Chapter 22:

Creation of Negotiable
Instruments

2007 Prentice Hall, Business Law,

19 - 1

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,

19 - 2

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,

19 - 3

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,

19 - 4

Types of Negotiable Instruments

Drafts

Certificates
of Deposit
2007 Prentice Hall, Business Law,

Checks

Promissory
Notes
19 - 5

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,

19 - 6

Drafts

(continued)

Sight Draft
Time Draft
A draft payable on
A draft payable at
sight.
a designated
future date
Also called a demand
draft.
Trade Acceptance
a sight draft that
arises when credit is
extended with the
sale of goods.

2007 Prentice Hall, Business Law,

19 - 7

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,

19 - 8

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,

19 - 9

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,

19 - 10

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,

19 - 11

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,

19 - 12

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,

19 - 13

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,

19 - 14

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,

19 - 15

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 instruments negotiability.
If payment is conditional on the performance of
another agreement, the instrument is nonnegotiable.

2007 Prentice Hall, Business Law,

19 - 16

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,

19 - 17

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
countrys 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,

19 - 18

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.

2007 Prentice Hall, Business Law,

19 - 19

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,

19 - 20

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.

2007 Prentice Hall, Business Law,

19 - 21

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,

19 - 22

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.

2007 Prentice Hall, Business Law,

19 - 23