Negotiable Instruments - Order or Bearer Paper
When is Commercial Paper Order Paper or Bearer Paper?
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To constitute a negotiable instrument (both notes and drafts), an instrument must be either order paper or bearer paper.
What is order paper?
Order paper must include the words pay to the order of (identified person) or to (identified person) or order. Including the word order indicates that the instrument is not limited to only one person. That is, the payee of the instrument can designate someone else to receive payment. This generally requires the identified person to indorse (sign) the instrument. Signing the instrument makes it bearer paper, unless the signor identifies a person to whom the instrument is being transferred.
Note: If the note is simply made out to pay a particular person without the word order, it is not negotiable.
What is bearer paper?
If the commercial paper is made out to bearer or it is not made out to any specific person, it is bearer paper. It can be redeemed by any holder of the paper, subject to certain defenses.
Note: Bearer paper may also use the wording order. If the paper is made out to order of gift or order of cash or pay to order of (blank space) , it is bearer paper.
If all other requirements are met, the UCC provides an exception to the order paper or bearer paper requirement for commercial paper to be negotiable, but this exception does not apply to notes. Primarily, this exception applies to drafts drawn on third-party institutions that inadvertently leave off the to order language, but the nature of the paper is obvious.
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Discussion: Why do you think it is important to identify whether the paper is order or bearer paper? Does it affect your opinion knowing that bearer paper can be converted to order paper and vice versa? Why or why not? Can you think of specific uses or order paper versus bearer paper? How does bearer paper limit the liquidity of the instrument? Should this affect the instruments value?
Practice Question: Constance creates a promissory note that names Doug as the payee. Is this a negotiable instrument? What would need to be included to make the instrument negotiable order paper? What would need to be included to make the instrument negotiable bearer paper?