5. What is required for commercial paper to be “negotiable”?
An instrument is negotiable if it meets the following qualifications:
• Writing – The instrument must be in writing,
⁃ Note: The writing must be permanent in nature and must be moveable.
⁃ Example: Drawing the terms of an instrument in the dirt would not be permanent, and spray painting the terms of an instrument on the side of a building would not be moveable.
• Signed by Issuer – The issuer must sign the instrument. A mark may constitute a signature if the issuer intends for the mark to be a signature.
⁃ Example: Valid marks constituting signatures may include seals, auto-pen signatures, personal stamps, etc.
• Unconditional Promise to Pay – The instrument must contain an unconditional promise to pay. A condition is any requirement that a holder must undertake before she has the right to present the paper for payment.
⁃ Note: The only acceptable condition is providing a time when the note becomes valid. That is, the note can state that it may only be presented for payment after a certain date. Further, any “acceleration” or “extension” clauses are valid and do not destroy negotiability. Reciting that consideration was provided for the instrument does not harm negotiability. Limiting the payment to a specific fund may destroy negotiability, unless it is an order instrument drawn on a specific account.
⁃ Example: “I promise to pay money to the order of bearer, if the bearer is a US citizen” is not an unconditional promise to pay.
• Definite Amount – The instrument must state a specific amount of money that it will pay.
⁃ Note: The promise cannot be to pay in anything other than money. If the instrument pays an interest rate, the interest rate may reference a standard rate for calculation.
⁃ Example: “Promise to pay $3,000 with interest of 3% + prime rate, compounding annually from the date of issuance” is a definite amount.
• Payable on Demand or on Time – A “demand instrument” must be paid whenever the holder requests payment, while a payable “on time” instrument indicates a specific date and time.
⁃ Note: An instrument that does not have a specific maturity date or payment time is assumed to be payable on demand.
⁃ Example: A note including the language, “payable on or before 90 days after October 15, 2017” is a definite time.
• Payable to Order or To Bearer – To be negotiable, an instrument must be either “order paper” or “bearer paper”. Order paper is payable to a specific individual. This individual’s signature is required if the instrument is transferred to another holder. Bearer paper means that any holder of the paper can present it for payment.
⁃ Note: Order paper can be converted to bearer paper with the holder’s signature (indorsement). A holder can also make bearer paper into order paper by signing and making a restrictive indorsement.
⁃ Example: “Pay to John or order” is order paper. “Pay to the order of ______” or “Payable to bearer” are examples bearer paper.
• No Further Undertaking – With limited exception, the instrument cannot require the holder to undertake any action other than present the instrument to receive payment.
⁃ Note: This is an extension of the requirement that the instrument contain an “unconditional” promise to pay.
⁃ Example: A holder, upon presentment, must post a temporary bond. This is a further undertaking that makes the instrument non-negotiable.
Remember, non-negotiable paper may still be transferred. The transferee of non-negotiable paper may have fewer rights than the holder of negotiable paper through a valid negotiation.
• Discussion: Why do you think each of the above elements is necessary to make an instrument negotiable? Do you believe that any of these elements should be excluded or other elements added? Why?
• Practice Question: Devon is debating whether to accept commercial paper from Clint as payment on a contract. The promissory note was created by a third party and used to satisfy a debt to Clint. It is payable on or after a specific date six months away. The Devon is worried about the liquidity of the instrument and whether the maker of the note has any defenses against its enforcement. Can you explain to Devon the requirements and benefits of a negotiable instrument?