This is the second of two Nolo overview articles on the Uniform Commercial Code (UCC) and negotiable instruments. As discussed in the first article, negotiable instruments are special pieces of paper that can be passed from one person to another and, ultimately, exchanged for money. Two of the most common negotiable instruments are:
- checks you would write to pay for things for your business, like your customers or clients use to pay you; and
- promissory notes you might sign in order to get a business loan, or possibly to document a deal to exchange property for money.
An official comment in the UCC states that a negotiable instrument is “a signed writing that orders or promises payment of money.” However, the writing on the piece of paper must also meet five more specific requirements in order to work as a negotiable instrument:
- the promise or order must be unconditional
- the amount of money must be a fixed amount (with or without interest charges)
- the instrument must be payable to bearer or payable to order
- the promise or order must be payable on demand or at a definite time; and
- the promise or order must not state any other “undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money” (the UCC lays out a few exceptions to this final requirement that we don’t cover here).
We will briefly look at each of the latter five requirements.
Unconditional Promise or Order
The UCC assumes that promises or orders to pay are unconditional unless:
- there is an express condition to the promise or order
- the promise or order is subject to some other record; or
- rights or obligations with respect to the promise or order are stated in another record.
In the case of a standard, properly written check, which you can think of as an order for a bank to pay the person presenting the check, there shouldn’t be any concern about the order to pay being conditional.
However, you might imagine a signed piece of paper that states, “I promise to pay Dennis $50,000 if he transfers the title of his 2012 yellow Maserati convertible to me.” While this might be a binding contract between you and Dennis, it is not a negotiable instrument because your payment of money is expressly conditioned on Dennis transferring title to his car. If Dennis “negotiated” this piece of paper to Michelle, it would not give Michelle the right to demand the $50,000 from you.
Similarly, a promissory note that includes a statement such as, “This note is subject to a sales agreement dated July 1, 2010 between the payee and the maker of this note” is not a negotiable instrument. The latter language makes the note subject to another record (another document). The note itself might well be an enforceable contract with regard to both the maker and the payee. But, if the note is transferred by the payee to some other person, that other person would not be able to demand payment from the maker.
Finally, a promissory note might contain a statement like, “The rights and obligations of the parties with respect to this note are stated in an agreement dated July 1, 2010 between the payee and the maker of this note.” Once again, this note is not a negotiable instrument: the foregoing statement indicates that rights and obligations regarding the note are contained in another record.
In short, negotiable instruments, such as checks and many promissory notes, generally are intended to stand on their own. In order to transfer, or negotiate, these pieces of paper to other people who can then exchange them for money, nothing else should be necessary—neither some special, additional condition, nor reference to some additional document or record.
Fixed Amount of Money
This requirement is largely self-explanatory. One point worth making, however, is that the amount to be paid on a negotiable instrument—notably a promissory note—may include interest. In such cases, the fixed amount requirement refers only to the principal due on the instrument and not the interest. The interest rate may be variable, and may require reference to information not contained in the note, without rendering the note non-negotiable. In fact, even if the amount of interest payable cannot be ascertained from whatever description is contained in the instrument, the UCC provides for a default interest rate—the judgment rate—which is a rate defined in state law in relation to judgments in certain court cases.
Payable to Bearer or Payable to Order
Most checks are preprinted with the words “Payable to the order of” followed by a blank line for the name of the payee. A check or other negotiable instrument does need clear language stating “payable to the order of” along with a payee’s name, or else “payable to bearer,” in order to serve as a negotiable instrument. In fact, the phrases “payable to order of” and “payable to bearer” are often called “words of negotiability,” meaning that they are special phrases to look for in trying to figure out if a signed order or promise is in fact a negotiable instrument.
In the case of a check or other instrument that states “payable to the order of” along with a payee’s name, transferring (negotiating) the instrument to another person requires that the payee, or any subsequent holder of the instrument, sign the instrument as part of the transfer process. Similarly, a holder of the instrument who is trying to exchange it for money (for example, from a bank) must also sign the instrument. (The UCC calls signing in this context an indorsement—and, yes, that’s spelled with an initial “i” not an “e.”) However, in the case of an instrument that states “payable to bearer,” no signature is needed to properly transfer the instrument to a new person, or to exchange the instrument for money.
An official comment in the UCC clarifies how a check preprinted with the words “Payable to the order of” may nonetheless be payable to the bearer, i.e., whoever is holding the check and presents it to the bank on which it’s drawn. For example, if, after the preprinted words “Pay to order of,” you fill in the blank line with the word “Cash” or “Bearer,” then the check is payable to the bearer. Similarly, you could fill in the blank with something like “Winona Garbadale or Bearer,” and, according to the UCC, that check, too, would be payable to the bearer. And, finally, a check without a stated payee is also payable to the bearer (this is true even though instruments that do not state a payee are technically considered “incomplete” (for more information, see the first Nolo overview article on negotiable instruments)).
As a final point, note that a check or other instrument cannot be payable both to order and to bearer, it can only be payable to one or the other. Consequently, if there is some question about whether or not a check being passed on to you is payable to bearer, you should take time to investigate the matter, and, if necessary, obtain the proper indorsements.
On Demand or at a Definite Time
The general rule is that a negotiable instrument is payable on demand if it either states “payable on demand” or does not state any time of payment. However, a promise or order is payable at a definite time if it is payable:
- on a fixed date
- at a time readily ascertainable at the time the promise or order is issued; or
- after the elapse of a definite period of time.
It is also possible for a negotiable instrument to be both payable on demand and on a fixed date, in which case if demand for payment is not made before the fixed date, it is payable on the fixed date.
Must Not State Any Other Undertaking or Instruction
A negotiable instrument must not require any “undertaking or instruction” other than that related to the payment of money. As an official comment in the UCC makes clear, the terms “undertaking” and “instruction” are actually adapted from earlier rules that used the words “promise” and “order;” because “promise” and “order” are used in other rules regarding negotiable instruments (see the first Nolo overview article on negotiable instruments), the new terms are used to avoid confusion. In short, apart from a promise or order to pay money, a negotiable instrument must not also include other promises, orders, or similar undertakings or instructions. Like the requirement that a negotiable instrument be an unconditional promise or order, this requirement regarding other undertakings and instructions is related to the fundamental purpose that negotiable instruments be quickly and easily transferable between holders and ultimately be readily exchangeable for money.
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 other basic information on negotiable instruments, such as the distinction between drafts and notes, and rules regarding incomplete instruments, check the first Nolo overview article on the topic.