Negotiable InstrumentsNegotiation and Holder in Due Course

Liability of PartiesChecks and Electronic Transfers

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Negotiable Instruments

We at Chrysler borrow money the old-fashioned way. We pay it back.

Lee Iacocca, Chairman and CEO of

Chrysler Corporation, quoted in the

New York Times (1983)

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives

Nature of negotiable instrumentsTypes of negotiable instrumentsBenefits of negotiable instrumentsFormal requirements for

negotiability

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Commercial paper refers to checks, promissory notes, and certificates of deposit Basically a contract for the payment of money

Commercial paper may be negotiable: Transferred from party to party and accepted

as a money substitute payable immediately (check) or as credit (promissory note)

Overview

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UCC Article 3 (Negotiable Instruments) and Article 4 (Bank Deposits and Collections) cover commercial paper Other negotiable documents (documents of

title, investment securities) covered by other sections

Two basic types of negotiable instruments: Promises to pay money Orders to pay money

The Uniform Commercial Code

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Promissory notes and certificates of deposit issued by banks are promises to pay money

Promissory note: two-party instrument in which the maker promises unconditionally in writing to pay the payee, a person specified by the payee, or the bearer of the note, a fixed amount of money (with or without interest) either on demand or at a specified, future time [3–104]

Promises to Pay Money

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A certificate of deposit is an instrument containing (1) an acknowledgment by a bank that it has received a deposit of money and (2) a promise by the bank to repay the sum of money [3–104(j)] Generally in electronic form

Promises to Pay Money

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A draft is an order (not a promise) by one person to a second person to pay money to a third person [3–104(e)] A check is the most common draft

Specifically, the drawer orders the drawee to pay a certain sum of money to the payee, to a person specified by the payee, or to the bearer of the instrument Example: writing a bank check to pay a

bill

Orders to Pay Money

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Cashier’s check: draft on which drawer and drawee are the same bank (or branches of same bank)

Teller’s check: draft drawn by a bank (as drawer) on second bank or payable through a bank [3–104(g) and (h)]

Orders to Pay Money

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Purpose of negotiability is to decrease risk of transfer (assignment of commercial paper contract) so the instrument will be accepted as a substitute for money

Thus, (1) the contract for payment of money must meet requirements for negotiability, and (2) the person who acquires instrument must qualify as a holder in due course

Negotiability

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A holder in due course has good title to the instrument, paid value for it, acquired it in good faith, and had no notice of certain claims or defenses against payment Instrument bears no evidence of forgery or

triggers concerns about authenticity A holder in due course takes the

instrument free of all defenses and claims except those that concern its validity

A Holder in Due Course

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For an instrument to be negotiable, it must be in writing, signed by the maker, containing an unconditional promise or order to pay a fixed amount of money, payable to order or to bearer, payable on demand at a definite time, lack any other instruction by the maker (three exceptions) [3–103; 3–104]

Requirements For Negotiability

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The instrument must be in writing and signed by the maker

Any writing (print, handwritten) or type of signature (handwritten, authorized stamped signature, or an X if witnessed) See Interbank of New York v. Fleet Bank

A bank that pays an unauthorized check (e.g., Interbank) bears the economic loss, but may sue the person that created the unauthorized item

The Signed Writing

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The instrument must must contain an unconditional promise or order to pay (e.g., “pay to the order of”)

Conditional phrases destroy negotiability, though reference to another document about collateral, prepayment, or acceleration does not destroy negotiability

Unconditional Promise or Order

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The requirement of a “fixed amount of money” applies only to principal

Interest may be stated in an instrument as a fixed or variable amount of money or expressed as a fixed or variable rate or rates

Fixed Amount of Money

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A promise or order is “payable on demand” if (1) it states it is payable on “demand” or “sight” or (2) does not state any time for payment [3–108(a)]

A promise or order is “payable at a definite time” if payable at fixed date(s) or at time(s) readily ascertainable at the time the promise or order is issued [3–108(b)] The typical promissory note

Payable on Demand or At a Definite Time

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An instrument is payable “to order” (order paper) if payable to (1) order of identified person or (2) an identified person or that person’s order [3–109(b)] Requires indorsement for negotiation

An instrument payable “to bearer” or “to cash” (bearer paper) may be negotiated or transferred by delivery of possession without indorsement [3– 201(b)]

Payable to Order or Bearer

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Pelican National Bank v. Provident Bank of Maryland

Facts: Insurance company issued check drawn on a bank to several payees listed without punctuation or grammatical connector (and/or)

Holding: Court concluded the check was ambiguous and applied the default rule that treated the document as if payable in the alternative: “The indorsement of any one of the payees was sufficient.”

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A instrument will remain negotiable if it includes statements about: Giving, maintaining, or protecting

collateral to secure payment An authorization to confess judgment

or realize on or dispose of collateral Waiving the benefit of any law

intended for the protection or benefit of a person obligated on the instrument

Special Terms

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If terms conflict or an ambiguous term exists, general rules of interpretation apply: Typewritten terms prevail over printed

terms, handwritten terms prevail over printed and typewritten terms, and where words and numbers conflict, words control the numbers [3–114]

See Galatia Community State Bank v. Kindy: Difference between numbers on the check from

checkwriting machine and number written by hand

Ambiguous Terms

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Test Your Knowledge

True=A, False = B Commercial paper includes checks,

promissory notes, and certificates of deposit. A holder in due course takes the instrument

free of all defenses and claims. UCC Articles 3 & 4 cover commercial paper. A certificate of deposit is a negotiable

instrument in which a bank acknowledges is received a money deposit and promises to repay the sum in the future.

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Test Your Knowledge

Multiple Choice The basic types of commercial paper

are: (a) Promises to pay money(b) Orders to pay money (c) A document of title(d) Both A and B (e) All of the above

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Test Your Knowledge

Multiple Choice Which of the following would be non-

negotiable? (a) Please pay to the order of Sarah $100.” (b) “This promissory note is secured by my

property in Pender County.” (c) “This promissory note is subject to

Sarah’s graduation from college.” (d) None of the above; they are all

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Thought Questions

Do you use negotiable instruments each week? How do you do your banking?

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