Negotiable Instruments

What is a Negotiable Instrument?

A negotiable instrument is an unconditional form of writing that promises the payment of a set amount of money. A negotiable instrument requires six essential elements: it must be in writing, be signed by the maker or drawer, contain an unconditional promise to pay, have a fixed amount of money, be paid on demand or at a definite time, and be made payable to order or to bearer.
Almost all commercial transactions include a negotiable instrument, which is a signed writing that contains an unconditional promise or order to pay an exact amount, either on demand or at a specified time. Negotiable instruments are monetary alternatives to cash. They are often paper documents and are thus often referred to as commercial paper.

Sample Negotiable Check

Each item on a check corresponds to one of the six essential elements of a negotiable instrument.
The Uniform Commercial Code (UCC) specifies four types of negotiable instruments. A check is an order directing a bank to pay a sum of money to a payee. A draft is a negotiable instrument with three parties involved, with one party ordering another party to pay a third party on demand. Drafts and checks are orders to pay. A promissory note is a promise to pay a specific amount at a specific time, usually in the form of a loan. A certificate of deposit (CD) is also a promise to pay a sum at a future date and is usually issued by a bank or other financial institution. When payment can be demanded is a factor as well. A demand instrument is payable on demand at the time of presentment, while a time instrument is a negotiable instrument payable at a specified future date and time. For example, a promissory note or certificate of deposit with a specific maturity date states when it can be redeemed for payment.

Negotiable Order

There are multiple parties in a negotiable order, including the drawer, the drawee, and the payee. Each party relates to the other parties.
Under the UCC, for a negotiable instrument to be valid, it must follow these rules:
  • in writing
  • signed by the maker, who makes a promise to pay, or drawer, who is ordered to pay on a check, usually a bank
  • contains unconditional promise to pay
  • has a fixed amount of money from the drawee, who makes the order to pay on a check
  • on demand or at a definite time
  • payable to order or bearer

There are also other conditions. For example, it must be written on something permanent, such as a piece of paper. Writing on materials such as a chalkboard or in pencil would not be considered permanent. The writing must also be portable, so it cannot be painted on the side of a barn, for instance. Signatures must be on the face of the instrument, but they can be in any form, including a rubber stamp. To satisfy the need for an unconditional promise or order to pay, the negotiable instrument must have words such as "pay on demand" or something that designates that payment is not subject to any conditions or restrictions. The payment amount must be set and easy to understand from the face of the instrument by being either a set amount or for an interest rate with a formula that is easy to calculate and cannot be payable in something that isn't money, such as shares of stock or barrels of oil. Finally, it must be clear who the payor or the payee is. The payor is the person or organization that distributes funds and the payee is the person or organization that receives the funds. This person or organization can be named in a check, draft, or promissory note. If payee information is missing, then the payment is payable to the bearer, which is whoever presents the instrument for payment.