Commercial Paper• Commercial paper is a contract to pay

money.• It can be:– A Substitute for Money– A Loan of Money

Promissory Note• The possessor of a piece of commercial

paper has an unconditional right to be paid, as long as: – the paper is negotiable; – it has been negotiated to the possessor; – the possessor is a holder in due course;

and – the issuer cannot claim any of the limited

number of “real” defenses.

Types of Negotiable Instruments• Note (also called a promisory note) is a

promise to pay money.– Certificate of Deposit (CD) is a note made by

a bank.• Draft is an order directing someone else

to pay money for you (e.g., checks).– Cashier’s check -- a draft drawn by a bank on

its own account.– Traveler’s check -- a draft issued by and paid

by the same company (such as American Express)

Definitions• Trade acceptance -- draft drawn by a seller

of goods on the buyer and payable to the sell or some third party

• Sight draft -- payable on demand• Time draft -- payable at some particular

time in the future• Order paper -- payable to the named

person or anyone designated by that named person

• Bearer paper -- payable to anyone in possession of the paper

Rights• The possessor of non-negotiable

commercial paper has the same rights--no more, no less--as the person who made the original contract.

• The possessor of negotiable commercial paper has more rights than the person who made the original contract.

Requirements for Negotiability

• The Instrument Must:– Be in Writing.– Be Signed by the Maker or Drawer.– Contain an Unconditional Promise or Order to

Pay.– State a Definite Amount of Money.– Be Payable on Demand or at a Definite Time.– Be Payable to Order or to Bearer.

Interpretation of Ambiguities• When terms contradict, three rules

apply:– Words take precedence over numbers.– Handwritten terms prevail over

typewritten terms.– Typed terms prevail over printed terms.

Negotiation• Negotiation means that an instrument

has been transferred to the holder by someone other than the issuer.– To be negotiated, order paper must first

be indorsed and then delivered to the transferee.

– Bearer paper must simply be delivered to the transferee; no indorsement is required.

Indorsement • An indorsement is the signature of the

payee.– Blank Indorsement -- does not designate a

new payee; becomes bearer paper.– Special Indorsement -- does designate a new

payee; only that person may cash the check.– Restrictive Indorsement -- limits the check to

one particular use (such as deposit into a particular account).

Holder in Due Course• A holder in due course has an automatic

right to receive payment for a negotiable instrument (unless issuer can claim one of a few “real” defenses).

• Requirements for Holder in Due Course– Under §3-302 of the UCC, a holder in due

course is a holder who have given value for the instrument, in good faith, without notice of outstanding claims or other defects.

Notice of Outstanding Claims or Other Defects

• The instrument is overdue• The instrument is dishonored• The instrument is altered, forged, or

incomplete• The holder has notice of certain claims or

disputes

Shelter Rule• Under the shelter rule, the transferor

of an instrument passes on all of his rights.

• When a holder in due course transfers an instrument, the recipient acquires all the same rights even if she is made a holder in due course herself.

Defenses• Real and personal defenses are valid against an

ordinary holder; only real defenses can be used against a holder in due course.

• Real Defenses– Forgery, Bankruptcy, Minority, Alteration Duress, Mental

Incapacity, Illegality, and Fraud in the Execution

• Personal Defenses– Breach of Contract, Lack of Consideration, Prior

Payment, Unauthorized Completion, Fraud in the Inducement and Non-Delivery

Claims in Recoupment• A Claim in Recoupment is not the same as a

defense, but it has similar impact.• Claim in Recoupment is a refusal to pay the full

amount of the instrument because the payee owes the issuer another debt. Issuer subtracts the prior debt from the payoff of the current instrument.

• In contrast, a defense is a refusal to pay the instrument due to some problem with the instrument or the underlying agreement.

Consumer Exception

• A consumer credit contract is one in which the seller is also the lender.

• In such cases, the Federal Trade Commission requires a specifically-worded notice to be included on the contract, making it non-negotiable.

“Commercial paper is a fact of life for most people today; it is used

extensively in business and consumer transactions. But,

whenever someone acquires a document, he ought to quickly ask

himself, ‘How certain am I to be paid the face value of this

document?’”