1. C H A P T E R
31
Negotiable Instruments
We at Chrysler borrow money the
old-fashioned way. We pay it back.
Lee Iacocca, Chairman and CEO
of Chrysler Corporation, quoted in
the New York Times (1983)
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2. Learning Objectives
• Explain advantages of commercial
paper and the requirements to
qualify as a negotiable instrument
• Identify different types of negotiable
instruments and the key features
• Apply UCC rules for situations when
the terms of an instrument are
ambiguous or inherently conflicting
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3. Overview
• Commercial paper refers to checks,
promissory notes, & certificates of deposit
– Basically a contract for payment of money
• Commercial paper may be negotiable:
– Transferred from party to party and
accepted as a money substitute payable
immediately (check) or as credit
(promissory note)
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4. The Uniform Commercial Code
• UCC Article 3 (Negotiable Instruments)
and Article 4 (Bank Deposits and
Collections) cover commercial paper
– Other negotiable documents (documents
of title, investment securities) covered by
other sections
• Two basic types of negotiable instruments:
– Promises to pay money
– Orders to pay money
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5. Promises to Pay Money
• Promissory notes and certificates of
deposit issued by banks are promises to
pay money
• Promissory note: two-party instrument in
which the maker promises unconditionally
in writing to pay the payee, a person
specified by the payee, or the bearer of
the note, a fixed amount of money (with
or without interest) either on demand or
at a specified, future time [3–104]
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6. Promises to Pay Money
• A certificate of deposit is an instrument
containing (1) an acknowledgment by a
bank that it has received a deposit of
money and (2) a promise by the bank to
repay the sum of money [3–104(j)]
– Generally in electronic form
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7. Orders to Pay Money
• A draft is an order (not a promise) by one
person to a second person to pay money
to a third person [3–104(e)]
– A check is the most common draft
• Specifically, the drawer orders the drawee
to pay a certain sum of money to the
payee, to a person specified by the
payee, or to the bearer of the instrument
– Example: writing a bank check to pay a bill
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8. Orders to Pay Money
• Cashier’s check: draft on
which drawer and drawee
are the same bank (or
branches of same bank)
• Teller’s check: draft
drawn by a bank (as
drawer) on second bank or
payable through a bank
[3–104(g) and (h)]
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9. Negotiability
• Purpose of negotiability is to decrease risk
of transfer (assignment of commercial
paper contract) so the instrument will be
accepted as a substitute for money
• Thus, (1) the contract for payment of
money must meet requirements for
negotiability, and (2) the person who
acquires instrument must qualify as a
holder in due course
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10. A Holder in Due Course
• A holder in due course has good title to
the instrument, paid value for it, acquired
it in good faith, and had no notice of
certain claims or defenses against
payment
– Instrument bears no evidence of forgery or
triggers concerns about authenticity
• A holder in due course takes instrument
free of all defenses and claims except
those that concern its validity
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11. Requirements For Negotiability
• For an instrument to be negotiable, it must
be in writing, signed by the maker,
containing an unconditional promise or
order to pay a fixed amount of money,
payable to order or to bearer, payable on
demand at a definite time, lack any other
instruction by the maker (three exceptions)
[3–103; 3–104]
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12. The Signed Writing
• The instrument must be in
writing and signed by the
maker
• Any writing (print,
handwritten) or type of
signature (handwritten,
authorized stamped
signature, or an X if
witnessed)
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13. Unconditional Promise or Order
• The instrument must must contain an
unconditional promise or order to
pay (e.g., “pay to the order of”)
• Conditional phrases destroy the
negotiability, though reference to
another document about collateral,
prepayment, or acceleration does
not destroy negotiability
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14. Fixed Amount of Money
• The requirement of a
“fixed amount of money”
applies only to principal
• Interest may be stated in
an instrument as a fixed
or variable amount of
money or expressed as a
fixed or variable rate or
rates
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15. Payable on Demand or
At a Definite Time
• A promise or order is payable on demand
if (1) it states it is payable on “demand” or
“sight” or (2) does not state a specific
time for payment [3–108(a)]
• A promise or order is payable at a definite
time if payable at fixed date(s) or at
time(s) readily ascertainable at the time
the promise or order is issued [3–108(b)]
– The typical promissory note
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16. Payable to Order or Bearer
• An instrument is payable to order (order
paper) if payable to (1) order of
identified person or (2) an identified
person or that person’s order [3–109(b)]
– Requires indorsement for negotiation
• An instrument payable to bearer or to
cash (bearer paper) may be negotiated
or transferred by delivery of possession
without indorsement [3– 201(b)]
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17. Pelican National Bank v. Provident Bank
• Facts: Insurance company issued check
drawn on a bank to several payees listed
without punctuation or grammatical
connector (and/or)
• Holding: Court concluded the check was
ambiguous and applied the default rule
that treated the document as if payable in
the alternative: “The indorsement of any
one of the payees was sufficient.”
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18. Special Terms
• A instrument will remain negotiable if it
includes statements about:
– Giving, maintaining, or protecting
collateral to secure payment
– An authorization to confess judgment or
realize on or dispose of collateral
– Waiving the benefit of any law intended
for the protection or benefit of a person
obligated on the instrument
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19. Ambiguous Terms
• If terms conflict or ambiguous term exists,
general rules of interpretation apply:
– Typewritten terms prevail over printed
terms, handwritten terms prevail over
printed and typewritten terms, and where
words and numbers conflict, words
control the numbers [3–114]
– See Galatia Community State Bank v. Kindy:
• Ambiguity caused by difference between
numbers on the check from checkwriting
machine and number written by hand
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20. Test Your Knowledge
• True=A, False = B
– Commercial paper includes checks,
promissory notes, and certificates of deposit.
– A holder in due course takes the instrument
free of all defenses and claims.
– UCC Articles 3 & 4 cover commercial paper.
– A certificate of deposit is a negotiable
instrument in which a bank acknowledges is
received a money deposit and promises to
repay the sum in the future.
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21. Test Your Knowledge
• Multiple Choice
– Basic types of commercial paper
include:
a) Promises to pay money
b) Orders to pay money
c) A document of title
d) Both A and B
e) All of the above
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22. Test Your Knowledge
• Multiple Choice
– Which of the following would be non-
negotiable?
a) Please pay to the order of Sarah $100.”
b) “This promissory note is secured by my
property in Pender County.”
c) “This promissory note is subject to Sarah’s
graduation from college.”
d) None of the above; they are all
negotiable
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23. Thought Questions
• Do you use negotiable instruments?
How do you do your banking?
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