One bank will not normally act to carry out a funds transfer
for another bank unless there is a preexisting arrangement between the
banks for transmittal of payment orders and settlement of accounts. For
example, if Bank B is a foreign bank with which Bank A has no
relationship, Bank A can utilize a bank that is a correspondent of both
Bank A and Bank B. Assume Bank A issues a payment order to Bank
C to pay $1,000,000 to Y's account in Bank B. With respect to this
order, Bank A is the sender, Bank C is the receiving bank, and Y is the
beneficiary. Bank C will execute the payment order of Bank A by
issuing a payment order to Bank B to pay $1,000,000 to Y's account in
Bank B. With respect to Bank C's payment order, Bank C is the sender,
Bank B is the receiving bank, and Y is the beneficiary. Payment of
$1,000,000 by X to Y occurs when Bank B accepts the payment order
issued to it by Bank C. In this case the funds transfer involves three
payment orders. In the funds transfer, X is the originator, Bank A is the
originator's bank, Bank B is the beneficiary's bank, and Bank C is an
"intermediary bank." Section 4A-104 (b). In some cases
there may be more than one intermediary bank, and in those cases each
intermediary bank is treated like Bank C in Case #3.
As the three cases demonstrate, a payment under Article 4A involves
an overall transaction, the funds transfer, in which the originator, X, is
making payment to the beneficiary, Y, but the funds transfer may
encompass a series of payment orders that are issued in order to effect
the payment initiated by the originator's payment order.
In some cases the originator and the beneficiary may be the same
person. This will occur, for example, when a corporation orders a bank
to transfer funds from an account of the corporation in that bank to
another account of the corporation in that bank or in some other bank.
In some funds transfers the first bank to issue a payment order is a bank
that is executing a payment order of a customer that is not a bank. In
this case the customer is the originator. In other cases, the first bank to
issue a payment order is not acting for a customer, but is making a
payment for its own account. In that event the first bank to issue a
payment order is the originator as well as the originator's bank.
2. "Payment order" is defined in Section 4A-103(a)(1)
as an instruction to a bank to pay, or to cause another bank to pay, a
fixed or determinable amount of money. The bank to which the
instruction is addressed is known as the "receiving bank."
Section 4A-103(a)(4). "Bank" is defined in Section
4A-105(a)(2). The effect of this definition is to limit Article 4A to
payments made through the banking system. A transfer of funds made
by an entity outside the banking system is excluded. A transfer of funds
through an entity other than a bank is usually a consumer transaction
involving relatively small amounts of money and a single contract
carried out by transfers of cash or a cash equivalent such as a check.
Typically, the transferor delivers cash or a check to the company making
the transfer, which agrees to pay a like amount to a person designated by
the transferor. Transactions covered by Article 4A typically involve
very large amounts of money in which several transactions involving
several banks may be necessary to carry out the payment. Payments are
normally made by debits or credits to bank accounts. Originators and
beneficiaries are almost always business organizations and the transfers
are usually made to pay obligations. Moreover, these transactions are
frequently done on the basis of very short-term credit granted by the
receiving bank to the sender of the payment order. Wholesale wire
transfers involve policy questions that are distinct from those involved
in consumer-based transactions by nonbanks.
3. Further limitations on the scope of Article 4A are found in the
three requirements found in subparagraphs (i), (ii), and (iii) of Section
4A-103(a)(1). Subparagraph (i) states that the instruction to pay is a
payment order only if it "does not state a condition to payment to
the beneficiary other than time of payment." An instruction to pay
a beneficiary sometimes is subject to a requirement that the beneficiary
perform some act such as delivery of documents. For example, a New
York bank may have issued a letter of credit in favor of X, a California
seller of goods to be shipped to the New York bank's customer in New
York. The terms of the letter of credit provide for payment to X if
documents are presented to prove shipment of the goods. Instead of
providing for presentment of the documents to the New York bank, the
letter of credit states that they may be presented to a California bank that
acts as an agent for payment. The New York bank sends an instruction
to the California bank to pay X upon presentation of the required
documents. The instruction is not covered by Article 4A because
payment to the beneficiary is conditional upon receipt of shipping
documents. The function of banks in a funds transfer under Article 4A
is comparable to the role of banks in the collection and payment of
checks in that it is essentially mechanical in nature. The low price and
high speed that characterize funds transfers reflect this fact. Conditions
to payment by the California bank other than time of payment impose
responsibilities on that bank that go beyond those in Article 4A funds
transfers. Although the payment by the New York bank to X under the
letter of credit is not covered by Article 4A, if X is paid by the
California bank, payment of the obligation of the New York bank to
reimburse the California bank could be made by an Article 4A funds
transfer. In such a case there is a distinction between the payment by the
New York bank to X under the letter of credit and the payment by the
New York bank to the California bank. For example, if the New York
bank pays its reimbursement obligation to the California bank by a
Fedwire naming the California bank as beneficiary (see Comment 1 to
Section 4A-107), payment is made to the California bank rather than to
X. That payment is governed by Article 4A and it could be made either
before or after payment by the California bank to X. The payment by
the New York bank to X under the letter of credit is not governed by
Article 4A and it occurs when the California bank, as agent of the New
York bank, pays X. No payment order was involved in that transaction.
In this example, if the New York bank had erroneously sent an
instruction to the California bank unconditionally instructing payment
to X, the instruction would have been an Article 4A payment order. If
the payment order was accepted (Section 4A-209(b)) by the California
bank, a payment by the New York bank to X would have resulted
(Section 4A-406(a)). But Article 4A would not prevent recovery of
funds from X on the basis that X was not entitled to retain the funds
under the law of mistake and restitution, letter of credit law or other
applicable law.
4. Transfers of funds made through the banking system are
commonly referred to as either "credit" transfers or
"debit" transfers. In a credit transfer the instruction to pay
is given by the person making payment. In a debit transfer the
instruction to pay is given by the person receiving payment. The
purpose of subparagraph (ii) of subsection (a)(1) of Section 4A-103 is
to include credit transfers in Article 4A and to exclude debit transfers.
All of the instructions to pay in the three cases described in Comment 1
fall within subparagraph (ii). Take Case #2 as an example. With respect
to X's instruction given to Bank A, Bank A will be reimbursed by
debiting X's account or otherwise receiving payment from X. With
respect to Bank A's instruction to Bank B, Bank B will be reimbursed by
receiving payment from Bank A. In a debit transfer, a creditor, pursuant
to authority from the debtor, is enabled to draw on the debtor's bank
account by issuing an instruction to pay to the debtor's bank. If the
debtor's bank pays, it will be reimbursed by the debtor rather than by the
person giving the instruction. For example, the holder of an insurance
policy may pay premiums by authorizing the insurance company to
order the policyholder's bank to pay the insurance company. The order
to pay may be in the form of a draft covered by Article 3, or it might be
an instruction to pay that is not an instrument under that Article. The
bank receives reimbursement by debiting the policyholder's account. Or,
a subsidiary corporation may make payments to its parent by authorizing
the parent to order the subsidiary's bank to pay the parent from the
subsidiary's account. These transactions are not covered by Article 4A
because subparagraph (2) is not satisfied. Article 4A is limited to
transactions in which the account to be debited by the receiving bank is
that of the person in whose name the instruction is given.
If the beneficiary of a funds transfer is the originator of the transfer,
the transfer is governed by Article 4A if it is a credit transfer in form.
If it is in the form of a debit transfer it is not governed by Article 4A.
For example, Corporation has accounts in Bank A and Bank B.
Corporation instructs Bank A to pay to Corporation's account in Bank
B. The funds transfer is governed by Article 4A. Sometimes,
Corporation will authorize Bank B to draw on Corporation's account in
Bank A for the purpose of transferring funds into Corporation's account
in Bank B. If Corporation also makes an agreement with Bank A under
which Bank A is authorized to follow instructions of Bank B, as agent
of Corporation, to transfer funds from Customer's account in Bank A,
the instruction of Bank B is a payment order of Customer and is
governed by Article 4A. This kind of transaction is known in the
wire-transfer business as a "drawdown transfer." If
Corporation does not make such an agreement with Bank A and Bank
B instructs Bank A to make the transfer, the order is in form a debit
transfer and is not governed by Article 4A. These debit transfers are
normally ACH transactions in which Bank A relies on Bank B's
warranties pursuant to ACH rules, including the warranty that the
transfer is authorized.
5. The principal effect of subparagraph (iii) of subsection (a) of
Section 4A-103 is to exclude from Article 4A payments made by check
or credit card. In those cases the instruction of the debtor to the bank on
which the check is drawn or to which the credit card slip is to be
presented is contained in the check or credit card slip signed by the
debtor. The instruction is not transmitted by the debtor directly to the
debtor's bank. Rather, the instruction is delivered or otherwise
transmitted by the debtor to the creditor who then presents it to the bank
either directly or through bank collection channels. These payments are
governed by Articles 3 and 4 and federal law. There are, however,
limited instances in which the paper on which a check is printed can be
used as the means of transmitting a payment order that is covered by
Article 4A. Assume that Originator instructs Originator's Bank to pay
$10,000 to the account of Beneficiary in Beneficiary's Bank. Since the
amount of Originator's payment order is small, if Originator's Bank and
Beneficiary's Bank do not have an account relationship, Originator's
Bank may execute Originator's order by issuing a teller's check payable
to Beneficiary's Bank for $10,000 along with instructions to credit
Beneficiary's account in that amount. The instruction to Beneficiary's
Bank to credit Beneficiary's account is a payment order. The check is
the means by which Originator's Bank pays its obligation as sender of
the payment order. The instruction of Originator's Bank to Beneficiary's
Bank might be given in a letter accompanying the check or it may be
written on the check itself. In either case the instruction to Beneficiary's
Bank is a payment order but the check itself (which is an order to pay
addressed to the drawee rather than to Beneficiary's Bank) is an
instrument under Article 3 and is not a payment order. The check can
be both the means by which Originator's Bank pays its obligation under
Section 4A-402(b) to Beneficiary's Bank and the means by which the
instruction to Beneficiary's Bank is transmitted.
6. Most payments covered by Article 4A are commonly referred to
as wire transfers and usually involve some kind of electronic
transmission, but the applicability of Article 4A does not depend upon
the means used to transmit the instruction of the sender. Transmission
may be by letter or other written communication, oral communication or
electronic communication. An oral communication is normally given by
telephone. Frequently the message is recorded by the receiving bank to
provide evidence of the transaction, but apart from problems of proof
there is no need to record the oral instruction. Transmission of an
instruction may be a direct communication between the sender and the
receiving bank or through an intermediary such as an agent of the
sender, a communication system such as international cable, or a funds
transfer system such as CHIPS, SWIFT or an automated clearing house.
Section 36-4A-105. OTHER DEFINITIONS.
(a) In this chapter:
(1) `Authorized account' means a deposit account of a
customer in a bank designated by the customer as a source of payment
of payment orders issued by the customer to the bank. If a customer
does not so designate an account, any account of the customer is an
authorized account if payment of a payment order from that account is
not inconsistent with a restriction on the use of that account.
(2) `Bank' means a person engaged in the business of banking
and includes a savings bank, savings and loan association, credit union,
and trust company. A branch or separate office of a bank is a separate
bank for purposes of this chapter.
(3) `Customer' means a person, including a bank, having an
account with a bank or from whom a bank has agreed to receive
payment orders.
(4) `Funds-transfer business day' of a receiving bank means
the part of a day during which the receiving bank is open for the receipt,
processing, and transmittal of payment orders and cancellations and
amendments of payment orders.
(5) `Funds-transfer system' means a wire transfer network,
automated clearing house, or other communication system of a clearing
house or other association of banks through which a payment order by
a bank may be transmitted to the bank to which the order is addressed.
(6) `Good faith' means honesty in fact and the observance of
reasonable commercial standards of fair dealing.
(7) `Prove' with respect to a fact means to meet the burden of
establishing the fact (Section 36-1-201(8)).
(b) Other definitions applying to this chapter and the sections in
which they appear are:
`Acceptance' Section 36-4A-209
`Beneficiary' Section 36-4A-103
`Beneficiary's bank' Section 36-4A-103
`Executed' Section 36-4A-301
`Execution date' Section 36-4A-301
`Funds transfer' Section 36-4A-104
`Funds-transfer system rule' Section 36-4A-501
`Intermediary bank' Section 36-4A-104
`Originator' Section 36-4A-104
`Originator's bank' Section 36-4A-104
`Payment by beneficiary's bank
to beneficiary' Section 36-4A-405
`Payment by originator to
beneficiary' Section 36-4A-406
`Payment by sender
to receiving bank' Section 36-4A-403
`Payment date' Section 36-4A-401
`Payment order' Section 36-4A-103
`Receiving bank' Section 36-4A-103
`Security procedure' Section 36-4A-201
`Sender' Section 36-4A-103
(c) The following definitions in Chapter 4 apply to this chapter:
`Clearing house' Section 36-4-104
`Item' Section 36-4-104
`Suspends payments' Section 36-4-104
(d) In addition Chapter 1 contains general definitions and
principles of construction and interpretation applicable throughout this
chapter.
OFFICIAL COMMENT
1. The definition of "bank" in subsection (a)(2) includes
some institutions that are not commercial banks. The definition reflects
the fact that many financial institutions now perform functions
previously restricted to commercial banks, including acting on behalf of
customers in funds transfers. Since many funds transfers involve
payment orders to or from foreign countries the definition also covers
foreign banks. The definition also includes Federal Reserve Banks.
Funds transfers carried out by Federal Reserve Banks are described in
Comments 1 and 2 to Section 4A-107.
2. Funds transfer business is frequently transacted by banks outside
of general banking hours. Thus, the definition of banking day in Section
4-104(1)(c) cannot be used to describe when a bank is open for funds
transfer business. Subsection (a)(4) defines a new term, "funds
transfer business day," which is applicable to Article 4A. The
definition states, "is open for the receipt, processing, and
transmittal of payment orders and cancellations and amendments of
payment orders." In some cases it is possible to electronically
transmit payment orders and other communications to a receiving bank
at any time. If the receiving bank is not open for the processing of an
order when it is received, the communication is stored in the receiving
bank's computer for retrieval when the receiving bank is open for
processing. The use of the conjunctive makes clear that the defined term
is limited to the period during which all functions of the receiving bank
can be performed, i.e., receipt, processing, and transmittal of payment
orders, cancellations and amendments.
3. Subsection (a)(5) defines "funds transfer system."
The term includes a system such as CHIPS which provides for
transmission of a payment order as well as settlement of the obligation
of the sender to pay the order. It also includes automated clearing
houses, operated by a clearing house or other association of banks,
which process and transmit payment orders of banks to other banks. In
addition the term includes organizations that provide only transmission
services such as SWIFT. The definition also includes the wire transfer
network and automated clearing houses of Federal Reserve Banks.
Systems of the Federal Reserve Banks, however, are treated differently
from systems of other associations of banks. Funds transfer systems
other than systems of the Federal Reserve Banks are treated in Article
4A as a means of communication of payment orders between
participating banks. Section 4A-206. The Comment to that section and
the Comment to Section 4A-107 explain how Federal Reserve Banks
function under Article 4A. Funds transfer systems are also able to
promulgate rules binding on participating banks that, under Section
4A-501, may supplement or in some cases may even override provisions
of Article 4A.
4. Subsection (d) incorporates definitions stated in Article 1 as well
as principles of construction and interpretation stated in that Article.
Included is Section 1-103. The last paragraph of the Comment to
Section 4A-102 is addressed to the issue of the extent to which general
principles of law and equity should apply to situations covered by
provisions of Article 4A.
Section 36-4A-106. TIME PAYMENT ORDER IS RECEIVED.
(a) The time of receipt of a payment order or communication
canceling or amending a payment order is determined by the rules
applicable to receipt of a notice stated in Section 36-1-201(27). A
receiving bank may fix a cut-off time or times on a funds-transfer
business day for the receipt and processing of payment orders and
communications canceling or amending payment orders. Different
cut-off times may apply to payment orders, cancellations, or
amendments, or to different categories of payment orders, cancellations,
or amendments. A cut-off time may apply to senders generally or
different cut-off times may apply to different senders or categories of
payment orders. If a payment order or communication canceling or
amending a payment order is received after the close of a funds-transfer
business day or after the appropriate cut-off time on a funds-transfer
business day, the receiving bank may treat the payment order or
communication as received at the opening of the next funds-transfer
business day.
(b) If this chapter refers to an execution date or payment date or
states a day on which a receiving bank is required to take action, and the
date or day does not fall on a funds-transfer business day, the next day
that is a funds-transfer business day is treated as the date or day stated,
unless the contrary is stated in this chapter.
OFFICIAL COMMENT
The time that a payment order is received by a receiving bank usually
defines the payment date or the execution date of a payment order.
Section 4A-401 and Section 4A-301. The time of receipt of a payment
order, or communication cancelling or amending a payment order is
defined in subsection (a) by reference to the rules stated in Section
1-201(27). Thus, time of receipt is determined by the same rules that
determine when a notice is received. Time of receipt, however, may be
altered by a cut-off time.
Section 36-4A-107. FEDERAL RESERVE REGULATIONS AND
OPERATING CIRCULARS.
Regulations of the Board of Governors of the Federal Reserve
System and operating circulars of the Federal Reserve Banks supersede
any inconsistent provision of this chapter to the extent of the
inconsistency.
OFFICIAL COMMENT
1. Funds transfers under Article 4A may be made, in whole or in
part, by payment orders through a Federal Reserve Bank in what is
usually referred to as a transfer by Fedwire. If Bank A, which has an
account in Federal Reserve Bank X, wants to pay $1,000,000 to Bank B,
which has an account in Federal Reserve Bank Y, Bank A can issue an
instruction to Reserve Bank X requesting a debit of $1,000,000 to Bank
A's Reserve account and an equal credit to Bank B's Reserve account.
Reserve Bank X will debit Bank A's account and will credit the account
of Reserve Bank Y. Reserve Bank X will issue an instruction to Reserve
Bank Y requesting a debit of $1,000,000 to the account of Reserve Bank
X and an equal credit to Bank B's account in Reserve Bank Y. Reserve
Bank Y will make the requested debit and credit and will give Bank B
an advice of credit. The definition of "bank" in Section
4A-105(a)(2) includes both Reserve Bank X and Reserve Bank Y. Bank
A's instruction to Reserve Bank X to pay money to Bank B is a payment
order under Section 4A-103(a)(1). Bank A is the sender and Reserve
Bank X is the receiving bank. Bank B is the beneficiary of Bank A's
order and of the funds transfer. Bank A is the originator of the funds
transfer and is also the originator's bank. Section 4A-104(c) and (d).
Reserve Bank X, an intermediary bank under Section 4A-104(b),
executes Bank A's order by sending a payment order to Reserve Bank Y
instructing that bank to credit the Federal Reserve account of Bank B.
Reserve Bank Y is the beneficiary's bank.
Suppose the transfer of funds from Bank A to Bank B is part of a
larger transaction in which Originator, a customer of Bank A, wants to
pay Beneficiary, a customer of Bank B. Originator issues a payment
order to Bank A to pay $1,000,000 to the account of Beneficiary in Bank
B. Bank A may execute Originator's order by means of Fedwire which
simultaneously transfers $1,000,000 from Bank A to Bank B and carries
a message instructing Bank B to pay $1,000,000 to the account of Y.
The Fedwire transfer is carried out as described in the previous
paragraph, except that the beneficiary of the funds transfer is Beneficiary
rather than Bank B. Reserve Bank X and Reserve Bank Y are
intermediary banks. When Reserve Bank Y advises Bank B of the credit
to its Federal Reserve account it will also instruct Bank B to pay to the
account of Beneficiary. The instruction is a payment order to Bank B
which is the beneficiary's bank. When Reserve Bank Y advises Bank B
of the credit to its Federal Reserve account Bank B receives payment of
the payment order issued to it by Reserve Bank Y. Section
4A-403(a)(1). The payment order is automatically accepted by Bank B
at the time it receives the payment order of Reserve Bank Y. Section
4A-209(b)(2). At the time of acceptance by Bank B payment by
Originator to Beneficiary also occurs. Thus, in a Fedwire transfer,
payment to the beneficiary's bank, acceptance by the beneficiary's bank
and payment by the originator to the beneficiary all occur
simultaneously by operation of law at the time the payment order to the
beneficiary's bank is received.
If Originator orders payment to the account of Beneficiary in Bank
C rather than Bank B, the analysis is somewhat modified. Bank A may
not have any relationship with Bank C and may not be able to make
payment directly to Bank C. In that case, Bank A could send a Fedwire
instructing Bank B to instruct Bank C to pay Beneficiary. The analysis
is the same as the previous case except that Bank B is an intermediary
bank and Bank C is the beneficiary's bank.
2. A funds transfer can also be made through a Federal Reserve
Bank in an automated clearing house transaction. In a typical case,
Originator instructs Originator's Bank to pay to the account of
Beneficiary in Beneficiary's Bank. Originator's instruction to pay a
particular beneficiary is transmitted to Originator's Bank along with
many other instructions for payment to other beneficiaries by many
different beneficiary's banks. All of these instructions are contained in
a magnetic tape or other electronic device. Transmission of instructions
to the various beneficiary's banks requires that Originator's instructions
be processed and repackaged with instructions of other originators so
that all instructions to a particular beneficiary's bank are transmitted
together to that bank. The repackaging is done in processing centers
usually referred to as automated clearing houses. Automated clearing
houses are operated either by Federal Reserve Banks or by other
associations of banks. If Originator's Bank chooses to execute
Originator's instructions by transmitting them to a Federal Reserve Bank
for processing by the Federal Reserve Bank, the transmission to the
Federal Reserve Bank results in the issuance of payment orders by
Originator's Bank to the Federal Reserve Bank, which is an intermediary
bank. Processing by the Federal Reserve Bank will result in the issuance
of payment orders by the Federal Reserve Bank to Beneficiary's Bank
as well as payment orders to other beneficiary's banks making payments
to carry out Originator's instructions.
3. Although the terms of Article 4A apply to funds transfers
involving Federal Reserve Banks, federal preemption would make
ineffective any Article 4A provision that conflicts with federal law. The
payments activities of the Federal Reserve Banks are governed by
regulations of the Federal Reserve Board and by operating circulars
issued by the Reserve Banks themselves. In some instances, the
operating circulars are issued pursuant to a Federal Reserve Board
regulation. In other cases, the Reserve Bank issues the operating
circular under its own authority under the Federal Reserve Act, subject
to review by the Federal Reserve Board. Section 4A-107 states that
Federal Reserve Board regulations and operating circulars of the Federal
Reserve Banks supersede any inconsistent provision of Article 4A to the
extent of the inconsistency. Federal Reserve Board regulations, being
valid exercises of regulatory authority pursuant to a federal statute, take
precedence over state law if there is an inconsistency. Childs v.
Federal Reserve Bank of Dallas, 719 F.2d 812 (5th Cir. 1983), reh.
den. 724 F.2d 127 (5th Cir. 1984). Section 4A-107 treats operating
circulars as having the same effect whether issued under the Reserve
Bank's own authority or under a Federal Reserve Board regulation.
Section 36-4A-108. EXCLUSION OF CONSUMER
TRANSACTIONS GOVERNED BY FEDERAL LAW.
This chapter does not apply to a funds transfer any part of which is
governed by the Electronic Fund Transfer Act of 1978 (Title XX, Public
Law 95-630, 92 Stat. 3728, 15 U.S.C. Section 1693 et seq.) as amended
from time to time.
OFFICIAL COMMENT
The Electronic Fund Transfer Act of 1978 is a federal statute that
covers a wide variety of electronic funds transfers involving consumers.
The types of transfers covered by the federal statute are essentially
different from the wholesale wire transfers that are the primary focus of
Article 4A. Section 4A-108 excludes a funds transfer from Article 4A
if any part of the transfer is covered by the federal law. Existing
procedures designed to comply with federal law will not be affected by
Article 4A. The effect of Section 4A-108 is to make Article 4A and
EFTA mutually exclusive. For example, if a funds transfer is to a
consumer account in the beneficiary's bank and the funds transfer is
made in part by use of Fedwire and in part by means of an automated
clearing house, EFTA applies to the ACH part of the transfer but not to
the Fedwire part. Under Section 4A-108, Article 4A does not apply to
any part of the transfer. However, in the absence of any law to govern
the part of the funds transfer that is not subject to EFTA, a court might
apply appropriate principles from Article 4A by analogy.
PART 2
ISSUE AND ACCEPTANCE OF PAYMENT
ORDER
Section 36-4A-201. SECURITY PROCEDURE.
`Security procedure' means a procedure established by agreement of
a customer and a receiving bank for the purpose of (i) verifying that a
payment order or communication amending or canceling a payment
order is that of the customer, or (ii) detecting error in the transmission
or the content of the payment order or communication. A security
procedure may require the use of algorithms or other codes, identifying
words or numbers, encryption, callback procedures, or similar security
devices. Comparison of a signature on a payment order or
communication with an authorized specimen signature of the customer
is not by itself a security procedure.
OFFICIAL COMMENT
A large percentage of payment orders and communications amending
or cancelling payment orders are transmitted electronically and it is
standard practice to use security procedures that are designed to assure
the authenticity of the message. Security procedures can also be used to
detect error in the content of messages or to detect payment orders that
are transmitted by mistake as in the case of multiple transmission of the
same payment order. Security procedures might also apply to
communications that are transmitted by telephone or in writing. Section
4A-201 defines these security procedures. The definition of security
procedure limits the term to a procedure "established by agreement
of a customer and a receiving bank." The term does not apply to
procedures that the receiving bank may follow unilaterally in processing
payment orders. The question of whether loss that may result from the
transmission of a spurious or erroneous payment order will be borne by
the receiving bank or the sender or purported sender is affected by
whether a security procedure was or was not in effect and whether there
was or was not compliance with the procedure. Security procedures are
referred to in Sections 4A-202 and 4A-203, which deal with authorized
and verified payment orders, and Section 4A-205, which deals with
erroneous payment orders.
Section 36-4A-202. AUTHORIZED AND VERIFIED PAYMENT
ORDERS.
(a) A payment order received by the receiving bank is the authorized
order of the person identified as sender if that person authorized the
order or is otherwise bound by it under the law of agency.
(b) If a bank and its customer have agreed that the authenticity of
payment orders issued to the bank in the name of the customer as sender
will be verified pursuant to a security procedure, a payment order
received by the receiving bank is effective as the order of the customer,
whether or not authorized, if (i) the security procedure is a commercially
reasonable method of providing security against unauthorized payment
orders, and (ii) the bank proves that it accepted the payment order in
good faith and in compliance with the security procedure and any
written agreement or instruction of the customer restricting acceptance
of payment orders issued in the name of the customer. The bank is not
required to follow an instruction that violates a written agreement with
the customer or notice of which is not received at a time and in a manner
affording the bank a reasonable opportunity to act on it before the
payment order is accepted.
(c) Commercial reasonableness of a security procedure is a question
of law to be determined by considering the wishes of the customer
expressed to the bank, the circumstances of the customer known to the
bank, including the size, type, and frequency of payment orders
normally issued by the customer to the bank, alternative security
procedures offered to the customer, and security procedures in general
use by customers and receiving banks similarly situated. A security
procedure is considered to be commercially reasonable if (i) the security
procedure was chosen by the customer after the bank offered, and the
customer refused, a security procedure that was commercially reasonable
for that customer, and (ii) the customer expressly agreed in writing to be
bound by any payment order, whether or not authorized, issued in its
name and accepted by the bank in compliance with the security
procedure chosen by the customer.
(d) The term `sender' in this chapter includes the customer in
whose name a payment order is issued if the order is the authorized
order of the customer under subsection (a), or it is effective as the order
of the customer under subsection (b).
(e) This section applies to amendments and cancellations of payment
orders to the same extent it applies to payment orders.
(f) Except as provided in this section and in Section
36-4A-203(a)(1), rights and obligations arising under this section or
Section 36-4A-203 may not be varied by agreement.
OFFICIAL COMMENT
This section is discussed in the Comment following Section 4A-203.
Section 36-4A-203. UNENFORCEABILITY OF CERTAIN
VERIFIED PAYMENT ORDERS.
(a) If an accepted payment order is not, under Section 36-4A-202(a),
an authorized order of a customer identified as sender, but is effective
as an order of the customer pursuant to Section 36-4A-202(b), the
following rules apply:
(1) By express written agreement, the receiving bank may
limit the extent to which it is entitled to enforce or retain payment of the
payment order.
(2) The receiving bank is not entitled to enforce or retain
payment of the payment order if the customer proves that the order was
not caused, directly or indirectly, by a person (i) entrusted at any time
with duties to act for the customer with respect to payment orders or the
security procedure, or (ii) who obtained access to transmitting facilities
of the customer or who obtained, from a source controlled by the
customer and without authority of the receiving bank, information
facilitating breach of the security procedure, regardless of how the
information was obtained or whether the customer was at fault.
Information includes any access device, computer software, or the like.
(b) This section applies to amendments of payment orders to the
same extent it applies to payment orders.
OFFICIAL COMMENT
1. Some person will always be identified as the sender of a payment
order. Acceptance of the order by the receiving bank is based on a belief
by the bank that the order was authorized by the person identified as the
sender. If the receiving bank is the beneficiary's bank acceptance means
that the receiving bank is obliged to pay the beneficiary. If the receiving
bank is not the beneficiary's bank, acceptance means that the receiving
bank has executed the sender's order and is obliged to pay the bank that
accepted the order issued in execution of the sender's order. In either
case the receiving bank may suffer a loss unless it is entitled to enforce
payment of the payment order that it accepted. If the person identified
as the sender of the order refuses to pay on the ground that the order was
not authorized by that person, what are the rights of the receiving bank?
In the absence of a statute or agreement that specifically addresses the
issue, the question usually will be resolved by the law of agency. In
some cases, the law of agency works well. For example, suppose the
receiving bank executes a payment order given by means of a letter
apparently written by a corporation that is a customer of the bank and
apparently signed by an officer of the corporation. If the receiving bank
acts solely on the basis of the letter, the corporation is not bound as the
sender of the payment order unless the signature was that of the officer
and the officer was authorized to act for the corporation in the issuance
of payment orders, or some other agency doctrine such as apparent
authority or estoppel causes the corporation to be bound. Estoppel can
be illustrated by the following example. Suppose P is aware that A, who
is unauthorized to act for P, has fraudulently misrepresented to T that A
is authorized to act for P. T believes A and is about to rely on the
misrepresentation. If P does not notify T of the true facts although P
could easily do so, P may be estopped from denying A's lack of
authority. A similar result could follow if the failure to notify T is the
result of negligence rather than a deliberate decision. Restatement,
Second, Agency Section 8B. Other equitable principles such as
subrogation or restitution might also allow a receiving bank to recover
with respect to an unauthorized payment order that it accepted. In
Gatoil (U.S.A.), Inc. v. Forest Hill State Bank, 1 U.C.C. Rep.
Serv. 2d 171 (D.Md. 1986), a joint venturer not authorized to order
payments from the account of the joint venture, ordered a funds transfer
from the account. The transfer paid a bona fide debt of the joint venture.
Although the transfer was unauthorized the court refused to require
recredit of the account because the joint venture suffered no loss. The
result can be rationalized on the basis of subrogation of the receiving
bank to the right of the beneficiary of the funds transfer to receive the
payment from the joint venture.
But in most cases these legal principles give the receiving bank very
little protection in the case of an authorized payment order. Cases like
those just discussed are not typical of the way that most payment orders
are transmitted and accepted, and such cases are likely to become even
less common. Given the large amount of the typical payment order, a
prudent receiving bank will be unwilling to accept a payment order
unless it has assurance that the order is what it purports to be. This
assurance is normally provided by security procedures described in
Section 4A-201.
In a very large percentage of cases covered by Article 4A,
transmission of the payment order is made electronically. The receiving
bank may be required to act on the basis of a message that appears on a
computer screen. Common law concepts of authority of agent to bind
principal are not helpful. There is no way of determining the identity or
the authority of the person who caused the message to be sent. The
receiving bank is not relying on the authority of any particular person to
act for the purported sender. The case is not comparable to payment of
a check by the drawee bank on the basis of a signature that is forged.
Rather, the receiving bank relies on a security procedure pursuant to
which the authenticity of the message can be "tested" by
various devices which are designed to provide certainty that the message
is that of the sender identified in the payment order. In the wire transfer
business the concept of "authorized" is different from that
found in agency law. In that business a payment order is treated as the
order of the person in whose name it is issued if it is properly tested
pursuant to a security procedure and the order passes the test.
Section 4A-202 reflects the reality of the wire transfer business. A
person in whose name a payment order is issued is considered to be the
sender of the order if the order is "authorized" as stated in
subsection (a) or if the order is "verified" pursuant to a
security procedure in compliance with subsection (b). If subsection (b)
does not apply, the question of whether the customer is responsible for
the order is determined by the law of agency. The issue is one of actual
or apparent authority of the person who caused the order to be issued in
the name of the customer. In some cases the law of agency might allow
the customer to be bound by an unauthorized order if conduct of the
customer can be used to find an estoppel against the customer to deny
that the order was unauthorized. If the customer is bound by the order
under any of these agency doctrines, subsection (a) treats the order as
authorized and thus the customer is deemed to be the sender of the order.
In most cases, however, subsection (b) will apply. In that event there is
no need to make an agency law analysis to determine authority. Under
Section 4A-202, the issue of liability of the purported sender of the
payment order will be determined by agency law only if the receiving
bank did not comply with subsection (b).
2. The scope of Section 4A-202 can be illustrated by the following
cases. Case #1. A payment order purporting to be that of
Customer is received by Receiving Bank but the order was fraudulently
transmitted by a person who had no authority to act for Customer.
Case #2. An authentic payment order was sent by Customer,
but before the order was received by Receiving Bank the order was
fraudulently altered by an unauthorized person to change the
beneficiary. Case #3. An authentic payment order was
received by Receiving Bank, but before the order was executed by
Receiving Bank a person who had no authority to act for Customer
fraudulently sent a communication purporting to amend the order by
changing the beneficiary. In each case Receiving Bank acted on the
fraudulent communication by accepting the payment order. These cases
are all essentially similar and they are treated identically by Section
4A-202. In each case Receiving Bank acted on a communication that it
thought was authorized by Customer when in fact the communication
was fraudulent. No distinction is made between Case #1 in which
Customer took no part at all in the transaction and Case #2 and Case #3
in which an authentic order was fraudulently altered or amended by an
unauthorized person. If subsection (b) does not apply, each case is
governed by subsection (a). If there are no additional facts on which an
estoppel might be found, Customer is not responsible in Case #1 for the
fraudulently issued payment order, in Case #2 for the fraudulent
alteration or in Case #3 for the fraudulent amendment. Thus, in each
case Customer is not liable to pay the order and Receiving Bank takes
the loss. The only remedy of Receiving Bank is to seek recovery from
the person who received payment as beneficiary of the fraudulent order.
If there was verification in compliance with subsection (b), Customer
will take the loss unless Section 4A-203 applies.
3. Subsection (b) of Section 4A-202 is based on the assumption that
losses due to fraudulent payment orders can best be avoided by the use
of commercially reasonable security procedures, and that the use of such
procedures should be encouraged. The subsection is designed to protect
both the customer and the receiving bank. A receiving bank needs to be
able to rely on objective criteria to determine whether it can safely act
on a payment order. Employees of the bank can be trained to
"test" a payment order according to the various steps
specified in the security procedure. The bank is responsible for the acts
of these employees. Subsection (b)(ii) requires the bank to prove that it
accepted the payment order in good faith and "in compliance with
the security procedure." If the fraud was not detected because the
bank's employee did not perform the acts required by the security
procedure, the bank has not complied. Subsection (b)(ii) also requires
the bank to prove that it complied with any agreement or instruction that
restricts acceptance of payment orders issued in the name of the
customer. A customer may want to protect itself by imposing limitations
on acceptance of payment orders by the bank. For example, the
customer may prohibit the bank from accepting a payment order that is
not payable from an authorized account, that exceeds the credit balance
in specified accounts of the customer, or that exceeds some other
amount. Another limitation may relate to the beneficiary. The customer
may provide the bank with a list of authorized beneficiaries and prohibit
acceptance of any payment order to a beneficiary not appearing on the
list. Such limitations may be incorporated into the security procedure
itself or they may be covered by a separate agreement or instruction. In
either case, the bank must comply with the limitations if the conditions
stated in subsection (b) are met. Normally limitations on acceptance
would be incorporated into an agreement between the customer and the
receiving bank, but in some cases the instruction might be unilaterally
given by the customer. If standing instructions or an agreement state
limitations on the ability of the receiving bank to act, provision must be
made for later modification of the limitations. Normally this would be
done by an agreement that specifies particular procedures to be
followed. Thus, subsection (b) states that the receiving bank is not
required to follow an instruction that violates a written agreement. The
receiving bank is not bound by an instruction unless it has adequate
notice of it. Subsections (25), (26) and (27) of Section 1-201 apply.
Subsection (b)(i) assures that the interests of the customer will be
protected by providing an incentive to a bank to make available to the
customer a security procedure that is commercially reasonable. If a
commercially reasonable security procedure is not made available to the
customer, subsection (b) does not apply. The result is that subsection (a)
applies and the bank acts at its peril in accepting a payment order that
may be unauthorized. Prudent banking practice may require that
security procedures be utilized in virtually all cases except for those in
which personal contact between the customer and the bank eliminates
the possibility of an unauthorized order. The burden of making
available commercially reasonable security procedures is imposed on
receiving banks because they generally determine what security
procedures can be used and are in the best position to evaluate the
efficacy of procedures offered to customers to combat fraud. The
burden on the customer is to supervise its employees to assure
compliance with the security procedure and to safeguard confidential
security information and access to transmitting facilities so that the
security procedure cannot be breached.
4. The principal issue that is likely to arise in litigation involving
subsection (b) is whether the security procedure in effect when a
fraudulent payment order was accepted was commercially reasonable.
The concept of what is commercially reasonable in a given case is
flexible. Verification entails labor and equipment costs that can vary
greatly depending upon the degree of security that is sought. A
customer that transmits very large numbers of payment orders in very
large amounts may desire and may reasonably expect to be provided
with state-of-the-art procedures that provide maximum security. But the
expense involved may make use of a state-of-the-art procedure
infeasible for a customer that normally transmits payment orders
infrequently or in relatively low amounts. Another variable is the type
of receiving bank. It is reasonable to require large money center banks
to make available state-of-the-art security procedures. On the other
hand, the same requirement may not be reasonable for a small country
bank. A receiving bank might have several security procedures that are
designed to meet the varying needs of different customers. The type of
payment order is another variable. For example, in a wholesale wire
transfer, each payment order is normally transmitted electronically and
individually. A testing procedure will be individually applied to each
payment order. In funds transfers to be made by means of an automated
clearing house many payment orders are incorporated into an electronic
device such as a magnetic tape that is physically delivered. Testing of
the individual payment orders is not feasible. Thus, a different kind of
security procedure must be adopted to take into account the different
mode of transmission.
The issue of whether a particular security procedure is commercially
reasonable is a question of law. Whether the receiving bank complied
with the procedure is a question of fact. It is appropriate to make the
finding concerning commercial reasonability a matter of law because
security procedures are likely to be standardized in the banking industry
and a question of law standard leads to more predictability concerning
the level of security that a bank must offer to its customers. The purpose
of subsection (b) is to encourage banks to institute reasonable safeguards
against fraud but not to make them insurers against fraud. A security
procedure is not commercially unreasonable simply because another
procedure might have been better or because the judge deciding the
question would have opted for a more stringent procedure. The standard
is not whether the security procedure is the best available. Rather it is
whether the procedure is reasonable for the particular customer and the
particular bank, which is a lower standard. On the other hand, a security
procedure that fails to meet prevailing standards of good banking
practice applicable to the particular bank should not be held to be
commercially reasonable. Subsection (c) states factors to be considered
by the judge in making the determination of commercial reasonableness.
Sometimes an informed customer refuses a security procedure that is
commercially reasonable and suitable for that customer and insists on
using a higher-risk procedure because it is more convenient or cheaper.
In that case, under the last sentence of subsection (c), the customer has
voluntarily assumed the risk of failure of the procedure and cannot shift
the loss to the bank. But this result follows only if the customer
expressly agrees in writing to assume that risk. It is implicit in the last
sentence of subsection (c) that a bank that accedes to the wishes of its
customer in this regard is not acting in bad faith by so doing so long as
the customer is made aware of the risk. In all cases, however, a
receiving bank cannot get the benefit of subsection (b) unless it has
made available to the customer a security procedure that is commercially
reasonable and suitable for use by that customer. In most cases, the
mutual interest of bank and customer to protect against fraud should lead
to agreement to a security procedure which is commercially reasonable.
5. The effect of Section 4A-202(b) is to place the risk of loss on the
customer if an unauthorized payment order is accepted by the receiving
bank after verification by the bank in compliance with a commercially
reasonable security procedure. An exception to this result is provided
by Section 4A-203(a)(2). The customer may avoid the loss resulting
from such a payment order if the customer can prove that the fraud was
not committed by a person described in that subsection. Breach of a
commercially reasonable security procedure requires that the person
committing the fraud have knowledge of how the procedure works and
knowledge of codes, identifying devices, and the like. That person may
also need access to transmitting facilities through an access device or
other software in order to breach the security procedure. This
confidential information must be obtained either from a source
controlled by the customer or from a source controlled by the receiving
bank. If the customer can prove that the person committing the fraud did
not obtain the confidential information from an agent or former agent of
the customer or from a source controlled by the customer, the loss is
shifted to the bank. "Prove" is defined in Section
4A-105(a)(7). Because of bank regulation requirements, in this kind of
case there will always be a criminal investigation as well as an internal
investigation of the bank to determine the probable explanation for the
breach of security. Because a funds transfer fraud usually will involve
a very large amount of money, both the criminal investigation and the
internal investigation are likely to be thorough. In some cases there may
be an investigation by bank examiners as well. Frequently, these
investigations will develop evidence of who is at fault and the cause of
the loss. The customer will have access to evidence developed in these
investigations and that evidence can be used by the customer in meeting
its burden of proof.
6. The effect of Section 4A-202(b) may also be changed by an
agreement meeting the requirements of Section 4A-203(a)(1). Some
customers may be unwilling to take all or part of the risk of loss with
respect to unauthorized payment orders even if all of the requirements
of Section 4A-202(b) are met. By virtue of Section 4A-203(a)(1), a
receiving bank may assume all of the risk of loss with respect to
unauthorized payment orders or the customer and bank may agree that
losses from unauthorized payment orders are to be divided as provided
in the agreement.
7. In a large majority of cases the sender of a payment order is a
bank. In many cases in which there is a bank sender, both the sender
and the receiving bank will be members of a funds transfer system over
which the payment order is transmitted. Since Section 4A-202(f) does
not prohibit a funds transfer system rule from varying rights and
obligations under Section 4A-202, a rule of the funds transfer system
can determine how loss due to an unauthorized payment order from a
participating bank to another participating bank is to be allocated. A
funds transfer system rule, however, cannot change the rights of a
customer that is not a participating bank. Section 4A-501(b). Section
4A-202(f) also prevents variation by agreement except to the extent
stated.
Section 36-4A-204. REFUND OF PAYMENT AND DUTY OF
CUSTOMER TO REPORT WITH RESPECT TO UNAUTHORIZED
PAYMENT ORDER.
(a) If a receiving bank accepts a payment order issued in the name
of its customer as sender which is (i) not authorized and not effective as
the order of the customer under Section 36-4A-202, or (ii) not
enforceable, in whole or in part, against the customer under Section
36-4A-203, the bank shall refund any payment of the payment order
received from the customer to the extent the bank is not entitled to
enforce payment and shall pay interest on the refundable amount
calculated from the date the bank received payment to the date of the
refund. However, the customer is not entitled to interest from the bank
on the amount to be refunded if the customer fails to exercise ordinary
care to determine that the order was not authorized by the customer and
to notify the bank of the relevant facts within a reasonable time not
exceeding 90 days after the date the customer received notification from
the bank that the order was accepted or that the customer's account was
debited with respect to the order. The bank is not entitled to any
recovery from the customer on account of a failure by the customer to
give notification as stated in this section.
(b) Reasonable time under subsection (a) may be fixed by agreement
as stated in Section 36-1-204(1), but the obligation of a receiving bank
to refund payment as stated in subsection (a) may not otherwise be
varied by agreement.
OFFICIAL COMMENT
1. With respect to unauthorized payment orders, in a very large
percentage of cases a commercially reasonable security procedure will
be in effect. Section 4A-204 applies only to cases in which (i) no
commercially reasonable security procedure is in effect, (ii) the bank did
not comply with a commercially reasonable security procedure that was
in effect, (iii) the sender can prove, pursuant to Section 4A-203(a)(2),
that the culprit did not obtain confidential security information
controlled by the customer, or (iv) the bank, pursuant to Section
4A-203(a)(1) agreed to take all or part of the loss resulting from an
unauthorized payment order. In each of these cases the bank takes the
risk of loss with respect to an unauthorized payment order because the
bank is not entitled to payment from the customer with respect to the
order. The bank normally debits the customer's account or otherwise
receives payment from the customer shortly after acceptance of the
payment order. Subsection (a) of Section 4A-204 states that the bank
must recredit the account or refund payment to the extent the bank is not
entitled to enforce payment.
2. Section 4A-204 is designed to encourage a customer to promptly
notify the receiving bank that it has accepted an unauthorized payment
order. Since cases of unauthorized payment orders will almost always
involve fraud, the bank's remedy is normally to recover from the
beneficiary of the unauthorized order if the beneficiary was party to the
fraud. This remedy may not be worth very much and it may not make
any difference whether or not the bank promptly learns about the fraud.
But in some cases prompt notification may make it easier for the bank
to recover some part of its loss from the culprit. The customer will
routinely be notified of the debit to its account with respect to an
unauthorized order or will otherwise be notified of acceptance of the
order. The customer has a duty to exercise ordinary care to determine
that the order was unauthorized after it has received notification from the
bank, and to advise the bank of the relevant facts within a reasonable
time not exceeding 90 days after receipt of notification. Reasonable
time is not defined and it may depend on the facts of the particular case.
If a payment order for $1,000,000 is wholly unauthorized, the customer
should normally discover it in far less than 90 days. If a $1,000,000
payment order was authorized but the name of the beneficiary was
fraudulently changed, a much longer period may be necessary to
discover the fraud. But in any event, if the customer delays more than
90 days the customer's duty has not been met. The only consequence of
a failure of the customer to perform this duty is a loss of interest on the
refund payable by the bank. A customer that acts promptly is entitled to
interest from the time the customer's account was debited or the
customer otherwise made payment. The rate of interest is stated in
Section 4A-506. If the customer fails to perform the duty, no interest is
recoverable for any part of the period before the bank learns that it
accepted an unauthorized order. But the bank is not entitled to any
recovery from the customer based on negligence for failure to inform the
bank. Loss of interest is in the nature of a penalty on the customer
designed to provide an incentive for the customer to police its account.
There is no intention to impose a duty on the customer that might result
in shifting loss from the unauthorized order to the customer.
Section 36-4A-205. ERRONEOUS PAYMENT ORDERS.
(a) If an accepted payment order was transmitted pursuant to a
security procedure for the detection of error and the payment order (i)
erroneously instructed payment to a beneficiary not intended by the
sender, (ii) erroneously instructed payment in an amount greater than the
amount intended by the sender, or (iii) was an erroneously transmitted
duplicate of a payment order previously sent by the sender, the
following rules apply:
(1) If the sender proves that the sender or a person acting on
behalf of the sender pursuant to Section 36-4A-206 complied with the
security procedure and that the error would have been detected if the
receiving bank had also complied, the sender is not obliged to pay the
order to the extent stated in paragraphs (2) and (3).
(2) If the funds transfer is completed on the basis of an
erroneous payment order described in clause (i) or (iii) of subsection (a),
the sender is not obliged to pay the order and the receiving bank is
entitled to recover from the beneficiary any amount paid to the
beneficiary to the extent allowed by the law governing mistake and
restitution.
(3) If the funds transfer is completed on the basis of a payment
order described in clause (ii) of subsection (a), the sender is not obliged
to pay the order to the extent the amount received by the beneficiary is
greater than the amount intended by the sender. In that case, the
receiving bank is entitled to recover from the beneficiary the excess
amount received to the extent allowed by the law governing mistake and
restitution.
(b) If (i) the sender of an erroneous payment order described in
subsection (a) is not obliged to pay all or part of the order, and (ii) the
sender receives notification from the receiving bank that the order was
accepted by the bank or that the sender's account was debited with
respect to the order, the sender has a duty to exercise ordinary care, on
the basis of information available to the sender, to discover the error
with respect to the order and to advise the bank of the relevant facts
within a reasonable time, not exceeding ninety days, after the bank's
notification was received by the sender. If the bank proves that the
sender failed to perform that duty, the sender is liable to the bank for the
loss the bank proves it incurred as a result of the failure, but the liability
of the sender may not exceed the amount of the sender's order.
(c) This section applies to amendments to payment orders to the same
extent it applies to payment orders.
OFFICIAL COMMENT
1. This section concerns error in the content or in the transmission
of payment orders. It deals with three kinds of error. Case #1.
The order identifies a beneficiary not intended by the sender. For
example, Sender intends to wire funds to a beneficiary identified only by
an account number. The wrong account number is stated in the order.
Case #2. The error is in the amount of the order. For example,
Sender intends to wire $1,000 to Beneficiary. Through error, the
payment order instructs payment of $1,000,000. Case #3. A
payment order is sent to the receiving bank and then, by mistake, the
same payment order is sent to the receiving bank again. In Case #3, the
receiving bank may have no way of knowing whether the second order
is a duplicate of the first or is another order. Similarly, in Case #1 and
Case #2, the receiving bank may have no way of knowing that the error
exists. In each case, if this section does not apply and the funds transfer
is completed, Sender is obliged to pay the order. Section 36-4A-402.
Sender's remedy, based on payment by mistake, is to recover from the
beneficiary that received payment.
Sometimes, however, transmission of payment orders of the sender
to the receiving bank is made pursuant to a security procedure designed
to detect one or more of the errors described above. Since
"security procedure" is defined by Section 36-4A-201 as
"a procedure established by agreement of a customer and a
receiving bank for the purpose of * * * detecting error * * *,"
Section 4A-205 does not apply if the receiving bank and the customer
did not agree to the establishment of a procedure for detecting error. A
security procedure may be designed to detect an account number that is
not one to which Sender normally makes payment. In that case, the
security procedure may require a special verification that payment to the
stated account number was intended. In the case of dollar amounts, the
security procedure may require different codes for different dollar
amounts. If a $1,000,000 payment order contains a code that is
inappropriate for that amount, the error in amount should be detected.
In the case of duplicate orders, the security procedure may require that
each payment order be identified by a number or code that applies to no
other order. If the number or code of each payment order received is
registered in a computer base, the receiving bank can quickly identify a
duplicate order. The three cases covered by this section are essentially
similar. In each, if the error is not detected, some beneficiary will
receive funds that the beneficiary was not intended to receive. If this
section applies, the risk of loss with respect to the error of the sender is
shifted to the bank which has the burden of recovering the funds from
the beneficiary. The risk of loss is shifted to the bank only if the sender
proves that the error would have been detected if there had been
compliance with the procedure and that the sender (or an agent under
Section 4A-206) complied. In the case of a duplicate order or a wrong
beneficiary, the sender doesn't have to pay the order. In the case of an
overpayment, the sender does not have to pay the order to the extent of
the overpayment. If subsection (a)(1) applies, the position of the
receiving bank is comparable to that of a receiving bank that erroneously
executes a payment order as stated in Section 4A-303. However, failure
of the sender to timely report the error is covered by Section 4A-205(b)
rather than by Section 4A-304 which applies only to erroneous
execution under Section 4A-303. A receiving bank to which the risk of
loss is shifted by subsection (a)(1) or (2) is entitled to recover the
amount erroneously paid to the beneficiary to the extent allowed by the
law of mistake and restitution. Rights of the receiving bank against the
beneficiary are similar to those of a receiving bank that erroneously
executes a payment order as stated in Section 4A-303. Those rights are
discussed in Comment 2 to Section 4A-303.
2. A security procedure established for the purpose of detecting error
is not effective unless both sender and receiving bank comply with the
procedure. Thus, the bank undertakes a duty of complying with the
procedure for the benefit of the sender. This duty is recognized in
subsection (a)(1). The loss with respect to the sender's error is shifted
to the bank if the bank fails to comply with the procedure and the sender
(or an agent under Section 4A-206) does comply. Although the
customer may have been negligent in transmitting the erroneous
payment order, the loss is put on the bank on a last-clear-chance theory.
A similar analysis applies to subsection (b). If the loss with respect to
an error is shifted to the receiving bank and the sender is notified by the
bank that the erroneous payment order was accepted, the sender has a
duty to exercise ordinary care to discover the error and notify the bank
of the relevant facts within a reasonable time not exceeding 90 days. If
the bank can prove that the sender failed in this duty it is entitled to
compensation for the loss incurred as a result of the failure. Whether the
bank is entitled to recover from the sender depends upon whether the
failure to give timely notice would have made any difference. If the
bank could not have recovered from the beneficiary that received
payment under the erroneous payment order even if timely notice had
been given, the sender's failure to notify did not cause any loss of the
bank.
3. Section 4A-205 is subject to variation by agreement under Section
4A-501. Thus, if a receiving bank and its customer have agreed to a
security procedure for detection of error, the liability of the receiving
bank for failing to detect an error of the customer as provided in Section
4A-205 may be varied as provided in an agreement of the bank and the
customer.
Section 36-4A-206. TRANSMISSION OF PAYMENT ORDER
THROUGH FUNDS-TRANSFER OR OTHER COMMUNICATION
SYSTEM.
(a) If a payment order addressed to a receiving bank is transmitted
to a funds-transfer system or other third-party communication system for
transmittal to the bank, the system is considered to be an agent of the
sender for the purpose of transmitting the payment order to the bank. If
there is a discrepancy between the terms of the payment order
transmitted to the system and the terms of the payment order transmitted
by the system to the bank, the terms of the payment order of the sender
are those transmitted by the system. This section does not apply to a
funds-transfer system of the Federal Reserve Banks.
(b) This section applies to cancellations and amendments of payment
orders to the same extent it applies to payment orders.
OFFICIAL COMMENT
1. A payment order may be issued to a receiving bank directly by
delivery of a writing or electronic device or by an oral or electronic
communication. If an agent of the sender is employed to transmit orders
on behalf of the sender, the sender is bound by the order transmitted by
the agent on the basis of agency law. Section 4A-206 is an application
of that principle to cases in which a funds transfer or communication
system acts as an intermediary in transmitting the sender's order to the
receiving bank. The intermediary is deemed to be an agent of the sender
for the purpose of transmitting payment orders and related messages for
the sender. Section 4A-206 deals with error by the intermediary.
2. Transmission by an automated clearing house of an association of
banks other than the Federal Reserve Banks is an example of a
transaction covered by Section 4A-206. Suppose Originator orders
Originator's Bank to cause a large number of payments to be made to
many accounts in banks in various parts of the country. These payment
orders are electronically transmitted to Originator's Bank and stored in
an electronic device that is held by Originator's Bank. Or, transmission
of the various payment orders is made by delivery to Originator's Bank
of an electronic device containing the instruction to the bank. In either
case the terms of the various payment orders by Originator are
determined by the information contained in the electronic device. In
order to execute the various orders, the information in the electronic
device must be processed. For example, if some of the orders are for
payments to accounts in Bank X and some to accounts in Bank Y,
Originator's Bank will execute these orders of Originator by issuing a
series of payment orders to Bank X covering all payments to accounts
in that bank, and by issuing a series of payment orders to Bank Y
covering all payments to accounts in that bank. The orders to Bank X
may be transmitted together by means of an electronic device, and those
to Bank Y may be included in another electronic device. Typically, this
processing is done by an automated clearing house acting for a group of
banks including Originator's Bank. The automated clearing house is a
funds transfer system. Section 4A-105(a)(5). Originator's Bank delivers
Originator's electronic device or transmits the information contained in
the device to the funds transfer system for processing into payment
orders of Originator's Bank to the appropriate beneficiary's banks. The
processing may result in an erroneous payment order. Originator's Bank,
by use of Originator's electronic device, may have given information to
the funds transfer system instructing payment of $100,000 to an account
in Bank X, but because of human error or an equipment malfunction the
processing may have converted that instruction into an instruction to
Bank X to make a payment of $1,000,000. Under Section 4A-206,
Originator's Bank issued a payment order for $1,000,000 to Bank X
when the erroneous information was sent to Bank X. Originator's Bank
is responsible for the error of the automated clearing house. The liability
of the funds transfer system that made the error is not governed by
Article 4A. It is left to the law of contract, a funds transfer system rule,
or other applicable law.
In the hypothetical case just discussed, if the automated clearing
house is operated by a Federal Reserve Bank, the analysis is different.
Section 4A-206 does not apply. Originator's Bank will execute
Originator's payment orders by delivery or transmission of the electronic
information to the Federal Reserve Bank for processing. The result is
that Originator's Bank has issued payment orders to the Federal Reserve
Bank which, in this case, is acting as an intermediary bank. When the
Federal Reserve Bank has processed the information given to it by
Originator's Bank it will issue payment orders to the various
beneficiary's banks. If the processing results in an erroneous payment
order, the Federal Reserve Bank has erroneously executed the payment
order of Originator's Bank and the case is governed by Section 4A-303.
Section 36-4A-207. MISDESCRIPTION OF BENEFICIARY.
(a) Subject to subsection (b), if, in a payment order received by the
beneficiary's bank, the name, bank account number, or other
identification of the beneficiary refers to a nonexistent or unidentifiable
person or account, no person has rights as a beneficiary of the order and
acceptance of the order cannot occur.
(b) If a payment order received by the beneficiary's bank
identifies the beneficiary both by name and by an identifying or bank
account number and the name and number identify different persons, the
following rules apply:
(1) Except as otherwise provided in subsection (c), if the
beneficiary's bank does not know that the name and number refer to
different persons, it may rely on the number as the proper identification
of the beneficiary of the order. The beneficiary's bank need not
determine whether the name and number refer to the same person.
(2) If the beneficiary's bank pays the person identified by
name or knows that the name and number identify different persons, no
person has rights as beneficiary except the person paid by the
beneficiary's bank if that person was entitled to receive payment from
the originator of the funds transfer. If no person has rights as
beneficiary, acceptance of the order cannot occur.
(c) If (i) a payment order described in subsection (b) is accepted, (ii)
the originator's payment order described the beneficiary inconsistently
by name and number, and (iii) the beneficiary's bank pays the person
identified by number as permitted by subsection (b)(1), the following
rules apply:
(1) If the originator is a bank, the originator is obliged to pay
its order.
(2) If the originator is not a bank and proves that the person
identified by number was not entitled to receive payment from the
originator, the originator is not obliged to pay its order unless the
originator's bank proves that the originator, before acceptance of the
originator's order, had notice that payment of a payment order issued by
the originator might be made by the beneficiary's bank on the basis of an
identifying or bank account number even if it identifies a person
different from the named beneficiary. Proof of notice may be made by
any admissible evidence. The originator's bank satisfies the burden of
proof if it proves that the originator, before the payment order was
accepted, signed a writing stating the information to which the notice
relates.
(d) In a case governed by subsection (b)(1), if the beneficiary's
bank rightfully pays the person identified by number and that person was
not entitled to receive payment from the originator, the amount paid may
be recovered from that person to the extent allowed by the law
governing mistake and restitution as follows:
(1) If the originator is obliged to pay its payment order as
stated in subsection (c), the originator has the right to recover.
(2) If the originator is not a bank and is not obliged to pay its
payment order, the originator's bank has the right to recover.
OFFICIAL COMMENT
1. Subsection (a) deals with the problem of payment orders issued
to the beneficiary's bank for payment to nonexistent or unidentifiable
persons or accounts. Since it is not possible in that case for the funds
transfer to be completed, subsection (a) states that the order cannot be
accepted. Under Section 4A-402(c), a sender of a payment order is not
obliged to pay its order unless the beneficiary's bank accepts a payment
order instructing payment to the beneficiary of that sender's order. Thus,
if the beneficiary of a funds transfer is nonexistent or unidentifiable,
each sender in the funds transfer that has paid its payment order is
entitled to get its money back.
2. Subsection (b), which takes precedence over subsection (a), deals
with the problem of payment orders in which the description of the
beneficiary does not allow identification of the beneficiary because the
beneficiary is described by name and by an identifying number or an
account number and the name and number refer to different persons. A
very large percentage of payment orders issued to the beneficiary's bank
by another bank are processed by automated means using machines
capable of reading orders on standard formats that identify the
beneficiary by an identifying number or the number of a bank account.
The processing of the order by the beneficiary's bank and the crediting
of the beneficiary's account are done by use of the identifying or bank
account number without human reading of the payment order itself. The
process is comparable to that used in automated payment of checks. The
standard format, however, may also allow the inclusion of the name of
the beneficiary and other information which can be useful to the
beneficiary's bank and the beneficiary but which plays no part in the
process of payment. If the beneficiary's bank has both the account
number and name of the beneficiary supplied by the originator of the
funds transfer, it is possible for the beneficiary's bank to determine
whether the name and number refer to the same person, but if a duty to
make that determination is imposed on the beneficiary's bank the
benefits of automated payment are lost. Manual handling of payment
orders is both expensive and subject to human error. If payment orders
can be handled on an automated basis there are substantial economies of
operation and the possibility of clerical error is reduced. Subsection (b)
allows banks to utilize automated processing by allowing banks to act
on the basis of the number without regard to the name if the bank does
not know that the name and number refer to different persons.
"Know" is defined in Section 1-201(25) to mean actual
knowledge, and Section 1-201(27) states rules for determining when an
organization has knowledge of information received by the organization.
The time of payment is the pertinent time at which knowledge or lack of
knowledge must be determined.
Although the clear trend is for beneficiary's banks to process
payment orders by automated means, Section 4A-207 is not limited to
cases in which processing is done by automated means. A bank that
processes by semi-automated means or even manually may rely on
number as stated in Section 4A-207.
In cases covered by subsection (b) the erroneous identification would
in virtually all cases be the identifying or bank account number. In the
typical case the error is made by the originator of the funds transfer. The
originator should know the name of the person who is to receive
payment and can further identify that person by an address that would
normally be known to the originator. It is not unlikely, however, that the
originator may not be sure whether the identifying or account number
refers to the person the originator intends to pay. Subsection (b)(1) deals
with the typical case in which the beneficiary's bank pays on the basis
of the account number and is not aware at the time of payment that the
named beneficiary is not the holder of the account which was paid. In
some cases the false number will be the result of error by the originator.
In other cases fraud is involved. For example, Doe is the holder of
shares in Mutual Fund. Thief, impersonating Doe, requests redemption
of the shares and directs Mutual Fund to wire the redemption proceeds
to Doe's account #12345 in Beneficiary's Bank. Mutual Fund originates
a funds transfer by issuing a payment order to Originator's Bank to make
the payment to Doe's account #12345 in Beneficiary's Bank.
Originator's Bank executes the order by issuing a conforming payment
order to Beneficiary's Bank which makes payment to account #12345.
That account is the account of Roe rather than Doe. Roe might be a
person acting in concert with Thief or Roe might be an innocent third
party. Assume that Roe is a gem merchant that agreed to sell gems to
Thief who agreed to wire the purchase price to Roe's account in
Beneficiary's Bank. Roe believed that the credit to Roe's account was
a transfer of funds from Thief and released the gems to Thief in good
faith in reliance on the payment. The case law is unclear on the
responsibility of a beneficiary's bank in carrying out a payment order in
which the identification of the beneficiary by name and number is
conflicting. See Securities Fund Services, Inc. v. American National
Bank, 542 F.Supp. 323 (N.D.Ill. 1982) and Bradford Trust Co.
v. Texas American Bank, 790 F.2d 407 (5th Cir. 1986). Section
4A-207 resolves the issue.
If Beneficiary's Bank did not know about the conflict between the
name and number, subsection (b)(1) applies. Beneficiary's Bank has no
duty to determine whether there is a conflict and it may rely on the
number as the proper identification of the beneficiary of the order.
When it accepts the order, it is entitled to payment from Originator's
Bank. Section 4A-402(b). On the other hand, if Beneficiary's Bank
knew about the conflict between the name and number and nevertheless
paid Roe, subsection (b)(2) applies. Under that provision, acceptance of
the payment order of Originator's Bank did not occur because there is no
beneficiary of that order. Since acceptance did not occur Originator's
Bank is not obliged to pay Beneficiary's Bank. Section 4A-402(b).
Similarly, Mutual Fund is excused from its obligation to pay Originator's
Bank. Section 4A-402(c). Thus, Beneficiary's Bank takes the loss. Its
only cause of action is against Thief. Roe is not obliged to return the
payment to the beneficiary's bank because Roe received the payment in
good faith and for value. Article 4A makes irrelevant the issue of
whether Mutual Fund was or was not negligent in issuing its payment
order.
3. Normally, subsection (b)(1) will apply to the hypothetical case
discussed in Comment 2. Beneficiary's Bank will pay on the basis of the
number without knowledge of the conflict. In that case subsection (c)
places the loss on either Mutual Fund or Originator's Bank. It is not
unfair to assign the loss to Mutual Fund because it is the person who
dealt with the impostor and it supplied the wrong account number. It
could have avoided the loss if it had not used an account number that it
was not sure was that of Doe. Mutual Fund, however, may not have
been aware of the risk involved in giving both name and number.
Subsection (c) is designed to protect the originator, Mutual Fund, in this
case. Under that subsection, the originator is responsible for the
inconsistent description of the beneficiary if it had notice that the order
might be paid by the beneficiary's bank on the basis of the number. If
the originator is a bank, the originator always has that responsibility.
The rationale is that any bank should know how payment orders are
processed and paid. If the originator is not a bank, the originator's bank
must prove that its customer, the originator, had notice. Notice can be
proved by any admissible evidence, but the bank can always prove
notice by providing the customer with a written statement of the required
information and obtaining the customer's signature to the statement.
That statement will then apply to any payment order accepted by the
bank thereafter. The information need not be supplied more than once.
In the hypothetical case if Originator's Bank made the disclosure
stated in the last sentence of subsection (c)(2), Mutual Fund must pay
Originator's Bank. Under subsection (d)(1), Mutual Fund has an action
to recover from Roe if recovery from Roe is permitted by the law
governing mistake and restitution. Under the assumed facts Roe should
be entitled to keep the money as a person who took it in good faith and
for value since it was taken as payment for the gems. In that case,
Mutual Fund's only remedy is against Thief. If Roe was not acting in
good faith, Roe has to return the money to Mutual Fund. If Originator's
Bank does not prove that Mutual Fund had notice as stated in subsection
(c)(2), Mutual Fund is not required to pay Originator's Bank. Thus, the
risk of loss falls on Originator's Bank whose remedy is against Roe or
Thief as stated above. Subsection (d)(2).
Section 36-4A-208. MISDESCRIPTION OF INTERMEDIARY
BANK OR BENEFICIARY'S BANK.
(a) This subsection applies to a payment order identifying an
intermediary bank or the beneficiary's bank only by an identifying
number.
(1) The receiving bank may rely on the number as the proper
identification of the intermediary or beneficiary's bank and need not
determine whether the number identifies a bank.
(2) The sender is obliged to compensate the receiving bank for
any loss and expenses incurred by the receiving bank as a result of its
reliance on the number in executing or attempting to execute the order.
(b) This subsection applies to a payment order identifying an
intermediary bank or the beneficiary's bank both by name and an
identifying number if the name and number identify different persons.
(1) If the sender is a bank, the receiving bank may rely on the
number as the proper identification of the intermediary or beneficiary's
bank if the receiving bank, when it executes the sender's order, does not
know that the name and number identify different persons. The
receiving bank need not determine whether the name and number refer
to the same person or whether the number refers to a bank. The sender
is obliged to compensate the receiving bank for any loss and expenses
incurred by the receiving bank as a result of its reliance on the number
in executing or attempting to execute the order.
(2) If the sender is not a bank and the receiving bank proves that
the sender, before the payment order was accepted, had notice that the
receiving bank might rely on the number as the proper identification of
the intermediary or beneficiary's bank even if it identifies a person
different from the bank identified by name, the rights and obligations of
the sender and the receiving bank are governed by subsection (b)(1), as
though the sender were a bank. Proof of notice may be made by any
admissible evidence. The receiving bank satisfies the burden of proof
if it proves that the sender, before the payment order was accepted,
signed a writing stating the information to which the notice relates.
(3) Regardless of whether the sender is a bank, the receiving
bank may rely on the name as the proper identification of the
intermediary or beneficiary's bank if the receiving bank, at the time it
executes the sender's order, does not know that the name and number
identify different persons. The receiving bank need not determine
whether the name and number refer to the same person.
(4) If the receiving bank knows that the name and number
identify different persons, reliance on either the name or the number in
executing the sender's payment order is a breach of the obligation stated
in Section 36-4A-302(a)(1).
OFFICIAL COMMENT
1. This section addresses an issue similar to that addressed by
Section 4A-207. Because of automation in the processing of payment
orders, a payment order may identify the beneficiary's bank or an
intermediary bank by an identifying number. The bank identified by
number might or might not also be identified by name. The following
two cases illustrate Section 4A-208(a) and (b):
Case #1. Originator's payment order to Originator's Bank
identifies the beneficiary's bank as Bank A and instructs payment to
Account #12345 in that bank. Originator's Bank executes Originator's
order by issuing a payment order to Intermediary Bank. In the payment
order of Originator's Bank the beneficiary's bank is identified as Bank
A but is also identified by number, #67890. The identifying number
refers to Bank B rather than Bank A. If processing by Intermediary
Bank of the payment order of Originator's Bank is done by automated
means, Intermediary Bank, in executing the order, will rely on the
identifying number and will issue a payment order to Bank B rather than
Bank A. If there is an Account #12345 in Bank B, the payment order of
Intermediary Bank would normally be accepted and payment would be
made to a person not intended by Originator. In this case, Section
4A-208(b)(1) puts the risk of loss on Originator's Bank. Intermediary
Bank may rely on the number #67890 as the proper identification of the
beneficiary's bank. Intermediary Bank has properly executed the
payment order of Originator's Bank. By using the wrong number to
describe the beneficiary's bank, Originator's Bank has improperly
executed Originator's payment order because the payment order of
Originator's Bank provides for payment to the wrong beneficiary, the
holder of Account #12345 in Bank B rather than the holder of Account
#12345 in Bank A. Section 4A-302(a) (1) and Section 4A-303(c).
Originator's Bank is not entitled to payment from Originator but is
required to pay Intermediary Bank. Section 4A-303(c) and Section
4A-402(c). Intermediary Bank is also entitled to compensation for any
loss and expenses resulting from the error by Originator's Bank.
If there is no Account #12345 in Bank B, the result is that there is no
beneficiary of the payment order issued by Originator's Bank and the
funds transfer will not be completed. Originator's Bank is not entitled
to payment from Originator and Intermediary Bank is not entitled to
payment from Originator's Bank. Section 4A-402(c). Since Originator's
Bank improperly executed Originator's payment order it may be liable
for damages under Section 4A-305. As stated above, Intermediary Bank
is entitled to compensation for loss and expenses resulting from the error
by Originator's Bank.
Case #2. Suppose the same payment order by Originator to
Originator's Bank as in Case #1. In executing the payment order
Originator's Bank issues a payment order to Intermediary Bank in which
the beneficiary's bank is identified only by number, #67890. That
number does not refer to Bank A. Rather, it identifies a person that is
not a bank. If processing by Intermediary Bank of the payment order of
Originator's Bank is done by automated means, Intermediary Bank will
rely on the number #67890 to identify the beneficiary's bank.
Intermediary Bank has no duty to determine whether the number
identifies a bank. The funds transfer cannot be completed in this case
because no bank is identified as the beneficiary's bank. Subsection (a)
puts the risk of loss on Originator's Bank. Originator's Bank is not
entitled to payment from Originator. Section 4A-402(c). Originator's
Bank has improperly executed Originator's payment order and may be
liable for damages under Section 4A-305. Originator's Bank is obliged
to compensate Intermediary Bank for loss and expenses resulting from
the error by Originator's Bank.
Subsection (a) also applies if #67890 identifies a bank, but the bank
is not Bank A. Intermediary Bank may rely on the number as the proper
identification of the beneficiary's bank. If the bank to which
Intermediary Bank sends its payment order accepts the order,
Intermediary Bank is entitled to payment from Originator's Bank, but
Originator's Bank is not entitled to payment from Originator. The
analysis is similar to that in Case #1.
2. Subsection (b)(2) of Section 4A-208 addresses cases in which an
erroneous identification of a beneficiary's bank or intermediary bank by
name and number is made in a payment order of a sender that is not a
bank. Suppose Originator issues a payment order to Originator's Bank
that instructs that bank to use an intermediary bank identified as Bank
A and by an identifying number, #67890. The identifying number refers
to Bank B. Originator intended to identify Bank A as intermediary
bank. If Originator's Bank relied on the number and issued a payment
order to Bank B the rights of Originator's Bank depend upon whether the
proof of notice stated in subsection (b)(2) is made by Originator's Bank.
If proof is made, Originator's Bank's rights are governed by subsection
(b)(1) of Section 4A-208. Originator's Bank is not liable for breach of
Section 4A-302(a)(1) and is entitled to compensation from Originator
for any loss and expenses resulting from Originator's error. If notice is
not proved, Originator's Bank may not rely on the number in executing
Originator's payment order. Since Originator's Bank does not get the
benefit of subsection (b)(1) in that case, Originator's Bank improperly
executed Originator's payment order and is in breach of the obligation
stated in Section 4A-302(a)(1). If notice is not given, Originator's Bank
can rely on the name if it is not aware of the conflict in name and
number. Subsection (b)(3).
3. Although the principal purpose of Section 4A-208 is to
accommodate automated processing of payment orders, Section 4A-208
applies regardless of whether processing is done by automation,
semi-automated means or manually.
Section 36-4A-209. ACCEPTANCE OF PAYMENT ORDER.
(a) Subject to subsection (d), a receiving bank other than the
beneficiary's bank accepts a payment order when it executes the order.
(b) Subject to subsections (c) and (d), a beneficiary's bank accepts
a payment order at the earliest of the following times:
(1) when the bank (i) pays the beneficiary as stated in Section
36-4A-405(a) or 36-4A-405(b), or (ii) notifies the beneficiary of receipt
of the order or that the account of the beneficiary has been credited with
respect to the order unless the notice indicates that the bank is rejecting
the order or that funds with respect to the order may not be withdrawn
or used until receipt of payment from the sender of the order;
(2) when the bank receives payment of the entire amount of
the sender's order pursuant to Section 36-4A-403(a)(1) or
36-4A-403(a)(2); or
(3) the opening of the next funds-transfer business day of the
bank following the payment date of the order if, at that time, the amount
of the sender's order is fully covered by a withdrawable credit balance
in an authorized account of the sender or the bank has otherwise
received full payment from the sender, unless the order was rejected
before that time or is rejected within (i) one hour after that time, or (ii)
one hour after the opening of the next business day of the sender
following the payment date if that time is later. If notice of rejection is
received by the sender after the payment date and the authorized account
of the sender does not bear interest, the bank is obliged to pay interest
to the sender on the amount of the order for the number of days elapsing
after the payment date to the day the sender receives notice or learns that
the order was not accepted, counting that day as an elapsed day. If the
withdrawable credit balance during that period falls below the amount
of the order, the amount of interest payable is reduced accordingly.
(c) Acceptance of a payment order cannot occur before the order is
received by the receiving bank. Acceptance does not occur under
subsection (b)(2) or (b)(3) if the beneficiary of the payment order does
not have an account with the receiving bank, the account has been
closed, or the receiving bank is not permitted by law to receive credits
for the beneficiary's account.
(d) A payment order issued to the originator's bank cannot be
accepted until the payment date if the bank is the beneficiary's bank, or
the execution date if the bank is not the beneficiary's bank. If the
originator's bank executes the originator's payment order before the
execution date or pays the beneficiary of the originator's payment order
before the payment date and the payment order is subsequently canceled
pursuant to Section 36-4A-211(b), the bank may recover from the
beneficiary any payment received to the extent allowed by the law
governing mistake and restitution.
OFFICIAL COMMENT
1. This section treats the sender's payment order as a request by the
sender to the receiving bank to execute or pay the order and that request
can be accepted or rejected by the receiving bank. Section 4A-209
defines when acceptance occurs. Section 4A-210 covers rejection.
Acceptance of the payment order imposes an obligation on the receiving
bank to the sender if the receiving bank is not the beneficiary's bank, or
to the beneficiary if the receiving bank is the beneficiary's bank. These
obligations are stated in Section 4A-302 and Section 4A-404.
2. Acceptance by a receiving bank other than the beneficiary's bank
is defined in Section 4A-209(a). That subsection states the only way
that a bank other than the beneficiary's bank can accept a payment order.
A payment order to a bank other than the beneficiary's bank is, in effect,
a request that the receiving bank execute the sender's order by issuing a
payment order to the beneficiary's bank or to an intermediary bank.
Normally, acceptance occurs at the time of execution, but there is an
exception stated in subsection (d) and discussed in Comment 9.
Execution occurs when the receiving bank "issues a payment order
intended to carry out" the sender's order. Section 4A-301(a). In
some cases the payment order issued by the receiving bank may not
conform to the sender's order. For example, the receiving bank might
make a mistake in the amount of its order, or the order might be issued
to the wrong beneficiary's bank or for the benefit of the wrong
beneficiary. In all of these cases there is acceptance of the sender's order
by the bank when the receiving bank issues its order intended to carry
out the sender's order, even though the bank's payment order does not in
fact carry out the instruction of the sender. Improper execution of the
sender's order may lead to liability to the sender for damages or it may
mean that the sender is not obliged to pay its payment order. These
matters are covered in Section 4A-303, Section 4A-305, and Section
4A-402.
3. A receiving bank has no duty to accept a payment order unless the
bank makes an agreement, either before or after issuance of the payment
order, to accept it, or acceptance is required by a funds transfer system
rule. If the bank makes such an agreement it incurs a contractual
obligation based on the agreement and may be held liable for breach of
contract if a failure to execute violates the agreement. In many cases a
bank will enter into an agreement with its customer to govern the rights
and obligations of the parties with respect to payment orders issued to
the bank by the customer or, in cases in which the sender is also a bank,
there may be a funds transfer system rule that governs the obligations of
a receiving bank with respect to payment orders transmitted over the
system. Such agreements or rules can specify the circumstances under
which a receiving bank is obliged to execute a payment order and can
define the extent of liability of the receiving bank for breach of the
agreement or rule. Section 4A-305(d) states the liability for breach of
an agreement to execute a payment order.
4. In the case of a payment order issued to the beneficiary's bank,
acceptance is defined in Section 4A-209(b). The function of a
beneficiary's bank that receives a payment order is different from that of
a receiving bank that receives a payment order for execution. In the
typical case, the beneficiary's bank simply receives payment from the
sender of the order, credits the account of the beneficiary and notifies the
beneficiary of the credit. Acceptance by the beneficiary's bank does not
create any obligation to the sender. Acceptance by the beneficiary's
bank means that the bank is liable to the beneficiary for the amount of
the order. Section 4A-404(a). There are three ways in which the
beneficiary's bank can accept a payment order which are described in the
following comments.
5. Under Section 4A-209(b)(1), the beneficiary's bank can accept a
payment order by paying the beneficiary. In the normal case of crediting
an account of the beneficiary, payment occurs when the beneficiary is
given notice of the right to withdraw the credit, the credit is applied to
a debt of the beneficiary, or "funds with respect to the order"
are otherwise made available to the beneficiary. Section 4A-405(a).
The quoted phrase covers cases in which funds are made available to the
beneficiary as a result of receipt of a payment order for the benefit of the
beneficiary but the release of funds is not expressed as payment of the
order. For example, the beneficiary's bank might express a release of
funds equal to the amount of the order as a "loan" that will
be automatically repaid when the beneficiary's bank receives payment
by the sender of the order. If the release of funds is designated as a loan
pursuant to a routine practice of the bank, the release is conditional
payment of the order rather than a loan, particularly if normal incidents
of a loan such as the signing of a loan agreement or note and the
payment of interest are not present. Such a release of funds is payment
to the beneficiary under Section 4A-405(a). Under Section 4A-405(c)
the bank cannot recover the money from the beneficiary if the bank does
not receive payment from the sender of the payment order that it
accepted. Exceptions to this rule are stated in Section 4A-405(d) and
(e). The beneficiary's bank may also accept by notifying the beneficiary
that the order has been received. "Notifies" is defined in
Section 1-201(26). In some cases a beneficiary's bank will receive a
payment order during the day but settlement of the sender's obligation
to pay the order will not occur until the end of the day. If the
beneficiary's bank wants to defer incurring liability to the beneficiary
until the beneficiary's bank receives payment, it can do so. The
beneficiary's bank incurs no liability to the beneficiary with respect to
a payment order that it receives until it accepts the order. If the bank
does not accept pursuant to subsection (b)(1), acceptance does not occur
until the end of the day when the beneficiary's bank receives settlement.
If the sender settles, the payment order will be accepted under
subsection (b)(2) and the funds will be released to the beneficiary the
next morning. If the sender doesn't settle, no acceptance occurs. In
either case the beneficiary's bank suffers no loss.
6. In most cases the beneficiary's bank will receive a payment order
from another bank. If the sender is a bank and the beneficiary's bank
receives payment from the sender by final settlement through the Federal
Reserve System or a funds transfer system (Section 4A-403(a)(1)) or,
less commonly, through credit to an account of the beneficiary's bank
with the sender or another bank (Section 4A-403(a)(2)), acceptance by
the beneficiary's bank occurs at the time payment is made. Section
4A-209(b)(2). A minor exception to this rule is stated in Section
4A-209(c). Section 4A-209(b)(2) results in automatic acceptance of
payment orders issued to a beneficiary's bank by means of Fedwire
because the Federal Reserve account of the beneficiary's bank is credited
and final payment is made to that bank when the payment order is
received.
Subsection (b)(2) would also apply to cases in which the
beneficiary's bank mistakenly pays a person who is not the beneficiary
of the payment order issued to the beneficiary's bank. For example,
suppose the payment order provides for immediate payment to Account
#12345. The beneficiary's bank erroneously credits Account #12346
and notifies the holder of that account of the credit. No acceptance
occurs in this case under subsection (b)(1) because the beneficiary of the
order has not been paid or notified. The holder of Account #12345 is
the beneficiary of the order issued to the beneficiary's bank. But
acceptance will normally occur if the beneficiary's bank takes no other
action, because the bank will normally receive settlement with respect
to the payment order. At that time the bank has accepted because the
sender paid its payment order. The bank is liable to pay the holder of
Account #12345. The bank has paid the holder of Account #12346 by
mistake, and has a right to recover the payment if the credit is
withdrawn, to the extent provided in the law governing mistake and
restitution.
7. Subsection (b)(3) covers cases of inaction by the beneficiary's
bank. It applies whether or not the sender is a bank and covers a case in
which the sender and the beneficiary both have accounts with the
receiving bank and payment will be made by debiting the account of the
sender and crediting the account of the beneficiary. Subsection (b)(3)
is similar to subsection (b)(2) in that it bases acceptance by the
beneficiary's bank on payment by the sender. Payment by the sender is
effected by a debit to the sender's account if the account balance is
sufficient to cover the amount of the order. On the payment date
(Section 4A-401) of the order the beneficiary's bank will normally credit
the beneficiary's account and notify the beneficiary of receipt of the
order if it is satisfied that the sender's account balance covers the order
or is willing to give credit to the sender. In some cases, however, the
bank may not be willing to give credit to the sender and it may not be
possible for the bank to determine until the end of the day on the
payment date whether there are sufficient good funds in the sender's
account. There may be various transactions during the day involving
funds going into and out of the account. Some of these transactions may
occur late in the day or after the close of the banking day. To
accommodate this situation, subsection (b)(3) provides that the status of
the account is determined at the opening of the next funds transfer
business day of the beneficiary's bank after the payment date of the
order. If the sender's account balance is sufficient to cover the order, the
beneficiary's bank has a source of payment and the result in almost all
cases is that the bank accepts the order at that time if it did not
previously accept under subsection (b)(1). In rare cases, a bank may
want to avoid acceptance under subsection (b)(3) by rejecting the order
as discussed in Comment 8.
8. Section 4A-209 is based on a general principle that a receiving
bank is not obliged to accept a payment order unless it has agreed or is
bound by a funds transfer system rule to do so. Thus, provision is made
to allow the receiving bank to prevent acceptance of the order. This
principle is consistently followed if the receiving bank is not the
beneficiary's bank. If the receiving bank is not the beneficiary's bank,
acceptance is in the control of the receiving bank because it occurs only
if the order is executed. But in the case of the beneficiary's bank
acceptance can occur by passive receipt of payment under subsection
(b)(2) or (3). In the case of a payment made by Fedwire acceptance
cannot be prevented. In other cases the beneficiary's bank can prevent
acceptance by giving notice of rejection to the sender before payment
occurs under Section 4A-403(a)(1) or (2). A minor exception to the
ability of the beneficiary's bank to reject is stated in Section
4A-502(c)(3).
Under subsection (b)(3) acceptance occurs at the opening of the next
funds transfer business day of the beneficiary's bank following the
payment date unless the bank rejected the order before that time or it
rejects within one hour after that time. In some cases the sender and the
beneficiary's bank may not be in the same time zone or the beginning of
the business day of the sender and the funds transfer business day of the
beneficiary's bank may not coincide. For example, the sender may be
located in California and the beneficiary's bank in New York. Since in
most cases notice of rejection would be communicated electronically or
by telephone, it might not be feasible for the bank to give notice before
one hour after the opening of the funds transfer business day in New
York because at that hour, the sender's business day may not have
started in California. For that reason, there are alternative deadlines
stated in subsection (b)(3). In the case stated, the bank acts in time if it
gives notice within one hour after the opening of the business day of the
sender. But if the notice of rejection is received by the sender after the
payment date, the bank is obliged to pay interest to the sender if the
sender's account does not bear interest. In that case the bank had the use
of funds of the sender that the sender could reasonably assume would be
used to pay the beneficiary. The rate of interest is stated in Section
4A-506. If the sender receives notice on the day after the payment date
the sender is entitled to one day's interest. If receipt of notice is delayed
for more than one day, the sender is entitled to interest for each
additional day of delay.
9. Subsection (d) applies only to a payment order by the originator
of a funds transfer to the originator's bank and it refers to the following
situation. On April 1, Originator instructs Bank A to make a payment
on April 15 to the account of Beneficiary in Bank B. By mistake, on
April 1, Bank A executes Originator's payment order by issuing a
payment order to Bank B instructing immediate payment to Beneficiary.
Bank B credited Beneficiary's account and immediately released the
funds to Beneficiary. Under subsection (d) no acceptance by Bank A
occurred on April 1 when Originator's payment order was executed
because acceptance cannot occur before the execution date which in this
case would be April 15 or shortly before that date. Section 4A-301(b).
Under Section 4A-402(c), Originator is not obliged to pay Bank A until
the order is accepted and that can't occur until the execution date. But
Bank A is required to pay Bank B when Bank B accepted Bank A's
order on April 1. Unless Originator and Beneficiary are the same
person, in almost all cases Originator is paying a debt owed to
Beneficiary and early payment does not injure Originator because
Originator does not have to pay Bank A until the execution date.
Section 4A-402(c). Bank A takes the interest loss. But suppose that on
April 3, Originator concludes that no debt was owed to Beneficiary or
that the debt was less than the amount of the payment order. Under
Section 4A-211(b) Originator can cancel its payment order if Bank A
has not accepted. If early execution of Originator's payment order is
acceptance, Originator can suffer a loss because cancellation after
acceptance is not possible without the consent of Bank A and Bank B.
Section 4A-211(c). If Originator has to pay Bank A, Originator would
be required to seek recovery of the money from Beneficiary. Subsection
(d) prevents this result and puts the risk of loss on Bank A by providing
that the early execution does not result in acceptance until the execution
date. Since on April 3 Originator's order was not yet accepted,
Originator can cancel it under Section 4A-211(b). The result is that
Bank A is not entitled to payment from Originator but is obliged to pay
Bank B. Bank A has paid Beneficiary by mistake. If Originator's
payment order is cancelled, Bank A becomes the originator of an
erroneous funds transfer to Beneficiary. Bank A has the burden of
recovering payment from Beneficiary on the basis of a payment by
mistake. If Beneficiary received the money in good faith in payment of
a debt owed to Beneficiary by Originator, the law of mistake and
restitution may allow Beneficiary to keep all or part of the money
received. If Originator owed money to Beneficiary, Bank A has paid
Originator's debt and, under the law of restitution, which applies
pursuant to Section 1-103, Bank A is subrogated to Beneficiary's rights
against Originator on the debt.
If Bank A is the Beneficiary's bank and Bank A credited
Beneficiary's account and released the funds to Beneficiary on April 1,
the analysis is similar. If Originator's order is cancelled, Bank A has
paid Beneficiary by mistake. The right of Bank A to recover the
payment from Beneficiary is similar to Bank A's rights in the preceding
paragraph.
Section 36-4A-210. REJECTION OF PAYMENT ORDER.
(a) A payment order is rejected by the receiving bank by a notice of
rejection transmitted to the sender orally, electronically, or in writing.
A notice of rejection need not use any particular words and is sufficient
if it indicates that the receiving bank is rejecting the order or will not
execute or pay the order. Rejection is effective when the notice is given
if transmission is by a means that is reasonable in the circumstances. If
notice of rejection is given by a means that is not reasonable, rejection
is effective when the notice is received. If an agreement of the sender
and receiving bank establishes the means to be used to reject a payment
order, (i) any means complying with the agreement is reasonable and (ii)
any means not complying is not reasonable unless no significant delay
in receipt of the notice resulted from the use of the noncomplying
means.
(b) This subsection applies if a receiving bank other than the
beneficiary's bank fails to execute a payment order despite the existence
on the execution date of a withdrawable credit balance in an authorized
account of the sender sufficient to cover the order. If the sender does not
receive notice of rejection of the order on the execution date and the
authorized account of the sender does not bear interest, the bank is
obliged to pay interest to the sender on the amount of the order for the
number of days elapsing after the execution date to the earlier of the day
the order is canceled pursuant to Section 36-4A-211(d) or the day the
sender receives notice or learns that the order was not executed,
counting the final day of the period as an elapsed day. If the
withdrawable credit balance during that period falls below the amount
of the order, the amount of interest is reduced accordingly.
(c) If a receiving bank suspends payments, all unaccepted payment
orders issued to it are considered rejected at the time the bank suspends
payments.
(d) Acceptance of a payment order precludes a later rejection of
the order. Rejection of a payment order precludes a later acceptance of
the order.
OFFICIAL COMMENT
1. With respect to payment orders issued to a receiving bank other
than the beneficiary's bank, notice of rejection is not necessary to
prevent acceptance of the order. Acceptance can occur only if the
receiving bank executes the order. Section 4A-209(a). But notice of
rejection will routinely be given by such a bank in cases in which the
bank cannot or is not willing to execute the order for some reason.
There are many reasons why a bank doesn't execute an order. The
payment order may not clearly instruct the receiving bank because of
some ambiguity in the order or an internal inconsistency. In some cases,
the receiving bank may not be able to carry out the instruction because
of equipment failure, credit limitations on the receiving bank, or some
other factor which makes proper execution of the order infeasible. In
those cases notice of rejection is a means of informing the sender of the
facts so that a corrected payment order can be transmitted or the sender
can seek alternate means of completing the funds transfer. The other
major reason for not executing an order is that the sender's account is
insufficient to cover the order and the receiving bank is not willing to
give credit to the sender. If the sender's account is sufficient to cover the
order and the receiving bank chooses not to execute the order, notice of
rejection is necessary to prevent liability to pay interest to the sender if
the case falls within Section 4A-210(b) which is discussed in Comment
3.
2. A payment order to the beneficiary's bank can be accepted by
inaction of the bank. Section 4A-209(b)(2) and (3). To prevent
acceptance under those provisions it is necessary for the receiving bank
to send notice of rejection before acceptance occurs. Subsection (a) of
Section 4A-210 states the rule that rejection is accomplished by giving
notice of rejection. This incorporates the definitions in Section
1-201(26). Rejection is effective when notice is given if it is given by
a means that is reasonable in the circumstances. Otherwise it is effective
when the notice is received. The question of when rejection is effective
is important only in the relatively few cases under subsection (b)(2) and
(3) in which a notice of rejection is necessary to prevent acceptance.
The question of whether a particular means is reasonable depends on the
facts in a particular case. In a very large percentage of cases the sender
and the receiving bank will be in direct electronic contact with each
other and in those cases a notice of rejection can be transmitted
instantaneously. Since time is of the essence in a large proportion of
funds transfers, some quick means of transmission would usually be
required, but this is not always the case. The parties may specify by
agreement the means by which communication between the parties is to
be made.
3. Subsection (b) deals with cases in which a sender does not learn
until after the execution date that the sender's order has not been
executed. It applies only to cases in which the receiving bank was
assured of payment because the sender's account was sufficient to cover
the order. Normally, the receiving bank will accept the sender's order if
it is assured of payment, but there may be some cases in which the bank
chooses to reject. Unless the receiving bank had obligated itself by
agreement to accept, the failure to accept is not wrongful. There is no
duty of the receiving bank to accept the payment order unless it is
obliged to accept by express agreement. Section 4A-212. But even if
the bank has not acted wrongfully, the receiving bank had the use of the
sender's money that the sender could reasonably assume was to be the
source of payment of the funds transfer. Until the sender learns that the
order was not accepted the sender is denied the use of that money.
Subsection (b) obliges the receiving bank to pay interest to the sender as
restitution unless the sender receives notice of rejection on the execution
date. The time of receipt of notice is determined pursuant to
Section 1-201(27). The rate of interest is stated in Section 4A-506. If
the sender receives notice on the day after the execution date, the sender
is entitled to one day's interest. If receipt of notice is delayed for more
than one day, the sender is entitled to interest for each additional day of
delay.
4. Subsection (d) treats acceptance and rejection as mutually
exclusive. If a payment order has been accepted, rejection of that order
becomes impossible. If a payment order has been rejected it cannot be
accepted later by the receiving bank. Once notice of rejection has been
given, the sender may have acted on the notice by making the payment
through other channels. If the receiving bank wants to act on a payment
order that it has rejected it has to obtain the consent of the sender. In
that case the consent of the sender would amount to the giving of a
second payment order that substitutes for the rejected first order. If the
receiving bank suspends payments (Section 4-104(1)(k)), subsection (c)
provides that unaccepted payment orders are deemed rejected at the time
suspension of payments occurs. This prevents acceptance by passage of
time under Section 4A-209(b)(3).
Section 36-4A-211. CANCELLATION AND AMENDMENT OF
PAYMENT ORDER.
(a) A communication of the sender of a payment order canceling or
amending the order may be transmitted to the receiving bank orally,
electronically, or in writing. If a security procedure is in effect between
the sender and the receiving bank, the communication is not effective
to cancel or amend the order unless the communication is verified
pursuant to the security procedure or the bank agrees to the cancellation
or amendment.
(b) Subject to subsection (a), a communication by the sender
canceling or amending a payment order is effective to cancel or amend
the order if notice of the communication is received at a time and in a
manner affording the receiving bank a reasonable opportunity to act on
the communication before the bank accepts the payment order.
(c) After a payment order has been accepted, cancellation or
amendment of the order is not effective unless the receiving bank agrees
or a funds-transfer system rule allows cancellation or amendment
without agreement of the bank.
(1) With respect to a payment order accepted by a receiving
bank other than the beneficiary's bank, cancellation or amendment is not
effective unless a conforming cancellation or amendment of the payment
order issued by the receiving bank is also made.
(2) With respect to a payment order accepted by the
beneficiary's bank, cancellation or amendment is not effective unless the
order was issued in execution of an unauthorized payment order, or
because of a mistake by a sender in the funds transfer which resulted in
the issuance of a payment order (i) that is a duplicate of a payment order
previously issued by the sender, (ii) that orders payment to a beneficiary
not entitled to receive payment from the originator, or (iii) that orders
payment in an amount greater than the amount the beneficiary was
entitled to receive from the originator. If the payment order is canceled
or amended, the beneficiary's bank is entitled to recover from the
beneficiary any amount paid to the beneficiary to the extent allowed by
the law governing mistake and restitution.
(d) An unaccepted payment order is canceled by operation of law
at the close of the fifth funds-transfer business day of the receiving bank
after the execution date or payment date of the order.
(e) A canceled payment order cannot be accepted. If an accepted
payment order is canceled, the acceptance is nullified and no person has
any right or obligation based on the acceptance. Amendment of a
payment order is considered to be cancellation of the original order at
the time of amendment and issue of a new payment order in the amended
form at the same time.
(f) Unless otherwise provided in an agreement of the parties or in a
funds-transfer system rule, if the receiving bank, after accepting a
payment order, agrees to cancellation or amendment of the order by the
sender or is bound by a funds-transfer system rule allowing cancellation
or amendment without the bank's agreement, the sender, whether or not
cancellation or amendment is effective, is liable to the bank for any loss
and expenses, including reasonable attorney's fees, incurred by the bank
as a result of the cancellation or amendment or attempted cancellation
or amendment.
(g) A payment order is not revoked by the death or legal
incapacity of the sender unless the receiving bank knows of the death or
of an adjudication of incapacity by a court of competent jurisdiction and
has reasonable opportunity to act before acceptance of the order.
(h) A funds-transfer system rule is not effective to the extent it
conflicts with subsection (c)(2).
OFFICIAL COMMENT
1. This section deals with cancellation and amendment of payment
orders. It states the conditions under which cancellation or amendment
is both effective and rightful. There is no concept of wrongful
cancellation or amendment of a payment order. If the conditions stated
in this section are not met the attempted cancellation or amendment is
not effective. If the stated conditions are met the cancellation or
amendment is effective and rightful. The sender of a payment order may
want to withdraw or change the order because the sender has had a
change of mind about the transaction or because the payment order was
erroneously issued or for any other reason. One common situation is
that of multiple transmission of the same order. The sender that
mistakenly transmits the same order twice wants to correct the mistake
by cancelling the duplicate order. Or, a sender may have intended to
order a payment of $1,000,000 but mistakenly issued an order to pay
$10,000,000. In this case the sender might try to correct the mistake by
cancelling the order and issuing another order in the proper amount. Or,
the mistake could be corrected by amending the order to change it to the
proper amount. Whether the error is corrected by amendment or
cancellation and reissue the net result is the same. This result is stated
in the last sentence of subsection (e).
2. Subsection (a) allows a cancellation or amendment of a payment
order to be communicated to the receiving bank "orally,
electronically, or in writing." The quoted phrase is consistent with
the language of Section 4A-103(a) applicable to payment orders.
Cancellations and amendments are normally subject to verification
pursuant to security procedures to the same extent as payment orders.
Subsection (a) recognizes this fact by providing that in cases in which
there is a security procedure in effect between the sender and the
receiving bank the bank is not bound by a communication cancelling or
amending an order unless verification has been made. This is necessary
to protect the bank because under subsection (b) a cancellation or
amendment can be effective by unilateral action of the sender. Without
verification the bank cannot be sure whether the communication was or
was not effective to cancel or amend a previously verified payment
order.
3. If the receiving bank has not yet accepted the order, there is no
reason why the sender should not be able to cancel or amend the order
unilaterally so long as the requirements of subsections (a) and (b) are
met. If the receiving bank has accepted the order, it is possible to cancel
or amend but only if the requirements of subsection (c) are met.
First consider the case of a receiving bank other than the
beneficiary's bank. If the bank has not yet accepted the order, the sender
can unilaterally cancel or amend. The communication amending or
cancelling the payment order must be received in time to allow the bank
to act on it before the bank issues its payment order in execution of the
sender's order. The time that the sender's communication is received is
governed by Section 4A-106. If a payment order does not specify a
delayed payment date or execution date, the order will normally be
executed shortly after receipt. Thus, as a practical matter, the sender
will have very little time in which to instruct cancellation or amendment
before acceptance. In addition, a receiving bank will normally have
cut-off times for receipt of such communications, and the receiving bank
is not obliged to act on communications received after the cut-off hour.
Cancellation by the sender after execution of the order by the receiving
bank requires the agreement of the bank unless a funds transfer rule
otherwise provides. Subsection (c). Although execution of the sender's
order by the receiving bank does not itself impose liability on the
receiving bank (under Section 4A-402 no liability is incurred by the
receiving bank to pay its order until it is accepted), it would commonly
be the case that acceptance follows shortly after issuance. Thus, as a
practical matter, a receiving bank that has executed a payment order will
incur a liability to the next bank in the chain before it would be able to
act on the cancellation request of its customer. It is unreasonable to
impose on the receiving bank a risk of loss with respect to a cancellation
request without the consent of the receiving bank.
The statute does not state how or when the agreement of the
receiving bank must be obtained for cancellation after execution. The
receiving bank's consent could be obtained at the time cancellation
occurs or it could be based on a preexisting agreement. Or, a funds
transfer system rule could provide that cancellation can be made
unilaterally by the sender. By virtue of that rule any receiving bank
covered by the rule is bound. Section 4A-501. If the receiving bank has
already executed the sender's order, the bank would not consent to
cancellation unless the bank to which the receiving bank has issued its
payment order consents to cancellation of that order. It makes no sense
to allow cancellation of a payment order unless all subsequent payment
orders in the funds transfer that were issued because of the cancelled
payment order are also cancelled. Under subsection (c)(1), if a receiving
bank consents to cancellation of the payment order after it is executed,
the cancellation is not effective unless the receiving bank also cancels
the payment order issued by the bank.
4. With respect to a payment order issued to the beneficiary's bank,
acceptance is particularly important because it creates liability to pay the
beneficiary, it defines when the originator pays its obligation to the
beneficiary, and it defines when any obligation for which the payment
is made is discharged. Since acceptance affects the rights of the
originator and the beneficiary it is not appropriate to allow the
beneficiary's bank to agree to cancellation or amendment except in
unusual cases. Except as provided in subsection (c)(2), cancellation or
amendment after acceptance by the beneficiary's bank is not possible
unless all parties affected by the order agree. Under subsection (c)(2),
cancellation or amendment is possible only in the four cases stated. The
following examples illustrate subsection (c)(2):
Case #1. Originator's Bank executed a payment order issued
in the name of its customer as sender. The order was not authorized by
the customer and was fraudulently issued. Beneficiary's Bank accepted
the payment order issued by Originator's Bank. Under subsection (c)(2)
Originator's Bank can cancel the order if Beneficiary's Bank consents.
It doesn't make any difference whether the payment order that
Originator's Bank accepted was or was not enforceable against the
customer under Section 4A-202(b). Verification under that provision is
important in determining whether Originator's Bank or the customer has
the risk of loss, but it has no relevance under Section 4A-211(c)(2).
Whether or not verified, the payment order was not authorized by the
customer. Cancellation of the payment order to Beneficiary's Bank
causes the acceptance of Beneficiary's Bank to be nullified. Subsection
(e). Beneficiary's Bank is entitled to recover payment from the
beneficiary to the extent allowed by the law of mistake and restitution.
In this kind of case the beneficiary is usually a party to the fraud who
has no right to receive or retain payment of the order.
Case #2. Originator owed Beneficiary $1,000,000 and
ordered Bank A to pay that amount to the account of Beneficiary in
Bank B. Bank A issued a complying order to Bank B, but by mistake
issued a duplicate order as well. Bank B accepted both orders. Under
subsection (c)(2)(i) cancellation of the duplicate order could be made
by Bank A with the consent of Bank B. Beneficiary has no right to
receive or retain payment of the duplicate payment order if only
$1,000,000 was owed by Originator to Beneficiary. If Originator owed
$2,000,000 to Beneficiary, the law of restitution might allow Beneficiary
to retain the $1,000,000 paid by Bank B on the duplicate order. In that
case Bank B is entitled to reimbursement from Bank A under subsection
(f).
Case #3. Originator owed $1,000,000 to X. Intending to
pay X, Originator ordered Bank A to pay $1,000,000 to Y's account in
Bank B. Bank A issued a complying payment order to Bank B which
Bank B accepted by releasing the $1,000,000 to Y. Under subsection
(c)(2)(ii) Bank A can cancel its payment order to Bank B with the
consent of Bank B if Y was not entitled to receive payment from
Originator. Originator can also cancel its order to Bank A with Bank A's
consent. Subsection (c) (1). Bank B may recover the $1,000,000 from
Y unless the law of mistake and restitution allows Y to retain some or all
of the amount paid. If no debt was owed to Y, Bank B should have a
right of recovery.
Case #4. Originator owed Beneficiary $10,000. By mistake
Originator ordered Bank A to pay $1,000,000 to the account of
Beneficiary in Bank B. Bank A issued a complying order to Bank B
which accepted by notifying Beneficiary of its right to withdraw
$1,000,000. Cancellation is permitted in this case under subsection
(c)(2)(iii). If Bank B paid Beneficiary it is entitled to recover the
payment except to the extent the law of mistake and restitution allows
Beneficiary to retain payment. In this case Beneficiary might be entitled
to retain $10,000, the amount of the debt owed to Beneficiary. If
Beneficiary may retain $10,000, Bank B would be entitled to $10,000
from Bank A pursuant to subsection (f). In this case Originator also
cancelled its order. Thus Bank A would be entitled to $10,000 from
Originator pursuant to subsection (f).
5. Unless constrained by a funds transfer system rule, a receiving
bank may agree to cancellation or amendment of the payment order
under subsection (c) but is not required to do so regardless of the
circumstances. If the receiving bank has incurred liability as a result of
its acceptance of the sender's order, there are substantial risks in
agreeing to cancellation or amendment. This is particularly true for a
beneficiary's bank. Cancellation or amendment after acceptance by the
beneficiary's bank can be made only in the four cases stated and the
beneficiary's bank may not have any way of knowing whether the
requirements of subsection (c) have been met or whether it will be able
to recover payment from the beneficiary that received payment. Even
with indemnity the beneficiary's bank may be reluctant to alienate its
customer, the beneficiary, by denying the customer the funds.
Subsection (c) leaves the decision to the beneficiary's bank unless the
consent of the beneficiary's bank is not required under a funds transfer
system rule or other interbank agreement. If a receiving bank agrees to
cancellation or amendment under subsection (c)(1) or (2), it is
automatically entitled to indemnification from the sender under
subsection (f). The indemnification provision recognizes that a sender
has no right to cancel a payment order after it is accepted by the
receiving bank. If the receiving bank agrees to cancellation, it is doing
so as an accommodation to the sender and it should not incur a risk of
loss in doing so.
6. Acceptance by the receiving bank of a payment order issued by
the sender is comparable to acceptance of an offer under the law of
contracts. Under that law the death or legal incapacity of an offeror
terminates the offer even though the offeree has no notice of the death
or incapacity. Restatement Second, Contracts Section 48. Comment a.
to that section states that the "rule seems to be a relic of the
obsolete view that a contract requires a 'meeting of minds,' and it is out
of harmony with the modern doctrine that a manifestation of assent is
effective without regard to actual mental assent." Subsection (g),
which reverses the Restatement rule in the case of a payment order, is
similar to Section 4-405(1) which applies to checks. Subsection (g) does
not address the effect of the bankruptcy of the sender of a payment order
before the order is accepted, but the principle of subsection (g) has been
recognized in Bank of Marin v. England, 385 U.S. 99 (1966).
Although Bankruptcy Code Section 542(c) may not have been drafted
with wire transfers in mind, its language can be read to allow the
receiving bank to charge the sender's account for the amount of the
payment order if the receiving bank executed it in ignorance of the
bankruptcy.
7. Subsection (d) deals with stale payment orders. Payment orders
normally are executed on the execution date or the day after. An order
issued to the beneficiary's bank is normally accepted on the payment
date or the day after. If a payment order is not accepted on its execution
or payment date or shortly thereafter, it is probable that there was some
problem with the terms of the order or the sender did not have sufficient
funds or credit to cover the amount of the order. Delayed acceptance of
such an order is normally not contemplated, but the order may not have
been cancelled by the sender. Subsection (d) provides for cancellation
by operation of law to prevent an unexpected delayed acceptance.
8. A funds transfer system rule can govern rights and obligations
between banks that are parties to payment orders transmitted over the
system even if the rule conflicts with Article 4A. In some cases,
however, a rule governing a transaction between two banks can affect
a third party in an unacceptable way. Subsection (h) deals with such a
case. A funds transfer system rule cannot allow cancellation of a
payment order accepted by the beneficiary's bank if the rule conflicts
with subsection (c)(2). Because rights of the beneficiary and the
originator are directly affected by acceptance, subsection (c)(2) severely
limits cancellation. These limitations cannot be altered by funds transfer
system rule.
Section 36-4A-212. LIABILITY AND DUTY OF RECEIVING
BANK REGARDING UNACCEPTED PAYMENT ORDER.
If a receiving bank fails to accept a payment order that it is obliged
by express agreement to accept, the bank is liable for breach of the
agreement to the extent provided in the agreement or in this chapter, but
does not otherwise have any duty to accept a payment order or, before
acceptance, to take any action, or refrain from taking action, with respect
to the order except as provided in this chapter or by express agreement.
Liability based on acceptance arises only when acceptance occurs as
stated in Section 36-4A-209, and liability is limited to that provided in
this chapter. A receiving bank is not the agent of the sender or
beneficiary of the payment order it accepts, or of any other party to the
funds transfer, and the bank owes no duty to any party to the funds
transfer except as provided in this chapter or by express agreement.
OFFICIAL COMMENT
With limited exceptions stated in this Article, the duties and
obligations of receiving banks that carry out a funds transfer arise only
as a result of acceptance of payment orders or of agreements made by
receiving banks. Exceptions are stated in Section 4A-209(b)(3) and
Section 4A-210(b). A receiving bank is not like a collecting bank under
Article 4. No receiving bank, whether it be an originator's bank, an
intermediary bank or a beneficiary's bank, is an agent for any other party
in the funds transfer.
PART 3
EXECUTION OF SENDER'S PAYMENT ORDER BY
RECEIVING BANK
Section 36-4A-301. EXECUTION AND EXECUTION DATE.
(a) A payment order is `executed' by the receiving bank when it
issues a payment order intended to carry out the payment order received
by the bank. A payment order received by the beneficiary's bank can be
accepted but cannot be executed.
(b) `Execution date' of a payment order means the day on which
the receiving bank may properly issue a payment order in execution of
the sender's order. The execution date may be determined by instruction
of the sender but cannot be earlier than the day the order is received and,
unless otherwise determined, is the day the order is received. If the
sender's instruction states a payment date, the execution date is the
payment date or an earlier date on which execution is reasonably
necessary to allow payment to the beneficiary on the payment date.
OFFICIAL COMMENT
1. The terms "executed," "execution" and
"execution date" are used only with respect to a payment
order to a receiving bank other than the beneficiary's bank. The
beneficiary's bank can accept the payment order that it receives, but it
does not execute the order. Execution refers to the act of the receiving
bank in issuing a payment order "intended to carry out" the
payment order that the bank received. A receiving bank has executed an
order even if the order issued by the bank does not carry out the order
received by the bank. For example, the bank may have erroneously
issued an order to the wrong beneficiary, or in the wrong amount or to
the wrong beneficiary's bank. In each of these cases execution has
occurred but the execution is erroneous. Erroneous execution is covered
in Section 4A-303.
2. "Execution date" refers to the time a payment order
should be executed rather than the day it is actually executed. Normally
the sender will not specify an execution date, but most payment orders
are meant to be executed immediately. Thus, the execution date is
normally the day the order is received by the receiving bank. It is
common for the sender to specify a "payment date" which
is defined in Section 4A-401 as "the day on which the amount of
the order is payable to the beneficiary by the beneficiary's bank."
Except for automated clearing house transfers, if a funds transfer is
entirely within the United States and the payment is to be carried out
electronically, the execution date is the payment date unless the order is
received after the payment date. If the payment is to be carried out
through an automated clearing house, execution may occur before the
payment date. In an ACH transfer the beneficiary is usually paid one or
two days after issue of the originator's payment order. The execution
date is determined by the stated payment date and is a date before the
payment date on which execution is reasonably necessary to allow
payment on the payment date. A funds transfer system rule could also
determine the execution date of orders received by the receiving bank if
both the sender and the receiving bank are participants in the funds
transfer system. The execution date can be determined by the payment
order itself or by separate instructions of the sender or an agreement of
the sender and the receiving bank. The second sentence of subsection
(b) must be read in the light of Section 4A-106 which states that if a
payment order is received after the cut-off time of the receiving bank it
may be treated by the bank as received at the opening of the next funds
transfer business day.
3. Execution on the execution date is timely, but the order can be
executed before or after the execution date. Section 4A-209(d) and
Section 4A-402(c) state the consequences of early execution and Section
4A-305(a) states the consequences of late execution.
Section 36-4A-302. OBLIGATIONS OF RECEIVING BANK IN
EXECUTION OF PAYMENT ORDER.
(a) Except as provided in subsections (b) through (d), if the receiving
bank accepts a payment order pursuant to Section 36-4A-209 (a), the
bank has the following obligations in executing the order:
(1) The receiving bank is obliged to issue, on the execution
date, a payment order complying with the sender's order and to follow
the sender's instructions concerning (i) any intermediary bank or
funds-transfer system to be used in carrying out the funds transfer, or (ii)
the means by which payment orders are to be transmitted in the funds
transfer. If the originator's bank issues a payment order to an
intermediary bank, the originator's bank is obliged to instruct the
intermediary bank according to the instruction of the originator. An
intermediary bank in the funds transfer is similarly bound by an
instruction given to it by the sender of the payment order it accepts.
(2) If the sender's instruction states that the funds transfer is
to be carried out telephonically or by wire transfer or otherwise indicates
that the funds transfer is to be carried out by the most expeditious
means, the receiving bank is obliged to transmit its payment order by the
most expeditious available means, and to instruct any intermediary bank
accordingly. If a sender's instruction states a payment date, the receiving
bank is obliged to transmit its payment order at a time and by means
reasonably necessary to allow payment to the beneficiary on the
payment date or as soon thereafter as is feasible.
(b) Unless otherwise instructed, a receiving bank executing a
payment order may (i) use any funds-transfer system if use of that
system is reasonable in the circumstances, and (ii) issue a payment order
to the beneficiary's bank or to an intermediary bank through which a
payment order conforming to the sender's order can expeditiously be
issued to the beneficiary's bank if the receiving bank exercises ordinary
care in the selection of the intermediary bank. A receiving bank is not
required to follow an instruction of the sender designating a
funds-transfer system to be used in carrying out the funds transfer if the
receiving bank, in good faith, determines that it is not feasible to follow
the instruction or that following the instruction would unduly delay
completion of the funds transfer.
(c) Unless subsection (a)(2) applies or the receiving bank is
otherwise instructed, the bank may execute a payment order by
transmitting its payment order by first class mail or by any means
reasonable in the circumstances. If the receiving bank is instructed to
execute the sender's order by transmitting its payment order by a
particular means, the receiving bank may issue its payment order by the
means stated or by any means as expeditious as the means stated.
(d) Unless instructed by the sender, (i) the receiving bank may not
obtain payment of its charges for services and expenses in connection
with the execution of the sender's order by issuing a payment order in an
amount equal to the amount of the sender's order less the amount of the
charges, and (ii) may not instruct a subsequent receiving bank to obtain
payment of its charges in the same manner.
OFFICIAL COMMENT
1. In the absence of agreement, the receiving bank is not obliged to
execute an order of the sender. Section 4A-212. Section 4A-302 states
the manner in which the receiving bank may execute the sender's order
if execution occurs. Subsection (a)(1) states the residual rule. The
payment order issued by the receiving bank must comply with the
sender's order and, unless some other rule is stated in the section, the
receiving bank is obliged to follow any instruction of the sender
concerning which funds transfer system is to be used, which
intermediary banks are to be used, and what means of transmission is to
be used. The instruction of the sender may be incorporated in the
payment order itself or may be given separately. For example, there
may be a master agreement between the sender and receiving bank
containing instructions governing payment orders to be issued from time
to time by the sender to the receiving bank. In most funds transfers,
speed is a paramount consideration. A sender that wants assurance that
the funds transfer will be expeditiously completed can specify the means
to be used. The receiving bank can follow the instructions literally or it
can use an equivalent means. For example, if the sender instructs the
receiving bank to transmit by telex, the receiving bank could use
telephone instead. Subsection (c). In most cases the sender will not
specify a particular means but will use a general term such as "by
wire" or "wire transfer" or "as soon as
possible." These words signify that the sender wants a same-day
transfer. In these cases the receiving bank is required to use a telephonic
or electronic communication to transmit its order and is also required to
instruct any intermediary bank to which it issues its order to transmit by
similar means. Subsection (a)(2). In other cases, such as an automated
clearing house transfer, a same-day transfer is not contemplated.
Normally the sender's instruction or the context in which the payment
order is received makes clear the type of funds transfer that is
appropriate. If the sender states a payment date with respect to the
payment order, the receiving bank is obliged to execute the order at a
time and in a manner to meet the payment date if that is feasible.
Subsection (a)(2). This provision would apply to many ACH transfers
made to pay recurring debts of the sender. In other cases, involving
relatively small amounts, time may not be an important factor and cost
may be a more important element. Fast means, such as telephone or
electronic transmission, are more expensive than slow means such as
mailing. Subsection (c) states that in the absence of instructions the
receiving bank is given discretion to decide. It may issue its payment
order by first class mail or by any means reasonable in the
circumstances. Section 4A-305 states the liability of a receiving bank
for breach of the obligations stated in Section 4A-302. 2. Subsection
(b) concerns the choice of intermediary banks to be used in completing
the funds transfer, and the funds transfer system to be used. If the
receiving bank is not instructed about the matter, it can issue an order
directly to the beneficiary's bank or can issue an order to an intermediary
bank. The receiving bank also has discretion concerning use of a funds
transfer system. In some cases it may be reasonable to use either an
automated clearing house system or a wire transfer system such as
Fedwire or CHIPS. Normally, the receiving bank will follow the
instruction of the sender in these matters, but in some cases it may be
prudent for the bank not to follow instructions. The sender may have
designated a funds transfer system to be used in carrying out the funds
transfer, but it may not be feasible to use the designated system because
of some impediment such as a computer breakdown which prevents
prompt execution of the order. The receiving bank is permitted to use
an alternate means of transmittal in a good faith effort to execute the
order expeditiously. The same leeway is not given to the receiving bank
if the sender designates an intermediary bank through which the funds
transfer is to be routed. The sender's designation of that intermediary
bank may mean that the beneficiary's bank is expecting to obtain a credit
from that intermediary bank and may have relied on that anticipated
credit. If the receiving bank uses another intermediary bank the
expectations of the beneficiary's bank may not be realized. The
receiving bank could choose to route the transfer to another intermediary
bank and then to the designated intermediary bank if there were some
reason such as a lack of a correspondent-bank relationship or a bilateral
credit limitation, but the designated intermediary bank cannot be
circumvented. To do so violates the sender's instructions.
3. The normal rule, under subsection (a)(1), is that the receiving
bank, in executing a payment order, is required to issue a payment order
that complies as to amount with that of the sender's order. In most cases
the receiving bank issues an order equal to the amount of the sender's
order and makes a separate charge for services and expenses in
executing the sender's order. In some cases, particularly if it is an
intermediary bank that is executing an order, charges are collected by
deducting them from the amount of the payment order issued by the
executing bank. If that is done, the amount of the payment order
accepted by the beneficiary's bank will be slightly less than the amount
of the originator's payment order. For example, Originator, in order to
pay an obligation of $1,000,000 owed to Beneficiary, issues a payment
order to Originator's Bank to pay $1,000,000 to the account of
Beneficiary in Beneficiary's Bank. Originator's Bank issues a payment
order to Intermediary Bank for $1,000,000 and debits Originator's
account for $1,000,010. The extra $10 is the fee of Originator's Bank.
Intermediary Bank executes the payment order of Originator's Bank by
issuing a payment order to Beneficiary's Bank for $999,990, but under
Section 4A-402(c) is entitled to receive $1,000,000 from Originator's
Bank. The $10 difference is the fee of Intermediary Bank. Beneficiary's
Bank credits Beneficiary's account for $999,990. When Beneficiary's
Bank accepts the payment order of Intermediary Bank the result is a
payment of $999,990 from Originator to Beneficiary. Section
4A-406(a). If that payment discharges the $1,000,000 debt, the effect
is that Beneficiary has paid the charges of Intermediary Bank and
Originator has paid the charges of Originator's Bank. Subsection (d) of
Section 4A-302 allows Intermediary Bank to collect its charges by
deducting them from the amount of the payment order, but only if
instructed to do so by Originator's Bank. Originator's Bank is not
authorized to give that instruction to Intermediary Bank unless
Originator authorized the instruction. Thus, Originator can control how
the charges of Originator's Bank and Intermediary Bank are to be paid.
Subsection (d) does not apply to charges of Beneficiary's Bank to
Beneficiary.
In the case discussed in the preceding paragraph the $10 charge is
trivial in relation to the amount of the payment and it may not be
important to Beneficiary how the charge is paid. But it may be very
important if the $1,000,000 obligation represented the price of
exercising a right such as an option favorable to Originator and
unfavorable to Beneficiary. Beneficiary might well argue that it was
entitled to receive $1,000,000. If the option was exercised shortly
before its expiration date, the result could be loss of the option benefit
because the required payment of $1,000,000 was not made before the
option expired. Section 4A-406(c) allows Originator to preserve the
option benefit. The amount received by Beneficiary is deemed to be
$1,000,000 unless Beneficiary demands the $10 and Originator does not
pay it.
Section 36-4A-303. ERRONEOUS EXECUTION OF PAYMENT
ORDER.
(a) A receiving bank that (i) executes the payment order of the sender
by issuing a payment order in an amount greater than the amount of the
sender's order, or (ii) issues a payment order in execution of the sender's
order and then issues a duplicate order, is entitled to payment of the
amount of the sender's order under Section 36-4A-402(c) if that
subsection is otherwise satisfied. The bank is entitled to recover from
the beneficiary of the erroneous order the excess payment received to the
extent allowed by the law governing mistake and restitution.
(b) A receiving bank that executes the payment order of the
sender by issuing a payment order in an amount less than the amount of
the sender's order is entitled to payment of the amount of the sender's
order under Section 36-4A-402(c) if (i) that subsection is otherwise
satisfied and (ii) the bank corrects its mistake by issuing an additional
payment order for the benefit of the beneficiary of the sender's order. If
the error is not corrected, the issuer of the erroneous order is entitled to
receive or retain payment from the sender of the order it accepted only
to the extent of the amount of the erroneous order. This subsection does
not apply if the receiving bank executes the sender's payment order by
issuing a payment order in an amount less than the amount of the
sender's order for the purpose of obtaining payment of its charges for
services and expenses pursuant to instruction of the sender.
(c) If a receiving bank executes the payment order of the sender by
issuing a payment order to a beneficiary different from the beneficiary
of the sender's order and the funds transfer is completed on the basis of
that error, the sender of the payment order that was erroneously executed
and all previous senders in the funds transfer are not obliged to pay the
payment orders they issued. The issuer of the erroneous order is entitled
to recover from the beneficiary of the order the payment received to the
extent allowed by the law governing mistake and restitution.
OFFICIAL COMMENT
1. Section 4A-303 states the effect of erroneous execution of a
payment order by the receiving bank. Under Section 4A-402(c) the
sender of a payment order is obliged to pay the amount of the order to
the receiving bank if the bank executes the order, but the obligation to
pay is excused if the beneficiary's bank does not accept a payment order
instructing payment to the beneficiary of the sender's order. If erroneous
execution of the sender's order causes the wrong beneficiary to be paid,
the sender is not required to pay. If erroneous execution causes the
wrong amount to be paid the sender is not obliged to pay the receiving
bank an amount in excess of the amount of the sender's order. Section
4A-303 takes precedence over Section 4A-402(c) and states the liability
of the sender and the rights of the receiving bank in various cases of
erroneous execution.
2. Subsections (a) and (b) deal with cases in which the receiving
bank executes by issuing a payment order in the wrong amount. If
Originator ordered Originator's Bank to pay $1,000,000 to the account
of Beneficiary in Beneficiary's Bank, but Originator's Bank erroneously
instructed Beneficiary's Bank to pay $2,000,000 to Beneficiary's
account, subsection (a) applies. If Beneficiary's Bank accepts the order
of Originator's Bank, Beneficiary's Bank is entitled to receive
$2,000,000 from Originator's Bank, but Originator's Bank is entitled to
receive only $1,000,000 from Originator. Originator's Bank is entitled
to recover the overpayment from Beneficiary to the extent allowed by
the law governing mistake and restitution. Originator's Bank would
normally have a right to recover the overpayment from Beneficiary, but
in unusual cases the law of restitution might allow Beneficiary to keep
all or part of the overpayment. For example, if Originator owed
$2,000,000 to Beneficiary and Beneficiary received the extra $1,000,000
in good faith in discharge of the debt, Beneficiary may be allowed to
keep it. In this case Originator's Bank has paid an obligation of
Originator and under the law of restitution, which applies through
Section 1-103, Originator's Bank would be subrogated to Beneficiary's
rights against Originator on the obligation paid by Originator's Bank.
If Originator's Bank erroneously executed Originator's order by
instructing Beneficiary's Bank to pay less than $1,000,000, subsection
(b) applies. If Originator's Bank corrects its error by issuing another
payment order to Beneficiary's Bank that results in payment of
$1,000,000 to Beneficiary, Originator's Bank is entitled to payment of
$1,000,000 from Originator. If the mistake is not corrected, Originator's
Bank is entitled to payment from Originator only in the amount of the
order issued by Originator's Bank.
3. Subsection (a) also applies to duplicate payment orders. Assume
Originator's Bank properly executes Originator's $1,000,000 payment
order and then by mistake issues a second $1,000,000 payment order in
execution of Originator's order. If Beneficiary's Bank accepts both
orders issued by Originator's Bank, Beneficiary's Bank is entitled to
receive $2,000,000 from Originator's Bank but Originator's Bank is
entitled to receive only $1,000,000 from Originator. The remedy of
Originator's Bank is the same as that of a receiving bank that executes
by issuing an order in an amount greater than the sender's order. It may
recover the overpayment from Beneficiary to the extent allowed by the
law governing mistake and restitution and in a proper case as stated in
Comment 2 may have subrogation rights if it is not entitled to recover
from Beneficiary.
4. Suppose Originator instructs Originator's Bank to pay $1,000,000
to Account #12345 in Beneficiary's Bank. Originator's Bank
erroneously instructs Beneficiary's Bank to pay $1,0000,000 to Account
#12346 and Beneficiary's Bank accepted. Subsection (c) covers this
case. Originator is not obliged to pay its payment order, but Originator's
Bank is required to pay $1,000,000 to Beneficiary's Bank. The remedy
of Originator's Bank is to recover $1,000,000 from the holder of
Account #12346 that received payment by mistake. Recovery based on
the law of mistake and restitution is described in Comment 2.
Section 36-4A-304. DUTY OF SENDER TO REPORT
ERRONEOUSLY EXECUTED PAYMENT ORDER.
If the sender of a payment order that is erroneously executed as
stated in Section 36-4A-303 receives notification from the receiving
bank that the order was executed or that the sender's account was debited
with respect to the order, the sender has a duty to exercise ordinary care
to determine, on the basis of information available to the sender, that the
order was erroneously executed and to notify the bank of the relevant
facts within a reasonable time not exceeding 90 days after the
notification from the bank was received by the sender. If the sender fails
to perform that duty, the bank is not obliged to pay interest on any
amount refundable to the sender under Section 36-4A-402(d) for the
period before the bank learns of the execution error. The bank is not
entitled to any recovery from the sender on account of a failure by the
sender to perform the duty stated in this section.
OFFICIAL COMMENT
This section is identical in effect to Section 4A-204 which applies to
unauthorized orders issued in the name of a customer of the receiving
bank. The rationale is stated in Comment 2 to Section 4A-204.
Section 36-4A-305. LIABILITY FOR LATE OR IMPROPER
EXECUTION OR FAILURE TO EXECUTE PAYMENT ORDER.
(a) If a funds transfer is completed but execution of a payment order
by the receiving bank in breach of Section 36-4A-302 results in delay in
payment to the beneficiary, the bank is obliged to pay interest to either
the originator or the beneficiary of the funds transfer for the period of
delay caused by the improper execution. Except as provided in
subsection (c), additional damages are not recoverable.
(b) If execution of a payment order by a receiving bank in breach
of Section 36-4A-302 results in (i) noncompletion of the funds transfer,
(ii) failure to use an intermediary bank designated by the originator, or
(iii) issuance of a payment order that does not comply with the terms of
the payment order of the originator, the bank is liable to the originator
for its expenses in the funds transfer and for incidental expenses and
interest losses, to the extent not covered by subsection (a), resulting from
the improper execution. Except as provided in subsection (c), additional
damages are not recoverable.
(c) In addition to the amounts payable under subsections (a) and (b),
damages, including consequential damages, are recoverable to the extent
provided in an express written agreement of the receiving bank.
(d) If a receiving bank fails to execute a payment order it was
obliged by express agreement to execute, the receiving bank is liable to
the sender for its expenses in the transaction and for incidental expenses
and interest losses resulting from the failure to execute. Additional
damages, including consequential damages, are recoverable to the extent
provided in an express written agreement of the receiving bank, but are
not otherwise recoverable.
(e) Reasonable attorney's fees are recoverable if demand for
compensation under subsection (a) or (b) is made and refused before an
action is brought on the claim. If a claim is made for breach of an
agreement under subsection (d) and the agreement does not provide for
damages, reasonable attorney's fees are recoverable if demand for
compensation under subsection (d) is made and refused before an action
is brought on the claim.
(f) Except as stated in this section, the liability of a receiving bank
under subsections (a) and (b) may not be varied by agreement.
OFFICIAL COMMENT
1. Subsection (a) covers cases of delay in completion of a funds
transfer resulting from an execution by a receiving bank in breach of
Section 4A-302(a). The receiving bank is obliged to pay interest on the
amount of the order for the period of the delay. The rate of interest is
stated in Section 4A-506. With respect to wire transfers (other than
ACH transactions) within the United States, the expectation is that the
funds transfer will be completed the same day. In those cases, the
originator can reasonably expect that the originator's account will be
debited on the same day as the beneficiary's account is credited. If the
funds transfer is delayed, compensation can be paid either to the
originator or to the beneficiary. The normal practice is to compensate
the beneficiary's bank to allow that bank to compensate the beneficiary
by back-valuing the payment by the number of days of delay. Thus, the
beneficiary is in the same position that it would have been in if the funds
transfer had been completed on the same day. Assume on Day 1,
Originator's Bank issues its payment order to Intermediary Bank which
is received on that day. Intermediary Bank does not execute that order
until Day 2 when it issues an order to Beneficiary's Bank which is
accepted on that day. Intermediary Bank complies with subsection (a)
by paying one day's interest to Beneficiary's Bank for the account of
Beneficiary.
2. Subsection (b) applies to cases of breach of Section 4A-302
involving more than mere delay. In those cases the bank is liable for
damages for improper execution but they are limited to compensation for
interest losses and incidental expenses of the sender resulting from the
breach, the expenses of the sender in the funds transfer and attorney's
fees. This subsection reflects the judgment that imposition of
consequential damages on a bank for commission of an error is not
justified.
The leading common law case on the subject of consequential
damages is Evra Corp. v. Swiss Bank Corp., 673 F.2d 951 (7th
Cir. 1982), in which Swiss Bank, an intermediary bank, failed to execute
a payment order. Because the beneficiary did not receive timely
payment the originator lost a valuable ship charter. The lower court
awarded the originator $2.1 million for lost profits even though the
amount of the payment order was only $27,000. The Seventh Circuit
reversed, in part on the basis of the common law rule of Hadley v.
Baxendale that consequential damages may not be awarded unless
the defendant is put on notice of the special circumstances giving rise to
them. Swiss Bank may have known that the originator was paying the
shipowner for the hire of a vessel but did not know that a favorable
charter would be lost if the payment was delayed. "Electronic
payments are not so unusual as to automatically place a bank on notice
of extraordinary consequences if such a transfer goes awry. Swiss Bank
did not have enough information to infer that if it lost a $27,000
payment order it would face liability in excess of $2 million." 673
F.2d at 956.
If Evra means that consequential damages can be imposed
if the culpable bank has notice of particular circumstances giving rise to
the damages, it does not provide an acceptable solution to the problem
of bank liability for consequential damages. In the typical case
transmission of the payment order is made electronically. Personnel of
the receiving bank that process payment orders are not the appropriate
people to evaluate the risk of liability for consequential damages in
relation to the price charged for the wire transfer service. Even if notice
is received by higher level management personnel who could make an
appropriate decision whether the risk is justified by the price, liability
based on notice would require evaluation of payment orders on an
individual basis. This kind of evaluation is inconsistent with the
high-speed, low-price, mechanical nature of the processing system that
characterizes wire transfers. Moreover, in Evra the culpable
bank was an intermediary bank with which the originator did not deal.
Notice to the originator's bank would not bind the intermediary bank,
and it seems impractical for the originator's bank to convey notice of this
kind to intermediary banks in the funds transfer. The success of the
wholesale wire transfer industry has largely been based on its ability to
effect payment at low cost and great speed. Both of these essential
aspects of the modern wire transfer system would be adversely affected
by a rule that imposed on banks liability for consequential damages. A
banking industry amicus brief in Evra stated: "Whether
banks can continue to make EFT services available on a widespread
basis, by charging reasonable rates, depends on whether they can do so
without incurring unlimited consequential risks. Certainly, no bank
would handle for $3.25 a transaction entailing potential liability in the
millions of dollars."
As the court in Evra also noted, the originator of the funds
transfer is in the best position to evaluate the risk that a funds transfer
will not be made on time and to manage that risk by issuing a payment
order in time to allow monitoring of the transaction. The originator, by
asking the beneficiary, can quickly determine if the funds transfer has
been completed. If the originator has sent the payment order at a time
that allows a reasonable margin for correcting error, no loss is likely to
result if the transaction is monitored. The other published cases on this
issue reach the Evra result. Central Coordinates, Inc. v.
Morgan Guaranty Trust Co., 40 U.C.C. Rep. Serv. 1340
(N.Y.Sup.Ct. 1985), and Gatoil (U.S.A.), Inc. v. Forest Hill State
Bank, 1 U.C.C. Rep. Serv. 2d 171 (D.Md. 1986).
Subsection (c) allows the measure of damages in subsection (b) to be
increased by an express written agreement of the receiving bank. An
originator's bank might be willing to assume additional responsibilities
and incur additional liability in exchange for a higher fee.
3. Subsection (d) governs cases in which a receiving bank has
obligated itself by express agreement to accept payment orders of a
sender. In the absence of such an agreement there is no obligation by a
receiving bank to accept a payment order. Section 4A-212. The
measure of damages for breach of an agreement to accept a payment
order is the same as that stated in subsection (b). As in the case of
subsection (b), additional damages, including consequential damages,
may be recovered to the extent stated in an express written agreement of
the receiving bank.
4. Reasonable attorney's fees are recoverable only in cases in which
damages are limited to statutory damages stated in subsection (a), (b)
and (d). If additional damages are recoverable because provided for by
an express written agreement, attorney's fees are not recoverable. The
rationale is that there is no need for statutory attorney's fees in the latter
case, because the parties have agreed to a measure of damages which
may or may not provide for attorney's fees.
5. The effect of subsection (f) is to prevent reduction of a receiving
bank's liability under Section 4A-305.
PART 4
PAYMENT
Section 36-4A-401. PAYMENT DATE.
`Payment date' of a payment order means the day on which the
amount of the order is payable to the beneficiary by the beneficiary's
bank. The payment date may be determined by instruction of the sender
but cannot be earlier than the day the order is received by the
beneficiary's bank and, unless otherwise determined, is the day the order
is received by the beneficiary's bank.
OFFICIAL COMMENT
"Payment date" refers to the day the beneficiary's bank
is to pay the beneficiary. The payment date may be expressed in various
ways so long as it indicates the day the beneficiary is to receive
payment. For example, in ACH transfers the payment date is the
equivalent of "settlement date" or "effective
date." Payment date applies to the payment order issued to the
beneficiary's bank, but a payment order issued to a receiving bank other
than the beneficiary's bank may also state a date for payment to the
beneficiary. In the latter case, the statement of a payment date is to
instruct the receiving bank concerning time of execution of the sender's
order. Section 4A-301(b).
Section 36-4A-402. OBLIGATION OF SENDER TO PAY
RECEIVING BANK.
(a) This section is subject to Sections 36-4A-205 and 36-4A-207.
(b) With respect to a payment order issued to the beneficiary's
bank, acceptance of the order by the bank obliges the sender to pay the
bank the amount of the order, but payment is not due until the payment
date of the order.
(c) This subsection is subject to subsection (e) and to Section
36-4A-303. With respect to a payment order issued to a receiving bank
other than the beneficiary's bank, acceptance of the order by the
receiving bank obliges the sender to pay the bank the amount of the
sender's order. Payment by the sender is not due until the execution date
of the sender's order. The obligation of that sender to pay its payment
order is excused if the funds transfer is not completed by acceptance by
the beneficiary's bank of a payment order instructing payment to the
beneficiary of that sender's payment order.
(d) If the sender of a payment order pays the order and was not
obliged to pay all or part of the amount paid, the bank receiving payment
is obliged to refund payment to the extent the sender was not obliged to
pay. Except as provided in Sections 36-4A-204 and 36-4A-304, interest
is payable on the refundable amount from the date of payment.
(e) If a funds transfer is not completed as stated in subsection (c) and
an intermediary bank is obliged to refund payment as stated in
subsection (d) but is unable to do so because not permitted by applicable
law or because the bank suspends payments, a sender in the funds
transfer that executed a payment order in compliance with an instruction,
as stated in Section 36-4A-302(a)(1), to route the funds transfer through
that intermediary bank is entitled to receive or retain payment from the
sender of the payment order that it accepted. The first sender in the
funds transfer that issued an instruction requiring routing through that
intermediary bank is subrogated to the right of the bank that paid the
intermediary bank to refund as stated in subsection (d).
(f) The right of the sender of a payment order to be excused from the
obligation to pay the order as stated in subsection (c) or to receive
refund under subsection (d) may not be varied by agreement.
OFFICIAL COMMENT
1. Subsection (b) states that the sender of a payment order to the
beneficiary's bank must pay the order when the beneficiary's bank
accepts the order. At that point the beneficiary's bank is obliged to pay
the beneficiary. Section 4A-404(a). The last clause of subsection (b)
covers a case of premature acceptance by the beneficiary's bank. In
some funds transfers, notably automated clearing house transfers, a
beneficiary's bank may receive a payment order with a payment date
after the day the order is received. The beneficiary's bank might accept
the order before the payment date by notifying the beneficiary of receipt
of the order. Although the acceptance obliges the beneficiary's bank to
pay the beneficiary, payment is not due until the payment date. The last
clause of subsection (b) is consistent with that result. The beneficiary's
bank is also not entitled to payment from the sender until the payment
date.
2. Assume that Originator instructs Bank A to order immediate
payment to the account of Beneficiary in Bank B. Execution of
Originator's payment order by Bank A is acceptance under Section
4A-209(a). Under the second sentence of Section 4A-402(c) the
acceptance creates an obligation of Originator to pay Bank A the amount
of the order. The last clause of that sentence deals with attempted funds
transfers that are not completed. In that event the obligation of the
sender to pay its payment order is excused. Originator makes payment
to Beneficiary when Bank B, the beneficiary's bank, accepts a payment
order for the benefit of Beneficiary. Section 4A-406(a). If that
acceptance by Bank B does not occur, the funds transfer has miscarried
because Originator has not paid Beneficiary. Originator doesn't have to
pay its payment order, and if it has already paid it is entitled to refund
of the payment with interest. The rate of interest is stated in Section
4A-506. This "money-back guarantee" is an important
protection of Originator. Originator is assured that it will not lose its
money if something goes wrong in the transfer. For example, risk of
loss resulting from payment to the wrong beneficiary is borne by some
bank, not by Originator. The most likely reason for noncompletion is a
failure to execute or an erroneous execution of a payment order by Bank
A or an intermediary bank. Bank A may have issued its payment order
to the wrong bank or it may have identified the wrong beneficiary in its
order. The money-back guarantee is particularly important to Originator
if noncompletion of the funds transfer is due to the fault of an
intermediary bank rather than Bank A. In that case Bank A must refund
payment to Originator, and Bank A has the burden of obtaining refund
from the intermediary bank that it paid.
Subsection (c) can result in loss if an intermediary bank suspends
payments. Suppose Originator instructs Bank A to pay to Beneficiary's
account in Bank B and to use Bank C as an intermediary bank. Bank A
executes Originator's order by issuing a payment order to Bank C. Bank
A pays Bank C. Bank C fails to execute the order of Bank A and
suspends payments. Under subsections (c) and (d), Originator is not
obliged to pay Bank A and is entitled to refund from Bank A of any
payment that it may have made. Bank A is entitled to a refund from
Bank C, but Bank C is insolvent. Subsection (e) deals with this case.
Bank A was required to issue its payment order to Bank C because Bank
C was designated as an intermediary bank by Originator. Section
4A-302(a)(1). In this case Originator takes the risk of insolvency of
Bank C. Under subsection (e), Bank A is entitled to payment from
Originator and Originator is subrogated to the right of Bank A under
subsection (d) to refund of payment from Bank C.
3. A payment order is not like a negotiable instrument on which the
drawer or maker has liability. Acceptance of the order by the receiving
bank creates an obligation of the sender to pay the receiving bank the
amount of the order. That is the extent of the sender's liability to the
receiving bank and no other person has any rights against the sender
with respect to the sender's order.
Section 36-4A-403. PAYMENT BY SENDER TO RECEIVING
BANK.
(a) Payment of the sender's obligation under Section 36-4A-402 to
pay the receiving bank occurs as follows:
(1) If the sender is a bank, payment occurs when the receiving
bank receives final settlement of the obligation through a Federal
Reserve Bank or through a funds-transfer system.
(2) If the sender is a bank and the sender (i) credited an
account of the receiving bank with the sender, or (ii) caused an account
of the receiving bank in another bank to be credited, payment occurs
when the credit is withdrawn or, if not withdrawn, at midnight of the day
on which the credit is withdrawable and the receiving bank learns of that
fact.
(3) If the receiving bank debits an account of the sender with
the receiving bank, payment occurs when the debit is made to the extent
the debit is covered by a withdrawable credit balance in the account.
(b) If the sender and receiving bank are members of a
funds-transfer system that nets obligations multilaterally among
participants, the receiving bank receives final settlement when
settlement is complete in accordance with the rules of the system. The
obligation of the sender to pay the amount of a payment order
transmitted through the funds-transfer system may be satisfied, to the
extent permitted by the rules of the system, by setting off and applying
against the sender's obligation the right of the sender to receive payment
from the receiving bank of the amount of any other payment order
transmitted to the sender by the receiving bank through the
funds-transfer system. The aggregate balance of obligations owed by
each sender to each receiving bank in the funds-transfer system may be
satisfied, to the extent permitted by the rules of the system, by setting off
and applying against that balance the aggregate balance of obligations
owed to the sender by other members of the system. The aggregate
balance is determined after the right of setoff stated in the second
sentence of this subsection has been exercised.
(c) If two banks transmit payment orders to each other under an
agreement that settlement of the obligations of each bank to the other
under Section 36-4A-402 will be made at the end of the day or other
period, the total amount owed with respect to all orders transmitted by
one bank shall be set off against the total amount owed with respect to
all orders transmitted by the other bank. To the extent of the setoff, each
bank has made payment to the other.
(d) In a case not covered by subsection (a), the time when
payment of the sender's obligation under Section 36-4A-402(b) or
36-4A-402(c) occurs is governed by applicable principles of law that
determine when an obligation is satisfied.
OFFICIAL COMMENT
1. This section defines when a sender pays the obligation stated in
Section 4A-402. If a group of two or more banks engage in funds
transfers with each other, the participating banks will sometimes be
senders and sometimes receiving banks. With respect to payment orders
other than Fedwires, the amounts of the various payment orders may be
credited and debited to accounts of one bank with another or to a
clearing house account of each bank and amounts owed and amounts
due are netted. Settlement is made through a Federal Reserve Bank by
charges to the Federal Reserve accounts of the net debtor banks and
credits to the Federal Reserve accounts of the net creditor banks. In the
case of Fedwires the sender's obligation is settled by a debit to the
Federal Reserve account of the sender and a credit to the Federal
Reserve account of the receiving bank at the time the receiving bank
receives the payment order. Both of these cases are covered by
subsection (a)(1). When the Federal Reserve settlement becomes final
the obligation of the sender under Section 4A-402 is paid.
2. In some cases a bank does not settle an obligation owed to another
bank through a Federal Reserve Bank. This is the case if one of the
banks is a foreign bank without access to the Federal Reserve payment
system. In this kind of case, payment is usually made by credits or
debits to accounts of the two banks with each other or to accounts of the
two banks in a third bank. Suppose Bank B has an account in Bank A.
Bank A advises Bank B that its account in Bank A has been credited
$1,000,000 and that the credit is immediately withdrawable. Bank A
also instructs Bank B to pay $1,000,000 to the account of Beneficiary in
Bank B. This case is covered by subsection (a)(2). Bank B may want
to immediately withdraw this credit. For example, it might do so by
instructing Bank A to debit the account and pay some third party.
Payment by Bank A to Bank B of Bank A's payment order occurs when
the withdrawal is made. Suppose Bank B does not withdraw the credit.
Since Bank B is the beneficiary's bank, one of the effects of receipt of
payment by Bank B is that acceptance of Bank A's payment order
automatically occurs at the time of payment. Section 4A-209(b)(2).
Acceptance means that Bank B is obliged to pay $1,000,000 to
Beneficiary. Section 4A-404(a). Subsection (a)(2) of Section 4A-403
states that payment does not occur until midnight if the credit is not
withdrawn. This allows Bank B an opportunity to reject the order if it
does not have time to withdraw the credit to its account and it is not
willing to incur the liability to Beneficiary before it has use of the funds
represented by the credit.
3. Subsection (a)(3) applies to a case in which the sender (bank or
nonbank) has a funded account in the receiving bank. If Sender has an
account in Bank and issues a payment order to Bank, Bank can obtain
payment from Sender by debiting the account of Sender, which pays its
Section 4A-402 obligation to Bank when the debit is made.
4. Subsection (b) deals with multilateral settlements made through
a funds transfer system and is based on the CHIPS settlement system.
In a funds transfer system such as CHIPS, which allows the various
banks that transmit payment orders over the system to settle obligations
at the end of each day, settlement is not based on individual payment
orders. Each bank using the system engages in funds transfers with
many other banks using the system. Settlement for any participant is
based on the net credit or debit position of that participant with all other
banks using the system. Subsection (b) is designed to make clear that
the obligations of any sender are paid when the net position of that
sender is settled in accordance with the rules of the funds transfer
system. This provision is intended to invalidate any argument, based on
common-law principles, that multilateral netting is not valid because
mutuality of obligation is not present. Subsection (b) dispenses with any
mutuality of obligation requirements. Subsection (c) applies to cases in
which two banks send payment orders to each other during the day and
settle with each other at the end of the day or at the end of some other
period. It is similar to subsection (b) in that it recognizes that a sender's
obligation to pay a payment order is satisfied by a setoff. The
obligations of each bank as sender to the other as receiving bank are
obligations of the bank itself and not as representative of customers.
These two sections are important in the case of insolvency of a bank.
They make clear that liability under Section 4A-402 is based on the net
position of the insolvent bank after setoff.
5. Subsection (d) relates to the uncommon case in which the sender
doesn't have an account relationship with the receiving bank and doesn't
settle through a Federal Reserve Bank. An example would be a
customer that pays over the counter for a payment order that the
customer issues to the receiving bank. Payment would normally be by
cash, check or bank obligation. When payment occurs is determined by
law outside Article 4A.
Section 36-4A-404. OBLIGATION OF BENEFICIARY'S BANK
TO PAY AND GIVE NOTICE TO BENEFICIARY.
(a) Subject to Sections 36-4A-211(e), 36-4A-405(d), and
36-4A-405(e), if a beneficiary's bank accepts a payment order, the bank
is obliged to pay the amount of the order to the beneficiary of the order.
Payment is due on the payment date of the order, but if acceptance
occurs on the payment date after the close of the funds-transfer business
day of the bank, payment is due on the next funds-transfer business day.
If the bank refuses to pay after demand by the beneficiary and receipt of
notice of particular circumstances that will give rise to consequential
damages as a result of nonpayment, the beneficiary may recover
damages resulting from the refusal to pay to the extent the bank had
notice of the damages, unless the bank proves that it did not pay because
of a reasonable doubt concerning the right of the beneficiary to payment.
(b) If a payment order accepted by the beneficiary's bank instructs
payment to an account of the beneficiary, the bank is obliged to notify
the beneficiary of receipt of the order before midnight of the next
funds-transfer business day following the payment date. If the payment
order does not instruct payment to an account of the beneficiary, the
bank is required to notify the beneficiary only if notice is required by the
order. Notice may be given by first class mail or any other means
reasonable in the circumstances. If the bank fails to give the required
notice, the bank is obliged to pay interest to the beneficiary on the
amount of the payment order from the day notice should have been
given until the day the beneficiary learned of receipt of the payment
order by the bank. No other damages are recoverable. Reasonable
attorney's fees are also recoverable if demand for interest is made and
refused before an action is brought on the claim.
(c) The right of a beneficiary to receive payment and damages as
stated in subsection (a) may not be varied by agreement or a
funds-transfer system rule. The right of a beneficiary to be notified as
stated in subsection (b) may be varied by agreement of the beneficiary
or by a funds-transfer system rule if the beneficiary is notified of the rule
before initiation of the funds transfer.
OFFICIAL COMMENT
1. The first sentence of subsection (a) states the time when the
obligation of the beneficiary's bank arises. The second and third
sentences state when the beneficiary's bank must make funds available
to the beneficiary. They also state the measure of damages for failure,
after demand, to comply. Since the Expedited Funds Availability Act,
12 U.S.C. 4001 et seq., also governs funds availability in a funds
transfer, the second and third sentences of subsection (a) may be subject
to preemption by that Act.
2. Subsection (a) provides that the beneficiary of an accepted
payment order may recover consequential damages if the beneficiary's
bank refuses to pay the order after demand by the beneficiary if the bank
at that time had notice of the particular circumstances giving rise to the
damages. Such damages are recoverable only to the extent the bank had
"notice of the damages." The quoted phrase requires that the
bank have notice of the general type or nature of the damages that will
be suffered as a result of the refusal to pay and their general magnitude.
There is no requirement that the bank have notice of the exact or even
the approximate amount of the damages, but if the amount of damages
is extraordinary the bank is entitled to notice of that fact. For example,
in Evra Corp. v. Swiss Bank Corp., 673 F.2d 951 (7th Cir.
1982), failure to complete a funds transfer of only $27,000 required to
retain rights to a very favorable ship charter resulted in a claim for more
than $2,000,000 of consequential damages. Since it is not reasonably
foreseeable that a failure to make a relatively small payment will result
in damages of this magnitude, notice is not sufficient if the beneficiary's
bank has notice only that the $27,000 is necessary to retain rights on a
ship charter. The bank is entitled to notice that an exceptional amount
of damages will result as well. For example, there would be adequate
notice if the bank had been made aware that damages of $1,000,000 or
more might result.
3. Under the last clause of subsection (a) the beneficiary's bank is
not liable for damages if its refusal to pay was "because of a
reasonable doubt concerning the right of the beneficiary to
payment." Normally there will not be any question about the right
of the beneficiary to receive payment. Normally, the bank should be
able to determine whether it has accepted the payment order and, if it
has been accepted, the first sentence of subsection (a) states that the
bank is obliged to pay. There may be uncommon cases, however, in
which there is doubt whether acceptance occurred. For example, if
acceptance is based on receipt of payment by the beneficiary's bank
under Section 4A-403 (a)(1) or (2), there may be cases in which the bank
is not certain that payment has been received. There may also be cases
in which there is doubt about whether the person demanding payment is
the person identified in the payment order as beneficiary of the order.
The last clause of subsection (a) does not apply to cases in which a
funds transfer is being used to pay an obligation and a dispute arises
between the originator and the beneficiary concerning whether the
obligation is in fact owed. For example, the originator may try to
prevent payment to the beneficiary by the beneficiary's bank by alleging
that the beneficiary is not entitled to payment because of fraud against
the originator or a breach of contract relating to the obligation. The
fraud or breach of contract claim of the originator may be grounds for
recovery by the originator from the beneficiary after the beneficiary is
paid, but it does not affect the obligation of the beneficiary's bank to pay
the beneficiary. Unless the payment order has been cancelled pursuant
to Section 4A-211(c), there is no excuse for refusing to pay the
beneficiary and, in a proper case, the refusal may result in consequential
damages. Except in the case of a book transfer, in which the
beneficiary's bank is also the originator's bank, the originator of a funds
transfer cannot cancel a payment order to the beneficiary's bank, with or
without the consent of that bank, because the originator is not the sender
of that order. Thus, the beneficiary's bank may safely ignore any
instruction by the originator to withhold payment to the beneficiary.
4. Subsection (b) states the duty of the beneficiary's bank to notify
the beneficiary of receipt of the order. If acceptance occurs under
Section 4A-209(b)(1) the beneficiary is normally notified. Thus,
subsection (b) applies primarily to cases in which acceptance occurs
under Section 4A-209(b)(2) or (3). Notice under subsection (b) is not
required if the person entitled to the notice agrees or a funds transfer
system rule provides that notice is not required and the beneficiary is
given notice of the rule. In ACH transactions the normal practice is not
to give notice to the beneficiary unless notice is requested by the
beneficiary. This practice can be continued by adoption of a funds
transfer system rule. Subsection (a) is not subject to variation by
agreement or by a funds transfer system rule.
Section 36-4A-405. PAYMENT BY BENEFICIARY'S BANK TO
BENEFICIARY.
(a) If the beneficiary's bank credits an account of the beneficiary of
a payment order, payment of the bank's obligation under Section
36-4A-404(a) occurs when and to the extent (i) the beneficiary is
notified of the right to withdraw the credit, (ii) the bank lawfully applies
the credit to a debt of the beneficiary, or (iii) funds with respect to the
order are otherwise made available to the beneficiary by the bank.
(b) If the beneficiary's bank does not credit an account of the
beneficiary of a payment order, the time when payment of the bank's
obligation under Section 36-4A-404(a) occurs is governed by principles
of law that determine when an obligation is satisfied.
(c) Except as stated in subsections (d) and (e), if the beneficiary's
bank pays the beneficiary of a payment order under a condition to
payment or agreement of the beneficiary giving the bank the right to
recover payment from the beneficiary if the bank does not receive
payment of the order, the condition to payment or agreement is not
enforceable.
(d) A funds-transfer system rule may provide that payments made
to beneficiaries of funds transfers made through the system are
provisional until receipt of payment by the beneficiary's bank of the
payment order it accepted. A beneficiary's bank that makes a payment
that is provisional under the rule is entitled to refund from the
beneficiary if (i) the rule requires that both the beneficiary and the
originator be given notice of the provisional nature of the payment
before the funds transfer is initiated, (ii) the beneficiary, the beneficiary's
bank and the originator's bank agreed to be bound by the rule, and (iii)
the beneficiary's bank did not receive payment of the payment order that
it accepted. If the beneficiary is obliged to refund payment to the
beneficiary's bank, acceptance of the payment order by the beneficiary's
bank is nullified and no payment by the originator of the funds transfer
to the beneficiary occurs under Section 36-4A-406.
(e) This subsection applies to a funds transfer that includes a
payment order transmitted over a funds-transfer system that (i) nets
obligations multilaterally among participants, and (ii) has in effect a
loss-sharing agreement among participants for the purpose of providing
funds necessary to complete settlement of the obligations of one or more
participants that do not meet their settlement obligations. If the
beneficiary's bank in the funds transfer accepts a payment order and the
system fails to complete settlement pursuant to its rules with respect to
any payment order in the funds transfer, (i) the acceptance by the
beneficiary's bank is nullified and no person has any right or obligation
based on the acceptance, (ii) the beneficiary's bank is entitled to recover
payment from the beneficiary, (iii) no payment by the originator to the
beneficiary occurs under Section 36-4A-406, and (iv) subject to Section
36-4A-402(e), each sender in the funds transfer is excused from its
obligation to pay its payment order under Section 36-4A-402(c) because
the funds transfer has not been completed.
OFFICIAL COMMENT
1. This section defines when the beneficiary's bank pays the
beneficiary and when the obligation of the beneficiary's bank under
Section 4A-404 to pay the beneficiary is satisfied. In almost all cases
the bank will credit an account of the beneficiary when it receives a
payment order. In the typical case the beneficiary is paid when the
beneficiary is given notice of the right to withdraw the credit.
Subsection (a)(i). In some cases payment might be made to the
beneficiary not by releasing funds to the beneficiary, but by applying the
credit to a debt of the beneficiary. Subsection (a)(ii). In this case the
beneficiary gets the benefit of the payment order because a debt of the
beneficiary has been satisfied. The two principal cases in which
payment will occur in this manner are setoff by the beneficiary's bank
and payment of the proceeds of the payment order to a garnishing
creditor of the beneficiary. These cases are discussed in Comment 2 to
Section 4A-502.
2. If a beneficiary's bank releases funds to the beneficiary before it
receives payment from the sender of the payment order, it assumes the
risk that the sender may not pay the sender's order because of suspension
of payments or other reason. Subsection (c). As stated in Comment 5
to Section 4A-209, the beneficiary's bank can protect itself against this
risk by delaying acceptance. But if the bank accepts the order it is
obliged to pay the beneficiary. If the beneficiary's bank has given the
beneficiary notice of the right to withdraw a credit made to the
beneficiary's account, the beneficiary has received payment from the
bank. Once payment has been made to the beneficiary with respect to
an obligation incurred by the bank under Section 4A-404(a), the
payment cannot be recovered by the beneficiary's bank unless subsection
(d) or (e) applies. Thus, a right to withdraw a credit cannot be revoked
if the right to withdraw constituted payment of the bank's obligation.
This principle applies even if funds were released as a
"loan" (see Comment 5 to Section 4A-209), or were released
subject to a condition that they would be repaid in the event the bank
does not receive payment from the sender of the payment order, or the
beneficiary agreed to return the payment if the bank did not receive
payment from the sender.
3. Subsection (c) is subject to an exception stated in subsection (d)
which is intended to apply to automated clearing house transfers. ACH
transfers are made in batches. A beneficiary's bank will normally
accept, at the same time and as part of a single batch, payment orders
with respect to many different originator's banks. Comment 2 to Section
4A-206. The custom in ACH transactions is to release funds to the
beneficiary early on the payment date even though settlement to the
beneficiary's bank does not occur until later in the day. The
understanding is that payments to beneficiaries are provisional until the
beneficiary's bank receives settlement. This practice is similar to what
happens when a depositary bank releases funds with respect to a check
forwarded for collection. If the check is dishonored the bank is entitled
to recover the funds from the customer. ACH transfers are widely
perceived as check substitutes. Section 4A-405(d) allows the funds
transfer system to adopt a rule making payments to beneficiaries
provisional. If such a rule is adopted, a beneficiary's bank that releases
funds to the beneficiary will be able to recover the payment if it doesn't
receive payment of the payment order that it accepted. There are two
requirements with respect to the funds transfer system rule. The
beneficiary, the beneficiary's bank and the originator's bank must all
agree to be bound by the rule and the rule must require that both the
beneficiary and the originator be given notice of the provisional nature
of the payment before the funds transfer is initiated. There is no
requirement that the notice be given with respect to a particular funds
transfer. Once notice of the provisional nature of the payment has been
given, the notice is effective for all subsequent payments to or from the
person to whom the notice was given. Subsection (d) provides only that
the funds transfer system rule must require notice to the beneficiary and
the originator. The beneficiary's bank will know what the rule requires,
but it has no way of knowing whether the originator's bank complied
with the rule. Subsection (d) does not require proof that the originator
received notice. If the originator's bank failed to give the required notice
and the originator suffered as a result, the appropriate remedy is an
action by the originator against the originator's bank based on that
failure. But the beneficiary's bank will not be able to get the benefit of
subsection (d) unless the beneficiary had notice of the provisional nature
of the payment because subsection (d) requires an agreement by the
beneficiary to be bound by the rule. Implicit in an agreement to be
bound by a rule that makes a payment provisional is a requirement that
notice be given of what the rule provides. The notice can be part of the
agreement or separately given. For example, notice can be given by
providing a copy of the system's operating rules.
With respect to ACH transfers made through a Federal Reserve Bank
acting as an intermediary bank, the Federal Reserve Bank is obliged
under Section 4A-402(b) to pay a beneficiary's bank that accepts the
payment order. Unlike Fedwire transfers, under current ACH practice
a Federal Reserve Bank that processes a payment order does not obligate
itself to pay if the originator's bank fails to pay the Federal Reserve
Bank. It is assumed that the Federal Reserve will use its right of
preemption which is recognized in Section 4A-107 to disclaim the
Section 4A-402(b) obligation in ACH transactions if it decides to retain
the provisional payment rule.
4. Subsection (e) is another exception to subsection (c). It refers to
funds transfer systems having loss-sharing rules described in the
subsection. CHIPS has proposed a rule that fits the description. Under
the CHIPS loss-sharing rule the CHIPS banks will have agreed to
contribute funds to allow the system to settle for payment orders sent
over the system during the day in the event that one or more banks are
unable to meet their settlement obligations. Subsection (e) applies only
if CHIPS fails to settle despite the loss-sharing rule. Since funds under
the loss-sharing rule will be instantly available to CHIPS and will be in
an amount sufficient to cover any failure that can be reasonably
anticipated, it is extremely unlikely that CHIPS would ever fail to settle.
Thus, subsection (e) addresses an event that should never occur. If that
event were to occur, all payment orders made over the system would be
cancelled under the CHIPS rule. Thus, no bank would receive
settlement, whether or not a failed bank was involved in a particular
funds transfer. Subsection (e) provides that each funds transfer in which
there is a payment order with respect to which there is a settlement
failure is unwound. Acceptance by the beneficiary's bank in each funds
transfer is nullified. The consequences of nullification are that the
beneficiary has no right to receive or retain payment by the beneficiary's
bank, no payment is made by the originator to the beneficiary and each
sender in the funds transfer is, subject to Section 4A-402(e), not obliged
to pay its payment order and is entitled to refund under Section
4A-402(d) if it has already paid.
Section 36-4A-406. PAYMENT BY ORIGINATOR TO
BENEFICIARY; DISCHARGE OF UNDERLYING OBLIGATION.
(a) Subject to Sections 36-4A-211(e), 36-4A-405(d), and
36-4A-405(e), the originator of a funds transfer pays the beneficiary of
the originator's payment order (i) at the time a payment order for the
benefit of the beneficiary is accepted by the beneficiary's bank in the
funds transfer and (ii) in an amount equal to the amount of the order
accepted by the beneficiary's bank, but not more than the amount of the
originator's order.
(b) If payment under subsection (a) is made to satisfy an
obligation, the obligation is discharged to the same extent discharge
would result from payment to the beneficiary of the same amount in
money, unless (i) the payment under subsection (a) was made by a
means prohibited by the contract of the beneficiary with respect to the
obligation, (ii) the beneficiary, within a reasonable time after receiving
notice of receipt of the order by the beneficiary's bank, notified the
originator of the beneficiary's refusal of the payment, (iii) funds with
respect to the order were not withdrawn by the beneficiary or applied to
a debt of the beneficiary, and (iv) the beneficiary would suffer a loss that
could reasonably have been avoided if payment had been made by a
means complying with the contract. If payment by the originator does
not result in discharge under this section, the originator is subrogated to
the rights of the beneficiary to receive payment from the beneficiary's
bank under Section 36-4A-404(a).
(c) For the purpose of determining whether discharge of an
obligation occurs under subsection (b), if the beneficiary's bank accepts
a payment order in an amount equal to the amount of the originator's
payment order less charges of one or more receiving banks in the funds
transfer, payment to the beneficiary is considered to be in the amount of
the originator's order unless upon demand by the beneficiary the
originator does not pay the beneficiary the amount of the deducted
charges.
(d) Rights of the originator or of the beneficiary of a funds
transfer under this section may be varied only by agreement of the
originator and the beneficiary.
OFFICIAL COMMENT
1. Subsection (a) states the fundamental rule of Article 4A that
payment by the originator to the beneficiary is accomplished by
providing to the beneficiary the obligation of the beneficiary's bank to
pay. Since this obligation arises when the beneficiary's bank accepts a
payment order, the originator pays the beneficiary at the time of
acceptance and in the amount of the payment order accepted.
2. In a large percentage of funds transfers, the transfer is made to
pay an obligation of the originator. Subsection (a) states that the
beneficiary is paid by the originator when the beneficiary's bank accepts
a payment order for the benefit of the beneficiary. When that happens
the effect under subsection (b) is to substitute the obligation of the
beneficiary's bank for the obligation of the originator. The effect is
similar to that under Article 3 if a cashier's check payable to the
beneficiary had been taken by the beneficiary. Normally, payment by
funds transfer is sought by the beneficiary because it puts money into the
hands of the beneficiary more quickly. As a practical matter the
beneficiary and the originator will nearly always agree to the funds
transfer in advance. Under subsection (b) acceptance by the
beneficiary's bank will result in discharge of the obligation for which
payment was made unless the beneficiary had made a contract with
respect to the obligation which did not permit payment by the means
used. Thus, if there is no contract of the beneficiary with respect to the
means of payment of the obligation, acceptance by the beneficiary's
bank of a payment order to the account of the beneficiary can result in
discharge.
3. Suppose Beneficiary's contract stated that payment of an
obligation owed by Originator was to be made by a cashier's check of
Bank A. Instead, Originator paid by a funds transfer to Beneficiary's
account in Bank B. Bank B accepted a payment order for the benefit of
Beneficiary by immediately notifying Beneficiary that the funds were
available for withdrawal. Before Beneficiary had a reasonable
opportunity to withdraw the funds Bank B suspended payments. Under
the unless clause of subsection (b) Beneficiary is not required to accept
the payment as discharging the obligation owed by Originator to
Beneficiary if Beneficiary's contract means that Beneficiary was not
required to accept payment by wire transfer. Beneficiary could refuse
the funds transfer as payment of the obligation and could resort to rights
under the underlying contract to enforce the obligation. The rationale
is that Originator cannot impose the risk of Bank B's insolvency on
Beneficiary if Beneficiary had specified another means of payment that
did not entail that risk. If Beneficiary is required to accept Originator's
payment, Beneficiary would suffer a loss that would not have occurred
if payment had been made by a cashier's check on Bank A, and Bank A
has not suspended payments. In this case Originator will have to pay
twice. It is obliged to pay the amount of its payment order to the bank
that accepted it and has to pay the obligation it owes to Beneficiary
which has not been discharged. Under the last sentence of subsection
(b) Originator is subrogated to Beneficiary's right to receive payment
from Bank B under Section 4A-404(a).
4. Suppose Beneficiary's contract called for payment by a Fedwire
transfer to Bank B, but the payment order accepted by Bank B was not
a Fedwire transfer. Before the funds were withdrawn by Beneficiary,
Bank B suspended payments. The sender of the payment order to Bank
B paid the amount of the order to Bank B. In this case the payment by
Originator did not comply with Beneficiary's contract, but the
noncompliance did not result in a loss to Beneficiary as required by
subsection (b) (iv). A Fedwire transfer avoids the risk of insolvency of
the sender of the payment order to Bank B, but it does not affect the risk
that Bank B will suspend payments before withdrawal of the funds by
Beneficiary. Thus, the unless clause of subsection (b) is not applicable
and the obligation owed to Beneficiary is discharged.
5. Charges of receiving banks in a funds transfer normally are
nominal in relationship to the amount being paid by the originator to the
beneficiary. Wire transfers are normally agreed to in advance and the
parties may agree concerning how these charges are to be divided
between the parties. Subsection (c) states a rule that applies in the
absence of agreement. In some funds transfers charges of banks that
execute payment orders are collected by deducting the charges from the
amount of the payment order issued by the bank, i.e. the bank issues a
payment order that is slightly less than the amount of the payment order
that is being executed. The process is described in Comment 3 to
Section 4A-302. The result in such a case is that the payment order
accepted by the beneficiary's bank will be slightly less than the amount
of the originator's order. Subsection (c) recognizes the principle that a
beneficiary is entitled to full payment of a debt paid by wire transfer as
a condition to discharge. On the other hand, Subsection (c) prevents a
beneficiary from denying the originator the benefit of the payment by
asserting that discharge did not occur because deduction of bank charges
resulted in less than full payment. The typical case is one in which the
payment is made to exercise a valuable right such as an option which is
unfavorable to the beneficiary. Subsection (c) allows discharge
notwithstanding the deduction unless the originator fails to reimburse
the beneficiary for the deducted charges after demand by the beneficiary.
PART 5
MISCELLANEOUS PROVISIONS
Section 36-4A-501. VARIATION BY AGREEMENT AND
EFFECT OF FUNDS-TRANSFER SYSTEM RULE.
(a) Except as otherwise provided in this chapter, the rights and
obligations of a party to a funds transfer may be varied by agreement of
the affected party.
(b) `Funds-transfer system rule' means a rule of an association of
banks (i) governing transmission of payment orders by means of a
funds-transfer system of the association or rights and obligations with
respect to those orders, or (ii) to the extent the rule governs rights and
obligations between banks that are parties to a funds transfer in which
a Federal Reserve Bank, acting as an intermediary bank, sends a
payment order to the beneficiary's bank. Except as otherwise provided
in this chapter, a funds-transfer system rule governing rights and
obligations between participating banks using the system may be
effective even if the rule conflicts with this chapter and indirectly affects
another party to the funds transfer who does not consent to the rule. A
funds-transfer system rule may also govern rights and obligations of
parties other than participating banks using the system to the extent
stated in Sections 36-4A-404(c), 36-4A-405(d), and 36-4A-507(c).
OFFICIAL COMMENT
1. This section is designed to give some flexibility to Article 4A.
Funds transfer system rules govern rights and obligations between banks
that use the system. They may cover a wide variety of matters such as
form and content of payment orders, security procedures, cancellation
rights and procedures, indemnity rights, compensation rules for delays
in completion of a funds transfer, time and method of settlement, credit
restrictions with respect to senders of payment orders and risk allocation
with respect to suspension of payments by a participating bank. Funds
transfer system rules can be very effective in supplementing the
provisions of Article 4A and in filling gaps that may be present in
Article 4A. To the extent they do not conflict with Article 4A there is
no problem with respect to their effectiveness. In that case they merely
supplement Article 4A. Section 4A-501 goes further. It states that
unless the contrary is stated, funds transfer system rules can override
provisions of Article 4A. Thus, rights and obligations of a sender bank
and a receiving bank with respect to each other can be different from
that stated in Article 4A to the extent a funds transfer system rule
applies. Since funds transfer system rules are defined as those governing
the relationship between participating banks, a rule can have a direct
effect only on participating banks. But a rule that affects the conduct of
a participating bank may indirectly affect the rights of nonparticipants
such as the originator or beneficiary of a funds transfer, and such a rule
can be effective even though it may affect nonparticipants without their
consent. For example, a rule might prevent execution of a payment
order or might allow cancellation of a payment order with the result that
a funds transfer is not completed or is delayed. But a rule purporting to
define rights and obligations of nonparticipants in the system would not
be effective to alter Article 4A rights because the rule is not within the
definition of funds transfer system rule. Rights and obligations arising
under Article 4A may also be varied by agreement of the affected
parties, except to the extent Article 4A otherwise provides. Rights and
obligations arising under Article 4A can also be changed by Federal
Reserve regulations and operating circulars of Federal Reserve Banks.
Section 4A-107.
2. Subsection (b)(ii) refers to ACH transfers. Whether an ACH
transfer is made through an automated clearing house of a Federal
Reserve Bank or through an automated clearing house of another
association of banks, the rights and obligations of the originator's bank
and the beneficiary's bank are governed by uniform rules adopted by
various associations of banks in various parts of the nation. With
respect to transfers in which a Federal Reserve Bank acts as
intermediary bank these rules may be incorporated, in whole or in part,
in operating circulars of the Federal Reserve Bank. Even if not so
incorporated these rules can still be binding on the association banks.
If a transfer is made through a Federal Reserve Bank, the rules are
effective under subsection (b)(ii). If the transfer is not made through a
Federal Reserve Bank, the association rules are effective under
subsection (b)(i).
Section 36-4A-502. CREDITOR PROCESS SERVED ON
RECEIVING BANK; SETOFF BY BENEFICIARY'S BANK.
(a) As used in this section, `creditor process' means levy, attachment,
garnishment, notice of lien, sequestration, or similar process issued by
or on behalf of a creditor or other claimant with respect to an account.
(b) This subsection applies to creditor process with respect to an
authorized account of the sender of a payment order if the creditor
process is served on the receiving bank. For the purpose of determining
rights with respect to the creditor process, if the receiving bank accepts
the payment order the balance in the authorized account is considered to
be reduced by the amount of the payment order to the extent the bank
did not otherwise receive payment of the order, unless the creditor
process is served at a time and in a manner affording the bank a
reasonable opportunity to act on it before the bank accepts the payment
order.
(c) If a beneficiary's bank has received a payment order for payment
to the beneficiary's account in the bank, the following rules apply:
(1) The bank may credit the beneficiary's account. The
amount credited may be set off against an obligation owed by the
beneficiary to the bank or may be applied to satisfy creditor process
served on the bank with respect to the account.
(2) The bank may credit the beneficiary's account and allow
withdrawal of the amount credited unless creditor process with respect
to the account is served at a time and in a manner affording the bank a
reasonable opportunity to act to prevent withdrawal.
(3) If creditor process with respect to the beneficiary's account
has been served and the bank has had a reasonable opportunity to act on
it, the bank may not reject the payment order except for a reason
unrelated to the service of process.
(d) Creditor process with respect to a payment by the originator
to the beneficiary pursuant to a funds transfer may be served only on the
beneficiary's bank with respect to the debt owed by that bank to the
beneficiary. Any other bank served with the creditor process is not
obliged to act with respect to the process.
OFFICIAL COMMENT
1. When a receiving bank accepts a payment order, the bank
normally receives payment from the sender by debiting an authorized
account of the sender. In accepting the sender's order the bank may be
relying on a credit balance in the account. If creditor process is served
on the bank with respect to the account before the bank accepts the order
but the bank employee responsible for the acceptance was not aware of
the creditor process at the time the acceptance occurred, it is unjust to
the bank to allow the creditor process to take the credit balance on which
the bank may have relied. Subsection (b) allows the bank to obtain
payment from the sender's account in this case. Under that provision,
the balance in the sender's account to which the creditor process applies
is deemed to be reduced by the amount of the payment order unless there
was sufficient time for notice of the service of creditor process to be
received by personnel of the bank responsible for the acceptance.
2. Subsection (c) deals with payment orders issued to the
beneficiary's bank. The bank may credit the beneficiary's account when
the order is received, but under Section 4A-404(a) the bank incurs no
obligation to pay the beneficiary until the order is accepted pursuant to
Section 4A-209(b). Thus, before acceptance, the credit to the
beneficiary's account is provisional. But under Section 4A-209(b)
acceptance occurs if the beneficiary's bank pays the beneficiary pursuant
to Section 4A-405(a). Under that provision, payment occurs if the credit
to the beneficiary's account is applied to a debt of the beneficiary.
Subsection (c)(1) allows the bank to credit the beneficiary's account with
respect to a payment order and to accept the order by setting off the
credit against an obligation owed to the bank or applying the credit to
creditor process with respect to the account.
Suppose a beneficiary's bank receives a payment order for the benefit
of a customer. Before the bank accepts the order, the bank learns that
creditor process has been served on the bank with respect to the
customer's account. Normally there is no reason for a beneficiary's bank
to reject a payment order, but if the beneficiary's account is garnished,
the bank may be faced with a difficult choice. If it rejects the order, the
garnishing creditor's potential recovery of funds of the beneficiary is
frustrated. It may be faced with a claim by the creditor that the rejection
was a wrong to the creditor. If the bank accepts the order, the effect is
to allow the creditor to seize funds of its customer, the beneficiary.
Subsection (c)(3) gives the bank no choice in this case. It provides that
it may not favor its customer over the creditor by rejecting the order.
The beneficiary's bank may rightfully reject only if there is an
independent basis for rejection.
3. Subsection (c)(2) is similar to subsection (b). Normally the
beneficiary's bank will release funds to the beneficiary shortly after
acceptance or it will accept by releasing funds. Since the bank is bound
by a garnishment order served before funds are released to the
beneficiary, the bank might suffer a loss if funds were released without
knowledge that a garnishment order had been served. Subsection (c)(2)
protects the bank if it did not have adequate notice of the garnishment
when the funds were released.
4. A creditor may want to reach funds involved in a funds transfer.
The creditor may try to do so by serving process on the originator's
bank, an intermediary bank or the beneficiary's bank. The purpose of
subsection (d) is to guide the creditor and the court as to the proper
method of reaching the funds involved in a funds transfer. A creditor of
the originator can levy on the account of the originator in the originator's
bank before the funds transfer is initiated, but that levy is subject to the
limitations stated in subsection (b). The creditor of the originator cannot
reach any other funds because no property of the originator is being
transferred. A creditor of the beneficiary cannot levy on property of the
originator and until the funds transfer is completed by acceptance by the
beneficiary's bank of a payment order for the benefit of the beneficiary,
the beneficiary has no property interest in the funds transfer which the
beneficiary's creditor can reach. A creditor of the beneficiary that wants
to reach the funds to be received by the beneficiary must serve creditor
process on the beneficiary's bank to reach the obligation of the
beneficiary's bank to pay the beneficiary which arises upon acceptance
by the beneficiary's bank under Section 4A-404(a).
5. "Creditor process" is defined in subsection (a) to
cover a variety of devices by which a creditor of the holder of a bank
account or a claimant to a bank account can seize the account.
Procedure and nomenclature varies widely from state to state. The term
used in Section 4A-502 is a generic term.
Section 36-4A-503. INJUNCTION OR RESTRAINING ORDER
WITH RESPECT TO FUNDS TRANSFER.
For proper cause and in compliance with applicable law, a court may
restrain (i) a person from issuing a payment order to initiate a funds
transfer, (ii) an originator's bank from executing the payment order of
the originator, or (iii) the beneficiary's bank from releasing funds to the
beneficiary or the beneficiary from withdrawing the funds. A court may
not otherwise restrain a person from issuing a payment order, paying or
receiving payment of a payment order, or otherwise acting with respect
to a funds transfer.
OFFICIAL COMMENT
This section is related to Section 4A-502(d) and to Comment 4 to
Section 4A-502. It is designed to prevent interruption of a funds transfer
after it has been set in motion. The initiation of a funds transfer can be
prevented by enjoining the originator or the originator's bank from
issuing a payment order. After the funds transfer is completed by
acceptance of a payment order by the beneficiary's bank, that bank can
be enjoined from releasing funds to the beneficiary or the beneficiary
can be enjoined from withdrawing the funds. No other injunction is
permitted. In particular, intermediary banks are protected, and
injunctions against the originator and the originator's bank are limited to
issuance of a payment order. Except for the beneficiary's bank, nobody
can be enjoined from paying a payment order, and no receiving bank can
be enjoined from receiving payment from the sender of the order that it
accepted.
Section 36-4A-504. ORDER IN WHICH ITEMS AND PAYMENT
ORDERS MAY BE CHARGED TO ACCOUNT; ORDER OF
WITHDRAWALS FROM ACCOUNT.
(a) If a receiving bank has received more than one payment order of
the sender or one or more payment orders and other items that are
payable from the sender's account, the bank may charge the sender's
account with respect to the various orders and items in any sequence.
(b) In determining whether a credit to an account has been
withdrawn by the holder of the account or applied to a debt of the holder
of the account, credits first made to the account are first withdrawn or
applied.
OFFICIAL COMMENT
Subsection (a) concerns priority among various obligations that are
to be paid from the same account. A customer may have written checks
on its account with the receiving bank and may have issued one or more
payment orders payable from the same account. If the account balance
is not sufficient to cover all of the checks and payment orders, some
checks may be dishonored and some payment orders may not be
accepted. Although there is no concept of wrongful dishonor of a
payment order in Article 4A in the absence of an agreement to honor by
the receiving bank, some rights and obligations may depend on the
amount in the customer's account. Section 4A-209(b)(3) and Section
4A-210(b). Whether dishonor of a check is wrongful also may depend
upon the balance in the customer's account. Under subsection (a), the
bank is not required to consider the competing items and payment orders
in any particular order. Rather it may charge the customer's account for
the various items and orders in any order. Suppose there is $12,000 in
the customer's account. If a check for $5,000 is presented for payment
and the bank receives a $10,000 payment order from the customer, the
bank could dishonor the check and accept the payment order. Dishonor
of the check is not wrongful because the account balance was less than
the amount of the check after the bank charged the account $10,000 on
account of the payment order. Or, the bank could pay the check and not
execute the payment order because the amount of the order is not
covered by the balance in the account.
Section 36-4A-505. PRECLUSION OF OBJECTION TO DEBIT
OF CUSTOMER'S ACCOUNT.
If a receiving bank has received payment from its customer with
respect to a payment order issued in the name of the customer as sender
and accepted by the bank, and the customer received notification
reasonably identifying the order, the customer is precluded from
asserting that the bank is not entitled to retain the payment unless the
customer notifies the bank of the customer's objection to the payment
within one year after the notification was received by the customer.
OFFICIAL COMMENT
This section is in the nature of a statute of repose for objecting to
debits made to the customer's account. A receiving bank that executes
payment orders of a customer may have received payment from the
customer by debiting the customer's account with respect to a payment
order that the customer was not required to pay. For example, the
payment order may not have been authorized or verified pursuant to
Section 4A-202 or the funds transfer may not have been completed. In
either case the receiving bank is obliged to refund the payment to the
customer and this obligation to refund payment cannot be varied by
agreement. Section 4A-204 and Section 4A-402. Refund may also be
required if the receiving bank is not entitled to payment from the
customer because the bank erroneously executed a payment order.
Section 4A-303. A similar analysis applies to that case. Section
4A-402(d) and (f) require refund and the obligation to refund may not
be varied by agreement. Under 4A-505, however, the obligation to
refund may not be asserted by the customer if the customer has not
objected to the debiting of the account within one year after the
customer received notification of the debit.
Section 36-4A-506. RATE OF INTEREST.
(a) If, under this chapter, a receiving bank is obliged to pay interest
with respect to a payment order issued to the bank, the amount payable
may be determined (i) by agreement of the sender and receiving bank,
or (ii) by a funds-transfer system rule if the payment order is transmitted
through a funds-transfer system.
(b) If the amount of interest is not determined by an agreement or
rule as stated in subsection (a), the amount is calculated by multiplying
the applicable Federal Funds rate by the amount on which interest is
payable, and then multiplying the product by the number of days for
which interest is payable. The applicable Federal Funds rate is the
average of the Federal Funds rates published by the Federal Reserve
Bank of New York for each of the days for which interest is payable
divided by three hundred sixty. The Federal Funds rate for any day on
which a published rate is not available is the same as the published rate
for the next preceding day for which there is a published rate. If a
receiving bank that accepted a payment order is required to refund
payment to the sender of the order because the funds transfer was not
completed, but the failure to complete was not due to any fault by the
bank, the interest payable is reduced by a percentage equal to the reserve
requirement on deposits of the receiving bank.
OFFICIAL COMMENT
1. A receiving bank is required to pay interest on the amount of a
payment order received by the bank in a number of situations.
Sometimes the interest is payable to the sender and in other cases it is
payable to either the originator or the beneficiary of the funds transfer.
The relevant provisions are Section 4A-204(a), Section 4A-209(b) (3),
Section 4A-210(b), Section 4A-305(a), Section 4A-402(d) and Section
4A-404(b). The rate of interest may be governed by a funds transfer
system rule or by agreement as stated in subsection (a). If subsection (a)
doesn't apply, the rate is determined under subsection (b). Subsection
(b) is illustrated by the following example. A bank is obliged to pay
interest on $1,000,000 for three days, July 3, July 4, and July 5. The
published Fed Funds rate is .082 for July 3 and .081 for July 5. There
is no published rate for July 4 because that day is not a banking day.
The rate for July 3 applies to July 4. The applicable Fed Funds rate is
.08167 (the average of .082, .082, and .081) divided by 360 which
equals .0002268. The amount of interest payable is $1,000,000 X
.0002268 X 3 = $680.40.
2. In some cases, interest is payable in spite of the fact that there is
no fault by the receiving bank. The last sentence of subsection (b)
applies to those cases. For example, a funds transfer might not be
completed because the beneficiary's bank rejected the payment order
issued to it by the originator's bank or an intermediary bank. Section
4A-402(c) provides that the originator is not obliged to pay its payment
order and Section 4A-402(d) provides that the originator's bank must
refund any payment received plus interest. The requirement to pay
interest in this case is not based on fault by the originator's bank.
Rather, it is based on restitution. Since the originator's bank had the use
of the originator's money, it is required to pay the originator for the
value of that use. The value of that use is not determined by multiplying
the interest rate by the refundable amount because the originator's bank
is required to deposit with the Federal Reserve a percentage of the bank's
deposits as a reserve requirement. Since that deposit does not bear
interest, the bank had use of the refundable amount reduced by a
percentage equal to the reserve requirement. If the reserve requirement
is 12%, the amount of interest payable by the bank under the formula
stated in subsection (b) is reduced by 12%.
Section 36-4A-507. CHOICE OF LAW.
(a) The following rules apply unless the affected parties otherwise
agree or subsection (c) applies:
(1) The rights and obligations between the sender of a
payment order and the receiving bank are governed by the law of the
jurisdiction in which the receiving bank is located.
(2) The rights and obligations between the beneficiary's bank
and the beneficiary are governed by the law of the jurisdiction in which
the beneficiary's bank is located.
(3) The issue of when payment is made pursuant to a funds
transfer by the originator to the beneficiary is governed by the law of the
jurisdiction in which the beneficiary's bank is located.
(b) If the parties described in each paragraph of subsection (a)
have made an agreement selecting the law of a particular jurisdiction to
govern rights and obligations between each other, the law of that
jurisdiction governs those rights and obligations, whether or not the
payment order or the funds transfer bears a reasonable relation to that
jurisdiction.
(c) A funds-transfer system rule may select the law of a particular
jurisdiction to govern (i) rights and obligations between participating
banks with respect to payment orders transmitted or processed through
the system, or (ii) the rights and obligations of some or all parties to a
funds transfer any part of which is carried out by means of the system.
A choice of law made pursuant to clause (i) is binding on participating
banks. A choice of law made pursuant to clause (ii) is binding on the
originator, other sender, or a receiving bank having notice that the
funds-transfer system might be used in the funds transfer and of the
choice of law by the system when the originator, other sender, or
receiving bank issued or accepted a payment order. The beneficiary of
a funds transfer is bound by the choice of law if, when the funds transfer
is initiated, the beneficiary has notice that the funds-transfer system
might be used in the funds transfer and of the choice of law by the
system. The law of a jurisdiction selected pursuant to this subsection
may govern, whether or not that law bears a reasonable relation to the
matter in issue.
(d) In the event of inconsistency between an agreement under
subsection (b) and a choice-of-law rule under subsection (c), the
agreement under subsection (b) prevails.
(e) If a funds transfer is made by use of more than one funds-transfer
system and there is inconsistency between choice-of-law rules of the
systems, the matter in issue is governed by the law of the selected
jurisdiction that has the most significant relationship to the matter in
issue."
OFFICIAL COMMENT
1. Funds transfers are typically interstate or international in
character. If part of a funds transfer is governed by Article 4A and
another part is governed by other law, the rights and obligations of
parties to the funds transfer may be unclear because there is no clear
consensus in various jurisdictions concerning the juridical nature of the
transaction. Unless all of a funds transfer is governed by a single law it
may be very difficult to predict the result if something goes wrong in the
transfer. Section 4A-507 deals with this problem. Subsection (b) allows
parties to a funds transfer to make a choice-of-law agreement.
Subsection (c) allows a funds transfer system to select the law of a
particular jurisdiction to govern funds transfers carried out by means of
the system. Subsection (a) states residual rules if no choice of law has
occurred under subsection (b) or subsection (c).
2. Subsection (a) deals with three sets of relationships. Rights and
obligations between the sender of a payment order and the receiving
bank are governed by the law of the jurisdiction in which the receiving
bank is located. If the receiving bank is the beneficiary's bank the rights
and obligations of the beneficiary are also governed by the law of the
jurisdiction in which the receiving bank is located. Suppose Originator,
located in Canada, sends a payment order to Originator's Bank located
in a state in which Article 4A has been enacted. The order is for
payment to an account of Beneficiary in a bank in England. Under
subsection (a)(1), the rights and obligations of Originator and
Originator's Bank toward each other are governed by Article 4A if an
action is brought in a court in the Article 4A state. If an action is
brought in a Canadian court, the conflict of laws issue will be
determined by Canadian law which might or might not apply the law of
the state in which Originator's Bank is located. If that law is applied, the
execution of Originator's order will be governed by Article 4A, but with
respect to the payment order of Originator's Bank to the English bank,
Article 4A may or may not be applied with respect to the rights and
obligations between the two banks. The result may depend upon
whether action is brought in a court in the state in which Originator's
Bank is located or in an English court. Article 4A is binding only on a
court in a state that enacts it. It can have extraterritorial effect only to
the extent courts of another jurisdiction are willing to apply it.
Subsection (c) also bears on the issues discussed in this Comment.
Under Section 4A-406 payment by the originator to the beneficiary
of the funds transfer occurs when the beneficiary's bank accepts a
payment order for the benefit of the beneficiary. A jurisdiction in which
Article 4A is not in effect may follow a different rule or it may not have
a clear rule. Under Section 4A-507(a)(3) the issue is governed by the
law of the jurisdiction in which the beneficiary's bank is located. Since
the payment to the beneficiary is made through the beneficiary's bank it
is reasonable that the issue of when payment occurs be governed by the
law of the jurisdiction in which the bank is located. Since it is difficult
in many cases to determine where a beneficiary is located, the location
of the beneficiary's bank provides a more certain rule.
3. Subsection (b) deals with choice-of-law agreements and it gives
maximum freedom of choice. Since the law of funds transfers is not
highly developed in the case law there may be a strong incentive to
choose the law of a jurisdiction in which Article 4A is in effect because
it provides a greater degree of certainly with respect to the rights of
various parties. With respect to commercial transactions, it is often said
that "[u]niformity and predictability based upon commercial
convenience are the prime considerations in making the choice of
governing law . . . ." R. Leflar, American Conflicts Law,
Section 185 (1977). Subsection (b) is derived in part from recently
enacted choice-of-law rules in the States of New York and California.
N.Y. Gen. Obligations Law 5-1401 (McKinney's 1989 Supp.) and
California Civil Code Section 1646.5. This broad endorsement of
freedom of contract is an enhancement of the approach taken by
Restatement (Second) of Conflict of Laws Section 187(b) (1971). The
Restatement recognizes the basic right of freedom of contract, but the
freedom granted the parties may be more limited than the freedom
granted here. Under the formulation of the Restatement, if there is no
substantial relationship to the jurisdiction whose law is selected and
there is no "other" reasonable basis for the parties' choice,
then the selection of the parties need not be honored by a court. Further,
if the choice is violative of a fundamental policy of a state which has a
materially greater interest than the chosen state, the selection could be
disregarded by a court. Those limitations are not found in subsection
(b).
4. Subsection (c) may be the most important provision in regard to
creating uniformity of law in funds transfers. Most rights stated in
Article 4A regard parties who are in privity of contract such as
originator and beneficiary, sender and receiving bank, and beneficiary's
bank and beneficiary. Since they are in privity they can make a choice
of law by agreement. But that is not always the case. For example, an
intermediary bank that improperly executes a payment order is not in
privity with either the originator or the beneficiary. The ability of a
funds transfer system to make a choice of law by rule is a convenient
way of dispensing with individual agreements and to cover cases in
which agreements are not feasible. It is probable that funds transfer
systems will adopt a governing law to increase the certainty of
commercial transactions that are effected over such systems. A system
rule might adopt the law of an Article 4A state to govern transfers on the
system in order to provide a consistent, unitary, law governing all
transfers made on the system. To the extent such system rules develop,
individual choice-of-law agreements become unnecessary.
Subsection (c) has broad application. A system choice of law applies
not only to rights and obligations between banks that use the system, but
may also apply to other parties to the funds transfer so long as some part
of the transfer was carried out over the system. The originator and any
other sender or receiving bank in the funds transfer is bound if at the
time it issues or accepts a payment order it had notice that the funds
transfer involved use of the system and that the system chose the law of
a particular jurisdiction. Under Section 4A-107, the Federal Reserve by
regulation could make a similar choice of law to govern funds transfers
carried out by use of Federal Reserve Banks. Subsection (d) is a
limitation on subsection (c). If parties have made a choice-of-law
agreement that conflicts with a choice of law made under subsection (c),
the agreement prevails.
5. Subsection (e) addresses the case in which a funds transfer
involves more than one funds transfer system and the systems adopt
conflicting choice-of-law rules. The rule that has the most significant
relationship to the matter at issue prevails. For example, each system
should be able to make a choice of law governing payment orders
transmitted over that system without regard to a choice of law made by
another system.
SECTION 6. This act takes effect upon approval by the Governor.
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