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1
whole or in part.
The Function and Creation
of Negotiable Instruments
negotiable instrument has two functions—as a substitute for money and as a credit device. To fulfill these functions,
an instrument must be easily transferable and collectible. This chapter examines the essential features of various
instruments that qualify as negotiable and the roles and responsibilities of the parties who create these instruments.
Also, this chapter discusses the requirements for a negotiable instrument, and some of the omissions and terms that
do not affect an instrument’s negotiability.
A. DRAFTS AND CHECKS (ORDERS TO PAY)
A draft (bill of exchange) is an unconditional written order.
2 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
2. Trade Acceptances
A trade acceptance is a draft often used in sales of goods. The seller is both the drawer and the
payee, and the draft orders the buyer to pay a specified sum of money to the seller, usually at a
stated time in the future.
Does having a digital wallet in an iPhone, Android-based phone, or other smartphone entail more
or fewer security risks than carrying a physical wallet with cash and credit cards? Explain. Obviously
consumers worry about losing their smartphones and potentially having their eWallet “cleaned out.” Actually,
losing a smartphone might be better than losing an actual wallet or having it stolen. All smartphones and their
B. PROMISSORY NOTES (PROMISES TO PAY)
A promissory note (or simply note) is a written promise between two parties. Notes are used in a number
of credit transactions and often bear the name of the transaction involved.
Miracle Faith World Outreach, Inc., borrowed $1,962,000 to buy buildings and land, and signed a note
payable to Silicon Valley Bank. With more than $1,600,000 owing on the principal and almost $60,000 owing
on unpaid interest, Miracle Faith defaulted. Silicon Valley filed an action in a Connecticut state court to
foreclose. Eugene Wong, an associate at the bank, provided the court with only a copy of the note because,
as he explained, he was unable to locate the original. On appeal from a judgment in the bank’s favor, Miracle
whole or in part.
does not alter the rights of the owner. The bank showed that the note was lost and that the copy it produced
Who is the maker of the promissory note at the center of this case? A promissory note is a promise
made by one person (the maker of the promise) to another (the payee). In this case, the note is payable to
Silicon Valley Bank. Thus, Silicon Valley is the payee, and Miracle Faith World Outreach (the party who
signed the note and owes the money on it) is the maker.
found there, would that mean that the note had been “transferred” to the facility, making the storage
company the holder of the instrument? Explain. No. Moving notes and other negotiable instruments to a
third-party storage facility is not a “transfer” for negotiability purposes. Thus, storing an instrument with a third-
party does not make the storage company the “holder” of the instrument except, of course, in the literal,
physical sense of the word.
If a note is the best primary evidence of the existence of a debt, what might be the best evidence
of the amount of the debt and the interest calculation? The lender’s records of the debt are the best
evidence of the amount of the debt and the interest calculation. And there should be a witness who is familiar
with the records not only as a user but also as someone with a working acquaintance of the methods by
which the records are made to testify about them. For example, if a record of the debt is kept on the lender’s
on the maker’s obligation to pay.
2. Used as a Credit Device
Notes are used in a number of credit transactions and often bear the name of the transaction.
BASIC TYPES OF NEGOTIABLE INSTRUMENTS
PARTIES
ORDERS TO PAY
Draft
makes the order to pay.
Check
A draft drawn on a bank and pay-
drawn or payable at or through a
bank that requires, as a condition
to payment, a countersignature
by a person whose signature
appears on the instrument.
is ordered.
PROMISES TO PAY
Promissory note
pay.
Payee—the person to whom the
promise is made.
a. Under the UCC, “banks” include savings banks, savings and loan associations, credit unions, and trust companies.
b. A holder is the person who, by the terms of a negotiable instrument, is legally entitled to payment on it.
whole or in part.
THE
NEGOTIABILITY OF CHECKS IN OTHER NATIONS
WHERE CHECKS ARE RARELY USED
In some European nations, such as Austria, Germany, and the Netherlands, checks are now rarely used.
Direct bank transfers and electronic payments have replaced checks in these countries. The European Union
In the United Kingdom (U.K.), where checks have been used even longer than here, checks are rapidly
becoming a thing of the past. Since 2001, businesses’ electronic payments outnumber their payments by
check. In 2006, ASDA, the second largest British supermarket chain and a subsidiary of Wal-Mart, announced
that it will not accept checks as a means of payment in the future (beginning in the London area). Similarly,
Even in those nations where checks are still used, however, they are not actually negotiable. In France,
for example, although a segment of the population still uses checks, the payee named on a check cannot
endorse the check to a third party. Moreover, the payee on the check cannot walk into any bank in France
and cash the check as a payee can in the United States—in France, a check can only be deposited in into an
account at the bank. More and More shops in France no longer accept check payments at all.
II. Requirements for Negotiability
For an instrument to be negotiable, it must (1) be in writing, (2) be signed by the maker or the drawer, (3) be
an unconditional promise or order to pay, (4) state a fixed amount of money, (5) be payable on demand or at
a definite time, and (6) be payable to order or to bearer, unless it is a check.
6 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
Negotiable instruments must be in written form [UCC 3–103(a)(6)].
• The writing must be on material that lends itself to permanence.
• The writing must have portability.
whole or in part.
ENHANCING YOUR LECTURE—
WHAT IS A NEGOTIABLE INSTRUMENT?
bank’s name and address and “Pay to the order of.” The UCC, however, says nothing to indicate that
negotiable instruments must be typed or printed or placed on any specific kind of material. The UCC
stipulates only that a negotiable instrument must be in writing, the writing must lend itself to permanence, and
the writing must be freely transferable (movable).
B. SIGNATURES
For an instrument to be negotiable, it must be signed by the maker if it is a note or by the drawer if it is a
draft [UCC 3–103(a)(3)].
Jane Doe, promise to pay to the order of John Doe” can constitute Jane’s signature.
C. UNCONDITIONAL PROMISE OR ORDER TO PAY
1. Promises
8 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
agreement or to the security for the instrument does not affect negotiability. An instrument is ne-
gotiable even if its payment is to be made only out of a particular fund [UCC 3–106(b)(ii)].
D. A FIXED AMOUNT OF MONEY
To be negotiable, an instrument must state with certainty a fixed amount of money to be paid when the
interest rate notes are negotiable.
ADDITIONAL BACKGROUND—
practices had changed much since Article 3 was originally drafted in the 1940s, however, and other courts
concluded that such a note is negotiable if its interest rate is readily obtainable from a published source.
Because the conflicting case law was making uncertain what to businesspersons was otherwise certain, state
legislatures were being urged to change the law. Even before the revised Article 3 was presented to the
states, some states (notably New York) had changed their version of the UCC to render variable rate notes
E. PAYABLE ON DEMAND OR AT A DEFINITE TIME
1. Payable on Demand
Instruments payable on demand include those that contain the words “payable at sight” or “payable
whole or in part.
An instrument is payable at a definite time if it states that it is payable (1) on a specified date, (2)
within a definite period of time after sight or acceptance, or (3) on a date or time readily as-
National City Bank lent money to Reger Development, LLC to fund potential development opportunities in
Illinois. The loan took the form of a line of credit, which was structured as a promissory note, under an
agreement that required Reger to “pay this loan in full immediately upon Lender’s demand.” When the bank
asked Reger to pay down some of the loan, however, the borrower—who was not in default—filed a suit in an
“fundamentally inconsistent with the nature of a demand instrument.” But “the mere use of the terms ‘due
date’ or ‘default’ “ do not change the nature of the arrangement. “The language merely reinforces National
City’s right to collect scheduled monthly payments and does not deviate from the structure of a demand note.”
..................................................................................................................................................
statute of limitations.
ANSWERS TO LEGAL REASONING
payment is demanded), a promissory note, such as in this case, would not be an unconditional promise to
pay—and thus would not qualify as a negotiable instrument. Allowing good faith to apply to such transactions
would be contrary to the fundamental function of negotiable instruments, which is to be easily transferable
without danger of being uncollectible.
2. If National City had demanded “payment of the line” instead of just indicating that there was a
