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- W156943222 abstract "Is your collateral worth the paper it is? Financial instruments used as collateral may not be so valuable to lenders if they carry variable rates Variable-interest-rate provisions for financial instruments more realistically reflect the cost of money in credit transactions. However, an unintended effect of such provisions may be to increase lenders' risk when those instruments serve as loan collateral. The majority of recent decisions have held that variable-rate instruments are not negotiable under Article 3 of the Uniform Commercial Code. This in turn prevents the application of Article 3 to variable-rate instruments, which leads to three problems for lenders: (1) They are precluded from being or obtaining the rights of a holder in due course. (2) They lose certain procedural advantages provided by Article 3. (3) Their rights, and the rights of other parties involved in the transaction, are subject to significant uncertainty. Thus, there is much more risk associated with variable-rate instruments securing loans. Holder status. The greatest increase in risk arises because of the prevailing view that no one can be a holder in due course of such instruments. Status as a holder in due course is important because it provides insulation from most defenses that the entity obligated to pay the instrument may have. For example, assume a computer manufacturer sells on credit, taking 20% cash and a promissory note for the balance. In addition, assume that the manufacturer finances its operations by borrowing from a commercial bank and pledging its buyers' promissory notes as collateral. The primary risk associated with such collateral is when the party obligated to pay the instrument has a valid defense to payment. The most common defenses to payment arise in connection with the underlying transaction--in this case, the sales of computers that the promissory notes were signed for. To illustrate, consider the preceding example. The computer manufacturer may deliver the incorrect number of computers, the wrong model, inferior machines, or no machines at all. Any of these possibilities will give the buyer a valid defense to the manufacturer's demand for payment of the buyer's promissory note. Moreover, unless he has waived his right to do so, the buyer can assert his defenses against anyone to whom the manufacturer assigns or pledges the note--except a holder in due course. That is, even if the buyer has a valid defense against the computer manufacturer, if the computer manufacturer assigns the promissory note to the bank and the bank is a holder in due course, the buyer must pay the bank. He can sue the computer manufacturer separately. For example, assume that one of the computer manufacturer's sales was to A Corp. and that the manufacturer delivers A's note to the bank as collateral. Further assume that the machine delivered to A is defective. If the manufacturer defaults on its loan and the bank seeks to enforce A's note, the bank will be successful if it is a holder in due course. But if the bank is not a holder in due course because A's note contains a variable interest rate, the bank will not recover if A Corp.'s defense is upheld. Most banks that take financial instruments as collateral are not directly involved in the transactions underlying the instruments. They have no easy way to determine independently the enforceability of the underlying transactions. An important purpose of the Uniform Commercial Code's Article 3 was to minimize such risk by having the lender become a holder in due course. However, the code applies to negotiable instruments. Because it is not possible to be a holder in due course of a nonnegotiable instrument, lack of knowledge concerning the underlying transaction by a bank that takes nonnegotiable instruments as collateral exposes the bank to a significant unpredictable risk. …" @default.
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- W156943222 date "1989-02-01" @default.
- W156943222 modified "2023-09-23" @default.
- W156943222 title "Is Your Collateral Worth the Paper It Is" @default.
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