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before March 3, 20 ” are all acceptable. The holder must be able to determine from the face of the instrument thelatest possible time it can be paid without default.Even if the instrument is subject to an acceleration clause, as long as a specific date is otherwise named, theinstrument is still negotiable. An acceleration clause allows the obligee to declare the full amount due and payableupon the occurrence of a particular event, such as the failure to make a payment. An acceleration clause hastens thematurity date. An example is, “In case of default in payments of interest, or of an installment of the principal, theentire note shall become due and payable.” Example: John lends Robert 1,500. Robert makes a negotiable notepromising to pay 150 per month for 10 months. If the note contains a provision that if Robert fails to make a payment, the balance of the note is due at that time. If Robert fails to make the fourth payment, the balance of 1,050is due to John immediately.Payable to Order or BearerThe last requirement is the most straightforward: An order or bearer instrument must be “payable to the orderof the named payee(s),” “payable to the named payee’s order” or some equivalent wording. A bearer instrumentmust be written “pay to bearer,” “pay to cash,” “pay to the order of the bearer,” “pay to the order of the namedpayee(s) or bearer” or the like. Finally, if an instrument is made out to an obviously fictitious person, such as Superman, it is treated as a bearer instrument.CONCEPT SUMMARY:Eight Requirements for Negotiable Instruments1. Must be in writing. A writing can be on anything that is readily transferable.2. Must be signed by theinstrument. The signature can be any place on the instrument. It can be in any form (such as word, mark or stamp) that purports to be asignature and authenticates the writing. It can be signed in a representative capacity.3. Must be a definite order orpromise to pay. A promise must be more than a mere acknowledgement of a debt. The words “I/We Promise” or “Pay” meet this criterion.4. Must be unconditional. Payment cannot be expressly conditional upon the occurrence of an event. Payment cannot be made subject to or governed by another agreement. Payment cannot be paid out of a particular fund (except for a governmentissued instrument).5. M ust be an order or promiseto pay a sum certain. An instrument may state a sum certain even if payable in installments,with interest, at a stated discount or at an exchange rate. Inclusion of cost of collection and attorney’s feesdoes not disqualify the statement of a sum certain.6. Must be payable in money. Any medium of exchange recognized as the currency of a governmentis money. The maker or drawer cannot retain the option to pay the instrument inmoney or something else.16-4Principles of Business Credit

7. Must be payable on demandor at a definite time. Any instrument payable on sight, presentation or issue is a demandinstrument. An instrument is payable at a definite time even though it is payable on astated date, or within a fixed period after sight, or the drawer or makerhas an option to extend time for a definite period. Acceleration clauses, even if unenforceable, do not affect the negotiabilityof the instrument.8. Must be payable to orderor bearer. An order instrument must name the payee with reasonable certainty. An instrument whose terms intend payment to no particular person ispayable to bearer.Comprehension CheckKinds of Negotiable InstrumentsGive a brief explanation ofthe elements of a negotiableinstrument.To some extent, commercial law is a reflection of customs and usages of trade in the business world. The development of the law concerning commercial paper—checks, promissory notes and the like—grew from commercialnecessity. In 1896, the National Conference of Commissioners on Uniform Laws drafted the Uniform NegotiableInstruments Law. This law was reviewed by the states, and by 1920 all had adopted it. The Uniform NegotiableInstruments Law was the forerunner of Article 3 of the Uniform Commercial Code (UCC).There are four types of instruments specified in UCC 3-104, which serve as a substitute for money and as acredit device:1.2.3.4.Drafts.Checks.Notes.Certificates of deposit.Comprehension CheckList the basic types ofnegotiable instruments.DraftsA draft, also known as a bill of exchange, is an instrument that orders someone else to pay. The order is given bythe drawer, who issues the draft usually by signing it in the lower right-hand corner. The one who is ordered to paythe money is called the drawee. The one who is to receive the money is known as the payee.Drafts may be presented to the drawee for payment or for acceptance. When a draft is presented for acceptance, the drawee is asked to become liable on the instrument. To accept a draft, the drawee writes “accepted”across the face of the instrument, and dates and signs it. By doing this, the drawee agrees to pay the instrument ata later date when it becomes due. (See Figure 16-2.)Chapter 16 Negotiable Instruments16-5

Sight DraftFigure 16-2576.00 Anytown, USA, May 3, 20--At sightPay tothe order ofFive hundred seventy-six and 00/100DollarsBill of lading attachedValue received and charge the same to account ofTo World ShippingDavis CompanyNo. 361John DoeAnytown, USA}ChecksA check is a draft on which the drawee is a bank that is ordered to pay on demand; it is the most common formof a draft. It is drawn on a bank by a drawer, who has an account with the bank, to the order of a specified personor business named on the check, or to the bearer. Ownership of a check may be transferred to another person bythe endorsement of the payee. In this manner, a check may circulate among several parties, taking the place ofmoney. Banks provide regular and special printed check forms. These check forms display a series of numbersprinted in magnetic ink, known as the MICR line, which makes it possible to process checks electronically and accurately. Among the information found on a MICR line is the check number (usually located to the far left). If themagnetic numbers do not match the printed numbers at the upper right, the checkis likely fraudulent and should not be accepted.Comprehension CheckThe use of printed forms is not required. Any writing, no matter how crude,What is a check?may be used as a check if it is a draft drawn on a bank and payable on demand.Special Types of ChecksBank DraftsA bank draft, sometimes called a teller’s check or a treasurer’s check, is a check drawn by one bank on anotherbank in which it has funds on deposit in favor of a third person, the payee.Cashier’s ChecksA cashier’s check is a check drawn by a bank upon itself. The financial institution is both the drawer and thedrawee. The bank, in effect, lends its credit to the purchaser of the check. Courts have held that payment cannot bestopped on a cashier’s check because the bank, by issuing it, accepts the check in advance.Certified ChecksA certified check is a check that is guaranteed by the bank. At the request of either the depositor or the holder,the bank acknowledges that sufficient funds will be withheld from the drawer’s account to pay the amount statedon the check. The UCC provides that “certification of a check is acceptance.” This means that a drawee bank thatcertifies a check becomes primarily liable on the instrument just the same as the acceptor of a draft. The bank hasabsolute liability to pay.Whether anyone is secondarily liable depends upon who had the check certified. If the drawer had the checkcertified, the drawer and all endorsers remain secondarily liable on the instrument. If, on the other hand, the holderhad the check certified, the drawer and all prior endorsers are discharged. The UCC places no obligation on a bankto certify a check if it does not want to do so.16-6Principles of Business Credit

Money OrdersA money order is usually presumed to have the significance of cash, but one must be aware of the issuer’s identity and validity. In some areas of the country, money orders are sold by companies other than financial institutionsor the U.S. Postal Service. They are privately-owned companies and may or may not have sufficient cash to cover themoney order when it is presented for payment. Caution is advised when accepting a money order as payment if theissuer is not known. Investigate the issuer before negotiating the instrument.Traveler’s ChecksA traveler’s check is similar to a cashier’s check in that the issuing financial institution is both the drawer and thedrawee. The purchaser signs the checks in the presence of the issuer when they are purchased. Technically, mosttraveler’s checks are not checks but drafts, because the drawee—for example, American Express—is not ordinarilya bank.Postdated ChecksA check may be postdated when the drawer has insufficient funds in the bank but expects to have sufficient fundsto cover the amount of the check at a future date. A postdated check is not usually covered in the bad check laws ofthe states. Third-party collectors subject to the Fair Debt Collection Practices Act are restricted in their reliance onpostdated checks.Sight Drafts, Time Drafts and Trade AcceptancesA sight draft is payable as soon as it is presented to the drawee for payment. A time draft is not payable until thelapse of a particular time period stated on the draft. A trade acceptance is a draft used by a seller of goods to receivepayment and also to extend credit. It is often used in combination with a bill of lading, which is a receipt given by afreight company to someone who ships goods. For example, a seller ships goods to a buyer and sends a bill of lading,with a trade acceptance attached, to a bank in the buyer’s city. The trade acceptance is drawn by the seller orderingthe buyer to pay either the seller or someone else. If it is a sight draft, the buyer must pay the draft immediately toreceive the bill of lading from the bank. If it is a time draft, the buyer must accept the draft to receive the bill of lading from the bank. The freight company will not release the goods to the buyer unless the buyer has the bill of lading. (See Figures 16-2 and 16-3.)Figure 16-3 Time Draft250.00Anytown, USA, July 12, 20--In or within 30 daysdpte sRobert Jonesthe order ofecAc Wilke Two hundred fifty and 00/100Jim 16, 20yJulValue received and charge the same to account ofToJim WilkesNo. 1025Anytown, USA}Pay toDollarsJohn DoeDomestic Bill of ExchangeA domestic bill of exchange is a draft that is drawn and payable in the United States. A draft that is drawn in onecountry but is payable in another is called an international bill of exchange or foreign draft.Chapter 16 Negotiable Instruments16-7

NotesA note, or promissory note, is a written promise by one party, called the maker, to pay money to the order ofanother party, called the payee. In contrast with drafts, notes are promise instruments rather than order instruments, and they involve only two parties instead of three. They are used by people who loan money or extendcredit as evidence of debt. When two or more parties sign a note, they are called co-makers.Demand NotesA demand note, as its name implies, is payable whenever the payee demands payment. A time note is payableat some future time, on a definite date named in the instrument. Unless a note is payable in installments, the principal (face value) of the note plus interest must be paid on the date that it is due. In an installment note, the principal,together with interest on the unpaid balance, is payable in installments at specified times. (See Figure 16-4.)Figure 16-4Demand NoteAnytown, USA, February 27, 20-On demand, the undersigned, for value received, promise(s) to pay to the order ofanytown trust companyFive thousand two hundred and 00/100Dollarsat its offices in Anytown, USA, together with interest thereon from the date thereof untilpaid at the rate of 10percent per annum.500 Anyroad StreetAnytown, USAJohn DoePromissory NotesPromissory notes come in the following forms: Single-name paper is a note signed by only one maker. No one else is liable on it. Double-name paper is a promissory note signed by two or more makers or signed by themaker and endorsed by others. With additional people standing behind the note, thelikelihood of payment is increased.A straight note is the more common instrument, used merely as evidence of indebtedness. To make certain thatthe note is negotiable, the word “order” must be used.In a serial note, the amount to be paid is covered by a series of notes usually of equal amounts and with maturitydates equally spaced. A provision is usually added, stating that in the event of a default in payment, all subsequentnotes become due and payable. Thus, notes with stated maturities are converted into demand instruments underthis provision.Promissory notes are commonly used for bank loans. They are not frequently used for merchandise transactions.However, some credit executives will ask their customers to sign a note for past-due accounts, believing that it willstimulate payment and make collection of the account easier. This practice provides written acknowledgment of thepast-due debt, while also postponing the due date of the account until the date stated on the note.Collateral NotesA collateral note is a note that is secured by certain collateral, such as stocks, bonds, personal property or mortgages. Its outstanding feature is that the collateral is held by the creditor while the note is outstanding. Such a notemay be negotiated in the same manner as any negotiable note, whether the collateral is assigned or not.16-8Principles of Business Credit

Judgment NotesJudgment notes are controlled by state law and have many technical requirements associated with them. Thesepromissory notes are generally given in connection with a separate agreement by the maker who consents to havea judgment entered should payment not be made on the note when due. The separate agreement consenting to thejudgment is known as a confession of judgment. Clauses that sanction confession of judgment prior to maturity arenot authorized by the UCC because they do not contain an unconditional promise to pay at a definite time.The note may be endorsed and negotiated by the payee in the same manner as any other negotiable instrument.The confession of judgment is not negotiable but may be assigned by the payeeto an endorsee along with the note. In essence, the confession of judgmentComprehension Checkenables a creditor to enter a judgment without going to trial. Because it usuallyWhat are some of thecan be entered without advising the debtor, it has been criticized as violating thetypes of payment?constitutional rights of due process.Certificates of DepositA certificate of deposit (CD) is an acknowledgment by a bank of the receipt of money and its promise to pay themoney back on the due date, usually with interest. Certificates of deposit generally pay more interest than regularsavings accounts because the depositor cannot withdraw the money before the due date without penalty. Theirnegotiability allows them to be sold, to be used to pay debts or to serve as security or collateral for a loan or creditagreement.Negotiation of Commercial PaperAssignmentCommercial paper that does not meet all of the requirements of negotiability may only be transferred by assignment, which is governed by the ordinary principles of contract law. An assignment is the transfer of contract rightsfrom one person to another. Commercial paper is assigned either when a person whose endorsement is required onan instrument transfers it without endorsing it or when it is transferred to another person and does not meet therequirements of negotiability. In all such transfers, the transferee has only the rights of an assignee and is subject toall defenses existing against the assignor.An assignment of commercial paper also occurs by operation of law when the holder of an instrument dies orbecomes bankrupt. In such cases, title to the instrument vests in the personal representative of the estate or thetrustee in bankruptcy.NegotiationNegotiation is the transfer of an instrument in such a form that the transferee becomes a holder. A holder is aperson who is in possession of an instrument issued or endorsed to that person, to that person’s order, to bearer orin blank. For example, XYZ Supply issues a payroll check “to the order of Mary Jones.” Jones takes the check to thesupermarket, signs her name on the back (an endorsement), gives it to the cashier (at delivery) and receives cash.Smith has negotiated the check to the supermarket.If an instrument is payable to order, such as “pay to the order of,” it is known as order paper. To be negotiated,order paper must be endorsed by the payee and delivered to the party to whom it is transferred. If an instrumentis payable to bearer or cash, it is called bearer paper and may be negotiated by delivery alone, without an endorsement. When order paper is endorsed with a blank endorsement, it is turned into bearer paper and may be furthernegotiated by delivery alone. The use of bearer paper involves more risk through loss or theft than the use oforder paper.Chapter 16 Negotiable Instruments16-9

Assume Susan Smith writes a check “payable to cash” and hands it to John Doe (at delivery). Smith has negotiated the check (a bearer instrument) to Doe. Doe places the check in his wallet, which is subsequently stolen. Thethief has possession of the check. At this point, negotiation has not occurred, because delivery must be voluntary onthe part of the transferor. If the thief “delivers” the check to an innocent thirdperson, however, negotiation will be complete. All rights to the check will beComprehension Checkpassed absolutely to that third person, and Doe will lose all right to recover theDefine the conceptproceeds of the check from the third person. Of course, Smith can recover herof negotiation.money from the thief if the thief can be found!EndorsementsAn instrument is endorsed when the holder signs it, thereby indicating the intent to transfer ownership toanother. Endorsements may be written in ink, typewritten or stamped. They may be written on a separate piece ofpaper that becomes part of it. Although the UCC does not require endorsements to be on the back of the instrument, they are usually placed on the back of the instrument for convenience purposes. Each endorsement of anegotiable instrument is a separate contract, standing apart from that of the maker or any other endorser.Once an instrument qualifies as a negotiable instrument, the form of endorsement will have no effect on thecharacter of the underlying instrument. Endorsement relates to the right of the holder to negotiate the paper andthe manner in which negotiation must be done.Common Types of EndorsementsBlank EndorsementA blank or general endorsement consists merely of the signature of the payee and converts the instrument intoa bearer instrument and may be transferred by delivery alone. No particular endorsee, person to whom an instrument is endorsed, is named. If the instrument is lost or stolen and gets into the hands of another holder, the newholder can recover its face value by delivery alone. (See Figure 16-5.)Blank EndorsementFigure 16-5September 15, 20--ENDORSE HERERobert JonesBELOW THIS LINERobert Jones 132.00ty-two and 00/100DollarsThe Oakwood GrillByJohn OakwoodWhen an instrument is made payable to a person under a misspelled name or a name other than that person’sown, the payee may endorse in the incorrect name, in the correct name or in both. Signatures in both names maybe required by a person paying or giving value to the instrument.Special EndorsementA special endorsement, also called an endorsement in full, is made by writing the words “pay to the order of” or“pay to” followed by the name of the person to whom it is to be transferred (the endorsee) and the signature of theendorser. A special endorsement is one that specifies to whose order an instrument is payable. (See Figure 16-6.)16-10Principles of Business Credit

Figure 16-6Special EndorsementENDORSE HEREPay to the order ofAnytown Service StationJohn DoeDO NOT WRITE, STAMP OR SIGN BELOW THIS LINERESERVED FOR FINANCIAL INSTITUTION USE*Restrictive EndorsementA restrictive endorsement limits the rights of the endorsee in some manner in order to protect the rights of theendorser. An endorsement is restrictive if it is conditional; attempts to prohibit further transfer of the instrument;includes

16-2 Principles of Business Credit The Concept of Negotiability The concept of negotiability is one of the most important features of commercial paper.A negotiable instrument is basically a piece of paper that can be transferred multiple times from one person/entity to another without the