Copyright © 2004 by Prentice-Hall. All rights reserved. PowerPoint Slides to Accompany BUSINESS LAW E-Commerce and Digital Law International Law and Ethics 5 th Edition by Henry R. Cheeseman Slides developed by Les Wiletzky Wiletzky and Associates, Puyallup, WA Chapter 23 Creation and Transfer of Negotiable Instruments Chapter 23 Creation and Transfer of Negotiable Instruments

23 - 2Copyright © 2004 by Prentice-Hall. All rights reserved. Negotiable Instruments  To qualify as a negotiable instrument (commercial paper), the document must meet certain requirements established by Revised Article 3 (Negotiable Instruments) of the Uniform Commercial Code (UCC).

23 - 3Copyright © 2004 by Prentice-Hall. All rights reserved. Negotiable Instruments (continued)  If the requirements of Article 3 are met, a transferee who qualifies as a holder in due course takes the instrument free of many defenses that can be asserted against the original payee.  In addition, the document is considered an ordinary contract that is subject to contract law.

23 - 4Copyright © 2004 by Prentice-Hall. All rights reserved. Functions of Negotiable Instruments  Negotiable instruments serve the following functions: Substitute for money Substitute for money Credit device Credit device Record-keeping device Record-keeping device  Most purchases by businesses and many individuals are made by negotiable instruments instead of cash.

23 - 5Copyright © 2004 by Prentice-Hall. All rights reserved. Types of Negotiable Instruments Drafts Checks Promissory Notes Certificates of Deposit

23 - 6Copyright © 2004 by Prentice-Hall. All rights reserved. Drafts  A draft is a three-party instrument that is an unconditional written order by one party that orders the second party to pay money to a third party. Drawer of a draft Drawer of a draft Drawee of a draft Drawee of a draft Payee of a draft Payee of a draft

23 - 7Copyright © 2004 by Prentice-Hall. All rights reserved. Drafts (continued) Time Draft  A draft payable at a designated future date. Time Draft  A draft payable at a designated future date. Sight Draft  A draft payable on sight.  Also called a demand draft.  Trade Acceptance – a sight draft that arises when credit is extended with the sale of goods. Sight Draft  A draft payable on sight.  Also called a demand draft.  Trade Acceptance – a sight draft that arises when credit is extended with the sale of goods.

23 - 8Copyright © 2004 by Prentice-Hall. All rights reserved. Checks  A distinct form of draft drawn on a financial institution and payable on demand. Drawer of a check Drawer of a check Drawee of a check Drawee of a check Payee of a check Payee of a check

23 - 9Copyright © 2004 by Prentice-Hall. All rights reserved. Promissory Notes  A two-party negotiable instrument that is an unconditional written promise by one party to pay money to another party. Maker of a note Maker of a note Payee of a note Payee of a note  Types of notes: Time note Time note Demand note Demand note

Copyright © 2004 by Prentice-Hall. All rights reserved. Certificates of Deposit (CD)  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-upon rate of interest upon the expiration of a set time period agreed upon by the parties.

Copyright © 2004 by Prentice-Hall. All rights reserved. According to UCC 3-104(a), a negotiable instrument must:  Be in writing  Be signed by the maker or drawer  Be an unconditional promise or order to pay  State a fixed amount of money  Not require any undertaking in addition to the payment of money  Be payable on demand or at a definite time  Be payable to order or to bearer

Copyright © 2004 by Prentice-Hall. All rights reserved. Summary: Formal Requirements for a Negotiable Instrument (1 of 4) RequirementDescriptionWriting Writing must be permanent and portable. Oral or implied instruments are nonnegotiable [UCC 3-104(d)]. Signed by maker or drawer Signature must appear on the face of the instrument. It may be any mark intended by the signer to be his or her signature. Signature may be by an authorized representative [UCC 3-104(a)]. Unconditional promise or order to pay Instrument must be an unconditional promise or order to pay [UCC 3-104(a)]. Permissible notations listed in UCC 3-106(a) do not affect instrument’s negotiability. If payment is conditional on the performance of another agreement, the instrument is nonnegotiable.

Copyright © 2004 by Prentice-Hall. All rights reserved. Summary: Formal Requirements for a Negotiable Instrument (2 of 4) RequirementDescription Fixed amount of money Fixed amount: Amount required to discharge the instrument must be on the face of the instrument [UCC (a)]. Amount may include payment of interest, discount, and costs of collection. Revised Article 3 provides that variable interest rate notes are negotiable instruments. In money: Amount must be payable in U.S. or foreign country’s currency. If payment is to made in goods, services, or non-monetary items, the instrument is nonnegotiable [UCC 3-104(a)].

Copyright © 2004 by Prentice-Hall. All rights reserved. Summary: Formal Requirements for a Negotiable Instrument (3 of 4) RequirementDescription Cannot require any undertaking in addition to the payment of money A promise or order to pay cannot state any other undertaking to do an act in addition to the payment of money [UCC 3-104(a)(3)]. A promise or order to may include authorization or power to protect collateral, dispose of collateral, waive any law intended to protect the obligee, and the like.

Copyright © 2004 by Prentice-Hall. All rights reserved. Summary: Formal Requirements for a Negotiable Instrument (4 of 4) RequirementDescription Payable on demand or at a definite time Payable on demand: Payable at sight, upon presentation, or when no time for payment is stated [UCC 3-108(a)]. Payable at a definite time: Payable at a definite date, or before a stated date, a fixed period after a stated date, or at a fixed period after sight [UCC 3-108(b)(c)]. Instrument payable only upon the occurrence of an uncertain act or event is nonnegotiable.

Copyright © 2004 by Prentice-Hall. All rights reserved. Nonnegotiable Contract  A promise or order to pay that does not meet the requirements of a negotiable instrument.  It is not subject to the provisions of UCC Article 3.  A nonnegotiable contract can be enforced under normal contract law.

Copyright © 2004 by Prentice-Hall. All rights reserved. Transfer by Assignment or Negotiation Transfer by Assignment  The transfer of rights under a contract.  It transfers the rights of the transferor ( assignor ) to the transferee ( assignee ). Transfer by Assignment  The transfer of rights under a contract.  It transfers the rights of the transferor ( assignor ) to the transferee ( assignee ). Transfer by Negotiation  The transfer of a negotiable instrument by a person other than the issuer.  The person to whom the instrument is transferred becomes the holder. Transfer by Negotiation  The transfer of a negotiable instrument by a person other than the issuer.  The person to whom the instrument is transferred becomes the holder.

Copyright © 2004 by Prentice-Hall. All rights reserved. Indorsement  The signature (and other directions) written by or on behalf of the holder somewhere on the instrument.  The signature may: Appear alone Appear alone Name an individual to whom the instrument is to be paid, or Name an individual to whom the instrument is to be paid, or Be accompanied by other words Be accompanied by other words

Copyright © 2004 by Prentice-Hall. All rights reserved. Types of Indorsements (1 of 2) Type of Indorsement DescriptionBlank Does not specify a particular indorsee. This indorsement creates bearer paper. Special Specifies the person to whom the indorser intends the instrument to be payable. This indorsement creates order paper. Unqualified Does not disclaim or limit liability. The indorsee is liable on the instrument if it is not paid by the maker, acceptor, or drawer.

Copyright © 2004 by Prentice-Hall. All rights reserved. Types of Indorsements (2 of 2) Type of Indorsement DescriptionQualified Disclaims or limits the liability of the indorsee. There are two types: 1. Special qualified indorsement 2. Blank qualified indorsement Nonrestrictive No instructions or conditions attached to the payment of funds Restrictive Conditions or instructions restrict the indorsee’s rights. There are four types: 1. Conditional indorsement 2. Indorsement prohibiting further indorsement 3. Indorsement for deposit or collection 4. Indorsement in trust

Copyright © 2004 by Prentice-Hall. All rights reserved. Forged Indorsement The Imposter Rule  A rule that says if an imposter forges the indorsement of the named payee, the drawer or maker is liable on the instrument and bears the loss. The Imposter Rule  A rule that says if an imposter forges the indorsement of the named payee, the drawer or maker is liable on the instrument and bears the loss. The Fictitious Payee Rule  A rule that says that a drawer or maker is liable on a forged or unauthorized indorsement of a fictitious payee. The Fictitious Payee Rule  A rule that says that a drawer or maker is liable on a forged or unauthorized indorsement of a fictitious payee.