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Negotiable Instruments

PA ET RHC 31

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)

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Learning Objectives

• Explain advantages of commercial paper and the requirements to qualify as a negotiable instrument

• Identify different types of negotiable instruments and the key features

• Apply UCC rules for situations when the terms of an instrument are ambiguous or inherently conflicting

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• Commercial paper refers to checks, promissory notes, & certificates of deposit– Basically a contract for 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 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)

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 the 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 a specific 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 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: • Ambiguity caused by 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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• Multiple Choice– Basic types of commercial paper

include:a) Promises to pay moneyb) Orders to pay money c) A document of titled) Both A and B e) All of the above

Test Your Knowledge

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• 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

negotiable

Test Your Knowledge

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Thought Questions

• Do you use negotiable instruments? How do you do your banking?