NEGOTIABLE INSTRUMENTS: FORM AND CONTENT

At the end of the lesson the learners are able to:

1. Describe the concept and importance of negotiability.

2. Identify and describe the types of negotiable instruments involving an order to pay
3. Identify and describe the types of negotiable instruments involving a promise to pay
4. List and explain the formal requirements that an instrument must meet to be negotiable
5. Explain the effect on negotiability of an instrument’s (a) being undated, antedated or postdated;
(b)lack of completion and (c) ambiguity

Money is not, properly speaking one of the subjects of commerce; but only the instrument which men have
agreed upon to facilitate the exchange of one commodity for another. It is none of the wheels of trade: It is
the oil which renders the motion of the wheels more smooth and easy.

Negotiable instruments are also referred to simply as instruments which include drafts, checks,
promissory notes and certificates of deposit. These instruments are widely used by individuals and
businesses in paying for goods and services as well as in financing numerous types of transactions.

For a number of reasons, payment by noncash means is preferable in many transactions. Noncash
payments take two forms: paper (checks and drafts) and electronic (debit cards, credit cards, automated
clearing house [ACH] and prepaid cards).

The financing or credit function of negotiable instruments is indispensable. For example,

promissory notes are used extensively in financing sales of goods. In addition, corporations fund their
operating expenses or current assets by issuing commercial paper in the form of short-term promissory
notes.

A certificate of deposit (CD) is a promissory note issued by a bank and is used by many individuals
as a type of deposit account typically offers a higher rate of interest than a regular savings account.

Negotiability

Negotiability is a legal concept that makes written instruments freely transferable and therefore a
readily accepted form of payment in substitution for money. It invests negotiable instruments with a high
degree of marketability and commercial utility. It allows negotiable instruments to be freely transferable and
enforceable by a person with the rights of a holder in due course against any person obligated on the
instrument, subject only to a limited number of defenses.

Types of Negotiable Instruments

There are four types of negotiable instruments: drafts, checks, notes and certificate of deposits.
The first two contains orders or directions to pay money; the last two involve promises to pay money.
Drafts

A draft involves three parties, each in a distinct capacity. One party the drawer, orders a second
party, the drawee, to pay a fixed amount of money to a third party, the payee. Thus, the drawer “draws” the
draft on the drawee. The drawee is ordinarily a person or an entity that either is in possession of money
belonging to the drawer or owes money to him. The same party may appear in more than one capacity; for
instance, the drawer may also be the payee.

(Insert figure 24-1 and 24-2)

Drafts may be either “time or sight”. A time draft is payable at a specified future date whereas a
sight draft is payable on demand (i.e., immediately upon presentation of the drawee).

Checks

A check is a specialized form of draft, namely, an order to pay money drawn on a bank and
payable on demand (i.e. upon the payee’s request for payment). Once again, parties are involved in three
distinct capacities: the drawer who orders the drawee, a bank, to pay the payee on demand. Checks are by
far the most widely used form of negotiable instruments.

(inserT figure 24-3)

Notes

A promissory note is an instrument involving two parties in two capacities. One party, the maker,
promises to pay a second party, the payee, a stated sum of money, either on demand or a stated future
date. A note that is payable at a definite time (i.e. six months from the date of the notes is made) is referred
to as a time note. A note payable upon the request or demand of the payee or holder is a demand note.

(insert figure)

Certificate of deposit

A certificate of deposit or CD, as it frequently called, is a specialized form of promise to pay money
given by a bank. A certificate of deposit is a written acknowledgment by a bank of the receipt of money that
it promises to repay. The issuing party, the maker, which is always a bank, promises to pay a second party,
the payee, who is named in the CD.

(insert figure)

Formal Requirements of Negotiable Instruments

To perform its function in the business community effectively, a negotiable instrument must be able
to pass freely from person to person. The fact that negotiability is wholly a matter of form makes such
freedom possible. The instrument must contain with in its “four corners” all the information required to
determine whether it is negotiable. No reference to any other source is permitted. For this reason, a
negotiable instrument is called “courier without luggage”. In addition, endorsement cannot create or destroy
negotiability.

To be negotiable, the instruments must.

1. Be in writing (Writing is any intentional reduction to tangible form is sufficient)

2. Be signed (Signature is any symbol executed or adopted by a party with the present
intention to authenticate/adopt or accept the writing)
3. Contain a promise or order to pay (Promise to pay is an undertaking to pay, which must be
more than a mere acknowledgement or recognition of an existing debt. Order to pay is
instruction to pay.)
4. Be unconditional (Unconditional is an absolute promise to pay that is not subject to any
contingencies)
5. Be for a fix amount (Fixed amount is the holder must be assured of a determinable
minimum principal payment, although provisions in the instrument may increase the
amount of recovery under certain circumstances.)
6. Be for money (Money is the medium of exchange currently authorized or adopted by a
domestic or foreign government.)
7. Contain no other undertaking or instruction (no other undertaking or instruction is a
promise or order to do an act in addition to the payment of money that destroys
negotiability)
8. Be payable on demand or at a definite time (an instrument is demand paper if it is must be
paid upon request: an instrument is time paper if it is payable at a definite time) and
9. Be payable to order or to bearer ( a negotiable instrument must contain words indicating
that the maker or the drawer intends that it pass into the hands of someone other than the
payee. Payable to order is payable to the “order of” or other words that mean the same, a
named person or anyone designated by that person. Payable to bearer is payable to the
holder of the instrument: include instruments (1) payable to bearer or to the order of
bearer; (2) that do not specify a payee or (3) payable to “cash” or to the order of “cash”)

If these requirements are not met, the undertaking is not a negotiable instrument and the rights of
the parties are governed by the law of contract.

Terms and Omission and Their Effect on Negotiability

The negotiability of an instrument may be question because of an omission of a certain provision or

because of ambiguity. Problems may also arise in connection with the interpretation of an instrument,
whether or not negotiability is called into questions. Accordingly, the Code contains rules of construction
that apply to every instrument.

Dating of the Instrument. The negotiability of an instrument is not affected by the fact that it is antedated or
postdated. If the instrument is undated, its date is the date of its issuance. If it is unissued, its date is the
date it first comes in the possession of a holder.
Incomplete Instruments. Occasionally, a party will sign a paper that clearly is intended to become an
instrument but that, either by intention or through oversight, is incomplete because of omission of a
necessary element such as a promise or order, a designated payee, an amount or a time for payment. The
Code provides that such an instrument is not negotiable until completed.

Ambiguous Instruments. Rather than commit the parties to the use of parol evidence to established the
interpretation of an instrument, there is an establish rules to resolve common ambiguities. This promotes
negotiability by providing added certainty to the holder.

Assignemet:

Writing

The requirement that the instrument be in writing is broadly construed. Printing, typewriting, handwriting, or
any other intentional tangible expression is sufficient to satisfy the requirement. Most negotiable
instruments, of course, are written on paper, but this is not required. In one instance, a check was
reportedly written on a coconut.

Signed

A note or certificate of deposit must be signed by the maker; a draft or check must be signed by the drawer.
As in the case of writing, extreme latitude is granted in determining what constitutes a signature, which is
any symbol a party executes or adopts with the present intention to authenticate a writing. Moreover, it may
consist of any word or mark used in place of a written signature, such as initials, an X, or a thumbprint. It
may be a trade name or an assumed name. Even the location of the signature on the document is
unimportant. Normally, a maker or drawer signs in the lower right-hand corner of the instrument, but this is
not required. Negotiable instruments are frequently signed by an agent for her principal.

Promise or Order to Pay

A negotiable instrument must contain either a promise to pay money, in the case of a note or certificate of
deposit, or an order to pay, in the case of a draft or check.

Promise to Pay A promise to pay is an undertaking and must be more than the mere acknowledgment or
recognition of an existing obligation or debt. The so-called due bill or IOU is not a promise but merely an
acknowledgment of indebtedness. Accordingly, an instrument reciting "due Adam Brown $100" or "IOU,
Adam Brown, $100" is not negotiable because it does not contain a promise to pay.
Order to Pay An order to pay is an instruction to pay. It must be more than an authorization or request and
must identify with reasonable certainty the person to be paid. The usual way to express an order is by use
of the word pay: "Pay to the order of John Jones" or "Pay bearer." The addition of words of courtesy, such
as please pay or kindly pay, will not destroy the negotiability. Nonetheless, caution should be exercised in
employing words that modify the prototypically correct pay. For example, the use of the words I wish you
would pay has been held to destroy the negotiability of an instrument and to render its transfer a
contractual assignment.

Unconditional

The requirement that the promise or order be unconditional is to prevent the inclusion of any term that
could reduce the promisor's obligation to pay. Conditions limiting a promise would diminish the payment
and credit functions of negotiable instruments by necessitating costly and time-consuming investigations to
determine the degree of risk such conditions imposed. Moreover, if the holder (transferee) had to take an
instrument subject to certain conditions, her risk factor would be substantial, and this would lead to limited
transferability. Substitutes for money must be capable of rapid circulation at a minimum risk.

A promise or order to pay is unconditional if it is absolute and not subject to any contingencies or
qualifications. Thus, an instrument would not be negotiable if it stated that "ABC Corp. promises to pay
$100,000 to the order of Johnson provided the helicopter sold meets all contractual specifications." On the
other hand, suppose that upon delivering an instrument that provided "ABC Corp. promises to pay
$100,000 to the order of Johnson," Meeker, the president of ABC, stated that the money would be paid only
if the helicopter met all contractual specifications. The instrument would be negotiable because negotiability
is determined solely by examining the instrument itself and is not affected by matters beyond the
instrument's face.

A promise or order is unconditional unless it states (1) that there is an express condition to payment, (2)
that the promise or order is subject to or governed by another writing, or (3) that rights or obligations
concerning the order or promise are stated in another writing. A mere reference to another writing,
however, does not make the promise or order conditional.

An instrument is not made conditional by the fact that it is subject to implied or constructive conditions; the
condition must be expressed to destroy negotiability. Implications of law or fact are not to be considered in
deciding whether an instrument is negotiable. Thus, a statement in an instrument that it is given for an
executory promise does not imply that the instrument is conditioned upon performance of that promise.

Reference to Other Agreements The restriction against reference to another agreement is to enable
any person to determine the right to payment provided by the instrument without having to look beyond
its four corners. If such a right is made subject to the terms of another agreement, the instrument is
nonnegotiable.
 A distinction is to be made between a mere recital of the existence of a separate agreement (this does
not destroy negotiability) and a recital that makes the instrument subject to the terms of another
agreement (this does destroy negotiability).

A statement in a note, such as "This note is given in partial payment for a television to be delivered two
weeks from date in accordance with a contract of this date between the payee and the maker," does
not impair negotiability. It merely describes the consideration

You sent Today at 10:51 AM

and the transaction giving rise to the note. It does not place any restriction or condition on the maker's
obligation to pay. The promise is not made subject to any other agreement. The following is an
example of added words that would impair negotiability: "This note is subject to all terms of said
contract." Such words make the promise to pay conditional upon the adequate performance of the
television set in accordance with the terms of the contract and thus render the instrument
nonnegotiable.

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Fixed Amount

The purpose of the requirement of a fixed amount in money is to enable the person entitled to enforce the
instrument to determine from the instrument itself the amount that he is entitled to receive.

The requirement that payment be of a "fixed S amount" must be considered from the point of view of the
person entitled to enforce the instrument, not the maker or drawer. The holder must be assured of a
determinable minimum payment, although provisions of t the instrument may increase the recovery under
certain Circumstances. Revised Article 3, however, applies the fixed amount requirement only to the
principal. Thus, the fixed amount portion does not apply to interest or , to the charges, such as collection
fees or attorneys' fees.

Moreover, negotiability of an instrument is not affected by the inclusion or omission of a stated rate of
interest. If the instrument does not state a rate of interest, it is payable without interest. If the instrument
states that it is payable "with interest" but does not e specify a rate, the judgment rate of interest applies.

Most significantly, Revised Article 3 provides that "Interest may be stated in an instrument as a fixed or
variable amount of money or it may be expressed as a S fixed or variable rate or rates." Moreover,
determination of the rate of interest "may require reference to information not contained in the instrument."
Variable t rate mortgages, therefore, may be negotiable; this result (D is consistent with the rule that the
fixed amount requirement applies only to the principal.
 A sum payable is a fixed amount even though it is payable in installments or payable with a fixed
discount, if paid before maturity, or with a fixed addition, if paid after maturity. This is because it is
always possible to use the instrument itself to compute the amount due at any given time.

Money

The term money means a medium of exchange authorized or adopted by a sovereign government as part
of its currency. Consequently, even though local custom may make gold or diamonds a medium of
exchange, an instrument payable in such commodities would be nonnegotiable because of the lack of
governmental sanction of such media as legal tender. On the other hand, an instrument paying a fixed
amount in Swiss francs, Australian dollars, Nigerian naira, Japanese yen, or other foreign currency is
negotiable.

No Other Undertaking or Instruction

A negotiable instrument must contain a promise or order to pay money, but it may not "state any other
undertaking or instruction by the person promising or ordering payment to do any act in addition to the
payment of money." Accordingly, an instrument containing an order or promise to do an act in addition
to or in lieu of the payment of money is not negotiable. For example, a promise to pay $100 "and a ton
of coal" would be nonnegotiable.

The Code sets out a list of terms and provisions that may be included in instruments without adversely
affecting negotiability. Among these are (1) an undertaking or power to give, maintain, or protect collateral
to secure payment; (2) an authorization or power to confess judgment (written authority by the debtor to
allow the holder to enter judgment against the debtor in favor of d the holder) on the instrument; (3) an
authorization or power to sell or dispose of collateral upon default; and h (4) a waiver of the benefit of any
law intended for the of advantage or protection of the obligor. It is important to note that the Code does not
render any of these terms legal or effective; it merely provides that their inclusion will not affect
negotiability.

Payable on Demand or at a Definite Time

A negotiable instrument must "be payable on demand or at a definite time." This requirement, like the other
formal requirements of negotiability, is designed to promote certainty in determining the present value of a
negotiable instrument.
 Demand "Payable upon demand" means that the money owed under the instrument must be paid upon
the holder's request. Demand paper always has been considered sufficiently certain as to time of
payment to satisfy the requirements of negotiability, because it is the person entitled to enforce the
instrument who makes the demand and who thus sets the time for payment. Any instrument in which
no time for payment stated-a check, for example-is payable ondemand. An instrument also qualifies as
being payable on demand if it is payable at sight or on presentment.

DefiniteTime Instruments payable at a definite time are called time paper. A promise or order is
payable at a definite time if it is payable (1)at a fixed date or dates, (2)at a definite period of time after
sight or acceptance, or (3)at a time readily ascertainable at the time the promise or order is issued.

An instrument is payable at a definite time if it is payable "on or before" a stated date. The person entitled
to enforce the instrument is thus assured that she will have her money by the maturity date at the latest,
although she may receive it sooner. This right of anticipation enables the obligor, at his option, to pay
before the stated maturity date (prepayment) and thereby stop the further accrual of interest or, if interest
rates have gone down, to refinance at a lower rate of interest. Nevertheless, it constitutes sufficient
certainty so as not to impair negotiability.

Frequently, instruments are made payable at a fixed period after a stated date. For example, the instrument
may be made payable "thirty days after date." This means it is payable thirty days after the date of
issuance, which is recited on the instrument. Such an instrument is payable at a definite time, for its exact
maturity date can be determined by simple math.

An undated instrument payable "thirty days after date" is not payable at a definite time, as the date of
payment cannot be determined from its face. It is therefore nonnegotiable until it is completed.

An instrument that by its terms is otherwise payable only upon an act or event whose time of occurrence is
uncertain is not payable at a definite time. An example would be a note providing for payment to the order
"when X dies." However, as previously stated, a time that is readily ascertainable at the time the promise or
order is issued is a definite time. This seemingly would permit a note reading "payable on the day of the
next presidential election." As long as the scheduled event is certain to happen, Revised Article 3 appears
to be satisfied.

The clause "at a fixed period after sight" is frequently used in drafts. Because a fixed period after sight
means a fixed period after acceptance, a simple mathematical calculation makes the maturity date certain,
and the instrument is, therefore, negotiable.

An instrument payable at a fixed time subject to acceleration by the holder also satisfies the requirement of
being payable at a definite time. Indeed, such an instrument would seem to have a more certain maturity
date than a demand instrument because it at least states a definite maturity date. In addition, the
acceleration may be contingent upon the happening of some act or event.

Finally, a provision in an instrument granting the bolder an option to extend the maturity of the instrument
for a definite or indefinite period does not impair its negotiability. Nor does a provision permitting the
obligor of an instrument to extend the maturity date to a further definite time. For example, a provision in a
note, payable one year from date, that the maker may extend the maturity date six months does not impair
negotiability. If the obligor is given an option to extend the maturity of the instrument for an indefinite period,
however, his promise is illusory, and there is no certainty regarding time of payment. Such an instrument is
nonnegotiable. If the obligor's right to extend is limited to a definite time, the extension clause is no more
indefinite than an acceleration clause with a time limitation.

In addition, extension may be made automatic upon or after a specified act or event, provided a definite
time limit is stated. An example of such an extension clause is, "I promise to pay to the order of John Doe
the sum of $2,000 on December 1, 2017, but it is agreed that if the crop of sections 25 and 26 of Twp. 145
is below eight bushels per acre for the 2017 season, this note shall be extended for one year."

At a DefiniteTime and on Demand If the instrument, payable at a fixed date, also provides that it is payable
on demand made before the fixed date, it is still a negotiable instrument. Revised Article 3 provides that the
instrument is payable on demand until the fixed date and, if demand is not made prior to the specified date,
becomes payable at a definite time on the fixed date.

Payable to Order or to Bearer

A negotiable instrument must contain words indicating that the maker or drawer intends that it may pass
into the hands of someone other than the payee. Although the "magic" words of negotiability typically are
payable to order or to bearer, other clearly equivalent words also may fulfill this requirement. The use of
synonyms, however, only invites trouble. Moreover, as noted above, indorsements cannot create or destroy
negotiability, which must be determined from the "face" of the instrument. Words of negotiability must be
present when the instrument is issued or first comes into possession of a holder.

Revised Article 3 provides that a check that meets that all requirements it is not payable of being to bearer
a negotiable or order instrument is nevertheless except instruments a negotiable other instrument. than
checks.This rule does not apply to instruments other than checks.

Payable to Order An instrument is payable to order if it is payable (1) to the order of an identified person or
(2) to an identified person or order. If an instrument is payable to bearer, it cannot be payable to order; an
instrument that is ambiguous as to this point is payable to bearer. Prior Article 3 provided that use of the
word "assigns" met the requirement of words of negotiability; Revised Article 3, however, does not so
provide.

Moreover, in every instance the person to whose order the instrument is payable must be designated with
reasonable certainty. Within this limitation a broad range of payees is possible, including an individual, two
or more payees, an office, an estate, a trust or fund, a partnership or unincorporated association, and a
corporation.
This requirement should not be confused with the requirement that the instrument contain an order or
promise to pay. An order to pay is an instruction to a third party to pay the instrument as drawn. The word
"order" in terms of an "order instrument," on the other hand, pertains to the transferability of the instrument
rather than to instructions directing a specific party to pay.

A writing, other than a check, that names a specified person without indicating that it is payable to order for
example, "Pay to Justin Matthew"-is not payable to order or to bearer. Such a writing is not a negotiable
instruments and is not covered.

Payableto Bearer The UCC states that an instrument fulfills the requirements of being payable to bearer if it
(1) states it is payable to bearer or the order of bearer, (2) does not state a payee, or (3) states it is payable
to "cash" or to the order of "cash." An instrument made payable both to order and to bearer, that is, "pay to
the order of Mildred Courts or bearer," is payable to bearer.

An instrument that does not state a payee is payable to bearer. Thus, if a drawer leaves blank the "pay to
order of" line of a check or the maker of a notes writes "pay to" the instrument is a negotiable bearer
instrument.