© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Chapter 22: Creation of Negotiable Instruments Chapter 22: Creation of Negotiable Instruments

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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).

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Functions of Negotiable Instruments Negotiable instruments serve the following functions: –Substitute for money –Credit device –Record-keeping device Most purchases by businesses and many individuals are made by negotiable instruments instead of cash.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Types of Negotiable Instruments Drafts Promissory Notes Checks Certificates of Deposit

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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 –Drawee of a draft –Payee of a draft

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Drafts (continued) 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. Time Draft A draft payable at a designated future date

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Checks A distinct form of draft drawn on a financial institution and payable on demand. –Drawer of a check –Drawee of a check –Payee of a check

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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 –Payee of a note Types of notes: –Time note –Demand note –Installment notes

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Promissory Notes (continued) Collateral required –Some notes require posting security –May be automobiles, homes, buildings, securities, or other property –If maker fails to repay note as due, lender can foreclose and take collateral as payment

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Certificates of Deposit (CD) A two-party negotiable instrument Special form of note created when a depositor deposits money at a financial institution –Institution promises to pay back the amount of the deposit plus an agreed-upon rate of interest at set time.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Negotiable Instrument Must be: –In writing May be combination of writings –Permanent Most paper fulfills requirement –Portable Ensures free transfer

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Signed by Maker or Drawer Maker or drawer not liable unless signature appears on instrument –Agent may sign –Any symbol or device may be used if intention was to authenticate document

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Additional Requirements Must contain unconditional order to pay or unconditional promise to pay –Check or draft –CD do not require express promise to pay –If conditional, it is not negotiable because of risk of promise or event not occurring

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Summary: Formal Requirements for a Negotiable Instrument (Part 1) RequirementDescription WritingWriting must be permanent and portable. Oral or implied instruments are nonnegotiable [UCC (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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Fixed Amount of Money Ensures value of instrument No interest requirement, but may have fixed or variable amount Must be payable in money

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Summary: Formal Requirements for a Negotiable Instrument (Part 2) RequirementDescription Fixed amount of money Fixed amount: Amount required to discharge the instrument must be on the face of the instrument [UCC 3-104(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)].

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Summary: Formal Requirements for a Negotiable Instrument (Part 3) 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Instruments Payable on Demand or at a Definite Time Demand Instruments –Created by special language –Created by silence as to payment due date Checks CDs and drafts may be demand instruments Time Instruments –Payable at definite time and date

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Summary: Formal Requirements for a Negotiable Instrument (Part 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Additional Clauses Prepayment clause –Allows maker to pay amount before due date Acceleration clause –Payee or holder may accelerate payment of principal Extension clause –Allows date of maturity to be extended

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.