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Creating a Negotiable Instrument

CHAPTER 23. Creating a Negotiable Instrument. Commercial Paper. Commercial paper is a contract to pay money. It can be: A Substitute for Money A Loan of Money. Promissory Note. The possessor of a piece of commercial paper has an unconditional right to be paid, as long as:

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Creating a Negotiable Instrument

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  1. CHAPTER 23 Creating a Negotiable Instrument

  2. Commercial Paper • Commercial paper is a contract to pay money. • It can be: • A Substitute for Money • A Loan of Money

  3. Promissory Note • The possessor of a piece of commercial paper has an unconditional right to be paid, as long as: • the paper is negotiable; • it has been negotiated to the possessor; • the possessor is a holder in due course; and • the issuer cannot claim any of the limited number of “real” defenses.

  4. Types of Negotiable Instruments • Note (also called a promisory note) is a promise to pay money. • Certificate of Deposit (CD) is a note made by a bank. • Draft is an order directing someone else to pay money for you (e.g., checks). • Cashier’s check -- a draft drawn by a bank on its own account. • Traveler’s check -- a draft issued by and paid by the same company (such as American Express)

  5. Definitions • Trade acceptance -- draft drawn by a seller of goods on the buyer and payable to the sell or some third party • Sight draft -- payable on demand • Time draft -- payable at some particular time in the future • Order paper -- payable to the named person or anyone designated by that named person • Bearer paper -- payable to anyone in possession of the paper

  6. Rights • The possessor of non-negotiable commercial paper has the same rights--no more, no less--as the person who made the original contract. • The possessor of negotiable commercial paper has more rights than the person who made the original contract.

  7. Requirements for Negotiability • The Instrument Must: • Be in Writing. • Be Signed by the Maker or Drawer. • Contain an Unconditional Promise or Order to Pay. • State a Definite Amount of Money. • Be Payable on Demand or at a Definite Time. • Be Payable to Order or to Bearer.

  8. Interpretation of Ambiguities • When terms contradict, three rules apply: • Words take precedence over numbers. • Handwritten terms prevail over typewritten terms. • Typed terms prevail over printed terms.

  9. Negotiation • Negotiation means that an instrument has been transferred to the holder by someone other than the issuer. • To be negotiated, order paper must first be indorsed and then delivered to the transferee. • Bearer paper must simply be delivered to the transferee; no indorsement is required.

  10. Indorsement • An indorsement is the signature of the payee. • Blank Indorsement -- does not designate a new payee; becomes bearer paper. • Special Indorsement -- does designate a new payee; only that person may cash the check. • Restrictive Indorsement -- limits the check to one particular use (such as deposit into a particular account).

  11. Holder in Due Course • A holder in due course has an automatic right to receive payment for a negotiable instrument (unless issuer can claim one of a few “real” defenses). • Requirements for Holder in Due Course • Under §3-302 of the UCC, a holder in due course is a holder who have given value for the instrument, in good faith, without notice of outstanding claims or other defects.

  12. Notice of Outstanding Claims or Other Defects • The instrument is overdue • The instrument is dishonored • The instrument is altered, forged, or incomplete • The holder has notice of certain claims or disputes

  13. Shelter Rule • Under the shelter rule, the transferor of an instrument passes on all of his rights. • When a holder in due course transfers an instrument, the recipient acquires all the same rights even if she is made a holder in due course herself.

  14. Defenses • Real and personal defenses are valid against an ordinary holder; only real defenses can be used against a holder in due course. • Real Defenses • Forgery, Bankruptcy, Minority, Alteration Duress, Mental Incapacity, Illegality, and Fraud in the Execution • Personal Defenses • Breach of Contract, Lack of Consideration, Prior Payment, Unauthorized Completion, Fraud in the Inducement and Non-Delivery

  15. Claims in Recoupment • A Claim in Recoupment is not the same as a defense, but it has similar impact. • Claim in Recoupment is a refusal to pay the full amount of the instrument because the payee owes the issuer another debt. Issuer subtracts the prior debt from the payoff of the current instrument. • In contrast, a defense is a refusal to pay the instrument due to some problem with the instrument or the underlying agreement.

  16. Consumer Exception • A consumer credit contract is one in which the seller is also the lender. • In such cases, the Federal Trade Commission requires a specifically-worded notice to be included on the contract, making it non-negotiable.

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