Bus Law (Daisy Arabella)

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Chapter 13 Nature and Form of Commercial Paper

LEARNING OBJECTIVES

After reading this chapter, you should understand the following:

1. Why commercial paper is important in modern economic systems

2. How the law of commercial paper has developed over the past four hundred years,

and what role it plays in economics and finance

3. What the types of commercial paper are, and who the parties to such paper are

4. What is required for paper to be negotiable

Here we begin our examination of commercial paper, documents representing an obligation by one party

to pay another money. You are familiar with one kind of commercial paper: a check.

Chapter 13 from Advanced Business Law and the Legal Environment was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0

license without attribution as requested by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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13.1 Introduction to Commercial Paper

LEARNING OBJECTIVES

1. Understand why commercial paper is an important concept in modern finance.

2. Be familiar with the historical development of commercial paper.

3. Recognize how commercial paper is viewed in economics and finance.

The Importance of Commercial Paper Because commercial paper is a vital invention for the working of our economic system, brief attention to

its history and its function as a medium of exchange in economics and finance is appropriate.

The Central Role of Commercial Paper

Commercial paper is the collective term for various financial instruments, or tools, that include checks

drawn on commercial banks, drafts (drawn on something other than a bank), certificates of deposit, and

notes evidencing a promise to pay. Like money, commercial paper is a medium of exchange, but because it

is one step removed from money, difficulties arise that require a series of interlocking rules to protect

both sellers and buyers.

To understand the importance of commercial paper, consider the following example. It illustrates a

distinction that is critical to the discussion in our four chapters on commercial paper.

Lorna Love runs a tennis club. She orders a truckload of new tennis rackets from Rackets, Inc., a

manufacturer. The contract price of the rackets is $100,000. Rackets ships the rackets to Love. Rackets

then sells for $90,000 its contract rights (rights to receive the payment from Love of $100,000) to First

Bank (see Figure 13.1 "Assignment of Contract Rights"). Unfortunately, the rackets that arrive at Love’s

are warped and thus commercially worthless. Rackets files for bankruptcy.

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Figure 13.1 Assignment of Contract Rights

May the bank collect from Love $100,000, the value of the contract rights it purchased? No. Under the

contract rule discussed in(Reference mayer_1.0-ch13 not found in Book), an assignee—here, the bank—

steps into the shoes of the assignor and takes the assigned rights subject to any defense of the obligor,

Love. (Here, of course, Love’s defense against paying is that the rackets are worthless.) The result would

be the same if Love had given Rackets a nonnegotiable note, which Rackets proceeded to sell to the bank.

(By nonnegotiable we do not mean that the note cannot be sold but only that certain legal requirements,

discussed in Section 13.3 "Requirements for Negotiability" of this chapter, have not been met.)

Now let us add one fact: In addition to signing a contract, Love gives Rackets a negotiable note in

exchange for the rackets, and Rackets sells the note to the bank. By adding that the note is negotiable, the

result changes significantly. Because the note is negotiable and because the bank, we assume, bought the

note in good faith (i.e., unaware that the rackets were warped), the bank will recover the $100,000

(seeFigure 13.2 "Sale of Negotiable Note").

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Figure 13.2 Sale of Negotiable Note

The key to the central role that commercial paper plays in modern finance

is negotiability. Negotiability means that the paper is freely and unconditionally transferable from one

person to another by delivery or by delivery and indorsement. (“Indorsement,” not “endorsement,” is the

spelling used in the UCC, though the latter is more common in nonlegal usage.) Without the ability to pay

and finance through commercial paper, the business world would be paralyzed. At bottom, negotiability is

the means by which a person is empowered to transfer to another more than what the transferor himself

possesses. In essence, this is the power to convey to a transferee the right in turn to convey clear title,

when the original transferor does not have clear title.

Overview of Chapters on Commercial Paper

In this chapter, we examine the history and nature of commercial paper and define the types of parties

(persons who have an interest in the paper) and the types of instruments. We then proceed to four

fundamental issues that must be addressed to determine whether parties such as First Bank, in the

preceding example, can collect:

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1. Is the paper negotiable? That is, is the paper in the proper form? We explore that issue in this

chapter.

2. Was the paper negotiated properly? See Chapter 14 "Negotiation of Commercial Paper".

3. Is the purchaser of the paper a holder in due course? See Chapter 15 "Holder in Due Course and

Defenses".

4. Does the maker of the paper have available any defenses against even the holder in due course?

See Chapter 15 "Holder in Due Course and Defenses".

In most transactions, especially when the first three questions are answered affirmatively, the purchaser

will have little trouble collecting. But when the purchaser is unable to collect, questions of liability arise.

These questions, along with termination of liability, are discussed in Chapter 16 "Liability and Discharge".

Finally, in Chapter 17 "Legal Aspects of Banking" we examine other legal aspects of banking, including

letters of credit and electronic funds transfer.

History of Commercial Paper Development of the Law

Negotiable instruments are no modern invention; we know that merchants used them as long ago as the

age of Hammurabi, around 1700 BC. They fell into disuse after the collapse of the Roman Empire and

then reappeared in Italy around the fourteenth century. They became more common as long-distance

commerce spread. In an era before paper currency, payment in coins or bullion was awkward, especially

for merchants who traveled great distances across national boundaries to attend the fairs at which most

economic exchanges took place. Merchants and traders found it far more efficient to pay with paper.

Bills of exchange, today commonly known as drafts, were recognized instruments in the law merchant.

(The “law merchant” was the system of rules and customs recognized and adopted by early-modern

traders and is the basis of the UCC Article 3.) A draft is an unconditional order by one person (the drawer)

directing another person (drawee or payor) to pay money to a named third person or to bearer; a check is

the most familiar type of draft. The international merchant courts regularly enforced drafts and permitted

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them to be transferred to others by indorsement (the legal spelling of endorsement). By the beginning of

the sixteenth century, the British common-law courts began to hear cases involving bills of exchange, but

it took a half century before the courts became comfortable with them and accepted them as crucial to the

growing economy.

Courts were also hesitant until the end of the seventeenth century about sanctioning a transferor’s

assignment of a promissory note if it meant that the transferee would have better title than the transferor.

One reason for the courts’ reluctance to sanction assignments stemmed from the law that permitted

debtors to be jailed, a law that was not repealed until 1870. The buyer of goods might have been willing

originally to give a promissory note because he knew that a particular seller would not attempt to jail him

for default, but who could be sure that a transferee, probably a complete stranger, would be so charitable?

The inability to negotiate promissory notes prevented a banking system from fully developing. During the

English Civil War in the seventeenth century, merchants began to deposit cash with the goldsmiths, who

lent it out at interest and issued the depositors promissory notes, the forerunner of bank notes. But a

judicial decision in 1703 declared that promissory notes were not negotiable, whether they were made

payable to the order of a specific person or to the bearer. Parliament responded the following year with

the Promissory Notes Act, which for the first time permitted an assignee to sue the note’s maker.

Thereafter the courts in both England and the United States began to shape the modern law of negotiable

instruments. By the late nineteenth century, Parliament had codified the law of negotiable instruments in

England. Codification came later in the United States. In 1896, the National Conference of Commissioners

on Uniform State Laws proposed the Negotiable Instruments Act, which was adopted in all states by 1924.

That law eventually was superseded by the adoption of Articles 3 and 4 of the Uniform Commercial Code

(UCC), which we study in these chapters.

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In 1990, the American Law Institute and the National Conference of Commissioners on Uniform State

Laws approved revised Article 3, entitled “Negotiable Instruments,” and related amendments in Article 4.

The revisions clarified and updated the law. All states except New York and North Carolina have adopted

Articles 3 and 4.

The Future of Commercial Paper: Federal and International Preemption

State law governing commercial paper is vulnerable to federal preemption. This preemption could take

two major forms. First, the Federal Reserve Board governs the activities of Federal Reserve Banks. As a

result, Federal Reserve regulations provide important guidelines for the check collection process. Second,

Article 3 of the UCC can be preempted by federal statutes. An important example is the Expedited Funds

Availability Act, which became effective in 1988 (discussed in Chapter 17 "Legal Aspects of Banking").

Federal preemption may also become intertwined with international law. In 1988, the United Nations

General Assembly adopted the Convention on International Bills of Exchange and International

Promissory Notes. Progress on the treaty emanating from the convention has been slow, however: the

United States, Canada, and Russia have approved the convention (in 1989 and 1990) but have not ratified

the treaty; Gabon, Guinea, Honduras, Liberia, and Mexico are the only countries to have ratified it.

Commercial Paper in Economics and Finance Economics

To the economist, one type of commercial paper—the bank check—is the primary component of M1, the

basic money supply. It is easy to see why. When you deposit cash in a checking account, you may either

withdraw the currency—coins and bills—or draw on the account by writing out a check. If you write a

check to “cash,” withdraw currency, and pay a creditor, there has been no change in the money supply.

But if you pay your creditor by check, the quantity of money has increased: the cash you deposited

remains available, and your creditor deposits the check to his own account as though it were cash. (A

more broadly defined money supply, M2, includes savings deposits at commercial banks.)

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Finance

Commercial paper is defined more narrowly in finance than in law. To the corporate treasurer and other

financiers, commercial paper ordinarily means short-term promissory notes sold by finance companies

and large corporations for a fixed rate of interest. Maturity dates range from a low of three days to a high

of nine months. It is an easy way for issuers to raise short-term money quickly. And although short-term

notes are unsecured, historically they have been almost as safe as obligations of the US government. By

contrast, for legal purposes, commercial paper includes long-term notes (which are often secured), drafts,

checks, and certificates of deposit.

KEY TAKEAWAY

Commercial paper is a medium of exchange used like cash but safer than cash; cash is

rarely used today except for small transactions. The key to the success of this invention

is the concept of negotiability: through this process, a person can pass on—in most

cases—better title to receive payment than he had; thus the transferee of such paper

will most likely get paid by the obligor and will not be subject to most defenses of any

prior holders. The law of commercial paper has developed over the past four hundred

years. It is now the Uniform Commercial Code that governs most commercial paper

transactions in the United States, but federal or international preemption is possible in

the future. Commercial paper is important in both economics and finance.

EXERCISES

1. If there were no such thing as commercial paper, real or virtual (electronic funds

transfers), how would you pay your bills? How did merchants have to pay their bills

four hundred years ago?

2. What is it about negotiability that it is the key to the success of commercial paper?

3. How could state law—the UCC—be preempted in regard to commercial paper?

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13.2 Scope of Article 3 and Types of Commercial Paper and Parties

LEARNING OBJECTIVES

1. Understand the scope of Article 3 of the Uniform Commercial Code.

2. Recognize the types of commercial paper: drafts, checks, notes, and

certificates of deposit.

3. Give the names of the various parties to commercial paper.

Scope of Article 3 Article 3 of the Uniform Commercial Code (UCC) covers commercial paper but explicitly excludes money,

documents of title, and investment securities. Documents of title include bills of lading and warehouse

receipts and are governed by Article 7 of the UCC. Investment securities are covered by Article 8.

Instruments that fall within the scope of Article 3 may also be subject to Article 4 (bank deposits and

collections), Article 8 (securities), and Article 9 (secured transactions). If so, the rules of these other

articles supersede the provisions of Article 3 to the extent of conflict. Article 3 is a set of general provisions

on negotiability; the other articles deal more narrowly with specific transactions or instruments.

Types of Commercial Paper There are four types of commercial paper: drafts, checks, notes, and certificates of deposit.

Drafts

A draft is an unconditional written order by one person (the drawer) directing another person (the

drawee) to pay a certain sum of money on demand or at a definite time to a named third person (the

payee) or to bearer. The draft is one of the two basic types of commercial paper; the other is the note. As

indicated by its definition, the draft is a three-party transaction.

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Parties to a Draft

The drawer is one who directs a person or an entity, usually a bank, to pay a sum of money stated in an

instrument—for example, a person who makes a draft or writes a check. The drawer prepares a document

(a form, usually)—the draft—ordering the drawee to remit a stated sum of money to the payee.

The drawee is the person or entity that a draft is directed to and that is ordered to pay the amount stated

on it. The most common drawee is a bank. The drawer, drawee, and payee need not be different people;

the same person may have different capacities in a single transaction. For example, a drawer (the person

asking that payment be made) may also be the payee (the person to whom the payment is to be made). A

drawee who signs the draft becomes an acceptor: the drawee pledges to honor the draft as written. To

accept, the drawee need only sign her name on the draft, usually vertically on the face, but anywhere will

do. Words such as “accepted” or “good” are unnecessary. However, a drawee who indicates that she might

refuse to pay will not be held to have accepted. Thus in the archetypal case, the court held that a drawee

who signed his name and appended the words “Kiss my foot” did not accept the draft. [1]

The drawer directs the funds to be drawn from—pulled from—the drawee, and the drawee pays the person

entitled to payment as directed.

Types of Drafts

Drafts can be divided into two broad subcategories: sight drafts and time drafts.

A sight draft calls for payment “on sight,” that is, when presented. Recall from Section 13.1

"Introduction to Commercial Paper" that Lorna Love wished to buy tennis rackets from Rackets, Inc.

Suppose Love had the money to pay but did not want to do so before delivery. Rackets, on the other hand,

did not want to ship before Love paid. The solution: a sight draft, drawn on Love, to which would be

attached an order bill of lading that Rackets received from the trucker when it shipped the rackets. The

sight draft and bill of lading go to a bank in Love’s city. When the tennis rackets arrive, the carrier notifies

the bank, which presents the draft to Love for payment. When she has done so, the bank gives Love the

bill of lading, entitling her to receive the shipment. The bank forwards the payment to Rackets’ bank,

which credits Rackets’ account with the purchase amount.

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A time draft, not surprisingly, calls for payment on a date specified in the draft. Suppose that Love will

not have sufficient cash to pay until she has sold the rackets but that Rackets needs to be paid

immediately. The solution: a common form of time draft known as a trade acceptance. Rackets, the seller,

draws a draft on Love, who thus becomes a drawee. The draft orders Love to pay the purchase price to the

order of Rackets, as payee, on a fixed date. Rackets presents the draft to Love, who accepts it by signing

her name. Rackets then can indorse the draft (by signing it) and sell it, at a discount, to its bank or some

other financial institution. Rackets thus gets its money right away; the bank may collect from Love on the

date specified. See the example of a time draft in Figure 13.3 "A Time Draft".

Figure 13.3 A Time Draft

Drafts in International Trade

Drafts are an international convention. In England and the British Commonwealth, drafts are called bills

of exchange. Like a draft, a bill of exchange is a kind of check or promissory note without interest. Used

primarily in international trade, it is a written order by one person to pay another a specific sum on a

specific date sometime in the future. If the bill of exchange is drawn on a bank, it is called a bank draft. If

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it is drawn on another party, it is called a trade draft. Sometimes a bill of exchange will simply be called a

draft, but whereas a draft is always negotiable (transferable by endorsement), this is not necessarily true

of a bill of exchange.

A widely used draft in international trade is the banker’s acceptance. It is a short-term credit

investment created by a nonfinancial firm and guaranteed by a bank. This instrument is used when an

exporter agrees to extend credit to an importer.

Assume Love, the importer, is in New York; Rackets, the exporter, is in Taiwan. Rackets is willing to

permit Love to pay ninety days after shipment. Love makes a deal with her New York bank to issue

Rackets’ bank in Taiwan a letter of credit. This tells the seller’s bank that the buyer’s bank is willing to

accept a draft drawn on the buyer in accordance with terms spelled out in the letter of credit. Love’s bank

may insist on a security interest in the tennis rackets, or it may conclude that Love is creditworthy. On

receipt of the letter of credit, Rackets presents its bank in Taiwan with a draft drawn on Love’s bank. That

bank antes up the purchase amount (less its fees and interest), paying Rackets directly. It then forwards

the draft, bill of lading, and other papers to a correspondent bank in New York, which in turn presents it

to Love’s bank. If the papers are in order, Love’s bank will “accept” the draft (sign it). The signed draft is

the banker’s acceptance (see Figure 13.3 "A Time Draft"). It is returned to the bank in Taiwan, which can

then discount the banker’s acceptance if it wishes payment immediately or else wait the ninety days to

present it to the New York bank for payment. After remitting to the Taiwanese bank, the New York bank

then demands payment from Love.

Checks

A second type of commercial paper is the common bank check, a special form of draft. Section 3-104(2)(b)

of the UCC defines a check as “a draft drawn on a bank and payable on demand.” Postdating a check

(putting in a future date) does not invalidate it or change its character as payable on demand. Postdating

simply changes the first time at which the payee may demand payment. Checks are, of course, usually

written on paper forms, but a check can be written on anything—a door, a shirt, a rock—though certainly

the would-be holder is not obligated to accept it.

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Like drafts, checks may be accepted by the drawee bank. Bank acceptance of a check is

called certification; the check is said to be certified by stamping the word “certified” on the face of the

check. When the check is certified, the bank guarantees that it will honor the check when presented. It can

offer this guarantee because it removes from the drawer’s account the face amount of the check and holds

it for payment. The payee may demand payment from the bank but not from the drawer or any prior

indorser of the check.

A certified check is distinct from a cashier’s check. A cashier’s check is drawn on the account of the

bank itself and signed by an authorized bank representative in return for a cash payment to it from the

customer. The bank guarantees payment of the cashier’s check also.

Notes

A note—often called a promissory note—is a written promise to pay a specified sum of money on

demand or at a definite time. There are two parties to a note: the maker (promisor), and the payee

(promisee). For an example of a promissory note, see Figure 13.4 "A Promissory Note". The maker might

execute a promissory note in return for a money loan from a bank or other financial institution or in

return for the opportunity to make a purchase on credit.

Figure 13.4 A Promissory Note

Certificates of Deposit

A fourth type of commercial paper is the certificate of deposit, commonly called a CD. The CD is a

written acknowledgment by a bank that it has received money and agrees to repay it at a time specified in

the certificate. The first negotiable CD was issued in 1961 by First National City Bank of New York (now

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Citibank); it was designed to compete for corporate cash that companies were investing in Treasury notes

and other funds. Because CDs are negotiable, they can be traded easily if the holder wants cash, though

their price fluctuates with the market.

Other Parties to Commercial Paper In addition to makers, drawees, and payees, there are five other capacities in which one can deal with

commercial paper.

Indorser and Indorsee

The indorser (also spelled endorser) is one who transfers ownership of a negotiable instrument by

signing it. A depositor indorses a check when presenting it for deposit by signing it on the back. The bank

deposits its own funds, in the amount of the check, to the depositor’s account. By indorsing it, the

depositor transfers ownership of the check to the bank. The depositor’s bank then can present it to the

drawer’s bank for repayment from the drawer’s funds. The indorsee is the one to whom a draft or note is

indorsed. When a check is deposited in a bank, the bank is the indorsee.

Holder

A holder is “a person in possession of a negotiable that is payable either to bearer, or to an identified

person that is the person in possession.” [2] Holder is thus a generic term that embraces several of the

specific types of parties already mentioned. An indorsee and a drawee can be holders. But a holder can

also be someone unnamed whom the original parties did not contemplate by name—for example, the

holder of a bearer note.

Holder in Due Course

A holder in due course is a special type of holder who, if certain requirements are met, acquires rights

beyond those possessed by the transferor (we alluded to this in describing the significance of Lorna Love’s

making of a negotiable—as opposed to a nonnegotiable—instrument). We discuss the requirements for a

holder in due course inChapter 15 "Holder in Due Course and Defenses".

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Accommodation Party

An accommodation party is one who signs a negotiable instrument in order to lend her name to

another party to the instrument. It does not matter in what capacity she signs, whether as maker or

comaker, drawer or codrawer, or indorser. As a signatory, an accommodation party is always a surety

(Chapter 17 "Legal Aspects of Banking"; a surety is one who guarantees payment if the primarily obligated

party fails to pay). The extent of the accommodation party’s liability to pay depends on whether she has

added language specifying her purposes in signing. Section 3-416 of the UCC distinguishes between a

guaranty of payment and a guaranty of collection. An accommodation party who adds words such as

“payment guaranteed” subjects herself to primary liability: she is guaranteeing that she will pay if the

principal signatory fails to pay when the instrument is due. But if the accommodation party signs

“collection guaranteed,” the holder must first sue the maker and win a court judgment. Only if the

judgment is unsatisfied can the holder seek to collect from the accommodation party. When words of

guaranty do not specify the type, the law presumes a payment guaranty.

KEY TAKEAWAY

The modern law of commercial paper is, in general, covered by UCC Article 3. The

two basic types of commercial paper are drafts and notes. The note is a two-party

instrument whereby one person (maker) promises to pay money to a second

person (payee). The draft is a three-party instrument whereby one person

(drawer) directs a second (drawee) to pay money to the third (payee). Drafts may

be sight drafts, payable on sight, or they may be time drafts, payable at a date

specified on the draft. Checks are drafts drawn on banks. Other parties include

indorser and indorsee, holder, holder in due course, and accommodation party.

EXERCISES

1. What are the two basic types of commercial paper?

2. What are the two types of drafts?

3. What kind of commercial paper is a check?

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[1] Norton v. Knapp, 19 N.W. 867 (IA 1884).

[2] Uniform Commercial Code, Section 1-201(21).

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13.3 Requirements for Negotiability

LEARNING OBJECTIVE

1. Know what is required for an instrument to be negotiable.

Overview Whether or not a paper is negotiable is the first of our four major questions, and it is one that nonlawyers

must confront. Auditors, retailers, and financial institutions often handle notes and checks and usually

must make snap judgments about negotiability. Unless the required elements of Sections 3-103 and 3-104

of the Uniform Commercial Code (UCC) are met, the paper is not negotiable. Thus the paper meets the

following criteria:

1. It must be in writing.

2. It must be signed by the maker or drawer.

3. It must be an unconditional promise or order to pay.

4. It must be for a fixed amount in money.

5. It must be payable on demand or at a definite time.

6. It must be payable to order or bearer, unless it is a check.

This definition states the basic premise of a negotiable instrument: the holder must be able to ascertain all

essential terms from the face of the instrument.

Analysis of Required Elements In Writing

Under UCC Section 1-201, “written” or “writing” includes “printing, typewriting or any other intentional

reduction to tangible form.” That definition is broad—so broad, in fact, that from time to time the

newspapers report checks written on material ranging from a girdle (an Ohio resident wanted to make his

tax payment stretch) to granite. Since these are tangible materials, the checks meet the writing

requirement. The writing can be made in any medium: ink, pencil, or even spray paint, as was the case

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with the granite check. Of course, there is a danger in using pencil or an ink that can be erased, since the

drawer might be liable for alterations. For example, if you write out in pencil a check for $10 and someone

erases your figures and writes in $250, you may lose your right to protest when the bank cashes it.

Signed by the Maker or Drawer

Signature is not limited to the personal handwriting of one’s name. “Any symbol executed or adopted by a

party with present intention to authenticate a writing” will serve. [1] That means that a maker or drawer

may make an impression of his signature with a rubber stamp or even an X if he intends that by so doing

he has signed. It can be typed or by thumbprint. In some cases, an appropriate letterhead may serve to

make the note or draft negotiable without any other signature. Nor does the position of the signature

matter. Blackstone Kent’s handwritten note, “Ten days from this note, I, Blackstone Kent, promise to pay

$5,000 to the order of Webster Mews,” is sufficient to make the note negotiable, even though there is no

subsequent signature. Moreover, the signature may be in a trade name or an assumed name. (Note:

special problems arise when an agent signs on behalf of a principal. We consider these problems

in Chapter 16 "Liability and Discharge".)

Unconditional Promise or Order to Pay

Section 3-106(a) of the UCC provides that an instrument is notnegotiable if it “states (i) an express

condition to payment, (ii) that the promise or order is subject to or governed by another writing, or (iii)

that rights or obligations with respect to the promise or order are stated in another writing. A reference to

another writing does not of itself make the promise or order conditional.” Under 3-106(b), a promise is

not made conditional by “(i) reference to another writing for a statement of rights with respect to

collateral, pre-payment, or acceleration, or (ii) because payment is limited to resort to a particular fund or

source.” As to “reference to another writing,” see Holly Hill Acres, Ltd. v. Charter Bank of Gainesville,

in Section 13.4 "Cases".

The only permissible promise or order in a negotiable instrument is to pay a sum certain in money. Any

other promise or order negates negotiability. The reason for this rule is to prevent an instrument from

having an indeterminate value. The usefulness of a negotiable instrument as a substitute for money would

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be seriously eroded if the instrument’s holder had to investigate whether a stipulation or condition had

been met before the thing had any value (i.e., before the obligor’s obligation to pay ripened).

Fixed Amount in Money

The value of the paper must be fixed (specific) so it can be ascertained, and it must be payable in money.

Fixed Amount

The instrument must recite an exact amount of money that is to be paid, although the exact amount need

not be expressed in a single figure. For example, the note can state that the principal is $1,000 and the

interest is 11.5 percent, without specifying the total amount. Or the note could state the amount in

installments: twelve equal installments of $88.25. Or it could state different interest rates before and after

a certain date or depending on whether or not the maker has defaulted; it could be determinable by a

formula or by reference to a source described in the instrument. [2] It could permit the maker to take a

discount if he pays before a certain date or could assess a penalty if he pays after the date. It could also

provide for an attorney’s fees and the costs of collection on default. If it is clear that interest is to be

included but no interest amount is set, UCC Section 3-112 provides that it is “payable at the judgment rate

in effect at the place of payment of the instrument and at the time interest first accrues.” The fundamental

rule is that for any time of payment, the holder must be able to determine, after the appropriate

calculations, the amount then payable. See Section 13.4 "Cases", Centerre Bank of Branson v. Campbell,

for a case involving the “fixed amount” rule.

In Money

Section 1-201(24) of the UCC defines money as “a medium of exchange authorized or adopted by a

domestic or foreign government as a part of its currency.” As long as the medium of exchange was such at

the time the instrument was made, it is payable in money, even if the medium of exchange has been

abolished at the time the instrument is due. Section 3-107 provides the following as to payment in foreign

currency: “Unless the instrument otherwise provides, an instrument that states the amount payable in

foreign money may be paid in the foreign money or in an equivalent amount in dollars calculated by using

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the current bank-offered spot rate at the place of payment for the purchase of dollars on the day on which

the instrument is paid.”

Payable on Demand or at a Definite Time

An instrument that says it is payable on sight is payable on demand, as is one that states no time for

payment. “Definite time” may be stated in several ways; it is not necessary to set out a specific date. For

example, a note might say that it is payable on or before a stated date, at a fixed period after the date, at a

fixed period after sight, at a definite time subject to acceleration, or at a definite time subject to extension

at the option of the holder or automatically on or after the occurrence of a particular event. However, if

the only time fixed is on the occurrence of a contingent event, the time is not definite, even though the

event in fact has already occurred. An example of a valid acceleration clause is the following: “At the

option of the holder, this note shall become immediately due and payable in the event that the maker fails

to comply with any of the promises contained in this note or to perform any other obligation of the maker

to the holder.”

Is the note “Payable ten days after I give birth” negotiable? No, because the date the baby is due is

uncertain. Is the note “Payable on January 1, but if the Yankees win the World Series, payable four days

earlier” negotiable? Yes: this is a valid acceleration clause attached to a definite date.

One practical difference between a demand instrument and a time instrument is the date on which the

statute of limitations begins to run. (A statute of limitations is a limit on the time a creditor has to file a

lawsuit to collect the debt.) Section 3-118(1) of the UCC says that a lawsuit to enforce payment at a definite

time “must be commenced within six years after the due date” (or the accelerated due date). For demand

paper, an action must be brought “within six years after the demand.”

Payable to Order or Bearer

An instrument payable to order is one that will be paid to a particular person or organization identifiable

in advance. To be payable to order, the instrument must so state, as most ordinarily do, by placing the

words “payable to order of” before the name of the payee. An instrument may be payable to the order of

the maker, drawer, drawee, or someone else. It also may be payable to the order of two or more payees

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(together or in the alternative), to an estate, a trust, or a fund (in which case it is payable to the

representative, to an office or officer, or to a partnership or unincorporated association). Suppose a

printed form says that the instrument is payable both to order and to bearer. In that event, the instrument

is payable only to order. However, if the words “to bearer” are handwritten or typewritten, then the

instrument can be payable either to order or to bearer.

A negotiable instrument not payable to a particular person must be payable to bearer, meaning to any

person who presents it. To be payable to bearer, the instrument may say “payable to bearer” or “to the

order of bearer.” It may also say “payable to John Doe or bearer.” Or it may be made payable to cash or

the order of cash.

Section 3-104(c) of the UCC excepts checks from the requirement that the instrument be “payable to

bearer or order.” Official Comment 2 to that section explains why checks are not required to have the

“payable” wording: “Subsection (c) is based on the belief that it is good policy to treat checks, which are

payment instruments, as negotiable instruments whether or not they contain the words ‘to the order of.’

These words are almost always pre-printed on the check form.…Absence of the quoted words can easily be

overlooked and should not affect the rights of holders who may pay money or give credit for a check

without being aware that it is not in the conventional form.”

Also affecting this policy is the fact that almost all checks are now read by machines, not human beings.

There is no one to see that the printed form does not contain the special words, and the significance of the

words is recognized by very few people. In short, it doesn’t matter for checks.

Missing and Ambiguous Terms The rules just stated make up the conditions for negotiability. Dealing with two additional details—

missing terms or ambiguous terms—completes the picture. Notwithstanding the presence of readily

available form instruments, sometimes people leave words out or draw up confusing documents.

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Incompleteness

An incomplete instrument—one that is missing an essential element, like the due date or amount—can be

signed before being completed if the contents at the time of signing show that the maker or drawer

intends it to become a negotiable instrument. Unless the date of an instrument is required to determine

when it is payable, an undated instrument can still be negotiable. [3] Otherwise, to be enforceable, the

instrument must first be completed—if not by the maker or drawer, then by the holder in accordance with

whatever authority he has to do so. [4] See the case presented in Section 13.4 "Cases", Newman v.

Manufacturers Nat. Bank of Detroit.

Ambiguity

When it is unclear whether the instrument is a note or draft, the holder may treat it as either.

Handwritten terms control typewritten and printed terms, and typewritten terms control printed terms.

Words control figures, unless the words themselves are ambiguous, in which case the figures control. If

the instrument contains a “conspicuous statement, however expressed, to the effect that the promise or

order is not negotiable,” its negotiability is destroyed, except for checks, and “an instrument may be a

check even though it is described on its face by another term, such as ‘money order.’” [5]

KEY TAKEAWAY

If an instrument is not negotiable, it generally will not be acceptable as payment in

commercial transactions. The UCC requires that the value of a negotiable instrument be

ascertainable on its face, without reference to other documents. Thus the negotiable

instrument must be in writing, signed by the maker or drawer, an unconditional promise

or order to pay, for a fixed amount in money, payable on demand or at a definite time,

and payable to order or bearer, unless it is a check. If the instrument is incomplete or

ambiguous, the UCC provides rules to determine what the instrument means.

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EXERCISES

1. Why does the UCC require that the value of a negotiable instrument be

ascertainable from its face, without extrinsic reference?

2. What are the six requirements for an instrument to meet the negotiability test?

3. Why are the words “pay to order” or “pay to bearer” or similar words required on

negotiable instruments (except for checks—and why not for checks)?

4. If an instrument is incomplete, is it invalid?

[1] Uniform Commercial Code, Section 1-201(39).

[2] Uniform Commercial Code, Section 3-112(b).

[3] Uniform Commercial Code, Section 3-113(b).

[4] Uniform Commercial Code, Section 3-115.

[5] Uniform Commercial Code, Section 3-104(d); Uniform Commercial Code, Section 3-104(f).

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13.4 Cases

Negotiability: Requires Unconditional Promise to Pay Holly Hill Acres, Ltd. v. Charter Bank of Gainesville

314 So.2d 209 (Fla. App. 1975)

Scheb, J.

Appellant/defendant [Holly Hill] appeals from a summary judgment in favor of appellee/plaintiff Bank in

a suit wherein the plaintiff Bank sought to foreclose a note and mortgage given by defendant.

The plaintiff Bank was the assignee from Rogers and Blythe of a promissory note and purchase money

mortgage executed and delivered by the defendant. The note, executed April 28, 1972, contains the

following stipulation:

This note with interest is secured by a mortgage on real estate, of even date herewith, made by the maker

hereof in favor of the said payee, and shall be construed and enforced according to the laws of the State of

Florida. The terms of said mortgage are by this reference made a part hereof. (emphasis

added)

Rogers and Blythe assigned the promissory note and mortgage in question to the plaintiff Bank to secure

their own note. Plaintiff Bank sued defendant [Holly Hill] and joined Rogers and Blythe as defendants

alleging a default on their note as well as a default on defendant’s [Holly Hill’s] note.

Defendant answered incorporating an affirmative defense that fraud on the part of Rogers and Blythe

induced the sale which gave rise to the purchase money mortgage. Rogers and Blythe denied the fraud. In

opposition to plaintiff Bank’s motion for summary judgment, the defendant submitted an affidavit in

support of its allegation of fraud on the part of agents of Rogers and Blythe. The trial court held the

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plaintiff Bank was a holder in due course of the note executed by defendant and entered a summary final

judgment against the defendant.

The note having incorporated the terms of the purchase money mortgage was not negotiable. The plaintiff

Bank was not a holder in due course, therefore, the defendant was entitled to raise against the plaintiff

any defenses which could be raised between the appellant and Rogers and Blythe. Since defendant

asserted an affirmative defense of fraud, it was incumbent on the plaintiff to establish the non-existence of

any genuine issue of any material fact or the legal insufficiency of defendant’s affirmative defense. Having

failed to do so, plaintiff was not entitled to a judgment as a matter of law; hence, we reverse.

The note, incorporating by reference the terms of the mortgage, did not contain the unconditional

promise to pay required by [the UCC]. Rather, the note falls within the scope of [UCC 3-106(a)(ii)]: “A

promise or order is unconditional unless it states that…it is subject to or governed by any other writing.”

Plaintiff Bank relies upon Scott v. Taylor [Florida] 1912 [Citation], as authority for the proposition that its

note is negotiable. Scott, however, involved a note which stated: “this note secured by mortgage.” Mere

reference to a note being secured by mortgage is a common commercial practice and such reference in

itself does not impede the negotiability of the note. There is, however, a significant difference in a note

stating that it is “secured by a mortgage” from one which provides, “the terms of said mortgage are by this

reference made a part hereof.” In the former instance the note merely refers to a separate agreement

which does not impede its negotiability, while in the latter instance the note is rendered non-negotiable.

As a general rule the assignee of a mortgage securing a non-negotiable note, even though a bona fide

purchaser for value, takes subject to all defenses available as against the mortgagee. [Citation] Defendant

raised the issue of fraud as between himself and other parties to the note, therefore, it was incumbent on

the plaintiff Bank, as movant for a summary judgment, to prove the non-existence of any genuinely triable

issue. [Citation]

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Accordingly, the entry of a summary final judgment is reversed and the cause remanded for further

proceedings.

CASE QUESTIONS

1. What was wrong with the promissory note that made it nonnegotiable?

2. How did the note’s nonnegotiability—as determined by the court of appeals—

benefit the defendant, Holly Hill?

3. The court determined that the bank was not a holder in due course; on

remand, what happens now?

Negotiability: Requires Fixed Amount of Money Centerre Bank of Branson v. Campbell

744 S.W.2d 490 (Mo. App. 1988)

Crow, J.

On or about May 7, 1985, appellants (“the Campbells”) signed the following document:

Figure 13.5

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On May 13, 1985, the president and secretary of Strand Investment Company (“Strand”) signed the

following provision [see Figure 22.6] on the reverse side of the above [Figure 13.5] document:

Figure 13.6

On June 30, 1986, Centerre Bank of Branson (“Centerre”) sued the Campbells. Pertinent to the issues on

this appeal, Centerre’s petition averred:

“1. …on [May 7,] 1985, the [Campbells] made and delivered to Strand…their promissory note…and

thereby promised to pay to Strand…or its order…($11,250.00) with interest thereon from date at the rate

of fourteen percent (14%) per annum; that a copy of said promissory note is attached hereto…and

incorporated herein by reference.

2. That thereafter and before maturity, said note was assigned and delivered by Strand…to [Centerre] for

valuable consideration and [Centerre] is the owner and holder of said promissory note.”

Centerre’s petition went on to allege that default had been made in payment of the note and that there was

an unpaid principal balance of $9,000, plus accrued interest, due thereon. Centerre’s petition prayed for

judgment against the Campbells for the unpaid principal and interest.

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[The Campbells] aver that the note was given for the purchase of an interest in a limited partnership to be

created by Strand, that no limited partnership was thereafter created by Strand, and that by reason

thereof there was “a complete and total failure of consideration for the said promissory note.”

Consequently, pled the answers, Centerre “should be estopped from asserting a claim against [the

Campbells] on said promissory note because of such total failure of consideration for same.”

The cause was tried to the court, all parties having waived trial by jury. At trial, the attorney for the

Campbells asked Curtis D. Campbell what the consideration was for the note. Centerre’s attorney

interrupted: “We object to any testimony as to the consideration for the note because it’s our position that

is not a defense in this lawsuit since the bank is the holder in due course.”…

The trial court entered judgment in favor of Centerre and against the Campbells for $9,000, plus accrued

interest and costs. The trial court filed no findings of fact or conclusions of law, none having been

requested. The trial court did, however, include in its judgment a finding that Centerre “is a holder in due

course of the promissory note sued upon.”

The Campbells appeal, briefing four points. Their first three, taken together, present a single hypothesis of

error consisting of these components: (a) the Campbells showed “by clear and convincing evidence a valid

and meritorious defense in that there existed a total lack and failure of consideration for the promissory

note in question,” (b) Centerre acquired the note subject to such defense in that Centerre was not a holder

in due course, as one can be a holder in due course of a note only if the note is a negotiable instrument,

and (c) the note was not a negotiable instrument inasmuch as “it failed to state a sum certain due the

payee.”…

We have already noted that if Centerre is not a holder in due course, the Campbells can assert the defense

of failure of consideration against Centerre to the same degree they could have asserted it against Strand.

We have also spelled out that Centerre cannot be a holder in due course if the note is not a negotiable

instrument. The pivotal issue, therefore, is whether the provision that interest may vary with bank rates

charged to Strand prevents the note from being a negotiable instrument.…

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Neither side has cited a Missouri case applying [UCC 3-104(a)] to a note containing a provision similar to:

“Interest may vary with bank rates charged to Strand.” Our independent research has likewise proven

fruitless. There are, however, instructive decisions from other jurisdictions.

In Taylor v. Roeder, [Citation, Virginia] (1987), a note provided for interest at “[t]hree percent (3.00%)

over Chase Manhattan prime to be adjusted monthly.” A second note provided for interest at “3% over

Chase Manhattan prime adjusted monthly.” Applying sections of the Uniform Commercial Code adopted

by Virginia identical to [the Missouri UCC], the court held the notes were not negotiable instruments in

that the amounts required to satisfy them could not be ascertained without reference to an extrinsic

source, the varying prime rate of interest charged by Chase Manhattan Bank.

In Branch Banking and Trust Co. v. Creasy, [Citation, North Carolina] (1980), a guaranty agreement

provided that the aggregate amount of principal of all indebtedness and liabilities at any one time for

which the guarantor would be liable shall not exceed $35,000. The court, emphasizing that to be a

negotiable instrument a writing must contain, among other things, an unconditional promise to pay a sum

certain in money, held the agreement was not a negotiable instrument. The opinion recited that for the

requirement of a sum certain to be met, it is necessary that at the time of payment the holder be able to

determine the amount which is then payable from the instrument itself, with any necessary computation,

without reference to any outside source. It is essential, said the court, for a negotiable instrument “to bear

a definite sum so that subsequent holders may take and transfer the instrument without having to plumb

the intricacies of the instrument’s background.…

In A. Alport & Son, Inc. v. Hotel Evans, Inc., [Citation] (1970), a note contained the notation “with

interest at bank rates.” Applying a section of the Uniform Commercial Code adopted by New York

identical to [3-104(a)] the court held the note was not a negotiable instrument in that the amount of

interest had to be established by facts outside the instrument.

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In the instant case, the Campbells insist that it is impossible to determine from the face of the note the

amount due and payable on any payment date, as the note provides that interest may vary with bank rates

charged to Strand. Consequently, say the Campbells, the note is not a negotiable instrument, as it does not

contain a promise to pay a “sum certain” [UCC 3-104(a)].

Centerre responds that the provision that interest may vary with bank rates charged to Strand is not

“directory,” but instead is merely “discretionary.” The argument begs the question. Even if one assumes

that Strand would elect not to vary the interest charged the Campbells if interest rates charged Strand by

banks changed, a holder of the note would have to investigate such facts before determining the amount

due on the note at any time of payment. We hold that under 3-104 and 3-106, supra, and the authorities

discussed earlier, the provision that interest may vary with bank rates charged to Strand bars the note

from being a negotiable instrument, thus no assignee thereof can be a holder in due course. The trial court

therefore erred as a matter of law in ruling that Centerre was a holder in due course.…

An alert reader will have noticed two other extraordinary features about the note, not mentioned in this

opinion. First, the note provides in one place that principal and interest are to be paid in annual

installments; in another place it provides that interest will be payable semiannually. Second, there is no

acceleration clause providing that if default be made in the payment of any installment when due, then all

remaining installments shall become due and payable immediately. It would have thus been arguable

that, at time of trial, only the first year’s installment of principal and interest was due. No issue is raised,

however, regarding any of these matters, and we decline to consider them sua sponte [on our own].

The judgment is reversed and the cause is remanded for a new trial.

CASE QUESTIONS

1. What was defective about this note that made it nonnegotiable?

2. What was the consequence to Centerre of the court’s determination that the

note was nonnegotiable?

3. What did the Campbells give the note for in the first place, and why do they

deny liability on it?

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Undated or Incomplete Instruments Newman v. Manufacturers Nat. Bank of Detroit

152 N.W.2d 564 (Mich. App. 1967)

Holbrook, J.

As evidence of [a debt owed to a business associate, Belle Epstein], plaintiff [Marvin Newman in 1955]

drew two checks on the National Bank of Detroit, one for $1,000 [about $8,000 in 2010 dollars] and the

other for $200 [about $1,600 in 2010 dollars]. The checks were left undated. Plaintiff testified that he

paid all but $300 of this debt during the following next 4 years. Thereafter, Belle Epstein told plaintiff that

she had destroyed the two checks.…

Plaintiff never notified defendant Bank to stop payment on the checks nor that he had issued the checks

without filling in the dates. The date line of National Bank of Detroit check forms contained the first 3

numbers of the year but left the last numeral, month and day entries, blank, viz., “Detroit 1, Mich. _ _

195_ _.” The checks were cashed in Phoenix, Arizona, April 17, 1964, and the date line of each check was

completed…They were presented to and paid by Manufacturers National Bank of Detroit, April 22, 1964,

under the endorsement of Belle Epstein. The plaintiff protested such payment when he was informed of it

about a month later. Defendant Bank denied liability and plaintiff brought suit.…

The two checks were dated April 16, 1964. It is true that the dates were completed in pen and ink

subsequent to the date of issue. However, this was not known by defendant. Defendant had a right to rely

on the dates appearing on the checks as being correct. [UCC 3-113] provides in part as follows:

(a) An instrument may be antedated or postdated.

Also, [UCC 3-114] provides in part as follows:

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[T]ypewritten terms prevail over printed terms, handwritten terms prevail over both…

Without notice to the contrary, defendant was within its rights to assume that the dates were proper and

filled in by plaintiff or someone authorized by him.…

Plaintiff admitted at trial that defendant acted in good faith in honoring the two checks of plaintiff’s in

question, and therefore defendant’s good faith is not in issue.

In order to determine if defendant bank’s action in honoring plaintiff’s two checks under the facts present

herein constituted an exercise of proper procedure, we turn to article 4 of the UCC.…[UCC 4-401(d)]

provides as follows:

A bank that in good faith makes payment to a holder may charge the indicated account of its customer

according to:

(1) the original tenor of his altered item; or

(2) the tenor of his completed item, even though the bank knows the item has been completed unless the

bank has notice that the completion was improper.

…[W]e conclude it was shown that two checks were issued by plaintiff in 1955, filled out but for the dates

which were subsequently completed by the payee or someone else to read April 16, 1964, and presented to

defendant bank for payment, April 22, 1964. Applying the rules set forth in the UCC as quoted herein, the

action of the defendant bank in honoring plaintiff’s checks was in good faith and in accord with the

standard of care required under the UCC.

Since we have determined that there was no liability under the UCC, plaintiff cannot succeed on this

appeal.

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Affirmed.

CASE QUESTIONS

1. Why does handwriting control over printing or typing on negotiable

instruments?

2. How could the plaintiff have protected himself from liability in this case?

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13.5 Summary and Exercises

Summary Commercial paper is the collective term for a variety of instruments—including checks, certificates of

deposit, and notes—that are used to pay for goods; commercial paper is basically a contract to pay money.

The key to the central role of commercial paper is negotiability, the means by which a person is

empowered to transfer to another more than what the transferor himself possesses. The law regulating

negotiability is Article 3 of the Universal Commercial Code.

Commercial paper can be divided into two basic types: the draft and the note. A draft is a document

prepared by a drawer ordering the drawee to remit a stated sum of money to the payee. Drafts can be

subdivided into two categories: sight drafts and time drafts. A note is a written promise to pay a specified

sum of money on demand or at a definite time.

A special form of draft is the common bank check, a draft drawn on a bank and payable on demand. A

special form of note is the certificate of deposit, a written acknowledgment by a bank that it has received

money and agrees to repay it at a time specified in the certificate.

In addition to drawers, makers, drawees, and payees, one can deal with commercial paper in five other

capacities: as indorsers, indorsees, holders, holders in due course, and accommodation parties.

A holder of a negotiable instrument must be able to ascertain all essential terms from its face. These terms

are that the instrument (1) be in writing, (2) be signed by the maker or drawer, (3) contain an

unconditional promise or order to pay (4) a sum certain in money, (5) be payable on demand or at a

definite time, and (6) be payable to order or to bearer. If one of these terms is missing, the document is

not negotiable, unless it is filled in before being negotiated according to authority given.

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EXERCISES

1. Golf Inc. manufactures golf balls. Jack orders 1,000 balls from Golf and promises to

pay $4,000 two weeks after delivery. Golf Inc. delivers the balls and assigns its

contract rights to First Bank for $3,500. Golf Inc. then declares bankruptcy. May

First Bank collect $3,500 from Jack? Explain.

2. Assume in problem 1 that Jack gives Golf Inc. a nonnegotiable note for $3,500 and

Golf sells the note to the bank shortly after delivering the balls. May the bank

collect the $3,500? Would the result be different if the note were negotiable?

Explain.

3. George decides to purchase a new stereo system on credit. He signs two

documents—a contract and a note. The note states that it is given “in payment for

the stereo” and “if stereo is not delivered by July 2, the note is cancelled.” Is the

note negotiable? Explain.

4. Is the following instrument a note, check, or draft? Explain.

Figure 13.7

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5. State whether the following provisions in an instrument otherwise in the

proper form make the instrument nonnegotiable and explain why:

a. A note stating, “This note is secured by a mortgage of the same

date on property located at 1436 Dayton Street, Jameson, New

York”

b. A note for $25,000 payable in twenty installments of $1,250 each

that provides, “In the event the maker dies all unpaid installments

are cancelled”

c. An instrument reading, “I.O.U., Rachel Donaldson, $3,000”

d. A note for $1,500 “payable to the order of Marty Dooley, six

months after Nick Solster’s death”

e. A note A note reading, “I promise to pay Rachel Donaldson $3,000”

f. A note stating, “In accordance with our telephone conversation of

January 7th, I promise to pay Sally Wilkenson or order $1,500”

g. An undated note for $1,500 “payable one year after date”

h. for $18,000 payable in regular installments also stating, “In the

event any installment is not made as provided here, the entire

amount remaining unpaid may become due immediately”

Lou enters into a contract to buy Alan’s car and gives Alan an instrument that

states, “This acknowledges my debt to Alan in the amount of $10,000 that I owe

on my purchase of the 2008 Saturn automobile I bought from him today.” Alan

assigns the note to Judy for $8,000. Alan had represented to Lou that the car had

20,000 miles on it, but when Lou discovered the car had 120,000 miles he refused

to make further payments on the note. Can Judy successfully collect from Lou?

Explain.

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The same facts as above are true, but the instrument Lou delivered to Alan

reads, “I promise to pay to Alan or order $10,000 that I owe on my purchase of the

2008 automobile I bought from him today.” Can Judy successfully collect from

Lou? Explain.

Joe Mallen, of Sequim, Washington, was angry after being cited by a US Fish

and Wildlife Service for walking his dog without a leash in a federal bird refuge. He

was also aggravated with his local bank because it held an out-of-state check

made out to Mallen for ten days before honoring it. To vent his anger at both,

Mallen spray painted a twenty-five-pound rock from his front yard with three

coats of white paint, and with red paint, spelled out his account number, the

bank’s name, the payee, his leash law citation number, and his signature. Should

the US District Court in Seattle—the payee—attempt to cash the rock, would it be

good? Explain. [1]

Raul Castana purchased a new stereo system from Eddington Electronics

Store. He wrote a check on his account at Silver Bank in the amount of $1,200 and

gave it to Electronics’ clerk. David Eddington, the store owner, stamped the back

of the check with his rubber indorsement stamp, and then wrote, “Pay to the

order of City Water,” and he mailed it to City Water to pay the utility bill.

Designate the parties to this instrument using the vocabulary discussed in this

chapter.

Would Castana’s signed note made out to Eddington Electronics Store be

negotiable if it read, “I promise to pay Eddington’s or order $1,200 on or before

May 1, 2012, but only if the stereo I bought from them works to my satisfaction”?

Explain. And—disregarding negotiability for a moment—designate the parties to

this instrument using the vocabulary discussed in this chapter.

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SELF-TEST QUESTIONS

1. A negotiable instrument must

a. be signed by the payee

b. contain a promise to pay, which may be conditional

c. include a sum certain

d. be written on paper or electronically

The law governing negotiability is found in

a. Article 3 of the UCC

b. Article 9 of the UCC

c. the Uniform Negotiability Act

d. state common law

A sight draft

a. calls for payment on a certain date

b. calls for payment when presented

c. is not negotiable

d. is the same as a certificate of deposit

A note reads, “Interest hereon is 2% above the prime rate as determined

by First National Bank in New York City.” Under the UCC,

a. the interest rate provision is not a “sum certain” so negotiability is

destroyed

b. the note is not negotiable because the holder must look to some

extrinsic source to determine the interest rate

c. the note isn’t negotiable because the prime rate can vary before

the note comes due

d. variable interest rates are OK

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A “maker” in negotiable instrument law does what?

a. writes a check

b. becomes obligated to pay on a draft

c. is the primary obligor on a note

d. buys commercial paper of dubious value for collection

SELF-TEST ANSWERS

1. c

2. a

3. b

4. d

5. c

[1] Joel Schwarz, “Taking Things for Granite,” Student Lawyer, December 1981.