A negotiable instrument is a special piece of paper that can be passed from one person to another and, ultimately, exchanged for money. The passing, or transfer, of the piece of paper is known as negotiation, and the ability to freely make these kinds of person-to-person transfers, and then ultimately to exchange the piece of paper—or instrument—for money, is what makes the instrument negotiable. You are probably already familiar with one of the most common negotiable instruments: a check, such as you would write to pay for things for your business, and that your customers or clients might use to pay you. Another common negotiable instrument with which you also may be familiar is a promissory note, such as you might sign in order to get a business loan, or possibly to document a deal to exchange property for money.
Article 3 of the Uniform Commercial Code (UCC) contains dozens of sections laying out hundreds of rules for how checks, promissory notes, and other negotiable instruments work. In this first of two Nolo overview articles on negotiable instruments, we look at a few of the most basic UCC principles.
Two Types of Negotiable Instruments
The UCC defines two types of negotiable instruments: drafts and notes. A draft is an order to pay money and a note is a promise to pay money.
The most obvious example of a draft would be a check. When a person, often called a “bearer,” presents a check at the bank on which it is drawn, he or she is effectively presenting an order that the bank pay the amount of the check. As long as certain conditions are met—such as that the bearer not be engaging in some kind of fraud—the bank has the legal obligation to comply with that order.
A common example of a note is a promissory note associated with a loan. The borrower has promised to pay the amount of the note to a person presenting the note for payment (who is often known as the “holder”). The borrower is legally obligated to pay the note according to its terms, which, for example, usually include either a date by which the payment is due or a statement that payment is due upon demand.
Admittedly, the difference between a draft and a note, between an order to pay and a promise to pay, is not always entirely clear. However, when they are issued, checks and other drafts commonly involve three parties:
By contrast, notes generally involve just two parties:
The original payee of an instrument (check or note) usually also has physical possession of the instrument. In any case, the person currently possessing an instrument, whether or not he or she is specifically identified on the instrument as a payee, is generally known as the “holder” of the instrument.
Creating a Negotiable Instrument
As stated in an official comment in the UCC, in the most basic terms a negotiable instrument is “a signed writing that orders or promises payment of money.” However, not every signed piece of paper with a reference to money being paid is a negotiable instrument. For example, if you write “I owe Carol $5,000” on a sheet of paper and then sign it, you haven’t necessarily created a negotiable instrument under the UCC. On the contrary, beyond being a signed writing ordering or promising payment of money, a piece of paper with writing on it must meet five additional requirements in order to be a negotiable instrument:
In practice, of course, and especially when it comes to checks, it is usually fairly easy to comply with all these requirements and create a check that will work as a negotiable instrument. However, checks, as well as notes, are sometimes prepared in atypical ways. With that in mind, the UCC provides a great deal of additional detail regarding each of these five requirements. We review some of those additional details in another Nolo article on negotiable instruments.
Making an Instrument Non-negotiable
A promissory note that may otherwise be negotiable can be made non-negotiable by adding the words “NOT NEGOTIABLE” to the note. This added language does not, however, work to make checks non-negotiable.
In some cases, a check, promissory note, or other signed piece of paper intended to serve as a negotiable instrument may be missing some necessary piece of information that the signer intended to include. In such cases, the UCC considers the writing an “incomplete instrument.” An incomplete instrument is not necessarily non-negotiable. On the contrary, in some instances, the UCC permits words and numbers to be added, with the authority of the signer, to complete an incomplete instrument. In other instances, the UCC provides default rules when certain information is lacking. For example, a signed promissory note may not state a due date for payment. However, according to an official comment in the UCC, if both the maker and the payee had agreed on a due date, the payee may add in that date on the note. Alternatively, if no date is added to the note, then the default UCC rule is that the note is payable on demand. Also, a check with no payee listed is “incomplete,” but, nonetheless, according to the UCC, such a check is payable to the bearer.
This article is based on the current version of the model Uniform Commercial Code (UCC). However, not all states have adopted all sections of the current model UCC. Moreover, the model UCC specifically leaves it to individual states to determine the precise wording of certain sections. Therefore, you should always check your own state’s commercial code for the most accurate information.
For additional details on the required elements of negotiable instruments, check the Nolo website sectionon the Uniform Commercial Code.