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Chapter Four
Negotiable Instruments
*** TYPES OF NEGOTIABLE INSTRUMENTS ***
1. A Note or Promissory note is an unconditional written promise by a maker to pay a certain sum of money to a payee. (It is a promise to pay)
a. the maker is the issuer and the one promising to pay b. the payee is the party that is to receive the money c. a time note is payable at a specified time in the future
d. a demand note is payable on demand (payable immediately on presentation)
2. A Certificates of Deposit is a note signed by a bank acknowledging the receipt of money and promising to repay with interest (i.e. It is a bank promissory note)
3. A Draft is a written instrument in which a drawer unconditionally orders a specified drawee to pay a certain sum of money to a payee. (an order to a 3rd party to pay)
a. the three parties are the Drawer (the issuer), the Payee (the party to receive the money), and the Drawee (the party that is ordered to pay the payee)
b. sight drafts are drafts payable on demand (payable immediately on presentation) c. time drafts are drafts payable at a specified time in the future
4. A check is a special type of draft with two additional requirements a. the drawee must be a bank
b. the check must be payable on demand (payable immediately on presentation) c. a cashier's check is a bank check and the bank is both the drawer and drawee
5. A Trade Acceptance is a draft by a seller ordering a buyer to pay the seller or some 3rd party at a future time (it is an order to a 3rd party to pay)
a. a trade acceptance results in the buyer having additional time to pay for goods b. the seller is usually both the drawer and the payee of the instrument
c. the buyer is the drawee and accepts by signing in lower left hand corner of the instrument
d. the seller is secondarily liable on the instrument and the buyer becomes primarily liable on the date that they accept
6. Investment Securities (stocks and bonds) & Documents of Title (warehouse receipts and bills of lading) are not Commercial Paper but they follow many of the same rules
*** 5 ELEMENTS OF NEGOTIABILITY***
1. In order for an instrument to be a negotiable instrument, it must meet the 5 elements of negotiability (a nonnegotiable instrument is governed by the law of contracts)
a. it must be in writing Signed by the maker or drawer b. it must be an Unconditional promise or order c. it must be payable in a certain sum of Money d. it must be payable to Bearer or Order
e. it must be payable on Demand or at a definite time
4-2 SUMBOD
S Must be Signed
U Must be an Unconditional promise or order M Must be Money and nothing else but money B
O
Must be payable to Bearer or payable to Order
D Must be payable on Demand or payable at a definite time
note: The UCC permits some substitution or variance from the exact language set forth as to the elements of negotiability
2. The written instrument must be Signed by the maker or the drawer:
a. a signature is any type of mark made with an intent to validate the writing b. e.g. the signature may be printed, stamped, typed or even done in pencil 3. The promise or order must be Unconditional or the instrument is nonnegotiable
a. an instrument is not negotiable if it is subject to another agreement or contingent upon a specified occurrence
1). reference may be made to another agreement without affecting negotiability
2). but if it is subject to the agreement or contingent upon satisfactory completion of the agreement then it is nonnegotiable
b. exception: an instrument can be subject to implied or constructive conditions and be negotiable.
It must be subject to an express condition to destroy negotiability
Example: The statement "this note arises out of a contract between the parties dated May 13, 2000 for the purchase of a 2000 Ford Taurus to be delivered on May 20, 2000" would not affect negotiability, for it is a mere reference to the contract. If it were "subject to all the terms of said contract" or "contingent upon satisfactory completion of said contract," it would be nonnegotiable. However, if it stated it was "subject to all implied conditions of said contract," it would be negotiable.
c. references to collateral or security are permissible and do not prevent negotiability d. provisions as to consideration are permissible and do not prevent negotiability 4. The instrument must be payable in a fixed amount of Money
a. it must be payable in money and nothing else but money
1). money may be any type of legal tender to include foreign currency 2). e.g. an instrument payable in money or stock is not negotiable
3) the instrument cannot require doing anything additional to the payment of money (e.g. an instrument payable in money and services is not negotiable)
b. it must be payable in a fixed amount. The following are permissible and will not prevent the amount from being a fixed amount
1). collection costs, to specifically include attorney's fees upon default
2). provisions as to interest (e.g. variable interest rate provision is negotiable as is an instrument stating it is payable with interest but without specifying the rate)
3). it is a fixed amount even if the words and numbers differ (the words control) 5. The instrument must be payable to Bearer or to Order, the magic words of negotiability
a. an instrument that is bearer paper names no specific payee and can be transferred without endorsement, just like cash. Examples of bearer paper:
1). payable "to bearer" or "to the order of the bearer"
2). payable "to a specified party or the bearer" (e.g. to James Dokes or bearer) 3). payable "to cash" or "to the order of cash"
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4). an instrument that omits the name of a payee is a negotiable bearer instrument (e.g. "pay to the order of ____________" is negotiable and payable to bearer)
b. order paper is an instrument payable to a designated party and requires that party's endorsement for further negotiation. Examples of order paper:
1). pay "to the order of James Dokes"
2). pay "to Jane Jart or her order"
c. if it is not payable to bearer or order, it is nonnegotiable (e.g. pay to Jane Jart) d. exception: checks do not have to be payable to order or bearer to be negotiable 6. The instrument must be payable on Demand or at a definite time
a. an instrument is payable on demand when it must be paid upon the holder's request 1). it is payable on demand if no time of payment is specified
2). it is payable on demand if it is payable "at sight" or "at presentment"
b. an instrument may also be payable at a definite time in the future. Examples:
1). negotiable if it is payable "on or before June 1" (thus prepayment is allowed) 2). negotiable if it is payable "30 days after presentment or 30 days after sight"
3). negotiable if it is payable at a fixed time subject to acceleration
4). negotiable if it may be extended from a definite time to an other definite time (e.g. payable May 1 and Maker may elect to extend the date to June 1)
c. an instrument may be postdated, antedated, or undated and be negotiable d. it is not negotiable if the date of payment can not be determined
1). e.g. not negotiable if it was payable "10 days after X's death" or payable "10 days after the sale of my house"
2). e.g. not negotiable if it was payable "30 days after date" and undated. Note it would be negotiable if it had been dated
7. Once an instrument is negotiable on its front, it is always negotiable
a. thus, nothing placed on the back of the instrument will prevent further negotiation
b. e.g. an endorsement on the back of an instrument does not have to contain the magic words of negotiability "payable to bearer or pay to the order of"
*** NEGOTIATION ***
1. Negotiation is transferring Commercial Paper to a 3rd party, a holder (note: the transfer of a nonnegotiable instrument is an assignment and is governed by contract law)
2. Negotiation of bearer paper requires mere transfer of possession a. voluntary transfer of an instrument requires mere delivery
b. because bearer paper can be transferred without endorsement, anyone in possession of bearer paper qualifies as a holder (e.g. even a finder or a thief)
3. Negotiation of order paper requires both delivery and endorsement by the proper parties a. thus, to be a holder a party must have both possession and a proper endorsement
b. if order paper is transferred without a required endorsement, the immediate transferee has the right to an unqualified endorsement by the transferor
4. All endorsements are either Blank endorsements or Special endorsements a. in a Blank endorsement, the payee signs without naming a new payee
1). e.g. an instrument endorsed Sadie Brown is a blank endorsement as is Janet Jart, without recourse because no new payee was named
2). a blank endorsement always makes the instrument bearer paper
3). holder of an instrument with a blank endorsement may write a new payee above the blank endorsement and convert it to order paper
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b. in a Special endorsement, the payee signs and names a new payee
1). e.g. Pay to John Jones (signed) Betty Brown is a special endorsement (note: the words of negotiability "Pay to the order of John Jones" were not needed)
2). a special endorsement always makes the instrument order paper (thus, the endorsement of the new payee is required for further negotiation)
5. In a Restrictive endorsement the payee adds a restriction or condition, but doesn't prevent further negotiation or transfer of the instrument
a. e.g. "Bill Bates, for deposit only" or "Mickey Finn, for collection only"
b. note: "Bill Bates, for deposit only" is both a blank and a restrictive endorsement
6. In a Qualified endorsement the payee adds the words "without recourse" either before or after their name for the purpose of limiting their legal liability
a. it eliminates contract liability for the endorser (no guarantee of payment) b. it does not eliminate the warranty liability of the endorser
c. it doesn't destroy negotiability or prevent further negotiation or transfer of the instrument