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Identify
Negotiable Instruments

Master the UCC Article 3 requirements that make a document freely transferable as a substitute for money: the building blocks of commercial paper.

CPA Regulation (REG)

What Is a Negotiable Instrument?

A negotiable instrument is a written document that contains an unconditional promise or order to pay a fixed amount of money. It can be transferred from one party to another, functioning as a substitute for cash in commercial transactions.

Two Categories of Commercial Paper

Notes (Promises)
A two-party instrument: the maker promises to pay the payee. Example: a promissory note for a loan.
Drafts (Orders)
A three-party instrument: the drawer orders the drawee to pay the payee. Example: a personal check.

Why Negotiability Matters

Negotiability gives a transferred instrument special legal protection. A holder in due course (HDC) takes the instrument free of most personal defenses, making it more reliable than an ordinary contract right.

✓ Negotiable
HDC can enforce payment even if original parties have disputes
✕ Non-Negotiable
Transferee gets only the rights of the transferor: subject to all defenses

The Six Requirements of Negotiability

1
Writing: The instrument must be in a written (tangible) form.
2
Signed by maker/drawer: An authenticated signature of the person issuing it.
3
Unconditional promise or order to pay: No conditions or contingencies attached.
4
Fixed amount of money: The principal must be determinable from the face of the instrument.
5
Payable on demand or at a definite time: The holder must know when to expect payment.
6
Payable to order or to bearer: Must contain "words of negotiability."

Negotiability Decision Flow

Is it a Writing? Signed by maker/drawer? Unconditional promise/order? Fixed amount of money? Demand or definite time? Order or bearer language? YES NEGOTIABLE NO Not Negotiable NO NO NO NO NO YES YES YES YES YES

Requirement 3: Unconditional Promise or Order

The promise or order must not be subject to any condition or contingency. A statement like "I promise to pay if goods are delivered" destroys negotiability because it makes payment dependent on a future event.

✓ Permitted
A reference to another agreement for informational purposes (e.g., "as per contract dated...")
✕ Not Permitted
Making payment subject to or governed by another agreement's terms

Requirement 4: Fixed Amount of Money

The principal must be a fixed, determinable sum. The holder must be able to look at the face of the instrument and know how much is owed.

✓
Variable interest is allowed: "principal of \(\$10{,}000\) plus interest at prime rate" is still negotiable because the principal is fixed.
✓
Money means a government-authorized medium of exchange: dollars, euros, yen. Payment in goods or services destroys negotiability.
✕
"Pay \(\$5{,}000\) plus the value of 100 shares of XYZ stock" is not a fixed amount of money.

Requirement 6: Words of Negotiability

The instrument must include "pay to the order of" (order paper) or "pay to bearer" (bearer paper). These magic words signal that the instrument is intended to be freely transferable.

Order Paper
"Pay to the order of Jane Doe": payable to a specific person, transferred by endorsement + delivery.
Bearer Paper
"Pay to bearer" or "Pay to cash": payable to whoever holds it, transferred by delivery alone.

Notes vs. Drafts: Key Distinctions

Note (Promise) Draft (Order)
Number of Parties Two (maker, payee) Three (drawer, drawee, payee)
Language "I promise to pay..." "Pay to the order of..."
Primary Liability Maker Drawee (after acceptance)
Common Examples Promissory note, CD Check, trade acceptance
Demand vs. Time Usually time instrument Checks are demand; trade acceptances are time

How to Analyze an Instrument

1
Check the form: Is it a writing signed by the maker or drawer?
2
Read the promise/order: Is it unconditional, or does it depend on some outside event or agreement?
3
Identify the amount: Is the principal a fixed sum of money (not goods, services, or stock)?
4
Check timing: Is it payable on demand or at a definite time (a specific date or a determinable future date)?
5
Look for magic words: Does it say "to the order of" or "to bearer"? (Remember: checks are exempt.)
6
Conclude: If all six are met, the instrument is negotiable. If any one fails, it is not negotiable.

Example 1: Promissory Note

1
Writing? Yes: it is a written document.
2
Signed? Yes: "Signed: Alex Baker."
3
Unconditional? Yes: "I promise to pay" with no conditions.
4
Fixed amount of money? Yes: \(\$25{,}000\) (variable interest is OK).
5
Definite time? Yes: June 1, 2026.
6
Words of negotiability? Yes: "to the order of."

Example 2: Conditional IOU

✓
Writing and signed? Yes.
✕
Unconditional? No: payment depends on "once Sam completes renovation" : this is a condition.
✕
Definite time? No: "within 30 days of completion" is not a definite calendar date.
✕
Words of negotiability? No: says "pay to Sam Rivera" without "order of" or "bearer."

Example 3: The Check Exception

Under the general rule, the absence of "order of" or "bearer" would destroy negotiability. However, UCC 3-104(c) provides a special exception:

Common Mistakes to Avoid

✕ Confusing "Reference" with "Subject To"
A mere reference to another contract does not destroy negotiability. Only making payment subject to that contract's terms does.
✕ Thinking Variable Interest Kills Negotiability
Only the principal must be fixed. Interest may float at prime, LIBOR, or another variable rate without affecting negotiability.
✕ Forgetting the Check Exception
Checks are negotiable even without "order of" or "bearer." This exception applies only to checks, not to other drafts or notes.

Summary: All Six at a Glance

Requirement What Satisfies It What Destroys It
Writing Paper, tangible form Oral promise
Signature Any mark intended as authentication Unsigned document
Unconditional Reference to another agreement Payment "subject to" a condition
Fixed Amount Fixed principal + variable interest Payment in goods or stock
Time of Payment Specific date or "on demand" "When I feel like it"
Magic Words "Order of" / "bearer" (checks exempt) "Pay to John Smith" (non-check)

Question 1 of 5

A promissory note states: "I promise to pay to the order of First National Bank \(\$10{,}000\) on March 1, 2025, subject to the terms of our loan agreement dated January 15, 2024." Is this instrument negotiable?

Question 2 of 5

Which of the following statements about a certificate of deposit (CD) is correct?

Question 3 of 5

A note reads: "I promise to pay to bearer \(\$8{,}000\) plus 100 shares of ABC Corp. stock on December 31, 2025." Which requirement of negotiability does this note fail?

Question 4 of 5

A personal check is made payable to "Cash." This check is best described as:

Question 5 of 5

An instrument states: "I promise to pay to the order of Lee Park \(\$15{,}000\) with interest at prime rate plus 2%, payable when the borrower has sufficient funds." Is this negotiable?