CREATION OF NEGOTIABLE INSTRUMENTS CHAPTER 22 CREATION OF NEGOTIABLE INSTRUMENTS © 2010 Pearson Education, Inc., publishing as Prentice-Hall

Negotiable Instruments To qualify as a negotiable instrument (commercial paper), document must meet requirements established by Revised Article 3 of UCC.

Negotiable Instruments (continued) If requirements met, holder in due course takes the instrument free of many defenses that can be asserted against the original payee. In addition, the document is considered an ordinary contract subject to contract law.

Functions of Negotiable Instruments Substitute for money Credit device Record-keeping device

Types of Negotiable Instruments Drafts Checks Certificates of Deposit Promissory Notes

Drafts Three-party instrument. Unconditional written order by drawer that orders drawee to pay money to payee. Drawee is liable if accepts drawer’s order. Writes “accepted” on draft. Drawee is acceptor. Returns draft to drawer or payee. Drawer or payee can freely transfer draft to another party.

Draft (continued)

Drafts (continued) Sight Draft Payable on sight. E.g., “On demand pay.” Trade Acceptance is sight draft that arises when credit is extended with sale of goods. Time Draft Payable at designated future date E.g., “Pay on January 21, 2012.”

Checks Draft drawn on a financial institution and payable on demand.

Promissory Notes Two-party negotiable instrument. Unconditional written promise by maker to pay money to payee. Types: Time note Demand note Installment note

Promissory Notes (continued)

Promissory Notes (continued) Collateral may be required. Automobiles, homes, buildings, securities, or other property. If maker fails to repay note as due, lender can foreclose and take collateral as payment.

Certificates of Deposit (CD) Two-party negotiable instrument. Payee deposits money at a financial institution. Institution (maker) promises to pay back amount of deposit plus an agreed-upon rate of interest at set time.

CD (continued)

Negotiable Instrument Must be: In writing. Signed by maker or drawer. Unconditional. State fixed amount of money. Not require additional undertaking. Payable on demand or at definite time. Payable to order or to bearer. These requirements must appear on face of instrument.

Writing Must be: Permanent Portable Can be combination of different kinds of writing. E.g., preprinted and handwritten

Signed by Maker or Drawer Maker or drawer not liable unless signature appears on instrument Agent may sign. Any symbol or device may be used if intention was to authenticate document E.g., initials or thumbprint.

Unconditional Promise or Order to Pay Promise required for promissory note. E.g., “I promise to pay”; “I agree to pay.” Not required for CD. Order required for draft or check. Must contain word “pay.” E.g., “Pay to the order of.” If promise or order is conditional, the instrument is not negotiable.

Payable to Order or to Bearer Order instrument is payable to “to order of Jane Smith” or “to Jane Smith or order.” Bearer instrument is payable to person in physical possession of instrument who presents it for payment. E.g., “Payable to bearer,” or “Payable to Xerox or bearer.” Both types freely transferable to other persons or entities.

Formal Requirements for a Negotiable Instrument (Part 1) Description Writing Writing must be permanent and portable. Oral or implied instruments are nonnegotiable [UCC 3-104(d)]. Signed by maker or drawer Signature must appear on the face of the instrument. It may be any mark intended by the signer to be his or her signature. Signature may be by an authorized representative [UCC 3-104(a)]. Unconditional promise or order to pay Instrument must be an unconditional promise or order to pay [UCC 3-104(a)]. Permissible notations listed in UCC 3-106(a) do not affect instrument’s negotiability. If payment is conditional on the performance of another agreement, the instrument is nonnegotiable.

Fixed Amount of Money Ensures value of instrument. No interest requirement, but may have fixed or variable amount. Must be payable in money. May be foreign currency.

Formal Requirements for Negotiable Instrument (Part 2) Description Fixed amount of money Fixed amount: Amount required to discharge the instrument must be on the face of the instrument [UCC 3-104(a)]. Amount may include payment of interest, discount, and costs of collection. Revised Article 3 provides that variable interest rate notes are negotiable instruments. In money: Amount must be payable in U.S. or foreign country’s currency. If payment is to made in goods, services, or non-monetary items, the instrument is nonnegotiable [UCC 3-104(a)].

Formal Requirements for Negotiable Instrument (Part 3) Description Cannot require any undertaking in addition to the payment of money A promise or order to pay cannot state any other undertaking to do an act in addition to the payment of money [UCC 3-104(a)(3)]. A promise or order to may include authorization or power to protect collateral, dispose of collateral, waive any law intended to protect the obligee, and the like.

Instruments Payable on Demand or at Definite Time Demand Instruments Created by special language Created by silence as to payment due date Checks CDs and drafts may be demand instruments Time Instruments Payable at definite time and date

Formal Requirements for Negotiable Instrument (Part 4) Description Payable on demand or at a definite time Payable on demand: Payable at sight, upon presentation, or when no time for payment is stated [UCC 3-108(a)]. Payable at a definite time: Payable at a definite date, or before a stated date, a fixed period after a stated date, or at a fixed period after sight [UCC 3-108(b)(c)]. Instrument payable only upon the occurrence of an uncertain act or event is nonnegotiable.

Additional Clauses Prepayment clause Acceleration clause Allows maker to pay amount before due date Acceleration clause Payee or holder may accelerate payment of principal Extension clause Allows date of maturity to be extended

Nonnegotiable Contract A promise or order to pay that does not meet the requirements of a negotiable instrument. Not subject to Article 3. Enforced under normal contract law.