Chapter 24

The Function and Creation of Negotiable Instruments




Focus: Article 3 of the UCC





        A Negotiable Instrument is a


(1)     written instrument,

(2)     signed by the maker or drawer of the instrument,

(3)     that contains an unconditional promise or order to pay

(4)     an exact sum of money (with or without interest in a specified amount or at a specified rate)

(5)     on demand or at an exact future time

(6) to a specific person, or to order, or to its bearer.


Simply put, the negotiable instrument is a substitute for money or serves as an extension of credit. For it to work, it is imperative that the instrument be easily transferable without danger of being uncollectible.





Negotiable instruments include two main types: an order to pay (encompasses drafts and checks) and promises to pay (promissory notes and CD’s).  The instruments can also be classified as demand instruments or time instruments.  Thus there are four types of negotiable instruments.


Demand instrument: payable on demand. (demand= instrument states it is payable on sight or demand to a holder) [a holder is the person in possession]


A good example of a demand arrangement is a checking account, sometimes called a demand deposit account.




        Draft (or a bill of exchange): INVOLVES 3 PARTIES:  An unconditional written order to pay by which the party creating the draft (the drawer) orders another party (the drawee), typically a bank, to pay money to a third party (the payee) -- e.g., a check.   (first type of negotiable instrument)


        Time Draft: A draft payable at a time certain (definite time)


        Sight Draft: A draft payable on presentment. It may also be payable on acceptance- where you have the drawee’s written promise to pay the draft when it comes due.


        Trade Acceptance (frequently used in sale of goods): A draft that is drawn by a seller of goods ordering the buyer to pay a specified sum of money to the seller, usually at a specified future time. The buyer accepts the draft by signing and returning it to the seller.


è   What this does is makes it a negotiable instrument which can then be sold (negotiated) to another party to raise cash, kind of like a factor arrangement.


·        Checks: (see above) writer of the check is the drawer, the bank on which the check is written is the drawee, and the person to whom it is payable is the payee. (second type of negotiable instrument)




        Promissory Note: A written promise made by one person (the maker) to pay a fixed sum of money to another person (the payee) on demand or at a specified future time.  (third type of negotiable instrument)


        Certificate of Deposit: A note by which a bank or similar financial institution acknowledges the receipt of money from a party and promises to repay the money, plus interest, to the party or the party’s designee, on a certain date.  Known for high interest rates (J). (fourth type of negotiable instrument)





RECALL: The instrument must be a:


1)       written instrument, not oral (I.E., FORMALITY)


          It must written on something of “permanence”- not in sand, for example


          It must be portable- not on the side of a cow, for example


(2)     signed by the maker or drawer of the instrument,

          Note: an agent can sign for a principal.


A signature can be any symbol adopted by the maker, including thumbprints, X’s, rubber stamps, impressions, as well as a “regular” manual signature.


NOTE: “I, Sammy Taylor, promise to pay XYZ Co”, in the person’s handwriting, is enough.  Sammy Taylor does not have to be “re-signed” again


(3)     that contains an unconditional promise or order to pay (see below)


(4)     an exact sum of money (with or without interest in a specified amount or at a specified rate)


(5)     on demand or at an exact future time


(6)     to a specific person, or to order, or to its bearer





   Promise or Order: A negotiable instrument must contain an express order or promise to pay.


        A mere acknowledgment of a debt is not sufficient without evidence of an affirmative undertaking on the part of the debtor to repay the debt.


        The exception to this rule is a certificate of deposit.


·        Example of Unconditionality of Promise or Order (non negotiable) : A promise or order is conditional (and, therefore, not negotiable) if it states


(1)     an express condition to payment,


(2)     that the promise or order is subject to or governed by another writing, or


(3)     that the rights or obligations with respect to the promise or order are stated in another writing.


èIn other words, it has strings attached that are not part of the instrument.






It must be clear how much money is payable or it must be easily calculable.  For example, a note for $1,000 payable at 10% interest in 3 months from “x” date is sufficient.  You actually don’t have to have the end result actually calculated in this example.


It may also state “at the legal rate of interest”- where the amount is fixed by statute, it is also negotiable.


MUST BE payable in money.  It cannot say, pay $1000 in US gold.  Gold is no longer the medium of exchange.  You cannot say $1000 plus 10 liters of a certain wine.






In general, a negotiable instrument must be payable on demand or at a definite time.


       Payment On Demand: An instrument is payable on demand, “at sight,” or “upon presentment” if it is subject to payment immediately upon being presented to the payor or drawee.


·        If no time for payment is specified, a negotiable instrument is presumed to be payable on demand.



        Payment at a Definite Time: An instrument is payable at a definite time if it states that it is payable (i) on a specified date, (ii) within a definite period of time, or (iii) on a date or at a time readily ascertainable at the time the promise or order is made.  UCC 3-108


        Such instruments are frequently referred to as time instruments.


        Acceleration Clause: A clause that permits a payee or other holder of a time instrument to demand payment of the entire amount or balance due, with interest, if a certain event occurs, such as default in the payment of an installment when due.


        Extension Clause: A clause in a time instrument that permits the date of maturity to be extended.






       Order Instrument: An order instrument is a negotiable instrument that is payable “to the order of’ an identified person or “to” an identifiable person “or order.”  The person must be named with certainty (except in a bearer instrument)


        Bearer Instrument: A negotiable instrument payable “to bearer” or to “cash,” rather than to an identifiable payee.


        Bearer: The person possessing a bearer instrument.


        Any instrument payable to the following is a bearer instrument:


(i)      “Payable to the order of bearer”;


(ii)     “Payable to Jane Smith or bearer”;


(iii)    “Payable to bearer”;


(iv)    “Pay cash”; or


(v)      “Pay to the order of cash.”







(1)     The fact that an instrument is undated does not affect its negotiability, unless the date of the instrument is necessary to understand the payment term- for example, if we forget to put a date on our check, it doesn’t destroy negotiablity;


(2)     Postdating or antedating an instrument does not affect its negotiability;


(3)     Interlineations and other written or typewritten alterations need not affect negotiability;


        As before, handwritten terms “trump” typewritten terms, and typewritten terms “trump” printed terms.


(4)     Words “trump” figures, unless the words are ambiguous in and of themselves;


(5)     If the instrument fails to specific the applicable interest rate, the judgment rate of interest (defined by statute) becomes the interest rate on the instrument; and


(6)     Notations that an instrument is “non-negotiable” or “not governed by Article 3” do not affect the negotiability of a check but may make other instruments nonnegotiable.