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CHAPTER
31
NEGOTIABLE
INSTRUMENTS
I.
OBJECTNESS:
The objective of this chapter is to introduce students to the nature and advantages of
negotiable
instruments and to discuss the requirements for negotiable instruments so as to lay a
foundation
for three chapters that follow. After reading this chapter and attending class, a student should
be
able
to:
1. Explain the advantages of commercial paper that can qualify as a negotiable
instrument.
2. Identify the different types of negotiable instruments and the key features of each type
of
instrument.
3. List and discuss the formal requirements that commercial paper must have to qualify as a
negotiable
instrument.
4. Apply the Code's rules that are applicable when the terms of an instrument conflict or
are
ambiguous.
II. ANSWER TO
INTRODUCTORY PROBLEM
A. The first issue following the hypothetical that appears at the beginning of the
chapter
concerns the special qualities and benefits of negotiable instruments.
Negotiable
instruments are a special kind of commercial paper that
involve
promises or orders to
pay
money and can pass readily through the financial system and be accepted in place
of
money. They can be more advantageous than a normal contract rights because
an
assignee
of the negotiable instrument who qualifies as a holder in due course can
actually
get better
rights than his
assignor.
B. The second issue concerns the basic types of commercial paper and their
defining
characteristics.
There are two basic types: (1) promises to pay (notes and certificates
of
deposit) and (2) orders to pay (drafts; checks). Their defining characteristics are set
out
on pages
704-707.
C. The third issue concerns the formal requirements that must be met for instruments
to
qualify as negotiable instruments. For an instrument to be negotiable, it must: (1) be in
writing; (2) be signer by the issuer; (3) contain an unconditional promise or order to pay
a
fixed amount of money, with or without interest or other charges described in the
promise
or order; (4) be payable to order or to bearer at the time it is issued or first comes
into
possession of a holder; (5) be payable on demand or at a definite time; and (6) not
state
an
y
other undertaking or instruction by the person promising or ordering to do any act in
addition to the payment of money (but it may contain (a) an undertaking or
promise
relative to collateral to secure payment, (b) an authorization for confession of
judgment,
or (c) a waiver of benefit of any law intended for the advantage or protection of an
obligor
).
Chapter 31
-Negotiable Instruments
31-1
© 2016 by
McGraw-Hill
Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or
part.
D. The fourth issue concerns the validity of a check in which there is a conflict between
the
amount as set forth in figures and the amount set out in words. When there
are
ambiguous terms in an instrument, the UCC sets out several general rules
of
interpretation
that are applied to resolve the conflict or ambiguity: (1) Typewritten
terms
prevail over printed terms; (2) handwritten terms prevail over printed and
typewritten
terms; and, (3) where words and numbers conflict the words control the
numbers.
III. SUGGESTIONS FOR LECTURE
PREPARATION:
A.
Introduction
1. Note the long historical use of various kinds of commercial paper and the functions
they
served.
B. Nature
of Negotiable Instruments
1. Uses of Negotiable Instruments. Lead the students through a discussion that exposes
the
uses of commercial paper. For example, students buy groceries with a check and
may
buy stereos with promissory notes. These uses show that commercial paper is
a
substitute
for
money.
2. The Purpose of the Law
of Negotiable
Instruments. Clarify how commercial paper is
a
substitute for money, although not a perfect substitute.
It
should be pointed out that
a
characteristic of money is free transferability; that is, a person has title to money free
of
another's defenses or claims. Commercial paper is freely transferable in that a holder
in
due course takes it free of personal defenses, but not real defenses. Personal and
real
defenses should be briefly explained at this
time.
3. Make clear why our society wants to create a substitute for money: to reduce the cost
of
credit, and to reduce the cost of goods and services. Since a promissory note,
for
example, is negotiable, a merchant who takes a note can sell it to a factor or a
finance
company for more money that if it were not negotiable. Hence he does not have
to
increase the interest rate on credit sales or the cost of his merchandise to cover
his
expenses when notes he takes from customers are negotiable. To aid the
students'
understanding of the differing values given to negotiable instruments and
nonnegotiable
instruments, construct an example that shows an assignee of a contract taking the
contract
subject to all claims and defenses assertable against his assignor, and another
example
that shows the holder in due course of a negotiable instrument having greater rights
than
his
transferee.
Example: Problem Case
#2.
4. End this introduction to negotiable instrument law by stating that although the
law
imposes a harsh consequence on the issuer of a negotiable instrument, that burden
is
deemed to be offset by the benefit of receiving cheaper goods, services, and
credit.
5. Call the students' attention to the recent revision to Articles 3 and 4, noting the
reasons
for the revisions as well as the effect they have on the study of negotiable
instruments
law.
C. Kinds of Commercial
Paper
On the chalkboard display the various kinds of commercial paper. The parties to
each
instrument should be identified. A note should be emphasized as a promise to pay, while
the
draft should be stressed as an order to pay. Note that a check must be payable on
demand.
Example: Problem Case #1.
Point out the distinguishing characteristics of a cashier's check and a teller's
check.
Cyber Law in Action: Check Conversion and Remotely Created Checks (page 865):
Discuss
the concept, process of creating, and the advantages/limitations of e-checks and
remotely
created
checks.
D. Formal Requirements for
Negotiability
I. Basic Requirements. List on the chalkboard the elements of negotiability and
discuss
them with students.
It
must be pointed out that the harsh consequences of
negotiability
will not be imposed on an issuer unless all these elements are
met.
2. Importance of Form. Note that the intent of the issuer is irrelevant; only the
form
matters.
E. In Writing and Signed by the
Issuer
I. In
Writing.
2. Signed by the Maker (if a Note) or the Drawer (if a Draft). Indicate that Martin
A.
Morgan, nicknamed Masher by his friends, could sign a note in any of different ways
and
be obligated on the note. Also show the problems that an agent can create for himself
by
signing
improperly.
Cyber Law in Action: E-payments Compared to Negotiable Instruments (page 868).
Use
this feature to discuss the differences between payments using negotiable instruments
and
e-payments.
F. Unconditional Promise or
Order
1. Unconditional Promise (if a Note) or Order (if a Draft) to Pay. Reemphasize that a
note
is a promise and that a draft is an order. Also tell students that this is the first of
three
different uses of the word "order" in negotiable instrument law. Refer students to
the
handout on the three uses of the word order, which is reproduced at the end of
this
chapter of the teacher's
manual.
Examples: Problem Cases #3,n and
4.
Additional
Examples:
a. Pay to order of Joe, only if he sells me his bicycle.
Conditional.
b. Subject to contract #349.
Conditional.
c. Pursuant to contract #349.
Unconditional.
d. Pay out of pension account. Under original Article 3 it was considered
Conditional,
because it was not backed by the general credit of the issuer; however, under
Revised
Article 3 limiting payment to a particular fund or source does not make the
promise
or
order
conditional.
e. Debit pension account. Unconditional, because it merely requires an
accounting
entry.
f.. Problem Case #6.
Conditional.
2. Note that while conditional promises or orders to pay by the issuer destroy
negotiability,
such conditions in an indorsement do not destroy negotiability. Note that even if
the
condition has been met, the instrument is not negotiable; one has to look outside
the
instrument to see whether the condition has been
met.
G. Fixed Amount of
Money
1. Fixed Amount. Note that Revised Article 3 only requires that the principal payable be
set
forth in the instrument and, while permitting interest or other fixed charges to be
included
in the promise or order, they do may be calculated with reference to a formula or
index
identified in the instrument.
If
interest is payable, but the amount is not
ascertainable
from information in the instrument, then it is payable at the judgment rate. Thus,
Revised
Article 3 differs from original Article 3 that required a "sum certain" for an instrument
to
be negotiable. A sum was considered certain only if a person was able to calculate
from
the information on the note the amount required to pay it
off.
2. Payable in Money. Indicate that if a person obligated to pay can do something other
than
pay money, the instrument is not
negotiable.
H. Payable on Demand or at a Definite
Time
1. Explain what is meant by "demand" and "at sight." Special attention should be given
to
acceleration and extension clauses. Indicate that these clauses will not
destroy
negotiability if one can tell with certainty the latest possible date that the instrument is
due. Ask the students whether the following clauses will destroy
negotiability:
a. Payable June 1, 2013, but payable at any time if the maker defaults.
Negotiable.
b. Payable June 1, 2013, but payable later if the maker so desires.
Nonnegotiable.
c. Payable June 1, 2014, but payable June 1, 2013, if the maker has temporary cash
flow
problems.
Negotiable.
2. Note the change made by Revised Article 3 in the handling of postdated checks--i.e.
a
bank may properly pay them before the stated date unless the drawer used
the
notification procedure set out in the
DCC.
Example: Problem
Cases#
5 and
6.
I.
Payable to Order or to
Bearer
1. These are the words of negotiability that will distinguish a negotiable instrument from
an
ordinary contract to pay money. List on the chalkboard the various examples of
order
language and bearer language. This is the second use of the word "order" in
negotiable
instrument law. Refer again to the handout on the uses of the word order at the end
of
thi
s
chapter of the teacher's
manual.
2. Note the new rule introduced by Revised Article 3--i.e. that a check can be
negotiable
even if states only "pay to x" and that it does not have to be payable to order to be
negotiable.
Example: Problem
Case# 7.
3. Discuss the issue of whether certain checks where the payees names are separated by
the
virgule (I) are considered to be payable jointly or whether they are payable in
the
alternative with some courts concluding that they should be considered to be payable
in
the
alternative.
Pelican National Bank v. Provident Bank of Maryland (page 871): Where three
payees
on an insurance reimbursement check were listed on the check in stacked formation
on
the face of the check without any grammatical connector or punctuation, the court
held
that the check was ambiguous as to whether it was payable jointly or in the
alternative
and, accordingly, under DCC section
3-llO(d)
was considered to be payable in
the
alternative.
Points for Discussion: Ask the students whether in this situation the result reflects
the
intent of the drawer (and the expectations of the other payees)? Because it is payable
to
the three parties with an interest in the property, the result probably does not reflect
the
expectation of any of those parties.
If
so, what should the drawer do to avoid this
result
in the
future?
J. No Other Promise or
Obligation
1. Indicate that the negotiable instrument is a naked promise or order to pay money.
It may
not be burdened with other obligations. Do the following clauses destroy
negotiability?
a. Maker promises to maintain collateral pursuant to security agreement.
Negotiable.
b. I promise to pay $500 to the order of John and to sell him my dog.
Nonnegotiable.
c. Cashing this check acknowledges full satisfaction of any claim against
me.
Negotiable. (Note that this clause may or may not be enforceable,
however.
)
In Re Sia (873). The court found that the various provisions cited by the Maker
as
rendering the note non-negotiable were not in-fact provisions that altered any of
the
critical terms of the note or that imposed any additional obligation, promise
or
condition on the maker, but rather provisions that described the lender's rights
and
obligations and had no effect on the
maker.
K. Ambiguous
Terms
1. Briefly explain the rules regarding construction of negotiable instruments with
unclear
terms.
L.
Summary
Remind the students that all the elements must be met for an instrument to be negotiable.
If
one of the elements is not met, the instrument will not be negotiable, but it may
nevertheless
be an enforceable
contract.
N.
RECOMMENDED
REFERENCES:
A. James Brook, Payment
Systems:
Examples
and
Explanations, Aspen Law & Business,
2009.
B. Uniform Commercial Code Reporting Service, Chicago, Callaghan & Co. A complete
Code
service, including the Code and variations made by adopting states. This service
publishes
many of the Code cases, which are easily accessed through the service's indexing
system.
C. James J. White &
RobertS.
Summers, Handbook
of
the
Law
Under
the
Uniform
Commercial
Code, West Publishing Co. The standard handbook for the Code, this book presents
the
history
of the law concerning commercial transactions, explains why the law is what it is,
and
studies ambiguities in the
Code.
D. John Daniel, The
Elements
of
the
Law
of Negotiable
Instruments
(2010).
V.
ILLUSTRA
TNE
CHART:
Examples
and
Explanations
of
the
Three
Uses
of
the
Word
"Order"
in
Negotiable
Instrument
Law
Suppose an instrument on its face
says
Pay to the order of
John
1 2
3
We can categorize the three sections of this statement and illustrate the three interpretations of
the
word
"order."
The
Words
Appearing
on
the
Instrument The
Interpretation
of
the
Words
1. Pay An order or command to the drawee by the drawer telling
the
drawee to pay someone. The word "pay" is the order or
command.
Its use makes the instrument a draft (or check) rather than a note.
2. the order Language of negotiability, making the contract a
negotiable
instrument. This is order language.
(Remember:
there may
be
bearer language also that makes the instrument negotiable. If
there
is no order or bearer language, then the contract is not a
negotiable
instrument.
)
3. John Requires that the person (John) indorse the note to negotiate it
(
i.e.,
to make his transferee a holder). This makes the instrument
an
order instrument, because it is payable to a specific
person.
Contrast an order instrument with a bearer
instrument,
which
may
be negotiated by delivery of possession
alone.
Suppose an instrument says on its face
I promise to pay to the
order of
bearer
2
Here only the second usage of "order" exists. This is a note (a promise to pay, not an order
to
pay).
It
has order language (the order of).
It
is a bearer instrument
(
bearer
).
Suppose a check is indorsed on its back
Pay to
Joe
3
Here the third use of "order" appears.
It
is an order instrument because of the special
indorsement
(Pay to Joe). If we looked at the face of the instrument, we would see the first
use of the word "order," because a check is an order to the drawee to pay another person.
Also, the check may have order or bearer language on its face making it a negotiable
instrument. The indorsement has
nothing
to do with whether the check has order or bearer
language,
the language of negotiability.
31-7
©
2013 by McGraw-Hill Education.
This is
proprietary material solely
for
authorized instructor
use.
Not authorized
for
sale
or
distribution
in
any
manner. This document may
not
be copied, scanned, duplicated, forwarded, distributed,
or
posted
on a
website,
in
whole
or
part.
