1
Chapter 25
Negotiable Instruments
INTRODUCTION
Because the holder of a negotiable instrument may enjoy greater rights than the holder of a nonnegotiable
instrument, it is important for your students to understand the distinctions between these types of instruments. A
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
CHAPTER OUTLINE
I. Types of Negotiable Instruments
A. DRAFTS AND CHECKS (ORDERS TO PAY)
A draft (bill of exchange) is an unconditional written order.
2 UNIT FIVE: NEGOTIABLE INSTRUMENTS
1. Time Drafts and Sight Drafts
2. Trade Acceptances
A trade acceptance is a draft often used in sales of goods. The seller is both the drawer and the
3. Checks
A check is a draft, drawn on a bank and payable on demand.
B. PROMISSORY NOTES (PROMISES TO PAY)
A promissory note (or simply note) is a written promise between two parties. Notes are used in a num–
ber of credit transactions and often bear the name of the transaction involved.
CASE SYNOPSIS—
Case 25.1: Silicon Valley Bank v. Miracle Faith World Outreach, Inc.
Miracle Faith World Outreach 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.
……………………….………………………..………………………..…………………………….……………………..
Notes and Questions
Who is the maker of the promissory note at the center of this case? A promissory note is a promise
1. Commonly Assigned
Promissory notes are commonly assigned from one lender or payee to another. This has no effect
on the maker’s obligation to pay.
CHAPTER 25: NEGOTIABLE INSTRUMENTS 3
2. Used as a Credit Device
C. CERTIFICATES OF DEPOSIT (PROMISES TO PAY)
A certificate of deposit (CD) is a type of note issued by a bank.
BASIC TYPES OF NEGOTIABLE INSTRUMENTS
INSTRUMENTS
CHARACTERISTICS
PARTIES
Orders to Pay
Draft
An order by one person to another
person or to bearer.
Drawer—the person who signs or
makes the order to pay.
Check
A draft drawn on a bank and pay-
able on demand.a Checks include:
Drawee—the person to whom the
order to pay is made.
Promises to Pay
Promissory note
A promise by one party to pay
money to another party or to bearer.
Maker—the person who promises to
pay.
Payee—the person to whom the
promise is made.
4 UNIT FIVE: NEGOTIABLE INSTRUMENTS
ENHANCING YOUR LECTURE—
THE NEGOTIABILITY OF CHECKS IN OTHER NATIONS
For many people in the United States, checks are the ultimate negotiable instrument. After all, our parents
and grandparents negotiated checks for decades. Checks have a long history of being accepted the “same as
cash” at most locations in the United States. In other countries, however, checks are used less frequently
and sometimes are not even negotiable.
WHERE CHECKS ARE RARELY USED
the abandonment of checks worldwide. In most European countries, the majority of recurring monthly bills
are paid automatically—an automatic payment from customers’ bank accounts directly to the billing
companies’ bank accounts. For example, few Europeans write checks for phone bills, electric and gas bills,
and mortgage payments.
In the United Kingdom (U.K.), where checks have been used even longer than here, checks are rapidly
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, the largest pharmacy chain in the United Kingdom (Boots) is also phasing out checks as a payment
customers who pay by check.
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
has a low-cost electronic payment system that is much faster and more efficient than the systems available in
the United States. This fact—as well as the increase in identity theft and financial crimes—has contributed to
CHECKS, WHEN USED, ARE OFTEN NONNEGOTIABLE
endorse the check to a third party. Moreover, the payee on the check cannot walk into any bank in France
account at the bank. More and More shops in France no longer accept check payments at all.
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
FOR CRITICAL ANALYSIS
What are the disadvantages of not being able to endorse checks to other parties?
CHAPTER 25: NEGOTIABLE INSTRUMENTS 5
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
A. WRITTEN FORM
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.
ENHANCING YOUR LECTURE—
WHAT IS A NEGOTIABLE INSTRUMENT?
the writing must be freely transferable (movable).
The UCC leaves a lot of room for imagination when it comes to negotiable instruments. Bearer in–
struments, for example, need not always be written to “cash” or to “bearer.” They can be written to “Merry
Christmas” or “Happy New Year” or just about any nonexistent or inanimate object. Even more extraordinary
THE BOTTOM LINE
As might be imagined, this lack of specificity has led to some extraordinary negotiable instruments.
Checks and notes have been written on napkins, menus, tablecloths, shirts, and a variety of other materials—
including a tractor fender, an eggshell, a watermelon, underwear, and a tamale.
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)].
1. Signature Requirements
Initials, an X, a thumbprint, a rubber stamp, and a trade name or an assumed name (even if false)
will suffice [UCC 1–201(39), 3–401(b)].
2. Placement of the Signature
6 UNIT FIVE: NEGOTIABLE INSTRUMENTS
C. UNCONDITIONAL PROMISE OR ORDER TO PAY
1. Promises
To be negotiable, an instrument must contain an express order or promise to pay [UCC 3–104(a)].
2. Orders
An order is associated with three-party instruments, such as checks, drafts, and trade acceptances,
3. Unconditionality of Promise or Order
Only unconditional promises or orders are negotiable [UCC 3–104(1)(b)]. Reference to another
CASE SYNOPSIS—
Case 25.2: OneWest Bank, FSB v. Nunez
to enforce the note because it was not a negotiable instrument—the note’s reference to the conditions in the
and dismissed the complaint. OneWest appealed.
To buy property in Hallandale, Florida, Jose and Jessica Nunez, and Felipa Delrio signed a note and
mortgage payable to America’s Wholesale Lender (Countrywide Home Loans, Inc.). The note contained an
acceleration clause and a reference to the mortgage, which “describes how and under what conditions”
A state intermediate appellate court reversed. Under the UCC “the mention of the mortgage instrument as
to the * * * rights of acceleration in the promissory note does not destroy the unconditional nature of the
note.”.
……………………….………………………..………………………..…………………………….……………………..
Notes and Questions
might emphasize that the documents all refer to each other—the contract, the note, the payment schedule,
and the security agreement. The party might point out that the contract and the note were signed at the same
time and in conjunction with each other. And most likely, a holder attempting to enforce payment would attach
In circumstances like those in the OneWest case, could a maker successfully argue that a note is
conditional, and thus not negotiable, because it is not separate from its underlying contract but
CHAPTER 25: NEGOTIABLE INSTRUMENTS 7
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
instrument is payable [UCC 3–104(a)].
1. Fixed Amount
To be fixed, an amount must be ascertainable from the face of an instrument. The amount of
interest or its rate may be determined with reference to information not contained in the instrument
ADDITIONAL BACKGROUND—
Variable Rate Notes
Adjustable interest rate notes—with, for example, the interest rate tied to the rate of interest on U.S.
Treasury securities—have been in routine use since 1980. Before the revisions to Article 3, however, if such
notes came before courts for determinations regarding their negotiability, there was no certainty as to how a
2. Payable in Money
Money is “a medium of exchange authorized or adopted by a domestic or foreign government as a
part of its currency” [UCC 1–201(24)].
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
104(f)].
2. Payable at a Definite Time
An instrument is payable at a definite time if it states that it is payable (1) on a specified date, (2)
3. Acceleration Clause
Instruments that include acceleration clauses are negotiable.
8 UNIT FIVE: NEGOTIABLE INSTRUMENTS
4. Extension Clause
Instruments that include extension clauses are negotiable when the right to extend is given to the
CHAPTER 25: NEGOTIABLE INSTRUMENTS 9
F. PAYABLE TO ORDER OR TO BEARER
1. Order Instruments
An order instrument is payable (1) “to the order of an identified person” or (2) “to an identified per–
2. Bearer Instruments
A bearer instrument does not designate a specific payee [UCC 3–109(a)]. A bearer is a person in
possession of an instrument that is payable to bearer or indorsed in blank [UCC 1–201(5); 3–
109(a), (c)].
Any instrument containing the following terms is a bearer instrument—
• “Payable to the order of bearer;”
ADDITIONAL BACKGROUND—
When the Name of the Payee Is Left Blank
In a case decided in 1920, the Kentucky Court of Appeals (Kentucky’s highest state court until 1976)
stated that “the rule is well settled that the name of the payee may be left blank, which makes the instrument
payable in effect to the bearer” [Finley v. Rose, 189 Ky. 359, 224 S.W. 1059 (1920)]. Under the UCC, which
Kentucky adopted in 1958, this rule was superseded. Comment 2 to UCC 3–111 explains that the drafters of
the UCC reworded parts of Section 9 of the Uniform Negotiable Instruments Law in drafting UCC 3–111 “to
remove any possible implication that ‘Pay to the order of _____’ makes the instrument payable to bearer. It
is an incomplete order instrument, and falls under Section 3–115.”
note had been written on a preprinted bank form, but the bank’s name was scratched out, as was the town.
Jessie, alleging that he was the holder of a bearer instrument. Jessie refused to pay, claiming that Darrell
had no ownership rights in the note. She also claimed that the note could not be enforced because it had
judgment for Darrell. Jessie appealed.
10 UNIT FIVE: NEGOTIABLE INSTRUMENTS
tion which does not purport to designate a specific payee.” The court reasoned that the note was not a bearer
instrument under any of these definitions. The instrument was incomplete and could not be enforced until it
was completed. Because there was no indication that Aubrey had authorized anyone to complete the note,
the note was unenforceable [Davis v. Davis, 838 S.W.2d 415 (Ky.App. 1992)].
state a payee; or states that it is payable to or to the order of cash or otherwise indicates that it is not payable
Would the result in this case have been different if it had been decided under revised Article 3?
a. Can Be Payable to Nonexistent Person
An instrument that “indicates that it is not payable to an identified person” (“X” or “Captain
America”) is a bearer instrument [UCC 3–109(a)(3)].
b. Cannot Be Payable to Nonexistent Organization
An instrument issued to a nonexistent organization would not qualify as negotiable [UCC 3–
109, Comment 2].
III. Factors That Do Not Affect Negotiability
Factors not affecting negotiability include —
• The fact that an instrument is undated, unless the date of an instrument is necessary to determine a
definite time for payment [UCC 3–113(b)].
• Postdating or antedating an instrument [UCC 3–113(a)].
CASE SYNOPSIS—
Case 25.3: Charles R. Tips Family Trust v. PB Commercial, LLC
The Charles R. Tips Family Trust signed a promissory note in favor of Patriot Bank to buy a house. The
note identified the principal amount as “ONE MILLION SEVEN THOUSAND AND NO/100 ($1,700,000.00)
CHAPTER 25: NEGOTIABLE INSTRUMENTS 11
DOLLARS.” The trust made payments totaling only $595,586. PB Commercial, LLC acquired the note, sold
the residence for $874,125, and pursued litigation in a Texas state court against the borrower, alleging
default. The defendant argued that the written words in an instrument control and that the note had been
satisfied in full—“in fact, PBC has collected a surplus of $189,111.” The court entered a judgment in the
bank’s favor. The Trust appealed.
promissory note.”
……………………….………………………..………………………..…………………………….……………………..
Notes and Questions
needed (1) to determine the value of an instrument, (2) to know when secondary parties will be obligated for
statute of limitations.
Why is it necessary to know when payment on an instrument is required? Time of payment is
on good faith (either of the holder or of the party from whom payment is demanded), a promissory note, such
negotiable instruments, which is to be easily transferable without danger of being uncollectible.
The duty to act in good faith does not apply to lenders seeking payment on demand notes. Why is
this? By its very nature, a demand instrument allows the holder to demand payment at any time from the
appropriate party. Good faith plays no role in this transaction. If a holder’s right to payment was conditioned
ADDITIONAL CASES ADDRESSING THIS ISSUE—
Negotiable Instruments
Cases involving the negotiability of instruments include the following.
• In re Sabertooth, LLC, __ 443 Bankr. 671 (Bkrptcy. E.D. Pa. 2011) (promissory notes were not
“negotiable instruments” when they were subject to other rights and obligations that were stated in other loan
documents, making the notes conditional).
existence, notwithstanding that it was postdated to a date after the insured’s death).
any schedule or time for repayment—the note would be payable on demand).
12 UNIT FIVE: NEGOTIABLE INSTRUMENTS
TEACHING SUGGESTIONS
1. Because many students find it difficult to distinguish among the various forms of instruments, a small
packet of blank forms consisting of sample drafts, checks, notes, and certificates of deposit can be assembled
2. The drafters of the UCC do not create rules out of thin air, but attempt to codify existing business
Cyberlaw Link
What are the differences, and the benefits and the risks, of payment systems that are designed for
cyberspace? Which requirements of negotiability seem unnecessary for an online transaction?
DISCUSSION QUESTIONS
1. What is a certificate of deposit? A certificate of deposit (CD) is an acknowledgment by a bank of the receipt of
money with an engagement to repay it. Certificates of deposit in small denominations are often sold by savings and
2. What is a bearer? A bearer is any person who has physical possession of an instrument that either is payable
to anyone without specific designation or is indorsed in blank (an indorsement consisting of the indorser’s signature
CHAPTER 25: NEGOTIABLE INSTRUMENTS 13
3. What are the primary functions of negotiable instruments? A negotiable instrument has two functions—to
serve as a substitute for money and as a credit device. Debtors sometimes use currency, but for convenience and
4. What are the requirements for an instrument to be negotiable? For an instrument to be negotiable, it
5. What are some of the practical limitations concerning the writing evidencing a negotiable instrument and
the substance on which it is placed? The writing must be on material that lends itself to permanence. Paper
satisfies the necessary requirement that the writing be permanent although one could presumably use other materials
6. What sort of signature is required by the UCC to create a negotiable instrument? UCC 1–201(39) defines
the word “signed” as including “any symbol executed or adopted by a party with present intention to authenticate a
writing.” According to UCC 3–401(b), a “signature made be made (i) manually by means of a device or machine, and
7. Must a negotiable instrument contain a promise or order to pay? Yes. All negotiable instruments must con-
tain an express order or promise to pay. A mere acknowledgment of the debt, which might logically imply a promise,
8. When may reference to other agreements be made in a negotiable instrument without destroying its
negotiability? Mere reference to another agreement does not affect negotiability. If, on the other hand, the instru-
14 UNIT FIVE: NEGOTIABLE INSTRUMENTS
instrument states that it is dependent on the satisfaction of obligations contained in a separate agreement, however,
then it will not be negotiable.
9. What is an acceleration clause? An acceleration clause allows a payee or other holder of a time instrument to
demand payment of the entire amount due, with interest, if a certain event occurs, such as a default in payment of an
10. What is a bearer instrument? A bearer instrument is one that does not designate a specific payee. The maker
or a drawer of a bearer instrument agrees to pay anyone who presents the instrument for payment; such instruments
ACTIVITY AND RESEARCH ASSIGNMENTS
1. The use of a negotiable instrument as both a cash-substitute and a credit instrument is not a recent innovation.
Negotiable instruments in one form or another have been around since the Middle Ages when merchants, for reasons
2. Article 3 of the Uniform Commercial Code was revised in part in response to changing commercial realities and
EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT
Footnote 7: 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 Illinois state
court against the bank, alleging breach. The case was removed to a federal court, which dismissed the complaint on
the bank’s motion. Reger appealed
CHAPTER 25: NEGOTIABLE INSTRUMENTS 15
If National City had demanded “payment of the line” instead of just indicating that there was a possibility
it might do so in the future, would the outcome of this case be any different? Explain. The outcome of the
Why might a creditor such as National City Bank prefer a note that is payable on demand? A term that
makes a note payable on demand appears to increase its negotiability. A demand for payment of the note can be
Why might a debtor such as Reger Development agree to a note that includes a term making it payable
on demand? A debtor might agree to a note that includes a term making it payable on demand because the debtor
Footnote 8: Amine Nehme applied for credit at the Venetian Resort Hotel Casino in Las Vegas, Nevada, and
was granted $500,000 in credit. He soon accrued more than $1.2 million in gambling debts, which he paid. About a
year later, Nehme deposited $1,000 with the Venetian and signed a marker for $500,000. Nehme quickly lost that
amount gambling. The Venetian presented the marker for payment to Bank of America, Nehme’s bank, which
returned it for insufficient funds. The casino’s owner, Las Vegas Sands LLC, applied Nehme’s deposit against the
marker and filed a suit against him to recover the remainder—$499,000—plus interest, for failure to pay a negotiable
instrument. A federal district court issued a summary judgment in the Venetian’s favor. Nehme appealed
In Las Vegas Sands, LLC v. Nehme, the U.S. Court of Appeals for the Ninth Circuit agreed with the lower court
that the marker was a negotiable instrument. The marker fit the UCC’s definitions of negotiable instrument and check.
To obtain credit, Nehme filled out a credit application that stated the Venetian “endorses responsible
gaming. We will cancel or reduce your credit line upon your request.” Nehme’s attorney later wrote a letter to
the casino, asking that no further credit be extended to Nehme. In defense to the casino’s suit, Nehme
claimed that by later granting him credit for $500,000, the casino breached the terms of the credit application.
16 UNIT FIVE: NEGOTIABLE INSTRUMENTS
Suppose that the marker had stated “Payable to the order of the Venetian.” Could the casino have
What is the advantage to the Venetian of the holding that Nehme’s marker is a negotiable instrument? A
negotiable instrument is easily transferable without the danger of its being uncollectible. This is the fundamental