Chapter 22:
Creation of Negotiable
Instruments
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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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
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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
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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
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Types of Negotiable Instruments
Drafts
Certificates
of Deposit
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
Checks
Promissory
Notes
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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
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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
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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
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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
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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
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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.
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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
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Negotiable Instrument
• Must be:
– In writing
• May be combination of writings
– Permanent
• Most paper fulfills requirement
– Portable
• Ensures free transfer
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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
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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
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Summary: Formal Requirements for a
Negotiable Instrument (Part 1)
Requirement
Description
Writing
Writing must be permanent and portable. Oral or
implied instruments are nonnegotiable [UCC 3104(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.
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Fixed Amount of Money
• Ensures value of instrument
• No interest requirement, but
may have fixed or variable
amount
• Must be payable in money
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Summary: Formal Requirements for a
Negotiable Instrument (Part 2)
Requirement
Description
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
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Summary: Formal Requirements for a
Negotiable Instrument (Part 3)
Requirement
Description
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.
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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
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Summary: Formal Requirements for a
Negotiable Instrument (Part 4)
Requirement
Description
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.
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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
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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.
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