The Function and Creation of Negotiable Instruments - Chapter 12

Payable on Demand

Instruments that are payable on demand include those that contain the words "payable at sight" or "payable upon presentment." Presentment occurs when a person brings the instrument to the appropriate party for payment or acceptance.

Acceptance

The drawee's written promise to pay the draft when it comes due. Usually accepted by writing "accepted" across its face, followed by the date of acceptance and the signature of the drawee.

Checks:

The most commonly used type of draft. The writer of the check is the drawer, the bank on which the check is drawn is the drawee, and the person to whom the check is made payable is the payee. Checks are demand instruments because they are payable on demand. With cashier checks, the bank is both the drawer and the drawee.

Bearer Instruments

A bearer instrument is an instrument that does not designate a specified payee The term "bearer" refers to a person in possession of an instrument that is payable to bearer or indorsed in blank (with a signature only). This means that the maker or drawer agrees to pay anyone who presents the instrument for payment. Ex: if a person shows up to the maker with the instrument, because they bear the instrument, they will be paid. 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"

Negotiable Instrument

A signed writing containing an unconditional promise to pay an exact sum of money. Most negotiable instruments are paper documents, referred to as commercial paper.

Trade Acceptances

A type of draft that is used in the sale of goods. The seller of the goods is both the drawer and the payee. The buyer to whom the credit is extended is the drawee. The draft orders the buyer to pay a specified amount to the seller, usually at a stated time in the future.

Certificate of Deposit (Promise to Pay)

A type of note issued when a party deposits funds with a bank, and the bank promises to repay the funds, with interest, on a certain 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).

Promissory Notes (Promise to Pay)

A written promise to pay made by one person (the maker of the promise) to pay another (usually a payee) a specified sum. Promissory notes are used in a variety of credit transactions. Often, a promissory note will carry the name of the transaction involved.

Acceleration Clause

Allows a payee or other holder of a time instrument to demand payment of the entire amount due, with interest, if a certain event occurs, such as a default in payment. Under the UCC, instruments that include acceleration clauses are negotiable for two reasons: (1) The exact value of the instrument can be ascertained (2) The instrument will be payable on a specified date if the event allowing acceleration does not occur.

Extension Clause

Allows the date of maturity to be extended to the future. To keep an 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.

Indorsement

An indorsement is a signature placed on an instrument, such as on the back of a check, generally for the purpose of transferring one's ownership rights to the instrument. With instruments, the person specified must be identified with certainty because the transfer of an order instrument requires that indorsement, or signature, of the payee.

An instrument can be payable to a nonexistent person

An instrument that "indicates that it is not payable to an identified person" is a bearer instrument. Thus, an instrument that is "payable to X" can be negotiated as a bearer instrument, as though it were payable to cash.

Order instruments

An order instrument is an instrument that is payable: (1) to the order of an identified person, or (2) to an identified person or order An identified person is the person "to whom the instrument is initially payable" as determined by the intent of the maker or drawer. The identified person, in turn, may transfer the instrument to whomever he or she wishes. Ex: "Pay to the order of James Yung" or "Pay to James Yung or order".

Orders

An order is associated with three-party instruments, such as checks, drafts, and trade acceptances. An order directs a third party to pay the instrument as drawn (ex: "Pay X amount for..")

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 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: (1) Unless the date of an instrument is necessary to determine a definite time for payment, the fact that an instrument is undated does not affect its negotiability. (eg: an undated check) (2) Antedating (date predates calendar date) or postdating (date is after calendar date) does not affect its negotiability (3) Handwritten terms outweigh typewritten and printed terms, and typewritten terms outweigh printed terms. (ex: writing in the blank section of a check) (4) Words outweigh figures unless the words are ambiguous. This 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 judgement rate of interest (the rate of interest fixed by statute that applies to a monetary judgement awarded by a court). (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 marker's or drawer's conspicuously noting on it that it is "nonnegotiable" or "not governed by Article 3"

Time Drafts

Drafts payable at a certain future time.

Signatures

For an instrument to be negotiable, it must be signed by: * the maker if it is a note or a certificate of deposit * The drawer if it is a draft or a check An authorized agent can sign an instrument on behalf of the maker or drawer.

Promise

For an instrument to be negotiable, it must contain an express promise or order to pay. A mere acknowledgement of the debt (Ex: "I.O.U.") might imply a promise, but it is not sufficient under the UCC. The promise must be express (ex: "to be paid on demand" or "due on demand.")

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 drawer (3) Be an unconditional promise or orders 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 the drawee is under no obligation to pay until the specified date.

Written Form

Negotiable instruments must be in written form on a permanent material (paper).

Fixed Amount of Money

Negotiable instruments must state with certainty a fixed amount of money to be paid at the time the instrument is payable. The term "fixed amount" means that the amount must be ascertainable from the face of the instrument. Interest may be stated as a fixed or variable rate.

Four Types of Negotiable Instruments

Orders to pay: * Drafts: an order by one person to another person or bearer * Checks: A draft drawn on a bank and payable on demand. Promises to pay: * Notes: or promissory notes, a promise by one party to pay money to another party or to bearer. * Certificate of Deposit: A note made by a bank acknowledging a deposit of funds made payable to the holder of the note.

Sight Draft

Payable on sight - when it is presented to the drawee (usually a bank or institution) for payment.

Commonly Assigned

Promissory notes are commonly assigned (negotiated, or transferred) from one lender, or payee, to another. Assignment does not affect the maker's obligation to pay the note as promised.

An instrument cannot be payable to a nonexistent organization

The UCC does not accept an instrument issued to a nonexistent organization as a payable bearer. Therefore, an instrument "payable to the order of the Camrod Company," if no such company exists, would not be a negotiable instrument.

Unconditional Promise or Order to Pay

The terms of the promise or order must be included in the writing of the negotiable instrument and must be unconditional (cannot be conditional on the occurrence or nonoccurrence of some other event or agreement). Only unconditional promises or orders can be negotiable. A promise or order is conditional (and not negotiable) if it sates any of the following: (1) An express condition to payment (2) That the promise or order is subject to or governed by another writing (or record) (3) That the rights or obligations with respect to the promise or order are stated in another writing or record.

Drafts (orders to pay)

Unconditional orders to pay that involve three parties: * Party creating the draft (drawer) orders another party (the drawee) to pay the money, usually to a third party (the payee). The most common type of draft is a check, but drafts other than checks may be used in commercial transactions.