Chapter 24 - Negotiable Instruments Notes
The key points in this chapter include:
1. The four types of negotiable instruments.
2. The requirements for an instrument to be negotiable.
3. Factors that do not affect an instruments negotiability.
4. The process of negotiation.
5. The types of indorsements, and the legal effect of each.
A negotiable instrument is a signed writing that contains an unconditional promise or order to pay an exact sum of money, when demanded or at an exact future time. It is transferred more easily than a contract, and a person who acquires it is subject to less risk than the assignee of a contract. This chapter outlines types of negotiable instruments, requirements for negotiability, and the effect of indorsements.
I. ARTICLE 3 AND ITS REVISION
UCC Articles 3 applies to transactions involving negotiable instruments. Since 1990, most states have adopted revised versions of these articles. This outline refers to the revised articles.
II. THE FUNCTION OF INSTRUMENTS
A negotiable instrument can function as a substitute for money or as an extension of credit. To do so, it must be easily transferable without danger of being uncollectible.
III. TYPES OF INSTRUMENTS
A. DRAFTS AND CHECKS
The person who signs or makes an order to pay is the drawer. The person to whom the order is made is the drawee. The person to whom payment is ordered is the payee.
An unconditional written order by one person to another to pay money. The drawee must be obligated to the drawer either by an agreement or through a debtor-creditor relationship to honor the order.
a. Time Draft
Payable at a definite future time.
b. Sight Draft (Demand Draft)
Payable on sight (when presented for payment). A draft payable at a stated time after sight is both a time and a sight draft.
c. Trade Acceptance
A draft in which the seller is both the drawer and the payee. The draft orders the buyer to pay a specified sum of money to the seller, at a stated time in the future.
d. Bankers Acceptance
A draft drawn by a creditor against his or her debtor, who must pay the draft at maturity. Typically, the term is short.
A draft drawn on a bank and payable on demand. A cashiers check is a draft in which the bank is both the drawer and drawee. A tellers check is a draft drawn by one bank on another bank [UCC 3104(h)].
B. PROMISSORY NOTES AND CDS (PROMISES TO PAY)
A person who promises to pay is a maker. A person to whom the promise is made is a payee. A promissory note is a written
promise by one party to pay money to another party. A certificate of deposit (CD) is a note made by a bank promising to repay a deposit of funds with interest on a certain date [UCC 3104(j)].
IV. REQUIREMENTS FOR NEGOTIABILITY
To be negotiable, an instrument must [UCC 3104(a)] be
A. IN WRITING
A writing can be on anything that is (1) permanent and (2) has portability [UCC 3103(a)(6)].
B. SIGNED BY THE MAKER OR DRAWER
A signature can be any place on an instrument and in any form (a mark or rubber stamp) that purports to be a signature and authenticates the writing [UCC 1201(39), [UCC 3401(b)].
C. AN UNCONDITIONAL PROMISE OR ORDER
1. Promise or Order
A promise must be an affirmative written undertakingmore than a mere acknowledgment of a debt (an I.O.U. does not qualify; use of the words I promise or Pay qualifies) [UCC 3103(a)(9)].
a. Certificates of Deposit
The banks acknowledgment of a deposit and the other terms indicates a promise to repay a sum of money [UCC 3104(j)].
b. More Than One Payee
An order may be addressed to more than one person, either jointly or alternatively (Pay Joe or Jan) [UCC 3103(a)(6)].
Payment cannot be conditional, and the promise or order cannot be subject to or governed by another writing, or be subject to
rights or obligations stated in another writing UCC 3104(a), UCC 3106(a)]. Negotiability is not affected by
a. References to Other Writings [UCC 3106(a)].
b. Payments Only out of a Particular fund or Source [UCC 3106(b)(ii)].
c. A Statement that an Instrument Is Secured by a MortgageDestroys negotiability only if it stipulates that a promise to pay is subject to the terms of the mortgage [UCC 3106(b)(ii)].
E. AN ORDER OR PROMISE TO PAY A FIXED AMOUNT
A negotiable instrument must state a fixed amount to be paid when the instrument is payable.
1. References to Outside Sources
Interest may be determined with reference to information not contained in the instrument but readily ascertainable by reference to a source described in the instrument [UCC 3112(b)].
2. Variable Interest Rate Notes Can Be Negotiable
The fixed-amount requirement applies only to principal [UCC 3104].
F. PAYABLE IN MONEY
Only instruments payable in money (not bonds, stock, gold, or goods) are negotiable [UCC 3104(a)(3)]. Money is a medium of exchange recognized as the currency of a government [UCC 1201(24)].
G. PAYABLE ON DEMAND OR AT A DEFINITE TIME
1. Payable on Demand
An instrument that is payable on sight or presentment or that does not state any time for payment [UCC 3108(a)]. A check is payable on demand [UCC 3104(f)]. Presentment occurs when a person presents an instrument to a person liable on it for payment or when a person presents a draft to a drawee for acceptance.
2. Payable at a Definite Time
Payable on or before a stated date or within a fixed period after sight, or on a date or time ascertainable at the time the instrument is issued [UCC 3108(b)].
3. Acceleration Clauses
Allows a holder to demand payment of entire amount due if a certain event occurs. Does not affect negotiability [UCC 3108(b)(ii)]. A holder is any person in possession of an instrument drawn, issued, or indorsed to him or her, or to his or her order, to bearer, or in blank [UCC 1201(20)].
4. Extension Clauses
The period of the extension must be specified if the right to extend is given to the maker. If the holder has the right, no period need be specified [UCC 3108(b)(iii), (iv)].
H. PAYABLE TO ORDER OR BEARER
When it is issued or first comes into the possession of the holder [UCC 3104(a)(1)].
1. Order Instrument
May be payable to the order of an identified person or to an identified person or order, but must identify the payee with reasonable certainty [UCC 3109(b)].
2. Bearer Instruments
Does not designate a specific payee (but an instrument payable to a nonexistent entity is not bearer paper) [UCC 3109(a) and Comment 3]: Payable to the order of bearer, Pay to the order of cash, Pay cash.
V. FACTORS NOT AFFECTING NEGOTIABILITY
A. NO DATE
Negotiability is affected only if a date is necessary to determine a definite time for payment [UCC 3113(b)].
Postdating an instrument does not affect negotiability [UCC 3113(a)].
C. HANDWRITTEN WORDS
Handwritten words prevail typewritten words, which prevail over those that are printed (such as preprinted forms) [UCC 3114].
D. DISCREPANCY BETWEEN WORDS AND NUMBERS
An amount stated in words prevails over contradictory numbers [UCC 3114].
E. UNSPECIFIED INTEREST RATE
If a rate is unspecified, interest will be at the judgment rate [UCC 3112(b)].
F. NOTATION ON A CHECK THAT IT IS NONNEGOTIABLE
This has no effect on a check, but any other instrument is made nonnegotiable by the maker or drawer adding such a notation
V. TRANSFER BY ASSIGNMENT OR NEGOTIATION
A. TRANSFER BY ASSIGNMENT
A transfer by assignment (see Chapter 18) gives the assignee only those rights the assignor possessed. Defenses that can be
raised against an assignor can normally be raised against an assignee.
B. TRANSFER BY NEGOTIATION
On a transfer by negotiation, the transferee becomes a holder and receives the rights of the previous possessor (and possibly more) [UCC 3201(a), 3202(b), 3203(b), 3305, 3306]. Order paper is negotiated by delivery with indorsement; bearer paper is negotiated by delivery only [UCC 3201(b)].
C. CONVERTING INSTRUMENTS
An instrument can be converted from a bearer to an order instrument, or vice versa, by indorsement. A check payable to cash
subsequently indorsed Pay to Bob must be negotiated as an order instrument (by indorsement and delivery) [UCC 3205(a)].
An instrument payable to a named payee (Bob) and indorsed in blank is a bearer instrument [UCC 3205(b)].
Indorsements are required to negotiate an order instrument. The person who indorses an instrument is an indorser; the
person to whom the instrument is transferred is an indorsee.
A. WHAT AN INDORSEMENT IS
A signature with or without additional words or statements. Usually written on the back of an instrument but can be written on a separate piece of paper (an allonge) affixed (stapled) to it [UCC 3204(a)].
B. BLANK INDORSEMENT
Specifies no particular indorsee and can consist of a mere signature [UCC 3205(b)]. Converts an order instrument to a bearer
C. SPECIAL INDORSEMENT
Names the indorsee [UCC 3205(a)]. No special words are needed. Converts a bearer instrument into an order instrument.
D. QUALIFIED INDORSEMENT
Disclaims or limits contract liability (see Chapter 19) (the notation without recourse is commonly used) [UCC 3415(b)]. Often
used by persons acting in a representative capacity.
1. No Payment Guarantee
Does not guarantee payment, but does transfer title. (Most blank and special indorsements are unqualified, guaranteeing payment and transferring title).
2. Further Negotiation
A special qualified indorsement makes an instrument order paper (and requires indorsement and delivery for negotiation). A
blank qualified indorsement creates bearer paper (and requires only delivery).
E. RESTRICTIVE INDORSEMENTS
1. Indorsement Prohibiting Further Indorsement
Does not destroy negotiability [UCC 3206(a)]. Has the same effect as a special indorsement.
2. Conditional Indorsement
Specifying an event on which payment depends does not affect negotiability. A person paying or taking the instrument for value can disregard the condition [UCC 3206(b)]. (Conditional language on the face of an instrument, however, does destroy negotiability.)
3. Indorsement for Deposit or Collection
Making the indorsee (usually a bank) a collecting agent of the indorser (such as For deposit only) locks the instrument into the
bank collection process [UCC 3206(c)].
4. Trust Indorsement (Agency Indorsement)
An indorsement by one who is to hold or use the funds for the benefit of the indorser or a third party [UCC 3206(d), (e)]. To the extent the original indorsee pays or applies the proceeds consistently with the indorsement, he or she is a holder and can become a holder in due course (HDC). Any subsequent purchaser can qualify as an HDC (unless he or she knows the instrument was negotiated in breach of a fiduciary duty).
F. MISCELLANEOUS INDORSEMENT PROBLEMS
1. Forged or Unauthorized Indorsements
See Chapters 28 and 29.
2. Misspelled Name
An indorsement should be the same as the name on the instrument. An indorsee whose name is misspelled can indorse with the
misspelled name, the correct name, or both [UCC 3204(d)].
3. Multiple Payees
An instrument payable in the alternative (Pay to the order of Bill or Joan) requires the indorsement of only one. An instrument
payable jointly (Pay to the order of Bill and Joan) requires the indorsements of both. If it is not clear how it is payable, it requires the indorsement of only one [UCC 3110(d)].
4. Agents or Officers
An instrument payable to an entity (Pay to the order of the YWCA) can be negotiated by the entitys representative. An instrument payable to a public officer (Pay to the order of the County Tax Collector) can be negotiated by whoever holds the office [UCC 3110(c)].