Question

Discuss general and specific concepts concerning the types and classifications of negotiable instruments.

Answer 1

A Negotiable Instrument is a

(1) written instrument,

(2) signed by the maker or drawer of the instrument,

(3) that contains an unconditional promise or order to pay

(4) an exact sum of money (with or without interest in a specified amount or at a specified rate)

(5) on demand or at an exact future time

(6) to a specific person, or to order, or to its bearer.

FUNCTION OF THE INSTRUMENT

Simply put, the negotiable instrument is a substitute for money or serves as an extension of credit. For it to work, it is imperative that the instrument be easily transferable without danger of being uncollectible.

TYPES OF NEGOTIABLE INSTRUMENTS

Negotiable instruments include two main types: an order to pay (drafts and checks) and promises to pay (promissory notes and Certificate of Deposit).

The instruments can also be classified as demand instruments or time instruments. Thus there are four types of negotiable instruments.

DRAFTS AND CHECKS (ORDERS TO PAY)

Draft (or a bill of exchange):  An unconditional written order to pay by which the party creating the draft (the drawer) orders another party (the drawee), typically a bank, to pay money to a third party (the payee) (first type of negotiable instrument)

Time Draft: A draft payable at a time certain (definite time)

Sight Draft: A draft payable on presentment. It may also be payable on acceptance- where you have the drawee’s written promise to pay the draft when it comes due.

Trade Acceptance (frequently used in sale of goods): A draft that is drawn by a seller of goods ordering the buyer to pay a specified sum of money to the seller, usually at a specified future time. The buyer accepts the draft by signing and returning it to the seller.

What this does is makes it a negotiable instrument which can then be sold (negotiated) to another party to raise cash, kind of like a factor arrangement.

Checks: writer of the check is the drawer, the bank on which the check is written is the drawee, and the person to whom it is payable is the payee. (second type of negotiable instrument)

PROMISES TO PAY

Promissory Note: A written promise made by one person (the maker) to pay a fixed sum of money to another person (the payee) on demand or at a specified future time. (third type of negotiable instrument)

Certificate of Deposit: A note by which a bank or similar financial institution acknowledges the receipt of money from a party and promises to repay the money, plus interest, to the party or the party’s designee, on a certain date. Known for high interest rates. (fourth type of negotiable instrument)