Chapter 12: Creation of Negotiable Instruments

Requirements for Creating a Negotiable Instrument

1. Be in writing 2. Be signed by the maker or drawer 3. Be an unconditional promise or order to pay 4. State a fixed amount of money 5. Not require any undertaking in addition to payment of money. 6. Be payable on demand or at a definite time 7. Be payable to order or to bearer

Types of Negotiable Instruments

1. Draft 2. Check 3. Promissory Note 4. Certificate of Deposit

Functions of Negotiable Instruments

1. Substitute for Money 2. Act as Credit Devices 3. Act as Record Keeping Devices

A promissory note is evidence that...

1. The extension of credit 2. The borrower's promise to repay the debt.

Be in Writing R1

1. in writing 2. permanent and portable Met if on a pre-printed form, but type/hand written also acceptable.

Money

A "medium of exchange authorized or adopted by a domestic or foreign government" UCC.

CD Note

A CD is a promise to pay not an order to pay.

Installment Notes

A a note that is paid in installments.

Extension Clause

A clause in an instrument that allows the date of maturity of the instrument to be extended to sometime in the future.

Acceleration Clause

A clause in an instrument that allows the payee or holder to accelerate payment of the principal amount of the instrument, plus accrued interest, on the occurrence of an event.

Prepayment Clause

A clause in an instrument that permits the maker to pay the amount due prior to the date of the instrument.

Nonnegotiable Contract

A contract that fails to meet the requirements of a negotiable instrument and, therefore, is not subject to the provisions of the UCC Article 3.

Check

A distinct form of draft drawn on a financial institution and payable on demand.

Is a draft considered a Time Draft or a Sight Draft?

A draft can be both a time draft and a sight draft, created by language such as "payable 90 days after sight."

Time Draft

A draft payable at a designated future date.

Sight Draft (Demand Draft)

A draft payable on sight.

Order to Pay

A drawer's unconditional order to a drawee to pay a payee.

Representative's Signature

A maker or drawer can appoint an agent to sign a negotiable instrument on his or her behalf, the representative's signature is binding.

Promise to Pay

A maker's (borrower's) unconditional and affirmative undertaking to repay a debt to a payee (lender).

Article 3 Commercial Paper

A model code that establishes rules for the creation of, transfer of, enforcement of, and liability on negotiable instruments.

Time Note

A note payable at a specific time.

Demand Note

A note payable on demand.

Holder in Due Course (HDC)

A person who has received a negotiable instrument in good faith and without notice that it is overdue, that there is any prior claim, or that there is a defect in the title of the person who negotiated it.

Not Require Any Undertaking in Addition to the Payment of Money R5

A promise or order to pay cannot state any other undertaking by the person promising or ordering payment to do any act in addition to the payment of money.

Representative's Liability

A representative is not personally liable on the negotiable instrument if his or her signature properly unambiguously discloses 1) his or her agency status and 2) the identity of the maker or drawer.

Portability Requirement

A requirement of negotiable instruments that says they must be able to be easily transported between areas.

Permanency Requirement

A requirement of negotiable instruments that says they must be in a permanent state, such as written on ordinary paper. Tissue paper, video, and voice recordings are not negotiable instruments.

Fixed Amount of Money R4

A requirement that a negotiable instrument contain a promise or an order to pay a fixed amount of money. If interest is involved must also state the rate.

Payable on Demand or at a Definite Time R6

A requirement that a negotiable instrument must be payable either on demand or at a definite time.

Unconditional Promise to Pay or Order to Pay R3

A requirement that says a negotiable instrument must contain either an unconditional promise to pay (note or CD) or an unconditional order to pay (draft or check).

Signature Requirement

A requirement that states that a negotiable instrument must be signed by the drawer or maker. Any symbol executed or adopted by a party with a present intent to authenticate a writing qualifies as his or her signature.

Trade Acceptance (Bill of Exchange)

A sight draft that arises when credit is extended (by a seller to a buyer) with the sale of goods. The seller is both the drawer and the payee, and the buyer is the drawee.

Negotiable Instrument (Commercial Paper)

A special form of contract that satisfies the requirements established by Article 3 of the UCC.

Draft

A three party instrument that is an unconditional written order by one party that orders a second party to pay money to a third party.

Certificate of Deposit

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-on rate of interest on the expiration of a set time period agreed on by the parties.

Promissory Note

A two-party negotiable instrument that is an unconditional written promise by one party to pay money to another party.

Demand Instrument

An instrument payable on demand.

Order Instrument (Order Paper)

An instrument that is payable 1)to the order of an identified person or 2) to an identified person or order.

Bearer Instrument (Bearer Paper)

An instrument that is payable to anyone in physical possession of the instrument who presents it for payment when its due.

Be Signed by the Maker or the Drawer R2

Any adopted method of signing including mechanical means such as typed, printed, lithographed, rubber stamped, a thumbprint, etc.

Examples of Negotiable Instruments

Checks and Promissory Notes

CD's

Contain an Express Promise to pay, meaning they are the exception to the rule as the agreement to repay is acknowledged by the Lender's bank account.

Prepayment, Acceleration, or Extension Clauses...

Do not effect an instruments negotiability, commonly found in promissory notes.

Why is a Trade Acceptance considered a draft?

Even though only two actual parties are involved it is still considered a three party instrument because three legal positions are involved.

Negotiable

Freely transferable to subsequent parties.

Money Instrument

Instruments that are fully or partially payable in a medium of exchange other than money are not negotiable. i.e. cannot be paid in gold.

Note

Most notes require borrower to pay interest on the principal.

Be payable to Order or to Bearer R7

Must be payable to order or to the bearer, if not then nonnegotiable.

Unconditional

Not conditional or limited. Promises to pay and orders to pay must be unconditional in order to be negotiable.

Collateral

Security for the repayment of the note. Automobiles, houses, securities, or other property. Notes are named after what they're secured, i.e. Mortgage notes and collateral Notes.

CD Size

Small CD's - Under $100,000 Jumbo CD's - $100,000 and over

Drawer of Check

The checking account holder and writer of a check.

For a Drawee to be liable on a draft...

The drawee must accept the drawer's written order to pay it, usually shown by accepted written on the face of the draft, along with the drawee's signature and date.

Maker of a Certificate of Deposit

The financial institution that issues a CD (Borrower).

Drawee of a Check

The financial institution where the drawer of a check has his or her account.

Payee of a Certificate of Deposit

The party to whom a CD is made payable; usually the depositor (lender).

Payee of a Check

The party to whom a check is written.

Payee of a Note

The party to whom a promise to pay is made (lender).

Maker of a Note

The party who makes a promise to pay (borrower).

Drawee of a Draft

The party who must pay the money stated in a draft, also called the *Acceptor* of a draft.

Payee of a Draft

The party who receives the money from a draft.

Drawer of Draft

The party who writes an order for a draft.

Revised Article 3 Negotiable Instruments

a comprehensive revision of the UCC law of negotiable instruments that reflects modern commercial practices.

Time Instrument

an instrument payable 1) at a fixed date, 2) on or before a stated date, 3) at a fixed period after sight, or 4) at a time readily ascertainable when the promise or order is issued.