Negotiable Instruments Guide - Checks, Notes & Transfers
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This document discusses negotiable instruments such as checks, promissory notes, and certificates of deposit. It covers key topics such as the nature and types of negotiable instruments, the benefits of negotiability, and the formal requirements for an instrument to be considered negotiable under the Uniform Commercial Code. The document provides an overview of negotiable instruments and then delves into more specific details about promises to pay money, orders to pay money, holders in due course, and the requirements an instrument must meet to qualify as negotiable, including being an unconditional written promise or order to pay a fixed sum of money.
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Negotiable Instruments Guide - Checks, Notes & Transfers
- 1. Negotiable Instruments Negotiation and Holder in Due Course Liability of Parties Checks and Electronic Transfers © 2010 The McGraw-Hill Companies, Inc. All rights reserved.
- 2. Negotiable Instruments We at Chrysler borrow money the old- fashioned way. We pay it back. Lee Iacocca, Chairman and CEO of Chrysler Corporation, quoted in the New York Times (1983) © 2010 The McGraw-Hill Companies, Inc. All rights reserved.
- 3. Learning Objectives Nature of negotiable instruments Types of negotiable instruments Benefits of negotiable instruments Formal requirements for negotiability 31 - 3
- 4. Overview Commercial paper refers to checks, promissory notes, and certificates of deposit Basically a contract for the payment of money Commercial paper may be negotiable: Transferred from party to party and accepted as a money substitute payable immediately (check) or as credit (promissory note) 31 - 4
- 5. The Uniform Commercial Code UCC Article 3 (Negotiable Instruments) and Article 4 (Bank Deposits and Collections) cover commercial paper Other negotiable documents (documents of title, investment securities) covered by other sections Two basic types of negotiable instruments: Promises to pay money Orders to pay money 31 - 5
- 6. Promises to Pay Money Promissory notes and certificates of deposit issued by banks are promises to pay money Promissory note: two-party instrument in which the maker promises unconditionally in writing to pay the payee, a person specified by the payee, or the bearer of the note, a fixed amount of money (with or without interest) either on demand or at a specified, future time [3–104] 31 - 6
- 7. Promises to Pay Money A certificate of deposit is an instrument containing (1) an acknowledgment by a bank that it has received a deposit of money and (2) a promise by the bank to repay the sum of money [3–104(j)] Generally in electronic form 31 - 7
- 8. Orders to Pay Money A draft is an order (not a promise) by one person to a second person to pay money to a third person [3–104(e)] A check is the most common draft Specifically, the drawer orders the drawee to pay a certain sum of money to the payee, to a person specified by the payee, or to the bearer of the instrument Example: writing a bank check to pay a bill 31 - 8
- 9. Orders to Pay Money Cashier’s check: draft on which drawer and drawee are the same bank (or branches of same bank) Teller’s check: draft drawn by a bank (as drawer) on second bank or payable through a bank [3–104(g) and (h)] 31 - 9
- 10. Negotiability Purpose of negotiability is to decrease risk of transfer (assignment of commercial paper contract) so the instrument will be accepted as a substitute for money Thus, (1) the contract for payment of money must meet requirements for negotiability, and (2) the person who acquires instrument must qualify as a holder in due course 31 - 10
- 11. A Holder in Due Course A holder in due course has good title to the instrument, paid value for it, acquired it in good faith, and had no notice of certain claims or defenses against payment Instrument bears no evidence of forgery or triggers concerns about authenticity A holder in due course takes the instrument free of all defenses and claims except those that concern its validity 31 - 11
- 12. Requirements For Negotiability For an instrument to be negotiable, it must be in writing, signed by the maker, containing an unconditional promise or order to pay a fixed amount of money, payable to order or to bearer, payable on demand at a definite time, lack any other instruction by the maker (three exceptions) [3–103; 3–104] 31 - 12
- 13. The Signed Writing The instrument must be in writing and signed by the maker Any writing (print, handwritten) or type of signature (handwritten, authorized stamped signature, or an X if witnessed) See Interbank of New York v. Fleet Bank A bank that pays an unauthorized check (e.g., Interbank) bears the economic loss, but may sue the person that created the unauthorized item 31 - 13
- 14. Unconditional Promise or Order The instrument must must contain an unconditional promise or order to pay (e.g., “pay to the order of”) Conditional phrases destroy negotiability, though reference to another document about collateral, prepayment, or acceleration does not destroy negotiability 31 - 14
- 15. Fixed Amount of Money The requirement of a “fixed amount of money” applies only to principal Interest may be stated in an instrument as a fixed or variable amount of money or expressed as a fixed or variable rate or rates 31 - 15
- 16. Payable on Demand or At a Definite Time A promise or order is “payable on demand” if (1) it states it is payable on “demand” or “sight” or (2) does not state any time for payment [3–108(a)] A promise or order is “payable at a definite time” if payable at fixed date(s) or at time(s) readily ascertainable at the time the promise or order is issued [3–108(b)] The typical promissory note 31 - 16
- 17. Payable to Order or Bearer An instrument is payable “to order” (order paper) if payable to (1) order of identified person or (2) an identified person or that person’s order [3–109(b)] Requires indorsement for negotiation An instrument payable “to bearer” or “to cash” (bearer paper) may be negotiated or transferred by delivery of possession without indorsement [3– 201(b)] 31 - 17
- 18. Pelican National Bank v. Providen Facts: Insurance company issued check drawn on a bank to several payees listed without punctuation or grammatical connector (and/or) Holding: Court concluded the check was ambiguous and applied the default rule that treated the document as if payable in the alternative: “The indorsement of any one of the payees was sufficient.” 31 - 18
- 19. Special Terms A instrument will remain negotiable if it includes statements about: Giving, maintaining, or protecting collateral to secure payment An authorization to confess judgment or realize on or dispose of collateral Waiving the benefit of any law intended for the protection or benefit of a person obligated on the instrument 31 - 19
- 20. Ambiguous Terms If terms conflict or an ambiguous term exists, general rules of interpretation apply: Typewritten terms prevail over printed terms, handwritten terms prevail over printed and typewritten terms, and where words and numbers conflict, words control the numbers [3–114] See Galatia Community State Bank v. Kindy: Difference between numbers on the check from checkwriting machine and number written by hand 31 - 20
- 21. Test Your Knowledge True=A, False = B Commercial paper includes checks, promissory notes, and certificates of deposit. A holder in due course takes the instrument free of all defenses and claims. UCC Articles 3 & 4 cover commercial paper. A certificate of deposit is a negotiable instrument in which a bank acknowledges is received a money deposit and promises to repay the sum in the future. 31 - 21
- 22. Test Your Knowledge Multiple Choice The basic types of commercial paper are: (a) Promises to pay money (b) Orders to pay money (c) A document of title (d) Both A and B (e) All of the above 31 - 22
- 23. Test Your Knowledge Multiple Choice Which of the following would be non- negotiable? (a) Please pay to the order of Sarah $100.” (b) “This promissory note is secured by my property in Pender County.” (c) “This promissory note is subject to Sarah’s graduation from college.” (d) None of the above; they are all negotiable 31 - 23
- 24. Thought Questions Do you use negotiable instruments each week? How do you do your banking? 31 - 24
Editor's Notes
- Photo: Chrysler Center, NYC
- Figures 1 and 2 on pages 808 and 809 are examples of promissory notes.
- Figures 3 and 4 (page 810) depict a draft and check respectively.
- The assignee of a contract can obtain no greater rights than the assignor had at the time of the assignment. Taking an assignment of a contract involves assuming certain risks. An assignee who does not know what rights he is getting, or which risks he is assuming, may be reluctant to take an assignment of the contract. The object of a negotiable instrument is to have it accepted readily as a substitute for money. In order to accept it readily, a person must be able to take it free of many of the risks assumed by the assignee of a regular contract.
- In Interbank of New York v. Fleet Bank , a vendor company (Atlantic Mobile) sent preauthorized checks (telechecks) with the stamped notation, “verbally authorized by your depositor,” to their bank. The customer-depositor (Tasoulis) challenged the authorization and depositor’s bank (Interbank) sued vendor’s bank (Fleet) to recover the amount of the drafts. The court reasoned that “if Tasoulis had authorized Atlantic Mobile to issue the check with the notation ‘verbally authorized by your depositor,’ in place of his written signature, the check would qualify as a negotiable instrument. The only infirmity in the subject drafts is that Tasoulis did not authorize their issuance. Thus, the notation ‘verbally authorized by your depositor,’ which could constitute a signature under the UCC, is unauthorized. The unauthorized use of a stamped printed signature constitutes a forgery. So too here the notation ‘verbally authorized by your depositor,’ which can constitute a signature under the UCC, when unauthorized, constitutes a forged signature. Accordingly, the preauthorized checks should be treated as any other check that contains a forged signature. These preauthorized checks constitute negotiable instruments. Summary Judgment granted to Fleet.” The Federal Reserve issued a Final Rule Governing Remotely Created Checks on Dec. 1, 2005: “ A remotely created check is subject to state law on negotiable instruments, specifically Articles 3 and 4 of the Uniform Commercial Code (U.C.C.) as adopted in each state. …The provisions of the U.C.C. cited above implement the rule set forth in the seminal case of Price v. Neal ,6 which held that drawees of checks and other drafts must bear the economic loss when the instruments they pay are not properly payable because the drawer did not authorize the item. ( See also Interbank of New York v. Fleet Bank, 730 NYS 2d 208 (2001)) Under the Price v. Neal rule, the paying bank must bear the economic loss of an unauthorized check with little recourse other than bringing an action against the person that created the unauthorized item. This rule currently applies to all checks, including remotely created checks, in a majority of states. See also the Interbank appellate decision: 2004 NY Slip Op 50253(U) Decided on March 23, 2004 APPELLATE TERM OF THE SUPREME COURT, FIRST DEPARTMENT INTERBANK OF NEW YORK, Plaintiff-Appellant, against FLEET BANK, Defendant-Respondent, -and- MELLON BANK, SPRINT PCS, and VERIZON MOBILE, INC., Defendants. Plaintiff appeals from an order of the Civil Court, New York County, entered July 17, 2001 (Carol R. Edmead, J.) which granted a motion by defendant Fleet Bank for summary judgment dismissing the complaint as against it. PER CURIAM: Order entered July 17, 2001 (Carol R. Edmead, J.) affirmed, with $10 costs. The action was properly dismissed since plaintiff Interbank of New York, having made payment on the fraudulently issued demand drafts or "telechecks" drawn on its customer's account, is accountable for the amount of the instruments and may not seek recoupment against the defendant depositary bank in the absence of a showing that the latter breached its warranty of [*2]presentment (see, 1 Brady, Bank Checks § 28.04; see also, Manufacturer's and Traders Trust Co. v County Trust Region of the Bank of NY, 59 AD2d 645 [1977]; Fromer Distrib., Inc. v Bankers Trust Co., 36 AD2d 840 [1971]). It does not avail plaintiff that the demand drafts merely bore the printed notation "verbally authorized by your [i.e., plaintiff's] depositor" and were unsigned. Such a draft, even if not a negotiable instrument (see, UCC § 3-104[1]; Garden Check Cashing Serv., Inc. v First Nat. City Bank, 25 AD2d 137, affd 18 NY2d 941 [1966]), clearly qualifies as an "item" (see, UCC § 4-104[g]) subject to the final payment and warranty provisions of UCC article 4 (see, UCC §§ 4-207[1], 4-213[1]). If an exception to the existing UCC framework is to be carved out with respect to drafts of the type here involved, such a departure must be made by the Legislature rather than by the court (see, by way of illustration, Cal Comm Code § 3104[k], Historical and Statutory Notes, at 177-178). This constitutes the decision and order of the court.
- Unconditional promises (negotiable): “ Please pay to the order of ___” “ Pay to the bearer” or “Pay to ___” “ This note secured by ….” “ Payable to the order of ____ for (reason) ” Conditional promises (non-negotiable): “ I owe _____ $100” “ This note is subject to …” “ I promise to pay $100 to ___ if …”
- Hyperlink is to the case opinion on the Findlaw.com website.
- Appellate court: The $5550.00 amount imprinted by the check-writing machine upon the line customarily used for words is expressed in figures and not in words. One question is whether imprinted numbers located where words are customarily placed on a check control figures placed where figures are customarily placed. Another question is whether handwritten figures control printing. We find both questions satisfactorily answered in St. Paul Fire & Marine Ins. Co. v. Bank of Salem. In that case, there was a conflict between an amount imprinted by a check- mprinting machine and numbers expressed in typewritten figures. The court recognized the imprinted amount was not expressed in words but held “the purposes of the UCC are best served by considering an amount imprinted by a check-writing machine as ‘words’ for the purpose of resolving an ambiguity between an amount and an amount entered upon the line usually used to express the amount in figures.” Because a check-imprinting machine’s purpose is to protect against alterations, the amount shown on the imprint should control whether the number is in words or figures. Turning to the question of whether typewriting controls printing, the court in United States Fidelity and Guaranty Co. .. . did not say specifically that it regarded the portion written by the check-writing machine as the equivalent of handwriting, [but] that is the clear effect of the decision.”
- True. False. A holder in due course takes the instrument free of all defenses and claims except those that concern its validity his or her parent would have taken if the parent had survived. True. True.
- The correct answer is (d). A document of title is a negotiable instrument, but is not commercial paper.
- The correct answer is (c).
- Opportunity to discuss the banking industry and trends in banking practices. Given online banking, do students use checks or do all banking online?