A negotiable instrument is a signed document issued by one party, promising to pay a specific amount of money to another party. This payment can be made upon demand or at a future date specified on the document.
Once transferred, the funds can typically be used for the recipient’s desired purpose. Now, let’s address a common query: Is a promissory note a negotiable instrument? Read on to learn more about common agreement terms and how a promissory note qualifies as a negotiable instrument.
Key Takeaways
- Negotiable promissory notes, like cash, can be transferred to another party, giving them the same rights as the original holder.
- To be negotiable, a promissory note must meet strict criteria outlined by the Uniform Commercial Code (UCC), including a fixed amount, specified payment date, and no extra contractual obligations beyond the payment promise.
- Negotiable promissory notes, favored in business transactions for their transferability and legal enforceability, contrast with non-negotiable notes limited to private agreements with fewer legal regulations.
What ‘Negotiable’ Means
Negotiable for a promissory note or similar financial document implies it can be transferred in the same way as cash, giving the new holder the same rights as the original one. This transfer commonly happens when another institution or entity assumes the original loan or payment responsibility.
A non-negotiable promissory note, on the other hand, is non-transferable. Non-negotiability will need to be stipulated in the creation of the loan agreement.
Negotiable Instruments Under the UCC
The Uniform Commercial Code outlines how promissory notes and other negotiable instruments work. It defines a promissory note as a promise to pay money as determined in the note, and the borrower is legally obligated to return that amount when the promissory note is presented for payment.
This payment will usually come due either at a specific time or when the note is presented for payment. The second payment type is an “on demand” payment.
According to the UCC, a negotiable instrument must:
- Have no conditions that determine payment – the payment is due regardless of any other terms.
- Lay out specific payment amounts.
- Go to either a specific person or the “bearer” of the document, as laid out in its terms.
The UCC further notes that promissory notes should only include the promise of payment, with no further contractual requirements or information included in the document.
What Is a Negotiable Instrument Used For?
A negotiable instrument is used to guarantee the transfer of a specific amount of money between the bearer and the payee. Some types of negotiable instruments, like checks, are designed to initiate an immediate or on-demand transfer of funds without requiring either party to carry a great deal of cash.
Other negotiable instruments, like promissory notes, allow the payee to put off payment for a period of time until the note comes due.
Enforcing a Negotiable Instrument
Most of the time, seeking payment for a promissory note will go relatively smoothly. However, in some cases, the bearer of the document may need to request legal assistance in enforcing the note. The bearer should start by informing the borrower that they plan to call the promissory note due. If the borrower pays, no further action is necessary.
However, if the borrower refuses to or is unable to pay, the bearer may choose to enlist the services of a collection agency. If that is unsuccessful, the bearer should gather any necessary evidence against the borrower and file a lawsuit seeking the funds promised in the note.
Types of Negotiable Instruments
There are several types of negotiable instruments. Some are loan agreements, while others are a more direct transfer of funds:
- Personal checks, or checks drawn on a specific account.
- Certificates of deposit.
- Secured promissory notes, backed by collateral that can be sold or possessed by the bearer in order to make good on the note.
- Unsecured promissory notes, which are not backed by collateral.
- Cashier’s checks.
- Money orders.
- Traveler’s checks.
The right type of negotiable instrument for any given situation can depend on the borrower and bearer’s goals.
Negotiable Promissory Notes
Negotiable promissory notes, by definition, are a contract between the borrower and the bearer or the lender. They document the funds changing hands and the terms of the loan, including how it will be repaid. These notes can be transferred or sold to a third party.
The bearer of a promissory note can endorse or sign the back of the note to transfer it to another party or acknowledge that the borrower has repaid the debt. Typically, the bearer’s endorsement ends their legal involvement with the document, whether they are passing on the promissory note to another party or acknowledging that the borrower has paid back those funds as required.
Both parties involved in a promissory note bear liability for maintaining the terms of the note. That means that the borrower is liable for repaying all funds borrowed under the terms of the agreement. However, the bearer of the note also agrees to abide by its terms, including when the note comes due.
Promissory notes can prove risky, particularly if borrowers struggle with timely repayment, potentially leading to wage garnishment or legal action once the note comes due. Additionally, the bearer may face a delay in accessing funds, having to wait until the note comes due for payment. Although transferable, some institutions may hesitate to accept the note as an alternative to immediate payment.
Requirements for Negotiability
The key conditions for a promissory note to be considered negotiable are:
- In writing.
- Unconditional promise to pay.
- Fixed amount.
- Fixed date of payment or payable on demand.
- Inclusion of words of negotiability.
- Signature of the maker.
- Unconditional order or promise.
- Intention to circulate as a negotiable instrument.
Non-Negotiable Promissory Notes
Non-negotiable promissory notes are promissory notes that cannot be transferred. They are a direct agreement between the bearer and the borrower, and they cannot be purchased or used by a third party. It includes the same terms as a negotiable promissory note: payment terms, the timeline for repayment, and dispute resolution provisions, including restitution in the event of nonpayment.
Unlike a negotiable promissory note, however, non-negotiable promissory notes cannot be transferred, which means that the bearer will need to wait for the terms of the agreement to play out and payment to come due.
When Are Non-Negotiable Promissory Notes Used?
Non-negotiable promissory notes are generally used when there is a close relationship between the parties involved in the agreement. These agreements are commonly made between family members or friends when the lender has no intention of selling or transferring the loan to another party.
They include no provision for such a transfer, and an attempt to endorse or transfer the agreement would typically make it impossible for the third party to collect.
Non-Negotiable vs. Negotiable Promissory Notes Uses
Non Negotiable: Private loans between individuals, business loans with specific terms, loan agreements with restricted transferability, internal financing arrangements, specific loan terms or conditions.
Negotiable: Commercial loans, trade finance, real estate financing, personal loans with secondary market potential, government and municipal financing, corporate financing.
While negotiable promissory notes are often used in business transactions since they allow more freedom for the bearer, private transactions more frequently use non-negotiable instruments to accomplish their goals.
What Are the Downsides to a Non-Negotiable Promissory Note?
Non-negotiable promissory notes come with drawbacks that limit the bearer’s options compared to negotiable notes. For example, it may be more challenging to collect on the funds named in the agreement. Unlike negotiable notes, non-negotiable ones may be subject to fewer legal regulations, making it more challenging for the bearer to enforce payment.
For instance, if a borrower defaults on a non-negotiable promissory note, the bearer may encounter obstacles in pursuing legal remedies or may experience delays in recovering the owed funds due to the diminished legal framework governing such agreements. This reduced flexibility and legal protection highlight the downsides associated with opting for a non-negotiable promissory note.
The Bottom Line
Promissory notes are typically negotiable documents that allow the bearer to collect on the funds laid out in the agreement at a prespecified time or on demand, depending on the terms of the contract. These agreements are used in a variety of commercial and personal settings and can prove highly beneficial in streamlining the transfer of funds at a later time.
If you’re creating a promissory note or need help with your other legal contracts and templates, explore our available resources to discover suitable options for all your personal financial needs.
