2. Learning Objectives
1. State the purpose of a negotiable instrument.
2. Explain those negotiable instruments that contain
a promise to pay money.
3. Explain those negotiable instruments that contain
an order to pay money.
4. Differentiate among the different types of checks
and money orders.
5. Identify the requirements of a negotiable
instrument.
16-2
3. Learning Objectives (cont.)
6. Explain an assignment and a negotiation of an
instrument.
7. Name and describe four kinds of indorsements.
8. Identify the implied warranties related to
indorsements.
9. Explain the contract that is made when people
indorse negotiable instruments.
10.Describe the legal effect of a forged indorsement.
16-3
4. Purpose of Negotiable Instruments
• Merchants needed a safer and more convenient
method of exchanging their gold and silver for the
goods they bought.
• When the merchants bought goods, instead of
paying for them with gold or silver, they simply
filled in a piece of paper, called a bill of exchange
16-4
5. Purpose of Negotiable Instruments
• Negotiable instrument
– a written document signed by the maker or drawer that
contains:
• an unconditional promise or order to pay a fixed
amount of money
• on demand or at a definite time
• to the bearer or to order
– promise instruments, order instruments
16-5
6. Promise Instruments
• Note (promissory note)
– a written promise by one party, (the maker), to pay
money to the order of another party, (the payee)
16-6
7. Promise Instruments
• Demand note
– Payable whenever the payee demands payment
• Time Note
– Payable at some future time specified in the instrument
• Installment note
– Payable in installments at specified times
16-7
9. Promise Instruments
• Certificate of deposit (CD)
– An instrument containing:
• An acknowledgment that a bank has received a sum
of money, and
• A promise by the bank to repay the sum of money
– Come in a variety of time periods, higher interest
usually paid for longer periods
– Penalty for early withdrawal
Example CD rates
16-9
10. Order Instruments
• Draft (bill of exchange)
– An instrument in which one party writes an instrument
ordering a second party to pay money to a third party
– Drawer – one who draws the draft
– Drawee – one who is ordered to pay the money
– Payee – one who is to receive the money
16-10
11. Order Instruments
• Sight draft
– payable as soon as it is presented to the drawee for
payment.
• Time draft
– not payable until the lapse of a particular time period
stated on the draft.
16-11
12. Order Instruments
• Domestic bill of exchange
– A draft that is drawn and payable in the United States
• International bill of exchange or foreign draft
– A draft that is drawn in one country but payable in
another
16-12
13. Order Instruments
• Check
– A draft
• drawn on a bank
• by a drawer who has an account at the bank
• is payable on demand
– Is the most common form of a draft
16-13
14. Checks
• Certified check
– A check that is guaranteed by the bank that sufficient
funds will be withheld from the drawer’s account to pay
the amount stated on the check
16-14
15. Checks
• Bank draft (teller’s/treasurer’s check)
– A check drawn by one bank on another bank in which it
has funds on deposit in favor of a third person, the
payee
• Cashier’s check
– A check drawn by a bank upon itself, lending its credit
to the purchaser of the check
16-15
16. Checks
• Traveler’s check
– the issuing financial institution is both the drawer and
the drawee.
• The purchaser signs the checks in the presence of
the issuer when they are purchased.
• To cash a check, the purchaser writes the name of
the payee in the space provided and countersigns it
in the payee’s presence.
16-16
18. Checks
• Money order
– a type of draft that may be purchased as a substitute
for a check
• Instead of being drawn on an individual’s account as is a
check, however, a money order is drawn on the funds of
the organization that issues it (e.g., US Post Office)
16-18
19. Parties to Negotiable Instruments
•
•
•
•
•
•
Maker or comaker – sign a note, promising to pay
Drawer – signs a draft, ordering payment
Issuer – either a maker or drawer of an instrument
Drawee – ordered in a draft to make payment
Payee – person to whom a note or draft is payable
Bearer – is in possession of a negotiable
instrument payable to bearer or cash
16-19
20. Parties to Negotiable Instruments
• Holder – possesses a negotiable instrument issued or
indorsed to that person’s order or to bearer
• Indorser – indorses a negotiable instrument
• Indorsee – person to whom a negotiable instrument is
transferred by indorsement
• Acceptor – drawee of a draft who has promised to
honor the draft as presented by signing it on its face
16-20
22. Requirements of Negotiable Instruments
To be negotiable, instruments must:
• Be in writing
• Be signed by the maker or drawer
• Contain an unconditional promise or order to pay
• Be made out for a fixed amount of money
• Can include interest
• Be payable on demand or at a definite time
• Except for checks, be payable to order or to
bearer
16-22
23. Requirements of Negotiable Instruments
• A negotiable instrument must be in writing
– Printing
– Typewriting
– Pen/pencil writing
– or any other tangible form of writing
16-23
24. Requirements of Negotiable Instruments
• Must be signed by the maker or drawer
• Any writing, mark, or symbol is accepted as a
signature as long as it is the writer’s intent to be a
signature.
16-24
25. Requirements of Negotiable Instruments
• Must contain no conditions that might in any way
affect its payment
• Statements requiring that certain things be done or
that specific events take place prior to payment
make the instrument a simple contract rather than
negotiable paper.
• Must contain an order or promise to pay, not
simply an acknowledgement (IOU)
16-25
26. Requirements of Negotiable Instruments
• Must be payable in a fixed amount or sum of
money.
– an amount of money that is clearly known
• Money – a medium of exchange adopted by a
domestic or foreign government as part of its
currency.
16-26
27. Requirements of Negotiable Instruments
• Negotiable instruments must be made payable on
demand or at a definite time.
• Makes it possible to determine when the debtor or
promisor can be compelled to pay.
– Demand Paper – holder can require payment at any
time (payable “on demand”, “on sight”, “on
presentation”)
– Definite-Time Paper – Payable on, before, or for a
specified time period after some known date.
16-27
28. Requirements of Negotiable Instruments
• Payable to Order
– states that it is payable “to the order of” any person
with reasonable certainty.
• Payable to Bearer
– states that it is payable to:
•
•
•
•
bearer or the order of bearer,
a specified person or bearer,
cash or the order of cash,
or any other indication that does not designate a specific
payee.
16-28
29. Dates and Controlling Words
• Omission of date of issue does not affect
negotiability (date received would become date of
issue)
• Predating and postdating are allowed
• If there are conflicting terms:
• Handwritten terms > typewritten > pre-printed
• Words > numerals, except when words are
ambiguous
16-29
30. Transferring Instruments
• Assignment
– The transfer of a contract right from one person to another
• Negotiable instruments can be assigned when:
– Person whose indorsement is required transfers to another
party without indorsing
– When instrument is transferred but doesn’t meet all the
requirements of negotiability
– When holder of an instrument dies or goes bankrupt
16-30
31. Transferring Instruments
• Negotiation
– Transfer of an instrument in such form that the
transferee becomes a holder
• Holder
– A person in possession of an instrument issued or
indorsed to:
•
•
•
•
that person
that person’s order
to bearer
or in blank
16-31
32. Transferring Instruments
• Order paper
– To be negotiated, must be indorsed by the payee and
delivered to the transferee
• Bearer paper
– May be negotiated by delivery alone, without an
indorsement
16-32
33. The Concept of Negotiability
• Negotiation gives greater rights to the transferee
than assignment.
• Negotiation also provides the transferee with more
protection than was available to the person from
whom it was received
16-33
34. Negotiation by Indorsement
• An instrument is indorsed when the holder signs it,
thereby indicating the intent to transfer ownership
to another.
• Indorsements may be written in ink, typewritten,
or stamped with a rubber stamp.
• May be written on separate piece of paper (rider,
or allonge) and firmly affixed to the instrument.
16-34
35. Negotiation by Indorsement
• Blank indorsement
– Consists of the signature alone written on the
instrument (no indorsee named)
– Turns order paper into bearer paper, may be
transferred by delivery alone
– If an instrument is made payable to a person under a
misspelled name or name other than their own, payee
may indorse in the correct name, incorrect name, or
both.
16-35
37. Negotiation by Indorsement
• Special indorsement (indorsement in full)
– 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 (indorsee) and the signature of the indorser
16-37
38. Negotiation by Indorsement
• Restrictive indorsements
– limit the rights of the indorsee in some manner to
protect the rights of the indorser
– “for deposit only”
• Conditional indorsement
– type of restrictive indorsement, may be disregarded
– tries to make the rights of the indorsee subject to the
happening of a certain event or condition
– “when he turns 21” “after he mows my lawn”
16-38
40. Negotiation by Indorsement
• Qualified indorsement
– one in which words have been added to the signature
that limit the liability of the indorser
– “without recourse”
– indorser would not be held liable if the instrument was
dishonored
16-40
41. Warranties of Indorsers
1.
2.
3.
4.
Indorser is entitled to enforce the instrument
All signatures are authentic and authorized
The instrument has not been altered
The instrument is not subject to a defense of any
party that can be asserted against the indorser
(except qualified indorsement)
5. Indorser has no knowledge of the bankruptcy of
the maker, acceptor, or drawer
16-41
42. Contract of Indorsers
• Every indorser agrees to pay any subsequent
holder the face amount of the instrument if it is
dishonored (not paid by the maker or drawee)
– Except qualified indorsement (“without recourse”)
16-42
43. Multiple Payees & Missing Indorsements
• “pay to the order of Bob or Sally”
– indorsement of either Bob or Sally required
• “pay to the order of Bob and Sally”
– indorsement of both parties required
• Missing indorsements
– a bank that has taken an instrument from a customer
may supply an indorsement of the customer that is
necessary to title
16-43
44. Unauthorized or Forged Indorsements
• An unauthorized signature or indorsement is one
made without actual, implied, or apparent
authority.
• Does not serve as the signature of the person
whose name is signed
– 3 exceptions
• When payment is made based on a forged
indorsement, tort of conversion results
– the wrongful exercise of dominion and control over
another’s personal property.
16-44
45. Exceptions
• Imposter
– someone who impersonates another person
• When an instrument is issued to an imposter on
the false belief that the imposter is the payee, the
indorsement by any person in the name of the
payee is treated as an effective indorsement.
• Places the loss on the one who is in the best
position to prevent it—the maker or drawer of the
instrument
16-45
47. Imposter Rule Example
Katie gives Bob a check made out to Arnold.
“Here
you go,
Arnold!”
“Thanks! “
(Tee hee)
Bob signs Arnold’s name and cashes it.
16-47
48. Imposter Rule Example
Arnold notices money missing from his account and
asks Katie what’s up.
?
“Wait,
YOU’RE
Arnold?!”
Arnold wants his money back, but who is responsible
for paying?
16-48
49. Imposter Rule Example
Bob is nowhere to be found
“See ya!”
That leaves the bank or Katie
Assuming the bank exercised ordinary care, the
person in the best place to prevent the mistake is the
drawer (Katie)
“Dangit!”
16-49
50. Exceptions
• No Interest Intended; Fictitious Payee
• When the maker or drawer of an instrument
intends the payee to have no interest in the
instrument or the payee is a fictitious person, an
indorsement by any person in the name of the
payee is effective.
16-50
51. Padded Payrolls
• When an agent or employee of the maker or
drawer pads the payroll by supplying the employer
with fictitious names, an indorsement by any
person in the name of each fictitious payee is
effective.
• Places the burden of preventing this type of fraud
on the party in the best position to prevent it—
either the drawer (if a draft) or the maker (if a
note).
16-51
52. Question?
What written document contains an unconditional
promise to pay a fixed amount of money on
demand?
A. Ledger
B. Negotiable instrument
C. Memo
D. Note
16-52
53. Question?
What is written promise by one party to pay money
to the order of another party?
A. Memo
B. Mortgage
C. Note
D. Lien
16-53
54. Question?
What instrument contains an acknowledgment that a
bank has received a sum of money and a promise
by the bank to repay the sum of money?
A. Draft
B. Lien
C. Mortgage
D. Certificate of Deposit
16-54
55. Question?
What type of draft is payable as soon as it is
presented to the drawee for payment?
A. Site draft
B. Cite draft
C. Sight draft
D. Celious draft
16-55
56. Question?
What type of check is guaranteed by the bank that
sufficient funds will be withheld from the
drawer’s account to pay the amount stated on
the check?
A. Certified check
B. Bank check
C. Federal funds
D. Licensed check
16-56
57. Question?
What type of draft that may be purchased as a
substitute for a check?
A. Lien draft
B. Certified draft
C. Money order
D. Lien order
16-57
Editor's Notes
Throughout history, people have had a need to transact business without carrying around large sums of money. In the Middle Ages, for example, merchants carried gold and silver with them as they traveled from one fair to another buying goods. They were in constant danger of being robbed and needed a safer and more convenient method of exchanging their gold and silver for the goods they bought. A system was developed by which merchants could deposit their precious metals with goldsmiths or silversmiths for safekeeping. When the merchants bought goods, instead of paying for them with gold or silver, they simply filled in a piece of paper, called a bill of exchange (now known as a draft). The bill of exchange ordered the goldsmith or silversmith to give a certain amount of the precious metal to the person who sold the goods. That person would then take the bill of exchange to the goldsmith or silversmith and receive payment.
Getting Students Involved
To introduce Part 5, Negotiable Instruments, ask students to discuss how they manage and use money. Have them explain how and why they conduct particular transactions, such as borrowing money and writing and cashing checks. Discuss various problems that arise when people exchange money, and ask students to predict how such problems are addressed by the law.
People who loan money or extend credit as evidence of debt use notes. When two or more parties sign a note, they are called comakers.
Background Information
The first demand notes were the first series of U.S. currency put into circulation. In 1861, at the start of the Civil War, an act of Congress authorized the U.S. Treasury to issue legal tender notes in denominations of $5, $10, and $20. They were called demand notes because they carried the statement, “The U.S. promises to pay the bearer... on demand.” These demand notes were also known as “greenbacks” because they were green on one side.
A CD is a note of the bank, and CDs are written for a specific time period, such as six months, one year, two years, or five years. Banks pay higher interest for longer-term CDs and more interest than regular savings accounts because the depositor cannot withdraw the money before the due date without penalty. Some banks allow a one-time early withdrawal from a CD without penalty.
Terms The word draft comes from the Middle English draught, which is akin to the Old English dragan, meaning “to draw” or “to drag,” and the Latin trahere, “to pull” or “to draw.”
A draft may be presented by the holder to the drawee for payment or for acceptance. When a draft is presented for payment, the drawee may decline to pay it unless it has been accepted. If the drawee refuses to pay an unaccepted draft, the draft is dishonored, and the drawee has no liability for refusing to pay it. In contrast, when a draft is presented for acceptance, the drawee is asked to become liable on the instrument. Acceptance is the drawee’s signed agreement to pay the draft as presented. If the drawee refuses to accept the draft, it is dishonored, and again, the drawee has no liability. Drawees are liable on drafts only when they accept them, that is, agree to become liable on them.
Terms The term bill is derived from the Latin billa, meaning “seal.” During the Middle Ages, bill came to refer to any commercial document.
Ownership of a check may be transferred to another person by endorsement by the payee. In this manner, a check may circulate among several parties, taking the place of money. A bank must honor a check when it is properly drawn against a credit balance of the drawer. Failure to do so would make the bank liable to the drawer for resulting damages.
A certified check, under the UCC, is “a check accepted by the bank on which it is drawn.” The UCC places no obligation on a bank to certify a check if it does not want to do so, and the refusal to certify is not a dishonor of the check. When a check is certified, the drawer is discharged regardless of when it was done or who obtained the acceptance.
Sometimes called a teller’s check or treasurer’s check
A cashier’s check is a check drawn by a bank upon itself. The bank, in effect, lends its credit to the purchaser of the check. It is the equivalent of a promissory note of the bank. Courts have held that payment cannot be stopped on a cashier’s check because the bank, by issuing it, accepts the check in advance.
Only the purchaser can negotiate traveler’s checks, and they are easily replaced by the issuing bank if they are stolen. Traveler’s checks are issued in denominations of $10 and up, and the purchaser of the checks ordinarily pays a fixed fee to the issuer
That organization promises payment from its own funds. Purchasers of money orders fill in their name and address and the name of the payee on the instrument. They are given a receipt along with the money order. If the money order is lost and the purchaser has the receipt, it will be replaced if it has not already been cashed. U.S. Postal Service money orders can be purchased for amounts up to $1,000. U.S. International Postal Service Money Orders are often used to send money to foreign countries. Telegraphic money orders may be used to send money quickly. Under the UCC, a bank money order is a check, even though it is described on its face as a money order, and payment can be stopped on it like an ordinary check.
A maker is a person who signs a note, that is, a person who promises to pay. Comakers are two or more people who sign the same note promising to pay. A drawer is a person who signs a draft, that is, the one who orders payment. An issuer is either a maker or a drawer of an instrument. A drawee is a person ordered in a draft to make payment. A payee is a person to whom a note or draft is payable. A bearer is a person who is in possession of a negotiable instrument that is payable to the bearer or to cash. A person who is in possession of an instrument that has been indorsed in blank (by the payee’s signature alone) is also a bearer. A holder is a person who is in possession of a negotiable instrument that is issued or indorsed to that person’s order or to bearer. A holder in due course is a holder of a negotiable instrument who is treated as favored and given immunity from certain defenses. A detailed discussion of holders in due course can be found in Chapter 27. An indorser is a person who indorses a negotiable instrument, in most cases by signing one’s name on the back of the paper. The different kinds of indorsements are discussed in Chapter 27.
An indorsee is a person to whom a draft, note, or other negotiable instrument is transferred by indorsement. An acceptor is a drawee of a draft who has promised to honor the draft as presented by signing it on its face.
Terms Forgery consists of making a false written instrument with the intent to defraud, altering a genuine instrument in any way, or uttering a forged instrument. In this sense, the word utter means “to offer” or “to pass for value in return.”
A negotiable instrument written in pencil is, however, an invitation to alteration by forgery. If forgery should happen, the person who drew the instrument would be responsible for any loss caused by the negligent drawing of the instrument.
A signature may be made by an agent (one who represents and acts for another) or other representative. No particular form of appointment is necessary to establish such authority. Agents who sign their own names to an instrument are personally obligated if the instrument neither names the person represented nor shows that the agent signed in a representative capacity. The signature may appear in the body of the instrument as well as at the end.
An instrument is conditional, and thus not negotiable, if it states that it is subject to any other agreement. The same is true if an instrument states that it is to be paid only out of a particular fund. This latter rule does not apply to instruments issued by government agencies. An instrument may state that it “arises out of” another agreement without being conditional. Similarly, a negotiable instrument may indicate a particular account that is to be charged.
Money is defined as a medium of exchange adopted by a domestic or foreign government as part of its currency.
Thus, a fixed amount of money need not be money of the United States.
Demand Paper An instrument is payable on demand when it so states or when it is payable “on sight” or “on presentation.” The key characteristic of demand instruments is that the holder can require payment at any time by making the demand upon the person who is obligated to pay.
Definite-Time Paper Certainty as to the time of payment of an instrument is satisfied if it is payable on or before a stated date. Instruments payable at a fixed period after a stated date or at a fixed period after sight are also considered payable at a definite time. In each instance, a simple mathematical calculation makes the maturity date certain. The expressions “one year after date” and “thirty days after sight” are definite as to time. An undated instrument payable sixty days after date is negotiable as a demand paper.
An instrument may be payable to the order of the maker or drawer; the drawee; a payee who is not the maker, drawer, or drawee; two or more payees; an estate, trust, or fund; an office or officer by title; or a partnership or an unincorporated association.
An instrument is payable to bearer when it does not state a payee. An instrument made payable to both, such as “Pay to the order of Anthony Andrews or bearer,” is payable to order unless the word “bearer” is handwritten or typewritten.
An assignment of negotiable instruments also occurs by operation of law when the holder of an instrument dies or becomes bankrupt. In such cases, title to the instrument vests in the personal representative of the estate or the trustee in bankruptcy.
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 indorsed by the payee and delivered to the party to whom it is transferred. If an instrument is payable to bearer or cash, it is called bearer paper and may be negotiated by delivery alone, without an indorsement.
The person receiving the instrument is able, in many instances, to recover money on the instrument even when the person from whom the instrument was received could not have done so.
Negotiation is effective to transfer an instrument, even when it is transferred by a minor, a corporation exceeding its powers, or any other person without capacity; obtained by fraud, duress, or mistake of any kind; part of an illegal transaction; or made in breach of duty. Any such negotiations, however, may be rescinded except as against a holder in due course (defined and explained in Chapter 28), who is given special protection.
When an instrument is indorsed in blank, it becomes payable to the bearer and may be transferred by delivery alone. If the instrument is lost or stolen and gets into the hands of another holder, the new holder can recover its face value by delivery alone. For this reason, a blank indorsement should be used only in limited situations, such as at a bank teller’s window. A blank indorsement turns order paper into bearer paper and may be transferred by delivery alone.
When indorsed in this manner, the instrument remains an order instrument and must be indorsed by the indorsee before it can be negotiated further. The holder of an instrument may convert a blank indorsement into a special indorsement by writing the words pay to the order of a person or pay to a person above the indorser’s signature.
Indorsements for deposit or collection are restrictive indorsements designed to get an instrument into the banking system for the purpose of deposit or collection. When a check is indorsed “for deposit only,” as in Figure 27-2, the amount of the instrument is credited to the indorser’s account before it is negotiated further. Retail stores often stamp each check “for deposit only” when it is received. This wording provides protection in the event the check is stolen. Checks mailed to the bank for deposit should always be indorsed in this way.
By adding the words without recourse to the indorsement, the indorser is not liable in the event the instrument is dishonored, that is, not paid by the maker or drawer.
Indorsements have threefold significance. In addition to being necessary to negotiate order paper, they create obligations on the part of the indorser. These obligations come in the form of implied warranties and a contractual promise to pay subsequent holders of the instrument.
To enforce this obligation, it is necessary for the holder to do two things. The holder of an instrument must first present it for payment to the maker or drawee when it is due. If that person refuses to pay the instrument, it is said to be dishonored. The holder then must notify the indorser or indorsers of the dishonor. If the holder is a bank, notice must be given by midnight of the next banking day. Holders other than banks must give notice within 30 days after the dishonor. Failure by the holder to make presentment and give timely notice of dishonor to an indorser has the effect of discharging that indorser from liability on the contract to pay subsequent holders of the instrument.
A bank that has taken an instrument from a customer to send through the bank collection process may supply any indorsement of the customer that is necessary to title. This rule is designed to speed up bank collections by eliminating the necessity to return to a depositor any items that were not indorsed. Such an indorsement may not be supplied by a bank, however, if the instrument contains the words payee’s indorsement required.
This rule.
Background Information
The maker or drawer of an instrument does not have to meet the impostor to be held liable for any payments made. Fraud perpetrated through the mail is no exception to the rule.
This rule
The correct answer is “B” – Negotiable instrument . See next slide.
The correct answer is “C” – note. See next slide.
The correct answer is “C” – Certificate of Deposit . See next slide.
The correct answer is “C” – sight draft. See next slide.
The correct answer is “A” – certified check. See next slide.
The correct answer is “C” – money order. See next slide.
