Lender Liability Defenses

Requirements for negotiable instruments

Individuals commonly use negotiable instruments in business transactions to secure and distribute loans or to finance the movement of goods. For it to be a negotiable instrument, you must sign the instrument, in writing, and the:

• Promise or order is unconditional.
• Amount of money is fixed with or without interest charged.
• Instrument is payable to bearer or to order.
• Promise or order is payable on demand or at a definite time.
• 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.”

In some cases, negotiable instruments may be incomplete. The UCC refers to these as “incomplete instruments.” If a negotiable instrument is missing any of the aforementioned criteria, the UCC permits addendums to the incomplete instrument with the authority of the signer.

If there is no addendum, and the instrument remains incomplete, the UCC provides some guidelines. For instance, if a promissory note contains no specified date of payment, both parties may agree to amend the note by establishing one. If both parties can’t agree to the date of payment, the UCC defaults on the stance that the note is payable on demand.

When drafting a negotiable instrument, however, it’s important to understand the default rules of the UCC. If terms within the negotiable instrument are not defined specifically, the UCC provides “default” definitions for them. It’s important to know what those definitions are.

Categories of negotiable instruments

The two categories are:

• Drafts: An order to pay money, such as check or money order
• Notes: A promise to pay money, such as promissory notes associated with a loan

A New Jersey banking law attorney prefaces that although checks are a negotiable instrument, checks are generally covered by Article 4 (banking law) of the UCC rather than Article 3.

Drafts vs. promissory notes

Drafts are commands to pay. They are issued by the drawer ordering another party the drawee to pay a third party called the payee. A promissory note involves one party promising to pay a second party a specific amount of money at a specific time. Promissory notes are primarily used for loans while drafts are much more versatile and can be used for a number of different business deals.

Bearer instruments vs. order instruments

Negotiable instruments may be divided into other types: order instruments and bearer instruments. Essentially, these govern how the instrument is “negotiated” (or transferred).

An order instrument is made payable to the order of a specified party. A bearer instrument can be transferred to another party without being endorsed first. Bearer instruments are paid “to the bearer of” as opposed to the “order of”. In other words, bearer instruments do not specify a particular payee.

Generally speaking, endorsement requirements are laid out within the text of the negotiable instrument and can contain caveats that turn bearer instruments into order instruments and vice versa.

Endorsements of negotiable instruments

Generally, endorsement includes any party attaching themselves to a negotiable instrument. Usually, it refers to parties to whom the negotiable instrument is to be paid. These can either validate the negotiable instrument or make it payable to a new party.

The most basic type of endorsement is a signature. The signature authorizes the transfer of money from one party to another. This is also called a blank endorsement which authorizes the bearer to cash the funds attached to the instrument. The most common form of this is a money order.

A check, on the other hand, only authorizes a single individual to negotiate the instrument. Hence why you pay checks to the order of a specific person.

Liability and negotiable instruments

Any signatory on the negotiable instrument is liable for payment. Generally, however, there is an order of liability. One party may be primarily liable for the instrument while a second would have secondary liability. The party with secondary liability is essentially co-signing on the instrument. If the first party fails to pay, the other signatory would be required to do so in their stead.

In some cases, there may be a legitimate reason for refusing to negotiate the instrument. In these cases, a negotiable instruments attorney may be able to reduce or eliminate a signatory’s liability.

Contact a New Jersey banking law attorney

If you have questions about negotiable instruments, contact a knowledgeable New Jersey banking law attorney with Snellings Law LLC.