Business Law

Chapter 14: Negotiable Instruments, Securities and

Secured Transactions

What Are Negotiable Instruments?

• What we today call “negotiable instruments” were once known under the more general category of “commercial paper.”

• Negotiable Instrument: An unconditional promise or order to pay a fixed amount of money, with or without interest.

• Examples of negotiable instruments include drafts and notes.

Drafts

• Drafts are negotiable instruments that order payment to be made.

Notes

• Notes are instruments that promise payment in the future.

Cash versus Negotiable Instruments

• Currency is designed to be anonymous and to pass freely from person to person.

• Negotiable instruments, on the other hand, can be converted into cash at some point.

• Negotiable instruments are both more secure and more easily regulated than the use of cash.

Negotiable Instruments Are Governed By The UCC

• The Uniform Commercial Code also governs negotiable instruments under Article 3.

What Makes a Document Negotiable?

• UCC §3-104 explains that a document becomes negotiable when it contains an unconditional promise to pay money and is payable to a bearer or payable on demand.

Organization of Article 3

• Article 3 is divided into subparts that deal with a broad spectrum of negotiable instruments.

Part 1, Article 3

• Article 3 only applies to instruments that are payable to the bearer or to order at the time that they are issued.

Identifying Parties to be Paid

• Article 3 provides that the means for identifying the party to be paid must come from the language of the document and the intent of the signor.

Holder in Due Course

• The Holder in Due Course Rule grants complete and legal title to an instrument even when there are outstanding claims against it.

• It protects buyers who act in good faith.

Warranties

• Article 3 provides specific warranties including:

• That the signatures on the instrument are authentic and authorized

• That the instrument has not been altered

• That the person who transferred the instrument has no knowledge of an insolvency proceeding concerning the transaction

Accord and Satisfaction

• Article 3-311 provides that when an instrument contains a conspicuous statement that the instrument was tendered as payment in full, the debt is discharged and no further actions are warranted.

Negotiable Instruments and Securities

• Securities and negotiable instruments are sometimes confused with one another.

• A security is a share or ownership interest in a company.

• A negotiable instrument promises payment; a security is evidence of company ownership.

What Qualifies as a Security?

• A security is defined as a share in a corporation or an obligation by an issuing company.

Securities and Federal Law

• Securities law is controlled not only by state law, through the Uniform Commercial Code, but also through various federal statutes.

Federal Laws that Apply to Securities

• The first of a series of federal legislative initiatives aimed at the securities field was the Securities Act of 1933.

• The Securities Act was quickly followed by the Securities Exchange Act of 1934 which authorized the creation of the Securities and Exchange Commission.

The Securities and Exchange Commission

• The Securities and Exchange Commission (SEC) has been a potent force in the securities field since its inception.

• It polices stock exchanges, brokers, investment advisors, financial institutions and publicly-traded companies.

Registration with the SEC

• One way of ensuring that investors receive accurate information is the SEC’s requirement that all securities sold in the United States must be registered.

Viewing Registration Information

• The SEC maintains all of this information in a public-access database called EDGAR. This database can be accessed directly from the SEC’s web page at <http://www.sec.gov>

Securities and State Law (The UCC)

• Article 8 of the Uniform Commercial Code governs securities.

Provisions of Article 8 of the UCC

• Other features in Article 8 include a provision making the Statute of Frauds inapplicable to securities agreements.

• The Article is comprehensive in its coverage of securities and should always be referred to whenever a securities question arises.

Stock

• Stock represents ownership interest in companies.

Common Stock

• Common stock is the stock that a company issues in order to raise capital.

• This stock is sold on stock exchanges around the world.

Preferred Stock

• Preferred stock is a class of stock that entitles the person who possesses it with priority when it comes to paying dividends.

Article 9

• Article 9 of the UCC concerns secured transactions.

• A secured transaction is any promise to pay on a loan that is guaranteed by some form of collateral.

Care and Maintenance of the Collateral

• Other rules enforced under Article 9 include the requirement to care for the collateral.

• Article 9-207 requires the party in possession of collateral to use reasonable care in its custody and preservation.

Priority in Paying Claims

• Priority refers to the order in which claims will be paid.

• Article 9 creates rules for priority of claims.

UCC Financing Statements

• Article 9 also provides that proof of a secured transaction in property must be filed in order to substantiate the claim.

• These documents are often referred to as “UCC Financing Statements” and can often be located in the local courthouse.