Negotiable Instruments Commercial Paper
WHAT IS COMMERCIAL PAPER? • Unconditional written orders or promises to pay money • Demand instrument(A substitute for money)
A negotiable instrument must: • Be in writing • Be signed by the maker or drawer • Be an unconditional promise or order to pay • State a fixed amount of money • Not require any undertaking in addition to the payment of money • Be payable on demand or at a definite time • Be payable “to order” or “to bearer”
The Bank – Customer Relationship Creditor – Debtor Relationship • Created when a customer deposits money into the bank. • The customer is the creditor and the bank is the debtor (owes the money).
The Bank – Customer Relationship (continued) Principal – Agent Relationship • Created if the: • deposit is a check that the bank must collect for the customer or the • customer writes a check against his or her account • The customer is the principal and the bank is the agent.
TYPES OF COMMERCIAL PAPER • Drafts • Checks • Honor and dishonor • Stop-payment orders • Precautions and care • Promissory notes • Certificates of deposit
Draft • A draft is a three-party instrument that is an unconditional written order by one party that orders the second party to pay money to a third party. • Drawer of a draft • Drawee of a draft • Payee of a draft
Check • A distinct form of draft drawn on a financial institution and payable on demand. • Drawer of a check • Drawee of a check • Payee of a check
Parties to a Check • Drawer - Customer who maintains the checking account and writes checks against the account • Drawee - Bank on which the check is drawn • Payee - Party to whom the check is written
Duties of Bank and Customer • Customer must examine bank statements and promptly notify bank of unauthorized payments • Liable for failure to perform duties • Bank owes duty of ordinary care in presenting and sending checks for collection • Liable for losses caused by its negligence
Promissory Notes • A two-party negotiable instrument that is an unconditional written promise by one party to pay money to another party. • Maker of a note • Payee of a note • Types of notes: • Time note • Demand note • Installment notes
Promissory Notes (continued) • Collateral required • Some notes require posting security • May be automobiles, homes, buildings, securities, or other property • If maker fails to repay note as due, lender can foreclose and take collateral as payment
Certificates of Deposit (CD) • A two-party negotiable instrument • Special form of note created when a depositor deposits money at a financial institution • Institution promises to pay back the amount of the deposit plus an agreed-upon rate of interest at set time.
Primary Liability • Makers of promissory notes and certificates of deposit have primary liability for the instrument. • Maker unconditionally promises to pay the amount stipulated in the note when due. • Makers are absolutely liable to pay the instrument, subject only to certain real defenses.
Secondary Liability • Drawers of checks and drafts and unqualified indorsers of negotiable instruments have secondary liability on the instrument. • This liability is similar to that of a guarantor of a simple contract. • It arises when the party primarily liable on the instrument defaults and fails to pay the instrument.
Secondary Liability (continued) • Unqualified indorsers have secondary liability. • Qualified indorsers have no secondary liability. • They have expressly disclaimed liability. • Secondary liability arises from an instrument being: • Properly presented • Dishonored. • Notice being timely given to person who is secondarily liable.
SPECIALIZED TYPES OF COMMERCIAL PAPER • Certified checks • Teller’s check • Cashier’s check • Money orders • Traveler’s checks
Special Types of Checks • Certified Checks • Bank agrees to accept check when presented • Pays out of funds set aside in special account • Drawer is discharged from liability on check • Cashier’s Checks • Two party check • Bank is both drawer and drawee • Holder is payee • Traveler’s Checks • Issued without named payee • Requires purchaser’s signature at issuance and upon use
WHAT MAKES AN INSTRUMENT NEGOTIABLE? • In writing and signed by the maker or drawer • Unconditional promise or order • Payable in a sum certain in money • Payable on demand or at a definite time • Payable to bearer or to someone’s order
Negotiable instruments serve the following functions: • Substitute for money • Credit device • Record-keeping device • Most purchases by businesses and many individuals are made by negotiable instruments instead of cash.
Additional Clauses • Prepayment clause • Allows maker to pay amount before due date • Acceleration clause • Payee or holder may accelerate payment of principal • Extension clause • Allows date of maturity to be extended
Nonnegotiable Contract • A promise or order to pay that does not meet the requirements of a negotiable instrument. • It is not subject to the provisions of UCC Article 3. • A nonnegotiable contract can be enforced under normal contract law.
HOW IS COMMERCIAL PAPER TRANSFERRED? • Indorsement • Indorser • Indorsee • Holder
Transfers • Negotiable instruments can be transferred to subsequent parties by negotiation. • Done by placing endorsement on instrument
ENDORSEMENTS AND THEIR FUNCTIONS • Blank endorsements • Special endorsements • Qualified endorsements • Restrictive endorsements • Accommodation parties
Accommodation Party • A party who signs an instrument and lends his or her name (and credit) to another party to the instrument. • The accommodation party is obliged to pay the instrument in the capacity in which he or she signs. • Accommodation Maker – primarily liable • Accommodation Indorser – secondarily liable • Liability of accommodation party: • Guarantee of payment • Guarantee of collection
HOW IS COMMERCIAL PAPER DISCHARGED? • By payment • By cancellation • By alteration • By impairment of collateral • As a contract
Impairment of the Right of Recourse • Certain parties (holders, indorsers, accommodation parties) are discharged from liability on an instrument if the holder: • Releases an obligor from liability, or • Surrenders collateral without the consent of the parties who would benefit by it
COLLECTION OF COMMERCIAL PAPER OBLIGATIONS • Holder in due course • Qualifications of an HDC • Take in good faith and give value • Without knowledge of defense or dishonor
Holder A person who is in possession of a negotiable instrument that is drawn, issued, or indorsed to him or his order, or to bearer, or in blank. Holder in Due Course (HDC) A person who takes a negotiable instrument for value, in good faith, and without notice that it is defective or is overdue. Holder Versus Holder In Due Course
If the requirements of Article 3 are met, a transferee who qualifies as a holder in due course takes the instrument free of many defenses that can be asserted against the original payee. • In addition, the document is considered an ordinary contract that is subject to contract law.
WHAT ARE THE LIMITED (Personal) DEFENSES? • Breach of contract or failure of consideration • Fraud in the inducement • Temporary incapacity to contract—excluding minority • Ordinary duress • Prior payment or cancellation • Conditional delivery or non-delivery • Unauthorized completion • Theft
WHAT ARE THE UNIVERSAL DEFENSES? • Permanent incapacity to contract and minority • Illegality • Forgery or lack of authority • Alteration • Fraud in the execution of the paper or as to the essential terms • Duress depriving control • Claims and defenses stemming from a consumer transaction
Signature Liability • A person cannot be held contractually liable on a negotiable instrument unless his or her signature appears on the instrument. • The signatures on a negotiable instrument identify those who are obligated to pay it. • If it is unclear who the signer is, parol evidence can identify the signer.
Commercial Wire Transfers • Fast • Transfers usually completed within one day • Inexpensive
Questions? Next Week: Chapters 38 & 39