What Are Negotiable Instruments Under the UCC?

An overview of a few of the most basic UCC rules for how checks, promissory notes, and other negotiable instruments work.

By , Attorney
Updated by Amanda Hayes, Attorney · University of North Carolina School of Law

A negotiable instrument is a special piece of paper that can be passed from one person to another and, ultimately, exchanged for money. Negotiable instruments would include, for example, a check you write to pay for business inventory or a promissory note that you sign to get a business loan.

The passing, or transfer, of the piece of paper is known as a "negotiation." 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.

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.

Important UCC Article 3 Definitions Related to Negotiable Instruments

The UCC is riddled with terms and their corresponding definitions. Sometimes keeping track of them can be the most difficult part of understanding the model code. Before we dive too deep into the details of negotiable instruments, we should first clear up two terms that are often times confusing to parse:

  • "Bearer": A person who has possession of a negotiable instrument that's either payable to "bearer" or that's been signed with no payee specified.
  • "Holder": A person who has possession of a negotiable instrument that's payable either to "bearer" or specifically to the person who possesses it.

Both a holder and bearer can redeem a negotiable instrument (like a check) that's been made out to "bearer." For example, a check would say "Pay to the order of bearer."

But, generally, only a holder can redeem an instrument that specifies them (lists their name) as the payee. For instance, for a check that says "pay to the order of Alex Mack," Alex Mack would be the holder as long as she has possession of the check.

Two Types of Negotiable Instruments

The UCC defines two types of negotiable instruments:

  • a draft (an order to pay money) and
  • a note (a promise to pay money).

A Draft: An Order to Pay Money

The most obvious example of a draft would be a check. When a person with the authority to cash or deposit a check presents it to the appropriate bank, they're effectively presenting an order that the bank pay the amount of the check. As long as certain conditions are met—such as the person with the check being authorized to cash it and not engaging in some kind of fraud—the bank has the legal obligation to comply with that order.

When issued, checks and other drafts commonly involve three parties:

  • the person writing the check (the "drawer" of the check)
  • the person who the check specifies should be paid (the "payee" of the check); and
  • a bank that has the funds to cover, and will give money for, the check (the "drawee" of the check).

Generally, the payee of a draft (and of a note) has physical possession of the instrument and is the holder.

A Note: A Promise to Pay Money

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. The borrower is legally obligated to pay the note according to its terms. For example, a note will usually include either a date when the payment is due or a statement that payment is due upon demand.

Notes generally involve just two parties:

  • the person signing the note who's promising to pay money (the "maker" of the note); and
  • the person to whom the note specifies the money is to be paid (the "payee" of the note).

Another example of a note would be a certificate of deposit (CD) at a bank.

Creating a Negotiable Instrument

In the most basic terms, a "negotiable instrument" is a signed written order or promise to pay 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 written order or promise to pay money, a piece of paper with writing on it must contain five additional features to be considered a negotiable instrument.

To qualify as a negotiable instrument, the signed written order or promise must also:

  • be unconditional
  • be for a set amount of money (with or without interest charges)
  • be payable either to the "bearer" (an unspecified person who possesses the instrument) or to a specific person who must also endorse (sign) the instrument
  • be payable either on demand or at a specific time, and
  • only include the promise or order of payment and no additional action beyond that.

(U.C.C. §3-104.)

In practice, of course, and especially when it comes to checks, it's usually fairly easy to comply with all these requirements and to create a check that'll 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. For more information, see part one of Article 3 of the UCC.

Incomplete Negotiable Instruments Under the UCC

In some cases, a check, promissory note, or other signed piece of paper intended to serve as a negotiable instrument might be missing some necessary piece of information that the signer intended to include. In these cases, the UCC considers the writing an "incomplete instrument."

An incomplete instrument isn't necessarily non-negotiable. On the contrary, in some instances, the UCC allows words and numbers to be added—with the signer's authority—to complete an incomplete instrument. In other instances, the UCC provides default rules when certain information is lacking.

When there's no due date. A signed promissory note might 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 can add that date to the note. Alternatively, if no date is added to the note, then the default UCC rule is that the note is payable on demand.

When there's no payee listed. Also, a check with no payee listed is "incomplete," but, nonetheless—according to the UCC—such a check is payable to the bearer.

Enforcing a Negotiable Instrument

For a negotiable instrument to be enforced and redeemed, the person trying to enforce the instrument must meet certain requirements. Discussed below are some of these requirements.

Who can enforce the instrument? An instrument can be enforced by the holder of the instrument or by someone who has the rights of a holder—such as a holder's successor or someone who has a legal claim to the instrument through the holder. You can sometimes also enforce an instrument that's been lost or stolen.

Free of forgery or unauthorized alteration. You can't enforce an instrument that's been forged or altered in a way that's unacceptable under the UCC. Generally, you also can't enforce an instrument that's overdue or has been dishonored.

Exchanged for value. An instrument that's been exchanged for value (consideration) can typically be enforced. Exchanged for value can mean an instrument that's given in exchange for money, the performance of an obligation, a security interest, or another negotiable instrument.

Free of claims and defenses. Generally, an instrument can be enforced as long as the person promising to make the payment or writing the check (or draft)—referred to as the "obligor"—doesn't have a valid defense or claim against the instrument's enforcement. For example, the obligor can argue against enforcement by claiming they lacked legal capacity or were under fraud or duress when they made the note or draft. The obligor can also argue that you breached your obligation to them and therefore aren't entitled to enforce the instrument.

For more details on the enforcement of negotiable instruments, check out part three of Article 3 of the UCC.

Speaking With a Business Attorney

Negotiable instruments are subject to many rules. Violating a single one can make your negotiable instrument unenforceable. Most people dealing with negotiable instruments will find it helpful to speak with a business lawyer at some point. If you have a negotiable instrument you're not sure is valid or you need to create a negotiable instrument, a lawyer can help. They can advise you on your state's laws on negotiable instruments and help you make a valid and enforceable instrument.

Note that while all states have adopted Article 3 of the UCC into their laws, there might be slight differences from the model code. Make sure you check your state's laws or ask a lawyer for state-specific guidance.

For additional details on the required elements of negotiable instruments, check out our section on the UCC.

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