Chapter 25: Negotiable Instruments

Certificates of Deposit (CDs)

A note of a bank in which the bank acknowledges a receipt of money from a party and promises to repay the money, with interest, to the party on a specified date • The bank is the maker of the note, and the depositor is the payee. • Because CDs are time deposits, the purchaser-payee typically is not allowed to withdraw the funds before the date of maturity (except in limited circumstances, such as disability or death). • If a payee wants to access the funds before the maturity date, he or she can sell (negotiate) the CD to a third party

Extension Clause

A clause in a time instrument that allows the instrument's date of maturity to be extended into the future • To keep the instrument negotiable, the interval of the extension must be specified if the right to extend the time of payment is given to the maker or the drawer of the instrument. • If, however, the holder of the instrument can extend the time of payment, the extended maturity date need not be specified.

Acceleration Clause

A clause in an installment contract that provides for all future payments to become due immediately on the failure to tender timely payments or on the occurrence of a specified event. • An acceleration clause allows a payee or other holder of a time instrument to demand payment of the entire amount due, with interest, if a specified event occurs. • Holder - Any person in the possession of an instrument drawn, issued, or indorsed to him or her, to his or her order, to bearer, or in blank • The instrument will be payable on a specified date if the event allowing acceleration does not occur • Instruments that include acceleration clauses are negotiable because the exact value of the instrument can be ascertained.

Negotiable Instrument

A signed writing that contains an unconditional promise or order to pay an exact sum of money, on demand or at an exact future time, to a specific person or order, or to bearer.

Promissory note

A written promise made by one person (the maker) to pay a fixed sum of money to another person (the payee or a subsequent holder) on demand or on a specified date. • Maker - One who promises to pay a certain sum to the holder of a promissory note or certificate of deposit (CD). • A promissory note: • Can be made payable at a definite time or on demand • Can name a specific payee or merely be payable to bearer • Is commonly assigned (negotiated, or transferred) from one lender, one payee, to another • Is not a debt (it is only the evidence of debt) therefore its loss does NOT alter the rights of the owner

Order

An order directs a third party to pay the instrument as drawn. • A command, such as "pay," is mandatory in an order.• Generally, the language used must indicate that a command, or order, is being given. • Example: Stating "please pay" or "kindly pay" fulfills this requirement, whereas stating "I wish you would pay" does not fulfill this requirement. • An order may be addressed to one person or to more than one person, either jointly ("to A and B") or alternatively ("to A or B")

Payable to Order or to Bearer

Because one of the functions of a negotiable instrument is to serve as a substitute for cash, freedom to transfer is essential. • To ensure a proper transfer, the instrument must be "payable to order or to bearer" at the time it is issued or first comes into the possession of the holder • An instrument is not negotiable unless it meets this requirement.

Factors That Do Not Affect Negotiability

Certain ambiguities or omissions will not affect the negotiability of an instrument. • Article 3's rules for interpreting ambiguous terms include the following: 1. An undated instrument does not affect its negotiability, unless the date of an instrument is necessary to determine a definite time for payment 2. Antedating or postdating an instrument does not affect its negotiability • Antedating occurs when a party puts a date on an instrument that precedes the actual calendar date.• Postdating occurs when a party puts a date on an instrument that is after the actual date. 3. Handwritten terms outweigh typewritten and printed terms (preprinted terms on forms, for example), and typewritten terms outweigh printed terms 4. Words outweigh figures unless the words are ambiguous • This rule becomes important when the numerical amount and the written amount on a check differ. 5. When an instrument simply states "with interest" and does not specify a particular interest rate, the interest rate is the judgment rate of interest • The judgment rate of interest refers to a rate of interest fixed by statute that applies to court judgments. 6. A check is negotiable even if there is a notation on it stating that it is "nonnegotiable" or "not governed by Article 3." • Any other instrument, however, can be made nonnegotiable by the maker's or drawer's conspicuously noting on it that it is "nonnegotiable" or "not governed by Article 3"

Payable on Demand

Instruments that are payable on demand include those that contain the words "Payable at sight" or "Payable upon presentment." • Presentment - The act of presenting an instrument to the party liable on the instrument to collect payment; the act of presenting an instrument to a drawee for acceptance. • The very nature of the instrument may indicate that it is payable on demand • Example: A check, by definition, is payable on demand • If no time for payment is specified and the person responsible for payment must pay on the instrument's presentment, the instrument is payable on demand

Fixed Amount

The term "fixed amount" (sometimes called "sum certain") means that the amount must be ascertainable from the face of the instrument. • Interest may be stated as a fixed or variable rate. >Payable in Money • UCC provides that a fixed amount is to be payable in money. • The UCC defines money as "a medium of exchange authorized or adopted by a domestic or foreign government as a part of its currency" • An instrument payable in the United States with a face amount stated in a foreign currency can be paid in foreign money or in the equivalent of U.S. dollars

Unconditional Promise or Order to Pay

The terms of the promise or order must be: • Included in the writing on the face of a negotiable instrument • Unconditional—that is, they cannot be conditioned on the occurrence or nonoccurrence of some other event or agreement

4 types of negotiable instruments

drafts, checks, notes, and certificates of deposit

Can also be classified as either demand instruments or time instruments

• A demand instrument is payable on demand—that is, it is payable immediately after it is issued and for a reasonable period of time thereafter. • Example: Checks • Issue - The first transfer, or delivery, of an instrument to a holder • A time instrument is payable at a future date.

Negotiable interest can function as

• Substitute for cash • Extension of credit •For a negotiable instrument to operate practically as either a cash substitute or a credit device, it is essential that the instrument be easily transferable without danger of being uncollectible. •Article 3 of the Uniform Commercial Code imposes special requirements for the form and content of negotiable instruments.

A negotiable instrument must be

"payable on demand or at a definite time" • To determine the value of a negotiable instrument, it is necessary to know: • When the maker, drawee, or acceptor is required to pay • Acceptor - The person (the drawee) who accepts a draft and who agrees to be primarily responsible for its payment. • When the obligations of secondary parties, such as indorsers, will arise • The exact interval during which the interest will accrue • Furthermore, it is necessary to know when an instrument is due in order to calculate when the statute of limitations may apply

Negotiable instruments frequently are divided into two classifications:

1. Orders to pay • Examples: Drafts and checks 2. Promises to pay • Examples: Promissory notes and CDs

Checks

A draft drawn by a drawer ordering the drawee bank or financial institution to pay a certain amount of money to the holder on demand. • On certain types of checks, such as cashier's checks, the bank is both the drawer and the drawee. • Checks are the most commonly used type of draft. • Checks are demand instruments because they are payable on demand.

Trade acceptances

A draft that is drawn by a seller of goods ordering the buyer to pay a specified sum of money to the seller, usually at a stated time in the future. • The buyer accepts the draft by signing the face of the draft, thus creating an enforceable obligation to pay the draft when it comes due. • On a trade acceptance, the seller is both the drawer and the payee.

Order instrument

A negotiable instrument that is payable "to the order of an identified person" or "to an identified person or order • An identified person is the person "to whom the instrument is initially payable" as determined by the maker's or drawer's intent • The identified person may transfer the instrument to whomever he or she wishes. • The maker or drawer is agreeing to pay either the person specified on the instrument or whomever that person might designate. • In this way, the instrument retains its transferability. • The person specified must be identified with certainty, because the transfer of an order instrument requires the indorsement, or signature, of the payee.

Banker's acceptance

A promised future payment, or time draft, that is accepted and guaranteed by a bank and drawn on a deposit at a bank. • The banker's acceptance specifies the amount of money, the date, and the person to whom the payment is due, and is commonly used in international trade.

Time Drafts and Sight Drafts

A time draft is payable at a definite future date. • A sight draft (or demand draft) is payable on sight—that is, when it is presented to the drawee (usually a bank or financial institution) for payment. • A sight draft may be payable on acceptance. • Acceptance - The drawee's signed agreement to pay a draft when presented. • Usually, an instrument is accepted by writing the word "accepted" across its face, followed by the date of acceptance and the signature of the drawee.

Drafts

Any instrument (such as a check) drawn on a drawee (such as a bank) that orders the drawee to pay a certain sum of money, usually to a third party (the payee), on demand or at a definite future time. • Drawer - The party that initiates a draft (writes a check, for example), thereby ordering the drawee to pay. • Drawee - The party that is ordered to pay a draft or check. • With a check, a financial institution is always the drawee. • Payee - A person to whom an instrument is made payable. • The most common type of draft is a check, but drafts other than checks may be used in commercial transactions.

Bearer Instrument

Any instrument that is not payable to a specific person, including instruments payable to the bearer or to "cash" • Bearer - A person in the possession of an instrument payable to bearer or indorsed in blank • Any instrument containing terms such as the following is a bearer instrument: 1. "Payable to the order of bearer" 2. "Payable to Simon Reed or bearer" 3. "Payable to bearer" 4. "Pay cash" 5. "Pay to the order of cash"• An instrument that "indicates that it is not payable to an identified person" (or a nonexistent person) is a bearer instrument • The UCC does not accept an instrument issued to a nonexistent organization as payable to bearer

Signatures

For an instrument to be negotiable, it must be signed by: 1. The maker if it is a note or a certificate or deposit 2. The drawer if it is a draft or a check • If a person signs an instrument as an authorized agent for the maker or drawer, the maker or drawer has effectively signed the instrument

Promise

For an instrument to be negotiable, it must contain an express promise or order to pay. • The UCC requires that a promise be an affirmative (express) undertaking • Thus, a mere acknowledgment of the debt, such as an I.O.U. ("I owe you"), might logically imply a promise, but it is not sufficient under the UCC. • In contrast, if such words as "to be paid on demand" or "due on demand" are added to an I.O.U., the need for an express promise is satisfied. • A certificate of deposit is exceptional in this respect because no express promise is required. • The bank's acknowledgment of the deposit and the other terms of the instrument clearly indicate a promise by the bank to repay the sum of money

Requirements for Negotiability

For an instrument to be negotiable, it must meet the following requirements: 1. Be in writing 2. Be signed by the maker or the drawer 3. Be an unconditional promise or order to pay 4. State a fixed amount of money 5. Be payable on demand or at a definite time 6. Be payable to order or to bearer

Payable at a Definite Time

If an instrument is not payable on demand, to be negotiable it must be payable at a definite time. • An instrument is payable at a definite time if it states any of the following: 1. That it is payable on a specified date 2. That it is payable within a definite period of time (such as thirty days) after being presented for payment 3. That it is payable on a date or time readily ascertainable at the time the promise or order is issued • The maker or drawee is under no obligation to pay until the specified date. • When an instrument is payable by the maker or drawer on or before a stated date, it is clearly payable at a definite time. • When an instrument is undated and made payable "one month after date," the date is uncertain and, thus, the instrument is not payable at a definite time.

Written Form

Negotiable instruments must be in written form (but may be evidenced by electronic record) 1. The writing must be on material that lends itself to permanence. ex. not written in ice or sand, but can be on a napkin or shirt 2. The writing must have portability. ex. can not be written on side of a cow

Unconditionality of the Promise or Order

Only unconditional promises or orders can be negotiable • A promise or order is conditional (and not negotiable) if it states any of the following: 1. An express condition to payment 2. That the promise or order is subject to or governed by another writing 3. That the rights or obligations with respect to the promise or order are stated in another writing • A mere reference to another writing or record does not of itself make the promise or order conditional • Including the phrase "as per contract" or "This debt arises from the sale of goods X and Y" does not render an instrument nonnegotiable. • A statement in the instrument that payment can be made only out of a particular fund or source (such as the proceeds of a particular crop) will not render the instrument nonnegotiable, unless the payment is to be made from a fund that does not yet exist

A draft can be both a time and sight draft

Such a draft is payable at a stated time after sight

Signature Requirements

The UCC is quite lenient with regard to what constitutes a signature. • Signature - Under the Uniform Commercial Code, "any symbol executed or adopted by a party with a present intention to authenticate a writing" • A signature can: • Be made by a device, such as a rubber stamp• Consist of any name, including a trade or assumed name, or a word, mark, or symbol >Placement of the Signature • The location of the signature on the document is unimportant, although the usual place is the lower right-hand corner.

Negotiable instruments must state with certainty

a fixed amount of money to be paid at the time the instrument is payable • This requirement ensures that the value of the instrument can be determined with clarity and certainty.