Negotiable Instruments

Commercial Paper
WHAT IS COMMERCIAL PAPER?
• Unconditional written orders or promises
to pay money
• Demand instrument
(A substitute for money)
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”
Why are banks debtors of their checking
account depositors?
 The Bank – Customer Relationship
Creditor – Debtor Relationship
• Created when a customer deposits money
into the bank.
• The customer is the creditor and the bank
is the debtor (owes the money).
 The Bank – Customer Relationship
(continued)

Principal – Agent Relationship

• Created if the:
– deposit is a check that the bank must collect
for the customer or the
– customer writes a check against his or her
account
• The customer is the principal and the bank is
the agent.
 TYPES OF
COMMERCIAL PAPER
• Drafts
• Checks
– Honor and dishonor
– Stop-payment orders
– Precautions and care
• Promissory notes
• Certificates of deposit
Draft
• 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
Check
• 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
Parties to a Check
• Drawer
- Customer who maintains the checking
account and writes checks against the
account
• Drawee
- Bank on which the check is drawn
• Payee
- Party to whom the check is written
Duties of Bank and Customer
• Customer must examine bank statements
and promptly notify bank of unauthorized
payments
– Liable for failure to perform duties
• Bank owes duty of ordinary care in
presenting and sending checks for
collection
– Liable for losses caused by its negligence
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
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
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.
Primary Liability
• Makers of promissory notes and
certificates of deposit have primary
liability for the instrument.
• Maker unconditionally promises to pay
the amount stipulated in the note when
due.
• Makers are absolutely liable to pay the
instrument, subject only to certain real
defenses.
Secondary Liability
• Drawers of checks and drafts and
unqualified indorsers of negotiable
instruments have secondary liability on
the instrument.
• This liability is similar to that of a
guarantor of a simple contract.
• It arises when the party primarily liable on
the instrument defaults and fails to pay the
instrument.
Secondary Liability (continued)
• Unqualified indorsers have secondary liability.
• Qualified indorsers have no secondary liability.
– They have expressly disclaimed liability.
• Secondary liability arises from an instrument
being:
– Properly presented
– Dishonored.
– Notice being timely given to person who is
secondarily liable.
 SPECIALIZED TYPES OF
COMMERCIAL PAPER
• Certified checks
• Teller’s check
• Cashier’s check
• Money orders
• Traveler’s checks
 Special Types of Checks
• Certified Checks
– Bank agrees to accept check when presented
– Pays out of funds set aside in special account
– Drawer is discharged from liability on check
• Cashier’s Checks
– Two party check
– Bank is both drawer and drawee
– Holder is payee
• Traveler’s Checks
– Issued without named payee
– Requires purchaser’s signature at issuance and upon
use
 WHAT MAKES AN INSTRUMENT
NEGOTIABLE?
• In writing and signed by the maker or
drawer
• Unconditional promise or order
• Payable in a sum certain in money
• Payable on demand or at a definite time
• Payable to bearer or to someone’s order
• 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.
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
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.
HOW IS COMMERCIAL PAPER
TRANSFERRED?
• Indorsement
• Indorser
• Indorsee
• Holder
Transfers
• Negotiable instruments can be transferred
to subsequent parties by negotiation.
– Done by placing endorsement on instrument
 ENDORSEMENTS
AND THEIR FUNCTIONS
• Blank endorsements
• Special endorsements
• Qualified endorsements
• Restrictive endorsements
• Accommodation parties
Accommodation Party
• A party who signs an instrument and lends his or
her name (and credit) to another party to the
instrument.
• The accommodation party is obliged to pay the
instrument in the capacity in which he or she
signs.
– Accommodation Maker – primarily liable
– Accommodation Indorser – secondarily liable
• Liability of accommodation party:
– Guarantee of payment
– Guarantee of collection
BLANK INDORSEMENTS
SPECIAL INDORSEMENTS
 HOW IS COMMERCIAL PAPER
DISCHARGED?
• By payment
• By cancellation
• By alteration
• By impairment of collateral
• As a contract
Impairment of the Right of
Recourse
• Certain parties (holders, indorsers,
accommodation parties) are discharged
from liability on an instrument if the holder:
1.Releases an obligor from liability, or
2.Surrenders collateral without the consent of
the parties who would benefit by it
 COLLECTION OF COMMERCIAL
PAPER OBLIGATIONS
• Holder in due course
• Qualifications of an HDC
– Take in good faith and give value
– Without knowledge of defense or dishonor
Holder Versus Holder In Due
Course
Holder Holder in Due Course
• A person who is in (HDC)
possession of a • A person who takes a
negotiable instrument negotiable instrument
that is drawn, issued, for value, in good
or indorsed to him or faith, and without
his order, or to notice that it is
bearer, or in blank. defective or is
overdue.
• 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.
 WHAT ARE THE LIMITED
(Personal) DEFENSES?
• Breach of contract or failure of consideration
• Fraud in the inducement
• Temporary incapacity to contract—excluding
minority
• Ordinary duress
• Prior payment or cancellation
• Conditional delivery or non-delivery
• Unauthorized completion
• Theft
Personal Defenses
Personal Defenses Effect
1. Breach of contract Personal defenses
2. Fraud in the inducement cannot be raised
3. Mental illness that makes a against a holder in due
contract voidable instead of void course
4. Illegality of a contract that makes
the contract voidable instead of
void
5. Ordinary duress or undue
influence
6. Discharge of an instrument by
payment or cancellation
 WHAT ARE THE UNIVERSAL
DEFENSES?
• Permanent incapacity to contract and minority
• Illegality
• Forgery or lack of authority
• Alteration
• Fraud in the execution of the paper or as to the
essential terms
• Duress depriving control
• Claims and defenses stemming from a
consumer transaction
Universal Defenses
Universal Defenses Effect
1. Minority Real defenses can be
2. Extreme duress raised against a holder in
3. Mental incapacity due course
4. Illegality
5. Discharge in bankruptcy
6. Fraud in the inception
7. Forgery
8. Material alteration
Signature Liability
• A person cannot be held contractually
liable on a negotiable instrument unless
his or her signature appears on the
instrument.
• The signatures on a negotiable
instrument identify those who are
obligated to pay it.
• If it is unclear who the signer is, parol
evidence can identify the signer.
Commercial Wire Transfers
• Fast
– Transfers usually completed within one day
• Inexpensive
 Questions?

Next Week: Chapters 38 & 39