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The Charles Evans Gerber Transactional Studies Center


Center for Contract and Economic Organization


The casual observer of the legal academy would assume that negotiability is a legal principle of foundational importance to our nation's payment and credit systems. All of the obvious indicators support that assumption. Among other things, the 1980s witnessed a major effort by the American Law Institute and the National Conference of Commissioners on Uniform State Laws to update and revise the relevant provisions of the Uniform Commercial Code.1 Similarly, negotiability continues to occupy a safe position in law school curricula, as prominent academics at our most elite schools continue to write casebooks focusing on negotiability. Most recently, for example, Clayton Gillette, Alan Schwartz, and Bob Scott have published a prominent new casebook on Payment Systems and Credit Instruments, which presents a course organized around a detailed discussion of negotiability and its consequences.2 And Gillette, Schwartz, and Scott are not outliers. They are working in the heartland of academic attention: This decade has produced several other major casebooks for courses with a similar focus on the principles of negotiability, 3 as well as a number of treatises and related works that offer detailed doctrinal analyses of negotiability. 4

But it would be wrong to accept those indicators. At least in the payment and credit contexts (the subjects on which academics have focused their analysis of negotiability), negotiability is an outmoded and decaying relic. Moreover, even in the checking system-the most significant context where negotiable instruments survive-legal and practical developments have rendered principles of negotiability all but irrelevant to the operation of the system. To be sure, I am not the first to bear witness to the declining role of negotiability. A few previous scholars, most notably Jim Rogers, have noticed some aspects of the decline in the doctrinal significance of the rules of negotiability.5 Others have speculated as to the limited use of negotiable instruments in modem commerce.6 But those limited efforts have done little or nothing to dispel the general impression that negotiability remains significant. Certainly, negotiability must be important in some context or so many people would not be devoting so much time to industrious examination and explanation of the system. Right?

No. That impression is wrong, in a most fundamental way. In an effort to lay that impression finally to rest, this Article moves beyond the existing literature in two ways. First, by looking at payment and credit systems from a broad, functional perspective, I can illustrate how underlying systemic forces (predominantly technological, but sometimes law- related) have undermined the usefulness of negotiability in all of its manifestations. Like all legal institutions, negotiability was called into existence to respond to problems of a particular time and place. The complete transformation of the technology of financial activity that has taken place during the closing decades of this century has created a transactional setting that bears no significant resemblance to the pre-Industrial Revolution world in which negotiability first came to be used in payment systems. Accordingly, it should come as no surprise that it is hard to discern a useful role for negotiability in the financial world of the twenty-first century.

Secondly, and more importantly, I present several different categories of empirical evidence designed to demonstrate that my general view of the underlying technological forces is reflected in what actually has happened in our nation's financial markets. The evidence includes the results of a series of more than a dozen interviews with individuals experienced in various kinds of financial transactions.7 I also collected actual documents used in a variety of payment and credit transactions, enabling me to present evidence regarding the actual usage of negotiability in those contexts.8 Similarly, to get a firsthand look at the practicalities of check processing, I visited the check-collection facilities of two major banks located in different Federal Reserve districts.' Finally, in order to evaluate the accuracy of my impressions about the irrelevance of holder-in-due-course status to the check-collection process, I conducted a survey of reported cases decided since 1985 that mention holder-in-due-course status in the checking context.

This Article presents my analysis in four steps. I start in Part I with a general discussion of negotiability that focuses on two major points. The first is an explanation of the basic premise of negotiability: a system that fosters exclusive reliance on a document can enhance the liquidity of the assets covered by that document. The second is a discussion of why that premise is obsolete: designed for transactions in a horse-and-buggy economy, negotiability's focus on physical documents imposes a significant burden on transactions in the current age of electronic information processing.

Part II turns from the abstract analysis of Part I to present empirical evidence about actual current financial practices. The sections of Part II survey the various types of payment and credit systems used most commonly in our economy. My analysis includes the major nonchecking payment systems in which documents reflect the payment obligation (credit cards and letters of credit), as well as the most important types of credit obligations in our economy (consumer promissory notes used to purchase personal property or homes, private commercial obligations, and long-term and short-term publicly traded commercial obligations). Relying on the interviews and sample documents that I have collected, I can show that negotiability is rarely used in any of those systems.10

Analysis of the checking system is reserved for Part III. Based on my interviews and site visits, Part III shows how the exigencies of commerce have rendered the basic concepts of negotiability irrelevant to the current check-processing system. Although most previous scholars have focused on doctrinal niceties to show how the applicable legal rules can be explained without reference to traditional rules of negotiability, my focus on the practicalities of the processing system allows me to present a much broader critique. The irrelevance of negotiability is much more complete than previous scholars suggest because its cause is more fundamental than a simple revision of the applicable legal rules. The pressure of technological change has rendered the most basic features of the negotiable instrument a positive hindrance to any modem payment system. The legal rules accommodating the passage of negotiability are mere patchwork details that reflect a situation brought about by developments external to the law.

Finally, Part IV summarizes the implications of my analysis for the ongoing development of payment systems. The time has passed when it is sensible to complete payment transactions by transporting physical objects and examining them to determine the nature of the signatures that appear on them. To function effectively, a modem payment system must follow the lead already taken by most of the highly liquid credit systems. It must abandon all of the features that made negotiability useful in the pre- Industrial Revolution economies in which it developed. The demands of a modern economy call for payment systems that focus on data instead of documents, and that provide for contemporaneous approvals by the ultimate payor rather than the cumbersome and time-consuming clearing process that characterizes transactions using checks and other negotiable instruments.

Thus, the decline and fall of negotiability does not mean the end of the law of payment systems. It calls for new law-related systems designed to defuse the issues that arise in new data-based payment systems. To accomplish that task, the law must abandon its fixation with the paradigm of negotiability and focus instead on the practical realities of the contexts in which new payment systems are used.


This article was originally published in UCLA Law Review.