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Types of Commercial Paper

2. What are common types of commercial paper?

When examining the attributes of commercial paper, it is important to differentiate between the most common types of instrument. The types of commercial instrument include:

•    Note – This is a promise to pay money. It involves two parties. The maker of the note makes an unconditional promise to pay the payee. The payee is the personal entitled to payment of the note. This is normally the holder of the notes. The payment may be due at a date certain or on payable on demand.

⁃    Note: Most notes, such as a promissory note, have some form of the word note in the name. Bank notes are called certificates of deposit (CD). The UCC generally lists CDs as a completely separate type of instrument from a note because they are the subject of numerous special rules.

⁃    Example: Amy creates a document in which she promises to pay the holder of the note $500. She gives the note to Brenda as payment for a contract to purchase goods. Brenda is now the holder of this note (commercial paper). Because no dates is stated on the note, it is payable on demand. That is, Brenda or some other holder can present the note to Amy at any time and ask for payment. If the note states that it will be paid on October 1, 2017, it is payable on time or at this stated date.

•    Drafts – This is an order directing someone else to pay money. It involves three parties. The “drawer” is the maker of the draft. The “drawee” is the party ordered to make payment to the “payee” or holder of the draft. A draft can involve a drawee who is an individual or business.

⁃    Note: A check is the most common form of draft. In the case of a check, the drawee is a bank. The UCC generally lists a check as a completely separate type of instrument from a draft because checks are the subject of numerous special rules. Nonetheless, a check functions similarly to any form of draft.

⁃    Example: Charlie owes Doug money. Doug creates a document indicating that Charlie is ordered to pay the owed money to Evan. The document (a draft) states that Evan can present the draft to Charlie at any time for payment. This is a draft payable on demand.

Either of these types of types of instrument can be a negotiable instrument if they meet specific requirements.

•    Discussion: Why do you think notes and drafts are categorized separately in the context of commercial paper? Can you think of situations where a note might meet the requirements of commercial paper but the draft would not? Vice Versa?

•    Practice Question: Phillip enters into a contract with Henry to sell him construction supplies. Henry asks Phillip if he is willing to accept commercial paper as payment instead of cash. Can you explain to Phillip what is commercial paper and the requirements for each type?

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