Chapter 27
KINDS OF INSTRUMENTS, PARTIES, AND NEGOTIABILITY
RESTATEMENT
A negotiable instrument is a transferable written, signed promise or order to pay a specified sum of money. The two
kinds of instruments are notes and drafts.
A draft is an order to pay and the parties to a draft are the drawer (gives the order to pay), drawee (pays the
instrument) and payee (instrument is payable to them). A note is a two part instrument with a maker (debtor) and a
payee. A check is a draft drawn on a bank or credit union and payable on demand. A certificate of deposit is a
promise to pay drawn on a bank.
Other parties to instruments include acceptors, indorsers, bearers, holders, accommodation parties, and guarantors.
These parties have various levels of liability.
An instrument is negotiable if it is in writing and signed by the maker or drawer and it contains an unconditional
promise or order to pay a sum certain in money on demand or at a definite time. Factors that do not affect
negotiability include references to collateral or ambiguous language.
STUDENT LEARNING OUTCOMES
LO.1: Explain the importance and function of negotiable instruments.
LO.2: Name the parties to negotiable instruments.
LO.3: Describe the concept of negotiability and distinguish it from assignability.
LO.4: List the requirements for a negotiable instrument.
INSTRUCTOR’S INSIGHTS:
Break the chapter down into two components – related Learning Outcomes are indicated in ( ):
1. What are the types of instruments and parties?
Define negotiable instrument (LO.1)
2. What is a negotiable instrument?
Define negotiability (LO.3)
List the requirements for a negotiable instrument (LO.4)
CHAPTER OUTLINE
I. What are the Types of Instruments and Parties?
A. Definition – a transferable, written, signed promise or order to pay a specified sum of money
Before reading Chapter 27, the students may believe that the chapters concerning negotiable instruments
will explain how to open a checking account at a bank, how to write a check, how to reconcile a checkbook,
how a promissory note works, etc. Because most of them already have a checking account and/or have
signed a promissory note, the general attitude may be: “What else is there to know?” Introduce the material
by asking them to solve the following problem:
Arizona Auto Auction writes a check for $1,800 payable to Central Motors Company. Central Motors
deposits this check in its bank, Valley National Bank. Arizona Auto Auction discovers fraud by
Central Motors, goes to its bank, First National Bank of Arizona, and stops payment on the check to
prevent Central Motors from getting the money. When the check arrives at First National, the bank
honors the stop payment order and returns the check to Valley National. Unfortunately for Valley
Have your students respond by a show of hands as to who wins the lawsuit. Most of the students will raise
their hands for Arizona Auto Auction. When you announce that Valley National wins, most students will look
at you in disbelief. This is a good opportunity to emphasize that there are a lot of interesting rules involving
B. Kinds of instruments
1. Promissory notes – promise by one party to pay a sum certain to the holder (See Figure 27-1 in text)
2. Certificates of deposit – note with bank as maker
3. Drafts – order by one person on a second person to pay a sum certain (See Figure 27-2)
4. Checks – draft payable on demand and drawn on a credit union or bank
DISCUSSION POINTS: E-Commerce & Cyberlaw
The Check Is in the Internet
Discuss with students that banks can now use electronic images of checks as full and complete legal records.
C. Parties to instruments
Because terminology is critical in this chapter, make certain to go over each of the terms listed in Section 3.
Additional explanation will probably be necessary for the accommodation party and the guarantor. Give the
students examples of a person becoming an accommodation party and a guarantor. Also, follow up with a
discussion of the liability of these parties, as students find Sections 4(a) and 4(b) of this chapter confusing.
1. Maker – writes or creates note
2. Drawer – writes or creates draft or check
II. What is a Negotiable Instrument?
A. Definition of negotiability
B. Requirements of negotiability
1. In writing
2. Signed by the maker or drawer
a. Any symbol placed with intent to authenticate
b. Agent who signs – must disclose principal and representative capacity
c. Nondisclosure of agency or principal – with regard to this section, emphasize the importance of a
proper signature on the check and promissory note. Note the problems of the corporate officers in
d. An agent is not liable on a principal’s check, even if no capacity is shown
CASE BRIEF: Williams v. Houston Plants & Garden World, Inc.
508 B.R. 19 (S.D. Tex. 2014)
FACTS: Green Valley Growers, Inc. (GVG) was a plant nursery owned by O. Wayne Massey and others.
From 2001 until the GVG’s bankruptcy, KC Crushed provided GVG raw materials and construction
services, including the creation of ditches and irrigation ponds, building of rock roads, beds and
loading docks, as well as the work on some of the greenhouses located on the property operated
by GVG. GVG took out a loan and paid $396,527.10 of the proceeds to KC Crushed. On February
27, 2007, Massey and Hurley Ray Smith (owner of KC Crushed) executed a Promissory Note that
stated: “I, Wayne Massey, promise to repay Ray Smith for a Promissory Note in the amount of
$400,000.00 with Interest.”
Smith and Massey (defendants) contend that the Note “incorrectly listed Smith as the lender and
Wayne Massey as the borrower.” Smith stated that the Note was, in fact, between KC Crushed and
GVG, not himself and Massey, “I did not draft or prepare the Promissory Note. I did not review the
Promissory Note. When the Promissory Note was presented to me, I did not read it and simply
signed the note as written … I was signing on behalf of KC Crushed Concrete, not myself
individually. Wayne Massey and I agreed that [GVG] would repay KC Crushed Concrete with
periodic $5,000 loan repayments, as initial interest only payments.” From April 2007 until
December 2008, GVG paid Smith − not KC Crushed − $80,000 towards the Note, in $5,000
monthly installments.
Smith and KC Crushed moved for summary judgment that they are not liable to Randy Williams –
the bankruptcy trustee for the GVG bankruptcy.
ISSUE: Was the note, with mistakes in the parties’ roles, enforceable?
REASONING: The Note plainly stated that Massey was the borrower and Smith was the lender. But GVG wrote
the $5,000 monthly checks to Smith, not to KC Crushed. Smith’s argument that he did not read the
Note before he signed is unavailing. Parties are presumed to know the contents of a document and
have an obligation to protect themselves by reading documents prior to signing.
The parties’ subjective beliefs cannot contradict the intent of the parties expressed within the four
corners of the document. The rights and obligations of the parties to are determined solely from the
written loan agreement, and any prior oral agreements between the parties are superseded by and
merged into the loan agreement. The Note stated that the $400,000 debt ran from Massey to
Smith, not from GVG to KC Crushed. The payments were not relevant because the document was
clear. The payments could have been made for another purpose such as a capital contribution.
3. Promise or order to pay
4. Unconditional promise or order
a. There are no conditions on the face of the instrument
b. With regard to this section, advise the students that provisions in the instrument that use words
c. Source of payment – does not defeat negotiability where it is a government account or simply a
reference
5. Payment in money
DISCUSSION POINTS: Thinking Things Through
When Your John Hancock is Enough
The court held that Mr. Schaffer was not personally liable on the note. In fact, when the business defaulted on the
note, the bank took the funds from Mr. and Mrs. Schaffer’s account and the bank was held liable for conversion.
The UCC comment specifies: Subsection c…states that if the check identifies the represented person the agent who
signs on the signature line does not have to indicate agency status. Virtually all checks used today are in
personalized form[s] which identify the person on whose account the check is drawn. In this case, nobody is deceived
into thinking that the person signing the check is meant to be liable.
6. Sum certain
a. Attorneys’ fees do not affect negotiability
7. Payable on demand or a definite time
b. Definite time
CASE BRIEF: Smith v. Vaughn
882 N.E. 2d 941, 64 UCC Rep. Serv. 2d 757 (Ohio App. 2007)
FACTS: Gary Vaughn signed a document stating that Fred and Martha Smith were loaning him $9,900. As
to when the loan was to be repaid, the document stated, “when you can.” Approximately 18 months
later, the Smiths sued Vaughn for the entire amount, claiming default on the note as well as unjust
enrichment. The Smiths moved for summary judgment. They contended that Vaughn was
immediately liable for the entire amount, but that they were willing to work out a repayment
schedule. Vaughn also moved for summary judgment, arguing that he did not have to repay the
Smiths because he did not have the ability to do so.
The trial court denied the Smiths’ motion and granted Vaughn’s. The Smiths appealed.
ISSUE: Did the phrase “when you can” allow the instrument to be negotiable?
REASONING: “When you can” was not payable at a definite time and the court could not interpret the language to
mean that it was payable on demand because the use of the language implied that there was an
open-end agreement. The parties might have a contract, but the Smiths could not demand
payment as if the instrument were a demand negotiable instrument. Reversed.
DISCUSSION POINTS: Have the students discuss the meaning of definite time in negotiable instruments using the
Smith v. Vaughn case.
d. Effect of date on demand paper
DISCUSSION POINTS: Ethics & the Law
Medicaid Eligibility and Article 3 Negotiability
Discuss with the students the fact that there was a valid contract – the purchase agreement, but that purchase
agreement did not qualify as an asset for purposes of Medicaid eligibility – that is, it did not count. And the purchase
agreement had not yet been translated into a note and so you did not have a negotiable instrument that Doris could
easily sell and transfer in order to obtain cash. She had the present value of a purchase agreement, but its payment
was contingent on many future events. There was not yet a time for definitive payments, so the note would not be
negotiable and there was no signature on a note. The purchase agreement would be enforceable but tough to
translate into cash or proceeds.
However, the ethical issue is whether she will have cash coming in that could be used to pay some of the bill. She will
at some point, but the legal guidelines do not count non-negotiable instruments as assets because they are not easily
translated into cash. She gets the benefits even though she does have assets.
8. Order or bearer/words of negotiability
a. If it is not a check, it must be payable to order or bearer – with regard to the elements of a
negotiable instrument, students usually have problems distinguishing between order paper and
CASE BRIEF: Whitaker v. Limeco Corp.
32 So. 3d 429 (Miss. 2010)
FACTS: William Kidd served as managing director of Limeco Corporation. Beginning in 2001, negotiations
began between Kidd/Limeco (defendants) and R.W. Whitaker and Monty Fletcher (plaintiffs),the in
connection with what later became a failed effort to purchase a hockey team in Tupelo. Whitaker
and Fletcher loaned Limeco $750,000. Whitaker and Fletcher claim that Kidd concealed the fact
that Limeco had no assets. Whitaker also loaned Kidd an additional $100,000, with the
understanding that Kidd and Limeco would be responsible for paying back the loan Whitaker had
taken out from the Peoples Bank & Trust Company in Tupelo in order to make the loan to Kidd.
On July 1, 2002, the parties entered into what they referred to as promissory notes (referred to as
the “Fletcher note” and the “Whitaker note”) to memorialize the terms of the loan agreements they
had made in early 2002. Both Fletcher and Whitaker, in an effort to secure what they thought were
promissory notes, were granted a continuing lien on Limeco’s monies, securities, and/or other
property for the entire amount of the promissory notes (each in the amount of $375,000).
On December 11, 2003, Whitaker and Fletcher filed separate complaints against Limeco and Kidd
for recovery of the more than $850,000 that had never been repaid.
The trial court found that, because the suit was brought after the contracts statute of limitations had
expired that it had to be dismissed. Whitaker and Fletcher argued that the notes were negotiable
instruments and their fraud claim was valid because of the six-year statute of limitations that
applied with regard to negotiable instruments.
ISSUE: Were the notes contracts and subject to the three-year statute of limitations? Or were the notes
negotiable and subject to a six-year statute of limitations, which would allow the case to proceed?
HOLDING AND
REASONING: The court held that words of negotiability are an absolute requirement for a negotiable instrument.
Without those words, the note is simply a contract. And a suit on a contract required that it be filed
b. Order paper – directed at a person
c. Bearer paper (See Figure 27-3)
i. It’s payable to bearer or the order of bearer
ii. It’s payable to a specified person or bearer
CASE BRIEF: New Mexico v. Herrera
18 P. 3d 326 (N.M. App. 2001); cert. den. 20 P. 3d 810 (N.M. 2001)
FACTS: Joshua Herrera (defendant) found a purse in a dumpster near San Pedro and Kathryn Streets in
Albuquerque. Herrera took the purse with him to a friend’s house. Either Herrera or his friend called
the owner of the purse and the owner retrieved the purse at some point. After the purse was
returned to the owner, he returned to the dumpster where he found a check and some other items.
The check Herrera found was written out to “Cash” and that he thought this meant that he “could
get money for [the] check.”
When he presented the check to the teller at a credit union to cash it, the teller instructed him to put
his name on the payee line next to “Cash.” Herrera added “to Joshua Herrera” next to the word
“Cash” on the payee line of the check and indorsed the check.
Herrera had pleaded guilty to one count of forgery in violation of NMSA 1978, § 30-16-10 (1963)
but moved to have the indictment dismissed on the grounds that adding his name to a bearer
instrument was not forgery. The district court ruled that “Defendant altered a writing purporting to
[have] legal efficacy with intent to [defraud], [and] those acts constitute a crime of forgery.” He
appealed the denial of the motion to dismiss the indictment.
ISSUE: What was the legal effect of Herrera adding his name to an instrument and cashing it? Was it the
crime of forgery to cash a bearer instrument?
REASONING: The court held that the instrument that Herrera originally found was bearer paper. By adding his
named “to Joshua Herrera” to the “Pay to” line after “Cash” did not change the character of the
instrument from bearer to order paper. At best, the addition of the words created an ambiguity and
under the code interpretations should continue to be treated as bearer paper. Since he did not alter
the nature of the instrument or convert it to a different instrument, he could not be charged with
forgery.
DISCUSSION POINTS: Have the students discuss bearer paper using the New Mexico v. Herrera case.
C. Factors not affecting negotiability
1. No date – date can be filled in – need due date for negotiability
D. Ambiguous language
1. Words control figures
2. Handwriting over typed or printed
E. Statute of limitations – 1990 code provides for 3 years
ANSWERS TO QUESTIONS AND CASE PROBLEMS
1. Requirements of negotiability. The instrument contains no unconditional promise or order to pay a sum certain in
money, it is not payable at a definite time or on demand, and it is not payable to order or bearer. The credit
2. Negotiability; unconditional promise to pay. The court held that there was no payment schedule or time for
repayment, but that what that means is that the note is payable on demand and the demand for payment could
3. Requirements of negotiability. No. The bank is not a holder in due course. The mortgagor’s promissory note
incorporated the terms of the mortgage into the note, thereby making the note nonnegotiable. Payment of the
4. Negotiability; sum certain. Mr. Earthman’s note did not satisfy the “sum certain” requirement in Tenn.Code Ann.
§§ 47-3-104(1)(b), -106 when it was signed because its interest rate could not be computed “from the instrument
This interest rate provision makes little sense on its face and certainly does not permit the calculation of interest
The 1981 changes in the substance of Tenn.Code Ann. §§ 47-3- 104(1)(b), -106(1) do not apply to Mr.
Earthman’s note. However, even if they did, they would not render the note negotiable. As amended, Tenn.Code
Ann. § 47-3-104(1)(b)(ii) and Tenn.Code Ann. § 47-3-106(1)(f) permitted negotiable instruments to contain
Be sure to discuss the rule on changing interest rates and negotiability in your state.
5. Holder in due course; defenses and negotiability. Yes. A holder in due course takes a negotiable instrument free
Note that under § 3-104(b) an “instrument” is meant to mean a negotiable instrument throughout Article 3.
Univentures was decided under pre-revision Article 3. The Article 3 sections cited in this case have the following
current equivalents:
Old Article 3 Current Article 3
§ 3-302(1) § 3-302(a)
§ 3-306 (as cited) generally § 3-306, but also § 3-305
[National Bank v. Univentures, 824 P. 2d 1377 (Alaska)]
6. Payable to order or to bearer. Under the 1990 UCC, money orders are treated as checks; therefore, they are
negotiable. Under states not adopting the 1990 UCC, money orders would not be negotiable because they were
7. Personal liability of person signing in a representative capacity. From the court’s opinion: “We affirm the trial
court’s grant of summary judgment to plaintiff. Even though the stationary [sic] on which the note was typed
showed defendant served as president of the corporation, the note itself was signed in an individual and not a
representative capacity. Thus, contrary to defendant’s argument, this case is squarely governed by the holding in
Southern Oxygen Supply Co. v. de Golian, 230 Ga. 405, 197 S.E. 2d 374 (1973). In Southern Oxygen, the
The note in this case named the company which defendant represented but did not show he signed the note in a
representative capacity and, thus, the trial court did not err in finding the defendant personally liable for the note.
In an odd decision, the court held the officers personally liable because the promissory note unambiguously
created personal liability of signors, and parol evidence was not admissible to establish the intent of the parties
regarding liability, despite signors’ signing “as its President” and “as its Secretary,” in light of statutory
8. Signatures and personal liability. Only the facsimile copy of the note was presented at trial, and the court below
found that the writing on the Post-It, coupled with the signature, identified Northwest as the principal on the note.
The court held that Eoll was personally liable on the note. The Post-It note was separate from the document and
anything that Eoll and Major wanted to be part of the promissory note should have been written on the
9. Signature; representative capacity. The court held that Sleater did not take on the role of guarantor and thereby
assume personal liability. The court held that there was no ambiguity and that the note maker was referred to as
Mr. Sleater and that there could be no parol evidence. Further, the court noted that when someone fails to clarify
10. Negotiability. The note is not negotiable for two reasons. First, there are no words of negotiability because the
11. Time of payment. No. The instrument does not have a definite date for payment. Further, payment from the
estate may create some problems.
12. Type of instrument and negotiability. The instrument is a promissory note. The reference to the purchase of
stock shares does not affect negotiability. There is a sum certain and the note is payable at a definite date.
13. Definite time of payment. Decision for Master Homecraft. UCC § 3-108 provides that “instruments payable on
14. Negotiability. Not payable at a definite time; not negotiable. [Barclays Bank, P.L.C. v. Johnson, 499 S.E. 2d 769
(N.C. App.)]
15. Negotiability. No, the note is not a negotiable note. Although a promise to pay could be legally implied from such
acknowledgement, Revised § 3-103(a)(9) indicates that for a document to be a “promise,” and thus a “negotiable
management system for classroom use.