ADVERSE CLAIMS UNDER THE UNIFORM COMMERCIAL

CODE: A SURVEY AND PROPOSALS*

THE "adverse claim" situation presents problems as vexing as any encoun-
tered in the law of commercial paper.' The participants in this recurring situa-
tion are three: the payor, the claimant and the holder. The party against whom
claims are asserted is the payor, who owes a duty of performance to the holder
of a negotiable instrument. The performance owed may be the payment of
money, registration of securities or delivery of goods. Before the holder pre-
sents the instrument to the payor, an adverse claimant informs the payor that
he claims a right to the performance owed which is superior to the right of the
holder. The payor is generally a disinterested stakeholder: he concedes that a
performance is due, and insists only that no more than one of the parties is
entitled to it. The claimant, who may or may not be a party to the instrument,
typically bases his claim to the instrument or its proceeds on such allegations
as theft, mistake, fraud, or breach of fiduciary duty.2 The holder may contest
the claim by denying the claimant's allegations or by asserting that, whether
or not the allegations are true, he is a good faith purchaser who holds the in-
strument free of claims. 3
The draftsmen of the Uniform Commercial Code have attempted to deal
with variations of the adverse claim problem in their institutional settings.
Accordingly, the solution dictated by the Code in particular instances may de-

*AIMIERICAN LAW INSTITUTE & NATIONAL CONFERENCE OF COMIISSIONERS ON UNIFORM

STrATE LAWS, UNIFORM COMMERCIAL CODE (hereinafter cited as U.C.C.). Unless otherwise
stated, references are to the 1952 text and comments edition as finally approved in 1953.
Previous tentative drafts will be cited to the month and year (e.g., U.C.C. (May 1949)).
Amendments recommended by the Enlarged Editorial Board of the Code were printed
in SUPPLEMENT No. 1, UNIFORM COMMERCIAL CODE (1955) (hereinafter cited as 1955
Suep.). The Supplement also contains recommendations and replies to criticisms of the
various subcommittees. 1955 Supp. 89-189.
The 1952 draft of the Uniform Commercial Code has been adopted in Pennsylvania.
PA. STAT. ANN. tit. 12A, §§ 1-101-10-104 (1954). As amended, it is being considered
by the legislatures of many other states. The New York Law Revision Commission, after
extended study of each article of the Code, has recently recommended that the New
York Legislature not adopt the Code in its present form. N.Y. Times, March 12, 1956, p. 35,
col. 6.
1. While adverse claims may arise to property or choses in action which are not
repres ented by negotiable instruments or documents of title, these claims are not within
the scope of this comment.
2. The claimant may be the true owner of stolen goods. When he makes his claim,
it is as legal owner; theft vests no legal title in the transferee. See U.C.C. § 7-503(1).
On the other hand, the claimant may be a former holder or indorser of the instrument
claiming an equitable interest in it on the ground that it was improperly taken from him.
For a catalogue of the different situations in which equities of ownership may arise see
BRITTON, BILLS AND NOTES § 155 (1943) (hereinafter cited as BRInroN).
3. The "bona tide" holder or holder "in due course" is of course permitted by his
bona tides and the needs of commercial fluidity to take free of almost all the equities of
 THE YALE LAW JOURNAL [Vol. 65 :807

pend on whether the stakeholder is the payor of a negotiable instrument under

Article 3,4 the drawee bank in a checking transaction within the scope of
Article 4,5 the transfer agent of investment securities under Article 8,G the
issuer of a letter of credit under the provisions of Article 5,7 or a warehouse-
man or carrier governed by Article 7.9 But while solutions vary with institu-
tional settings, they all deal with the same basic policy conflict.) Each of the
Code's solutions to particular adverse claim problems thus represents a com-
promise between (1) the desire to maintain honesty in transactions involving
commercial paper; (2) the policy of facilitating the use and negotiation of
commercial paper: and (3) the need to avoid undue disruption of the flow of
commercial transactions. In the adverse claim situation, these policies are in-
voked primarily by the claimant, the holder and the stakeholder, respectively.
The claimant demands an opportunity to assert his equities against the
holder; and, more than this, to assert his equities before the holder has dis-
sipated the proceeds or the goods represented by the instrument. His claim
is supported by the need to maintain honesty, an objective in both commercial
and noncommercial transactions. However, only in the latter context is this
goal untempered by competing demands. In the business context the need for
honesty is no less urgent, but must be reconciled with the dictates of commer-
cial expediency and ease of negotiability.'
The holder, in demanding immediate payment, asserts the community's in-
terest in facilitating the use of commercial paper. Supporting his claim is the
well established premise that commercial transactions would be seriously im-
peded unless the law minimized the risks involved in the purchase and transfer
of negotiable instruments. Those sections of the Code which set out the rights

ownership. See, generally, Gilmore, The Commercial Doctrine of Good Faith Purchase,
63 YALE LJ. 1057 (1954).
4. Article 3 replaces the UNIORM NEGOTIABLE INSTRUMENTS LAW (hereinafter cited
as N.I.L.), which is now in force in every state except Pennsylvania. See U.C.C. § 3-101,
comment; pp. 810-16 infra.
5. Article 4 contains the bank collection provisions of the Code, which take priority
over inconsistent provisions in Article 3. U.C.C. § 4-102(1). See pp. 816-29 infra.
6. Article 8 deals with investment securities, presently covered by the N.I.L. and
the UNIFORM STOCK TRANSFER Acr (hereinafter cited as U.S.T.A.). U.C.C. § 8-101, com-
ment. See pp. 829-33 infra.
7. U.C.C. §§ 5-103(1) (a), (b), (c). See pp. 833-39 infra.
S. Article 7 replaces the UNIFORM WAREHOUSE REcE I's ACT, the UNI01u BILLS
OF LADING AcT and relevant provisions of the UNIFORM SALs AcT. U.C.C. § 7-101, com-
ment. See pp. 839-44 infra.
9. The code is largely predicated on the principle that a unifying theme underlies much
of commercial law. See U.C.C., comment pp. 2, 7; Leary, Article 4: Bank Deposits and
!Collections Under the Uniform Commercial Code, 15 U. PITT. L. RE. 565 (1954);
Littleton, Article 7: Documents of Title, 15 id. at 595; Llewellyn, Why a Commercial
Code? 22 TENN. L. REv. 779 (1953).
10. See TEXAS LEGISLATIVE COUNCIL, ANALySIS OF ARTICLE 7 OF THE UNIFORM COM-
MERCIAL CODE 141-42 (1952) ; Britton, Holder in Due Course, 49 Nw. U.L. REV. 417, 418
(1954) ; Strahorn, The Policy or Function of the Law of Bills and Notes, 87 U. P,%. L. REv.
662-63 (1939).
1956] ADVERSE CLAIMS

of the bona fide purchaser expressly recognize this policy," which has grown
in importance throughout the history of the commercial law. 12 Traditionally,
this policy is implemented by allowing the holder in due course to take free of
most defenses and claims, 13 and by according to the holder's claim substantial
presumptions of validity.' 4 But in the adverse claim situation, the holder may
well demand more. As presumptive owner, he should be entitled to payment
unless his adversary initiates legal action and persuades a court of the validity
of his claim. The holder certainly cannot demand immunity from legal action,
but he may well ask that the mere assertion of an adverse claim should not
shift to him the burden of initiating litigation to obtain payment.
The stakeholder's dilemma is perhaps the most familiar aspect of the adverse
claim situation. The stakeholder ordinarily has no direct interest in the claim-
ant-holder dispute; he wants only to render the promised performance and
thereupon to obtain a discharge, leaving the disputants to settle their contro-
versy between themselves. To satisfy these reasonable demands is to preserve
intact the normal flow of commercial transactions, and to avoid imposing on
a neutral party the vexation and expense of a controversy in which he has no
real concern. Yet the stakeholder's demands are not always met. The claim-
ant's natural adversary, the holder, is often unknown or beyond the reach of
service of process, so that the claim must be made effective, if at all, through
the stakeholder, before the holder presents the instrument for payment., 6 But
11. See U.C.C. §§ 2-403 (purchase of goods), 3-305 (holder in due course of com-
mercial paper), 4-209 (bank as holder in due course), 5-111(1) (holder in due course
under letter of credit), 7-502 (rights upon due negotiation of document of title), 8-301 (2)
(bona fide purchaser of investment security).
12. The development of the law is dramatically described by Gilmore, supra note 3.
13. See, e.g., U.C.C. sections cited at note 11 supra. Section 3-305(2) states the so-
called "real" defenses to which a holder in due course is subject. A discussion of defenses
and claims in commercial paper is found in Britton, Defenses, Clahns of Ownership and
Equities-A Comparison of the Negotiable Instruments Law with CorrespondingProvisions
of Article 3 of the Proposed Commercial Code, 7 HASTIrNGs L.J. 1 (1955.).
14. For a discussion of substantive and procedural advantages awarded the holder of
negotiable instruments, see Strahorn, supra note 10, at 664-80. Procedurally, the holder of
a negotiable instrument is presumed prima facie to be a holder in due course. N.I.L. § 59;
U.C.C. § 3-307(3).
15. See, e.g., Merrill, Bankers' Liability for Deposits of a Fiduciary to His Personal
Account, 40 HARV. L. Rv. 1077, 1091-1109 (1927). See also Empire Trust Co. v. Cahan,
274 U.S. 473 (1926). In the Cahan case a fiduciary had transferred trust funds to his
personal account with the bank. The Second Circuit had held that the transfer imported
notice to the bank of the fiduciary's intended misappropriation. Judge Hough phrased the
issue as a choice between "business convenience and expedition, a liking for that which is
'practicable,' rather than that which is burdensomely altruistic," and "a desire to yield
that measure of assistance which the law increasingly attempts to give to the victims
of misplaced confidence." Cahan v. Empire Trust Co., 9 F.2d 713, 719 (2d Cir. 1926). The
Supreme Court reversed. Justice Holmes adopted the view expressed by Judge Cardozo
in Whiting v. Hudson Trust Co., 234 N.Y. 394, 406, 138 N.E. 33, 37 (1923) : "The trans-
actions of banking in a great financial center are not to be clogged, and their pace slackened,
by overburdensome restrictions."
16. See text at notes 20 (commercial paper), 72 (checks), 91 (bank deposits), 108
(fiduciary funds) and 125 (stock transfer) infra.
 THE YALE LAW JOURNAL [Vol. 65: 807

the role which the stakeholder must play in this controversy should be minimal:
he is in no position to resolve the dispute, and the possibility of double lia-
7
bility or vexation which present law often imposes is usually unjustifiable.'
In some instances, concededly, automatic discharge is undesirable. Certain
losses are inherent in the use of negotiable instruments, and consequently
should be allocated to the stakeholder because he is best able to insure against
them and to distribute the cost over the segment of the community that utilizes
his services.' s But absolute liability of this type should not be imposed on a
stakeholder if the risk involved is not properly attributable to the type of com-
mercial enterprise involved, 19 or if the stakeholder's attempts to prevent lia-
bility by more careful inquiry would entail inordinate and cumbersome delays.
The success of the adverse claim provisions of the Code depends on the ex-
tent to which they reconcile the conflicting interests of the parties and the
exigencies of the institutional practices involved. Solutions proposed by the
applicable articles of the Code will be examined in the light of the general con-
siderations discussed above, with detailed discussion of the problems peculiar
to each.

ARTICLE 3: COMMERCIAL PAPER-THE KEYSTONE PROVISION

In the classical adverse claim situation A issues a note to B who indorses it
to C. C either transfers to D or presents the note himself. Before present-
ment, however, B notifies A that the transfer to C is legally inoperative, and
that he still retains a claim to the instrument.
Under existing law, although the dispute is between B and C (or D), the
burden of resolving it is often placed on A. Section 119 of the Negotiable In-
struments Law discharges A from liability on the instrument only upon pay-
ment "in due course," and under section 88, payment in due course must be
in good faith and without notice of a defect in the holder's title. 20 Thus, if B's

17. It should be noted that proper solicitude for the needs of modern commerce
does not require condoning dishonesty. The allegedly defrauded claimant must not be
left without a remedy. The only question is whether that remedy should be pursued by
interrupting the commercial process and imposing duties of inquiry on the commercial
institutions through which the transactions are made or only by suit against the alleged
defrauder or his assignees. The latter course would seem preferable so long as the claimant
has an opportunity to serve process on the defrauder or transferee while the latter is in
funds.
18. The classical example is allocation of forgery loss. See Comment, 62 YALE L.J.
417, 435-38 (1953).
19. Cf. EHRENZWEIG, NEGLIGENCE VITHOUT FAULT 61, 82-83 (1951) ; James, Accident
Liability Reconsidered: The Impact of Liability Insurance, 57 YALE L.J. 549, 550 (1948) ;
Smith, Frolic and Detour, 23 COLUm. L. REv. 444, 716, 718 (1923); Comment, 42 MICi.
L. REv. 694 (1944).
20. Dewey v. Metropolitan Life Ins. Co., 256 Mass. 281, 152 N.E. 82 (1926) ; Green-
berg v. World Exchange Bank, 227 App. Div. 413, 237 N.Y. Supp. 200 (1st Dep't 1929) ;
Saint Paul-Mercury Indemnity Co. v. State Dep't of Agriculture, 259 Wis. -12, 47 N.W.2d
312 (1951). But see Willoughby v. Newman, 46 Ga. App. 377, 167 S.E. 783 (1933).
Payment to one in possession of a note, but not holding under a regular chain of indorse-
19561 ADVERSE CLAIMS

claim proves to be justified, A will remain liable to B despite payment to the

holder.' But if A refuses to pay and the holder then sues on the instrument,
4 will not, in most states, be permitted to set up B's adverse claim as a de-
fense. 22 Even when he is allowed to assert B's claim, A may lose to the
holder on the merits; and because that judgment would not be binding on B,
A might incur a second liability in a suit by the adverse claimant.23 Under the
better rule, he may interplead both the holder and the claimant ;24 but the
restrictions on interpleader, even under statute, seriously limit the efficacy of
2
that remedy. 5

ments may not work a discharge. First Nat'l Bank v. Gorman, 45 Wyo. 519, 21 P.2d
549 (1933). But see Modern Equipment Corp. v. Northern Trust Co., 284 Ill. App. 586,
1 N.E.2d 105 (1936).
B may also place D in a similar dilemma under N.I.L. § 54 which provides that a holder
is "in due course" only to the extent that he has already given value on the instrument
when he receives notice of an adverse claim. If D has promised to give value to C for the
instrument, and is notified of B's claim before the value is actually given, D will not be a
holder in due course if B's claim is valid. On the other hand, D will be liable to C on the
agreement if B's claim is invalid. If, however, D's promise to C is represented by a nego-
tiable instrument, the harshness of § 54 is mitigated; D is considered to have given value.
People's Say. Bank v. Smith, 210 Iowa 136, 230 N.W. 565 (1930); Pennoyer v. Dubois
State Bank, 35 Wyo. 319, 249 Pac. 795 (1926). The Code incorporates the Pennoyer hold-
ing. U.C.C. § 3-303(c).
21. Nielsen v. Planters Trust & Sav. Bank, 183 La. 645, 164 So. 613 (1935); City
of Brunswick v. Peoples Say. Bank, 194 Mo. App. 360, 190 S.W. 60 (1916). Some courts,
however, apparently have moderated the harshness of the N.I.L. result by ignoring the
law when the claimant has refused to give indemnity. See Polotsky v. Artisans Say.
Bank, 37 Del. 151, 188 Atl. 63 (Super. Ct. 1936).
22. Bowles v. Oakman, 246 Mich. 674, 225 N.W. 613 (1929) (collecting citations)
Reynolds v. Gregg, 258 S.W. 1088 (Tex. Civ. App. 1924). Contra, Brinley v. Williams, 189
Okla. 183, 114 P.2d 463 (1941).
The question involves N.I.L. § 88 and the last sentence of N.I.L. § 59. The Com-
missioners' Note to § 59 implies that the intent was to deny the right of setting up third
party claims. BRANTAN, NEGOTIABLE INSTRUMENTS LAW 884-91 (7th ed., Beutel 1948)
(hereinafter cited as BEuTEL). See also BRIrox § 159. The weight of authority under
the common law was to the same effect. Kinney v. Kruse, 28 Wis. 183 (1871). For the
common law minority rule, see Solomons v. Bank of England, 13 East 136, 104 Eng. Rep.
319 (K.B. 1791). See Note, Jus Tertii Under Common Law and the N.I.L., 26 ST. Jon's
L. REv. 135 (1951).
23. BRITTON § 159.
24. Fourth Nat'l Bank v. Lattimore, 168 Ga. 547, 148 S.E. 396 (1929) (claim of
forgery) ; Welch v. Bank of the Manhattan Co., 264 App. Div. 906, 35 N.Y.S.2d 894 (2d
Dep't 1942) ; BEUTEL 885.
25. The purpose of interpleader is to relieve the stakeholder not only of double liability,
but also of vexation arising from multiple suits. Sovereign Camp v. Partridge, 221 Ala. 75,
127 So. 505 (1930); Livingstone v. Bank of Montreal, 50 Ill. App. 562, 566-67 (1893).
Interpleader not only discharges the stakeholder but also cuts off any interest on the res
from the time the funds are paid into court. Conner v. Bank of Bakersfield, 183 Cal. 199,
190 Pac. 801 (1920).
In practice, however, the possibility of vexation alone does not always appear to be
sUflicient to allow interpleader. Lassiter v. Bank of Dawson, 191 Ga. 208, 11 S.E.2d 910
(1940) (interpleader denied despite explicit statutory provision) ; South Side Bank &
 THE YALE LAW JOURNAL [Vol. 65 : 807

The Code has attempted to improve this situation by eliminating the require-
ment of payment "in due course." Under section 3-603,2o a fundamental
change has been established: payment to the holder,2 7 even with knowledge of
an adverse claim on the instrument, absolutely discharges the payor unless
the adverse claimant takes affirmative action either to have payment enjoined
or to provide the stakeholder with "adequate" indemnity. If the adverse claim-
ant obtains process or indemnifies him, the stakeholder must refuse to pay the
holder; he may then either move to interplead the parties or await legal action
by the holder. If the stakeholder elects to defend against the holder's action,
he will probably be able to assert the adverse claimant's equities as a defense,
despite the general Code prohibition of the use of third party claims as de-
fenses.28
Section 3-603 constitutes a significant step towards a desirable compromise
between commercial expediency and honesty. The stakeholder need not be
Trust Co. v. Siefert, 223 Mo. App. 431, 18 S.W.2d 572 (1929). The four common law
prerequisites to interpleader are: 1) the same debt must be claimed by the adverse parties;
2) the adverse titles must derive from a common source; 3) the stakeholder must have no
interest in the subject matter; 4) the stakeholder must have incurred no independent
liability to either of the claimants. 4 PoXmRoy, EQtUT JURISPRUDENCE §§ 1323-26 (5th ed.
1941) ; see Ranch v. Fort Dearborn Nat'l Bank, 223 Ill. 507, 79 N.E. 273 (1906). Even
under statutes the stakeholder may still have to show that the adverse claims are "apparently
well founded," Lassiter v. Bank of Dawson, supra, or that there are "debatable questions of
law," Mandeville v. First Nat'l Bank, 206 Ga. 426, 57 S.E.2d 553 (1950). See also note
95 infra. And the Federal Interpleader Act, 28 U.S.C. § 1335 (1952), has been construed
to retain the rule that the stakeholder must be under no independent liability to any of the
parties. Hurlbut v. Shell Oil Co., 131 F. Supp. 466 (W.D. La. 1955). Thus a paying bank,
having accepted a draft on itself, would be unable to interplead unless it showed that no
independent liability had thereby been incurred. First State Bank v. Citizens State Bank,
10 F.R.D. 424 (D. Neb. 1950), appeal disnissed, 191 F.2d 203 (8th Cir. 1951). But see
Note, 65 YALE L.J. 715 (1956).
The adverse claim treatment of the Code was intended to favor the use of interpleader,
although there is no general interpleader statute. See U.C.C. §§ 3-306(d), comment 5;
7-603, as amended 1955 Sup. (documents of title). Cf. Achtel v. Excelsior Say. Bank, 133
N.Y.S.2d 450 (Sup. Ct. 1954).
26. "[T]he liability of any party is discharged to the extent of his payment or satis-
faction to the holder even though it is made with knowledge of a claim of another person
to the instrument unless prior to such payment or satisfaction the person making the claim
either supplies indemnity deemed adequate by the party seeking the discharge or enjoins
payment or satisfaction by order of a court of competent jurisdiction in an action in which
the adverse claimant and the holder are parties." U.C.C. § 3-603(1).
27. Under U.C.C. § 1-201(20), a holder must have possession of the item, and it
must be indorsed to him or to bearer. This corresponds to definitions under existing
law. U.C.C. 1-201, comment 20; N.I.L. § 191.
28. Under U.C.C. § 3-306(d) a claim of a third party to the instrument may not be
asserted as a defense. This provision was inserted to protect the payor against a possible
double liability to both the holder and the claimant. U.C.C. § 3-306, comment 5; see note
25 supra and accompanying text. If the payor is indemnified, however, there is no longer
any reason for protecting him and he should be allowed to assert the third party claim.
This would follow existing law. Horrigan v. Wyman, 90 Mich. 121, 51 N.W. 187 (1892);
BEUTEL 885.
 ADVERSE CLAIMS

concerned with third party claims and the threat of double liability. The claim-
ant, who might otherwise be left with a worthless right against an insolvent or
absconding defrauder, is given an opportunity to prove his allegations before
payment is made. And the holder is protected against frivolous claims by the
requirement that the claimant post bond or initiate suit in order to make his
20
claim effective.
But while section 3-603 does make substantial improvements on existing
law, it nevertheless contains serious inadequacies and ambiguities. The ad-
verse claimant is allowed to prevent payment to a holder by obtaining a court
order, presumably a temporary or preliminary injunction, in a suit against the
holder. But this remedy will not be available when, as is often the case, the
adverse claimant is unable to locate or serve process on the holder before
presentment. Furthermore, even if service is obtained, temporary injunctions
are not immediately granted ;30 and it is unclear whether the stakeholder, if
notified that proceedings for injunction are pending, must defer payment until
an injunction is issued or denied. Finally, even if an injunction could be
granted in time, section 3-603 does not establish the criteria by which to deter-
mine whether a restraining order should be granted; the problem is left entire-
ly to the varying standards of local law.31
As a practical matter, most claimants will probably indemnify the stake-
holder rather than seek a judicial order restraining payment. But this course
of action will lead to problems of equal difficulty. Section 3-603 does not in-
dicate what amount of indemnity, if any, must be "deemed adequate" by the

29. Originally, the section did not provide for indemnity or injunction remedies. U.C.C.
art. 3, § 803 (1948). The 1952 provision substantially follows the suggestions outlined
in Comment, Automatic Discharge of Negotiable Instruments in the Proposed Com-
inercial Code, 44 ILL. L. RE,. 88 (1949). The writer of the comment sets out the competing
policy factors and summarizes the debates of the draftsmen in adopting the basic provisions
of § 3-603.
30. Temporary injunctions may be issued immediately, but generally are not given
prior to a weighing of the equities by the chancellor. Especially when contested by the
parties, this determination should not and generally will not be made summarily. See
McCLINTOcx, EmunTy 51-52, 383, 388-89 (2d ed. 1948) ; WALSH, EQUIrr 297-98 (1930).
A preferable rule in this situation would be an automatic grant of the injunction subject
to subsequent contempt citation if the court's process was abused. See note 38 infra and
accompanying text.
31. It seems quite likely that some courts will not give temporary injunctions freely
enough, or will subject them to ad hoe qualifications in line with the courts' views as to
the probable outcome of a trial on the merits. See Leeds v. Guaranty Trust Co., 193 Misc.
681, 85 N.Y.S.2d 70 (Sup. Ct. 1948), an action brought by an adverse claimant to a
bank deposit under N.Y. BANING LAW § 134(5), similar to U.C.C. § 3-603. The plaintiff
sought to enjoin the bank from paying the contents of the deposit to the depositor. The
court determined that the claimant, in order to obtain an injunction, would have to post
security; the statutory provision allowing a restraining order, although phrased in man-
datory language, was nevertheless held to be subject to the discretion of the court, which
could gear its relief to the nature of the claim. While the result seems sensible, it fore-
.hadows disparate results under § 3-603. See also Solicitor v. Bankers Trust Co., 197
Misc. 381, 94 N.Y.S.2d 658 (Sup. Ct. 1949).
 THE YALE LAW JOURNAL [Vol. 65 :807

stakeholder. Earlier drafts of the Code rejected the indemnity theory on the
ground that only a law suit would enable the stakeholder to determine what
amount of security would be "reasonable. '32 Since the term "claim" is not
defined, it is not even clear when indemnity can be demanded under section
3-603.33 At least when the adverse claim is based upon theft accompanied by
'4
forgery, the Code apparently retains the concept of payment "in due course.""
Thus a stakeholder bank might well prefer to refuse payment despite inade-
quate indemnity, and take the risk of nominal damages for wrongful dishonor,
rather than to pay with knowledge of an adverse claim, and risk the double
liability of payment without discharge. 35
Finally, and most fundamentally, use of the indemnity feature places the
holder in the tactically disadvantageous position of being forced to sue.3" The
32. Comment, 44 ILL. L. REv. 88, 97 (1949) (reviewing the "legislative history").
U.C.C. § 3-419(2) states that liability in conversion is presumed not to exceed the face
value of the instrument. However, the amount of the indemnity would probably have tu
cover more than the value of the instrument. Under § 4-103 (5) the payor's "bad faith"
could result in liability for damages exceeding the amount of the instrument. A drawee
would also request to be indemnified against liability for wrongful dishonor of the drawer's
check, which could greatly exceed the amount of the item under § 4-402. And certainly
no stakeholder would consider himself adequately indemnified unless protected against
the costs of litigation. See Britton, Defenses, Claims of Ownership and Equities-A Com-
parison of the Provisions of the Negotiable Instruments Law with Corresponding Pro-
visions of Article 3 of the Proposed Commercial Code, 7 HASTINGs L.J. 1, 27 (1955).
33. Since the word "claim" is not defined in the Code, it would be necessary to resort
to present law. Id. at 2. Claim would encompass any equity of ownership resulting from
fraud, and would also include a claim that bearer paper was stolen. U.C.C. §§ 3-305
& comment 2; 3-306 & comment 5. For the present state of the law, see BRIT-,,. 734-37.
If, however, the theft were accompanied by a forgery, § 3-603 would be inapplicable. See
note 34 infra.
34. U.C.C. 3-406, as amended 1955 Sop.
The Code, adopting the prevailing rule, expressly provides that the payor remains
liable to the claimant for payment over a forgery. U.C.C. § 3-419(1) (c) ; Fourth Nat'l
Bank v. Lattimore, 168 Ga. 547, 148 S.E. 396 (1929). Further, the payor would have no
right to recover payment against a holder in due course. U.C.C. § 3-418 (modifying the
rule of Price v. Neal, 3 Burr. 354, 97 Eng. Rep. 871 (K.B. 1762) ). The payor could, how-
ever, raise the forgery claim as a defense under § 3-307(1) (a) by not paying and requiring
the holder to prove all prior signatures. For discussions of problems raised by check
forgeries, see Kessler, Forged Indorsements, 47 YALE L.J. 863 (1938) ; Comment, 62 YALE
L.J. 417 (1953).
35. Eiblidge Reply, found in NEW YoRE LAw R.EvislON COIMsISSION, STUDY Or
UNIFO M COMMERCIAL CODE 192, 1.97 (1954) (memoranda and hearings on Articles 3 and
4; hereinafter cited as N.Y. REroar) ; ef. Beutel, The Proposed Uniform [?] Commercial
Code Should Not Be Adopted, 61 YALE L.J. 334, 362 (1952). A court, impressed with
the harshness of the rule in the case of payment to a "known thief" might narrowly construe
§ 3-603 or work an exception to it on an "abuse of legal rights" theory. Beutel, Compari-
son of the Proposed Commercial Code, Article 3, and the Negotiable Instruments Law.
30 NEB. L. Ray. 531, 553 (1951) ; ef. Nielsen v. Planters Trust and Say. Bank, 183 La. 645,
164 So. 613 (1935). Liability for wrongful dishonor, though possibly very costly, is limited
to actual damages to the drawer. U.C.C. § 4-402.
36. The Code is not explicit, but presumably the holder would sue the payor if he were
indemnified; the claimant-indemnitor would probably manage the defense. If the claimant
1956] ADVERSE CLAIMS

claimant, whose equity may or may not be valid, gains the advantage of stop-
ping payment without the necessity of proving his claim. This result is plainly
inconsistent with the principle that the holder of a negotiable instrument has
a prima facie right to recover.3 7 This principle, supported as it is by the policy
of promoting free transferability, demands that the claimant should bear the
burden of initiating suit.
The objections to both the injunction and indemnity devices can best be met
by creating a new statutory remedy having some of the characteristics of both
garnishment and interpleader.3" This remedy would enable the claimant to
immobilize the proceeds of a disputed instrument until the holder could be
served with process. The remedy would be granted only when the adverse
had obtained a temporary injunction (but see notes 30-31 supra and accompanying text),
the holder probably would defend the action in which the injunction had been granted.
The burden of initiating litigation may, of course, be assumed by the payor in an inter-
pleader suit. However, the payor is reimbursed for the cost of the litigation either under
the indemnity bond if he chooses to stand suit and defend, or by recovering costs from
the proceeds paid into court. United States v. Ullman, 115 F. Supp. 211 (E.D. Pa. 1953) ;
Burks v. Burks, 222 Ark. 97, 257 S.W.2d 369 (1953). But see Century Ins. Co. v. First
Nat'l Bank, 133 F.2d 789 (5th Cir. 1943) (bill in the nature of interpleader).
37. Compare U.C.C. § 3-804, which provides that if the claimant contends the instru-
ment is lost, stolen or destroyed he may be forced to sue to obtain (although not neces-
sarily to stop) payment. The comment to § 3-804 states that the claimant, because he is
not a holder, is to be given no presumptions.
Under § 3-803 the party initiating suit could require all other intermediary parties who
might be liable on the instrument to intervene. Service of process is not necessary if a
written notice is sent to such persons. If they do not intervene (apparently whether or
not they actually receive the notice, if reasonable steps are taken to have the notice de-
livered), they are nevertheless bound by the decision. Section 3-803 has, however, met
with considerable criticism on constitutional grounds. See Beutel, Comparison of the
Proposed Commercial Code, Article 3, and the Negotiable Instruments Law, 30 NEB. L.
REv. 531, 555-56 (1951); Milbank Memorandum, N.Y. REPORT 1024. For an excellent
reply see Mentschikoff Memorandum, N.Y. REPORT 67, 92-94.
38. The new statutory remedy described in text could be drafted substantially as
follows:
Section 3-603. Adverse Claim to an Instrument or Bank Deposit.
(1) The holder of a negotiable instrument shall be entitled to payment upon proper pre-
sentment, and upon payment the payor shall be discharged from any further liability,
notwithstanding any third party claim, defense or equity to the instrument, or to the
deposit on which the instrument is drawn, unless a writ of garnishment issued pursuant
to subsection (2) has been properly served upon the payor.
(2) Any court of general jurisdiction in this state shall issue a writ of garnishment
whenever any party:
(a) Files an affidavit with the court stating that he:
(i) has a specified claim of right to a specified instrument or deposit of funds
payable by the payor;
(ii) has been unable, in the exercise of reasonable diligence, to serve process
on the present holder of the instrument; and
(iii) will bring suit on the claim as specified as soon as jurisdiction over the
person of the holder can be obtained; and
(b) Deposits a bond with the court to indemnify the holder against all damages
and costs incurred by reason of the action taken by the claimant pursuant to this
 THE YALE LAW JOURNAL [Vol. 65 :807

claimant declares by affidavit that he (1) has a specified claim to the instru-
ment; (2) has been unable to serve process on the current holder despite due
diligence; (3) will sue the holder on the claim when presentment for payment
is made; and (4) has posted bond to indemnify the holder for costs if he fails
to sustain his claim, and for attorney's fees if his claim is found to be merely
colorable. Until served with the statutory writ of garnishment, the stakeholder
would be unconditionally required to pay the holder at presentment. Once he
had been served, however, he would not be permitted to pay the holder until
the holder obtained dismissal of the writ of garnishment. Dismissal would be
granted automatically two days after the holder filed an appearance or other-
wise consented to jurisdiction over his person. Attachment of the proceeds
should be made possible, at least to the extent normally allowed by local law. "
The proposed procedure would meet the legitimate needs of all parties to
the adverse claim situation, without giving any one of them an unwarranted
advantage. The stakeholder, who is not a party in interest to the dispute, could
exercise no discretion and would incur no liability. The adverse claimant, who
is a party in interest, would have the burden of beginning suit, but the assur-
ance of payment if his claim were sustained. The holder, though he must sub-
mit himself to possible suit in the process of collection, would still retain all
rights now accorded him by the Code, and would also be relieved from the
necessity of commencing an action to enforce a claim which is presumed to be
valid. Furthermore, the limitations on the remedy proposed would tend to
discourage litigation of frivolous claims more effectively than the present in-
demnity provisions.

ARTICLE 4: BANK COLLECTIONS

Article 4 deals with the most important facet of negotiable instruments law,
the collection of checks. 40 The low cost, automation, speed and rapid turnover
section if the claimant fails to make good his suit; and a reasonable attorney's fee
if it is adjudged that the adverse claimant's suit is without reasonable foundation.
(3) Dismissal of a writ of garnishment issued pursuant to subsection (2) shall be
granted upon application by the holder if he:
(a) Files written consent to jurisdiction over his person in any action commenced
by the claimant pursuant to subsection (2) (a) (iii) ; and
(b) Deposits the instrument in the registry of the court.
(4) If within two days thereafter the claimant shows to the court by affidavit that the
proceeds of the instrument are subject to seizure by mesne process under the laws of this
state, the instrument shall be collected, and the proceeds retained in the registry of the
court pending disposition of the action. If the claimant fails to make such showing, thu
holder shall be entitled to withdraw the instrument or any proceeds thereof.
39. It would seem advisable to allow each state to determine for itself on what con-
ditions the adverse claimant should be entitled to have the proceeds paid into court
pending litigation. Most states permit attachment on any contract claim against a non-
resident defendant; other grounds include fraud, concealment and absconding. See, e.g.,
CONN. GEN. STAT. §§ 8022-73 (1949); N.Y. Civ. PRAc. Acr § 903; PA. STAT. ANN. tit. 12,
§§ 2741, 2891 (1951).
40. In addition to checks and other negotiable instruments Article 4 covers nonnegoti-
able instruments and investment securities which may be collected through banks. U.C.C.
1956] ADVERSE CLAIMS

which characterize bank collections indicate the special necessity of an adverse

claim solution consistent with the particular problems encountered in the bank-
ing context. 41 The system should not contain an invitation to fraud, nor should
banks, as the best media for risk distribution, escape liability for those losses
which are inherent in the use of checks. However, banks handle millions of
items daily, 42 and more than 99Y2 per cent of all checks are honored without
difficulty. These circumstances indicate the strong need for adverse claim pro-
43
visions which will not impede the normal flow of banking items.
The principal problems which arise under Article 4 of the Code derive from
the failure of the draftsmen to deal explicitly with adverse claims. Section
3-603 applies, but only when it does not conflict with more specific provisions
of the bank collection article. 44 And while several provisions of that Article
seem to demand results inconsistent with section 3-603, their import is far
from clear.
The problems which arise under Article 4 are best discussed in terms of
whether the claim is asserted by (1) the drawer against the payee or subse-
quent parties to the instrument; (2) the payee or his indorsee against subse-
quent holders; or (3) a claimant against the depositor-drawer. A fourth,
related problem is presented by the Code's treatment of fiduciary deposits,
which introduces the concept of "constructive" notice of adverse claims.

Drawer v. Payee: The Stop Order

The drawer's claim against the payee or holder is made in the form of a
stop-payment order.4 5 It may be made for his own benefit or that of a sub-

§ 4-104 & comment 4. For a brief description of existing state law on bank collections,
see CLARKE & BAIEV, BANK DEPOSITS AND COLLECTIONS 7-10 (1955) (hereinafter referred
to as CLARKE & BAILEY).
41. See Comment, 51 YALE L.J. 986, 1010 (1942). Much of existing law was formulated
in a predominantly cash economy; the transition to a credit economy involving great numbers
of checking transactions has not been accompanied in every instance by similar changes in
the law governing these transactions. Morrison & Sneed, Bank Collections: The Stop-
Paynwnt Transaction--A Comparative Study, 32 TEXAS L. REv. 259-60 (1954); Leary,
Deferred Posting and Delayed Returns-The Current Check Collection Problem, 62
HARV. L. REv. 905, 909 (1949).
42. Bank debits in one year have been estimated at $2.8 trillion, with approximately
nine billion checks issued. Vergari, It Re Articles 3, 4, and 5, 28 T-mP. L.Q. 529 n.5
(1955). An estimated twenty-five million items are processed daily in over fourteen
thousand banking institutions. Id. at 540. In 1953 the Chase National Bank reportedly
paid 247 million checks through clearings alone, representing a value of $164 billion.
Milbank Memorandum, N.Y. REPoRT 10, 11. The constant increase in the use of checks
in the modern economy is indicated by the fact that debits to demand deposit accounts in
the United States rose from $757 billion in 1943 to $1.9 trillion in 1954. U.S. BUREAu oF
THE CENSUS, STATISTICAL ABSTRACT OF THE UNITED STATES: 1955, at 430 (76th ed. 1955).
43. See Leary, supra note 41, at 912. See also U.C.C. § 4-213, comments 1.9; CLARKE
& BAILEY 2-7.
44. U.C.C. § 4-102(1).
45. See U.C.C. § 4-403, as amended 1955 SuPP.
For the prerequisites of a valid stop order under existing law, see Moore, Sussman
 THE YALE LAW JOURNAL [Vol. 65:807

sequent party, 46 and his reason for stopping payment may or may not consti-
tute a valid defense to the instrument. 47 Whatever its basis, if the stop order
arrives at the bank before the check is paid, it must be heeded. 48 This abso-
lute right of the claimant to prevent payment, unique in adverse claim situa-
tions, is justified conceptually on the theory that a check is merely an order
to a debtor under a contractual obligation, and therefore may be revoked by
the drawer-creditor at any time before payment. 49 The payee or any subse-
quent holder is given no advantage by his status as holder. If payment is
stopped, he must sue the drawer on the instrument. 0
In practice, the stop order is inconsistent with the exigencies of modern check
collection. The banks have often been unable, even in the exercise of due care,
to perform this service imposed by law. 6 ' Bank collection is largely a mechani-

& Brand, Legal and Institutional Methods Applied to Orders to Stop Payment of Checks,
42 YALE L.J. 817, 825 (1933).
46. See, e.g., First Nat'l Bank v. Beier, 238 Iowa 280, 26 N.W.2d 853 (1947) ; Brinley
v. Williams, 189 Okla. 183, 114 P.2d 463 (1941) ; Mashek v. Leonard, 186 S.W.2d 745
(Tex. Civ. App. 1945).
47. See, e.g., Hiroshima v. Bank of Italy, 78 Cal. App. 362, 248 Pac. 947 (1926).
48. Acts constituting final payment are set out in U.C.C. § 4-213(1), as amended
1955 SupP. The bank must honor the stop order if it has been received before the bank
has taken action or decided to pay the item. U.C.C. § 4-303(1), as amended 1955 Sur.
However, under the 1955 revisions the payor cannot heed a stop order after an irrevocable
settlement of the item or after completion of the posting process. U.C.C. § 4-213(1) (1955
SueP.).
49. Second Nat'l Bank v. Meek Appliance Co., 244 S.W.2d 769 (Ky. 1951);
Speroff v. First-Cent. Trust Co., 149 Ohio St. 415, 79 N.E.2d 119 (1948); Thomas v. First
Nat'l Bank, 376 Pa. 181, 101 A.2d 910 (1954), In those states which under the common
law regarded a check as a pro tanto assignment of the debt owed by the drawee, the stop
order was not allowed. First Nat'l Bank v. Keith, 183 Ill. 475, 56 N.E. 179 (1899) ; Loan
& Sav. Bank v. Farmers & Merchants Bank, 74 S.C. 210, 54 S.E. 364 (1906).
50. The drawer is secondarily liable on the instrument. Western Title Ins. and
Guaranty Co. v. Bartolacelli, 124 Cal. App. 2d 690, 269 P.2d 165 (1954) ; U.C.C. § 3-413;
N.I.L. § 61. See Vergari, supra note 42, at 550.
51. Morrison & Sneed, supra note 41, at 300. The bank may be liable to the drawer for
payment even though the stop order failed to describe the item accurately. Compare
Kentucky-Farmers Bank v. Staton, 314 Ky. 313, 235 S.W.2d 767 (1951) (liability), with
John H. Mahon Co. v. Huntington Nat'l Bank, 62 Ohio App. 261, 23 N.E.2d 638 (1939)
(no liability).
Earlier drafts of the Code explicitly prohibited banks from using exculpatory clauses
to limit their liability for inadvertent payment over stop orders. U.C.C. § 4-202(3)
(Spring 1950). Although this provision has been eliminated, the depositor may still re-
cover if he can prove that the bank was negligent. U.C.C. § 4-103; CLARKa & BAILEY 48.
Exculpatory clauses in agreements with depositors have been struck down in a number of
states even without statutory proscription. In Reinhardt v. Passaic-Clifton Nat'l Bank
& Trust Co., 16 N.J. Super. 430, 84 A.2d 741 (App. Div. 1951), aff'd, 9 N.J. 607, 89 A.2d
242 (1952), the court invalidated an exculpatory clause on a "no consideration" theory,
and also suggested two other reasons which could be used to support the result reached:
(1) the parties lack equal bargaining power, and (2) the quasi-public nature of banking
prevents any contract to escape liability. Exculpatory clauses have also been held invalid
in Hiroshima v. Bank of Italy, 78 Cal. App. 362, 248 Pac. 947 (1926); Calamita v.
Tradesmens Nat'l Bank, 135 Conn. 326, 64 A2d 46 (1949); Speroff v. First-Cent.
 ADVERSE CLAIMS

cal and departmentalized process which is and should be geared towards speedy
and uninterrupted turnover of millions of items daily. 52 Retention of the stop
order subjects this process to the constant possibility of interruption, 3 and
often results in preventing discharge rather than stopping payment.5 4 Despite
its practical inconvenience, however, the stop order feature has been retained
by the Code as a service to which depositors are entitled and one which banks
offer as an inducement to the use of checks by drawers. 55 It has also been justi-
fied as a means of shifting an inherent risk of bank collection to the banks, 56
57
and reducing litigation between parties dealing with checks.
But stop orders may increase litigation. A bank which has paid a check
over a stop order may, by subrogation, assert the rights of either the drawer
or holder in order to prevent unjust enrichment. 5 Under a breach of warranty
of presentment theory, the bank may be able to recover from any party pre-
senting an item for payment with knowledge of an outstanding stop order.5 9
In addition, if the bank credits the customer's account at payment, the cus-
tomer may be forced to sue for a recredit. He may then be involved in prov-
ing issues more difficult than he had anticipated. He will carry the burden of
Trust Co., 149 Ohio St. 415, 79 N.E.2d 119 (1948) ; Thomas v. First Nat'l Bank, 376 Pa.
181, 101 A.2d 910 (1954). They were upheld in Hodnick v. Fidelity Trust Co., 96 Ind.
App. 342, 183 N.E. 488 (1932) ; Tremont Trust Co. v. Burack, 235 Mass. 398, 126 N.E.
782 (1920) ; Gaita v. Windsor Bank, 251 N.Y. 152, 167 N.E. 203 (1929).
52. See Leary, supra note 41, at 909-17.
53. Hearings,N.Y. REPORT 311-12.
54. Morrison & Sneed, supra note 41, at 317-18; Comment, 20 U. CHI. L. REV. 667,
669 (1953).
55. U.C.C. § 4-403, comment 2; Note, The Effect of Exculpatory Clauses on Bank
Stop Payment Orders, 44 ILL. L. REv. 530, 533 (1949).
56. See U.C.C. § 4-403, comment 2.
57. See Comment, 20 U. CHI. L. REv. 667, 668 (1953).
58. U.C.C. § 4-407. Since the bank will not be certain of whose rights it will eventually
assert, it will have to implead all parties concerned. See, e.g., Central Nat'l Bank v. Interna-
tional Sales Co., 87 Ohio App. 207, 91 N.E.2d 532 (1950). If the stop order is to be con-
tinued, this right of subrogation seems necessary to avoid unjust results. See, e.g., Chase
Nat'l Bank v. Battat, 297 N.Y. 185, 78 N.E.2d 465 (1948) ; Third Nat'l Bank v. Carver, 31
Tenn. App. 520, 218 S.W.2d 66 (1948).
59. There is authority to the effect that a paying bank may recover from a holder who
knew of the stop order. Chase Nat'l Bank v. Battat, 105 N.Y.S.2d 13 (Sup. Ct. 1951);
Murfreesboro Bank & Trust Co. v. Travis, 190 Tenn. 429, 230 S.W.2d 658 (1950);
Morrison & Sneed, supra note 41, at 308. Contra, Miller v. Chatham and Phenix Nat'l
Bank, 126 Misc. 559, 214 N.Y. Supp. 76 (Sup. Ct. 1926). However, the decisions seem
predicated on the grounds that the holder was not a bona fide purchaser for value, and
that the drawee bank was being defrauded, rather than that knowledge of the stop order
per se breached a warranty.
Under the 1952 draft, the holder presenting an item for payment warrants to his deposi-
tory bank and to the payor that he has no knowledge of an "effective" stop payment order.
U.C.C. §§ 3-417(1) (b), 4-207(1) (d). However, these provisions have met with serious
objection. N.Y. REPORT 124-25; N.Y. CIT BAR ASSOCIATION REPORT ON THE PROPOSED
UNIFORM Cou -mmciA.CODE 27-28 (1953). They were deleted by the 1955 amendments,
the draftsmen indicating an intention to revert to the common law "insofar as there are
common law decisions on the question." 1955 Supp. 31.
 THE YALE LAW JOURNAL [Vol. 65 :807

proof of loss. If he asserts the bank's negligence, he will have the burden of
proving the inadequacies of the bank's stop order procedure."" Furthermore,
complex problems of proof might arise if the drawer must disprove the bank'.
contentions that the stop order was not received in time.0 ' As a result, the
paying bank is under pressure to litigate issues which under Article 3 were
deemed not to be its concern.
It is doubtful that the loss resulting from a bank's failure to heed stop
orders should be placed on the bank as an inherent risk of its business. The
risk exists only because the law imposes it on the bank. 62 Unlike the forgery
situation, the dispute underlying the stop-payment order does not basically in-
volve the use of a check. The drawer may stop payment because he has been
defrauded, but the fraud could have been as easily perpetrated without a check.
Indeed, the Code provisions which allow the bank to sue prior parties under
subrogation or breach of warranty theories seem to recognize that the ultimate
3
loss should not be placed on the banks.
Stop orders have also been justified as a means of promoting the use of
checks, rather than cash, in that they afford the drawer greater opportunity
to withdraw from a transaction found to be fraudulent. 4 But at the present
stage of commercial development, the use of checks would not be materially
impeded by elimination of the stop-payment order. It is equally important to
the promotion of transferability that payees and indorsees take checks with
some amount of certainty. Indeed, use of the stop-payment order often works
to promote fraud by the drawer rather than to deter fraud by the holder.,,,
Checks are commonly considered to be the equivalent of final payment in cash,
and not a trial purchase on credit.66 Existing law, under which the drawer
of a check who is dissatisfied with the underlying transaction may force the

60. U.C.C. § 4-403(3). See Comment, 20 U. CHI. L. Rav. 667, 676-77 (1953).
61. See Malcohn Letter, N.Y. REPORT 133, 145-54; note 48 supra and accompanying text.
62. See note 51 supra.
63. See CLaxa.E & BAILEY 127; notes 58-59 supra and accompanying text.
64. Comment, 20 U. Cm. L. Rav. 667, 668 (1953).
65. See, e.g., Hearings,N.Y. RPoRT 280, 311; Comment, 20 U. Cm. L. REV. 667, 668
n.8 (1953). The editors of the Comment concluded that § 189 of the N.I.L. might indicate
a legislative determination that the drawer was more often defrauded than the payee.
Ibid. But § 189 was enacted with an eye to the drawee-payee relationship, and not the
relationship between the drawer and the payee of his check. Caledonia Nat'l Bank v. Me-
Pherson, 116 Vt. 328, 331, 75 A.2d 685, 687-88 (1950) ; Mountaineer Engineering Co. v.
Bossart, 133 W. Va. 668, 670, 57 S.E.2d 633, 634 (1950) ; In re Thornton's Guardianship, 243
Wis. 397, 405, 10 N.W.2d 193, 196 (1943) ; Aigler, Rights of Holder of Bill of Exchange
Against the Drawee, 38 HARv. L. RFv. 857, 884 (1925).
66. It is difficult to conclude that when a seller accepts a check as payment for the sale
of goods the seller believes that the sale is "conditional" upon the buyer's decision not to
stop payment on the check. Morrison & Sneed, supra note 41, at 260, contend that the buyer
assumes the risks of fraud and nonconformity of the goods when he pays "cash," but that
the seller assumes these risks when he accepts a check. The latter may be true under exist-
ing law, but it cannot be reconciled with the seller's desire to receive an instrument with
all the attributes of money. Id. at 261.
 ADVERSE CLAIMS

payee or his indorsee to sue on the instrument, is inconsistent with sound

commercial practice and should be changed.
The Code should recognize that the drawer is still an adverse claimant even
though his claim is against a check he himself has written. Transferability of
checks and ease of bank collection would be promoted by treating the check,
for this purpose, as an irrevocable order by the drawer which entitles the
holder to payment until his claim is disproved in court. 67 The drawer should
then be treated as any other adverse claimant. He could be permitted to in-
demnify the payor bank or obtain legal process to enjoin payment under
section 3-603; or, preferably, he could be allowed to garnishee the proceeds
under the statutory revision previously proposed.6 S In the final analysis, how-
ever, the perpetuation of the stop-payment order is likely to turn upon whether
most depositors, including the legislators who will pass on the Code, continue
to feel that this is a right which they should have, 69 even though as to banks
it is a serious handicap and as to drawers it provides protection which may
eventually prove to be illusory and misleading.

Payee v. Holder
A different type of adverse claim arises when the indorser of a check noti-
fies the drawee bank of an alleged defect in the title of the present holder, a
subsequent indorsee holding under the claimant's chain of title. Under present
law, the adverse claimant cannot require the bank to stop payment on the
check ;70 the bank's duty runs only to the owner of the deposit.71 Since, how-
ever, the drawee is under a duty to its customer to use care and good faith
67. This is not to say that, as regards the bank, a check should be treated as a pro
tanto assignment from the drawer to the payee. Cf. note 73 infra and accompanying text.
Since a check is not an assignment, a dissatisfied drawer would still be able to with-
draw the funds in the underlying account before the check was presented. Consequently,
elimination of the stop-payment order will not entirely solve the problem. However, this
procedure involves too many vexations to the drawer. He may, for example, have a number
of other checks outstanding against the underlying account which he cannot afford to
dishonor. This procedure cannot, therefore, be considered a ready substitute for the
stop-payment order.
68. See note 38 supraand accompanying text.
69. See, e.g., Hearbigs, N.Y. REPoRT 277.
70. Blake v. Hamilton Dime Say. Bank, 79 Ohio St. 189, 87 N.E. 73 (1907). See
U.C.C. § 3-603, comment 1.
"[The claimant's] only recourse, if his endorsement was procured by fraud or on an
illegal consideration . . . is against the endorsee. . . . The bank should not be thrust
against its will into the position of a contender with a third party whom it never knew,
with whom it had no dealings and for whose presence in the controversy the [claimant] ...
was solely responsible." Polotsky v. Artisans Say. Bank, 37 Del. 151, 160, 188 Ati. 63, 67
(Super. Ct. 1936). See also Kimbell Trust & Say. Bank v. Olsen, 239 Ill. App. 609 (1926).
71. Leary v. Citizens & Manufacturers Nat'l Bank, 128 Conn. 475, 23 A.2d 863
(1942) ; Henderson v. Lincoln Rochester Trust Co., 303 N.Y. 27, 100 N.E.2d 117 (1951);
General Am. Life Ins. Co. v. Stadiem, 223 N.C. 49, 25 S.E.2d 202 (1943). When a stop
order is issued by the drawer on behalf of the payee, however, the bank will be liable
to the payee if it fails to heed the stop order. Southern Bank & Trust Co. v. Whited, 25
 THE YALE LAW JOURNAL [Vol. 65 : 807

in paying his checks, 72 it is actually in the same dilemma as the maker of a

note. It would not be directly liable to the holder if it refused to pay the in-
strument, for a check generally does not operate as an assignment to the
holder of the debt owed to the drawer by the bank. 7 3 But refusal to pay a
properly presented check is a breach of duty to the drawer, which may subject
the bank to substantial damages for slander of credit.74 On the other hand,
payment to the holder will not necessarily discharge the bank. Although an
adverse claim may be ineffective as a stop order, it can constitute such notice
of defect in the holder's title that payment could not be "in due course" for pur-
poses of discharging the instrument. 75 Thus the adverse claimant would not
be barred from suing the drawer, who is secondarily liable on the check. 76 And
if the claimant should prevail, the bank would be liable to the drawer for a
7
wrongful charge to his account.
The Code changes existing law governing payee-holder disputes, but the
extent of the change is not clear. Under section 3-603 the payment in due
course requirement is eliminated ;78 payment to the holder would absolutely
discharge the instrument, entitling the drawee to charge its customer's ac-
count, 79 unless the adverse claim were accompanied by injunction or adequate
indemnity. It seems possible, however, that the bank may be able to pay the
holder and obtain discharge notwithstanding an offer of indemnity by the

Ala. App. 309, 145 So. 832 (1933) ; First Nat'l Bank v. Beier, 238 Iowa 280, 26 N.W.2d
853 (1947).
72. Allen v. Bank of America Nat'1 Trust & Say. Ass'n, 58 Cal. App. 2d 124, 127, 136
P.2d 345, 347 (1943) ; STEMN, COMMERCL AND INVESTIENT PAPER 648-49 (2d ed. 1954).
73. N.I.L. § 189; Marx v. Maddrey, 106 F. Supp. 535 (E.D.N.C. 1952); Hiroshima
v. Bank of Italy, 78 Cal. App. 362, 248 Pac. 947 (1926) ; Mountaineer Engineering Co. v.
Bassert, 133 W.Va. 668, 57 S.E.2d 633 (1950).
The holder will be permitted, however, to prove special circumstances indicating a
contrary intent. And if he proves that an assignment of the deposit in fact was made, the
drawee bank will be liable to him. Fourth Street Bank v. Yardley, 165 U.S. 634 (1897) ;
Jones v. Walsh, 194 Miss. 247, 11 So. 2d 908 (1943); Green v. Brown, 22 S.W.2d 701
(Tex. Civ. App. 1929); see 2 MORsE, BANKS AND BANKING §§ 492, 499, 500 (6th ed.
1928). The drawee may also incur a direct liability to the holder by accepting the check.
Southard v. Camden Nat'l Bank, 120 A.2d 221 (Me. 1956).
74. Jaselli v. Riggs Nat'l Bank, 36 App. D.C. 159 (1911); McFall v. First Nat'l Bank, 138
Ark. 370, 211 S.W. 919 (1919); Wildenberger v. Ridgewood Nat'l Bank, 230 N.Y. 425,
130 N.E. 600 (1921). But see Brown v. Bank of Minden, 167 La. 421, 119 So. 413 (1928).
75. N.I.L. §§ 88, 119; Llop v. First Nat'l Bank, 178 Misc. 436, 35 N.Y.S.2d 867 (Sup.
Ct. 1942). For a pre-N.I.L. decision to the same effect, see Public Grain & Stock Exchange
v. Kune, 20 Ill. App. 137 (1886). But cf. Polotsky v. Artisans Sa. Bank, 37 Del. 151, 188
Atl. 63 (Super. Ct. 1936).
76. N.I.L. § 61; Nielsen v. Planters Trust & Sax. Bank, 183 La. 645, 164 So. 613
(1935) ; see note 50 supra.
77. See, e.g., Silver v. Commonwealth Trust Co., 22 N.J. Super. 604, 92 A.2d 152 (L.
1952), sustained on rehearing,24 N.J. Super. 504, 94 A.2d 880 (L. 1953) ; Gates v. Bank
of America Nat'l Trust & Sav. Ass'n, 120 Cal. App. 2d 571, 261 P.2d 545 (1953). See
also Answers of First National Bank of Boston, N.Y. REPoRT 188, 192.
78. See note 26 supra.
79. U.C.C. § 4-401.
1956] ADVERSE CLAIMS

claimant. Section 4-203 of the Code provides that a bank can be given "notice"
only by its immediate "transferor." 80 If this section were taken at face value,
the claimant would seem unable to prevent payment to the holder except by
injunction. 8' However, it seems unlikely that section 4-203 will be construed
literally. There are statutory arguments for limiting the section to intermedi-
ary rather than depositary or payor banks. The section was primarily aimed
at facilitating the transmission of items between banks.8 2 The term "trans-
feror" could therefore be limited to another bank; this definition would ex-
clude the depositary bank from the immunity of the section, since its transferor
was the holder rather than another bank. "Transferor" could also be limited
to a bank not presenting for payment, on the theory that presentment is not a
transfer for payment ;83 this definition would exclude the payor bank, whose
transferor did present for payment. Furthermore, the courts may take the
view that, despite its language, section 4-203 simply was not intended to apply
to the adverse claim situation. There is authority for this position in the
"legislative history" of the Code.84 But if it was the intent of the draftsmen
thus to restrict section 4-203, their intent was not made clear in the language
of the section.
Article 4 should be amended to clarify the status of the adverse claimant
and provide a procedure consistent with the needs of bank collection and the
interests of the parties. Section 3-603, as has been seen, gives the claimant
overly adequate remedies.8, Section 4-203, however, if it were applied, would
not give him remedies enough: the injunction remedy is inadequate when, as
frequently happens, the holder is unknown or unavailable for service of pro-
cess. Section 4-203 does enact a chain of command theory which, between
banks, greatly facilitates the collection process; it should be retained to the
extent that adverse claims should not affect an intermediary bank, which could
80. "Subject to the provisions of Article 3 concerning restrictive indorsements and
subject to provisions of this Article concerning notice from prior indorsements ... only
a bank's transferor can give instructions which affect the bank or constitute notice to it
and a bank is not liable to prior parties for any action taken pursuant to such instructions
or in accordance with any agreement with its transferor." U.C.C. § 4-203, as amended
1955 Supp. (Italicized portions were added by the 1955 amendments.)
81. U.C.C. § 4-303(1) ; Morrison & Sneed, supra note 41, at 273; N.Y. ClearingHouse
Subcommittee, N.Y. REPORT 96, 101; Malcolm Letter, id. 133, 136; Brome Letter, id. 155,
158-59.
82. CLARKE & BAn.v 43-44.
83. "Transfer" is defined in U.C.C. § 3-201 as a process which vests in the transferee
such rights as the transferor had in the paper. Presentment for payment does not vest
rights in the paper but rather extinguishes any rights which the holder may have had.
Consequently, "transfer," used as a term of art, would exclude presentment for payment.
However, "transfer" is often used loosely to include presentment for payment. U.C.C.
§ 4-207(2) ; CLARIKE & BAILEY 57.
84. In answer to queries as to the effect of § 4-203 on adverse claims, note 81 supra,
the Code subcommittee on Article 4 read the section as based "on the normal situation"
and not including adverse claims within its scope. Thus according to the subcommittee a
bank would have to interplead as under existing law. 1955 Sutpp. 133-34.
85. See note 36 supra and accompanying text.
 THE YALE LAW JOURNAL [Vol. 65 :807

then rely wholly on the instructions of the bank which transferred the instru-
ment to it. But the payor bank should be subject to the proposed garnish-
ment remedy.8 6 In this way, the automatic character of the collection process
could be continued, subject to interruption only by legal notices with which
banks are already familiar,8 7 and the claimant could be assured of financial as
well as legal victory-if his claim is sound.

True Owner v. Drawer: Claims to the Deposit

A third type of adverse claim arises when the drawer has negotiated a check
and, before it is presented for payment, a third party who is a stranger to the
instrument claims a legal or equitable title to the underlying deposit superior
to that of the drawer-depositor. 88 The claimant may contend that the deposit
consists of proceeds wrongfully or mistakenly taken from him, 89 or that an
originally legal deposit is being diverted by the depositor, who is either a trus-
tee or an agent of the claimant ("true owner")9o His claim is not directly
against the holder, but it will, if heeded, prevent the holder from being paid
according to the terms of the check he holds.
Existing law, apart from statute, places the bank in a dilemma analogous
to that of the primary obligor under sections 88 and 119 of the Negotiable
Instruments Law. 91 The bank is under a contractual duty to the depositor not
only to pay his checks but also to protect his title.92 Refusal to honor the
check in deference to an adverse claim subsequently proved invalid is a breach
of duty to its customer, and would entail liability for slander of credit. 3 But
86. See note 38 supra.
87. See An.swers of First National Bank of Boston, N.Y. REPORT 188, 212; Communt,
51 YALE L.J. 986, 1008-09 (1942).
88. For the various situations in which adverse claims to bank deposits may arise see
Comment, 21 U. CHI. L. Rv. 135, 136-37 (1953); Comment, 51 YALE L.J. 986, 987-91
(1942).
89. See, e.g., Northwestern Upholstering Co. v. First Nat'l Bank & Trust Co., 193
Minn. 333, 258 N.W. 724 (1935) ; Fidelity & Cas. Co. v. First Nat'l Bank & Trust Co., 71
N.D. 415, 1 N.W.2d 401 (1941).
90. See, e.g., James Mills Orchard Co. v. Bank of America, 137 Cal. App. 299, 30 P.2d
626 (1934) ; Bank of Beaufort v. Commercial Nat'l Bank, 207 N.C. 216, 176 S.E. 734 (1934).
91. See note 20 supra and accompanying text.
92. See A. T. Albro Co. v. Union Dime Say. Inst., 15 App. Div. 351, 44 N.Y. Supp.
150 (1st Dep't 1897); Cole v. Canadian Bank of Commerce, 115 Ore. 456, 239 Pac. 98
(1925) ; Comment, 30 MARQ. L. REv. 54, 60 (1946). Upon notice of the adverse claim, the
bank must notify the depositor of the claim. Jaselli v. Riggs Nat'l Bank, 36 App. D.C. 159
(1911) ; cf. Detroit Say. Bank v. Burrows, 34 Mich. 153, 159 (1876).
93. See note 74 supraand accompanying text.
The bank would probably prefer to pay a check drawn by its depositor than to honor
the adverse claim. Comment, 51 YALE L.J. 986, 991, 1001 (1942) ; See Answers of First
National Bank of Boston, N.Y. REPORT 188, 203. However, the bank cannot resort to the
commercially desirable rule, adopted in England, that the contract between the bank and
the customer is of such importance that a claim to a deposit will not justify the dishonoring
of a check. Sims v. Bond, 5 Bar. & Ad. 389, 110 Eng. Rep. 834 (K.B. 1833) ; PA4.vf:T,
BANKING 188 (4th ed. 1930). Disputes in which the bank is involved in England must bo
1956] ADVERSE CLAIMS

the bank would be liable to the claimant in tort if it allowed withdrawals which
reduced the deposit below the amount of his claim and he subsequently proved
to be true owner.04 The bank's logical remedy, interpleader, may be denied if
the bank is independently liable to either party or has an adequate remedy at
law, or if the adverse claim is adjudged to have no "reasonable" foundation. 95
The case law today generally permits the bank to escape liability by compel-
ling the claimant to present indemnity or to take legal action within a rea-
sonable time ;96 indeed, the bank may take indemnity from either the drawer
or the claimant or bothY7 But a "reasonable time" standard has proved to
be a poor practical guide before litigation.98 To relieve the harshness and
uncertainty of the case law, many jurisdictions have enacted an adverse claim
statute with provisions similar to those of section 3-603 of the Code. 99 This
statute, however, explicitly excludes claims by beneficiaries of trust funds from
its operation. 100
referred to an arbitrator. Trustee Savings Bank Act, 1863, 26 & 27 Vicr., c. 87, § 48.
However, what might be deemed an adverse claim to bank deposits in this country may be
held to be only a dispute betveen the parties in which the bank should not be joined. Winter
v. Winter [1946] KB. 466 (C.A.).
94. Smith v. Security Bank &Trust Co., 196 Ark. 685, 119 S.W.2d 556 (1938); Trinity
Universal Ins. Co. v. First State Bank, 143 Tex. 164, 183 S.W.2d 422 (1944); 1 MoRSE,
BANK S AND BANKING § 343 (6th ed. 1928).
95. First State Bank v. Citizens State Bank, 10 F.R.D. 424 (D. Neb. 1950) (inde-
pendent liability) ; Baden Bank v. Trapp, 180 S.W.2d 755 (Mo. Ct. App. 1944) (adequate
remedy at law); Wall v. Wall, 181 S.W.2d 817 (Tex. Civ. App. 1944) (same); Citizens
Bank v. Middlebrooks, 209 Ga. 330, 72 S.,E.2d 298 (1952) (question of law must be reason-
ably debatable); White v. Bank of Angola, 130 Misc. 99, 223 N.Y. Supp. 508 (Sup. Ct.
1927) (bank must show claim was "substantial") ; cf. Mathot v. North River Bank, 16 N.Y.
Civ. Proc. 314, 6 N.Y. Supp. 498 (City Ct. 1889). See note 25 supra and accompanying
text.
96. Drumm-Flato Comm'n Co. v. Gerlach Bank, 107 Mo. App. 426, 81 S.W. 503
(1904) (reasonableness of time is jury question) ; Huff v. Oklahoma State Bank, 87 Okla.
7, 207 Pac. 963 (1922) (nine-day delay before payment to depositor allowed).
97. First Nat'l Bank v. Bache, 71 Pa. 213 (1872) ; Stair v. York Nat'l Bank, 55 Pa.
364 (1867) ; Comment, 51 YALE L.J. 986, 1006 (1942).
98. Comment, 21 U. Cm. L. Ray. 135, 140 (1953). For an excellent discussion of the
bank's dilemma, see Gendler v. Sibley State Bank, 62 F. Supp. 805, 811-13 (N.D. Iowa
1945).
The time element is considerably more material when the claim involves a checking
account than when it is made against a savings account. When the check is presented
through a clearing house, however, the bank may attempt to give itself more time by
sending the check back for later presentment, thus escaping a possible liability for wrongful
dishonor while it ascertains the validity of the claim. Comment, 51 YAI.E L.J. 986, 996
(1942).
99. An adverse claim statute recommended by the American Bankers Association has
been adopted, with modifications, in twenty-nine jurisdictions. 2 PATON, DIGEST 1657, 1658
(1942 ed.), § 6:3 (1955 Supp.). Under its terms, the bank is not affected by notice
of an adverse claim until the claimant has enjoined payment to the depositor or has in-
demnified the bank against any loss, including liability for wrongful dishonor of the de-
positor's checks.
100. This holds true for twenty-five of the twenty-nine jurisdictions which have adopted
the adverse claim statute; four make no explicit exception for fiduciary funds. MD. CODE
 THE YALE LAW JOURNAL [Vol. 65:807

The Code originally provided that an adverse claim to a deposit should not
affect the bank unless the claimant served the bank with a court order restrain-
ing payment.' 0' The present draft has eliminated this section, and apparently
leaves the problem as it exists under present law. The automatic discharge
provision of section 3-603 is by its own terms limited to claims "to the instru-
ment," and it seems unlikely that it will be applied to claims against an entire
deposit.' 0 2 It is even more unlikely that section 4-203 will be held to apply.'1"
In jurisdictions where an adverse claim statute has already been enacted, the
claimant would have to offer indemnity and the claim would then have the
effect of a stop-payment order. If there were no local statute, however, the
bank would probably be required to pay or refuse to pay at its peril. This
result would also obtain, whether or not there were a statute, whenever the
04
adverse claimant is the beneficiary of a trust.

Fiduciary Deposits and Constructive Knowledge of Adverse Claims: "Trute

Owner" v. Holder, Trustee or Agent
Notice imputed to a bank by law may operate as an adverse claim which
binds the bank more effectively than claims actually asserted. Funds repre-
sented by a check or bank deposit are often affected with a trust or agency
character. When a trustee or agent ("fiduciary"),1 ° 5 entrusted by a beneficiary
or principal ("true owner") with authority to manage his account, has abused
his authority by diverting the funds to his own use, 10 6 the true owner is seldom

ANN. art. 11, § 103 (Flack 1951); Miss. ANN. CODE § 5207 (1942); N.Y. BANKING LAw
88 134(5), 171(5), 239(5), 310(7a); S. DAi. CODE § 6.0416 (1939).
101. U.C.C. art. 3, § 748 (1948).
102. Under the 1948 draft, see note 101 supra, the section governing adverse claims
to bank deposits was separate from the section that is now § 3-603, see note 26 supra.
The elimination of the former section would more reasonably imply an intent to leave
existing law unchanged rather than to merge bank deposit claims into § 3-603. The tenor
of the comments to § 3-603 indicates that the section was intended to deal with claims
arising between an indorser and subsequent indorsees on the item, and not with claims
which have no particular reference to any item drawn.
103. See note 84 szupra and accompanying text.
104. See notes 100 supra, 105-19 infra and accompanying text.
105. Generally, under existing law, "trust" and "agency" funds are treated alike. See,
e.g., UNIFORM FIDUCIARIES Acr § 1 (agents, corporate officers, trustees are within the
definition of "fiduciary") (hereinafter cited as U.F.A.) ; Merrill, Bankers" Liability for
Deposits of a Fiduciary to His Personal Account, 40 HARv. L. Rsv. 1077, 1078 (1927).
However, some courts have sensed that the commercial nature of corporate accounts s.ts
them apart from noncommercial trust accounts. See Evans v. Prentice, 79 A.2d 3 9 6, 397
(D.C. Munic. Ct. App. 1951); Boston Ins. Co. v. Wells Fargo Bank & Union Trust Co.,
80 Cal. App. 2d 59, 64, 181 P.2d 84, 87 (1947). See, generally, BRITroN § 118; 5A MICHYF,
BANKS AND BANKING 130-73 (1950 ed.) ; 3 ScorT, TRuSTS §§ 321-24.5 (1939 ed.).
106. The diversion may take a number of forms. The fiduciary may either draw,
indorse or cash a check for his own use although the funds in truth are not his to use. A
special variation of the last two breaches of duty arises if the true owner, when he indors
the check, states in the indorsement that the indorsee is the true owner's trustee or agent
for collection. BRITTON § 67-71 (restrictive indorsements). Under N.I.L. § 37, a taker
 ADVERSE CLAIMS

aware of the act constituting the breach of duty until the drawee bank has paid
the instrument. 10 7 The true owner may, however, attempt to shift the loss to
the bank, alleging that the bank should be held liable to him as if it had been
given actual and timely notice of his claim. And he may succeed. Under exist-
ing law payment will not discharge the drawee bank from liability to the true
owner, even though the true owner has not directly asserted his claim, if the
drawee is deemed to have had actual or constructive knowledge of the fiduci-
08
ary's intended misappropriation.

after a restrictive indorsement can acquire only the rights of the first indorsee, and may
not become a holder in due course. First Nat'l Bank v. John Morrell & Co., 53 S.D. 496,
221 N.W. 95 (1928); Gulbranson-Dickinson Co. v. Hopkins, 170 Wis. 326, 175 N.W. 93
(1919). The 1952 draft of the U.C.C. reversed the N.I.L. and expressly provided that
subsequent takers could ignore the restrictive indorsement. U.C.C. § 3-206(c). See
Britton, Transfers and Negotiations Under the Negotiable Instruments Law and Article
3 of the Uniform Conmnercial Code, 32 TEXAs L. Rav. 153, 167-71 (1953). The 1955
amendments reverted somewhat to the N.I.L. The new provisions subject subsequent takers,
with the exception of intermediary and paying banks, to the rights of the restrictive in-
dorser. U.C.C. §§ 3-205 & comment, 3-206 (1955 Supp.). The discussion which follows does
not explicitly deal with, but is in most respects applicable to, the treatment of restrictive
indorsements.
107. Merrill, supra note 105, at 1093-96. The fiduciary's defalcations usually occur over
an extended period of time and are seldom discovered until most of the damage has been
done. See, e.g., Church of God in Christ v. Bank of Malvern, 212 Ark. 971, 208 S.W.2d
770 (1948). The true owner may have permitted the fraud over such a length of time that
he is deemed estopped from asserting his claim. See, e.g., McNutt Oil & Refining Co. v.
Mimbres Valley Bank, 174 F.2d 311 (10th Cir. 1949) ; Clark-Kelley Livestock Auction Co.
v. Pioneer Bank & Trust Co., 228 La. 224, 81 So. 2d 869 (1955).
108. Under the U.F.A. the drawee is liable for payment of a check if it knows of the
breach of trust, or if it has "knowledge of such facts that its action in paying the check
amounts to bad faith." U.F.A. §§ 7 (deposit in name of fiduciary as such), 8 (deposit in
name of true owner), 9 (deposit in fiduciary's personal account). "Good faith" is defined
in § 1(2) as honesty in fact, regardless of negligence.
The ultimate question of what circumstances will give the bank notice is one of fact.
Boston Ins. Co. v. Wells Fargo Bank & Union Trust Co., 80 Cal. App. 2d 59, 181 P.2d
84 (1947) ; American Surety Co. v. Trenton State Bank, 323 Mich. 276, 35 N.W.2d 260
(1948). Constructive notice may be imputed from a number of circumstances. See, e.g.,
Hartford Ace. & Indemnity Co. v. Bradley, 211 Ark. 1069, 204 S.W.2d 792 (1947) (know-
ledge that funds are held in trust puts bank under greater duty of surveillance) ; Lynch
v. Wells Fargo Bank & Union Trust Co., 114 Cal. App. 565, 300 Pac. 74 (1931) (same);
Torrence Nat'l Bank v. Enesco Federal Credit Union, 134 Cal. App. 2d 316, 285 P.2d
737 (1955) (overdraft creates duty to inquire into agent-drawer's authority) ; Risto v.
First Nat'l Bank, 314 I1l. App. 403, 41 N.E.2d 556 (1942) ("suspicious" circumstances) ;
Seaboard Surety Co. v. State Sav. Bank, 307 Mich. 48, 11 N.W.2d 321 (1943) (trust deposit
in contravention of statute puts bank on inquiry); Dunagan v. Bushey, 152 Tex. 630,
263 S.W.2d 148 (1953) (corporate charter gives bank notice of directors' authority).
Moreover, once a wrongful transaction has put the bank on inquiry, it may be on notice
as to subsequent diversions, however unrelated to the first. Fidelity & Deposit Co. v.
Farmers' Bank, 44 F.2d 11 (8th Cir. 1930), cert. denied, 282 U.S. 901 (1931). Contra,
Dockstader v. Brown, 204 S.W.2d 352 (Tex. Civ. App. 1947).
If the drawee bank has played a role beyond that of drawee only, e.g., receiving payment
as a creditor of the fiduciary, it will be liable to the true owner regardless of knowledge if
 THE YALE LAW JOURNAL [Vol. 65 :807

The Code seems to follow existing law although this type of adverse claim
is not specifically treated. A broad reading of section 3-603 would foreclose
recovery by the true owner unless he had indemnified the bank or enjoined
payment even if the bank had knowledge of a breach of trust.10 9 However,
section 3-603 applies only to claims "to the instrument." It can therefore be
interpreted to include only disputes between an indorser and subsequent in-
dorsees of an instrument, and not claims made by a beneficiary or principal
against an underlying deposit. 10 Because the claimant will seldom have an
opportunity to assert his claim before payment, I " it seems unlikely that the
courts will find a legislative intent to bind the true owner by a statute he will
generally be unable to utilize. Nor does section 4-203, which entitles a bank
to ignore any notice not given to it by its immediate transferor, make explicit
mention of trust or agency funds-if, indeed, it applies to adverse claims at
all."12 The drawee bank might well be reluctant to consider these generally
worded sections as overruling case law and relevant provisions of the Uniform
Fiduciaries Act."L3
Nevertheless, the same reasons which support section 3-603 (or the pro-
posed alternative of statutory garnishment)" apply with equal force in the
trust or agency situation. While it would be outrageous to require a bank to
pay a known swindler, the fact is that the bank does not know whether the
fiduciary is a swindler when he or his indorsee presents an instrument for pay-
ment. The knowledge upon which the bank's liability is predicated is knowledge
of the fiduciary's motives, imputed to it by a court of law long after payment
has occurred, and based upon knowledge of some of the fiduciary's acts which.
if inquired into, would have given the bank reasonable grounds to suspect a
misappropriation." 5 Thus the real question is whether the bank should be
under a duty to inquire, and to defer payment while inquiring, whether the
fiduciary really has breached his duty to the true owner.
This duty of inquiry is ill-suited to banking activities. The rapidity of the
collection process sharply restricts the time available to the bank for investi-

the deposit was in the name of the true owner or of the fiduciary denominated as such.
Ryan Bros. v. Curwensville State Bank, 382 Pa. 248, 114 A.2d 178 (1955) ; Dunagan v.
Bushey, supra; U.F.A. §§ 7, 8. When the deposit is in the personal account of the fiduciary,
however, the bank is liable only when it has actual knowledge of a breach of duty.
American Nat'l Bank v. National Indemnity Co., 222 F.2d 513 (8th Cir. 1955) ; Strong
v. City Nat'l Bank, 355 Pa. 390, 50 A.2d 323 (1947) ; U.F.A. § 9.
109. See note 26 supra.
110. See note 102 supra and accompanying text.
111. See note 107 supraand accompanying text.
1.12. See note 84 supra and accompanying text.
113. The possible conflict between Article 4 and the Uniform Fiduciaries Act has been
pointed out, but no solution has been offered. SuacommiTEE ON THE PROPOSEo UNIFORM
COMMERClAL CODE, PENNSYLVANIA ANNOTATIONS 99 (1952). U.C.C. § 10-102, the specific
repealer section of the Code, makes no mention of the U.F.A. However, under § 10-103,
inconsistent provisions of previous acts are repealed.
114. See notes 26,38 supraand accompanying text.
115. See cases cited at note 108 supra.
 ADVERSE CLAIMS

gation of possible claims, and even if unlimited time were available, the bank
would still be poorly equipped to ascertain the facts and decide the questions
of law involved.11 6 Admittedly the true owner is seldom able to detect a mis-
appropriation until it is too late to avoid it. Nevertheless, it was the true
owner who trusted the fiduciary, and it should be his responsibility to enforce
that trust. The remedies available to him for preventing diversions are at once
more effective and more readily utilized than those available to the bank.
Bonding and countersigning requirements, for example, are the most effective
methods of guarding against possible defalcations at the source."17 M\oreover,
the true owner may recover from parties that have given value to the fiduciary
by taking his check." 8 These considerations suggest that the statutory garnish-
ment suggested as an alternative to section 3-603 should be applied to prevent
constructive notice of this type of adverse claim. The bank, which acts only as
a conduit, should be under a duty of care to the depositor, but not a duty of
vigilance over his activities. The presumption that a fiduciary will act in con-
formity with his trust," 9 combined with the nature of the bank collection pro-
cess, should relieve the bank from liability for "knowledge" based upon sus-
picion or upon hypothetical inquiries which the bank is in no position to make.

ARTICLE 8: STOCK TRANsFERs

The nature of the stock transfer transaction suggests a treatment of ad-
verse claims similar to that given claims against a drawee bank.' 20 The duty
of a corporation to register the transfer of securities is generally delegated to

116. Kinstlinger v. Manufacturers Trust Co., 280 App. Div. 729, 734, 1.17 N.Y.S.2d
147, 151 (1st Dep't 1952) ; see text at note 29 supra.
117. Note, 25 ILL. L. RLv. 298, 302 (1930). But see Merrill, supra note 105, at 1095.
118. U.C.C. § 3-304(2) (b). This would also include a drawee bank of deposit which
with knowledge of the trust nature of the funds set off the fiduciary's personal debt against
his deposit. See note 108 supra.
119. American Security Co. v. Waggoner Nat'l Bank, 83 F.2d 99 (5th Cir. 1936)
Citizens Bank v. Middlebrooks, 209 Ga. 330, 72 S.E.2d 298 (1952) ; Bischoff v. Yorkville
Bank, 218 N.Y. 106, 111, 112 N.E. 759, 760 (1916) ; New Amsterdam Cas. Co. v. Robert-
son, 9 Ore. 663, 669, 278 Pac. 963, 965 (1929) ; Comment, 45 MICH. L. Rxv. 78, 86 (1-946).
120. CHRISTY & McLEAN, THE TRANSFER OF STOCK §§ 7-8 (2d ed. 1940) (hereinafter
cited as CHRIsn & McLFAN). All securities governed by Article 8 are negotiable under
§ 8-105(1). Under the Code, as under existing law, a transfer of securities is effective as
between the owner of record and the purchaser upon delivery to the latter. U.C.C. § 8-307;
Cunningham v. Schmitz, 137 Cal. App. 2d 640, 290 P.2d 937 (1955). The issuer need not
consider the transferee as owner of the security until the transferee has registered the
transfer with the issuer under § 8-207(1) ; but it is under a duty to register a valid trans-
fer as an incident df the stockholder's inherent right to transfer the stock as he might any
other property. Wentworth v. Russell State Bank, 167 Kan. 246, 205 P.2d 972 (1949)
Compania de Astral, S.A. v. Boston Metals Co., 205 Md. 237, 107 A.2d 357 (1954);
CHRusTY & McLEAN § 36. Thus the issuer, presented with a request for registration of
transfer, is a true stakeholder: it admits a duty to the true owner of the security to pay
dividends, recognize voting rights, and so on. U.C.C. §§ 8-102(1) (c), 8-207; BALLANTINE,
CORPORATIWO S 753-55 (rev. ed. 1946) ; CHRISTY & McLEAN §§ 30-31.
 THE YALE LAW JOURNAL [Vol. 65:807

banking institutions designated transfer agents.' 21 Transfer agents deal with

large numbers of registrations under circumstances which would warrant al-
most as automatic a rule as that sought in bank collections. 22 Since securities
are ordinarily purchased through stockbrokers, the incidence of holders in due
course is high.' 23 The resulting likelihood that most adverse claims will not be
successful suggests a strong need for protection against invalid claims.
Existing law has nevertheless placed the transfer agent, confronted with an
adverse claim, 124 in as precarious a situation as that of the payor of commer-
cial paper. 125 He will be liable to the holder if registration of transfer is
wrongly refused, 126 and liable to the claimant if the claim proves justified after
registration. 27 Seldom equipped to ascertain either the validity of the claim

121. BERLE & WARREN, BUSINESS ORGANIZATIONS 250-51 (1948) ; CHRISTY & McLEAN
§ 279; see Behrends & Elliott, Responsibilities and Liabilities of the Transfer Agent and
Registrar, 4 So. CALIF. L. REv. 203, 205 (1931). "Transfer agent" is used hereinafter to
include the "issuer." Section 8-406 of the Code places the transfer agent under the same
duties as an issuer.
122. See U.C.C. § 8-314, comment. For a description of the registration process, see
DIcE & EITEMAN, THE STOCK MARKET 300-01 (3d ed. 1952).
123. TEXAS LEGISLATIVE COUNCIL, ANALYSES OF ARTICLE 8 OF THE UNIFORM COM-
mEClAL CODE 54 (1954) ; see U.C.C. § 8-204, comment 1. The transferee of a security
seldom sees the old security; thus he can rarely be deemed to have had notice of claims
against the security. U.C.C. §§ 8-31.1, comment 1; 8-314, comment 1; Walker, U.C.C.
Article 8-Investment Securities, 14 OHIO ST. L.J. 57, 63 (1953). Moreover, brokerage
firms deal with hundreds of securities daily; they seldom have the opportunity to examine
their files for notices of claims which they may have received. The Code has set limits
beyond which brokers are allowed to "forget" such notices and still be deemed bona fide
purchasers for value. U.C.C. § 8-304 & comment 3.
124. Two types of claims are to be distinguished. The first is based on an allegation
which, if true, would render the transfer nugatory. Forgery is an example. For a discus-
sion of the Code solution to the forgery question, see Note, 103 U. PA. L. REv. 209, 216-
22 (1954). Another and more troublesome type of claim is one which involves a fraud or
a breach of fiduciary obligation, resulting in a voidable transfer. Christy, Responsibilities
in the Transfer of Stock, 72 BANKING L.J. 761, 765 (1955).
125. See note 20 supraand accompanying text.
The duty placed on the corporation has been likened to one of trust. See, e.g., Lowry
v. Commercial & Farmers' Bank, 15 Fed. Cas. No. 8581, at 1047 (C.C.D. Md. 1848) ("The
corporation is thus made the custodian of the shares of stock, and clothed with power suffi-
cient to protect the rights of every one interested, from unauthorized transfers . . . !").
See also Seymour v. National Biscuit Co., 107 F.2d 58, 63 (3d Cir. 1939), cert. denied,
309 U.S. 665 (1940).
126. Hertz v. Record Publishing Co., 219 F.2d 397 (3d Cir.), cert. denied, 349 U.S.
912 (1955) ; Jones v. Osage Oil & Refining Co., 280 Fed. 696 (2d Cir. 1922) ; Virginia
Pub. Serv. Co. v. Steindler, 166 Va. 686, 187 S.E. 353 (1936).
127. Seymour v. National Biscuit Co., 107 F.2d 58 (3d Cir. 1939), cert. denied, 309
U.S. 665 (1940); Wilson Lumber Co. v. McAllister, 101 F.2d 709 (9th Cir. 1939); Fiala
v. Connecticut Elec. Serv. Co., 114 Conn. 172, 158 Atl. 211 (1932) ; Dewey, The Transfer
Agent's Dilemma: Conflicting Claims to Shares of Stock, 52 HARv. L. REv. 553, 558-67
(1939). The transfer 4gent may deny registration for a "reasonable" time in order to make
an investigation, but this standard has given little certainty. Note, 103 U. PA. L. REv.
209, 215 (1954) ; cf. note 98 supra and accompanying text.
19561 ADVERSE CLAIMS

or the bona fides of the holder's purchase, 128 transfer agents have sought to
protect themselves by imposing cumbersome safeguards to establish the right-
fulness of transfers. These private safeguards have slowed and complicated
129
the procedures by which shares are registered.
The 1955 amendments to the Code sought to answer criticism leveled at
earlier drafts which had substantially incorporated the difficulties of present
law.' 30 Section 8-403 as amended contains an adverse claim provision funda-
mentally similar to section 3-603.131 Upon notice of a claim to an interest in

128. See Note, 103 U. PA. L. REv. 209, 215 (1954) ; Harper's Magazine, Jan. 1956,
p. 34.
129. CHmSTY & McLEAN 7; U.C.C. § 8-402, comment 1. The obstacles imposed by
the transfer agent in an attempt to assure himself of the rightfulness of the transfer have
also handicapped the management of trust estates. Scott, Participation in a Breach of
Trust, 34 HARV. L. RPv. 454, 466 (1921). Although § 3 of the Uniform Fiduciaries Act
relieves the transfer agent of liability unless he has actual knowledge of a breach of trust,
transfer agents have not always been able to rely on this provision. See Note, 103 U. PA.
L. REv. 209, 211 n.17 (1954). And because of the large number of requests for registration
under circumstances which may give rise to adverse claims, a resort to interpleader would
be impracticable. Dewey, supranote 127, at 577-78.
The result in practice has been to allow the claimant to provide indemnity to the trans-
fer agent while the former obtains legal process. CHRIsTY & McLEAN 403. Another alter-
native has been insurance against improper payment. Christy, Responsibilities in the
Transfer of Stock, 72 BANKING L.J. 761, 762 (1955). The Code has attempted in several
respects to facilitate transfer. Section 8-312 allows the transfer agent to rely upon signature
guarantees, thus making it unnecessary to look into possible claims of forgery or legal
incapacity. Sections 8-402(2) (a) - (g), as amended 1955 Sum'., limit the evidence which
the transfer agent may require to prove the rightfulness of the transfer.
130. Israels, Article 8-Investmwnt Securities, 16 LAW & CONTEMP. PROB. 249, 262
(1951). For an excellent comparison of existing law with the Code in this respect, see
Note, Duties and Liabilities of the Stock Transfer Agent Under the Uniform Commercial
Code, 103 U. PA. L. REv. 209 (1954).
131. U.C.C. § 8-403, as amended 1955 Supp., reads as follows:
"(1) Where a security presented for registration is fully indorsed for transfer,
the issuer is under no duty to inquire into the rightfulness of the transfer unless he
has notice of another claim to an interest in the security. In such event he may dis-
charge the duty of inquiry by any reasonable means, including notifying the adverse
claimant by registered mail ... that the security has beeh presented for registration
of transfer by a named person, and that such transfer will be registered unless with-
in fourteen days... the claimant either
(a) procures an appropriate restraining order, injunction or other process from
a court of competent jurisdiction in a cause therein instituted by the claimant
wherein the person who has presented the security for registration of transfer is
made a party and served with summons; or
(b) files with the issuer an indemnity bond sufficient to protect the [transfer
agent] . . . from any loss which it or they may suffer by complying with such
adverse claim.
"(2) The fact that the issuer has notice that the security is held for a third per-
son or is registered in the name of or indorsed by a fiduciary does not create a duty
of inquiry into the rightfulness of the transfer. If, however, the issuer has notice
 THE YALE LAW JOURNAL [N701. 65:807

the security, 132 the transfer agent is under a duty to inform the claimant when
the security is presented for registration.1 33 The claimant is allowed two
weeks after notification to take legal action against the holder or to indemnify
134
the transfer agent against harm resulting from continued refusal to register.
The new section is, however, open to the objections which have been made
against section 3-603.- 3 5 Logical extension of the presumptions afforded the
holder requires that he be entitled to registration of transfer unless the adverse
claimant undertakes to prove his claim in court, yet the indemnity feature of
section 8-403 places upon the holder the burden of initiating litigation.
The statutory garnishment previously proposed' 31 could not be utilized in the
stock transfer situation, since the stakeholder's duty is one of service rather
than payment; there are no proceeds to garnishee until presentment. The most
feasible alternative would be a temporary injunction against the transfer agent
requiring him to notify the claimant at presentment and restraining registra-
tion on condition that the claimant bring suit within twenty-four hours. This
is swifter than, but generally equivalent to, the injunction provision in section
8-403. The indemnity provision should be eliminated, 137 since, in a context
where bona fide purchasers are commonly found 133 and are given a high de-
gree of protection, 13 9 the burden of bringing suit should be on the claimant.
A further criticism of the Code provision is that the transfer agent may be

that . .. the transaction is for the individual benefit of the fiduciary, the issuer is
under a duty to inquire into the rightfulness of the transfer."
Compare CAL. CoRe. CoDE ANN. § 2410 (1953), under which the corporation may trans-
fer the stock on its books unless the claimant (1) gives written notice of his claim; (2)
provides indemnity within five days after notice; and (3) begins an action within sixty
days after giving notice of his claim.
132. It is not clear what kinds of claims fall within the meaning of "claim to an in-
terest in the security." Resort to prior law would be necessary to determine exactly what
claims are encompassed. It seems likely that insufficiency of consideration, breaches of
pooling or option agreements, and certain types of fraud will not be held to be included.
Note, 103 U. PA. L. REv. 209, 222-27 (1954). If adverse claims are to be given recognition
at all, however, and if the danger which uncertainty creates to the transfer agent is to be
removed, these claims, which are disputes between the parties going to the validity of the
underlying transaction, should also be included.
133. Failure to do so will result in the liability of the issuer to deliver a like security
to the claimant if the claim is substantiated. U.C.C. § 8-404.
134. Under § 8-401 the transfer agent must register the transfer and would presumably
be liable for a wrongful refusal to transfer. See §§ 8-401, comment 1; 8-406, comments 1, 3.
However, the transfer agent is under -noobligation to register if he has notice of an adverse
claim by the provisions of § 8-401 (1) (b). Therefore, the Code may be construed to prevent
liability for refusal to transfer upon notice of an adverse claim, even without an indemnity
bond, at least for a two-week period.
135. See text at notes 30-37 supra.
136. See note 38 sufpra and accompanying text.
137. Cf. ONTARMO CORORATIONs AcT c. 19, § 50 (1953).
138. See note 123 supraand accompanying text.
139. Walker, supra note 123, at 58-59; Israels, supra note 130, at 252.
1956] ADVERSE CLAIMS

given constructive notice of an adverse claim. Section 8-403(2) subjects the

transfer agent to a duty of inquiry upon actual or constructive notice of a
breach of trust. He would therefore be liable for failing to send notice to a
potential adverse claimant whenever, in retrospect, the surrounding circum-
stances can be used to impute knowledge to him. 140 Moreover, it is not clear
whether the transfer agent could discharge a duty of inquiry thus arising, even
if he knew it existed, by informing the beneficiary of presentment and requir-
ing indemnity or legal process under the provisions of subsection 8-403(1).
It is possible that he must actually make the type of investigation deemed
impracticable for payors of commercial paper. 141 But a similar result should
obtain whether or not the adverse claim is based on an alleged breach of trust.
Fiduciaries ordinarily are faithful to their duties,'142 and beneficiaries of trusts
can be better protected by other and more efficient means. 1 43 Therefore,
whether a trust is involved or not, the registration of transfer should be auto-
matic unless an adverse claimant takes affirmative action to protect his right
to sue on his claim.

ARTICLE 5: DOCUMENTARY LETTERS OF CREDIT

A documentary letter of credit is a promise made by a bank to a seller of
goods on behalf of the buyer. 4 4 The promise provides that the bank will pay

Under § 8-301 (2) the bona fide purchaser receives a perfect title to the security; he
takes free of adverse claims under § 8-315(1), as well as claims of forgery under § 8-311,
if he has received a new registered security. See also §§ 8-202(1) (restrictions not on
security), 8-202(4) (defense of nondelivery or conditional delivery), 8-205 (issuer may be
estopped from asserting forgery) and 8-206 (altered or fraudulently completed security).
140. See note 131 supra. Constructive notice is included within the meaning of "notice"
under U.C.C. § 1-201(25) (c). For a discussion of constructive notice under existing law,
see Hazzard v. Chase Nat'l Bank, 159 Misc. 57, 74, 287 N.Y. Supp. 541, 559 (Sup. Ct.
1936). Compare U.F.A. § 3 which limits the transfer agent's liability to cases of registra-
tion in bad faith.
141. Under a similarly phrased adverse claim statute to bank deposits, beneficiaries
of trusts are not required to provide indemnity or to obtain legal process. See note 100
supra and accompanying text.
142. Israels, supra note 130, at 265. See note 119 supra and accompanying text.
143. Bunn, Article 8-A Law for the Transfer of Investment Securities, 1952 Wis.
L. REv. 339, 346. See notes 117-18 supra and accompanying text. The beneficiary's rights
against purchasers are set forth in § 8-304 (2), which charges a purchaser with notice of a
breach of trust if value for a security held in trust is given in cash or otherwise to the
fiduciary individually. U.C.C. § 8-315(1) allows a claimant to reclaim possession of the
security against the holder if the transfer was wrongful, unless the latter is a bona fide
purchaser for value. Subsection (3) provides for an injunction against further transfer,
or, if possible, impounding of the security.
144. See Gilmore, The Commercial Doctrine of Good Faith Purchase,63 YALE L.J.
1057, 1108-09 (1954). Typical credit forms are set out in BRAucHER, SUTHERLAND & WILL-
COX, COMMERCIAL TRANSACTIONS 196-207 (1953). For discussions of variants of the basic
pattern of the letter of credit, see WARD & HARFIELD, BANK CREDITS AND ACCEPTANCES
10-17 (3d ed. 1948) (hereinafter referred to as WARD & HAmELD) ; McCurdy, Conmner-
 THE YALE LAW JOURNAL [Vol. 65:807

the purchase price of the sale by honoring drafts drawn upon it by the seller
on condition that the drafts be accompanied by specified shipping documents
which indicate that the seller has delivered the goods for which the buyer bar-
gained.' 4 5 Generally accepted case law and thought treat the letter of credit as
a transaction of documents, not of goods: the underlying sales contract is
theoretically not in issue.146 The adverse claim situation demonstrates, how-
ever, that the documents are the connecting link between the sales contract
1 7
and the credit, and that in practice the two cannot be completely divorced.
Thus, the claim against the right of the holder to payment generally arises as
a buyer-seller dispute: the buyer will order the bank not to pay drafts issued
under the credit when he believes that the documents demonstrate the seller's
breach of the underlying sales contract. The buyer's contentions may be in

cial Letters of Credit, 35 H.Av. L. Rav. 539, 542-43 (1.922). For a brief history of the letter
of credit, see Trimble, The Law Merchant and the Letter of Credit, 61 HARv. L. Ray. 981
(1948).
The letter of credit has major commercial advantages. One is that banks offer the ser-
vice at a rate of about 'A of 1% of the face value of the credit. Harfield, Article 5-Trade
Without Tears, 1952 Was. L. Rav. 298, 299-300. Another is that the seller can rely on the
promise of a bank rather than that of a buyer. This advantage is particularly significant
when the bank's promise is irrevocable, as is generally the case in commercial transactions.
U.C.C. § 5-105 provides that a credit is revocable unless otherwise stated. Even if revoca-
ble, however, the credit may not be changed or cancelled after it has been honored or drafts
have been negotiated under it. U.C.C. § 5-106(2) (c). In the following discussion it is
assumed that an irrevocable credit has been issued by a bank, or that if a revocable credit
was involved it has subsequently been sealed by honor or negotiation.
145. The documents required may vary with each credit, but usually include sellers'
invoices, bills of lading, and, in international transactions, consular invoices and weight and
insurance certificates. See, e.g., North Woods Paper Mills, Ltd. v. National City Bank,
121 N.Y.S.2d 543 (Sup. Ct. 1.953).
146. U.C.C. § 5-102(1); WARD & HAPFIELD 7; INTERNATIONAL CHAMBER OF COM-
MERCE, UNIFORM CUSTOMS AND PRACTICE FOR C0MERCIAL DOCUMENTARY CREDITS art.
10 (rev. ed. 1951) (hereinafter referred to as ICC CusTo-ms). Thus the bank is excused
from honoring the draft only when the documents fail to conform to the terms of the credit.
U.C.C. § 5-107(1) ; Banco Nacional v. Bank of America, 118 F. Supp. 308, 310 (N.D. Cal.
1954) ; Bank of East Asia, Ltd. v. Pang, 140 Wash. 603, 249 Pac. 1060 (1926). For the
transaction is solely between the issuing bank and the seller or holder of the draft; if the
buyer has a defense on the underlying sales contract, his remedy must be asserted directly
against the seller. American Steel Co. v. Irving Nat'l Bank, 266 Fed. 41 (2d Cir. 1920),
cert. denied, 258 U.S. 617 (1922) ; Grob v. Manufacturers Trust Co., 177 Misc. 45, 29
N.Y.S.2d 916 (Sup. Ct. 1941) ; Consolidated Sales Co. v. Bank of Hampton Roads, 193
Va. 307, 68 S.E.2d 652 (1952). But see Soci~t6 M~tallurgique v. British Bank for Foreign
Trade, 11 Lloyd's List L.R. 168, 170 (K.B. 1922). In addition, the issuing bank may not
raise as a defense to the draft any claim or defense it would have vis-A-vis the buyer. Cf.
Asbury Park & Ocean Grove Bank v. National City Bank, 35 N.Y.S.2d 985, 989 (Sup.
Ct. 1942).
147. See Asbury Park & Ocean Grove Bank v. National City Bank, supra note 146,
at 989; FINxELsTEIN, LEGAL ASPECTS OF CoMMRmCIAL LETTERS OF CREDIT 223-24 (1930)
(hereinafter refered to as FINKELSTEIN) ; McCiirdy, supra note 144, at 724; notes 157-59
infra.
 ADVERSE CLAIMS

good faith, but may often reflect an attempt to avoid the consequences of a fall-
ing market.148
The contemplated extension of the letter of credit form to domestic com-
merce will often bring a new party into the dispute. Today, the bank issu-
ing a letter of credit generally is indifferent to the sales contract; the bank
is used primarily to facilitate the mechanics of large-scale international deal-
ings. 140 But the domestic letter of credit,' in addition to assuring the seller
of payment, 151 will also be more frequently used to finance the buyer's end
of the sales transaction: the issuing bank will retain a security interest in
the underlying goods. 15 2 Thus the buyer's claim that the goods are defective
148. See, e.g., Maurice O'Meara Co. v. National Park Bank, 239 N.Y. 386, 146 N.E.
636 (1925); FINKELSTEIN 231; Note, 65 HAv. L. REv. 1420, 1424 (1952). The bulk of
letter of credit litigation arose after the break in the sugar market following the end of
World War I. See, e.g., Moss v. Old Colony Trust Co., 246 Mass. 139, 140 N.E. 803 (1923).
Absent a price break, the buyer will generally accept indemnity against apparent noncon-
formity between the documents and credit rather than attempt to avoid the entire trans-
action. See Dixon, Irmaos & Cie, Ltda. v. Chase Nat'l Bank, 144 F.2d 759 (2d Cir. 1944),
cert. denied, 324 U.S. 850 (1945).
149. See U.C.C. § 5-111, comment 2. Nine-tenths of international sales transactions
are financed by letters of credit. Note, 65 HARV. L. REv. 1420 n.2 (1952). Approximately
twenty-five banks in the United States handle over 75% of the volume of credit trans-
actions. Chadsey, Practical Effect of the Uniform Commercial Code on Documentary
Letter of Credit Transactions,102 U. PA. L. REv. 618, 620 (1954).
150. Prior to the war, the letter of credit had very limited use in domestic commerce.
See Chadsey, supranote 149, at 620; Harfield, supra note 144, at 302; note 149 supra. Al-
though domestic letters of credit are still in an experimental stage, the postwar period has
witnessed a substantial increase of the credit form in many phases of domestic commerce.
Dougan & Calkins, Documentary Letters of Credit, 15 OHIo ST. L.J. 33 (1954) ; Gilmore,
Chattel Security: II, 57 YA.E L.J. 761, 765 (1948). For examples of some instances in
which letters of credit have seen use in domestic transactions, see Consolidated Sales Co.
v. Bank of Hampton Roads, 193 Va. 307, 68 S.E.2d 652 (1952) (electrical appliance financ-
ing) ; McGOWAN, TRUST RacEin s 14, 15 (1947).
151. See Block v. Pennsylvania Exchange Bank, 253 N.Y. 227, 230-32, 170 N.E. 900,
901 (1930) ; note 144 supra. The assurance of payment under the credit has special signi-
ficance in so far as it enables the seller to discount the draft as soon as the goods are shipped
or the draft is accepted, and thereby finance his enterprise. Maurice O'Meara Co. v. Na-
tional Park Bank, 239 N.Y. 386, 397, 146 N.E. 636, 639 (1925) ; WARD & HwarIsE 25-26.
152. FiNKELSTEIN 230.
The usual procedure is for the buyer to provide collateral security guaranteeing reim-
bursement to the issuing bank before the credit is issued. The issuing bank then requests
reimbursement one day before payment of a draft it has accepted. This practice is codified
in U.C.C. § 5-107(2). If the draft is a time draft, the buyer is given the time between
acceptance and payment in which to raise the proceeds for reimbursement.
The buyer frequently pledges the goods bargained for as security for reimbursement.
The documents then arrive made out to the order of the issuing bank; as long as the bank
retains control over the documents, the letter of credit is, in a sense, self-securing. The
bank may also release the documents to the buyer in exchange for trust receipts to insure
its loan; the buyer then sells the goods, using the proceeds to pay its debt to the bank.
See, e.g., Gidden v. Chase Nat'l Bank, 82 N.Y.S.2d 341, 342 (Sup. Ct. 1948). This proce-
dure seems to be gaining favor as a method of floor-financing. See, e.g., Consolidated Sales
Co. v. Bank of Hampton Roads, 193 Va. 307, 68 S.E.2d 652 (1952).
 THE YALE LAW JOURNAL [Vol. 65 :807

will provide the bank with strong motives for resisting payment to the holder.
Even when it has no security interest in the goods, the bank's decision may
also be influenced by "outside" considerations. Where the bank is primarily
concerned with preserving its credit standing with confirming or negotiating
banks, it may be more inclined to pay.1 53 Especially in domestic commerce.
however, the buyer may be a regular customer of the issuing bank :154 his dis-
satisfaction with the sales contract may put the bank under considerable eco-
nomic pressure to refuse payment. 15 Conversely, the bank may have been
selected by the seller, who may exert a similar type of pressure to compel pay-
ment.1 56
Commercial policy dictates that when a draft has been issued or accepted
pursuant to the terms of the credit, the interests of both the buyer and the
issuing bank should be subordinated to the interests of the seller and the
holder presenting the draft. 157 The letter of credit is primarily a seller's device,
intended to insure the seller against the insolvency of an unknown buyer and

153. In international commerce, the issuing bank has usually obtained collateral securi-
ty from the buyer to assure it of reimbursement. With no security interest in the goods
immediately involved, the issuing bank will seek to pay the instrument rather than lose its
credit rating with other banks which have discounted the seller's draft. FINKELSTEIN 219:
U.C.C. § 5-111, comment 2. But cf. Trimble, supra note 144, at 1008.
154. A buyer in need of credit will ordinarily have to deal with his local bank rather
than a large metropolitan bank. Generally, the buyer arranges it so that the local bank
obtains a letter of credit in his favor from a large bank. See, e.g., Asbury Park & Ocean
Grove Bank v. National City Bank, 35 N.Y.S.2d 985 (Sup. Ct. 1942). Under the Code it
is also possible for the local bank to issue the credit directly, with the large bank "con-
firming" it (i.e., adding its irrevocable promise to that of the local bank). U.C.C. § 5-103,
comment 4. For existing confirmation practice, see WARD & HAFELD 25, 28-29.
155. Id. at 150; Comment, 63 HxAv. L. Rav. 1373, 1377 (1950). The issuing barok
generally notifies the buyer when the draft arrives for payment or acceptance; the buyer
may then raise any objections he has to payment. It has been suggested that the bank my
even be undetr an obligation to consult with the customer before payment. Comment, 62
YALE LJ. 227, 249 (1953).
156. WARD & HARFiD 59; see note 153 supra and accompanying text.
157. See Continental Nat'1 Bank v. National City Bank, 69 F.2d 312, 316 (9th Cir.),
cert. denied, 293 U.S. 557 (1934) ; Frey & Son, Inc. v. Sherburne Co., 193 App. Div. 849,
854, 184 N.Y. Supp. 661, 664 (1st Dep't 1920) ; Chadsey, supra note 149, at 624; Harfield,
supra note 144, at 309; Comment, 63 HARv. L. Rav. 1373, 1377 (1950) ; Note, 55 HARv. L.
REv. 878, 880 (1942). But see Campbell, Guaranties and the Suretyship Phases of Letters
of Credit, 85 U. PA. L. Ray. 175, 260, 272 (1936). The contrast between the commercial
need to protect the seller and the interest of the bank in protecting its security interest is
perhaps best brought out in the majority and minority opinions of the New York Court of
Appeals in Maurice O'Meara Co. v. National Park Bank, 239 N.Y. 386, 401, 146 N.E. 636.
641 (1925).
Although the bank with a security interest would have an interest in ascertaining the
conformity of the goods, the requirement that it act only on the face of the documents is, in
the long run, to the bank's advantage. A contrary rule would inevitably involve the bank
in technical disputes over the quality of the goods, forcing it into inquiries which it is sel-
dom equipped to make. Kingdom of Sweden v. New York Trust Co., 197 Misc. 431, 450,
96 N.Y.S.2d 779, 795 (Sup. Ct. 1949) ; Note, 29 ILL. L. Rv. 806, 809 (1935).
19561 ADVERSE CLAIMS

to guarantee prompt and sure payment.'5 8 In order to finance his enterprise,

the seller will probably discount the draft at his bank, which, having relied on
the credit, will present the draft to the issuing bank for payment. 15 9 If the
letter of credit form is to attain any degree of significance in domestic com-
merce, the discounting bank, which has almost invariably acted in good faith, 16'
must be protected. The efficacy of the documentary letter of credit as a means
of financing domestic transactions depends on the confidence with which
holders may rely solely on the terms of the credit and the documents in-
volved.' 0 '
The Code provisions fail to effectuate these policies sufficiently. Section
5-111(1) 162 recognizes the importance of free negotiability in the letter of
credit context, and places the burden of litigation on the buyer. He may pre-
vent payment only by procuring an injunction based upon allegations of

158. See Hibernia Bank & Trust Co. v. J. Aron & Co., 134 Misc. 18, 22, 233 N.Y.
Supp, 486, 490-91 (Sup. Ct. 1928) ; authorities cited note 151 supra.
159. The seller may need funds immediately, and so will often discount the draft rather
than present it himself for payment. See note 151 supra. The letter of credit may be for
"acceptance," the issuing bank accepting the draft upon presentment of the documents.
Before acceptance, of course, every holder bears the risk that the documents may not con-
form to the terms of the credit. After acceptance, however, the draft becomes "prime"
paper which the seller can more easily discount. See Dougan & Calkins, supra note 150,
at 34. Theoretically, neither buyer nor bank may then challenge the sufficiency of the docu-
ments, but buyer may attempt to stop payment by alleging that the goods are so different
from the description in the documents that fraud may be inferred. See notes 148 supra,
161, 171 infra.
160. AVRD& HARiUELD 22-24.
161. Correcting adverse claims defects will accomplish little if the Code allows the
buyer to sustain his claims indirectly by asserting a technical nonconformity of the docu-
ments to the highly detailed terms of the credit. It is almost always possible to find tech-
nical defects in the documents presented with the draft; when the market has fallen, the
buyer, and often the bank if it has retained a security interest in the goods, will be anxious
to assert these irregularities. See note 148 supra. The Code provides, however, that the
issuing bank is not necessarily under an obligation to accept an offer of indemnity against
harm resulting from even technical nonconformity of the documents; it leaves the problem
largely to banking custom. U.C.C. §§ 5-102, 5-113. This indefiniteness is the result of the
draftsmen's views that a too elaborate set of rules might freeze commercial development,
or, more likely, would rapidly become obsolete. Dougan & Calkins, supra note 150, at 40.
See also Gilmore, On the Difficulties of Codifying Commercial Law, 57 YALE L.J. 1341,
1356-59 (1948) ; Moss v. Old Colony Trust Co., 246 Mass. 139, 151, 140 N.E. 803, 807
(1923). But see Comment, 62 YALE L.J. 227, 262 (1953) (pointing out the need for more
ascertainable criteria).
162. "Unless otherwise agreed
(1) A bank which has issued or confirmed a credit is not excused from honor or re-
imbursement by the fact that the goods or documents do not conform to the underlying
contract for sale ... ; but in the event of forgery or fraud in a required document, a court
of appropriate jurisdiction may enjoin the issuing or confirming bank from honoring or
reimbursing unless such honor or reimbursement is demanded by a paying, accepting, or
confirming bank which has acted in good faith in reliance on the document or by a negotiat-
ing bank or other endorsee of a draft which is a holder in due course and acts under a
credit extending by its terms to a negotiating bank or endorsee." U.C.C. § 5-1,11 (1).
 THE YALE LAW JOURNAL [Vol. 65 :807

fraud1 63 or forgery 164 in the documents. ioreover, even then the injunction
may not pre-empt the rights of a holder in due course.'6 5 Section 5-111(2),"",
however, substantially offsets this result by allowing the issuing bank, in its
discretion, to refuse payment and set up the buyer's claim of fraud or forgery
as a defense. The holder in due course may eventually prevail, 1 7 but will be
forced to assume the burden of litigation; and he may be obliged, as a prac-
tical matter, to resell the goods in the interim. 168 The section therefore permits
a result counter to the essential purposes of the letter of credit: the buyer, with
the co-operation of the issuing bank, may gain important tactical advantages
without proving the validity of his claims. 169
In order to prevent both buyer and issuing bank from defeating the very
purposes for which the letter of credit was devised, the issuer should be obliged

163. The Code distinction between nonconformity of the goods to the documents and
fraud in the documents, see note 162 supra, will be difficult to enforce in practice. It is
stated that nonconformity of the goods is no defense to payment. U.C.C. § 5-111, comment
1; see Bank of East Asia, Ltd. v. Pang, 140 Wash. 603, 249 Pac. 1060 (1926). Neverthe-
less, in most instances the buyer's only method of establishing a prima facie case of fraud
"in the documents" will be to show a discrepancy between the goods and documents suffi-
cient to allow an inference of fraud. FINIKELsTEi 230; Bank of Montreal v. Recknagel,
109 N.Y. 482, 17 N.E. 217 (188); see U.C.C. § 4-116 (May 1949). But the Code offers
no guides to determine what amount of nonconformity constitutes fraud. Thus the courts
will have to consider the circumstances of each case to distinguish contract defenses from
fraud. Dougan & Calkins, surpra note 150, at 41; Comment, 62 YALe: L.J. 227, 254 (1953).
See Socint6 Mtallurgique v. British Bank for Foreign Trade, 11 Lloyd's List L.R. 168
(K.B. 1922).
164. The Code, following the weight of recent authority, has adopted the view that the
risk of forged documents is on the buyer; the buyer cannot pass the risk of loss on to the
bank, for paying or negotiating banks do not warrant the genuineness of the documents.
U.C.C. §§ 5-110(1), 5-111; see WARD & HARFIELD 54-55, 97. But see DAvis, CoMmeRCIAL
Lm-rs OF CREDIT 155-66 (2d ed. 1954); FINKELS= 239. Where the draft itself is
forged, however, the issuing bank assumes the risk of loss. McCurdy, supra note 144, at
735.
165. The Code follows existing law in refusing to permit an injunction against a holder
in due course. See Maitland v. Chartered Mercantile Bank, 38 L.J.R. 363 (Ch. 1869)
FIKELsTmN 171-72.
166. "(2) Whether or not the issuing or confirming bank is notified of... an alleged
forgery or fraud in a document apparently regular on its face, such bank, unless enjoined,
may nevertheless honor or reimburse and, in turn, it shall be entitled to recover reimburse-
ment from the person obligated to reimburse it." U.C.C. § 5-111(2). (Emphasis added.)
167. It is presumed that the protection given the good faith purchaser by § 5-111 (1),
see note 162 stupra, will be incorporated into § 5-111(2), so that the issuing bank will not
be able to sustain its defense of fraud or forgery. See Sub-Committee Report, 1955 Supr.
155-56. This result obtains under existing law. Bank of Taiwan v. Union Nat'l Bank, 1
F.2d 65, 66 (3d Cir. 1924).
168. Section 5-116(1) also gives the holder who is not the seller all the rights of a
seller similarly situated. See Comment, 62 YALE L.J. 227, 257-58 (1953).
169. See WARD & HAPSIELD 35.
The advantage of being sued rather than suing gains special importance in the letter of
credit situation. In addition to the ordinary procedural and jurisdictional advantages, the
buyer would have greater time and opportunity to select the grounds on which he will
 ADVERSE CLAIMS

to pay the holder unless the buyer has either obtained an injunction under pro-
visions similar to section 3-603 or procured a statutory writ of garnishment
pending an action against the holder.17o Bank and buyer may, of course, be
able to protect themselves by inserting safeguards in the terms of the credit.lrl
But once a holder has acted in good faith reliance on the terms stated, he should
be given the substantive and the procedural advantage against the buyer and
the issuing bank.

ARTICLE 7: NEGOTIABLE DocUmENTS OF TITLE

A negotiable bill of lading or warehouse receipt is a document of title, issued
by a bailee upon deposit of goods with him, in which he unqualifiedly promises
to deliver the goods to the holder of the document.1 72 The dual nature of these
documents is a characteristic which permeates not only their negotiation, but
also the method by which the law resolves problems involving adverse claims
to them and the goods they represent. For the documents, besides being sym-
bols of the underlying goods, are also negotiable instruments which play an
important role in credit finance?' 3 And in the latter context property rights
defend than if, as under the garnishment procedure previously discussed, he were required
to specify, at the time when he demands that payment be stopped, the! defects in the docu-
ments which he plans to attack. See note 38 supra.
170. See notes 26, 38 supra.
171. This procedure, however, has two limitations. First, the letter of credit has gained
acceptance mainly because of the simplicity with which it enables international transactions
to lie handled, and thus should not be hampered by too many conditions. MVAR& HEA-
FmID 3, 20, 34; Note, 65 HAv. L. REv. 1420, 1423 (1952). Secondly, a fraudulently in-
clined seller will attempt to make the documents conform as much as possible to the terms
of the credit. Thus the protection does not extend to the most objectionable types of fraud,
a risk which must eventually be borne by the buyer. Fx.-mmsTEx 216-18; Llewellyn,
Sone Advantages of Letters of Credit, 2 J. BusiNEss 1, 9-10 (1929); Note, 9 WAsH. L.
REv. 159, 161 (1934).
172. Article 7 replaces the UNIFORM WAREHOUSE REcErirS Acr (hereinafter cited as
U.W.R.A.), promulgated in 1906 and adopted by all jurisdictions, and the UN-NoaR Buy~s
oF LA G Acr (hereinafter cited as U.B.L.A.), promulgated in 1909 and enacted in 35
jurisdictions. Article 7 is superseded by applicable federal law. U.C.C. § 7-103. See United
States Warehouse Act, 39 STAT. 486-91 (1916), as amended, 7 U.S.C. §§ 241-73 (1952) ;
Federal Bills of Lading Act, 39 STAT. 538-45 (1916), 49 U.S.C. §§ 81-124 (1952). For
brief historical surveys of legislation concerning documents of title, see Blomquist, Tyare-
house Regulation since Munn v. Illinois, 29 CHL-KINT L. REv. 120 (1951); Braden, The
Story of the Bill of Lading, 18 I.C.C. PRAc.J. 810 (1951).
Typical warehouse receipt and bill of lading forms are set out in BRAucHE SUTr.-
LAND & WILLcoX, CoMmERcrAL TRANSAcrIONs 172-91 (1953). The term "bailee" is used
to include both a warehouseman, defined in § 7-102(1) (h), and a carrier issuing a bill of
lading. U.C.C. § 7-102(1) (a). Under § 7-104 documents of title may be made negotiable
if the bailee promises to deliver the goods to bearer, or to the order of a named person;
otherwise the document is nonnegotiable.
173. Ferson, Fraudulent Bills of Lading, 21 MfIcH. L. Rxv. 655, 656 (1923); Scott,
The Railroad Bill of Lading, 14 I.C.C. PRAc. J. 288, 292-94 (1947).
Over 90% of the loans made on merchantable commodities are secured by outstanding
documents of title. Britton, Negotiable Documents of Title, S HASTINGS L.U. 103, 111
 THE YALE LAW JOURNAL [Vol. 65:807

must often take second place to commercial necessity and to the risks that in-
here in negotiability. 174
The rights of adverse claimants under Article 7 of the Commercial Code
depend upon whether their claims are based on an interest in the document,
or in the goods. If the claimant can establish that the original bailment of the
goods was wrongful as to him, he is deemed to be "true" owner of the goods.
And since the Code, following existing law, treats the documents in this con-
text primarily as symbols of the goods, 75 the true owner's title to the goods
is paramount to the holder's right to the documents regardless of the holder's
good faith purchase. 7 6 A second type of adverse claim, however, relates to
defects arising after a valid bailment; the claimant contends that the docu-
ments were properly issued or negotiated to him, but were not properly nego-
tiated by him, so that his rights in the documents were never cut off.l The

(1954). Largely because of the legislation regulating the duties of bailees, banks are
afforded certainty that loans given on the documents are actually secured by the underlying
goods. State v. Frost, 91 N.H. 229, 17 A.2d 441, 443 (1941). As a result banks may dis-
count drafts accompanying documents of title at rates of Y3 to Y2% of the face value of the
drafts. Britton, supra, at 107. Documents of title are less frequently made negotiable when
used as collateral for bank loans than when they are used in contracts for the sale and re-
sale of the underlying goods. Banks prefer to prevent the possibility of having their securi-
ty interest defeated by negotiation to a bona fide purchaser. Id. at 108-09, 111; see note
179 infra; e.g., Star Transfer Line v. General Exporting Co., 308 Mich. 86, 13 N.V.2d
217 (1944).
174. See Brock v. Atteberry, 153 La. 649, 96 So. 505 (1923) ; Lundy v. Greenville
Bank & Trust Co., 179 Miss. 282, 174 So. 802 (1937) ; Mason v. Exporters & Traders
Compress Co., 94 S.W.2d 758, 760 (Tex. Civ. App. 1936) ; U.C.C. § 7-501, comment 1 ;
TEXAS LEGISLATIVE CouNciL, ANALYSES OF ARTIcnE 7 OF THE UNIFOZIS COMMERCIAL CODE
141-42 (1952). Of course, the need to protect the claimant is still important, not only from
the point of view of promoting honesty, but also from a commercial standpoint; if banks
are to advance credit on documents of title, they must have a fair opportunity to protect
their interests. BRAucHaF, DoCUMENTS OF TiTLE 94-95 (1955) ; Blomquist, supra note 172,
at 130; Braden, supra note 172, at 819.
175. U.C.C. § 7-503(1) & comment.
176. Lineburger Bros., Inc. v. Hodge, 212 Miss. 204, 54 So. 2d 268 (1951.) ; 2 WIILIs-
TON, SALES § 421 (rev. ed. 1948) (collecting citations).
The true owner may, however, be estopped from asserting his claim against a good
faith purchaser if the owner has entrusted the party who wrongfully bailed the goods.
Swift v. Davis, 118 Misc. 205, 193 N.Y. Supp. 848 (Sup. Ct. 1922) ; Commercial Bank v.
Canal-Louisiana Bank, 239 U.S. 520, 524-25 (1916) (dictum). See also Boswell Co. V.
Felder & Co., 103 Cal. App. 2d 767, 230 P.2d 386 (1951); Rotterman v. General Mills,
Inc., 245 Iowa 229, 61 N.W.2d 718 (1953) ; U.C.C. § 7-503(1). But see § 7-502(1) (c)
(1955 Supp.).
177. See, e.g., Tom Boy Stores, Inc. v. Douglas-Guardian Warehouse Corp., 237 Mo.
App. 892, 179 S.W.2d 145 (1944).
Claims may also arise out of a sales contract. The buyer may have paid for the goods
but allowed the seller to retain possession of the documents; or the seller may have
delivered the document of title to the buyer, retaining a security interest in the goods. See,
e.g., Garrett Freight Lines v. Cornwall, 120 Utah 175, 232 P.2d 786 (1951); Williston,
Ownership of Goods Shipped under a Bill of Lading to the Seller's Order, 82 U. PA. L.
REv. 1, 3 (1933). When the seller has discounted a draft on the buyer, the bank will assert
 1956] ADVERSE CLAIMS

policy considerations have shifted: the claimant, having authorized or used

this form of commercial arrangement, may more equitably be subjected to the
requisites of commercial expediency. 178 The Code therefore adopts the holder
in due course theory in this context and provides that a holder who has sub-
sequently received the documents through "due negotiation" prevails over
former holders. 17 The claimant must not only sustain the validity of his claim,
but must also show that the present holder is not a holder in due course who
took free of claims.' 80
The fact that the documents represent goods in commerce injects unique
considerations into the treatment of adverse claims to documents of title. The
holder of the document may be a merchant who has contracted to resell the
goods; unless he receives the goods immediately, he will often be unable to
find substitute goods in time to fulfill his other contractual obligations.','
Even though title may not in fact be his, and he may have to reimburse the
true owner, the holder might nevertheless prefer to supply indemnity and
receive the goods, thus mitigating his own costs on the resale contract. On the
other hand, the true owner or a prior holder claiming an interest in the docu-
ments might also have a contract to resell.' 8 2 Vhere contracts over are not
present, interpleader would afford the best remedy.' 83 But when they are in-
volved, compulsory interpleader could cause harmful delay.' 8 4 The goods
would be frozen in a court's registry while the claim was being litigated unless
the parties could agree to sell the goods and substitute money for the res. s 5
Similar objections obtain to a provision based upon section 3-603,186 under

the seller's rights. Gilmore & Axelrod, Chattel Security: I, 57 YALE L.J. 517, 524-27
(1948).
178. See note 174 supra and accompanying text.
179. U.C.C. § 7-502. See Britton, Negotiable Docunents of Title, 5 HAsTINGs L.J.
103, 115-16 (1954). "Due negotiation" is the purchase of a document of title made in
"observance of reasonable commercial standards," on the theory that negotiable documents
of title are not intended for use in noncommercial settings. U.C.C. §§ 7-501(4) ; 7-503,
comment. See also U.B.L.A. §§ 38, 39; U.W.R.A. §§ 47, 48; cases cited note 174 supra.
180. U.C.C. § 7-502(2).
181. See, e.g., Stitzel-Weller Distillery, Inc. v. Norman, 39 F. Supp. 182, 187 (W.D.
Ky. 1941) (warehouse receipts broker). In addition, the exigencies of a rapidly fluctuating
market militate against a delay in delivery. See, e.g., Behn v. Southern Pac. Co., 2 Ill.
App. 2d 62, 118 N.E.2d 625 (1954) (25% drop in market in four days) ; Railway Express
Agency v. Smith, 116 F. Supp. 609 (E.D.S.C. 1953) (perishables).
182. The "true owner," however, has less frequently engaged to sell the goods. He is
usually a landlord, mortgagee or conditional seller who is more interested in the proceeds
than in the goods themselves. See Braucher, In Re Article 7, 28 TEmp. L.Q. 564, 581
(1955).
183. See note 25 supra and accompanying text.
184. See note 181 supra and accompanying text. Interpleader would also be undesir-
able if the value of the goods in dispute were too low to justify the storage charges incurred,
or if the goods were perishable. BRATUCHER, DOCU SENTS OF TITLE 40 (1955).
185. See, e.g., In re Taub, 7 F.2d 447 (2d Cir. 1925); BRAUCHER, DOCUMENTS OF
TITLE 40-41 (1955).
186. See note 26 supra and accompanying text.
 THE YALE LAW JOURNAL [Vol. 65: 807

which the adverse claimant could prevent delivery to the holder, or obtain
delivery himself, by providing indemnity; the holder, who might have the
greater need for immediate performance, would be seriously handicapped.
Section 7-603 of the Code meets the need for flexibility by giving the bailee
a limited discretion upon notice of an adverse claim.1 8 7 The section is the re-
sult of historical evolution tempered by practice. The bailee originally was
denied interpleader, primarily on grounds of privity or independent liability.'_*
Since he was thus forced to pay at his peril, 8 9 the law allowed him a "rea-
sonable time" to essay a correct determination. 190 In actual practice, the
bailee soon began to protect himself by delivering the goods only when he
received the document of title or when a "true" owner supplied him with in-
demnity. 191 The Uniform Bills of Lading and Warehouse Receipt Acts elimi-
nated the restrictions on interpleader, 192 but nevertheless retained the reason-
able time provision. The Code follows the uniform acts in this respect.'0 3 The

187. "If more than one person claims title or possession of the goods, the bailee is
excused from delivering until he has had a reasonable time to ascertain the validity of the
adverse claims or to bring an action to compel all claimants to interplead and may compel
smch infterpleader,either in defending an action for non-delivery of the goods, or by original
action, whichever is appropriate." U.C.C. § 7-603, as amended 1955 SuPP. (Italicized
portions added by 1955 amendments.) Compare CAL. CIV. CODE § 1858.27 (1955 Supp.)
(warehouse receipts), under which the adverse claimant must bring suit within forty-eight
hours after notifying the warehouseman of his claim.
188. 3 Am. & ENG. ENCYC. oF LAw 762-63 (2d ed. 1897) ; Crawshay v. Thornton, 2
Myl. & Cr. 1, 40 Eng. Rep. 541 (Ch. 1837).
189. Powell v. Robinson, 76 Ala. 423 (1884) ; Esmay v. Fanning, 9 Barb. 176 (N.Y.
Sup. Ct. 1850) ; see Blaisdell v. Hersum & Co., 233 Mass. 91, 123 N.E. 386 (1919). Section
7-403(1) (b) of the Code follows existing law, allowing the bailee to set up delivery to the
true owner as a defense. Northwestern Cas. & Surety Co. v. Illinois Cent. Ry., 19 F.2d
868 (7th Cir. 1927) ; Wheelock Bros., Inc. v. Bankers Warehouse Co., 115 Colo. 197, 171
P.2d 405 (1946) ; Miller v. New York Cent. R.R., 205 App. Div. 663, 200 N.Y. Supp. 287
(1st Dep't 1923).
190. Merz v. Northwestern Ry., 86 Minn. 33, 90 N.W. 7 (1902). Solomon v. Dawes,
1 Esp. R. 83, 170 Eng. Rep. 287 (N.P. 1794); see, e.g., Zuker v. Mehrle, 112 N.Y. Supp.
1093 (Sup. Ct. 1908) ; McKeehan, The Uniform Commercial Acts, 20 DICK. L. REv. 33, 74
(1915).
191. This procedure has been in common usage for over a century. See Pearson v.
Cardon, 2 Russ. & My. 606, 613, 39 Eng. Rep. 525, 528 (Ch. 1831) ; Morse-Hubbard Co. v.
Michigan Cent. R.R., 286 Ill. App. 163, 168, 3 N.E.2d 93, 95 (1936) ; Bradley v. Illinois
Cent. Ry., 291 Ky. 25, 163 S.W.2d 26 (1942).
192. U.B.L.A. §§ 20-21; U.W.R.A. §§ 17-18; New Jersey Title Guarantee and Trust
Co. v. Rector, 76 N.J. Eq. 587, 75 Atl. 931 (Ct. Err. & App. 1910) ; Manhattan Storage &
Warehouse Co. v. Benguiat Art Museum, 155 App. Div. 196, 139 N.Y. Supp. 1073 (lst
Dep't 1913). Moreover, under the Uniform Acts, the possibility of an independent liability,
see note 25 supra, will not preclude interpleader. Rosenberg v. Viane, Inc., 109 Misc. 215,
179 N.Y. Supp. 447 (Sup. Ct. 1919) ; Chafee, Federal Interpleader since the Act of 1036,
49 YALE L.J. 377, 412 (1940).
193. See note 187 supra. For a general comparison of Article 7 with the Uniform
Acts, see Pryor, Article 7-Documents of Title: An Attempt at Coiniercial Unifori;nity,
1952 Wis. L. REv. 332.
 ADVERSE CLAIMS

bailee is given a reasonable time to decide who is entitled to the goods; this
means, in effect, that he may protect himself by delivering to either party
upon an offer of indemnity.'9 4
The result reached by the Code seems eminently sound. The bailee is sel-
dom in a position to make a valid determination of the facts, or to resolve the
complex problems of estoppel, agency or good faith purchase which may even-
tually defeat the claimant's rights. 195 However, at least when both parties have
equally plausible claims, and one has greater need to obtain the goods at once,
commercial expediency demands that the goods should not be equally frozen
for both. 190 And there is no one in as good a position as the bailee to deter-
mine promptly which of the two claimants has the greater need for the goods.
This determination will not subject the bailee to liability: although he delivers
the goods "at his peril" if the document is not surrendered to him, 19 7 he may
deliver the goods and protect himself against liability by taking indemnity
where there is need for immediate action. 198 Ioreover, requisites of honesty
are met, even when the party who has not received the goods is eventually
determined by a court to be the true owner, because of the protection of the
indemnity bond. 199 Where there is no need for haste, as in most noncommer-

194. WARD & HARFIELD 62-63. The Code does not state that the bailee must deliver
to either the claimant or the holder; he may be indemnified by either. See BRAUCHER,
DOCUMENTS OF TITLE 31 (1955). By contrast, in the stock transfer and commercial paper
contexts the stakeholder must heed the claimant's offer of indemnity. U.C.C. §§ 3-603,
8-403.
Although delivery upon indemnity precludes interpleader, Mallory S.S. Co. v. Thalheim,
277 Fed. 196, 202-03 (2d Cir. 1921), the real parties in the subsequent action against the
bailee are the adverse claimant and the holder. The bailee would be protected unless
delivery were in such bad faith that the bailee would be liable for fraud or collusion in a
civil or criminal suit. See Lawrence Warehouse Co. v. Twohig, 224 F.2d 493 (8th Cir.
1955) (participation in breach of trust) ; Henderson v. United States, 203 F.2d 81 (5th
Cir. 1953) (criminal liability of warehouseman) ; U.C.C. §§ 1-103; 7-101, comment. See
BRAUCHER, op. cit. supra at 33.
195. Swift v. Davis, 118 Misc. 205, 209, 193 N.Y. Supp. 848, 851 (Sup. Ct. 1922);
Teller & Co. v. American Ry. Express Co., 78 Pa. Super. 300, 303 (1922). See, e.g., Gar-
rett Freight Lines v. Cornwall, 120 Utah 175, 232 P.2d 786 (1951) (contract dispute)
U.C.C. § 7-303, comment 1.
196. Fulda, Svrrender of Documents of Title on Delivery of the Property, 25 CORNELL
L.Q. 203, 215 (1940).
197. Wheelock Bros., Inc. v. Bankers Warehouse Co., 115 Colo. 197, 171 P.2d 405
(1946) ; Friednash v. Lawrence Warehouse Co., 121 Cal. App. 2d 202, 263 P.2d 45 (1954) ;
Mercantile Trading Co. v. Roth, 350 Ill. App. 418, 113 N.E.2d 194 (1953); see U.C.C.
§ 7-403(3) ; U.B.L.A. 88 13, 15; U.W.R.A. §§ 10, 11.
198. The adverse claim provision follows other provisions of Article 7 which seek to
insulate the stakeholder from all risks not directly concerned with the storage or trans-
portation of goods. TEXAS LEGISLATIVE COUNCIL, ANALYSES OF ARTICLE 7 OF THE UNIFORM
COMMERCIAL CODE 147 (1952). Since the bailee may be liable for conversion under § 7-404,
the amount of the bond would have to exceed the value of the goods as stated in the bill of
lading. See McCoRMICK, DAMAGES § 123 (1935).
199. See BRAUCIER, DOCU.MENTS OF TITLE 22 (1955) ; Fulda, supra note 1.96, at 216.
In addition, licensed warehousemen are usually bonded under statute. See, e.g., State v.
 THE YALE LAW JOURNAL [Vol. 65: 807

cial transactions, the bailee may resort to interpleader. Indeed, if the contend-
ing parties have no urgent need for the goods, they may both refuse indemnity
200
and in effect compel the bailee to interplead.
The length of time that the bailee may "reasonably" defer delivery upon
notification of adverse claim should depend upon the type of claim made and
the commercial context involved. 201 To a large extent, the Code implicitly
recognizes the need of such flexibility in this area. Thus, judgment creditors
making claims to the goods are obliged to enjoin delivery to a holder..2 0 2- The
time element here is not nearly so important as it is in commercial trans-
actions, and the holder is therefore given fuller protection and may obtain
delivery unless the judgment creditor has procured the document. Conversely,
when the bailee is a carrier and the goods are in transit, section 7-303 allows
the bailee to follow the holder's instructions and disregard all others. 20 3 These
provisions provide a desirably automatic course of action where it is needed;
the time factor when goods are in transit renders inexpedient the flexibility
20
which, in warehousing, best meets commercial demands.

CONCLUSION
The Uniform Commercial Code's treatment of adverse claims marks a sig-
nificant improvement over existing statutory and case law methods of resolv-
ing conflicts between the dictates of honesty and negotiability in commercial
law. The adverse claim provisions have generally freed the stakeholder from
the impracticable duty of protecting "equities" which have not, when asserted,
Dalrymple, 227 Minn. 533, 35 N.W.2d 714 (1949). Under some circumstances, the claim-
ant will also be able to attach the goods or enjoin delivery. For example, if the claimant
has not authorized the bailment, he may reach the goods by obtaining a court order. If,
however, the claim occurs during the bailment, neither an attachment nor an injunction is
effective unless the claimant has been able to compel surrender of an outstanding negotiable
document. See Eyre & Co. v. Hirsch, 36 Wash. 2d 439, 218 P.2d 888 (1950); U.C.C.
§ 7-602; U.B.L.A. § 24; U.W.R.A. § 25.
200. See 2 WILUSTON, SALES 594 (rev. ed. 1948) ; cf. note 191 supra and accompany-
ing text.
201. Covlin v. Volochenko, 53 N.D. 6, 204 N.W. 892 (1925) ; see cases cited note 181
supra.
When the bailee has constructive notice of an adverse claim, § 7-404, by implication,
would hold the bailee liable for conversion if delivery to the holder were neither in good
faith nor in the "observance of reasonable commercial standards." For a statement of
existing law, which is similar, see 2 WILLISTON, SALES 593 (rev. ed. 1948) (collecting
citations) ; Lawrence Warehouse Co. v. Twohig, 224 F.2d 493 (8th Cir. 1955) ; Investment
Serv. Co. v. O'Brien, 1.90 Ore. 394, 223 P.2d 163 (1950). Contra, L. Fish Furniture Co.
v. Reliable Storage & Van Co., 187 Ill. App. 6 (1914).
202. U.C.C. § 7-602; see note 199 supra.
203. When the bill of lading is nonnegotiable, the carrier may take the orders of the
consignor. U.C.C. § 7-303(1) (b). See Louisville & N.R.R. v. Campbell Lumber Co., 45
Ga. App. 851, 166 S.E. 252 (1932) ; Getchell v. Northwestern Pac. Ry., 110 Wash. 66, 187
Pac. 707 (1920).
204. See Ahearn, Freight Forwarders and Common Carriage, 15 FORDHAMi L. REv.
248 (1.946).
 ADVERSE CLAIMS

withstood the test of litigation. The stakeholder is treated not as an arbiter

of adverse claims but as a channel through which business is transacted.
This treatment should be extended, however, to areas in which problems of
fiduciary relationships and constructive notice are present. The stakeholder
is equally unequipped to judge the merits of claims in these areas, and the
claimant has other means of protection available to him. Moreover, only half
the problem is solved by relieving the stakeholder of a possible double lia-
bility. The Code should also reconcile the protection of the adverse claimant
with the commercially desirable presumption that negotiable paper has been
purchased in good faith. In this respect the Code provisions allowing the claim-
ant to stop payment to the holder by an offer of indemnity have undervalued
the interests of the holder, who should not be forced to initiate litigation to
assert his rights. Except for adverse claims arising in the context of docu-
ments of title, where the documents represent goods in commerce, the demands
of the stakeholder, the claimant and the holder would be better adjusted to the
needs of commercial transactions by relieving the stakeholder from discretion
and a possible double liability, permitting the holder to obtain payment with-
out substantial delay, and guaranteeing the claimant an opportunity to serve
process on the holder when he presents the negotiable item for payment or
registration.