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Business Law

Principles and Practices

Goldman, A., & Sigismond, W. (2014). Business Law: Principles and Practices 9th ed. . _- - Western Cengage Learning.

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Cengage Advantage Books

PRINCIPLES AND PRACTICES

Nature and Types ol Negotiable Instruments CHAPTER PREVIEW

Negotiable Instruments-Critical to Our Economy

Negotiable Instruments-Types and Uses Promissory Notes and Certificates of

Deposit: Promises to Pay Drafts and Checks: Orders to Pay

Requirements for Negotiability Written Form Signature Unconditional Promise or Order to Pay Fixed Amount of Money Payable on Demand or at a Definite Time Payable to Order or Bearer Contain No Understanding or Instruction

Beyond the Promise or Order to Pay Drawee N amed with Reasonable Certainty

Added Language and Omissions Not Affecting Negotiability

330

CHAPTER HIGHliGHTS ,

(J A BUSINESS

SETTING

LEARNING OBJECTIVE ~ Summarize how negotiable

instruments are critical to our economy.

The purpose of this chapter is to introduce you to negotiable instruments:

written documents that may be used either as a substitute for money (e.g.,

checks) or as a way to extend credit (e.g., promissory notes). Negotiable

instruments as governed by Article 3 of the Uniform Commercial Code (UCC)

are the subject of this and the next three chapters. This chapter identifies the

types of negotiable instruments available in the business community and

describes the basic features of each type. Specimen documents that appear

in the chapter help you better understand these basic features. The chapter

also introduces the concept of negotiability (transferability), a key feature of

negotiable instruments, and examines the language that must be used to

make negotiable instruments transferable without worry of being

uncollectable.

The primary responsibility of a business (which includes banks) is to ensure that the business continues to be profitable. Making a profit enables the business to survive. No one will argue against this theory. However, the question becomes does a concentration on profit maximization provoke a conflict with ethical issues? Banking institutions are a good example. Historically, banks have been viewed solely as financial institutions. Ethics in banking is a relatively new area- which brings problems to light and , as a result, affects depositors. Banks do not keep depositor money in a big vault in their brick and mortar buildings, but rather they invest the money. In the meantime, depositors assume their banks will do their best to maximize returns for them by making good investments. In this modern age, however, depositors are not so sure that their welfare is high priority; depositors feel that banks are really looking to maximize profits through good investments for the banks' sake.

Questions 1. Do you feel that banks place profit motivation over depositors' interests in

maximizing their returns from deposits they make? Explain. 2. How could banks improve their image to show that they are ethically

concerned about their depositors? 3. Has the federal government done anything to regulate the ambitious desires

of banks?

Negotiable instruments may be new to you, but learn as much as you can about them because they play an important role in your life. You will use these instru- ments to conduct your business either on a personal level or as a person in busi- ness once you complete your college education and enter your planned career field. These next four chapters deal with negotiable instruments and how they can be used as a substitute for money when conducting everyday business trans- actions. Modern technology has made dealings with financial institutions much easier and quicker. In essence, it has made life in the fast lane better. The infor- mation in these chapters is just a tip of the iceberg of what you need to know about electronic commerce and how quickly business transactions are conducted in the business world, but you will quickly learn one thing: Modern business

cannot be carried on without the use of negotiable instruments. They are criri to our economy.

Article 3 of the Uniform Commercial Code (UCC) is the statutory law rh.r governs negotiable instruments. It is in effect in the District of Columbia, th:: Virgin Islands, and in every state. The revision of this Article occurred in 20~2 to accommodate the changing conditions in the business world, especially r~= advent of modern technologies and payment practices in the business world rh:1: had operated under a paper-based system. For example, today check process ic5 is done electronically. You can write a check in the morning, and the amount ca:: be deducted from your account by the end of the day. In the past, you could cour.: on at least a few days before it was cleared by your bank. This was called rh:= "float" period. (Wow! Are banks going to make money from bounced checL now.) While the revisions to Article 3 have been adopted in only a few states , ou:- study of negotiable instruments, in this and the next three chapters, will refle these revisions.

Negotiable Instruments-Types and Uses ------------- LEARNING OBJECTIVE~

Name the types and uses of negotiable instruments.

negotiable instrument: written and signed document that promises or orders the payment of an exact amount of money

promissory note : instrument by which one person promises to pay a sum of money to another

maker: one who makes out and signs

payee: one who receives payment on a check, draft, or promissory note

certificate of deposit: bank's promise to repay an amount left on deposit for a certain time

A negotiable instrument (also referred to simply as an instrument} is a written and signed document that promises or orders the payment of an exact amount oi money with or without interest. It can be used either as a substitute for money or as a credit device (a means of extending credit) . When a person pays a bill by check, the check substitutes for money. When a person buys a used automobile and gives the dealer a promissory note agreeing to pay for the car in ninety days. the note is a credit device. The seller has actually extended ninety days of credi to the buyer. Each instrument serves a different purpose. Keep in mind that as a substitute for money, a negotiable instrument becomes a very powerful piece oi paper because it can be passed on like money without fear that it is not collect- able. In Chapters 20 and 21, you will learn more about this special aspect of a negotiable instrument.

There are four types of negotiable instruments: drafts, checks, notes, and cer- tificates of deposit. (Actually, under revised Article 3, a certificate of deposit is treated as a note.) Drafts and checks constitute orders to pay, while promissory notes and certificates of deposit involve promises to pay. Negotiable instruments may also be classified as either demand instruments or time instruments. A dema nd instrument is payable on demand-that is, payable immediately after it is issued and thereafter for a reasonable period of time. Checks are demand instrument because they are payable on demand. A time instrument is payable at a future date.

Promissory Notes and Certificates of Deposit: Promises to Pay A promissory note is a writ ten promise (UCC 3-104) by one party, the maker, to pay a certain amount of money to another party, usually the payee (two parties are involved). The money may be payable either on demand or at a specified time. A promissory note is used to obtain goods and services on credit or to borrow money. For example, Figure 19.1 shows that Arnold Liteman borrowed $3,00 0 at 4 percent interest from Werner Klemp for ninety days.

A certificate of deposit (commonly called a CD) is an instrument containing an acknowledgment that a sum of money has been received by a bank and a promise by the bank to repay the sum of money to a depositor. A certificate of deposit is a note of the bank. The bank promises to repay the money to the depositor with interest after a certain period of time. The certificate of deposit shown in Figure 19.2 is an acknowledgment by the Citizens Bank (the maker} that it received $5,000 from Marsha Woodward (the depositor-payee) on January 5 (date of issuance) and that the $5,000 will be repaid with interest at the rate of 4 percent per year on July 5 (date of maturity).

Payee

$3,000 . 00 February 5, 20 _

I, Arnold Liteman do hereby acknowledge my debt to Werner Klemp for the amount of my tuition at Rober Community College, and promise to pay to Klemp or to his order THREE THOUSAND DOLLARS ninety days after date with interest at 4%.

Due May 5, 20

Maker

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----------------------------~~~~~~~~~~~~~~~~~ @ FIGURE 19.1 Promissory Note

----------------------------- -------------

CSB Citizens Bank 1200 West Clark Avenue Buffalo, New York TERM : 6 Month CD

Payee

CERTIFICATE OF DEPOSIT (negotiable)

Date Issued : January 5, 2012 Maturity Date: July 5, 2012

This acknowledges tha there has been deposited with the

undersigned, the sum of $ _s.c...,_o_o_o_._o_o ______ _

Fi ve thousand and 00/100------ Do ll ars

which is payable to the order of ____ M_ a _r _s _h_a_ w_o_o_d_w_a_r _d _ __ on the

~ day of ___ J_u_l.::..y ___ __ , 20~, upon presentation and

surrender of this certificate, and bears interest at the rate of

__ 4_% ___ per annum calculated and credited at maturity. No payment

may be made prior to, and no interest runs after, that date. There is a penalty for early withdrawal.

COLUMBIA SAVINGS BANK

By R.~T~-#f¥-""' Vice President

Member F.D.I.C .

FEDERAL REGULATIONS PROHIBIT THE C POUNDING OF INTEREST DURING THE TERM OF THE DEPOSIT.

Maker

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FIGURE 19.2 Certificate of Deposit

draft: instrument in which drawer orders drawee to pay a certain sum to payee

drawer: one who signs a check or draft ordering drawee to pay the payee

drawee: party to a check or draft who is ordered to pay the payee

trade acceptance: form of draft used by seller as a credit device

check: type of draft in wnicn the drawee is always a bank

Drafts and Checks: Orders to Pay A draft generally involves three parties. It is a written order (UCC 3-104) by o party, the drawer, to a second party, the drawee, to pay a sum of money to a thi~;: party, the payee, on demand or at a definite future time. Thus, the drawer "draws- the draft on the drawee. The drawee is ordinarily a person. (A note has two pa~­ ties: One party promises to pay another.) The draft has many uses. For instance suppose that Catherine Karshick owes William McKinney $500 and Claire Arde:: owes Karshick $500 and Karshick is transferring her right to receive $500 fro- Arden to McKinney. Assume also that McKinney and Arden live in the same ci and Karshick lives in another city. It would be possible for Karshick to draw ~ draft for $500 naming Arden as the drawee and McKinney as the payee. Karshi- could send the draft to McKinney, who would then present it for payment Arden. Figure 19.3 represents the draft Karshick would send to McKinney in th·- situation. For the drawee (Arden) to be obligated to honor the order, the drawee must be obligated to the drawer (Karshick) either by agreement or through 2 debtor-creditor relationship. Drafts may be payable "at sight" (i.e., on dema n meaning immediately upon presentation to the drawee for payment), or they rna be "time drafts" (i.e., payable at a future date). A draft can be both a time and sight draft- that is, payable at a stated time after sight. A form of time draf: known as a trade acceptance is often used by a seller of goods as a credit device It is drawn by the seller on the buyer. The seller (drawer) will send to the buye~ (drawee) a draft that names the seller or some third party as the payee. If the buyer accepts, he or she has agreed to pay the seller or any holder who ma ke- proper presentment (demand) a sum of money at a specified future date.

A check, the most common form of negotiable instrument, is a specializec type of draft drawn on a bank and payable on demand. While checks are nego- tiable instruments, they are mainly covered by Article 4 of the Uniform Commer- cial Code (Banking Law). The drawee is always a bank, and the drawer is t he depositor. The payee is the person to whom the check is made payable. A chec '· is the most common way of making payments. In Figure 19.4, Carol Masters . who has money in a checking account at First Federal Bank, made out a $5 0C check payable to John Miles . First Federal would be required to pay the $50C when the check was presented for payment at the bank by John Miles. Of course. Carol Masters would need at least $500 on deposit at the First Federal Bank.

A check can also be drawn by a bank on another bank. This instrument i known as a bank draft. (Article 3 of the UCC defines a bank draft as a teller's check.) Checks are discussed in more detail in Chapter 22 .

There is another type of check that came into existence because of the p a::. - sage of the Check Clearing for the 21st Century Act (also referred to as T he

Payee

Drawee

FIGURE 19.3 Draft

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Payee

Carol Masters 14 Russet Lane A ,lA _

Sudbury, MA 01776 ~ ~

NO. 169 5-17

20-=- 110

PAY TO THE ~ ???.-#,. OROEROF ~ ~ $ 500.QQ

~~~~~-~~~V~~~~~~~~~~~~~~~~============~=====DOL~RS FIRST FEDERAL BANK

Boston, Massachusetts 02108

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Drawee Drawer-Depositor

FIGURE 19.4 Check

Check 21 Act), which became effective in 2004. This act creates a new type of negotiable instrument called a substitute check. A substitute check is a legal equivalent of your original check, and includes all the information contained on the original check. Consequently, you can use it the same way you would use your original check. This type of check and its purpose will be discussed in Chapter 22.

Table 19.1 summarizes briefly the four types of negotiable instruments: notes, certificates of deposit, drafts, and checks.

Types of Negotiable Instruments

.:::enificate of Deposit (CD)

ra ft

rdinary Check

A written promise by one party (maker) to pay money to another party, usually the payee (or to bearer)

A note (special promise) issued by a bank to a depositor acknowledging that money was placed on deposit

A written order by one party to another to pay a third party (or to bearer)

A draft drawn on a bank and payable on demand

Payee-the party to whom the promise is made

Maker- the party who promises to pay

Payee - the party to whom the promise is made

Drawer-the party who initiates and signs the order to pay

Drawee-the party who is ordered to pay

Payee-the party to whom the drawee is ordered to pay

Drawer-the party who initiates and signs the order to pay (depositor)

Drawee- the party who is ordered to pay (always a bank)

Payee-the party to whom the check is made payable

Requirements for Negotiability

LEARNING OBJECTIVE c List the requirements that make an

instrument negotiable.

negotiable: legally transferable from one person to another

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To be negotiable (legally transferable) Section 3-104 of the UCC provides that~ instrument must meet each and every requirement of negotiability. In the la\•· negotiable instruments, these requirements are critical. Negotiability gi _ each person who receives the instrument a special privilege that is discus sed Chapter 21. Any missing element removes the instrument from Article 3, ma·- it nonnegotiable, and places it under the coverage of common law contracts = - signments) with, of course, loss of its special privilege.

To qualify as a negotiable instrument under Article 3, Section 3 -104, the !::' strument must (1) be in writing; (2) be signed by the maker or drawer; (3) co ma.: a promise or order that is unconditional; (4) be payable in a fixed amou nt money with or without interest; (5) be payable either on demand or at a defi m· time; (6) be payable to order or bearer; (7) contain no understanding or inst rG.- tion beyond the promise or order to pay; and (8) designate a drawee (in case o: draft) with reasonable certainty.

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Answer True (T) or False (F). 1. A check is an instrument that is payable on demand. 2. An instrument that places conditions on the promise or order to

pay is negotiable. 3. A draft is a negotiable instrument that is a written promise to

pay money. 4. The party who promises to pay a promissory note is called the

drawee. 5. A promissory note need not be in writing.

Written Form

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To promote certainty and prevent fraud, negotiable instruments must be in wr.~­ ing (UCC 3-103). There is no such thing as an oral note or check. Printing, typ=- writing, and handwriting are examples ·of the types of permanent materials r' are necessary to satisfy the requirement. If handwritten, pen or pencil may used, although ink is preferable to prevent someone from altering the written p..:- per. A negotiable instrument written on a piece of tree bark or a coconut wou.- not satisfy the requirement because they lack permanence. The instrument m-- also meet the requirement that the instrument is freely transferable . For examp.~ you write on the side of a shed, "I promise to pay $1,000 to the order of Frank li::- Although technically this writing meets the requirement of a negotiable instP-- ment, a shed would not be acceptable as an instrument for transfer in the orc.- nary course of business and thus would be nonnegotiable. The best thing is : place the instrument on traditional paper, which ensures that the permanerr,:: and transferability requirements are met and that people will readily accept C:: instrument.

Signature The signature on the instrument must be signed by the maker (for a promisso. note or a certificate of deposit) or drawer (for a draft or a check) or their aurh·- rized agents. The signature, which may appear in the body of the instrument (e._ "I, Merle Hanley, promise to pay . .. "), generally appears in the lower rig corner. According to the UCC, a signature may include any symbol executed ~­ adopted by a party with the intention to adopt or accept a writing (UCC 1-2C~ The signature may be made manually or by machine and could consist oi trade or assumed name, initials, an X (if witnessed), a rubber stamp, or evec.

thumbprint (UCC 3-401). In some cases (e.g., rubber stamp or thumbprint), proof of the signature may be required. Parole (oral) evidence, however, is admissible to identify the signer. Although the Code is lenient on what is acceptable as a signa- ture , one should be careful about accepting an instrument that is signed in an un- ordinary way, as people have a tendency to question an unusual type of signature.

The Atlas Company paid its employees by check each week. Because the company issued a large number of checks, it mechanically stamped the signature of its treasurer on each check rather than having the treasurer sign each check personally. This mechanically stamped signature in no way affects the negotiability of the checks.

Unconditional Promise or Order to Pay A promissory note or certificate of deposit must contain words on the face of the instrument indicating a promise to pay. The words "I promise to pay" in Figure 19.1 clearly indicate that a promise has been made. With a certificate of deposit, no express promise is required because the bank's acknowledgment of the deposit and the other terms of the instrument clearly indicates a promise by the bank to repay the sum of money (UCC 3 -104). A phrase such as IOU, Joan Hartman, $50 .00 merely acknowledges that a debt exists; it does not contain a promise to pay and therefore is not negotiable .

To be negotiable, a draft or check must order the drawee to pay. For exam- ple, the word pay that is printed on a draft or check (see Figures 19.3 and 19.4) constitutes this order. It is a demand, not a request, on the drawee by the drawer to pay a third party, the payee. (Article 3 treats as negotiable an instrument that otherwise meets the definition of a negotiable instrument but does not contain an order. Thus, an instrument made payable to a person as opposed to being payable to the order of a person can be a negotiable instrument.)

The promise or order to pay must be payable without any conditions attached (it must be unconditional) . Otherwise, the instrument is nonnegotiable (UCC 3-104; 3-106) . The Code specifically states that a promise or order is uncondi - tiona l unless it is made conditional because it states (1) there is an express condi- tion to payment, (2) the promise or order is governed by another writing, or (3) rights or obligations in regard to the promise or order are stated in another record (UCC 3 -106).

Mary (the maker) gave Britton (the payee) a promissory note for $500. The note contained a statement that it was "payable only if Pogas (a racehorse) won a race at Winton Downs (a racetrack) on july 1." Because the note was payable only upon the happening of a certain event (if Po gas won a race at Winton Downs on July 1), which may not occur, it was nonnegotiable.

In this example, the condition is obvious because it is stated on the instru- ment ("payable only if Pogas won a race at Winton Downs on July 1"). Because the note is nonnegotiable as a result of the condition, its utility as a substitute for money or as a credit device is almost nonexistent. No one could safely purchase this note from Britton without first checking to see if the condition has been met, in this case that the racehorse Pogas won the race at Winton Downs on July 1. In fact , probably no one would accept such an instrument. Thus, this requirement of an unconditional promise or order to pay is a practical one. After all, people do not want to spend time and money investigating whether or not the condition stated on a negotiable instrument will be met .

There were situations under the original Article 3 that made it difficult to de- termine whether the instrument was payable unconditionally. Revised Article 3 has taken great pains to clarify the meaning of the term unconditional. There is a presumption that every promise or order is unconditional unless a condition is evident from reading the instrument.

Belter delivered a promissory note to Gather promising to pay him $10,000 for building a shed on her farm. Belter, however, made an oral statement placing a condition on payment by stating that the money would be paid only if Gather met all contractual specifications.

In this example, the promissory note is still negotiable because negotiabili is determined by what is written on the face of the instrument; it would not bt affected by any statements made beyond the instrument itself.

Revised Article 3 eliminates as conditional a statement on an instrume-- that says "payment is to be made only out of a particular fund." Such a stateme-- no longer destroys negotiability even though payment depends on the existence of such a fund (UCC 3-106). For example, suppose the terms in a note include the statement that payment will be made out of the marketing research fund. Th~­ statement will no longer make the note nonnegotiable. This change, like other- emphasizes how the revised article aims to remove as many conditions impairin.;; negotiability of an instrument as possible.

A promise or order is conditional if the rights or obligations associated wi·~­ the promise or order are to be found in another writing; however, a mere refer- ence to another writing does not make the promise or order conditional (UCC 3-106). For example, if an instrument contains a statement such as, "the deb- from this instrument arises from the sale of a car as per our written contract," :: does not render an instrument nonnegotiable.

Fixed Amount of Money The requirement that the instrument be payable in a fixed sum of money (UCC 3-104) is designed to make it easy for the taker of the instrument to know the ex- act amount that will be received. The taker must be able to compute this amou n: from the face of the instrument without reference to any external data. A note o:- check payable in merchandise or anything other than money, such as services , is not negotiable. Furthermore, "money" does not require payment in U.S. cur- rency. A note or check payable in a foreign currency that is the legal currency o.: that foreign country is fully negotiable. Thus, a sum payable in German marL. French francs, Japanese yen, or Italian lira would not hinder negotiability. Unle:..~ specified otherwise in the instrument, if the instrument is payable in foreign cur- rency, Section 3-107 of the UCC provides that payment may be made in t he equivalent amount of U.S. dollars, calculated at the place of payment on the da~· on which the instrument is paid.

Albert, of Pittsburgh, Pennsylvania, gave Hanson, who lived in the same city, a note promising to pay "one ounce of platinum." Because platinum is not legal currency in the United States, Albert's note is not negotiable.

Article 3 applies the fixed-amount requirement only to the principal. ThuJ. a $500 note payable with 8 percent interest is still negotiable. It may be ex- pressed as a fixed or variable rate of interest or as a fixed or variable amount o: money. If the instrument states that it is payable "with interest" but does no: specify a rate, the court will supply an interest rate. If the instrument does no- state a rate of interest, it is payable without interest. Article 3, as revised, al sc al1ows for the payment of interest that cannot be definitely ascertained from t he instrument itself. An example is a statement included on the instrument indic at- ing that the interest is payable at "the prime rate" or "payable at the legal rate of interest" (fixed by a state statute}. Mortgage interest rates (those that fluct u- ate with market conditions) are also negotiable. The results of these statement are still consistent with the rule that the fixed-amount requirement applies on ly to the principal. Under the old Article 3, both principal and interest had to be determined from the face of the instrument. Other fees, like interest, that do nor affect the fixed -amount requirement are collection fees and attorney's fees. A sum payable is a fixed amount even though it is payable in installments . If t he

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· person who is required to pay the instrument has an option of paying something in addition to money or paying something other than money, the instrument is not negotiable.

Rickets gave Bellini a promissory note that read, in part, "I (Rickets) promise to pay Bellini two hundred dollars ($200) or one used stereo set." This note is not negotiable.

Under the UCC, if there is a discrepancy between the amount written in words and the amount indicated in figures on an instrument, the amount written in words would be paid. If the words are not clear, however, the figures will con- trol (UCC 3-114). For example, if the words on a check are "One hundred dol - lars" and the figures are "$1,000," the check would be for $100, but if the words read "Seven fifty-five dollars" and the figures are "$7.55," the check would be for $7.55 .

Payable on Demand or at a Definite Time To be negotiable, an instrument must be payable either on demand or at a def- inite time (UCC 3-104). "Payable on demand" means payable at the time when the payee presents the. instrument for payment to the person obligated to pay it (upon request). Also qualifying as payment on demand would be statements such as "payable at sight" or "payable on presentment." It is not necessary that the obligated party know ahead of time when the demand will be made (see Figure 19.4).

An instrument can also be payable at a definite time. An instrument is pay- able at a definite time if it states that it is payable (1) on a specified date, such as "payable on or before January 13, 2002" (because the maker has the option of paying before the scheduled due date, this factor did not make the time of pay- ment uncertain); (2) within a definite period of time, such as "payable sixty days after sight" (but an instrument "payable ten days after my death" is not negotia - ble because, although death is certain, the time when death will actually occur is not certain); or (3) on a date or time readily ascertainable at the time the promise or order is issued, such as is "payable on the day of the next presidential elec- tion," an event that is certain to happen. If nothing is said about the due date, the instrument is payable on demand. A check is a good example of an instrument payable on demand because no time of payment is stated on the instrument.

A time instrument may contain an acceleration clause, which requires the debtor to pay off the amount owed on a loan sooner than the stated due date. For example, if the debtor is paying in monthly installments and then fails to make a monthly payment, the payee or other holder of this time instrument may demand payment of the entire amount due immediately after the missed payment instead of waiting until the actual date. Nevertheless, the instrument is negotiable be- cause it would still be payable on a definite date if there was no acceleration clause. It is this date that governs negotiability under the UCC (3-108) .

If there is a clause calling for an extension and the extension is at the option of the holder, even without a time limit, negotiability is not affected since the holder is given a right that he or she would have without the clause. If, however, the extension is to be at the option of the maker or acceptor or is to be auto- matic, an extension to a further definite time must be stated or the time of pay- ment remains uncertain and the order to promise is not a negotiable instrument (UCC 3-108).

The importance of the requirement that a negotiable instrument be payable on demand or at a definite time is that the holder of the instrument must know when the note must be presented for collection and whether it is current or over- due . If an instrument were payable upon the happening of an event in the future, the holder might not know when that event occurred and therefore would not know when to present the note for payment. That situation would destroy the whole reason behind negotiability: easy transfer of negotiable instruments.

payable to bearer: words directing an instrument to be paid to person holding it

payable to order: words directing an instrument to be paid to named payee or to whomever payee orders the paper to be paid

RYou t eac

Payable to Order or Bearer To be negotiable, an instrument must contain words of negotiability. The wo:- order and bearer are words of negotiability (UCC 3-104); by using these wo- in the instrument, the maker or drawer states that the instrument is paya ble the original payee or to someone else designated by the payee. An inst rumen- payable to bearer if it is to be paid to anyone who has possession of it. For ex ple, the phrase Pay to Henry Ling or bearer means that the instrument is paya to Henry Ling or to anyone else who bears (possesses) it. An instrument conra·- ing any of the following terms also make it payable to bearer: "Pay to the ore~ of cash;" "Payable to bearer: Pay to the order of cash;" "Payable to the order bearer." An instrument is payable to order if it is to be paid to a specific iden~­ fied person or to anyone that person designates. For example, the phrase Pa ya to the order of Martha Mandry means that the instrument is payable to Ma rr- Mandry or to whomever Martha Mandry orders the paper to be paid. In t way, the instrument remains transferable. An instrument made payable to bear~­ " Cash," "To the order of cash," "Myself," "To the order of bearer," or to a fi t ious person such as "payable to Superman," is considered payable to the bea rer Without either the word order or the word bearer, payment of the instru me would be restricted to the original payee. Some courts hold an instrument naG- negotiable if these magic words are missing, even if the instrument states on r- face "This instrument is negotiable."

Bendix borrowed $2,000 from his friend Burr and gave Burr a promissot: note that read: "One year after date, I promise to pay Adam Burr two thousand dollars ($2,000) with interest at 8%. (Signed) William Bendix." Because this note does not contain either of the words of negotiability ("pay to the order" or "pay to the bearer"), the instrument is not negotiabi Adam Burr cannot legally transfer this promissory note to another person.

Revised Article 3 provides that a check meeting all the requirements of bein= a negotiable instrument except for including the words to the order of is ne.-e:-- theless a negotiable ins trument (UCC 3-104). Thus, a check "payable to Arno~~ Eckert" is a negotiable check. This revised rule does not apply to instrumen:_ other than check.

Contain No Understanding or Instructions Beyond the Promise or Order to Pay A negotiable instrument must be straightforward and very specific. If the instru- ment contains an order or promise to do anything else in addition to or in lieu c- the payment of money, it will be nonnegotiable. For example, a promise to pa $500 and a set of chef's knives would not be negotiable.

Drawee Named with Reasonable Certainty In the case of a draft or a check, the drawee must be named in the instrumell: with reasonable certainty. This rule permits the payee, or any individual who re- ceives the instrument from the payee, to know the person who is responsible fo: payment.

Mil ls agreed to lend $500 to her friend, Allen . Alle n had a birthday coming up, and he knew he would be receiving gifts of money that he could use to repay the loan . He gave Mills an instrument dated March 2 that said, "One week after I become 22 years of age, I prom ise to pay to the order of Barbara Mi ll s the sum of $500. (Signee Will iam Allen ."

Questions 1. Is this a va li d instrument? Why or why not? 2. Is this instrument negotiable? Why or why not?

dded Language and Omissions Not Affecting Negotiability

EARNING OBJECTIVE c dentify the added language and

omissions not affecting negotiability.

The UCC does not prevent instruments from being negotiable because informa- tion is lacking or because certain information is added. The date of issue on a note or check may be important, but it does not affect negotiability if it is omit- ted. An undated instrument such as a check is considered to be dated as of the date it is delivered. That date may be filled in by the person who receives the in- strument. A postdated check (a check dated after its actual date of issue) is also fully negotiable. It is like a note payable in the future (a time draft) and will be paid on or after the date appearing on its face. An antedated check (one that is dated before the time it was written) also has no effect on negotiability. Negotia- bility is also not affected because it designates a particular kind of currency or money in which payment is to be made.

For notes, it is common to insert information regarding the place of payment of the instrument, such as "Payable at First Federal Bank of Boston, Massachu- setts." The words "value received" are often inserted on the face of the note, meaning that consideration was given for the instrument. This information does not affect payment and, if omitted, does not make an instrument nonnegotiable. The sum in figures, which is generally included, has no effect on negotiability if not included as part of the instrument or if a different amount from what is writ- ten in words. If a party adds handwritten or typewritten language that is incon- sistent with the preprinted language on the instrument (note or draft), the handwriting takes precedence over both the typewritten and preprinted lan- guage. Typewritten language takes precedence over preprinted language. Finally, as mentioned earlier in the chapter, Article 3 provides that a check is nevertheless negotiable even though it does not contain the words "to the order of."

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Select the best answer from those given . 1. An instrument is payable on demand or at a definite time if it is payable:

(a) at someone's death, (b) under a certain condition, (c) on, before, or after a specified date, (d) at a bank .

2. A check that contains the words "three hundred fifty dollars" an d the figures ($3,50) is: (a) payable in the amount of $350, (b) illegal, (c) payable in the amount of $3.50, (d) void.

3. A promise to pay $1,000 and an iPad is: (a) negotiable, (b) nonnegotiable, (c) payable for the amount on the instrument less the cost of the iPad, (d) payable without interest.

4. A note or check payable in legal fore ign currency is: (a) non negotiab le, (b) fully negotiable, (c) not payable in the do llar equivalent of that currency, (d) void.

5. If the day of issue is omitted from a note or check, its negotiabi lity is: (a) restricted, (b) voided , (c) not affected, (d) postponed.

ey Points in Chapter • • • - negotiable instrument is a written and signed docu- -ent that promises or orders the payment of an exact

ount of money. It can be used either as a substitute for ney or as a means of extending credit. There are two classifications of negotiable instru-

nts: promises to pay and orders to pay. Within these two · sifications, the UCC specifies four types of instruments:

drafts and checks, which are orders to pay, and promissory notes and certificates of deposit, which are promises to pay.

Notes and certificates of deposit have two parties. Drafts and checks have three parties. A check is a type of draft in which the drawee is always a bank and the drawer is the depositor.

Instruments may be either negotiable or nonnegotia - ble depending on the language used in the instrument.

To be negotiable, an instrument must meet the following requirements: It must (1) be in writing; (2) be signed by the maker or drawer; (3) contain an uncondi- tional promise or order to pay; (4) state a fixed amount of money; (5) be payable on demand (or at sight) or at a def- inite time; (6) be payable to order or to bearer; (7) con- tain no understanding or instruction beyond the promise or order to pay; and (8) designate a drawee (in the case of a draft) with reasonable certainty.

Certain language that is added, such as the place where the instrument is payable and the words value re- ceived, has no effect on negotiability. Certain informa-

Important Legal Terms

certificate of deposit

check

draft

drawee

drawer

maker

negotiable

tion that is lacking, such as the date of issue of the ins- ment, the place of payment, and the sum in fi gu.:- likewise has no effect on the negotiability of the ins:- ment; neither does the practice of postdating or anr-- ing a check. Negotiability is also not affected becaus designates a particular kind of currency or mone. which payment is to be made. If a party adds hand ten or typewritten language that is inconsistent with - preprinted language on the instrument (note or dr the handwriting takes precedence over both the r: _ written and preprinted language. Typewritten langu.::_ takes precedence over preprinted language.

Under revised Article 3, a check lacking the words the order of is still negotiable.

negotiable instrument

payable to bearer

payable to order

payee

promissory note

trade acceptance

Questions and Problems for Discussion

1. What test is used to determine whether an instrument is payable in money?

2. How is a check different from other drafts? 3. Barnes made out a check payable "to the order of"

Williams. The amount written in figures was "10.00"; the amount written in words was "One hundred and 00/100 dollars." Is this check still negotiable? Explain.

4. Which of the following circumstances would prevent a promissory note from being negotiable? a. An acceleration clause that allows the holder to

move up the maturity date of the note in the event of default

b. A clause that allows the maker to satisfy the note by the performance of services or the payment of money

c. The signature that appears in the body of the instrument

d. If the instrument is to be paid in German marks

Cases for Review

1. Horne made out a note for $100,000 payable to Clark and written on the note was a restriction that the note could not be transferred or pledged without Horne's consent. Horne did, however, sign a letter authorizing Clark to use the note as collateral for a loan. Clark pledged the note as collateral for a $50,000 loan from First State Bank of Gallup. After making several payments, Clark

5. An order instrument involves three parties. The three parties are: a. drawer, drawee, maker. b. maker, payee, drawee. c. drawer, drawee, payee. d. drawee, payee, payor.

6. May a maker or acceptor have an option to exten.: payment without destroying negotiability?

7. If an instrument is made payable to cash, to who is it payable?

8. What kind of writing is required for a negotiab le instrument?

9. What is the importance of placing the words ordr or bearer on a negotiable instrument?

10. What is the effect of making an instrument payab __ in the event of something happening (even something certain)?

defaulted on the loan. First State Bank tried to collect, but Horne refused to pay claiming that t he note was not a negotiable instrument and therefore inva lid in the hands of the bank. Did the restrictio~ noted on Horne's promissory note prevent the note from being negotiable in spite of the letter of authorization? (First State Bank of Gallup v. Clar- & Horne, 570 P.2d 1144)

_ Li ndsay signed a note to Clements that stated, "On or about five years from date, I promise to pay Bonnie M. Clements $25,000 without interest." W hen Lindsay failed to pay the note, Clements -ued. Lindsay claimed that the note was invalid ' ecause it did not contain any fixed or determined :Uture time for payment. Will Clements recover on ~he note? (Clements v. Lindsay, La. 320 So. 2d 608) ~1r. and Mrs. Hinphy borrowed money from DeRouin and signed a document stating, "I have -his day borrowed $12,000 from David DeRouin to be paid on demand. (Signed) Mrs. W. Hinphy and W. Hinphy." More than three years later, DeRouin ued the Hinphys for failing to pay the amount due.

The Hinphys claimed that the document was not a no te but was only an acknowledgment of indebtedness that was no longer valid because of a -hree-year statute of limitations. Are the Hinphys .:orrect? (DeRouin v. Hinphy, La . 209 So. 2d 352) Dr. W. H. Bailey drew up a promissory note

ayable to California Dreamstreet, an investment 5rm. The note read as follows : "Dr. William H. Bailey promises to pay to the order of California ::Jreamstreet the sum of $329,800." Dreamstreet ~hen negotiated the note to Cooperative Centrale Ra iffeisen- Boerenleenbank B.A., a foreign bank. Bailey defaulted and Cooperative Centrale filed suit against him to recover on the note. Is the note executed by Bailey a negotiable instrument? Cooperative Centrale Raiffeisen-Boerenleenbank

B.A . v. Bailey, 9 UCC Rep. Serv.2d 145)

5. Fabacher gave a promissory note to Hoss. At the top of the note, the date was given as well as the figure $6,002.19. The body of the note read, "Pay to the order of." T he name of the payee was never inserted, nor was any amount. Was the note enforceable? (Hoss v. Fabacher, Tex. 578 S.W.2d 454)

6. Andersen gave the following undated, handwritten promissory note to the Great Lakes Nursery Corporation for the purchase of 65,000 trees: "Robert Andersen promises to pay to Great Lakes Nursery Corporation at Waukesha, Wisconsin, six thousand four hundred twelve dollars with interest at 7% per annum." Great Lakes Nursery, in payment of a debt, transferred the note to the First Investment Co., which questioned its negotiability. Is this note negotiable? (First Investment Co. v. Andersen, Utah 621 P.2d 683)

7. Robinson had purchased a certificate of deposit (CD) from a bank and had the instrument made payable to him. On its face, the instrument stipulated that if Robinson was deceased at the time the instrument was to be paid, that payment should be made to his stepdaughter, Wygant (payee). Before the note was due, Robinson remarried and changed the name of the payee from Wygant to that of his new wife. When Robinson died, Wygant claimed the proceeds from the CD. Her contention was that the CD was a negotiable instrument that required her to sign it before it could be transferred to Robinson's new wife. Was Wygant correct? (West Grely National Bank v. Wygant and Robinson, 650 P.2d 1339)