Slides developed by Les Wiletzky Wiletzky and Associates Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. PowerPoint Slides to Accompany CONTEMPORARY BUSINESS AND ONLINE COMMERCE LAW 5 th Edition by Henry R. Cheeseman Chapter 19 Creation and Transfer of Negotiable Instruments

19 - 2Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Negotiable Instruments (1 of 2) Revised Article 3 (Negotiable Instruments) of the Uniform Commercial Code (UCC) To qualify as a negotiable instrument (commercial paper), the document must meet certain requirements established by Revised Article 3 (Negotiable Instruments) of the Uniform Commercial Code (UCC)

19 - 3Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Negotiable Instruments (2 of 2) holder in due course If the requirements of Article 3 are met, a transferee who qualifies as a 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 that is subject to contract law

19 - 4Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Functions of Negotiable Instruments Negotiable instruments serve the following functions: Substitute for money Credit device Record-keeping device Most purchases by businesses and many individuals are made by negotiable instruments instead of cash

19 - 5Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Types of Negotiable Instruments Instrument Term that means negotiable instrument [UCC 3-104(b)]Instrument Revised Article 3 recognizes four finds of instruments: 1. Drafts 2. Checks 3. Promissory Notes 4. Certificates of Deposit Revised Article 3 recognizes four finds of instruments: 1. Drafts 2. Checks 3. Promissory Notes 4. Certificates of Deposit

19 - 6Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Drafts (1 of 2) draft A draft is a three-party instrument that is an unconditional written order by one party that orders the second party to pay money to a third party Drawer of a draft Drawee of a draft Payee of a draft

19 - 7Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Drafts (2 of 2) Time Draft A draft payable at a designated future date Time Draft A draft payable at a designated future date Sight Draft A draft payable on sight Also called a demand draft Trade Acceptance Trade Acceptance – a sight draft that arises when credit is extended with the sale of goods Sight Draft A draft payable on sight Also called a demand draft Trade Acceptance Trade Acceptance – a sight draft that arises when credit is extended with the sale of goods

19 - 8Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Checks A distinct form of draft drawn on a financial institution and payable on demand Drawer of a check Drawee of a check Payee of a check

19 - 9Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Promissory Notes A two-party negotiable instrument that is an unconditional written promise by one party to pay money to another party Maker of a note Payee of a note Types of notes: Time note Demand note Collateral

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Certificates of Deposit (CD) A two-party negotiable instrument that is a special form of note created when a depositor deposits money at a financial institution in exchange for the institution’s promise to pay back the amount of the deposit plus an agreed-upon rate of interest upon the expiration of a set time period agreed upon by the parties Maker of the CD Payer of the CD A two-party negotiable instrument that is a special form of note created when a depositor deposits money at a financial institution in exchange for the institution’s promise to pay back the amount of the deposit plus an agreed-upon rate of interest upon the expiration of a set time period agreed upon by the parties Maker of the CD Payer of the CD

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Summary: Types of Negotiable Instruments (1 of 2) Orders to Pay PartyDescription of Party DraftDrawer Drawee Payee Person who issues the draft Person who owes money to the drawer; person who is ordered to pay the draft and accepts the draft Person to whom the draft is made payable CheckDrawer Drawee Payee Owner of a checking account at a financial institution; person who issues the check Financial institution where drawer’s checking account is located; party who is ordered to pay the check Person to whom the check is made payable Instrument:

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Summary: Types of Negotiable Instruments (2 of 2) Promises to Pay PartyDescription of Party Promissory Note Maker Payee Party who issues the promissory note; usually the borrower Party to whom the promissory note is made payable; usually the lender Certificate of Deposit (CD) Maker Payee Financial institution that issues the certificate of deposit Party to whom the certificate of deposit is made payable; usually the depositor Instrument:

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. negotiable instrument According to UCC 3-104(a), a negotiable instrument must: Be in writing Be signed by the maker or drawer Be an unconditional promise or order to pay State a fixed amount of money Not require any undertaking in addition to the payment of money Be payable on demand or at a definite time Be payable to order or to bearer Be in writing Be signed by the maker or drawer Be an unconditional promise or order to pay State a fixed amount of money Not require any undertaking in addition to the payment of money Be payable on demand or at a definite time Be payable to order or to bearer

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Summary: Formal Requirements for a Negotiable Instrument (1 of 4) RequirementDescription WritingWriting must be permanent and portable. Oral or implied instruments are nonnegotiable [UCC (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.

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Summary: Formal Requirements for a Negotiable Instrument (2 of 4) RequirementDescription 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)].

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Summary: Formal Requirements for a Negotiable Instrument (3 of 4) RequirementDescription 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.

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Summary: Formal Requirements for a Negotiable Instrument (4 of 4) RequirementDescription 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.

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Nonnegotiable Contract A promise or order to pay that does not meet the requirements of a negotiable instrument It is not subject to the provisions of UCC Article 3 A nonnegotiable contract can be enforced under normal contract law

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Transfer by Assignment or Negotiation Transfer by Assignment The transfer of rights under a contract It transfers the rights of the transferor ( assignor ) to the transferee ( assignee ) Transfer by Assignment The transfer of rights under a contract It transfers the rights of the transferor ( assignor ) to the transferee ( assignee ) Transfer by Negotiation The transfer of a negotiable instrument by a person other than the issuer The person to whom the instrument is transferred becomes the holder Negotiating order paper Negotiating bearer paper Transfer by Negotiation The transfer of a negotiable instrument by a person other than the issuer The person to whom the instrument is transferred becomes the holder Negotiating order paper Negotiating bearer paper

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Indorsement The signature (and other directions) written by or on behalf of the holder somewhere on the instrument The signature may: Appear alone Name an individual to whom the instrument is to be paid; or Be accompanied by other words

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Types of Indorsements (1 of 3) Type of Indorsement Description BlankDoes not specify a particular indorsee. This indorsement creates bearer paper. SpecialSpecifies the person to whom the indorser intends the instrument to be payable. This indorsement creates order paper. UnqualifiedDoes not disclaim or limit liability. The indorsee is liable on the instrument if it is not paid by the maker, acceptor, or drawer.

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Types of Indorsements (2 of 3) Type of Indorsement Description QualifiedDisclaims or limits the liability of the indorsee. There are two types: 1. Special qualified indorsement 2. Blank qualified indorsement NonrestrictiveNo instructions or conditions attached to the payment of funds

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Types of Indorsements (3 of 3) Type of Indorsement Description RestrictiveConditions or instructions restrict the indorsee’s rights. There are four types: 1. Conditional indorsement 2. Indorsement prohibiting further indorsement 3. Indorsement for deposit or collection 4. Indorsement in trust

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Misspelled or Wrong Name Where the name of the payee or indorsee is misspelled in a negotiable instrument, the payee or indorsee can indorse the instrument in the misspelled name, the correct name, or both A person paying or taking the instrument for value or collection may require a signature in both the misspelled and the correct name [UCC 3-204(d)]

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Multiple Payees or Indorsees Payable Jointly and An instrument that is payable to two or more persons with and between their names All their indorsements are required to negotiate the instrument Payable Jointly and An instrument that is payable to two or more persons with and between their names All their indorsements are required to negotiate the instrument Payable in the Alternative or An instrument that is payable to two or more persons with or between their names Only one of their indorsements is required to negotiate the instrument Payable in the Alternative or An instrument that is payable to two or more persons with or between their names Only one of their indorsements is required to negotiate the instrument

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Forged Indorsement Forged Indorsement Forged Indorsement – the forged signature of a payee or holder on a negotiable instrument Generally, the person who took the check from the forger is liable on a forged indorsement There are two exceptions: The Imposter Rule The Fictitious Payee Rule

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Forged Indorsement: Exceptions to the General Rule The Imposter Rule A rule that says if an imposter forges the indorsement of the named payee, the drawer or maker is liable on the instrument and bears the loss The Imposter Rule A rule that says if an imposter forges the indorsement of the named payee, the drawer or maker is liable on the instrument and bears the loss The Fictitious Payee Rule A rule that says that a drawer or maker is liable on a forged or unauthorized indorsement of a fictitious payee The Fictitious Payee Rule A rule that says that a drawer or maker is liable on a forged or unauthorized indorsement of a fictitious payee