Commercial Paper

Author:Jeffrey Lehman, Shirelle Phelps
 
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A written instrument or document such as a check, draft, promissory note, or a certificate of deposit, that manifests the pledge or duty of one individual to pay money to another.

Commercial paper is ordinarily used in business transactions, since it is a reliable and expedient means of dealing with large sums of money and minimizes the risks inherent in using cash, such as the increased possibility of theft.

One of the most significant aspects of commercial paper is that it is negotiable, which means that it can be freely transferred from one party to another, either through endorsement or delivery. The terms commercial paper and negotiable instrument can be used interchangeably.

Since commercial paper constitutes PERSONAL PROPERTY, it is transferable by sale or gift and can be loaned, lost, stolen, and taxed. Commercial paper is a specific type of property primarily governed by article 3 of the UNIFORM COMMERCIAL CODE (UCC), which is in effect in all 50 states, the District of Columbia, and the Virgin Islands. Although Louisiana has not enacted all the articles of the UCC, it has adopted article 3.

Types of Commercial Paper

The UCC identifies four basic kinds of commercial paper: promissory notes, drafts, checks, and certificates of deposit. The most fundamental type of commercial paper is a promissory note, a written pledge to pay money. A promissory note is a two-party paper. The maker is the individual who promises to pay while the payee or holder is the person to whom payment is promised. The payee can be either a specifically named individual or merely the bearer of the

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Checks are considered a type of commercial paper, as well as a specific kind of bank draft.

DENNIS DEGNAN/CORBIS

instrument who has it in his or her physical possession when he or she seeks to be paid according to its terms. A note payable to "bearer" can be paid to the person who presents it for remuneration. Such an instrument is said to be bearer paper.

A promissory note that is payable on demand can be redeemed by the payee at any time, whereas a time note has a date for payment on its face that establishes the date when the holder will have an enforceable right to receive payment under it. There is no obligation to pay a time note until the date designated on its face.

The ordinary purpose of a promissory note is to borrow money. Promissory notes should not be confused with credit or loan agreements, which are separate instruments that are usually signed at the same time as promissory notes, but which merely describe the terms of the transactions.

A promissory note serves as documentary evidence of a debt. It can be endorsed and sold at a discount to other parties, and each subsequent endorser becomes secondarily liable for the amount specified on the face of the instrument. A number of CONSUMER CREDIT dealings are funded through the use of promissory notes.

Certain types of promissory notes are sold at a discount, such as U.S. savings bonds and corporation bonds. Such an instrument is sold for an amount below its face value and can subsequently be redeemed on the due date or date of maturity for the entire face amount. The interest obtained by the holder of the instrument is the difference between the purchase price and the redemption price. In certain instances, bonds that are not redeemed immediately upon maturity accumulate interest following the due date and are ultimately worth more than their face value when redeemed at a later time. If such bonds are cashed in before maturity, the holder receives less than the face value.

A draft, also known as a bill of exchange, is a three-party paper ordering the payment of money. The drawer is the individual issuing the order to pay, while the drawee is the party to whom the order to pay is given. As in the case of a promissory note, the payee is either a specified individual or the bearer of the draft who is to receive payment according to its terms. The draft is made payable on demand or on a certain date. A common example of a draft is a cashier's check.

A draft is often used in business to obtain payment for items that must be shipped over long distances. Drafts are often the preferred method of payment for purchasers who want to examine goods prior to payment or who do not have the necessary funds available at the time of sale. The vendor might have reservations concerning the buyer's credit and desire payment as soon as possible. The procedure ordinarily followed in such instances is that upon shipment of the goods, the seller receives a bill of lading from the carrier. The bill of lading also serves as a certificate of title to the goods, which is ordinarily in the seller's name.

Upon shipment, the seller draws a draft against the buyer-drawee, who is required to pay the draft. The seller's bank is named as the payee. The seller endorses the bill of lading to the payee and attaches the bill to the draft. The seller can either negotiate these instruments to the payee at a discount or use them as security for a loan. Subsequently, the papers are endorsed by the seller's bank and delivered to a correspondent bank in the community where the buyer is located. The correspondent bank seeks payment of the draft from the buyer and when payment is made, the bank transfers ownership of the goods from seller to buyer by endorsing

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the bill of lading to the buyer. The buyer can then obtain the goods from the carrier upon presentation of the bill of lading, which demonstrates his or her title to the shipped goods.

A check is a specific kind of draft, which is drawn on a bank and payable on demand to a particular individual or to the bearer, in which case it can be written payable to "cash."

An individual who opens a checking account is engaged in a contractual relationship with a bank. The individual agrees to deposit money therein, while the bank agrees that it is indebted to the depositor for the amount in the account, in addition to promising to honor checks written for payment against the account when there are sufficient funds on hand to do so.

A certificate of deposit, frequently referred to as a CD, is a written recognition by a bank of the acquisition of a sum of money from a depositor for a designated period of time at a specified interest rate, coupled with a promise of repayment. The bank is both the maker and the drawee, and the individual making the deposit is the payee.

Ordinarily, certificates of deposit come in specific denominations that vary according to the length of the term that the bank will hold the funds and are available only for large sums of money. They are used mainly by corporations and individuals as savings devices since they generally bear higher interest rates than ordinary savings accounts. They must, however, be left on deposit for the designated time period. Ordinarily, a CD can be cashed in prior to the date of maturity, but some interest will be forfeited. Depending upon the provisions of the CD, however, a bank may have the legal right to refuse to close an account before the expiration of the designated date of maturity.

Negotiability

There are basic requirements for the negotiability of commercial paper. The instrument must be in writing and signed by either its maker or its drawer. In addition, it must be either an unconditional promise, as in the case of a promissory note, or an order to pay a specific amount of money, such as a draft. It must be payable either on demand or at a fixed time to order or to bearer.

The requirement that the instrument must be in writing can be met in various ways. The paper can...

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